symbol
stringclasses 685
values | quarter
int64 1
4
| year
int64 2.01k
2.03k
| date
stringdate 2005-10-13 14:45:00
2025-05-15 16:30:00
| content
stringlengths 0
245k
| structured_content
listlengths 0
369
| company_name
stringclasses 496
values | company_id
float64 18.7k
1.87B
⌀ |
|---|---|---|---|---|---|---|---|
AES | 1 | 2,020 | 2020-05-07 09:00:00 | Operator: Good day, and welcome to the AES Corporation First Quarter 2020 Financial Review Conference Call. [Operator Instructions]. I would now like to turn the conference over to Ahmed Pasha, Vice President of Investor Relations. Please go ahead.
Ahmed Pasha: Thank you, and good morning, everyone, and welcome to our first quarter 2020 financial review call. Our press release, presentation and financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres. Andres?
Andrés Gluski: Good morning, everyone, and thank you for joining our first quarter financial review call. Today, I will discuss the current state of our business and our strategic goals going forward. We are well positioned to withstand the effects of the COVID-19 pandemic and are seeing the benefits of our multiyear effort to enhance the resilience of our business. The vast majority of our earnings come from long-term contracted generation, which provides significant protection from the downturn in electricity demand and prices. Furthermore, our liquidity position is strong. We have no major near-term debt amortizations, and we continue to improve our investment-grade metrics. Our construction projects are progressing on schedule without any supply chain disruptions, and we are on track to grow our renewables backlog and achieve our environmental goals. The net effect of this is that despite seeing double-digit reductions in demand in some of our markets, we are lowering our earnings guidance for the year by only 5% to a range of $1.32 to $1.42. We are reaffirming our expectations for 2020 parent free cash flow and our longer-term growth projections for both adjusted EPS and current free cash flow. Gustavo will provide an overview of our first quarter financial results, our liquidity and our guidance in more detail. Turning to Slide 4. Today, I will focus my discussion on the 3 core themes of resilience, sustainable growth and leadership in innovation. Beginning on Slide 5 with the resilience. These are certainly unprecedented times with a global pandemic and a sharp economic downturn, resulting from restrictions on travel, mobility and work. Fortunately, for AES, as you may recall from our last quarterly call, we were closely monitoring the spread of COVID-19 and taking steps to reduce its impact on our business. We began to implement our plans for all nonessential personnel to work remotely by the first week of March, increased our stocks of fuel and PPE at our plants and work sites and built up cash liquidity at all levels of our portfolio. We also ensured that national and local governments recognize the critical importance of the service we provide and classified our operations as essential, facilitating the movement of personnel to our generation plants, utilities and construction sites. As a result of all of these early actions, we have continued to deliver our services without any significant impact and have minimized contagion among our people and contractors. To date, only 10 AES people out of a population of 9,000 have tested positive for the virus. And more importantly, none have become seriously ill or hospitalized. Of these, 5 have been deemed recovered and virus-free. Turning to Slide 6. Our resilience comes not just from our actions to address the crisis but from our fundamental business model. Across our portfolio, we have an average remaining contract life of 14 years. Approximately 70% of our business is long-term contracted generation with the vast majority in U.S. dollars or euros. Nearly all of our offtakers are investment grade, and our contracts are primarily for capacity with our revenue relatively unaffected by the actual energy produced. Thus, this part of our business is very resilient to a downturn in energy prices and demand. We have an additional 15% of our business, which is generation with shorter-term contracts, which has some modest exposure to spot prices. The remaining 15% of our business is regulated utilities, principally in the U.S., and this is where we have been most impacted by the decrease in demand. We saw a net reduction of around 10% in April, mainly from commercial and industrial customers, and we expect lower demand to continue for several months before recovering by early next year. We are taking measures to offset the reduction in 2020 earnings, primarily through cost savings that we are realizing from our digital initiatives. For example, investments we have made over the past two years have made it possible for much of our staff to work remotely, including many positions on the operational side. We expect some degree of remote work and the associated benefits to continue even in a post pandemic world. Through these and other initiatives, we expect to deliver additional cost savings of around $50 million this year, which Gustavo will cover in more detail. Now let me turn to Slide 7 and our second theme, sustainable growth, which continues to be a key area of focus. Despite the current crisis, we remain on track with our current growth projections and ambitions to triple our renewables portfolio by 2024 versus 2016. Our backlog is now 5.3 gigawatts, of which 1.8 gigawatts are currently under construction. Turning to Slide 8. Construction includes the 531 megawatt hydro at Alto Maipo in Chile, which continues to progress according to our prior schedule. Phase 1 is now more than 93% complete. The turbines are in place and only 2.7 miles of tunneling out of a total of 46 remains to complete Phase 1 and start operations early next year. Of our more than 30 renewable projects under construction, only 2 small ones have been affected to date by the COVID-19 lockdown. Both are in upstate New York, where we had to temporarily stop work. Fortunately, as you may recall from our fourth quarter call, we took very early steps to ensure we had solar PV panels and our balance of plant in-country and at our construction sites as we foresaw potential supply chain bottlenecks in China and Korea. Turning to Slide 9. I am pleased to announce the start of commissioning of the world's most efficient solar project, Andes Solar in Chile, which at 37% has the world's highest capacity factor as a result of using bifacial PV panels and a high solar irradiation, combined with the low temperatures of the Atacama desert. Building on our innovation in solar, we are bringing a new prefabricated PV design to our projects, starting with an initial 10 megawatts in Chile. We are finalizing a strategic partnership with a company that has a patented design that not only allows for construction to be completed in half the time but can also double the energy output per acre versus today's best-in-class project designs. We expect to expand this solar PV technology to many of our projects in the future to allow for faster construction, more efficient use of land and new C&I offerings. Regarding new PPA signed, so far this year, we have added approximately 700 megawatts of new renewable PPAs to our backlog, mostly in Chile and the U.S. Thanks to our leadership in innovation, we continue to see mid-teen levered returns on our renewable projects at the stand-alone project level. We are on track to deliver between 2 and 3 gigawatts of new renewable PPAs this year and growth in demand for smaller projects in the U.S. remains especially strong. In Chile and Colombia, our green blend and extend strategy has resulted in 2.5 gigawatts of new PPAs and the construction of 1.6 gigawatts of new renewables. Now on to Slide 10. In addition to wind and solar, our Energy Storage business also continues to grow rapidly, both through our own projects and through Fluence, our joint venture with Siemens, which sells energy storage systems to third parties. Both aspects of our business are benefiting from an acceleration in demand for battery based systems. Today, about half of our solar bids in the U.S. include an energy storage component. New markets and application also continue to emerge, such as Virginia's 3.1 gigawatt energy storage mandate and Germany's plan to add up to 6 gigawatts to support the transmission network. Even in the midst of the current crisis, in early April, we signed a 15-year PPA for 100 megawatts of 4-hour duration energy storage in Southern California through sPower. I'm also very proud that we will soon be commissioning the world's first virtual reservoir at the Alfalfal hydro complex just outside Santiago, Chile. This virtual reservoir consists of 10 megawatts of 5-hour batteries, which allow for dispatching the run of the river hydro largely at night when solar power is not available and energy prices are higher. We will be increasing this virtual reservoir to 250 megawatts over the next couple of years, and there are several smaller virtual reservoir projects in late-stage development in the U.S. Fluence currently has an all-time high of 1.3 gigawatts of energy storage systems under construction, which include some of the largest projects in the world. This year, we will be rolling out our sixth generation energy storage technology platform. It is both factory assembled and modular, and will improve reliability, increase the speed of execution and lower costs. Through our growth in renewables and energy storage, we continue to make progress towards our ambitious environmental goals. As you can see on Slide 11, we remain committed to reducing our coal generation to less than 30% of our gigawatt hours by the end of this year, which will make us compliant with ESG standards set by Norges Bank, among other institutions. We expect to realize this target through the continued sale and decommissioning of coal plants, along with the execution of our extensive backlog of renewable projects. Finally, turning to our leadership and innovation on Slide 12. We continue to move forward on a number of innovative solutions that we see as highly relevant for the long-term future of the industry. One example is Uplight, which, as a reminder, works with more than 80 electric and gas utilities in the U.S., reaching more than 100 million households and businesses, providing a suite of digital solutions. We expect revenue growth of 30% this year, fueled in part by utilities' desire to improve customers' experiences in a capital-efficient digital way. Another example of our innovation is our partnership with Google, which is progressing well. We continue to make headway on a number of initiatives that we will be in a position to announce in the near future. Now I would like to pass the call to Gustavo Pimenta, our CFO, so he can provide more color on our results, debt profile and guidance.
Gustavo Pimenta: Thank you, Andres. Today, I will cover our financial results, credit profile and capital allocation. I will conclude by addressing the impact of COVID-19 on our guidance for this year and expectations through 2022. In the first quarter, we made good progress on our key financial metrics. As shown on Slide 14, adjusted EPS was $0.29 versus $0.28 in Q1 2019, in line with our expectations. We benefited from higher contributions from the MCAC SBU, largely due to improved availability and hydrology in Panama as well as lower effective tax rate. These positive drivers were partially offset by the reversion to prior rates at DPL in Ohio and mild weather at our regulated utilities in the U.S. Turning to Slide 15. Adjusted pretax contribution, or PTC, was $250 million for the quarter, a decrease of $22 million versus the first quarter of 2019. I'll cover our results in more detail over the next four slides, beginning on Slide 16. In the U.S. and Utilities SBU, lower PTC reflects the reversion to ESP 1 rates at DPL as well as mild weather at both DPL and IPL. These impacts were partially offset by contributions from new renewable projects. At our South America SBU, higher PTC was largely driven by lower interest expense and realized FX gains in Chile, partially offset by a planned major outage at our hydro plant in Colombia as part of a larger project to extend its useful life. Higher PTC at our MCAC SBU reflects the return to operations at our Sanginel hydro plant in Panama, following an extended major outage in 2019, as well as improved availability at our Colon plant. We also benefited from improved hydrology in Panama following a very dry year in 2019. Finally, in Eurasia. Lower results primarily reflect the sale of our business in the United Kingdom. Before moving on, I want to provide an update on the DP&L in Ohio on Slide '20. As we discussed on our fourth quarter call, after reverting to previous ESP 1 rates, the DP&L was required to pass certain regulatory tasks, including the significantly excessive earnings test, or SEET. In April, DP&L began this process by filing an application with the commission. There is a comment period set for July and potential hearing, if needed, set for October. A final ruling is expected by early 2021. We feel good about our ability to best this test and maintain ESP 1 rates. As we have said in the past, AES continues to be fully committed to the DP&L. We are now planning to invest approximately $900 million in its grid over the next 4 years, including base distribution, transmission and its market investments, which will lead to low double-digit rate base growth through 2023. To that end, AES plans to invest $300 million of new equity in the DP&L, half of it this year and the other half in 2021. These investments will allow DP&L to continue to provide safe and reliable service, while materially improving the experience we deliver to our customers and preserving very competitive rates. Now turning to our credit profile on Slide '21. As we discussed on our fourth quarter call, between 2011 and 2019, we reduced our parent debt by $3.1 billion, which is about 50%. At year-end, our parent leverage was 3.7x and our FFO to debt was 21%, comfortably within the investment-grade threshold of 4x and 20%, respectively. Currently, we have $800 million of borrowings under the revolver, roughly half of which was drawn as precautionary measure to reinforce our cash position. We expected to end the year with a 0 revolver balance and credit metrics that are even stronger than in 2019. We are also maintaining our regular dialogue with the rating agencies and continue to be on track to receive our second investment-grade rating. While the fundamental credit strength of AES remains unchanged, given the current macro environment, we believe the timing of this upgrade is now more likely to be closer to year-end. Moving on to liquidity on Slide 22. In times of uncertainty, we recognize that cash is king. To that end, we are in the strongest financial position of our history. We have $3.3 billion in available liquidity, 2/3 of which is in cash. This is more than sufficient to meet any unforeseen needs over the remainder of the year. Turning to our receivables on Slide 23, which have remained stable over the last few years. We have been monitoring our receivables very closely to ensure they are within the 45- to 60-day grace period allowed under our contracts. And so far, through April, they are in line. It is worthwhile to mention that in a few of our markets, governments have declared a payment moratorium for certain residential utility clients as the lockdown is in place. While we are mostly removed from this impact as a generator, this could create some additional working capital needs at certain businesses. To that end, we are working with multilateral organizations, such as the Inter-American Development Bank to create mechanism for securitizing receivables in these markets. Now turning to our refinancing needs in 2020 on Slide 24. As you may know, we have been proactively strengthening our debt maturity profile. In fact, just last year, we executed more than $5 billion in liability management across our portfolio. As a result, we have only $300 million of debt to be refinanced for the remainder of the year, most of which is at our U.S. utilities. We are pleased to see investor interest in the $407 million IPALCO refinanced we recently completed, with the deal being 5x oversubscribed, reducing our refinancing needs to just over $300 million for the remainder of the year. Now to 2020 parent capital allocation on Slide 25. Beginning on the left-hand side, sources reflect $1.4 billion of total discretionary cash, which is largely consistent with our previous disclosure. Moving to uses on the right-hand side. Including the 5% dividend increase we announced in December, we'll be returning $381 million to shareholders this year. We do not plan any additional debt reduction beyond repayment of the temporary drawings on our revolver, which was $180 million at the end of 2019. Our credit metrics are strong and will continue to improve on the strength of our cash flow alone. And we plan to invest $565 million in our subsidiaries, including our equity for the Southland repowering, our renewables backlog and the $150 million investment in grid modernization at DPL this year. This leave us with up to $452 million to be allocated. The amount is largely a function of the asset sales we plan to close this year. The use of this cash may include investment in AES Gener, Green Blend & Extend strategy, as we discussed on our last call. The timing of this investment is dependent on AES Gener's funding needs, so it may be later this year or early next year. Next, moving to our capital allocation from 2020 through 2022, beginning on Slide 26. We continue to expect our portfolio to generate $3.4 billion in discretionary cash, 3/4 of this is expected to be generated from parent free cash flow, with the remaining $900 million coming from asset sale proceeds. Turning to the uses of this discretionary cash on Slide 27. Roughly, 1/3 of this cash will be allocated to shareholder dividends. Looking forward, subject to annual review by the Board, we continue to expect to increase the dividend by 4% to 6% per year, in line with the industry average. We are also expecting to use $1.9 billion to invest in our backlog, new project and PPAs, T&D investments at IPL, the partial funding of our Vietnam LNG project and the investment in AES Gener, I just discussed. This $1.9 billion also includes the $300 million infrastructure investment in DP&L, which is incremental to our last call. Once completed, these projects will contribute to our growth through 2022 and beyond. Finally, turning to our guidance and the impact of COVID-19 on Slide 28. As Andres mentioned, AES is well positioned to weather this storm due to the actions we have taken over the last several years to improve the resilience of our portfolio. So let me start first with the impact from commodities and FX. Despite significant volatility in both markets, we are expecting an impact of only $0.03. This is because today, our business is mostly contracted and denominated in U.S. dollars, materially reducing our exposure. We are also forecasting a $0.02 impact due to a higher interest expense as a result of drawing on our revolving credit facilities to reinforce our liquidity. Like many other companies in our sector, we are also seeing an impact on demand, primarily at our regulated utilities, including IPL and DPL, where we do not currently benefit from the coupling protection. In April, we saw C&I demand decline in the mid-teens at both businesses, with a partial offset of about 6% from an increased residential demand, where we have better margins. Internationally, demand has dropped 5% to 15% in our key markets. But again, in those markets, our model is mostly based on take-or-pay contracts or tolling agreements with limited exposure to demand. The impact from lower demand across our portfolio is expected to be $0.07 in 2020. Although projecting future load, GDP recovery is very challenging in this unprecedented times, we are currently assuming demand will have an extended U-shaped recovery with a mid-teens average decline across our portfolio in the second quarter, high single digits in the third quarter and low single digits in the fourth quarter, not returning to precrisis levels until next year. As a reference, and assuming our current geographic mix, a 1% change in the year to go demand translates into an approximately $0.01 impact on our full year earnings. We have also been working very hard on potential levers to offset this impact and are expecting an incremental cost savings in the year of about $0.05. As Andres mentioned, most of these savings are coming from our digital and laser-focused cost control initiatives. This includes reduced maintenance and lower fixed costs and G&A. Turning to Slide 29. As a result, we are reducing the midpoint of our guidance by 5% or $0.07 with a new range of $1.32 to $1.42. On the parent free cash flow side, we are not seeing an impact versus our previously communicated goal of $725 million to $775 million as a result of the strength and diversification of our portfolio. We are also reaffirming our 7% to 9% average annual growth rate through 2022. Although it is disappointing to revise our adjusted EPS guidance for the year, the limited impact we are seeing in the midst of an unprecedented global crisis, illustrates the current strength of our portfolio and balance sheet. With that, I'll turn the call back over to Andres.
Andrés Gluski: Thank you, Gustavo. Before we take your questions, let me summarize today's call. The fundamentals of our business remain strong, and our portfolio of largely long-term contracted generation is resilient in the current pandemic and related economic downturn. Therefore, we remain on track to achieve our strategic goals of greening our portfolio, leading in new technologies and attaining a second investment-grade rating. We have already taken steps this year to strengthen our liquidity and further reduce costs to mitigate the impact on earnings from decreases in our sales. Although we expect a 5% reduction in this year's earnings, we are reaffirming our 2020 parent free cash flow and longer-term growth rates in earnings, cash and dividends. We expect to generate $3.4 billion of discretionary cash through 2022, which we will invest to continue to deliver double-digit returns to our shareholders. And finally, I would like to thank the people of AES, who through their discipline and hard work are ensuring safe, reliable and affordable energy in all of the markets we serve. Operator, I now would like to open the line for questions.
Operator: [Operator Instructions]. And our first question will come from Ryan Greenwald with Bank of America.
Unidentified Analyst: So maybe if we can just start with asset sales. It looks like Jordan through late last month. So if you kind of just talk about your commitment there and you're confidence to get out of the sales on those in here?
Andrés Gluski: Yes. Look, our asset sales continue to progress. In the specific case of Jordan, I don't think is as binary as you described. So we remain confident of closing a number of sales this year, and there's continued interest in those assets, and we're making progress. I would add that we're really not depending this year for any asset sales to fund our growth. So we remain confident. We think that we'll close a number of sales. There's interest. And of course, we don't talk about them until they're actually completed.
Unidentified Analyst: Got it. Fair enough. And then I appreciate all the commentary around demand trends and sensitivities. But could you just allude a little more to any latitude you might have under a more severe protracted scenario? I know you kind of alluded to $50 million in additional savings already?
Andrés Gluski: Yes. So first, I want to be clear that we're trying to be as transparent as possible. So as Gustavo described, what we're seeing is, quite frankly, continued reduction in demand, lower demand for the remainder of the year. So most severe in the second quarter. And then you have a single-digit -- high single-digit decline in the third quarter and lower single-digit decline in the fourth, and only recovering in the first quarter of next year. So that's our assumption. So that really would is consistent with a U-shaped recovery or even a double U-shaped recovery. If things are more severe, we are in a resilient case. And of course, we have more latitude on different levers that we can pull. I would add that because what we did very early on was increase our liquidity, we have about $0.02 of having that additional liquidity on hand. But I think that was the right thing to do given that there was a lot of uncertainty. So we have a very good track record of cost controls and reductions. And I think that, again, we will react given to how we see the situation evolving. Now we did mention $0.05 this year, mostly from our digital initiatives. And I think that we have learned how to work remotely. And there are more digital tools that we can implement, and we expect to -- that these savings will continue into next year. So we have some continued additional upside because that's really not in next year's numbers.
Unidentified Analyst: Got it. And then just lastly, the interest capitalization that you guys did at Alto Maipo, is that included in adjusted EPS?
Andrés Gluski: It is. It is included in the adjusted EPS.
Unidentified Analyst: And what was kind of the thinking there?
Andrés Gluski: No, that's just an adjustment based on the history of the project. We've adjusted this year as the team refined the calculation. So it impacted Q1 this year.
Operator: Out next question will come from Charles Fishman of Morningstar.
Charles Fishman: Andres, you mentioned a 10% reduction in demand in April at the U.S. utilities, was that weather normalized?
Andrés Gluski: Yes, that's weather normalized.
Charles Fishman: Okay. And then earlier this week or it might have been late last week, there was an article in The Wall Street Journal about the impact of the pandemic in Brazil. And it was -- looked pretty severe. Are you noticing -- obviously, you got boots on the ground in there. Are you noticing anything? Is there any color you can add? You've got a significant interest in Tiete? You've got other solar projects in Brazil and maybe just expand that to Argentina as well.
Andrés Gluski: Sure. So let's take maybe sort of the Latin American region. So first, the reaction there will be different, perhaps by country, but it's also somewhat different than the developed countries. So there's a number of things. First, in general, they were quite quick lock down. Brazil was an exception to that and Mexico. But in most countries, the lockdown was quite severe and quite early. Second, they will be lifting these restrictions. But in general, the pandemic has been less severe in those countries than it has in the developed world. What we do know about the pandemic is that the, quite frankly, biggest drivers are age. And the second is obesity rates. So when you think of age, a lot of these countries have an average age of 30, which is very different from an average age of almost 50 in some of the developed countries. So the pandemic will have a different effect there. So I'd say the main difference is how much fiscal stimulus can they apply to react to that. So what we're seeing is -- again, it varies by country, but some of the smaller countries have had pretty aggressive fiscal stimulus. And they have gone out and basically assured the liquidity in countries like Panama, for example, have assured the liquidity on hand. And then Gustav also mentioned that we have worked with the -- even though we're not in most cases, not directly affected because it's more at the distribution company level, but we've also been working with multilateral institutions to have windows to a discount accounts receivable. But the vast bulk of our clients are multinationals, investment-grade multinationals in these countries. So taking a specific case of Brazil, I mean, as of yet, we have -- it's in one of those countries in the range that Gustavo talked about, between sort of 5% to 15% of our key countries. In Brazil, it's different very much state to state. Brazil is 1 of the countries where we don't have the long-term contracts. They tend to be shorter-term contracts. So there has been some effect there in Brazil, and it's also the 1 of the ones that we have in local currency. Brazil is obviously 1 that's been affected. What is our feeling about it? I think, again, in general, these countries will open up. The effects of the pandemic will be somewhat different because of the demographics of it. Personally, I think that 1 of the things to watch is commodity prices. Because that will maybe even have a bigger effect than some of the shutdowns, given the large informal sectors that these countries have. You mentioned Argentina. Argentina is doing very well on the shutdown in terms of its few cases, very controlled cases. And I would say that the main thing to watch in Argentina is debt refinancing or debt restructuring, let's say, that they're undergoing now. You will notice that our parent free cash flow is unchanged, but we have a decrease in earnings. One of the -- that's reflecting in part Argentina, where you've had significant devaluations. And you've had some degradation of our tariffs. But we weren't expecting to get any dividends out of it. One of the other businesses affected was the P&L, for example, where we don't expect any dividend. So that's -- I just wanted to explain why our cash remains unchanged and we're seeing a decrease in dividend. So regarding Latin America, in general, I'm pleased by the reaction of a lot of countries. The populations have been very supportive of their governments in that respect. And given the different demographics, it will evolve differently. So I do expect them to start opening up. Depends on the country. But later on this month and certainly by June. And the -- again, the reaction of a younger population will be different.
Charles Fishman: Okay. Andres, that's very helpful. Just 1 final question on DP&L. The $300 million incremental investment over the next couple of years. Is that dependent on the resolution of the earnings test or any other regulatory things you need to put in place before you make that investment announcement?
Andrés Gluski: So the first 150 -- the answer is no for the C test because we feel pretty good about it. Our average ROE filed is below 10% and our recommended threshold is around 16%. So we feel good about that one. But we are discussing an acceleration of our smart grid plan. Remember, we had filed for a smart grid plan 2 years ago, and we are now resuming that conversation. So we're expecting to have the approval to fund the second $150 million, and that's going to come as we get more clarity around this market approval.
Operator: [Operator Instructions]. And our next Richard Rosen with Columbia [ph].
Unidentified Analyst: Yes. How is it that, that expectations for new renewable signings should be thought of and financing thereof? Should there be more issues in getting financing going forward?
Andrés Gluski: Let me see if I understood the question. In terms of how we are proceeding with our renewables as we were before. We are getting project financing. We are seeing perhaps some areas be stronger than other areas. As I said, smaller projects in the states, we see demand particularly strong. At this point, about -- if you look at our renewables about 1 quarter is related to energy storage, and we see demand there very strong. So I guess the question is, we basically see demand for like energy storage projects and renewables, especially for utilities is very strong. We have the green blend and extend angle in Latin America, and that remains strong for large, especially mining offtakers.
Unidentified Analyst: Your goal has been, what, 2 to 3 gigawatts a year. Is that still a reasonable expectation?
Andrés Gluski: Yes, absolutely. And if you look at our run rate for the first trimester, it was 700 megawatts. So that's, quite frankly, almost on the button of what we were doing last year.
Unidentified Analyst: Well, the world changed between Q1 and Q2, which is why -- but you're keeping that expectation. That's really fantastic. Okay. That's it. And stay safe.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Ahmed Pasha for any closing remarks. Please go ahead, sir.
Ahmed Pasha: Thank you, everybody, for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and stay safe. Bye-bye. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to the AES Corporation First Quarter 2020 Financial Review Conference Call. [Operator Instructions]. I would now like to turn the conference over to Ahmed Pasha, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you, and good morning, everyone, and welcome to our first quarter 2020 financial review call. Our press release, presentation and financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres. Andres?"
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, everyone, and thank you for joining our first quarter financial review call. Today, I will discuss the current state of our business and our strategic goals going forward. We are well positioned to withstand the effects of the COVID-19 pandemic and are seeing the benefits of our multiyear effort to enhance the resilience of our business. The vast majority of our earnings come from long-term contracted generation, which provides significant protection from the downturn in electricity demand and prices. Furthermore, our liquidity position is strong. We have no major near-term debt amortizations, and we continue to improve our investment-grade metrics. Our construction projects are progressing on schedule without any supply chain disruptions, and we are on track to grow our renewables backlog and achieve our environmental goals. The net effect of this is that despite seeing double-digit reductions in demand in some of our markets, we are lowering our earnings guidance for the year by only 5% to a range of $1.32 to $1.42. We are reaffirming our expectations for 2020 parent free cash flow and our longer-term growth projections for both adjusted EPS and current free cash flow. Gustavo will provide an overview of our first quarter financial results, our liquidity and our guidance in more detail. Turning to Slide 4. Today, I will focus my discussion on the 3 core themes of resilience, sustainable growth and leadership in innovation. Beginning on Slide 5 with the resilience. These are certainly unprecedented times with a global pandemic and a sharp economic downturn, resulting from restrictions on travel, mobility and work. Fortunately, for AES, as you may recall from our last quarterly call, we were closely monitoring the spread of COVID-19 and taking steps to reduce its impact on our business. We began to implement our plans for all nonessential personnel to work remotely by the first week of March, increased our stocks of fuel and PPE at our plants and work sites and built up cash liquidity at all levels of our portfolio. We also ensured that national and local governments recognize the critical importance of the service we provide and classified our operations as essential, facilitating the movement of personnel to our generation plants, utilities and construction sites. As a result of all of these early actions, we have continued to deliver our services without any significant impact and have minimized contagion among our people and contractors. To date, only 10 AES people out of a population of 9,000 have tested positive for the virus. And more importantly, none have become seriously ill or hospitalized. Of these, 5 have been deemed recovered and virus-free. Turning to Slide 6. Our resilience comes not just from our actions to address the crisis but from our fundamental business model. Across our portfolio, we have an average remaining contract life of 14 years. Approximately 70% of our business is long-term contracted generation with the vast majority in U.S. dollars or euros. Nearly all of our offtakers are investment grade, and our contracts are primarily for capacity with our revenue relatively unaffected by the actual energy produced. Thus, this part of our business is very resilient to a downturn in energy prices and demand. We have an additional 15% of our business, which is generation with shorter-term contracts, which has some modest exposure to spot prices. The remaining 15% of our business is regulated utilities, principally in the U.S., and this is where we have been most impacted by the decrease in demand. We saw a net reduction of around 10% in April, mainly from commercial and industrial customers, and we expect lower demand to continue for several months before recovering by early next year. We are taking measures to offset the reduction in 2020 earnings, primarily through cost savings that we are realizing from our digital initiatives. For example, investments we have made over the past two years have made it possible for much of our staff to work remotely, including many positions on the operational side. We expect some degree of remote work and the associated benefits to continue even in a post pandemic world. Through these and other initiatives, we expect to deliver additional cost savings of around $50 million this year, which Gustavo will cover in more detail. Now let me turn to Slide 7 and our second theme, sustainable growth, which continues to be a key area of focus. Despite the current crisis, we remain on track with our current growth projections and ambitions to triple our renewables portfolio by 2024 versus 2016. Our backlog is now 5.3 gigawatts, of which 1.8 gigawatts are currently under construction. Turning to Slide 8. Construction includes the 531 megawatt hydro at Alto Maipo in Chile, which continues to progress according to our prior schedule. Phase 1 is now more than 93% complete. The turbines are in place and only 2.7 miles of tunneling out of a total of 46 remains to complete Phase 1 and start operations early next year. Of our more than 30 renewable projects under construction, only 2 small ones have been affected to date by the COVID-19 lockdown. Both are in upstate New York, where we had to temporarily stop work. Fortunately, as you may recall from our fourth quarter call, we took very early steps to ensure we had solar PV panels and our balance of plant in-country and at our construction sites as we foresaw potential supply chain bottlenecks in China and Korea. Turning to Slide 9. I am pleased to announce the start of commissioning of the world's most efficient solar project, Andes Solar in Chile, which at 37% has the world's highest capacity factor as a result of using bifacial PV panels and a high solar irradiation, combined with the low temperatures of the Atacama desert. Building on our innovation in solar, we are bringing a new prefabricated PV design to our projects, starting with an initial 10 megawatts in Chile. We are finalizing a strategic partnership with a company that has a patented design that not only allows for construction to be completed in half the time but can also double the energy output per acre versus today's best-in-class project designs. We expect to expand this solar PV technology to many of our projects in the future to allow for faster construction, more efficient use of land and new C&I offerings. Regarding new PPA signed, so far this year, we have added approximately 700 megawatts of new renewable PPAs to our backlog, mostly in Chile and the U.S. Thanks to our leadership in innovation, we continue to see mid-teen levered returns on our renewable projects at the stand-alone project level. We are on track to deliver between 2 and 3 gigawatts of new renewable PPAs this year and growth in demand for smaller projects in the U.S. remains especially strong. In Chile and Colombia, our green blend and extend strategy has resulted in 2.5 gigawatts of new PPAs and the construction of 1.6 gigawatts of new renewables. Now on to Slide 10. In addition to wind and solar, our Energy Storage business also continues to grow rapidly, both through our own projects and through Fluence, our joint venture with Siemens, which sells energy storage systems to third parties. Both aspects of our business are benefiting from an acceleration in demand for battery based systems. Today, about half of our solar bids in the U.S. include an energy storage component. New markets and application also continue to emerge, such as Virginia's 3.1 gigawatt energy storage mandate and Germany's plan to add up to 6 gigawatts to support the transmission network. Even in the midst of the current crisis, in early April, we signed a 15-year PPA for 100 megawatts of 4-hour duration energy storage in Southern California through sPower. I'm also very proud that we will soon be commissioning the world's first virtual reservoir at the Alfalfal hydro complex just outside Santiago, Chile. This virtual reservoir consists of 10 megawatts of 5-hour batteries, which allow for dispatching the run of the river hydro largely at night when solar power is not available and energy prices are higher. We will be increasing this virtual reservoir to 250 megawatts over the next couple of years, and there are several smaller virtual reservoir projects in late-stage development in the U.S. Fluence currently has an all-time high of 1.3 gigawatts of energy storage systems under construction, which include some of the largest projects in the world. This year, we will be rolling out our sixth generation energy storage technology platform. It is both factory assembled and modular, and will improve reliability, increase the speed of execution and lower costs. Through our growth in renewables and energy storage, we continue to make progress towards our ambitious environmental goals. As you can see on Slide 11, we remain committed to reducing our coal generation to less than 30% of our gigawatt hours by the end of this year, which will make us compliant with ESG standards set by Norges Bank, among other institutions. We expect to realize this target through the continued sale and decommissioning of coal plants, along with the execution of our extensive backlog of renewable projects. Finally, turning to our leadership and innovation on Slide 12. We continue to move forward on a number of innovative solutions that we see as highly relevant for the long-term future of the industry. One example is Uplight, which, as a reminder, works with more than 80 electric and gas utilities in the U.S., reaching more than 100 million households and businesses, providing a suite of digital solutions. We expect revenue growth of 30% this year, fueled in part by utilities' desire to improve customers' experiences in a capital-efficient digital way. Another example of our innovation is our partnership with Google, which is progressing well. We continue to make headway on a number of initiatives that we will be in a position to announce in the near future. Now I would like to pass the call to Gustavo Pimenta, our CFO, so he can provide more color on our results, debt profile and guidance."
},
{
"speaker": "Gustavo Pimenta",
"text": "Thank you, Andres. Today, I will cover our financial results, credit profile and capital allocation. I will conclude by addressing the impact of COVID-19 on our guidance for this year and expectations through 2022. In the first quarter, we made good progress on our key financial metrics. As shown on Slide 14, adjusted EPS was $0.29 versus $0.28 in Q1 2019, in line with our expectations. We benefited from higher contributions from the MCAC SBU, largely due to improved availability and hydrology in Panama as well as lower effective tax rate. These positive drivers were partially offset by the reversion to prior rates at DPL in Ohio and mild weather at our regulated utilities in the U.S. Turning to Slide 15. Adjusted pretax contribution, or PTC, was $250 million for the quarter, a decrease of $22 million versus the first quarter of 2019. I'll cover our results in more detail over the next four slides, beginning on Slide 16. In the U.S. and Utilities SBU, lower PTC reflects the reversion to ESP 1 rates at DPL as well as mild weather at both DPL and IPL. These impacts were partially offset by contributions from new renewable projects. At our South America SBU, higher PTC was largely driven by lower interest expense and realized FX gains in Chile, partially offset by a planned major outage at our hydro plant in Colombia as part of a larger project to extend its useful life. Higher PTC at our MCAC SBU reflects the return to operations at our Sanginel hydro plant in Panama, following an extended major outage in 2019, as well as improved availability at our Colon plant. We also benefited from improved hydrology in Panama following a very dry year in 2019. Finally, in Eurasia. Lower results primarily reflect the sale of our business in the United Kingdom. Before moving on, I want to provide an update on the DP&L in Ohio on Slide '20. As we discussed on our fourth quarter call, after reverting to previous ESP 1 rates, the DP&L was required to pass certain regulatory tasks, including the significantly excessive earnings test, or SEET. In April, DP&L began this process by filing an application with the commission. There is a comment period set for July and potential hearing, if needed, set for October. A final ruling is expected by early 2021. We feel good about our ability to best this test and maintain ESP 1 rates. As we have said in the past, AES continues to be fully committed to the DP&L. We are now planning to invest approximately $900 million in its grid over the next 4 years, including base distribution, transmission and its market investments, which will lead to low double-digit rate base growth through 2023. To that end, AES plans to invest $300 million of new equity in the DP&L, half of it this year and the other half in 2021. These investments will allow DP&L to continue to provide safe and reliable service, while materially improving the experience we deliver to our customers and preserving very competitive rates. Now turning to our credit profile on Slide '21. As we discussed on our fourth quarter call, between 2011 and 2019, we reduced our parent debt by $3.1 billion, which is about 50%. At year-end, our parent leverage was 3.7x and our FFO to debt was 21%, comfortably within the investment-grade threshold of 4x and 20%, respectively. Currently, we have $800 million of borrowings under the revolver, roughly half of which was drawn as precautionary measure to reinforce our cash position. We expected to end the year with a 0 revolver balance and credit metrics that are even stronger than in 2019. We are also maintaining our regular dialogue with the rating agencies and continue to be on track to receive our second investment-grade rating. While the fundamental credit strength of AES remains unchanged, given the current macro environment, we believe the timing of this upgrade is now more likely to be closer to year-end. Moving on to liquidity on Slide 22. In times of uncertainty, we recognize that cash is king. To that end, we are in the strongest financial position of our history. We have $3.3 billion in available liquidity, 2/3 of which is in cash. This is more than sufficient to meet any unforeseen needs over the remainder of the year. Turning to our receivables on Slide 23, which have remained stable over the last few years. We have been monitoring our receivables very closely to ensure they are within the 45- to 60-day grace period allowed under our contracts. And so far, through April, they are in line. It is worthwhile to mention that in a few of our markets, governments have declared a payment moratorium for certain residential utility clients as the lockdown is in place. While we are mostly removed from this impact as a generator, this could create some additional working capital needs at certain businesses. To that end, we are working with multilateral organizations, such as the Inter-American Development Bank to create mechanism for securitizing receivables in these markets. Now turning to our refinancing needs in 2020 on Slide 24. As you may know, we have been proactively strengthening our debt maturity profile. In fact, just last year, we executed more than $5 billion in liability management across our portfolio. As a result, we have only $300 million of debt to be refinanced for the remainder of the year, most of which is at our U.S. utilities. We are pleased to see investor interest in the $407 million IPALCO refinanced we recently completed, with the deal being 5x oversubscribed, reducing our refinancing needs to just over $300 million for the remainder of the year. Now to 2020 parent capital allocation on Slide 25. Beginning on the left-hand side, sources reflect $1.4 billion of total discretionary cash, which is largely consistent with our previous disclosure. Moving to uses on the right-hand side. Including the 5% dividend increase we announced in December, we'll be returning $381 million to shareholders this year. We do not plan any additional debt reduction beyond repayment of the temporary drawings on our revolver, which was $180 million at the end of 2019. Our credit metrics are strong and will continue to improve on the strength of our cash flow alone. And we plan to invest $565 million in our subsidiaries, including our equity for the Southland repowering, our renewables backlog and the $150 million investment in grid modernization at DPL this year. This leave us with up to $452 million to be allocated. The amount is largely a function of the asset sales we plan to close this year. The use of this cash may include investment in AES Gener, Green Blend & Extend strategy, as we discussed on our last call. The timing of this investment is dependent on AES Gener's funding needs, so it may be later this year or early next year. Next, moving to our capital allocation from 2020 through 2022, beginning on Slide 26. We continue to expect our portfolio to generate $3.4 billion in discretionary cash, 3/4 of this is expected to be generated from parent free cash flow, with the remaining $900 million coming from asset sale proceeds. Turning to the uses of this discretionary cash on Slide 27. Roughly, 1/3 of this cash will be allocated to shareholder dividends. Looking forward, subject to annual review by the Board, we continue to expect to increase the dividend by 4% to 6% per year, in line with the industry average. We are also expecting to use $1.9 billion to invest in our backlog, new project and PPAs, T&D investments at IPL, the partial funding of our Vietnam LNG project and the investment in AES Gener, I just discussed. This $1.9 billion also includes the $300 million infrastructure investment in DP&L, which is incremental to our last call. Once completed, these projects will contribute to our growth through 2022 and beyond. Finally, turning to our guidance and the impact of COVID-19 on Slide 28. As Andres mentioned, AES is well positioned to weather this storm due to the actions we have taken over the last several years to improve the resilience of our portfolio. So let me start first with the impact from commodities and FX. Despite significant volatility in both markets, we are expecting an impact of only $0.03. This is because today, our business is mostly contracted and denominated in U.S. dollars, materially reducing our exposure. We are also forecasting a $0.02 impact due to a higher interest expense as a result of drawing on our revolving credit facilities to reinforce our liquidity. Like many other companies in our sector, we are also seeing an impact on demand, primarily at our regulated utilities, including IPL and DPL, where we do not currently benefit from the coupling protection. In April, we saw C&I demand decline in the mid-teens at both businesses, with a partial offset of about 6% from an increased residential demand, where we have better margins. Internationally, demand has dropped 5% to 15% in our key markets. But again, in those markets, our model is mostly based on take-or-pay contracts or tolling agreements with limited exposure to demand. The impact from lower demand across our portfolio is expected to be $0.07 in 2020. Although projecting future load, GDP recovery is very challenging in this unprecedented times, we are currently assuming demand will have an extended U-shaped recovery with a mid-teens average decline across our portfolio in the second quarter, high single digits in the third quarter and low single digits in the fourth quarter, not returning to precrisis levels until next year. As a reference, and assuming our current geographic mix, a 1% change in the year to go demand translates into an approximately $0.01 impact on our full year earnings. We have also been working very hard on potential levers to offset this impact and are expecting an incremental cost savings in the year of about $0.05. As Andres mentioned, most of these savings are coming from our digital and laser-focused cost control initiatives. This includes reduced maintenance and lower fixed costs and G&A. Turning to Slide 29. As a result, we are reducing the midpoint of our guidance by 5% or $0.07 with a new range of $1.32 to $1.42. On the parent free cash flow side, we are not seeing an impact versus our previously communicated goal of $725 million to $775 million as a result of the strength and diversification of our portfolio. We are also reaffirming our 7% to 9% average annual growth rate through 2022. Although it is disappointing to revise our adjusted EPS guidance for the year, the limited impact we are seeing in the midst of an unprecedented global crisis, illustrates the current strength of our portfolio and balance sheet. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Gustavo. Before we take your questions, let me summarize today's call. The fundamentals of our business remain strong, and our portfolio of largely long-term contracted generation is resilient in the current pandemic and related economic downturn. Therefore, we remain on track to achieve our strategic goals of greening our portfolio, leading in new technologies and attaining a second investment-grade rating. We have already taken steps this year to strengthen our liquidity and further reduce costs to mitigate the impact on earnings from decreases in our sales. Although we expect a 5% reduction in this year's earnings, we are reaffirming our 2020 parent free cash flow and longer-term growth rates in earnings, cash and dividends. We expect to generate $3.4 billion of discretionary cash through 2022, which we will invest to continue to deliver double-digit returns to our shareholders. And finally, I would like to thank the people of AES, who through their discipline and hard work are ensuring safe, reliable and affordable energy in all of the markets we serve. Operator, I now would like to open the line for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. And our first question will come from Ryan Greenwald with Bank of America."
},
{
"speaker": "Unidentified Analyst",
"text": "So maybe if we can just start with asset sales. It looks like Jordan through late last month. So if you kind of just talk about your commitment there and you're confidence to get out of the sales on those in here?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Look, our asset sales continue to progress. In the specific case of Jordan, I don't think is as binary as you described. So we remain confident of closing a number of sales this year, and there's continued interest in those assets, and we're making progress. I would add that we're really not depending this year for any asset sales to fund our growth. So we remain confident. We think that we'll close a number of sales. There's interest. And of course, we don't talk about them until they're actually completed."
},
{
"speaker": "Unidentified Analyst",
"text": "Got it. Fair enough. And then I appreciate all the commentary around demand trends and sensitivities. But could you just allude a little more to any latitude you might have under a more severe protracted scenario? I know you kind of alluded to $50 million in additional savings already?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. So first, I want to be clear that we're trying to be as transparent as possible. So as Gustavo described, what we're seeing is, quite frankly, continued reduction in demand, lower demand for the remainder of the year. So most severe in the second quarter. And then you have a single-digit -- high single-digit decline in the third quarter and lower single-digit decline in the fourth, and only recovering in the first quarter of next year. So that's our assumption. So that really would is consistent with a U-shaped recovery or even a double U-shaped recovery. If things are more severe, we are in a resilient case. And of course, we have more latitude on different levers that we can pull. I would add that because what we did very early on was increase our liquidity, we have about $0.02 of having that additional liquidity on hand. But I think that was the right thing to do given that there was a lot of uncertainty. So we have a very good track record of cost controls and reductions. And I think that, again, we will react given to how we see the situation evolving. Now we did mention $0.05 this year, mostly from our digital initiatives. And I think that we have learned how to work remotely. And there are more digital tools that we can implement, and we expect to -- that these savings will continue into next year. So we have some continued additional upside because that's really not in next year's numbers."
},
{
"speaker": "Unidentified Analyst",
"text": "Got it. And then just lastly, the interest capitalization that you guys did at Alto Maipo, is that included in adjusted EPS?"
},
{
"speaker": "Andrés Gluski",
"text": "It is. It is included in the adjusted EPS."
},
{
"speaker": "Unidentified Analyst",
"text": "And what was kind of the thinking there?"
},
{
"speaker": "Andrés Gluski",
"text": "No, that's just an adjustment based on the history of the project. We've adjusted this year as the team refined the calculation. So it impacted Q1 this year."
},
{
"speaker": "Operator",
"text": "Out next question will come from Charles Fishman of Morningstar."
},
{
"speaker": "Charles Fishman",
"text": "Andres, you mentioned a 10% reduction in demand in April at the U.S. utilities, was that weather normalized?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes, that's weather normalized."
},
{
"speaker": "Charles Fishman",
"text": "Okay. And then earlier this week or it might have been late last week, there was an article in The Wall Street Journal about the impact of the pandemic in Brazil. And it was -- looked pretty severe. Are you noticing -- obviously, you got boots on the ground in there. Are you noticing anything? Is there any color you can add? You've got a significant interest in Tiete? You've got other solar projects in Brazil and maybe just expand that to Argentina as well."
},
{
"speaker": "Andrés Gluski",
"text": "Sure. So let's take maybe sort of the Latin American region. So first, the reaction there will be different, perhaps by country, but it's also somewhat different than the developed countries. So there's a number of things. First, in general, they were quite quick lock down. Brazil was an exception to that and Mexico. But in most countries, the lockdown was quite severe and quite early. Second, they will be lifting these restrictions. But in general, the pandemic has been less severe in those countries than it has in the developed world. What we do know about the pandemic is that the, quite frankly, biggest drivers are age. And the second is obesity rates. So when you think of age, a lot of these countries have an average age of 30, which is very different from an average age of almost 50 in some of the developed countries. So the pandemic will have a different effect there. So I'd say the main difference is how much fiscal stimulus can they apply to react to that. So what we're seeing is -- again, it varies by country, but some of the smaller countries have had pretty aggressive fiscal stimulus. And they have gone out and basically assured the liquidity in countries like Panama, for example, have assured the liquidity on hand. And then Gustav also mentioned that we have worked with the -- even though we're not in most cases, not directly affected because it's more at the distribution company level, but we've also been working with multilateral institutions to have windows to a discount accounts receivable. But the vast bulk of our clients are multinationals, investment-grade multinationals in these countries. So taking a specific case of Brazil, I mean, as of yet, we have -- it's in one of those countries in the range that Gustavo talked about, between sort of 5% to 15% of our key countries. In Brazil, it's different very much state to state. Brazil is 1 of the countries where we don't have the long-term contracts. They tend to be shorter-term contracts. So there has been some effect there in Brazil, and it's also the 1 of the ones that we have in local currency. Brazil is obviously 1 that's been affected. What is our feeling about it? I think, again, in general, these countries will open up. The effects of the pandemic will be somewhat different because of the demographics of it. Personally, I think that 1 of the things to watch is commodity prices. Because that will maybe even have a bigger effect than some of the shutdowns, given the large informal sectors that these countries have. You mentioned Argentina. Argentina is doing very well on the shutdown in terms of its few cases, very controlled cases. And I would say that the main thing to watch in Argentina is debt refinancing or debt restructuring, let's say, that they're undergoing now. You will notice that our parent free cash flow is unchanged, but we have a decrease in earnings. One of the -- that's reflecting in part Argentina, where you've had significant devaluations. And you've had some degradation of our tariffs. But we weren't expecting to get any dividends out of it. One of the other businesses affected was the P&L, for example, where we don't expect any dividend. So that's -- I just wanted to explain why our cash remains unchanged and we're seeing a decrease in dividend. So regarding Latin America, in general, I'm pleased by the reaction of a lot of countries. The populations have been very supportive of their governments in that respect. And given the different demographics, it will evolve differently. So I do expect them to start opening up. Depends on the country. But later on this month and certainly by June. And the -- again, the reaction of a younger population will be different."
},
{
"speaker": "Charles Fishman",
"text": "Okay. Andres, that's very helpful. Just 1 final question on DP&L. The $300 million incremental investment over the next couple of years. Is that dependent on the resolution of the earnings test or any other regulatory things you need to put in place before you make that investment announcement?"
},
{
"speaker": "Andrés Gluski",
"text": "So the first 150 -- the answer is no for the C test because we feel pretty good about it. Our average ROE filed is below 10% and our recommended threshold is around 16%. So we feel good about that one. But we are discussing an acceleration of our smart grid plan. Remember, we had filed for a smart grid plan 2 years ago, and we are now resuming that conversation. So we're expecting to have the approval to fund the second $150 million, and that's going to come as we get more clarity around this market approval."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. And our next Richard Rosen with Columbia [ph]."
},
{
"speaker": "Unidentified Analyst",
"text": "Yes. How is it that, that expectations for new renewable signings should be thought of and financing thereof? Should there be more issues in getting financing going forward?"
},
{
"speaker": "Andrés Gluski",
"text": "Let me see if I understood the question. In terms of how we are proceeding with our renewables as we were before. We are getting project financing. We are seeing perhaps some areas be stronger than other areas. As I said, smaller projects in the states, we see demand particularly strong. At this point, about -- if you look at our renewables about 1 quarter is related to energy storage, and we see demand there very strong. So I guess the question is, we basically see demand for like energy storage projects and renewables, especially for utilities is very strong. We have the green blend and extend angle in Latin America, and that remains strong for large, especially mining offtakers."
},
{
"speaker": "Unidentified Analyst",
"text": "Your goal has been, what, 2 to 3 gigawatts a year. Is that still a reasonable expectation?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes, absolutely. And if you look at our run rate for the first trimester, it was 700 megawatts. So that's, quite frankly, almost on the button of what we were doing last year."
},
{
"speaker": "Unidentified Analyst",
"text": "Well, the world changed between Q1 and Q2, which is why -- but you're keeping that expectation. That's really fantastic. Okay. That's it. And stay safe."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to Ahmed Pasha for any closing remarks. Please go ahead, sir."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you, everybody, for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and stay safe. Bye-bye. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | The AES Corporation | 35,312 |
AES | 4 | 2,021 | 2022-02-25 10:00:00 | Operator: Hello, and welcome to today's AES Corporation Q4 2021 Financial Review. My name is Bailey, and I will be the moderator for today's call. [Operator Instructions] I would now like to pass the conference over to Ahmed Pasha, Global Treasurer and Vice President of Investor Relations. Ahmed, please go ahead.
Ahmed Pasha: Thank you, operator. Good morning, and welcome to our fourth quarter and full year 2021 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres. Andres?
Andres Gluski: Good morning, everyone, and thank you for joining our fourth quarter and full year 2021 financial review call. Today, I will cover our full year results and discuss our strategy and areas of focus for this year. Before discussing our 2021 results and future plans, I want to state that we do not see any significant impact on our portfolio from the outbreak of hostility in the Ukraine. Nonetheless, our thoughts and prayers go out to the Ukrainian people and government, and we hope for a speedy return to peace. Now turning our focus back to our business. Today marks an important and exciting milestone for AES with the announcement of our intention to fully exit coal by year-end 2025. This accelerated goal is a result of our success in growing our renewables portfolio. And our backlog gives us the confidence to take this step. As a leader in the global energy transition, we are committed to the goals of the Paris Agreement in achieving a net-zero economy. We will work with our stakeholders to ensure a smooth transition while meeting our regulatory obligations. Our exit from coal will be modestly dilutive, but we feel comfortable with our growth trajectory. And accordingly, we are reaffirming our annualized growth target of 7% to 9% in earnings and cash flow through 2025. Now moving on to our 2021 results and accomplishments. First, I am pleased to report our financial results, including adjusted earnings per share of $1.52, which was in line with our expectations. Our 2021 parent free cash flow of $839 million exceeded our expected range of $775 million to $825 million. Second, we signed contracts for 5 gigawatts of new renewable projects, significantly above our target of 3 to 4 gigawatts that we set last year. In fact, according to Bloomberg New Energy Finance, AES signed more renewable deals with corporate customers in 2021 than anyone else in the world. Included in these deals were two groundbreaking arrangements to provide renewable energy on an hour-by-hour basis, 24 hours a day, 7 days a week signed with Google and Microsoft. Third, Fluence successfully completed their IPO in November and have no foreseeable need for external funding to achieve their strategic and financial objectives. Furthermore, Fluence has made progress towards mitigating the supply chain challenges they have faced, which I shall discuss shortly. Finally, safety is our most important value. I am very proud to report that our safety performance in 2021 was the best in our 40-year history, with no major incidents recorded among roughly 25,000 AES people, contractors and construction workers. Today, I will be discussing two things: first, executing today; and second, investing for the future. Beginning with executing today on Slide 4. Even as we are transitioning to a carbon-free future, we are laser-focused on delivering on our commitments. Our business model has proven itself to be resilient and enables us to deliver predictable results. For example, 85% of our adjusted PTC is from long-term contracted generation and utilities and 88% is in U.S. dollars, with the remaining 12% split between euros and various Latin American currencies. Similarly, we're largely insulated from macroeconomic headwinds, such as rising inflation and interest rates. As shown on Slide 5, 83% of our revenue is from businesses that have indexation clauses or are hedged to limit the impact from inflation. At the same time, almost 90% of our interest rate exposure is fixed or hedged, protecting us from the impact of rising interest rates. Next, turning to Slide 6. In January, we completed a tender to acquire the publicly-traded shares of AES Andes, bringing our ownership from 67% to 99% today. This was motivated by our conviction in the underlying strength of the business, which is highly contracted, predominantly in U.S. dollars and transitioning to low-carbon generation. This transaction is immediately earnings and cash flow accretive. Moving to Slide 7. We now have a backlog of 9.2 gigawatts, including the 5 gigawatts we signed in 2021. About 3/4 of the 5 gigawatts is in the U.S., with the vast majority signed with C&I customers and to grow the rate base at our AES Indiana utility. We have secured supply arrangements for the bulk of our current backlog. In 2021, we successfully added 2.1 gigawatts to our portfolio without any material delays or cost overrun. This execution demonstrates the robust nature of our supply chain and the strength of our relationships with our suppliers. For example, we secured Samsung battery for many of our new energy storage facilities to alleviate some of the supply chain challenges faced by Fluence. Being able to switch to different battery suppliers shows the inherent flexibility of their Gen 6 product. As we look towards our 2.3 gigawatts of new projects coming online in 2022, two-third of which is in the U.S., we do not expect any significant delays or supply chain disruptions. We remain confident in our ability to complete our projects under construction on time and on budget. Moving to our second theme, investing for the future on Slide 8. Our actions today ensure that we will be able to take full advantage of the unprecedented transformation of our sector. One clear example is the 5 gigawatts of new PPAs that we signed last year, an increase of 65% from 2020. For full year '22, we expect to sign 4.5 to 5.5 gigawatts of new renewables under long-term contracts. We are seeing strong demand for renewables. And so far this year, we have already signed more than 600 megawatts of new contracts. We expect our portfolio of operating renewable assets to more than double from approximately 13 gigawatts to 26 gigawatts by 2026. Despite any current headwinds for our sector, such as delays in legislation and supply chain issues, we see very strong demand for low-carbon energy, especially for tailored products, such as our 24/7 renewable offering. That is why we have been investing in growing our pipeline of future projects to ensure that we're able to meet our customers' growing demand for AES services. As you can see on Slide 9, we now have a development pipeline of 59 gigawatts, which we believe is the second largest among U.S. renewable developers. Our pipeline includes almost 10 gigawatts in the U.S. that are ready to bid. This robust pipeline provides us with the projects we need to deliver on our backlog and to continue to build on our competitive position in the U.S. As a result, we're accelerating our goal of increasing the proportion of earnings coming from our U.S. businesses to 50% by two years from 2025 to 2023. We are also investing for the future by growing the rate base at our U.S. utilities by 9% annually, while delivering safe, reliable and affordable services to our customers. As you can see on Slide 10, AES Indiana is executing on the approved plan to retire two coal units, which we will replace with nearly 500 megawatts of new renewable generation. We have already started our next integrated resource plan process, which could include additional retirement or fuel conversions for the remaining 1 gigawatt of coal generation. At AES Ohio, we're executing on our smart grid and transmission investment programs approved in 2021. AES Ohio is also in the midst of a distribution rate case and recently completed the hearing. AES Ohio's base distribution rates have been the lowest in the state for the past five years. In fact, as of the end of 2021, AES Ohio's rates were 16% lower than the next lowest utility in the state and even with the requested rate increase, would remain the lowest. Turning to Slide 11. Another way we're investing for the future is by developing and incubating new products and businesses' platforms through AES Next. Our investment in AES Next help our core businesses be more innovative and competitive and drive value for our customers and shareholders. Turning to Slide 12. The most mature initiative under AES Next today is Fluence, the leading energy storage technology company. In 2021, Fluence completed their IPO with $1 billion in capital raised to invest in developing their products and supply chain as well as their digital platform. As of December 31, Fluence had 4.2 gigawatts of energy storage products deployed and contracted and a signed backlog of $1.9 billion. Additionally, Fluence's digital platform, Fluence IQ, now has 6 gigawatts contracted, of which more than 80% is with third-party customers. Over the past several months, Fluence has been dealing with short-term challenges stemming from COVID-19-related supply chain issues. Their management team has taken proactive actions to address these challenges, including diversifying battery suppliers, signing and shipping agreements and building out their in-house supply chain team. Overall, demand for energy storage remains robust, and Fluence is well positioned as a market leader. We see significant opportunity for them to continue to grow and remain confident that they will execute on their long-term plan, which will deliver value to their shareholders. AES Next is also working to develop and incubate other technologies that help accelerate the deployment of renewables, as shown on Slide 13. One example is our investment in 5B, which has a prefabricated solar solution called MAVERICK, that is hurricane wind-resistant and allows projects to be built in 1/3 of the time and on 1/2 as much land. This innovative product is currently being rolled out in Australia, Chile, the Dominican Republic, India, Panama and the U.S. Turning to Slide 14. We're one of a small number of company in our sector with targets that are fully aligned with the Paris Agreement according to the Transition Pathway Initiative. We already have a goal to have net-zero emissions from electricity by 2040. And as I mentioned earlier, we're excited to announce our intent to exit coal completely by the end of 2025, subject to receiving necessary approvals. We expect to achieve this objective through a combination of retirement, fuel conversions and asset sales. In summary, we have consolidated our position as a leader of innovation in the industry and accelerated the decarbonization of our portfolio, while delivering attractive returns to our shareholders. With that, I now turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will cover the following key topics: our financial performance during 2021, our parent capital allocation and our 2022 guidance and expectations through 2025. As Andres mentioned, our results for 2021 show our continued progress in leading the energy transition, while achieving our financial goals. We delivered strong financial results even while absorbing the previously discussed impact from the share count adjustment related to the equity units issued last year. Overall, the strong growth of our core energy business, which includes generation and utilities, gives us confidence that we will continue to achieve our earnings and cash flow target. Turning to Slide 16. Full year 2021 adjusted EPS was $1.52, $0.08 higher than 2020. 2020 adjusted EPS of $1.44 included $0.03 of dilution from AES Next, implying that our core business generated adjusted EPS of $1.47. In 2021, our core business grew by $0.21 to $1.68, primarily as a result of higher contributions from new renewables businesses, improved operations at both U.S. generation and MCAC and lower parent interest. Our 2021 results of $1.52 include the $0.07 impact due to a higher share count as a result of the accounting adjustment for the equity unit and the dilution from AES Next where we are investing in expanding our high-growth technology businesses. The impact from ASX Next was $0.03 higher than our prior expectation due to the nonrecurring COVID-related supply chain issues at Fluence. Going forward, we plan to manage the AES Next portfolio such that these businesses will yield a neutral to positive contribution to AES' earnings by 2024. Turning to Slide 17. Adjusted pretax contribution or PTC was $1.4 billion for the year, an increase of $171 million and 14% growth over 2020. I'll cover our results in more detail over the next 4 slides, beginning with the U.S. and Utilities SBU on Slide 18. Our increased investments in the U.S. show PTC growth of $155 million, a 31% increase over 2020. As of year-end 2021, the U.S. represented 41% of our adjusted PTC, up from 34% in 2020. About half of this growth was driven by new businesses at AES Clean Energy that came online in 2021. And the rest of the increase was from our legacy Southland units, which remained a key contributor to the stability of the California grid during the peak summer season and delivered solid growth from increased dispatch and attractive market prices. We continue to see the potential for some of our legacy Southland units to support the energy transition in California for several years to come. Lower PTC at our South America SBU was primarily driven by regulatory adjustments and recovery of expenses from customers that were recorded in 2020. Hydrology was not a major driver as we benefited from the increased diversity of our generation portfolio and favorable hydrological conditions in Colombia offset drier conditions in Brazil. Higher PTC at our MCAC SBU reflects higher LNG sales in both Panama and the Dominican Republic as we benefited from higher contract levels at our LNG terminals. We now have roughly 80% of our LNG capacity contracted, leaving approximately $20 million to $30 million of potential annual upside to our longer-term expectations. Finally, in Eurasia, higher PTC was primarily driven by higher contributions from Bulgaria due to improved operating performance at Maritza and increased revenue at our wind farm, which benefited from favorable market prices. Now let's turn to review of how we allocated our capital in 2021 on Slide 22. Beginning on the left-hand side, sources reflect $2.3 billion of total discretionary cash. And I'm pleased to report that this includes parent free cash flow of $839 million, which exceeded the top end of our guidance expectations. The remaining sources are largely in line with our prior disclosures except the $295 million in temporary drawings under our revolver, which we utilized to fund our accelerating growth in clean energy. Moving to the uses on the right-hand side. We allocated $450 million of our discretionary cash to our dividend. We invested nearly $1.8 billion in our subsidiaries, of which approximately two-third was in the U.S. As Andres mentioned, we expect the relative share of our allocation for the U.S. to continue to grow. And I'm glad to report that we now expect to reach our goal of 50% of our earnings coming from the U.S. in 2023, two years earlier than our previous target in 2025. Now turning to our credit profile on Slide 23. As a result of the successful execution of our strategy over the last few years, our balance sheet continues to be in a much stronger position. We significantly reduced debt while growing our parent free cash flow. At the end of 2021, our parent free cash flow to net debt ratio was approximately 23%, which is well above the 20% threshold required for an investment-grade rating. We expect this ratio to continue to improve over time putting us in BBB territory by 2025. We are in active discussions with Moody's and remain optimistic that we will be upgraded this year. Turning to our guidance and expectations beginning on Slide 24. We are reaffirming our annualized growth target of 7% to 9% in both adjusted EPS and parent free cash flow through 2025 off a base year of 2020. Today, we are initiating guidance for 2022 adjusted EPS of $1.55 to $1.65. Key drivers of our expected growth include the approximate $0.09 benefit from our higher ownership of AES Andes, which we increased to 99%, as Andres mentioned earlier. This transaction is immediately significantly accretive on both an earnings and cash flow basis. And with a simplified shareholder base, AES Andes will be able to more efficiently execute on its substantial renewables pipeline. Our adjusted - our 2022 adjusted EPS will also benefit from continued growth in renewables and higher contributions from existing operations, adding $0.10. This growth is expected to be partially offset by $0.11 of impacts from the higher adjusted tax rate, a full year of a higher share count due to the accounting adjustment for the equity units issued in 2021 and assumed dilution from planned asset sales. Our target for this year has increased to reflect our efforts to further decarbonize and fully exit coal by the end of 2025. I would also note that we previously expected the pending distribution rate case at DPL to be resolved earlier in the year. However, we now expect resolution later this year and, therefore, have assumed only a small contribution in 2022. Turning to Slide 25. Parent free cash flow for 2022 is expected to be $860 million to $910 million, in line with our annualized growth target of 7% to 9%. Now turning to our 2022 parent capital allocation plan on Slide 26. Beginning with approximately $1.5 billion of sources on the left-hand side, in addition to parent free cash flow, we expect to generate $500 million to $700 million in asset sale proceeds. Roughly half of this is from already announced sales in Vietnam and Jordan, and the remaining portion is expected to come from additional asset sales that have not yet been announced. Recycling of capital is an integral part of our capital allocation framework. And as we have done in the past, we will deploy asset sale proceeds to achieve our strategic objectives and maximize shareholder value. Now to the uses on the right-hand side. We expect to allocate $494 million to our shareholder dividend, which reflects our announced 5% increase. We are also projecting investments of roughly $1 billion in our subsidiaries for growth, of which about 3/4 will be allocated to the U.S. to renewables and utilities. Finally, turning to our 4-year capital allocation plan through 2025 beginning on Slide 27. Our financial strategy is centered around maintaining a strong investment-grade rated balance sheet, while investing in our growth to achieve our strategic and financial objectives. Our total growth investments for 2022 through 2025 have increased to $3.8 billion. We expect to continue to increase our dividend 4% to 6% annually, in line with our prior guidance. As you can see on Slide 28, we plan to fund this $6 billion with 60% parent free cash flow and the remaining 40% will be from asset sale proceeds and future parent debt issuances. Relative to our prior plan, you may notice that we have increased asset sale proceeds by $500 million and future parent debt by $300 million, which will be utilized to fund our future growth and repay drawings on our revolver that funded the higher growth from 2021. In summary, we accelerated AES growth in 2021 and executed on our financial and strategic commitments. Going forward, we will continue to deliver on our strategy, including executing on asset sales to decarbonize and exit coal, maintaining the strength of our balance sheet and allocating capital to maximize per share value for our shareholders. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. As you can see, we're not only delivering on our commitments, but accelerating our transformation. Our near-term actions will enable us to achieve our three goals for creating additional shareholder value: first, attaining an investment-grade rating from Moody's in 2022; second, increasing the proportion of earnings from the U.S. to 50% by 2023; and third, exiting coal generation by the end of 2025. With that, I'd like to open up the call to questions.
Operator: [Operator Instructions] So our first question today comes from Angie Storozynski from Seaport. Angie, please go ahead. Your line is now open.
Angie Storozynski: So my first question, and I see your disclosures on sensitivities, but I'm just wondering if you could describe the impact of the higher power price environment that we're seeing pretty much everywhere in the world on your both existing assets and growth prospects. I mean any sort of increased economic dispatch and how - and the appeal of renewables and how those are embedded in your '22 guidance and long-term growth.
Andres Gluski: Angie, thank you. Basically, as you know, we're highly contracted. But what we're seeing in terms of higher prices for oil-based generation in many of our markets that favors us because we're much more hydro renewables and even coal. In places like where we have a big plant in Europe and Bulgaria, our plant is now very much cheaper than the other generations in the country. So we're seeing improved prospects for a lot of our generation because we are not a big generator using international price gas. Most of our gas units are running on Henry Hub or almost all. So we're basically competing against those very high prices. So even though we're highly contracted, there's always some margin, so that's positive. It's also positive on the renewable front and on the innovative front because I think people are seeing that renewables in an environment where gas prices can be more volatile is favorable. So in the net-net, overall, it's positive for us in the short run and certainly even more so in the long run because, as I said, we're highly contracted.
Angie Storozynski: Okay. Just one follow-up. How about the LNG business? Is there any near-term or longer-term impact?
Andres Gluski: Well, we're contracted now in Panama and the Dominican Republic. Basically, it had Henry Hub, Henry Hub plus, of course. So it's favorable to us in that prospect. Now when those contracts burn off in a couple of years, then we have to see when the recontracting levels will be. And hopefully, there will be more supply of gas at that point in time.
Angie Storozynski: Okay. And just one other question. So you show the impact - the drag on earnings from asset sales. If you could comment a little bit, does that include any of those accelerated coal plant shutdowns or sales? Again, I'm just trying to reconcile the earnings impact with the transactions already announced.
Andres Gluski: Go, Steve.
Steve Coughlin: Yes. Angie, this is Steve. So yes, I mean, we are - consistent with the announcement to exit coal, we are increasing our total asset sale plan to $1 billion and then have increased the sales target this year to $500 million to $700 million. So yes, it does reflect in part the announcement that we made today. We had prior announcements in the past about Vietnam and Jordan. So that's a portion of it. But the additional portion reflects the updated strategy to accelerate our exit.
Andres Gluski: Just to be clear, it's fully reflected. So some of it has been included in the past. It reflects 100% of the additional.
Angie Storozynski: Okay. And my last question on Ohio, a delay in resolution of your rate case. Is there - I mean, is there something that we should be concerned about? Or is this just that the process takes longer?
Ahmed Pasha: Sure. Angie, this is Ahmed. I think no, I don't think there's - it's a process because previously, we were hoping to settle. And now we are going through - because we could not reach this settlement, although the staff had recommended a reasonable increase in response to our request. And one of the intervenors OCC subsequently argued that the rate freeze should remain intact. And now we are going through the litigation process. But we think our request is fair. And is driven by the costs which are out of our control. And frankly, primarily to deliver the more reliable and economic power to our customers. So we think we will get through this by mid this year with the approval from the commission. So net-net, our rates are the lowest in the state and will remain lowest with this requested increase. So we feel pretty good that commission will approve our request by mid- to late '22.
Andres Gluski: So in summary, it's just a timing issue.
Ahmed Pasha: Yes.
Steve Coughlin: Yes. It's the timing. And in fact, the PUCO staff did support an increase as part of the process already.
Ahmed Pasha: Yes, they did recommend.
Operator: The next question today comes from Rich Sunderland from JPMorgan. Rich, please go ahead. Your line is now open.
RichSunderland: Maybe starting on 2022 guidance. Could you walk from the outlook a year ago at the Investor Day to now in terms of AES Next, the rate case and other factors separate from the equity units issue you called out in terms of changes from the 7% to 9% growth rate versus the growth embedded in the current guidance?
Steve Coughlin: Yes. Sure. This is Steve. So really, the two primary drivers - well, a couple. So our growth is faster. So we've accelerated our renewables growth. Now that's been offset by the additional share count, of course, which we talked about last year. Now again, we took advantage of the value opportunity with Andes. So we've largely offset the share price - share count dilution with our acquisition of the additional shares in Andes. So really, what's been changed on a net basis is more on the asset sale program, which we just talked about and how we are accelerating our decarbonization and our exit of coal. And then the other real driver is the - is what we also just talked about, which is the DPL rates, which we previously assumed would be in effect early this year and now are assuming late this year. So those are really the two primary drivers. And then there is an uptick in the tax rate from the past. At this point, we're guiding to 26% to 28% on the tax rate. So that's a piece of the story as well.
RichSunderland: Understood. So then just kind of walking forward in terms of regaining the 7% to 9% trajectory in the second half of the plan, I guess you called out the rate cases and timing factor. Could you just speak a little bit more to how you see the growth coming to kind of regain the 7% to 9% earnings trajectory?
Andres Gluski: Sure. This is Andres. I'll give a sort of high level. Look, we have a backlog of 9.2 gigawatts of projects. This year, we'll be commissioning 2.3 gigawatts. So obviously, in a steady state, these two have to be about equal. And so what you're going to have is a real pickup in commissionings '23, '24 going forward. So we feel very confident about that because those are already signed projects. We already have the sites, and it's a question of executing on building them. The other one is that we expect AES Next, as Steve mentioned, is going to be neutral to positive by 2024. So that's a driver as well. So the drivers are our growth, which is part of our backlog, what we're talking about. And then we're also talking about the other things you mentioned, DPL rate case in IPL. Again, when we build all the wind and rate base that as well, you have the smart grid and DPL. So our growth projections are based on things that we have in the bag.
RichSunderland: Understood. And just one more for me. The unannounced asset sales, the incremental portion versus the prior plan, is that solely related to the coal exit? Or is there anything else you're looking at maybe LNG or elsewhere?
Andres Gluski: Look, we tend not to talk about exact assets that we're going to sell. As you know, we've been always turning capital. We've made a major transformation of our portfolio. I can think back, we peaked at probably 22,000 megawatts of coal. We're down to 7. We have basically sales for three of those, so we're down to 4. So yes, part of it is selling those coal assets, but also the continual churn that we have. So it might include other assets. We don't like to comment on them. But we will be hitting our 50% U.S., 50% renewables on an accelerated basis. And those sales help us achieve those goals.
Operator: The next question today comes from Insoo Kim from Goldman Sachs. Insoo, please go ahead. Your line is now open.
Insoo Kim: My first question, going back to that 9.2 gigawatts of backlog, it seems unchanged from the amount you've set out in the third quarter earnings. Just wondering if there's any read-through in the current inflationary environment, at least just for this year with any resistance or unwillingness for additional contracts to be signed for now.
Andres Gluski: That's a good question. No, we're not seeing that at all. We're seeing strong demand. I mean, of course, if the backlog remains constant. Yes, we commissioned quite a lot of projects between the third quarter and now. So already this year, we have 600 megawatts of new PPAs signed in the - under AES Clean Energy. We're seeing strong demand, especially for our tailored projects. So no, I don't think there's - what we're seeing in the market is, again, especially for differentiated products, there's a lot of demand. It's a matter of being able to have all the projects, let's say, in pipeline to be able to meet that demand, meet the structured product that they want. I would say that, yes, PPA prices are going up to reflect the increase in prices. But as you know, we've handled the supply constraints. First, I would say the importing of solar panels from China, PV panels from China, that we were able to first move out of China. And then second, we're diversifying the source of our polysilicon away from China as well. And so we're not seeing that as a constraint. As we said, we have an inventory, everything that we need to fulfill certainly this year's construction and also already assigned a lot of the backlog. So we feel we're in a good position.
Steve Coughlin: I would just also add on the number specifically. So as you've said, as Andres alluded to, there are subtractions coming from that backlog. So as we're completing construction, completing acquisitions, so it's about 1.5 gigawatts that we actually pulled out of the backlog because of completion. So net, there's significant additions going into.
Insoo Kim: Okay. That's both good color there. And maybe, Andres, just a broader question for you. I think three key points that you guys made on this call, the accelerated collection plan, the U.S. earnings being 50% earlier and then the IG plan. Those are all definitely good strategies. But I guess when we think about the investor base and how over the past few years the structure of growing EPS and having consistent dividend, all of that to mirror kind of a utility-like structure, I think it served you well as you've consistently executed at least over the past few years. Just wondering that when you think about strategy and the cost benefit of the actions you're taking on the asset sales and whatnot, maybe having a near-term dilutive impact, I just wonder - just wondering your strategy on that going forward and whether that's worth taking the hit now versus kind of trying to make a more consistent or a predictable growth profile.
Andres Gluski: Well, that's a great question. Look, we are laser-focused on delivering on our commitments. So we haven't changed our growth profile. Maybe to some extent, a little bit back-end loaded because of the dilution that we're putting in for earlier sales. However, I think this strategy has served us well. We've gone from a 2,200 megawatts of coal to completely exit by the end of 2025. And we think that's what a lot of new investors will like. So we think we'll have the triple investment-grade. We have a growing dividend. We are continually derisking as we get out. We are more concentrated in the U.S. and more concentrated on renewables. So we think this will be a company that will attract new additional shareholders and continue to serve our existing shareholders as well.
Operator: Our next question today comes from Julien Dumoulin-Smith from Bank of America. Julien, please go ahead. Your line is now open.
Julien Dumoulin-Smith: Excellent. Perfect. So just a couple of follow-up items here, if I can. So when you talk about asset sales, but more specifically driving to a neutral to positive outcome for AES Next, I mean, how does one do that? Are further divestments and sell-downs of your stakes part of how you manage those earnings? Or is this really about managing it organically to make sure that whether it's Fluence or other pieces of the business, they ultimately all cohesively drive an inflection in earnings contribution here in that '24 time frame? I just want to clarify that.
Andres Gluski: Yes. No, that is organic. We expect the business to turn around. A lot of what have occurred this year is onetime related to COVID, both on the supply chain. And that, of course, includes shipping as well. So we expect the business to turn around. As they said on their call, they expect to be at a gross margin run rate by the fourth quarter. And so we will hold them accountable for that and - through the board, and we continue to innovate together. So both the big companies are Fluence and Uplight, and we expect them both to execute on their plans, and that is inorganic. Again, what we're mentioning is that we always have many levers to pull. So what we're saying is by 2024, this will be positive or - neutral at worst and hopefully positive.
Steve Coughlin: Yes. And I would just add, Julien, if you think about the state of these businesses, they're investing in their product development and in their market expansion, the Digital IQ for Fluence, for example. So you'd expect them to be bottom line losses at this point of their life cycle. And as Andres said, they have a plan to get back to the gross margin targets by the fourth quarter. And then with the added volume, as that grows and the top line has been very successful, as the volume and the margin grows, then the bottom line of that business will overcome its R&D and G&A costs and get to a positive place.
Julien Dumoulin-Smith: Got it. And if I can come back to one of the underlying points. Obviously, you have a long-term earnings trajectory and growth in '22 is a little bit slower than that trajectory would otherwise indicate. So If you will, there's got to be a pickup at some point here. You've talked about some of the timing-related issues specifically in '22. How do you think about that sort of inflection in that catch-up period? Is there a bigger step-up in, say, '23 or '24? Just curious about the sort of the profile against that average CAGR number you threw out there?
Andres Gluski: Of course, we can't guide to '23, '24 specifically. But obviously, if you look at the number of PPAs we have signed, which will come online in '23, '24, that's the big driver behind that. If you also look at the rate cases we have in the utilities in the U.S., that's a big driver of that as well. So that's a pickup. I mean, realize that for '22, we're also making up for the change in how it is accounting, the accounting issue that we had for the share count. So actually, we are more than delivering on what we had set out, say, two years ago. So we're making up a $0.09 hit for this year based solely on how you account for the number of shares.
Steve Coughlin: Yes. And I think in addition to that, the opportunity to take advantage of the value in AES Andes and increasing the shares, that was significantly earnings and cash accretive immediately and will continue to be. So that's a big help to us, too.
Julien Dumoulin-Smith: In fact, if I may, and again, I know you don't want to provide longer-term guidance, but given what you just said a moment ago and you offset some of the '22 impacts that are somewhat technical here. I mean to what extent could we expect an extension or acceleration, if you will, implicitly, given what your success is on renewables, the ability to drive that cash up against your 7% to 9% in the later years? And what that means for sort of an exit rate trajectory subsequent to - in '25 and beyond? Do you get what I'm saying? If the plan is that sort of way what does that mean about the longer term?
Andres Gluski: Well, again, we're very optimistic about the longer term. We feel we're in the right place in the market. We have differentiated products. We have - are growing very fast in renewables. We're in the right markets. And we have upside potential from projects like in green hydrogen. We have a number of projects that we're progressing there. I think something that will give us additional juice is the pass of the climate plus plan, which will clarify what are the various subsidies or, if you want, tax percentages, tax - ITC, PTC, et cetera. So once that's clarified, that could give us upside. And then also, as Steve mentioned in his speech, a greater use of our facilities in Southern California, longer - and extension of it, which looks technically possible. So there certainly are upsides from that. What we're doing is saying, based on the situation that we're in today, this is our plan.
Ahmed Pasha: The only thing I would - Julien, I would add, this is Ahmed, is that back in March last year at our Investor Day, we had already assumed significant dilution because we said our goal is to go below 10% coal by '25. So our growth rate already had embedded at that time decent dilution. We showed that roughly $0.30 at that time. So I think now we are saying we are down to 0. So I think we - and the factors that we've discussed today, the positive things that go in our favor, like increased share in AES Andes, accelerated growth in renewables, things like that will help us offset that. So we don't expect any hockey stick, if you wish, type profile if that's - that was your question.
Steve Coughlin: And the share count change was baked in, Julien, to '24 and '25. So that's relative to the near-term guidance that's having a disproportionate effect on '22 and '23. But as of '24, those shares were assumed to be converted anyway, so they're already baked in.
Julien Dumoulin-Smith: Right. Clearly. But again, you give me no reason to be less confident here.
Operator: The next question today comes from Durgesh Chopra from Evercore ISI. Durgesh, please go ahead. Your line is now open.
Durgesh Chopra: I want to go back to the renewal backlog. And I think Steve, you said, I mean, the projects that were completed and taken out and then a few new adds. But there's a fair bit of gas in that 9.2 gigawatt number. Can you elaborate what - those are gas-fired plants? Or those are LNG projects? What does that comprise of?
Steve Coughlin: Yes. So we do have - so we have the project that we acquired in Panama in those numbers, the Gatun project is included. Otherwise, it's renewables.
Andres Gluski: And just to state, we own 25% of the gas project in Panama. So actually, we own higher percentages of the renewables.
Steve Coughlin: Yes. Yes, the whole amount is reflected here. But yes, from an economic standpoint, we have more of the renewables.
Durgesh Chopra: Okay. And maybe I could just follow up with Ahmed on that. Okay. And then just can you talk about sort of how should we think about the financial impacts if any of the community energy acquisition, I mean, in terms of financing costs and things like that on 2022 guidance and future earnings projections?
Andres Gluski: Yes. The community - look, we've grown our AES Clean Energy very quickly. We've merged our sPower with Distributed Energy. And then we've also acquired Community Energy. Now Community Energy comes with a pipeline of 10 gigawatts and 70 seasoned professionals. So it was very important at this time of rapid growth to have, first, the people, and second, the pipeline. So that's going to help our growth. Now in terms of their projects, when those will be offered to our customers and come online, they didn't - no backlog is coming from Community Energy. But certainly, we think that we can get better financing terms and better costs for equipment and improve execution. So that's upside from that. So I don't know if that answers your question. But basically, they're now part of that unit. And what they've done is help us accelerate that growth.
Operator: The next question today comes from Stephen Byrd from Morgan Stanley. Stephen, please go ahead. Your line is now open.
Stephen Byrd: I wanted to first just talk about Chile and just wondered if you could expand a bit on the dialogue you've had with the Chilean government in terms of helping the nation to decarbonize and pursuing green ammonia and just a little bit more color on the nature of that dialogue.
Andres Gluski: Sure. Well, let's see, we know the new President, Boric, through the Council of Americas. We know about him. I would say that it's very much aligned with our plans because he wants to continue to decarbonize the mining sector. That would fit in well with our project to supply the mining sector with hydrogen fuel for their large machinery. Also, it fits in very well with our planned shutdowns of our coal plants and the replacement for - with our pipeline of renewables. So I think we're very much aligned with that plan. And I think he wants to increase and accelerate the carbon tax. So we don't see - our contracts have pass-throughs for the higher carbon tax in most cases. And our renewables would benefit from it. So we felt there was a tremendous opportunity at AES Andes. And we're rolling a lot of new technology out in Chile in terms of batteries, in terms of the MAVERICK product for 5B. We have, we believe, the most efficient solar farm in the world. It's close to 38% in Chile. So we have a lot of good things happening in Chile, which weren't reflected in the market price. And in terms of the government, our plans are very much aligned with what they want to achieve.
Stephen Byrd: Very good. And then just another topic I've been getting some questions on is just El Salvador and the state of the economy. I guess I've been seeing that there's been fairly good economic growth in El Salvador. It's an important country for you. There is some concern though about the linkage with Bitcoin and just sort of the overall sort of growth and stability potential there. Wonder if you could just expand a little bit on what you're seeing in El Salvador and sort of the outlook there for your business there.
Andres Gluski: Look, our business in El Salvador has been very stable. The dollar is the currency of the country. So Bitcoin is not going to replace it. And certainly, with the volatility that Bitcoin has, it's not feasible. They did do one financing in Bitcoin that I'm aware of. So I don't see a change there. The biggest export of El Salvador is people, especially if you live in the D.C. area. So it's remittances that drive the economy. So a big factor there is that the U.S. economy is doing well. So I'd say the thing to watch in El Salvador is we always have to be on top of collections. And those are doing very well. So I know there's some noise, there's some political noise, and there have been some announcements like Bitcoin. But we don't see anything that would substantially affect our business.
Operator: [Operator Instructions] The next question today comes from Gregg Orrill from UBS. Gregg, please go ahead. Your line is now open.
Gregg Orrill: I'm sorry if you covered this, but what was the last 10% on - that relates to the exit of coal by '25? What steps would get you there?
Steve Coughlin: Yes. So that was our previously stated goal. So we're just above 20%, around 20% this year. And so our previously stated goal was to get below 10% by 2025. And that is through a combination of asset sales, retirements, fuel conversion. So what we've talked about today is really just a full exit by the end of 2025. So that's really the difference there.
Gregg Orrill: Can you be any more specific plant-wise?
Andres Gluski: Gregg, what I'd put it this way is, again, in the big - if you look over time, I mean, we've gone from 22 to 7. We've already signed about - of that 7, about half of it is already basically sold. And we have to just close the sales. So you're left with a number of plants. And there's a combination of replacements, let's say, for renewables. There's fuel conversions where we can start running those plants on gas. And those few cases where we - that does not work, then there's obviously the possibility of asset sales. So just like we've been doing, we're just accelerating that and saying, look, rather than have 10% linger on for a couple of years, let's just go ahead and bite the bullet and say we're out of coal by end of '25.
Operator: There are no additional questions registered at this time. So I'll hand the call back to Ahmed Pasha for closing remarks. Ahmed, please go ahead.
Ahmed Pasha: Thanks, everyone, for joining us on today's call. As always, the IR team will be available to answer any questions you may have. Thank you, and have a great day.
Operator: This concludes today's conference call. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Hello, and welcome to today's AES Corporation Q4 2021 Financial Review. My name is Bailey, and I will be the moderator for today's call. [Operator Instructions] I would now like to pass the conference over to Ahmed Pasha, Global Treasurer and Vice President of Investor Relations. Ahmed, please go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you, operator. Good morning, and welcome to our fourth quarter and full year 2021 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres. Andres?"
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our fourth quarter and full year 2021 financial review call. Today, I will cover our full year results and discuss our strategy and areas of focus for this year. Before discussing our 2021 results and future plans, I want to state that we do not see any significant impact on our portfolio from the outbreak of hostility in the Ukraine. Nonetheless, our thoughts and prayers go out to the Ukrainian people and government, and we hope for a speedy return to peace. Now turning our focus back to our business. Today marks an important and exciting milestone for AES with the announcement of our intention to fully exit coal by year-end 2025. This accelerated goal is a result of our success in growing our renewables portfolio. And our backlog gives us the confidence to take this step. As a leader in the global energy transition, we are committed to the goals of the Paris Agreement in achieving a net-zero economy. We will work with our stakeholders to ensure a smooth transition while meeting our regulatory obligations. Our exit from coal will be modestly dilutive, but we feel comfortable with our growth trajectory. And accordingly, we are reaffirming our annualized growth target of 7% to 9% in earnings and cash flow through 2025. Now moving on to our 2021 results and accomplishments. First, I am pleased to report our financial results, including adjusted earnings per share of $1.52, which was in line with our expectations. Our 2021 parent free cash flow of $839 million exceeded our expected range of $775 million to $825 million. Second, we signed contracts for 5 gigawatts of new renewable projects, significantly above our target of 3 to 4 gigawatts that we set last year. In fact, according to Bloomberg New Energy Finance, AES signed more renewable deals with corporate customers in 2021 than anyone else in the world. Included in these deals were two groundbreaking arrangements to provide renewable energy on an hour-by-hour basis, 24 hours a day, 7 days a week signed with Google and Microsoft. Third, Fluence successfully completed their IPO in November and have no foreseeable need for external funding to achieve their strategic and financial objectives. Furthermore, Fluence has made progress towards mitigating the supply chain challenges they have faced, which I shall discuss shortly. Finally, safety is our most important value. I am very proud to report that our safety performance in 2021 was the best in our 40-year history, with no major incidents recorded among roughly 25,000 AES people, contractors and construction workers. Today, I will be discussing two things: first, executing today; and second, investing for the future. Beginning with executing today on Slide 4. Even as we are transitioning to a carbon-free future, we are laser-focused on delivering on our commitments. Our business model has proven itself to be resilient and enables us to deliver predictable results. For example, 85% of our adjusted PTC is from long-term contracted generation and utilities and 88% is in U.S. dollars, with the remaining 12% split between euros and various Latin American currencies. Similarly, we're largely insulated from macroeconomic headwinds, such as rising inflation and interest rates. As shown on Slide 5, 83% of our revenue is from businesses that have indexation clauses or are hedged to limit the impact from inflation. At the same time, almost 90% of our interest rate exposure is fixed or hedged, protecting us from the impact of rising interest rates. Next, turning to Slide 6. In January, we completed a tender to acquire the publicly-traded shares of AES Andes, bringing our ownership from 67% to 99% today. This was motivated by our conviction in the underlying strength of the business, which is highly contracted, predominantly in U.S. dollars and transitioning to low-carbon generation. This transaction is immediately earnings and cash flow accretive. Moving to Slide 7. We now have a backlog of 9.2 gigawatts, including the 5 gigawatts we signed in 2021. About 3/4 of the 5 gigawatts is in the U.S., with the vast majority signed with C&I customers and to grow the rate base at our AES Indiana utility. We have secured supply arrangements for the bulk of our current backlog. In 2021, we successfully added 2.1 gigawatts to our portfolio without any material delays or cost overrun. This execution demonstrates the robust nature of our supply chain and the strength of our relationships with our suppliers. For example, we secured Samsung battery for many of our new energy storage facilities to alleviate some of the supply chain challenges faced by Fluence. Being able to switch to different battery suppliers shows the inherent flexibility of their Gen 6 product. As we look towards our 2.3 gigawatts of new projects coming online in 2022, two-third of which is in the U.S., we do not expect any significant delays or supply chain disruptions. We remain confident in our ability to complete our projects under construction on time and on budget. Moving to our second theme, investing for the future on Slide 8. Our actions today ensure that we will be able to take full advantage of the unprecedented transformation of our sector. One clear example is the 5 gigawatts of new PPAs that we signed last year, an increase of 65% from 2020. For full year '22, we expect to sign 4.5 to 5.5 gigawatts of new renewables under long-term contracts. We are seeing strong demand for renewables. And so far this year, we have already signed more than 600 megawatts of new contracts. We expect our portfolio of operating renewable assets to more than double from approximately 13 gigawatts to 26 gigawatts by 2026. Despite any current headwinds for our sector, such as delays in legislation and supply chain issues, we see very strong demand for low-carbon energy, especially for tailored products, such as our 24/7 renewable offering. That is why we have been investing in growing our pipeline of future projects to ensure that we're able to meet our customers' growing demand for AES services. As you can see on Slide 9, we now have a development pipeline of 59 gigawatts, which we believe is the second largest among U.S. renewable developers. Our pipeline includes almost 10 gigawatts in the U.S. that are ready to bid. This robust pipeline provides us with the projects we need to deliver on our backlog and to continue to build on our competitive position in the U.S. As a result, we're accelerating our goal of increasing the proportion of earnings coming from our U.S. businesses to 50% by two years from 2025 to 2023. We are also investing for the future by growing the rate base at our U.S. utilities by 9% annually, while delivering safe, reliable and affordable services to our customers. As you can see on Slide 10, AES Indiana is executing on the approved plan to retire two coal units, which we will replace with nearly 500 megawatts of new renewable generation. We have already started our next integrated resource plan process, which could include additional retirement or fuel conversions for the remaining 1 gigawatt of coal generation. At AES Ohio, we're executing on our smart grid and transmission investment programs approved in 2021. AES Ohio is also in the midst of a distribution rate case and recently completed the hearing. AES Ohio's base distribution rates have been the lowest in the state for the past five years. In fact, as of the end of 2021, AES Ohio's rates were 16% lower than the next lowest utility in the state and even with the requested rate increase, would remain the lowest. Turning to Slide 11. Another way we're investing for the future is by developing and incubating new products and businesses' platforms through AES Next. Our investment in AES Next help our core businesses be more innovative and competitive and drive value for our customers and shareholders. Turning to Slide 12. The most mature initiative under AES Next today is Fluence, the leading energy storage technology company. In 2021, Fluence completed their IPO with $1 billion in capital raised to invest in developing their products and supply chain as well as their digital platform. As of December 31, Fluence had 4.2 gigawatts of energy storage products deployed and contracted and a signed backlog of $1.9 billion. Additionally, Fluence's digital platform, Fluence IQ, now has 6 gigawatts contracted, of which more than 80% is with third-party customers. Over the past several months, Fluence has been dealing with short-term challenges stemming from COVID-19-related supply chain issues. Their management team has taken proactive actions to address these challenges, including diversifying battery suppliers, signing and shipping agreements and building out their in-house supply chain team. Overall, demand for energy storage remains robust, and Fluence is well positioned as a market leader. We see significant opportunity for them to continue to grow and remain confident that they will execute on their long-term plan, which will deliver value to their shareholders. AES Next is also working to develop and incubate other technologies that help accelerate the deployment of renewables, as shown on Slide 13. One example is our investment in 5B, which has a prefabricated solar solution called MAVERICK, that is hurricane wind-resistant and allows projects to be built in 1/3 of the time and on 1/2 as much land. This innovative product is currently being rolled out in Australia, Chile, the Dominican Republic, India, Panama and the U.S. Turning to Slide 14. We're one of a small number of company in our sector with targets that are fully aligned with the Paris Agreement according to the Transition Pathway Initiative. We already have a goal to have net-zero emissions from electricity by 2040. And as I mentioned earlier, we're excited to announce our intent to exit coal completely by the end of 2025, subject to receiving necessary approvals. We expect to achieve this objective through a combination of retirement, fuel conversions and asset sales. In summary, we have consolidated our position as a leader of innovation in the industry and accelerated the decarbonization of our portfolio, while delivering attractive returns to our shareholders. With that, I now turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will cover the following key topics: our financial performance during 2021, our parent capital allocation and our 2022 guidance and expectations through 2025. As Andres mentioned, our results for 2021 show our continued progress in leading the energy transition, while achieving our financial goals. We delivered strong financial results even while absorbing the previously discussed impact from the share count adjustment related to the equity units issued last year. Overall, the strong growth of our core energy business, which includes generation and utilities, gives us confidence that we will continue to achieve our earnings and cash flow target. Turning to Slide 16. Full year 2021 adjusted EPS was $1.52, $0.08 higher than 2020. 2020 adjusted EPS of $1.44 included $0.03 of dilution from AES Next, implying that our core business generated adjusted EPS of $1.47. In 2021, our core business grew by $0.21 to $1.68, primarily as a result of higher contributions from new renewables businesses, improved operations at both U.S. generation and MCAC and lower parent interest. Our 2021 results of $1.52 include the $0.07 impact due to a higher share count as a result of the accounting adjustment for the equity unit and the dilution from AES Next where we are investing in expanding our high-growth technology businesses. The impact from ASX Next was $0.03 higher than our prior expectation due to the nonrecurring COVID-related supply chain issues at Fluence. Going forward, we plan to manage the AES Next portfolio such that these businesses will yield a neutral to positive contribution to AES' earnings by 2024. Turning to Slide 17. Adjusted pretax contribution or PTC was $1.4 billion for the year, an increase of $171 million and 14% growth over 2020. I'll cover our results in more detail over the next 4 slides, beginning with the U.S. and Utilities SBU on Slide 18. Our increased investments in the U.S. show PTC growth of $155 million, a 31% increase over 2020. As of year-end 2021, the U.S. represented 41% of our adjusted PTC, up from 34% in 2020. About half of this growth was driven by new businesses at AES Clean Energy that came online in 2021. And the rest of the increase was from our legacy Southland units, which remained a key contributor to the stability of the California grid during the peak summer season and delivered solid growth from increased dispatch and attractive market prices. We continue to see the potential for some of our legacy Southland units to support the energy transition in California for several years to come. Lower PTC at our South America SBU was primarily driven by regulatory adjustments and recovery of expenses from customers that were recorded in 2020. Hydrology was not a major driver as we benefited from the increased diversity of our generation portfolio and favorable hydrological conditions in Colombia offset drier conditions in Brazil. Higher PTC at our MCAC SBU reflects higher LNG sales in both Panama and the Dominican Republic as we benefited from higher contract levels at our LNG terminals. We now have roughly 80% of our LNG capacity contracted, leaving approximately $20 million to $30 million of potential annual upside to our longer-term expectations. Finally, in Eurasia, higher PTC was primarily driven by higher contributions from Bulgaria due to improved operating performance at Maritza and increased revenue at our wind farm, which benefited from favorable market prices. Now let's turn to review of how we allocated our capital in 2021 on Slide 22. Beginning on the left-hand side, sources reflect $2.3 billion of total discretionary cash. And I'm pleased to report that this includes parent free cash flow of $839 million, which exceeded the top end of our guidance expectations. The remaining sources are largely in line with our prior disclosures except the $295 million in temporary drawings under our revolver, which we utilized to fund our accelerating growth in clean energy. Moving to the uses on the right-hand side. We allocated $450 million of our discretionary cash to our dividend. We invested nearly $1.8 billion in our subsidiaries, of which approximately two-third was in the U.S. As Andres mentioned, we expect the relative share of our allocation for the U.S. to continue to grow. And I'm glad to report that we now expect to reach our goal of 50% of our earnings coming from the U.S. in 2023, two years earlier than our previous target in 2025. Now turning to our credit profile on Slide 23. As a result of the successful execution of our strategy over the last few years, our balance sheet continues to be in a much stronger position. We significantly reduced debt while growing our parent free cash flow. At the end of 2021, our parent free cash flow to net debt ratio was approximately 23%, which is well above the 20% threshold required for an investment-grade rating. We expect this ratio to continue to improve over time putting us in BBB territory by 2025. We are in active discussions with Moody's and remain optimistic that we will be upgraded this year. Turning to our guidance and expectations beginning on Slide 24. We are reaffirming our annualized growth target of 7% to 9% in both adjusted EPS and parent free cash flow through 2025 off a base year of 2020. Today, we are initiating guidance for 2022 adjusted EPS of $1.55 to $1.65. Key drivers of our expected growth include the approximate $0.09 benefit from our higher ownership of AES Andes, which we increased to 99%, as Andres mentioned earlier. This transaction is immediately significantly accretive on both an earnings and cash flow basis. And with a simplified shareholder base, AES Andes will be able to more efficiently execute on its substantial renewables pipeline. Our adjusted - our 2022 adjusted EPS will also benefit from continued growth in renewables and higher contributions from existing operations, adding $0.10. This growth is expected to be partially offset by $0.11 of impacts from the higher adjusted tax rate, a full year of a higher share count due to the accounting adjustment for the equity units issued in 2021 and assumed dilution from planned asset sales. Our target for this year has increased to reflect our efforts to further decarbonize and fully exit coal by the end of 2025. I would also note that we previously expected the pending distribution rate case at DPL to be resolved earlier in the year. However, we now expect resolution later this year and, therefore, have assumed only a small contribution in 2022. Turning to Slide 25. Parent free cash flow for 2022 is expected to be $860 million to $910 million, in line with our annualized growth target of 7% to 9%. Now turning to our 2022 parent capital allocation plan on Slide 26. Beginning with approximately $1.5 billion of sources on the left-hand side, in addition to parent free cash flow, we expect to generate $500 million to $700 million in asset sale proceeds. Roughly half of this is from already announced sales in Vietnam and Jordan, and the remaining portion is expected to come from additional asset sales that have not yet been announced. Recycling of capital is an integral part of our capital allocation framework. And as we have done in the past, we will deploy asset sale proceeds to achieve our strategic objectives and maximize shareholder value. Now to the uses on the right-hand side. We expect to allocate $494 million to our shareholder dividend, which reflects our announced 5% increase. We are also projecting investments of roughly $1 billion in our subsidiaries for growth, of which about 3/4 will be allocated to the U.S. to renewables and utilities. Finally, turning to our 4-year capital allocation plan through 2025 beginning on Slide 27. Our financial strategy is centered around maintaining a strong investment-grade rated balance sheet, while investing in our growth to achieve our strategic and financial objectives. Our total growth investments for 2022 through 2025 have increased to $3.8 billion. We expect to continue to increase our dividend 4% to 6% annually, in line with our prior guidance. As you can see on Slide 28, we plan to fund this $6 billion with 60% parent free cash flow and the remaining 40% will be from asset sale proceeds and future parent debt issuances. Relative to our prior plan, you may notice that we have increased asset sale proceeds by $500 million and future parent debt by $300 million, which will be utilized to fund our future growth and repay drawings on our revolver that funded the higher growth from 2021. In summary, we accelerated AES growth in 2021 and executed on our financial and strategic commitments. Going forward, we will continue to deliver on our strategy, including executing on asset sales to decarbonize and exit coal, maintaining the strength of our balance sheet and allocating capital to maximize per share value for our shareholders. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. As you can see, we're not only delivering on our commitments, but accelerating our transformation. Our near-term actions will enable us to achieve our three goals for creating additional shareholder value: first, attaining an investment-grade rating from Moody's in 2022; second, increasing the proportion of earnings from the U.S. to 50% by 2023; and third, exiting coal generation by the end of 2025. With that, I'd like to open up the call to questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] So our first question today comes from Angie Storozynski from Seaport. Angie, please go ahead. Your line is now open."
},
{
"speaker": "Angie Storozynski",
"text": "So my first question, and I see your disclosures on sensitivities, but I'm just wondering if you could describe the impact of the higher power price environment that we're seeing pretty much everywhere in the world on your both existing assets and growth prospects. I mean any sort of increased economic dispatch and how - and the appeal of renewables and how those are embedded in your '22 guidance and long-term growth."
},
{
"speaker": "Andres Gluski",
"text": "Angie, thank you. Basically, as you know, we're highly contracted. But what we're seeing in terms of higher prices for oil-based generation in many of our markets that favors us because we're much more hydro renewables and even coal. In places like where we have a big plant in Europe and Bulgaria, our plant is now very much cheaper than the other generations in the country. So we're seeing improved prospects for a lot of our generation because we are not a big generator using international price gas. Most of our gas units are running on Henry Hub or almost all. So we're basically competing against those very high prices. So even though we're highly contracted, there's always some margin, so that's positive. It's also positive on the renewable front and on the innovative front because I think people are seeing that renewables in an environment where gas prices can be more volatile is favorable. So in the net-net, overall, it's positive for us in the short run and certainly even more so in the long run because, as I said, we're highly contracted."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. Just one follow-up. How about the LNG business? Is there any near-term or longer-term impact?"
},
{
"speaker": "Andres Gluski",
"text": "Well, we're contracted now in Panama and the Dominican Republic. Basically, it had Henry Hub, Henry Hub plus, of course. So it's favorable to us in that prospect. Now when those contracts burn off in a couple of years, then we have to see when the recontracting levels will be. And hopefully, there will be more supply of gas at that point in time."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And just one other question. So you show the impact - the drag on earnings from asset sales. If you could comment a little bit, does that include any of those accelerated coal plant shutdowns or sales? Again, I'm just trying to reconcile the earnings impact with the transactions already announced."
},
{
"speaker": "Andres Gluski",
"text": "Go, Steve."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Angie, this is Steve. So yes, I mean, we are - consistent with the announcement to exit coal, we are increasing our total asset sale plan to $1 billion and then have increased the sales target this year to $500 million to $700 million. So yes, it does reflect in part the announcement that we made today. We had prior announcements in the past about Vietnam and Jordan. So that's a portion of it. But the additional portion reflects the updated strategy to accelerate our exit."
},
{
"speaker": "Andres Gluski",
"text": "Just to be clear, it's fully reflected. So some of it has been included in the past. It reflects 100% of the additional."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And my last question on Ohio, a delay in resolution of your rate case. Is there - I mean, is there something that we should be concerned about? Or is this just that the process takes longer?"
},
{
"speaker": "Ahmed Pasha",
"text": "Sure. Angie, this is Ahmed. I think no, I don't think there's - it's a process because previously, we were hoping to settle. And now we are going through - because we could not reach this settlement, although the staff had recommended a reasonable increase in response to our request. And one of the intervenors OCC subsequently argued that the rate freeze should remain intact. And now we are going through the litigation process. But we think our request is fair. And is driven by the costs which are out of our control. And frankly, primarily to deliver the more reliable and economic power to our customers. So we think we will get through this by mid this year with the approval from the commission. So net-net, our rates are the lowest in the state and will remain lowest with this requested increase. So we feel pretty good that commission will approve our request by mid- to late '22."
},
{
"speaker": "Andres Gluski",
"text": "So in summary, it's just a timing issue."
},
{
"speaker": "Ahmed Pasha",
"text": "Yes."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. It's the timing. And in fact, the PUCO staff did support an increase as part of the process already."
},
{
"speaker": "Ahmed Pasha",
"text": "Yes, they did recommend."
},
{
"speaker": "Operator",
"text": "The next question today comes from Rich Sunderland from JPMorgan. Rich, please go ahead. Your line is now open."
},
{
"speaker": "RichSunderland",
"text": "Maybe starting on 2022 guidance. Could you walk from the outlook a year ago at the Investor Day to now in terms of AES Next, the rate case and other factors separate from the equity units issue you called out in terms of changes from the 7% to 9% growth rate versus the growth embedded in the current guidance?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Sure. This is Steve. So really, the two primary drivers - well, a couple. So our growth is faster. So we've accelerated our renewables growth. Now that's been offset by the additional share count, of course, which we talked about last year. Now again, we took advantage of the value opportunity with Andes. So we've largely offset the share price - share count dilution with our acquisition of the additional shares in Andes. So really, what's been changed on a net basis is more on the asset sale program, which we just talked about and how we are accelerating our decarbonization and our exit of coal. And then the other real driver is the - is what we also just talked about, which is the DPL rates, which we previously assumed would be in effect early this year and now are assuming late this year. So those are really the two primary drivers. And then there is an uptick in the tax rate from the past. At this point, we're guiding to 26% to 28% on the tax rate. So that's a piece of the story as well."
},
{
"speaker": "RichSunderland",
"text": "Understood. So then just kind of walking forward in terms of regaining the 7% to 9% trajectory in the second half of the plan, I guess you called out the rate cases and timing factor. Could you just speak a little bit more to how you see the growth coming to kind of regain the 7% to 9% earnings trajectory?"
},
{
"speaker": "Andres Gluski",
"text": "Sure. This is Andres. I'll give a sort of high level. Look, we have a backlog of 9.2 gigawatts of projects. This year, we'll be commissioning 2.3 gigawatts. So obviously, in a steady state, these two have to be about equal. And so what you're going to have is a real pickup in commissionings '23, '24 going forward. So we feel very confident about that because those are already signed projects. We already have the sites, and it's a question of executing on building them. The other one is that we expect AES Next, as Steve mentioned, is going to be neutral to positive by 2024. So that's a driver as well. So the drivers are our growth, which is part of our backlog, what we're talking about. And then we're also talking about the other things you mentioned, DPL rate case in IPL. Again, when we build all the wind and rate base that as well, you have the smart grid and DPL. So our growth projections are based on things that we have in the bag."
},
{
"speaker": "RichSunderland",
"text": "Understood. And just one more for me. The unannounced asset sales, the incremental portion versus the prior plan, is that solely related to the coal exit? Or is there anything else you're looking at maybe LNG or elsewhere?"
},
{
"speaker": "Andres Gluski",
"text": "Look, we tend not to talk about exact assets that we're going to sell. As you know, we've been always turning capital. We've made a major transformation of our portfolio. I can think back, we peaked at probably 22,000 megawatts of coal. We're down to 7. We have basically sales for three of those, so we're down to 4. So yes, part of it is selling those coal assets, but also the continual churn that we have. So it might include other assets. We don't like to comment on them. But we will be hitting our 50% U.S., 50% renewables on an accelerated basis. And those sales help us achieve those goals."
},
{
"speaker": "Operator",
"text": "The next question today comes from Insoo Kim from Goldman Sachs. Insoo, please go ahead. Your line is now open."
},
{
"speaker": "Insoo Kim",
"text": "My first question, going back to that 9.2 gigawatts of backlog, it seems unchanged from the amount you've set out in the third quarter earnings. Just wondering if there's any read-through in the current inflationary environment, at least just for this year with any resistance or unwillingness for additional contracts to be signed for now."
},
{
"speaker": "Andres Gluski",
"text": "That's a good question. No, we're not seeing that at all. We're seeing strong demand. I mean, of course, if the backlog remains constant. Yes, we commissioned quite a lot of projects between the third quarter and now. So already this year, we have 600 megawatts of new PPAs signed in the - under AES Clean Energy. We're seeing strong demand, especially for our tailored projects. So no, I don't think there's - what we're seeing in the market is, again, especially for differentiated products, there's a lot of demand. It's a matter of being able to have all the projects, let's say, in pipeline to be able to meet that demand, meet the structured product that they want. I would say that, yes, PPA prices are going up to reflect the increase in prices. But as you know, we've handled the supply constraints. First, I would say the importing of solar panels from China, PV panels from China, that we were able to first move out of China. And then second, we're diversifying the source of our polysilicon away from China as well. And so we're not seeing that as a constraint. As we said, we have an inventory, everything that we need to fulfill certainly this year's construction and also already assigned a lot of the backlog. So we feel we're in a good position."
},
{
"speaker": "Steve Coughlin",
"text": "I would just also add on the number specifically. So as you've said, as Andres alluded to, there are subtractions coming from that backlog. So as we're completing construction, completing acquisitions, so it's about 1.5 gigawatts that we actually pulled out of the backlog because of completion. So net, there's significant additions going into."
},
{
"speaker": "Insoo Kim",
"text": "Okay. That's both good color there. And maybe, Andres, just a broader question for you. I think three key points that you guys made on this call, the accelerated collection plan, the U.S. earnings being 50% earlier and then the IG plan. Those are all definitely good strategies. But I guess when we think about the investor base and how over the past few years the structure of growing EPS and having consistent dividend, all of that to mirror kind of a utility-like structure, I think it served you well as you've consistently executed at least over the past few years. Just wondering that when you think about strategy and the cost benefit of the actions you're taking on the asset sales and whatnot, maybe having a near-term dilutive impact, I just wonder - just wondering your strategy on that going forward and whether that's worth taking the hit now versus kind of trying to make a more consistent or a predictable growth profile."
},
{
"speaker": "Andres Gluski",
"text": "Well, that's a great question. Look, we are laser-focused on delivering on our commitments. So we haven't changed our growth profile. Maybe to some extent, a little bit back-end loaded because of the dilution that we're putting in for earlier sales. However, I think this strategy has served us well. We've gone from a 2,200 megawatts of coal to completely exit by the end of 2025. And we think that's what a lot of new investors will like. So we think we'll have the triple investment-grade. We have a growing dividend. We are continually derisking as we get out. We are more concentrated in the U.S. and more concentrated on renewables. So we think this will be a company that will attract new additional shareholders and continue to serve our existing shareholders as well."
},
{
"speaker": "Operator",
"text": "Our next question today comes from Julien Dumoulin-Smith from Bank of America. Julien, please go ahead. Your line is now open."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Excellent. Perfect. So just a couple of follow-up items here, if I can. So when you talk about asset sales, but more specifically driving to a neutral to positive outcome for AES Next, I mean, how does one do that? Are further divestments and sell-downs of your stakes part of how you manage those earnings? Or is this really about managing it organically to make sure that whether it's Fluence or other pieces of the business, they ultimately all cohesively drive an inflection in earnings contribution here in that '24 time frame? I just want to clarify that."
},
{
"speaker": "Andres Gluski",
"text": "Yes. No, that is organic. We expect the business to turn around. A lot of what have occurred this year is onetime related to COVID, both on the supply chain. And that, of course, includes shipping as well. So we expect the business to turn around. As they said on their call, they expect to be at a gross margin run rate by the fourth quarter. And so we will hold them accountable for that and - through the board, and we continue to innovate together. So both the big companies are Fluence and Uplight, and we expect them both to execute on their plans, and that is inorganic. Again, what we're mentioning is that we always have many levers to pull. So what we're saying is by 2024, this will be positive or - neutral at worst and hopefully positive."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And I would just add, Julien, if you think about the state of these businesses, they're investing in their product development and in their market expansion, the Digital IQ for Fluence, for example. So you'd expect them to be bottom line losses at this point of their life cycle. And as Andres said, they have a plan to get back to the gross margin targets by the fourth quarter. And then with the added volume, as that grows and the top line has been very successful, as the volume and the margin grows, then the bottom line of that business will overcome its R&D and G&A costs and get to a positive place."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. And if I can come back to one of the underlying points. Obviously, you have a long-term earnings trajectory and growth in '22 is a little bit slower than that trajectory would otherwise indicate. So If you will, there's got to be a pickup at some point here. You've talked about some of the timing-related issues specifically in '22. How do you think about that sort of inflection in that catch-up period? Is there a bigger step-up in, say, '23 or '24? Just curious about the sort of the profile against that average CAGR number you threw out there?"
},
{
"speaker": "Andres Gluski",
"text": "Of course, we can't guide to '23, '24 specifically. But obviously, if you look at the number of PPAs we have signed, which will come online in '23, '24, that's the big driver behind that. If you also look at the rate cases we have in the utilities in the U.S., that's a big driver of that as well. So that's a pickup. I mean, realize that for '22, we're also making up for the change in how it is accounting, the accounting issue that we had for the share count. So actually, we are more than delivering on what we had set out, say, two years ago. So we're making up a $0.09 hit for this year based solely on how you account for the number of shares."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And I think in addition to that, the opportunity to take advantage of the value in AES Andes and increasing the shares, that was significantly earnings and cash accretive immediately and will continue to be. So that's a big help to us, too."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "In fact, if I may, and again, I know you don't want to provide longer-term guidance, but given what you just said a moment ago and you offset some of the '22 impacts that are somewhat technical here. I mean to what extent could we expect an extension or acceleration, if you will, implicitly, given what your success is on renewables, the ability to drive that cash up against your 7% to 9% in the later years? And what that means for sort of an exit rate trajectory subsequent to - in '25 and beyond? Do you get what I'm saying? If the plan is that sort of way what does that mean about the longer term?"
},
{
"speaker": "Andres Gluski",
"text": "Well, again, we're very optimistic about the longer term. We feel we're in the right place in the market. We have differentiated products. We have - are growing very fast in renewables. We're in the right markets. And we have upside potential from projects like in green hydrogen. We have a number of projects that we're progressing there. I think something that will give us additional juice is the pass of the climate plus plan, which will clarify what are the various subsidies or, if you want, tax percentages, tax - ITC, PTC, et cetera. So once that's clarified, that could give us upside. And then also, as Steve mentioned in his speech, a greater use of our facilities in Southern California, longer - and extension of it, which looks technically possible. So there certainly are upsides from that. What we're doing is saying, based on the situation that we're in today, this is our plan."
},
{
"speaker": "Ahmed Pasha",
"text": "The only thing I would - Julien, I would add, this is Ahmed, is that back in March last year at our Investor Day, we had already assumed significant dilution because we said our goal is to go below 10% coal by '25. So our growth rate already had embedded at that time decent dilution. We showed that roughly $0.30 at that time. So I think now we are saying we are down to 0. So I think we - and the factors that we've discussed today, the positive things that go in our favor, like increased share in AES Andes, accelerated growth in renewables, things like that will help us offset that. So we don't expect any hockey stick, if you wish, type profile if that's - that was your question."
},
{
"speaker": "Steve Coughlin",
"text": "And the share count change was baked in, Julien, to '24 and '25. So that's relative to the near-term guidance that's having a disproportionate effect on '22 and '23. But as of '24, those shares were assumed to be converted anyway, so they're already baked in."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Right. Clearly. But again, you give me no reason to be less confident here."
},
{
"speaker": "Operator",
"text": "The next question today comes from Durgesh Chopra from Evercore ISI. Durgesh, please go ahead. Your line is now open."
},
{
"speaker": "Durgesh Chopra",
"text": "I want to go back to the renewal backlog. And I think Steve, you said, I mean, the projects that were completed and taken out and then a few new adds. But there's a fair bit of gas in that 9.2 gigawatt number. Can you elaborate what - those are gas-fired plants? Or those are LNG projects? What does that comprise of?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So we do have - so we have the project that we acquired in Panama in those numbers, the Gatun project is included. Otherwise, it's renewables."
},
{
"speaker": "Andres Gluski",
"text": "And just to state, we own 25% of the gas project in Panama. So actually, we own higher percentages of the renewables."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Yes, the whole amount is reflected here. But yes, from an economic standpoint, we have more of the renewables."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay. And maybe I could just follow up with Ahmed on that. Okay. And then just can you talk about sort of how should we think about the financial impacts if any of the community energy acquisition, I mean, in terms of financing costs and things like that on 2022 guidance and future earnings projections?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. The community - look, we've grown our AES Clean Energy very quickly. We've merged our sPower with Distributed Energy. And then we've also acquired Community Energy. Now Community Energy comes with a pipeline of 10 gigawatts and 70 seasoned professionals. So it was very important at this time of rapid growth to have, first, the people, and second, the pipeline. So that's going to help our growth. Now in terms of their projects, when those will be offered to our customers and come online, they didn't - no backlog is coming from Community Energy. But certainly, we think that we can get better financing terms and better costs for equipment and improve execution. So that's upside from that. So I don't know if that answers your question. But basically, they're now part of that unit. And what they've done is help us accelerate that growth."
},
{
"speaker": "Operator",
"text": "The next question today comes from Stephen Byrd from Morgan Stanley. Stephen, please go ahead. Your line is now open."
},
{
"speaker": "Stephen Byrd",
"text": "I wanted to first just talk about Chile and just wondered if you could expand a bit on the dialogue you've had with the Chilean government in terms of helping the nation to decarbonize and pursuing green ammonia and just a little bit more color on the nature of that dialogue."
},
{
"speaker": "Andres Gluski",
"text": "Sure. Well, let's see, we know the new President, Boric, through the Council of Americas. We know about him. I would say that it's very much aligned with our plans because he wants to continue to decarbonize the mining sector. That would fit in well with our project to supply the mining sector with hydrogen fuel for their large machinery. Also, it fits in very well with our planned shutdowns of our coal plants and the replacement for - with our pipeline of renewables. So I think we're very much aligned with that plan. And I think he wants to increase and accelerate the carbon tax. So we don't see - our contracts have pass-throughs for the higher carbon tax in most cases. And our renewables would benefit from it. So we felt there was a tremendous opportunity at AES Andes. And we're rolling a lot of new technology out in Chile in terms of batteries, in terms of the MAVERICK product for 5B. We have, we believe, the most efficient solar farm in the world. It's close to 38% in Chile. So we have a lot of good things happening in Chile, which weren't reflected in the market price. And in terms of the government, our plans are very much aligned with what they want to achieve."
},
{
"speaker": "Stephen Byrd",
"text": "Very good. And then just another topic I've been getting some questions on is just El Salvador and the state of the economy. I guess I've been seeing that there's been fairly good economic growth in El Salvador. It's an important country for you. There is some concern though about the linkage with Bitcoin and just sort of the overall sort of growth and stability potential there. Wonder if you could just expand a little bit on what you're seeing in El Salvador and sort of the outlook there for your business there."
},
{
"speaker": "Andres Gluski",
"text": "Look, our business in El Salvador has been very stable. The dollar is the currency of the country. So Bitcoin is not going to replace it. And certainly, with the volatility that Bitcoin has, it's not feasible. They did do one financing in Bitcoin that I'm aware of. So I don't see a change there. The biggest export of El Salvador is people, especially if you live in the D.C. area. So it's remittances that drive the economy. So a big factor there is that the U.S. economy is doing well. So I'd say the thing to watch in El Salvador is we always have to be on top of collections. And those are doing very well. So I know there's some noise, there's some political noise, and there have been some announcements like Bitcoin. But we don't see anything that would substantially affect our business."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] The next question today comes from Gregg Orrill from UBS. Gregg, please go ahead. Your line is now open."
},
{
"speaker": "Gregg Orrill",
"text": "I'm sorry if you covered this, but what was the last 10% on - that relates to the exit of coal by '25? What steps would get you there?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So that was our previously stated goal. So we're just above 20%, around 20% this year. And so our previously stated goal was to get below 10% by 2025. And that is through a combination of asset sales, retirements, fuel conversion. So what we've talked about today is really just a full exit by the end of 2025. So that's really the difference there."
},
{
"speaker": "Gregg Orrill",
"text": "Can you be any more specific plant-wise?"
},
{
"speaker": "Andres Gluski",
"text": "Gregg, what I'd put it this way is, again, in the big - if you look over time, I mean, we've gone from 22 to 7. We've already signed about - of that 7, about half of it is already basically sold. And we have to just close the sales. So you're left with a number of plants. And there's a combination of replacements, let's say, for renewables. There's fuel conversions where we can start running those plants on gas. And those few cases where we - that does not work, then there's obviously the possibility of asset sales. So just like we've been doing, we're just accelerating that and saying, look, rather than have 10% linger on for a couple of years, let's just go ahead and bite the bullet and say we're out of coal by end of '25."
},
{
"speaker": "Operator",
"text": "There are no additional questions registered at this time. So I'll hand the call back to Ahmed Pasha for closing remarks. Ahmed, please go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thanks, everyone, for joining us on today's call. As always, the IR team will be available to answer any questions you may have. Thank you, and have a great day."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. You may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AES | 3 | 2,021 | 2021-11-04 09:50:00 | Operator: Hello, and welcome to AES Corporation third quarter 2021, final review. My name is Juan, and I will be coordinating your call today. [Operator Instructions] I will now hand over to your host, Ahmed Pasha, Global Treasurer, Vice President of Investor Relations to begin with. Ahmed, please go ahead.
Ahmed Pasha: Thank you, operator. Good morning and welcome to our Third Quarter 2021 Financial Review Call. Our press release, presentation, and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website, along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer, Steve Coughlin, our Chief Financial Officer, and other senior members of our management team. With that, I will turn the call over to Andres. Andres.
Andres Gluski: Good morning, everyone. And thank you for joining our third quarter financial review call. Before discussing our progress since our last call, I want to introduce our new Chief Financial Officer, Steve Coughlin. Steve has been with AES for 14 years and has served in a variety of roles, including as CEO of Fluence, and most recently, as head of both Strategy and Financial Planning. I am happy to report that we're making excellent progress on our strategic and financial goals. And remain on track to deliver on our 7% to 9% annualized growth in adjusted EPS and parent-free cash flow through 2025. We had a strong third quarter with adjusted EPS of $0.5 and 19% increase versus the same quarter last year. We expect to deliver on our full-year guidance, even with a $0.07 non-cash impact from an updated accounting interpretation related to the equity units of a convert we issued earlier this year. Steve will provide more details shortly. Today I will discuss both the growth in our core business, as well as the strategy and evolution of our innovation business, called AES Next. We see ourselves as the leading integrator of new technologies. The two parts of our portfolio are mutually beneficial to one another and enabled us to deliver greater total returns to our shareholders. More specifically, and as we have proven, our core business platforms provide the optimal environment for exponentially growing technology startups. At the same time, our AES Next businesses provide us with unique capabilities that enable us to offer customers the differentiated products they seek to achieve their sustainability goals. Turning to slide 4, I will provide you with an update on our core business, including our growth in renewable, and an update on the overall macroeconomic environment. Beginning with renewables: we continue to see great momentum in demand overall. As we speak, we have senior members of our team attending a COP26 Climate Conference in Glasgow, meeting with governments, organizations, and potential customers. Since our last call in August, we have signed an additional 1.1 gigawatts of renewable PPAs, bringing our year-to-date total to 4 gigawatts. Additionally, we are in very advanced discussions for another 850 megawatts of wind, solar, and energy storage. Based on our current progress, we now expect to sign at least 5 gigawatts this year, versus our prior expectations of 4 gigawatts. This represents the largest addition in our history, and 66% more than in 2020. With our pipeline of 38 gigawatts of potential projects, including ten gigawatts that are ready to bid in the U.S. we are well-positioned to capitalize on this substantial opportunity. Our success is a result of our strategy of working with our clients on long-term contracts that provide customized solutions for their specific energy and sustainability goals. As such, almost 90% of our new business has been from bilateral negotiating contracts with corporate customers. This allowed us to compete on what we do best. Providing differentiated, innovative solutions. One example of our work with major technology companies to provide competitively priced renewable energy netted on an hour-by-hour basis. As we announced earlier this week, we signed a 15-year agreement to provide around the clock renewable energy to power Microsoft's data centers in Virginia. Year-to-date, we have signed almost two gigawatts of similarly structured contracts with a number of tech companies, integrating a mix of renewable sources and energy storage. Outside the U.S., we have a similar strategy of focusing on bilateral sales with corporate customers, which has enabled us to sign long-term U.S. dollar-denominated contracts with investment-grade customers. For example, in Brazil, we see demand for more than 25 gigawatts of renewables, providing a significant opportunity to earn mid to high-teen returns in U.S. dollars. While at the same time, diversifying our Brazilian portfolio of mostly hydro generation. To that end, for the first time ever in Brazil, we are in very advanced negotiations to sign a 300-megawatt U.S. dollar-denominated contract with a large multinational corporation for 15 years. Turning to Slide 5, our backlog of 9.2 gigawatts, is the largest ever, with 60% in the U.S. These projects represent one of the main drivers for our growth through 2025, and beyond. With this pace of growth, we are laser-focused on ensuring that we have adequate and reliable supply chains. For several years, we have anticipated a boom in renewable development that could potentially lead to inadequate panel supply, and as such, we took preemptive measures to ensure supply chain flexibility. Despite current challenges in the market, we have non-Chinese panels secured for the majority of our backlog, which is expected to come online through 2024. We have benefited from a number of strategic relationships with various suppliers and a clear advantage stemming from our scale and visibility of our pipeline. More generally, we continue to proactively manage potential macroeconomic headwinds. Including inflation and commodity prices. As part of our efforts to de -risk our portfolio over the past decade, we have taken a systematic approach to risk management. In fact, in places where we use fuel it is mostly a pass-through, and therefore we have limited exposure to changes in commodity prices. Furthermore, more than 80% of our adjusted pre -tax contribution is in U.S. dollars, insulating us from fluctuations in foreign currencies. We not only remain committed to achieving our long-term adjusted EPS and parent free cash flow targets, but we also continue to improve our credit metrics, are on track to achieve triple-B ratings from all agencies by 2025. Now to slide 6, we continue to benefit from a virtual cycle with our corporate customers, in which our ability to provide innovative solutions leads to more opportunities for collaboration and more projects. For example, this quarter we announced a partnership with Google, to provide our utility customers cost savings and energy efficiency features. As well as opportunities to accelerate their own clean energy goals through Nest Thermostats. Moving to Slide 7, through AES Next, we integrate new technologies to bring innovation to the industry and work with existing and new customers. AES Next operates as a separate unit within AES, where we develop and incubate new businesses, including a combination of strategic investments and internally developed businesses, representing approximately $50 million of growth capital annually. As I mentioned, the combination of AES Next and our core business, creates the optimal environment for growth, whereby we can better create solutions for customers by utilizing our industry insights and operating platforms. One example of this mutually beneficial arrangement is in the combinations of renewables plus storage. We first combined solar and storage in 2018 in Hawaii. And today, nearly half of our renewable PPAs have an energy storage component. Another example is 5B, a prefabricated solar solution Company that has patented technology, allowing projects to be built in a third of the time, and on half as much land while being resistant to hurricane force winds. We see 5B technology as a source of current and future competitive advantage for years. Allowing us to build more projects in places where there is a land scarcity, constraints around height or soil disruption, or hurricane risk. Likewise, 5G benefits greatly from the ability to grow rapidly on our platform. And we are currently developing projects in the U.S., Puerto Rico, Chile, Panama, and India. I am highlighting the AES Next portion of our business because it is increasingly clear that AES essentially has 2 distinct business models that add value to our shareholders in very different ways. With our core business, we continue to measure our success through growth in adjusted EPS and parent-free cash flow, as well PPA signed. With AES Next, these businesses contribute value creation through their extremely rapid growth in valuation, with the potential for future monetization. Nonetheless, they are a drag on AES earnings during their ramp up phase. In 2021, this drag on earnings is expected to be approximately $0.06 per share. We assume these losses from AES Next in our 2021 guidance, and our 7% to 9% annualized growth rate, through 2025. Turning to slide eight, as you know, last week Fluence, our energy storage joint venture with Seasons, which began as a small business within AES, became a publicly listed Company with the current valuation of around 6 billion. Similarly, early this year, another AES Next business offline received evaluation in a private transaction of 1.5 billion. The value of our interest in these two businesses is now at least $2.5 billion or $3 per share compared to the book value of our investments of approximately a $150 million. In my view, this massive shareholder value creation more than justifies the temporary negative impact to earnings. In summary, our strategy of being the leading integrator of new technologies on our platform has yielded great results. And we have several other innovations in development under AES Next. As they mature, we will continue to take actions to accelerate our growth and so their value. With that, I will now turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres and good morning, everyone. It's my pleasure to participate in my first earnings call as CFO of AES. I have been at AES for 14 years, and feel very fortunate to work at a Company that is transforming the electric sector so profoundly along so many talented people in finance and throughout the Company. With our strategic and financial progress to date, AES is well-positioned to continue leading this transformation. In my previous role, I led corporate strategy and financial planning, where we developed our plan to get to greater than 50% renewable, at least 50% of our business in the U.S., and to reduce our coal share to less than 10% by 2025. All while growing the Company 7% to 9%. We are committed to those goals, and I look forward to continue executing toward them. Before I dive into our financial performance, I want to discuss the adjustment to our accounting that we made this quarter relating to the treatment of the $1 billion in equity units we issued in the first quarter this year. Our prior guidance assume that the underlying shares would not be included in our Fully diluted share count until 2024 upon settlement of the equity units. This approach was in line with industry practice, and supported by our interpretation of the accounting literature, and our external auditors. However, we're now subject to an updated interpretation of these instruments and we are adjusting to include these shares in our fully diluted EPS calculations. This adjustment results in an annual impact of roughly $0.07 this year and $0.09 in 2022 and 2023 using a full-year of an additional 40 million shares. It's important to keep in mind that this adjustment has no cash impact, and has absolutely no impact on our business or longer-term growth rates, as we had included the underlying shares in our projections for 2024, and beyond. Prior to this adjustment, we had expected to be in the upper half of our 2021 adjusted EPS guidance range, but we now expect to be at the low-end of the range. Now, I'd like to cover two important topics. Our performance during the third quarter and our capital allocation plan. Turning to slide 11, you can see the strong performance of our portfolio in this quarter. Adjusted EPS was $0.50 for the quarter versus $0.42 for the comparable quarter last year. This 19% increase was primarily driven by improvements at our operating businesses, new renewables, and parent interest savings. These positive drivers were partially offset by lower contributions from South America, largely due to unscheduled outages in Chile. Third quarter results also reflect an approximate $0.03 quarter-to-date impact from the higher share count due to the inclusion of $40 million additional weighted average shares relating to the equity units as I just mentioned. Turning to Slide 12, adjusted pre -tax contribution, or PTC, was $428 million for the quarter, an increase of $97 million versus third quarter of 2020. I'll cover our results by strategic business unit over the next 4 slides, beginning on Slide 13. In the U.S. in utilities SBU, PTC increased $69 million as a result of our continued progress in growing our U.S. footprint. The improvement was largely driven by higher contributions from Southland, which benefited from higher contracted prices, new renewables coming online at AES Clean Energy, and higher availability at AES Puerto Rico. In California, our 2.3-gigawatts Southland Legacy portfolio demonstrated its critical importance by continuing to meet the State's pressing energy needs. And it transitioned to a more sustainable carbon-free future. In fact, as you may have heard, last month the State Water Resources Control Board unanimously approved an extension of our 876 megawatt Redondo Beach facility for two years through 2023 to align with our remaining legacy units. If the demand supply situation remains tight, some of our Legacy portfolio could be available to meet California 's energy needs beyond 2023 if State energy official determine a need. Although we have not assumed this in our guidance. As you can see on Slide 14, at our South America SBU, lower PTC was primarily driven by unscheduled outages in Chile, due to a blade defect impacting 6 turbines across our fleet that has now largely been resolved. Our third quarter results were also driven by lower hydrology in Brazil. Before moving to MCAC, I would like to provide an update on the 531 megawatt Alto Maipo hydro project, owned by a subsidiary of AES Andes in Chile. Construction continues to go well, and generation is expected to begin in December of this year, with full commercial operation of the plant expected in the first half of 2022, in line with our expectations. Alto Maipo is in discussions with its non-recourse lenders to restructure its debt to achieve a more sustainable and flexible capital structure for the long term. AES Andy's has honored its equity commitments to Alto Alto Maipo and will not be assuming any additional equity obligations. We expect this restructuring to be completed in 2022. And AF Andy's already assumed zero cash flow from Alto Maipo. So we don't see the restructuring impacting our guidance. Now, turning back to our third-quarter results on slide 15, the higher PTC at our MCAC SBU primarily reflects higher LNG sales in Dominican Republic and demand recovery in Panama. And finally, in Eurasia, as shown on Slide 16, higher results reflect improved operating performance in Bulgaria. Now to Slide 17. To summarize our performance in the first 3 quarters of the year, we earned adjusted EPS of $1.07 versus $0.96 last year. As I mentioned earlier, in terms of our full-year guidance, we are incorporating the $0.07 per share non-cash impact from the adjustment for the equity units issued earlier this year. Prior to this adjustment, we had expected to be in the upper half of our 2021 adjusted EPS guidance range. But we now expect to come in at the lower end of the range of $1.50 to $1.58. It's important to note that this adjustment does not affect our longer-term growth expectations, and has no impact on our cash flow. With 3/4 of the year behind us, our year-to-go results will benefit from contributions for new renewables, continued demand recovery across our markets, reduced interest expense, and our cost savings programs. These positive drivers are offset by the impacts of the higher share count and the dilution from AES Next, as Andres discussed earlier. Now, turning to our 2021 parent capital allocation on Slide 18, Beginning on the left hand of the slide, and consistent with our prior disclosure, we expect approximately $2 billion of discretionary cash this year. We remain confident in our parent-free cash flow target midpoint of $800 million, and the $100 million from the sale of Itabo. And we received the $1 billion of proceeds from the equity units issued in March. Moving over to the right-hand side, the uses are largely on the strength -- unchanged from the last quarter, with $450 million in returns to our shareholders this year, consisting of our common share dividend and a coupon on the equity units. We also continue to expect almost $1.5 billion of investment in our subsidiaries, with about 60% going towards renewables globally. Our investment program continue to be heavily weighted to the U.S. with approximately 70% targeted for our U.S. businesses. The increased focus on U.S. investments will contribute to our goal of growing the proportion of earnings from the U.S. to at least 1/2 of our base. Finally, as I ramp up in my new role, I've had the chance to speak with many of our internal and external stakeholders. It's clear that AES continues to successfully execute on our strategy, and we've remained resilient in the face of volatile macroeconomic conditions. Continuing to drive the successful execution and delivering on our financial goals is my top priority. I look forward to getting input from more of our investors and analysts, and providing the information you need to understand the great future ahead for AES. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. In summary, we have had a strong third quarter with both our core business and AES Next doing well. We're increasing our target for science renewable PPAs from 4 gigawatts to 5 gigawatts, and Fluence successfully completed its $6 billion IPO. We remain committed to delivering on our strategic and financial goals, including our 7% to 9% annualized growth rate in earnings and cash flow, and will continue to create greater shareholder value by being the leading integrator of new technologies. With that, I would like to open up the call to questions.
Operator: [Operator Instructions]. And our first question comes from Greg Chamberlain from JP Morgan. Please reach out, your line is now open.
Unidentified Analyst: Hi. Good morning. Thanks for taking my questions. Just wanted to start with the equity units change here. We look to offset any of the $0.09 impacts to '22 or '23, and just thinking about the incremental positives after the Analyst Day this year, such as the higher renewable signings and the Redondo extension. How do you see all of that shaking out with the latest change here?
Andres Gluski: Well, as you know we have a work portfolio, and so we have pluses and minus. Overall it's a portfolio that had shown it's great resilience over the last two years. So right now we're not ready to give guidance for next year. But we're committed to the 7% to 9% growth rates in earnings and free cash flow. So we'll be getting back to you on that. But as you correctly point out, there are positives. And then we have the drag of the additional shares. And we will be working with that. I'd say overall, we feel we're in an excellent position. We had a very strong quarter and year-to-date. One of the things I'd like to highlight is, that we had a design malfunction in our steam turbines in Chile. And this required them to undergo maintenance at 50,000 hours, instead of 100,000 hours. And this happened during the worst drought in Chile's history. We were short energy when energy prices were high. But nonetheless, if it weren't for the accounting, we would have been well within the mid or upper region of our earnings. So this is the way that our portfolio works. I don't know, Steve, you want to add something?
Steve Coughlin: Sure, no -- thanks, Andres. And thanks for the question. As I said in my script, this is recalculation, so it's just a different denominator on the capital, on the equity units that we raised earlier this year. It's purely just math, frankly. And looking ahead, we do see we have many levers, as Andres said. so we're fully committed to the 7% to 9%. These shares were already incorporated as of 2024, so it has no impact on that longer-term growth rate. And then, looking ahead, we have a number of value accretive opportunities in the portfolio. So we're in the midst of our planning process at this point and we'll give 2022 guidance in February. But we feel very confident in the overall growth rate and there's definitely things that we can do to stay within -- stay within that range going forward.
Unidentified Analyst: Understood. Thank you for the color there. And then maybe just switching gears to the C&I side of the progress shown with the Microsoft deal. Curious if you could speak a little bit to the 2 gigawatts you cited at similarly structured solutions signed year-to-date, how that compares to initial expectations. And then just broadly, any near term limitations to your ability to further rollout this around the clock product to just how you think about scalability there overall. Thank you.
Andres Gluski: Sure. I think we're rolling it out very well. We have said, from the beginning when we did the first Google one, that this was a product that was -- there was a lot of interest from other large corporate customers. We feel good that this is not the last deal we'll do. I think, the key here is the ability to provide around the clock, and so this is 100% renewable for 15 years. So the product keeps getting more sophisticate. Now, to do that, you need to be able to model all possible situations in a given area of service, integrating also batteries and different forms of renewable power. So we've been very flexible on that. We're very excited about that, and we see additional opportunities going forward. I think as we mentioned, 90% of the deals we have signed, in the last year-to-date, have been with corporate customers. And so we really see this type of structured project -- product really being a competitive advantage for us. So stay tuned. We think there's a -- something that we've been talking about. We're really seeing it come to fruition.
Unidentified Analyst: Understood. Thank you for the time today. Thank you. The next question comes from Durgesh Chopra from Evercore ISI. Please, Durgesh, your line is now open.
Durgesh Chopra: Hey, good morning, Andres and Steve. Welcome and I look forward to working with you. A couple of questions from my end. First, just, Andres you made that comment, that majority of the backlog to 2024 is now secured. Can I just ask you to clarify when you say that, that means wind, solar, storage, everything?
Andres Gluski: No, we were basically talking about solar panels, but we also have the balance of plan. So we feel very secured about it. But the one that's been, let's say, more in the press and more top of mind for everybody, has been solar panels. We very early on, started switching buying from Chinese panels to buying panels made in Malaysia, Vietnam, and in the future, Cambodia. And we've also, I think, been leaders in getting our suppliers to certify that there's no, let's say, poly silicon coming from Western China in the -- that could be questionable in terms of the labor practices. So we feel very comfortable. We have the supplies. We have flexibility. And we're also buying a number of U.S. panels made in the U.S. so -- without polysilicone by the by the way. So altogether we feel very comfortable that we have enough to meet our backlog to 2024, and that includes the balance of the plant, and that includes a batteries.
Durgesh Chopra: Got it. I mean, I guess in the last quarter, Andres, you'd mentioned something around maybe 90% of the equipment needed for your then-stated backlog of like, I think it was 8.5 gigawatts. Are you in that similar percentage wise for this updated 9.2 gigawatt number?
Andres Gluski: Yes.
Durgesh Chopra: Okay. Perfect. Thank you. And then just, obviously, great execution 5-gigawatts year-to-date. You have a target of 3 to 4, going to 5 up to 2025, right? Like 5-gigawatts a year to 2025. So as you have this momentum, can you talk about your margins, profitability, cash returns of your seen cost pressures?
Andres Gluski: Sure, great question. Look, we are achieving -- targeting and achieving low teen returns in the U.S. And we are targeting and achieving mid to higher teens outside of the U.S. Those are the -- those are really our hurdle rates that we are achieving, we feel very good about that. Now, realizing that there's a lag between signing a PPA and commissioning the project, so this year, we'll commission north of 1.5 gigawatts, maybe as high as 2. Next year, we should be somewhere between 3.5 and 4 gigawatts. This momentum will continue. We see -- it's not just the number of megawatts, we have to make sure that we're earning, on average, the right returns.
Durgesh Chopra: Perfect. Thanks for the time, guys.
Operator: Thank you. Our next question comes from David Peters from [Indiscernible]. Please, David, go ahead.
David Peters: Hey, good morning, guys.
Andres Gluski: Good morning.
David Peters: Back to the different accounting treatment for the equity units, you guys made the point to mention that it was consistent with other peers and the auditors had signed off. I'm wondering what specifically changed that you are now subject to this new interpretation?
Steve Coughlin: Yes. This is Steve. I'm happy to describe it in a little more detail. We issued the $1 billion equity units back in March. And as I said, it was -- the treatment that we use was very well vetted by our accountants, by our external auditors, and to external advisors. at that point, we were using a treasury stock method for the treatment, so it didn't show up in the shared account. So there's a number of companies that have used similar instruments, and in consultation with our auditors, SEC had done a review of the treatment of these types of instruments, and has informed our auditors that they see a different interpretation. So, although we haven't had direct communications with the SEC, we felt it was most prudent that we go ahead and update the interpretation. So we're really just taking the prudent course of action here. This conversion was already assumed in the 2024 share count, so it's just an interim impact to the calculation. There's no new transaction here. It's just this recalculation of the shares. Ultimately, that's the source of it and we're trying to be as prudent as we can in terms of the treatment.
David Peters: Great. I appreciate the detail there. Another question I had, switching gears, and appreciate the slide in the deck that you -- showing the value you've created through Fluence and Uplight, and, I guess, now that Fluence is public, would be a little bit more curious to hear about Uplight in terms of how you think about the value of that Company today versus when you got the value mark and going forward? Particularly because, I think, I just saw that Uplight completed an acquisition recently?
Andres Gluski: Thanks for the question. Look, we see Uplight,in the terms of its maturity, two to three years behind Fluence. But we're very happy with the progress that up Uplight has made and very happy with what we've done with AES Next. Because, if you look at our capital contribution and today's valuation, that's a 20-X. So that's -- some of this has been in -- even though we were working for example, on batteries for a long time, but really in terms of having a business, it's been roughly about three years -- 3, 4 years. This has created a lot a lot of value for our shareholders. And it's very interesting because there's two sides of the business. The AES Next is really a value play, especially during this rapid growth phase because you have to expense a lot of your investments really. But at the same time, they are helping us grow. When you talk about the structured products that we're selling to corporations, having AES Next and the know-how from there, has been extremely helpful. As I said, stay tuned, we have others in the works. The most mature probably is 5B. We think 5B has a lot of potential because of what it offers. It offers speed of build, it offers less use of land, and hurricane resistant is very important. Hurricane wind resistant is very important. So we're very happy with the progress there and very happy about the relationship between the AES core business and AES Next.
David Peters: Great. And then just last one quickly, just a point of clarification. You said AES Next was roughly at the $0.06 drag today. But as we get out into the outer years of your plan, I guess '24 and '25, are you expecting it to be contributing at that point or would it still be a drag?
Steve Coughlin: Yeah. No. No, we are. So I mean, I think there's a near-term dilution around of a similar level, say for 2022 and then that gradually reduces. And so by 2024, '25, we're expecting positive contributions and then significant acceleration in the positive contribution from that point.
David Peters: Great. Thank you guys.
Andres Gluski: Thank you
Operator: Thank you David. The next question comes from Julien Dumoulin-Smith from Bank of America. Please Julien. Your line is now open.
Julien Dumoulin Smith: Hey, good morning team. Congratulations on everything. Well done. To come back to this AES Next -- again, kudos there. As you guys think about the drag here, you talked about '21 having $0.06 drag. Through the '25 period here, how are you thinking about the cadence of that drag to evolve here? By the timing of '25, what is that reflected in your expectations here? And then, maybe, I'll throw in another nuanced EPS questions. When you're -- when you're thinking about the converts here, obviously you were able to offset that and be at the top end of '21. What does that say about by the time you get to 25, considering that the converts admittedly would've been sort of effectively fully diluted by then in terms of where you stand within your range as well. Again, give us a backdrop of all your successes, be it origination or otherwise.
Andres Gluski: Sure. Steve and I will answer this one. Let me take the second one, so it's definitely within our 25 numbers, because it was assumed that they would convert until the stat was the share count. So what is different is that we have a higher share count, '21, '22, and '23. That is the only difference in these calculations regarding AES Next, the one that's producing the largest drag is Fluence, quite frankly in Fluence, as it matures. And it's made all these investments in new designs, in gearing up to be able to meet that supply, in terms of guaranteeing supply of batteries around the world. And as sales increase, this will, I would say, gradually turn positive. And Steve, you want to mention --
Steve Coughlin: Obviously, as Andres said, I lead Fluence for its first 2.5 years, so I'm very familiar with the Company and its trajectory. And look the opportunity for Fluence has gotten massive, more massive than even we predicted when I started there. Going out and raising this capital was clearly targeted to go big and go much bigger. And so this, in some ways, what it does is it increases the near-term dilution deliberately because we're investing to accelerate the scale of the Company. And we know that it can be successful if we accelerate. But it's also then significantly increasing the upside when you get out into 24-25 period. Putting this capital to work is going to be near-term dilutive, but it's tremendously value accretive. And we've already seen some recognition of that in where it is today. And we think it's only going to go significantly upward from here. In our numbers, it turns positive, and it turns significantly positive by 2025.
Julien Dumoulin Smith: And that significantly positive, is reflected in that 25 number today? Want to understand how much of the earnings [Indiscernible]
Steve Coughlin: Yeah. Yeah. It is reflected, and I would say, it comes -- from the level of dilution today, it's going to flip flop to being at least that level positive by that point.
Julien Dumoulin Smith: And we say at least that level positive that is AES Next in entirety, right? Not just look.
Steve Coughlin: Yeah, I think Fluence will be at that point. Uplight will have grown too, but I would expect Fluence would likely be a few ahead be the largest driver, but I would say at least $0.06 positive from Next, by 2025.
Julien Dumoulin Smith: Right. Okay. Got it. Excellent. Thank you for the clarity there. And then if I can just -- more strategic question here also against your backdrop of 25 numbers. California extension, you've only reflected this new numbers through -- you haven't reflected this through 2025. That seems like a further upside whether it's Redondo or the entirety of the Legacy portfolio. And then ultimately you -- just when you think about the portfolio all together at this possible transition, again, kudos on transition, how are you thinking about some of the lingering assets and especially some of the renewed interest across the marketplace city for instance LNG?
Steve Coughlin: I will take the Southland question and then I'll turn it over to Andres, but that's correct, Julien. The Southland extension is -- the Redondo extension provide some upside. We had the Alamitos Huntington Beach, through 2023. We have the recent decision that's now upside for Redondo beach. But at this point, everything is just through 2023, and not beyond that. So the extent, there's an opportunity beyond that that would be upside to our guidance. And in addition, this year in the third quarter, we've seen in the numbers, we had the margin favorability from the hedges. There -- those legacy assets are quite valuable and we see the potential for further Q3 value recognition in our assets, which would also be upside into the guidance going forward.
Andres Gluski: Julien, regarding the LNG. We have a very strong position in the Gulf of Mexico, between the Dominican Republic and Panama. We have basically been contracting much more in terms of the Dominican Republic filling up the second tank, and the Panama filling up the first tank. So we see LNG as a necessary transition fuel. And I think what we're seeing a little bit in Europe and a little bit in China. It's very important to manage this transition. So while we were coming up with new technologies, making it possible to put more renewables on the grid, make renewable cheaper, make them more efficient and satisfy more what customers want. We see that in some -- many places, LNG natural gas is the necessary transition fuel. These two will work together. And as we said, we are on our way to filling up our full capacity of the two locations of the three tanks.
Julien Dumoulin Smith: Got it. So it sounds like literally and perhaps figuratively, you haven't quite filled the tank on the incremental contribution from LNG or California when it comes to '25 yet, but there's more go.
Andres Gluski: Yes. That's right. That's right. There's still more potential. Quite frankly, that's the most profitable thing we can do, is to fill up an existing tank.
Julien Dumoulin Smith: Yeah. Actually guys. Thank you. Best of luck.
Andres Gluski: Thank you Julien.
Steve Coughlin: Thanks, Julien.
Operator: [Operator Instructions] The next question comes from Stephen Byrd, from Morgan Stanley. Please Stephen, your line is now open.
Stephen Byrd: Thanks very much and congrats on a very constructive update here.
Andres Gluski: Thank you, Steve, and -- go ahead.
Stephen Byrd: Yes, Sir. I wanted to explore the Google Nest agreement and talk a little bit more about the magnitude if you could, and repeatability of that approach? it looks like a great solution where you can bring a lot of your skills to bear, to provide some value, but I'm struggling thinking about how to try to assess the magnitude of the opportunity here.
Andres Gluski: Well, this is through Uplight. And Uplight has been -- I believe the biggest seller of Nest in the U.S. because it reaches around 100 million final consumers in the U.S. So the idea is to continue to add on that platform more things, and improve customers experience, and customers capabilities of improving their energy efficiency use. Now, of course, Uplight works through large utilities. That's really how it goes. I think, there is a lot of opportunity there. I agree with that. And what Uplight has been doing is acquiring additional capabilities by some of these acquisitions, adding onto that platform. It's really using that platform, using that entry, into final consumers to provide additional value-add services.
Stephen Byrd: Understood. And is there a way to think about that value in terms of the per customer value, or some other metric, in terms of the benefit that utilities would receive from the kinds of services you provide here?
Andres Gluski: I don't have that available right now. I think the way to think about it, is this is the value of the total Uplight platform. And as you know, we partnered with Schneider Electric to have more capabilities, with more acquisitions. and we're working very closely with our utility customers. So I think the way this value will be reflected and captured, is through the value of Uplight. And as I said, I think it's 2-3 years behind Fluence in terms of its evolution.
Stephen Byrd: Okay. Very clear. And then just last question for me, just on LNG. You've been making great progress, you just described on Julien 's question, you're moving towards filling up a number of these resources. I was thinking once they're essentially filled to the capacity that you've targeted, they're fairly mature assets at that point and there might be a more logical owner with a fairly low discount rate at that point once they're mature. Are these good monetization assets when they're mature? The reasons you kind of see further option value essentially around these assets longer-term?
Andres Gluski: I think, 2 things: As you know, we are growing very rapidly in renewables. We have plans to sell down coal. So we will continue to manage this portfolio to optimize its value for our shareholders, and we'll see how that develops. Right now, our focus is really on filling up the gas tanks.
Stephen Byrd: Okay. Understood. Thank you very much.
Andres Gluski: Thanks, Steve.
Operator: [Operator Instructions] We currently have no further questions. I would like to hand over to Ahmed Pasha for any final remarks.
Ahmed Pasha: Thank you. Thanks everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Next week, we look forward to seeing many of you at the EEI Conference. Thanks again. And have a nice day.
Operator: This concludes today's call. Thank you so much for joining. You may now disconnect your lines and have a great rest of your day. | [
{
"speaker": "Operator",
"text": "Hello, and welcome to AES Corporation third quarter 2021, final review. My name is Juan, and I will be coordinating your call today. [Operator Instructions] I will now hand over to your host, Ahmed Pasha, Global Treasurer, Vice President of Investor Relations to begin with. Ahmed, please go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you, operator. Good morning and welcome to our Third Quarter 2021 Financial Review Call. Our press release, presentation, and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website, along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer, Steve Coughlin, our Chief Financial Officer, and other senior members of our management team. With that, I will turn the call over to Andres. Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone. And thank you for joining our third quarter financial review call. Before discussing our progress since our last call, I want to introduce our new Chief Financial Officer, Steve Coughlin. Steve has been with AES for 14 years and has served in a variety of roles, including as CEO of Fluence, and most recently, as head of both Strategy and Financial Planning. I am happy to report that we're making excellent progress on our strategic and financial goals. And remain on track to deliver on our 7% to 9% annualized growth in adjusted EPS and parent-free cash flow through 2025. We had a strong third quarter with adjusted EPS of $0.5 and 19% increase versus the same quarter last year. We expect to deliver on our full-year guidance, even with a $0.07 non-cash impact from an updated accounting interpretation related to the equity units of a convert we issued earlier this year. Steve will provide more details shortly. Today I will discuss both the growth in our core business, as well as the strategy and evolution of our innovation business, called AES Next. We see ourselves as the leading integrator of new technologies. The two parts of our portfolio are mutually beneficial to one another and enabled us to deliver greater total returns to our shareholders. More specifically, and as we have proven, our core business platforms provide the optimal environment for exponentially growing technology startups. At the same time, our AES Next businesses provide us with unique capabilities that enable us to offer customers the differentiated products they seek to achieve their sustainability goals. Turning to slide 4, I will provide you with an update on our core business, including our growth in renewable, and an update on the overall macroeconomic environment. Beginning with renewables: we continue to see great momentum in demand overall. As we speak, we have senior members of our team attending a COP26 Climate Conference in Glasgow, meeting with governments, organizations, and potential customers. Since our last call in August, we have signed an additional 1.1 gigawatts of renewable PPAs, bringing our year-to-date total to 4 gigawatts. Additionally, we are in very advanced discussions for another 850 megawatts of wind, solar, and energy storage. Based on our current progress, we now expect to sign at least 5 gigawatts this year, versus our prior expectations of 4 gigawatts. This represents the largest addition in our history, and 66% more than in 2020. With our pipeline of 38 gigawatts of potential projects, including ten gigawatts that are ready to bid in the U.S. we are well-positioned to capitalize on this substantial opportunity. Our success is a result of our strategy of working with our clients on long-term contracts that provide customized solutions for their specific energy and sustainability goals. As such, almost 90% of our new business has been from bilateral negotiating contracts with corporate customers. This allowed us to compete on what we do best. Providing differentiated, innovative solutions. One example of our work with major technology companies to provide competitively priced renewable energy netted on an hour-by-hour basis. As we announced earlier this week, we signed a 15-year agreement to provide around the clock renewable energy to power Microsoft's data centers in Virginia. Year-to-date, we have signed almost two gigawatts of similarly structured contracts with a number of tech companies, integrating a mix of renewable sources and energy storage. Outside the U.S., we have a similar strategy of focusing on bilateral sales with corporate customers, which has enabled us to sign long-term U.S. dollar-denominated contracts with investment-grade customers. For example, in Brazil, we see demand for more than 25 gigawatts of renewables, providing a significant opportunity to earn mid to high-teen returns in U.S. dollars. While at the same time, diversifying our Brazilian portfolio of mostly hydro generation. To that end, for the first time ever in Brazil, we are in very advanced negotiations to sign a 300-megawatt U.S. dollar-denominated contract with a large multinational corporation for 15 years. Turning to Slide 5, our backlog of 9.2 gigawatts, is the largest ever, with 60% in the U.S. These projects represent one of the main drivers for our growth through 2025, and beyond. With this pace of growth, we are laser-focused on ensuring that we have adequate and reliable supply chains. For several years, we have anticipated a boom in renewable development that could potentially lead to inadequate panel supply, and as such, we took preemptive measures to ensure supply chain flexibility. Despite current challenges in the market, we have non-Chinese panels secured for the majority of our backlog, which is expected to come online through 2024. We have benefited from a number of strategic relationships with various suppliers and a clear advantage stemming from our scale and visibility of our pipeline. More generally, we continue to proactively manage potential macroeconomic headwinds. Including inflation and commodity prices. As part of our efforts to de -risk our portfolio over the past decade, we have taken a systematic approach to risk management. In fact, in places where we use fuel it is mostly a pass-through, and therefore we have limited exposure to changes in commodity prices. Furthermore, more than 80% of our adjusted pre -tax contribution is in U.S. dollars, insulating us from fluctuations in foreign currencies. We not only remain committed to achieving our long-term adjusted EPS and parent free cash flow targets, but we also continue to improve our credit metrics, are on track to achieve triple-B ratings from all agencies by 2025. Now to slide 6, we continue to benefit from a virtual cycle with our corporate customers, in which our ability to provide innovative solutions leads to more opportunities for collaboration and more projects. For example, this quarter we announced a partnership with Google, to provide our utility customers cost savings and energy efficiency features. As well as opportunities to accelerate their own clean energy goals through Nest Thermostats. Moving to Slide 7, through AES Next, we integrate new technologies to bring innovation to the industry and work with existing and new customers. AES Next operates as a separate unit within AES, where we develop and incubate new businesses, including a combination of strategic investments and internally developed businesses, representing approximately $50 million of growth capital annually. As I mentioned, the combination of AES Next and our core business, creates the optimal environment for growth, whereby we can better create solutions for customers by utilizing our industry insights and operating platforms. One example of this mutually beneficial arrangement is in the combinations of renewables plus storage. We first combined solar and storage in 2018 in Hawaii. And today, nearly half of our renewable PPAs have an energy storage component. Another example is 5B, a prefabricated solar solution Company that has patented technology, allowing projects to be built in a third of the time, and on half as much land while being resistant to hurricane force winds. We see 5B technology as a source of current and future competitive advantage for years. Allowing us to build more projects in places where there is a land scarcity, constraints around height or soil disruption, or hurricane risk. Likewise, 5G benefits greatly from the ability to grow rapidly on our platform. And we are currently developing projects in the U.S., Puerto Rico, Chile, Panama, and India. I am highlighting the AES Next portion of our business because it is increasingly clear that AES essentially has 2 distinct business models that add value to our shareholders in very different ways. With our core business, we continue to measure our success through growth in adjusted EPS and parent-free cash flow, as well PPA signed. With AES Next, these businesses contribute value creation through their extremely rapid growth in valuation, with the potential for future monetization. Nonetheless, they are a drag on AES earnings during their ramp up phase. In 2021, this drag on earnings is expected to be approximately $0.06 per share. We assume these losses from AES Next in our 2021 guidance, and our 7% to 9% annualized growth rate, through 2025. Turning to slide eight, as you know, last week Fluence, our energy storage joint venture with Seasons, which began as a small business within AES, became a publicly listed Company with the current valuation of around 6 billion. Similarly, early this year, another AES Next business offline received evaluation in a private transaction of 1.5 billion. The value of our interest in these two businesses is now at least $2.5 billion or $3 per share compared to the book value of our investments of approximately a $150 million. In my view, this massive shareholder value creation more than justifies the temporary negative impact to earnings. In summary, our strategy of being the leading integrator of new technologies on our platform has yielded great results. And we have several other innovations in development under AES Next. As they mature, we will continue to take actions to accelerate our growth and so their value. With that, I will now turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres and good morning, everyone. It's my pleasure to participate in my first earnings call as CFO of AES. I have been at AES for 14 years, and feel very fortunate to work at a Company that is transforming the electric sector so profoundly along so many talented people in finance and throughout the Company. With our strategic and financial progress to date, AES is well-positioned to continue leading this transformation. In my previous role, I led corporate strategy and financial planning, where we developed our plan to get to greater than 50% renewable, at least 50% of our business in the U.S., and to reduce our coal share to less than 10% by 2025. All while growing the Company 7% to 9%. We are committed to those goals, and I look forward to continue executing toward them. Before I dive into our financial performance, I want to discuss the adjustment to our accounting that we made this quarter relating to the treatment of the $1 billion in equity units we issued in the first quarter this year. Our prior guidance assume that the underlying shares would not be included in our Fully diluted share count until 2024 upon settlement of the equity units. This approach was in line with industry practice, and supported by our interpretation of the accounting literature, and our external auditors. However, we're now subject to an updated interpretation of these instruments and we are adjusting to include these shares in our fully diluted EPS calculations. This adjustment results in an annual impact of roughly $0.07 this year and $0.09 in 2022 and 2023 using a full-year of an additional 40 million shares. It's important to keep in mind that this adjustment has no cash impact, and has absolutely no impact on our business or longer-term growth rates, as we had included the underlying shares in our projections for 2024, and beyond. Prior to this adjustment, we had expected to be in the upper half of our 2021 adjusted EPS guidance range, but we now expect to be at the low-end of the range. Now, I'd like to cover two important topics. Our performance during the third quarter and our capital allocation plan. Turning to slide 11, you can see the strong performance of our portfolio in this quarter. Adjusted EPS was $0.50 for the quarter versus $0.42 for the comparable quarter last year. This 19% increase was primarily driven by improvements at our operating businesses, new renewables, and parent interest savings. These positive drivers were partially offset by lower contributions from South America, largely due to unscheduled outages in Chile. Third quarter results also reflect an approximate $0.03 quarter-to-date impact from the higher share count due to the inclusion of $40 million additional weighted average shares relating to the equity units as I just mentioned. Turning to Slide 12, adjusted pre -tax contribution, or PTC, was $428 million for the quarter, an increase of $97 million versus third quarter of 2020. I'll cover our results by strategic business unit over the next 4 slides, beginning on Slide 13. In the U.S. in utilities SBU, PTC increased $69 million as a result of our continued progress in growing our U.S. footprint. The improvement was largely driven by higher contributions from Southland, which benefited from higher contracted prices, new renewables coming online at AES Clean Energy, and higher availability at AES Puerto Rico. In California, our 2.3-gigawatts Southland Legacy portfolio demonstrated its critical importance by continuing to meet the State's pressing energy needs. And it transitioned to a more sustainable carbon-free future. In fact, as you may have heard, last month the State Water Resources Control Board unanimously approved an extension of our 876 megawatt Redondo Beach facility for two years through 2023 to align with our remaining legacy units. If the demand supply situation remains tight, some of our Legacy portfolio could be available to meet California 's energy needs beyond 2023 if State energy official determine a need. Although we have not assumed this in our guidance. As you can see on Slide 14, at our South America SBU, lower PTC was primarily driven by unscheduled outages in Chile, due to a blade defect impacting 6 turbines across our fleet that has now largely been resolved. Our third quarter results were also driven by lower hydrology in Brazil. Before moving to MCAC, I would like to provide an update on the 531 megawatt Alto Maipo hydro project, owned by a subsidiary of AES Andes in Chile. Construction continues to go well, and generation is expected to begin in December of this year, with full commercial operation of the plant expected in the first half of 2022, in line with our expectations. Alto Maipo is in discussions with its non-recourse lenders to restructure its debt to achieve a more sustainable and flexible capital structure for the long term. AES Andy's has honored its equity commitments to Alto Alto Maipo and will not be assuming any additional equity obligations. We expect this restructuring to be completed in 2022. And AF Andy's already assumed zero cash flow from Alto Maipo. So we don't see the restructuring impacting our guidance. Now, turning back to our third-quarter results on slide 15, the higher PTC at our MCAC SBU primarily reflects higher LNG sales in Dominican Republic and demand recovery in Panama. And finally, in Eurasia, as shown on Slide 16, higher results reflect improved operating performance in Bulgaria. Now to Slide 17. To summarize our performance in the first 3 quarters of the year, we earned adjusted EPS of $1.07 versus $0.96 last year. As I mentioned earlier, in terms of our full-year guidance, we are incorporating the $0.07 per share non-cash impact from the adjustment for the equity units issued earlier this year. Prior to this adjustment, we had expected to be in the upper half of our 2021 adjusted EPS guidance range. But we now expect to come in at the lower end of the range of $1.50 to $1.58. It's important to note that this adjustment does not affect our longer-term growth expectations, and has no impact on our cash flow. With 3/4 of the year behind us, our year-to-go results will benefit from contributions for new renewables, continued demand recovery across our markets, reduced interest expense, and our cost savings programs. These positive drivers are offset by the impacts of the higher share count and the dilution from AES Next, as Andres discussed earlier. Now, turning to our 2021 parent capital allocation on Slide 18, Beginning on the left hand of the slide, and consistent with our prior disclosure, we expect approximately $2 billion of discretionary cash this year. We remain confident in our parent-free cash flow target midpoint of $800 million, and the $100 million from the sale of Itabo. And we received the $1 billion of proceeds from the equity units issued in March. Moving over to the right-hand side, the uses are largely on the strength -- unchanged from the last quarter, with $450 million in returns to our shareholders this year, consisting of our common share dividend and a coupon on the equity units. We also continue to expect almost $1.5 billion of investment in our subsidiaries, with about 60% going towards renewables globally. Our investment program continue to be heavily weighted to the U.S. with approximately 70% targeted for our U.S. businesses. The increased focus on U.S. investments will contribute to our goal of growing the proportion of earnings from the U.S. to at least 1/2 of our base. Finally, as I ramp up in my new role, I've had the chance to speak with many of our internal and external stakeholders. It's clear that AES continues to successfully execute on our strategy, and we've remained resilient in the face of volatile macroeconomic conditions. Continuing to drive the successful execution and delivering on our financial goals is my top priority. I look forward to getting input from more of our investors and analysts, and providing the information you need to understand the great future ahead for AES. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. In summary, we have had a strong third quarter with both our core business and AES Next doing well. We're increasing our target for science renewable PPAs from 4 gigawatts to 5 gigawatts, and Fluence successfully completed its $6 billion IPO. We remain committed to delivering on our strategic and financial goals, including our 7% to 9% annualized growth rate in earnings and cash flow, and will continue to create greater shareholder value by being the leading integrator of new technologies. With that, I would like to open up the call to questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. And our first question comes from Greg Chamberlain from JP Morgan. Please reach out, your line is now open."
},
{
"speaker": "Unidentified Analyst",
"text": "Hi. Good morning. Thanks for taking my questions. Just wanted to start with the equity units change here. We look to offset any of the $0.09 impacts to '22 or '23, and just thinking about the incremental positives after the Analyst Day this year, such as the higher renewable signings and the Redondo extension. How do you see all of that shaking out with the latest change here?"
},
{
"speaker": "Andres Gluski",
"text": "Well, as you know we have a work portfolio, and so we have pluses and minus. Overall it's a portfolio that had shown it's great resilience over the last two years. So right now we're not ready to give guidance for next year. But we're committed to the 7% to 9% growth rates in earnings and free cash flow. So we'll be getting back to you on that. But as you correctly point out, there are positives. And then we have the drag of the additional shares. And we will be working with that. I'd say overall, we feel we're in an excellent position. We had a very strong quarter and year-to-date. One of the things I'd like to highlight is, that we had a design malfunction in our steam turbines in Chile. And this required them to undergo maintenance at 50,000 hours, instead of 100,000 hours. And this happened during the worst drought in Chile's history. We were short energy when energy prices were high. But nonetheless, if it weren't for the accounting, we would have been well within the mid or upper region of our earnings. So this is the way that our portfolio works. I don't know, Steve, you want to add something?"
},
{
"speaker": "Steve Coughlin",
"text": "Sure, no -- thanks, Andres. And thanks for the question. As I said in my script, this is recalculation, so it's just a different denominator on the capital, on the equity units that we raised earlier this year. It's purely just math, frankly. And looking ahead, we do see we have many levers, as Andres said. so we're fully committed to the 7% to 9%. These shares were already incorporated as of 2024, so it has no impact on that longer-term growth rate. And then, looking ahead, we have a number of value accretive opportunities in the portfolio. So we're in the midst of our planning process at this point and we'll give 2022 guidance in February. But we feel very confident in the overall growth rate and there's definitely things that we can do to stay within -- stay within that range going forward."
},
{
"speaker": "Unidentified Analyst",
"text": "Understood. Thank you for the color there. And then maybe just switching gears to the C&I side of the progress shown with the Microsoft deal. Curious if you could speak a little bit to the 2 gigawatts you cited at similarly structured solutions signed year-to-date, how that compares to initial expectations. And then just broadly, any near term limitations to your ability to further rollout this around the clock product to just how you think about scalability there overall. Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Sure. I think we're rolling it out very well. We have said, from the beginning when we did the first Google one, that this was a product that was -- there was a lot of interest from other large corporate customers. We feel good that this is not the last deal we'll do. I think, the key here is the ability to provide around the clock, and so this is 100% renewable for 15 years. So the product keeps getting more sophisticate. Now, to do that, you need to be able to model all possible situations in a given area of service, integrating also batteries and different forms of renewable power. So we've been very flexible on that. We're very excited about that, and we see additional opportunities going forward. I think as we mentioned, 90% of the deals we have signed, in the last year-to-date, have been with corporate customers. And so we really see this type of structured project -- product really being a competitive advantage for us. So stay tuned. We think there's a -- something that we've been talking about. We're really seeing it come to fruition."
},
{
"speaker": "Unidentified Analyst",
"text": "Understood. Thank you for the time today. Thank you. The next question comes from Durgesh Chopra from Evercore ISI. Please, Durgesh, your line is now open."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, good morning, Andres and Steve. Welcome and I look forward to working with you. A couple of questions from my end. First, just, Andres you made that comment, that majority of the backlog to 2024 is now secured. Can I just ask you to clarify when you say that, that means wind, solar, storage, everything?"
},
{
"speaker": "Andres Gluski",
"text": "No, we were basically talking about solar panels, but we also have the balance of plan. So we feel very secured about it. But the one that's been, let's say, more in the press and more top of mind for everybody, has been solar panels. We very early on, started switching buying from Chinese panels to buying panels made in Malaysia, Vietnam, and in the future, Cambodia. And we've also, I think, been leaders in getting our suppliers to certify that there's no, let's say, poly silicon coming from Western China in the -- that could be questionable in terms of the labor practices. So we feel very comfortable. We have the supplies. We have flexibility. And we're also buying a number of U.S. panels made in the U.S. so -- without polysilicone by the by the way. So altogether we feel very comfortable that we have enough to meet our backlog to 2024, and that includes the balance of the plant, and that includes a batteries."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. I mean, I guess in the last quarter, Andres, you'd mentioned something around maybe 90% of the equipment needed for your then-stated backlog of like, I think it was 8.5 gigawatts. Are you in that similar percentage wise for this updated 9.2 gigawatt number?"
},
{
"speaker": "Andres Gluski",
"text": "Yes."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay. Perfect. Thank you. And then just, obviously, great execution 5-gigawatts year-to-date. You have a target of 3 to 4, going to 5 up to 2025, right? Like 5-gigawatts a year to 2025. So as you have this momentum, can you talk about your margins, profitability, cash returns of your seen cost pressures?"
},
{
"speaker": "Andres Gluski",
"text": "Sure, great question. Look, we are achieving -- targeting and achieving low teen returns in the U.S. And we are targeting and achieving mid to higher teens outside of the U.S. Those are the -- those are really our hurdle rates that we are achieving, we feel very good about that. Now, realizing that there's a lag between signing a PPA and commissioning the project, so this year, we'll commission north of 1.5 gigawatts, maybe as high as 2. Next year, we should be somewhere between 3.5 and 4 gigawatts. This momentum will continue. We see -- it's not just the number of megawatts, we have to make sure that we're earning, on average, the right returns."
},
{
"speaker": "Durgesh Chopra",
"text": "Perfect. Thanks for the time, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from David Peters from [Indiscernible]. Please, David, go ahead."
},
{
"speaker": "David Peters",
"text": "Hey, good morning, guys."
},
{
"speaker": "Andres Gluski",
"text": "Good morning."
},
{
"speaker": "David Peters",
"text": "Back to the different accounting treatment for the equity units, you guys made the point to mention that it was consistent with other peers and the auditors had signed off. I'm wondering what specifically changed that you are now subject to this new interpretation?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. This is Steve. I'm happy to describe it in a little more detail. We issued the $1 billion equity units back in March. And as I said, it was -- the treatment that we use was very well vetted by our accountants, by our external auditors, and to external advisors. at that point, we were using a treasury stock method for the treatment, so it didn't show up in the shared account. So there's a number of companies that have used similar instruments, and in consultation with our auditors, SEC had done a review of the treatment of these types of instruments, and has informed our auditors that they see a different interpretation. So, although we haven't had direct communications with the SEC, we felt it was most prudent that we go ahead and update the interpretation. So we're really just taking the prudent course of action here. This conversion was already assumed in the 2024 share count, so it's just an interim impact to the calculation. There's no new transaction here. It's just this recalculation of the shares. Ultimately, that's the source of it and we're trying to be as prudent as we can in terms of the treatment."
},
{
"speaker": "David Peters",
"text": "Great. I appreciate the detail there. Another question I had, switching gears, and appreciate the slide in the deck that you -- showing the value you've created through Fluence and Uplight, and, I guess, now that Fluence is public, would be a little bit more curious to hear about Uplight in terms of how you think about the value of that Company today versus when you got the value mark and going forward? Particularly because, I think, I just saw that Uplight completed an acquisition recently?"
},
{
"speaker": "Andres Gluski",
"text": "Thanks for the question. Look, we see Uplight,in the terms of its maturity, two to three years behind Fluence. But we're very happy with the progress that up Uplight has made and very happy with what we've done with AES Next. Because, if you look at our capital contribution and today's valuation, that's a 20-X. So that's -- some of this has been in -- even though we were working for example, on batteries for a long time, but really in terms of having a business, it's been roughly about three years -- 3, 4 years. This has created a lot a lot of value for our shareholders. And it's very interesting because there's two sides of the business. The AES Next is really a value play, especially during this rapid growth phase because you have to expense a lot of your investments really. But at the same time, they are helping us grow. When you talk about the structured products that we're selling to corporations, having AES Next and the know-how from there, has been extremely helpful. As I said, stay tuned, we have others in the works. The most mature probably is 5B. We think 5B has a lot of potential because of what it offers. It offers speed of build, it offers less use of land, and hurricane resistant is very important. Hurricane wind resistant is very important. So we're very happy with the progress there and very happy about the relationship between the AES core business and AES Next."
},
{
"speaker": "David Peters",
"text": "Great. And then just last one quickly, just a point of clarification. You said AES Next was roughly at the $0.06 drag today. But as we get out into the outer years of your plan, I guess '24 and '25, are you expecting it to be contributing at that point or would it still be a drag?"
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. No. No, we are. So I mean, I think there's a near-term dilution around of a similar level, say for 2022 and then that gradually reduces. And so by 2024, '25, we're expecting positive contributions and then significant acceleration in the positive contribution from that point."
},
{
"speaker": "David Peters",
"text": "Great. Thank you guys."
},
{
"speaker": "Andres Gluski",
"text": "Thank you"
},
{
"speaker": "Operator",
"text": "Thank you David. The next question comes from Julien Dumoulin-Smith from Bank of America. Please Julien. Your line is now open."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Hey, good morning team. Congratulations on everything. Well done. To come back to this AES Next -- again, kudos there. As you guys think about the drag here, you talked about '21 having $0.06 drag. Through the '25 period here, how are you thinking about the cadence of that drag to evolve here? By the timing of '25, what is that reflected in your expectations here? And then, maybe, I'll throw in another nuanced EPS questions. When you're -- when you're thinking about the converts here, obviously you were able to offset that and be at the top end of '21. What does that say about by the time you get to 25, considering that the converts admittedly would've been sort of effectively fully diluted by then in terms of where you stand within your range as well. Again, give us a backdrop of all your successes, be it origination or otherwise."
},
{
"speaker": "Andres Gluski",
"text": "Sure. Steve and I will answer this one. Let me take the second one, so it's definitely within our 25 numbers, because it was assumed that they would convert until the stat was the share count. So what is different is that we have a higher share count, '21, '22, and '23. That is the only difference in these calculations regarding AES Next, the one that's producing the largest drag is Fluence, quite frankly in Fluence, as it matures. And it's made all these investments in new designs, in gearing up to be able to meet that supply, in terms of guaranteeing supply of batteries around the world. And as sales increase, this will, I would say, gradually turn positive. And Steve, you want to mention --"
},
{
"speaker": "Steve Coughlin",
"text": "Obviously, as Andres said, I lead Fluence for its first 2.5 years, so I'm very familiar with the Company and its trajectory. And look the opportunity for Fluence has gotten massive, more massive than even we predicted when I started there. Going out and raising this capital was clearly targeted to go big and go much bigger. And so this, in some ways, what it does is it increases the near-term dilution deliberately because we're investing to accelerate the scale of the Company. And we know that it can be successful if we accelerate. But it's also then significantly increasing the upside when you get out into 24-25 period. Putting this capital to work is going to be near-term dilutive, but it's tremendously value accretive. And we've already seen some recognition of that in where it is today. And we think it's only going to go significantly upward from here. In our numbers, it turns positive, and it turns significantly positive by 2025."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "And that significantly positive, is reflected in that 25 number today? Want to understand how much of the earnings [Indiscernible]"
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. Yeah. It is reflected, and I would say, it comes -- from the level of dilution today, it's going to flip flop to being at least that level positive by that point."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "And we say at least that level positive that is AES Next in entirety, right? Not just look."
},
{
"speaker": "Steve Coughlin",
"text": "Yeah, I think Fluence will be at that point. Uplight will have grown too, but I would expect Fluence would likely be a few ahead be the largest driver, but I would say at least $0.06 positive from Next, by 2025."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Right. Okay. Got it. Excellent. Thank you for the clarity there. And then if I can just -- more strategic question here also against your backdrop of 25 numbers. California extension, you've only reflected this new numbers through -- you haven't reflected this through 2025. That seems like a further upside whether it's Redondo or the entirety of the Legacy portfolio. And then ultimately you -- just when you think about the portfolio all together at this possible transition, again, kudos on transition, how are you thinking about some of the lingering assets and especially some of the renewed interest across the marketplace city for instance LNG?"
},
{
"speaker": "Steve Coughlin",
"text": "I will take the Southland question and then I'll turn it over to Andres, but that's correct, Julien. The Southland extension is -- the Redondo extension provide some upside. We had the Alamitos Huntington Beach, through 2023. We have the recent decision that's now upside for Redondo beach. But at this point, everything is just through 2023, and not beyond that. So the extent, there's an opportunity beyond that that would be upside to our guidance. And in addition, this year in the third quarter, we've seen in the numbers, we had the margin favorability from the hedges. There -- those legacy assets are quite valuable and we see the potential for further Q3 value recognition in our assets, which would also be upside into the guidance going forward."
},
{
"speaker": "Andres Gluski",
"text": "Julien, regarding the LNG. We have a very strong position in the Gulf of Mexico, between the Dominican Republic and Panama. We have basically been contracting much more in terms of the Dominican Republic filling up the second tank, and the Panama filling up the first tank. So we see LNG as a necessary transition fuel. And I think what we're seeing a little bit in Europe and a little bit in China. It's very important to manage this transition. So while we were coming up with new technologies, making it possible to put more renewables on the grid, make renewable cheaper, make them more efficient and satisfy more what customers want. We see that in some -- many places, LNG natural gas is the necessary transition fuel. These two will work together. And as we said, we are on our way to filling up our full capacity of the two locations of the three tanks."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Got it. So it sounds like literally and perhaps figuratively, you haven't quite filled the tank on the incremental contribution from LNG or California when it comes to '25 yet, but there's more go."
},
{
"speaker": "Andres Gluski",
"text": "Yes. That's right. That's right. There's still more potential. Quite frankly, that's the most profitable thing we can do, is to fill up an existing tank."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Yeah. Actually guys. Thank you. Best of luck."
},
{
"speaker": "Andres Gluski",
"text": "Thank you Julien."
},
{
"speaker": "Steve Coughlin",
"text": "Thanks, Julien."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] The next question comes from Stephen Byrd, from Morgan Stanley. Please Stephen, your line is now open."
},
{
"speaker": "Stephen Byrd",
"text": "Thanks very much and congrats on a very constructive update here."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve, and -- go ahead."
},
{
"speaker": "Stephen Byrd",
"text": "Yes, Sir. I wanted to explore the Google Nest agreement and talk a little bit more about the magnitude if you could, and repeatability of that approach? it looks like a great solution where you can bring a lot of your skills to bear, to provide some value, but I'm struggling thinking about how to try to assess the magnitude of the opportunity here."
},
{
"speaker": "Andres Gluski",
"text": "Well, this is through Uplight. And Uplight has been -- I believe the biggest seller of Nest in the U.S. because it reaches around 100 million final consumers in the U.S. So the idea is to continue to add on that platform more things, and improve customers experience, and customers capabilities of improving their energy efficiency use. Now, of course, Uplight works through large utilities. That's really how it goes. I think, there is a lot of opportunity there. I agree with that. And what Uplight has been doing is acquiring additional capabilities by some of these acquisitions, adding onto that platform. It's really using that platform, using that entry, into final consumers to provide additional value-add services."
},
{
"speaker": "Stephen Byrd",
"text": "Understood. And is there a way to think about that value in terms of the per customer value, or some other metric, in terms of the benefit that utilities would receive from the kinds of services you provide here?"
},
{
"speaker": "Andres Gluski",
"text": "I don't have that available right now. I think the way to think about it, is this is the value of the total Uplight platform. And as you know, we partnered with Schneider Electric to have more capabilities, with more acquisitions. and we're working very closely with our utility customers. So I think the way this value will be reflected and captured, is through the value of Uplight. And as I said, I think it's 2-3 years behind Fluence in terms of its evolution."
},
{
"speaker": "Stephen Byrd",
"text": "Okay. Very clear. And then just last question for me, just on LNG. You've been making great progress, you just described on Julien 's question, you're moving towards filling up a number of these resources. I was thinking once they're essentially filled to the capacity that you've targeted, they're fairly mature assets at that point and there might be a more logical owner with a fairly low discount rate at that point once they're mature. Are these good monetization assets when they're mature? The reasons you kind of see further option value essentially around these assets longer-term?"
},
{
"speaker": "Andres Gluski",
"text": "I think, 2 things: As you know, we are growing very rapidly in renewables. We have plans to sell down coal. So we will continue to manage this portfolio to optimize its value for our shareholders, and we'll see how that develops. Right now, our focus is really on filling up the gas tanks."
},
{
"speaker": "Stephen Byrd",
"text": "Okay. Understood. Thank you very much."
},
{
"speaker": "Andres Gluski",
"text": "Thanks, Steve."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We currently have no further questions. I would like to hand over to Ahmed Pasha for any final remarks."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you. Thanks everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Next week, we look forward to seeing many of you at the EEI Conference. Thanks again. And have a nice day."
},
{
"speaker": "Operator",
"text": "This concludes today's call. Thank you so much for joining. You may now disconnect your lines and have a great rest of your day."
}
] | The AES Corporation | 35,312 |
AES | 2 | 2,021 | 2021-08-05 09:00:00 | Operator: Good day and welcome to the AES Corporation Second Quarter 2021 Financial Review Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ahmed Pasha, Treasurer and Vice President of Investor Relations. Please go ahead.
Ahmed Pasha: Thank you, Operator. Good morning and welcome to our second quarter 2021 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can also be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer and other senior members of our management team. With that, I will turn the call over to Andrés. Andrés?
Andrés Gluski: Good morning, everyone. And thank you for joining our second quarter financial review call. Today I will discuss our progress today on a number of key strategic objectives. Before turning the call over to our CFO, Gustavo Pimenta, to discuss our financial results in more detail. We had an excellent second quarter with a 24% increase in adjusted EPS from the second quarter of 2020. And a record 1.8 gigawatts of renewables under long-term contracts added to our backlog, bringing our total to 8.5 gigawatts. We remain on track to achieve 7% to 9% average annual growth in adjusted EPS and parent-free cash flow through 2025. I will give more color on our accomplishments while covering the following three themes shown on slide four. One, the growth and transformation of our U.S. utilities; two, our rapidly growing renewables business; and three, our strategic advantage from innovation. As you may recall, during our Investor Day in March, we outlined our plan to invest $2.3 billion to transform our two U.S. utilities, AES Ohio and AES Indiana. During the second quarter, we concluded key outstanding regulatory proceedings at both of our U.S. utilities, clearing the path for investment in the latest technologies, which will enable us to deliver a higher level of service and reduce carbon emissions. At the core of our efforts is a focus and deep understanding of the digital tools that vastly improve customer experience and enable the integration and orchestration of diverse and distributed renewable resources. Starting with AES Ohio on Slide five, where we expect to nearly double the rate base by growing 12% annually to 2025. Recently, we made a substantial headway on outstanding regulatory filings. First, the Commission approved as Ohio stipulation allowing predictable cash flows at investment in Smart Grid initiatives over the next four years. And second, AES Ohio also received approval for the FERC regulated formulary allowing recovery of transmission investments. Now moving on to AES Indiana on Slide six, where we're investing 1.5 billion over the next five years as part of our grid modernization program and our transition to more renewables-based generation. We recently received regulatory approval for our 195-megawatt Hardy Hills solar project. And we announced an agreement to acquire the Petersburg solar project, which includes 250 megawatts of solar and 100 megawatt hours of energy storage. We expect to grow the rate base at AES Indiana by more than 7% annually. With many of the key regulatory approvals behind us, we're now positioned to execute on our utility modernization and decarbonization programs, which have been years in the making. Now turning to the second theme of renewables growth on Slide seven, last year was a record-breaking year of renewable contracts for us with over three gigawatts sign. So far this year, we have already signed almost three gigawatts of contracts for wind, solar and energy storage, nearly double the amount at the same time last year. More than 90% of the new contracts are in the U.S. And we are well on our way towards achieving or exceeding our target of four gigawatts for 2021. At the same time, more than 80% are with C&I customers, negotiated on a bilateral basis. Our new projects will yield after tax returns at the project level, in line with our low teens average for the U.S. and mid to high teens internationally. Our progress so far this year, includes our recent agreement to acquire 612 megawatts of operating wind assets in New York, as shown on Slide eight. New York State's supportive renewables policies, combined with the scarcity of wind projects in the northeast, provides us with several pathways for long-term attractive cash flows to support repowering by 2025. This wind acquisition complements our solar and energy storage pipeline, providing us with another resource to offer diversified and differentiated products to our consumers. Turning to Slide nine, we're particularly pleased with our ability to advance new plant energy products. This year, we announced the world's first ever large scale 24/7 carbon free energy netted on an hourly basis, supplying Google's Virginia data centers. We see this concept of real-time renewable generation, as opposed to the purchase of offsetting renewable credits as the new highest standard in clean energy. We have since replicated similar structures with other large-scale customers, helping them to achieve their sustainability targets, while supporting our renewables growth goals, or a total of 1.5 gigawatts of these clean energy products signed or awarded thus far this year. We see these innovative carbon free energy products as examples of our unique advantages, both in our technical and commercial abilities, as well as our culture working together with customers to understand their specific needs. Turning to Slide 10, with nearly three gigawatts of renewables and energy storage project added this year, we now have a backlog of 8.5 gigawatts, including 2.5 gigawatts currently under construction. We expect to bring 1.4 gigawatts online during the remainder of 2021. The strength of our U.S. renewables growth in the rapidly expanding market will support achieving our goal of having 50% of our earnings from renewables and utilities and 50% of our earnings from the U.S. by 2025. We also continue to aggressively grow our pipeline of early mid and late stage development projects to support future growth. As you can see, on Slide 11, we now have a pipeline of 37 gigawatts among the largest in the world. More than 60% of this pipeline is in the U.S., including eight gigawatts in the hottest market in the country, California. Now to decarbonization on Slide 12. Last month, AES Andes announced a 1.1 gigawatts of coal-fired generation would be voluntarily retired as soon as January 2025. And will be replaced with 2.3 gigawatts of newly contracted renewables. Since 2017, we have announced the sale or retirement of almost 12 gigawatts of coal-fired generation, which is among the largest programs of any American company. I'm pleased to report that these exits along with our substantial renewable additions, [indiscernible] generation from coal to approximately 20% of total generation on a pro forma basis, an additional reduction of five percentage points since last quarter. I would like to address two key concerns that we're hearing from investors related to growth in renewables. Inflationary pressures and supply chain bottlenecks. As one of the largest global renewable developers with a strong reputation, we have a long history of successfully negotiating strategic supply agreements, resulting in preferential access and pricing. Furthermore, we lock in the hardware prices, when we sign the PPA, sheltering us from future price fluctuations, with 90% of the equipment needed for 8.5 gigawatts backlog already secured, we feel very comfortable in our ability to execute on our strong pipeline over the short and medium-term. Now turning to Slide 13, and a third theme of innovation. As our entire sector continues to rapidly evolve, we increasingly find that there is a competitive advantage for those who are able to effectively incorporate new technologies and business models. For example, we have benefited significantly from our energy storage business, which we started over 10 years ago, and which now is one of the largest in the industry. There are important synergies between our core businesses and technology ventures. For example, this year, about half of our renewable energy PPAs include an energy storage component. Last month, once again, we were awarded the highest honor in the power and utility sector, the Edison award from the Edison Electric Institute. For our work, developing energy storage, as a cost effective alternative to new gas peaking plants. Specifically, the award was for the AES Alamitos Battery Energy Storage System, consisting of 400 megawatt hours of energy storage, it can supply power to 10s of 1000s of homes in milliseconds. This is our seventh Edison award overall. And third U.S. Edison award over the last decade, I would like to note that we have won many more Edison awards than any other company in recent years. Turning to Slide 14, we also continue to build on our prior success in creating technology [unit growth] [ph]. For example, we have previously mentioned our strategic investment in 5B, a prefabricated solar solution company that has patented technology, allowing solar projects to be built in a third of the time and on half as much land while being resistant to hurricane force winds. We continue to grow 5Bs footprint across several markets, including the U.S., Puerto Rico, Chile and Panama. And they're now expanding into India, where we are working with domestic partners to establish local manufacturing. We hope India will enable 5B to reach a much greater scale much more quickly, which combined with our leading work in robotics construction, will help us lower all in solar costs, as we advance on the learning curve. Turning to Slide 15. Similarly, we continue to benefit from our investment in Uplight, which provides cloud-based energy efficiency solutions to more than 110 million households and businesses through its numerous utility customers, including AES Ohio and AES Indiana. In July, we closed the previously announced transaction with Schneider Electric, and a group of investors that valued Uplight at $1.5 billion. In conclusion, we're very pleased with our progress to-date, across all of our key strategic initiatives. Not only are we well positioned to achieve all of our financial goals but we are on track to hit our transformational targets of more than 50% of our earnings from renewables and utilities and more than 50% from the U.S., while having less than 10% of our generation from coal by 2025. I will now turn the call over to Gustavo Pimenta, our CFO.
Gustavo Pimenta: Thank you, Andrés and good morning everyone. As Andrés mentioned, we are making excellent progress this year. Having already achieved significant milestones on our strategic and financial objectives. We are pleased to see the continued economic recovery across our markets driven by the reopening of local economies. In Latin America, many of our clients continue to benefit from records steel, copper and soybean prices, resulting in a significant improvement in electricity demand across our businesses. This also reflect in our day sales outstanding, which remain at a historically low levels. Turning to our financial results for the second quarter on Slide 17. Adjusted EPS was up 24% to $0.31, primarily reflecting execution on our growth plan, demand recovery at our U.S. utilities and parent interest savings. This positive drivers were partially offset by lower contributions from Chile and Brazil, and a slightly higher adjusted tax rate. Turning to Slide 18, adjusted pre-tax contribution or PTC was $303 million for the quarter, an increase of $65 million versus the second quarter of 2020. I will discuss the key drivers of our second quarter results in more detail beginning on Slide 19. In the U.S. and utilities strategic business units or SBU, PTC was up $71 million, driven primarily by the demand recovery that our utilities, higher contributions for about one gigawatts of new renewable assets and the commencement of power purchase agreements or PPAs at Southland Energy in California. Turning to Slide 20, we are very encouraged to see material recovery consistent demand at our U.S. utilities. For Q2 on a weather normalized basis, demand at AES Ohio is up 9% and demand at AES Indiana is up 4%. The net combined volume in Ohio and Indiana is largely back to 2019 pre-COVID levels. This recovery is mainly driven by higher load from commercial and industrial customers this year as a result of the reopening of local businesses. Separately in California, our 2.3 gigawatts Southland legacy units are well positioned to contribute to the state's pressing energy needs and its transition to a more sustainable carbon free future. In fact, the State Water Board is considering the California Energy Agency's recommendation for our 876-megawatt Redondo Beach facility to be extended for two years through 2023 to align with our remaining legacy units. This proposed expansion would be an upside to expectations for 2025. Now turning back to our quarterly results on Slide 21, at our South America SBU, lower PTC was mostly driven by recovery of expenses from customers in Chile in 2020. Lower equity earnings from workorder also in Chile and drier hydrology in Brazil. These impacts were partially offset by higher generation of the Chivor hydro plant in Colombia. Higher PTC at our Mexico, Central America and Caribbean or MCC SBU primarily reflects better hydrology in Panama, which was partially offset by the sale of Itabo in the Dominican Republic. Finally in Eurasia, PTC remained relatively flat. The impact from the sale of OPGC in India was largely offset by lower interest expense in Bulgaria. Turning to Slide 24, with our first half results, we are on track to achieve our full year 2021 adjusted EPS guidance of $1.50 to $1.58. As we have discussed in the past, our typical quarterly earnings profile was more back hand weighted with roughly 40% of earnings occurring in the first half of the year. But also in the year to go, we will be primarily driven by 1.4 gigawatts of new renewables assets coming online in the remainder of the year, continued demand recovery across all markets, reduced interest expense and cost savings benefits. We are also reaffirming our expected 7% to 9% average annual growth targets through 2025. Now turning to our credit profile on Slide 25, strong credit metrics remain one of our top priorities. In the last four years, we obtained two to three notches of upgrades from the three credit rating agencies, including investment grade ratings from Fitch and S&P. We are also very encouraged by the recent change in outlook to positive on our BA1 one rating at Moody's. These actions validate the strength of our business model and our commitment to improving our credit metrics. We expected positive momentum in these metrics to continue enabling us to reach BBB ratios by 2025. Now to our 2021 parent capital allocation plan on Slide 26, consistent with our private disclosures, sources shown on the left-hand side of the slide reflect approximately $2 billion of total discretionary cash. This includes $800 million of parent free cash flow, $100 million of proceeds received from the sale of the Itabo in the Dominican Republic and the successful issuance of the $1 billion of equity units in March. Now to uses on the right-hand side, we'll be returning $450 million to shareholders this year, consistent of our common share dividends and the coupon of the equity units. And we plan to invest approximately 1.4 billion to $1.5 billion in our subsidiaries, as we capitalize on attractive opportunities for growth. Approximately 60% of these investments are in global renewables, reflecting our success in originations during 2020 and our expectations for 2021. And about 25% of these investments are in our U.S. utilities to fund rate base growth with a continued focus on grid and fleet modernization. In the first half of the year, we invested approximately $700 million primarily in renewables, which is roughly 50% of our expected investments for the year. In summary, we are making significant progress on executing on the strategic and financial objectives, we laid out in our Investor Day in March positioning AES as the leader in the energy transition, while delivering superior returns to our shareholders. With that, I'll turn the call back over to Andrés.
Andrés Gluski: Thank you, Gustavo. In summary, the world has decided to seriously tackle climate change. And this is driving unprecedented and accelerating growth in demand for renewables and energy efficiency applications and services. In relative terms, I don't believe anyone is better positioned than AES to capitalize on this once in a lifetime transformation of our sector. We have a proven track record of success, we have the most innovative new products and an 8.5 gigawatt backlog and the 37-gigawatt pipeline projects. All in all, we're enthusiastic about our future. And we will feel confident about delivering on our 7% to 9% average annual growth rate. Our core contracted generation and utility businesses have shown great resilience in the face of global and regional effects of COVID. Beyond our robust growth rates in earnings and cash flow from our core businesses, we are creating very significant value for our shareholders through our technology joint ventures. There has never been a better time for AES. With that, I would like to open up the call for questions.
Operator: We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Julien Dumoulin Smith from Bank of America.
Julien Dumoulin Smith: Congratulations on developments year-to-date. I am very curious on the latest on the battery business and some of the strategic angles you're thinking about here. Can you talk about what's evolved around Fluence given the latest comments here? And then also at the same time, can you comment a little bit on the storage availability, I know you all have been making or taking some preemptive actions to ensure continued supply availability. But if you can comment on the latest backdrop would very much appreciated.
Andrés Gluski: Sure. Well, good morning, Julien. There's not too much I can comment other than the statement in our press release. In the past, I've talked about it that ensuring supply was very important to us and we have mentioned the strategic arrangement with Northvolt for European supply. So as I said in the call today, overall we feel very good about being able to have access to the equipment we need for our growth program, but I really can't comment much more on Fluence at this time.
Ahmed Pasha: Julien, are you there?
Operator: Julien, your line is still open. The next question comes from Angie Storozynski from Evercore ISI.
Angie Storozynski: So I'm just wondering, what is the reason for this acceleration in the renewable power generation that we're seeing year-to-date? Is it just because you're increasingly focused on C&I customers? Hence the higher than expected backlog year-to-date?
Andrés Gluski: Hi, Angie. That's a great question. I would say yes, as you can see, where we're focusing a lot on C&I. We have come up with innovative products, like the around the clock, carbon free energy. So as we mentioned in my speech, we have 1.5 gigawatts of new contracts just coming from similar products, to the one that we had announced with Google. So certainly, that is a big driver. The other thing of course, is we have a good pipeline of potential projects. So we're just finding that we're working very well with our clients, we have many repeat clients in terms of signing on new deals. So this second quarter was particularly strong in the U.S. And we see that as the most rapidly growing market. We're very well placed. So we feel good about it, we feel good about the product offerings that we have -- we feel good about our customer relations, and we feel good about our supply chain.
Angie Storozynski: Okay. And secondly, I mean, it seems like you guys are starting to do projects, which I mean, you don't typically pursue like repowering of the wind farms in New York State, or the acquisition of renewable assets in Indiana from NextEra. I mean, is it just because, those are opportunistic deals that offer highest returns and those are not that traditional ground mount solar installations that you would physically pursue?
Andrés Gluski: Look, we're focused on satisfying our customers' needs, in this particular case, yes, Indiana. So if there was a better project in MISO that we need to put together to meet our transition towards more renewables. We will take it. So in many of our deals, we use a lot of required additionality. So we're building most of them. But there's no problem with acquiring somebody else's project to get the optimal mix from a risk. And also, I'd say production capability. So first, that's something that's inherent in our product offering. So we're really trying to solve the client's need. It's much less about sort of RFPs and busbar PPAs, that's what we're going after. In the case of New York, look, look, we don't have a lot of wind assets of ourselves. Other people have done a lot of wind assets repowering. We think this is an idea that the time has come with the technology. So we're doing some repowering on our old wind farms. But we saw this is a great opportunity in New York to repower. And again, this comes back to the idea that we want a mix of assets; wind, solar, energy storage, in some cases, even small hydro's to be able to deliver those sort of round the clock renewables. So think of it that way that, we're solving for what the customer wants. And we'll put the package of sources, whether we build them or we buy somebody else's project to satisfy that.
Angie Storozynski: Yes, very good. Again, an incredible start of the year. Thank you.
Operator: And the next question comes from Durgesh Chopra from Evercore ISI.
Durgesh Chopra: Andrés, I appreciate you can't say much about points, but maybe I'm just kind of curious on the timing of the announcement here. So QIA sort of made their investment late last year. Are you seeing more growth opportunity, just walk us through some of your thought process and why now versus wait a couple of years, just anything along those lines?
Andrés Gluski: Honestly, I can't comment much on it. What I can refer you to what I've said in the past. And with QIA, I would say it's just not a financial investor. It's a strategic investment, which has investments in other very important companies, which can help this business. So I'll have to limit my comments to that, and I'm sorry.
Durgesh Chopra: Okay. We'll leave that. Maybe just shifting gears to Chile. The last time, I remember there were some legislations on early retirements, you guys have kind of retired your coal plants. Can you talk about your exposure there as a percentage of the company as a whole, post the announcement of these coal retirements? And do you see any risks to margins and cash flow there in July?
Andrés Gluski: Look, overall, Chile is maybe like 15%. Remember that's AES Andes includes Colombia and includes 100%, renewable hydro in Colombia. AES Andes has done a remarkable transformation in terms of being a primarily coal -- contracted coal generator into by 2025, having very little coal. And a lot of green blend and extent, so this really gave us an in, was the ability to modify those contracts. So that a large proportion, if not, the majority of the energy would come from new contracted renewables, and you keep the coal for capacity. So this is, again, quite a remarkable transformation. So the last thing I would say is, regarding the potential legislation that's been -- I think, it's really, Chile is a serious country, they're really looking at how the grid can maintain its reliability with the retirement of these coal plants. So what we said is, look, we are willing to retire these plants, as soon as 2025 is really to give the grid operator the opportunity to have -- to ensure a reliable grid, we can shut them down sooner from our perspective. So I don't see, everything that we're doing is in our forecast, I'll pass it to Gustavo to make some more comments.
Gustavo Pimenta: Yes. I guess I think the one thing that I would add is, after they announced retirement, the latest one that we've done, we are left with just two facilities for green blend and extend and retirement. So it's about 800 megawatt left and everything else has been announced. We've been able to implement green blend and an extent. So it's a substantially smaller share of where we were in there a couple years ago.
Durgesh Chopra: Got it. Sounds like a small portion of EBITDA cashflow, earnings, whatever comes from [July] [ph] post these retirements. Okay, thanks, guys. Great execution in the backlog and congratulations on getting [indiscernible] on the Board here.
Operator: [Operator Instructions] The next question comes from Biju Perincheril with Susquehanna.
Biju Perincheril: Hi, good morning. Thanks for taking my question. Andrés, you touched on some of the supply chain concerns, I was wondering if you could talk a little bit about, how you might be impacted from the Hoshin, WRO, and maybe some of the steps you're taking to mitigate that impact?
Andrés Gluski: Yes, great question. Look, some of you, who follow us for a while, we're always very paranoid about our supply chain. That's why I think it was January of '20 -- February of 2020. We were talking about supply chain issues with COVID and how we're going to get ahead of it. So here, we've also been on top of this, they're obviously in the past year, there were supply chain issues with, imports, what was going to be the tariff on panels from China. And then, what was going to be the tariff, for example, on aluminum. So, could you manufacture locally? So we've been on top of this issue. So today, I'd say all of our solar panels coming into the states are not coming in from China, they're coming in from Malaysia. We do buy some U.S. panels as well, which are non-polysilicon. We're also working with top-notch -- only top-notch panel manufacturers, first tier and getting certificate so that none of the polysilicon comes from Hoshin, they could be associated in any way with forced labor. So that's where we are. This is a developing story. In the past what we've been able to do with the tariffs for example is to move panels that were coming to the stage, for example to Chile, and vice versa, to optimize the supply chain, so which quite frankly worked out very well. So if you look at what we're doing. We are certainly in solar, one of the top five, I would say in the country, in terms of new solar development. So we're very well positioned. We're on top of that. We have longstanding agreements and our suppliers are doing everything possible. I think I could add that in the future, we're going to -- we're making sure that the polysilicon would come from alternative sources like Germany or Korea. So that's in the works. But this does take a transition. So we're on top of that. And stay tuned, because, while we feel very good about our certification and all the rest it's a question of where does that polysilicon arrive? Can you prove it? So again, we are having as extensive affidavits from our suppliers as anybody on this matter.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Ahmed Pasha for any closing.
Ahmed Pasha: Thanks everybody, for joining us on today's call. As always, the IR team will be available to answer any follow up questions you may have. Thanks and have a nice day.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day and welcome to the AES Corporation Second Quarter 2021 Financial Review Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ahmed Pasha, Treasurer and Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you, Operator. Good morning and welcome to our second quarter 2021 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can also be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer and other senior members of our management team. With that, I will turn the call over to Andrés. Andrés?"
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, everyone. And thank you for joining our second quarter financial review call. Today I will discuss our progress today on a number of key strategic objectives. Before turning the call over to our CFO, Gustavo Pimenta, to discuss our financial results in more detail. We had an excellent second quarter with a 24% increase in adjusted EPS from the second quarter of 2020. And a record 1.8 gigawatts of renewables under long-term contracts added to our backlog, bringing our total to 8.5 gigawatts. We remain on track to achieve 7% to 9% average annual growth in adjusted EPS and parent-free cash flow through 2025. I will give more color on our accomplishments while covering the following three themes shown on slide four. One, the growth and transformation of our U.S. utilities; two, our rapidly growing renewables business; and three, our strategic advantage from innovation. As you may recall, during our Investor Day in March, we outlined our plan to invest $2.3 billion to transform our two U.S. utilities, AES Ohio and AES Indiana. During the second quarter, we concluded key outstanding regulatory proceedings at both of our U.S. utilities, clearing the path for investment in the latest technologies, which will enable us to deliver a higher level of service and reduce carbon emissions. At the core of our efforts is a focus and deep understanding of the digital tools that vastly improve customer experience and enable the integration and orchestration of diverse and distributed renewable resources. Starting with AES Ohio on Slide five, where we expect to nearly double the rate base by growing 12% annually to 2025. Recently, we made a substantial headway on outstanding regulatory filings. First, the Commission approved as Ohio stipulation allowing predictable cash flows at investment in Smart Grid initiatives over the next four years. And second, AES Ohio also received approval for the FERC regulated formulary allowing recovery of transmission investments. Now moving on to AES Indiana on Slide six, where we're investing 1.5 billion over the next five years as part of our grid modernization program and our transition to more renewables-based generation. We recently received regulatory approval for our 195-megawatt Hardy Hills solar project. And we announced an agreement to acquire the Petersburg solar project, which includes 250 megawatts of solar and 100 megawatt hours of energy storage. We expect to grow the rate base at AES Indiana by more than 7% annually. With many of the key regulatory approvals behind us, we're now positioned to execute on our utility modernization and decarbonization programs, which have been years in the making. Now turning to the second theme of renewables growth on Slide seven, last year was a record-breaking year of renewable contracts for us with over three gigawatts sign. So far this year, we have already signed almost three gigawatts of contracts for wind, solar and energy storage, nearly double the amount at the same time last year. More than 90% of the new contracts are in the U.S. And we are well on our way towards achieving or exceeding our target of four gigawatts for 2021. At the same time, more than 80% are with C&I customers, negotiated on a bilateral basis. Our new projects will yield after tax returns at the project level, in line with our low teens average for the U.S. and mid to high teens internationally. Our progress so far this year, includes our recent agreement to acquire 612 megawatts of operating wind assets in New York, as shown on Slide eight. New York State's supportive renewables policies, combined with the scarcity of wind projects in the northeast, provides us with several pathways for long-term attractive cash flows to support repowering by 2025. This wind acquisition complements our solar and energy storage pipeline, providing us with another resource to offer diversified and differentiated products to our consumers. Turning to Slide nine, we're particularly pleased with our ability to advance new plant energy products. This year, we announced the world's first ever large scale 24/7 carbon free energy netted on an hourly basis, supplying Google's Virginia data centers. We see this concept of real-time renewable generation, as opposed to the purchase of offsetting renewable credits as the new highest standard in clean energy. We have since replicated similar structures with other large-scale customers, helping them to achieve their sustainability targets, while supporting our renewables growth goals, or a total of 1.5 gigawatts of these clean energy products signed or awarded thus far this year. We see these innovative carbon free energy products as examples of our unique advantages, both in our technical and commercial abilities, as well as our culture working together with customers to understand their specific needs. Turning to Slide 10, with nearly three gigawatts of renewables and energy storage project added this year, we now have a backlog of 8.5 gigawatts, including 2.5 gigawatts currently under construction. We expect to bring 1.4 gigawatts online during the remainder of 2021. The strength of our U.S. renewables growth in the rapidly expanding market will support achieving our goal of having 50% of our earnings from renewables and utilities and 50% of our earnings from the U.S. by 2025. We also continue to aggressively grow our pipeline of early mid and late stage development projects to support future growth. As you can see, on Slide 11, we now have a pipeline of 37 gigawatts among the largest in the world. More than 60% of this pipeline is in the U.S., including eight gigawatts in the hottest market in the country, California. Now to decarbonization on Slide 12. Last month, AES Andes announced a 1.1 gigawatts of coal-fired generation would be voluntarily retired as soon as January 2025. And will be replaced with 2.3 gigawatts of newly contracted renewables. Since 2017, we have announced the sale or retirement of almost 12 gigawatts of coal-fired generation, which is among the largest programs of any American company. I'm pleased to report that these exits along with our substantial renewable additions, [indiscernible] generation from coal to approximately 20% of total generation on a pro forma basis, an additional reduction of five percentage points since last quarter. I would like to address two key concerns that we're hearing from investors related to growth in renewables. Inflationary pressures and supply chain bottlenecks. As one of the largest global renewable developers with a strong reputation, we have a long history of successfully negotiating strategic supply agreements, resulting in preferential access and pricing. Furthermore, we lock in the hardware prices, when we sign the PPA, sheltering us from future price fluctuations, with 90% of the equipment needed for 8.5 gigawatts backlog already secured, we feel very comfortable in our ability to execute on our strong pipeline over the short and medium-term. Now turning to Slide 13, and a third theme of innovation. As our entire sector continues to rapidly evolve, we increasingly find that there is a competitive advantage for those who are able to effectively incorporate new technologies and business models. For example, we have benefited significantly from our energy storage business, which we started over 10 years ago, and which now is one of the largest in the industry. There are important synergies between our core businesses and technology ventures. For example, this year, about half of our renewable energy PPAs include an energy storage component. Last month, once again, we were awarded the highest honor in the power and utility sector, the Edison award from the Edison Electric Institute. For our work, developing energy storage, as a cost effective alternative to new gas peaking plants. Specifically, the award was for the AES Alamitos Battery Energy Storage System, consisting of 400 megawatt hours of energy storage, it can supply power to 10s of 1000s of homes in milliseconds. This is our seventh Edison award overall. And third U.S. Edison award over the last decade, I would like to note that we have won many more Edison awards than any other company in recent years. Turning to Slide 14, we also continue to build on our prior success in creating technology [unit growth] [ph]. For example, we have previously mentioned our strategic investment in 5B, a prefabricated solar solution company that has patented technology, allowing solar projects to be built in a third of the time and on half as much land while being resistant to hurricane force winds. We continue to grow 5Bs footprint across several markets, including the U.S., Puerto Rico, Chile and Panama. And they're now expanding into India, where we are working with domestic partners to establish local manufacturing. We hope India will enable 5B to reach a much greater scale much more quickly, which combined with our leading work in robotics construction, will help us lower all in solar costs, as we advance on the learning curve. Turning to Slide 15. Similarly, we continue to benefit from our investment in Uplight, which provides cloud-based energy efficiency solutions to more than 110 million households and businesses through its numerous utility customers, including AES Ohio and AES Indiana. In July, we closed the previously announced transaction with Schneider Electric, and a group of investors that valued Uplight at $1.5 billion. In conclusion, we're very pleased with our progress to-date, across all of our key strategic initiatives. Not only are we well positioned to achieve all of our financial goals but we are on track to hit our transformational targets of more than 50% of our earnings from renewables and utilities and more than 50% from the U.S., while having less than 10% of our generation from coal by 2025. I will now turn the call over to Gustavo Pimenta, our CFO."
},
{
"speaker": "Gustavo Pimenta",
"text": "Thank you, Andrés and good morning everyone. As Andrés mentioned, we are making excellent progress this year. Having already achieved significant milestones on our strategic and financial objectives. We are pleased to see the continued economic recovery across our markets driven by the reopening of local economies. In Latin America, many of our clients continue to benefit from records steel, copper and soybean prices, resulting in a significant improvement in electricity demand across our businesses. This also reflect in our day sales outstanding, which remain at a historically low levels. Turning to our financial results for the second quarter on Slide 17. Adjusted EPS was up 24% to $0.31, primarily reflecting execution on our growth plan, demand recovery at our U.S. utilities and parent interest savings. This positive drivers were partially offset by lower contributions from Chile and Brazil, and a slightly higher adjusted tax rate. Turning to Slide 18, adjusted pre-tax contribution or PTC was $303 million for the quarter, an increase of $65 million versus the second quarter of 2020. I will discuss the key drivers of our second quarter results in more detail beginning on Slide 19. In the U.S. and utilities strategic business units or SBU, PTC was up $71 million, driven primarily by the demand recovery that our utilities, higher contributions for about one gigawatts of new renewable assets and the commencement of power purchase agreements or PPAs at Southland Energy in California. Turning to Slide 20, we are very encouraged to see material recovery consistent demand at our U.S. utilities. For Q2 on a weather normalized basis, demand at AES Ohio is up 9% and demand at AES Indiana is up 4%. The net combined volume in Ohio and Indiana is largely back to 2019 pre-COVID levels. This recovery is mainly driven by higher load from commercial and industrial customers this year as a result of the reopening of local businesses. Separately in California, our 2.3 gigawatts Southland legacy units are well positioned to contribute to the state's pressing energy needs and its transition to a more sustainable carbon free future. In fact, the State Water Board is considering the California Energy Agency's recommendation for our 876-megawatt Redondo Beach facility to be extended for two years through 2023 to align with our remaining legacy units. This proposed expansion would be an upside to expectations for 2025. Now turning back to our quarterly results on Slide 21, at our South America SBU, lower PTC was mostly driven by recovery of expenses from customers in Chile in 2020. Lower equity earnings from workorder also in Chile and drier hydrology in Brazil. These impacts were partially offset by higher generation of the Chivor hydro plant in Colombia. Higher PTC at our Mexico, Central America and Caribbean or MCC SBU primarily reflects better hydrology in Panama, which was partially offset by the sale of Itabo in the Dominican Republic. Finally in Eurasia, PTC remained relatively flat. The impact from the sale of OPGC in India was largely offset by lower interest expense in Bulgaria. Turning to Slide 24, with our first half results, we are on track to achieve our full year 2021 adjusted EPS guidance of $1.50 to $1.58. As we have discussed in the past, our typical quarterly earnings profile was more back hand weighted with roughly 40% of earnings occurring in the first half of the year. But also in the year to go, we will be primarily driven by 1.4 gigawatts of new renewables assets coming online in the remainder of the year, continued demand recovery across all markets, reduced interest expense and cost savings benefits. We are also reaffirming our expected 7% to 9% average annual growth targets through 2025. Now turning to our credit profile on Slide 25, strong credit metrics remain one of our top priorities. In the last four years, we obtained two to three notches of upgrades from the three credit rating agencies, including investment grade ratings from Fitch and S&P. We are also very encouraged by the recent change in outlook to positive on our BA1 one rating at Moody's. These actions validate the strength of our business model and our commitment to improving our credit metrics. We expected positive momentum in these metrics to continue enabling us to reach BBB ratios by 2025. Now to our 2021 parent capital allocation plan on Slide 26, consistent with our private disclosures, sources shown on the left-hand side of the slide reflect approximately $2 billion of total discretionary cash. This includes $800 million of parent free cash flow, $100 million of proceeds received from the sale of the Itabo in the Dominican Republic and the successful issuance of the $1 billion of equity units in March. Now to uses on the right-hand side, we'll be returning $450 million to shareholders this year, consistent of our common share dividends and the coupon of the equity units. And we plan to invest approximately 1.4 billion to $1.5 billion in our subsidiaries, as we capitalize on attractive opportunities for growth. Approximately 60% of these investments are in global renewables, reflecting our success in originations during 2020 and our expectations for 2021. And about 25% of these investments are in our U.S. utilities to fund rate base growth with a continued focus on grid and fleet modernization. In the first half of the year, we invested approximately $700 million primarily in renewables, which is roughly 50% of our expected investments for the year. In summary, we are making significant progress on executing on the strategic and financial objectives, we laid out in our Investor Day in March positioning AES as the leader in the energy transition, while delivering superior returns to our shareholders. With that, I'll turn the call back over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Gustavo. In summary, the world has decided to seriously tackle climate change. And this is driving unprecedented and accelerating growth in demand for renewables and energy efficiency applications and services. In relative terms, I don't believe anyone is better positioned than AES to capitalize on this once in a lifetime transformation of our sector. We have a proven track record of success, we have the most innovative new products and an 8.5 gigawatt backlog and the 37-gigawatt pipeline projects. All in all, we're enthusiastic about our future. And we will feel confident about delivering on our 7% to 9% average annual growth rate. Our core contracted generation and utility businesses have shown great resilience in the face of global and regional effects of COVID. Beyond our robust growth rates in earnings and cash flow from our core businesses, we are creating very significant value for our shareholders through our technology joint ventures. There has never been a better time for AES. With that, I would like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Julien Dumoulin Smith from Bank of America."
},
{
"speaker": "Julien Dumoulin Smith",
"text": "Congratulations on developments year-to-date. I am very curious on the latest on the battery business and some of the strategic angles you're thinking about here. Can you talk about what's evolved around Fluence given the latest comments here? And then also at the same time, can you comment a little bit on the storage availability, I know you all have been making or taking some preemptive actions to ensure continued supply availability. But if you can comment on the latest backdrop would very much appreciated."
},
{
"speaker": "Andrés Gluski",
"text": "Sure. Well, good morning, Julien. There's not too much I can comment other than the statement in our press release. In the past, I've talked about it that ensuring supply was very important to us and we have mentioned the strategic arrangement with Northvolt for European supply. So as I said in the call today, overall we feel very good about being able to have access to the equipment we need for our growth program, but I really can't comment much more on Fluence at this time."
},
{
"speaker": "Ahmed Pasha",
"text": "Julien, are you there?"
},
{
"speaker": "Operator",
"text": "Julien, your line is still open. The next question comes from Angie Storozynski from Evercore ISI."
},
{
"speaker": "Angie Storozynski",
"text": "So I'm just wondering, what is the reason for this acceleration in the renewable power generation that we're seeing year-to-date? Is it just because you're increasingly focused on C&I customers? Hence the higher than expected backlog year-to-date?"
},
{
"speaker": "Andrés Gluski",
"text": "Hi, Angie. That's a great question. I would say yes, as you can see, where we're focusing a lot on C&I. We have come up with innovative products, like the around the clock, carbon free energy. So as we mentioned in my speech, we have 1.5 gigawatts of new contracts just coming from similar products, to the one that we had announced with Google. So certainly, that is a big driver. The other thing of course, is we have a good pipeline of potential projects. So we're just finding that we're working very well with our clients, we have many repeat clients in terms of signing on new deals. So this second quarter was particularly strong in the U.S. And we see that as the most rapidly growing market. We're very well placed. So we feel good about it, we feel good about the product offerings that we have -- we feel good about our customer relations, and we feel good about our supply chain."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And secondly, I mean, it seems like you guys are starting to do projects, which I mean, you don't typically pursue like repowering of the wind farms in New York State, or the acquisition of renewable assets in Indiana from NextEra. I mean, is it just because, those are opportunistic deals that offer highest returns and those are not that traditional ground mount solar installations that you would physically pursue?"
},
{
"speaker": "Andrés Gluski",
"text": "Look, we're focused on satisfying our customers' needs, in this particular case, yes, Indiana. So if there was a better project in MISO that we need to put together to meet our transition towards more renewables. We will take it. So in many of our deals, we use a lot of required additionality. So we're building most of them. But there's no problem with acquiring somebody else's project to get the optimal mix from a risk. And also, I'd say production capability. So first, that's something that's inherent in our product offering. So we're really trying to solve the client's need. It's much less about sort of RFPs and busbar PPAs, that's what we're going after. In the case of New York, look, look, we don't have a lot of wind assets of ourselves. Other people have done a lot of wind assets repowering. We think this is an idea that the time has come with the technology. So we're doing some repowering on our old wind farms. But we saw this is a great opportunity in New York to repower. And again, this comes back to the idea that we want a mix of assets; wind, solar, energy storage, in some cases, even small hydro's to be able to deliver those sort of round the clock renewables. So think of it that way that, we're solving for what the customer wants. And we'll put the package of sources, whether we build them or we buy somebody else's project to satisfy that."
},
{
"speaker": "Angie Storozynski",
"text": "Yes, very good. Again, an incredible start of the year. Thank you."
},
{
"speaker": "Operator",
"text": "And the next question comes from Durgesh Chopra from Evercore ISI."
},
{
"speaker": "Durgesh Chopra",
"text": "Andrés, I appreciate you can't say much about points, but maybe I'm just kind of curious on the timing of the announcement here. So QIA sort of made their investment late last year. Are you seeing more growth opportunity, just walk us through some of your thought process and why now versus wait a couple of years, just anything along those lines?"
},
{
"speaker": "Andrés Gluski",
"text": "Honestly, I can't comment much on it. What I can refer you to what I've said in the past. And with QIA, I would say it's just not a financial investor. It's a strategic investment, which has investments in other very important companies, which can help this business. So I'll have to limit my comments to that, and I'm sorry."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay. We'll leave that. Maybe just shifting gears to Chile. The last time, I remember there were some legislations on early retirements, you guys have kind of retired your coal plants. Can you talk about your exposure there as a percentage of the company as a whole, post the announcement of these coal retirements? And do you see any risks to margins and cash flow there in July?"
},
{
"speaker": "Andrés Gluski",
"text": "Look, overall, Chile is maybe like 15%. Remember that's AES Andes includes Colombia and includes 100%, renewable hydro in Colombia. AES Andes has done a remarkable transformation in terms of being a primarily coal -- contracted coal generator into by 2025, having very little coal. And a lot of green blend and extent, so this really gave us an in, was the ability to modify those contracts. So that a large proportion, if not, the majority of the energy would come from new contracted renewables, and you keep the coal for capacity. So this is, again, quite a remarkable transformation. So the last thing I would say is, regarding the potential legislation that's been -- I think, it's really, Chile is a serious country, they're really looking at how the grid can maintain its reliability with the retirement of these coal plants. So what we said is, look, we are willing to retire these plants, as soon as 2025 is really to give the grid operator the opportunity to have -- to ensure a reliable grid, we can shut them down sooner from our perspective. So I don't see, everything that we're doing is in our forecast, I'll pass it to Gustavo to make some more comments."
},
{
"speaker": "Gustavo Pimenta",
"text": "Yes. I guess I think the one thing that I would add is, after they announced retirement, the latest one that we've done, we are left with just two facilities for green blend and extend and retirement. So it's about 800 megawatt left and everything else has been announced. We've been able to implement green blend and an extent. So it's a substantially smaller share of where we were in there a couple years ago."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Sounds like a small portion of EBITDA cashflow, earnings, whatever comes from [July] [ph] post these retirements. Okay, thanks, guys. Great execution in the backlog and congratulations on getting [indiscernible] on the Board here."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] The next question comes from Biju Perincheril with Susquehanna."
},
{
"speaker": "Biju Perincheril",
"text": "Hi, good morning. Thanks for taking my question. Andrés, you touched on some of the supply chain concerns, I was wondering if you could talk a little bit about, how you might be impacted from the Hoshin, WRO, and maybe some of the steps you're taking to mitigate that impact?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes, great question. Look, some of you, who follow us for a while, we're always very paranoid about our supply chain. That's why I think it was January of '20 -- February of 2020. We were talking about supply chain issues with COVID and how we're going to get ahead of it. So here, we've also been on top of this, they're obviously in the past year, there were supply chain issues with, imports, what was going to be the tariff on panels from China. And then, what was going to be the tariff, for example, on aluminum. So, could you manufacture locally? So we've been on top of this issue. So today, I'd say all of our solar panels coming into the states are not coming in from China, they're coming in from Malaysia. We do buy some U.S. panels as well, which are non-polysilicon. We're also working with top-notch -- only top-notch panel manufacturers, first tier and getting certificate so that none of the polysilicon comes from Hoshin, they could be associated in any way with forced labor. So that's where we are. This is a developing story. In the past what we've been able to do with the tariffs for example is to move panels that were coming to the stage, for example to Chile, and vice versa, to optimize the supply chain, so which quite frankly worked out very well. So if you look at what we're doing. We are certainly in solar, one of the top five, I would say in the country, in terms of new solar development. So we're very well positioned. We're on top of that. We have longstanding agreements and our suppliers are doing everything possible. I think I could add that in the future, we're going to -- we're making sure that the polysilicon would come from alternative sources like Germany or Korea. So that's in the works. But this does take a transition. So we're on top of that. And stay tuned, because, while we feel very good about our certification and all the rest it's a question of where does that polysilicon arrive? Can you prove it? So again, we are having as extensive affidavits from our suppliers as anybody on this matter."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to Ahmed Pasha for any closing."
},
{
"speaker": "Ahmed Pasha",
"text": "Thanks everybody, for joining us on today's call. As always, the IR team will be available to answer any follow up questions you may have. Thanks and have a nice day."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | The AES Corporation | 35,312 |
AES | 1 | 2,021 | 2021-05-06 09:00:00 | Operator: Good morning and welcome to the AES Corporation Q1 2021 Financial Review Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I now like to turn the conference over to Ahmed Pasha, Chief Treasurer and Vice President of Investor Relations. Thank you and over to you.
Ahmed Pasha: Thank you, Operator. Good morning and welcome to our first quarter 2021 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can also be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer and other senior members of our management team. With that, I will turn the call over to Andrés. Andrés?
Andrés Gluski: Good morning, everyone, and thank you for joining our first quarter financial review call. Our first quarter results put us on track to achieve our 2021 guidance and 7% to 9% average annual growth through 2025. Gustavo will provide more color on our financial results later in the call. As we spoke about on our Investor Day in early March, we see a great opportunity for growth. Given the momentum is changes in our sector. And we are very well positioned to capitalize on the shift to low carbon sources of energy. Over the past five years we have transformed our company to be a leader in renewable and we have invested in innovative technologies that will give us a competitive advantage for many years to come. Although it has been less than two months since our Investor Day we had a number of significant achievements to announce, including a landmark deal with Google which I will describe in more detail later. A strategic collaboration to develop new battery technologies between Fluence and Northvolt the leading European supplier of sustainable battery systems and a significant increase in LNG sales in Central America and the Caribbean to support those economies in the transition away from heavy fuels. First let me lay out our strategic priorities for 2021 and the substantial progress that we have made year-to-date for the achieving those objectives. Turning to Slide, our five key goals for the year are one signed contracts for 4 gigawatts of renewables. Two, launch the 24-7 product for carbon free energy on an hourly basis. Three, further unlock the value of our technology platforms. Four, continue to improve our ESG positioning through the transformation of our portfolio. And five, monetize excess LNG capacity in Central America and the Caribbean. Turning to Slide 5 last year, we set and exceeded a goal of signing 2 to 3 gigawatts of PPAs for renewables and energy storage. This year we are increasing that goal by 60% to a target of 4 gigawatts. Today. I am pleased to report that year-to-date, we've already signed 1.1 gigawatt including a landmark deal with moving. As you can see on Slide 6, we have a backlog of 6.9 gigawatts of renewables consisting of projects already under construction or under signed power purchase agreements or PPAs. This equates to 20% growth in our total installed capacity and a 60% increase in our renewables capacity. Turning to Slide 7. We continue to increase our pipeline of projects to support our growth and now have a global pipeline of more than 30 gigawatts of renewable projects. What we, half of which is the United States. With increasing demand from corporate customers and a much more favorable policy environment, we expect the need for renewables to grow dramatically and we're taking steps to ensure a continued competitive advantage. Moving to Slide 8. Our second key goal for this year is to launch the first 24-7 energy product that matches a customer's load with carbon free energy on an hourly basis. To that end, earlier this week, we announced a landmark first of its kind agreement to supply Google's Virginia-based data centers with 24-7 carbon free energy source from a portfolio of 500 megawatts of renewables. Under this innovative structure AES will become the sole supplier of the datacenters energy needs. Ensuring that the energy supplied will meet carbon free targets when measured on an hourly basis for the next 10 years. The carbon free energy will come from an optimized portfolio of wind, solar, hydro and battery storage resources. This agreement has a new standard in carbon free energy for commercial and industrial customers who signed 23 gigawatts of PPAs in 2020. As we discussed at our Investor Day we almost 300 companies that make up the RE 100 will need more than 100 gigawatts of new renewables by 2030. This transaction with Google demonstrate that a higher sustainability standard is possible. And we expect a substantial portion of customers to pursue 24-7 carbon free objectives. Based on our leadership position, we are well placed to serve this growing market. And in fact, we've already seen significant interest from a number of large clients. Turning to Slide 9, our third key goal is to further unlock the value of our technology platforms. One of these platforms is Uplight and energy efficiency, software company that works directly with utility and has access to more than a 100 million households and businesses in the US. Uplight is at the forefront of the shift to low-carbon and digital solutions on the cloud. In March, we announced a capital raise with a consortium led by Schneider Electric valuing Uplight at 1.5 billion. Now to Slide 10. We are seeing increasing value in many of our other technology platforms as well. Fluence our joint venture with Siemens are a global leader in energy storage, which is a key component of the energy transition. This dynamic industry is expected to grow 40% annually and Fluence is well positioned to capitalize on this immense opportunity through its distinct competitive advantages including its AI enabled leading engine. Turning to Slide 11, as you may have seen last month Fluence announced a multi-year agreement with Northvolt the leading European battery developer and manufacturer for assured supply and to co-develop next-generation battery technology. This is an example of Fluence is continued innovation, which has been validated by the consistent rank as the number one utility scale energy storage technology company, according to guide house insight. Similarly, we see the rapid progress of our prefab solution 5B as you can see on Slide 12. This technology double the energy density and cuts construction time by 2/3. We now have 5G projects in Australia, Panama and Chile. We will be, including 5G technology in our business in Puerto Rico. Or it's proven resilience to Category 4 hurricane winds will provide greater energy security. Proving out the unique value proposition of 5G could significantly speed up the adoption of solar in cyclone prone areas. Lastly, we continue to work towards the approval of the first large-scale green hydrogen based ammonia plant in the Western Hemisphere in Chile. Moving to Slide 13 we have undergone one of the most dramatic transformations in our sector. Over the past five years, we have announced the retirement or sale of 10.7 gigawatts of coal or 70% of our coal capacity one of the largest reductions in our sector. We recognize that we have more work to do and have set a goal of reducing our generation from coal to less than 10% of total generation by 2025 furthermore, we expect to achieve net zero emissions from electricity by 2040 one of the most ambitious goals of any power company. As we achieve decarbonization targets and continuing our near-term growth in renewables. We anticipate being included in additional ESG oriented indices. Finally, turning to Slide 14 we see natural gas as a transition fuel that can lower emissions and reduce overall energy costs as markets work for the future with more renewable power. Last month, we reached an agreement to provide terminal services for an additional 34 tera BTUs of LNG throughput under a 20-year take-or-pay contract. This will bring our total contracted terminal capacity in Panama and the Dominican Republic to almost 80%. There are 45 tera BTUs of available capacity remaining. We expect to sign in the next couple of years. Our LNG business is focused on providing environmentally responsible LNG or Green LNG as soon as feasible which ensures the lowest levels of the missions throughout the entire supply chain. Now I would like to turn the call over to Gustavo Pimenta, our CFO.
Gustavo Pimenta : Thanks Andrés and good morning everyone. As Andrés mentioned, we are off to a good start this year having already achieved significant milestones towards the strategic and financial objectives that we discussed on our Investor Day. We are also encouraged by the continued economic recovery across our markets with demand in line with pre-COVID levels. Turning to our financial results for the quarter. As you can see on Slide 16 adjusted pre-tax contribution or B2C was $247 million for the quarter which was very much in line with our expectations and similar to last year's performance. I'll discuss the key drivers of our first quarter results and outlook for the year in the following slides. Turning to Slide 17 adjusted EPS for the quarter was $0.28 versus $0.29 last year. With adjusted PTC essentially flat. The $0.01 decrease in adjusted EPS was the result of a slightly higher effective tax rate this quarter. In the US and utilities, the Strategic Business Units or SBU, PTC was down $27 million driven primarily by a lower contribution from our legacy units at Southland and higher spend in our clean energy business as we accelerate our development pipeline given the growing market opportunities. There is impacts were partially offset by the benefits from the commencement of PPAs at the Southland energy combined cycle gas turbines or CCGTs. At our South America SBU, B2C was down $31 million mostly driven by lower contributions from AES Andes [ph] formerly known as AES Hamer [ph], due to higher interest expense and lower equity earnings from the Guacolda plant in Chile. These impacts were partially offset by higher generation at the Chivor or hydro plant in Colombia. Lower PTC at our Mexico Central America and the Caribbean or MCC, as we primarily reflects outages at two facilities in Domenic Republic and Mexico with both already back online since April. Results also reflect the expiration of the 72 megawatt barge PPA in Panama. Finally in Eurasia higher PTC reflects improved operational performance and lower interest expense in our Bulgaria businesses. Now to Slide 22. With our first quarter results, we are on track to achieve our full-year 2021 adjusted EPS guidance range of $1.50 to $1.58 . Our expected 2021 quarterly earnings profile is consistent with the average of the last five years. Our typical quarterly earnings is more back-end weighted with roughly 40% of the earnings occurred in the first half of the year and the remaining in the second half. Growth in the year to go will be primarily driven by contributions from new businesses including a full years of operations of the Southland repowering project, 2.3 gigawatt of projects in our backlog coming online during the next nine months. Reduced interest expense, the benefits from cost savings and the Med normalization to pre-COVID levels. We are also reaffirming our expected 7% to 9% average annual growth target through 2025. Now turning to our credit profile on Slide 23, as discussed at our Investor Day, strong credit metrics remain one of our top priorities. In the last four years we obtained two to three notches of upgrades from the three credit rating agencies, including investment grade rating from Fitch and S&P. This action validates the strength of our business model and our commitment to improving our credit metrics. We expect the positive momentum in these metrics to continue enabling the strategic BBB flat credit metrics by 2025. Now to our 2021 parent capital allocation plan on the Slide 24. Consistent with the discussion at our Investor Day sources reflect approximately $2 billion of total discretionary cash including $800 million of parent-free cash flow and $100 million of proceeds from the sale of the table [ph] in the Dominican Republic which just closed in April. Sources also include the successful issuance of the $1 billion of equity units in March. Eliminating the need for any additional equity raise to fund our current growth plan through June, 25. Now to uses on the right hand side we'll be returning $350 million to shareholders this year. This consists of our common share dividend, including the 5% increase we announced in December and the coupon of the equity units. And we plan to invest approximately $1.4 billion to $1.5 billion in our subsidiaries, as we capitalize on attractive growth opportunities. Approximately 60% of investments are in global renewable, reflecting our success in renewables origination during 2020 and our expectations for 2021. About 25% of the investments are in our US utilities to fund rate base growth with a continued focus on grid and fleet modernization. In the first quarter, we invested approximately $450 million in renewables, which is roughly 1/3 of our expected investment for the year. In summary, 85% of our investments are going into the US utilities and global renewables helping us to achieve our goal of increasing the proportion of earnings from the US to more than half and from carbon for businesses to about 2/3 by 2025. The remaining 50% of our investments will go towards green LNG and other innovative opportunities that support and accelerate the energy transition. With that, I'll turn the call back over to Andrés.
Andrés Gluski : Thank you, Gustavo. Before we take your questions let me summarize today's call. As I have noted we have made great progress on our 2021 and long-term strategic goals and we are reaffirming our 2021 guidance and expectations through 2025. We see a tremendous opportunity for growth and further increasing our technological leadership as the industry transition unfolds. From advancing our renewables to unlocking the value of our new technology businesses we have a competitive advantage that will continue to benefit our customers and investors. With that I would like to open up the call to your questions.
Operator: [Operator Instructions] The first question is from the line of Richard Sunderland from JP Morgan. Please go ahead.
Richard Sunderland: Hi, good morning. Thanks for taking my questions. Just wanted to start off on the North agreement and what it could be the Fluence and maybe the energy storage market more broadly and kind of curious on the development front itself is this more sort of iterative development work or further up the installment curve?
Andrés Gluski : Yes, that's a great question. This is really a landmark agreement as we move to essentially have strategic relationships with battery manufacturers. So Northvolt is building a new plant in Sweden. And in Poland and we will have one train of the plant in Poland producing batteries for us. So as this market expands and as you have a real growth in demand this assures battery supply for one of our markets. And also I would say Europe, Middle East, Africa and in addition, we will not only have supply of batteries and again dedicated train to us, but we will also be working with Northvolt. So you have the new developments in battery. So in terms as battery technology develops as you have better chemistry, as we say fine-tune our cube stacked design. We will have joint development of additional improve batteries on multiple fronts. So this is a, I think, a very interesting development of getting a little bit more involved, that's a one-step prior to just being the integrator and providing the control softwares.
Richard Sunderland: Got it, thank you for the color. And then, separately, thinking about this Google deal, you would have the ability to replicate that with other C&I customers, I know you mentioned some interest already. And I guess curious alongside that's some aspects around the agreement itself, whether you -- this is about having the right assets and the right location to procure or, you know, about the energy kind of management angle as well.
Andrés Gluski: Or, you know, it's both in a sense, so let me take the second part first, explain a little bit what the product is. So the product really -- that the key point is that we're netting on an hourly basis, a, you know, carbon-free energy. So, this is -- you know, most contracts. Prior to this, virtually all, are really netting, you know, to be on a yearly basis could be, et cetera. So you have an excess purchases of renewables during certain hours, but you're actually using non-renewables during other hours, obviously, when you don't have the production of the renewables. This is actually saying, "You know, on an hourly basis, the energy that I'm getting is carbon free." So you ask -- you know the right question it's not just a question of, you know, having overbuild solar or overbuilt wind, it's really how do you manage these different sources of energy, you know, not only to ensure that it's carbon free, but to minimize the cost? So you know, when are you buying -- When are you using wind? When are you using solar? And the real key to make this happen is adding hydro -- small hydros and adding, of course, battery storage? So it's really how do you optimize multiple uses of -- multiple sources of renewable energy to provide the lowest cost guaranteed carbon-free energy netted on an hourly basis? So behind this offer, there's a lot of math, a lot of algorithms, a lot of risk management. And we think that, you know, this is a deal that with Google itself, you know, we had a $1 billion -- I sorry, one gigawatts agreement to the first 500 and we expect it to grow as demand in these data center grows. But, of course, there are other corporate clients that are interested in this. And you know, we've seen interest from. So as people, I would say up their environmental goals, and saying, well, we're going to be net zero carbon emissions on a global scale, and really having an hourly netting. This is really the only product on the market. So, of course, those companies that have the highest environmental standards are interested in this product. So it's a -- we think, a very interesting development, and one that we expect to replicate with multiple clients.
Richard Sunderland: Great. Thank you for the time today.
Operator: Thank you. Next question comes from Durgesh Chopra from Evercore ISI. Please go ahead.
Durgesh Chopra: Hey. Good morning, team. Thanks for taking my question. Maybe just -- I wanted to start with the 0.21 target. You know, Analyst Day, you guys were targeting three to four gigawatts of PPAs this year. And now it sort of seems like it's 4 [ph]. I just want to make sure I'm understanding that correctly. Is that just because you had a strong start? And now you're expecting 4 instead of 24 [ph] at the Analyst Day?
Andrés Gluski: But, yes, I mean, we did three in 2019 and 2020. We're seeing a strong start, you know, not only inside PPAs, but the deals we have in progress. So we feel sufficiently confident to say that, you know, we expect to be at the upper end of our initial guidance range of 3 or 4 [ph]. So we expect to be and four gigawatts of new renewable PPAs signed in 2021.
Durgesh Chopra: That's perfect. Thank you for clarifying that, Andrés. Maybe this -- can I get your thoughts on competition. And there's, obviously, there's all a lot of us, sort of domestic players in the market. You're seeing a lot of international competition. Maybe just any thoughts as you sort of compete with these PPAs, what's the competition like and sort of, you know, what's your competitive advantage?
Andrés Gluski: All -- we do see, you know, a lot of competition out there in the market. Our strategy has been to offer more value to our clients. So we don't want to just compete for commoditized, you know, thus, far, renewable PPAs. So we have several competitive advantages. And, of course, with our knowledge of energy storage, you know, we have been really a leader in the new applications for energy storage, not only through influence in terms of the new design, but you know, A.I., bidding -- enabled bidding engines, and how do we combine them? So, the Google deal is a perfect example of how we brought together multiple energy sources -- renewable energy sources, and provided a unique product to a very demanding client. So that's our angle. Our angle is really you know, how we bring these things together? How we create more value for the client? And I think very importantly, is that we co-create with our clients. So this was a joint project with Google that, you know, reflects more than a year's work. It's just like what we did in Kauai, what was really sort of the first sort of 24/7 solar energy storage product offering. We co-developed it with the Kauai Island utility cooperative. So that's our unique angle. So again, we see more deals like this Google deal, and more ways of working with clients to provide more value, and just not a commoditized product. So, the other advantage we have is, we started working on our pipeline. So we have a pipeline of 30 gigawatts, globally. We have a pipeline of more than 15 gigawatts in the U.S. And, you know, pipeline is not an equally defined term across all players. What we mean a pipeline, these are projects that we can execute on. So we have a land bank, we've been buying land, we've been buying land rights, we've been getting interconnection rights, looking really at the overlay of like best solar irradiation, best interconnections with the grid. And in addition, you know, best wind sites. So you know, we feel very good. I mean, putting something together like we did for Google in Virginia, it's something that we can replicate in other markets, where we have big presence, whether it be New York, whether it be California, that we don't think other people can present. So I think we're very well situated. And we also have some other angles that people don't have, that are very new. One I'll mention is 5B, 5B allows us to double the energy density. So think about that if you need to locate 100 megawatts of energy, we can do it in a space, other people can do it in 15, we can build it in a third of the time. Now 5B, you know, the MAVERICK product is still early in its stage of development. We still have to massify to drive down costs and prove it out. But it has unique characteristics, not only the ones I've mentioned, but in Australia, it has been tested in actual life situations, like category four hurricane winds. And that's something that conventional solar cannot do. So we feel very optimistic of offering this suite of technologies, and also a unique way of bringing them together and also a unique way of working with clients.
Durgesh Chopra: That's great. Thank you for that color, Andrés. Lots of exciting talk. I'll jump back in the queue. Thanks for the time.
Andrés Gluski: Thank you.
Operator: Thank you. The next question is from the mind of Stephen Byrd from Morgan Stanley. Please go ahead.
Stephen Byrd: Hey, good morning.
Andrés Gluski: Good morning, Steve.
Stephen Byrd: Wanted to talk through supply chain stresses. We regularly get questions just throughout the whole renewables value chain about, you know, shortages, cost increases, et cetera, and I respect that sort of the Northvolt agreement is one example of many ways that you've, you know, ensure availability. But, I guess, broadly put across, you know, solar, across the balance of system class stores, et cetera. Are you seeing any stresses on supply chain for you all any impacts from that broadly?
Andrés Gluski: No, that's a great question. And as you know, we've been, I think, always very concerned about this. You know, when we talk to, you know, beginning of last year, about COVID at the time, and we said look, you know, we were concerned about supply from Asia, and you know, the possible effects of COVID on the supply chain, even here in the States. So, you know, we've been on top of this. But right now we're not seeing any real supply constraints, whether it be on batteries, whether it be on solar panels, whether we see on wind turbines. However, if you look at the growth plans that are reflected in, for example, the Biden's renewable energy agenda. And you see what utilities are talking about, they're seeing a dramatic increase in demand. And we think that that could be a problem in the future. So we're getting out ahead of this. And, you know, I think, you know, it's not only the physical supplies that, you know, we're talking about. But it could be things like land, for example, you know, how many megawatts of readily available land is there to meet this great need. So right now, we're not seeing it safe. But we're on top of it. And that's what we're making the kind of strategic agreements like Northvolt. You know, expect more, I would say because that, we think, is a key element. And we expect this market to grow very rapidly. And we think you have to be thinking about that now, at all angles, whether it be people, you know, land interconnections? I don't see -- and I think we've spoken about it in the past, you know, energy storage, playing a role in eliminating transmission constraints. So that's an exciting new area that needs to be developed. And really, isn't that. So getting to your answer, we're not seeing it today. We're on top of it. I do expect there to be a pinch if sometime in the future, when I don't know, you know, going to be 12 months could be 18 months. But we're preparing for that possibility.
Stephen Byrd: That's really helpful. And maybe shifting gears to 5B, you know, you've spoken about this before. You laid it out again today. And I'm just curious, your latest thoughts in terms of as you think about the growth of a 5B, whether that this is going to be is there a potential given just how beneficial this approach is that this is something that's similar to other technologies you develop that you can broadly monetize, broadly market and sell? Or is this something more for your own purposes over time? How like -- how broad could this be? And is this another candidate that could be monetized over time?
Andrés Gluski: You know I love the question. So you know, we've had -- my counting four unicorns, you know, small companies, in fact with more than $1 billion valuation. I think our secret sauce has been to buy small companies. And then some of them we bought for, you know, $20 million, $30 million, initial investment, and now are worth more than $1 billion. And what's the secret sauce? The secret sauce really is -- one, we give them a platform for massive expansion; two, we work with them to create new applications. So we're not just a client, it's like we are co-developing and creating new uses for this technology. So we allow it to grow fast, we allow it to grow new areas. But equally important, we're able to keep the entrepreneurial spirit of these businesses. So in other words, even though we're a big company, we make a real effort not to smother them, you know, and let them run as much as possible on their own. Now, we made a philosophical decision years ago, that just to use it on our own platform, while that gives us a temporary advantage limits the growth of this new technology. And, quite frankly, a lot of this has to do with massive buying them to really drive down costs. You know, energy storage is a lot cheaper today, because we massified it. You know, we're in 29 countries, we have 5.6 gigawatts in 29 countries that we either built, or we're providing control systems, you know, bidding platforms. So, that's -- you know, that's quite large and allows us to learn from that. So with 5B, it's the same. You know, we will have certain kind of exclusivity in certain markets. But, no, this will be available to the broader market overtime. So what we're doing with 5B is again, massive, buying it, proving it out. And then eventually, we will, it will be available to other players as well. So for example, today in Australia, other people are using 5B technology. And I see it very similar to you know, our prior ventures, whether it be fluids, whether it be distributed energy that we have, whether it be up like [ph] that, you know, our philosophy is not just keep it to ourselves, just keep it to our own platform, but expand it more broadly. So, it's interesting; we make money but we make money for our shareholders in two ways. One is our platforms, which we are shifting from fossil fuels to renewables and there you can value us on cash flow, earnings per share et cetera. But at the same time we're creating value in these new technology companies, and those have a different valuation and the different value creation and that's why, selling to third parties is so important to maximize the value of them. Now the fact is that having the link between AES and these startups is key because as I said we mutually beneficial to create value. We help them grow. They help us to really be a leading-edge technology provider. If we didn't have the knowledge of batteries that we have, we wouldn't have done the budget deal. So there are two ways that we're creating value here with these new companies.
Stephen Byrd: Really helpful. Thanks so much.
Operator: The next question is from the line of David Peters from Wolfe Research. Please go ahead.
David Peters: Hey, good morning guys. I was just curious on the strategic alliance with Google, are you guys still working on similar agreements and locations beyond Virginia. I guess I'm just wondering how far you expect kind of the scope of that particular dealer Alliance to reach?
Andrés Gluski : What I can say is really that we had an initial agreement, which we had talked about that we really the sort of RFP for one gigawatt that has, I would say developed if you willing to the deal that we have announced. We expect to expansion of that energy provided over time as their needs grow and again, we have this unique product that we will offer to then and other clients at this stage in time. So that's all I really can say at this stage of the game.
David Peters: Okay. And then maybe just on some of the other products you have in the works. Is there been any updates on the hydrogen study in Chile or we're in Vietnam, the LNG and CCGT projects, I guess since Investor Day.
Andrés Gluski : Look regarding first the green hydrogen really green ammonia project in Chile. We continue to work with our partner on the feasibility study. So where it goes on and as I said, we'll probably have news before the end of the year one way or the other. So it's really a matter of, can we get the cost down to be competitive with grey or blue hydrogen products. So I'm optimistic, we're working hard, stay tuned. Regarding Vietnam. It's the same thing. We continue to work towards a new LNG terminal, which would be 450 or so Terra BTUs. So, more than double what we have between Panama and the Dominican Republic, and there is an associated 0.2 gig watts of combined cycle gas plants. So not that progress continues on that were part of the government's plan realize at this facility will avoid the construction of many, many coal plants, and I also mentioned that we will be as soon as feasible moving towards, providing green hydrogen, which basically means that it certified that it doesn't, it has less a certain amount of leakage from production to delivery, and we think that's very important to really reap the climate advantages of natural gas versus say other heavy fossil fuels.
David Peters: Great, thank you for your time.
Operator: Thank you. The next question is from the line of Charles Fishman from Morningstar. Please go ahead.
Charles Fishman: Good morning, Andreas. I wanted to follow up on that Vietnam questions first of all recent strength then crude oil prices help you in the development of that project in Vietnam. I would think. I appreciate there is some coal plants there but it is in a lot of the competition, or at least that you'd be replacing residual fuel for power generation in that region. And yes the strength of the crude oil price help in that?
Andrés Gluski : Our RLNG business is really tolling in Central America and the Caribbean. So we get a tolling fee. We're not taking direct commodity risk now of course the bigger the spread between Henry Hub and world oil prices especially WTI, the more tolling will do at the margins in a lot of these take-or-pay agreements. So what we've announced is take or pay. So we're not so directly affect but all things being equal, a bigger spread between natural gas and oil is favorable, will do at the margin, some more. In Vietnam this is a project which is very much needed because they had been relying on offshore gas and that's running out, so this will, it has an immediate demand unlike say Dominican Republic and Panama, where we had to develop to demand [ph]. So you have to bring in gas to feed the existing combined cycles. So I really don't see it as much as directly as oil price gas play. Again at the margin, you could have more industries converter more transportation convert to compressed natural gas or other forms, but not really. These were tolling agreements and in Vietnam, the demand is there, it doesn't have to be created but again, as [indiscernible].
Charles Fishman: As I recall, the Vietnam project doesn't enter into the 7.9% through 2025 that's really 25 events and beyond correct?
Andrés Gluski : That's correct?
Charles Fishman: Okay, thank you. That's all I have.
Operator: Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I would like turn the conference back to Ahmed Pasha for closing comments. Please go ahead.
Ahmed Pasha: Thank you everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thanks again and have a great day.
Operator: Thank you very much, ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Thank you. | [
{
"speaker": "Operator",
"text": "Good morning and welcome to the AES Corporation Q1 2021 Financial Review Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I now like to turn the conference over to Ahmed Pasha, Chief Treasurer and Vice President of Investor Relations. Thank you and over to you."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you, Operator. Good morning and welcome to our first quarter 2021 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can also be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Gustavo Pimenta, our Chief Financial Officer and other senior members of our management team. With that, I will turn the call over to Andrés. Andrés?"
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, everyone, and thank you for joining our first quarter financial review call. Our first quarter results put us on track to achieve our 2021 guidance and 7% to 9% average annual growth through 2025. Gustavo will provide more color on our financial results later in the call. As we spoke about on our Investor Day in early March, we see a great opportunity for growth. Given the momentum is changes in our sector. And we are very well positioned to capitalize on the shift to low carbon sources of energy. Over the past five years we have transformed our company to be a leader in renewable and we have invested in innovative technologies that will give us a competitive advantage for many years to come. Although it has been less than two months since our Investor Day we had a number of significant achievements to announce, including a landmark deal with Google which I will describe in more detail later. A strategic collaboration to develop new battery technologies between Fluence and Northvolt the leading European supplier of sustainable battery systems and a significant increase in LNG sales in Central America and the Caribbean to support those economies in the transition away from heavy fuels. First let me lay out our strategic priorities for 2021 and the substantial progress that we have made year-to-date for the achieving those objectives. Turning to Slide, our five key goals for the year are one signed contracts for 4 gigawatts of renewables. Two, launch the 24-7 product for carbon free energy on an hourly basis. Three, further unlock the value of our technology platforms. Four, continue to improve our ESG positioning through the transformation of our portfolio. And five, monetize excess LNG capacity in Central America and the Caribbean. Turning to Slide 5 last year, we set and exceeded a goal of signing 2 to 3 gigawatts of PPAs for renewables and energy storage. This year we are increasing that goal by 60% to a target of 4 gigawatts. Today. I am pleased to report that year-to-date, we've already signed 1.1 gigawatt including a landmark deal with moving. As you can see on Slide 6, we have a backlog of 6.9 gigawatts of renewables consisting of projects already under construction or under signed power purchase agreements or PPAs. This equates to 20% growth in our total installed capacity and a 60% increase in our renewables capacity. Turning to Slide 7. We continue to increase our pipeline of projects to support our growth and now have a global pipeline of more than 30 gigawatts of renewable projects. What we, half of which is the United States. With increasing demand from corporate customers and a much more favorable policy environment, we expect the need for renewables to grow dramatically and we're taking steps to ensure a continued competitive advantage. Moving to Slide 8. Our second key goal for this year is to launch the first 24-7 energy product that matches a customer's load with carbon free energy on an hourly basis. To that end, earlier this week, we announced a landmark first of its kind agreement to supply Google's Virginia-based data centers with 24-7 carbon free energy source from a portfolio of 500 megawatts of renewables. Under this innovative structure AES will become the sole supplier of the datacenters energy needs. Ensuring that the energy supplied will meet carbon free targets when measured on an hourly basis for the next 10 years. The carbon free energy will come from an optimized portfolio of wind, solar, hydro and battery storage resources. This agreement has a new standard in carbon free energy for commercial and industrial customers who signed 23 gigawatts of PPAs in 2020. As we discussed at our Investor Day we almost 300 companies that make up the RE 100 will need more than 100 gigawatts of new renewables by 2030. This transaction with Google demonstrate that a higher sustainability standard is possible. And we expect a substantial portion of customers to pursue 24-7 carbon free objectives. Based on our leadership position, we are well placed to serve this growing market. And in fact, we've already seen significant interest from a number of large clients. Turning to Slide 9, our third key goal is to further unlock the value of our technology platforms. One of these platforms is Uplight and energy efficiency, software company that works directly with utility and has access to more than a 100 million households and businesses in the US. Uplight is at the forefront of the shift to low-carbon and digital solutions on the cloud. In March, we announced a capital raise with a consortium led by Schneider Electric valuing Uplight at 1.5 billion. Now to Slide 10. We are seeing increasing value in many of our other technology platforms as well. Fluence our joint venture with Siemens are a global leader in energy storage, which is a key component of the energy transition. This dynamic industry is expected to grow 40% annually and Fluence is well positioned to capitalize on this immense opportunity through its distinct competitive advantages including its AI enabled leading engine. Turning to Slide 11, as you may have seen last month Fluence announced a multi-year agreement with Northvolt the leading European battery developer and manufacturer for assured supply and to co-develop next-generation battery technology. This is an example of Fluence is continued innovation, which has been validated by the consistent rank as the number one utility scale energy storage technology company, according to guide house insight. Similarly, we see the rapid progress of our prefab solution 5B as you can see on Slide 12. This technology double the energy density and cuts construction time by 2/3. We now have 5G projects in Australia, Panama and Chile. We will be, including 5G technology in our business in Puerto Rico. Or it's proven resilience to Category 4 hurricane winds will provide greater energy security. Proving out the unique value proposition of 5G could significantly speed up the adoption of solar in cyclone prone areas. Lastly, we continue to work towards the approval of the first large-scale green hydrogen based ammonia plant in the Western Hemisphere in Chile. Moving to Slide 13 we have undergone one of the most dramatic transformations in our sector. Over the past five years, we have announced the retirement or sale of 10.7 gigawatts of coal or 70% of our coal capacity one of the largest reductions in our sector. We recognize that we have more work to do and have set a goal of reducing our generation from coal to less than 10% of total generation by 2025 furthermore, we expect to achieve net zero emissions from electricity by 2040 one of the most ambitious goals of any power company. As we achieve decarbonization targets and continuing our near-term growth in renewables. We anticipate being included in additional ESG oriented indices. Finally, turning to Slide 14 we see natural gas as a transition fuel that can lower emissions and reduce overall energy costs as markets work for the future with more renewable power. Last month, we reached an agreement to provide terminal services for an additional 34 tera BTUs of LNG throughput under a 20-year take-or-pay contract. This will bring our total contracted terminal capacity in Panama and the Dominican Republic to almost 80%. There are 45 tera BTUs of available capacity remaining. We expect to sign in the next couple of years. Our LNG business is focused on providing environmentally responsible LNG or Green LNG as soon as feasible which ensures the lowest levels of the missions throughout the entire supply chain. Now I would like to turn the call over to Gustavo Pimenta, our CFO."
},
{
"speaker": "Gustavo Pimenta",
"text": "Thanks Andrés and good morning everyone. As Andrés mentioned, we are off to a good start this year having already achieved significant milestones towards the strategic and financial objectives that we discussed on our Investor Day. We are also encouraged by the continued economic recovery across our markets with demand in line with pre-COVID levels. Turning to our financial results for the quarter. As you can see on Slide 16 adjusted pre-tax contribution or B2C was $247 million for the quarter which was very much in line with our expectations and similar to last year's performance. I'll discuss the key drivers of our first quarter results and outlook for the year in the following slides. Turning to Slide 17 adjusted EPS for the quarter was $0.28 versus $0.29 last year. With adjusted PTC essentially flat. The $0.01 decrease in adjusted EPS was the result of a slightly higher effective tax rate this quarter. In the US and utilities, the Strategic Business Units or SBU, PTC was down $27 million driven primarily by a lower contribution from our legacy units at Southland and higher spend in our clean energy business as we accelerate our development pipeline given the growing market opportunities. There is impacts were partially offset by the benefits from the commencement of PPAs at the Southland energy combined cycle gas turbines or CCGTs. At our South America SBU, B2C was down $31 million mostly driven by lower contributions from AES Andes [ph] formerly known as AES Hamer [ph], due to higher interest expense and lower equity earnings from the Guacolda plant in Chile. These impacts were partially offset by higher generation at the Chivor or hydro plant in Colombia. Lower PTC at our Mexico Central America and the Caribbean or MCC, as we primarily reflects outages at two facilities in Domenic Republic and Mexico with both already back online since April. Results also reflect the expiration of the 72 megawatt barge PPA in Panama. Finally in Eurasia higher PTC reflects improved operational performance and lower interest expense in our Bulgaria businesses. Now to Slide 22. With our first quarter results, we are on track to achieve our full-year 2021 adjusted EPS guidance range of $1.50 to $1.58 . Our expected 2021 quarterly earnings profile is consistent with the average of the last five years. Our typical quarterly earnings is more back-end weighted with roughly 40% of the earnings occurred in the first half of the year and the remaining in the second half. Growth in the year to go will be primarily driven by contributions from new businesses including a full years of operations of the Southland repowering project, 2.3 gigawatt of projects in our backlog coming online during the next nine months. Reduced interest expense, the benefits from cost savings and the Med normalization to pre-COVID levels. We are also reaffirming our expected 7% to 9% average annual growth target through 2025. Now turning to our credit profile on Slide 23, as discussed at our Investor Day, strong credit metrics remain one of our top priorities. In the last four years we obtained two to three notches of upgrades from the three credit rating agencies, including investment grade rating from Fitch and S&P. This action validates the strength of our business model and our commitment to improving our credit metrics. We expect the positive momentum in these metrics to continue enabling the strategic BBB flat credit metrics by 2025. Now to our 2021 parent capital allocation plan on the Slide 24. Consistent with the discussion at our Investor Day sources reflect approximately $2 billion of total discretionary cash including $800 million of parent-free cash flow and $100 million of proceeds from the sale of the table [ph] in the Dominican Republic which just closed in April. Sources also include the successful issuance of the $1 billion of equity units in March. Eliminating the need for any additional equity raise to fund our current growth plan through June, 25. Now to uses on the right hand side we'll be returning $350 million to shareholders this year. This consists of our common share dividend, including the 5% increase we announced in December and the coupon of the equity units. And we plan to invest approximately $1.4 billion to $1.5 billion in our subsidiaries, as we capitalize on attractive growth opportunities. Approximately 60% of investments are in global renewable, reflecting our success in renewables origination during 2020 and our expectations for 2021. About 25% of the investments are in our US utilities to fund rate base growth with a continued focus on grid and fleet modernization. In the first quarter, we invested approximately $450 million in renewables, which is roughly 1/3 of our expected investment for the year. In summary, 85% of our investments are going into the US utilities and global renewables helping us to achieve our goal of increasing the proportion of earnings from the US to more than half and from carbon for businesses to about 2/3 by 2025. The remaining 50% of our investments will go towards green LNG and other innovative opportunities that support and accelerate the energy transition. With that, I'll turn the call back over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Gustavo. Before we take your questions let me summarize today's call. As I have noted we have made great progress on our 2021 and long-term strategic goals and we are reaffirming our 2021 guidance and expectations through 2025. We see a tremendous opportunity for growth and further increasing our technological leadership as the industry transition unfolds. From advancing our renewables to unlocking the value of our new technology businesses we have a competitive advantage that will continue to benefit our customers and investors. With that I would like to open up the call to your questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] The first question is from the line of Richard Sunderland from JP Morgan. Please go ahead."
},
{
"speaker": "Richard Sunderland",
"text": "Hi, good morning. Thanks for taking my questions. Just wanted to start off on the North agreement and what it could be the Fluence and maybe the energy storage market more broadly and kind of curious on the development front itself is this more sort of iterative development work or further up the installment curve?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes, that's a great question. This is really a landmark agreement as we move to essentially have strategic relationships with battery manufacturers. So Northvolt is building a new plant in Sweden. And in Poland and we will have one train of the plant in Poland producing batteries for us. So as this market expands and as you have a real growth in demand this assures battery supply for one of our markets. And also I would say Europe, Middle East, Africa and in addition, we will not only have supply of batteries and again dedicated train to us, but we will also be working with Northvolt. So you have the new developments in battery. So in terms as battery technology develops as you have better chemistry, as we say fine-tune our cube stacked design. We will have joint development of additional improve batteries on multiple fronts. So this is a, I think, a very interesting development of getting a little bit more involved, that's a one-step prior to just being the integrator and providing the control softwares."
},
{
"speaker": "Richard Sunderland",
"text": "Got it, thank you for the color. And then, separately, thinking about this Google deal, you would have the ability to replicate that with other C&I customers, I know you mentioned some interest already. And I guess curious alongside that's some aspects around the agreement itself, whether you -- this is about having the right assets and the right location to procure or, you know, about the energy kind of management angle as well."
},
{
"speaker": "Andrés Gluski",
"text": "Or, you know, it's both in a sense, so let me take the second part first, explain a little bit what the product is. So the product really -- that the key point is that we're netting on an hourly basis, a, you know, carbon-free energy. So, this is -- you know, most contracts. Prior to this, virtually all, are really netting, you know, to be on a yearly basis could be, et cetera. So you have an excess purchases of renewables during certain hours, but you're actually using non-renewables during other hours, obviously, when you don't have the production of the renewables. This is actually saying, \"You know, on an hourly basis, the energy that I'm getting is carbon free.\" So you ask -- you know the right question it's not just a question of, you know, having overbuild solar or overbuilt wind, it's really how do you manage these different sources of energy, you know, not only to ensure that it's carbon free, but to minimize the cost? So you know, when are you buying -- When are you using wind? When are you using solar? And the real key to make this happen is adding hydro -- small hydros and adding, of course, battery storage? So it's really how do you optimize multiple uses of -- multiple sources of renewable energy to provide the lowest cost guaranteed carbon-free energy netted on an hourly basis? So behind this offer, there's a lot of math, a lot of algorithms, a lot of risk management. And we think that, you know, this is a deal that with Google itself, you know, we had a $1 billion -- I sorry, one gigawatts agreement to the first 500 and we expect it to grow as demand in these data center grows. But, of course, there are other corporate clients that are interested in this. And you know, we've seen interest from. So as people, I would say up their environmental goals, and saying, well, we're going to be net zero carbon emissions on a global scale, and really having an hourly netting. This is really the only product on the market. So, of course, those companies that have the highest environmental standards are interested in this product. So it's a -- we think, a very interesting development, and one that we expect to replicate with multiple clients."
},
{
"speaker": "Richard Sunderland",
"text": "Great. Thank you for the time today."
},
{
"speaker": "Operator",
"text": "Thank you. Next question comes from Durgesh Chopra from Evercore ISI. Please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey. Good morning, team. Thanks for taking my question. Maybe just -- I wanted to start with the 0.21 target. You know, Analyst Day, you guys were targeting three to four gigawatts of PPAs this year. And now it sort of seems like it's 4 [ph]. I just want to make sure I'm understanding that correctly. Is that just because you had a strong start? And now you're expecting 4 instead of 24 [ph] at the Analyst Day?"
},
{
"speaker": "Andrés Gluski",
"text": "But, yes, I mean, we did three in 2019 and 2020. We're seeing a strong start, you know, not only inside PPAs, but the deals we have in progress. So we feel sufficiently confident to say that, you know, we expect to be at the upper end of our initial guidance range of 3 or 4 [ph]. So we expect to be and four gigawatts of new renewable PPAs signed in 2021."
},
{
"speaker": "Durgesh Chopra",
"text": "That's perfect. Thank you for clarifying that, Andrés. Maybe this -- can I get your thoughts on competition. And there's, obviously, there's all a lot of us, sort of domestic players in the market. You're seeing a lot of international competition. Maybe just any thoughts as you sort of compete with these PPAs, what's the competition like and sort of, you know, what's your competitive advantage?"
},
{
"speaker": "Andrés Gluski",
"text": "All -- we do see, you know, a lot of competition out there in the market. Our strategy has been to offer more value to our clients. So we don't want to just compete for commoditized, you know, thus, far, renewable PPAs. So we have several competitive advantages. And, of course, with our knowledge of energy storage, you know, we have been really a leader in the new applications for energy storage, not only through influence in terms of the new design, but you know, A.I., bidding -- enabled bidding engines, and how do we combine them? So, the Google deal is a perfect example of how we brought together multiple energy sources -- renewable energy sources, and provided a unique product to a very demanding client. So that's our angle. Our angle is really you know, how we bring these things together? How we create more value for the client? And I think very importantly, is that we co-create with our clients. So this was a joint project with Google that, you know, reflects more than a year's work. It's just like what we did in Kauai, what was really sort of the first sort of 24/7 solar energy storage product offering. We co-developed it with the Kauai Island utility cooperative. So that's our unique angle. So again, we see more deals like this Google deal, and more ways of working with clients to provide more value, and just not a commoditized product. So, the other advantage we have is, we started working on our pipeline. So we have a pipeline of 30 gigawatts, globally. We have a pipeline of more than 15 gigawatts in the U.S. And, you know, pipeline is not an equally defined term across all players. What we mean a pipeline, these are projects that we can execute on. So we have a land bank, we've been buying land, we've been buying land rights, we've been getting interconnection rights, looking really at the overlay of like best solar irradiation, best interconnections with the grid. And in addition, you know, best wind sites. So you know, we feel very good. I mean, putting something together like we did for Google in Virginia, it's something that we can replicate in other markets, where we have big presence, whether it be New York, whether it be California, that we don't think other people can present. So I think we're very well situated. And we also have some other angles that people don't have, that are very new. One I'll mention is 5B, 5B allows us to double the energy density. So think about that if you need to locate 100 megawatts of energy, we can do it in a space, other people can do it in 15, we can build it in a third of the time. Now 5B, you know, the MAVERICK product is still early in its stage of development. We still have to massify to drive down costs and prove it out. But it has unique characteristics, not only the ones I've mentioned, but in Australia, it has been tested in actual life situations, like category four hurricane winds. And that's something that conventional solar cannot do. So we feel very optimistic of offering this suite of technologies, and also a unique way of bringing them together and also a unique way of working with clients."
},
{
"speaker": "Durgesh Chopra",
"text": "That's great. Thank you for that color, Andrés. Lots of exciting talk. I'll jump back in the queue. Thanks for the time."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. The next question is from the mind of Stephen Byrd from Morgan Stanley. Please go ahead."
},
{
"speaker": "Stephen Byrd",
"text": "Hey, good morning."
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, Steve."
},
{
"speaker": "Stephen Byrd",
"text": "Wanted to talk through supply chain stresses. We regularly get questions just throughout the whole renewables value chain about, you know, shortages, cost increases, et cetera, and I respect that sort of the Northvolt agreement is one example of many ways that you've, you know, ensure availability. But, I guess, broadly put across, you know, solar, across the balance of system class stores, et cetera. Are you seeing any stresses on supply chain for you all any impacts from that broadly?"
},
{
"speaker": "Andrés Gluski",
"text": "No, that's a great question. And as you know, we've been, I think, always very concerned about this. You know, when we talk to, you know, beginning of last year, about COVID at the time, and we said look, you know, we were concerned about supply from Asia, and you know, the possible effects of COVID on the supply chain, even here in the States. So, you know, we've been on top of this. But right now we're not seeing any real supply constraints, whether it be on batteries, whether it be on solar panels, whether we see on wind turbines. However, if you look at the growth plans that are reflected in, for example, the Biden's renewable energy agenda. And you see what utilities are talking about, they're seeing a dramatic increase in demand. And we think that that could be a problem in the future. So we're getting out ahead of this. And, you know, I think, you know, it's not only the physical supplies that, you know, we're talking about. But it could be things like land, for example, you know, how many megawatts of readily available land is there to meet this great need. So right now, we're not seeing it safe. But we're on top of it. And that's what we're making the kind of strategic agreements like Northvolt. You know, expect more, I would say because that, we think, is a key element. And we expect this market to grow very rapidly. And we think you have to be thinking about that now, at all angles, whether it be people, you know, land interconnections? I don't see -- and I think we've spoken about it in the past, you know, energy storage, playing a role in eliminating transmission constraints. So that's an exciting new area that needs to be developed. And really, isn't that. So getting to your answer, we're not seeing it today. We're on top of it. I do expect there to be a pinch if sometime in the future, when I don't know, you know, going to be 12 months could be 18 months. But we're preparing for that possibility."
},
{
"speaker": "Stephen Byrd",
"text": "That's really helpful. And maybe shifting gears to 5B, you know, you've spoken about this before. You laid it out again today. And I'm just curious, your latest thoughts in terms of as you think about the growth of a 5B, whether that this is going to be is there a potential given just how beneficial this approach is that this is something that's similar to other technologies you develop that you can broadly monetize, broadly market and sell? Or is this something more for your own purposes over time? How like -- how broad could this be? And is this another candidate that could be monetized over time?"
},
{
"speaker": "Andrés Gluski",
"text": "You know I love the question. So you know, we've had -- my counting four unicorns, you know, small companies, in fact with more than $1 billion valuation. I think our secret sauce has been to buy small companies. And then some of them we bought for, you know, $20 million, $30 million, initial investment, and now are worth more than $1 billion. And what's the secret sauce? The secret sauce really is -- one, we give them a platform for massive expansion; two, we work with them to create new applications. So we're not just a client, it's like we are co-developing and creating new uses for this technology. So we allow it to grow fast, we allow it to grow new areas. But equally important, we're able to keep the entrepreneurial spirit of these businesses. So in other words, even though we're a big company, we make a real effort not to smother them, you know, and let them run as much as possible on their own. Now, we made a philosophical decision years ago, that just to use it on our own platform, while that gives us a temporary advantage limits the growth of this new technology. And, quite frankly, a lot of this has to do with massive buying them to really drive down costs. You know, energy storage is a lot cheaper today, because we massified it. You know, we're in 29 countries, we have 5.6 gigawatts in 29 countries that we either built, or we're providing control systems, you know, bidding platforms. So, that's -- you know, that's quite large and allows us to learn from that. So with 5B, it's the same. You know, we will have certain kind of exclusivity in certain markets. But, no, this will be available to the broader market overtime. So what we're doing with 5B is again, massive, buying it, proving it out. And then eventually, we will, it will be available to other players as well. So for example, today in Australia, other people are using 5B technology. And I see it very similar to you know, our prior ventures, whether it be fluids, whether it be distributed energy that we have, whether it be up like [ph] that, you know, our philosophy is not just keep it to ourselves, just keep it to our own platform, but expand it more broadly. So, it's interesting; we make money but we make money for our shareholders in two ways. One is our platforms, which we are shifting from fossil fuels to renewables and there you can value us on cash flow, earnings per share et cetera. But at the same time we're creating value in these new technology companies, and those have a different valuation and the different value creation and that's why, selling to third parties is so important to maximize the value of them. Now the fact is that having the link between AES and these startups is key because as I said we mutually beneficial to create value. We help them grow. They help us to really be a leading-edge technology provider. If we didn't have the knowledge of batteries that we have, we wouldn't have done the budget deal. So there are two ways that we're creating value here with these new companies."
},
{
"speaker": "Stephen Byrd",
"text": "Really helpful. Thanks so much."
},
{
"speaker": "Operator",
"text": "The next question is from the line of David Peters from Wolfe Research. Please go ahead."
},
{
"speaker": "David Peters",
"text": "Hey, good morning guys. I was just curious on the strategic alliance with Google, are you guys still working on similar agreements and locations beyond Virginia. I guess I'm just wondering how far you expect kind of the scope of that particular dealer Alliance to reach?"
},
{
"speaker": "Andrés Gluski",
"text": "What I can say is really that we had an initial agreement, which we had talked about that we really the sort of RFP for one gigawatt that has, I would say developed if you willing to the deal that we have announced. We expect to expansion of that energy provided over time as their needs grow and again, we have this unique product that we will offer to then and other clients at this stage in time. So that's all I really can say at this stage of the game."
},
{
"speaker": "David Peters",
"text": "Okay. And then maybe just on some of the other products you have in the works. Is there been any updates on the hydrogen study in Chile or we're in Vietnam, the LNG and CCGT projects, I guess since Investor Day."
},
{
"speaker": "Andrés Gluski",
"text": "Look regarding first the green hydrogen really green ammonia project in Chile. We continue to work with our partner on the feasibility study. So where it goes on and as I said, we'll probably have news before the end of the year one way or the other. So it's really a matter of, can we get the cost down to be competitive with grey or blue hydrogen products. So I'm optimistic, we're working hard, stay tuned. Regarding Vietnam. It's the same thing. We continue to work towards a new LNG terminal, which would be 450 or so Terra BTUs. So, more than double what we have between Panama and the Dominican Republic, and there is an associated 0.2 gig watts of combined cycle gas plants. So not that progress continues on that were part of the government's plan realize at this facility will avoid the construction of many, many coal plants, and I also mentioned that we will be as soon as feasible moving towards, providing green hydrogen, which basically means that it certified that it doesn't, it has less a certain amount of leakage from production to delivery, and we think that's very important to really reap the climate advantages of natural gas versus say other heavy fossil fuels."
},
{
"speaker": "David Peters",
"text": "Great, thank you for your time."
},
{
"speaker": "Operator",
"text": "Thank you. The next question is from the line of Charles Fishman from Morningstar. Please go ahead."
},
{
"speaker": "Charles Fishman",
"text": "Good morning, Andreas. I wanted to follow up on that Vietnam questions first of all recent strength then crude oil prices help you in the development of that project in Vietnam. I would think. I appreciate there is some coal plants there but it is in a lot of the competition, or at least that you'd be replacing residual fuel for power generation in that region. And yes the strength of the crude oil price help in that?"
},
{
"speaker": "Andrés Gluski",
"text": "Our RLNG business is really tolling in Central America and the Caribbean. So we get a tolling fee. We're not taking direct commodity risk now of course the bigger the spread between Henry Hub and world oil prices especially WTI, the more tolling will do at the margins in a lot of these take-or-pay agreements. So what we've announced is take or pay. So we're not so directly affect but all things being equal, a bigger spread between natural gas and oil is favorable, will do at the margin, some more. In Vietnam this is a project which is very much needed because they had been relying on offshore gas and that's running out, so this will, it has an immediate demand unlike say Dominican Republic and Panama, where we had to develop to demand [ph]. So you have to bring in gas to feed the existing combined cycles. So I really don't see it as much as directly as oil price gas play. Again at the margin, you could have more industries converter more transportation convert to compressed natural gas or other forms, but not really. These were tolling agreements and in Vietnam, the demand is there, it doesn't have to be created but again, as [indiscernible]."
},
{
"speaker": "Charles Fishman",
"text": "As I recall, the Vietnam project doesn't enter into the 7.9% through 2025 that's really 25 events and beyond correct?"
},
{
"speaker": "Andrés Gluski",
"text": "That's correct?"
},
{
"speaker": "Charles Fishman",
"text": "Okay, thank you. That's all I have."
},
{
"speaker": "Operator",
"text": "Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I would like turn the conference back to Ahmed Pasha for closing comments. Please go ahead."
},
{
"speaker": "Ahmed Pasha",
"text": "Thank you everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thanks again and have a great day."
},
{
"speaker": "Operator",
"text": "Thank you very much, ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Thank you."
}
] | The AES Corporation | 35,312 |
AES | 4 | 2,022 | 2023-02-27 10:00:00 | Operator: Good morning and a warm welcome to the AES Corporation Fourth Quarter and Full-Year 2022 Financial Results Call. My name is Candice, and I will be your moderator for today’s call. [Operator Instructions] I would now like to hand you over to our host, Susan Harcourt, Vice President of Investor Relations. The floor is yours. Please go ahead.
Susan Harcourt: Thank you, operator. Good morning and welcome to our fourth quarter and full-year 2022 financial review call. Our press release, presentation, and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our fourth quarter and full-year 2022 financial review call. Today, I will discuss our 2022 financial results and strategic accomplishments, as well as our 2023 guidance. Steve Coughlin, our CFO will discuss our financial results and outlook in more detail shortly. Beginning with our 2002 results and accomplishments on Slide 3. I am very pleased with our performance in 2022, which was our best year ever. Adjusted EPS came in at $1.67, above our guidance range of $1.55 to $1.65. This accomplishment is primarily the result of three factors: strong performance across our portfolio, growth in renewables, particularly from solar and energy storage in the U.S., and the benefit of embedded optionality in our LNG contracts. Turning to Slide 4. I would like to highlight an area in which we are particularly proud of our performance, our success in bringing our construction projects online. In 2022, despite numerous market-wide challenges throughout the year, we added approximately 2 gigawatts of new projects to our portfolio, which was consistent with our expectations at the beginning of the year. Our success was the result of the extensive work we have done to develop the people, processes, and solid supplier relationships to rapidly expand our portfolio of renewables. We see our ability to execute as the source of competitive advantage that is highly valued in the marketplace. Not only does it support our strong global customer relationships, but it also contributes to our confidence in our long-term forecast. In addition to our execution, 2022 was a year where we focused on taking actions that will position us well for future growth. These actions included signing a record number of new PPAs for projects that we will complete in the coming years, investing in our pipeline of future projects, creating a leading position in green hydrogen, establishing strong regulatory foundations to support future utility growth, and achieving significant cold phase out milestones in Hawaii and Chile. As you can see on Slide 5, 2022 was a record year for PPA signings for AES. We signed 5.2 gigawatts of renewables under long-term contracts, increasing our backlog to 12.2 gigawatts. In fact, for the second year in a row, BNEF reported that AES signed more renewable deals with corporate customers than anyone else in the world. This included an expansion of our 24/7 structured projects. Moving to Slide 6. We also worked hard throughout the year to grow our pipeline of future projects, which increased by 25% to 64 gigawatts, including 51 gigawatts in the U.S. We see extensive and growing demand for renewables worldwide and expect that in the future a key limitation to growth will be the availability of projects. We have been preparing by investing in land, interconnections, and permitting work to advance the projects that will be used for future PPA signings. Turning to Slide 7. We also established ourselves as a leader in green hydrogen. In December, we announced a partnership with Air Products to develop, build, and own, and operate the largest green hydrogen production facility in the U.S. This project will have the capacity to produce more than 200 metric tons per day of green hydrogen and will include approximately 1.4 gigawatts of wind and solar generation. It builds upon the expertise we have developed in combining renewables to create around the clock carbon free energy. This project has the potential to serve approximately 4,000 trucks, which while significant represents less than 0.1% of the current market for long haul trucking. As such, we see a massive total addressable market for decarbonizing the transportation sector. Turning to Slide 8. Another focus of our 2022 work was to develop strong regulatory foundations for future growth at our U.S. Utilities, where we expect to grow the combined rate basis 9% annually through 2025. Specifically, at AES Ohio, we filed a new electric security plan or ESP 4 to enhance and upgrade the network and improve service reliability. With the lowest [CND rates] [ph] in the states, across all customer categories, AES Ohio is well positioned to make the much needed customer centric investments. A ruling by the Ohio Commission on ESP 4 is expected this summer. Finally, we're pleased with the constructive outcome of AES Ohio's distribution rate case in which the Ohio Commission approved an annual revenue increase of $75.6 million. At AES Indiana, we filed our integrated resource plan for IRP with the Indiana Utility Regulatory Commission in December. AES Indiana's near term plan includes the conversion of the utility's last two coal units to natural gas in 2025 using an existing on-site gas pipeline. It also includes the addition of up to 1.3 gigawatts of new wind, solar, and energy storage by 2027 and should reduce AES Indiana's carbon intensity by two-thirds from 2018 to 2030. This plan is an important step to fully transition away from coal and provides the opportunity for substantial additional investments at AES Indiana. Now, turning to our outlook for 2023 on Slide 9. Today, we're initiating adjusted EPS guidance of $1.65 to $1.75, and reaffirming our long-term growth rate of 7% to 9% through 2025 for both adjusted EPS and parent free cash flow of a base year of 2020. Our focus this year will remain on execution. As you can see on Slide 10, we expect to complete approximately 3.4 gigawatts of new projects, including 2.1 gigawatts in the U.S. I will note that our 2023 guidance range does not include a potential upside from 600 megawatts of projects currently scheduled to be completed in December 2023, but which are likely to come online in 2024. Looking at our growth through 2025 on Slide 11. We expect to maintain the pace of PPA signings we have established with an estimated 14 gigawatts to 17 gigawatts expected to be signed over the next three years. We see strong demand for renewables across all of our key markets, particularly the U.S. where the benefits of the Inflation Reduction Act or IRA are becoming even clearer. Thus, given the strength of our backlog and our visibility into future PPA signings and project completions. We are confident in reaffirming our long-term guidance through 2025. Finally, today we're announcing that we will hold an Investor Day this spring, we will be sharing our strategic long-term view of the company, introducing new business segments, and extending our long-term growth rate. We will provide additional details at a later date. With that, I now would like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning everyone. Today, I will cover the following key topics. Our financial performance during 2022, our parent capital allocation, and our 2023 guidance and expectations through 2025. As Andres mentioned, our results for 2022 demonstrate the strength, resiliency, and flexibility of our portfolio as we surpassed our guidance range of $1.55 to $1.65. Overall, our portfolio was well structure to perform in the current market environment and is well-positioned for growth as AES continues to lead the global energy transition. Turning to Slide 13. Full-year 2022 adjusted EPS was $1.67 versus $1.52 in 2021, driven primarily by a significant volume of LNG sales in our increased ownership of AES Andes. These positive drivers were partially offset by unplanned outages, several one-time expenses we recorded at our U.S. and utilities and South America SBUs, a higher share count as a result of the 2021 accounting adjustment for our equity units, and higher parent interest stemming from higher debt balances. The $1.67 per share also includes approximately $0.12 of losses from AES Next. Primarily from our ownership in Fluence, which served as an additional drag year-over-year. We expect Fluence's results to significantly improve beginning this year as they discussed on their recent earnings call. Turning to Slide 14. Adjusted pretax contribution or PTC was $1.6 billion for the year, an increase of 149 million and a 11% growth over 2021. I'll cover our results in more detail over the next four slides, beginning with the U.S. and utilities SBU on Slide 15. Lower PTC in the U.S. was primarily driven by the recognition of one-time expenses from previously deferred purchased fuel and energy costs at our utilities. Outages at Southland Energy and AES Indiana in the second quarter and lower contributions from Clean Energy and the retirement of our coal plant in Hawaii. Partially offset by higher contributions from our Southland legacy assets in the third quarter. Higher PTC at our South America SBU was primarily driven by our increased ownership of AES Andes and higher margins at both AES Andes and AES Brazil, but partially offset by a prior year gain related to an arbitration at Alto Maipo, outages at AES Andes and a one-time regulatory provision in Argentina. Higher PTC at our MCAC SBU reflects the benefit from a large volume of LNG sales redirected to the international market. As I'll discuss later, we do not expect an opportunity of the same scale recur this year and anticipate lower PTC from MCAC in 2023. The LNG sales were partially offset by the full-year impact from the sale of our coal plant in the Dominican Republic in 2021. Finally, in Eurasia, adjusted PTC was relatively flat year-over-year with an overall net decline driven by higher interest expense, but partially offset by higher energy prices earned at our wind plant in Bulgaria. Now, let's turn to how we allocated our capital in 2022 on Slide 19. Beginning on the left hand side, sources reflect 1.3 billion or total discretionary cash. This includes parent free cash flow of $906 million, which was near the top end of our guidance expectations. Asset sales were below our expectations for the year, but we still expect to achieve our goal of $1 billion in proceeds by 2025. Given the delay in asset sales, we accelerated the issuance of some parent debt, which is within our long-term expectations. Moving to uses on the right hand side. We invested more than 700 million in growth at our subsidiaries, of which approximately two-thirds were in the U.S. We also allocated nearly 500 million of our discretionary cash to our dividend. Turning to our guidance and expectations, beginning on Slide 20. Today, we are initiating 2023 adjusted EPS guidance of $1.65 to $1.75. This year, we expect to commission approximately 3.4 gigawatts of new renewables, which is the largest year-over-year increase in AES history. This growth further validates AES' position as a leader in renewables and highlights the outstanding efforts of our commercial and operations teams in our markets. Roughly 65% of this new renewable capacity is located in the U.S. More than half our total 2023 adjusted PTC will come from the U.S. this year as we execute on the transformation of our portfolio. As I discussed last quarter, our U.S. renewables projects benefit from both investment tax credits and production tax credits. Our 2023 guidance includes approximately 500 million of adjusted PTC from tax credits generated and recognized by new U.S. renewable projects coming online this year, which is approximately double the amount from 2022. Tax credits are an important component of our renewables business earnings and cash flow and we intend to provide updates on our 2023 tax credit expectations throughout the year. While the midpoint of our 2023 guidance range is below our long-term annual growth target, we are reaffirming the 7% to 9% growth rate through 2025. 2023 growth is lower than the long-term trend for a few reasons. First, we've taken a conservative approach to modeling renewables projects expected to come online in 2023. Our renewables construction is typically concentrated in the fourth quarter and this year will be no exception. As a result, construction delays of only a few days could cause a project to shift from 2023 to 2024 and negatively impact this year's results. This is particularly relevant for our U.S. renewables projects where we recognized significant earnings from investment tax credits in the year a project is placed into service. Of the 2.1 gigawatts we plan to complete in 2023, two-thirds are expected to come online in the fourth quarter. Our guidance assumes that an additional 600 megawatts of projects currently scheduled to come online in December slip into 2024. If some or all of these projects are completed on schedule, this will create up to $0.10 of upside to our 2023 guidance. It's also important to note that even if there are delays to next year, this is only a timing issue with no material value impact. And would support higher growth in 2024 with no impact on our long-term growth rate expectation. Second, we expect to see lower contributions from our MCAC SBU on a year-over-year basis, primarily driven by more than 200 million of adjusted PTC from LNG sales we executed in 2022. Our commercial team was able to leverage the optionality embedded in our LNG supply contracts to capitalize on high international gas prices by redirecting Henry Hub-linked LNG cargoes to the international market. Although LNG sales will continue in 2023, we do not expect the same magnitude of opportunity as the spreads between Henry Hub and international gas prices have compressed and more of our gas supply this year is linked to TTF international prices rather than Henry Hub. Third, we expect to see lower margins at our Chile business this year, particularly in the first half of the year, which is a temporary impact of our Green blend and extend strategy to transition our customers from coal power to renewables. Several coal PPAs have or will expire this year as we proceed with our intent to fully exit coal by 2025, and others have been restructured to be priced off renewables that are still under construction. We view this as a short-term cost of decarbonizing our portfolio and do not expect any impact to our 7% to 9% long-term growth rate. Looking ahead, our teams are working on commercial solutions to mitigate the dilution as the portion of our earnings from coal continues to decline. Based on the drivers discussed, we expect our 2023 earnings to be significantly second half weighted with approximately three quarters recognized in the second half of the year. While we typically have had about two-thirds of our earnings in the second half, the increase in seasonality this year is driven by the significant volume of new U.S. renewable projects coming online in the fourth quarter. Now, turning to our 2023 parent capital allocation plan on Slide 21, beginning with approximately 2.2 billion of sources on the left-hand side. Parent free cash flow for 2023 is expected to be 950 million to 1 billion, in-line with our annualized growth target. In addition to parent free cash flow, we expect to generate 400 million to 600 million in asset sale proceeds this year. This includes our previously announced sale in Jordan, as well as the pending sell-down of some of our operating renewables in the U.S. I also want to point out that we intend to relaunch the sale process for our Mong Duong coal plant in Vietnam to better align with the approval requirements that became clear during the initial sale. The remaining portion of our 2023 asset sales is expected to come from additional sell-downs and sales supporting our decarbonization goals. Now, to the uses on the right-hand side. We plan to invest approximately 1.7 billion toward new growth, of which about two-thirds will be allocated in the U.S. to renewables and to increase our utility rate base. We expect to allocate approximately 500 million to our shareholder dividend, which reflects the previously announced 5% increase. In summary, we exceeded our financial commitments for 2022 and are confident in this year's guidance and the long-term outlook for AES. The energy transition provides tremendous investment and innovation opportunities, and I believe no company is better positioned than AES to lead this transition. As we execute on our strategy, we will continue to deliver on our financial commitments to maximize per share value for our shareholders. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. In summary, 2022 was our best year ever. Not only did we meet or exceed our targets for adjusted EPS and parent free cash flow, but we signed more PPAs and added more renewables to our portfolio than ever before. Once again, we were recognized by BNEF as the top developer worldwide, selling clean energy to corporations through PPAs. We also launched the first mega scale green hydrogen project in the U.S. and developed a regulatory foundation that will enable us to grow our U.S. utilities by 9% annually through 2025. Looking forward, we are very well positioned for the future. Our leadership in corporate PPAs and green hydrogen gives a line of sight into our continued success. We remain focused on executing on our construction program and further developing our pipeline of potential future projects, and we are on track to exit coal by the end of 2025. With that, I would like to open up the call for questions.
Operator: Thank you. [Operator Instructions] So, our first question comes from the line of Angie Storozynski. Your line is now open. Please go ahead.
Angie Storozynski: Good morning, guys. So first, maybe about the disclosure that you guys have in the – in your presentation, I understand that there's an Analyst Day coming, but there are a number of slides that are missing, especially the segmental earnings contributions for 2023. I mean, is there any reason for that?
Steve Coughlin: Yes, Angie, hey it's Steve. So yes, and that's because, as Andres shared in his remarks, we are intending to update you on our new business segments. And so when we issue that level of guidance, it will come in the Investor Day.
Angie Storozynski: Okay. I understand. Okay. Just moving on, just looking at the year-over-year bridge between 2022 and 2023 [EPS] [ph] there is no benefit from lower losses of AES Next. And I'm just wondering, I mean, it's not even mentioned as a driver. Can you comment about your expectations for that business?
Steve Coughlin: Yes. So Next, in total, Angie, was roughly a $0.12 drag last year. We have to be careful because Fluence is a separate public company, and we can't get ahead of their disclosures. They haven't specifically guided to earnings, but on their last call, they did guide to a significant improvement in margins this year. So, Next is a positive driver this year, and I would say, to a material extent, but I can't say specifically because I can't get ahead of them on their earnings disclosures. But we are expecting it to be much better. They've made a ton of progress on all of the operational and commercial improvements that they've been outlining. And as I've said previously, the Next portfolio we expect to be neutral to earnings by 2024, and I still expect that.
Angie Storozynski: Okay. But I'm just – so again, not to be picky, but so which bucket would this be included in? I mean on that Slide 20, I mean, I understand that it's lumped with some other drivers. So, would it be based on the upside to the guidance?
Steve Coughlin: No, it would be lumped into that second column with the negative – it would be an offset in that negative $0.15, basically.
Angie Storozynski: Okay. Okay. I understand. Okay. And then just one other question about 2022. So, when I'm looking at the actual results versus what you were guiding to, the corporate drag as more than 100 million higher than expected. And I'm just wondering, I understand some of it is interest expense, but any other driver?
Steve Coughlin: The corporate does include AES Next, under our current segments. And so, we'll be talking more at Investor Day about the future, but I can say, it's largely parent interest on the revolver, where we've had higher balances and of course, higher rates going into the revolver, as well as the incremental drag from AES Next.
Angie Storozynski: Okay. Thank you. And then the core question. So, based on the IRA, I mean, there's this discussion about shifting from solar ITC to solar PTC, there's obviously the bonus ITC. And I'm just wondering how are you positioned to benefit from those additional tax credits in the U.S.? And also, I mean, it's a very competitive market, as I understand. So, can you actually retain some of this benefit, i.e., boost the profitability of future solar projects in the U.S. or is it more a function of basically securing more contracts by trading away that benefit?
Steve Coughlin: Sure. So, look, first of all, we're very happy to have the optionality from the IRA on choosing ITC or PTC newly for solar, as well as having the ITC for storage. So, typically we're going to choose the tax credit structure that yields the highest return in the project. So, it's great to have that optionality. I would say, going forward, the ITC – there is a difference in the earnings profile. There's an upfront recognition of the ITC versus the PTC is spread out over 10 years, but other than that, you'd expect the lifetime earnings roughly to be the same if the credit structure yielded roughly the same returns. So, in this case, we have about – in AES’ case, about one-third of our pipeline, we believe, will qualify for the energy community adder. And so, we feel that we're going to be very competitively positioned to get at least the 40% level for about one-third of our pipeline. So, that's a good thing. I would say in terms of where the credit accrues, I think it's going to be a mix of things. Certainly, there's been higher costs that the industry has absorbed on the order of 30%. I think part of it goes to absorbing that impact of higher costs in renewables. I would say some will go to competitiveness in terms of bidding for the PPAs. And largely, as Andres has talked about before, we see there being more of a constraint on the supply side in the renewables market. So, we do see that continued strong demand, but that there's going to be constraints on the supply side of projects being ready to meet that demand and that will have some upward pressure on returns.
Andres Gluski: Yes. Angie, the way I'd put it is that the cost increases have largely been absorbed by the market. So, we're seeing constant margins. What you saw the last year, there was less commissioning of new projects in renewables than it was expected by a big factor, like 40%. So, what a lot of the clients have done has postponed some of their renewable goals, but eventually, what you're going to see is a shortage in the market. So, we feel confident about that, and that's why we're continuing to invest to build that pipeline to be able to respond to that demand. So, those are the dynamics. This is a market that, yes, while it's very competitive, the dynamics are positive. And then we are also selling a lot of our projects are differentiated projects. So, they're structured projects. They bring something to the table other just than your [indiscernible] PPA.
Angie Storozynski: Great. Thank you.
Operator: Our next question comes from the line of Nick Campanella of Credit Suisse. Your line is now open. Please go ahead.
Unidentified Analyst: Hi, good morning. Thanks for taking my question. This is [indiscernible] for Nick today. First, a quick question on the Analyst Day. Can we just get some color on your thoughts on the timing? I know you mentioned spring, but what are some of the specific drivers to determine the timing of the Analyst Day?
Steve Coughlin: Yes. I mean – so first of all, Andres mentioned, we will be discussing new business segments. So, we are closing out 2022 under our current segments. We will then move over to new segments very shortly. And so, part of the timing is to fully make that transition internally and then to be able to come out in the spring time frame with that look at the new segments, the new way of looking at AES going forward, as well as discussion about guidance beyond 2025.
Unidentified Analyst: Okay. That's helpful. Thanks. And just maybe just on the asset sales proceeds. I know you're feeling some of the add to sales proceeds with the parent debt issuance, but as we think about the [79] [ph] CAGR currently, can you just – are you able to continue to bridge this growth rate without any additional common equity? Just want to check in on that.
Andres Gluski: Yes. Look, we feel confident in terms of what we've said in the past that to grow through 2025, we don't need additional equity for that period of time. So, we also feel confident in our ability to raise $1 billion through asset sales.
Steve Coughlin: Yes. Yes. And with regard to the debt, it's really just – it's somewhat fungible. We look at both our sales program, as well as our debt capacity, always holding to our investment-grade metric, plus a cushion as a minimum, but it's really just timing. So, there's just flex between when we determine to issue the debt within our expectations and when those asset sales come in. So, it's just executing somewhat of a flexibility on the timing of the asset sales and the debt, kind of flex back and forth.
Unidentified Analyst: Great. Thanks for the color. I appreciate and I’ll back to the queue. Thanks.
Operator: Our next question comes from Durgesh Chopra of Evercore. Your line is now open. Please go ahead.
Durgesh Chopra: Hi, good morning team. Thank you for taking my question. Just, kind of – I want to focus on the plan for this year 2023, that is, what's the level of confidence? I mean maybe you can share some details with us in terms of what you already have in terms of material secured, et cetera, et cetera, and getting the, sort of the 3.4 gigawatts online and getting the $0.27 earnings accretion year-over-year.
Andres Gluski: Okay. Hi, Durgesh. Listen, we feel good about the numbers that we're giving out there. We have all the equipment basically secured. And we're very – I'd say about what we have about 5.5 gigawatts under construction as we speak. Okay. Not all of them are going to come in line in 2023. But just to give you an idea, we feel very good about it. Now, the [600] [ph] megawatts that we said might slip into 2024. What are the issues? Well, for some of that, there could be equipment delivery. There could be interconnect timing, easement issues, [indiscernible] permits, the usual stuff that when you're doing construction. So, we're going to try very hard to get it done this year, but we feel it's prudent to say that these are going to slip most likely, slip into 2024. Now, what I would like to reiterate is that this really isn't a business issue. This is just an accounting issue from my perspective because we – all of those 600 megawatts, I feel very confident would get done, for example, by – certainly by March. So, there aren't any penalties involved and there isn't any significant change to the return of those projects. So, unfortunately, what you really have is given that we run on a calendar year. We have so much happening in the last quarter. But I want to really emphasize this is not a – we have – of all the renewable developers, we have not abandoned any project because of equipment delays or permit delays. We have delivered on [indiscernible]. So, we feel very good, but there is a timing issue, and we thought it prudent to say, look, these 600 megawatts, we think are most likely to fall into next year. But it's a matter of – it could be weeks. And we will nonetheless try very hard to get them done this year.
Durgesh Chopra: Thank you, Andres. That's very helpful. And just in terms of milestones for us to watch, as to whether you can get them done this year or are they going to push next year? When are you going to have that clarity? Is that, sort of kind of a summer type of event or will you have more clarity by your Investor Day?
Andres Gluski: I really don't think we'd have it honestly, by our Investor Day, to be frank. I think it'd be more by the summer that we would have more indications on particularly the project. This gets quite granular. [X projects] [ph] got a permit or something that was missing, but I don't really don't see that before that.
Steve Coughlin: Yes Durgesh, our plan is – just on each call, we will give updates to the extent we have updates on the construction program, as well as the tax credit expectations throughout the year on the calls as well.
Durgesh Chopra: Got it. And thanks, Steve. And just one last one. I noticed the 2023 to 2025 PPA finding is, again, very healthy 14 gigawatts to 17 gigawatts, but you're not, sort of giving us an annual number this year like you did in 2022, which was 4.5 gigawatts to 5.5 gigawatts and you came in right in that range. Are you expecting that 2023 to 2025 signings to be lumpy or should we still expect right, the new PPAs in the [indiscernible] range each year?
Andres Gluski: I would expect, honestly, them to be right around that, sort of 4.5 megawatts, 5.5 megawatts every year, but we decided to [give] [ph] a multi-year range because there is some lumpiness. I mean, we do have some projects, which are like 1 gigawatt. And it's the same thing. The signing could happen in January instead of December. So, we wanted to give a – basically, think of it more as sort of a rolling number, but again, we feel good about being able to reach that range.
Durgesh Chopra: Got it. Thanks guys. And congrats on the BNEF recognition again this year. I appreciate the time.
Andres Gluski: Thanks a lot.
Operator: Our next question comes from the line of Julien Dumoulin-Smith of Bank of America. Your line is now open. Please go ahead.
Cameron Lochridge: Hi, there. Good morning. This is actually Cameron Lochridge on for Julien. Thanks for taking my questions. I wanted to maybe come back real quick to the idea of the renewal with backlog and how maybe that influences 7% to 9% growth CAGR that you guys have laid out. I appreciate that we reaffirm that through 2025, but given where the backlog is and where the growth is expected to come from over the next several years, is there any reason we should not be perhaps rolling that forward out beyond 2025 and continuing to underwrite to that or is there something else that may be driving that either higher or lower beyond 2025?
Andres Gluski: Yes. I mean, look, let's say, we have a 12.2 gigawatt backlog, of which about 5.5% are under construction now. And a good portion of that is going to come online between now and 2025. So, there's no reason to think of a change. If anything, the market continues to grow, and we see a shortage. I don't know if – Steve, you want to comment...
Steve Coughlin: Yes, I would say the backlog is at 12.2 and we're delivering [3.4] [ph] this year plus potentially some of that upside from the [600] [ph]. So that leaves still about [8.5] [ph] to be delivered over the next few years. So, we feel really good about the commissioning coming through 2025 to support the growth. And then as Andres has covered, the pipeline in the U.S. is 51 gigawatts and it is continuing to mature. So, we'll talk more at Investor Day about beyond 2025, but I feel really good about the growth expectations.
Andres Gluski: Yes. This is not a market that is not growing very rapidly. And we do see pent-up demand. What we do see is that because a lot of people did not deliver in 2022, we see pent-up demand. So, what we have to do is really make sure that we're getting the returns that we want and really going after the value-add on those projects, but it's not for a [indiscernible] of projects by any means.
Cameron Lochridge: Understood. Understood. Thank you both. Maybe just going back to 2023 and looking at guidance, I know you're looking at $0.27 a share from the new renewables in 2023. I kind of wanted to unpack that a little bit. In terms of how much, if you could quantify, how much of that $0.27 is, you know we'll call it a roll forward from projects that were placed in service in 4Q 2022? And is there any reason that was meaningfully different or will be meaningfully different this year thinking about the $0.10 a share that could potentially slip into 2024?
Steve Coughlin: Yes. So, the primary portion of that relates to the increase in the tax credit. So, a portion of the $0.27 is related to just that base of projects from 2022 coming into 2023. So that's part of it. But I would say the largest component is the increase in the tax credit to the range of about 500 million recognized this year, which is a little more than double what we recognize that last year. So, that's the largest component of the $0.27.
Cameron Lochridge: Okay. Got it. I guess… [Multiple Speakers] No, no, go ahead. I'm sorry.
Steve Coughlin: Yes. I was also just going to say, and that's partly why we're calling out this additional 600 megawatts because it's largely – in fact, it's all investment tax credit-based projects. So, as Andres described in the most extreme, even if you just had a project that was commissioned on January 1 instead of December 31, you would move that tax recognition over a calendar year. So that's why we're calling out that as potential upside and the sensitivity to the tax credit, and it's just timing is all it is.
Andres Gluski: Yes. The other thing I'd point out is, when we sell the tax credits, we also get the cash.
Steve Coughlin: Exactly.
Andres Gluski: So, there is lumpiness in the cash as a result of this. So, the cash and the earnings go together.
Cameron Lochridge: Got it. Okay. That would do for us. Thank you guys, both.
Operator: Thank you. Our next question comes from the line of Richard Sunderland of JPMorgan. Your line is now open. Please go ahead.
Richard Sunderland: Hi, good morning. Thanks for the time today. Just one last one on this 2023 versus 2024 [on 600 megawatts] [ph]. It sounds like if the $0.10 looks to 2024, this clearly should be additive to the prior growth outlook [meaning] [ph] attitude to the 7% to 9% CAGR. Is that the right frame of reference for whether the 600 megawatts [indiscernible] in 2023 and brings you kind of back to the original range or 2024 pushes you above?
Steve Coughlin: Exactly. So, that's exactly right. It doesn't change the 7% to 9% through 2025, but all else being equal, 2024 would go well above the 7% to 9% as a result of these projects moving into next year. That's exactly right.
Richard Sunderland: Okay. Got it. Very clear. Thank you. Turning to Ohio, you asked before, any sense on the backdrop in conversations there after all the time and engagement around the [ASI] [ph] rate case?
Steve Coughlin: Yes. So at this point, as Andres said in his remarks, the ESP 4, we're expecting to be decided this summer. So that was filed last fall. The [PUC] [ph] did issue the order on the distribution rate case back in December, which was very favorable to us. And so, really those rates are just pending the approval and finalization of the ESP 4. So – and keep in mind, the ESP 4 has a couple of things that are very additive. So, one is that it will catch up the investment that's occurred between the last rate case filing in 2020, up close to the point in which the ESP 4 was filed last year. So, there's a catch up there. There's also a new framework for investment going forward, including a distribution investment rider, as well as some additional riders that will result in faster recognition of investment going forward. So, our expectation is that we'll see the new structure in place that sets Ohio in the course for new investment for the second half of this year, and then it becomes a growth driver going forward into the next several years. We see in total our net rate base increasing close to 1.5 billion across both utilities from now until 2025.
Richard Sunderland: Understood. Understood. Thank you. And then you reference changes around the Vietnam requirements for sale and relaunching that transaction. Could you just parse that a little bit more in terms of what you're expecting there now? Do you see a quicker path to divestment under a second go, anything else would be helpful here?
Andres Gluski: Yes. Well, we hope so, and then it will be [indiscernible] second time around. I mean, basically, the – what happened here is that the government wanted more of an operator then a financial investor. They're very happy with us, and they want somebody equally good. So, we feel there is a number of people interested in the asset because they actually canceled the number of new coal plants that were going to be built. So, there's an appetite, especially from Asian operators for this asset. So, hopefully, it will be faster. It was somewhat of a surprise, but our intentions remain the same. So, to be out of coal by the end of 2025.
Richard Sunderland: Got it. Thank you for the time today.
Operator: Our next question comes from the line of Steve Fleishman of Wolfe Research. Your line is now open. Please go ahead.
Steve Fleishman: Yes, thank you. Andres, maybe could you give us just some overall color on how things are proceeding on panel supplies and particularly you flip up implementation issues. And is that kind of a key variable in the timing of these projects or is it more other issues?
Andres Gluski: Let's see. Well, we feel pretty – we feel good about the panel issue. As you know, again, we got all the panels we could use in 2022. So, in 2023, we have all the orders in. Our suppliers have been getting through. So, again, we feel good about that. In terms of what would determine that last, sort of 600 megawatts, it's really a combination of issues. It's not just solar panels. It runs the gamut from wind turbines, deliveries, et cetera, pyramids easing. Also, the interconnection timing, is the client ready to take that [energy] [ph]. That was one of the biggest issues we had in 2022. We were ready, but the client wasn't ready. So, it's just a bag of different issues. I'd say an important issue going forward is, as you know, we're heading the solar panel buyers consortium. We want to have solar panels starting to be delivered late 2024, 2025 made in the U.S.A., and what we're seeing now is really one of the regulations may be issued by treasury, what constitutes domestic content to get those additional credits. So, I'd say that's an item that we're watching very closely, but generally, we feel good about. And there are certainly people interested in locating that flat here to supply that contract.
Steve Fleishman: Okay. And then just – I know this was discussed on the last call, but just how are you making the decision between on U.S. projects, ITC versus PTC. I guess, -- so PTC, I think you had talked about still having a lot of value in the tax equity and the depreciation, but just – do you see that starting to shift at some point in the – as you execute on future projects?
Steve Coughlin: Yes, I do, Steve, now that we have the optionality for production tax credits on solar, I would see that option being exercised primarily in the sunniest places in the U.S. So, in the Southwest U.S. projects where the production-based incentive is going to yield a higher value than necessarily the CapEx based on the capital investment based incentive. So, we are modeling more production tax credit into our longer-term. For this year, it's not – I wouldn't say, it's impacted us really at all this year because for the most part, we're locked into a tax credit structure election and a tax equity partnership that we've already agreed to. But going forward, we'll start to see more production-based incentive come into the mix. And that's something, again, for Investor Day, as we talk about beyond 2025, kind of how do we look at the business, how do you look at the metrics of the business, how do you look at tax credits, distinct from earnings that don't include tax credits, things like that, that we'll be giving more guidance on to help people understand what that looks like going forward.
Steve Fleishman: Okay. Thank you.
Operator: Our next question comes from the line of Gregg Orrill of UBS. Your line is now open. Please go ahead.
Gregg Orrill: Hi, thanks for taking my question. I just wanted to, sort of confirm where the credit goals are, sort of with the guidance update and the segment – the new segments that you're thinking about? Sorry, if I'm getting ahead of my [indiscernible].
Steve Coughlin: No, no, no. No problem. Are you referring to the tax credit?
Andres Gluski: I think the credit rating, right?
Steve Coughlin: Credit rating, okay. We've been talking so much about tax credit. So, yes, the credit rating, certainly the BBB- is a constant constraint. And then we see likely improvement going forward, particularly as our business mix evolves to more long-term contracted renewables and more investment in the U.S. utilities. So, I would say, that's going to be a driver of improvement to the overall profile and view on the source of where our cash is coming from going forward. The segments, there's no – I can't say too much about that right now. As we've been operating under the current segments, we'll be moving to the new one soon and then talking about that on the call going forward, but the segments will make it very clear as to the sources of earnings and cash going forward and where the business is growing, frankly, much, much higher than 7% to 9% and where the business is shrinking, largely consistent with our decarbonization goals. So, it will peel apart where that 7% to 9% has come from [2025] [ph] as well as go beyond [2025] [ph].
Andres Gluski: Yes. So Gregg, in terms of the credit rating, we're already more than 50% of our earnings are coming from the U.S. and a higher and higher percentage is coming from renewables. So, we already have a – if we're growing 7% to 9%, that includes the dilution from getting out of coal. So, actually, our renewables are growing at a much higher rate, more like 10% to 12%. So, to put that in context, all of those things point to an improvement, as Steve was saying, in terms of the quality of the numbers beyond the metrics. So, again, we feel very confident in what we've said. This is a red line. We're not going to drop below investment grade, and we're going to continue to strengthen it.
Gregg Orrill: Thank you.
Operator: Thank you. Our next question comes from Ryan Levine of Citi. Your line is now open. Please go ahead.
Ryan Levine: Good morning. Hoping to follow-up on the change – in terms of the change in segmentation, maybe just to take a step back, what's prompting the re-review of how you're looking to disclose information? And is there anything that any re-review would signal strategically for the company?
Andres Gluski: No. I mean we really think this is a culmination of what we've been doing in terms of moving into renewables. And our business is long-term contracted. And what we're seeing is a lot of this would make our business we feel more transparent and more comparable to other people's businesses. So, that's all I can say at this point, but it's something that I think you guys will welcome because it gives greater transparency. And I think it makes more and more sense as, again, we transition more to renewables.
Ryan Levine: Okay. And in your guidance, you disclosed a step down from the LNG contribution for this calendar year. What are you assuming for like TTF Henry Hub spreads or upside or contribution from that portion of your contract portfolio?
Andres Gluski: Well, I'll say the two elements. One is that we have less gas available to take advantage of that opportunity because we had a step down in our Henry Hub-based gas contracts. The second is, has to do with the spread between Henry Hub plus and TTF. So, those spreads have narrowed. It's been a very warm winter, especially in Europe. So, we'll see. So, that's an opportunity that exists there, but we're not – it would be smaller, smaller quantity. And we're not counting on it this year because right now, the spreads are not such that between all the transportation and the sharing of the upside with oil traders, et cetera, look particularly attractive, but the option is there, should the situation change.
Steve Coughlin: Yes. So, it's – I mean, it's largely based on current outlook for the year on the commodities, but to the extent that spread were to increase, that would be an upside to the guidance we've given here.
Ryan Levine: Great. And then last question for me. In terms of the asset sale process, to the extent some of these deals don't happen or get delayed, what tools do you have to alter your financing plan in light of looks like a choppy M&A market.
Andres Gluski: Well, first, we have many assets that we can sell, and it's not only sell-out, sell-down. So, we have, I think, a lot of levers there. And we don't like to talk a lot about any specific asset until we have a deal done. It doesn't help us, but we always also sell-down, for example, some of our renewables because that increases our returns, sell-down a portion of it, we continue to operate them. So, if you have movements, say, in time that a specific asset sale gets delayed and you're not ready to do another one, that's where other kinds of financings come in, and we'll do the one that makes the most sense. But again, as I said before, maintaining our credit metrics and our investment grade, that's a red line in the [sand] [ph].
Ryan Levine: Great. Thank you.
Operator: Our final question is a follow-up question from Angie Storozynski from Seaport. Your line is now open. Please go ahead.
Angie Storozynski: Thank you. Just one thing. So, the 600 megawatts that might slip into 2024, that's the growth number, right? What would it be adjusted by ownership?
Andres Gluski: There’s two things. I mean, we normally sell-down after the commissioning.
Steve Coughlin: Yes. I mean, so we do have [indiscernible] so this is the U.S. number. So, we have our partnership with Alberta Investment Management. And so, I would say, for the most part, it's about 75% AES is that number. And the – up to $0.10 that I mentioned, Angie, is AES' share. So, that's not the [indiscernible].
Angie Storozynski: Okay. That’s all I need. Thank you.
Operator: Thank you. As there are no additional questions waiting at this time, I'd like to pass the conference back over to Susan Harcourt for closing remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day.
Operator: Ladies and gentlemen, this concludes today's call. Have a great day ahead. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning and a warm welcome to the AES Corporation Fourth Quarter and Full-Year 2022 Financial Results Call. My name is Candice, and I will be your moderator for today’s call. [Operator Instructions] I would now like to hand you over to our host, Susan Harcourt, Vice President of Investor Relations. The floor is yours. Please go ahead."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning and welcome to our fourth quarter and full-year 2022 financial review call. Our press release, presentation, and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our fourth quarter and full-year 2022 financial review call. Today, I will discuss our 2022 financial results and strategic accomplishments, as well as our 2023 guidance. Steve Coughlin, our CFO will discuss our financial results and outlook in more detail shortly. Beginning with our 2002 results and accomplishments on Slide 3. I am very pleased with our performance in 2022, which was our best year ever. Adjusted EPS came in at $1.67, above our guidance range of $1.55 to $1.65. This accomplishment is primarily the result of three factors: strong performance across our portfolio, growth in renewables, particularly from solar and energy storage in the U.S., and the benefit of embedded optionality in our LNG contracts. Turning to Slide 4. I would like to highlight an area in which we are particularly proud of our performance, our success in bringing our construction projects online. In 2022, despite numerous market-wide challenges throughout the year, we added approximately 2 gigawatts of new projects to our portfolio, which was consistent with our expectations at the beginning of the year. Our success was the result of the extensive work we have done to develop the people, processes, and solid supplier relationships to rapidly expand our portfolio of renewables. We see our ability to execute as the source of competitive advantage that is highly valued in the marketplace. Not only does it support our strong global customer relationships, but it also contributes to our confidence in our long-term forecast. In addition to our execution, 2022 was a year where we focused on taking actions that will position us well for future growth. These actions included signing a record number of new PPAs for projects that we will complete in the coming years, investing in our pipeline of future projects, creating a leading position in green hydrogen, establishing strong regulatory foundations to support future utility growth, and achieving significant cold phase out milestones in Hawaii and Chile. As you can see on Slide 5, 2022 was a record year for PPA signings for AES. We signed 5.2 gigawatts of renewables under long-term contracts, increasing our backlog to 12.2 gigawatts. In fact, for the second year in a row, BNEF reported that AES signed more renewable deals with corporate customers than anyone else in the world. This included an expansion of our 24/7 structured projects. Moving to Slide 6. We also worked hard throughout the year to grow our pipeline of future projects, which increased by 25% to 64 gigawatts, including 51 gigawatts in the U.S. We see extensive and growing demand for renewables worldwide and expect that in the future a key limitation to growth will be the availability of projects. We have been preparing by investing in land, interconnections, and permitting work to advance the projects that will be used for future PPA signings. Turning to Slide 7. We also established ourselves as a leader in green hydrogen. In December, we announced a partnership with Air Products to develop, build, and own, and operate the largest green hydrogen production facility in the U.S. This project will have the capacity to produce more than 200 metric tons per day of green hydrogen and will include approximately 1.4 gigawatts of wind and solar generation. It builds upon the expertise we have developed in combining renewables to create around the clock carbon free energy. This project has the potential to serve approximately 4,000 trucks, which while significant represents less than 0.1% of the current market for long haul trucking. As such, we see a massive total addressable market for decarbonizing the transportation sector. Turning to Slide 8. Another focus of our 2022 work was to develop strong regulatory foundations for future growth at our U.S. Utilities, where we expect to grow the combined rate basis 9% annually through 2025. Specifically, at AES Ohio, we filed a new electric security plan or ESP 4 to enhance and upgrade the network and improve service reliability. With the lowest [CND rates] [ph] in the states, across all customer categories, AES Ohio is well positioned to make the much needed customer centric investments. A ruling by the Ohio Commission on ESP 4 is expected this summer. Finally, we're pleased with the constructive outcome of AES Ohio's distribution rate case in which the Ohio Commission approved an annual revenue increase of $75.6 million. At AES Indiana, we filed our integrated resource plan for IRP with the Indiana Utility Regulatory Commission in December. AES Indiana's near term plan includes the conversion of the utility's last two coal units to natural gas in 2025 using an existing on-site gas pipeline. It also includes the addition of up to 1.3 gigawatts of new wind, solar, and energy storage by 2027 and should reduce AES Indiana's carbon intensity by two-thirds from 2018 to 2030. This plan is an important step to fully transition away from coal and provides the opportunity for substantial additional investments at AES Indiana. Now, turning to our outlook for 2023 on Slide 9. Today, we're initiating adjusted EPS guidance of $1.65 to $1.75, and reaffirming our long-term growth rate of 7% to 9% through 2025 for both adjusted EPS and parent free cash flow of a base year of 2020. Our focus this year will remain on execution. As you can see on Slide 10, we expect to complete approximately 3.4 gigawatts of new projects, including 2.1 gigawatts in the U.S. I will note that our 2023 guidance range does not include a potential upside from 600 megawatts of projects currently scheduled to be completed in December 2023, but which are likely to come online in 2024. Looking at our growth through 2025 on Slide 11. We expect to maintain the pace of PPA signings we have established with an estimated 14 gigawatts to 17 gigawatts expected to be signed over the next three years. We see strong demand for renewables across all of our key markets, particularly the U.S. where the benefits of the Inflation Reduction Act or IRA are becoming even clearer. Thus, given the strength of our backlog and our visibility into future PPA signings and project completions. We are confident in reaffirming our long-term guidance through 2025. Finally, today we're announcing that we will hold an Investor Day this spring, we will be sharing our strategic long-term view of the company, introducing new business segments, and extending our long-term growth rate. We will provide additional details at a later date. With that, I now would like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning everyone. Today, I will cover the following key topics. Our financial performance during 2022, our parent capital allocation, and our 2023 guidance and expectations through 2025. As Andres mentioned, our results for 2022 demonstrate the strength, resiliency, and flexibility of our portfolio as we surpassed our guidance range of $1.55 to $1.65. Overall, our portfolio was well structure to perform in the current market environment and is well-positioned for growth as AES continues to lead the global energy transition. Turning to Slide 13. Full-year 2022 adjusted EPS was $1.67 versus $1.52 in 2021, driven primarily by a significant volume of LNG sales in our increased ownership of AES Andes. These positive drivers were partially offset by unplanned outages, several one-time expenses we recorded at our U.S. and utilities and South America SBUs, a higher share count as a result of the 2021 accounting adjustment for our equity units, and higher parent interest stemming from higher debt balances. The $1.67 per share also includes approximately $0.12 of losses from AES Next. Primarily from our ownership in Fluence, which served as an additional drag year-over-year. We expect Fluence's results to significantly improve beginning this year as they discussed on their recent earnings call. Turning to Slide 14. Adjusted pretax contribution or PTC was $1.6 billion for the year, an increase of 149 million and a 11% growth over 2021. I'll cover our results in more detail over the next four slides, beginning with the U.S. and utilities SBU on Slide 15. Lower PTC in the U.S. was primarily driven by the recognition of one-time expenses from previously deferred purchased fuel and energy costs at our utilities. Outages at Southland Energy and AES Indiana in the second quarter and lower contributions from Clean Energy and the retirement of our coal plant in Hawaii. Partially offset by higher contributions from our Southland legacy assets in the third quarter. Higher PTC at our South America SBU was primarily driven by our increased ownership of AES Andes and higher margins at both AES Andes and AES Brazil, but partially offset by a prior year gain related to an arbitration at Alto Maipo, outages at AES Andes and a one-time regulatory provision in Argentina. Higher PTC at our MCAC SBU reflects the benefit from a large volume of LNG sales redirected to the international market. As I'll discuss later, we do not expect an opportunity of the same scale recur this year and anticipate lower PTC from MCAC in 2023. The LNG sales were partially offset by the full-year impact from the sale of our coal plant in the Dominican Republic in 2021. Finally, in Eurasia, adjusted PTC was relatively flat year-over-year with an overall net decline driven by higher interest expense, but partially offset by higher energy prices earned at our wind plant in Bulgaria. Now, let's turn to how we allocated our capital in 2022 on Slide 19. Beginning on the left hand side, sources reflect 1.3 billion or total discretionary cash. This includes parent free cash flow of $906 million, which was near the top end of our guidance expectations. Asset sales were below our expectations for the year, but we still expect to achieve our goal of $1 billion in proceeds by 2025. Given the delay in asset sales, we accelerated the issuance of some parent debt, which is within our long-term expectations. Moving to uses on the right hand side. We invested more than 700 million in growth at our subsidiaries, of which approximately two-thirds were in the U.S. We also allocated nearly 500 million of our discretionary cash to our dividend. Turning to our guidance and expectations, beginning on Slide 20. Today, we are initiating 2023 adjusted EPS guidance of $1.65 to $1.75. This year, we expect to commission approximately 3.4 gigawatts of new renewables, which is the largest year-over-year increase in AES history. This growth further validates AES' position as a leader in renewables and highlights the outstanding efforts of our commercial and operations teams in our markets. Roughly 65% of this new renewable capacity is located in the U.S. More than half our total 2023 adjusted PTC will come from the U.S. this year as we execute on the transformation of our portfolio. As I discussed last quarter, our U.S. renewables projects benefit from both investment tax credits and production tax credits. Our 2023 guidance includes approximately 500 million of adjusted PTC from tax credits generated and recognized by new U.S. renewable projects coming online this year, which is approximately double the amount from 2022. Tax credits are an important component of our renewables business earnings and cash flow and we intend to provide updates on our 2023 tax credit expectations throughout the year. While the midpoint of our 2023 guidance range is below our long-term annual growth target, we are reaffirming the 7% to 9% growth rate through 2025. 2023 growth is lower than the long-term trend for a few reasons. First, we've taken a conservative approach to modeling renewables projects expected to come online in 2023. Our renewables construction is typically concentrated in the fourth quarter and this year will be no exception. As a result, construction delays of only a few days could cause a project to shift from 2023 to 2024 and negatively impact this year's results. This is particularly relevant for our U.S. renewables projects where we recognized significant earnings from investment tax credits in the year a project is placed into service. Of the 2.1 gigawatts we plan to complete in 2023, two-thirds are expected to come online in the fourth quarter. Our guidance assumes that an additional 600 megawatts of projects currently scheduled to come online in December slip into 2024. If some or all of these projects are completed on schedule, this will create up to $0.10 of upside to our 2023 guidance. It's also important to note that even if there are delays to next year, this is only a timing issue with no material value impact. And would support higher growth in 2024 with no impact on our long-term growth rate expectation. Second, we expect to see lower contributions from our MCAC SBU on a year-over-year basis, primarily driven by more than 200 million of adjusted PTC from LNG sales we executed in 2022. Our commercial team was able to leverage the optionality embedded in our LNG supply contracts to capitalize on high international gas prices by redirecting Henry Hub-linked LNG cargoes to the international market. Although LNG sales will continue in 2023, we do not expect the same magnitude of opportunity as the spreads between Henry Hub and international gas prices have compressed and more of our gas supply this year is linked to TTF international prices rather than Henry Hub. Third, we expect to see lower margins at our Chile business this year, particularly in the first half of the year, which is a temporary impact of our Green blend and extend strategy to transition our customers from coal power to renewables. Several coal PPAs have or will expire this year as we proceed with our intent to fully exit coal by 2025, and others have been restructured to be priced off renewables that are still under construction. We view this as a short-term cost of decarbonizing our portfolio and do not expect any impact to our 7% to 9% long-term growth rate. Looking ahead, our teams are working on commercial solutions to mitigate the dilution as the portion of our earnings from coal continues to decline. Based on the drivers discussed, we expect our 2023 earnings to be significantly second half weighted with approximately three quarters recognized in the second half of the year. While we typically have had about two-thirds of our earnings in the second half, the increase in seasonality this year is driven by the significant volume of new U.S. renewable projects coming online in the fourth quarter. Now, turning to our 2023 parent capital allocation plan on Slide 21, beginning with approximately 2.2 billion of sources on the left-hand side. Parent free cash flow for 2023 is expected to be 950 million to 1 billion, in-line with our annualized growth target. In addition to parent free cash flow, we expect to generate 400 million to 600 million in asset sale proceeds this year. This includes our previously announced sale in Jordan, as well as the pending sell-down of some of our operating renewables in the U.S. I also want to point out that we intend to relaunch the sale process for our Mong Duong coal plant in Vietnam to better align with the approval requirements that became clear during the initial sale. The remaining portion of our 2023 asset sales is expected to come from additional sell-downs and sales supporting our decarbonization goals. Now, to the uses on the right-hand side. We plan to invest approximately 1.7 billion toward new growth, of which about two-thirds will be allocated in the U.S. to renewables and to increase our utility rate base. We expect to allocate approximately 500 million to our shareholder dividend, which reflects the previously announced 5% increase. In summary, we exceeded our financial commitments for 2022 and are confident in this year's guidance and the long-term outlook for AES. The energy transition provides tremendous investment and innovation opportunities, and I believe no company is better positioned than AES to lead this transition. As we execute on our strategy, we will continue to deliver on our financial commitments to maximize per share value for our shareholders. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. In summary, 2022 was our best year ever. Not only did we meet or exceed our targets for adjusted EPS and parent free cash flow, but we signed more PPAs and added more renewables to our portfolio than ever before. Once again, we were recognized by BNEF as the top developer worldwide, selling clean energy to corporations through PPAs. We also launched the first mega scale green hydrogen project in the U.S. and developed a regulatory foundation that will enable us to grow our U.S. utilities by 9% annually through 2025. Looking forward, we are very well positioned for the future. Our leadership in corporate PPAs and green hydrogen gives a line of sight into our continued success. We remain focused on executing on our construction program and further developing our pipeline of potential future projects, and we are on track to exit coal by the end of 2025. With that, I would like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] So, our first question comes from the line of Angie Storozynski. Your line is now open. Please go ahead."
},
{
"speaker": "Angie Storozynski",
"text": "Good morning, guys. So first, maybe about the disclosure that you guys have in the – in your presentation, I understand that there's an Analyst Day coming, but there are a number of slides that are missing, especially the segmental earnings contributions for 2023. I mean, is there any reason for that?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, Angie, hey it's Steve. So yes, and that's because, as Andres shared in his remarks, we are intending to update you on our new business segments. And so when we issue that level of guidance, it will come in the Investor Day."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. I understand. Okay. Just moving on, just looking at the year-over-year bridge between 2022 and 2023 [EPS] [ph] there is no benefit from lower losses of AES Next. And I'm just wondering, I mean, it's not even mentioned as a driver. Can you comment about your expectations for that business?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So Next, in total, Angie, was roughly a $0.12 drag last year. We have to be careful because Fluence is a separate public company, and we can't get ahead of their disclosures. They haven't specifically guided to earnings, but on their last call, they did guide to a significant improvement in margins this year. So, Next is a positive driver this year, and I would say, to a material extent, but I can't say specifically because I can't get ahead of them on their earnings disclosures. But we are expecting it to be much better. They've made a ton of progress on all of the operational and commercial improvements that they've been outlining. And as I've said previously, the Next portfolio we expect to be neutral to earnings by 2024, and I still expect that."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. But I'm just – so again, not to be picky, but so which bucket would this be included in? I mean on that Slide 20, I mean, I understand that it's lumped with some other drivers. So, would it be based on the upside to the guidance?"
},
{
"speaker": "Steve Coughlin",
"text": "No, it would be lumped into that second column with the negative – it would be an offset in that negative $0.15, basically."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. Okay. I understand. Okay. And then just one other question about 2022. So, when I'm looking at the actual results versus what you were guiding to, the corporate drag as more than 100 million higher than expected. And I'm just wondering, I understand some of it is interest expense, but any other driver?"
},
{
"speaker": "Steve Coughlin",
"text": "The corporate does include AES Next, under our current segments. And so, we'll be talking more at Investor Day about the future, but I can say, it's largely parent interest on the revolver, where we've had higher balances and of course, higher rates going into the revolver, as well as the incremental drag from AES Next."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. Thank you. And then the core question. So, based on the IRA, I mean, there's this discussion about shifting from solar ITC to solar PTC, there's obviously the bonus ITC. And I'm just wondering how are you positioned to benefit from those additional tax credits in the U.S.? And also, I mean, it's a very competitive market, as I understand. So, can you actually retain some of this benefit, i.e., boost the profitability of future solar projects in the U.S. or is it more a function of basically securing more contracts by trading away that benefit?"
},
{
"speaker": "Steve Coughlin",
"text": "Sure. So, look, first of all, we're very happy to have the optionality from the IRA on choosing ITC or PTC newly for solar, as well as having the ITC for storage. So, typically we're going to choose the tax credit structure that yields the highest return in the project. So, it's great to have that optionality. I would say, going forward, the ITC – there is a difference in the earnings profile. There's an upfront recognition of the ITC versus the PTC is spread out over 10 years, but other than that, you'd expect the lifetime earnings roughly to be the same if the credit structure yielded roughly the same returns. So, in this case, we have about – in AES’ case, about one-third of our pipeline, we believe, will qualify for the energy community adder. And so, we feel that we're going to be very competitively positioned to get at least the 40% level for about one-third of our pipeline. So, that's a good thing. I would say in terms of where the credit accrues, I think it's going to be a mix of things. Certainly, there's been higher costs that the industry has absorbed on the order of 30%. I think part of it goes to absorbing that impact of higher costs in renewables. I would say some will go to competitiveness in terms of bidding for the PPAs. And largely, as Andres has talked about before, we see there being more of a constraint on the supply side in the renewables market. So, we do see that continued strong demand, but that there's going to be constraints on the supply side of projects being ready to meet that demand and that will have some upward pressure on returns."
},
{
"speaker": "Andres Gluski",
"text": "Yes. Angie, the way I'd put it is that the cost increases have largely been absorbed by the market. So, we're seeing constant margins. What you saw the last year, there was less commissioning of new projects in renewables than it was expected by a big factor, like 40%. So, what a lot of the clients have done has postponed some of their renewable goals, but eventually, what you're going to see is a shortage in the market. So, we feel confident about that, and that's why we're continuing to invest to build that pipeline to be able to respond to that demand. So, those are the dynamics. This is a market that, yes, while it's very competitive, the dynamics are positive. And then we are also selling a lot of our projects are differentiated projects. So, they're structured projects. They bring something to the table other just than your [indiscernible] PPA."
},
{
"speaker": "Angie Storozynski",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Nick Campanella of Credit Suisse. Your line is now open. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"text": "Hi, good morning. Thanks for taking my question. This is [indiscernible] for Nick today. First, a quick question on the Analyst Day. Can we just get some color on your thoughts on the timing? I know you mentioned spring, but what are some of the specific drivers to determine the timing of the Analyst Day?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. I mean – so first of all, Andres mentioned, we will be discussing new business segments. So, we are closing out 2022 under our current segments. We will then move over to new segments very shortly. And so, part of the timing is to fully make that transition internally and then to be able to come out in the spring time frame with that look at the new segments, the new way of looking at AES going forward, as well as discussion about guidance beyond 2025."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. That's helpful. Thanks. And just maybe just on the asset sales proceeds. I know you're feeling some of the add to sales proceeds with the parent debt issuance, but as we think about the [79] [ph] CAGR currently, can you just – are you able to continue to bridge this growth rate without any additional common equity? Just want to check in on that."
},
{
"speaker": "Andres Gluski",
"text": "Yes. Look, we feel confident in terms of what we've said in the past that to grow through 2025, we don't need additional equity for that period of time. So, we also feel confident in our ability to raise $1 billion through asset sales."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Yes. And with regard to the debt, it's really just – it's somewhat fungible. We look at both our sales program, as well as our debt capacity, always holding to our investment-grade metric, plus a cushion as a minimum, but it's really just timing. So, there's just flex between when we determine to issue the debt within our expectations and when those asset sales come in. So, it's just executing somewhat of a flexibility on the timing of the asset sales and the debt, kind of flex back and forth."
},
{
"speaker": "Unidentified Analyst",
"text": "Great. Thanks for the color. I appreciate and I’ll back to the queue. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from Durgesh Chopra of Evercore. Your line is now open. Please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hi, good morning team. Thank you for taking my question. Just, kind of – I want to focus on the plan for this year 2023, that is, what's the level of confidence? I mean maybe you can share some details with us in terms of what you already have in terms of material secured, et cetera, et cetera, and getting the, sort of the 3.4 gigawatts online and getting the $0.27 earnings accretion year-over-year."
},
{
"speaker": "Andres Gluski",
"text": "Okay. Hi, Durgesh. Listen, we feel good about the numbers that we're giving out there. We have all the equipment basically secured. And we're very – I'd say about what we have about 5.5 gigawatts under construction as we speak. Okay. Not all of them are going to come in line in 2023. But just to give you an idea, we feel very good about it. Now, the [600] [ph] megawatts that we said might slip into 2024. What are the issues? Well, for some of that, there could be equipment delivery. There could be interconnect timing, easement issues, [indiscernible] permits, the usual stuff that when you're doing construction. So, we're going to try very hard to get it done this year, but we feel it's prudent to say that these are going to slip most likely, slip into 2024. Now, what I would like to reiterate is that this really isn't a business issue. This is just an accounting issue from my perspective because we – all of those 600 megawatts, I feel very confident would get done, for example, by – certainly by March. So, there aren't any penalties involved and there isn't any significant change to the return of those projects. So, unfortunately, what you really have is given that we run on a calendar year. We have so much happening in the last quarter. But I want to really emphasize this is not a – we have – of all the renewable developers, we have not abandoned any project because of equipment delays or permit delays. We have delivered on [indiscernible]. So, we feel very good, but there is a timing issue, and we thought it prudent to say, look, these 600 megawatts, we think are most likely to fall into next year. But it's a matter of – it could be weeks. And we will nonetheless try very hard to get them done this year."
},
{
"speaker": "Durgesh Chopra",
"text": "Thank you, Andres. That's very helpful. And just in terms of milestones for us to watch, as to whether you can get them done this year or are they going to push next year? When are you going to have that clarity? Is that, sort of kind of a summer type of event or will you have more clarity by your Investor Day?"
},
{
"speaker": "Andres Gluski",
"text": "I really don't think we'd have it honestly, by our Investor Day, to be frank. I think it'd be more by the summer that we would have more indications on particularly the project. This gets quite granular. [X projects] [ph] got a permit or something that was missing, but I don't really don't see that before that."
},
{
"speaker": "Steve Coughlin",
"text": "Yes Durgesh, our plan is – just on each call, we will give updates to the extent we have updates on the construction program, as well as the tax credit expectations throughout the year on the calls as well."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. And thanks, Steve. And just one last one. I noticed the 2023 to 2025 PPA finding is, again, very healthy 14 gigawatts to 17 gigawatts, but you're not, sort of giving us an annual number this year like you did in 2022, which was 4.5 gigawatts to 5.5 gigawatts and you came in right in that range. Are you expecting that 2023 to 2025 signings to be lumpy or should we still expect right, the new PPAs in the [indiscernible] range each year?"
},
{
"speaker": "Andres Gluski",
"text": "I would expect, honestly, them to be right around that, sort of 4.5 megawatts, 5.5 megawatts every year, but we decided to [give] [ph] a multi-year range because there is some lumpiness. I mean, we do have some projects, which are like 1 gigawatt. And it's the same thing. The signing could happen in January instead of December. So, we wanted to give a – basically, think of it more as sort of a rolling number, but again, we feel good about being able to reach that range."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Thanks guys. And congrats on the BNEF recognition again this year. I appreciate the time."
},
{
"speaker": "Andres Gluski",
"text": "Thanks a lot."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Julien Dumoulin-Smith of Bank of America. Your line is now open. Please go ahead."
},
{
"speaker": "Cameron Lochridge",
"text": "Hi, there. Good morning. This is actually Cameron Lochridge on for Julien. Thanks for taking my questions. I wanted to maybe come back real quick to the idea of the renewal with backlog and how maybe that influences 7% to 9% growth CAGR that you guys have laid out. I appreciate that we reaffirm that through 2025, but given where the backlog is and where the growth is expected to come from over the next several years, is there any reason we should not be perhaps rolling that forward out beyond 2025 and continuing to underwrite to that or is there something else that may be driving that either higher or lower beyond 2025?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. I mean, look, let's say, we have a 12.2 gigawatt backlog, of which about 5.5% are under construction now. And a good portion of that is going to come online between now and 2025. So, there's no reason to think of a change. If anything, the market continues to grow, and we see a shortage. I don't know if – Steve, you want to comment..."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, I would say the backlog is at 12.2 and we're delivering [3.4] [ph] this year plus potentially some of that upside from the [600] [ph]. So that leaves still about [8.5] [ph] to be delivered over the next few years. So, we feel really good about the commissioning coming through 2025 to support the growth. And then as Andres has covered, the pipeline in the U.S. is 51 gigawatts and it is continuing to mature. So, we'll talk more at Investor Day about beyond 2025, but I feel really good about the growth expectations."
},
{
"speaker": "Andres Gluski",
"text": "Yes. This is not a market that is not growing very rapidly. And we do see pent-up demand. What we do see is that because a lot of people did not deliver in 2022, we see pent-up demand. So, what we have to do is really make sure that we're getting the returns that we want and really going after the value-add on those projects, but it's not for a [indiscernible] of projects by any means."
},
{
"speaker": "Cameron Lochridge",
"text": "Understood. Understood. Thank you both. Maybe just going back to 2023 and looking at guidance, I know you're looking at $0.27 a share from the new renewables in 2023. I kind of wanted to unpack that a little bit. In terms of how much, if you could quantify, how much of that $0.27 is, you know we'll call it a roll forward from projects that were placed in service in 4Q 2022? And is there any reason that was meaningfully different or will be meaningfully different this year thinking about the $0.10 a share that could potentially slip into 2024?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So, the primary portion of that relates to the increase in the tax credit. So, a portion of the $0.27 is related to just that base of projects from 2022 coming into 2023. So that's part of it. But I would say the largest component is the increase in the tax credit to the range of about 500 million recognized this year, which is a little more than double what we recognize that last year. So, that's the largest component of the $0.27."
},
{
"speaker": "Cameron Lochridge",
"text": "Okay. Got it. I guess… [Multiple Speakers] No, no, go ahead. I'm sorry."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. I was also just going to say, and that's partly why we're calling out this additional 600 megawatts because it's largely – in fact, it's all investment tax credit-based projects. So, as Andres described in the most extreme, even if you just had a project that was commissioned on January 1 instead of December 31, you would move that tax recognition over a calendar year. So that's why we're calling out that as potential upside and the sensitivity to the tax credit, and it's just timing is all it is."
},
{
"speaker": "Andres Gluski",
"text": "Yes. The other thing I'd point out is, when we sell the tax credits, we also get the cash."
},
{
"speaker": "Steve Coughlin",
"text": "Exactly."
},
{
"speaker": "Andres Gluski",
"text": "So, there is lumpiness in the cash as a result of this. So, the cash and the earnings go together."
},
{
"speaker": "Cameron Lochridge",
"text": "Got it. Okay. That would do for us. Thank you guys, both."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Richard Sunderland of JPMorgan. Your line is now open. Please go ahead."
},
{
"speaker": "Richard Sunderland",
"text": "Hi, good morning. Thanks for the time today. Just one last one on this 2023 versus 2024 [on 600 megawatts] [ph]. It sounds like if the $0.10 looks to 2024, this clearly should be additive to the prior growth outlook [meaning] [ph] attitude to the 7% to 9% CAGR. Is that the right frame of reference for whether the 600 megawatts [indiscernible] in 2023 and brings you kind of back to the original range or 2024 pushes you above?"
},
{
"speaker": "Steve Coughlin",
"text": "Exactly. So, that's exactly right. It doesn't change the 7% to 9% through 2025, but all else being equal, 2024 would go well above the 7% to 9% as a result of these projects moving into next year. That's exactly right."
},
{
"speaker": "Richard Sunderland",
"text": "Okay. Got it. Very clear. Thank you. Turning to Ohio, you asked before, any sense on the backdrop in conversations there after all the time and engagement around the [ASI] [ph] rate case?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So at this point, as Andres said in his remarks, the ESP 4, we're expecting to be decided this summer. So that was filed last fall. The [PUC] [ph] did issue the order on the distribution rate case back in December, which was very favorable to us. And so, really those rates are just pending the approval and finalization of the ESP 4. So – and keep in mind, the ESP 4 has a couple of things that are very additive. So, one is that it will catch up the investment that's occurred between the last rate case filing in 2020, up close to the point in which the ESP 4 was filed last year. So, there's a catch up there. There's also a new framework for investment going forward, including a distribution investment rider, as well as some additional riders that will result in faster recognition of investment going forward. So, our expectation is that we'll see the new structure in place that sets Ohio in the course for new investment for the second half of this year, and then it becomes a growth driver going forward into the next several years. We see in total our net rate base increasing close to 1.5 billion across both utilities from now until 2025."
},
{
"speaker": "Richard Sunderland",
"text": "Understood. Understood. Thank you. And then you reference changes around the Vietnam requirements for sale and relaunching that transaction. Could you just parse that a little bit more in terms of what you're expecting there now? Do you see a quicker path to divestment under a second go, anything else would be helpful here?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Well, we hope so, and then it will be [indiscernible] second time around. I mean, basically, the – what happened here is that the government wanted more of an operator then a financial investor. They're very happy with us, and they want somebody equally good. So, we feel there is a number of people interested in the asset because they actually canceled the number of new coal plants that were going to be built. So, there's an appetite, especially from Asian operators for this asset. So, hopefully, it will be faster. It was somewhat of a surprise, but our intentions remain the same. So, to be out of coal by the end of 2025."
},
{
"speaker": "Richard Sunderland",
"text": "Got it. Thank you for the time today."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Steve Fleishman of Wolfe Research. Your line is now open. Please go ahead."
},
{
"speaker": "Steve Fleishman",
"text": "Yes, thank you. Andres, maybe could you give us just some overall color on how things are proceeding on panel supplies and particularly you flip up implementation issues. And is that kind of a key variable in the timing of these projects or is it more other issues?"
},
{
"speaker": "Andres Gluski",
"text": "Let's see. Well, we feel pretty – we feel good about the panel issue. As you know, again, we got all the panels we could use in 2022. So, in 2023, we have all the orders in. Our suppliers have been getting through. So, again, we feel good about that. In terms of what would determine that last, sort of 600 megawatts, it's really a combination of issues. It's not just solar panels. It runs the gamut from wind turbines, deliveries, et cetera, pyramids easing. Also, the interconnection timing, is the client ready to take that [energy] [ph]. That was one of the biggest issues we had in 2022. We were ready, but the client wasn't ready. So, it's just a bag of different issues. I'd say an important issue going forward is, as you know, we're heading the solar panel buyers consortium. We want to have solar panels starting to be delivered late 2024, 2025 made in the U.S.A., and what we're seeing now is really one of the regulations may be issued by treasury, what constitutes domestic content to get those additional credits. So, I'd say that's an item that we're watching very closely, but generally, we feel good about. And there are certainly people interested in locating that flat here to supply that contract."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. And then just – I know this was discussed on the last call, but just how are you making the decision between on U.S. projects, ITC versus PTC. I guess, -- so PTC, I think you had talked about still having a lot of value in the tax equity and the depreciation, but just – do you see that starting to shift at some point in the – as you execute on future projects?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, I do, Steve, now that we have the optionality for production tax credits on solar, I would see that option being exercised primarily in the sunniest places in the U.S. So, in the Southwest U.S. projects where the production-based incentive is going to yield a higher value than necessarily the CapEx based on the capital investment based incentive. So, we are modeling more production tax credit into our longer-term. For this year, it's not – I wouldn't say, it's impacted us really at all this year because for the most part, we're locked into a tax credit structure election and a tax equity partnership that we've already agreed to. But going forward, we'll start to see more production-based incentive come into the mix. And that's something, again, for Investor Day, as we talk about beyond 2025, kind of how do we look at the business, how do you look at the metrics of the business, how do you look at tax credits, distinct from earnings that don't include tax credits, things like that, that we'll be giving more guidance on to help people understand what that looks like going forward."
},
{
"speaker": "Steve Fleishman",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Gregg Orrill of UBS. Your line is now open. Please go ahead."
},
{
"speaker": "Gregg Orrill",
"text": "Hi, thanks for taking my question. I just wanted to, sort of confirm where the credit goals are, sort of with the guidance update and the segment – the new segments that you're thinking about? Sorry, if I'm getting ahead of my [indiscernible]."
},
{
"speaker": "Steve Coughlin",
"text": "No, no, no. No problem. Are you referring to the tax credit?"
},
{
"speaker": "Andres Gluski",
"text": "I think the credit rating, right?"
},
{
"speaker": "Steve Coughlin",
"text": "Credit rating, okay. We've been talking so much about tax credit. So, yes, the credit rating, certainly the BBB- is a constant constraint. And then we see likely improvement going forward, particularly as our business mix evolves to more long-term contracted renewables and more investment in the U.S. utilities. So, I would say, that's going to be a driver of improvement to the overall profile and view on the source of where our cash is coming from going forward. The segments, there's no – I can't say too much about that right now. As we've been operating under the current segments, we'll be moving to the new one soon and then talking about that on the call going forward, but the segments will make it very clear as to the sources of earnings and cash going forward and where the business is growing, frankly, much, much higher than 7% to 9% and where the business is shrinking, largely consistent with our decarbonization goals. So, it will peel apart where that 7% to 9% has come from [2025] [ph] as well as go beyond [2025] [ph]."
},
{
"speaker": "Andres Gluski",
"text": "Yes. So Gregg, in terms of the credit rating, we're already more than 50% of our earnings are coming from the U.S. and a higher and higher percentage is coming from renewables. So, we already have a – if we're growing 7% to 9%, that includes the dilution from getting out of coal. So, actually, our renewables are growing at a much higher rate, more like 10% to 12%. So, to put that in context, all of those things point to an improvement, as Steve was saying, in terms of the quality of the numbers beyond the metrics. So, again, we feel very confident in what we've said. This is a red line. We're not going to drop below investment grade, and we're going to continue to strengthen it."
},
{
"speaker": "Gregg Orrill",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Ryan Levine of Citi. Your line is now open. Please go ahead."
},
{
"speaker": "Ryan Levine",
"text": "Good morning. Hoping to follow-up on the change – in terms of the change in segmentation, maybe just to take a step back, what's prompting the re-review of how you're looking to disclose information? And is there anything that any re-review would signal strategically for the company?"
},
{
"speaker": "Andres Gluski",
"text": "No. I mean we really think this is a culmination of what we've been doing in terms of moving into renewables. And our business is long-term contracted. And what we're seeing is a lot of this would make our business we feel more transparent and more comparable to other people's businesses. So, that's all I can say at this point, but it's something that I think you guys will welcome because it gives greater transparency. And I think it makes more and more sense as, again, we transition more to renewables."
},
{
"speaker": "Ryan Levine",
"text": "Okay. And in your guidance, you disclosed a step down from the LNG contribution for this calendar year. What are you assuming for like TTF Henry Hub spreads or upside or contribution from that portion of your contract portfolio?"
},
{
"speaker": "Andres Gluski",
"text": "Well, I'll say the two elements. One is that we have less gas available to take advantage of that opportunity because we had a step down in our Henry Hub-based gas contracts. The second is, has to do with the spread between Henry Hub plus and TTF. So, those spreads have narrowed. It's been a very warm winter, especially in Europe. So, we'll see. So, that's an opportunity that exists there, but we're not – it would be smaller, smaller quantity. And we're not counting on it this year because right now, the spreads are not such that between all the transportation and the sharing of the upside with oil traders, et cetera, look particularly attractive, but the option is there, should the situation change."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So, it's – I mean, it's largely based on current outlook for the year on the commodities, but to the extent that spread were to increase, that would be an upside to the guidance we've given here."
},
{
"speaker": "Ryan Levine",
"text": "Great. And then last question for me. In terms of the asset sale process, to the extent some of these deals don't happen or get delayed, what tools do you have to alter your financing plan in light of looks like a choppy M&A market."
},
{
"speaker": "Andres Gluski",
"text": "Well, first, we have many assets that we can sell, and it's not only sell-out, sell-down. So, we have, I think, a lot of levers there. And we don't like to talk a lot about any specific asset until we have a deal done. It doesn't help us, but we always also sell-down, for example, some of our renewables because that increases our returns, sell-down a portion of it, we continue to operate them. So, if you have movements, say, in time that a specific asset sale gets delayed and you're not ready to do another one, that's where other kinds of financings come in, and we'll do the one that makes the most sense. But again, as I said before, maintaining our credit metrics and our investment grade, that's a red line in the [sand] [ph]."
},
{
"speaker": "Ryan Levine",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Our final question is a follow-up question from Angie Storozynski from Seaport. Your line is now open. Please go ahead."
},
{
"speaker": "Angie Storozynski",
"text": "Thank you. Just one thing. So, the 600 megawatts that might slip into 2024, that's the growth number, right? What would it be adjusted by ownership?"
},
{
"speaker": "Andres Gluski",
"text": "There’s two things. I mean, we normally sell-down after the commissioning."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. I mean, so we do have [indiscernible] so this is the U.S. number. So, we have our partnership with Alberta Investment Management. And so, I would say, for the most part, it's about 75% AES is that number. And the – up to $0.10 that I mentioned, Angie, is AES' share. So, that's not the [indiscernible]."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. That’s all I need. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. As there are no additional questions waiting at this time, I'd like to pass the conference back over to Susan Harcourt for closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today's call. Have a great day ahead. You may now disconnect."
}
] | The AES Corporation | 35,312 |
AES | 3 | 2,022 | 2022-11-04 10:00:00 | Operator: Ladies and gentlemen, welcome to the AES Corporation Third Quarter 2022 Financial Review Call. My name is Glenn, and I will be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Susan, to begin. Susan, please go ahead.
Susan Harcourt: Thank you, operator. Good morning, and welcome to our third quarter 2022 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our third quarter 2022 financial review call. This morning, we reported third quarter adjusted EPS of $0.63, bringing our year-to-date adjusted EPS to $1.18. With these results, we now expect our full year adjusted EPS to come in at or near the high end of our guidance range of $1.55 to $1.65. We're also reaffirming our 7% to 9% annualized growth target for adjusted EPS and parent cash flow through 2025. Steve Coughlin, our CFO, will discuss our financial results in more detail shortly. Our business model continues to demonstrate its resilience with strong contractual protections and natural hedges that have insulated us well from foreign currency movements, higher interest rates and volatile commodity prices. In addition, the vast majority of our business is with U.S. utilities or investment-grade off-takers. Turning to Slide 4. At the same time, we have built flexibility into our portfolio, which has allowed us to capture upside in the current environment. For example, in Panama, we've been able to redirect Henry Hub priced LNG to European markets to capitalize on high international gas prices. This upside is the direct result of actions we took in the past to create a diverse portfolio that would limit our downside exposure to fluctuations, both in commodity prices and hydrology. With above-average rainfall in Panama this year, we have been able to buy cheap hydro power and run our gas plant less, which has made it possible to redirect a portion of our contracted LNG creating meaningful upside in our results. Now to Slide 5. We spoke briefly about the U.S. Inflation Reduction Act, or IRA, on our previous call. But since then, it has become even more apparent how it is likely to greatly accelerate the demand for renewables and stand-alone storage in the U.S. We are very well positioned to capitalize on this demand and growth through our market leadership in renewables, particularly in the C&I segment due to our strong customer relationship, our ownership interest influence and our extensive and growing pipeline. Specifically, the IRA extends the production tax credit, or PTC, and the investment tax credit, or ITC, for 10 years and provides additional tax credits for energy communities such as low-income areas or places where coal mining or thermal generation previously took place. We anticipate that the benefits of the IRA will result in a meaningful step-up in demand across the U.S., but particularly from C&I customers looking to reach their decarbonization goals. The IRA also includes a 30% ITC for stand-alone energy storage. AES benefits not only from being one of the largest developers of energy storage projects, but also from our ownership stake influence, the market leader in energy storage integration. We see battery-based energy storage as an essential enabler of more renewables on the grid by reducing intermittency and providing renewables-based capacity. As you can see on Slide 6, to address this expected growth in demand, we have been working hard to grow our pipeline of renewables and energy storage projects. Today, our pipeline stands at 64 gigawatts or more than twice the size of our entire current portfolio. The majority of our pipeline, 51 gigawatts is in the U.S. and much of it is in the most attractive markets for renewables such as California and PJM. Our pipeline consists of projects that have a combination of land, interconnection access or advanced permitting. Approximately 1/3 of our pipeline is in the energy communities that I previously described and are eligible for additional tax credits. We believe our pipeline will become increasingly valuable as sites for projects become scarcer. Turning to Slide 7. At the same time, since our last earnings call in August, we have signed an additional 1.6 gigawatts of new renewable PPAs or 3.2 gigawatts year-to-date. Furthermore, we are in very advanced late-stage discussions on several large contracts that we expect will bring us within our full year range of 4.5 to 5.5 gigawatts. Today, our backlog of signed PPAs stands at 11.2 gigawatts, the majority of which is expected to come online by 2025. We remain largely on track with our construction program, which is now 5.2 gigawatts. There are some projects that have been moved from this year to next, primarily due to delays from customers. But as we've mentioned before, none of these projects are late due to a lack of solar panels. We also continue to make very good progress on our 2 very large green hydrogen projects in the U.S. and Chile, which include the integration of electrolyzers and renewables. Although we don't have any specific announcements to make today, we are confident that we will have more to share with you on this important initiative before the end of the year. Turning to Slide 8 for an update on growth initiatives at our U.S. utilities. This quarter, AES Ohio filed a new electric security plan or ESP 4, which outlines a comprehensive road map to position AES Ohio to resolve outstanding regulatory proceedings and make significant investments to modernize its network. The filing is a substantial achievement for AES Ohio as it will lay a strong regulatory foundation for growth by implementing a more traditional utility rate structure. We expect the public utilities kind of Ohio to approve ESP 4 in the next 12 months. As a reminder, AES Ohio has the lowest T&D rates in the state across all customer groups, and we see significant opportunity to invest to improve reliability and strengthen the balance sheet, while remaining cost competitive. Finally, AES Indiana is in the last phases of its integrated resource plan process and plans to file the 2022 IRP report with the state regulator by December 1. The proposal includes another milestone in AES' decarbonization plan with the conversion of the last remaining units of coal operated by AES Indiana to natural gas in 2025 and the addition of up to 1.3 gigawatts of renewables, including wind, solar and battery storage. With that, I now would like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will discuss our third quarter results 2022 parent capital allocation and 2022 guidance. Turning to our financial results for the quarter beginning on Slide 10. I'm pleased to share that our third quarter results are very strong, and we now expect to be at or near the high end of our full year 2022 adjusted EPS guidance range of $1.55 to $1.65. Third quarter adjusted EPS was $0.63 versus $0.50 last year, driven primarily by our LNG business, as Andres discussed. In addition, we also benefited from an increased ownership in AES Andes as well as higher margins in Brazil. These positive contributions were partially offset by onetime charges at our U.S. utilities in Argentina businesses. Relative to last year, we also had higher losses from our AES portfolio as financial results from Fluence were not reported in our Q3 numbers last year, higher parent interest stemming from higher debt balances as we increase investment in our subsidiaries and a higher adjusted tax rate due to a nonrecurring benefit in Q3 2021. I should also note that despite considerable macroeconomic volatility, we see very little impact on our financial performance. For example, the forecasted full year impact of foreign currency movements after tax is well under $0.01 of adjusted EPS due to our highly contracted and largely dollarized business, along with our very active hedging program. In addition, nearly 80% of our debt is either fixed rate or hedged against interest rate exposure and approximately 82% of our revenue is protected by inflation index for hedging. Turning to Slide 11. Adjusted pretax contribution, or PTC, was $569 million for the quarter, a $141 million increase year-over-year due to the drivers I just discussed. I'll cover the performance of our strategic business units or SBUs in more detail over the next 4 slides, beginning on Slide 12. In the U.S. and Utilities SBU, lower PTC was driven primarily recognition of onetime expenses at our U.S. utilities from previously deferred purchase fuel and energy costs. Including those related to an outage at our Eagle Valley plant from April 2021 to March 2022. We pursued and entered into a settlement for Eagle Valley and took a provision against a deferred fuel recovery asset at AES Ohio, which we will continue to pursue. These expenses impacted adjusted PTC by approximately $48 million in the third quarter. In addition, lower PTC was driven by lower availability in Puerto Rico. Our legacy Southland units provided significant energy margin contribution again in the third quarter this year, although this was not a material year-over-year driver. We are also very pleased that in the third quarter, the California State Regulatory Authorities formally launched the process required to further extend our Southland legacy units beyond 2023. Higher PTC at our South America SBU was mostly driven by our increased ownership of AES Andes and higher margins at both AES Andes and Brazil, but partially offset by a provision in Argentina. Higher PTC at our Mexico, Central America and the Caribbean, or MCAC SBU primarily reflects our commercial team's outstanding effort to redirect our LNG supply from Panama to the international market as discussed earlier. These LNG sales were enabled by the flexibility we built into our commercial structure and gas supply agreements along with favorable market conditions, which may be present going forward, although we expect to a more limited extent. Finally, in Eurasia, adjusted PTC was relatively flat year-over-year with an overall net benefit from higher power prices at our wind plant in Bulgaria. Now to Slide 16. As a result of our overall strong performance year-to-date, along with the significant contribution from LNG sales, we now expect to come in at or near the high end of our full year 2022 adjusted EPS guidance range of $1.55 to $1.65. Growth in the year to go will be primarily driven by contributions from new businesses, including roughly 500 megawatts of projects under construction coming online as well as further accretion from our increased ownership of AES Andes. We expect to recognize additional LNG sales in the fourth quarter, but the contribution will be much smaller than the benefit in Q3. We are also reaffirming our expected 7% to 9% annualized growth target through 2025, based primarily on our expected growth in renewables, energy storage and U.S. utilities. Turning to Slide 17. As Andres highlighted, the Inflation Reduction Act extended and expanded the tax incentives available for U.S. renewables and energy storage. Tax credits have been an important part of the economic value creation of our U.S. renewables portfolio, and the IRA provides clarity on long-term eligibility for these credits. As U.S. renewables become a larger share of our portfolio, I want to briefly touch on the way these tax incentives contribute to our earnings and cash flow. Our U.S. wind projects are typically eligible for production tax credits over the first 10 years of operations. Our solar and solar plus storage projects typically qualify for an investment tax credit generally recognized within the first 2 years, the project begins commercial operations. To ensure we take full advantage of the tax value of our U.S. renewables, we usually bring on partners that will invest in these projects to be allocated the majority of the associated tax attributes. These are called tax equity partnerships. It's important to recognize that as we monetize these tax credits, they create earnings and cash for AES. For full year 2022, we expect our projects to generate approximately $280 million to $310 million in new tax credits. After monetizing these credits through our tax equity partnerships, the earnings recognized by AES this year from new project commissioning’s will be approximately $200 million to $230 million, with the remaining earnings from tax credits to be largely recognized next year. Due to the late year seasonality of new project commissioning’s, approximately two-thirds of these earnings will occur in the fourth quarter. This year, we expect to commission more projects in the fourth quarter than in 2021 which will benefit our earnings in the year-to-go period, improving the year-over-year comparison of adjusted PTC in our U.S. and Utilities SBU by the end of the year. Now to our 2022 parent capital allocation plan on Slide 18. Sources reflect approximately $1.6 billion of total discretionary cash, including $900 million of parent free cash flow, $500 million of asset sales and $200 million of new parent debt. On the right-hand side, you can see our planned use of capital. We will return nearly $500 million to shareholders this year. This consists of our common share dividend, including the 5% increase announced last December and the coupon on the equity units. We plan to invest approximately $1.1 billion in our subsidiaries as we capitalize on attractive opportunities for growth. About half of these investments are in renewables, which represent the largest portion of our growth. Nearly a quarter of these investments are in our U.S. utilities to fund rate base growth with a continued focus on grid and fleet modernization. In summary, nearly 3/4 of our investments this year are going to grow AES' renewables businesses in our U.S. utilities, reflecting our commitment to continue executing on our portfolio transformation. In addition, approximately 70% of our planned future investments are targeted for our U.S. subsidiaries, which will contribute to our goal of more than 50% of our earnings coming from the U.S. in 2023. I look forward to AES continuing our strong performance this year and sharing updates with you on our fourth quarter call. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. In summary, we now expect our 2022 adjusted EPS to come in at or near the high end of our guidance range of $1.55 to $1.65, and we are reaffirming our 7% to 9% annualized growth target for adjusted EPS and parent free cash flow through 2025. Our strong financial results continue to demonstrate the resilience of our portfolio to macroeconomic volatility. We signed additional agreements that will redirect excess LNG from our business in Panama to international customers. We expect the Inflation Reduction Act to greatly accelerate the demand for renewables, stand-alone storage and green hydrogen. To address this growth in demand, we have increased our pipeline to 64 gigawatts, including 51 gigawatts in the U.S. and year-to-date, we have signed 3.2 gigawatts of renewables and energy storage under long-term contracts, and we are in late-stage discussions on several more that we expect will bring us within our full year range of 4.5 to 5.5 gigawatts. With that, I would like to open the call for questions.
Operator: [Operator Instructions] We have our first question comes from Insoo Kim from Goldman Sachs. Insoo, your line is open.
Insoo Kim: First question on the revised outlooks that you gave on U.S. pipeline and also just the backlog that you've updated. Given the IRA has passed, especially while we await the 4Q earnings for more guidance, do you -- at this point, do you have a pretty good sense of how upside to that backlog you see, whether it's through '25, '26 and whether that still gives you a good confidence that there is potential to achieve the upper end of that 7% to 9% EPS growth range?
Andres Gluski: Yes. Insoo, what I'd say is that we're seeing very strong demand, especially in the U.S. market, especially among C&I customers. So really, I don't think it's an issue of demand. It's really an issue of having permitted projects that can meet our clients' demand in the different markets. So regarding the -- our growth rates, we feel very confident about achieving our 7% to 9%. The IRA is obviously a positive to this number. But we expect some adjustments in the market. So it's not only a question of growth. It's really a question of the profitability of those projects. So what we expect over the next, I'd say, months or year is there to be somewhat more, let's say, scarcity of projects as demand increases. So I think that's where people who have gotten ahead of this and really have a mature pipeline are going to be in a substantial benefit. Obviously, the IRA also has a $3 a kilogram incentive for green hydrogen, and this is also going to be a plus for the growth of renewables and the growth of AES. So all these things I see is positive. But right now, we're saying 7% to 9%. But we're seeing -- as the market becomes more favorable, it's not just a matter of how much you can grow, it's really making sure that you grow profitably.
Insoo Kim: And we'll await more guidance there. Second question for me on LNG. It seems like a pretty sizable benefit at the MCAC segment. I think on an EPS basis, $0.25 or so of benefit year-over-year, which from our perspective, was much greater than expected. Could you just give more details on, if you can, on how much of that -- how much volume was driving that? And while acknowledging the hydro conditions will dominate whether you could see any level of benefit going forward next year and beyond. Assuming normal hydro next year and the current prices and global gas, could that still provide some level of tailwind as we think about '23?
Andres Gluski: Yes. I mean, as we laid out, we have structured our contracts such that, for example, if it's a dry year, we have all of the LNG that we need to be able to fulfill our thermal contracts. However, if you have a wet year, then you are able to buy cheaper hydro and redirect those shipments. And I think what's very important is not only having the LNG, but having the capacity to ship that mostly to Europe and really get into the port because as you know, there are really bottlenecks in the port. So I think this really talks about the flexibility that we built in, the strategic relationships we have with LNG suppliers that allow us to take advantage of their position in these markets to move those shipments. So going forward, I mean, basically, when there's a La Nina in Panama hydrology, there's more water available. So we've -- so -- there's also a factor that where -- what's the level of the reservoirs. So it's -- right now, I'd say that we expect the conditions to continue. We -- it's really a matter of the spread between Henry Hub plus the shipping and what international prices are. So as Steve mentioned, we expect -- we have some additional contracts coming in, in the fourth quarter. And regarding next year, it's really are the conditions there? Is there water in the reservoirs? Is the hydrology positive? Is there the spread between Henry Hub, again, plus shipping and international prices? So those are the conditions given. So this is mostly an upside, let's say, going forward. We're not counting on it. And regarding the tonnage, we would expect somewhat less next year than we have shipped this year in terms of the actual volume. We can get back to you on the actual volume that was shipped.
Operator: We have our next question. This comes from Richard Sunderland from JPMorgan. Richard, your line is open.
Richard Sunderland: I mean one of these broader play in inflation, thinking about the outlook through 2025 and the broader inflation backdrop, how do you see the cost savings opportunity through 2025 currently standing versus your Analyst Day plan?
Andres Gluski: If I understood the question, right, you're basically saying that in the inflationary environment that we're in, how do we see cost savings developing? What I would say is that we -- given our international exposure, we're very accustomed to dealing with inflation and having to control costs in an inflationary environment. So what we've seen so far, as we've mentioned on prior calls is that the cost of building renewables has gone up over the past year. There's no question there were panel prices have gone up in the U.S., EPC costs have gone up. However, we're seeing in this strong market, we're -- this is basically able to pass through, we're able to maintain our margins on new projects. Going forward, I mean, we've had cost saving programs in place for the past 12 years. On a run rate basis, we've got about $500 million of cost. So again, we have the infrastructure in place. It's part of our culture, continual improvement. So we're not particularly concerned on that side. On the pricing side, about 80% of our contracts and businesses have some form of inflation indexation. So we're very well protected on that side as well. So we have the experience. We have the methodology. It's part of our mindset. So we don't see that as a particular concern.
Steve Coughlin: This is Steve. I would just add also, if you look at the escalation of fuel prices on the thermal side, they've gone tripled in some cases. So renewables, although the costs have increased are relatively more competitive than they were before this current inflationary cycle. And then in addition, we have the benefit with renewables, we're largely firming up prices right around the time that we're also signing up our PPA. So you have a good sense of what your levelized cost is over the life of the project and very little variable costs, of course. So we are able to build in this into the market. And then, of course, the IRA bill in the U.S., certainly with the expansion and extension and re-upping of credits, does serve to offset some of these additional inflationary increases in the renewables capital cost. So that's as an opposing effect, helping bring prices somewhat back down off of what they otherwise would have been.
Richard Sunderland: No, that certainly makes sense. And I appreciate the color there. And maybe Steve, picking up that last point around the IRA. Curious on transferability could impact your tax credit outlook? Is this an opportunity to invest more on a net to AES basis or any other impacts you foresee?
Steve Coughlin: Yes. Certainly, transferability. I mean what we like about the IRA is it brings a lot of optionality, a lot of flexibility. It brings the production tax credit as an option for solar. And certainly, that could be a opportunity for high installation is in the southwest of the U.S., for example, may be the best option. So with transferability, it certainly adds more liquidity to, I would say, a more liquid market to monetizing the tax attributes. There are still some significant benefits to having tax equity partnerships, though, where you have the tax depreciation benefit in addition to the credit that you're monetizing as well as just in the way these projects get structured, there's a step-up in the value of the assets when they're contributed to a partnership and there's a benefit to the value of the tax attributes when that occurs as well. So it does add some optionality, flexibility. And so for us, it's good to have in our toolkit. And then down the road, we'll look to see as AES moves forward in time, we may be able to utilize some of these tax credits for our own account, but I wouldn't expect that until several years down the road.
Operator: Our next question comes from Angie Storozynski from Seaport. Angie, your line is open.
Angie Storozynski: So first, just one clarification. So Stephen, you talked about the ITC contributions from the new build this year and the carryforward for 2023. Is there some change here versus how you have been accounting for these? I mean, I'm just trying to make sure that it's not somehow related to the IRA and some different recognition of the tax attributes.
Steve Coughlin: No. No, Angie. No change. But what we wanted to do was, a, as the IRA has been put in place and now we see the tax credits having a much longer life cycle extension well into the next decade. We wanted people to understand this is part of the economics of renewables of the whole in the U.S. We wanted people to understand what it means for AES and that this is a long runway and is an important component of how these assets get monetized and the return gets earned. The -- certainly, they will -- this will escalate over time. So we should expect that as we grow the business as anyone would grow the business, they'll have more share of credits. The other thing we wanted to point out is just if we look at the U.S. and utilities business unit, the fourth quarter, the skew towards the fourth quarter is, in large part, driven by the fact that we are commissioning more projects typically in the fourth quarter, more renewables projects and the tax credit recognition for the investment tax credit is tied to the commissioning. And so we will see a lift in the U.S. fourth quarter results as we did last year, as we will again this year in the fourth quarter as a result. So it was really those 2 reasons I wanted to point out the IRA and then the seasonality of the tax credit recognition in the U.S. and utilities SBU.
Angie Storozynski: And secondly and probably most importantly, so I remember a couple of quarters back, you guys had the seemingly lost growth targets. 4.5 to 5.5 gigs of PPAs per year. It seems like you're tracking well against that. I'm just wondering if there's any upside to that number. And even more importantly, it seems like you guys have more than 5 gigs of capacity under construction. And so I'm just hoping to get some reassurance how you're coping with that level of activity? And if you -- if there is a possibility to increase it and how, again, like logistically, can you handle that many projects?
Andres Gluski: Yes. Thank you, Angie. That's a great question. Yes, we have a significant step-up in our construction between this year and next. And you correctly point out, we have more than 5 gigawatts currently under construction. I think we've handled it very well. We have doubled the amount of people that we have working on construction in renewables in the U.S. We have been working with strategic EPC contractors, meaning that we can give them not sort of just project by project, but really a line of sight, how much work they're going to get over the next 2 years, so they're able to staff up. So we've done very well there. I think we've done a very good job of managing the solar panel supply, which has been very turbulent. We've had no delays this year due to solar panels. We have already most of the solar panels that we need for 2023. So we're working very closely with that also the inverter. So I feel very good about that. We have done a lot of outside the renewables area, a lot of big projects. So I think we have experience there. So I feel very comfortable. We will have a roughly doubling of what we commissioned this year to next year. And again, we've been worried about the supply chain. We started more than 2 years ago. So we, I think, are in as good shape as anybody in handling it. And I think the results speak for themselves. We haven't had to delay any projects because of a lack of supplies or a lack of construction workers or anything of the sort. Regarding sort of the upside, as I said, the IRA does provide upside. It has good incentives for renewables. They will be, I think, increasing demand certainly from corporations. And I think what's very important is we're not just looking at increasing our growth rate but making sure that we're growing profitably and growing well.
Angie Storozynski: And my last question about the financing of that incremental growth, especially in this higher interest rate environment. So I mean, are you revisiting the past idea of more of like a systematic recycling of capital from your existing assets? Is there again, especially ahead of the announcement for green hydrogen projects. I mean I'm assuming that, that comes with a pretty aggressive capital outlays. So how do you finance it?
Andres Gluski: What I'd say, we're going to continue to churn capital. As our projects mature, it's a way of increasing our return on invested capital. As you know, once we finish renewable projects, we sell down to people who want a fully contracted U.S. dollar renewable. So our plan through 2025 that we've laid out is fully financed. If we were going to know I would say, going forward, if there are additional very profitable opportunities, we'll have to look at that, but we have a lot of options. We have a lot of options. We're investment grade. And as we have done in the past, we can turn more quickly some of our assets in terms of our sell-downs.
Operator: Our next question comes from Nick Campanella from Credit Suisse. Nick, your line is now open.
Unidentified Analyst: This [Fae] is for Nick today. I just want to quickly touch on Ohio rate case. We saw some peers going through this process, having some challenges there. Could you just update us on how you're managing your regulatory strategy in Ohio and the rate outcome there? If there's any changes from the last update. But again, recognizing Ohio is pretty -- has a pretty minimal impact to the consolidated EPS. Just any color would be appreciated.
Steve Coughlin: Yes. No, happy to. This is Steve. We are being very strategic. And I'm sure you saw that we did file for an electric security plan for, so our ESP 4 very recently. So we are still awaiting the decision from the utility commission on the rate case that's outstanding. We are expecting that decision still before the end of the year. . But look, the issue at hand is whether rates need to be frozen while we currently have this rate stability charge that's been in place for about 20 years. We think there is broad support for the new rates that are -- have been asked for in the plan and the staff came out and supported those. So what we decided to do was go ahead and chart a path to moving on to a new ESP regardless of what this outcome is in this case. And therefore, that clock has already started ticking. As Andres said, we'd expect that to be resolved by middle to second half of next year on the ESP 4. And our focus is really on growing the utility. As Andres said, this is a utility where we have the lowest rates by far across all customer classes. We want to get to a place. There's a significant opportunity for upgrades and investments, and we want to have a healthy structure from which to continue investing in a healthy balance sheet for the utility. So the ESP 4 was filed to give that path there. We still believe in the case that we filed and that the stability charge can still be in place. But in the case that the commission decides they want to hold rates until that stability charge is retired, then we'll have this ESP 4 path -- it's already out there. It's already being in the process, and we'll have that then by the middle of next year as opposed to waiting for this to be decided and then going ahead and creating what's the next security plan. So that was our goal and our thinking here. And as I said, we still expect a decision this year on the case.
Operator: Our next question comes from Julien Dumoulin-Smith. Julien, your line is open.
Julien Dumoulin-Smith: Congratulations on the continued success here. If I can, just to pivot back to where we started with some of this conversation. I want to try to get back at some of the tax credit dynamics and how that plays itself out over the next few years. So clearly, you all have outperformed on continued backlog generation and bring into construction. Can we talk about some of the cadence of in-service here and how that translates back to credit? I appreciate the detail on '22 about what that means on an income basis. But can you talk a little bit relative to the earlier guidance, what was embedded as far as earnings expectations? And then try to transpose that against where we are against the current cadence of when is that construction progress going to reach in-service? When is that backlog effectively fully in service, right, i.e., over the next 2 or 3 years? I just try to reconcile prior versus today on the updated backlog as well as considering the pivot to a solar PTC from an ITC, which also may meet be something of an offset to the positives described here?
Andres Gluski: Okay. Julien, good to talk to you, there are a lot of questions.
Julien Dumoulin-Smith: Sorry, I know a lot take it as you will.
Andres Gluski: So let me -- let me try to frame it we'll answer between Steve and myself. So I guess the first question is, I think regarding the new IRA, it does give us flexibility to choose in terms of ITC, PTC on some projects. This will start in 2023, which is somewhat of a -- I'd say it's a slight upside there. Regarding sort of the cadence, these do tend to be somewhat backloaded in the end of the year. So that Steve had mentioned, this is just because of the financing structure. So it tends to be Q3, Q4. And I think that will continue to be so going forward. In terms of our backlog, yes, I mean we have -- as we mentioned, it's 11.2 gigawatts, and the vast majority of that is going to be commissioned before end of 2025. So there are a few projects that go beyond that. So as projects get commissioned, new ones come into the backlog. I think what's important, again, if you think of this in terms of our installed capacity, it's -- the backlog is one-thirds of our current installed capacity. So we feel good about our growth rates. We feel good about the -- who we're contracting with. So our growth in the U.S., of course, is investment-grade off-takers, utilities and -- but mostly corporate clients and internationally as well. What we're signing overseas is mainly in Chile with people like Codelco, big copper exporter, others that -- it's -- we feel it's just as good a risk as if they were in the U.S. So I think I'll pass it off to Steve to get a little bit more in the weeds of the tax itself, some of your other questions.
Julien Dumoulin-Smith: And if I can, just to clarify, if you don't mind, just to jump in, the cadence by year rather not by intra-quarter kind of thing, but by year breaking down that 11 gig, if we can. Just -- again, I'm just trying to reconcile the older expectations versus newer and try to understand how many gigs per year you can kind of credibly expect?
Andres Gluski: What I would say is, look, we're going from about, I think, less than 2 gig this year, somewhere around 4 gigs next year. And then at some point, if you are always signing 5 gigs of new renewable contracts, you will be commissioning or bringing online 5 gig. The 2 sort of come together. So the catch-up is -- the biggest catch-up will be next year. And then you have the 2 lines going in parallel. Now again, if our signings increase, well, then there will be a lag of about a -- let's say, between 18 months and 24 months between the greater number for signing PPAs and the commissionings are bringing online.
Steve Coughlin: Yes. And Julien, so I would say, also taking the number -- Andres said 4 gigawatts next year, that will continue to grow. This is our main growth business for us. It's 5 gigawatts, 6 gigawatts. We'll give more color on that next year as we update our guidance. And then I would look at that and say that roughly, on average, say, two-thirds of that is in the U.S. And then a larger share of that is solar and solar plus storage of that that's in the U.S. So say, roughly 75% today is solar, solar plus storage of the U.S. backlog. And so that's ITC qualified. We can't elect PTC now, as I said, we're looking at that where it makes sense for the returns, and that's typically where you have higher capacity factors, where the installation is high as, say, the Southwest of the U.S. The credits will continue to increase significantly. I think next year is on is going to be a big jump year-over-year because the level of commissioning is going way up next year. And it is heavily weighted towards the fourth quarter of the year. But as we continue to grow this business, the timing will become less of an issue as we get to more of a consistent state of additions year-over-year. But the credits are an important part of how it's monetized and wanted to show that given the IRA and also given how the U.S. Utilities SBU seasonality is becoming more shaped by the renewables, the clean energy business in the U.S. but it's important for everyone to understand what that looks like for modeling purposes.
Operator: We have our next question comes from Ryan Levine from Citi. Ryan, your line is open.
Ryan Levine: I wanted to follow up on some of the ITC clarifications. So as you're looking for the U.S. portion, what adders are you assuming that you'll be able to realize as you move forward with these projects? And specifically, are you seeing any low mineral income adders anticipated for your solar projects and both in your current portfolio? And then on a go-forward basis, are you looking to evolve what types of projects you're pursuing in light of the details of the IRA?
Steve Coughlin: Yes. So you're talking about like the adders for the energy communities and domestic content, things like that. Is that right?
Ryan Levine: Correct.
Steve Coughlin: So yes, I think roughly one-third of our U.S. pipeline today is in these energy communities that qualify for the 10% adder. I think as we move forward, then we look at domestic content, we are a leader. We've launched our U.S. solar buyer consortium. We expect first supplies from that in 2024. So I would expect us to be having a share. I don't have a specific percentage right now, but a material share of our projects meeting the domestic content production in 2024. And then we are fully ready to be qualified for the wage and apprenticeship requirements and training already. So that's a nonissue. We're already have that 30% level with our project. And then I would expect at least one-third to be in that 40% level and some perhaps even higher up to 50% with the domestic content as that starts to become part of our panel supply in '24 and beyond.
Ryan Levine: And then in terms of the transferability comments, as you're looking to make decisions around whether or not to use tax equity partners or utilize the transferability feature. Has that fully been determined at this point? Or is there still some negotiation or analysis that needs to do to determine how you'll structure for future deals?
Steve Coughlin: I mean, I would say, look, I think the -- for us, as a leader in the market, we have a lot of long-term deep relationships on the tax equity side. So for us, and we have a lot of capabilities of very -- the top talent in the industry on structuring these projects on the commercial side, on the tax side so that we're optimizing returns. So for us, as I said before, transferability is an option, I'm not convinced, in fact, that it actually optimizes returns because there is the tax depreciation component, which is also an important component of value of the accelerated depreciation. So -- and they're structuring to step up the value of these projects as once they're built, the value of them is typically higher than what the capital cost was. So there's an important -- it's important that we pay attention to returns. And for us, transferability, although it brings more liquidity to the market. AES as a leader already has I would say, the liquidity we need to monetize the tax attributes. So we'll look at it, but there's nothing -- I wouldn't say for us, it's a significant game changer, given our scale existing capabilities.
Operator: We have our last question comes from Gregg Orrill from UBS. Gregg, your line is open.
Gregg Orrill: Congratulations. Regarding the LNG success year-to-date and your thoughts on next year, just in terms of the repeatability there. What gives you the confidence there? If there's anything you could share about what you might have sold forward or thoughts on what sort of conditions need to repeat for you to deliver that again?
Andres Gluski: Yes. Gregg, I would say, look, -- what we said is that there are -- there is a continuation of this into the fourth quarter, a bit smaller. There's a possibility for next year. And that will depend on the spread between, again, Henry Hub plus prices that we get on our contracts and prices in Europe. So that's really the importance. I think in terms of the hydrology, we need continued good hydrology in Panama, and reservoirs are quite high. So we're going in, in a favorable condition. So it really is what will be the spreads that justify this making that shipment. And I would say also, we would expect less volume in any case next year than this year. So it would be an upside. We're not counting on a very large amount of LNG. So conditions, it looks like it's a possibility, but we're not counting on it. And those are the drivers. And so I think you can see how those drivers are moving and see there's a possibility for this.
Steve Coughlin: Yes. And I would say just to add, for the fourth quarter of this year, we've already -- for whatever we would do with LNG has done for this year. So we've already -- we have a much smaller upside in the fourth quarter already built into our commentary on meeting the -- at or near the top end of our guidance range. So that any additional volumes would be -- we'd be talking about next year and whether the market conditions, as Andres said, are conducive to that, we think it's very possible, and it would be more upside. But for this year, we've already contracted what we could contract.
Gregg Orrill: Does where you end up this year? Obviously, you've said at or near the top of earnings guidance. Does that have an impact at all on how you think about giving '23 guidance? Does it serve as a base or some kind of reference point? Or are you still sort of pointing back to a different base?
Andres Gluski: We'd be pointing back to the different base. I mean we've said 7 to 9 growth and through 2025, and that's what we're committed to achieving. So it's not changing our base year for our growth rate.
Steve Coughlin: Yes. And that was my -- yes. It's a very good year. I think there's more upside, as Andres said. But I wouldn't say it's such a new baseline because this isn't necessarily a recurring at this level thing.
Operator: We have no more further questions on the line. I will now hand back to Susan for closing remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. We will look forward to seeing many of you at the EEI Financial Conference later this month. Thank you, and have a nice day.
Operator: Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, welcome to the AES Corporation Third Quarter 2022 Financial Review Call. My name is Glenn, and I will be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Susan, to begin. Susan, please go ahead."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning, and welcome to our third quarter 2022 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our third quarter 2022 financial review call. This morning, we reported third quarter adjusted EPS of $0.63, bringing our year-to-date adjusted EPS to $1.18. With these results, we now expect our full year adjusted EPS to come in at or near the high end of our guidance range of $1.55 to $1.65. We're also reaffirming our 7% to 9% annualized growth target for adjusted EPS and parent cash flow through 2025. Steve Coughlin, our CFO, will discuss our financial results in more detail shortly. Our business model continues to demonstrate its resilience with strong contractual protections and natural hedges that have insulated us well from foreign currency movements, higher interest rates and volatile commodity prices. In addition, the vast majority of our business is with U.S. utilities or investment-grade off-takers. Turning to Slide 4. At the same time, we have built flexibility into our portfolio, which has allowed us to capture upside in the current environment. For example, in Panama, we've been able to redirect Henry Hub priced LNG to European markets to capitalize on high international gas prices. This upside is the direct result of actions we took in the past to create a diverse portfolio that would limit our downside exposure to fluctuations, both in commodity prices and hydrology. With above-average rainfall in Panama this year, we have been able to buy cheap hydro power and run our gas plant less, which has made it possible to redirect a portion of our contracted LNG creating meaningful upside in our results. Now to Slide 5. We spoke briefly about the U.S. Inflation Reduction Act, or IRA, on our previous call. But since then, it has become even more apparent how it is likely to greatly accelerate the demand for renewables and stand-alone storage in the U.S. We are very well positioned to capitalize on this demand and growth through our market leadership in renewables, particularly in the C&I segment due to our strong customer relationship, our ownership interest influence and our extensive and growing pipeline. Specifically, the IRA extends the production tax credit, or PTC, and the investment tax credit, or ITC, for 10 years and provides additional tax credits for energy communities such as low-income areas or places where coal mining or thermal generation previously took place. We anticipate that the benefits of the IRA will result in a meaningful step-up in demand across the U.S., but particularly from C&I customers looking to reach their decarbonization goals. The IRA also includes a 30% ITC for stand-alone energy storage. AES benefits not only from being one of the largest developers of energy storage projects, but also from our ownership stake influence, the market leader in energy storage integration. We see battery-based energy storage as an essential enabler of more renewables on the grid by reducing intermittency and providing renewables-based capacity. As you can see on Slide 6, to address this expected growth in demand, we have been working hard to grow our pipeline of renewables and energy storage projects. Today, our pipeline stands at 64 gigawatts or more than twice the size of our entire current portfolio. The majority of our pipeline, 51 gigawatts is in the U.S. and much of it is in the most attractive markets for renewables such as California and PJM. Our pipeline consists of projects that have a combination of land, interconnection access or advanced permitting. Approximately 1/3 of our pipeline is in the energy communities that I previously described and are eligible for additional tax credits. We believe our pipeline will become increasingly valuable as sites for projects become scarcer. Turning to Slide 7. At the same time, since our last earnings call in August, we have signed an additional 1.6 gigawatts of new renewable PPAs or 3.2 gigawatts year-to-date. Furthermore, we are in very advanced late-stage discussions on several large contracts that we expect will bring us within our full year range of 4.5 to 5.5 gigawatts. Today, our backlog of signed PPAs stands at 11.2 gigawatts, the majority of which is expected to come online by 2025. We remain largely on track with our construction program, which is now 5.2 gigawatts. There are some projects that have been moved from this year to next, primarily due to delays from customers. But as we've mentioned before, none of these projects are late due to a lack of solar panels. We also continue to make very good progress on our 2 very large green hydrogen projects in the U.S. and Chile, which include the integration of electrolyzers and renewables. Although we don't have any specific announcements to make today, we are confident that we will have more to share with you on this important initiative before the end of the year. Turning to Slide 8 for an update on growth initiatives at our U.S. utilities. This quarter, AES Ohio filed a new electric security plan or ESP 4, which outlines a comprehensive road map to position AES Ohio to resolve outstanding regulatory proceedings and make significant investments to modernize its network. The filing is a substantial achievement for AES Ohio as it will lay a strong regulatory foundation for growth by implementing a more traditional utility rate structure. We expect the public utilities kind of Ohio to approve ESP 4 in the next 12 months. As a reminder, AES Ohio has the lowest T&D rates in the state across all customer groups, and we see significant opportunity to invest to improve reliability and strengthen the balance sheet, while remaining cost competitive. Finally, AES Indiana is in the last phases of its integrated resource plan process and plans to file the 2022 IRP report with the state regulator by December 1. The proposal includes another milestone in AES' decarbonization plan with the conversion of the last remaining units of coal operated by AES Indiana to natural gas in 2025 and the addition of up to 1.3 gigawatts of renewables, including wind, solar and battery storage. With that, I now would like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our third quarter results 2022 parent capital allocation and 2022 guidance. Turning to our financial results for the quarter beginning on Slide 10. I'm pleased to share that our third quarter results are very strong, and we now expect to be at or near the high end of our full year 2022 adjusted EPS guidance range of $1.55 to $1.65. Third quarter adjusted EPS was $0.63 versus $0.50 last year, driven primarily by our LNG business, as Andres discussed. In addition, we also benefited from an increased ownership in AES Andes as well as higher margins in Brazil. These positive contributions were partially offset by onetime charges at our U.S. utilities in Argentina businesses. Relative to last year, we also had higher losses from our AES portfolio as financial results from Fluence were not reported in our Q3 numbers last year, higher parent interest stemming from higher debt balances as we increase investment in our subsidiaries and a higher adjusted tax rate due to a nonrecurring benefit in Q3 2021. I should also note that despite considerable macroeconomic volatility, we see very little impact on our financial performance. For example, the forecasted full year impact of foreign currency movements after tax is well under $0.01 of adjusted EPS due to our highly contracted and largely dollarized business, along with our very active hedging program. In addition, nearly 80% of our debt is either fixed rate or hedged against interest rate exposure and approximately 82% of our revenue is protected by inflation index for hedging. Turning to Slide 11. Adjusted pretax contribution, or PTC, was $569 million for the quarter, a $141 million increase year-over-year due to the drivers I just discussed. I'll cover the performance of our strategic business units or SBUs in more detail over the next 4 slides, beginning on Slide 12. In the U.S. and Utilities SBU, lower PTC was driven primarily recognition of onetime expenses at our U.S. utilities from previously deferred purchase fuel and energy costs. Including those related to an outage at our Eagle Valley plant from April 2021 to March 2022. We pursued and entered into a settlement for Eagle Valley and took a provision against a deferred fuel recovery asset at AES Ohio, which we will continue to pursue. These expenses impacted adjusted PTC by approximately $48 million in the third quarter. In addition, lower PTC was driven by lower availability in Puerto Rico. Our legacy Southland units provided significant energy margin contribution again in the third quarter this year, although this was not a material year-over-year driver. We are also very pleased that in the third quarter, the California State Regulatory Authorities formally launched the process required to further extend our Southland legacy units beyond 2023. Higher PTC at our South America SBU was mostly driven by our increased ownership of AES Andes and higher margins at both AES Andes and Brazil, but partially offset by a provision in Argentina. Higher PTC at our Mexico, Central America and the Caribbean, or MCAC SBU primarily reflects our commercial team's outstanding effort to redirect our LNG supply from Panama to the international market as discussed earlier. These LNG sales were enabled by the flexibility we built into our commercial structure and gas supply agreements along with favorable market conditions, which may be present going forward, although we expect to a more limited extent. Finally, in Eurasia, adjusted PTC was relatively flat year-over-year with an overall net benefit from higher power prices at our wind plant in Bulgaria. Now to Slide 16. As a result of our overall strong performance year-to-date, along with the significant contribution from LNG sales, we now expect to come in at or near the high end of our full year 2022 adjusted EPS guidance range of $1.55 to $1.65. Growth in the year to go will be primarily driven by contributions from new businesses, including roughly 500 megawatts of projects under construction coming online as well as further accretion from our increased ownership of AES Andes. We expect to recognize additional LNG sales in the fourth quarter, but the contribution will be much smaller than the benefit in Q3. We are also reaffirming our expected 7% to 9% annualized growth target through 2025, based primarily on our expected growth in renewables, energy storage and U.S. utilities. Turning to Slide 17. As Andres highlighted, the Inflation Reduction Act extended and expanded the tax incentives available for U.S. renewables and energy storage. Tax credits have been an important part of the economic value creation of our U.S. renewables portfolio, and the IRA provides clarity on long-term eligibility for these credits. As U.S. renewables become a larger share of our portfolio, I want to briefly touch on the way these tax incentives contribute to our earnings and cash flow. Our U.S. wind projects are typically eligible for production tax credits over the first 10 years of operations. Our solar and solar plus storage projects typically qualify for an investment tax credit generally recognized within the first 2 years, the project begins commercial operations. To ensure we take full advantage of the tax value of our U.S. renewables, we usually bring on partners that will invest in these projects to be allocated the majority of the associated tax attributes. These are called tax equity partnerships. It's important to recognize that as we monetize these tax credits, they create earnings and cash for AES. For full year 2022, we expect our projects to generate approximately $280 million to $310 million in new tax credits. After monetizing these credits through our tax equity partnerships, the earnings recognized by AES this year from new project commissioning’s will be approximately $200 million to $230 million, with the remaining earnings from tax credits to be largely recognized next year. Due to the late year seasonality of new project commissioning’s, approximately two-thirds of these earnings will occur in the fourth quarter. This year, we expect to commission more projects in the fourth quarter than in 2021 which will benefit our earnings in the year-to-go period, improving the year-over-year comparison of adjusted PTC in our U.S. and Utilities SBU by the end of the year. Now to our 2022 parent capital allocation plan on Slide 18. Sources reflect approximately $1.6 billion of total discretionary cash, including $900 million of parent free cash flow, $500 million of asset sales and $200 million of new parent debt. On the right-hand side, you can see our planned use of capital. We will return nearly $500 million to shareholders this year. This consists of our common share dividend, including the 5% increase announced last December and the coupon on the equity units. We plan to invest approximately $1.1 billion in our subsidiaries as we capitalize on attractive opportunities for growth. About half of these investments are in renewables, which represent the largest portion of our growth. Nearly a quarter of these investments are in our U.S. utilities to fund rate base growth with a continued focus on grid and fleet modernization. In summary, nearly 3/4 of our investments this year are going to grow AES' renewables businesses in our U.S. utilities, reflecting our commitment to continue executing on our portfolio transformation. In addition, approximately 70% of our planned future investments are targeted for our U.S. subsidiaries, which will contribute to our goal of more than 50% of our earnings coming from the U.S. in 2023. I look forward to AES continuing our strong performance this year and sharing updates with you on our fourth quarter call. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. In summary, we now expect our 2022 adjusted EPS to come in at or near the high end of our guidance range of $1.55 to $1.65, and we are reaffirming our 7% to 9% annualized growth target for adjusted EPS and parent free cash flow through 2025. Our strong financial results continue to demonstrate the resilience of our portfolio to macroeconomic volatility. We signed additional agreements that will redirect excess LNG from our business in Panama to international customers. We expect the Inflation Reduction Act to greatly accelerate the demand for renewables, stand-alone storage and green hydrogen. To address this growth in demand, we have increased our pipeline to 64 gigawatts, including 51 gigawatts in the U.S. and year-to-date, we have signed 3.2 gigawatts of renewables and energy storage under long-term contracts, and we are in late-stage discussions on several more that we expect will bring us within our full year range of 4.5 to 5.5 gigawatts. With that, I would like to open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We have our first question comes from Insoo Kim from Goldman Sachs. Insoo, your line is open."
},
{
"speaker": "Insoo Kim",
"text": "First question on the revised outlooks that you gave on U.S. pipeline and also just the backlog that you've updated. Given the IRA has passed, especially while we await the 4Q earnings for more guidance, do you -- at this point, do you have a pretty good sense of how upside to that backlog you see, whether it's through '25, '26 and whether that still gives you a good confidence that there is potential to achieve the upper end of that 7% to 9% EPS growth range?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Insoo, what I'd say is that we're seeing very strong demand, especially in the U.S. market, especially among C&I customers. So really, I don't think it's an issue of demand. It's really an issue of having permitted projects that can meet our clients' demand in the different markets. So regarding the -- our growth rates, we feel very confident about achieving our 7% to 9%. The IRA is obviously a positive to this number. But we expect some adjustments in the market. So it's not only a question of growth. It's really a question of the profitability of those projects. So what we expect over the next, I'd say, months or year is there to be somewhat more, let's say, scarcity of projects as demand increases. So I think that's where people who have gotten ahead of this and really have a mature pipeline are going to be in a substantial benefit. Obviously, the IRA also has a $3 a kilogram incentive for green hydrogen, and this is also going to be a plus for the growth of renewables and the growth of AES. So all these things I see is positive. But right now, we're saying 7% to 9%. But we're seeing -- as the market becomes more favorable, it's not just a matter of how much you can grow, it's really making sure that you grow profitably."
},
{
"speaker": "Insoo Kim",
"text": "And we'll await more guidance there. Second question for me on LNG. It seems like a pretty sizable benefit at the MCAC segment. I think on an EPS basis, $0.25 or so of benefit year-over-year, which from our perspective, was much greater than expected. Could you just give more details on, if you can, on how much of that -- how much volume was driving that? And while acknowledging the hydro conditions will dominate whether you could see any level of benefit going forward next year and beyond. Assuming normal hydro next year and the current prices and global gas, could that still provide some level of tailwind as we think about '23?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. I mean, as we laid out, we have structured our contracts such that, for example, if it's a dry year, we have all of the LNG that we need to be able to fulfill our thermal contracts. However, if you have a wet year, then you are able to buy cheaper hydro and redirect those shipments. And I think what's very important is not only having the LNG, but having the capacity to ship that mostly to Europe and really get into the port because as you know, there are really bottlenecks in the port. So I think this really talks about the flexibility that we built in, the strategic relationships we have with LNG suppliers that allow us to take advantage of their position in these markets to move those shipments. So going forward, I mean, basically, when there's a La Nina in Panama hydrology, there's more water available. So we've -- so -- there's also a factor that where -- what's the level of the reservoirs. So it's -- right now, I'd say that we expect the conditions to continue. We -- it's really a matter of the spread between Henry Hub plus the shipping and what international prices are. So as Steve mentioned, we expect -- we have some additional contracts coming in, in the fourth quarter. And regarding next year, it's really are the conditions there? Is there water in the reservoirs? Is the hydrology positive? Is there the spread between Henry Hub, again, plus shipping and international prices? So those are the conditions given. So this is mostly an upside, let's say, going forward. We're not counting on it. And regarding the tonnage, we would expect somewhat less next year than we have shipped this year in terms of the actual volume. We can get back to you on the actual volume that was shipped."
},
{
"speaker": "Operator",
"text": "We have our next question. This comes from Richard Sunderland from JPMorgan. Richard, your line is open."
},
{
"speaker": "Richard Sunderland",
"text": "I mean one of these broader play in inflation, thinking about the outlook through 2025 and the broader inflation backdrop, how do you see the cost savings opportunity through 2025 currently standing versus your Analyst Day plan?"
},
{
"speaker": "Andres Gluski",
"text": "If I understood the question, right, you're basically saying that in the inflationary environment that we're in, how do we see cost savings developing? What I would say is that we -- given our international exposure, we're very accustomed to dealing with inflation and having to control costs in an inflationary environment. So what we've seen so far, as we've mentioned on prior calls is that the cost of building renewables has gone up over the past year. There's no question there were panel prices have gone up in the U.S., EPC costs have gone up. However, we're seeing in this strong market, we're -- this is basically able to pass through, we're able to maintain our margins on new projects. Going forward, I mean, we've had cost saving programs in place for the past 12 years. On a run rate basis, we've got about $500 million of cost. So again, we have the infrastructure in place. It's part of our culture, continual improvement. So we're not particularly concerned on that side. On the pricing side, about 80% of our contracts and businesses have some form of inflation indexation. So we're very well protected on that side as well. So we have the experience. We have the methodology. It's part of our mindset. So we don't see that as a particular concern."
},
{
"speaker": "Steve Coughlin",
"text": "This is Steve. I would just add also, if you look at the escalation of fuel prices on the thermal side, they've gone tripled in some cases. So renewables, although the costs have increased are relatively more competitive than they were before this current inflationary cycle. And then in addition, we have the benefit with renewables, we're largely firming up prices right around the time that we're also signing up our PPA. So you have a good sense of what your levelized cost is over the life of the project and very little variable costs, of course. So we are able to build in this into the market. And then, of course, the IRA bill in the U.S., certainly with the expansion and extension and re-upping of credits, does serve to offset some of these additional inflationary increases in the renewables capital cost. So that's as an opposing effect, helping bring prices somewhat back down off of what they otherwise would have been."
},
{
"speaker": "Richard Sunderland",
"text": "No, that certainly makes sense. And I appreciate the color there. And maybe Steve, picking up that last point around the IRA. Curious on transferability could impact your tax credit outlook? Is this an opportunity to invest more on a net to AES basis or any other impacts you foresee?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Certainly, transferability. I mean what we like about the IRA is it brings a lot of optionality, a lot of flexibility. It brings the production tax credit as an option for solar. And certainly, that could be a opportunity for high installation is in the southwest of the U.S., for example, may be the best option. So with transferability, it certainly adds more liquidity to, I would say, a more liquid market to monetizing the tax attributes. There are still some significant benefits to having tax equity partnerships, though, where you have the tax depreciation benefit in addition to the credit that you're monetizing as well as just in the way these projects get structured, there's a step-up in the value of the assets when they're contributed to a partnership and there's a benefit to the value of the tax attributes when that occurs as well. So it does add some optionality, flexibility. And so for us, it's good to have in our toolkit. And then down the road, we'll look to see as AES moves forward in time, we may be able to utilize some of these tax credits for our own account, but I wouldn't expect that until several years down the road."
},
{
"speaker": "Operator",
"text": "Our next question comes from Angie Storozynski from Seaport. Angie, your line is open."
},
{
"speaker": "Angie Storozynski",
"text": "So first, just one clarification. So Stephen, you talked about the ITC contributions from the new build this year and the carryforward for 2023. Is there some change here versus how you have been accounting for these? I mean, I'm just trying to make sure that it's not somehow related to the IRA and some different recognition of the tax attributes."
},
{
"speaker": "Steve Coughlin",
"text": "No. No, Angie. No change. But what we wanted to do was, a, as the IRA has been put in place and now we see the tax credits having a much longer life cycle extension well into the next decade. We wanted people to understand this is part of the economics of renewables of the whole in the U.S. We wanted people to understand what it means for AES and that this is a long runway and is an important component of how these assets get monetized and the return gets earned. The -- certainly, they will -- this will escalate over time. So we should expect that as we grow the business as anyone would grow the business, they'll have more share of credits. The other thing we wanted to point out is just if we look at the U.S. and utilities business unit, the fourth quarter, the skew towards the fourth quarter is, in large part, driven by the fact that we are commissioning more projects typically in the fourth quarter, more renewables projects and the tax credit recognition for the investment tax credit is tied to the commissioning. And so we will see a lift in the U.S. fourth quarter results as we did last year, as we will again this year in the fourth quarter as a result. So it was really those 2 reasons I wanted to point out the IRA and then the seasonality of the tax credit recognition in the U.S. and utilities SBU."
},
{
"speaker": "Angie Storozynski",
"text": "And secondly and probably most importantly, so I remember a couple of quarters back, you guys had the seemingly lost growth targets. 4.5 to 5.5 gigs of PPAs per year. It seems like you're tracking well against that. I'm just wondering if there's any upside to that number. And even more importantly, it seems like you guys have more than 5 gigs of capacity under construction. And so I'm just hoping to get some reassurance how you're coping with that level of activity? And if you -- if there is a possibility to increase it and how, again, like logistically, can you handle that many projects?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Thank you, Angie. That's a great question. Yes, we have a significant step-up in our construction between this year and next. And you correctly point out, we have more than 5 gigawatts currently under construction. I think we've handled it very well. We have doubled the amount of people that we have working on construction in renewables in the U.S. We have been working with strategic EPC contractors, meaning that we can give them not sort of just project by project, but really a line of sight, how much work they're going to get over the next 2 years, so they're able to staff up. So we've done very well there. I think we've done a very good job of managing the solar panel supply, which has been very turbulent. We've had no delays this year due to solar panels. We have already most of the solar panels that we need for 2023. So we're working very closely with that also the inverter. So I feel very good about that. We have done a lot of outside the renewables area, a lot of big projects. So I think we have experience there. So I feel very comfortable. We will have a roughly doubling of what we commissioned this year to next year. And again, we've been worried about the supply chain. We started more than 2 years ago. So we, I think, are in as good shape as anybody in handling it. And I think the results speak for themselves. We haven't had to delay any projects because of a lack of supplies or a lack of construction workers or anything of the sort. Regarding sort of the upside, as I said, the IRA does provide upside. It has good incentives for renewables. They will be, I think, increasing demand certainly from corporations. And I think what's very important is we're not just looking at increasing our growth rate but making sure that we're growing profitably and growing well."
},
{
"speaker": "Angie Storozynski",
"text": "And my last question about the financing of that incremental growth, especially in this higher interest rate environment. So I mean, are you revisiting the past idea of more of like a systematic recycling of capital from your existing assets? Is there again, especially ahead of the announcement for green hydrogen projects. I mean I'm assuming that, that comes with a pretty aggressive capital outlays. So how do you finance it?"
},
{
"speaker": "Andres Gluski",
"text": "What I'd say, we're going to continue to churn capital. As our projects mature, it's a way of increasing our return on invested capital. As you know, once we finish renewable projects, we sell down to people who want a fully contracted U.S. dollar renewable. So our plan through 2025 that we've laid out is fully financed. If we were going to know I would say, going forward, if there are additional very profitable opportunities, we'll have to look at that, but we have a lot of options. We have a lot of options. We're investment grade. And as we have done in the past, we can turn more quickly some of our assets in terms of our sell-downs."
},
{
"speaker": "Operator",
"text": "Our next question comes from Nick Campanella from Credit Suisse. Nick, your line is now open."
},
{
"speaker": "Unidentified Analyst",
"text": "This [Fae] is for Nick today. I just want to quickly touch on Ohio rate case. We saw some peers going through this process, having some challenges there. Could you just update us on how you're managing your regulatory strategy in Ohio and the rate outcome there? If there's any changes from the last update. But again, recognizing Ohio is pretty -- has a pretty minimal impact to the consolidated EPS. Just any color would be appreciated."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. No, happy to. This is Steve. We are being very strategic. And I'm sure you saw that we did file for an electric security plan for, so our ESP 4 very recently. So we are still awaiting the decision from the utility commission on the rate case that's outstanding. We are expecting that decision still before the end of the year. . But look, the issue at hand is whether rates need to be frozen while we currently have this rate stability charge that's been in place for about 20 years. We think there is broad support for the new rates that are -- have been asked for in the plan and the staff came out and supported those. So what we decided to do was go ahead and chart a path to moving on to a new ESP regardless of what this outcome is in this case. And therefore, that clock has already started ticking. As Andres said, we'd expect that to be resolved by middle to second half of next year on the ESP 4. And our focus is really on growing the utility. As Andres said, this is a utility where we have the lowest rates by far across all customer classes. We want to get to a place. There's a significant opportunity for upgrades and investments, and we want to have a healthy structure from which to continue investing in a healthy balance sheet for the utility. So the ESP 4 was filed to give that path there. We still believe in the case that we filed and that the stability charge can still be in place. But in the case that the commission decides they want to hold rates until that stability charge is retired, then we'll have this ESP 4 path -- it's already out there. It's already being in the process, and we'll have that then by the middle of next year as opposed to waiting for this to be decided and then going ahead and creating what's the next security plan. So that was our goal and our thinking here. And as I said, we still expect a decision this year on the case."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith. Julien, your line is open."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Congratulations on the continued success here. If I can, just to pivot back to where we started with some of this conversation. I want to try to get back at some of the tax credit dynamics and how that plays itself out over the next few years. So clearly, you all have outperformed on continued backlog generation and bring into construction. Can we talk about some of the cadence of in-service here and how that translates back to credit? I appreciate the detail on '22 about what that means on an income basis. But can you talk a little bit relative to the earlier guidance, what was embedded as far as earnings expectations? And then try to transpose that against where we are against the current cadence of when is that construction progress going to reach in-service? When is that backlog effectively fully in service, right, i.e., over the next 2 or 3 years? I just try to reconcile prior versus today on the updated backlog as well as considering the pivot to a solar PTC from an ITC, which also may meet be something of an offset to the positives described here?"
},
{
"speaker": "Andres Gluski",
"text": "Okay. Julien, good to talk to you, there are a lot of questions."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Sorry, I know a lot take it as you will."
},
{
"speaker": "Andres Gluski",
"text": "So let me -- let me try to frame it we'll answer between Steve and myself. So I guess the first question is, I think regarding the new IRA, it does give us flexibility to choose in terms of ITC, PTC on some projects. This will start in 2023, which is somewhat of a -- I'd say it's a slight upside there. Regarding sort of the cadence, these do tend to be somewhat backloaded in the end of the year. So that Steve had mentioned, this is just because of the financing structure. So it tends to be Q3, Q4. And I think that will continue to be so going forward. In terms of our backlog, yes, I mean we have -- as we mentioned, it's 11.2 gigawatts, and the vast majority of that is going to be commissioned before end of 2025. So there are a few projects that go beyond that. So as projects get commissioned, new ones come into the backlog. I think what's important, again, if you think of this in terms of our installed capacity, it's -- the backlog is one-thirds of our current installed capacity. So we feel good about our growth rates. We feel good about the -- who we're contracting with. So our growth in the U.S., of course, is investment-grade off-takers, utilities and -- but mostly corporate clients and internationally as well. What we're signing overseas is mainly in Chile with people like Codelco, big copper exporter, others that -- it's -- we feel it's just as good a risk as if they were in the U.S. So I think I'll pass it off to Steve to get a little bit more in the weeds of the tax itself, some of your other questions."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "And if I can, just to clarify, if you don't mind, just to jump in, the cadence by year rather not by intra-quarter kind of thing, but by year breaking down that 11 gig, if we can. Just -- again, I'm just trying to reconcile the older expectations versus newer and try to understand how many gigs per year you can kind of credibly expect?"
},
{
"speaker": "Andres Gluski",
"text": "What I would say is, look, we're going from about, I think, less than 2 gig this year, somewhere around 4 gigs next year. And then at some point, if you are always signing 5 gigs of new renewable contracts, you will be commissioning or bringing online 5 gig. The 2 sort of come together. So the catch-up is -- the biggest catch-up will be next year. And then you have the 2 lines going in parallel. Now again, if our signings increase, well, then there will be a lag of about a -- let's say, between 18 months and 24 months between the greater number for signing PPAs and the commissionings are bringing online."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And Julien, so I would say, also taking the number -- Andres said 4 gigawatts next year, that will continue to grow. This is our main growth business for us. It's 5 gigawatts, 6 gigawatts. We'll give more color on that next year as we update our guidance. And then I would look at that and say that roughly, on average, say, two-thirds of that is in the U.S. And then a larger share of that is solar and solar plus storage of that that's in the U.S. So say, roughly 75% today is solar, solar plus storage of the U.S. backlog. And so that's ITC qualified. We can't elect PTC now, as I said, we're looking at that where it makes sense for the returns, and that's typically where you have higher capacity factors, where the installation is high as, say, the Southwest of the U.S. The credits will continue to increase significantly. I think next year is on is going to be a big jump year-over-year because the level of commissioning is going way up next year. And it is heavily weighted towards the fourth quarter of the year. But as we continue to grow this business, the timing will become less of an issue as we get to more of a consistent state of additions year-over-year. But the credits are an important part of how it's monetized and wanted to show that given the IRA and also given how the U.S. Utilities SBU seasonality is becoming more shaped by the renewables, the clean energy business in the U.S. but it's important for everyone to understand what that looks like for modeling purposes."
},
{
"speaker": "Operator",
"text": "We have our next question comes from Ryan Levine from Citi. Ryan, your line is open."
},
{
"speaker": "Ryan Levine",
"text": "I wanted to follow up on some of the ITC clarifications. So as you're looking for the U.S. portion, what adders are you assuming that you'll be able to realize as you move forward with these projects? And specifically, are you seeing any low mineral income adders anticipated for your solar projects and both in your current portfolio? And then on a go-forward basis, are you looking to evolve what types of projects you're pursuing in light of the details of the IRA?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So you're talking about like the adders for the energy communities and domestic content, things like that. Is that right?"
},
{
"speaker": "Ryan Levine",
"text": "Correct."
},
{
"speaker": "Steve Coughlin",
"text": "So yes, I think roughly one-third of our U.S. pipeline today is in these energy communities that qualify for the 10% adder. I think as we move forward, then we look at domestic content, we are a leader. We've launched our U.S. solar buyer consortium. We expect first supplies from that in 2024. So I would expect us to be having a share. I don't have a specific percentage right now, but a material share of our projects meeting the domestic content production in 2024. And then we are fully ready to be qualified for the wage and apprenticeship requirements and training already. So that's a nonissue. We're already have that 30% level with our project. And then I would expect at least one-third to be in that 40% level and some perhaps even higher up to 50% with the domestic content as that starts to become part of our panel supply in '24 and beyond."
},
{
"speaker": "Ryan Levine",
"text": "And then in terms of the transferability comments, as you're looking to make decisions around whether or not to use tax equity partners or utilize the transferability feature. Has that fully been determined at this point? Or is there still some negotiation or analysis that needs to do to determine how you'll structure for future deals?"
},
{
"speaker": "Steve Coughlin",
"text": "I mean, I would say, look, I think the -- for us, as a leader in the market, we have a lot of long-term deep relationships on the tax equity side. So for us, and we have a lot of capabilities of very -- the top talent in the industry on structuring these projects on the commercial side, on the tax side so that we're optimizing returns. So for us, as I said before, transferability is an option, I'm not convinced, in fact, that it actually optimizes returns because there is the tax depreciation component, which is also an important component of value of the accelerated depreciation. So -- and they're structuring to step up the value of these projects as once they're built, the value of them is typically higher than what the capital cost was. So there's an important -- it's important that we pay attention to returns. And for us, transferability, although it brings more liquidity to the market. AES as a leader already has I would say, the liquidity we need to monetize the tax attributes. So we'll look at it, but there's nothing -- I wouldn't say for us, it's a significant game changer, given our scale existing capabilities."
},
{
"speaker": "Operator",
"text": "We have our last question comes from Gregg Orrill from UBS. Gregg, your line is open."
},
{
"speaker": "Gregg Orrill",
"text": "Congratulations. Regarding the LNG success year-to-date and your thoughts on next year, just in terms of the repeatability there. What gives you the confidence there? If there's anything you could share about what you might have sold forward or thoughts on what sort of conditions need to repeat for you to deliver that again?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Gregg, I would say, look, -- what we said is that there are -- there is a continuation of this into the fourth quarter, a bit smaller. There's a possibility for next year. And that will depend on the spread between, again, Henry Hub plus prices that we get on our contracts and prices in Europe. So that's really the importance. I think in terms of the hydrology, we need continued good hydrology in Panama, and reservoirs are quite high. So we're going in, in a favorable condition. So it really is what will be the spreads that justify this making that shipment. And I would say also, we would expect less volume in any case next year than this year. So it would be an upside. We're not counting on a very large amount of LNG. So conditions, it looks like it's a possibility, but we're not counting on it. And those are the drivers. And so I think you can see how those drivers are moving and see there's a possibility for this."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And I would say just to add, for the fourth quarter of this year, we've already -- for whatever we would do with LNG has done for this year. So we've already -- we have a much smaller upside in the fourth quarter already built into our commentary on meeting the -- at or near the top end of our guidance range. So that any additional volumes would be -- we'd be talking about next year and whether the market conditions, as Andres said, are conducive to that, we think it's very possible, and it would be more upside. But for this year, we've already contracted what we could contract."
},
{
"speaker": "Gregg Orrill",
"text": "Does where you end up this year? Obviously, you've said at or near the top of earnings guidance. Does that have an impact at all on how you think about giving '23 guidance? Does it serve as a base or some kind of reference point? Or are you still sort of pointing back to a different base?"
},
{
"speaker": "Andres Gluski",
"text": "We'd be pointing back to the different base. I mean we've said 7 to 9 growth and through 2025, and that's what we're committed to achieving. So it's not changing our base year for our growth rate."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And that was my -- yes. It's a very good year. I think there's more upside, as Andres said. But I wouldn't say it's such a new baseline because this isn't necessarily a recurring at this level thing."
},
{
"speaker": "Operator",
"text": "We have no more further questions on the line. I will now hand back to Susan for closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. We will look forward to seeing many of you at the EEI Financial Conference later this month. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AES | 2 | 2,022 | 2022-08-05 10:00:00 | Operator: Ladies and gentlemen, thank you for standing by. Welcome to the AES Corporation Second Quarter 2022 Financial Review Call. My name is Irene, and I will be coordinating this event. [Operator Instructions] I would like to turn the conference over to our host Susan Harcourt, Vice President of Investor Relations. Susan, please go ahead.
Susan Harcourt: Thank you operator. Good morning and welcome to our second quarter 2022 financial review call. Our press release presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andrés.
Andrés Gluski: Good morning everyone and thank you for joining our second quarter 2022 financial review call. As you have seen from our earnings release, we reported second quarter adjusted EPS of $0.34, which was in line with our expectations and consistent with our historical quarterly earnings profile. Our CFO, Steve Coughlin will discuss our financial results in more detail. Based on our year-to-date results and outlook for the second half of the year, we are reaffirming our 2022 guidance and our expectation for annualized growth in adjusted EPS and parent free cash flow of 7% to 9% through 2025. I would also note that our guidance and expectations do not include any benefit from proposed US climate legislation, which we see as a meaningful source of potential upside as it would drive additional demand for renewables and energy storage and accelerate the development of green hydrogen projects in the US. This morning I will discuss our strategy in the context of two broad themes. First, our resilience to macroeconomic volatility including high inflation, high commodity prices, fluctuations in foreign currency and ongoing supply chain constraints; and second, continued strong demand for renewables, particularly from corporate and industrial customers. With this backdrop in mind, I will discuss the robustness of our business and also review our disciplined approach to growth, both of which provide us with full confidence in our ability to hit our financial and strategic goals this year and beyond. Beginning with our resilience on slide 4. As a result of the transformation of our portfolio over the last 10 years, our financial results this quarter were insulated from the impacts of rising inflation, depreciating US dollar and volatile commodity prices. We do not expect any of these factors to have any impact on our full year results. As I have discussed on previous calls, 85% of our adjusted pretax contribution is derived from long-term contracts for generation and our regulated utilities. For the 15% of our earnings that is not derived from long-term contracts or utilities, such as our legacy Southland business in California or the 10% that is not denominated in US dollars, we have largely hedged both exposures. In some cases our strong contractual arrangements have allowed for additional upside. Throughout 2022, we have signed agreements to redirect excess LNG from Panama to international customers. The benefits of these agreements will accrue through the remainder of the year and we have the potential to sign similar agreements next year depending on market conditions. Turning to construction and supply chains on Slide 5. Our strategic sourcing and ability to execute on our commitments our key competitive advantages and we expect to complete all of the projects in our 10.5 gigawatt backlog with no cancellations or significant changes. We take a proactive approach to working with our suppliers and as a result, we had all of the solar panels required for our 2022 projects in country earlier this year. More recently, we worked to quickly resume imports following the Biden Administration's June executive order and none of our suppliers' panels have been stopped by customs this year. We also took decisive steps to further decrease solar panel supply risk by creating a more robust US supply chain. In June, we launched the US Solar Buyer Consortium along with three other solar developers to significantly drive the expansion of domestic solar manufacturing. Collectively, we committed to purchasing more than $6 billion of solar panels for manufacturers that can supply up to seven gigawatts of solar modules per year made in the USA starting from 2024. Therefore, despite industry-wide supply chain challenges, we do not anticipate any major delays to our US renewables backlog of 5.9 gigawatts. I would note that only two projects have been shifted from 2022 to 2023 and these were moved as a result of changes requested by customers with no impact on our guidance and expectations for this year or next. In addition, we recently broke ground on the largest utility scale solar plus storage project in the state of Hawaii. Across the states, we have more renewable projects under development and/or under construction than anyone else. As you can see on Slide 6, we anticipate completing 1.8 gigawatts of new renewables globally this year, 4.6 gigawatts next year for a total of 6.4 gigawatts by the end of 2023. Turning to Slide 7. Looking to our future growth. We continue to see strong demand for renewables from our key customer groups. Despite increases in the cost of renewables resulting from inflation and supply chain constraints, a far greater increase in the cost of fossil fuels has made renewable energy even more price competitive. As a result, demand from corporate customers has never been higher. So far this year, we have signed or been awarded 1.6 gigawatts of long-term renewable PPAs, the majority of which have been negotiated on a bilateral basis. For full year 2022, we continue to expect to reach a total of 4.5 gigawatts to 5.5 gigawatts. As shown on Slide 8, we now have a backlog of 10.5 gigawatts all of which is expected to come online through 2025. Turning to Slide 9. I'd like to note that we currently have 13.7 gigawatts of renewables and operations. So this backlog of projects in construction or with signed PPAs represent more than 75% growth in our installed renewable capacity over the next four years. Including additional PPAs, we expect to sign by 2025, our portfolio will grow to almost 50 gigawatts of which 77% will be renewables. We also expect to have completely exited coal at that time. As we scale up in renewables, we continue to complement our portfolio with innovative businesses and solutions which require the best talent in order to deliver on our commitments. Earlier this week, Fast Company recognized AES in their top 10 rankings of best workplaces for Innovators and as the winner in the category of best workplaces for Early Career Innovator. We are very proud of receiving this recognition and our innovative teams and their many accomplishments. Additionally, although we don't have any specific announcements to make today, we continue to make good progress on our two large green hydrogen projects in the US and Chile. These projects include the integration of electrolyzers and renewable and have the potential to provide significant new sources of growth. I will provide additional updates in the coming months. In the meantime, we launched a 2.5-megawatt pilot project in Chile. This project will be a hydrogen fueling station and will produce up to one metric ton of green hydrogen per day. Finally turning to Slide 10. Growth opportunities at our US utilities represent one of the key drivers of our overall 7% to 9% annual growth in earnings and cash flow. This growth also advances our objective of increasing the proportion of our earnings from the US to 50%. As a reminder in both Indiana and Ohio, we have the lowest residential rates in each state, providing a great runway for growth and investment, while keeping rates affordable for our customers. Through 2025, we expect to invest a total of $4 billion in new renewables, generation, transmission, modernization and smart grid at our US utilities. These investments will improve our customers' experience and translate to average annual rate base growth of 9% which is at the high-end of growth projection for US utility. We expect the earnings from these core businesses to grow inline with the rate base. At AES Ohio, we are currently awaiting the commission's decision on our distribution rate case. As a reminder, we see significant opportunity to invest to improve reliability and strengthen AES Ohio's balance sheet, while remaining cost competitive. With that I will now turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andrés and good morning, everyone. Today I will discuss our second quarter results 2022 parent capital allocation and 2022 guidance. Turning to our financial results for the quarter beginning on Slide 12. I'm pleased to share that we had a good second quarter in line with our expectations which keeps us well on track for our full year guidance. Adjusted EPS was $0.34 versus $0.31 last year, driven by growth in our core business segments higher margins primarily at AES Andes and a lower adjusted tax rate. These positive contributions were partially offset by the higher share count as a result of the accounting adjustment we made for our equity units, higher parent interest expense related to growth funding and onetime outages at select thermal businesses. These outages were primarily driven by turbine manufacturer component defects and the plants impacted are now all back online. There are two additional points I would like to highlight from the second quarter. First, we successfully closed several nonrecourse subsidiary financing, extending tenures at very attractive rates and expanding facilities that support our renewables growth. And second, our collections and days sales outstanding in all of our businesses remain strong reflecting our predominantly investment-grade rated customer base. Turning to side 13. Adjusted pre-tax contribution or PTC was $304 million for the quarter, which was relatively flat year-over-year consistent with the drivers I just discussed. I'll cover the performance of our strategic business units or SBUs in more detail over the next four slides beginning on slide 14. In the US in Utilities SBU, lower PTC was driven primarily by outages at Southland and AES Indiana as well as lower contributions from AES Clean Energy due to increased investment in renewables development. Contributions from new clean energy project commissionings will be more skewed to the second half of the year. Higher PTC at our South America SBU was mostly driven by higher contributions from AES Andes resulting from our increased ownership as well as higher margins, but partially offset by the outages I previously mentioned. Higher PTC at our Mexico Central America and Caribbean or MCAC SBU, primarily reflects favorable market conditions caused by better hydrology in Panama. As Andrés discussed the reduced need for thermal generation in Panama has allowed us to sell our excess LNG on the international market at higher prices, which will serve as a positive driver in the remainder of the year. Finally in Eurasia, while our business performance has been very strong the lower PTC reflects higher interest expense coming from additional non-recourse debt at one of our Eurasia Holdco. Now to slide 18. We are on track to achieve our full year 2022 adjusted EPS guidance range of $1.55 to $1.65. Our typical quarterly earnings profile is more heavily weighted toward Q3 and Q4 with about two-thirds of our earnings occurring in the second half of the year. We continue to expect a similar profile this year as we grow more in the US where earnings are higher in the second half based on solar generation profiles, utility demand seasonality, the commissioning of more new projects in the third and fourth quarters and higher demand at Southland and the peak cooling months in Southern California. Growth in the year to go will be primarily driven by contributions from new businesses including 1.4 gigawatts of projects in our backlog coming online over the next six months as well as further accretion from our increased ownership of AES Andes, higher LNG revenues and growth at our US utilities. We are also reaffirming our expected 7% to 9% average annual growth target through 2025 based on our expected growth in renewables energy storage and US utilities. Our guidance also assumes the recycling of capital from many of our thermal businesses into those three growth areas across our portfolio. Now to our 2022 parent capital allocation plan on slide 19. Sources reflect approximately $1.6 billion of total discretionary cash including $900 million of parent free cash flow. Due to timing uncertainty around our planned asset sales, we are now expecting to achieve the lower end of our $500 million to $700 million asset sales target within the year with the remaining sales expected to close in 2023. To fund our strong growth expectations until the asset sales are completed, we plan to issue approximately $200 million of new parent debt which was already included in the long-term capital allocation plan we laid out earlier this year. On the right-hand side, you can see our planned use of capital. We will return nearly $500 million to shareholders this year. This consists of our common share dividend including the 5% increase we announced last December and a coupon on the equity units. We plan to invest approximately $1.1 billion in our subsidiaries as we capitalize on attractive opportunities for growth. About half of these investments are in renewables reflecting our success in securing new long-term contracts during 2021 and our expectations for 2022. Nearly one-quarter of these investments are in our US utilities to fund rate base growth with a continued focus on grid and fleet modernization. In summary, nearly three-quarters of our investments this year are going to grow AES' renewables businesses in our US utilities, reflecting our commitment to continue executing on AES' portfolio transformation. We have made great progress on our growth investments so far this year and remain on track with our annual investment targets. We will continue to allocate our capital in line with our strategy to lead in renewables, grow our utilities by 9% annually and to recycle capital out of thermal assets to decarbonize our portfolio. With that, I'll turn the call back over to Andrés.
Andrés Gluski: Thank you Steve. In summary, our actions and strategy have put us in a strong position to achieve this year's guidance and a 7% to 9% annualized growth through 2025. Once again, our portfolio of businesses is proving its resilience to any macroeconomic volatility in the US or internationally. We have signed or been awarded 1.6 gigawatts of new renewable PPAs year-to-date and we're targeting 4.5 gigawatts to 5.5 gigawatts this year. Our backlog has reached 10.5 gigawatts and our construction schedule has not been affected by supply chain issues. To further derisk our supply chain, we have led a consortium to buy up to seven gigawatts of US made solar panels annually starting in 2024. Finally, we see significant upside to our growth including green hydrogen in the US, should the proposed Inflation Reduction Act be approved. With that, I would like to open up the call for questions.
Operator: Thank you. [Operator Instructions] Our next question comes from Insoo Kim from Goldman Sachs. Insoo, your line is open.
Insoo Kim: Thank you. First question starting off with the IRA bill. Thank you for the comments on potential upside and all that stuff. I guess, are you inferring that if this bill does pass as proposed that you could potentially see upside to your 7% to 9% EPS growth over the next few years on a CAGR basis?
Andrés Gluski: Yes. Good morning Insoo. Look what we're saying is that there is a number of very good opportunities, which would be certainly made more likely by the IRA bill. And one of them for example is green hydrogen in the US. We'd also expect greater demand from utilities and corporate customers as well. So it's generally. So rather than say we're going to exceed that it certainly would push us towards the higher end if these come true. So that's how I would think about it.
Insoo Kim: Okay. And you think at that higher end there's enough visibility of that if the component of the bill has passed?
Andrés Gluski: Yes. I mean, I think there will be discrete projects potentially in green hydrogen. And also you would see it in the number of renewables that we signed in the US.
Insoo Kim: Got it. My second question on that consortium for domestic panel manufacturing on solar. How should we think about what that does for the projects that get those panels domestically from a cost perspective, and just any changes to the return profile for those projects that we should be considering?
Andrés Gluski: Well, this starts in 2024. I would say that the major component is the security of supply. As we've seen this just this week, having a domestic manufacturing is very beneficial. You'll also see that Fluence came out with an announcement that they're going to manufacture their modules in Utah, here in the States. So, I'd say, look, it's large enough that it should be cost competitive and so this would be incorporated and we have to see what is the market clearing prices here in the US for solar projects. Now as we talked about in the past, most of our projects in the US are bilateral, negotiated with corporate clients. We're not just adding a generic clean kilowatt hours, we're you're also adding other features and more value for our customers. So, I think this will help us be more cost competitive. I think that -- but, the most important factor is that it will insulate us from any sort of trade restrictions in the future on the imports of solar panels from Asia. So that is the -- I think the main benefit.
Insoo Kim: Understood. Thank you so much.
Andrés Gluski:
Operator: Thank you, Insoo. Our next question comes from David Arcaro from Morgan Stanley. David, you may ask your question.
David Arcaro: Hi. Good morning. Thanks so much for taking my question. I was wondering on the pace of PPA signings here. What's the pace we should expect through the rest of the year? We've seen, I guess, a bit of a slowdown in the second quarter with the uncertainty around the tariff. But what's your confidence level right now in still achieving that 4.5 gigawatt to 5.5 gigawatt level by the end of the year?
Andrés Gluski: Yes. Good morning, David. Great questions. As I had said on the prior call that we expected this to be more weighted towards the second half of the year, because of uncertainties that we continue to negotiate it with key clients, but there was a certain amount of price uncertainty that we had to have cleared and that has occurred. So, just as we speak right now, we expect to sign a another 500 megawatts roughly today and that would bring us up to 2.1 gigawatts. So, as of -- again, we expect sort of breaking news. We expect them to be signing as we speak. And if that occurs then we would be at 2.1 gigawatts, which is close to the half of the bottom range, but we do expect activity to pick up in the second half. So, we feel confident that we'll be in the range of 4.5 gigawatts to 5.5 gigawatts. These are lumpy. So, you noticed that this -- it's not like we're signing them in 50-megawatt increments. It had this occurred on day earlier, the information on the press release and our disclosure would have been different. So, we expect to sign this morning. And with that, we'd be at 2.1 gigawatts.
David Arcaro: Got it. Okay. No, that's great to hear. It sounds like active dialogue going on obviously. And then, I just -- I wanted to touch on foreign exchange. We've seen some sizable moves in the foreign exchange rates. But are you seeing -- or any way you could quantify the potential kind of drag there is some impact on future years? And if efforts are kind of underway to look for offsets and to manage that any downside exposure there?
Steve Coughlin: Yes, hey, this is Steve. So we are -- I think you're asking for the longer term, but we are very well hedged through 2023, even a little bit beyond. So actually -- we actually see some net upside frankly this year based on our hedge positions. The other thing to keep in mind is that, we're -- about 90% of our business is US dollar denominated. So where we're exposed is a limited set of businesses, its Argentina, its Brazil and Colombia. So it's basically a fairly small exposure. I think, in fact, in Brazil we've seen the real appreciate this year, so we've had some favorability there. So I would say, really, it's just we have to keep our eye on Argentina. We have ways to mitigate that. We have expenses in the country; have local debt in the country. So it's manageable within the guidance is how I would look at it.
Andrés Gluski: Yes. I would add also that, part of that is Bulgaria.
Steve Coughlin: Yes.
Andrés Gluski: Which is euros.
Steve Coughlin: Yes.
Andrés Gluski: So if you look at between dollars and euros, you're probably getting to about 95%. So we're very much in strong currency. This is, again, a decade of work and with the great job that the finance team has done in shaping our portfolio, but also making sure that the new contracts we sign are primarily in dollars.
David Arcaro: Got it. That’s helpful. Thanks so much.
Andrés Gluski: Thank you.
Operator: Thank you, David. Our next question comes from Durgesh Chopra from Evercore. Durgesh, your line is open.
Durgesh Chopra: Hey, good morning, Steve and Andrés. Breaking news in the 500 megawatts. Can you -- is that what, with one customer? Congrats, by the way. Is that with one customer or is that multiple customers?
Andrés Gluski: That is one transaction. That is one transaction.
Durgesh Chopra: Excellent. Congrats on that. Okay. So I wanted to kind of dig in a little bit on the alternative minimum tax and how do you think that impacts you and your business. I mean, I think, the last time we talked about it, the headwind was offset by credits. Maybe just talk to that. And then, Andrés, I'd love to get your views on this transferability concept that is introduced in the bill. How do you think that works?
Steve Coughlin: Okay. So I'll take on the tax side, I guess. So, look, it is still somewhat early. The situation is still fluid and moving around. But based on what we know at this point, we don't see any material impact from the 15% global min tax in the near term. So we'll continue to look into the details and monitor it and we'll make a final assessment once the bill is finalized. If anything, it would be several years into the future and I would expect that we would have offsets and planning activities by that time. So basically, this is like a -- it's a parallel methodology. We already are subject to the GILTI tax regime. This is just another way of calculating to ensure you reach a minimum. Again, I don't expect and our taxing doesn't expect it to impact us over the next few years.
Andrés Gluski: Yes. Regarding your question on transferability, this is being able to sell tax credits to third parties. We don't see like a major impact, but we see it as an additional tool in our cash management practices. So that's favorable.
Steve Coughlin: Yes. I mean, it could impact the way tax equity partnerships are structured, could make it simpler perhaps. So we've got to see what all the rules are around the transferability first. But if anything it looks that it may make the financing structure simpler to manage and account for.
Durgesh Chopra: Got it, okay. I appreciate it certainly. So thank you for the discussion. Maybe just a really quick follow-up, Steve when you say several years out on the alternative minimum tax is that because of your U.S. businesses are not of that $1 billion threshold. Is that why it is, or when you say several years out, what does that mean?
Steve Coughlin: Yeah. So there is a $1 billion test as you referred to. So I don't expect that we would meet that. And there's like a three-year I think averaging of that. I don't expect we would meet that for several years to come.
Durgesh Chopra: Got it. Thanks for the time guys.
Steve Coughlin: Thank you.
Operator: Thank you. Our next question comes from Richard Sunderland from JPMorgan. Richard, your line is open.
Richard Sunderland: Hi. Good morning. Thanks for the time today. Starting with the 2H walk, I see $0.08 from new renewables. I'm curious is that pretty locked in given your commentary around only two projects shifting into 2023? I guess, similarly on that front, the $0.08 of LNG utilities and other, can you break that down to the component uses and relative line of sight to the U.S. utilities portion you've given Ohio remains outstanding?
Steve Coughlin: Yeah. So the $0.08 of renewables, yeah, I feel very good about both of these buckets frankly. So the renewables is both the growth in new projects as well as we do have some higher generation out of our hydro portfolio. As you recall last year was a poor hydro year. So that's in that bucket as well. And then, on the utilities and LNG side, as Andrés mentioned, we've had -- we've been really on the right side of things with the commodities this year. So LNG international prices are quite high. We have LNG position of course in our MCAC unit, specifically in Panama where we've had quite a wet year we've been able to not use that gas in Panama and redirect those cargoes and sell them on the international market. So there -- while that's not in the year-to-date, it is a year to go favorability. So that's a little over half I would say of that $0.08. We've got some additional utility growth baked in for the second half of the year. Those are the two primary components of that $0.08. And frankly, I see potential for even more upside. So that's -- and then, I think you asked about Ohio as well. So with Ohio where, -- as Andrés said in his comments, we don't yet have a decision. It's not something that we had a material contribution assumed from the new rates this year. So certainly we look forward to a decision continue to expect a constructive outcome. But it's not going to be a driver one way or the other for this year.
Richard Sunderland: Understood, I appreciate the color there. And they're thinking broadly about the U.S. green hydrogen opportunity. How do you think this, ties in with the existing renewables platform? How could it expand I guess both the demand for new renewables and timing with some of the more complex structured products opportunities you capitalized on in the past two years?
Steve Coughlin: Well, as we said in the past we are looking at partnerships with producers of hydrogen to actually get more integrated in the whole production chain. So, what's very interesting is that the problem of producing cheap green hydrogen is very much like supplying 24/7 100% green energy or carbon-free energy to data centers. So, we think we have a leg up here. So, we're working on this. If the legislation passes then it's very likely to move forward. So, that's what we've been waiting for. In the meantime in Chile we have a different project which obviously does not depend on this. And that would be much more to supply the local market. And we have done a very good job of decarbonizing the Chilean system and the mining sector in particular. So, we feel good about both of these and these would be significant projects. So, they would accelerate the growth of renewables because of the additional demand.
Richard Sunderland: Understood. Very helpful. Just one final cleanup for me. The Southland outage what led to that and any inflation impact there?
Steve Coughlin: Yes. So it was actually Southland and also it was the same root cause at Indiana. So, there are veins on the turbine compressor unit I understand. So, don't go to go into too much detail but they -- there's a failure of component related to manufacturing defect. And so those units both have replacements in Eagle Valley in Indiana and our Southland the New Southland combined cycles in the gas turbine. So, those have been replaced. They are both back online at this point.
Richard Sunderland: Understood. Thank you for the time today.
Steve Coughlin: Thank you.
Operator: Thank you. Our next question comes from Angie Storozynski from Seaport. Angie, your line is open.
Angie Storozynski: Thank you. So, I wanted to go back to the Ohio rate case. I understand that it has no impact on the timing of the those decision on 2022, but it will have on 2023. I mean by all accounts it sounds like you will have to file an ESP. So, it might take time right to the final of the resolution? So, there should be an impact in 2023. And so in that context I mean can you -- I mean you mentioned that there is additional optionality around the LNG cargoes that could impact 2023. So, is it fair to assume that any impact by the shifting of the LNG cargoes also in 2023?
Steve Coughlin: I mean it certainly could be. We're not necessarily attributing one as an offset to the other Angie. So, the issue -- the staff had already come out and supported a rate increase. The issue at hand was whether because we've historically had this rate stability charge in place. It's been in place for about 20 years now whether the rate any new rates could be implemented while that charge is still in place. And so that's I think the fundamental issue on being evaluated by the commissioners. If in fact the rates are frozen, we'll move quickly to file a new ESP, and that will have new riders associated with it. And so it would be more of a delay than anything. So at that point, the current rate stability charge would stay in place, we would file a new ESP and we would then – and that the new rates would be implemented once that ESP has been approved. So that would take into the middle of next year to some delay. We're still optimistic based on our belief of the – our legal position here that the rate freeze is not necessary or not – should not be required that the outcome will be in our favor on that. But regardless, we see a path to what we included in our guidance just could be a delay, if we have to go down the path of the rate freeze, as I described to get that ESP filed.
Andrés Gluski: And Angie, maybe to describe a little bit the opportunity in Panama. We have hydro, but we also have the LNG re-gasification terminal being at Henry Hub prices. Of course, Henry Hub prices plus transportation liquefaction re-gasification. But nonetheless, it's kind of a one-sided bet, because we have enough cash to fulfill our contracts, but we had the opportunity, if there is a lot of water a lot of water in the reservoirs to not burn, and therefore ship those cargoes to international customers at obviously the international rates. So there's a very interesting arbitrage opportunity there. So it's a one-sided bet. If it stops raining, or if the reservoir levels fall then we'll just consume the gas and fulfill our contracts.
Angie Storozynski: And how sort of, are you going to know that? So in a sense, I mean, it's hard to predict hydro conditions, but I mean, is it a bit like a rainy season by some months?
Andrés Gluski: Yeah. So look, it's been raining a lot. So the rainy season has started. The reservoirs are full and that's why we're able to make these sell gas to international customers and get that arbitrage. What I'm referring to more really would be 2023 do these conditions persist, or does say 2023 start off being a very dry year. So for 2022, we're locked in. It's really a question of will this opportunity repeat in 2023.
Angie Storozynski: Okay. Okay. So moving on to the other inflation bill, so I understand, the comments you made about green hydrogen and energy storage. But when you actually listen to smaller developers they are also talking about maybe installing – adding solar PV to existing sites of conventional power assets, retrofitting existing assets with storage facilities. I mean, some changes in repowering of wind farms. I mean, there are some I would say secondary benefits from that bill, which could also benefit your portfolio. I guess it depends on the age of your contracts, and how heavy they are in the money. But could you talk about again benefits or additional benefits that this bill could add to your existing portfolio?
Andrés Gluski: Yeah. Well, of course, I think it helps repowering and add-ons. What we have to see is that, we already have contracts in these places. And so the question is, do we negotiate an additional contract from that location based on – we've done repowering already we're starting to – we've been repowering units in California at Mountain View, and also we plan to do some in Maryland at Laurel Mountain. So this helps those to happen, and you're right. It does -- one does have to look at what you have existing and what additional opportunities there, but since we are on the renewable side pretty much fully contracted then the question would be that additional energy do you -- is there an adder that you could add to the same client to keep it simple, or what are the opportunities there? But you're right, this is an upside that's smaller so we haven't talked that much about it.
Angie Storozynski: Okay. And lastly, I mean, we saw these media reports about Vietnam and offshore wind. I mean, I don't think that I've ever imagined yet and offshore winds in the same sentence. So could you talk about that opportunity?
Andrés Gluski: Sure. You noticed it was in our press release. First, so I'd say, look this is a -- we're in Vietnam. We're helping the Vietnamese come up with a plan to decarbonize their grid. So we do have the LNG terminal project there. And we are -- have been talking about bringing in energy storage and other renewables. So, to eliminate the need for additional coal plants. So at this point, I'd say, this was more sort of an exploratory issue. We will be very disciplined and committed to all the goals that we've given 50% US, 50% renewables. Now whenever we get into a new technology, we'd obviously have to partner with somebody. So we haven't done any offshore wind, because it didn't make sense economically. The markets we're in like the US, there's still plenty of land and it just really wasn't cost competitive. But we have nothing, let's say, against the technology itself. But of course, we would have to partner with somebody who has a long experience. And so we're not going to get into a new technology in a large scale on our own at this time. And so this was -- again, this is not an announcement from us and what we guarantee is we're going to stick to the exact goals that we have given you.
Angie Storozynski : Great. Thank you.
Andrés Gluski: Thank you.
Operator: Thank you, Angie. Our next question comes from Julien Dumoulin-Smith from Bank of America. Julien, your line is open.
Paul Zimbardo: Hi. Good morning. It's Paul Zimbardo sitting in this busy morning. Thanks a lot.
Andrés Gluski: Good morning.
Paul Zimbardo: I wanted to check in. I believe the last long-term guidance you gave for AES Next was breakeven net income by the end of the plan in 2025. That's still a good assumption? And how could that evolve under the Inflation Reduction Act?
Steve Coughlin : Yes. Actually, it was 2024, Paul, that I said that. So look Fluence is the largest component of Next. So I can't go into detail, they'll have their call soon and we'll talk about their performance. But they've been executing on a number of things lately. As Andrés talked about, they are launching their Utah manufacturing facility. They're diversifying their battery supply base. So, we fully expect based on what they've guided to which is that they'll be bottom line neutral by 2024. That's very consistent with what we've included in our guidance as well. And so I would say, they'll talk about their progress, but we feel good about both. But Fluence is doing as well as the levers that AES has regardless of what happens with Fluence that that portfolio will be neutral and then growing from there.
Andrés Gluski: And maybe speak a little bit about the other components like Uplight. As you know, they did the deal with Schneider Electric. So they now have a much, let's say wider product offering and very strong strategic partner in Schneider. And then you have 5B, which is the producer of Maverick the prefab solar. We're seeing a lot of interest in Maverick, where you have the first large-scale projects being completed in Chile. We have big projects in Puerto Rico. And we've already done a small project in Panama. So what's very important about this project is – this product is that it's hurricane wind resistant. So we're seeing a lot of interest in all sort of hurricane built of the Caribbean for this product. And there's also been a change of government in Australia. This is an Australian company. So they have very large projects in Australia, which were looking very favorably and that's the sort of hometown [indiscernible]. So we feel good about that as well. So overall we feel that AES Next is fulfilling its mission of really giving us the leading-edge technologies and giving us the opportunity to be the first to roll them out.
Paul Zimbardo: Okay. Great. Thank you. And then just separately could you please elaborate a little bit on the recent California legislation, how that would impact either extending, increasing or both the cash flows from the gas assets you have there?
Steve Coughlin: Yes. No we feel very optimistic. So we have – as I talked about previously, we've only included Southland legacy businesses, you've got Alamitos Huntington Beach and Redondo through 2023. So it may not be all three plants, but I would say probably at least two that we would expect to be extended possibly for several years. So the formal process I would expect in terms of permitting the ones through cooling permits that are needed, et cetera will likely kick off here in the next one to two months. And then that will run into the first say half of next year through the first half of next year. As we've done in the past, when we've been facing a potential extension, we've looked to do where we've executed contingent capacity contracts, continued upon the permitting and all that coming forward – going forward. So we'll start looking at commercial opportunities for the extensions, once the formal process gets underway in the state. And so we'll have more certainty next year but I would say, we're all very optimistic here that given the fundamentals of the California system and the droughts in the Southwest of the US but that additional peak capacity is going to be needed for several years to come. And so we feel we're in a good position to provide that and that will provide some upside to our plan.
Paul Zimbardo: Great. Thank you, Coughlin.
Steve Coughlin: Thank you, Paul
Operator: Thank you. Our next question comes from David Peters from Wolfe Research. David, your line is open.
David Peters: Yes. Hey, good morning, everyone. Andrés, I was just wondering if you could comment, specifically with respect to the US, LPA. We've heard from some companies here recently that they're seeing issues with panels being stopped recently at the border. Just wondering if you all are seeing this at all and if not kind of what you're doing differently I guess.
Andrés Gluski: Yes. The Uyghur Forced Labor Prevention Act, we have not seen any of our panel imports stopped by -- excuse me. As you know we've been on top of this matter for a long time, the polysilicon -- first the panels that we import to the US, come from Southeast Asia ASEAN countries. And we have asked the manufacturers to make sure that there's nothing that comes from Western China, that could be allegedly using forced labor. Polysilicon, the plan is that we're starting to use polysilicon coming from Korea. And that China would be the more likely place, where you -- there could be allegations of forced labor. But as you know the making of the wafers themselves, 95% of that today is still occurring in China. So we have to move that supply chain out of China, but it's going to take some time. But the short answer is no, we haven't seen anything and we believe our suppliers are the best place not to have any issues and documentations and we've been working with them, for a long time now. So this is nothing new, but we have to just see how this develops. So we don't expect any major issues.
David Peters: Great. And then just one other one on the asset sale target being at the low end, and I guess you're expecting a little less dilution this year, as a result too. Can you just give a little bit more of an update on the processes in Vietnam and Jordan? And just when are those expected to close I guess?
Andrés Gluski: Yes. Look, what's basically have, at least have to do with government approval. So we've agreed with our counterpart. It's not a question of price. It's just a question that the government -- well in the case of Vietnam, it's been the government's approval, of the new operator of the plant. And so that's taken some time for them to get comfortable with it. That's why it's dragged on. But we do expect resolution, by the end of this year. And the other case, I think you mentioned is Jordan, and that really has to do with some of the lenders including the US government signing off the loans, to the new buyers. So these have been really just bureaucratic issues, but the sale price, the buyer, the conditions have all been agreed to and it has taken longer than we expected.
Steve Coughlin: Yes. Yes. And that's the majority of the $500 million. So we feel good, as Andrés said, we'll get there on those by the end of this year. And then, we have been working on additional sales and sell-downs of primarily thermal businesses. So as we work towards those and the timing around those, some variability, it looks like some of that may happen in say the first half of 2023, which is why we said, let's focus on $500 million this year, the remaining of the $500 million to $700 million will come in through next year. And then we have the full $1 billion target, we feel well on track for. So, it's just a matter of some timing expectations around, what we're doing in the next say 12 months or so.
David Peters: Okay. Thank you, guys.
Andrés Gluski: Thank you.
Operator: Thank you. We have no further questions. Therefore, I would like to hand back to Susan Harcourt, for any closing remarks. Susan, please go ahead.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions, you may have. Thank you and have a nice day.
Operator: Thank you. Ladies and gentlemen this is today's conference call. Thank you for being with us today. Have a lovely day ahead. You may disconnect your lines now. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by. Welcome to the AES Corporation Second Quarter 2022 Financial Review Call. My name is Irene, and I will be coordinating this event. [Operator Instructions] I would like to turn the conference over to our host Susan Harcourt, Vice President of Investor Relations. Susan, please go ahead."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you operator. Good morning and welcome to our second quarter 2022 financial review call. Our press release presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Good morning everyone and thank you for joining our second quarter 2022 financial review call. As you have seen from our earnings release, we reported second quarter adjusted EPS of $0.34, which was in line with our expectations and consistent with our historical quarterly earnings profile. Our CFO, Steve Coughlin will discuss our financial results in more detail. Based on our year-to-date results and outlook for the second half of the year, we are reaffirming our 2022 guidance and our expectation for annualized growth in adjusted EPS and parent free cash flow of 7% to 9% through 2025. I would also note that our guidance and expectations do not include any benefit from proposed US climate legislation, which we see as a meaningful source of potential upside as it would drive additional demand for renewables and energy storage and accelerate the development of green hydrogen projects in the US. This morning I will discuss our strategy in the context of two broad themes. First, our resilience to macroeconomic volatility including high inflation, high commodity prices, fluctuations in foreign currency and ongoing supply chain constraints; and second, continued strong demand for renewables, particularly from corporate and industrial customers. With this backdrop in mind, I will discuss the robustness of our business and also review our disciplined approach to growth, both of which provide us with full confidence in our ability to hit our financial and strategic goals this year and beyond. Beginning with our resilience on slide 4. As a result of the transformation of our portfolio over the last 10 years, our financial results this quarter were insulated from the impacts of rising inflation, depreciating US dollar and volatile commodity prices. We do not expect any of these factors to have any impact on our full year results. As I have discussed on previous calls, 85% of our adjusted pretax contribution is derived from long-term contracts for generation and our regulated utilities. For the 15% of our earnings that is not derived from long-term contracts or utilities, such as our legacy Southland business in California or the 10% that is not denominated in US dollars, we have largely hedged both exposures. In some cases our strong contractual arrangements have allowed for additional upside. Throughout 2022, we have signed agreements to redirect excess LNG from Panama to international customers. The benefits of these agreements will accrue through the remainder of the year and we have the potential to sign similar agreements next year depending on market conditions. Turning to construction and supply chains on Slide 5. Our strategic sourcing and ability to execute on our commitments our key competitive advantages and we expect to complete all of the projects in our 10.5 gigawatt backlog with no cancellations or significant changes. We take a proactive approach to working with our suppliers and as a result, we had all of the solar panels required for our 2022 projects in country earlier this year. More recently, we worked to quickly resume imports following the Biden Administration's June executive order and none of our suppliers' panels have been stopped by customs this year. We also took decisive steps to further decrease solar panel supply risk by creating a more robust US supply chain. In June, we launched the US Solar Buyer Consortium along with three other solar developers to significantly drive the expansion of domestic solar manufacturing. Collectively, we committed to purchasing more than $6 billion of solar panels for manufacturers that can supply up to seven gigawatts of solar modules per year made in the USA starting from 2024. Therefore, despite industry-wide supply chain challenges, we do not anticipate any major delays to our US renewables backlog of 5.9 gigawatts. I would note that only two projects have been shifted from 2022 to 2023 and these were moved as a result of changes requested by customers with no impact on our guidance and expectations for this year or next. In addition, we recently broke ground on the largest utility scale solar plus storage project in the state of Hawaii. Across the states, we have more renewable projects under development and/or under construction than anyone else. As you can see on Slide 6, we anticipate completing 1.8 gigawatts of new renewables globally this year, 4.6 gigawatts next year for a total of 6.4 gigawatts by the end of 2023. Turning to Slide 7. Looking to our future growth. We continue to see strong demand for renewables from our key customer groups. Despite increases in the cost of renewables resulting from inflation and supply chain constraints, a far greater increase in the cost of fossil fuels has made renewable energy even more price competitive. As a result, demand from corporate customers has never been higher. So far this year, we have signed or been awarded 1.6 gigawatts of long-term renewable PPAs, the majority of which have been negotiated on a bilateral basis. For full year 2022, we continue to expect to reach a total of 4.5 gigawatts to 5.5 gigawatts. As shown on Slide 8, we now have a backlog of 10.5 gigawatts all of which is expected to come online through 2025. Turning to Slide 9. I'd like to note that we currently have 13.7 gigawatts of renewables and operations. So this backlog of projects in construction or with signed PPAs represent more than 75% growth in our installed renewable capacity over the next four years. Including additional PPAs, we expect to sign by 2025, our portfolio will grow to almost 50 gigawatts of which 77% will be renewables. We also expect to have completely exited coal at that time. As we scale up in renewables, we continue to complement our portfolio with innovative businesses and solutions which require the best talent in order to deliver on our commitments. Earlier this week, Fast Company recognized AES in their top 10 rankings of best workplaces for Innovators and as the winner in the category of best workplaces for Early Career Innovator. We are very proud of receiving this recognition and our innovative teams and their many accomplishments. Additionally, although we don't have any specific announcements to make today, we continue to make good progress on our two large green hydrogen projects in the US and Chile. These projects include the integration of electrolyzers and renewable and have the potential to provide significant new sources of growth. I will provide additional updates in the coming months. In the meantime, we launched a 2.5-megawatt pilot project in Chile. This project will be a hydrogen fueling station and will produce up to one metric ton of green hydrogen per day. Finally turning to Slide 10. Growth opportunities at our US utilities represent one of the key drivers of our overall 7% to 9% annual growth in earnings and cash flow. This growth also advances our objective of increasing the proportion of our earnings from the US to 50%. As a reminder in both Indiana and Ohio, we have the lowest residential rates in each state, providing a great runway for growth and investment, while keeping rates affordable for our customers. Through 2025, we expect to invest a total of $4 billion in new renewables, generation, transmission, modernization and smart grid at our US utilities. These investments will improve our customers' experience and translate to average annual rate base growth of 9% which is at the high-end of growth projection for US utility. We expect the earnings from these core businesses to grow inline with the rate base. At AES Ohio, we are currently awaiting the commission's decision on our distribution rate case. As a reminder, we see significant opportunity to invest to improve reliability and strengthen AES Ohio's balance sheet, while remaining cost competitive. With that I will now turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andrés and good morning, everyone. Today I will discuss our second quarter results 2022 parent capital allocation and 2022 guidance. Turning to our financial results for the quarter beginning on Slide 12. I'm pleased to share that we had a good second quarter in line with our expectations which keeps us well on track for our full year guidance. Adjusted EPS was $0.34 versus $0.31 last year, driven by growth in our core business segments higher margins primarily at AES Andes and a lower adjusted tax rate. These positive contributions were partially offset by the higher share count as a result of the accounting adjustment we made for our equity units, higher parent interest expense related to growth funding and onetime outages at select thermal businesses. These outages were primarily driven by turbine manufacturer component defects and the plants impacted are now all back online. There are two additional points I would like to highlight from the second quarter. First, we successfully closed several nonrecourse subsidiary financing, extending tenures at very attractive rates and expanding facilities that support our renewables growth. And second, our collections and days sales outstanding in all of our businesses remain strong reflecting our predominantly investment-grade rated customer base. Turning to side 13. Adjusted pre-tax contribution or PTC was $304 million for the quarter, which was relatively flat year-over-year consistent with the drivers I just discussed. I'll cover the performance of our strategic business units or SBUs in more detail over the next four slides beginning on slide 14. In the US in Utilities SBU, lower PTC was driven primarily by outages at Southland and AES Indiana as well as lower contributions from AES Clean Energy due to increased investment in renewables development. Contributions from new clean energy project commissionings will be more skewed to the second half of the year. Higher PTC at our South America SBU was mostly driven by higher contributions from AES Andes resulting from our increased ownership as well as higher margins, but partially offset by the outages I previously mentioned. Higher PTC at our Mexico Central America and Caribbean or MCAC SBU, primarily reflects favorable market conditions caused by better hydrology in Panama. As Andrés discussed the reduced need for thermal generation in Panama has allowed us to sell our excess LNG on the international market at higher prices, which will serve as a positive driver in the remainder of the year. Finally in Eurasia, while our business performance has been very strong the lower PTC reflects higher interest expense coming from additional non-recourse debt at one of our Eurasia Holdco. Now to slide 18. We are on track to achieve our full year 2022 adjusted EPS guidance range of $1.55 to $1.65. Our typical quarterly earnings profile is more heavily weighted toward Q3 and Q4 with about two-thirds of our earnings occurring in the second half of the year. We continue to expect a similar profile this year as we grow more in the US where earnings are higher in the second half based on solar generation profiles, utility demand seasonality, the commissioning of more new projects in the third and fourth quarters and higher demand at Southland and the peak cooling months in Southern California. Growth in the year to go will be primarily driven by contributions from new businesses including 1.4 gigawatts of projects in our backlog coming online over the next six months as well as further accretion from our increased ownership of AES Andes, higher LNG revenues and growth at our US utilities. We are also reaffirming our expected 7% to 9% average annual growth target through 2025 based on our expected growth in renewables energy storage and US utilities. Our guidance also assumes the recycling of capital from many of our thermal businesses into those three growth areas across our portfolio. Now to our 2022 parent capital allocation plan on slide 19. Sources reflect approximately $1.6 billion of total discretionary cash including $900 million of parent free cash flow. Due to timing uncertainty around our planned asset sales, we are now expecting to achieve the lower end of our $500 million to $700 million asset sales target within the year with the remaining sales expected to close in 2023. To fund our strong growth expectations until the asset sales are completed, we plan to issue approximately $200 million of new parent debt which was already included in the long-term capital allocation plan we laid out earlier this year. On the right-hand side, you can see our planned use of capital. We will return nearly $500 million to shareholders this year. This consists of our common share dividend including the 5% increase we announced last December and a coupon on the equity units. We plan to invest approximately $1.1 billion in our subsidiaries as we capitalize on attractive opportunities for growth. About half of these investments are in renewables reflecting our success in securing new long-term contracts during 2021 and our expectations for 2022. Nearly one-quarter of these investments are in our US utilities to fund rate base growth with a continued focus on grid and fleet modernization. In summary, nearly three-quarters of our investments this year are going to grow AES' renewables businesses in our US utilities, reflecting our commitment to continue executing on AES' portfolio transformation. We have made great progress on our growth investments so far this year and remain on track with our annual investment targets. We will continue to allocate our capital in line with our strategy to lead in renewables, grow our utilities by 9% annually and to recycle capital out of thermal assets to decarbonize our portfolio. With that, I'll turn the call back over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you Steve. In summary, our actions and strategy have put us in a strong position to achieve this year's guidance and a 7% to 9% annualized growth through 2025. Once again, our portfolio of businesses is proving its resilience to any macroeconomic volatility in the US or internationally. We have signed or been awarded 1.6 gigawatts of new renewable PPAs year-to-date and we're targeting 4.5 gigawatts to 5.5 gigawatts this year. Our backlog has reached 10.5 gigawatts and our construction schedule has not been affected by supply chain issues. To further derisk our supply chain, we have led a consortium to buy up to seven gigawatts of US made solar panels annually starting in 2024. Finally, we see significant upside to our growth including green hydrogen in the US, should the proposed Inflation Reduction Act be approved. With that, I would like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our next question comes from Insoo Kim from Goldman Sachs. Insoo, your line is open."
},
{
"speaker": "Insoo Kim",
"text": "Thank you. First question starting off with the IRA bill. Thank you for the comments on potential upside and all that stuff. I guess, are you inferring that if this bill does pass as proposed that you could potentially see upside to your 7% to 9% EPS growth over the next few years on a CAGR basis?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Good morning Insoo. Look what we're saying is that there is a number of very good opportunities, which would be certainly made more likely by the IRA bill. And one of them for example is green hydrogen in the US. We'd also expect greater demand from utilities and corporate customers as well. So it's generally. So rather than say we're going to exceed that it certainly would push us towards the higher end if these come true. So that's how I would think about it."
},
{
"speaker": "Insoo Kim",
"text": "Okay. And you think at that higher end there's enough visibility of that if the component of the bill has passed?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. I mean, I think there will be discrete projects potentially in green hydrogen. And also you would see it in the number of renewables that we signed in the US."
},
{
"speaker": "Insoo Kim",
"text": "Got it. My second question on that consortium for domestic panel manufacturing on solar. How should we think about what that does for the projects that get those panels domestically from a cost perspective, and just any changes to the return profile for those projects that we should be considering?"
},
{
"speaker": "Andrés Gluski",
"text": "Well, this starts in 2024. I would say that the major component is the security of supply. As we've seen this just this week, having a domestic manufacturing is very beneficial. You'll also see that Fluence came out with an announcement that they're going to manufacture their modules in Utah, here in the States. So, I'd say, look, it's large enough that it should be cost competitive and so this would be incorporated and we have to see what is the market clearing prices here in the US for solar projects. Now as we talked about in the past, most of our projects in the US are bilateral, negotiated with corporate clients. We're not just adding a generic clean kilowatt hours, we're you're also adding other features and more value for our customers. So, I think this will help us be more cost competitive. I think that -- but, the most important factor is that it will insulate us from any sort of trade restrictions in the future on the imports of solar panels from Asia. So that is the -- I think the main benefit."
},
{
"speaker": "Insoo Kim",
"text": "Understood. Thank you so much."
},
{
"speaker": "Andrés Gluski",
"text": ""
},
{
"speaker": "Operator",
"text": "Thank you, Insoo. Our next question comes from David Arcaro from Morgan Stanley. David, you may ask your question."
},
{
"speaker": "David Arcaro",
"text": "Hi. Good morning. Thanks so much for taking my question. I was wondering on the pace of PPA signings here. What's the pace we should expect through the rest of the year? We've seen, I guess, a bit of a slowdown in the second quarter with the uncertainty around the tariff. But what's your confidence level right now in still achieving that 4.5 gigawatt to 5.5 gigawatt level by the end of the year?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Good morning, David. Great questions. As I had said on the prior call that we expected this to be more weighted towards the second half of the year, because of uncertainties that we continue to negotiate it with key clients, but there was a certain amount of price uncertainty that we had to have cleared and that has occurred. So, just as we speak right now, we expect to sign a another 500 megawatts roughly today and that would bring us up to 2.1 gigawatts. So, as of -- again, we expect sort of breaking news. We expect them to be signing as we speak. And if that occurs then we would be at 2.1 gigawatts, which is close to the half of the bottom range, but we do expect activity to pick up in the second half. So, we feel confident that we'll be in the range of 4.5 gigawatts to 5.5 gigawatts. These are lumpy. So, you noticed that this -- it's not like we're signing them in 50-megawatt increments. It had this occurred on day earlier, the information on the press release and our disclosure would have been different. So, we expect to sign this morning. And with that, we'd be at 2.1 gigawatts."
},
{
"speaker": "David Arcaro",
"text": "Got it. Okay. No, that's great to hear. It sounds like active dialogue going on obviously. And then, I just -- I wanted to touch on foreign exchange. We've seen some sizable moves in the foreign exchange rates. But are you seeing -- or any way you could quantify the potential kind of drag there is some impact on future years? And if efforts are kind of underway to look for offsets and to manage that any downside exposure there?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, hey, this is Steve. So we are -- I think you're asking for the longer term, but we are very well hedged through 2023, even a little bit beyond. So actually -- we actually see some net upside frankly this year based on our hedge positions. The other thing to keep in mind is that, we're -- about 90% of our business is US dollar denominated. So where we're exposed is a limited set of businesses, its Argentina, its Brazil and Colombia. So it's basically a fairly small exposure. I think, in fact, in Brazil we've seen the real appreciate this year, so we've had some favorability there. So I would say, really, it's just we have to keep our eye on Argentina. We have ways to mitigate that. We have expenses in the country; have local debt in the country. So it's manageable within the guidance is how I would look at it."
},
{
"speaker": "Andrés Gluski",
"text": "Yes. I would add also that, part of that is Bulgaria."
},
{
"speaker": "Steve Coughlin",
"text": "Yes."
},
{
"speaker": "Andrés Gluski",
"text": "Which is euros."
},
{
"speaker": "Steve Coughlin",
"text": "Yes."
},
{
"speaker": "Andrés Gluski",
"text": "So if you look at between dollars and euros, you're probably getting to about 95%. So we're very much in strong currency. This is, again, a decade of work and with the great job that the finance team has done in shaping our portfolio, but also making sure that the new contracts we sign are primarily in dollars."
},
{
"speaker": "David Arcaro",
"text": "Got it. That’s helpful. Thanks so much."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you, David. Our next question comes from Durgesh Chopra from Evercore. Durgesh, your line is open."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, good morning, Steve and Andrés. Breaking news in the 500 megawatts. Can you -- is that what, with one customer? Congrats, by the way. Is that with one customer or is that multiple customers?"
},
{
"speaker": "Andrés Gluski",
"text": "That is one transaction. That is one transaction."
},
{
"speaker": "Durgesh Chopra",
"text": "Excellent. Congrats on that. Okay. So I wanted to kind of dig in a little bit on the alternative minimum tax and how do you think that impacts you and your business. I mean, I think, the last time we talked about it, the headwind was offset by credits. Maybe just talk to that. And then, Andrés, I'd love to get your views on this transferability concept that is introduced in the bill. How do you think that works?"
},
{
"speaker": "Steve Coughlin",
"text": "Okay. So I'll take on the tax side, I guess. So, look, it is still somewhat early. The situation is still fluid and moving around. But based on what we know at this point, we don't see any material impact from the 15% global min tax in the near term. So we'll continue to look into the details and monitor it and we'll make a final assessment once the bill is finalized. If anything, it would be several years into the future and I would expect that we would have offsets and planning activities by that time. So basically, this is like a -- it's a parallel methodology. We already are subject to the GILTI tax regime. This is just another way of calculating to ensure you reach a minimum. Again, I don't expect and our taxing doesn't expect it to impact us over the next few years."
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Regarding your question on transferability, this is being able to sell tax credits to third parties. We don't see like a major impact, but we see it as an additional tool in our cash management practices. So that's favorable."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. I mean, it could impact the way tax equity partnerships are structured, could make it simpler perhaps. So we've got to see what all the rules are around the transferability first. But if anything it looks that it may make the financing structure simpler to manage and account for."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it, okay. I appreciate it certainly. So thank you for the discussion. Maybe just a really quick follow-up, Steve when you say several years out on the alternative minimum tax is that because of your U.S. businesses are not of that $1 billion threshold. Is that why it is, or when you say several years out, what does that mean?"
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. So there is a $1 billion test as you referred to. So I don't expect that we would meet that. And there's like a three-year I think averaging of that. I don't expect we would meet that for several years to come."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Thanks for the time guys."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Richard Sunderland from JPMorgan. Richard, your line is open."
},
{
"speaker": "Richard Sunderland",
"text": "Hi. Good morning. Thanks for the time today. Starting with the 2H walk, I see $0.08 from new renewables. I'm curious is that pretty locked in given your commentary around only two projects shifting into 2023? I guess, similarly on that front, the $0.08 of LNG utilities and other, can you break that down to the component uses and relative line of sight to the U.S. utilities portion you've given Ohio remains outstanding?"
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. So the $0.08 of renewables, yeah, I feel very good about both of these buckets frankly. So the renewables is both the growth in new projects as well as we do have some higher generation out of our hydro portfolio. As you recall last year was a poor hydro year. So that's in that bucket as well. And then, on the utilities and LNG side, as Andrés mentioned, we've had -- we've been really on the right side of things with the commodities this year. So LNG international prices are quite high. We have LNG position of course in our MCAC unit, specifically in Panama where we've had quite a wet year we've been able to not use that gas in Panama and redirect those cargoes and sell them on the international market. So there -- while that's not in the year-to-date, it is a year to go favorability. So that's a little over half I would say of that $0.08. We've got some additional utility growth baked in for the second half of the year. Those are the two primary components of that $0.08. And frankly, I see potential for even more upside. So that's -- and then, I think you asked about Ohio as well. So with Ohio where, -- as Andrés said in his comments, we don't yet have a decision. It's not something that we had a material contribution assumed from the new rates this year. So certainly we look forward to a decision continue to expect a constructive outcome. But it's not going to be a driver one way or the other for this year."
},
{
"speaker": "Richard Sunderland",
"text": "Understood, I appreciate the color there. And they're thinking broadly about the U.S. green hydrogen opportunity. How do you think this, ties in with the existing renewables platform? How could it expand I guess both the demand for new renewables and timing with some of the more complex structured products opportunities you capitalized on in the past two years?"
},
{
"speaker": "Steve Coughlin",
"text": "Well, as we said in the past we are looking at partnerships with producers of hydrogen to actually get more integrated in the whole production chain. So, what's very interesting is that the problem of producing cheap green hydrogen is very much like supplying 24/7 100% green energy or carbon-free energy to data centers. So, we think we have a leg up here. So, we're working on this. If the legislation passes then it's very likely to move forward. So, that's what we've been waiting for. In the meantime in Chile we have a different project which obviously does not depend on this. And that would be much more to supply the local market. And we have done a very good job of decarbonizing the Chilean system and the mining sector in particular. So, we feel good about both of these and these would be significant projects. So, they would accelerate the growth of renewables because of the additional demand."
},
{
"speaker": "Richard Sunderland",
"text": "Understood. Very helpful. Just one final cleanup for me. The Southland outage what led to that and any inflation impact there?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So it was actually Southland and also it was the same root cause at Indiana. So, there are veins on the turbine compressor unit I understand. So, don't go to go into too much detail but they -- there's a failure of component related to manufacturing defect. And so those units both have replacements in Eagle Valley in Indiana and our Southland the New Southland combined cycles in the gas turbine. So, those have been replaced. They are both back online at this point."
},
{
"speaker": "Richard Sunderland",
"text": "Understood. Thank you for the time today."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Angie Storozynski from Seaport. Angie, your line is open."
},
{
"speaker": "Angie Storozynski",
"text": "Thank you. So, I wanted to go back to the Ohio rate case. I understand that it has no impact on the timing of the those decision on 2022, but it will have on 2023. I mean by all accounts it sounds like you will have to file an ESP. So, it might take time right to the final of the resolution? So, there should be an impact in 2023. And so in that context I mean can you -- I mean you mentioned that there is additional optionality around the LNG cargoes that could impact 2023. So, is it fair to assume that any impact by the shifting of the LNG cargoes also in 2023?"
},
{
"speaker": "Steve Coughlin",
"text": "I mean it certainly could be. We're not necessarily attributing one as an offset to the other Angie. So, the issue -- the staff had already come out and supported a rate increase. The issue at hand was whether because we've historically had this rate stability charge in place. It's been in place for about 20 years now whether the rate any new rates could be implemented while that charge is still in place. And so that's I think the fundamental issue on being evaluated by the commissioners. If in fact the rates are frozen, we'll move quickly to file a new ESP, and that will have new riders associated with it. And so it would be more of a delay than anything. So at that point, the current rate stability charge would stay in place, we would file a new ESP and we would then – and that the new rates would be implemented once that ESP has been approved. So that would take into the middle of next year to some delay. We're still optimistic based on our belief of the – our legal position here that the rate freeze is not necessary or not – should not be required that the outcome will be in our favor on that. But regardless, we see a path to what we included in our guidance just could be a delay, if we have to go down the path of the rate freeze, as I described to get that ESP filed."
},
{
"speaker": "Andrés Gluski",
"text": "And Angie, maybe to describe a little bit the opportunity in Panama. We have hydro, but we also have the LNG re-gasification terminal being at Henry Hub prices. Of course, Henry Hub prices plus transportation liquefaction re-gasification. But nonetheless, it's kind of a one-sided bet, because we have enough cash to fulfill our contracts, but we had the opportunity, if there is a lot of water a lot of water in the reservoirs to not burn, and therefore ship those cargoes to international customers at obviously the international rates. So there's a very interesting arbitrage opportunity there. So it's a one-sided bet. If it stops raining, or if the reservoir levels fall then we'll just consume the gas and fulfill our contracts."
},
{
"speaker": "Angie Storozynski",
"text": "And how sort of, are you going to know that? So in a sense, I mean, it's hard to predict hydro conditions, but I mean, is it a bit like a rainy season by some months?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. So look, it's been raining a lot. So the rainy season has started. The reservoirs are full and that's why we're able to make these sell gas to international customers and get that arbitrage. What I'm referring to more really would be 2023 do these conditions persist, or does say 2023 start off being a very dry year. So for 2022, we're locked in. It's really a question of will this opportunity repeat in 2023."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. Okay. So moving on to the other inflation bill, so I understand, the comments you made about green hydrogen and energy storage. But when you actually listen to smaller developers they are also talking about maybe installing – adding solar PV to existing sites of conventional power assets, retrofitting existing assets with storage facilities. I mean, some changes in repowering of wind farms. I mean, there are some I would say secondary benefits from that bill, which could also benefit your portfolio. I guess it depends on the age of your contracts, and how heavy they are in the money. But could you talk about again benefits or additional benefits that this bill could add to your existing portfolio?"
},
{
"speaker": "Andrés Gluski",
"text": "Yeah. Well, of course, I think it helps repowering and add-ons. What we have to see is that, we already have contracts in these places. And so the question is, do we negotiate an additional contract from that location based on – we've done repowering already we're starting to – we've been repowering units in California at Mountain View, and also we plan to do some in Maryland at Laurel Mountain. So this helps those to happen, and you're right. It does -- one does have to look at what you have existing and what additional opportunities there, but since we are on the renewable side pretty much fully contracted then the question would be that additional energy do you -- is there an adder that you could add to the same client to keep it simple, or what are the opportunities there? But you're right, this is an upside that's smaller so we haven't talked that much about it."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And lastly, I mean, we saw these media reports about Vietnam and offshore wind. I mean, I don't think that I've ever imagined yet and offshore winds in the same sentence. So could you talk about that opportunity?"
},
{
"speaker": "Andrés Gluski",
"text": "Sure. You noticed it was in our press release. First, so I'd say, look this is a -- we're in Vietnam. We're helping the Vietnamese come up with a plan to decarbonize their grid. So we do have the LNG terminal project there. And we are -- have been talking about bringing in energy storage and other renewables. So, to eliminate the need for additional coal plants. So at this point, I'd say, this was more sort of an exploratory issue. We will be very disciplined and committed to all the goals that we've given 50% US, 50% renewables. Now whenever we get into a new technology, we'd obviously have to partner with somebody. So we haven't done any offshore wind, because it didn't make sense economically. The markets we're in like the US, there's still plenty of land and it just really wasn't cost competitive. But we have nothing, let's say, against the technology itself. But of course, we would have to partner with somebody who has a long experience. And so we're not going to get into a new technology in a large scale on our own at this time. And so this was -- again, this is not an announcement from us and what we guarantee is we're going to stick to the exact goals that we have given you."
},
{
"speaker": "Angie Storozynski",
"text": "Great. Thank you."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you, Angie. Our next question comes from Julien Dumoulin-Smith from Bank of America. Julien, your line is open."
},
{
"speaker": "Paul Zimbardo",
"text": "Hi. Good morning. It's Paul Zimbardo sitting in this busy morning. Thanks a lot."
},
{
"speaker": "Andrés Gluski",
"text": "Good morning."
},
{
"speaker": "Paul Zimbardo",
"text": "I wanted to check in. I believe the last long-term guidance you gave for AES Next was breakeven net income by the end of the plan in 2025. That's still a good assumption? And how could that evolve under the Inflation Reduction Act?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Actually, it was 2024, Paul, that I said that. So look Fluence is the largest component of Next. So I can't go into detail, they'll have their call soon and we'll talk about their performance. But they've been executing on a number of things lately. As Andrés talked about, they are launching their Utah manufacturing facility. They're diversifying their battery supply base. So, we fully expect based on what they've guided to which is that they'll be bottom line neutral by 2024. That's very consistent with what we've included in our guidance as well. And so I would say, they'll talk about their progress, but we feel good about both. But Fluence is doing as well as the levers that AES has regardless of what happens with Fluence that that portfolio will be neutral and then growing from there."
},
{
"speaker": "Andrés Gluski",
"text": "And maybe speak a little bit about the other components like Uplight. As you know, they did the deal with Schneider Electric. So they now have a much, let's say wider product offering and very strong strategic partner in Schneider. And then you have 5B, which is the producer of Maverick the prefab solar. We're seeing a lot of interest in Maverick, where you have the first large-scale projects being completed in Chile. We have big projects in Puerto Rico. And we've already done a small project in Panama. So what's very important about this project is – this product is that it's hurricane wind resistant. So we're seeing a lot of interest in all sort of hurricane built of the Caribbean for this product. And there's also been a change of government in Australia. This is an Australian company. So they have very large projects in Australia, which were looking very favorably and that's the sort of hometown [indiscernible]. So we feel good about that as well. So overall we feel that AES Next is fulfilling its mission of really giving us the leading-edge technologies and giving us the opportunity to be the first to roll them out."
},
{
"speaker": "Paul Zimbardo",
"text": "Okay. Great. Thank you. And then just separately could you please elaborate a little bit on the recent California legislation, how that would impact either extending, increasing or both the cash flows from the gas assets you have there?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. No we feel very optimistic. So we have – as I talked about previously, we've only included Southland legacy businesses, you've got Alamitos Huntington Beach and Redondo through 2023. So it may not be all three plants, but I would say probably at least two that we would expect to be extended possibly for several years. So the formal process I would expect in terms of permitting the ones through cooling permits that are needed, et cetera will likely kick off here in the next one to two months. And then that will run into the first say half of next year through the first half of next year. As we've done in the past, when we've been facing a potential extension, we've looked to do where we've executed contingent capacity contracts, continued upon the permitting and all that coming forward – going forward. So we'll start looking at commercial opportunities for the extensions, once the formal process gets underway in the state. And so we'll have more certainty next year but I would say, we're all very optimistic here that given the fundamentals of the California system and the droughts in the Southwest of the US but that additional peak capacity is going to be needed for several years to come. And so we feel we're in a good position to provide that and that will provide some upside to our plan."
},
{
"speaker": "Paul Zimbardo",
"text": "Great. Thank you, Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Paul"
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from David Peters from Wolfe Research. David, your line is open."
},
{
"speaker": "David Peters",
"text": "Yes. Hey, good morning, everyone. Andrés, I was just wondering if you could comment, specifically with respect to the US, LPA. We've heard from some companies here recently that they're seeing issues with panels being stopped recently at the border. Just wondering if you all are seeing this at all and if not kind of what you're doing differently I guess."
},
{
"speaker": "Andrés Gluski",
"text": "Yes. The Uyghur Forced Labor Prevention Act, we have not seen any of our panel imports stopped by -- excuse me. As you know we've been on top of this matter for a long time, the polysilicon -- first the panels that we import to the US, come from Southeast Asia ASEAN countries. And we have asked the manufacturers to make sure that there's nothing that comes from Western China, that could be allegedly using forced labor. Polysilicon, the plan is that we're starting to use polysilicon coming from Korea. And that China would be the more likely place, where you -- there could be allegations of forced labor. But as you know the making of the wafers themselves, 95% of that today is still occurring in China. So we have to move that supply chain out of China, but it's going to take some time. But the short answer is no, we haven't seen anything and we believe our suppliers are the best place not to have any issues and documentations and we've been working with them, for a long time now. So this is nothing new, but we have to just see how this develops. So we don't expect any major issues."
},
{
"speaker": "David Peters",
"text": "Great. And then just one other one on the asset sale target being at the low end, and I guess you're expecting a little less dilution this year, as a result too. Can you just give a little bit more of an update on the processes in Vietnam and Jordan? And just when are those expected to close I guess?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. Look, what's basically have, at least have to do with government approval. So we've agreed with our counterpart. It's not a question of price. It's just a question that the government -- well in the case of Vietnam, it's been the government's approval, of the new operator of the plant. And so that's taken some time for them to get comfortable with it. That's why it's dragged on. But we do expect resolution, by the end of this year. And the other case, I think you mentioned is Jordan, and that really has to do with some of the lenders including the US government signing off the loans, to the new buyers. So these have been really just bureaucratic issues, but the sale price, the buyer, the conditions have all been agreed to and it has taken longer than we expected."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Yes. And that's the majority of the $500 million. So we feel good, as Andrés said, we'll get there on those by the end of this year. And then, we have been working on additional sales and sell-downs of primarily thermal businesses. So as we work towards those and the timing around those, some variability, it looks like some of that may happen in say the first half of 2023, which is why we said, let's focus on $500 million this year, the remaining of the $500 million to $700 million will come in through next year. And then we have the full $1 billion target, we feel well on track for. So, it's just a matter of some timing expectations around, what we're doing in the next say 12 months or so."
},
{
"speaker": "David Peters",
"text": "Okay. Thank you, guys."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. We have no further questions. Therefore, I would like to hand back to Susan Harcourt, for any closing remarks. Susan, please go ahead."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions, you may have. Thank you and have a nice day."
},
{
"speaker": "Operator",
"text": "Thank you. Ladies and gentlemen this is today's conference call. Thank you for being with us today. Have a lovely day ahead. You may disconnect your lines now."
}
] | The AES Corporation | 35,312 |
AES | 1 | 2,022 | 2022-05-06 10:00:00 | Operator: Good morning. Thank you for attending today's AES First Quarter 2022 Financial Review Call. My name is Amber, and I will be your moderator for today's call. [Operator Instructions] I now have the pleasure of handing the conference over to our host, Susan Harcourt, Vice President of Investor Relations with AES. Susan, please go ahead.
Susan Harcourt: Thank you, operator. Good morning, and welcome to our first quarter 2022 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our first quarter 2022 financial review call. I am very happy to report that we have attained an investment-grade rating for Moody's. We are now investment-grade rated by all 3 major agencies, which is an important milestone for our company, and reflects a decade worth of work to transform our business. We're also reaffirming our 2022 guidance and annualized growth of 7% to 9% through 2025. Our business model continues to demonstrate its resilience and predictability even in the face of market volatility. Steve will cover our expectations for the remainder of the year in more detail, including the seasonality of our earnings profile. Today, I will discuss our 2022 construction program and the Department of Commerce's investigation into solar panel imports, the diverse drivers of our growth, including signed renewable energy PPAs and our U.S. utility, AES Next influence, and our strategic outlook for the sector. Beginning with our 2022 construction program on Slide 4. We are laser-focused on ensuring timely completion of projects. As we see our ability to execute on our commitments as a key source of competitive advantage. This year, we expect to complete more than 2 gigawatts of new renewables, including over 800 megawatts of solar in the U.S. In late March, the U.S. Department of Commerce launched an investigation into solar imports from 4 Southeast Asian countries, which collectively supply approximately 80% of solar panels for the U.S. market. The Department of Commerce is expected to make a preliminary determination on this case by no later than August. The resulting uncertainty around tariff levels has led to a drop in imports and project delays across the industry. However, due to our supply chain strategy, all of the panels for our 830 megawatts of projects to be completed in 2022 in the U.S. are already in country, and we do not anticipate any delays to those projects. I'd also note that 1/3 of our 2022 renewable projects are international and the remaining 683 megawatts in the U.S. are wind and energy storage. Moving to the diverse drivers of future growth, beginning on Slide 5. Our strategy is to provide differentiated products that allow us to work with our customers on a bilateral basis. As a result, last year, we signed a total of 5 gigawatts of PPAs for renewable energy, including more contracts with C&I customers than anyone else in the world. For full year 2022, we continue to expect to sign 4.5 to 5.5 gigawatts of renewables under long-term contracts with a roughly 50-50 split between the U.S. and international markets. We do expect PPA signings in the U.S. to be more weighted towards the second half of the year. So far this year, we have signed or been awarded 1.1 gigawatts, bringing our backlog to 10.3 gigawatts. Despite current headwinds for the sector, such as delays in U.S. climate legislation, and the supply chain issues we just discussed, we continue to see very strong demand for low-carbon energy and especially for structured products, such as our 24/7 renewable offering. In fact, as you may have seen earlier this week, we announced 2 key agreements for our structured products. First, the expansion of our partnership with Microsoft into California, the third market where we will supply renewable energy to match the load at their data centers; and second, our agreement with Amazon, under which we will provide 675 megawatts of renewable energy to their operations in California, including AWS' data centers. With these agreements, we are helping both companies achieve their ambitious sustainability goals. As you can see on Slide 6, we believe our development pipeline of 59 gigawatts is the second largest among U.S. renewables developers. This robust pipeline provides us with the projects we need to deliver on our backlog and continue to build on our competitive position in the market. Now turning to our regulated U.S. utility platforms, beginning on Slide 7. These businesses represent one of the key contributors to our overall 7% to 9% annual growth in earnings and cash flow as well as advancing our objective of increasing the proportion of earnings from the U.S. to 50%. In both markets, we have the lowest residential rates in the entire state which provides a runway for growth and investment while keeping affordable rates for our customers. Moving to Slide 8. In Indiana, we're benefiting from incentives to modernize the transmission and distribution network and transitioning to greener generation. Through 2025, we will be investing $2.7 billion, which we will recover through already approved rate mechanisms. Additionally, we expect to finalize our next integrated resource plan by this fall, allowing us to further transform AES Indiana's generation fuel mix. In Ohio, we're capitalizing on formula rate-based investments in the transmission network. At the same time, we are implementing our Smart Grid investment program, which is recovered through an existing rate mechanism. We also have a distribution rate case pending before the Public Utilities Commission of Ohio. Later this month, we will be presenting oral arguments directly to the commission and a favorable outcome, in this case, will bolster our ability to make the new investments needed to further strengthen AES Ohio's network. Turning to Slide 9. Through 2025, we expect to invest $4 billion to modernize our U.S. utilities. These investments translate to average annual rate base growth of 9% through 2025, which is at the high end of growth projections for U.S. utilities. We expect the earnings from these core businesses to grow in line with the rate base. Turning to Slide 10 for an update on AES Next. We are developing and incubating new products and business platforms through AES Next. Our investments in AES next help our businesses to be more innovative and competitive and drive value for our customers and shareholders. We are proud that earlier this year, Fast Company named AES is one of the 10 most innovative energy companies in the world and the only large publicly-traded company to be included on that list. Turning to Slide 11. The most mature initiative under AES Next today is Fluence, which as of December 31, had 4.2 gigawatts of energy storage products deployed and contracted and a signed backlog of $1.9 billion. Additionally, Fluence's digital platform, Fluence IQ, recently acquired Nispera, and now has a combined 15 gigawatts contracted or under management, of which more than 80% is with third-party customers. Over the past several months, Fluence has been dealing with short-term challenges mostly stemming from COVID-19 related supply chain issues. Their management team has taken proactive steps to address these challenges, including diversifying battery suppliers signing new shipping agreements, building out their in-house supply chain team and regionalizing their manufacturing. Overall, demand for energy storage remains very robust, and Fluence is well capitalized and positioned to grow as a market leader. We see a pathway for them to improve their margins and grow as the global energy transition continues to progress. Finally, turning to our strategic outlook for the sector, beginning on Slide 12. Our goal is to be the leader in providing low carbon energy solutions while delivering annualized earnings and cash flow growth of 7% to 9% through 2025. Today, there is an unprecedented transformation of our sector underway with governments, utilities and companies working to shift to low carbon sources of power. For example, just looking at the public commitment of the RE100, a group of over 350 large corporations who have committed to 100% renewable energy. We expect our annual demand to more than double to almost 400 terawatt hours of renewable energy by 2030. Facing this immense opportunity, we’re taking steps to ensure our continued competitive advantage in this once in a generation information of our sector. As you can see on Slide 13, this transformation is reflected in our own portfolio as we expect renewables to represent more than 3 quarters of our installed capacity by the end of 2025. During that same time period, we expect our renewables business to nearly triple from 13 gigawatts to approximately 38 gigawatts and our capacity from coal to go from 7 gigawatts to zero. With that, I will now turn the call over to our CFO, Stephen Coughlin.
Steve Coughlin : Thank you, Andres, and good morning, everyone. Today, I will discuss our first quarter results 2022 parent capital allocation and 2022 guidance. Beginning on Slide 15, as Andres highlighted, I'm very pleased to share that Moody's recently completed a thorough review of our consolidated debt and cash flow across our businesses and upgraded AES to investment grade. This conclusion further validates our year's long effort to reduce risk and strengthen our balance sheet and will yield further benefits as we grow our business and attract new investors to AES. As an investment-grade rated company, we will continue to lead the renewable sector while growing our U.S. utility asset base and our long-term contracted generation portfolio. Turning to Slide 16 and the resiliency of our business model. Today, 85% of our adjusted PTC is from long-term contracted generation and utilities. We are largely insulated from the current macroeconomic volatility affecting commodity prices, inflation, interest rates and foreign currencies, with the vast majority of our portfolio benefiting from contractual indexation, fuel pass-through or hedging programs that limit our exposure. Combined, these macroeconomic factors had an impact of less than $2 million on our adjusted PTC in the first quarter. For the full year, we currently expect a net positive contribution from these macroeconomic factors as a result of higher natural gas prices and higher power prices in some of our markets. Now turning to our financial results for the quarter, beginning on Slide 17. Adjusted EPS for the quarter was $0.21 versus $0.28 last year. Our core business segments grew by $0.04 over the first quarter of 2021. These positive contributions were offset by several negative drivers we had already anticipated in our 2022 guidance. First, higher losses at AES Next, primarily resulting from COVID-related supply chain issues at Fluence in the fourth quarter of 2021. As a reminder, we report Fluence's results on a 1 quarter lag. So the Fluence results relate to their December quarter end, which was disclosed in February and included in AES' full year guidance on our last call. Second, the higher share count as a result of the accounting adjustment we made for our equity units. Third, a higher quarterly effective tax rate than our overall expectation for the full year due to timing. And finally, nonrecurring gains on interest rate hedges recorded last year, which skewed the quarter over prior year quarter comparison. Turning to Slide 18. Adjusted pretax contribution, or PTC, was $207 million for the quarter, which was $40 million lower than 2021, consistent with the drivers I just discussed. I'll cover the performance of our strategic business units or SBUs in more detail over the next 4 slides. In the U.S. and utility strategic business unit, or SBU, higher PTC was driven primarily by earnings from new renewables coming online and higher contributions from Southland, partially offset by higher spend at AES Clean Energy due to an accelerated growth plan. Higher PTC at our South America SBU was mostly driven by our increased ownership of AES Andy's and higher contracted revenue in Colombia. Lower PTC at our Mexico, Central America and the Caribbean, or MCAC SBU primarily reflects the sale of Tablo in the Dominican Republic in 2021 and lower availability at our generation facilities in Mexico. Finally, in Eurasia, higher PTC reflects higher revenue at our Mandan facility in Vietnam and higher power prices at our wind plant in Bulgaria, driven by commodity price increases. Now to Slide 23. We are on track to achieve our full year 2022 adjusted EPS guidance range of $1.55 to $1.65. Our typical quarterly earnings profile is more heavily weighted towards Q3 and Q4, with about 2/3 of our earnings occurring in the second half of the year. We continue to expect a similar profile this year as we grow more in the U.S. where earnings are higher in the second half of the year based on solar generation profiles, utility demand seasonality and the commissioning of more new projects in the third and fourth quarters. Growth in the year to go will be primarily driven by contributions from new businesses, including over 2 gigawatts of projects in our backlog coming online over the next 9 months, as well as further accretion from our increased ownership of ASMs. We are also reaffirming our expected 7% to 9% average annual growth target through 2025, based on our expected growth in renewables and U.S. utilities as well as the recycling of our capital into additional investment opportunities we see across our global portfolio. Now to our 2022 parent capital allocation plan on Slide 24. Sources reflect approximately $1.4 billion to $1.7 billion of total discretionary cash, including $900 million of parent free cash flow and $500 million to $700 million of proceeds from asset sales. On the right-hand side, you can see our planned use of capital. We will return nearly $500 million to shareholders this year. This consists of our common share dividend, including the 5% increase we announced in December and the coupon on the equity units. We plan to invest approximately $900 million to $1.1 billion in our subsidiaries as we capitalize on attractive opportunities for growth. Nearly half of these investments are in renewables, reflecting our success in securing long-term contracts during 2021 and our expectations for 2022. About 25% of these investments are in our U.S. utilities, to fund rate base growth with a continued focus on grid and fleet modernization. In summary, close to 3/4 of our investments this year are going to renewables growth in our U.S. utilities businesses helping us to achieve our goal of increasing the proportion of earnings from the U.S. to more than half by 2023. In fact, we have made great progress on our growth investments so far this year with approximately $650 million already invested primarily in renewables and to increase our ownership in AES Andres. We will continue to allocate our capital in line with our strategy to lead the renewable sector, further anchor AES in the U.S. market and to decarbonize our portfolio. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. In summary, our core business continues to perform well. We have attained investment-grade ratings from all 3 major agencies. We are reaffirming our 2022 guidance and annualized growth through 2025. We continue to deliver on our commitments, including our 2022 construction projects, which we expect to commission on time even with the ongoing Department of Commerce investigation into solar panel imports. We are energized by the immense opportunity for growth in our business and remain committed to maintaining our competitive advantage. With that, I would like to open up the call for questions.
Operator: [Operator Instructions] Our first question comes from Insoo Kim with Goldman Sachs.
Insoo Kim: First question on the solar -- the U.S. solar investigation. Good to see that the '22 projects are on time and on schedule. Just for 2023 exposure, could you give a little bit more clarity on the amount of capacity that maybe has been contracted and need to be delivered? And what type of timing delays, if any, that we could expect for next year? And then just related to that, if there are delays to that, that were embedded in your growth for '23, how much flexibility do you have to move around other items to still hit your growth.
Andres Gluski: Let me start with a little background on the commerce case. So this case is an investigation by commerce into allegations of 1 U.S. manufacturer that panels and sells imported from 4 countries in Southeast Asia are circumventing existing antidumping and countervailing duties on solar panels and cells coming from China. So we think there are strong legal grounds for commerce to make a preliminary determination before August that will signal to the market that the allegations are unfounded and will be conclusively dismissed without new tariffs. One of the legal requirements for determining that circumvention occurred is that the activity in Southeast Asian countries must be considered minor or insignificant. However, the solar panel and cell suppliers operating in these countries have invested billions of dollars in technologically sophisticated manufacturing, assembly and processing facilities so that their activities do not appear to be minor or insignificant. Additionally, the critical step of creating solar cells occurs in these countries and not in China and involves the conversion of the wafer into a cell. Commerce itself as previously ruled that this step determines the country of origin for solar imports. For these reasons, we think that there are strong grounds for commerce to make an expedited determination. It's also important to note that there's broad industry opposition to this investigation, including from many U.S. manufacturers because they rely on solar cells from Southeast Asia in order to manufacture solar modules here in the U.S. Currently, the U.S. manufacturing industry can only need about 20% of U.S. demand and their capacity to increase supply is negatively impacted by this investigation. This further supports the decision by commerce to dismiss the circumvention plane underground that a finding of circumvention would not be appropriate due to harmful impacts. So we'll continue to advocate a rapid resolution of this case. Now getting specifically to your question, I think what we were able to do this year shows to our supply chain management strategy. And many of you will recall that for 3 years, I've been arguing that this huge wave of renewable demand was coming and that there were going to be shortages of everything, from developers, to land, to interconnections. And now, we've had, I'd say, an additional issue with this commerce -- before commerce for solar pounds. So we've been not ahead of this. Now what will determine what will happen in '23 to us. And again, I think we're in the best shape of anybody in the industry, will be if there's an early resolution or if there is a determination they take the worst case. There's comes out and they say that there is a convention and there's going to be a tariff of X. Okay. Well, then people can put cash deposits at that point. Now I think this would have a very deleterious effect for the whole solar industry in the U.S. I think we would be in better shape because we're primarily selling to corporates who have more flexibility than people say utilities with RFPs who are much more regulated. So given that, I'd say, look, right now, we don't know. I mean worst case, and we continue to negotiate with our clients, with advances. We're not signing them yet because we're waiting for this final determination. But this is not going to stop us. And in terms of the construction, it depends how the case comes and the sort of shipping backlogs and the rest. It could potentially affect the second half of '23 but we'll have to see. So we're doing everything possible to minimize this. And I think the proof of the pudding is in the eating. I think we're one of the few solar U.S. developers who did not have to postpone or cancel any projects this year.
Insoo Kim: That's good color. And maybe just the second part of my question was just if maybe the -- not the worst case, but a nonconstructive case comes down and the delays are more significant for the whole industry. Just your portfolio of global projects, whether it's wind or storage or whatnot, ARPU diverse, how much flexibility do you have to pull different levers to still achieve that growth?
Andres Gluski: Well, that's a great point. If you think of our backlog of 10.3 gigawatts, only about 1/3 is U.S. solar. So the rest is either international or wind or other technology. So again, I think that what will happen, well, it -- we are at a diverse portfolio. And so we will try to make it up elsewhere. But again, we think that they're very strong ground to this miss case, honestly, it doesn't make a lot of legal sense, honestly. A prior similar case was dismissed because they didn't have let's say, nobody was standing up in front of it. Now you have 1 small U.S. manufacturer. And I think the grounds of this being insignificant or not material, the value-add added in Southeast Asian countries is almost laughable quite frankly. So it is just rent seeking, I think, from a few small U.S. players. What is dramatic is it's had such an effect on the industry. Now again, fortunately, we've been very concerned about shortages for 3 years. And you'll also recall that even with COVID that first appeared in February of 2020, we talked about a potential effects on supply chain. So again, stay tuned. I don't think there's anybody in better shape than us. And as you point out, we are diverse in terms of technologies and also in terms of geographies.
Insoo Kim: Okay. That makes sense. My second question quickly. The Slide 43, the sensitivity slide to different moving commodities or currencies or whatnot, it’s always helpful. Us. Just the update there. I think with stuff like Henry Hub gas prices being almost $8 to $9 right now, just looking at your sensitivity of the year-to-go assumptions. If these commodity prices do remain elevated and with no other changes, it seems like there could be a more meaningful EPS impact for 2022, but that assumes no other changes, whether it’s power prices or whatnot. Can you just walk through at this point with the various commodity price or power price environment? How do you see that net for the balance of the year as it stands today?
Steve Coughlin: Yes, it’s Steve. So just as a reminder, that page, those sensitivities are in isolation. So when you see the gas price sensitivity, it’s not – doesn’t include any corresponding power price increase, which we would actually expect to happen in most cases. So on balance, the environment, we’re really on the net positive side as I said in my comments. In particular, in Bulgaria, we have our wind portfolio there, which has done very well, and I expect we’ll do very well for the rest of this year. It does have some market exposure and with power prices in excess of 200, it’s done very well. And then the other thing I would point to is our LNG business in MCAC. So we have long-term contracted gas that’s been contracted for some time. So in fact, there are some upsides that we’re working – have worked through and we’ll continue to work through to take advantage of some of the high gas price opportunities to benefit our LNG business. So I think there’s upside there as well. Southland has been another upside we see the Q3 hedging program, another success. We expect more success this year was $0.05 of energy margin upside last year. So on balance, we’re actually in quite good shape. Most of our contracts are inflation indexed around the world. I think it’s like 83%. Those that are not are really U.S. renewable contracts where we’ve locked in our cost upfront, and that was baked into the overall cost of the – our pricing in PPA. So really, AES has transformed a lot. And actually, we’re in quite good shape in this environment.
Andres Gluski: I would say, too, we’re on the right side of history on this one. I mean, because where we have fuel, it’s mostly a pass-through. And we’re mostly competing with fossil fuels with either hydro, with renewables. So – and I would say the biggest winner of what’s happened is really Bulgaria because in Bulgaria, we’ve just signed an MOU with the government of Bulgaria where they recognize the validity of the PPA. And they also – we’re working together on decarbonizing the Maritza project, whether it be – we’re looking at different alternatives, whether it carbon capture and sequestration, biofuels or conversion to gas and at the same time, stepping up investments in energy. Again, I really can’t think of any case where this is impacting us negatively.
Operator: Our next question comes from Richard Sunderland with JPMorgan.
Richard Sunderland: And maybe just wanted to touch on the 2023 solar outlook a little bit more. Could you speak to a little bit more around the risks there beyond just the earnings delays? Is it really just so much as the timing of the earnings come in? Are there any contractual obligations around energy procurement or elsewhere that you need to fulfill with those contracts?
Andres Gluski: Yes. No, I'm not aware of any, quite frankly. I think that I don't think it would be demand destruction. It would be a delay in some cases of commissioning them. But no, we would obviously have -- our contracts would not hold us to having to supply energy if there is a major disruption in the solar panel market. But again, we think that's the -- not the most likely scenario, but if it were to occur, we wouldn't be suffering LDs because of not fulfilling contracts.
Richard Sunderland: Got it. Very helpful. And then thinking about the announcements around these recent structured deals, could you speak to a little bit of the capacity, overall appetite there? And then I guess just to be clear on the Amazon front, are those new projects or reflected in the 2021 signings?
Andres Gluski: Yes. First, most of these are reflected in 2021 projects. But what I would say is we're seeing a tremendous demand for our structured project. And we have been talking about this year, we weren't able to release some of the names prior to that until the client was ready. But we can do more projects. I think the real issue is to have the projects in the right market ready. So it's -- stay tuned. More is coming. But I think what we like very much is it shows like a repeat buying. So with microcells, for example, we've done projects in PJM. We did a project in Chile, and now we big clients. So if you think of the large data center clients, we have big contracts with 3 of them. And we're very big. The demand is there. It's a question of how fast we can bring the projects online.
Steve Coughlin: Yes. And I would just add, this customer, Richard, we have the flexibility to pivot to some other markets. We've done Microsoft, we've done Google in Chile. And so the Amazon announcement is what we've been able to announce. This is something I wanted to talk about for some time, but there's more to come. And we've built the pipeline significantly. We're up pipeline, and that's in large part because we're playing forward the demand coming from our commercial industrial customers in aggregating the pipeline where we know that they're going to need us to supply their load.
Andres Gluski: Yes. I think an important point -- a good part of this pipeline is in California, and it's quite ready. And that we started acquiring land and interconnection rights about 3 years ago. We really got a little bit ahead of this wave that we see now. So the demand is there. It's a question of bringing all the projects online. Now realize that these are versions of 24/7 or round the clock renewables. So it's not only a question of having the availability to build new megawatts, it's all guaranteed netted on an hourly basis, renewable energy.
Richard Sunderland: That's very helpful color. And I just wanted to follow up real quick on the sort of contracting backdrop. You talked a little bit about more risk weighted into the U.S. signings, obviously, the DSC overshadowing all of these. So can you give us a little bit more color on what you're seeing in terms of discussions to get it active, but you just point to then start finalizing. Any more information would be helpful there.
Andres Gluski: Yes, right. You can characterize this, right. We are in discussions, and there are more contracts with clients and that I'd say a factor is having some clarity in August, what it would be because you have to make cash deposits and have greater flexibility and speed than, say, regulated clients. So let's see what happens. But again, I think it's just going to be more cars, this would slow us down. And it would basically make renewables in the U.S. more expensive. So if you want onshore manufacturing, what do you need? You need cheap and clean energy. It's a vital factor. And again, we are in the best shape, I think, of anybody in the sector. So its effects will be much greater outside of AES.
Steve Coughlin: Yes. And I would just add, the last year, 80% of the contracts were done in bilateral commercial industrial PPAs, so bilateral negotiations. So the customers that we're working with are very much aware of this issue. We're moving forward with all the details that we can move forward on, and this piece is open, and it's very frustrating, and it's not a good thing. But these are customers that have made very strong and vocal commitments to their decarbonization, and we suspect they're going to want to continue to find the path to get there. And since we're in a bilateral relationship, I think we're going to work through that.
Andres Gluski: And I would add look, we're all in favor of onshoring. But what you need is certainty and you need a time line. So you need to know what tariffs will be applied in what way. And -- but you also have to say how far down the supply chain they're going to go. And the further down the supply chain, you're going to go, the more time you need to move the supply chain. And so for example, right now, most of -- most of the solar panels we're buying from Southeast Asia. Actually, the polysilicon is going to be coming from Germany. So it's not even coming from China. So this is basically rent-seeking by a small number of -- or actually 1 firm in this case. And in significant firm I may add. I don't think it's delivering 1% of the supply in the U.S. So it really is quite agree to the whole situation.
Operator: Our next question comes from Durgesh Chopra with Evercore.
Durgesh Chopra: Steve, maybe this one is in sort of your house. I was just going to ask you, as it relates to the 2022 EPS guidance, Steve, can you remind us what are you modeling for Fluence in that -- embedded in that guidance? And then obviously, Fluence had some challenges with COVID-19 as Andrés articulated in his prepared remarks. If that continues throughout the year, what kind of flexibility do you have to kind of make that up in other areas of the business?
Steve Coughlin: Yes. So thanks for the question. Look, to Fluence had a difficult their first quarter, which, as I had in my remarks, for their fiscal '22, our fiscal year runs October to September, and we report them on a 1 quarter lag. So what they reported in December is just hitting this quarter that we're now reporting. So we already had anticipated an updated forecast for Fluence when we gave our guidance, and that's largely -- that's about what I can say on it. Unfortunately, Fluence. I can't say much more. My hands are tied here. They're a public company, they'll be releasing earnings next week. But what I can say is I feel very comfortable given that I have the latest expectations for Fluence in our numbers. We've already absorbed their first quarter, and we reported that here. So look, they've had a lot of issues that they've talked about. I think they're working through those. Some of them are quite temporary in nature, and they've already worked through both shiny new shipping contracts, diversifying their battery supply, they're regionalizing their manufacturing around the world. So I think it's going to take some time as they've said to work through some of these challenges. But we're very confident. The long term is strong. They're -- the entire market has continued to be very strong. The demand is still there. I think they had kind of the perfect storm of some issues coming together here with supply chain batteries, shipping, et cetera. But in our guidance, we have the latest forecast, and it's not it's knocking us off our guidance range.
Andres Gluski: What I would add is that the company is well capitalized and see strong demand. And what you're seeing is increase in battery supply outside of China. So you just saw the announcement by the U.S. government that they would have incentives for battery manufacturer in the U.S. Point has an agreement with North Volt for production of batteries in Poland. So I think what you're going to see is the main constraint, which has been access to batteries will start to be addressed. Now it's not going to be immediate, but by next year, you start seeing more capacity come online.
Durgesh Chopra: Got it. That's very comprehensive. In terms of just going back to the backlog of additions, right? I mean you started the year strong, roughly over 1 gig versus the 4.5 to 5.5 gig target. Sounds like you're confident that you're going to hit that in 2022, but as we think about '23 in light of the solar investigation, in light of the commentary around potential delays. Do you go back? Like, I mean what's -- so the current plan, I think the long term, the 7% to 9% EPS growth is predicated on, correct me if I'm wrong, 3 to 4 gigawatts a year. Is that sort of -- do you expect to sort of hit that in 2023, maybe the low end? Or what's the thinking there as we think about 2023 this year?
Andres Gluski: So you're talking about signing new PPAs? Are you talking about commissioning of projects?
Durgesh Chopra: The new PPAs, Andrés, the target.
Andres Gluski: The PPAs. Okay. Look, in the first quarter, we did 1.1 gigawatts. So we are on target for our 4.5 to 5.5 gigawatts for the year. As I mentioned, due to this Commerce case, some of the signing of PPAs in solar in the U.S. will be more heavily weighted towards the second half of the year because people will wait until this resolution and come to a conclusion. Do I think that this will knock us off our growth trajectory? No? The answer is no. And because -- if anything, it might move things around from 1 quarter to the next. But we're seeing very strong demand for our products. And this will -- the RE100, for example, they're not going to render their sustainability goals. So they're going to go forward with this. So I think that -- I feel confident of it. Kind of cause some delays in signing of PPAs. Yes, we're saying that. But I think that we'll have a catch-up. So it might make things a little bit lumpier than they would be otherwise, which is not ideal. But that's the hand we've been built.
Durgesh Chopra: Understood. It sounds like the long-term trajectory intact; you may have some lumpiness in the near term. But you feel confident long term in hitting all of our targets?
Andres Gluski: Exactly, exactly.
Operator: Our next question comes from Julien Dumoulin-Smith with Bank of America.
Julien Dumoulin-Smith: So I want to sort of quantify things a little bit more if we can. Obviously, we talked about these commodity sensitivities a little bit earlier. Can we talk about the longer-dated commodity sensitivities and trying to quantify it based on what's implied in your slides? And it looks as if -- again, these commodities are flying around, but it could be north of $0.10 positive versus what you guys -- your last guidance. I mean, is that directionally, correct? I mean can you try to quantify that a little bit in the affirm it? And then related to the extent to which that is true directionally, what does that mean in terms of your appetite to potentially expedite the exit from Bulgaria, for instance. I just want to try to get at that a little bit more and/or absorb some of these other impacts, be it solar or affluent and still be within your range or higher within your range.
Steve Coughlin: Sure. Julien. So you're right. I mean, and you're looking through the page on the commodities and seeing that there's actually upside here, as I described. So Bulgaria, where the power prices are high, we're really seeing significant upside there, both in the near term as well as in the value of the Maritza plant, which is under contract, but that PPA is well in the money for the government of the people in Bulgaria, plus we have the upside in the wind plant. In our LNG business, in our gas businesses in Central America and the Caribbean, we have long-term gas contracts that have been set well before this commodities environment. So we have some flexibility in how we manage our cargoes, we have customers or plants that have dual fuel capability. And so we're able to perhaps work in swapping to liquid fuels and redirecting cargoes into Europe, for example, with our partners. So this is a really important part of our portfolio, one that we don't tend to talk a lot about, but it is in this environment, important diversification of our portfolio. So we see both with power prices as well as the upside in our position in natural gas, given our long-term contracts. But yes, directionally, you are correct. I wouldn't venture to say whether it's $0.10 or exactly at this point. But some of that relies on discrete transactions that we will do and have done and will do to take advantage of that upside in LNG.
Andres Gluski: Yes. And talking about Bulgaria, what I would say is, look, -- in the past, the PPA had been questioned before the sort of anticompetitive -- say, legal state really was the case before the European Commission. So what we're seeing is that -- to some extent, we're getting past that. This is a confirmation of the PPA. So it's a very attractive asset. Maritza is a very attractive asset through the end of its contract period and beyond, it's actually doing what -- the reason it was built was to make Bulgaria independent of Russian gas. That's why it was built and it uses local coal. So it's not affected by international prices. So it's very much in the money for our clients. So the asset is much more valuable today than it was, say, 6 months ago. And we've also agreed to help the Bulgarian government look at energy storage and other alternatives to wean, say, Maritza away from just running on coal. So stay tuned to that. But I'd say this has been the big winner from this horrible situation in Europe.
Julien Dumoulin-Smith: Got it. Fair enough. And then I just want to try to quantify versus some of the qualitative comments earlier around the AD CVD risk on '23. I just -- again, it sounds as if specifically, you're reaffirming the origination ranges going into next year, your confidence is there. Is there any -- I mean, when you try to quantify any of these risks, any way to do so around solar here? Just any quantum of origination risk? Any quantum of impact and higher costs, et cetera. I just want to make sure we're crystal clear on this all.
Andres Gluski: Yes. Look, what I would say is the following. Look, we are continuing to negotiate with our clients. This has pushed off the final signing of a number of additional PPAs because there's uncertainty about the tariff. So that's sort of the remaining item to complete these PPAs. Now its effect will depend on -- will August provide enough clarity and it should. You should have an indication of how much the tariff would be, how much you would have to put in sort of cash deposits, even though it might be finalized later. But typically, those move up and down that drastically. So we think we could work with that. However, I mean, the issue -- to me, the biggest issue is whether the suppliers continue to run these factories in Southeast Asia. Do you have a decrease in global supply of solar panels. So that's a little bit more of the issue. So there are a lot of things there. But rest assured that we're doing everything possible and using our sort of global footprint to try to be able to give certainty to some of the suppliers that they will be able to continue to be running. So stay tuned, but we hope that by August or actually sooner because the case is so weak, it should be dismissed, and it's amazing that it's gotten this far. But if there's there should be some clarity or has to be some clarity by August, and then we'll let you know, and we'll continue to work with all the suppliers to ensure that we get those panels to the states on time to complete 2023 projects.
Julien Dumoulin-Smith: Got it. All right. Fair enough. And then just the last one [indiscernible]. Fluence, obviously, it's a trailing impact, et cetera, the lockup expired of late. It seems it's still strategic to you from an origination perspective and your sales efforts, right, regardless of the results?
Andres Gluski: Yes, I'm optimistic about Fluence in the long run or it will say medium term because these -- it's very difficult to launch a new product when you get hit by COVID shutdowns in China. There were -- some of the battery suppliers had issues, let's face it. And that caused a shortage in the market as well. So there were tremendous shipping issues that they had to face. But look, it's a well-capitalized firm. The product is good. Digital is expanding well. They'll talk about these things. And for us, it has helped us really create a market for energy storage, solar plus energy storage. Our 24/7 relies on energy storage. If a version of the climate plus bill gets passed, and there's clarity around green hydrogen that will require a lot of energy story. So yes, it is a strategic relationship. And we hope to grow together for years to come.
Operator: Our next question comes from Agnieszka Storozynski with Seaport.
Agnieszka Storozynski: So my first question is about the time line of your coal plant retirements. We seem to be in this new gas price environment, basically everywhere in the world. We haven't yet heard many companies change the time line, but there is money to be made on continued operations of some of these assets. So that's one. And then the second question, a little bit more longer dated, I guess, is that so far, when you see the reasons why C&I customers signed renewable power PPAs, they mentioned decarbonization as the main driver. We haven't yet heard much about economic renewables, and it's probably the inflation and equipment prices doesn't help. But are you expecting the second wave of demand from C&I customers as we are in this higher power price environment probably for years to come?
Andres Gluski: Yes, those are great questions. Look, first on the first one, we have to reach our goal by 2025. So it's a question of trying to sell these assets or shut them down at times that are most appropriate. So the shutdowns, it's talking a lot with the local system operator or the Ministry of Energy. So those I don't see being affected by what's happening now. On top of the sales, you're right, many of these plants are more valuable in certain locations, again, Maritza being the prime example. And some of these shutdowns may be somewhat delayed because they must run in terms of availability of natural gas. But it doesn't change our goal of getting rid of all coal plants by 2025. The second question is I'm really glad you asked it because the companies are committed to their decarbonization goals. They're not just going to abandon them because of the case before commerce or because of slightly higher prices of let's say, everything from wind turbines or solar panels to batteries due to what's happening on the mineral side, commodity side. But what people aren't talking about is that the increase in cost of renewables is much, much less than the increase in the price of fossil fuels, all of them, whether it be coal, gas or diesel. So actually, renewables are more competitive today than ever. And in almost all cases, I can say that the energy from renewables is the cheapest energy. It's just a matter of degree, how much cheaper is it even with the increase in the cost of construction. So I'd say that the main issue is not energy, it's capacity. How to keep the lights on 24/7. And you really have 2 choices. One is to continue to run your legacy assets, whether they be gas or coal and combine it with renewables. That's what we did in Chile, the sort of Green integra or Green blend and extend or energy start. And as people go, let's say, further on this journey of decarbonization, that's why there's going to be such strong demand for energy storage, lithium ion-based energy storage. So really, to me, it's a question of supply. Can you get enough batteries to meet this? And the more batteries that become available, then you'll be able to retire fossil plants sooner. So that's, I'd say, the main thing. So you're right. But on the cost equation, renewables are more competitive than ever than before this crisis.
Agnieszka Storozynski: Yes, because it is pretty amazing to see that large commercial industrial customers are comfortable locking in, for example, in PJM power prices as far as high as $50 in 2026, 2027 when they could purchase renewables for like 45%, 46%. I mean that is just one thing that I don't fully grasp and I'm hopeful that, that just means that there is no growth to come for you guys.
Andres Gluski: There is going to be more growth. I mean, maybe in some of these cases, it's just that -- do they have confidence the projects are there because it's -- can you deliver those projects. And in this sector, there have been a lot of projects delayed or canceled, not by us due to different kinds of supply shortages. So that might be it. It might be that they're going for certainty. So what we feel differentiates us, and we're very conscious of is that we have been delivering on our projects.
Operator: Our next question comes from Gregg Orrill with UBS.
Gregg Orrill: I was wondering if you could comment on what got Moody's to investment grade. Anything you wanted to highlight there?
Andres Gluski: Look, this has been -- I'll pass this over to Steve because he did most of the work. But what I would just add, this has been a decade. So if you look at any of our statistics in terms of our exposure to commodities, if you look at the fact that we're almost, what, 88%, I think, in dollars, 85% contracted I guess, almost 90% hedged. I mean, all the indicators are very strong. So our cash flow has been really strong for a long time, but I'll pass it off to Steve.
Steve Coughlin: Thanks, Andrés, and thanks for the question, Gregg. I was hoping someone would bring you up. We're very proud of the Moody's achievement. So look, this is the third of of 3. And so it really fully solidifies our investment-grade status as AES, something that the team set out to do a long time ago. I can't -- I've only been in my job for 6 months, so I can't really claim too much credit for it. So it really goes to that John and the team. And so look, Moody's takes a different approach where they're looking at our consolidated debt, including all the nonrecourse debt and all the cash flow from our businesses, our subs. So they really did a very deep review and they looked at also the overall risk profile of our businesses. So our commercial structure, our long-term contracts, dollar-denominated, our growth in our utilities -- and so it's been a combination of the strengthening of the balance sheet, the increases in our cash flow and that business mix, so -- and we've actually been in Moody's territory for 4 quarters straight -- well into Moody's territory. So this was becoming really, really obvious that it was something that AES deserved, and we're very proud of it and look at -- we felt really good about our transformation. And I think this is just another validation point of that transformation. As I said, they did a really thorough review.
Andres Gluski: Yes. And I would highlight what Steve said that Moody's methodology is different. So it takes into account not only the nonrecourse debt, but the recourse debt. So in our case, it's about I guess, $3.5 billion of recourse?
Steve Coughlin: Yes, yes.
Andres Gluski: $14.3 million of nonrecourse.
Steve Coughlin: Yes, exactly. Yes. I mean I think I said on request the recourse debt that's different here. They really look deeply into the whole organization.
Andres Gluski: So this tells you that all our subs that they have confidence in the cash flow coming from ourselves and most of our subs are investment-grade rating. So it's a great confirmation. It was a decade in the making, but the team did a fantastic job in the last year to get this across the finish line.
Steve Coughlin: Yes. And the other thing I would just point out is I think it's a bright line for some investors. So having this third one, having 3 all locked in. I think we'll likely see some new investors be attracted to the company now.
Operator: Our next question comes from Ryan Levine with Citi.
Ryan Levine: Given your favorable view of the DOC outcome and balance sheet strength, are you looking to be more acquisitive and new in development, third-party solar projects in solar?
Andres Gluski: Look, what we are seeing is that clients are coming to us and asking us, can we do projects that other people have walked away from, quite frankly. So that -- now what we're mostly interested in the states, these 24/7. So really, it has to do -- does it fit into where we're trying to combine assets to be able to deliver 24/7. But it does open up some opportunities. So I think, again, on the Department of Commerce case, we just feel that the legal case of the length of here is very, very weak. And we think that -- furthermore, if you look at the objectives of decarbonization of onshoring, this actually moves us in the wrong direction. So yes, what I would put it is that we continue to see opportunities to acquire some projects if they help us meet our clients' demands.
Ryan Levine: I appreciate the color. And then I guess one follow-up from earlier. Are you going to break out the Bulgarian win contribution for the quarter?
Steve Coughlin: We did not break that out for the quarter, probably best as we talk about the full year. But it -- we expect it will be a few cents for the full year.
Operator: Our next question comes from David Peters with Wolfe Research.
David Peters: Just curious, Andrés, I think in your prepared remarks, you said you expect backlog addition this year to be roughly 50-50 U.S. and international. Is that the mix you guys expected heading into this year? Or are you leveraging your geographic diversity, some given the uncertainty here in the U.S. in the near term? And should we maybe think of that as a lever you can sort of pull in '23 to the extent there are delays with U.S. projects?
Andres Gluski: Well, I mean, for '23, these will be projects that are already signed in terms of commissioning. Now in terms of signings, yes, obviously, we can -- we have a diverse portfolio, and we can adjust correspondingly. So I don't think it would affect 2023 per se. Now the sort of 50-50 mix, again, that's sort of legacy. And Again, what we hope, again, with the resolution.
Steve Coughlin: Of this case is that the proportion of U.S. would increase. Yes. And I would just add, it's also coming from our utility rate base growth, so 9% rate base growth in utilities is helping achieve that. And then a lot of what we're doing -- well, really, almost everything we're doing even internationally is in a similar strategy with commercial industrial customers, some of them the same customers in the U.S. powering data centers in our core markets overseas. So we'd expect to have a similar if it's a different flag, but it would still be a long-term contract, and in many cases, U.S. dollar-denominated contracts.
Andres Gluski: That's a very important point. I mean what we're really emphasizing abroad is long-term renewable contracts in dollars. So if you're supplying, say, Microsoft in Chile, it really isn't a different risk from Microsoft in California. So again, our business is already over 80% in dollars, and that will only grow.
David Peters: And then just last one. In California, just in light of solar delays this year and next and maybe storage that's attached that, too. Potentially have an extension of the Ablecon being discussed. I'm just curious your guys' most recent thoughts on the likelihood of your OTC units itself and is getting extended at the end of '23.
Steve Coughlin: Without jinxing ourselves very, we think it's very likely. So these -- the environment there is not such that they want to do long-term extensions all at once, but we've extended through 2023. And we have -- it's an upside to our guidance, but we do think there's a very good chance that those plants will get extended into several years following. So it may be year by year, maybe 2 years at a time. But we think that portfolio is very important, some of the disruption. This is a bit of an offset to some of the current disruption in the solar supply chain. And that comes both from a capacity revenue perspective as well as the opportunity for the Q3 peak demand energy hedging that we've done. So it's quite -- it can be quite material.
Operator: That concludes today's Q&A portion of the call. I will now pass the conference back over to Susan Harcourt for any closing remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day.
Operator: That concludes today's AES first quarter 2022 financial review conference call. Thank you for your participation. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning. Thank you for attending today's AES First Quarter 2022 Financial Review Call. My name is Amber, and I will be your moderator for today's call. [Operator Instructions] I now have the pleasure of handing the conference over to our host, Susan Harcourt, Vice President of Investor Relations with AES. Susan, please go ahead."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning, and welcome to our first quarter 2022 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our first quarter 2022 financial review call. I am very happy to report that we have attained an investment-grade rating for Moody's. We are now investment-grade rated by all 3 major agencies, which is an important milestone for our company, and reflects a decade worth of work to transform our business. We're also reaffirming our 2022 guidance and annualized growth of 7% to 9% through 2025. Our business model continues to demonstrate its resilience and predictability even in the face of market volatility. Steve will cover our expectations for the remainder of the year in more detail, including the seasonality of our earnings profile. Today, I will discuss our 2022 construction program and the Department of Commerce's investigation into solar panel imports, the diverse drivers of our growth, including signed renewable energy PPAs and our U.S. utility, AES Next influence, and our strategic outlook for the sector. Beginning with our 2022 construction program on Slide 4. We are laser-focused on ensuring timely completion of projects. As we see our ability to execute on our commitments as a key source of competitive advantage. This year, we expect to complete more than 2 gigawatts of new renewables, including over 800 megawatts of solar in the U.S. In late March, the U.S. Department of Commerce launched an investigation into solar imports from 4 Southeast Asian countries, which collectively supply approximately 80% of solar panels for the U.S. market. The Department of Commerce is expected to make a preliminary determination on this case by no later than August. The resulting uncertainty around tariff levels has led to a drop in imports and project delays across the industry. However, due to our supply chain strategy, all of the panels for our 830 megawatts of projects to be completed in 2022 in the U.S. are already in country, and we do not anticipate any delays to those projects. I'd also note that 1/3 of our 2022 renewable projects are international and the remaining 683 megawatts in the U.S. are wind and energy storage. Moving to the diverse drivers of future growth, beginning on Slide 5. Our strategy is to provide differentiated products that allow us to work with our customers on a bilateral basis. As a result, last year, we signed a total of 5 gigawatts of PPAs for renewable energy, including more contracts with C&I customers than anyone else in the world. For full year 2022, we continue to expect to sign 4.5 to 5.5 gigawatts of renewables under long-term contracts with a roughly 50-50 split between the U.S. and international markets. We do expect PPA signings in the U.S. to be more weighted towards the second half of the year. So far this year, we have signed or been awarded 1.1 gigawatts, bringing our backlog to 10.3 gigawatts. Despite current headwinds for the sector, such as delays in U.S. climate legislation, and the supply chain issues we just discussed, we continue to see very strong demand for low-carbon energy and especially for structured products, such as our 24/7 renewable offering. In fact, as you may have seen earlier this week, we announced 2 key agreements for our structured products. First, the expansion of our partnership with Microsoft into California, the third market where we will supply renewable energy to match the load at their data centers; and second, our agreement with Amazon, under which we will provide 675 megawatts of renewable energy to their operations in California, including AWS' data centers. With these agreements, we are helping both companies achieve their ambitious sustainability goals. As you can see on Slide 6, we believe our development pipeline of 59 gigawatts is the second largest among U.S. renewables developers. This robust pipeline provides us with the projects we need to deliver on our backlog and continue to build on our competitive position in the market. Now turning to our regulated U.S. utility platforms, beginning on Slide 7. These businesses represent one of the key contributors to our overall 7% to 9% annual growth in earnings and cash flow as well as advancing our objective of increasing the proportion of earnings from the U.S. to 50%. In both markets, we have the lowest residential rates in the entire state which provides a runway for growth and investment while keeping affordable rates for our customers. Moving to Slide 8. In Indiana, we're benefiting from incentives to modernize the transmission and distribution network and transitioning to greener generation. Through 2025, we will be investing $2.7 billion, which we will recover through already approved rate mechanisms. Additionally, we expect to finalize our next integrated resource plan by this fall, allowing us to further transform AES Indiana's generation fuel mix. In Ohio, we're capitalizing on formula rate-based investments in the transmission network. At the same time, we are implementing our Smart Grid investment program, which is recovered through an existing rate mechanism. We also have a distribution rate case pending before the Public Utilities Commission of Ohio. Later this month, we will be presenting oral arguments directly to the commission and a favorable outcome, in this case, will bolster our ability to make the new investments needed to further strengthen AES Ohio's network. Turning to Slide 9. Through 2025, we expect to invest $4 billion to modernize our U.S. utilities. These investments translate to average annual rate base growth of 9% through 2025, which is at the high end of growth projections for U.S. utilities. We expect the earnings from these core businesses to grow in line with the rate base. Turning to Slide 10 for an update on AES Next. We are developing and incubating new products and business platforms through AES Next. Our investments in AES next help our businesses to be more innovative and competitive and drive value for our customers and shareholders. We are proud that earlier this year, Fast Company named AES is one of the 10 most innovative energy companies in the world and the only large publicly-traded company to be included on that list. Turning to Slide 11. The most mature initiative under AES Next today is Fluence, which as of December 31, had 4.2 gigawatts of energy storage products deployed and contracted and a signed backlog of $1.9 billion. Additionally, Fluence's digital platform, Fluence IQ, recently acquired Nispera, and now has a combined 15 gigawatts contracted or under management, of which more than 80% is with third-party customers. Over the past several months, Fluence has been dealing with short-term challenges mostly stemming from COVID-19 related supply chain issues. Their management team has taken proactive steps to address these challenges, including diversifying battery suppliers signing new shipping agreements, building out their in-house supply chain team and regionalizing their manufacturing. Overall, demand for energy storage remains very robust, and Fluence is well capitalized and positioned to grow as a market leader. We see a pathway for them to improve their margins and grow as the global energy transition continues to progress. Finally, turning to our strategic outlook for the sector, beginning on Slide 12. Our goal is to be the leader in providing low carbon energy solutions while delivering annualized earnings and cash flow growth of 7% to 9% through 2025. Today, there is an unprecedented transformation of our sector underway with governments, utilities and companies working to shift to low carbon sources of power. For example, just looking at the public commitment of the RE100, a group of over 350 large corporations who have committed to 100% renewable energy. We expect our annual demand to more than double to almost 400 terawatt hours of renewable energy by 2030. Facing this immense opportunity, we’re taking steps to ensure our continued competitive advantage in this once in a generation information of our sector. As you can see on Slide 13, this transformation is reflected in our own portfolio as we expect renewables to represent more than 3 quarters of our installed capacity by the end of 2025. During that same time period, we expect our renewables business to nearly triple from 13 gigawatts to approximately 38 gigawatts and our capacity from coal to go from 7 gigawatts to zero. With that, I will now turn the call over to our CFO, Stephen Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our first quarter results 2022 parent capital allocation and 2022 guidance. Beginning on Slide 15, as Andres highlighted, I'm very pleased to share that Moody's recently completed a thorough review of our consolidated debt and cash flow across our businesses and upgraded AES to investment grade. This conclusion further validates our year's long effort to reduce risk and strengthen our balance sheet and will yield further benefits as we grow our business and attract new investors to AES. As an investment-grade rated company, we will continue to lead the renewable sector while growing our U.S. utility asset base and our long-term contracted generation portfolio. Turning to Slide 16 and the resiliency of our business model. Today, 85% of our adjusted PTC is from long-term contracted generation and utilities. We are largely insulated from the current macroeconomic volatility affecting commodity prices, inflation, interest rates and foreign currencies, with the vast majority of our portfolio benefiting from contractual indexation, fuel pass-through or hedging programs that limit our exposure. Combined, these macroeconomic factors had an impact of less than $2 million on our adjusted PTC in the first quarter. For the full year, we currently expect a net positive contribution from these macroeconomic factors as a result of higher natural gas prices and higher power prices in some of our markets. Now turning to our financial results for the quarter, beginning on Slide 17. Adjusted EPS for the quarter was $0.21 versus $0.28 last year. Our core business segments grew by $0.04 over the first quarter of 2021. These positive contributions were offset by several negative drivers we had already anticipated in our 2022 guidance. First, higher losses at AES Next, primarily resulting from COVID-related supply chain issues at Fluence in the fourth quarter of 2021. As a reminder, we report Fluence's results on a 1 quarter lag. So the Fluence results relate to their December quarter end, which was disclosed in February and included in AES' full year guidance on our last call. Second, the higher share count as a result of the accounting adjustment we made for our equity units. Third, a higher quarterly effective tax rate than our overall expectation for the full year due to timing. And finally, nonrecurring gains on interest rate hedges recorded last year, which skewed the quarter over prior year quarter comparison. Turning to Slide 18. Adjusted pretax contribution, or PTC, was $207 million for the quarter, which was $40 million lower than 2021, consistent with the drivers I just discussed. I'll cover the performance of our strategic business units or SBUs in more detail over the next 4 slides. In the U.S. and utility strategic business unit, or SBU, higher PTC was driven primarily by earnings from new renewables coming online and higher contributions from Southland, partially offset by higher spend at AES Clean Energy due to an accelerated growth plan. Higher PTC at our South America SBU was mostly driven by our increased ownership of AES Andy's and higher contracted revenue in Colombia. Lower PTC at our Mexico, Central America and the Caribbean, or MCAC SBU primarily reflects the sale of Tablo in the Dominican Republic in 2021 and lower availability at our generation facilities in Mexico. Finally, in Eurasia, higher PTC reflects higher revenue at our Mandan facility in Vietnam and higher power prices at our wind plant in Bulgaria, driven by commodity price increases. Now to Slide 23. We are on track to achieve our full year 2022 adjusted EPS guidance range of $1.55 to $1.65. Our typical quarterly earnings profile is more heavily weighted towards Q3 and Q4, with about 2/3 of our earnings occurring in the second half of the year. We continue to expect a similar profile this year as we grow more in the U.S. where earnings are higher in the second half of the year based on solar generation profiles, utility demand seasonality and the commissioning of more new projects in the third and fourth quarters. Growth in the year to go will be primarily driven by contributions from new businesses, including over 2 gigawatts of projects in our backlog coming online over the next 9 months, as well as further accretion from our increased ownership of ASMs. We are also reaffirming our expected 7% to 9% average annual growth target through 2025, based on our expected growth in renewables and U.S. utilities as well as the recycling of our capital into additional investment opportunities we see across our global portfolio. Now to our 2022 parent capital allocation plan on Slide 24. Sources reflect approximately $1.4 billion to $1.7 billion of total discretionary cash, including $900 million of parent free cash flow and $500 million to $700 million of proceeds from asset sales. On the right-hand side, you can see our planned use of capital. We will return nearly $500 million to shareholders this year. This consists of our common share dividend, including the 5% increase we announced in December and the coupon on the equity units. We plan to invest approximately $900 million to $1.1 billion in our subsidiaries as we capitalize on attractive opportunities for growth. Nearly half of these investments are in renewables, reflecting our success in securing long-term contracts during 2021 and our expectations for 2022. About 25% of these investments are in our U.S. utilities, to fund rate base growth with a continued focus on grid and fleet modernization. In summary, close to 3/4 of our investments this year are going to renewables growth in our U.S. utilities businesses helping us to achieve our goal of increasing the proportion of earnings from the U.S. to more than half by 2023. In fact, we have made great progress on our growth investments so far this year with approximately $650 million already invested primarily in renewables and to increase our ownership in AES Andres. We will continue to allocate our capital in line with our strategy to lead the renewable sector, further anchor AES in the U.S. market and to decarbonize our portfolio. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. In summary, our core business continues to perform well. We have attained investment-grade ratings from all 3 major agencies. We are reaffirming our 2022 guidance and annualized growth through 2025. We continue to deliver on our commitments, including our 2022 construction projects, which we expect to commission on time even with the ongoing Department of Commerce investigation into solar panel imports. We are energized by the immense opportunity for growth in our business and remain committed to maintaining our competitive advantage. With that, I would like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Insoo Kim with Goldman Sachs."
},
{
"speaker": "Insoo Kim",
"text": "First question on the solar -- the U.S. solar investigation. Good to see that the '22 projects are on time and on schedule. Just for 2023 exposure, could you give a little bit more clarity on the amount of capacity that maybe has been contracted and need to be delivered? And what type of timing delays, if any, that we could expect for next year? And then just related to that, if there are delays to that, that were embedded in your growth for '23, how much flexibility do you have to move around other items to still hit your growth."
},
{
"speaker": "Andres Gluski",
"text": "Let me start with a little background on the commerce case. So this case is an investigation by commerce into allegations of 1 U.S. manufacturer that panels and sells imported from 4 countries in Southeast Asia are circumventing existing antidumping and countervailing duties on solar panels and cells coming from China. So we think there are strong legal grounds for commerce to make a preliminary determination before August that will signal to the market that the allegations are unfounded and will be conclusively dismissed without new tariffs. One of the legal requirements for determining that circumvention occurred is that the activity in Southeast Asian countries must be considered minor or insignificant. However, the solar panel and cell suppliers operating in these countries have invested billions of dollars in technologically sophisticated manufacturing, assembly and processing facilities so that their activities do not appear to be minor or insignificant. Additionally, the critical step of creating solar cells occurs in these countries and not in China and involves the conversion of the wafer into a cell. Commerce itself as previously ruled that this step determines the country of origin for solar imports. For these reasons, we think that there are strong grounds for commerce to make an expedited determination. It's also important to note that there's broad industry opposition to this investigation, including from many U.S. manufacturers because they rely on solar cells from Southeast Asia in order to manufacture solar modules here in the U.S. Currently, the U.S. manufacturing industry can only need about 20% of U.S. demand and their capacity to increase supply is negatively impacted by this investigation. This further supports the decision by commerce to dismiss the circumvention plane underground that a finding of circumvention would not be appropriate due to harmful impacts. So we'll continue to advocate a rapid resolution of this case. Now getting specifically to your question, I think what we were able to do this year shows to our supply chain management strategy. And many of you will recall that for 3 years, I've been arguing that this huge wave of renewable demand was coming and that there were going to be shortages of everything, from developers, to land, to interconnections. And now, we've had, I'd say, an additional issue with this commerce -- before commerce for solar pounds. So we've been not ahead of this. Now what will determine what will happen in '23 to us. And again, I think we're in the best shape of anybody in the industry, will be if there's an early resolution or if there is a determination they take the worst case. There's comes out and they say that there is a convention and there's going to be a tariff of X. Okay. Well, then people can put cash deposits at that point. Now I think this would have a very deleterious effect for the whole solar industry in the U.S. I think we would be in better shape because we're primarily selling to corporates who have more flexibility than people say utilities with RFPs who are much more regulated. So given that, I'd say, look, right now, we don't know. I mean worst case, and we continue to negotiate with our clients, with advances. We're not signing them yet because we're waiting for this final determination. But this is not going to stop us. And in terms of the construction, it depends how the case comes and the sort of shipping backlogs and the rest. It could potentially affect the second half of '23 but we'll have to see. So we're doing everything possible to minimize this. And I think the proof of the pudding is in the eating. I think we're one of the few solar U.S. developers who did not have to postpone or cancel any projects this year."
},
{
"speaker": "Insoo Kim",
"text": "That's good color. And maybe just the second part of my question was just if maybe the -- not the worst case, but a nonconstructive case comes down and the delays are more significant for the whole industry. Just your portfolio of global projects, whether it's wind or storage or whatnot, ARPU diverse, how much flexibility do you have to pull different levers to still achieve that growth?"
},
{
"speaker": "Andres Gluski",
"text": "Well, that's a great point. If you think of our backlog of 10.3 gigawatts, only about 1/3 is U.S. solar. So the rest is either international or wind or other technology. So again, I think that what will happen, well, it -- we are at a diverse portfolio. And so we will try to make it up elsewhere. But again, we think that they're very strong ground to this miss case, honestly, it doesn't make a lot of legal sense, honestly. A prior similar case was dismissed because they didn't have let's say, nobody was standing up in front of it. Now you have 1 small U.S. manufacturer. And I think the grounds of this being insignificant or not material, the value-add added in Southeast Asian countries is almost laughable quite frankly. So it is just rent seeking, I think, from a few small U.S. players. What is dramatic is it's had such an effect on the industry. Now again, fortunately, we've been very concerned about shortages for 3 years. And you'll also recall that even with COVID that first appeared in February of 2020, we talked about a potential effects on supply chain. So again, stay tuned. I don't think there's anybody in better shape than us. And as you point out, we are diverse in terms of technologies and also in terms of geographies."
},
{
"speaker": "Insoo Kim",
"text": "Okay. That makes sense. My second question quickly. The Slide 43, the sensitivity slide to different moving commodities or currencies or whatnot, it’s always helpful. Us. Just the update there. I think with stuff like Henry Hub gas prices being almost $8 to $9 right now, just looking at your sensitivity of the year-to-go assumptions. If these commodity prices do remain elevated and with no other changes, it seems like there could be a more meaningful EPS impact for 2022, but that assumes no other changes, whether it’s power prices or whatnot. Can you just walk through at this point with the various commodity price or power price environment? How do you see that net for the balance of the year as it stands today?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, it’s Steve. So just as a reminder, that page, those sensitivities are in isolation. So when you see the gas price sensitivity, it’s not – doesn’t include any corresponding power price increase, which we would actually expect to happen in most cases. So on balance, the environment, we’re really on the net positive side as I said in my comments. In particular, in Bulgaria, we have our wind portfolio there, which has done very well, and I expect we’ll do very well for the rest of this year. It does have some market exposure and with power prices in excess of 200, it’s done very well. And then the other thing I would point to is our LNG business in MCAC. So we have long-term contracted gas that’s been contracted for some time. So in fact, there are some upsides that we’re working – have worked through and we’ll continue to work through to take advantage of some of the high gas price opportunities to benefit our LNG business. So I think there’s upside there as well. Southland has been another upside we see the Q3 hedging program, another success. We expect more success this year was $0.05 of energy margin upside last year. So on balance, we’re actually in quite good shape. Most of our contracts are inflation indexed around the world. I think it’s like 83%. Those that are not are really U.S. renewable contracts where we’ve locked in our cost upfront, and that was baked into the overall cost of the – our pricing in PPA. So really, AES has transformed a lot. And actually, we’re in quite good shape in this environment."
},
{
"speaker": "Andres Gluski",
"text": "I would say, too, we’re on the right side of history on this one. I mean, because where we have fuel, it’s mostly a pass-through. And we’re mostly competing with fossil fuels with either hydro, with renewables. So – and I would say the biggest winner of what’s happened is really Bulgaria because in Bulgaria, we’ve just signed an MOU with the government of Bulgaria where they recognize the validity of the PPA. And they also – we’re working together on decarbonizing the Maritza project, whether it be – we’re looking at different alternatives, whether it carbon capture and sequestration, biofuels or conversion to gas and at the same time, stepping up investments in energy. Again, I really can’t think of any case where this is impacting us negatively."
},
{
"speaker": "Operator",
"text": "Our next question comes from Richard Sunderland with JPMorgan."
},
{
"speaker": "Richard Sunderland",
"text": "And maybe just wanted to touch on the 2023 solar outlook a little bit more. Could you speak to a little bit more around the risks there beyond just the earnings delays? Is it really just so much as the timing of the earnings come in? Are there any contractual obligations around energy procurement or elsewhere that you need to fulfill with those contracts?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. No, I'm not aware of any, quite frankly. I think that I don't think it would be demand destruction. It would be a delay in some cases of commissioning them. But no, we would obviously have -- our contracts would not hold us to having to supply energy if there is a major disruption in the solar panel market. But again, we think that's the -- not the most likely scenario, but if it were to occur, we wouldn't be suffering LDs because of not fulfilling contracts."
},
{
"speaker": "Richard Sunderland",
"text": "Got it. Very helpful. And then thinking about the announcements around these recent structured deals, could you speak to a little bit of the capacity, overall appetite there? And then I guess just to be clear on the Amazon front, are those new projects or reflected in the 2021 signings?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. First, most of these are reflected in 2021 projects. But what I would say is we're seeing a tremendous demand for our structured project. And we have been talking about this year, we weren't able to release some of the names prior to that until the client was ready. But we can do more projects. I think the real issue is to have the projects in the right market ready. So it's -- stay tuned. More is coming. But I think what we like very much is it shows like a repeat buying. So with microcells, for example, we've done projects in PJM. We did a project in Chile, and now we big clients. So if you think of the large data center clients, we have big contracts with 3 of them. And we're very big. The demand is there. It's a question of how fast we can bring the projects online."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And I would just add, this customer, Richard, we have the flexibility to pivot to some other markets. We've done Microsoft, we've done Google in Chile. And so the Amazon announcement is what we've been able to announce. This is something I wanted to talk about for some time, but there's more to come. And we've built the pipeline significantly. We're up pipeline, and that's in large part because we're playing forward the demand coming from our commercial industrial customers in aggregating the pipeline where we know that they're going to need us to supply their load."
},
{
"speaker": "Andres Gluski",
"text": "Yes. I think an important point -- a good part of this pipeline is in California, and it's quite ready. And that we started acquiring land and interconnection rights about 3 years ago. We really got a little bit ahead of this wave that we see now. So the demand is there. It's a question of bringing all the projects online. Now realize that these are versions of 24/7 or round the clock renewables. So it's not only a question of having the availability to build new megawatts, it's all guaranteed netted on an hourly basis, renewable energy."
},
{
"speaker": "Richard Sunderland",
"text": "That's very helpful color. And I just wanted to follow up real quick on the sort of contracting backdrop. You talked a little bit about more risk weighted into the U.S. signings, obviously, the DSC overshadowing all of these. So can you give us a little bit more color on what you're seeing in terms of discussions to get it active, but you just point to then start finalizing. Any more information would be helpful there."
},
{
"speaker": "Andres Gluski",
"text": "Yes, right. You can characterize this, right. We are in discussions, and there are more contracts with clients and that I'd say a factor is having some clarity in August, what it would be because you have to make cash deposits and have greater flexibility and speed than, say, regulated clients. So let's see what happens. But again, I think it's just going to be more cars, this would slow us down. And it would basically make renewables in the U.S. more expensive. So if you want onshore manufacturing, what do you need? You need cheap and clean energy. It's a vital factor. And again, we are in the best shape, I think, of anybody in the sector. So its effects will be much greater outside of AES."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And I would just add, the last year, 80% of the contracts were done in bilateral commercial industrial PPAs, so bilateral negotiations. So the customers that we're working with are very much aware of this issue. We're moving forward with all the details that we can move forward on, and this piece is open, and it's very frustrating, and it's not a good thing. But these are customers that have made very strong and vocal commitments to their decarbonization, and we suspect they're going to want to continue to find the path to get there. And since we're in a bilateral relationship, I think we're going to work through that."
},
{
"speaker": "Andres Gluski",
"text": "And I would add look, we're all in favor of onshoring. But what you need is certainty and you need a time line. So you need to know what tariffs will be applied in what way. And -- but you also have to say how far down the supply chain they're going to go. And the further down the supply chain, you're going to go, the more time you need to move the supply chain. And so for example, right now, most of -- most of the solar panels we're buying from Southeast Asia. Actually, the polysilicon is going to be coming from Germany. So it's not even coming from China. So this is basically rent-seeking by a small number of -- or actually 1 firm in this case. And in significant firm I may add. I don't think it's delivering 1% of the supply in the U.S. So it really is quite agree to the whole situation."
},
{
"speaker": "Operator",
"text": "Our next question comes from Durgesh Chopra with Evercore."
},
{
"speaker": "Durgesh Chopra",
"text": "Steve, maybe this one is in sort of your house. I was just going to ask you, as it relates to the 2022 EPS guidance, Steve, can you remind us what are you modeling for Fluence in that -- embedded in that guidance? And then obviously, Fluence had some challenges with COVID-19 as Andrés articulated in his prepared remarks. If that continues throughout the year, what kind of flexibility do you have to kind of make that up in other areas of the business?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So thanks for the question. Look, to Fluence had a difficult their first quarter, which, as I had in my remarks, for their fiscal '22, our fiscal year runs October to September, and we report them on a 1 quarter lag. So what they reported in December is just hitting this quarter that we're now reporting. So we already had anticipated an updated forecast for Fluence when we gave our guidance, and that's largely -- that's about what I can say on it. Unfortunately, Fluence. I can't say much more. My hands are tied here. They're a public company, they'll be releasing earnings next week. But what I can say is I feel very comfortable given that I have the latest expectations for Fluence in our numbers. We've already absorbed their first quarter, and we reported that here. So look, they've had a lot of issues that they've talked about. I think they're working through those. Some of them are quite temporary in nature, and they've already worked through both shiny new shipping contracts, diversifying their battery supply, they're regionalizing their manufacturing around the world. So I think it's going to take some time as they've said to work through some of these challenges. But we're very confident. The long term is strong. They're -- the entire market has continued to be very strong. The demand is still there. I think they had kind of the perfect storm of some issues coming together here with supply chain batteries, shipping, et cetera. But in our guidance, we have the latest forecast, and it's not it's knocking us off our guidance range."
},
{
"speaker": "Andres Gluski",
"text": "What I would add is that the company is well capitalized and see strong demand. And what you're seeing is increase in battery supply outside of China. So you just saw the announcement by the U.S. government that they would have incentives for battery manufacturer in the U.S. Point has an agreement with North Volt for production of batteries in Poland. So I think what you're going to see is the main constraint, which has been access to batteries will start to be addressed. Now it's not going to be immediate, but by next year, you start seeing more capacity come online."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. That's very comprehensive. In terms of just going back to the backlog of additions, right? I mean you started the year strong, roughly over 1 gig versus the 4.5 to 5.5 gig target. Sounds like you're confident that you're going to hit that in 2022, but as we think about '23 in light of the solar investigation, in light of the commentary around potential delays. Do you go back? Like, I mean what's -- so the current plan, I think the long term, the 7% to 9% EPS growth is predicated on, correct me if I'm wrong, 3 to 4 gigawatts a year. Is that sort of -- do you expect to sort of hit that in 2023, maybe the low end? Or what's the thinking there as we think about 2023 this year?"
},
{
"speaker": "Andres Gluski",
"text": "So you're talking about signing new PPAs? Are you talking about commissioning of projects?"
},
{
"speaker": "Durgesh Chopra",
"text": "The new PPAs, Andrés, the target."
},
{
"speaker": "Andres Gluski",
"text": "The PPAs. Okay. Look, in the first quarter, we did 1.1 gigawatts. So we are on target for our 4.5 to 5.5 gigawatts for the year. As I mentioned, due to this Commerce case, some of the signing of PPAs in solar in the U.S. will be more heavily weighted towards the second half of the year because people will wait until this resolution and come to a conclusion. Do I think that this will knock us off our growth trajectory? No? The answer is no. And because -- if anything, it might move things around from 1 quarter to the next. But we're seeing very strong demand for our products. And this will -- the RE100, for example, they're not going to render their sustainability goals. So they're going to go forward with this. So I think that -- I feel confident of it. Kind of cause some delays in signing of PPAs. Yes, we're saying that. But I think that we'll have a catch-up. So it might make things a little bit lumpier than they would be otherwise, which is not ideal. But that's the hand we've been built."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. It sounds like the long-term trajectory intact; you may have some lumpiness in the near term. But you feel confident long term in hitting all of our targets?"
},
{
"speaker": "Andres Gluski",
"text": "Exactly, exactly."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Bank of America."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "So I want to sort of quantify things a little bit more if we can. Obviously, we talked about these commodity sensitivities a little bit earlier. Can we talk about the longer-dated commodity sensitivities and trying to quantify it based on what's implied in your slides? And it looks as if -- again, these commodities are flying around, but it could be north of $0.10 positive versus what you guys -- your last guidance. I mean, is that directionally, correct? I mean can you try to quantify that a little bit in the affirm it? And then related to the extent to which that is true directionally, what does that mean in terms of your appetite to potentially expedite the exit from Bulgaria, for instance. I just want to try to get at that a little bit more and/or absorb some of these other impacts, be it solar or affluent and still be within your range or higher within your range."
},
{
"speaker": "Steve Coughlin",
"text": "Sure. Julien. So you're right. I mean, and you're looking through the page on the commodities and seeing that there's actually upside here, as I described. So Bulgaria, where the power prices are high, we're really seeing significant upside there, both in the near term as well as in the value of the Maritza plant, which is under contract, but that PPA is well in the money for the government of the people in Bulgaria, plus we have the upside in the wind plant. In our LNG business, in our gas businesses in Central America and the Caribbean, we have long-term gas contracts that have been set well before this commodities environment. So we have some flexibility in how we manage our cargoes, we have customers or plants that have dual fuel capability. And so we're able to perhaps work in swapping to liquid fuels and redirecting cargoes into Europe, for example, with our partners. So this is a really important part of our portfolio, one that we don't tend to talk a lot about, but it is in this environment, important diversification of our portfolio. So we see both with power prices as well as the upside in our position in natural gas, given our long-term contracts. But yes, directionally, you are correct. I wouldn't venture to say whether it's $0.10 or exactly at this point. But some of that relies on discrete transactions that we will do and have done and will do to take advantage of that upside in LNG."
},
{
"speaker": "Andres Gluski",
"text": "Yes. And talking about Bulgaria, what I would say is, look, -- in the past, the PPA had been questioned before the sort of anticompetitive -- say, legal state really was the case before the European Commission. So what we're seeing is that -- to some extent, we're getting past that. This is a confirmation of the PPA. So it's a very attractive asset. Maritza is a very attractive asset through the end of its contract period and beyond, it's actually doing what -- the reason it was built was to make Bulgaria independent of Russian gas. That's why it was built and it uses local coal. So it's not affected by international prices. So it's very much in the money for our clients. So the asset is much more valuable today than it was, say, 6 months ago. And we've also agreed to help the Bulgarian government look at energy storage and other alternatives to wean, say, Maritza away from just running on coal. So stay tuned to that. But I'd say this has been the big winner from this horrible situation in Europe."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. Fair enough. And then I just want to try to quantify versus some of the qualitative comments earlier around the AD CVD risk on '23. I just -- again, it sounds as if specifically, you're reaffirming the origination ranges going into next year, your confidence is there. Is there any -- I mean, when you try to quantify any of these risks, any way to do so around solar here? Just any quantum of origination risk? Any quantum of impact and higher costs, et cetera. I just want to make sure we're crystal clear on this all."
},
{
"speaker": "Andres Gluski",
"text": "Yes. Look, what I would say is the following. Look, we are continuing to negotiate with our clients. This has pushed off the final signing of a number of additional PPAs because there's uncertainty about the tariff. So that's sort of the remaining item to complete these PPAs. Now its effect will depend on -- will August provide enough clarity and it should. You should have an indication of how much the tariff would be, how much you would have to put in sort of cash deposits, even though it might be finalized later. But typically, those move up and down that drastically. So we think we could work with that. However, I mean, the issue -- to me, the biggest issue is whether the suppliers continue to run these factories in Southeast Asia. Do you have a decrease in global supply of solar panels. So that's a little bit more of the issue. So there are a lot of things there. But rest assured that we're doing everything possible and using our sort of global footprint to try to be able to give certainty to some of the suppliers that they will be able to continue to be running. So stay tuned, but we hope that by August or actually sooner because the case is so weak, it should be dismissed, and it's amazing that it's gotten this far. But if there's there should be some clarity or has to be some clarity by August, and then we'll let you know, and we'll continue to work with all the suppliers to ensure that we get those panels to the states on time to complete 2023 projects."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. All right. Fair enough. And then just the last one [indiscernible]. Fluence, obviously, it's a trailing impact, et cetera, the lockup expired of late. It seems it's still strategic to you from an origination perspective and your sales efforts, right, regardless of the results?"
},
{
"speaker": "Andres Gluski",
"text": "Yes, I'm optimistic about Fluence in the long run or it will say medium term because these -- it's very difficult to launch a new product when you get hit by COVID shutdowns in China. There were -- some of the battery suppliers had issues, let's face it. And that caused a shortage in the market as well. So there were tremendous shipping issues that they had to face. But look, it's a well-capitalized firm. The product is good. Digital is expanding well. They'll talk about these things. And for us, it has helped us really create a market for energy storage, solar plus energy storage. Our 24/7 relies on energy storage. If a version of the climate plus bill gets passed, and there's clarity around green hydrogen that will require a lot of energy story. So yes, it is a strategic relationship. And we hope to grow together for years to come."
},
{
"speaker": "Operator",
"text": "Our next question comes from Agnieszka Storozynski with Seaport."
},
{
"speaker": "Agnieszka Storozynski",
"text": "So my first question is about the time line of your coal plant retirements. We seem to be in this new gas price environment, basically everywhere in the world. We haven't yet heard many companies change the time line, but there is money to be made on continued operations of some of these assets. So that's one. And then the second question, a little bit more longer dated, I guess, is that so far, when you see the reasons why C&I customers signed renewable power PPAs, they mentioned decarbonization as the main driver. We haven't yet heard much about economic renewables, and it's probably the inflation and equipment prices doesn't help. But are you expecting the second wave of demand from C&I customers as we are in this higher power price environment probably for years to come?"
},
{
"speaker": "Andres Gluski",
"text": "Yes, those are great questions. Look, first on the first one, we have to reach our goal by 2025. So it's a question of trying to sell these assets or shut them down at times that are most appropriate. So the shutdowns, it's talking a lot with the local system operator or the Ministry of Energy. So those I don't see being affected by what's happening now. On top of the sales, you're right, many of these plants are more valuable in certain locations, again, Maritza being the prime example. And some of these shutdowns may be somewhat delayed because they must run in terms of availability of natural gas. But it doesn't change our goal of getting rid of all coal plants by 2025. The second question is I'm really glad you asked it because the companies are committed to their decarbonization goals. They're not just going to abandon them because of the case before commerce or because of slightly higher prices of let's say, everything from wind turbines or solar panels to batteries due to what's happening on the mineral side, commodity side. But what people aren't talking about is that the increase in cost of renewables is much, much less than the increase in the price of fossil fuels, all of them, whether it be coal, gas or diesel. So actually, renewables are more competitive today than ever. And in almost all cases, I can say that the energy from renewables is the cheapest energy. It's just a matter of degree, how much cheaper is it even with the increase in the cost of construction. So I'd say that the main issue is not energy, it's capacity. How to keep the lights on 24/7. And you really have 2 choices. One is to continue to run your legacy assets, whether they be gas or coal and combine it with renewables. That's what we did in Chile, the sort of Green integra or Green blend and extend or energy start. And as people go, let's say, further on this journey of decarbonization, that's why there's going to be such strong demand for energy storage, lithium ion-based energy storage. So really, to me, it's a question of supply. Can you get enough batteries to meet this? And the more batteries that become available, then you'll be able to retire fossil plants sooner. So that's, I'd say, the main thing. So you're right. But on the cost equation, renewables are more competitive than ever than before this crisis."
},
{
"speaker": "Agnieszka Storozynski",
"text": "Yes, because it is pretty amazing to see that large commercial industrial customers are comfortable locking in, for example, in PJM power prices as far as high as $50 in 2026, 2027 when they could purchase renewables for like 45%, 46%. I mean that is just one thing that I don't fully grasp and I'm hopeful that, that just means that there is no growth to come for you guys."
},
{
"speaker": "Andres Gluski",
"text": "There is going to be more growth. I mean, maybe in some of these cases, it's just that -- do they have confidence the projects are there because it's -- can you deliver those projects. And in this sector, there have been a lot of projects delayed or canceled, not by us due to different kinds of supply shortages. So that might be it. It might be that they're going for certainty. So what we feel differentiates us, and we're very conscious of is that we have been delivering on our projects."
},
{
"speaker": "Operator",
"text": "Our next question comes from Gregg Orrill with UBS."
},
{
"speaker": "Gregg Orrill",
"text": "I was wondering if you could comment on what got Moody's to investment grade. Anything you wanted to highlight there?"
},
{
"speaker": "Andres Gluski",
"text": "Look, this has been -- I'll pass this over to Steve because he did most of the work. But what I would just add, this has been a decade. So if you look at any of our statistics in terms of our exposure to commodities, if you look at the fact that we're almost, what, 88%, I think, in dollars, 85% contracted I guess, almost 90% hedged. I mean, all the indicators are very strong. So our cash flow has been really strong for a long time, but I'll pass it off to Steve."
},
{
"speaker": "Steve Coughlin",
"text": "Thanks, Andrés, and thanks for the question, Gregg. I was hoping someone would bring you up. We're very proud of the Moody's achievement. So look, this is the third of of 3. And so it really fully solidifies our investment-grade status as AES, something that the team set out to do a long time ago. I can't -- I've only been in my job for 6 months, so I can't really claim too much credit for it. So it really goes to that John and the team. And so look, Moody's takes a different approach where they're looking at our consolidated debt, including all the nonrecourse debt and all the cash flow from our businesses, our subs. So they really did a very deep review and they looked at also the overall risk profile of our businesses. So our commercial structure, our long-term contracts, dollar-denominated, our growth in our utilities -- and so it's been a combination of the strengthening of the balance sheet, the increases in our cash flow and that business mix, so -- and we've actually been in Moody's territory for 4 quarters straight -- well into Moody's territory. So this was becoming really, really obvious that it was something that AES deserved, and we're very proud of it and look at -- we felt really good about our transformation. And I think this is just another validation point of that transformation. As I said, they did a really thorough review."
},
{
"speaker": "Andres Gluski",
"text": "Yes. And I would highlight what Steve said that Moody's methodology is different. So it takes into account not only the nonrecourse debt, but the recourse debt. So in our case, it's about I guess, $3.5 billion of recourse?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, yes."
},
{
"speaker": "Andres Gluski",
"text": "$14.3 million of nonrecourse."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, exactly. Yes. I mean I think I said on request the recourse debt that's different here. They really look deeply into the whole organization."
},
{
"speaker": "Andres Gluski",
"text": "So this tells you that all our subs that they have confidence in the cash flow coming from ourselves and most of our subs are investment-grade rating. So it's a great confirmation. It was a decade in the making, but the team did a fantastic job in the last year to get this across the finish line."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And the other thing I would just point out is I think it's a bright line for some investors. So having this third one, having 3 all locked in. I think we'll likely see some new investors be attracted to the company now."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ryan Levine with Citi."
},
{
"speaker": "Ryan Levine",
"text": "Given your favorable view of the DOC outcome and balance sheet strength, are you looking to be more acquisitive and new in development, third-party solar projects in solar?"
},
{
"speaker": "Andres Gluski",
"text": "Look, what we are seeing is that clients are coming to us and asking us, can we do projects that other people have walked away from, quite frankly. So that -- now what we're mostly interested in the states, these 24/7. So really, it has to do -- does it fit into where we're trying to combine assets to be able to deliver 24/7. But it does open up some opportunities. So I think, again, on the Department of Commerce case, we just feel that the legal case of the length of here is very, very weak. And we think that -- furthermore, if you look at the objectives of decarbonization of onshoring, this actually moves us in the wrong direction. So yes, what I would put it is that we continue to see opportunities to acquire some projects if they help us meet our clients' demands."
},
{
"speaker": "Ryan Levine",
"text": "I appreciate the color. And then I guess one follow-up from earlier. Are you going to break out the Bulgarian win contribution for the quarter?"
},
{
"speaker": "Steve Coughlin",
"text": "We did not break that out for the quarter, probably best as we talk about the full year. But it -- we expect it will be a few cents for the full year."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Peters with Wolfe Research."
},
{
"speaker": "David Peters",
"text": "Just curious, Andrés, I think in your prepared remarks, you said you expect backlog addition this year to be roughly 50-50 U.S. and international. Is that the mix you guys expected heading into this year? Or are you leveraging your geographic diversity, some given the uncertainty here in the U.S. in the near term? And should we maybe think of that as a lever you can sort of pull in '23 to the extent there are delays with U.S. projects?"
},
{
"speaker": "Andres Gluski",
"text": "Well, I mean, for '23, these will be projects that are already signed in terms of commissioning. Now in terms of signings, yes, obviously, we can -- we have a diverse portfolio, and we can adjust correspondingly. So I don't think it would affect 2023 per se. Now the sort of 50-50 mix, again, that's sort of legacy. And Again, what we hope, again, with the resolution."
},
{
"speaker": "Steve Coughlin",
"text": "Of this case is that the proportion of U.S. would increase. Yes. And I would just add, it's also coming from our utility rate base growth, so 9% rate base growth in utilities is helping achieve that. And then a lot of what we're doing -- well, really, almost everything we're doing even internationally is in a similar strategy with commercial industrial customers, some of them the same customers in the U.S. powering data centers in our core markets overseas. So we'd expect to have a similar if it's a different flag, but it would still be a long-term contract, and in many cases, U.S. dollar-denominated contracts."
},
{
"speaker": "Andres Gluski",
"text": "That's a very important point. I mean what we're really emphasizing abroad is long-term renewable contracts in dollars. So if you're supplying, say, Microsoft in Chile, it really isn't a different risk from Microsoft in California. So again, our business is already over 80% in dollars, and that will only grow."
},
{
"speaker": "David Peters",
"text": "And then just last one. In California, just in light of solar delays this year and next and maybe storage that's attached that, too. Potentially have an extension of the Ablecon being discussed. I'm just curious your guys' most recent thoughts on the likelihood of your OTC units itself and is getting extended at the end of '23."
},
{
"speaker": "Steve Coughlin",
"text": "Without jinxing ourselves very, we think it's very likely. So these -- the environment there is not such that they want to do long-term extensions all at once, but we've extended through 2023. And we have -- it's an upside to our guidance, but we do think there's a very good chance that those plants will get extended into several years following. So it may be year by year, maybe 2 years at a time. But we think that portfolio is very important, some of the disruption. This is a bit of an offset to some of the current disruption in the solar supply chain. And that comes both from a capacity revenue perspective as well as the opportunity for the Q3 peak demand energy hedging that we've done. So it's quite -- it can be quite material."
},
{
"speaker": "Operator",
"text": "That concludes today's Q&A portion of the call. I will now pass the conference back over to Susan Harcourt for any closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "That concludes today's AES first quarter 2022 financial review conference call. Thank you for your participation. You may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AES | 4 | 2,023 | 2024-02-27 10:00:00 | Operator: Hello and welcome to the AES Corporation Fourth Quarter and Full Year 2023 Financial Review call. My name is Elliot and I'll be coordinating your call today. [Operator Instructions]. I'd now like to hand over to Susan Harcourt, Vice President of Investor Relations. The floor is yours. Please go ahead.
Susan Harcourt: Thank you, operator. Good morning and welcome to our fourth quarter and full year 2023 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today we will be making forward looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer, Steve Coughlin, our Chief Financial Officer and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our fourth quarter and full year 2023 financial review call. Today I will discuss our 2023 strategic and financial performance. Steve Coughlin, our CFO, will discuss our financial results and outlook in more detail shortly. Beginning on slide three, 2023 was our best year ever as we met or exceeded all of our strategic and financial objectives, including signing a record of 5.6 gigawatts of new PPAs, putting us well on track to achieve 14 to 17 gigawatts of new signings through 2025, completing 3.5 gigawatts of construction, exceeding the target we laid out and doubling our additions compared to 2022, delivering adjusted EBITDA of $2.8 billion in the top end of our guidance range and adjusted EBITDA with tax attributes of $3.4 billion, achieving adjusted EPS of $1.76 and parent-free cash flow of just over $1 billion, both beyond the top end of our guidance ranges, and realizing asset sales proceeds of $1.1 billion, significantly above our target of $400 million to $600 million. Turning to slide four, despite the backdrop of rising interest rates and supply chain challenges across the sector, we demonstrated that our business model is strong, resilient, and well-positioned. Demand across the sector has never been stronger, and in this context, I'm pleased to announce that we are raising our expected annual growth rate for adjusted EBITDA and adjusted EPS. We now expect our adjusted EBITDA to grow at an annual rate of 5% to 7% and adjusted EPS to grow at 7% to 9%, both through 2027. We are also reaffirming all of our other existing guidance. I can definitely say that I have never felt better about the outlook for this business. Turning to power purchase agreement signings on slide five, we signed 5.6 gigawatts of new PPAs in 2023, more than any other year in our company's 43-year history, putting us well on track to sign 14 to 17 gigawatts of new renewable contracts from 2023 through 2025. Today, our backlog of projects with signed PPAs is 12.3 gigawatts, the vast majority of which will be commissioned over the next three years. It is worthwhile to note that all of the projects in our contracted backlog remain on track for timely completion, consistent with our historical performance. Moving to slide six, I'd like to highlight that the largest segment of our new business is with corporate customers. In fact, in 2023, nearly 60% of the 3.5 gigawatts of projects we brought online were to serve corporate customers and large technology companies in particular. Bloomberg New Energy Finance has consistently named AES as one of the top two providers of renewable energy to corporations worldwide, and our business continues to expand, particularly given our focus on serving the power needs from data centers which are powering the rapid growth of AI. We are well positioned to serve this customer segment for a number of reasons. First, we have been on the forefront of working directly with these technology companies to provide innovative solutions to achieve specific renewable energy profiles. Back in 2021, we were the first company to introduce hourly match renewable energy, and today we are working with all of the hyperscale data center companies to provide solutions that are tailored for their renewable energy and sustainability goals. Second, we have a strong track record of delivering our projects on time, on budget, while meeting the unique needs of our customers, which I will cover in more detail momentarily. Our record of reliability is something that is increasingly recognized and valued by our customers. And third, we have the scale and the pipeline to address growing demand from data centers, which is estimated to more than double by 2030. With over 50 gigawatts of projects in our development pipeline and advanced interconnection queue positions in the most relevant markets in the U.S., we are particularly well positioned to meet the energy demand of technology customers. Turning to slide seven, our success with corporate customers combined with our improved efficiency in development and construction have increased the returns that we have seen across our renewable portfolio. As a result, we are upping our U.S. return ranges by 200 basis points to 12% to 15% on a levered after-tax cash basis. We are seeing even higher returns internationally. With strong market demand in AES's leading position, we are able to be increasingly selective about the projects we build with a focus on those with the best overall financial benefits. Next, turning to construction on slide eight, our ability to complete projects on time and on budget has become a major differentiator for AES. Not only is this something that our customers highly value, but it is also a pillar of our business model and ensures that our realized financial returns are on average equal to or better than our projections. At the time of PPA signings, we lock in contractual arrangements for all major equipment, EPC, and long-term financing, which we hedge to ensure no interest rate exposure. At the same time, we systematically embed flexibility in our supply chain to safeguard against a variety of scenarios. We also have a multi-year strategic arrangement with top suppliers, including Fluence, who we see as having the most competitive product in the industry. More than half of our solar projects in recent years have co-located storage components, and our relationship with Fluence helped us to have the best on-time project completion rate in the industry. In 2024, we feel very confident in our ability to add 3.6 gigawatts of new projects, including 2.2 gigawatts in the U.S. We currently have 100% of the major equipment for these projects contractually secured and nearly 80% already on site. Now turning to our utilities, beginning on slide nine. In 2023, we achieved important milestones at our U.S. utilities that will drive future growth, continue decarbonization, and improvement in customer service. At AES Ohio, we put in place a new regulatory framework, and at AES Indiana, we reached a unanimous settlement for our first-rate case since 2018. As a result, investments are on track for the rate-based growth in the high teens at both utilities, and we now have close to 70% of our planned investments through 2027 already approved in regulatory orders. Turning to slide 10. At AES Ohio, we are embarking on the largest investment program that this utility has ever seen, which includes the expansion and enhancement in our transmission assets. With over 25% rate-based growth per year, this is one of the fastest transmission growth rates in the country. We also recently filed for regulatory approval of the second phase of our smart grid plan, which upgrades our grid to improve service quality and customer experience. Turning to slide 11. At AES Indiana, we continue to invest to improve service quality and greener generation mix. I am happy to say that we now have regulatory approval for the build-out of all named renewable projects at AES Indiana, encompassing 106 megawatts of wind, 445 megawatts of solar, and 245 megawatts of energy storage. As we continue to invest in our customer experience, service quality, and sustainability at both of our U.S. utilities, two core principles have guided our growth plan. First is customer affordability as we address much-needed investments. We currently have the lowest residential rate in both states, which we expect to maintain throughout this period of growth. And second is to prioritize the timely recovery of our investments through existing mechanisms and programs. Across both utilities, we now anticipate approximately 75% of the growth capital to be deployed under such mechanisms, which substantially reduces regulatory lag. Finally, turning to slide 12. Last year, we set an asset sale proceeds target of 400 million to 600 million. We greatly exceeded this range with 1.1 billion of gross proceeds. These transactions not only put a high valuation marker on our businesses, but also put us well on our way towards achieving our asset sales goal of $2 billion through 2025 and $3.5 billion through 2027. Our success this past year provides us with a cushion, and we expect 2024 to be another strong year. With that, I would like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will discuss our 2023 results and capital allocation, our 2024 guidance, and our updated expectations through 2027. As Andres mentioned, 2023 was AES's best year on record as we met or exceeded all of our strategic and financial targets. We beat our adjusted EPS guidance range of $1.65 to $1.75 and our parent-free cash flow guidance range of $950 million to $1 billion. We also recorded strong adjusted EBITDA well above the midpoint of our inaugural guidance range of $2.6 billion to $2.9 billion. Turning to slide 14, full year 2023 adjusted EBITDA with tax attributes was $3.4 billion versus $3.2 billion in 2022, driven primarily by contributions from new renewables projects, as well as the recovery of prior year's purchase power costs at AES Ohio included as part of the ESP4 settlement. These drivers were partially offset by lower contributions from the energy infrastructure SBU. Turning to slide 15, adjusted EPS was $1.76 in 2023 versus $1.67 in 2022. Drivers were similar to those for adjusted EBITDA with tax attributes. In addition, there was a $0.06 headwind from parent interest on higher debt balances primarily used to fund new renewables projects. I'll cover our results in more detail over the next four slides, beginning with the Renewable Strategic Business Unit or SBU on slide 16. Higher adjusted EBITDA with tax attributes at our renewables SBU was primarily driven by contributions from the 3.5 gigawatts of new projects that came online in 2023, as well as higher margins in Columbia, but partially offset by the sell down of select U.S. renewable operating assets. At our utilities SBU, higher adjusted PTC was primarily driven by the recovery of prior year's purchase power costs at AES Ohio included as part of the ESP4 settlement, as well as rate-based growth in the U.S. Lower adjusted EBITDA at our energy infrastructure SBU reflects significant LNG transaction margins in 2022, lower margins in Chile, and the sale of a minority interest in our Southland combined cycle assets. These drivers were partially offset by the higher revenues recognized from the accelerated monetization of the PPA at our Warrior Run coal plant. Finally, at our new energy technologies SBU, higher adjusted EBITDA reflects improved results at Fluence, which achieves positive adjusted EBITDA in their fiscal fourth quarter of 2023. Fluence also guided to positive adjusted EBITDA for their full fiscal year 2024. Now let's turn to how we allocated our capital last year on slide 20. Beginning on the left-hand side, Sources reflect $3 billion of total discretionary cash. This includes parent-free cash flow of just over $1 billion, which increased nearly 11% from the prior year to just above the top end of our guidance. We also significantly surpassed our asset sale target with $750 million in net asset sales proceeds to the AES parent after subsidiary level debt repayment, reinvestment, and taxes. And we issued $900 million of parent debt in May of last year. Moving to Uses on the right-hand side, we invested more than $2.1 billion in growth at our subsidiary, of which approximately two-thirds was in the U.S. We also allocated more than $500 million of discretionary cash to our dividends. Overall, I'm extremely pleased with our financial performance throughout 2023. Now let's turn to our guidance and expectations, beginning on slide 21. Today, we're initiating 2024 adjusted EBITDA with tax attributes guidance of $3.6 billion to $4 billion, driven by over $500 million in contributions from new renewables projects and from rate-based growth at our U.S. utilities. We have also incorporated a $200 million partially offsetting impact from asset sales we either closed in 2023 or plan to close this year. Excluding the $1 billion in tax attributes we expect to recognize in 2024, adjusted EBITDA is expected to be $2.6 billion to $2.9 billion. The increase in tax attributes versus the prior year is partially due to our continued use of tax credit transfers, which results in earlier recognition of tax credit than typical tax equity structures. In addition, last year's increase in new project completions will drive higher tax attribute recognition in 2024. As a reminder, we will recognize approximately one-third of tax attributes generated on 2023 projects in the 2024 fiscal year. Looking beyond this year, our head start on asset sales gives us greater visibility toward our longer-term growth and puts downward pressure on our capital budget. We expect EBITDA to increase each year through the remainder of our long-term guidance period. Turning to slide 22, we expect 2024 adjusted EPS of $1.87 to $1.97, which represents a 9% increase year-over-year and puts us on track to achieve our 7% to 9% long-term growth target through 2025. Growth will be primarily driven by our renewables and utilities businesses and will be partially offset by higher parent interest. We also expect an 8% headwind from asset sales. Our construction program this year is more evenly spread than in recent years. As a result, we expect approximately 40% of our earnings to be recognized in the first half of the year and 60% in the second half. And we will have greater visibility throughout the year into our expected construction completion. Turning to slide 23, as Andres mentioned, our very strong market position in providing tailored solutions to corporate clients, including large data centers, has allowed us to realize higher returns on our renewable’s projects. In addition, as our renewables business continues to scale, we anticipate further realization of productivity and scale benefits. Based on these factors and our 2023 results, we now expect AES's U.S. renewables returns to be in the 12% to 15% range. These higher returns in the U.S., along with productivity benefits, are directly accreted to our earnings and cash flow, and as a result, we are increasing our expected long-term adjusted EBITDA growth rate to 5% to 7% and our long-term adjusted EPS growth rate to 7% to 9% through 2027 off of base of our 2023 guidance midpoint. Now, turning to our 2024 parent capital allocation plan on slide 24, beginning with approximately $3.1 billion of Sources on the left-hand side. Parent free cash flow for 2024 is expected to be around $1.05 billion to $1.15 billion. We expect to generate $900 million to $1.1 billion of net asset sale proceeds this year. By the end of this year, we expect to be more than halfway toward the $3.5 billion gross asset sales target we announced on our third quarter earnings call. Although we expect an increase of approximately $1 billion of parent debt this year, our business is well insulated from changes in interest rates. Our new projects are funded primarily with fixed rate or long-term hedged self-amortizing debt with tenors similar to the length of our PPAs, and more than 80% of our outstanding debt is non-recourse to AES Corp. Our exposure from floating rates and future issuances is managed with nearly $8 billion in outstanding hedging. Looking at the impact of a 100 basis point shift in rates on our future issuances, refinancing’s and outstanding U.S. floating rate debt, we have only one penny of EPS exposure from interest rates in 2024. Now to the Uses on the right-hand side. We plan to invest approximately $2.6 billion in new growth, of which about 85% will be allocated to growing our renewables portfolio and utility rate base. More than 90% of this will be directed into the U.S., with the remainder going to growth projects in Chile and Panama. We expect to allocate approximately $500 million to our shareholder dividend, which reflects the previously announced 4% increase. Turning to slide 25, our long-term sources of parent capital through 2027 reflect the accelerated asset sales target we introduced on our third quarter call. We also expect higher organic cash generation as a result of our increased long-term growth rates. As a reminder, we will not issue any new equity until 2026 at the earliest, and we'll only do so in a way that creates value on a per share basis. Now to slide 26. Uses through 2027 reflect more than $7 billion of investment in our subsidiaries, primarily to grow our renewables and utilities businesses. We also expect to allocate more than $2 billion to our dividend. Given our surplus of attractive investment opportunities and our desire to minimize equity issuance as a source of capital, we now expect to grow our dividend at 2% to 3% annually beyond 2024. We believe this provides an optimal balance between an already attractive dividend yield and strong earnings and cash flow growth throughout our planned period. In summary, 2023 was an extraordinary year for AES. We demonstrated our ability to adapt to the current market and execute on our growth commitments while we further advanced our competitive position. As we continue to perfect and scale our renewables machine, we expect to have another record year in 2024 and to deliver on our now higher long-term growth target. We have positioned AES to achieve our strategic priorities and grow our business in a way that's highly value accretive to our shareholders. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. In summary, 2023 was our best year ever as we met or exceeded all of our strategic and financial objectives across our guidance metrics, PPA signings, construction completions, and asset sales. We are seeing strong demand for renewables across the sector, particularly due to the unprecedented demand from data centers. As a result, we are not only upping our U.S. project return ranges, but increasing our expected average annual growth rates for adjusted EBITDA and adjusted earnings per share through 2027. Finally, our significant success with asset sales to date, as well as the outlook for the near future, gives us great comfort in our long-term funding plans. With that, I would like to open the call for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Nick Campanella with Barclays. Your line is open. Please go ahead.
Nicholas Campanella: Hey, good morning. Thanks for taking my questions today and appreciate all the update. I guess you originally had a 3% to 5% EBITDA target when you put out that analyst day range. Then I guess the EBITDA guidance that you gave today for fiscal 2024 does seem to just be a bit flat versus that growth outlook. Is that just from the timing of asset sales? Could you just help clarify what's driving that?
Steve Coughlin: Yes. Hey, Nick. It's Steve. That's right. It's primarily because we're ahead on the asset sale target significantly from 2023. We had the $1.1 billion versus the $400 to $600 guidance. That's why the asset sale drag, as there's a lag to when we redeploy the capital and it's yielding again, is about $200 this year. A little higher than what we would have anticipated a year ago. Overall, good news for the [Technical Difficulty] but it is offsetting the growth that's coming from the rate base and utilities in the renewables projects. That's right.
Nicholas Campanella: That's helpful. Then just on asset sales, to the extent that you're continuing to be successful here and doing more versus what you have in this plan, is there room to offset that $1 billion apparent debt issuance? Does that change at all? Where exactly is there flexibility in this plan today from your perspective? Then could you just also update us on where your leverage targets are and your minimums in this new plan? Thanks.
Steve Coughlin: Yes. Definitely. The investment grade is a top priority. We designed the plan to meet the investment grade targets that we have. We built cushion into the metrics themselves, but also keep in mind that the quality and the duration of the cash flows in the business is transitioning dramatically. We're going to a much longer duration, average duration of contracts, more than -- is 20-year contracts. This is Clean Energy, no carbon risk. These are U.S. dollar contracts with large corporates, many of which are data center customers, big tech companies, very high-quality credit. It's both the solid credit metrics as well as the quality and profile of the cash flows that's evolving. We don't count on that when sizing the new debt. We count on the metrics, but the quality is improving as well. In terms of levers, the asset sale target is, as it's always been, has multiple ways that it can be achieved. There's some conservatism built in over the total. We have fully anticipated any temporal dilutive impacts in the numbers that we've given, as I said, but there is some flex there as needed. On the debt side, the investment grade is a top priority.
Nicholas Campanella: Alright. I'll leave it there. I really appreciate it. Thank you.
Operator: We now turn to David Arcaro with Morgan Stanley. Your line is open. Please go ahead.
David Arcaro: Great. Good morning. Thanks so much for taking the questions. I wanted to dig in a little bit on the higher return levels that you're projecting here. Was there something that sparked it? Any kind of catalyst that has pushed you up in terms of the higher return levels in the renewables business? You've been in a higher interest rate environment, obviously, for a while, higher PPA price environment for a while. Is it more the mix of end customers that you're selling to now?
Andres Gluski: David, I'd say it's a combination of things. First and foremost is the returns that we are [Technical Difficulty] on prior PPAs that we signed. So that's the first. We are seeing that we're getting higher returns. Second, what is driving these higher returns? You may recall for some time, maybe like three years ago, starting three, four years ago, I started saying that in select markets, there would be really a shortage of good renewable projects. These are markets like California, like PJM, New York. What we started to do was position ourselves and actually enter the queue, buy land rights, etcetera, to have projects to be able to fulfill this. I think that part of it is in these select markets, you are starting to see the shortage of renewables that we had been seeing. I think this is something that will spread market to market. It's not going to be true for all markets. Out West, there's a lot of land. There's not that much demand, but in select markets, you will be seeing that. I think that's also part of the result is that we are positioned in the right markets. The third thing I would say is that we're becoming more efficient in our construction and in our development process. Stay tuned. I think that will continue to improve. Realize that 2021, you had a lot of supply chain disruptions. Those are well past us and we're really getting to optimize that. Based on our greater efficiency, what we're seeing is that we are getting higher returns. We've also positioned ourselves, this is about our fourth year, fifth year of really positioning ourselves with large corporate customers. Those corporate customers have very strong demand growing very quickly. If you ask me from a sector point of view, I think the real question is, can we meet the demand that they have for Clean Energy in all of these markets? By the way, I would add Chile is a similar market to California where there's a real shortage of projects. There's a very strong demand from our customers and that we're very well placed. This is not like a catalyst. We had several pieces which are played out as we expected them to play out.
Steve Coughlin: The only thing I would add, David, is that looking at 2023, what we signed up was well within that new updated range.
David Arcaro: Okay, thanks. That's good to hear. Then in terms of the higher growth rates that you've outlined today, wondering if we could just unpack that a little bit. Is that all coming from the renewables segment in terms of the higher returns that you're seeing or is the utilities business or energy infrastructure also experiencing higher EBITDA growth outlooks here?
Andres Gluski: What you have is both. I think there are two key segments. One is the utilities. We have some of the fastest growing utilities in the U.S. Second, yes, we are also seeing better returns in the renewable sector. The combination of those two is resulting in a faster growth rate.
David Arcaro: Okay, great. Thanks so much.
Andres Gluski: Thank you.
Operator: Our next question comes from Julian Dumoulin-Smith with Bank of America. Your line is open. Please go ahead.
Cameron Lochridge: Hi there. Hey, thanks for taking my question. This is actually Cameron Lochridge on for Julian. I wanted to start just on the raised growth expectations. And kind of piggybacking on the last question, if I look at what you had planned for your EBITDA contributions across the different businesses, 45% renewables, 32% utilities, 23% energy infrastructure in 2027, how has that mix shifted as a reflection of this -- these raised expectations for growth?
Steve Coughlin: Yes. So, I would say, I think the mix roughly be maybe a little bit more on the renewable side, we're seeing the higher returns. So maybe that's above the 45 50-ish. So, it's going to be higher on the renewables. I think the utilities, as Andres said, will be a little bit more of a share. On the energy infrastructure, we did communicate that, that was going to shrink as we execute on the coal exit plan. Although for just a handful of assets, we extended that to 2027. So that dilution from those coal exits, this is the smaller portion, will be spread out over more time, which overall, I think, is a good thing in terms of the -- in the financials as well. So a little more renewables, a little more utilities and then the energy infrastructure is shrinking a little bit less, but it's still in that same range.
Cameron Lochridge: Got it. And then just digging in on the renewables, just the cumulative capacity additions you guys have communicated, tripling the bag to 25 to 30 gigawatts of cumulative additions, is that still the case through 2027? Or is that bumped higher? Or is this purely just a function of returns improving? And then on that returns improving piece, how do we think about the bifurcation between, perhaps more ability to capitalize on IRA credits versus just true economic improvement vis-à-vis PPAs, pricing increasing. Just kind of help us unpack that a little bit.
Andres Gluski: Let me sort of give a big picture, and then I'll pass it off to Steve. Look, what we're going after, really, as I said in my script, is really going after those projects, which provide the best financial benefits. You've known me for a while, I've never gone for growth for growth's sake. So really, what we want to do is maximize shareholder value on a per share basis. So really, this is an upgrading of the quality of the growth, more than a greater numeric growth. Now I do think that it's very important to understand sort of what market segments we're in. We're in the corporate segment, but we're also very heavily into the data center segment. And this is something, again, we've been working on for many years. We have really very good relationships with key clients, and that is a demand that's growing very quickly. And certainly, that we don't mention in our speech, quite frankly, because it's very early times. But we're really going to go after artificial intelligence as an efficiency improvement in the company. And we have a big kickoff meeting that we're going to have in the next couple of months. But this is something I think we've taken in a very sort of strategic line. Inderpal Bhandari, who was the global Chief Data Officer for IBM until 2023 has just joined our Board, and somebody who is very knowledgeable in the area. We also have Janet Davidson, who's also a PhD in computer science. It's interesting. I mean, right now, with Inderpal, we have 5 PhDs on our Board, which has got to be one of the highest percentages in things that run from computer science to finance to economics of business. So that's what I wanted to put it in. What we're pursuing is returns, we're pursuing value per share. And I think we've been very systematic now for many years in positioning ourselves in a given sector and learning about and preparing ourselves for the new technologies which are coming. So, there's a lot of buzzwords of AI. Well, what's behind this is 5, 6 years of getting ourselves in a position to really utilize the data and have the understanding of the company. So, with that, I'll pass it off to Steve to answer the other parts of your question.
Steve Coughlin: Yes. No, I agree wholeheartedly that we're focused on cash returns, and that's primarily where the higher growth is coming from. You'll notice that it was really the EBITDA growth rate that ticked up the most. And so not really from tax credits. So, we had already talked about that about 40% of our pipeline was in energy communities that continues to be roughly the case. So, it's really from the cash generation of the assets that the increase in rates is coming up. And we're less focused on megawatts. So, it's roughly a similar amount of capital, maybe even a little bit lower. But if that means less megawatts, that's okay. We're focused on what are the best returns that we can get for our capital that's deployed. And that's cash based and not based on the credit.
Cameron Lochridge: Got it. Awesome, guys. Thank you very much.
Steve Coughlin: Alright. Thank you.
Operator: Our next question comes from Durgesh Chopra with Evercore ISI. Your line is open. Please go ahead.
Durgesh Chopra: Hey good morning, team. Thanks for giving me time. I just wanted to ask about the -- I want to ask you about the new projects, the 3.6 gigawatts to be added in 2024. I mean, obviously, you've done pretty well versus your own stated 5-gigawatt target, the renewable signing. You're doing 5.6, materially higher than 5 gigawatts. But why only like the level of gigawatts actually entering commercial operation is kind of flat to 2023? So just wondering if that's just related to project timing? Because I would have expected to materially tick up, just the new projects going here.
Andres Gluski: Yes. Hi, Durgesh. That's a good question. Look, 2023 was a dramatic year where we increased construction, 100%. And we've been saying, look, we're not going to grow it at 100% per year. Now we've been signing over 5 gigawatts a year of new PPAs. So eventually, these two have to somewhat converge. I mean, at some point, we have to be cutting the ribbon on around 5 gigawatts. But that's not going to happen likely next year, just because of the timing of some of the projects. We also have a developing transfer project as well, and that's not part of our backlog, but it's part of the signing. So that also is part of the reason for that. So -- this is not a signal of anything. It just has to be the particular timing of the projects that we have. And again, we feel this year, very good about commissioning them all on time and on budget. We have 100% of the major equipment already secured and 80% of it is on site, which is we've never been that good this early in the process. And I think another thing important that Steve said, this is going to be reflected in our earnings profile, whereas we were very back-end loaded last year because of this very rapid growth. As growth enters a more steady state, we're going to have 40% of our earnings in the first half and only 60% in the second half. So, this is something we also worked very hard to achieve. So qualitatively, we feel [Technical Difficulty] here is 2024, 2025, you're going to have a catch up to the amount of PPAs that we're signing.
Durgesh Chopra: Got it. Thank you for that Andres. And then maybe, Steve, can I just go back to Nick's question earlier on credit metrics. Can you remind us where you’re ending FFO to debt in 2023 and then where are you projecting 2024 to be versus your credit downgrade thresholds? Thank you.
Steve Coughlin: Yes, I had no problem to guess. So we had a solid year end on the credit metrics. So our thresholds are at 20% FFO to debt and we were roughly at 22% approximately. We do keep atleast a very strong cushion that’s very healthy. And going forward that ratio is actually improving over time in our plan. So for the end of 2024 I would expect it to be at least at 22 if not a little bit higher that. So the leverage of the company overall, we do get a lot of questions about it, but it is important to keep in mind we have a recourse, not recourse structure. And particularly in the non-recourse debt this is amortizing debt. I think not everyone is doing it that way and so our project debt is really amortizing and it serves by the cash flows from the projects. The parent debt level is actually going to be, it will come up a little bit over the planned period, but not a lot. So, it's $4.5 billion now. And as I said in my comments on the slides, maybe another 1 to 1.5 over the 4-year period, but it's going to be pretty stable.
Durgesh Chopra: I appreciate that. Thank you very much.
Steve Coughlin: Thank you.
Operator: Our next question comes from Angie Storozynski with Seaport Research Partners. Your line is open. Please go ahead.
Angie Storozynski: Thank you. So I was just wondering, are you guys seeing any degradation in either EBITDA or cash flow generation of existing assets? I mean, we're seeing examples of -- especially on the wind side -- that wind assets are having some issues with both OpEx and CapEx, hence re-powerings. But just wondering if there's obviously this positive momentum on the new build side, but is there any offset from existing assets?
Andres Gluski: Hi, Angie. No, none whatsoever. In fact, as I said, we continue to operate better. And we are seeing that our older projects are giving the returns that we are actually giving better returns than we had forecast. So, we're not seeing that. I mean, we don't have perhaps that many older wins. We do have awful low gap, but we have not seen any degradation in performance.
Angie Storozynski: Okay. And then the second question. So I remember in the past, you were mentioning that the slightly delayed coal plant retirements could be a lever for actually both earnings and cash flow. So is there an update there?
Steve Coughlin: Yes. So Angie, as I was mentioning, the -- so there's just a handful of assets that we've extended through 2027, primarily due to the short remaining duration of the contracts, and it's making both operational sense as well as financial sense for us to remain the owner through the end of life. So there is some upside to that -- 2 upsides really. It smooths out the $750 million of EBITDA reduction from the coal exit plans throughout the 2025, 2026, 2027, 2028 period, so there's no real cliff. And then it does add to the EBITDA over the time frame. But it's one of the -- it's the smaller driver. The biggest driver of the EBITDA uplift is the higher returns we're realizing on the renewable projects, given the market dynamics that Andres discussed as well as the productivity and scale benefits we've realized in the portfolio and expect to continue to realize as we scale up.
Andres Gluski: Yes. And I'd like to add that we still plan to be out of coal by the end of 2027, and that we -- after 2025, we'll have somewhere about 1 gigawatt plant. And part of this is driven by the fact that these plants are still needed to for stability of the system, so we are not allowed to shut them down in part. I just wanted to clarify. So the strategic objective remains the same, it's just slightly delayed in time.
Angie Storozynski: Okay. And then lastly, and again, it's a bigger picture question, right? We -- it's very topical for today, given a lot of discussion about nuclear power. So we're all getting excited about the colocation of data centers and nuclear plants, and there is argument about spatial limitations for renewable power, given how much land it actually needs to offer similar amounts of computing capacity and especially in Virginia, where those land shortages, I think are most pronounced. So do you actually see that there is disadvantage to your pursuit of tech clients, if that's nuclear angle were to take off?
Andres Gluski: Well, I think, look, a rising tide lifts all boats. So I don't think this is a situation where there's just going to be like one technology that solves all the needs. So I don't see that any future where there's not, quite frankly, a shortage of renewable projects in the key markets. I know it takes a long time to permit nuclear plants. To my knowledge, excuse me, no new nuclear plants have been built, maybe even in the last decade, anywhere near budget. So on the one hand, I do think nuclear is part of the long-run solution, because I do agree. There's only so much land, so much interconnection. On the other hand, I think that the nuclear renaissance has yet to prove itself and it has yet to build out. So the demand from these clients is so strong. I mean, they are taking second best. Sometimes they can't get -- they want to require additionality because they really want to be part of the solution to climate change. Well, there are circumstances where they will take no additional audit and basically have recontract nuclear power today, at least 0 carbon. But the truth is that squeezing the balloon. That's taking 0 carbon energy off the grid. So I don't think -- I'll put it this way, I feel it's extraordinarily unlikely that the growth in renewables will stop and be replaced with nuclear power. And it's certainly in the next 5 years, I don't see it, and I see it very difficult in the next 10 years.
Angie Storozynski: Okay, thank you.
Andres Gluski: Thank you.
Operator: [Operator Instructions] We now turn to Ryan Levine with Citi. Your line is open. Please go ahead.
Ryan Levine: Good morning. Given the scarcity of data center projects, how are returns for these projects compared to the projects for other customers?
Andres Gluski: The scarcity -- look, we don't talk about individual projects, but we do talk about our averages. And so the return on the project will depend, obviously, if you have the suitable location, if it's providing something other than a plain vanilla. So all put together, what I can say is, again, on average, we're seeing an increase in our returns, looking backwards and looking forward, and corporate customers are our most important segment. But yes, we will not comment on sort of specific client areas.
Ryan Levine: Okay. And then how did you arrive at the 2% to 3% long-term dividend growth is the right growth rate from a financial policy standpoint? And what are factors that could cause that policy to continue to evolve?
Steve Coughlin: Ryan. So look, I mean AES has established itself as a dividend payer a long time ago. We've been consistently growing the dividend at that 4 to 6 range for quite a long time. Obviously, the company's success in the renewable space and now our utilities position for significant growth, has put us in front of a huge amount of growth opportunity, and we want to manage our capital sources appropriately. And so we are committed to our dividend. We want to continue to grow, but we felt on balance given the capital opportunities in front of us and the higher returns that growing the dividend at a little bit of a lower rate made sense at this point, particularly as we've seen higher returns coming from our growth investments.
Ryan Levine: Okay. And why start that in 2025 as opposed to another year from a timing standpoint?
Steve Coughlin: Well, we look at this -- so I'm not sure that you were pointing out, so we did grow at 4% this year. This is a policy that we take very seriously and thoughtfully. And so we weren't prepared -- we made that decision for this year, towards the end of last year. We weren't prepared to make this decision until we had thoroughly analyzed it and recently made that decision as we locked down our final plan here. And we think, therefore, it makes sense once we've made the decision to go ahead and implement it as soon as we're able, which will be 2025.
Ryan Levine: Thank you.
Steve Coughlin: Thank you.
Operator: Our final question today comes from Gregg Orrill with UBS. Your line is open. Please go ahead.
Gregg Orrill: Yes, thank you, congratulations. Just a detail-oriented question. The 2024 tax credit guidance of $1 billion. Is there anything in there that is timing related or you might describe as more onetime in nature? Or is that -- would you grow that from that level as you add renewables projects?
Steve Coughlin: Yes. So it will grow. And it's not timing so much as it's just the success of the business. As Andres said, we doubled our construction last year. And keep in mind that not all of the credits are recognized in year one in tax equity structures. It's roughly 1/3 get recognized in the second year. So that's boosting the credit this year as well as all of the projects that will come online this year, the new projects on top of that. The other thing that's driving it is the transfer of credit does get recognized earlier, essentially almost all in the first year. And so there's a greater mix of credits transferred in this vintage this year as we -- that grows as a component of how we monetize the credits. So that's driving it higher. But I don't expect this to have dipped, I think it will continue to rise as we head into the years ahead, as the growth program continues. And then keep in mind that we are benefiting from the energy community adder and a significant portion, which increases the credit. And our wind projects are all qualifying for domestic content also going forward. So that all else being equal, is driving the credit value up. And what's important for everyone to understand is the credit is cash and earnings. And the great thing about these -- particularly the investment credits, which is the lion's share of our mix of tax attributes is upfront. So you're getting a return on your capital investment of a significant portion, at least 30%, in some cases, up to 50% right away, which is a fantastic cash profile as well as an earnings profile.
Gregg Orrill: Okay, thanks.
Operator: This concludes our Q&A. I'll now hand back to Susan Harcourt, Vice President of Investor Relations, for final remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day.
Operator: Ladies and gentlemen, today's call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Hello and welcome to the AES Corporation Fourth Quarter and Full Year 2023 Financial Review call. My name is Elliot and I'll be coordinating your call today. [Operator Instructions]. I'd now like to hand over to Susan Harcourt, Vice President of Investor Relations. The floor is yours. Please go ahead."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning and welcome to our fourth quarter and full year 2023 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today we will be making forward looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer, Steve Coughlin, our Chief Financial Officer and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our fourth quarter and full year 2023 financial review call. Today I will discuss our 2023 strategic and financial performance. Steve Coughlin, our CFO, will discuss our financial results and outlook in more detail shortly. Beginning on slide three, 2023 was our best year ever as we met or exceeded all of our strategic and financial objectives, including signing a record of 5.6 gigawatts of new PPAs, putting us well on track to achieve 14 to 17 gigawatts of new signings through 2025, completing 3.5 gigawatts of construction, exceeding the target we laid out and doubling our additions compared to 2022, delivering adjusted EBITDA of $2.8 billion in the top end of our guidance range and adjusted EBITDA with tax attributes of $3.4 billion, achieving adjusted EPS of $1.76 and parent-free cash flow of just over $1 billion, both beyond the top end of our guidance ranges, and realizing asset sales proceeds of $1.1 billion, significantly above our target of $400 million to $600 million. Turning to slide four, despite the backdrop of rising interest rates and supply chain challenges across the sector, we demonstrated that our business model is strong, resilient, and well-positioned. Demand across the sector has never been stronger, and in this context, I'm pleased to announce that we are raising our expected annual growth rate for adjusted EBITDA and adjusted EPS. We now expect our adjusted EBITDA to grow at an annual rate of 5% to 7% and adjusted EPS to grow at 7% to 9%, both through 2027. We are also reaffirming all of our other existing guidance. I can definitely say that I have never felt better about the outlook for this business. Turning to power purchase agreement signings on slide five, we signed 5.6 gigawatts of new PPAs in 2023, more than any other year in our company's 43-year history, putting us well on track to sign 14 to 17 gigawatts of new renewable contracts from 2023 through 2025. Today, our backlog of projects with signed PPAs is 12.3 gigawatts, the vast majority of which will be commissioned over the next three years. It is worthwhile to note that all of the projects in our contracted backlog remain on track for timely completion, consistent with our historical performance. Moving to slide six, I'd like to highlight that the largest segment of our new business is with corporate customers. In fact, in 2023, nearly 60% of the 3.5 gigawatts of projects we brought online were to serve corporate customers and large technology companies in particular. Bloomberg New Energy Finance has consistently named AES as one of the top two providers of renewable energy to corporations worldwide, and our business continues to expand, particularly given our focus on serving the power needs from data centers which are powering the rapid growth of AI. We are well positioned to serve this customer segment for a number of reasons. First, we have been on the forefront of working directly with these technology companies to provide innovative solutions to achieve specific renewable energy profiles. Back in 2021, we were the first company to introduce hourly match renewable energy, and today we are working with all of the hyperscale data center companies to provide solutions that are tailored for their renewable energy and sustainability goals. Second, we have a strong track record of delivering our projects on time, on budget, while meeting the unique needs of our customers, which I will cover in more detail momentarily. Our record of reliability is something that is increasingly recognized and valued by our customers. And third, we have the scale and the pipeline to address growing demand from data centers, which is estimated to more than double by 2030. With over 50 gigawatts of projects in our development pipeline and advanced interconnection queue positions in the most relevant markets in the U.S., we are particularly well positioned to meet the energy demand of technology customers. Turning to slide seven, our success with corporate customers combined with our improved efficiency in development and construction have increased the returns that we have seen across our renewable portfolio. As a result, we are upping our U.S. return ranges by 200 basis points to 12% to 15% on a levered after-tax cash basis. We are seeing even higher returns internationally. With strong market demand in AES's leading position, we are able to be increasingly selective about the projects we build with a focus on those with the best overall financial benefits. Next, turning to construction on slide eight, our ability to complete projects on time and on budget has become a major differentiator for AES. Not only is this something that our customers highly value, but it is also a pillar of our business model and ensures that our realized financial returns are on average equal to or better than our projections. At the time of PPA signings, we lock in contractual arrangements for all major equipment, EPC, and long-term financing, which we hedge to ensure no interest rate exposure. At the same time, we systematically embed flexibility in our supply chain to safeguard against a variety of scenarios. We also have a multi-year strategic arrangement with top suppliers, including Fluence, who we see as having the most competitive product in the industry. More than half of our solar projects in recent years have co-located storage components, and our relationship with Fluence helped us to have the best on-time project completion rate in the industry. In 2024, we feel very confident in our ability to add 3.6 gigawatts of new projects, including 2.2 gigawatts in the U.S. We currently have 100% of the major equipment for these projects contractually secured and nearly 80% already on site. Now turning to our utilities, beginning on slide nine. In 2023, we achieved important milestones at our U.S. utilities that will drive future growth, continue decarbonization, and improvement in customer service. At AES Ohio, we put in place a new regulatory framework, and at AES Indiana, we reached a unanimous settlement for our first-rate case since 2018. As a result, investments are on track for the rate-based growth in the high teens at both utilities, and we now have close to 70% of our planned investments through 2027 already approved in regulatory orders. Turning to slide 10. At AES Ohio, we are embarking on the largest investment program that this utility has ever seen, which includes the expansion and enhancement in our transmission assets. With over 25% rate-based growth per year, this is one of the fastest transmission growth rates in the country. We also recently filed for regulatory approval of the second phase of our smart grid plan, which upgrades our grid to improve service quality and customer experience. Turning to slide 11. At AES Indiana, we continue to invest to improve service quality and greener generation mix. I am happy to say that we now have regulatory approval for the build-out of all named renewable projects at AES Indiana, encompassing 106 megawatts of wind, 445 megawatts of solar, and 245 megawatts of energy storage. As we continue to invest in our customer experience, service quality, and sustainability at both of our U.S. utilities, two core principles have guided our growth plan. First is customer affordability as we address much-needed investments. We currently have the lowest residential rate in both states, which we expect to maintain throughout this period of growth. And second is to prioritize the timely recovery of our investments through existing mechanisms and programs. Across both utilities, we now anticipate approximately 75% of the growth capital to be deployed under such mechanisms, which substantially reduces regulatory lag. Finally, turning to slide 12. Last year, we set an asset sale proceeds target of 400 million to 600 million. We greatly exceeded this range with 1.1 billion of gross proceeds. These transactions not only put a high valuation marker on our businesses, but also put us well on our way towards achieving our asset sales goal of $2 billion through 2025 and $3.5 billion through 2027. Our success this past year provides us with a cushion, and we expect 2024 to be another strong year. With that, I would like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our 2023 results and capital allocation, our 2024 guidance, and our updated expectations through 2027. As Andres mentioned, 2023 was AES's best year on record as we met or exceeded all of our strategic and financial targets. We beat our adjusted EPS guidance range of $1.65 to $1.75 and our parent-free cash flow guidance range of $950 million to $1 billion. We also recorded strong adjusted EBITDA well above the midpoint of our inaugural guidance range of $2.6 billion to $2.9 billion. Turning to slide 14, full year 2023 adjusted EBITDA with tax attributes was $3.4 billion versus $3.2 billion in 2022, driven primarily by contributions from new renewables projects, as well as the recovery of prior year's purchase power costs at AES Ohio included as part of the ESP4 settlement. These drivers were partially offset by lower contributions from the energy infrastructure SBU. Turning to slide 15, adjusted EPS was $1.76 in 2023 versus $1.67 in 2022. Drivers were similar to those for adjusted EBITDA with tax attributes. In addition, there was a $0.06 headwind from parent interest on higher debt balances primarily used to fund new renewables projects. I'll cover our results in more detail over the next four slides, beginning with the Renewable Strategic Business Unit or SBU on slide 16. Higher adjusted EBITDA with tax attributes at our renewables SBU was primarily driven by contributions from the 3.5 gigawatts of new projects that came online in 2023, as well as higher margins in Columbia, but partially offset by the sell down of select U.S. renewable operating assets. At our utilities SBU, higher adjusted PTC was primarily driven by the recovery of prior year's purchase power costs at AES Ohio included as part of the ESP4 settlement, as well as rate-based growth in the U.S. Lower adjusted EBITDA at our energy infrastructure SBU reflects significant LNG transaction margins in 2022, lower margins in Chile, and the sale of a minority interest in our Southland combined cycle assets. These drivers were partially offset by the higher revenues recognized from the accelerated monetization of the PPA at our Warrior Run coal plant. Finally, at our new energy technologies SBU, higher adjusted EBITDA reflects improved results at Fluence, which achieves positive adjusted EBITDA in their fiscal fourth quarter of 2023. Fluence also guided to positive adjusted EBITDA for their full fiscal year 2024. Now let's turn to how we allocated our capital last year on slide 20. Beginning on the left-hand side, Sources reflect $3 billion of total discretionary cash. This includes parent-free cash flow of just over $1 billion, which increased nearly 11% from the prior year to just above the top end of our guidance. We also significantly surpassed our asset sale target with $750 million in net asset sales proceeds to the AES parent after subsidiary level debt repayment, reinvestment, and taxes. And we issued $900 million of parent debt in May of last year. Moving to Uses on the right-hand side, we invested more than $2.1 billion in growth at our subsidiary, of which approximately two-thirds was in the U.S. We also allocated more than $500 million of discretionary cash to our dividends. Overall, I'm extremely pleased with our financial performance throughout 2023. Now let's turn to our guidance and expectations, beginning on slide 21. Today, we're initiating 2024 adjusted EBITDA with tax attributes guidance of $3.6 billion to $4 billion, driven by over $500 million in contributions from new renewables projects and from rate-based growth at our U.S. utilities. We have also incorporated a $200 million partially offsetting impact from asset sales we either closed in 2023 or plan to close this year. Excluding the $1 billion in tax attributes we expect to recognize in 2024, adjusted EBITDA is expected to be $2.6 billion to $2.9 billion. The increase in tax attributes versus the prior year is partially due to our continued use of tax credit transfers, which results in earlier recognition of tax credit than typical tax equity structures. In addition, last year's increase in new project completions will drive higher tax attribute recognition in 2024. As a reminder, we will recognize approximately one-third of tax attributes generated on 2023 projects in the 2024 fiscal year. Looking beyond this year, our head start on asset sales gives us greater visibility toward our longer-term growth and puts downward pressure on our capital budget. We expect EBITDA to increase each year through the remainder of our long-term guidance period. Turning to slide 22, we expect 2024 adjusted EPS of $1.87 to $1.97, which represents a 9% increase year-over-year and puts us on track to achieve our 7% to 9% long-term growth target through 2025. Growth will be primarily driven by our renewables and utilities businesses and will be partially offset by higher parent interest. We also expect an 8% headwind from asset sales. Our construction program this year is more evenly spread than in recent years. As a result, we expect approximately 40% of our earnings to be recognized in the first half of the year and 60% in the second half. And we will have greater visibility throughout the year into our expected construction completion. Turning to slide 23, as Andres mentioned, our very strong market position in providing tailored solutions to corporate clients, including large data centers, has allowed us to realize higher returns on our renewable’s projects. In addition, as our renewables business continues to scale, we anticipate further realization of productivity and scale benefits. Based on these factors and our 2023 results, we now expect AES's U.S. renewables returns to be in the 12% to 15% range. These higher returns in the U.S., along with productivity benefits, are directly accreted to our earnings and cash flow, and as a result, we are increasing our expected long-term adjusted EBITDA growth rate to 5% to 7% and our long-term adjusted EPS growth rate to 7% to 9% through 2027 off of base of our 2023 guidance midpoint. Now, turning to our 2024 parent capital allocation plan on slide 24, beginning with approximately $3.1 billion of Sources on the left-hand side. Parent free cash flow for 2024 is expected to be around $1.05 billion to $1.15 billion. We expect to generate $900 million to $1.1 billion of net asset sale proceeds this year. By the end of this year, we expect to be more than halfway toward the $3.5 billion gross asset sales target we announced on our third quarter earnings call. Although we expect an increase of approximately $1 billion of parent debt this year, our business is well insulated from changes in interest rates. Our new projects are funded primarily with fixed rate or long-term hedged self-amortizing debt with tenors similar to the length of our PPAs, and more than 80% of our outstanding debt is non-recourse to AES Corp. Our exposure from floating rates and future issuances is managed with nearly $8 billion in outstanding hedging. Looking at the impact of a 100 basis point shift in rates on our future issuances, refinancing’s and outstanding U.S. floating rate debt, we have only one penny of EPS exposure from interest rates in 2024. Now to the Uses on the right-hand side. We plan to invest approximately $2.6 billion in new growth, of which about 85% will be allocated to growing our renewables portfolio and utility rate base. More than 90% of this will be directed into the U.S., with the remainder going to growth projects in Chile and Panama. We expect to allocate approximately $500 million to our shareholder dividend, which reflects the previously announced 4% increase. Turning to slide 25, our long-term sources of parent capital through 2027 reflect the accelerated asset sales target we introduced on our third quarter call. We also expect higher organic cash generation as a result of our increased long-term growth rates. As a reminder, we will not issue any new equity until 2026 at the earliest, and we'll only do so in a way that creates value on a per share basis. Now to slide 26. Uses through 2027 reflect more than $7 billion of investment in our subsidiaries, primarily to grow our renewables and utilities businesses. We also expect to allocate more than $2 billion to our dividend. Given our surplus of attractive investment opportunities and our desire to minimize equity issuance as a source of capital, we now expect to grow our dividend at 2% to 3% annually beyond 2024. We believe this provides an optimal balance between an already attractive dividend yield and strong earnings and cash flow growth throughout our planned period. In summary, 2023 was an extraordinary year for AES. We demonstrated our ability to adapt to the current market and execute on our growth commitments while we further advanced our competitive position. As we continue to perfect and scale our renewables machine, we expect to have another record year in 2024 and to deliver on our now higher long-term growth target. We have positioned AES to achieve our strategic priorities and grow our business in a way that's highly value accretive to our shareholders. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. In summary, 2023 was our best year ever as we met or exceeded all of our strategic and financial objectives across our guidance metrics, PPA signings, construction completions, and asset sales. We are seeing strong demand for renewables across the sector, particularly due to the unprecedented demand from data centers. As a result, we are not only upping our U.S. project return ranges, but increasing our expected average annual growth rates for adjusted EBITDA and adjusted earnings per share through 2027. Finally, our significant success with asset sales to date, as well as the outlook for the near future, gives us great comfort in our long-term funding plans. With that, I would like to open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Nick Campanella with Barclays. Your line is open. Please go ahead."
},
{
"speaker": "Nicholas Campanella",
"text": "Hey, good morning. Thanks for taking my questions today and appreciate all the update. I guess you originally had a 3% to 5% EBITDA target when you put out that analyst day range. Then I guess the EBITDA guidance that you gave today for fiscal 2024 does seem to just be a bit flat versus that growth outlook. Is that just from the timing of asset sales? Could you just help clarify what's driving that?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Hey, Nick. It's Steve. That's right. It's primarily because we're ahead on the asset sale target significantly from 2023. We had the $1.1 billion versus the $400 to $600 guidance. That's why the asset sale drag, as there's a lag to when we redeploy the capital and it's yielding again, is about $200 this year. A little higher than what we would have anticipated a year ago. Overall, good news for the [Technical Difficulty] but it is offsetting the growth that's coming from the rate base and utilities in the renewables projects. That's right."
},
{
"speaker": "Nicholas Campanella",
"text": "That's helpful. Then just on asset sales, to the extent that you're continuing to be successful here and doing more versus what you have in this plan, is there room to offset that $1 billion apparent debt issuance? Does that change at all? Where exactly is there flexibility in this plan today from your perspective? Then could you just also update us on where your leverage targets are and your minimums in this new plan? Thanks."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Definitely. The investment grade is a top priority. We designed the plan to meet the investment grade targets that we have. We built cushion into the metrics themselves, but also keep in mind that the quality and the duration of the cash flows in the business is transitioning dramatically. We're going to a much longer duration, average duration of contracts, more than -- is 20-year contracts. This is Clean Energy, no carbon risk. These are U.S. dollar contracts with large corporates, many of which are data center customers, big tech companies, very high-quality credit. It's both the solid credit metrics as well as the quality and profile of the cash flows that's evolving. We don't count on that when sizing the new debt. We count on the metrics, but the quality is improving as well. In terms of levers, the asset sale target is, as it's always been, has multiple ways that it can be achieved. There's some conservatism built in over the total. We have fully anticipated any temporal dilutive impacts in the numbers that we've given, as I said, but there is some flex there as needed. On the debt side, the investment grade is a top priority."
},
{
"speaker": "Nicholas Campanella",
"text": "Alright. I'll leave it there. I really appreciate it. Thank you."
},
{
"speaker": "Operator",
"text": "We now turn to David Arcaro with Morgan Stanley. Your line is open. Please go ahead."
},
{
"speaker": "David Arcaro",
"text": "Great. Good morning. Thanks so much for taking the questions. I wanted to dig in a little bit on the higher return levels that you're projecting here. Was there something that sparked it? Any kind of catalyst that has pushed you up in terms of the higher return levels in the renewables business? You've been in a higher interest rate environment, obviously, for a while, higher PPA price environment for a while. Is it more the mix of end customers that you're selling to now?"
},
{
"speaker": "Andres Gluski",
"text": "David, I'd say it's a combination of things. First and foremost is the returns that we are [Technical Difficulty] on prior PPAs that we signed. So that's the first. We are seeing that we're getting higher returns. Second, what is driving these higher returns? You may recall for some time, maybe like three years ago, starting three, four years ago, I started saying that in select markets, there would be really a shortage of good renewable projects. These are markets like California, like PJM, New York. What we started to do was position ourselves and actually enter the queue, buy land rights, etcetera, to have projects to be able to fulfill this. I think that part of it is in these select markets, you are starting to see the shortage of renewables that we had been seeing. I think this is something that will spread market to market. It's not going to be true for all markets. Out West, there's a lot of land. There's not that much demand, but in select markets, you will be seeing that. I think that's also part of the result is that we are positioned in the right markets. The third thing I would say is that we're becoming more efficient in our construction and in our development process. Stay tuned. I think that will continue to improve. Realize that 2021, you had a lot of supply chain disruptions. Those are well past us and we're really getting to optimize that. Based on our greater efficiency, what we're seeing is that we are getting higher returns. We've also positioned ourselves, this is about our fourth year, fifth year of really positioning ourselves with large corporate customers. Those corporate customers have very strong demand growing very quickly. If you ask me from a sector point of view, I think the real question is, can we meet the demand that they have for Clean Energy in all of these markets? By the way, I would add Chile is a similar market to California where there's a real shortage of projects. There's a very strong demand from our customers and that we're very well placed. This is not like a catalyst. We had several pieces which are played out as we expected them to play out."
},
{
"speaker": "Steve Coughlin",
"text": "The only thing I would add, David, is that looking at 2023, what we signed up was well within that new updated range."
},
{
"speaker": "David Arcaro",
"text": "Okay, thanks. That's good to hear. Then in terms of the higher growth rates that you've outlined today, wondering if we could just unpack that a little bit. Is that all coming from the renewables segment in terms of the higher returns that you're seeing or is the utilities business or energy infrastructure also experiencing higher EBITDA growth outlooks here?"
},
{
"speaker": "Andres Gluski",
"text": "What you have is both. I think there are two key segments. One is the utilities. We have some of the fastest growing utilities in the U.S. Second, yes, we are also seeing better returns in the renewable sector. The combination of those two is resulting in a faster growth rate."
},
{
"speaker": "David Arcaro",
"text": "Okay, great. Thanks so much."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julian Dumoulin-Smith with Bank of America. Your line is open. Please go ahead."
},
{
"speaker": "Cameron Lochridge",
"text": "Hi there. Hey, thanks for taking my question. This is actually Cameron Lochridge on for Julian. I wanted to start just on the raised growth expectations. And kind of piggybacking on the last question, if I look at what you had planned for your EBITDA contributions across the different businesses, 45% renewables, 32% utilities, 23% energy infrastructure in 2027, how has that mix shifted as a reflection of this -- these raised expectations for growth?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So, I would say, I think the mix roughly be maybe a little bit more on the renewable side, we're seeing the higher returns. So maybe that's above the 45 50-ish. So, it's going to be higher on the renewables. I think the utilities, as Andres said, will be a little bit more of a share. On the energy infrastructure, we did communicate that, that was going to shrink as we execute on the coal exit plan. Although for just a handful of assets, we extended that to 2027. So that dilution from those coal exits, this is the smaller portion, will be spread out over more time, which overall, I think, is a good thing in terms of the -- in the financials as well. So a little more renewables, a little more utilities and then the energy infrastructure is shrinking a little bit less, but it's still in that same range."
},
{
"speaker": "Cameron Lochridge",
"text": "Got it. And then just digging in on the renewables, just the cumulative capacity additions you guys have communicated, tripling the bag to 25 to 30 gigawatts of cumulative additions, is that still the case through 2027? Or is that bumped higher? Or is this purely just a function of returns improving? And then on that returns improving piece, how do we think about the bifurcation between, perhaps more ability to capitalize on IRA credits versus just true economic improvement vis-à-vis PPAs, pricing increasing. Just kind of help us unpack that a little bit."
},
{
"speaker": "Andres Gluski",
"text": "Let me sort of give a big picture, and then I'll pass it off to Steve. Look, what we're going after, really, as I said in my script, is really going after those projects, which provide the best financial benefits. You've known me for a while, I've never gone for growth for growth's sake. So really, what we want to do is maximize shareholder value on a per share basis. So really, this is an upgrading of the quality of the growth, more than a greater numeric growth. Now I do think that it's very important to understand sort of what market segments we're in. We're in the corporate segment, but we're also very heavily into the data center segment. And this is something, again, we've been working on for many years. We have really very good relationships with key clients, and that is a demand that's growing very quickly. And certainly, that we don't mention in our speech, quite frankly, because it's very early times. But we're really going to go after artificial intelligence as an efficiency improvement in the company. And we have a big kickoff meeting that we're going to have in the next couple of months. But this is something I think we've taken in a very sort of strategic line. Inderpal Bhandari, who was the global Chief Data Officer for IBM until 2023 has just joined our Board, and somebody who is very knowledgeable in the area. We also have Janet Davidson, who's also a PhD in computer science. It's interesting. I mean, right now, with Inderpal, we have 5 PhDs on our Board, which has got to be one of the highest percentages in things that run from computer science to finance to economics of business. So that's what I wanted to put it in. What we're pursuing is returns, we're pursuing value per share. And I think we've been very systematic now for many years in positioning ourselves in a given sector and learning about and preparing ourselves for the new technologies which are coming. So, there's a lot of buzzwords of AI. Well, what's behind this is 5, 6 years of getting ourselves in a position to really utilize the data and have the understanding of the company. So, with that, I'll pass it off to Steve to answer the other parts of your question."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. No, I agree wholeheartedly that we're focused on cash returns, and that's primarily where the higher growth is coming from. You'll notice that it was really the EBITDA growth rate that ticked up the most. And so not really from tax credits. So, we had already talked about that about 40% of our pipeline was in energy communities that continues to be roughly the case. So, it's really from the cash generation of the assets that the increase in rates is coming up. And we're less focused on megawatts. So, it's roughly a similar amount of capital, maybe even a little bit lower. But if that means less megawatts, that's okay. We're focused on what are the best returns that we can get for our capital that's deployed. And that's cash based and not based on the credit."
},
{
"speaker": "Cameron Lochridge",
"text": "Got it. Awesome, guys. Thank you very much."
},
{
"speaker": "Steve Coughlin",
"text": "Alright. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Durgesh Chopra with Evercore ISI. Your line is open. Please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey good morning, team. Thanks for giving me time. I just wanted to ask about the -- I want to ask you about the new projects, the 3.6 gigawatts to be added in 2024. I mean, obviously, you've done pretty well versus your own stated 5-gigawatt target, the renewable signing. You're doing 5.6, materially higher than 5 gigawatts. But why only like the level of gigawatts actually entering commercial operation is kind of flat to 2023? So just wondering if that's just related to project timing? Because I would have expected to materially tick up, just the new projects going here."
},
{
"speaker": "Andres Gluski",
"text": "Yes. Hi, Durgesh. That's a good question. Look, 2023 was a dramatic year where we increased construction, 100%. And we've been saying, look, we're not going to grow it at 100% per year. Now we've been signing over 5 gigawatts a year of new PPAs. So eventually, these two have to somewhat converge. I mean, at some point, we have to be cutting the ribbon on around 5 gigawatts. But that's not going to happen likely next year, just because of the timing of some of the projects. We also have a developing transfer project as well, and that's not part of our backlog, but it's part of the signing. So that also is part of the reason for that. So -- this is not a signal of anything. It just has to be the particular timing of the projects that we have. And again, we feel this year, very good about commissioning them all on time and on budget. We have 100% of the major equipment already secured and 80% of it is on site, which is we've never been that good this early in the process. And I think another thing important that Steve said, this is going to be reflected in our earnings profile, whereas we were very back-end loaded last year because of this very rapid growth. As growth enters a more steady state, we're going to have 40% of our earnings in the first half and only 60% in the second half. So, this is something we also worked very hard to achieve. So qualitatively, we feel [Technical Difficulty] here is 2024, 2025, you're going to have a catch up to the amount of PPAs that we're signing."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Thank you for that Andres. And then maybe, Steve, can I just go back to Nick's question earlier on credit metrics. Can you remind us where you’re ending FFO to debt in 2023 and then where are you projecting 2024 to be versus your credit downgrade thresholds? Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, I had no problem to guess. So we had a solid year end on the credit metrics. So our thresholds are at 20% FFO to debt and we were roughly at 22% approximately. We do keep atleast a very strong cushion that’s very healthy. And going forward that ratio is actually improving over time in our plan. So for the end of 2024 I would expect it to be at least at 22 if not a little bit higher that. So the leverage of the company overall, we do get a lot of questions about it, but it is important to keep in mind we have a recourse, not recourse structure. And particularly in the non-recourse debt this is amortizing debt. I think not everyone is doing it that way and so our project debt is really amortizing and it serves by the cash flows from the projects. The parent debt level is actually going to be, it will come up a little bit over the planned period, but not a lot. So, it's $4.5 billion now. And as I said in my comments on the slides, maybe another 1 to 1.5 over the 4-year period, but it's going to be pretty stable."
},
{
"speaker": "Durgesh Chopra",
"text": "I appreciate that. Thank you very much."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Angie Storozynski with Seaport Research Partners. Your line is open. Please go ahead."
},
{
"speaker": "Angie Storozynski",
"text": "Thank you. So I was just wondering, are you guys seeing any degradation in either EBITDA or cash flow generation of existing assets? I mean, we're seeing examples of -- especially on the wind side -- that wind assets are having some issues with both OpEx and CapEx, hence re-powerings. But just wondering if there's obviously this positive momentum on the new build side, but is there any offset from existing assets?"
},
{
"speaker": "Andres Gluski",
"text": "Hi, Angie. No, none whatsoever. In fact, as I said, we continue to operate better. And we are seeing that our older projects are giving the returns that we are actually giving better returns than we had forecast. So, we're not seeing that. I mean, we don't have perhaps that many older wins. We do have awful low gap, but we have not seen any degradation in performance."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And then the second question. So I remember in the past, you were mentioning that the slightly delayed coal plant retirements could be a lever for actually both earnings and cash flow. So is there an update there?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So Angie, as I was mentioning, the -- so there's just a handful of assets that we've extended through 2027, primarily due to the short remaining duration of the contracts, and it's making both operational sense as well as financial sense for us to remain the owner through the end of life. So there is some upside to that -- 2 upsides really. It smooths out the $750 million of EBITDA reduction from the coal exit plans throughout the 2025, 2026, 2027, 2028 period, so there's no real cliff. And then it does add to the EBITDA over the time frame. But it's one of the -- it's the smaller driver. The biggest driver of the EBITDA uplift is the higher returns we're realizing on the renewable projects, given the market dynamics that Andres discussed as well as the productivity and scale benefits we've realized in the portfolio and expect to continue to realize as we scale up."
},
{
"speaker": "Andres Gluski",
"text": "Yes. And I'd like to add that we still plan to be out of coal by the end of 2027, and that we -- after 2025, we'll have somewhere about 1 gigawatt plant. And part of this is driven by the fact that these plants are still needed to for stability of the system, so we are not allowed to shut them down in part. I just wanted to clarify. So the strategic objective remains the same, it's just slightly delayed in time."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And then lastly, and again, it's a bigger picture question, right? We -- it's very topical for today, given a lot of discussion about nuclear power. So we're all getting excited about the colocation of data centers and nuclear plants, and there is argument about spatial limitations for renewable power, given how much land it actually needs to offer similar amounts of computing capacity and especially in Virginia, where those land shortages, I think are most pronounced. So do you actually see that there is disadvantage to your pursuit of tech clients, if that's nuclear angle were to take off?"
},
{
"speaker": "Andres Gluski",
"text": "Well, I think, look, a rising tide lifts all boats. So I don't think this is a situation where there's just going to be like one technology that solves all the needs. So I don't see that any future where there's not, quite frankly, a shortage of renewable projects in the key markets. I know it takes a long time to permit nuclear plants. To my knowledge, excuse me, no new nuclear plants have been built, maybe even in the last decade, anywhere near budget. So on the one hand, I do think nuclear is part of the long-run solution, because I do agree. There's only so much land, so much interconnection. On the other hand, I think that the nuclear renaissance has yet to prove itself and it has yet to build out. So the demand from these clients is so strong. I mean, they are taking second best. Sometimes they can't get -- they want to require additionality because they really want to be part of the solution to climate change. Well, there are circumstances where they will take no additional audit and basically have recontract nuclear power today, at least 0 carbon. But the truth is that squeezing the balloon. That's taking 0 carbon energy off the grid. So I don't think -- I'll put it this way, I feel it's extraordinarily unlikely that the growth in renewables will stop and be replaced with nuclear power. And it's certainly in the next 5 years, I don't see it, and I see it very difficult in the next 10 years."
},
{
"speaker": "Angie Storozynski",
"text": "Okay, thank you."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We now turn to Ryan Levine with Citi. Your line is open. Please go ahead."
},
{
"speaker": "Ryan Levine",
"text": "Good morning. Given the scarcity of data center projects, how are returns for these projects compared to the projects for other customers?"
},
{
"speaker": "Andres Gluski",
"text": "The scarcity -- look, we don't talk about individual projects, but we do talk about our averages. And so the return on the project will depend, obviously, if you have the suitable location, if it's providing something other than a plain vanilla. So all put together, what I can say is, again, on average, we're seeing an increase in our returns, looking backwards and looking forward, and corporate customers are our most important segment. But yes, we will not comment on sort of specific client areas."
},
{
"speaker": "Ryan Levine",
"text": "Okay. And then how did you arrive at the 2% to 3% long-term dividend growth is the right growth rate from a financial policy standpoint? And what are factors that could cause that policy to continue to evolve?"
},
{
"speaker": "Steve Coughlin",
"text": "Ryan. So look, I mean AES has established itself as a dividend payer a long time ago. We've been consistently growing the dividend at that 4 to 6 range for quite a long time. Obviously, the company's success in the renewable space and now our utilities position for significant growth, has put us in front of a huge amount of growth opportunity, and we want to manage our capital sources appropriately. And so we are committed to our dividend. We want to continue to grow, but we felt on balance given the capital opportunities in front of us and the higher returns that growing the dividend at a little bit of a lower rate made sense at this point, particularly as we've seen higher returns coming from our growth investments."
},
{
"speaker": "Ryan Levine",
"text": "Okay. And why start that in 2025 as opposed to another year from a timing standpoint?"
},
{
"speaker": "Steve Coughlin",
"text": "Well, we look at this -- so I'm not sure that you were pointing out, so we did grow at 4% this year. This is a policy that we take very seriously and thoughtfully. And so we weren't prepared -- we made that decision for this year, towards the end of last year. We weren't prepared to make this decision until we had thoroughly analyzed it and recently made that decision as we locked down our final plan here. And we think, therefore, it makes sense once we've made the decision to go ahead and implement it as soon as we're able, which will be 2025."
},
{
"speaker": "Ryan Levine",
"text": "Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our final question today comes from Gregg Orrill with UBS. Your line is open. Please go ahead."
},
{
"speaker": "Gregg Orrill",
"text": "Yes, thank you, congratulations. Just a detail-oriented question. The 2024 tax credit guidance of $1 billion. Is there anything in there that is timing related or you might describe as more onetime in nature? Or is that -- would you grow that from that level as you add renewables projects?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So it will grow. And it's not timing so much as it's just the success of the business. As Andres said, we doubled our construction last year. And keep in mind that not all of the credits are recognized in year one in tax equity structures. It's roughly 1/3 get recognized in the second year. So that's boosting the credit this year as well as all of the projects that will come online this year, the new projects on top of that. The other thing that's driving it is the transfer of credit does get recognized earlier, essentially almost all in the first year. And so there's a greater mix of credits transferred in this vintage this year as we -- that grows as a component of how we monetize the credits. So that's driving it higher. But I don't expect this to have dipped, I think it will continue to rise as we head into the years ahead, as the growth program continues. And then keep in mind that we are benefiting from the energy community adder and a significant portion, which increases the credit. And our wind projects are all qualifying for domestic content also going forward. So that all else being equal, is driving the credit value up. And what's important for everyone to understand is the credit is cash and earnings. And the great thing about these -- particularly the investment credits, which is the lion's share of our mix of tax attributes is upfront. So you're getting a return on your capital investment of a significant portion, at least 30%, in some cases, up to 50% right away, which is a fantastic cash profile as well as an earnings profile."
},
{
"speaker": "Gregg Orrill",
"text": "Okay, thanks."
},
{
"speaker": "Operator",
"text": "This concludes our Q&A. I'll now hand back to Susan Harcourt, Vice President of Investor Relations, for final remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, today's call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AES | 3 | 2,023 | 2023-11-03 10:00:00 | Operator: Good morning, and thank you for joining The AES Corporation Third Quarter 2023 Financial Review Call. My name is Kate, and I will be the moderator for today's call. [Operator Instructions] I would now like to turn the call over to your host, Susan Harcourt, Vice President of Investor Relations. You may proceed.
Susan Harcourt: Thank you, operator. Good morning, and welcome to our third quarter 2023 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Stephen Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our third quarter 2023 financial review call. In addition to discussing our third quarter and outlook for the remainder of the year, I will address some concerns that we have heard from investors since our second quarter call in August. Specifically, my remarks today will focus on three areas: strategic and financial updates, our funding sources, and our exposure to interest rates. Beginning on Slide 3. I am pleased to report that our financial results continue to be strong and we now expect full year adjusted EPS to be in the top half of our guidance range of $1.65 to $1.75. We are also reaffirming all of our short- and long-term financial metrics. For the third quarter, adjusted EBITDA with tax attributes was $1 billion, and adjusted earnings per share was $0.60. I'm very pleased with these results, which Steve will address in more detail shortly. Turning to Slide 4. We continue to see strong demand for long-term contracts for renewables, particularly from our primary customer base of large technology companies with a rapidly expanding data center business. Notably, even with rising interest rates, renewables continue to have the lowest levelized cost of energy, or LCOE, across almost all of the markets where we operate. So far this year, we have signed 3.7 gigawatts of new PPAs, including 1.5 gigawatts since our second quarter call in August. This number does not include the 1.2 gigawatts of new projects we were recently awarded in New York. Given that we have several large contracts that could be finalized in the coming weeks, we remain confident in our ability to sign at least 5 gigawatts of new long-term PPAs this year. Included in the new contracts that we have already signed, is our first-ever developed transfer agreement, or DTA, to transfer to a utility 975 megawatts of solar plus storage at the point of commencement of construction. This structure allows us to create value from our advanced pipeline without the investment of any AES equity beyond the development costs. Now turning to our backlog on Slide 5. Our backlog of projects with signed long-term contracts is now 13.1 gigawatts. Of this total backlog, we expect more than 70% or over 9 gigawatts to come online through 2025, and we have already secured all of the necessary equipment for these projects. Furthermore, 44% or 5.8 gigawatts is already under construction. Moving to Slide 6. Our construction program continues to make excellent progress with 93% of the megawatts expected to come online this year, already having achieved mechanical completion. As a result, we have increased our year-end construction target from 3.4 gigawatts to 3.5 gigawatts to incorporate the progress we have made this year. This figure reflects a more than doubling of the renewable projects placed in service compared to last year. Now turning to Slide 7. In light of current market conditions, I would like to directly address the sources of funding that we have in our long-term plan. We will not be issuing any equity until at least 2026, and even then, we will only issue equity if it is value accretive to our shareholders. Instead, we are significantly accelerating our asset sales, and believe, we now have line of sight to at least $2 billion of asset sale proceeds in '24 and '25, and expect our asset sale proceeds to total at least $3.5 billion through 2027. With the proceeds from the sell-downs of our businesses in the Dominican Republic and Panama that we announced in September, we have already secured all of our external financing needs for the year at attractive terms. The general buckets that are part of our asset sales plan are: coal exit; sell-downs of U.S. renewable projects; partial monetization of businesses, including new energy technologies; and the exit of certain noncore businesses. We also plan to bring in partners at some of our businesses as we have done in the past to reduce future equity needs. While we never disclose specific transactions until we have actually signed sales agreement, we are in active and positive discussions with many interested counterparties. Turning to Slide 8. The last topic I want to address before turning the call over to Steve is our exposure to interest rates. As a normal course of business, we have always proactively matched the profile of the debt to the profile of the cash flows that are supporting, which minimizes any impact from higher interest rates. Approximately 80% of our debt is non-recourse to the AES parent. And of that, the vast majority is either utility debt included in our customer rates or project level debt that is matched to the underlying project revenues. All of our long-term debt at Corp is either fixed or hedged, and as we have stated before, we've been able to pass on higher costs and interest rates in the new PPAs we signed. Finally, I want to highlight our commitment to maintaining our investment-grade credit ratings, which we see as an important component of our value proposition. To that end, in every business decision we make, we take into consideration our relevant credit metrics. We take a disciplined approach to growth and overall risk management to ensure that we consistently maintain these metrics. With that, I would like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will discuss our third quarter results, our 2023 guidance, how we are flexing our plans to adapt to current financial market conditions and how we minimize our exposure to interest rates. Turning to our financial results for the quarter, beginning on Slide 10. I'm pleased to share that we had a strong third quarter and are fully on track to achieve our full year guidance. Adjusted EBITDA with tax attributes was just over $1 billion versus $991 million last year, driven primarily by higher contributions at our Renewables SBU, the recovery of prior year's purchase power costs at AES Ohio included as part of the ESP4 settlement and improved results at Fluence. These drivers were partially offset by the absence of the significant LNG transaction margins, which we earned last year. Tax attributes earned by our U.S. renewables projects this quarter were $18 million versus $60 million a year ago, in-line with our expectations of a higher share of renewable projects coming online in the fourth quarter. Turning to Slide 11. Adjusted EPS was $0.60 versus $0.63 last year. In addition to the drivers of adjusted EBITDA, we saw higher parent interest expense this quarter as well as a higher adjusted tax rate. I'll cover the performance of our strategic business units or SBUs in more detail over the next few slides, beginning on Slide 12. In the Renewables SBU, we saw higher adjusted EBITDA with tax attributes, driven primarily by higher contributions from new projects brought online in the last 12 months, as well as higher margins in Colombia. This was partially offset by lower tax credit recognition as a result of fewer new projects placed into service this quarter versus a year ago. Our business continues to make strong progress, not just with construction, but also the financing of new projects. We continue to see a robust market for tax credits. This year, we have already raised $1.8 billion in tax capital financing. The market for tax attributes is also greatly expanding as a result of the tax credit transfer option that has brought many more participants to the market. Importantly, tax credit transfers get recognized in operating and free cash flow, which further enhances our financial funding flexibility. Going forward, we will increasingly use tax credit transfers as a means to monetize tax credits including for nearly 500 megawatts of projects in 2023. At our Utilities SBU, higher adjusted PTC was driven by the recovery of prior year's purchase power costs at AES Ohio included as part of the ESP4 settlement, which have been recognized as an expense in the third quarter of last year. I'd now like to take a moment to discuss the continued progress of our utility growth program on Slide 14. In August, we received commission approval at AES Ohio for our new Electric Security Plan, or ESP4, which includes timely recovery of $500 million of grid modernization investments at a 10% return on equity, allowing us to further improve the quality of service. As a reminder, we plan to grow the combined rate bases of our U.S. utilities at a 10% average annual rate through 2027. 80% of our planned investments through 2027 are either already approved or under FERC formula rate programs. We are executing on this plan and with our investment programs across the two utilities, we are on track to increase our capital expenditures by over 35% year-over-year as we work to modernize and invest in system reliability. As we previously discussed, our utilities in Ohio and Indiana continue to charge the lowest residential rates of all electric utilities in both states. Turning back to our third quarter results, with our Energy Infrastructure SBU on Slide 15. Lower adjusted EBITDA primarily reflects significant LNG transaction margins in the prior year, partially offset by prior year onetime expenses in Argentina and higher revenues recognized from the monetization of the PPA at our Warrior Run coal plant. Finally, at our New Energy Technologies SBU, higher adjusted EBITDA reflects continued improved results at Fluence. Fluence has continued to demonstrate improving margins and strong pipeline growth, and they have indicated their expectation to be close to adjusted EBITDA breakeven in the fourth quarter of their 2023 fiscal year. This year-over-year improvement would be reflected in our own fourth quarter results. Turning to Slide 17. I'm very pleased to highlight that we now expect to achieve the top half of both our 2023 adjusted EPS guidance range of $1.65 to $1.75 and our parent free cash flow range of $950 million to $1 billion. This reflects the strong performance of our renewables construction team whose excellent execution this year means that we expect to exceed our construction target of 3.4 gigawatts by at least 100 megawatts. Now to Slide 18. We are reaffirming our full year 2023 adjusted EBITDA guidance range of $2.6 billion to $2.9 billion. Including the $500 million to $560 million of tax attributes we expect to realize in 2023, we expect adjusted EBITDA with tax attributes of $3.1 billion to $3.5 billion. The additional U.S. projects we expect to bring online this year should allow us to exceed the midpoint of the tax attributes estimate we provided at Investor Day. Now to our 2023 parent capital allocation plan on Slide 19. Sources reflect approximately $2.4 billion of total discretionary cash, including $1 billion of parent free cash flow, $400 million to $600 million of asset sales, and the $900 million parent debt issuance we completed in Q2. With the agreement to sell down a minority interest in our gas and LNG business in the Dominican Republic and Panama, we have secured the entirety of our external sources of parent level capital for 2023. Turning to Slide 20. Since our Investor Day in May, financial market conditions have changed, and AES will flex its near-term and long-term plans accordingly. Looking ahead, we will continue to prioritize our strong credit profile and investment-grade ratings, hitting our financial metric growth targets, funding our growth primarily in U.S. renewables and U.S. utilities and advancing on our decarbonization and portfolio simplification goals. We have a number of levers to adjust that will keep us on track with these objectives. First, and to be clear, we will not issue equity at or near current share price levels and not until it is value accretive to our shareholders on a per share basis. As such, we are increasing our asset sale target to at least $3.5 billion for the 2023 to 2027 timeframe and accelerating our plan to achieve $2 billion of asset sale proceeds in 2024 and 2025. With this change, we will not issue any equity until at least 2026, and the amount anticipated has been reduced to $500 million to $1 billion through our guidance period. Second, the tax credit transferability option that we now have creates added flexibility to monetize the tax value of our U.S. renewables projects with a broader base of market participants while also increasing free cash flow and the capacity to fund growth. Third, while we still intend to exit all of our coal businesses in a few of our markets, our coal assets will be temporarily needed to support the energy transition beyond 2025 as renewable deployments and transmission have not progressed as quickly as required. We still intend to exit the majority of our remaining coal businesses by the end of 2025. However, we have the flexibility to delay the exit of a few select plants through 2027 to support continued electricity reliability. This delay would yield continued financial contributions from these assets during this period. For 2024 and 2025, we expect to fund our remaining parent capital needs entirely with asset sales and planned debt issuances. We feel confident that we can achieve the $2 billion asset sale target in these years, as we have already held discussions for a large portion of the assets in this program. We anticipate competitive processes that will yield attractive valuations with minimal dilution to earnings and cash beyond what had been incorporated in our plan. Our sales program is designed to meet our strategic objectives to simplify and decarbonize our portfolio while funding our core growth investments in U.S. renewables and utilities. Finally, turning to Slide 21, we are largely hedged against future increases in interest rates. Looking at the parent company, our long-term debt is entirely fixed and we hedge our exposure to refinancing risk over a five-year window. Our nearest maturities in 2025 and 2026 were previously hedged at a rate of approximately 3%. Approximately 80% of our consolidated debt is at the subsidiary or project level and is non-recourse to the parent. We typically pre-hedge future project debt issuance for the full tenor when we sign a PPA, insulating our expected returns from future rate movements. The amortizing structure of our project debt rather than bullet maturities allow the project to support higher leverage. As we grow, our long-term debt balances will increase proportionally to the underlying cash flow of our businesses, enabling us to maintain steady leverage ratios and investment-grade credit metrics. At the end of the third quarter, we had approximately $6 billion of interest rate hedges outstanding at an average rate of 2.9%. Looking at the impact of a 100 basis point shift in interest rates on our future issuances, refinancings and U.S. floating rate debt, we have under $0.01 of EPS exposure from interest rates in 2024 and $0.03 to $0.04 of exposure in 2025. Unhedged floating rate debt is primarily located outside the U.S. where inflation indexation in our PPAs provides a natural hedge against rising rates. In summary, as we approach year-end, we've made excellent progress on achieving our financial and strategic objectives for 2023. Our balance sheet is strong, and we are flexing to adapt to current financial market conditions. With line of sight to our future growth funding needs, we will create value from our excellent market position while continuing to prioritize maintaining investment-grade credit metrics and achieving our financial commitments. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. Before moving to Q&A, I would like to briefly address a few other concerns that we have heard from some of you regarding the future of the renewable sector in general. For starters, global warming is, unfortunately, very real and likely accelerating. We have seen it in all-time record temperatures over the past five years and especially this summer in the Northern Hemisphere. This new reality was reflected in record demand for energy during heat waves, unprecedented wildfires and more volatile rainfall, all of which affect the general public. Completely apolitical actors, such as insurance companies, are pulling out of certain markets in vulnerable areas after suffering material losses due to climate change. It is, therefore, extremely unlikely that major corporations will abruptly walk away from all of their carbon reduction goals regardless of any short-term unscientific political rhetoric. Given all that is happening in the renewable space, it is now more important than ever to differentiate among companies and developers. In my opinion, nobody is better placed than AES to create shareholder value from the ongoing energy transition because we have been focusing for years on the most resilient and lucrative opportunities. We are among the largest suppliers of renewable energy in the most attractive markets in the U.S., California, New York and PJM. We are also the biggest supplier of renewable energy to corporations in the world and particularly to data centers. Already, data centers represent half of our U.S. backlog and the growth of generative AI will only accelerate their demand for more renewable energy. An important differentiator is that AES is one of the very few major renewable developers that has not had to abandon projects in its backlog due to cost increases or supply chain disruptions. This has cemented our reputation for reliability among premium customers. And finally, AES is the most innovative company in the sector, developing and implementing new technologies such as: grid scale energy storage, hourly match renewable power purchase agreements, refabricated solar, construction robotics and software for energy efficiency in AI-enabled grid visualization. I believe these efforts will have material and growing benefit to our shareholders, especially by maintaining our lead in the most lucrative market segments. Regarding significant drivers for future growth post 2027, AES is best positioned to be the leader in green hydrogen production with the most advanced large project in the country, in Texas, in our participation in two of the largest hubs chosen by the Department of Energy. Our green hydrogen projects have real off-takers and sites, and we expect that they will meet the most exacting standards of additionality, regionality and hourly matching. Today, AES has the technology, the people, customer and supplier relationships, the scale and proven track record to continue to grow renewables profitably during the now unstoppable energy transition. While the total addressable market for our products and services is truly immense, I want to emphasize, once more, that our aim is to maximize shareholder value, not the number of megawatts or market share. Our priority will always be to ensure the best risk-adjusted returns for our shareholders on a per share basis. With that, I would like to open up the call for questions.
Operator: Thank you. [Operator Instructions] The first question will be from the line of David Arcaro with Morgan Stanley. Your line is now open.
David Arcaro: So strong update in terms of the contract originations within the renewables development portfolio. I was wondering if you could elaborate on what you're seeing in terms of that backdrop, the trends in customer demand. There have been concerns in the market around renewable slowdown given the higher PPA prices financing challenges, et cetera. Wondering if you could talk about what your conversations are like with your customers? Are there pockets of weakness? Or is there still an ample opportunity set out there for contract signings?
Andres Gluski: What we're seeing is very strong demand from our target customers. So we have not seen a weakening. And as we said, it's -- I think it's very important to distinguish what markets you're operating in. So markets like California and New York, PJM, there is very strong demand. And there's very strong demand from corporations, especially from the tech companies in the data center business. So we have not seen a slowing down. Now, if you're talking about WEC and auctions for public utilities, et cetera, we're seeing a lot more competition for those projects. But for the -- our target customers in our target markets, we're seeing demand very firm.
David Arcaro: Great. That's helpful. That's encouraging. And then maybe a question on the asset sale outlook here. You're accelerating -- targeting $2 billion over the next two years, I guess, what gives you the line of sight there? How is that market in terms of project sales? Are you seeing demand and the kind of off-takers there to acquire projects? And what are you seeing in terms of pricing? Are there favorable yields versus what you're developing those projects at?
Andres Gluski: Okay. So I think that's sort of two parts of the question. So a lot of the asset sales are selling out or selling down a specific businesses as we have been doing for the past decade. Our businesses continue to perform very well. So we see that there is interest in these businesses, because it's not -- again, not all businesses are created equal and we have very favorable positions in these markets. We're also seeing great interest for people to partner with us. And that also includes our existing partners for greater participation. So those are things which decrease the equity needs over the next four, five years. So I think that's very important to see that we're balancing both. I think the question regarding the sell-down of renewable projects, I'll pass over to Steve, so he can give you an update on that.
Steve Coughlin: Yes, that's going well. We -- as part of our sales, Andres walked through in his comments, there's a number of ways we achieve it. With the renewable sell-downs, we typically will sell down after the projects come online. And these are very low risk, long duration cash flows. Our average contract duration is 19 years. Obviously, no variable fuel cost, very little variable O&M in these types of assets. So they're very attractive -- and so yes, returns expectations have come up somewhat, but not in lockstep with where base rates have come because of the very low risk profile of these assets. So those sell-downs continue to yield a lift in AES' equity returns commensurate with what we've talked about in the past, David.
Operator: The next question will be from the line of Durgesh Chopra with Evercore ISI. Your line is now open.
Durgesh Chopra: Just want to start off with a quick housekeeping question here. Just the $0.10 EPS upside that we talked about, Steve, from projects potentially being moved from '24 into late '23, is that factored into your raised EPS guidance now, or is that still an upside?
Steve Coughlin: Yes. So a portion of it, Durgesh, so we did guide to 100 megawatts over at least this year, so the 3.4 to 3.5. So just a portion of that $0.10 is included. And the good thing is we have a very clear line of sight at this point to that increase as mechanical completion has been achieved on 93% of the new capacity. That means everything is all built out. We're just in final synchronization of equipment and systems. And so, we feel very confident in the year-end number. That which does not come online this year of that upside will be in the first half of next year.
Durgesh Chopra: Got it. Okay. That's clear. And then maybe, Steve, there was a report from credit rating agency highlighting sort of weakening of your credit metrics here and then going into 2024. And then, Andres and you both talked about the importance of maintaining a strong balance sheet. Could you just sort of frame for us what your expectation is? With these asset sales because obviously, there's going to be a cash flow drop. What the expectation is for your FFO debt metrics next year versus your downgrade thresholds?
Steve Coughlin: Yes. So one thing I would point out is that the credit metrics do fluctuate some during the year as we have higher construction balances in the middle of the year. We also have a higher level on our corporate revolver as projects come online towards the end of the year, paying down construction balances, and then we have the corporate revolver used to manage timing and distributions from our subsidiaries. The other thing to keep in mind is that we are in a high-growth mode. So at any point in time, we do have construction debt that's not yet yielding and that's all non-recourse. And it's also used to finance the tax credit value as well. So there's very quick paydowns on that debt once these projects come online. But no, we feel -- we're in regular contact with all the rating agencies. We feel very good about exceeding -- not just meeting but exceeding the thresholds. The other thing to keep in mind is that our leverage is amortizing. So most of our project level debt is amortizing over the PPA period. So this is a very low risk structure. It's non-recourse and it's not subject to significant bullets and it allows us to maintain a leverage ratio that will grow just proportionately -- our debt will only grow proportionately to the cash flows of the business.
Durgesh Chopra: Okay. So but just to be clear though, Steve, I mean, next year, you feel with the plan that you have in place that versus your downgrade thresholds, you'll exceed them, right, into 2024?
Steve Coughlin: Yes, absolutely. This is a top priority metric in all of our planning. So maintaining investment credit is at the top. And so as we look at the asset sales -- keep in mind, we already had a significant amount, $2.7 billion to $3 billion considered in our Investor Day numbers. And we are prioritizing assets that both hit our strategy, but as well are minimally dilutive on earnings, cash and credit. So I'm very confident that we will not impact our credit metrics negatively with the plans that we have.
Durgesh Chopra: Got it. Perfect. And I know just -- but I just want to ask just one last question, and then I'll pass it on to others. But just Andres you mentioned active discussions with a lot of parties on assets. $3.5 billion is already very significant in asset sales. Could that number be higher as you sort of get more interest as you have those discussions?
Andres Gluski: At this point in time, I would say that we feel that we will sell at least $3.5 billion through end of 2027, but a lot of these, again, are partial sell-down, sell-down of renewables, our plan to exit from coal. So if you look in the past, we've done a multiple of this number. I'd also point out that I'm not aware of any time that we have set a target for asset sales and not achieved it or exceeded it. So we feel very confident in achieving those asset sale numbers.
Operator: The next question will be from the line of Angie Storozynski with Seaport Global. Your line is now open.
Angie Storozynski: Okay. So first, I wanted to -- you mentioned about -- you mentioned transferability of tax credits. I just wanted to make sure that were not in a sense window dressing and trying to solve for a certain credit metrics, but this is actually driven by economics. So when I look back to your Analyst Day, you financed your renewables in the U.S., 40% tax equity, 40% project level debt and then 20% equity. So I just wanted to make sure that, that structure is still in and we're not trying to basically boost credit metrics by levering these projects more? And again, just explain to me that why we're moving from the traditional credit -- tax equity structures, which allowed you to monetize accelerated depreciation, among others to the transferability?
Steve Coughlin: Yes. Angie, it's Steve. Thanks for the question. No, it is important to recognize that AES has always been maximizing their tax credit value. And so that continues to be the case. The reality is the transfers offer a more -- a broader market -- a broader set of market participants. I think a more liquid market, so many more corporates coming in from different sectors. It's a faster, simpler transaction to execute, but we'll still do both because it's important that you not only monetize the tax credit value but also the benefit of the accelerated depreciation which is not something that's transferable and does require either AES or a partner in the asset to be able to utilize that accelerated depreciation benefit. So there'll be hybrids done here. But my primary point is that it is a broader market, simpler transactions, more liquidity. And I do think it's appropriate that it shows up in operating cash and free cash because this is truly an important component of value and a return to the investment that gets made in the assets.
Angie Storozynski: Okay. So that's treatment so that the FFO uplift under those structures, you already considered that when you quantified your equity needs during the Analyst Day?
Steve Coughlin: So I would say at this point, we have already done 500 megawatts in transfer credits. The market is moving faster. So, I think in the Analyst Day, I would say there's upside in terms of our cash flow metrics related to the use of more transferability. But it's not necessarily something that is changing returns or anything. It's just that it's creating more visibility, more market participation and shows up in the operating cash flow.
Angie Storozynski: Okay. But again, it's -- you're still sticking with solar ITCs. Again, that financing structure that I mentioned at the beginning, doesn't change, right? So you're not increasing leverage of the project, okay.
Steve Coughlin: No, we are not just to be clear. So we are not increasing leverage at the projects that we are only looking to monetize the tax credits as efficiently as possible. And I would expect that given our credibility and our track record, any discount applied to the credits will be quite small relative to perhaps other market participants. And then, Andy, just also to reiterate, as I have said in the past, we choose the credit option based on what is the best cash financial return from the credit. So whether in most cases, that's been ITC for us, it makes very little sense to be choosing production-based credits, for example, in New England solar, where the capacity factors tend to be quite small. So I would question anyone that's doing that in their motives, but we are very focused on what's the credit that is yield the best return.
Angie Storozynski: Okay. And then secondly, you mentioned the attractiveness of renewables versus other sources of power based on the levelized cost of electricity, so i.e., new-builds for renewables versus new-builds for thermal assets. But -- and not everywhere, do you have to actually add incremental generation sources, right? And then the pushback that we are hearing is that the PPA prices have now slightly exceeded forward power prices, be it on peak for solar or around the clock for wind. So again, I understand the distinction with tech clients, but how about any other locations and any other off-takers for new renewables?
Andres Gluski: Well, again, we're talking about the markets where we're located. And the way I look at it is a little bit different. I mean, in terms of the energy, the LCOE, again, as I said, in most markets that we're operating, it is the cheapest. The issue with renewables is really having that dispatchable 24/7. So you need to complement it with regular power or batteries, which will require even more renewals. But I think the state is a huge play. So you can't say in every single location. But certainly in states that have high solar radiation or high wind, that's just the fact. I mean, the real issue is more having the 24/7 capability.
Angie Storozynski: Okay. And then the last question about the -- some flexibility on the retirement of the coal plants. I understand the reliability needs of local grids, et cetera. But this is not your renewables coming online later than expected. It's just more of the market backdrop in which the coal plants operate. Is that correct?
Andres Gluski: Exactly. No, exactly. You're taking it right. And as we've always indicated, we need regulatory approval to retire the coal plants. So what we're seeing is in some of the markets not us, but the general build-out of renewables enough transmission has been somewhat slower than planned and that these plants are likely to be needed through 2027. But I would add that this is the small minority of our total plants, okay? So we've gone from 22 gigawatts to 7. We have line of sight to about 4 of that is already planned. And of the remaining roughly 3, it would be a minority of that in terms. So I'm not talking about any walking away from our decarbonization plan. It's just a question that there -- we're seeing there's a couple of plants where it's going to be difficult to take them off-line prior to the expiry of their PPAs.
Operator: The next question will be from the line of Richard Sunderland with JPMorgan. Your line is now open.
Richard Sunderland: Andres, you spoke to active conversations on the asset sale front. I'm curious if you can outline at a high level how advanced those discussions are? And if this is an effort that could yield any announcements before year-end or I guess, earlier on in that sort of '24, '25 window?
Andres Gluski: Yes. It's a good question. I would think that, again, it's over a two-year period, but I would expect some important announcements in the first half of next year. And again, we tend to announce things when they're very firm. So the negotiations, et cetera, are ongoing. It's several assets. But yes, I would expect to be able to say something in the first half of next year.
Richard Sunderland: Understood. And then looking back at, I guess, it's Slide 7, where you lay out the potential asset sales. Has any of your thinking on those buckets in terms of what's actually in those buckets changed since the May Investor Day, I guess, in particular, I'm thinking about the noncore businesses and if there are any new thoughts there relative to six months ago?
Andres Gluski: What I'd say is, yes, I really can't comment on that. I would say stay tuned, and we will make announcements in that regard. But it's mostly assets that we have designated as noncore over time. So it's more of an acceleration or perhaps a deepening of some of the sell-downs.
Richard Sunderland: That's helpful. And I'll try this from one other side if you'll indulge me here, new and expanded partnerships. New partnerships, any flavor for what that means? Just again, trying to get a sense of the scope of the opportunity. Obviously, you've laid out the magnitude with this $2 billion figure in the over $3.5 billion in total.
Andres Gluski: Well, what I'd say is see what we've done in the past. So for example, if you look at when we made a big move into renewable energy, we -- our first big acquisition was sPower and we brought in a new partner and that relationship has evolved over time. So we're in a number of fields, which are very attractive right now. So I think it's an interesting time to see what our partners want to do or if some additional partners want to come in. But we're really sitting in a privileged position, especially for a lot of the new growing fields.
Operator: The next question will be from the line of Julien Dumoulin-Smith with Bank of America. Your line is now open.
Julien Dumoulin-Smith: First question here, I'm going to take it and play in every direction. All right, deal. $3.5 billion here. You talk about coal exits of selective assets in '27. To me, I hear that, and I'm asking well, how much does that delay some of the loss of contribution in the plan out to '28, i.e., the earlier targets that you gave through '27 contemplated full divestment of these assets. Now I get that you're raising the asset divestment target. So in theory, there's going to be fewer assets at the end. So in theory, you should be sacrificing some of the net income to the plan. But obviously, by selling some of the coal assets in '27, you're delaying or deferring some of the chunkiest lowest multiple assets potentially and the loss of the contribution into '28. I just want to like kind of hear how you think about that '27 versus '28, are you effectively pushing out a little bit of an earnings impact from '27 into '28 if you think about it or from '25 into '28?
Andres Gluski: What I'd say is you're basically right that say, operating through the end of a couple of plants, PPAs, we have that flexibility, it would be beneficial. In terms of our asset sales, I mean, we have -- our assets have different earnings profiles. So, how would I say, we feel confident that we have a plan in place that we will hit our numbers. Now when you talk about post 2027, getting into '28, there'll be a balance between bringing in partners for some of those growth projects post '28. And there are a lot of factors, I think, happening in the market. I would expect, quite frankly, in our numbers, we don't have much more efficiency improvements, and we're working on a lot of technologies, which should have that. So in the net, again, you're right about some of the big blocks, but I really think that -- I feel very confident about our numbers, what they're going to look like '28 forwards because we have a really a pull position in all these new technologies and new sectors that are opening up. So there's not going to be a cliff that were pushed off into '28. I want to make that clear. As we've made clear in the past, there's no cliff in '26. So we manage -- we have a lot of variables, a lot of levers. So we're making sure that we have a smooth transition. So our real problem is not one of demand. There's a tremendous amount of demand, tremendous opportunities, is that what we want to make sure is that we're maximizing value per share and taking advantage of it and being smart in the best combination of levers that we pull.
Julien Dumoulin-Smith: No. Look, I get it. It makes sense. And just to clarify, the select assets, though, those are the ones that the PPAs are expiring or the -- otherwise been regulatory issues, right? Again, I think that's a nice catch all, right? If that's the way you're framing it, one or the other?
Andres Gluski: Well, that's correct. I mean that we have some assets that may be still under contract and that -- it's going to be -- it's looking more difficult to get regulatory approval to retire those assets in '25.
Julien Dumoulin-Smith: Right. Yes, indeed, right. There's a couple of them that stand out, if you will, that would seem to fit that right?
Andres Gluski: I guess.
Julien Dumoulin-Smith: I know you don't want to be too specific [indiscernible]. I'm sorry, I'm trying to be less specific here. Quickly, if I can pivot here real quickly. Yes, go for it.
Steve Coughlin: I was just going to say, there's a number of ways we're exiting both the retirements and sales. So looking at this, we have 7 gigawatts of coal. We've already announced and the exits of half of that. So you're talking about 3.5% roughly remaining. And we're not talking about that whole amount. Even a small portion of that are these assets that will be selectively considered.
Andres Gluski: Yes. as I said, it's a small part of the 3 that's remaining.
Julien Dumoulin-Smith: Yes. Okay. Sorry, I just wanted to try to put that in a box a little bit more. And just to clarify this, the partial monetization, how do you think about Fluence here just to hit that a little bit more squarely? I know it's a sensitive subject, whatever you can offer here about how you think about that through the plan? You talk about beginning next year here on sell-downs bit large, not specific to the new technologies bucket. Whatever you can offer?
Andres Gluski: We can't call for much that we haven't said already. I mean what we've said is that we are really as an accelerator of new technologies. We create a lot of applications together. They help us. That's why we're the leader, I think, in the premium markets. But over time, we will monetize the positions. It's not just Fluence. We have other investments as well. And those new technologies have progressed very well. So we have other companies besides Fluence. But I'm not -- we really can't provide any further color on that.
Julien Dumoulin-Smith: And you feel confident in the previous marks in the other technologies? I mean, I know it's been a little bit of time there, but that's important as well.
Andres Gluski: Sure. I mean -- there are different ones of levels of maturity. But of course, you have Uplight, which is, I think, proceeding well and incorporating more product offerings and becoming part of Schneider Electric's energy efficiency offerings. But then we have other ones that are in earlier stages. And whether they will create a lot of value outside of what they create for us. So certainly, one of the more exciting ones is the building of solar farms with robotics, I think, has a lot of promise. If you look at a longer term sort of four years out there, I would expect a lot from that. There's a lot -- we're doing a lot with AI operationally for us. I mean today, we use AI on the operations of our wind farms of next-day predictions for energy demand and weather. We're also using -- Fluence is using on its bidding engines, but there's much, much more. We have collaborated with some of the technology companies on things like grid visualization, et cetera, which I think will become part and parcel of how ISOs manage their build-outs and dispatches and reaction to natural catastrophes. And we do have a -- we would receive part of the royalties from the sales of the technology companies because we co-created them with them. So these are all things that are not in our numbers, but I think we'll we will be able increasingly to have significant cost savings and greater efficiencies from applying them. And in some cases, we'll be able to monetize these over time at the right time when market conditions are right.
Julien Dumoulin-Smith: Yes, absolutely. Sorry. And just a quick clarification, more setting expectations ahead. You guys have done a lot on the new origination front. You flagged it at the outset, this 5 gigawatt number, I think. Just to set expectations, you've also done a number of acquisitions of backlog here, too. How does that mesh with your commentary about origination, a? And b, should we expect a steady cadence of announcements of further backlog acquisitions here as some of these have been the higher price points? Again, I just want to tackle that directly and give you an opportunity to kind of bifurcate and clearly set expectations.
Andres Gluski: Look, we -- I think you have to -- when you think about what we're doing is we're making -- creating the most value of the different assets we have. So we did our first sale of -- in the pipeline, if you will, with the DTA, where we actually don't build the project, but we sell a development project because we felt that, that was the greatest creation of value. So sometimes from our pipeline, we may be doing this because that's the best use of that pipeline. As I said in the past, probably the most attractive thing for us to do is to acquire late-stage development projects when -- especially when we have a premium customer who needs that energy. And why? Well, because -- well, you have a development project, it's some cost if you have to invest to create that development project. And so you don't know what is the conversion rate of your pipeline. So if you have something that's in late stage your conversion rate is basically one if you have the client. So it's a very good risk-adjusted rate of return. So we're going to be doing all those things. In the case of one of our utilities, they're buying one of the projects that have been developed by somebody else. We're selling one from the pipeline. Others are going to be repowering. So, we'll use all of the means at our disposal to create shareholder value. So I don't think it's -- the way to think about this correctly, is just pipeline, greenfield through final delivery is the best way to create value. I think it's really -- the most important really is having the right projects in the right markets and the right clients and thinking about how can you best satisfy what the clients' needs are. So I just mentioned that we can talk about it off-line. But quite frankly, what we're seeing is that all things being equal, acquiring late-stage projects, and it is a buyer's market now. It is one of the most attractive businesses for us.
Operator: The final question for today's call will be from the line of Michael Sullivan with Wolfe Research. Your line is now open.
Michael Sullivan: I wanted to start with, can we just confirm if there's been any change to your levered returns targets in the current environment up or down? And then maybe also just you alluded to it a little bit, but just a sense of like how much LCOEs or PPA pricing on new projects have changed?
Andres Gluski: Okay. I'll take the first part of that. I'll have the second -- I'll pass that to Steve. Look, we are getting from our portfolio sort of low-teen returns. And that's at the project level. If we would include sort of core financing or mezzanine financing, we'd be high-teen returns. I don't think anybody is getting consistently higher returns than us because of the type of projects, the type of markets that we're in and the scale. We have sufficient scale to compete with anybody. And we have I think, had the best record of supply chain management. So, what I think has changed, we use a CAPM model, which is updated for risk-free U.S. treasuries, and they have moved up, obviously. So that's when we calculate our net present value that really comes into effect. So we do look at what's the net present value from these projects. So what I would say is that we've been able to pass on higher interest rates, pass on higher cost. And cost, by the way, are coming down. Battery prices are down 50%, solar prices are receding. And we do new projects for corporate clients outside of the U.S. And solar panels are near all-time lows. So all that put together, yes, we are using higher discount rates to see if the projects worthwhile pursuing in our net present value. And we have maintained our margins. And so we're seeing right now no stress on the market from that side. Now the second question you wanted to talk about was the particular projects here in the States and the returns we're seeing.
Steve Coughlin: Yes. So I would say, generally in the States with our corporate clients, in particular, where we're doing structured products, we are seeing the higher end of that return range. And also, it's important, while PPA prices have been increasing, over the past one to two years, they've actually leveled off and are starting to come back down. We've seen significant reductions in solar module pricing this year. We've seen significant reductions in the commodities going into batteries and battery pricing coming down. So we're starting to see levelized costs come back down, which is also supporting the activity and the demand going forward. So I think we're in kind of past the difficulties of the supply chain past the impacts of the inflation and back to a declining curve in the key technologies we're using.
Andres Gluski: Yes. Michael, maybe something that hasn't been asked on this call is that, first, we had the first project that we know they got the energy community additional 10%, which was a Chevelon Butte wind project, the largest wind project in Arizona. But we're also -- in terms of our wind farms, we are achieving the domestic content requirements. We expect that Fluence will be having next year, starting to receive domestic -- sufficient domestic content from its batteries and from its and casings. And then we're also in discussions for solar. We were one of the first to start discussions for solar. So what we see is upside from domestic content additionality. And we also see the energy communities we have already been achieving that. So I'll remind you, at least 40% plus of our pipeline is in energy communities as is today. So that would all be upside. So we are seeing upsides from the IRA in terms of the returns of some of the projects, especially those that are already signed.
Michael Sullivan: Okay. One quick last one. Just -- can you give any thoughts on just the initial intervenor testimony in the Indiana rate case and what the path looks like from here to whether it be settlement or final order?
Steve Coughlin: Yes. So just to kind of put things in context, too. This is our first rate case in over five years. And as I mentioned in my comments, we have the lowest residential rates in Indiana of any utility. So we're starting from a very good place. We had our IRP last year where we also have a lot of support for the growth that's there. So of course, any process like this, there are multiple stakeholders involved and interveners, they need to be heard. But we feel very good about what we asked for, given our position with the lowest rates and the growth plan that's been supported through the IRP. And again, it's our first rate case in five years. So in terms of timing, at this point, I would say, middle of next year for this to be all resolved and new rates to come into effect thereafter.
Operator: Thank you. That concludes today's Q&A session, and I will turn the call back over to Susan for final remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. We look forward to seeing many of you at the EEI Financial Conference later this month. Thank you, and have a nice day.
Operator: That concludes today's conference call. Thank you all for your participation, and you may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning, and thank you for joining The AES Corporation Third Quarter 2023 Financial Review Call. My name is Kate, and I will be the moderator for today's call. [Operator Instructions] I would now like to turn the call over to your host, Susan Harcourt, Vice President of Investor Relations. You may proceed."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning, and welcome to our third quarter 2023 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Stephen Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our third quarter 2023 financial review call. In addition to discussing our third quarter and outlook for the remainder of the year, I will address some concerns that we have heard from investors since our second quarter call in August. Specifically, my remarks today will focus on three areas: strategic and financial updates, our funding sources, and our exposure to interest rates. Beginning on Slide 3. I am pleased to report that our financial results continue to be strong and we now expect full year adjusted EPS to be in the top half of our guidance range of $1.65 to $1.75. We are also reaffirming all of our short- and long-term financial metrics. For the third quarter, adjusted EBITDA with tax attributes was $1 billion, and adjusted earnings per share was $0.60. I'm very pleased with these results, which Steve will address in more detail shortly. Turning to Slide 4. We continue to see strong demand for long-term contracts for renewables, particularly from our primary customer base of large technology companies with a rapidly expanding data center business. Notably, even with rising interest rates, renewables continue to have the lowest levelized cost of energy, or LCOE, across almost all of the markets where we operate. So far this year, we have signed 3.7 gigawatts of new PPAs, including 1.5 gigawatts since our second quarter call in August. This number does not include the 1.2 gigawatts of new projects we were recently awarded in New York. Given that we have several large contracts that could be finalized in the coming weeks, we remain confident in our ability to sign at least 5 gigawatts of new long-term PPAs this year. Included in the new contracts that we have already signed, is our first-ever developed transfer agreement, or DTA, to transfer to a utility 975 megawatts of solar plus storage at the point of commencement of construction. This structure allows us to create value from our advanced pipeline without the investment of any AES equity beyond the development costs. Now turning to our backlog on Slide 5. Our backlog of projects with signed long-term contracts is now 13.1 gigawatts. Of this total backlog, we expect more than 70% or over 9 gigawatts to come online through 2025, and we have already secured all of the necessary equipment for these projects. Furthermore, 44% or 5.8 gigawatts is already under construction. Moving to Slide 6. Our construction program continues to make excellent progress with 93% of the megawatts expected to come online this year, already having achieved mechanical completion. As a result, we have increased our year-end construction target from 3.4 gigawatts to 3.5 gigawatts to incorporate the progress we have made this year. This figure reflects a more than doubling of the renewable projects placed in service compared to last year. Now turning to Slide 7. In light of current market conditions, I would like to directly address the sources of funding that we have in our long-term plan. We will not be issuing any equity until at least 2026, and even then, we will only issue equity if it is value accretive to our shareholders. Instead, we are significantly accelerating our asset sales, and believe, we now have line of sight to at least $2 billion of asset sale proceeds in '24 and '25, and expect our asset sale proceeds to total at least $3.5 billion through 2027. With the proceeds from the sell-downs of our businesses in the Dominican Republic and Panama that we announced in September, we have already secured all of our external financing needs for the year at attractive terms. The general buckets that are part of our asset sales plan are: coal exit; sell-downs of U.S. renewable projects; partial monetization of businesses, including new energy technologies; and the exit of certain noncore businesses. We also plan to bring in partners at some of our businesses as we have done in the past to reduce future equity needs. While we never disclose specific transactions until we have actually signed sales agreement, we are in active and positive discussions with many interested counterparties. Turning to Slide 8. The last topic I want to address before turning the call over to Steve is our exposure to interest rates. As a normal course of business, we have always proactively matched the profile of the debt to the profile of the cash flows that are supporting, which minimizes any impact from higher interest rates. Approximately 80% of our debt is non-recourse to the AES parent. And of that, the vast majority is either utility debt included in our customer rates or project level debt that is matched to the underlying project revenues. All of our long-term debt at Corp is either fixed or hedged, and as we have stated before, we've been able to pass on higher costs and interest rates in the new PPAs we signed. Finally, I want to highlight our commitment to maintaining our investment-grade credit ratings, which we see as an important component of our value proposition. To that end, in every business decision we make, we take into consideration our relevant credit metrics. We take a disciplined approach to growth and overall risk management to ensure that we consistently maintain these metrics. With that, I would like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our third quarter results, our 2023 guidance, how we are flexing our plans to adapt to current financial market conditions and how we minimize our exposure to interest rates. Turning to our financial results for the quarter, beginning on Slide 10. I'm pleased to share that we had a strong third quarter and are fully on track to achieve our full year guidance. Adjusted EBITDA with tax attributes was just over $1 billion versus $991 million last year, driven primarily by higher contributions at our Renewables SBU, the recovery of prior year's purchase power costs at AES Ohio included as part of the ESP4 settlement and improved results at Fluence. These drivers were partially offset by the absence of the significant LNG transaction margins, which we earned last year. Tax attributes earned by our U.S. renewables projects this quarter were $18 million versus $60 million a year ago, in-line with our expectations of a higher share of renewable projects coming online in the fourth quarter. Turning to Slide 11. Adjusted EPS was $0.60 versus $0.63 last year. In addition to the drivers of adjusted EBITDA, we saw higher parent interest expense this quarter as well as a higher adjusted tax rate. I'll cover the performance of our strategic business units or SBUs in more detail over the next few slides, beginning on Slide 12. In the Renewables SBU, we saw higher adjusted EBITDA with tax attributes, driven primarily by higher contributions from new projects brought online in the last 12 months, as well as higher margins in Colombia. This was partially offset by lower tax credit recognition as a result of fewer new projects placed into service this quarter versus a year ago. Our business continues to make strong progress, not just with construction, but also the financing of new projects. We continue to see a robust market for tax credits. This year, we have already raised $1.8 billion in tax capital financing. The market for tax attributes is also greatly expanding as a result of the tax credit transfer option that has brought many more participants to the market. Importantly, tax credit transfers get recognized in operating and free cash flow, which further enhances our financial funding flexibility. Going forward, we will increasingly use tax credit transfers as a means to monetize tax credits including for nearly 500 megawatts of projects in 2023. At our Utilities SBU, higher adjusted PTC was driven by the recovery of prior year's purchase power costs at AES Ohio included as part of the ESP4 settlement, which have been recognized as an expense in the third quarter of last year. I'd now like to take a moment to discuss the continued progress of our utility growth program on Slide 14. In August, we received commission approval at AES Ohio for our new Electric Security Plan, or ESP4, which includes timely recovery of $500 million of grid modernization investments at a 10% return on equity, allowing us to further improve the quality of service. As a reminder, we plan to grow the combined rate bases of our U.S. utilities at a 10% average annual rate through 2027. 80% of our planned investments through 2027 are either already approved or under FERC formula rate programs. We are executing on this plan and with our investment programs across the two utilities, we are on track to increase our capital expenditures by over 35% year-over-year as we work to modernize and invest in system reliability. As we previously discussed, our utilities in Ohio and Indiana continue to charge the lowest residential rates of all electric utilities in both states. Turning back to our third quarter results, with our Energy Infrastructure SBU on Slide 15. Lower adjusted EBITDA primarily reflects significant LNG transaction margins in the prior year, partially offset by prior year onetime expenses in Argentina and higher revenues recognized from the monetization of the PPA at our Warrior Run coal plant. Finally, at our New Energy Technologies SBU, higher adjusted EBITDA reflects continued improved results at Fluence. Fluence has continued to demonstrate improving margins and strong pipeline growth, and they have indicated their expectation to be close to adjusted EBITDA breakeven in the fourth quarter of their 2023 fiscal year. This year-over-year improvement would be reflected in our own fourth quarter results. Turning to Slide 17. I'm very pleased to highlight that we now expect to achieve the top half of both our 2023 adjusted EPS guidance range of $1.65 to $1.75 and our parent free cash flow range of $950 million to $1 billion. This reflects the strong performance of our renewables construction team whose excellent execution this year means that we expect to exceed our construction target of 3.4 gigawatts by at least 100 megawatts. Now to Slide 18. We are reaffirming our full year 2023 adjusted EBITDA guidance range of $2.6 billion to $2.9 billion. Including the $500 million to $560 million of tax attributes we expect to realize in 2023, we expect adjusted EBITDA with tax attributes of $3.1 billion to $3.5 billion. The additional U.S. projects we expect to bring online this year should allow us to exceed the midpoint of the tax attributes estimate we provided at Investor Day. Now to our 2023 parent capital allocation plan on Slide 19. Sources reflect approximately $2.4 billion of total discretionary cash, including $1 billion of parent free cash flow, $400 million to $600 million of asset sales, and the $900 million parent debt issuance we completed in Q2. With the agreement to sell down a minority interest in our gas and LNG business in the Dominican Republic and Panama, we have secured the entirety of our external sources of parent level capital for 2023. Turning to Slide 20. Since our Investor Day in May, financial market conditions have changed, and AES will flex its near-term and long-term plans accordingly. Looking ahead, we will continue to prioritize our strong credit profile and investment-grade ratings, hitting our financial metric growth targets, funding our growth primarily in U.S. renewables and U.S. utilities and advancing on our decarbonization and portfolio simplification goals. We have a number of levers to adjust that will keep us on track with these objectives. First, and to be clear, we will not issue equity at or near current share price levels and not until it is value accretive to our shareholders on a per share basis. As such, we are increasing our asset sale target to at least $3.5 billion for the 2023 to 2027 timeframe and accelerating our plan to achieve $2 billion of asset sale proceeds in 2024 and 2025. With this change, we will not issue any equity until at least 2026, and the amount anticipated has been reduced to $500 million to $1 billion through our guidance period. Second, the tax credit transferability option that we now have creates added flexibility to monetize the tax value of our U.S. renewables projects with a broader base of market participants while also increasing free cash flow and the capacity to fund growth. Third, while we still intend to exit all of our coal businesses in a few of our markets, our coal assets will be temporarily needed to support the energy transition beyond 2025 as renewable deployments and transmission have not progressed as quickly as required. We still intend to exit the majority of our remaining coal businesses by the end of 2025. However, we have the flexibility to delay the exit of a few select plants through 2027 to support continued electricity reliability. This delay would yield continued financial contributions from these assets during this period. For 2024 and 2025, we expect to fund our remaining parent capital needs entirely with asset sales and planned debt issuances. We feel confident that we can achieve the $2 billion asset sale target in these years, as we have already held discussions for a large portion of the assets in this program. We anticipate competitive processes that will yield attractive valuations with minimal dilution to earnings and cash beyond what had been incorporated in our plan. Our sales program is designed to meet our strategic objectives to simplify and decarbonize our portfolio while funding our core growth investments in U.S. renewables and utilities. Finally, turning to Slide 21, we are largely hedged against future increases in interest rates. Looking at the parent company, our long-term debt is entirely fixed and we hedge our exposure to refinancing risk over a five-year window. Our nearest maturities in 2025 and 2026 were previously hedged at a rate of approximately 3%. Approximately 80% of our consolidated debt is at the subsidiary or project level and is non-recourse to the parent. We typically pre-hedge future project debt issuance for the full tenor when we sign a PPA, insulating our expected returns from future rate movements. The amortizing structure of our project debt rather than bullet maturities allow the project to support higher leverage. As we grow, our long-term debt balances will increase proportionally to the underlying cash flow of our businesses, enabling us to maintain steady leverage ratios and investment-grade credit metrics. At the end of the third quarter, we had approximately $6 billion of interest rate hedges outstanding at an average rate of 2.9%. Looking at the impact of a 100 basis point shift in interest rates on our future issuances, refinancings and U.S. floating rate debt, we have under $0.01 of EPS exposure from interest rates in 2024 and $0.03 to $0.04 of exposure in 2025. Unhedged floating rate debt is primarily located outside the U.S. where inflation indexation in our PPAs provides a natural hedge against rising rates. In summary, as we approach year-end, we've made excellent progress on achieving our financial and strategic objectives for 2023. Our balance sheet is strong, and we are flexing to adapt to current financial market conditions. With line of sight to our future growth funding needs, we will create value from our excellent market position while continuing to prioritize maintaining investment-grade credit metrics and achieving our financial commitments. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. Before moving to Q&A, I would like to briefly address a few other concerns that we have heard from some of you regarding the future of the renewable sector in general. For starters, global warming is, unfortunately, very real and likely accelerating. We have seen it in all-time record temperatures over the past five years and especially this summer in the Northern Hemisphere. This new reality was reflected in record demand for energy during heat waves, unprecedented wildfires and more volatile rainfall, all of which affect the general public. Completely apolitical actors, such as insurance companies, are pulling out of certain markets in vulnerable areas after suffering material losses due to climate change. It is, therefore, extremely unlikely that major corporations will abruptly walk away from all of their carbon reduction goals regardless of any short-term unscientific political rhetoric. Given all that is happening in the renewable space, it is now more important than ever to differentiate among companies and developers. In my opinion, nobody is better placed than AES to create shareholder value from the ongoing energy transition because we have been focusing for years on the most resilient and lucrative opportunities. We are among the largest suppliers of renewable energy in the most attractive markets in the U.S., California, New York and PJM. We are also the biggest supplier of renewable energy to corporations in the world and particularly to data centers. Already, data centers represent half of our U.S. backlog and the growth of generative AI will only accelerate their demand for more renewable energy. An important differentiator is that AES is one of the very few major renewable developers that has not had to abandon projects in its backlog due to cost increases or supply chain disruptions. This has cemented our reputation for reliability among premium customers. And finally, AES is the most innovative company in the sector, developing and implementing new technologies such as: grid scale energy storage, hourly match renewable power purchase agreements, refabricated solar, construction robotics and software for energy efficiency in AI-enabled grid visualization. I believe these efforts will have material and growing benefit to our shareholders, especially by maintaining our lead in the most lucrative market segments. Regarding significant drivers for future growth post 2027, AES is best positioned to be the leader in green hydrogen production with the most advanced large project in the country, in Texas, in our participation in two of the largest hubs chosen by the Department of Energy. Our green hydrogen projects have real off-takers and sites, and we expect that they will meet the most exacting standards of additionality, regionality and hourly matching. Today, AES has the technology, the people, customer and supplier relationships, the scale and proven track record to continue to grow renewables profitably during the now unstoppable energy transition. While the total addressable market for our products and services is truly immense, I want to emphasize, once more, that our aim is to maximize shareholder value, not the number of megawatts or market share. Our priority will always be to ensure the best risk-adjusted returns for our shareholders on a per share basis. With that, I would like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] The first question will be from the line of David Arcaro with Morgan Stanley. Your line is now open."
},
{
"speaker": "David Arcaro",
"text": "So strong update in terms of the contract originations within the renewables development portfolio. I was wondering if you could elaborate on what you're seeing in terms of that backdrop, the trends in customer demand. There have been concerns in the market around renewable slowdown given the higher PPA prices financing challenges, et cetera. Wondering if you could talk about what your conversations are like with your customers? Are there pockets of weakness? Or is there still an ample opportunity set out there for contract signings?"
},
{
"speaker": "Andres Gluski",
"text": "What we're seeing is very strong demand from our target customers. So we have not seen a weakening. And as we said, it's -- I think it's very important to distinguish what markets you're operating in. So markets like California and New York, PJM, there is very strong demand. And there's very strong demand from corporations, especially from the tech companies in the data center business. So we have not seen a slowing down. Now, if you're talking about WEC and auctions for public utilities, et cetera, we're seeing a lot more competition for those projects. But for the -- our target customers in our target markets, we're seeing demand very firm."
},
{
"speaker": "David Arcaro",
"text": "Great. That's helpful. That's encouraging. And then maybe a question on the asset sale outlook here. You're accelerating -- targeting $2 billion over the next two years, I guess, what gives you the line of sight there? How is that market in terms of project sales? Are you seeing demand and the kind of off-takers there to acquire projects? And what are you seeing in terms of pricing? Are there favorable yields versus what you're developing those projects at?"
},
{
"speaker": "Andres Gluski",
"text": "Okay. So I think that's sort of two parts of the question. So a lot of the asset sales are selling out or selling down a specific businesses as we have been doing for the past decade. Our businesses continue to perform very well. So we see that there is interest in these businesses, because it's not -- again, not all businesses are created equal and we have very favorable positions in these markets. We're also seeing great interest for people to partner with us. And that also includes our existing partners for greater participation. So those are things which decrease the equity needs over the next four, five years. So I think that's very important to see that we're balancing both. I think the question regarding the sell-down of renewable projects, I'll pass over to Steve, so he can give you an update on that."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, that's going well. We -- as part of our sales, Andres walked through in his comments, there's a number of ways we achieve it. With the renewable sell-downs, we typically will sell down after the projects come online. And these are very low risk, long duration cash flows. Our average contract duration is 19 years. Obviously, no variable fuel cost, very little variable O&M in these types of assets. So they're very attractive -- and so yes, returns expectations have come up somewhat, but not in lockstep with where base rates have come because of the very low risk profile of these assets. So those sell-downs continue to yield a lift in AES' equity returns commensurate with what we've talked about in the past, David."
},
{
"speaker": "Operator",
"text": "The next question will be from the line of Durgesh Chopra with Evercore ISI. Your line is now open."
},
{
"speaker": "Durgesh Chopra",
"text": "Just want to start off with a quick housekeeping question here. Just the $0.10 EPS upside that we talked about, Steve, from projects potentially being moved from '24 into late '23, is that factored into your raised EPS guidance now, or is that still an upside?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So a portion of it, Durgesh, so we did guide to 100 megawatts over at least this year, so the 3.4 to 3.5. So just a portion of that $0.10 is included. And the good thing is we have a very clear line of sight at this point to that increase as mechanical completion has been achieved on 93% of the new capacity. That means everything is all built out. We're just in final synchronization of equipment and systems. And so, we feel very confident in the year-end number. That which does not come online this year of that upside will be in the first half of next year."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Okay. That's clear. And then maybe, Steve, there was a report from credit rating agency highlighting sort of weakening of your credit metrics here and then going into 2024. And then, Andres and you both talked about the importance of maintaining a strong balance sheet. Could you just sort of frame for us what your expectation is? With these asset sales because obviously, there's going to be a cash flow drop. What the expectation is for your FFO debt metrics next year versus your downgrade thresholds?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So one thing I would point out is that the credit metrics do fluctuate some during the year as we have higher construction balances in the middle of the year. We also have a higher level on our corporate revolver as projects come online towards the end of the year, paying down construction balances, and then we have the corporate revolver used to manage timing and distributions from our subsidiaries. The other thing to keep in mind is that we are in a high-growth mode. So at any point in time, we do have construction debt that's not yet yielding and that's all non-recourse. And it's also used to finance the tax credit value as well. So there's very quick paydowns on that debt once these projects come online. But no, we feel -- we're in regular contact with all the rating agencies. We feel very good about exceeding -- not just meeting but exceeding the thresholds. The other thing to keep in mind is that our leverage is amortizing. So most of our project level debt is amortizing over the PPA period. So this is a very low risk structure. It's non-recourse and it's not subject to significant bullets and it allows us to maintain a leverage ratio that will grow just proportionately -- our debt will only grow proportionately to the cash flows of the business."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay. So but just to be clear though, Steve, I mean, next year, you feel with the plan that you have in place that versus your downgrade thresholds, you'll exceed them, right, into 2024?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, absolutely. This is a top priority metric in all of our planning. So maintaining investment credit is at the top. And so as we look at the asset sales -- keep in mind, we already had a significant amount, $2.7 billion to $3 billion considered in our Investor Day numbers. And we are prioritizing assets that both hit our strategy, but as well are minimally dilutive on earnings, cash and credit. So I'm very confident that we will not impact our credit metrics negatively with the plans that we have."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Perfect. And I know just -- but I just want to ask just one last question, and then I'll pass it on to others. But just Andres you mentioned active discussions with a lot of parties on assets. $3.5 billion is already very significant in asset sales. Could that number be higher as you sort of get more interest as you have those discussions?"
},
{
"speaker": "Andres Gluski",
"text": "At this point in time, I would say that we feel that we will sell at least $3.5 billion through end of 2027, but a lot of these, again, are partial sell-down, sell-down of renewables, our plan to exit from coal. So if you look in the past, we've done a multiple of this number. I'd also point out that I'm not aware of any time that we have set a target for asset sales and not achieved it or exceeded it. So we feel very confident in achieving those asset sale numbers."
},
{
"speaker": "Operator",
"text": "The next question will be from the line of Angie Storozynski with Seaport Global. Your line is now open."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. So first, I wanted to -- you mentioned about -- you mentioned transferability of tax credits. I just wanted to make sure that were not in a sense window dressing and trying to solve for a certain credit metrics, but this is actually driven by economics. So when I look back to your Analyst Day, you financed your renewables in the U.S., 40% tax equity, 40% project level debt and then 20% equity. So I just wanted to make sure that, that structure is still in and we're not trying to basically boost credit metrics by levering these projects more? And again, just explain to me that why we're moving from the traditional credit -- tax equity structures, which allowed you to monetize accelerated depreciation, among others to the transferability?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Angie, it's Steve. Thanks for the question. No, it is important to recognize that AES has always been maximizing their tax credit value. And so that continues to be the case. The reality is the transfers offer a more -- a broader market -- a broader set of market participants. I think a more liquid market, so many more corporates coming in from different sectors. It's a faster, simpler transaction to execute, but we'll still do both because it's important that you not only monetize the tax credit value but also the benefit of the accelerated depreciation which is not something that's transferable and does require either AES or a partner in the asset to be able to utilize that accelerated depreciation benefit. So there'll be hybrids done here. But my primary point is that it is a broader market, simpler transactions, more liquidity. And I do think it's appropriate that it shows up in operating cash and free cash because this is truly an important component of value and a return to the investment that gets made in the assets."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. So that's treatment so that the FFO uplift under those structures, you already considered that when you quantified your equity needs during the Analyst Day?"
},
{
"speaker": "Steve Coughlin",
"text": "So I would say at this point, we have already done 500 megawatts in transfer credits. The market is moving faster. So, I think in the Analyst Day, I would say there's upside in terms of our cash flow metrics related to the use of more transferability. But it's not necessarily something that is changing returns or anything. It's just that it's creating more visibility, more market participation and shows up in the operating cash flow."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. But again, it's -- you're still sticking with solar ITCs. Again, that financing structure that I mentioned at the beginning, doesn't change, right? So you're not increasing leverage of the project, okay."
},
{
"speaker": "Steve Coughlin",
"text": "No, we are not just to be clear. So we are not increasing leverage at the projects that we are only looking to monetize the tax credits as efficiently as possible. And I would expect that given our credibility and our track record, any discount applied to the credits will be quite small relative to perhaps other market participants. And then, Andy, just also to reiterate, as I have said in the past, we choose the credit option based on what is the best cash financial return from the credit. So whether in most cases, that's been ITC for us, it makes very little sense to be choosing production-based credits, for example, in New England solar, where the capacity factors tend to be quite small. So I would question anyone that's doing that in their motives, but we are very focused on what's the credit that is yield the best return."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And then secondly, you mentioned the attractiveness of renewables versus other sources of power based on the levelized cost of electricity, so i.e., new-builds for renewables versus new-builds for thermal assets. But -- and not everywhere, do you have to actually add incremental generation sources, right? And then the pushback that we are hearing is that the PPA prices have now slightly exceeded forward power prices, be it on peak for solar or around the clock for wind. So again, I understand the distinction with tech clients, but how about any other locations and any other off-takers for new renewables?"
},
{
"speaker": "Andres Gluski",
"text": "Well, again, we're talking about the markets where we're located. And the way I look at it is a little bit different. I mean, in terms of the energy, the LCOE, again, as I said, in most markets that we're operating, it is the cheapest. The issue with renewables is really having that dispatchable 24/7. So you need to complement it with regular power or batteries, which will require even more renewals. But I think the state is a huge play. So you can't say in every single location. But certainly in states that have high solar radiation or high wind, that's just the fact. I mean, the real issue is more having the 24/7 capability."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And then the last question about the -- some flexibility on the retirement of the coal plants. I understand the reliability needs of local grids, et cetera. But this is not your renewables coming online later than expected. It's just more of the market backdrop in which the coal plants operate. Is that correct?"
},
{
"speaker": "Andres Gluski",
"text": "Exactly. No, exactly. You're taking it right. And as we've always indicated, we need regulatory approval to retire the coal plants. So what we're seeing is in some of the markets not us, but the general build-out of renewables enough transmission has been somewhat slower than planned and that these plants are likely to be needed through 2027. But I would add that this is the small minority of our total plants, okay? So we've gone from 22 gigawatts to 7. We have line of sight to about 4 of that is already planned. And of the remaining roughly 3, it would be a minority of that in terms. So I'm not talking about any walking away from our decarbonization plan. It's just a question that there -- we're seeing there's a couple of plants where it's going to be difficult to take them off-line prior to the expiry of their PPAs."
},
{
"speaker": "Operator",
"text": "The next question will be from the line of Richard Sunderland with JPMorgan. Your line is now open."
},
{
"speaker": "Richard Sunderland",
"text": "Andres, you spoke to active conversations on the asset sale front. I'm curious if you can outline at a high level how advanced those discussions are? And if this is an effort that could yield any announcements before year-end or I guess, earlier on in that sort of '24, '25 window?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. It's a good question. I would think that, again, it's over a two-year period, but I would expect some important announcements in the first half of next year. And again, we tend to announce things when they're very firm. So the negotiations, et cetera, are ongoing. It's several assets. But yes, I would expect to be able to say something in the first half of next year."
},
{
"speaker": "Richard Sunderland",
"text": "Understood. And then looking back at, I guess, it's Slide 7, where you lay out the potential asset sales. Has any of your thinking on those buckets in terms of what's actually in those buckets changed since the May Investor Day, I guess, in particular, I'm thinking about the noncore businesses and if there are any new thoughts there relative to six months ago?"
},
{
"speaker": "Andres Gluski",
"text": "What I'd say is, yes, I really can't comment on that. I would say stay tuned, and we will make announcements in that regard. But it's mostly assets that we have designated as noncore over time. So it's more of an acceleration or perhaps a deepening of some of the sell-downs."
},
{
"speaker": "Richard Sunderland",
"text": "That's helpful. And I'll try this from one other side if you'll indulge me here, new and expanded partnerships. New partnerships, any flavor for what that means? Just again, trying to get a sense of the scope of the opportunity. Obviously, you've laid out the magnitude with this $2 billion figure in the over $3.5 billion in total."
},
{
"speaker": "Andres Gluski",
"text": "Well, what I'd say is see what we've done in the past. So for example, if you look at when we made a big move into renewable energy, we -- our first big acquisition was sPower and we brought in a new partner and that relationship has evolved over time. So we're in a number of fields, which are very attractive right now. So I think it's an interesting time to see what our partners want to do or if some additional partners want to come in. But we're really sitting in a privileged position, especially for a lot of the new growing fields."
},
{
"speaker": "Operator",
"text": "The next question will be from the line of Julien Dumoulin-Smith with Bank of America. Your line is now open."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "First question here, I'm going to take it and play in every direction. All right, deal. $3.5 billion here. You talk about coal exits of selective assets in '27. To me, I hear that, and I'm asking well, how much does that delay some of the loss of contribution in the plan out to '28, i.e., the earlier targets that you gave through '27 contemplated full divestment of these assets. Now I get that you're raising the asset divestment target. So in theory, there's going to be fewer assets at the end. So in theory, you should be sacrificing some of the net income to the plan. But obviously, by selling some of the coal assets in '27, you're delaying or deferring some of the chunkiest lowest multiple assets potentially and the loss of the contribution into '28. I just want to like kind of hear how you think about that '27 versus '28, are you effectively pushing out a little bit of an earnings impact from '27 into '28 if you think about it or from '25 into '28?"
},
{
"speaker": "Andres Gluski",
"text": "What I'd say is you're basically right that say, operating through the end of a couple of plants, PPAs, we have that flexibility, it would be beneficial. In terms of our asset sales, I mean, we have -- our assets have different earnings profiles. So, how would I say, we feel confident that we have a plan in place that we will hit our numbers. Now when you talk about post 2027, getting into '28, there'll be a balance between bringing in partners for some of those growth projects post '28. And there are a lot of factors, I think, happening in the market. I would expect, quite frankly, in our numbers, we don't have much more efficiency improvements, and we're working on a lot of technologies, which should have that. So in the net, again, you're right about some of the big blocks, but I really think that -- I feel very confident about our numbers, what they're going to look like '28 forwards because we have a really a pull position in all these new technologies and new sectors that are opening up. So there's not going to be a cliff that were pushed off into '28. I want to make that clear. As we've made clear in the past, there's no cliff in '26. So we manage -- we have a lot of variables, a lot of levers. So we're making sure that we have a smooth transition. So our real problem is not one of demand. There's a tremendous amount of demand, tremendous opportunities, is that what we want to make sure is that we're maximizing value per share and taking advantage of it and being smart in the best combination of levers that we pull."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "No. Look, I get it. It makes sense. And just to clarify, the select assets, though, those are the ones that the PPAs are expiring or the -- otherwise been regulatory issues, right? Again, I think that's a nice catch all, right? If that's the way you're framing it, one or the other?"
},
{
"speaker": "Andres Gluski",
"text": "Well, that's correct. I mean that we have some assets that may be still under contract and that -- it's going to be -- it's looking more difficult to get regulatory approval to retire those assets in '25."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Right. Yes, indeed, right. There's a couple of them that stand out, if you will, that would seem to fit that right?"
},
{
"speaker": "Andres Gluski",
"text": "I guess."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "I know you don't want to be too specific [indiscernible]. I'm sorry, I'm trying to be less specific here. Quickly, if I can pivot here real quickly. Yes, go for it."
},
{
"speaker": "Steve Coughlin",
"text": "I was just going to say, there's a number of ways we're exiting both the retirements and sales. So looking at this, we have 7 gigawatts of coal. We've already announced and the exits of half of that. So you're talking about 3.5% roughly remaining. And we're not talking about that whole amount. Even a small portion of that are these assets that will be selectively considered."
},
{
"speaker": "Andres Gluski",
"text": "Yes. as I said, it's a small part of the 3 that's remaining."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Yes. Okay. Sorry, I just wanted to try to put that in a box a little bit more. And just to clarify this, the partial monetization, how do you think about Fluence here just to hit that a little bit more squarely? I know it's a sensitive subject, whatever you can offer here about how you think about that through the plan? You talk about beginning next year here on sell-downs bit large, not specific to the new technologies bucket. Whatever you can offer?"
},
{
"speaker": "Andres Gluski",
"text": "We can't call for much that we haven't said already. I mean what we've said is that we are really as an accelerator of new technologies. We create a lot of applications together. They help us. That's why we're the leader, I think, in the premium markets. But over time, we will monetize the positions. It's not just Fluence. We have other investments as well. And those new technologies have progressed very well. So we have other companies besides Fluence. But I'm not -- we really can't provide any further color on that."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "And you feel confident in the previous marks in the other technologies? I mean, I know it's been a little bit of time there, but that's important as well."
},
{
"speaker": "Andres Gluski",
"text": "Sure. I mean -- there are different ones of levels of maturity. But of course, you have Uplight, which is, I think, proceeding well and incorporating more product offerings and becoming part of Schneider Electric's energy efficiency offerings. But then we have other ones that are in earlier stages. And whether they will create a lot of value outside of what they create for us. So certainly, one of the more exciting ones is the building of solar farms with robotics, I think, has a lot of promise. If you look at a longer term sort of four years out there, I would expect a lot from that. There's a lot -- we're doing a lot with AI operationally for us. I mean today, we use AI on the operations of our wind farms of next-day predictions for energy demand and weather. We're also using -- Fluence is using on its bidding engines, but there's much, much more. We have collaborated with some of the technology companies on things like grid visualization, et cetera, which I think will become part and parcel of how ISOs manage their build-outs and dispatches and reaction to natural catastrophes. And we do have a -- we would receive part of the royalties from the sales of the technology companies because we co-created them with them. So these are all things that are not in our numbers, but I think we'll we will be able increasingly to have significant cost savings and greater efficiencies from applying them. And in some cases, we'll be able to monetize these over time at the right time when market conditions are right."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Yes, absolutely. Sorry. And just a quick clarification, more setting expectations ahead. You guys have done a lot on the new origination front. You flagged it at the outset, this 5 gigawatt number, I think. Just to set expectations, you've also done a number of acquisitions of backlog here, too. How does that mesh with your commentary about origination, a? And b, should we expect a steady cadence of announcements of further backlog acquisitions here as some of these have been the higher price points? Again, I just want to tackle that directly and give you an opportunity to kind of bifurcate and clearly set expectations."
},
{
"speaker": "Andres Gluski",
"text": "Look, we -- I think you have to -- when you think about what we're doing is we're making -- creating the most value of the different assets we have. So we did our first sale of -- in the pipeline, if you will, with the DTA, where we actually don't build the project, but we sell a development project because we felt that, that was the greatest creation of value. So sometimes from our pipeline, we may be doing this because that's the best use of that pipeline. As I said in the past, probably the most attractive thing for us to do is to acquire late-stage development projects when -- especially when we have a premium customer who needs that energy. And why? Well, because -- well, you have a development project, it's some cost if you have to invest to create that development project. And so you don't know what is the conversion rate of your pipeline. So if you have something that's in late stage your conversion rate is basically one if you have the client. So it's a very good risk-adjusted rate of return. So we're going to be doing all those things. In the case of one of our utilities, they're buying one of the projects that have been developed by somebody else. We're selling one from the pipeline. Others are going to be repowering. So, we'll use all of the means at our disposal to create shareholder value. So I don't think it's -- the way to think about this correctly, is just pipeline, greenfield through final delivery is the best way to create value. I think it's really -- the most important really is having the right projects in the right markets and the right clients and thinking about how can you best satisfy what the clients' needs are. So I just mentioned that we can talk about it off-line. But quite frankly, what we're seeing is that all things being equal, acquiring late-stage projects, and it is a buyer's market now. It is one of the most attractive businesses for us."
},
{
"speaker": "Operator",
"text": "The final question for today's call will be from the line of Michael Sullivan with Wolfe Research. Your line is now open."
},
{
"speaker": "Michael Sullivan",
"text": "I wanted to start with, can we just confirm if there's been any change to your levered returns targets in the current environment up or down? And then maybe also just you alluded to it a little bit, but just a sense of like how much LCOEs or PPA pricing on new projects have changed?"
},
{
"speaker": "Andres Gluski",
"text": "Okay. I'll take the first part of that. I'll have the second -- I'll pass that to Steve. Look, we are getting from our portfolio sort of low-teen returns. And that's at the project level. If we would include sort of core financing or mezzanine financing, we'd be high-teen returns. I don't think anybody is getting consistently higher returns than us because of the type of projects, the type of markets that we're in and the scale. We have sufficient scale to compete with anybody. And we have I think, had the best record of supply chain management. So, what I think has changed, we use a CAPM model, which is updated for risk-free U.S. treasuries, and they have moved up, obviously. So that's when we calculate our net present value that really comes into effect. So we do look at what's the net present value from these projects. So what I would say is that we've been able to pass on higher interest rates, pass on higher cost. And cost, by the way, are coming down. Battery prices are down 50%, solar prices are receding. And we do new projects for corporate clients outside of the U.S. And solar panels are near all-time lows. So all that put together, yes, we are using higher discount rates to see if the projects worthwhile pursuing in our net present value. And we have maintained our margins. And so we're seeing right now no stress on the market from that side. Now the second question you wanted to talk about was the particular projects here in the States and the returns we're seeing."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So I would say, generally in the States with our corporate clients, in particular, where we're doing structured products, we are seeing the higher end of that return range. And also, it's important, while PPA prices have been increasing, over the past one to two years, they've actually leveled off and are starting to come back down. We've seen significant reductions in solar module pricing this year. We've seen significant reductions in the commodities going into batteries and battery pricing coming down. So we're starting to see levelized costs come back down, which is also supporting the activity and the demand going forward. So I think we're in kind of past the difficulties of the supply chain past the impacts of the inflation and back to a declining curve in the key technologies we're using."
},
{
"speaker": "Andres Gluski",
"text": "Yes. Michael, maybe something that hasn't been asked on this call is that, first, we had the first project that we know they got the energy community additional 10%, which was a Chevelon Butte wind project, the largest wind project in Arizona. But we're also -- in terms of our wind farms, we are achieving the domestic content requirements. We expect that Fluence will be having next year, starting to receive domestic -- sufficient domestic content from its batteries and from its and casings. And then we're also in discussions for solar. We were one of the first to start discussions for solar. So what we see is upside from domestic content additionality. And we also see the energy communities we have already been achieving that. So I'll remind you, at least 40% plus of our pipeline is in energy communities as is today. So that would all be upside. So we are seeing upsides from the IRA in terms of the returns of some of the projects, especially those that are already signed."
},
{
"speaker": "Michael Sullivan",
"text": "Okay. One quick last one. Just -- can you give any thoughts on just the initial intervenor testimony in the Indiana rate case and what the path looks like from here to whether it be settlement or final order?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So just to kind of put things in context, too. This is our first rate case in over five years. And as I mentioned in my comments, we have the lowest residential rates in Indiana of any utility. So we're starting from a very good place. We had our IRP last year where we also have a lot of support for the growth that's there. So of course, any process like this, there are multiple stakeholders involved and interveners, they need to be heard. But we feel very good about what we asked for, given our position with the lowest rates and the growth plan that's been supported through the IRP. And again, it's our first rate case in five years. So in terms of timing, at this point, I would say, middle of next year for this to be all resolved and new rates to come into effect thereafter."
},
{
"speaker": "Operator",
"text": "Thank you. That concludes today's Q&A session, and I will turn the call back over to Susan for final remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. We look forward to seeing many of you at the EEI Financial Conference later this month. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "That concludes today's conference call. Thank you all for your participation, and you may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AES | 2 | 2,023 | 2023-08-04 10:00:00 | Operator: Good morning, everyone, and welcome to today's conference call titled the AES Corporation Second Quarter Financial Review Call. My name is Ellen, and I will be coordinating the call for today. At the end of today’s presentation there will be an opportunity to ask question. [Operator Instructions] It's now my pleasure to turn the call over to Susan Harcourt, Vice President of Investor Relations. Susan, please go ahead whenever you are ready.
Susan Harcourt: Thank you, operator. Good morning, and welcome to our second quarter 2023 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our second quarter 2023 financial review call. Today, I will discuss our second quarter results as well as the excellent progress we're making towards our financial and strategic objectives. Steve Coughlin, our CFO, will give some more detail on our financial performance and outlook. For the second quarter, adjusted EBITDA with tax attributes was $607 million, and adjusted earnings per share was $0.21. Results for the quarter as well as for the first half of the year are very much in line with our expectations. Thus, we're reaffirming our 2023 guidance for all metrics and our targeted annualized growth rate through 2027. As we noted earlier this year, approximately 75% of our 2023 earnings will come in the second half of the year. Now for an update on our strategic priorities. At the core of our strategy is a focus on, first, new renewables with the target to triple our installed capacity by 2027. Second, growth at our U.S. utilities, where we expect to increase the rate base by more than 10% per year through 2027. And third, the transformation of our portfolio as we exit coal by the end of 2025 and invest in the new technologies that will define our industry for years to come. Today, I will provide an update on how we are executing across each of these focus areas, beginning with our renewables on Slide 4. We continue to see significant inbound interest from key customers wanting to do large U.S.-based renewable projects with us. We believe this reflects both our reputation for consistently delivering on time as well as our best-in-class ability to tailor projects to the specific needs of our customers. Year-to-date, we have now signed 2.2 gigawatts of new PPAs, including 2.1 gigawatts since our Investor Day in May. These numbers do not include 1 gigawatt from Belfield second phase or 1.4 gigawatts from our Green Hydrogen Project with Air Products in Texas, both of which could be signed before the year's end. I feel good about the likelihood that we will sign 5 to 6 gigawatts of new PPAs this year. We continue to be globally the number one seller of renewable energy to corporate customers. We also had a leading position in the U.S., providing renewable energy to data centers, which are seeing explosive growth in part as a result of the generative AI revolution. Turning to Slide 5. Another area of recent success is how we have been working with technology customers to complete projects initiated by other developers. Our corporate customers want us to take on these projects because they know we will deliver them on time and can also restructure the original PPAs to provide customized solutions. Two great recent examples of this are the 185-megawatt Delta Wind project in Mississippi which has a signed PPA with Amazon and the 2 gigawatt Belfield project in California, 1 gigawatt, of which has a signed PPA with a large technology company that is a repeat customers. Both of these projects demonstrate the strength of the relationships we have with our customers. For us, completing other developers' projects is especially attractive because we can get similar returns to greenfield projects while preserving our current pipeline for future projects. Our 61 gigawatt pipeline represents investments in land, interconnection and development which must be replaced once utilized, given growing constraints on new transmission in markets like California and PJM, having the flexibility to decide when to utilize these resources helps us maximize total returns from our renewables business. Moving on to Slide 6. We now have a backlog of projects with signed long-term contracts of 13.2 gigawatts, which is the largest in AES' history. I would like to reiterate once more that our definition of backlog includes only signed contracts for which we have an obligation to deliver and our customers have an obligation to take a given amount of renewable energy for a given amount of time. The average tenure of the contracts in our backlog is 19 years, and currently, 41% of our 13.2 backlog is already under construction, and 74% is slated to come online within the next 3 years. Turning to Slide 7. Since our Investor Day in May, we have completed a number of landmark projects. In June, we announced the commercial operation of the 238-megawatt Phase 1 of the Chevelon Butte Wind project in Arizona. It is one of the first projects in the country to be placed in service to qualify for the 10% additional energy community tax credit bonus under the Inflation Reduction Act. And once Phase 2 is completed, it will reach 454 megawatts and be the largest wind project in the state. In addition, we completed the Andes 2B solar-plus storage project in Chile for our copper mining customers. It's 180 megawatts of solar plus 560-megawatt hours of storage will make it the largest battery storage installation in all of Latin America. We were also able to use 5b prefabricated solar panels for a portion of the project, which advances the learning and lowers the cost of future developments. Turning to Slide 8. We are on track to complete the 3.4 gigawatts of new renewable projects we committed to earlier this year, including nearly 800 megawatts we've already brought online. In the U.S., we expect to commission roughly 2.1 watts which is roughly double the capacity we installed last year. I am very proud of the work our teams have done to ensure that we have had no supply chain or construction delays. All of the necessary equipment has been contracted for our 2023 through 2025 backlog. There remains the potential for completion of up to an additional 600 megawatts this year in the U.S. given the strong performance of our construction program. We see our record of completing projects on time as a key competitive advantage that is highly valued by our customers. We are one of the only major developers that did not abandon or meaningfully delay construction projects over the last 2 years due to supply chain issues. Furthermore, due to our emphasis on long-term planning and strong contractual agreements, we have maintained our project margins despite inflationary pressures and rising interest rates. Now moving to our second priority of utility growth on Slide 9. We remain on track to grow our U.S. pretax contribution at an annualized rate of 17% to 20% through 2027. At AES, Ohio, we expect to receive commission approval for our new electric security plan or ESP 4 by the end of August, at which point our new distribution rates would go into immediate effect. As a reminder, ESP 4 includes approval of timely recovery of $500 million in grid modernization over the next 3 years, carrying a 10% return on equity. This will allow us to accelerate investments to continue to improve the quality of service while maintaining the most competitive rates in Ohio. At AES, Indiana, we filed for a new rate case in June, the first rate case since 2018. The proposed new rates are designed to recover inflationary impacts since the last case as well as investments in reliability, resiliency improvements and system upgrades. We expect commission approval by the middle of next year. Even after this proposed increase, we still expect our residential rates to be among the lowest in the state. At AES Indiana, we continue to advance our low carbon generation growth plan. We recently filed for approval to build a 200-megawatt or 800-megawatt hour storage facility at the site of the retiring Petersburg coal plant. This project is expected to come online by the end of next year, at which point it will be the largest battery storage project in the Midwest. Now turning to Slide 10 and our third priority of transforming our portfolio by exiting coal generation by the end of 2025. Since our Investor Day in May, we have significantly advanced our decarbonization objective by assuring the retirement of an additional 900 megawatts of coal generation. In June, we retired 415 megawatts of coal as we shut down Unit 2 of the Petersburg plant at AES Indiana. We also announced the retirement of the 276-megawatt Norgener Air Plant in Chile by 2025. Additionally, we received final approval, allowing for the termination of the PPA at our 205-megawatt Warrior Run Plant in Maryland for proceeds of $357 million. Now turning to Slide 11. We have expanded our leadership in the development and application of new technologies in our sector. We see this as another important competitive advantage. A new example is the use of embedded artificial intelligence, including generative AI across our operations. This year, we already expect more than $200 million of our adjusted EBITDA to be enabled by AI through both cost reductions and revenue enhance. We have incorporated AI and data analytics across our operations from areas such as wind production forecasting to vegetation management to identification of isolated solar panel failures. As part of this program, we also continue to pioneer and advance the use of robotics to install and maintain solar panels. Through our solar robotics program, we are developing proprietary AI-based computer vision to install a wide variety of solar modules, including the largest and heaviest models. With this technology, we plan to install projects significantly faster and across a wide range of working conditions, including extreme heat. In the coming months, we will be validating this technology for the installation of tens of megawatts and expect to move to use it for full scale solar projects in 2024. Finally, we're consolidating our lead in advanced green hydrogen projects with committed offtakers. We are currently developing the largest announced green hydrogen project in the U.S. jointly with Air Products in Texas. It features 1.4 gigawatts of inside defense, hourly matched renewables, 200 metric tons of hydrogen per day and a 30-year take-or-pay contract. It is expected to come online in 2027. Our pipeline of advanced green hydrogen projects is equivalent to more than 6 gigawatts of renewables and 800 metric tons of hydrogen per day. With that, I would like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will discuss our second quarter results, 2023 parent capital allocation and 2023 guidance. Turning to our financial results for the quarter, beginning on Slide 13. I'm pleased to share that the second quarter was fully in line with our expectations, keeping us well on track to achieve our full year guidance. Adjusted EBITDA with tax attributes was $607 million versus $722 million last year, driven primarily by lower margins at AES Andes and higher costs at our renewables SBU due to an accelerated growth plan, but partially offset by new renewables coming online and higher availability at select thermal businesses. Tax attributes earned by our U.S. renewables projects were relatively flat at $38 million in the second quarter of this year, in line with our expectations. Turning to Slide 14. Adjusted EPS was $0.21 versus $0.34 last year. In addition to the drivers of adjusted EBITDA, we saw higher parent interest expense this quarter. As a reminder, our year-to-date EPS is fully in line with the breakdown that we outlined earlier this year, in which we noted that roughly 25% of our earnings would come in the first half of the year and 75% in the second half. I'll cover the performance of our strategic business units or SBUs in more detail over the next 4 slides, beginning on Slide 15. In the renewables SBU, we continue to execute on our strategic priority to triple our portfolio by 2027. For the second quarter, as expected, we saw higher adjusted EBITDA with tax attributes driven primarily by higher wind generation and new projects coming online, partially offset by higher business development and fixed costs due to our accelerated growth plan. At our utilities SBU, we saw higher adjusted PTC driven by lower maintenance expenses, but partially offset by higher interest expense from new debt. We continue to expect strong utilities earnings for the second half of the year driven by typical second half demand seasonality and the pending August decision on ESP 4 at AES, Ohio. With this pending decision and the great progress in renewables growth at AES Indiana, we are continuing to pursue our strategic priority to increase rate base by an average of 10% annually through 2027. Lower adjusted EBITDA at our energy infrastructure SBU, primarily reflects lower margins at AES Andes in line with our phase out of coal, partially offset by higher availability at select thermal units. As we execute -- our third strategic priority to exit coal and complete the transformation of our portfolio, although not every quarter, we generally expect to see annual year-over-year declines in energy infrastructure as we discussed at Investor Day in May. Finally, at our new energy technologies SBU, higher adjusted EBITDA reflects continued improved profit margins at Fluence. Fluence has shown year-over-year improvement for 3 straight quarters, and we are very pleased with the strong results they are delivering this year. Now to Slide 19. We are on track to achieve our full year 2023 adjusted EBITDA guidance range of $2.6 billion to $2.9 billion. Growth in the year to go will be primarily driven by contributions from new businesses including growth at our U.S. utilities and contributions from new renewables projects coming online. As a reminder, the 3.4 gigawatts of new renewables we expect to add this year represents an increase of over 75% compared to the 1.9 gigawatts we added to our portfolio last year. This amount also represents a doubling of new renewables in the U.S. versus 2022. This growth will be offset by approximately $200 million of LNG sales we've recorded primarily in the third quarter last year, which we do not expect to recur this year. In addition to our adjusted EBITDA, we expect to realize $500 million to $560 million of tax attributes in 2023, bringing our total adjusted EBITDA plus tax attributes to $3.1 billion to $3.5 billion for the year. Turning to Slide 20. We are also reaffirming our full year 2023 adjusted EPS guidance range of $1.65 to $1.75. As a reminder, we expect our adjusted EPS to be heavily fourth quarter weighted due to the late year seasonality of our U.S. renewable project commissioning. Now to our 2023 parent capital allocation plan on Slide 21. Sources reflect approximately $2.4 billion of total discretionary cash, including $1 billion of parent free cash flow, $400 million to $600 million of asset sales and a $900 million parent debt issuance we completed in Q2. For more information on our debt issuances at the parent company and our subsidiaries, please refer to the appendix of the presentation. On the right-hand side, you can see our planned use of capital remains largely in line with guidance, with higher parent investment reflecting our recent acquisition of the 2-gigawatt Belfield project in the U.S. At our Investor Day in May, we outlined our capital allocation plan through 2027, including asset sales, along with debt and potential future equity issuances. We appreciate all of the feedback we've received, and I want to take a moment to clarify that we will only raise and invest capital in a way that's value accretive to our shareholders. Any potential future equity issuances would have to yield accretive value to shareholders for us to pursue equity as a source of capital. We are also committed to improving our credit profile over time and further bolstering our investment grade rating. We have a number of other levers to pull to support our growth such as increased capital recycling through asset sales and sell-downs. Given our strong asset sales track record and recent success, it is possible that any future equity issuances could be materially lower than the 5-year figure we previously shared. As always, our Investor Relations team is happy to take additional feedback and to follow up on additional questions or data requests. In summary, we're continuing to make progress on transforming AES' portfolio while delivering strong growth in adjusted EBITDA, earnings and parent free cash flow. Our businesses are executing successfully and delivering on their commitments. We will continue to allocate our capital towards our high-growth renewables and utilities to maximize shareholder value. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. In summary, we're reaffirming our 2023 guidance for all metrics and our targeted annualized growth rates through 2027. We continue to make substantial progress on our strategic priorities, including tripling our installed renewables capacity by 2027, increasing the rate base at our U.S. utilities by more than 10% per year through 2027 and and transforming our portfolio by exiting coal by the end of 2025, while investing in new technologies. We are delivering on all the commitments we made on our Q4 2022 earnings call and at our Investor Day presentation. With that, I would like to open up the call for questions.
Operator: [Operator Instructions] We will take our first question from Durgesh Chopra with Evercore ISI. Durgesh, your line is open. Please proceed.
Durgesh Chopra: Andres, just you're now -- if I heard you correctly in your remarks are targeting 5 to 6 gigawatts of new PPAs first. Can you confirm whether that is accurate because that's higher than what kind of you might have locked down in previous years? And then what's driving that higher range?
Andres Gluski: Sure, Durgesh. Good to talk to you. Look, we signed 5.2 gigawatts of new PPAs last year. So what we're seeing this year is we already have 2.2 signed. We have visibility into just 2 projects, which would be another about 2.4, right? Which would put us 4.4. And of course, we have other projects in the pipeline. So we're not really setting out an official target, but I'm saying that we believe that we should be similar to last year. And we do have a couple of what I call these whales, the 1 gigawatt plus targets, but we feel very good because we see a lot of demand for our products. We have people coming to us with products. So it's really looking at how do we best allocate our money where we get the highest returns and best allocate our teams.
Durgesh Chopra: And then maybe when could we get clarity on the potential 600 megawatts in terms of timing. Is that really sort of a Q3 call event when we would know more. How should we think about that? I'm just thinking about the projects that pushed into 2024, yes.
Andres Gluski: Sure. Look, I would say that we feel very good about our construction program. So -- versus -- this was the big challenge of this year to grow our construction program in the U.S. by 100%. We feel very good about it. Unfortunately, a lot of these are slated to be commissioned towards the latter part of the year. So we should have a good view in -- on the Q3 call of where we stand. And whether we're going to do more of these projects this year. But in general, we're very pleased with the supply chain, with our construction teams. The team has really stepped up to the task, and I'm very proud of them.
Durgesh Chopra: And then just one last one for me. Steve, you mentioned that the equity needs could be materially reduced. It's nice to hear that in your prepared remarks. Maybe just can you give us more color when could we get an update on timing? Where are you thinking just the current equity needs, when in the plan are those scheduled to hit? And just when could we get an update?
Steve Coughlin: Yes. Look, I mean, as I said in my remarks, Durgesh, this is just a function of multiple levers. And we're seeing a lot of great progress on our asset sale program and the $3 billion that we put out at Investor Day was well below the total universe of opportunities. So -- what I wanted to point out is that we're only going to issue equity in the future, and that could be far in the future to the point that it's value accretive to shareholders, and we haven't also tapped other sources that we intend to tap, which is our asset recycling program. So as you saw with where you run, as we've seen, as we've executed on the renewable sell-downs, as we exit further coal assets, we have a lot of upside in that asset sale number. So at this point, it's indefinitely into the future and our share price would need to be substantially higher than where it is today, and it would have to be value accretive to shareholders on a per share basis.
Andres Gluski: Durgesh, I guess another point I'd like to make is that we've been very effective at bringing in partners to fund our projects. So that's obviously another lever that we have. So we laid out what could be a possible path. We were very conservative on the numbers. But if we don't feel that we want to, at some point in the future, issue equity, we can always invite partners into our project. Of course, we're giving them part of the upside as well.
Operator: Our next question comes from David Arcaro from Morgan Stanley. David, your line is open. Please go ahead.
David Arcaro: I was wondering, just what's your latest thinking on just the hydrogen PTC timing in terms of treasury guidance here and what the rules around matching and additionality might be? And kind of just in coordination with that, what are your -- what's your current like project pipeline and discussions with potential partners on that side of the business as it stands currently? .
Andres Gluski: Well, of course, the final rules haven't come out. What I would like to say is that our Felix project -- our project in Texas is -- really would meet the very strictest criteria. So it is additional. It is hourly matched. It is regional. So it has the very lowest carbon footprint technically feasible in the U.S. So I'd like to put that right out there that our project is not dependent in any way about how the rules come out. Now having said that, I do believe that additionality is important. I also believe that we have to move to early matching, in part because we need green hydrogen projects to be tradable goods. So these are the rules in Europe. I also think regionality is important, so we don't add further congestion. So really, what we want is that the new rules come out help us create a market, but they also help lower our total carbon footprint. So we don't want to just be squeezing the balloon, taking off renewable energy from the grid to produce green hydrogen. And we can get into more specifics there. So I do expect that the rules will come out, we'll incorporate some of these factors. But I want to say that our projects are very solid. We have committed off-takers, which I think is the key because this market for green hydrogen is developing. So to have early-on projects, I think the key is not only have a great project, and it -- with a very low carbon footprint. So you get all of the benefits of the IRA, but to have a committed offtaker.
David Arcaro: And then I was curious if you could speak to the transmission challenges just related to transformation interconnection in the renewable industry. You alluded to it in your commentary, but I was wondering if you could speak to what your kind of current pipeline of maybe transmission positions and also with regard to like early stage development, land positions, things like that. How soon could a transmission constraint potentially impact your business? And how are you positioned now to kind of avoid that in the foreseeable future?
Andres Gluski: Well, look, I think transmission constraints are affecting the market already. So we got out early, and we started getting a filing for interconnections on a big way 3 years ago in key markets like PJM and CAISO. So I think we're in a good position there. I think right now, we have a new industry here. And so I think we have to come to terms with the new definitions. What is pipeline? So for us, pipeline is projects that we already have, either land rights, interconnection rights, real prospects to make a project. And then, of course, there are different phases. Some projects are far more advanced shovel ready and some are more at the beginning of the Q. I think having looked at a lot of say, proposals from other developers, they count pipeline things that are -- we would call prospects. And I think we have to move towards a common definition, I mean, a little bit perhaps like the oil sector, which has possible reserves -- has probable reserves and has proven reserves, right? And I think what's very important is that the -- to get a pipeline, you have to invest and you have to have money. So some of the new changes, for example, on the interconnections will make it a little bit more costly just sort of spurious flood the zone request for interconnections. So maybe Steve can give you some comments on how that is progressing, which would be favorable to us. We don't see any sort of short-run effect of it. But in the long run, it's favorable to us because I think we've been the most, I would say, stringent about what we consider pipeline. And what we're very interested in doing is maximizing the conversion rate. But I do also want to emphasize that if somebody comes to us, a client and ask us to complete on advanced stage development project, that's the best of all worlds because we get to conserve the pipeline. We weren't investing money when it was at the highest risk stage and can bring it online more quickly and satisfy that client.
Steve Coughlin: Yes. And I would just add to that, look, I mean, we're very pleased with the final rules coming out of the third quarter 2023. But although, as Andre said, we've -- this has been our strategy to lead renewables development for many years. So we put ourselves in an advantaged position, I think, many years ago getting into these cues. Nonetheless, it is important for the industry overall for these cues to be move along faster in the process to be more efficient. So having the higher financial thresholds to get into the cues and to stay in the cue, having to demonstrate project maturity in terms of permits, and financing behind them, having cluster studies so that this isn't just a one by one review process. And then having the penalties and the teeth behind the deadlines that have to be met to do the studies is also important. So there's a number of angles at which this issue is being approached through the order. The order is due to be published, I think, very soon and will go into effect 60 days later. I think it's a great thing for the industry. We've already felt great about our position. But of course, over the longer term to have these cues cleaned up and moving faster is very important, and I think we'll further accelerate growth throughout the rest of the decade.
Andres Gluski: And I say, look, we're also taking sort of technological a look at how we can improve transmission for our projects. So this is like using the grid stack to be able to baseload transmission lines, which were really peakers. This means dynamic line rating. This means using our prefab solar, which takes about half the space to be able to put higher loads where we have a good interconnection. And you also noticed that we're putting large battery projects where we have interconnections from our decommissioned coal plants. So we're looking at this problem rather holistically. And again, I think we're in a very good position to take advantage of what's going to be an increasingly congested grid.
Operator: Our next question comes from Richard Sunderland from JPMorgan. Richard, your line is open. Please proceed.
Richard Sunderland: Circling back to the data center commentary from scripts. Curious how much of a near-term change in C&I demand you're seeing from this subsector specifically? And any indications of upside just on that ramp over the next 1 to 2 years relative to what you were seeing maybe 6 months or a year ago?
Andres Gluski: I would say yes. I mean, the -- there's some definitions that they are waiting for in various markets, but about rules of where you can locate data centers. But no, we're definitely seeing increased interest and increasing demand, and we are the largest provider to U.S. data centers. And so I think we can uniquely provide data centers with the same quality of service, for example, in certain markets abroad, be it Mexico, Chile, Brazil, which is another advantage for us. So yes, we are seeing increased demand from that sector.
Richard Sunderland: And then just wanted to parse the kind of backlog pipeline conversation a little bit more finally for the hydrogen. It sounds like the 1.4 gigawatts for Texas could come in this year. Could you just speak a little bit more to your confidence level there for '23 specifically, and what you're focused on there? And then thinking about the balance of the hydrogen opportunities, when could those come in over the next few years?
Andres Gluski: Well, again, I think we're the most advanced in terms of real green hydrogen projects. So in the U.S., we have committed offtakers for that project in Texas. We have several other projects, including two of the hubs, one in Los Angeles also one in Houston. I would say that we could sign the first project this year. It will be -- we're coming online for 2027 outside our guidance range. And the subsequent wins would be somewhat further out, '27, '28. But what we're seeing is strong demand. And basically, we are seen as a preferred partner by several people. And we also have very good projects, for example, in Chile, which is to green the mining sector. They're heavy equipment. We've already green electricity use, and a possible ammonia export project in the Northeast of Brazil. So again, stay tuned, but I feel quite confident in saying we're the most advanced in projects with committed off-takers. And we think we will hit these numbers. It's really a question of as they come online because you have to have the equipment that can use it. Certainly, in the shorter term, you can substitute green hydrogen in thermal processes in a lot of petrochemicals or steel plants, other things like that. So we have to see as this market develops. But again, I think we're very well positioned. It's a very exciting opportunity for us.
Richard Sunderland: And then just one final one for me. The Belfield project, you've been very clear in a lot of the messaging around how that came together. I'm just curious in terms of considerations around Phase 2 versus Phase 1, just Phase 1 your return thresholds on a stand-alone basis. How do you think about the progress to signing Phase 2? Anything you can offer there would be helpful.
Andres Gluski: I think we're well advanced on Phase 2 is what I'm willing to say. It would be a similar project to Phase 1. So that is the largest solar plus storage project in the U.S. in California. So it's a very unique offering that we can bring together.
Operator: Our next question comes from Angie Storozynski with Seaport. Angie, your line is open. Please go ahead.
Angie Storozynski: So I wanted to start with some high-profile management departures we've seen since the Analyst Day, basically from your core businesses, right, the U.S. utilities and U.S. renewables. I mean, you might be just victims of your own success in a sense, but just how you can reassure us that there's no change in the execution of your growth plans, especially in these 2 businesses and the demand that you have to fill those vacancies?
Andres Gluski: Angie, and thanks for that question. And I think you got it spot on. Look, this is, quite frankly, a symptom of strength in our case. We have the hottest management team in the market. And so of course, people are going to be being made offers. And if people are obviously -- if they want to go to private equity and bet on a longer-term IPO, that's their right. But this in no way affects our business whatsoever. And I think the best proof of that is after the departure in clean energy, we've signed more PPIs. So we're doing very well. I don't expect it to have any impact on the business. And I expect the same in U.S. utilities. I don't expect this will have any impact whatsoever. But it is a sign of that, yes, we have a strong team, we have a deep bench, and we'll continue to identify talent and prepare it and move it up. Again, let's say, where AES was in, say, in 2012 or something, our team wasn't the honest in the business, people wouldn't be trying to poach it. So it is what it is, but I feel very good about where we are, and it doesn't change our plans whatsoever. And I think the teams are very motivated on executing on the plans that we laid out.
Angie Storozynski: And then moving on, I mean, you talked a lot about your backlog of renewable power projects. So -- and then potential monetization of assets in the world of equity. So First, on the backlog, I mean, we've heard stories about some public renewable power developers basically showing in their backlog third-party projects where they don't have exclusivity for these projects. So again, this is just anecdotal evidence, but I'm just wondering if you've heard of those instances and if any of this could be true for you guys?
Andres Gluski: Well, I can say categorically, absolutely, under no uncertain terms, we have no such projects in our backlog. I want to make very clear because maybe some other people are doing that. I think that's not transparent. I would not recommend anybody to do it. In our case, whatever we have in the backlog, we are -- we have the project, we are committed to delivering it on a certain date for a certain amount of time, and our clients have an obligation to take that energy -- a certain amount of energy for a certain amount of time. So this is binding for both sides. And the fact that 43% of our backlog is currently being built, we have ordered all the equipment for our '23 through '25 backlog, and about 3 quarters of them will come online by 2025. So I want to make very clear that's a good question. I wouldn't recommend anybody to do that. And I can say, categorically, we would never do something like that.
Angie Storozynski: And then on the monetization of assets. So I understand that there is a very big difference between the assets that recently transacted and the ones that you are developing, it's only because of the duration of the PPAs, so basically the duration of the cash flows. But on the flip side, right, you have higher discount rates for the DCF value of those cash flows. So I'm just thinking if you were to monetize some of these assets, again, I guess it all depends where the stock is. But again, how would that, from your perspective, demonstrate the value of the portfolio that you currently have?
Steve Coughlin: Yes, Angie, this is Steve. So look, we have, as you know, have been selling down our renewable projects after they've come online and we package them together in portfolio. So we have seen some, I would say, relatively small uptick in return requirements there, but nothing outside the range of what we expected within our plan in terms of -- this is -- these are very low-risk assets. They're solar coupon, essentially, no fuel costs, very low maintenance. So these are very predictable, and the demand for these assets continues to be very strong. So we don't see any impact to the plan for how we sell down from sort of where rates are in the market today. Does that address your question?
Andres Gluski: I think -- I mean the other thing is that these are -- all investment-grade quality offtake or the very highest quality off-takers that you can have. So we are selling down the premium product in the market. So I think it's important to say that, look, people have talked about inflation, people have talked about writing interest rates, we're not seeing a degradation of our margins. So the margin of our money into these projects, we're not seeing any squeeze whatsoever.
Steve Coughlin: Yes. And on top of that in site -- so just as Andreas pointed out, with the new project, we have the energy community adder for that project. And actually, most -- all of our wind projects going forward, we expect to qualify for the domestic adder as well, Angie, so there's some significant offsets to the cost of financing that we've been achieving too.
Operator: Our next question comes from Julien Dumoulin-Smith with Bank of America. Julien, your line is open. Please go ahead.
Julien Dumoulin-Smith: I know a lot has been said here already, but let me follow up on some details here, just on the year-over-year comparisons here as we go to the back half of the year, if I may. Look, I'd love to talk about -- I think you have in your slides here, $0.24 of positive net impact in the back half of the year from renewables and year-over-year comps on LNG if I rewind here, I think you said in the back half of the year that -- I mean, last year, it was like $0.30 contribution from LNG. Just as I think about that, that seems like a pretty big step-up year-over-year renewables. Can you talk about what renewables assumptions you're baking in as sort of a discrete item in -- especially in the back half of the year to sort of make up for what you need to get to your guidance? And then if I think about the start of the year, right, in terms of what you talked about renewable contributing, I think we talked about $0.27 for the full year. So -- it seems like what's implied here again, I'm curious that renewable is actually contributing more than what we thought at the start of the year and maybe what that says for future years as well. But please, by all means, respond accordingly.
Steve Coughlin: So yes, this is Steve, Julien. So the $0.30 it doesn't -- sound correct or actually more like $0.20 is the LNG year-over-year delta to be offset. And then, of course, we're more than doubling the renewable commissioning this year. So if you recall, it was just around 1 gigawatt last year, and it's 2.1 gigawatts this year, most all of which is in the second half of the year. So what we're carrying in the first half is sort of more of the cost in renewables. The EBITDA has been relatively flat through the first half. In the second half, then we're going to see that renewable number pick up substantially, and that's why we have the 75% loading on the second half of the year earnings. That's a major driver. The other is, of course, utility demand in Ohio and Indiana peaking in Q3. You've got Southland, where we have the peak cooling season in the third quarter. And then we have hydro in Latin America, typically, the volumes are much higher as we come out of the wet season in the summer and the winter and you have the snow melt into the fall. So those are really the primary drivers is the clean energy Southland, the utilities and then some of the hydro assets in Latin America having much more volume in the second half of the year. But the LNG offset is really only about $0.20 for the -- and mostly in the third quarter.
Julien Dumoulin-Smith: Is there a use on that -- sorry, go forward.
Andres Gluski: I was just say we're executing exactly what we laid out at the beginning of the year. So there's been no change. I want to make that clear.
Steve Coughlin: Yes. Yes, this is -- I think we're right at 25% on the EPS, Julian, year-to-date. So this is -- what we're seeing, although the year-over-year in the quarter is lower, that's primarily due to coal retirements in Chile as we've done the green blended extend, some of the coal that's still there, the margins have come down, which was all expected. So we're exactly on track. And also, to your point, there is some potential upside, as Andres noted, we feel really good about being on track with the construction program and there still remains the upside on the 600 megawatts potential.
Julien Dumoulin-Smith: But the point is the plan for $0.27 of renewables contribution in '23 unchanged from the start of the year still.
Steve Coughlin: Yes. Let us get back to you on the exact number because I don't have that math in front of me, but the renewables contribution is looking at least on track, is what I would say.
Julien Dumoulin-Smith: If I can give a slight different direction here, trying to follow up on a few earlier questions. Just on the asset sale dynamics versus equity, can you comment a little bit further about what else you're seeing out there? Or what else could be monetized just as you think about deemphasizing equity. It sounds like the principal lever Andres, you were alluding to is that you would just sell down your interest in the new renewables even more so. Is that fair to say in terms of like the alternative lever here versus the corporate level equity? And also just to clarify the point you made earlier on just very precisely, at these levels today, you would definitively move away from the equity levels that you -- equity-ish levels you defined earlier. -- in lieu of these alternatives?
Andres Gluski: So on the first point, no, it's not fair. Characterization is not fair. So what -- look, all right, we have partnerships in all of our businesses. So we don't necessarily have to do it on the new projects. So we can bring in partners to -- money is fungible. So if we monetize a different business, that means we have more money available for renewables. We will -- as we have in the past, we can choose to optimize the return on invested capital. And I think that we're doing a very good job of how we exit coal. I think the Warrior Run monetization, I think is probably better than people's expectations. And so we continue to manage that. So all I'm saying is that -- we never -- as Steve said in his script, we didn't -- we put this out as a 5-year plan. And in the 5-year plan, we had a certain amount of asset sales, a conservative number, and we had a sort of range for potential equity issuance as well. So the 2 somewhat offset each other. So if we do better on the asset sales, we will need less equity and we do better in terms of bringing in partnerships. So what we're saying at these levels, we do not feel comfortable issuing equity. But I think it's been very clear from our presentation that we have tremendous demand for what we're doing. And that is a once-in-a-lifetime market opportunity. So we want to create the most value for our shareholders from that opportunity. So obviously, if we don't have -- what we feel is correctly valued equity, we'll have to use other levers. And this should be nothing new to you guys. We have financed a remarkable change in this company without issuing equity. We did it by selling down assets. We got into wind by bringing in partners. So what we're saying is nothing like a promise for the future. It's just more of the same. So we will use whatever the levers creates the most value for our shareholders, and we will continue to do so.
Julien Dumoulin-Smith: So your point ultimately is not committing to selling down partners per se, a variety of different sources here incrementally just not issuing the equity at current levels. And if I can also clarify this process underway. I know that it was listed in the queue here as well. Is that still status quo in a way?
Steve Coughlin: No, there's no -- there's no specific Maritza process underway, Julien, at this point. So still evaluating different pathways for Maritza.
Operator: Our next question comes from Ryan Levine from Citi. Ryan, your line is now open. Please go ahead.
Ryan Levine: A couple of specific follow-on questions. Is your Fluence take core to your portfolio? And I guess secondly, on the financing side, are you still open to considering the convert market to help offset equity issuance?
Steve Coughlin: So this is Steve. So yes, Fluence is part of the portfolio we own roughly 1/3, 34% of Fluence. It is not consolidated, but it does come in through equity method. And we do, in our adjusted EBITDA definition include an adjustment to include Fluence EBITDA. So that does show up and it's in our new energy technologies SBU influence margin...
Ryan Levine: The question is that core, is that core?
Steve Coughlin: Is it core? Or did you say -- is it core to our business?
Ryan Levine: Core.
Steve Coughlin: So look, I mean, I would say -- so given that it's an outside business, I don't think I would parse this out as like core or noncore. It's been a really important strategy for us to be able to lead in energy storage, both in development as well as in the technology as well as sort of advancing the way that storage gets used to create the innovative solutions we've done like 24/7 carbon-free energy to make those products work. We've done a lot of co-innovation, co-development with Fluence around that. So that's, I would say, definitely core to our strategy is what we've been able to do with storage. But as Andres said many times, these are technology businesses of their own right. They're separated. We are not in them indefinitely, and we continue to grow new opportunities. And as we do we may look to monetize part of our positions down the road. No time soon, and we see a lot of value upside. We're very pleased with how the new management team has driven value already that's been recognized, but we still see a lot of upside and there's a lot of partnership that we continue to work on new solutions around. So it is core from that perspective that I laid out.
Ryan Levine: Okay. And then on the convert option?
Steve Coughlin: So no, nothing that we're contemplating at this point. I mean, look, we did a $900 million debt deal just in the second quarter. Nothing -- no specific convert for us contemplated at this point.
Ryan Levine: And then last question. In terms of Puerto Rico, what's your strategy there from existing assets and future development perspective?
Andres Gluski: Well, in Puerto Rico, we're greening the island's energy grid. So we do have renewal projects we're bringing in batteries as well. And it's our plan to phase out coal by 2025. So we're assisting the island and its energy transition. And I think we've been very clear what our objectives are.
Operator: Our final question comes from Gregg Orrill from UBS. Gregg, your line is now open. Please go ahead.
Gregg Orrill: Yes. Probably quick. On AES Ohio, is the DPO rate case, how does that timing compare with what you were assuming in guidance or any other differences with how that's proceeding versus the '23 guidance?
Steve Coughlin: Yes. Gregg, it's right on track with what we assumed in our guidance. So the decision has been put on the agenda for next week, August 9, that was just published, I believe, yesterday. So right on track in terms of when we assume the decision to be made. And we still feel really good about where that is likely to come out. As a reminder, once the decision is made, is to put in place, then the new rates that were decided upon last year immediately go into effect. And as we've laid out, the riders would go into effect and then the frequent quarterly recovery on our distribution investments going forward, would start to be put in place. And so this is a business really pivoting to a very different phase from where we've been delevering and setting that business up for a more normalized structure. This is an important pivot point for Ohio to really pivot to growth, and there's a lot of room for growth as there's the lowest rates in the state there in all customer classes. And even with the ESP 4, the new rates, we expect it to continue to be the lowest rates in the state for the foreseeable future. And we have, as Andres noted, 10%-plus rate base growth expected going forward. So we're very excited about this and look forward to the decision next week.
Andres Gluski: Yes. And I'm also very excited about that Dayton is finally getting incoming investment. So you have a new Honda EV plant to have a battery plant coming into our service area. So you're starting to see an economic recovery. Dayton had sort of been not participating in the expansion that we had seen in Eastern Ohio. So it's a very exciting time, and we're very happy that we could invest and continue to improve the quality of service and continue to attract new investments into the Dayton area. So it's not only a rate base story, I think there's an economic recovery story happening in Dayton for the first time in decades. So it's a very exciting time to be in Dayton.
Operator: I will now hand back to Susan Harcourt for any closing remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day.
Operator: This concludes today's conference for everybody. Thank you very much for joining. You may now disconnect your lines. Have a great rest of your day. | [
{
"speaker": "Operator",
"text": "Good morning, everyone, and welcome to today's conference call titled the AES Corporation Second Quarter Financial Review Call. My name is Ellen, and I will be coordinating the call for today. At the end of today’s presentation there will be an opportunity to ask question. [Operator Instructions] It's now my pleasure to turn the call over to Susan Harcourt, Vice President of Investor Relations. Susan, please go ahead whenever you are ready."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning, and welcome to our second quarter 2023 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our second quarter 2023 financial review call. Today, I will discuss our second quarter results as well as the excellent progress we're making towards our financial and strategic objectives. Steve Coughlin, our CFO, will give some more detail on our financial performance and outlook. For the second quarter, adjusted EBITDA with tax attributes was $607 million, and adjusted earnings per share was $0.21. Results for the quarter as well as for the first half of the year are very much in line with our expectations. Thus, we're reaffirming our 2023 guidance for all metrics and our targeted annualized growth rate through 2027. As we noted earlier this year, approximately 75% of our 2023 earnings will come in the second half of the year. Now for an update on our strategic priorities. At the core of our strategy is a focus on, first, new renewables with the target to triple our installed capacity by 2027. Second, growth at our U.S. utilities, where we expect to increase the rate base by more than 10% per year through 2027. And third, the transformation of our portfolio as we exit coal by the end of 2025 and invest in the new technologies that will define our industry for years to come. Today, I will provide an update on how we are executing across each of these focus areas, beginning with our renewables on Slide 4. We continue to see significant inbound interest from key customers wanting to do large U.S.-based renewable projects with us. We believe this reflects both our reputation for consistently delivering on time as well as our best-in-class ability to tailor projects to the specific needs of our customers. Year-to-date, we have now signed 2.2 gigawatts of new PPAs, including 2.1 gigawatts since our Investor Day in May. These numbers do not include 1 gigawatt from Belfield second phase or 1.4 gigawatts from our Green Hydrogen Project with Air Products in Texas, both of which could be signed before the year's end. I feel good about the likelihood that we will sign 5 to 6 gigawatts of new PPAs this year. We continue to be globally the number one seller of renewable energy to corporate customers. We also had a leading position in the U.S., providing renewable energy to data centers, which are seeing explosive growth in part as a result of the generative AI revolution. Turning to Slide 5. Another area of recent success is how we have been working with technology customers to complete projects initiated by other developers. Our corporate customers want us to take on these projects because they know we will deliver them on time and can also restructure the original PPAs to provide customized solutions. Two great recent examples of this are the 185-megawatt Delta Wind project in Mississippi which has a signed PPA with Amazon and the 2 gigawatt Belfield project in California, 1 gigawatt, of which has a signed PPA with a large technology company that is a repeat customers. Both of these projects demonstrate the strength of the relationships we have with our customers. For us, completing other developers' projects is especially attractive because we can get similar returns to greenfield projects while preserving our current pipeline for future projects. Our 61 gigawatt pipeline represents investments in land, interconnection and development which must be replaced once utilized, given growing constraints on new transmission in markets like California and PJM, having the flexibility to decide when to utilize these resources helps us maximize total returns from our renewables business. Moving on to Slide 6. We now have a backlog of projects with signed long-term contracts of 13.2 gigawatts, which is the largest in AES' history. I would like to reiterate once more that our definition of backlog includes only signed contracts for which we have an obligation to deliver and our customers have an obligation to take a given amount of renewable energy for a given amount of time. The average tenure of the contracts in our backlog is 19 years, and currently, 41% of our 13.2 backlog is already under construction, and 74% is slated to come online within the next 3 years. Turning to Slide 7. Since our Investor Day in May, we have completed a number of landmark projects. In June, we announced the commercial operation of the 238-megawatt Phase 1 of the Chevelon Butte Wind project in Arizona. It is one of the first projects in the country to be placed in service to qualify for the 10% additional energy community tax credit bonus under the Inflation Reduction Act. And once Phase 2 is completed, it will reach 454 megawatts and be the largest wind project in the state. In addition, we completed the Andes 2B solar-plus storage project in Chile for our copper mining customers. It's 180 megawatts of solar plus 560-megawatt hours of storage will make it the largest battery storage installation in all of Latin America. We were also able to use 5b prefabricated solar panels for a portion of the project, which advances the learning and lowers the cost of future developments. Turning to Slide 8. We are on track to complete the 3.4 gigawatts of new renewable projects we committed to earlier this year, including nearly 800 megawatts we've already brought online. In the U.S., we expect to commission roughly 2.1 watts which is roughly double the capacity we installed last year. I am very proud of the work our teams have done to ensure that we have had no supply chain or construction delays. All of the necessary equipment has been contracted for our 2023 through 2025 backlog. There remains the potential for completion of up to an additional 600 megawatts this year in the U.S. given the strong performance of our construction program. We see our record of completing projects on time as a key competitive advantage that is highly valued by our customers. We are one of the only major developers that did not abandon or meaningfully delay construction projects over the last 2 years due to supply chain issues. Furthermore, due to our emphasis on long-term planning and strong contractual agreements, we have maintained our project margins despite inflationary pressures and rising interest rates. Now moving to our second priority of utility growth on Slide 9. We remain on track to grow our U.S. pretax contribution at an annualized rate of 17% to 20% through 2027. At AES, Ohio, we expect to receive commission approval for our new electric security plan or ESP 4 by the end of August, at which point our new distribution rates would go into immediate effect. As a reminder, ESP 4 includes approval of timely recovery of $500 million in grid modernization over the next 3 years, carrying a 10% return on equity. This will allow us to accelerate investments to continue to improve the quality of service while maintaining the most competitive rates in Ohio. At AES, Indiana, we filed for a new rate case in June, the first rate case since 2018. The proposed new rates are designed to recover inflationary impacts since the last case as well as investments in reliability, resiliency improvements and system upgrades. We expect commission approval by the middle of next year. Even after this proposed increase, we still expect our residential rates to be among the lowest in the state. At AES Indiana, we continue to advance our low carbon generation growth plan. We recently filed for approval to build a 200-megawatt or 800-megawatt hour storage facility at the site of the retiring Petersburg coal plant. This project is expected to come online by the end of next year, at which point it will be the largest battery storage project in the Midwest. Now turning to Slide 10 and our third priority of transforming our portfolio by exiting coal generation by the end of 2025. Since our Investor Day in May, we have significantly advanced our decarbonization objective by assuring the retirement of an additional 900 megawatts of coal generation. In June, we retired 415 megawatts of coal as we shut down Unit 2 of the Petersburg plant at AES Indiana. We also announced the retirement of the 276-megawatt Norgener Air Plant in Chile by 2025. Additionally, we received final approval, allowing for the termination of the PPA at our 205-megawatt Warrior Run Plant in Maryland for proceeds of $357 million. Now turning to Slide 11. We have expanded our leadership in the development and application of new technologies in our sector. We see this as another important competitive advantage. A new example is the use of embedded artificial intelligence, including generative AI across our operations. This year, we already expect more than $200 million of our adjusted EBITDA to be enabled by AI through both cost reductions and revenue enhance. We have incorporated AI and data analytics across our operations from areas such as wind production forecasting to vegetation management to identification of isolated solar panel failures. As part of this program, we also continue to pioneer and advance the use of robotics to install and maintain solar panels. Through our solar robotics program, we are developing proprietary AI-based computer vision to install a wide variety of solar modules, including the largest and heaviest models. With this technology, we plan to install projects significantly faster and across a wide range of working conditions, including extreme heat. In the coming months, we will be validating this technology for the installation of tens of megawatts and expect to move to use it for full scale solar projects in 2024. Finally, we're consolidating our lead in advanced green hydrogen projects with committed offtakers. We are currently developing the largest announced green hydrogen project in the U.S. jointly with Air Products in Texas. It features 1.4 gigawatts of inside defense, hourly matched renewables, 200 metric tons of hydrogen per day and a 30-year take-or-pay contract. It is expected to come online in 2027. Our pipeline of advanced green hydrogen projects is equivalent to more than 6 gigawatts of renewables and 800 metric tons of hydrogen per day. With that, I would like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our second quarter results, 2023 parent capital allocation and 2023 guidance. Turning to our financial results for the quarter, beginning on Slide 13. I'm pleased to share that the second quarter was fully in line with our expectations, keeping us well on track to achieve our full year guidance. Adjusted EBITDA with tax attributes was $607 million versus $722 million last year, driven primarily by lower margins at AES Andes and higher costs at our renewables SBU due to an accelerated growth plan, but partially offset by new renewables coming online and higher availability at select thermal businesses. Tax attributes earned by our U.S. renewables projects were relatively flat at $38 million in the second quarter of this year, in line with our expectations. Turning to Slide 14. Adjusted EPS was $0.21 versus $0.34 last year. In addition to the drivers of adjusted EBITDA, we saw higher parent interest expense this quarter. As a reminder, our year-to-date EPS is fully in line with the breakdown that we outlined earlier this year, in which we noted that roughly 25% of our earnings would come in the first half of the year and 75% in the second half. I'll cover the performance of our strategic business units or SBUs in more detail over the next 4 slides, beginning on Slide 15. In the renewables SBU, we continue to execute on our strategic priority to triple our portfolio by 2027. For the second quarter, as expected, we saw higher adjusted EBITDA with tax attributes driven primarily by higher wind generation and new projects coming online, partially offset by higher business development and fixed costs due to our accelerated growth plan. At our utilities SBU, we saw higher adjusted PTC driven by lower maintenance expenses, but partially offset by higher interest expense from new debt. We continue to expect strong utilities earnings for the second half of the year driven by typical second half demand seasonality and the pending August decision on ESP 4 at AES, Ohio. With this pending decision and the great progress in renewables growth at AES Indiana, we are continuing to pursue our strategic priority to increase rate base by an average of 10% annually through 2027. Lower adjusted EBITDA at our energy infrastructure SBU, primarily reflects lower margins at AES Andes in line with our phase out of coal, partially offset by higher availability at select thermal units. As we execute -- our third strategic priority to exit coal and complete the transformation of our portfolio, although not every quarter, we generally expect to see annual year-over-year declines in energy infrastructure as we discussed at Investor Day in May. Finally, at our new energy technologies SBU, higher adjusted EBITDA reflects continued improved profit margins at Fluence. Fluence has shown year-over-year improvement for 3 straight quarters, and we are very pleased with the strong results they are delivering this year. Now to Slide 19. We are on track to achieve our full year 2023 adjusted EBITDA guidance range of $2.6 billion to $2.9 billion. Growth in the year to go will be primarily driven by contributions from new businesses including growth at our U.S. utilities and contributions from new renewables projects coming online. As a reminder, the 3.4 gigawatts of new renewables we expect to add this year represents an increase of over 75% compared to the 1.9 gigawatts we added to our portfolio last year. This amount also represents a doubling of new renewables in the U.S. versus 2022. This growth will be offset by approximately $200 million of LNG sales we've recorded primarily in the third quarter last year, which we do not expect to recur this year. In addition to our adjusted EBITDA, we expect to realize $500 million to $560 million of tax attributes in 2023, bringing our total adjusted EBITDA plus tax attributes to $3.1 billion to $3.5 billion for the year. Turning to Slide 20. We are also reaffirming our full year 2023 adjusted EPS guidance range of $1.65 to $1.75. As a reminder, we expect our adjusted EPS to be heavily fourth quarter weighted due to the late year seasonality of our U.S. renewable project commissioning. Now to our 2023 parent capital allocation plan on Slide 21. Sources reflect approximately $2.4 billion of total discretionary cash, including $1 billion of parent free cash flow, $400 million to $600 million of asset sales and a $900 million parent debt issuance we completed in Q2. For more information on our debt issuances at the parent company and our subsidiaries, please refer to the appendix of the presentation. On the right-hand side, you can see our planned use of capital remains largely in line with guidance, with higher parent investment reflecting our recent acquisition of the 2-gigawatt Belfield project in the U.S. At our Investor Day in May, we outlined our capital allocation plan through 2027, including asset sales, along with debt and potential future equity issuances. We appreciate all of the feedback we've received, and I want to take a moment to clarify that we will only raise and invest capital in a way that's value accretive to our shareholders. Any potential future equity issuances would have to yield accretive value to shareholders for us to pursue equity as a source of capital. We are also committed to improving our credit profile over time and further bolstering our investment grade rating. We have a number of other levers to pull to support our growth such as increased capital recycling through asset sales and sell-downs. Given our strong asset sales track record and recent success, it is possible that any future equity issuances could be materially lower than the 5-year figure we previously shared. As always, our Investor Relations team is happy to take additional feedback and to follow up on additional questions or data requests. In summary, we're continuing to make progress on transforming AES' portfolio while delivering strong growth in adjusted EBITDA, earnings and parent free cash flow. Our businesses are executing successfully and delivering on their commitments. We will continue to allocate our capital towards our high-growth renewables and utilities to maximize shareholder value. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. In summary, we're reaffirming our 2023 guidance for all metrics and our targeted annualized growth rates through 2027. We continue to make substantial progress on our strategic priorities, including tripling our installed renewables capacity by 2027, increasing the rate base at our U.S. utilities by more than 10% per year through 2027 and and transforming our portfolio by exiting coal by the end of 2025, while investing in new technologies. We are delivering on all the commitments we made on our Q4 2022 earnings call and at our Investor Day presentation. With that, I would like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We will take our first question from Durgesh Chopra with Evercore ISI. Durgesh, your line is open. Please proceed."
},
{
"speaker": "Durgesh Chopra",
"text": "Andres, just you're now -- if I heard you correctly in your remarks are targeting 5 to 6 gigawatts of new PPAs first. Can you confirm whether that is accurate because that's higher than what kind of you might have locked down in previous years? And then what's driving that higher range?"
},
{
"speaker": "Andres Gluski",
"text": "Sure, Durgesh. Good to talk to you. Look, we signed 5.2 gigawatts of new PPAs last year. So what we're seeing this year is we already have 2.2 signed. We have visibility into just 2 projects, which would be another about 2.4, right? Which would put us 4.4. And of course, we have other projects in the pipeline. So we're not really setting out an official target, but I'm saying that we believe that we should be similar to last year. And we do have a couple of what I call these whales, the 1 gigawatt plus targets, but we feel very good because we see a lot of demand for our products. We have people coming to us with products. So it's really looking at how do we best allocate our money where we get the highest returns and best allocate our teams."
},
{
"speaker": "Durgesh Chopra",
"text": "And then maybe when could we get clarity on the potential 600 megawatts in terms of timing. Is that really sort of a Q3 call event when we would know more. How should we think about that? I'm just thinking about the projects that pushed into 2024, yes."
},
{
"speaker": "Andres Gluski",
"text": "Sure. Look, I would say that we feel very good about our construction program. So -- versus -- this was the big challenge of this year to grow our construction program in the U.S. by 100%. We feel very good about it. Unfortunately, a lot of these are slated to be commissioned towards the latter part of the year. So we should have a good view in -- on the Q3 call of where we stand. And whether we're going to do more of these projects this year. But in general, we're very pleased with the supply chain, with our construction teams. The team has really stepped up to the task, and I'm very proud of them."
},
{
"speaker": "Durgesh Chopra",
"text": "And then just one last one for me. Steve, you mentioned that the equity needs could be materially reduced. It's nice to hear that in your prepared remarks. Maybe just can you give us more color when could we get an update on timing? Where are you thinking just the current equity needs, when in the plan are those scheduled to hit? And just when could we get an update?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Look, I mean, as I said in my remarks, Durgesh, this is just a function of multiple levers. And we're seeing a lot of great progress on our asset sale program and the $3 billion that we put out at Investor Day was well below the total universe of opportunities. So -- what I wanted to point out is that we're only going to issue equity in the future, and that could be far in the future to the point that it's value accretive to shareholders, and we haven't also tapped other sources that we intend to tap, which is our asset recycling program. So as you saw with where you run, as we've seen, as we've executed on the renewable sell-downs, as we exit further coal assets, we have a lot of upside in that asset sale number. So at this point, it's indefinitely into the future and our share price would need to be substantially higher than where it is today, and it would have to be value accretive to shareholders on a per share basis."
},
{
"speaker": "Andres Gluski",
"text": "Durgesh, I guess another point I'd like to make is that we've been very effective at bringing in partners to fund our projects. So that's obviously another lever that we have. So we laid out what could be a possible path. We were very conservative on the numbers. But if we don't feel that we want to, at some point in the future, issue equity, we can always invite partners into our project. Of course, we're giving them part of the upside as well."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Arcaro from Morgan Stanley. David, your line is open. Please go ahead."
},
{
"speaker": "David Arcaro",
"text": "I was wondering, just what's your latest thinking on just the hydrogen PTC timing in terms of treasury guidance here and what the rules around matching and additionality might be? And kind of just in coordination with that, what are your -- what's your current like project pipeline and discussions with potential partners on that side of the business as it stands currently? ."
},
{
"speaker": "Andres Gluski",
"text": "Well, of course, the final rules haven't come out. What I would like to say is that our Felix project -- our project in Texas is -- really would meet the very strictest criteria. So it is additional. It is hourly matched. It is regional. So it has the very lowest carbon footprint technically feasible in the U.S. So I'd like to put that right out there that our project is not dependent in any way about how the rules come out. Now having said that, I do believe that additionality is important. I also believe that we have to move to early matching, in part because we need green hydrogen projects to be tradable goods. So these are the rules in Europe. I also think regionality is important, so we don't add further congestion. So really, what we want is that the new rules come out help us create a market, but they also help lower our total carbon footprint. So we don't want to just be squeezing the balloon, taking off renewable energy from the grid to produce green hydrogen. And we can get into more specifics there. So I do expect that the rules will come out, we'll incorporate some of these factors. But I want to say that our projects are very solid. We have committed off-takers, which I think is the key because this market for green hydrogen is developing. So to have early-on projects, I think the key is not only have a great project, and it -- with a very low carbon footprint. So you get all of the benefits of the IRA, but to have a committed offtaker."
},
{
"speaker": "David Arcaro",
"text": "And then I was curious if you could speak to the transmission challenges just related to transformation interconnection in the renewable industry. You alluded to it in your commentary, but I was wondering if you could speak to what your kind of current pipeline of maybe transmission positions and also with regard to like early stage development, land positions, things like that. How soon could a transmission constraint potentially impact your business? And how are you positioned now to kind of avoid that in the foreseeable future?"
},
{
"speaker": "Andres Gluski",
"text": "Well, look, I think transmission constraints are affecting the market already. So we got out early, and we started getting a filing for interconnections on a big way 3 years ago in key markets like PJM and CAISO. So I think we're in a good position there. I think right now, we have a new industry here. And so I think we have to come to terms with the new definitions. What is pipeline? So for us, pipeline is projects that we already have, either land rights, interconnection rights, real prospects to make a project. And then, of course, there are different phases. Some projects are far more advanced shovel ready and some are more at the beginning of the Q. I think having looked at a lot of say, proposals from other developers, they count pipeline things that are -- we would call prospects. And I think we have to move towards a common definition, I mean, a little bit perhaps like the oil sector, which has possible reserves -- has probable reserves and has proven reserves, right? And I think what's very important is that the -- to get a pipeline, you have to invest and you have to have money. So some of the new changes, for example, on the interconnections will make it a little bit more costly just sort of spurious flood the zone request for interconnections. So maybe Steve can give you some comments on how that is progressing, which would be favorable to us. We don't see any sort of short-run effect of it. But in the long run, it's favorable to us because I think we've been the most, I would say, stringent about what we consider pipeline. And what we're very interested in doing is maximizing the conversion rate. But I do also want to emphasize that if somebody comes to us, a client and ask us to complete on advanced stage development project, that's the best of all worlds because we get to conserve the pipeline. We weren't investing money when it was at the highest risk stage and can bring it online more quickly and satisfy that client."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And I would just add to that, look, I mean, we're very pleased with the final rules coming out of the third quarter 2023. But although, as Andre said, we've -- this has been our strategy to lead renewables development for many years. So we put ourselves in an advantaged position, I think, many years ago getting into these cues. Nonetheless, it is important for the industry overall for these cues to be move along faster in the process to be more efficient. So having the higher financial thresholds to get into the cues and to stay in the cue, having to demonstrate project maturity in terms of permits, and financing behind them, having cluster studies so that this isn't just a one by one review process. And then having the penalties and the teeth behind the deadlines that have to be met to do the studies is also important. So there's a number of angles at which this issue is being approached through the order. The order is due to be published, I think, very soon and will go into effect 60 days later. I think it's a great thing for the industry. We've already felt great about our position. But of course, over the longer term to have these cues cleaned up and moving faster is very important, and I think we'll further accelerate growth throughout the rest of the decade."
},
{
"speaker": "Andres Gluski",
"text": "And I say, look, we're also taking sort of technological a look at how we can improve transmission for our projects. So this is like using the grid stack to be able to baseload transmission lines, which were really peakers. This means dynamic line rating. This means using our prefab solar, which takes about half the space to be able to put higher loads where we have a good interconnection. And you also noticed that we're putting large battery projects where we have interconnections from our decommissioned coal plants. So we're looking at this problem rather holistically. And again, I think we're in a very good position to take advantage of what's going to be an increasingly congested grid."
},
{
"speaker": "Operator",
"text": "Our next question comes from Richard Sunderland from JPMorgan. Richard, your line is open. Please proceed."
},
{
"speaker": "Richard Sunderland",
"text": "Circling back to the data center commentary from scripts. Curious how much of a near-term change in C&I demand you're seeing from this subsector specifically? And any indications of upside just on that ramp over the next 1 to 2 years relative to what you were seeing maybe 6 months or a year ago?"
},
{
"speaker": "Andres Gluski",
"text": "I would say yes. I mean, the -- there's some definitions that they are waiting for in various markets, but about rules of where you can locate data centers. But no, we're definitely seeing increased interest and increasing demand, and we are the largest provider to U.S. data centers. And so I think we can uniquely provide data centers with the same quality of service, for example, in certain markets abroad, be it Mexico, Chile, Brazil, which is another advantage for us. So yes, we are seeing increased demand from that sector."
},
{
"speaker": "Richard Sunderland",
"text": "And then just wanted to parse the kind of backlog pipeline conversation a little bit more finally for the hydrogen. It sounds like the 1.4 gigawatts for Texas could come in this year. Could you just speak a little bit more to your confidence level there for '23 specifically, and what you're focused on there? And then thinking about the balance of the hydrogen opportunities, when could those come in over the next few years?"
},
{
"speaker": "Andres Gluski",
"text": "Well, again, I think we're the most advanced in terms of real green hydrogen projects. So in the U.S., we have committed offtakers for that project in Texas. We have several other projects, including two of the hubs, one in Los Angeles also one in Houston. I would say that we could sign the first project this year. It will be -- we're coming online for 2027 outside our guidance range. And the subsequent wins would be somewhat further out, '27, '28. But what we're seeing is strong demand. And basically, we are seen as a preferred partner by several people. And we also have very good projects, for example, in Chile, which is to green the mining sector. They're heavy equipment. We've already green electricity use, and a possible ammonia export project in the Northeast of Brazil. So again, stay tuned, but I feel quite confident in saying we're the most advanced in projects with committed off-takers. And we think we will hit these numbers. It's really a question of as they come online because you have to have the equipment that can use it. Certainly, in the shorter term, you can substitute green hydrogen in thermal processes in a lot of petrochemicals or steel plants, other things like that. So we have to see as this market develops. But again, I think we're very well positioned. It's a very exciting opportunity for us."
},
{
"speaker": "Richard Sunderland",
"text": "And then just one final one for me. The Belfield project, you've been very clear in a lot of the messaging around how that came together. I'm just curious in terms of considerations around Phase 2 versus Phase 1, just Phase 1 your return thresholds on a stand-alone basis. How do you think about the progress to signing Phase 2? Anything you can offer there would be helpful."
},
{
"speaker": "Andres Gluski",
"text": "I think we're well advanced on Phase 2 is what I'm willing to say. It would be a similar project to Phase 1. So that is the largest solar plus storage project in the U.S. in California. So it's a very unique offering that we can bring together."
},
{
"speaker": "Operator",
"text": "Our next question comes from Angie Storozynski with Seaport. Angie, your line is open. Please go ahead."
},
{
"speaker": "Angie Storozynski",
"text": "So I wanted to start with some high-profile management departures we've seen since the Analyst Day, basically from your core businesses, right, the U.S. utilities and U.S. renewables. I mean, you might be just victims of your own success in a sense, but just how you can reassure us that there's no change in the execution of your growth plans, especially in these 2 businesses and the demand that you have to fill those vacancies?"
},
{
"speaker": "Andres Gluski",
"text": "Angie, and thanks for that question. And I think you got it spot on. Look, this is, quite frankly, a symptom of strength in our case. We have the hottest management team in the market. And so of course, people are going to be being made offers. And if people are obviously -- if they want to go to private equity and bet on a longer-term IPO, that's their right. But this in no way affects our business whatsoever. And I think the best proof of that is after the departure in clean energy, we've signed more PPIs. So we're doing very well. I don't expect it to have any impact on the business. And I expect the same in U.S. utilities. I don't expect this will have any impact whatsoever. But it is a sign of that, yes, we have a strong team, we have a deep bench, and we'll continue to identify talent and prepare it and move it up. Again, let's say, where AES was in, say, in 2012 or something, our team wasn't the honest in the business, people wouldn't be trying to poach it. So it is what it is, but I feel very good about where we are, and it doesn't change our plans whatsoever. And I think the teams are very motivated on executing on the plans that we laid out."
},
{
"speaker": "Angie Storozynski",
"text": "And then moving on, I mean, you talked a lot about your backlog of renewable power projects. So -- and then potential monetization of assets in the world of equity. So First, on the backlog, I mean, we've heard stories about some public renewable power developers basically showing in their backlog third-party projects where they don't have exclusivity for these projects. So again, this is just anecdotal evidence, but I'm just wondering if you've heard of those instances and if any of this could be true for you guys?"
},
{
"speaker": "Andres Gluski",
"text": "Well, I can say categorically, absolutely, under no uncertain terms, we have no such projects in our backlog. I want to make very clear because maybe some other people are doing that. I think that's not transparent. I would not recommend anybody to do it. In our case, whatever we have in the backlog, we are -- we have the project, we are committed to delivering it on a certain date for a certain amount of time, and our clients have an obligation to take that energy -- a certain amount of energy for a certain amount of time. So this is binding for both sides. And the fact that 43% of our backlog is currently being built, we have ordered all the equipment for our '23 through '25 backlog, and about 3 quarters of them will come online by 2025. So I want to make very clear that's a good question. I wouldn't recommend anybody to do that. And I can say, categorically, we would never do something like that."
},
{
"speaker": "Angie Storozynski",
"text": "And then on the monetization of assets. So I understand that there is a very big difference between the assets that recently transacted and the ones that you are developing, it's only because of the duration of the PPAs, so basically the duration of the cash flows. But on the flip side, right, you have higher discount rates for the DCF value of those cash flows. So I'm just thinking if you were to monetize some of these assets, again, I guess it all depends where the stock is. But again, how would that, from your perspective, demonstrate the value of the portfolio that you currently have?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, Angie, this is Steve. So look, we have, as you know, have been selling down our renewable projects after they've come online and we package them together in portfolio. So we have seen some, I would say, relatively small uptick in return requirements there, but nothing outside the range of what we expected within our plan in terms of -- this is -- these are very low-risk assets. They're solar coupon, essentially, no fuel costs, very low maintenance. So these are very predictable, and the demand for these assets continues to be very strong. So we don't see any impact to the plan for how we sell down from sort of where rates are in the market today. Does that address your question?"
},
{
"speaker": "Andres Gluski",
"text": "I think -- I mean the other thing is that these are -- all investment-grade quality offtake or the very highest quality off-takers that you can have. So we are selling down the premium product in the market. So I think it's important to say that, look, people have talked about inflation, people have talked about writing interest rates, we're not seeing a degradation of our margins. So the margin of our money into these projects, we're not seeing any squeeze whatsoever."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And on top of that in site -- so just as Andreas pointed out, with the new project, we have the energy community adder for that project. And actually, most -- all of our wind projects going forward, we expect to qualify for the domestic adder as well, Angie, so there's some significant offsets to the cost of financing that we've been achieving too."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Bank of America. Julien, your line is open. Please go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "I know a lot has been said here already, but let me follow up on some details here, just on the year-over-year comparisons here as we go to the back half of the year, if I may. Look, I'd love to talk about -- I think you have in your slides here, $0.24 of positive net impact in the back half of the year from renewables and year-over-year comps on LNG if I rewind here, I think you said in the back half of the year that -- I mean, last year, it was like $0.30 contribution from LNG. Just as I think about that, that seems like a pretty big step-up year-over-year renewables. Can you talk about what renewables assumptions you're baking in as sort of a discrete item in -- especially in the back half of the year to sort of make up for what you need to get to your guidance? And then if I think about the start of the year, right, in terms of what you talked about renewable contributing, I think we talked about $0.27 for the full year. So -- it seems like what's implied here again, I'm curious that renewable is actually contributing more than what we thought at the start of the year and maybe what that says for future years as well. But please, by all means, respond accordingly."
},
{
"speaker": "Steve Coughlin",
"text": "So yes, this is Steve, Julien. So the $0.30 it doesn't -- sound correct or actually more like $0.20 is the LNG year-over-year delta to be offset. And then, of course, we're more than doubling the renewable commissioning this year. So if you recall, it was just around 1 gigawatt last year, and it's 2.1 gigawatts this year, most all of which is in the second half of the year. So what we're carrying in the first half is sort of more of the cost in renewables. The EBITDA has been relatively flat through the first half. In the second half, then we're going to see that renewable number pick up substantially, and that's why we have the 75% loading on the second half of the year earnings. That's a major driver. The other is, of course, utility demand in Ohio and Indiana peaking in Q3. You've got Southland, where we have the peak cooling season in the third quarter. And then we have hydro in Latin America, typically, the volumes are much higher as we come out of the wet season in the summer and the winter and you have the snow melt into the fall. So those are really the primary drivers is the clean energy Southland, the utilities and then some of the hydro assets in Latin America having much more volume in the second half of the year. But the LNG offset is really only about $0.20 for the -- and mostly in the third quarter."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Is there a use on that -- sorry, go forward."
},
{
"speaker": "Andres Gluski",
"text": "I was just say we're executing exactly what we laid out at the beginning of the year. So there's been no change. I want to make that clear."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Yes, this is -- I think we're right at 25% on the EPS, Julian, year-to-date. So this is -- what we're seeing, although the year-over-year in the quarter is lower, that's primarily due to coal retirements in Chile as we've done the green blended extend, some of the coal that's still there, the margins have come down, which was all expected. So we're exactly on track. And also, to your point, there is some potential upside, as Andres noted, we feel really good about being on track with the construction program and there still remains the upside on the 600 megawatts potential."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "But the point is the plan for $0.27 of renewables contribution in '23 unchanged from the start of the year still."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Let us get back to you on the exact number because I don't have that math in front of me, but the renewables contribution is looking at least on track, is what I would say."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "If I can give a slight different direction here, trying to follow up on a few earlier questions. Just on the asset sale dynamics versus equity, can you comment a little bit further about what else you're seeing out there? Or what else could be monetized just as you think about deemphasizing equity. It sounds like the principal lever Andres, you were alluding to is that you would just sell down your interest in the new renewables even more so. Is that fair to say in terms of like the alternative lever here versus the corporate level equity? And also just to clarify the point you made earlier on just very precisely, at these levels today, you would definitively move away from the equity levels that you -- equity-ish levels you defined earlier. -- in lieu of these alternatives?"
},
{
"speaker": "Andres Gluski",
"text": "So on the first point, no, it's not fair. Characterization is not fair. So what -- look, all right, we have partnerships in all of our businesses. So we don't necessarily have to do it on the new projects. So we can bring in partners to -- money is fungible. So if we monetize a different business, that means we have more money available for renewables. We will -- as we have in the past, we can choose to optimize the return on invested capital. And I think that we're doing a very good job of how we exit coal. I think the Warrior Run monetization, I think is probably better than people's expectations. And so we continue to manage that. So all I'm saying is that -- we never -- as Steve said in his script, we didn't -- we put this out as a 5-year plan. And in the 5-year plan, we had a certain amount of asset sales, a conservative number, and we had a sort of range for potential equity issuance as well. So the 2 somewhat offset each other. So if we do better on the asset sales, we will need less equity and we do better in terms of bringing in partnerships. So what we're saying at these levels, we do not feel comfortable issuing equity. But I think it's been very clear from our presentation that we have tremendous demand for what we're doing. And that is a once-in-a-lifetime market opportunity. So we want to create the most value for our shareholders from that opportunity. So obviously, if we don't have -- what we feel is correctly valued equity, we'll have to use other levers. And this should be nothing new to you guys. We have financed a remarkable change in this company without issuing equity. We did it by selling down assets. We got into wind by bringing in partners. So what we're saying is nothing like a promise for the future. It's just more of the same. So we will use whatever the levers creates the most value for our shareholders, and we will continue to do so."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "So your point ultimately is not committing to selling down partners per se, a variety of different sources here incrementally just not issuing the equity at current levels. And if I can also clarify this process underway. I know that it was listed in the queue here as well. Is that still status quo in a way?"
},
{
"speaker": "Steve Coughlin",
"text": "No, there's no -- there's no specific Maritza process underway, Julien, at this point. So still evaluating different pathways for Maritza."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ryan Levine from Citi. Ryan, your line is now open. Please go ahead."
},
{
"speaker": "Ryan Levine",
"text": "A couple of specific follow-on questions. Is your Fluence take core to your portfolio? And I guess secondly, on the financing side, are you still open to considering the convert market to help offset equity issuance?"
},
{
"speaker": "Steve Coughlin",
"text": "So this is Steve. So yes, Fluence is part of the portfolio we own roughly 1/3, 34% of Fluence. It is not consolidated, but it does come in through equity method. And we do, in our adjusted EBITDA definition include an adjustment to include Fluence EBITDA. So that does show up and it's in our new energy technologies SBU influence margin..."
},
{
"speaker": "Ryan Levine",
"text": "The question is that core, is that core?"
},
{
"speaker": "Steve Coughlin",
"text": "Is it core? Or did you say -- is it core to our business?"
},
{
"speaker": "Ryan Levine",
"text": "Core."
},
{
"speaker": "Steve Coughlin",
"text": "So look, I mean, I would say -- so given that it's an outside business, I don't think I would parse this out as like core or noncore. It's been a really important strategy for us to be able to lead in energy storage, both in development as well as in the technology as well as sort of advancing the way that storage gets used to create the innovative solutions we've done like 24/7 carbon-free energy to make those products work. We've done a lot of co-innovation, co-development with Fluence around that. So that's, I would say, definitely core to our strategy is what we've been able to do with storage. But as Andres said many times, these are technology businesses of their own right. They're separated. We are not in them indefinitely, and we continue to grow new opportunities. And as we do we may look to monetize part of our positions down the road. No time soon, and we see a lot of value upside. We're very pleased with how the new management team has driven value already that's been recognized, but we still see a lot of upside and there's a lot of partnership that we continue to work on new solutions around. So it is core from that perspective that I laid out."
},
{
"speaker": "Ryan Levine",
"text": "Okay. And then on the convert option?"
},
{
"speaker": "Steve Coughlin",
"text": "So no, nothing that we're contemplating at this point. I mean, look, we did a $900 million debt deal just in the second quarter. Nothing -- no specific convert for us contemplated at this point."
},
{
"speaker": "Ryan Levine",
"text": "And then last question. In terms of Puerto Rico, what's your strategy there from existing assets and future development perspective?"
},
{
"speaker": "Andres Gluski",
"text": "Well, in Puerto Rico, we're greening the island's energy grid. So we do have renewal projects we're bringing in batteries as well. And it's our plan to phase out coal by 2025. So we're assisting the island and its energy transition. And I think we've been very clear what our objectives are."
},
{
"speaker": "Operator",
"text": "Our final question comes from Gregg Orrill from UBS. Gregg, your line is now open. Please go ahead."
},
{
"speaker": "Gregg Orrill",
"text": "Yes. Probably quick. On AES Ohio, is the DPO rate case, how does that timing compare with what you were assuming in guidance or any other differences with how that's proceeding versus the '23 guidance?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Gregg, it's right on track with what we assumed in our guidance. So the decision has been put on the agenda for next week, August 9, that was just published, I believe, yesterday. So right on track in terms of when we assume the decision to be made. And we still feel really good about where that is likely to come out. As a reminder, once the decision is made, is to put in place, then the new rates that were decided upon last year immediately go into effect. And as we've laid out, the riders would go into effect and then the frequent quarterly recovery on our distribution investments going forward, would start to be put in place. And so this is a business really pivoting to a very different phase from where we've been delevering and setting that business up for a more normalized structure. This is an important pivot point for Ohio to really pivot to growth, and there's a lot of room for growth as there's the lowest rates in the state there in all customer classes. And even with the ESP 4, the new rates, we expect it to continue to be the lowest rates in the state for the foreseeable future. And we have, as Andres noted, 10%-plus rate base growth expected going forward. So we're very excited about this and look forward to the decision next week."
},
{
"speaker": "Andres Gluski",
"text": "Yes. And I'm also very excited about that Dayton is finally getting incoming investment. So you have a new Honda EV plant to have a battery plant coming into our service area. So you're starting to see an economic recovery. Dayton had sort of been not participating in the expansion that we had seen in Eastern Ohio. So it's a very exciting time, and we're very happy that we could invest and continue to improve the quality of service and continue to attract new investments into the Dayton area. So it's not only a rate base story, I think there's an economic recovery story happening in Dayton for the first time in decades. So it's a very exciting time to be in Dayton."
},
{
"speaker": "Operator",
"text": "I will now hand back to Susan Harcourt for any closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "This concludes today's conference for everybody. Thank you very much for joining. You may now disconnect your lines. Have a great rest of your day."
}
] | The AES Corporation | 35,312 |
AES | 1 | 2,023 | 2023-05-05 10:00:00 | Operator: Good morning. Thank you for attending today’s The AES Corporation First Quarter 2023 Financial Review. My name is Alicia, and I’ll be your moderator for today’s call. [Operator Instructions] I would now like to pass the conference over to your host, Susan Harcourt, Vice President of Investor Relations with AES Corporation. You may now proceed.
Susan Harcourt: Thank you, operator. Good morning, and welcome to our first quarter 2023 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone. And thank you for joining our first quarter 2023 financial review call. We are very pleased with our progress so far this year. And today, I will discuss our first quarter results and provide key business updates. Steve Coughlin, our CFO, will give some more detail on our financial performance and outlook. Beginning on Slide 3. As you may have seen in our press release, we introduced new strategic business units, which better reflect the greatly simplified company that AES is today and the pillars of our future growth. We will be giving a broader strategic review at our Investor Day on Monday, including an update on our portfolio transformation and an overview of our strong growth expectations for our renewables and utility businesses. Our first quarter 2023 adjusted earnings per share was $0.22 compared with $0.21 in 2022, which is in line with our expectations. With these results and the underlying performance we are seeing across our business, we are reaffirming our 2023 adjusted earnings per share guidance of $1.65 to $1.75, and our 7% to 9% annualized growth rate target through 2025. Now turning to Slide 4. We continue to see strong demand for renewables both in the U.S. and internationally, including from U.S. corporate customers with operations in international markets. So far this year, we have signed PPAs for 309 megawatts of new renewables, including 154 megawatts of wind with a U.S. technology customer in Brazil. We’re in advanced negotiations for several large additional projects and remain on track to meet our PPA signing target of 14 to 17 gigawatts over the next 3 years. In the U.S., key elements of the inflation Reduction Act or IRA are being clarified. This past month, the Department of Treasury and the IRS release detailed guidance on how clean energy projects located in energy communities can qualify for an additional 10% bonus tax credit. We estimate that approximately 1/3 of our 51 gigawatt pipeline of projects in the U.S. would qualify, which directly translates into a combination of higher potential returns and increased competitiveness for the projects we are developing. We are currently awaiting treasury department guidance on certain provisions of the IRA, including requirements for the clean hydrogen production tax credit. As a reminder, at our green hydrogen project in Texas, the largest advanced green hydrogen project in the U.S., which we are developing jointly with Air Products. We plan to co-locate 1.4 gigawatts of new renewables with the electrolyzers. This means that the projects would have the lowest possible carbon emissions of any known project in the U.S. Additionally, the project is located adjacent to the site of a decommissioned coal plant, which will provide significant existing infrastructure. All of these attributes and the fact that the energy will include hourly matching indicate that the project should qualify for the highest possible tax credit in any scenario. Turning to Slide 5. Our backlog of projects with signed long-term contracts is now around 12 gigawatts. Of which roughly half are already under construction. We continue to maintain a robust supply chain, and we continue to hit our construction milestones without delay. We expect to bring online more than 3 gigawatts of new wind, solar and battery storage this year. As we bring projects currently in the backlog online in coming years, we will nearly double our installed renewables capacity, making us one of the fastest-growing renewable companies in the world. Turning to Slide 6. We are also happy to report a positive development at AES Ohio which puts us on track for unprecedented growth in the business. In April, AES Ohio signed a comprehensive settlement agreement for its Electric Security Plan, or ESP 4 which received broad support from residential, commercial, industrial and low-income customers. The settlement included the commission staff as a signatory, and we expect to receive final approval by the end of the third quarter. With ESP 4 in place, along with our existing investment programs, we expect to more than double our rate base by the end of 2027 which would make AES Ohio, one of the fastest-growing utility businesses in the country, while still having the lowest tariffs in the state. Turning to Slide 7. We also reached a major milestone towards exiting coal by the end of 2025. We agreed to terminate the PPA at the Warrior Run plant in Maryland, for which we will receive total payments of $357 million. We will retain control of the site and are exploring new uses that capitalize on its valuable location and existing infrastructure. We see this transaction is very beneficial for all parties involved. Moving to Slide 8. We signed agreements to extend the operations of 1.4 gigawatts of gas generation at our legacy Southland units in California for 3 more years. These plans were previously scheduled to retire at the end of this year. The extensions will lock in additional upside and will help meet the state of California’s grid liability needs while supporting its efforts to transition over time to low carbon source of electricity. The monetization of the contract that Warrior Run and the extension of the legacy Southland units are both good examples of how we are creating value from our existing infrastructure assets during the energy transition. Finally, as I mentioned earlier, we will be holding an Investor Day on Monday, where we will be sharing our strategic long-term view of the company, discussing our new business segments and providing long-term growth rates through 2027 for adjusted earnings per share, adjusted EBITDA and parent free cash flow. With that, I would like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will discuss our first quarter results, 2023 guidance and 2023 parent capital allocation. Turning to Slide 10. As Andres mentioned, in the first quarter, we launched our new Strategic Business Units or SBUs. This new organizational structure reflects AES very focused and simplified portfolio. It also aligns our management teams by business line to maximize our operational synergies and to continue delivering excellent customer experiences across all our markets. Our new SBU reporting segments highlight our rapidly growing renewables and utility businesses and facilitate simplified modeling of AES, which will benefit current and new potential shareholders and analysts. Our new SBUs include renewables, which includes our solar, wind, energy storage and hydro businesses, utilities, which includes AES Indiana, AES Ohio and AES Salvador, Energy infrastructure composed of our thermal generation and LNG infrastructure businesses and new energy technologies, which includes our investments in energy technology businesses such as Fluence and Uplight as well as our green hydrogen business line and future new business innovations which support our mission. In addition to the SBUs, we also have a corporate reporting segment, which includes our corporate G&A our parent level debt and associated interest expense in our captive insurance program called AGC. Turning to Slide 11. Adjusted EPS for the quarter was $0.22 versus $0.21 last year. Our business was favorable year-over-year, which I will discuss in more detail shortly. Our results were also impacted by higher parent interest expense and a lower adjusted tax rate. Now to Slide 12. We are fully on track to achieve our full year 2023 adjusted EPS guidance range of $1.65 to $1.75. We expect a significant contribution from new renewables of at least $0.27 this year. This is partially offset by lower contributions from LNG sales, as we have previously mentioned, higher parent interest expense from incremental debt and higher rates on our revolving credit facility and a marginally higher tax rate this year. As is typically the case, our earnings are heavily weighted toward the second half of the year. This year, we expect approximately 3/4 of our earnings to occur in the second half. Growth in the year to go will be primarily driven by contributions from new businesses including over 3 gigawatts of projects in our backlog coming online, which remains solidly on track for completion. We are also reaffirming our expected 7% to 9% average annual growth target through 2025. Turning to Slide 13. As you may have seen in our press release, while we continue to report adjusted EPS, today, we are also introducing adjusted EBITDA as a new reporting metric. As the renewables portion of our business grows at an extremely high rate, we believe adjusted EBITDA is a very informative metric in understanding our business results. First, it aligns well with the performance of our underlying business and operating cash generation. And second, adjusted EBITDA is reported before the impact of U.S. renewables tax attributes so that investors and analysts can separate renewable operating earnings from the very valuable tax incentives for U.S. renewables. Beginning this quarter, I will discuss our new SBU financial results using adjusted EBITDA, with the exception of our utilities SBU, which will be measured using adjusted pretax contribution, or PTC, to facilitate comparisons with other utilities. We will provide full year guidance by SBU during our Investor Day on Monday. Adjusted EBITDA was $628 million this quarter versus $621 million in the prior year. This was driven by higher first quarter LNG sales and growth in renewables, but was partially offset by the impact of warmer than normal weather at our U.S. utilities. I’ll cover the performance of our new SBUs in the next 4 slides. Beginning with our renewables SBU on Slide 14. Higher EBITDA was driven primarily by a higher level of generation at our facilities in Panama higher wind generation and contributions from new businesses. This was partially offset by higher spend as we continue to ramp up our renewables development and lower power prices impacting our Bulgaria wind facility. Lower PTC at our Utilities SBU was mostly driven by warmer-than-normal winter weather and higher interest expense, but partially offset by higher revenues as a result of our continued investment in the rate base. Higher EBITDA and our energy infrastructure SBU primarily reflects higher LNG sales, partially offset by lower margins from coal PPAs, the retirement of our coal plant in Hawaii last year and lower availability at Southland Energy. Finally, higher EBITDA at our New Energy Technologies SBU reflects a significant improvement in operations and gross margins at Fluence. Now to our 2023 parent capital allocation plan on Slide 18. Sources reflect approximately $2.1 billion to $2.6 billion of total discretionary cash, including $950 million to $1 billion of parent free cash flow, $400 million to $600 million of proceeds from asset sales and $700 million to $1 billion of planned parent debt issuance. On the right-hand side, you can see our planned use of capital. We will return nearly $500 million to shareholders this year. This consists of our common share dividend, including the previously announced 5% increase as well as the coupon on the equity units. We plan to invest approximately $1.7 billion toward new growth, of which the majority will go to renewables and utilities. In summary, we’ve made great progress on our financial commitments for the year. At our Investor Day on Monday, we will provide detail on the strategy and future of AES overall and for each of our new SBUs. We will also provide long-term growth rates through 2027 for adjusted EPS, adjusted EBITDA and parent free cash flow. I look forward to talking with many of you then. With that, I’ll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. In summary, we are pleased with our progress to date and remain on track to hit our 2023 adjusted earnings per share guidance of $1.65 to $1.75 and our 7% to 9% annualized growth rate target through 2025. We continue to see strong demand for renewables and especially from our corporate customers. Our supply chain is robust and our construction projects are progressing as planned. We’re also encouraged by the settlement agreement at AS Ohio, which paves the way for final approval of our new electric security plan later this year and creates the framework for significant investments in the utility. Finally, we see our successful negotiations to terminate the Warrior Run contract and extend the operations of the 1.4 gigawatts of our legacy South line units as indicative of the success we are having in maximizing shareholder value from our existing assets as we transform the portfolio. We look forward to providing a broader strategic update at our Investor Day on Monday, including more details around our growth plans and guidance through 2027. With that, I would like to open up the call for questions.
Operator: Thank you [Operator Instructions] The first question comes from the line of David Arcaro with Morgan Stanley. You may now proceed.
David Arcaro: Hi, good morning thanks for taking my question. One thing I wanted to check on, would there be any risk to your renewables growth outlook if the AD/CVD tariffs were to come back into effect just after we’ve seen the House and Senate passed some legislation there. Just curious how you view that risk and also just longer term, how you mitigate that AD/CVD tariff risk.
Andres Gluski: Yes, honestly, we don’t see any risk whatsoever. First, it in the past, I believe the setting was 56 votes, and that was -- the President will be to it. And by the -- we have all the panels that we need for this year, and expect to have for next year, by June of next year when the tariff, let’s say, tariff holiday rolls off. So we’re in very good shape for 2023 and 2024. And after that, we expect to have supply coming in from the U.S. We’re having no problems from our suppliers getting through under the UFLPA. So really, I think we’re in the best shape of anybody. We have not delayed a single project due to solar panel supply issues to date. And I think that’s something -- I don’t know if anybody else can say that.
David Arcaro: Excellent. That’s helpful. And then I was just curious, any updates into the visibility for the 600 megawatts of projects that are potentially getting completed this year, but could get pushed to next year? Any increased visibility there at this point in the year?
Andres Gluski: Look, as I said in my script, we are progressing well we have the supply chain. Everything is in place. But look, we won’t know until the fourth quarter of this year, and they’re going to fall in this year and they’re going to follow in next. But I would remind everybody that’s not value issue. If they come in a couple of weeks later, it doesn’t affect the profitability of the project at all. It is an accounting issue. But as of now, we we’re doing well, but we can’t say -- give you any particular update with greater clarity and probably until the fourth quarter of this year.
David Arcaro: Yes. Understood. That makes sense. And just one other quick question. I was curious if with the Warrior run project. Is there any level of EBITDA or earnings contribution that you would point to for that as that rolls off? And then curious how you think about the use of proceeds there if there’s debt specifically on the project that would be paid down or if it gets used more broadly at the corporate level?
Steve Coughlin: Yes, hi, this is Steve. There is definitely earnings from this. And so effectively, we’re monetizing the remaining 7 roughly years of the PPA this year. And so we’ll recognize earnings this year, and we expect to have an obligation for capacity through the middle of next year. So the earnings over this termination agreement will be recognized over roughly 11, 12 months following when the commission approval comes in. So say if it comes in, in June, probably about half this year and half next year. And there’s very little debt to pay down here. So this is -- these proceeds will likely -- this is a 7-year payment stream, but we’ll likely monetize that this year. And then that’s captured in our asset sale in terms of our capital sources this year, if you saw on that slide. So that will be used to fund the growth of the business.
David Arcaro: Okay, perfect. Great, thanks so much.
Operator: The next question comes from the line of Angie Storozynski with Seaport Global. You may now proceed.
Agnieszka Storozynski: Good morning. So I know we’re going to talk about it on Monday, this transition from EPS to EBITDA. And if I understand correctly, at least that’s how I see it. It’s about renewables being more levered and having a higher depreciation rate than the thermal assets, for example, however. So there’s only one issue here that as we’re looking at the first quarter results, right, the contributions from renewables seems very small, right, to the total EBITDA. So that’s one. And also, as you are aware, there are different ways how your peers show adjusted EBITDA. I mean in your case, you’re adjusting it for minority interest there’s no inclusion of the tax benefits, which, again, might understate the EBITDA versus what your peers report. So anyway -- and I know that we’re going to talk about it on Monday, but just ease us into this EBITDA transition, please?
Andres Gluski: Sure, Angie. Well, thanks for the question. Look, first, I’d say, we continue to provide adjusted earnings per share guidance. And as we said, we’ll be providing adjusted earnings per share guidance through 2027 on Monday. So I want to make that perfectly clear, but we’re adding as an additional indicator which is adjusted EBITDA that we’re going to be giving. And partly, it’s to give greater clarity into our performance of our renewables and partly that has to do with sort of the lumpiness of the projects. So that’s the real reason that we’re giving an additional one. It also helped people to do so, for example, if some of the parts of our different businesses, renewables, utilities, infrastructure. So I want to make very clear that we are providing adjusted earnings per share through 2027. Regarding the other questions that you have, I’m going to go ahead and pass that to Steve.
Steve Coughlin: Yes. Thanks, Andres, and thanks, Angie. So definitely, we’ll be talking some more about this on Monday. But our goal here is to really give the clarity that we think is important to understand and model the business. So as Andre said, we’ll give the adjusted EPS, we’ll also give the EBITDA, which is more closely aligned to the underlying business performance and cash generation from the PPAs and then we’ll also give the tax attributes and then the sum of the adjusted EBITDA plus the tax attributes. So we think it’s going to be a very complete view and package that helps people truly understand how the business is earning and generating cash. From the different components of the PPAs and the tax attributes.
Agnieszka Storozynski: Okay. And then you can also help us how to allocate the corporate leverage across -- I mean, again, if we are trying to move to the sum of the part valuation from an EBITDA perspective, we need to figure out how to allocate the corporate debt, right, among these subsidiaries.
Steve Coughlin: Yes. I mean, certainly, in our reporting now, we’ll be able to separate the debt here for the business. And then as we look ahead, most all of our growth is in renewables and Utilities. About 80% of the growth is in renewables and utilities and about close to 0.75 80% in the U.S. market. So I think you’ll have a lot of good detail to help understand how to do that allocation.
Agnieszka Storozynski: Okay, okay. See you guys on Monday. Thank you.
Operator: Thank you Miss Storozynski. The next question comes from the line of Richard Sunderland with JPMorgan. You may now proceed.
Richard Sunderland: Hi, good morning and thanks for the time today. Maybe I’ll pick it up where Angie left off on the new SBUs. Turning to the new energy technologies, SBU, can you speak more to the green hydrogen side. Curious if this represents a shift in thinking of where you like to be involved in hydrogen? Or are you just specifically calling out the breakout there relative to the renewables feeding in?
Andres Gluski: Yes. Thanks for the question. Look, what I’d say is that we have a very interesting pipeline, which we’ll be discussing on Monday of green hydrogen projects. We really think we’re a leader here. We have the most advanced and lowest carbon emitting project in Texas here in the U.S. But we also have projects in Los Angeles. We have projects in Houston. We have projects in Brazil for export, and we have projects in Chile for the -- for our corporate clients or the mining sector. So we’ll be providing more color there. Now in the specific case, for example, Texas, we do co-own the electrolyzers as well as the renewables with our joint venture partner of Air Products. And the reason for that is to really maximize the value of the project because even though the project will be basically co-locating all the renewables with the electrolyzers, it is interconnected with the grid. So there could be occasions just to give you a hypothetical polar vortex in Texas where the most profitable use of our renewables is to inject them into the grid and actually not run the electrolyzers. And so we wanted to have all of our interests aligned. So there will be some projects like that where we also own the electrolyzers as well. In the case of Texas, it’s a take-or-pay with Air Products, but there are other ones in which we would be selling possibly selling green hydrogen to our corporate customers to whom we’re already selling renewables. So that’s the reason for calling it out. Also, as you know, AES next looks at what’s next in terms of technologies. So we’re also, I would say, have it there so that we can look at what new technologies help us produce green hydrogen, cheaper and better for our clients. So that’s the reason for calling it out there.
Richard Sunderland: Got it. That’s very clear. Sticking with the SBU theme, energy infrastructure, are you able to disclose how much of that is called today?
Steve Coughlin: Yes. So we have roughly a little bit shy of 7 gigawatts of coal today, and that includes some of the assets that we’ve already announced sales and retirement of including, for example, Mong gang in Vietnam, some of the retirements in Chile, and Ventanas, for example, so that number is coming down rapidly, but that’s roughly what’s in the base of energy infrastructure today.
Richard Sunderland: Just this on an EBITDA contribution basis or a percentage of SBU basis?
Steve Coughlin: Yes. So on a percentage, so what we’ve talked about is it’s about $0.30 of EPS is coming from coal today. Now what’s important is that is -- that’s not all necessarily going away. For example, we are converting the Petersburg 3 of 4 units in Indiana under the integrated utility in Indiana. So this will leave -- this will actually be a new investment to do the gas conversion, and so there’ll be earnings from the rate base and the increasing rate base from that asset. And then in other cases, we are looking at some additional conversion opportunities for these. And then, of course, where there is sales, we’ll have proceeds from those sales to then recycle capital into the renewable and utility growth segments.
Richard Sunderland: Got it. Very helpful. And then just one more for me. in consideration of the Warrior Run termination relative to the $400 million to $600 million asset sale target, where are you currently with announced and closed transactions relative to that range?
Steve Coughlin: Yes. So we -- I mean we initially announced this exit a year ago. And -- but really prior to that, we had already been significantly reducing our coal portfolio. So our coal portfolio at one point was around 22 gigawatts and we’re already down to 7%. So the reality is we’ve already executed on 2/3 of this program over the many years. And as we a year ago saw the pathway to meet our financial commitments and to fully exit coal, which we think is going to attract new investors to AES that have some bright line thresholds here. We saw that path. So I think we’ve made tremendous progress already, and we have visibility into how we’re going to exit the remaining assets, either through sales that we’ve announced, additional sales that we have not yet announced and then some of these conversions and retirement that will continue. So we feel very good about the program and very good about the earnings trajectory even post coal.
Richard Sunderland: But just on the numbers -- sorry. Sorry, Andres.
Andres Gluski: No. Just what I would add is that just like we have simplified our portfolio, getting out of different markets over time. I think we’ve done it in a way that maximizes shareholder value. I think we’re doing the same with coal. So we could have perhaps accelerated this faster. But I think where you’re run and for example, the monetization, some years ago, the BHP contract in Chile shows that we’re really able to make money from the transition and tying this in a way that we can provide renewables to meet the energy demands of our clients, in some cases, batteries or hydro to meet the capacity or dispatchable need. So I just mentioned that we feel very good about the program, and we think we’re executing very well on it.
Richard Sunderland: Got it. Thank you. But just on the Warrior Run $357 million, $400 million is the low range of the 23 targets that gets you most of the way there? And then did you receive any proceeds on the quarter? Or is the rest either, I guess, Jordan or future announcements?
Steve Coughlin: We had -- so also included in that number is the asset or the renewable business recycling. So we had the closure of that operating portfolio of renewable assets that capital into recycling it to new growth in renewable. So that’s an important part of the program here is not just exits of coal, but also the way we recycle capital. Once we’ve derisked projects, we brought them online, we’ve recognized tax credits. We sell them down to relatively low-risk type capital and improve both our returns as well as then help us support a higher growth rate in the renewables business. So that’s part of the asset sale program. And then we have the Jordan sale that has not yet been closed, but it’s been announced, and then there’s some additional possible sales and sell-downs in the works this year that could come into that number. But as you point out, we’ve already made significant progress towards the target this year. So we feel very good about the target that we’ve laid out.
Richard Sunderland: Perfect. Well thank you for the time today. See you on Monday.
Steve Coughlin: See you on Monday.
Operator: Thank you Mr. Sunderland. The next question comes from the line of Durgesh Chopra with Evercore ISI. You may now proceed.
Durgesh Chopra: Hey good morning team. Thanks for taking my questions. Andres, just -- can you comment on the new PPAs signed year-to-date. When I compare this to first quarter of last year that is 2022, it signed over a gig you’ve only signed 309 megawatts. I think in your commentary, you mentioned a couple of large contracts. So just maybe a little bit more color there? And are you confident that the 4 to 4.5 to 5.5 gigs per year signage, is that -- are you still tracking well against that?
Andres Gluski: Well, thanks for the question. It’s a great question. Look, we feel very good. And the one thing is, if you recall from last year, I believe we had a lot of signings in the last quarter. And so what we’re seeing here, these things are lumpy. So we have been ranked 2 years running as the largest developer of renewable projects for corporations. And so when you’re dealing with these corporations, these are big projects. So one project can easily be a giga. For example, the just another case, our green hydrogen project in Texas, that’s 1.4 giga. So these are lumpy. So I’m not the least bit concerned about meeting our growth targets. We’re seeing a lot of interest. We’re in advanced negotiations. But they don’t count until you sign them. So we feel good about them. No cause for concern. And that’s one of the issues we have, that they’re lumpy. But when you’re going for big contracts, as an example, the project -- the green hydrogen project in Texas, that’s 1.4 gigawatts just in one. And we have others that are in that range. So it’s going to be lumpy, but we’re not concerned because we will land enough of these to keep us on track.
Durgesh Chopra: Understood. That’s very clear. And maybe is there a cost update on the -- on your joint venture, the hydrogen project with APD. I know their project, and I’m not -- I’m going to mispronounce this, but NUM. They had some increases early in the year when they reported, I believe. So any update to cost there in terms of the overall project cost or cost allocated to you for that project?
Andres Gluski: Look, we have no update for cost. It’s still going to be in the range of around $4 billion, the whole project. We think it’s, again, it’s going to be the lowest carbon project in the states. As you know, you have a $3 per kilogram subsidy, if you have below a certain threshold of carbon intensity. So we feel we’re well within that. If you have less than that, for example, if you’re taking energy from the grid, then it drops to $1. So we feel very good about that. In terms of the costs, what I’d say is what they announced on their Neon project. And again, I’m just repeating what they put on there that they were going to make some more capital investments to lower operating costs. So it’s the Neon project in Saudi Arabia which is very good for us because they are using a very similar project to this one but it’s at more advanced, so we can learn from that project jointly learned from that project. But no, we have no updates, but we have no reason to think that there’d be any additional cost overruns at this point in time.
Durgesh Chopra: That’s very helpful color. Thank you Andres. See you on Monday.
Andres Gluski: See you on Monday.
Operator: Thank you Mr. Chopra. The next question comes from the line of Julien Dumoulin-Smith with Bank of America. You may now proceed.
Julien Dumoulin-Smith: Hey good morning team. Thank you guys for the time and the question here. Look, I just wanted to follow up on the ITC, PTC conversation we’ve been having of late. Just curious, are you guys still pretty committed to using ITCs. I know some of your peers have been evolving towards PTCs, you guys focused on the Eastern U.S. Can you talk about the thought process and philosophy there? And then also to follow up back on Angie’s question to the extent to which that you are using ITCs. 70-30 split is still good. I know that, for instance, here in the quarter for tax cut, it’s fairly low. So I just want to make sure that ITC heuristic of 70-30 in year 1, year 2 still applies.
Steve Coughlin: Yes. Julien, it’s Steve. So definitely, we have the lion’s share of our tax attributes are from investment tax credits and will continue to be. So -- and I would say when we look at the investment tax credit with the profile of when projects are coming online, it is roughly fair to say about 2/3 of the investment tax credit gets recognized in the year of the commissioning and then about 1/3, 30% in the second year following commissioning. So that holds. The total volume of tax credits will grow annually, and we expect as the portfolio grows. So we’re targeting the commissioning of about 2.1 gigawatts this year of U.S. renewables, say that doubles next year, I would expect the volume of tax attributes to roughly follow that same growth rate. So a doubling of the tax credit from this year to next year, just as it doubled from last year to this year when we went from 1 gigawatts to 2 gigawatts. The production tax credit is a good incentive in some or a better incentive in some projects. Typically, it has been in wind. But in some cases now where we see an energy community adder now that we have some clarity on that. And we see the potential for domestic content adders with the investment tax credit. Keep in mind, those adders are actually richer on the investment tax credit than they are on the production tax credit basis the way the higher was written. So we -- there’s a bit of an offset there in that some projects where we have a very healthy pipeline, good opportunity to get these bonuses, the investment tax credit may still be the best option. But we’ll look at that project by project and look at what yields the best returns. But I see very strong growth in our tax attribute number year-over-year going forward.
Julien Dumoulin-Smith: Right. But the point is your ITC, you’re still vastly weighted towards ITC versus PTC, right, as you have been and you don’t intend to change that necessarily, especially given your commentary here. I just want to make sure there’s been some concern otherwise.
Steve Coughlin: Yes. Vastly. And the vastness of that will be clear on Monday when I show you the tax credit breakdown between ITC and PTC. And then also keep in mind that for our backlog we’ve essentially locked in already that election and who that tax equity partner is going to be. So for the next couple of years, it’s pretty well decided.
Andres Gluski: The one thing I would add on the... Julien, so we’ll be doing more wind in the states, which will be PTC. So for example, the project in Texas is 900 megawatts of wind. So yes, we’ve been more towards ITC partly is because we’ve been very heavily in solar. We’re very strong in solar. Over time, we expect more of a balance.
Julien Dumoulin-Smith: Right. And then on just the backlog adds, I know you said it’s lumpy, but is domestic content is one of the reasons why customers aren’t moving because they don’t have guidance from treasury yet and so therefore, holding folks back? We’ve heard this from some folks.
Andres Gluski: Yes. I mean in our case, not really. I think I would point to that. It’s just we’re in some negotiations for some whales. And when we land them, it will come through. What did happen last year because of the OXi tariff circumvention case that did delay projects. It did delay projects and set them off into, let’s say, a longer time horizon than would otherwise. But again, since we do a lot of bilateral negotiations, and we haven’t had any problems with our supply chain. That is not what’s driving it. Where the domestic content issue does come in is in terms of the $6 billion contract we have for domestic manufacturer of solar panels here in the states. And so obviously, what’s key there before sort of sitting on the dot line is what is domestic content. And the main difference is how granular it’s defined because if it’s more similar to what has been done, for example, for wind, then it’s much easier to comply with initially. But our plan is to move up the supply chain and have more and more of the inputs made in the states, including some of the more basic minerals, et cetera, coming in. We already have with our suppliers, the wafering is moving out of China, which was the last sort of main component. We’re already buying panels that were made outside of China. And of course, all the wafering etcetera was done in Eastern China, not Western China. So we feel very good about that, and we’ve had no issue thus far.
Julien Dumoulin-Smith: Got it. And last question just on 23 earnings. Just when you look at some of the items in the quarter, whether it was the gain on the asset sale, or whether it was LNG, was that upside relative to the plan? Are you trending better than you would have expected? Or was that gain kind of contemplated in your 2023 guide earlier when you think about your positioning on the year here?
Steve Coughlin: Yes. I would say some of these are definitely upsides, Julien. So all else being equal, yes, there’s upside. Unfortunately, as is the case, I think, with most utilities, the warmer winter weather was somewhat of an offset to those upsides for the first quarter. So we still see the potential for upside above even the midpoint of our guidance, but that’s not -- it remains to be seen how the rest of the year goes.
Julien Dumoulin-Smith: Okay, excellent guys. See you Monday. Thank you very much. All the best.
Operator: Thank you Mr. Julien. The next question comes from the line of Gregg Orrill with UBS. You may now proceed.
Gregg Orrill: Yes hi, thanks for the question. I was wondering if you could. Congratulations. I was wondering if you could touch on the financing plan, just sort of the levers that you feel are available to you for equity or equity-like and would you need that to execute at least the plan through 2025, just to sort of reaffirm your thoughts there. Thank you.
Steve Coughlin: Yes. No, it’s Steve. So sure. So we’ll definitely talk some more about the longer-term financing plan through 2027. So I think that will give additional color. So we’ll hold for that. This year, I think as I laid out on the slide, we will raise additional parent debt capital largely to fund growth in the renewables segment. And then we have the asset sale program in addition to the close to $1 billion of parent free cash flow coming up from the existing business. So there’s no plan for equity this year. Looking ahead, we’ll talk some more about that in the plan for Monday. What I would say there is, certainly, we have we’re well positioned for growth. We’re in a leadership position, and we want to grow beyond 2025. But certainly, through 2025, we would not need equity to meet our 2025 commitments. However, we would expect to start investing in growth, including things like the green hydrogen project, which would get started before 2025 to support the second half of the decade. But we’ll share more detail on that on Monday.
Gregg Orrill: Thank you.
Operator: Thank you Mr. Orrill. The next question comes from the line of Ryan Levine with Citi. You may now proceed.
Ryan Levine: Hi. Hoping to get a better understanding of how you arrived at the new disclosure. You’re using EBITDA with additional tax disclosure. How did you decide on that versus maybe CAFD or free cash flow for FFO metrics than some other peers are utilized?
Andres Gluski: I would say, look, part of it is that, that’s what the most of our peers are using. And what we felt was most transparent is to provide EBITDA and also then the tax attributes. And so if for comparison purposes, you need to add the two, you can do so. But it was really try to make it easier on everyone by using what’s most used in the market.
Ryan Levine: And then in terms of the new developments and extending contracts in California, are you anticipating that, that get extended further beyond the initial expansion that was recently announced?
Andres Gluski: I think -- we’ve got a 3-year extension. It’s -- those assets -- those locations are extremely valuable for the grid. So we’ll see what developments there are. But right now, 3 years going forward, it’s pretty good.
Ryan Levine: Okay. Thank you.
Andres Gluski: Thank you.
Operator: Thank you Mr. Levine. There are no additional questions waiting at this time. So I will pass the conference back over to Susan Harcourt, for closing remarks.
Susan Harcourt: We thank everybody for joining us on today’s call. We look forward to seeing many of you at our Investor Day on Monday. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day.
Operator: That concludes today’s conference call. Thank you for your participation. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning. Thank you for attending today’s The AES Corporation First Quarter 2023 Financial Review. My name is Alicia, and I’ll be your moderator for today’s call. [Operator Instructions] I would now like to pass the conference over to your host, Susan Harcourt, Vice President of Investor Relations with AES Corporation. You may now proceed."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning, and welcome to our first quarter 2023 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are discussed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone. And thank you for joining our first quarter 2023 financial review call. We are very pleased with our progress so far this year. And today, I will discuss our first quarter results and provide key business updates. Steve Coughlin, our CFO, will give some more detail on our financial performance and outlook. Beginning on Slide 3. As you may have seen in our press release, we introduced new strategic business units, which better reflect the greatly simplified company that AES is today and the pillars of our future growth. We will be giving a broader strategic review at our Investor Day on Monday, including an update on our portfolio transformation and an overview of our strong growth expectations for our renewables and utility businesses. Our first quarter 2023 adjusted earnings per share was $0.22 compared with $0.21 in 2022, which is in line with our expectations. With these results and the underlying performance we are seeing across our business, we are reaffirming our 2023 adjusted earnings per share guidance of $1.65 to $1.75, and our 7% to 9% annualized growth rate target through 2025. Now turning to Slide 4. We continue to see strong demand for renewables both in the U.S. and internationally, including from U.S. corporate customers with operations in international markets. So far this year, we have signed PPAs for 309 megawatts of new renewables, including 154 megawatts of wind with a U.S. technology customer in Brazil. We’re in advanced negotiations for several large additional projects and remain on track to meet our PPA signing target of 14 to 17 gigawatts over the next 3 years. In the U.S., key elements of the inflation Reduction Act or IRA are being clarified. This past month, the Department of Treasury and the IRS release detailed guidance on how clean energy projects located in energy communities can qualify for an additional 10% bonus tax credit. We estimate that approximately 1/3 of our 51 gigawatt pipeline of projects in the U.S. would qualify, which directly translates into a combination of higher potential returns and increased competitiveness for the projects we are developing. We are currently awaiting treasury department guidance on certain provisions of the IRA, including requirements for the clean hydrogen production tax credit. As a reminder, at our green hydrogen project in Texas, the largest advanced green hydrogen project in the U.S., which we are developing jointly with Air Products. We plan to co-locate 1.4 gigawatts of new renewables with the electrolyzers. This means that the projects would have the lowest possible carbon emissions of any known project in the U.S. Additionally, the project is located adjacent to the site of a decommissioned coal plant, which will provide significant existing infrastructure. All of these attributes and the fact that the energy will include hourly matching indicate that the project should qualify for the highest possible tax credit in any scenario. Turning to Slide 5. Our backlog of projects with signed long-term contracts is now around 12 gigawatts. Of which roughly half are already under construction. We continue to maintain a robust supply chain, and we continue to hit our construction milestones without delay. We expect to bring online more than 3 gigawatts of new wind, solar and battery storage this year. As we bring projects currently in the backlog online in coming years, we will nearly double our installed renewables capacity, making us one of the fastest-growing renewable companies in the world. Turning to Slide 6. We are also happy to report a positive development at AES Ohio which puts us on track for unprecedented growth in the business. In April, AES Ohio signed a comprehensive settlement agreement for its Electric Security Plan, or ESP 4 which received broad support from residential, commercial, industrial and low-income customers. The settlement included the commission staff as a signatory, and we expect to receive final approval by the end of the third quarter. With ESP 4 in place, along with our existing investment programs, we expect to more than double our rate base by the end of 2027 which would make AES Ohio, one of the fastest-growing utility businesses in the country, while still having the lowest tariffs in the state. Turning to Slide 7. We also reached a major milestone towards exiting coal by the end of 2025. We agreed to terminate the PPA at the Warrior Run plant in Maryland, for which we will receive total payments of $357 million. We will retain control of the site and are exploring new uses that capitalize on its valuable location and existing infrastructure. We see this transaction is very beneficial for all parties involved. Moving to Slide 8. We signed agreements to extend the operations of 1.4 gigawatts of gas generation at our legacy Southland units in California for 3 more years. These plans were previously scheduled to retire at the end of this year. The extensions will lock in additional upside and will help meet the state of California’s grid liability needs while supporting its efforts to transition over time to low carbon source of electricity. The monetization of the contract that Warrior Run and the extension of the legacy Southland units are both good examples of how we are creating value from our existing infrastructure assets during the energy transition. Finally, as I mentioned earlier, we will be holding an Investor Day on Monday, where we will be sharing our strategic long-term view of the company, discussing our new business segments and providing long-term growth rates through 2027 for adjusted earnings per share, adjusted EBITDA and parent free cash flow. With that, I would like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our first quarter results, 2023 guidance and 2023 parent capital allocation. Turning to Slide 10. As Andres mentioned, in the first quarter, we launched our new Strategic Business Units or SBUs. This new organizational structure reflects AES very focused and simplified portfolio. It also aligns our management teams by business line to maximize our operational synergies and to continue delivering excellent customer experiences across all our markets. Our new SBU reporting segments highlight our rapidly growing renewables and utility businesses and facilitate simplified modeling of AES, which will benefit current and new potential shareholders and analysts. Our new SBUs include renewables, which includes our solar, wind, energy storage and hydro businesses, utilities, which includes AES Indiana, AES Ohio and AES Salvador, Energy infrastructure composed of our thermal generation and LNG infrastructure businesses and new energy technologies, which includes our investments in energy technology businesses such as Fluence and Uplight as well as our green hydrogen business line and future new business innovations which support our mission. In addition to the SBUs, we also have a corporate reporting segment, which includes our corporate G&A our parent level debt and associated interest expense in our captive insurance program called AGC. Turning to Slide 11. Adjusted EPS for the quarter was $0.22 versus $0.21 last year. Our business was favorable year-over-year, which I will discuss in more detail shortly. Our results were also impacted by higher parent interest expense and a lower adjusted tax rate. Now to Slide 12. We are fully on track to achieve our full year 2023 adjusted EPS guidance range of $1.65 to $1.75. We expect a significant contribution from new renewables of at least $0.27 this year. This is partially offset by lower contributions from LNG sales, as we have previously mentioned, higher parent interest expense from incremental debt and higher rates on our revolving credit facility and a marginally higher tax rate this year. As is typically the case, our earnings are heavily weighted toward the second half of the year. This year, we expect approximately 3/4 of our earnings to occur in the second half. Growth in the year to go will be primarily driven by contributions from new businesses including over 3 gigawatts of projects in our backlog coming online, which remains solidly on track for completion. We are also reaffirming our expected 7% to 9% average annual growth target through 2025. Turning to Slide 13. As you may have seen in our press release, while we continue to report adjusted EPS, today, we are also introducing adjusted EBITDA as a new reporting metric. As the renewables portion of our business grows at an extremely high rate, we believe adjusted EBITDA is a very informative metric in understanding our business results. First, it aligns well with the performance of our underlying business and operating cash generation. And second, adjusted EBITDA is reported before the impact of U.S. renewables tax attributes so that investors and analysts can separate renewable operating earnings from the very valuable tax incentives for U.S. renewables. Beginning this quarter, I will discuss our new SBU financial results using adjusted EBITDA, with the exception of our utilities SBU, which will be measured using adjusted pretax contribution, or PTC, to facilitate comparisons with other utilities. We will provide full year guidance by SBU during our Investor Day on Monday. Adjusted EBITDA was $628 million this quarter versus $621 million in the prior year. This was driven by higher first quarter LNG sales and growth in renewables, but was partially offset by the impact of warmer than normal weather at our U.S. utilities. I’ll cover the performance of our new SBUs in the next 4 slides. Beginning with our renewables SBU on Slide 14. Higher EBITDA was driven primarily by a higher level of generation at our facilities in Panama higher wind generation and contributions from new businesses. This was partially offset by higher spend as we continue to ramp up our renewables development and lower power prices impacting our Bulgaria wind facility. Lower PTC at our Utilities SBU was mostly driven by warmer-than-normal winter weather and higher interest expense, but partially offset by higher revenues as a result of our continued investment in the rate base. Higher EBITDA and our energy infrastructure SBU primarily reflects higher LNG sales, partially offset by lower margins from coal PPAs, the retirement of our coal plant in Hawaii last year and lower availability at Southland Energy. Finally, higher EBITDA at our New Energy Technologies SBU reflects a significant improvement in operations and gross margins at Fluence. Now to our 2023 parent capital allocation plan on Slide 18. Sources reflect approximately $2.1 billion to $2.6 billion of total discretionary cash, including $950 million to $1 billion of parent free cash flow, $400 million to $600 million of proceeds from asset sales and $700 million to $1 billion of planned parent debt issuance. On the right-hand side, you can see our planned use of capital. We will return nearly $500 million to shareholders this year. This consists of our common share dividend, including the previously announced 5% increase as well as the coupon on the equity units. We plan to invest approximately $1.7 billion toward new growth, of which the majority will go to renewables and utilities. In summary, we’ve made great progress on our financial commitments for the year. At our Investor Day on Monday, we will provide detail on the strategy and future of AES overall and for each of our new SBUs. We will also provide long-term growth rates through 2027 for adjusted EPS, adjusted EBITDA and parent free cash flow. I look forward to talking with many of you then. With that, I’ll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. In summary, we are pleased with our progress to date and remain on track to hit our 2023 adjusted earnings per share guidance of $1.65 to $1.75 and our 7% to 9% annualized growth rate target through 2025. We continue to see strong demand for renewables and especially from our corporate customers. Our supply chain is robust and our construction projects are progressing as planned. We’re also encouraged by the settlement agreement at AS Ohio, which paves the way for final approval of our new electric security plan later this year and creates the framework for significant investments in the utility. Finally, we see our successful negotiations to terminate the Warrior Run contract and extend the operations of the 1.4 gigawatts of our legacy South line units as indicative of the success we are having in maximizing shareholder value from our existing assets as we transform the portfolio. We look forward to providing a broader strategic update at our Investor Day on Monday, including more details around our growth plans and guidance through 2027. With that, I would like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you [Operator Instructions] The first question comes from the line of David Arcaro with Morgan Stanley. You may now proceed."
},
{
"speaker": "David Arcaro",
"text": "Hi, good morning thanks for taking my question. One thing I wanted to check on, would there be any risk to your renewables growth outlook if the AD/CVD tariffs were to come back into effect just after we’ve seen the House and Senate passed some legislation there. Just curious how you view that risk and also just longer term, how you mitigate that AD/CVD tariff risk."
},
{
"speaker": "Andres Gluski",
"text": "Yes, honestly, we don’t see any risk whatsoever. First, it in the past, I believe the setting was 56 votes, and that was -- the President will be to it. And by the -- we have all the panels that we need for this year, and expect to have for next year, by June of next year when the tariff, let’s say, tariff holiday rolls off. So we’re in very good shape for 2023 and 2024. And after that, we expect to have supply coming in from the U.S. We’re having no problems from our suppliers getting through under the UFLPA. So really, I think we’re in the best shape of anybody. We have not delayed a single project due to solar panel supply issues to date. And I think that’s something -- I don’t know if anybody else can say that."
},
{
"speaker": "David Arcaro",
"text": "Excellent. That’s helpful. And then I was just curious, any updates into the visibility for the 600 megawatts of projects that are potentially getting completed this year, but could get pushed to next year? Any increased visibility there at this point in the year?"
},
{
"speaker": "Andres Gluski",
"text": "Look, as I said in my script, we are progressing well we have the supply chain. Everything is in place. But look, we won’t know until the fourth quarter of this year, and they’re going to fall in this year and they’re going to follow in next. But I would remind everybody that’s not value issue. If they come in a couple of weeks later, it doesn’t affect the profitability of the project at all. It is an accounting issue. But as of now, we we’re doing well, but we can’t say -- give you any particular update with greater clarity and probably until the fourth quarter of this year."
},
{
"speaker": "David Arcaro",
"text": "Yes. Understood. That makes sense. And just one other quick question. I was curious if with the Warrior run project. Is there any level of EBITDA or earnings contribution that you would point to for that as that rolls off? And then curious how you think about the use of proceeds there if there’s debt specifically on the project that would be paid down or if it gets used more broadly at the corporate level?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, hi, this is Steve. There is definitely earnings from this. And so effectively, we’re monetizing the remaining 7 roughly years of the PPA this year. And so we’ll recognize earnings this year, and we expect to have an obligation for capacity through the middle of next year. So the earnings over this termination agreement will be recognized over roughly 11, 12 months following when the commission approval comes in. So say if it comes in, in June, probably about half this year and half next year. And there’s very little debt to pay down here. So this is -- these proceeds will likely -- this is a 7-year payment stream, but we’ll likely monetize that this year. And then that’s captured in our asset sale in terms of our capital sources this year, if you saw on that slide. So that will be used to fund the growth of the business."
},
{
"speaker": "David Arcaro",
"text": "Okay, perfect. Great, thanks so much."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Angie Storozynski with Seaport Global. You may now proceed."
},
{
"speaker": "Agnieszka Storozynski",
"text": "Good morning. So I know we’re going to talk about it on Monday, this transition from EPS to EBITDA. And if I understand correctly, at least that’s how I see it. It’s about renewables being more levered and having a higher depreciation rate than the thermal assets, for example, however. So there’s only one issue here that as we’re looking at the first quarter results, right, the contributions from renewables seems very small, right, to the total EBITDA. So that’s one. And also, as you are aware, there are different ways how your peers show adjusted EBITDA. I mean in your case, you’re adjusting it for minority interest there’s no inclusion of the tax benefits, which, again, might understate the EBITDA versus what your peers report. So anyway -- and I know that we’re going to talk about it on Monday, but just ease us into this EBITDA transition, please?"
},
{
"speaker": "Andres Gluski",
"text": "Sure, Angie. Well, thanks for the question. Look, first, I’d say, we continue to provide adjusted earnings per share guidance. And as we said, we’ll be providing adjusted earnings per share guidance through 2027 on Monday. So I want to make that perfectly clear, but we’re adding as an additional indicator which is adjusted EBITDA that we’re going to be giving. And partly, it’s to give greater clarity into our performance of our renewables and partly that has to do with sort of the lumpiness of the projects. So that’s the real reason that we’re giving an additional one. It also helped people to do so, for example, if some of the parts of our different businesses, renewables, utilities, infrastructure. So I want to make very clear that we are providing adjusted earnings per share through 2027. Regarding the other questions that you have, I’m going to go ahead and pass that to Steve."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Thanks, Andres, and thanks, Angie. So definitely, we’ll be talking some more about this on Monday. But our goal here is to really give the clarity that we think is important to understand and model the business. So as Andre said, we’ll give the adjusted EPS, we’ll also give the EBITDA, which is more closely aligned to the underlying business performance and cash generation from the PPAs and then we’ll also give the tax attributes and then the sum of the adjusted EBITDA plus the tax attributes. So we think it’s going to be a very complete view and package that helps people truly understand how the business is earning and generating cash. From the different components of the PPAs and the tax attributes."
},
{
"speaker": "Agnieszka Storozynski",
"text": "Okay. And then you can also help us how to allocate the corporate leverage across -- I mean, again, if we are trying to move to the sum of the part valuation from an EBITDA perspective, we need to figure out how to allocate the corporate debt, right, among these subsidiaries."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. I mean, certainly, in our reporting now, we’ll be able to separate the debt here for the business. And then as we look ahead, most all of our growth is in renewables and Utilities. About 80% of the growth is in renewables and utilities and about close to 0.75 80% in the U.S. market. So I think you’ll have a lot of good detail to help understand how to do that allocation."
},
{
"speaker": "Agnieszka Storozynski",
"text": "Okay, okay. See you guys on Monday. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you Miss Storozynski. The next question comes from the line of Richard Sunderland with JPMorgan. You may now proceed."
},
{
"speaker": "Richard Sunderland",
"text": "Hi, good morning and thanks for the time today. Maybe I’ll pick it up where Angie left off on the new SBUs. Turning to the new energy technologies, SBU, can you speak more to the green hydrogen side. Curious if this represents a shift in thinking of where you like to be involved in hydrogen? Or are you just specifically calling out the breakout there relative to the renewables feeding in?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Thanks for the question. Look, what I’d say is that we have a very interesting pipeline, which we’ll be discussing on Monday of green hydrogen projects. We really think we’re a leader here. We have the most advanced and lowest carbon emitting project in Texas here in the U.S. But we also have projects in Los Angeles. We have projects in Houston. We have projects in Brazil for export, and we have projects in Chile for the -- for our corporate clients or the mining sector. So we’ll be providing more color there. Now in the specific case, for example, Texas, we do co-own the electrolyzers as well as the renewables with our joint venture partner of Air Products. And the reason for that is to really maximize the value of the project because even though the project will be basically co-locating all the renewables with the electrolyzers, it is interconnected with the grid. So there could be occasions just to give you a hypothetical polar vortex in Texas where the most profitable use of our renewables is to inject them into the grid and actually not run the electrolyzers. And so we wanted to have all of our interests aligned. So there will be some projects like that where we also own the electrolyzers as well. In the case of Texas, it’s a take-or-pay with Air Products, but there are other ones in which we would be selling possibly selling green hydrogen to our corporate customers to whom we’re already selling renewables. So that’s the reason for calling it out. Also, as you know, AES next looks at what’s next in terms of technologies. So we’re also, I would say, have it there so that we can look at what new technologies help us produce green hydrogen, cheaper and better for our clients. So that’s the reason for calling it out there."
},
{
"speaker": "Richard Sunderland",
"text": "Got it. That’s very clear. Sticking with the SBU theme, energy infrastructure, are you able to disclose how much of that is called today?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So we have roughly a little bit shy of 7 gigawatts of coal today, and that includes some of the assets that we’ve already announced sales and retirement of including, for example, Mong gang in Vietnam, some of the retirements in Chile, and Ventanas, for example, so that number is coming down rapidly, but that’s roughly what’s in the base of energy infrastructure today."
},
{
"speaker": "Richard Sunderland",
"text": "Just this on an EBITDA contribution basis or a percentage of SBU basis?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So on a percentage, so what we’ve talked about is it’s about $0.30 of EPS is coming from coal today. Now what’s important is that is -- that’s not all necessarily going away. For example, we are converting the Petersburg 3 of 4 units in Indiana under the integrated utility in Indiana. So this will leave -- this will actually be a new investment to do the gas conversion, and so there’ll be earnings from the rate base and the increasing rate base from that asset. And then in other cases, we are looking at some additional conversion opportunities for these. And then, of course, where there is sales, we’ll have proceeds from those sales to then recycle capital into the renewable and utility growth segments."
},
{
"speaker": "Richard Sunderland",
"text": "Got it. Very helpful. And then just one more for me. in consideration of the Warrior Run termination relative to the $400 million to $600 million asset sale target, where are you currently with announced and closed transactions relative to that range?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So we -- I mean we initially announced this exit a year ago. And -- but really prior to that, we had already been significantly reducing our coal portfolio. So our coal portfolio at one point was around 22 gigawatts and we’re already down to 7%. So the reality is we’ve already executed on 2/3 of this program over the many years. And as we a year ago saw the pathway to meet our financial commitments and to fully exit coal, which we think is going to attract new investors to AES that have some bright line thresholds here. We saw that path. So I think we’ve made tremendous progress already, and we have visibility into how we’re going to exit the remaining assets, either through sales that we’ve announced, additional sales that we have not yet announced and then some of these conversions and retirement that will continue. So we feel very good about the program and very good about the earnings trajectory even post coal."
},
{
"speaker": "Richard Sunderland",
"text": "But just on the numbers -- sorry. Sorry, Andres."
},
{
"speaker": "Andres Gluski",
"text": "No. Just what I would add is that just like we have simplified our portfolio, getting out of different markets over time. I think we’ve done it in a way that maximizes shareholder value. I think we’re doing the same with coal. So we could have perhaps accelerated this faster. But I think where you’re run and for example, the monetization, some years ago, the BHP contract in Chile shows that we’re really able to make money from the transition and tying this in a way that we can provide renewables to meet the energy demands of our clients, in some cases, batteries or hydro to meet the capacity or dispatchable need. So I just mentioned that we feel very good about the program, and we think we’re executing very well on it."
},
{
"speaker": "Richard Sunderland",
"text": "Got it. Thank you. But just on the Warrior Run $357 million, $400 million is the low range of the 23 targets that gets you most of the way there? And then did you receive any proceeds on the quarter? Or is the rest either, I guess, Jordan or future announcements?"
},
{
"speaker": "Steve Coughlin",
"text": "We had -- so also included in that number is the asset or the renewable business recycling. So we had the closure of that operating portfolio of renewable assets that capital into recycling it to new growth in renewable. So that’s an important part of the program here is not just exits of coal, but also the way we recycle capital. Once we’ve derisked projects, we brought them online, we’ve recognized tax credits. We sell them down to relatively low-risk type capital and improve both our returns as well as then help us support a higher growth rate in the renewables business. So that’s part of the asset sale program. And then we have the Jordan sale that has not yet been closed, but it’s been announced, and then there’s some additional possible sales and sell-downs in the works this year that could come into that number. But as you point out, we’ve already made significant progress towards the target this year. So we feel very good about the target that we’ve laid out."
},
{
"speaker": "Richard Sunderland",
"text": "Perfect. Well thank you for the time today. See you on Monday."
},
{
"speaker": "Steve Coughlin",
"text": "See you on Monday."
},
{
"speaker": "Operator",
"text": "Thank you Mr. Sunderland. The next question comes from the line of Durgesh Chopra with Evercore ISI. You may now proceed."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey good morning team. Thanks for taking my questions. Andres, just -- can you comment on the new PPAs signed year-to-date. When I compare this to first quarter of last year that is 2022, it signed over a gig you’ve only signed 309 megawatts. I think in your commentary, you mentioned a couple of large contracts. So just maybe a little bit more color there? And are you confident that the 4 to 4.5 to 5.5 gigs per year signage, is that -- are you still tracking well against that?"
},
{
"speaker": "Andres Gluski",
"text": "Well, thanks for the question. It’s a great question. Look, we feel very good. And the one thing is, if you recall from last year, I believe we had a lot of signings in the last quarter. And so what we’re seeing here, these things are lumpy. So we have been ranked 2 years running as the largest developer of renewable projects for corporations. And so when you’re dealing with these corporations, these are big projects. So one project can easily be a giga. For example, the just another case, our green hydrogen project in Texas, that’s 1.4 giga. So these are lumpy. So I’m not the least bit concerned about meeting our growth targets. We’re seeing a lot of interest. We’re in advanced negotiations. But they don’t count until you sign them. So we feel good about them. No cause for concern. And that’s one of the issues we have, that they’re lumpy. But when you’re going for big contracts, as an example, the project -- the green hydrogen project in Texas, that’s 1.4 gigawatts just in one. And we have others that are in that range. So it’s going to be lumpy, but we’re not concerned because we will land enough of these to keep us on track."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. That’s very clear. And maybe is there a cost update on the -- on your joint venture, the hydrogen project with APD. I know their project, and I’m not -- I’m going to mispronounce this, but NUM. They had some increases early in the year when they reported, I believe. So any update to cost there in terms of the overall project cost or cost allocated to you for that project?"
},
{
"speaker": "Andres Gluski",
"text": "Look, we have no update for cost. It’s still going to be in the range of around $4 billion, the whole project. We think it’s, again, it’s going to be the lowest carbon project in the states. As you know, you have a $3 per kilogram subsidy, if you have below a certain threshold of carbon intensity. So we feel we’re well within that. If you have less than that, for example, if you’re taking energy from the grid, then it drops to $1. So we feel very good about that. In terms of the costs, what I’d say is what they announced on their Neon project. And again, I’m just repeating what they put on there that they were going to make some more capital investments to lower operating costs. So it’s the Neon project in Saudi Arabia which is very good for us because they are using a very similar project to this one but it’s at more advanced, so we can learn from that project jointly learned from that project. But no, we have no updates, but we have no reason to think that there’d be any additional cost overruns at this point in time."
},
{
"speaker": "Durgesh Chopra",
"text": "That’s very helpful color. Thank you Andres. See you on Monday."
},
{
"speaker": "Andres Gluski",
"text": "See you on Monday."
},
{
"speaker": "Operator",
"text": "Thank you Mr. Chopra. The next question comes from the line of Julien Dumoulin-Smith with Bank of America. You may now proceed."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey good morning team. Thank you guys for the time and the question here. Look, I just wanted to follow up on the ITC, PTC conversation we’ve been having of late. Just curious, are you guys still pretty committed to using ITCs. I know some of your peers have been evolving towards PTCs, you guys focused on the Eastern U.S. Can you talk about the thought process and philosophy there? And then also to follow up back on Angie’s question to the extent to which that you are using ITCs. 70-30 split is still good. I know that, for instance, here in the quarter for tax cut, it’s fairly low. So I just want to make sure that ITC heuristic of 70-30 in year 1, year 2 still applies."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Julien, it’s Steve. So definitely, we have the lion’s share of our tax attributes are from investment tax credits and will continue to be. So -- and I would say when we look at the investment tax credit with the profile of when projects are coming online, it is roughly fair to say about 2/3 of the investment tax credit gets recognized in the year of the commissioning and then about 1/3, 30% in the second year following commissioning. So that holds. The total volume of tax credits will grow annually, and we expect as the portfolio grows. So we’re targeting the commissioning of about 2.1 gigawatts this year of U.S. renewables, say that doubles next year, I would expect the volume of tax attributes to roughly follow that same growth rate. So a doubling of the tax credit from this year to next year, just as it doubled from last year to this year when we went from 1 gigawatts to 2 gigawatts. The production tax credit is a good incentive in some or a better incentive in some projects. Typically, it has been in wind. But in some cases now where we see an energy community adder now that we have some clarity on that. And we see the potential for domestic content adders with the investment tax credit. Keep in mind, those adders are actually richer on the investment tax credit than they are on the production tax credit basis the way the higher was written. So we -- there’s a bit of an offset there in that some projects where we have a very healthy pipeline, good opportunity to get these bonuses, the investment tax credit may still be the best option. But we’ll look at that project by project and look at what yields the best returns. But I see very strong growth in our tax attribute number year-over-year going forward."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Right. But the point is your ITC, you’re still vastly weighted towards ITC versus PTC, right, as you have been and you don’t intend to change that necessarily, especially given your commentary here. I just want to make sure there’s been some concern otherwise."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Vastly. And the vastness of that will be clear on Monday when I show you the tax credit breakdown between ITC and PTC. And then also keep in mind that for our backlog we’ve essentially locked in already that election and who that tax equity partner is going to be. So for the next couple of years, it’s pretty well decided."
},
{
"speaker": "Andres Gluski",
"text": "The one thing I would add on the... Julien, so we’ll be doing more wind in the states, which will be PTC. So for example, the project in Texas is 900 megawatts of wind. So yes, we’ve been more towards ITC partly is because we’ve been very heavily in solar. We’re very strong in solar. Over time, we expect more of a balance."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Right. And then on just the backlog adds, I know you said it’s lumpy, but is domestic content is one of the reasons why customers aren’t moving because they don’t have guidance from treasury yet and so therefore, holding folks back? We’ve heard this from some folks."
},
{
"speaker": "Andres Gluski",
"text": "Yes. I mean in our case, not really. I think I would point to that. It’s just we’re in some negotiations for some whales. And when we land them, it will come through. What did happen last year because of the OXi tariff circumvention case that did delay projects. It did delay projects and set them off into, let’s say, a longer time horizon than would otherwise. But again, since we do a lot of bilateral negotiations, and we haven’t had any problems with our supply chain. That is not what’s driving it. Where the domestic content issue does come in is in terms of the $6 billion contract we have for domestic manufacturer of solar panels here in the states. And so obviously, what’s key there before sort of sitting on the dot line is what is domestic content. And the main difference is how granular it’s defined because if it’s more similar to what has been done, for example, for wind, then it’s much easier to comply with initially. But our plan is to move up the supply chain and have more and more of the inputs made in the states, including some of the more basic minerals, et cetera, coming in. We already have with our suppliers, the wafering is moving out of China, which was the last sort of main component. We’re already buying panels that were made outside of China. And of course, all the wafering etcetera was done in Eastern China, not Western China. So we feel very good about that, and we’ve had no issue thus far."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. And last question just on 23 earnings. Just when you look at some of the items in the quarter, whether it was the gain on the asset sale, or whether it was LNG, was that upside relative to the plan? Are you trending better than you would have expected? Or was that gain kind of contemplated in your 2023 guide earlier when you think about your positioning on the year here?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. I would say some of these are definitely upsides, Julien. So all else being equal, yes, there’s upside. Unfortunately, as is the case, I think, with most utilities, the warmer winter weather was somewhat of an offset to those upsides for the first quarter. So we still see the potential for upside above even the midpoint of our guidance, but that’s not -- it remains to be seen how the rest of the year goes."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Okay, excellent guys. See you Monday. Thank you very much. All the best."
},
{
"speaker": "Operator",
"text": "Thank you Mr. Julien. The next question comes from the line of Gregg Orrill with UBS. You may now proceed."
},
{
"speaker": "Gregg Orrill",
"text": "Yes hi, thanks for the question. I was wondering if you could. Congratulations. I was wondering if you could touch on the financing plan, just sort of the levers that you feel are available to you for equity or equity-like and would you need that to execute at least the plan through 2025, just to sort of reaffirm your thoughts there. Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. No, it’s Steve. So sure. So we’ll definitely talk some more about the longer-term financing plan through 2027. So I think that will give additional color. So we’ll hold for that. This year, I think as I laid out on the slide, we will raise additional parent debt capital largely to fund growth in the renewables segment. And then we have the asset sale program in addition to the close to $1 billion of parent free cash flow coming up from the existing business. So there’s no plan for equity this year. Looking ahead, we’ll talk some more about that in the plan for Monday. What I would say there is, certainly, we have we’re well positioned for growth. We’re in a leadership position, and we want to grow beyond 2025. But certainly, through 2025, we would not need equity to meet our 2025 commitments. However, we would expect to start investing in growth, including things like the green hydrogen project, which would get started before 2025 to support the second half of the decade. But we’ll share more detail on that on Monday."
},
{
"speaker": "Gregg Orrill",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you Mr. Orrill. The next question comes from the line of Ryan Levine with Citi. You may now proceed."
},
{
"speaker": "Ryan Levine",
"text": "Hi. Hoping to get a better understanding of how you arrived at the new disclosure. You’re using EBITDA with additional tax disclosure. How did you decide on that versus maybe CAFD or free cash flow for FFO metrics than some other peers are utilized?"
},
{
"speaker": "Andres Gluski",
"text": "I would say, look, part of it is that, that’s what the most of our peers are using. And what we felt was most transparent is to provide EBITDA and also then the tax attributes. And so if for comparison purposes, you need to add the two, you can do so. But it was really try to make it easier on everyone by using what’s most used in the market."
},
{
"speaker": "Ryan Levine",
"text": "And then in terms of the new developments and extending contracts in California, are you anticipating that, that get extended further beyond the initial expansion that was recently announced?"
},
{
"speaker": "Andres Gluski",
"text": "I think -- we’ve got a 3-year extension. It’s -- those assets -- those locations are extremely valuable for the grid. So we’ll see what developments there are. But right now, 3 years going forward, it’s pretty good."
},
{
"speaker": "Ryan Levine",
"text": "Okay. Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you Mr. Levine. There are no additional questions waiting at this time. So I will pass the conference back over to Susan Harcourt, for closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today’s call. We look forward to seeing many of you at our Investor Day on Monday. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "That concludes today’s conference call. Thank you for your participation. You may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AES | 4 | 2,024 | 2025-02-28 10:00:00 | Operator: Hello, everyone, and a warm welcome to The AES Corporation Fourth Quarter and Full Year 2024 Financial Review Call. My name is Emily, and I will be coordinating your call today. After the presentation, you will have the opportunity to ask any questions, which you can do so by pressing star followed by the number one on your telephone keypad. I will now hand over to Susan Harcourt, Vice President of Investor Relations, to begin. Susan, you may begin.
Susan Harcourt: Good morning, and welcome to our Fourth Quarter and Full Year 2024 Financial Review Call. Our press release, presentation, and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-Ks and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; Ricardo Fallu, our Chief Operating Officer; and other senior members of our management. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our Fourth Quarter and Full Year 2024 Financial Review Call. Today, I will cover our 2024 accomplishments, the resiliency of our business, and our 2025 guidance and longer-term outlook. Steve Coughlin, our CFO, will provide more details on our financial performance and expectations after my remarks. To say that we are extremely disappointed with our stock price performance is an understatement. Steve and I will address what we believe to be investors' concerns, including policy uncertainties, renewable EBITDA growth, and balance sheet and funding constraints. We will review why renewables are critical to meeting growing demand for electricity, particularly among technology customers, and why our business model is relatively well insulated from and resilient to potential regulatory changes. Even with our resilient position, we are taking immediate steps to strengthen our financial position and outlook. These steps include reducing our parent investment in renewables by focusing on the highest risk-adjusted return projects, improving organizational efficiency, and continuing to operate some of our energy infrastructure assets. As a result of these actions, we expect to improve our credit metrics over time while eliminating the need for issuing new equity during the forecast period and maintaining our dividend. Turning to slide four, we signed 4.4 gigawatts of new power purchase agreements for renewables last year. Our performance in 2024 puts us on track to achieve our goal of signing 14 to 17 gigawatts of new PPAs through 2025. We are prioritizing signing those contracts with the best risk-adjusted returns rather than just maximizing growth in gigawatts. In 2024, we also completed the construction or acquisition of 3 gigawatts of renewables and a 670-megawatt combined cycle gas plant in Panama, greatly increasing the utilization of our existing LNG terminal in that country. Our best-in-class record of on-time and on-budget delivery of renewable projects is something that our customers value highly and is one of our competitive advantages. Lastly, I should note that in 2024, we received approval from the Indiana Regulatory Commission for new base rates and an ROE of 9.9%, supporting an investment program that will improve reliability for our customers and support local economic development. Now moving to our financial results. In 2024, we achieved adjusted EBITDA of $2.64 billion, which is in the lower half of our guidance range as a result of extreme one-time weather-related events in Colombia and Brazil, with both businesses down a combined $200 million year on year. Nonetheless, we generated parent free cash flow of $1.1 billion, which is at the midpoint of our guidance. We earned a record adjusted EPS of $2.14, which is materially above our guidance range and puts us well on track to achieve our annualized growth target of 7% to 9% from 2020 to 2025. Moving to our renewables business on slide five, 2025 will be an inflection point as we begin to realize the financial benefits from the maturing of our renewable business, including the addition of 6.6 gigawatts we inaugurated in 2023 and 2024. We are able to achieve increasing economies of scale that reduce our overhead per megawatt, as we now have 16.2 gigawatts of renewables online versus 5.9 gigawatts in 2018, excluding Brazil. At the same time, our development business is becoming more efficient. We are now harvesting the investments we made in creating our pipeline. Furthermore, as profitability of each megawatt of new PPA signed has substantially increased, we do not need to bring online as many new projects to achieve the same level of financial growth. This strategy allows us to focus on the most profitable new projects while reducing costs and capital requirements. As I will shortly discuss, there is a time lag between renewables development expenditures, which flow through the P&L, and growth in EBITDA. Creating a pipeline of potential projects requires expenditures on development activities such as scouting for prospects, negotiating land purchases or leases, measuring the wind or sun resource, and finally, obtaining permits. As our renewables are in a more mature state, our financials will start to reflect the true profitability of the business as new projects coming online cover the cost of early-stage projects. As the business grows, stewardship, including administrative and back-office activities, will get allocated over a larger operating base. This inflection in our life cycle starting in 2025 will strengthen our credit metrics as we achieve a higher ratio of projects online selling energy versus spending on pipeline and projects under construction. With this background, let me turn to our financial expectations for our renewables business. In 2025, we expect over 60% year-over-year growth in our renewables EBITDA, which Steve will discuss in more detail. Previous growth in our US renewables portfolio drives the majority of our expected EBITDA growth. In 2025, another 3.2 gigawatts of renewable capacity we expect to bring online will contribute to strong EBITDA growth in 2026 and beyond. These numbers also reflect the maturing of our US renewable business as we harvest the investments we made to create our 50-gigawatt US pipeline. Finally, I should note that our 2025 renewable segment guidance incorporates some changes in segment makeup, including the sale of 5.2 gigawatts in Brazil last year and the addition of 2.5 gigawatts in Chile. As the business has evolved, these Chilean renewable assets have now been moved from the energy infrastructure SBU to the renewables SBU. The sale of Brazil is an important de-risking of our portfolio as we have eliminated a significant portion of our hydrology, currency, spot price, and floating interest rate risk exposures. Turning to slide six and the renewables market and our business, last year, the US added 49 gigawatts of new capacity with renewables, battery storage, representing 92% of those additions. In 2025, the US is expected to add 63 gigawatts, 93% of which are solar, storage, and wind. While we will likely see a surge for new gas capacity over the next decade, delayed delivery of new gas turbine averages three to four years, without taking into account new permitting requirements or building new gas pipelines. While a few decommissioned nuclear units are expected to be brought online in the next five years, a material contribution in new capacity from small nuclear reactors or advanced design nuclear plants is unlikely to occur for at least another decade. Taking all this into consideration, renewables have the shortest time to power and much greater price certainty. Therefore, there is no doubt that the increased demand for electricity over the next decade, coming from data centers and advanced manufacturing, will continue to require vast amounts of renewable energy and batteries. Moving to slide seven, over the past five years, we have endeavored to make our business resilient to potential policy changes. First, we have taken a lead in onshoring our supply chain to the US, which limits our exposure to new tariffs. We now have essentially all of our solar panels, trackers, and batteries either in-country or contracted to be domestically produced for our US projects coming online through 2027. Second, of the 8.4 gigawatts of signed contracts we have in the US, more than half are under construction, and nearly all have significant safe harbor protections, which will grandfather them under the existing tax policy. Third, about 3 gigawatts, or 30% of our backlog of signed PPAs, are in US dollars but in international markets, primarily Chile, which are unaffected by US policy changes. I should note that in our international markets, renewables can be even more profitable and most often the cheapest form of dispatchable energy, even in a regime without meaningful subsidies. Lastly, the vast majority of AES' customer base are corporations whose demand for new renewables continues to increase at a rapid pace. In fact, in 2024, approximately 70% of the PPAs we signed were with large corporations. And notably, we have once again been designated by BNEF as the largest provider of clean energy to corporations in the world. Even in the very unlikely scenario where tax credits for renewables are eliminated prospectively in their entirety, we believe that there will be continued strong demand from our corporate clients, especially data centers, because there are no realistic alternatives for many years. Without timely access to power, there can be no AI revolution. Obviously, the price of new PPAs in a future without tax incentives would increase, and the profile of earnings and cash flow would change. This will look a lot like our projects in Chile. However, in any case, what ultimately matters to AES is our returns and cash flow per dollar invested. Now let me turn to our utilities business on slide eight. AES Indiana and AES Ohio are executing on a multiyear investment program to improve customer reliability and support economic development. In 2024, we invested $1.6 billion, leading to a rate base growth of 20%. This investment program includes growth and modernization programs at both of our utilities and a plan to transition our aging coal generation in Indiana. Our investment plans are driven by our customers, and our top priority is to support local communities with reliable, resilient, and affordable power. We have among the lowest residential rates in both states, which we expect to maintain even as we grow our rate base. Turning to slide nine, across our two utilities, we have growth riders or trackers, which shield near real-time returns on our investments. More than 70% of the investment program is recovered through formula rates or existing riders, such as the TDSIC program at AES Indiana, with the FERC formula rates that support transmission investment at AES Ohio. All of this, combined with signed agreements for over 2 gigawatts of new data center demand, make AES Indiana and AES Ohio among the fastest-growing and modernizing utilities in the nation. From 2023 to 2027, we expect annualized growth in a rate base of at least 11% across the two utilities. This plan will support credit improvement at DPL Inc., which we expect to achieve investment-grade metrics by 2026. Now turning to slide ten, our energy infrastructure business provides a substantial and steady base of earnings and cash flow that support our credit ratings and help fund our dividends and new growth. We remain committed to an all-of-the-above strategy, which includes an important role for gas in our businesses and customer offerings. During the fourth quarter, we completed the construction of a new 670-megawatt fully contracted in dollars CCGT in Panama, which will result in much greater utilization of our existing LNG regasification in the country. In addition, we are delaying the closure or sale of a few of our coal plants as a result of increased demand in those markets. These assets are largely depreciated yet contribute meaningful EBITDA and cash flow. We still remain committed, nonetheless, to a full exit from coal generation and will continue to rapidly lower our carbon intensity and minimize carbon emissions from our generation fleet. Now moving to our financial outlook on slide eleven. Today, we are initiating our 2025 guidance, including adjusted EBITDA of $2.65 to $2.85 billion, parent free cash flow of $1.15 to $1.25 billion, and adjusted EPS of $2.10 to $2.26. We are also reaffirming all of our long-term growth rates, including 5% to 7% adjusted EBITDA growth through 2027. As we grow, we are also improving our business mix as we see a significant increase in adjusted EBITDA from renewables and US utilities. Now turning to our balance sheet and plans to improve our credit ratios through and beyond our guidance period on slide twelve. We are firmly committed to maintaining our investment-grade credit ratings as well as our dividend. As a result, we are taking several actions to improve cash flow and reduce parent equity requirements while ensuring that our capital plan will be totally self-funded. I should note that these efforts are ongoing, and we will continue to evaluate measures to strengthen our financial position on top of what is already included in our guidance. First, we have resized our development program and organization to focus on executing on our backlog and pursuing fewer but larger projects to better serve our core customers. This strategy allows us to increase our returns on our available capital by selecting the most attractive projects. Given the strength of our 50-gigawatt US pipeline, we also expect to execute more development transfer agreements, enabling us to monetize a portion of our renewables pipeline without requiring significant AES equity. As a result of all of these actions, we have reduced our parent investments in the renewables business by $1.3 billion from now through 2027 and eliminated the need for equity. Second, we are streamlining our organization ahead of what was originally planned. Our business is significantly simpler today than it was ten years ago. As we now operate in fewer countries, our portfolio consists of more than 50% renewables, and our growth is primarily concentrated in the US. In 2025, after the execution of this restructuring, we will realize approximately $150 million in cost savings, ramping up to over $300 million in 2026 as we achieve a full-year run rate. Third, as I previously mentioned, we will retain a few of our coal assets beyond 2027 to support our financial metrics and fund new projects. Taken together, these actions enable an even stronger AES with a clear path to achieve our 2025 and long-term financial commitments and strengthen our credit metrics. In summary, we have a resilient strategy to deliver on our financial commitments regardless of regulatory outcomes. We have continued to de-risk our business by exiting Brazil, locking in and onshoring our equipment, and moving our supply chain to the US. As I mentioned earlier, 2025 is an inflection point for the financial results of our US renewable business as we begin to harvest many years of work and investment. Demand from our core corporate clients remains strong and growing, and we are taking all steps to increase our efficiency and profitability. We are confident in the underlying value of our business, and we are committed to strengthening our balance sheet while capitalizing on our unique competitive advantages. With that, I will turn the call over to Steve.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will discuss our 2024 results and capital allocation, our 2025 guidance, and our updated expectations through 2027. Turning to slide fourteen, full-year 2024 adjusted EBITDA was $2.64 billion versus $2.8 billion in 2023, driven primarily by record-breaking drought conditions in South America, several forced outages, and asset sales but partially offset by contributions from new renewables projects. Turning to slide fifteen, adjusted EPS was $2.14 in 2024 versus $1.76 in 2023. Drivers were similar to those for adjusted EBITDA but also include significantly higher tax attributes on new renewables commissionings and a lower adjusted tax rate. This tax benefit was associated with our transition to a simpler, more US-oriented holding company structure better aligned with our growth. This is partially offset by a $0.07 headwind from parent interest on higher debt balances, primarily used to fund new renewables projects. I will cover our results in more detail over the next four slides, beginning with the Renewable Strategic Business Unit or SBU on slide sixteen. Lower adjusted EBITDA at the renewables SBU was primarily driven by historic weather volatility in South America. In the second quarter, an unprecedented flood forced an outage at our Chivor facility for nearly two months, which was then followed by a record-breaking drought across the country. Brazil was also impacted by a lengthy drought and extremely low wind resource, and the sale closing in the fourth quarter reduced EBITDA on a year-over-year basis. These negative drivers were partially offset by contributions from new projects that came online primarily in the US. At our utilities SBU, higher adjusted PTC was primarily driven by rate-based investment in the US, new rates at AES Indiana, and improved weather but partially offset by the 2023 recovery of purchased power costs at AES Ohio included as part of the ESP4 settlement as well as higher interest expense from new borrowings. Lower adjusted EBITDA at our energy infrastructure reflects an outage in Mexico, lower margins at Southland, and sell-downs in Panama and the Dominican Republic. Finally, at our new energy technologies SBU, higher adjusted EBITDA reflects improved results at Fluence. Now let's turn to how we allocated our capital last year on slide twenty. Beginning on the left-hand side, sources reflect $3.1 billion of total discretionary cash. This includes parent free cash flow of just over $1.1 billion, increased more than 10% from the prior year. We distributed nearly $600 million of asset sales proceeds to the ASP. Alright. And we issued $1.4 billion of hybrid parent debt. Moving to uses on the right-hand side, we invested approximately $1.9 billion in growth at our subsidiaries, of which more than 80% was allocated toward our renewables and utilities businesses. We also repaid roughly $180 million of subsidiary debt and allocated $500 million of discretionary cash to our dividend. In addition, we used a portion of December hybrid issuance proceeds to repay parent debt and have ended the year with a significant cash balance that will go toward executing on our backlog in 2025. Turning to our guidance and expectations beginning on slide twenty-one. Today, we are initiating 2025 adjusted EBITDA guidance of $2.65 billion to $2.85 billion, in which growth in our core businesses is offsetting a number of one-time year-over-year headwinds. Our guidance includes more than $300 million of growth at our Renewables and Utilities SBUs. This is partially offset by the sale of AES Brazil, the pending 30% sale of AES Ohio, as well as approximately $200 million from a reduction in Southland margins related to declining power prices in California, and the retirement of our Warrior Run coal plant in energy infrastructure where we recognized revenues in the first half of 2024 related to the monetization of the PPA. The timing of these 2024 items combined with the seasonality of our renewables growth will result in our first-half EBITDA being lower on a year-over-year basis, while the second half will be significantly higher. In addition to these drivers, we also expect to realize $150 million of cost savings in 2025 across all businesses from the actions we are taking that Andres outlined. Looking beyond this year, these savings, which increase to a run rate of over $300 million in 2026, combined with continued growth in renewables and utilities, will accelerate the growth trajectory of AES. As a result, we now expect a much higher low teens EBITDA growth rate in 2026 versus 2025. In addition, we expect to recognize $1.4 billion of tax attributes in 2025. This represents an increase of nearly $100 million driven by more projects coming online in the US. In total, we expect to achieve $3.95 to $4.35 billion of adjusted EBITDA with tax attributes in 2025. Turning to slide twenty-two, I will now provide some additional color on our renewables as SBU adjusted EBITDA, which we expect to increase significantly year over year in 2025. This growth includes more than $150 million from new projects, much of which relates to the 6.6 gigawatts of new capacity we placed in service in late 2023 and throughout 2024. These projects are already online and operating and will now contribute a full year of EBITDA in 2025. The sale of AES Brazil in the fourth quarter of last year will serve as a $100 million headwind year over year but is more than offset by the resegmenting and growth of our renewables business, which is forecasted to be close to $190 million in 2025. The last two drivers are the normalization of Colombia results after the second quarter flood-driven outage and historic drought conditions in 2024, and the impact of resizing our development business as Andres previously discussed. Turning to slide twenty-three, we are initiating 2025 adjusted EPS guidance of $2.10 to $2.26, and we expect to achieve the upper half of the 7% to 9% long-term growth target initiated in 2021. Drivers are similar to adjusted EBITDA with tax attributes but will be offset by higher parent interest and a higher adjusted tax rate. As a reminder, our results have historically been somewhat seasonally weighted toward the second half of the year, and this year is no exception. Now turning to our 2025 parent capital allocation plan on slide twenty-four. Beginning with approximately $2.7 billion of sources on the left-hand side, parent free cash flow for 2025 is expected to be around $1.15 to $1.25 billion. We expect to generate $400 million to $500 million of net asset sale proceeds this year and issue an additional $700 million of net new parent debt. For the uses on the right-hand side, we plan to invest approximately $1.8 billion in new growth, of which more than 85% will be in the US. We also plan to repay roughly $400 million of subsidiary debt and allocate more than $500 million to our shareholder dividend, which reflects the previously announced 2% increase. Turning to slide twenty-five and our long-term expectation, we expect tremendous growth at our renewables SBU, with an average annual CAGR of 19% to 21% expected from our 2023 guidance midpoint. This will be primarily driven by 6.6 gigawatts of new projects already placed in service, along with roughly $700 million of new EBITDA from bringing the majority of our 11.9 gigawatt backlog online. Also included is the addition of Chile Renewables, offset by the sale of AES Brazil, neither of which were contemplated in our 2023 SBU guidance ranges. For our utilities SBU, we expect annualized growth of 13% to 15% through 2027, reflecting upside from new data center development in our service territories that could serve as an even greater tailwind beyond 2027. This growth is largely covered by trackers and will be critical to improving service quality and reliability for our customers. Our utilities plan also incorporates the 30% sell-down of AES Ohio, which we expect to close in the first half of this year. This will reduce adjusted EBITDA in the near term but allows us to fully capture the data center opportunity in the long term and maximize shareholder value. In our energy infrastructure SBU, we now expect EBITDA contributions will decline at a slower rate than in our prior guidance, as we plan to operate a few coal plants beyond our previously planned 2027 exit, improving earnings and cash flow. Now to slide twenty-six. Bringing it all together, I am pleased to reaffirm our long-term adjusted EBITDA growth target of 5% to 7% and our long-term parent free cash flow growth target of 6% to 8% through 2027. This growth is largely locked in through signed PPAs for our backlog projects and approved or tracked rate-based investment at our utilities. Turning to slide twenty-seven, in our long-term capital plan, total sources of $6 billion will be funded primarily with parent free cash of $3.6 billion to $3.9 billion, reflecting average annual growth of 6% to 8% off our 2023 guidance midpoint. We also expect to issue $900 million to $1 billion of net new parent debt and realize $800 million to $1.2 billion of proceeds from asset sales. It is important to note here that we have fully removed any need for equity issuance throughout our guidance period. On the right-hand side, parent investment of approximately $4 billion reflects our reduced investment in renewables. We also plan to repay $600 million of subsidiary debt. We expect to allocate another $1.6 billion of cash to our dividend, which we are fully committed to maintaining at its current level. However, given our efforts to minimize parent cash needs and the already highly active yield, we do not expect to grow the dividend during our plan period. Our long-term guidance includes the impact of the actions we are taking to simplify our operations, reduce spending on development, and further increase our cash flow and strengthen our credit metrics. These include reducing our planned renewables investments by $1.3 billion, implementing a restructuring program to generate over $300 million of run-rate cost savings by 2026, and continuing to operate select coal assets with earnings and cash potential beyond 2027. These actions demonstrate our commitment to our financial targets as well as our investment-grade credit ratings. I want to briefly make a few points about our capital structure and financing model. While we see an uptick in our total debt levels by the end of 2027, which should be looked at on an ownership-adjusted basis, our actions to reduce costs and focus our development efforts on higher-returning projects will increase cash flows and improve our credit metrics. This eliminates any need for new equity and gives us more flexibility on timing to execute asset sales and sell-downs. Approximately 20% of our debt is related to projects still under construction that are not yet yielding EBITDA or cash, and more than half of this amount will be permanently taken out by monetizing tax attributes when projects are placed in service, leading to a significantly lower level of long-term project debt. Given that we carry this construction debt, it is relevant to consider a pro forma view of the annual EBITDA and cash generation that will recur once construction is complete. To be specific, the projects that come online during 2027 or are still in construction at the end of 2027 will generate an additional $400 million of annual adjusted EBITDA that is not reflected in our 2027 guidance window. Beyond construction, our projects are financed with long-term non-recourse debt that fully amortizes using project-level cash flows over the life of the PPA. This project debt is non-recourse to the AES parent, resulting in a capital structure that is robust and low risk. Turning to slide twenty-eight, this chart provides an example of the typical debt and EBITDA levels we would expect over the life of a US renewables project. While a new project is under construction, debt ramps up with no corresponding EBITDA. Once the project is placed in service, there is a material reduction in the debt balance as more than half of the construction debt is repaid through the monetization of tax attributes. The remainder is refinanced using long-term fixed-rate amortizing project debt that is pre-hedged when the PPA is signed. In the first full year of operations, leverage ratios begin at approximately six times debt to EBITDA and will continue to decline each year as the project debt amortizes. This example helps demonstrate how AES leverage ratios appear artificially high while we execute on our ongoing construction program but will come back down as our operating portfolio reaches a larger scale. In conclusion, 2025 is an inflection point for our business. The renewable segment will increase over 60% in 2025 and will yield annual growth at least in line with our 19% to 21% guidance through 2027. Utilities rate-based growth is even stronger than previously expected, while energy infrastructure continues to contribute meaningfully to EBITDA and cash. We have taken actions to streamline our organization and reduce both costs and capital investments. These actions are further increasing our cash flows and will enable AES to deliver increasingly higher credit metrics as we execute on our backlog. Finally, we are on track to achieve our long-term financial guidance. I look forward to providing updates throughout the year as we continue executing on our plan and capitalizing on the actions we have taken to ensure continued success at AES. With that, I will turn the call back over to Andres.
Andres Gluski: Thank you, Steve. In conclusion, here are the key points we want to leave with you today. There is an unprecedented need for incremental energy to power the AI revolution in the United States. Notwithstanding concerns about potential regulatory changes under the new administration, renewables have the best time to market at a competitive price. Additionally, we are well insulated from potential changes in US renewables policy or tariffs through safe harbor protections for our backlog, having locked in equipment and EPC pricing, and established domestically based supply chains. Our renewables business is at an inflection point with improving financial results from the combination of continued growth, reaching economies of scale, and reductions in development expenses. We are reaffirming our longer-term growth rates through 2027 as we execute on our 11.9 gigawatt backlog. And we are taking steps to improve our credit metrics. As always, we are highly focused on delivering the highest risk-adjusted returns to our shareholders, and we believe that AES is very well positioned to meet both our customers' energy demands as well as our financial commitments. Operator, please open the line for questions.
Operator: Thank you. We will now begin the question and answer session. You can press star followed by two to withdraw yourself from the queue. Our first question comes from Nicholas Campanella with Barclays. Nick, please go ahead.
Nicholas Campanella: Hey. Good morning. So just on the cost savings, you know, you have $150 million, ramping to $300 million over time. I heard you, Steve, say that these are run rates. So I assume these are ongoing and not one-time in nature. Just recognize you had about $52 million in the bridge for renewables. So is the bulk of this coming from the parent, does it happen naturally as you sell down more in the energy infrastructure business? And maybe you can kind of just expand on your confidence level in achieving these reductions and where you see a bulk of these happening in the portfolio. Thanks.
Steve Coughlin: Yeah. Hi, Nick. It's Steve. So the cost savings are spread across the portfolio and definitely include the renewables business as well. It is a run rate when we hit over $300 million next year. So these are not one-time. And I would emphasize that we've already taken these actions. So this is something that we're very confident in because we've already made the decisions and taken the actions that we need to take to achieve cost savings. So the renewables number that you see for 2025 in that bridge, that will also ramp up in line with, you know, the $150 million going to $300 million. I would expect that proportion to remain roughly the same.
Nicholas Campanella: Okay. Okay. And then, you know, just on the comments you're cutting CapEx, but you're still hitting the growth target of 5% to 7% long-term EBITDA. So yeah. You previously talked about a 12% to 15% IRR on renewables. What's the IRR of these higher quality projects that you're now targeting? And is the cost cuts just making up for the rest of that delta? Just tying out to the long-term guidance? Thank you.
Andres Gluski: Sure. Look. We're taking an integrated approach. So yes, we see strong demand in the markets. We see that we have very attractive projects so that our IRRs are going up, you know, on average. But at the same time, we're also reducing those costs not directly associated with the project. So it's really coming from both sides. So it's an integrated approach. So what we're doing is and then, you know, we quite frankly have said this to some extent in the past. It's not just the number of gigawatts. It's the returns we get, for example, EBITDA created by each investment dollar. So that's really what we're focusing on. So, you know, it will mean fewer projects, but larger projects, and at the end, more profitable projects.
Nicholas Campanella: Okay. Thank you. Our next question comes from David Arcaro with Morgan Stanley. Please go ahead, David.
David Arcaro: Okay. Thanks. Good morning. On the let's see. Looking at that, it seems like you're pulling back somewhat on the renewable CapEx in the forecast. Wondering from a high-level kind of strategic perspective, Andres, do you see this as a kind of a pause in, I guess, in the renewables growth or just a bit of a pullback in making those investments into the renewables business just given the current environment? You know, and over time, would you expect to reassess and potentially reaccelerate to the extent, you know, financing becomes easier to backdrop becomes more favorable.
Andres Gluski: Yeah. That's a great question. Look, we are focusing on executing on our 12-gigawatt pipeline, which 85% of that will be online by 2027. So that's our number one focus. As we mentioned in our script, we've been spending a lot, which flows through, you know, P&L is building that 50-gigawatt pipeline in the states and 10-gigawatt pipeline outside. So really what we're doing is harvesting that pipeline. You know, we don't want to grow it to 100 gigawatts. So we've done that work. We're going to harvest it. So, basically, we're spending less, if you will, on, you know, future projects with a time horizon of five to seven years because we've done that work. Now in terms of, you know, total growth rate, what we're saying is we're going to be building less gigawatts, for sure, but we're going to maintain our financial results. So that's the sort of picture. Now again, what we see is strong demand from our clients. But, you know, we're very happy to, you know, this year, we'll be commissioning around 3 gigawatts of new projects. Next year, that would step up to 4 gigawatts. So you're seeing we're signing around, you know, four plus per year. So, eventually, the amount that we commission and the amount that we build have to, you know, roughly come in line.
David Arcaro: Yep. Got it. Great. Thanks for that extra detail. And then I guess, looking at the overall profile of the businesses and your asset sales target now. I guess it seems like you're increasing the asset sales target overall, but you're keeping coal in the plan for a bit longer than originally planned. Could you maybe talk about what the profile is of the assets that you might be looking at in the asset sales target now? What could be represented in there?
Steve Coughlin: Sure. Hey. Hey, David. So, you know, similar to what we have talked about in the past, you know, it does still include some coal exit. It does still include some monetization of our technology portfolio. But we have, you know, always said that the universe is greater than the $3.5 billion. We've actually taken a little bit more conservative view on what we intend to execute here. So we're really confident in the number between 2025 and 2027. And, you know, we have looked at the sell-downs as well. So this number includes some of the partnerships that we do. But what I would say is this capital plan, you know, relies less on these asset sales than in the past. And, you know, we have over time baked in more flexibility to execute the sales.
David Arcaro: Okay. Got it. Makes sense. Thanks so much.
Operator: Our next question comes from Durgesh Chopra with Evercore ISI. Please go ahead.
Durgesh Chopra: Hey, team. Good morning. Thanks for giving me time. Alright. Just wanted to double click on cost savings. $300 million annual target, you know, it's pretty substantial when I look at your EBITDA number, roughly 10%. Maybe just can you give us some examples of what cost reductions are these? Are these personnel reductions? Are these process improvements? Just so we can get a little bit more comfort around your target level of cost reduction, please?
Andres Gluski: Sure, Durgesh. Great question. With me is Ricardo Fallu, our Chief Operating Officer, who's been leading a lot of the reorganization restructuring efforts. So I'll let him answer that question.
Ricardo Fallu: Thank you, and good morning. So AES' cost reduction program includes, as Andres and Steve mentioned, first, the resizing of our development program to focus it on executing on our backlog as well as pursuing fewer but larger projects. And as a result, we sized the team. We also materially cut the new site's origination as well as early-stage project costs. And on top of that, we reduced a 10% reduction in our workforce, which includes the elimination of certain management layers as well as a much leaner organization, both at corporate and business levels. This is something that we plan to course more gradually through 2027. However, in response to the current market conditions, we decided to accelerate, and this organization now is aligned to the much simpler portfolio that Andres mentioned.
Andres Gluski: Yeah. Because I'd like to mention that these actions have been taken. So Steve also mentioned that these are done. And also the decisions in terms of losing the amount of capital we put into the renewables business. So, you know, there is very little execution risk on it because it's done.
Durgesh Chopra: That's very helpful color. And I could sense the confidence you have in executing on these cost reductions. Okay. Thank you. And then my final question, Steve, just maybe can you help us with where you landed on a federal debt basis and referring to sort of on a Moody's adjusted basis for 2024 relative to your credit downgrade thresholds. Thank you.
Steve Coughlin: Yeah. Absolutely, Durgesh. So on the recourse metric, so at the parent level, we ended at 22%. So, you know, it's a significant cushion above the 20% threshold. On the Moody's metric, we ended on our calculations at 10%, which is right in line with where we expected to be. In both cases, these metrics will improve over time. At this point, with this updated plan where we focus very closely on improving our credit metrics, we do expect to get into the mid-twenties on the recourse metrics by the end of the guidance period. And in 2026, in line with what we've been discussing with Moody's, we expect to be at or above the 12% threshold. I feel really good about the actions that we've taken and what we're doing to increase our cash and EBITDA. Net debt to EBITDA ratios will improve over time as well. The other thing I would point out is, as I said in my prepared remarks, we do carry about $4 to $5 billion of construction debt on our balance sheet at any one time. It is not yet yielding. And so, you know, our leverage ratios look artificially high at any one point in time as a result. And so these ratios, when adjusted for that, for example, on a net debt to EBITDA, comes down one to one and a half times just by adjusting for that construction debt. But as I looked at the ratios, or I mentioned the ratios, those are based on the actual way that they get calculated, you know, without this adjustment. But I do think it's important in understanding our leverage profile. You know, it's very important to look at this ownership-adjusted debt level because the EBITDA, of course, is ownership-adjusted. And to understand that the leverage profile continues to improve over time as the operating portfolio gets bigger and bigger relative to the construction.
Durgesh Chopra: Got it. Very helpful color, Steve, and appreciate the added disclosure in slides explaining the debt to EBITDA over time. Thank you.
Steve Coughlin: Thank you, Durgesh.
Operator: Our next question comes from Julien Dumoulin-Smith with Jefferies. Please go ahead.
Julien Dumoulin-Smith: Hey. Good morning, Steve. Thank you guys very much. I appreciate it. Maybe just to follow up on that last one, just following on the subject. Can you just elaborate, I mean, to what extent have you gotten in front of Moody's with this plan? And just if you could elaborate a little bit on how you're thinking through 2027 on that evolution of those metrics and that's the icing given the backdrop of Moody's care.
Steve Coughlin: Yeah. Sure. Good morning, Julien. So we have, you know, discussed that we were working with Moody's last year where this was headed. What I would say is it looks right on track. In fact, even a little bit better. Given the actions that we've taken, effectively, you know, what's happening is, you know, our cash flow and EBITDA is increasing substantially through the plan period. And, you know, that's a result of bringing on substantial amounts of operating since we have, you know, 12 gigawatts in our backlog, most of which will be coming online through 2027. And then on top of that, we are reducing, as Andres and Ricardo discussed, our development spending is down based on our updated strategy of pursuing larger but fewer projects. We're putting less money into early-stage prospecting and more maturing the pipeline that we have. And then our administrative spending is down substantially as well. And that's also as a result of what was mentioned about our simplification of our portfolio and the reduction of management layers and efficiencies that result from these actions that we have already taken. So together with this cash flow increase from operations, the reduction in cost, the ratios continue to look very healthy, in line to better than our prior expectations.
Julien Dumoulin-Smith: Excellent. Thanks, Steven. Maybe just to keep going with that a little bit further. Just given the reduction of $1.3 billion here, just on balance, are you actually selling down stakes in more renewables in order to reduce that need for contributions? Or is the aggregate level of renewable investment per year slowing down here? I just want to make sure we're clear. You've talked about backlog and executing at this. Just want to understand, like, how you think about, like, renewables per year install. Evolving through the period now given the update as well as what level of contribution from coal, not what assets, but just what level of cash or EBITDA, however you want to talk about it, from coal are you anticipating, you know, in 2026 and 2027 beyond now as well?
Andres Gluski: Okay. Let's sort of break that. I think there's several questions there. So on the first one, again, through 2027, we're basically executing on our backlog. And look, we're seeing very strong demand from our clients. Since our last call, we signed 450 megawatts with tech customers. So we see no downturn in demand. So basically, what we see is, you know, there's no cliff in 2027. I mean, our demand continues to grow. Second, maybe an easy way of thinking would Steve had described is, if you have a pool, say roughly $4 to $5 billion in construction debt, and you are basically carrying that over 16 gigawatts, and then you go up to 25, 30 gigawatts, you know, that your credit metrics improve. Even though that debt is really sort of short-term rotating because half of it's going to be paid back upon completion. That's number one. So then number two, talking about how much the coal is going to contribute, sort of post-2027. I'll pass that to Ricardo.
Ricardo Fallu: Thank you, Andres. Good morning, Julien. So just to put it into perspective, the keeping or retaining a few coal assets, half or less than half of what we currently have, will be less than 8% of the expected capacity by the end of 2027. These assets continue to provide critical capacity to the grid and also to our customers, and therefore they continue contributing, I would say, you know, to the financial health of the company. We're clearly not abandoning our intention to exit coal, but it will take longer than we previously expected.
Steve Coughlin: Yeah. And I would also add here, Julien, that these are also assets that as they're more mature, their debt is amortized, but they're also very accretive in terms of our credit metrics.
Andres Gluski: And lastly, to say, you know, we're doing this because in those markets, because of the sort of supply-demand balance, they need to keep these plants online. So, you know, it all comes together. It's good for our financials, but it's also giving the market what the market is asking for.
Julien Dumoulin-Smith: Bottom line, though, you're seeing a down so you're seeing a leveling off in renewable the cadence just per annum. Just to come back to that backlog comment? I'm just trying to understand at the end of the day, like, how you see it?
Andres Gluski: Yes. I would put it this way. You know, post-2027, what we see is less growth in the number of megawatts than our original plans. I mean, that's clear. Because we're spending less on creating a pipeline of potential projects five to seven years out. So, yes, the answer is yes.
Julien Dumoulin-Smith: Okay. Thanks, guys.
Operator: The next question comes from Michael Sullivan with Wolfe Research. Please go ahead, Michael.
Michael Sullivan: Hey. Good morning. Thanks for the update. Good morning.
Steve Coughlin: Morning.
Michael Sullivan: Yeah. Hey, guys. Why don't I just pick up on the last question around just the coal contribution? I think Ricardo, you're giving it on a capacity basis. Any chance we can get that on an EBITDA basis? Just trying to think about when you had the Analyst Day, you said coal was like a $750 million roll-off. What does that look like now through 2027?
Steve Coughlin: Since I'm the financial numbers guy, Steve, I'll take that one. Michael. So we had guided, as you said, about $750 million that would be eliminated. I would say, you know, we're looking at, you know, roughly a third of that that may continue, you know, beyond 2027 for a period of time.
Michael Sullivan: Okay. That's very helpful. And then on just interest rates. I think you have a couple of parent maturities coming up. Should we think of those as derisked from a sensitivity standpoint, or what are you embedding there in terms of refi or anything like that?
Steve Coughlin: Yeah. So we did do a hybrid at the end of last year, $500 million, which starts us well into this year. And then we will be in the market to refi. So we have a maturity here in July and one in January. So we will be in the market, I would say, relatively soon. We typically refi, you know, somewhere between three to six months in advance of these maturities, and our plans will be similar this year.
Michael Sullivan: Okay. And then last one, I yeah. I definitely can appreciate the sort of ramp of things here. The 5% to 7% EBITDA CAGR, can you get in that range in 2026 off of 2023, or are we really looking to 2027 to really get in there?
Steve Coughlin: Yeah. No. So definitely in 2026, and actually, let me add one other thing to your prior question is that on those refis, by the way, we are nearly fully hedged, so we don't carry any interest exposure, further interest exposure on those refis. And then with respect to 2026, if that's a significant benefit from this action plan, you know, we did contemplate simplification of the portfolio and cost reduction in the past over time. But what we have really done here is we've accelerated this, and so 2026 is going to be a year of significant growth in our EBITDA. And I think I mentioned in my comments in the low teens, and we expect another significant year of growth in 2027. So we will, you know, jump ourselves up onto at least that trend line next year. This year in 2025, the guidance isn't as exciting simply because we had some of the, you know, remaining transformation here around the Brazil exit. We had the Warrior Run benefit last year. And so, you know, some of these items, you know, depressed the year over year. But the reality is where the core business is growing is contributing more than $300 million this year. There's just those offsets going forward. The energy infrastructure SBU, we've largely absorbed most of the decline as of 2025, and so we won't see as significant of an offset from energy infrastructure going forward, and therefore, sort of that growth is unleashed from the core businesses to truly drop all the way into the total bottom line, and therefore, we have higher growth rates beyond this year.
Andres Gluski: You know, one thing I'd like to mention is, you know, we're talking about the quantitative results, but it is really very important qualitative results. Yes. You know, we're transitioning this portfolio to be more contracted, to be, you know, more renewables, more utilities, you know, less but by getting rid of 5 gigawatts, you know, think about Brazil. I mean, that was about, you know, we have about 30 gigawatts. We sold out of 5. That was most of our hydrology, currency, it was all floating rate, interest rate exposure. So qualitatively, we're transforming this portfolio at the same time. So it's not just that it's going to have very good growth in 2026 and 2027, but it's going to be a much better portfolio as well.
Michael Sullivan: Okay. Appreciate all the color. Thank you.
Steve Coughlin: Thank you, Michael.
Operator: Our final question today comes from Willard Grainger with Mizuho. Please go ahead, Will.
Willard Grainger: Hi. Good morning, everybody. I appreciate all the disclosures here. Understand, you know, you reduced the CapEx here, but just want to understand a little bit more what's the flexibility to, you know, thinking about maybe we're reducing it even more and investing in your stock here just given where you're trading. Any color on that, you know, cost of capital would be super helpful.
Andres Gluski: Now we're, you know, as I said in my very first statement, you know, we're very well aware of where AES is. We're doing everything possible to improve it. What I would say is that, you know, what we're presenting here is a plan that we think accomplishes this. And, you know, we are paying, we're giving back to shareholders $500 million a year. We're paying a very healthy dividend. So right now, you know, this is the plan that we feel very confident about executing. And that we think will, when the market, you know, settles down, you know, we think will result in very good returns for our shareholders. But thanks for the question, and we are constantly thinking of those things.
Willard Grainger: Appreciate that. And then maybe just one final one from me. Understand you're doing a lot of work with technology customers, manufacturing customers, and just on the items that the FERC and what we're seeing also in Texas, does that impact your ability to contract long-term renewables either, you know, through colocation or virtual PPAs and the right color on that would be appreciated.
Andres Gluski: Yes. I think you're probably referring to like this as a private, you know, so colocation private use networks. And look, we don't see that affecting us. We think that, you know, most of our we have a very, I would say, resilient pipeline because we have very few federal lands if at all, all on private lands, and we don't have as part of that pipeline any any BUNs at this point. So we feel very, very confident about our pipeline, and we don't see any of these regulations affecting us.
Willard Grainger: Great. Appreciate the color. Thank you.
Andres Gluski: Thank you.
Operator: Those are all the questions we have. And so I'll turn the call back to Susan Harcourt for closing remarks.
Susan Harcourt: We thank everyone for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day.
Operator: Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Hello, everyone, and a warm welcome to The AES Corporation Fourth Quarter and Full Year 2024 Financial Review Call. My name is Emily, and I will be coordinating your call today. After the presentation, you will have the opportunity to ask any questions, which you can do so by pressing star followed by the number one on your telephone keypad. I will now hand over to Susan Harcourt, Vice President of Investor Relations, to begin. Susan, you may begin."
},
{
"speaker": "Susan Harcourt",
"text": "Good morning, and welcome to our Fourth Quarter and Full Year 2024 Financial Review Call. Our press release, presentation, and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-Ks and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; Ricardo Fallu, our Chief Operating Officer; and other senior members of our management. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our Fourth Quarter and Full Year 2024 Financial Review Call. Today, I will cover our 2024 accomplishments, the resiliency of our business, and our 2025 guidance and longer-term outlook. Steve Coughlin, our CFO, will provide more details on our financial performance and expectations after my remarks. To say that we are extremely disappointed with our stock price performance is an understatement. Steve and I will address what we believe to be investors' concerns, including policy uncertainties, renewable EBITDA growth, and balance sheet and funding constraints. We will review why renewables are critical to meeting growing demand for electricity, particularly among technology customers, and why our business model is relatively well insulated from and resilient to potential regulatory changes. Even with our resilient position, we are taking immediate steps to strengthen our financial position and outlook. These steps include reducing our parent investment in renewables by focusing on the highest risk-adjusted return projects, improving organizational efficiency, and continuing to operate some of our energy infrastructure assets. As a result of these actions, we expect to improve our credit metrics over time while eliminating the need for issuing new equity during the forecast period and maintaining our dividend. Turning to slide four, we signed 4.4 gigawatts of new power purchase agreements for renewables last year. Our performance in 2024 puts us on track to achieve our goal of signing 14 to 17 gigawatts of new PPAs through 2025. We are prioritizing signing those contracts with the best risk-adjusted returns rather than just maximizing growth in gigawatts. In 2024, we also completed the construction or acquisition of 3 gigawatts of renewables and a 670-megawatt combined cycle gas plant in Panama, greatly increasing the utilization of our existing LNG terminal in that country. Our best-in-class record of on-time and on-budget delivery of renewable projects is something that our customers value highly and is one of our competitive advantages. Lastly, I should note that in 2024, we received approval from the Indiana Regulatory Commission for new base rates and an ROE of 9.9%, supporting an investment program that will improve reliability for our customers and support local economic development. Now moving to our financial results. In 2024, we achieved adjusted EBITDA of $2.64 billion, which is in the lower half of our guidance range as a result of extreme one-time weather-related events in Colombia and Brazil, with both businesses down a combined $200 million year on year. Nonetheless, we generated parent free cash flow of $1.1 billion, which is at the midpoint of our guidance. We earned a record adjusted EPS of $2.14, which is materially above our guidance range and puts us well on track to achieve our annualized growth target of 7% to 9% from 2020 to 2025. Moving to our renewables business on slide five, 2025 will be an inflection point as we begin to realize the financial benefits from the maturing of our renewable business, including the addition of 6.6 gigawatts we inaugurated in 2023 and 2024. We are able to achieve increasing economies of scale that reduce our overhead per megawatt, as we now have 16.2 gigawatts of renewables online versus 5.9 gigawatts in 2018, excluding Brazil. At the same time, our development business is becoming more efficient. We are now harvesting the investments we made in creating our pipeline. Furthermore, as profitability of each megawatt of new PPA signed has substantially increased, we do not need to bring online as many new projects to achieve the same level of financial growth. This strategy allows us to focus on the most profitable new projects while reducing costs and capital requirements. As I will shortly discuss, there is a time lag between renewables development expenditures, which flow through the P&L, and growth in EBITDA. Creating a pipeline of potential projects requires expenditures on development activities such as scouting for prospects, negotiating land purchases or leases, measuring the wind or sun resource, and finally, obtaining permits. As our renewables are in a more mature state, our financials will start to reflect the true profitability of the business as new projects coming online cover the cost of early-stage projects. As the business grows, stewardship, including administrative and back-office activities, will get allocated over a larger operating base. This inflection in our life cycle starting in 2025 will strengthen our credit metrics as we achieve a higher ratio of projects online selling energy versus spending on pipeline and projects under construction. With this background, let me turn to our financial expectations for our renewables business. In 2025, we expect over 60% year-over-year growth in our renewables EBITDA, which Steve will discuss in more detail. Previous growth in our US renewables portfolio drives the majority of our expected EBITDA growth. In 2025, another 3.2 gigawatts of renewable capacity we expect to bring online will contribute to strong EBITDA growth in 2026 and beyond. These numbers also reflect the maturing of our US renewable business as we harvest the investments we made to create our 50-gigawatt US pipeline. Finally, I should note that our 2025 renewable segment guidance incorporates some changes in segment makeup, including the sale of 5.2 gigawatts in Brazil last year and the addition of 2.5 gigawatts in Chile. As the business has evolved, these Chilean renewable assets have now been moved from the energy infrastructure SBU to the renewables SBU. The sale of Brazil is an important de-risking of our portfolio as we have eliminated a significant portion of our hydrology, currency, spot price, and floating interest rate risk exposures. Turning to slide six and the renewables market and our business, last year, the US added 49 gigawatts of new capacity with renewables, battery storage, representing 92% of those additions. In 2025, the US is expected to add 63 gigawatts, 93% of which are solar, storage, and wind. While we will likely see a surge for new gas capacity over the next decade, delayed delivery of new gas turbine averages three to four years, without taking into account new permitting requirements or building new gas pipelines. While a few decommissioned nuclear units are expected to be brought online in the next five years, a material contribution in new capacity from small nuclear reactors or advanced design nuclear plants is unlikely to occur for at least another decade. Taking all this into consideration, renewables have the shortest time to power and much greater price certainty. Therefore, there is no doubt that the increased demand for electricity over the next decade, coming from data centers and advanced manufacturing, will continue to require vast amounts of renewable energy and batteries. Moving to slide seven, over the past five years, we have endeavored to make our business resilient to potential policy changes. First, we have taken a lead in onshoring our supply chain to the US, which limits our exposure to new tariffs. We now have essentially all of our solar panels, trackers, and batteries either in-country or contracted to be domestically produced for our US projects coming online through 2027. Second, of the 8.4 gigawatts of signed contracts we have in the US, more than half are under construction, and nearly all have significant safe harbor protections, which will grandfather them under the existing tax policy. Third, about 3 gigawatts, or 30% of our backlog of signed PPAs, are in US dollars but in international markets, primarily Chile, which are unaffected by US policy changes. I should note that in our international markets, renewables can be even more profitable and most often the cheapest form of dispatchable energy, even in a regime without meaningful subsidies. Lastly, the vast majority of AES' customer base are corporations whose demand for new renewables continues to increase at a rapid pace. In fact, in 2024, approximately 70% of the PPAs we signed were with large corporations. And notably, we have once again been designated by BNEF as the largest provider of clean energy to corporations in the world. Even in the very unlikely scenario where tax credits for renewables are eliminated prospectively in their entirety, we believe that there will be continued strong demand from our corporate clients, especially data centers, because there are no realistic alternatives for many years. Without timely access to power, there can be no AI revolution. Obviously, the price of new PPAs in a future without tax incentives would increase, and the profile of earnings and cash flow would change. This will look a lot like our projects in Chile. However, in any case, what ultimately matters to AES is our returns and cash flow per dollar invested. Now let me turn to our utilities business on slide eight. AES Indiana and AES Ohio are executing on a multiyear investment program to improve customer reliability and support economic development. In 2024, we invested $1.6 billion, leading to a rate base growth of 20%. This investment program includes growth and modernization programs at both of our utilities and a plan to transition our aging coal generation in Indiana. Our investment plans are driven by our customers, and our top priority is to support local communities with reliable, resilient, and affordable power. We have among the lowest residential rates in both states, which we expect to maintain even as we grow our rate base. Turning to slide nine, across our two utilities, we have growth riders or trackers, which shield near real-time returns on our investments. More than 70% of the investment program is recovered through formula rates or existing riders, such as the TDSIC program at AES Indiana, with the FERC formula rates that support transmission investment at AES Ohio. All of this, combined with signed agreements for over 2 gigawatts of new data center demand, make AES Indiana and AES Ohio among the fastest-growing and modernizing utilities in the nation. From 2023 to 2027, we expect annualized growth in a rate base of at least 11% across the two utilities. This plan will support credit improvement at DPL Inc., which we expect to achieve investment-grade metrics by 2026. Now turning to slide ten, our energy infrastructure business provides a substantial and steady base of earnings and cash flow that support our credit ratings and help fund our dividends and new growth. We remain committed to an all-of-the-above strategy, which includes an important role for gas in our businesses and customer offerings. During the fourth quarter, we completed the construction of a new 670-megawatt fully contracted in dollars CCGT in Panama, which will result in much greater utilization of our existing LNG regasification in the country. In addition, we are delaying the closure or sale of a few of our coal plants as a result of increased demand in those markets. These assets are largely depreciated yet contribute meaningful EBITDA and cash flow. We still remain committed, nonetheless, to a full exit from coal generation and will continue to rapidly lower our carbon intensity and minimize carbon emissions from our generation fleet. Now moving to our financial outlook on slide eleven. Today, we are initiating our 2025 guidance, including adjusted EBITDA of $2.65 to $2.85 billion, parent free cash flow of $1.15 to $1.25 billion, and adjusted EPS of $2.10 to $2.26. We are also reaffirming all of our long-term growth rates, including 5% to 7% adjusted EBITDA growth through 2027. As we grow, we are also improving our business mix as we see a significant increase in adjusted EBITDA from renewables and US utilities. Now turning to our balance sheet and plans to improve our credit ratios through and beyond our guidance period on slide twelve. We are firmly committed to maintaining our investment-grade credit ratings as well as our dividend. As a result, we are taking several actions to improve cash flow and reduce parent equity requirements while ensuring that our capital plan will be totally self-funded. I should note that these efforts are ongoing, and we will continue to evaluate measures to strengthen our financial position on top of what is already included in our guidance. First, we have resized our development program and organization to focus on executing on our backlog and pursuing fewer but larger projects to better serve our core customers. This strategy allows us to increase our returns on our available capital by selecting the most attractive projects. Given the strength of our 50-gigawatt US pipeline, we also expect to execute more development transfer agreements, enabling us to monetize a portion of our renewables pipeline without requiring significant AES equity. As a result of all of these actions, we have reduced our parent investments in the renewables business by $1.3 billion from now through 2027 and eliminated the need for equity. Second, we are streamlining our organization ahead of what was originally planned. Our business is significantly simpler today than it was ten years ago. As we now operate in fewer countries, our portfolio consists of more than 50% renewables, and our growth is primarily concentrated in the US. In 2025, after the execution of this restructuring, we will realize approximately $150 million in cost savings, ramping up to over $300 million in 2026 as we achieve a full-year run rate. Third, as I previously mentioned, we will retain a few of our coal assets beyond 2027 to support our financial metrics and fund new projects. Taken together, these actions enable an even stronger AES with a clear path to achieve our 2025 and long-term financial commitments and strengthen our credit metrics. In summary, we have a resilient strategy to deliver on our financial commitments regardless of regulatory outcomes. We have continued to de-risk our business by exiting Brazil, locking in and onshoring our equipment, and moving our supply chain to the US. As I mentioned earlier, 2025 is an inflection point for the financial results of our US renewable business as we begin to harvest many years of work and investment. Demand from our core corporate clients remains strong and growing, and we are taking all steps to increase our efficiency and profitability. We are confident in the underlying value of our business, and we are committed to strengthening our balance sheet while capitalizing on our unique competitive advantages. With that, I will turn the call over to Steve."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our 2024 results and capital allocation, our 2025 guidance, and our updated expectations through 2027. Turning to slide fourteen, full-year 2024 adjusted EBITDA was $2.64 billion versus $2.8 billion in 2023, driven primarily by record-breaking drought conditions in South America, several forced outages, and asset sales but partially offset by contributions from new renewables projects. Turning to slide fifteen, adjusted EPS was $2.14 in 2024 versus $1.76 in 2023. Drivers were similar to those for adjusted EBITDA but also include significantly higher tax attributes on new renewables commissionings and a lower adjusted tax rate. This tax benefit was associated with our transition to a simpler, more US-oriented holding company structure better aligned with our growth. This is partially offset by a $0.07 headwind from parent interest on higher debt balances, primarily used to fund new renewables projects. I will cover our results in more detail over the next four slides, beginning with the Renewable Strategic Business Unit or SBU on slide sixteen. Lower adjusted EBITDA at the renewables SBU was primarily driven by historic weather volatility in South America. In the second quarter, an unprecedented flood forced an outage at our Chivor facility for nearly two months, which was then followed by a record-breaking drought across the country. Brazil was also impacted by a lengthy drought and extremely low wind resource, and the sale closing in the fourth quarter reduced EBITDA on a year-over-year basis. These negative drivers were partially offset by contributions from new projects that came online primarily in the US. At our utilities SBU, higher adjusted PTC was primarily driven by rate-based investment in the US, new rates at AES Indiana, and improved weather but partially offset by the 2023 recovery of purchased power costs at AES Ohio included as part of the ESP4 settlement as well as higher interest expense from new borrowings. Lower adjusted EBITDA at our energy infrastructure reflects an outage in Mexico, lower margins at Southland, and sell-downs in Panama and the Dominican Republic. Finally, at our new energy technologies SBU, higher adjusted EBITDA reflects improved results at Fluence. Now let's turn to how we allocated our capital last year on slide twenty. Beginning on the left-hand side, sources reflect $3.1 billion of total discretionary cash. This includes parent free cash flow of just over $1.1 billion, increased more than 10% from the prior year. We distributed nearly $600 million of asset sales proceeds to the ASP. Alright. And we issued $1.4 billion of hybrid parent debt. Moving to uses on the right-hand side, we invested approximately $1.9 billion in growth at our subsidiaries, of which more than 80% was allocated toward our renewables and utilities businesses. We also repaid roughly $180 million of subsidiary debt and allocated $500 million of discretionary cash to our dividend. In addition, we used a portion of December hybrid issuance proceeds to repay parent debt and have ended the year with a significant cash balance that will go toward executing on our backlog in 2025. Turning to our guidance and expectations beginning on slide twenty-one. Today, we are initiating 2025 adjusted EBITDA guidance of $2.65 billion to $2.85 billion, in which growth in our core businesses is offsetting a number of one-time year-over-year headwinds. Our guidance includes more than $300 million of growth at our Renewables and Utilities SBUs. This is partially offset by the sale of AES Brazil, the pending 30% sale of AES Ohio, as well as approximately $200 million from a reduction in Southland margins related to declining power prices in California, and the retirement of our Warrior Run coal plant in energy infrastructure where we recognized revenues in the first half of 2024 related to the monetization of the PPA. The timing of these 2024 items combined with the seasonality of our renewables growth will result in our first-half EBITDA being lower on a year-over-year basis, while the second half will be significantly higher. In addition to these drivers, we also expect to realize $150 million of cost savings in 2025 across all businesses from the actions we are taking that Andres outlined. Looking beyond this year, these savings, which increase to a run rate of over $300 million in 2026, combined with continued growth in renewables and utilities, will accelerate the growth trajectory of AES. As a result, we now expect a much higher low teens EBITDA growth rate in 2026 versus 2025. In addition, we expect to recognize $1.4 billion of tax attributes in 2025. This represents an increase of nearly $100 million driven by more projects coming online in the US. In total, we expect to achieve $3.95 to $4.35 billion of adjusted EBITDA with tax attributes in 2025. Turning to slide twenty-two, I will now provide some additional color on our renewables as SBU adjusted EBITDA, which we expect to increase significantly year over year in 2025. This growth includes more than $150 million from new projects, much of which relates to the 6.6 gigawatts of new capacity we placed in service in late 2023 and throughout 2024. These projects are already online and operating and will now contribute a full year of EBITDA in 2025. The sale of AES Brazil in the fourth quarter of last year will serve as a $100 million headwind year over year but is more than offset by the resegmenting and growth of our renewables business, which is forecasted to be close to $190 million in 2025. The last two drivers are the normalization of Colombia results after the second quarter flood-driven outage and historic drought conditions in 2024, and the impact of resizing our development business as Andres previously discussed. Turning to slide twenty-three, we are initiating 2025 adjusted EPS guidance of $2.10 to $2.26, and we expect to achieve the upper half of the 7% to 9% long-term growth target initiated in 2021. Drivers are similar to adjusted EBITDA with tax attributes but will be offset by higher parent interest and a higher adjusted tax rate. As a reminder, our results have historically been somewhat seasonally weighted toward the second half of the year, and this year is no exception. Now turning to our 2025 parent capital allocation plan on slide twenty-four. Beginning with approximately $2.7 billion of sources on the left-hand side, parent free cash flow for 2025 is expected to be around $1.15 to $1.25 billion. We expect to generate $400 million to $500 million of net asset sale proceeds this year and issue an additional $700 million of net new parent debt. For the uses on the right-hand side, we plan to invest approximately $1.8 billion in new growth, of which more than 85% will be in the US. We also plan to repay roughly $400 million of subsidiary debt and allocate more than $500 million to our shareholder dividend, which reflects the previously announced 2% increase. Turning to slide twenty-five and our long-term expectation, we expect tremendous growth at our renewables SBU, with an average annual CAGR of 19% to 21% expected from our 2023 guidance midpoint. This will be primarily driven by 6.6 gigawatts of new projects already placed in service, along with roughly $700 million of new EBITDA from bringing the majority of our 11.9 gigawatt backlog online. Also included is the addition of Chile Renewables, offset by the sale of AES Brazil, neither of which were contemplated in our 2023 SBU guidance ranges. For our utilities SBU, we expect annualized growth of 13% to 15% through 2027, reflecting upside from new data center development in our service territories that could serve as an even greater tailwind beyond 2027. This growth is largely covered by trackers and will be critical to improving service quality and reliability for our customers. Our utilities plan also incorporates the 30% sell-down of AES Ohio, which we expect to close in the first half of this year. This will reduce adjusted EBITDA in the near term but allows us to fully capture the data center opportunity in the long term and maximize shareholder value. In our energy infrastructure SBU, we now expect EBITDA contributions will decline at a slower rate than in our prior guidance, as we plan to operate a few coal plants beyond our previously planned 2027 exit, improving earnings and cash flow. Now to slide twenty-six. Bringing it all together, I am pleased to reaffirm our long-term adjusted EBITDA growth target of 5% to 7% and our long-term parent free cash flow growth target of 6% to 8% through 2027. This growth is largely locked in through signed PPAs for our backlog projects and approved or tracked rate-based investment at our utilities. Turning to slide twenty-seven, in our long-term capital plan, total sources of $6 billion will be funded primarily with parent free cash of $3.6 billion to $3.9 billion, reflecting average annual growth of 6% to 8% off our 2023 guidance midpoint. We also expect to issue $900 million to $1 billion of net new parent debt and realize $800 million to $1.2 billion of proceeds from asset sales. It is important to note here that we have fully removed any need for equity issuance throughout our guidance period. On the right-hand side, parent investment of approximately $4 billion reflects our reduced investment in renewables. We also plan to repay $600 million of subsidiary debt. We expect to allocate another $1.6 billion of cash to our dividend, which we are fully committed to maintaining at its current level. However, given our efforts to minimize parent cash needs and the already highly active yield, we do not expect to grow the dividend during our plan period. Our long-term guidance includes the impact of the actions we are taking to simplify our operations, reduce spending on development, and further increase our cash flow and strengthen our credit metrics. These include reducing our planned renewables investments by $1.3 billion, implementing a restructuring program to generate over $300 million of run-rate cost savings by 2026, and continuing to operate select coal assets with earnings and cash potential beyond 2027. These actions demonstrate our commitment to our financial targets as well as our investment-grade credit ratings. I want to briefly make a few points about our capital structure and financing model. While we see an uptick in our total debt levels by the end of 2027, which should be looked at on an ownership-adjusted basis, our actions to reduce costs and focus our development efforts on higher-returning projects will increase cash flows and improve our credit metrics. This eliminates any need for new equity and gives us more flexibility on timing to execute asset sales and sell-downs. Approximately 20% of our debt is related to projects still under construction that are not yet yielding EBITDA or cash, and more than half of this amount will be permanently taken out by monetizing tax attributes when projects are placed in service, leading to a significantly lower level of long-term project debt. Given that we carry this construction debt, it is relevant to consider a pro forma view of the annual EBITDA and cash generation that will recur once construction is complete. To be specific, the projects that come online during 2027 or are still in construction at the end of 2027 will generate an additional $400 million of annual adjusted EBITDA that is not reflected in our 2027 guidance window. Beyond construction, our projects are financed with long-term non-recourse debt that fully amortizes using project-level cash flows over the life of the PPA. This project debt is non-recourse to the AES parent, resulting in a capital structure that is robust and low risk. Turning to slide twenty-eight, this chart provides an example of the typical debt and EBITDA levels we would expect over the life of a US renewables project. While a new project is under construction, debt ramps up with no corresponding EBITDA. Once the project is placed in service, there is a material reduction in the debt balance as more than half of the construction debt is repaid through the monetization of tax attributes. The remainder is refinanced using long-term fixed-rate amortizing project debt that is pre-hedged when the PPA is signed. In the first full year of operations, leverage ratios begin at approximately six times debt to EBITDA and will continue to decline each year as the project debt amortizes. This example helps demonstrate how AES leverage ratios appear artificially high while we execute on our ongoing construction program but will come back down as our operating portfolio reaches a larger scale. In conclusion, 2025 is an inflection point for our business. The renewable segment will increase over 60% in 2025 and will yield annual growth at least in line with our 19% to 21% guidance through 2027. Utilities rate-based growth is even stronger than previously expected, while energy infrastructure continues to contribute meaningfully to EBITDA and cash. We have taken actions to streamline our organization and reduce both costs and capital investments. These actions are further increasing our cash flows and will enable AES to deliver increasingly higher credit metrics as we execute on our backlog. Finally, we are on track to achieve our long-term financial guidance. I look forward to providing updates throughout the year as we continue executing on our plan and capitalizing on the actions we have taken to ensure continued success at AES. With that, I will turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. In conclusion, here are the key points we want to leave with you today. There is an unprecedented need for incremental energy to power the AI revolution in the United States. Notwithstanding concerns about potential regulatory changes under the new administration, renewables have the best time to market at a competitive price. Additionally, we are well insulated from potential changes in US renewables policy or tariffs through safe harbor protections for our backlog, having locked in equipment and EPC pricing, and established domestically based supply chains. Our renewables business is at an inflection point with improving financial results from the combination of continued growth, reaching economies of scale, and reductions in development expenses. We are reaffirming our longer-term growth rates through 2027 as we execute on our 11.9 gigawatt backlog. And we are taking steps to improve our credit metrics. As always, we are highly focused on delivering the highest risk-adjusted returns to our shareholders, and we believe that AES is very well positioned to meet both our customers' energy demands as well as our financial commitments. Operator, please open the line for questions."
},
{
"speaker": "Operator",
"text": "Thank you. We will now begin the question and answer session. You can press star followed by two to withdraw yourself from the queue. Our first question comes from Nicholas Campanella with Barclays. Nick, please go ahead."
},
{
"speaker": "Nicholas Campanella",
"text": "Hey. Good morning. So just on the cost savings, you know, you have $150 million, ramping to $300 million over time. I heard you, Steve, say that these are run rates. So I assume these are ongoing and not one-time in nature. Just recognize you had about $52 million in the bridge for renewables. So is the bulk of this coming from the parent, does it happen naturally as you sell down more in the energy infrastructure business? And maybe you can kind of just expand on your confidence level in achieving these reductions and where you see a bulk of these happening in the portfolio. Thanks."
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. Hi, Nick. It's Steve. So the cost savings are spread across the portfolio and definitely include the renewables business as well. It is a run rate when we hit over $300 million next year. So these are not one-time. And I would emphasize that we've already taken these actions. So this is something that we're very confident in because we've already made the decisions and taken the actions that we need to take to achieve cost savings. So the renewables number that you see for 2025 in that bridge, that will also ramp up in line with, you know, the $150 million going to $300 million. I would expect that proportion to remain roughly the same."
},
{
"speaker": "Nicholas Campanella",
"text": "Okay. Okay. And then, you know, just on the comments you're cutting CapEx, but you're still hitting the growth target of 5% to 7% long-term EBITDA. So yeah. You previously talked about a 12% to 15% IRR on renewables. What's the IRR of these higher quality projects that you're now targeting? And is the cost cuts just making up for the rest of that delta? Just tying out to the long-term guidance? Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Sure. Look. We're taking an integrated approach. So yes, we see strong demand in the markets. We see that we have very attractive projects so that our IRRs are going up, you know, on average. But at the same time, we're also reducing those costs not directly associated with the project. So it's really coming from both sides. So it's an integrated approach. So what we're doing is and then, you know, we quite frankly have said this to some extent in the past. It's not just the number of gigawatts. It's the returns we get, for example, EBITDA created by each investment dollar. So that's really what we're focusing on. So, you know, it will mean fewer projects, but larger projects, and at the end, more profitable projects."
},
{
"speaker": "Nicholas Campanella",
"text": "Okay. Thank you. Our next question comes from David Arcaro with Morgan Stanley. Please go ahead, David."
},
{
"speaker": "David Arcaro",
"text": "Okay. Thanks. Good morning. On the let's see. Looking at that, it seems like you're pulling back somewhat on the renewable CapEx in the forecast. Wondering from a high-level kind of strategic perspective, Andres, do you see this as a kind of a pause in, I guess, in the renewables growth or just a bit of a pullback in making those investments into the renewables business just given the current environment? You know, and over time, would you expect to reassess and potentially reaccelerate to the extent, you know, financing becomes easier to backdrop becomes more favorable."
},
{
"speaker": "Andres Gluski",
"text": "Yeah. That's a great question. Look, we are focusing on executing on our 12-gigawatt pipeline, which 85% of that will be online by 2027. So that's our number one focus. As we mentioned in our script, we've been spending a lot, which flows through, you know, P&L is building that 50-gigawatt pipeline in the states and 10-gigawatt pipeline outside. So really what we're doing is harvesting that pipeline. You know, we don't want to grow it to 100 gigawatts. So we've done that work. We're going to harvest it. So, basically, we're spending less, if you will, on, you know, future projects with a time horizon of five to seven years because we've done that work. Now in terms of, you know, total growth rate, what we're saying is we're going to be building less gigawatts, for sure, but we're going to maintain our financial results. So that's the sort of picture. Now again, what we see is strong demand from our clients. But, you know, we're very happy to, you know, this year, we'll be commissioning around 3 gigawatts of new projects. Next year, that would step up to 4 gigawatts. So you're seeing we're signing around, you know, four plus per year. So, eventually, the amount that we commission and the amount that we build have to, you know, roughly come in line."
},
{
"speaker": "David Arcaro",
"text": "Yep. Got it. Great. Thanks for that extra detail. And then I guess, looking at the overall profile of the businesses and your asset sales target now. I guess it seems like you're increasing the asset sales target overall, but you're keeping coal in the plan for a bit longer than originally planned. Could you maybe talk about what the profile is of the assets that you might be looking at in the asset sales target now? What could be represented in there?"
},
{
"speaker": "Steve Coughlin",
"text": "Sure. Hey. Hey, David. So, you know, similar to what we have talked about in the past, you know, it does still include some coal exit. It does still include some monetization of our technology portfolio. But we have, you know, always said that the universe is greater than the $3.5 billion. We've actually taken a little bit more conservative view on what we intend to execute here. So we're really confident in the number between 2025 and 2027. And, you know, we have looked at the sell-downs as well. So this number includes some of the partnerships that we do. But what I would say is this capital plan, you know, relies less on these asset sales than in the past. And, you know, we have over time baked in more flexibility to execute the sales."
},
{
"speaker": "David Arcaro",
"text": "Okay. Got it. Makes sense. Thanks so much."
},
{
"speaker": "Operator",
"text": "Our next question comes from Durgesh Chopra with Evercore ISI. Please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, team. Good morning. Thanks for giving me time. Alright. Just wanted to double click on cost savings. $300 million annual target, you know, it's pretty substantial when I look at your EBITDA number, roughly 10%. Maybe just can you give us some examples of what cost reductions are these? Are these personnel reductions? Are these process improvements? Just so we can get a little bit more comfort around your target level of cost reduction, please?"
},
{
"speaker": "Andres Gluski",
"text": "Sure, Durgesh. Great question. With me is Ricardo Fallu, our Chief Operating Officer, who's been leading a lot of the reorganization restructuring efforts. So I'll let him answer that question."
},
{
"speaker": "Ricardo Fallu",
"text": "Thank you, and good morning. So AES' cost reduction program includes, as Andres and Steve mentioned, first, the resizing of our development program to focus it on executing on our backlog as well as pursuing fewer but larger projects. And as a result, we sized the team. We also materially cut the new site's origination as well as early-stage project costs. And on top of that, we reduced a 10% reduction in our workforce, which includes the elimination of certain management layers as well as a much leaner organization, both at corporate and business levels. This is something that we plan to course more gradually through 2027. However, in response to the current market conditions, we decided to accelerate, and this organization now is aligned to the much simpler portfolio that Andres mentioned."
},
{
"speaker": "Andres Gluski",
"text": "Yeah. Because I'd like to mention that these actions have been taken. So Steve also mentioned that these are done. And also the decisions in terms of losing the amount of capital we put into the renewables business. So, you know, there is very little execution risk on it because it's done."
},
{
"speaker": "Durgesh Chopra",
"text": "That's very helpful color. And I could sense the confidence you have in executing on these cost reductions. Okay. Thank you. And then my final question, Steve, just maybe can you help us with where you landed on a federal debt basis and referring to sort of on a Moody's adjusted basis for 2024 relative to your credit downgrade thresholds. Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. Absolutely, Durgesh. So on the recourse metric, so at the parent level, we ended at 22%. So, you know, it's a significant cushion above the 20% threshold. On the Moody's metric, we ended on our calculations at 10%, which is right in line with where we expected to be. In both cases, these metrics will improve over time. At this point, with this updated plan where we focus very closely on improving our credit metrics, we do expect to get into the mid-twenties on the recourse metrics by the end of the guidance period. And in 2026, in line with what we've been discussing with Moody's, we expect to be at or above the 12% threshold. I feel really good about the actions that we've taken and what we're doing to increase our cash and EBITDA. Net debt to EBITDA ratios will improve over time as well. The other thing I would point out is, as I said in my prepared remarks, we do carry about $4 to $5 billion of construction debt on our balance sheet at any one time. It is not yet yielding. And so, you know, our leverage ratios look artificially high at any one point in time as a result. And so these ratios, when adjusted for that, for example, on a net debt to EBITDA, comes down one to one and a half times just by adjusting for that construction debt. But as I looked at the ratios, or I mentioned the ratios, those are based on the actual way that they get calculated, you know, without this adjustment. But I do think it's important in understanding our leverage profile. You know, it's very important to look at this ownership-adjusted debt level because the EBITDA, of course, is ownership-adjusted. And to understand that the leverage profile continues to improve over time as the operating portfolio gets bigger and bigger relative to the construction."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Very helpful color, Steve, and appreciate the added disclosure in slides explaining the debt to EBITDA over time. Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Durgesh."
},
{
"speaker": "Operator",
"text": "Our next question comes from Julien Dumoulin-Smith with Jefferies. Please go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hey. Good morning, Steve. Thank you guys very much. I appreciate it. Maybe just to follow up on that last one, just following on the subject. Can you just elaborate, I mean, to what extent have you gotten in front of Moody's with this plan? And just if you could elaborate a little bit on how you're thinking through 2027 on that evolution of those metrics and that's the icing given the backdrop of Moody's care."
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. Sure. Good morning, Julien. So we have, you know, discussed that we were working with Moody's last year where this was headed. What I would say is it looks right on track. In fact, even a little bit better. Given the actions that we've taken, effectively, you know, what's happening is, you know, our cash flow and EBITDA is increasing substantially through the plan period. And, you know, that's a result of bringing on substantial amounts of operating since we have, you know, 12 gigawatts in our backlog, most of which will be coming online through 2027. And then on top of that, we are reducing, as Andres and Ricardo discussed, our development spending is down based on our updated strategy of pursuing larger but fewer projects. We're putting less money into early-stage prospecting and more maturing the pipeline that we have. And then our administrative spending is down substantially as well. And that's also as a result of what was mentioned about our simplification of our portfolio and the reduction of management layers and efficiencies that result from these actions that we have already taken. So together with this cash flow increase from operations, the reduction in cost, the ratios continue to look very healthy, in line to better than our prior expectations."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Excellent. Thanks, Steven. Maybe just to keep going with that a little bit further. Just given the reduction of $1.3 billion here, just on balance, are you actually selling down stakes in more renewables in order to reduce that need for contributions? Or is the aggregate level of renewable investment per year slowing down here? I just want to make sure we're clear. You've talked about backlog and executing at this. Just want to understand, like, how you think about, like, renewables per year install. Evolving through the period now given the update as well as what level of contribution from coal, not what assets, but just what level of cash or EBITDA, however you want to talk about it, from coal are you anticipating, you know, in 2026 and 2027 beyond now as well?"
},
{
"speaker": "Andres Gluski",
"text": "Okay. Let's sort of break that. I think there's several questions there. So on the first one, again, through 2027, we're basically executing on our backlog. And look, we're seeing very strong demand from our clients. Since our last call, we signed 450 megawatts with tech customers. So we see no downturn in demand. So basically, what we see is, you know, there's no cliff in 2027. I mean, our demand continues to grow. Second, maybe an easy way of thinking would Steve had described is, if you have a pool, say roughly $4 to $5 billion in construction debt, and you are basically carrying that over 16 gigawatts, and then you go up to 25, 30 gigawatts, you know, that your credit metrics improve. Even though that debt is really sort of short-term rotating because half of it's going to be paid back upon completion. That's number one. So then number two, talking about how much the coal is going to contribute, sort of post-2027. I'll pass that to Ricardo."
},
{
"speaker": "Ricardo Fallu",
"text": "Thank you, Andres. Good morning, Julien. So just to put it into perspective, the keeping or retaining a few coal assets, half or less than half of what we currently have, will be less than 8% of the expected capacity by the end of 2027. These assets continue to provide critical capacity to the grid and also to our customers, and therefore they continue contributing, I would say, you know, to the financial health of the company. We're clearly not abandoning our intention to exit coal, but it will take longer than we previously expected."
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. And I would also add here, Julien, that these are also assets that as they're more mature, their debt is amortized, but they're also very accretive in terms of our credit metrics."
},
{
"speaker": "Andres Gluski",
"text": "And lastly, to say, you know, we're doing this because in those markets, because of the sort of supply-demand balance, they need to keep these plants online. So, you know, it all comes together. It's good for our financials, but it's also giving the market what the market is asking for."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Bottom line, though, you're seeing a down so you're seeing a leveling off in renewable the cadence just per annum. Just to come back to that backlog comment? I'm just trying to understand at the end of the day, like, how you see it?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. I would put it this way. You know, post-2027, what we see is less growth in the number of megawatts than our original plans. I mean, that's clear. Because we're spending less on creating a pipeline of potential projects five to seven years out. So, yes, the answer is yes."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Okay. Thanks, guys."
},
{
"speaker": "Operator",
"text": "The next question comes from Michael Sullivan with Wolfe Research. Please go ahead, Michael."
},
{
"speaker": "Michael Sullivan",
"text": "Hey. Good morning. Thanks for the update. Good morning."
},
{
"speaker": "Steve Coughlin",
"text": "Morning."
},
{
"speaker": "Michael Sullivan",
"text": "Yeah. Hey, guys. Why don't I just pick up on the last question around just the coal contribution? I think Ricardo, you're giving it on a capacity basis. Any chance we can get that on an EBITDA basis? Just trying to think about when you had the Analyst Day, you said coal was like a $750 million roll-off. What does that look like now through 2027?"
},
{
"speaker": "Steve Coughlin",
"text": "Since I'm the financial numbers guy, Steve, I'll take that one. Michael. So we had guided, as you said, about $750 million that would be eliminated. I would say, you know, we're looking at, you know, roughly a third of that that may continue, you know, beyond 2027 for a period of time."
},
{
"speaker": "Michael Sullivan",
"text": "Okay. That's very helpful. And then on just interest rates. I think you have a couple of parent maturities coming up. Should we think of those as derisked from a sensitivity standpoint, or what are you embedding there in terms of refi or anything like that?"
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. So we did do a hybrid at the end of last year, $500 million, which starts us well into this year. And then we will be in the market to refi. So we have a maturity here in July and one in January. So we will be in the market, I would say, relatively soon. We typically refi, you know, somewhere between three to six months in advance of these maturities, and our plans will be similar this year."
},
{
"speaker": "Michael Sullivan",
"text": "Okay. And then last one, I yeah. I definitely can appreciate the sort of ramp of things here. The 5% to 7% EBITDA CAGR, can you get in that range in 2026 off of 2023, or are we really looking to 2027 to really get in there?"
},
{
"speaker": "Steve Coughlin",
"text": "Yeah. No. So definitely in 2026, and actually, let me add one other thing to your prior question is that on those refis, by the way, we are nearly fully hedged, so we don't carry any interest exposure, further interest exposure on those refis. And then with respect to 2026, if that's a significant benefit from this action plan, you know, we did contemplate simplification of the portfolio and cost reduction in the past over time. But what we have really done here is we've accelerated this, and so 2026 is going to be a year of significant growth in our EBITDA. And I think I mentioned in my comments in the low teens, and we expect another significant year of growth in 2027. So we will, you know, jump ourselves up onto at least that trend line next year. This year in 2025, the guidance isn't as exciting simply because we had some of the, you know, remaining transformation here around the Brazil exit. We had the Warrior Run benefit last year. And so, you know, some of these items, you know, depressed the year over year. But the reality is where the core business is growing is contributing more than $300 million this year. There's just those offsets going forward. The energy infrastructure SBU, we've largely absorbed most of the decline as of 2025, and so we won't see as significant of an offset from energy infrastructure going forward, and therefore, sort of that growth is unleashed from the core businesses to truly drop all the way into the total bottom line, and therefore, we have higher growth rates beyond this year."
},
{
"speaker": "Andres Gluski",
"text": "You know, one thing I'd like to mention is, you know, we're talking about the quantitative results, but it is really very important qualitative results. Yes. You know, we're transitioning this portfolio to be more contracted, to be, you know, more renewables, more utilities, you know, less but by getting rid of 5 gigawatts, you know, think about Brazil. I mean, that was about, you know, we have about 30 gigawatts. We sold out of 5. That was most of our hydrology, currency, it was all floating rate, interest rate exposure. So qualitatively, we're transforming this portfolio at the same time. So it's not just that it's going to have very good growth in 2026 and 2027, but it's going to be a much better portfolio as well."
},
{
"speaker": "Michael Sullivan",
"text": "Okay. Appreciate all the color. Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Michael."
},
{
"speaker": "Operator",
"text": "Our final question today comes from Willard Grainger with Mizuho. Please go ahead, Will."
},
{
"speaker": "Willard Grainger",
"text": "Hi. Good morning, everybody. I appreciate all the disclosures here. Understand, you know, you reduced the CapEx here, but just want to understand a little bit more what's the flexibility to, you know, thinking about maybe we're reducing it even more and investing in your stock here just given where you're trading. Any color on that, you know, cost of capital would be super helpful."
},
{
"speaker": "Andres Gluski",
"text": "Now we're, you know, as I said in my very first statement, you know, we're very well aware of where AES is. We're doing everything possible to improve it. What I would say is that, you know, what we're presenting here is a plan that we think accomplishes this. And, you know, we are paying, we're giving back to shareholders $500 million a year. We're paying a very healthy dividend. So right now, you know, this is the plan that we feel very confident about executing. And that we think will, when the market, you know, settles down, you know, we think will result in very good returns for our shareholders. But thanks for the question, and we are constantly thinking of those things."
},
{
"speaker": "Willard Grainger",
"text": "Appreciate that. And then maybe just one final one from me. Understand you're doing a lot of work with technology customers, manufacturing customers, and just on the items that the FERC and what we're seeing also in Texas, does that impact your ability to contract long-term renewables either, you know, through colocation or virtual PPAs and the right color on that would be appreciated."
},
{
"speaker": "Andres Gluski",
"text": "Yes. I think you're probably referring to like this as a private, you know, so colocation private use networks. And look, we don't see that affecting us. We think that, you know, most of our we have a very, I would say, resilient pipeline because we have very few federal lands if at all, all on private lands, and we don't have as part of that pipeline any any BUNs at this point. So we feel very, very confident about our pipeline, and we don't see any of these regulations affecting us."
},
{
"speaker": "Willard Grainger",
"text": "Great. Appreciate the color. Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Those are all the questions we have. And so I'll turn the call back to Susan Harcourt for closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everyone for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AES | 3 | 2,024 | 2024-11-01 11:02:00 | Operator: Good morning. Thank you for attending today's AES Corporation Third Quarter 2024 Financial Review Call. My name is Megan, and I'll be your moderator for today. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. [Operator Instructions]. I would now like to turn the call over to Susan Harcourt, Vice President of Investor Relations at AES Corporation. Susan, you may begin.
Susan Harcourt: Thank you, operator. Good morning, and welcome to our third quarter 2024 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our third quarter 2024 financial review call. We are pleased with our performance this year. And today, I will discuss our third quarter results, a robust growth we are seeing at our renewables and U.S. utility businesses and our progress towards our asset sales target. Beginning on Slide 3 with our third quarter results, which were generally in line with our expectations. Adjusted EBITDA with tax attributes was about 1.2 billion, adjusted EBITDA was 692 million and adjusted EPS was $0.71. We're on track to meet our 2024 financial objectives, including our expectation to be in the top half of our ranges for adjusted EBITDA with tax attributes and adjusted EPS. At the same time, we now expect adjusted EBITDA to be towards the low end of the guidance range for the year, primarily due to the one-time impact of extreme weather in Colombia and the lower margins in the Energy Infrastructure SBU. We are reaffirming our expected growth rate through 2027. Steve Coughlin, our CFO, will provide more detail on our financial performance and outlook. I'm also very pleased to report that since our last call in August, we have signed or been awarded 2.2 gigawatts of new contracts. This includes both long-term renewable PPAs and new data center load growth at our U.S. utilities. Moving to our Renewables business on Slide 4. Since our Q2 financial review call, we have added 1.3 gigawatts of new PPAs to our backlog, bringing our year-to-date total to 3.5 gigawatts, more than 70% of which is with corporate customers. As a reminder, last year, we set a target of signing 14 to 17 gigawatts of new PPAs from 2023 to 2025. And with 9.1 gigawatts signed or awarded since the beginning of last year, we're currently well on track to meet this objective. Since setting that goal, we also materially increased our project return targets and we are focused on prioritizing the most profitable PPAs. Moving to Slide 5 and our construction progress. Since our second quarter call in August, we have completed construction of an additional 1.2 gigawatts of new projects, bringing our year-to-date total to 2.8 gigawatts, which represents nearly 80% of the 3.6 gigawatts we expect to complete this year. On-time execution is one of our competitive advantages, and we believe we have the best supply chain management in the industry. In the U.S., we have 100% of our solar panels on site for those projects coming online this year and 84% in country for next year. For 2026, we have 100% of our solar panels either in country or contracted to be domestically manufactured, providing protection against potential changes in tariff policy. We have also been a first mover in securing domestically manufactured battery modules and cells. We expect our first battery energy storage project with domestic content to come online in the first half of 2026. Additionally, we have established a robust supply chain for wind through our strategic suppliers with domestic manufacturing. Regarding long lead time equipment, such as transformers, and high-voltage breakers, we have secured all of the supply for our backlog through 2027. Turning to Slide 6. We are very well positioned as a leading provider of renewable energy to data center companies, particularly in the U.S. and to large mining companies outside the U.S. These customers want to work with AES due to our track record of providing customized solutions that best serve their specific needs and delivering our projects on time and on budget. With the U.S. elections only a few days away, I have great confidence in the resilience of our business plan, regardless of the outcomes of the presidential and congressional elections. While we do not believe the elimination of the investment tax credit or production tax credit is likely, even in an extreme scenario, we're uniquely well positioned due to the following. First, regardless of federal policies, our corporate customers had a massive need for new power that can only be met by renewables over the next decade. McKinsey estimates that in the U.S. data centers alone could require an additional 450 terawatt hours through the end of the decade, which is equivalent to more than the annual electricity consumption of France. With these market dynamics, we will continue to sign high-return renewables PPAs with our core customers. Second, should there be any changes to U.S. tariff policy, we have a resilient supply chain, with a large majority of our project components manufactured domestically by 2026. Finally, our strategy of procuring our equipment at the time of the PPA signing provides clear Safe Harboring protection from potential changes in policy. Now turning to Slide 7. Over the last 12 months, we have embarked on the most ambitious investment program in the history of our U.S. utilities, which will improve reliability and quality of service for our customers, while maintaining some of the lowest rates in both states. AES Indiana and AES Ohio are now 2 of the fastest-growing U.S. utilities, with projected double-digit rate base growth through 2027 based on necessary investments for our customers. As you may recall, in the third quarter of last year, we received commission approval for a new regulatory structure for AES Ohio, providing for timely recovery of the majority of these investments. Similarly, earlier last year, we received commission approval for new rates at AES Indiana, our first rate case in seven years. We are starting to see the benefits from the $1.2 billion we have invested in both utilities so far this year, representing a year-over-year increase of investment of 60%. Excluding the onetime settlement benefit recognized in 2023, year-to-date EBITDA is up 25%. Turning to Slide 8. We're also seeing additional investment opportunities from data center growth in our service areas above and beyond our existing rate base projections. Our utilities have many natural advantages that are attractive to large technology companies, such as proximity to fiber networks and the presence of ample land and water. We have worked to proactively identify sites that are well positioned to support new data centers, capitalizing on our deep relationships with technology companies. At AES Indiana, we expect to have specific data center deals to announce in the coming months, as we've been in active negotiations with several parties. We recently launched an RFP for 3 gigawatts of new generation to support accelerating demand growth. From a regulatory perspective, we will use the results of this RFP to help inform our IRP submission next year. At AES Ohio, we have now signed agreements for new data center load growth of 2.1 gigawatts, including an incremental 900 megawatts, on top of the 1.2 gigawatts we already announced on our last call. On our fourth quarter call in February, we will provide a comprehensive update on how these agreements impact our long-term investment plan and rate based growth. Today, we can indicate that just what we've signed to date provides a nearly 30% increase in investment through the end of the decade over our current plan. Turning to Slide 9. In September, we announced the plan to sell down 30% of AES Ohio to CDPQ, our longtime partner in AES Indiana. This transaction builds upon our strong relationship with CDPQ and allow us for common ownership across our U.S. utilities. This partnership will support growth at AES Ohio, with CDPQ as a funding partner for increasing investments to support reliability and economic development. Finally, as you may have seen in our release, we are pleased to report that we have now closed the sale of our equity interest in AES Brazil. We are proud of the work our people have done in Brazil to expand beyond the 2.7 gigawatt hydro portfolio by adding 2.5 gigawatts of operating wind and solar, creating one of the largest renewable businesses in the country. With these two transactions, we have now signed or closed agreements for more than three quarter of our 3.5 billion asset sale proceeds target through 2027. We have also further simplified our portfolio and eliminated Brazilian weather, interest rate and currency risks. With that, I would now like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will discuss our third quarter results and our 2024 guidance and parent capital allocation. Turning to Slide 11. Adjusted EBITDA with tax attributes was approximately 1.2 billion in the third quarter versus 1 billion a year ago. Although we realized 458 million of additional tax value year-over-year, renewables EBITDA was down 68 million, driven mostly by breaking drought conditions in South America. In addition, our energy infrastructure SBU was down 221 million largely due to expected items, which I'll cover in more detail on a later slide. Turning to Slide 12. Adjusted EPS for the quarter was $0.71 versus $0.60 last year. Drivers were similar to those of adjusted EBITDA with tax attributes, but partially offset by higher parent interest due to growth investments as well as a higher adjusted tax rate. I'll cover the performance of our SBUs, or strategic business units, on the next four slides. Beginning with our Renewables SBU on Slide 13. Higher EBITDA with tax attributes was driven primarily by significant growth from new projects in the U.S., where we've added 3.3 gigawatts since Q3 2023, but was partially offset by significant declines at our Colombia and Brazil businesses. This year, we've experienced unprecedented weather volatility and a record-breaking drought in South America, driven by El Nino conditions. In June, a historic flooding event took out our 1 gigawatt Chivor facility in Colombia for nearly 2 months, followed by an extreme drought across the entire country. Also, you may recall that the third quarter of 2023 was extremely positive as we had better hydrology at our Chivor facility than the rest of the country, while spot prices were very high, yielding significant margins. As a result, Colombia is down 92 million versus the third quarter of last year and over 130 million year-to-date versus last year. In Brazil, the record drought and extremely low wind resource this year have also negatively impacted renewables in Q3 and year-to- date. While 2024 has been a difficult year due to the events in South America, we expect our renewables segment will grow significantly in 2025. Emerging La Nina conditions in the Pacific are expected to return the region to much better hydrology. While in the U.S., by the end of this year, we will have brought online a total of nearly 2 gigawatts of new capacity, which will drive a large increase in our Renewable segment EBITDA in 2025. Now turning to Slide 14. Lower adjusted PTC at our Utilities SBU was mostly driven by the prior year recovery of 39 million of purchase power costs at AES Ohio, included as part of the ESP IV settlement, as well as higher interest expense from new borrowings. This was offset by returns on new rate base investment in the U.S. as well as new rates implemented in Indiana in May. Adjusting for the onetime settlement last year, utilities adjusted PTC grew by 18% in the third quarter over prior year. Lower year-over-year Q3 EBITDA at our energy infrastructure SBU was primarily driven by nearly 200 million of expected declines at our Warrior Run Southland legacy businesses and the impact of several sell-downs, all of which were baked into our guidance. At Warrior Run, we recognized revenues from the accelerated monetization of the PPA beginning last year and ending in the second quarter of this year. Our legacy Southland assets benefited from energy margins earned in the prior year, which are no longer an opportunity in 2024 under the new extension monetization structure. In addition to these known drivers, we experienced lower margins at our new Southland combined-cycle asset U.S. due to much milder weather as well as extended outages at our TEG and TEP thermal plants in Mexico. Finally, higher EBITDA at our New Energy Technologies SBU reflects continued high growth and margin increases at Fluence. Now turning to our expectations on Slide 17. We are reaffirming our 2024 adjusted EBITDA with tax attributes guidance of 3.6 billion to 4 billion and adjusted EPS guidance of 1.87 to 1.97 and continue to expect to be in the top half of both ranges, driven in part by the success we've had securing higher tax value on our new projects. Our renewables team expects to capture over 200 million in tax value upside this year, which reduces our growth capital needs. EBITDA from renewables will be favorable in the fourth quarter from revenues earned on our PPAs, although we expect lower tax attributes in the fourth quarter as a result of the more balanced timing of renewable commissionings throughout the year. We also expect further growth in our U.S. utilities in Q4 as we continue to realize returns from our investment program. This will be offset by the negative impact from the prior year monetization of the Warrior Run PPA as well as incremental impact from asset sales, including AES Brazil. Drivers of adjusted EPS will be similar along with higher interest expense from growth capital, but benefiting from a lower adjusted tax rate. As a result of our efforts to spread renewables construction more evenly throughout the year, we've achieved more than 80% of our adjusted EPS guidance year-to-date, providing greater certainty around our 2024 financial objectives. Turning to Slide 18. We are also reaffirming our adjusted EBITDA guidance range of 2.6 billion to 2.9 billion. While I'm pleased with our execution this year on our growth objectives, several large drivers have impacted results, primarily at our legacy businesses, and we now expect to end the year towards the lower end of our guidance range. Milder weather compressed spark spreads in California resulting in lower margins at our South and combined cycle gas plants. The PPA for these assets contains an option that allows us to choose to sell the energy to the market in a given year. We previously chose to execute this option for 2024 and were therefore impacted by declining spark spreads that occurred later in the year. In Mexico, the unplanned outages, which have now been resolved, further impacted our results in the second and third quarter. In Colombia, the combination of the Q2 flood-related outage at Chivor and year-long record drought have negatively impacted us versus our guidance. Finally, inverter failures at several of our solar sites impacted availability versus our plan. These inverters were under warranty and are being remediated by the manufacturers. Despite the confluence of these onetime negative impacts, growth in U.S. renewables remains very strong, and our U.S. utilities have outperformed. We expect to continue this momentum and substantially increase EBITDA at both our renewables and utilities businesses in 2025. Now to our 2024 parent capital allocation plan on Slide 19. Sources reflect approximately $2.7 billion of total discretionary cash, including $1.1 billion of parent free cash flow, $950 million of hybrid debt that we issued in May and $650 million of proceeds from asset sales. Sale proceeds will be slightly lower than expected in 2024 due to timing, but we are well ahead of our $3.5 billion long- term target through 2027. On the right-hand side, you can see our planned use of capital. We will return approximately $500 million to shareholders this year, reflecting the previously announced 4% dividend increase. We also plan to invest $2.2 billion to $2.3 billion in new growth. In summary, we've continued to execute in the year-to-date and are well positioned for a strong finish to 2024. Our substantial renewables commissioning thus far give us greater line of sight toward achieving our earnings and cash targets, and our funding plan is largely complete. With $1.60 of adjusted EPS year-to-date, we have overachieved on our EPS growth with a clear path to landing at least in the upper half of our guidance range. As we look ahead to 2025, we see strong growth in our Renewables and Utility segments and continued execution of our decarbonization strategy in energy infrastructure. I look forward to providing additional detail around 2025 and beyond on our fourth quarter call. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. Before opening up the call for Q&A, I would like to summarize the highlights from today's call. We continue to execute well on our strategic priorities, including robust growth at our renewables and U.S. utility businesses. With 9.1 gigawatts of new PPAs signed or awarded in 2023 and year-to-date 2024, we are well on our way towards achieving our goal of 14 gigawatts to 17 gigawatts in 2023 through 2025. Regarding our construction program, we have added 2.8 gigawatts of new projects to our operating portfolio so far this year, and we're seeing the direct financial benefits in our adjusted EPS and adjusted EBITDA with tax attributes results. At our U.S. utilities, we have embarked on the most ambition investment program in their history, while signing agreements for 2.1 gigawatts of data center load growth, and we expect more in the coming months. We're also executing well on our asset sale and transformation program and we feel good about the remainder of 2024 and our long-term outlook, despite specific onetime weather-related events this year. Finally, I can confidently say that I believe no one is better positioned with large technology customers than AES. Energy market fundamentals and the strong demand we're seeing from our corporate customers give us great confidence in the resilience of our business plan, regardless of the outcomes of the upcoming U.S. elections. Operator, please open up the line for questions.
Operator: [Operator Instructions]. Our first question will go to the line of Nick Campanella with Barclays.
Nicholas Campanella: Good morning, thank you for taking my question. So, I wanted to just ask the comments about supply chain, you seem well positioned through 2026 with panels, etcetera. But you continue to construct 3.5 gigs for this year. You kind of outlined this previous target at the Analyst Day of 14 gig into 2025. So, we're getting closer up to '25 now. I just kind of check in and see how you feel progressing towards that target because it seems like it will be a pretty good step up into '25 here? And is that still attainable?
Andres Gluski: Yes. Thanks for the question, Nick. I mean we feel very strong about our supply chain management and construction program. We are the only large renewables developer, which really hasn't had to abandon any large PPAs over the last 3, 4 years. So, what we've said, we have all the equipment we need this year. We have 84% of what we need for next year already in country. In the next month or so, we should have 100%. So, we feel very good about supply chain. We intend to concentrate on the big items like wind turbines, batteries, solar panels. But you also have inverters and you have transformers, which are long lead time and we feel very solid there. In addition, we've really had no problems with the workforce either because we have strategic relationships with EPC contractors so that they can move the crews from one project to the next. So, in answering your question, we feel very good about our construction program. And as you know, in 2023, we geared up 100%. So now we've been able to really smooth out our commissioning throughout the year, and we expect that in 2025 and 2026.
Nicholas Campanella: All right. When I think about '25 again, obviously, you had, on a tax attribute basis, some one-timers that's kind of putting you a little lower here. And I sense the notable confidence on the growth into 2025. Can you just kind of quantify for us how much has really just returned to normal versus new EBITDA from renewables contributions? And then when you consider things like Brazil rolling off, do you still expect that renewable segment to grow year-over-year?
Andres Gluski: Yes. Look, that's a very good question. We aren't giving guidance for 2025 at this time. But you're right, what you really have is mean reversion. You were really coming back to sort of more normal year. 2024 is a year that we've never had before, the sort of combination of extreme floods and extreme droughts in some of our service territories, largely driven by El Nino, coming into La Nina, we expect a return to normal. But you also correctly point out that we're maintaining all of our guidance and our long-term growth rates without Brazil. And so that means that the other sectors are picking up. So, to the extent that I can say we expect next year to be a more normal year and we've absorbed the sale of Brazil by increasing the growth rates, especially in U.S. renewables and U.S. utilities.
Stephen Coughlin: Hi, Nick. It's Steve. I would just add. We've added and will add a total of 3 gigawatts of new renewables this year across the portfolio. So in addition to some more normalization, like La Nina coming in South America, the installed base is going to be significantly higher. So that's part of it. Renewables segment will grow significantly. And we also have outside the renewables, we have the utilities growth. So, with a full year of new rates in Indiana and continued rate base growth in Ohio.
Nicholas Campanella: That makes sense. Thanks for answering my question and see you soon.
Operator: Thank you, Nick. Our next question comes from the line of David Arcaro with Morgan Stanley. David your line is now open.
David Arcaro: Hi. Thanks so much. Good morning. I was wondering if you could elaborate on the outperformance you had in tax credits that you received. You referenced the $200 million higher-than-expected tax credits. Wondering what that stemmed from? And is there an opportunity for any more outperformance from here?
Steve Coughlin: Dave, it's Steve. Definitely been a very good year. Look this is I would say, a very core competency for us and a key differentiator. We have I think the strongest tax team and renewables finance team there is. We're always looking to ensure that we maximize the tax value opportunity because what does that do? It reduces our capital requirements and also increases returns. So we've had a good year. We've done a number of things to ensure we qualify for bonuses, including places where there's a brownfield at or -- that allows us to qualify for the energy community. These are sites that were formerly, say, agricultural sites that had, had different materials, chemicals applied that allowed them to qualify. So we've done a lot of research and digging to justify adders where we can. So the other thing we're doing is all tax credits are not created equal. So because of our track record, people tend to come to us, expect -- and we get less of a discount and we get people very focused on working with us. So I would say monetizing through transfers, we've had a lot of success and transfers do tend to get recognized a little earlier than through the tax equity partnerships the credit value. So that's part of it as well. So I do see this as potential upside in the future. But of course, there's other things going on in the portfolio. We have to take a holistic look. And when we give guidance in '25, we'll update you guys on the entire portfolio.
David Arcaro: Okay. Got it. That's helpful. Good to see just chipping away at the financing need with that. And then wondering if you could just touch on what renewable returns have been on the incremental projects that you've been signing, I guess, since raising your return expectations earlier in the year, how those return levels have been trending? Has there been continued momentum upwards?
Andres Gluski: Well, we're seeing good returns from our projects, and we continue to see a market that values what we bring to our customers. So the answer to that is yes, that we continue to see -- our newer projects have been within that range towards the upper end of that range. So we feel very confident in the numbers that we've provided.
David Arcaro: Okay got it. Appreciate it. Thanks so much.
Andres Gluski: Thanks, David.
Operator: Thank you, David. Our next question comes from the line of Durgesh Chopra with Evercore ISI. Durgesh your line is open.
Durgesh Chopra: Hi. Thank you. Good morning team thanks for taking my question. Just wanted to start off with the actual portfolio that is going to come online, not from the guidance. But in terms of the 2.8 gigawatts that's coming online this year, should we expect an uptick in that number as we go into 2025, the actual construction and getting projects online?
Steve Coughlin: Yes. So this is Steve. So we'll give that guidance in February. So there's a number of moving pieces here. I would say the largest inflection will be beyond 2025, Durgesh. And so I expect renewables will be up somewhat. But I think based on what our COD schedules look like, the largest increases will come in '26 and '27.
Durgesh Chopra: Got it. Okay. That's very helpful. That's just project timing. Okay. I have two other questions. First, on the hydrogen project with APD, there may have been some changes there, with the activist involvement with the company. Just can you update us what your plan is there? How much capital might you have invested to date? And what do we do with those gigawatts coming online? Just anything you can share there, that would be helpful.
Andres Gluski: Sure. No, I appreciate the question. Look we have developed a very attractive 1.5 gigawatts of renewables which, as you know, there is a market that there's a shortage of large advanced renewable projects. So we have to see when 45 V comes out and other things, how much of this goes to hydrogen. But in any case, we have a very attractive asset there. Regarding outside of the states, I do see those projects likely going forward with Asian buyers stepping up and as partners in the early part of it. So we don't have a lot of money invested other than development money that we've done. However, I think that this is probably some of the best pipeline development that we've done because it's a particularly attractive asset.
Durgesh Chopra: Got it, Andres. That's very helpful. And this is part of the backlog that you show, right? The -- I believe that number is 12 now. Is that the 1.5 gig that's included in the 12?
Andres Gluski: No, no. We only include in our backlog, that's which is signed or awarded at the very final stage. We've never taken any project out of our backlog really. Nothing but -- so we wouldn't include it until we have a signed PPA.
Durgesh Chopra: Understood. Okay. Very clear. And then one final question, sorry for dragging for this long. Steve, just on Moody's basis, earlier in the year, we've had conversations on the methodology -- potentially a methodology change at Moody's. Maybe just update us on where you stand on Moody's basis and the latest conversations you've had with the credit rating agency?
Steve Coughlin: Sure, Durgesh. So the dialogue continues. I do expect that they will publish an update before year-end. I characterize the conversation continuing to be very constructive. I hate to see that our credit quality has indeed improved since they gave us the initial upgrade a few years back. What's the reality here is that we've been really transforming the portfolio, exiting markets, exiting carbon-intensive assets and rotating capital into long duration, U.S. dollar, high creditworthy counter-parties with no fuel exposure. So we have a very, very attractive profile. I think what they're working through since Moody's looks at AES on a consolidated basis, as opposed to S&P and Fitch, which is at the parent recourse level only, they're looking at the project finance structures and how they take account of those. Project finance is amortizing when we put debt on our projects, it amortizes over the life of the contract, so there's not an exposed levered tail there. So it's a low-risk structure. It's actually investment-grade-rated debt at the project level. So it's an attractive structure, it just hasn't fit within the well within the way they define their thresholds. So they're looking at that. They're also looking at how -- given our high growth, we carry a fairly material amount of construction debt, and that's not yet yielding. And so they're looking at that in ways to recognize that there is cash flow pending that's certain. And of course, this is nonrecourse debt as well that they're looking for adjustments along those lines as well. So I feel good about where we are. I feel really good about the conversations. And I do expect there'll be sharing their view here before the end of the year.
Andres Gluski: I would add that if you think of the sort of the big picture overall, we continue to improve our credit profile. So we exited Brazil which was a substantial amount of our FX, certainly a big part of our foreign interest rate exposure and weather-related exposures we learned this year. So as we shut down coal plants or sell coal plants, you're changing 2-year PPAs with fuel risk for really long-term 20-year PPAs with no fuel risk with investment-grade off-takers in the U.S. So I feel very confident that any credit rating agency looking at overall company, where we are today versus where they gave us the ratings a year or 2 ago is a substantially better company.
Durgesh Chopra: Got it. Really appreciate that color guys. Thank you.
Andres Gluski: Thank you, Durgesh.
Operator: Thank you, Durgesh. Our next question comes from the line of Julien Dumoulin-Smith with Jefferies. Julien, your line is open.
Julien Dumoulin-Smith: Hi, good morning team. Thank you guys very much for the time. I appreciate it. Can you guys hear me?
Andres Gluski: Yes, Julien very well.
Julien Dumoulin-Smith: Thanks you, Andres. Excellent. Well, actually since we're talking on the credit here, just to kick off on the nuance, just where do you see your metrics getting here and then more specifically, do you anticipate needing to upsize the asset sales or accelerate the asset sale target to kind of true up the balance sheet for any reason here? I get the Moody's methodology is in flux, but as you think about the asset sale piece of this, any observations to make on that front since we were focused on in the second year?
Steve Coughlin: No, certainly. So I mean the credit metrics remain strong at the parent level. And actually, things that we've been doing are quite credit accretive. So some of the largest things we've done here now just closing on Brazil. Brazil, while it was generating a significant amount of EBITDA in the Renewable segment was actually producing very, very little cash. The business is highly levered and so the sale is actually very credit accretive. Similarly, with the Ohio sell-down when that closes next year, we're going to be paying down a tranche debt that's due at the holdco over 400 million. So we see that as also credit accretive and that we do, in fact, expect as a result of the transaction Ohio will be able to start paying dividends at least a year sooner than it otherwise would have. So we really feel good about the trajectory. I would expect at the end of this year, the parent level metrics will be between 22% and 23% which are well above the threshold of 20% that we have. And so yes, no, Julien, I think the asset sale program, we've had a lot of success, targeted 3.5. The universe is, in fact, bigger. So we'll see what makes sense going into the future. But I see us having a lot of runway here and that the credit metric has actually, in fact, been supported by the asset sale program.
Andres Gluski: I'd like to sort of also say that we've always exceeded our asset sale program targets. And I would also say, quite frankly, I think we have a very good record of selling assets at good value. And what we've always been doing is maximizing the value for our shareholders and not just doing asset sales to hit a certain, let's say, megawatt or generation composition target.
Julien Dumoulin-Smith: No. Fair enough, guys and thank you for that. Let me pivot real quickly to Palco here. We saw your peers to the north with NIPSCO. NiSource gave a very robust update. You guys are talking about 3 gigawatts of procurement activity. I know you guys already had a team's trajectory articulated at the Analyst Day last year, but I suspect that number is potentially meaningfully higher or potentially extend it out for meaningfully greater duration given A the 3 gigawatts and B the baseline of the rate base at Palco here. If you can speak a little bit to what your expectations on what total portion that you can own and how it impacts your financials here?
Steve Coughlin: Okay. So look, I mean the rate case this year was resolved early settled early and approved early. So we had a significant increase over $70 million annual increase. And so that is driving a significant year-over-year. We'll have a full year of the new rates next year. And then as Andres described in his comments, we're once RFP for a lot of new generation in the utility. It will go into the integrated resource plan to be filed next year. And we're talking -- I think we said in the last call, 3 gigawatts total and that's increasing of data center load across the utilities, in addition to what we've already signed. So there's a -- I would say what we guided to is double-digit rate base growth across the utilities. It's going to be much higher than that. So we'll give more guidance in '25, Julien, but -- given what we're seeing the utility investment is going to increase, the returns are going to increase, the rate base will increase. And that's also part of why we also sold down Ohio because although we're selling down 30%, in fact, our net investment in the utilities is increasing. So this sell-down is allowing us to improve credit, get to earlier distributions from the utility, it will improve the credit quality in Ohio and it helps fund a much bigger investment program than even we anticipated a year ago. And our net investment, even though we're at 70% ownership in both utilities it’s going to be even higher. So that's how I would look at it. And of course, in Indiana, it's an integrated utility. So not only do we have the load on the network, but we also have the generation piece to supply as well. So we see a lot of generation growth.
Julien Dumoulin-Smith: Right. So even the medium-term rate base growth CAGR, it could potentially be heading higher is what I'm hearing. But actually, you made allusion to one thing here, if I can just clarify. You'll be providing an updated outlook here on the fourth quarter. And I know that there's a lot of different things that are moving around in the plan. So as you guys have done historically, expect that kind of integrated update here on 4Q roll forward from the Analyst Day?
Steve Coughlin: Yes, absolutely. Yes, we will update you on our long term for -- in February.
Julien Dumoulin-Smith: Wonderful. Excellent, guys. Thank you for the time. Appreciate it.
Steve Coughlin: Thanks Julien.
Operator: Thank you, Julien. Our next question comes from the line of Angie Storozynski with Seaport. Angie your line is open.
Angie Storozynski: Thank you for taking my question. So I just wanted to focus on the renewable power EBITDA. So the one without credits for cash EBITDA, I would call it. So I'm looking at these results. I mean you will be basically flat since 2022. And now it looks like 2025 is going to be also like 620, 630 range. So I mean I understand that there are one-off items that weighed on this year's EBITDA which is going to be even lower than the number I just mentioned. So I mean there has to be some growth in that number. And I hear you, Steve, that there will be some in '26, '27, but you're making very substantial investments and we're not seeing growth in that cash renewable EBITDA. Now the reason I'm actually asking about it is because if you look at the parent free cash flow, parent distributions, I mean the vast majority of them come from energy infrastructure, but that's a segment that is shrinking. So I will have to rely on cash distributions from renewables very soon in order to hit the free cash flow expectations. So I'm just hoping that we can reconcile this. Thanks.
Andres Gluski: Yes. First, we're not saying that the renewable EBITDA will grow substantially in 2025. And what you have is the fact that we're selling Brazil. That's 5 gigawatts, so -- which are having a little bit of apples and oranges here. So we're seeing the operating results from our renewable build, absolutely in where we think it should be. So it is -- there's a number of things going on here, Angie, that we can -- time will clarify. But I don't think that it's -- you can say that we're not getting the results from the investments that we're making. It's just moving. And then second, on the energy infrastructure, yes, I mean, we have a balanced portfolio. So we tend to have that event in one spot, offset by good events in the other. And this was a particular quarter where really a lot of things came together that normally don't come together. So normally, if you have conditions, you have more win. This time we had both. But what we also had was sort of all the years rain came in a very short period of time and damage of 1 gigawatt hydro, so I think we really did have sort of onetime events, and I think you're drawing sort of longer-term conclusions from that. I'll pass it to Steve.
Steve Coughlin: Yes. I would just say, Angie, the only reason we're down year-over-year is because of the record drought. The only material reason is because of the record drought, primarily Colombia and to a degree, Brazil as well. So those conditions are known to be changing, moving to La Nina. Obviously, Brazil is out of the portfolio. So Colombia, we do expect returning to much more normal conditions next year. And don't forget, we also had an extremely high third quarter last year in Colombia, unusually high. So it makes the year-over-year comparison look more extreme. But what's the reality is the U.S. growth is significant. And so this year and even higher into next year, more than overcoming the loss of Brazil from the renewables segment. So the renewables growth will be very material this year. So we get that we're not on track at this point with the guidance for -- if you were to straight line the guidance, but we're picking up substantially into next year and are reaffirming through 2027 that 19% to 21% growth rate, and that's largely driven by all of this U.S. growth, which is taking off. As I said, we have added a total of 3 gigawatts of renewables across the across the year since Q3 of last year. We also will ultimately move Chile into the renewable segment where it belongs as we execute on our coal exit. So the cash from this renewable segment will grow accordingly as well, and the EBITDA will be on track with that growth rate.
Angie Storozynski: Okay. So let me just push back the latter, meaning that Chile was supposed to be additive to the growth trajectory that you were showing at the Analyst Day. And now that we see the results, like year-over-year changes versus '23 results, you clearly point out that the second half of '23 had some big onetime benefits, which you could not have counted on during your '23 Analyst Day, and yet you came below your expectations, even the low end on renewables EBITDA for '23.So again, I mean I hear you that there is growth in the U.S. portfolio, which will benefit the EBITDA, but again, I mean, you had some big positives in the second half of '23, which you could not have expected when you were giving guidance on '23 on renewables and you came below expectations on renewables in '23 now. So why should I have conviction that the same is not going to true in future years?
Andres Gluski: Well, we feel confident we're going to hit the long-range growth that we talked about. I mean it has to do with reaching critical mass on some of these things. And certainly, we can have onetime weather events. But I think the important thing is what returns are you actually seeing from the projects you're bringing online? What is the value of the PPAs you are signing? And as we move forward, it will be easier to make apples-and-apples comparisons as we have the same portfolio new year.
Steve Coughlin: Yes. The other thing I would say, Angie, is referring to last year, we did end up having more of our commissionings very late in the year, in fact, most in December. So a little later than expected this year. We have substantially changed that trend. And so the renewable commissionings were much more really spread throughout the year. That's why we've already recognized $900 million of tax attributes already. So I think that's another reason that, that program has become more mature and spread throughout the year that we're seeing a better result, and that ‘23 was lower.
Angie Storozynski: And just one other question. So I'm looking at your guidance here on the free cash flow for the parent for the year. It seems like you are expecting about $1.5 billion to $1.6 billion in distributions from subsidiary and you are at about 800, 880, I forget. So is this apples-to-apples, meaning that I am basically 50% of distributions, meaning that the fourth quarter will be the big catch-up on distributions?
Steve Coughlin: Yes, but that's a normal trend. So that's -- we've been having that type of seasonality for a long time. And I would say, in most cases, the cash is already sitting there. It's based on the windows in time relative to our debt service that we're also allowed to pay dividends. So we have clear visibility into the remaining dividend. It's just a matter of timing at this point as to when they get released on the periodic twice a year, once a year in some cases. So I'm very, very confident in the distribution level.
Angie Storozynski: Okay. Thank you.
Steve Coughlin: Thank you, Angie.
Operator: Our next question comes from the line of Michael Sullivan with Wolfe Research. Michael your line is now open.
Michael Sullivan: Hi. Good morning.
Steve Coughlin: Good morning, Michael.
Michael Sullivan: Yes, just -- I know that kind of got passed through a bunch there on the last line of questions or commentary, I guess. Just to make it simple, like you keep talking about significant growth in '25. We obviously don't know what that means exactly. But you have this 5% to 7% EBITDA CAGR off of '23. When do you get inside of that within your plan?
Steve Coughlin: Yes. So again, we'll give an update in February. The early years as we have been executing on the transformation and things like the Brazil exit, we'll have the Vietnam exit next year. We had the Warrior Run shutdown, and so that goes away. So that weighs on the early years, but the trajectory, as I said, there's more of an inflection point beyond next year, overall, getting through the 2027. Period. So what's happening is that the renewables will grow significantly next year. The utilities will grow significantly, catching back up to closer to that level of return of growth that we've been expecting, but the energy infrastructure shrinking has been a little more front-end loaded. And then the Brazil sale, obviously, is a headwind in renewables in the near term, but we're more -- significantly more than offsetting it next year. So that's how I would characterize it. We feel good about the growth rate overall, but it's influenced by how we execute on the transformation as well as the growth, and the transformation shows up in the shrinking of the energy infrastructure. So that's how I would characterize it. And so we'll give more in February. But again, I feel really good about the renewables and the utilities. And then the energy infrastructure we’ll look at choices we have around how fast to continue the transformation and discuss that in February.
Michael Sullivan: Okay. That's very helpful, Steve. And then I had 2 ones just on your resource additions. The first, just in terms of looking at new gas at the utility, do you see that in the RFP? Or is that not until the IRP? And do you have a good handle on how much you could look to be doing in gas? And then on the nonutility side, you all have traditionally been pretty solar heavy though I think you mentioned wind a few times just in terms of supply chain. But when I look at you and your peers, it doesn't seem like anyone's adding too much wind these days. So just curious what you're seeing on that front?
Andres Gluski: Yes. On your first question, that would be really waiting for the IRP. So we certainly are looking at all options. So it will be likely a mix of renewables and some thermal, of course, batteries as well. Now regarding the second question in wind. Well, we were -- we had been building quite a lot of wind in Brazil. But a lot of the projects that we have in the pipeline have a considerable amount of wind. So if you think of the -- what's been known as sort of the green hydrogen project in Texas, 1.5 giga, that's primarily wind. So we'll have a more of a balance in the U.S. between wind and solar in future years.
Michael Sullivan: Okay. Thank you very much.
Operator: Thank you, Michael. Our next question comes from the line of Ryan Levine with Citi. Ryan your lines are open.
Ryan Levine: Good morning, and thanks for taking my question. What is the time line for the $92 million Colombia impact to return to historic norms? And what is the risk to achieving this ramp at this stage in the year?
Steve Coughlin: Yes. So conditions are already improving. The fourth quarter, in fact, I expect will be higher in Colombia than last year, Ryan. And all forecasts point to La Nina being highly probable over the next couple of months and lasting well into next year. So it's pretty much turning around now. Again, I expect the fourth quarter to be higher. And then throughout next year, I expect Colombia to be higher in this year overall. So Colombia has been -- and it was $92 million in the quarter alone. It's $130 million down year-to-date over prior year. So that is the single largest driver here, and it shows up in the Renewables segment. But the U.S. growth is doing hard work to offset that and significantly overcome overcomes it in the fourth quarter here and into next year.
Andres Gluski: Yes. I would add we had a two-month outage. Yes. So the truth is that outage was at the worst possible time because if we hadn't had the outage because we had a rain, which was 25% higher than anything prior previously recorded, we could have used that water to very good results subsequently in the drought. So being out for two months is -- that's part of the recovery.
Ryan Levine: Okay. So then by 2026, you should be back to a more normal performance?
Steve Coughlin: No, '25, Ryan. So the conditions are already improving. We expect this quarter, fourth quarter to be higher than last year. And next year, in 2025, we expect normal to better hydrology from the La Nina.
Ryan Levine: Okay. And then maybe switching gears, as you referenced in your prepared comments, impact to California spark spreads, are you looking to change your hedging strategy there? Or any color you could share around the outlook going forward for the Southland?
Steve Coughlin: Yes. So just -- as a reminder, the Southland structure has a 20-year contract for capacity and energy. So we have a very known monetization stream. It is at our election annually a year in advance to decide whether we want to market the energy ourselves and hedge it or put it to the uptake or under the PPA. So for '24 we did previously decide, at the end of '22, to call the energy to us and to market it. Unfortunately, spark spreads changed significantly during the time that we made that decision, and we're executing on the hedge program. And so we had downtime this year. But still relative to the put value, still a good decision. And so we have made that decision also for 2025 that we will market the energy. We are over 95% hedged already at values well in excess of the put value. So it -- the market has changed. The market has compressed a lot due to better hydro conditions. What we've had is milder weather. There's been a lot more battery penetration in California. So the market value is not as high over the long term as it had been back in '22 when we first made that decision. But nonetheless, we see, overall, the strategy is -- has been increasing or has added over the put is just not as much as we expected when we gave the guidance, unfortunately.
Ryan Levine: So, then as a follow-up, given that framework and your decisions for next year, is there any color around -- any direction of travel for that asset's performance for '25 given what your parties decided?
Steve Coughlin: Yes. I would say, at this point, since we've already decided on '25, it is in excess of the put value. And we're already nearly 100% hedged, 95% hedged, as I said. So it the value is lower than it was in the original guidance, but still above had we taken a no-risk strategy. And then for 2026, we have not yet made that decision. And we'll have to here later in the fourth quarter, and we'll update you all on that later. And that will be based just upon what we see in the hedge market at the time relative to the put value.
Ryan Levine: Thanks for taking my question.
Operator: Thank you. Ryan. Our next question is from the line of Richard Sunderland with JPMorgan. Richard, your line is open.
Richard Sunderland: Thanks for the time. I know you've covered a lot of ground. Just one quick cleanup. You've talked at various points about asset sale program and how you've thought about timing that and affecting that it sounds like more to come on year-end around that. But just curious how you're thinking about monetizing the new energy technologies investments? And if that's something that should fall within the planned period? Any thoughts there.
Andres Gluski: When you think about the new energy technologies, look, what we've talked about is through 2027. And we approached these strategically. So what we've always said is that we will monetize these assets when we feel it's appropriate. And when we are out of long-term venture capitalist investors. So we'll monetize them at the right time when we don't think we're adding a lot of value. And we've already done some monetization and taking some money off the table. So it's been a very successful program. And I think there's a lot more value there than is being recognized by most of the parts. But what I would say is that so long as we add a lot of value, we'll stay in. However, we'll continue to opportunistically monetize. And certainly, we're well ahead of our plan for 2027. But as Steve mentioned, the universe is greater. So it would include some things from new energy technologies.
Richard Sunderland: Great, thank you.
Operator: Thank you, Richard. There are no additional questions waiting at this time. So I'll turn the call back over to Susan Harcourt for closing remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. We look forward to seeing many of you at the EEI Financial Conference later this month. Thank you, and have a nice day.
Operator: That concludes today's conference call. Thank you for your participation. I hope you have a wonderful rest of your day. | [
{
"speaker": "Operator",
"text": "Good morning. Thank you for attending today's AES Corporation Third Quarter 2024 Financial Review Call. My name is Megan, and I'll be your moderator for today. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. [Operator Instructions]. I would now like to turn the call over to Susan Harcourt, Vice President of Investor Relations at AES Corporation. Susan, you may begin."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning, and welcome to our third quarter 2024 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our third quarter 2024 financial review call. We are pleased with our performance this year. And today, I will discuss our third quarter results, a robust growth we are seeing at our renewables and U.S. utility businesses and our progress towards our asset sales target. Beginning on Slide 3 with our third quarter results, which were generally in line with our expectations. Adjusted EBITDA with tax attributes was about 1.2 billion, adjusted EBITDA was 692 million and adjusted EPS was $0.71. We're on track to meet our 2024 financial objectives, including our expectation to be in the top half of our ranges for adjusted EBITDA with tax attributes and adjusted EPS. At the same time, we now expect adjusted EBITDA to be towards the low end of the guidance range for the year, primarily due to the one-time impact of extreme weather in Colombia and the lower margins in the Energy Infrastructure SBU. We are reaffirming our expected growth rate through 2027. Steve Coughlin, our CFO, will provide more detail on our financial performance and outlook. I'm also very pleased to report that since our last call in August, we have signed or been awarded 2.2 gigawatts of new contracts. This includes both long-term renewable PPAs and new data center load growth at our U.S. utilities. Moving to our Renewables business on Slide 4. Since our Q2 financial review call, we have added 1.3 gigawatts of new PPAs to our backlog, bringing our year-to-date total to 3.5 gigawatts, more than 70% of which is with corporate customers. As a reminder, last year, we set a target of signing 14 to 17 gigawatts of new PPAs from 2023 to 2025. And with 9.1 gigawatts signed or awarded since the beginning of last year, we're currently well on track to meet this objective. Since setting that goal, we also materially increased our project return targets and we are focused on prioritizing the most profitable PPAs. Moving to Slide 5 and our construction progress. Since our second quarter call in August, we have completed construction of an additional 1.2 gigawatts of new projects, bringing our year-to-date total to 2.8 gigawatts, which represents nearly 80% of the 3.6 gigawatts we expect to complete this year. On-time execution is one of our competitive advantages, and we believe we have the best supply chain management in the industry. In the U.S., we have 100% of our solar panels on site for those projects coming online this year and 84% in country for next year. For 2026, we have 100% of our solar panels either in country or contracted to be domestically manufactured, providing protection against potential changes in tariff policy. We have also been a first mover in securing domestically manufactured battery modules and cells. We expect our first battery energy storage project with domestic content to come online in the first half of 2026. Additionally, we have established a robust supply chain for wind through our strategic suppliers with domestic manufacturing. Regarding long lead time equipment, such as transformers, and high-voltage breakers, we have secured all of the supply for our backlog through 2027. Turning to Slide 6. We are very well positioned as a leading provider of renewable energy to data center companies, particularly in the U.S. and to large mining companies outside the U.S. These customers want to work with AES due to our track record of providing customized solutions that best serve their specific needs and delivering our projects on time and on budget. With the U.S. elections only a few days away, I have great confidence in the resilience of our business plan, regardless of the outcomes of the presidential and congressional elections. While we do not believe the elimination of the investment tax credit or production tax credit is likely, even in an extreme scenario, we're uniquely well positioned due to the following. First, regardless of federal policies, our corporate customers had a massive need for new power that can only be met by renewables over the next decade. McKinsey estimates that in the U.S. data centers alone could require an additional 450 terawatt hours through the end of the decade, which is equivalent to more than the annual electricity consumption of France. With these market dynamics, we will continue to sign high-return renewables PPAs with our core customers. Second, should there be any changes to U.S. tariff policy, we have a resilient supply chain, with a large majority of our project components manufactured domestically by 2026. Finally, our strategy of procuring our equipment at the time of the PPA signing provides clear Safe Harboring protection from potential changes in policy. Now turning to Slide 7. Over the last 12 months, we have embarked on the most ambitious investment program in the history of our U.S. utilities, which will improve reliability and quality of service for our customers, while maintaining some of the lowest rates in both states. AES Indiana and AES Ohio are now 2 of the fastest-growing U.S. utilities, with projected double-digit rate base growth through 2027 based on necessary investments for our customers. As you may recall, in the third quarter of last year, we received commission approval for a new regulatory structure for AES Ohio, providing for timely recovery of the majority of these investments. Similarly, earlier last year, we received commission approval for new rates at AES Indiana, our first rate case in seven years. We are starting to see the benefits from the $1.2 billion we have invested in both utilities so far this year, representing a year-over-year increase of investment of 60%. Excluding the onetime settlement benefit recognized in 2023, year-to-date EBITDA is up 25%. Turning to Slide 8. We're also seeing additional investment opportunities from data center growth in our service areas above and beyond our existing rate base projections. Our utilities have many natural advantages that are attractive to large technology companies, such as proximity to fiber networks and the presence of ample land and water. We have worked to proactively identify sites that are well positioned to support new data centers, capitalizing on our deep relationships with technology companies. At AES Indiana, we expect to have specific data center deals to announce in the coming months, as we've been in active negotiations with several parties. We recently launched an RFP for 3 gigawatts of new generation to support accelerating demand growth. From a regulatory perspective, we will use the results of this RFP to help inform our IRP submission next year. At AES Ohio, we have now signed agreements for new data center load growth of 2.1 gigawatts, including an incremental 900 megawatts, on top of the 1.2 gigawatts we already announced on our last call. On our fourth quarter call in February, we will provide a comprehensive update on how these agreements impact our long-term investment plan and rate based growth. Today, we can indicate that just what we've signed to date provides a nearly 30% increase in investment through the end of the decade over our current plan. Turning to Slide 9. In September, we announced the plan to sell down 30% of AES Ohio to CDPQ, our longtime partner in AES Indiana. This transaction builds upon our strong relationship with CDPQ and allow us for common ownership across our U.S. utilities. This partnership will support growth at AES Ohio, with CDPQ as a funding partner for increasing investments to support reliability and economic development. Finally, as you may have seen in our release, we are pleased to report that we have now closed the sale of our equity interest in AES Brazil. We are proud of the work our people have done in Brazil to expand beyond the 2.7 gigawatt hydro portfolio by adding 2.5 gigawatts of operating wind and solar, creating one of the largest renewable businesses in the country. With these two transactions, we have now signed or closed agreements for more than three quarter of our 3.5 billion asset sale proceeds target through 2027. We have also further simplified our portfolio and eliminated Brazilian weather, interest rate and currency risks. With that, I would now like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our third quarter results and our 2024 guidance and parent capital allocation. Turning to Slide 11. Adjusted EBITDA with tax attributes was approximately 1.2 billion in the third quarter versus 1 billion a year ago. Although we realized 458 million of additional tax value year-over-year, renewables EBITDA was down 68 million, driven mostly by breaking drought conditions in South America. In addition, our energy infrastructure SBU was down 221 million largely due to expected items, which I'll cover in more detail on a later slide. Turning to Slide 12. Adjusted EPS for the quarter was $0.71 versus $0.60 last year. Drivers were similar to those of adjusted EBITDA with tax attributes, but partially offset by higher parent interest due to growth investments as well as a higher adjusted tax rate. I'll cover the performance of our SBUs, or strategic business units, on the next four slides. Beginning with our Renewables SBU on Slide 13. Higher EBITDA with tax attributes was driven primarily by significant growth from new projects in the U.S., where we've added 3.3 gigawatts since Q3 2023, but was partially offset by significant declines at our Colombia and Brazil businesses. This year, we've experienced unprecedented weather volatility and a record-breaking drought in South America, driven by El Nino conditions. In June, a historic flooding event took out our 1 gigawatt Chivor facility in Colombia for nearly 2 months, followed by an extreme drought across the entire country. Also, you may recall that the third quarter of 2023 was extremely positive as we had better hydrology at our Chivor facility than the rest of the country, while spot prices were very high, yielding significant margins. As a result, Colombia is down 92 million versus the third quarter of last year and over 130 million year-to-date versus last year. In Brazil, the record drought and extremely low wind resource this year have also negatively impacted renewables in Q3 and year-to- date. While 2024 has been a difficult year due to the events in South America, we expect our renewables segment will grow significantly in 2025. Emerging La Nina conditions in the Pacific are expected to return the region to much better hydrology. While in the U.S., by the end of this year, we will have brought online a total of nearly 2 gigawatts of new capacity, which will drive a large increase in our Renewable segment EBITDA in 2025. Now turning to Slide 14. Lower adjusted PTC at our Utilities SBU was mostly driven by the prior year recovery of 39 million of purchase power costs at AES Ohio, included as part of the ESP IV settlement, as well as higher interest expense from new borrowings. This was offset by returns on new rate base investment in the U.S. as well as new rates implemented in Indiana in May. Adjusting for the onetime settlement last year, utilities adjusted PTC grew by 18% in the third quarter over prior year. Lower year-over-year Q3 EBITDA at our energy infrastructure SBU was primarily driven by nearly 200 million of expected declines at our Warrior Run Southland legacy businesses and the impact of several sell-downs, all of which were baked into our guidance. At Warrior Run, we recognized revenues from the accelerated monetization of the PPA beginning last year and ending in the second quarter of this year. Our legacy Southland assets benefited from energy margins earned in the prior year, which are no longer an opportunity in 2024 under the new extension monetization structure. In addition to these known drivers, we experienced lower margins at our new Southland combined-cycle asset U.S. due to much milder weather as well as extended outages at our TEG and TEP thermal plants in Mexico. Finally, higher EBITDA at our New Energy Technologies SBU reflects continued high growth and margin increases at Fluence. Now turning to our expectations on Slide 17. We are reaffirming our 2024 adjusted EBITDA with tax attributes guidance of 3.6 billion to 4 billion and adjusted EPS guidance of 1.87 to 1.97 and continue to expect to be in the top half of both ranges, driven in part by the success we've had securing higher tax value on our new projects. Our renewables team expects to capture over 200 million in tax value upside this year, which reduces our growth capital needs. EBITDA from renewables will be favorable in the fourth quarter from revenues earned on our PPAs, although we expect lower tax attributes in the fourth quarter as a result of the more balanced timing of renewable commissionings throughout the year. We also expect further growth in our U.S. utilities in Q4 as we continue to realize returns from our investment program. This will be offset by the negative impact from the prior year monetization of the Warrior Run PPA as well as incremental impact from asset sales, including AES Brazil. Drivers of adjusted EPS will be similar along with higher interest expense from growth capital, but benefiting from a lower adjusted tax rate. As a result of our efforts to spread renewables construction more evenly throughout the year, we've achieved more than 80% of our adjusted EPS guidance year-to-date, providing greater certainty around our 2024 financial objectives. Turning to Slide 18. We are also reaffirming our adjusted EBITDA guidance range of 2.6 billion to 2.9 billion. While I'm pleased with our execution this year on our growth objectives, several large drivers have impacted results, primarily at our legacy businesses, and we now expect to end the year towards the lower end of our guidance range. Milder weather compressed spark spreads in California resulting in lower margins at our South and combined cycle gas plants. The PPA for these assets contains an option that allows us to choose to sell the energy to the market in a given year. We previously chose to execute this option for 2024 and were therefore impacted by declining spark spreads that occurred later in the year. In Mexico, the unplanned outages, which have now been resolved, further impacted our results in the second and third quarter. In Colombia, the combination of the Q2 flood-related outage at Chivor and year-long record drought have negatively impacted us versus our guidance. Finally, inverter failures at several of our solar sites impacted availability versus our plan. These inverters were under warranty and are being remediated by the manufacturers. Despite the confluence of these onetime negative impacts, growth in U.S. renewables remains very strong, and our U.S. utilities have outperformed. We expect to continue this momentum and substantially increase EBITDA at both our renewables and utilities businesses in 2025. Now to our 2024 parent capital allocation plan on Slide 19. Sources reflect approximately $2.7 billion of total discretionary cash, including $1.1 billion of parent free cash flow, $950 million of hybrid debt that we issued in May and $650 million of proceeds from asset sales. Sale proceeds will be slightly lower than expected in 2024 due to timing, but we are well ahead of our $3.5 billion long- term target through 2027. On the right-hand side, you can see our planned use of capital. We will return approximately $500 million to shareholders this year, reflecting the previously announced 4% dividend increase. We also plan to invest $2.2 billion to $2.3 billion in new growth. In summary, we've continued to execute in the year-to-date and are well positioned for a strong finish to 2024. Our substantial renewables commissioning thus far give us greater line of sight toward achieving our earnings and cash targets, and our funding plan is largely complete. With $1.60 of adjusted EPS year-to-date, we have overachieved on our EPS growth with a clear path to landing at least in the upper half of our guidance range. As we look ahead to 2025, we see strong growth in our Renewables and Utility segments and continued execution of our decarbonization strategy in energy infrastructure. I look forward to providing additional detail around 2025 and beyond on our fourth quarter call. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. Before opening up the call for Q&A, I would like to summarize the highlights from today's call. We continue to execute well on our strategic priorities, including robust growth at our renewables and U.S. utility businesses. With 9.1 gigawatts of new PPAs signed or awarded in 2023 and year-to-date 2024, we are well on our way towards achieving our goal of 14 gigawatts to 17 gigawatts in 2023 through 2025. Regarding our construction program, we have added 2.8 gigawatts of new projects to our operating portfolio so far this year, and we're seeing the direct financial benefits in our adjusted EPS and adjusted EBITDA with tax attributes results. At our U.S. utilities, we have embarked on the most ambition investment program in their history, while signing agreements for 2.1 gigawatts of data center load growth, and we expect more in the coming months. We're also executing well on our asset sale and transformation program and we feel good about the remainder of 2024 and our long-term outlook, despite specific onetime weather-related events this year. Finally, I can confidently say that I believe no one is better positioned with large technology customers than AES. Energy market fundamentals and the strong demand we're seeing from our corporate customers give us great confidence in the resilience of our business plan, regardless of the outcomes of the upcoming U.S. elections. Operator, please open up the line for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question will go to the line of Nick Campanella with Barclays."
},
{
"speaker": "Nicholas Campanella",
"text": "Good morning, thank you for taking my question. So, I wanted to just ask the comments about supply chain, you seem well positioned through 2026 with panels, etcetera. But you continue to construct 3.5 gigs for this year. You kind of outlined this previous target at the Analyst Day of 14 gig into 2025. So, we're getting closer up to '25 now. I just kind of check in and see how you feel progressing towards that target because it seems like it will be a pretty good step up into '25 here? And is that still attainable?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Thanks for the question, Nick. I mean we feel very strong about our supply chain management and construction program. We are the only large renewables developer, which really hasn't had to abandon any large PPAs over the last 3, 4 years. So, what we've said, we have all the equipment we need this year. We have 84% of what we need for next year already in country. In the next month or so, we should have 100%. So, we feel very good about supply chain. We intend to concentrate on the big items like wind turbines, batteries, solar panels. But you also have inverters and you have transformers, which are long lead time and we feel very solid there. In addition, we've really had no problems with the workforce either because we have strategic relationships with EPC contractors so that they can move the crews from one project to the next. So, in answering your question, we feel very good about our construction program. And as you know, in 2023, we geared up 100%. So now we've been able to really smooth out our commissioning throughout the year, and we expect that in 2025 and 2026."
},
{
"speaker": "Nicholas Campanella",
"text": "All right. When I think about '25 again, obviously, you had, on a tax attribute basis, some one-timers that's kind of putting you a little lower here. And I sense the notable confidence on the growth into 2025. Can you just kind of quantify for us how much has really just returned to normal versus new EBITDA from renewables contributions? And then when you consider things like Brazil rolling off, do you still expect that renewable segment to grow year-over-year?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Look, that's a very good question. We aren't giving guidance for 2025 at this time. But you're right, what you really have is mean reversion. You were really coming back to sort of more normal year. 2024 is a year that we've never had before, the sort of combination of extreme floods and extreme droughts in some of our service territories, largely driven by El Nino, coming into La Nina, we expect a return to normal. But you also correctly point out that we're maintaining all of our guidance and our long-term growth rates without Brazil. And so that means that the other sectors are picking up. So, to the extent that I can say we expect next year to be a more normal year and we've absorbed the sale of Brazil by increasing the growth rates, especially in U.S. renewables and U.S. utilities."
},
{
"speaker": "Stephen Coughlin",
"text": "Hi, Nick. It's Steve. I would just add. We've added and will add a total of 3 gigawatts of new renewables this year across the portfolio. So in addition to some more normalization, like La Nina coming in South America, the installed base is going to be significantly higher. So that's part of it. Renewables segment will grow significantly. And we also have outside the renewables, we have the utilities growth. So, with a full year of new rates in Indiana and continued rate base growth in Ohio."
},
{
"speaker": "Nicholas Campanella",
"text": "That makes sense. Thanks for answering my question and see you soon."
},
{
"speaker": "Operator",
"text": "Thank you, Nick. Our next question comes from the line of David Arcaro with Morgan Stanley. David your line is now open."
},
{
"speaker": "David Arcaro",
"text": "Hi. Thanks so much. Good morning. I was wondering if you could elaborate on the outperformance you had in tax credits that you received. You referenced the $200 million higher-than-expected tax credits. Wondering what that stemmed from? And is there an opportunity for any more outperformance from here?"
},
{
"speaker": "Steve Coughlin",
"text": "Dave, it's Steve. Definitely been a very good year. Look this is I would say, a very core competency for us and a key differentiator. We have I think the strongest tax team and renewables finance team there is. We're always looking to ensure that we maximize the tax value opportunity because what does that do? It reduces our capital requirements and also increases returns. So we've had a good year. We've done a number of things to ensure we qualify for bonuses, including places where there's a brownfield at or -- that allows us to qualify for the energy community. These are sites that were formerly, say, agricultural sites that had, had different materials, chemicals applied that allowed them to qualify. So we've done a lot of research and digging to justify adders where we can. So the other thing we're doing is all tax credits are not created equal. So because of our track record, people tend to come to us, expect -- and we get less of a discount and we get people very focused on working with us. So I would say monetizing through transfers, we've had a lot of success and transfers do tend to get recognized a little earlier than through the tax equity partnerships the credit value. So that's part of it as well. So I do see this as potential upside in the future. But of course, there's other things going on in the portfolio. We have to take a holistic look. And when we give guidance in '25, we'll update you guys on the entire portfolio."
},
{
"speaker": "David Arcaro",
"text": "Okay. Got it. That's helpful. Good to see just chipping away at the financing need with that. And then wondering if you could just touch on what renewable returns have been on the incremental projects that you've been signing, I guess, since raising your return expectations earlier in the year, how those return levels have been trending? Has there been continued momentum upwards?"
},
{
"speaker": "Andres Gluski",
"text": "Well, we're seeing good returns from our projects, and we continue to see a market that values what we bring to our customers. So the answer to that is yes, that we continue to see -- our newer projects have been within that range towards the upper end of that range. So we feel very confident in the numbers that we've provided."
},
{
"speaker": "David Arcaro",
"text": "Okay got it. Appreciate it. Thanks so much."
},
{
"speaker": "Andres Gluski",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Thank you, David. Our next question comes from the line of Durgesh Chopra with Evercore ISI. Durgesh your line is open."
},
{
"speaker": "Durgesh Chopra",
"text": "Hi. Thank you. Good morning team thanks for taking my question. Just wanted to start off with the actual portfolio that is going to come online, not from the guidance. But in terms of the 2.8 gigawatts that's coming online this year, should we expect an uptick in that number as we go into 2025, the actual construction and getting projects online?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So this is Steve. So we'll give that guidance in February. So there's a number of moving pieces here. I would say the largest inflection will be beyond 2025, Durgesh. And so I expect renewables will be up somewhat. But I think based on what our COD schedules look like, the largest increases will come in '26 and '27."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Okay. That's very helpful. That's just project timing. Okay. I have two other questions. First, on the hydrogen project with APD, there may have been some changes there, with the activist involvement with the company. Just can you update us what your plan is there? How much capital might you have invested to date? And what do we do with those gigawatts coming online? Just anything you can share there, that would be helpful."
},
{
"speaker": "Andres Gluski",
"text": "Sure. No, I appreciate the question. Look we have developed a very attractive 1.5 gigawatts of renewables which, as you know, there is a market that there's a shortage of large advanced renewable projects. So we have to see when 45 V comes out and other things, how much of this goes to hydrogen. But in any case, we have a very attractive asset there. Regarding outside of the states, I do see those projects likely going forward with Asian buyers stepping up and as partners in the early part of it. So we don't have a lot of money invested other than development money that we've done. However, I think that this is probably some of the best pipeline development that we've done because it's a particularly attractive asset."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it, Andres. That's very helpful. And this is part of the backlog that you show, right? The -- I believe that number is 12 now. Is that the 1.5 gig that's included in the 12?"
},
{
"speaker": "Andres Gluski",
"text": "No, no. We only include in our backlog, that's which is signed or awarded at the very final stage. We've never taken any project out of our backlog really. Nothing but -- so we wouldn't include it until we have a signed PPA."
},
{
"speaker": "Durgesh Chopra",
"text": "Understood. Okay. Very clear. And then one final question, sorry for dragging for this long. Steve, just on Moody's basis, earlier in the year, we've had conversations on the methodology -- potentially a methodology change at Moody's. Maybe just update us on where you stand on Moody's basis and the latest conversations you've had with the credit rating agency?"
},
{
"speaker": "Steve Coughlin",
"text": "Sure, Durgesh. So the dialogue continues. I do expect that they will publish an update before year-end. I characterize the conversation continuing to be very constructive. I hate to see that our credit quality has indeed improved since they gave us the initial upgrade a few years back. What's the reality here is that we've been really transforming the portfolio, exiting markets, exiting carbon-intensive assets and rotating capital into long duration, U.S. dollar, high creditworthy counter-parties with no fuel exposure. So we have a very, very attractive profile. I think what they're working through since Moody's looks at AES on a consolidated basis, as opposed to S&P and Fitch, which is at the parent recourse level only, they're looking at the project finance structures and how they take account of those. Project finance is amortizing when we put debt on our projects, it amortizes over the life of the contract, so there's not an exposed levered tail there. So it's a low-risk structure. It's actually investment-grade-rated debt at the project level. So it's an attractive structure, it just hasn't fit within the well within the way they define their thresholds. So they're looking at that. They're also looking at how -- given our high growth, we carry a fairly material amount of construction debt, and that's not yet yielding. And so they're looking at that in ways to recognize that there is cash flow pending that's certain. And of course, this is nonrecourse debt as well that they're looking for adjustments along those lines as well. So I feel good about where we are. I feel really good about the conversations. And I do expect there'll be sharing their view here before the end of the year."
},
{
"speaker": "Andres Gluski",
"text": "I would add that if you think of the sort of the big picture overall, we continue to improve our credit profile. So we exited Brazil which was a substantial amount of our FX, certainly a big part of our foreign interest rate exposure and weather-related exposures we learned this year. So as we shut down coal plants or sell coal plants, you're changing 2-year PPAs with fuel risk for really long-term 20-year PPAs with no fuel risk with investment-grade off-takers in the U.S. So I feel very confident that any credit rating agency looking at overall company, where we are today versus where they gave us the ratings a year or 2 ago is a substantially better company."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Really appreciate that color guys. Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Durgesh."
},
{
"speaker": "Operator",
"text": "Thank you, Durgesh. Our next question comes from the line of Julien Dumoulin-Smith with Jefferies. Julien, your line is open."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hi, good morning team. Thank you guys very much for the time. I appreciate it. Can you guys hear me?"
},
{
"speaker": "Andres Gluski",
"text": "Yes, Julien very well."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Thanks you, Andres. Excellent. Well, actually since we're talking on the credit here, just to kick off on the nuance, just where do you see your metrics getting here and then more specifically, do you anticipate needing to upsize the asset sales or accelerate the asset sale target to kind of true up the balance sheet for any reason here? I get the Moody's methodology is in flux, but as you think about the asset sale piece of this, any observations to make on that front since we were focused on in the second year?"
},
{
"speaker": "Steve Coughlin",
"text": "No, certainly. So I mean the credit metrics remain strong at the parent level. And actually, things that we've been doing are quite credit accretive. So some of the largest things we've done here now just closing on Brazil. Brazil, while it was generating a significant amount of EBITDA in the Renewable segment was actually producing very, very little cash. The business is highly levered and so the sale is actually very credit accretive. Similarly, with the Ohio sell-down when that closes next year, we're going to be paying down a tranche debt that's due at the holdco over 400 million. So we see that as also credit accretive and that we do, in fact, expect as a result of the transaction Ohio will be able to start paying dividends at least a year sooner than it otherwise would have. So we really feel good about the trajectory. I would expect at the end of this year, the parent level metrics will be between 22% and 23% which are well above the threshold of 20% that we have. And so yes, no, Julien, I think the asset sale program, we've had a lot of success, targeted 3.5. The universe is, in fact, bigger. So we'll see what makes sense going into the future. But I see us having a lot of runway here and that the credit metric has actually, in fact, been supported by the asset sale program."
},
{
"speaker": "Andres Gluski",
"text": "I'd like to sort of also say that we've always exceeded our asset sale program targets. And I would also say, quite frankly, I think we have a very good record of selling assets at good value. And what we've always been doing is maximizing the value for our shareholders and not just doing asset sales to hit a certain, let's say, megawatt or generation composition target."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "No. Fair enough, guys and thank you for that. Let me pivot real quickly to Palco here. We saw your peers to the north with NIPSCO. NiSource gave a very robust update. You guys are talking about 3 gigawatts of procurement activity. I know you guys already had a team's trajectory articulated at the Analyst Day last year, but I suspect that number is potentially meaningfully higher or potentially extend it out for meaningfully greater duration given A the 3 gigawatts and B the baseline of the rate base at Palco here. If you can speak a little bit to what your expectations on what total portion that you can own and how it impacts your financials here?"
},
{
"speaker": "Steve Coughlin",
"text": "Okay. So look, I mean the rate case this year was resolved early settled early and approved early. So we had a significant increase over $70 million annual increase. And so that is driving a significant year-over-year. We'll have a full year of the new rates next year. And then as Andres described in his comments, we're once RFP for a lot of new generation in the utility. It will go into the integrated resource plan to be filed next year. And we're talking -- I think we said in the last call, 3 gigawatts total and that's increasing of data center load across the utilities, in addition to what we've already signed. So there's a -- I would say what we guided to is double-digit rate base growth across the utilities. It's going to be much higher than that. So we'll give more guidance in '25, Julien, but -- given what we're seeing the utility investment is going to increase, the returns are going to increase, the rate base will increase. And that's also part of why we also sold down Ohio because although we're selling down 30%, in fact, our net investment in the utilities is increasing. So this sell-down is allowing us to improve credit, get to earlier distributions from the utility, it will improve the credit quality in Ohio and it helps fund a much bigger investment program than even we anticipated a year ago. And our net investment, even though we're at 70% ownership in both utilities it’s going to be even higher. So that's how I would look at it. And of course, in Indiana, it's an integrated utility. So not only do we have the load on the network, but we also have the generation piece to supply as well. So we see a lot of generation growth."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Right. So even the medium-term rate base growth CAGR, it could potentially be heading higher is what I'm hearing. But actually, you made allusion to one thing here, if I can just clarify. You'll be providing an updated outlook here on the fourth quarter. And I know that there's a lot of different things that are moving around in the plan. So as you guys have done historically, expect that kind of integrated update here on 4Q roll forward from the Analyst Day?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, absolutely. Yes, we will update you on our long term for -- in February."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Wonderful. Excellent, guys. Thank you for the time. Appreciate it."
},
{
"speaker": "Steve Coughlin",
"text": "Thanks Julien."
},
{
"speaker": "Operator",
"text": "Thank you, Julien. Our next question comes from the line of Angie Storozynski with Seaport. Angie your line is open."
},
{
"speaker": "Angie Storozynski",
"text": "Thank you for taking my question. So I just wanted to focus on the renewable power EBITDA. So the one without credits for cash EBITDA, I would call it. So I'm looking at these results. I mean you will be basically flat since 2022. And now it looks like 2025 is going to be also like 620, 630 range. So I mean I understand that there are one-off items that weighed on this year's EBITDA which is going to be even lower than the number I just mentioned. So I mean there has to be some growth in that number. And I hear you, Steve, that there will be some in '26, '27, but you're making very substantial investments and we're not seeing growth in that cash renewable EBITDA. Now the reason I'm actually asking about it is because if you look at the parent free cash flow, parent distributions, I mean the vast majority of them come from energy infrastructure, but that's a segment that is shrinking. So I will have to rely on cash distributions from renewables very soon in order to hit the free cash flow expectations. So I'm just hoping that we can reconcile this. Thanks."
},
{
"speaker": "Andres Gluski",
"text": "Yes. First, we're not saying that the renewable EBITDA will grow substantially in 2025. And what you have is the fact that we're selling Brazil. That's 5 gigawatts, so -- which are having a little bit of apples and oranges here. So we're seeing the operating results from our renewable build, absolutely in where we think it should be. So it is -- there's a number of things going on here, Angie, that we can -- time will clarify. But I don't think that it's -- you can say that we're not getting the results from the investments that we're making. It's just moving. And then second, on the energy infrastructure, yes, I mean, we have a balanced portfolio. So we tend to have that event in one spot, offset by good events in the other. And this was a particular quarter where really a lot of things came together that normally don't come together. So normally, if you have conditions, you have more win. This time we had both. But what we also had was sort of all the years rain came in a very short period of time and damage of 1 gigawatt hydro, so I think we really did have sort of onetime events, and I think you're drawing sort of longer-term conclusions from that. I'll pass it to Steve."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. I would just say, Angie, the only reason we're down year-over-year is because of the record drought. The only material reason is because of the record drought, primarily Colombia and to a degree, Brazil as well. So those conditions are known to be changing, moving to La Nina. Obviously, Brazil is out of the portfolio. So Colombia, we do expect returning to much more normal conditions next year. And don't forget, we also had an extremely high third quarter last year in Colombia, unusually high. So it makes the year-over-year comparison look more extreme. But what's the reality is the U.S. growth is significant. And so this year and even higher into next year, more than overcoming the loss of Brazil from the renewables segment. So the renewables growth will be very material this year. So we get that we're not on track at this point with the guidance for -- if you were to straight line the guidance, but we're picking up substantially into next year and are reaffirming through 2027 that 19% to 21% growth rate, and that's largely driven by all of this U.S. growth, which is taking off. As I said, we have added a total of 3 gigawatts of renewables across the across the year since Q3 of last year. We also will ultimately move Chile into the renewable segment where it belongs as we execute on our coal exit. So the cash from this renewable segment will grow accordingly as well, and the EBITDA will be on track with that growth rate."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. So let me just push back the latter, meaning that Chile was supposed to be additive to the growth trajectory that you were showing at the Analyst Day. And now that we see the results, like year-over-year changes versus '23 results, you clearly point out that the second half of '23 had some big onetime benefits, which you could not have counted on during your '23 Analyst Day, and yet you came below your expectations, even the low end on renewables EBITDA for '23.So again, I mean I hear you that there is growth in the U.S. portfolio, which will benefit the EBITDA, but again, I mean, you had some big positives in the second half of '23, which you could not have expected when you were giving guidance on '23 on renewables and you came below expectations on renewables in '23 now. So why should I have conviction that the same is not going to true in future years?"
},
{
"speaker": "Andres Gluski",
"text": "Well, we feel confident we're going to hit the long-range growth that we talked about. I mean it has to do with reaching critical mass on some of these things. And certainly, we can have onetime weather events. But I think the important thing is what returns are you actually seeing from the projects you're bringing online? What is the value of the PPAs you are signing? And as we move forward, it will be easier to make apples-and-apples comparisons as we have the same portfolio new year."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. The other thing I would say, Angie, is referring to last year, we did end up having more of our commissionings very late in the year, in fact, most in December. So a little later than expected this year. We have substantially changed that trend. And so the renewable commissionings were much more really spread throughout the year. That's why we've already recognized $900 million of tax attributes already. So I think that's another reason that, that program has become more mature and spread throughout the year that we're seeing a better result, and that ‘23 was lower."
},
{
"speaker": "Angie Storozynski",
"text": "And just one other question. So I'm looking at your guidance here on the free cash flow for the parent for the year. It seems like you are expecting about $1.5 billion to $1.6 billion in distributions from subsidiary and you are at about 800, 880, I forget. So is this apples-to-apples, meaning that I am basically 50% of distributions, meaning that the fourth quarter will be the big catch-up on distributions?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, but that's a normal trend. So that's -- we've been having that type of seasonality for a long time. And I would say, in most cases, the cash is already sitting there. It's based on the windows in time relative to our debt service that we're also allowed to pay dividends. So we have clear visibility into the remaining dividend. It's just a matter of timing at this point as to when they get released on the periodic twice a year, once a year in some cases. So I'm very, very confident in the distribution level."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Angie."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Michael Sullivan with Wolfe Research. Michael your line is now open."
},
{
"speaker": "Michael Sullivan",
"text": "Hi. Good morning."
},
{
"speaker": "Steve Coughlin",
"text": "Good morning, Michael."
},
{
"speaker": "Michael Sullivan",
"text": "Yes, just -- I know that kind of got passed through a bunch there on the last line of questions or commentary, I guess. Just to make it simple, like you keep talking about significant growth in '25. We obviously don't know what that means exactly. But you have this 5% to 7% EBITDA CAGR off of '23. When do you get inside of that within your plan?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So again, we'll give an update in February. The early years as we have been executing on the transformation and things like the Brazil exit, we'll have the Vietnam exit next year. We had the Warrior Run shutdown, and so that goes away. So that weighs on the early years, but the trajectory, as I said, there's more of an inflection point beyond next year, overall, getting through the 2027. Period. So what's happening is that the renewables will grow significantly next year. The utilities will grow significantly, catching back up to closer to that level of return of growth that we've been expecting, but the energy infrastructure shrinking has been a little more front-end loaded. And then the Brazil sale, obviously, is a headwind in renewables in the near term, but we're more -- significantly more than offsetting it next year. So that's how I would characterize it. We feel good about the growth rate overall, but it's influenced by how we execute on the transformation as well as the growth, and the transformation shows up in the shrinking of the energy infrastructure. So that's how I would characterize it. And so we'll give more in February. But again, I feel really good about the renewables and the utilities. And then the energy infrastructure we’ll look at choices we have around how fast to continue the transformation and discuss that in February."
},
{
"speaker": "Michael Sullivan",
"text": "Okay. That's very helpful, Steve. And then I had 2 ones just on your resource additions. The first, just in terms of looking at new gas at the utility, do you see that in the RFP? Or is that not until the IRP? And do you have a good handle on how much you could look to be doing in gas? And then on the nonutility side, you all have traditionally been pretty solar heavy though I think you mentioned wind a few times just in terms of supply chain. But when I look at you and your peers, it doesn't seem like anyone's adding too much wind these days. So just curious what you're seeing on that front?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. On your first question, that would be really waiting for the IRP. So we certainly are looking at all options. So it will be likely a mix of renewables and some thermal, of course, batteries as well. Now regarding the second question in wind. Well, we were -- we had been building quite a lot of wind in Brazil. But a lot of the projects that we have in the pipeline have a considerable amount of wind. So if you think of the -- what's been known as sort of the green hydrogen project in Texas, 1.5 giga, that's primarily wind. So we'll have a more of a balance in the U.S. between wind and solar in future years."
},
{
"speaker": "Michael Sullivan",
"text": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"text": "Thank you, Michael. Our next question comes from the line of Ryan Levine with Citi. Ryan your lines are open."
},
{
"speaker": "Ryan Levine",
"text": "Good morning, and thanks for taking my question. What is the time line for the $92 million Colombia impact to return to historic norms? And what is the risk to achieving this ramp at this stage in the year?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So conditions are already improving. The fourth quarter, in fact, I expect will be higher in Colombia than last year, Ryan. And all forecasts point to La Nina being highly probable over the next couple of months and lasting well into next year. So it's pretty much turning around now. Again, I expect the fourth quarter to be higher. And then throughout next year, I expect Colombia to be higher in this year overall. So Colombia has been -- and it was $92 million in the quarter alone. It's $130 million down year-to-date over prior year. So that is the single largest driver here, and it shows up in the Renewables segment. But the U.S. growth is doing hard work to offset that and significantly overcome overcomes it in the fourth quarter here and into next year."
},
{
"speaker": "Andres Gluski",
"text": "Yes. I would add we had a two-month outage. Yes. So the truth is that outage was at the worst possible time because if we hadn't had the outage because we had a rain, which was 25% higher than anything prior previously recorded, we could have used that water to very good results subsequently in the drought. So being out for two months is -- that's part of the recovery."
},
{
"speaker": "Ryan Levine",
"text": "Okay. So then by 2026, you should be back to a more normal performance?"
},
{
"speaker": "Steve Coughlin",
"text": "No, '25, Ryan. So the conditions are already improving. We expect this quarter, fourth quarter to be higher than last year. And next year, in 2025, we expect normal to better hydrology from the La Nina."
},
{
"speaker": "Ryan Levine",
"text": "Okay. And then maybe switching gears, as you referenced in your prepared comments, impact to California spark spreads, are you looking to change your hedging strategy there? Or any color you could share around the outlook going forward for the Southland?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So just -- as a reminder, the Southland structure has a 20-year contract for capacity and energy. So we have a very known monetization stream. It is at our election annually a year in advance to decide whether we want to market the energy ourselves and hedge it or put it to the uptake or under the PPA. So for '24 we did previously decide, at the end of '22, to call the energy to us and to market it. Unfortunately, spark spreads changed significantly during the time that we made that decision, and we're executing on the hedge program. And so we had downtime this year. But still relative to the put value, still a good decision. And so we have made that decision also for 2025 that we will market the energy. We are over 95% hedged already at values well in excess of the put value. So it -- the market has changed. The market has compressed a lot due to better hydro conditions. What we've had is milder weather. There's been a lot more battery penetration in California. So the market value is not as high over the long term as it had been back in '22 when we first made that decision. But nonetheless, we see, overall, the strategy is -- has been increasing or has added over the put is just not as much as we expected when we gave the guidance, unfortunately."
},
{
"speaker": "Ryan Levine",
"text": "So, then as a follow-up, given that framework and your decisions for next year, is there any color around -- any direction of travel for that asset's performance for '25 given what your parties decided?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. I would say, at this point, since we've already decided on '25, it is in excess of the put value. And we're already nearly 100% hedged, 95% hedged, as I said. So it the value is lower than it was in the original guidance, but still above had we taken a no-risk strategy. And then for 2026, we have not yet made that decision. And we'll have to here later in the fourth quarter, and we'll update you all on that later. And that will be based just upon what we see in the hedge market at the time relative to the put value."
},
{
"speaker": "Ryan Levine",
"text": "Thanks for taking my question."
},
{
"speaker": "Operator",
"text": "Thank you. Ryan. Our next question is from the line of Richard Sunderland with JPMorgan. Richard, your line is open."
},
{
"speaker": "Richard Sunderland",
"text": "Thanks for the time. I know you've covered a lot of ground. Just one quick cleanup. You've talked at various points about asset sale program and how you've thought about timing that and affecting that it sounds like more to come on year-end around that. But just curious how you're thinking about monetizing the new energy technologies investments? And if that's something that should fall within the planned period? Any thoughts there."
},
{
"speaker": "Andres Gluski",
"text": "When you think about the new energy technologies, look, what we've talked about is through 2027. And we approached these strategically. So what we've always said is that we will monetize these assets when we feel it's appropriate. And when we are out of long-term venture capitalist investors. So we'll monetize them at the right time when we don't think we're adding a lot of value. And we've already done some monetization and taking some money off the table. So it's been a very successful program. And I think there's a lot more value there than is being recognized by most of the parts. But what I would say is that so long as we add a lot of value, we'll stay in. However, we'll continue to opportunistically monetize. And certainly, we're well ahead of our plan for 2027. But as Steve mentioned, the universe is greater. So it would include some things from new energy technologies."
},
{
"speaker": "Richard Sunderland",
"text": "Great, thank you."
},
{
"speaker": "Operator",
"text": "Thank you, Richard. There are no additional questions waiting at this time. So I'll turn the call back over to Susan Harcourt for closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. We look forward to seeing many of you at the EEI Financial Conference later this month. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"text": "That concludes today's conference call. Thank you for your participation. I hope you have a wonderful rest of your day."
}
] | The AES Corporation | 35,312 |
AES | 2 | 2,024 | 2024-08-02 10:00:00 | Operator: Hello, everyone, and a warm welcome to the AES Corporation Q2 2024 Financial Review Call. My name is Emily, and I'll be coordinating your call today. [Operator Instructions] I will now hand over to our host, Vice President of Investor Relations, Susan Harcourt, to begin. Susan, please go ahead.
Susan Harcourt: Thank you, Operator. Good morning and welcome to our second quarter 2024 financial review call. Our press release, presentation, and related financial information are available on our website at aes.com. Today we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer, and other senior members of our management team. With that, I will turn the call over to Andres.
Andres Gluski: Good morning, everyone, and thank you for joining our second quarter 2024 financial review call. We are very pleased with financial performance so far this year. Today, I will discuss our results, the significant advancements we've made with large technology customers, and the work we are doing to incorporate generative AI in our portfolio to develop new competitive advantages. Beginning on slide three, with our second quarter results, we had a strong second quarter that was in line with our expectations, with adjusted EBITDA with tax attributes of $843 million, adjusted EBITDA of $652 million, and adjusted EPS of $0.38. We are on track to meet our 2024 financial objective, and we now expect to be in the top-half of our ranges for adjusted EBITDA with tax attributes and adjusted EPS. We are also reaffirming our remaining 2024 guidance metrics and growth rate to 2027. Steve Coughlin, our CFO, will give more detail on our financial performance and outlook. I'm also pleased to report that, since our last call in May, we have signed 2.5 gigawatts of new agreements in total, including 2.2 gigawatts with hyperscalers across our Utilities and Renewal businesses. This includes 1.2 gigawatts of new datacenter load growth across AES Ohio and AES Indiana. A PPA to provide 727 megawatts of new renewables in Texas, and a 310 megawatt retail supply agreement in Ohio. With these arrangements, we are expanding our work with the major datacenter providers to new areas of business. Turning now to datacenter growth at our U.S. utilities, on slide four, since our last call, we have signed agreements to support 1.2 gigawatt of new load across AES Ohio and AES Indiana, expected to come online in phases, beginning in 2026. Additionally, we're in advanced negotiations across several sites to support another 3 gigawatts of new load. These agreements are transformative for both utilities, with the potential to increase the peak load at both AES Ohio and AES Indiana by more than 50%. As a result, AES Ohio's rate base will consist predominantly of FERC-regulated transmission assets, receiving timely recovery through a formula rate. For AES Indiana, this growth creates the potential for significant investment in transmission, as well as additional build-out of new-generation assets. These opportunities will even further increase our industry-leading U.S. utility rate base growth plans. Our service territories are particularly well-positioned to serve datacenters and other large loads with available interconnection, lower rates, and land prices, access to water resources and local incentives. Turning to slide five, and the generation build-out at AES Indiana, we continue to make progress in upgrading and transforming our generation fleet as we shutdown or convert our coal units to gas, and build our renewable fleet. I am pleased to announce that we have signed a deal to acquire 170 megawatt solar plus storage development project that AES Indiana will construct and own. The project will require approximately $350 million of CapEx, with an expected completion date in late 2027. Once approved by the Indiana Utility Regulatory Commission, this will be the sixth project supporting AES Indiana's recent generation growth. Now turning to our Renewables business on slide six, since our last all in may, we have further expanded our partnership with Google, signing a 15-year PPA for 727 megawatts in Texas to power its datacenter growth. The agreement includes a combination of wind and solar to further Google's 24-7 carbon-free energy goals. These projects are expected to come online in 2026 and 2027. We also recently signed a retail supply agreement with Google for 310 megawatts to support their Ohio datacenters. This agreement demonstrates the strong trust and collaboration between our companies, which began with our original 2021 partnership to provide 24-7 renewable power in Virginia. We see further opportunities to add renewables to support Google's datacenter growth in Ohio. Turning to slide seven, with these major announcements today on our collaborations with hyperscalers, we have now signed a total of 8.1 gigawatts directly with technology companies, which is clearly a leading market position. As you can see on slide eight, our backlog of projects under signed long-term contracts now stands at 12.6 gigawatts. Our focus remains on maximizing the quality of megawatts over the quantity, which means delivering high-quality projects with higher returns and long-duration PPAs. We have never felt better about our key customer relationships, the long-term market dynamics that are supporting growth and value creation in our portfolio. Turning to slide nine, the demand for power that is coming from the rise in generative AI in datacenters, represents a significant structural change in the Power segment, and no one is better positioned than AES for sustained growth from this opportunity. Regardless of election or policy outcomes, we are confident in our ability to continue signing renewable PPAs with mid-teen IRRs. Our corporate customers value our unique record of bringing projects online on time over the past five years. Furthermore, looking at the interconnection queues, time to power and price certainty, we see renewables as the only source of new power that can meet most of the demand over the next decade. AES has a longstanding and deep relationship with hyperscaler customers. This includes our ability to co-create new offerings and structure innovative clean energy solutions, such as hybrid PPAs, shaped products, and 24/7 renewables. As you can see on slide 10, of the 3.6 gigawatts that we expect to bring online this year, we have already completed the construction of 1.6 gigawatts and expect the remainder to be weighted towards the third quarter. I should note that for the projects coming online this year, we have all of the major equipment already on site in almost all for 2025. Additionally, we expect a significant portion of our solar panels to be domestically produced beginning in 2026. All of the above combined with having panels on site for 2025 projects, greatly mitigates our exposure to any potential new tariffs. Our diversified and resilient supply chain has been and will continue to be best-in-class. Finally, turning to slide 11, not only is generative AI shaping the customer landscape, but it is also transforming how we work internally, providing new opportunities for efficiencies, customer service and innovation that will give us new competitive advantages. As you may have seen, in June, we announced a partnership with AI Fund to accelerate AI-driven energy solutions. Founded by AI leader, Andrew Ng, AI Fund is a venture studio that works with entrepreneurs to rapidly build companies. We are collaborating with AI Fund on co-building companies that leverage AI to address bottlenecks and improve efficiencies in the energy transition in areas such as developing and operating renewables and asset management. At the same time, we continue to leverage AI across our portfolio with our culture of innovation and continuous improvement. We are increasingly using proprietary tools across a wide range of our business operations, enabling our people to work faster and smarter. For example, our renewables team has built sophisticated tools that utilize generative AI to accurately predict the speed at which projects will move through interconnection queues, helping us more efficiently coordinate the various simultaneous development processes. As you can see on slide 12, earlier this week, we launched the world's first AI-powered solar installation robot, Maximo, which uses state-of-the-art AI and robotics to complement our construction crews in the installation of solar modules. Maximo enables faster construction times and reduces overall project costs. It can work three shifts, even in the worst weather conditions, with a more inclusive workforce. Not only does it reduce time to power, which is highly valued by our customers, but it will boost overall project returns. We plan to ramp up our use of Maximo in 2025 and are already utilizing it to construct a portion of our two gigawatt Bellefield project in California, which is the largest solar plus storage project in the U.S. and is contracted to serve Amazon. With that, I would now like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andres, and good morning, everyone. Today, I will discuss our second quarter results and our 2024 guidance and parent capital allocation. Turning to slide 14, adjusted EBITDA with tax attributes was $843 million in the second quarter versus $607 million a year ago. This was driven by growth in our renewables SBU, new rates and growth investments in our U.S. utilities, and higher margins in our energy infrastructure SBU. Turning to slide 15, adjusted EPS for the quarter was $0.38 versus $0.21 cents last year. Drivers were similar to those of adjusted with tax attributes, but partially offset by higher depreciation and higher interest expense as a result of our growth. I'll cover the performance of our SBUs or Strategic Business Units on the next four slides. Beginning with our renewables SBU on slide 16, higher EBITDA with tax attributes was driven primarily by contributions from new projects, but was partially offset by lower availability from a forced outage event at our 1 gigawatt Chivor hydroplant in Columbia. The outage was caused by record water inflows in early June, which brought significant sediment into the plant and damaged the units. Repairs of the plant were completed quickly and all units resumed operations by mid July. Higher adjusted PTC at our utilities SBU was mostly driven by higher revenues from the $1.6 billion we invested in our rate base in the past year, new rates implemented in Indiana in May, year-over-year low growth of 3.1% as well as favorable weather. Higher EBITDA at our energy infrastructure SBU primarily reflects higher revenues recognized from the accelerated monetization of the PPA at our Warrior Run plant and higher margins in Chile. Partially offset by lower margins in the Dominican Republic and the sell-down of our gas and LNG businesses in Panama and the Dominican Republic. Finally, relatively flat EBITDA at our new energy technologies SBU reflects our continued development of early stage technology businesses. Partially offset by continued margin increases at Fluence. Now turning to our expectations on slide 20, as a result of our strong first-half performance and high confidence in a strong second-half, I am very happy to share that we now expect adjusted EBITDA with tax attribute to be in the top half of our 2024 expected range of $3.6 billion to $4 billion. Drivers of adjusted EBITDA with tax attributes in the year ago include higher contribution from new renewable commissioning, contributions from growth investment, and expected higher load at our U.S. utilities. Partially offset by expected closings in our asset sale program. Turning to slide 21, I am also very glad to share that we now expect our 2024 adjusted EPS to be in the upper half of our guidance range of $1.87 to $1.97. We increased our share of earnings in the first-half of the year from 25% in 2023 to nearly half in 2024. Growth in the year to go will have similar drivers as adjusted EBITDA with tax attributes. Partially offset by higher interest expense from growth capital. Now to our 2024 parent capital allocation on slide 22, sources reflect approximately $3 billion of total discretionary cash including $1.1 billion of parent free cash flow, $900 million to $1.1 billion of proceeds from asset sales, and $950 million of hybrid debt that we issued since our last earnings call in May. On the right-hand side, you can see our planned use of capital. We will return approximately $500 million to shareholders this year, reflecting the previously announced 4% dividend increase. We also plan to invest $2.4 billion to $2.7 billion towards new growth. Of which, 85% will go to renewable and utility. Turning to slide 23, we are well on our way to towards achieving our long-term asset sale target of $3.5 billion from 2023 through 2027. We signed or closed more than $2.2 billion of asset sales since the beginning of last year. And we are now nearly two-thirds of the way to reaching our target even though we are only 1.5 years into our five-year guidance period. We do not announce specific asset sales in advance. But the remaining proceeds could come from sell-downs of renewables projects, our intended coal exist, monetization of our new energy technologies businesses, and sales or sell-down of other noncore assets. In summary, we made excellent progress this quarter toward all of our strategic and financial targets. We have clear line of sight towards achieving the key drivers of our year-to-go earnings growth. And we are well-positioned to continue delivering on our financial goals beyond this year. We also made significant headway on our long-term funding plan which allows us continue simplifying and focusing our portfolio while we scale our leading renewables and utilities business. Our strategy to serve high value corporate customers including a rapidly growing base of datacenter providers across our Renewables and Utilities businesses is highly resilient, and will continue to yield financial success for AES and our shareholders. With that, I'll turn the call back over to Andres.
Andres Gluski: Thank you, Steve. Before opening up the call for Q&A, I would like to summarize the highlights from today's call. With more than 8 gigawatts of agreements already signed directly with large technology customers, including 2.2 gigawatts signed since our last call. We continue to be the industry leader in this segment. At the same time, we continue to deliver our projects on time and on budget, with 1.6 gigawatts completed so far this year. We are fully on track to add a total of 3.6 gigawatts by the end of 2024. We see demand for power from datacenters in the U.S. growing around 22% a year. And we could not be better positioned to serve these customers, from our Renewable business to our Utilities. I would like to reiterate that with strong demand for the projects in our 66 gigawatt development pipeline and our existing 12.6 gigawatt backlog of signed long-term PPAs. We are very confident in our ability to continue to meet or exceed our long-term objectives. Operator, please open up the line for question.
Operator: Thank you. [Operator Instructions] Our first question today comes from Durgesh Chopra with Evercore ISI. Durgesh, please go ahead.
Durgesh Chopra: Hey, team, good morning. First off, congrats on a solid quarter and first-half. Too bad the market is [viscose] (ph) today. Maybe just I had one question on the numbers, and then I have just one high-level macro question. First, to Steve, could you update us on credit metrics, where did you end up as of Q2, and then were do you expect to be at the end of 2024 on FFO to debt?
Steve Coughlin: Yes, sure. Hi, Durgesh, it's good to hear your voice. So, the credit is looking very, very strong. So, we continue to be on a path of improving credit. At the parent level, I expect will be even higher than last year's year-end. And so, it looks very good. There's obviously intra movement in quarters as we have some cash flow lumpiness coming up, but it continues very strong. I think we'll see the year end be even better than last year.
Durgesh Chopra: So, just to be clear there, Steve, I think the target last year was 22%, if I have those numbers right on FFO to debt basis is the S&P methodology. Is that still kind of a good goalpost?
Steve Coughlin: Yes. So, we have a threshold of 20%. So, you're referring more to, I think, where we ended, which had plenty of cushion above that. And I think we will likely see ourselves even higher than that at the end of this year.
Durgesh Chopra: Okay, perfect. [A lot of] (ph) question on the balance sheet. Okay, then maybe just one election question. Andres, appreciate the commentary in your prepared remarks. But I'm just wondering, obviously a great quarter here. You added to the Utilities, you added on the Renewable side. But I'm just wondering if all the noise around repeal of tax credits and other policy chatter, does that hurt your ability to sign new contracts? Does that come up in your contract negotiation, is that a risk? Maybe just help us sort through that. Thank you.
Andres Gluski: Sure, Durgesh. No, it's not slowing down our signing of contracts. What we really had is a situation that we had, to some extent; foreseen a couple years ago where it's really there's a shortage of renewable power for datacenters in many markets. So, what's the biggest concern of our clients is actually time to power, can you get me the power on time to power datacenters. And that's their main constraint. So, no, there has been anything holding us down or, quite frankly, a major issue of conversation with them. I do think we have to step back and say, "Look, ITC investment tax credits, production tax credits, they've been around for 32 years." Second, there's been a tremendous amount of investment related to the Inflation Reduction Act. And 85% of that investment has gone into republican districts. Today, there are eight million people working directly or indirectly in renewables in the U.S. So, a total dismantling is highly unlikely in any scenario, whether there are some changes around the margin; sure. But thinking about the sector, quite frankly we operate in markets where there are no subsidies. We actually make more money in those subsidies. And it would change somewhat the structure of the contracts. But we see a wholesale revision of this very, very unlikely. Something more likely what happened to NAFTA, where it became the USMCA, and actually was, quite frankly, updated and improved in some areas. So, that's where we se the market right now.
Durgesh Chopra: Got it. [Indiscernible]. Thanks so much for the time, I appreciate it.
Andres Gluski: You're welcome. Thank you.
Operator: The next question comes from Richard Sunderland with J.P. Morgan. Please go ahead.
Richard Sunderland: Hi, good morning, and thank you for the time today.
Andres Gluski: Hi, good morning, Rich.
Steve Coughlin: Hi, Rich.
Richard Sunderland: Starting on the Utility announcements, can you outline the utility load opportunity in terms of the breakdown of that 3 gigawatt in advanced negotiations between Indiana and Ohio, plus how much of that capital could fall into the transmission and generation buckets relative to what's in the plant today?
Andres Gluski: Okay, look, that's a great question. But we will give you more color on that as time passes, because these are multiple agreements with multiple clients. And we'd really like to see how it shakes out. We're certain that there's going to be a lot of load added, a lot of transmission assets added. But this is between two utilities, between multiple clients. So, right now it's a little bit too early for us to give too much in term of exact load growth by business.
Steve Coughlin: Yes, and just to add to that, Rich, we had previously guided to around 10% up for the utilities combined, this is definitely upside. There's significant acceleration of discussions. So, definitely upside to the plans that we've given in the past. Timing matters here though, so we'll see some within our long-term guidance period, and some beyond that. But we do see a lot more growth than we saw even at the start of this year.
Richard Sunderland: Understood. Thanks for the color there. And then, your language in the slides on maximizing megawatt quality over quantity; that message has certainly been clear. But I'm curious if this is consistent with your raise per turn assumptions, I think that was back in 4Q. Or do you see further upside potential to returns given the supply and demand dynamics currently?
Andres Gluski: Okay. Basically, I think there's several things. One, when we talk about pipeline, that means we have something in the interconnection queue. And we have some degree of land control. So, I would say not all pipeline were created equal. And when we talk about backlog, that's actually contracts that are signed and that we have to deliver, and people have to buy that energy. So, we've never taken anything material out of our backlog, even during COVID. So, what we're saying here with -- the basic message is, one, yes we increased our average rate of returns on these projects. We're not talking about mid-teens. The other thing is that rather than sign like one umbrella agreement with one particular client, we're optimizing the value of this resource among various clients and among opportunities. So, we see this as something where we invest in, we create this real pipeline. And then, we want to optimize the value from it. Will the average returns go up further? Well, I think it would depend market by market, and the opportunity. But right now, we feel very good about the mid-teen returns that we talked about. And we also feel very good about that we're making the best use of that pipeline to create value for our shareholders.
Richard Sunderland: Great, thank you for the color there. I'll leave it there.
Andres Gluski: Okay. Thanks, Rich.
Operator: The next question comes from Antoine Aurimond with Jefferies. Please go ahead.
Antoine Aurimond: Hey, guys. Hope you're well. Thank you for taking my question.
Andres Gluski: Good morning.
Antoine Aurimond: Good morning. I guess to follow-up on Durgesh on the credit side, how do you frame the prospects of going towards a mid-BBB rating and what would be the timeline, we'll be contemplating?
Steve Coughlin: Yes. So, as I said, credit metrics are definitely continuing to improve and so I see that as a possibility in a matter of years, not this year, that will be have those metrics. So, we don't have a specific target to share with you at this point, but I expect to be higher than last year and I expect it to continue to improve. As the installed base of our growth continues to grow and add cash. Today, we do carry construction debt that's not yet yielding. But relative to the base, the base is increasing every year significantly in this moment that we are in. So, yes, I think that's very possible, but I don't have a specific date to share with you at this point.
Andres Gluski: One thing I'd like to add, as we exit countries and as we're investing primarily in long-term contracted with investment grade off takers in renewables, or our U.S. utilities, which also with this transformation are moving more towards a transmission rate base. The quality of our cash flow continues to improve. So, it's not only a question of the metrics, which as Steve said are improving, but the quality of that cash flow or how it's seen by credit rating agencies is improving as well. So, on both sides, we feel very good about it.
Steve Coughlin: Yes, and actually, I guess we'll keep going here because I have just that reminds me of another topic really here. Keep in mind that 80% of our debt is nonrecourse to the parent, and nearly all of that is amortizing investment grade rated subsidiary debt. So, it's a very high quality structure, and the agencies are seeing that. So, I think this, both the quantified metrics as I've mentioned as well as Andres said in the quality and looking at the debt structures, amortizing investment grade, it's a very, very robust, healthy structure.
Antoine Aurimond: Got it. Yes, that makes sense guys. I guess on that note, with 85% of the CapEx going towards U.S. based businesses, where do you see the geographical mix trending towards the end of the time period?
Steve Coughlin: End of the time period, like 2027 you're speaking?
Antoine Aurimond: Yes, yes.
Steve Coughlin: Okay. Look, I'd say we can I think there's a transformation in terms of, we're moving more towards U.S. dollar based investment grade off takers? So, yes, there's going to be heavier weighting towards the U.S. We do have opportunities to serve the same type of clients outside the U.S., with your investment grade dollar contracts, many times with the same, with the same client. So, if we serve hyperscalers in the U.S. and they want the same services, say, in Chile or in Mexico, then we can service. And that is a competitive advantage we have.
Antoine Aurimond: Got it. Okay. That makes sense. And then, I guess, so you mentioned more sort of quality of megawatt versus this is just volume. We're going to do, what 3.6 gigs this year. How should we think about that number evolving? Assuming it's still going to increase, but I guess you mentioned more quality, right? So what's sort of like that number fast forward a couple years?
Andres Gluski: Look, when I put it this way, we have a backlog of more than 12 gigawatts of signed PPAs we have to deliver. The majority of that will be within the period of by 2027. So, that gives you -- that that's a guaranteed build out that we have to do over the next three years. So, over time, assuming we're signing somewhere about 4.5, 5.5 gigawatts of new PPAs, those numbers have to converge. Unless, we grow the number of megawatt, PPAs that we're signing, and then it'll take a little bit more time to converge. But given -- that gives you sort of the run rate. Yes. We'll be 4 plus in coming years just from the backlog we have today, and expect that to grow over time past that period of time of 2027.
Antoine Aurimond: Yes, that makes sense. Okay, great. Well, Andres, thank you so much.
Andres Gluski: Thank you.
Operator: The next question comes from David Arcaro with Morgan Stanley. Please go ahead.
David Arcaro: Hey, good morning. Thank you. Maybe back on the utility side of things, it's great to see all that load growth opportunity coming. When do you think you'd have an opportunity to relook at the CapEx outlook? And then at a high level, how do you think about financing, upsides in the utility CapEx trajectory?
Andres Gluski: Yes, hey, David. Good morning. So, as we are looking through the details of the timing of what we've recently signed, we'll flesh that out in our planning process, in the second-half of this year and bake that into our update of guidance for the beginning of next year. So, definitely, I would see in the long-term horizon that we have out there through '27, this will start to come into play in the capital plan, but our funding plan, I don't expect to change at all. We have really done well on our asset sale plan. We are two-thirds of the way through, after only 18 months on a five year plan. We've got a lot of flexibility there. We have partnership capital. So, there is no shortage of capital to invest in the utility growth here. It's a very attractive profile. And so, I see it becoming material, but I see it within the funding plan that we've already released through '27.
David Arcaro: Got it. That's really helpful. Thanks for that. And then, just appreciate the comments on the supply chain outlook on the renewable side. I was just curious if I could get your sense, like how much line of sight do you have right now for that domestic supply in 2026, just as we think about navigating some of the tariffs on solar panels and battery storage? How are you feeling right now in terms of the line of sight for both of those supply chains?
Andres Gluski: Well, we're feeling very good. And what I would say is, as we've mentioned, we have everything we need for this year, for 2024, and most of you know, vast majority of what we want for 2025. And then, we have signed agreement with domestic suppliers for starting in 2026. So, we feel very good about our ability to execute, deliver on our backlog in the U.S. And I would say that again, to date, we have not had to postpone or abandon any material project in our pipeline over the last five years. So, compared to what happened to supply chains with COVID, this is much more predictable. So, we feel very good about it. And basically, we're again going to make that switch to domestic supply starting in 2026.
David Arcaro: Okay, great, understood. Thanks so much.
Andres Gluski: Thank you.
Steve Coughlin: Thanks, Dave.
Operator: The next question comes from [Feeney Shea] (ph) with Barclays. Please go ahead.
Unidentified Analyst: Hi, good morning. Thanks very much for taking my question. So, I guess just first quickly on renewable execution, really great to see the guidance update in terms of EBITDA with tax attributes. I guess, could you maybe just talk about, given the backlog, the PPA signing cadence, the ability to bring projects online, how does your EBITDA excluding tax attribute would trend, I guess given where it is now year-to-date? Seems a little light, but just wanted to see how should we think about it going deeper into the year? Thanks.
Steve Coughlin: Yes, good morning. Thanks. So, we do have a significant upside in our tax credits as I mentioned in my remarks, primarily that's driven by -- we're qualifying for more energy communities than originally anticipated. And we also have seen the valuation of our tax attributes, particularly through transfers, be valued at a higher level. What's important, as I've always emphasized is that these are cash. It's a very attractive profile. This is not just earnings, but it's cash coming in, which is a very early return of a significant amount of capital 30% up to 50%. So, we're really, really pleased with this upside. There are a few other upsides in EBITDA as well. So, we have had higher margins and higher dispatch in our gas business in the Dominican Republic. We've also continued to drive efficiency and productivity in our renewables and utilities businesses where we're very focused on growth. And in fact, growing those businesses is actually costing less than we anticipated. So, we see favorability in costs going through EBITDA this year. So, as you caught on, there has been an offset to that, and it's what I mentioned in my remarks, which is primarily the Columbia outage. It was a record amount of flooding and inflow that took the units out for all of the month of June and the first part of July. So, that unfortunately did offset and is a negative driver to EBITDA this year. And then, the other, and I think we mentioned this, we did have a very low wind resource in Brazil, more so in the first quarter, but that also had impacted our EBITDA this year. So, we have some offsets, but overall really pleased with the growth, the cash-driven growth, and that we continue to be even more efficient in our renewables and utilities growth machines.
Unidentified Analyst: Got it. No, that's very helpful. I guess second, we noticed a comment on being able to bring the majority of the backlog online by 2027. I guess with this year, 2024, a targeted 3.6 gigawatts of new projects online, could you talk about the cadence on bringing new projects online -- just on this front, from this year through 2027, and what kind of lumpiness should we expect coming out of it?
Andres Gluski: Yes, well, I think we've very much smoothed out the cadence of bringing projects online. At the beginning where we were ramping up very fast, in fact, last year we grew 100% the number of projects we're bringing online. So, this year we're able to manage it much better in the sense that it's almost about half is being done in the first-half, and the third quarter is going to be quite heavy as well. So, the cadence is going to be much more even throughout the year, as again, the growth rate is not 100% in one year, and obviously it will increase because again, we have to deliver 12.6% over the next three years. And so, most of that is it gets your numbers closer to four. So, we feel very good about the cadence. The biggest challenge was to ramp up 100%, and we did that, and we actually did all of our projects that we needed to get done last year on time.
Unidentified Analyst: That's great. Really appreciate the colors from both. Thanks.
Andres Gluski: Thank you.
Steve Coughlin: Thank you.
Operator: The next question comes from Michael Sullivan with Wolfe Research. Please go ahead.
Michael Sullivan: Hey, good morning.
Andres Gluski: Good morning, Michael.
Michael Sullivan: Yes. Hey, Andres. A couple of questions, I know there's been some on the utility growth, but 50% plus load growth seems pretty eye-popping, and I'm just curious, like, how you're feeling about the supply side and ability to serve that. Like, for example, if I just look at, you have an AES Indiana, I don't know, I mean, there's like a planned conversion, and then a handful of renewables, and a lot of load growth coming. And then, obviously, in Ohio, you have less control over the supply, and we got a data point on that earlier this week. I guess, yes, just how explosive load growth, how are you feeling about the ability for generation to serve that in those two states?
Andres Gluski: Yes. Look, that's a great question. This is going to be timed over the years, so it's not like all at once we have to deliver this in the next two years. So, it represents opportunities, definitely, for additional generation. And as I've been saying in my remarks a good part of that's going to come from renewables. Some of that increased demand may come from gas in some locations. So, definitely all of this is we feel it will get done, and the solution will be different in MISO or PJM, there will be differences, and it'll be different between the two utilities, in terms of one of them will involve more direct securing the generation itself. So, this will pan out, but it's a very good question, because yes, there is quite a high number of growth. It represents a great opportunity, but we wouldn't have said it if we didn't know how this could be served.
Steve Coughlin: Yes. And I would just add to Andres' point in Indiana, where generation will be part of the solution keep in mind, we have multiple existing gas sites. So, we have the conversion at Petersburg, but we also have space for additional gas at Eagle Valley, at Harding Street, and at the Georgetown site. So, we are seeing the whole package being able to support datacenter growth there. In Ohio, of course, you mentioned that that's a distribution transmission. We have a very attractive area for datacenters, our service territory is quite large, a lot of available cheap land, very centrally located to fiber networks and data load, accessible water. So, it is a very appealing area. You can see from the -- I think you're referring to the PJM capacity auction, was quite high, demonstrating how significant demand has increased. But within PJM, I think our territory in Western Ohio is one of the most attractive areas, if not the most.
Michael Sullivan: Yes, appreciate all that Color. Just to follow up on that last point this came up on some of your peers' calls, but any appetite from your standpoint to own regulated generation in Ohio, and what could that look like if it turns out that this can't be done through competitive markets?
Andres Gluski: Yes, look, right now we have no appetite for generation in Ohio directly, but again, this represents opportunities for our renewables team. So, I would say stay tuned, but certainly we feel that these targets can be met, but again realize this is going to happen over time, as Steve had said in his comments.
Michael Sullivan: Okay, great. And then, just one more, over to like the renewable side, I think since the last call we had the Brazil asset sale announcement, should we just think about that as fully embedded in your longer-term guidance, or is there like more additions than expected that are going to kind of backfill that in terms of the longer-term growth?
Andres Gluski: No, that's already embedded in our guidance.
Steve Coughlin: Yes, both this year and obviously the long-term Brazil exit is included in our numbers.
Michael Sullivan: Great. Thank you.
Andres Gluski: Thank you.
Operator: The next question comes from Willard Grainger with Mizuho. Please go ahead.
Willard Grainger: Hi. Good morning, everybody. Can you hear me?
Andres Gluski: Yes. Good morning.
Willard Grainger: Thanks for taking my question. Just maybe one, with the results of the PJM capacity auction coming out this week and just directionally higher power prices and projects coming out of the queue for next year, just how are you thinking about the cadence of your development pipeline? And any color on that would be super helpful. Thank you.
Andres Gluski: Look, we have been saying, again, for several years that we were seeing shortages developing, just looking at the corporate demand, especially for renewables, and the ability of suppliers to ramp up to meet that demand. So, to some extent, what is happening in the market is what we expected. This is not going to make any difference to our plans. Again, we have contracts, we have sites, we've already locked in financing, et cetera. So, equipment prices, so it doesn't make any change to our plans. What it does, I think, signal is the value of our existing assets are going to go up as this shortages materialize. So, no effect in the, generally, in the shorter term, but in the longer term, it means that our assets are more valuable, and to some extent, it's what we've been planning for. So, it's not, of course, a specific option, we don't intend to be clairvoyant, but the general direction of the market that's unfolding is what we expected.
Willard Grainger: I appreciate the color there. Most of my questions have been answered. Thank you. I'll get back in queue.
Andres Gluski: Okay. Thank you.
Operator: The next question comes from Angie Storozynski with Seaport. Please go ahead.
Angie Storozynski: Thank you. So, I have lots of questions. So, first, maybe in this low interest rate environment, I'm just, I'm actually wondering. So, first, again, so does that actually help further boost the profitability of the projects that are yet to be built? Meaning, I mean, you have embedded certain assumptions about interest rates for like construction financing, for cost of debt, et cetera. So, do I get actually an incremental benefit now that we're seeing seemingly in a lower interest rate environment?
Steve Coughlin: So, Angie, this is Steve. Good morning. So, look, we can't have it both ways. So, we have, as I've often talked about, a very low risk way of executing, which means we lock in almost all of our costs when we sign our PPAs, including hedging the long-term financing. So, for anything that we've signed, we're pretty much, we've baked in the price of that financing. But on a go-forward basis, look, lower interest rates are a good thing. They reduce the cost of new infrastructure, and so reduce the cost to the customer. So, overall, I think it's a further catalyst to demand and will help the whole sector. But we maintain a low risk structure in the way we execute.
Andres Gluski: Obviously, we are highly contracted for future cash flows. So, lower interest rates means a lower discount rate. It means those cash flows are worth more. But the benefits on a sort of new contract basis will be for new contracts being signed, but not for the backlog.
Angie Storozynski: Okay. So, then, changing topics, so those emission reduction targets or renewable power targets for hyperscalers, so obviously, here are those points that they're making, but I also see a number of these datacenters being developed on very coal-heavy grids, like Kentucky and Mississippi. I mean, and then the utilities that are on the other side of those transactions are basically saying that hyperscalers have eventual targets for emission reductions or carbon goals. But they're happy with just absorbing carbon-heavy power early on and then dealing with that carbon footprint later. So, how does that tie into this pitch that, in a sense, they have to just procure renewable power when, again, when we have these instances where they're just going for large quantities of available power, largely regardless of the carbon footprint?
Andres Gluski: That's a great question. The way I would put it is their preference is renewable power. Right? So basically, you're talking about situations where they have no other alternative. So, they're not happy to suck up coal power from the grid. They basically will either have offsets with a VPP or by RECs, and quite frankly, in most cases, will require that renewables come online in the future. So, you have to put it like this is the last alternative. And so, obviously, if you have a datacenter, the most important thing is to have power. So, if you have no other alternative, you will not go for renewables. But they do have the renewables goals, and they do want that power to be as low carbon as possible. So, that's in terms of the demand. Now, let's look at the supply. If you look at what's in the interconnection queue, almost all of it is renewables, if you include batteries. So, the fact is what can get built, let's say, over the next five years, for sure, is going to be very heavily weighted towards renewables. As Steve mentioned, you have to combine these in the lowest carbon way possible. And if that means adding some gas plants, that will be done. But I think that the direction is clear, because I remember you on one call said that it's all going to be nuclear. And I kind of laughed, we both laughed and said, tell me what the price of an SMR is? How can we sign a PPA with embedding nuclear? Second of all, the regulatory hurdles to bringing on nuclear are still very significant. And we really don't have price certainty on it. So, renewables are going to be the bulk of that add-on. That's what they want. Again, yes, they will make deals for the short run if that's the only alternative. But it's not their preferred route.
Angie Storozynski: No, I understand. But again, I obviously hear your point, yes. It's just that I'm wondering if renewable power is more like a source of basically carbon-free credit, or is it the source of energy? Because again, one could argue that the datacenters are basically using traditional thermal power for the supply of energy. And then, renewables, again, just offset the carbon footprint. And I'm not sure if that's actually bad or good. I'm debating it myself; it depends on my question. But I'm just again.
Andres Gluski: Yes, I think it depends on the client, quite frankly. Some clients are much more stringent. Some clients actually want hourly-matched renewables. Some clients require additionality. Most of them require additionality. So, it's not just one-size-fits-all. I think the renewable standards will differ among them. But the direction is very clear. So, I don't see anybody sort of walking away from it at this point. And quite to the contrary, they're under pressure a lot because as they ramp up very significantly their datacenters and they're taking some power which is not renewable, their total carbon footprint goes up, and that's something that they've had to address. So, I would say that, yes, they're being pragmatic. But in terms of their goals and desires, those remain unchanged. And it's not uniform across all of them. It's not one-size-fits-all.
Angie Storozynski: And then lastly, you have this page where you mention all of these additional transactions you've entered into with hyperscalers. So, is this co-location? Is it that this is sort of a set of assets located at least in the same sort of zone, like say in PJM or again, I'm just -- I'm not trying to be facetious here? But I'm just wondering, so is this power really directly feeding into these hyperscalers? Or is it just like being commingled with other power and it's, again, this sort of a carbon attribute as opposed to the energy?
Steve Coughlin: Yes. So, I'll just add on to what Andre said. So, in almost all these cases, even you're talking about, Angie, not to say, yes, these are resulting in renewable PPAs, some cases in the same location or nearby locations, and others where they're focused on time to power going to the grid, but then also contracting for renewables perhaps further away. Most of what we are doing is I would say you would call more of a co-location regionally where we're supplying energy, including most of what we signed recently in the same grid and relatively close to the datacenter. So, that is by and large what we've seen most looking for. But when time to power is, of course, a priority, they're looking for alternatives. But the great thing is that in all cases, the additionality of renewables, whether it's direct or through RECs, is a top demand from these customers.
Angie Storozynski: Okay. And then, lastly, so what happens, for example, with AES Ohio now that we have this pickup in capacity prices, most of the energy prices will follow. I mean, this is a wires only business. Are you concerned about the impact on electric bills and affordability and how that might suppress any sort of a T&D investment?
Andres Gluski: I would say, look, first, we have the lowest rates in the state. So, we're starting off from the best position of anybody. Second, realize that our new additional growth, these are people who, again, the most important thing is to find a good location and to have the power and the other services that they need. So, that does not concern me in terms of, let's say, saying, well, this growth will not happen because the capacity prices went up. And as I've said before, to some extent, not this particular auction, not the extent of this one-time jump. But we had been expecting this. So, this is not something that's like out of left field and we have to scramble. We have been talking about, and you can hear from all our earnings calls, and we've been saying, look, there's going to be a shortage. And returns are going to improve over time. And so, directionally, this is very much what we expected.
Angie Storozynski: Okay. Thank you. Thanks.
Andres Gluski: All right. Thanks, Angie.
Operator: The next question comes from Biju Perincheril with SIG. Please go ahead.
Biju Perincheril: Yes, thanks for taking my question. A question on domestic content bonus, can you talk about when your projects might -- when you're targeting your projects to be eligible for that and maybe the implications for your returns? And if you could talk to separately the solar and storage projects, that would be great. And then, I have a follow-up.
Andres Gluski: Okay. So, first, I'd say in terms of domestic content, in terms of our wind project, those already meet the criteria. Remember, it's a criteria based on the total cost of the project, the different components. In terms of solar panels, again, we expect to be meeting that by 2026. In terms of batteries, our main supplier is Fluence, and they should be meeting that, quite frankly, starting in 2025. So, all together we feel very good about meeting domestic content requirements. And then, there are other things like trackers, inverters, et cetera, that we've been working on as well. So, I think the team's done a very good job to combine the various assets such that they do meet the domestic content criteria. So, it's not one-size-fits-all. It's like what's available and if you have wind, it may be greater. If you have, say, solar panels, it may be lesser, but you put it together and the total meets it. So, we feel very good about that meeting the domestic content criteria.
Steve Coughlin: And I would just add, keep in mind that the adder is across the entire capital cost of the project once you meet the threshold for the certain components that have to be domestically sourced. So, it's a 10% across not just those components, but the whole thing, which is really attractive.
Andres Gluski: Yes. And we have no trouble meeting things like prevailing wage, et cetera.
Steve Coughlin: Right.
Andres Gluski: So again, the team's been working very hard on this, and we feel that we're very well positioned.
Biju Perincheril: And is your expectation that you would be able to retain most of that or you would have to pass along that in terms of PPA pricing, just trying to understand the impact to your returns?
Andres Gluski: Again, I think it's on a case-by-case basis. It depends on the demand supply in the particular market. So, --
Biju Perincheril: Okay.
Andres Gluski: I think the best answer would be shared. And then, the vision of spoils will depend on the particular circumstances.
Biju Perincheril: Got it. My follow-up was -- and we talked about a lot about sort of time to power. So, for renewables projects, can you talk about sort of the advantages or what you bring to the table specifically from a technology perspective? I think last quarter you sort of talked about DLR and batteries and that almost that or there are other solutions that you could bring to the table in terms of addressing that concern for your end customers.
Andres Gluski: Yes, we really look at this sort of holistically and we tend to co-create with the client. Say, look, what do you want? And then we'll bring the technologies to bear. We don't come and say, look, we have this really neat widget. This is what you should buy. Now, given the new technologies I really do feel that we've been a leader in this. So, in everything from we did invent lithium ion -- the use of lithium-ion batteries for grid stability. We started that 14 years ago. We do have the biggest dynamic line rating project in the country. Fluence is doing a number of very innovative things to use batteries to be able to get more use out of existing transmission lines. We also were the first to do hourly matched 24/7 long-term contracts for hyperscaler clients. So, we continue to do that. And with Uplight, there's a number of VPP facilities that's well-managed -- energy management. And finally, I think Maximo is a great example of we are thinking about the future. One of the constraints, and I am sure you've heard it, was like labor force for building solar projects. And the fact is you have lift 65 pound today solar panels. In heavy heat the restrictions, crews can only work six hours for example. And it takes a very strong individual to be able to do this task at all. So, with Maximo this really allows us, first, to do it much more quickly. You can work three shifts even in terrible weather or hot weather conditions. In addition to that, we don't have to be particularly physically strong to do it. You have to be able to supervise the robot. So, Maximo is an example of how we would bring projects online faster and also with cost at damages as well. So, this is the first step. We are starting to use it. Next year, we will be ramping up. But after that, we can see a fleet Maximo out there, which would give us a competitive advantage. In other words, that we could bring -- we wouldn't say it's labor shortages, because we can hire a much broader universe of individuals. We can work in three shifts in all weather conditions. And we can quite frankly do it faster and better. So, that's another example. So, again, I think our AES Next and our views on technology have been really industry leading.
Biju Perincheril: Okay. Thank you.
Andres Gluski: Thank you.
Operator: Those were the questions we have time for today. And so, I'll turn the call back to Susan for any closing remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you. And have a nice day.
Operator: Thank you everyone for joining us today. This concludes our call. And you may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Hello, everyone, and a warm welcome to the AES Corporation Q2 2024 Financial Review Call. My name is Emily, and I'll be coordinating your call today. [Operator Instructions] I will now hand over to our host, Vice President of Investor Relations, Susan Harcourt, to begin. Susan, please go ahead."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, Operator. Good morning and welcome to our second quarter 2024 financial review call. Our press release, presentation, and related financial information are available on our website at aes.com. Today we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer, and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, everyone, and thank you for joining our second quarter 2024 financial review call. We are very pleased with financial performance so far this year. Today, I will discuss our results, the significant advancements we've made with large technology customers, and the work we are doing to incorporate generative AI in our portfolio to develop new competitive advantages. Beginning on slide three, with our second quarter results, we had a strong second quarter that was in line with our expectations, with adjusted EBITDA with tax attributes of $843 million, adjusted EBITDA of $652 million, and adjusted EPS of $0.38. We are on track to meet our 2024 financial objective, and we now expect to be in the top-half of our ranges for adjusted EBITDA with tax attributes and adjusted EPS. We are also reaffirming our remaining 2024 guidance metrics and growth rate to 2027. Steve Coughlin, our CFO, will give more detail on our financial performance and outlook. I'm also pleased to report that, since our last call in May, we have signed 2.5 gigawatts of new agreements in total, including 2.2 gigawatts with hyperscalers across our Utilities and Renewal businesses. This includes 1.2 gigawatts of new datacenter load growth across AES Ohio and AES Indiana. A PPA to provide 727 megawatts of new renewables in Texas, and a 310 megawatt retail supply agreement in Ohio. With these arrangements, we are expanding our work with the major datacenter providers to new areas of business. Turning now to datacenter growth at our U.S. utilities, on slide four, since our last call, we have signed agreements to support 1.2 gigawatt of new load across AES Ohio and AES Indiana, expected to come online in phases, beginning in 2026. Additionally, we're in advanced negotiations across several sites to support another 3 gigawatts of new load. These agreements are transformative for both utilities, with the potential to increase the peak load at both AES Ohio and AES Indiana by more than 50%. As a result, AES Ohio's rate base will consist predominantly of FERC-regulated transmission assets, receiving timely recovery through a formula rate. For AES Indiana, this growth creates the potential for significant investment in transmission, as well as additional build-out of new-generation assets. These opportunities will even further increase our industry-leading U.S. utility rate base growth plans. Our service territories are particularly well-positioned to serve datacenters and other large loads with available interconnection, lower rates, and land prices, access to water resources and local incentives. Turning to slide five, and the generation build-out at AES Indiana, we continue to make progress in upgrading and transforming our generation fleet as we shutdown or convert our coal units to gas, and build our renewable fleet. I am pleased to announce that we have signed a deal to acquire 170 megawatt solar plus storage development project that AES Indiana will construct and own. The project will require approximately $350 million of CapEx, with an expected completion date in late 2027. Once approved by the Indiana Utility Regulatory Commission, this will be the sixth project supporting AES Indiana's recent generation growth. Now turning to our Renewables business on slide six, since our last all in may, we have further expanded our partnership with Google, signing a 15-year PPA for 727 megawatts in Texas to power its datacenter growth. The agreement includes a combination of wind and solar to further Google's 24-7 carbon-free energy goals. These projects are expected to come online in 2026 and 2027. We also recently signed a retail supply agreement with Google for 310 megawatts to support their Ohio datacenters. This agreement demonstrates the strong trust and collaboration between our companies, which began with our original 2021 partnership to provide 24-7 renewable power in Virginia. We see further opportunities to add renewables to support Google's datacenter growth in Ohio. Turning to slide seven, with these major announcements today on our collaborations with hyperscalers, we have now signed a total of 8.1 gigawatts directly with technology companies, which is clearly a leading market position. As you can see on slide eight, our backlog of projects under signed long-term contracts now stands at 12.6 gigawatts. Our focus remains on maximizing the quality of megawatts over the quantity, which means delivering high-quality projects with higher returns and long-duration PPAs. We have never felt better about our key customer relationships, the long-term market dynamics that are supporting growth and value creation in our portfolio. Turning to slide nine, the demand for power that is coming from the rise in generative AI in datacenters, represents a significant structural change in the Power segment, and no one is better positioned than AES for sustained growth from this opportunity. Regardless of election or policy outcomes, we are confident in our ability to continue signing renewable PPAs with mid-teen IRRs. Our corporate customers value our unique record of bringing projects online on time over the past five years. Furthermore, looking at the interconnection queues, time to power and price certainty, we see renewables as the only source of new power that can meet most of the demand over the next decade. AES has a longstanding and deep relationship with hyperscaler customers. This includes our ability to co-create new offerings and structure innovative clean energy solutions, such as hybrid PPAs, shaped products, and 24/7 renewables. As you can see on slide 10, of the 3.6 gigawatts that we expect to bring online this year, we have already completed the construction of 1.6 gigawatts and expect the remainder to be weighted towards the third quarter. I should note that for the projects coming online this year, we have all of the major equipment already on site in almost all for 2025. Additionally, we expect a significant portion of our solar panels to be domestically produced beginning in 2026. All of the above combined with having panels on site for 2025 projects, greatly mitigates our exposure to any potential new tariffs. Our diversified and resilient supply chain has been and will continue to be best-in-class. Finally, turning to slide 11, not only is generative AI shaping the customer landscape, but it is also transforming how we work internally, providing new opportunities for efficiencies, customer service and innovation that will give us new competitive advantages. As you may have seen, in June, we announced a partnership with AI Fund to accelerate AI-driven energy solutions. Founded by AI leader, Andrew Ng, AI Fund is a venture studio that works with entrepreneurs to rapidly build companies. We are collaborating with AI Fund on co-building companies that leverage AI to address bottlenecks and improve efficiencies in the energy transition in areas such as developing and operating renewables and asset management. At the same time, we continue to leverage AI across our portfolio with our culture of innovation and continuous improvement. We are increasingly using proprietary tools across a wide range of our business operations, enabling our people to work faster and smarter. For example, our renewables team has built sophisticated tools that utilize generative AI to accurately predict the speed at which projects will move through interconnection queues, helping us more efficiently coordinate the various simultaneous development processes. As you can see on slide 12, earlier this week, we launched the world's first AI-powered solar installation robot, Maximo, which uses state-of-the-art AI and robotics to complement our construction crews in the installation of solar modules. Maximo enables faster construction times and reduces overall project costs. It can work three shifts, even in the worst weather conditions, with a more inclusive workforce. Not only does it reduce time to power, which is highly valued by our customers, but it will boost overall project returns. We plan to ramp up our use of Maximo in 2025 and are already utilizing it to construct a portion of our two gigawatt Bellefield project in California, which is the largest solar plus storage project in the U.S. and is contracted to serve Amazon. With that, I would now like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andres, and good morning, everyone. Today, I will discuss our second quarter results and our 2024 guidance and parent capital allocation. Turning to slide 14, adjusted EBITDA with tax attributes was $843 million in the second quarter versus $607 million a year ago. This was driven by growth in our renewables SBU, new rates and growth investments in our U.S. utilities, and higher margins in our energy infrastructure SBU. Turning to slide 15, adjusted EPS for the quarter was $0.38 versus $0.21 cents last year. Drivers were similar to those of adjusted with tax attributes, but partially offset by higher depreciation and higher interest expense as a result of our growth. I'll cover the performance of our SBUs or Strategic Business Units on the next four slides. Beginning with our renewables SBU on slide 16, higher EBITDA with tax attributes was driven primarily by contributions from new projects, but was partially offset by lower availability from a forced outage event at our 1 gigawatt Chivor hydroplant in Columbia. The outage was caused by record water inflows in early June, which brought significant sediment into the plant and damaged the units. Repairs of the plant were completed quickly and all units resumed operations by mid July. Higher adjusted PTC at our utilities SBU was mostly driven by higher revenues from the $1.6 billion we invested in our rate base in the past year, new rates implemented in Indiana in May, year-over-year low growth of 3.1% as well as favorable weather. Higher EBITDA at our energy infrastructure SBU primarily reflects higher revenues recognized from the accelerated monetization of the PPA at our Warrior Run plant and higher margins in Chile. Partially offset by lower margins in the Dominican Republic and the sell-down of our gas and LNG businesses in Panama and the Dominican Republic. Finally, relatively flat EBITDA at our new energy technologies SBU reflects our continued development of early stage technology businesses. Partially offset by continued margin increases at Fluence. Now turning to our expectations on slide 20, as a result of our strong first-half performance and high confidence in a strong second-half, I am very happy to share that we now expect adjusted EBITDA with tax attribute to be in the top half of our 2024 expected range of $3.6 billion to $4 billion. Drivers of adjusted EBITDA with tax attributes in the year ago include higher contribution from new renewable commissioning, contributions from growth investment, and expected higher load at our U.S. utilities. Partially offset by expected closings in our asset sale program. Turning to slide 21, I am also very glad to share that we now expect our 2024 adjusted EPS to be in the upper half of our guidance range of $1.87 to $1.97. We increased our share of earnings in the first-half of the year from 25% in 2023 to nearly half in 2024. Growth in the year to go will have similar drivers as adjusted EBITDA with tax attributes. Partially offset by higher interest expense from growth capital. Now to our 2024 parent capital allocation on slide 22, sources reflect approximately $3 billion of total discretionary cash including $1.1 billion of parent free cash flow, $900 million to $1.1 billion of proceeds from asset sales, and $950 million of hybrid debt that we issued since our last earnings call in May. On the right-hand side, you can see our planned use of capital. We will return approximately $500 million to shareholders this year, reflecting the previously announced 4% dividend increase. We also plan to invest $2.4 billion to $2.7 billion towards new growth. Of which, 85% will go to renewable and utility. Turning to slide 23, we are well on our way to towards achieving our long-term asset sale target of $3.5 billion from 2023 through 2027. We signed or closed more than $2.2 billion of asset sales since the beginning of last year. And we are now nearly two-thirds of the way to reaching our target even though we are only 1.5 years into our five-year guidance period. We do not announce specific asset sales in advance. But the remaining proceeds could come from sell-downs of renewables projects, our intended coal exist, monetization of our new energy technologies businesses, and sales or sell-down of other noncore assets. In summary, we made excellent progress this quarter toward all of our strategic and financial targets. We have clear line of sight towards achieving the key drivers of our year-to-go earnings growth. And we are well-positioned to continue delivering on our financial goals beyond this year. We also made significant headway on our long-term funding plan which allows us continue simplifying and focusing our portfolio while we scale our leading renewables and utilities business. Our strategy to serve high value corporate customers including a rapidly growing base of datacenter providers across our Renewables and Utilities businesses is highly resilient, and will continue to yield financial success for AES and our shareholders. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"text": "Thank you, Steve. Before opening up the call for Q&A, I would like to summarize the highlights from today's call. With more than 8 gigawatts of agreements already signed directly with large technology customers, including 2.2 gigawatts signed since our last call. We continue to be the industry leader in this segment. At the same time, we continue to deliver our projects on time and on budget, with 1.6 gigawatts completed so far this year. We are fully on track to add a total of 3.6 gigawatts by the end of 2024. We see demand for power from datacenters in the U.S. growing around 22% a year. And we could not be better positioned to serve these customers, from our Renewable business to our Utilities. I would like to reiterate that with strong demand for the projects in our 66 gigawatt development pipeline and our existing 12.6 gigawatt backlog of signed long-term PPAs. We are very confident in our ability to continue to meet or exceed our long-term objectives. Operator, please open up the line for question."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question today comes from Durgesh Chopra with Evercore ISI. Durgesh, please go ahead."
},
{
"speaker": "Durgesh Chopra",
"text": "Hey, team, good morning. First off, congrats on a solid quarter and first-half. Too bad the market is [viscose] (ph) today. Maybe just I had one question on the numbers, and then I have just one high-level macro question. First, to Steve, could you update us on credit metrics, where did you end up as of Q2, and then were do you expect to be at the end of 2024 on FFO to debt?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, sure. Hi, Durgesh, it's good to hear your voice. So, the credit is looking very, very strong. So, we continue to be on a path of improving credit. At the parent level, I expect will be even higher than last year's year-end. And so, it looks very good. There's obviously intra movement in quarters as we have some cash flow lumpiness coming up, but it continues very strong. I think we'll see the year end be even better than last year."
},
{
"speaker": "Durgesh Chopra",
"text": "So, just to be clear there, Steve, I think the target last year was 22%, if I have those numbers right on FFO to debt basis is the S&P methodology. Is that still kind of a good goalpost?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So, we have a threshold of 20%. So, you're referring more to, I think, where we ended, which had plenty of cushion above that. And I think we will likely see ourselves even higher than that at the end of this year."
},
{
"speaker": "Durgesh Chopra",
"text": "Okay, perfect. [A lot of] (ph) question on the balance sheet. Okay, then maybe just one election question. Andres, appreciate the commentary in your prepared remarks. But I'm just wondering, obviously a great quarter here. You added to the Utilities, you added on the Renewable side. But I'm just wondering if all the noise around repeal of tax credits and other policy chatter, does that hurt your ability to sign new contracts? Does that come up in your contract negotiation, is that a risk? Maybe just help us sort through that. Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Sure, Durgesh. No, it's not slowing down our signing of contracts. What we really had is a situation that we had, to some extent; foreseen a couple years ago where it's really there's a shortage of renewable power for datacenters in many markets. So, what's the biggest concern of our clients is actually time to power, can you get me the power on time to power datacenters. And that's their main constraint. So, no, there has been anything holding us down or, quite frankly, a major issue of conversation with them. I do think we have to step back and say, \"Look, ITC investment tax credits, production tax credits, they've been around for 32 years.\" Second, there's been a tremendous amount of investment related to the Inflation Reduction Act. And 85% of that investment has gone into republican districts. Today, there are eight million people working directly or indirectly in renewables in the U.S. So, a total dismantling is highly unlikely in any scenario, whether there are some changes around the margin; sure. But thinking about the sector, quite frankly we operate in markets where there are no subsidies. We actually make more money in those subsidies. And it would change somewhat the structure of the contracts. But we see a wholesale revision of this very, very unlikely. Something more likely what happened to NAFTA, where it became the USMCA, and actually was, quite frankly, updated and improved in some areas. So, that's where we se the market right now."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. [Indiscernible]. Thanks so much for the time, I appreciate it."
},
{
"speaker": "Andres Gluski",
"text": "You're welcome. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Richard Sunderland with J.P. Morgan. Please go ahead."
},
{
"speaker": "Richard Sunderland",
"text": "Hi, good morning, and thank you for the time today."
},
{
"speaker": "Andres Gluski",
"text": "Hi, good morning, Rich."
},
{
"speaker": "Steve Coughlin",
"text": "Hi, Rich."
},
{
"speaker": "Richard Sunderland",
"text": "Starting on the Utility announcements, can you outline the utility load opportunity in terms of the breakdown of that 3 gigawatt in advanced negotiations between Indiana and Ohio, plus how much of that capital could fall into the transmission and generation buckets relative to what's in the plant today?"
},
{
"speaker": "Andres Gluski",
"text": "Okay, look, that's a great question. But we will give you more color on that as time passes, because these are multiple agreements with multiple clients. And we'd really like to see how it shakes out. We're certain that there's going to be a lot of load added, a lot of transmission assets added. But this is between two utilities, between multiple clients. So, right now it's a little bit too early for us to give too much in term of exact load growth by business."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, and just to add to that, Rich, we had previously guided to around 10% up for the utilities combined, this is definitely upside. There's significant acceleration of discussions. So, definitely upside to the plans that we've given in the past. Timing matters here though, so we'll see some within our long-term guidance period, and some beyond that. But we do see a lot more growth than we saw even at the start of this year."
},
{
"speaker": "Richard Sunderland",
"text": "Understood. Thanks for the color there. And then, your language in the slides on maximizing megawatt quality over quantity; that message has certainly been clear. But I'm curious if this is consistent with your raise per turn assumptions, I think that was back in 4Q. Or do you see further upside potential to returns given the supply and demand dynamics currently?"
},
{
"speaker": "Andres Gluski",
"text": "Okay. Basically, I think there's several things. One, when we talk about pipeline, that means we have something in the interconnection queue. And we have some degree of land control. So, I would say not all pipeline were created equal. And when we talk about backlog, that's actually contracts that are signed and that we have to deliver, and people have to buy that energy. So, we've never taken anything material out of our backlog, even during COVID. So, what we're saying here with -- the basic message is, one, yes we increased our average rate of returns on these projects. We're not talking about mid-teens. The other thing is that rather than sign like one umbrella agreement with one particular client, we're optimizing the value of this resource among various clients and among opportunities. So, we see this as something where we invest in, we create this real pipeline. And then, we want to optimize the value from it. Will the average returns go up further? Well, I think it would depend market by market, and the opportunity. But right now, we feel very good about the mid-teen returns that we talked about. And we also feel very good about that we're making the best use of that pipeline to create value for our shareholders."
},
{
"speaker": "Richard Sunderland",
"text": "Great, thank you for the color there. I'll leave it there."
},
{
"speaker": "Andres Gluski",
"text": "Okay. Thanks, Rich."
},
{
"speaker": "Operator",
"text": "The next question comes from Antoine Aurimond with Jefferies. Please go ahead."
},
{
"speaker": "Antoine Aurimond",
"text": "Hey, guys. Hope you're well. Thank you for taking my question."
},
{
"speaker": "Andres Gluski",
"text": "Good morning."
},
{
"speaker": "Antoine Aurimond",
"text": "Good morning. I guess to follow-up on Durgesh on the credit side, how do you frame the prospects of going towards a mid-BBB rating and what would be the timeline, we'll be contemplating?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So, as I said, credit metrics are definitely continuing to improve and so I see that as a possibility in a matter of years, not this year, that will be have those metrics. So, we don't have a specific target to share with you at this point, but I expect to be higher than last year and I expect it to continue to improve. As the installed base of our growth continues to grow and add cash. Today, we do carry construction debt that's not yet yielding. But relative to the base, the base is increasing every year significantly in this moment that we are in. So, yes, I think that's very possible, but I don't have a specific date to share with you at this point."
},
{
"speaker": "Andres Gluski",
"text": "One thing I'd like to add, as we exit countries and as we're investing primarily in long-term contracted with investment grade off takers in renewables, or our U.S. utilities, which also with this transformation are moving more towards a transmission rate base. The quality of our cash flow continues to improve. So, it's not only a question of the metrics, which as Steve said are improving, but the quality of that cash flow or how it's seen by credit rating agencies is improving as well. So, on both sides, we feel very good about it."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, and actually, I guess we'll keep going here because I have just that reminds me of another topic really here. Keep in mind that 80% of our debt is nonrecourse to the parent, and nearly all of that is amortizing investment grade rated subsidiary debt. So, it's a very high quality structure, and the agencies are seeing that. So, I think this, both the quantified metrics as I've mentioned as well as Andres said in the quality and looking at the debt structures, amortizing investment grade, it's a very, very robust, healthy structure."
},
{
"speaker": "Antoine Aurimond",
"text": "Got it. Yes, that makes sense guys. I guess on that note, with 85% of the CapEx going towards U.S. based businesses, where do you see the geographical mix trending towards the end of the time period?"
},
{
"speaker": "Steve Coughlin",
"text": "End of the time period, like 2027 you're speaking?"
},
{
"speaker": "Antoine Aurimond",
"text": "Yes, yes."
},
{
"speaker": "Steve Coughlin",
"text": "Okay. Look, I'd say we can I think there's a transformation in terms of, we're moving more towards U.S. dollar based investment grade off takers? So, yes, there's going to be heavier weighting towards the U.S. We do have opportunities to serve the same type of clients outside the U.S., with your investment grade dollar contracts, many times with the same, with the same client. So, if we serve hyperscalers in the U.S. and they want the same services, say, in Chile or in Mexico, then we can service. And that is a competitive advantage we have."
},
{
"speaker": "Antoine Aurimond",
"text": "Got it. Okay. That makes sense. And then, I guess, so you mentioned more sort of quality of megawatt versus this is just volume. We're going to do, what 3.6 gigs this year. How should we think about that number evolving? Assuming it's still going to increase, but I guess you mentioned more quality, right? So what's sort of like that number fast forward a couple years?"
},
{
"speaker": "Andres Gluski",
"text": "Look, when I put it this way, we have a backlog of more than 12 gigawatts of signed PPAs we have to deliver. The majority of that will be within the period of by 2027. So, that gives you -- that that's a guaranteed build out that we have to do over the next three years. So, over time, assuming we're signing somewhere about 4.5, 5.5 gigawatts of new PPAs, those numbers have to converge. Unless, we grow the number of megawatt, PPAs that we're signing, and then it'll take a little bit more time to converge. But given -- that gives you sort of the run rate. Yes. We'll be 4 plus in coming years just from the backlog we have today, and expect that to grow over time past that period of time of 2027."
},
{
"speaker": "Antoine Aurimond",
"text": "Yes, that makes sense. Okay, great. Well, Andres, thank you so much."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from David Arcaro with Morgan Stanley. Please go ahead."
},
{
"speaker": "David Arcaro",
"text": "Hey, good morning. Thank you. Maybe back on the utility side of things, it's great to see all that load growth opportunity coming. When do you think you'd have an opportunity to relook at the CapEx outlook? And then at a high level, how do you think about financing, upsides in the utility CapEx trajectory?"
},
{
"speaker": "Andres Gluski",
"text": "Yes, hey, David. Good morning. So, as we are looking through the details of the timing of what we've recently signed, we'll flesh that out in our planning process, in the second-half of this year and bake that into our update of guidance for the beginning of next year. So, definitely, I would see in the long-term horizon that we have out there through '27, this will start to come into play in the capital plan, but our funding plan, I don't expect to change at all. We have really done well on our asset sale plan. We are two-thirds of the way through, after only 18 months on a five year plan. We've got a lot of flexibility there. We have partnership capital. So, there is no shortage of capital to invest in the utility growth here. It's a very attractive profile. And so, I see it becoming material, but I see it within the funding plan that we've already released through '27."
},
{
"speaker": "David Arcaro",
"text": "Got it. That's really helpful. Thanks for that. And then, just appreciate the comments on the supply chain outlook on the renewable side. I was just curious if I could get your sense, like how much line of sight do you have right now for that domestic supply in 2026, just as we think about navigating some of the tariffs on solar panels and battery storage? How are you feeling right now in terms of the line of sight for both of those supply chains?"
},
{
"speaker": "Andres Gluski",
"text": "Well, we're feeling very good. And what I would say is, as we've mentioned, we have everything we need for this year, for 2024, and most of you know, vast majority of what we want for 2025. And then, we have signed agreement with domestic suppliers for starting in 2026. So, we feel very good about our ability to execute, deliver on our backlog in the U.S. And I would say that again, to date, we have not had to postpone or abandon any material project in our pipeline over the last five years. So, compared to what happened to supply chains with COVID, this is much more predictable. So, we feel very good about it. And basically, we're again going to make that switch to domestic supply starting in 2026."
},
{
"speaker": "David Arcaro",
"text": "Okay, great, understood. Thanks so much."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Thanks, Dave."
},
{
"speaker": "Operator",
"text": "The next question comes from [Feeney Shea] (ph) with Barclays. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"text": "Hi, good morning. Thanks very much for taking my question. So, I guess just first quickly on renewable execution, really great to see the guidance update in terms of EBITDA with tax attributes. I guess, could you maybe just talk about, given the backlog, the PPA signing cadence, the ability to bring projects online, how does your EBITDA excluding tax attribute would trend, I guess given where it is now year-to-date? Seems a little light, but just wanted to see how should we think about it going deeper into the year? Thanks."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, good morning. Thanks. So, we do have a significant upside in our tax credits as I mentioned in my remarks, primarily that's driven by -- we're qualifying for more energy communities than originally anticipated. And we also have seen the valuation of our tax attributes, particularly through transfers, be valued at a higher level. What's important, as I've always emphasized is that these are cash. It's a very attractive profile. This is not just earnings, but it's cash coming in, which is a very early return of a significant amount of capital 30% up to 50%. So, we're really, really pleased with this upside. There are a few other upsides in EBITDA as well. So, we have had higher margins and higher dispatch in our gas business in the Dominican Republic. We've also continued to drive efficiency and productivity in our renewables and utilities businesses where we're very focused on growth. And in fact, growing those businesses is actually costing less than we anticipated. So, we see favorability in costs going through EBITDA this year. So, as you caught on, there has been an offset to that, and it's what I mentioned in my remarks, which is primarily the Columbia outage. It was a record amount of flooding and inflow that took the units out for all of the month of June and the first part of July. So, that unfortunately did offset and is a negative driver to EBITDA this year. And then, the other, and I think we mentioned this, we did have a very low wind resource in Brazil, more so in the first quarter, but that also had impacted our EBITDA this year. So, we have some offsets, but overall really pleased with the growth, the cash-driven growth, and that we continue to be even more efficient in our renewables and utilities growth machines."
},
{
"speaker": "Unidentified Analyst",
"text": "Got it. No, that's very helpful. I guess second, we noticed a comment on being able to bring the majority of the backlog online by 2027. I guess with this year, 2024, a targeted 3.6 gigawatts of new projects online, could you talk about the cadence on bringing new projects online -- just on this front, from this year through 2027, and what kind of lumpiness should we expect coming out of it?"
},
{
"speaker": "Andres Gluski",
"text": "Yes, well, I think we've very much smoothed out the cadence of bringing projects online. At the beginning where we were ramping up very fast, in fact, last year we grew 100% the number of projects we're bringing online. So, this year we're able to manage it much better in the sense that it's almost about half is being done in the first-half, and the third quarter is going to be quite heavy as well. So, the cadence is going to be much more even throughout the year, as again, the growth rate is not 100% in one year, and obviously it will increase because again, we have to deliver 12.6% over the next three years. And so, most of that is it gets your numbers closer to four. So, we feel very good about the cadence. The biggest challenge was to ramp up 100%, and we did that, and we actually did all of our projects that we needed to get done last year on time."
},
{
"speaker": "Unidentified Analyst",
"text": "That's great. Really appreciate the colors from both. Thanks."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Michael Sullivan with Wolfe Research. Please go ahead."
},
{
"speaker": "Michael Sullivan",
"text": "Hey, good morning."
},
{
"speaker": "Andres Gluski",
"text": "Good morning, Michael."
},
{
"speaker": "Michael Sullivan",
"text": "Yes. Hey, Andres. A couple of questions, I know there's been some on the utility growth, but 50% plus load growth seems pretty eye-popping, and I'm just curious, like, how you're feeling about the supply side and ability to serve that. Like, for example, if I just look at, you have an AES Indiana, I don't know, I mean, there's like a planned conversion, and then a handful of renewables, and a lot of load growth coming. And then, obviously, in Ohio, you have less control over the supply, and we got a data point on that earlier this week. I guess, yes, just how explosive load growth, how are you feeling about the ability for generation to serve that in those two states?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Look, that's a great question. This is going to be timed over the years, so it's not like all at once we have to deliver this in the next two years. So, it represents opportunities, definitely, for additional generation. And as I've been saying in my remarks a good part of that's going to come from renewables. Some of that increased demand may come from gas in some locations. So, definitely all of this is we feel it will get done, and the solution will be different in MISO or PJM, there will be differences, and it'll be different between the two utilities, in terms of one of them will involve more direct securing the generation itself. So, this will pan out, but it's a very good question, because yes, there is quite a high number of growth. It represents a great opportunity, but we wouldn't have said it if we didn't know how this could be served."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. And I would just add to Andres' point in Indiana, where generation will be part of the solution keep in mind, we have multiple existing gas sites. So, we have the conversion at Petersburg, but we also have space for additional gas at Eagle Valley, at Harding Street, and at the Georgetown site. So, we are seeing the whole package being able to support datacenter growth there. In Ohio, of course, you mentioned that that's a distribution transmission. We have a very attractive area for datacenters, our service territory is quite large, a lot of available cheap land, very centrally located to fiber networks and data load, accessible water. So, it is a very appealing area. You can see from the -- I think you're referring to the PJM capacity auction, was quite high, demonstrating how significant demand has increased. But within PJM, I think our territory in Western Ohio is one of the most attractive areas, if not the most."
},
{
"speaker": "Michael Sullivan",
"text": "Yes, appreciate all that Color. Just to follow up on that last point this came up on some of your peers' calls, but any appetite from your standpoint to own regulated generation in Ohio, and what could that look like if it turns out that this can't be done through competitive markets?"
},
{
"speaker": "Andres Gluski",
"text": "Yes, look, right now we have no appetite for generation in Ohio directly, but again, this represents opportunities for our renewables team. So, I would say stay tuned, but certainly we feel that these targets can be met, but again realize this is going to happen over time, as Steve had said in his comments."
},
{
"speaker": "Michael Sullivan",
"text": "Okay, great. And then, just one more, over to like the renewable side, I think since the last call we had the Brazil asset sale announcement, should we just think about that as fully embedded in your longer-term guidance, or is there like more additions than expected that are going to kind of backfill that in terms of the longer-term growth?"
},
{
"speaker": "Andres Gluski",
"text": "No, that's already embedded in our guidance."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, both this year and obviously the long-term Brazil exit is included in our numbers."
},
{
"speaker": "Michael Sullivan",
"text": "Great. Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Willard Grainger with Mizuho. Please go ahead."
},
{
"speaker": "Willard Grainger",
"text": "Hi. Good morning, everybody. Can you hear me?"
},
{
"speaker": "Andres Gluski",
"text": "Yes. Good morning."
},
{
"speaker": "Willard Grainger",
"text": "Thanks for taking my question. Just maybe one, with the results of the PJM capacity auction coming out this week and just directionally higher power prices and projects coming out of the queue for next year, just how are you thinking about the cadence of your development pipeline? And any color on that would be super helpful. Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Look, we have been saying, again, for several years that we were seeing shortages developing, just looking at the corporate demand, especially for renewables, and the ability of suppliers to ramp up to meet that demand. So, to some extent, what is happening in the market is what we expected. This is not going to make any difference to our plans. Again, we have contracts, we have sites, we've already locked in financing, et cetera. So, equipment prices, so it doesn't make any change to our plans. What it does, I think, signal is the value of our existing assets are going to go up as this shortages materialize. So, no effect in the, generally, in the shorter term, but in the longer term, it means that our assets are more valuable, and to some extent, it's what we've been planning for. So, it's not, of course, a specific option, we don't intend to be clairvoyant, but the general direction of the market that's unfolding is what we expected."
},
{
"speaker": "Willard Grainger",
"text": "I appreciate the color there. Most of my questions have been answered. Thank you. I'll get back in queue."
},
{
"speaker": "Andres Gluski",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Angie Storozynski with Seaport. Please go ahead."
},
{
"speaker": "Angie Storozynski",
"text": "Thank you. So, I have lots of questions. So, first, maybe in this low interest rate environment, I'm just, I'm actually wondering. So, first, again, so does that actually help further boost the profitability of the projects that are yet to be built? Meaning, I mean, you have embedded certain assumptions about interest rates for like construction financing, for cost of debt, et cetera. So, do I get actually an incremental benefit now that we're seeing seemingly in a lower interest rate environment?"
},
{
"speaker": "Steve Coughlin",
"text": "So, Angie, this is Steve. Good morning. So, look, we can't have it both ways. So, we have, as I've often talked about, a very low risk way of executing, which means we lock in almost all of our costs when we sign our PPAs, including hedging the long-term financing. So, for anything that we've signed, we're pretty much, we've baked in the price of that financing. But on a go-forward basis, look, lower interest rates are a good thing. They reduce the cost of new infrastructure, and so reduce the cost to the customer. So, overall, I think it's a further catalyst to demand and will help the whole sector. But we maintain a low risk structure in the way we execute."
},
{
"speaker": "Andres Gluski",
"text": "Obviously, we are highly contracted for future cash flows. So, lower interest rates means a lower discount rate. It means those cash flows are worth more. But the benefits on a sort of new contract basis will be for new contracts being signed, but not for the backlog."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. So, then, changing topics, so those emission reduction targets or renewable power targets for hyperscalers, so obviously, here are those points that they're making, but I also see a number of these datacenters being developed on very coal-heavy grids, like Kentucky and Mississippi. I mean, and then the utilities that are on the other side of those transactions are basically saying that hyperscalers have eventual targets for emission reductions or carbon goals. But they're happy with just absorbing carbon-heavy power early on and then dealing with that carbon footprint later. So, how does that tie into this pitch that, in a sense, they have to just procure renewable power when, again, when we have these instances where they're just going for large quantities of available power, largely regardless of the carbon footprint?"
},
{
"speaker": "Andres Gluski",
"text": "That's a great question. The way I would put it is their preference is renewable power. Right? So basically, you're talking about situations where they have no other alternative. So, they're not happy to suck up coal power from the grid. They basically will either have offsets with a VPP or by RECs, and quite frankly, in most cases, will require that renewables come online in the future. So, you have to put it like this is the last alternative. And so, obviously, if you have a datacenter, the most important thing is to have power. So, if you have no other alternative, you will not go for renewables. But they do have the renewables goals, and they do want that power to be as low carbon as possible. So, that's in terms of the demand. Now, let's look at the supply. If you look at what's in the interconnection queue, almost all of it is renewables, if you include batteries. So, the fact is what can get built, let's say, over the next five years, for sure, is going to be very heavily weighted towards renewables. As Steve mentioned, you have to combine these in the lowest carbon way possible. And if that means adding some gas plants, that will be done. But I think that the direction is clear, because I remember you on one call said that it's all going to be nuclear. And I kind of laughed, we both laughed and said, tell me what the price of an SMR is? How can we sign a PPA with embedding nuclear? Second of all, the regulatory hurdles to bringing on nuclear are still very significant. And we really don't have price certainty on it. So, renewables are going to be the bulk of that add-on. That's what they want. Again, yes, they will make deals for the short run if that's the only alternative. But it's not their preferred route."
},
{
"speaker": "Angie Storozynski",
"text": "No, I understand. But again, I obviously hear your point, yes. It's just that I'm wondering if renewable power is more like a source of basically carbon-free credit, or is it the source of energy? Because again, one could argue that the datacenters are basically using traditional thermal power for the supply of energy. And then, renewables, again, just offset the carbon footprint. And I'm not sure if that's actually bad or good. I'm debating it myself; it depends on my question. But I'm just again."
},
{
"speaker": "Andres Gluski",
"text": "Yes, I think it depends on the client, quite frankly. Some clients are much more stringent. Some clients actually want hourly-matched renewables. Some clients require additionality. Most of them require additionality. So, it's not just one-size-fits-all. I think the renewable standards will differ among them. But the direction is very clear. So, I don't see anybody sort of walking away from it at this point. And quite to the contrary, they're under pressure a lot because as they ramp up very significantly their datacenters and they're taking some power which is not renewable, their total carbon footprint goes up, and that's something that they've had to address. So, I would say that, yes, they're being pragmatic. But in terms of their goals and desires, those remain unchanged. And it's not uniform across all of them. It's not one-size-fits-all."
},
{
"speaker": "Angie Storozynski",
"text": "And then lastly, you have this page where you mention all of these additional transactions you've entered into with hyperscalers. So, is this co-location? Is it that this is sort of a set of assets located at least in the same sort of zone, like say in PJM or again, I'm just -- I'm not trying to be facetious here? But I'm just wondering, so is this power really directly feeding into these hyperscalers? Or is it just like being commingled with other power and it's, again, this sort of a carbon attribute as opposed to the energy?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. So, I'll just add on to what Andre said. So, in almost all these cases, even you're talking about, Angie, not to say, yes, these are resulting in renewable PPAs, some cases in the same location or nearby locations, and others where they're focused on time to power going to the grid, but then also contracting for renewables perhaps further away. Most of what we are doing is I would say you would call more of a co-location regionally where we're supplying energy, including most of what we signed recently in the same grid and relatively close to the datacenter. So, that is by and large what we've seen most looking for. But when time to power is, of course, a priority, they're looking for alternatives. But the great thing is that in all cases, the additionality of renewables, whether it's direct or through RECs, is a top demand from these customers."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. And then, lastly, so what happens, for example, with AES Ohio now that we have this pickup in capacity prices, most of the energy prices will follow. I mean, this is a wires only business. Are you concerned about the impact on electric bills and affordability and how that might suppress any sort of a T&D investment?"
},
{
"speaker": "Andres Gluski",
"text": "I would say, look, first, we have the lowest rates in the state. So, we're starting off from the best position of anybody. Second, realize that our new additional growth, these are people who, again, the most important thing is to find a good location and to have the power and the other services that they need. So, that does not concern me in terms of, let's say, saying, well, this growth will not happen because the capacity prices went up. And as I've said before, to some extent, not this particular auction, not the extent of this one-time jump. But we had been expecting this. So, this is not something that's like out of left field and we have to scramble. We have been talking about, and you can hear from all our earnings calls, and we've been saying, look, there's going to be a shortage. And returns are going to improve over time. And so, directionally, this is very much what we expected."
},
{
"speaker": "Angie Storozynski",
"text": "Okay. Thank you. Thanks."
},
{
"speaker": "Andres Gluski",
"text": "All right. Thanks, Angie."
},
{
"speaker": "Operator",
"text": "The next question comes from Biju Perincheril with SIG. Please go ahead."
},
{
"speaker": "Biju Perincheril",
"text": "Yes, thanks for taking my question. A question on domestic content bonus, can you talk about when your projects might -- when you're targeting your projects to be eligible for that and maybe the implications for your returns? And if you could talk to separately the solar and storage projects, that would be great. And then, I have a follow-up."
},
{
"speaker": "Andres Gluski",
"text": "Okay. So, first, I'd say in terms of domestic content, in terms of our wind project, those already meet the criteria. Remember, it's a criteria based on the total cost of the project, the different components. In terms of solar panels, again, we expect to be meeting that by 2026. In terms of batteries, our main supplier is Fluence, and they should be meeting that, quite frankly, starting in 2025. So, all together we feel very good about meeting domestic content requirements. And then, there are other things like trackers, inverters, et cetera, that we've been working on as well. So, I think the team's done a very good job to combine the various assets such that they do meet the domestic content criteria. So, it's not one-size-fits-all. It's like what's available and if you have wind, it may be greater. If you have, say, solar panels, it may be lesser, but you put it together and the total meets it. So, we feel very good about that meeting the domestic content criteria."
},
{
"speaker": "Steve Coughlin",
"text": "And I would just add, keep in mind that the adder is across the entire capital cost of the project once you meet the threshold for the certain components that have to be domestically sourced. So, it's a 10% across not just those components, but the whole thing, which is really attractive."
},
{
"speaker": "Andres Gluski",
"text": "Yes. And we have no trouble meeting things like prevailing wage, et cetera."
},
{
"speaker": "Steve Coughlin",
"text": "Right."
},
{
"speaker": "Andres Gluski",
"text": "So again, the team's been working very hard on this, and we feel that we're very well positioned."
},
{
"speaker": "Biju Perincheril",
"text": "And is your expectation that you would be able to retain most of that or you would have to pass along that in terms of PPA pricing, just trying to understand the impact to your returns?"
},
{
"speaker": "Andres Gluski",
"text": "Again, I think it's on a case-by-case basis. It depends on the demand supply in the particular market. So, --"
},
{
"speaker": "Biju Perincheril",
"text": "Okay."
},
{
"speaker": "Andres Gluski",
"text": "I think the best answer would be shared. And then, the vision of spoils will depend on the particular circumstances."
},
{
"speaker": "Biju Perincheril",
"text": "Got it. My follow-up was -- and we talked about a lot about sort of time to power. So, for renewables projects, can you talk about sort of the advantages or what you bring to the table specifically from a technology perspective? I think last quarter you sort of talked about DLR and batteries and that almost that or there are other solutions that you could bring to the table in terms of addressing that concern for your end customers."
},
{
"speaker": "Andres Gluski",
"text": "Yes, we really look at this sort of holistically and we tend to co-create with the client. Say, look, what do you want? And then we'll bring the technologies to bear. We don't come and say, look, we have this really neat widget. This is what you should buy. Now, given the new technologies I really do feel that we've been a leader in this. So, in everything from we did invent lithium ion -- the use of lithium-ion batteries for grid stability. We started that 14 years ago. We do have the biggest dynamic line rating project in the country. Fluence is doing a number of very innovative things to use batteries to be able to get more use out of existing transmission lines. We also were the first to do hourly matched 24/7 long-term contracts for hyperscaler clients. So, we continue to do that. And with Uplight, there's a number of VPP facilities that's well-managed -- energy management. And finally, I think Maximo is a great example of we are thinking about the future. One of the constraints, and I am sure you've heard it, was like labor force for building solar projects. And the fact is you have lift 65 pound today solar panels. In heavy heat the restrictions, crews can only work six hours for example. And it takes a very strong individual to be able to do this task at all. So, with Maximo this really allows us, first, to do it much more quickly. You can work three shifts even in terrible weather or hot weather conditions. In addition to that, we don't have to be particularly physically strong to do it. You have to be able to supervise the robot. So, Maximo is an example of how we would bring projects online faster and also with cost at damages as well. So, this is the first step. We are starting to use it. Next year, we will be ramping up. But after that, we can see a fleet Maximo out there, which would give us a competitive advantage. In other words, that we could bring -- we wouldn't say it's labor shortages, because we can hire a much broader universe of individuals. We can work in three shifts in all weather conditions. And we can quite frankly do it faster and better. So, that's another example. So, again, I think our AES Next and our views on technology have been really industry leading."
},
{
"speaker": "Biju Perincheril",
"text": "Okay. Thank you."
},
{
"speaker": "Andres Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Those were the questions we have time for today. And so, I'll turn the call back to Susan for any closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you. And have a nice day."
},
{
"speaker": "Operator",
"text": "Thank you everyone for joining us today. This concludes our call. And you may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AES | 1 | 2,025 | 2025-05-02 12:13:00 | Operator: Hello, everybody, and welcome to The AES Corporation Q1 2025 Financial Review Call. My name is Emily, and I'll be moderating your call today. [Operator Instructions]. I will now hand the call over to Susan Harcourt, Vice President of Investor Relations to begin. Susan, please go ahead.
Susan Harcourt: Thank you, operator. Good morning, and welcome to our first quarter 2025 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; Ricardo Falú, our Chief Operating Officer; and other senior members of our management team. With that, I will turn the call over to Andrés.
Andrés Gluski: Good morning, everyone, and thank you for joining our first quarter 2025 financial review call. Today, I'm very pleased to reaffirm both our 2025 guidance and long-term growth rate targets, which reflect our strong execution to date as well as the resilience of our business overall. I will discuss this in more detail and provide an update on the robust growth program at our U.S. utilities. Following my remarks, Steve Coughlin, our CFO, will provide additional color on our financial performance and outlook. Beginning on Slide 3 with our first quarter results. Our financial performance was in line with our expectations with adjusted EBITDA of 591 million and adjusted EPS of $0.27. We completed the construction of 643 megawatts and signed or were awarded 443 megawatts of new PPAs, bringing our backlog to 11.7 gigawatts. We have achieved our asset sale proceeds target for the year, including the sale of a minority stake in our global insurance company, AGIC, for 450 million. Now turning to the resilience of our business model and portfolio. Our execution is proceeding as planned and we expect to hit all of our financial metrics for the year. We have positioned ourselves for success even in the face of uncertainty around tariffs, changes to the Inflation Reduction Act or potential recession. Our business model is based on long-term contracted generation with creditworthy offtakers as well as growth in our U.S. regulated utilities. Our contracting, financing and supply chain strategies have all been designed to minimize the impact of economic conditions, including inflation, interest rates, energy prices and tariffs. As a result, we have clear visibility into our future financial performance. I'll first discuss the performance of our renewable business and then address the ways we have ensured that this business is resilient to macroeconomic and policy shifts. Turning to Slide 4. A major driver of our renewables EBITDA growth this year is the approximately 3 gigawatts of new projects we expect to bring online. I'm pleased to say that we are fully on track with more than 600 megawatts already completed, including the 250-megawatt Morris Solar project in Missouri serving Microsoft. Our remaining projects under construction for the year are now approximately 80% complete. Our 1 gigawatt Bellefield 1 project, which includes 500 megawatts of solar and 500 megawatts of storage, is virtually complete and we will be fully operational this summer. This is the first phase of what will be a 2 gigawatt project and the largest solar plus storage plant ever built in the United States, all of which is contracted with Amazon. Moving on to Slide 5. Our supply chain strategy provides us strong protections from any current or potential future tariffs as well as from the impact of inflation. Of the 7 gigawatts in our backlog scheduled to come online in the U.S. between 2025 and 2027, nearly all of the CapEx is protected with zero exposure to tariffs as the equipment is already in the U.S., in transit or contracted to be produced domestically. Our tariff exposure is limited to a small quantity of batteries that are being imported from Korea for projects coming online in 2026 with a maximum potential exposure of 50 million, which we are actively working to further mitigate. This represents just 0.3% of the total U.S. CapEx and is well within the normal project contingency. I would like to emphasize that our U.S. supply chain protects us from any potential tariffs that could be announced, including reciprocal tariffs. We also serve our corporate customers outside the U.S. where we continue to see substantial demand. Contracts that we are signing outside the U.S. are benefiting from lower equipment prices as the result of the increase in international equipment supply, with solar panels typically one-third the cost in Chile versus the U.S. Turning to Slide 6. Our business is also well protected from possible changes to U.S. renewable policy for several reasons. First, we are the top electricity provider to premier corporate clients, including data center customers that require capacity that can come online relatively quickly. We have signed agreements for 9.5 gigawatts with data center companies, more than anyone else in the sector. There are a few others in the industry who can develop, build and operate the projects we offer, which are often large, geographically diverse and with customized commercial structures. Furthermore, with our extensive history of working with large corporate customers, our development projects are tailored to meet their specific needs. We believe our customers will have strong demand for renewables in any scenario. Through the end of the decade, Bloomberg New Energy Finance sees increased electricity demand requiring at least 425 gigawatts of new capacity. While AES is committed to serving our customers with an all of the above strategy, including new gas generation, we see renewables as the primary source of new energy to serve this demand for the following reasons. First, they offer the fastest time to power, given their short construction period and advanced permitting and interconnection queue positions. Second, the fact that they are a low-cost source of power, particularly considering the rapidly rising cost of gas turbines and long lead times. And third, the price stability that they offer customers once contracted, unlike thermal power, which is subject to fluctuating fuel prices. In addition, roughly one-third of our backlog is in international markets where we develop, build and operate renewable projects without tax credits, usually with higher returns than in the U.S. In the absence of tax credit, projects have higher net capital needs but PPA prices are also higher to account for this funding structure. In these cases, we earn higher EBITDA per megawatt and are able to achieve our financial targets with fewer projects. Turning to Slide 7. Another reason for our confidence in the resilience of our business is that nearly our entire U.S. backlog has Safe Harbor protections. Once a project starts construction or incurs 5% of the cost of materials, the project has Safe Harbor protections and has a period of four years to be placed in service and begin receiving tax credits. For example, any project that reaches start of construction milestones in 2025 is Safe Harbored through 2029. Turning to Slide 8. We're also resilient to any economic downturn. Our business is heavily contracted with approximately two-thirds of our EBITDA coming from long-term contracted generation, essentially all of which are take-or-pay and not tied to underlying demand conditions. Looking to the future, nearly all of our growth through 2027 is already secured through our 11.7-gigawatt backlog of signed long-term contracts. At the same time we sign our PPAs, we contractually lock in all major capital costs, EPC arrangements and hedge our long-term financing. This approach gives us clear line of sight to our future EBITDA. We have also achieved our asset sale proceeds target for the year with the sale of a minority interest in our captive insurance company, and we have closed the sell-down of AES Ohio. Furthermore, with our March debt issuance, we have successfully completed all financings needed to address our 2025 debt maturities, and we have hedged 100% of our benchmark interest rate exposure for all corporate financings through 2027. Next, I'll discuss the robust growth program we're undertaking at our U.S. utilities on Slide 9. We are executing on the largest investment program in the history of both AES Indiana and AES Ohio as we work to improve customer reliability and support economic development. This year, we're on track to invest approximately $1.4 billion across the two utilities to support areas such as hardening the distribution network, smart grid, new generation and transmission buildout for data centers. We signed agreements for 2.1 gigawatts of new data centers in AES Ohio's service territory. We are beginning construction on new transmission to serve this load. This summer, we'll be breaking ground on the $500 million transmission investment needed to serve a new Amazon data center in Fayette County. Additionally, last month, we completed the sale of a 30% stake in AES Ohio for $544 million to CDPQ, a global investment partner that also owns 30% of AES Indiana. This partnership helped support capital requirements for their substantial growth programs while also strengthening our balance sheet. Now turning to AES Indiana. We're continuing to invest in new generation to support our customers with affordable and reliable power. In March, we brought online the Pipe County Energy Storage project, which includes 200 megawatts of installed capacity and 800 megawatt hours of dispatchable energy, the largest operational battery project in MISO. We continue to make progress on the Petersburg Energy Center, a 250-megawatt solar and 180 megawatt hour energy storage facility, which we expect to be operational by the end of the year. And in April, we received final regulatory approval for the 170-megawatt cross-buying solar plus storage project, which we expect to bring online in 2027. With that, I would now like to turn the call over to our CFO, Steve Coughlin.
Steve Coughlin: Thank you, Andrés, and good morning, everyone. Today, I will discuss our first quarter results, our 2025 full year guidance and our parent capital allocation plan. Turning to Slide 11. Adjusted EBITDA was $591 million in the first quarter versus $640 million a year ago. This decline was anticipated in our guidance and was primarily driven by prior year revenues from the accelerated monetization of the Warrior Run PPA and the sale of our 5-gigawatt AES Brazil business but partially offset by growth in our renewables and utilities businesses. Turning to Slide 12. Adjusted EPS for the quarter was $0.27 versus $0.50 last year and was also in line with our expectations. Drivers include the prior year Warrior Run PPA monetization, the timing of U.S. renewables tax attribute recognition, higher parent interest and the prior year tax benefit associated with our transition to a more U.S.-oriented holding company structure. This was partially offset by higher contributions from our utilities SBU. I'll cover the performance of our SBUs or strategic business units on the next four slides. Beginning with our renewables SBU on Slide 13. Higher EBITDA of approximately 45% year-over-year was driven primarily by contributions from new projects, which includes projects brought online over the prior four quarters. In addition, the renewables segment now includes all of our renewables in Chile which were a part of the energy infrastructure SBU in prior years. This change was offset by the EBITDA impact from the sale of AES Brazil in the fourth quarter of last year. With this quarter's results, we are fully on track to achieve our full year renewables SBU guidance of $890 million to $960 million. Our construction program is proceeding on schedule. Cost savings measures have been implemented and we have already seen hydrological conditions in Colombia normalize year-to-date. In other words, our main segment drivers are greatly derisked, and we're well on our way to achieving 60% renewables growth year-over-year. Turning to Slide 14. Higher adjusted PTC at our utilities SBU was mostly driven by tax attributes from the completion of the Pipe County Energy Storage project, new rates implemented in Indiana in May of last year, demand growth and favorable weather in the U.S. Lower EBITDA at our energy infrastructure SBU primarily reflects prior year revenues recognized from the accelerated monetization of the coal PPA at our Warrior Run plant as well as Chile renewables moving to the renewables segment. Finally, lower EBITDA at our new energy technologies SBU reflects lower contributions from Fluence in the first quarter. Now turning to our guidance beginning on Slide 17. We are reaffirming our 2025 adjusted EBITDA guidance of 2.65 billion to 2.85 billion. We continue to see strong growth in our renewables SBU and expect our utilities businesses to grow approximately 7% this year despite the sell-down of AES Ohio. The cost savings actions we announced on our February call have already been implemented. We expect the 150 million cost savings in 2025 will primarily benefit the second half of the year, and we remain on track to achieve a full run rate of over 300 million of cost savings next year. We are also reaffirming our 2025 adjusted EPS guidance of $2.10 to $2.26. As you can see on Slide 18, we expect growth in the three remaining quarters of this year to be driven by adjusted EBITDA growth in renewables and utilities and monetization of tax attributes on new renewables projects, partially offset by higher interest and a higher adjusted tax rate. Now to our 2025 parent capital allocation plan on Slide 19. Sources reflect approximately 2.7 billion of total discretionary cash, including 1.2 billion of parent free cash flow, which represents more than an 8% increase versus 2024. We also expect 700 million of planned parent debt issuance and closed the 450 million sell-down of a minority interest in our global insurance business earlier this week. Our captive global insurance business is a valuable asset within the AES portfolio that consistently produces attractive cash flow while managing property and business interruption risk within our operating portfolio. This structured transaction allows us to monetize a minority portion of this valuable business to support growth capital for renewables and utilities businesses. With this transaction, we have achieved our entire asset sale target for 2025. On the right-hand side, you can see our planned use of capital. We will return approximately 500 million to shareholders this year, reflecting the 2% dividend increase announced last December. We also plan to invest approximately 1.8 billion toward new growth and have already repaid roughly 400 million of subsidiary debt. With the sell-down of a minority interest in AES Ohio at the beginning of April, we now have CDPQ as a 30% partner in both of our U.S. utilities. This partnership is another example of how we use private capital to help fund growth and reduce parent investment requirements into our subsidiaries. Finally, turning to Slide 20. Our credit metrics are progressing in line with our expectations, benefiting from the actions we've taken since the beginning of this year. With the sell-down of our global insurance business, we have locked in our asset sales proceeds for the year. The sell-down of AES Ohio and subsequent debt paydown enabled S&P's recent one and two-notch upgrades for DPO Inc. and AES Ohio, respectively. We have also refinanced this year's parent debt maturity and have already fully hedged the benchmark on all expected parent financing through 2027. Additionally, we implemented cost efficiencies and resized our development business to generate over 300 million in annual savings by next year. These actions provide us with a fully self-funded plan through 2027. In summary, I am very pleased with our results this quarter, which were fully in line with the guidance we gave in February. We expect significant growth in the year to go that will come from projects that have already been brought online but which are still ramping to their full EBITDA, rate base investments that have already been made and cost reduction actions already implemented. I am confident we will achieve our guidance regardless of changes in the economic environment or changes in policy due to our focus on regulated utilities and long-term contracted generation, which has minimal volume interest rate for foreign currency exposure. I look forward to providing an update on our progress on our second quarter call. With that, I'll turn the call back over to Andrés.
Andrés Gluski: Thank you, Steve. In summary, our long-term contracted business model continues to demonstrate its resilience to tariffs, economic policies and business cycles. Our first quarter results are in line with our expectations, and we are reaffirming our 2025 guidance and long-term growth rate targets. Demand from our core corporate customers remains very strong, and we're seeing no slowdown in the energy needs of hyperscalers in any scenario. As a result of our strategy to be a first mover in creating a domestic supply chain and working with existing suppliers to onshore imported equipment, the tariff exposure on our 11.7-gigawatt backlog is de minimis. Similarly, our construction program of 3.2 gigawatts this year is on track and well advanced. We have completed construction of 643 megawatts and we are 80% complete for the remaining 2.6 gigawatts, including 99% complete on the 1 gigawatt of our Bellefield project, which will be the largest solar plus storage project in the U.S. Our two utilities are among the fastest growing in the country, and we continue to make progress on attracting new data centers to our service territory. And lastly, we have already completed all of our major asset sales and financings for the year, solidifying our commitment to self-funding through our long-term guidance period. With that, I would like to open up the call for questions.
Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Julien Dumoulin-Smith with Jefferies. Please go ahead, Julien.
Julien Dumoulin-Smith: Hi, good morning, team. Thank you guys very much. I appreciate the time and the opportunity here. Nicely done on this insurance transaction. Actually, if I can just start off a little bit of housekeeping there. How do you think about that transaction just in terms of the prospective EBITDA impact, just when you think about the financials here? I mean again, innovative idea in how to raise kind of equity indirectly, right, from private capital as you say?
Andrés Gluski: Good morning, Julien. I'm going to pass that question to Steve.
Steve Coughlin: Yes, good morning, Julien. The EBITDA impact, expect in the 25 million to 30 million range. So overall, given that we've raised 450 million, we're reinvesting that in returns, 13%, 14%, 15%. It's very accretive for us so very pleased. This was an opportunity that we have seen quite a while ago. It had been part of the universe of potential asset sales. And so we've anticipated for some time, we did include it in our guidance in February. And it's effectively the low-cost equity financing that supports growth while also meeting our credit goal. So very happy to complete this early this year.
Julien Dumoulin-Smith: Awesome. Yes. Nicely done, Steve, I got to say. Neat idea. If I can turn more substantively, right, just to clarify your earlier comments. First, just on the tariff exposure, is it principally that you've got a recovery from your suppliers, i.e., they are taking the risk when you guys provide this 0.3% that effectively the risk burden is effectively put on the vast majority of your suppliers versus going back to your customers? I just wanted to clarify that. And then related, just given the 400-and-change megawatts of origination this quarter given the backdrop today, would you say that this is kind of what we should be expecting for this year? Or could you see some sort of more meaningful uptick? I'm just trying to get a sense of what that cadence should be against setting expectations for further down the line?
Andrés Gluski: So I'll have Ricardo answer the first question and then I'll take the second.
Ricardo Falú: Thank you, Julien. I think let me provide a bit of more context on our supply chain. Three years ago, we have made the decision of basically building a reliable and U.S.A. made supply chain. And guided by that sort of decision, we implemented three actions. The first one was that we entered into strategic partnerships with suppliers with manufacturing capacity outside of China. That was the first action. The second action, we were a first mover, as Andrés mentioned, in supporting U.S. manufacturing to secure solar batteries and wind components. And third, to bridge the gap as local manufacturing ramps up, we accelerated the import of all the equipment coming from abroad required to support our backlog through 2027. And as a result of these actions, apart from the small quantity of batteries that Andrés mentioned that these are for a few projects coming online in 2026, we have no impact on tariff for our 2025-2027 backlog. I think with respect to who sort of bear the exposure, these contracts are with a Korean supplier for a very few projects. Of course, this tariff were not in place at the time we signed the contract and what we are doing, the $50 million represent the full exposure to be shared between the parties. And of course, the first action, as Andrés mentioned, is to actively reduce that exposure, which we've been so far very successful and for the remaining impact to share it evenly. So we expect the overall impact to be well below that $50 million that is the total exposure that Andrés mentioned. Other than that contract, we have no exposure to tariffs, yes.
Andrés Gluski: Yes. I'd like to clarify that what we did was we imported all of the equipment, the vast majority of it. So we have all that equipment that we need, for example for 2025 with the exception that we pointed out already in the U.S. and most of it on site. And we have a lot of the equipment for 2026 that's imported as well. So in 2026, we expect to shift over to domestic supply. So when we say that the exposure is de minimis, we really got ahead of this. Now I will remind you this is what we did in 2020 as well. In 2020, we achieved all of our targets and we're the only large developer who did not abandon or a significant delay any large project and we intend to continue that track record. Now getting your question about the cadence of PPA signings. As we've been saying, look, we're concentrating on fewer, larger projects that are also more financially attractive. So the 400 megawatts is not a cadence that you should expect for every quarter. We are in final negotiations of a number of large projects. We expect it, 4 gigawatts roughly, that we have talked about prior to this year, to hit sort of the three year target. We had talked about of 14 to 17 gigawatts. So we remain on track. And we've always said these are lumpy so it's not like we're doing a lot of small projects. We're doing a few large ones and sometimes they happen in a quarter or they happen in the next quarter or they come together. So there's nothing to be read in the 400 megawatts.
Julien Dumoulin-Smith: Got it. All right. Excellent guys. Thank you. I’ll leave it there.
Ricardo Falú : All right. Thanks, Julien.
Operator: Thank you. Our next question comes from Nick Campanella with Barclays. Please go ahead, Nick.
Nick Campanella: Hi. Good morning, everyone. Thanks for taking my questions. And I appreciate all the color. I just wanted to come back to the insurance sale quickly. So I know you kind of disclosed the Class B dividends are like $145 million to $198 million. Is that like a yearly number or is that a cumulative number? And I guess if you hit that call option in 2030 to 2035, what is that strike price? And how should we kind of think of the cost of financing here that you just raised versus, I guess, deploying future CapEx at 13% to 15% returns? Maybe you could just unpack that.
Steve Coughlin: Yes. Nick, it's Steve. So those numbers are based on the five year, the first five year target distribution. And so this would be the aggregate amount at that five year call date that needs to get met. And that's very much in line with a fairly conservative case on what this insurance business delivers. Keep in mind, this is a business that is -- it's captive but it has a reinsurance behind it. So we have a very predictable max amount of losses and then the reinsurance kicks in. So this was structured very conservatively that even in the event of max losses, we feel very comfortable servicing this financial structure. In terms of the cost of this, I would think about it as roughly in line with like a junior subordinated debt issuance at the parent. And given that this is getting equity treatment that effectively looks like a low-cost equity financing that is quite accretive. It will have target payments in the range of about $37 million to $40 million per year to the counterparty.
Nick Campanella: Okay, that's helpful. Appreciate that. And I'll try not to butcher it but just the Cochrane buyout that you disclosed in the 10-Q. Can you just give us a sense of what you're purchasing? And how much you paid for it, either on like a multiple basis or cash and just the rationale behind that transaction?
Steve Coughlin: Yes. Look, I mean, this is an asset that we already own and operate. We have a minority partner that was looking to exit. So what we're doing is we're buying up the 40% minority and taking nearly complete ownership of the asset. It's very valuable. It's contracted well into the next decade, serving key customers for us in Chile. And the valuation was at a very low multiple so it's quite accretive immediately this year and beyond. So we're pleased with it. It's one of the assets that we had already guided that would be extended beyond 2027. So it's no additional new capacity, just taking advantage of an attractive financial return on owning the entire thing as opposed to just the share that we had.
Nick Campanella: Okay, thank you.
Steve Coughlin: All right. Thanks, Nick.
Operator: Thank you. The next question comes from David Arcaro with Morgan Stanley. Please go ahead David.
David Arcaro: Hi. Thanks so much. Good morning.
Steve Coughlin: Good morning, David.
David Arcaro: I was wondering on the AGIC sale, just one other follow-up there. You sold a minority stake. I'm just wondering, is there any strategic reason that you want to retain control in the remaining stake there? Or could that be a consideration for future asset sales out in the rest of the program, the financing plans going forward as…?
Andrés Gluski: Yes. No, we want to maintain our control of this asset. And as Steve said, it's -- the financial metrics are very conservative and we're coming in with considerable margin on this. So we do want to maintain it. It's been very successful. We've set this up about 15, 20 years ago. It was an independent business, it's a unicorn. So it's been very successful, lowered our insurance costs and improved the quality of our reinsurers.
David Arcaro: Okay, great. And I was wondering if you could comment on just what you're seeing in terms of latest renewable demand trends. Has there been any pull forward ahead of potential IRA changes here or any just general change in customer demand levels that you're seeing?
Andrés Gluski: Yes, great question. Look, what we are seeing is continued strong demand. We're not seeing any sort of temporal shifts as a result. So our data center customers continued strong demand. I think the key word is time to power. And that's why we mentioned that certainly, for the next five years, the predominance of this is going to be renewables because it's the fastest to power. It's also very cost effective. And so it's more sort of you can combine this with gas, in many cases, to reach the optimal solution. I think there's too much discussion about the technology and not really what the customer wants. So we combine ways of producing energy in a way that satisfies our customers. So look, we're not seeing any pull forward. We are seeing, I would say, some of the contracts that we're signing today that they have provisions for, say, changes in law, changes in tariffs, etcetera, to take that into account. Now for our backlog, as I said before, we have imported the materials or have domestic supply. We have the EPC and we have the financing. So all that's locked in.
David Arcaro: Okay, sounds good. Thank you.
Andrés Gluski: Thanks, David.
Operator: Thank you. Our next question comes from Durgesh Chopra with Evercore. Please go ahead, Durgesh.
Durgesh Chopra: Thank you. Good morning, team. Thanks for giving me time. Steve, congrats on this transaction. Maybe just a little bit more detail. You talked about the cash distributions being conservative. Can you just frame for us the $40 million or so average distributions a year? What is that as a percentage of total cash generated for that business?
Steve Coughlin: Yes, it's roughly around -- depending on the year, 35%, 40% I would say, in terms of this business reliably generates about $100 million of cash, thereabouts, even with typical losses. And that includes some amortization of the instruments so this is self-amortizing over the full 20-year life. It's nothing like these convertible portfolio financings that you've heard about with some other yieldcos that were not amortizing and had a significant economic ownership flip. This doesn't have that kind of change. We have a call right at year five. And otherwise, there's no incentive to have to call it. It continues along the same economics for the full 20-year potential period. So it's priced, as I said, like a junior parent note and gives us access to cheap, what I call, cheap equity capital. And then we can continue to retain this so long as it's -- unless we had a better option down the road that's lower cost. But this one is a good way to monetize an asset that I think is perhaps underappreciated in the value that it generates. It's been in our disclosures around the distributions to the parent from this asset in the past, so you can see that. And this is capital that will be put to work to generate mid-teens returns. So I think it looks quite good.
Durgesh Chopra: Got it. Thank you for that clarity. Accretive transaction there. Just digging on the financing topic, there's been a lot of discussion around transferability. Some legislation recently proposed or is probably doesn't get much traction. But just in terms of thinking about risks, can you talk about like in an event the transferability is eliminated, do you go back to tax equity and perhaps even frame for us what percentage of your plan is being provided by cash financing, is being provided by transferability? Thank you.
Steve Coughlin: Yes, absolutely, Durgesh. So look, first of all, transferability has only been around for a little over two years when the IRA was passed in 2022. It has been very good for the industry as it's opened up a broader participation in the market for monetizing tax value. And it is typically a little bit more efficient in transferring most of the tax benefit savings on to customers, just there's less friction in these types of transactions. But that said, for the IRA, we did tax equity. The majority of what we continue to do is still through tax equity partnerships. And in fact, we continue to form the partnerships anyway because we need to monetize the tax depreciation to maximize the opportunity even when we are doing transfers. So we can continue to do the tax equity partnerships for all of our future projects if this were removed. We don't think it will be because we think it goes with the tax credits in terms of getting the most benefit of the tax credit to the cost of the end consumer of the energy. And then effectively, the cash benefit to AES is the same. So we bridge the tax financing with debt during construction, as I walked through on the February call. And then we immediately, when the tax value comes in, either from the transfer counterparty or from the tax equity partner, we immediately monetize that at the place and service date and pay down a significant portion of the debt, typically more than 50% at that point. So you have a significant deleveraging from this. The fundamental cash and credit profile is really exactly the same. So I think it's been good, a lot more for some smaller developers and to sort of democratize the participation in the market. But as a large-scale developer with deep relationships with sophisticated tax equity partners, we still feel very comfortable that we can monetize all of the tax value that we create with the tax equity venue if needed.
Durgesh Chopra: Thanks, Steve. Appreciate that discussion. Just real quick, sorry, this is my third question I understand and realize. Just the hydrogen project that was canceled in Texas, are we still pursuing other customers for contracted the power generation that I believe it was over 1 gig?
Andrés Gluski: The answer is yes. I mean, that was a very attractive asset of development. It's in -- it's all on private land on 1 farm and it's very well located for the grid and for anything else. So yes, we're continuing to pursue it. It's part of our pipeline, so yes.
Durgesh Chopra: Thank you, Andrés.
Andrés Gluski: Thank you, Durgesh.
Operator: Thank you. Our next question comes from Michael Sullivan with Wolfe Research. Please go ahead.
Michael Sullivan: Hi, good morning.
Steve Coughlin: Good morning, Michael.
Michael Sullivan: Wanted to just ask on where we stand on the longer-term asset sale target. Are you still shooting for that 3.5 billion? Where are we against that? And what else are you looking at for potential sales?
Steve Coughlin: Yes, this is Steve. So no, we -- so with respect to the 3.5 billion, we're at 3.4 billion, so we're right almost there to the finish line on that target. We did talk about getting to 800 million to 1.2 billion on the February call from '25 to '27. So with this sale, and that's not including the Ohio sell-down, which went to paying down debt. This was referring to proceeds up to the parent. With this insurance sell-down, we're halfway, roughly there, close to halfway on that target. What's remaining is we have the -- in terms of proceeds, the Vietnam sale. We have some other asset sales in the thermal portfolio that are on a smaller scale. We have partnerships of operating assets. We've done partnerships with our LNG portfolio. As you've seen, those can and maybe extended. We've done partnerships, sell-downs at attractive low-cost capital of our renewable operating portfolios. So those remain an option. And our technology portfolio. At this point, Fluence is not at a value that we would tap that. It is significantly undervalued, but we do -- we are optimistic down the road that, that's a potential. So we're not counting on that. We do have other assets in that portfolio like Uplight that we've talked about that may be a candidate. So the universe is larger than what's remaining. What's remaining is only roughly 500 million in that target through '27. And so I feel extremely comfortable that we'll be able to execute on that between now and 2027 across the range of things that I mentioned.
Michael Sullivan: Okay, great. That's helpful. And back to the IRA discussion here. Do you all have any view on kind of when this starts to take shape in the Reconciliation Bill? Feels like things starting to come to a head a little bit. And then also just specifically on transferability, your view on whether a Safe Harbor would cover you on that even in a scenario where that were to go away?
Andrés Gluski: Okay, let's see. I spent some time up in the Hill with key senators and congressmen. What I would say is that I do expect in sort of a first draft to come out of the House and Ways and Means Committee, and that's to start the discussion. So that's certainly, I don't think that's the final point. That was made clear to us. I do think that there is -- what I heard was a very pragmatic approach. One was the importance of, I would say, reliability in a sense that something like -- if you look at Safe Harboring, I think that everybody I spoke to said that, that's a very important component to maintain because that's really the credibility of U.S. laws or, let's say, U.S. programs. So I feel very good about that. I think regarding the IRA, it's a question of -- certainly going to be addressed certain aspects of it. I think that you might have an earlier sunset of it. I would say very likely, actually, that's where the majority of the savings that they would score would come from. But having said all that, I think that at the end, it's going to be quite pragmatic. There are hundreds of thousands of jobs depending on this. A lot of people are going to be going into elections in '26. And you don't want to have a jump in unemployment in rural areas where a lot of this is getting done. And you also have the tax revenues that this is going to generate. So my feeling on this is that we will have something relatively early. That's not the final -- whatever comes out, it's not final. When can reconciliation done? Take it with a huge grain of salt, people think it's before the August recess, that people will want to have this done before they go out of town. So that's more or less the time frame. But I think the discussions were -- that I had, I think, were very encouraging about thinking about what's good for the country and what can realistically be done.
Michael Sullivan: Appreciate that color. Thank you.
Andrés Gluski: Thank you.
Operator: Thank you. The next question comes from Richard Sunderland with JPMorgan. Please go ahead, Richard.
Richard Sunderland: Hi, good morning.
Steve Coughlin: Good morning, Richard.
Richard Sunderland: I just wanted to follow up on transferability one more time. On an agency metric basis, what would be the impact to your FFO without transferability and how do you expect the agencies to treat that?
Steve Coughlin: So the transferability, as I said, Rich, is fundamentally the same cash and credit profile. The difference is the transfer credits do go through operating cash flow. So there's no -- in terms of S&P and Fitch, it really has no impact to their focus on the parent free cash flow, whereas this comes in at the subsidiary level and pays down debt primarily. And so it does get captured in the Moody's metric. So I think we will need to work with Moody's to ensure that this is well understood. I think they do understand it that it's fundamentally no change. The cash comes in when the project is placed in service, whether it comes from a transfer or from a tax equity partner and the debt gets paid down. So I think practically, it has no impact. And if we got to that point, we would, of course, work with Moody's as we have and they've been very constructive in understanding how renewables works, including the adjustments that they made in the last update that they gave. So I don't see it as a negative at all for the credit profile.
Richard Sunderland: Got it. That was very clear. So presumably on a Moody's basis, this would push out the improvement you've called out for '26, but you also expect Moody's to look through the impacts, given what you laid out earlier on the value through tax equities being the same?
Steve Coughlin: I mean, look, I can't speak for Moody's, but look it's very logical and we're talking about geography issue on the cash flow statement. So I have a hard time being that logic won't prevail there, that fundamentally the credit profile is exactly the same.
Richard Sunderland: Understood. And then maybe I'll just follow up with one more. I mean, I think there's been a lot of attention on transferability and maybe some fears out there that this first draft on the IRA could have a lot of negative headlines, then we migrate some more reasonable middle ground. Do you think transferability is something that may come out in that initial draft and then goes back in? Any thoughts on sort of the magnitude of that headline risk initially versus where things might ultimately shake out in your earlier commentary?
Andrés Gluski: No. What I would say is that there are two sort of groups. One is uses of capital and there's one that's sort of be more blunt. I think again, there's going to be a compromise. So I really have no insight in terms of what the initial language can be. But it's clear, bills always come out to start a discussion so it has to come from the house and then it has to be resolved with the senate and you have to have this reconciliation. So I just think that anything that comes out now is the start and it's not the ending point. But I also -- again, from my discussions, I think they were very constructive, very, very positive in general, but I think people understand the issues, which is what's most important. Look, the most important thing is, among other things, we want two things, energy dominance and you want to -- with the AI race. Both of those require a lot of renewable energy, well, actually a lot of energy now. If you think about additional gas plants, if we order a new gas turbine today, the waiting period is between three to five years to say nothing that is not permitted and it's not an interconnection queue. So if you come out with something that was very negative, let's say, to new energy, well, you're forfeiting two of the most important goals of the administration. So that's why I felt that there was clarity in terms of cause and effect and what it's going to take to have energy dominant and what is going to -- it's a question also of time frame. So this is a question that must be resolved in the next four, five years. And we have to be pragmatic what we can get accomplished in that time period. So I feel that, that is understood. So I'm, let's say, reasonably optimistic about where it's going to end up. Who knows the political path or headlines? I can't know. Your guess is as good as mine.
Richard Sunderland: Perfect. Thanks for the time today.
Andrés Gluski: Thank you. Thanks, Rich.
Operator: Thank you. Our final question today comes from Anthony Crowdell with Mizuho. Please go ahead, Anthony.
Anthony Crowdell: Hi, good morning. Thanks for squeezing me in. Most of my questions Richard's taken care of in front of me. Just quickly on Ohio, some legislation passed earlier, I think this week, multiyear rate plans, but also maybe removal of OVEC revenues. Just curious the impact for AES Ohio and does it change your plan on rate filings?
Ricardo Falú: Thank you so much. This is Ricardo. So I will start saying that overall the impact of the bill is net positive for us, while on one side eliminates the ESP. It's going to be now replaced by a 3-year forward-looking distribution rate case with annual true-up, which is a more constructive regulatory framework in a growing business such as AES Ohio. In addition, the language clearly states that the current ESP4 features will be extended from August 2026, which was the original expiration date to May of 2027. So, this will give us enough time to have the new rates coming from this 3-year forward-looking framework in place. I think this is very, very constructive. It eliminates regulatory lags, so again, very, very positive for a growing business such as AES Ohio. I think in terms of our timing for filing the distribution rate case, more likely it's going to be by the end of this year. With respect to OVEC, the impact is estimated to be between $0 million and $10 million. Why 0? Because it depends very much on the financial performance of the asset or assets, I should say, because we are talking about 2.3 gigawatt to coal assets that provide capacity to PJM and we are seeing a significant increase in capacity prices where you may recall it were like around $29 and now $270 per megawatt per day. So it's going to be within that sort of range, $0 million to $10 million depending on the financial performance and capacity prices in PJM. And as I said, all-in-all, net positive and I think this regulatory framework with a three-year forward-looking is extremely constructive for AES Ohio.
Anthony Crowdell: Great. Thanks for taking my questions.
Ricardo Falú: Thank you, Anthony.
Operator: Thank you. Those are all the questions we have for today and so I'll hand the call back over to Susan Harcourt for closing remarks.
Susan Harcourt: We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you and have a nice day.
Operator: Thank you everyone for joining us today. This concludes our call and you may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Hello, everybody, and welcome to The AES Corporation Q1 2025 Financial Review Call. My name is Emily, and I'll be moderating your call today. [Operator Instructions]. I will now hand the call over to Susan Harcourt, Vice President of Investor Relations to begin. Susan, please go ahead."
},
{
"speaker": "Susan Harcourt",
"text": "Thank you, operator. Good morning, and welcome to our first quarter 2025 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; Ricardo Falú, our Chief Operating Officer; and other senior members of our management team. With that, I will turn the call over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, everyone, and thank you for joining our first quarter 2025 financial review call. Today, I'm very pleased to reaffirm both our 2025 guidance and long-term growth rate targets, which reflect our strong execution to date as well as the resilience of our business overall. I will discuss this in more detail and provide an update on the robust growth program at our U.S. utilities. Following my remarks, Steve Coughlin, our CFO, will provide additional color on our financial performance and outlook. Beginning on Slide 3 with our first quarter results. Our financial performance was in line with our expectations with adjusted EBITDA of 591 million and adjusted EPS of $0.27. We completed the construction of 643 megawatts and signed or were awarded 443 megawatts of new PPAs, bringing our backlog to 11.7 gigawatts. We have achieved our asset sale proceeds target for the year, including the sale of a minority stake in our global insurance company, AGIC, for 450 million. Now turning to the resilience of our business model and portfolio. Our execution is proceeding as planned and we expect to hit all of our financial metrics for the year. We have positioned ourselves for success even in the face of uncertainty around tariffs, changes to the Inflation Reduction Act or potential recession. Our business model is based on long-term contracted generation with creditworthy offtakers as well as growth in our U.S. regulated utilities. Our contracting, financing and supply chain strategies have all been designed to minimize the impact of economic conditions, including inflation, interest rates, energy prices and tariffs. As a result, we have clear visibility into our future financial performance. I'll first discuss the performance of our renewable business and then address the ways we have ensured that this business is resilient to macroeconomic and policy shifts. Turning to Slide 4. A major driver of our renewables EBITDA growth this year is the approximately 3 gigawatts of new projects we expect to bring online. I'm pleased to say that we are fully on track with more than 600 megawatts already completed, including the 250-megawatt Morris Solar project in Missouri serving Microsoft. Our remaining projects under construction for the year are now approximately 80% complete. Our 1 gigawatt Bellefield 1 project, which includes 500 megawatts of solar and 500 megawatts of storage, is virtually complete and we will be fully operational this summer. This is the first phase of what will be a 2 gigawatt project and the largest solar plus storage plant ever built in the United States, all of which is contracted with Amazon. Moving on to Slide 5. Our supply chain strategy provides us strong protections from any current or potential future tariffs as well as from the impact of inflation. Of the 7 gigawatts in our backlog scheduled to come online in the U.S. between 2025 and 2027, nearly all of the CapEx is protected with zero exposure to tariffs as the equipment is already in the U.S., in transit or contracted to be produced domestically. Our tariff exposure is limited to a small quantity of batteries that are being imported from Korea for projects coming online in 2026 with a maximum potential exposure of 50 million, which we are actively working to further mitigate. This represents just 0.3% of the total U.S. CapEx and is well within the normal project contingency. I would like to emphasize that our U.S. supply chain protects us from any potential tariffs that could be announced, including reciprocal tariffs. We also serve our corporate customers outside the U.S. where we continue to see substantial demand. Contracts that we are signing outside the U.S. are benefiting from lower equipment prices as the result of the increase in international equipment supply, with solar panels typically one-third the cost in Chile versus the U.S. Turning to Slide 6. Our business is also well protected from possible changes to U.S. renewable policy for several reasons. First, we are the top electricity provider to premier corporate clients, including data center customers that require capacity that can come online relatively quickly. We have signed agreements for 9.5 gigawatts with data center companies, more than anyone else in the sector. There are a few others in the industry who can develop, build and operate the projects we offer, which are often large, geographically diverse and with customized commercial structures. Furthermore, with our extensive history of working with large corporate customers, our development projects are tailored to meet their specific needs. We believe our customers will have strong demand for renewables in any scenario. Through the end of the decade, Bloomberg New Energy Finance sees increased electricity demand requiring at least 425 gigawatts of new capacity. While AES is committed to serving our customers with an all of the above strategy, including new gas generation, we see renewables as the primary source of new energy to serve this demand for the following reasons. First, they offer the fastest time to power, given their short construction period and advanced permitting and interconnection queue positions. Second, the fact that they are a low-cost source of power, particularly considering the rapidly rising cost of gas turbines and long lead times. And third, the price stability that they offer customers once contracted, unlike thermal power, which is subject to fluctuating fuel prices. In addition, roughly one-third of our backlog is in international markets where we develop, build and operate renewable projects without tax credits, usually with higher returns than in the U.S. In the absence of tax credit, projects have higher net capital needs but PPA prices are also higher to account for this funding structure. In these cases, we earn higher EBITDA per megawatt and are able to achieve our financial targets with fewer projects. Turning to Slide 7. Another reason for our confidence in the resilience of our business is that nearly our entire U.S. backlog has Safe Harbor protections. Once a project starts construction or incurs 5% of the cost of materials, the project has Safe Harbor protections and has a period of four years to be placed in service and begin receiving tax credits. For example, any project that reaches start of construction milestones in 2025 is Safe Harbored through 2029. Turning to Slide 8. We're also resilient to any economic downturn. Our business is heavily contracted with approximately two-thirds of our EBITDA coming from long-term contracted generation, essentially all of which are take-or-pay and not tied to underlying demand conditions. Looking to the future, nearly all of our growth through 2027 is already secured through our 11.7-gigawatt backlog of signed long-term contracts. At the same time we sign our PPAs, we contractually lock in all major capital costs, EPC arrangements and hedge our long-term financing. This approach gives us clear line of sight to our future EBITDA. We have also achieved our asset sale proceeds target for the year with the sale of a minority interest in our captive insurance company, and we have closed the sell-down of AES Ohio. Furthermore, with our March debt issuance, we have successfully completed all financings needed to address our 2025 debt maturities, and we have hedged 100% of our benchmark interest rate exposure for all corporate financings through 2027. Next, I'll discuss the robust growth program we're undertaking at our U.S. utilities on Slide 9. We are executing on the largest investment program in the history of both AES Indiana and AES Ohio as we work to improve customer reliability and support economic development. This year, we're on track to invest approximately $1.4 billion across the two utilities to support areas such as hardening the distribution network, smart grid, new generation and transmission buildout for data centers. We signed agreements for 2.1 gigawatts of new data centers in AES Ohio's service territory. We are beginning construction on new transmission to serve this load. This summer, we'll be breaking ground on the $500 million transmission investment needed to serve a new Amazon data center in Fayette County. Additionally, last month, we completed the sale of a 30% stake in AES Ohio for $544 million to CDPQ, a global investment partner that also owns 30% of AES Indiana. This partnership helped support capital requirements for their substantial growth programs while also strengthening our balance sheet. Now turning to AES Indiana. We're continuing to invest in new generation to support our customers with affordable and reliable power. In March, we brought online the Pipe County Energy Storage project, which includes 200 megawatts of installed capacity and 800 megawatt hours of dispatchable energy, the largest operational battery project in MISO. We continue to make progress on the Petersburg Energy Center, a 250-megawatt solar and 180 megawatt hour energy storage facility, which we expect to be operational by the end of the year. And in April, we received final regulatory approval for the 170-megawatt cross-buying solar plus storage project, which we expect to bring online in 2027. With that, I would now like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"text": "Thank you, Andrés, and good morning, everyone. Today, I will discuss our first quarter results, our 2025 full year guidance and our parent capital allocation plan. Turning to Slide 11. Adjusted EBITDA was $591 million in the first quarter versus $640 million a year ago. This decline was anticipated in our guidance and was primarily driven by prior year revenues from the accelerated monetization of the Warrior Run PPA and the sale of our 5-gigawatt AES Brazil business but partially offset by growth in our renewables and utilities businesses. Turning to Slide 12. Adjusted EPS for the quarter was $0.27 versus $0.50 last year and was also in line with our expectations. Drivers include the prior year Warrior Run PPA monetization, the timing of U.S. renewables tax attribute recognition, higher parent interest and the prior year tax benefit associated with our transition to a more U.S.-oriented holding company structure. This was partially offset by higher contributions from our utilities SBU. I'll cover the performance of our SBUs or strategic business units on the next four slides. Beginning with our renewables SBU on Slide 13. Higher EBITDA of approximately 45% year-over-year was driven primarily by contributions from new projects, which includes projects brought online over the prior four quarters. In addition, the renewables segment now includes all of our renewables in Chile which were a part of the energy infrastructure SBU in prior years. This change was offset by the EBITDA impact from the sale of AES Brazil in the fourth quarter of last year. With this quarter's results, we are fully on track to achieve our full year renewables SBU guidance of $890 million to $960 million. Our construction program is proceeding on schedule. Cost savings measures have been implemented and we have already seen hydrological conditions in Colombia normalize year-to-date. In other words, our main segment drivers are greatly derisked, and we're well on our way to achieving 60% renewables growth year-over-year. Turning to Slide 14. Higher adjusted PTC at our utilities SBU was mostly driven by tax attributes from the completion of the Pipe County Energy Storage project, new rates implemented in Indiana in May of last year, demand growth and favorable weather in the U.S. Lower EBITDA at our energy infrastructure SBU primarily reflects prior year revenues recognized from the accelerated monetization of the coal PPA at our Warrior Run plant as well as Chile renewables moving to the renewables segment. Finally, lower EBITDA at our new energy technologies SBU reflects lower contributions from Fluence in the first quarter. Now turning to our guidance beginning on Slide 17. We are reaffirming our 2025 adjusted EBITDA guidance of 2.65 billion to 2.85 billion. We continue to see strong growth in our renewables SBU and expect our utilities businesses to grow approximately 7% this year despite the sell-down of AES Ohio. The cost savings actions we announced on our February call have already been implemented. We expect the 150 million cost savings in 2025 will primarily benefit the second half of the year, and we remain on track to achieve a full run rate of over 300 million of cost savings next year. We are also reaffirming our 2025 adjusted EPS guidance of $2.10 to $2.26. As you can see on Slide 18, we expect growth in the three remaining quarters of this year to be driven by adjusted EBITDA growth in renewables and utilities and monetization of tax attributes on new renewables projects, partially offset by higher interest and a higher adjusted tax rate. Now to our 2025 parent capital allocation plan on Slide 19. Sources reflect approximately 2.7 billion of total discretionary cash, including 1.2 billion of parent free cash flow, which represents more than an 8% increase versus 2024. We also expect 700 million of planned parent debt issuance and closed the 450 million sell-down of a minority interest in our global insurance business earlier this week. Our captive global insurance business is a valuable asset within the AES portfolio that consistently produces attractive cash flow while managing property and business interruption risk within our operating portfolio. This structured transaction allows us to monetize a minority portion of this valuable business to support growth capital for renewables and utilities businesses. With this transaction, we have achieved our entire asset sale target for 2025. On the right-hand side, you can see our planned use of capital. We will return approximately 500 million to shareholders this year, reflecting the 2% dividend increase announced last December. We also plan to invest approximately 1.8 billion toward new growth and have already repaid roughly 400 million of subsidiary debt. With the sell-down of a minority interest in AES Ohio at the beginning of April, we now have CDPQ as a 30% partner in both of our U.S. utilities. This partnership is another example of how we use private capital to help fund growth and reduce parent investment requirements into our subsidiaries. Finally, turning to Slide 20. Our credit metrics are progressing in line with our expectations, benefiting from the actions we've taken since the beginning of this year. With the sell-down of our global insurance business, we have locked in our asset sales proceeds for the year. The sell-down of AES Ohio and subsequent debt paydown enabled S&P's recent one and two-notch upgrades for DPO Inc. and AES Ohio, respectively. We have also refinanced this year's parent debt maturity and have already fully hedged the benchmark on all expected parent financing through 2027. Additionally, we implemented cost efficiencies and resized our development business to generate over 300 million in annual savings by next year. These actions provide us with a fully self-funded plan through 2027. In summary, I am very pleased with our results this quarter, which were fully in line with the guidance we gave in February. We expect significant growth in the year to go that will come from projects that have already been brought online but which are still ramping to their full EBITDA, rate base investments that have already been made and cost reduction actions already implemented. I am confident we will achieve our guidance regardless of changes in the economic environment or changes in policy due to our focus on regulated utilities and long-term contracted generation, which has minimal volume interest rate for foreign currency exposure. I look forward to providing an update on our progress on our second quarter call. With that, I'll turn the call back over to Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Steve. In summary, our long-term contracted business model continues to demonstrate its resilience to tariffs, economic policies and business cycles. Our first quarter results are in line with our expectations, and we are reaffirming our 2025 guidance and long-term growth rate targets. Demand from our core corporate customers remains very strong, and we're seeing no slowdown in the energy needs of hyperscalers in any scenario. As a result of our strategy to be a first mover in creating a domestic supply chain and working with existing suppliers to onshore imported equipment, the tariff exposure on our 11.7-gigawatt backlog is de minimis. Similarly, our construction program of 3.2 gigawatts this year is on track and well advanced. We have completed construction of 643 megawatts and we are 80% complete for the remaining 2.6 gigawatts, including 99% complete on the 1 gigawatt of our Bellefield project, which will be the largest solar plus storage project in the U.S. Our two utilities are among the fastest growing in the country, and we continue to make progress on attracting new data centers to our service territory. And lastly, we have already completed all of our major asset sales and financings for the year, solidifying our commitment to self-funding through our long-term guidance period. With that, I would like to open up the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Julien Dumoulin-Smith with Jefferies. Please go ahead, Julien."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Hi, good morning, team. Thank you guys very much. I appreciate the time and the opportunity here. Nicely done on this insurance transaction. Actually, if I can just start off a little bit of housekeeping there. How do you think about that transaction just in terms of the prospective EBITDA impact, just when you think about the financials here? I mean again, innovative idea in how to raise kind of equity indirectly, right, from private capital as you say?"
},
{
"speaker": "Andrés Gluski",
"text": "Good morning, Julien. I'm going to pass that question to Steve."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, good morning, Julien. The EBITDA impact, expect in the 25 million to 30 million range. So overall, given that we've raised 450 million, we're reinvesting that in returns, 13%, 14%, 15%. It's very accretive for us so very pleased. This was an opportunity that we have seen quite a while ago. It had been part of the universe of potential asset sales. And so we've anticipated for some time, we did include it in our guidance in February. And it's effectively the low-cost equity financing that supports growth while also meeting our credit goal. So very happy to complete this early this year."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Awesome. Yes. Nicely done, Steve, I got to say. Neat idea. If I can turn more substantively, right, just to clarify your earlier comments. First, just on the tariff exposure, is it principally that you've got a recovery from your suppliers, i.e., they are taking the risk when you guys provide this 0.3% that effectively the risk burden is effectively put on the vast majority of your suppliers versus going back to your customers? I just wanted to clarify that. And then related, just given the 400-and-change megawatts of origination this quarter given the backdrop today, would you say that this is kind of what we should be expecting for this year? Or could you see some sort of more meaningful uptick? I'm just trying to get a sense of what that cadence should be against setting expectations for further down the line?"
},
{
"speaker": "Andrés Gluski",
"text": "So I'll have Ricardo answer the first question and then I'll take the second."
},
{
"speaker": "Ricardo Falú",
"text": "Thank you, Julien. I think let me provide a bit of more context on our supply chain. Three years ago, we have made the decision of basically building a reliable and U.S.A. made supply chain. And guided by that sort of decision, we implemented three actions. The first one was that we entered into strategic partnerships with suppliers with manufacturing capacity outside of China. That was the first action. The second action, we were a first mover, as Andrés mentioned, in supporting U.S. manufacturing to secure solar batteries and wind components. And third, to bridge the gap as local manufacturing ramps up, we accelerated the import of all the equipment coming from abroad required to support our backlog through 2027. And as a result of these actions, apart from the small quantity of batteries that Andrés mentioned that these are for a few projects coming online in 2026, we have no impact on tariff for our 2025-2027 backlog. I think with respect to who sort of bear the exposure, these contracts are with a Korean supplier for a very few projects. Of course, this tariff were not in place at the time we signed the contract and what we are doing, the $50 million represent the full exposure to be shared between the parties. And of course, the first action, as Andrés mentioned, is to actively reduce that exposure, which we've been so far very successful and for the remaining impact to share it evenly. So we expect the overall impact to be well below that $50 million that is the total exposure that Andrés mentioned. Other than that contract, we have no exposure to tariffs, yes."
},
{
"speaker": "Andrés Gluski",
"text": "Yes. I'd like to clarify that what we did was we imported all of the equipment, the vast majority of it. So we have all that equipment that we need, for example for 2025 with the exception that we pointed out already in the U.S. and most of it on site. And we have a lot of the equipment for 2026 that's imported as well. So in 2026, we expect to shift over to domestic supply. So when we say that the exposure is de minimis, we really got ahead of this. Now I will remind you this is what we did in 2020 as well. In 2020, we achieved all of our targets and we're the only large developer who did not abandon or a significant delay any large project and we intend to continue that track record. Now getting your question about the cadence of PPA signings. As we've been saying, look, we're concentrating on fewer, larger projects that are also more financially attractive. So the 400 megawatts is not a cadence that you should expect for every quarter. We are in final negotiations of a number of large projects. We expect it, 4 gigawatts roughly, that we have talked about prior to this year, to hit sort of the three year target. We had talked about of 14 to 17 gigawatts. So we remain on track. And we've always said these are lumpy so it's not like we're doing a lot of small projects. We're doing a few large ones and sometimes they happen in a quarter or they happen in the next quarter or they come together. So there's nothing to be read in the 400 megawatts."
},
{
"speaker": "Julien Dumoulin-Smith",
"text": "Got it. All right. Excellent guys. Thank you. I’ll leave it there."
},
{
"speaker": "Ricardo Falú",
"text": "All right. Thanks, Julien."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Nick Campanella with Barclays. Please go ahead, Nick."
},
{
"speaker": "Nick Campanella",
"text": "Hi. Good morning, everyone. Thanks for taking my questions. And I appreciate all the color. I just wanted to come back to the insurance sale quickly. So I know you kind of disclosed the Class B dividends are like $145 million to $198 million. Is that like a yearly number or is that a cumulative number? And I guess if you hit that call option in 2030 to 2035, what is that strike price? And how should we kind of think of the cost of financing here that you just raised versus, I guess, deploying future CapEx at 13% to 15% returns? Maybe you could just unpack that."
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Nick, it's Steve. So those numbers are based on the five year, the first five year target distribution. And so this would be the aggregate amount at that five year call date that needs to get met. And that's very much in line with a fairly conservative case on what this insurance business delivers. Keep in mind, this is a business that is -- it's captive but it has a reinsurance behind it. So we have a very predictable max amount of losses and then the reinsurance kicks in. So this was structured very conservatively that even in the event of max losses, we feel very comfortable servicing this financial structure. In terms of the cost of this, I would think about it as roughly in line with like a junior subordinated debt issuance at the parent. And given that this is getting equity treatment that effectively looks like a low-cost equity financing that is quite accretive. It will have target payments in the range of about $37 million to $40 million per year to the counterparty."
},
{
"speaker": "Nick Campanella",
"text": "Okay, that's helpful. Appreciate that. And I'll try not to butcher it but just the Cochrane buyout that you disclosed in the 10-Q. Can you just give us a sense of what you're purchasing? And how much you paid for it, either on like a multiple basis or cash and just the rationale behind that transaction?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes. Look, I mean, this is an asset that we already own and operate. We have a minority partner that was looking to exit. So what we're doing is we're buying up the 40% minority and taking nearly complete ownership of the asset. It's very valuable. It's contracted well into the next decade, serving key customers for us in Chile. And the valuation was at a very low multiple so it's quite accretive immediately this year and beyond. So we're pleased with it. It's one of the assets that we had already guided that would be extended beyond 2027. So it's no additional new capacity, just taking advantage of an attractive financial return on owning the entire thing as opposed to just the share that we had."
},
{
"speaker": "Nick Campanella",
"text": "Okay, thank you."
},
{
"speaker": "Steve Coughlin",
"text": "All right. Thanks, Nick."
},
{
"speaker": "Operator",
"text": "Thank you. The next question comes from David Arcaro with Morgan Stanley. Please go ahead David."
},
{
"speaker": "David Arcaro",
"text": "Hi. Thanks so much. Good morning."
},
{
"speaker": "Steve Coughlin",
"text": "Good morning, David."
},
{
"speaker": "David Arcaro",
"text": "I was wondering on the AGIC sale, just one other follow-up there. You sold a minority stake. I'm just wondering, is there any strategic reason that you want to retain control in the remaining stake there? Or could that be a consideration for future asset sales out in the rest of the program, the financing plans going forward as…?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes. No, we want to maintain our control of this asset. And as Steve said, it's -- the financial metrics are very conservative and we're coming in with considerable margin on this. So we do want to maintain it. It's been very successful. We've set this up about 15, 20 years ago. It was an independent business, it's a unicorn. So it's been very successful, lowered our insurance costs and improved the quality of our reinsurers."
},
{
"speaker": "David Arcaro",
"text": "Okay, great. And I was wondering if you could comment on just what you're seeing in terms of latest renewable demand trends. Has there been any pull forward ahead of potential IRA changes here or any just general change in customer demand levels that you're seeing?"
},
{
"speaker": "Andrés Gluski",
"text": "Yes, great question. Look, what we are seeing is continued strong demand. We're not seeing any sort of temporal shifts as a result. So our data center customers continued strong demand. I think the key word is time to power. And that's why we mentioned that certainly, for the next five years, the predominance of this is going to be renewables because it's the fastest to power. It's also very cost effective. And so it's more sort of you can combine this with gas, in many cases, to reach the optimal solution. I think there's too much discussion about the technology and not really what the customer wants. So we combine ways of producing energy in a way that satisfies our customers. So look, we're not seeing any pull forward. We are seeing, I would say, some of the contracts that we're signing today that they have provisions for, say, changes in law, changes in tariffs, etcetera, to take that into account. Now for our backlog, as I said before, we have imported the materials or have domestic supply. We have the EPC and we have the financing. So all that's locked in."
},
{
"speaker": "David Arcaro",
"text": "Okay, sounds good. Thank you."
},
{
"speaker": "Andrés Gluski",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Durgesh Chopra with Evercore. Please go ahead, Durgesh."
},
{
"speaker": "Durgesh Chopra",
"text": "Thank you. Good morning, team. Thanks for giving me time. Steve, congrats on this transaction. Maybe just a little bit more detail. You talked about the cash distributions being conservative. Can you just frame for us the $40 million or so average distributions a year? What is that as a percentage of total cash generated for that business?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, it's roughly around -- depending on the year, 35%, 40% I would say, in terms of this business reliably generates about $100 million of cash, thereabouts, even with typical losses. And that includes some amortization of the instruments so this is self-amortizing over the full 20-year life. It's nothing like these convertible portfolio financings that you've heard about with some other yieldcos that were not amortizing and had a significant economic ownership flip. This doesn't have that kind of change. We have a call right at year five. And otherwise, there's no incentive to have to call it. It continues along the same economics for the full 20-year potential period. So it's priced, as I said, like a junior parent note and gives us access to cheap, what I call, cheap equity capital. And then we can continue to retain this so long as it's -- unless we had a better option down the road that's lower cost. But this one is a good way to monetize an asset that I think is perhaps underappreciated in the value that it generates. It's been in our disclosures around the distributions to the parent from this asset in the past, so you can see that. And this is capital that will be put to work to generate mid-teens returns. So I think it looks quite good."
},
{
"speaker": "Durgesh Chopra",
"text": "Got it. Thank you for that clarity. Accretive transaction there. Just digging on the financing topic, there's been a lot of discussion around transferability. Some legislation recently proposed or is probably doesn't get much traction. But just in terms of thinking about risks, can you talk about like in an event the transferability is eliminated, do you go back to tax equity and perhaps even frame for us what percentage of your plan is being provided by cash financing, is being provided by transferability? Thank you."
},
{
"speaker": "Steve Coughlin",
"text": "Yes, absolutely, Durgesh. So look, first of all, transferability has only been around for a little over two years when the IRA was passed in 2022. It has been very good for the industry as it's opened up a broader participation in the market for monetizing tax value. And it is typically a little bit more efficient in transferring most of the tax benefit savings on to customers, just there's less friction in these types of transactions. But that said, for the IRA, we did tax equity. The majority of what we continue to do is still through tax equity partnerships. And in fact, we continue to form the partnerships anyway because we need to monetize the tax depreciation to maximize the opportunity even when we are doing transfers. So we can continue to do the tax equity partnerships for all of our future projects if this were removed. We don't think it will be because we think it goes with the tax credits in terms of getting the most benefit of the tax credit to the cost of the end consumer of the energy. And then effectively, the cash benefit to AES is the same. So we bridge the tax financing with debt during construction, as I walked through on the February call. And then we immediately, when the tax value comes in, either from the transfer counterparty or from the tax equity partner, we immediately monetize that at the place and service date and pay down a significant portion of the debt, typically more than 50% at that point. So you have a significant deleveraging from this. The fundamental cash and credit profile is really exactly the same. So I think it's been good, a lot more for some smaller developers and to sort of democratize the participation in the market. But as a large-scale developer with deep relationships with sophisticated tax equity partners, we still feel very comfortable that we can monetize all of the tax value that we create with the tax equity venue if needed."
},
{
"speaker": "Durgesh Chopra",
"text": "Thanks, Steve. Appreciate that discussion. Just real quick, sorry, this is my third question I understand and realize. Just the hydrogen project that was canceled in Texas, are we still pursuing other customers for contracted the power generation that I believe it was over 1 gig?"
},
{
"speaker": "Andrés Gluski",
"text": "The answer is yes. I mean, that was a very attractive asset of development. It's in -- it's all on private land on 1 farm and it's very well located for the grid and for anything else. So yes, we're continuing to pursue it. It's part of our pipeline, so yes."
},
{
"speaker": "Durgesh Chopra",
"text": "Thank you, Andrés."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you, Durgesh."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Michael Sullivan with Wolfe Research. Please go ahead."
},
{
"speaker": "Michael Sullivan",
"text": "Hi, good morning."
},
{
"speaker": "Steve Coughlin",
"text": "Good morning, Michael."
},
{
"speaker": "Michael Sullivan",
"text": "Wanted to just ask on where we stand on the longer-term asset sale target. Are you still shooting for that 3.5 billion? Where are we against that? And what else are you looking at for potential sales?"
},
{
"speaker": "Steve Coughlin",
"text": "Yes, this is Steve. So no, we -- so with respect to the 3.5 billion, we're at 3.4 billion, so we're right almost there to the finish line on that target. We did talk about getting to 800 million to 1.2 billion on the February call from '25 to '27. So with this sale, and that's not including the Ohio sell-down, which went to paying down debt. This was referring to proceeds up to the parent. With this insurance sell-down, we're halfway, roughly there, close to halfway on that target. What's remaining is we have the -- in terms of proceeds, the Vietnam sale. We have some other asset sales in the thermal portfolio that are on a smaller scale. We have partnerships of operating assets. We've done partnerships with our LNG portfolio. As you've seen, those can and maybe extended. We've done partnerships, sell-downs at attractive low-cost capital of our renewable operating portfolios. So those remain an option. And our technology portfolio. At this point, Fluence is not at a value that we would tap that. It is significantly undervalued, but we do -- we are optimistic down the road that, that's a potential. So we're not counting on that. We do have other assets in that portfolio like Uplight that we've talked about that may be a candidate. So the universe is larger than what's remaining. What's remaining is only roughly 500 million in that target through '27. And so I feel extremely comfortable that we'll be able to execute on that between now and 2027 across the range of things that I mentioned."
},
{
"speaker": "Michael Sullivan",
"text": "Okay, great. That's helpful. And back to the IRA discussion here. Do you all have any view on kind of when this starts to take shape in the Reconciliation Bill? Feels like things starting to come to a head a little bit. And then also just specifically on transferability, your view on whether a Safe Harbor would cover you on that even in a scenario where that were to go away?"
},
{
"speaker": "Andrés Gluski",
"text": "Okay, let's see. I spent some time up in the Hill with key senators and congressmen. What I would say is that I do expect in sort of a first draft to come out of the House and Ways and Means Committee, and that's to start the discussion. So that's certainly, I don't think that's the final point. That was made clear to us. I do think that there is -- what I heard was a very pragmatic approach. One was the importance of, I would say, reliability in a sense that something like -- if you look at Safe Harboring, I think that everybody I spoke to said that, that's a very important component to maintain because that's really the credibility of U.S. laws or, let's say, U.S. programs. So I feel very good about that. I think regarding the IRA, it's a question of -- certainly going to be addressed certain aspects of it. I think that you might have an earlier sunset of it. I would say very likely, actually, that's where the majority of the savings that they would score would come from. But having said all that, I think that at the end, it's going to be quite pragmatic. There are hundreds of thousands of jobs depending on this. A lot of people are going to be going into elections in '26. And you don't want to have a jump in unemployment in rural areas where a lot of this is getting done. And you also have the tax revenues that this is going to generate. So my feeling on this is that we will have something relatively early. That's not the final -- whatever comes out, it's not final. When can reconciliation done? Take it with a huge grain of salt, people think it's before the August recess, that people will want to have this done before they go out of town. So that's more or less the time frame. But I think the discussions were -- that I had, I think, were very encouraging about thinking about what's good for the country and what can realistically be done."
},
{
"speaker": "Michael Sullivan",
"text": "Appreciate that color. Thank you."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. The next question comes from Richard Sunderland with JPMorgan. Please go ahead, Richard."
},
{
"speaker": "Richard Sunderland",
"text": "Hi, good morning."
},
{
"speaker": "Steve Coughlin",
"text": "Good morning, Richard."
},
{
"speaker": "Richard Sunderland",
"text": "I just wanted to follow up on transferability one more time. On an agency metric basis, what would be the impact to your FFO without transferability and how do you expect the agencies to treat that?"
},
{
"speaker": "Steve Coughlin",
"text": "So the transferability, as I said, Rich, is fundamentally the same cash and credit profile. The difference is the transfer credits do go through operating cash flow. So there's no -- in terms of S&P and Fitch, it really has no impact to their focus on the parent free cash flow, whereas this comes in at the subsidiary level and pays down debt primarily. And so it does get captured in the Moody's metric. So I think we will need to work with Moody's to ensure that this is well understood. I think they do understand it that it's fundamentally no change. The cash comes in when the project is placed in service, whether it comes from a transfer or from a tax equity partner and the debt gets paid down. So I think practically, it has no impact. And if we got to that point, we would, of course, work with Moody's as we have and they've been very constructive in understanding how renewables works, including the adjustments that they made in the last update that they gave. So I don't see it as a negative at all for the credit profile."
},
{
"speaker": "Richard Sunderland",
"text": "Got it. That was very clear. So presumably on a Moody's basis, this would push out the improvement you've called out for '26, but you also expect Moody's to look through the impacts, given what you laid out earlier on the value through tax equities being the same?"
},
{
"speaker": "Steve Coughlin",
"text": "I mean, look, I can't speak for Moody's, but look it's very logical and we're talking about geography issue on the cash flow statement. So I have a hard time being that logic won't prevail there, that fundamentally the credit profile is exactly the same."
},
{
"speaker": "Richard Sunderland",
"text": "Understood. And then maybe I'll just follow up with one more. I mean, I think there's been a lot of attention on transferability and maybe some fears out there that this first draft on the IRA could have a lot of negative headlines, then we migrate some more reasonable middle ground. Do you think transferability is something that may come out in that initial draft and then goes back in? Any thoughts on sort of the magnitude of that headline risk initially versus where things might ultimately shake out in your earlier commentary?"
},
{
"speaker": "Andrés Gluski",
"text": "No. What I would say is that there are two sort of groups. One is uses of capital and there's one that's sort of be more blunt. I think again, there's going to be a compromise. So I really have no insight in terms of what the initial language can be. But it's clear, bills always come out to start a discussion so it has to come from the house and then it has to be resolved with the senate and you have to have this reconciliation. So I just think that anything that comes out now is the start and it's not the ending point. But I also -- again, from my discussions, I think they were very constructive, very, very positive in general, but I think people understand the issues, which is what's most important. Look, the most important thing is, among other things, we want two things, energy dominance and you want to -- with the AI race. Both of those require a lot of renewable energy, well, actually a lot of energy now. If you think about additional gas plants, if we order a new gas turbine today, the waiting period is between three to five years to say nothing that is not permitted and it's not an interconnection queue. So if you come out with something that was very negative, let's say, to new energy, well, you're forfeiting two of the most important goals of the administration. So that's why I felt that there was clarity in terms of cause and effect and what it's going to take to have energy dominant and what is going to -- it's a question also of time frame. So this is a question that must be resolved in the next four, five years. And we have to be pragmatic what we can get accomplished in that time period. So I feel that, that is understood. So I'm, let's say, reasonably optimistic about where it's going to end up. Who knows the political path or headlines? I can't know. Your guess is as good as mine."
},
{
"speaker": "Richard Sunderland",
"text": "Perfect. Thanks for the time today."
},
{
"speaker": "Andrés Gluski",
"text": "Thank you. Thanks, Rich."
},
{
"speaker": "Operator",
"text": "Thank you. Our final question today comes from Anthony Crowdell with Mizuho. Please go ahead, Anthony."
},
{
"speaker": "Anthony Crowdell",
"text": "Hi, good morning. Thanks for squeezing me in. Most of my questions Richard's taken care of in front of me. Just quickly on Ohio, some legislation passed earlier, I think this week, multiyear rate plans, but also maybe removal of OVEC revenues. Just curious the impact for AES Ohio and does it change your plan on rate filings?"
},
{
"speaker": "Ricardo Falú",
"text": "Thank you so much. This is Ricardo. So I will start saying that overall the impact of the bill is net positive for us, while on one side eliminates the ESP. It's going to be now replaced by a 3-year forward-looking distribution rate case with annual true-up, which is a more constructive regulatory framework in a growing business such as AES Ohio. In addition, the language clearly states that the current ESP4 features will be extended from August 2026, which was the original expiration date to May of 2027. So, this will give us enough time to have the new rates coming from this 3-year forward-looking framework in place. I think this is very, very constructive. It eliminates regulatory lags, so again, very, very positive for a growing business such as AES Ohio. I think in terms of our timing for filing the distribution rate case, more likely it's going to be by the end of this year. With respect to OVEC, the impact is estimated to be between $0 million and $10 million. Why 0? Because it depends very much on the financial performance of the asset or assets, I should say, because we are talking about 2.3 gigawatt to coal assets that provide capacity to PJM and we are seeing a significant increase in capacity prices where you may recall it were like around $29 and now $270 per megawatt per day. So it's going to be within that sort of range, $0 million to $10 million depending on the financial performance and capacity prices in PJM. And as I said, all-in-all, net positive and I think this regulatory framework with a three-year forward-looking is extremely constructive for AES Ohio."
},
{
"speaker": "Anthony Crowdell",
"text": "Great. Thanks for taking my questions."
},
{
"speaker": "Ricardo Falú",
"text": "Thank you, Anthony."
},
{
"speaker": "Operator",
"text": "Thank you. Those are all the questions we have for today and so I'll hand the call back over to Susan Harcourt for closing remarks."
},
{
"speaker": "Susan Harcourt",
"text": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you and have a nice day."
},
{
"speaker": "Operator",
"text": "Thank you everyone for joining us today. This concludes our call and you may now disconnect your lines."
}
] | The AES Corporation | 35,312 |
AFL | 4 | 2,020 | 2021-02-04 08:00:00 | Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Aflac Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your first speaker today, David Young, Vice President Investor and Rating Agency Relations. Please go ahead, Mr. Young.
David Young: Thank you, Carol, and good morning and welcome to Aflac Incorporated fourth quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning we will be hearing remarks about the quarter and the year related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in Japan and the U.S.; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the fourth quarter and discuss key initiatives, including how we are navigating the pandemic; Max Broden, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of fourth quarter financial results and current capital on liquidity. Members of our U.S. Executive Management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual Benefits; Rich Williams, President of Group Benefits; Eric Kirsch, Global Chief investment Officer and President of Aflac Global Investments; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing. Before we begin some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?
Dan Amos: Thank you. Good morning and thank you for joining us. At this time last year, it would have been very difficult to foresee the gravity of what was soon to unfold for society and for the company due to COVID-19. I’m proud of our employees, our sales distribution and Board of Directors for their decisive people first initiatives, we spearheaded early on in both the United States and Japan to protect our workforce and to be here for our policyholders throughout this trying time. We were able to reinforce our financial strength in operations as well as our distribution franchise with digital and virtual investments through the position of our company for the future growth. Adjusted earnings per diluted share excluding the impact of foreign exchange increased 10.8% in 2020. While benefiting from a lower effective tax rate, we were pleased with the results when you consider the pandemic pressure on revenues, accelerated investment in our core technological platforms and the initiatives to drive future earned premium growth and efficiency. Investing in growth and innovation will continue to be critical strategic focus this year. There is one central message that I’ve been emphasizing with our management team. It is imperative that we control the factors we have the ability to control. And what we don’t have control over, we must monitor continually to be ready to adapt. Despite the facts that sales in both U.S. and Japan have been suppressed considerably due to the constraints of face-to-face opportunities, we did not sit still. We maintained forward motion as we absorbed accelerated investment in our platform, while continuing strong earnings performance. In 2020, Aflac Japan generated solid overall financial results with a stable profit margin of 21.2%, an extremely strong premium persistency of 95.1%. The relaunch of our new Cancer Rider drove a sequential improvement in both cancer insurance and total sales in the fourth quarter. As a result, total sales were down 22.2% for the quarter and 36.2% for the year. In Japan, we introduced our new medical product in January and even up against difficult comparisons of last January, that were pre-COVID sales, it is a positive launch exceeding our expectations. We are encouraged by the reception of both the consumers and our sales force. While these sales results represent sequential improvements relative to last quarter, the effective reduced face-to-face activity are evident, and we continue to promote virtual sales. Our goal in Japan is to be the leading company for living in your own way. This is a declaration of how we tailor our products to fit the needs of customers during the different stages of their lives and reach them where they want to buy through agencies, strategic alliance and banks. Now turning to Aflac U.S., we saw a stable profit margin of 19.3%, amid a year of intense investments in the future of our business and the global pandemic conditions. However, this backdrop continues to noticeably impact our sales results in this segment as well, largely due to reduced face-to-face activity. As expected, we saw modest sequential sales improvement in the quarter with a decrease of 27.2% for the quarter and 30.3% for the year. In the U.S., we continue to feel the impact of limited access at the worksite, especially among our career agents, who have historically relied upon face-to-face meetings to engage small business owners and their employees. However, we remain cautiously optimistic for continued modest sequential sales improvement contingent upon the face of the economic recovery and as a result expect to see a brighter second half of 2021. Fred is responsible for acquisitions and he will cover that shortly. But while these acquisitions may not have an immediate effect on the top line, they better position Aflac for future long-term sales in the United States. As part of the Vision 2025 in the U.S., we seek to further develop a world where people are better prepared for unexpected health expenses. The need for the products we offer is a strong or stronger than ever has been. And at the same time, we know consumer habits and buying preferences have been evolving, and we are looking to reach them in ways other than the traditional media and the outside the worksite. This is part of the strategy to increase access, penetration and retention. Even while working remotely for the greater part of the year, we remain true to our culture and identity as a socially responsible company. We stepped up our engagement with our employees through virtual town meetings and weekly touch-base letters. Additionally, diversity continues to play an important role at Aflac as it has for decades. I have always believed that in order to accomplish our goals and serve the community where we have a presence, we must surround ourselves with a group of people, who bring different perspectives to the table. We have done that for years. At the end of 2020, nearly 50% of Aflac’s U.S. employees were minorities, 66% were women, 23% of our U.S. senior officers were minorities, and 30% were women. And then when you think of Aflac’s Board of Directors, 36% were minorities and 36% were women. Diversity has always played an important role within ESG, and we have Fred with executive oversight of our ESG efforts. He will provide greater detail on our 2021 key objectives. I’ve always said that the true test of strength is how one handles adversity. While pandemic conditions are ongoing, I’m pleased that 2020 confirmed what we knew all along and that is that Aflac is strong, adaptable and resilient. We strive to be where people want to purchase insurance that applies to both Japan and the United States. In the past, this has been meeting face-to-face with individuals to understand their situation, propose a solution and close the sale. However, the pandemic clearly demonstrates the need for virtual means, in other words, non face-to-face sales, to reach potential customers and provide them with the protection that they need. Therefore, we have accelerated investments to enhance the tools available for our distribution in both countries. Related to capital deployment, we placed significant importance on continuing to achieve strong capital ratios in the United States and Japan on behalf of our policyholders and shareholders. When it comes to capital deployment, we pursue value creation through a balance of actions including– excuse me, growth investments, stable dividend growth and disciplined tactical stock repurchase. It goes without saying that we treasure our record of dividend growth. The fourth quarter’s declaration marked the 38th consecutive year of dividend increases. Additionally, the board approved our first quarter dividend increase of 17.9%. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we remain tactical in our approach to share repurchase, buying back $1.5 billion of our shares in 2020. We have also focused on integrating the growth investments we have made in our platform. As always, we are working to achieve our earnings per share objectives, while also ensuring we deliver on our promise to our policyholders. By doing so, we look to emerge from this period in a continued position of strength and leadership. I don’t think it’s coincidental that we’ve achieved our success while focusing on doing the right things for our policyholders, shareholders, employees, distribution channel, business partners, and communities. In fact, I believe that go hand-in-hand. I’m proud of what we have accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Now, let me turn the program over to Fred. Fred?
Fred Crawford: Thank you, Dan. I’m going to touch briefly on conditions in the fourth quarter with respect to the pandemic. I’ll then provide an update on key initiatives in Japan and the U.S. Japan has experienced approximately 400,000 COVID-19 cases and 6,000 confirmed deaths since inception of the virus. While quite low as compared to other developed countries and the U.S., these statistics have more than doubled since the end of the third quarter. Earlier this week, the government of Japan extended their state of emergency for Tokyo and nine other prefectures through March 7. This action includes the suspension of domestic tourism campaign and entry of foreigners into Japan. We have responded with again moving more of our workforce to working from home unlike the state of emergency declared last year in the initial stages of the virus, government restrictions are more balanced with economic recovery considerations, and we have not prohibited face-to-face consultations and/or closed our sales shops. Meanwhile, Prime Minister, Suga, has announced a goal of beginning vaccinations mid-February. Through the fourth quarter, Aflac Japan’s COVID-19 impact totaled approximately 3,400 unique claimants with incurred claims totaling JPY1 billion. We continue to experience a significant reduction in paid claims for medical conditions other than COVID-19 as Japan manages hospital capacity and discourages more routine visits. Despite the recent rise in infection rates in Japan, we continue to track well below our stress assumptions. As Dan outlined, sales have clearly been impacted, but when looking at policies in force, the impact of reduced sales on earned premium has largely been offset by improved persistency with the reduction in reported revenue driven primarily by paid-up policies. Finally, pandemic related expenses in the quarter totaled JPY1.8 billion, which includes the rollout of virtual distribution tools, employee teleworking equipment and distribution support. Turning to the U.S., there are nearly 27 million COVID-19 cases and over 450,000 deaths as reported by the CDC. For Aflac U.S., in 2020, COVID-19 claimants totaled 23,000 with incurred claims of approximately 71 million in the quarter and 128 million for all of 2020. We are now in a better position to back test the correlation of U.S. rates of infection to paid claims in order to build an estimate for incurred claim reserves. It’s fair to say this is still very difficult to estimate as IBNR often works from years of reliable data to establish trends. While our reserves assume elevated claims, we continue to see the length of stay in hospital and transition to ICU traveling below our expectations. We have seen limited impact to our reported persistency numbers. However, we believe this is in part attributed to the combination of reduced sales, where lapse rates tend to be much higher in the first year and the State Executive orders requiring premium grace periods. Executive orders are still in place in 11 states as of the end of the quarter with five states having open-ended expiration dates. We have reduced pressure on lapse rates through proactive work with our policyholders, including converting from payroll, deduction to direct bill, and encouraging a review of wellness benefits. Turning to key operating initiatives, 2020 was an important year in setting the stage for growth once we move clear of pandemic conditions. Beginning with Japan, after launching and promoting a simplified Cancer Rider in the fourth quarter, we successfully launched our refreshed medical product called EVER Prime in January. As Dan noted in his comments, it’s early and our associate channel is having to navigate pandemic conditions, but January medical sales are promising. Introduced in October of 2020, we have technology in place to allow agents to pivot from face-to-face to virtual sales and an entirely digital customer experience. True virtual sales in Japan is relatively limited. In addition, the majority of applications are still filed in paper form although digital applications have been adopted in face-to-face consultations. Excluding traditional non face-to-face means of distributing products like worksite, direct mail and call center sales, we estimate only 2% to 3% of our sales are currently digital end-to-end. However, we understand some of our agencies has significantly adopted virtual tools to supplement face-to-face consultations. We have discussed our paperless initiative across all operations in Japan. This is JPY10 billion investment with approximately JPY2.8 billion spent in the fourth quarter and JPY4.8 billion spent in 2020. We are projecting another JPY4.3 billion in spend planned for 2021. This investment has a three-year payback and will reduce the production and circulation of over 80 million pieces of paper per year. In summary, we expect the combination of product development, improved pandemic conditions and the return of Japan Post to distributing Aflac cancer insurance will drive growth as we look towards the second half of 2021. Turning to the U.S., we focused our efforts in 2020 on setting the table for 2021, including a national launch of network dental and vision, completing our Group Benefits acquisition and standing up our new direct-to-consumer digital platform. On the operation side, we rolled out a new and upgraded enrollment platform called Everwell 2.0 in September, which requires time for full adoption and stabilizing the platform, 2020 was an important year to introduce digital tools, increase adoption rates, and take on any corrective action before 2021. In addition, under Teresa White’s leadership, we have reorganized the U.S. forming Group Benefits in individual division. Rich Williams will now lead our Group Benefits division, which includes Aflac Voluntary Group, Aflac Network Dental and Vision, Argus our Dental TPA and our new Aflac Premier Life Absence Management and Disability business. Virgil Miller will lead our Individual Benefits Division, which includes Aflac’s individually issued and small business focused worksite products and our new consumer markets business targeting workers not at the traditional worksite. Both divisions pull from shared service U.S. operating platforms. This new alignment provides focus for each division within the U.S. business segments and allows Aflac to offer tailored products and services for our career agency teams and broker partners based on the unique markets they serve. Like Japan, we have all the tools in place for agents to conduct business without a face-to-face meeting. However, most sales are being driven on a continuum of face-to-face and digital interaction. We estimate about 15% of our traditional individual sales are completed without some form of face-to-face interaction. This excludes digital direct-to-consumer, which is naturally non-face-to-face. Turning to more specifics on our key growth initiatives, on January 12 we announced the national rollout of Aflac Dental and Vision. Our dental and vision products are now available in 40 states with more coming online throughout the year. This is a broad launch that is available to large and small companies and distributed through agents and brokers. In November, we closed down our Zurich Group Benefits acquisition, the new platform managed to contribute to sales in the quarter, with 5 million in production. This is more of a turnkey launch meaning products are filed and we are open for business in 2021 under the Aflac brand. Finally, we officially launched our new digital direct-to-consumer platform in the first week of January. We offer critical illness, accident and cancer, and are approved to sell all three products in approximately 30 States with more states and products coming online throughout the year. As highlighted during our investor conference, we are addressing expenses over two horizons. In 2020, we took actions to realize approximately 100 million of annualized run rate expense savings on a go-forward basis. Actions included restricting hiring, rationalizing distribution expenses and a voluntary separation plan that resulted in a 9% reduction to our U.S. workforce. Longer-term expense initiatives center on our group division and the migration onto a new administrative platform as well as inauguration of the Zurich Group Benefits business. As you are all aware, we have adopted a conservative buy-to-build acquisition strategy. The build efforts taken together impacted our expense ratio in the fourth quarter by 160 basis points, and is expected to impact the 2021 ratio by approximately 180 basis points. Our global investments team remains focused on asset quality, monitoring economic conditions, and sourcing new investment opportunities. Portfolio actions prior to and in the early days of the pandemic, lowered our exposure to prolonged economic weakness, and we ended 2020 with a modest amount of asset losses. We continue to watch closely our middle market loan and traditional real estate, transitional real estate portfolios, while we have seen ratings downgrades, our portfolios are resilient consisting of diversified first-lien loans, conservatively underwritten to high-quality borrowers. We have further refined our approach to managing the unhedged dollars in Japan, both lowering our hedge ratio and maintaining our out-of-the-money protection for extreme moves in foreign exchange. These unhedged dollars provide diversification and income benefits as well as lowering our enterprise exposure to the yen. As has been our practice, for 2021, we have locked in lower hedge costs with floating rate loan yields benefiting from LIBOR floors. Finally, we are pleased with the performance of our strategic investment and alliance with Varagon Capital Partners during 2020 contributing to corporate investment income. We are working to establish similar strategic alliances that leverage the capabilities of our asset management subsidiary and further the performance of our insurance segments. As commented on by Dan, we have refocused our efforts in key areas to drive tangible ESG initiatives in 2021. We are focused on the following. Building off our published ESG investment policy, Aflac Global Investments is advancing a responsible investing framework that includes the establishment of a core ESG team and formal governance process. We initiated work with third-party experts to measure, draft, and eventually disclose a formal plan to be carbon-neutral on or before 2040 and carbon net-zero emissions on or before 2050. We pledged to continue hitting key milestones on our important women in leadership initiative as part of a diversity and inclusion in Japan and targeting 30% of leadership positions in Japan filled by women by 2025. In the U.S., we seek to advance our already strong diversity statistics by broadening our influence through identifying and providing capital to organizations that advance diversity and inclusion as well as social justice and economic mobility. Finally, we pledged to advance reporting and disclosure framework in compliance with SASB and TCFD reporting standards. We’ll provide further disclosures on ESG initiatives in our proxy material and on our ESG Hub, esg.aflac.com. Wrapping up my comments, we believe the investments made in the past two years and accelerated during the pandemic, position us for future growth and efficiency in the face of what we believe to be temporary weakness in sales and earned premium. I’ll now pass on to Max to discuss financial performance in more detail. Max?
Max Broden: Thank you, Fred. We finished the year with stable fourth quarter earnings in a year marked by significant mortality and morbidity events, as well as continued low interest rates. Fourth quarter adjusted earnings per share increased 3.9% to $1.07, and the full year EPS was a record $4.96, up 11.7% year-over-year. Adjusted book value per share including foreign currency translation gains and losses grew 19.1% both for the quarter and full year. The adjusted ROE excluding the foreign currency impact was 12.1% in the fourth quarter and a respectable 15.1% for the full year, a material spread to our cost of capital. This quarter benefited from favorable marks on our alternative investment portfolio to the amount of $47 million pre-tax above our long-term return expectations, a very good outcome on our building alternatives portfolio. We also booked the severance charge associated with our previously announced voluntary separation program or VSP, in our U.S. and corporate segments, totaling pre-tax $43 million, included in adjusted earnings. Turning to our Japan segment, total earned premium for the quarter declined 3.5%, reflecting mainly first sector policies paid-up impacts, while earned premium for our third sector products was down 1.9%. For the full year, total earned premium was down 2.8%, while totaling policies in force declined by a lesser rate at 1.2%. As policies in force are not impacted by the paid-up status, it tends to serve as a better indicator of the growth of the underlying business. Persistency has been on a positive trajectory inched up slightly sequentially to 95.1%, up 70 basis points year-over-year. Japan’s total benefit ratio came in at 68.9% for the quarter, down 110 basis points year-over-year. And the third sector benefit ratio was 58.6%, down 150 basis points year-over-year. The main driver for the lower benefit ratio was a higher than normal IBNR release due to a sustained lower paid claims environment in 2020. We estimate that this lowered the benefit ratio by roughly 130 basis points compared to what we would deem a normal IBNR release to be. For the full year, the reported total benefit ratio was 69.9%, up 40 basis points year-over-year. And our third sector benefit ratio was 59.7%, also up 40 basis points year-over-year, largely due to improved persistency. The expense ratio in Japan was 23%, up 130 basis points year-over-year. The main driver was our paperless initiative, which kicked in at a higher gear as we digitize our operations and drive efficiencies throughout the value chain to a future state with significantly reduced paper usage. This investment increases our quarterly expense ratio by 85 basis points. For the quarter, adjusted net investment income increased 11.9% in yen terms, led by strong returns in our alternatives portfolio, but also strong results from the loan book like transactional real estate and middle market loans. For the full year, adjusted net investment income rose 4.4%. The pre-tax margin in the quarter was 20.9%, up 110 basis points year-over-year, as the combined effect from the lower benefit ratio and higher expense ratio was still positive. For the full year, the pre-tax margin was a respectable 21.2%. Turning to U.S. results, earned premium was down 2.3% for the quarter, due to weaker sales results. Persistency improved 160 basis points to 79.3%. This was driven by emergency orders in various states and by lower sales in 2020, as new policies lapsed at a higher rate than in force policies older than one year. Removing these factors would result in a stable year-over-year persistency rate. And we view that as a good outcome to date, given a pandemic environment impact on our policyholders and reflecting our efforts to retain accounts and keep premium in force. For the full year, earned premium was down 0.9%. Our total benefit ratio came in at 51.6%, which was 250 basis points higher than Q4 2019. Pandemic conditions continue to be very relevant when analyzing our benefit ratio. Due to the recent increase in infection rates, we estimate incurred claims impact of $72 million of which $58 million was an increase to IBNR, resulting in an impact to the benefit ratio of 5.1 percentage points from COVID related claims. This is somewhat offset by favorable non-COVID related claims activity, generating an underlying benefit ratio of 46.5%. COVID and non-COVID related claims tend to have a negative correlation, which clearly can be seen in our quarterly results throughout 2020. We would expect this pattern to continue in early 2021. Going forward we still expect the guided range of FAB of 48% to 51% to be a reasonable future benefit ratio. Our expense ratio in the U.S. was 43.5%, up 360 basis points year-over-year. The severance charge for our VSP explains 220 basis points of the rise, while the residual is primarily driven by digital investments and the reduction in revenues. The full year expense ratio landed at 38.6%. Adjusted net investment income in the U.S. was up 1.1% due to strong alternative investment income, while the portfolio book yield contracted 22 basis points year-over-year. Full year adjusted net investment income declined 2.1%. As both the benefit and expense ratio rose, profitability did come under pressure with a pre-tax margin of 11.6% in the quarter. For the full year, we still reported a solid pre-tax margin of 19.3% in line with recent historical average. In our Corporate segment, the pre-tax loss widened to $47 million in the quarter compared to $9 million from a year-ago. Lower net investment income on our short duration Hold Co. cash position, increased retirement expenses and $8 million of VSP severance expense were the main components of the delta. For the full year, the Corporate segment pre-tax loss was $115 million. Our capital position remains strong and stable. We ended the quarter with an SMR of north of 900% in Japan and an RBC of approximately 525% in Aflac Columbus. Holding company liquidity stood at $4 billion, $2 billion above our minimum balance. With a leverage of 23%, we continue to travel in the middle of our stated leverage range of 20% to 25% offering ample debt capacity. The continued spread of COVID-19 leads us to remain cautious in how we manage our capital base, make investments, and deploy capital to the benefit of the shareholder. In the quarter, we repurchased $500 million of our own stock and paid dividends of $196 million, offering good relative IRR on these capital deployments. For the full year, we paid $798 million of dividends and returned an additional $1.5 billion to shareholders in a formal share repurchases. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with meaningful spread to our cost of capital. A recent example is the board’s decision to increase the quarterly dividend by 17.9% to $0.33 per share. Before going into Q&A, I would characterize our 2020 financial performance as solid, despite significant external challenges. As we look forward into 2021, we do not see any fundamental drivers causing us to change the outlook provided at our financial analyst briefing in November. In order to achieve these objectives, we remain laser-focused on executing on our growth initiatives, expense efficiency and continue to drive ROE at the significant spread to our cost of capital. With that, let me turn over to David to begin Q&A.
David Young: Thank you, Max. Now, we are ready to take your questions. But first, let me ask that you please limit yourself to one initial question and then one related follow-up to allow other participants an opportunity to ask a question. Carol, we will now take the first question, please.
Operator: Thank you. Your first question comes from Nigel Dally from Morgan Stanley. Please go ahead.
Nigel Dally: Great. Thanks and good morning. Wanted to ask about Japan sales. You mentioned the new medical product had exceeded initial expectations. Can you elaborate somewhat on that? And how sustainable should that improve demand base, more just a first quarter phenomena or should we expect that group momentum to continue into the second quarter and perhaps move on?
Dan Amos: This is Dan, and I’m going to let Japan. But let me just say that it tracked to me more of what other products in past introductions have done. It’s really too early to tell. It’s really only been out two weeks. So to go ahead forecast on two weeks, it’s a little too early to tell, but I am certainly optimistic that the field force or our agents are excited about it and the consumer seem to be excited about it, which means it’s a good product at a good time to be introducing. Of course, we’ll know much more details next quarter, but I would expect it to have the same pattern that we’ve seen with past introductions. Koji?
Koji Ariyoshi: [Foreign Language] And this new medical product is being very much well taken by the agencies because of the new coverage and the functions that we offer. [Foreign Language] And this product also is designed to be able to be sold through the non-exclusive agencies and be competitive in that market as well. [Foreign Language] So we are expecting that the sale of this product will increase in a non-exclusive market as we have taken a product strategy with more competitive advantage with this product. [Foreign Language] So we do believe that this product will last for a long time as this product will be very popular among younger generation as well. [Foreign Language] And although it only has been two weeks since the launch of the product, the actual number of new insurance policies coming in are increasing and at the same time a pay per policy is also on the increase. [Foreign Language] I think we have been able to get a much better start this time under the current environment compared with the medical product that we launched in 2019 as Rider. [Foreign Language] And we are expecting to see improvements in sales this quarter much more and we have seen some improvements in the fourth quarter last year as well, but we were planning to have more improved this quarter. [Foreign Language] And that’s all for me.
Nigel Dally: That’s great. That’s very helpful. The second question is just on U.S. sales, understand broker-driven sales are holding in better than agency sales. Is it possible to get some quantification behind how much better I think with brokeraging group becoming much larger part of the strategy and business would find it helpful to understand how sales are trending along distribution lines.
Dan Amos: I think it’s probably best for Teresa and Rich to handle the aperture. The premise of your question is correct. Broker group driven sales will hold up better under this environment than agent-driven small business sales for sure. So Teresa and Rich.
Teresa White: Well, I’ll let Rich answer, but I’ll just make the comment that, yes, the broker sales are traditionally a lot more automated. We have a lot more digital presence in the broker environment just from the beginning. But I’ll let Rich response.
Rich Williams: Thank you, Teresa. As Dan alluded to in his comments, we’ve seen reduced face-to-face activity, which certainly impacts agency sales. And then from a broker sales perspective, given that they tend to work with larger accounts, they are less dependent on face-to-face activity. And as a result in particular with our group business, our group business saw results in the single-digit decline whereas our traditional businesses saw it at a larger decline. But all those comments between Teresa, Fred and myself, I think, kind of speak to the question.
Nigel Dally: That’s great. Thanks a lot.
Operator: Our next question comes from John Barnidge from Piper Sandler. Please go ahead.
John Barnidge: Yes. Thank you very much. I saw a headline the other day that Japan had banned chanting and required masks in the preparation to try and host the 2021 Olympics. Assuming that were to go through, I know previously you talked about joint marketing and product campaigns with Japan Post. Is there a possibility of some increased marketing expenses in the mid-year?
Dan Amos: Koji? Yes, we’ll have Koji or Koide-san address that. I would tell you that if what your question is, do you expect to build some form of marketing campaign surrounding the Olympics that is not in the plans and not normally what we would do. What we are doing, however, is building marketing campaigns around the launch of our new products and particularly taking advantage of a heightened awareness for supplemental health products in the COVID environment. So Koji and Koide-san, you can address it with more detail.
Masatoshi Koide: [Foreign Language] And this is Koide from Japan. And we are not planning on having any particular campaign around the Olympics.
Fred Crawford: John, I don’t know if that’s a correct thing you’re–
John Barnidge: Yes, Fred, it addressed, thank you very much. And then the follow-up, the wellness program you’ve started in 3Q 2020, is that still in play, because I think last time you said it would carry over a little bit? And how should we think about cost of that?
Fred Crawford: Yes, it is still in play in the sense that there’s sort of a – I’ll call it a tail to, if you will. In other words, we did the mailings. We saw, as you recall from last quarter, a spike in some of the wellness claims which will be flaunt, we hadn’t anticipate because we believe the payoff of that is not only persistency, but also being able to come back into companies. Let me explain that for a second. A lot of what our agents will do with their business clients is they will phone them up and say, based on our analysis you’ve got a certain number of employees that have wellness benefits. And we can help with understanding whether they are fully utilizing those wellness benefits to get money back in their pockets. As you can imagine, particularly as a small employer that’s an attractive proposition these days to get money in the pockets of your employees. And so that ends up lead or leading us into the account to talk about future enrollments and cross-selling and up-selling et cetera. And so that has been fairly successful. So it’s a very important piece of our product features and one that we would continue. If what you’re asking is what are we looking at in terms of ongoing, perhaps elevated claims related to wellness, that’s factored into some of our IBNR estimates, for example, where we’ll set up those types of reserves in anticipation of a trend line of wellness claims. And so at the moment, I’ll ask Max to give color, but I don’t anticipate that being a mover for our benefit ratio.
Max Broden: That’s right, Fred. And John, as you remember, we did a – we had a campaign in the third quarter and obviously we had the impact on our benefit ratio in the U.S. in the third quarter both from paid claims, but also that we established an IBNR associated with that wellness campaign. As you now look at the impact on the fourth quarter, you did not really see any impact follow through into the fourth quarter because of the IBNR that we established in the third quarter. Going forward, we would expect these to be more normal activity for us. There may be instances with any significant campaigns that could trigger an increase in claims temporarily, but generally be relatively small. But if you refer specifically to the campaign, the big campaign we had in the third quarter, that hit the benefit ratio in the third quarter and we didn’t really have much of a follow through into the fourth quarter.
John Barnidge: Great. Thank you very much.
Operator: Our next question comes from Suneet Kamath from Citi. Please go ahead.
Suneet Kamath: Thanks. Good morning. I wanted to go to the Japan benefit ratio. I think you said that some of the improvement or the lower than expected result or better than expected result was due to reserve releases. How are you guys planning for benefit ratios as you think about a world where the economy opens up again? And maybe we see the more people in Japan going to hospitals versus what we’re seeing right now, which I understand is a sort of subdued level of activity.
Max Broden: Let me kick it off at a high level. And I have Todd to fill in the blanks as well. Specifically for the fourth quarter, we had an reserve release all of about JPY 7 billion that is higher than we would normally incur in a quarter. We estimate that lowered the benefit ratio by about a 130 basis points in the quarter. And this is because of the paid claims pattern that we’re seeing primarily to the non-COVID-related claims activity as – that Fred referred to in his prepared remarks. Going forward, you could obviously see an impact on the benefits ratio temporarily from an element of the sort of pent-up demand for hospitalizations, like elective surgery, physicals, et cetera. I think that’s much more the case in the U.S. than in Japan, where the Japan hospital system have been running at a more normal level than what we’ve seen here in the U.S. So you could see a little bit of a higher benefit ratio from that, but this has been taken into consideration when we gave you the benefit ratio range at FAB of 68.5% to 71% in our outlook. So I’ll leave it at that and Todd, please feel free to give some additional comments.
Todd Daniels: No, Max. I think you’re right, especially if you think about our hospitalizations as it relates to accident hospitalizations, they won’t come back, accidents that have happened and you’ve recovered. However, there could be a level of sickness hospitalizations that would increase in the future. One other aspect of our benefit ratio that I’ll mention, if we get our sales back to more normal level and we start with introducing product when people refresh product that has a slight impact on the benefit ratio as well in the form of reserve releases on old policy. So last year as we saw in our results, persistency increased which led to a slightly higher net benefit reserve with those policy holders hanging onto those policies.
Suneet Kamath: Okay, thanks. And then just my follow-up is on U.S. sales. Dan, you had commented that you’re optimistic about a recovery in the second half. How much of that is just due to sort of recovery in face-to-face sales versus some of the things that you’re doing to try to improve the penetration of the direct-to-consumer or the digital virtual sales?
Dan Amos: Well, I think it’s a combination of both. And of course, you’re going against much easier numbers, especially in the second quarter and so that within itself makes it easier. But all-in-all we have been working on trying to find ways to do less face-to-face and more virtual. And we’ve been preparing for that and it just got accelerated. I will say, the new norm today is much improved over six months ago in terms of ability to get around as the vaccines are getting out. So we are seeing some stability from that standpoint. Teresa, would you like to make any comments specifically?
Teresa White: Yes, I’ll make a couple of comments. I agree if the combination of both the virtual environment and as our agents get better with adopting some of the virtual tools, I think we’ll continue to see improvement. But the other thing that I think that we are excited about is the idea of having new product that has been introduced, the dental vision product specifically in some of the broker and the small case market as well as in the larger case market having some of the life and disability products available as well. So we have a great opportunity in the second half to really start selling some of the newer product that we have out there. And so I think that’s what gives us – that’s what makes us excited about the second half of the year, of course vaccines, et cetera.
Suneet Kamath: Okay. Thanks.
Operator: Our next question comes from Gregory Peters from Raymond James. Please go ahead.
Gregory Peters: Good morning. Thanks for squeezing me in. I want a just big picture on – you talked about risk adjusted return on equities, when we look at your slide deck, I mean you have a great track record of ROE. We’ve seen a number of other large insurance companies sort of get away from earnings per share guidance and focus on sort of setting ROE target. So given all the changes and challenges you’ve dealt with last year and with growth being uncertain at least in the near-term. How should we be thinking about sort of the ROE objectives for your company for 2021 and 2022?
Dan Amos: Yes. So Greg, I think we will be operating in a fairly stable environment. We obviously are running at fairly high capital levels and that is putting some pressure on ROE as we go forward. So it makes it somewhat challenging to continue to sort of operating in the strong ROE levels that we have been in the mid-teens. Like for example this year, we came in slightly above 15% for the full year. That being said, I do think that long-term, one way to sort of think about our business is, it’s a fairly capital light products that we sell, both in Japan and in the U.S. And over time I would expect that we should sort of run into sort of 600 basis points above our cost of capital is a reasonable way to sort of think about where our ROE should be over time. Because we don’t have a whole lot of interest rate sensitivity, but it does play a factor in terms of what sort of driving the ROE as well.
Max Broden: Yes. One thing Greg to I would add is, yes, you’re seeing a bit of a migration from EPS to ROE, but also from GAAP earnings to cash flow valuation and the cash flow dynamics of the company remain extremely strong even further advanced than that. I think particularly soon when it comes to Aflac, you’re going to want to focus in on economic value. And what I mean by that is, if you think about our goal with the new businesses we’ve brought on, which is network dental and vision, absentee management, disability and life true group if you will, and then the direct-to-consumer. These are businesses that we expect to combine, contribute upwards of $1 billion of earned premium over the next five to seven years. And that earned premium will have a different GAAP profit dynamic associated with it because it’s in building mode. And as you know, direct-to-consumer, you don’t DAC expenses and so by definition you have lower reported profit. At the same time that business if actuarially appraised, absolutely has value and some would argue great value as you can imagine. So I think as we communicate going forward, it’s not just communicating on EPS and ROE, but it’s also communicating on cash flow and the economic value that we’re driving in the company for the long run.
Gregory Peters: Got it. The second question is more in the weeds, but I know, on you’re prepared comments you talked about, now that COVID – we’ve got a year of COVID under the belt. You’re looking at reserves and using the data sort of set the reserve levels. And I’m just curious, both in Japan and in the U.S., how you’re reconciling one-year’s results with the fact that there’s a rollout of a vaccine? And that may cause data to shift entirely in a different direction over the course of the next 12 months?
Fred Crawford: I commented a bit on this in my script and Max commented on it. Look, it’s a very interesting science right now for valuation actuaries establishing reserves, particularly incurred but not reported reserves. These are practices that these models and so-called completion factors, if you want to use the technical language, are built-off of years-and-years and quarters-and-quarters of information that gives particularly for a stable business like ours, very high confidence in the level of IBNR to set up on a per-product basis. Here, you have pandemic conditions, but you also have not a linear dynamic but a convex dynamic of infections. And as you said, you’ve got these new wrinkles as in vaccination, the amount of vaccinations that rolls out, the acceptance and absorption of the vaccination among the public et cetera. And so it is a tricky environment, but these are incurred but not yet reported claims. Meaning it’s our best estimate right now of what we believe to be claims coming in and in-hand. It is still however an estimate and it’s an estimate under a convex environment. And so we’ll have to continue to back test, monitor and adjust our completion factors accordingly.
Gregory Peters: Got it. Thanks for the answers.
Operator: This concludes the Q&A portion of our call. And I’ll turn it back for any closing remarks.
Dan Amos: Thank you, Carol, and thank you all for joining our call this morning. We look forward to speaking with you soon, if you have any additional follow-ups. And I wish you all continued good health. Thank you.
Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, thank you for standing by, and welcome to the Aflac Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your first speaker today, David Young, Vice President Investor and Rating Agency Relations. Please go ahead, Mr. Young."
},
{
"speaker": "David Young",
"text": "Thank you, Carol, and good morning and welcome to Aflac Incorporated fourth quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning we will be hearing remarks about the quarter and the year related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in Japan and the U.S.; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the fourth quarter and discuss key initiatives, including how we are navigating the pandemic; Max Broden, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of fourth quarter financial results and current capital on liquidity. Members of our U.S. Executive Management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual Benefits; Rich Williams, President of Group Benefits; Eric Kirsch, Global Chief investment Officer and President of Aflac Global Investments; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing. Before we begin some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you. Good morning and thank you for joining us. At this time last year, it would have been very difficult to foresee the gravity of what was soon to unfold for society and for the company due to COVID-19. I’m proud of our employees, our sales distribution and Board of Directors for their decisive people first initiatives, we spearheaded early on in both the United States and Japan to protect our workforce and to be here for our policyholders throughout this trying time. We were able to reinforce our financial strength in operations as well as our distribution franchise with digital and virtual investments through the position of our company for the future growth. Adjusted earnings per diluted share excluding the impact of foreign exchange increased 10.8% in 2020. While benefiting from a lower effective tax rate, we were pleased with the results when you consider the pandemic pressure on revenues, accelerated investment in our core technological platforms and the initiatives to drive future earned premium growth and efficiency. Investing in growth and innovation will continue to be critical strategic focus this year. There is one central message that I’ve been emphasizing with our management team. It is imperative that we control the factors we have the ability to control. And what we don’t have control over, we must monitor continually to be ready to adapt. Despite the facts that sales in both U.S. and Japan have been suppressed considerably due to the constraints of face-to-face opportunities, we did not sit still. We maintained forward motion as we absorbed accelerated investment in our platform, while continuing strong earnings performance. In 2020, Aflac Japan generated solid overall financial results with a stable profit margin of 21.2%, an extremely strong premium persistency of 95.1%. The relaunch of our new Cancer Rider drove a sequential improvement in both cancer insurance and total sales in the fourth quarter. As a result, total sales were down 22.2% for the quarter and 36.2% for the year. In Japan, we introduced our new medical product in January and even up against difficult comparisons of last January, that were pre-COVID sales, it is a positive launch exceeding our expectations. We are encouraged by the reception of both the consumers and our sales force. While these sales results represent sequential improvements relative to last quarter, the effective reduced face-to-face activity are evident, and we continue to promote virtual sales. Our goal in Japan is to be the leading company for living in your own way. This is a declaration of how we tailor our products to fit the needs of customers during the different stages of their lives and reach them where they want to buy through agencies, strategic alliance and banks. Now turning to Aflac U.S., we saw a stable profit margin of 19.3%, amid a year of intense investments in the future of our business and the global pandemic conditions. However, this backdrop continues to noticeably impact our sales results in this segment as well, largely due to reduced face-to-face activity. As expected, we saw modest sequential sales improvement in the quarter with a decrease of 27.2% for the quarter and 30.3% for the year. In the U.S., we continue to feel the impact of limited access at the worksite, especially among our career agents, who have historically relied upon face-to-face meetings to engage small business owners and their employees. However, we remain cautiously optimistic for continued modest sequential sales improvement contingent upon the face of the economic recovery and as a result expect to see a brighter second half of 2021. Fred is responsible for acquisitions and he will cover that shortly. But while these acquisitions may not have an immediate effect on the top line, they better position Aflac for future long-term sales in the United States. As part of the Vision 2025 in the U.S., we seek to further develop a world where people are better prepared for unexpected health expenses. The need for the products we offer is a strong or stronger than ever has been. And at the same time, we know consumer habits and buying preferences have been evolving, and we are looking to reach them in ways other than the traditional media and the outside the worksite. This is part of the strategy to increase access, penetration and retention. Even while working remotely for the greater part of the year, we remain true to our culture and identity as a socially responsible company. We stepped up our engagement with our employees through virtual town meetings and weekly touch-base letters. Additionally, diversity continues to play an important role at Aflac as it has for decades. I have always believed that in order to accomplish our goals and serve the community where we have a presence, we must surround ourselves with a group of people, who bring different perspectives to the table. We have done that for years. At the end of 2020, nearly 50% of Aflac’s U.S. employees were minorities, 66% were women, 23% of our U.S. senior officers were minorities, and 30% were women. And then when you think of Aflac’s Board of Directors, 36% were minorities and 36% were women. Diversity has always played an important role within ESG, and we have Fred with executive oversight of our ESG efforts. He will provide greater detail on our 2021 key objectives. I’ve always said that the true test of strength is how one handles adversity. While pandemic conditions are ongoing, I’m pleased that 2020 confirmed what we knew all along and that is that Aflac is strong, adaptable and resilient. We strive to be where people want to purchase insurance that applies to both Japan and the United States. In the past, this has been meeting face-to-face with individuals to understand their situation, propose a solution and close the sale. However, the pandemic clearly demonstrates the need for virtual means, in other words, non face-to-face sales, to reach potential customers and provide them with the protection that they need. Therefore, we have accelerated investments to enhance the tools available for our distribution in both countries. Related to capital deployment, we placed significant importance on continuing to achieve strong capital ratios in the United States and Japan on behalf of our policyholders and shareholders. When it comes to capital deployment, we pursue value creation through a balance of actions including– excuse me, growth investments, stable dividend growth and disciplined tactical stock repurchase. It goes without saying that we treasure our record of dividend growth. The fourth quarter’s declaration marked the 38th consecutive year of dividend increases. Additionally, the board approved our first quarter dividend increase of 17.9%. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we remain tactical in our approach to share repurchase, buying back $1.5 billion of our shares in 2020. We have also focused on integrating the growth investments we have made in our platform. As always, we are working to achieve our earnings per share objectives, while also ensuring we deliver on our promise to our policyholders. By doing so, we look to emerge from this period in a continued position of strength and leadership. I don’t think it’s coincidental that we’ve achieved our success while focusing on doing the right things for our policyholders, shareholders, employees, distribution channel, business partners, and communities. In fact, I believe that go hand-in-hand. I’m proud of what we have accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Now, let me turn the program over to Fred. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Dan. I’m going to touch briefly on conditions in the fourth quarter with respect to the pandemic. I’ll then provide an update on key initiatives in Japan and the U.S. Japan has experienced approximately 400,000 COVID-19 cases and 6,000 confirmed deaths since inception of the virus. While quite low as compared to other developed countries and the U.S., these statistics have more than doubled since the end of the third quarter. Earlier this week, the government of Japan extended their state of emergency for Tokyo and nine other prefectures through March 7. This action includes the suspension of domestic tourism campaign and entry of foreigners into Japan. We have responded with again moving more of our workforce to working from home unlike the state of emergency declared last year in the initial stages of the virus, government restrictions are more balanced with economic recovery considerations, and we have not prohibited face-to-face consultations and/or closed our sales shops. Meanwhile, Prime Minister, Suga, has announced a goal of beginning vaccinations mid-February. Through the fourth quarter, Aflac Japan’s COVID-19 impact totaled approximately 3,400 unique claimants with incurred claims totaling JPY1 billion. We continue to experience a significant reduction in paid claims for medical conditions other than COVID-19 as Japan manages hospital capacity and discourages more routine visits. Despite the recent rise in infection rates in Japan, we continue to track well below our stress assumptions. As Dan outlined, sales have clearly been impacted, but when looking at policies in force, the impact of reduced sales on earned premium has largely been offset by improved persistency with the reduction in reported revenue driven primarily by paid-up policies. Finally, pandemic related expenses in the quarter totaled JPY1.8 billion, which includes the rollout of virtual distribution tools, employee teleworking equipment and distribution support. Turning to the U.S., there are nearly 27 million COVID-19 cases and over 450,000 deaths as reported by the CDC. For Aflac U.S., in 2020, COVID-19 claimants totaled 23,000 with incurred claims of approximately 71 million in the quarter and 128 million for all of 2020. We are now in a better position to back test the correlation of U.S. rates of infection to paid claims in order to build an estimate for incurred claim reserves. It’s fair to say this is still very difficult to estimate as IBNR often works from years of reliable data to establish trends. While our reserves assume elevated claims, we continue to see the length of stay in hospital and transition to ICU traveling below our expectations. We have seen limited impact to our reported persistency numbers. However, we believe this is in part attributed to the combination of reduced sales, where lapse rates tend to be much higher in the first year and the State Executive orders requiring premium grace periods. Executive orders are still in place in 11 states as of the end of the quarter with five states having open-ended expiration dates. We have reduced pressure on lapse rates through proactive work with our policyholders, including converting from payroll, deduction to direct bill, and encouraging a review of wellness benefits. Turning to key operating initiatives, 2020 was an important year in setting the stage for growth once we move clear of pandemic conditions. Beginning with Japan, after launching and promoting a simplified Cancer Rider in the fourth quarter, we successfully launched our refreshed medical product called EVER Prime in January. As Dan noted in his comments, it’s early and our associate channel is having to navigate pandemic conditions, but January medical sales are promising. Introduced in October of 2020, we have technology in place to allow agents to pivot from face-to-face to virtual sales and an entirely digital customer experience. True virtual sales in Japan is relatively limited. In addition, the majority of applications are still filed in paper form although digital applications have been adopted in face-to-face consultations. Excluding traditional non face-to-face means of distributing products like worksite, direct mail and call center sales, we estimate only 2% to 3% of our sales are currently digital end-to-end. However, we understand some of our agencies has significantly adopted virtual tools to supplement face-to-face consultations. We have discussed our paperless initiative across all operations in Japan. This is JPY10 billion investment with approximately JPY2.8 billion spent in the fourth quarter and JPY4.8 billion spent in 2020. We are projecting another JPY4.3 billion in spend planned for 2021. This investment has a three-year payback and will reduce the production and circulation of over 80 million pieces of paper per year. In summary, we expect the combination of product development, improved pandemic conditions and the return of Japan Post to distributing Aflac cancer insurance will drive growth as we look towards the second half of 2021. Turning to the U.S., we focused our efforts in 2020 on setting the table for 2021, including a national launch of network dental and vision, completing our Group Benefits acquisition and standing up our new direct-to-consumer digital platform. On the operation side, we rolled out a new and upgraded enrollment platform called Everwell 2.0 in September, which requires time for full adoption and stabilizing the platform, 2020 was an important year to introduce digital tools, increase adoption rates, and take on any corrective action before 2021. In addition, under Teresa White’s leadership, we have reorganized the U.S. forming Group Benefits in individual division. Rich Williams will now lead our Group Benefits division, which includes Aflac Voluntary Group, Aflac Network Dental and Vision, Argus our Dental TPA and our new Aflac Premier Life Absence Management and Disability business. Virgil Miller will lead our Individual Benefits Division, which includes Aflac’s individually issued and small business focused worksite products and our new consumer markets business targeting workers not at the traditional worksite. Both divisions pull from shared service U.S. operating platforms. This new alignment provides focus for each division within the U.S. business segments and allows Aflac to offer tailored products and services for our career agency teams and broker partners based on the unique markets they serve. Like Japan, we have all the tools in place for agents to conduct business without a face-to-face meeting. However, most sales are being driven on a continuum of face-to-face and digital interaction. We estimate about 15% of our traditional individual sales are completed without some form of face-to-face interaction. This excludes digital direct-to-consumer, which is naturally non-face-to-face. Turning to more specifics on our key growth initiatives, on January 12 we announced the national rollout of Aflac Dental and Vision. Our dental and vision products are now available in 40 states with more coming online throughout the year. This is a broad launch that is available to large and small companies and distributed through agents and brokers. In November, we closed down our Zurich Group Benefits acquisition, the new platform managed to contribute to sales in the quarter, with 5 million in production. This is more of a turnkey launch meaning products are filed and we are open for business in 2021 under the Aflac brand. Finally, we officially launched our new digital direct-to-consumer platform in the first week of January. We offer critical illness, accident and cancer, and are approved to sell all three products in approximately 30 States with more states and products coming online throughout the year. As highlighted during our investor conference, we are addressing expenses over two horizons. In 2020, we took actions to realize approximately 100 million of annualized run rate expense savings on a go-forward basis. Actions included restricting hiring, rationalizing distribution expenses and a voluntary separation plan that resulted in a 9% reduction to our U.S. workforce. Longer-term expense initiatives center on our group division and the migration onto a new administrative platform as well as inauguration of the Zurich Group Benefits business. As you are all aware, we have adopted a conservative buy-to-build acquisition strategy. The build efforts taken together impacted our expense ratio in the fourth quarter by 160 basis points, and is expected to impact the 2021 ratio by approximately 180 basis points. Our global investments team remains focused on asset quality, monitoring economic conditions, and sourcing new investment opportunities. Portfolio actions prior to and in the early days of the pandemic, lowered our exposure to prolonged economic weakness, and we ended 2020 with a modest amount of asset losses. We continue to watch closely our middle market loan and traditional real estate, transitional real estate portfolios, while we have seen ratings downgrades, our portfolios are resilient consisting of diversified first-lien loans, conservatively underwritten to high-quality borrowers. We have further refined our approach to managing the unhedged dollars in Japan, both lowering our hedge ratio and maintaining our out-of-the-money protection for extreme moves in foreign exchange. These unhedged dollars provide diversification and income benefits as well as lowering our enterprise exposure to the yen. As has been our practice, for 2021, we have locked in lower hedge costs with floating rate loan yields benefiting from LIBOR floors. Finally, we are pleased with the performance of our strategic investment and alliance with Varagon Capital Partners during 2020 contributing to corporate investment income. We are working to establish similar strategic alliances that leverage the capabilities of our asset management subsidiary and further the performance of our insurance segments. As commented on by Dan, we have refocused our efforts in key areas to drive tangible ESG initiatives in 2021. We are focused on the following. Building off our published ESG investment policy, Aflac Global Investments is advancing a responsible investing framework that includes the establishment of a core ESG team and formal governance process. We initiated work with third-party experts to measure, draft, and eventually disclose a formal plan to be carbon-neutral on or before 2040 and carbon net-zero emissions on or before 2050. We pledged to continue hitting key milestones on our important women in leadership initiative as part of a diversity and inclusion in Japan and targeting 30% of leadership positions in Japan filled by women by 2025. In the U.S., we seek to advance our already strong diversity statistics by broadening our influence through identifying and providing capital to organizations that advance diversity and inclusion as well as social justice and economic mobility. Finally, we pledged to advance reporting and disclosure framework in compliance with SASB and TCFD reporting standards. We’ll provide further disclosures on ESG initiatives in our proxy material and on our ESG Hub, esg.aflac.com. Wrapping up my comments, we believe the investments made in the past two years and accelerated during the pandemic, position us for future growth and efficiency in the face of what we believe to be temporary weakness in sales and earned premium. I’ll now pass on to Max to discuss financial performance in more detail. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Fred. We finished the year with stable fourth quarter earnings in a year marked by significant mortality and morbidity events, as well as continued low interest rates. Fourth quarter adjusted earnings per share increased 3.9% to $1.07, and the full year EPS was a record $4.96, up 11.7% year-over-year. Adjusted book value per share including foreign currency translation gains and losses grew 19.1% both for the quarter and full year. The adjusted ROE excluding the foreign currency impact was 12.1% in the fourth quarter and a respectable 15.1% for the full year, a material spread to our cost of capital. This quarter benefited from favorable marks on our alternative investment portfolio to the amount of $47 million pre-tax above our long-term return expectations, a very good outcome on our building alternatives portfolio. We also booked the severance charge associated with our previously announced voluntary separation program or VSP, in our U.S. and corporate segments, totaling pre-tax $43 million, included in adjusted earnings. Turning to our Japan segment, total earned premium for the quarter declined 3.5%, reflecting mainly first sector policies paid-up impacts, while earned premium for our third sector products was down 1.9%. For the full year, total earned premium was down 2.8%, while totaling policies in force declined by a lesser rate at 1.2%. As policies in force are not impacted by the paid-up status, it tends to serve as a better indicator of the growth of the underlying business. Persistency has been on a positive trajectory inched up slightly sequentially to 95.1%, up 70 basis points year-over-year. Japan’s total benefit ratio came in at 68.9% for the quarter, down 110 basis points year-over-year. And the third sector benefit ratio was 58.6%, down 150 basis points year-over-year. The main driver for the lower benefit ratio was a higher than normal IBNR release due to a sustained lower paid claims environment in 2020. We estimate that this lowered the benefit ratio by roughly 130 basis points compared to what we would deem a normal IBNR release to be. For the full year, the reported total benefit ratio was 69.9%, up 40 basis points year-over-year. And our third sector benefit ratio was 59.7%, also up 40 basis points year-over-year, largely due to improved persistency. The expense ratio in Japan was 23%, up 130 basis points year-over-year. The main driver was our paperless initiative, which kicked in at a higher gear as we digitize our operations and drive efficiencies throughout the value chain to a future state with significantly reduced paper usage. This investment increases our quarterly expense ratio by 85 basis points. For the quarter, adjusted net investment income increased 11.9% in yen terms, led by strong returns in our alternatives portfolio, but also strong results from the loan book like transactional real estate and middle market loans. For the full year, adjusted net investment income rose 4.4%. The pre-tax margin in the quarter was 20.9%, up 110 basis points year-over-year, as the combined effect from the lower benefit ratio and higher expense ratio was still positive. For the full year, the pre-tax margin was a respectable 21.2%. Turning to U.S. results, earned premium was down 2.3% for the quarter, due to weaker sales results. Persistency improved 160 basis points to 79.3%. This was driven by emergency orders in various states and by lower sales in 2020, as new policies lapsed at a higher rate than in force policies older than one year. Removing these factors would result in a stable year-over-year persistency rate. And we view that as a good outcome to date, given a pandemic environment impact on our policyholders and reflecting our efforts to retain accounts and keep premium in force. For the full year, earned premium was down 0.9%. Our total benefit ratio came in at 51.6%, which was 250 basis points higher than Q4 2019. Pandemic conditions continue to be very relevant when analyzing our benefit ratio. Due to the recent increase in infection rates, we estimate incurred claims impact of $72 million of which $58 million was an increase to IBNR, resulting in an impact to the benefit ratio of 5.1 percentage points from COVID related claims. This is somewhat offset by favorable non-COVID related claims activity, generating an underlying benefit ratio of 46.5%. COVID and non-COVID related claims tend to have a negative correlation, which clearly can be seen in our quarterly results throughout 2020. We would expect this pattern to continue in early 2021. Going forward we still expect the guided range of FAB of 48% to 51% to be a reasonable future benefit ratio. Our expense ratio in the U.S. was 43.5%, up 360 basis points year-over-year. The severance charge for our VSP explains 220 basis points of the rise, while the residual is primarily driven by digital investments and the reduction in revenues. The full year expense ratio landed at 38.6%. Adjusted net investment income in the U.S. was up 1.1% due to strong alternative investment income, while the portfolio book yield contracted 22 basis points year-over-year. Full year adjusted net investment income declined 2.1%. As both the benefit and expense ratio rose, profitability did come under pressure with a pre-tax margin of 11.6% in the quarter. For the full year, we still reported a solid pre-tax margin of 19.3% in line with recent historical average. In our Corporate segment, the pre-tax loss widened to $47 million in the quarter compared to $9 million from a year-ago. Lower net investment income on our short duration Hold Co. cash position, increased retirement expenses and $8 million of VSP severance expense were the main components of the delta. For the full year, the Corporate segment pre-tax loss was $115 million. Our capital position remains strong and stable. We ended the quarter with an SMR of north of 900% in Japan and an RBC of approximately 525% in Aflac Columbus. Holding company liquidity stood at $4 billion, $2 billion above our minimum balance. With a leverage of 23%, we continue to travel in the middle of our stated leverage range of 20% to 25% offering ample debt capacity. The continued spread of COVID-19 leads us to remain cautious in how we manage our capital base, make investments, and deploy capital to the benefit of the shareholder. In the quarter, we repurchased $500 million of our own stock and paid dividends of $196 million, offering good relative IRR on these capital deployments. For the full year, we paid $798 million of dividends and returned an additional $1.5 billion to shareholders in a formal share repurchases. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with meaningful spread to our cost of capital. A recent example is the board’s decision to increase the quarterly dividend by 17.9% to $0.33 per share. Before going into Q&A, I would characterize our 2020 financial performance as solid, despite significant external challenges. As we look forward into 2021, we do not see any fundamental drivers causing us to change the outlook provided at our financial analyst briefing in November. In order to achieve these objectives, we remain laser-focused on executing on our growth initiatives, expense efficiency and continue to drive ROE at the significant spread to our cost of capital. With that, let me turn over to David to begin Q&A."
},
{
"speaker": "David Young",
"text": "Thank you, Max. Now, we are ready to take your questions. But first, let me ask that you please limit yourself to one initial question and then one related follow-up to allow other participants an opportunity to ask a question. Carol, we will now take the first question, please."
},
{
"speaker": "Operator",
"text": "Thank you. Your first question comes from Nigel Dally from Morgan Stanley. Please go ahead."
},
{
"speaker": "Nigel Dally",
"text": "Great. Thanks and good morning. Wanted to ask about Japan sales. You mentioned the new medical product had exceeded initial expectations. Can you elaborate somewhat on that? And how sustainable should that improve demand base, more just a first quarter phenomena or should we expect that group momentum to continue into the second quarter and perhaps move on?"
},
{
"speaker": "Dan Amos",
"text": "This is Dan, and I’m going to let Japan. But let me just say that it tracked to me more of what other products in past introductions have done. It’s really too early to tell. It’s really only been out two weeks. So to go ahead forecast on two weeks, it’s a little too early to tell, but I am certainly optimistic that the field force or our agents are excited about it and the consumer seem to be excited about it, which means it’s a good product at a good time to be introducing. Of course, we’ll know much more details next quarter, but I would expect it to have the same pattern that we’ve seen with past introductions. Koji?"
},
{
"speaker": "Koji Ariyoshi",
"text": "[Foreign Language] And this new medical product is being very much well taken by the agencies because of the new coverage and the functions that we offer. [Foreign Language] And this product also is designed to be able to be sold through the non-exclusive agencies and be competitive in that market as well. [Foreign Language] So we are expecting that the sale of this product will increase in a non-exclusive market as we have taken a product strategy with more competitive advantage with this product. [Foreign Language] So we do believe that this product will last for a long time as this product will be very popular among younger generation as well. [Foreign Language] And although it only has been two weeks since the launch of the product, the actual number of new insurance policies coming in are increasing and at the same time a pay per policy is also on the increase. [Foreign Language] I think we have been able to get a much better start this time under the current environment compared with the medical product that we launched in 2019 as Rider. [Foreign Language] And we are expecting to see improvements in sales this quarter much more and we have seen some improvements in the fourth quarter last year as well, but we were planning to have more improved this quarter. [Foreign Language] And that’s all for me."
},
{
"speaker": "Nigel Dally",
"text": "That’s great. That’s very helpful. The second question is just on U.S. sales, understand broker-driven sales are holding in better than agency sales. Is it possible to get some quantification behind how much better I think with brokeraging group becoming much larger part of the strategy and business would find it helpful to understand how sales are trending along distribution lines."
},
{
"speaker": "Dan Amos",
"text": "I think it’s probably best for Teresa and Rich to handle the aperture. The premise of your question is correct. Broker group driven sales will hold up better under this environment than agent-driven small business sales for sure. So Teresa and Rich."
},
{
"speaker": "Teresa White",
"text": "Well, I’ll let Rich answer, but I’ll just make the comment that, yes, the broker sales are traditionally a lot more automated. We have a lot more digital presence in the broker environment just from the beginning. But I’ll let Rich response."
},
{
"speaker": "Rich Williams",
"text": "Thank you, Teresa. As Dan alluded to in his comments, we’ve seen reduced face-to-face activity, which certainly impacts agency sales. And then from a broker sales perspective, given that they tend to work with larger accounts, they are less dependent on face-to-face activity. And as a result in particular with our group business, our group business saw results in the single-digit decline whereas our traditional businesses saw it at a larger decline. But all those comments between Teresa, Fred and myself, I think, kind of speak to the question."
},
{
"speaker": "Nigel Dally",
"text": "That’s great. Thanks a lot."
},
{
"speaker": "Operator",
"text": "Our next question comes from John Barnidge from Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Yes. Thank you very much. I saw a headline the other day that Japan had banned chanting and required masks in the preparation to try and host the 2021 Olympics. Assuming that were to go through, I know previously you talked about joint marketing and product campaigns with Japan Post. Is there a possibility of some increased marketing expenses in the mid-year?"
},
{
"speaker": "Dan Amos",
"text": "Koji? Yes, we’ll have Koji or Koide-san address that. I would tell you that if what your question is, do you expect to build some form of marketing campaign surrounding the Olympics that is not in the plans and not normally what we would do. What we are doing, however, is building marketing campaigns around the launch of our new products and particularly taking advantage of a heightened awareness for supplemental health products in the COVID environment. So Koji and Koide-san, you can address it with more detail."
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language] And this is Koide from Japan. And we are not planning on having any particular campaign around the Olympics."
},
{
"speaker": "Fred Crawford",
"text": "John, I don’t know if that’s a correct thing you’re–"
},
{
"speaker": "John Barnidge",
"text": "Yes, Fred, it addressed, thank you very much. And then the follow-up, the wellness program you’ve started in 3Q 2020, is that still in play, because I think last time you said it would carry over a little bit? And how should we think about cost of that?"
},
{
"speaker": "Fred Crawford",
"text": "Yes, it is still in play in the sense that there’s sort of a – I’ll call it a tail to, if you will. In other words, we did the mailings. We saw, as you recall from last quarter, a spike in some of the wellness claims which will be flaunt, we hadn’t anticipate because we believe the payoff of that is not only persistency, but also being able to come back into companies. Let me explain that for a second. A lot of what our agents will do with their business clients is they will phone them up and say, based on our analysis you’ve got a certain number of employees that have wellness benefits. And we can help with understanding whether they are fully utilizing those wellness benefits to get money back in their pockets. As you can imagine, particularly as a small employer that’s an attractive proposition these days to get money in the pockets of your employees. And so that ends up lead or leading us into the account to talk about future enrollments and cross-selling and up-selling et cetera. And so that has been fairly successful. So it’s a very important piece of our product features and one that we would continue. If what you’re asking is what are we looking at in terms of ongoing, perhaps elevated claims related to wellness, that’s factored into some of our IBNR estimates, for example, where we’ll set up those types of reserves in anticipation of a trend line of wellness claims. And so at the moment, I’ll ask Max to give color, but I don’t anticipate that being a mover for our benefit ratio."
},
{
"speaker": "Max Broden",
"text": "That’s right, Fred. And John, as you remember, we did a – we had a campaign in the third quarter and obviously we had the impact on our benefit ratio in the U.S. in the third quarter both from paid claims, but also that we established an IBNR associated with that wellness campaign. As you now look at the impact on the fourth quarter, you did not really see any impact follow through into the fourth quarter because of the IBNR that we established in the third quarter. Going forward, we would expect these to be more normal activity for us. There may be instances with any significant campaigns that could trigger an increase in claims temporarily, but generally be relatively small. But if you refer specifically to the campaign, the big campaign we had in the third quarter, that hit the benefit ratio in the third quarter and we didn’t really have much of a follow through into the fourth quarter."
},
{
"speaker": "John Barnidge",
"text": "Great. Thank you very much."
},
{
"speaker": "Operator",
"text": "Our next question comes from Suneet Kamath from Citi. Please go ahead."
},
{
"speaker": "Suneet Kamath",
"text": "Thanks. Good morning. I wanted to go to the Japan benefit ratio. I think you said that some of the improvement or the lower than expected result or better than expected result was due to reserve releases. How are you guys planning for benefit ratios as you think about a world where the economy opens up again? And maybe we see the more people in Japan going to hospitals versus what we’re seeing right now, which I understand is a sort of subdued level of activity."
},
{
"speaker": "Max Broden",
"text": "Let me kick it off at a high level. And I have Todd to fill in the blanks as well. Specifically for the fourth quarter, we had an reserve release all of about JPY 7 billion that is higher than we would normally incur in a quarter. We estimate that lowered the benefit ratio by about a 130 basis points in the quarter. And this is because of the paid claims pattern that we’re seeing primarily to the non-COVID-related claims activity as – that Fred referred to in his prepared remarks. Going forward, you could obviously see an impact on the benefits ratio temporarily from an element of the sort of pent-up demand for hospitalizations, like elective surgery, physicals, et cetera. I think that’s much more the case in the U.S. than in Japan, where the Japan hospital system have been running at a more normal level than what we’ve seen here in the U.S. So you could see a little bit of a higher benefit ratio from that, but this has been taken into consideration when we gave you the benefit ratio range at FAB of 68.5% to 71% in our outlook. So I’ll leave it at that and Todd, please feel free to give some additional comments."
},
{
"speaker": "Todd Daniels",
"text": "No, Max. I think you’re right, especially if you think about our hospitalizations as it relates to accident hospitalizations, they won’t come back, accidents that have happened and you’ve recovered. However, there could be a level of sickness hospitalizations that would increase in the future. One other aspect of our benefit ratio that I’ll mention, if we get our sales back to more normal level and we start with introducing product when people refresh product that has a slight impact on the benefit ratio as well in the form of reserve releases on old policy. So last year as we saw in our results, persistency increased which led to a slightly higher net benefit reserve with those policy holders hanging onto those policies."
},
{
"speaker": "Suneet Kamath",
"text": "Okay, thanks. And then just my follow-up is on U.S. sales. Dan, you had commented that you’re optimistic about a recovery in the second half. How much of that is just due to sort of recovery in face-to-face sales versus some of the things that you’re doing to try to improve the penetration of the direct-to-consumer or the digital virtual sales?"
},
{
"speaker": "Dan Amos",
"text": "Well, I think it’s a combination of both. And of course, you’re going against much easier numbers, especially in the second quarter and so that within itself makes it easier. But all-in-all we have been working on trying to find ways to do less face-to-face and more virtual. And we’ve been preparing for that and it just got accelerated. I will say, the new norm today is much improved over six months ago in terms of ability to get around as the vaccines are getting out. So we are seeing some stability from that standpoint. Teresa, would you like to make any comments specifically?"
},
{
"speaker": "Teresa White",
"text": "Yes, I’ll make a couple of comments. I agree if the combination of both the virtual environment and as our agents get better with adopting some of the virtual tools, I think we’ll continue to see improvement. But the other thing that I think that we are excited about is the idea of having new product that has been introduced, the dental vision product specifically in some of the broker and the small case market as well as in the larger case market having some of the life and disability products available as well. So we have a great opportunity in the second half to really start selling some of the newer product that we have out there. And so I think that’s what gives us – that’s what makes us excited about the second half of the year, of course vaccines, et cetera."
},
{
"speaker": "Suneet Kamath",
"text": "Okay. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from Gregory Peters from Raymond James. Please go ahead."
},
{
"speaker": "Gregory Peters",
"text": "Good morning. Thanks for squeezing me in. I want a just big picture on – you talked about risk adjusted return on equities, when we look at your slide deck, I mean you have a great track record of ROE. We’ve seen a number of other large insurance companies sort of get away from earnings per share guidance and focus on sort of setting ROE target. So given all the changes and challenges you’ve dealt with last year and with growth being uncertain at least in the near-term. How should we be thinking about sort of the ROE objectives for your company for 2021 and 2022?"
},
{
"speaker": "Dan Amos",
"text": "Yes. So Greg, I think we will be operating in a fairly stable environment. We obviously are running at fairly high capital levels and that is putting some pressure on ROE as we go forward. So it makes it somewhat challenging to continue to sort of operating in the strong ROE levels that we have been in the mid-teens. Like for example this year, we came in slightly above 15% for the full year. That being said, I do think that long-term, one way to sort of think about our business is, it’s a fairly capital light products that we sell, both in Japan and in the U.S. And over time I would expect that we should sort of run into sort of 600 basis points above our cost of capital is a reasonable way to sort of think about where our ROE should be over time. Because we don’t have a whole lot of interest rate sensitivity, but it does play a factor in terms of what sort of driving the ROE as well."
},
{
"speaker": "Max Broden",
"text": "Yes. One thing Greg to I would add is, yes, you’re seeing a bit of a migration from EPS to ROE, but also from GAAP earnings to cash flow valuation and the cash flow dynamics of the company remain extremely strong even further advanced than that. I think particularly soon when it comes to Aflac, you’re going to want to focus in on economic value. And what I mean by that is, if you think about our goal with the new businesses we’ve brought on, which is network dental and vision, absentee management, disability and life true group if you will, and then the direct-to-consumer. These are businesses that we expect to combine, contribute upwards of $1 billion of earned premium over the next five to seven years. And that earned premium will have a different GAAP profit dynamic associated with it because it’s in building mode. And as you know, direct-to-consumer, you don’t DAC expenses and so by definition you have lower reported profit. At the same time that business if actuarially appraised, absolutely has value and some would argue great value as you can imagine. So I think as we communicate going forward, it’s not just communicating on EPS and ROE, but it’s also communicating on cash flow and the economic value that we’re driving in the company for the long run."
},
{
"speaker": "Gregory Peters",
"text": "Got it. The second question is more in the weeds, but I know, on you’re prepared comments you talked about, now that COVID – we’ve got a year of COVID under the belt. You’re looking at reserves and using the data sort of set the reserve levels. And I’m just curious, both in Japan and in the U.S., how you’re reconciling one-year’s results with the fact that there’s a rollout of a vaccine? And that may cause data to shift entirely in a different direction over the course of the next 12 months?"
},
{
"speaker": "Fred Crawford",
"text": "I commented a bit on this in my script and Max commented on it. Look, it’s a very interesting science right now for valuation actuaries establishing reserves, particularly incurred but not reported reserves. These are practices that these models and so-called completion factors, if you want to use the technical language, are built-off of years-and-years and quarters-and-quarters of information that gives particularly for a stable business like ours, very high confidence in the level of IBNR to set up on a per-product basis. Here, you have pandemic conditions, but you also have not a linear dynamic but a convex dynamic of infections. And as you said, you’ve got these new wrinkles as in vaccination, the amount of vaccinations that rolls out, the acceptance and absorption of the vaccination among the public et cetera. And so it is a tricky environment, but these are incurred but not yet reported claims. Meaning it’s our best estimate right now of what we believe to be claims coming in and in-hand. It is still however an estimate and it’s an estimate under a convex environment. And so we’ll have to continue to back test, monitor and adjust our completion factors accordingly."
},
{
"speaker": "Gregory Peters",
"text": "Got it. Thanks for the answers."
},
{
"speaker": "Operator",
"text": "This concludes the Q&A portion of our call. And I’ll turn it back for any closing remarks."
},
{
"speaker": "Dan Amos",
"text": "Thank you, Carol, and thank you all for joining our call this morning. We look forward to speaking with you soon, if you have any additional follow-ups. And I wish you all continued good health. Thank you."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 3 | 2,020 | 2020-10-28 09:00:00 | Operator: Good day everyone and welcome to Aflac’s third quarter 2020 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to your host, David Young, Vice President of Aflac Incorporated Investor Relations. Please go ahead, sir.
David Young: Thank you Adrienne. Good morning and welcome to Aflac Incorporated’s third quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter as well as our operations in Japan and the United States amid the COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated will begin with an overview of our operations in Japan and the U.S. Fred Crawford, President and COO of Aflac Incorporated will then touch briefly on conditions in the third quarter and discuss how we are navigating the pandemic, including some key initiatives. Max Broden, Executive Vice President and CFO of Aflac Incorporated will then conclude our prepared remarks with a summary of third quarter financial results and current capital and liquidity. Joining us this morning during the Q&A portion are members of our executive management team in the U.S.: Teresa White, President of Aflac U.S., Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Rich Williams, Chief Distribution Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer, and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan: Charles Lake, Chairman and representative Director, President of Aflac International; Masatoshi Koide, President and representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations to certain non-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?
Daniel Amos: Thank you David, and good morning. Thanks for joining us. As we all know, the COVID-19 pandemic has ushered in some of the most difficult times for so many people around the globe, and we continue to pray for all those affected. I’d like to share my appreciation for our employees and sales force in Japan and the United States for their tireless work in helping our policyholders and communities impacted by the pandemic. During this difficult time, it’s important to note that we remain focused on doing what we do best, that is providing protective products to help consumers when they need it most. This morning, I’ll provide an overview of the quarter and how we performed by operating segment. Financially, Aflac continues to be impacted by the pandemic but remains strong in terms of capital and liquidity. In addition, our investments are high quality and diversified, and they are among the highest return on capital and lowest cost of capital in the industry. Amid the challenges of COVID-19, this quarter was also significantly impacted by the release of favorable U.S. tax regulations related to the utilization of foreign tax credits. You will recall that our Japanese subsidiary is taxed as a U.S. domestic company for U.S. tax purposes. In the quarter, we recognized a cumulative year to date benefit from these regulations of $202 million, or $0.28 per share compared to our previous run rate. Max will provide additional details. Turning to our operations, starting with Aflac Japan, the effect of COVID-19 continues to noticeably impact our results, as seen in the third quarter with sales decreasing 32%. We continued to have around 50% of the workforce working from home in Japan and in September, traffic coming into the shops remained at 70% of pre-pandemic levels. While these sales results represent sequential improvements relative to the last quarter, the effect of the reduced face-to-face activities are evident and we continue to promote virtual sales. 2020 has also ushered in a change on the Japanese political front. Prime Minister Abe was Japan’s longest serving prime minister and a source of political stability with nearly eight years in office. Mr. Suga was a core member of Abe’s administration leadership team, serving as the Chief Cabinet Secretary. We believe Mr. Suga’s administration will carry on skilled leadership. This will continue to promote a good business environment in Japan and emphasize policies in terms of the response to COVID-19 and economic policies. Prime Minister Suga is accelerating efforts to move forward with regulatory reforms for a post pandemic world, promoting digital transformation. In that respect, I am pleased that Aflac Japan’s paperless initiative is well underway, and Fred will share more. Turning to Aflac U.S., the effects of COVID-19 continued to noticeably impact our results in this segment as well. Largely due to reduced face-to-face activity, third quarter sales were down 35.7%. In the U.S., we continue to feel the impact of temporary business closures and lack of access to the worksite, especially among our career agents who have historically relied upon face-to-face meetings to engage our small business owners and their employees. At the same time, the fourth quarter is typically when we see strong results in the broker-driven group market, which has generally been more resilient to non face-to-face conditions. As a result, we remain cautiously optimistic for modest sequential sales improvement for Aflac U.S. in the fourth quarter compared to the second and third quarter, contingent upon the pace of the economic recovery. We are also on track to close our acquisition of Zurich Group Business Benefit soon, which allows us to extend our distribution reach and appeal to brokers and large employers. While having little effect on the fourth quarter, the acquisition positions us for expanded capacity as we look forward to 2021. To place Aflac in a position of strength, we know that we must balance investing in growth with an eye towards reducing expenses in the long run. As such, we took an opportunity to offer a very generous voluntary separation package to eligible employees who expressed an interest. As a result, we have achieved an approximate 9% reduction in our U.S. and corporate workforce with expected one-time expenses of $45 million in the fourth quarter. This allowed us to thank employees for their years of faithful service and dedication as they pursue a new path or open up the next chapter. You will recall that the U.S. benefit ratio was significantly affected by policyholders’ limited visits to the doctor. With this in mind, we launched a U.S. initiative early in the third quarter to remind policyholders of the value of their wellness benefits attached to their products. The wellness benefit pays on certain routine doctor, dentist, and hospitalization visits. In addition, we made sure that it pays a benefit for COVID-19 testing. The wellness initiative has been a success. We are glad we emphasized this important aspect of our policy as it reinforces how we are there for the policyholder when they need us most. This wellness campaign and the voluntary separation programs were a couple of near term headwinds to the profit margin; however, we expect that they will serve us well as we enter 2021. To conclude our operational discussion, as I’ve said before, we want to be where the people want to purchase insurance. That applies to both Japan and the U.S. In the past, this has meant meeting face-to-face with individuals to understand their situation, propose a solution, and close the sale; however, the pandemic clearly demonstrates the need for virtual meets, in other words non face-to-face sales to reach potential customers and provide them with the protection that they need. Therefore, we have accelerated investment to enhance the tools available to our distribution in both countries. As always, we are committed to prudent liquidity and capital management. This includes maintaining strong capital ratios on behalf of the policyholders in both the U.S. and Japan, and a tactical approach to capital allocation. It goes without saying that we treasure our record of dividend growth. With the fourth quarter declaration, 2020 will mark the 38th consecutive year of dividend increases. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we have remained tactical in our approach to share repurchase, buying back $400 million of our shares in the third quarter. We have also focused on integrating the growth investments that we have made in our platform. By doing so, we look to emerge from this period of continued position of strength and leadership. As always, we are working to achieve our earnings per share objectives while also ensuring we deliver on our promise to our policyholders. We look forward to going into greater detail on our strategic growth plans and efforts to drive efficiency at the financial analyst briefing conference call in a few weeks. Now I’d like to turn the program over to Fred. Fred?
Frederick Crawford: Thank you Dan. I’m going to touch briefly on conditions in the third quarter and how we’re navigating the pandemic. I’ll also provide an update on key initiatives in Japan and the U.S. to include our approach to managing expenses. There are currently approximately 97,000 COVID-19 cases and 1,730 deaths in all of Japan. Through the third quarter, Aflac Japan COVID-19 impact totaled 1,750 unique claimants with incurred claims totaling approximately ¥550 million in the quarter and ¥760 million year to date. In short, we are tracking well below our stress assumptions with no measurable impact from COVID-19 claims; however, reduced sales and delaying the promotion of the new cancer rider and refreshed medical product are contributing to revenue pressure. This pressure is offset somewhat by favorable persistency. COVID-related expenses in the quarter totaled ¥1.7 billion, which included the rollout of virtual distribution tools, employee teleworking equipment, and distribution support. In the U.S., the dynamics are understandably more complex. COVID-19 case levels in the U.S. now exceed 8.5 million with deaths nearly 230,000. Through the end of the third quarter, COVID-19 claimants in the U.S. totaled 12,800 with incurred claims of approximately $23 million in the quarter and year to date approximately $57 million. We are closely monitoring the recent surge in infections but continue to see the rate of hospitalization, length of stay in the hospital, and transition to ICU traveling below our expectations. We believe this is attributed to advancements in treatment and the nature of the worksite, which is a generally younger and healthier population of policyholders. As Dan noted in his comments, we launched an initiative early in the third quarter to remind policyholders of their wellness benefits, which drove increased utilization. This effort involved connecting with 2.7 million accident and hospital policyholders through a combination of email and direct mail in the month of August. This impacted our benefit ratio in the period but is designed to reinforce the value proposition of our products. We have thus far seen limited impact to persistency, however we believe this is partially attributed to state executive orders requiring premium grace periods. These executive orders are still in place in 13 states as of the end of the quarter. In those states where the executive orders have expired, we have reduced pressure on lapse rates through proactive outreach to policyholders and employers, actively converting policyholders from payroll deduction to direct bill and notifying policyholders of their wellness benefits. Turning to key operating initiatives in both Japan and the U.S., we are balancing investments in growth while addressing our expense structure. A material driver of elevated expense ratios in Japan and the U.S. is weakness in revenue, thus the need for a balanced approach. Beginning with Japan, we are set to promote a simplified cancer rider in the fourth quarter and launching our refreshed medical product in the first quarter of 2021. Rolled out in late October, we have the technology in place to pivot from face-to-face to virtual sales and an entirely digital customer experience. We continue with direct mail campaigns aided by data analytics that serve to enhance the close rate. We expect the combination of product development, a recovery in pandemic conditions, and our alliance with Japan Post to be important growth drivers as we make our way through 2021. We view the pandemic as a call to action on accelerating investment in our digital road map and related process improvements. On our second quarter call, I noted our paperless initiative across all operations in Japan. This is a three-year and roughly ¥10 billion investment with approximately ¥2 billion spent in the third quarter along with another ¥3.6 billion estimated spend in the fourth quarter. While elevating our 2020 expenses, this effort will reduce the production and circulation of 80 million pieces of paper per year with run rate savings in the range of ¥3 billion annually. As we move to the fourth quarter, we have budgeted an increase in general administration expenses over our third quarter of approximately ¥6 billion. This includes 50% of our 2020 annual advertising spend concentrated in the quarter to raise new product awareness as well as a stepped up level of investment in the paperless initiative. We are effectively accelerating investments in our digital platform into 2020 and 2021. Turning to the U.S., the build-out of network dental and vision remains on track. We have successfully filed our new network products in 48 states with approvals received in 37 states. We are up and running with sales in 10 states and expect to ramp this up as we move into 2021. Our consumer markets platform remains on track with hospital, accident and cancer product filings expected to be completed in early 2021. We also plan to include life insurance in 2021, recognizing that is a natural product to sell digitally empowered by the Aflac brand. Finally, we will soon close on our Zurich Benefits acquisition, having successfully completed the required regulatory approvals. Along with efforts to improve overall persistency, these are the three largest incremental drivers to earned premium growth in the coming years. Anticipating further pressure on near term earned premium as we move into 2021, we are addressing expenses in the U.S. with a sense of urgency. We are addressing expenses across two horizons. Horizon one is near term focused and includes a series of actions in 2020 designed to take out approximately $100 million of annualized run rate expenses as we enter 2021. This includes both the U.S. platform and corporate expenses. Early in the fourth quarter, we completed a voluntary separation plan for eligible employees which will result in a 9% reduction to our U.S. workforce. We expect to record a one-time separation expense of approximately $45 million in the fourth quarter and will realize annualized run rate savings in the $45 million to $50 million range. Horizon two expense initiatives elevate near term expenses until such time the investment is complete. Legacy platforms are decommissioned and business processes are adjusted. The most significant investment is in our group business and migration off an old administrative platform onto a new platform. In addition, we are completing a broader digital road map which includes approximately $25 million of accelerated investment in 2020, much of that investment coming in the fourth quarter. As I noted, we need to balance these expense initiatives with investment in growth. We have adopted a buy to build acquisition strategy. While a tactical and prudent use of excess capital, this is not an inexpensive effort in the early years. These build efforts include dental and vision, direct to consumer, and group benefits and taken together impacted our expense ratio in the third quarter by 110 basis points, and are expected to impact the fourth quarter by approximately 160 basis points. I’ll conclude my comments with investment conditions. Our global investment team remains focused on asset quality, monitoring economic conditions, and sourcing new investment opportunities in a low interest rate environment. Our firm view is that we will experience a checkmark-shaped recovery, meaning a slow road to recovery with pockets of volatility along the way. Our actions prior the pandemic to tactically improve the risk profile of our portfolio combined with some additional de-risking earlier this year has served us well, with only modest losses on the sale of securities, impairments and loss reserve increases. These actions have also positioned the portfolio defensively should we see a second surge in the virus impact economic conditions. We continue to watch closely our middle market loan and transitional real estate portfolios. While we have seen credit rating downgrades, our middle market loan portfolio is more resilient, consisting of first lien loans to high quality borrowers backed by strong equity sponsors. In the case of transitional real estate, our portfolio is also consisting of only first lien positions and is diversified with strong loans to value. We continue to explore ways to optimize currency hedging. Overall, no material change, but we are further refining our approach to managing the unhedged dollars in Japan. These unhedged dollars provide diversification and income benefits, as well as lowering our enterprise exposure to the yen. As we look towards 2021, we will reset 2020 hedges on our floating rate portfolio and currency hedges at materially lower rates. While we do not see this impacting net investment income to any great degree, you will see line item impacts to Japan’s net investment income, hedge costs, and corporate investment income. Wrapping up my comments, we are not backing off critical investments to drive long term growth and efficiency in the face of what we believe to be temporary weakness in sales results and earned premium. We will provide further detail around this when we meet for our annual financial investor conference in the coming weeks, and we’ll talk about the details of investments and when we expect them to turn the corner to having a positive impact on growth and profits. I’ll now pass onto Max to discuss financial performance in more detail. Max?
Max Broden: Thank you Fred. Let me begin my comments with a review of our third quarter performance with a focus on how our core capital and earnings drivers have developed. For the third quarter, adjusted earnings per share increased 19.8% to $1.39 with no significant impact from FX in the quarter. Adjusted book value per share, including foreign currency translation gains and losses, grew 17.4% and the adjusted ROE, excluding the foreign currency impact, was a strong 16.8%, a material spread to our cost of capital. This quarter was significantly impacted by the release of favorable U.S. tax regulations related to the utilization of foreign tax credits. As a reminder, our Japanese subsidiary is taxed as a U.S. domestic company for U.S. tax purposes. In the quarter, we recognized a cumulative year-to-date benefit from these regulations which lowered our tax rate on adjusted earnings for the quarter to 4.1%, a benefit of $0.28 versus our previous run rate. Our tax rate for the quarter further benefited from tax credits in our solar and historic rehabilitation investments which lowered our tax expense by approximately $20 million more than in a normal quarter. In addition, variable investment income came in $6 million above our long-term return expectations, and together these two items boosted current quarter EPS by about $0.03. On a go forward basis and under the current U.S. corporate tax regime, we would expect our go forward tax rate on adjusted earnings to be approximately 20%. Turning to our Japan segment, total earned premium for the quarter declined 3.3%, reflecting mainly first sector policies paid up impacts, while earned premium put at third sector product was down 1.7%. Japan’s revenue trend should be considered in light of impact of paid-up policies. For example, year-over-year earned premium was down 3.3% in the quarter while policies in force was down a little less than 1%. This disconnect masks the strength of persistency which has been rising during the pandemic. In short, expenses related to managing our in force tend to hold steady despite the drop in reported earned premium, putting pressure on our expense ratio. Japan’s total benefit ratio came in at 71.3% for the quarter, up 130 basis points year over year, and the third sector benefit ratio was 61.7%, up 170 basis points year over year. The main driver of the increase was lower lapses associated with policyholders updating their coverage. Given the current lower new business activity, this naturally pushes up our benefit ratio due to lower reserve releases, decreases back amortization, and improves reported persistency. We did experience all of this in the third quarter, manifested by our persistency improving by 80 basis points year over year. The IBNR was also less favorable this quarter. We’ve seen a drop in paid claims during the pandemic, more so in our medical coverages. Our IBNR as met has only partially reflected this drop given there is not much data to base an adjustment on. We continue to monitor experience and will adjust our paid data as it gets more complete. In addition, for our cancer claims that are more than three years old, we extended the completion of claims which led to a smaller release in IBNR compared to 2019. Our expense ratio in Japan was 21.7%, up 110 basis points year over year. Our paperless initiative kicked into higher gear as we digitized our operations and drove efficiencies throughout the value chain to a future state with significantly reduced paper usage. Overall, when considering COVID-related spend, promotional spend and digital and paperless initiatives, we anticipate expense ratios in Japan to remain elevated in the 22% range for the remainder of 2020. Net investment income declined 0.2% in yen terms despite the higher variable investment income, as our yen-denominated portfolio generated lower yields due to lower call income in this quarter. The pre-tax margin for Japan in the quarter was 19.4%, impacted by both the higher benefit ratio as well as a higher expense ratio in the quarter. Turning to U.S. results, earned premium was down 2.6% due to weaker sales results. Premium persistency improved 80 basis points to 78.8% as our efforts to retain accounts and keep premium in force showed early positive results. As Fred mentioned, there are still 13 states with premium grace periods in place at the end of Q3, so we are monitoring these developments closely. Our total benefit ratio came in at 48.3%, which was 80 basis points lower than Q3 2019. We have seen a normalization of claims activity across our portfolio compared to the second quarter. In order to improve customer experience and persistency, we conducted an extensive policyholder communication campaign highlighting the embedded wellness benefit in our accident products, and we encouraged policyholders to utilize this benefit. We estimate this initiative drove incremental claims of approximately $14 million and impacted our benefit ratio in the range of 100 basis points over what we would normally expect, but we believe our efforts will add value for the customer and improve their experience along with improved long term persistency. Our expense ratio in the U.S. was 37.2%, up 130 basis points year over year. The inclusion of Argus added 80 basis points in the quarter and a decline in revenues roughly explains the residual year-over-year impact. The impact from declining revenues has become more pronounced on our ratios in this quarter relative to prior quarters. We anticipate expense ratios in the U.S. to remain elevated in the 39% range for the full year 2020, driven by near term weakness in revenues, uptick in seasonal business activity, and expected inclusion of the Zurich Group Benefits acquisition. Net investment income in the U.S. was down 4.4% due to a 14 basis point contraction in portfolio yield. Profitability in the U.S. segment remained healthy at 20.5% with a low benefit ratio as the core driver. In our corporate segment, amortized hedge income contributed $22 million on a pre-tax basis to the quarter’s earnings with an ending notional position of $5 billion. Our capital position remained strong and we ended the quarter with an SMR north of 900% in Japan and an RBC of approximately 700% in Aflac Columbus. Our RBC is temporarily boosted by delaying statutory subsidiary dividends to Q4. We still expect to end the year with an RBC in the range of 550 to 600%. Holding company liquidity stood at $3.8 billion, $1.8 billion above our minimum balance. This is down compared to earlier in the year but reflects our decision to delay regular Q3 subsidiary dividends to Q4. On an annual basis, we expect uninterrupted dividend flows to continue from our subsidiaries. Leverage improved to a comfortable 22.9% due to the increase in shareholders equity driven by the release of the tax valuation allowance of $1.4 billion. While we remain cautious in terms of monitoring the pandemic, we have comfort in the strength of our capital ratios, excess capital, statutory earnings and dividend capacity, and our ability to navigate any current and future stress brought on by the pandemic or associated economic conditions. In the quarter, we repurchased $400 million of our own stock and paid dividends of $192 million. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive a strong risk-adjusted return on equity with a meaningful spread to our cost of capital. Let me now turn it over to David to begin Q&A.
David Young: Thank you Max. We’re now ready to take your questions, but first let me ask you to please limit yourselves to one initial question, followed by a related follow-up question to allow other participants an opportunity to ask a question. Adrienne, we will now take that first question.
Operator: Your first question comes from the line of Nigel Dally with Morgan Stanley.
Nigel Dally: Great, thanks, and good morning everyone. My question is on expenses. You announced the U.S. expense reduction initiative together with the paperless initiative in Japan, but you’re also talking about ramping higher investments in other digital and growth initiatives. Appreciate the color for the fourth quarter, but how should we be thinking about expense ratios in 2021? Should we see the benefit of those initiatives flow through to the bottom line or still elevated expense ratios looking forward?
Frederick Crawford: Nigel, this is Fred. I would say in general, both in the case of the U.S. as well as Japan in 2021, you should anticipate a continuation of elevated expenses as these investments will continue at their current pace. In fact in the U.S., we will particularly be building more proactively on the dental and vision, the consumer markets, and then now adding the group benefits business, so you’ll see the pace of investment improve. When it comes to business as usual expenses, or what we would call our general operating expenses, that’s where you’ll see improvement particularly in the U.S. as we take action around staffing models, headcount and other related cost savings efforts, so it’s a balancing act. We’ll give more color on our expense ratios, both in Japan and the U.S., at the financial analyst briefing as we traditionally do, so I don’t want to get out in front of that; but I can certainly answer your question that the pace of investment will continue to go forward but it’s really directed towards growth, as well as efficiency. Remember there’s two components to the expense ratio, and one of the things weighing on our expense ratios right now in Japan and the U.S. is weakness in revenue, so we’ve got to drive these expenses through to generate revenue improvement over time. That will be the path to victory on expense ratios ultimately.
Nigel Dally: Very helpful, thank you.
Operator: Your next question comes from the line of Jimmy Bhullar with JP Morgan Securities LLC.
Jimmy Bhullar: Hi, good morning. I had a question just on the U.S. business. Obviously sales have been pretty weak recently, and I’m assuming that 4Q will be a little bit better just given that a majority of the sales are broker sales and that channel doesn’t seem to be as impacted by social distancing and stuff. But what’s your path to an improvement in sales beyond that, because I’m assuming even though businesses are starting to open up, most of them are going to be reluctant to have salespeople come in and pitch products or [indiscernible] people, so what’s--like, just a few comments on what you feel is going to drive recovery in your sales in the U.S. beyond just a vaccine or normalization of social and business trends?
Daniel Amos: I’m going to have Richard answer that.
Richard Williams: Okay, thank you Jimmy. As Dan noted in his comments, we expect modest sequential improvement in the fourth quarter compared to the second and the third quarter, and as you recall, the fourth quarter for us is more heavily weighted to broker sales, roughly about 50% of our quarter. That’s where less face-to-face enrollment is utilized as well as larger cases, so I think those are the support points to Dan’s comments around modest sequential improvement. I think secondly, we will reserve comment around 2021 for our outlook call and financial analyst briefing, and we look forward to that discussion then.
Daniel Amos: Teresa, do you want to add anything?
Teresa White: No, I think Rich covered it. Thank you.
Jimmy Bhullar: Maybe just another one on the U.S. on your persistency. Can you talk about what you’ve seen in terms of persistency in the regions where premium grace periods have expired? Are you seeing an uptick in lapses there, or not?
Teresa White: Overall we have not seen a notable increase in policy lapses given the stability in our persistency rates, but we continue to monitor especially with the small business side. It’s important to note that small business is a large part of our in force; however, the premium is more balanced across small and large cases, so really we’re not seeing what we thought we would see, but we’re continuing to monitor this and we’ll give more insight at the investor conference as well.
Frederick Crawford: And I think the wellness benefit and our ability to pay claims for it, although it kicked up our benefit ratio which we wanted to happen, we believe it will also have a positive impact on persistency as people realize they need the product.
Jimmy Bhullar: Thanks.
Operator: The next question comes from the line of Suneet Kamath with Citi.
Suneet Kamath: Thanks, good morning. I think you had said you expect some new products in Japan in the first quarter, so just curious - normally when you launch a new product, we see an almost immediate pick-up in sales. Just given the pandemic and how the sales dynamic has changed, should we expect the same sort of trend that we’ve seen historically, and will you be selling this new medical product in the Japan--sorry, the cancer product in the Japan closed channel?
Daniel Amos: Koide?
Masatoshi Koide: Koji will answer that question.
Koji Ariyoshi: [translated from Japanese] In terms of medical insurance, as we have already started with our cancer insurance, we have implemented web certification as well as application--insurance application system, from October, and this will allow reduction of COVID-19 risk, like having social distance. On top of that, this medical insurance product that we plan to launch is a competitive product, so we will be able to win in the competition, and that way we should be able to increase our share in the medical market. Our new product has a broad range of coverage to really be able to respond to various types of customers. For example, a lot of the customers have concerns about the three dread diseases, which we will cover further in this new product, as well as short term coverage in the medical insurance, and at the same time those customers who really do not want to just keep on paying premium and gain nothing, we do have some no-claim bonus rider that can be added to this rider, so we should be able to respond to various needs of customers. We would like to use this medical insurance product as sort of the engine to start our sales in 2021, and with the web virtual sales we should be able to minimize the negative impact or the risk of COVID-19, so we’d like to really use this to harness our sales.
Suneet Kamath: Okay, thanks. Then I guess for Max on the tax rate change, was any of this related to the Trump tax cuts, and then accordingly is there any risk that under a different administration, this tax ruling that you got could be reversed?
Max Broden: No, it’s not related to the Trump tax cuts. This is related to a new regulation issued by the U.S. Treasury and the IRS that came out on September 29.
Suneet Kamath: Okay, thanks.
Operator: The next question comes from the line of John Barnidge with Piper Sandler.
John Barnidge: How should we be thinking about the permanence of the some of the declines in utilization in the U.S. from maybe changed behavior from COVID, principally maybe telemedicine driving down the benefits ratio?
Daniel Amos: Well, I think it’s still in limbo in terms of what we’re absolutely sure will happen. Certainly we have seen when, let’s say April-May-June, people were staying inside more, they were not going to the doctor, we saw a drop-off in the claims. The idea of the wellness benefit is to get them back to a doctor, twofold: one, to have utilization of the policy and therefore improved persistency, raise the loss ratio some but also prevent people from--I mean, I have a friend whose wife was diagnosed with a stage 3 cancer, and if they had gone to the doctor as they should have but couldn’t because of COVID, they could have caught it much earlier. So one of the things that we’re watching is to see whether or not there’s a tail on this, and that’s why we’re trying to encourage people to go ahead now and go back to the doctor, use these wellness benefits, get the exams you should get, and hopefully that brings down the tail on the business. We know that it’s already picking back up in terms of people going back to the doctor, but it’s not back to the normal amount that it was running pre-COVID.
John Barnidge: Okay, very helpful. The wellness initiative that trimmed 100 basis points on the benefits ratio, has that completely played out or could there be still more to come?
Teresa White: We believe that there could still be more to come there.
John Barnidge: Thank you.
Operator: The next question comes from the line of Erik Bass with Autonomous Research.
Erik Bass: Hi, thank you. Do you intend to let all of the tax benefit drop to the bottom line, and do you see opportunity to either accelerate investment or adjust product pricing to boost growth?
Max Broden: We obviously have multiple initiatives in place in order to drive growth, as Fred outlined, and that is pushing up our expense ratio and has. That’s been in play for the last couple of years, and we see that ongoing. Generally I would characterize this benefit as dropping to the bottom line.
Frederick Crawford: One thing I would add, though, and this goes to the previous question too about how to think about future corporate tax rate changes, is that we do have to be mindful of that. This effectively just creates an even playing field for the way in which we report our effective tax rate and cash tax payments; in other words, we are effectively paying a 21% corporate tax rate as being a U.S. taxpayer at Aflac, and so to the degree there is a change in tax law going forward, we’ll be impacted much like any other corporate taxpayer in the U.S., so we do have to be mindful of that and we’ll be watching that carefully. Having said that, though, there is a very real benefit to us, both cash-wise and effective tax rate for a period of time, including going back and grabbing some cash flows that we had previously paid out in the way of tax payments, so it’s a real benefit that one that you want to be careful about taking into the future, if you believe there could be changes in the corporate tax rate going forward.
Erik Bass: Thank you, then can you talk a little bit about the recruiting and licensing backdrop for new agents?
Teresa White: Rich?
Richard Williams: Absolutely. First of all, recruiting continues to be a very important part of our element and strategy going forward. We saw improvement in the third quarter compared to the second quarter, and we--you know, at the beginning of 2020 we implemented significant alignment from a compensation program to drive producer growth and to drive recruiting. The anticipation on recruiting for the fourth quarter is we expect to see moderate improvement compared to the second and third quarter, and then as we look to 2021, we’ll clearly talk about that more at the investor conference, but it will be a key part of our strategy.
Erik Bass: Got it, thank you.
Operator: The next question comes from the line of Humphrey Lee with Dowling & Partners.
Humphrey Lee: Good morning and thank you for taking my questions. My first question is related to the expenses in Japan. I heard that you talked about the ¥1.7 billion for the COVID-related expenses in the quarter, and then also there was ¥2 billion related to the paperless initiatives. But just looking at the sequential increase in expenses, still those two pieces only explain half of the increase, so I was just wondering what’s the other driver for the much higher expenses in the quarter?
Max Broden: The main driver in terms of the expense ratio is the decline in revenues, so you have the increased spending but also the function of lower revenues is impacting the expense ratio.
Humphrey Lee: But I’m just referring to the notional general expense amount of ¥72 billion.
Frederick Crawford: I think much of that has to do with just seasonal dynamics related to direct mail spend as well as other promotional initiatives in the quarter related to--you know, as compared to last year, so I think some of it was just natural fluctuation. The two main drivers, and maybe I would add a third, are not only COVID-related expenses and the paperless initiative, but we also continue to accelerate certain digital investments in the quarter, and those are the primary drivers of just an incremental increase in general operating expenses.
Humphrey Lee: Okay, and then in terms of the Zurich addition in the fourth quarter, how should we think about the size of the premium add, and then also by extension the expense impacts of that platform, and also what’s your expectation on a full year premium basis for that business?
Frederick Crawford: That business has been running at around, I believe in the $75 million to $100 million annualized premium range. As you can expect, that’s a lumpy business because it’s largely a start-up at Zurich and it tends to focus on large accounts. But it’s also a very persistent business, so there’s high persistency with that business, so I would expect on an annualized basis it’s in that range, so it will have a modest impact to annual earned premium. In terms of the overall P&L impact on it, as we mentioned when we announced the transaction, we would expect there to be roughly $0.05 dilution on an annualized basis related to that transaction, and that’s largely because as they are still ramping up the business, their revenue is not enough to offset their cost structure because it’s in a growth mode, and so--and we expect obviously and intend to continue that growth mode going forward, so that’s essentially the nature of the business. It’s modestly dilutive to earnings and modestly accretive to earned premium.
Humphrey Lee: Got it, thank you.
Operator: The next question comes from the line of Andrew Kligerman with Credit Suisse.
Andrew Kligerman: Hey, good morning. My first question is around the benefits ratio, and I’m wondering as we look out in the U.S. at 48.3, down from 49.1 year-over-year, and then of course 44.3 quarter-over-quarter, have we reached kind of a stable zone now? How would you expect it to trend over the course of the next several quarters?
Frederick Crawford: Well in general, we would expect it to trend up, but really up to previous reported numbers prior to the pandemic, and that’s simply because of what Dan outlined in his comments, that there will be naturally a gradual increase in utilization but really back to normal levels, and still overall favorable relative to going back in history, so you’ll see it trend up. Wellness related impacts will subside, we certainly hope, but frankly we’re monitoring, as you can imagine given the news, COVID related cases, but overall we would expect utilization to find its more normal levels over time. We are bringing on businesses that tend to have higher benefit ratios and lower expense ratios - network dental and vision, for example, and then of course group benefits, so over time you’ll eventually have a bit of a mix play in our benefit ratio to be aware of, but that’s unlikely to be material certainly over the next several quarters and in 2021. But you’ll see that play out over time and we’ll of course be able to report that out and let you know what’s influencing the benefit ratio and expense ratio.
Andrew Kligerman: Great. Earlier in the year, you provided a credit stress scenario of about $680 million of credit losses. Has that changed, improved, worsened? What’s the outlook there, and what are you seeing into 2021?
Frederick Crawford: Eric, why don’t you take that?
Eric Kirsch: Sure thing, thank you, Andrew. Naturally we continue to analyze our portfolio with stress scenarios, inclusive of how our portfolio actually performed over these past six months, and looking forward including assumptions about a second wave and economic and market impacts. In fact, our portfolio has performed very well through the first part of the pandemic and better than expected relative to our stress test. In addition, as you may recollect, in the second quarter we did some marginal de-risking and risk reduction, and there were particular names in the stress test that in essence were impacted or went away. Having said that, we’re completing our newest stress test and intend on presenting that at this upcoming FAB, so if you can be patient for about another month, you’ll see some of the new results.
Andrew Kligerman: Got it, thank you.
Operator: The final question comes from the line of Tom Gallagher with Evercore ISI.
Tom Gallagher: Good morning. First question, Max, can you give a sense for how the cash tax benefits will compare to the reduction in the GAAP tax rate, and how we should think about that playing out over time?
Max Broden: Cash taxes will always be volatile, and there will be timing differences between our GAAP and our cash taxes, but over time I would expect them to have about the same impact from this change in tax regulation.
Tom Gallagher: Would you expect there to be a meaningful difference in the first couple of years and converge over time, or is it going to be, would you say, directionally similar with some volatility around it, if you know what I mean?
Max Broden: Yes, it would be the latter. There will not any material, significant difference, and certainly not over as long period as a number of years. It’s more the latter, where we might in a short term have some timing differences, but generally speaking we would expect our cash taxes to come down as well.
Tom Gallagher: Got you, and then my follow-up is can you--just given the increase in the benefit ratio in Japan this quarter, the 150 basis points to 200 basis points, can you talk about--and I know you had referenced that was somewhat related to the slowdown in sales and the impact of lapse and reissue, can you talk--given that sales are likely to remain at least somewhat lower relative to historical levels, can you talk about whether you would still expect to see the broader trend of benefit ratio improving here over the next couple of years, or are we likely to see that maybe go the other way?
Max Broden: Todd, why don’t you take a crack at that?
Todd Daniels: Okay, thanks Max. Really when we look forward for our persistency, and as Max alluded to, it’s totally related to sales activity, and about 80 basis points in the benefit ratio for the quarter is attributed to lack of what I will call lapse in reissue activity. As we introduce product in the first quarter, I would expect that to pick up somewhat for the medical block, so I would really anticipate as we go through next year that you see more of a normalized termination rate, which will lead to a more normal looking benefit ratio, especially as it pertains to the policy reserve aspect of it.
Tom Gallagher: Got you, and Todd, would you still expect the broader trend over multiple years of improvement in the benefit ratio?
Todd Daniels: I think as we see claims come in and our trends that we have in our cancer and medical blocks, that will be reflected in the benefit ratio going forward.
Tom Gallagher: Okay, thanks.
Max Broden: Tom, we will address some of the underlying drivers in terms of hospitalizations and duration of hospital stays, etc. at FAB, so we’ll give you a little bit more insight into that.
Tom Gallagher: Thank you.
David Young: That leads us to the top of the hour. Before concluding, I just wanted to remind you that we have combined our financial analyst briefing and our 2021 outlook call into a special webcast event on the morning of November 19 at 8:00 am Eastern time. For more details, please reach out to Investor Relations here, and we thank you all for joining us today, and look forward to speaking with you soon and wish you all continued good health. Thank you.
Operator: This concludes today’s call. Everyone may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day everyone and welcome to Aflac’s third quarter 2020 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to your host, David Young, Vice President of Aflac Incorporated Investor Relations. Please go ahead, sir."
},
{
"speaker": "David Young",
"text": "Thank you Adrienne. Good morning and welcome to Aflac Incorporated’s third quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter as well as our operations in Japan and the United States amid the COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated will begin with an overview of our operations in Japan and the U.S. Fred Crawford, President and COO of Aflac Incorporated will then touch briefly on conditions in the third quarter and discuss how we are navigating the pandemic, including some key initiatives. Max Broden, Executive Vice President and CFO of Aflac Incorporated will then conclude our prepared remarks with a summary of third quarter financial results and current capital and liquidity. Joining us this morning during the Q&A portion are members of our executive management team in the U.S.: Teresa White, President of Aflac U.S., Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Rich Williams, Chief Distribution Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer, and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan: Charles Lake, Chairman and representative Director, President of Aflac International; Masatoshi Koide, President and representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations to certain non-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?"
},
{
"speaker": "Daniel Amos",
"text": "Thank you David, and good morning. Thanks for joining us. As we all know, the COVID-19 pandemic has ushered in some of the most difficult times for so many people around the globe, and we continue to pray for all those affected. I’d like to share my appreciation for our employees and sales force in Japan and the United States for their tireless work in helping our policyholders and communities impacted by the pandemic. During this difficult time, it’s important to note that we remain focused on doing what we do best, that is providing protective products to help consumers when they need it most. This morning, I’ll provide an overview of the quarter and how we performed by operating segment. Financially, Aflac continues to be impacted by the pandemic but remains strong in terms of capital and liquidity. In addition, our investments are high quality and diversified, and they are among the highest return on capital and lowest cost of capital in the industry. Amid the challenges of COVID-19, this quarter was also significantly impacted by the release of favorable U.S. tax regulations related to the utilization of foreign tax credits. You will recall that our Japanese subsidiary is taxed as a U.S. domestic company for U.S. tax purposes. In the quarter, we recognized a cumulative year to date benefit from these regulations of $202 million, or $0.28 per share compared to our previous run rate. Max will provide additional details. Turning to our operations, starting with Aflac Japan, the effect of COVID-19 continues to noticeably impact our results, as seen in the third quarter with sales decreasing 32%. We continued to have around 50% of the workforce working from home in Japan and in September, traffic coming into the shops remained at 70% of pre-pandemic levels. While these sales results represent sequential improvements relative to the last quarter, the effect of the reduced face-to-face activities are evident and we continue to promote virtual sales. 2020 has also ushered in a change on the Japanese political front. Prime Minister Abe was Japan’s longest serving prime minister and a source of political stability with nearly eight years in office. Mr. Suga was a core member of Abe’s administration leadership team, serving as the Chief Cabinet Secretary. We believe Mr. Suga’s administration will carry on skilled leadership. This will continue to promote a good business environment in Japan and emphasize policies in terms of the response to COVID-19 and economic policies. Prime Minister Suga is accelerating efforts to move forward with regulatory reforms for a post pandemic world, promoting digital transformation. In that respect, I am pleased that Aflac Japan’s paperless initiative is well underway, and Fred will share more. Turning to Aflac U.S., the effects of COVID-19 continued to noticeably impact our results in this segment as well. Largely due to reduced face-to-face activity, third quarter sales were down 35.7%. In the U.S., we continue to feel the impact of temporary business closures and lack of access to the worksite, especially among our career agents who have historically relied upon face-to-face meetings to engage our small business owners and their employees. At the same time, the fourth quarter is typically when we see strong results in the broker-driven group market, which has generally been more resilient to non face-to-face conditions. As a result, we remain cautiously optimistic for modest sequential sales improvement for Aflac U.S. in the fourth quarter compared to the second and third quarter, contingent upon the pace of the economic recovery. We are also on track to close our acquisition of Zurich Group Business Benefit soon, which allows us to extend our distribution reach and appeal to brokers and large employers. While having little effect on the fourth quarter, the acquisition positions us for expanded capacity as we look forward to 2021. To place Aflac in a position of strength, we know that we must balance investing in growth with an eye towards reducing expenses in the long run. As such, we took an opportunity to offer a very generous voluntary separation package to eligible employees who expressed an interest. As a result, we have achieved an approximate 9% reduction in our U.S. and corporate workforce with expected one-time expenses of $45 million in the fourth quarter. This allowed us to thank employees for their years of faithful service and dedication as they pursue a new path or open up the next chapter. You will recall that the U.S. benefit ratio was significantly affected by policyholders’ limited visits to the doctor. With this in mind, we launched a U.S. initiative early in the third quarter to remind policyholders of the value of their wellness benefits attached to their products. The wellness benefit pays on certain routine doctor, dentist, and hospitalization visits. In addition, we made sure that it pays a benefit for COVID-19 testing. The wellness initiative has been a success. We are glad we emphasized this important aspect of our policy as it reinforces how we are there for the policyholder when they need us most. This wellness campaign and the voluntary separation programs were a couple of near term headwinds to the profit margin; however, we expect that they will serve us well as we enter 2021. To conclude our operational discussion, as I’ve said before, we want to be where the people want to purchase insurance. That applies to both Japan and the U.S. In the past, this has meant meeting face-to-face with individuals to understand their situation, propose a solution, and close the sale; however, the pandemic clearly demonstrates the need for virtual meets, in other words non face-to-face sales to reach potential customers and provide them with the protection that they need. Therefore, we have accelerated investment to enhance the tools available to our distribution in both countries. As always, we are committed to prudent liquidity and capital management. This includes maintaining strong capital ratios on behalf of the policyholders in both the U.S. and Japan, and a tactical approach to capital allocation. It goes without saying that we treasure our record of dividend growth. With the fourth quarter declaration, 2020 will mark the 38th consecutive year of dividend increases. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we have remained tactical in our approach to share repurchase, buying back $400 million of our shares in the third quarter. We have also focused on integrating the growth investments that we have made in our platform. By doing so, we look to emerge from this period of continued position of strength and leadership. As always, we are working to achieve our earnings per share objectives while also ensuring we deliver on our promise to our policyholders. We look forward to going into greater detail on our strategic growth plans and efforts to drive efficiency at the financial analyst briefing conference call in a few weeks. Now I’d like to turn the program over to Fred. Fred?"
},
{
"speaker": "Frederick Crawford",
"text": "Thank you Dan. I’m going to touch briefly on conditions in the third quarter and how we’re navigating the pandemic. I’ll also provide an update on key initiatives in Japan and the U.S. to include our approach to managing expenses. There are currently approximately 97,000 COVID-19 cases and 1,730 deaths in all of Japan. Through the third quarter, Aflac Japan COVID-19 impact totaled 1,750 unique claimants with incurred claims totaling approximately ¥550 million in the quarter and ¥760 million year to date. In short, we are tracking well below our stress assumptions with no measurable impact from COVID-19 claims; however, reduced sales and delaying the promotion of the new cancer rider and refreshed medical product are contributing to revenue pressure. This pressure is offset somewhat by favorable persistency. COVID-related expenses in the quarter totaled ¥1.7 billion, which included the rollout of virtual distribution tools, employee teleworking equipment, and distribution support. In the U.S., the dynamics are understandably more complex. COVID-19 case levels in the U.S. now exceed 8.5 million with deaths nearly 230,000. Through the end of the third quarter, COVID-19 claimants in the U.S. totaled 12,800 with incurred claims of approximately $23 million in the quarter and year to date approximately $57 million. We are closely monitoring the recent surge in infections but continue to see the rate of hospitalization, length of stay in the hospital, and transition to ICU traveling below our expectations. We believe this is attributed to advancements in treatment and the nature of the worksite, which is a generally younger and healthier population of policyholders. As Dan noted in his comments, we launched an initiative early in the third quarter to remind policyholders of their wellness benefits, which drove increased utilization. This effort involved connecting with 2.7 million accident and hospital policyholders through a combination of email and direct mail in the month of August. This impacted our benefit ratio in the period but is designed to reinforce the value proposition of our products. We have thus far seen limited impact to persistency, however we believe this is partially attributed to state executive orders requiring premium grace periods. These executive orders are still in place in 13 states as of the end of the quarter. In those states where the executive orders have expired, we have reduced pressure on lapse rates through proactive outreach to policyholders and employers, actively converting policyholders from payroll deduction to direct bill and notifying policyholders of their wellness benefits. Turning to key operating initiatives in both Japan and the U.S., we are balancing investments in growth while addressing our expense structure. A material driver of elevated expense ratios in Japan and the U.S. is weakness in revenue, thus the need for a balanced approach. Beginning with Japan, we are set to promote a simplified cancer rider in the fourth quarter and launching our refreshed medical product in the first quarter of 2021. Rolled out in late October, we have the technology in place to pivot from face-to-face to virtual sales and an entirely digital customer experience. We continue with direct mail campaigns aided by data analytics that serve to enhance the close rate. We expect the combination of product development, a recovery in pandemic conditions, and our alliance with Japan Post to be important growth drivers as we make our way through 2021. We view the pandemic as a call to action on accelerating investment in our digital road map and related process improvements. On our second quarter call, I noted our paperless initiative across all operations in Japan. This is a three-year and roughly ¥10 billion investment with approximately ¥2 billion spent in the third quarter along with another ¥3.6 billion estimated spend in the fourth quarter. While elevating our 2020 expenses, this effort will reduce the production and circulation of 80 million pieces of paper per year with run rate savings in the range of ¥3 billion annually. As we move to the fourth quarter, we have budgeted an increase in general administration expenses over our third quarter of approximately ¥6 billion. This includes 50% of our 2020 annual advertising spend concentrated in the quarter to raise new product awareness as well as a stepped up level of investment in the paperless initiative. We are effectively accelerating investments in our digital platform into 2020 and 2021. Turning to the U.S., the build-out of network dental and vision remains on track. We have successfully filed our new network products in 48 states with approvals received in 37 states. We are up and running with sales in 10 states and expect to ramp this up as we move into 2021. Our consumer markets platform remains on track with hospital, accident and cancer product filings expected to be completed in early 2021. We also plan to include life insurance in 2021, recognizing that is a natural product to sell digitally empowered by the Aflac brand. Finally, we will soon close on our Zurich Benefits acquisition, having successfully completed the required regulatory approvals. Along with efforts to improve overall persistency, these are the three largest incremental drivers to earned premium growth in the coming years. Anticipating further pressure on near term earned premium as we move into 2021, we are addressing expenses in the U.S. with a sense of urgency. We are addressing expenses across two horizons. Horizon one is near term focused and includes a series of actions in 2020 designed to take out approximately $100 million of annualized run rate expenses as we enter 2021. This includes both the U.S. platform and corporate expenses. Early in the fourth quarter, we completed a voluntary separation plan for eligible employees which will result in a 9% reduction to our U.S. workforce. We expect to record a one-time separation expense of approximately $45 million in the fourth quarter and will realize annualized run rate savings in the $45 million to $50 million range. Horizon two expense initiatives elevate near term expenses until such time the investment is complete. Legacy platforms are decommissioned and business processes are adjusted. The most significant investment is in our group business and migration off an old administrative platform onto a new platform. In addition, we are completing a broader digital road map which includes approximately $25 million of accelerated investment in 2020, much of that investment coming in the fourth quarter. As I noted, we need to balance these expense initiatives with investment in growth. We have adopted a buy to build acquisition strategy. While a tactical and prudent use of excess capital, this is not an inexpensive effort in the early years. These build efforts include dental and vision, direct to consumer, and group benefits and taken together impacted our expense ratio in the third quarter by 110 basis points, and are expected to impact the fourth quarter by approximately 160 basis points. I’ll conclude my comments with investment conditions. Our global investment team remains focused on asset quality, monitoring economic conditions, and sourcing new investment opportunities in a low interest rate environment. Our firm view is that we will experience a checkmark-shaped recovery, meaning a slow road to recovery with pockets of volatility along the way. Our actions prior the pandemic to tactically improve the risk profile of our portfolio combined with some additional de-risking earlier this year has served us well, with only modest losses on the sale of securities, impairments and loss reserve increases. These actions have also positioned the portfolio defensively should we see a second surge in the virus impact economic conditions. We continue to watch closely our middle market loan and transitional real estate portfolios. While we have seen credit rating downgrades, our middle market loan portfolio is more resilient, consisting of first lien loans to high quality borrowers backed by strong equity sponsors. In the case of transitional real estate, our portfolio is also consisting of only first lien positions and is diversified with strong loans to value. We continue to explore ways to optimize currency hedging. Overall, no material change, but we are further refining our approach to managing the unhedged dollars in Japan. These unhedged dollars provide diversification and income benefits, as well as lowering our enterprise exposure to the yen. As we look towards 2021, we will reset 2020 hedges on our floating rate portfolio and currency hedges at materially lower rates. While we do not see this impacting net investment income to any great degree, you will see line item impacts to Japan’s net investment income, hedge costs, and corporate investment income. Wrapping up my comments, we are not backing off critical investments to drive long term growth and efficiency in the face of what we believe to be temporary weakness in sales results and earned premium. We will provide further detail around this when we meet for our annual financial investor conference in the coming weeks, and we’ll talk about the details of investments and when we expect them to turn the corner to having a positive impact on growth and profits. I’ll now pass onto Max to discuss financial performance in more detail. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you Fred. Let me begin my comments with a review of our third quarter performance with a focus on how our core capital and earnings drivers have developed. For the third quarter, adjusted earnings per share increased 19.8% to $1.39 with no significant impact from FX in the quarter. Adjusted book value per share, including foreign currency translation gains and losses, grew 17.4% and the adjusted ROE, excluding the foreign currency impact, was a strong 16.8%, a material spread to our cost of capital. This quarter was significantly impacted by the release of favorable U.S. tax regulations related to the utilization of foreign tax credits. As a reminder, our Japanese subsidiary is taxed as a U.S. domestic company for U.S. tax purposes. In the quarter, we recognized a cumulative year-to-date benefit from these regulations which lowered our tax rate on adjusted earnings for the quarter to 4.1%, a benefit of $0.28 versus our previous run rate. Our tax rate for the quarter further benefited from tax credits in our solar and historic rehabilitation investments which lowered our tax expense by approximately $20 million more than in a normal quarter. In addition, variable investment income came in $6 million above our long-term return expectations, and together these two items boosted current quarter EPS by about $0.03. On a go forward basis and under the current U.S. corporate tax regime, we would expect our go forward tax rate on adjusted earnings to be approximately 20%. Turning to our Japan segment, total earned premium for the quarter declined 3.3%, reflecting mainly first sector policies paid up impacts, while earned premium put at third sector product was down 1.7%. Japan’s revenue trend should be considered in light of impact of paid-up policies. For example, year-over-year earned premium was down 3.3% in the quarter while policies in force was down a little less than 1%. This disconnect masks the strength of persistency which has been rising during the pandemic. In short, expenses related to managing our in force tend to hold steady despite the drop in reported earned premium, putting pressure on our expense ratio. Japan’s total benefit ratio came in at 71.3% for the quarter, up 130 basis points year over year, and the third sector benefit ratio was 61.7%, up 170 basis points year over year. The main driver of the increase was lower lapses associated with policyholders updating their coverage. Given the current lower new business activity, this naturally pushes up our benefit ratio due to lower reserve releases, decreases back amortization, and improves reported persistency. We did experience all of this in the third quarter, manifested by our persistency improving by 80 basis points year over year. The IBNR was also less favorable this quarter. We’ve seen a drop in paid claims during the pandemic, more so in our medical coverages. Our IBNR as met has only partially reflected this drop given there is not much data to base an adjustment on. We continue to monitor experience and will adjust our paid data as it gets more complete. In addition, for our cancer claims that are more than three years old, we extended the completion of claims which led to a smaller release in IBNR compared to 2019. Our expense ratio in Japan was 21.7%, up 110 basis points year over year. Our paperless initiative kicked into higher gear as we digitized our operations and drove efficiencies throughout the value chain to a future state with significantly reduced paper usage. Overall, when considering COVID-related spend, promotional spend and digital and paperless initiatives, we anticipate expense ratios in Japan to remain elevated in the 22% range for the remainder of 2020. Net investment income declined 0.2% in yen terms despite the higher variable investment income, as our yen-denominated portfolio generated lower yields due to lower call income in this quarter. The pre-tax margin for Japan in the quarter was 19.4%, impacted by both the higher benefit ratio as well as a higher expense ratio in the quarter. Turning to U.S. results, earned premium was down 2.6% due to weaker sales results. Premium persistency improved 80 basis points to 78.8% as our efforts to retain accounts and keep premium in force showed early positive results. As Fred mentioned, there are still 13 states with premium grace periods in place at the end of Q3, so we are monitoring these developments closely. Our total benefit ratio came in at 48.3%, which was 80 basis points lower than Q3 2019. We have seen a normalization of claims activity across our portfolio compared to the second quarter. In order to improve customer experience and persistency, we conducted an extensive policyholder communication campaign highlighting the embedded wellness benefit in our accident products, and we encouraged policyholders to utilize this benefit. We estimate this initiative drove incremental claims of approximately $14 million and impacted our benefit ratio in the range of 100 basis points over what we would normally expect, but we believe our efforts will add value for the customer and improve their experience along with improved long term persistency. Our expense ratio in the U.S. was 37.2%, up 130 basis points year over year. The inclusion of Argus added 80 basis points in the quarter and a decline in revenues roughly explains the residual year-over-year impact. The impact from declining revenues has become more pronounced on our ratios in this quarter relative to prior quarters. We anticipate expense ratios in the U.S. to remain elevated in the 39% range for the full year 2020, driven by near term weakness in revenues, uptick in seasonal business activity, and expected inclusion of the Zurich Group Benefits acquisition. Net investment income in the U.S. was down 4.4% due to a 14 basis point contraction in portfolio yield. Profitability in the U.S. segment remained healthy at 20.5% with a low benefit ratio as the core driver. In our corporate segment, amortized hedge income contributed $22 million on a pre-tax basis to the quarter’s earnings with an ending notional position of $5 billion. Our capital position remained strong and we ended the quarter with an SMR north of 900% in Japan and an RBC of approximately 700% in Aflac Columbus. Our RBC is temporarily boosted by delaying statutory subsidiary dividends to Q4. We still expect to end the year with an RBC in the range of 550 to 600%. Holding company liquidity stood at $3.8 billion, $1.8 billion above our minimum balance. This is down compared to earlier in the year but reflects our decision to delay regular Q3 subsidiary dividends to Q4. On an annual basis, we expect uninterrupted dividend flows to continue from our subsidiaries. Leverage improved to a comfortable 22.9% due to the increase in shareholders equity driven by the release of the tax valuation allowance of $1.4 billion. While we remain cautious in terms of monitoring the pandemic, we have comfort in the strength of our capital ratios, excess capital, statutory earnings and dividend capacity, and our ability to navigate any current and future stress brought on by the pandemic or associated economic conditions. In the quarter, we repurchased $400 million of our own stock and paid dividends of $192 million. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive a strong risk-adjusted return on equity with a meaningful spread to our cost of capital. Let me now turn it over to David to begin Q&A."
},
{
"speaker": "David Young",
"text": "Thank you Max. We’re now ready to take your questions, but first let me ask you to please limit yourselves to one initial question, followed by a related follow-up question to allow other participants an opportunity to ask a question. Adrienne, we will now take that first question."
},
{
"speaker": "Operator",
"text": "Your first question comes from the line of Nigel Dally with Morgan Stanley."
},
{
"speaker": "Nigel Dally",
"text": "Great, thanks, and good morning everyone. My question is on expenses. You announced the U.S. expense reduction initiative together with the paperless initiative in Japan, but you’re also talking about ramping higher investments in other digital and growth initiatives. Appreciate the color for the fourth quarter, but how should we be thinking about expense ratios in 2021? Should we see the benefit of those initiatives flow through to the bottom line or still elevated expense ratios looking forward?"
},
{
"speaker": "Frederick Crawford",
"text": "Nigel, this is Fred. I would say in general, both in the case of the U.S. as well as Japan in 2021, you should anticipate a continuation of elevated expenses as these investments will continue at their current pace. In fact in the U.S., we will particularly be building more proactively on the dental and vision, the consumer markets, and then now adding the group benefits business, so you’ll see the pace of investment improve. When it comes to business as usual expenses, or what we would call our general operating expenses, that’s where you’ll see improvement particularly in the U.S. as we take action around staffing models, headcount and other related cost savings efforts, so it’s a balancing act. We’ll give more color on our expense ratios, both in Japan and the U.S., at the financial analyst briefing as we traditionally do, so I don’t want to get out in front of that; but I can certainly answer your question that the pace of investment will continue to go forward but it’s really directed towards growth, as well as efficiency. Remember there’s two components to the expense ratio, and one of the things weighing on our expense ratios right now in Japan and the U.S. is weakness in revenue, so we’ve got to drive these expenses through to generate revenue improvement over time. That will be the path to victory on expense ratios ultimately."
},
{
"speaker": "Nigel Dally",
"text": "Very helpful, thank you."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Jimmy Bhullar with JP Morgan Securities LLC."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hi, good morning. I had a question just on the U.S. business. Obviously sales have been pretty weak recently, and I’m assuming that 4Q will be a little bit better just given that a majority of the sales are broker sales and that channel doesn’t seem to be as impacted by social distancing and stuff. But what’s your path to an improvement in sales beyond that, because I’m assuming even though businesses are starting to open up, most of them are going to be reluctant to have salespeople come in and pitch products or [indiscernible] people, so what’s--like, just a few comments on what you feel is going to drive recovery in your sales in the U.S. beyond just a vaccine or normalization of social and business trends?"
},
{
"speaker": "Daniel Amos",
"text": "I’m going to have Richard answer that."
},
{
"speaker": "Richard Williams",
"text": "Okay, thank you Jimmy. As Dan noted in his comments, we expect modest sequential improvement in the fourth quarter compared to the second and the third quarter, and as you recall, the fourth quarter for us is more heavily weighted to broker sales, roughly about 50% of our quarter. That’s where less face-to-face enrollment is utilized as well as larger cases, so I think those are the support points to Dan’s comments around modest sequential improvement. I think secondly, we will reserve comment around 2021 for our outlook call and financial analyst briefing, and we look forward to that discussion then."
},
{
"speaker": "Daniel Amos",
"text": "Teresa, do you want to add anything?"
},
{
"speaker": "Teresa White",
"text": "No, I think Rich covered it. Thank you."
},
{
"speaker": "Jimmy Bhullar",
"text": "Maybe just another one on the U.S. on your persistency. Can you talk about what you’ve seen in terms of persistency in the regions where premium grace periods have expired? Are you seeing an uptick in lapses there, or not?"
},
{
"speaker": "Teresa White",
"text": "Overall we have not seen a notable increase in policy lapses given the stability in our persistency rates, but we continue to monitor especially with the small business side. It’s important to note that small business is a large part of our in force; however, the premium is more balanced across small and large cases, so really we’re not seeing what we thought we would see, but we’re continuing to monitor this and we’ll give more insight at the investor conference as well."
},
{
"speaker": "Frederick Crawford",
"text": "And I think the wellness benefit and our ability to pay claims for it, although it kicked up our benefit ratio which we wanted to happen, we believe it will also have a positive impact on persistency as people realize they need the product."
},
{
"speaker": "Jimmy Bhullar",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Suneet Kamath with Citi."
},
{
"speaker": "Suneet Kamath",
"text": "Thanks, good morning. I think you had said you expect some new products in Japan in the first quarter, so just curious - normally when you launch a new product, we see an almost immediate pick-up in sales. Just given the pandemic and how the sales dynamic has changed, should we expect the same sort of trend that we’ve seen historically, and will you be selling this new medical product in the Japan--sorry, the cancer product in the Japan closed channel?"
},
{
"speaker": "Daniel Amos",
"text": "Koide?"
},
{
"speaker": "Masatoshi Koide",
"text": "Koji will answer that question."
},
{
"speaker": "Koji Ariyoshi",
"text": "[translated from Japanese] In terms of medical insurance, as we have already started with our cancer insurance, we have implemented web certification as well as application--insurance application system, from October, and this will allow reduction of COVID-19 risk, like having social distance. On top of that, this medical insurance product that we plan to launch is a competitive product, so we will be able to win in the competition, and that way we should be able to increase our share in the medical market. Our new product has a broad range of coverage to really be able to respond to various types of customers. For example, a lot of the customers have concerns about the three dread diseases, which we will cover further in this new product, as well as short term coverage in the medical insurance, and at the same time those customers who really do not want to just keep on paying premium and gain nothing, we do have some no-claim bonus rider that can be added to this rider, so we should be able to respond to various needs of customers. We would like to use this medical insurance product as sort of the engine to start our sales in 2021, and with the web virtual sales we should be able to minimize the negative impact or the risk of COVID-19, so we’d like to really use this to harness our sales."
},
{
"speaker": "Suneet Kamath",
"text": "Okay, thanks. Then I guess for Max on the tax rate change, was any of this related to the Trump tax cuts, and then accordingly is there any risk that under a different administration, this tax ruling that you got could be reversed?"
},
{
"speaker": "Max Broden",
"text": "No, it’s not related to the Trump tax cuts. This is related to a new regulation issued by the U.S. Treasury and the IRS that came out on September 29."
},
{
"speaker": "Suneet Kamath",
"text": "Okay, thanks."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of John Barnidge with Piper Sandler."
},
{
"speaker": "John Barnidge",
"text": "How should we be thinking about the permanence of the some of the declines in utilization in the U.S. from maybe changed behavior from COVID, principally maybe telemedicine driving down the benefits ratio?"
},
{
"speaker": "Daniel Amos",
"text": "Well, I think it’s still in limbo in terms of what we’re absolutely sure will happen. Certainly we have seen when, let’s say April-May-June, people were staying inside more, they were not going to the doctor, we saw a drop-off in the claims. The idea of the wellness benefit is to get them back to a doctor, twofold: one, to have utilization of the policy and therefore improved persistency, raise the loss ratio some but also prevent people from--I mean, I have a friend whose wife was diagnosed with a stage 3 cancer, and if they had gone to the doctor as they should have but couldn’t because of COVID, they could have caught it much earlier. So one of the things that we’re watching is to see whether or not there’s a tail on this, and that’s why we’re trying to encourage people to go ahead now and go back to the doctor, use these wellness benefits, get the exams you should get, and hopefully that brings down the tail on the business. We know that it’s already picking back up in terms of people going back to the doctor, but it’s not back to the normal amount that it was running pre-COVID."
},
{
"speaker": "John Barnidge",
"text": "Okay, very helpful. The wellness initiative that trimmed 100 basis points on the benefits ratio, has that completely played out or could there be still more to come?"
},
{
"speaker": "Teresa White",
"text": "We believe that there could still be more to come there."
},
{
"speaker": "John Barnidge",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Erik Bass with Autonomous Research."
},
{
"speaker": "Erik Bass",
"text": "Hi, thank you. Do you intend to let all of the tax benefit drop to the bottom line, and do you see opportunity to either accelerate investment or adjust product pricing to boost growth?"
},
{
"speaker": "Max Broden",
"text": "We obviously have multiple initiatives in place in order to drive growth, as Fred outlined, and that is pushing up our expense ratio and has. That’s been in play for the last couple of years, and we see that ongoing. Generally I would characterize this benefit as dropping to the bottom line."
},
{
"speaker": "Frederick Crawford",
"text": "One thing I would add, though, and this goes to the previous question too about how to think about future corporate tax rate changes, is that we do have to be mindful of that. This effectively just creates an even playing field for the way in which we report our effective tax rate and cash tax payments; in other words, we are effectively paying a 21% corporate tax rate as being a U.S. taxpayer at Aflac, and so to the degree there is a change in tax law going forward, we’ll be impacted much like any other corporate taxpayer in the U.S., so we do have to be mindful of that and we’ll be watching that carefully. Having said that, though, there is a very real benefit to us, both cash-wise and effective tax rate for a period of time, including going back and grabbing some cash flows that we had previously paid out in the way of tax payments, so it’s a real benefit that one that you want to be careful about taking into the future, if you believe there could be changes in the corporate tax rate going forward."
},
{
"speaker": "Erik Bass",
"text": "Thank you, then can you talk a little bit about the recruiting and licensing backdrop for new agents?"
},
{
"speaker": "Teresa White",
"text": "Rich?"
},
{
"speaker": "Richard Williams",
"text": "Absolutely. First of all, recruiting continues to be a very important part of our element and strategy going forward. We saw improvement in the third quarter compared to the second quarter, and we--you know, at the beginning of 2020 we implemented significant alignment from a compensation program to drive producer growth and to drive recruiting. The anticipation on recruiting for the fourth quarter is we expect to see moderate improvement compared to the second and third quarter, and then as we look to 2021, we’ll clearly talk about that more at the investor conference, but it will be a key part of our strategy."
},
{
"speaker": "Erik Bass",
"text": "Got it, thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Humphrey Lee with Dowling & Partners."
},
{
"speaker": "Humphrey Lee",
"text": "Good morning and thank you for taking my questions. My first question is related to the expenses in Japan. I heard that you talked about the ¥1.7 billion for the COVID-related expenses in the quarter, and then also there was ¥2 billion related to the paperless initiatives. But just looking at the sequential increase in expenses, still those two pieces only explain half of the increase, so I was just wondering what’s the other driver for the much higher expenses in the quarter?"
},
{
"speaker": "Max Broden",
"text": "The main driver in terms of the expense ratio is the decline in revenues, so you have the increased spending but also the function of lower revenues is impacting the expense ratio."
},
{
"speaker": "Humphrey Lee",
"text": "But I’m just referring to the notional general expense amount of ¥72 billion."
},
{
"speaker": "Frederick Crawford",
"text": "I think much of that has to do with just seasonal dynamics related to direct mail spend as well as other promotional initiatives in the quarter related to--you know, as compared to last year, so I think some of it was just natural fluctuation. The two main drivers, and maybe I would add a third, are not only COVID-related expenses and the paperless initiative, but we also continue to accelerate certain digital investments in the quarter, and those are the primary drivers of just an incremental increase in general operating expenses."
},
{
"speaker": "Humphrey Lee",
"text": "Okay, and then in terms of the Zurich addition in the fourth quarter, how should we think about the size of the premium add, and then also by extension the expense impacts of that platform, and also what’s your expectation on a full year premium basis for that business?"
},
{
"speaker": "Frederick Crawford",
"text": "That business has been running at around, I believe in the $75 million to $100 million annualized premium range. As you can expect, that’s a lumpy business because it’s largely a start-up at Zurich and it tends to focus on large accounts. But it’s also a very persistent business, so there’s high persistency with that business, so I would expect on an annualized basis it’s in that range, so it will have a modest impact to annual earned premium. In terms of the overall P&L impact on it, as we mentioned when we announced the transaction, we would expect there to be roughly $0.05 dilution on an annualized basis related to that transaction, and that’s largely because as they are still ramping up the business, their revenue is not enough to offset their cost structure because it’s in a growth mode, and so--and we expect obviously and intend to continue that growth mode going forward, so that’s essentially the nature of the business. It’s modestly dilutive to earnings and modestly accretive to earned premium."
},
{
"speaker": "Humphrey Lee",
"text": "Got it, thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Andrew Kligerman with Credit Suisse."
},
{
"speaker": "Andrew Kligerman",
"text": "Hey, good morning. My first question is around the benefits ratio, and I’m wondering as we look out in the U.S. at 48.3, down from 49.1 year-over-year, and then of course 44.3 quarter-over-quarter, have we reached kind of a stable zone now? How would you expect it to trend over the course of the next several quarters?"
},
{
"speaker": "Frederick Crawford",
"text": "Well in general, we would expect it to trend up, but really up to previous reported numbers prior to the pandemic, and that’s simply because of what Dan outlined in his comments, that there will be naturally a gradual increase in utilization but really back to normal levels, and still overall favorable relative to going back in history, so you’ll see it trend up. Wellness related impacts will subside, we certainly hope, but frankly we’re monitoring, as you can imagine given the news, COVID related cases, but overall we would expect utilization to find its more normal levels over time. We are bringing on businesses that tend to have higher benefit ratios and lower expense ratios - network dental and vision, for example, and then of course group benefits, so over time you’ll eventually have a bit of a mix play in our benefit ratio to be aware of, but that’s unlikely to be material certainly over the next several quarters and in 2021. But you’ll see that play out over time and we’ll of course be able to report that out and let you know what’s influencing the benefit ratio and expense ratio."
},
{
"speaker": "Andrew Kligerman",
"text": "Great. Earlier in the year, you provided a credit stress scenario of about $680 million of credit losses. Has that changed, improved, worsened? What’s the outlook there, and what are you seeing into 2021?"
},
{
"speaker": "Frederick Crawford",
"text": "Eric, why don’t you take that?"
},
{
"speaker": "Eric Kirsch",
"text": "Sure thing, thank you, Andrew. Naturally we continue to analyze our portfolio with stress scenarios, inclusive of how our portfolio actually performed over these past six months, and looking forward including assumptions about a second wave and economic and market impacts. In fact, our portfolio has performed very well through the first part of the pandemic and better than expected relative to our stress test. In addition, as you may recollect, in the second quarter we did some marginal de-risking and risk reduction, and there were particular names in the stress test that in essence were impacted or went away. Having said that, we’re completing our newest stress test and intend on presenting that at this upcoming FAB, so if you can be patient for about another month, you’ll see some of the new results."
},
{
"speaker": "Andrew Kligerman",
"text": "Got it, thank you."
},
{
"speaker": "Operator",
"text": "The final question comes from the line of Tom Gallagher with Evercore ISI."
},
{
"speaker": "Tom Gallagher",
"text": "Good morning. First question, Max, can you give a sense for how the cash tax benefits will compare to the reduction in the GAAP tax rate, and how we should think about that playing out over time?"
},
{
"speaker": "Max Broden",
"text": "Cash taxes will always be volatile, and there will be timing differences between our GAAP and our cash taxes, but over time I would expect them to have about the same impact from this change in tax regulation."
},
{
"speaker": "Tom Gallagher",
"text": "Would you expect there to be a meaningful difference in the first couple of years and converge over time, or is it going to be, would you say, directionally similar with some volatility around it, if you know what I mean?"
},
{
"speaker": "Max Broden",
"text": "Yes, it would be the latter. There will not any material, significant difference, and certainly not over as long period as a number of years. It’s more the latter, where we might in a short term have some timing differences, but generally speaking we would expect our cash taxes to come down as well."
},
{
"speaker": "Tom Gallagher",
"text": "Got you, and then my follow-up is can you--just given the increase in the benefit ratio in Japan this quarter, the 150 basis points to 200 basis points, can you talk about--and I know you had referenced that was somewhat related to the slowdown in sales and the impact of lapse and reissue, can you talk--given that sales are likely to remain at least somewhat lower relative to historical levels, can you talk about whether you would still expect to see the broader trend of benefit ratio improving here over the next couple of years, or are we likely to see that maybe go the other way?"
},
{
"speaker": "Max Broden",
"text": "Todd, why don’t you take a crack at that?"
},
{
"speaker": "Todd Daniels",
"text": "Okay, thanks Max. Really when we look forward for our persistency, and as Max alluded to, it’s totally related to sales activity, and about 80 basis points in the benefit ratio for the quarter is attributed to lack of what I will call lapse in reissue activity. As we introduce product in the first quarter, I would expect that to pick up somewhat for the medical block, so I would really anticipate as we go through next year that you see more of a normalized termination rate, which will lead to a more normal looking benefit ratio, especially as it pertains to the policy reserve aspect of it."
},
{
"speaker": "Tom Gallagher",
"text": "Got you, and Todd, would you still expect the broader trend over multiple years of improvement in the benefit ratio?"
},
{
"speaker": "Todd Daniels",
"text": "I think as we see claims come in and our trends that we have in our cancer and medical blocks, that will be reflected in the benefit ratio going forward."
},
{
"speaker": "Tom Gallagher",
"text": "Okay, thanks."
},
{
"speaker": "Max Broden",
"text": "Tom, we will address some of the underlying drivers in terms of hospitalizations and duration of hospital stays, etc. at FAB, so we’ll give you a little bit more insight into that."
},
{
"speaker": "Tom Gallagher",
"text": "Thank you."
},
{
"speaker": "David Young",
"text": "That leads us to the top of the hour. Before concluding, I just wanted to remind you that we have combined our financial analyst briefing and our 2021 outlook call into a special webcast event on the morning of November 19 at 8:00 am Eastern time. For more details, please reach out to Investor Relations here, and we thank you all for joining us today, and look forward to speaking with you soon and wish you all continued good health. Thank you."
},
{
"speaker": "Operator",
"text": "This concludes today’s call. Everyone may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 2 | 2,020 | 2020-07-29 09:00:00 | Operator: Welcome to the Aflac Second Quarter 2020 Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Please be advised today’s conference is being recorded. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor and Rating Agency Relations. Thank you, sir. You may begin. Sir, could you check the mute button, please?
David Young: Thank you, Fran. Good morning. And welcome to Aflac Incorporated second quarter call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter, as well as our operations in Japan and the United States amid the COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin by discussing the impact of the pandemic and our ongoing response. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the second quarter before providing perspective on claims exposure to COVID-19. Max Brodén, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of second quarter financial results and current capital and liquidity. Joining us this morning during the Q&A portion are members of our executive management team in the U.S., Teresa White, President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Rich Williams, Chief Distribution Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on the company’s investor site, investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I will now hand the call over to Dan. Dan?
Dan Amos: Thank you, David, and good morning. Shortly, I will provide an overview of the quarter and how we perform [Technical Difficulty] provide perspective on the ongoing [Technical Difficulty] in their families, the people who are on the frontlines fighting the spread of COVID-19 and those who are providing essential services including our own employees. As I shared with you last quarter, the guiding focus of our actions has centered on the healthy and safety of our employees, distribution partners and policyholders we serve. You will recall last quarter, that we ramped up our work-at-home staffing models in both Japan and the United States. We saw a little in the way of disruption in the operations and our employees adapted well. Since our last earnings call, the government of Japan has lifted state of emergency on May 25th and the country has seen new cases rise since mid-June, but on a lesser scale relative to the United States. Recently Japan reported a little over 900 cases in a day. With risk of infection remaining, the national and local governments are monitoring spread very closely, as the country gradually opens, taking action when necessary. Aflac Japan has also taken steps with approximately 50% of the workforce returning to work on site. Our actions are taken into consultation with leading medical experts in Japan, including Professor and Dr. Koji Wada, and following health and safety protocols for the industry developed by the Japanese Business Federation and Life insurance Association of Japan. Aflac Japan continues to monitor the situation and encourage remote work to the greatest extent possible. At the same time, the United States has seen daily new cases and hospitalizations significantly on the rise since mid-June. Recently, new cases exceeded 75,000 in one day in the United States. Increasingly public health experts are advocating for the need to observe prudent protective measures through the fall and early winter. As a result, Aflac U.S. plans on beginning a regional stage gating approach for returning to on-site work in 2021. We feel that this is the best approach for our employees, as well as the health of our communities. Our employees in both countries have shown incredible determination and professionalism over the course of this year. For example, even amid the global pandemics ever-changing working locations and conditions, our employees in Japan and the United States have demonstrated a determination to now more than ever, put policyholders first. In fact, two weeks ago, Aflac Japan received the honor of being the number one company in customer loyalty among the 13 life insurance companies in the NTT Com Online Benchmark Survey. This survey was conducted in May, right in the middle of the COVID pandemic, which shows our ability to adapt. Our factors customers ranked were Aflac number one included our customer service and listening approach, our corporate and brand image, and our friendly policyholder website. Receiving recognition such as this from the very people we support is the highest honor, especially considered in the current environment. It also reflects our collective hard work and dedication to be there for the policyholders when they need us most. Another way we have supported our policyholders through this difficult time is extending the grace periods for premium payments in both Japan and the United States. Initially, Aflac Japan followed the FSA guidance and extended the grace period on premium payments to September 30, 2020. In June, Aflac Japan like its industry peers extended the premium grace period until April 30, 2021. Policyholders are required to file for relief through this extension. Aflac U.S. has also implemented premium grace periods. And those periods remain in effect in 23 states as of July, 2020. The environment created by COVID-19, which has included sheltering in place and social distancing, continues to impact our sales results, both in the United States and in Japan. We are carefully monitoring our core products and actual to expected non-COVID claims. We are proactively reaching out to employers and policyholders to assist in understanding our product benefits and to ease the filing of qualified claims. We are also communicating on the value of the wellness benefits attached to our products for reimbursement of routine doctor, dentist and hospital visits. As shelter-at-home orders subside and normal activities recover. We have done this in the past and while current conditions are unique, our experience is that this will drive utilization, benefit ratios and improved persistency. Turning to sales, Aflac U.S. total sales were down 56% in the quarter. Aflac Japan sales were down 60% in the quarter, which also reflects last year’s strong second quarter sales by Japan Post. While the technology for virtual sales existed prior to the pandemic, market practice and preference favored face-to-face presentations. In both countries, we are having to pivot to a more virtual sales execution. Within the current environment, virtual takes on greater importance, especially in those areas that are slower to open up. For Aflac Japan, this will mean additional digital transformation initiatives, utilizing artificial intelligence to better identify customers’ needs and consult with customers through the web. On July the 3rd at the Strategic Alliance Executive Meeting, Japan Post Holdings CEO, Masuda-san and I agreed to a joint promotion of such digital transformation initiatives. I was glad that we were able to have our virtual meeting that evening and I hope that we can visit very soon in person. Recognizing that face-to-face sales will be challenging, Aflac Japan continues to pursue new business through direct mail and calling campaigns to existing and prospective customers. We are also preparing to introduce a new system that enables online consultation by allowing the customer and our agency to see the same screen through the digital device. Additionally, we will enhance this system to enable smartphone-based insurance application ahead of all other companies in Japan. Likewise, our production model in the United States relies heavily on face-to-face interaction at the work site and is small business oriented. As such, we were hit hard by temporary closures of business and lack of access at the work site, especially in the second quarter. Keep in mind, the fourth quarter is typically the quarter in which we see strong results in the broker-driven group market, which has generally been more resilient to conditions. This makes us cautiously optimistic as we see potential for modest sales improvements for Aflac U.S. in the second half of the year, also contingent upon the pace of the economic recovery. We continue to progress toward closing our definitive agreement to acquire Zurich Group Benefits business, which allows us to extend our distribution reach and extend our appeal to brokers and larger employers. When stepping back from the quarter and reflecting on the events impacted the economy and our business model, I remain confident in how we are positioned, despite our shared concerns over conditions in the United States, we are able to move forward with key growth and efficiency initiatives that require near-term investments in order to be positioned for future growth and opportunity. We are learning more about how the pandemic is impacting our business and are quickly pivoting to better balance to face-to-face and virtual sales practices. We have thus far dependent our strong margins in Japan and the United States, and asset quality remains strong. Additionally, our overall capital and liquidity positions allow us to continue uninterrupted the balance of the investments in the business, opportunistic investments and returning capital to the shareholders. Let me conclude with the topic of social justice, which has been thrust into the spotlight in the United States since the last earnings release. Aflac is and has always been for fairness and justice, diversity and inclusion are not new concepts for Aflac. We have consistently received recognition in various publications, including being named to Black Enterprise list of the 50 best companies for diversity 13 times and Latino Style list of the 50 best companies for Latinos to work for in the United States 20 times. A key tenet of the Aflac way is treating people with respect and care. This is critical when considering that 46% of our U.S. employees ethnic minorities and 66% are women. We continue to partner with organizations like the Congressional Black Caucus Institute’s 20 First Century Council and the business roundtable to raise issues that can lead to meaningful change in public policy. As an inherent part of the culture, we oppose any form of bigotry, intolerance and disrespect in our society. We are committed to fight for racial justice and equality for all. At Aflac, we have always believed that fostering a diverse workforce isn’t just the right thing to do, it makes good business sense. When our people reflect the diversity of our communities in which we operate, we strengthen our opportunities in connections with customers and policyholders. Now, I will hand the program off to Fred and Max. Fred?
Fred Crawford: Thanks, Dan. I am going to touch briefly on conditions in the second quarter, how we are tracking to COVID-19 stress testing assumptions and an update on key initiatives in Japan and in the U.S. In Japan, we track data coming from the Ministry of Health, Labor and Welfare, as well as the COVID-19 subcommittee of the Cabinet Advisory Council for infectious disease. As of July 27th, there were approximately 30,500 cases and 1,000 deaths in all of Japan. Our stress test assumed a midpoint estimate of 1.2 million confirmed cases and 100% hospitalization rate consistent with Japan’s infectious disease guidelines. When applied to our book of medical policies and assuming an average of 20 days in hospitalization, the result was a potential impact to our third sector benefit ratio of 50 basis points to 100 basis points in 2020. However, through the second quarter, Aflac Japan’s COVID-19 impact totaled only 626 claimants with claim payments totaling 138 million yen. For COVID hospitalization claims thus far, the average stay in a hospital is approximately 20 days, with two-thirds of claims in hospital and one-third at home or hotel-based hospitalization. In short, we are tracking well below any risk of stress conditions with no measurable COVID-19 impact to core ratios from paid claims. The impact is somewhat isolated to sales and a related uptick in persistency, which Max will comment on later. Turning to the U.S., the story of course, is very different. We continue to track the rate of reported cases, hospitalization and deaths from sources such as the CDC and Johns Hopkins. As a country, COVID-19 case levels in the U.S. now exceed 4.3 million, with deaths nearing 150,000. In addition, hospitalization rates in certain CDC red zones have been on the rise. Our U.S. stress test assumed 6.4 million confirmed cases in the U.S., 1.5 million hospitalizations and 150,000 deaths. In short, we are unfortunately tracking to our U.S. macro stress test assumptions. It is however important to understand the critical statistics that impact our business model that surround hospitalization and disability. Our stress test applied age-based hospitalization rates, with 40% of those hospitalized spending time in the ICU. We further assumed 75% of confirmed cases filed for short-term disability. The resulting stress test impacted our U.S. benefit ratio in the range of 300 basis points to 500 basis points for 2020. Through the end of the second quarter, U. S. actual U.S. COVID-19 claims now totaled 5,000 claimants, incurred claims in the quarter totaled $31 million with 70% representing COVID-specific increase in IBNR. The majority were filed under our short-term disability policies representing 80% of claimants and we have yet to see any expected increase in overall hospitalization and wellness claims. To give you perspective, COVID-19 incurred claims, excluding wellness benefits are coming in at 40% of our modeling assumptions. While still early, given a natural lag in filing claims, we suspect our favorable experience relative to stress test assumptions is partially attributed to the worksite and a younger population of policyholders, with a lower level of co-morbidity or preexisting conditions. As Dan noted in his comments, the impact of COVID-19 incurred claims in the quarter [Technical Difficulty] was more than offset by a temporary reduction in routine doctor and hospital visits driving down our benefit ratios. We believe this is largely timing related and not likely to change our view of expected lifetime loss ratios. In fact, while still below pre-COVID volume, we have seen frequency of claims rise in the last few weeks of June and into July. Recall that in the U.S., we are stressing persistency, which has historically [Technical Difficulty] unemployment. We have thus far seen limited impact to cash receipts and persistency, and believe this is somewhat supported by the Paycheck Protection Act that is set to expire August 8th. As Dan mentioned, premium grace periods are still in place in many states, thus somewhat supporting persistency. We see the third quarter as a critical period with state regulatory orders expiring and further stimulus under consideration. A key pressure point for our U.S. business model as we enter 2021 is earned premium. We are, therefore, focusing on retention efforts that include proactive outreach to policyholders, conversion of payroll deduction to direct bill and campaigns to work with the employers and employees on how best to leverage health and wellness benefits. We are also naturally focused on expenses, carefully regulating staffing models and giving investment priority to initiatives designed to drive a lower cost structure. Turning to Aflac Global investments, we remain focused on asset quality, monitoring global economic conditions and sourcing new investment opportunities in this low interest rate environment. Our firm view is that we will experience a check mark shaped recovery, meaning a slow road to recovery with pockets of volatility along the way. We have moved away from the notion of a V-shaped or even U-shaped recovery, as the basis for tactical asset allocation, capital management and maintaining a cautious credit view. Therefore, our tactical approach has included further derisking activity, on vulnerable exposures. While net investment income is tracking ahead of our original outlook guidance for 2020, we do see a slower build in our loan portfolios, as well as lower variable net investment income from alternative investments that we originally forecasted. While retaining more invested capital, we are also remaining more liquid, thus enjoying very little contribution to net investment income. We continue to explore ways to optimize our approach to currency hedging and just this week completed locking in a portion of our hedge costs for 2021, given a low relative hedge cost environment. Finally, this is the first quarter recognizing income from our Varagon strategic investment, booking $4 million of income through our corporate segment and integrating their investment expertise into our investment strategy. While modest, we see our tactical approach to strategic investments as a natural extension of our external manager platform and an area of growth in sourcing new investment opportunities, while taking minority stakes in attractive asset management franchises. Let me switch gears and comment briefly on key initiatives within our insurance segments. Despite an understandable focus on COVID, we continue to push forward on significant initiatives in readying our platform for future growth and efficiency. On our first quarter call, I noted our paperless initiative in Japan, specifically in our Policyholder Services division. We have completed further analysis and now intend to expand beyond Policyholder Services to a broad commitment across all operations in Japan. Our decision to expand the scope is driven by economic return, but also to improve business continuity and work-from-home capacity, while reducing our carbon footprint, which is consistent with our commitment to ESG. This is a three-year and roughly 10 billion yen investment that is front-end loaded with approximately 40% to 50% of the investment targeted for 2020. The expanded and accelerated scope is expected to reduce the production and circulation of 80 million pieces of paper per year with run rate savings in the range of 3 billion yen annually once completed. Our product pipeline is also a key work stream in Japan and we have altered our strategy to recognize launching new product in 2020 as suboptimal given the reduced face-to-face sales environment. This strategy also recognizes conditions at key banking, post office and other agent driven alliance partners. While critical work will be accomplished in 2020, we plan to re-launch our enhanced cancer product early in the fourth quarter and have postponed the timing of our new medical product to early 2021. Turning to the U.S., we accelerated certain investments specific elements of our digital roadmap into 2020. These initiatives include advancing virtual tools as part of the rollout of our refreshed small business enrollment platform, allowing our agents to be more productive in a virtual-engaged model. Group ecosystem investments to automate account on-boarding and in advance of integrating our Zurich Group Benefit acquisition, advancing My Aflac digital self-service, both web and mobile for more intuitive customer experience and to reduce reliance on expensive call center support. And then, finally, investment in digital claims automation, requiring an agile approach from product design to ultimate payment of claims. These investments are multi-year and larger in scale, the total incremental or accelerated investment in 2020 is approximately $25 million. The build-out of U.S. Network Dental and Vision remains on track. We have successfully filed our new Network Dental and Vision products in 40 states and expect to ramp-up as we move towards 2021. Very important is the introduction of this product into our new enrollment tools to drive small business opportunities, including further penetration and improved persistency. Our consumer markets platform remains on track with product filings underway and systems work to ensure a digital end-to-end experience. We are currently offering accident, critical illness and cancer products on our platform, as well as partnering on other third-party digital platforms. In terms of our March announcement on Zurich Benefits, we continue to track towards closing later in the year with good progress on the regulatory approvals and day one integration planning. We are very excited about welcoming the Zurich team to Aflac and are focused on limiting any disruption as the acquired business strives to hit existing growth targets. In both Japan and the U.S., we view 2020 as a critical year of execution and readying for 2021, and hopefully, the other side of this devastating pandemic. I will now pass on to Max to discuss our financial performance in more detail. Max?
Max Brodén: Thank you, Fred. Let me begin with a review of our second quarter performance and focus on how our core capital and earnings drivers have developed over the past quarter. As was the case when we announced first quarter earnings, the timing and magnitude of the COVID-19 impact on 2020 earnings continue to be uncertain. For the second quarter, adjusted earnings per share increased 13% to $1.28, driven primarily by favorable benefit ratios in the U.S. The strengthening yen impacted earnings in the quarter by $0.01. As a result, adjusted earnings per share on a currency-neutral basis rose 12% to $1.27 per share. Adjusted book value per share, including foreign currency translation gains and losses grew 7.5% and the adjusted ROE, excluding the foreign currency impact was a strong 16.3%, a significant spread above our cost of capital. There were no one-time items to call out for normalizing purposes in the quarter. As expected, given the market conditions, our alternative investment portfolio recorded a loss in the quarter of $7 million and was approximately $20 million below our long-term return expectations for the portfolio adjusted for the J-curve. We have a modest but building portfolio, which currently stands at $657 million. Turning to our Japan segment. Total earned premium for the quarter declined 2.5%, reflecting first sector policies paid-up impacts, while earned premium for our first sector protection and third sector products was flat year-over-year. Japan’s total benefit ratio came in at 69.8% for the quarter, up 90 basis points year-over-year and the third sector benefit ratio was 59.6%, up 110 basis points year-over-year. The main driver for the increase was lower lapses associated with policyholders updating their coverage, which tends to lead to reserve releases, boosting current quarter results by lowering the benefit ratio. Given the current lower new business activity, this naturally pushes up our benefit ratio due to lower reserve releases, decreases DAC amortization and improves reported persistency. We did experience all of this in the second quarter, manifested by our persistency improving 70 basis points year-over-year. Our expense ratio in Japan was 20%, down 60 basis points year-over-year. In the current environment, we did incur lower acquisition expenses like lower promotional spend and lower surrenders brought down our DAC monetization, as previously mentioned. We view this as primarily timing related and would expect our expense ratio to increase when a new business environment normalizes. Net investment income increased 2% in yen terms, despite lower variable investment income, driven primarily by higher allocation to U.S. dollar floating rate assets early in the year. The pre-tax margin for Japan in the quarter was a strong 22%. Turning to our U.S. results. Earned premium was down 0.1% due to weaker sales results and a flat persistency year-over-year. Our total benefit ratio came in at 44.3%, 590 basis points lower than Q2 2019, driven by reduced claims from accidents, less wellness basics and elective surgeries. Our expense ratio in the U.S. was 35.3%, up 50 basis points year-over-year, as the inclusion of Argus and direct-to-consumer digital investments structurally had increased the expense ratio by 140 basis points. Lower sales bonus, travel and expenses associated with claims adjudication were a meaningful offset to the Argus consolidation and lower earned premiums. Net investment income in the U.S. was down 4.4% due to capital management actions in December 2019, leading to a reduced invested balance and 13 basis points contraction in portfolio yield year-over-year. Profitability in the U.S. segment was boosted by the previously discussed benefit ratio, leading to a pre-tax profit margin of 25.7% in Q2, up 510 basis points year-over-year. As Fred noted, we are carefully monitoring persistency in the U.S., as premium grace periods expire and economic particularly unemployment conditions develop. We expect the combination of reduced sales and persistency to weigh on revenue during the second half of 2020 and more materially as we enter 2021. We expected earned premium decline in the range of minus 3% to flat for the full year of 2020 and we will update our forecast for 2021 later in the year, given the number of variables involved. In our Corporate segment, amortized hedge income contributed $27 million on a pre-tax basis to the quarter’s earnings and we had an ending, notional position of approximately $5 billion. Our capital position remains strong and we ended the quarter with an SMR of above 900% in Japan and an RBC of approximately 600% in Aflac Columbus. Holding company liquidity stood at $4.7 billion, $2.7 billion above our minimum balance. In terms of credit conditions in our insurance general account, we took further derisking actions, selling out of approximately $320 million of COVID exposed securities, triggering a realized loss of $45 million. While total impairments and losses may appear elevated, the $166 million net investment loss includes an increase in CECL reserves of $161 million, reflecting ratings downgrades and calibrating our third-party model inputs for COVID-driven economic conditions. We remain cautious in regards to both the economic outlook and spread of COVID-19, leading us to retain more capital in our subsidiaries as a first line of defense in case of any sudden deterioration in capital markets or virus related claims. At this point, we deem it more efficient to temporarily hold capital at the subsidiary level versus at the holding company. It is the flexibility in our capital structure and capital resources that gives us this option, while continuing to deploy capital to the benefit of our shareholders through dividends and buybacks. In the second quarter, we repurchased $188 million of our stock. Going forward, we will continue to be tactical around both our capital structure and deployment in order to drive a balanced risk adjusted return on capital within the company. Now, let me turn it over to David to begin Q&A. David?
David Young: Thank you, Max. Now we are ready to take your questions. But first let me ask you to please limit yourself to one initial question and one related follow-up to allow other participants an opportunity to ask a question. Fran, we will now take the first question. Fran, are we open to take questions. We are not hearing anything?
Operator: Yes. We definitely are. We had a delay there. [Operator Instructions] Thank you so much. Our first is from Jimmy Bhullar with JP Morgan. Sir, your line is open.
Jimmy Bhullar: Hi. Thanks. Good morning. So I had a question on your sales in the U.S. and it doesn’t seem like there was much of an improvement in sales as you went through the quarter. But as businesses are opening up, are you seeing your sales recover or if the companies are still reluctant to have agents come in and try to sell to their employees. So just any sort of color on what’s going on, obviously, in the fourth quarter, the broker sales will pick up. But any color on the agency channel and I think last quarter you had given some guidance on April sales, if you have anything similar to July?
Dan Amos: Teresa, would you like to answer that?
Teresa White: Yeah. I will start and then I will pass it to Rich. Certainly, I think, the environment is impacting the sales results and specifically in the small case market, we see it being more pronounced. As we see states start to open back up and our sales teams starting to adjust, I think, they are trying to find the right balance between safety and productivity and so from an Aflac perspective, what we are attempting to do is provide support, ensuring that the accounts -- that our accounts and their employees have information for the sales teams. We are equipping them with information to provide to accounts. And this is really to get activity, get people back out and get people to utilizing their virtual tools, while also we are working to preserve the distribution platform for our agents, specifically by providing loans, technology and training, preparing for a virtual sales environment. So we do realize that it’s going to take time for adoption. I will let Rich speak specifically on the quarter and go forward. Rich?
Rich Williams: All right. Thank you, Theresa. So specifically to the question, in the month of July, we have definitely seen levels that are better than what we experienced in the second quarter, but clearly not at pre-pandemic levels. As we think about the second half of the year, very consistent with guidance we have shared. We tend to see more broker sales in the second half of the year and in larger cases. And so the larger case market is more receptive to virtual enrollment and so we do expect to see some progress there, obviously, in the smaller business market, it will just simply depend on businesses availability and adoption of virtual enrollment. But as Teresa mentioned, the long-term play is to recover our distribution platforms for 2021 going forward to use the virtual tools that we have had for many years and really just to pivot to a new way of doing business.
Fred Crawford: Jimmy, this is Fred. One other thing and Rich can comment on this. But one other dynamic that we are experiencing is recruiting. Recruiting normally strengthens during weak employment periods. That’s been our history through say normal economic cycles and it’s no different here. We can see a tick-up in eligible recruits and recruiting activity during weakness in the economy. The problem is a unique one, and that is the licensing processes at the state level are often closed or slow to operate with backlog. Some of that is related to gathering people for more larger licensing processing. And so because we recruit so many people across the country that come to us without previous insurance experience, that licensing becomes critical. It’s very different if you had a model that was recruiting previously licensed agents away from other insurance carriers, et cetera, that’s not our model. So we also would like to see that open up as time goes on at the state level and that would help with the natural volume of new sales that comes as you bring in new recruits.
Jimmy Bhullar: Okay. And any comments on what you might have seen in Japan since the end of the quarter or as things are getting at least a little bit better than they were earlier?
Dan Amos: All right. Japan, who would like to take that? Koji?
Koji Ariyoshi: So during the state of emergency declaration in May, shops were shutdown and we were not able to conduct face-to-face sales. So we were in a very difficult position. And we have been continuing non face-to-face solicitation through phones and mail. And since June, after the state of emergency declaration has been lifted in Japan, we follow -- we have been following the guidelines issued from the government, as well as Life Insurance Association of Japan in terms of prevention of infection and we have gradually started our solicitation through face-to-face. Our shops have resumed or reopened. Now that the shops have been reopened for a while, the number of customers and the traffic coming into shops are on the increase. In June, we had about 50% of customers compared with our normal times coming into our shops and in July we are back to 70%. However, we are still not at a point where we had lots of customers coming in pre-COVID-19. And at the same time, face-to-face solicitation is also recovering as well, I mean, it is very gradual that we are starting. And because face-to-face solicitation is very challenging under the current COVID-19 situation. And since it’s very difficult to see customers face-to-face directly, what we are doing is developing a tool to have virtual face-to-face meeting with customers using digital tools on the web. And we are trying to develop this tool so that the tool itself will allow the concluding of the entire process to the application for the insurance policy. And this tool and this kind of activity is -- we are taking this activity ahead of others. So what we would like to do is to really strengthen our response capability to customers under the new normal after the COVID or -- during the COVID-19 because of the current situation. So what we are planning to do is, of course, continue to use our phones and mails as we did in our previous or the current non-face-to-face environment. But we would also like to be adding like a virtual face to face through the web and then, perhaps, have the application be submitted through this virtual web face -- non-face-to-face tool. That’s all for me.
Jimmy Bhullar: Thank you.
Operator: Thank you. Our next is from Humphrey Lee with Dowling & Partners. And your line is open.
Humphrey Lee: Good morning and thank you for taking my question. A question related to the U.S. health benefit ratio. I think you talked about the deferral treatments have helped some of the have delayed some of the expected claim activity, but you assume some normalization. I was wondering if you can elaborate a little bit more about your kind of expectations for your claims experience for the second half of the year?
Dan Amos: Yeah. We -- what we are seeing is, I think, what you are starting to see across the industry as more companies report and that is there’s been the natural putting off, if you will, of routine doctor, dentist and more routine hospital visits due to the shelter-in-place and general concerns over COVID. And we are, in fact, starting to see that open back up again in select areas of the country, where people are coming back in and we are starting to see claims pick up, particularly in the last week or so of the quarter and then into July. What I would say, is that we are still traveling at levels lower year-over-year than the claims experience in those products last year this time. So they have not recovered back up to what we would call a normal level. But they are certainly more elevated than what we experienced in the early part through, say, midway into the second quarter. What we are doing, however, is also very important and that is we are proactively reaching out to employees and employers to remind them of the benefits that they have in our policies how to consider whether or not they are eligible or have a qualified event and can file a claim, how easy it is to file a claim, how quickly the money comes directly to them. And in particular, we are focused on wellness claims, which are attached to many of our policies, but most notably our accident policy. And by proactively reaching out to policyholders to remind them that if they did in fact go to see the doctor or dentist on a routine measure or they plan to remember that they have got a wellness benefit, which will typically reimburse them to the tune of, say, $60 or so by visit. Historically, we have done this on a kind of a state-by-state basis at times and usually what we find is that there will be a pickup in utilization, which you would expect, but we also hope to achieve better persistency by reminding people of their benefits. The key time to do this is in fact typically in the third quarter, not just because of COVID dynamics, but because that’s also about the time when people are reviewing with their employer, their benefits and considering whether to sign up again. It’s also particularly important for us right now because it’s a way to moderate to some degree the risk of these state orders falling off throughout the quarter, as well as the possibility of stimulus falling off. So we would expect to do some outreach in the third quarter. We would expect that to increase utilization. It’s very difficult to project it and so we can’t really guide on what we expect. But we think those activities will recover some of the benefit ratio in the second half.
Humphrey Lee: That’s helpful. Shifting gears to kind of the investment portfolio. So in Max prepared remarks you talked about there are some CECL allowance in the quarter. My understanding is that it’s largely for the middle market loan portfolio. Can you talk about for the balance of your portfolio kind of what percentage of that is on kind of potential downgrade you watch right now?
Max Brodén: So, this is, as you mentioned, it’s predominantly in the middle-market loan portfolio that we did experience some rating migration. We are not going to speak to specifically on any breaking down the whole portfolio, what is sort of on any sort of watch list. But I would say that the two categories that primarily is driving the CECL reserve to increase if the middle-market loan portfolio and the transitional real estate portfolio. Those are the two asset classes that primarily drove that. Of the $161 million of this generic increase in the CECL reserve, about half of it was driven by ratings and about half is driven by updated economic outlook input into the model. And keep in mind that this model is a third-party model that we utilize and there is a lag impact. So you may question, why is the increase coming now, not at the end of the first quarter. It’s really because there’s a moving window in terms of data that goes into the model, and obviously, we now have greater weight on two quarters of, let’s call it, COVID related economic input and outlook and that’s really what’s driving it.
Humphrey Lee: Okay. Thank you.
Operator: Thank you. Our next is from Andrew Kligerman with Crédit Suisse. And sir, your line is open.
Andrew Kligerman: Hi. Good morning. Thinking about Japan Post, just given the tremendous disruption that they have had. How are things moving along with them on the regulatory front, customer perceptions? And when might they get back on it -- assuming we could get beyond COVID-19 pressures, when might they get back on a track that was consistent with, say, 2017 or 2018 in terms of sales?
Dan Amos: Well, I will start and then maybe Aflac Japan will want to make some comments as well. I think our relationship with Aflac, I mean, with Japan Post and Masuda-san is good as it could possibly be. They are positive. They are very interested in the new technology and the ability to use digital to help. In my opinion, they are wrapping up all phases of past issues, because you have got a new management team. I think the press is pretty much seen and heard everything and now it’s just been repetitive. So I am hoping that by, certainly, end of August, September, it will kind of finish out and then they will move forward. Now how the impact of that will go in regard to COVID and the ability to sell is uncertain. But the willingness on their part to want to sell and move forward is very positive. And I think they would like to see the numbers go back to where they were as well, of course, not only for sales but also being a large shareholder themselves. They are interested in that. So what I would say is, is we are well-positioned. We are looking forward to that movement and I think they are as well. So let me turn the program over to Koide to see what else he might want to add in that regard.
Masatoshi Koide: This is Koide from Aflac Japan. Currently, Japan Post Group is prioritizing their activities to win back the customers trust. So Aflac Japan, of course, is supporting their activities, and for example, helping them with conducting training to really have focused on more customer-oriented activities. Under these circumstances today Japan Time -- the Japan Post Group companies, they are Japan Post Holdings, Japan Post Company and Japan Post Insurance called the press conference to announce various things.
Dan Amos: All right.
Andrew Kligerman: Great. And then just shifting over to capital management, I think, Max, used the term tactical with regard to…
Masatoshi Koide: Excuse me, may I continue? This is Koide.
Andrew Kligerman: Okay.
Dan Amos: Go ahead Koide.
Masatoshi Koide: Okay. All right. So let me repeat again. Today, Japan Time, the CEOs of the three Japan Post Group companies, Japan Post Holdings, Japan Post Company and Japan Post Insurance held a press conference. And the announcement that they have made in the press conference was the disciplinary actions of our sales representatives. So for the first time related to the inappropriate sales, this announcement makes clear Japan Post framework apply disciplinary action to address the market conduct issues in response to stakeholder demand. And then given the current status and the announcement that they have made, Japan Post Holdings CEO, Mr. Masuda said, that with this clarity on Japan Post framework for disciplinary action, the Japan Post Group has largely met the five evaluation criteria established by the Japan Post Reform Execution Committee for resuming sales activities. And he also stated the decision to restart sales will be made by the Board of Directors of the three Japan Post Group companies possibly within August or September. Having said that, once the decision to resume sales is made, Japan Post will begin with customer visits to express apologies. So against that backdrop, we expect it will take some time before sales of Aflac cancer Insurance to begin in earnest. And the disciplinary actions that were announced today were on the sales of Japan Post Insurance products and has nothing to do with the sale of Aflac Cancer products. And that is the current state of Japan Post.
Dan Amos: Thank you, Koide. Now we have the second part to that question.
Andrew Kligerman: Yeah. No. Just kind of shifting real quickly over to Max’ comment that he wanted to be tactical on capital management. You did about $188 million of buybacks in the quarter, which relative to other companies in respect it is quite strong. For this gap, I think, it’s [ph] about half the level that you have done historically, maybe a little less. So could I take tactical to mean that that’s probably the level you will going at over the next few quarters until you can get visibility on COVID-19 and maybe can you [Technical Difficulty] it down?
Max Brodén: So Andrew, tactical, that word means tactical. We have by any matter very strong capital positions in our operating subsidiaries, and very strong capital and liquidity at the holding company. But we also recognize that the economic environment continues to be very uncertain and also the spread of the virus, obviously, is clearly linked to that. And I would say that until we get better clarity, we will continue to be fairly cautious in terms of how we deploy capital. But we will also look for opportunities and when we see that we would have a good opportunity and we think that the risk reward given all the risks out there is appropriate or is good for us, we will deploy capital. All this means that we may have -- if you think about the run rate we were running at the second quarter, we may decrease the buyback going forward. We may keep it at the current level and we may even increase it. But at this point, given everything that is going on and all the uncertainty out there, we want to keep all options available to us.
Andrew Kligerman: Thanks a lot.
Dan Amos: We will take one more question.
Operator: Thank you very much. Our last question then is from Mr. John Barnidge with Piper Sandler. Sir, your line is open.
John Barnidge: Thank you. Could you talk about how you approach the rollout of Dental and Vision nationally beginning in January when individuals are largely underutilizing dental benefits possibly catch up in 2021 and then how do you manage the pricing and rollout of such? Thank you.
Fred Crawford: Sure. John, I will -- just a couple of quick things and then I will hand off to Rich and he can spell out the rollout. But just note that, we do have a dental product out there right now, which is our historical indemnity product and that continues to sell. It represents only about 3% of our earned premium and around 4% of our sales. Where we are going with the Argus acquisition and then the rollout of Dental and Vision is with a true network Dental and Vision, which is just in the building mode. I think we have, for example, this year we are targeting something less than $5 million in sales of that product once we get up and running. As mentioned in my comments, we have got the product actually rolled out and approved in 40 states, which is a more significant task or undertaking than you might think on the surface, particularly in the current environment, so we are quite pleased with that. And now we will start to be in a better position come 2021 to rollout. So, with that, Rich, why don’t you take it from here in terms of how we see the rollout.
Rich Williams: Okay. Thank you, Fred. And as everyone will recall, last year at our financial analyst briefing and our outlook, we talked about 2020 being a measured rollout of Aflac Dental and Vision. And we are pleased to say, consistent with Fred’s comments that we have done that here in 2020 rolling out the product in 10 states in significant areas for our distribution. So 2020 really is the burn in and the implementation for our field training, our enrollment platform and making sure that we have a very favorable experience for our customers and for our agents and our brokers. So 2021 will be the actual ramp up of the volume for Aflac Dental and Vision and we are on track to have the national rollout in 2021.
Dan Amos: Thank you, Fred. And just before we conclude our call today, I wanted to remind you that we have combined financial analyst -- combined our financial analyst briefing, as well as our 2021 outlook call for a special webcasted event on November 19th in that morning and we will have more details on that. We hope you will join us. And please feel free to contact Investor Relations for more information with any questions that you may have before then and we look forward to speaking with you soon. Wish you all continued good health. Thank you.
Operator: This conference has concluded. Again, thank you for your participation. Please go ahead and disconnect. Thank you very much. | [
{
"speaker": "Operator",
"text": "Welcome to the Aflac Second Quarter 2020 Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Please be advised today’s conference is being recorded. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor and Rating Agency Relations. Thank you, sir. You may begin. Sir, could you check the mute button, please?"
},
{
"speaker": "David Young",
"text": "Thank you, Fran. Good morning. And welcome to Aflac Incorporated second quarter call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter, as well as our operations in Japan and the United States amid the COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin by discussing the impact of the pandemic and our ongoing response. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the second quarter before providing perspective on claims exposure to COVID-19. Max Brodén, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of second quarter financial results and current capital and liquidity. Joining us this morning during the Q&A portion are members of our executive management team in the U.S., Teresa White, President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Rich Williams, Chief Distribution Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on the company’s investor site, investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I will now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, David, and good morning. Shortly, I will provide an overview of the quarter and how we perform [Technical Difficulty] provide perspective on the ongoing [Technical Difficulty] in their families, the people who are on the frontlines fighting the spread of COVID-19 and those who are providing essential services including our own employees. As I shared with you last quarter, the guiding focus of our actions has centered on the healthy and safety of our employees, distribution partners and policyholders we serve. You will recall last quarter, that we ramped up our work-at-home staffing models in both Japan and the United States. We saw a little in the way of disruption in the operations and our employees adapted well. Since our last earnings call, the government of Japan has lifted state of emergency on May 25th and the country has seen new cases rise since mid-June, but on a lesser scale relative to the United States. Recently Japan reported a little over 900 cases in a day. With risk of infection remaining, the national and local governments are monitoring spread very closely, as the country gradually opens, taking action when necessary. Aflac Japan has also taken steps with approximately 50% of the workforce returning to work on site. Our actions are taken into consultation with leading medical experts in Japan, including Professor and Dr. Koji Wada, and following health and safety protocols for the industry developed by the Japanese Business Federation and Life insurance Association of Japan. Aflac Japan continues to monitor the situation and encourage remote work to the greatest extent possible. At the same time, the United States has seen daily new cases and hospitalizations significantly on the rise since mid-June. Recently, new cases exceeded 75,000 in one day in the United States. Increasingly public health experts are advocating for the need to observe prudent protective measures through the fall and early winter. As a result, Aflac U.S. plans on beginning a regional stage gating approach for returning to on-site work in 2021. We feel that this is the best approach for our employees, as well as the health of our communities. Our employees in both countries have shown incredible determination and professionalism over the course of this year. For example, even amid the global pandemics ever-changing working locations and conditions, our employees in Japan and the United States have demonstrated a determination to now more than ever, put policyholders first. In fact, two weeks ago, Aflac Japan received the honor of being the number one company in customer loyalty among the 13 life insurance companies in the NTT Com Online Benchmark Survey. This survey was conducted in May, right in the middle of the COVID pandemic, which shows our ability to adapt. Our factors customers ranked were Aflac number one included our customer service and listening approach, our corporate and brand image, and our friendly policyholder website. Receiving recognition such as this from the very people we support is the highest honor, especially considered in the current environment. It also reflects our collective hard work and dedication to be there for the policyholders when they need us most. Another way we have supported our policyholders through this difficult time is extending the grace periods for premium payments in both Japan and the United States. Initially, Aflac Japan followed the FSA guidance and extended the grace period on premium payments to September 30, 2020. In June, Aflac Japan like its industry peers extended the premium grace period until April 30, 2021. Policyholders are required to file for relief through this extension. Aflac U.S. has also implemented premium grace periods. And those periods remain in effect in 23 states as of July, 2020. The environment created by COVID-19, which has included sheltering in place and social distancing, continues to impact our sales results, both in the United States and in Japan. We are carefully monitoring our core products and actual to expected non-COVID claims. We are proactively reaching out to employers and policyholders to assist in understanding our product benefits and to ease the filing of qualified claims. We are also communicating on the value of the wellness benefits attached to our products for reimbursement of routine doctor, dentist and hospital visits. As shelter-at-home orders subside and normal activities recover. We have done this in the past and while current conditions are unique, our experience is that this will drive utilization, benefit ratios and improved persistency. Turning to sales, Aflac U.S. total sales were down 56% in the quarter. Aflac Japan sales were down 60% in the quarter, which also reflects last year’s strong second quarter sales by Japan Post. While the technology for virtual sales existed prior to the pandemic, market practice and preference favored face-to-face presentations. In both countries, we are having to pivot to a more virtual sales execution. Within the current environment, virtual takes on greater importance, especially in those areas that are slower to open up. For Aflac Japan, this will mean additional digital transformation initiatives, utilizing artificial intelligence to better identify customers’ needs and consult with customers through the web. On July the 3rd at the Strategic Alliance Executive Meeting, Japan Post Holdings CEO, Masuda-san and I agreed to a joint promotion of such digital transformation initiatives. I was glad that we were able to have our virtual meeting that evening and I hope that we can visit very soon in person. Recognizing that face-to-face sales will be challenging, Aflac Japan continues to pursue new business through direct mail and calling campaigns to existing and prospective customers. We are also preparing to introduce a new system that enables online consultation by allowing the customer and our agency to see the same screen through the digital device. Additionally, we will enhance this system to enable smartphone-based insurance application ahead of all other companies in Japan. Likewise, our production model in the United States relies heavily on face-to-face interaction at the work site and is small business oriented. As such, we were hit hard by temporary closures of business and lack of access at the work site, especially in the second quarter. Keep in mind, the fourth quarter is typically the quarter in which we see strong results in the broker-driven group market, which has generally been more resilient to conditions. This makes us cautiously optimistic as we see potential for modest sales improvements for Aflac U.S. in the second half of the year, also contingent upon the pace of the economic recovery. We continue to progress toward closing our definitive agreement to acquire Zurich Group Benefits business, which allows us to extend our distribution reach and extend our appeal to brokers and larger employers. When stepping back from the quarter and reflecting on the events impacted the economy and our business model, I remain confident in how we are positioned, despite our shared concerns over conditions in the United States, we are able to move forward with key growth and efficiency initiatives that require near-term investments in order to be positioned for future growth and opportunity. We are learning more about how the pandemic is impacting our business and are quickly pivoting to better balance to face-to-face and virtual sales practices. We have thus far dependent our strong margins in Japan and the United States, and asset quality remains strong. Additionally, our overall capital and liquidity positions allow us to continue uninterrupted the balance of the investments in the business, opportunistic investments and returning capital to the shareholders. Let me conclude with the topic of social justice, which has been thrust into the spotlight in the United States since the last earnings release. Aflac is and has always been for fairness and justice, diversity and inclusion are not new concepts for Aflac. We have consistently received recognition in various publications, including being named to Black Enterprise list of the 50 best companies for diversity 13 times and Latino Style list of the 50 best companies for Latinos to work for in the United States 20 times. A key tenet of the Aflac way is treating people with respect and care. This is critical when considering that 46% of our U.S. employees ethnic minorities and 66% are women. We continue to partner with organizations like the Congressional Black Caucus Institute’s 20 First Century Council and the business roundtable to raise issues that can lead to meaningful change in public policy. As an inherent part of the culture, we oppose any form of bigotry, intolerance and disrespect in our society. We are committed to fight for racial justice and equality for all. At Aflac, we have always believed that fostering a diverse workforce isn’t just the right thing to do, it makes good business sense. When our people reflect the diversity of our communities in which we operate, we strengthen our opportunities in connections with customers and policyholders. Now, I will hand the program off to Fred and Max. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thanks, Dan. I am going to touch briefly on conditions in the second quarter, how we are tracking to COVID-19 stress testing assumptions and an update on key initiatives in Japan and in the U.S. In Japan, we track data coming from the Ministry of Health, Labor and Welfare, as well as the COVID-19 subcommittee of the Cabinet Advisory Council for infectious disease. As of July 27th, there were approximately 30,500 cases and 1,000 deaths in all of Japan. Our stress test assumed a midpoint estimate of 1.2 million confirmed cases and 100% hospitalization rate consistent with Japan’s infectious disease guidelines. When applied to our book of medical policies and assuming an average of 20 days in hospitalization, the result was a potential impact to our third sector benefit ratio of 50 basis points to 100 basis points in 2020. However, through the second quarter, Aflac Japan’s COVID-19 impact totaled only 626 claimants with claim payments totaling 138 million yen. For COVID hospitalization claims thus far, the average stay in a hospital is approximately 20 days, with two-thirds of claims in hospital and one-third at home or hotel-based hospitalization. In short, we are tracking well below any risk of stress conditions with no measurable COVID-19 impact to core ratios from paid claims. The impact is somewhat isolated to sales and a related uptick in persistency, which Max will comment on later. Turning to the U.S., the story of course, is very different. We continue to track the rate of reported cases, hospitalization and deaths from sources such as the CDC and Johns Hopkins. As a country, COVID-19 case levels in the U.S. now exceed 4.3 million, with deaths nearing 150,000. In addition, hospitalization rates in certain CDC red zones have been on the rise. Our U.S. stress test assumed 6.4 million confirmed cases in the U.S., 1.5 million hospitalizations and 150,000 deaths. In short, we are unfortunately tracking to our U.S. macro stress test assumptions. It is however important to understand the critical statistics that impact our business model that surround hospitalization and disability. Our stress test applied age-based hospitalization rates, with 40% of those hospitalized spending time in the ICU. We further assumed 75% of confirmed cases filed for short-term disability. The resulting stress test impacted our U.S. benefit ratio in the range of 300 basis points to 500 basis points for 2020. Through the end of the second quarter, U. S. actual U.S. COVID-19 claims now totaled 5,000 claimants, incurred claims in the quarter totaled $31 million with 70% representing COVID-specific increase in IBNR. The majority were filed under our short-term disability policies representing 80% of claimants and we have yet to see any expected increase in overall hospitalization and wellness claims. To give you perspective, COVID-19 incurred claims, excluding wellness benefits are coming in at 40% of our modeling assumptions. While still early, given a natural lag in filing claims, we suspect our favorable experience relative to stress test assumptions is partially attributed to the worksite and a younger population of policyholders, with a lower level of co-morbidity or preexisting conditions. As Dan noted in his comments, the impact of COVID-19 incurred claims in the quarter [Technical Difficulty] was more than offset by a temporary reduction in routine doctor and hospital visits driving down our benefit ratios. We believe this is largely timing related and not likely to change our view of expected lifetime loss ratios. In fact, while still below pre-COVID volume, we have seen frequency of claims rise in the last few weeks of June and into July. Recall that in the U.S., we are stressing persistency, which has historically [Technical Difficulty] unemployment. We have thus far seen limited impact to cash receipts and persistency, and believe this is somewhat supported by the Paycheck Protection Act that is set to expire August 8th. As Dan mentioned, premium grace periods are still in place in many states, thus somewhat supporting persistency. We see the third quarter as a critical period with state regulatory orders expiring and further stimulus under consideration. A key pressure point for our U.S. business model as we enter 2021 is earned premium. We are, therefore, focusing on retention efforts that include proactive outreach to policyholders, conversion of payroll deduction to direct bill and campaigns to work with the employers and employees on how best to leverage health and wellness benefits. We are also naturally focused on expenses, carefully regulating staffing models and giving investment priority to initiatives designed to drive a lower cost structure. Turning to Aflac Global investments, we remain focused on asset quality, monitoring global economic conditions and sourcing new investment opportunities in this low interest rate environment. Our firm view is that we will experience a check mark shaped recovery, meaning a slow road to recovery with pockets of volatility along the way. We have moved away from the notion of a V-shaped or even U-shaped recovery, as the basis for tactical asset allocation, capital management and maintaining a cautious credit view. Therefore, our tactical approach has included further derisking activity, on vulnerable exposures. While net investment income is tracking ahead of our original outlook guidance for 2020, we do see a slower build in our loan portfolios, as well as lower variable net investment income from alternative investments that we originally forecasted. While retaining more invested capital, we are also remaining more liquid, thus enjoying very little contribution to net investment income. We continue to explore ways to optimize our approach to currency hedging and just this week completed locking in a portion of our hedge costs for 2021, given a low relative hedge cost environment. Finally, this is the first quarter recognizing income from our Varagon strategic investment, booking $4 million of income through our corporate segment and integrating their investment expertise into our investment strategy. While modest, we see our tactical approach to strategic investments as a natural extension of our external manager platform and an area of growth in sourcing new investment opportunities, while taking minority stakes in attractive asset management franchises. Let me switch gears and comment briefly on key initiatives within our insurance segments. Despite an understandable focus on COVID, we continue to push forward on significant initiatives in readying our platform for future growth and efficiency. On our first quarter call, I noted our paperless initiative in Japan, specifically in our Policyholder Services division. We have completed further analysis and now intend to expand beyond Policyholder Services to a broad commitment across all operations in Japan. Our decision to expand the scope is driven by economic return, but also to improve business continuity and work-from-home capacity, while reducing our carbon footprint, which is consistent with our commitment to ESG. This is a three-year and roughly 10 billion yen investment that is front-end loaded with approximately 40% to 50% of the investment targeted for 2020. The expanded and accelerated scope is expected to reduce the production and circulation of 80 million pieces of paper per year with run rate savings in the range of 3 billion yen annually once completed. Our product pipeline is also a key work stream in Japan and we have altered our strategy to recognize launching new product in 2020 as suboptimal given the reduced face-to-face sales environment. This strategy also recognizes conditions at key banking, post office and other agent driven alliance partners. While critical work will be accomplished in 2020, we plan to re-launch our enhanced cancer product early in the fourth quarter and have postponed the timing of our new medical product to early 2021. Turning to the U.S., we accelerated certain investments specific elements of our digital roadmap into 2020. These initiatives include advancing virtual tools as part of the rollout of our refreshed small business enrollment platform, allowing our agents to be more productive in a virtual-engaged model. Group ecosystem investments to automate account on-boarding and in advance of integrating our Zurich Group Benefit acquisition, advancing My Aflac digital self-service, both web and mobile for more intuitive customer experience and to reduce reliance on expensive call center support. And then, finally, investment in digital claims automation, requiring an agile approach from product design to ultimate payment of claims. These investments are multi-year and larger in scale, the total incremental or accelerated investment in 2020 is approximately $25 million. The build-out of U.S. Network Dental and Vision remains on track. We have successfully filed our new Network Dental and Vision products in 40 states and expect to ramp-up as we move towards 2021. Very important is the introduction of this product into our new enrollment tools to drive small business opportunities, including further penetration and improved persistency. Our consumer markets platform remains on track with product filings underway and systems work to ensure a digital end-to-end experience. We are currently offering accident, critical illness and cancer products on our platform, as well as partnering on other third-party digital platforms. In terms of our March announcement on Zurich Benefits, we continue to track towards closing later in the year with good progress on the regulatory approvals and day one integration planning. We are very excited about welcoming the Zurich team to Aflac and are focused on limiting any disruption as the acquired business strives to hit existing growth targets. In both Japan and the U.S., we view 2020 as a critical year of execution and readying for 2021, and hopefully, the other side of this devastating pandemic. I will now pass on to Max to discuss our financial performance in more detail. Max?"
},
{
"speaker": "Max Brodén",
"text": "Thank you, Fred. Let me begin with a review of our second quarter performance and focus on how our core capital and earnings drivers have developed over the past quarter. As was the case when we announced first quarter earnings, the timing and magnitude of the COVID-19 impact on 2020 earnings continue to be uncertain. For the second quarter, adjusted earnings per share increased 13% to $1.28, driven primarily by favorable benefit ratios in the U.S. The strengthening yen impacted earnings in the quarter by $0.01. As a result, adjusted earnings per share on a currency-neutral basis rose 12% to $1.27 per share. Adjusted book value per share, including foreign currency translation gains and losses grew 7.5% and the adjusted ROE, excluding the foreign currency impact was a strong 16.3%, a significant spread above our cost of capital. There were no one-time items to call out for normalizing purposes in the quarter. As expected, given the market conditions, our alternative investment portfolio recorded a loss in the quarter of $7 million and was approximately $20 million below our long-term return expectations for the portfolio adjusted for the J-curve. We have a modest but building portfolio, which currently stands at $657 million. Turning to our Japan segment. Total earned premium for the quarter declined 2.5%, reflecting first sector policies paid-up impacts, while earned premium for our first sector protection and third sector products was flat year-over-year. Japan’s total benefit ratio came in at 69.8% for the quarter, up 90 basis points year-over-year and the third sector benefit ratio was 59.6%, up 110 basis points year-over-year. The main driver for the increase was lower lapses associated with policyholders updating their coverage, which tends to lead to reserve releases, boosting current quarter results by lowering the benefit ratio. Given the current lower new business activity, this naturally pushes up our benefit ratio due to lower reserve releases, decreases DAC amortization and improves reported persistency. We did experience all of this in the second quarter, manifested by our persistency improving 70 basis points year-over-year. Our expense ratio in Japan was 20%, down 60 basis points year-over-year. In the current environment, we did incur lower acquisition expenses like lower promotional spend and lower surrenders brought down our DAC monetization, as previously mentioned. We view this as primarily timing related and would expect our expense ratio to increase when a new business environment normalizes. Net investment income increased 2% in yen terms, despite lower variable investment income, driven primarily by higher allocation to U.S. dollar floating rate assets early in the year. The pre-tax margin for Japan in the quarter was a strong 22%. Turning to our U.S. results. Earned premium was down 0.1% due to weaker sales results and a flat persistency year-over-year. Our total benefit ratio came in at 44.3%, 590 basis points lower than Q2 2019, driven by reduced claims from accidents, less wellness basics and elective surgeries. Our expense ratio in the U.S. was 35.3%, up 50 basis points year-over-year, as the inclusion of Argus and direct-to-consumer digital investments structurally had increased the expense ratio by 140 basis points. Lower sales bonus, travel and expenses associated with claims adjudication were a meaningful offset to the Argus consolidation and lower earned premiums. Net investment income in the U.S. was down 4.4% due to capital management actions in December 2019, leading to a reduced invested balance and 13 basis points contraction in portfolio yield year-over-year. Profitability in the U.S. segment was boosted by the previously discussed benefit ratio, leading to a pre-tax profit margin of 25.7% in Q2, up 510 basis points year-over-year. As Fred noted, we are carefully monitoring persistency in the U.S., as premium grace periods expire and economic particularly unemployment conditions develop. We expect the combination of reduced sales and persistency to weigh on revenue during the second half of 2020 and more materially as we enter 2021. We expected earned premium decline in the range of minus 3% to flat for the full year of 2020 and we will update our forecast for 2021 later in the year, given the number of variables involved. In our Corporate segment, amortized hedge income contributed $27 million on a pre-tax basis to the quarter’s earnings and we had an ending, notional position of approximately $5 billion. Our capital position remains strong and we ended the quarter with an SMR of above 900% in Japan and an RBC of approximately 600% in Aflac Columbus. Holding company liquidity stood at $4.7 billion, $2.7 billion above our minimum balance. In terms of credit conditions in our insurance general account, we took further derisking actions, selling out of approximately $320 million of COVID exposed securities, triggering a realized loss of $45 million. While total impairments and losses may appear elevated, the $166 million net investment loss includes an increase in CECL reserves of $161 million, reflecting ratings downgrades and calibrating our third-party model inputs for COVID-driven economic conditions. We remain cautious in regards to both the economic outlook and spread of COVID-19, leading us to retain more capital in our subsidiaries as a first line of defense in case of any sudden deterioration in capital markets or virus related claims. At this point, we deem it more efficient to temporarily hold capital at the subsidiary level versus at the holding company. It is the flexibility in our capital structure and capital resources that gives us this option, while continuing to deploy capital to the benefit of our shareholders through dividends and buybacks. In the second quarter, we repurchased $188 million of our stock. Going forward, we will continue to be tactical around both our capital structure and deployment in order to drive a balanced risk adjusted return on capital within the company. Now, let me turn it over to David to begin Q&A. David?"
},
{
"speaker": "David Young",
"text": "Thank you, Max. Now we are ready to take your questions. But first let me ask you to please limit yourself to one initial question and one related follow-up to allow other participants an opportunity to ask a question. Fran, we will now take the first question. Fran, are we open to take questions. We are not hearing anything?"
},
{
"speaker": "Operator",
"text": "Yes. We definitely are. We had a delay there. [Operator Instructions] Thank you so much. Our first is from Jimmy Bhullar with JP Morgan. Sir, your line is open."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hi. Thanks. Good morning. So I had a question on your sales in the U.S. and it doesn’t seem like there was much of an improvement in sales as you went through the quarter. But as businesses are opening up, are you seeing your sales recover or if the companies are still reluctant to have agents come in and try to sell to their employees. So just any sort of color on what’s going on, obviously, in the fourth quarter, the broker sales will pick up. But any color on the agency channel and I think last quarter you had given some guidance on April sales, if you have anything similar to July?"
},
{
"speaker": "Dan Amos",
"text": "Teresa, would you like to answer that?"
},
{
"speaker": "Teresa White",
"text": "Yeah. I will start and then I will pass it to Rich. Certainly, I think, the environment is impacting the sales results and specifically in the small case market, we see it being more pronounced. As we see states start to open back up and our sales teams starting to adjust, I think, they are trying to find the right balance between safety and productivity and so from an Aflac perspective, what we are attempting to do is provide support, ensuring that the accounts -- that our accounts and their employees have information for the sales teams. We are equipping them with information to provide to accounts. And this is really to get activity, get people back out and get people to utilizing their virtual tools, while also we are working to preserve the distribution platform for our agents, specifically by providing loans, technology and training, preparing for a virtual sales environment. So we do realize that it’s going to take time for adoption. I will let Rich speak specifically on the quarter and go forward. Rich?"
},
{
"speaker": "Rich Williams",
"text": "All right. Thank you, Theresa. So specifically to the question, in the month of July, we have definitely seen levels that are better than what we experienced in the second quarter, but clearly not at pre-pandemic levels. As we think about the second half of the year, very consistent with guidance we have shared. We tend to see more broker sales in the second half of the year and in larger cases. And so the larger case market is more receptive to virtual enrollment and so we do expect to see some progress there, obviously, in the smaller business market, it will just simply depend on businesses availability and adoption of virtual enrollment. But as Teresa mentioned, the long-term play is to recover our distribution platforms for 2021 going forward to use the virtual tools that we have had for many years and really just to pivot to a new way of doing business."
},
{
"speaker": "Fred Crawford",
"text": "Jimmy, this is Fred. One other thing and Rich can comment on this. But one other dynamic that we are experiencing is recruiting. Recruiting normally strengthens during weak employment periods. That’s been our history through say normal economic cycles and it’s no different here. We can see a tick-up in eligible recruits and recruiting activity during weakness in the economy. The problem is a unique one, and that is the licensing processes at the state level are often closed or slow to operate with backlog. Some of that is related to gathering people for more larger licensing processing. And so because we recruit so many people across the country that come to us without previous insurance experience, that licensing becomes critical. It’s very different if you had a model that was recruiting previously licensed agents away from other insurance carriers, et cetera, that’s not our model. So we also would like to see that open up as time goes on at the state level and that would help with the natural volume of new sales that comes as you bring in new recruits."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. And any comments on what you might have seen in Japan since the end of the quarter or as things are getting at least a little bit better than they were earlier?"
},
{
"speaker": "Dan Amos",
"text": "All right. Japan, who would like to take that? Koji?"
},
{
"speaker": "Koji Ariyoshi",
"text": "So during the state of emergency declaration in May, shops were shutdown and we were not able to conduct face-to-face sales. So we were in a very difficult position. And we have been continuing non face-to-face solicitation through phones and mail. And since June, after the state of emergency declaration has been lifted in Japan, we follow -- we have been following the guidelines issued from the government, as well as Life Insurance Association of Japan in terms of prevention of infection and we have gradually started our solicitation through face-to-face. Our shops have resumed or reopened. Now that the shops have been reopened for a while, the number of customers and the traffic coming into shops are on the increase. In June, we had about 50% of customers compared with our normal times coming into our shops and in July we are back to 70%. However, we are still not at a point where we had lots of customers coming in pre-COVID-19. And at the same time, face-to-face solicitation is also recovering as well, I mean, it is very gradual that we are starting. And because face-to-face solicitation is very challenging under the current COVID-19 situation. And since it’s very difficult to see customers face-to-face directly, what we are doing is developing a tool to have virtual face-to-face meeting with customers using digital tools on the web. And we are trying to develop this tool so that the tool itself will allow the concluding of the entire process to the application for the insurance policy. And this tool and this kind of activity is -- we are taking this activity ahead of others. So what we would like to do is to really strengthen our response capability to customers under the new normal after the COVID or -- during the COVID-19 because of the current situation. So what we are planning to do is, of course, continue to use our phones and mails as we did in our previous or the current non-face-to-face environment. But we would also like to be adding like a virtual face to face through the web and then, perhaps, have the application be submitted through this virtual web face -- non-face-to-face tool. That’s all for me."
},
{
"speaker": "Jimmy Bhullar",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next is from Humphrey Lee with Dowling & Partners. And your line is open."
},
{
"speaker": "Humphrey Lee",
"text": "Good morning and thank you for taking my question. A question related to the U.S. health benefit ratio. I think you talked about the deferral treatments have helped some of the have delayed some of the expected claim activity, but you assume some normalization. I was wondering if you can elaborate a little bit more about your kind of expectations for your claims experience for the second half of the year?"
},
{
"speaker": "Dan Amos",
"text": "Yeah. We -- what we are seeing is, I think, what you are starting to see across the industry as more companies report and that is there’s been the natural putting off, if you will, of routine doctor, dentist and more routine hospital visits due to the shelter-in-place and general concerns over COVID. And we are, in fact, starting to see that open back up again in select areas of the country, where people are coming back in and we are starting to see claims pick up, particularly in the last week or so of the quarter and then into July. What I would say, is that we are still traveling at levels lower year-over-year than the claims experience in those products last year this time. So they have not recovered back up to what we would call a normal level. But they are certainly more elevated than what we experienced in the early part through, say, midway into the second quarter. What we are doing, however, is also very important and that is we are proactively reaching out to employees and employers to remind them of the benefits that they have in our policies how to consider whether or not they are eligible or have a qualified event and can file a claim, how easy it is to file a claim, how quickly the money comes directly to them. And in particular, we are focused on wellness claims, which are attached to many of our policies, but most notably our accident policy. And by proactively reaching out to policyholders to remind them that if they did in fact go to see the doctor or dentist on a routine measure or they plan to remember that they have got a wellness benefit, which will typically reimburse them to the tune of, say, $60 or so by visit. Historically, we have done this on a kind of a state-by-state basis at times and usually what we find is that there will be a pickup in utilization, which you would expect, but we also hope to achieve better persistency by reminding people of their benefits. The key time to do this is in fact typically in the third quarter, not just because of COVID dynamics, but because that’s also about the time when people are reviewing with their employer, their benefits and considering whether to sign up again. It’s also particularly important for us right now because it’s a way to moderate to some degree the risk of these state orders falling off throughout the quarter, as well as the possibility of stimulus falling off. So we would expect to do some outreach in the third quarter. We would expect that to increase utilization. It’s very difficult to project it and so we can’t really guide on what we expect. But we think those activities will recover some of the benefit ratio in the second half."
},
{
"speaker": "Humphrey Lee",
"text": "That’s helpful. Shifting gears to kind of the investment portfolio. So in Max prepared remarks you talked about there are some CECL allowance in the quarter. My understanding is that it’s largely for the middle market loan portfolio. Can you talk about for the balance of your portfolio kind of what percentage of that is on kind of potential downgrade you watch right now?"
},
{
"speaker": "Max Brodén",
"text": "So, this is, as you mentioned, it’s predominantly in the middle-market loan portfolio that we did experience some rating migration. We are not going to speak to specifically on any breaking down the whole portfolio, what is sort of on any sort of watch list. But I would say that the two categories that primarily is driving the CECL reserve to increase if the middle-market loan portfolio and the transitional real estate portfolio. Those are the two asset classes that primarily drove that. Of the $161 million of this generic increase in the CECL reserve, about half of it was driven by ratings and about half is driven by updated economic outlook input into the model. And keep in mind that this model is a third-party model that we utilize and there is a lag impact. So you may question, why is the increase coming now, not at the end of the first quarter. It’s really because there’s a moving window in terms of data that goes into the model, and obviously, we now have greater weight on two quarters of, let’s call it, COVID related economic input and outlook and that’s really what’s driving it."
},
{
"speaker": "Humphrey Lee",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next is from Andrew Kligerman with Crédit Suisse. And sir, your line is open."
},
{
"speaker": "Andrew Kligerman",
"text": "Hi. Good morning. Thinking about Japan Post, just given the tremendous disruption that they have had. How are things moving along with them on the regulatory front, customer perceptions? And when might they get back on it -- assuming we could get beyond COVID-19 pressures, when might they get back on a track that was consistent with, say, 2017 or 2018 in terms of sales?"
},
{
"speaker": "Dan Amos",
"text": "Well, I will start and then maybe Aflac Japan will want to make some comments as well. I think our relationship with Aflac, I mean, with Japan Post and Masuda-san is good as it could possibly be. They are positive. They are very interested in the new technology and the ability to use digital to help. In my opinion, they are wrapping up all phases of past issues, because you have got a new management team. I think the press is pretty much seen and heard everything and now it’s just been repetitive. So I am hoping that by, certainly, end of August, September, it will kind of finish out and then they will move forward. Now how the impact of that will go in regard to COVID and the ability to sell is uncertain. But the willingness on their part to want to sell and move forward is very positive. And I think they would like to see the numbers go back to where they were as well, of course, not only for sales but also being a large shareholder themselves. They are interested in that. So what I would say is, is we are well-positioned. We are looking forward to that movement and I think they are as well. So let me turn the program over to Koide to see what else he might want to add in that regard."
},
{
"speaker": "Masatoshi Koide",
"text": "This is Koide from Aflac Japan. Currently, Japan Post Group is prioritizing their activities to win back the customers trust. So Aflac Japan, of course, is supporting their activities, and for example, helping them with conducting training to really have focused on more customer-oriented activities. Under these circumstances today Japan Time -- the Japan Post Group companies, they are Japan Post Holdings, Japan Post Company and Japan Post Insurance called the press conference to announce various things."
},
{
"speaker": "Dan Amos",
"text": "All right."
},
{
"speaker": "Andrew Kligerman",
"text": "Great. And then just shifting over to capital management, I think, Max, used the term tactical with regard to…"
},
{
"speaker": "Masatoshi Koide",
"text": "Excuse me, may I continue? This is Koide."
},
{
"speaker": "Andrew Kligerman",
"text": "Okay."
},
{
"speaker": "Dan Amos",
"text": "Go ahead Koide."
},
{
"speaker": "Masatoshi Koide",
"text": "Okay. All right. So let me repeat again. Today, Japan Time, the CEOs of the three Japan Post Group companies, Japan Post Holdings, Japan Post Company and Japan Post Insurance held a press conference. And the announcement that they have made in the press conference was the disciplinary actions of our sales representatives. So for the first time related to the inappropriate sales, this announcement makes clear Japan Post framework apply disciplinary action to address the market conduct issues in response to stakeholder demand. And then given the current status and the announcement that they have made, Japan Post Holdings CEO, Mr. Masuda said, that with this clarity on Japan Post framework for disciplinary action, the Japan Post Group has largely met the five evaluation criteria established by the Japan Post Reform Execution Committee for resuming sales activities. And he also stated the decision to restart sales will be made by the Board of Directors of the three Japan Post Group companies possibly within August or September. Having said that, once the decision to resume sales is made, Japan Post will begin with customer visits to express apologies. So against that backdrop, we expect it will take some time before sales of Aflac cancer Insurance to begin in earnest. And the disciplinary actions that were announced today were on the sales of Japan Post Insurance products and has nothing to do with the sale of Aflac Cancer products. And that is the current state of Japan Post."
},
{
"speaker": "Dan Amos",
"text": "Thank you, Koide. Now we have the second part to that question."
},
{
"speaker": "Andrew Kligerman",
"text": "Yeah. No. Just kind of shifting real quickly over to Max’ comment that he wanted to be tactical on capital management. You did about $188 million of buybacks in the quarter, which relative to other companies in respect it is quite strong. For this gap, I think, it’s [ph] about half the level that you have done historically, maybe a little less. So could I take tactical to mean that that’s probably the level you will going at over the next few quarters until you can get visibility on COVID-19 and maybe can you [Technical Difficulty] it down?"
},
{
"speaker": "Max Brodén",
"text": "So Andrew, tactical, that word means tactical. We have by any matter very strong capital positions in our operating subsidiaries, and very strong capital and liquidity at the holding company. But we also recognize that the economic environment continues to be very uncertain and also the spread of the virus, obviously, is clearly linked to that. And I would say that until we get better clarity, we will continue to be fairly cautious in terms of how we deploy capital. But we will also look for opportunities and when we see that we would have a good opportunity and we think that the risk reward given all the risks out there is appropriate or is good for us, we will deploy capital. All this means that we may have -- if you think about the run rate we were running at the second quarter, we may decrease the buyback going forward. We may keep it at the current level and we may even increase it. But at this point, given everything that is going on and all the uncertainty out there, we want to keep all options available to us."
},
{
"speaker": "Andrew Kligerman",
"text": "Thanks a lot."
},
{
"speaker": "Dan Amos",
"text": "We will take one more question."
},
{
"speaker": "Operator",
"text": "Thank you very much. Our last question then is from Mr. John Barnidge with Piper Sandler. Sir, your line is open."
},
{
"speaker": "John Barnidge",
"text": "Thank you. Could you talk about how you approach the rollout of Dental and Vision nationally beginning in January when individuals are largely underutilizing dental benefits possibly catch up in 2021 and then how do you manage the pricing and rollout of such? Thank you."
},
{
"speaker": "Fred Crawford",
"text": "Sure. John, I will -- just a couple of quick things and then I will hand off to Rich and he can spell out the rollout. But just note that, we do have a dental product out there right now, which is our historical indemnity product and that continues to sell. It represents only about 3% of our earned premium and around 4% of our sales. Where we are going with the Argus acquisition and then the rollout of Dental and Vision is with a true network Dental and Vision, which is just in the building mode. I think we have, for example, this year we are targeting something less than $5 million in sales of that product once we get up and running. As mentioned in my comments, we have got the product actually rolled out and approved in 40 states, which is a more significant task or undertaking than you might think on the surface, particularly in the current environment, so we are quite pleased with that. And now we will start to be in a better position come 2021 to rollout. So, with that, Rich, why don’t you take it from here in terms of how we see the rollout."
},
{
"speaker": "Rich Williams",
"text": "Okay. Thank you, Fred. And as everyone will recall, last year at our financial analyst briefing and our outlook, we talked about 2020 being a measured rollout of Aflac Dental and Vision. And we are pleased to say, consistent with Fred’s comments that we have done that here in 2020 rolling out the product in 10 states in significant areas for our distribution. So 2020 really is the burn in and the implementation for our field training, our enrollment platform and making sure that we have a very favorable experience for our customers and for our agents and our brokers. So 2021 will be the actual ramp up of the volume for Aflac Dental and Vision and we are on track to have the national rollout in 2021."
},
{
"speaker": "Dan Amos",
"text": "Thank you, Fred. And just before we conclude our call today, I wanted to remind you that we have combined financial analyst -- combined our financial analyst briefing, as well as our 2021 outlook call for a special webcasted event on November 19th in that morning and we will have more details on that. We hope you will join us. And please feel free to contact Investor Relations for more information with any questions that you may have before then and we look forward to speaking with you soon. Wish you all continued good health. Thank you."
},
{
"speaker": "Operator",
"text": "This conference has concluded. Again, thank you for your participation. Please go ahead and disconnect. Thank you very much."
}
] | Aflac Incorporated | 250,178 |
AFL | 1 | 2,020 | 2020-04-30 09:00:00 | Operator: Welcome to the Aflac First Quarter 2020 Earnings Conference Call [Operator Instructions]. Please be advised, today's conference is being recorded. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor Relations.
David Young: Thank you, Brittany. Good morning, and welcome to Aflac Incorporated first quarter call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. There you will also find slides relevant to today's remarks. This morning, we will be hearing remarks about the quarter as well as our operations in Japan and United States amid the COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin by discussing the impact of the pandemic and our response. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the first quarter before providing perspective on future clinic exposure to COVID-19 and commenting on our Group Benefits acquisition. Then Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments will provide investment highlights from the quarter, including an update on our investment portfolio and related stress test. Max Broden, Executive Vice President and CFO of Aflac Incorporated will conclude our prepared remarks with a summary of first quarter financial results and current capital and liquidity. Joining us this morning during the Q&A portion are members of our executive management team in United States. Teresa White, President of Aflac U. S.; Rich Williams, Chief Distribution Officer; and Al Riggieri, Global Chief Risk Officer and Chief Actuary. We are joined by members of our executive management team in Tokyo as well at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on the company’s Investors site, investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?
Dan Amos: Thank you, David and good morning, everyone. Normally, I’d begin by providing a high-level view of the quarter and how we performed, but we're in an unusual and unprecedented time. Instead, I want to start by thanking all of those who are on the front lines fighting the spread of COVID-19 and those who are providing essential services including our own employees. We truly appreciate all that you do. Our thoughts and prayers are also with those who are among the confirmed cases. This is a challenging time but we will get through it together. Let me start by addressing our enterprise-wide COVID-19 response efforts. The guiding focus of our actions has centered around; first, the health and safety of our employees and distribution partners; second, the well being of our policy holders; third, the business community and maintaining our operations; and fourth, prudent financial and risk management. I will concentrate on how we're protecting our people, operations and brand and ask Fred, Eric and Max to collectively cover how we've positioned from an operational, financial and risk perspective. First, I want to note that we took early actions when the news of the virus broke. We benefited from Japan providing us with an early window into the potential response efforts as they were about three weeks ahead of the U. S. in combating the spread of the virus. We also benefited from the Board expertise, specifically long time director, Dr. Barbara Rimer, who is the dean and Alumni Distinguished Professor of Gillings School of Public Health at the University of North Carolina at Chapel Hill. She advised us back in early February about the emerging threat of the virus. Early on, we implemented travel restrictions, shifted to working remotely and installed several social-distancing measures, both in Japan and the United States. Japan remains ahead of many countries with respect to COVID-19 with 14,000 confirmed cases and 400 related deaths as of yesterday. We see several possible reasons for this, including existing social norms of wearing mask, not shaking hands. In addition, Japan jumped out early having to deal with the cruise ship, Diamond Princess, and prepare for the Olympic games. Finally, it's worth noting that Japan is taking a more measured approach to testing, focused on sympathetic cases and localized to where outbreaks have been identified. Despite these factors, cases have been on the rise resulting in the Prime Minister declaring a national state-of-emergency through the end of golden week holidays on May 6th and possibly extending further. Along with economic stimulus packages, the state of emergency includes a requirement for business to reduce employees at the work site by 70%. COVID 19 is now classified as an infectious disease requiring doctors to prescribe hospital care. Further, the Japanese government recognized that the potential shortage of hospital beds, and is allowing doctors to instruct a patient with symptoms to receive medical treatments outside the hospital consistent with government policy and industry guidelines and standards. Aflac Japan and other major domestic life insurance companies announced that hospitalization benefits will be paid for the period, a test by a doctor if a patient receives medical treatment at an alternative accommodation or a temporary facility. I'm sure most of you are all familiar with the U. S. government's actions and state by state shelter in place restrictions. From a state regulatory environment several states have issued executive orders directing premium grace periods and guidance on treating policy holders with care. In both the United States and Japan, we have taken action in response to COVID-19 to help mitigate risks to our employees, policy holders and communities. We have ramped up work at home staffing models with more than 75% of our on site employees in Japan, and more than 90% of our employees in the U. S. working from home. I'm pleased to report that we have had little in the way of disruption in operations. And while not optimal, we have adapted very well. We have adjusted our approach to employee benefits to accommodate the need for extended pay leave and to account for school closing. In terms of policy holders, we have liberalized how we pay claims to include such things as expanded definition of hospitalization, accepting telemedicine diagnosis from doctors and even documentation requirements. We have offered premium payment grace periods with no risk of cancellation, and following any regulatory guidelines or suggested practices. Given our strong relationships with the health care industry in both Japan and the United States, we recently announced additional contributions to help provide support to combat the virus in both countries. In the U. S., our contribution of $5 million supports medical device shortages, particularly as it relates to ventilators and protective mask and humanitarian aid to the 50 state organizations. This aid will be used to provide personal protection equipment and essential medical items for health workers responding to the coronavirus. Similarly, Aflac Japan is also making a charitable contribution in equivalent of approximately $5 million to Japan Medical Association, and identified local municipalities and supportive medical professionals on the front lines fighting COVID-19. With this donation, Aflac Japan hopes to help foster improvements and enhance the work environment for medical institutions and healthcare professionals in Japan. Turning to the first quarter production and beginning with Japan. Total sales were down 25.4% in the first quarter, recognizing last year's quarter was prior to Japan Post running into the challenges. Japan Post made up the majority of the decline and as they remained focused on rebuilding the trust of customers and installing high quality governance and compliance processes. With respect to what we're seeing in April, total sales are down in the range of 65%, reflecting a full month’s impact of reduced activity related to COVID-19 and Japan Post having been a full strength in 2019 period. We have taken steps to defend our distribution franchise in Japan. We have focused our attention on our exclusive agency relationships and walk-in shops impacted by the virus. Actions in place or under review include extending interest free loans to the agencies. For walk in sales shops, we're offering to provide rent assistance. Recognizing the face to face sales will be a challenge, we are remaining active in generating business focusing on direct mail and calling campaigns to existing and perspective customers. In addition, we are promoting digital and web based sales to groups. We are also preparing to introduce the new system that enables smartphone based insurance applications by allowing the customer and Aflac operator see the same screen through the smartphones. In the U. S., total sales were down 5.2% in the quarter. Recruiting of career agents was up 2.5% for the first quarter, and average weekly producers’ productivity increased 4.9%. Recognizing our production model in the U. S. relies heavily on face to face agent interaction at the work site and is small business oriented, we are being hit hard by temporary closures of businesses and lack of access to the work site. In April, sales were down in the range of 55% and we are actively working to adjust. In the U. S., we have focused on our agency channel. For example, providing zero interest rate loans to qualified producers, helping agents pivot to digital solutions, which include training and recruiting. It's important to remember the more successful agents are in fact independent small business owners and are suffering through the same dynamics you're reading about with respect to the U. S. economy. On a positive note, we continue to build out our digital consumer market platform. Also, our recent definitive agreement to acquire Zurich Group Benefits business allows us to expand our distribution reach and extend our appeal to brokers and large employers. Fred will cover more of this a little later. Just to wrap things up, let me say the way a company responds during an unprecedented times like this truly defines the company and its brand. Our people come first and that includes our employees, our sales force, the policy holders and the communities in which we operate. In doing so, we create value for the shareholders. As I often say, the product we sell is an intangible product. It is nothing more than a promise on a piece of paper that we will be there for the policy holder when they need us most. So for many that time of need is right now. Our policy holders have put their trust in Aflac to come through. And I am proud to say that we will be there when they need us most, because that's who we are and what we do. Finally, I've always said that with change comes opportunities. With all the changes that we're seeing, we think there will be opportunity, not just to survive but to thrive. So with that, I'll turn the program over to Fred. Fred?
Fred Crawford: Thank you, Dan. I'm going to touch briefly on conditions in the first quarter and key variables we are tracking, provide some perspective on future claims exposure to COVID-19 and comment on our Group Benefit acquisition, which we expect to close later this year. As you can see from our first quarter results, we entered this crisis with strong margins, both in Japan and the U. S. We have the capacity to absorb a period of elevated claims, while maintaining important investments in our franchise. In terms of Japan, COVID-19 claims in the quarter amounted to ¥1.8 million. We also increased our medical product IBNR reserves to include ¥500 million specific to COVID-19. Taken together, there was very little impact from the claims related to the virus in the quarter. Thus far, in the month of April, we have paid out approximately ¥8 million in COVID-19 claims. As we look at expenses for the rest of the year, we expect downward pressure related to reduced overall activity, offset by a decision to accelerate ¥2 billion investment in our going paperless in our policyholder services operation. This paperless initiative is important for ongoing efficiency, supporting our distribution partners as they move towards digital production and business continuity in the current environment. Turning to the U. S., we had very little in the way of COVID-19 claims during the first quarter, but did add approximately $3 million to IBNR reserves specific to COVID-19 and based on disclosed infection rates as of the quarter end. Thus far in the month of April, we have paid a total of $1 million in COVID-19 related claims. As we look at the U. S. expense dynamics, we would expect expenses to remain stable as we push forward on key growth initiatives and factor in the Zurich Group Benefits acquisition later this year. Key initiatives surrounding improvements to our agent online enrollment tool, the conversion to our new group administrative platform, our efforts on the build out of network, dental and vision and digital direct-to-consumer, all remain on track. The initiatives have never been more important when considering the current benefits of diversification in product, distribution and market segmentation. I would add one final point on expenses. As Dan pointed out in his remarks, we are taking action to defend our franchise in Japan and the U. S. during this period of uncertainty. This includes actions to support our employees, policy holders, distribution partners and the communities we serve. While not material overall, these actions will play into our segment and corporate expenses for 2020, and are essential in being positioned to respond when markets recover. The first quarter reflects strength in benefit ratios and is consistent with our original outlook for 2020, depicted here on Slide 5. However, that outlook obviously did not contemplate COVID-19 and therefore, does not represent reliable guidance as we sit here today. Let me give you an idea of the variables when considering the remainder of 2020. In Japan, COVID-19 cases are very low relative to the U. S. but trends are up and uncertain. A key variable is Japan's declaration of a state-of-emergency and the life and health insurance industry's approach to infectious disease treatment and associated hospitalization coverage. In the U. S. along with uncertainty on the trends and COVID-19 rates of infection, we need to carefully track the rate of hospitalization, movement into intensive care and percentage of infected filing for short-term disability. Another important variable in the U.S. is persistency and the impact of high unemployment levels. The next few quarters will be significant in terms of providing us a window into the rest of the year and outlook for 2021, which then naturally leads us to a discussion of stress testing. If you look at Slide 6, our overall approach to stress testing seeks to inform our decision making along with ensuring we defend the following during periods of high volatility; keeping our promise to policy holders in a time of need; protecting our strong insurance ratings and access to capital; maintaining our strong regulatory standing and communication; ensuring no disruption to our core franchise and planned investments; and finally, defending our 37-year track record of increasing the common stock dividend. I'll focus my comments on the stress testing of claims exposure. Eric will cover investments and Max will tie together and testing our overall capital position. Let me start by saying that, while we have included stress on mortality, our risk is naturally concentrated in morbidity experience. We are tracking the rate of reported cases, hospitalization and deaths from sources, such as the CDC and Johns Hopkins. We are factoring in third-party forecasting models, like the IHME model and any associated revisions. We treat this as a rapid rate of rise in confirmed cases, so we accelerate the impact into 2020 for additional stress. We then build in a significant stress margin. Once bounced up against our enforced policies, we make one last adjustment to building a range around the point estimate. In terms of Japan, the focus is on morbidity exposure and our block of medical policies. Our testing in Japan assumes a mid-point estimate of 1.2 million confirmed cases or 1% of the population and we have assumed a 100% hospitalization rate consistent with infectious disease guidelines and approximately 100,000 deaths. We assume on average 20 days in the hospital or related accommodations and run a wide range of outcomes to then build the range. Recognizing Japan has less than 15,000 reported cases and 500 deaths, we believe this to be a very conservative stress test. We estimate the potential stress impact to our Japan served sector benefit ratio in the range of 50 to 100 basis points in 2020. Turning to the U. S., key products that are subject to elevated claims include hospitalization and short-term disability. We also include ICU benefits that materially increase the daily hospitalization reimbursement rate. There are also wellness benefits that apply across a number of product sets that may see elevated claims. Our testing in the U. S. assumes a mid-point estimate of 6.4 million confirmed COVID-19 cases, 1.5 million hospitalizations and 150,000 deaths. We apply hospitalization rates of 20% beginning around age 20 then increasing to 70% for policy holders reaching age 80. Of those hospitalized, we assume approximately 40% will have time spent in the ICU. We have assumed 20 days in hospital with 10 days in the ICU. We further assume 75% of confirmed cases file for short term disability coverage for 30 days on average. Given the current and projected rate of hospitalization in the U. S., we believe this is a very conservative stress test. Furthermore, in the U. S. we are a work site company with the majority of our policy holders younger and healthier, driving a lower rate of hospitalization. We estimate a potential stress impact to our U. S. benefit ratio in the range of 300 to 500 basis points impact in 2020. One last sensitivity to touch on, persistency in the U. S. has historically been tied to unemployment. We have stressed unemployment levels to 20% and based on historical correlation to persistency, we could see 3% reduction in 2020 earn premium. Again, we believe this is a conservative view and we think economic stimulus actions design to support and stabilize small business and employment are helpful. Finally, our stress testing should not be taken as guidance. The testing applies a significant stress margin and isolates the impact of COVID-19 on our 2020 results, while holding all else equal, such as temporary conditions that may lower claims in this environment. We provide the study to better understand the difficulty in maintaining guidance on benefit ratios at this point and to give investors a sense of our ability to absorb a true pandemic test. We also use this information to guide our decision making around expense management, capital and liquidity. Let me switch gears and comment on our March announcement of our planned acquisition of Zurich Group Benefits business. For several years now, we have expressed interest in finding the right true group life and disability property. We have passed on a number of larger businesses that came to the market in favor of a buy to build strategy that reduces the capital at risk. This strategy also recognizes that our model in the U. S. is unique in that regardless of the size of the property, we will need to invest in order to properly leverage our voluntary and small to midsize business model. This strategic move has broad long-term positive economic benefits to Aflac, including cross-selling, persistency and deeper account penetration with our higher margin voluntary business. It is also not uncommon to bundle true group with dental and vision, so this investment furthers our network, dental and vision growth strategy. In the process, we're able to drive more expansive broker relationships and a total benefit solution. The Zurich business fits well with our strategy as a startup platform four years in the making with modern technology, best in class products and leave management capabilities, and a very experienced staff who understands this business. The current business is designed for the large case market where we intend on being a competitive alternative to the current market leaders in the space. We are taking a phased approach to integration with the first few years continuing the momentum that currently exists in the platform, and exploring opportunities as part of the Zurich network of international group carriers. Our second phase will combine with core Aflac voluntary solutions that fully exploits the breadth and depth of our products as we look to accelerate our current position in the mid case market. This phase will include network, dental and vision. Our final phase will be bringing the capabilities down market into the smaller employers and via our unique agency driven small business distribution model. The teams on both sides of the transaction are excited about what the possibilities can be armed with the Aflac brand, our voluntary capabilities and an expanded client list. The total consideration is less than 200 million, including capital in support of the business. However, we plan to invest a similar amount in the coming years to build the business to scale. In that regard, we expect $0.05 to $0.06 of dilution on an annualized run rate for the next three years as we build the business. I'll now pass on to Eric to discuss our investment portfolio, Eric?
Eric Kirsch: Thank you, Fred. We ended the first quarter in a strong asset quality position, which I will comment further on in a moment. Impairments experienced in the quarter were partly due to the adoption of a new accounting treatment for loan losses, which many of you know as CECL. This accounted for approximately half of our loss reserves. In addition, we impaired two energy names, both of which are below investment grade. Net investment income was modestly positive to our plans, a result of stable rates in Japan. And in the case of U. S. dollar loan portfolios, because we locked in the majority of our floating rate income and our associated hedge costs prior to the large drop in LIBOR. As we look forward, the low rate environment will be a headwind to net investment income. In addition, our full year 2020 plan presume certain deployment objectives for our middle market loan portfolio, which includes our recent strategic alliance with Varagon. We have seen that markets slow and do not currently expect to invest as much money in 2020, which will negatively impact income. As an offset to these challenges, we also expect to slow down in prepayments in our loan portfolio. Many of these higher yielding loans have LIBOR floors that protect our income against low rates. So, we expect to retain much of this protection in the current environment. We also expect out performance from our floating rate income hedges due to more loans hitting LIBOR floors, given the significant LIBOR decline. In terms of our alternative investment portfolio, namely private equity and real estate equity, we like the rest of the industry, are likely to experience lower returns in the second quarter as these results typically lag by quarter and track public equity valuation. Fortunately, since we have a relatively young portfolio, we entered this crisis with a relatively low allocation of approximately $600 million. With respect to our U. S. dollar hedging, we have not seen any meaningful impacts to the program since we locked in the majority of our FX forward costs for the year. In order to protect the SMR impact of unhedged dollar investments, we use costless collars with caps for extra protection against negative settlements in the event of an extreme yen weakening. With current market volatility, we have been tactical in our approach to the use of collars and caps, balancing capital protection with the potential for negative settlements. We currently have $9 billion of collars and associated caps in place. And while not material to overall investment income, we could see additional costs associated with maintaining this program throughout the year. Max will add his comments to this later in the call. We have executed on about $8.5 billion in derisking activity across our fixed income and public equity portfolio since 2015. Our activity includes reducing our energy exposure by about one third, lowering our overall BBB exposure, including 47% decline in BBB minus position, reducing about 1.4 billion of foreign angels and a continued reduction in concentrated and low rated private placements. We have tactically reduced our public equity portfolio by 888 million over this time as well. Our strategy had been to reduce credit and equity risk that might underperform during the slow down and shift in the credit cycle. Additionally, proceeds from derisking activity allowed us to accelerate our alignment with our strategic asset allocation plan. As a reminder, the SAA modeling provides guideposts for optimal portfolio allocation among asset classes considering risk tolerances and asset liability management. The reinvestment of derisking proceeds is reflected in our new money asset allocation, which align with greater diversification and capital efficiency serving to reduce overall risk and improve returns. While of course we did not envision COVID-19, we did have a view of the credit cycle emerging in 2020. And over the past few years, we have moved our portfolio into a relatively defensive position. Our portfolio is well diversified by asset class, has a high average quality rating of single A and is highly diversified by sectors. As you can see in the sector allocation chart, we have limited exposure to those sectors that we expect to be most impacted from COVID-19 and the economic slowdown. Continuing with our approach to stress testing, we have conducted a bottoms up loss analysis focused on risk assets in the most vulnerable sectors as defined by the nature of this crisis and where we are most likely to experience potential defaults. The analysis pictured here focuses on a universe of approximately $3.2 billion of our most concerning fixed maturity exposure given the nature of the COVID-19 economic crisis. Asset categories include BBB and lower rated energy exposure, travel and leisure sectors, the airline industry and casino gaming. In addition, we have identified approximately $1.4 billion of middle-market loans, most exposed in the current environment, and have stress tested $1.3 billion of transitional real estate. While this economic crisis is unprecedented and predicting the trajectory of the economy and recovery is difficult, we have taken a pretty bearish view in our credit stress test. For instance, we have assumed an extremely severe second quarter drop in economic activity, up 30% to 50% with just a modest pickup through year-end; revenue decline of 30% to 80% depending on the specific sector and companies; losses on our most sensitive below investment grade and middle-market loans of up to 20%; oil prices staying below $20 for most of the of the year as demand slowly recovers. Let me emphasize that the impacts to the global and U. S. economy are going to be highly volatile and very difficult to predict. We will continue to evaluate as more economic information becomes available along with the impacts to the sectors and companies in our portfolio. Our loss analysis estimates approximately $680 million in pre-tax potential losses. This equates to approximately 100 basis points of potential losses on our total fixed maturity and loan portfolios, of which fixed maturity corporates of 72 basis points. This compares to about 94 basis points using the Moody's market loss rate experience from the 2008 to 2010 financial crisis. We estimate about 16% default rate on our middle market loan portfolio, which is higher than the 12% experienced during the last crisis. This reflects what we believe is the severity of our stress test given the unprecedented economic impacts we know will occur to small and medium-size businesses across the country. For our transitional real estate portfolio, we estimate about 90 basis points of potential losses, mostly reflecting exposure to the hotel industry. I'll go into more detail on our loan portfolios in a moment. This stress test is a pure economic loss approach and unlike a capital stress test, does not take into account accounting driven losses, such as impairment and associated bright line tests or downgrade risk. Let me stress, these estimates are subject to change as we all learn more about economic consequences during this unprecedented shutdown of economies around the world. In summary, while it's natural to anticipate a higher level of defaults and losses, we are very well-positioned to address weakness on the asset side from an economic loss perspective. We have been building our middle-market and transitional real estate loan portfolios, favoring loan structures for shorter duration and favorable underwriting protection. Our middle market loans remained well-diversified, are entirely first lien, senior secured, have low leverage and come with natural protections, including loan covenants and collateral. Recognizing most of our middle-market loans are sourced via equity sponsors, there is the potential added protection that they will be a source of capital to bridge the short-term liquidity strains brought on by a steep drop in business activity. Our investment philosophy in this asset class has always been focused on disciplined underwriting and diversification. In addition, we take a regular CECL reserve of 203 basis points, reflecting that overtime we expect loan losses to occur. We are well-positioned entering into this credit cycle brought on by COVID-19. Our commercial real estate portfolio about 7.3 billion in size is 76% allocated to transitional real estate, and 24% to commercial mortgage loans. The portfolios are highly diversified by property type, geography and conservatively underwritten to average loan to values of 60%. We only hold loans secured by first lien on quality assets. We do not have any B-notes, mezzanine or other subordinated exposure and we do not utilize leverage against our loans. Because of these strong attributes, we anticipate the potential for only a small economic loss stemming from our transitional real estate debt holding. Transitional real estate is unique and that the quality of properties only improves from the moment we make our loan as a asset owner is transitioning the property to a more valuable state. This typically requires the owner ingest their capital before any loan capital is drawn, providing an important protection for our guests. TRE underwriting incorporates the property value at time of purchase, as well as the value upon completion of the business plan. The risk to the business plan includes costs to execute and prospects for success given the local market conditions and the strength of the sponsor, including their experience with the type of asset transition and their financial resources to ensure completion. We do expect to see many amendments to our loan, primarily offering short term relief from monthly cash interest payment in exchange for other protections. This is especially true for the $1.1 billion of hotel loans in our TRE portfolio. We believe the modest LTVs on solid assets supported by strong owners will cause our loss rate to be very low. Our commercial mortgage loan portfolio is a very high quality with an average rating equivalent of A plus. This portfolio is well diversified with an average loan size of $21 million, and our average LTV is right at a very low 50%. As such, we do not anticipate any losses from this segment of our commercial real estate debt portfolio. I will now turn the call over to Max.
Max Broden: Thank you, Eric. Let me start my comments with a review of our first quarter performance with a focus on how our core capital and earnings drivers are positioned heading into the COVID-19 crisis. For the first quarter, adjusted earnings per share increased 8% to $1.21. The strengthening yen benefited earnings in the quarter by $0.01. As a result adjusted earnings per share on a currency neutral basis rose 7.1% to $1.20 per share. Adjusted book value per share, including foreign currency translation gains and losses, grew 8.9% and the adjusted ROE excluding foreign currency impact was a strong 15.8%. A significant spread over our cost of capital. There were no onetime items to call out for normalizing purposes in the quarter. Turning to our Japan segment. Total net premiums for the quarter declined 2.1%, reflecting perspective policies paid up impact and to pay medical policies sold in 2018 reaching paid up status, while net premiums for our served sector protection and served sector products was flat year-over-year. Japan's total benefit ratio came in at 69.4% for the quarter with served sector benefit ratio coming in at 59%. We did not experience any increased incidents rates in our cancer block this quarter as we did during the back end of last year. Our expense ratio in Japan was 20%, down 20 basis points year over year. In the current environment, we experienced lower promotional spend, which we view as primarily timing related and lower surrenders brought down our back amortization. Both factors contributing about the same to the decrease in the expense ratio, which was driven by strong expense discipline as revenues are under pressure. Net investment income increased 4% in yen terms despite variable investment income coming in at the lower end of plan, driven primarily by higher allocation to U. S. dollar floating rate assets. The pretax profit margin for Japan in the quarter was 22.5%. Turning to our U. S. segment. Total net premiums increased 1.5% despite weaker sales results and 100 basis decrease in persistency similar to our experience in Q4 of 2019. Our total benefit ratio coming at a strong 48.1%, 120 basis points lower than Q1 2019, driven by similar claims plans and mix of business with a continued shift toward our group and accident products. Our expense ratio in the U. S. was 38.4%, up 210 basis points year over year, primarily driven by our continued increased spending on digital capabilities and the inclusion of Argus and build out of Aflac network dental and vision, which structurally has increased the expense ratio by 140 basis points. Net investment income in the U. S. was flat. Profitability in the U. S. segment was impacted by the previously discussed elevated expense ratio leading to a pretax profit margin of 19.3% in Q1, down 40 basis points year over year. In our corporate segment, the main driver of improved results is higher levels of amortized hedge income, driven by our enterprise corporate hedging program. Amortized hedge income contributed $29 million on a pretax basis to the quarter’s earnings with an ending notional proposition of $5 billion. For 2020, we expect the quarter and another segment to record a prepretax loss for the full year in a range of $100 millionto $120 million. This incorporates increased interest expense from our recent global yen and U. S. dollar debt issuances of approximately $1.5 4 billion and increased philanthropic donations to support those individuals who are at the front line and fight against COVID-19. Our capital position remains strong and we ended the quarter with a headline SMR of approximately 881%, and 837% excluding unrealized gains in Japan. The estimated RBC was 550% for Aflac Columbus. Holding company liquidity stood at $4.8 billion for four months, including our recent $1 billion debt issuance. The low interest rate environment clearly adds earnings pressure, but our products generally have low interest rate sensitivity and our asset leverage is low, driving continued strong gross profit testing margins as we cash flow test products and blocks of our enforce. In short, while the first quarter is materially different than what we may face in the coming nine months, we entered this period of uncertainty with strong capital, liquidity, earnings and as Eric highlighted, strong asset quality. As Fred noted, we have been monitoring current conditions and making refinements to our stress testing. Fred discussed claims, stress testing and Eric addressed our asset loss analysis and estimates. In both cases, we have taken a practical approach with respect to current models on the spread of the virus and current economic views. When considering capital and liquidity stress testing, we take a more severe approach, more in alignment with what we share with regulators and rating agencies. Our approach to capital stress testing assumes a greater and more prolonged spread of the virus, which is roughly 6 times as severe as the stress Fred walked you through it. On the asset side, we combine Eric's economic loss analysis with changes in market value of bonds, impairments and downgrades, recognizing our core ratios can be impacted by these factors. We have assumed that market prices depends both the global financial crisis of 2008 and the 2016 oil shock. Then we have further refined the shock to various sectors in our portfolio by moderating and the impact to the financial sector, which has much improved liquidity since 2008. By increasing the assumed severity of the impact to COVID in vulnerable sectors, mainly travel, energy and middle market loans. This is arguably a very stressed scenario and certainly not our base case. But we do find it instructive to stress our balance sheet and capital plan with these kind of scenarios as it can inform us of how to utilize capital tools, enhance optionality and plan for capital deployments. Under this scenario and assuming that we shutdown share repurchase and retain capital in the insurance subsidiaries, we expect SMR to hold at or above 700% and RBC to hold at or above 400%. In addition, we expect holding company available cash and liquidity of over $3 billion through 2021. This scenario assumes no change in our franchise investment plans and defending our 37-year dividend growth track record. In light of our stress testing work, we have taken certain defensive steps to ensure stability on our core capital ratios and liquidity position. These include raising $1.54 billion in the global yen and U. S. senior debt markets. In both cases, we enjoyed favorable pricing and strong subscription levels. This move provides ample contingent capital and liquidity with a very modest cost to EPS and leverage. Retaining capital in our Japan subsidiary by ¥75 billion in 2020, adding additional buffer to our SMR ratio given the potential for continued market volatility. This move provided an additional 40 points of SMR. In the U. S., while we are not experienced deterioration in RBC levels, we are reducing our second quarter U. S. dividend by $75 million and injecting $150 million of capital into our smaller group legal entity CAIC. Our group business continues to grow and we are investing heavily in this part of the business. So the capital both protects and sustains strategic investments in this legal entity. All told, we entered the critical second quarter in a very strong position and these moves do not materially impact our capital planning as we carefully monitor conditions. We also have no debt maturities until 2023 due to liability management actions taken in 2019 setting us up well for the future. Before turn the call back to David, let me comment briefly on our approach to guidance. As you can see from our press release issued last night, recognizing likely volatility and a need to be tactical in our approach to access capital, we have elected to withdraw adjusted EPS and share repurchase guidance for 2020. While this withdrawal of guidance is not necessarily a view that our ranges are not achievable, we are off to a strong start to the year but must recognize that the current spread of COVID-19, its impact on the communities that we serve and volatile markets typically make it very difficult to accurately predict benefit ratios and other earnings drivers. It is fair to say we face a number of obvious EPS headwinds in terms of benefit ratios, investment income and overall revenue. But it's still very uncertain as to timing and the magnitude of the COVID-19 impact on 2020 earnings. We also need to be flexible in the actions we take to defend our franchise and making sure we do all we can to support policyholders. In terms of repurchase, we remain in the market but are buying at roughly 60% level in dollar terms versus the first quarter. We are taking a tactical approach depending on how the crisis develop in the second quarter. By tactical, we mean we maybe in a position to maintain, cancel or even accelerate as we see conditions evolve. And let me now hand off to David to take us to Q&A.
David Young: Thank you, Max. Before we begin, I just want to ask that you please limit yourself to one question and a related follow up to allow participants an opportunity to ask a question. Brittany, we’ll now take the first question.
Operator: Thank you. We will now begin our question-and-answer session [Operator instructions]. And our first question comes from Humphrey Lee from Dowling Partners.
Humphrey Lee: Good morning, and thank you for taking my questions. In terms of the capital and liquidity stress test, I was just wondering like when you look at the potential kind of downgrades and rating migrations. Can you share some of the -- what was your findings were related to that, how's that impact your RBC or your capital position?
Dan Amos: We're not disclosing in detail the underlying assumption for specifically for rating migration. But at a high level I can comment that rating migration is predominantly an issue when it comes to risk based capital and less so when it comes to our solvency margin ratio in Japan. It's obviously a factor in Japan as well but it's really to RBC formula that is more sensitive to rating migration. Our asset leverage in the us is fairly low. And even when we'll look at rating migration, it has a fairly limited impact on our capital conditions in the operating subsidiaries.
Humphrey Lee: And then my final question related to sales in U. S. and Japan. I clearly understand that there's going to be a very fluid situation, there's a lot of unknowns, but looking at the decline in April. Is there any of difference between the beginning of the crisis versus kind of more towards the late April? Do you see a change in productivity or sales decline maybe in a sense and maybe how your agents are adapting to the new situation?
Fred Crawford: Let's, do this. This is Fred. Let's split this up and have our colleagues speak directly to their markets. And so perhaps we'll start with Koide and Koji to address how they're adapting in Japan to the new environment and then we'll switch to Teresa and Rich Williams.
Masatoshi Koide: Yes, Koji will answer to that question…
Koji Ariyoshi: This is Koji, let me talk about agency first. So the state of emergency has been declared effective April 7th to seven prefecture, major prefectures in Japan and this state of emergency expanded to all prefectures in Japan on April 16th. So as a result, activities of the agencies have turned to be refraining from voluntary training from face to face activities. And we have also decided to suspend or close down our shops. And in Japan, there has been some impact from coronavirus from mid-February. So as a result, the number of people coming to our shops or going to face to face solicitation have been declining. And then as we got into April, because of the state of emergency, face to face solicitation was refrained, as well as we had to stop or close down our shops as well. So as a result, the agencies are not doing face-to-face solicitations anymore. Instead the combination of phone calls and mail outs are being done by agencies. However, because of more and more customers are staying home, there's a better chance of being able to communicate with customers. Although, the policies may not be purchased right away, it is good to maintain relationship with customers and expand or enhance relationship with customers and also to develop new prospective customers as well. And in May, we are trying to send out a direct emails nationwide and there will be follow up calls made after direct mails. So, we do believe that this will be successful and see some results in May. And during this time, we are also conducting trainings to the sales agents of a large exclusive agencies using the web. So, there are some advantages that we are able to conduct the training in a very efficient manner rather than visiting them or having them visit us. And at the same time, our agencies are starting to feel that the benefit or the convenience of using digital tool. So as a result, we do believe that there will be some improvement in efficiencies, as well as productivity by leveraging digital tools. That's all from sales perspective.
Dan Amos: Let me say one other thing. I want to make sure it's clear. The closing of shops is only temporary. We're still going to be using the shops. It very much plays an important role in Japanese culture. They actually like to bring the families in and sit down and discuss their overall products that they own and what they have and what this has done for us, talking about with change brings opportunity, it forced our singles associates to use technology more and ultimately will enhance us long-term. So, I wanted to be sure we said that.
Fred Crawford: And Rich Williams, why don’t you comment on the U. S. and our activities to pivot.
Richard Willams: So Humphrey, thanks for the question. I'll just speak maybe near-term about what we see, the preparation for work site and then really what the future holds. Really through the first 11 weeks, we're seeing a very favorable quarter play out. And then as everyone knows, we had 42 state stay at home or shelter in place and that basically just stopped the progress of worksite sales. So, near term until businesses get back in business, I think we'll see about this level. From a preparation perspective for the worksite, we've always had multiple enrollment options, face to face, enrollment call center, self enroll using digital means. And what you're seeing right now is really the ingenuity of our sales force in leveraging those latter two tools enrollment call center and co-browsing and self enrollment to be able to sell in this in a sort of impaired environment. I think thirdly and more broadly, I know both Dan and Fred made these comments is the plan for the future. We're expanding our value proposition to increase access and distribution diversification, with our consumer markets, building at that business, as well as our Aflac dental and vision and now with our Aflac Group Benefits, I think that that's the perspective of the U. S.
Fred Crawford: So Humphrey, hopefully that covers it for you and others in terms of what we're seeing out there production wise and this attempt to pivot. I think one general theme we're seeing, both in Japan and the U. S. is that digital communication non face-to-face communication has always been the secondary approach, the primary being face-to-face. Now you have agents and distribution partners having to pivot to making digital the primary and face-to-face a secondary, that takes a little bit of time to make that switch. And so we'll just have to be patient and work to support those efforts. We can go to the next question.
Operator: Thank you. And our next question comes from Nigel Dally from Morgan Stanley. Sir, your line is now open.
Nigel Dally: So, I wanted to question, I had a question on the U. S. operations, small businesses clearly being hit very hard and in addition to lower sales, you mentioned pressure on persistency. How much high should we expect lapses to go? Is there going to be a major hit? And I think you mentioned 3% potential premium decline, but I don't think you mentioned the sales and persistency assumptions and we should base that. So any color there would be helpful.
Fred Crawford: Yes, I think as it pertains specifically to persistency, it's a very tricky dynamic. We have historically seen our persistency, for example, during the last financial crisis, track unemployment levels and that is that we see greater lapsation or weakness in persistency during periods of high unemployment. And so it stands to reason we would have that as a sensitivity test or a stress test as part of looking at the U. S. and that's why we provided that number. Obviously, it's quite severe in its approach, particularly any sort of prolonged level of unemployment at the levels I discussed 20%. But nevertheless, it's a worthwhile stress to apply. I would say that one other aspect to be aware of is that we're providing right now guarantees, if you will, waivers of premium payments while guaranteeing the policy remains in place. And it defers by state but generally speaking, it tends to be upwards of 90 days or so, 60 to 90 days depending on the dynamics. Similarly, we’re doing that in Japan. When you do that in the United States, what happens is you see actually persistency remain high until such time those efforts are released and then you'll find a level of shock last typically, particularly if there's unemployment associated with the crisis. We know this. We have some experience in this, because this is very commonly done in states where there's been natural disasters, hurricanes, even recently, tornadoes in Tennessee for example. And so this is not an unusual event. What is unusual is that it's nationwide. And so what we're trying to do is understand what that sensitivity might be like. It has very little bottom line implications, because you're releasing reserves, you're writing off DAC. And so this is not necessarily a profitability or margin issue, it's really more related to your earned premium. And that's why we provided that forecast. I think Nigel, that's a very severe stress. We certainly hope we wouldn't get there. We find it beneficial that the stimulus packages that are being announced are directed towards small businesses and are wired to payroll and maintaining employment, which is how we collect our premium and how we sell our product. So there are some offsetting or mitigating factors, but we have to take a conservative approach when we're applying a stress test.
Operator: Thank you. And our next question comes from Jimmy Bhullar from JP Morgan. Sir. Your line is now open.
Jimmy Bhullar: I just had a question on the Japan Post and if you could just give us an update on what's going on there, and how you see your business sort of trending through the post over the next, especially in the near-term?
Dan Amos: Well, I think Koide, you should start with that and then I might say something afterwards. Koide?
Masatoshi Koide: Japan Post Group is currently doing additional research or investigation into their policy holder base, and they are also trying to gain confidence of the policy holders at the same time. And although the administrative order for suspending their sales was until the end of March, Japan Post is voluntarily refraining from sales at this moment still from April and after as well. So from an asset perspective, we are supporting Japan Post Group’s activities to recover or reinstate the confidence of the customers and we do respect and we like to support their activities. So what we are trying to do right now is to help them conduct, to take in the customers’ needs and then try to sale and try to train them to do solicitation from that perspective. And then at the same time conducting these kind of trainings, we are also enhancing solicitation management activities as well. And what we are expecting is that whenever Japan Post sales resume, they are able to sell our counter insurance based on customer needs and have appropriate solicitation management in doing their sales. And the situation continues that since Japan Post Group is refraining sales of Japan Post insurance product, which means that our counter product is not selling that much as well, so we are in that situation. And that's all from me.
Dan Amos: I'll make a couple of comments. I don't believe our Japan Post relationship’s ever been any stronger. I believe, and no one knows in these uncertain times, but this is just my personal belief and gut feelings from being an CEO for 30 years is that, when the COVID issues pass to some degree and we go back to whatever the new normal is, we'll see a pickup in Japan Post and things will start back again. And so, I'm encouraged about that. As you know, they're our largest shareholder and we are confident that that relationship was made even stronger with that acquisition and it's in their best interest and our best interest to see cancer insurance grow with them, and I think we'll see that moving forward.
Operator: Thank you. And our next question comes from John Barnidge from Piper Sandler. Sir, your line is now open.
John Barnidge: This question is on the investment portfolio. Can you talk about rental forbearance experience, and then maybe based on communications what your expectations for May 1st are?
Dan Amos: Today or at least through the end of March, we didn't have any. We certainly expect going forward there to be some. We don't necessarily think a huge amount just because of the nature of our properties. But where we do have them, as I mentioned in the speech, will be making more amendments to loans, getting other protections in return and just really adjusting cash flows. So, we do expect those but we don't expect financial difficulty at the end of the day for those sponsors that may need it.
Operator: Thank you [Operator Instructions]. And our next question comes from Erik Bass from Autonomous Research. Sir, your line is now open.
Erik Bass: Can you provide a bit more color on how you're thinking about the NII outlook both near-term and also beyond 2020, when some of the current hedges roll off? And I think you have some more reinvestment risk.
Fred Crawford: Well, as we reported, the first quarter was slightly better than we had expected. We did get most of our deployment and middle market loans drawn by the end of February for the quarter. So, that was fortunate just because as I reported, it'll be slower rest of the year. As we think of the rest of the year, I'll put it in two buckets, stable and variable, the alternatives just because it's two different stories. On the stable, we actually expect it to be a fairly decent year, despite some of the headwinds of lower rates. On our floating rate book, as I reported, we locked in our hedges and our income. So, despite the low drop in LIBOR, we're protected by the hedges we did and the LIBOR floors. And in fact because of the precipitous decline in LIBOR, our hedges actually ended up performing better than we expected, because more loans hit the floor that was so extreme. So actually we were able to book some of that extra income, if you will, which will help offset some of the headlines naturally from lower rates. The other thing to mention for the year, part of our allocation actually does go to yen assets. And in a surprise that we haven't seen in a number of years, yen yields have actually been stable to going up a little bit. So, relative to our plan that put us in a good position and when we are buying yen, we continue to see actually attractive opportunities in yen public credit as well as some yen private placements. So we can find good credit and earnest spread. So on that part of the allocation, doing relatively well. Obviously for alternatives, we're expecting lower variable income versus our plan. Now that will depend on what happens with equity markets. Now they're up, there's still a lag effect on valuations but our base case right now is lower than we had planned. But if you put that on together between the stable and the variable, we're feeling like we're going to come right in the strike zone maybe a bit better versus planned for the year. Looking forward, I obviously can't really comment holistically in the sense of being specific to 2021. But to your question, Eric, around the floating rate assets, as I've mentioned, in many fabs and answering other questions around this. The way we think of those floating rates is the natural hedge between hedge costs and the income. And right now we're in an environment where if you were to just say today was January 1st and I don't have the specific days of the rolls of our coupon hedges but they're around in the fourth quarter maybe beginning January, February. But if you just said re-roll them right now, well for this year, we locked in hedge costs in the area of 210 basis points and 220 basis points, because you locked them in December and January. Well, right now three months hedge costs are I think last night 69 basis points. So, if the notional of our floating rate book is the same, our hedge costs will go extremely down the same token, those loans which are based off of LIBOR, those are resetting down now they have LIBOR floors, so there is a natural protection. But the point of me saying is that way is at the end for net investment income, I'm looking at the net result, the net result of the income on the asset less than hedge cost. So all things being equal, we actually see that net result being fairly manageable going into next year, if you take out any one time gains like from hedges that I described earlier for this year. So as time goes on, we'll see. But that's how I would think of group one. And then you know, the rest of the book, obviously, if reinvestment rates continue to stay at this low level, again, as you know, we have high coupon private placements from years ago maturing. So that would be a headwind, going forward into income. Hope that helps.
Operator: Thank you. And our next question comes from Tom Gallagher from Evercore. Sir, your line in now open.
Tom Gallagher: Fred, just a follow up on your question about premium waivers that you had mentioned, 60 to 90 days in the U. S. Can you comment on what percentage of your in force in the U. S. is currently paying versus what percent is on this premium waiver? And is that a decent way to gauge some proportion of that might end up lapsing? Is that the way you're approaching it?
Fred Crawford: You know, it's a good question and we're studying all those metrics, Tom, for that reason, but it's a bit early, to give you anything with any sort of concise nature. It's just been rolled out state by state. We’re just getting into it. What I would tell you is we're collecting our received premium. We're calculating our received premium. And actually I just saw a report on that yesterday and it was into the month of April, which is really where things are kicking in. And so far we haven't seen much movement in terms of collected premium. I think it's down a little bit.
Teresa White: I think we have 86.2% of premium collected versus 87.6%. So we're still doing pretty well on premium collection and that's collected through invoices to the worksite. It's a little bit more on the group side, 89% collected. But we're doing relatively well.
Fred Crawford: So we're tracking that, Tom, and we'll have to continue to watch it. But we've been here before. You know, as I mentioned earlier we've had to do this in various states Florida, Texas, et cetera, with hurricanes, California fires and so forth. So we understand how this works and typically operates. And so, we've got a good handle on it.
Operator: Thank you. And our next question comes from Alex Scott from Goldman Sachs. Your line is now open.
Alex Scott: My first one is just a quick follow-up on the last question actually, and I'd just be interested. Is there anything going on in Japan around premium relief and any way to think about an impact there as well?
Fred Crawford: We can have Koide add any comments he wants, but the answer is yes. There is a somewhat industry adopted conventional practice of allowing premium waiver for an extended period of time. I think the big difference in Japan is that you tend not to see necessarily implications for persistency, because these policies are age priced there. As you know, the Japanese consumer values the policy and that's very specific intentions around the policy protecting savings and their livelihood. And so while the waivers do matter from an economic perspective, we tend not to see dramatic movements in persistency related to what I mentioned earlier in the U. S. But if I'm off on that, either Todd or Koide if you want to add any color.
Masatoshi Koide: Todd, could you answer that question?
Todd Daniels: Yes, Fred's correct. Just to be clear, this is a premium grace period, not necessarily a premium waiver that's being put in place. So we're not forgiving premium in any of these cases. Japan does have special circumstances, and as Fred said, has been adopted by industry each company that operates in Japan, is looking at the situation and the states of emergency and adopting their practices during that time period.
Fred Crawford: Thanks for making that point, Todd that both in the U. S. and in Japan, these are grace periods, not waivers in the sense of outright waving the collection of premium.
David Young: Brittany, I think that concludes our call.
Operator: Thank you for your participation in today's conference. All parties may disconnect at this time. Speakers, please stand by for your post conference. | [
{
"speaker": "Operator",
"text": "Welcome to the Aflac First Quarter 2020 Earnings Conference Call [Operator Instructions]. Please be advised, today's conference is being recorded. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor Relations."
},
{
"speaker": "David Young",
"text": "Thank you, Brittany. Good morning, and welcome to Aflac Incorporated first quarter call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. There you will also find slides relevant to today's remarks. This morning, we will be hearing remarks about the quarter as well as our operations in Japan and United States amid the COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin by discussing the impact of the pandemic and our response. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the first quarter before providing perspective on future clinic exposure to COVID-19 and commenting on our Group Benefits acquisition. Then Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments will provide investment highlights from the quarter, including an update on our investment portfolio and related stress test. Max Broden, Executive Vice President and CFO of Aflac Incorporated will conclude our prepared remarks with a summary of first quarter financial results and current capital and liquidity. Joining us this morning during the Q&A portion are members of our executive management team in United States. Teresa White, President of Aflac U. S.; Rich Williams, Chief Distribution Officer; and Al Riggieri, Global Chief Risk Officer and Chief Actuary. We are joined by members of our executive management team in Tokyo as well at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on the company’s Investors site, investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, David and good morning, everyone. Normally, I’d begin by providing a high-level view of the quarter and how we performed, but we're in an unusual and unprecedented time. Instead, I want to start by thanking all of those who are on the front lines fighting the spread of COVID-19 and those who are providing essential services including our own employees. We truly appreciate all that you do. Our thoughts and prayers are also with those who are among the confirmed cases. This is a challenging time but we will get through it together. Let me start by addressing our enterprise-wide COVID-19 response efforts. The guiding focus of our actions has centered around; first, the health and safety of our employees and distribution partners; second, the well being of our policy holders; third, the business community and maintaining our operations; and fourth, prudent financial and risk management. I will concentrate on how we're protecting our people, operations and brand and ask Fred, Eric and Max to collectively cover how we've positioned from an operational, financial and risk perspective. First, I want to note that we took early actions when the news of the virus broke. We benefited from Japan providing us with an early window into the potential response efforts as they were about three weeks ahead of the U. S. in combating the spread of the virus. We also benefited from the Board expertise, specifically long time director, Dr. Barbara Rimer, who is the dean and Alumni Distinguished Professor of Gillings School of Public Health at the University of North Carolina at Chapel Hill. She advised us back in early February about the emerging threat of the virus. Early on, we implemented travel restrictions, shifted to working remotely and installed several social-distancing measures, both in Japan and the United States. Japan remains ahead of many countries with respect to COVID-19 with 14,000 confirmed cases and 400 related deaths as of yesterday. We see several possible reasons for this, including existing social norms of wearing mask, not shaking hands. In addition, Japan jumped out early having to deal with the cruise ship, Diamond Princess, and prepare for the Olympic games. Finally, it's worth noting that Japan is taking a more measured approach to testing, focused on sympathetic cases and localized to where outbreaks have been identified. Despite these factors, cases have been on the rise resulting in the Prime Minister declaring a national state-of-emergency through the end of golden week holidays on May 6th and possibly extending further. Along with economic stimulus packages, the state of emergency includes a requirement for business to reduce employees at the work site by 70%. COVID 19 is now classified as an infectious disease requiring doctors to prescribe hospital care. Further, the Japanese government recognized that the potential shortage of hospital beds, and is allowing doctors to instruct a patient with symptoms to receive medical treatments outside the hospital consistent with government policy and industry guidelines and standards. Aflac Japan and other major domestic life insurance companies announced that hospitalization benefits will be paid for the period, a test by a doctor if a patient receives medical treatment at an alternative accommodation or a temporary facility. I'm sure most of you are all familiar with the U. S. government's actions and state by state shelter in place restrictions. From a state regulatory environment several states have issued executive orders directing premium grace periods and guidance on treating policy holders with care. In both the United States and Japan, we have taken action in response to COVID-19 to help mitigate risks to our employees, policy holders and communities. We have ramped up work at home staffing models with more than 75% of our on site employees in Japan, and more than 90% of our employees in the U. S. working from home. I'm pleased to report that we have had little in the way of disruption in operations. And while not optimal, we have adapted very well. We have adjusted our approach to employee benefits to accommodate the need for extended pay leave and to account for school closing. In terms of policy holders, we have liberalized how we pay claims to include such things as expanded definition of hospitalization, accepting telemedicine diagnosis from doctors and even documentation requirements. We have offered premium payment grace periods with no risk of cancellation, and following any regulatory guidelines or suggested practices. Given our strong relationships with the health care industry in both Japan and the United States, we recently announced additional contributions to help provide support to combat the virus in both countries. In the U. S., our contribution of $5 million supports medical device shortages, particularly as it relates to ventilators and protective mask and humanitarian aid to the 50 state organizations. This aid will be used to provide personal protection equipment and essential medical items for health workers responding to the coronavirus. Similarly, Aflac Japan is also making a charitable contribution in equivalent of approximately $5 million to Japan Medical Association, and identified local municipalities and supportive medical professionals on the front lines fighting COVID-19. With this donation, Aflac Japan hopes to help foster improvements and enhance the work environment for medical institutions and healthcare professionals in Japan. Turning to the first quarter production and beginning with Japan. Total sales were down 25.4% in the first quarter, recognizing last year's quarter was prior to Japan Post running into the challenges. Japan Post made up the majority of the decline and as they remained focused on rebuilding the trust of customers and installing high quality governance and compliance processes. With respect to what we're seeing in April, total sales are down in the range of 65%, reflecting a full month’s impact of reduced activity related to COVID-19 and Japan Post having been a full strength in 2019 period. We have taken steps to defend our distribution franchise in Japan. We have focused our attention on our exclusive agency relationships and walk-in shops impacted by the virus. Actions in place or under review include extending interest free loans to the agencies. For walk in sales shops, we're offering to provide rent assistance. Recognizing the face to face sales will be a challenge, we are remaining active in generating business focusing on direct mail and calling campaigns to existing and perspective customers. In addition, we are promoting digital and web based sales to groups. We are also preparing to introduce the new system that enables smartphone based insurance applications by allowing the customer and Aflac operator see the same screen through the smartphones. In the U. S., total sales were down 5.2% in the quarter. Recruiting of career agents was up 2.5% for the first quarter, and average weekly producers’ productivity increased 4.9%. Recognizing our production model in the U. S. relies heavily on face to face agent interaction at the work site and is small business oriented, we are being hit hard by temporary closures of businesses and lack of access to the work site. In April, sales were down in the range of 55% and we are actively working to adjust. In the U. S., we have focused on our agency channel. For example, providing zero interest rate loans to qualified producers, helping agents pivot to digital solutions, which include training and recruiting. It's important to remember the more successful agents are in fact independent small business owners and are suffering through the same dynamics you're reading about with respect to the U. S. economy. On a positive note, we continue to build out our digital consumer market platform. Also, our recent definitive agreement to acquire Zurich Group Benefits business allows us to expand our distribution reach and extend our appeal to brokers and large employers. Fred will cover more of this a little later. Just to wrap things up, let me say the way a company responds during an unprecedented times like this truly defines the company and its brand. Our people come first and that includes our employees, our sales force, the policy holders and the communities in which we operate. In doing so, we create value for the shareholders. As I often say, the product we sell is an intangible product. It is nothing more than a promise on a piece of paper that we will be there for the policy holder when they need us most. So for many that time of need is right now. Our policy holders have put their trust in Aflac to come through. And I am proud to say that we will be there when they need us most, because that's who we are and what we do. Finally, I've always said that with change comes opportunities. With all the changes that we're seeing, we think there will be opportunity, not just to survive but to thrive. So with that, I'll turn the program over to Fred. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Dan. I'm going to touch briefly on conditions in the first quarter and key variables we are tracking, provide some perspective on future claims exposure to COVID-19 and comment on our Group Benefit acquisition, which we expect to close later this year. As you can see from our first quarter results, we entered this crisis with strong margins, both in Japan and the U. S. We have the capacity to absorb a period of elevated claims, while maintaining important investments in our franchise. In terms of Japan, COVID-19 claims in the quarter amounted to ¥1.8 million. We also increased our medical product IBNR reserves to include ¥500 million specific to COVID-19. Taken together, there was very little impact from the claims related to the virus in the quarter. Thus far, in the month of April, we have paid out approximately ¥8 million in COVID-19 claims. As we look at expenses for the rest of the year, we expect downward pressure related to reduced overall activity, offset by a decision to accelerate ¥2 billion investment in our going paperless in our policyholder services operation. This paperless initiative is important for ongoing efficiency, supporting our distribution partners as they move towards digital production and business continuity in the current environment. Turning to the U. S., we had very little in the way of COVID-19 claims during the first quarter, but did add approximately $3 million to IBNR reserves specific to COVID-19 and based on disclosed infection rates as of the quarter end. Thus far in the month of April, we have paid a total of $1 million in COVID-19 related claims. As we look at the U. S. expense dynamics, we would expect expenses to remain stable as we push forward on key growth initiatives and factor in the Zurich Group Benefits acquisition later this year. Key initiatives surrounding improvements to our agent online enrollment tool, the conversion to our new group administrative platform, our efforts on the build out of network, dental and vision and digital direct-to-consumer, all remain on track. The initiatives have never been more important when considering the current benefits of diversification in product, distribution and market segmentation. I would add one final point on expenses. As Dan pointed out in his remarks, we are taking action to defend our franchise in Japan and the U. S. during this period of uncertainty. This includes actions to support our employees, policy holders, distribution partners and the communities we serve. While not material overall, these actions will play into our segment and corporate expenses for 2020, and are essential in being positioned to respond when markets recover. The first quarter reflects strength in benefit ratios and is consistent with our original outlook for 2020, depicted here on Slide 5. However, that outlook obviously did not contemplate COVID-19 and therefore, does not represent reliable guidance as we sit here today. Let me give you an idea of the variables when considering the remainder of 2020. In Japan, COVID-19 cases are very low relative to the U. S. but trends are up and uncertain. A key variable is Japan's declaration of a state-of-emergency and the life and health insurance industry's approach to infectious disease treatment and associated hospitalization coverage. In the U. S. along with uncertainty on the trends and COVID-19 rates of infection, we need to carefully track the rate of hospitalization, movement into intensive care and percentage of infected filing for short-term disability. Another important variable in the U.S. is persistency and the impact of high unemployment levels. The next few quarters will be significant in terms of providing us a window into the rest of the year and outlook for 2021, which then naturally leads us to a discussion of stress testing. If you look at Slide 6, our overall approach to stress testing seeks to inform our decision making along with ensuring we defend the following during periods of high volatility; keeping our promise to policy holders in a time of need; protecting our strong insurance ratings and access to capital; maintaining our strong regulatory standing and communication; ensuring no disruption to our core franchise and planned investments; and finally, defending our 37-year track record of increasing the common stock dividend. I'll focus my comments on the stress testing of claims exposure. Eric will cover investments and Max will tie together and testing our overall capital position. Let me start by saying that, while we have included stress on mortality, our risk is naturally concentrated in morbidity experience. We are tracking the rate of reported cases, hospitalization and deaths from sources, such as the CDC and Johns Hopkins. We are factoring in third-party forecasting models, like the IHME model and any associated revisions. We treat this as a rapid rate of rise in confirmed cases, so we accelerate the impact into 2020 for additional stress. We then build in a significant stress margin. Once bounced up against our enforced policies, we make one last adjustment to building a range around the point estimate. In terms of Japan, the focus is on morbidity exposure and our block of medical policies. Our testing in Japan assumes a mid-point estimate of 1.2 million confirmed cases or 1% of the population and we have assumed a 100% hospitalization rate consistent with infectious disease guidelines and approximately 100,000 deaths. We assume on average 20 days in the hospital or related accommodations and run a wide range of outcomes to then build the range. Recognizing Japan has less than 15,000 reported cases and 500 deaths, we believe this to be a very conservative stress test. We estimate the potential stress impact to our Japan served sector benefit ratio in the range of 50 to 100 basis points in 2020. Turning to the U. S., key products that are subject to elevated claims include hospitalization and short-term disability. We also include ICU benefits that materially increase the daily hospitalization reimbursement rate. There are also wellness benefits that apply across a number of product sets that may see elevated claims. Our testing in the U. S. assumes a mid-point estimate of 6.4 million confirmed COVID-19 cases, 1.5 million hospitalizations and 150,000 deaths. We apply hospitalization rates of 20% beginning around age 20 then increasing to 70% for policy holders reaching age 80. Of those hospitalized, we assume approximately 40% will have time spent in the ICU. We have assumed 20 days in hospital with 10 days in the ICU. We further assume 75% of confirmed cases file for short term disability coverage for 30 days on average. Given the current and projected rate of hospitalization in the U. S., we believe this is a very conservative stress test. Furthermore, in the U. S. we are a work site company with the majority of our policy holders younger and healthier, driving a lower rate of hospitalization. We estimate a potential stress impact to our U. S. benefit ratio in the range of 300 to 500 basis points impact in 2020. One last sensitivity to touch on, persistency in the U. S. has historically been tied to unemployment. We have stressed unemployment levels to 20% and based on historical correlation to persistency, we could see 3% reduction in 2020 earn premium. Again, we believe this is a conservative view and we think economic stimulus actions design to support and stabilize small business and employment are helpful. Finally, our stress testing should not be taken as guidance. The testing applies a significant stress margin and isolates the impact of COVID-19 on our 2020 results, while holding all else equal, such as temporary conditions that may lower claims in this environment. We provide the study to better understand the difficulty in maintaining guidance on benefit ratios at this point and to give investors a sense of our ability to absorb a true pandemic test. We also use this information to guide our decision making around expense management, capital and liquidity. Let me switch gears and comment on our March announcement of our planned acquisition of Zurich Group Benefits business. For several years now, we have expressed interest in finding the right true group life and disability property. We have passed on a number of larger businesses that came to the market in favor of a buy to build strategy that reduces the capital at risk. This strategy also recognizes that our model in the U. S. is unique in that regardless of the size of the property, we will need to invest in order to properly leverage our voluntary and small to midsize business model. This strategic move has broad long-term positive economic benefits to Aflac, including cross-selling, persistency and deeper account penetration with our higher margin voluntary business. It is also not uncommon to bundle true group with dental and vision, so this investment furthers our network, dental and vision growth strategy. In the process, we're able to drive more expansive broker relationships and a total benefit solution. The Zurich business fits well with our strategy as a startup platform four years in the making with modern technology, best in class products and leave management capabilities, and a very experienced staff who understands this business. The current business is designed for the large case market where we intend on being a competitive alternative to the current market leaders in the space. We are taking a phased approach to integration with the first few years continuing the momentum that currently exists in the platform, and exploring opportunities as part of the Zurich network of international group carriers. Our second phase will combine with core Aflac voluntary solutions that fully exploits the breadth and depth of our products as we look to accelerate our current position in the mid case market. This phase will include network, dental and vision. Our final phase will be bringing the capabilities down market into the smaller employers and via our unique agency driven small business distribution model. The teams on both sides of the transaction are excited about what the possibilities can be armed with the Aflac brand, our voluntary capabilities and an expanded client list. The total consideration is less than 200 million, including capital in support of the business. However, we plan to invest a similar amount in the coming years to build the business to scale. In that regard, we expect $0.05 to $0.06 of dilution on an annualized run rate for the next three years as we build the business. I'll now pass on to Eric to discuss our investment portfolio, Eric?"
},
{
"speaker": "Eric Kirsch",
"text": "Thank you, Fred. We ended the first quarter in a strong asset quality position, which I will comment further on in a moment. Impairments experienced in the quarter were partly due to the adoption of a new accounting treatment for loan losses, which many of you know as CECL. This accounted for approximately half of our loss reserves. In addition, we impaired two energy names, both of which are below investment grade. Net investment income was modestly positive to our plans, a result of stable rates in Japan. And in the case of U. S. dollar loan portfolios, because we locked in the majority of our floating rate income and our associated hedge costs prior to the large drop in LIBOR. As we look forward, the low rate environment will be a headwind to net investment income. In addition, our full year 2020 plan presume certain deployment objectives for our middle market loan portfolio, which includes our recent strategic alliance with Varagon. We have seen that markets slow and do not currently expect to invest as much money in 2020, which will negatively impact income. As an offset to these challenges, we also expect to slow down in prepayments in our loan portfolio. Many of these higher yielding loans have LIBOR floors that protect our income against low rates. So, we expect to retain much of this protection in the current environment. We also expect out performance from our floating rate income hedges due to more loans hitting LIBOR floors, given the significant LIBOR decline. In terms of our alternative investment portfolio, namely private equity and real estate equity, we like the rest of the industry, are likely to experience lower returns in the second quarter as these results typically lag by quarter and track public equity valuation. Fortunately, since we have a relatively young portfolio, we entered this crisis with a relatively low allocation of approximately $600 million. With respect to our U. S. dollar hedging, we have not seen any meaningful impacts to the program since we locked in the majority of our FX forward costs for the year. In order to protect the SMR impact of unhedged dollar investments, we use costless collars with caps for extra protection against negative settlements in the event of an extreme yen weakening. With current market volatility, we have been tactical in our approach to the use of collars and caps, balancing capital protection with the potential for negative settlements. We currently have $9 billion of collars and associated caps in place. And while not material to overall investment income, we could see additional costs associated with maintaining this program throughout the year. Max will add his comments to this later in the call. We have executed on about $8.5 billion in derisking activity across our fixed income and public equity portfolio since 2015. Our activity includes reducing our energy exposure by about one third, lowering our overall BBB exposure, including 47% decline in BBB minus position, reducing about 1.4 billion of foreign angels and a continued reduction in concentrated and low rated private placements. We have tactically reduced our public equity portfolio by 888 million over this time as well. Our strategy had been to reduce credit and equity risk that might underperform during the slow down and shift in the credit cycle. Additionally, proceeds from derisking activity allowed us to accelerate our alignment with our strategic asset allocation plan. As a reminder, the SAA modeling provides guideposts for optimal portfolio allocation among asset classes considering risk tolerances and asset liability management. The reinvestment of derisking proceeds is reflected in our new money asset allocation, which align with greater diversification and capital efficiency serving to reduce overall risk and improve returns. While of course we did not envision COVID-19, we did have a view of the credit cycle emerging in 2020. And over the past few years, we have moved our portfolio into a relatively defensive position. Our portfolio is well diversified by asset class, has a high average quality rating of single A and is highly diversified by sectors. As you can see in the sector allocation chart, we have limited exposure to those sectors that we expect to be most impacted from COVID-19 and the economic slowdown. Continuing with our approach to stress testing, we have conducted a bottoms up loss analysis focused on risk assets in the most vulnerable sectors as defined by the nature of this crisis and where we are most likely to experience potential defaults. The analysis pictured here focuses on a universe of approximately $3.2 billion of our most concerning fixed maturity exposure given the nature of the COVID-19 economic crisis. Asset categories include BBB and lower rated energy exposure, travel and leisure sectors, the airline industry and casino gaming. In addition, we have identified approximately $1.4 billion of middle-market loans, most exposed in the current environment, and have stress tested $1.3 billion of transitional real estate. While this economic crisis is unprecedented and predicting the trajectory of the economy and recovery is difficult, we have taken a pretty bearish view in our credit stress test. For instance, we have assumed an extremely severe second quarter drop in economic activity, up 30% to 50% with just a modest pickup through year-end; revenue decline of 30% to 80% depending on the specific sector and companies; losses on our most sensitive below investment grade and middle-market loans of up to 20%; oil prices staying below $20 for most of the of the year as demand slowly recovers. Let me emphasize that the impacts to the global and U. S. economy are going to be highly volatile and very difficult to predict. We will continue to evaluate as more economic information becomes available along with the impacts to the sectors and companies in our portfolio. Our loss analysis estimates approximately $680 million in pre-tax potential losses. This equates to approximately 100 basis points of potential losses on our total fixed maturity and loan portfolios, of which fixed maturity corporates of 72 basis points. This compares to about 94 basis points using the Moody's market loss rate experience from the 2008 to 2010 financial crisis. We estimate about 16% default rate on our middle market loan portfolio, which is higher than the 12% experienced during the last crisis. This reflects what we believe is the severity of our stress test given the unprecedented economic impacts we know will occur to small and medium-size businesses across the country. For our transitional real estate portfolio, we estimate about 90 basis points of potential losses, mostly reflecting exposure to the hotel industry. I'll go into more detail on our loan portfolios in a moment. This stress test is a pure economic loss approach and unlike a capital stress test, does not take into account accounting driven losses, such as impairment and associated bright line tests or downgrade risk. Let me stress, these estimates are subject to change as we all learn more about economic consequences during this unprecedented shutdown of economies around the world. In summary, while it's natural to anticipate a higher level of defaults and losses, we are very well-positioned to address weakness on the asset side from an economic loss perspective. We have been building our middle-market and transitional real estate loan portfolios, favoring loan structures for shorter duration and favorable underwriting protection. Our middle market loans remained well-diversified, are entirely first lien, senior secured, have low leverage and come with natural protections, including loan covenants and collateral. Recognizing most of our middle-market loans are sourced via equity sponsors, there is the potential added protection that they will be a source of capital to bridge the short-term liquidity strains brought on by a steep drop in business activity. Our investment philosophy in this asset class has always been focused on disciplined underwriting and diversification. In addition, we take a regular CECL reserve of 203 basis points, reflecting that overtime we expect loan losses to occur. We are well-positioned entering into this credit cycle brought on by COVID-19. Our commercial real estate portfolio about 7.3 billion in size is 76% allocated to transitional real estate, and 24% to commercial mortgage loans. The portfolios are highly diversified by property type, geography and conservatively underwritten to average loan to values of 60%. We only hold loans secured by first lien on quality assets. We do not have any B-notes, mezzanine or other subordinated exposure and we do not utilize leverage against our loans. Because of these strong attributes, we anticipate the potential for only a small economic loss stemming from our transitional real estate debt holding. Transitional real estate is unique and that the quality of properties only improves from the moment we make our loan as a asset owner is transitioning the property to a more valuable state. This typically requires the owner ingest their capital before any loan capital is drawn, providing an important protection for our guests. TRE underwriting incorporates the property value at time of purchase, as well as the value upon completion of the business plan. The risk to the business plan includes costs to execute and prospects for success given the local market conditions and the strength of the sponsor, including their experience with the type of asset transition and their financial resources to ensure completion. We do expect to see many amendments to our loan, primarily offering short term relief from monthly cash interest payment in exchange for other protections. This is especially true for the $1.1 billion of hotel loans in our TRE portfolio. We believe the modest LTVs on solid assets supported by strong owners will cause our loss rate to be very low. Our commercial mortgage loan portfolio is a very high quality with an average rating equivalent of A plus. This portfolio is well diversified with an average loan size of $21 million, and our average LTV is right at a very low 50%. As such, we do not anticipate any losses from this segment of our commercial real estate debt portfolio. I will now turn the call over to Max."
},
{
"speaker": "Max Broden",
"text": "Thank you, Eric. Let me start my comments with a review of our first quarter performance with a focus on how our core capital and earnings drivers are positioned heading into the COVID-19 crisis. For the first quarter, adjusted earnings per share increased 8% to $1.21. The strengthening yen benefited earnings in the quarter by $0.01. As a result adjusted earnings per share on a currency neutral basis rose 7.1% to $1.20 per share. Adjusted book value per share, including foreign currency translation gains and losses, grew 8.9% and the adjusted ROE excluding foreign currency impact was a strong 15.8%. A significant spread over our cost of capital. There were no onetime items to call out for normalizing purposes in the quarter. Turning to our Japan segment. Total net premiums for the quarter declined 2.1%, reflecting perspective policies paid up impact and to pay medical policies sold in 2018 reaching paid up status, while net premiums for our served sector protection and served sector products was flat year-over-year. Japan's total benefit ratio came in at 69.4% for the quarter with served sector benefit ratio coming in at 59%. We did not experience any increased incidents rates in our cancer block this quarter as we did during the back end of last year. Our expense ratio in Japan was 20%, down 20 basis points year over year. In the current environment, we experienced lower promotional spend, which we view as primarily timing related and lower surrenders brought down our back amortization. Both factors contributing about the same to the decrease in the expense ratio, which was driven by strong expense discipline as revenues are under pressure. Net investment income increased 4% in yen terms despite variable investment income coming in at the lower end of plan, driven primarily by higher allocation to U. S. dollar floating rate assets. The pretax profit margin for Japan in the quarter was 22.5%. Turning to our U. S. segment. Total net premiums increased 1.5% despite weaker sales results and 100 basis decrease in persistency similar to our experience in Q4 of 2019. Our total benefit ratio coming at a strong 48.1%, 120 basis points lower than Q1 2019, driven by similar claims plans and mix of business with a continued shift toward our group and accident products. Our expense ratio in the U. S. was 38.4%, up 210 basis points year over year, primarily driven by our continued increased spending on digital capabilities and the inclusion of Argus and build out of Aflac network dental and vision, which structurally has increased the expense ratio by 140 basis points. Net investment income in the U. S. was flat. Profitability in the U. S. segment was impacted by the previously discussed elevated expense ratio leading to a pretax profit margin of 19.3% in Q1, down 40 basis points year over year. In our corporate segment, the main driver of improved results is higher levels of amortized hedge income, driven by our enterprise corporate hedging program. Amortized hedge income contributed $29 million on a pretax basis to the quarter’s earnings with an ending notional proposition of $5 billion. For 2020, we expect the quarter and another segment to record a prepretax loss for the full year in a range of $100 millionto $120 million. This incorporates increased interest expense from our recent global yen and U. S. dollar debt issuances of approximately $1.5 4 billion and increased philanthropic donations to support those individuals who are at the front line and fight against COVID-19. Our capital position remains strong and we ended the quarter with a headline SMR of approximately 881%, and 837% excluding unrealized gains in Japan. The estimated RBC was 550% for Aflac Columbus. Holding company liquidity stood at $4.8 billion for four months, including our recent $1 billion debt issuance. The low interest rate environment clearly adds earnings pressure, but our products generally have low interest rate sensitivity and our asset leverage is low, driving continued strong gross profit testing margins as we cash flow test products and blocks of our enforce. In short, while the first quarter is materially different than what we may face in the coming nine months, we entered this period of uncertainty with strong capital, liquidity, earnings and as Eric highlighted, strong asset quality. As Fred noted, we have been monitoring current conditions and making refinements to our stress testing. Fred discussed claims, stress testing and Eric addressed our asset loss analysis and estimates. In both cases, we have taken a practical approach with respect to current models on the spread of the virus and current economic views. When considering capital and liquidity stress testing, we take a more severe approach, more in alignment with what we share with regulators and rating agencies. Our approach to capital stress testing assumes a greater and more prolonged spread of the virus, which is roughly 6 times as severe as the stress Fred walked you through it. On the asset side, we combine Eric's economic loss analysis with changes in market value of bonds, impairments and downgrades, recognizing our core ratios can be impacted by these factors. We have assumed that market prices depends both the global financial crisis of 2008 and the 2016 oil shock. Then we have further refined the shock to various sectors in our portfolio by moderating and the impact to the financial sector, which has much improved liquidity since 2008. By increasing the assumed severity of the impact to COVID in vulnerable sectors, mainly travel, energy and middle market loans. This is arguably a very stressed scenario and certainly not our base case. But we do find it instructive to stress our balance sheet and capital plan with these kind of scenarios as it can inform us of how to utilize capital tools, enhance optionality and plan for capital deployments. Under this scenario and assuming that we shutdown share repurchase and retain capital in the insurance subsidiaries, we expect SMR to hold at or above 700% and RBC to hold at or above 400%. In addition, we expect holding company available cash and liquidity of over $3 billion through 2021. This scenario assumes no change in our franchise investment plans and defending our 37-year dividend growth track record. In light of our stress testing work, we have taken certain defensive steps to ensure stability on our core capital ratios and liquidity position. These include raising $1.54 billion in the global yen and U. S. senior debt markets. In both cases, we enjoyed favorable pricing and strong subscription levels. This move provides ample contingent capital and liquidity with a very modest cost to EPS and leverage. Retaining capital in our Japan subsidiary by ¥75 billion in 2020, adding additional buffer to our SMR ratio given the potential for continued market volatility. This move provided an additional 40 points of SMR. In the U. S., while we are not experienced deterioration in RBC levels, we are reducing our second quarter U. S. dividend by $75 million and injecting $150 million of capital into our smaller group legal entity CAIC. Our group business continues to grow and we are investing heavily in this part of the business. So the capital both protects and sustains strategic investments in this legal entity. All told, we entered the critical second quarter in a very strong position and these moves do not materially impact our capital planning as we carefully monitor conditions. We also have no debt maturities until 2023 due to liability management actions taken in 2019 setting us up well for the future. Before turn the call back to David, let me comment briefly on our approach to guidance. As you can see from our press release issued last night, recognizing likely volatility and a need to be tactical in our approach to access capital, we have elected to withdraw adjusted EPS and share repurchase guidance for 2020. While this withdrawal of guidance is not necessarily a view that our ranges are not achievable, we are off to a strong start to the year but must recognize that the current spread of COVID-19, its impact on the communities that we serve and volatile markets typically make it very difficult to accurately predict benefit ratios and other earnings drivers. It is fair to say we face a number of obvious EPS headwinds in terms of benefit ratios, investment income and overall revenue. But it's still very uncertain as to timing and the magnitude of the COVID-19 impact on 2020 earnings. We also need to be flexible in the actions we take to defend our franchise and making sure we do all we can to support policyholders. In terms of repurchase, we remain in the market but are buying at roughly 60% level in dollar terms versus the first quarter. We are taking a tactical approach depending on how the crisis develop in the second quarter. By tactical, we mean we maybe in a position to maintain, cancel or even accelerate as we see conditions evolve. And let me now hand off to David to take us to Q&A."
},
{
"speaker": "David Young",
"text": "Thank you, Max. Before we begin, I just want to ask that you please limit yourself to one question and a related follow up to allow participants an opportunity to ask a question. Brittany, we’ll now take the first question."
},
{
"speaker": "Operator",
"text": "Thank you. We will now begin our question-and-answer session [Operator instructions]. And our first question comes from Humphrey Lee from Dowling Partners."
},
{
"speaker": "Humphrey Lee",
"text": "Good morning, and thank you for taking my questions. In terms of the capital and liquidity stress test, I was just wondering like when you look at the potential kind of downgrades and rating migrations. Can you share some of the -- what was your findings were related to that, how's that impact your RBC or your capital position?"
},
{
"speaker": "Dan Amos",
"text": "We're not disclosing in detail the underlying assumption for specifically for rating migration. But at a high level I can comment that rating migration is predominantly an issue when it comes to risk based capital and less so when it comes to our solvency margin ratio in Japan. It's obviously a factor in Japan as well but it's really to RBC formula that is more sensitive to rating migration. Our asset leverage in the us is fairly low. And even when we'll look at rating migration, it has a fairly limited impact on our capital conditions in the operating subsidiaries."
},
{
"speaker": "Humphrey Lee",
"text": "And then my final question related to sales in U. S. and Japan. I clearly understand that there's going to be a very fluid situation, there's a lot of unknowns, but looking at the decline in April. Is there any of difference between the beginning of the crisis versus kind of more towards the late April? Do you see a change in productivity or sales decline maybe in a sense and maybe how your agents are adapting to the new situation?"
},
{
"speaker": "Fred Crawford",
"text": "Let's, do this. This is Fred. Let's split this up and have our colleagues speak directly to their markets. And so perhaps we'll start with Koide and Koji to address how they're adapting in Japan to the new environment and then we'll switch to Teresa and Rich Williams."
},
{
"speaker": "Masatoshi Koide",
"text": "Yes, Koji will answer to that question…"
},
{
"speaker": "Koji Ariyoshi",
"text": "This is Koji, let me talk about agency first. So the state of emergency has been declared effective April 7th to seven prefecture, major prefectures in Japan and this state of emergency expanded to all prefectures in Japan on April 16th. So as a result, activities of the agencies have turned to be refraining from voluntary training from face to face activities. And we have also decided to suspend or close down our shops. And in Japan, there has been some impact from coronavirus from mid-February. So as a result, the number of people coming to our shops or going to face to face solicitation have been declining. And then as we got into April, because of the state of emergency, face to face solicitation was refrained, as well as we had to stop or close down our shops as well. So as a result, the agencies are not doing face-to-face solicitations anymore. Instead the combination of phone calls and mail outs are being done by agencies. However, because of more and more customers are staying home, there's a better chance of being able to communicate with customers. Although, the policies may not be purchased right away, it is good to maintain relationship with customers and expand or enhance relationship with customers and also to develop new prospective customers as well. And in May, we are trying to send out a direct emails nationwide and there will be follow up calls made after direct mails. So, we do believe that this will be successful and see some results in May. And during this time, we are also conducting trainings to the sales agents of a large exclusive agencies using the web. So, there are some advantages that we are able to conduct the training in a very efficient manner rather than visiting them or having them visit us. And at the same time, our agencies are starting to feel that the benefit or the convenience of using digital tool. So as a result, we do believe that there will be some improvement in efficiencies, as well as productivity by leveraging digital tools. That's all from sales perspective."
},
{
"speaker": "Dan Amos",
"text": "Let me say one other thing. I want to make sure it's clear. The closing of shops is only temporary. We're still going to be using the shops. It very much plays an important role in Japanese culture. They actually like to bring the families in and sit down and discuss their overall products that they own and what they have and what this has done for us, talking about with change brings opportunity, it forced our singles associates to use technology more and ultimately will enhance us long-term. So, I wanted to be sure we said that."
},
{
"speaker": "Fred Crawford",
"text": "And Rich Williams, why don’t you comment on the U. S. and our activities to pivot."
},
{
"speaker": "Richard Willams",
"text": "So Humphrey, thanks for the question. I'll just speak maybe near-term about what we see, the preparation for work site and then really what the future holds. Really through the first 11 weeks, we're seeing a very favorable quarter play out. And then as everyone knows, we had 42 state stay at home or shelter in place and that basically just stopped the progress of worksite sales. So, near term until businesses get back in business, I think we'll see about this level. From a preparation perspective for the worksite, we've always had multiple enrollment options, face to face, enrollment call center, self enroll using digital means. And what you're seeing right now is really the ingenuity of our sales force in leveraging those latter two tools enrollment call center and co-browsing and self enrollment to be able to sell in this in a sort of impaired environment. I think thirdly and more broadly, I know both Dan and Fred made these comments is the plan for the future. We're expanding our value proposition to increase access and distribution diversification, with our consumer markets, building at that business, as well as our Aflac dental and vision and now with our Aflac Group Benefits, I think that that's the perspective of the U. S."
},
{
"speaker": "Fred Crawford",
"text": "So Humphrey, hopefully that covers it for you and others in terms of what we're seeing out there production wise and this attempt to pivot. I think one general theme we're seeing, both in Japan and the U. S. is that digital communication non face-to-face communication has always been the secondary approach, the primary being face-to-face. Now you have agents and distribution partners having to pivot to making digital the primary and face-to-face a secondary, that takes a little bit of time to make that switch. And so we'll just have to be patient and work to support those efforts. We can go to the next question."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from Nigel Dally from Morgan Stanley. Sir, your line is now open."
},
{
"speaker": "Nigel Dally",
"text": "So, I wanted to question, I had a question on the U. S. operations, small businesses clearly being hit very hard and in addition to lower sales, you mentioned pressure on persistency. How much high should we expect lapses to go? Is there going to be a major hit? And I think you mentioned 3% potential premium decline, but I don't think you mentioned the sales and persistency assumptions and we should base that. So any color there would be helpful."
},
{
"speaker": "Fred Crawford",
"text": "Yes, I think as it pertains specifically to persistency, it's a very tricky dynamic. We have historically seen our persistency, for example, during the last financial crisis, track unemployment levels and that is that we see greater lapsation or weakness in persistency during periods of high unemployment. And so it stands to reason we would have that as a sensitivity test or a stress test as part of looking at the U. S. and that's why we provided that number. Obviously, it's quite severe in its approach, particularly any sort of prolonged level of unemployment at the levels I discussed 20%. But nevertheless, it's a worthwhile stress to apply. I would say that one other aspect to be aware of is that we're providing right now guarantees, if you will, waivers of premium payments while guaranteeing the policy remains in place. And it defers by state but generally speaking, it tends to be upwards of 90 days or so, 60 to 90 days depending on the dynamics. Similarly, we’re doing that in Japan. When you do that in the United States, what happens is you see actually persistency remain high until such time those efforts are released and then you'll find a level of shock last typically, particularly if there's unemployment associated with the crisis. We know this. We have some experience in this, because this is very commonly done in states where there's been natural disasters, hurricanes, even recently, tornadoes in Tennessee for example. And so this is not an unusual event. What is unusual is that it's nationwide. And so what we're trying to do is understand what that sensitivity might be like. It has very little bottom line implications, because you're releasing reserves, you're writing off DAC. And so this is not necessarily a profitability or margin issue, it's really more related to your earned premium. And that's why we provided that forecast. I think Nigel, that's a very severe stress. We certainly hope we wouldn't get there. We find it beneficial that the stimulus packages that are being announced are directed towards small businesses and are wired to payroll and maintaining employment, which is how we collect our premium and how we sell our product. So there are some offsetting or mitigating factors, but we have to take a conservative approach when we're applying a stress test."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from Jimmy Bhullar from JP Morgan. Sir. Your line is now open."
},
{
"speaker": "Jimmy Bhullar",
"text": "I just had a question on the Japan Post and if you could just give us an update on what's going on there, and how you see your business sort of trending through the post over the next, especially in the near-term?"
},
{
"speaker": "Dan Amos",
"text": "Well, I think Koide, you should start with that and then I might say something afterwards. Koide?"
},
{
"speaker": "Masatoshi Koide",
"text": "Japan Post Group is currently doing additional research or investigation into their policy holder base, and they are also trying to gain confidence of the policy holders at the same time. And although the administrative order for suspending their sales was until the end of March, Japan Post is voluntarily refraining from sales at this moment still from April and after as well. So from an asset perspective, we are supporting Japan Post Group’s activities to recover or reinstate the confidence of the customers and we do respect and we like to support their activities. So what we are trying to do right now is to help them conduct, to take in the customers’ needs and then try to sale and try to train them to do solicitation from that perspective. And then at the same time conducting these kind of trainings, we are also enhancing solicitation management activities as well. And what we are expecting is that whenever Japan Post sales resume, they are able to sell our counter insurance based on customer needs and have appropriate solicitation management in doing their sales. And the situation continues that since Japan Post Group is refraining sales of Japan Post insurance product, which means that our counter product is not selling that much as well, so we are in that situation. And that's all from me."
},
{
"speaker": "Dan Amos",
"text": "I'll make a couple of comments. I don't believe our Japan Post relationship’s ever been any stronger. I believe, and no one knows in these uncertain times, but this is just my personal belief and gut feelings from being an CEO for 30 years is that, when the COVID issues pass to some degree and we go back to whatever the new normal is, we'll see a pickup in Japan Post and things will start back again. And so, I'm encouraged about that. As you know, they're our largest shareholder and we are confident that that relationship was made even stronger with that acquisition and it's in their best interest and our best interest to see cancer insurance grow with them, and I think we'll see that moving forward."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from John Barnidge from Piper Sandler. Sir, your line is now open."
},
{
"speaker": "John Barnidge",
"text": "This question is on the investment portfolio. Can you talk about rental forbearance experience, and then maybe based on communications what your expectations for May 1st are?"
},
{
"speaker": "Dan Amos",
"text": "Today or at least through the end of March, we didn't have any. We certainly expect going forward there to be some. We don't necessarily think a huge amount just because of the nature of our properties. But where we do have them, as I mentioned in the speech, will be making more amendments to loans, getting other protections in return and just really adjusting cash flows. So, we do expect those but we don't expect financial difficulty at the end of the day for those sponsors that may need it."
},
{
"speaker": "Operator",
"text": "Thank you [Operator Instructions]. And our next question comes from Erik Bass from Autonomous Research. Sir, your line is now open."
},
{
"speaker": "Erik Bass",
"text": "Can you provide a bit more color on how you're thinking about the NII outlook both near-term and also beyond 2020, when some of the current hedges roll off? And I think you have some more reinvestment risk."
},
{
"speaker": "Fred Crawford",
"text": "Well, as we reported, the first quarter was slightly better than we had expected. We did get most of our deployment and middle market loans drawn by the end of February for the quarter. So, that was fortunate just because as I reported, it'll be slower rest of the year. As we think of the rest of the year, I'll put it in two buckets, stable and variable, the alternatives just because it's two different stories. On the stable, we actually expect it to be a fairly decent year, despite some of the headwinds of lower rates. On our floating rate book, as I reported, we locked in our hedges and our income. So, despite the low drop in LIBOR, we're protected by the hedges we did and the LIBOR floors. And in fact because of the precipitous decline in LIBOR, our hedges actually ended up performing better than we expected, because more loans hit the floor that was so extreme. So actually we were able to book some of that extra income, if you will, which will help offset some of the headlines naturally from lower rates. The other thing to mention for the year, part of our allocation actually does go to yen assets. And in a surprise that we haven't seen in a number of years, yen yields have actually been stable to going up a little bit. So, relative to our plan that put us in a good position and when we are buying yen, we continue to see actually attractive opportunities in yen public credit as well as some yen private placements. So we can find good credit and earnest spread. So on that part of the allocation, doing relatively well. Obviously for alternatives, we're expecting lower variable income versus our plan. Now that will depend on what happens with equity markets. Now they're up, there's still a lag effect on valuations but our base case right now is lower than we had planned. But if you put that on together between the stable and the variable, we're feeling like we're going to come right in the strike zone maybe a bit better versus planned for the year. Looking forward, I obviously can't really comment holistically in the sense of being specific to 2021. But to your question, Eric, around the floating rate assets, as I've mentioned, in many fabs and answering other questions around this. The way we think of those floating rates is the natural hedge between hedge costs and the income. And right now we're in an environment where if you were to just say today was January 1st and I don't have the specific days of the rolls of our coupon hedges but they're around in the fourth quarter maybe beginning January, February. But if you just said re-roll them right now, well for this year, we locked in hedge costs in the area of 210 basis points and 220 basis points, because you locked them in December and January. Well, right now three months hedge costs are I think last night 69 basis points. So, if the notional of our floating rate book is the same, our hedge costs will go extremely down the same token, those loans which are based off of LIBOR, those are resetting down now they have LIBOR floors, so there is a natural protection. But the point of me saying is that way is at the end for net investment income, I'm looking at the net result, the net result of the income on the asset less than hedge cost. So all things being equal, we actually see that net result being fairly manageable going into next year, if you take out any one time gains like from hedges that I described earlier for this year. So as time goes on, we'll see. But that's how I would think of group one. And then you know, the rest of the book, obviously, if reinvestment rates continue to stay at this low level, again, as you know, we have high coupon private placements from years ago maturing. So that would be a headwind, going forward into income. Hope that helps."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from Tom Gallagher from Evercore. Sir, your line in now open."
},
{
"speaker": "Tom Gallagher",
"text": "Fred, just a follow up on your question about premium waivers that you had mentioned, 60 to 90 days in the U. S. Can you comment on what percentage of your in force in the U. S. is currently paying versus what percent is on this premium waiver? And is that a decent way to gauge some proportion of that might end up lapsing? Is that the way you're approaching it?"
},
{
"speaker": "Fred Crawford",
"text": "You know, it's a good question and we're studying all those metrics, Tom, for that reason, but it's a bit early, to give you anything with any sort of concise nature. It's just been rolled out state by state. We’re just getting into it. What I would tell you is we're collecting our received premium. We're calculating our received premium. And actually I just saw a report on that yesterday and it was into the month of April, which is really where things are kicking in. And so far we haven't seen much movement in terms of collected premium. I think it's down a little bit."
},
{
"speaker": "Teresa White",
"text": "I think we have 86.2% of premium collected versus 87.6%. So we're still doing pretty well on premium collection and that's collected through invoices to the worksite. It's a little bit more on the group side, 89% collected. But we're doing relatively well."
},
{
"speaker": "Fred Crawford",
"text": "So we're tracking that, Tom, and we'll have to continue to watch it. But we've been here before. You know, as I mentioned earlier we've had to do this in various states Florida, Texas, et cetera, with hurricanes, California fires and so forth. So we understand how this works and typically operates. And so, we've got a good handle on it."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from Alex Scott from Goldman Sachs. Your line is now open."
},
{
"speaker": "Alex Scott",
"text": "My first one is just a quick follow-up on the last question actually, and I'd just be interested. Is there anything going on in Japan around premium relief and any way to think about an impact there as well?"
},
{
"speaker": "Fred Crawford",
"text": "We can have Koide add any comments he wants, but the answer is yes. There is a somewhat industry adopted conventional practice of allowing premium waiver for an extended period of time. I think the big difference in Japan is that you tend not to see necessarily implications for persistency, because these policies are age priced there. As you know, the Japanese consumer values the policy and that's very specific intentions around the policy protecting savings and their livelihood. And so while the waivers do matter from an economic perspective, we tend not to see dramatic movements in persistency related to what I mentioned earlier in the U. S. But if I'm off on that, either Todd or Koide if you want to add any color."
},
{
"speaker": "Masatoshi Koide",
"text": "Todd, could you answer that question?"
},
{
"speaker": "Todd Daniels",
"text": "Yes, Fred's correct. Just to be clear, this is a premium grace period, not necessarily a premium waiver that's being put in place. So we're not forgiving premium in any of these cases. Japan does have special circumstances, and as Fred said, has been adopted by industry each company that operates in Japan, is looking at the situation and the states of emergency and adopting their practices during that time period."
},
{
"speaker": "Fred Crawford",
"text": "Thanks for making that point, Todd that both in the U. S. and in Japan, these are grace periods, not waivers in the sense of outright waving the collection of premium."
},
{
"speaker": "David Young",
"text": "Brittany, I think that concludes our call."
},
{
"speaker": "Operator",
"text": "Thank you for your participation in today's conference. All parties may disconnect at this time. Speakers, please stand by for your post conference."
}
] | Aflac Incorporated | 250,178 |
AFL | 4 | 2,021 | 2022-02-03 08:00:00 | Operator: Good day, and welcome to the Aflac Incorporated Fourth Quarter 2021 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor Relations. Please go ahead.
David Young: Good morning, and welcome to Aflac Inc.'s fourth quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in both countries. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the quarter and discuss key initiatives, including how we are navigating the pandemic. Max Broden, Executive Vice President and CFO of Aflac Incorporated will conclude our prepared remarks with a summary of quarterly financial results and current capital and liquidity. Members of our U.S. executive management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual and Group Benefits; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Brad Dyslin, Deputy Global Chief Investment Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koichiro Yoshizumi, Director, Deputy President and Director of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available at investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?
Dan Amos: Good morning and thank you for joining us. 2021 was another year of uncertainty with vaccines incrementally gaining some momentum as the year progressed. There were hopes that the severity of COVID-19 would fade and allow us to return to some type of normalcy. Unfortunately, one year in several variants later the normalcy has been yet it did not remain idle. We have worked hard to adapt using virtual technology and seize the opportunity to accelerate investments in our platform. Considering what the global and national business landscape has experienced over the last two years, I think Aflac has been very fortunate with some tailwinds while simultaneously working hard to achieve our objectives and continue our strong earnings performance. While Max will address the quarter in more detail, I'd like to highlight some of the items for the year. Adjusted earnings per diluted share, excluding the impact of foreign currency, increased 21% in 2021. This result was largely supported by the continuation of the low benefit ratios associated with the pandemic conditions and better-than-expected returns on alternative investments. We were pleased with this result, especially when you consider the pandemic pressure on revenues, accelerated investment in our core technology platforms and initiatives to drive future earned premium growth and efficiency. 2021, Aflac Japan generated solid overall financial results with an extremely strong profit margin of 20.2% and solid premium persistency of 94.3%. We continue to navigate Japan's evolving pandemic conditions, including various degrees of COVID-19-related restrictions that created headwinds for our face-to-face sales opportunities. Especially given this backdrop, I am encouraged by Aflac Japan's annual sales increase of 7.7%. This reflected the first quarter introduction of our medical product, EVER Prime, and the September launch of our new nursing care product. Amid evolving pandemic conditions, we continue to enhance and actively leverage our virtual sales technology to connect with customers as we monitor the recovery of face-to-face sales. Our goal in Japan is to be the leading company for living in your own way. This approach captures how we tailor our products to fill consumers' needs during the various stages of their lives, reaching them where and how they prefer to purchase insurance. This includes through our agencies, strategic alliance and banks as well as virtually. Aflac Japan continues to offer various measures of support to Japan Post Group as they gradually increase proactive sales activities in GEAR Up for the start of their new fiscal year in April of 2022. This will include the transfer of approximately 10,000 Japan Post company employees to Japan Post in terms. These employees will handle only Japan Post insurance products and most importantly, for us, Aflac Japan's insurance or cancer insurance. We expect this continued collaboration to further position the companies for the long-term growth and gradual improvement of Aflac cancer insurance sales in the interim. Turning to Aflac U.S. We saw a strong profit margin of 22.8%. This result was driven by lower incurred benefits and higher adjusted net investment income, partially offset by higher adjusted expenses. I am pleased with the 16.9% annual sales increase, especially considering the constraint face-to-face activities continues to be somewhat of a headwind in the U.S. as well. Aflac U.S. also continued to generate strong premium persistency of nearly 80%. In the U.S. small businesses have gained some incremental ground toward recovery, and we expect this to continue gradually. Within the challenging and small business and labor market, we continue to engage our veteran agents. At the same time, larger businesses appear to be more resilient given their traditional reliance on online virtual self-enrollment tools and we are making ongoing investments in the group platform. Excluding our acquired platforms 2021 group sales or more than 104% of 2019 group sales, we remain focused on being able to sell and service customers whether in person or virtually. s part of the Vision 2025, we seek to further develop a world where people are better prepared for unexpected health expenses. Fred will provide more detail, but as we seek to fill the needs of customers, businesses and our distribution, we continue to build out our U.S. product portfolio with Aflac network Dental and Vision and premier life and disability. These new lines modestly impact the top line in the short term. In combination with our core products, they are better positioned Aflac U.S. for future long-term success. Depending on continued progress in the pandemic conditions, we remain cautiously optimistic for continued sales improvement in the U.S. The need for our products we offer is as strong or stronger than it has ever been. At the same time, we know consumers' habits and buying preferences have been evolving, and we are looking to reach them in ways other than traditional media and outside the work site. This is part of the strategy to increase access, penetration and retention. I've always said that the true test of strength is how one handles adversity. While the pandemic has been and continues to be this type of test, I am pleased that 2021 confirms what we all knew. Aflac is strong, adaptable and resilient in both Japan and the United States we look for ways to be where people want to purchase insurance. Related to capital deployment, we placed significant importance on continuing to achieve strong capital ratios in the U.S. and Japan on behalf of our policyholders and shareholders. When it comes to capital deployment, we pursue value creation through a balance of actions, including growth investments, stable dividend growth and disciplined and tactical stock repurchase. It goes without saying that we treasure our record of dividend growth. The fourth quarter's declaration marks the 39th consecutive year of dividend increases. Additionally, the Board approved a first quarter dividend increase of 21.2%. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we remain tactical in our approach to share repurchase, deploying $2.3 billion in capital to repurchase 43.3 million of the shares in 2021. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We have also focused on integrating the growth investments we have made in our platform. As always, we are working to achieve our earnings per share objective, while also ensuring we deliver on our promise to the policyholders. By doing so, we look to emerge from this period in a continued position of strength and leadership. I want to point out that the world has changed in many ways that surprises even the most cynical, but what it hasn't changed is the fact that the pandemic or no pandemic, people are facing the same illnesses, accidents and health conditions every day only now COVID has been added. This means that the need for our products is even greater now. And we are committed to being there for them in their time of need. I don't think it's coincidental that we've achieved success while focusing on doing the right things for the policyholders, the shareholders, the employees, the distribution channel, the business partners and the communities. I am proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Now, I'll turn the program over to Fred. Fred?
Fred Crawford: Thank you, Dan. I'll reflect briefly on 2021, but we'll focus my comments on growth and efficiency initiatives in 2022. Beginning with Japan, COVID conditions continue to negatively impact our business. We expect sales to build from 2021 levels. However, there are currently 34 prefectures and soon to be 35 prefectures subject to COVID prevention measures that can have the effect of restricting economic activity. There are no restrictions that directly impact the sale of insurance or our operations. However, consumers are naturally more reluctant to engage in face-to-face meetings with prevention measures in place. As we look to 2022, we're focused on the following: first, strengthening of our associates channel through increased policy solicitations at the worksite, marketing new products to existing policyholders and building market share in non-exclusive agencies where we have been historically weaker. The associate channel responds to periodic medical and cancer product refreshment, but we believe these efforts will defend sales in this channel at 2021 levels despite it being a year without a major product refresh. Following on Dan's comments regarding Japan Post, we have seen proposal activity to potential customers grow materially during 2021. We are a long way from recovering to the volumes enjoyed in 2018. However, as part of our organization-wide coordination with Japan Post Group and building on past initiatives, we ran a test pilot initiative during the fourth quarter that provided sales process management tools and practices to Japan Post in support of customer-centric engagement. This initiative was implemented by model post offices and led to increased written proposal activity and ultimately increase sales. Through our strategic alliance framework, the Japan Post companies have agreed to a nationwide campaign to roll out the best practices learned from our fourth quarter initiative. As the campaign will be linked with the transfer of 10,000 postal network sales employees to Japan Post Insurance this April, we are confident this will result in a meaningful level of recovery as compared to 2021. In terms of product development, we ended 2021 with a little over ¥1 billion in sales of our new nursing care product. We are introducing targeted incentive programs and TV advertising that profiles the mental and financial burden of caring for an aging parent. In addition, we plan to launch a new work leave or short-term disability product in March. The new short-term disability product targets small- and medium-sized businesses that tend to have less comprehensive coverage. We expect both products to combine for 5% to 10% of our sales in 2022. Turning to operations. We are focused on initiatives designed to stabilize our expense ratio in the face of declining revenue as sales recover and we continue to run off first sector interest-sensitive product. These initiatives include a transition away from paper-based processes to digital, IT modernization and reimagining policyholder services, our largest operating platform within Aflac Japan. Turning to the U.S., COVID conditions are not expected to be the headwind faced in 2021. We can't control the risk of new variants, but we plan to return to near normal operating conditions as we enter the second quarter, while cautiously following CDC guidelines. We are seeing promising new business formation and associated momentum in sales. Having spent time with our agents and brokers in January, the overall energy among our distribution partners gives us confidence results will certainly build from 2021 levels. Dan covered our core small business and group voluntary results. We are focused on continued recovery in our agent-driven small business franchise. Recruiting is critical, as is converting recruits to average weekly producers. Recruiting was up 17% in 2021. However, on the back of a significant jump in small business broker appointments, which unlike agent recruiting takes time to convert to producing new business. Our broker-sold group voluntary business performed at a higher level than pre-pandemic 2019. It's important to note that we are one of the few companies that focuses specifically on driving voluntary product through specialized VB brokers and in partnership with leading benefit administrators. In 2021, group sales through brokers which tends to focus on the mid to large marketplace where 1/3 of Aflac's total U.S. sales. Turning to our building platforms. Our network Dental and Vision line of business continues to develop. We now have over 7,000 agents trained with 50% of 2021 quote activity occurring in just the last four months of 2021. Sales were $23 million in 2021 with an additional $15 million of voluntary products sold alongside capturing what we refer to as the halo effect. Today, we have a network of 90,000 providers, of which 15,000 are proprietary and the remainder leased. We expect to double the size of our proprietary dental network in 2022. Controlling the quality and design of our network is critical as we seek to create a competitive advantage and move upmarket into broker-sold business. Our Premier Life and Disability business ended the year with $62 million in sales and has carved out a strong reputation as having unique client care model, advanced lead management capabilities and a building referral network as consultants and clients realize bigger is not necessarily better. Not included in these sales results we officially launched our Connecticut paid family medical leave administrative platform and hope to see additional states entertain outsourcing PFML administration. Our consumer markets business recorded sales of $39 million for 2021. The platform is in expansion mode with plans to add network dental, vision and hearing along with senior market products in 2022. Later this quarter, we expect to roll out through select brokers, our new Aflac Pet insurance powered by Trupanion. We are targeting the larger case market and believe our solution is superior to the competition and leverages the best of both the powerful worksite brand and a recognized leader in pet insurance with a unique value proposition. Operations will continue to be a key area of execution with the goal of bending the expense ratio curve in the next few years. You can see from my comments, we are clearly in building mode along with platform modernization. Investments include stabilizing in our small business enrollment tool, modernizing our dental and vision platform to handle increased volumes and migrating off a legacy group voluntary platform armed with an expanded product portfolio. These are a few of the initiatives elevating our current expense ratio, but as discussed at our investor conference, we'll turn the corner in the next few years moving from the higher end of our forecasted range to the lower end, come 2024. Commenting on our investment operations, we completed our strategic asset allocation work in 2021 and are now executing on that strategy. Together with corporate finance activities at the holding company, we are confident we have engineered a prudent approach to our U.S. dollar program in Japan. The program is constantly refined and optimized driving yield, maintaining diversification, lowering hedge costs, reducing exposure to negative settlements, all while sheltering our investors' exposure to a weakening yen. While late in the game as compared to some in the industry, our disciplined approach of building an alternative portfolio resulted in strong variable investment income last year. We understand these portfolios are likely to give back some of the gains in the last year, but we are off to a strong start in generating the favorable returns expected from these portfolios. Finally, I'm very pleased with the progress made on ESG front in 2021. We are now a PRI signatory. We have returned to the Dow Jones Sustainability Index. And last week were once again named to the Bloomberg Gender Equality Index, great progress and more to come. I'll now hand off to Max to cover financial performance. Max?
Max Broden: Thank you, Fred. For the fourth quarter, adjusted earnings per diluted share increased 19.6% to $1.28, with a $0.05 negative impact from FX in the quarter. Full year adjusted earnings per diluted share of $5.94 was 19.8% higher than a year ago. This strong performance for the quarter and full year was largely driven by lower claims utilization due to pandemic conditions. Variable investment income rent $0.13 per share above our long-term return expectations for the quarter and $0.40 per share for the full year, a very good outcome for our growing private equity portfolio. Adjusted book value per share, including foreign currency translation gains and losses grew 7.7% year-over-year. And the adjusted ROE, excluding the foreign currency impact, was 13.6% in Q4 and 16.1% for the full year, a satisfactory result in significant spread to our cost of capital. Starting with our Japan segment. Total net earned premiums for the quarter declined 4.3%. And for the full year, it was down 3.9%. Policy count in force declined 1.8%, which better reflects our overall growth in our business. Low new sales and a slight uptick in lapse rates were the main drivers for earned premium decline. Japan's total benefit ratio came in at 67.3% for the quarter, down 160 basis points year-over-year, and the third sector benefit ratio was 57%, also down 160 basis points year-over-year. For the full year, the benefit ratio was 67.2%, down 270 basis points year-over-year. We experienced a slightly greater than normal IBNR release in our third sector block as experience continues to come in favorable relative to initial reserving. This quarter, it was primarily due to pandemic conditions constraining utilization and a slightly higher lapse rate within our medical block. Adjusting for greater than normal IBNR releases an in-period experience, we estimate our normalized benefit ratio for Q4 to be 68%. Persistency remained strong with a rate of 94.3%, down 80 basis points year-over-year. Our expense ratio in Japan was 22.6%, down 40 basis points year-over-year. Good cost control in combination with higher-than-expected NII have helped our expense ratio despite the overall decline of policies in force and earned premium. For the full year, the expense ratio increased 30 basis points to 21.5%. Adjusted net investment income increased 16.8% in yen terms, primarily driven by favorable returns on our growing private equity portfolio and lower hedge costs partially offset by a lower reinvestment yield on our fixed rate portfolio. For the full year, adjusted NII was up 17.6%. The pretax margin for Japan in the quarter was 24.7%, up 380 basis points year-over-year, a good result for the quarter. For the full year, the pretax margin was 25.2%, supported by a very low benefit ratio and stronger-than-expected variable investment income. Turning to U.S. results. Net earned premium was down 1.3% as lower sales during the pandemic continued to have an impact on our earned premium. For the full year, earned premium declined 2.5%. Persistency improved 30 basis points to 79.6%, driven partially by emergency orders continuing in certain states. Our total benefit ratio came in lower than expected at 46.7% or 490 basis points lower than Q4 2020. Lower and deferred claims utilization impacts our IBNR held for incurred claims within a year, and as we get more data, our long-term models, increased reliance on source data, both leading to IBNR releases. This quarter, the IBNR release amounted to a 1.5% net impact on the benefit ratio, which leads to an underlying benefit ratio, excluding IBNR releases of 48.2%. Our expense ratio in the U.S. was 43.8%, up 30 basis points year-over-year. Q4 seasonally experiences a higher expense ratio as business activity and enrollment picks up towards the year-end. For the full year, the expense ratio was up 90 basis points to 39.5%. Our continued build-out of growth initiatives group life and disability, network dental ambition and the direct-to-consumer contributed to a 120 basis points increase to the ratio. These strategic growth investments are largely offset by our efforts to lower core operating expenses as we strive towards being the low-cost producer in the voluntary benefits space. We also incurred $6.1 million of integration expenses associated with recent acquisitions, which are not included in adjusted earnings or the reported expense ratios. Adjusted net investment income in the U.S. was up 8.2% in the quarter and 7% for the full year, mainly driven by favorable variable investment income. In the U.S. segment reported a pretax margin of 16.1% for the quarter and 22.8% for the full year, with a low benefit ratio as the core driver of improved results in both periods. In our corporate segment, we recorded a pretax loss of $155 million as adjusted net investment income was $109 million lower than last year, due to low interest rates at the short end of the yield curve, lower amortized hedge income and changing value of certain tax credit investments. These tax credit investments run through the NII line for U.S. GAAP purposes with an associated credit to the tax line. In the quarter, the impact to NII was a negative $104 million and the offsetting credit to GAAP taxes was a favorable $80 million, leading to a net impact to our bottom line of a negative $23 million in the quarter. To date, these investments are performing well above our cost of capital and in line with expectations. Our capital position remains strong, and we ended the quarter with an SMR north of 950% in Japan and a combined RBC north of 600% for Aflac U.S. Unencumbered holding company liquidity, holding company liquidity stood at $4 billion, $1.6 billion above our minimum balance. Leverage remains at a comfortable 22.4% in the middle of our leverage corridor of 20% to 25%. In the quarter, we repurchased $625 million of our own stock and paid dividends of $217 million, offering good relative IRR on these capital deployments. For the full year, we repurchased $2.3 billion of our own stock and paid dividends of $888 million for a total of $3.2 billion of capital returned to shareholders. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Before closing, I'd like to reiterate the outlook given at FAB for our key value drivers for the time period 2022 and 2023. With that, I hand it over to David to begin Q&A.
David Young: Thank you, Max. We are now ready to take questions. But first, let me ask that you please limit yourself to one initial question and a related follow-up to allow other participants an opportunity to ask a question. And with that, Jason, if you will, open up the line to our first caller.
Operator: [Operator Instructions] Our first question comes from Nigel Dally from Morgan Stanley. Please go ahead.
Nigel Dally: I wanted to start on network dental, vision group life and disability. I appreciate the color on sales. I guess how those results compare to your expectations. And as we look to 2022, do you have a number in mind as to what portion of total U.S. sales would come from those platforms?
Fred Crawford: Nigel, this is Fred. Let me try to address it, but then I'll ask Teresa and Virgil to weigh in with any comments they have. But -- so first of all, with PLADs, extremely pleased, we call it PLADS, premier life and disability and lead management. Not only did they hit the sales expectations that we had when acquiring the property, but they advanced beyond that, particularly with the state of Connecticut contract for leave management which is not an insignificant contract from a revenue standpoint. We don't include it in the traditional measure of sales only because it's not linked with an actual life and disability contract, but it's a meaningful business and one that certainly wasn't expected when we made the acquisition. So we couldn't be more pleased. The other thing I would note is that we successfully renewed 100% of our contracts this year with a 4% average pricing increase across the board. And that was very good news. Our team -- our PLADs team very careful attention to the quality of service and quality metrics as they lead into renewal period, and that proved to really benefit us on the renewal side. I say that because the earned premium, which is as important as the sales, is tracking on or better than our expectations as well. So both sales and retention are very good. Again, as we peel the onion back on that property, having acquired it and folded it in over the last year, the news just gets better on that property, very good platform, very pleased. Dental and Vision, of course, we had -- remember, we bought a TPA, but really needed to build from scratch the actual dental and vision product, along with the network. And so we very much have been in building mode on that property. I would say the sales in 2021 were below the expectations we were expecting coming into the year, but we're not due to necessarily bad performance. It was more a decision to roll that business out carefully and also had timing-related issues with entering those products onto our enrollment tool. Remember, with Dental and Vision, we're actually starting out in the small business community with our agents. So we're selling into 100 and less employees. And that means it has to be not only approved by all the states which we did throughout the year, but also has to be installed on our enrollment platform, which takes time and energy to put that on available in all states. So you had a pretty big lift with that product. And it's fair to say that COVID conditions impacted the small business world, which meant it impacted the agent delivery model from a distribution, and it just so happens that we decided long ago that our first entry point with Dental and Vision was with the small business agent-driven model, and we did not anticipate COVID. So it was behind what we originally had forecasted. But I can tell you that we're extremely pleased with it. One thing that we're really pleased with that has outperformed is the halo effect I mentioned. Selling $23 million of network dental and vision, but then sell an additional $15 million of voluntary product associated with the dental and vision sales, that exceeds our halo expectations. We would expect to have a halo effect of around 30% and to be north of 50%, approaching 60%, 70% is well above our expectations. I don't think it's going to stay at that level, particularly as we go more aggressively upmarket but still very with that halo effect. So, all in all, I would say, very good. Now in terms of what percentage of our sales next year, we've been climbing gradually north of 10% of sales heading towards 13% to 15% of sales. And in 2022, I would expect to be in that range. So, let's just call it 10% to 15% of sales. Obviously, in some ways, we don't want that percentage to be too high because we fully expect the rest of our business to grow significantly as well, but I think that's not a bad estimate.
Teresa White: Brett you actually covered most of what we would cover. So, I do agree in 2022, this is Teresa. We will see about 13% to 15% of our buy to bill as a percentage of U.S. sales. And we're actually just expecting as we continue to move out by 2025, about 20% of sales, U.S. sales will be by the bill property.
Nigel Dally: That is great. And just as a follow-up, I just want to stick on the U.S. career agency recruiting, broker recruits were up meaningfully Creating was under pressure. Is that a reflection of the labor markets and should we be thinking about that as a headwind for 2022 or are there other initiatives to try to accelerate that from here?
Dan Amos: Virgil, you take that, but let me just make sure I'm very clear on something that I just listening to Teresa, I want to make sure it's clear. Nigel, when you asked the question, you asked specifically to our life and disability business and our dental and vision. When we say 13% to 15%, we consider our buy-to-build properties to be those two properties plus the build of our direct-to-consumer platform. So just note that we consider those three businesses when we quote you 13% to 15%, just to make sure we're clear on that. Sorry, Virgil, why don't you or Teresa take the recruiting question?
Unidentified Company Representative: I'll let, Virgil, take that question.
Virgil Miller: Okay. Well, thank you for the question, Nigel. Actually, we're very pleased with where we're sitting with the recruiting. I think you noticed, as you indicated your question that we achieved about 17.5% growth but we changed our focus. If you think about it, there were some headwinds with the labor market. So instead of just relying on new recruits, which we were able to recruit over 10,000, we did pivot our -- and evolve our model to focus on the small brokers. We activated over 5,000, and we're starting to see them perform going into the second half of last year. So, we're very pleased, as you can see, contributed to our overall increase in productivity. So -- as I look going into 2022, I expect to see more of the same. It's going to be a combination of new recruits, but we will continue our focus still though in that small broker space also.
Operator: The next question comes from Jimmy Bhullar from JPMorgan. Please go ahead.
Jimmy Bhullar: So, a question just on sales in Japan. And obviously, it seems like sales have bottomed and they recovered a little bit, obviously, still depressed versus historical levels. But is it possible that in the early part of 2022, you actually take a step back given some of the restrictions that the government imposed in Japan and you don't see the ongoing improvement that we've seen recently.
Koichiro Yoshizumi: Okay. This is Yoshizumi of Japan. Thank you for the question. So it is true that the quality emergency measures for 34 prefectures, and today, I think it will be 35 prefectures. So, it is true that there are some impact to our sales. However, as we promoted online sales of virtual sales last year, actively, we are also enhancing that these virtual sales began this year. And this virtual sales plus the wheel or the physical sales have been established as like hybrid sales, and we will be promoting this method.
Dan Amos: Yes. I think one thing I would add is just then this is Fred. Again, to remind you, there are various grades, if you will, of level of severity that the government will put in place prefigure by prefecture, the most severe being the state of emergency. When we talk about 35 prefectures being under prevention measures, that is one step below the state of emergency level. And it's important to note that the government of Japan is really trying to balance containing, of course, the virus without dampening economic activity, and they're trying to play that balancing act. And so even state of emergencies have been a little less restrictive than in the early days of COVID. And these cautionary practices and the prefectures in of themselves don't really restrict our activity and our ability to sell and meet with potential clients and so forth. The issue that's hard to measure is if you are a citizen of Japan, and you live in a prefectur that is in a -- where there is a prevention measures that are being put in place, do you feel less comfortable meeting face in conducting business in a normal way. And that's very difficult to measure, but we see it in our results. And so there's no question there's a bit of a headwind as we head into 2022 but it's certainly not as severe state of emergency, and it's definitely not as severe as the early days of COVID.
Jimmy Bhullar: Okay. And then just on Japan as well, can you just talk about what's going on with the Post? And what's your expectation of longer term being able to potentially expand that relationship beyond cancer?
Fred Crawford: I'll let the Japan team fill in some of the blanks and talk about it. But as I mentioned in my comments, first of all, there is no specific plan to expand products. However, again, remember, we consider our cancer business in Japan Post to be a line of business. And so for example, when we upgrade cancer products or add riders or feature to cancer products, we do that within the Japan Post system. As you may know from some of our comments at the investor conference, what we're really excited about is, we're starting to introduce concierge non-insurance services to support our cancer business. This involves a cancer policyholder being able to call into a concierge line and be tapped into non-insurance services that support their needs, whether they are going on claim or preventions or detection needs, care needs, even oncologist recommendations these types of services. So all of that product capability that we house within a company we called Hatch Healthcare. All of that will be available to Japan Post policyholders and will help with both retention and growth. So no new product lines, but the cancer line continues to expand and develop within the Japan Post system. And I'll let my colleagues in Japan talk about the momentum coming off our fourth quarter pilot exercise and looking at 2022.
Koichiro Yoshizumi: So, this is Yoshizumi once again. And in specific, what we refer to by pilot is to take examples of branches and sales offices that are doing well and not doing well. And especially those that are doing well is taken as the model for all the other new offices and outlets. So what we normally do is to reflect the successful sales offices practices to other sales offices. And the three particular initiatives that we are planning to do is to give guidance to those sales professionals, conduct training and then also enhance proposal capabilities. And by going through the PDCA cycle, we will be improving each of these initiatives. And then as we have conducted a pilot in the fourth quarter, we were successful and since we have seen some success in the fourth quarter, we are going to be promoting our sales in 2022 by using similar measures.
Fred Crawford: Yes. And I might add just to put a little bit of numbers behind it because I know there's sort of a question, what do you mean by improved? But just to give you an idea, when looking at those model offices and our results in this test pilot program in the fourth quarter, when we moved from third quarter results to fourth quarter results, we had over a 50% increase from third quarter to fourth quarter, both in the number of proposals put forward and the resulting sales. And so it was clearly successful. And so what the executive teams and sales teams are doing between our team and Japan Post as they're sitting down, analyzing those results and now looking at more of a national spread of that platform, but it was a very tangible increase and gets us excited about some increased momentum in 2022.
Operator: The next question comes from John Barnidge from Piper Sandler. Please go ahead.
John Barnidge: My question, it seems like when we enter each new quarter, the expectation is for claims normalization to occur over the future quarter that hadn't occurred over the last 1.5 years. But can you maybe talk about how claims utilization, especially in the U.S., but also in Japan, has trended as the Omicron variant has emerged and probably COVID fatigue sets in?
Dan Amos: Thank you, John, and thank you for pointing out that my prediction about claims utilization has been wrong for the last year. Throughout the year of 2021, and I'll start by talking to the U.S. We did see a gradual increase in claims utilization each quarter with very, very low claims utilization in the first quarter, and then we saw a little bit of a -- and that continued quite frankly, throughout the second quarter and then we started to see a normalization in the third quarter and then into the fourth quarter as well. We're not fully back to normal. But I would say when I look at, for example, paid claims data for the fourth quarter, then November was higher than October and December was higher than November. And we are getting back very close to what I would be sort of normal claims utilization starting the year of 2022 for the U.S. So that means that I do think that we are fairly close to normal claims utilization going forward. It's also the fact that the -- we did have a correlation between infection rates in the society and claims utilization and what Omicron has done is that, that correlation has pretty much broken down. And I think that is due to people who are living in a much more normal life. You see mobility coming back to more normal levels. And with that, people are getting into accidents. They are going for physical checkups, et cetera, and that is sort of driving a more normal claims pattern and behavior among our policyholder base in the U.S. So that is why I do believe that we are going to come back to sort of a more normal claims utilization pattern for 2022. And we do expect that our benefit ratio in the U.S. will fall within the sort of normalized range. So, we do expect that we will be within the 48% to 52% benefit ratio in the U.S. for 2022. When you go to Japan, you have a somewhat of a similar pattern, but it has lagged the U.S. You don't see the reactions as quick as you do and the changes as quick as you do in the U.S. and you don't see the ups and downs as much as we have seen in the U.S. So you have a much more flatter and more prolonged pattern of claims utilization in Japan. In Japan, we are trending a little bit below but not significantly below what we would deem to be sort of our sort of normalized claims utilization. I hope that helps.
John Barnidge: It does. And then my follow-up, as you think about pet insurance for '22, how meaningful a contributor do you think that will be?
Dan Amos: So, a couple of things about the pet insurance products, so as I mentioned in my comments, later in the quarter, we expect to launch taking a very targeted approach and that is we're launching and what we characterize internally as our premier broker platform. These are some of the largest brokers in the country that deal, particularly with typically larger companies, think of it as 1,000 employees and larger, that's also where a lot of the employee benefit based demand is for pet insurance. And we expect there's a lot of pent-up expectation for the product. There's a lot of momentum around pet insurance in the work site. So we do believe there's going to be a lot of interest. Now remember, in terms of our results, recognize that we don't book any earned premium, if you will, or sales on that product. That earned premium and sales is booked by Trupanion. Our rationale for putting our brand on it powered by Trupanion is that it creates -- it first, it checks a box in terms of having a pet insurance product, which many of the brokers and their clients like to see and have interest in. But also it creates an opportunity to have a more unique conversation and broader capability when we're in finalist presentations on voluntary benefits overall. So, it really helps create more energy around our broader voluntary products and once again, looking for that halo effect. So that's our expectation. We don't have really specific sales expectations other than its going to be gradual, because we want to get it right. And when you come into the premier broker world with a new product, you don't have too many chances to get it right. You need to get it right out of the gate. You need to measure three times and cut once. And the reason is because if it doesn't get off to a good and controlled start, it can be problematic in that community of brokers and we don't want that to happen. But it's a very unique product. Those of you who are familiar with Trupanion and I'm sure you've read the news recently that they were excited to announce an alliance with Chewy, which is really bonified their unique value proposition. We think this is a different type of a product. We think this is not simply a check-the-box pet insurance product. We think the special value proposition, veterinarian-driven type product set is a unique differentiator. And we've coupled it even with benefits where you as an employee can purchase a rider that pays you your out-of-pocket costs, if your pet is sick and you need to take off work and experience some of the same out-of-pocket cost come with human health conditions. So, we really have built a unique value proposition. We think it's a differentiator, and we think it will create more fulsome conversations when selling our broader voluntary platform.
Operator: The next question comes from Humphrey Lee from Dowling & Partners. Please go ahead.
Humphrey Lee: My first question is regarding the Japan Post employee kind of transferring 10,000 of them to Japan Post Insurance. How should we think about the required time for them to ramp up? And how should we think about the potential impact on kind of the sales outlook?
Fred Crawford: I think it's best for our Japan colleagues to address that. So Yoshizumi, the transfer of postal sales people to Japan Post Insurance and how that flows through? And is there any ramp-up period?
Masatoshi Koide: This is Koide of Aflac Japan. As you mentioned, there will be 10,000 people or salespeople moving from Japan Post Company to Japan Post Insurance in April, and this is being planned. And what is very important about this is that, after these people are transferred to Japan Post Insurance, they will only be selling Japan Post insurance product and Aflac cancer products. And since their people's moves are in April and preparation is going extremely well towards April. However, right after their move in April, there may not be a significant impact. However, once they get used to it, there will be a gradual increase in the momentum of sales. So what we are expecting is that after this transfer occurs, and then perhaps in the second half of this year, there will be some more momentum in sales. And let me just add a little bit more information that these 10,000 salespeople that are currently working for Japan Post Company is already -- are already selling our cancer insurance. Therefore, they do have the experience and the knowledge of cancer insurance. That's all from me.
Humphrey Lee: That's helpful. Just staying on Japan. So you talked about some of the counter measures for COVID is not really restrictive and one of the bigger question would be how kind of the consumers will react given the current environment. I think I read somewhere that the lawmakers are looking at potentially more restrictive countermeasures for COVID and also the consumer confidence has been dropping in Japan. I was just wondering if you can elaborate a little more if there are more restrictive measures to put in place and the consumer confidence is continue to drop, like should we see -- could we see a more dampened sales outlook for 2022?
Dan Amos: This is Dan. Let me -- I want to make a couple of comments. Number one is it hadn't been stated, but they have they have 90% of the people have been vaccinated in Japan. And so, the -- as we've seen with the new variants the death rate is much lower and there's improvement. I don't think we have any specific answers at this time. I'll let them answer in terms of what the government will require. But I think it's -- you're going to see the death rate and the issues trend down instead of up because we're seeing everybody vaccinated compared to the United States. Now some states, of course, are higher than others, but there is a movement in that direction. You also may have saw the Johns Hopkins report last week that a lot of these things that they're doing in regard to trying to control the variant has not worked very well. And so, I think you're going to see more movement back to normal. We certainly, as a corporation, both in Japan and the United States are moving in a gradual, but for example, we had a meeting of 1,000 people of our salespeople. We tested them all before they came. Some didn't want to come, but over 800 showed up after it was all said and done, we had about 15 cases of COVID in the United States for that particular meeting, which was really, if you took 1,000 people at random, that would be a relatively low number. So, I think you're seeing things move back in Japan. We're back to over 50% of the employees are at work, what they'll have to give you the exact number, but it's over 50%. So, I see things moving back more to normal. Koide, would you take that question, please, and talk a little bit about it.
Masatoshi Koide: This is Koide once again. And it is true that even in Japan, the number of new cases that are on the increase. However, as Fred mentioned earlier, the current infection prevention measures that are being issued is much milder than the state of emergency that the government has issued a long time ago. And the government of Japan is aiming to strike a balance between prevention of the infection. At the same time, promote economic measures and activities. And therefore, the government is extra careful about whether to issue even severe or like emergency measures. So as a result, we are not -- there is no plan of Japan issuing very severe measures such as lockdown or any severe measures, then the state of emergency that the government of Japan has issued a while ago. So, there is no change -- no plan for the change in loss either. That's all for me.
Fred Crawford: Yes, one thing, not to pile on. This is Fred. But one thing I would say, just in terms of the basis of your question, as you always want to be careful about the correlation of economic activity in Japan and the sale or demand for our products. Right now, really, what we're talking about is the practical implications of meeting face-to-face and having a naturally higher close rate meeting face-to-face. But it is after all a pandemic. And so you would imagine that supplemental medical disability product, even elderly care and cancer product, that there will be a natural level of elevated and awareness for these types of products given pandemic conditions. So, it's really more a practical execution issue than it is a demand and economic issue in my view.
David Young: Thank you, Humphrey. And Jason, I believe that was our last call, we've gone past the top of the hour. For anyone that has any follow-up questions, though, I'm pleased to ask you to contact Investor and Rating Agency Relations. We'll be happy to help you. Thank you all for your time today and look forward to speaking to you soon. Thank you.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to the Aflac Incorporated Fourth Quarter 2021 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "David Young",
"text": "Good morning, and welcome to Aflac Inc.'s fourth quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in both countries. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the quarter and discuss key initiatives, including how we are navigating the pandemic. Max Broden, Executive Vice President and CFO of Aflac Incorporated will conclude our prepared remarks with a summary of quarterly financial results and current capital and liquidity. Members of our U.S. executive management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual and Group Benefits; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Brad Dyslin, Deputy Global Chief Investment Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koichiro Yoshizumi, Director, Deputy President and Director of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available at investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Good morning and thank you for joining us. 2021 was another year of uncertainty with vaccines incrementally gaining some momentum as the year progressed. There were hopes that the severity of COVID-19 would fade and allow us to return to some type of normalcy. Unfortunately, one year in several variants later the normalcy has been yet it did not remain idle. We have worked hard to adapt using virtual technology and seize the opportunity to accelerate investments in our platform. Considering what the global and national business landscape has experienced over the last two years, I think Aflac has been very fortunate with some tailwinds while simultaneously working hard to achieve our objectives and continue our strong earnings performance. While Max will address the quarter in more detail, I'd like to highlight some of the items for the year. Adjusted earnings per diluted share, excluding the impact of foreign currency, increased 21% in 2021. This result was largely supported by the continuation of the low benefit ratios associated with the pandemic conditions and better-than-expected returns on alternative investments. We were pleased with this result, especially when you consider the pandemic pressure on revenues, accelerated investment in our core technology platforms and initiatives to drive future earned premium growth and efficiency. 2021, Aflac Japan generated solid overall financial results with an extremely strong profit margin of 20.2% and solid premium persistency of 94.3%. We continue to navigate Japan's evolving pandemic conditions, including various degrees of COVID-19-related restrictions that created headwinds for our face-to-face sales opportunities. Especially given this backdrop, I am encouraged by Aflac Japan's annual sales increase of 7.7%. This reflected the first quarter introduction of our medical product, EVER Prime, and the September launch of our new nursing care product. Amid evolving pandemic conditions, we continue to enhance and actively leverage our virtual sales technology to connect with customers as we monitor the recovery of face-to-face sales. Our goal in Japan is to be the leading company for living in your own way. This approach captures how we tailor our products to fill consumers' needs during the various stages of their lives, reaching them where and how they prefer to purchase insurance. This includes through our agencies, strategic alliance and banks as well as virtually. Aflac Japan continues to offer various measures of support to Japan Post Group as they gradually increase proactive sales activities in GEAR Up for the start of their new fiscal year in April of 2022. This will include the transfer of approximately 10,000 Japan Post company employees to Japan Post in terms. These employees will handle only Japan Post insurance products and most importantly, for us, Aflac Japan's insurance or cancer insurance. We expect this continued collaboration to further position the companies for the long-term growth and gradual improvement of Aflac cancer insurance sales in the interim. Turning to Aflac U.S. We saw a strong profit margin of 22.8%. This result was driven by lower incurred benefits and higher adjusted net investment income, partially offset by higher adjusted expenses. I am pleased with the 16.9% annual sales increase, especially considering the constraint face-to-face activities continues to be somewhat of a headwind in the U.S. as well. Aflac U.S. also continued to generate strong premium persistency of nearly 80%. In the U.S. small businesses have gained some incremental ground toward recovery, and we expect this to continue gradually. Within the challenging and small business and labor market, we continue to engage our veteran agents. At the same time, larger businesses appear to be more resilient given their traditional reliance on online virtual self-enrollment tools and we are making ongoing investments in the group platform. Excluding our acquired platforms 2021 group sales or more than 104% of 2019 group sales, we remain focused on being able to sell and service customers whether in person or virtually. s part of the Vision 2025, we seek to further develop a world where people are better prepared for unexpected health expenses. Fred will provide more detail, but as we seek to fill the needs of customers, businesses and our distribution, we continue to build out our U.S. product portfolio with Aflac network Dental and Vision and premier life and disability. These new lines modestly impact the top line in the short term. In combination with our core products, they are better positioned Aflac U.S. for future long-term success. Depending on continued progress in the pandemic conditions, we remain cautiously optimistic for continued sales improvement in the U.S. The need for our products we offer is as strong or stronger than it has ever been. At the same time, we know consumers' habits and buying preferences have been evolving, and we are looking to reach them in ways other than traditional media and outside the work site. This is part of the strategy to increase access, penetration and retention. I've always said that the true test of strength is how one handles adversity. While the pandemic has been and continues to be this type of test, I am pleased that 2021 confirms what we all knew. Aflac is strong, adaptable and resilient in both Japan and the United States we look for ways to be where people want to purchase insurance. Related to capital deployment, we placed significant importance on continuing to achieve strong capital ratios in the U.S. and Japan on behalf of our policyholders and shareholders. When it comes to capital deployment, we pursue value creation through a balance of actions, including growth investments, stable dividend growth and disciplined and tactical stock repurchase. It goes without saying that we treasure our record of dividend growth. The fourth quarter's declaration marks the 39th consecutive year of dividend increases. Additionally, the Board approved a first quarter dividend increase of 21.2%. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we remain tactical in our approach to share repurchase, deploying $2.3 billion in capital to repurchase 43.3 million of the shares in 2021. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We have also focused on integrating the growth investments we have made in our platform. As always, we are working to achieve our earnings per share objective, while also ensuring we deliver on our promise to the policyholders. By doing so, we look to emerge from this period in a continued position of strength and leadership. I want to point out that the world has changed in many ways that surprises even the most cynical, but what it hasn't changed is the fact that the pandemic or no pandemic, people are facing the same illnesses, accidents and health conditions every day only now COVID has been added. This means that the need for our products is even greater now. And we are committed to being there for them in their time of need. I don't think it's coincidental that we've achieved success while focusing on doing the right things for the policyholders, the shareholders, the employees, the distribution channel, the business partners and the communities. I am proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Now, I'll turn the program over to Fred. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Dan. I'll reflect briefly on 2021, but we'll focus my comments on growth and efficiency initiatives in 2022. Beginning with Japan, COVID conditions continue to negatively impact our business. We expect sales to build from 2021 levels. However, there are currently 34 prefectures and soon to be 35 prefectures subject to COVID prevention measures that can have the effect of restricting economic activity. There are no restrictions that directly impact the sale of insurance or our operations. However, consumers are naturally more reluctant to engage in face-to-face meetings with prevention measures in place. As we look to 2022, we're focused on the following: first, strengthening of our associates channel through increased policy solicitations at the worksite, marketing new products to existing policyholders and building market share in non-exclusive agencies where we have been historically weaker. The associate channel responds to periodic medical and cancer product refreshment, but we believe these efforts will defend sales in this channel at 2021 levels despite it being a year without a major product refresh. Following on Dan's comments regarding Japan Post, we have seen proposal activity to potential customers grow materially during 2021. We are a long way from recovering to the volumes enjoyed in 2018. However, as part of our organization-wide coordination with Japan Post Group and building on past initiatives, we ran a test pilot initiative during the fourth quarter that provided sales process management tools and practices to Japan Post in support of customer-centric engagement. This initiative was implemented by model post offices and led to increased written proposal activity and ultimately increase sales. Through our strategic alliance framework, the Japan Post companies have agreed to a nationwide campaign to roll out the best practices learned from our fourth quarter initiative. As the campaign will be linked with the transfer of 10,000 postal network sales employees to Japan Post Insurance this April, we are confident this will result in a meaningful level of recovery as compared to 2021. In terms of product development, we ended 2021 with a little over ¥1 billion in sales of our new nursing care product. We are introducing targeted incentive programs and TV advertising that profiles the mental and financial burden of caring for an aging parent. In addition, we plan to launch a new work leave or short-term disability product in March. The new short-term disability product targets small- and medium-sized businesses that tend to have less comprehensive coverage. We expect both products to combine for 5% to 10% of our sales in 2022. Turning to operations. We are focused on initiatives designed to stabilize our expense ratio in the face of declining revenue as sales recover and we continue to run off first sector interest-sensitive product. These initiatives include a transition away from paper-based processes to digital, IT modernization and reimagining policyholder services, our largest operating platform within Aflac Japan. Turning to the U.S., COVID conditions are not expected to be the headwind faced in 2021. We can't control the risk of new variants, but we plan to return to near normal operating conditions as we enter the second quarter, while cautiously following CDC guidelines. We are seeing promising new business formation and associated momentum in sales. Having spent time with our agents and brokers in January, the overall energy among our distribution partners gives us confidence results will certainly build from 2021 levels. Dan covered our core small business and group voluntary results. We are focused on continued recovery in our agent-driven small business franchise. Recruiting is critical, as is converting recruits to average weekly producers. Recruiting was up 17% in 2021. However, on the back of a significant jump in small business broker appointments, which unlike agent recruiting takes time to convert to producing new business. Our broker-sold group voluntary business performed at a higher level than pre-pandemic 2019. It's important to note that we are one of the few companies that focuses specifically on driving voluntary product through specialized VB brokers and in partnership with leading benefit administrators. In 2021, group sales through brokers which tends to focus on the mid to large marketplace where 1/3 of Aflac's total U.S. sales. Turning to our building platforms. Our network Dental and Vision line of business continues to develop. We now have over 7,000 agents trained with 50% of 2021 quote activity occurring in just the last four months of 2021. Sales were $23 million in 2021 with an additional $15 million of voluntary products sold alongside capturing what we refer to as the halo effect. Today, we have a network of 90,000 providers, of which 15,000 are proprietary and the remainder leased. We expect to double the size of our proprietary dental network in 2022. Controlling the quality and design of our network is critical as we seek to create a competitive advantage and move upmarket into broker-sold business. Our Premier Life and Disability business ended the year with $62 million in sales and has carved out a strong reputation as having unique client care model, advanced lead management capabilities and a building referral network as consultants and clients realize bigger is not necessarily better. Not included in these sales results we officially launched our Connecticut paid family medical leave administrative platform and hope to see additional states entertain outsourcing PFML administration. Our consumer markets business recorded sales of $39 million for 2021. The platform is in expansion mode with plans to add network dental, vision and hearing along with senior market products in 2022. Later this quarter, we expect to roll out through select brokers, our new Aflac Pet insurance powered by Trupanion. We are targeting the larger case market and believe our solution is superior to the competition and leverages the best of both the powerful worksite brand and a recognized leader in pet insurance with a unique value proposition. Operations will continue to be a key area of execution with the goal of bending the expense ratio curve in the next few years. You can see from my comments, we are clearly in building mode along with platform modernization. Investments include stabilizing in our small business enrollment tool, modernizing our dental and vision platform to handle increased volumes and migrating off a legacy group voluntary platform armed with an expanded product portfolio. These are a few of the initiatives elevating our current expense ratio, but as discussed at our investor conference, we'll turn the corner in the next few years moving from the higher end of our forecasted range to the lower end, come 2024. Commenting on our investment operations, we completed our strategic asset allocation work in 2021 and are now executing on that strategy. Together with corporate finance activities at the holding company, we are confident we have engineered a prudent approach to our U.S. dollar program in Japan. The program is constantly refined and optimized driving yield, maintaining diversification, lowering hedge costs, reducing exposure to negative settlements, all while sheltering our investors' exposure to a weakening yen. While late in the game as compared to some in the industry, our disciplined approach of building an alternative portfolio resulted in strong variable investment income last year. We understand these portfolios are likely to give back some of the gains in the last year, but we are off to a strong start in generating the favorable returns expected from these portfolios. Finally, I'm very pleased with the progress made on ESG front in 2021. We are now a PRI signatory. We have returned to the Dow Jones Sustainability Index. And last week were once again named to the Bloomberg Gender Equality Index, great progress and more to come. I'll now hand off to Max to cover financial performance. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Fred. For the fourth quarter, adjusted earnings per diluted share increased 19.6% to $1.28, with a $0.05 negative impact from FX in the quarter. Full year adjusted earnings per diluted share of $5.94 was 19.8% higher than a year ago. This strong performance for the quarter and full year was largely driven by lower claims utilization due to pandemic conditions. Variable investment income rent $0.13 per share above our long-term return expectations for the quarter and $0.40 per share for the full year, a very good outcome for our growing private equity portfolio. Adjusted book value per share, including foreign currency translation gains and losses grew 7.7% year-over-year. And the adjusted ROE, excluding the foreign currency impact, was 13.6% in Q4 and 16.1% for the full year, a satisfactory result in significant spread to our cost of capital. Starting with our Japan segment. Total net earned premiums for the quarter declined 4.3%. And for the full year, it was down 3.9%. Policy count in force declined 1.8%, which better reflects our overall growth in our business. Low new sales and a slight uptick in lapse rates were the main drivers for earned premium decline. Japan's total benefit ratio came in at 67.3% for the quarter, down 160 basis points year-over-year, and the third sector benefit ratio was 57%, also down 160 basis points year-over-year. For the full year, the benefit ratio was 67.2%, down 270 basis points year-over-year. We experienced a slightly greater than normal IBNR release in our third sector block as experience continues to come in favorable relative to initial reserving. This quarter, it was primarily due to pandemic conditions constraining utilization and a slightly higher lapse rate within our medical block. Adjusting for greater than normal IBNR releases an in-period experience, we estimate our normalized benefit ratio for Q4 to be 68%. Persistency remained strong with a rate of 94.3%, down 80 basis points year-over-year. Our expense ratio in Japan was 22.6%, down 40 basis points year-over-year. Good cost control in combination with higher-than-expected NII have helped our expense ratio despite the overall decline of policies in force and earned premium. For the full year, the expense ratio increased 30 basis points to 21.5%. Adjusted net investment income increased 16.8% in yen terms, primarily driven by favorable returns on our growing private equity portfolio and lower hedge costs partially offset by a lower reinvestment yield on our fixed rate portfolio. For the full year, adjusted NII was up 17.6%. The pretax margin for Japan in the quarter was 24.7%, up 380 basis points year-over-year, a good result for the quarter. For the full year, the pretax margin was 25.2%, supported by a very low benefit ratio and stronger-than-expected variable investment income. Turning to U.S. results. Net earned premium was down 1.3% as lower sales during the pandemic continued to have an impact on our earned premium. For the full year, earned premium declined 2.5%. Persistency improved 30 basis points to 79.6%, driven partially by emergency orders continuing in certain states. Our total benefit ratio came in lower than expected at 46.7% or 490 basis points lower than Q4 2020. Lower and deferred claims utilization impacts our IBNR held for incurred claims within a year, and as we get more data, our long-term models, increased reliance on source data, both leading to IBNR releases. This quarter, the IBNR release amounted to a 1.5% net impact on the benefit ratio, which leads to an underlying benefit ratio, excluding IBNR releases of 48.2%. Our expense ratio in the U.S. was 43.8%, up 30 basis points year-over-year. Q4 seasonally experiences a higher expense ratio as business activity and enrollment picks up towards the year-end. For the full year, the expense ratio was up 90 basis points to 39.5%. Our continued build-out of growth initiatives group life and disability, network dental ambition and the direct-to-consumer contributed to a 120 basis points increase to the ratio. These strategic growth investments are largely offset by our efforts to lower core operating expenses as we strive towards being the low-cost producer in the voluntary benefits space. We also incurred $6.1 million of integration expenses associated with recent acquisitions, which are not included in adjusted earnings or the reported expense ratios. Adjusted net investment income in the U.S. was up 8.2% in the quarter and 7% for the full year, mainly driven by favorable variable investment income. In the U.S. segment reported a pretax margin of 16.1% for the quarter and 22.8% for the full year, with a low benefit ratio as the core driver of improved results in both periods. In our corporate segment, we recorded a pretax loss of $155 million as adjusted net investment income was $109 million lower than last year, due to low interest rates at the short end of the yield curve, lower amortized hedge income and changing value of certain tax credit investments. These tax credit investments run through the NII line for U.S. GAAP purposes with an associated credit to the tax line. In the quarter, the impact to NII was a negative $104 million and the offsetting credit to GAAP taxes was a favorable $80 million, leading to a net impact to our bottom line of a negative $23 million in the quarter. To date, these investments are performing well above our cost of capital and in line with expectations. Our capital position remains strong, and we ended the quarter with an SMR north of 950% in Japan and a combined RBC north of 600% for Aflac U.S. Unencumbered holding company liquidity, holding company liquidity stood at $4 billion, $1.6 billion above our minimum balance. Leverage remains at a comfortable 22.4% in the middle of our leverage corridor of 20% to 25%. In the quarter, we repurchased $625 million of our own stock and paid dividends of $217 million, offering good relative IRR on these capital deployments. For the full year, we repurchased $2.3 billion of our own stock and paid dividends of $888 million for a total of $3.2 billion of capital returned to shareholders. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Before closing, I'd like to reiterate the outlook given at FAB for our key value drivers for the time period 2022 and 2023. With that, I hand it over to David to begin Q&A."
},
{
"speaker": "David Young",
"text": "Thank you, Max. We are now ready to take questions. But first, let me ask that you please limit yourself to one initial question and a related follow-up to allow other participants an opportunity to ask a question. And with that, Jason, if you will, open up the line to our first caller."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Nigel Dally from Morgan Stanley. Please go ahead."
},
{
"speaker": "Nigel Dally",
"text": "I wanted to start on network dental, vision group life and disability. I appreciate the color on sales. I guess how those results compare to your expectations. And as we look to 2022, do you have a number in mind as to what portion of total U.S. sales would come from those platforms?"
},
{
"speaker": "Fred Crawford",
"text": "Nigel, this is Fred. Let me try to address it, but then I'll ask Teresa and Virgil to weigh in with any comments they have. But -- so first of all, with PLADs, extremely pleased, we call it PLADS, premier life and disability and lead management. Not only did they hit the sales expectations that we had when acquiring the property, but they advanced beyond that, particularly with the state of Connecticut contract for leave management which is not an insignificant contract from a revenue standpoint. We don't include it in the traditional measure of sales only because it's not linked with an actual life and disability contract, but it's a meaningful business and one that certainly wasn't expected when we made the acquisition. So we couldn't be more pleased. The other thing I would note is that we successfully renewed 100% of our contracts this year with a 4% average pricing increase across the board. And that was very good news. Our team -- our PLADs team very careful attention to the quality of service and quality metrics as they lead into renewal period, and that proved to really benefit us on the renewal side. I say that because the earned premium, which is as important as the sales, is tracking on or better than our expectations as well. So both sales and retention are very good. Again, as we peel the onion back on that property, having acquired it and folded it in over the last year, the news just gets better on that property, very good platform, very pleased. Dental and Vision, of course, we had -- remember, we bought a TPA, but really needed to build from scratch the actual dental and vision product, along with the network. And so we very much have been in building mode on that property. I would say the sales in 2021 were below the expectations we were expecting coming into the year, but we're not due to necessarily bad performance. It was more a decision to roll that business out carefully and also had timing-related issues with entering those products onto our enrollment tool. Remember, with Dental and Vision, we're actually starting out in the small business community with our agents. So we're selling into 100 and less employees. And that means it has to be not only approved by all the states which we did throughout the year, but also has to be installed on our enrollment platform, which takes time and energy to put that on available in all states. So you had a pretty big lift with that product. And it's fair to say that COVID conditions impacted the small business world, which meant it impacted the agent delivery model from a distribution, and it just so happens that we decided long ago that our first entry point with Dental and Vision was with the small business agent-driven model, and we did not anticipate COVID. So it was behind what we originally had forecasted. But I can tell you that we're extremely pleased with it. One thing that we're really pleased with that has outperformed is the halo effect I mentioned. Selling $23 million of network dental and vision, but then sell an additional $15 million of voluntary product associated with the dental and vision sales, that exceeds our halo expectations. We would expect to have a halo effect of around 30% and to be north of 50%, approaching 60%, 70% is well above our expectations. I don't think it's going to stay at that level, particularly as we go more aggressively upmarket but still very with that halo effect. So, all in all, I would say, very good. Now in terms of what percentage of our sales next year, we've been climbing gradually north of 10% of sales heading towards 13% to 15% of sales. And in 2022, I would expect to be in that range. So, let's just call it 10% to 15% of sales. Obviously, in some ways, we don't want that percentage to be too high because we fully expect the rest of our business to grow significantly as well, but I think that's not a bad estimate."
},
{
"speaker": "Teresa White",
"text": "Brett you actually covered most of what we would cover. So, I do agree in 2022, this is Teresa. We will see about 13% to 15% of our buy to bill as a percentage of U.S. sales. And we're actually just expecting as we continue to move out by 2025, about 20% of sales, U.S. sales will be by the bill property."
},
{
"speaker": "Nigel Dally",
"text": "That is great. And just as a follow-up, I just want to stick on the U.S. career agency recruiting, broker recruits were up meaningfully Creating was under pressure. Is that a reflection of the labor markets and should we be thinking about that as a headwind for 2022 or are there other initiatives to try to accelerate that from here?"
},
{
"speaker": "Dan Amos",
"text": "Virgil, you take that, but let me just make sure I'm very clear on something that I just listening to Teresa, I want to make sure it's clear. Nigel, when you asked the question, you asked specifically to our life and disability business and our dental and vision. When we say 13% to 15%, we consider our buy-to-build properties to be those two properties plus the build of our direct-to-consumer platform. So just note that we consider those three businesses when we quote you 13% to 15%, just to make sure we're clear on that. Sorry, Virgil, why don't you or Teresa take the recruiting question?"
},
{
"speaker": "Unidentified Company Representative",
"text": "I'll let, Virgil, take that question."
},
{
"speaker": "Virgil Miller",
"text": "Okay. Well, thank you for the question, Nigel. Actually, we're very pleased with where we're sitting with the recruiting. I think you noticed, as you indicated your question that we achieved about 17.5% growth but we changed our focus. If you think about it, there were some headwinds with the labor market. So instead of just relying on new recruits, which we were able to recruit over 10,000, we did pivot our -- and evolve our model to focus on the small brokers. We activated over 5,000, and we're starting to see them perform going into the second half of last year. So, we're very pleased, as you can see, contributed to our overall increase in productivity. So -- as I look going into 2022, I expect to see more of the same. It's going to be a combination of new recruits, but we will continue our focus still though in that small broker space also."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar from JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "So, a question just on sales in Japan. And obviously, it seems like sales have bottomed and they recovered a little bit, obviously, still depressed versus historical levels. But is it possible that in the early part of 2022, you actually take a step back given some of the restrictions that the government imposed in Japan and you don't see the ongoing improvement that we've seen recently."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Okay. This is Yoshizumi of Japan. Thank you for the question. So it is true that the quality emergency measures for 34 prefectures, and today, I think it will be 35 prefectures. So, it is true that there are some impact to our sales. However, as we promoted online sales of virtual sales last year, actively, we are also enhancing that these virtual sales began this year. And this virtual sales plus the wheel or the physical sales have been established as like hybrid sales, and we will be promoting this method."
},
{
"speaker": "Dan Amos",
"text": "Yes. I think one thing I would add is just then this is Fred. Again, to remind you, there are various grades, if you will, of level of severity that the government will put in place prefigure by prefecture, the most severe being the state of emergency. When we talk about 35 prefectures being under prevention measures, that is one step below the state of emergency level. And it's important to note that the government of Japan is really trying to balance containing, of course, the virus without dampening economic activity, and they're trying to play that balancing act. And so even state of emergencies have been a little less restrictive than in the early days of COVID. And these cautionary practices and the prefectures in of themselves don't really restrict our activity and our ability to sell and meet with potential clients and so forth. The issue that's hard to measure is if you are a citizen of Japan, and you live in a prefectur that is in a -- where there is a prevention measures that are being put in place, do you feel less comfortable meeting face in conducting business in a normal way. And that's very difficult to measure, but we see it in our results. And so there's no question there's a bit of a headwind as we head into 2022 but it's certainly not as severe state of emergency, and it's definitely not as severe as the early days of COVID."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. And then just on Japan as well, can you just talk about what's going on with the Post? And what's your expectation of longer term being able to potentially expand that relationship beyond cancer?"
},
{
"speaker": "Fred Crawford",
"text": "I'll let the Japan team fill in some of the blanks and talk about it. But as I mentioned in my comments, first of all, there is no specific plan to expand products. However, again, remember, we consider our cancer business in Japan Post to be a line of business. And so for example, when we upgrade cancer products or add riders or feature to cancer products, we do that within the Japan Post system. As you may know from some of our comments at the investor conference, what we're really excited about is, we're starting to introduce concierge non-insurance services to support our cancer business. This involves a cancer policyholder being able to call into a concierge line and be tapped into non-insurance services that support their needs, whether they are going on claim or preventions or detection needs, care needs, even oncologist recommendations these types of services. So all of that product capability that we house within a company we called Hatch Healthcare. All of that will be available to Japan Post policyholders and will help with both retention and growth. So no new product lines, but the cancer line continues to expand and develop within the Japan Post system. And I'll let my colleagues in Japan talk about the momentum coming off our fourth quarter pilot exercise and looking at 2022."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "So, this is Yoshizumi once again. And in specific, what we refer to by pilot is to take examples of branches and sales offices that are doing well and not doing well. And especially those that are doing well is taken as the model for all the other new offices and outlets. So what we normally do is to reflect the successful sales offices practices to other sales offices. And the three particular initiatives that we are planning to do is to give guidance to those sales professionals, conduct training and then also enhance proposal capabilities. And by going through the PDCA cycle, we will be improving each of these initiatives. And then as we have conducted a pilot in the fourth quarter, we were successful and since we have seen some success in the fourth quarter, we are going to be promoting our sales in 2022 by using similar measures."
},
{
"speaker": "Fred Crawford",
"text": "Yes. And I might add just to put a little bit of numbers behind it because I know there's sort of a question, what do you mean by improved? But just to give you an idea, when looking at those model offices and our results in this test pilot program in the fourth quarter, when we moved from third quarter results to fourth quarter results, we had over a 50% increase from third quarter to fourth quarter, both in the number of proposals put forward and the resulting sales. And so it was clearly successful. And so what the executive teams and sales teams are doing between our team and Japan Post as they're sitting down, analyzing those results and now looking at more of a national spread of that platform, but it was a very tangible increase and gets us excited about some increased momentum in 2022."
},
{
"speaker": "Operator",
"text": "The next question comes from John Barnidge from Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "My question, it seems like when we enter each new quarter, the expectation is for claims normalization to occur over the future quarter that hadn't occurred over the last 1.5 years. But can you maybe talk about how claims utilization, especially in the U.S., but also in Japan, has trended as the Omicron variant has emerged and probably COVID fatigue sets in?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, John, and thank you for pointing out that my prediction about claims utilization has been wrong for the last year. Throughout the year of 2021, and I'll start by talking to the U.S. We did see a gradual increase in claims utilization each quarter with very, very low claims utilization in the first quarter, and then we saw a little bit of a -- and that continued quite frankly, throughout the second quarter and then we started to see a normalization in the third quarter and then into the fourth quarter as well. We're not fully back to normal. But I would say when I look at, for example, paid claims data for the fourth quarter, then November was higher than October and December was higher than November. And we are getting back very close to what I would be sort of normal claims utilization starting the year of 2022 for the U.S. So that means that I do think that we are fairly close to normal claims utilization going forward. It's also the fact that the -- we did have a correlation between infection rates in the society and claims utilization and what Omicron has done is that, that correlation has pretty much broken down. And I think that is due to people who are living in a much more normal life. You see mobility coming back to more normal levels. And with that, people are getting into accidents. They are going for physical checkups, et cetera, and that is sort of driving a more normal claims pattern and behavior among our policyholder base in the U.S. So that is why I do believe that we are going to come back to sort of a more normal claims utilization pattern for 2022. And we do expect that our benefit ratio in the U.S. will fall within the sort of normalized range. So, we do expect that we will be within the 48% to 52% benefit ratio in the U.S. for 2022. When you go to Japan, you have a somewhat of a similar pattern, but it has lagged the U.S. You don't see the reactions as quick as you do and the changes as quick as you do in the U.S. and you don't see the ups and downs as much as we have seen in the U.S. So you have a much more flatter and more prolonged pattern of claims utilization in Japan. In Japan, we are trending a little bit below but not significantly below what we would deem to be sort of our sort of normalized claims utilization. I hope that helps."
},
{
"speaker": "John Barnidge",
"text": "It does. And then my follow-up, as you think about pet insurance for '22, how meaningful a contributor do you think that will be?"
},
{
"speaker": "Dan Amos",
"text": "So, a couple of things about the pet insurance products, so as I mentioned in my comments, later in the quarter, we expect to launch taking a very targeted approach and that is we're launching and what we characterize internally as our premier broker platform. These are some of the largest brokers in the country that deal, particularly with typically larger companies, think of it as 1,000 employees and larger, that's also where a lot of the employee benefit based demand is for pet insurance. And we expect there's a lot of pent-up expectation for the product. There's a lot of momentum around pet insurance in the work site. So we do believe there's going to be a lot of interest. Now remember, in terms of our results, recognize that we don't book any earned premium, if you will, or sales on that product. That earned premium and sales is booked by Trupanion. Our rationale for putting our brand on it powered by Trupanion is that it creates -- it first, it checks a box in terms of having a pet insurance product, which many of the brokers and their clients like to see and have interest in. But also it creates an opportunity to have a more unique conversation and broader capability when we're in finalist presentations on voluntary benefits overall. So, it really helps create more energy around our broader voluntary products and once again, looking for that halo effect. So that's our expectation. We don't have really specific sales expectations other than its going to be gradual, because we want to get it right. And when you come into the premier broker world with a new product, you don't have too many chances to get it right. You need to get it right out of the gate. You need to measure three times and cut once. And the reason is because if it doesn't get off to a good and controlled start, it can be problematic in that community of brokers and we don't want that to happen. But it's a very unique product. Those of you who are familiar with Trupanion and I'm sure you've read the news recently that they were excited to announce an alliance with Chewy, which is really bonified their unique value proposition. We think this is a different type of a product. We think this is not simply a check-the-box pet insurance product. We think the special value proposition, veterinarian-driven type product set is a unique differentiator. And we've coupled it even with benefits where you as an employee can purchase a rider that pays you your out-of-pocket costs, if your pet is sick and you need to take off work and experience some of the same out-of-pocket cost come with human health conditions. So, we really have built a unique value proposition. We think it's a differentiator, and we think it will create more fulsome conversations when selling our broader voluntary platform."
},
{
"speaker": "Operator",
"text": "The next question comes from Humphrey Lee from Dowling & Partners. Please go ahead."
},
{
"speaker": "Humphrey Lee",
"text": "My first question is regarding the Japan Post employee kind of transferring 10,000 of them to Japan Post Insurance. How should we think about the required time for them to ramp up? And how should we think about the potential impact on kind of the sales outlook?"
},
{
"speaker": "Fred Crawford",
"text": "I think it's best for our Japan colleagues to address that. So Yoshizumi, the transfer of postal sales people to Japan Post Insurance and how that flows through? And is there any ramp-up period?"
},
{
"speaker": "Masatoshi Koide",
"text": "This is Koide of Aflac Japan. As you mentioned, there will be 10,000 people or salespeople moving from Japan Post Company to Japan Post Insurance in April, and this is being planned. And what is very important about this is that, after these people are transferred to Japan Post Insurance, they will only be selling Japan Post insurance product and Aflac cancer products. And since their people's moves are in April and preparation is going extremely well towards April. However, right after their move in April, there may not be a significant impact. However, once they get used to it, there will be a gradual increase in the momentum of sales. So what we are expecting is that after this transfer occurs, and then perhaps in the second half of this year, there will be some more momentum in sales. And let me just add a little bit more information that these 10,000 salespeople that are currently working for Japan Post Company is already -- are already selling our cancer insurance. Therefore, they do have the experience and the knowledge of cancer insurance. That's all from me."
},
{
"speaker": "Humphrey Lee",
"text": "That's helpful. Just staying on Japan. So you talked about some of the counter measures for COVID is not really restrictive and one of the bigger question would be how kind of the consumers will react given the current environment. I think I read somewhere that the lawmakers are looking at potentially more restrictive countermeasures for COVID and also the consumer confidence has been dropping in Japan. I was just wondering if you can elaborate a little more if there are more restrictive measures to put in place and the consumer confidence is continue to drop, like should we see -- could we see a more dampened sales outlook for 2022?"
},
{
"speaker": "Dan Amos",
"text": "This is Dan. Let me -- I want to make a couple of comments. Number one is it hadn't been stated, but they have they have 90% of the people have been vaccinated in Japan. And so, the -- as we've seen with the new variants the death rate is much lower and there's improvement. I don't think we have any specific answers at this time. I'll let them answer in terms of what the government will require. But I think it's -- you're going to see the death rate and the issues trend down instead of up because we're seeing everybody vaccinated compared to the United States. Now some states, of course, are higher than others, but there is a movement in that direction. You also may have saw the Johns Hopkins report last week that a lot of these things that they're doing in regard to trying to control the variant has not worked very well. And so, I think you're going to see more movement back to normal. We certainly, as a corporation, both in Japan and the United States are moving in a gradual, but for example, we had a meeting of 1,000 people of our salespeople. We tested them all before they came. Some didn't want to come, but over 800 showed up after it was all said and done, we had about 15 cases of COVID in the United States for that particular meeting, which was really, if you took 1,000 people at random, that would be a relatively low number. So, I think you're seeing things move back in Japan. We're back to over 50% of the employees are at work, what they'll have to give you the exact number, but it's over 50%. So, I see things moving back more to normal. Koide, would you take that question, please, and talk a little bit about it."
},
{
"speaker": "Masatoshi Koide",
"text": "This is Koide once again. And it is true that even in Japan, the number of new cases that are on the increase. However, as Fred mentioned earlier, the current infection prevention measures that are being issued is much milder than the state of emergency that the government has issued a long time ago. And the government of Japan is aiming to strike a balance between prevention of the infection. At the same time, promote economic measures and activities. And therefore, the government is extra careful about whether to issue even severe or like emergency measures. So as a result, we are not -- there is no plan of Japan issuing very severe measures such as lockdown or any severe measures, then the state of emergency that the government of Japan has issued a while ago. So, there is no change -- no plan for the change in loss either. That's all for me."
},
{
"speaker": "Fred Crawford",
"text": "Yes, one thing, not to pile on. This is Fred. But one thing I would say, just in terms of the basis of your question, as you always want to be careful about the correlation of economic activity in Japan and the sale or demand for our products. Right now, really, what we're talking about is the practical implications of meeting face-to-face and having a naturally higher close rate meeting face-to-face. But it is after all a pandemic. And so you would imagine that supplemental medical disability product, even elderly care and cancer product, that there will be a natural level of elevated and awareness for these types of products given pandemic conditions. So, it's really more a practical execution issue than it is a demand and economic issue in my view."
},
{
"speaker": "David Young",
"text": "Thank you, Humphrey. And Jason, I believe that was our last call, we've gone past the top of the hour. For anyone that has any follow-up questions, though, I'm pleased to ask you to contact Investor and Rating Agency Relations. We'll be happy to help you. Thank you all for your time today and look forward to speaking to you soon. Thank you."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 3 | 2,021 | 2021-10-28 09:00:00 | Operator: Good day, and welcome to Aflac Third Quarter 2021 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I'd now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations and ESG. Please go ahead.
David Young: Thank you, Ian. Good morning, and welcome. As always, we have posted our earnings release and financial supplement to investors.aflac.com. And this morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated will begin with an overview of our operations in both countries. Fred Crawford, President and COO of Aflac Incorporated will then touch briefly on conditions in the quarter and discuss key initiatives, including how we are navigating the pandemic. Max Broden, Executive Vice President and CFO of Aflac Incorporated will conclude our prepared remarks with a summary of third quarter financial results and current capital and liquidity. Members of our U.S. executive management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual and Group Benefits; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; and Todd Daniels, Director and CFO; as well as Koichiro Yoshizumi, Director, Deputy President and Director of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?
Dan Amos: Thank you, David, and good morning. Thank you for joining us. With the pandemic conditions continuing to evolve, I'm proud of our response over the last year. I am also grateful to our team of employees and sales representatives who have empowered Aflac to adapt to what has been a very challenging time for everyone. During the third quarter, we saw a rise and then a decline in COVID cases and hospitalizations in both the United States and in Japan, but to varying degrees. With that in mind, I continue to address our employees in a way that's similar to how with my own family. I'm keeping them informed in updates from the medical community and encourage them to get the COVID-19 vaccine because I want people to avoid being sick or even worse being a casualty due to this pandemic. As we entered the fourth quarter, when the weather gets colder and indoor gatherings increase, the recovery from the pandemic remains uncertain, and we must remain diligent. For the third quarter, adjusted earnings per diluted share, excluding foreign currency impact increased 10.1% for the quarter and 20.1% for the year. These results are largely driven by lower-than-expected benefit ratios and higher net investment income, primarily in Japan. Looking at the operations in Japan in the third quarter, Aflac Japan generated solid overall financial results as reflected in the profit margin of 26.3%, which was above the outlook range provided at our financial analyst briefing for 2020. As Max will explain in a few moments, Aflac Japan has reported very strong premium persistency of 94.5%. Aflac Japan sales were essentially flat for the quarter. Sales for the first 9 months of this year were approximately 66% of 2019 level. We continue to navigate evolving pandemic conditions in Japan, which include widespread state of emergencies that extended to multiple prefectures and persisted through the third quarter. These states of emergency in Japan are much less restrictive and more limited in scope than lockdowns in other countries, but they have impacted face-to-face sales opportunities. As we entered the fourth quarter, the ability to meet face-to-face with customers appears to be improving somewhat gradually and the degree to which our ability to meet face-to-face continues to improve with a very key driver in the recovery of our sales. We were encouraged by the September launch of our new nursing care insurance in Japan, which we view as another opportunity to meet the needs of certain consumers. However, it's still very early in the launch of this new product to determine the potential of the nursing care insurance. In addition, Aflac Japan continues to work to strengthen the alliance with Japan Post, which resumed proactive sales of the cancer insurance on April 1. We expect continued collaboration to further position both companies for the long-term growth and a gradual improvement of Japan Post cancer insurance sales in the intermediate term. Now turning to Aflac U.S. We saw a strong profit margin of 22.2%. This result was driven by lower incurred benefits and higher adjusted net investment income, particularly offset by the higher adjusted expenses. Aflac U.S. also continued to have strong premium persistency of nearly 80%. Sales increased 35% for the quarter and are at approximately 78% of sales for the first 9 months of 2019. These sales results reflect what we believe are improving pandemic conditions in the United States, allowing us more face-to-face meetings and enrollments than prior periods. In the U.S., small businesses have gained some incremental ground toward recovery, which we expect to continue gradually. Within the challenging small business and labor markets, we continue to make investments in developments of traditional independent sales agents that make up about 53% of our sales as of the third quarter of 2021. At the same time, larger businesses appear to be more resilient given their traditional reliance on online self-enrollment tools, and we continue to invest in the group platform. Group business, which is being driven by broker performance is performing very well. excluding our acquired platforms, group sales have generated a year-to-date sales increase of 14% over the same period for 2019. As we enter historically higher enrollment periods in the United States, we remain focused on being able to sell and service customers, whether in-person or virtually. With an eye toward responding to the needs of consumers, businesses and our distribution, we continue to build out the U.S. portfolio with Aflac Network Dental and Vision, premier life and disability. These new lines modestly impact the top line in the short term. These new products in combination with our core products, better position Aflac U.S. for future long-term success. Pandemic conditions have served to fuel our long-standing strategy of being where people want to purchase insurance in both the United States and in Japan. And while face-to-face sales remains the most effective way for us to convey the financial protection only Aflac products provide. The pandemic has clearly demonstrated the need for virtual avenues to help us reach potential customers. We have continued to invest in tools for our distribution in both countries and to integrate these investments into our operations. As always, we place significant importance on continuing to achieve strong capital ratios in the U.S. and Japan on behalf of our policyholders and investors. We remain committed to prudent liquidity and capital management. With the fourth quarter declaration, 2021 will mark the 39th consecutive year of dividend increases. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we will continue to be tactical in our share repurchase and focus on integrating the growth investments we've made in our platform. We are well-positioned as we work toward achieving long-term growth while also ensuring we deliver on our promise to our policyholders. By doing so, we look to emerge from this period in continued position of strength and leadership and look forward to sharing more about our strategic and financial priorities at the Financial Analyst Briefing on November 16, 2021. Now let me turn the program over to Fred. Fred?
Fred Crawford : Thank you, Dan. Recognizing we have our analyst and investor briefing scheduled in the next few weeks, I'll keep my comments brief before handing off to Max on the quarter's financial results. Beginning with Aflac Japan, as Dan noted, it was an unusual quarter with the states of emergency declarations across most of the country. Declarations are triggered in Japan by, among other things, a combination of rates of infection and hospital utilization by prefecture. The precise impact is difficult to calculate, but the practical implications include reduced face-to-face consultations, limited access to on-site workers and payroll solicitation, reduced foot traffic to the roughly 400 owned and affiliated retail shops that we sell through, and restricted travel between prefectures, which further constrains sales professionals. When looking at claims experience through the third quarter and since inception of the virus, Aflac Japan's COVID impact has totaled approximately 31,000 claimants with incurred claims of JPY 5.6 billion. We expect conditions to improve and remain focused on what we can control, including product development and advancing our business model. Our medical product EVER Prime continues to do well with medical sales up roughly 14% in the quarter and 36% year-to-date over the same period in 2020. Our market share has improved, but we're still at roughly 85% of the medical sales enjoyed in 2019, which was also a medical product refresh year. So pandemic conditions in the quarter are having an impact. Regarding our nursing care product, since our late September launch, we have sold nearly 10,000 policies. This is a strong start, but within our expectations given the marketing support put behind the product. From a risk perspective, this is a supplemental product aligned with coverage provided by the Japanese government and targeting the mass market. Benefits are, therefore, less rich and capped both in an amount and duration. The product is designed for protection versus savings with modest interest rate sensitivity. In summary, the product has a similar risk profile to our existing third sector products. We continue the development of noninsurance services that wrap our cancer and now nursing care product offerings. This has become more common among the large domestic insurers and we see these services as important for both defending and building our market share. Turning to the U.S., pandemic conditions remain at elevated levels with the spread of the Delta strain of the virus. As of the end of the third quarter, Aflac U.S. COVID claimants since inception of the virus has totaled approximately 79,000 with incurred claims of $135 million. Dan covered overall U.S. sales conditions. I'll focus my comments specifically on our buy-to-build growth platforms. Our 2021 Dental and Vision strategy can be summed up as a year of launch, learn and adjust. This quarter, we processed over 1,600 cases, up 30% over the second quarter as we roll out training and development to agents and launch in additional states. We are focused on small- and medium-sized businesses with sold cases averaging around 95 employees. Looking forward into 2022, we continue building out our dental network and readying the platform for increased volumes as we move upmarket and introduce a direct-to-consumer individual product. Our premier life and disability team successfully renewed 100% of their current accounts, a testimony to their high-quality service model. We are preparing to launch with Connecticut administering benefits for their state-wide paid family and medical leave program in 2022. This is an administrative-only contract leveraging our acquired leave management platform. With respect to our e-commerce initiative, Aflac Direct, we currently offer products in 46 states. We are actively building out a licensed call center and currently have 14 licensed agents. The call center platform is in the early days of building and augments our digital-only conversion rates as well as reduces operational dependency on call center vendors. In the third quarter, these 3 platforms accounted for roughly 13% of sales and are expected to build as a percentage of sales and earned premium in the coming years. Before handing off to Max, a few comments on operations. In Japan, we continue to drive volume through our online sales solution. Year-to-date, we have processed over 38,000 online applications with September being our largest month since launching the capability. We are pushing forward on technology and digital modernization and are sizing the investment required to streamline our policyholder services platform. This is the largest operating platform in Japan and a key to driving down our long-term expense ratio. In the U.S., our premier life and disability platform completed a successful transition this month from Zurich on time, on budget and without client or customer disruption. We are focused on migrating our voluntary business to a new group administration platform and building out critical data connections with leading benefit administration and HR systems. The goal is to ensure ease of doing business, smooth onboarding and renewals and quality service and analytics. When looking at our Japan and U.S. expense ratios going forward, we continue with critical platform development despite a period of weaker revenue. We expect to stay within previously guided ranges for expense ratios, recognizing prolonged pandemic conditions require recalibrating the precise trajectory and time line for reaching our ultimate targets. Finally, at Aflac Global Investments, performance remains strong. We continue to advance our sustainable investing platform and recently refreshed our strategic asset allocation work. Our team will dive deeper into operations and strategic execution at next month’s Analyst and Investor Briefing. Let me now turn things over to Max to cover financial performance. Max?
Max Broden : Thank you, Fred. For the third quarter, adjusted earnings per share increased 10.1% to $1.53, with a $0.02 negative impact from foreign exchange in the quarter. This strong performance for the quarter was largely driven by lower claims utilization due to pandemic conditions, especially in Japan. Variable investment income ran $0.11 above our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses, grew 10.1%. And the adjusted ROE, excluding the foreign currency impact, was strong 16.2%, a significant spread to our cost of capital. Starting with our Japan segment. Total earned premium for the quarter declined 4%, reflecting first sector policies paid up impacts, while earned premium for our third sector products was down 2.6% due to recent low sales volumes. Policy count in force, which we view as a better measure of our overall business growth declined 1.8%. Japan's total benefit ratio came in at 66.1% for the quarter, down 520 basis points year-over-year, and the third sector benefit ratio was 55% and down 670 basis points year-over-year. We experienced a greater-than-normal IBNR release in our third sector block as experience continues to come in favorable relative to initial reserving. Utilization continues to be constrained by pandemic conditions and we now have more than a year's worth of pandemic data, and with that, our model output is more refined, leading to increased releases. Adjusting for greater than normal IBNR releases and in-period experience, we estimate that our normalized benefit ratio for the third quarter to be 68.7%. Persistency remained strong with a rate of 94.5%, down 50 basis points year-over-year. Consistent with past refreshed product launches, we have experienced a slight uptick in lapse rates on our medical product as policyholders look to update their coverage. Our expense ratio in Japan was 21.4%, down 30 basis points year-over-year. Constrained business activity lowered our expenses in Q3, which we view to be a temporary phenomenon. We generally expect increased spending on key initiatives to continue and especially in Q4 as we tend to see some seasonality in spending and booking of projects. Adjusted net investment income increased 19.7% in yen terms, primarily driven by favorable returns on our growing private equity portfolio and lower hedge costs, partially offset by lower reinvestment yields on our fixed rate portfolio. The pretax margin for Japan in the quarter was 26.3%, up 690 basis points year-over-year, a very good result for the quarter. This quarter's strong financial results lead us to expect a full year benefit ratio for Japan to be below the 3-year guidance range of 68.5% to 71% given at FAB. And the pretax margin to be above the 20.5% to 22.5% range given at -- for the full year 2021. Turning to U.S. results. Net earned premium was down 1% as lower sales results during the pandemic continued to have an impact on our earned premium. Persistency improved 110 basis points to 79.9%. 70 basis points of which are from lower sales, as first year lapse rates are roughly twice the level of in-force lapse rates. In addition, there still remains about 40 basis points of positive impact from emergency orders. Our total benefit ratio in the U.S. came in lower than expected at 45.1% or 320 basis points lower than Q3 2020, which itself was heavily impacted by the initial pandemic. Lower and deferred claims utilization impacts our IBNR held for incurred claims within a year. And as we get more data, our long-term models increased reliance on raw data leading to IBNR releases. This quarter, they amounted to a 3.5 percentage point impact on the benefit ratio, which leads to an underlying benefit ratio, excluding IBNR releases of 48.6%. We expect the benefit ratio to increase gradually throughout the remainder of the year with the resumption of normal activity in our communities and by our policyholders. For the full year, we now expect our benefit ratio to be in the range of 43% to 46% versus original guidance of 48% to 51%. Our expense ratio in the U.S. was 38.9%, up 170 basis points year-over-year, but with a lot of moving parts. Weaker sales performance negatively impacts revenue, however, the impact to our expense ratio is largely offset by lower duck expense. Higher advertising spend increased the expense ratio by 40 basis points. Our continued build-out of growth initiatives, group life and disability, network dental and vision, and direct-to-consumer contributed to a 260 basis points increase to the ratio when isolating these investments. These important strategic growth investments are somewhat offset by our efforts to lower our core operating expenses as we strive towards being the low-cost producer in the voluntary benefits space. Net-net, despite a lot of moving parts, Q3 expenses are tracking according to plan. In the quarter, we also incurred $7.8 million of integration expenses not included in adjusted earnings associated with recent acquisitions. Adjusted net investment income in the U.S. was up 9.1%, mainly driven by favorable variable investment income in the quarter. Profitability in the U.S. segment remained strong with a pretax margin of 22.2%, with a low benefit ratio as the core driver. With 9 months now in the books, we are increasing our pretax expectation for the full year. Initial expectations were for us to be towards the low end of 16% to 19%. We now expect to end up above the range indicated at FAB 2020. In our corporate segment, we recorded a pretax loss of $41 million, as adjusted net investment income was down $12 million versus last year due to low interest rates at the short end of the yield curve and change in value of certain tax credit investments. These tax credit investments run through the corporate net investment income line for U.S. GAAP purposes with an associated credit to the tax line. The net impact to our bottom line was a positive $5 million in the quarter. To date, these investments are performing well and in line with expectations. In the fourth quarter, we do expect a significant tax credit investment to fund, which will bring some volatility to the corporate NII line as well as an offsetting credit to the tax line. Our capital position remains strong and we ended the quarter with an SMR in Japan of north of 900% and an RBC north of 600% in Aflac Columbus. Unencumbered holding company liquidity stood at $4.2 billion, $1.8 billion above our minimum balance. Leverage, which includes the sustainability bond issued earlier this year, remains at a comfortable 22.6% in the middle of our leverage corridor of 20% to 25%. In the quarter, we repurchased $525 million of our own stock and paid dividends of $220 million, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted return on equity with a meaningful spread to our cost of capital. Finally, I would like to mention that we will begin to expand our disclosures around the adoption of LDTI in our Form 10-Q and at FAB. At a high level, we do not see this accounting adoption as an economic event with no impact to our regulatory financials or capital base. There will be no change to how we manage the company, cash flows or capital. With that, I'll hand it over to David to begin Q&A.
David Young: [Operator Instructions]. Ian, we will now take the first question.
Operator: [Operator Instructions] At this time, our first question comes from Nigel Dally of Morgan Stanley.
Nigel Dally : I wanted to touch on Japan sales. Hoping to get some color on a number of points. First, progression of sales throughout the quarter, in particular, whether you saw a sharp dip during the Olympics. Second, as the emergency orders were lifted. Have you seen sales rebound if it's possible to comment on that? And third, an update on the ramp-up in cancer sales within Japan Post?
Dan Amos : Well, let me just get Aflac Japan to start with that, and then I may make a comment afterwards, but I think that'd be best. So Koi, however you want to handle this, please?
Koichiro Yoshizumi : Yes. Yoshizumi san will answer to this question. [Foreign Language] This is Yoshizumi of Aflac Japan. [Foreign Language]. Thank you for the question. [Foreign Language]. Let me start from our situation in the third quarter. And in the third quarter, since we had the largest spread of COVID-19 due to Delta strain. [Foreign Language]. And as a result of that, the state of emergency declaration, which only covered 20 prefectures in the second quarter increased to 33 prefectures in the third quarter. [Foreign Language]. In other words, the state of emergency declaration area covered 90% of population in Japan. [Foreign Language]. And so there were impact to our sales performance and results due to a decrease in face-to-face both station and meetings with customers and also delaying some of the worksite sales station as well as the number of traffic -- customer traffic coming into our walk-in shops. And on top of that, there were some restrictions in traveling across prefectural borders, which prevented us from visiting customers. [Foreign Language]. However, under this environment, we have been able to arrive at a point the same level of sales as for the third quarter last year. That is because of the online solicitation that we have conducted. And also the new product that we launched at the end of September, which is the nursing care product. So as a result, we have been able to reach the same level of sales as in the third quarter last year. [Foreign Language]. Right now, in the fourth quarter, there is no area in Japan that is covered under the state of emergency declaration. [Foreign Language]. And the economic activities are becoming much more active in Japan, although it's gradual. [Foreign Language]. We are expecting that our set sales will grow in the fourth quarter with -- by focusing on the sales of the nursing care product.
Dan Amos : I will -- go ahead, please.
Masatoshi Koide: [Foreign Language]. This is Masatoshi Koide from Aflac Japan. I will address the overall strategic alliance. But before doing so, Yoshizumi san, would you please talk about our sales performance or prospects through the Japan Post channel.
Koichiro Yoshizumi : [Foreign Language] Once again, this is Yoshizumi. [Foreign Language] While new policy sales increased over the second quarter. However, the pace of recovery has been moderate. [Foreign Language]. Well, this was driven by several factors, including that it has been approximately 2 years since Japan post refrain from conducting proactive sales states of emergency limited the ability of sales representatives in many areas to meet customers and preparations are underway for the upcoming transfer of sales employees from Japan Post Company to Japan Post Insurance. [Foreign Language]. We have been conducting a range of activities to help promote sales through the Japan Post channel. For example, in the third quarter, we conducted training aimed at improving Japan post agent mindset and skills. We did so through activities to inform policyholders about the latest coverage and engaged in proposal activities for those not yet covered by cancer insurance. [Foreign Language]. We are currently promoting cancer insurance sales by managing the sales process, which includes approaching customers, getting to know their needs informed them of the latest coverage, making proposals based on the proposal form and closing the deal, we are emphasizing with Japan Post to increasing the number of proposals. [Foreign Language]. As the Japan Post Group announced in September, approximately 10,000 sales employees to be transferred from postal network to Japan Post Insurance will offer only Japan Post insurance and Aflac cancer insurance product. [Foreign Language]. We believe that preparations for the transfer and transition of these employees also affected third quarter sales activities. [Foreign Language]. And against that backdrop, sales will continue to strengthen, but we expect that a full recovery will take time. [Foreign Language]. Okay. That's it for me. So I will give it back to Mr. Koide, Koide San, please.
Masatoshi Koide: [Foreign Language]. In the June agreement to further expand the strategic alliance, we confirmed that FAB counter insurance sales are an important part of Japan Post Group's co-creation platform vision which is a central theme of its medium-term management plan. We also confirmed that Japan Post Group will continue to promote cancer insurance sales as an important product in its sales strategy. [Foreign Language]. In October, Aflac and Japan Post Group senior executives held our quarterly strategic alliance committee meeting. At that meeting, the Japan Post Group President, Charles Lake, I and others met. We had a very constructive discussion about the current situation, including the pace of sales recovery and discussed specific measures to improve counter insurance sales. [Foreign Language]. We walked away pleased by the strong commitment expressed to strengthen the alliance to achieve growth. Against that backdrop, we expect that cancer insurance sales through the Japan Post channel will steadily recover over the medium term.
Dan Amos : All right. You heard a lot because there's been a lot going on, because we consider this to be 1 of the most important issues that we are looking at. Let me just sum it up by saying that the third quarter definitely hurt our production everywhere because of people being required to stay at home under those emergency orders, to some degree, not like Europe, but strong enough that hurt space sales, has the attitude of the management team at Japan Post changed in any way from what it was earlier in the year. The answer is no. We are aligned. They are large shareholders. They know that so goes their production will play a big impact on the company, Aflac specifically and what will take place. Is it slower than we thought -- it's slower than I thought. I was hoping it would kick back up. But with the emergency, it did slow it down. do I think they will recapture where they were? I absolutely do. Do I know the time on it? I do not. Do I think that top management is pushing it Yes, I do think they're pushing it. Do I think the lower management levels are on board yet? I think they're very tentative because not about our products, but any products. because they've been pushed by the FSA, not to make any mistakes to be -- so it's just a little bit slower getting them comfortable back to normal where they can begin to go. So I still think we have a winner with Japan Post. I think it's nice that not only are they selling for us, but that they are a large shareholder because that ties us so closely together. So I know you've heard a lot about this, so I'll stop there.
Max Broden: Nigel, you also asked a very specific question about the quarter. Let me just give you some color. July was about JPY 4.4 billion in sales. August JPY 3.7 billion and September rebounded back to JPY 4.5 billion. That may suggest on the surface, some impact related to the Olympics, but it's extremely difficult to calculate that type of precise impact. I think the broader issue is states of emergency picking up throughout the quarter, as we discussed earlier. I'd also note that September had about 300 -- a little over 300 million of sales of the new care product, which we launched in the last 7 days of the month. So that will give you an idea of some of the trend dynamics.
Operator: Our next question comes from Humphrey Lee of Dowling & Partners.
Humphrey Lee : My first question is on the IBNR reserve releases, but more about the reserving practice. I feel like we’ve tried to get to a better understanding for a while now. But you have continued to see these favorable reserve releases for a number of quarters. I appreciate the guidance for the full year basis, that’s helpful, at least for kind of looking at the fourth quarter. But just can you walk us through you’re reserving process during the pandemic. And should we see more releases in the coming quarters as long as COVID is still around since on a rolling basis, the IBNR that you set up 12 months ago will have to be released if claims incidents remain low?
Dan Amos : So Humphrey, so first of all, we have not changed our reserving practices. They continue the way they have always been, and follows the same methodology. When it comes to future reserve releases, that’s very difficult to predict. But in general terms, I would say that if we continue to be in pandemic conditions with low claims utilization, you are likely -- and therefore, you’re likely to continue to see some reserve releases come through our results. Simply because we continue to reserve the way we have before. We have not adjusted our new claims reserving to the more recent claims utilization experience, but we continue to reserve to a more normalized claims expectation.
Humphrey Lee : Okay. Got it. My second question is related to the U.S. sales, especially those through your broker channel, which has continued to show good recovery given the channel has the largest production in the fourth quarter, have you seen any early signs of what the fourth quarter may look like through that channel?
David Young : Teresa?
Teresa White: Yes, this is Teresa. I’ll make a couple of comments, and then I’ll ask Virgil to respond specifically to the question. But as far as broker sales, first of all, we benefited from really stellar broker sales in the third quarter. We also benefited from veteran sales as well in existing and new accounts. From a broker standpoint, you know that during the quarter, we have the Delta variant. So with that, we saw pressure with career agency sales. And so 1 of the ways that we mitigate that was to pivot and drive broker contracting so that we could set up the third and fourth quarter for good sales through that channel. So I’ll let Virgil respond with additional color.
Virgil Miller : Yes. Thanks, Teresa. Just to add up a few things you said, Teresa. Within what we saw in the third quarter returned about veterans, veterans, we talk about really being 5 years plus. I saw a 10% increase over last year in the return of those veterans. That gives us a good start going in Q4, specific to the broker channel Third quarter, we saw a 62% increase year-over-year. And also, that was 112% performance compared to 2019 pre-COVID. I am optimistic we will see the same thing going into fourth quarter. Our pipelines are strong. And so therefore, we stick with our expectations going through the rest of the year.
Operator: Our next question comes from Jimmy Bhullar of JP Morgan Securities LLC.
Jimmy Bhullar : I just had a question on Japan sales, and you gave a very detailed response to the earlier question. But I think everyone was sort of surprised that sales declined on a sequential basis. And to the extent this was driven by more widespread emergency orders and the Olympics, I just wanted to see if you could comment on how you feel sales activity will pick up now that the orders have been lifted? And have you seen that already now that you've gone through the first month in the fourth quarter.
Max Broden: Yes, Jimmy, 1 thing I would say and our Japanese colleagues can weigh in if they'd like, but a few things. One, I think we -- it's very difficult to give a precise percentage, if you will, as to what the impact of the rolling states of emergency and the Olympics are in the third quarter. And so that makes judging the fourth quarter more difficult. But we clearly expect conditions to be better in the fourth quarter. We also -- as you remember, we only had 7 days -- or my earlier comments, we only had 7 days of the new care product sales in September. And we continue to see momentum through the first 20-plus days in October in that product. And then meanwhile, we continue to work with Japan Post. And so we have a positive view of the trend lines heading into the fourth quarter for all of those things, but it's very difficult to put sort of percentage or more precise guidance around that, and we wouldn't venture to do that. But certainly, conditions suggest that we will see some recovery.
Jimmy Bhullar : And then just on the U.S. business, can you sort of compare and contrast what's going on in the agency channel versus the process what's going on in the agency channel versus the broker channel, it seems like the broker business has obviously done better and then also similarly small versus larger employers where it seems like the larger employer markets coming back a lot faster than smaller employers.
Teresa White: I'll ask Virgil to respond to that.
Virgil Miller : Yes. Thanks, Teresa. So first, I'll start on a large case market. In the lowest case market, like I said before, we've seen good performance with our overall broker channel, again, they're performing about 2019, predominantly selling the group product. Group product is dominating now in large case space. We've seen really 146% of 2019 sales when it comes to group. So I agree with you, we've seen strong recovery in the large case space. Really, that relates to the fact that the large case space is already really used to more virtual and online experience sales. A little bit more, let's say, headwinds in smaller cases, small case that we continue to dominate with our career channel. Again, I integrated earlier that we saw a return of on veterans. We have veterans come back to produce in that third quarter that had not produced all year, so we're looking well. Added to together, really, 1 of the things we've been doing, though, is ensuring that we go to market as a unified sales distribution channel. Distribution continues to be a core competency of Aflac as has always been. And you will see that for broker-driven sales in the lowest case space, our agents participate in many cases, that's fulfillment. So that's a key aspect is there's overlap when it to work together also.
Max Broden: One of the things that we're seeing, Jimmy, in the U.S. is you've read a lot about the labor markets. And when you think about the 3 to 99 space, which is where our agents sell, that's a particular part of the economy that obviously was hit harder and it's taking longer to recover from the pandemic. They're now facing a different kind of issue, and that is can they get the help to actually keep the businesses open and running properly. Labor market conditions are very difficult to navigate right now for many small businesses. That same dynamic goes to our recruiting -- So recruiting dynamics are more challenging in this type of a labor market. There's a lot of speculation about those conditions also starting to improve more so as we get out of the fourth quarter into early part of next year. But I just want to remind folks that you tend to think about the pandemic and that's, of course, affected small businesses but labor market dynamics are also uniquely impactful to that franchise.
Operator: Our next question comes from Tom Gallagher of Evercore ISI.
Tom Gallagher : Max, just a follow-up on some of the underlying claim trends you were referring to. The -- I heard what you said about U.S. is returning closer to normal, but Japan remains below normal. How much lower is Japan in terms of the underlying claims trends? Are we talking about 1% to 2% below normal? Is it closer to 5%? Can you comment on what the level is? And then also relatedly, how does that split between medical and cancer? Is it below normal for both? Or is 1 kind of driving that?
Max Broden: So Tom, specifically for Japan, it bounces around from month-to-month. But I would say that it’s single digits below normal run rate. It is what we have experienced for an extended period of time. In the U.S., it’s been a little bit more volatile where we’ve seen anything between zero and 20% below normal sort of claims run rates. And more recently, we have approached more sort of normal run rate, especially when we look at the -- for example, the first 2 weeks of the fourth quarter, we have come back to more -- certainly more normal levels.
Tom Gallagher : Got it. And then the between medical and cancer in Japan, where -- is it across bolters at 1 or the other?
Max Broden: It’s really both where we have seen it. It’s for -- on -- again, it’s different for different benefits within those products. But generally speaking, when we sort of average it out and look at both product lines, we see similar impacts on both medical and cancer.
Tom Gallagher : And when you say single digit, is it mid-single digit or high or low?
Max Broden: Single digits.
Operator: Our next question comes from John Barnidge of Piper Sandler.
John Barnidge : Sticking with the U.S. benefit ratio a little bit. I get it seems reasonable to assume claims utilization coming in that next quarter. But given the IBNR nature, how do we think about like the time decay of this as a weak forward?
Dan Amos : I think you were cut off. You might want to ask the question 1 more time because we only heard part of it.
John Barnidge : I get it seems reasonable that claims utilization will normalize in that next quarter. But given the IBNR nature, how should we think about that time decay of that tailwind may be leaking into subsequent years?
Dan Amos : I'll kick off, and then I'll ask Al Riggieri, our Chief Actuary, to maybe give some comments as well. But generally speaking, you tend to see a quicker reaction to more recent claims trends in our U.S. business than what you see in Japan. But please, Al, if you would like to add some color, please.
Al Riggieri: Sure. The U.S., as Max said, was a little bit more -- it fluctuates more. So you'd see a little bit more fluctuation around that. But we go through approximately 12 months of accruals to really get zeroed in on the claims level. So it takes data and time to mature the information coming in and looking at it for IBNR. So the judgment during the period. I'd expect it to continue to have a little -- a bit of a tail going out the back end through the remainder of COVID. But with -- as the claims rebound, you'll begin to see more of normalization back into normal sort of benefit ratio trends.
Operator: Our next question comes from Erik Bass of Autonomous Research.
Erik Bass : Max, can you just talk about how much capital generation is running ahead of your initial expectations this year, given the strong results? And how does that play into your outlook for capital deployment?
Max Broden: It clearly runs above what we initially expected. And you can essentially break it down as the upside is primarily driven by the lower-than-expected benefit ratios. They pretty much immediately flow through into higher statutory earnings and also higher FSA earnings as well, which then drives our capital formation and generation and ultimately, dividends up to the holding company. So you can use the difference between our reported benefit ratios and our normalized benefit ratios as a guidance for what that sort of increased capital generation this year would be. Now, when we then think about capital deployment, we have significant capital around the company and all the operating subsidiaries. We operate with very strong capital ratios. And also at the holding company, we hold a very high level. Therefore, if our capital generation in a single year or a single period deviates from our initial expectations, it’s not necessarily driving or changing our tactical view of how we deploy capital. So I wouldn’t necessarily immediately lead it into that from a -- on a short-term basis. Obviously, long term, it’s more capital that we have available to us to deploy into our different deployment strategies.
Erik Bass : Got it. And then a follow-up. Fred, you mentioned some of the ancillary products and services that you could offer kind of around the cancer and senior care product. Just want to get a sense of what those might be and how you would, I guess, bring those to market?
Fred Crawford : Yes. It’s becoming a very developed approach by not many, but a few of the leading insurance companies in Japan. And it’s largely developed around care products historically, and that is offering certain concierge services for the elderly that are attached to elderly care insurance policy support, everything from nursing care support to in-home modernization to reduce the risk of injury, et cetera. You’re seeing some of that, of course, go on in the U.S., and it’s going on in Japan, too. Our approach has been to, A, make sure that we’re building out those types of services around the care product. But also, we think there’s an opportunity for particularly Aflac to do that in the cancer space. And the way to think about it, we have formed an entity in Japan called Hatch Healthcare. And that entity has been building out these noninsurance services surrounding cancer and now care insurance. And effectively, the way it works is you as a policyholder, have an ability to call in to effectively a concierge desk that then helps direct you to either internal or third-party contractual agreements to support both diagnosis and early screening type services on cancer as well as post-cancer diagnosis care, everything from nutrition to mental health to other dynamics. And so this is in the early stages of being built. We’ve been working on it for about 2 years now. It’s now starting to become in a spot to be put into action. But we think this is really the next horizon, if you will, of securing our market share and building our capabilities on the cancer side. And then also, it’s really a necessary entity in supporting care insurance and competing with the other big care providers in the country.
Erik Bass : Got it. Is it fee for service or part of your covered under your premium?
Fred Crawford : Yes. Essentially, it’s covered under the premium. And then once you funnel through a concierge desk. It depends on what services you request and then there are charges that are applied through third-party contractual arrangements predominantly. That is the vision at the moment. So it’s more around customer service, persistency, sales opportunity and market share, I should note that these types of services would also be offered on cancer policies sold through Japan Post. So it’s really both a defensive and offensive play, but ultimately, this Hatch Healthcare entity would drive its own independent revenue through contractual relationships and margins with third-party providers. By the way, these are the types of things we would develop more at the Financial Analyst Briefing because it’s probably better done there. But just to provide you some color.
Operator: Our next question comes from Ryan Krueger of KBW.
Ryan Krueger: Max, could you talk a little bit about your -- the potential uses of excess capital at both the holding company and in the U.S. subsidiary over the next few years? And if you'd look to work that down?
Max Broden: Yes. So let's start with the U.S. Clearly, we are carrying excess capital right now. But we also have a number of growing businesses that are building. And we would expect over time that, that will drive through growth that will drive quite some new business strain. And if we are successful in really executing on our plans, that will gradually drive down the capital level towards a long-term RBC ratio of 400%. When we move up to the holding company, we clearly have significant readily deployable capital at $1.8 billion as of today. This will continue to support the deployment strategies that we have through dividends. We increased the dividend earlier this year by 17.9%. We have a very long-standing track record, as Dan mentioned, in terms of continuing to increase the dividend. We have done a number of smaller acquisitions as well, where we have allocated capital to, and we've been in very active acquirer of our own stock as well. So I would expect that all of these to continue. I see the same headlines as all of you in terms of tax surcharge on buybacks. And obviously, we will study the details very, very closely. And that may mean that we will change our strategy somewhat. But long term, I don't see that as a significant change to how we generally funnel the capital back to shareholders.
Ryan Krueger: And then just 1 follow-up since you mentioned you were going to start providing more LDTI disclosure. Have you had conversations with the rating agencies on, I guess, debt to capital levels given the potential impact to equity and kind of confirmed with them that your debt is still appropriate?
Max Broden: We've had a number of conversations with rating agencies and quite frankly, for quite some time, we began already in 2019 to have close discussions with them and that they have continued throughout the LDTI project.
David Young : All right. I just want to thank everyone for joining us and remind you that, as mentioned today, we will be hosting our Virtual 2021 Financial Analyst Briefing on November 16, beginning at 8 a.m. Eastern. Registration opens today, so keep an eye out for that, and reach out to Investor and Rating Agency Relations if you need more details or have questions. And we look forward to having you join us then on the 16th and wish you all continued good health until then. That concludes our call for today.
Operator: The call has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to Aflac Third Quarter 2021 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I'd now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations and ESG. Please go ahead."
},
{
"speaker": "David Young",
"text": "Thank you, Ian. Good morning, and welcome. As always, we have posted our earnings release and financial supplement to investors.aflac.com. And this morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated will begin with an overview of our operations in both countries. Fred Crawford, President and COO of Aflac Incorporated will then touch briefly on conditions in the quarter and discuss key initiatives, including how we are navigating the pandemic. Max Broden, Executive Vice President and CFO of Aflac Incorporated will conclude our prepared remarks with a summary of third quarter financial results and current capital and liquidity. Members of our U.S. executive management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual and Group Benefits; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; and Todd Daniels, Director and CFO; as well as Koichiro Yoshizumi, Director, Deputy President and Director of Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, David, and good morning. Thank you for joining us. With the pandemic conditions continuing to evolve, I'm proud of our response over the last year. I am also grateful to our team of employees and sales representatives who have empowered Aflac to adapt to what has been a very challenging time for everyone. During the third quarter, we saw a rise and then a decline in COVID cases and hospitalizations in both the United States and in Japan, but to varying degrees. With that in mind, I continue to address our employees in a way that's similar to how with my own family. I'm keeping them informed in updates from the medical community and encourage them to get the COVID-19 vaccine because I want people to avoid being sick or even worse being a casualty due to this pandemic. As we entered the fourth quarter, when the weather gets colder and indoor gatherings increase, the recovery from the pandemic remains uncertain, and we must remain diligent. For the third quarter, adjusted earnings per diluted share, excluding foreign currency impact increased 10.1% for the quarter and 20.1% for the year. These results are largely driven by lower-than-expected benefit ratios and higher net investment income, primarily in Japan. Looking at the operations in Japan in the third quarter, Aflac Japan generated solid overall financial results as reflected in the profit margin of 26.3%, which was above the outlook range provided at our financial analyst briefing for 2020. As Max will explain in a few moments, Aflac Japan has reported very strong premium persistency of 94.5%. Aflac Japan sales were essentially flat for the quarter. Sales for the first 9 months of this year were approximately 66% of 2019 level. We continue to navigate evolving pandemic conditions in Japan, which include widespread state of emergencies that extended to multiple prefectures and persisted through the third quarter. These states of emergency in Japan are much less restrictive and more limited in scope than lockdowns in other countries, but they have impacted face-to-face sales opportunities. As we entered the fourth quarter, the ability to meet face-to-face with customers appears to be improving somewhat gradually and the degree to which our ability to meet face-to-face continues to improve with a very key driver in the recovery of our sales. We were encouraged by the September launch of our new nursing care insurance in Japan, which we view as another opportunity to meet the needs of certain consumers. However, it's still very early in the launch of this new product to determine the potential of the nursing care insurance. In addition, Aflac Japan continues to work to strengthen the alliance with Japan Post, which resumed proactive sales of the cancer insurance on April 1. We expect continued collaboration to further position both companies for the long-term growth and a gradual improvement of Japan Post cancer insurance sales in the intermediate term. Now turning to Aflac U.S. We saw a strong profit margin of 22.2%. This result was driven by lower incurred benefits and higher adjusted net investment income, particularly offset by the higher adjusted expenses. Aflac U.S. also continued to have strong premium persistency of nearly 80%. Sales increased 35% for the quarter and are at approximately 78% of sales for the first 9 months of 2019. These sales results reflect what we believe are improving pandemic conditions in the United States, allowing us more face-to-face meetings and enrollments than prior periods. In the U.S., small businesses have gained some incremental ground toward recovery, which we expect to continue gradually. Within the challenging small business and labor markets, we continue to make investments in developments of traditional independent sales agents that make up about 53% of our sales as of the third quarter of 2021. At the same time, larger businesses appear to be more resilient given their traditional reliance on online self-enrollment tools, and we continue to invest in the group platform. Group business, which is being driven by broker performance is performing very well. excluding our acquired platforms, group sales have generated a year-to-date sales increase of 14% over the same period for 2019. As we enter historically higher enrollment periods in the United States, we remain focused on being able to sell and service customers, whether in-person or virtually. With an eye toward responding to the needs of consumers, businesses and our distribution, we continue to build out the U.S. portfolio with Aflac Network Dental and Vision, premier life and disability. These new lines modestly impact the top line in the short term. These new products in combination with our core products, better position Aflac U.S. for future long-term success. Pandemic conditions have served to fuel our long-standing strategy of being where people want to purchase insurance in both the United States and in Japan. And while face-to-face sales remains the most effective way for us to convey the financial protection only Aflac products provide. The pandemic has clearly demonstrated the need for virtual avenues to help us reach potential customers. We have continued to invest in tools for our distribution in both countries and to integrate these investments into our operations. As always, we place significant importance on continuing to achieve strong capital ratios in the U.S. and Japan on behalf of our policyholders and investors. We remain committed to prudent liquidity and capital management. With the fourth quarter declaration, 2021 will mark the 39th consecutive year of dividend increases. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we will continue to be tactical in our share repurchase and focus on integrating the growth investments we've made in our platform. We are well-positioned as we work toward achieving long-term growth while also ensuring we deliver on our promise to our policyholders. By doing so, we look to emerge from this period in continued position of strength and leadership and look forward to sharing more about our strategic and financial priorities at the Financial Analyst Briefing on November 16, 2021. Now let me turn the program over to Fred. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Dan. Recognizing we have our analyst and investor briefing scheduled in the next few weeks, I'll keep my comments brief before handing off to Max on the quarter's financial results. Beginning with Aflac Japan, as Dan noted, it was an unusual quarter with the states of emergency declarations across most of the country. Declarations are triggered in Japan by, among other things, a combination of rates of infection and hospital utilization by prefecture. The precise impact is difficult to calculate, but the practical implications include reduced face-to-face consultations, limited access to on-site workers and payroll solicitation, reduced foot traffic to the roughly 400 owned and affiliated retail shops that we sell through, and restricted travel between prefectures, which further constrains sales professionals. When looking at claims experience through the third quarter and since inception of the virus, Aflac Japan's COVID impact has totaled approximately 31,000 claimants with incurred claims of JPY 5.6 billion. We expect conditions to improve and remain focused on what we can control, including product development and advancing our business model. Our medical product EVER Prime continues to do well with medical sales up roughly 14% in the quarter and 36% year-to-date over the same period in 2020. Our market share has improved, but we're still at roughly 85% of the medical sales enjoyed in 2019, which was also a medical product refresh year. So pandemic conditions in the quarter are having an impact. Regarding our nursing care product, since our late September launch, we have sold nearly 10,000 policies. This is a strong start, but within our expectations given the marketing support put behind the product. From a risk perspective, this is a supplemental product aligned with coverage provided by the Japanese government and targeting the mass market. Benefits are, therefore, less rich and capped both in an amount and duration. The product is designed for protection versus savings with modest interest rate sensitivity. In summary, the product has a similar risk profile to our existing third sector products. We continue the development of noninsurance services that wrap our cancer and now nursing care product offerings. This has become more common among the large domestic insurers and we see these services as important for both defending and building our market share. Turning to the U.S., pandemic conditions remain at elevated levels with the spread of the Delta strain of the virus. As of the end of the third quarter, Aflac U.S. COVID claimants since inception of the virus has totaled approximately 79,000 with incurred claims of $135 million. Dan covered overall U.S. sales conditions. I'll focus my comments specifically on our buy-to-build growth platforms. Our 2021 Dental and Vision strategy can be summed up as a year of launch, learn and adjust. This quarter, we processed over 1,600 cases, up 30% over the second quarter as we roll out training and development to agents and launch in additional states. We are focused on small- and medium-sized businesses with sold cases averaging around 95 employees. Looking forward into 2022, we continue building out our dental network and readying the platform for increased volumes as we move upmarket and introduce a direct-to-consumer individual product. Our premier life and disability team successfully renewed 100% of their current accounts, a testimony to their high-quality service model. We are preparing to launch with Connecticut administering benefits for their state-wide paid family and medical leave program in 2022. This is an administrative-only contract leveraging our acquired leave management platform. With respect to our e-commerce initiative, Aflac Direct, we currently offer products in 46 states. We are actively building out a licensed call center and currently have 14 licensed agents. The call center platform is in the early days of building and augments our digital-only conversion rates as well as reduces operational dependency on call center vendors. In the third quarter, these 3 platforms accounted for roughly 13% of sales and are expected to build as a percentage of sales and earned premium in the coming years. Before handing off to Max, a few comments on operations. In Japan, we continue to drive volume through our online sales solution. Year-to-date, we have processed over 38,000 online applications with September being our largest month since launching the capability. We are pushing forward on technology and digital modernization and are sizing the investment required to streamline our policyholder services platform. This is the largest operating platform in Japan and a key to driving down our long-term expense ratio. In the U.S., our premier life and disability platform completed a successful transition this month from Zurich on time, on budget and without client or customer disruption. We are focused on migrating our voluntary business to a new group administration platform and building out critical data connections with leading benefit administration and HR systems. The goal is to ensure ease of doing business, smooth onboarding and renewals and quality service and analytics. When looking at our Japan and U.S. expense ratios going forward, we continue with critical platform development despite a period of weaker revenue. We expect to stay within previously guided ranges for expense ratios, recognizing prolonged pandemic conditions require recalibrating the precise trajectory and time line for reaching our ultimate targets. Finally, at Aflac Global Investments, performance remains strong. We continue to advance our sustainable investing platform and recently refreshed our strategic asset allocation work. Our team will dive deeper into operations and strategic execution at next month’s Analyst and Investor Briefing. Let me now turn things over to Max to cover financial performance. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Fred. For the third quarter, adjusted earnings per share increased 10.1% to $1.53, with a $0.02 negative impact from foreign exchange in the quarter. This strong performance for the quarter was largely driven by lower claims utilization due to pandemic conditions, especially in Japan. Variable investment income ran $0.11 above our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses, grew 10.1%. And the adjusted ROE, excluding the foreign currency impact, was strong 16.2%, a significant spread to our cost of capital. Starting with our Japan segment. Total earned premium for the quarter declined 4%, reflecting first sector policies paid up impacts, while earned premium for our third sector products was down 2.6% due to recent low sales volumes. Policy count in force, which we view as a better measure of our overall business growth declined 1.8%. Japan's total benefit ratio came in at 66.1% for the quarter, down 520 basis points year-over-year, and the third sector benefit ratio was 55% and down 670 basis points year-over-year. We experienced a greater-than-normal IBNR release in our third sector block as experience continues to come in favorable relative to initial reserving. Utilization continues to be constrained by pandemic conditions and we now have more than a year's worth of pandemic data, and with that, our model output is more refined, leading to increased releases. Adjusting for greater than normal IBNR releases and in-period experience, we estimate that our normalized benefit ratio for the third quarter to be 68.7%. Persistency remained strong with a rate of 94.5%, down 50 basis points year-over-year. Consistent with past refreshed product launches, we have experienced a slight uptick in lapse rates on our medical product as policyholders look to update their coverage. Our expense ratio in Japan was 21.4%, down 30 basis points year-over-year. Constrained business activity lowered our expenses in Q3, which we view to be a temporary phenomenon. We generally expect increased spending on key initiatives to continue and especially in Q4 as we tend to see some seasonality in spending and booking of projects. Adjusted net investment income increased 19.7% in yen terms, primarily driven by favorable returns on our growing private equity portfolio and lower hedge costs, partially offset by lower reinvestment yields on our fixed rate portfolio. The pretax margin for Japan in the quarter was 26.3%, up 690 basis points year-over-year, a very good result for the quarter. This quarter's strong financial results lead us to expect a full year benefit ratio for Japan to be below the 3-year guidance range of 68.5% to 71% given at FAB. And the pretax margin to be above the 20.5% to 22.5% range given at -- for the full year 2021. Turning to U.S. results. Net earned premium was down 1% as lower sales results during the pandemic continued to have an impact on our earned premium. Persistency improved 110 basis points to 79.9%. 70 basis points of which are from lower sales, as first year lapse rates are roughly twice the level of in-force lapse rates. In addition, there still remains about 40 basis points of positive impact from emergency orders. Our total benefit ratio in the U.S. came in lower than expected at 45.1% or 320 basis points lower than Q3 2020, which itself was heavily impacted by the initial pandemic. Lower and deferred claims utilization impacts our IBNR held for incurred claims within a year. And as we get more data, our long-term models increased reliance on raw data leading to IBNR releases. This quarter, they amounted to a 3.5 percentage point impact on the benefit ratio, which leads to an underlying benefit ratio, excluding IBNR releases of 48.6%. We expect the benefit ratio to increase gradually throughout the remainder of the year with the resumption of normal activity in our communities and by our policyholders. For the full year, we now expect our benefit ratio to be in the range of 43% to 46% versus original guidance of 48% to 51%. Our expense ratio in the U.S. was 38.9%, up 170 basis points year-over-year, but with a lot of moving parts. Weaker sales performance negatively impacts revenue, however, the impact to our expense ratio is largely offset by lower duck expense. Higher advertising spend increased the expense ratio by 40 basis points. Our continued build-out of growth initiatives, group life and disability, network dental and vision, and direct-to-consumer contributed to a 260 basis points increase to the ratio when isolating these investments. These important strategic growth investments are somewhat offset by our efforts to lower our core operating expenses as we strive towards being the low-cost producer in the voluntary benefits space. Net-net, despite a lot of moving parts, Q3 expenses are tracking according to plan. In the quarter, we also incurred $7.8 million of integration expenses not included in adjusted earnings associated with recent acquisitions. Adjusted net investment income in the U.S. was up 9.1%, mainly driven by favorable variable investment income in the quarter. Profitability in the U.S. segment remained strong with a pretax margin of 22.2%, with a low benefit ratio as the core driver. With 9 months now in the books, we are increasing our pretax expectation for the full year. Initial expectations were for us to be towards the low end of 16% to 19%. We now expect to end up above the range indicated at FAB 2020. In our corporate segment, we recorded a pretax loss of $41 million, as adjusted net investment income was down $12 million versus last year due to low interest rates at the short end of the yield curve and change in value of certain tax credit investments. These tax credit investments run through the corporate net investment income line for U.S. GAAP purposes with an associated credit to the tax line. The net impact to our bottom line was a positive $5 million in the quarter. To date, these investments are performing well and in line with expectations. In the fourth quarter, we do expect a significant tax credit investment to fund, which will bring some volatility to the corporate NII line as well as an offsetting credit to the tax line. Our capital position remains strong and we ended the quarter with an SMR in Japan of north of 900% and an RBC north of 600% in Aflac Columbus. Unencumbered holding company liquidity stood at $4.2 billion, $1.8 billion above our minimum balance. Leverage, which includes the sustainability bond issued earlier this year, remains at a comfortable 22.6% in the middle of our leverage corridor of 20% to 25%. In the quarter, we repurchased $525 million of our own stock and paid dividends of $220 million, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted return on equity with a meaningful spread to our cost of capital. Finally, I would like to mention that we will begin to expand our disclosures around the adoption of LDTI in our Form 10-Q and at FAB. At a high level, we do not see this accounting adoption as an economic event with no impact to our regulatory financials or capital base. There will be no change to how we manage the company, cash flows or capital. With that, I'll hand it over to David to begin Q&A."
},
{
"speaker": "David Young",
"text": "[Operator Instructions]. Ian, we will now take the first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] At this time, our first question comes from Nigel Dally of Morgan Stanley."
},
{
"speaker": "Nigel Dally",
"text": "I wanted to touch on Japan sales. Hoping to get some color on a number of points. First, progression of sales throughout the quarter, in particular, whether you saw a sharp dip during the Olympics. Second, as the emergency orders were lifted. Have you seen sales rebound if it's possible to comment on that? And third, an update on the ramp-up in cancer sales within Japan Post?"
},
{
"speaker": "Dan Amos",
"text": "Well, let me just get Aflac Japan to start with that, and then I may make a comment afterwards, but I think that'd be best. So Koi, however you want to handle this, please?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Yes. Yoshizumi san will answer to this question. [Foreign Language] This is Yoshizumi of Aflac Japan. [Foreign Language]. Thank you for the question. [Foreign Language]. Let me start from our situation in the third quarter. And in the third quarter, since we had the largest spread of COVID-19 due to Delta strain. [Foreign Language]. And as a result of that, the state of emergency declaration, which only covered 20 prefectures in the second quarter increased to 33 prefectures in the third quarter. [Foreign Language]. In other words, the state of emergency declaration area covered 90% of population in Japan. [Foreign Language]. And so there were impact to our sales performance and results due to a decrease in face-to-face both station and meetings with customers and also delaying some of the worksite sales station as well as the number of traffic -- customer traffic coming into our walk-in shops. And on top of that, there were some restrictions in traveling across prefectural borders, which prevented us from visiting customers. [Foreign Language]. However, under this environment, we have been able to arrive at a point the same level of sales as for the third quarter last year. That is because of the online solicitation that we have conducted. And also the new product that we launched at the end of September, which is the nursing care product. So as a result, we have been able to reach the same level of sales as in the third quarter last year. [Foreign Language]. Right now, in the fourth quarter, there is no area in Japan that is covered under the state of emergency declaration. [Foreign Language]. And the economic activities are becoming much more active in Japan, although it's gradual. [Foreign Language]. We are expecting that our set sales will grow in the fourth quarter with -- by focusing on the sales of the nursing care product."
},
{
"speaker": "Dan Amos",
"text": "I will -- go ahead, please."
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language]. This is Masatoshi Koide from Aflac Japan. I will address the overall strategic alliance. But before doing so, Yoshizumi san, would you please talk about our sales performance or prospects through the Japan Post channel."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Once again, this is Yoshizumi. [Foreign Language] While new policy sales increased over the second quarter. However, the pace of recovery has been moderate. [Foreign Language]. Well, this was driven by several factors, including that it has been approximately 2 years since Japan post refrain from conducting proactive sales states of emergency limited the ability of sales representatives in many areas to meet customers and preparations are underway for the upcoming transfer of sales employees from Japan Post Company to Japan Post Insurance. [Foreign Language]. We have been conducting a range of activities to help promote sales through the Japan Post channel. For example, in the third quarter, we conducted training aimed at improving Japan post agent mindset and skills. We did so through activities to inform policyholders about the latest coverage and engaged in proposal activities for those not yet covered by cancer insurance. [Foreign Language]. We are currently promoting cancer insurance sales by managing the sales process, which includes approaching customers, getting to know their needs informed them of the latest coverage, making proposals based on the proposal form and closing the deal, we are emphasizing with Japan Post to increasing the number of proposals. [Foreign Language]. As the Japan Post Group announced in September, approximately 10,000 sales employees to be transferred from postal network to Japan Post Insurance will offer only Japan Post insurance and Aflac cancer insurance product. [Foreign Language]. We believe that preparations for the transfer and transition of these employees also affected third quarter sales activities. [Foreign Language]. And against that backdrop, sales will continue to strengthen, but we expect that a full recovery will take time. [Foreign Language]. Okay. That's it for me. So I will give it back to Mr. Koide, Koide San, please."
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language]. In the June agreement to further expand the strategic alliance, we confirmed that FAB counter insurance sales are an important part of Japan Post Group's co-creation platform vision which is a central theme of its medium-term management plan. We also confirmed that Japan Post Group will continue to promote cancer insurance sales as an important product in its sales strategy. [Foreign Language]. In October, Aflac and Japan Post Group senior executives held our quarterly strategic alliance committee meeting. At that meeting, the Japan Post Group President, Charles Lake, I and others met. We had a very constructive discussion about the current situation, including the pace of sales recovery and discussed specific measures to improve counter insurance sales. [Foreign Language]. We walked away pleased by the strong commitment expressed to strengthen the alliance to achieve growth. Against that backdrop, we expect that cancer insurance sales through the Japan Post channel will steadily recover over the medium term."
},
{
"speaker": "Dan Amos",
"text": "All right. You heard a lot because there's been a lot going on, because we consider this to be 1 of the most important issues that we are looking at. Let me just sum it up by saying that the third quarter definitely hurt our production everywhere because of people being required to stay at home under those emergency orders, to some degree, not like Europe, but strong enough that hurt space sales, has the attitude of the management team at Japan Post changed in any way from what it was earlier in the year. The answer is no. We are aligned. They are large shareholders. They know that so goes their production will play a big impact on the company, Aflac specifically and what will take place. Is it slower than we thought -- it's slower than I thought. I was hoping it would kick back up. But with the emergency, it did slow it down. do I think they will recapture where they were? I absolutely do. Do I know the time on it? I do not. Do I think that top management is pushing it Yes, I do think they're pushing it. Do I think the lower management levels are on board yet? I think they're very tentative because not about our products, but any products. because they've been pushed by the FSA, not to make any mistakes to be -- so it's just a little bit slower getting them comfortable back to normal where they can begin to go. So I still think we have a winner with Japan Post. I think it's nice that not only are they selling for us, but that they are a large shareholder because that ties us so closely together. So I know you've heard a lot about this, so I'll stop there."
},
{
"speaker": "Max Broden",
"text": "Nigel, you also asked a very specific question about the quarter. Let me just give you some color. July was about JPY 4.4 billion in sales. August JPY 3.7 billion and September rebounded back to JPY 4.5 billion. That may suggest on the surface, some impact related to the Olympics, but it's extremely difficult to calculate that type of precise impact. I think the broader issue is states of emergency picking up throughout the quarter, as we discussed earlier. I'd also note that September had about 300 -- a little over 300 million of sales of the new care product, which we launched in the last 7 days of the month. So that will give you an idea of some of the trend dynamics."
},
{
"speaker": "Operator",
"text": "Our next question comes from Humphrey Lee of Dowling & Partners."
},
{
"speaker": "Humphrey Lee",
"text": "My first question is on the IBNR reserve releases, but more about the reserving practice. I feel like we’ve tried to get to a better understanding for a while now. But you have continued to see these favorable reserve releases for a number of quarters. I appreciate the guidance for the full year basis, that’s helpful, at least for kind of looking at the fourth quarter. But just can you walk us through you’re reserving process during the pandemic. And should we see more releases in the coming quarters as long as COVID is still around since on a rolling basis, the IBNR that you set up 12 months ago will have to be released if claims incidents remain low?"
},
{
"speaker": "Dan Amos",
"text": "So Humphrey, so first of all, we have not changed our reserving practices. They continue the way they have always been, and follows the same methodology. When it comes to future reserve releases, that’s very difficult to predict. But in general terms, I would say that if we continue to be in pandemic conditions with low claims utilization, you are likely -- and therefore, you’re likely to continue to see some reserve releases come through our results. Simply because we continue to reserve the way we have before. We have not adjusted our new claims reserving to the more recent claims utilization experience, but we continue to reserve to a more normalized claims expectation."
},
{
"speaker": "Humphrey Lee",
"text": "Okay. Got it. My second question is related to the U.S. sales, especially those through your broker channel, which has continued to show good recovery given the channel has the largest production in the fourth quarter, have you seen any early signs of what the fourth quarter may look like through that channel?"
},
{
"speaker": "David Young",
"text": "Teresa?"
},
{
"speaker": "Teresa White",
"text": "Yes, this is Teresa. I’ll make a couple of comments, and then I’ll ask Virgil to respond specifically to the question. But as far as broker sales, first of all, we benefited from really stellar broker sales in the third quarter. We also benefited from veteran sales as well in existing and new accounts. From a broker standpoint, you know that during the quarter, we have the Delta variant. So with that, we saw pressure with career agency sales. And so 1 of the ways that we mitigate that was to pivot and drive broker contracting so that we could set up the third and fourth quarter for good sales through that channel. So I’ll let Virgil respond with additional color."
},
{
"speaker": "Virgil Miller",
"text": "Yes. Thanks, Teresa. Just to add up a few things you said, Teresa. Within what we saw in the third quarter returned about veterans, veterans, we talk about really being 5 years plus. I saw a 10% increase over last year in the return of those veterans. That gives us a good start going in Q4, specific to the broker channel Third quarter, we saw a 62% increase year-over-year. And also, that was 112% performance compared to 2019 pre-COVID. I am optimistic we will see the same thing going into fourth quarter. Our pipelines are strong. And so therefore, we stick with our expectations going through the rest of the year."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jimmy Bhullar of JP Morgan Securities LLC."
},
{
"speaker": "Jimmy Bhullar",
"text": "I just had a question on Japan sales, and you gave a very detailed response to the earlier question. But I think everyone was sort of surprised that sales declined on a sequential basis. And to the extent this was driven by more widespread emergency orders and the Olympics, I just wanted to see if you could comment on how you feel sales activity will pick up now that the orders have been lifted? And have you seen that already now that you've gone through the first month in the fourth quarter."
},
{
"speaker": "Max Broden",
"text": "Yes, Jimmy, 1 thing I would say and our Japanese colleagues can weigh in if they'd like, but a few things. One, I think we -- it's very difficult to give a precise percentage, if you will, as to what the impact of the rolling states of emergency and the Olympics are in the third quarter. And so that makes judging the fourth quarter more difficult. But we clearly expect conditions to be better in the fourth quarter. We also -- as you remember, we only had 7 days -- or my earlier comments, we only had 7 days of the new care product sales in September. And we continue to see momentum through the first 20-plus days in October in that product. And then meanwhile, we continue to work with Japan Post. And so we have a positive view of the trend lines heading into the fourth quarter for all of those things, but it's very difficult to put sort of percentage or more precise guidance around that, and we wouldn't venture to do that. But certainly, conditions suggest that we will see some recovery."
},
{
"speaker": "Jimmy Bhullar",
"text": "And then just on the U.S. business, can you sort of compare and contrast what's going on in the agency channel versus the process what's going on in the agency channel versus the broker channel, it seems like the broker business has obviously done better and then also similarly small versus larger employers where it seems like the larger employer markets coming back a lot faster than smaller employers."
},
{
"speaker": "Teresa White",
"text": "I'll ask Virgil to respond to that."
},
{
"speaker": "Virgil Miller",
"text": "Yes. Thanks, Teresa. So first, I'll start on a large case market. In the lowest case market, like I said before, we've seen good performance with our overall broker channel, again, they're performing about 2019, predominantly selling the group product. Group product is dominating now in large case space. We've seen really 146% of 2019 sales when it comes to group. So I agree with you, we've seen strong recovery in the large case space. Really, that relates to the fact that the large case space is already really used to more virtual and online experience sales. A little bit more, let's say, headwinds in smaller cases, small case that we continue to dominate with our career channel. Again, I integrated earlier that we saw a return of on veterans. We have veterans come back to produce in that third quarter that had not produced all year, so we're looking well. Added to together, really, 1 of the things we've been doing, though, is ensuring that we go to market as a unified sales distribution channel. Distribution continues to be a core competency of Aflac as has always been. And you will see that for broker-driven sales in the lowest case space, our agents participate in many cases, that's fulfillment. So that's a key aspect is there's overlap when it to work together also."
},
{
"speaker": "Max Broden",
"text": "One of the things that we're seeing, Jimmy, in the U.S. is you've read a lot about the labor markets. And when you think about the 3 to 99 space, which is where our agents sell, that's a particular part of the economy that obviously was hit harder and it's taking longer to recover from the pandemic. They're now facing a different kind of issue, and that is can they get the help to actually keep the businesses open and running properly. Labor market conditions are very difficult to navigate right now for many small businesses. That same dynamic goes to our recruiting -- So recruiting dynamics are more challenging in this type of a labor market. There's a lot of speculation about those conditions also starting to improve more so as we get out of the fourth quarter into early part of next year. But I just want to remind folks that you tend to think about the pandemic and that's, of course, affected small businesses but labor market dynamics are also uniquely impactful to that franchise."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tom Gallagher of Evercore ISI."
},
{
"speaker": "Tom Gallagher",
"text": "Max, just a follow-up on some of the underlying claim trends you were referring to. The -- I heard what you said about U.S. is returning closer to normal, but Japan remains below normal. How much lower is Japan in terms of the underlying claims trends? Are we talking about 1% to 2% below normal? Is it closer to 5%? Can you comment on what the level is? And then also relatedly, how does that split between medical and cancer? Is it below normal for both? Or is 1 kind of driving that?"
},
{
"speaker": "Max Broden",
"text": "So Tom, specifically for Japan, it bounces around from month-to-month. But I would say that it’s single digits below normal run rate. It is what we have experienced for an extended period of time. In the U.S., it’s been a little bit more volatile where we’ve seen anything between zero and 20% below normal sort of claims run rates. And more recently, we have approached more sort of normal run rate, especially when we look at the -- for example, the first 2 weeks of the fourth quarter, we have come back to more -- certainly more normal levels."
},
{
"speaker": "Tom Gallagher",
"text": "Got it. And then the between medical and cancer in Japan, where -- is it across bolters at 1 or the other?"
},
{
"speaker": "Max Broden",
"text": "It’s really both where we have seen it. It’s for -- on -- again, it’s different for different benefits within those products. But generally speaking, when we sort of average it out and look at both product lines, we see similar impacts on both medical and cancer."
},
{
"speaker": "Tom Gallagher",
"text": "And when you say single digit, is it mid-single digit or high or low?"
},
{
"speaker": "Max Broden",
"text": "Single digits."
},
{
"speaker": "Operator",
"text": "Our next question comes from John Barnidge of Piper Sandler."
},
{
"speaker": "John Barnidge",
"text": "Sticking with the U.S. benefit ratio a little bit. I get it seems reasonable to assume claims utilization coming in that next quarter. But given the IBNR nature, how do we think about like the time decay of this as a weak forward?"
},
{
"speaker": "Dan Amos",
"text": "I think you were cut off. You might want to ask the question 1 more time because we only heard part of it."
},
{
"speaker": "John Barnidge",
"text": "I get it seems reasonable that claims utilization will normalize in that next quarter. But given the IBNR nature, how should we think about that time decay of that tailwind may be leaking into subsequent years?"
},
{
"speaker": "Dan Amos",
"text": "I'll kick off, and then I'll ask Al Riggieri, our Chief Actuary, to maybe give some comments as well. But generally speaking, you tend to see a quicker reaction to more recent claims trends in our U.S. business than what you see in Japan. But please, Al, if you would like to add some color, please."
},
{
"speaker": "Al Riggieri",
"text": "Sure. The U.S., as Max said, was a little bit more -- it fluctuates more. So you'd see a little bit more fluctuation around that. But we go through approximately 12 months of accruals to really get zeroed in on the claims level. So it takes data and time to mature the information coming in and looking at it for IBNR. So the judgment during the period. I'd expect it to continue to have a little -- a bit of a tail going out the back end through the remainder of COVID. But with -- as the claims rebound, you'll begin to see more of normalization back into normal sort of benefit ratio trends."
},
{
"speaker": "Operator",
"text": "Our next question comes from Erik Bass of Autonomous Research."
},
{
"speaker": "Erik Bass",
"text": "Max, can you just talk about how much capital generation is running ahead of your initial expectations this year, given the strong results? And how does that play into your outlook for capital deployment?"
},
{
"speaker": "Max Broden",
"text": "It clearly runs above what we initially expected. And you can essentially break it down as the upside is primarily driven by the lower-than-expected benefit ratios. They pretty much immediately flow through into higher statutory earnings and also higher FSA earnings as well, which then drives our capital formation and generation and ultimately, dividends up to the holding company. So you can use the difference between our reported benefit ratios and our normalized benefit ratios as a guidance for what that sort of increased capital generation this year would be. Now, when we then think about capital deployment, we have significant capital around the company and all the operating subsidiaries. We operate with very strong capital ratios. And also at the holding company, we hold a very high level. Therefore, if our capital generation in a single year or a single period deviates from our initial expectations, it’s not necessarily driving or changing our tactical view of how we deploy capital. So I wouldn’t necessarily immediately lead it into that from a -- on a short-term basis. Obviously, long term, it’s more capital that we have available to us to deploy into our different deployment strategies."
},
{
"speaker": "Erik Bass",
"text": "Got it. And then a follow-up. Fred, you mentioned some of the ancillary products and services that you could offer kind of around the cancer and senior care product. Just want to get a sense of what those might be and how you would, I guess, bring those to market?"
},
{
"speaker": "Fred Crawford",
"text": "Yes. It’s becoming a very developed approach by not many, but a few of the leading insurance companies in Japan. And it’s largely developed around care products historically, and that is offering certain concierge services for the elderly that are attached to elderly care insurance policy support, everything from nursing care support to in-home modernization to reduce the risk of injury, et cetera. You’re seeing some of that, of course, go on in the U.S., and it’s going on in Japan, too. Our approach has been to, A, make sure that we’re building out those types of services around the care product. But also, we think there’s an opportunity for particularly Aflac to do that in the cancer space. And the way to think about it, we have formed an entity in Japan called Hatch Healthcare. And that entity has been building out these noninsurance services surrounding cancer and now care insurance. And effectively, the way it works is you as a policyholder, have an ability to call in to effectively a concierge desk that then helps direct you to either internal or third-party contractual agreements to support both diagnosis and early screening type services on cancer as well as post-cancer diagnosis care, everything from nutrition to mental health to other dynamics. And so this is in the early stages of being built. We’ve been working on it for about 2 years now. It’s now starting to become in a spot to be put into action. But we think this is really the next horizon, if you will, of securing our market share and building our capabilities on the cancer side. And then also, it’s really a necessary entity in supporting care insurance and competing with the other big care providers in the country."
},
{
"speaker": "Erik Bass",
"text": "Got it. Is it fee for service or part of your covered under your premium?"
},
{
"speaker": "Fred Crawford",
"text": "Yes. Essentially, it’s covered under the premium. And then once you funnel through a concierge desk. It depends on what services you request and then there are charges that are applied through third-party contractual arrangements predominantly. That is the vision at the moment. So it’s more around customer service, persistency, sales opportunity and market share, I should note that these types of services would also be offered on cancer policies sold through Japan Post. So it’s really both a defensive and offensive play, but ultimately, this Hatch Healthcare entity would drive its own independent revenue through contractual relationships and margins with third-party providers. By the way, these are the types of things we would develop more at the Financial Analyst Briefing because it’s probably better done there. But just to provide you some color."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ryan Krueger of KBW."
},
{
"speaker": "Ryan Krueger",
"text": "Max, could you talk a little bit about your -- the potential uses of excess capital at both the holding company and in the U.S. subsidiary over the next few years? And if you'd look to work that down?"
},
{
"speaker": "Max Broden",
"text": "Yes. So let's start with the U.S. Clearly, we are carrying excess capital right now. But we also have a number of growing businesses that are building. And we would expect over time that, that will drive through growth that will drive quite some new business strain. And if we are successful in really executing on our plans, that will gradually drive down the capital level towards a long-term RBC ratio of 400%. When we move up to the holding company, we clearly have significant readily deployable capital at $1.8 billion as of today. This will continue to support the deployment strategies that we have through dividends. We increased the dividend earlier this year by 17.9%. We have a very long-standing track record, as Dan mentioned, in terms of continuing to increase the dividend. We have done a number of smaller acquisitions as well, where we have allocated capital to, and we've been in very active acquirer of our own stock as well. So I would expect that all of these to continue. I see the same headlines as all of you in terms of tax surcharge on buybacks. And obviously, we will study the details very, very closely. And that may mean that we will change our strategy somewhat. But long term, I don't see that as a significant change to how we generally funnel the capital back to shareholders."
},
{
"speaker": "Ryan Krueger",
"text": "And then just 1 follow-up since you mentioned you were going to start providing more LDTI disclosure. Have you had conversations with the rating agencies on, I guess, debt to capital levels given the potential impact to equity and kind of confirmed with them that your debt is still appropriate?"
},
{
"speaker": "Max Broden",
"text": "We've had a number of conversations with rating agencies and quite frankly, for quite some time, we began already in 2019 to have close discussions with them and that they have continued throughout the LDTI project."
},
{
"speaker": "David Young",
"text": "All right. I just want to thank everyone for joining us and remind you that, as mentioned today, we will be hosting our Virtual 2021 Financial Analyst Briefing on November 16, beginning at 8 a.m. Eastern. Registration opens today, so keep an eye out for that, and reach out to Investor and Rating Agency Relations if you need more details or have questions. And we look forward to having you join us then on the 16th and wish you all continued good health until then. That concludes our call for today."
},
{
"speaker": "Operator",
"text": "The call has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 2 | 2,021 | 2021-07-29 09:00:00 | Operator: Welcome to the Aflac Incorporated 2021 Second Quarter Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Please be advised today’s conference is being recorded. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor and Rating Agency Relations. Please go ahead.
David Young: Thank you, Andrea. Good morning, and welcome to Aflac Incorporated second quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in Japan and the U.S.; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the quarter and discuss key initiatives, including how we are navigating the pandemic; Max Broden, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of second quarter financial results and current capital on liquidity. Members of our U.S. Executive Management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual and Group Benefits; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our Executive Management team in Tokyo at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO and Koichiro Yoshizumi, Director, Deputy President and Director Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?
Daniel Amos: Thanks, David, and good morning, and thank you for joining us. With the pandemic conditions to evolve, we remain cautiously optimistic and vigilant as the vaccination efforts continued in the face of uncertainty associated with the emerging variants. I am proud of our response over the last year and our ability to adapt to what has been a very challenging time for everyone, and I continue to pray each day for everyone affected. Adjusted earnings per diluted share excluding foreign currency impact increased 24.2% for the quarter and 24.5% for the year. While earnings are off to a very strong start for the first half of the year, it's important to bear in mind that they are largely supported by a low benefit ratio associated with the pandemic conditions as well as a better than expected return on alternative investments. At the same time, sales improved year-over-year for the first time during the pandemic in the second quarter in both the United States and Japan. As part of our strategy, we strive to be where people want to purchase insurance. That applies to both Japan and the United States. Face-to-face sales are still the most effective way for us to convey the financial protection only Aflac products provide. However, the pandemic has clearly demonstrated the need for virtual means. In other words, non-face-to-face sales that help us reach potential customers and provide them with the protection that they need. We have continued to invest in tools from a distribution in both countries and to integrate these investments into our operation. Recognizing the uncertain nature of a recovery from the pandemic, we expect a stronger second half of the year in both countries, especially if the communities and businesses continue to open up, which would allow more face-to-face interactions. Keeping vaccinations in mind, right now, I am addressing our employees in a way that is similar to how I talk to my family, keeping them informed with the medical community by bringing doctors in, but also by encouraging them to get COVID-19 vaccinations. As I want people to avoid being sick or even worse becoming a casualty of the virus or variant. Looking at our operations in Japan, in the second quarter, Aflac Japan generated solid financial growth results as reflected in its profit margin of 26.5%. This was above the outlook range provided at the 2020 Financial Analyst Briefing. Aflac Japan also reported strong premium persistency of 94.7%. Sales improved year-over-year generating an increase of 38.4% for the quarter and 15.7% for the first six months. These results reflect easier costs, improved pandemic conditions and a boost from the first quarter launch of our new medical product. While sales in the first half of 2021 are at approximately 65% of 2019 levels, we continue to navigate the evolving pandemic conditions in Japan. The states of emergency have been in the targeted areas, especially Tokyo and Okinawa, however, cases have begun increasing in Tokyo and Osaka metropolitan area, and we expect the Japanese government to make a determination soon to expand the declaration of the state of emergency to three other prefectures surrounding Tokyo and Osaka. But most importantly, these states of emergencies are less restricted and limited in scope and do not represent lockdowns as experienced in other countries. Japan Post resumption of proactive sales starting in April is contributing toward a gradual improvement in Aflac cancer insurance sales and we continue to work to strengthen the strategic alliance to create a sustained cycle of growth for both companies. In June for example, Aflac and Japan Post Holdings, Japan Post Company and Japan Post Insurance reached agreements to further the strategic alliance in a matter consistent with Japan Post Group's five-year medium term management plan, which was announced in May. While we do not expect this to have an immediate impact on sales recovery, it will further position our company for long-term growth as we respond to customer's needs, provide customer-centric services and create shared value of resolving societal and local community issues. Turning to Aflac U.S., we saw a strong profit margin of 25.4% and very strong premium persistency of 80.1%. As expected, we also saw a sequential sales improvement and more opportunities for face-to-face activities. As a result of softer sales a year earlier and more face-to-face opportunities, sales increased 64.1% for the quarter and are at a 73% of the first half of the 2019 level. In the U.S., small businesses are still in recovery mode, which we expect to continue through 2021. At the same time, larger businesses will remain primarily focused on returning employees to the worksite. As I stated earlier, we will focus on being able to sell and service customers, whether in person or virtually. In addition, we continue to build out the U.S. product portfolio with previously acquired businesses, Aflac network dental and vision and premier life and disability. While these acquisitions have a modest near-term impact on the topline, they better position Aflac for future long-term success in the U.S., meanwhile, strong persistency, underwriting profits and investment income continue to drive strong pretax margins in the United States as they do in Japan. As always, we placed significant importance on continuing to achieve strong capital ratios in the U.S. and in Japan on behalf of our policyholders and investors. We remain committed to prudent liquidity and capital management. We treasure our 38-year track record of dividend growth and remain committed to extending it supported by the strength of the capital and the cash flows. At the same time, we will continue to tactically repurchase shares, focus on integrating the growth investments that we've made in our platform. We are well-positioned as we work toward achieving long-term growth, while also ensuring we deliver on our promise to our policyholders. By doing so, we look to emerge from this period in a continued position of strength and leadership, and look forward to sharing more about the strategic and financial priorities at our Financial Analysts Briefing on November the 16, 2021. So now I turn the program over to Fred. Fred?
Frederick Crawford: Thank you, Dan. I'm going to focus my comments on activities to restore our production platform and progress on growth strategies. Beginning with Aflac Japan, we are focused on three areas in building back to pre-pandemic levels of production, product development, online or digital assistant sales and specific sales efforts within the Japan Post platform. With respect to product development, we continue to see positive reception to our revised medical product EVER Prime. Medical product sales for the first half of the year are up roughly 48% over the same period in 2020 and have approached pre-pandemic levels down only 4% from the 2019 period. We are gaining back market share in this highly competitive medical market. Earlier this year, we launched our first short-term insurance product under a newly formed subsidiary called SUDACHI. The product is a small amount, substandard medical product targeting customers who do not qualify for traditional medical coverage. In the second quarter, we have registered close to 600 agencies with SUDACHI and issued about 230 policies. We are in the very early stages of this initiative, but over time, we anticipate adding additional short-term health and income support products. We are in the process of developing a new care product aimed at supplemental elderly care coverage provided by the government of Japan. We will provide strategic context and timing around this product in the coming months, but we believe this product line will mature into a meaningful driver of future third sector sales with an aging population and in anticipation of a continued shift in financial burden from the government to individuals. Turning to distribution. We have technology in place to allow agents to pivot from face-to-face to virtual sales. On March 26, we launched a national advertising campaign promoting this capability. In the second quarter, we have processed over 14,000 online applications as compared to nearly 8,000 in the first quarter. On Japan Post, proposal activity has increased month-to-month, as sales training and promotion permeates the 20,000 branches that sell our insurance. Through the month of June, Aflac Japan has conducted over 35,000 training sessions with Japan Post sales agents nationwide, along with providing contact information on nearly 700,000 existing cancer policyholders to inform on the latest coverage advantages. Activities in the third quarter included visits with regional office managers in the JP system and post office visits to reinforce the sales process. Turning to the U.S. Our group voluntary platform continues to respond well with sales exceeding 2019 pre-pandemic levels. Overall sales recovery is focused on restoring our agent-driven small business franchise hurt by the pandemic. Critical areas of investment include recruiting, converting recruits to weekly producers and product development. In terms of recruiting, we have refocused our efforts in the past year on broker recruiting with new appointments exceeding pre-pandemic levels. Appointing small business brokers takes time to convert into production, but is critical to expanding our reach and gaining traction in the dental and vision markets. Individual agent recruiting remains under pressure, and we are running at 70% of weekly producers we enjoyed pre-pandemic. Agent recruiting is impacted by onboarding and training under COVID restrictions, tight labor markets and employment subsidy programs, all of which we expect to subside later in the year. Our network dental product is approved in 43 states and vision in 42 states, with more states coming online later in the year. We are completing national training programs and have about 50% of trained agents who have quoted on our new dental and vision product offerings. It's early, however, we continue to see our volume building each month and over 50% of our dental and vision cases include voluntary benefits sales. We believe this supports our strategic intent to increase access in new accounts and deepen relationships in our existing accounts. As I said last quarter, our 2021 dental and vision strategy can be summed up as a year of launch, learn and adjust. Our premier life and disability platform continues to support their key client relationships and are building a pipeline of quoted business. Our service model remains exceptional and since closing, we have not lost any notable accounts and have seen early interest among some of our larger voluntary benefit clients. In fact, this morning, Connecticut, Governor Ned Lamont announced the selection of Aflac as administrator for the Connecticut Paid Leave Authority, administering benefits for their statewide paid leave program. This awarded business would not have been possible without our recently acquired group capabilities. With respect to our e-commerce initiative, Aflac Direct, we offer critical illness, accident and cancer and are now approved in 45 states, including California. As a reminder, this platform is focused on reaching customers outside the traditional work site. Like most digital sales platforms, we enjoy higher conversion rates when a digital lead is handed to a licensed call center agent. Currently, most of our leads are funneled to third-party call center platforms, and we are actively building out an Aflac licensed call center. Our digital platform overall is experiencing a 16% conversion rate on qualified leads and generally consistent with many digital D2C insurance platforms. Our consumer market strategy also includes digital distribution and product partnerships and while early in development are designed to expand access to protection products and increased traffic to our site. Through six months in 2021, these three new platforms have combined for 5% of sales as they are in the early building and development stages. We continue to forecast a strong second half based on increased activity and expect these three growth initiatives will contribute upwards of 15% to sales in the second half of 2021. Aflac Global Investments announced last week an investment partnership with Denham Capital. Aflac has made a $2 billion multi-year general account commitment to launch a new debt platform focused on investing in the senior secured debt of sustainable infrastructure projects. Aflac will hold a 24.9% minority interest in a newly created entity Denham sustainable infrastructure. We are also making a $100 million commitment to Denham equity fund focused on sustainable infrastructure investments. We are pleased to partner with Denham, a recognized and leading investment firm in the sustainable infrastructure markets. Under Eric's leadership, this transaction furthers our strategy of partnering with external managers. We seek alliances with firms that maintain strong track records in specialized asset classes that play an important role in our portfolio. We then leverage our capital to take a minority stake to further maximize the potential benefits. When combined with our recent Sound Point Capital investment, we advanced our ESG efforts by investing in sustainable infrastructure and distressed communities across the U.S. I'll now pass on to Max to discuss our financial performance in more detail. Max?
Max Broden: Thank you, Fred. Let me begin my comments with a review of our Q2 performance with a focus on our core capital and earnings drivers have developed. For the second quarter, adjusted earnings per share increased 24.2% to $1.59. The slightly weaker yen/dollar exchange rate did not have a significant impact on adjusted earnings per diluted share. This strong performance for the quarter was largely driven by lower claims utilization due to the pandemic, especially in the U.S. In addition, variable investment income went $112 million above our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses, grew 20.5%, and the adjusted ROE, excluding the foreign currency impact, was a strong 17%, which is a significant spread to our cost of capital. Starting with our Japan segment. Total earned premium for the quarter declined 3.8%, reflecting the impact of first sector policies reaching paid up status, while earned premium for our third sector products was down 2.3% due to recent lower sales volumes. Japan's total benefit ratio came in at 66.9% for the quarter, down 290 basis points year-over-year, and the third sector benefit ratio was 56.5%, down 305 basis points year-over-year. We experienced a slightly higher than normal IBNR release in our third sector block as experience continues to come in favorable relative to initial reserving. This quarter, the IBNR release was primarily due to pandemic conditions constraining utilization since second quarter of 2020 and year-to-date. Although claims activity have begun to rebound, it remains below longer term normalized levels. Our claim reporting lags require up to a year to mature the data, and now with more than a year's worth of pandemic data, our estimates are more refined, which has led to increased IBNR releases. Persistency was down 10 basis points, yet remains strong at 94.7%. Our adjusted expense ratio in Japan was 20.8%, up 80 basis points year-over-year. We continue our technology-related investments to convert Aflac Japan to a paperless company, which also includes higher system maintenance expenses. Additional telework expenses also added to the higher expense ratio in the quarter. Adjusted net investment income increased 27.4% in yen terms, primarily driven by favorable returns on our growing alternatives portfolio and lower hedge costs, partially offset by lower reinvestment yield on our fixed rate portfolio. The pretax margin for Japan in the quarter was 26.5%, up 450 basis points year-over-year, which was a very favorable result for the quarter. This quarters strong financial results leads us to expect the full-year benefit ratio for Japan to be at the lower end of the three-year guidance range of 68.5% to 71% given at FAB and the pretax margin to be at the higher end of the 20.5% to 22.5% range. Turning to U.S. results. Net earned premium was down 3.4% due to weaker sales results. Persistency improved 180 basis points to 80.1%, 63 basis points of the elevated persistency in both the second quarter of this year and the prior year can be explained by emergency orders. So there was no net impact for the quarter year-over-year. 80 basis points of improved persistency in the quarter is attributed to lower sales as first year lapse rates are roughly twice total in-force lapse rates. Another 30 basis points of improved persistency is due to conservation efforts and the remainder largely comes from improved experience. Our total benefit ratio came in lower than expected at 43.5% or 80 basis points lower than Q2 2020, which itself was heavily impacted by the initial pandemic. Lower claims utilization impact our estimates for incurred claims as data matures over the course of a year. As our data matures, we increase our reliance on raw data and with a year of pandemic data behind us, we reduced our IBNR to reflect the lower utilization. This quarter, IBNR releases amounted to 5.6 percentage points impact on the benefit ratio, which leaves an underlying benefit ratio, excluding IBNR releases of 49.1%. We expect the benefit ratio to increase gradually throughout the remainder of the year, with the resumption of normal activity in our communities and by our policyholders. For the full-year, we now expect our benefit ratio to be in the range of 45% to 48% versus our original guidance of 48% to 51%. Our expense ratio in the U.S. was 36.9%, up 160 basis points year-over-year, but with a lot of moving parts. Weaker sales performance negatively impacts revenue. However, the impact to our expense ratio is offset by lower DAC and commission expense. Higher advertising spend increased the expense ratio by 60 basis points. Our continued build-out of growth initiatives, group life and disability, network, dental and vision and direct-to-consumer, contributed to a 170 basis point increase to the ratio. These strategic growth investments are largely offset by our efforts to lower core operating expenses as we strive towards being the low-cost producer in the voluntary benefit space. Net-net, despite a lot of moving parts, Q2 expenses are tracking according to plan. In the quarter, we also incurred $5.5 million of integration and transition expenses not included in adjusted earnings associated with recent acquisitions. Adjusted net investment income in the U.S. was up 9.9%, mainly driven by favorable variable investment income in the quarter. Profitability in the U.S. segment was very strong, with a pretax margin of 25.4%, with a low benefit ratio as the core driver. With the first half now in the books, we are increasing our pretax margin expectation for the full-year. Initial expectations were for us to be towards the low-end of 16% to 19%. We now expect to end up slightly above the range indicated at FAB. In our Corporate segment, we recorded a pretax loss of $76 million as adjusted net investment income was $45 million lower than last year, due to lower interest rates at the short end of the yield curve and amortization of certain tax credit investments, which amounted to $30 million this quarter held at the corporate level. Under U.S. GAAP, we recognized a negative impact to corporate NII, this is offset by a lower effective tax rate for the enterprise. This result in a level of reported volatility to our Corporate segment, but the economic returns on these investments are above our cost of equity capital. To-date, these investments are performing well and in line with expectations. Our capital position remains strong, and we ended the quarter with an SMR about 900% in Japan and an RBC of approximately 600% in Aflac Columbus. Unencumbered holding company liquidity stood at $4.4 billion, which was $2 billion above our minimum balance, excluding the $400 million proceeds from the sustainability bond that we issued in March that reinforced our ESG initiatives and believe that sustainable investments are also good long-term investments. Leverage, which includes our sustainability bond remains at a comfortable 22.8% in the middle of our leverage corridor of 20% to 25%. In the quarter, we repurchased $500 million of our own stock and paid dividends of $223 million, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. And with that, I'll hand it over to David to begin Q&A.
David Young: Thank you, Max. Now we are ready to take your questions. But first, let me ask you to please limit yourself to one initial question and a related follow-up to allow other participants an opportunity to ask a question. Andrea, we will take our first question, please.
Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Nigel Dally of Morgan Stanley. Please go ahead.
Nigel Dally: Thanks. Good morning. So I wanted to ask about sales, how they trended throughout the quarter. In the first quarter, they improved every month. February was better than January, March was better than February. So interested in how they trended in the second quarter, both in the U.S. and Japan.
Teresa White: Well, the U.S. [indiscernible] Virgil, do you want to speak to the sales trend?
Virgil Miller: Yes. Nigel, this is Virgil Miller. Let me share with you about our sales trends we've seen in the second quarter. First, you heard from Fred say that we are very pleased to install in our group side of the business, we trended positive and favorably once again. We're trending right now about 117% of 2019, looking strong. We're looking good with our buy-to-build platforms. We expected to hit our goals for the end of the year. And then I'll turn to our individual block of the business was really driven by our career channel. We ran into some headwinds, as you can see, with career recruits. Overall, recruiting looks strong though. We surpassed our Q1 numbers with our Q2. We're looking strong with our veteran recruits. One of the things I look at daily is our veterans getting back to business. In Q1, 73%, we were in 2019 level with our veteran average week of producers. In the second quarter, we were at 78%, so showing a favorable increase there, and we're looking for that to increase throughout the second half of the year and have a strong third and fourth quarter. So overall, I would say we're performing just right at plan when it comes to what we're expecting, a little bit behind with the credit channel but exceeding with the group channel.
Daniel Amos: Now, maybe turn to Japan to answer Nigel's question.
Masatoshi Koide: Yes. Masatoshi Koide, Aflac Japan. I will have Mr. Yoshizumi answer that question. But before asking him to answer the question, let me introduce to you who Mr. Yoshizumi is. Mr. Yoshizumi has assumed the position of the Head of Sales and Marketing of Aflac Japan succeeding Mr. Ariyoshi effective July 1. Mr. Yoshizumi has more than 30 years of experience in the life insurance sales. And before joining Aflac in January this year, he had led the Sales Division in Manulife Japan, and then took on the position of the CEO of Manulife Japan. We are very extremely pleased to welcome Mr. Yoshizumi to Aflac Japan Sales and Marketing Division Head, as he has very rich leadership experience as well as very extensive experience in sales in Japanese life insurance industry.
Koichiro Yoshizumi: Thank you for the introduction. Really great to talk to you all in the U.S. My name is Yoshizumi. And as Mr. Koide just introduced, I have been appointed to lead the Sales and Marketing Division of Aflac Japan, effective July 1. And before I joined the Aflac, I was the CEO of Manulife Japan. However, most of my experience has been – or the 30 years of my experience has been sales promotion and marketing of life insurance. But the types of channels that I've experienced in sales are captive agents channel, independent agents channel, financial institutions, so all sales distribution channels that exist in Japan have been my experience. And I'm very honored to be able to have this wonderful opportunity to be able to discuss Aflac Japan’s sales with you going forward. And once again, great to be here with you. So now let me start to talk about Aflac Japan’s sales results in the first and the second quarter. And under the current COVID situation, let me first of all touch upon on the new medical product that we launched. This was also discussed earlier. And as discussed, we have achieved 48.1% increase year-on-year. And also under this COVID situation, the online application has become a very popular and become a common means for application. As a result, we have enabled to have very active moves and active activities under the current environment. And that's what was covered by Dan. As he said, we are at about 65% of where we were in 2019. And that's it for me.
Nigel Dally: That's great. Just a follow-up on Japan Post as well, given that they've begun to actively proactive – they've begun proactive sales, any early indications as to how the sales are coming in relative to your expectations? I know you expected to pay some improvement to be gradual but any early color there?
Daniel Amos: At this particular point, it's too early. But again, I wan to reiterate what I said in the first quarter call. Our relationship has never been better with Japan Post. Actually the thing they're dealing with is adjusting from a corrective matters that they took into account due to sales that the new regime has been addressing to now being proactively getting back to the way they were writing business that was properly done. And so it's taking a little bit longer. But all-in-all, as we said in our reports, outlook for both the United States and Japan to see stronger growth in the second half, assuming there isn't some event that takes place with this variant that we're not aware of, but if that happens, everybody is affected with that. So I feel good that you're going to see continued growth more so probably in the fourth quarter than the third. But we don't even know that for sure at this point, but I'm encouraged.
Nigel Dally: That's very helpful. Thank you.
Operator: The next question comes from Jimmy Bhullar of JMP Securities. Please go ahead.
Jamminder Bhullar: Hi, good morning. So first, just had a question on sales as well. And I guess this is built in the U.S. and in Japan. Has the increase that we've seen in cases recently in both markets, and then also in the U.S., we've heard of some companies push back the return to work, have those things affected your views on your sales trends in the second half of the year?
Daniel Amos: Go ahead, Teresa.
Teresa White: We'll start with the U.S. First, I’ll ask Virgil to respond.
Virgil Miller: Yes. We learned throughout the COVID time that large case market specifically around where we sell our group products, that they're more used to it and dealing with brokers used to, we were called self-enrollments and virtual enrollments and online engagements, we really haven't seen much impact there at all. Again, with smaller companies in a small market, really driven by our career channel, we faced some headwinds, like I said earlier around recruiting some of the small businesses not really going face-to-face for 100% of the time. We anticipated that. Rolled our virtual toolsets last year. We're able to – as Dan said in his speech, pretty much serve the customer any way possible. We can do it virtually. We can do it online, or we can meet face-to-face. Now I will tell you this though, I have yet to see that any of our setup enrollments have been changed from a face-to-face yet, we're monitoring that very closely, but right now, we're still able to get face-to-face enrollments, we have them set up.
Jamminder Bhullar: And then in Japan…
Masatoshi Koide: Thank you for the question. Now this is from Japan. So let me answer your question regarding Japan. In Japan, although we have been limiting the number of people, our employees to come onsite under the state of emergency, sales activities are continuing. And the state of emergency declaration in Japan is different from the lockdown situation in the U.S. And the purpose of the state of emergency declaration in Japan is to really control the people's movement from one place to another. As a result, there is really not that much impact to our sales activities during daytime. And the current state of emergency declaration is imposed to just Tokyo and Okinawa. And so, as we do try to prevent being affected, the activities are being done with full prevention nationwide. And the areas outside of the state of emergency declaration are able to do the normal course of sales. And on top of that, we have online consultation and applications that have spread nationwide and these measures have taken root under this kind of environment. We do believe that we can be quite successful in our sales activities.
Jamminder Bhullar: Okay. And if I could just follow-up on recruiting in the U.S., you had pretty strong results this quarter, mostly because of the broker market. On the career side, how was the labor market affecting your ability to sort of recruit and retain agents? And is it getting harder? Not so hard because the services sector seems like it is coming back over all.
Daniel Amos: Can you take that Virgil?
Virgil Miller: It's certainly getting harder. And you can see, we came out strong, coming out of Q4, going into Q1 our pipeline. Now remember, recruiting new agents, we really got to go through a full process, giving them license, having them basically take an exam and certifying them to understand Aflac products, and we were very strong with our pipeline in Q1. We've seen that pipeline begin to slacken slightly in Q2. Again, as we said earlier, though, this is why we made a conscious decision to really recruit brokers, now why brokers, brokers already come to the table with license. They're already familiar with all products. We just really used to get activated in the second half of the year.
Daniel Amos: This is Dan. The one thing I would add is, is that I think the U.S. is doing a very good job of bringing back some of the agents who have been licensed with us have renewals and basically because of COVID have just kind of stopped producing, they've got contests going on with them, they're coming back, they're the soul of the company, and we need to bring them back. And I think we'll be doing that. And I think Virgil is doing a good job with Teresa in terms of pushing that. And Fred has been very instrumental in it too. So I'm thinking that we'll continue to come back, which will reflect in the production. Now, the new recruits, as Virgil mentioned, is harder simply because the labor market, as you can imagine, if you're having trouble with people coming to work based on salary, it's even more difficult with commissions, but all in all, we've got a lot of licensed people out there that we just need to get back. And of course, as you have in higher employment, that gives us an opportunity to enroll people at the work site. So we believe the potential is there and certainly we should see it.
Jamminder Bhullar: Okay. Thank you.
Operator: The next question comes from Humphrey Lee of Dowling & Partners. Please go ahead.
Humphrey Lee: Good morning and thank you for taking the questions. I want to focus a little more on the claims experience this quarter and kind of how to think about it. Can you just talk about, like, what is the overall level of IBNR reserves that you have not just for COVID, but just the overall piece? Like how big were kind of IBNR reserves in Japan and the U.S. at the end of this quarter compared to maybe a pre-pandemic level, say like, 2Q 2019 or year-end 2019?
Max Broden: Thank you, Humphrey. This is Max. We don't go into exact the total IBNR levels that we hold. But I would say that, generally speaking, throughout the quarter, we did experience a below expected paid claims. In the first quarter, we had increased month-over-month paid claims that came through. Going into the second quarter, that trend more or less fall, and in April, May and June, we sort of leveled out at a level below what we normally would expect to see, and that to some extent together with more raw data used as input into our IBNR models and led to the reserve releases that we saw in this quarter. Going forward, we obviously reserve to the – our best expectation of future claims results.
Humphrey Lee: I guess, maybe just kind of qualitatively, are you still holding more IBNR reserves right now compared to a pre-pandemic level?
Max Broden: No, we have not changed our reserving practices.
Humphrey Lee: Okay. I guess my follow-up was going to kind of stay on that topic. In terms of the lower paid claims, is there any sense that you can help us to think about the actual paid claims in Japan and the U.S.? Where they were in the second quarter versus maybe during the pandemic and how do they compare to like a pre-pandemic level of normal paid claim activities?
Max Broden: Paid claims activity continues to be below our long-term expectations by policy. And the activity is constrained by [simply daily activity] in economies. So given the products that we are selling, the coverage that we are providing to our policyholders is protecting them from different kinds of life events and also, accidents as an example, and with less people out and about to drive and getting into car accidents, less people playing sports getting into sports accidents that drives both lower claims utilization on the accident line or policies, but also in terms of our hospital indemnity product. So I would say that our claims activity is very much driven by mobility or people.
Humphrey Lee: But is there any sense like so, like in sale – when you're talking about sales, you're able to provide like percentage of 2019 levels. Can you do something similar? Like how many – like what percentage of claims, I guess, relative to 2019?
Todd Daniels: Hey, Humphrey. This is Todd. I think if you look at second quarter 2020 and second quarter 2021, paid claim activity was pretty flat, roughly about ¥3 billion lower in 2021. And that's reflective of people having restricted movements and what Max just described. That is below, as he said, our long-term expectation for paid claims.
Teresa White: Then I would say from the U.S. side, consistent with what Max said, it's based on the type of policies that people have. So in general, when you look at our short-term disability policies, you may see higher utilization there, yet, you don't see as high utilization on, for example, on accident policy.
Humphrey Lee: Okay. Thank you.
Operator: The next question comes from Ryan Krueger of KBW. Please go ahead.
Ryan Krueger: Hi, good morning. Fred, are you able to provide any more color on the elderly care products that you're developing and in particular, how it would differ from current medical products that would be purchased by elderly individuals?
Frederick Crawford: Sure. So the care product under development and a couple of things that are very important. One is the product risk involved is not to be confused with what you maybe familiar with relative to U.S. long-term care. And there are some very fundamental reasons for that. This is a supplemental product and its supplements the actual elderly care government support mechanisms. And so it's a very specific supplement to that government platform as opposed to broader universal care medical coverage. And it also is being designed to where payments are more on a lump sum basis for some of the lower levels of assisted care. And then when you move into the more significant levels of assisted care, there's more of a defined annuity type benefit. The reason I described it that way is realize you do not have the escalating benefit structures such as healthcare inflation. You don't have the tail risk, that's assumed with more of a lifetime coverage, if you will, once moving into assisted living. Therefore, you're not building nearly the reserves, and therefore, don't have nearly the interest rate risk as well. So there's several different reasons why this should not be confused, for example, with other types of riskier elderly care support, it really is a supplemental defined mechanism. The other is it plays directly off the qualifications of the government program. And so it has a more narrow definition of what is covered and what is not covered then you might be used to in the U.S. I feel it plays off those definitions. Now, one thing to keep in mind is that this is the third largest third sector platform in Japan. This is not a new area that's newly developed, it's been an existence, but it's a smaller area of product sales. To give you an idea, it's probably roughly a quarter of the size of the medical supplemental industry in Japan. The key, however, is that we expected to grow that with an aging population and what we believe, or at least suspect will be a gradual shifting of burden onto individuals or their families related to elderly care that this will be a building platform over time. And so we want to get in there now. We want to get in there with a competitive product, and we want to leverage off of our third sector prominence. So that is the strategy. We will tell you more about this and build out more around the strategy when we get to our Investor Conference because it will be more developed at that time. But it's clearly something we think could be a difference maker in the future as we move forward.
Ryan Krueger: Thanks. I just had one follow-up. Are the current insurance carriers that offer that? Are they mostly, I guess the domestic life insurance in Japan and you just haven't been in the market in the past, and you're now going to enter?
Frederick Crawford: They are. It's a narrower group of players then you will find with traditional first sector and some of the larger categories of third sector, notably medical. But they are largely domestic players. One other aspect of this business that's important to understand is that many of the players that build successful market share in this industry don't just sell the care insurance. They also surround the insurance with other non-insurance services that supplement elderly care. Good example would be things like smart home technology that helps prevent frankly, elderly individuals of going on claim or better managing concierge type service to help the elderly manage the many different moving parts necessary to settle into an assisted living atmosphere. So alongside this product, we're also building within a incubated business, other care like non-insurance services because that is one of the keys to building market share. So it's a larger and more expansive platform if you intend to be a leader in this business, which we do. And again, we'll build more color around that as we go forward.
Ryan Krueger: Thanks. Appreciate it.
Operator: We have time for one more question and that question will come from John Barnidge of Piper Sandler. Please go ahead.
John Barnidge: Thanks for the opportunity. Can you maybe talk about the market opportunity to do in other states, what you briefly talked about for Connecticut? Thank you.
Frederick Crawford: Sure. This is Fred again. There is about 10 states right now. In fact, Connecticut was the 10th to put together this medical family leave programs in their state. And we do believe that there's the opportunity for this to expand into further states in the future. These require typically fairly expensive legislative activities within each of the states. And because these are programs that cover effectively the employees of all the qualified or opted in employers in the states, it gives you an idea, in Connecticut, we are projecting when you add up the qualified employers who are likely to opt into this program that the coverage may include as much as a bit in excess of 1.5 million potential participants in the state of Connecticut. So this is a substantial platform. But the nature of it and the nature of the program and the fact that it is a state organized benefit program offered up to opted in employees’ means legislative activity typically needs to take place, that takes time. And obviously, it can depend on the political atmosphere and the prioritization dynamics within the state legislators. So right now 10 states, but we believe it will expand. I think a lot of that expansion, frankly, it's going to be based on the success and the receptivity of the programs that are already in place. The good news is that Connecticut is a very important client for us. We were very pleased to be awarded that. It's the capabilities of our acquired business from Zurich that allowed us to bid and be qualified to run that program and we expect to use this as a foothold to entertain additional states.
John Barnidge: That was great, Fred and a follow-up to that. Yes. I know legislative action needs to occur in the remaining 40 states, but is there an opportunity with the other nine states that currently have the program? Thank you.
Frederick Crawford: Interestingly enough, when you look at the other nine states, some of them outsource it like handed out to an outsource provider. Others actually do the service internally. And in fact, Connecticut was originally looking to administer internally and then move to an outside provider for greater efficiencies, quality specialization, et cetera. And so some states do it in-house, some states outsource it. So there's a mix of providers. One thing that's important is you're not taking a risk on this. And so some would consider this a – an extensive PPA platform or administrative-only platform, so you're not really competing on what you would call traditional insurance parameters, you're competing on your ability to administer the technology and service level that you drive to the consumer. So one of the reasons why we like this contract is it really sends a strong statement to the marketplace that if you're an employer, you don't get this kind of contract unless you have premier service capabilities, strong technology and great customer service, without that, you'd never qualify for these programs. And so that's what we're pleased about.
John Barnidge: Thanks. Best of luck in the quarter ahead.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young: Thank you and thank you all for joining us here today. Looking ahead, we hope you'll join us on November 16 for our 2021 Financial Analyst Briefing. More details will follow. We look forward to speaking with you soon. If you have any additional questions, please follow-up with Investor and Rating Agency Relations. And I wish you all continued good health. Thank you.
Operator: The conference has now concluded. Thank you for attending today's presentation and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Welcome to the Aflac Incorporated 2021 Second Quarter Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Please be advised today’s conference is being recorded. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor and Rating Agency Relations. Please go ahead."
},
{
"speaker": "David Young",
"text": "Thank you, Andrea. Good morning, and welcome to Aflac Incorporated second quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in Japan and the U.S.; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the quarter and discuss key initiatives, including how we are navigating the pandemic; Max Broden, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of second quarter financial results and current capital on liquidity. Members of our U.S. Executive Management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual and Group Benefits; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our Executive Management team in Tokyo at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO and Koichiro Yoshizumi, Director, Deputy President and Director Sales and Marketing. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?"
},
{
"speaker": "Daniel Amos",
"text": "Thanks, David, and good morning, and thank you for joining us. With the pandemic conditions to evolve, we remain cautiously optimistic and vigilant as the vaccination efforts continued in the face of uncertainty associated with the emerging variants. I am proud of our response over the last year and our ability to adapt to what has been a very challenging time for everyone, and I continue to pray each day for everyone affected. Adjusted earnings per diluted share excluding foreign currency impact increased 24.2% for the quarter and 24.5% for the year. While earnings are off to a very strong start for the first half of the year, it's important to bear in mind that they are largely supported by a low benefit ratio associated with the pandemic conditions as well as a better than expected return on alternative investments. At the same time, sales improved year-over-year for the first time during the pandemic in the second quarter in both the United States and Japan. As part of our strategy, we strive to be where people want to purchase insurance. That applies to both Japan and the United States. Face-to-face sales are still the most effective way for us to convey the financial protection only Aflac products provide. However, the pandemic has clearly demonstrated the need for virtual means. In other words, non-face-to-face sales that help us reach potential customers and provide them with the protection that they need. We have continued to invest in tools from a distribution in both countries and to integrate these investments into our operation. Recognizing the uncertain nature of a recovery from the pandemic, we expect a stronger second half of the year in both countries, especially if the communities and businesses continue to open up, which would allow more face-to-face interactions. Keeping vaccinations in mind, right now, I am addressing our employees in a way that is similar to how I talk to my family, keeping them informed with the medical community by bringing doctors in, but also by encouraging them to get COVID-19 vaccinations. As I want people to avoid being sick or even worse becoming a casualty of the virus or variant. Looking at our operations in Japan, in the second quarter, Aflac Japan generated solid financial growth results as reflected in its profit margin of 26.5%. This was above the outlook range provided at the 2020 Financial Analyst Briefing. Aflac Japan also reported strong premium persistency of 94.7%. Sales improved year-over-year generating an increase of 38.4% for the quarter and 15.7% for the first six months. These results reflect easier costs, improved pandemic conditions and a boost from the first quarter launch of our new medical product. While sales in the first half of 2021 are at approximately 65% of 2019 levels, we continue to navigate the evolving pandemic conditions in Japan. The states of emergency have been in the targeted areas, especially Tokyo and Okinawa, however, cases have begun increasing in Tokyo and Osaka metropolitan area, and we expect the Japanese government to make a determination soon to expand the declaration of the state of emergency to three other prefectures surrounding Tokyo and Osaka. But most importantly, these states of emergencies are less restricted and limited in scope and do not represent lockdowns as experienced in other countries. Japan Post resumption of proactive sales starting in April is contributing toward a gradual improvement in Aflac cancer insurance sales and we continue to work to strengthen the strategic alliance to create a sustained cycle of growth for both companies. In June for example, Aflac and Japan Post Holdings, Japan Post Company and Japan Post Insurance reached agreements to further the strategic alliance in a matter consistent with Japan Post Group's five-year medium term management plan, which was announced in May. While we do not expect this to have an immediate impact on sales recovery, it will further position our company for long-term growth as we respond to customer's needs, provide customer-centric services and create shared value of resolving societal and local community issues. Turning to Aflac U.S., we saw a strong profit margin of 25.4% and very strong premium persistency of 80.1%. As expected, we also saw a sequential sales improvement and more opportunities for face-to-face activities. As a result of softer sales a year earlier and more face-to-face opportunities, sales increased 64.1% for the quarter and are at a 73% of the first half of the 2019 level. In the U.S., small businesses are still in recovery mode, which we expect to continue through 2021. At the same time, larger businesses will remain primarily focused on returning employees to the worksite. As I stated earlier, we will focus on being able to sell and service customers, whether in person or virtually. In addition, we continue to build out the U.S. product portfolio with previously acquired businesses, Aflac network dental and vision and premier life and disability. While these acquisitions have a modest near-term impact on the topline, they better position Aflac for future long-term success in the U.S., meanwhile, strong persistency, underwriting profits and investment income continue to drive strong pretax margins in the United States as they do in Japan. As always, we placed significant importance on continuing to achieve strong capital ratios in the U.S. and in Japan on behalf of our policyholders and investors. We remain committed to prudent liquidity and capital management. We treasure our 38-year track record of dividend growth and remain committed to extending it supported by the strength of the capital and the cash flows. At the same time, we will continue to tactically repurchase shares, focus on integrating the growth investments that we've made in our platform. We are well-positioned as we work toward achieving long-term growth, while also ensuring we deliver on our promise to our policyholders. By doing so, we look to emerge from this period in a continued position of strength and leadership, and look forward to sharing more about the strategic and financial priorities at our Financial Analysts Briefing on November the 16, 2021. So now I turn the program over to Fred. Fred?"
},
{
"speaker": "Frederick Crawford",
"text": "Thank you, Dan. I'm going to focus my comments on activities to restore our production platform and progress on growth strategies. Beginning with Aflac Japan, we are focused on three areas in building back to pre-pandemic levels of production, product development, online or digital assistant sales and specific sales efforts within the Japan Post platform. With respect to product development, we continue to see positive reception to our revised medical product EVER Prime. Medical product sales for the first half of the year are up roughly 48% over the same period in 2020 and have approached pre-pandemic levels down only 4% from the 2019 period. We are gaining back market share in this highly competitive medical market. Earlier this year, we launched our first short-term insurance product under a newly formed subsidiary called SUDACHI. The product is a small amount, substandard medical product targeting customers who do not qualify for traditional medical coverage. In the second quarter, we have registered close to 600 agencies with SUDACHI and issued about 230 policies. We are in the very early stages of this initiative, but over time, we anticipate adding additional short-term health and income support products. We are in the process of developing a new care product aimed at supplemental elderly care coverage provided by the government of Japan. We will provide strategic context and timing around this product in the coming months, but we believe this product line will mature into a meaningful driver of future third sector sales with an aging population and in anticipation of a continued shift in financial burden from the government to individuals. Turning to distribution. We have technology in place to allow agents to pivot from face-to-face to virtual sales. On March 26, we launched a national advertising campaign promoting this capability. In the second quarter, we have processed over 14,000 online applications as compared to nearly 8,000 in the first quarter. On Japan Post, proposal activity has increased month-to-month, as sales training and promotion permeates the 20,000 branches that sell our insurance. Through the month of June, Aflac Japan has conducted over 35,000 training sessions with Japan Post sales agents nationwide, along with providing contact information on nearly 700,000 existing cancer policyholders to inform on the latest coverage advantages. Activities in the third quarter included visits with regional office managers in the JP system and post office visits to reinforce the sales process. Turning to the U.S. Our group voluntary platform continues to respond well with sales exceeding 2019 pre-pandemic levels. Overall sales recovery is focused on restoring our agent-driven small business franchise hurt by the pandemic. Critical areas of investment include recruiting, converting recruits to weekly producers and product development. In terms of recruiting, we have refocused our efforts in the past year on broker recruiting with new appointments exceeding pre-pandemic levels. Appointing small business brokers takes time to convert into production, but is critical to expanding our reach and gaining traction in the dental and vision markets. Individual agent recruiting remains under pressure, and we are running at 70% of weekly producers we enjoyed pre-pandemic. Agent recruiting is impacted by onboarding and training under COVID restrictions, tight labor markets and employment subsidy programs, all of which we expect to subside later in the year. Our network dental product is approved in 43 states and vision in 42 states, with more states coming online later in the year. We are completing national training programs and have about 50% of trained agents who have quoted on our new dental and vision product offerings. It's early, however, we continue to see our volume building each month and over 50% of our dental and vision cases include voluntary benefits sales. We believe this supports our strategic intent to increase access in new accounts and deepen relationships in our existing accounts. As I said last quarter, our 2021 dental and vision strategy can be summed up as a year of launch, learn and adjust. Our premier life and disability platform continues to support their key client relationships and are building a pipeline of quoted business. Our service model remains exceptional and since closing, we have not lost any notable accounts and have seen early interest among some of our larger voluntary benefit clients. In fact, this morning, Connecticut, Governor Ned Lamont announced the selection of Aflac as administrator for the Connecticut Paid Leave Authority, administering benefits for their statewide paid leave program. This awarded business would not have been possible without our recently acquired group capabilities. With respect to our e-commerce initiative, Aflac Direct, we offer critical illness, accident and cancer and are now approved in 45 states, including California. As a reminder, this platform is focused on reaching customers outside the traditional work site. Like most digital sales platforms, we enjoy higher conversion rates when a digital lead is handed to a licensed call center agent. Currently, most of our leads are funneled to third-party call center platforms, and we are actively building out an Aflac licensed call center. Our digital platform overall is experiencing a 16% conversion rate on qualified leads and generally consistent with many digital D2C insurance platforms. Our consumer market strategy also includes digital distribution and product partnerships and while early in development are designed to expand access to protection products and increased traffic to our site. Through six months in 2021, these three new platforms have combined for 5% of sales as they are in the early building and development stages. We continue to forecast a strong second half based on increased activity and expect these three growth initiatives will contribute upwards of 15% to sales in the second half of 2021. Aflac Global Investments announced last week an investment partnership with Denham Capital. Aflac has made a $2 billion multi-year general account commitment to launch a new debt platform focused on investing in the senior secured debt of sustainable infrastructure projects. Aflac will hold a 24.9% minority interest in a newly created entity Denham sustainable infrastructure. We are also making a $100 million commitment to Denham equity fund focused on sustainable infrastructure investments. We are pleased to partner with Denham, a recognized and leading investment firm in the sustainable infrastructure markets. Under Eric's leadership, this transaction furthers our strategy of partnering with external managers. We seek alliances with firms that maintain strong track records in specialized asset classes that play an important role in our portfolio. We then leverage our capital to take a minority stake to further maximize the potential benefits. When combined with our recent Sound Point Capital investment, we advanced our ESG efforts by investing in sustainable infrastructure and distressed communities across the U.S. I'll now pass on to Max to discuss our financial performance in more detail. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Fred. Let me begin my comments with a review of our Q2 performance with a focus on our core capital and earnings drivers have developed. For the second quarter, adjusted earnings per share increased 24.2% to $1.59. The slightly weaker yen/dollar exchange rate did not have a significant impact on adjusted earnings per diluted share. This strong performance for the quarter was largely driven by lower claims utilization due to the pandemic, especially in the U.S. In addition, variable investment income went $112 million above our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses, grew 20.5%, and the adjusted ROE, excluding the foreign currency impact, was a strong 17%, which is a significant spread to our cost of capital. Starting with our Japan segment. Total earned premium for the quarter declined 3.8%, reflecting the impact of first sector policies reaching paid up status, while earned premium for our third sector products was down 2.3% due to recent lower sales volumes. Japan's total benefit ratio came in at 66.9% for the quarter, down 290 basis points year-over-year, and the third sector benefit ratio was 56.5%, down 305 basis points year-over-year. We experienced a slightly higher than normal IBNR release in our third sector block as experience continues to come in favorable relative to initial reserving. This quarter, the IBNR release was primarily due to pandemic conditions constraining utilization since second quarter of 2020 and year-to-date. Although claims activity have begun to rebound, it remains below longer term normalized levels. Our claim reporting lags require up to a year to mature the data, and now with more than a year's worth of pandemic data, our estimates are more refined, which has led to increased IBNR releases. Persistency was down 10 basis points, yet remains strong at 94.7%. Our adjusted expense ratio in Japan was 20.8%, up 80 basis points year-over-year. We continue our technology-related investments to convert Aflac Japan to a paperless company, which also includes higher system maintenance expenses. Additional telework expenses also added to the higher expense ratio in the quarter. Adjusted net investment income increased 27.4% in yen terms, primarily driven by favorable returns on our growing alternatives portfolio and lower hedge costs, partially offset by lower reinvestment yield on our fixed rate portfolio. The pretax margin for Japan in the quarter was 26.5%, up 450 basis points year-over-year, which was a very favorable result for the quarter. This quarters strong financial results leads us to expect the full-year benefit ratio for Japan to be at the lower end of the three-year guidance range of 68.5% to 71% given at FAB and the pretax margin to be at the higher end of the 20.5% to 22.5% range. Turning to U.S. results. Net earned premium was down 3.4% due to weaker sales results. Persistency improved 180 basis points to 80.1%, 63 basis points of the elevated persistency in both the second quarter of this year and the prior year can be explained by emergency orders. So there was no net impact for the quarter year-over-year. 80 basis points of improved persistency in the quarter is attributed to lower sales as first year lapse rates are roughly twice total in-force lapse rates. Another 30 basis points of improved persistency is due to conservation efforts and the remainder largely comes from improved experience. Our total benefit ratio came in lower than expected at 43.5% or 80 basis points lower than Q2 2020, which itself was heavily impacted by the initial pandemic. Lower claims utilization impact our estimates for incurred claims as data matures over the course of a year. As our data matures, we increase our reliance on raw data and with a year of pandemic data behind us, we reduced our IBNR to reflect the lower utilization. This quarter, IBNR releases amounted to 5.6 percentage points impact on the benefit ratio, which leaves an underlying benefit ratio, excluding IBNR releases of 49.1%. We expect the benefit ratio to increase gradually throughout the remainder of the year, with the resumption of normal activity in our communities and by our policyholders. For the full-year, we now expect our benefit ratio to be in the range of 45% to 48% versus our original guidance of 48% to 51%. Our expense ratio in the U.S. was 36.9%, up 160 basis points year-over-year, but with a lot of moving parts. Weaker sales performance negatively impacts revenue. However, the impact to our expense ratio is offset by lower DAC and commission expense. Higher advertising spend increased the expense ratio by 60 basis points. Our continued build-out of growth initiatives, group life and disability, network, dental and vision and direct-to-consumer, contributed to a 170 basis point increase to the ratio. These strategic growth investments are largely offset by our efforts to lower core operating expenses as we strive towards being the low-cost producer in the voluntary benefit space. Net-net, despite a lot of moving parts, Q2 expenses are tracking according to plan. In the quarter, we also incurred $5.5 million of integration and transition expenses not included in adjusted earnings associated with recent acquisitions. Adjusted net investment income in the U.S. was up 9.9%, mainly driven by favorable variable investment income in the quarter. Profitability in the U.S. segment was very strong, with a pretax margin of 25.4%, with a low benefit ratio as the core driver. With the first half now in the books, we are increasing our pretax margin expectation for the full-year. Initial expectations were for us to be towards the low-end of 16% to 19%. We now expect to end up slightly above the range indicated at FAB. In our Corporate segment, we recorded a pretax loss of $76 million as adjusted net investment income was $45 million lower than last year, due to lower interest rates at the short end of the yield curve and amortization of certain tax credit investments, which amounted to $30 million this quarter held at the corporate level. Under U.S. GAAP, we recognized a negative impact to corporate NII, this is offset by a lower effective tax rate for the enterprise. This result in a level of reported volatility to our Corporate segment, but the economic returns on these investments are above our cost of equity capital. To-date, these investments are performing well and in line with expectations. Our capital position remains strong, and we ended the quarter with an SMR about 900% in Japan and an RBC of approximately 600% in Aflac Columbus. Unencumbered holding company liquidity stood at $4.4 billion, which was $2 billion above our minimum balance, excluding the $400 million proceeds from the sustainability bond that we issued in March that reinforced our ESG initiatives and believe that sustainable investments are also good long-term investments. Leverage, which includes our sustainability bond remains at a comfortable 22.8% in the middle of our leverage corridor of 20% to 25%. In the quarter, we repurchased $500 million of our own stock and paid dividends of $223 million, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. And with that, I'll hand it over to David to begin Q&A."
},
{
"speaker": "David Young",
"text": "Thank you, Max. Now we are ready to take your questions. But first, let me ask you to please limit yourself to one initial question and a related follow-up to allow other participants an opportunity to ask a question. Andrea, we will take our first question, please."
},
{
"speaker": "Operator",
"text": "We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Nigel Dally of Morgan Stanley. Please go ahead."
},
{
"speaker": "Nigel Dally",
"text": "Thanks. Good morning. So I wanted to ask about sales, how they trended throughout the quarter. In the first quarter, they improved every month. February was better than January, March was better than February. So interested in how they trended in the second quarter, both in the U.S. and Japan."
},
{
"speaker": "Teresa White",
"text": "Well, the U.S. [indiscernible] Virgil, do you want to speak to the sales trend?"
},
{
"speaker": "Virgil Miller",
"text": "Yes. Nigel, this is Virgil Miller. Let me share with you about our sales trends we've seen in the second quarter. First, you heard from Fred say that we are very pleased to install in our group side of the business, we trended positive and favorably once again. We're trending right now about 117% of 2019, looking strong. We're looking good with our buy-to-build platforms. We expected to hit our goals for the end of the year. And then I'll turn to our individual block of the business was really driven by our career channel. We ran into some headwinds, as you can see, with career recruits. Overall, recruiting looks strong though. We surpassed our Q1 numbers with our Q2. We're looking strong with our veteran recruits. One of the things I look at daily is our veterans getting back to business. In Q1, 73%, we were in 2019 level with our veteran average week of producers. In the second quarter, we were at 78%, so showing a favorable increase there, and we're looking for that to increase throughout the second half of the year and have a strong third and fourth quarter. So overall, I would say we're performing just right at plan when it comes to what we're expecting, a little bit behind with the credit channel but exceeding with the group channel."
},
{
"speaker": "Daniel Amos",
"text": "Now, maybe turn to Japan to answer Nigel's question."
},
{
"speaker": "Masatoshi Koide",
"text": "Yes. Masatoshi Koide, Aflac Japan. I will have Mr. Yoshizumi answer that question. But before asking him to answer the question, let me introduce to you who Mr. Yoshizumi is. Mr. Yoshizumi has assumed the position of the Head of Sales and Marketing of Aflac Japan succeeding Mr. Ariyoshi effective July 1. Mr. Yoshizumi has more than 30 years of experience in the life insurance sales. And before joining Aflac in January this year, he had led the Sales Division in Manulife Japan, and then took on the position of the CEO of Manulife Japan. We are very extremely pleased to welcome Mr. Yoshizumi to Aflac Japan Sales and Marketing Division Head, as he has very rich leadership experience as well as very extensive experience in sales in Japanese life insurance industry."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Thank you for the introduction. Really great to talk to you all in the U.S. My name is Yoshizumi. And as Mr. Koide just introduced, I have been appointed to lead the Sales and Marketing Division of Aflac Japan, effective July 1. And before I joined the Aflac, I was the CEO of Manulife Japan. However, most of my experience has been – or the 30 years of my experience has been sales promotion and marketing of life insurance. But the types of channels that I've experienced in sales are captive agents channel, independent agents channel, financial institutions, so all sales distribution channels that exist in Japan have been my experience. And I'm very honored to be able to have this wonderful opportunity to be able to discuss Aflac Japan’s sales with you going forward. And once again, great to be here with you. So now let me start to talk about Aflac Japan’s sales results in the first and the second quarter. And under the current COVID situation, let me first of all touch upon on the new medical product that we launched. This was also discussed earlier. And as discussed, we have achieved 48.1% increase year-on-year. And also under this COVID situation, the online application has become a very popular and become a common means for application. As a result, we have enabled to have very active moves and active activities under the current environment. And that's what was covered by Dan. As he said, we are at about 65% of where we were in 2019. And that's it for me."
},
{
"speaker": "Nigel Dally",
"text": "That's great. Just a follow-up on Japan Post as well, given that they've begun to actively proactive – they've begun proactive sales, any early indications as to how the sales are coming in relative to your expectations? I know you expected to pay some improvement to be gradual but any early color there?"
},
{
"speaker": "Daniel Amos",
"text": "At this particular point, it's too early. But again, I wan to reiterate what I said in the first quarter call. Our relationship has never been better with Japan Post. Actually the thing they're dealing with is adjusting from a corrective matters that they took into account due to sales that the new regime has been addressing to now being proactively getting back to the way they were writing business that was properly done. And so it's taking a little bit longer. But all-in-all, as we said in our reports, outlook for both the United States and Japan to see stronger growth in the second half, assuming there isn't some event that takes place with this variant that we're not aware of, but if that happens, everybody is affected with that. So I feel good that you're going to see continued growth more so probably in the fourth quarter than the third. But we don't even know that for sure at this point, but I'm encouraged."
},
{
"speaker": "Nigel Dally",
"text": "That's very helpful. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar of JMP Securities. Please go ahead."
},
{
"speaker": "Jamminder Bhullar",
"text": "Hi, good morning. So first, just had a question on sales as well. And I guess this is built in the U.S. and in Japan. Has the increase that we've seen in cases recently in both markets, and then also in the U.S., we've heard of some companies push back the return to work, have those things affected your views on your sales trends in the second half of the year?"
},
{
"speaker": "Daniel Amos",
"text": "Go ahead, Teresa."
},
{
"speaker": "Teresa White",
"text": "We'll start with the U.S. First, I’ll ask Virgil to respond."
},
{
"speaker": "Virgil Miller",
"text": "Yes. We learned throughout the COVID time that large case market specifically around where we sell our group products, that they're more used to it and dealing with brokers used to, we were called self-enrollments and virtual enrollments and online engagements, we really haven't seen much impact there at all. Again, with smaller companies in a small market, really driven by our career channel, we faced some headwinds, like I said earlier around recruiting some of the small businesses not really going face-to-face for 100% of the time. We anticipated that. Rolled our virtual toolsets last year. We're able to – as Dan said in his speech, pretty much serve the customer any way possible. We can do it virtually. We can do it online, or we can meet face-to-face. Now I will tell you this though, I have yet to see that any of our setup enrollments have been changed from a face-to-face yet, we're monitoring that very closely, but right now, we're still able to get face-to-face enrollments, we have them set up."
},
{
"speaker": "Jamminder Bhullar",
"text": "And then in Japan…"
},
{
"speaker": "Masatoshi Koide",
"text": "Thank you for the question. Now this is from Japan. So let me answer your question regarding Japan. In Japan, although we have been limiting the number of people, our employees to come onsite under the state of emergency, sales activities are continuing. And the state of emergency declaration in Japan is different from the lockdown situation in the U.S. And the purpose of the state of emergency declaration in Japan is to really control the people's movement from one place to another. As a result, there is really not that much impact to our sales activities during daytime. And the current state of emergency declaration is imposed to just Tokyo and Okinawa. And so, as we do try to prevent being affected, the activities are being done with full prevention nationwide. And the areas outside of the state of emergency declaration are able to do the normal course of sales. And on top of that, we have online consultation and applications that have spread nationwide and these measures have taken root under this kind of environment. We do believe that we can be quite successful in our sales activities."
},
{
"speaker": "Jamminder Bhullar",
"text": "Okay. And if I could just follow-up on recruiting in the U.S., you had pretty strong results this quarter, mostly because of the broker market. On the career side, how was the labor market affecting your ability to sort of recruit and retain agents? And is it getting harder? Not so hard because the services sector seems like it is coming back over all."
},
{
"speaker": "Daniel Amos",
"text": "Can you take that Virgil?"
},
{
"speaker": "Virgil Miller",
"text": "It's certainly getting harder. And you can see, we came out strong, coming out of Q4, going into Q1 our pipeline. Now remember, recruiting new agents, we really got to go through a full process, giving them license, having them basically take an exam and certifying them to understand Aflac products, and we were very strong with our pipeline in Q1. We've seen that pipeline begin to slacken slightly in Q2. Again, as we said earlier, though, this is why we made a conscious decision to really recruit brokers, now why brokers, brokers already come to the table with license. They're already familiar with all products. We just really used to get activated in the second half of the year."
},
{
"speaker": "Daniel Amos",
"text": "This is Dan. The one thing I would add is, is that I think the U.S. is doing a very good job of bringing back some of the agents who have been licensed with us have renewals and basically because of COVID have just kind of stopped producing, they've got contests going on with them, they're coming back, they're the soul of the company, and we need to bring them back. And I think we'll be doing that. And I think Virgil is doing a good job with Teresa in terms of pushing that. And Fred has been very instrumental in it too. So I'm thinking that we'll continue to come back, which will reflect in the production. Now, the new recruits, as Virgil mentioned, is harder simply because the labor market, as you can imagine, if you're having trouble with people coming to work based on salary, it's even more difficult with commissions, but all in all, we've got a lot of licensed people out there that we just need to get back. And of course, as you have in higher employment, that gives us an opportunity to enroll people at the work site. So we believe the potential is there and certainly we should see it."
},
{
"speaker": "Jamminder Bhullar",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Humphrey Lee of Dowling & Partners. Please go ahead."
},
{
"speaker": "Humphrey Lee",
"text": "Good morning and thank you for taking the questions. I want to focus a little more on the claims experience this quarter and kind of how to think about it. Can you just talk about, like, what is the overall level of IBNR reserves that you have not just for COVID, but just the overall piece? Like how big were kind of IBNR reserves in Japan and the U.S. at the end of this quarter compared to maybe a pre-pandemic level, say like, 2Q 2019 or year-end 2019?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Humphrey. This is Max. We don't go into exact the total IBNR levels that we hold. But I would say that, generally speaking, throughout the quarter, we did experience a below expected paid claims. In the first quarter, we had increased month-over-month paid claims that came through. Going into the second quarter, that trend more or less fall, and in April, May and June, we sort of leveled out at a level below what we normally would expect to see, and that to some extent together with more raw data used as input into our IBNR models and led to the reserve releases that we saw in this quarter. Going forward, we obviously reserve to the – our best expectation of future claims results."
},
{
"speaker": "Humphrey Lee",
"text": "I guess, maybe just kind of qualitatively, are you still holding more IBNR reserves right now compared to a pre-pandemic level?"
},
{
"speaker": "Max Broden",
"text": "No, we have not changed our reserving practices."
},
{
"speaker": "Humphrey Lee",
"text": "Okay. I guess my follow-up was going to kind of stay on that topic. In terms of the lower paid claims, is there any sense that you can help us to think about the actual paid claims in Japan and the U.S.? Where they were in the second quarter versus maybe during the pandemic and how do they compare to like a pre-pandemic level of normal paid claim activities?"
},
{
"speaker": "Max Broden",
"text": "Paid claims activity continues to be below our long-term expectations by policy. And the activity is constrained by [simply daily activity] in economies. So given the products that we are selling, the coverage that we are providing to our policyholders is protecting them from different kinds of life events and also, accidents as an example, and with less people out and about to drive and getting into car accidents, less people playing sports getting into sports accidents that drives both lower claims utilization on the accident line or policies, but also in terms of our hospital indemnity product. So I would say that our claims activity is very much driven by mobility or people."
},
{
"speaker": "Humphrey Lee",
"text": "But is there any sense like so, like in sale – when you're talking about sales, you're able to provide like percentage of 2019 levels. Can you do something similar? Like how many – like what percentage of claims, I guess, relative to 2019?"
},
{
"speaker": "Todd Daniels",
"text": "Hey, Humphrey. This is Todd. I think if you look at second quarter 2020 and second quarter 2021, paid claim activity was pretty flat, roughly about ¥3 billion lower in 2021. And that's reflective of people having restricted movements and what Max just described. That is below, as he said, our long-term expectation for paid claims."
},
{
"speaker": "Teresa White",
"text": "Then I would say from the U.S. side, consistent with what Max said, it's based on the type of policies that people have. So in general, when you look at our short-term disability policies, you may see higher utilization there, yet, you don't see as high utilization on, for example, on accident policy."
},
{
"speaker": "Humphrey Lee",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Ryan Krueger of KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "Hi, good morning. Fred, are you able to provide any more color on the elderly care products that you're developing and in particular, how it would differ from current medical products that would be purchased by elderly individuals?"
},
{
"speaker": "Frederick Crawford",
"text": "Sure. So the care product under development and a couple of things that are very important. One is the product risk involved is not to be confused with what you maybe familiar with relative to U.S. long-term care. And there are some very fundamental reasons for that. This is a supplemental product and its supplements the actual elderly care government support mechanisms. And so it's a very specific supplement to that government platform as opposed to broader universal care medical coverage. And it also is being designed to where payments are more on a lump sum basis for some of the lower levels of assisted care. And then when you move into the more significant levels of assisted care, there's more of a defined annuity type benefit. The reason I described it that way is realize you do not have the escalating benefit structures such as healthcare inflation. You don't have the tail risk, that's assumed with more of a lifetime coverage, if you will, once moving into assisted living. Therefore, you're not building nearly the reserves, and therefore, don't have nearly the interest rate risk as well. So there's several different reasons why this should not be confused, for example, with other types of riskier elderly care support, it really is a supplemental defined mechanism. The other is it plays directly off the qualifications of the government program. And so it has a more narrow definition of what is covered and what is not covered then you might be used to in the U.S. I feel it plays off those definitions. Now, one thing to keep in mind is that this is the third largest third sector platform in Japan. This is not a new area that's newly developed, it's been an existence, but it's a smaller area of product sales. To give you an idea, it's probably roughly a quarter of the size of the medical supplemental industry in Japan. The key, however, is that we expected to grow that with an aging population and what we believe, or at least suspect will be a gradual shifting of burden onto individuals or their families related to elderly care that this will be a building platform over time. And so we want to get in there now. We want to get in there with a competitive product, and we want to leverage off of our third sector prominence. So that is the strategy. We will tell you more about this and build out more around the strategy when we get to our Investor Conference because it will be more developed at that time. But it's clearly something we think could be a difference maker in the future as we move forward."
},
{
"speaker": "Ryan Krueger",
"text": "Thanks. I just had one follow-up. Are the current insurance carriers that offer that? Are they mostly, I guess the domestic life insurance in Japan and you just haven't been in the market in the past, and you're now going to enter?"
},
{
"speaker": "Frederick Crawford",
"text": "They are. It's a narrower group of players then you will find with traditional first sector and some of the larger categories of third sector, notably medical. But they are largely domestic players. One other aspect of this business that's important to understand is that many of the players that build successful market share in this industry don't just sell the care insurance. They also surround the insurance with other non-insurance services that supplement elderly care. Good example would be things like smart home technology that helps prevent frankly, elderly individuals of going on claim or better managing concierge type service to help the elderly manage the many different moving parts necessary to settle into an assisted living atmosphere. So alongside this product, we're also building within a incubated business, other care like non-insurance services because that is one of the keys to building market share. So it's a larger and more expansive platform if you intend to be a leader in this business, which we do. And again, we'll build more color around that as we go forward."
},
{
"speaker": "Ryan Krueger",
"text": "Thanks. Appreciate it."
},
{
"speaker": "Operator",
"text": "We have time for one more question and that question will come from John Barnidge of Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Thanks for the opportunity. Can you maybe talk about the market opportunity to do in other states, what you briefly talked about for Connecticut? Thank you."
},
{
"speaker": "Frederick Crawford",
"text": "Sure. This is Fred again. There is about 10 states right now. In fact, Connecticut was the 10th to put together this medical family leave programs in their state. And we do believe that there's the opportunity for this to expand into further states in the future. These require typically fairly expensive legislative activities within each of the states. And because these are programs that cover effectively the employees of all the qualified or opted in employers in the states, it gives you an idea, in Connecticut, we are projecting when you add up the qualified employers who are likely to opt into this program that the coverage may include as much as a bit in excess of 1.5 million potential participants in the state of Connecticut. So this is a substantial platform. But the nature of it and the nature of the program and the fact that it is a state organized benefit program offered up to opted in employees’ means legislative activity typically needs to take place, that takes time. And obviously, it can depend on the political atmosphere and the prioritization dynamics within the state legislators. So right now 10 states, but we believe it will expand. I think a lot of that expansion, frankly, it's going to be based on the success and the receptivity of the programs that are already in place. The good news is that Connecticut is a very important client for us. We were very pleased to be awarded that. It's the capabilities of our acquired business from Zurich that allowed us to bid and be qualified to run that program and we expect to use this as a foothold to entertain additional states."
},
{
"speaker": "John Barnidge",
"text": "That was great, Fred and a follow-up to that. Yes. I know legislative action needs to occur in the remaining 40 states, but is there an opportunity with the other nine states that currently have the program? Thank you."
},
{
"speaker": "Frederick Crawford",
"text": "Interestingly enough, when you look at the other nine states, some of them outsource it like handed out to an outsource provider. Others actually do the service internally. And in fact, Connecticut was originally looking to administer internally and then move to an outside provider for greater efficiencies, quality specialization, et cetera. And so some states do it in-house, some states outsource it. So there's a mix of providers. One thing that's important is you're not taking a risk on this. And so some would consider this a – an extensive PPA platform or administrative-only platform, so you're not really competing on what you would call traditional insurance parameters, you're competing on your ability to administer the technology and service level that you drive to the consumer. So one of the reasons why we like this contract is it really sends a strong statement to the marketplace that if you're an employer, you don't get this kind of contract unless you have premier service capabilities, strong technology and great customer service, without that, you'd never qualify for these programs. And so that's what we're pleased about."
},
{
"speaker": "John Barnidge",
"text": "Thanks. Best of luck in the quarter ahead."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you and thank you all for joining us here today. Looking ahead, we hope you'll join us on November 16 for our 2021 Financial Analyst Briefing. More details will follow. We look forward to speaking with you soon. If you have any additional questions, please follow-up with Investor and Rating Agency Relations. And I wish you all continued good health. Thank you."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation and you may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 1 | 2,021 | 2021-04-29 10:00:00 | Operator: Welcome to the Aflac 2021 First Quarter Earnings Conference Call. [Operator Instructions]. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor and Rating Agency Relations.
David Young: Thank you, Parsha, and good morning and welcome to Aflac Incorporated first quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning we will be hearing remarks about the quarter related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in Japan and the U.S.; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the fourth quarter and discuss key initiatives, including how we are navigating the pandemic; Max Broden, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of first quarter financial results and current capital on liquidity. Members of our U.S. Executive Management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual and Group Benefits; Eric Kirsch, Global Chief investment Officer and President of Aflac Global Investments; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing and Koichiro Yoshizumi, Assistant to Director of Sales and Marketing. Before we begin some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?
Daniel Amos: Thank you, David. Good morning and thank you for joining us. At our first quarter conference call one year ago we were facing the early days of the pandemic, at that time I shared with you actions that we had taken to ensure that we protect the employees, the distribution partners, the policy holders and the communities. I'm proud of our response and our ability to handle these challenging times for everyone. Our people first embodies the spirit of corporate culture which we refer to as the Aflac way. Within the pandemic environment we are encouraged by the production of the distribution of the COVID-19 vaccines but we also recognize that vaccination efforts are still in the early stages around the world. Our thoughts and prayers are with everyone affected and we are cautiously optimistic while also remaining diligent. There is one essential message that I continue to emphasize with our management team. It is imperative that we control the factors we have the ability to control, and what we don't have the ability to control, we must monitor continually to be ready to adapt. This approach allows us to respond in the most effective way possible. In the first quarter adjusted earnings per diluted share increased 26.4% while earnings are off to a strong start for the year. It's important to bear in mind that they are largely supported by low benefit ratio associated with the pandemic condition. Before covering our segments I'll make a few comments about the overall perspective. Pandemic conditions in the first quarter continued to impact our sales results, as well as earn premium and revenues, both in the United States and Japan. We continue to expect these pandemic conditions to remain with us through the first half of 2021, but look for improvement in the second half of the year, as communities and businesses, further open up, allowing more face to face interactions, despite the fact that sales in both the United States and Japan have been suppressed considerably due to the constrained, face to face opportunities. We did not sit still. We continue to make progress in integration of our accelerated investment in our platform while continuing strong earnings performance. Looking at the operations in Aflac Japan generated solid overall financial results with a profit margin of 23.1%, which was above the outlook range that we provided at the Financial Analyst briefing. Aflac Japan also reported strong premium persistency of 95%. Sales were essentially flat for the first quarter, with the January launch of our new medical product, all set by continued impact of the pandemic conditions. We are encouraged by the reception of the new medical product by both consumers and the Salesforce. In addition, Japan Post group's announcement to resume proactive sales in April, paves the way for gradual improvement in Aflac's Cancer Insurance sales in the second half of the year. We are actively working with Japan Post to ready the platform, recognizing that it will take time to return to the full strength. We continue to navigate evolving pandemic conditions in Japan, including the recent reestablished state of an emergency, for Tokyo, Osaka and two other prefectures affected from April 25th through May 11th. Restrictions will be tightened to curb the movement of people and group activities during the major holiday known as Golden Week. Turning to the U.S., we saw a strong profit margin of 27.3%, Aflac U.S. also reported very strong premium persistency of 80%. Max will cover the persistency later. Current pandemic conditions continue to notably impact our sales results, largely due to reduced face to face activity. As expected, we saw modest sequential sales improvement in the quarter with an overall decrease of 22.1%. In the U.S. small businesses are still in the recovery mode, and we expect that they will be that way for most of 2021. At the same time larger businesses remain focused on returning employees to the worksite, rather than modifying the benefits for their employees. We strive to be where the people want to purchase insurance. That applies to both Japan and the United States. In the past, this is meant meeting face to face with individuals to understand their situation, propose the solution, and close the sale. Face to face sales are still the most effective way for us to convey the financial protection only Aflac products provide. However, the pandemic has clearly demonstrated the need for virtual means. In other words, non-face to face sales that help us reach potential customers and provide them with the protection that they need. Even prior to the pandemic we've been working on building our virtual capacities. Given the current backdrop, we have accelerated investments to enhance the tools available to our distribution in both countries, and continue to integrate these investments into our operation. In addition, we continue to build out the U.S. product portfolio with previously acquired businesses that serve as a base for Aflac Network Dental and Vision and group [indiscernible] management and disability. While these acquisitions have a modest near term impact on the top line, they better position Aflac for future long term success in the United States. Our core earnings drivers, which are persistency, underwriting profits investment income and expense ratios, continue to drive, strong pre-tax margins, both in the United States and in Japan, both Japan and the U.S., we experienced sequential sales growth in the months of January, February and March. In addition, provided we don't experience a setback in terms of pandemic conditions. We're forecasting a sequential increase in absolute sales in the second quarter over the first quarter in both the U.S. and in Japan. As always we placed significant importance on continuing to achieve strong capital ratios in the U.S. and in Japan, on behalf of our policyholders and shareholders. We remain committed to prudent liquidity and capital management; we issued our first sustainability bond in March, as we seek to allocate proceeds from the issuance, to reinforce our commitment to social and environmental initiatives. As we balance purpose for profit. We treasure our 38 year track record of dividend growth and remain committed to extending it supported by the strength of our capital and cash flows. At the same time, we will continue to tactically repurchase shares focus on integrating the growth investments we've made in our platform. By doing so, we look to emerge from this period, in a continued position of strength, and leadership. I've always said that the true test of strength is how one handles adversity. This past year confirms what I knew all along, and that is that Aflac is strong, adaptable and resilient. We will continue to work to achieve long term growth, while also ensuring we deliver on our promise to our policyholders. By doing so, we look to emerge from this period in a continued position of strength and leadership. I don't think it's a coincidence that we've achieved success while focusing on doing the right things for the policyholders, the shareholders, the employees, the sales distribution the business partners and the communities. In fact, I believe success and doing the right thing go hand-in-hand. I'm proud of what we've accomplished by balancing purpose with financial results. This has ultimately translated into a strong long-term shareholder value. Now I'll turn the program over to Fred. Fred?
Frederick Crawford: Thank you, Dan. I'm going to touch briefly on current pandemic conditions in Japan and the U.S., then focus my comments on efforts to restore our production platform in 2021. Japan has experienced approximately 575,000 COVID cases and 10,000 confirmed deaths since inception of the virus. Through the first quarter of 2021 and since the inception of the virus, Aflac Japan's COVID impact has totaled approximately 10,500 claimants, with incurred claims of JPY 1.9 billion. We continue to experience a low level of paid claims for medical conditions other than COVID, as policyholders refrain from routine hospital visits. . There are essentially 3 areas of focus in building back to prepandemic levels of production in Japan: Our traditional product refreshment activities, online sales driving productivity in the face of pandemic conditions, and active engagement with Japan Post to begin the recovery process in cancer insurance sales. As Dan noted, there has been a positive reception to our revised medical product. This product was designed to better compete in the independent agent channel, where we had seen a decline in market share heading into 2020. Sales of medical insurance are up 34% over the first quarter of 2020 and up 8% over the 2019 quarter. The new product, called Ever Prime, has enhanced benefits that, on average, result in 5% to 10% more premiums per policy versus our old medical product. The product also includes a low claims bonus structure that has contributed to growth among younger demographics. We have technology in place to allow agents to pivot from face-to-face to virtual sales and an entirely digital customer experience. The agent is not removed from the process. The agent can make the sale and process the policy from point of solicitation to point of issuance, entirely online without face-to-face contact. We introduced this capability in October 2020, and for the month of November, we processed 1,600 applications utilizing this digital experience. In the month of March, that number doubled to approximately 3,200 applications. Not surprisingly, we are seeing higher adoption rates among younger demographics. On March 26, we launched a national advertising campaign promoting the capability and expect to see increased utilization. We see this capability contributing to productivity even after pandemic conditions subside. On Japan Post, as Dan noted, we anticipate sales volume will recover gradually in the second half of 2021. Separate from Japan Post activities to revive sales, Aflac Japan is actively supporting recovery in the sale of cancer insurance. This includes reinforcing communication on Japan Post sales policy down to the postal branch level, training and education on our latest cancer products and sales proposal strategies, and identifying existing cancer policyholders in the Japan Post system to both explain the benefits of their current products and create an opportunity for potential upgrade. It's important to remember that the Japan Post sales force has been inactive for 18 months. Therefore, product training and sales coaching are critical efforts in the coming months. Turning to the U.S., there is approximately 32 million COVID-19 cases and 575,000 deaths as reported by the CDC. As of the end of the first quarter, COVID claimants, since inception of the virus, has totaled approximately 38,000, with incurred claims of $130 million. Along with infection rates declining from peak levels in 2020, our data suggests hospitalization rates and days in the hospital have trended lower. However, infection hotspots in areas of the U.S. remain, and as is the case in Japan, there is concern over a potential fourth wave of infection. Executive orders requiring premium grace periods are still in place in 9 states, with 6 states having open-ended expiration dates. Persistency has improved. However, most of that improvement is attributed to the combination of state orders and lower overall sales as we typically experience higher lapse rates in the first year after the sale. Turning to recovery and restore efforts, we have seen our agent channel and small business benefit franchise hurt by the pandemic. It's important to note that roughly 390,000 of our 420,000 U.S. business clients have less than 100 employees. Critical areas of investment include recruiting, training, technology advancement and product development. Key indicators of recovery include agent and broker recruiting, a build in average weekly producers and traction in the rollout of our dental and vision products. For the first quarter, we are running at approximately 70% of the average weekly producers during the same period in pre-pandemic 2019. Trends are positive, and we expect to narrow this gap throughout the year, assuming pandemic conditions improve. We are experiencing favorable recruiting numbers, have reopened training centers closed during the pandemic and veteran agents are reengaging after a difficult year. We are in the early days of our national rollout of Aflac Network Dental and Vision. Our dental product is approved in 43 states, and vision in 41 states, with more states coming online throughout the year. Network Dental and Vision is critical in the small business marketplace and a key component to agent productivity along with new account growth retention and penetration or seeing more employees at a given employer. This month, we are completing the national training programs, making select product refinements and reinforcing incentives to drive new dental accounts. In addition, we are busy upgrading our administrative platforms to ready for increased volumes. 2021 is the year of launch, learn and adjust, and we expect to see our pipeline, close rate and new accounts gradually increasing throughout the year. Our Premier life and disability platform acquired from Zurich is now operating under the Aflac brand. We have started to see our quoted pipeline build in the last 45 days. However, many employee employers are reluctant to move critical benefit plans while sorting through returning to work site and changing workforce dynamics. In addition, consultants often proceed with caution in a year or so after an acquisition. We need to remain patient over the next few years as we settle into this new line of business. Our competitive calling card is the proven premier service and technology capabilities of the acquired platform, coupled with Aflac Group's core leadership in supplemental work site benefits. We will not resort to winning business via relaxed underwriting and pricing standards in this highly competitive market. Finally, earlier this year, we launched our new e-commerce direct-to-consumer platform, Aflac Direct. We offer critical illness, accident and cancer and are approved in approximately 30 states with more states and product coming online throughout the year. This platform targets individuals, the self-employed, gig workers and part-time employees. In short, those who are not offered traditional benefit packages at the work site. We are actively building out a licensed agent call center to better manage conversion rates and control overall economics. With a modest amount of committed marketing dollars, we are attracting about 500,000 visitors per month to aflac.com. Which has resulted in 120,000 leads for call center conversion this year. We are currently experiencing a 15% conversion rate once in the call center. This is a data analytics-driven business and core metrics will improve as this model matures. In terms of the contribution of these businesses to overall sales in 2021, we expect these 3 growth initiatives will make up roughly 10% of sales in 2021 after having contributed less than 5% to 2020 sales. We remain committed to the revenue growth targets discussed at our November investor conference. We expect these initiatives to drive incremental revenue in excess of $1 billion over the next 5 to 7 years. As these separate initiatives mature, they leverage off each other. Network dental and vision drives agent recruitment and conversion to average weekly producers, employer paid benefits drives supplemental work site sales, and direct-to-consumer expands our addressable market while being leveraged to funnel work site leads to our agents in the field. In the future, as employees leave the work site, a digital relationship directly with Aflac helps with persistency and customer satisfaction. To close out my comments this morning, we continue to advance ESG initiatives in 2021. As Dan noted, we issued our inaugural sustainability bond, raising $400 million to be invested towards our path to net 0 emissions by 2050 and investments that support climate as well as diversity and inclusion efforts. The bond offering itself is an important step in that it requires formal processes around reporting, tracking and auditing of qualified sustainable investments. This rigor serves to benefit the control environment surrounding our enterprise-wide ESG reporting and accountability. In addition, Aflac Global Investments announced late February, a partnership with Sound Point Capital Management to create a new asset management business focused on the transitional real estate loan market. As part of that alliance, we have made an initial $1.5 billion general account allocation to the newly created Sound Point commercial Real Estate Finance, LLC, with $500 million of that amount dedicated to providing transitional and other debt financing to support economically distressed communities designated as qualified opportunity zones. Aflac will hold a 9.9% minority interest in this newly created investment LLC, with the ability to grow our stake over time in line with future growth of the new venture. I'll now pass on to Max to discuss our financial performance in more detail. Max?
Max Broden: Thank you, Fred. Let me follow my comments with a review of our Q1 performance with a focus on how our core capital and earnings drivers have developed. For the first quarter, adjusted earnings per share increased 26.4% to $1.53, with a $0.02 positive impact from FX in the quarter. This strong performance for the quarter was largely driven by lower utilization during the pandemic, especially in the U.S. and a lower tax rate compared to last year. Variable investment income $24.5 million above our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses, grew 20.6%, and the adjusted ROE, excluding the foreign currency impact, was a strong 16.7%, a significant spread to our cost of capital. Starting with our Japan segment. Total earned premium for the quarter declined 3.6%, reflecting per policies paid up impact while earned premium for our third sector product was down 2.2% as sales were under pressure in 2020. Japan's total benefit ratio came in at 68.4% for the quarter, down 100 basis points year-over-year, and the third sector benefit ratio was down -- was 58%, also down 100 basis points year-over-year. We experienced slightly higher than normal IBNR release in our third sector block as experience continues to come in favorable relative to initial. This quarter, it was primarily due to pandemic conditions constraining utilization. Persistency remains strong, with a rate of 95%, up 50 basis points year-over-year. Our expense ratio in Japan was 21.3%, up 130 basis points year-over-year. With improved sales activity, expenses naturally pick up in our technology-related investments into converting Aflac Japan to a paperless company continues, which also includes higher system maintenance expenses. Adjusted net investment income increased 6.9% in yen terms, primarily driven by favorable returns on our growing private equity portfolio and lower hedge costs, partially offset by lower reinvestment yield on our fixed and floating rate portfolio. The pretax margin for Japan in the quarter was 23.1%, up 60 basis points year-over-year. A very good start to the year. Turning to the U.S. Net earned premium was down 4.1% due to weaker sales results. Persistency improved 240 basis points to 80%, as our efforts to retain accounts and reduce lapsation show early positive results. As Fred noted, there are still 9 states with premium grace periods in place. So we are monitoring these developments closely. Breaking down the 240 basis points persistency rate improvement further. 70 basis points can be explained by the emergency orders in place, 90 basis points by lower sales as first year lapse rates are roughly twice total in-force lapse rates. And the residual of 80 basis points includes conservation efforts executed on last year. Our total benefit ratio came in much lower than expected. At 39.1%, a full 900 basis points lower than Q1 2020. In the quarter, we experienced lower paid claims, especially in the month of January. As pandemic conditions impacted behavior of our policyholders. This is in line with disclosures in 2020, indicating a negative correlation between infection levels and claims generating activities like accidents, elective surgeries and physical exams. This low activity level related to non-COVID claims accounted for most of the year-over-year drop in the benefit ratio. Our total incurred COVID-related claims also came in lower than expected due to an IBNR release. We estimated new COVID claims at approximately $42 million, and this was offset by an IBNR release of $41 million. As our experience accumulates, we have refined our assumptions, and this led to this IBNR reserve release. We expect the benefit ratio to increase gradually throughout the remainder of the year, with the resumption of normal activity in our communities and by our policyholders.. For the full year, we now expect our benefit ratio to be towards the lower end or slightly below our guided range of 48% to 51%. Our expense ratio in the U.S. was 38.5%, up 10 basis points year-over-year, but with a lot of moving parts. Weaker sales performance negatively impacts revenue, however, the impact to our expense ratio is largely offset by lower DAC expense. Higher advertising spend increased the expense ratio by 70 basis points along with our continued build-out of growth initiatives, group life and disability, network and direct-to-consumer. These contributed to a 110 basis point increase to the ratio. The strategic growth initiative investments are largely offset by our efforts to lower core operating expenses as we strive towards being the low-cost producer in the voluntary benefit space. Net-net, despite a lot of moving parts, Q1 expenses are tracking according to plan. In the quarter, we also incurred $6 million of integration expenses not included in adjusted earnings associated with recent acquisitions. Adjusted net investment income in the U.S. was down 0.6% due to a 22 basis points contraction in the portfolio yield year-over-year, partially offset by favorable variable investment income. Profitability in the U.S. segment was very strong, with a pretax margin of 27.3%, with a low benefit ratio as the core driver. With Q1 now in the books, we are increasing our pretax margin expectation for the full year. Initial expectations were for us to be towards the low end of 16% to 19%. We now expect to end up for the full year towards the high end of this range indicated at. In our corporate segment, we recorded a pretax loss of $26 million as adjusted net investment income was $20 million lower than last year, due to lower interest rates at the short end of the yield curve. Other adjusted expenses were $7 million lower as our cost reduction activities are coming through. Our capital position remains strong, and we ended the quarter with an SMR north of 900% in Japan and an RBC of approximately 563% in Aflac Columbus. Unencumbered holding company liquidity stood at $3.9 billion, $1.5 billion above our minimum balance, excluding the $400 million proceeds from the sustainability bond that we issued in March that reinforced our ESG initiatives and believe that sustainable investments are also good long-term investments. Leverage, which includes the sustainability bond, increased but remains at a comfortable 23% in the middle of our leverage corridor of 20% to 25%. In the quarter, we repurchased $650 million of our own stock and paid dividends of $227 million, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. And with that, I'll hand it over to David to begin Q&A.
David Young: Thank you, Max. Now we are ready to take your questions. [Operator Instructions]. Pasha, we will now take the first question.
Operator: [Operator Instructions]. Your first question is from the line of Nigel Dally with Morgan Stanley.
Nigel Dally: So Max, perhaps we can start on capital management. Capital ratios look very strong. Cash balances, obviously very high. Concerns regarding credit are dissipating. In the quarter, you bought back more stock than expected given that, could we perhaps see some upside to your capital management plans? Or should we view the outside in buybacks this quarter as being a little more tactical in the decision to front-end your annual plans?
Max Broden: So Nigel, obviously, as we travel through the pandemic, we're now moving into more, I would call, normal economic conditions in environment, i.e., less impacted over time by the pandemic. That means that obviously, we gain confidence in how we can deploy capital, and you saw that in the quarter. At the same time, we're not fully out of this yet. And we will continue to look at the -- all the different deployment opportunities that we have. In the quarter, $650 million was a step-up from what we've seen previously, and that reflects our confidence in what we see the franchise driving and coming through over time. And going forward, we will continue to make sure that we hold capital in the right places around the company and deploy capital at favorable IRRs.
Nigel Dally: Great. And just a follow-up on premium persistency as well. In the space where the premium waivers have been lifted. Do you tend to see a spike in lapses? Any color there would be would be interesting. I just wanted to try to get an understanding as to whether there's perhaps a challenge for the remaining states that are yet to lift the executive orders?
Frederick Crawford: Nigel, it's Fred. You do tend to see a bit of a spike in lapse rates when the state orders subside. And we have actually a fairly good amount of historical experience on this, as I might have mentioned in past comments. It's not unusual to have these state mandates put in place during natural disasters and the like. And so we've seen this before. What I would tell you, however, is when it comes to our financials, we try to account for a level of this in the form of do premium allowance, if you will, meaning the idea of what is an uncollectible amount of premium that may be out there embedded in the book of business that are being suspended, if you will, related to the grace periods. So we try to take into account such that when you do see these state mandates lifted, there's not a pronounced impact, if you will, or measurable impact to our actual financials, even though you may see lapse rates move around.
Operator: Your next question is from the line of Humphrey Lee with Dowling & Partners.
Humphrey Lee : I guess my first question is on the U.S. underwriting. So Max, in your prepared remarks, you talked about lower claims incidents in January. Do you -- can you share in terms of like how the number claims submitted in January or in the first quarter in general compared to kind of the second and third quarter of last year?
Max Broden: So I can give you one example. So in the month of January, we had paid claims drop about 28% in the U.S. compared to prepandemic conditions. That's a very significant drop. We saw a significant normalization from that level in the month of February and further normalization in the month of March. This, to a large extent, explains the low benefit ratio in the quarter.
Unidentified Company Representative: And you have to think that one of the reasons for it. And of course, no one knows for sure. But if you think back, we had just had the holidays, and we were seeing on the TV constantly by the government, be careful, don't go out, protect yourselves. We're going to have a spike and I think that brought in the lower numbers.
Max Broden: And one thing I would like to add, Humphrey, as well, as we look forward, is that there are certain of our products, you could see an increase in claims being filed as people go back for their physicals, go back for elective surgeries. Even in the line of cancer, we could see a step-up in terms of claims being filed in the future that did not occur during the pandemic. That's why we view the period that we just have been through as abnormal.
Humphrey Lee: Yes. I guess, like the -- I understand people getting reminded during January, but at the same time, I feel like was state kind of opening up in the first quarter compared to where we were in the second or third quarter that the entire country was pretty much fully locked down. I guess I was just a little surprised to see the first quarter results being so much better than second or third quarter when we're kind of deep in the pandemic. So...
Unidentified Company Representative: I think we were, too. I mean, we certainly would have given you closer projections, had we thought that was the case. So we were certainly surprised for January. But I think what Max is also saying is February and March, we're on target.
Max Broden: Our actuaries also remind us constantly that there is a little bit of a lagging environment, and that is there's a bit of a timing gap, as you can imagine, between the actual incident taking place, i.e., going to the doctor and then the filing of the claim. And so you can see some lagging. So we watch the trends and try to embed that in our forecasting as well.
Humphrey Lee: So there wasn't any kind of IBNR reserves for non-cover claims that you both in previous quarter that given the projected incidents never materialized that you had a release. So it's not like that, just simply pure from an incidence perspective?
Max Broden: Yes, there was an element of that coming through as well. That moved our benefit ratio by about 1.5 points down.
Operator: Your next question is from the line of Jimmy Bhullar with JPMorgan Securities.
Jimmy Bhullar: I had a question on just your sales in the U.S. and Japan through the quarter. And if you saw a noticeable improvement in March versus what was happening in January? And then relatedly, in Japan, what do you think of the impact of the lockdowns as well as the Olympics coming up and could that affect your sales negatively in late 2Q, early 3Q?
Daniel Amos: Well, I'll start and then turn it over to Japan. But in my talk, I said that we saw improvement with January -- February numbers were better than January, and March numbers were better than February, and we expect the second quarter to be better than the first quarter. And that was true in both countries. So from that standpoint, so let me let or whoever he would like to speak talk specifically about your questions.
Koji Ariyoshi: Yes. This is from Japan. First of all, let me start out with the current situation in Japan, followed by the sales and our business in Japan as well. Well, first of all, as Fred mentioned earlier, the number of infections in Japan is 575,000, and the number of deaths in total is about 10,000. So compared to other countries, this number is much smaller. And this is -- the reason why we have been able to control much of the infection is because of the nature of our citizens that we normally wear masks, and we care very much about our hygiene. And on top of that, instead of taking the risk, people are really worrying about eating and dining outside, and the restaurants are reducing their business hours, and these things have been very effective. However, even still then, there has been a number of increase of the new infections in Osaka and Tokyo. And as a result, there is a third declaration of emergency, which was issued on April 25. However, the third emergency declaration in Japan is not a lockdown. It is much more focused measure. And for example, the state of emergency declaration that was issued this time only covers four prefectures, and the period that it covers is up to May 11. So compared with the past state of emergency declarations, it's very much limited in terms of time and location. However, the government is imposing much stronger restrictions on restaurants and shopping -- large shopping centers that they are asked to shut down their response and shops for the time being. And the vaccination started in April, starting from the elderly population. And since older population accounts for about 30% of the overall population, we are expecting that this will have a positive effect. However, the situation of the pandemic is very fluid. Therefore, we really need to watch out for the variance and the vaccination status going forward as well. And because of the situation and since the COVID-19 infection is still rising it is very difficult to mention how it is going to be going forward in terms of our projection. But as you can see, as a result of -- in our results of the first quarter, even under the state of emergency declaration, we have been able to promote our medical insurance, and it's been and also because of the extent of the use of online proposals and applications, we haven't been able to mark the same level of performance as this last year. And even from the second quarter and on, we would like to maintain this positive benefit or positive effect from the medical insurance, and we will also be further expanding the use of online proposals and applications. And on top of that, we would also like to be expanding the enrollment through online for group as well. And furthermore, we would also like to be using direct mails, which will enhance the non face-to-face solicitation. And by doing so, we should be we should be minimizing the impact from COVID-19. And that's all for me.
Max Broden: One thing I would add that's interesting, just to give you some color on the relative nature of the state of emergency. We sell product through what we would call retail shops, about a little over 20 of those shops are actually owned by Aflac and about 380 of those shops are through affiliate ownership, and we'll do about JPY 6 billion a year in a normal year of production through those shops. During the peak of the emergency orders in the pandemic in April of 2020, essentially all 400 of those locations were shut. Today, under the state of emergency issued around the Tokyo and Osaka and Kobe area, 13 of those shops are closed. And so it gives you a little bit of a perspective on the difference between the early days of the pandemic and more severe approach to emergency orders and the current period that's trying to balance productivity and businesses remaining open, while at the same time, exercising caution.
Jimmy Bhullar: Okay. Any comments on how the Olympics would impact?
Max Broden: I'm sorry, Jimmy. Can you ask again?
Jimmy Bhullar: Yes. I was just on like on the Olympics, is there going to be an impact on sales from the Olympics, do you think? Or should that not be much of a factor?
Max Broden: Go ahead.
Koji Ariyoshi: This is Koji. We do not think there will be any impact.
Max Broden: Yes. That's essentially what I was going to say is we have not factored in any impact, and so we are not expecting.
Teresa White: I think the second part of that question was from the U.S. perspective. And I'll just mention this, as we see increase in vaccinations in arms and state mandates being lifted we are now starting to see the markets open up. We've also opened up our market offices, sales offices around the U.S. as well. So we're starting to see a lot more activity from a sales perspective. Virgil, did you have anything else you wanted to add to that?
Virgil Miller: No, I'll just reemphasize, Teresa, that as Dan stated and stated earlier, we did see the sequential improvement month-over-month with all sales is really driven by activity of opening up the markets in the offices, along with ensuring that we're continuing to drive our average weaker producers do mine.
Teresa White: That's it from the U.S. side.
Operator: Your next question is from the line of Tom Gallagher with Evercore.
Tom Gallagher: Just wanted to follow-up on the U.S. just to get a handle on what you're thinking about earned premium. I guess, particularly the commentary about the small businesses still being in recovery mode, large employers, focusing on returning employees to work rather than modifying benefits. I guess that commentary sounded a bit cautious to me, but how are you thinking about those issues impacting your sales as -- and overall earned premium? It doesn't sound like you're adjusting your 3-year guidance for earned premium of flattish? Is it changing the trajectory of what you expect for '21 versus '22? Just a little more elaboration on those issues?
Max Broden: Will -- go ahead. Well, shorter answer is it's not we -- meaning, we have not adjusted our guidance or even really the path of that guidance, while down for the reasons we've talked about, most notably just simply sales being down. It is actually essentially on plan, meaning it is meeting our expectations and what we thought would take place, Tom. So we're not adjusting any of our thoughts for the roll forward.
Unidentified Company Representative: Because persistency is 80% doing better than we thought.
Max Broden: Yes, it is doing better. And -- but I would say, overall, it's coming in just as we thought might happen.
Tom Gallagher: Okay. And then just a follow-up on the benefit ratio. Max, can you give a sense for when you talk about very favorable in January and then gradually elevating, was March back up to around 48%, 49%? Or was it still below that? And is this still the possibility that 2Q is going to trend favorably based on the trend you saw in March?
Max Broden: The total benefits ratio is obviously heavily impacted by quarter end actuarial review studies. But I would say there's just tracking sort of paid claims. We were getting closer to a normal level in the month of March, still not all the way up to what I would say to be prepandemic levels, but we're getting fairly close.
Tom Gallagher: Okay. So slightly favorable, but much closer to that level.
Max Broden: And that is factored into when we then look at our full year benefit ratio, as we sit here today, and we look out for our benefit ratio we obviously incorporate a whole host of different factors when we look at the full year, including the possibility of some pent-up demand in terms of claims being filed as well. I touched earlier on that, including a potential increase in cancer claims. That's factored into our revised guidance of being towards the low end or slightly below the 48% to 51% for the benefit ratio for the full year in the U.S.
Operator: Your next question is from the line of John Barnidge with Piper Seller.
John Barnidge: The last time Japan closed proactively selling cancer insurance, the world looked a whole lot different. Can you talk about digital tools? I mean you talked about the new medical product and digital tools that help the distribution there. But can you talk a little bit about the digital tools you're working to bring to Japan post as they work to ramp up proactively starting the product, please?
Koji Ariyoshi: Currently, digital tools are into both medical insurance and health insurance. The younger generation uses more than digital tools, it is being very much used by your people. Regarding the, we are preparing them to start using the digital tools. And we already have a plan to get started with the test marketing in some part of the JV. And the really has an intention that wanting to emphasize using the digital tool. So I'm sure that they will be fully leveraging the digital tools going forward. And that's it for me.
Max Broden: Yes. Even though -- what's interesting is even though sales were somewhat suspended in the system during this period of recovery for Japan post, the alliance never stopped. And that's important to understand. And so other areas of the alliance, including investing in the distribution platform, investing in mutual technology, certain investment in venture-related strategies. The entire governance structure and regular meetings with executive management and with frontline management, none of that was suspended. It kept moving forward. And much of it was designed around advancing technology and advancing process improvement between the two parties, taking advantage of this pause in the action to be ready to come back into market.
Operator: Our next question is from the line of Michael Ward with UBS.
Michael Ward: I just had a quick question on the idea of delayed cancer screens. I know you've kind of touched on incidents or frequency but I was wondering if you had any updated expectations on the trend in cancer severity once the economy reopens? Just on the idea that delayed screenings are delaying the detection or worsening cancer conditions. And I thought maybe if you had some historical experience managing premium grace periods from natural disasters, maybe you've kind of seen this happen before.
Max Broden: I don't think that we have really gone through such a prolonged time, something like COVID and the type that has had. We saw in the very beginning of COVID that cancer screenings dropped significantly. That then started to normalize. So it's still sort of difficult to fully sort of see or have a clear expectation of it, what the impacts may or may not be. We are trying to be conservative in the estimates that we have and our expectations for what the different outcomes could be in general. I would also remind you that generally, severity does have a little bit of an impact on our claims, but it's relatively small. We're -- primarily frequencies really what drives our benefit ratio.
Operator: Your next question is from the line of Ryan Krueger with KBW.
Ryan Krueger: I had a follow-up on the Japan post. Can you just give any -- I know it's early and there's a lot of uncertainty, but can you give any sense of, at least directionally, how meaningful you think their sales could be this year? And maybe how many years it might take for them to rebuild back to prior levels?
Daniel Amos: Yes. I think it's too early for us to tell. But what I would, Fred mentioned this, but I want to reinforce it, is we've got as good a relationship with the new management team as we had, if not better, with the old management team and being large shareholders that they are. They're also very interested and their stock and what they've invested in. And so it's a win-win opportunity. And I think it will be coming back but when you -- we're in uncharted waters with all of this COVID stuff. And so it's hard for us to go out when we don't know about it as well. But look, this is not in any projections, but my gut just tells me, and it's just mind. So for what it's worth, but that it's going to do very well, and it's going to be a little slow in the second quarter. And then they're going to ramp it up. The one thing I've seen with the Japanese over the years is they tend to analyze, reanalyze, reanalyze again and then all of a sudden move at once. So you don't -- in the U.S., we kind of ease into it, add a little more, add a little more and then it builds. If you take both groups at the starting line, the U.S. will always take off first. But at some point, halfway through that, Japan will all of a sudden decide, we're ready to go. And they will boil out and then all of a sudden go to that point. I believe we're in that stage right now. I believe that will go through the first quarter. But I think by the end of the year, you're going to see them coming back and pulling out. Aflac Japan is a little bit more reluctant than to say all of that. So I am not speaking on their behalf, but I've been doing this for 31 years. And I just have a real good feeling that also Japan post wants to make money, and they need to do those things. And Aflac's products with cancer insurance are something that consumer wants and needs. So when you add that to it, I would say there's a good chance. Now the downside is, something goes wrong with the -- with COVID or something like that. But that's not limited to us. That happens every business out there today. So I'm sure you take that into account. But if you exclude that, I feel pretty good about what's going to be taking place.
Operator: Your final question comes from the line of Gregory Peters with Raymond James.
Unidentified Analyst: This is Alex on calling in on behalf of Greg Peters. Maybe just one question on the Japan paperless initiative. Just curious if the adoption of digital has any acceleration of that initiative? And as well as are there any other social and environmental initiatives that you're pursuing related to the $400 million bond?
Max Broden: I think in terms of the Japan paperless initiative, it's on track. It's moving well. As you might recall, it's a JPY 10 billion, roughly 2.5-year investment. And I would say we're probably in the range of JPY 3 billion, perhaps approaching JPY 4 billion of investment to date. It's designed to take about 80 million pieces of paper out of the system. And it's largely oriented around our policyholder services platform, where when the application starts in a paper form, it remains in a paper form through the processing environment. And so we're looking to get that out of the system, and that benefits cost structure. It benefits business recovery because you can move information around the country of Japan, which can be prone to natural disaster, as you know, and so -- and then also finally has environmental benefits, of course. And so that's a big initiative. We expect to save about JPY 3 billion a year in the way of expenses, and it remains on track, and it is closely tied to the digitization of the platform. It's essentially one and the same. It's one of the major efforts, if you will, that's involved in overall digitization of the platform. In terms of the $400 million sustainability bond, yes, we have very well-articulated and dedicated plans for the investment of those funds. They largely surround classic sustainability investments, meaning climate, climate-related renewable energy investments. They also include, among other things, investments in opportunity zones in areas that suffer from a lack of income equality. And so those are largely the areas that we're targeting. And as you may know, in the sustainability bond, so-called green bond, et cetera, marketplace. There's very strict and well-defined requirements around what you invest in, the qualification of those investments, the tracking of those investments and the yielding of benefits from those investments. And so while it's a $400 million bond, my point in my comments was it's a much bigger effort for the company because it serves to set the entire structure up for broader-based investment, far greater than $400 million over time, particularly the utilization of our general account on ESG efforts.
Unidentified Company Representative: And we would expect to earn favorable risk-adjusted returns on these investments.
Daniel Amos: Thank you, and I believe that wraps up our call. I want to thank everyone for joining us. Today, if you have any follow-up questions, please feel free to reach out to the investor and rating agency Relations teams, and I look forward to seeing you soon, hopefully, and also talking to you in the near future. Thank you. | [
{
"speaker": "Operator",
"text": "Welcome to the Aflac 2021 First Quarter Earnings Conference Call. [Operator Instructions]. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor and Rating Agency Relations."
},
{
"speaker": "David Young",
"text": "Thank you, Parsha, and good morning and welcome to Aflac Incorporated first quarter earnings call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning we will be hearing remarks about the quarter related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in Japan and the U.S.; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the fourth quarter and discuss key initiatives, including how we are navigating the pandemic; Max Broden, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of first quarter financial results and current capital on liquidity. Members of our U.S. Executive Management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual and Group Benefits; Eric Kirsch, Global Chief investment Officer and President of Aflac Global Investments; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koji Ariyoshi, Director and Head of Sales and Marketing and Koichiro Yoshizumi, Assistant to Director of Sales and Marketing. Before we begin some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?"
},
{
"speaker": "Daniel Amos",
"text": "Thank you, David. Good morning and thank you for joining us. At our first quarter conference call one year ago we were facing the early days of the pandemic, at that time I shared with you actions that we had taken to ensure that we protect the employees, the distribution partners, the policy holders and the communities. I'm proud of our response and our ability to handle these challenging times for everyone. Our people first embodies the spirit of corporate culture which we refer to as the Aflac way. Within the pandemic environment we are encouraged by the production of the distribution of the COVID-19 vaccines but we also recognize that vaccination efforts are still in the early stages around the world. Our thoughts and prayers are with everyone affected and we are cautiously optimistic while also remaining diligent. There is one essential message that I continue to emphasize with our management team. It is imperative that we control the factors we have the ability to control, and what we don't have the ability to control, we must monitor continually to be ready to adapt. This approach allows us to respond in the most effective way possible. In the first quarter adjusted earnings per diluted share increased 26.4% while earnings are off to a strong start for the year. It's important to bear in mind that they are largely supported by low benefit ratio associated with the pandemic condition. Before covering our segments I'll make a few comments about the overall perspective. Pandemic conditions in the first quarter continued to impact our sales results, as well as earn premium and revenues, both in the United States and Japan. We continue to expect these pandemic conditions to remain with us through the first half of 2021, but look for improvement in the second half of the year, as communities and businesses, further open up, allowing more face to face interactions, despite the fact that sales in both the United States and Japan have been suppressed considerably due to the constrained, face to face opportunities. We did not sit still. We continue to make progress in integration of our accelerated investment in our platform while continuing strong earnings performance. Looking at the operations in Aflac Japan generated solid overall financial results with a profit margin of 23.1%, which was above the outlook range that we provided at the Financial Analyst briefing. Aflac Japan also reported strong premium persistency of 95%. Sales were essentially flat for the first quarter, with the January launch of our new medical product, all set by continued impact of the pandemic conditions. We are encouraged by the reception of the new medical product by both consumers and the Salesforce. In addition, Japan Post group's announcement to resume proactive sales in April, paves the way for gradual improvement in Aflac's Cancer Insurance sales in the second half of the year. We are actively working with Japan Post to ready the platform, recognizing that it will take time to return to the full strength. We continue to navigate evolving pandemic conditions in Japan, including the recent reestablished state of an emergency, for Tokyo, Osaka and two other prefectures affected from April 25th through May 11th. Restrictions will be tightened to curb the movement of people and group activities during the major holiday known as Golden Week. Turning to the U.S., we saw a strong profit margin of 27.3%, Aflac U.S. also reported very strong premium persistency of 80%. Max will cover the persistency later. Current pandemic conditions continue to notably impact our sales results, largely due to reduced face to face activity. As expected, we saw modest sequential sales improvement in the quarter with an overall decrease of 22.1%. In the U.S. small businesses are still in the recovery mode, and we expect that they will be that way for most of 2021. At the same time larger businesses remain focused on returning employees to the worksite, rather than modifying the benefits for their employees. We strive to be where the people want to purchase insurance. That applies to both Japan and the United States. In the past, this is meant meeting face to face with individuals to understand their situation, propose the solution, and close the sale. Face to face sales are still the most effective way for us to convey the financial protection only Aflac products provide. However, the pandemic has clearly demonstrated the need for virtual means. In other words, non-face to face sales that help us reach potential customers and provide them with the protection that they need. Even prior to the pandemic we've been working on building our virtual capacities. Given the current backdrop, we have accelerated investments to enhance the tools available to our distribution in both countries, and continue to integrate these investments into our operation. In addition, we continue to build out the U.S. product portfolio with previously acquired businesses that serve as a base for Aflac Network Dental and Vision and group [indiscernible] management and disability. While these acquisitions have a modest near term impact on the top line, they better position Aflac for future long term success in the United States. Our core earnings drivers, which are persistency, underwriting profits investment income and expense ratios, continue to drive, strong pre-tax margins, both in the United States and in Japan, both Japan and the U.S., we experienced sequential sales growth in the months of January, February and March. In addition, provided we don't experience a setback in terms of pandemic conditions. We're forecasting a sequential increase in absolute sales in the second quarter over the first quarter in both the U.S. and in Japan. As always we placed significant importance on continuing to achieve strong capital ratios in the U.S. and in Japan, on behalf of our policyholders and shareholders. We remain committed to prudent liquidity and capital management; we issued our first sustainability bond in March, as we seek to allocate proceeds from the issuance, to reinforce our commitment to social and environmental initiatives. As we balance purpose for profit. We treasure our 38 year track record of dividend growth and remain committed to extending it supported by the strength of our capital and cash flows. At the same time, we will continue to tactically repurchase shares focus on integrating the growth investments we've made in our platform. By doing so, we look to emerge from this period, in a continued position of strength, and leadership. I've always said that the true test of strength is how one handles adversity. This past year confirms what I knew all along, and that is that Aflac is strong, adaptable and resilient. We will continue to work to achieve long term growth, while also ensuring we deliver on our promise to our policyholders. By doing so, we look to emerge from this period in a continued position of strength and leadership. I don't think it's a coincidence that we've achieved success while focusing on doing the right things for the policyholders, the shareholders, the employees, the sales distribution the business partners and the communities. In fact, I believe success and doing the right thing go hand-in-hand. I'm proud of what we've accomplished by balancing purpose with financial results. This has ultimately translated into a strong long-term shareholder value. Now I'll turn the program over to Fred. Fred?"
},
{
"speaker": "Frederick Crawford",
"text": "Thank you, Dan. I'm going to touch briefly on current pandemic conditions in Japan and the U.S., then focus my comments on efforts to restore our production platform in 2021. Japan has experienced approximately 575,000 COVID cases and 10,000 confirmed deaths since inception of the virus. Through the first quarter of 2021 and since the inception of the virus, Aflac Japan's COVID impact has totaled approximately 10,500 claimants, with incurred claims of JPY 1.9 billion. We continue to experience a low level of paid claims for medical conditions other than COVID, as policyholders refrain from routine hospital visits. . There are essentially 3 areas of focus in building back to prepandemic levels of production in Japan: Our traditional product refreshment activities, online sales driving productivity in the face of pandemic conditions, and active engagement with Japan Post to begin the recovery process in cancer insurance sales. As Dan noted, there has been a positive reception to our revised medical product. This product was designed to better compete in the independent agent channel, where we had seen a decline in market share heading into 2020. Sales of medical insurance are up 34% over the first quarter of 2020 and up 8% over the 2019 quarter. The new product, called Ever Prime, has enhanced benefits that, on average, result in 5% to 10% more premiums per policy versus our old medical product. The product also includes a low claims bonus structure that has contributed to growth among younger demographics. We have technology in place to allow agents to pivot from face-to-face to virtual sales and an entirely digital customer experience. The agent is not removed from the process. The agent can make the sale and process the policy from point of solicitation to point of issuance, entirely online without face-to-face contact. We introduced this capability in October 2020, and for the month of November, we processed 1,600 applications utilizing this digital experience. In the month of March, that number doubled to approximately 3,200 applications. Not surprisingly, we are seeing higher adoption rates among younger demographics. On March 26, we launched a national advertising campaign promoting the capability and expect to see increased utilization. We see this capability contributing to productivity even after pandemic conditions subside. On Japan Post, as Dan noted, we anticipate sales volume will recover gradually in the second half of 2021. Separate from Japan Post activities to revive sales, Aflac Japan is actively supporting recovery in the sale of cancer insurance. This includes reinforcing communication on Japan Post sales policy down to the postal branch level, training and education on our latest cancer products and sales proposal strategies, and identifying existing cancer policyholders in the Japan Post system to both explain the benefits of their current products and create an opportunity for potential upgrade. It's important to remember that the Japan Post sales force has been inactive for 18 months. Therefore, product training and sales coaching are critical efforts in the coming months. Turning to the U.S., there is approximately 32 million COVID-19 cases and 575,000 deaths as reported by the CDC. As of the end of the first quarter, COVID claimants, since inception of the virus, has totaled approximately 38,000, with incurred claims of $130 million. Along with infection rates declining from peak levels in 2020, our data suggests hospitalization rates and days in the hospital have trended lower. However, infection hotspots in areas of the U.S. remain, and as is the case in Japan, there is concern over a potential fourth wave of infection. Executive orders requiring premium grace periods are still in place in 9 states, with 6 states having open-ended expiration dates. Persistency has improved. However, most of that improvement is attributed to the combination of state orders and lower overall sales as we typically experience higher lapse rates in the first year after the sale. Turning to recovery and restore efforts, we have seen our agent channel and small business benefit franchise hurt by the pandemic. It's important to note that roughly 390,000 of our 420,000 U.S. business clients have less than 100 employees. Critical areas of investment include recruiting, training, technology advancement and product development. Key indicators of recovery include agent and broker recruiting, a build in average weekly producers and traction in the rollout of our dental and vision products. For the first quarter, we are running at approximately 70% of the average weekly producers during the same period in pre-pandemic 2019. Trends are positive, and we expect to narrow this gap throughout the year, assuming pandemic conditions improve. We are experiencing favorable recruiting numbers, have reopened training centers closed during the pandemic and veteran agents are reengaging after a difficult year. We are in the early days of our national rollout of Aflac Network Dental and Vision. Our dental product is approved in 43 states, and vision in 41 states, with more states coming online throughout the year. Network Dental and Vision is critical in the small business marketplace and a key component to agent productivity along with new account growth retention and penetration or seeing more employees at a given employer. This month, we are completing the national training programs, making select product refinements and reinforcing incentives to drive new dental accounts. In addition, we are busy upgrading our administrative platforms to ready for increased volumes. 2021 is the year of launch, learn and adjust, and we expect to see our pipeline, close rate and new accounts gradually increasing throughout the year. Our Premier life and disability platform acquired from Zurich is now operating under the Aflac brand. We have started to see our quoted pipeline build in the last 45 days. However, many employee employers are reluctant to move critical benefit plans while sorting through returning to work site and changing workforce dynamics. In addition, consultants often proceed with caution in a year or so after an acquisition. We need to remain patient over the next few years as we settle into this new line of business. Our competitive calling card is the proven premier service and technology capabilities of the acquired platform, coupled with Aflac Group's core leadership in supplemental work site benefits. We will not resort to winning business via relaxed underwriting and pricing standards in this highly competitive market. Finally, earlier this year, we launched our new e-commerce direct-to-consumer platform, Aflac Direct. We offer critical illness, accident and cancer and are approved in approximately 30 states with more states and product coming online throughout the year. This platform targets individuals, the self-employed, gig workers and part-time employees. In short, those who are not offered traditional benefit packages at the work site. We are actively building out a licensed agent call center to better manage conversion rates and control overall economics. With a modest amount of committed marketing dollars, we are attracting about 500,000 visitors per month to aflac.com. Which has resulted in 120,000 leads for call center conversion this year. We are currently experiencing a 15% conversion rate once in the call center. This is a data analytics-driven business and core metrics will improve as this model matures. In terms of the contribution of these businesses to overall sales in 2021, we expect these 3 growth initiatives will make up roughly 10% of sales in 2021 after having contributed less than 5% to 2020 sales. We remain committed to the revenue growth targets discussed at our November investor conference. We expect these initiatives to drive incremental revenue in excess of $1 billion over the next 5 to 7 years. As these separate initiatives mature, they leverage off each other. Network dental and vision drives agent recruitment and conversion to average weekly producers, employer paid benefits drives supplemental work site sales, and direct-to-consumer expands our addressable market while being leveraged to funnel work site leads to our agents in the field. In the future, as employees leave the work site, a digital relationship directly with Aflac helps with persistency and customer satisfaction. To close out my comments this morning, we continue to advance ESG initiatives in 2021. As Dan noted, we issued our inaugural sustainability bond, raising $400 million to be invested towards our path to net 0 emissions by 2050 and investments that support climate as well as diversity and inclusion efforts. The bond offering itself is an important step in that it requires formal processes around reporting, tracking and auditing of qualified sustainable investments. This rigor serves to benefit the control environment surrounding our enterprise-wide ESG reporting and accountability. In addition, Aflac Global Investments announced late February, a partnership with Sound Point Capital Management to create a new asset management business focused on the transitional real estate loan market. As part of that alliance, we have made an initial $1.5 billion general account allocation to the newly created Sound Point commercial Real Estate Finance, LLC, with $500 million of that amount dedicated to providing transitional and other debt financing to support economically distressed communities designated as qualified opportunity zones. Aflac will hold a 9.9% minority interest in this newly created investment LLC, with the ability to grow our stake over time in line with future growth of the new venture. I'll now pass on to Max to discuss our financial performance in more detail. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Fred. Let me follow my comments with a review of our Q1 performance with a focus on how our core capital and earnings drivers have developed. For the first quarter, adjusted earnings per share increased 26.4% to $1.53, with a $0.02 positive impact from FX in the quarter. This strong performance for the quarter was largely driven by lower utilization during the pandemic, especially in the U.S. and a lower tax rate compared to last year. Variable investment income $24.5 million above our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses, grew 20.6%, and the adjusted ROE, excluding the foreign currency impact, was a strong 16.7%, a significant spread to our cost of capital. Starting with our Japan segment. Total earned premium for the quarter declined 3.6%, reflecting per policies paid up impact while earned premium for our third sector product was down 2.2% as sales were under pressure in 2020. Japan's total benefit ratio came in at 68.4% for the quarter, down 100 basis points year-over-year, and the third sector benefit ratio was down -- was 58%, also down 100 basis points year-over-year. We experienced slightly higher than normal IBNR release in our third sector block as experience continues to come in favorable relative to initial. This quarter, it was primarily due to pandemic conditions constraining utilization. Persistency remains strong, with a rate of 95%, up 50 basis points year-over-year. Our expense ratio in Japan was 21.3%, up 130 basis points year-over-year. With improved sales activity, expenses naturally pick up in our technology-related investments into converting Aflac Japan to a paperless company continues, which also includes higher system maintenance expenses. Adjusted net investment income increased 6.9% in yen terms, primarily driven by favorable returns on our growing private equity portfolio and lower hedge costs, partially offset by lower reinvestment yield on our fixed and floating rate portfolio. The pretax margin for Japan in the quarter was 23.1%, up 60 basis points year-over-year. A very good start to the year. Turning to the U.S. Net earned premium was down 4.1% due to weaker sales results. Persistency improved 240 basis points to 80%, as our efforts to retain accounts and reduce lapsation show early positive results. As Fred noted, there are still 9 states with premium grace periods in place. So we are monitoring these developments closely. Breaking down the 240 basis points persistency rate improvement further. 70 basis points can be explained by the emergency orders in place, 90 basis points by lower sales as first year lapse rates are roughly twice total in-force lapse rates. And the residual of 80 basis points includes conservation efforts executed on last year. Our total benefit ratio came in much lower than expected. At 39.1%, a full 900 basis points lower than Q1 2020. In the quarter, we experienced lower paid claims, especially in the month of January. As pandemic conditions impacted behavior of our policyholders. This is in line with disclosures in 2020, indicating a negative correlation between infection levels and claims generating activities like accidents, elective surgeries and physical exams. This low activity level related to non-COVID claims accounted for most of the year-over-year drop in the benefit ratio. Our total incurred COVID-related claims also came in lower than expected due to an IBNR release. We estimated new COVID claims at approximately $42 million, and this was offset by an IBNR release of $41 million. As our experience accumulates, we have refined our assumptions, and this led to this IBNR reserve release. We expect the benefit ratio to increase gradually throughout the remainder of the year, with the resumption of normal activity in our communities and by our policyholders.. For the full year, we now expect our benefit ratio to be towards the lower end or slightly below our guided range of 48% to 51%. Our expense ratio in the U.S. was 38.5%, up 10 basis points year-over-year, but with a lot of moving parts. Weaker sales performance negatively impacts revenue, however, the impact to our expense ratio is largely offset by lower DAC expense. Higher advertising spend increased the expense ratio by 70 basis points along with our continued build-out of growth initiatives, group life and disability, network and direct-to-consumer. These contributed to a 110 basis point increase to the ratio. The strategic growth initiative investments are largely offset by our efforts to lower core operating expenses as we strive towards being the low-cost producer in the voluntary benefit space. Net-net, despite a lot of moving parts, Q1 expenses are tracking according to plan. In the quarter, we also incurred $6 million of integration expenses not included in adjusted earnings associated with recent acquisitions. Adjusted net investment income in the U.S. was down 0.6% due to a 22 basis points contraction in the portfolio yield year-over-year, partially offset by favorable variable investment income. Profitability in the U.S. segment was very strong, with a pretax margin of 27.3%, with a low benefit ratio as the core driver. With Q1 now in the books, we are increasing our pretax margin expectation for the full year. Initial expectations were for us to be towards the low end of 16% to 19%. We now expect to end up for the full year towards the high end of this range indicated at. In our corporate segment, we recorded a pretax loss of $26 million as adjusted net investment income was $20 million lower than last year, due to lower interest rates at the short end of the yield curve. Other adjusted expenses were $7 million lower as our cost reduction activities are coming through. Our capital position remains strong, and we ended the quarter with an SMR north of 900% in Japan and an RBC of approximately 563% in Aflac Columbus. Unencumbered holding company liquidity stood at $3.9 billion, $1.5 billion above our minimum balance, excluding the $400 million proceeds from the sustainability bond that we issued in March that reinforced our ESG initiatives and believe that sustainable investments are also good long-term investments. Leverage, which includes the sustainability bond, increased but remains at a comfortable 23% in the middle of our leverage corridor of 20% to 25%. In the quarter, we repurchased $650 million of our own stock and paid dividends of $227 million, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. And with that, I'll hand it over to David to begin Q&A."
},
{
"speaker": "David Young",
"text": "Thank you, Max. Now we are ready to take your questions. [Operator Instructions]. Pasha, we will now take the first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Your first question is from the line of Nigel Dally with Morgan Stanley."
},
{
"speaker": "Nigel Dally",
"text": "So Max, perhaps we can start on capital management. Capital ratios look very strong. Cash balances, obviously very high. Concerns regarding credit are dissipating. In the quarter, you bought back more stock than expected given that, could we perhaps see some upside to your capital management plans? Or should we view the outside in buybacks this quarter as being a little more tactical in the decision to front-end your annual plans?"
},
{
"speaker": "Max Broden",
"text": "So Nigel, obviously, as we travel through the pandemic, we're now moving into more, I would call, normal economic conditions in environment, i.e., less impacted over time by the pandemic. That means that obviously, we gain confidence in how we can deploy capital, and you saw that in the quarter. At the same time, we're not fully out of this yet. And we will continue to look at the -- all the different deployment opportunities that we have. In the quarter, $650 million was a step-up from what we've seen previously, and that reflects our confidence in what we see the franchise driving and coming through over time. And going forward, we will continue to make sure that we hold capital in the right places around the company and deploy capital at favorable IRRs."
},
{
"speaker": "Nigel Dally",
"text": "Great. And just a follow-up on premium persistency as well. In the space where the premium waivers have been lifted. Do you tend to see a spike in lapses? Any color there would be would be interesting. I just wanted to try to get an understanding as to whether there's perhaps a challenge for the remaining states that are yet to lift the executive orders?"
},
{
"speaker": "Frederick Crawford",
"text": "Nigel, it's Fred. You do tend to see a bit of a spike in lapse rates when the state orders subside. And we have actually a fairly good amount of historical experience on this, as I might have mentioned in past comments. It's not unusual to have these state mandates put in place during natural disasters and the like. And so we've seen this before. What I would tell you, however, is when it comes to our financials, we try to account for a level of this in the form of do premium allowance, if you will, meaning the idea of what is an uncollectible amount of premium that may be out there embedded in the book of business that are being suspended, if you will, related to the grace periods. So we try to take into account such that when you do see these state mandates lifted, there's not a pronounced impact, if you will, or measurable impact to our actual financials, even though you may see lapse rates move around."
},
{
"speaker": "Operator",
"text": "Your next question is from the line of Humphrey Lee with Dowling & Partners."
},
{
"speaker": "Humphrey Lee",
"text": "I guess my first question is on the U.S. underwriting. So Max, in your prepared remarks, you talked about lower claims incidents in January. Do you -- can you share in terms of like how the number claims submitted in January or in the first quarter in general compared to kind of the second and third quarter of last year?"
},
{
"speaker": "Max Broden",
"text": "So I can give you one example. So in the month of January, we had paid claims drop about 28% in the U.S. compared to prepandemic conditions. That's a very significant drop. We saw a significant normalization from that level in the month of February and further normalization in the month of March. This, to a large extent, explains the low benefit ratio in the quarter."
},
{
"speaker": "Unidentified Company Representative",
"text": "And you have to think that one of the reasons for it. And of course, no one knows for sure. But if you think back, we had just had the holidays, and we were seeing on the TV constantly by the government, be careful, don't go out, protect yourselves. We're going to have a spike and I think that brought in the lower numbers."
},
{
"speaker": "Max Broden",
"text": "And one thing I would like to add, Humphrey, as well, as we look forward, is that there are certain of our products, you could see an increase in claims being filed as people go back for their physicals, go back for elective surgeries. Even in the line of cancer, we could see a step-up in terms of claims being filed in the future that did not occur during the pandemic. That's why we view the period that we just have been through as abnormal."
},
{
"speaker": "Humphrey Lee",
"text": "Yes. I guess, like the -- I understand people getting reminded during January, but at the same time, I feel like was state kind of opening up in the first quarter compared to where we were in the second or third quarter that the entire country was pretty much fully locked down. I guess I was just a little surprised to see the first quarter results being so much better than second or third quarter when we're kind of deep in the pandemic. So..."
},
{
"speaker": "Unidentified Company Representative",
"text": "I think we were, too. I mean, we certainly would have given you closer projections, had we thought that was the case. So we were certainly surprised for January. But I think what Max is also saying is February and March, we're on target."
},
{
"speaker": "Max Broden",
"text": "Our actuaries also remind us constantly that there is a little bit of a lagging environment, and that is there's a bit of a timing gap, as you can imagine, between the actual incident taking place, i.e., going to the doctor and then the filing of the claim. And so you can see some lagging. So we watch the trends and try to embed that in our forecasting as well."
},
{
"speaker": "Humphrey Lee",
"text": "So there wasn't any kind of IBNR reserves for non-cover claims that you both in previous quarter that given the projected incidents never materialized that you had a release. So it's not like that, just simply pure from an incidence perspective?"
},
{
"speaker": "Max Broden",
"text": "Yes, there was an element of that coming through as well. That moved our benefit ratio by about 1.5 points down."
},
{
"speaker": "Operator",
"text": "Your next question is from the line of Jimmy Bhullar with JPMorgan Securities."
},
{
"speaker": "Jimmy Bhullar",
"text": "I had a question on just your sales in the U.S. and Japan through the quarter. And if you saw a noticeable improvement in March versus what was happening in January? And then relatedly, in Japan, what do you think of the impact of the lockdowns as well as the Olympics coming up and could that affect your sales negatively in late 2Q, early 3Q?"
},
{
"speaker": "Daniel Amos",
"text": "Well, I'll start and then turn it over to Japan. But in my talk, I said that we saw improvement with January -- February numbers were better than January, and March numbers were better than February, and we expect the second quarter to be better than the first quarter. And that was true in both countries. So from that standpoint, so let me let or whoever he would like to speak talk specifically about your questions."
},
{
"speaker": "Koji Ariyoshi",
"text": "Yes. This is from Japan. First of all, let me start out with the current situation in Japan, followed by the sales and our business in Japan as well. Well, first of all, as Fred mentioned earlier, the number of infections in Japan is 575,000, and the number of deaths in total is about 10,000. So compared to other countries, this number is much smaller. And this is -- the reason why we have been able to control much of the infection is because of the nature of our citizens that we normally wear masks, and we care very much about our hygiene. And on top of that, instead of taking the risk, people are really worrying about eating and dining outside, and the restaurants are reducing their business hours, and these things have been very effective. However, even still then, there has been a number of increase of the new infections in Osaka and Tokyo. And as a result, there is a third declaration of emergency, which was issued on April 25. However, the third emergency declaration in Japan is not a lockdown. It is much more focused measure. And for example, the state of emergency declaration that was issued this time only covers four prefectures, and the period that it covers is up to May 11. So compared with the past state of emergency declarations, it's very much limited in terms of time and location. However, the government is imposing much stronger restrictions on restaurants and shopping -- large shopping centers that they are asked to shut down their response and shops for the time being. And the vaccination started in April, starting from the elderly population. And since older population accounts for about 30% of the overall population, we are expecting that this will have a positive effect. However, the situation of the pandemic is very fluid. Therefore, we really need to watch out for the variance and the vaccination status going forward as well. And because of the situation and since the COVID-19 infection is still rising it is very difficult to mention how it is going to be going forward in terms of our projection. But as you can see, as a result of -- in our results of the first quarter, even under the state of emergency declaration, we have been able to promote our medical insurance, and it's been and also because of the extent of the use of online proposals and applications, we haven't been able to mark the same level of performance as this last year. And even from the second quarter and on, we would like to maintain this positive benefit or positive effect from the medical insurance, and we will also be further expanding the use of online proposals and applications. And on top of that, we would also like to be expanding the enrollment through online for group as well. And furthermore, we would also like to be using direct mails, which will enhance the non face-to-face solicitation. And by doing so, we should be we should be minimizing the impact from COVID-19. And that's all for me."
},
{
"speaker": "Max Broden",
"text": "One thing I would add that's interesting, just to give you some color on the relative nature of the state of emergency. We sell product through what we would call retail shops, about a little over 20 of those shops are actually owned by Aflac and about 380 of those shops are through affiliate ownership, and we'll do about JPY 6 billion a year in a normal year of production through those shops. During the peak of the emergency orders in the pandemic in April of 2020, essentially all 400 of those locations were shut. Today, under the state of emergency issued around the Tokyo and Osaka and Kobe area, 13 of those shops are closed. And so it gives you a little bit of a perspective on the difference between the early days of the pandemic and more severe approach to emergency orders and the current period that's trying to balance productivity and businesses remaining open, while at the same time, exercising caution."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. Any comments on how the Olympics would impact?"
},
{
"speaker": "Max Broden",
"text": "I'm sorry, Jimmy. Can you ask again?"
},
{
"speaker": "Jimmy Bhullar",
"text": "Yes. I was just on like on the Olympics, is there going to be an impact on sales from the Olympics, do you think? Or should that not be much of a factor?"
},
{
"speaker": "Max Broden",
"text": "Go ahead."
},
{
"speaker": "Koji Ariyoshi",
"text": "This is Koji. We do not think there will be any impact."
},
{
"speaker": "Max Broden",
"text": "Yes. That's essentially what I was going to say is we have not factored in any impact, and so we are not expecting."
},
{
"speaker": "Teresa White",
"text": "I think the second part of that question was from the U.S. perspective. And I'll just mention this, as we see increase in vaccinations in arms and state mandates being lifted we are now starting to see the markets open up. We've also opened up our market offices, sales offices around the U.S. as well. So we're starting to see a lot more activity from a sales perspective. Virgil, did you have anything else you wanted to add to that?"
},
{
"speaker": "Virgil Miller",
"text": "No, I'll just reemphasize, Teresa, that as Dan stated and stated earlier, we did see the sequential improvement month-over-month with all sales is really driven by activity of opening up the markets in the offices, along with ensuring that we're continuing to drive our average weaker producers do mine."
},
{
"speaker": "Teresa White",
"text": "That's it from the U.S. side."
},
{
"speaker": "Operator",
"text": "Your next question is from the line of Tom Gallagher with Evercore."
},
{
"speaker": "Tom Gallagher",
"text": "Just wanted to follow-up on the U.S. just to get a handle on what you're thinking about earned premium. I guess, particularly the commentary about the small businesses still being in recovery mode, large employers, focusing on returning employees to work rather than modifying benefits. I guess that commentary sounded a bit cautious to me, but how are you thinking about those issues impacting your sales as -- and overall earned premium? It doesn't sound like you're adjusting your 3-year guidance for earned premium of flattish? Is it changing the trajectory of what you expect for '21 versus '22? Just a little more elaboration on those issues?"
},
{
"speaker": "Max Broden",
"text": "Will -- go ahead. Well, shorter answer is it's not we -- meaning, we have not adjusted our guidance or even really the path of that guidance, while down for the reasons we've talked about, most notably just simply sales being down. It is actually essentially on plan, meaning it is meeting our expectations and what we thought would take place, Tom. So we're not adjusting any of our thoughts for the roll forward."
},
{
"speaker": "Unidentified Company Representative",
"text": "Because persistency is 80% doing better than we thought."
},
{
"speaker": "Max Broden",
"text": "Yes, it is doing better. And -- but I would say, overall, it's coming in just as we thought might happen."
},
{
"speaker": "Tom Gallagher",
"text": "Okay. And then just a follow-up on the benefit ratio. Max, can you give a sense for when you talk about very favorable in January and then gradually elevating, was March back up to around 48%, 49%? Or was it still below that? And is this still the possibility that 2Q is going to trend favorably based on the trend you saw in March?"
},
{
"speaker": "Max Broden",
"text": "The total benefits ratio is obviously heavily impacted by quarter end actuarial review studies. But I would say there's just tracking sort of paid claims. We were getting closer to a normal level in the month of March, still not all the way up to what I would say to be prepandemic levels, but we're getting fairly close."
},
{
"speaker": "Tom Gallagher",
"text": "Okay. So slightly favorable, but much closer to that level."
},
{
"speaker": "Max Broden",
"text": "And that is factored into when we then look at our full year benefit ratio, as we sit here today, and we look out for our benefit ratio we obviously incorporate a whole host of different factors when we look at the full year, including the possibility of some pent-up demand in terms of claims being filed as well. I touched earlier on that, including a potential increase in cancer claims. That's factored into our revised guidance of being towards the low end or slightly below the 48% to 51% for the benefit ratio for the full year in the U.S."
},
{
"speaker": "Operator",
"text": "Your next question is from the line of John Barnidge with Piper Seller."
},
{
"speaker": "John Barnidge",
"text": "The last time Japan closed proactively selling cancer insurance, the world looked a whole lot different. Can you talk about digital tools? I mean you talked about the new medical product and digital tools that help the distribution there. But can you talk a little bit about the digital tools you're working to bring to Japan post as they work to ramp up proactively starting the product, please?"
},
{
"speaker": "Koji Ariyoshi",
"text": "Currently, digital tools are into both medical insurance and health insurance. The younger generation uses more than digital tools, it is being very much used by your people. Regarding the, we are preparing them to start using the digital tools. And we already have a plan to get started with the test marketing in some part of the JV. And the really has an intention that wanting to emphasize using the digital tool. So I'm sure that they will be fully leveraging the digital tools going forward. And that's it for me."
},
{
"speaker": "Max Broden",
"text": "Yes. Even though -- what's interesting is even though sales were somewhat suspended in the system during this period of recovery for Japan post, the alliance never stopped. And that's important to understand. And so other areas of the alliance, including investing in the distribution platform, investing in mutual technology, certain investment in venture-related strategies. The entire governance structure and regular meetings with executive management and with frontline management, none of that was suspended. It kept moving forward. And much of it was designed around advancing technology and advancing process improvement between the two parties, taking advantage of this pause in the action to be ready to come back into market."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Michael Ward with UBS."
},
{
"speaker": "Michael Ward",
"text": "I just had a quick question on the idea of delayed cancer screens. I know you've kind of touched on incidents or frequency but I was wondering if you had any updated expectations on the trend in cancer severity once the economy reopens? Just on the idea that delayed screenings are delaying the detection or worsening cancer conditions. And I thought maybe if you had some historical experience managing premium grace periods from natural disasters, maybe you've kind of seen this happen before."
},
{
"speaker": "Max Broden",
"text": "I don't think that we have really gone through such a prolonged time, something like COVID and the type that has had. We saw in the very beginning of COVID that cancer screenings dropped significantly. That then started to normalize. So it's still sort of difficult to fully sort of see or have a clear expectation of it, what the impacts may or may not be. We are trying to be conservative in the estimates that we have and our expectations for what the different outcomes could be in general. I would also remind you that generally, severity does have a little bit of an impact on our claims, but it's relatively small. We're -- primarily frequencies really what drives our benefit ratio."
},
{
"speaker": "Operator",
"text": "Your next question is from the line of Ryan Krueger with KBW."
},
{
"speaker": "Ryan Krueger",
"text": "I had a follow-up on the Japan post. Can you just give any -- I know it's early and there's a lot of uncertainty, but can you give any sense of, at least directionally, how meaningful you think their sales could be this year? And maybe how many years it might take for them to rebuild back to prior levels?"
},
{
"speaker": "Daniel Amos",
"text": "Yes. I think it's too early for us to tell. But what I would, Fred mentioned this, but I want to reinforce it, is we've got as good a relationship with the new management team as we had, if not better, with the old management team and being large shareholders that they are. They're also very interested and their stock and what they've invested in. And so it's a win-win opportunity. And I think it will be coming back but when you -- we're in uncharted waters with all of this COVID stuff. And so it's hard for us to go out when we don't know about it as well. But look, this is not in any projections, but my gut just tells me, and it's just mind. So for what it's worth, but that it's going to do very well, and it's going to be a little slow in the second quarter. And then they're going to ramp it up. The one thing I've seen with the Japanese over the years is they tend to analyze, reanalyze, reanalyze again and then all of a sudden move at once. So you don't -- in the U.S., we kind of ease into it, add a little more, add a little more and then it builds. If you take both groups at the starting line, the U.S. will always take off first. But at some point, halfway through that, Japan will all of a sudden decide, we're ready to go. And they will boil out and then all of a sudden go to that point. I believe we're in that stage right now. I believe that will go through the first quarter. But I think by the end of the year, you're going to see them coming back and pulling out. Aflac Japan is a little bit more reluctant than to say all of that. So I am not speaking on their behalf, but I've been doing this for 31 years. And I just have a real good feeling that also Japan post wants to make money, and they need to do those things. And Aflac's products with cancer insurance are something that consumer wants and needs. So when you add that to it, I would say there's a good chance. Now the downside is, something goes wrong with the -- with COVID or something like that. But that's not limited to us. That happens every business out there today. So I'm sure you take that into account. But if you exclude that, I feel pretty good about what's going to be taking place."
},
{
"speaker": "Operator",
"text": "Your final question comes from the line of Gregory Peters with Raymond James."
},
{
"speaker": "Unidentified Analyst",
"text": "This is Alex on calling in on behalf of Greg Peters. Maybe just one question on the Japan paperless initiative. Just curious if the adoption of digital has any acceleration of that initiative? And as well as are there any other social and environmental initiatives that you're pursuing related to the $400 million bond?"
},
{
"speaker": "Max Broden",
"text": "I think in terms of the Japan paperless initiative, it's on track. It's moving well. As you might recall, it's a JPY 10 billion, roughly 2.5-year investment. And I would say we're probably in the range of JPY 3 billion, perhaps approaching JPY 4 billion of investment to date. It's designed to take about 80 million pieces of paper out of the system. And it's largely oriented around our policyholder services platform, where when the application starts in a paper form, it remains in a paper form through the processing environment. And so we're looking to get that out of the system, and that benefits cost structure. It benefits business recovery because you can move information around the country of Japan, which can be prone to natural disaster, as you know, and so -- and then also finally has environmental benefits, of course. And so that's a big initiative. We expect to save about JPY 3 billion a year in the way of expenses, and it remains on track, and it is closely tied to the digitization of the platform. It's essentially one and the same. It's one of the major efforts, if you will, that's involved in overall digitization of the platform. In terms of the $400 million sustainability bond, yes, we have very well-articulated and dedicated plans for the investment of those funds. They largely surround classic sustainability investments, meaning climate, climate-related renewable energy investments. They also include, among other things, investments in opportunity zones in areas that suffer from a lack of income equality. And so those are largely the areas that we're targeting. And as you may know, in the sustainability bond, so-called green bond, et cetera, marketplace. There's very strict and well-defined requirements around what you invest in, the qualification of those investments, the tracking of those investments and the yielding of benefits from those investments. And so while it's a $400 million bond, my point in my comments was it's a much bigger effort for the company because it serves to set the entire structure up for broader-based investment, far greater than $400 million over time, particularly the utilization of our general account on ESG efforts."
},
{
"speaker": "Unidentified Company Representative",
"text": "And we would expect to earn favorable risk-adjusted returns on these investments."
},
{
"speaker": "Daniel Amos",
"text": "Thank you, and I believe that wraps up our call. I want to thank everyone for joining us. Today, if you have any follow-up questions, please feel free to reach out to the investor and rating agency Relations teams, and I look forward to seeing you soon, hopefully, and also talking to you in the near future. Thank you."
}
] | Aflac Incorporated | 250,178 |
AFL | 4 | 2,022 | 2023-02-02 08:00:00 | Operator: Good morning, and welcome to the Aflac Incorporated Fourth Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Ratings Agency Relations and ESG. Please go ahead.
David Young: Thank you, Andrea. Good morning, and welcome to Aflac Incorporated's fourth quarter earnings call. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated. Fred Crawford, President and COO of Aflac Incorporated, who is joining us from Japan, will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com, along with a video for Max Broden, Executive Vice President and CFO of Aflac Incorporated, who provided an update on our quarterly financial results and current capital and liquidity. Max will be joining us for the Q&A segment of the call, along with other members of our executive management; Virgil Miller, President of Aflac U.S,; Brad Dyslin, Global Chief Investment Officer and President of Aflac Global Investments; Al Roziere, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurances that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. And we encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com, and includes reconciliations of certain non-GAAP U.S. measures. Please also note that after we file our 10-K, we plan to post, on our investor site, a recast quarterly financial supplement, showing the effects of the new long-duration targeted improvement accounting standard had it been applied to the 2022 and 2021 fiscal years. I'll now hand the call over to Dan. Dan?
Dan Amos: Thank you, David, and good morning. Thank you for joining us. Reflecting on 2022, our management team, employees and sales distribution have continued to be resilient stewards of our business, being there for the policyholders when they need us most, just as we promise. From an overall standpoint, pandemic conditions impacted operations in Japan, especially in the first half of 2022. But they are gradually improving. Meanwhile, pandemic conditions in the U.S. have largely subsided. Turning to our financials, when adjusting for material weakening in the yen, the Company delivered another quarter of solid earnings results that rounded out a year of overall strong performance, as Max addressed in this quarterly video update. For 2022, Aflac Incorporated reported adjusted earnings per diluted share, excluding the impact of foreign currency, of $5.67, which was the Company's second best year in the history following a record 2021. Aflac Japan generated solid overall financial results in 2022, with an extremely strong profit margin of 24.9%. One of the consistent key contributors to Aflac Japan's strong financial results is its persistency, which was 94.1% in 2022. As anticipated, our benefit ratio returned to a more normal level in the fourth quarter after seeing a spike due to the practice of deemed hospitalizations, the scope of which was narrowed last September. Throughout the year, we continued to navigate the waves of COVID in Japan. We expected sales would pick up in the second half of the year, especially in the quarter, and that's exactly what we saw happen. Sales in Japan rose 10.8% in the second half of the year, including an 11. 4% increase in the fourth quarter, which led to a full year sales coming in essentially flat. These results reflected the August launch through Associates of Wings, our new cancer insurance products. They also reflected our first sector product updates in the fourth quarter that better positioned Aflac Japan for future long-term sales opportunities. Recently, Prime Minister, Kishida announced that COVID would be downgraded to the same level as seasonal flu starting in mid-May. While we're encouraged by this announcement as a sign of daily life in Japan returning to pre-pandemic conditions, we will see how this evolves, but look to continue building on our sales momentum in 2023. In April, Aflac Japan will begin selling through Japan Post Group, our new cancer insurance product, and subject to FSA approval, [indiscernible] for serious diseases, which was developed in collaboration with Japan Post Group. We expect this close collaboration to produce continued gradual improvement of Aflac cancer insurance sales over the intermediate term and to further position the companies for long-term growth. Another element of our growth strategy is our intense focus on being there where consumers want to buy insurance. Our broad network of distribution channels, including agencies, alliance partners and banks continually optimized on opportunities to help provide financial protection to Japanese consumers and we are working hard to support each channel. Turning to the U.S., for 2022, we saw a solid profit margin of 20.4% in the fourth quarter. This result was driven by lower incurred benefits and higher adjusted net income, particularly offset by higher adjusted expenses. I'm pleased with the 17.4% sales increase in the fourth quarter, which reflected the largest amount of quarterly premium in the history of Aflac U.S. and continued to a 16.1% sales increase for the year. This reflects continued improvement in the productivity of our agents and brokers as well as contributions from the build-out of our acquired platforms, namely dental and vision, group life and disability. These are relatively small parts of our sales, but key elements of our growth strategy to sell in our core supplemental health policies. I'm encouraged by the continued improvement in the productivity of our sales associates and brokers. We are seeing success in our efforts to reengage veteran sales associates. And at a time, we're seeing strong growth through brokers. These results reflect continued adaptation to the pandemic conditions, growth in the core products and our investment and build-out of growth initiatives. I believe that the need for the products we offer is strong or stronger than ever before in both Japan and the United States. At the same time, we know consumers' habits and buying preferences have been evolving. We also know that our products are sold, not bought. As we communicate the value of our products, we know that a strong brand alone is not enough. We must paint a better picture of how our products help. In the latest commercial featuring the Aflac Duck and the Gap Goat, the goat personifies the gap that people face when they get medical treatment. Fortunately, the Aflac Duck is the hero who helps overcome the problem. I know this helps demonstrate the need for our products, thus helping our sales opportunities. We continue to work toward reinforcing our leading position and building on the momentum into 2023. Related to capital deployment, we placed significant importance on achieving strong capital ratios in the United States and Japan on behalf of our policyholders and shareholders. In addition, we have taken proactive steps in recent years to defend cash flows and deployable capital against the weakening yen. We pursue value creation through our balanced actions, including growth investments, stable dividend growth and disciplined tactical stock repurchase. With the fourth quarter's declaration, 2022 marks the 40th consecutive year of dividend increases. We treasure our track record of dividend growth and remain committed to extending it supported by the strength of our capital and cash flows. Additionally, the board reiterated its first quarter dividend increase of 5%. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we have remained tactical in our approach to share repurchase, deploying $2.4 billion in capital to repurchase 39.2 million shares in 2022. Combined with dividends, this means we delivered $3.4 billion back to the shareholders in 2022. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We have also focused on integrating the growth investments we made in our platform. We also believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. We are well positioned as we work toward achieving long-term growth, while also ensuring we deliver on our promise to our policyholders. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Before I turn it over to Fred, you may recall that the financial analyst briefing in November that I mentioned how Fred would be increasing his focus on Japan and spending more time over there to delve deeper into learning about the operations there. As David mentioned, he is joining us today from Japan where he's on assignment for the better part of 2023. As President and Chief Operating Officer, he is also continuing to focus on Aflac U.S. as well. I'll now turn it over to Fred. Fred?
Fred Crawford: Thank you, Dan. I'm joined here in Tokyo by our Aflac Japan leadership team led by Masatoshi Koide, President of Aflac Japan. Let me begin by saying 2022 was an important year of operational and strategic progress across the organization. Our U.S. growth platforms, dental and vision, group life and disability and consumer markets have moved from integration to full production, with comprehensive product portfolios that are broadly filed and marketed across the U.S. under the Aflac brand. These businesses have modernized operating platforms built to support the scale we anticipate in the future and are now fully contributing to sales and earned premium growth. In Japan, our refreshed cancer product is now further enhanced with the launch of our new [Yuriso] consulting support model after nearly a year of successful testing. We launched a revised and tactical approach to the sale of our WAYS and child endowment products, leveraging the strengthened product appeal to promote third sector cross-sell. While navigating difficult COVID conditions, we were proactive in addressing our expense structure, defending strong margins in the face of revenue pressure. From a corporate perspective, we remain focused on risk management and capital efficiency. Two areas of focus included our approach to hedging the U. S. dollar portfolio in Japan and efforts to improve enterprise return on equity and Japan product competitiveness with the launch of Aflac Re, our Bermuda-based reinsurer. Finally, across the organization, we launched a coordinated effort to address the balancing act of investing in and delivering on growth, reducing expenses simplifying our business model and improving overall customer experience. This includes comprehensive project governance, a network of agile teams and regular reporting up to the Board level. The financial goal is simple: to deliver on the outlook provided at this year's investor conference with respect to growth and margins in the U. S. and Japan. We're proud of our efforts, but it's clear from our results that we have worked to do in a few key areas. This includes addressing weak premium persistency in the U.S. and revitalizing our production platform in Japan. Furthermore, we need to address these issues while continuing to advance our technology and associated process improvement across the organization. With that quick review, let's turn to current conditions and what we're focused on in 2023, starting with Aflac Japan. As Dan noted, claims recovered in the fourth quarter, as did the benefit ratio, on January 20th, Prime Minister Kishida announced plans to downgrade under the law COVID-19 to the same level of seasonal influenza, which will be enacted in mid-May. Importantly, this removes the immediate option to implement quarantine and other restrictive measures, such as state of emergency orders. We believe this move is designed to signal and encourage a return to normal, including business activity. While claims processing volumes remain high, this is driven by a natural lag in reporting of claims generated during Japan's seventh wave of COVID under the old deemed hospitalization rules. You can think of this as working the IBNR claims that were financially recognized in the third quarter. Despite continued waves of COVID, we expect our team in Japan to improve on the performance in 2022 as COVID, like the common flu, appears destined to become a way of life in Japan and elsewhere. In that regard, we're focused on the following: First, in terms of distribution recovery and productivity across our channels, our powerful associates channel requires aggressive approach to training and development to drive new customers. Separately, we are working with Japan Post on a campaign surrounding the introduction of the new cancer product in the second quarter. As Dan noted, we have strong commitment at the top of Japan Post, and we are cooperating at levels throughout the organization. It should be noted late this January we also introduced the new cancer product in our Dai-Ichi alliance as well as the financial institutions channel, both of which have performed below our expectations in recent periods. Turning to core product refreshment, our new cancer product will add a critical illness lump sum benefit rider in April, available on old and new cancer products and through Japan Post Group and our associates channels. Cancer ecosystem development is moving from launch to expansion. When analyzing current call volume, over 50% of the calls that are coming into our consulted related service platform relate to treatment, thus suggesting a value proposition beyond the pure financial benefit of paying a claim. Our 2022 refreshed approach to first sector savings is yielding expected results, with approximately 80% of all sales representing customers who are under the age of 49 and approximately 50% of all new first sector customers purchasing a third sector product which is twice our target of 25% cross-sell. Finally, in the face of increased competition and focus on selling the new cancer product, we have seen our medical sales decline and have plans to refresh our product in the fourth quarter. When stepping back to consider these activities, we are and have been taking broad action across product and distribution with an eye towards returning to an ¥80 billion production platform in the 2025 and 2026 period. The path to that level of production will build over time. But as we look towards 2023, we expect the continuation of our experience in the second half of 2022, where we generated consistent growth in production. Meeting our long-term targets will require strong execution on all fronts, as well as supportive market conditions and the cooperation of third-party alliances and partners to aid in driving productivity improvement. Finally, while we have made progress, we seek further advancement in digitizing paper and manual processes for greater operating efficiency. This is not entirely an Aflac Japan issue. It's a Japan financial service industry issue. In recent years, we have moved from 30% to approximately 50% of our applications submitted in digital form, with only 10% of claims processed digitally. Over time, we seek to drive digital applications to 80% and digital claims processed to over 40%. This will allow us to take additional cost out of our operations, but requires the commitment of our distribution partners, their agents and customers to drive adoption. I'm here in Japan in part, recognizing this is an important time for Aflac Japan. We are engaged in transformative activities that have long-term franchise implications as we seek to leverage our financial strength and leading third sector position. My focus will be partnering with our leadership team in revitalizing our distribution, incubating new product end markets and digital adoption to drive down expenses and improve customer experience. Turning to the U.S., as Dan noted in his comments, we continue to deliver a balanced attack to the marketplace. Split by product class, group benefits were up 28%, individual benefits up 8%. Split by channel, agent sales were up 7% and broker up 25%. With respect to our expansion businesses, network dental and vision and premier life and disability sales were up 98% and 75%, respectively, for the full year. The underlying signs of momentum are encouraging. For example, in our agent small business franchise, average weekly producers are up 3%, the second consecutive year of growth after a period of steady decline. Dental and vision is proving out our thesis of cross-sell as roughly $0.80 of supplemental health and life products are sold with every dollar of dental and vision. Our life and disability platform, not only has strong sales, but a successful renewal year, and recorded 97% premium persistency. Now fully integrated and expanding, we see 2023 as a year of leveraging this platform to both defend and grow voluntary group business. While it was a difficult year industry-wide for direct-to-consumer sales, we are encouraged by consumer markets 5% increase in sales in the fourth quarter with new alliances coming online. Finally, it was a challenging year for persistency in the U.S. Persistency has stabilized in our individual business. However, weakness earlier in the year continues to impact our trailing 12-month metric. Group Voluntary, a smaller contributor to earned premium, drove most of the 260-basis-point decline in overall persistency. Account persistency across the organization has remained relatively flat, but we lost a few very large accounts during the year. The industry has experienced weakness in voluntary persistency, which tells us there are also labor force dynamics contributing. We have stepped up our focus on persistency, establishing a dedicated office to drive and oversee a series of efforts, including product development, client service, technology solutions and incentive designs. Turning to investment results, investment income in the quarter was stable, with strength from higher yields on floating rate portfolios offset by increased hedge costs and anticipated weakness in alternative investment income. As expected and discussed last quarter, our alternative investment portfolio remained under pressure, posting a loss of $21 million in the quarter. By comparison, last year's quarter enjoyed $127 million in gains. This decline was anticipated given the natural correlation to the public equity markets and the lag in private equity reporting. Despite losses in the quarter, year-to-date, the alternative portfolio generated $103 million in income following an exceptional 2021. Throughout the year, we have refined our hedging strategy, reducing $2 billion in notional currency forwards in exchange for options that reduced hedge costs while protecting capital against material moves in the yen. Overall, as we look at 2023, we are staying the course with respect to our strategic and tactical asset allocations as we watch closely the risk of economic slowdown driven by Fed action to fight inflation. We are also watching the Bank of Japan as they introduce a new governor this spring which many believe could lead to a change in policy. Before turning the call back to David, it's worth following up on Max's recorded comments to reinforce how we are positioned with respect to potential for a period of U.S. or global weakness. Our morbidity-based insurance model is defensive in nature, with relative stability in sales, earned premium and profit margins through economic cycles. Among traditional life insurance peers, we maintain low asset leverage as defined by the ratio of general account assets to regulatory capital, particularly if you exclude our concentration in JGBs. We believe our portfolio is well positioned to weather the current economic uncertainty, recognizing we would anticipate some pressure on our $12 billion loan portfolios. We work closely with our external managers for middle market and real estate loans and have conducted a comprehensive stress test designed to apply recessionary pressure to these portfolios. Our approach included a moderate and severe recession, applying loss rates consistent with past economic cycles. Both scenarios resulted in elevated, but manageable losses, with no immediate need to change our disciplined approach to these asset classes and putting new money to work. When looking at the impact of core capital ratios, we developed a market pricing, ratings migration and loss scenario that falls in between a mild and severe recession and includes the entirety of our general account assets. When applying these stress tests, our core ratios of RBC, SMR and ESR all came out the other side well above are minimum thresholds. While it is wide to proceed with caution -- wise is to proceed with caution, we do not see recessionary conditions as disruptive to our capital deployment plans. I'll now hand the call back to David for Q&A. David?
David Young: Thank you, Fred. Now we are ready to take your questions. But first, let me ask you to please limit yourself to one initial question followed by a related question. And then get back in the queue to allow other participants an opportunity to ask a question. We'll now take the first question, Andrea?
Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jimmy Bhullar of JP Morgan Securities. Please go ahead.
Jimmy Bhullar: So I had a question for Fred on long-term Japan sales outlook. I think you mentioned ¥80 billion in the '25 period. If we look back historically, that's still -- while it's up a lot from here, it's still consistent with what you had in 2019 and a lower number than '18. So is it that the market opportunity is less than it was before? Or do you think -- or should we assume that your market share has declined?
Fred Crawford: I think really -- so first of all, over the long run that is beyond 2025 and '26 we obviously would expect to continue some level of growth pattern. We simply stopped the timing around that time frame as a reasonable forecasting period. But there's no doubt, in the short run, meaning the next three to four years, that one of the shortfall compared to pre-pandemic levels was strength in the Japan Post distribution platform, including some very strong years of introducing new cancer in that platform. And it's clear to us at this point in time that while that platform is recovering, it's going to recover in a more linear fashion over time as opposed to a step function with dramatic increases. And that's because Japan Post is under a very diligent program of improving and investing in their platform, retraining their sales force and recovering from effectively halting and being out of the market for a period of time, as you know. So I think it's more of that gradual approach to the build that we expect that is playing on the slower growth rate. Now having said that, we're doing a lot of different things, as you know, we're refreshing our cancer product. We're adding to that cancer product competitiveness with our [Yuriso] consulting practice. We're also adding lump sum critical illness benefits, and we continue to focus on our other product development, including refreshing our medical product, particularly with an eye towards competing better in non-exclusive channels that are very competitive on the medical product, and we need to compete better there and build share. And then we're excited actually about the developments with WAYS and child endowment, particularly with WAYS. While it is not as high a return product as our other third sector, we're very pleased with the cross-sell activity, and it's also serving to build a little bit of momentum back in our core associate channel who needs more product to generate more commission and have more opportunity to recruit and build the sales force. So, so far, it's very early in that program. We're only a few months into reviving the WAYS product, but so far, the data is very supportive of the halo effect, if you will, particularly cross-sell. So we're doing a lot of different things here in Japan. But ultimately, the reason you see muted recovery is when we look at the throughput of these new products and capabilities, meaning the throughput through agents at Japan Post, agents at Dai-Ichi, agents and agencies in our associate channel, they're busy recovering from COVID, getting back out into the marketplace with face-to-face meetings. And of course, Japan Post is going through their own dynamics of recovery. So it's really the recovery in those third-party platforms that's causing us to be more cautious.
Jimmy Bhullar: Okay. And then on the change in classification of COVID as a seasonal flu beginning, I think, you said mid-May, how should we think about the impact of that on your claims and potentially sales?
Fred Crawford: I think from a claims perspective, you're seeing the recovery already, and that is we're expecting it to recover back to previous traditional levels of claims activity. I think I mentioned to you last quarter, a normal week in Japan for us is processing something in the neighborhood of 30,000 claims in our operating center. That rose to north of 90, 000 claims a week during the deemed hospitalization period and seventh wave of COVID. So we've seen that dramatically come back down to normal levels with the exception of working the backlog that I mentioned in my comments. So I think the idea is to return back down to normal levels of benefit ratios, and that's the answer there. In terms of new sales, we have Yoshizumi-san here and Koide-san and they can add their commentary. I think the trickier thing is, when you're talking about thousands of agents, some of whom were forced into quarantine conditions during COVID, the issue becomes not only are more agents out there able to produce and share numbers undisrupted by COVID, but will there be a recovery in face-to-face activity, which is more effective. This is still an extremely cautious society here. As we sit here today, we are all wearing masks on the way into work, on the way home from work, while at work and while walking the streets of Tokyo. So there's still some time to take place to recover the full normal activity. Yoshizumi-san, I don't know if you feel differently or have anything to add about COVID conditions.
Koichiro Yoshizumi: First of all, this COVID environment last year in the first quarter between January and March, sales have been severely impacted. And following that, the next peak, or the largest peak was between July and August, and many of the sales offices and branches were forced to shut down. However, the environment gradually changed, of course, at the timing of cancer launch, the things have been changing. And at the same time, agencies and sales agent activities became much more active. And as you've seen in our sales results, you can see that our new cancer insurance sales, is increasing and there's been a great momentum in sales as a result. And the result is that compared with 2021, we have about 30% increase in cancer sales. And also, our product strategy really was successful. For example, we were able to propose to customers more comprehensively of our products using WAYS. And as a result, third sector product sales increased because sales were done in a more cross-sell way. And as a result, we were able to exceed our second half 2021 sales in 2022. And as we enter this year, the COVID situation has been improving. And as a result, the agency's activities are even more active. And we are seeing that we now are gaining really good momentum with our strategies related to products plus the channel strategy in this new environment and in this environment with living with COVID. So what I am thinking now is that we are starting to really see an environment where we would like to be aiming for ¥80 billion in 2025 or 2026 time frame. That's all from me.
Operator: The next question comes from John Barnidge of Piper Sandler. Please go ahead.
John Barnidge: My question is around the paperless initiatives that have been moved to digital and claims. You mentioned, I think it was 10% of claims digitally now moving higher, I think. Can you maybe talk about how this may impact benefits ratios over time for maybe a one-day pay style approach to digital?
Fred Crawford: Well, I think the primary benefit, there is certainly an ease -- customer ease element to moving to digital. But the primary motivation of moving to digital is increased agent productivity, yes, ease of doing business with the customer and the agent. There is, in fact, speed of processing claims that would pick up. For example, imagine paper-based claims processing when your claims went from 30,000 to over 90,000 a week during the last seventh wave of COVID. Had we been -- frankly, as an industry, this is not an Aflac thing. Had the industry been far more digitized in the level of claims they process digitally, you would have had much greater speed of claims adjudication. Normally, we'll pay a claim on average in around three days or so in Japan, sometimes four days. It had gone up to around 12 days during that peak level. It's now come down to around five days, so we've recovered quite a bit. But if you are in a digital environment, there's no doubt, John that you could speed that up and also protect against elevated claims periods to keep the speed and turnaround time faster. But I will tell you, a big motivation on our part to move to paperless is taking cost out of our structure. So when you're dealing with paper applications and paper claims processing and a heavy call volume related to customer service activities, all of that adds to cost structure. And in order for us to get that cost structure down, we've got to move it to digital, and that's what we're on a path to doing.
John Barnidge: Okay. That's fantastic. And then my follow-up question, if we can stick with expenses. You had talked about a joint work with Japan Post for cancer launch. And then you talked about that backlog of claims from that seventh wave being the review mirror. But with that joint work on the cancer launch, are there any planned onetime expenses we should be thinking about?
Fred Crawford: Not materially. I'm looking at Todd Daniel's here, our CFO, and no, we wouldn't expect that. It's not unusual, however, when we launch a new cancer product in general and then launch in a major system that there is, in fact, a level of marketing expense that comes into play and launch expense. But quite candidly, while you may see it have modest implications to your expenses and expense ratio, it's not material and it's nothing I would characterize as a onetime thing that would pop out on our financials. It's just sort of normal way of doing business and normal business activity. So I wouldn't anticipate that, John.
Operator: The next question comes from Alex Scott of Goldman Sachs. Please go ahead.
Alex Scott: I just wanted to get an updated view on just capital management and capital management priorities. Just looking at even just in the U.S., I mean, how strong the RBC ratio is, I mean I think there's companies that run with around half of your RBC level. There's seemingly a lot of excess capital around the organization. So, I was just interested in your views on that and how that's evolving?
Max Broden: Thank you, Alex. So, we have, obviously, throughout the COVID times, we made an active decision to hold capital in the subsidiaries given that we initially didn't know exactly where our benefit ratios and underlying profitability were going to go. So we opted to hold capital at a high level, both in Japan and in our U.S. subsidiaries. Coming out of COVID obviously, realizing that we are now operating at a high level, especially in the U.S. with an RBC ratio, on a combined basis, north of 60%, we do agree that, that's an excess capital position and that, over time, we would expect to operate our U.S. entities closer to 400%. That means that there will be capital coming out of those entities over the next couple of years. But we will do it when we sort of need it, and we will hold capital where we think it makes the most sense. There are times when it makes more sense to hold the capital centrally at the holding company, and other times when it makes more sense to holding at the subsidiary level. And we will, over time, optimize that.
Alex Scott: Got it. And then the second question I had, I think it was mentioned earlier that Fred was going to be in Japan for some time. And I'd just be interested in sort of what the focus is for you, Fred, as you're over there? It sounded like maybe a year or something. What is your focus? What are your key objectives as you spent some time over there?
Fred Crawford: Sure. Yes, this is the result of Dan and I sitting down in the few months or so leading up to the year-end, and why Dan signaled that fab that I'd be shifting a bit of my weight to focus a bit on Japan. To be clear, I'm spending effectively 2023 in Japan. It started mid-January and will run through mid-December. There'll be times where I'll be back in the States for critical activities and other Board-related activities, et cetera, in the U.S. So I won't be here entirely. And very importantly, I haven't changed any of my job description. And so a s Dan mentioned, I remain actively involved in driving U.S. activities. But the main reason I'm here in Japan is that it's a recognition that, at Aflac, this is very different in how we operate Japan is not a subsidiary in what you would consider to be a normal global corporate company. Japan is intertwined in the fabric of the entirety of Aflac. There's extremely coordinated and close activities shared governance committees, shared intellectual capital around technology, digitization, product development techniques of going to market. We're really, in many respects, one company despite being 13, now 14 time zones away from each other. And so in order for me to do my job effectively, that is being President and Chief Operating Officer of this company, you've got to immerse yourself in understanding the Japan marketplace, our business model and the unique dynamics that drive this business. And you really -- you can do some of that making four to six trips a year for one week at a time or two weeks at a time, which I've done for seven years, eight years -- coming on eight years now. But it's entirely different when you immerse yourself in living here and working day-to-day with the groups. And where my focus is, is real simple. It's where you would expect when you look at our results. Number one, it's partnering with Koide-san and Yoshizumi-san to help revitalize the distribution platform of this company. We need to make a leg up. We need to address certain parts of the distribution, and we're going to have to execute and deliver to bring back that path to ¥80 billion. I think we have a wonderful opportunity to leverage the brand, our scale, being in one in four households where we can drive some of the new products and capabilities that we have been incubating in recent years. And so, I'll be focused on that. And then this move to digital, realize this is a significant effort. This is not as simple as looking at your operations and moving away from paper and moving to digital. This is really not about the technology. The technology is in place. This is about partnering with third-party distribution partners, everything from Japan Post and Dai-Ichi to our associate channel to banks to move them towards more digital adoption through campaigns and programs that increase that adoption. You have to realize this is not an Aflac issue. This is quite literally no different than what the rest of the financial service industry is trying to do. And so when we talk about moving from 10% to 40% of claims or 50% to 80% of applications, that's not just an Aflac issue to handle, it is attempting to move forward and beyond the rest of the industry that is plagued by paper. You don't realize this, but many insurance companies in Japan quite literally never went remote in their operating platforms because they couldn't during COVID. They had to keep bringing their people back in because they were tied to paper and processing. That was not our situation. We were able to go to 50% remote, but even 50% remote was a bit high -- a bit low, if you will, high in terms of bringing people in. So, there's a real need to do this, and it's transformative. So anytime you use the word transformation on distribution and transformation on operations, it's very important for somebody like me and my capacity to be here on the ground spending time in Japan.
Dan Amos: This is Dan. I want to make a comment is that actually, I wanted Fred to go in 2020. And of all things, as you know, that was the year he got promoted to Chief Operating Officer and then COVID. So the year really is behind because I just thought -- it was actually his idea to stay there. My idea was to go there and live three months. And so that just shows how committed he is to the Company and doing well, and at the same time, working with the U.S. So I'm very pleased with Fred being over there. And that knowledge you cannot buy. It takes being over there, either the way I've been going for 40 -- over 40 years of the Fred's doing in the last seven. So thank you, Fred, and... David?
Operator: The next question comes from Suneet Kamath of Jefferies. Please go ahead.
Suneet Kamath: On the Japan sales, can you give a sense of how much of those sales represent to the lapse and reissue -- and when we think about the sales metric that you show in your supplement, is that a sort of a gross number? Or is that a net number when we think about policies that may be lapsing?
Fred Crawford: When you look at sales, it's a gross number. So it includes the sale of policies to new customers or customers without the policies and replacement policies. At the same time, a replacement policy also counts towards lapsation. So in other words, yes, it counts as a sale on a gross basis, but also a replacement policy is considered a lapsed policy as well. So you end up having higher lapse rates and higher sales when you have replacement activity. That's why, in fact, you see our amortization expense pop up in the fourth quarter when we launch a new cancer product or a new medical product because you effectively have a greater level of lapsation. But there's nothing wrong with a replacement policy. It's really nothing more than going out to a customer and saying, you may benefit from an upgraded structure of benefits and pricing and other additive writers, et cetera., and there's nothing wrong with that. The issue isn't the lapse and replacement policy. The issue is when it's too much of what you sell, meaning you want to be driving more new customers and have the proportion of your lapsed and reissued or replacement policies be a lower percentage of your overall sales. That's why you're seeing what we're doing, developing coming back out with WAYS, which attracts a younger, as I mentioned, and newer cohort of investors. Creating products like the disability or income products that are sold and now small businesses to employees who lack that type of coverage, and elderly care product, which is a growing market, albeit a slow growing market. All of this is designed to try to attract and develop new customers. And we believe we can make progress on that. But right now, the lapse reissue is naturally higher when you launch a new cancer product. And that's really typical of what we've seen in the past.
Max Broden: And just to add, Suneet, to how this impacts our P&L, it obviously impacts our benefit ratio and expense ratio as well. The benefit ratio was lower by about 90 basis points in the quarter from increased lapse and reissue activity, and our expense ratio was roughly 50 basis points higher because of higher DAC monetization that Fred referenced.
Suneet Kamath: Got it. I think last quarter, you had said that the lapse reissue is over 50%. Is that kind of still where it's running in Japan?
Todd Daniels: Yes, Suneet, this is Todd. It's still running around that rate. We saw it a little higher in the third quarter when we launched. And naturally, that rate starts to come down. So I think as a whole, over the first six months or so, we anticipate being around 50%.
Operator: The next question comes from Ryan Krueger of KBW. Please go ahead.
Ryan Krueger: Could you talk a little bit more about what you saw in terms of the elevated U. S. lab activity in the fourth quarter? And then, also if you can provide any commentary on if that's continued into January or is settled down?
Fred Crawford: I commented in my script, this is Fred, about the lapse rates in the U.S., and it really mimics what I said. And there's really two categories to look at it. One is our individual products. You can think of these as our traditional products sold to small businesses, the largest portion of our in-force and sales. And that lapse rate was down around 1% and, honestly, down 1.5-or-so early in the year and then slowly recovered to where, by the fourth quarter, it was down more modestly.
Dan Amos: Yes, Fred, Steve's got some numbers here on that, I think. Steve?
Steve Beaver: Yes, I would just add that Fred's script and talking points were spot on. We did see account lapses in the fourth quarter, particularly in our group business. not attributable to anything specific or systemic. We do have -- we did experience some large account lapses. We did pick up, as Fred highlighted, in the third quarter, some large accounts through the last half of the year. But net-net, we were down through the last half of the year at group. I would just add that looking forward into 2023, we are going to -- we have this office on persistency where we're going to approach this experience that we had in 2022 through product development, client service, technology solutions and incentive designs, but moderating that or modifying that to how the economy performs in 2023. That's an important thing for us to make sure that we use data to drive our actions in 2023 to get persistency back online.
Max Broden: Yes. We certainly expect the continued decent velocity of the labor force and so that will continue to be there. But at the same time, we do expect the recovery overall in our persistency going into 2023 relative to 2022.
Fred Crawford: I think you have to put it in perspective, too. This was largely focused on large accounts, the loss of large accounts, which will happen from time to time in the group business and the group business represents 15% of our earned premium. So in other words, look at our earned premium. It was down 0.2% in the fourth quarter. It was down 0.8% or less than 1% for the full year. That's not what we want. We want growth in earned premium. But we can recover from periods of week persistency. We have to focus on it. We have to bring it back. But the largest lapse rates were in the group business, which currently represents a smaller portion of our earned premium and is the fastest-growing part of our company so generated tremendous sales, which helps make up for some of that lapse rate. So we're trying to hold the line on earned premium, which is the most important component to manage.
Ryan Krueger: And then just one question on the critical illness rider that you're going to be operating in Japan. Can you help frame how big of an opportunity that is? And it seems like trying -- I know that Japan Post is in a gradual recovery mode, but it seems like that would be a fairly meaningful opportunity given that you can add it to the existing policies.
Dan Amos: Yes, I'd like Kite to answer that or Yoshizumi to cover that.
Koichiro Yoshizumi: This is Yishizumi. I will cover your question. We are currently planning to launch this lump-sum serious disease rider in April in Atria. But then that assumes that this product will be approved by the SSA, This product responds to customers' needs of having to want to prepare against, not only cancer, but also for cerebral vascular diseases as well as heart diseases. And the Japan Post Group as well as with Aflac, we are trying to fully prepare to launch this product. And as you know, the Japan Post sales is gradually recovering. And what we are expecting is that this new rider will also help accelerate sales and recovery of the Japan Post.
Masatoshi Koide: So let me just add a little bit here. This is Koide. And this new rider that is to be attached to cancer product was jointly developed by Aflac and the Japan Post Group as part of our strategic alliance collaboration. That's all from me.
Operator: The next question comes from...
Dan Amos: Excuse me, let me just make one other comment. I don't think the rider is going to be that much premium. But what it does is it gives an opportunity to get with the salespeople and go back to everyone telling them what we've got, which will ultimately help sales of the cancer policy as well. So I would look at it that way. Now that's just my viewpoint. Thanks.
Operator: The next question comes from Wilma Burdis of Raymond James. Please go ahead.
Wilma Burdis: This is Wilma. Maybe you could give us some color on how modestly higher interest rates in Japan will impact Aflac in the longer run.
Fred Crawford: I think it may be good for Brad island to talk about that. It's largely an investment question.
Brad Dyslin: Wilma, thanks for the question. We are expecting to see a little bit of volatility in rates in first quarter. As you're probably aware, there is an expected change in the governorship scheduled for February. And there is a lot of expectation that, that could lead to a policy change -- we saw a bit of a move in December when they widened the range on the 10-year JGBs by 25 basis points. So the magnitude of the opportunity is really going to depend on how much rates move. Remember, we are still at very low levels. And while a 25- or 50-basis-point move is certainly welcome, it's unlikely to result in a very big left or right turn on our asset allocation. But of course, yen assets are very important to us for the obvious asset liability management reasons, and we'll be keeping a close look as well as any opportunities to swap JGBs into higher-yielding yen credit assets.
Max Broden: And Rima, just a reminder in terms of the impact on our capital ratios, our SMR sensitivity to 100 basis points shift in the yen yield curve is 35-point -- negative 35 points on our SMR. Our ESR, more importantly, goes the other way. And obviously, higher yen rates are positive to our ESR. So a 100-basis-point shift in the gain yield curve would increase our ESR by 34 points.
Wilma Burdis: And I guess could you give us a more specific examples of the lapses in the U.S. and some of the things you're doing to address it address those?
Dan Amos: Virgil?
Virgil Miller: I'm sorry -- this is Virgil Miller, coming off mute. So Steve talked a little bit about it, let me give a little bit more color though. At the end of the day, when Steve and Fred both mentioned the office of persistency, what we're really looking at is, how do we drive utilization so that people understand the benefits they even acquired? When we're looking at selling our products, we do so making sure that our products are benefit-rich and -- but also that they're being utilized, so some of the things you'll hear us talk about is activity to make sure people have a knowledge and education around the benefits of how do we partner with our brokers, how we partner with our agents out there, and then with the employer to help drive utilization. We know that when they actually use the benefits, they have more of a tendency to keep it. And so you'll hear us talk a little bit of share more results around activities like that.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young: Thank you all for joining our call this morning. And I just want to say, if you have any questions, please feel free to reach out to the investor and rating agency relations team. We look forward to speaking with you soon, and wish you all continued good health. Thank you.
Operator: The conference has now concluded. Thank you for attending today's presentation and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the Aflac Incorporated Fourth Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Ratings Agency Relations and ESG. Please go ahead."
},
{
"speaker": "David Young",
"text": "Thank you, Andrea. Good morning, and welcome to Aflac Incorporated's fourth quarter earnings call. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated. Fred Crawford, President and COO of Aflac Incorporated, who is joining us from Japan, will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com, along with a video for Max Broden, Executive Vice President and CFO of Aflac Incorporated, who provided an update on our quarterly financial results and current capital and liquidity. Max will be joining us for the Q&A segment of the call, along with other members of our executive management; Virgil Miller, President of Aflac U.S,; Brad Dyslin, Global Chief Investment Officer and President of Aflac Global Investments; Al Roziere, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurances that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. And we encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com, and includes reconciliations of certain non-GAAP U.S. measures. Please also note that after we file our 10-K, we plan to post, on our investor site, a recast quarterly financial supplement, showing the effects of the new long-duration targeted improvement accounting standard had it been applied to the 2022 and 2021 fiscal years. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, David, and good morning. Thank you for joining us. Reflecting on 2022, our management team, employees and sales distribution have continued to be resilient stewards of our business, being there for the policyholders when they need us most, just as we promise. From an overall standpoint, pandemic conditions impacted operations in Japan, especially in the first half of 2022. But they are gradually improving. Meanwhile, pandemic conditions in the U.S. have largely subsided. Turning to our financials, when adjusting for material weakening in the yen, the Company delivered another quarter of solid earnings results that rounded out a year of overall strong performance, as Max addressed in this quarterly video update. For 2022, Aflac Incorporated reported adjusted earnings per diluted share, excluding the impact of foreign currency, of $5.67, which was the Company's second best year in the history following a record 2021. Aflac Japan generated solid overall financial results in 2022, with an extremely strong profit margin of 24.9%. One of the consistent key contributors to Aflac Japan's strong financial results is its persistency, which was 94.1% in 2022. As anticipated, our benefit ratio returned to a more normal level in the fourth quarter after seeing a spike due to the practice of deemed hospitalizations, the scope of which was narrowed last September. Throughout the year, we continued to navigate the waves of COVID in Japan. We expected sales would pick up in the second half of the year, especially in the quarter, and that's exactly what we saw happen. Sales in Japan rose 10.8% in the second half of the year, including an 11. 4% increase in the fourth quarter, which led to a full year sales coming in essentially flat. These results reflected the August launch through Associates of Wings, our new cancer insurance products. They also reflected our first sector product updates in the fourth quarter that better positioned Aflac Japan for future long-term sales opportunities. Recently, Prime Minister, Kishida announced that COVID would be downgraded to the same level as seasonal flu starting in mid-May. While we're encouraged by this announcement as a sign of daily life in Japan returning to pre-pandemic conditions, we will see how this evolves, but look to continue building on our sales momentum in 2023. In April, Aflac Japan will begin selling through Japan Post Group, our new cancer insurance product, and subject to FSA approval, [indiscernible] for serious diseases, which was developed in collaboration with Japan Post Group. We expect this close collaboration to produce continued gradual improvement of Aflac cancer insurance sales over the intermediate term and to further position the companies for long-term growth. Another element of our growth strategy is our intense focus on being there where consumers want to buy insurance. Our broad network of distribution channels, including agencies, alliance partners and banks continually optimized on opportunities to help provide financial protection to Japanese consumers and we are working hard to support each channel. Turning to the U.S., for 2022, we saw a solid profit margin of 20.4% in the fourth quarter. This result was driven by lower incurred benefits and higher adjusted net income, particularly offset by higher adjusted expenses. I'm pleased with the 17.4% sales increase in the fourth quarter, which reflected the largest amount of quarterly premium in the history of Aflac U.S. and continued to a 16.1% sales increase for the year. This reflects continued improvement in the productivity of our agents and brokers as well as contributions from the build-out of our acquired platforms, namely dental and vision, group life and disability. These are relatively small parts of our sales, but key elements of our growth strategy to sell in our core supplemental health policies. I'm encouraged by the continued improvement in the productivity of our sales associates and brokers. We are seeing success in our efforts to reengage veteran sales associates. And at a time, we're seeing strong growth through brokers. These results reflect continued adaptation to the pandemic conditions, growth in the core products and our investment and build-out of growth initiatives. I believe that the need for the products we offer is strong or stronger than ever before in both Japan and the United States. At the same time, we know consumers' habits and buying preferences have been evolving. We also know that our products are sold, not bought. As we communicate the value of our products, we know that a strong brand alone is not enough. We must paint a better picture of how our products help. In the latest commercial featuring the Aflac Duck and the Gap Goat, the goat personifies the gap that people face when they get medical treatment. Fortunately, the Aflac Duck is the hero who helps overcome the problem. I know this helps demonstrate the need for our products, thus helping our sales opportunities. We continue to work toward reinforcing our leading position and building on the momentum into 2023. Related to capital deployment, we placed significant importance on achieving strong capital ratios in the United States and Japan on behalf of our policyholders and shareholders. In addition, we have taken proactive steps in recent years to defend cash flows and deployable capital against the weakening yen. We pursue value creation through our balanced actions, including growth investments, stable dividend growth and disciplined tactical stock repurchase. With the fourth quarter's declaration, 2022 marks the 40th consecutive year of dividend increases. We treasure our track record of dividend growth and remain committed to extending it supported by the strength of our capital and cash flows. Additionally, the board reiterated its first quarter dividend increase of 5%. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we have remained tactical in our approach to share repurchase, deploying $2.4 billion in capital to repurchase 39.2 million shares in 2022. Combined with dividends, this means we delivered $3.4 billion back to the shareholders in 2022. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We have also focused on integrating the growth investments we made in our platform. We also believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. We are well positioned as we work toward achieving long-term growth, while also ensuring we deliver on our promise to our policyholders. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Before I turn it over to Fred, you may recall that the financial analyst briefing in November that I mentioned how Fred would be increasing his focus on Japan and spending more time over there to delve deeper into learning about the operations there. As David mentioned, he is joining us today from Japan where he's on assignment for the better part of 2023. As President and Chief Operating Officer, he is also continuing to focus on Aflac U.S. as well. I'll now turn it over to Fred. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Dan. I'm joined here in Tokyo by our Aflac Japan leadership team led by Masatoshi Koide, President of Aflac Japan. Let me begin by saying 2022 was an important year of operational and strategic progress across the organization. Our U.S. growth platforms, dental and vision, group life and disability and consumer markets have moved from integration to full production, with comprehensive product portfolios that are broadly filed and marketed across the U.S. under the Aflac brand. These businesses have modernized operating platforms built to support the scale we anticipate in the future and are now fully contributing to sales and earned premium growth. In Japan, our refreshed cancer product is now further enhanced with the launch of our new [Yuriso] consulting support model after nearly a year of successful testing. We launched a revised and tactical approach to the sale of our WAYS and child endowment products, leveraging the strengthened product appeal to promote third sector cross-sell. While navigating difficult COVID conditions, we were proactive in addressing our expense structure, defending strong margins in the face of revenue pressure. From a corporate perspective, we remain focused on risk management and capital efficiency. Two areas of focus included our approach to hedging the U. S. dollar portfolio in Japan and efforts to improve enterprise return on equity and Japan product competitiveness with the launch of Aflac Re, our Bermuda-based reinsurer. Finally, across the organization, we launched a coordinated effort to address the balancing act of investing in and delivering on growth, reducing expenses simplifying our business model and improving overall customer experience. This includes comprehensive project governance, a network of agile teams and regular reporting up to the Board level. The financial goal is simple: to deliver on the outlook provided at this year's investor conference with respect to growth and margins in the U. S. and Japan. We're proud of our efforts, but it's clear from our results that we have worked to do in a few key areas. This includes addressing weak premium persistency in the U.S. and revitalizing our production platform in Japan. Furthermore, we need to address these issues while continuing to advance our technology and associated process improvement across the organization. With that quick review, let's turn to current conditions and what we're focused on in 2023, starting with Aflac Japan. As Dan noted, claims recovered in the fourth quarter, as did the benefit ratio, on January 20th, Prime Minister Kishida announced plans to downgrade under the law COVID-19 to the same level of seasonal influenza, which will be enacted in mid-May. Importantly, this removes the immediate option to implement quarantine and other restrictive measures, such as state of emergency orders. We believe this move is designed to signal and encourage a return to normal, including business activity. While claims processing volumes remain high, this is driven by a natural lag in reporting of claims generated during Japan's seventh wave of COVID under the old deemed hospitalization rules. You can think of this as working the IBNR claims that were financially recognized in the third quarter. Despite continued waves of COVID, we expect our team in Japan to improve on the performance in 2022 as COVID, like the common flu, appears destined to become a way of life in Japan and elsewhere. In that regard, we're focused on the following: First, in terms of distribution recovery and productivity across our channels, our powerful associates channel requires aggressive approach to training and development to drive new customers. Separately, we are working with Japan Post on a campaign surrounding the introduction of the new cancer product in the second quarter. As Dan noted, we have strong commitment at the top of Japan Post, and we are cooperating at levels throughout the organization. It should be noted late this January we also introduced the new cancer product in our Dai-Ichi alliance as well as the financial institutions channel, both of which have performed below our expectations in recent periods. Turning to core product refreshment, our new cancer product will add a critical illness lump sum benefit rider in April, available on old and new cancer products and through Japan Post Group and our associates channels. Cancer ecosystem development is moving from launch to expansion. When analyzing current call volume, over 50% of the calls that are coming into our consulted related service platform relate to treatment, thus suggesting a value proposition beyond the pure financial benefit of paying a claim. Our 2022 refreshed approach to first sector savings is yielding expected results, with approximately 80% of all sales representing customers who are under the age of 49 and approximately 50% of all new first sector customers purchasing a third sector product which is twice our target of 25% cross-sell. Finally, in the face of increased competition and focus on selling the new cancer product, we have seen our medical sales decline and have plans to refresh our product in the fourth quarter. When stepping back to consider these activities, we are and have been taking broad action across product and distribution with an eye towards returning to an ¥80 billion production platform in the 2025 and 2026 period. The path to that level of production will build over time. But as we look towards 2023, we expect the continuation of our experience in the second half of 2022, where we generated consistent growth in production. Meeting our long-term targets will require strong execution on all fronts, as well as supportive market conditions and the cooperation of third-party alliances and partners to aid in driving productivity improvement. Finally, while we have made progress, we seek further advancement in digitizing paper and manual processes for greater operating efficiency. This is not entirely an Aflac Japan issue. It's a Japan financial service industry issue. In recent years, we have moved from 30% to approximately 50% of our applications submitted in digital form, with only 10% of claims processed digitally. Over time, we seek to drive digital applications to 80% and digital claims processed to over 40%. This will allow us to take additional cost out of our operations, but requires the commitment of our distribution partners, their agents and customers to drive adoption. I'm here in Japan in part, recognizing this is an important time for Aflac Japan. We are engaged in transformative activities that have long-term franchise implications as we seek to leverage our financial strength and leading third sector position. My focus will be partnering with our leadership team in revitalizing our distribution, incubating new product end markets and digital adoption to drive down expenses and improve customer experience. Turning to the U.S., as Dan noted in his comments, we continue to deliver a balanced attack to the marketplace. Split by product class, group benefits were up 28%, individual benefits up 8%. Split by channel, agent sales were up 7% and broker up 25%. With respect to our expansion businesses, network dental and vision and premier life and disability sales were up 98% and 75%, respectively, for the full year. The underlying signs of momentum are encouraging. For example, in our agent small business franchise, average weekly producers are up 3%, the second consecutive year of growth after a period of steady decline. Dental and vision is proving out our thesis of cross-sell as roughly $0.80 of supplemental health and life products are sold with every dollar of dental and vision. Our life and disability platform, not only has strong sales, but a successful renewal year, and recorded 97% premium persistency. Now fully integrated and expanding, we see 2023 as a year of leveraging this platform to both defend and grow voluntary group business. While it was a difficult year industry-wide for direct-to-consumer sales, we are encouraged by consumer markets 5% increase in sales in the fourth quarter with new alliances coming online. Finally, it was a challenging year for persistency in the U.S. Persistency has stabilized in our individual business. However, weakness earlier in the year continues to impact our trailing 12-month metric. Group Voluntary, a smaller contributor to earned premium, drove most of the 260-basis-point decline in overall persistency. Account persistency across the organization has remained relatively flat, but we lost a few very large accounts during the year. The industry has experienced weakness in voluntary persistency, which tells us there are also labor force dynamics contributing. We have stepped up our focus on persistency, establishing a dedicated office to drive and oversee a series of efforts, including product development, client service, technology solutions and incentive designs. Turning to investment results, investment income in the quarter was stable, with strength from higher yields on floating rate portfolios offset by increased hedge costs and anticipated weakness in alternative investment income. As expected and discussed last quarter, our alternative investment portfolio remained under pressure, posting a loss of $21 million in the quarter. By comparison, last year's quarter enjoyed $127 million in gains. This decline was anticipated given the natural correlation to the public equity markets and the lag in private equity reporting. Despite losses in the quarter, year-to-date, the alternative portfolio generated $103 million in income following an exceptional 2021. Throughout the year, we have refined our hedging strategy, reducing $2 billion in notional currency forwards in exchange for options that reduced hedge costs while protecting capital against material moves in the yen. Overall, as we look at 2023, we are staying the course with respect to our strategic and tactical asset allocations as we watch closely the risk of economic slowdown driven by Fed action to fight inflation. We are also watching the Bank of Japan as they introduce a new governor this spring which many believe could lead to a change in policy. Before turning the call back to David, it's worth following up on Max's recorded comments to reinforce how we are positioned with respect to potential for a period of U.S. or global weakness. Our morbidity-based insurance model is defensive in nature, with relative stability in sales, earned premium and profit margins through economic cycles. Among traditional life insurance peers, we maintain low asset leverage as defined by the ratio of general account assets to regulatory capital, particularly if you exclude our concentration in JGBs. We believe our portfolio is well positioned to weather the current economic uncertainty, recognizing we would anticipate some pressure on our $12 billion loan portfolios. We work closely with our external managers for middle market and real estate loans and have conducted a comprehensive stress test designed to apply recessionary pressure to these portfolios. Our approach included a moderate and severe recession, applying loss rates consistent with past economic cycles. Both scenarios resulted in elevated, but manageable losses, with no immediate need to change our disciplined approach to these asset classes and putting new money to work. When looking at the impact of core capital ratios, we developed a market pricing, ratings migration and loss scenario that falls in between a mild and severe recession and includes the entirety of our general account assets. When applying these stress tests, our core ratios of RBC, SMR and ESR all came out the other side well above are minimum thresholds. While it is wide to proceed with caution -- wise is to proceed with caution, we do not see recessionary conditions as disruptive to our capital deployment plans. I'll now hand the call back to David for Q&A. David?"
},
{
"speaker": "David Young",
"text": "Thank you, Fred. Now we are ready to take your questions. But first, let me ask you to please limit yourself to one initial question followed by a related question. And then get back in the queue to allow other participants an opportunity to ask a question. We'll now take the first question, Andrea?"
},
{
"speaker": "Operator",
"text": "We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jimmy Bhullar of JP Morgan Securities. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "So I had a question for Fred on long-term Japan sales outlook. I think you mentioned ¥80 billion in the '25 period. If we look back historically, that's still -- while it's up a lot from here, it's still consistent with what you had in 2019 and a lower number than '18. So is it that the market opportunity is less than it was before? Or do you think -- or should we assume that your market share has declined?"
},
{
"speaker": "Fred Crawford",
"text": "I think really -- so first of all, over the long run that is beyond 2025 and '26 we obviously would expect to continue some level of growth pattern. We simply stopped the timing around that time frame as a reasonable forecasting period. But there's no doubt, in the short run, meaning the next three to four years, that one of the shortfall compared to pre-pandemic levels was strength in the Japan Post distribution platform, including some very strong years of introducing new cancer in that platform. And it's clear to us at this point in time that while that platform is recovering, it's going to recover in a more linear fashion over time as opposed to a step function with dramatic increases. And that's because Japan Post is under a very diligent program of improving and investing in their platform, retraining their sales force and recovering from effectively halting and being out of the market for a period of time, as you know. So I think it's more of that gradual approach to the build that we expect that is playing on the slower growth rate. Now having said that, we're doing a lot of different things, as you know, we're refreshing our cancer product. We're adding to that cancer product competitiveness with our [Yuriso] consulting practice. We're also adding lump sum critical illness benefits, and we continue to focus on our other product development, including refreshing our medical product, particularly with an eye towards competing better in non-exclusive channels that are very competitive on the medical product, and we need to compete better there and build share. And then we're excited actually about the developments with WAYS and child endowment, particularly with WAYS. While it is not as high a return product as our other third sector, we're very pleased with the cross-sell activity, and it's also serving to build a little bit of momentum back in our core associate channel who needs more product to generate more commission and have more opportunity to recruit and build the sales force. So, so far, it's very early in that program. We're only a few months into reviving the WAYS product, but so far, the data is very supportive of the halo effect, if you will, particularly cross-sell. So we're doing a lot of different things here in Japan. But ultimately, the reason you see muted recovery is when we look at the throughput of these new products and capabilities, meaning the throughput through agents at Japan Post, agents at Dai-Ichi, agents and agencies in our associate channel, they're busy recovering from COVID, getting back out into the marketplace with face-to-face meetings. And of course, Japan Post is going through their own dynamics of recovery. So it's really the recovery in those third-party platforms that's causing us to be more cautious."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. And then on the change in classification of COVID as a seasonal flu beginning, I think, you said mid-May, how should we think about the impact of that on your claims and potentially sales?"
},
{
"speaker": "Fred Crawford",
"text": "I think from a claims perspective, you're seeing the recovery already, and that is we're expecting it to recover back to previous traditional levels of claims activity. I think I mentioned to you last quarter, a normal week in Japan for us is processing something in the neighborhood of 30,000 claims in our operating center. That rose to north of 90, 000 claims a week during the deemed hospitalization period and seventh wave of COVID. So we've seen that dramatically come back down to normal levels with the exception of working the backlog that I mentioned in my comments. So I think the idea is to return back down to normal levels of benefit ratios, and that's the answer there. In terms of new sales, we have Yoshizumi-san here and Koide-san and they can add their commentary. I think the trickier thing is, when you're talking about thousands of agents, some of whom were forced into quarantine conditions during COVID, the issue becomes not only are more agents out there able to produce and share numbers undisrupted by COVID, but will there be a recovery in face-to-face activity, which is more effective. This is still an extremely cautious society here. As we sit here today, we are all wearing masks on the way into work, on the way home from work, while at work and while walking the streets of Tokyo. So there's still some time to take place to recover the full normal activity. Yoshizumi-san, I don't know if you feel differently or have anything to add about COVID conditions."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "First of all, this COVID environment last year in the first quarter between January and March, sales have been severely impacted. And following that, the next peak, or the largest peak was between July and August, and many of the sales offices and branches were forced to shut down. However, the environment gradually changed, of course, at the timing of cancer launch, the things have been changing. And at the same time, agencies and sales agent activities became much more active. And as you've seen in our sales results, you can see that our new cancer insurance sales, is increasing and there's been a great momentum in sales as a result. And the result is that compared with 2021, we have about 30% increase in cancer sales. And also, our product strategy really was successful. For example, we were able to propose to customers more comprehensively of our products using WAYS. And as a result, third sector product sales increased because sales were done in a more cross-sell way. And as a result, we were able to exceed our second half 2021 sales in 2022. And as we enter this year, the COVID situation has been improving. And as a result, the agency's activities are even more active. And we are seeing that we now are gaining really good momentum with our strategies related to products plus the channel strategy in this new environment and in this environment with living with COVID. So what I am thinking now is that we are starting to really see an environment where we would like to be aiming for ¥80 billion in 2025 or 2026 time frame. That's all from me."
},
{
"speaker": "Operator",
"text": "The next question comes from John Barnidge of Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "My question is around the paperless initiatives that have been moved to digital and claims. You mentioned, I think it was 10% of claims digitally now moving higher, I think. Can you maybe talk about how this may impact benefits ratios over time for maybe a one-day pay style approach to digital?"
},
{
"speaker": "Fred Crawford",
"text": "Well, I think the primary benefit, there is certainly an ease -- customer ease element to moving to digital. But the primary motivation of moving to digital is increased agent productivity, yes, ease of doing business with the customer and the agent. There is, in fact, speed of processing claims that would pick up. For example, imagine paper-based claims processing when your claims went from 30,000 to over 90,000 a week during the last seventh wave of COVID. Had we been -- frankly, as an industry, this is not an Aflac thing. Had the industry been far more digitized in the level of claims they process digitally, you would have had much greater speed of claims adjudication. Normally, we'll pay a claim on average in around three days or so in Japan, sometimes four days. It had gone up to around 12 days during that peak level. It's now come down to around five days, so we've recovered quite a bit. But if you are in a digital environment, there's no doubt, John that you could speed that up and also protect against elevated claims periods to keep the speed and turnaround time faster. But I will tell you, a big motivation on our part to move to paperless is taking cost out of our structure. So when you're dealing with paper applications and paper claims processing and a heavy call volume related to customer service activities, all of that adds to cost structure. And in order for us to get that cost structure down, we've got to move it to digital, and that's what we're on a path to doing."
},
{
"speaker": "John Barnidge",
"text": "Okay. That's fantastic. And then my follow-up question, if we can stick with expenses. You had talked about a joint work with Japan Post for cancer launch. And then you talked about that backlog of claims from that seventh wave being the review mirror. But with that joint work on the cancer launch, are there any planned onetime expenses we should be thinking about?"
},
{
"speaker": "Fred Crawford",
"text": "Not materially. I'm looking at Todd Daniel's here, our CFO, and no, we wouldn't expect that. It's not unusual, however, when we launch a new cancer product in general and then launch in a major system that there is, in fact, a level of marketing expense that comes into play and launch expense. But quite candidly, while you may see it have modest implications to your expenses and expense ratio, it's not material and it's nothing I would characterize as a onetime thing that would pop out on our financials. It's just sort of normal way of doing business and normal business activity. So I wouldn't anticipate that, John."
},
{
"speaker": "Operator",
"text": "The next question comes from Alex Scott of Goldman Sachs. Please go ahead."
},
{
"speaker": "Alex Scott",
"text": "I just wanted to get an updated view on just capital management and capital management priorities. Just looking at even just in the U.S., I mean, how strong the RBC ratio is, I mean I think there's companies that run with around half of your RBC level. There's seemingly a lot of excess capital around the organization. So, I was just interested in your views on that and how that's evolving?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Alex. So, we have, obviously, throughout the COVID times, we made an active decision to hold capital in the subsidiaries given that we initially didn't know exactly where our benefit ratios and underlying profitability were going to go. So we opted to hold capital at a high level, both in Japan and in our U.S. subsidiaries. Coming out of COVID obviously, realizing that we are now operating at a high level, especially in the U.S. with an RBC ratio, on a combined basis, north of 60%, we do agree that, that's an excess capital position and that, over time, we would expect to operate our U.S. entities closer to 400%. That means that there will be capital coming out of those entities over the next couple of years. But we will do it when we sort of need it, and we will hold capital where we think it makes the most sense. There are times when it makes more sense to hold the capital centrally at the holding company, and other times when it makes more sense to holding at the subsidiary level. And we will, over time, optimize that."
},
{
"speaker": "Alex Scott",
"text": "Got it. And then the second question I had, I think it was mentioned earlier that Fred was going to be in Japan for some time. And I'd just be interested in sort of what the focus is for you, Fred, as you're over there? It sounded like maybe a year or something. What is your focus? What are your key objectives as you spent some time over there?"
},
{
"speaker": "Fred Crawford",
"text": "Sure. Yes, this is the result of Dan and I sitting down in the few months or so leading up to the year-end, and why Dan signaled that fab that I'd be shifting a bit of my weight to focus a bit on Japan. To be clear, I'm spending effectively 2023 in Japan. It started mid-January and will run through mid-December. There'll be times where I'll be back in the States for critical activities and other Board-related activities, et cetera, in the U.S. So I won't be here entirely. And very importantly, I haven't changed any of my job description. And so a s Dan mentioned, I remain actively involved in driving U.S. activities. But the main reason I'm here in Japan is that it's a recognition that, at Aflac, this is very different in how we operate Japan is not a subsidiary in what you would consider to be a normal global corporate company. Japan is intertwined in the fabric of the entirety of Aflac. There's extremely coordinated and close activities shared governance committees, shared intellectual capital around technology, digitization, product development techniques of going to market. We're really, in many respects, one company despite being 13, now 14 time zones away from each other. And so in order for me to do my job effectively, that is being President and Chief Operating Officer of this company, you've got to immerse yourself in understanding the Japan marketplace, our business model and the unique dynamics that drive this business. And you really -- you can do some of that making four to six trips a year for one week at a time or two weeks at a time, which I've done for seven years, eight years -- coming on eight years now. But it's entirely different when you immerse yourself in living here and working day-to-day with the groups. And where my focus is, is real simple. It's where you would expect when you look at our results. Number one, it's partnering with Koide-san and Yoshizumi-san to help revitalize the distribution platform of this company. We need to make a leg up. We need to address certain parts of the distribution, and we're going to have to execute and deliver to bring back that path to ¥80 billion. I think we have a wonderful opportunity to leverage the brand, our scale, being in one in four households where we can drive some of the new products and capabilities that we have been incubating in recent years. And so, I'll be focused on that. And then this move to digital, realize this is a significant effort. This is not as simple as looking at your operations and moving away from paper and moving to digital. This is really not about the technology. The technology is in place. This is about partnering with third-party distribution partners, everything from Japan Post and Dai-Ichi to our associate channel to banks to move them towards more digital adoption through campaigns and programs that increase that adoption. You have to realize this is not an Aflac issue. This is quite literally no different than what the rest of the financial service industry is trying to do. And so when we talk about moving from 10% to 40% of claims or 50% to 80% of applications, that's not just an Aflac issue to handle, it is attempting to move forward and beyond the rest of the industry that is plagued by paper. You don't realize this, but many insurance companies in Japan quite literally never went remote in their operating platforms because they couldn't during COVID. They had to keep bringing their people back in because they were tied to paper and processing. That was not our situation. We were able to go to 50% remote, but even 50% remote was a bit high -- a bit low, if you will, high in terms of bringing people in. So, there's a real need to do this, and it's transformative. So anytime you use the word transformation on distribution and transformation on operations, it's very important for somebody like me and my capacity to be here on the ground spending time in Japan."
},
{
"speaker": "Dan Amos",
"text": "This is Dan. I want to make a comment is that actually, I wanted Fred to go in 2020. And of all things, as you know, that was the year he got promoted to Chief Operating Officer and then COVID. So the year really is behind because I just thought -- it was actually his idea to stay there. My idea was to go there and live three months. And so that just shows how committed he is to the Company and doing well, and at the same time, working with the U.S. So I'm very pleased with Fred being over there. And that knowledge you cannot buy. It takes being over there, either the way I've been going for 40 -- over 40 years of the Fred's doing in the last seven. So thank you, Fred, and... David?"
},
{
"speaker": "Operator",
"text": "The next question comes from Suneet Kamath of Jefferies. Please go ahead."
},
{
"speaker": "Suneet Kamath",
"text": "On the Japan sales, can you give a sense of how much of those sales represent to the lapse and reissue -- and when we think about the sales metric that you show in your supplement, is that a sort of a gross number? Or is that a net number when we think about policies that may be lapsing?"
},
{
"speaker": "Fred Crawford",
"text": "When you look at sales, it's a gross number. So it includes the sale of policies to new customers or customers without the policies and replacement policies. At the same time, a replacement policy also counts towards lapsation. So in other words, yes, it counts as a sale on a gross basis, but also a replacement policy is considered a lapsed policy as well. So you end up having higher lapse rates and higher sales when you have replacement activity. That's why, in fact, you see our amortization expense pop up in the fourth quarter when we launch a new cancer product or a new medical product because you effectively have a greater level of lapsation. But there's nothing wrong with a replacement policy. It's really nothing more than going out to a customer and saying, you may benefit from an upgraded structure of benefits and pricing and other additive writers, et cetera., and there's nothing wrong with that. The issue isn't the lapse and replacement policy. The issue is when it's too much of what you sell, meaning you want to be driving more new customers and have the proportion of your lapsed and reissued or replacement policies be a lower percentage of your overall sales. That's why you're seeing what we're doing, developing coming back out with WAYS, which attracts a younger, as I mentioned, and newer cohort of investors. Creating products like the disability or income products that are sold and now small businesses to employees who lack that type of coverage, and elderly care product, which is a growing market, albeit a slow growing market. All of this is designed to try to attract and develop new customers. And we believe we can make progress on that. But right now, the lapse reissue is naturally higher when you launch a new cancer product. And that's really typical of what we've seen in the past."
},
{
"speaker": "Max Broden",
"text": "And just to add, Suneet, to how this impacts our P&L, it obviously impacts our benefit ratio and expense ratio as well. The benefit ratio was lower by about 90 basis points in the quarter from increased lapse and reissue activity, and our expense ratio was roughly 50 basis points higher because of higher DAC monetization that Fred referenced."
},
{
"speaker": "Suneet Kamath",
"text": "Got it. I think last quarter, you had said that the lapse reissue is over 50%. Is that kind of still where it's running in Japan?"
},
{
"speaker": "Todd Daniels",
"text": "Yes, Suneet, this is Todd. It's still running around that rate. We saw it a little higher in the third quarter when we launched. And naturally, that rate starts to come down. So I think as a whole, over the first six months or so, we anticipate being around 50%."
},
{
"speaker": "Operator",
"text": "The next question comes from Ryan Krueger of KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "Could you talk a little bit more about what you saw in terms of the elevated U. S. lab activity in the fourth quarter? And then, also if you can provide any commentary on if that's continued into January or is settled down?"
},
{
"speaker": "Fred Crawford",
"text": "I commented in my script, this is Fred, about the lapse rates in the U.S., and it really mimics what I said. And there's really two categories to look at it. One is our individual products. You can think of these as our traditional products sold to small businesses, the largest portion of our in-force and sales. And that lapse rate was down around 1% and, honestly, down 1.5-or-so early in the year and then slowly recovered to where, by the fourth quarter, it was down more modestly."
},
{
"speaker": "Dan Amos",
"text": "Yes, Fred, Steve's got some numbers here on that, I think. Steve?"
},
{
"speaker": "Steve Beaver",
"text": "Yes, I would just add that Fred's script and talking points were spot on. We did see account lapses in the fourth quarter, particularly in our group business. not attributable to anything specific or systemic. We do have -- we did experience some large account lapses. We did pick up, as Fred highlighted, in the third quarter, some large accounts through the last half of the year. But net-net, we were down through the last half of the year at group. I would just add that looking forward into 2023, we are going to -- we have this office on persistency where we're going to approach this experience that we had in 2022 through product development, client service, technology solutions and incentive designs, but moderating that or modifying that to how the economy performs in 2023. That's an important thing for us to make sure that we use data to drive our actions in 2023 to get persistency back online."
},
{
"speaker": "Max Broden",
"text": "Yes. We certainly expect the continued decent velocity of the labor force and so that will continue to be there. But at the same time, we do expect the recovery overall in our persistency going into 2023 relative to 2022."
},
{
"speaker": "Fred Crawford",
"text": "I think you have to put it in perspective, too. This was largely focused on large accounts, the loss of large accounts, which will happen from time to time in the group business and the group business represents 15% of our earned premium. So in other words, look at our earned premium. It was down 0.2% in the fourth quarter. It was down 0.8% or less than 1% for the full year. That's not what we want. We want growth in earned premium. But we can recover from periods of week persistency. We have to focus on it. We have to bring it back. But the largest lapse rates were in the group business, which currently represents a smaller portion of our earned premium and is the fastest-growing part of our company so generated tremendous sales, which helps make up for some of that lapse rate. So we're trying to hold the line on earned premium, which is the most important component to manage."
},
{
"speaker": "Ryan Krueger",
"text": "And then just one question on the critical illness rider that you're going to be operating in Japan. Can you help frame how big of an opportunity that is? And it seems like trying -- I know that Japan Post is in a gradual recovery mode, but it seems like that would be a fairly meaningful opportunity given that you can add it to the existing policies."
},
{
"speaker": "Dan Amos",
"text": "Yes, I'd like Kite to answer that or Yoshizumi to cover that."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "This is Yishizumi. I will cover your question. We are currently planning to launch this lump-sum serious disease rider in April in Atria. But then that assumes that this product will be approved by the SSA, This product responds to customers' needs of having to want to prepare against, not only cancer, but also for cerebral vascular diseases as well as heart diseases. And the Japan Post Group as well as with Aflac, we are trying to fully prepare to launch this product. And as you know, the Japan Post sales is gradually recovering. And what we are expecting is that this new rider will also help accelerate sales and recovery of the Japan Post."
},
{
"speaker": "Masatoshi Koide",
"text": "So let me just add a little bit here. This is Koide. And this new rider that is to be attached to cancer product was jointly developed by Aflac and the Japan Post Group as part of our strategic alliance collaboration. That's all from me."
},
{
"speaker": "Operator",
"text": "The next question comes from..."
},
{
"speaker": "Dan Amos",
"text": "Excuse me, let me just make one other comment. I don't think the rider is going to be that much premium. But what it does is it gives an opportunity to get with the salespeople and go back to everyone telling them what we've got, which will ultimately help sales of the cancer policy as well. So I would look at it that way. Now that's just my viewpoint. Thanks."
},
{
"speaker": "Operator",
"text": "The next question comes from Wilma Burdis of Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"text": "This is Wilma. Maybe you could give us some color on how modestly higher interest rates in Japan will impact Aflac in the longer run."
},
{
"speaker": "Fred Crawford",
"text": "I think it may be good for Brad island to talk about that. It's largely an investment question."
},
{
"speaker": "Brad Dyslin",
"text": "Wilma, thanks for the question. We are expecting to see a little bit of volatility in rates in first quarter. As you're probably aware, there is an expected change in the governorship scheduled for February. And there is a lot of expectation that, that could lead to a policy change -- we saw a bit of a move in December when they widened the range on the 10-year JGBs by 25 basis points. So the magnitude of the opportunity is really going to depend on how much rates move. Remember, we are still at very low levels. And while a 25- or 50-basis-point move is certainly welcome, it's unlikely to result in a very big left or right turn on our asset allocation. But of course, yen assets are very important to us for the obvious asset liability management reasons, and we'll be keeping a close look as well as any opportunities to swap JGBs into higher-yielding yen credit assets."
},
{
"speaker": "Max Broden",
"text": "And Rima, just a reminder in terms of the impact on our capital ratios, our SMR sensitivity to 100 basis points shift in the yen yield curve is 35-point -- negative 35 points on our SMR. Our ESR, more importantly, goes the other way. And obviously, higher yen rates are positive to our ESR. So a 100-basis-point shift in the gain yield curve would increase our ESR by 34 points."
},
{
"speaker": "Wilma Burdis",
"text": "And I guess could you give us a more specific examples of the lapses in the U.S. and some of the things you're doing to address it address those?"
},
{
"speaker": "Dan Amos",
"text": "Virgil?"
},
{
"speaker": "Virgil Miller",
"text": "I'm sorry -- this is Virgil Miller, coming off mute. So Steve talked a little bit about it, let me give a little bit more color though. At the end of the day, when Steve and Fred both mentioned the office of persistency, what we're really looking at is, how do we drive utilization so that people understand the benefits they even acquired? When we're looking at selling our products, we do so making sure that our products are benefit-rich and -- but also that they're being utilized, so some of the things you'll hear us talk about is activity to make sure people have a knowledge and education around the benefits of how do we partner with our brokers, how we partner with our agents out there, and then with the employer to help drive utilization. We know that when they actually use the benefits, they have more of a tendency to keep it. And so you'll hear us talk a little bit of share more results around activities like that."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you all for joining our call this morning. And I just want to say, if you have any questions, please feel free to reach out to the investor and rating agency relations team. We look forward to speaking with you soon, and wish you all continued good health. Thank you."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation and you may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 3 | 2,022 | 2022-11-01 08:00:00 | Operator: Good day, and welcome to the Aflac Inc. Third Quarter and Total Year 2022 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I'd now like to turn the conference over to David Young. Please go ahead.
David Young: Thank you, and good morning. Welcome to Aflac Incorporated's third quarter earnings call. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com, along with a video from Max Broden, Executive Vice President and CFO of Aflac Incorporated, who provided an update on our quarterly financial results and current capital and liquidity. Max will be joining us for the Q&A segment of the call, along with other members of our executive management, including Teresa White, President of Aflac U.S.; Virgil Miller, Deputy President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Brad Dyslin, Deputy Global Chief Investment Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; Steve Beaver, CFO of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO of Aflac Life Insurance Japan; Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?
Dan Amos: Well, good morning and thank you for joining us. Let me begin by saying that the third quarter of 2022 concluded a solid first nine months for the Company. Aflac Incorporated reported net earnings per diluted share for the third quarter of $2.53 and $6.25 year-to-date. Adjusted earnings per diluted share were $1.15 in the third quarter and 4.03% for the first nine months. These results are solid despite the impact of significantly elevated COVID claims in Japan during the third quarter due to the industry practice of deemed hospitalization. Overall, I am pleased with where we stand at the beginning of the fourth quarter. We remain on track for another good year of financial results, and we expect continued sales momentum in both markets. As we have communicated in the second quarter, we anticipated a sharp third quarter increase in COVID claims in Japan, and we experienced that increase. We are now seeing more normalized COVID claims during the fourth quarter. Reflecting on the third quarter, our management team, employees and sales force have continued to be resilient while being there for the policyholders when they need us most, just as we promised. Looking at our operations in Japan in the quarter, Aflac Japan generated solid overall financial results with a profit margin of 21.6%. One of the key contributors to Aflac Japan's strong financial results is its persistency, which has remained consistently strong at 94.3% for the past four quarters. New annualized premium sales continued to improve in the quarter with the launch of our new cancer insurance product through agencies in late August, which drove a 32.6% increase in cancer insurance sales in the quarter. This contributed to an overall sales increase of 10.2%. I just recently returned from my trip to Japan this year. As you'll recall, I traveled to Japan in June and had a successful meeting with the management at Japan Post Holding, Japan Post Company and Japan Post Insurance. This most recent trip in mid-October was geared toward connecting with our agencies, where I went to five different cities across Japan, and it was equally successful. As you know, we strive to be where consumers want to buy insurance, and this is accomplished through all the distribution channels, agencies, alliance partners and banks. We continue to closely track how pandemic conditions are evolving, particularly because of its correlation with the opportunities for face-to-face sales, which is key to the recovery in sales. I arrived home from Japan excited by the energy at the agencies with whom I met and feel very good about our ability to sell new policies as we emerge from the pandemic. As I mentioned, we have seen our benefit ratio normalize so far in the fourth quarter given the narrow scope of deemed hospitalizations introduced towards the end of the third quarter. We continue to expect stronger sales momentum in the fourth quarter, assuming that productivity continues to improve at Japan Post Group and that we execute on our product introduction and refreshment plans. We will start selling our new cancer insurance product through Japan Post Group in the second quarter of 2023. Turning to Aflac U.S., we saw solid profit margin of 19.3%. I am pleased that we again generated sales growth with an 11.8% sales increase in the third quarter and a 15.2% increase year-to-date. I am encouraged by the continued improvement in the productivity of our sales associates and brokers with the strength of both channels approaching pre-pandemic levels, as we enter what trends, excuse me, to be our strongest quarter of the year. We are seeing success in our efforts to reengage better in sales associates. And at the same time, we are seeing strong growth through brokers. These results reflect continued adaptation of the pandemic conditions, growth in our core products and investments and build-out of our growth initiatives. While Aflac Dental and Vision and Group Premier Life Management and Disability Solutions, which we now call PLADS, a relatively small part of our sales, we are pleased with how they're contributing to our growth, and opening opportunities to sell our core supplemental health products. We continue to work toward reinforcing our leading position and generating stronger sales for the fourth quarter. I believe that the need for the products that we offer is strong or stronger than ever before in both Japan and the United States. At the same time, we know consumer habits and buying preferences have been evolving. We remain focused on being able to sell and service customers whether in person. This is part of the ongoing strategy to increase access, penetration and retention. Turning to capital deployment. We place significant importance on continuing to achieve strong capital ratios in the U.S. and Japan of behalf of our policyholders and shareholders. We continue to generate strong investment results while remaining in a defensive position as we monitor evolving economic conditions. In addition, we have taken proactive steps in recent years to defend cash flows and deployable capital against a weakening yen. When it comes to capital deployment, we pursue value creation through a balance of actions, including growth investments, stable dividend growth, and discipline and tactical stock repurchase. With fourth quarter's declaration, 2022 will mark the 40th consecutive year of dividend increases. We treasure our track record of dividend growth and remain committed to extending it, supported by the strength of our capital and cash flows. We have remained in the market repurchasing shares with a tactical approach. Year-to-date, Aflac Incorporated deployed $1.8 billion in capital to repurchase 30.3 million of our shares. Combined with dividends, that means that we delivered $2.6 billion back to the shareholders for the first nine months. With this approach, we look to emerge from this period in a continued position of strength and leadership. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We have also focused on integrating the growth investments we have made. We are well positioned as we work toward achieving long-term growth, while also ensuring we deliver on our promise to the policyholders. I am proud of what we've accomplished in terms of both social purpose and financial results, which have ultimately translated into strong long-term shareholder return. We also believe in underlying strengths of the business and our potential for continued growth in Japan and the U.S., the two largest life insurance markets in the world. Throughout the uncertainty of the last few years, I think we've done a good job in maintaining our focus on controlling the things that we have the power to control. We can and will control our efforts to build our business and take care of those who depend upon us, our policyholders, our shareholders, our customers, our employees, our distribution and the communities in which we operate. In closing, you've heard me say many times this before of how I believe that one of my key roles as CEO in conjunction with the Board is to develop our leaders to lay a groundwork for strong succession planning. This approach enables continuity and expertise in strategic execution. You saw that succession planning in action recently with the two deputy positions moving to the next level. The announcement last week of Brad Dyslin, who will assume the role of Chief Investment Officer in January of 2023 as well as the August announcement of Virgil Miller, assuming the role of President of Aflac U.S. I want to thank Eric for his vision and expertise in building a world-class investment organization that has performed at a high level. I also want to thank Brad for his new leadership role. Brad has proven himself as a distinguished leader collaborating with Eric and the team to deliver strong results and enhancing the reputation of Aflac Global investment. I also am grateful for Teresa's 24 years of outstanding leadership and contribution to Aflac, most recently as President of Aflac U.S. for the last eight years. As Virgil assumes his role, I know he is well suited to lead Aflac U.S. with a seamless transition as Aflac continues to build on its path toward delivering efficiencies, innovation and growth. These are great examples of how we place a high priority on ensuring that we have the right people in the right place at the right time. In doing so, we have continued our focus on building a strong, deep bench of leaders preparing to take on more responsibility. Thank you all for joining us this morning, and I'll turn the program over to Fred. Fred?
Fred Crawford: Thank you, Dan. Last quarter, I commented on how we are positioned as a company when considering current U.S. and global economic conditions. The impact of inflation does apply upward pressure to expenses. However, this is mitigated by rising rates and additional investment income. In terms of the risk of recession, our morbidity-based insurance model is generally defensive in nature with relative stability in sales and earned premium through the economic cycles, low asset leverage, and exposure to risk assets. Finally, while certainly not immune to volatility in foreign exchange, we have put in place defensive measures to combat the economic impact of a weakening yen. Overall, we like how we are positioned and see no material adjustments to our operating or capital plans. Turning to Japan. We witnessed COVID cases surging in what is now referred to as Japan's seventh wave of infections. Daily new cases in the quarter reached a peak of 260,000 in August with the wave concentrated in the July through September time frame, effectively running its course in the third quarter. Daily cases have now slowed to a seven-day average of roughly 40,000. As we signaled last quarter, we experienced elevated COVID incurred claims, driven by its designation as an infectious disease and the industry practice of deemed hospitalization, which allows for payment of claims for care outside of the hospital. To give you an idea of the magnitude, before the seventh wave, our weekly COVID claims were in the 7,000 to 13,000 range. During the recent wave, we peaked at approximately 47,000 weekly COVID claims. Hospitalization remains low, and this lack of severity has resulted in the government of Japan changing the definition of deemed hospitalization. Effective September 26, the scope has been narrowed to the elderly, those requiring hospitalization and individuals more vulnerable to severe symptoms. This change in policy, together with lower overall rates of infection will greatly reduce the volume of new claim submissions. While more volatile than usual, we have established reserves for claims incurred in the period, but not yet reported. Therefore, we expect pressure on Japan's benefit ratio to subside in the fourth quarter. Dan mentioned his trip to Japan. I also traveled to Japan in the last few weeks. The general population remains very cautious with respect to the potential for COVID infection. For example, if you walk the busy streets of Tokyo, you'll stand out if you're not wearing a mask outside. While difficult to measure, we believe this remains a headwind for proposal volume and sales; however, our view is conditions are improving. Despite these conditions, we remain focused on the following: distribution recovery and productivity across all channels, core product refreshment and product line expansion, cancer and elderly care ecosystem development through Hatch Healthcare and digitizing paper and manual processes for greater operating efficiency. We will develop these themes in more detail at our financial analyst briefing later this month. Before I jump to the U.S., let me also extend my gratitude to Teresa White. She's been a trusted adviser to me and helped me acclimate into this new role of mine and getting educated on the U.S. platform, and I also look forward to working with Virgil as we're off to a great start in 2022. Turning to the U.S. As Dan noted in his comments, we continue to deliver a balanced attack to the marketplace. Split by product class, group benefits were up nearly 28%, individual benefits up 4%. Split by channel, agent sales were up 6% and broker up 20%. With respect to our expansion businesses, Network Dental and Vision and Premier Life and Disability were up 120% and 39%, respectively, for the quarter. Consumer markets continues to struggle down 13% and somewhat expected given the cost of lead generation and timing related to the rollout of new product. We remain bullish on this building business, having recently launched our direct-to-consumer dental and vision products as well as new alliances introducing senior and core Aflac products on third-party platforms. Persistency has recovered in our individual business as labor markets appear to have stabilized; however, group persistency has been weak throughout 2022. Our group business represents about 15% of our U.S. earned premium and has traditionally lower persistency compared to individual. There are no systemic drivers, but this segment can be more volatile, and we have experienced the loss of a few larger accounts this year. Our focus in the U.S. remains the following: recovery in our agent-driven small business model post COVID, maintaining momentum in our group voluntary business, building out our expansion businesses and realizing the halo effect in associated voluntary sales, and bending the expense ratio curve, transitioning from investment to benefit realization. Again, we will develop these themes at a briefing later this month. Turning to global investments. Let me first add my sincere gratitude to Eric for his years of leadership and trusted counsel in managing not only our investments, but contributing to many of the key financial strategies that have positioned us well today. Congratulations to Brad. I can't think of a better prepared executive to ensure continuity and carry-forward our record of strong investment performance. In terms of investment conditions, with the rise in short-term interest rates, we are actively managing the interplay of net investment income and the cost of currency hedging. Given the material increase in LIBOR forward curves, we elected to lock-in a large portion of our floating rate portfolio to protect against future rate declines. A portion remains floating and will benefit if rates continue higher. We believe this balanced approach to managing interest rate risk in our floating rate book positions us well for future rate volatility. We maintain our traditional approach to rolling foreign currency hedges on a portion of our U.S. dollar portfolio in Aflac Japan. We also continue to hold options against our unhedged dollar assets, a strategy that protects our Aflac Japan capital position against a large weakening of the dollar. While hedge costs are on the rise and will impact Japan segment earnings, the combination of floating rate investment income and offsetting hedge instruments at the holding company, serve to largely neutralize the impact to enterprise earnings. Our alternative investment portfolio pressured results in the quarter, recording a $40 million loss from our third quarter valuation marks. This was anticipated given the natural correlation to the public equity markets and the lag in private equity reporting. Despite losses in the quarter, year-to-date, the alternative portfolio has generated $125 million in income following a very strong year in 2021. We expect continued pressure on alternatives in the fourth quarter as the markets remain volatile, but fully intend to invest through the cycle and capture the long-term return benefits of this strategy. Offsetting our variable investment income results was a negotiated prepayment of a private security and large amount of associated make-whole income. This -- we call this out in our results as the event contributed a one-time boost of $84 million pretax to investment income. Our middle market and transitional real estate loan portfolios continue to perform well. We have reserves set up for these loans, which have increased modestly, reflecting potential softening of economic conditions. We are closely monitoring the risk of recession. We maintain a defensive position to risk assets and feel good about how we're positioned. We continue to seek attractive opportunities recognizing the near-term risk of a global slowdown and do not have any acute de-risking activity planned at this time. I'll now hand back to David to take us to Q&A. David?
David Young: Thank you, Fred. We're ready to take your questions, but before we do, I ask please limit yourself to one initial question and one related follow-up to allow others an opportunity to ask a question, and you may get back in the queue as well. Jason, we'll now take the first question, please.
Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from John Barnidge from Piper Sandler. Please go ahead.
John Barnidge: My question, you announced in October Dental, Vision and Hearing plans available to individuals outside of the traditional work site. Can you talk about how you're going to meet the customer, how sizable an opportunity is and how you think about acquisition costs there, please?
Fred Crawford: So the -- what we announced was the launching of Dental and Vision and Hearing on our direct-to-consumer platform. And so this is really what we mean by outside the work site is our direct-to-consumer platform is designed specifically to go after potential customers outside the normal work site pay or W-2 employee environment, meaning the gig economy, individuals who are -- work outside traditional W-2 environment, self-employed, for example, and then also to some degree, the senior markets who are naturally concentrated outside the work site. So, this is really a strategy to enhance our product lineup the direct-to-consumer platform. We think the Dental and Vision piece of it is important really for two reasons. One is, of course, the ability to generate sales through that channel, but the other is Dental and Vision and Hearing is a heavier searched item by individuals. And by putting product on our platform that caters to more search activity, it offers up an opportunity to cross-sell some of our traditional supplemental health products, which are less searched for. So that's effectively the strategy, John. Did I answer your question? Or do you have a second question there?
John Barnidge: Yes, Fred, that was fantastic briefly, the related follow-up. Can you talk about the initial tech rollout of the group benefits package? I know the fourth quarter of '22 is the big rollout since it has pet insurance?
Fred Crawford: So, on the topic of pet insurance, we have, in fact, rolled out the pet insurance alliance. This is the Aflac Pet insurance powered by Trupanion. We have focused on the larger broker-driven case size for that product. We characterize that as our premier broker relationships, which tend to travel in the 1,000 employee and up case size. It is really just getting off the floor. I think we have been awarded four accounts so far and are in the process of building that out. I would characterize this year as still somewhat of a proof-of-concept year in terms of getting out there with the product, successfully landing accounts, integrating those accounts between the two parties, our partnership with Trupanion and then making any tweaks or adjustments that we think are necessary to better compete as we roll towards 2023. But we are up running and launched. We're filed in all the states. The product is ready to go but concentrated in the large case market. So we will have, obviously, a fairly small level of sales this year. Also be mindful of this is really earned premium and economics for Trupanion. Our play from a pet insurance perspective is to fill out our portfolio, as you suggest, to where we're able to offer a broader array of benefits to brokerage clients, who desire that plus also their end clients. Other than that, I would say our product upgrades have been relatively routine in nature, meaning natural upgrades, covering things like mental health and other dynamics that have become more important to the broker and the consumer this year, and we continue to do that as a normal part of our business activities.
Dan Amos: This is Dan. Let me make one comment is that, for example, with Dental and Vision, it's not so much selling that product as it is open the door to sell our existing products. And for every five Dental and Vision products we sell, we sell an additional three supplemental health insurance products. So that's what we're really looking towards. The other is gravy of how we're doing those other things, and we like that, and I'm glad to have it. But it's being on the front page of the benefit section of the employers' HR that really makes the difference, and this is what we're counting on long term.
Operator: The next question comes from Nigel Dally from Morgan Stanley.
Nigel Dally: So I just wanted to start on the new cancer product. How long should we expect this product to boost all -- it seems like product lifecycles have shortened, perhaps to only a quarter or two. So we'll be interested whether that's consistent with the view for this product. And also if you can touch on additional product introductions you have slated for 2023, you mentioned the Cantor product for Japan Post. Are there other products also due to be refreshed next year?
Koichiro Yoshizumi: Thank you for the question. This is Yoshizumi. Let me answer your question. Well, in terms of the cancer insurance, we have launched our new product in -- on August 22. The channel that we have launched the new product is in the general agencies channel and live channel. And the sales through these channels between August and September this year have been quite successful. The actual sales was up 50%, 5-0% year-on-year. And we are seeing a great momentum still in the fourth quarter as well regarding this cancer insurance. And we are seeing about 47% increase year-on-year at the moment. And also from January 2023, we will start offering more comprehensive support related to cancer called Cancer consolidation service. This is a new service that would comprehensively support the patients or the policyholders from the time they develop cancer and up to the point they recover to their work. And this is the first of its kind in the industry. And this service will be able to respond to all the struggles and all the things that the patient as well as the family members have difficulties with. This is a great differentiator against other cancer insurance. And regarding the sales to start in the Japan Post Group, we are hoping to have it launched in the second quarter next year. We are thinking of working closely together with the Japan Post Group to increase the actual sales channel or sales route as well as training. And in terms of the other channels such as financial institutions and Dai-ichi Life, we are planning to launch the cancer product in January next year. And we will be actively and aggressively selling cancer insurance in the fourth quarter this year as well as the first quarter next year, and that's all for me.
Nigel Dally: That's great. Then just as a follow-up, I saw a bit of a step up in the pace of buybacks this quarter. I just wanted to understand what's. Your excess capital position seems to be at a level where you could easily continue at that pace, conversely with the risk of recession, maybe you want to hold on to some more capital. So just some comments as to how we should be thinking about buybacks?
Max Broden: Thank you, Nigel. It's Max. So $650 million in the quarter, and as always, we look at our capital levels, the capital generation, current and future that we expect from our subsidiaries in the overall enterprise, as well as the opportunity set that we see in terms of deploying capital, that being through dividends, buybacks, opportunistic deployment, et cetera. And that's really what sort of drives how much of buybacks we are doing at any point in time. And generally speaking, we want to deploy capital where we see good IRRs, and the buybacks that you saw in the quarter was a reflection of that. In terms of looking forward, we feel good about our overall capital position and liquidity as well despite the very significant movement that we've seen in the yen.
Operator: Next question comes from Jimmy Bhullar from JPMorgan. Please go ahead.
Jimmy Bhullar: Teresa and Eric, good luck in the future. So first on a question just on policy usage in the U.S. The benefits ratio has been lower than normal through the pandemic, and it was fairly low in 3Q as well. Do you feel that you're still benefiting from low usage in the U.S.? Or is the benefits ratio reflective of what you expect it to be going forward?
Max Broden: Yes. It's Max again. I would just say that overall claims utilization continues to be at a relatively low level in the U.S. And especially on some lines of business, like accident, hospital, et cetera, we have been a little bit surprised that we haven't sort of come back to the full normal levels, as well as cancer that have not gone sort of above the pre-pandemic trend. We would expect that to actually happen for a short period of time, simply because there's some catching up to do in terms of cancers that should be detected and also some severity come through as well. We have not seen that yet. We do expect that in the cancer lines of business, but overall, we have seen favorable claims utilization in the quarter and throughout the full year so far. And I ask the U.S. team and Teresa and Virgil to sort of fill in with your comments as well.
Teresa White: Yes. I'll just add to that. You're absolutely spot on with your comments. We are seeing lower hospital benefits as well coming out of the pandemic and more outpatient-focused therapies wherever possible. So, we're seeing first occurrence benefits to rebound to 2019 levels, but hospitalization has lagged. That's really all I wanted to add to that.
Jimmy Bhullar: And Fred, you had commented in your prepared remarks about, I think you implied that people wearing masks, is still a hindrance to sales in Japan. Are you seeing lower appointments than normal? And are there other things besides just masking, like social distancing, people not coming back to work full time that are also weighing on sales results?
Fred Crawford: Yes, I think there's a couple of things going on. One is, yes, there is a general headwind to face-to-face communication unless necessary. And so that persists in Japan, although as I mentioned, it is improving. And in fact, the actual government of Japan is now coming out and encouraging people to open up a little bit and get back to traditional business. So, it's not at pre-COVID levels of activity. And that's what I mean by remains a headwind, but it certainly is improving. I think the other dynamic that we mentioned last quarter that remained the case during the third quarter is when you have a high level of cases and a high level of infection rates of COVID, you naturally are going to have actual agents that are infected and impacted and are pulled out of the field, so to speak, unable to meet with clients or meet effectively with clients. And so that has played into it. You're talking about our distribution model through third parties has several thousand agents that we sell through. And so when you have something as widespread as the third quarter level of COVID cases, you naturally will see less feet on the street, so to speak selling. Again, we think this will naturally improve for the same reasons we see our benefit ratio and claims activity improving in the fourth quarter.
Dan Amos: And Fred and I have discussed this, but one other point is, just remember, Japanese were wearing the mask before COVID. So I don't think I went anywhere that I saw anyone that did not have on the mask, but it begins to look more normal. And so we'll have to wait and see. But everyone's -- I hardly ever see anybody with mask, except at hospitals and other places in the U.S., but they're still wearing them, but they're beginning to function. And I think that's the point that we're both making is, is that things are moving back to normal. But if you take a snapshot, you're going to see everybody with mask on and you're going to say, Oh, well, it's awful. Well, it's their culture too. So don't not think about that as you're a little going forward.
Operator: The next question comes from Suneet Kamath from Jefferies. Please go ahead.
Suneet Kamath: Just on the Japan cancer sales. Can you give a sense of what percentage of the sales were lapsed reissue and how that compares to prior product launches?
Todd Daniels: Suneet, this is Todd. I think I'll take that. It takes time for us to look back and know exactly how to identify the lapse and reissue. We don't see it until the lapse actually is processed. So right now, we're seeing slightly higher lapse and reissue rates over 50%. And we believe that this could go higher as we look backwards, but this is within our expectation.
Suneet Kamath: Okay. Got it. And then I guess, just curious on the timing of when you're going to start sales through Japan Post in the second quarter. I think that's probably the start of their fiscal year. So maybe that's the reason. But any color on what the client overlap is between Japan Post and some of your other distribution channels?
Fred Crawford: I don't know if you'll see Yoshizumi-san or Koide-san have any color they can provide on the overlap.
Koichiro Yoshizumi: So, this is Yoshizumi once again. In regards to the Japan Post sales of new cancer, we are thinking of it to start in the second quarter. And in other channels, we are thinking of having the product launched in January such as in bank channel or the Dai-ichi Life channel. And I'm not quite sure whether I'm answering to your question or not, but because of the overlapping of the channel's launch or the timing difference of the launch in each channel, there will be smooth launching of products from one channel to another.
Masatoshi Koide: Okay, this is Koide. Let me just add a little bit. And of course, in each channel, there are some overlaps of customers. And although I did mention that there are some overlaps of customers between channels, at the same time, each channel has its own specific customer base. Therefore, for example, in Japan Post Group, the other channels may start selling the product before the Japan Post Group, because the Japan Post will not start its sales until the second quarter. However, because Japan Post Group has a very solid customer base on its own, there should be a great sales from there as well.
Operator: The next question comes from Wilma Burdis from Raymond James. Please go ahead.
Wilma Burdis: My understanding of the 940 basis points of higher Japan benefits ratio from the hospitalizations, about half of that was reported, and the other half as IBNR. This feels a little bit conservative. I don't know if you agree. Is it possible that some of this could be reversed in 4Q? Or is that -- just help us think about the benefit ratio in 4Q between releases and what's going on there?
Max Broden: Let me kick off, and I'll have Al or Todd sort of add their comments as well. So for the full year, we would expect to have a Japan benefit ratio in the range of 69% to 70%. And we were sitting at 69.8% as of the first nine months. That obviously means that we are expecting a more normal benefit ratio in the fourth quarter if you then compare to where our underlying run rate has been more recently. So I'll stop there, and I'll have Al and Todd to sort of give their thoughts on the IBNR that we put up in the quarter.
Al Riggieri: Yes. It's Al Riggieri. I'll give you a quick comment. I think it's much around the common sense on the IBNR. If you think about that peak in claims happening around August when you think about how long it takes for it to actually come through our peak infections during August coming through our financials. Approximately 60 days later, it's going to start really washing its way through. So the 50-50 split in the third quarter is pretty reasonable in the sense that half of the claims that you saw in the quarter are actually cash and the other half is sitting there and will be cleared during the fourth quarter, sort of a rough estimate of how that 50-50 will play out during the fourth quarter.
Todd Daniels: Yes. And this is Todd. Just to give you an idea of how the claims are coming through. Our peak of paid claims was in the middle of September. And for the last two weeks, we've been running at about 60% of that level. So, we anticipate, as Al said, with the six-week to two-month time period, these claims will begin to come down. And then with the change of definition at the end of September, they should come down even further.
Wilma Burdis: Thank you. Another question. Could you talk about the potential impact of a recession on the group disability business and maybe talk about why this is or isn't a good time to get into that business?
Fred Crawford: One thing that's important -- thank you for the question. Generally speaking, when you enter into weak economic conditions, you would find some weakness in loss ratios related to disability, short and long term. That has not traditionally been the case with our more voluntary sold, small business, short-term disability. And remember, even though we have acquired the Zurich business a few years ago, in terms of the amount of premium that we're running through that business, which I think is approaching $300 million, it is a relatively small business as compared to our total in-force business in the U.S. Obviously, we're seeking to change that over time and are working actively to do that. But right now, we're not a company that is particularly exposed to the disability volatility that comes with a recession. And again, our voluntary business tends not to see that type of loss ratio behavior, at least by historical measurements.
Operator: The next question comes from Alex Scott from Goldman Sachs. Please go ahead.
Alex Scott: First I have a view is just a follow-up on capital deployment. When I think about your yen hedging strategy, a big part of it is a capital hedge. And at least my crude understanding of it is that the yen is weakening, your capital position in Japan is getting stronger. And so in my mind, to sort of offset the dilution in earnings, some of that capital has got to be redeployed. So when you answered the question earlier, I didn't gather from that response that there was a whole lot of incremental capital deployment being considered. So I just wanted to probe there a bit and see if you could help me understand the way that works. And is there a lag? Or am I thinking about it right that there would or should be more capital deployed as a result of that strategy in the yen weakening?
Max Broden: So Alex, you're right in your thinking that, generally speaking, given the significant dollar assets that we hold in Japan, that works relatively well as a capital hedge. And in fact, to your point, it strengthens the SMR ratio and the ESR ratio in a weakening yen scenario that we now have been in. That means that over time, the dividend capacity of Aflac Japan, all things being equal, is slightly higher than before. And you should then expect that over time more capital to find its way up to the holding company. Now that is not immediate, and it's coming through over time. So over time, you would then see a liquidity and capital at the holding company build unless we were to deploy that. And obviously, if you want to have sort of a restored EPS trajectory, you would need to deploy that capital either through dividends, buybacks or an opportunistic deployment. And obviously, we try to deploy that as best as we can to obviously generate an IRR that is north of our cost of capital and preferably with a cushion significantly above our cost of capital. Also, when you think about the capital hedge that is sitting at the holding company, the two components there, which is the first one, the yen debt that that we have, that is currently, we hold about $3.8 billion of equivalent debt denominated in yen. Right now, our leverage then obviously has declined and it's below our leverage corridor of 20% to 25%. But I also know that the yen could strengthen and it could strengthen sharply and then all of a sudden, our leverage will move up sharply as well. So, we need to be quite thoughtful and sensitive to what our underlying and really look through debt capacity, yes. And I wanted to give you one number that I actually kind of look at and I find interesting. So if you take our leverage right now and you -- what sort of yen move would take us to the middle of the range, i.e., 22.5%. And that's roughly an immediate move of the yen dollar to $102. So that gives you a little bit of a sense for how we sort of think about what our debt capacity potentially could be. And then the -- the last piece as well is the forwards that we have at the holding company. They are spread out in terms of maturities. And obviously, they are in a net gain position, so they will settle into cash, but that will occur over the next 24 months, and it's fairly spread out. So, the increased cash flow to the holding company from a weakening Yen is not immediate. On a mark-to-market basis, they are, but I don't count that until they have fully settled and we have received all that cash. That's when we move the cash to become unencumbered in terms of definition. So if I take all of this and sort of wrap it up, I would say that there is a lag in terms of the cash flow to find its way to the hold the Company from all these capital hedges. And that means that you have a little bit of a lag in terms of capital deployment that would then ultimately lead to your sort of restored EPS capacity on a run rate basis. And we are currently in that sort of lag period, i.e., our reported EPS has dipped because of the gain. But then we will -- if the Yen stays at these levels, the capital hedges will start to kick in. And then over time, as we deploy that capital, that should restore our earnings power on an EPS basis going forward. That was a long answer, but I hope that was helpful.
Alex Scott: Yes. No, that was very helpful. Second question I had is on net investment income. With your net investment income, there's some more ins and outs for us to think about in terms of hedge costs, two currencies, having a floating rate portfolio, offsetting some and so forth. So, I was hoping maybe you could help us just think about when we think about all those different things, higher yields. What is your sensitivity to higher yields? I mean how would you think about the benefit in net investment income from increasing yields in the U.S. and how we should be forecasting that as we look into the future?
Dan Amos: How about Eric and Brad take that?
Eric Kirsch: Thanks, Fred. Thank you, Alex. It's Eric. I'll start, and then Brad can supplement. In terms of higher yields, those are really good tailwinds for us. We do get the benefit in the floating rate portfolio. As Fred mentioned, some of that is hedged, a good portion of it is, but we're still enjoying the upside. Right now, our reinvestment yields are higher, more or less than our redemption yields. So it's really this interest rate environment and where we're investing is accretive to net investment income. Obviously, there are some offsets and headwinds as well, headwinds being higher hedge costs for next year that we expect, but those will be offset by higher income. And of course, we have the offset of ink from the forwards that Max mentioned. And then variable net investment income, we'll just have to see. We expect some pressure in the fourth quarter given where public equity markets are, and we'll have to see for next year, if equity markets start to stabilize, we would expect to see a positive trend there again. I'll also mention, as was mentioned, we had that significant amount of call income this past quarter. So that's not going to replicate obviously. But net-net, higher rates are generally going to be accretive towards our net investment income. The last thing I'll mention is the weakening yen, obviously lowers income in dollar terms. So that's a headwind for us as well.
Operator: The next question comes from Ryan Krueger from KBW. Please go ahead.
Ryan Krueger: I had a follow-up on Alex's last question. I guess, first on the floaters. Could you give us a sense of, how much is hedged? And then, and I guess, how much additional upside you could have from here based on the forward curve on the unhedged fees?
Dan Amos: Sure thing, it's approximately 70%. That number can fluctuate based on market values and the movement in interest rates, but it's approximately 70%. In terms of the sensitivity, we still have upside, but I think when we get to fab, we'll be able to illustrate that better for you in terms of some sensitivities.
Fred Crawford: I realize when one thing also to realize is that when Eric uses the 70% term, specific to the floating rate book, obviously, then 30% of it left free to enjoy downside of rates. But in addition to that, we have a fairly good amount of liquidity at the holding company, which is not hedged or remains largely floating and enjoying our rate movement. So we look at both on a combined basis to just judge our overall enterprise exposure to floating and locking in.
Ryan Krueger: And my follow-up is also related to this. Can you update us on where the yen hedge costs are running at this point? And then how to think about the offset to that from the forward of the holding company?
Eric Kirsch: Then Max may want to make some comments as well. For this year, as you know, for 2022, we locked in most of our hedge costs at the beginning of the year. And if you go back to the beginning of the year, LIBOR and hedge costs were very, very low. So I think we're running this year around 80-some-odd basis points, if I recollect right. Now if you look at the market today for one year forward, you're in the neighborhood of high 4s, low 500 basis points. So, there will be a significant pickup in our hedge costs in '23. Having said that, remember for the Japan entity where our forward sit, we've got floaters against those. So that floating rate income is going up. And even though it's 70% hedged, as we said a moment ago, that 30% unhedged should track the amount of that -- those hedge costs increase, if not even exceed those. And then finally, for the enterprise, because at Inc., we have offsetting hedges, for the enterprise, the cost increase should be relatively neutral, not exact obviously, but pretty well offset.
Max Broden: Yes. Just adding to Eric's very good memory in terms of hedge costs. Just in terms of notional, the forwards in Japan that we are rolling into this higher hedge cost environment is $4.1 billion of notional. And then at the holding company, we have $5 billion of notional that obviously benefits from the higher hedge costs and that runs through as positive net investment income at the Corporate & Other segment. That will not be immediate as those are spread out and some of that have already started to earn in, but the real impact also at the Corporate & Other segment will sort of occur in the in the 2023 time frame. But overall, this is also designed to make sure that we are not as an enterprise too exposed to any significant movements in hedge costs up or down, quite frankly. So net-net, we are actually $0.9 billion positively exposed in terms of the notional balance to the higher interest rate differential between the yen and the dollar.
Operator: The next question comes from Erik Bass from Autonomous Research. Please go ahead.
Erik Bass: Can you provide some more color on the group voluntary benefits case lapse as you alluded to about this quarter and year-to-date. Is there any common trend that you're seeing? And should we expect any more case movement during 4Q enrollment?
Fred Crawford: Thanks, Eric. It's Fred. Yes, the -- as I mentioned in my comments, we've been seeing a little bit of weaker persistency on the group side this year, individual having recovered, but there's no systemic -- when we look at each of the case losses, we don't see anything systemic in them. They vary from one of the large cases, for example, that we lost, there wasn't really a loss to competition. The Company in question simply decided to reduce the number of payroll deduction slots, if you will, for voluntary product, and so they eliminated some of their voluntary product holdings period. And in another case, there was a merger of one large company and another and we ended up not being on the winning side of that merger, which will happen from time to time. And then normal competitive landscape will come into play. And so the themes are varied, but not, frankly, unusual. What can be unusual from time to time is it can be lumpy. There are years where some of the cases that laps are not particularly sizable as compared to the cases one. There are other years where you might have lumpiness with the loss of a larger case. We are, in fact, starting to gain ground in larger case wins. And so, we're starting to build out some larger cases on our platform, which is good. And we've won several large cases this year, as you can see in some of our sales results on the group side. And so with those larger cases, you'll naturally have some lumpiness realizing this is just 15% of our earned premium. So it doesn't take much in the way of a large case to move the lapse rate on the group side, but nothing systemic. I would note one thing to, I think, Jimmy's earlier question around benefit ratio, realize that there is an interplay between lapse rates, benefit ratio and expense ratio. When you go through a period of higher lapsation, you will normally find downward pressure on your benefit ratio and upward pressure on your expense ratio. These are not big movers, which is why we don't call it out, but there is a relationship between the two. It's not necessarily a profit loss or profit on dynamic you usually on a lapse case, simply end up releasing reserves, but also writing off DAC for a somewhat net neutral impact to profitability, sometimes even a benefit to profitability, although that's not the design of what we like. So, it's not really a P&L or margin issue, but we are going to spend more time and make sure that we do what we need to do to improve persistency over time. That's a major focus of ours because we know it's something that represents opportunity.
Erik Bass: And then maybe a follow-up on Alex' question a little bit. But based on the SMR sensitivities that you provided at last year's fab, it seems like the most challenging scenario would be higher interest rates globally, wider credit spreads in a strengthening yen. And year-to-date, we haven't really seen that because of the DOJ's actions, but how do you think about the potential scenario where the BOJ eases its commitment to yield curve control and JGB yields rise and the currency appreciates. Is that a risk? Or are there other mitigating offsets?
Max Broden: It's absolutely a risk and that's why we obviously run stress tests on our SMR ratio and capital base all the time, quite frankly, and we think about these kind of scenarios, and we manage our capital accordingly. Fred mentioned, for example, that we have a significant portion significant notional level of put options protecting us from any severe strengthening of the yen that could happen in the kind of scenario that you just outlined. And we have that in place in order to protect our capital base. So, it is real. And we always have to manage for that. We make sure that we always have a strong capital ratio, so we can continue to write business and capital does not become a constraining factor for our businesses.
Fred Crawford: Something that on the topic of capital in Japan, something that will no doubt touch on at our investor conference, but you're starting to find the industry, not just Aflac slowly migrate and turn their attention more significantly to ESR and away from SMR. SMR will not fade to black or become insignificant for the industry anytime soon, but as we creep towards 2025 and the adoption of ESR, we're starting to pay more and more attention to that economic ratio, and that ratio is far less sensitive to these mark-to-market rate spread dynamics and will help with stabilizing capital position. As you know, we maintain a very strong ESR.
Operator: The next question comes from Tom Gallagher from Evercore ISI. Please go ahead.
Tom Gallagher: Just a question on Japan sales. If you're tracking up 47% quarter-to-date is what I believe I heard in an earlier response. And that was, I think, just for general agency and Daido Life. Can you just comment on what proportion of sales are those channels? And sort of taking that all together, would you expect a big increase in Q4 Japan sales overall? Any perspective there is appreciated.
David Young: Tom, this is David. I think we can say that those are mostly agency barrels.
Fred Crawford: In other words, the contribution from cancer.
Koichiro Yoshizumi: This is Yoshizumi. You're right. 47% is the agency channel sales. And we believe that we will be able to maintain this momentum in the fourth quarter as well. And that's all for me.
Tom Gallagher: And just a follow up on that. Any perspective on what this means for 4Q sales? And I'm not asking for a specific forecast, but are we looking at a pretty big sequential inflection in sales, because the launch of the new product was August, as you said. So, I just want to make sure I'm understanding the numbers here correctly, if we're looking at kind of a big outlook for sales or is it not broad enough yet to move the needle overall?
Dan Amos: I think -- this is Dan. I think what we're saying is that it is a significant increase, but it was expected. Our fourth quarter is our biggest quarter. We are expecting that as we go against the fourth quarter last year. But all in all, it's well within what we expected to do for the year -- for the quarter and for the year.
Operator: The next question comes from Mike Ward from Citi. Please go ahead.
Mike Ward: Kind of similar to Tom's question, just wondering on U.S. sales. Growth still solid and recovering though, I guess, decelerating a little bit. Wondering if we should think about U.S. sales as maybe at pre-COVID levels yet? Or I guess, in addition, could you comment on any visibility into 4Q? I think that's the most important quarter.
Dan Amos: Virgil, why don't you take that?
Virgil Miller: Okay. Thank you, Dan. This is Virgil. Yes, we are optimistic we will see continued momentum in Q4. I remember just because of seasonality, Q4 would be our largest sales quarter. But I'm also anticipating it'd be our largest in terms of growth -- percent growth. So overall, you can expect that momentum to carry forward and again, looking for a strong performance in Q4.
Mike Ward: Okay. Do you think we're back sort of at pre-COVID levels going forward?
Virgil Miller: Yes. I'll be specific on that. So, we finished third quarter at 97% of pre-pandemic sales, and I'm expected to be over 100% in Q4, and that will carry forward throughout 2023.
David Young: All right, Jason. I think that's our last question in the line, and I appreciate everybody joining us today. I want to remind you that we will have our financial analyst briefing in New York on November 15 at the NYSE. There will also be a webcast for those who can't join in person, and registration is still open. In the interim, please reach out to Investor and Rating Agency Relations. If you have any questions, we'll be happy to help and look forward to talking to you soon. Take care.
Operator: Conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to the Aflac Inc. Third Quarter and Total Year 2022 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I'd now like to turn the conference over to David Young. Please go ahead."
},
{
"speaker": "David Young",
"text": "Thank you, and good morning. Welcome to Aflac Incorporated's third quarter earnings call. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com, along with a video from Max Broden, Executive Vice President and CFO of Aflac Incorporated, who provided an update on our quarterly financial results and current capital and liquidity. Max will be joining us for the Q&A segment of the call, along with other members of our executive management, including Teresa White, President of Aflac U.S.; Virgil Miller, Deputy President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Brad Dyslin, Deputy Global Chief Investment Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; Steve Beaver, CFO of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO of Aflac Life Insurance Japan; Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Well, good morning and thank you for joining us. Let me begin by saying that the third quarter of 2022 concluded a solid first nine months for the Company. Aflac Incorporated reported net earnings per diluted share for the third quarter of $2.53 and $6.25 year-to-date. Adjusted earnings per diluted share were $1.15 in the third quarter and 4.03% for the first nine months. These results are solid despite the impact of significantly elevated COVID claims in Japan during the third quarter due to the industry practice of deemed hospitalization. Overall, I am pleased with where we stand at the beginning of the fourth quarter. We remain on track for another good year of financial results, and we expect continued sales momentum in both markets. As we have communicated in the second quarter, we anticipated a sharp third quarter increase in COVID claims in Japan, and we experienced that increase. We are now seeing more normalized COVID claims during the fourth quarter. Reflecting on the third quarter, our management team, employees and sales force have continued to be resilient while being there for the policyholders when they need us most, just as we promised. Looking at our operations in Japan in the quarter, Aflac Japan generated solid overall financial results with a profit margin of 21.6%. One of the key contributors to Aflac Japan's strong financial results is its persistency, which has remained consistently strong at 94.3% for the past four quarters. New annualized premium sales continued to improve in the quarter with the launch of our new cancer insurance product through agencies in late August, which drove a 32.6% increase in cancer insurance sales in the quarter. This contributed to an overall sales increase of 10.2%. I just recently returned from my trip to Japan this year. As you'll recall, I traveled to Japan in June and had a successful meeting with the management at Japan Post Holding, Japan Post Company and Japan Post Insurance. This most recent trip in mid-October was geared toward connecting with our agencies, where I went to five different cities across Japan, and it was equally successful. As you know, we strive to be where consumers want to buy insurance, and this is accomplished through all the distribution channels, agencies, alliance partners and banks. We continue to closely track how pandemic conditions are evolving, particularly because of its correlation with the opportunities for face-to-face sales, which is key to the recovery in sales. I arrived home from Japan excited by the energy at the agencies with whom I met and feel very good about our ability to sell new policies as we emerge from the pandemic. As I mentioned, we have seen our benefit ratio normalize so far in the fourth quarter given the narrow scope of deemed hospitalizations introduced towards the end of the third quarter. We continue to expect stronger sales momentum in the fourth quarter, assuming that productivity continues to improve at Japan Post Group and that we execute on our product introduction and refreshment plans. We will start selling our new cancer insurance product through Japan Post Group in the second quarter of 2023. Turning to Aflac U.S., we saw solid profit margin of 19.3%. I am pleased that we again generated sales growth with an 11.8% sales increase in the third quarter and a 15.2% increase year-to-date. I am encouraged by the continued improvement in the productivity of our sales associates and brokers with the strength of both channels approaching pre-pandemic levels, as we enter what trends, excuse me, to be our strongest quarter of the year. We are seeing success in our efforts to reengage better in sales associates. And at the same time, we are seeing strong growth through brokers. These results reflect continued adaptation of the pandemic conditions, growth in our core products and investments and build-out of our growth initiatives. While Aflac Dental and Vision and Group Premier Life Management and Disability Solutions, which we now call PLADS, a relatively small part of our sales, we are pleased with how they're contributing to our growth, and opening opportunities to sell our core supplemental health products. We continue to work toward reinforcing our leading position and generating stronger sales for the fourth quarter. I believe that the need for the products that we offer is strong or stronger than ever before in both Japan and the United States. At the same time, we know consumer habits and buying preferences have been evolving. We remain focused on being able to sell and service customers whether in person. This is part of the ongoing strategy to increase access, penetration and retention. Turning to capital deployment. We place significant importance on continuing to achieve strong capital ratios in the U.S. and Japan of behalf of our policyholders and shareholders. We continue to generate strong investment results while remaining in a defensive position as we monitor evolving economic conditions. In addition, we have taken proactive steps in recent years to defend cash flows and deployable capital against a weakening yen. When it comes to capital deployment, we pursue value creation through a balance of actions, including growth investments, stable dividend growth, and discipline and tactical stock repurchase. With fourth quarter's declaration, 2022 will mark the 40th consecutive year of dividend increases. We treasure our track record of dividend growth and remain committed to extending it, supported by the strength of our capital and cash flows. We have remained in the market repurchasing shares with a tactical approach. Year-to-date, Aflac Incorporated deployed $1.8 billion in capital to repurchase 30.3 million of our shares. Combined with dividends, that means that we delivered $2.6 billion back to the shareholders for the first nine months. With this approach, we look to emerge from this period in a continued position of strength and leadership. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We have also focused on integrating the growth investments we have made. We are well positioned as we work toward achieving long-term growth, while also ensuring we deliver on our promise to the policyholders. I am proud of what we've accomplished in terms of both social purpose and financial results, which have ultimately translated into strong long-term shareholder return. We also believe in underlying strengths of the business and our potential for continued growth in Japan and the U.S., the two largest life insurance markets in the world. Throughout the uncertainty of the last few years, I think we've done a good job in maintaining our focus on controlling the things that we have the power to control. We can and will control our efforts to build our business and take care of those who depend upon us, our policyholders, our shareholders, our customers, our employees, our distribution and the communities in which we operate. In closing, you've heard me say many times this before of how I believe that one of my key roles as CEO in conjunction with the Board is to develop our leaders to lay a groundwork for strong succession planning. This approach enables continuity and expertise in strategic execution. You saw that succession planning in action recently with the two deputy positions moving to the next level. The announcement last week of Brad Dyslin, who will assume the role of Chief Investment Officer in January of 2023 as well as the August announcement of Virgil Miller, assuming the role of President of Aflac U.S. I want to thank Eric for his vision and expertise in building a world-class investment organization that has performed at a high level. I also want to thank Brad for his new leadership role. Brad has proven himself as a distinguished leader collaborating with Eric and the team to deliver strong results and enhancing the reputation of Aflac Global investment. I also am grateful for Teresa's 24 years of outstanding leadership and contribution to Aflac, most recently as President of Aflac U.S. for the last eight years. As Virgil assumes his role, I know he is well suited to lead Aflac U.S. with a seamless transition as Aflac continues to build on its path toward delivering efficiencies, innovation and growth. These are great examples of how we place a high priority on ensuring that we have the right people in the right place at the right time. In doing so, we have continued our focus on building a strong, deep bench of leaders preparing to take on more responsibility. Thank you all for joining us this morning, and I'll turn the program over to Fred. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Dan. Last quarter, I commented on how we are positioned as a company when considering current U.S. and global economic conditions. The impact of inflation does apply upward pressure to expenses. However, this is mitigated by rising rates and additional investment income. In terms of the risk of recession, our morbidity-based insurance model is generally defensive in nature with relative stability in sales and earned premium through the economic cycles, low asset leverage, and exposure to risk assets. Finally, while certainly not immune to volatility in foreign exchange, we have put in place defensive measures to combat the economic impact of a weakening yen. Overall, we like how we are positioned and see no material adjustments to our operating or capital plans. Turning to Japan. We witnessed COVID cases surging in what is now referred to as Japan's seventh wave of infections. Daily new cases in the quarter reached a peak of 260,000 in August with the wave concentrated in the July through September time frame, effectively running its course in the third quarter. Daily cases have now slowed to a seven-day average of roughly 40,000. As we signaled last quarter, we experienced elevated COVID incurred claims, driven by its designation as an infectious disease and the industry practice of deemed hospitalization, which allows for payment of claims for care outside of the hospital. To give you an idea of the magnitude, before the seventh wave, our weekly COVID claims were in the 7,000 to 13,000 range. During the recent wave, we peaked at approximately 47,000 weekly COVID claims. Hospitalization remains low, and this lack of severity has resulted in the government of Japan changing the definition of deemed hospitalization. Effective September 26, the scope has been narrowed to the elderly, those requiring hospitalization and individuals more vulnerable to severe symptoms. This change in policy, together with lower overall rates of infection will greatly reduce the volume of new claim submissions. While more volatile than usual, we have established reserves for claims incurred in the period, but not yet reported. Therefore, we expect pressure on Japan's benefit ratio to subside in the fourth quarter. Dan mentioned his trip to Japan. I also traveled to Japan in the last few weeks. The general population remains very cautious with respect to the potential for COVID infection. For example, if you walk the busy streets of Tokyo, you'll stand out if you're not wearing a mask outside. While difficult to measure, we believe this remains a headwind for proposal volume and sales; however, our view is conditions are improving. Despite these conditions, we remain focused on the following: distribution recovery and productivity across all channels, core product refreshment and product line expansion, cancer and elderly care ecosystem development through Hatch Healthcare and digitizing paper and manual processes for greater operating efficiency. We will develop these themes in more detail at our financial analyst briefing later this month. Before I jump to the U.S., let me also extend my gratitude to Teresa White. She's been a trusted adviser to me and helped me acclimate into this new role of mine and getting educated on the U.S. platform, and I also look forward to working with Virgil as we're off to a great start in 2022. Turning to the U.S. As Dan noted in his comments, we continue to deliver a balanced attack to the marketplace. Split by product class, group benefits were up nearly 28%, individual benefits up 4%. Split by channel, agent sales were up 6% and broker up 20%. With respect to our expansion businesses, Network Dental and Vision and Premier Life and Disability were up 120% and 39%, respectively, for the quarter. Consumer markets continues to struggle down 13% and somewhat expected given the cost of lead generation and timing related to the rollout of new product. We remain bullish on this building business, having recently launched our direct-to-consumer dental and vision products as well as new alliances introducing senior and core Aflac products on third-party platforms. Persistency has recovered in our individual business as labor markets appear to have stabilized; however, group persistency has been weak throughout 2022. Our group business represents about 15% of our U.S. earned premium and has traditionally lower persistency compared to individual. There are no systemic drivers, but this segment can be more volatile, and we have experienced the loss of a few larger accounts this year. Our focus in the U.S. remains the following: recovery in our agent-driven small business model post COVID, maintaining momentum in our group voluntary business, building out our expansion businesses and realizing the halo effect in associated voluntary sales, and bending the expense ratio curve, transitioning from investment to benefit realization. Again, we will develop these themes at a briefing later this month. Turning to global investments. Let me first add my sincere gratitude to Eric for his years of leadership and trusted counsel in managing not only our investments, but contributing to many of the key financial strategies that have positioned us well today. Congratulations to Brad. I can't think of a better prepared executive to ensure continuity and carry-forward our record of strong investment performance. In terms of investment conditions, with the rise in short-term interest rates, we are actively managing the interplay of net investment income and the cost of currency hedging. Given the material increase in LIBOR forward curves, we elected to lock-in a large portion of our floating rate portfolio to protect against future rate declines. A portion remains floating and will benefit if rates continue higher. We believe this balanced approach to managing interest rate risk in our floating rate book positions us well for future rate volatility. We maintain our traditional approach to rolling foreign currency hedges on a portion of our U.S. dollar portfolio in Aflac Japan. We also continue to hold options against our unhedged dollar assets, a strategy that protects our Aflac Japan capital position against a large weakening of the dollar. While hedge costs are on the rise and will impact Japan segment earnings, the combination of floating rate investment income and offsetting hedge instruments at the holding company, serve to largely neutralize the impact to enterprise earnings. Our alternative investment portfolio pressured results in the quarter, recording a $40 million loss from our third quarter valuation marks. This was anticipated given the natural correlation to the public equity markets and the lag in private equity reporting. Despite losses in the quarter, year-to-date, the alternative portfolio has generated $125 million in income following a very strong year in 2021. We expect continued pressure on alternatives in the fourth quarter as the markets remain volatile, but fully intend to invest through the cycle and capture the long-term return benefits of this strategy. Offsetting our variable investment income results was a negotiated prepayment of a private security and large amount of associated make-whole income. This -- we call this out in our results as the event contributed a one-time boost of $84 million pretax to investment income. Our middle market and transitional real estate loan portfolios continue to perform well. We have reserves set up for these loans, which have increased modestly, reflecting potential softening of economic conditions. We are closely monitoring the risk of recession. We maintain a defensive position to risk assets and feel good about how we're positioned. We continue to seek attractive opportunities recognizing the near-term risk of a global slowdown and do not have any acute de-risking activity planned at this time. I'll now hand back to David to take us to Q&A. David?"
},
{
"speaker": "David Young",
"text": "Thank you, Fred. We're ready to take your questions, but before we do, I ask please limit yourself to one initial question and one related follow-up to allow others an opportunity to ask a question, and you may get back in the queue as well. Jason, we'll now take the first question, please."
},
{
"speaker": "Operator",
"text": "Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from John Barnidge from Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "My question, you announced in October Dental, Vision and Hearing plans available to individuals outside of the traditional work site. Can you talk about how you're going to meet the customer, how sizable an opportunity is and how you think about acquisition costs there, please?"
},
{
"speaker": "Fred Crawford",
"text": "So the -- what we announced was the launching of Dental and Vision and Hearing on our direct-to-consumer platform. And so this is really what we mean by outside the work site is our direct-to-consumer platform is designed specifically to go after potential customers outside the normal work site pay or W-2 employee environment, meaning the gig economy, individuals who are -- work outside traditional W-2 environment, self-employed, for example, and then also to some degree, the senior markets who are naturally concentrated outside the work site. So, this is really a strategy to enhance our product lineup the direct-to-consumer platform. We think the Dental and Vision piece of it is important really for two reasons. One is, of course, the ability to generate sales through that channel, but the other is Dental and Vision and Hearing is a heavier searched item by individuals. And by putting product on our platform that caters to more search activity, it offers up an opportunity to cross-sell some of our traditional supplemental health products, which are less searched for. So that's effectively the strategy, John. Did I answer your question? Or do you have a second question there?"
},
{
"speaker": "John Barnidge",
"text": "Yes, Fred, that was fantastic briefly, the related follow-up. Can you talk about the initial tech rollout of the group benefits package? I know the fourth quarter of '22 is the big rollout since it has pet insurance?"
},
{
"speaker": "Fred Crawford",
"text": "So, on the topic of pet insurance, we have, in fact, rolled out the pet insurance alliance. This is the Aflac Pet insurance powered by Trupanion. We have focused on the larger broker-driven case size for that product. We characterize that as our premier broker relationships, which tend to travel in the 1,000 employee and up case size. It is really just getting off the floor. I think we have been awarded four accounts so far and are in the process of building that out. I would characterize this year as still somewhat of a proof-of-concept year in terms of getting out there with the product, successfully landing accounts, integrating those accounts between the two parties, our partnership with Trupanion and then making any tweaks or adjustments that we think are necessary to better compete as we roll towards 2023. But we are up running and launched. We're filed in all the states. The product is ready to go but concentrated in the large case market. So we will have, obviously, a fairly small level of sales this year. Also be mindful of this is really earned premium and economics for Trupanion. Our play from a pet insurance perspective is to fill out our portfolio, as you suggest, to where we're able to offer a broader array of benefits to brokerage clients, who desire that plus also their end clients. Other than that, I would say our product upgrades have been relatively routine in nature, meaning natural upgrades, covering things like mental health and other dynamics that have become more important to the broker and the consumer this year, and we continue to do that as a normal part of our business activities."
},
{
"speaker": "Dan Amos",
"text": "This is Dan. Let me make one comment is that, for example, with Dental and Vision, it's not so much selling that product as it is open the door to sell our existing products. And for every five Dental and Vision products we sell, we sell an additional three supplemental health insurance products. So that's what we're really looking towards. The other is gravy of how we're doing those other things, and we like that, and I'm glad to have it. But it's being on the front page of the benefit section of the employers' HR that really makes the difference, and this is what we're counting on long term."
},
{
"speaker": "Operator",
"text": "The next question comes from Nigel Dally from Morgan Stanley."
},
{
"speaker": "Nigel Dally",
"text": "So I just wanted to start on the new cancer product. How long should we expect this product to boost all -- it seems like product lifecycles have shortened, perhaps to only a quarter or two. So we'll be interested whether that's consistent with the view for this product. And also if you can touch on additional product introductions you have slated for 2023, you mentioned the Cantor product for Japan Post. Are there other products also due to be refreshed next year?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Thank you for the question. This is Yoshizumi. Let me answer your question. Well, in terms of the cancer insurance, we have launched our new product in -- on August 22. The channel that we have launched the new product is in the general agencies channel and live channel. And the sales through these channels between August and September this year have been quite successful. The actual sales was up 50%, 5-0% year-on-year. And we are seeing a great momentum still in the fourth quarter as well regarding this cancer insurance. And we are seeing about 47% increase year-on-year at the moment. And also from January 2023, we will start offering more comprehensive support related to cancer called Cancer consolidation service. This is a new service that would comprehensively support the patients or the policyholders from the time they develop cancer and up to the point they recover to their work. And this is the first of its kind in the industry. And this service will be able to respond to all the struggles and all the things that the patient as well as the family members have difficulties with. This is a great differentiator against other cancer insurance. And regarding the sales to start in the Japan Post Group, we are hoping to have it launched in the second quarter next year. We are thinking of working closely together with the Japan Post Group to increase the actual sales channel or sales route as well as training. And in terms of the other channels such as financial institutions and Dai-ichi Life, we are planning to launch the cancer product in January next year. And we will be actively and aggressively selling cancer insurance in the fourth quarter this year as well as the first quarter next year, and that's all for me."
},
{
"speaker": "Nigel Dally",
"text": "That's great. Then just as a follow-up, I saw a bit of a step up in the pace of buybacks this quarter. I just wanted to understand what's. Your excess capital position seems to be at a level where you could easily continue at that pace, conversely with the risk of recession, maybe you want to hold on to some more capital. So just some comments as to how we should be thinking about buybacks?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Nigel. It's Max. So $650 million in the quarter, and as always, we look at our capital levels, the capital generation, current and future that we expect from our subsidiaries in the overall enterprise, as well as the opportunity set that we see in terms of deploying capital, that being through dividends, buybacks, opportunistic deployment, et cetera. And that's really what sort of drives how much of buybacks we are doing at any point in time. And generally speaking, we want to deploy capital where we see good IRRs, and the buybacks that you saw in the quarter was a reflection of that. In terms of looking forward, we feel good about our overall capital position and liquidity as well despite the very significant movement that we've seen in the yen."
},
{
"speaker": "Operator",
"text": "Next question comes from Jimmy Bhullar from JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Teresa and Eric, good luck in the future. So first on a question just on policy usage in the U.S. The benefits ratio has been lower than normal through the pandemic, and it was fairly low in 3Q as well. Do you feel that you're still benefiting from low usage in the U.S.? Or is the benefits ratio reflective of what you expect it to be going forward?"
},
{
"speaker": "Max Broden",
"text": "Yes. It's Max again. I would just say that overall claims utilization continues to be at a relatively low level in the U.S. And especially on some lines of business, like accident, hospital, et cetera, we have been a little bit surprised that we haven't sort of come back to the full normal levels, as well as cancer that have not gone sort of above the pre-pandemic trend. We would expect that to actually happen for a short period of time, simply because there's some catching up to do in terms of cancers that should be detected and also some severity come through as well. We have not seen that yet. We do expect that in the cancer lines of business, but overall, we have seen favorable claims utilization in the quarter and throughout the full year so far. And I ask the U.S. team and Teresa and Virgil to sort of fill in with your comments as well."
},
{
"speaker": "Teresa White",
"text": "Yes. I'll just add to that. You're absolutely spot on with your comments. We are seeing lower hospital benefits as well coming out of the pandemic and more outpatient-focused therapies wherever possible. So, we're seeing first occurrence benefits to rebound to 2019 levels, but hospitalization has lagged. That's really all I wanted to add to that."
},
{
"speaker": "Jimmy Bhullar",
"text": "And Fred, you had commented in your prepared remarks about, I think you implied that people wearing masks, is still a hindrance to sales in Japan. Are you seeing lower appointments than normal? And are there other things besides just masking, like social distancing, people not coming back to work full time that are also weighing on sales results?"
},
{
"speaker": "Fred Crawford",
"text": "Yes, I think there's a couple of things going on. One is, yes, there is a general headwind to face-to-face communication unless necessary. And so that persists in Japan, although as I mentioned, it is improving. And in fact, the actual government of Japan is now coming out and encouraging people to open up a little bit and get back to traditional business. So, it's not at pre-COVID levels of activity. And that's what I mean by remains a headwind, but it certainly is improving. I think the other dynamic that we mentioned last quarter that remained the case during the third quarter is when you have a high level of cases and a high level of infection rates of COVID, you naturally are going to have actual agents that are infected and impacted and are pulled out of the field, so to speak, unable to meet with clients or meet effectively with clients. And so that has played into it. You're talking about our distribution model through third parties has several thousand agents that we sell through. And so when you have something as widespread as the third quarter level of COVID cases, you naturally will see less feet on the street, so to speak selling. Again, we think this will naturally improve for the same reasons we see our benefit ratio and claims activity improving in the fourth quarter."
},
{
"speaker": "Dan Amos",
"text": "And Fred and I have discussed this, but one other point is, just remember, Japanese were wearing the mask before COVID. So I don't think I went anywhere that I saw anyone that did not have on the mask, but it begins to look more normal. And so we'll have to wait and see. But everyone's -- I hardly ever see anybody with mask, except at hospitals and other places in the U.S., but they're still wearing them, but they're beginning to function. And I think that's the point that we're both making is, is that things are moving back to normal. But if you take a snapshot, you're going to see everybody with mask on and you're going to say, Oh, well, it's awful. Well, it's their culture too. So don't not think about that as you're a little going forward."
},
{
"speaker": "Operator",
"text": "The next question comes from Suneet Kamath from Jefferies. Please go ahead."
},
{
"speaker": "Suneet Kamath",
"text": "Just on the Japan cancer sales. Can you give a sense of what percentage of the sales were lapsed reissue and how that compares to prior product launches?"
},
{
"speaker": "Todd Daniels",
"text": "Suneet, this is Todd. I think I'll take that. It takes time for us to look back and know exactly how to identify the lapse and reissue. We don't see it until the lapse actually is processed. So right now, we're seeing slightly higher lapse and reissue rates over 50%. And we believe that this could go higher as we look backwards, but this is within our expectation."
},
{
"speaker": "Suneet Kamath",
"text": "Okay. Got it. And then I guess, just curious on the timing of when you're going to start sales through Japan Post in the second quarter. I think that's probably the start of their fiscal year. So maybe that's the reason. But any color on what the client overlap is between Japan Post and some of your other distribution channels?"
},
{
"speaker": "Fred Crawford",
"text": "I don't know if you'll see Yoshizumi-san or Koide-san have any color they can provide on the overlap."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "So, this is Yoshizumi once again. In regards to the Japan Post sales of new cancer, we are thinking of it to start in the second quarter. And in other channels, we are thinking of having the product launched in January such as in bank channel or the Dai-ichi Life channel. And I'm not quite sure whether I'm answering to your question or not, but because of the overlapping of the channel's launch or the timing difference of the launch in each channel, there will be smooth launching of products from one channel to another."
},
{
"speaker": "Masatoshi Koide",
"text": "Okay, this is Koide. Let me just add a little bit. And of course, in each channel, there are some overlaps of customers. And although I did mention that there are some overlaps of customers between channels, at the same time, each channel has its own specific customer base. Therefore, for example, in Japan Post Group, the other channels may start selling the product before the Japan Post Group, because the Japan Post will not start its sales until the second quarter. However, because Japan Post Group has a very solid customer base on its own, there should be a great sales from there as well."
},
{
"speaker": "Operator",
"text": "The next question comes from Wilma Burdis from Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"text": "My understanding of the 940 basis points of higher Japan benefits ratio from the hospitalizations, about half of that was reported, and the other half as IBNR. This feels a little bit conservative. I don't know if you agree. Is it possible that some of this could be reversed in 4Q? Or is that -- just help us think about the benefit ratio in 4Q between releases and what's going on there?"
},
{
"speaker": "Max Broden",
"text": "Let me kick off, and I'll have Al or Todd sort of add their comments as well. So for the full year, we would expect to have a Japan benefit ratio in the range of 69% to 70%. And we were sitting at 69.8% as of the first nine months. That obviously means that we are expecting a more normal benefit ratio in the fourth quarter if you then compare to where our underlying run rate has been more recently. So I'll stop there, and I'll have Al and Todd to sort of give their thoughts on the IBNR that we put up in the quarter."
},
{
"speaker": "Al Riggieri",
"text": "Yes. It's Al Riggieri. I'll give you a quick comment. I think it's much around the common sense on the IBNR. If you think about that peak in claims happening around August when you think about how long it takes for it to actually come through our peak infections during August coming through our financials. Approximately 60 days later, it's going to start really washing its way through. So the 50-50 split in the third quarter is pretty reasonable in the sense that half of the claims that you saw in the quarter are actually cash and the other half is sitting there and will be cleared during the fourth quarter, sort of a rough estimate of how that 50-50 will play out during the fourth quarter."
},
{
"speaker": "Todd Daniels",
"text": "Yes. And this is Todd. Just to give you an idea of how the claims are coming through. Our peak of paid claims was in the middle of September. And for the last two weeks, we've been running at about 60% of that level. So, we anticipate, as Al said, with the six-week to two-month time period, these claims will begin to come down. And then with the change of definition at the end of September, they should come down even further."
},
{
"speaker": "Wilma Burdis",
"text": "Thank you. Another question. Could you talk about the potential impact of a recession on the group disability business and maybe talk about why this is or isn't a good time to get into that business?"
},
{
"speaker": "Fred Crawford",
"text": "One thing that's important -- thank you for the question. Generally speaking, when you enter into weak economic conditions, you would find some weakness in loss ratios related to disability, short and long term. That has not traditionally been the case with our more voluntary sold, small business, short-term disability. And remember, even though we have acquired the Zurich business a few years ago, in terms of the amount of premium that we're running through that business, which I think is approaching $300 million, it is a relatively small business as compared to our total in-force business in the U.S. Obviously, we're seeking to change that over time and are working actively to do that. But right now, we're not a company that is particularly exposed to the disability volatility that comes with a recession. And again, our voluntary business tends not to see that type of loss ratio behavior, at least by historical measurements."
},
{
"speaker": "Operator",
"text": "The next question comes from Alex Scott from Goldman Sachs. Please go ahead."
},
{
"speaker": "Alex Scott",
"text": "First I have a view is just a follow-up on capital deployment. When I think about your yen hedging strategy, a big part of it is a capital hedge. And at least my crude understanding of it is that the yen is weakening, your capital position in Japan is getting stronger. And so in my mind, to sort of offset the dilution in earnings, some of that capital has got to be redeployed. So when you answered the question earlier, I didn't gather from that response that there was a whole lot of incremental capital deployment being considered. So I just wanted to probe there a bit and see if you could help me understand the way that works. And is there a lag? Or am I thinking about it right that there would or should be more capital deployed as a result of that strategy in the yen weakening?"
},
{
"speaker": "Max Broden",
"text": "So Alex, you're right in your thinking that, generally speaking, given the significant dollar assets that we hold in Japan, that works relatively well as a capital hedge. And in fact, to your point, it strengthens the SMR ratio and the ESR ratio in a weakening yen scenario that we now have been in. That means that over time, the dividend capacity of Aflac Japan, all things being equal, is slightly higher than before. And you should then expect that over time more capital to find its way up to the holding company. Now that is not immediate, and it's coming through over time. So over time, you would then see a liquidity and capital at the holding company build unless we were to deploy that. And obviously, if you want to have sort of a restored EPS trajectory, you would need to deploy that capital either through dividends, buybacks or an opportunistic deployment. And obviously, we try to deploy that as best as we can to obviously generate an IRR that is north of our cost of capital and preferably with a cushion significantly above our cost of capital. Also, when you think about the capital hedge that is sitting at the holding company, the two components there, which is the first one, the yen debt that that we have, that is currently, we hold about $3.8 billion of equivalent debt denominated in yen. Right now, our leverage then obviously has declined and it's below our leverage corridor of 20% to 25%. But I also know that the yen could strengthen and it could strengthen sharply and then all of a sudden, our leverage will move up sharply as well. So, we need to be quite thoughtful and sensitive to what our underlying and really look through debt capacity, yes. And I wanted to give you one number that I actually kind of look at and I find interesting. So if you take our leverage right now and you -- what sort of yen move would take us to the middle of the range, i.e., 22.5%. And that's roughly an immediate move of the yen dollar to $102. So that gives you a little bit of a sense for how we sort of think about what our debt capacity potentially could be. And then the -- the last piece as well is the forwards that we have at the holding company. They are spread out in terms of maturities. And obviously, they are in a net gain position, so they will settle into cash, but that will occur over the next 24 months, and it's fairly spread out. So, the increased cash flow to the holding company from a weakening Yen is not immediate. On a mark-to-market basis, they are, but I don't count that until they have fully settled and we have received all that cash. That's when we move the cash to become unencumbered in terms of definition. So if I take all of this and sort of wrap it up, I would say that there is a lag in terms of the cash flow to find its way to the hold the Company from all these capital hedges. And that means that you have a little bit of a lag in terms of capital deployment that would then ultimately lead to your sort of restored EPS capacity on a run rate basis. And we are currently in that sort of lag period, i.e., our reported EPS has dipped because of the gain. But then we will -- if the Yen stays at these levels, the capital hedges will start to kick in. And then over time, as we deploy that capital, that should restore our earnings power on an EPS basis going forward. That was a long answer, but I hope that was helpful."
},
{
"speaker": "Alex Scott",
"text": "Yes. No, that was very helpful. Second question I had is on net investment income. With your net investment income, there's some more ins and outs for us to think about in terms of hedge costs, two currencies, having a floating rate portfolio, offsetting some and so forth. So, I was hoping maybe you could help us just think about when we think about all those different things, higher yields. What is your sensitivity to higher yields? I mean how would you think about the benefit in net investment income from increasing yields in the U.S. and how we should be forecasting that as we look into the future?"
},
{
"speaker": "Dan Amos",
"text": "How about Eric and Brad take that?"
},
{
"speaker": "Eric Kirsch",
"text": "Thanks, Fred. Thank you, Alex. It's Eric. I'll start, and then Brad can supplement. In terms of higher yields, those are really good tailwinds for us. We do get the benefit in the floating rate portfolio. As Fred mentioned, some of that is hedged, a good portion of it is, but we're still enjoying the upside. Right now, our reinvestment yields are higher, more or less than our redemption yields. So it's really this interest rate environment and where we're investing is accretive to net investment income. Obviously, there are some offsets and headwinds as well, headwinds being higher hedge costs for next year that we expect, but those will be offset by higher income. And of course, we have the offset of ink from the forwards that Max mentioned. And then variable net investment income, we'll just have to see. We expect some pressure in the fourth quarter given where public equity markets are, and we'll have to see for next year, if equity markets start to stabilize, we would expect to see a positive trend there again. I'll also mention, as was mentioned, we had that significant amount of call income this past quarter. So that's not going to replicate obviously. But net-net, higher rates are generally going to be accretive towards our net investment income. The last thing I'll mention is the weakening yen, obviously lowers income in dollar terms. So that's a headwind for us as well."
},
{
"speaker": "Operator",
"text": "The next question comes from Ryan Krueger from KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "I had a follow-up on Alex's last question. I guess, first on the floaters. Could you give us a sense of, how much is hedged? And then, and I guess, how much additional upside you could have from here based on the forward curve on the unhedged fees?"
},
{
"speaker": "Dan Amos",
"text": "Sure thing, it's approximately 70%. That number can fluctuate based on market values and the movement in interest rates, but it's approximately 70%. In terms of the sensitivity, we still have upside, but I think when we get to fab, we'll be able to illustrate that better for you in terms of some sensitivities."
},
{
"speaker": "Fred Crawford",
"text": "I realize when one thing also to realize is that when Eric uses the 70% term, specific to the floating rate book, obviously, then 30% of it left free to enjoy downside of rates. But in addition to that, we have a fairly good amount of liquidity at the holding company, which is not hedged or remains largely floating and enjoying our rate movement. So we look at both on a combined basis to just judge our overall enterprise exposure to floating and locking in."
},
{
"speaker": "Ryan Krueger",
"text": "And my follow-up is also related to this. Can you update us on where the yen hedge costs are running at this point? And then how to think about the offset to that from the forward of the holding company?"
},
{
"speaker": "Eric Kirsch",
"text": "Then Max may want to make some comments as well. For this year, as you know, for 2022, we locked in most of our hedge costs at the beginning of the year. And if you go back to the beginning of the year, LIBOR and hedge costs were very, very low. So I think we're running this year around 80-some-odd basis points, if I recollect right. Now if you look at the market today for one year forward, you're in the neighborhood of high 4s, low 500 basis points. So, there will be a significant pickup in our hedge costs in '23. Having said that, remember for the Japan entity where our forward sit, we've got floaters against those. So that floating rate income is going up. And even though it's 70% hedged, as we said a moment ago, that 30% unhedged should track the amount of that -- those hedge costs increase, if not even exceed those. And then finally, for the enterprise, because at Inc., we have offsetting hedges, for the enterprise, the cost increase should be relatively neutral, not exact obviously, but pretty well offset."
},
{
"speaker": "Max Broden",
"text": "Yes. Just adding to Eric's very good memory in terms of hedge costs. Just in terms of notional, the forwards in Japan that we are rolling into this higher hedge cost environment is $4.1 billion of notional. And then at the holding company, we have $5 billion of notional that obviously benefits from the higher hedge costs and that runs through as positive net investment income at the Corporate & Other segment. That will not be immediate as those are spread out and some of that have already started to earn in, but the real impact also at the Corporate & Other segment will sort of occur in the in the 2023 time frame. But overall, this is also designed to make sure that we are not as an enterprise too exposed to any significant movements in hedge costs up or down, quite frankly. So net-net, we are actually $0.9 billion positively exposed in terms of the notional balance to the higher interest rate differential between the yen and the dollar."
},
{
"speaker": "Operator",
"text": "The next question comes from Erik Bass from Autonomous Research. Please go ahead."
},
{
"speaker": "Erik Bass",
"text": "Can you provide some more color on the group voluntary benefits case lapse as you alluded to about this quarter and year-to-date. Is there any common trend that you're seeing? And should we expect any more case movement during 4Q enrollment?"
},
{
"speaker": "Fred Crawford",
"text": "Thanks, Eric. It's Fred. Yes, the -- as I mentioned in my comments, we've been seeing a little bit of weaker persistency on the group side this year, individual having recovered, but there's no systemic -- when we look at each of the case losses, we don't see anything systemic in them. They vary from one of the large cases, for example, that we lost, there wasn't really a loss to competition. The Company in question simply decided to reduce the number of payroll deduction slots, if you will, for voluntary product, and so they eliminated some of their voluntary product holdings period. And in another case, there was a merger of one large company and another and we ended up not being on the winning side of that merger, which will happen from time to time. And then normal competitive landscape will come into play. And so the themes are varied, but not, frankly, unusual. What can be unusual from time to time is it can be lumpy. There are years where some of the cases that laps are not particularly sizable as compared to the cases one. There are other years where you might have lumpiness with the loss of a larger case. We are, in fact, starting to gain ground in larger case wins. And so, we're starting to build out some larger cases on our platform, which is good. And we've won several large cases this year, as you can see in some of our sales results on the group side. And so with those larger cases, you'll naturally have some lumpiness realizing this is just 15% of our earned premium. So it doesn't take much in the way of a large case to move the lapse rate on the group side, but nothing systemic. I would note one thing to, I think, Jimmy's earlier question around benefit ratio, realize that there is an interplay between lapse rates, benefit ratio and expense ratio. When you go through a period of higher lapsation, you will normally find downward pressure on your benefit ratio and upward pressure on your expense ratio. These are not big movers, which is why we don't call it out, but there is a relationship between the two. It's not necessarily a profit loss or profit on dynamic you usually on a lapse case, simply end up releasing reserves, but also writing off DAC for a somewhat net neutral impact to profitability, sometimes even a benefit to profitability, although that's not the design of what we like. So, it's not really a P&L or margin issue, but we are going to spend more time and make sure that we do what we need to do to improve persistency over time. That's a major focus of ours because we know it's something that represents opportunity."
},
{
"speaker": "Erik Bass",
"text": "And then maybe a follow-up on Alex' question a little bit. But based on the SMR sensitivities that you provided at last year's fab, it seems like the most challenging scenario would be higher interest rates globally, wider credit spreads in a strengthening yen. And year-to-date, we haven't really seen that because of the DOJ's actions, but how do you think about the potential scenario where the BOJ eases its commitment to yield curve control and JGB yields rise and the currency appreciates. Is that a risk? Or are there other mitigating offsets?"
},
{
"speaker": "Max Broden",
"text": "It's absolutely a risk and that's why we obviously run stress tests on our SMR ratio and capital base all the time, quite frankly, and we think about these kind of scenarios, and we manage our capital accordingly. Fred mentioned, for example, that we have a significant portion significant notional level of put options protecting us from any severe strengthening of the yen that could happen in the kind of scenario that you just outlined. And we have that in place in order to protect our capital base. So, it is real. And we always have to manage for that. We make sure that we always have a strong capital ratio, so we can continue to write business and capital does not become a constraining factor for our businesses."
},
{
"speaker": "Fred Crawford",
"text": "Something that on the topic of capital in Japan, something that will no doubt touch on at our investor conference, but you're starting to find the industry, not just Aflac slowly migrate and turn their attention more significantly to ESR and away from SMR. SMR will not fade to black or become insignificant for the industry anytime soon, but as we creep towards 2025 and the adoption of ESR, we're starting to pay more and more attention to that economic ratio, and that ratio is far less sensitive to these mark-to-market rate spread dynamics and will help with stabilizing capital position. As you know, we maintain a very strong ESR."
},
{
"speaker": "Operator",
"text": "The next question comes from Tom Gallagher from Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Just a question on Japan sales. If you're tracking up 47% quarter-to-date is what I believe I heard in an earlier response. And that was, I think, just for general agency and Daido Life. Can you just comment on what proportion of sales are those channels? And sort of taking that all together, would you expect a big increase in Q4 Japan sales overall? Any perspective there is appreciated."
},
{
"speaker": "David Young",
"text": "Tom, this is David. I think we can say that those are mostly agency barrels."
},
{
"speaker": "Fred Crawford",
"text": "In other words, the contribution from cancer."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "This is Yoshizumi. You're right. 47% is the agency channel sales. And we believe that we will be able to maintain this momentum in the fourth quarter as well. And that's all for me."
},
{
"speaker": "Tom Gallagher",
"text": "And just a follow up on that. Any perspective on what this means for 4Q sales? And I'm not asking for a specific forecast, but are we looking at a pretty big sequential inflection in sales, because the launch of the new product was August, as you said. So, I just want to make sure I'm understanding the numbers here correctly, if we're looking at kind of a big outlook for sales or is it not broad enough yet to move the needle overall?"
},
{
"speaker": "Dan Amos",
"text": "I think -- this is Dan. I think what we're saying is that it is a significant increase, but it was expected. Our fourth quarter is our biggest quarter. We are expecting that as we go against the fourth quarter last year. But all in all, it's well within what we expected to do for the year -- for the quarter and for the year."
},
{
"speaker": "Operator",
"text": "The next question comes from Mike Ward from Citi. Please go ahead."
},
{
"speaker": "Mike Ward",
"text": "Kind of similar to Tom's question, just wondering on U.S. sales. Growth still solid and recovering though, I guess, decelerating a little bit. Wondering if we should think about U.S. sales as maybe at pre-COVID levels yet? Or I guess, in addition, could you comment on any visibility into 4Q? I think that's the most important quarter."
},
{
"speaker": "Dan Amos",
"text": "Virgil, why don't you take that?"
},
{
"speaker": "Virgil Miller",
"text": "Okay. Thank you, Dan. This is Virgil. Yes, we are optimistic we will see continued momentum in Q4. I remember just because of seasonality, Q4 would be our largest sales quarter. But I'm also anticipating it'd be our largest in terms of growth -- percent growth. So overall, you can expect that momentum to carry forward and again, looking for a strong performance in Q4."
},
{
"speaker": "Mike Ward",
"text": "Okay. Do you think we're back sort of at pre-COVID levels going forward?"
},
{
"speaker": "Virgil Miller",
"text": "Yes. I'll be specific on that. So, we finished third quarter at 97% of pre-pandemic sales, and I'm expected to be over 100% in Q4, and that will carry forward throughout 2023."
},
{
"speaker": "David Young",
"text": "All right, Jason. I think that's our last question in the line, and I appreciate everybody joining us today. I want to remind you that we will have our financial analyst briefing in New York on November 15 at the NYSE. There will also be a webcast for those who can't join in person, and registration is still open. In the interim, please reach out to Investor and Rating Agency Relations. If you have any questions, we'll be happy to help and look forward to talking to you soon. Take care."
},
{
"speaker": "Operator",
"text": "Conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 2 | 2,022 | 2022-08-02 08:00:00 | Operator: Good morning, and welcome to the Aflac Incorporated Second Quarter 2022 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Ratings Agency Relations and ESG. Please go ahead.
David Young: Thank you, Andrea. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com along with a video with Max Broden, Executive Vice President and CFO of Aflac Incorporated, providing an update on our quarterly financial results and current capital and liquidity. Max will also be joining us for the Q&A segment of the call along with other members of our U.S. executive management: Teresa White, President of Aflac U.S.; Virgil Miller, Deputy President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Brad Dyslin, Deputy Global Chief Investment Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan: Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; Koichiro Yoshizumi, Director, Deputy President and Director of Sales and Marketing. Before we begin, some statements in the teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that can materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?
Daniel Amos: Good morning, and thank you for joining us. As I reflect on the second quarter of 2022, our management team, employees and sales force have continued to adapt more tirelessly to be there for the policy holders when they need us the most, just as we promised. Aflac Incorporated reported solid results for the second quarter with net earnings per diluted share of $2.16 and $3.73 year-to-date. Adjusted earnings per diluted share were solid at $1.46 in the second quarter and $2.88 for the first 6 months, supported in part by the continuation of the low benefit ratio associated with the pandemic conditions. Also contributing was a better-than-expected investment income, including returns from alternative investments. We remain cautiously optimistic as our efforts focus on growth and efficiency initiatives amid this evolving pandemic backdrop. Looking at our operation in Japan in the second quarter. Aflac Japan generated strong overall financial results with a profit margin of 27.4%. This was again above the outlook range we provided at the November 2021 financial analyst briefing. Persistency remains strong. However, sales continued to be somewhat constrained as the pandemic conditions that impact our ability to meet face-to-face with customers. Also contributed to the quarterly results was the 2021 comparison following the launch of our new medical product. Regarding Japan Post strategic alliance, as part of our ongoing collaboration and governance framework, I traveled to Japan towards the end of June to meet with Japan Post Holdings' CEO, Mr. Masuda, along with the presidents of Japan Post Postal and Insurance Companies. We had an understanding and productive visit discussing our plans. This included a renewed commitment from executive management to drive sales with a focus on distribution, growth and marketing of cancer insurance. Aflac Japan has continued to offer sales support to Japan Post, especially after the new fiscal year began in April of 2022 and following Japan Post sales structure transformation. This support includes further aligning of our sales offices with Japan Post regional offices to strengthen support and to share our best practices. As you may recall, under the new structure, sales employees focus solely on selling Japan Post insurance products and Aflac Japan's cancer insurance product. We have made gradual progress towards providing cancer insurance protection to more consumers, demonstrated by the increased proposal activity and sequential monthly sales growth during the second quarter. There is more progress to be made, and we continue to work to strengthen the strategic alliance to create a sustained cycle of growth for both companies. We believe that sales through Japan Post Group will improve in the second half of the year as sales employees gain more experience and momentum. As we look forward to 2023, we will introduce our new cancer insurance product through Japan Post likely in the second quarter. This will allow both entities to invest in a more complex, coordinated required by the distribution system of this size. We plan to launch our revised cancer product and agencies in the second half of 2022, and we continue to expect stronger overall sales in the second quarter of the year. This assumes that pandemic conditions do not escalate and that sales productivity continues to improve at Japan Post Group and that we execute on our product introductions and refreshment plans. Turning to the U.S., we saw a solid profit margin of 21.4%. I'm pleased with the U.S. sales momentum has continued with a 15.6% sales increase in the second quarter. This reflects continued adaptation to the pandemic conditions, growth in the core products and our investment and build-out of growth initiatives. While Aflac network dental and vision and group premier life, asset management and disability solutions, which we call PLADS, a relatively small part of our sales, we are pleased with how they are contributing to our growth. Our growth initiatives modestly impacted the top line in the short term, but also tend to be accompanied by the sale of our core supplemental health products. In combination with our core products, they also better position Aflac U.S. for future long-term success. The need for our products we offer is as strong or stronger than ever before. At the same time, we know consumers' habits and buying preferences have been evolving. We remain focused on being able to sell and service customers whether in person or virtually. This is part of the ongoing strategy to increase access, penetration and retention. Turning to capital deployment. We placed significant importance on continuing to achieve strong capital ratios in the U.S. and Japan on behalf of our policyholders and shareholders. We continue to generate strong investment results while remaining in a defensive position as we monitor evolving economic conditions. In addition, we've taken proactive steps in recent years to defend cash flow and deployable capital against a weakening yen. When it comes to capital deployment, we pursue value creation through a balance of actions, including growth investments, stable dividend growth and disciplined and tactical stock repurchase. It goes without saying that we treasure our 39-year track record of dividend growth, and we remain committed to extending it, supported by the strength of capital and cash flows. In 2022, we remained in the market repurchasing shares with a tactical approach. In the second quarter, Aflac Incorporated deployed $650 million in capital to repurchase 11.2 million of its common shares, bringing the 6-month total to $1.15 billion in purchase and 19.2 million of the shares. With this approach, we look to emerge from this period in a continued position of strength and leadership. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We've also focused on integrating the growth investments that we've made. We are well positioned as we work towards achieving long-term growth while also ensuring we deliver on our promise to the policyholders. I don't think it's a coincidence that we have achieved success while focusing on doing the right things for the policyholders, shareholders, employees, sales distribution, business partners and communities. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. We also believe that the underlying strength of our business and our potential for continued growth in Japan and the United States, the 2 of the largest life insurance markets in the world. Thank you again for joining us this morning. And now I'm going to turn it over to Fred. Fred?
Frederick Crawford: Thank you, Dan. Before commenting on our results, let me start with some perspective on how we're positioned when considering current U.S. economic conditions. We have not witnessed this level of inflation in the U.S. in many years, and we are closely monitoring conditions. Wage inflation and full employment is generally supportive of growth in worksite benefits. However, when considering voluntary product, there is a question as to how much of any increased income is available for supplemental products as real wages are likely neutral to down. Our benefits are defined at time of purchase and do not adjust for health care inflation. Therefore, we do not expect any measurable impact on claims. In terms of recruiting and retaining agents, it can be more of a challenge as agents are commission-only and need to keep pace with any increase in costs. When looking at enterprise margins, the impact of inflation does apply upward pressure on expenses. However, this is mitigated by rising rates and additional investment income, having built a significant floating rate loan portfolio. In terms of the risk of economic slowdown and recession, our business model is generally defensive in nature with low asset leverage and exposure to risk assets. Profits and cash flow are driven largely by morbidity margins that tend to remain stable during periods of economic volatility. While employment levels may decrease, we often benefit in the recruiting side during an economic slowdown versus today's tight labor markets. Max spoke in his recorded comments to the work we have done to defend our cash flow from weakness in the yen, we have built a sizable unhedged US-dollar portfolio in Japan, shifted most of our senior debt to yen for both hedging and cost of capital purposes and maintain a flexible hedging position at the holding company. It's important to understand what makes all this possible: significant economic value, strong capital ratios and predictable cash flow out of Japan. Overall, in recognizing the balance we have in operating in the U.S. and Japan, we like how we are positioned to defend our performance under today's U.S. inflationary conditions and the potential for economic slowdown. We see no interruption in our core margins and return of capital to shareholders, including dividend pattern and share repurchase. Turning back to our businesses and beginning with Japan. COVID cases have surged again with daily new cases reaching 200,000, up significantly from already elevated levels earlier in July and considerably higher than levels experienced in the second quarter. However, hospitalization and deaths remain low. Based on commentary from the Japanese government, there does not appear to be plans to introduce a nationwide state of emergency, which are typically triggered by both increasing cases and declining hospital capacity. We continue to experience elevated COVID-incurred claims, driven by its designation as an infectious disease and deemed hospitalization, which allows for payment of claims for care outside the hospital. We would expect the recent surge in COVID cases to apply pressure to near-term benefit ratios. While not guaranteed, this may be partially offset by other drivers of hospitalization and care, which have remained low during periods of higher COVID. Our data suggests this is driven by increased and less expensive outpatient treatments as policyholders and their doctors seek to avoid going to the hospital with COVID cases on the rise. With respect to COVID's classification under the Infectious Disease law, August 1, a special committee of the Ministry of Health, Labor and Welfare started reviewing COVID's classification under the law. Revision of the classification requires amending the law, which is expected to be discussed at the extraordinary Diet session beginning in September at the earliest. Having just spent a few weeks in Japan, the general population remains cautious with respect to the potential for COVID infection. With widespread infection, this is not simply a matter of customer behavior and face-to-face interaction but also agents who are sidelined temporarily with COVID. As a result, we typically experience reduced proposal volumes during periods of elevated cases, an early indication of potential sales weakness. While COVID conditions remain outside our control, our work continues to position Japan for sales recovery in the second half of the year and as we move into 2023. These actions include items that Dan referenced in his comments, such as accelerating the launch of our new cancer product, direct marketing campaigns more closely tied to targeted TV advertising and adjusting our distribution model for better alignment with our third-party partners. We continue to review our broader product portfolio, both first and third sector, for enhancements designed to increase the value proposition for our policyholders, offer a broad product lineup for our core distribution partners and secure our competitive position in the market. We have been making investments in technology and in working with our distribution partners to reduce launch costs associated with product refreshment and development. It's becoming clear that both the competitive environment and our broader product line creates a product refreshment cycle that is more continuous in nature. Separately, our incubated businesses continue to develop. We are seeing favorable results piloting Hatch Healthcare, our provider of noninsurance support, to develop the ecosystem for both cancer and nursing care policyholders and expect to expand availability in early 2023. Our short-term insurance subsidiary, Sidachi, was launched in early 2021 and currently offers 2 products: a substandard medical product and a disability product aimed at the contingent or freelance workforce in Japan. Sidachi serves 2 strategic purposes: to grow and develop these specialized markets; and second, as a proof-of-concept platform for product innovation that may become more broadly popular in the future. We can't control COVID conditions but we are not standing still. We will develop these themes in more detail at our financial analyst briefing in November. Turning to the U.S., and as you are aware, COVID conditions are also elevated. This is not currently causing any issue in terms of either our operations or distribution in the U.S. We saw persistency recover to more normal levels when isolating results in the quarter and accounting for seasonality. Account persistency has remained stable through the year. So we believe this is driven by an increase in employee turnover with tight labor markets. There are moving parts when looking year-over-year, including the retirement of state mandates that serve to reduce lapsation. As Dan noted in his comments, we continue to deliver a balanced performance. We see recovery in the small business market with growth in veteran average weekly producers while also continuing to strengthen relationships with our broker partners. For example, split by product type, group voluntary was up 16%; individual benefits, up 11%; split by channel, agent sales were up 11% and broker up 22%. The combination of network dental and vision and premier life and disability were ahead of our plan as we continue to see strong performance with our buy-to-build properties. We were up 175%, albeit off a smaller but building base. Direct-to-consumer is down 7% and largely the result of the increase in costs associated with organically generating, purchasing and converting leads and meeting our return expectations. In terms of the U.S. expense ratio, it's important to identify the impact of our build investments. We have 3 important business initiatives underway that are essential to the future growth of the company. These investments include group life, disability and asset management, network dental and vision and having a digital direct-to-consumer platform to reach consumers that are outside the traditional workforce. In the quarter, investment in these efforts impacted our expense ratio by 280 basis points, and we would expect this pace of investment to continue for the rest of 2022 and into 2023. Our 2021 outlook for a 3% to 5% compound annual growth rate in revenue through 2026 is largely driven by these 3 growth platforms and related halo impact of cross-sell and retention of core voluntary products. In the next 3 years, we expect a natural swing in these platforms from contributing to an elevated expense ratio to being the principal driver of returning to more normalized levels. In the interim, we are navigating investment in the future growth, advancements in our digital platform while maintaining strong profitability. Turning to Global Investments. With the rise in short-term interest rates driven by Federal Reserve as they combat inflation, together with deployment activity, net investment income generated from our $12 billion floating rate portfolio is currently estimated to increase approximately $160 million for the year as compared to our original plan. As mentioned last quarter, we have locked in the favorable LIBOR curve on a large portion of our portfolio and expect continued tailwinds to floating rate income going into 2023. Along with being an attractive asset class and strategic to our U.S. dollar program in Japan, our floating rate book acts as a logical hedge against inflationary cost pressure. We maintain a book of foreign exchange hedge instruments on our U.S. dollar portfolio in Japan that is also impacted by inflation as the cost of these forward contracts are generally aligned with short-term rates in the U.S. However, we have locked in those costs for 2022 and have offsetting hedge instruments at the holding company that serve to neutralize the impact to the enterprise. Our alternatives portfolio continues to deliver strong results. We fully expect lower valuations of these portfolios in the second half of the year as private equity marks track public equity valuations, likely resulting in giving back much of their 2022 gains. There is a well-understood lag in reporting numbers on private equity, and this is a natural expectation given private equity's correlation to the public equity returns. Naturally, we are closely monitoring economic conditions and the chance of recession. We maintain a defensive position to risk assets in terms of private and real estate equity, our investment thesis and risk appetite remains the same. We are willing to accept some equity market volatility to earn 10-plus percent over the long term, adding to NII or net investment income, on a risk-adjusted basis. We maintain a conservative allocation of under 3% of our invested assets with marginal growth expected over the next 5 years. We closely monitor our middle market and transitional real estate portfolios where recessionary impacts could be felt sooner. We expect these portfolios to perform well given their senior, secured, first lien structure, protective covenants, reasonable leverage and private equity sponsorship for middle-market loans as well as a high degree of diversification. The portfolio has performed well during the stressful period of COVID, and we expect they will continue to. I'll now hand the call back to David to take us to Q&A. David?
David Young: Thank you, Fred. Now we are ready to take your questions. [Operator Instructions]. Andrea will now take the first question.
Operator: [Operator Instructions]. Our first question will come from Nigel Dally of Morgan Stanley.
Nigel Dally: So I wanted to touch on U.S. losses. Last quarter, it was a little troubling. In this quarter it seems to have returned to more normal levels. Can you talk a little more about what was driving that? Was it purely just macro conditions? Or -- I know you're looking at various initiatives to help improve it. Was that a play as well? And then also looking forward, do you expect higher inflation have an impact on activity as well?
Frederick Crawford: Nigel, it's Fred. Let me comment on lapse rates. When we talk about -- as you know, we report our lapse rates on a trailing 12-month basis. And as a result, you'll see pressure in our reported lapse ratios year-over-year. And so what we have done is looked at our quarterly lapse rates seasonally adjusted when we make our comments about a recovery in lapse rates. And let me give you an idea. Our lapse rate in the quarter, or said differently, our persistency in the quarter -- for the second quarter only was around 79%. And that is approximately equal to the pre-COVID levels of lapse rates that we tend to enjoy or persistency that we tend to enjoy in the second quarter. To give you an idea, before COVID, we would travel again around that 79% rate. It rose up into the 81% territory over the last couple of years, and we believe that's largely related to the state mandates that require keeping policies in place. As those started to expire and have now largely expired, we've traveled back into normal persistency. In the first quarter, what spooked us is that our persistency in that quarter was around 74.5%, and that seasonally adjusted was about 200 basis points lower than we expect. We always expect the first quarter persistency to be lower because it has implications. It's timed related to annual enrollment process and year-end process, so it's normally a lower persisting quarter. But in this case, it traveled about 200 basis points lower than we would have expected, and that's what gave rise to our comments last quarter. So we're very pleased to see it recover back to normal seasonal adjustments in the second quarter, and that would be my comment there. We'll have to obviously monitor it as we go forward. To my comments on inflation, I would tell you that we don't see necessarily the implications of inflation impacting lapse rates, per se. Right now, we haven't seen any evidence of that. But it's a very unusual inflationary period, and quite honestly, we don't have a lot of history of inflation at these levels and watching how our business behaves. And that's why I have some of the cautionary language. Thus far, I would tell you, we don't see any acute implications from inflation, but we simply want to note the fact that we're going to monitor that. Again, we see offsetting dynamics related to inflation, so we don't see this as having an impact to overall U.S. financial performance.
Operator: The next question comes from Jimmy Bhullar of JPMorgan Securities.
Jamminder Bhullar: So I had a question on sales trends in the U.S. and in Japan, and if you could talk about how sales trended through the quarter. And specifically on Japan, it seems like your comments are pretty positive on an expected improvement in sales. Are you seeing that? Or are you just hopeful that things will get better? And then just relatedly, any impact that you're seeing on your production activities in Japan because of the recent increase in COVID cases?
Daniel Amos: Let me let ask Yoshizumi to answer that.
Koichiro Yoshizumi: This is Yoshizumi. Let me answer your question. For the second quarter of 2022, so a downturn continuing from first quarter, as sales of the new medical insurance product had run its course after its release in January last year. Additionally, COVID-19 continue to have a negative impact on sales activities as the number of new cases increased 8.2x compared to the same period last year, although intensive infection prevention measures have been lifted. While COVID-19 infections have been rapidly increasing since the start of July, Japan is experiencing its seventh wave and uncertainty remains. While having said that, from the third quarter, we are hopeful that sales will exceed last year's results, building on the new cancer insurance product launch and the gradual recovery of Japan Post Group sales. That's all for me.
Teresa White: I'll ask Virgil to respond to the U.S. sales question.
Virgil Miller: Thank you, Teresa. As Fred and Dan shared earlier, we did see a 15.6% increase in sales. Very pleased with the second quarter performance. I think Fred said it well, though. It's a combination of what we're seeing from our distribution channels. If you think about the small market, which was disrupted quite heavily at the beginning from COVID, we've seen a solid recovery. It's really driven by our veterans returning to producing. We saw another increase in our veteran average week of producers, and we saw an increase in productivity from our veterans. And then when you look at the large case space, it was less disrupted by COVID. We continue to see great performance from our broker partners in that space. We saw a 24% quarter-over-quarter increase in production from our brokers. So when you look at it, how we're going to the market in large with our brokers, large case space with our brokers and continue to see recovery in the small market with our veterans, overall, we're pleased with that quarter.
Operator: The next question comes from Alex Scott of Goldman Sachs.
Alexander Scott: First one I had is on the Japan benefit ratios. I guess when I think about the, I think it was 190 basis points you caught out of unfavorable COVID claims and -- but then the normalized benefit ratio that's materially higher, could you help us think through, I think it was over a 400 basis point delta associated with these IBNR releases, when you sort of go through that. And I struggle with it because I know you guys have had favorable IBNR over time. I mean, do you have any way of sort of breaking that apart a little for us and helping us think through like what portion of it is more the outpatient treatments associated with COVID specifically? I mean, any help with how to sort of figure out where things should be on a run rate basis.
Max Broden: Thank you, Alex. If you start with -- obviously, you make the walk from the reported benefit ratio of 67.4% to adjusting for all the sort of special factors in the quarter, you get to 69.8%. What I think is reasonable to sort of add back is the sort of run rate more permanent or somewhat permanent reserve releases that we have experienced from favorable hospitalization trends, et cetera. Those added up in the quarter to about 170 basis points. And that's what we have seen historically run through our results. So if I were to adjust for that to sort of get to -- sort of adding back what we normally see as an ongoing reserve release in each quarter, you get back to 68.1% in sort of an adjusted underlying benefit ratio for the quarter. Going forward, over time, these reserve releases have been running relatively high recently, and we would expect those to continue, maybe not at the level of 170 basis points, but we certainly expect an element of that going forward.
Alexander Scott: Got it. That was really helpful. Next one I had is just on inflation and the expenses. I heard some of the comments that, that could put upward pressure on expenses. I mean, is that material enough for us to think about maybe a different range for expense ratios? I know things are a little more focused on the back half or expenses as well. So I was just wondering if there's any update to sort of the expense ratio guide that you guys have out there.
Frederick Crawford: I think essentially, where we face inflation is in just a couple of areas. One, predominantly is simply wage inflation, so your overall headcount and what we're all experiencing and seeing in the market with wage inflation and salary inflation. And we've got to do that. We've got to fall in line to retain and keep our talent, and we'll do so. Having said that, for a company our size, our employment levels are quite manageable. I mean, we're a very large U.S. and Japan company, but we have 5,300 employees in the U.S. and approximately 7,000 in Japan. And so we don't have the type of business model that is overly concentrated from that perspective. And so therefore, the wage inflation numbers, while they do apply pressure, they're more manageable. There's also certain contracts that we have, and quite frankly, the industry has that will have inflation riders. And so certain IT and servicing contracts often have inflationary provisions that kick into place when inflation gets out of control. That can also calm back down as inflation gets back into control. Overall, what I would tell you is inflation in and of itself is not causing us to rethink our guidance on expense ratios. The bigger moves on expense ratios is what I noted in the fact that we're heavily investing in growth platforms. We're very pleased to see that the growth is coming through in those platforms, as I mentioned in my comments. But it's going to -- that's really going to weigh on expense ratios in the U.S. more than inflationary pressure issues.
Max Broden: And just to add one reminder. Obviously, expense ratio, it's a ratio. And you have net investment income coming into play here as well, and it helps boost the top line, and therefore, gives you some relief on the expense ratio when you think about the inflationary pressures. And the last piece is that, yes, we do obviously acknowledge that it is putting upward pressure on expenses in dollar terms as well, and we are taking active actions in order to combat that as well.
Daniel Amos: And I'll also remind you that 1.5 years ago, we had a voluntary program for retirement in the U.S., and about 10% of our workforce retired. So we -- this is not something that has not been top of mind. [Technical Difficulty].
Max Broden: Operator?
Operator: The next question comes from Erik Bass of Autonomous Research.
Erik Bass: I was hoping you can provide a little bit more detail on the NII outlook. I think Fred mentioned $160 million of higher expected NII in 2022 than the original plan. Just wanted to confirm, is this gross or net of hedge costs? And then how should we think about the impact moving into 2023 when, I guess, floating rate NII should continue to build but hedge costs will also reset and probably move higher?
Eric Kirsch: Fred, would you like me to take that?
Frederick Crawford: Yes, please, Eric.
Eric Kirsch: Sure thing. The numbers that Fred quoted are gross of currency hedge costs. They are net of interest rate hedging because we've done some interest rate hedging with respect to the floating rate book. So I just want to bifurcate those two buckets. And as a reminder, for this year, our FX hedge costs are primarily locked in, like 95%, 98% of those hedge costs are pretty locked in. Clearly, going into next year, the cost of hedging is substantially higher, and we still carry about $4.1 billion or so forwards on the Japan dollar program. So the hedge costs next year will certainly go up. But as a reminder, we have what we call the back-to-back program or sort of countering forwards at inc. So for the enterprise, the FX hedge cost from a forward perspective should stay relatively stable on a net basis. We do have some FX options on the book as well that help us with tail protection for the unhedged portion of the dollar program in Japan. And those are based on options pricing. We do expect those to go up, which won't necessarily have an offset, but we do often look at our hedge ratios and how much we want hedged. So the amount of that could be a variable but we would expect the option costs to go up as well. And then more broadly speaking, when you look at next year's forecast from the perspective of where do we think our floating rate income is going, as Fred said, we still expect tailwinds. The forward curve for LIBOR is still upward sloping. We're all watching the Fed. And assuming it stays where it is, we would expect further tailwinds in floating rate income for next year. But again, the Fed is moving with inflation in the markets. The latest Fed meeting was a little bit more dovish than hawkish for the future. So it's -- so that's going to be a moving target, if you will. However, having said that, and we reported on this before, on our floating rate book, we have put on interest rate hedges. And we did that because at the beginning of the year with the aggressive Fed hikes, an increase in LIBOR, when we do our financial planning over a 3- and 5-year period, we saw that there's a substantial increase based on the forward curves in that floating rate income over that time period. But we also know that there's no guarantee we'll get that. It all depends on where LIBOR is at that time. So the purpose of the interest rate hedge was to say, given that potential large increase in income, why not lock in a good portion of it and put better surety around that, which we did. So it gives us great protection now in case in the future there's recession and the Fed starts to lower rates. But we didn't hedge all of it. So we still have some upside as well if rates should continue to go up. So that's a picture, if you will, of the future and some specifics on the hedge cost.
Erik Bass: That's helpful. And just to confirm then, given the back-to-back program, should we really think of most of the kind of NII uplift from the higher floating rate yields dropping to the bottom line at an enterprise level, realizing it may not -- you may see less of an impact in the Japan segment and more of it in corporate?
Frederick Crawford: That's correct. Basically, you would see as the locked-in hedge costs roll off and we go into a new level of hedge costs in Japan, you would see those hedge costs increase. But then that same increase would be offset by increased hedge income at the corporate level so that there'd be no effective impact to the enterprise. And then also keep in mind what Eric said, that of the $12 billion in floating rate portfolio, our hedge instruments are around $4 billion notional. And so we still have an ability to enjoy outside net investment income despite the rise in hedge costs.
Operator: The next question comes from Suneet Kamath of Jefferies.
Suneet Kamath: Just a follow-up on Eric's question. So if we're getting $160 million of higher NII from the floaters, does that influence your thinking around expense initiatives, maybe an opportunity to accelerate that in order to generate maybe faster growth going forward?
Frederick Crawford: Well, they are two different topics. What I would tell you -- if what you're saying is would you accelerate your initiatives and actually increase the pace of investment with added net investment income, we're not really adjusting our plans around NII up or down. The plans we have around investing in our platform are really related to core growth in earned premium, policies in force, sales and overall efficiency measures. So it really would not render any impact on those plans. And I do want to highlight, as Dan mentioned in his comments, we are very much at work in terms of addressing the long-term expense structure, both in Japan and in the U.S., and have several initiatives underway to drive productivity improvements and efficiency improvements. Those do require near-term investment, but we have plans in place to help our expense dynamics and certainly combat any inflationary pressure as we go forward. But none of that, Suneet, is really impacted by watching NII move up and down.
Suneet Kamath: Okay. Got it. And then just shifting to Japan. I was hoping to get a little bit more color on this COVID as an infectious disease policy that the government has. Maybe what are your expectations for the, I guess, early September conversation around this that the government will have? And I believe that your products have certain caps in terms of number of days where benefits can be drawn. Is there any risk to potentially that changing in the future?
Frederick Crawford: I think perhaps Koide-san can address that. We can add our color here in the U.S., But Koide-san, maybe address your views of the Diet conversation in September.
Masatoshi Koide: Yes. This is Aflac Japan, Koide. So as Fred mentioned earlier, the discussion and deliberation related to COVID-19 infection disease law discussion is really gaining momentum. And in light of the situation, experts from the government subcommittee on countermeasures against infectious disease [indiscernible] coronavirus and the National Governors Association have proposed a review of the classification. And also, as Fred mentioned earlier, starting from August 1, a special committee of the Ministry of Health, Labor and Welfare started reviewing COVID-19's classification under the law. And revision of the classification under the infectious disease law requires amending the law, which is expected to be discussed at the extraordinary Diet session beginning in September at the earliest. So we cannot predict the outcome of the Diet discussion, and we would highlight that it is not focused on the insurance industry. Rather, it is focused on how the law has pressured the overall health care system. However, we feel it is a positive development that a dialogue is taking place on the issue. That's all for me.
Frederick Crawford: So I would also just note something that I think is perhaps obvious, but just to be clear. This is really not uniquely an Aflac issue. The major insurance companies in Japan are all facing substantial increased claims activity on medical policies. In fact, we're not even among the top few in terms of the volume of claims we have relative to other peers in the industry, domestic insurers with large platforms. So this is really broadly based. We can't confirm some of these statistics, but there's been recent news articles suggesting that the amount of claims paid in the month of June, for example, under medical policies was up nearly twelvefold over the same time period last year this time. So it is absolutely pressuring the system. And we think that the legislative community in Japan is taking this under consideration and realizing they've got to contemplate a change in the law.
Daniel Amos: While saying that, we're still very comfortable with our projections for 2022. So I want to make sure you grasp that.
Operator: The next question comes from Ryan Krueger of KBW.
Ryan Krueger: I guess, first, could you just give us some sense of how much NII uplift in the current quarter did you realize from higher short-term rates on the floating portfolio?
Frederick Crawford: Go ahead, Eric.
Eric Kirsch: It's Eric. It was about $38 million for the quarter, but that's in total for the portfolio. But just from rates alone, it's around $2 million to $4 million. And that's pretty logical because if you think about the ascent of LIBOR, it really didn't start increasing until February, March, April, and these are 1 month of quarterly reset. So the impact from just rates alone on the floaters was rather small, but we did have other portfolio activity around deployment. The new money yield on deployment was better than planned. We were able to purchase some floating rate assets ahead of plan from a particular provider. So a number of portfolio activities really added to most of that increase. But as the year goes by, the impact from rates alone just continues to get higher because of that substantial rise in LIBOR.
Ryan Krueger: I guess just to clarify, is the $38 million part of the $160 million? Or should we think about the $2 million to $3 million as...
Eric Kirsch: $38 million is part of the $160 million, that's just for the second quarter. And the $160 million is for the full year forecast.
Ryan Krueger: Okay. Understood. And then I guess, in the U.S. did you see any normalization in the benefit ratio as we went through the quarter or it was pretty spread throughout?
Max Broden: I think it's relatively well spread out over the quarter. There was no specific movements between the different reporting months in the quarter.
Frederick Crawford: One thing back on Japan to just make sure that you're capturing is, again, when it comes to these COVID cases we're talking about, just want to make sure you take to heart Max's comments and Dan's comments and my script comments, and that is the very same dynamic that is giving rise to these higher infectious disease COVID claims, we believe are absolutely impacting the rate of hospitalization on other claims activities, not the least of which is cancer insurance related claims. And remember, again, as you all know, we are a dominant cancer insurance provider. And so when the world of Japan health care moves to more outpatient treatment, that has material implications for your cancer claims and how they trend over time. So this is why, despite all of the comments around COVID claims and increases in medical claims, you still see a low benefit ratio in Japan even by historical standards. There's no guarantee of that direct correlation, but it's certainly what we have seen in the data thus far.
Operator: The next question will come from Tom Gallagher of Evercore ISI.
Thomas Gallagher: First question, back on the floating rate portfolio. The -- so the $12 billion floating rate portfolio in the transitional real estate, Eric, how do you feel about the quality of those portfolios if we do enter into a recession? Would you expect the higher yield you're getting on to keep the higher yield on a net basis? Or would you expect some portion of that is going to be given back through impairments? And are you looking to grow that portfolio or you're keeping it steady?
Eric Kirsch: Sure thing. And Tom, actually, since we have Brad Dyslin on the call, who's my deputy but also in charge of credit, I'm going to shift that question over to Brad.
Bradley Dyslin: Thank you, Eric. And thank you for the question, Tom. We're definitely paying very close attention to both of these portfolios. As I think Fred mentioned in his opening comments, we think this is where as the economy slows down, we could see the first sign of any issues. We're really focused, as you would expect, on their ability -- especially in our middle-market loan portfolio, their ability to pass along these cost increases and absorb higher financing costs. We've worked very closely with our managers. We stressed the portfolio for some very severe outcomes, and we think any potential loss is going to be very manageable. When you look across the space, we feel we have a relatively high-quality portfolio across middle-market lending. It's all first lien. We have modest leverage. It's a very well-diversified portfolio. We think there's some inherent characteristics that allowed us to perform well during COVID, and we -- the COVID shock, and we think it will continue to support the portfolio with a downturn. Now of course, we don't expect to come through entirely unscathed. We would be surprised that we didn't have a few losses if we get the kind of downturn that is possible. But we don't expect it to be overly material. In the real estate portfolio, again, it all boils down to the quality of assets you underwrite, the leverage you have, and in the case of transitional real estate, how well we underwrite the actual transition of the asset, the strength of the sponsor and the strength of the business plan. Again, we stressed this portfolio with our managers and we feel really good about how we're positioned and don't currently expect we'll have any losses in real estate. But of course, we're keeping a very close eye on it.
Eric Kirsch: Tom, I would also just add to Brad's remarks. Just as a reminder, for our TREs and middle-market loans, these are first lien, senior secured assets. We take a more conservative approach to those asset classes. We definitely earn higher yields and spreads, but that's to offset the risk that we're taking. The other reminder is just from a financial standpoint, we do take a CECL reserve for these asset classes. And those are, generally speaking, based on long-term historical default rates. Based on Brad's comments and our actual expected performance, while certainly we won't come out of this unscathed, my suspicion is we will outperform those CECL reserves. And in essence, while there could be some losses in the future depending on how deep a recession is, how long it will be, it will be much better performance than the expected CECL reserves that we've taken already.
Thomas Gallagher: Okay. Just one quick follow-up. The U.S. earned premium is still modestly declined despite the sales recovery and some improved persistency, and I know there's a bit of a lag here in terms of how that earns in. But based on what you're seeing now, would you expect earned premium to begin to grow again in the second half and then maybe pick up in 2023?
Max Broden: We would expect an improvement throughout the year and then that it really picks up in 2023 as lapses come down and we continue to see sales growth.
Operator: The next question comes from John Barnidge of Piper Sandler.
John Barnidge: Can you maybe talk about foot traffic in shops in Japan in 2Q versus 1Q? Because I know that's a metric you've discussed previously.
Frederick Crawford: Are you talking about our walk-in shops and shop traffic? Is that the question?
John Barnidge: Yes, that's correct.
Frederick Crawford: Yes. I think I would ask Yoshizumi-san in Japan to answer that question. I don't have that data right in front of me. Yoshizumi-san, do you have any data on the level of traffic through our retail shops?
Koichiro Yoshizumi: Thank you, Fred. Let me answer the question. This is Yoshizumi. Well, the number of customers in-store or the shop in the second quarter was at the same level as the previous year, and which indicates a recovery from the first quarter when we had a negative 9.3%. That said, this figure has not yet returned to pre-COVID-19 levels, and we will continue monitoring the trend in the number of visiting customers. That's all for me.
Operator: The next question comes from Michael Ward of Citi.
Michael Ward: I just wanted to expand on the concept of delayed cancer screenings. I think Dan was actually talking about this on CNBC this morning. But just wondering if you could maybe give an update on what you're seeing in terms of cancer severity and the impact -- potential impact from delayed screening in the U.S. and Japan?
Daniel Amos: Well, I mentioned it on CNBC when I was talking to Joe. And we have not seen an enormous jump of any kind that was not actuarially computated. So we're falling within our ranges. Saying that, it's now getting -- from the original, it's getting out to be 2.5 years it's been. So I think the chances are less and less as we move forward. But at the same time, it's just to show you how you don't know what you have ahead of you. And -- but all of our tracking says that we should have seen more if it was going to really spike by now. And I've got a guy that knows all the actuarial computation is shaking his head, that's correct. So that's the answer.
Max Broden: One thing I would add to that answer is that we have seen first occurrence coming back to more normal levels. And obviously, that tends to be -- should be a leading indicator for our overall total cancer claims. So overall, we're still running a little bit low where we would expect to be in the low pre-pandemic levels, but in component of first diagnosis and first occurrence, is generally back both in the U.S. and in Japan to more normal levels. And we've said before and we still expect that there is sort of a level of cancer out there to be detected within our policyholder base that we think will come our way at some point. We just haven't seen the full impact of that yet. And all of that is incorporated in our guidance for benefit ratios going forward.
Daniel Amos: But I think most people that were going to the doctor and, whatever, they were having checkups, are now back to normal. And it's been going on probably for a year or so. So we feel pretty good about those numbers. And that's one reason we said, overall, we feel good about even the issue in Japan regarding the government's move here and how we can handle those claims. So we feel well positioned.
David Young: All right. Thank you, Mike, and thank you, Andrea. I believe that was our last question, and we're a little past the top of the hour. I want to thank you all for joining us. I hope you'll mark your calendars for Tuesday, November 15, for our financial analyst briefing. And we look forward to seeing and talking to you then. Until then, please reach out to Investor and Rating Agency Relations with any questions that you may have, and we look forward to talking to you soon. Take care.
Operator: The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the Aflac Incorporated Second Quarter 2022 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Ratings Agency Relations and ESG. Please go ahead."
},
{
"speaker": "David Young",
"text": "Thank you, Andrea. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com along with a video with Max Broden, Executive Vice President and CFO of Aflac Incorporated, providing an update on our quarterly financial results and current capital and liquidity. Max will also be joining us for the Q&A segment of the call along with other members of our U.S. executive management: Teresa White, President of Aflac U.S.; Virgil Miller, Deputy President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Brad Dyslin, Deputy Global Chief Investment Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan: Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; Koichiro Yoshizumi, Director, Deputy President and Director of Sales and Marketing. Before we begin, some statements in the teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that can materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Daniel Amos",
"text": "Good morning, and thank you for joining us. As I reflect on the second quarter of 2022, our management team, employees and sales force have continued to adapt more tirelessly to be there for the policy holders when they need us the most, just as we promised. Aflac Incorporated reported solid results for the second quarter with net earnings per diluted share of $2.16 and $3.73 year-to-date. Adjusted earnings per diluted share were solid at $1.46 in the second quarter and $2.88 for the first 6 months, supported in part by the continuation of the low benefit ratio associated with the pandemic conditions. Also contributing was a better-than-expected investment income, including returns from alternative investments. We remain cautiously optimistic as our efforts focus on growth and efficiency initiatives amid this evolving pandemic backdrop. Looking at our operation in Japan in the second quarter. Aflac Japan generated strong overall financial results with a profit margin of 27.4%. This was again above the outlook range we provided at the November 2021 financial analyst briefing. Persistency remains strong. However, sales continued to be somewhat constrained as the pandemic conditions that impact our ability to meet face-to-face with customers. Also contributed to the quarterly results was the 2021 comparison following the launch of our new medical product. Regarding Japan Post strategic alliance, as part of our ongoing collaboration and governance framework, I traveled to Japan towards the end of June to meet with Japan Post Holdings' CEO, Mr. Masuda, along with the presidents of Japan Post Postal and Insurance Companies. We had an understanding and productive visit discussing our plans. This included a renewed commitment from executive management to drive sales with a focus on distribution, growth and marketing of cancer insurance. Aflac Japan has continued to offer sales support to Japan Post, especially after the new fiscal year began in April of 2022 and following Japan Post sales structure transformation. This support includes further aligning of our sales offices with Japan Post regional offices to strengthen support and to share our best practices. As you may recall, under the new structure, sales employees focus solely on selling Japan Post insurance products and Aflac Japan's cancer insurance product. We have made gradual progress towards providing cancer insurance protection to more consumers, demonstrated by the increased proposal activity and sequential monthly sales growth during the second quarter. There is more progress to be made, and we continue to work to strengthen the strategic alliance to create a sustained cycle of growth for both companies. We believe that sales through Japan Post Group will improve in the second half of the year as sales employees gain more experience and momentum. As we look forward to 2023, we will introduce our new cancer insurance product through Japan Post likely in the second quarter. This will allow both entities to invest in a more complex, coordinated required by the distribution system of this size. We plan to launch our revised cancer product and agencies in the second half of 2022, and we continue to expect stronger overall sales in the second quarter of the year. This assumes that pandemic conditions do not escalate and that sales productivity continues to improve at Japan Post Group and that we execute on our product introductions and refreshment plans. Turning to the U.S., we saw a solid profit margin of 21.4%. I'm pleased with the U.S. sales momentum has continued with a 15.6% sales increase in the second quarter. This reflects continued adaptation to the pandemic conditions, growth in the core products and our investment and build-out of growth initiatives. While Aflac network dental and vision and group premier life, asset management and disability solutions, which we call PLADS, a relatively small part of our sales, we are pleased with how they are contributing to our growth. Our growth initiatives modestly impacted the top line in the short term, but also tend to be accompanied by the sale of our core supplemental health products. In combination with our core products, they also better position Aflac U.S. for future long-term success. The need for our products we offer is as strong or stronger than ever before. At the same time, we know consumers' habits and buying preferences have been evolving. We remain focused on being able to sell and service customers whether in person or virtually. This is part of the ongoing strategy to increase access, penetration and retention. Turning to capital deployment. We placed significant importance on continuing to achieve strong capital ratios in the U.S. and Japan on behalf of our policyholders and shareholders. We continue to generate strong investment results while remaining in a defensive position as we monitor evolving economic conditions. In addition, we've taken proactive steps in recent years to defend cash flow and deployable capital against a weakening yen. When it comes to capital deployment, we pursue value creation through a balance of actions, including growth investments, stable dividend growth and disciplined and tactical stock repurchase. It goes without saying that we treasure our 39-year track record of dividend growth, and we remain committed to extending it, supported by the strength of capital and cash flows. In 2022, we remained in the market repurchasing shares with a tactical approach. In the second quarter, Aflac Incorporated deployed $650 million in capital to repurchase 11.2 million of its common shares, bringing the 6-month total to $1.15 billion in purchase and 19.2 million of the shares. With this approach, we look to emerge from this period in a continued position of strength and leadership. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We've also focused on integrating the growth investments that we've made. We are well positioned as we work towards achieving long-term growth while also ensuring we deliver on our promise to the policyholders. I don't think it's a coincidence that we have achieved success while focusing on doing the right things for the policyholders, shareholders, employees, sales distribution, business partners and communities. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. We also believe that the underlying strength of our business and our potential for continued growth in Japan and the United States, the 2 of the largest life insurance markets in the world. Thank you again for joining us this morning. And now I'm going to turn it over to Fred. Fred?"
},
{
"speaker": "Frederick Crawford",
"text": "Thank you, Dan. Before commenting on our results, let me start with some perspective on how we're positioned when considering current U.S. economic conditions. We have not witnessed this level of inflation in the U.S. in many years, and we are closely monitoring conditions. Wage inflation and full employment is generally supportive of growth in worksite benefits. However, when considering voluntary product, there is a question as to how much of any increased income is available for supplemental products as real wages are likely neutral to down. Our benefits are defined at time of purchase and do not adjust for health care inflation. Therefore, we do not expect any measurable impact on claims. In terms of recruiting and retaining agents, it can be more of a challenge as agents are commission-only and need to keep pace with any increase in costs. When looking at enterprise margins, the impact of inflation does apply upward pressure on expenses. However, this is mitigated by rising rates and additional investment income, having built a significant floating rate loan portfolio. In terms of the risk of economic slowdown and recession, our business model is generally defensive in nature with low asset leverage and exposure to risk assets. Profits and cash flow are driven largely by morbidity margins that tend to remain stable during periods of economic volatility. While employment levels may decrease, we often benefit in the recruiting side during an economic slowdown versus today's tight labor markets. Max spoke in his recorded comments to the work we have done to defend our cash flow from weakness in the yen, we have built a sizable unhedged US-dollar portfolio in Japan, shifted most of our senior debt to yen for both hedging and cost of capital purposes and maintain a flexible hedging position at the holding company. It's important to understand what makes all this possible: significant economic value, strong capital ratios and predictable cash flow out of Japan. Overall, in recognizing the balance we have in operating in the U.S. and Japan, we like how we are positioned to defend our performance under today's U.S. inflationary conditions and the potential for economic slowdown. We see no interruption in our core margins and return of capital to shareholders, including dividend pattern and share repurchase. Turning back to our businesses and beginning with Japan. COVID cases have surged again with daily new cases reaching 200,000, up significantly from already elevated levels earlier in July and considerably higher than levels experienced in the second quarter. However, hospitalization and deaths remain low. Based on commentary from the Japanese government, there does not appear to be plans to introduce a nationwide state of emergency, which are typically triggered by both increasing cases and declining hospital capacity. We continue to experience elevated COVID-incurred claims, driven by its designation as an infectious disease and deemed hospitalization, which allows for payment of claims for care outside the hospital. We would expect the recent surge in COVID cases to apply pressure to near-term benefit ratios. While not guaranteed, this may be partially offset by other drivers of hospitalization and care, which have remained low during periods of higher COVID. Our data suggests this is driven by increased and less expensive outpatient treatments as policyholders and their doctors seek to avoid going to the hospital with COVID cases on the rise. With respect to COVID's classification under the Infectious Disease law, August 1, a special committee of the Ministry of Health, Labor and Welfare started reviewing COVID's classification under the law. Revision of the classification requires amending the law, which is expected to be discussed at the extraordinary Diet session beginning in September at the earliest. Having just spent a few weeks in Japan, the general population remains cautious with respect to the potential for COVID infection. With widespread infection, this is not simply a matter of customer behavior and face-to-face interaction but also agents who are sidelined temporarily with COVID. As a result, we typically experience reduced proposal volumes during periods of elevated cases, an early indication of potential sales weakness. While COVID conditions remain outside our control, our work continues to position Japan for sales recovery in the second half of the year and as we move into 2023. These actions include items that Dan referenced in his comments, such as accelerating the launch of our new cancer product, direct marketing campaigns more closely tied to targeted TV advertising and adjusting our distribution model for better alignment with our third-party partners. We continue to review our broader product portfolio, both first and third sector, for enhancements designed to increase the value proposition for our policyholders, offer a broad product lineup for our core distribution partners and secure our competitive position in the market. We have been making investments in technology and in working with our distribution partners to reduce launch costs associated with product refreshment and development. It's becoming clear that both the competitive environment and our broader product line creates a product refreshment cycle that is more continuous in nature. Separately, our incubated businesses continue to develop. We are seeing favorable results piloting Hatch Healthcare, our provider of noninsurance support, to develop the ecosystem for both cancer and nursing care policyholders and expect to expand availability in early 2023. Our short-term insurance subsidiary, Sidachi, was launched in early 2021 and currently offers 2 products: a substandard medical product and a disability product aimed at the contingent or freelance workforce in Japan. Sidachi serves 2 strategic purposes: to grow and develop these specialized markets; and second, as a proof-of-concept platform for product innovation that may become more broadly popular in the future. We can't control COVID conditions but we are not standing still. We will develop these themes in more detail at our financial analyst briefing in November. Turning to the U.S., and as you are aware, COVID conditions are also elevated. This is not currently causing any issue in terms of either our operations or distribution in the U.S. We saw persistency recover to more normal levels when isolating results in the quarter and accounting for seasonality. Account persistency has remained stable through the year. So we believe this is driven by an increase in employee turnover with tight labor markets. There are moving parts when looking year-over-year, including the retirement of state mandates that serve to reduce lapsation. As Dan noted in his comments, we continue to deliver a balanced performance. We see recovery in the small business market with growth in veteran average weekly producers while also continuing to strengthen relationships with our broker partners. For example, split by product type, group voluntary was up 16%; individual benefits, up 11%; split by channel, agent sales were up 11% and broker up 22%. The combination of network dental and vision and premier life and disability were ahead of our plan as we continue to see strong performance with our buy-to-build properties. We were up 175%, albeit off a smaller but building base. Direct-to-consumer is down 7% and largely the result of the increase in costs associated with organically generating, purchasing and converting leads and meeting our return expectations. In terms of the U.S. expense ratio, it's important to identify the impact of our build investments. We have 3 important business initiatives underway that are essential to the future growth of the company. These investments include group life, disability and asset management, network dental and vision and having a digital direct-to-consumer platform to reach consumers that are outside the traditional workforce. In the quarter, investment in these efforts impacted our expense ratio by 280 basis points, and we would expect this pace of investment to continue for the rest of 2022 and into 2023. Our 2021 outlook for a 3% to 5% compound annual growth rate in revenue through 2026 is largely driven by these 3 growth platforms and related halo impact of cross-sell and retention of core voluntary products. In the next 3 years, we expect a natural swing in these platforms from contributing to an elevated expense ratio to being the principal driver of returning to more normalized levels. In the interim, we are navigating investment in the future growth, advancements in our digital platform while maintaining strong profitability. Turning to Global Investments. With the rise in short-term interest rates driven by Federal Reserve as they combat inflation, together with deployment activity, net investment income generated from our $12 billion floating rate portfolio is currently estimated to increase approximately $160 million for the year as compared to our original plan. As mentioned last quarter, we have locked in the favorable LIBOR curve on a large portion of our portfolio and expect continued tailwinds to floating rate income going into 2023. Along with being an attractive asset class and strategic to our U.S. dollar program in Japan, our floating rate book acts as a logical hedge against inflationary cost pressure. We maintain a book of foreign exchange hedge instruments on our U.S. dollar portfolio in Japan that is also impacted by inflation as the cost of these forward contracts are generally aligned with short-term rates in the U.S. However, we have locked in those costs for 2022 and have offsetting hedge instruments at the holding company that serve to neutralize the impact to the enterprise. Our alternatives portfolio continues to deliver strong results. We fully expect lower valuations of these portfolios in the second half of the year as private equity marks track public equity valuations, likely resulting in giving back much of their 2022 gains. There is a well-understood lag in reporting numbers on private equity, and this is a natural expectation given private equity's correlation to the public equity returns. Naturally, we are closely monitoring economic conditions and the chance of recession. We maintain a defensive position to risk assets in terms of private and real estate equity, our investment thesis and risk appetite remains the same. We are willing to accept some equity market volatility to earn 10-plus percent over the long term, adding to NII or net investment income, on a risk-adjusted basis. We maintain a conservative allocation of under 3% of our invested assets with marginal growth expected over the next 5 years. We closely monitor our middle market and transitional real estate portfolios where recessionary impacts could be felt sooner. We expect these portfolios to perform well given their senior, secured, first lien structure, protective covenants, reasonable leverage and private equity sponsorship for middle-market loans as well as a high degree of diversification. The portfolio has performed well during the stressful period of COVID, and we expect they will continue to. I'll now hand the call back to David to take us to Q&A. David?"
},
{
"speaker": "David Young",
"text": "Thank you, Fred. Now we are ready to take your questions. [Operator Instructions]. Andrea will now take the first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question will come from Nigel Dally of Morgan Stanley."
},
{
"speaker": "Nigel Dally",
"text": "So I wanted to touch on U.S. losses. Last quarter, it was a little troubling. In this quarter it seems to have returned to more normal levels. Can you talk a little more about what was driving that? Was it purely just macro conditions? Or -- I know you're looking at various initiatives to help improve it. Was that a play as well? And then also looking forward, do you expect higher inflation have an impact on activity as well?"
},
{
"speaker": "Frederick Crawford",
"text": "Nigel, it's Fred. Let me comment on lapse rates. When we talk about -- as you know, we report our lapse rates on a trailing 12-month basis. And as a result, you'll see pressure in our reported lapse ratios year-over-year. And so what we have done is looked at our quarterly lapse rates seasonally adjusted when we make our comments about a recovery in lapse rates. And let me give you an idea. Our lapse rate in the quarter, or said differently, our persistency in the quarter -- for the second quarter only was around 79%. And that is approximately equal to the pre-COVID levels of lapse rates that we tend to enjoy or persistency that we tend to enjoy in the second quarter. To give you an idea, before COVID, we would travel again around that 79% rate. It rose up into the 81% territory over the last couple of years, and we believe that's largely related to the state mandates that require keeping policies in place. As those started to expire and have now largely expired, we've traveled back into normal persistency. In the first quarter, what spooked us is that our persistency in that quarter was around 74.5%, and that seasonally adjusted was about 200 basis points lower than we expect. We always expect the first quarter persistency to be lower because it has implications. It's timed related to annual enrollment process and year-end process, so it's normally a lower persisting quarter. But in this case, it traveled about 200 basis points lower than we would have expected, and that's what gave rise to our comments last quarter. So we're very pleased to see it recover back to normal seasonal adjustments in the second quarter, and that would be my comment there. We'll have to obviously monitor it as we go forward. To my comments on inflation, I would tell you that we don't see necessarily the implications of inflation impacting lapse rates, per se. Right now, we haven't seen any evidence of that. But it's a very unusual inflationary period, and quite honestly, we don't have a lot of history of inflation at these levels and watching how our business behaves. And that's why I have some of the cautionary language. Thus far, I would tell you, we don't see any acute implications from inflation, but we simply want to note the fact that we're going to monitor that. Again, we see offsetting dynamics related to inflation, so we don't see this as having an impact to overall U.S. financial performance."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar of JPMorgan Securities."
},
{
"speaker": "Jamminder Bhullar",
"text": "So I had a question on sales trends in the U.S. and in Japan, and if you could talk about how sales trended through the quarter. And specifically on Japan, it seems like your comments are pretty positive on an expected improvement in sales. Are you seeing that? Or are you just hopeful that things will get better? And then just relatedly, any impact that you're seeing on your production activities in Japan because of the recent increase in COVID cases?"
},
{
"speaker": "Daniel Amos",
"text": "Let me let ask Yoshizumi to answer that."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "This is Yoshizumi. Let me answer your question. For the second quarter of 2022, so a downturn continuing from first quarter, as sales of the new medical insurance product had run its course after its release in January last year. Additionally, COVID-19 continue to have a negative impact on sales activities as the number of new cases increased 8.2x compared to the same period last year, although intensive infection prevention measures have been lifted. While COVID-19 infections have been rapidly increasing since the start of July, Japan is experiencing its seventh wave and uncertainty remains. While having said that, from the third quarter, we are hopeful that sales will exceed last year's results, building on the new cancer insurance product launch and the gradual recovery of Japan Post Group sales. That's all for me."
},
{
"speaker": "Teresa White",
"text": "I'll ask Virgil to respond to the U.S. sales question."
},
{
"speaker": "Virgil Miller",
"text": "Thank you, Teresa. As Fred and Dan shared earlier, we did see a 15.6% increase in sales. Very pleased with the second quarter performance. I think Fred said it well, though. It's a combination of what we're seeing from our distribution channels. If you think about the small market, which was disrupted quite heavily at the beginning from COVID, we've seen a solid recovery. It's really driven by our veterans returning to producing. We saw another increase in our veteran average week of producers, and we saw an increase in productivity from our veterans. And then when you look at the large case space, it was less disrupted by COVID. We continue to see great performance from our broker partners in that space. We saw a 24% quarter-over-quarter increase in production from our brokers. So when you look at it, how we're going to the market in large with our brokers, large case space with our brokers and continue to see recovery in the small market with our veterans, overall, we're pleased with that quarter."
},
{
"speaker": "Operator",
"text": "The next question comes from Alex Scott of Goldman Sachs."
},
{
"speaker": "Alexander Scott",
"text": "First one I had is on the Japan benefit ratios. I guess when I think about the, I think it was 190 basis points you caught out of unfavorable COVID claims and -- but then the normalized benefit ratio that's materially higher, could you help us think through, I think it was over a 400 basis point delta associated with these IBNR releases, when you sort of go through that. And I struggle with it because I know you guys have had favorable IBNR over time. I mean, do you have any way of sort of breaking that apart a little for us and helping us think through like what portion of it is more the outpatient treatments associated with COVID specifically? I mean, any help with how to sort of figure out where things should be on a run rate basis."
},
{
"speaker": "Max Broden",
"text": "Thank you, Alex. If you start with -- obviously, you make the walk from the reported benefit ratio of 67.4% to adjusting for all the sort of special factors in the quarter, you get to 69.8%. What I think is reasonable to sort of add back is the sort of run rate more permanent or somewhat permanent reserve releases that we have experienced from favorable hospitalization trends, et cetera. Those added up in the quarter to about 170 basis points. And that's what we have seen historically run through our results. So if I were to adjust for that to sort of get to -- sort of adding back what we normally see as an ongoing reserve release in each quarter, you get back to 68.1% in sort of an adjusted underlying benefit ratio for the quarter. Going forward, over time, these reserve releases have been running relatively high recently, and we would expect those to continue, maybe not at the level of 170 basis points, but we certainly expect an element of that going forward."
},
{
"speaker": "Alexander Scott",
"text": "Got it. That was really helpful. Next one I had is just on inflation and the expenses. I heard some of the comments that, that could put upward pressure on expenses. I mean, is that material enough for us to think about maybe a different range for expense ratios? I know things are a little more focused on the back half or expenses as well. So I was just wondering if there's any update to sort of the expense ratio guide that you guys have out there."
},
{
"speaker": "Frederick Crawford",
"text": "I think essentially, where we face inflation is in just a couple of areas. One, predominantly is simply wage inflation, so your overall headcount and what we're all experiencing and seeing in the market with wage inflation and salary inflation. And we've got to do that. We've got to fall in line to retain and keep our talent, and we'll do so. Having said that, for a company our size, our employment levels are quite manageable. I mean, we're a very large U.S. and Japan company, but we have 5,300 employees in the U.S. and approximately 7,000 in Japan. And so we don't have the type of business model that is overly concentrated from that perspective. And so therefore, the wage inflation numbers, while they do apply pressure, they're more manageable. There's also certain contracts that we have, and quite frankly, the industry has that will have inflation riders. And so certain IT and servicing contracts often have inflationary provisions that kick into place when inflation gets out of control. That can also calm back down as inflation gets back into control. Overall, what I would tell you is inflation in and of itself is not causing us to rethink our guidance on expense ratios. The bigger moves on expense ratios is what I noted in the fact that we're heavily investing in growth platforms. We're very pleased to see that the growth is coming through in those platforms, as I mentioned in my comments. But it's going to -- that's really going to weigh on expense ratios in the U.S. more than inflationary pressure issues."
},
{
"speaker": "Max Broden",
"text": "And just to add one reminder. Obviously, expense ratio, it's a ratio. And you have net investment income coming into play here as well, and it helps boost the top line, and therefore, gives you some relief on the expense ratio when you think about the inflationary pressures. And the last piece is that, yes, we do obviously acknowledge that it is putting upward pressure on expenses in dollar terms as well, and we are taking active actions in order to combat that as well."
},
{
"speaker": "Daniel Amos",
"text": "And I'll also remind you that 1.5 years ago, we had a voluntary program for retirement in the U.S., and about 10% of our workforce retired. So we -- this is not something that has not been top of mind. [Technical Difficulty]."
},
{
"speaker": "Max Broden",
"text": "Operator?"
},
{
"speaker": "Operator",
"text": "The next question comes from Erik Bass of Autonomous Research."
},
{
"speaker": "Erik Bass",
"text": "I was hoping you can provide a little bit more detail on the NII outlook. I think Fred mentioned $160 million of higher expected NII in 2022 than the original plan. Just wanted to confirm, is this gross or net of hedge costs? And then how should we think about the impact moving into 2023 when, I guess, floating rate NII should continue to build but hedge costs will also reset and probably move higher?"
},
{
"speaker": "Eric Kirsch",
"text": "Fred, would you like me to take that?"
},
{
"speaker": "Frederick Crawford",
"text": "Yes, please, Eric."
},
{
"speaker": "Eric Kirsch",
"text": "Sure thing. The numbers that Fred quoted are gross of currency hedge costs. They are net of interest rate hedging because we've done some interest rate hedging with respect to the floating rate book. So I just want to bifurcate those two buckets. And as a reminder, for this year, our FX hedge costs are primarily locked in, like 95%, 98% of those hedge costs are pretty locked in. Clearly, going into next year, the cost of hedging is substantially higher, and we still carry about $4.1 billion or so forwards on the Japan dollar program. So the hedge costs next year will certainly go up. But as a reminder, we have what we call the back-to-back program or sort of countering forwards at inc. So for the enterprise, the FX hedge cost from a forward perspective should stay relatively stable on a net basis. We do have some FX options on the book as well that help us with tail protection for the unhedged portion of the dollar program in Japan. And those are based on options pricing. We do expect those to go up, which won't necessarily have an offset, but we do often look at our hedge ratios and how much we want hedged. So the amount of that could be a variable but we would expect the option costs to go up as well. And then more broadly speaking, when you look at next year's forecast from the perspective of where do we think our floating rate income is going, as Fred said, we still expect tailwinds. The forward curve for LIBOR is still upward sloping. We're all watching the Fed. And assuming it stays where it is, we would expect further tailwinds in floating rate income for next year. But again, the Fed is moving with inflation in the markets. The latest Fed meeting was a little bit more dovish than hawkish for the future. So it's -- so that's going to be a moving target, if you will. However, having said that, and we reported on this before, on our floating rate book, we have put on interest rate hedges. And we did that because at the beginning of the year with the aggressive Fed hikes, an increase in LIBOR, when we do our financial planning over a 3- and 5-year period, we saw that there's a substantial increase based on the forward curves in that floating rate income over that time period. But we also know that there's no guarantee we'll get that. It all depends on where LIBOR is at that time. So the purpose of the interest rate hedge was to say, given that potential large increase in income, why not lock in a good portion of it and put better surety around that, which we did. So it gives us great protection now in case in the future there's recession and the Fed starts to lower rates. But we didn't hedge all of it. So we still have some upside as well if rates should continue to go up. So that's a picture, if you will, of the future and some specifics on the hedge cost."
},
{
"speaker": "Erik Bass",
"text": "That's helpful. And just to confirm then, given the back-to-back program, should we really think of most of the kind of NII uplift from the higher floating rate yields dropping to the bottom line at an enterprise level, realizing it may not -- you may see less of an impact in the Japan segment and more of it in corporate?"
},
{
"speaker": "Frederick Crawford",
"text": "That's correct. Basically, you would see as the locked-in hedge costs roll off and we go into a new level of hedge costs in Japan, you would see those hedge costs increase. But then that same increase would be offset by increased hedge income at the corporate level so that there'd be no effective impact to the enterprise. And then also keep in mind what Eric said, that of the $12 billion in floating rate portfolio, our hedge instruments are around $4 billion notional. And so we still have an ability to enjoy outside net investment income despite the rise in hedge costs."
},
{
"speaker": "Operator",
"text": "The next question comes from Suneet Kamath of Jefferies."
},
{
"speaker": "Suneet Kamath",
"text": "Just a follow-up on Eric's question. So if we're getting $160 million of higher NII from the floaters, does that influence your thinking around expense initiatives, maybe an opportunity to accelerate that in order to generate maybe faster growth going forward?"
},
{
"speaker": "Frederick Crawford",
"text": "Well, they are two different topics. What I would tell you -- if what you're saying is would you accelerate your initiatives and actually increase the pace of investment with added net investment income, we're not really adjusting our plans around NII up or down. The plans we have around investing in our platform are really related to core growth in earned premium, policies in force, sales and overall efficiency measures. So it really would not render any impact on those plans. And I do want to highlight, as Dan mentioned in his comments, we are very much at work in terms of addressing the long-term expense structure, both in Japan and in the U.S., and have several initiatives underway to drive productivity improvements and efficiency improvements. Those do require near-term investment, but we have plans in place to help our expense dynamics and certainly combat any inflationary pressure as we go forward. But none of that, Suneet, is really impacted by watching NII move up and down."
},
{
"speaker": "Suneet Kamath",
"text": "Okay. Got it. And then just shifting to Japan. I was hoping to get a little bit more color on this COVID as an infectious disease policy that the government has. Maybe what are your expectations for the, I guess, early September conversation around this that the government will have? And I believe that your products have certain caps in terms of number of days where benefits can be drawn. Is there any risk to potentially that changing in the future?"
},
{
"speaker": "Frederick Crawford",
"text": "I think perhaps Koide-san can address that. We can add our color here in the U.S., But Koide-san, maybe address your views of the Diet conversation in September."
},
{
"speaker": "Masatoshi Koide",
"text": "Yes. This is Aflac Japan, Koide. So as Fred mentioned earlier, the discussion and deliberation related to COVID-19 infection disease law discussion is really gaining momentum. And in light of the situation, experts from the government subcommittee on countermeasures against infectious disease [indiscernible] coronavirus and the National Governors Association have proposed a review of the classification. And also, as Fred mentioned earlier, starting from August 1, a special committee of the Ministry of Health, Labor and Welfare started reviewing COVID-19's classification under the law. And revision of the classification under the infectious disease law requires amending the law, which is expected to be discussed at the extraordinary Diet session beginning in September at the earliest. So we cannot predict the outcome of the Diet discussion, and we would highlight that it is not focused on the insurance industry. Rather, it is focused on how the law has pressured the overall health care system. However, we feel it is a positive development that a dialogue is taking place on the issue. That's all for me."
},
{
"speaker": "Frederick Crawford",
"text": "So I would also just note something that I think is perhaps obvious, but just to be clear. This is really not uniquely an Aflac issue. The major insurance companies in Japan are all facing substantial increased claims activity on medical policies. In fact, we're not even among the top few in terms of the volume of claims we have relative to other peers in the industry, domestic insurers with large platforms. So this is really broadly based. We can't confirm some of these statistics, but there's been recent news articles suggesting that the amount of claims paid in the month of June, for example, under medical policies was up nearly twelvefold over the same time period last year this time. So it is absolutely pressuring the system. And we think that the legislative community in Japan is taking this under consideration and realizing they've got to contemplate a change in the law."
},
{
"speaker": "Daniel Amos",
"text": "While saying that, we're still very comfortable with our projections for 2022. So I want to make sure you grasp that."
},
{
"speaker": "Operator",
"text": "The next question comes from Ryan Krueger of KBW."
},
{
"speaker": "Ryan Krueger",
"text": "I guess, first, could you just give us some sense of how much NII uplift in the current quarter did you realize from higher short-term rates on the floating portfolio?"
},
{
"speaker": "Frederick Crawford",
"text": "Go ahead, Eric."
},
{
"speaker": "Eric Kirsch",
"text": "It's Eric. It was about $38 million for the quarter, but that's in total for the portfolio. But just from rates alone, it's around $2 million to $4 million. And that's pretty logical because if you think about the ascent of LIBOR, it really didn't start increasing until February, March, April, and these are 1 month of quarterly reset. So the impact from just rates alone on the floaters was rather small, but we did have other portfolio activity around deployment. The new money yield on deployment was better than planned. We were able to purchase some floating rate assets ahead of plan from a particular provider. So a number of portfolio activities really added to most of that increase. But as the year goes by, the impact from rates alone just continues to get higher because of that substantial rise in LIBOR."
},
{
"speaker": "Ryan Krueger",
"text": "I guess just to clarify, is the $38 million part of the $160 million? Or should we think about the $2 million to $3 million as..."
},
{
"speaker": "Eric Kirsch",
"text": "$38 million is part of the $160 million, that's just for the second quarter. And the $160 million is for the full year forecast."
},
{
"speaker": "Ryan Krueger",
"text": "Okay. Understood. And then I guess, in the U.S. did you see any normalization in the benefit ratio as we went through the quarter or it was pretty spread throughout?"
},
{
"speaker": "Max Broden",
"text": "I think it's relatively well spread out over the quarter. There was no specific movements between the different reporting months in the quarter."
},
{
"speaker": "Frederick Crawford",
"text": "One thing back on Japan to just make sure that you're capturing is, again, when it comes to these COVID cases we're talking about, just want to make sure you take to heart Max's comments and Dan's comments and my script comments, and that is the very same dynamic that is giving rise to these higher infectious disease COVID claims, we believe are absolutely impacting the rate of hospitalization on other claims activities, not the least of which is cancer insurance related claims. And remember, again, as you all know, we are a dominant cancer insurance provider. And so when the world of Japan health care moves to more outpatient treatment, that has material implications for your cancer claims and how they trend over time. So this is why, despite all of the comments around COVID claims and increases in medical claims, you still see a low benefit ratio in Japan even by historical standards. There's no guarantee of that direct correlation, but it's certainly what we have seen in the data thus far."
},
{
"speaker": "Operator",
"text": "The next question will come from Tom Gallagher of Evercore ISI."
},
{
"speaker": "Thomas Gallagher",
"text": "First question, back on the floating rate portfolio. The -- so the $12 billion floating rate portfolio in the transitional real estate, Eric, how do you feel about the quality of those portfolios if we do enter into a recession? Would you expect the higher yield you're getting on to keep the higher yield on a net basis? Or would you expect some portion of that is going to be given back through impairments? And are you looking to grow that portfolio or you're keeping it steady?"
},
{
"speaker": "Eric Kirsch",
"text": "Sure thing. And Tom, actually, since we have Brad Dyslin on the call, who's my deputy but also in charge of credit, I'm going to shift that question over to Brad."
},
{
"speaker": "Bradley Dyslin",
"text": "Thank you, Eric. And thank you for the question, Tom. We're definitely paying very close attention to both of these portfolios. As I think Fred mentioned in his opening comments, we think this is where as the economy slows down, we could see the first sign of any issues. We're really focused, as you would expect, on their ability -- especially in our middle-market loan portfolio, their ability to pass along these cost increases and absorb higher financing costs. We've worked very closely with our managers. We stressed the portfolio for some very severe outcomes, and we think any potential loss is going to be very manageable. When you look across the space, we feel we have a relatively high-quality portfolio across middle-market lending. It's all first lien. We have modest leverage. It's a very well-diversified portfolio. We think there's some inherent characteristics that allowed us to perform well during COVID, and we -- the COVID shock, and we think it will continue to support the portfolio with a downturn. Now of course, we don't expect to come through entirely unscathed. We would be surprised that we didn't have a few losses if we get the kind of downturn that is possible. But we don't expect it to be overly material. In the real estate portfolio, again, it all boils down to the quality of assets you underwrite, the leverage you have, and in the case of transitional real estate, how well we underwrite the actual transition of the asset, the strength of the sponsor and the strength of the business plan. Again, we stressed this portfolio with our managers and we feel really good about how we're positioned and don't currently expect we'll have any losses in real estate. But of course, we're keeping a very close eye on it."
},
{
"speaker": "Eric Kirsch",
"text": "Tom, I would also just add to Brad's remarks. Just as a reminder, for our TREs and middle-market loans, these are first lien, senior secured assets. We take a more conservative approach to those asset classes. We definitely earn higher yields and spreads, but that's to offset the risk that we're taking. The other reminder is just from a financial standpoint, we do take a CECL reserve for these asset classes. And those are, generally speaking, based on long-term historical default rates. Based on Brad's comments and our actual expected performance, while certainly we won't come out of this unscathed, my suspicion is we will outperform those CECL reserves. And in essence, while there could be some losses in the future depending on how deep a recession is, how long it will be, it will be much better performance than the expected CECL reserves that we've taken already."
},
{
"speaker": "Thomas Gallagher",
"text": "Okay. Just one quick follow-up. The U.S. earned premium is still modestly declined despite the sales recovery and some improved persistency, and I know there's a bit of a lag here in terms of how that earns in. But based on what you're seeing now, would you expect earned premium to begin to grow again in the second half and then maybe pick up in 2023?"
},
{
"speaker": "Max Broden",
"text": "We would expect an improvement throughout the year and then that it really picks up in 2023 as lapses come down and we continue to see sales growth."
},
{
"speaker": "Operator",
"text": "The next question comes from John Barnidge of Piper Sandler."
},
{
"speaker": "John Barnidge",
"text": "Can you maybe talk about foot traffic in shops in Japan in 2Q versus 1Q? Because I know that's a metric you've discussed previously."
},
{
"speaker": "Frederick Crawford",
"text": "Are you talking about our walk-in shops and shop traffic? Is that the question?"
},
{
"speaker": "John Barnidge",
"text": "Yes, that's correct."
},
{
"speaker": "Frederick Crawford",
"text": "Yes. I think I would ask Yoshizumi-san in Japan to answer that question. I don't have that data right in front of me. Yoshizumi-san, do you have any data on the level of traffic through our retail shops?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Thank you, Fred. Let me answer the question. This is Yoshizumi. Well, the number of customers in-store or the shop in the second quarter was at the same level as the previous year, and which indicates a recovery from the first quarter when we had a negative 9.3%. That said, this figure has not yet returned to pre-COVID-19 levels, and we will continue monitoring the trend in the number of visiting customers. That's all for me."
},
{
"speaker": "Operator",
"text": "The next question comes from Michael Ward of Citi."
},
{
"speaker": "Michael Ward",
"text": "I just wanted to expand on the concept of delayed cancer screenings. I think Dan was actually talking about this on CNBC this morning. But just wondering if you could maybe give an update on what you're seeing in terms of cancer severity and the impact -- potential impact from delayed screening in the U.S. and Japan?"
},
{
"speaker": "Daniel Amos",
"text": "Well, I mentioned it on CNBC when I was talking to Joe. And we have not seen an enormous jump of any kind that was not actuarially computated. So we're falling within our ranges. Saying that, it's now getting -- from the original, it's getting out to be 2.5 years it's been. So I think the chances are less and less as we move forward. But at the same time, it's just to show you how you don't know what you have ahead of you. And -- but all of our tracking says that we should have seen more if it was going to really spike by now. And I've got a guy that knows all the actuarial computation is shaking his head, that's correct. So that's the answer."
},
{
"speaker": "Max Broden",
"text": "One thing I would add to that answer is that we have seen first occurrence coming back to more normal levels. And obviously, that tends to be -- should be a leading indicator for our overall total cancer claims. So overall, we're still running a little bit low where we would expect to be in the low pre-pandemic levels, but in component of first diagnosis and first occurrence, is generally back both in the U.S. and in Japan to more normal levels. And we've said before and we still expect that there is sort of a level of cancer out there to be detected within our policyholder base that we think will come our way at some point. We just haven't seen the full impact of that yet. And all of that is incorporated in our guidance for benefit ratios going forward."
},
{
"speaker": "Daniel Amos",
"text": "But I think most people that were going to the doctor and, whatever, they were having checkups, are now back to normal. And it's been going on probably for a year or so. So we feel pretty good about those numbers. And that's one reason we said, overall, we feel good about even the issue in Japan regarding the government's move here and how we can handle those claims. So we feel well positioned."
},
{
"speaker": "David Young",
"text": "All right. Thank you, Mike, and thank you, Andrea. I believe that was our last question, and we're a little past the top of the hour. I want to thank you all for joining us. I hope you'll mark your calendars for Tuesday, November 15, for our financial analyst briefing. And we look forward to seeing and talking to you then. Until then, please reach out to Investor and Rating Agency Relations with any questions that you may have, and we look forward to talking to you soon. Take care."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 1 | 2,022 | 2022-04-28 08:00:00 | Operator: Good morning, and welcome to the Aflac Incorporated First Quarter 2022 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations and ESG. Please go ahead.
David Young: Thank you, Andrea. And good morning. Welcome all to Aflac Incorporated's first quarter earnings call. This morning we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated; Fred Crawford, President and COO of Aflac Incorporated will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday after the close we posted our earnings release and financial supplements to investors.aflac.com along with a video with Max Broden, Executive Vice President and CFO of Aflac Incorporated, who provided an update on our quarterly financial results and current capital and liquidity. Max will be joining us for the Q&A segment of the call along with other members of our U.S. Executive Management. Teresa White, President of Aflac U.S.; Virgil Miller, Deputy President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments. Brad Dyslin, Deputy Global Chief Investment Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our Executive Management Team at Aflac Life Insurance Japan. Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO, Koichiro Yoshizumi, Director, Deputy President and Director of Sales and Marketing. Before we began, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. And we encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?
Daniel Amos: Thank you, David and good morning. Thank you for joining us. As I reflect on the first quarter of 2022. I'm thankful for the dedication, compassion and hard work of our committed Aflac team in the United States and Japan. Our management team, employees, sales force have continued to work tirelessly to be there for the policyholders when they need us most, just as we promise. As Max highlighted in his video update, Aflac Incorporated reported first quarter net earnings per diluted share of $1.58 in the first quarter of 2022. Adjusted earnings per diluted share were solid at $1.42 in the first quarter, supported in part by the continuation of a low benefit ratio associated with the pandemic conditions. Also contributed were better than expected returns from alternative investments, despite the weakening of the yen. We remain cautiously optimistic as we continue to navigate the pandemic. Looking at the operations in Japan in the first quarter, Aflac Japan generated strong overall financial results with a profit margin of 25.3%. This was above the outlook range that we provided at the November 2021 financial analyst briefing. Persistency remains strong, however, sales were constrained as a quasi-states of emergency remained in place through mid-March. This impacted our ability to meet face-to-face with customers also contributing to the decline in the quarter were comparisons of the first quarter of 2021 When our new medical product was launched. Aflac Japan has continued to offer support to Japan Post Group as it gears up for the start of the new fiscal year of April 2022. This included the transfer of approximately 10,000 Japan Post company sales employees to Japan Post insurance. These sales employees will focus solely on selling Japan Post insurance products and Aflac's Japan's cancer insurance product. Since it may take some time for these employees to ramp up sales activities under the new framework, we anticipate sales momentum picking up in the second half of the year. On that note, as part of the ongoing collaboration and governance framework of the strategic alliance. I'm excited to be traveling to Japan towards the end of June to meet with Mr. Masuda Japan Post Holding CEO along with the President of Japan Post Postal and insurance companies. Given this we expect stronger overall sales in the second half of the year, assuming that the pandemic conditions do not escalate that we execute on our product introductions and refreshment plans, and the sales productivity continues to improve in Japan Post Group. Turning to Aflac U.S., we saw a solid profit margin of 19.8%. This results was also above the outlook range that we provided at the Financial Analyst Briefing. I'm pleased that our U.S. sales momentum has continued from the fourth quarter with a 19% annual sales increase in the first quarter. This reflects continued improvements in the pandemic conditions, growth in our core products and investment in a build out of growth initiatives. While Aflac Dental and Vision and Group Premier Life, Absent Management and Disability Solutions, which we call plants are relatively small part of our sales. We are very pleased with how they're contributing to our growth. Our growth initiatives modestly impacted the top-line in the short-term, but also tend to comp -- excuse me, they tend to be accompanied by the sale of our core supplemental health products, as Fred will explain in a moment. In combination with our core products they also better position Aflac U.S. for future long-term success. The need for the products we offer is as strong or stronger than ever before. At the same time, we know that consumers habits and buying preferences have been evolving. We remain focused on being able to sell and service customers, whether in person or virtually. This is part of our ongoing strategy to increase access, penetration and retention. Turning to capital deployment, we play significant importance on continuing to achieve strong capital ratios in the United States and Japan on behalf of our policyholders and shareholders. When it comes to capital deployment. We pursue value creation through a balance of actions, including growth investments, stable dividend growth, a discipline and tactical stock repurchase. It goes without saying that we treasure our record of dividend growth. The fourth quarters declaration marked our 39th consecutive year of dividend increases. This is a record we seek to extend demonstrated by our 21.2% increase in the first quarter cash dividend. 2020 will remain in the market purchasing shares with a tactical approach. In the first quarter Aflac Incorporated deployed $500 million in capital to repurchase $8 million of its common shares. With this approach, we look to emerge from this period in a continued position of strength and leadership. Keep in mind, in addition, we have among the highest return on capital and lowest cost of capital in the industry. We have also focused on integrating the growth investments we've made. I don't think it's a coincidence that we've achieved success, while focusing on doing the right things for our policyholders, shareholders, employees, sales distribution, business partners and communities. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong, long-term shareholder return. We also believe in the underlying strength of our business and our potential for continued growth in the U.S. and Japan, the two of the largest life insurance markets in the world. Thank you for joining us this morning. And now turn the program over to Fred, Fred?
Frederick Crawford: Thank you, Dan. I'm going to focus my comments today on efforts to drive growth. I'll also provide some perspective on market and economic conditions in Japan and in the U.S., beginning with Japan, COVID related critical illness, daily deaths and hospitalization remains at very low levels. While weekly new cases were elevated for much of the quarter, they have come down in the last month and the government's intensive infection prevention measures were lifted as of March 21. However, for much of the quarter, we felt the ongoing COVID impact and as evidenced, a further 17% decline in traffic through our retail insurance shops as compared to 2021. We have seen COVID incurred claims increase despite the lower rate of hospitalization. This is driven by the rising cases along with COVID designation as an infectious disease or deemed hospitalization, which allows for payment of claims for care outside of the hospital. To give you a perspective, we estimate over 80% of our COVID related claims in the quarter were considered deemed hospitalization. In the meantime, and despite the increase in COVID claims, third sector benefit ratios remain very low. Sales in the quarter were weaker than we had hoped for provided COVID dynamics continued to trend positive, we remain confident we will hit our internal expectations for the year. While COVID conditions partially explain the weakness, we are taking additional action to strengthen the associate channel to include renewed investment in our exclusive agency platform and efforts designed to build market share with non-exclusive agencies where we have low market share. With this in mind, we are accelerating our Cancer Insurance refreshment timing, and plan to launch in the second half of 2022. With respect to Japan Post, we have experienced sequential growth in sales with increased proposal activity as we continue to roll out a successful pilot program launched late last year. As Dan mentioned, the April transfer of 10,000 sales employees to Japan Post Insurance was completed without disruption. Our alliance now is best characterized as distribution through 20,000 post offices, 10,000 sales employees selling from 223 locations within the Japan Post Insurance network, and 88 Japan Post Insurance branches focused on corporate sales. Importantly, cancer sales targets have been communicated to the regional offices of both the postal system and within Japan Post Insurance for the first time in three years. With respect to our elderly care product, sales were softer in the first quarter after our initial promotional period. This market is still relatively small, roughly one-tenth the size of the medical product industry. The market is further divided into two distinct and equally sized classes of product, protection and savings. We are focused on the Protection segment of the market, where we have quickly captured market share in the high teens. We are well positioned with competitive product, should the government of Japan contemplate shifting more of the burden to individuals. Turning to the U.S., the markets for voluntary and other worksite benefits have effectively recovered to pre-pandemic conditions. However, we are navigating inflation and a challenging labor market. When we reflect on the U.S. economic environment, we are especially focused on two areas of impact to our U.S. model, recruiting and persistency. Tight labor markets create difficulty in recruiting to a full-time commission based profession. We are therefore focused on improving conversion rates of new recruits to producing agents and reengaging veteran agents who are less productive during the pandemic. Our strategy has been successful, driving a 7% increase in average weekly producers year-over-year. In addition, veteran agents are better equipped to leverage our recent product expansion and strategy to grow within the small business brokers. In terms of persistency, it's important to note our account persistency was stable in the quarter. However policyholder persistency was weak and broad based, which leads us to believe it's partially attributable to the extreme movement in the labor markets. We track the Labor Department's quit rate, which had been declining during the pandemic then jumped in the first quarter to levels not seen in recent history. While higher turnover in the small business sector is common, the so called great resignation along with COVID and return to office dynamics is driving higher turnover. Unfortunately, when employees leave their place of work, they often leave their policies behind. With this backdrop, what is most impressive about the sales results, Dan covered is the balance. Split by product type, group voluntary was up 23%, individual benefits up 17%, split by channel, agent sales were up 15% and broker up 25%. Our buy-to-build platforms were all up year-over-year with the combination of network Dental and Vision, Premier life and disability and consumer markets up 65% albeit off a small but building base. We track the halo impact of Dental and Vision sales and for every dollar of Dental and Vision sales, we were able to cross sell $0.57 of other voluntary products. Finally, we launched Aflac Pet insurance powered by Trupanion targeting the larger case market and are busy responding to request for proposals. It's the balance in our results that give us added confidence that performance should continue throughout the year. Turning to our investment operations, we do not have any direct exposure in Russia, or Ukraine. Of course, our large global credit portfolio does include multinational companies with business interests in the impacted region, but nothing significant enough to cause us concern among what are generally large, high quality credits. We're closely watching secondary risks, namely the impact to the European energy sector, the conflicts impact to existing supply chain and inflation risks and a risk of recession in Europe. While increasing yields erode some of our unrealized gain in the bond portfolio, we also have benefits from rising interest rate environment, rising rates obviously provide a tailwind for new money investments. Further, our sizable floating rate portfolio will benefit directly from aggressive Fed rate hikes as their interest rate resets are based of short-term rates. Given the significant move in the forward rate curve, we expect we elected to lock in a portion of the expected rate increases by increasing the notional of our interest rate swap strategy such that now approximately 70% of our income is protected from changes in short-term interest rates over the next five years. In addition, the holding company holds short-term investments that will benefit with rising short-term yields. Our alternative portfolio continues to deliver strong results, we understand these portfolios could very well give back some of the gains as the year goes on. But we're off to a strong start in generating the favorable returns expected from these portfolios. Finally, Max provided helpful perspective on our exposure to the weakening Yen in his recorded comments. In short, while there are GAAP reported impacts, we are well protected from an economic perspective and do not see the weakness in the Yen is altering our investment strategy, hedging strategy, or overall capital deployment activities. There are certainly no implications to our business model, which reinforces our strategic focus on currency neutral outcomes. And I'll hand the call back to David to take us to Q&A, David?
David Young: Thank you, Fred. [Operator Instructions] Andrea, we will now take the first question.
Operator: Our first question comes from Nigel Dally of Morgan Stanley. Please go ahead.
Nigel Dally: Great, thanks, good morning. So once we start in the U.S., I know there's some potential seasonality in the life, but if that has remained high, are you considering some potential strategies to improve persistency? And if so, what are some of the options that you have available?
Daniel Amos: We have an outlet, Teresa and Virgil comment on this, but we have had for a while a number of strategies under a way to help over the long run persistency, not the least of which has been our expanding product portfolio. As you know, we believe Dental and Vision for example will over time contribute to better persistency just by the very nature of the product and how that works. However, we think that much of the persistency issue that we're seeing right now is a combination of number one, the fall off -- the final fall off of state regulations that were requiring policies to remain in place. But on a larger scale, we think this labor force in motion is contributing to a lot of the lapse rates, and we would expect or anticipate that to eventually calm down. In the meantime, we remain focused on activities that drive better persistency. But we think right now, there's certain market conditions influencing it. Virgil, Teresa, if you have any comments.
Teresa White: I'll just mentioned, you mailed it, as it relates to some of the high level things that we're doing. But we also, in addition to the stickiness of the product, which you talked about with the product mix. We're also from an operational perspective, making sure that we stabilize account retention or account persistency, because when we do that, we know that our premium persistency is generally stable as well. But as you said, what we're seeing today is a lot of what we think might be labor market or labor force impacts based on what's going on. And so we're thinking that that's what's going on with our premium persistency at this point, and so more to come on that.
Nigel Dally: Great. Then, as a follow-up just on Japan sales. The sales decline, I think was -- that's a little worse than some of us were expecting medical appear particularly weak. So perhaps you can discuss why that was the case. And with your expectation the sales will recover in the back half. Should we expect that mostly to being canceled or given your product refresh? Or you also expect to rebound in medical as well?
Frederick Crawford: I think we'll let Koide san and Yoshizumi san answer that question. But you have in fact identified some of the issues. Number one realize the first quarter last year medical was during a fresh launch period. And we normally see medical sales calm down really sales of all products calm down after that initial launch period. However, there's no question that COVID conditions are really impacting across the board results. Cancer held up better for the simple reason that we're seeing some increased momentum slowly within the Japan Post System and that offset things. But generally speaking, you have it right. And then I'll Koide san and Yoshizumi san talk about the types of things we're looking at in the second half of the year to improve sales results and addition to our cancer launch.
Koichiro Yoshizumi: [Foreign Language]. Yes, this is Yoshizumi. Thank you, Fred. Let me answer the question. [Foreign Language]. In Japan in the first quarter with explosive infection increase we have been infected very much. [Foreign Language] And that goes to both the salespeople who visit the customers as well as those customers who visit our agency shops. For example, in February the number of people, the customers visiting our insurance shops decreased by 22%. [Foreign Language] And we are also gathering information from various associates to analyze what actually had occurred. And as far as we hear, it seems like the appointments that we -- that our agencies are trying to make for a visit to customers has been declined by like 30%. [Foreign Language] And I believe your question was related to medical. [Foreign Language] And in regards to the medical insurance, we did launch a new product last year. [Foreign Language] And since it's been a year, since we launched the product I think we have gone through a cycle of customers. [Foreign Language] And we did have a plan that our medical insurance in the first quarter sales will decrease. [Foreign Language] And the fact is that the actual sales was even lower than what we had expected, because of the impact of Omicron. [Foreign Language] And as for the future sales measures, we would like to further promote our sales activities through online sales. [Foreign Language]. And we would also like to be proposing more comprehensively our coverage and benefits to our customers using the new products such as nursing care product, and our work lead product. [Foreign Language] And the rest are basically what Fred had said. And then now regarding in Japan Post Group. [Foreign Language] There was bit organizational change there. [Foreign Language] And what that means is that the sales consultants from this town post company, this is a post office company has been transferred it to the Japan Post insurance company. [Foreign Language] And the preparation to move this many people over to the pampers to insurance took place in a first quarter and they are fully prepared. And they have gotten a very good start in April. [Foreign Language]. And the Japan Post Group will resume their sales under the new organization now that they have a good infrastructure in place for sale. [Foreign Language] That's off for me.
Daniel Amos: But let me make one comment. This is Dan. And what I think you're seeing evolve here with sales in the U.S. and in Japan, is that we've got one more quarter the second quarter of things adjusting. But I see things moving back to a new normal. What that normal is I'm not exactly sure. But I don't think it's going to be that different from the way we've been rolling in the past. And I think you'll see that in the second half of the year. And I have not been to Japan in quite a while and I can't wait to get back. But I have been talking all of us have with Japan constantly. And I don't think you can underestimate the impact of those cost of moves that they had in terms of restrictions. And but they are over right now. And assuming that we don't see it come back in any great degree, I think you're going to see the second half, and the second quarter start to improve. But the second half really be more like the past in terms of our selling ability. Because as they mentioned, people coming into the offices was down 22% some other things. And those are just reflections. And they affect everything, they affect recruiting, they affects new sales, they affect every aspect.
Nigel Dally: That's great. Appreciate the color.
Operator: The next question comes from Suneet Kamath of Jefferies. Please go ahead.
Suneet Kamath: Thanks. I wanted to start with Japan again. Just as we think about these new product refreshes and launches, it seems to us that the shelf life post these launches has been shortening over time. Maybe years ago, you had a couple of years of runway now it feels like it's a couple of quarters if that. So I'm wondering one, if you think that's a fair observation. And two, is some of what we're seeing in Japan due to increased competition. In other words, do you have any data on your market share and medical and how that's changed over time?
Frederick Crawford: Yes, I think let's have Japan maybe comment on it. But what I would tell you Suneet is in general, your comments, I think hold up a bit and I think it is in fact largely due to the competitive environment. One of the things that I would tell you just as an observation is in 2016, when the Bank of Japan went to their negative interest rate environment. We saw a slow and steady migration of shift towards third sector not a first sector not surprisingly. But for a period of time you had firms that were moving into currency product, and then all of a sudden rate movements and other reserving dynamics rendered currency product to be less attractive and so that started to back off. And now you have companies, including domestic companies that have subsidiaries that often specialize in third sector of business. Even by the way, property casualty insurance companies that have life and health related subsidiaries are getting into the action as a way to drive more business. Competition and intense competition is not new that's been around and we've navigated that for years and years. But there's no question that has become more intensified, which means your product cycle product refreshment, and the nimble nature of how you go at product has to speed up and be quicker. So yes, the life expectancy of a new product is shorter, but that simply means that you have to be quicker to revise and refresh products, then maybe the old two year cycles for medical and four year cycles for cancer. That's my perspective based on talking with our Japan colleagues. But I'll let Koide san or Yoshizumi san to comment.
Koichiro Yoshizumi: [Foreign Language] Thank you very much, again this is Yoshizumi. [Foreign Language] And that's we just mentioned the market is becoming very, very competitive. [Foreign Language] And especially the medical insurance market is really evolving or changing almost every day. [Foreign Language] And what we are saying is that the good the data until it's good is short become shorter and shorter. [Foreign Language] On the other hand, since we do have very good sales and solicitation platform. [Foreign Language] And using that base [Foreign Language] we do believe that we can still grow this area. [Foreign Language] With our overwhelming brand very strong brand. [Foreign Language] And we also have very good advertisement capability. [Foreign Language] And even with this very severe competition, I think we can work towards expanding the market and really make efforts and perform. [Foreign Language] Now let me go into cancer insurance. [Foreign Language] And regarding new product for cancer insurance, we are thinking of it, because it is still before the approval of the authority we cannot say -- tell you about the details. [Foreign Language] We are thinking of a product that that will differentiate ourselves from competitors by having very competitive benefit, as well as various services that would support the cancer patients from the time of when they start developing cancer until these patients recover to society or work. [Foreign Language] That's all for me.
Suneet Kamath: Got it. Okay. All right. And then I just wanted to pivot. Fred, you've made a comment in your prepared remarks about the floating rate portfolio and having the income on that locked in for five years, or 70% have been locked in for five years? Can you just go into a little bit more detail on that? I'm just trying to think through, if the fed is really aggressive. Does that mean that you've limited some of the upside? Or just how do we think about that?
Frederick Crawford: Yes, and we have Eric and Brad Dyslin here that can provide color, but just a couple of points to be to be very clear on. Remember, what we're doing effectively is locking in the forward curve, not current rates. In other words, we're locking in the expectation in the marketplace for aggressive fed action. And so that's the very nature of the swaps. So we're not losing out, if you will on that aggressive forward, what we're doing is we're protecting against the risk of that reversing or calming down or not meeting the expectations that are embedded in the forward curve. Also note that we've got about $10 billion of floating rate, floaters if you will, in our general account, and another $2 billion at the holding company. And so we still remain relatively exposed if you want to define it that way to taking advantage of a rate environment that exceeds the forward curve expectation. So we haven't taken it all off the table. But I'll get either Eric or Brad to comment.
Eric Kirsch: Yes, thanks, Fred. And that's an excellent start, I would just dive a little deeper to have you understand. When we do our planning, if you will, which is of course, the current year. Plus, we look out over five years. For the floating rate buck, we typically use forward curves. The last set of financial plans we did, were back in November, which Max then uses as part of the overall franchise's EPS, if you will. But the forward curves, as you know, because of the fed change and policy has substantially increased. So if you just look at a projecting based on the flow occurs, where the floating rate income will be over the next five years, significantly higher than what our plan was. Having said that we all know forward curves are never realized. So we have an opportunity to basically say, we don't really know what's going to happen in years, two, three, four, and five, but what we do know is, if the forward curves became true, there's a significant amount of pickup in income. What we've chosen to do is take about 70% of that book, and do a fixed or floating rate swaps, such that we've locked in a good portion of that upside, if the forward curves end up coming down. An example of that would be and many people are talking about recession, in the U.S. next year. Those forward curves will likely never be realized in years three, four, and five, because the fed will then change policy. If rates continue to go up, because the fed is even more aggressive. Fortunately, we've got a good portion of the book about a third that's not covered by the swap. So we'll still enjoy some upside, as well. And then of course over the next few years, we continue to invest potentially in more floating rate assets. So we've got good exposure to rising rates as well.
Suneet Kamath: Would you be willing to size the pickup just from November to March on that portion that you've locked in?
Frederick Crawford: Yes, I think we would have to kind of give some thought to that. The pickup this year, is relatively modest. It's not insignificant. But remember, all we're really doing is locking in the pickup that's there anyway, if you will. We're trying to. So I think let us give some thought to that. I don't have the numbers right in front of me, because we've looked at it more on a present value over the life of the swap what it has done, but it's not in material to net investment income.
Eric Kirsch: Yes, and I would further say there is a pickup in income from our floating rate book this year. But when we talk about the forward curves, as an example, LIBOR started the year at 10 or 17 basis points one and three month LIBOR. It's currently three months LIBOR is like 120. So we get a pickup this year. Now, the forward curves and we went out, if you look at the forward curves for years three, four and five LIBOR is projected to be 2.5% that debt the fed goes through with all these aggressive rate hikes. So there is a positive tailwind to our income from the floating rate book this year, but we'd have to come back to size it.
Suneet Kamath: All right. Thank you.
Operator: The next question comes from John Barnidge of Piper Sandler. Please go ahead.
John Barnidge: Thank you. What percent of sales in the first quarter was consumer markets in buy-to-build products? We've with 10% last year expected to grow this year? Thanks.
Frederick Crawford: So, no. Go ahead, Teresa.
Teresa White: I'll Virgil response to that.
Virgil Miller: Okay, thank you, Teresa. So 6% to 7% in between 6% and 7% for Q1. Remember, there's seasonality on our numbers. So when you've talking about 10%, our numbers grow, especially during the fourth quarter, which give us a high annual average. So we're anticipating this year that when you combine all the buy-to-build, we'll end up between 10% and 50% again this year. Again, first quarter though solid growth with the 6% to 7% it was more than we had anticipated. So we're starting to gain traction out in the market with those products now.
John Barnidge: Great. That might follow-up. [Indiscernible] in the U.S. capture on FAB. What it ended up coming in higher than anticipated? Thanks.
Frederick Crawford: Would you ask that question again?
John Barnidge: Sure, how much of the higher lapse station rates in the U.S. were captured into the guidance reflected at the FAB in November? Or did lapse rates end up coming in higher than anticipated?
Brad Dyslin: Yes, we did see a higher lapse station that we plan for -- at FAB of last year. So there's obviously an impact going on here running through our financials and across the benefit ratio expense ratio, and also the bottom-line through lower and premium as well. But the net impact on all of those three combined is a favorable $5 million in the quarter. So that's the way I would think about it. Overall obviously, it lowers future net earned premiums. And because we're sitting with slightly lower policies enforced than what we otherwise would have expected. So from an embedded value standpoint, it's clearly a negative. That being said, our sales were off to a strong start this year, and that builds an embedded value for us for the future as well. So there's a number of puts and takes, but in the quarter, there was a bottom-line $5 million positive impact from higher than expected lapses.
Daniel Amos: Hey, let's come back to the swap, because we pulled up some of the numbers. And so we can answer that question more directly. So Eric, why don't you kind of give us a little bit an idea.
Eric Kirsch: Yes, our current projection for the year, and this assumes the forward curve. So this year, materializes about an extra $39 million of income from our floating rate bucks versus our plan.
Operator: The next question comes from Erik Bass of Autonomous Research. Please go ahead.
Erik Bass: Hi, thank you. I was hoping maybe you could talk about kind of the other moving piece in NII, which would be that hedge costs. And so could you talk about the outlook for hedge costs and the Aflac Japan business? And as these move higher are you still able to lock and generate the same level of spread on U.S. dollar assets? Are you making any changes to your investment approach?
Frederick Crawford: Yes, thank you very much for the question. First talking about this year, as you'll recollect for a number of years. Now, our strategy has been at the beginning of the year to lock in our hedge costs. For the majority of the buck, there are moving parts. So that was very good for us this year, because our hedge costs were locked in on the forwards at about 89 basis points. And on the FX options we do at around 44 basis points. And altogether, I think about $110 million so estimated hedge costs for this year. Obviously, hedge costs are higher with short-term rates going up significantly. So just to give you a flavor of the differential and this really wouldn't impact us till 2023. Forward costs today for 12 months forwards around 256 basis points versus what we're paying this year of 89. So a significant increase and we expect that from what's happening with interest rates. And similarly, options would probably cost us around two times more than what we paid, given increased FX volatility and overall levels at the end. So when we get to next year, if rates stay where they are, hedge costs would be significantly up probably by about 125% or so on the book. Now having said that, our book does change over time. So I can assure you the balances in all of our asset classes or even when we revisit our hedge ratio, that may change as well. But that's just looking at it as a static book. The other thing to remind you of though, as well, on our forward book, which is much reduced than what it was, those forwards are applied against our floating rate assets. So those floating rate assets as we just discussed with question, their income is going up substantially. So the income, while not 100% correlation will go up pretty close to the amount of the hedge costs going up. So the net should stay pretty even with the one variable being the level of spreads on the assets and those spreads have generally been going up. So on a net basis, at least on the forward book, it should be pretty neutral, but the actual line item of hedge costs would definitely go up.
Daniel Amos: But I want to make a comment is, I've always said I like evolution, not revolution. And for you that have been following our stock for 10 years or more, I just want to tell you, what a sophisticated model we have today and how it's evolved, not only from Eric and Brad and the team and what they've done, but also our board and specifically, Tom is Chairman of what they've done from an investment standpoint. It is very gratifying to hear as we get into such volatility and change in the last year or so, even in the last three months with the Yen. And yet we have prepared for and to hear these answers, I just want all of you to know what hard work and dedication they've done through Fred and Max. And what's gone on. So, Max, I think you were going to make a comment.
Max Brodén: Yes, I wanted to add one more comment. So Eric, when you think about these four words in our flag, Japan, so that's about $4.5 billion of notional at the end of the quarter. At the holding company, we also have $5 billion of notional going the other way. So even in a scenario where you would have dislocation in the marketplace that could significantly increase the hedge costs perhaps like Japan, you would have an associated increased hedge income as the holding company. So from an enterprise standpoint, we're somewhat reduce the exposure to volatility and hedge costs as well.
Erik Bass: Got it. Thank you, and I guess putting it all together. So you talked about the benefits to NII this year kind of the floating rates being higher? It sounds like the hedge costs are locked in. So maybe those, is that a net benefit you'd expect this year? And then the comment on 2023 based on what you've locked in for the floating rates expectation for hedging costs, and then what happens in corporate that kind of putting it all together is sort of a neutral impact.
Max Brodén: I think putting it all together, it's a positive impact, yes. We realize we got a $30 billion, $30 billion, $31 billion U.S. dollar portfolio, and I think we have $6 billion of it hedged. So you got $10 billion of floaters. We've locked in 70% of it. I mean, it's a positive catalyst. There's no question.
Erik Bass: Got it. Thank you.
Operator: The next question comes from Jimmy Bhullar of JPMorgan Securities. Please go ahead.
Jimmy Bhullar: Hi, good morning. I had a question following up on, I think Dan, your comment on the environment sort of returning to normal, as you think about sort of the whole sales process in the U.S., how close to normal is it in terms or are there still ongoing headwinds, whether it's people working from home, or businesses less interested in letting agents come in and pitching to their employees or schedule meetings? So how do you think about like return to normal pre-pandemic versus ongoing headwinds that might preclude sales from getting to pre-pandemic levels in over the next year or so?
Daniel Amos: Well, I'm going to let Virgil but let me just say, just take our company, for example. Today, we really have our first officer meeting, after for lunch today. And we've got about 150 people coming and that is normally, that includes our Directors, and our Directors. And that's about a little lower than what we normally have that pre-pandemic, maybe we would have had up to 200. So it gives you an idea of how things are getting back to normal. They're not quite there. But as I said, I look forward to happen in the second half, I look for everything to kind of move back, but it will be a new normal. I mean, there will be a certain amount of people that will work from home. But things are moving back. So let me let Virgil because I'm real pleased of what Teresa and Virgil had done in terms of having an impact on sales. And I've been very pleased with persistency until this issue that just came up in the first quarter. And I know they'll address it and fix that problem too as we go forward. So go ahead, Virgil, you can start and if Teresa wants to make comments, she can do whatever she wants. She's the boss.
Virgil Miller: Thank you so much, Dan. Yes, so do a few anecdotal comments. I'm going to support it with some numbers. So one of our key focuses was to return to normal by driving out culture. So as Dan mentioned, we got back last year to a lot of normal things we do. That includes like having sales meetings, we gather our top producing sales agents, our veterans out there to make sure that they were informed along strategies and kept that momentum going. They were very, very pleased to bring everybody back together, as well as our brokers, working with our broker sales professional teams, which is when our company is out in the market and bringing in those broker partners, we still had our events where we sat around and taught stress to them, make sure we're collecting their feedback and make sure we've got the right model to support the service levels they need going forward. Having said that, you also mentioned about how things have changed about face-to-face, and being able to support virtually. So I will tell you this, that we're able to provide the level of service. However, whether it's face-to-face, whether it's virtual, whether it is self-enrollment, I'll share a couple of numbers with you to support that, one back looking at pre-COVID 2019, 95% of our sales were face-to-face. As you saw the height of the pandemic in 2020, our face-to-face sales were at 80%, the rest of them were doing virtual enrollment, a hybrid type model, or self-service. And now as I look at Q1, 85% of our sales are back to being face-to-face. So to sum that up, of course, we were more face-to-face, pre-pandemic, we saw a tremendous drop in that and we were able to accommodate still getting our product sold through other means. And now you can see that number of face-to-face going back up. So I hope that helps. But overall, I can tell you, there's a lot of momentum in the sales force right now, I expect more the same. The hit when we spoke about earlier that Fred mentioned was around recruiting. Again, recruiting was important, but we did adjust our model to reengage our veterans, our average week of reducers are up, our productivity is up across all lines and our conversions, we saw 11% increase in converting veterans who have been here more than five years in Q1. So as you can see the confidence in the voice here, feeling very good about we're going to see the remainder of the year.
Teresa White: Yes, and that I've just mentioned, we're just well positioned to address many of the headwinds that we were seeing in the environment, specifically, due to our financial strength, our distribution model, and our digital solutions. And so you hear the energy in Virgil's comments. And that's because there is a tremendous amount of momentum in our sales force today. And so we're going to ride that momentum. And we'll continue to address any issues that we see come up in the market.
Jimmy Bhullar: And then just in terms of progression of sales for the year, the last couple of years, obviously, have been off because of COVID. But prior to that, typically your second quarter used to be higher in sales than the first quarter and obviously fourth quarter, you got a lot of local sales, should we assume a similar pattern this year as well? Or is there something else that would affect the results?
Daniel Amos: Yes, so I'll say that the first quarter is certainly higher than we anticipated, I think and more higher than most anticipated for us. So we're very pleased with that, we certainly will see the same seasonality definitely in the third and fourth quarters, where you'll see the majority of our production. Again, we're looking to maintain this consistency in the second quarter. But I will tell you that the momentum, and in a lot of has to do with two the contributing factors we mentioned earlier that have come from our buy-to-build, with our premier life and absence products and disability, those products really is the selling season right now early in the year. And those sales will come through in Q4, so the growth and the seasonality of the highest impact, you'll see is definitely going to be in Q4. We'll look to maintain this consistent momentum from Q1 going into Q2. But again, I expect more on the third and fourth quarters.
Jimmy Bhullar: Thank you.
Operator: The next question comes from Alex Scott of Goldman Sachs. Please go ahead.
Alex Scott: Hey, good morning. First one I had is on Capital deployment. When I think about what you're saying on the economic hedge and how it's not just the GAAP EPS impact we got to think about here. It's also this economic hedge. My understanding of that hedge is with the Yen weakening, it would actually make your capital in Japan stronger. And just in general, I think the capital of the overall business stronger. And if that's the case, I think it'll give you maybe GAAP EPS is short-term hurt, but then you have like more capital deployment opportunities as a result of that. Am I understanding that correct? And if I am what are your priorities for deploying that capital if the Yen remains weaker, and you have that flexibility?
Daniel Amos: Yes, Alex, I think that the way you sort of described it is a reasonable description of how our long-term hedging model actually works. Capital in Japan obviously is stronger with a weakening Yen and you know SMR sensitivities, you can go back to our fab disclosures, and we give those sensitivities there. So you can sort of calculate what the impact is on the capital position in Japan. And also, if you travel over to the holding company in this quarter alone because we issue debt denominated in Yen, you saw our leverage dropped 60 basis points simply because of FX move in the first quarter. So that ultimately leads to a somewhat higher debt capacity over time, and then you should also expect that over time as the $5 billion of forwards as they settle, they convert into cash. At the end of the first quarter, we had $3.6 billion of unencumbered cash at the holding company. And I use the term unencumbered, and that's actually quite important in this context, because it excludes any collateral receipt that we have. And obviously, that will add to that pile of cash, if the FX rate continues to be at this current level, we have forwards that the settlements will spread out, there's no specific sort of tower as generally settle, we got some forward settle every month. So over time, this hedging program will then convert into cash. So short-term, you're going to see our EPS obviously get hit by it from the translation impact. But over time, it leads to deployment opportunities, by lower leverage, FX words converted into cash. And then also long-term, you have a higher capital position in Japan, associated with the dollar portfolio that we have in Japan that strengthens the SMR in a scenario, weakening Yen, all these sort of balances out to some extent over the long-term. As it relates to deployment of additional capital, it follows the same criteria that we have for all deployments of capital that we deploy, where we see a good risk return based on an IRR basis.
Alex Scott: Got it. And maybe a little more of a housekeeping question, in Corporate, yes how should we expect that to trend from here? I guess it's just a lot of moving parts, because you have this offsetting derivatives that are sort of housed in corporate I believe. So I mean, could you help us think through where the run rate of earnings for that segment would be or even how to maybe we can do that, just how to think about net investment income in corporate?
Daniel Amos: Yes, so first of all the derivatives housed at the corporate level, the mark to marketing pack does not run through the GAAP EPS number, but the amortize hedge income does. And that's a fairly stable number. So if you look at the results for corporate this quarter, we're running a little bit high on expenses in the quarter, and a little bit low on NII in the quarter, the NII was somewhat depressed by our tax credit investments, that run as a negative -- that run as a negative through the NII line. But then obviously, you have a favorable offsetting impact on the tax credit line. As discussed earlier, we do have most of the assets at the holding company are floating rate in nature. So obviously, that means that as the short-end of the yield curve now has increased and come up, you're going to see a little bit of a pickup in NII over time. So if you look at the results of this quarter, there's some puts and takes and a lot of moving parts, but generally, I think it's a decent run rate for the current.
Alex Scott: Got it, thank you.
Operator: The next question comes from Tom Gallagher of Evercore ISI. Please go ahead.
Tom Gallagher: Good morning. First question, Fred, just to come back to the underlying benefit ratio in Japan, the 69.1%. I think excluding the extraordinary IBNR releases. That's a little bit above the range that you've guided to, I think you explain why it happened, just elevated medical COVID claims, is it fair to expect that this is going to drop back down to within the range for the balance of the year as COVID cases go down?
Frederick Crawford: Yes, let me actually give you some perspective, if you don't mind, just over the last few quarters on incurred claims related to COVID. Because it'll really illustrate what's going on with this most recent Omicron. If you go back to the first quarter of last year, our incurred claims were around ¥800 million in the second quarter and picked up to about ¥1.3 billion, obviously, very small numbers. In the third quarter, it picked up to ¥2.3 billion, and that was actually the Delta peak. That was right when that Delta peak took place, and we had claims coming in, then they dropped down in the fourth quarter to about ¥100 million, so almost non-existent. And then in the first quarter, ¥8.3 billion. And so what I think if you're living and working in the U.S., and if you're following largely U.S. companies and economy, I think many don't realize just what a peak of Omicron we saw here in Japan, you're talking about case levels, that were running at around 100,000 a week, two, three times at least, the level of peak that what you saw during the Delta. Now fortunately, it's a very mild version of Omicron. And fortunately, vaccination rates, particularly among the elderly, in Japan, are very high. And so as a result, you haven't really seen hospitalization, nor have you seen deaths pick up in Japan. But don't think for a moment that that's because things calmed down, it's quite the opposite. This is the most severe peak of infection rates, particularly in that February time period that Japan has seen throughout the entirety of the COVID environment. As a result, that's why you're seeing some of the face-to-face dynamics. And what Dan mentioned about on again, off again, states of emergency going on. Now, the reason I pointed out the nature of our claims was that this deemed hospitalization issue, essentially the life insurance industry at Japan got together and agreed with the government, the COVID-19 and versions, variants of COVID-19 as an infectious disease. And when you do that, you're allowed to cover if you will, you're allowed as a doctor to diagnose and allow for at home treatment, and cover the claims related to at home. The reason for that is Japan does not want infectious disease to cause hospital capacity issues. And so they allow more degrees of freedom as to where that care takes place. So we're seeing claims go up not because of the severity, but because of the sheer volume or frequency of cases and at home treatment, we would expect that to calm down over time, because we've seen cases calm down, but there's a lagging effect. Right now in April, in May, for example, we're seeing claims coming in that are likely related to two, three months ago, related peak levels. So we think that's probably going to continue, I would say into the second quarter, it's early, we don't really know at the end of the day, what it may mean for the benefit ratio in the second quarter. But we should see COVID claims continue. But then calm down as the year goes on. And again, remember, while this is all going on, and you have lower activity levels, lower face-to-face, you're seeing other types of medical claims not come in. And so you don't necessarily see your benefit ratio moving the wrong direction. It's just the mix of claims have shifted during this period of time. So it's quite interesting. And we've been busting down this data and looking at it very carefully. But you should expect claims and COVID to continue, I would say into the second quarter given the lagging effect, but not necessarily be dramatic upward pressure on benefit ratio, I would not anticipate that.
Daniel Amos: And Tom, just to give you some more color on it, if you take the incurred impact from COVID in the quarter on our normalized benefit ratio was a little bit north of 100 basis points. So if you take that and you isolate that component, that will take your normalized benefit ratio in the first quarter smack in the middle of our range of 67% to 69%.
Tom Gallagher: Got you, that's helpful guys. Thanks for that color. My follow-up is with the recruiting numbers down so much in the U.S. on both agents and brokers, and knowing there's a lag in terms of recruits converting into sales but then taking that together with your comment about improvement in productivity gains based on some of those initiatives. What do you think that all if you add all that up does to sales, if you look out, I don't know two, three quarters from now, do you think you can maintain the strong momentum you're seeing in the U.S., it sounded like from what Virgil said, he thought so. But I'm just curious if you think just given the severity of the drop in recruiting, whether you think that's going to start to impact your sales?
Daniel Amos: Well, if they don't, they won't make bonuses. So it's going certainly going to impact them. But Virgil, you want to comment?
Virgil Miller: Yes, thank you, Dan. So if you look at the numbers, we still recruited over 10,000 crew agents last year, and over 5,000, close to 6,000 of small brokers that we do business with. And when I talked about the focus where the focus was converting on them, so think about it coming out of Q4 last year, which is our busiest time of the year, we put a lot of focus on getting those converted. And I'll tell you 70%, we had a 70% increase in broker conversions in Q1. So that strategy is working. Now, having said that, that's not to say that recruiting is important, you know, it's a formula, you can add it up, you can look at productivity, you can look at conversion rates into and tell you, how many people we need to hit our numbers. Right now we're solid, because we are seeing again, when those veterans come back and reengage the veterans produce at a higher rate. So I've ran these numbers over and over, we are optimistic about how we're going to look, not to say that we're not going to still recruit. So I can tell you right now, we've got some additional efforts going on in 2Q and I look at it on a weekly basis. If I look, week over week, back in March, seeing progress in the final few weeks of March and that progress is translating over into April.
Daniel Amos: And one thing I would add and Virgil can add color to it, but one column that you may be looking at in the recruiting is the recruited agents through brokers. And remember to some of our comments at year-end in this past quarter, we're focusing on driving sales now through small business brokers as well, which has not been historically a focused effort of our company. And as a result, you saw the recruiting level of broker agents go up dramatically in 2021, averaging over upwards of 1,200 to 1,500. Now, what does that mean, when you recruit a small business broker, what it means is you've appointed them, and they've appointed you to be eligible to sell product through that broker, it doesn't mean you're selling product through that broker. And so one of the things that Virgil is talking about when he uses the term conversion is that we're now working on those large amount of brokers that were signed up and appointed last year, we're now focusing on converting them into actually generating sales through their brokerage platform. So that's a big piece, and there's a lot of runway yet to go on that.
Operator: The next question comes from Ryan Krueger of KBW. Please go ahead.
Ryan Krueger: Thanks, good morning. I was just curious if you could give it, I know you can give it back quantification, but if you could give any qualitative commentary on how much you think Japan Post could contribute as they begin more actively selling cancer products again, maybe one metric, you could help us think about it, I think I believe Japan Post was about a third of your cancer production, prior to the mis-selling issue. If you could give any thoughts on what percentage of your cancer sales you think they could build back up to?
Daniel Amos: Well, we can't go into any detail regarding Japan Post. They've always been, you know since inception of Japan Post, they have asked us to never go into detail or go into detail. Basically they stopped last year, and they have regained a position but it's still very low. And all I can tell you is they have committed to us that they are dedicated to seeing a return to stronger production. And I'm expecting that that as you all know there are large shareholders, I feel like that's important. And the message that I've been saying is, those two tasks gather with them and so we'll have to wait and see. But I'm encouraged about the production, but I can't if this give you any more detail other than to say, we have a wonderful relationship. They know what we want, they want to help us. It's just the timing and how to do it. But there's no problem that I can tell you, other than just getting it started again. There's absolutely nothing. They're happy with us. We're happy with them and but we want to see the production now.
Ryan Krueger: Okay, understood. Appreciate the comments.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young: Thank you, Andrea. And I want to thank all of you for joining our call this morning. If you have any follow-up questions, I'll be happy to take them, please contact me via email or the phone and look forward to speaking to you all soon. Till then, take care.
Operator: The conference is now concluded. Thank you for attending today's presentation. And you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the Aflac Incorporated First Quarter 2022 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations and ESG. Please go ahead."
},
{
"speaker": "David Young",
"text": "Thank you, Andrea. And good morning. Welcome all to Aflac Incorporated's first quarter earnings call. This morning we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated; Fred Crawford, President and COO of Aflac Incorporated will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday after the close we posted our earnings release and financial supplements to investors.aflac.com along with a video with Max Broden, Executive Vice President and CFO of Aflac Incorporated, who provided an update on our quarterly financial results and current capital and liquidity. Max will be joining us for the Q&A segment of the call along with other members of our U.S. Executive Management. Teresa White, President of Aflac U.S.; Virgil Miller, Deputy President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments. Brad Dyslin, Deputy Global Chief Investment Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our Executive Management Team at Aflac Life Insurance Japan. Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO, Koichiro Yoshizumi, Director, Deputy President and Director of Sales and Marketing. Before we began, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. And we encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Daniel Amos",
"text": "Thank you, David and good morning. Thank you for joining us. As I reflect on the first quarter of 2022. I'm thankful for the dedication, compassion and hard work of our committed Aflac team in the United States and Japan. Our management team, employees, sales force have continued to work tirelessly to be there for the policyholders when they need us most, just as we promise. As Max highlighted in his video update, Aflac Incorporated reported first quarter net earnings per diluted share of $1.58 in the first quarter of 2022. Adjusted earnings per diluted share were solid at $1.42 in the first quarter, supported in part by the continuation of a low benefit ratio associated with the pandemic conditions. Also contributed were better than expected returns from alternative investments, despite the weakening of the yen. We remain cautiously optimistic as we continue to navigate the pandemic. Looking at the operations in Japan in the first quarter, Aflac Japan generated strong overall financial results with a profit margin of 25.3%. This was above the outlook range that we provided at the November 2021 financial analyst briefing. Persistency remains strong, however, sales were constrained as a quasi-states of emergency remained in place through mid-March. This impacted our ability to meet face-to-face with customers also contributing to the decline in the quarter were comparisons of the first quarter of 2021 When our new medical product was launched. Aflac Japan has continued to offer support to Japan Post Group as it gears up for the start of the new fiscal year of April 2022. This included the transfer of approximately 10,000 Japan Post company sales employees to Japan Post insurance. These sales employees will focus solely on selling Japan Post insurance products and Aflac's Japan's cancer insurance product. Since it may take some time for these employees to ramp up sales activities under the new framework, we anticipate sales momentum picking up in the second half of the year. On that note, as part of the ongoing collaboration and governance framework of the strategic alliance. I'm excited to be traveling to Japan towards the end of June to meet with Mr. Masuda Japan Post Holding CEO along with the President of Japan Post Postal and insurance companies. Given this we expect stronger overall sales in the second half of the year, assuming that the pandemic conditions do not escalate that we execute on our product introductions and refreshment plans, and the sales productivity continues to improve in Japan Post Group. Turning to Aflac U.S., we saw a solid profit margin of 19.8%. This results was also above the outlook range that we provided at the Financial Analyst Briefing. I'm pleased that our U.S. sales momentum has continued from the fourth quarter with a 19% annual sales increase in the first quarter. This reflects continued improvements in the pandemic conditions, growth in our core products and investment in a build out of growth initiatives. While Aflac Dental and Vision and Group Premier Life, Absent Management and Disability Solutions, which we call plants are relatively small part of our sales. We are very pleased with how they're contributing to our growth. Our growth initiatives modestly impacted the top-line in the short-term, but also tend to comp -- excuse me, they tend to be accompanied by the sale of our core supplemental health products, as Fred will explain in a moment. In combination with our core products they also better position Aflac U.S. for future long-term success. The need for the products we offer is as strong or stronger than ever before. At the same time, we know that consumers habits and buying preferences have been evolving. We remain focused on being able to sell and service customers, whether in person or virtually. This is part of our ongoing strategy to increase access, penetration and retention. Turning to capital deployment, we play significant importance on continuing to achieve strong capital ratios in the United States and Japan on behalf of our policyholders and shareholders. When it comes to capital deployment. We pursue value creation through a balance of actions, including growth investments, stable dividend growth, a discipline and tactical stock repurchase. It goes without saying that we treasure our record of dividend growth. The fourth quarters declaration marked our 39th consecutive year of dividend increases. This is a record we seek to extend demonstrated by our 21.2% increase in the first quarter cash dividend. 2020 will remain in the market purchasing shares with a tactical approach. In the first quarter Aflac Incorporated deployed $500 million in capital to repurchase $8 million of its common shares. With this approach, we look to emerge from this period in a continued position of strength and leadership. Keep in mind, in addition, we have among the highest return on capital and lowest cost of capital in the industry. We have also focused on integrating the growth investments we've made. I don't think it's a coincidence that we've achieved success, while focusing on doing the right things for our policyholders, shareholders, employees, sales distribution, business partners and communities. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong, long-term shareholder return. We also believe in the underlying strength of our business and our potential for continued growth in the U.S. and Japan, the two of the largest life insurance markets in the world. Thank you for joining us this morning. And now turn the program over to Fred, Fred?"
},
{
"speaker": "Frederick Crawford",
"text": "Thank you, Dan. I'm going to focus my comments today on efforts to drive growth. I'll also provide some perspective on market and economic conditions in Japan and in the U.S., beginning with Japan, COVID related critical illness, daily deaths and hospitalization remains at very low levels. While weekly new cases were elevated for much of the quarter, they have come down in the last month and the government's intensive infection prevention measures were lifted as of March 21. However, for much of the quarter, we felt the ongoing COVID impact and as evidenced, a further 17% decline in traffic through our retail insurance shops as compared to 2021. We have seen COVID incurred claims increase despite the lower rate of hospitalization. This is driven by the rising cases along with COVID designation as an infectious disease or deemed hospitalization, which allows for payment of claims for care outside of the hospital. To give you a perspective, we estimate over 80% of our COVID related claims in the quarter were considered deemed hospitalization. In the meantime, and despite the increase in COVID claims, third sector benefit ratios remain very low. Sales in the quarter were weaker than we had hoped for provided COVID dynamics continued to trend positive, we remain confident we will hit our internal expectations for the year. While COVID conditions partially explain the weakness, we are taking additional action to strengthen the associate channel to include renewed investment in our exclusive agency platform and efforts designed to build market share with non-exclusive agencies where we have low market share. With this in mind, we are accelerating our Cancer Insurance refreshment timing, and plan to launch in the second half of 2022. With respect to Japan Post, we have experienced sequential growth in sales with increased proposal activity as we continue to roll out a successful pilot program launched late last year. As Dan mentioned, the April transfer of 10,000 sales employees to Japan Post Insurance was completed without disruption. Our alliance now is best characterized as distribution through 20,000 post offices, 10,000 sales employees selling from 223 locations within the Japan Post Insurance network, and 88 Japan Post Insurance branches focused on corporate sales. Importantly, cancer sales targets have been communicated to the regional offices of both the postal system and within Japan Post Insurance for the first time in three years. With respect to our elderly care product, sales were softer in the first quarter after our initial promotional period. This market is still relatively small, roughly one-tenth the size of the medical product industry. The market is further divided into two distinct and equally sized classes of product, protection and savings. We are focused on the Protection segment of the market, where we have quickly captured market share in the high teens. We are well positioned with competitive product, should the government of Japan contemplate shifting more of the burden to individuals. Turning to the U.S., the markets for voluntary and other worksite benefits have effectively recovered to pre-pandemic conditions. However, we are navigating inflation and a challenging labor market. When we reflect on the U.S. economic environment, we are especially focused on two areas of impact to our U.S. model, recruiting and persistency. Tight labor markets create difficulty in recruiting to a full-time commission based profession. We are therefore focused on improving conversion rates of new recruits to producing agents and reengaging veteran agents who are less productive during the pandemic. Our strategy has been successful, driving a 7% increase in average weekly producers year-over-year. In addition, veteran agents are better equipped to leverage our recent product expansion and strategy to grow within the small business brokers. In terms of persistency, it's important to note our account persistency was stable in the quarter. However policyholder persistency was weak and broad based, which leads us to believe it's partially attributable to the extreme movement in the labor markets. We track the Labor Department's quit rate, which had been declining during the pandemic then jumped in the first quarter to levels not seen in recent history. While higher turnover in the small business sector is common, the so called great resignation along with COVID and return to office dynamics is driving higher turnover. Unfortunately, when employees leave their place of work, they often leave their policies behind. With this backdrop, what is most impressive about the sales results, Dan covered is the balance. Split by product type, group voluntary was up 23%, individual benefits up 17%, split by channel, agent sales were up 15% and broker up 25%. Our buy-to-build platforms were all up year-over-year with the combination of network Dental and Vision, Premier life and disability and consumer markets up 65% albeit off a small but building base. We track the halo impact of Dental and Vision sales and for every dollar of Dental and Vision sales, we were able to cross sell $0.57 of other voluntary products. Finally, we launched Aflac Pet insurance powered by Trupanion targeting the larger case market and are busy responding to request for proposals. It's the balance in our results that give us added confidence that performance should continue throughout the year. Turning to our investment operations, we do not have any direct exposure in Russia, or Ukraine. Of course, our large global credit portfolio does include multinational companies with business interests in the impacted region, but nothing significant enough to cause us concern among what are generally large, high quality credits. We're closely watching secondary risks, namely the impact to the European energy sector, the conflicts impact to existing supply chain and inflation risks and a risk of recession in Europe. While increasing yields erode some of our unrealized gain in the bond portfolio, we also have benefits from rising interest rate environment, rising rates obviously provide a tailwind for new money investments. Further, our sizable floating rate portfolio will benefit directly from aggressive Fed rate hikes as their interest rate resets are based of short-term rates. Given the significant move in the forward rate curve, we expect we elected to lock in a portion of the expected rate increases by increasing the notional of our interest rate swap strategy such that now approximately 70% of our income is protected from changes in short-term interest rates over the next five years. In addition, the holding company holds short-term investments that will benefit with rising short-term yields. Our alternative portfolio continues to deliver strong results, we understand these portfolios could very well give back some of the gains as the year goes on. But we're off to a strong start in generating the favorable returns expected from these portfolios. Finally, Max provided helpful perspective on our exposure to the weakening Yen in his recorded comments. In short, while there are GAAP reported impacts, we are well protected from an economic perspective and do not see the weakness in the Yen is altering our investment strategy, hedging strategy, or overall capital deployment activities. There are certainly no implications to our business model, which reinforces our strategic focus on currency neutral outcomes. And I'll hand the call back to David to take us to Q&A, David?"
},
{
"speaker": "David Young",
"text": "Thank you, Fred. [Operator Instructions] Andrea, we will now take the first question."
},
{
"speaker": "Operator",
"text": "Our first question comes from Nigel Dally of Morgan Stanley. Please go ahead."
},
{
"speaker": "Nigel Dally",
"text": "Great, thanks, good morning. So once we start in the U.S., I know there's some potential seasonality in the life, but if that has remained high, are you considering some potential strategies to improve persistency? And if so, what are some of the options that you have available?"
},
{
"speaker": "Daniel Amos",
"text": "We have an outlet, Teresa and Virgil comment on this, but we have had for a while a number of strategies under a way to help over the long run persistency, not the least of which has been our expanding product portfolio. As you know, we believe Dental and Vision for example will over time contribute to better persistency just by the very nature of the product and how that works. However, we think that much of the persistency issue that we're seeing right now is a combination of number one, the fall off -- the final fall off of state regulations that were requiring policies to remain in place. But on a larger scale, we think this labor force in motion is contributing to a lot of the lapse rates, and we would expect or anticipate that to eventually calm down. In the meantime, we remain focused on activities that drive better persistency. But we think right now, there's certain market conditions influencing it. Virgil, Teresa, if you have any comments."
},
{
"speaker": "Teresa White",
"text": "I'll just mentioned, you mailed it, as it relates to some of the high level things that we're doing. But we also, in addition to the stickiness of the product, which you talked about with the product mix. We're also from an operational perspective, making sure that we stabilize account retention or account persistency, because when we do that, we know that our premium persistency is generally stable as well. But as you said, what we're seeing today is a lot of what we think might be labor market or labor force impacts based on what's going on. And so we're thinking that that's what's going on with our premium persistency at this point, and so more to come on that."
},
{
"speaker": "Nigel Dally",
"text": "Great. Then, as a follow-up just on Japan sales. The sales decline, I think was -- that's a little worse than some of us were expecting medical appear particularly weak. So perhaps you can discuss why that was the case. And with your expectation the sales will recover in the back half. Should we expect that mostly to being canceled or given your product refresh? Or you also expect to rebound in medical as well?"
},
{
"speaker": "Frederick Crawford",
"text": "I think we'll let Koide san and Yoshizumi san answer that question. But you have in fact identified some of the issues. Number one realize the first quarter last year medical was during a fresh launch period. And we normally see medical sales calm down really sales of all products calm down after that initial launch period. However, there's no question that COVID conditions are really impacting across the board results. Cancer held up better for the simple reason that we're seeing some increased momentum slowly within the Japan Post System and that offset things. But generally speaking, you have it right. And then I'll Koide san and Yoshizumi san talk about the types of things we're looking at in the second half of the year to improve sales results and addition to our cancer launch."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language]. Yes, this is Yoshizumi. Thank you, Fred. Let me answer the question. [Foreign Language]. In Japan in the first quarter with explosive infection increase we have been infected very much. [Foreign Language] And that goes to both the salespeople who visit the customers as well as those customers who visit our agency shops. For example, in February the number of people, the customers visiting our insurance shops decreased by 22%. [Foreign Language] And we are also gathering information from various associates to analyze what actually had occurred. And as far as we hear, it seems like the appointments that we -- that our agencies are trying to make for a visit to customers has been declined by like 30%. [Foreign Language] And I believe your question was related to medical. [Foreign Language] And in regards to the medical insurance, we did launch a new product last year. [Foreign Language] And since it's been a year, since we launched the product I think we have gone through a cycle of customers. [Foreign Language] And we did have a plan that our medical insurance in the first quarter sales will decrease. [Foreign Language] And the fact is that the actual sales was even lower than what we had expected, because of the impact of Omicron. [Foreign Language] And as for the future sales measures, we would like to further promote our sales activities through online sales. [Foreign Language]. And we would also like to be proposing more comprehensively our coverage and benefits to our customers using the new products such as nursing care product, and our work lead product. [Foreign Language] And the rest are basically what Fred had said. And then now regarding in Japan Post Group. [Foreign Language] There was bit organizational change there. [Foreign Language] And what that means is that the sales consultants from this town post company, this is a post office company has been transferred it to the Japan Post insurance company. [Foreign Language] And the preparation to move this many people over to the pampers to insurance took place in a first quarter and they are fully prepared. And they have gotten a very good start in April. [Foreign Language]. And the Japan Post Group will resume their sales under the new organization now that they have a good infrastructure in place for sale. [Foreign Language] That's off for me."
},
{
"speaker": "Daniel Amos",
"text": "But let me make one comment. This is Dan. And what I think you're seeing evolve here with sales in the U.S. and in Japan, is that we've got one more quarter the second quarter of things adjusting. But I see things moving back to a new normal. What that normal is I'm not exactly sure. But I don't think it's going to be that different from the way we've been rolling in the past. And I think you'll see that in the second half of the year. And I have not been to Japan in quite a while and I can't wait to get back. But I have been talking all of us have with Japan constantly. And I don't think you can underestimate the impact of those cost of moves that they had in terms of restrictions. And but they are over right now. And assuming that we don't see it come back in any great degree, I think you're going to see the second half, and the second quarter start to improve. But the second half really be more like the past in terms of our selling ability. Because as they mentioned, people coming into the offices was down 22% some other things. And those are just reflections. And they affect everything, they affect recruiting, they affects new sales, they affect every aspect."
},
{
"speaker": "Nigel Dally",
"text": "That's great. Appreciate the color."
},
{
"speaker": "Operator",
"text": "The next question comes from Suneet Kamath of Jefferies. Please go ahead."
},
{
"speaker": "Suneet Kamath",
"text": "Thanks. I wanted to start with Japan again. Just as we think about these new product refreshes and launches, it seems to us that the shelf life post these launches has been shortening over time. Maybe years ago, you had a couple of years of runway now it feels like it's a couple of quarters if that. So I'm wondering one, if you think that's a fair observation. And two, is some of what we're seeing in Japan due to increased competition. In other words, do you have any data on your market share and medical and how that's changed over time?"
},
{
"speaker": "Frederick Crawford",
"text": "Yes, I think let's have Japan maybe comment on it. But what I would tell you Suneet is in general, your comments, I think hold up a bit and I think it is in fact largely due to the competitive environment. One of the things that I would tell you just as an observation is in 2016, when the Bank of Japan went to their negative interest rate environment. We saw a slow and steady migration of shift towards third sector not a first sector not surprisingly. But for a period of time you had firms that were moving into currency product, and then all of a sudden rate movements and other reserving dynamics rendered currency product to be less attractive and so that started to back off. And now you have companies, including domestic companies that have subsidiaries that often specialize in third sector of business. Even by the way, property casualty insurance companies that have life and health related subsidiaries are getting into the action as a way to drive more business. Competition and intense competition is not new that's been around and we've navigated that for years and years. But there's no question that has become more intensified, which means your product cycle product refreshment, and the nimble nature of how you go at product has to speed up and be quicker. So yes, the life expectancy of a new product is shorter, but that simply means that you have to be quicker to revise and refresh products, then maybe the old two year cycles for medical and four year cycles for cancer. That's my perspective based on talking with our Japan colleagues. But I'll let Koide san or Yoshizumi san to comment."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Thank you very much, again this is Yoshizumi. [Foreign Language] And that's we just mentioned the market is becoming very, very competitive. [Foreign Language] And especially the medical insurance market is really evolving or changing almost every day. [Foreign Language] And what we are saying is that the good the data until it's good is short become shorter and shorter. [Foreign Language] On the other hand, since we do have very good sales and solicitation platform. [Foreign Language] And using that base [Foreign Language] we do believe that we can still grow this area. [Foreign Language] With our overwhelming brand very strong brand. [Foreign Language] And we also have very good advertisement capability. [Foreign Language] And even with this very severe competition, I think we can work towards expanding the market and really make efforts and perform. [Foreign Language] Now let me go into cancer insurance. [Foreign Language] And regarding new product for cancer insurance, we are thinking of it, because it is still before the approval of the authority we cannot say -- tell you about the details. [Foreign Language] We are thinking of a product that that will differentiate ourselves from competitors by having very competitive benefit, as well as various services that would support the cancer patients from the time of when they start developing cancer until these patients recover to society or work. [Foreign Language] That's all for me."
},
{
"speaker": "Suneet Kamath",
"text": "Got it. Okay. All right. And then I just wanted to pivot. Fred, you've made a comment in your prepared remarks about the floating rate portfolio and having the income on that locked in for five years, or 70% have been locked in for five years? Can you just go into a little bit more detail on that? I'm just trying to think through, if the fed is really aggressive. Does that mean that you've limited some of the upside? Or just how do we think about that?"
},
{
"speaker": "Frederick Crawford",
"text": "Yes, and we have Eric and Brad Dyslin here that can provide color, but just a couple of points to be to be very clear on. Remember, what we're doing effectively is locking in the forward curve, not current rates. In other words, we're locking in the expectation in the marketplace for aggressive fed action. And so that's the very nature of the swaps. So we're not losing out, if you will on that aggressive forward, what we're doing is we're protecting against the risk of that reversing or calming down or not meeting the expectations that are embedded in the forward curve. Also note that we've got about $10 billion of floating rate, floaters if you will, in our general account, and another $2 billion at the holding company. And so we still remain relatively exposed if you want to define it that way to taking advantage of a rate environment that exceeds the forward curve expectation. So we haven't taken it all off the table. But I'll get either Eric or Brad to comment."
},
{
"speaker": "Eric Kirsch",
"text": "Yes, thanks, Fred. And that's an excellent start, I would just dive a little deeper to have you understand. When we do our planning, if you will, which is of course, the current year. Plus, we look out over five years. For the floating rate buck, we typically use forward curves. The last set of financial plans we did, were back in November, which Max then uses as part of the overall franchise's EPS, if you will. But the forward curves, as you know, because of the fed change and policy has substantially increased. So if you just look at a projecting based on the flow occurs, where the floating rate income will be over the next five years, significantly higher than what our plan was. Having said that we all know forward curves are never realized. So we have an opportunity to basically say, we don't really know what's going to happen in years, two, three, four, and five, but what we do know is, if the forward curves became true, there's a significant amount of pickup in income. What we've chosen to do is take about 70% of that book, and do a fixed or floating rate swaps, such that we've locked in a good portion of that upside, if the forward curves end up coming down. An example of that would be and many people are talking about recession, in the U.S. next year. Those forward curves will likely never be realized in years three, four, and five, because the fed will then change policy. If rates continue to go up, because the fed is even more aggressive. Fortunately, we've got a good portion of the book about a third that's not covered by the swap. So we'll still enjoy some upside, as well. And then of course over the next few years, we continue to invest potentially in more floating rate assets. So we've got good exposure to rising rates as well."
},
{
"speaker": "Suneet Kamath",
"text": "Would you be willing to size the pickup just from November to March on that portion that you've locked in?"
},
{
"speaker": "Frederick Crawford",
"text": "Yes, I think we would have to kind of give some thought to that. The pickup this year, is relatively modest. It's not insignificant. But remember, all we're really doing is locking in the pickup that's there anyway, if you will. We're trying to. So I think let us give some thought to that. I don't have the numbers right in front of me, because we've looked at it more on a present value over the life of the swap what it has done, but it's not in material to net investment income."
},
{
"speaker": "Eric Kirsch",
"text": "Yes, and I would further say there is a pickup in income from our floating rate book this year. But when we talk about the forward curves, as an example, LIBOR started the year at 10 or 17 basis points one and three month LIBOR. It's currently three months LIBOR is like 120. So we get a pickup this year. Now, the forward curves and we went out, if you look at the forward curves for years three, four and five LIBOR is projected to be 2.5% that debt the fed goes through with all these aggressive rate hikes. So there is a positive tailwind to our income from the floating rate book this year, but we'd have to come back to size it."
},
{
"speaker": "Suneet Kamath",
"text": "All right. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from John Barnidge of Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Thank you. What percent of sales in the first quarter was consumer markets in buy-to-build products? We've with 10% last year expected to grow this year? Thanks."
},
{
"speaker": "Frederick Crawford",
"text": "So, no. Go ahead, Teresa."
},
{
"speaker": "Teresa White",
"text": "I'll Virgil response to that."
},
{
"speaker": "Virgil Miller",
"text": "Okay, thank you, Teresa. So 6% to 7% in between 6% and 7% for Q1. Remember, there's seasonality on our numbers. So when you've talking about 10%, our numbers grow, especially during the fourth quarter, which give us a high annual average. So we're anticipating this year that when you combine all the buy-to-build, we'll end up between 10% and 50% again this year. Again, first quarter though solid growth with the 6% to 7% it was more than we had anticipated. So we're starting to gain traction out in the market with those products now."
},
{
"speaker": "John Barnidge",
"text": "Great. That might follow-up. [Indiscernible] in the U.S. capture on FAB. What it ended up coming in higher than anticipated? Thanks."
},
{
"speaker": "Frederick Crawford",
"text": "Would you ask that question again?"
},
{
"speaker": "John Barnidge",
"text": "Sure, how much of the higher lapse station rates in the U.S. were captured into the guidance reflected at the FAB in November? Or did lapse rates end up coming in higher than anticipated?"
},
{
"speaker": "Brad Dyslin",
"text": "Yes, we did see a higher lapse station that we plan for -- at FAB of last year. So there's obviously an impact going on here running through our financials and across the benefit ratio expense ratio, and also the bottom-line through lower and premium as well. But the net impact on all of those three combined is a favorable $5 million in the quarter. So that's the way I would think about it. Overall obviously, it lowers future net earned premiums. And because we're sitting with slightly lower policies enforced than what we otherwise would have expected. So from an embedded value standpoint, it's clearly a negative. That being said, our sales were off to a strong start this year, and that builds an embedded value for us for the future as well. So there's a number of puts and takes, but in the quarter, there was a bottom-line $5 million positive impact from higher than expected lapses."
},
{
"speaker": "Daniel Amos",
"text": "Hey, let's come back to the swap, because we pulled up some of the numbers. And so we can answer that question more directly. So Eric, why don't you kind of give us a little bit an idea."
},
{
"speaker": "Eric Kirsch",
"text": "Yes, our current projection for the year, and this assumes the forward curve. So this year, materializes about an extra $39 million of income from our floating rate bucks versus our plan."
},
{
"speaker": "Operator",
"text": "The next question comes from Erik Bass of Autonomous Research. Please go ahead."
},
{
"speaker": "Erik Bass",
"text": "Hi, thank you. I was hoping maybe you could talk about kind of the other moving piece in NII, which would be that hedge costs. And so could you talk about the outlook for hedge costs and the Aflac Japan business? And as these move higher are you still able to lock and generate the same level of spread on U.S. dollar assets? Are you making any changes to your investment approach?"
},
{
"speaker": "Frederick Crawford",
"text": "Yes, thank you very much for the question. First talking about this year, as you'll recollect for a number of years. Now, our strategy has been at the beginning of the year to lock in our hedge costs. For the majority of the buck, there are moving parts. So that was very good for us this year, because our hedge costs were locked in on the forwards at about 89 basis points. And on the FX options we do at around 44 basis points. And altogether, I think about $110 million so estimated hedge costs for this year. Obviously, hedge costs are higher with short-term rates going up significantly. So just to give you a flavor of the differential and this really wouldn't impact us till 2023. Forward costs today for 12 months forwards around 256 basis points versus what we're paying this year of 89. So a significant increase and we expect that from what's happening with interest rates. And similarly, options would probably cost us around two times more than what we paid, given increased FX volatility and overall levels at the end. So when we get to next year, if rates stay where they are, hedge costs would be significantly up probably by about 125% or so on the book. Now having said that, our book does change over time. So I can assure you the balances in all of our asset classes or even when we revisit our hedge ratio, that may change as well. But that's just looking at it as a static book. The other thing to remind you of though, as well, on our forward book, which is much reduced than what it was, those forwards are applied against our floating rate assets. So those floating rate assets as we just discussed with question, their income is going up substantially. So the income, while not 100% correlation will go up pretty close to the amount of the hedge costs going up. So the net should stay pretty even with the one variable being the level of spreads on the assets and those spreads have generally been going up. So on a net basis, at least on the forward book, it should be pretty neutral, but the actual line item of hedge costs would definitely go up."
},
{
"speaker": "Daniel Amos",
"text": "But I want to make a comment is, I've always said I like evolution, not revolution. And for you that have been following our stock for 10 years or more, I just want to tell you, what a sophisticated model we have today and how it's evolved, not only from Eric and Brad and the team and what they've done, but also our board and specifically, Tom is Chairman of what they've done from an investment standpoint. It is very gratifying to hear as we get into such volatility and change in the last year or so, even in the last three months with the Yen. And yet we have prepared for and to hear these answers, I just want all of you to know what hard work and dedication they've done through Fred and Max. And what's gone on. So, Max, I think you were going to make a comment."
},
{
"speaker": "Max Brodén",
"text": "Yes, I wanted to add one more comment. So Eric, when you think about these four words in our flag, Japan, so that's about $4.5 billion of notional at the end of the quarter. At the holding company, we also have $5 billion of notional going the other way. So even in a scenario where you would have dislocation in the marketplace that could significantly increase the hedge costs perhaps like Japan, you would have an associated increased hedge income as the holding company. So from an enterprise standpoint, we're somewhat reduce the exposure to volatility and hedge costs as well."
},
{
"speaker": "Erik Bass",
"text": "Got it. Thank you, and I guess putting it all together. So you talked about the benefits to NII this year kind of the floating rates being higher? It sounds like the hedge costs are locked in. So maybe those, is that a net benefit you'd expect this year? And then the comment on 2023 based on what you've locked in for the floating rates expectation for hedging costs, and then what happens in corporate that kind of putting it all together is sort of a neutral impact."
},
{
"speaker": "Max Brodén",
"text": "I think putting it all together, it's a positive impact, yes. We realize we got a $30 billion, $30 billion, $31 billion U.S. dollar portfolio, and I think we have $6 billion of it hedged. So you got $10 billion of floaters. We've locked in 70% of it. I mean, it's a positive catalyst. There's no question."
},
{
"speaker": "Erik Bass",
"text": "Got it. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar of JPMorgan Securities. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hi, good morning. I had a question following up on, I think Dan, your comment on the environment sort of returning to normal, as you think about sort of the whole sales process in the U.S., how close to normal is it in terms or are there still ongoing headwinds, whether it's people working from home, or businesses less interested in letting agents come in and pitching to their employees or schedule meetings? So how do you think about like return to normal pre-pandemic versus ongoing headwinds that might preclude sales from getting to pre-pandemic levels in over the next year or so?"
},
{
"speaker": "Daniel Amos",
"text": "Well, I'm going to let Virgil but let me just say, just take our company, for example. Today, we really have our first officer meeting, after for lunch today. And we've got about 150 people coming and that is normally, that includes our Directors, and our Directors. And that's about a little lower than what we normally have that pre-pandemic, maybe we would have had up to 200. So it gives you an idea of how things are getting back to normal. They're not quite there. But as I said, I look forward to happen in the second half, I look for everything to kind of move back, but it will be a new normal. I mean, there will be a certain amount of people that will work from home. But things are moving back. So let me let Virgil because I'm real pleased of what Teresa and Virgil had done in terms of having an impact on sales. And I've been very pleased with persistency until this issue that just came up in the first quarter. And I know they'll address it and fix that problem too as we go forward. So go ahead, Virgil, you can start and if Teresa wants to make comments, she can do whatever she wants. She's the boss."
},
{
"speaker": "Virgil Miller",
"text": "Thank you so much, Dan. Yes, so do a few anecdotal comments. I'm going to support it with some numbers. So one of our key focuses was to return to normal by driving out culture. So as Dan mentioned, we got back last year to a lot of normal things we do. That includes like having sales meetings, we gather our top producing sales agents, our veterans out there to make sure that they were informed along strategies and kept that momentum going. They were very, very pleased to bring everybody back together, as well as our brokers, working with our broker sales professional teams, which is when our company is out in the market and bringing in those broker partners, we still had our events where we sat around and taught stress to them, make sure we're collecting their feedback and make sure we've got the right model to support the service levels they need going forward. Having said that, you also mentioned about how things have changed about face-to-face, and being able to support virtually. So I will tell you this, that we're able to provide the level of service. However, whether it's face-to-face, whether it's virtual, whether it is self-enrollment, I'll share a couple of numbers with you to support that, one back looking at pre-COVID 2019, 95% of our sales were face-to-face. As you saw the height of the pandemic in 2020, our face-to-face sales were at 80%, the rest of them were doing virtual enrollment, a hybrid type model, or self-service. And now as I look at Q1, 85% of our sales are back to being face-to-face. So to sum that up, of course, we were more face-to-face, pre-pandemic, we saw a tremendous drop in that and we were able to accommodate still getting our product sold through other means. And now you can see that number of face-to-face going back up. So I hope that helps. But overall, I can tell you, there's a lot of momentum in the sales force right now, I expect more the same. The hit when we spoke about earlier that Fred mentioned was around recruiting. Again, recruiting was important, but we did adjust our model to reengage our veterans, our average week of reducers are up, our productivity is up across all lines and our conversions, we saw 11% increase in converting veterans who have been here more than five years in Q1. So as you can see the confidence in the voice here, feeling very good about we're going to see the remainder of the year."
},
{
"speaker": "Teresa White",
"text": "Yes, and that I've just mentioned, we're just well positioned to address many of the headwinds that we were seeing in the environment, specifically, due to our financial strength, our distribution model, and our digital solutions. And so you hear the energy in Virgil's comments. And that's because there is a tremendous amount of momentum in our sales force today. And so we're going to ride that momentum. And we'll continue to address any issues that we see come up in the market."
},
{
"speaker": "Jimmy Bhullar",
"text": "And then just in terms of progression of sales for the year, the last couple of years, obviously, have been off because of COVID. But prior to that, typically your second quarter used to be higher in sales than the first quarter and obviously fourth quarter, you got a lot of local sales, should we assume a similar pattern this year as well? Or is there something else that would affect the results?"
},
{
"speaker": "Daniel Amos",
"text": "Yes, so I'll say that the first quarter is certainly higher than we anticipated, I think and more higher than most anticipated for us. So we're very pleased with that, we certainly will see the same seasonality definitely in the third and fourth quarters, where you'll see the majority of our production. Again, we're looking to maintain this consistency in the second quarter. But I will tell you that the momentum, and in a lot of has to do with two the contributing factors we mentioned earlier that have come from our buy-to-build, with our premier life and absence products and disability, those products really is the selling season right now early in the year. And those sales will come through in Q4, so the growth and the seasonality of the highest impact, you'll see is definitely going to be in Q4. We'll look to maintain this consistent momentum from Q1 going into Q2. But again, I expect more on the third and fourth quarters."
},
{
"speaker": "Jimmy Bhullar",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Alex Scott of Goldman Sachs. Please go ahead."
},
{
"speaker": "Alex Scott",
"text": "Hey, good morning. First one I had is on Capital deployment. When I think about what you're saying on the economic hedge and how it's not just the GAAP EPS impact we got to think about here. It's also this economic hedge. My understanding of that hedge is with the Yen weakening, it would actually make your capital in Japan stronger. And just in general, I think the capital of the overall business stronger. And if that's the case, I think it'll give you maybe GAAP EPS is short-term hurt, but then you have like more capital deployment opportunities as a result of that. Am I understanding that correct? And if I am what are your priorities for deploying that capital if the Yen remains weaker, and you have that flexibility?"
},
{
"speaker": "Daniel Amos",
"text": "Yes, Alex, I think that the way you sort of described it is a reasonable description of how our long-term hedging model actually works. Capital in Japan obviously is stronger with a weakening Yen and you know SMR sensitivities, you can go back to our fab disclosures, and we give those sensitivities there. So you can sort of calculate what the impact is on the capital position in Japan. And also, if you travel over to the holding company in this quarter alone because we issue debt denominated in Yen, you saw our leverage dropped 60 basis points simply because of FX move in the first quarter. So that ultimately leads to a somewhat higher debt capacity over time, and then you should also expect that over time as the $5 billion of forwards as they settle, they convert into cash. At the end of the first quarter, we had $3.6 billion of unencumbered cash at the holding company. And I use the term unencumbered, and that's actually quite important in this context, because it excludes any collateral receipt that we have. And obviously, that will add to that pile of cash, if the FX rate continues to be at this current level, we have forwards that the settlements will spread out, there's no specific sort of tower as generally settle, we got some forward settle every month. So over time, this hedging program will then convert into cash. So short-term, you're going to see our EPS obviously get hit by it from the translation impact. But over time, it leads to deployment opportunities, by lower leverage, FX words converted into cash. And then also long-term, you have a higher capital position in Japan, associated with the dollar portfolio that we have in Japan that strengthens the SMR in a scenario, weakening Yen, all these sort of balances out to some extent over the long-term. As it relates to deployment of additional capital, it follows the same criteria that we have for all deployments of capital that we deploy, where we see a good risk return based on an IRR basis."
},
{
"speaker": "Alex Scott",
"text": "Got it. And maybe a little more of a housekeeping question, in Corporate, yes how should we expect that to trend from here? I guess it's just a lot of moving parts, because you have this offsetting derivatives that are sort of housed in corporate I believe. So I mean, could you help us think through where the run rate of earnings for that segment would be or even how to maybe we can do that, just how to think about net investment income in corporate?"
},
{
"speaker": "Daniel Amos",
"text": "Yes, so first of all the derivatives housed at the corporate level, the mark to marketing pack does not run through the GAAP EPS number, but the amortize hedge income does. And that's a fairly stable number. So if you look at the results for corporate this quarter, we're running a little bit high on expenses in the quarter, and a little bit low on NII in the quarter, the NII was somewhat depressed by our tax credit investments, that run as a negative -- that run as a negative through the NII line. But then obviously, you have a favorable offsetting impact on the tax credit line. As discussed earlier, we do have most of the assets at the holding company are floating rate in nature. So obviously, that means that as the short-end of the yield curve now has increased and come up, you're going to see a little bit of a pickup in NII over time. So if you look at the results of this quarter, there's some puts and takes and a lot of moving parts, but generally, I think it's a decent run rate for the current."
},
{
"speaker": "Alex Scott",
"text": "Got it, thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Tom Gallagher of Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Good morning. First question, Fred, just to come back to the underlying benefit ratio in Japan, the 69.1%. I think excluding the extraordinary IBNR releases. That's a little bit above the range that you've guided to, I think you explain why it happened, just elevated medical COVID claims, is it fair to expect that this is going to drop back down to within the range for the balance of the year as COVID cases go down?"
},
{
"speaker": "Frederick Crawford",
"text": "Yes, let me actually give you some perspective, if you don't mind, just over the last few quarters on incurred claims related to COVID. Because it'll really illustrate what's going on with this most recent Omicron. If you go back to the first quarter of last year, our incurred claims were around ¥800 million in the second quarter and picked up to about ¥1.3 billion, obviously, very small numbers. In the third quarter, it picked up to ¥2.3 billion, and that was actually the Delta peak. That was right when that Delta peak took place, and we had claims coming in, then they dropped down in the fourth quarter to about ¥100 million, so almost non-existent. And then in the first quarter, ¥8.3 billion. And so what I think if you're living and working in the U.S., and if you're following largely U.S. companies and economy, I think many don't realize just what a peak of Omicron we saw here in Japan, you're talking about case levels, that were running at around 100,000 a week, two, three times at least, the level of peak that what you saw during the Delta. Now fortunately, it's a very mild version of Omicron. And fortunately, vaccination rates, particularly among the elderly, in Japan, are very high. And so as a result, you haven't really seen hospitalization, nor have you seen deaths pick up in Japan. But don't think for a moment that that's because things calmed down, it's quite the opposite. This is the most severe peak of infection rates, particularly in that February time period that Japan has seen throughout the entirety of the COVID environment. As a result, that's why you're seeing some of the face-to-face dynamics. And what Dan mentioned about on again, off again, states of emergency going on. Now, the reason I pointed out the nature of our claims was that this deemed hospitalization issue, essentially the life insurance industry at Japan got together and agreed with the government, the COVID-19 and versions, variants of COVID-19 as an infectious disease. And when you do that, you're allowed to cover if you will, you're allowed as a doctor to diagnose and allow for at home treatment, and cover the claims related to at home. The reason for that is Japan does not want infectious disease to cause hospital capacity issues. And so they allow more degrees of freedom as to where that care takes place. So we're seeing claims go up not because of the severity, but because of the sheer volume or frequency of cases and at home treatment, we would expect that to calm down over time, because we've seen cases calm down, but there's a lagging effect. Right now in April, in May, for example, we're seeing claims coming in that are likely related to two, three months ago, related peak levels. So we think that's probably going to continue, I would say into the second quarter, it's early, we don't really know at the end of the day, what it may mean for the benefit ratio in the second quarter. But we should see COVID claims continue. But then calm down as the year goes on. And again, remember, while this is all going on, and you have lower activity levels, lower face-to-face, you're seeing other types of medical claims not come in. And so you don't necessarily see your benefit ratio moving the wrong direction. It's just the mix of claims have shifted during this period of time. So it's quite interesting. And we've been busting down this data and looking at it very carefully. But you should expect claims and COVID to continue, I would say into the second quarter given the lagging effect, but not necessarily be dramatic upward pressure on benefit ratio, I would not anticipate that."
},
{
"speaker": "Daniel Amos",
"text": "And Tom, just to give you some more color on it, if you take the incurred impact from COVID in the quarter on our normalized benefit ratio was a little bit north of 100 basis points. So if you take that and you isolate that component, that will take your normalized benefit ratio in the first quarter smack in the middle of our range of 67% to 69%."
},
{
"speaker": "Tom Gallagher",
"text": "Got you, that's helpful guys. Thanks for that color. My follow-up is with the recruiting numbers down so much in the U.S. on both agents and brokers, and knowing there's a lag in terms of recruits converting into sales but then taking that together with your comment about improvement in productivity gains based on some of those initiatives. What do you think that all if you add all that up does to sales, if you look out, I don't know two, three quarters from now, do you think you can maintain the strong momentum you're seeing in the U.S., it sounded like from what Virgil said, he thought so. But I'm just curious if you think just given the severity of the drop in recruiting, whether you think that's going to start to impact your sales?"
},
{
"speaker": "Daniel Amos",
"text": "Well, if they don't, they won't make bonuses. So it's going certainly going to impact them. But Virgil, you want to comment?"
},
{
"speaker": "Virgil Miller",
"text": "Yes, thank you, Dan. So if you look at the numbers, we still recruited over 10,000 crew agents last year, and over 5,000, close to 6,000 of small brokers that we do business with. And when I talked about the focus where the focus was converting on them, so think about it coming out of Q4 last year, which is our busiest time of the year, we put a lot of focus on getting those converted. And I'll tell you 70%, we had a 70% increase in broker conversions in Q1. So that strategy is working. Now, having said that, that's not to say that recruiting is important, you know, it's a formula, you can add it up, you can look at productivity, you can look at conversion rates into and tell you, how many people we need to hit our numbers. Right now we're solid, because we are seeing again, when those veterans come back and reengage the veterans produce at a higher rate. So I've ran these numbers over and over, we are optimistic about how we're going to look, not to say that we're not going to still recruit. So I can tell you right now, we've got some additional efforts going on in 2Q and I look at it on a weekly basis. If I look, week over week, back in March, seeing progress in the final few weeks of March and that progress is translating over into April."
},
{
"speaker": "Daniel Amos",
"text": "And one thing I would add and Virgil can add color to it, but one column that you may be looking at in the recruiting is the recruited agents through brokers. And remember to some of our comments at year-end in this past quarter, we're focusing on driving sales now through small business brokers as well, which has not been historically a focused effort of our company. And as a result, you saw the recruiting level of broker agents go up dramatically in 2021, averaging over upwards of 1,200 to 1,500. Now, what does that mean, when you recruit a small business broker, what it means is you've appointed them, and they've appointed you to be eligible to sell product through that broker, it doesn't mean you're selling product through that broker. And so one of the things that Virgil is talking about when he uses the term conversion is that we're now working on those large amount of brokers that were signed up and appointed last year, we're now focusing on converting them into actually generating sales through their brokerage platform. So that's a big piece, and there's a lot of runway yet to go on that."
},
{
"speaker": "Operator",
"text": "The next question comes from Ryan Krueger of KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "Thanks, good morning. I was just curious if you could give it, I know you can give it back quantification, but if you could give any qualitative commentary on how much you think Japan Post could contribute as they begin more actively selling cancer products again, maybe one metric, you could help us think about it, I think I believe Japan Post was about a third of your cancer production, prior to the mis-selling issue. If you could give any thoughts on what percentage of your cancer sales you think they could build back up to?"
},
{
"speaker": "Daniel Amos",
"text": "Well, we can't go into any detail regarding Japan Post. They've always been, you know since inception of Japan Post, they have asked us to never go into detail or go into detail. Basically they stopped last year, and they have regained a position but it's still very low. And all I can tell you is they have committed to us that they are dedicated to seeing a return to stronger production. And I'm expecting that that as you all know there are large shareholders, I feel like that's important. And the message that I've been saying is, those two tasks gather with them and so we'll have to wait and see. But I'm encouraged about the production, but I can't if this give you any more detail other than to say, we have a wonderful relationship. They know what we want, they want to help us. It's just the timing and how to do it. But there's no problem that I can tell you, other than just getting it started again. There's absolutely nothing. They're happy with us. We're happy with them and but we want to see the production now."
},
{
"speaker": "Ryan Krueger",
"text": "Okay, understood. Appreciate the comments."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you, Andrea. And I want to thank all of you for joining our call this morning. If you have any follow-up questions, I'll be happy to take them, please contact me via email or the phone and look forward to speaking to you all soon. Till then, take care."
},
{
"speaker": "Operator",
"text": "The conference is now concluded. Thank you for attending today's presentation. And you may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 4 | 2,023 | 2024-02-01 08:00:00 | Operator: Good day, and welcome to the Aflac Incorporated Fourth Quarter Year End 2023 Earnings and 2024 Outlook Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations for Aflac Incorporated. Please go ahead.
David Young: Good morning and welcome. This morning, we will be hearing remarks about earnings for 2023 as well as our outlook for 2024. First, Dan Amos, Chairman, CEO, and President of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then Max Broden, Executive Vice-President and CFO of Aflac Incorporated, will provide an update on our financial results and current capital and liquidity, as well as our outlook for 2024. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2024. We also posted, under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans. For Q&A, we are also joined by Virgil Miller, President of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non- U.S. GAAP measures. I'll now turn the call over to Dan. Dan?
Dan Amos: Thank you, David, and good morning, everyone. We're glad you are joining us. Reflecting on 2023, it was a very good year. Our management team, employees, sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for our policyholders when they need us most, just as we promised. Aflac Incorporated delivered a very strong earnings for the year. Net earnings per diluted share for 2023 were $7.78, adjusted earnings per diluted share was $6.23 were the best in the company's history despite the weakening yen and the impact of the reinsurance retrocession late in the fourth quarter. Beginning with Japan, Aflac Japan generated solid overall financial results in 2023. For the year, total adjusted revenues declined 3.6% to nearly ¥1.5 trillion, largely reflecting the impacts of reinsurance and paid-up policies. But this was largely offset by a 7.3% decrease in total benefits and adjusted expenses. Pre-tax adjusted earnings increased 6% to nearly ¥457 billion for the year. As a result, Aflac Japan produced an extremely strong profit margin of 30.5%. I am pleased with Aflac Japan's 10.9% year-over-year increase in sales, which was largely driven 26% increase in cancer insurance sales with very significant contributions from Japan Post Company and Japan Post Insurance as well as other alliances, Dai-ichi Life and Daido Life. As you may recall, Aflac Japan aims to have a product lined up to meet customers' needs during any life stage. Our latest medical insurance is designed to appeal to younger policyholders' basic needs and older and existing policyholders who want additional or updated coverage. While our medical insurance sales were off for the year, they increased 6.5% year-over-year in the fourth quarter following the introduction of our new medical insurance product in mid-September. Similarly, Aflac Japan refreshed WAYS and Child Endowment in 2022 as a way of acquiring younger customers and also introducing opportunities to sell our core third-sector products to them. Since the launch of our refreshed WAYS product, approximately 80% of our sales are to younger customers below the age of 50. The level of concurrent third-sector sales remains above 50%. Given Japan's demographics, our product strategy is to fit the needs of the customers at any stage in life. Acquiring younger customers is critical to our success along with our intense focus on being where the customer wants to buy insurance. We have a broad network of distribution channels, including agencies, alliance partners, and banks. This reach continually optimizes opportunities to help provide financial protection to the Japanese consumers. We are working hard to support each channel. While the market presents challenges, we expect to reach ¥67 billion to ¥73 billion of sales in Japan by the end of 2026. Turning to the U.S. We also generated strong overall financial results in 2023. Total adjusted revenues increased 2.1% to $6.6 billion. The decline in total net benefits and claims was slightly offset by the increase in adjusted expenses. Pretax adjusted earnings increased 10.4% to an all-time high of $1.5 billion for the year. As a result, Aflac U.S. produced an extremely strong profit margin of 22.7%. Aflac U.S. sales increased 5% in 2023, which was at the lower end of our expectations. As you know, we've been focused on increasing persistence to grow profitable earned premiums. In addition, we continually evaluate new business to ensure that it is profitable. During the fourth quarter, we made some tactical decisions to avoid sales opportunities to certain less profitable larger accounts like those of high turnover. At the same time, we focused on updating our products to ensure that our policyholders continue to realize the value of -- our products provide. As part of our efforts, we introduced our new cancer protection insurance policy in the second quarter of 2023. Since that time, our cancer insurance has increased nearly 25%. We know that when people experience the value of our products, it increases persistency, which benefits our policyholders and lowers our expenses. I believe that the need for the products and the solutions we offer are as strong or stronger than ever before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers, particularly given that our products are sold, not bought. As we communicate the value of our products, we know that the strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face, even when they have major medical insurance. Knowing our products help lift people up when they need us most is something that makes all of us at Aflac very proud, and propels us to do more and achieve more. We continue to reinforce our leading position and build on that momentum. We are confident that the successful execution of our strategy will lead to sales of at least $1.8 billion in the U.S. by the end of 2025. I'd like to end on addressing our ongoing commitment to prudent liquidity and capital management. We have taken proactive steps in recent years to defend our cash flow and deployable capital against the weakening yen. At the end of 2023, we had nearly $2.8 billion of liquidity at the holding company, which means more than $1 billion over the minimum balance. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders while being responsive to the needs of our shareholders. We remain committed to maintaining strong capital ratios on behalf of our policyholders and balance this financial strength with the tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both the dividend track record and the tactical share repurchase. 2023 marked the 41st consecutive year of dividend increases. We treasure our track record of dividend growth and remain committed to extending it. Last quarter, the Board put us on a path to continue this record when it increased in the first quarter of 2024 dividend 19% to $0.50. We also remain in the market, repurchasing our shares through 2023 at a historically high level of $700 million per quarter. We have remained tactical in our approach to share repurchase, deploying $2.8 billion in capital to repurchase nearly 39 million of our shares in 2023. Combined with a dividend, this means we delivered over $3.8 billion back to the shareholders in 2023, while also investing in the growth of our business. At the same time, we have maintained our position among companies with the highest return on capital and the lowest cost of capital in the industry. Overall, I think we can say that it's been another strong year. I'll now turn the program over to Max, who will cover more details on the financial results for this year and provide an outlook for the key drivers of earnings in 2024. Max?
Max Broden: Thank you, Dan. This morning, I'm going to address our 2023 results before providing an outlook for certain drivers for 2024 that were included in the slides with our earnings materials filed yesterday with our 8-K. Aflac Incorporated delivered very strong earnings for the year as adjusted earnings per diluted share rose 9.9% to $6.23, the highest amount in our company's history. This result included a $0.19 negative impact from foreign currency and variable investment income was $0.14 per share below our long-term return expectations. In addition, our annual results included remeasurement gains of $0.51 per share, a $0.20 per share non-economic loss in the fourth quarter under U.S. GAAP related to the innovation of our reinsurance treaty with a third-party ceded back to the company, and a $0.04 per share write-off of certain capitalized software development costs in the third quarter. Our liquidity remained strong with unencumbered holding company liquidity being $1 billion above our minimum balance. Likewise, our capital position remained strong and we ended the year with an SMR above 1,100% in Japan. At the end of 2023, we estimated our internally modeled ESR to be above 250% and we expect the FSA to provide final guidance on the ESR later in 2024. We also estimated our combined RBC in the U.S. to be greater than 650% at the end of 2023. These are strong capital ratios which we actively monitor, stress, and manage to withstand credit cycles as well as external shocks. In addition, impairments have remained within our expectations and with limited impact to both earnings and capital. Our Adjusted leverage remains below our leverage corridor of 20% to 25% at 19.7%. And this will fluctuate with the yen-dollar rate, since we hold approximately two-thirds of our debt denominated in yen as part of our enterprise hedging program to protect the economic value of Aflac Japan in U.S. dollar terms. In 2023, we repurchased $2.8 billion of our own stock and paid dividends of $245 million in Q4, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Adjusted book value per share increased 10.1% and the adjusted ROE was 13.8%, an acceptable spread to our cost of capital. I'm also pleased with our continued development of our Bermuda reinsurance platform, which resulted in three transactions during 2023. We will continue to utilize this platform to better manage risk and improve capital efficiency across the enterprise, and we expect these transactions to be part of a series that will improve our run-rate adjusted ROE by 100 to 200 basis points over time, all things being equal. Overall, we're very pleased with these results, especially when normalizing for one-time items. Turning to Aflac Japan. Its total benefit ratio for the year was 66%, down 140 basis points from the prior year. Throughout the year, we continue to experience favorable actual to expected on our well-priced large and mature in-force block. We estimate the impact from remeasurement gains to be 130 basis points favorable to the benefit ratio in 2023. Long-term experience trends, as it relates to the treatment of cancer and hospitalization, have continued to lead to favorable underwriting experience. Persistency remained solid with a rate of 93.4%, and was down 70 basis points year-over-year, reflecting elevated lapse as customers updated their cancer and medical coverage with our latest cancer and medical products. Our expense ratio in Japan was 19.8%, down 50 basis points year-over-year, driven primarily by good expense control and to some extent, by expense allowance from reinsurance transactions. For the full year, total adjusted revenues in yen were down 3.6% to ¥1.5 trillion. Net earned premiums declined 5.9% to ¥1.1 trillion, reflecting the impacts of reinsurance transactions, paid-up policies, and deferred profit liability. When excluding these three factors, net earned premiums declined an estimated 1.7%. On this same basis, we would expect net earned premiums in 2024 to decline 2.5% to 1.5% when taking into consideration the impact of reinsurance, paid-up policies, and the deferred profit liability reclassification. Adjusted net investment income increased by 4% to ¥365.6 billion as we experienced higher yields on our U.S. dollar-denominated investments and related favorable FX. This was partially offset by a transfer of assets due to reinsurance. Pretax earnings were ¥456.9 billion or 6% higher than a year ago. For 2024, we would expect our well-priced in-force to show greater stability in terms of the benefit ratio excluding unlockings and to be in the range of 66% to 68%. This is a function of both favorable morbidity experience and improved mix of business. With the current trend in revenues, we are actively reducing our expenses. We are taking both tactical efforts as well as more long-term transformational initiatives and we would expect our expense ratio to be in the range of 19% to 21% going forward. The pre-tax profit margin for Japan for 2023 was 30.5%, up 280 basis points year-over-year. A very good result. With approximately 30% of the Japan portfolio in U.S. dollar assets, the strength of the U.S. dollar versus the yen has increased the proportion of net investment income as a component of our pretax profit. With a greater contribution to profitability from net investment income in yen terms, our pre-tax margin is naturally pushed up. In addition, having transitioned to option-based currency hedging, we expect quarterly hedge costs to remain roughly in line with what we experienced in the fourth quarter of 2023. In combination with a lower expected benefit ratio, we expect a pretax profit margin of 29% to 31% in 2024. Turning to Aflac U.S. Our 2023 total benefit ratio came in well below expectations at 42.8%. We estimate that the remeasurement gains impacted the benefit ratio by 500 basis points in 2023. Claims utilization has stabilized, but as we incorporate more recent experience into our reserve models, we unlocked assumptions and released reserves during the year. Persistency increased 130 basis points year-over-year to 78.6%. This is a function of poor persistency quarters falling out of the metric and stabilization across numerous product categories. Our expense ratio in the U.S. was 40.6%, up 90 basis points year-over-year, primarily driven by our growth initiatives and higher DAC amortization. We would expect the U.S. expense ratio to decrease over time as these businesses grow to scale and improve their profitability. For the full year, total adjusted revenues were up 2.1% to $6.6 billion. Net earned premiums increased 1.9% to $5.7 billion in 2023. Adjusted net investment income increased 8.6% to $820 million, mainly driven by higher yields on both our fixed and floating-rate portfolios. Pretax earnings were $1.5 billion or 10.4% higher than a year ago, driven primarily by the lower benefit ratio which was largely impacted by the third quarter unlock and only partially offset by the higher expense ratio. For 2024, we would expect net earned premium growth to be in the range of 3% to 5%. Profitability for the U.S. segment was solid with a pretax margin of 22.7%, driven primarily by the remeasurement gains from unlocking. Looking forward at 2024, as we grow products with a higher benefit ratio and lower expense ratio, like group life and disability, and network dental and vision, you should start to see those changes reflected in our ratios over time. In 2024, we would expect to operate with a benefit ratio in the range of 45% to 47% and an expense ratio of 38% to 40%. This translates into an expected profit margin of 19% to 21%. In our corporate segment, we recorded a pre-tax loss of $425 million, compared to a loss of $218 million a year ago, primarily due to higher investment tax credits and the impact of the innovation of our reinsurance treaty with a third party. Adjusted net investment income was $54 million lower than last year due to an increased volume of tax credit investments. Higher rates began to earn in and amortized hedge income increased. These tax credit investments impacted the corporate net investment income line for U.S. GAAP purposes negatively by $343 million with an associated credit to the tax line. The net impact to our bottom line was a positive $39 million. To date, these investments are performing well and in line with expectations. The impact from the reinsurance innovation was a one-time negative of $151 million. Overall, we're very pleased with our 2023 results and our outlook for 2024. I'll now turn the call back to David, so we can begin Q&A. David?
David Young: Thank you, Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. Then you're welcome to rejoin the queue to ask any additional questions. Betsy, we will now take the first question.
Operator: [Operator Instructions] The first question today comes from Tom Gallagher with Evercore ISI. Please go ahead.
Tom Gallagher: Good morning. One numbers question and then one on strategy. Just the numbers question. I guess for the last several years, you've had better portfolio yield in Japan being driven by the pivot into USD portfolio. If I look at the last couple of quarters, that seems to be flattening out. So your portfolio yield has been more stable. Can you talk about what's driving that and what it means for 2024 NII in Japan? And then, Dan, strategy question is, just given the growth headwinds in Japan, would you guys consider anything more meaningful on M&A strategically to help facilitate growth? I know you haven't really done this in the past, but there does seem to be an element of kind of unavoidable demographic headwind in Japan that you're fighting against here. So curious what you think on strategy there. Thanks.
Max Broden: Thank you, Tom. I'll kick it off and then hand over to Brad and then to Dan for the strategy question. As it relates to our investment portfolio and net investment income, you're correct in noticing that our net investment income has increased over the last couple of years. A portion of that is driven by our increased allocation to U.S. dollar assets. And I do want to remind you that, that is primarily driven by the view that we have of hedging our economic exposure to the yen as it relates to the overall exposure that we have as a company to the yen throughout like Japan. We have now reached what we view to be more of a steady state as it relates to our total U.S. dollar allocation. So from that level, I would expect a stabilization in terms of our total allocation between yen and dollars within the investment portfolio. But as it relates to more of an outlook into 2024 for our NII, I'll turn to Brad, and he can give you some more color.
BradDyslin: Yes. The only thing I would add is just to remind you that our new money yield is both a blend of lower yen rates as well as the higher U.S. dollar rates. Most of our deployment is planned for U.S. dollar assets and that is to maintain the balances, as Max just described. But we do still like yen spread products when we can locate acceptable outlets. When that happens, then we will put them in the portfolio, and that does result in pulling down the overall reported new money yield just because of the simple math of lower yen rates.
DanAmos: And Tom, in regards to strategy, that's been an issue we've had for several years. We feel like that one of the things we are addressing is cancer or medical product suite is by starting them off on an inexpensive savings plan that gets them to participate with us. We also continue to look for new product. We have still not found that third product or third leg that we want to find and we're continuing to try things. But I don't know of anyone right now that I would trade places with in Japan in terms of distribution and product that we have and believe we can continue to grow our business moving forward. Saying that, we have to be realistic that it is an aging population, and it also is a position where it's not the population is declining, but all in all, I still believe it's the best market in the country or in the world because of the persistency and our ability to continue to grow it. And so, I think you're going to see growth for the next several years. We did lower that number to -- from 80 billion just to be cautious, but we're encouraged. Our Japan Post growth and what's gone there continues to do very well, and we've enjoyed our relationship there. It's our existing distribution system that was really hurt, both in the U.S. and Japan, by COVID, but more so in Japan because if you look back at COVID, it really lasted an additional year in Japan. And because our agents are commission-driven, our newer agents, when COVID hit, all of a sudden did not have an opportunity to go out and sell one-on-one. And as we've always said, our products are sold, they're not bought. And so, we go out and make those presentations, and we couldn't do it. And so people that were normally working for us on a commission basis tried to find other jobs that were salary in nature, and that's what we've been fighting, but it is coming back both in the U.S. and Japan, and I'm encouraged by what I'm seeing there.
Operator: The next question comes from Suneet Kamath with Jefferies. Please go ahead.
Suneet Kamath: Thanks. Just a couple on Japan. And the first one, Dan, just gets back to something you're just talking about in terms of the ¥67 billion to ¥73 billion sort of target down from the ¥80 billion. Are you viewing that as sort of just a delay? And that, that ¥80 billion is ultimately achievable, maybe a year beyond your original target? Just -- I wanted to think about it a little bit longer term.
DanAmos: Well, I certainly think it's the potential out there. I don't know what year -- because the COVID, with such an anomaly, what I'd like to do is, is to let our people that are there on the -- Koide or whoever wants to take this particular question can do it. And then I'll follow up if there's any other part you want me to directly address.
Masatoshi Koide: This is Koide Aflac Japan. So let me answer the question. And the reason why we've changed our target from ¥80 billion to ¥67 billion to ¥73 billion was because we knew that it would take a longer time. So we do think that we are able to achieve ¥80 billion if we look beyond 2026 or after.
Suneet Kamath: Got it. Okay. All right. And then I just had another question on, I guess, persistency in Japan. If I just think back to Aflac from years ago, it strikes me that part of the reason the persistency was so strong is because you sold at the work site and there just was very little job mobility in Japan so people just kept the products for a long time. And I guess the question is, as you're shifting now to new distribution channels outside of the work site and to a younger population, which seems to be the objective, should we just expect a natural decline in that persistency over time?
Max Broden: I'll kick it off and I'll let anybody add some commentary to that as well. As we sell to younger customers, that should actually improve the persistency. Because of the age-based pricing that we have in Japan, there's a very strong incentive to hold on to the product for a long time and maybe even for life. So as you sell into a younger population, that tends to reduce your lapse rates and improve your persistency. Suneet, you are correct to -- when you look at the corporate agencies that you are referring to from the past that, that was -- had very strong persistency overall in that channel. And as that has become a smaller piece of our overall inforce, that have structurally reduced our persistency. The other thing I would mention as well is that we have seen an aging of the block. And when you have an aging of the block, that naturally leads to higher lapsation and lower persistency as well. So you hear us talk about that we are trying to reach younger customers, that is partially to sort of fight these sort of long-term trends that we have going on in our in-force block to not only provide coverage and new coverages to the younger population but also to improve the overall persistency of the block. All of this is marginal from year to year, and it's very slow-moving, but it's certainly something that we're watching closely.
DanAmos: Yoshizumi, do you have any comments you'd like to add? Our head of sales in Japan.
Koichiro Yoshizumi: Thank you. This is Yoshizumi. And regarding the persistency that was just asked and answered by Max, and as Max answered, by us focusing on young and middle-aged customers, our persistency is going to be higher, and that is our strategy. And that is actually represented by the medical insurance that was just launched on September 19. And this product is very popular among the young and middle-aged customers whose ages are under 49 -- or 49 and under. In terms of the number of policy count that we sold to these young and middle-aged customers, we actually saw a 46% increase year-on-year from the time that we launched in September to the end of the year last year. And these customers are for our middle and long-term growth of Aflac Japan. And these are the customers who will be our asset and our treasure going forward. And the actual premiums that are being paid by young and middle-aged customers are lower. And we truly believe that by focusing on these younger customers and increasing these young customers would contribute to stable growth of our company. And at the same time, as I mentioned, the persistency rate will be higher, and this is our strategy.
Suneet Kamath: Okay. Thanks for the answers.
DanAmos: I just want to remind you all that the persistency rate is really high. And we can move it up a little bit, move down a little bit, but it is more than we ever dreamed when we first started doing business over there. So we're very pleased with it. So -- but at the same time, we will improve because when you're writing younger people, of course, they'll live longer, and therefore, they'll be more persistent.
Operator: The next question comes from Jimmy Bhullar with JPMorgan. Please go ahead.
Jimmy Bhullar: Good morning. So first, a question on Japan. And if you think really long term, is it even realistic to assume that the business can grow given that the population shrinking, the population is aging as well? And then versus 10, 20 years ago, there are a lot more companies in the product lines that you're in? So if you could just comment on that, like -- and maybe on your -- the reduction in guidance on sales, how much of that has to do with just Japan taking longer to recover from COVID versus some of these demographic headwinds?
DanAmos: Well, my first comment is, you're correct in terms of a competitive environment. But what is in Japan or any other country that isn't competitive. So being competitive is nothing new to us, and something that we are understanding that we have to constantly look for ways to address how we can identify with consumers and show the need for our products even more. Now don't forget, we've seen copays and deductibles over many years. I don't know when another one will take place or what will happen. But as inflation, even though small in Japan, you have to take that into account, too. So remember, our ability to convert and add more premium to existing policyholders always makes a difference and grows our block of business as well, and we especially think that with the younger people. Let me now turn to Japan and let them comment on it.
Masatoshi Koide: Yes. This is Koide, Aflac Japan. And it is true that Japan is being projected as having declining population. But at the same time, with the advancement of longevity in the 100-year life era, the need to prepare for longevity risk is expected to increase steadily. And it's also expected that the aging population could increase the medical cost because as you live long, the probability of suffering from cancer and other diseases will increase. And in Japan, the sustainability of the overall social security system is being discussed. And this would also include medical and nursing care. And this is being questioned and the discussions are underway within the Japanese government to review how the benefits and burden should be balanced. And given these circumstances, there is a way of thinking about helping themselves or self-help and preparing for the future as people become more aware of the situation. And as a result, although the population may decline, we do think that the third sector market will steadily grow going forward as well.
Jimmy Bhullar: Okay. And then on the U.S. business, do you have a better clarity on the tri-agency rule and its potential impact on your sales?
Virgil Miller: Hi. This is Virgil, from the U.S. We have been working with the tri-agency sales to talk about any potential impact we could see to those selling supplemental into the consumers out there. And we're waiting on a ruling. Thus far, they set a date to be on April 2024, you know and I know that a date may move. However, we remain encouraged that our policies and coverages are relevant regardless if that rule does come through. We looked at our indemnity sales from last year. We really didn't see any decline. We remain flat there. And again, regardless, even if there is a rule of not a rule, our coverage is relevant, and we're not predicting any major impact going forward.
Jimmy Bhullar: Thank you.
Operator: The next question comes from Wilma Burdis with Raymond James. Please go ahead.
Wilma Burdis: Hi, good morning. Could you talk a little bit about the outlook for capital generation, and if we should expect anything on an ongoing basis from internal reinsurance opportunities? Thank you.
Max Broden: Thank you, Wilma. If you think about the total capital generation that we've had recently and also going into 2024, I don't see any significant change to our overall capital generation on an organic basis. That remains in the $2.6 billion to $3 billion range. On top of that, we know that we have opportunities that we can, over time, unlock more capital through utilizing our reinsurance platform, and we intend to do so. We can't necessarily predict exactly when that will happen or what amounts that will be, but you've seen us in the recent past be quite active on that front. So I would expect us to do more. But on a pure sort of run rate organic basis, I would have pegged our underlying capital generation at $2.6 billion to $3 billion annually.
Wilma Burdis: Thank you. And could you just talk more about the commercial real estate watch list? It's higher than a lot of the peers, and you guys have taken the keys back on a few properties lately. So if you could go into that and what you're seeing there? Thank you.
Virgil Miller: Sure. I think there's one primary thing related to our watch list relative to our portfolio that makes us different than peers, and that's the fact that the bulk of our exposure is in transitional real estate. Remember, that's a much shorter asset class. It's a much shorter maturity, generally a three-year term with some options to extend out a fourth and fifth year. So because of that, when you have a market downturn and you've got these maturities coming due and the liquidity is as poor as we're seeing in the market today, it naturally creates an elevated watch list and creates an elevated amount of potential foreclosures. Now, we work very closely with our borrowers to address those maturities. We do our best to avoid foreclosure. But if they are not willing to work with us, if they're not willing to reset the loan to reflect current valuations and give us other protections, we are fortunate that we're in a position, we can and will foreclose if we think that's the best route to maximize our recoveries. We are blessed with a strong capital and liquidity position, which prevents us from being a forced seller here. So I think it's a combination of the nature of our portfolio, having shorter maturities relative to our total exposure. And then the fact that we are much more willing to foreclose and able to foreclose, if we think that's the best route.
Wilma Burdis: Thank you.
Operator: The next question comes from Elyse Greenspan with Wells Fargo. Please go ahead.
Elyse Greenspan: Hi, thanks. Good morning. My first question, going back to just Japan sales guidance. Dan, I know you said you guys are being cautious in lowering the outlook there. But how do we think about -- how should we think about going from the ¥60.7 billion of sales in '23 to the new ¥67 billion to ¥73 billion target? Should we think about that being even -- even over the next few years or maybe a bit more back-ended?
DanAmos: Japan? Okay. Well, we, at this particular time, are just evaluating what we think might happen for the next two years. And frankly, we've just tried to be conservative and give us some latitude on what would happen. But we have some very positive things coming out in 2024 that we think will drive sales and are encouraged about it and even some things as we're looking to 2025 that will be coming. Let me make sure that Koide or -- they don't want to make any comments in that regard. Koide?
Koichiro Yoshizumi: Yes. This is Yoshizumi.
DanAmos: Okay, Yoshizumi.
Koichiro Yoshizumi: Yes, thank you. Okay. Let me answer the question. And as Dan mentioned earlier, it is true that COVID has impacted Japan way beyond our expectation. And as a result, the number of solicitors or sales agents have decreased significantly. And even if you were -- even if our agencies are able to hire the sales agents, we were not able to train them. It was not until May last year in Japan that COVID has been reclassified at the same level as with influenza. So we had no choice, but to face really truly difficult situation in sales for a long time. And at the same time, it is also true that it took us quite a bit of time to train those sales agents that have lower skills. But right now, what we are very much focused on is really recruit and train the solicitors or sales agents. Otherwise, we will not be able to train and grow those sales agents that are customer-centric. Aflac sales agents must be those agents that are very welcomed by our customers. What I mean by that is that those sales agents must respond to customers' needs when they solicit policies, but at the same time, when the benefits and claims are paid. And I do believe that it is Aflac's mission to send out these kind of sales agents to the market appropriately. And that is the reason why we have set our sales target relatively conservative. And we currently do have recruiting and development and training plan for our future, as Koide mentioned earlier, beyond maybe ¥80 billion or even more in the future. Thank you.
Max Broden: Elyse, I would think about the sales trajectory as being relatively linear, i.e., not back-end loaded.
Elyse Greenspan: That's helpful. Thanks Max. And then my second question, you guys you pointed out, you obviously have a good amount of buffer at the holdco relative to where you've talked about running. How do you think about, I guess, managing that down? And how should we think about the level of potential buybacks in '24?
Max Broden: So we're obviously operating with a very significant capital levels in all of our subsidiaries at the moment. Over time, I would expect us to operate at slightly lower capital levels in terms of the ratios and where we are today. I would reflect that in Japan, we are now going through a transition from SMR to ESR. So I wouldn't necessarily make any dramatic changes ahead of that. In the U.S., we are looking to, over time, target in an RBC of closer to 400%, and we have active plans towards drawing that down. At the same time, we have strong capital and liquidity at the holding companies. We always think about where is capital serving us the best at that very point in time, at the same time making sure that we have capital available for deployment into dividends, buybacks, et cetera. So overall, I would say that our capital plans remain solid. We've got plenty of capital around, and we try to place it where it makes the best use.
Elyse Greenspan: Thank you.
Operator: Your next question comes from John B. Barnidge from Piper Sandler. Please go ahead.
John Barnidge: Good morning. Thanks for the opportunity. I had a question of - going back to the Japan sales target. I know you put out a press release in December about the Trupanion pet insurance partnership for Japan. Did that pivot remove any sales contribution from the ¥80 billion assumption? And can you talk - thank you.
Dan Amos: No, it did not.
John Barnidge: Okay. Then can you maybe talk about the growth opportunity for that product in the U.S. that was called out in the pivot and commitment to ownership stake? Thank you.
Max Broden: Pet insurance, we think, has a significant opportunity in the U.S. market because of the very low penetration of the product itself. For Aflac, we act as a distributor where these premiums, claims, et cetera, do not hit our income statement. So it's an opportunity to - for our distribution to earn additional commissions, so in that sense, it's very positive to Aflac. We do, obviously, have an alliance and a partnership with Trupanion that is strong through the equity ownership that we have in the company, and we capture significant economics over time through that equity ownership.
John Barnidge: Thanks for the answers. Appreciate it.
Operator: Your next question comes from Joel Hurwitz with Dowling & Partners. Please go ahead.
Joel Hurwitz: Hi. Good morning. First, a question on U.S. expenses. So the outlook looks to be largely in line with prior year. You've talked in the past on bending the expense curve and getting closer to a mid-30% expense ratio. Can you just provide an update on those expectations and when we should start to see a more significant drop in the expense ratio in the U.S.?
Max Broden: So you are starting to see a drop in 2024, and I would expect that to continue. There are two forces at play here, both expenses and our revenues. Expenses, we have active plans to improve our expense efficiency and reduce expenses both from a tactical and transformational standpoint. But also do not disregard the impact from revenues here. So as we have a number of businesses that are not at scale today, they will grow to scale. And when they do that, their expense ratios will drop significantly, and that will improve overall our expense ratio, i.e., push that down. The last piece to all of this is also where is our future growth coming from. It is generally coming from low expense ratio businesses. Predominantly, the group life and disability business that operates at a significantly lower structural expense ratio than the voluntary benefits business. So if you take all of that together, we should have a trajectory that is going lower, and we would expect to operate in the 35% to 37% over time.
Joel Hurwitz: Okay. Makes sense. And then just on the recapture. Any color on the economic benefit? And then are there other blocks that you could potentially execute something similar on?
Max Broden: So overall, we're very pleased with the economics. In terms of the impact on future run rate results, they're relatively small, but they're obviously favorable. So there's a favorable run rate going forward. In terms of the other blocks out there, I do deem that this is - was the one that we really had out there. I wish we had more than we could do, but this was really the one that we had outstanding.
Joel Hurwitz: Okay. Thank you.
Operator: The next question comes from Ryan Krueger with KBW. Please go ahead.
Ryan Krueger: Hi, thanks. Good morning. First, I just wanted to follow up on the U.S. expense ratio, given that the group products also tend to have higher benefit ratio. So just curious, as you continue - as you do grow those business lines and the expense ratio comes down, would you expect, ultimately, for the margins in the U.S. is to increase? Or to what extent would that be offset by naturally higher benefit ratios on those products?
Max Broden: So I think that we have been in a structurally low benefit ratio period, which means that over time, I would expect our benefit ratios to increase. And you're right, Ryan, to acknowledge that the mix impact will also push our benefit ratios higher. So we're always going to see that mix impact impacting both expense ratio and benefit ratios going forward. And that will have a slightly negative impact to the pretax margin going forward because of mix. But I'll kick it over to Virgil Miller to give his comments as well.
Virgil Miller: Thank you, Max. So first, we're not pleased where we sit with the expense ratio. That is absolutely a focus for the U.S. And one of the things we're doing is making sure we have plans that are going to continue to be in that curve, and you'll see that happening over a period of time. And we're basically challenging all of the U.S. leadership to be accountable for that, and it is tied to our little compensation. Now I'll go step further, though, I mentioned that when we talked about the actual sales growth this year, one of the things we mentioned - you heard Dan mention earlier, is our strong underwriting discipline. We are making sure that we only put policies and business on the books that actually have better persistency and lower turnover rates with employees. So the underwriting discipline itself will continue to help drive and bend that expense curve and drive up that benefit ratio, along with, as Max mentioned, the continued growth that we're seeing in our vita bills, it would change the overall business mix in the U.S. So just to conclude, it is absolutely a focus for us and that we are confident we've got the right plans in place to start bidding that curve starting next year.
Ryan Krueger: Thank you. And then on Japan internal reinsurance, you've done a transaction two years in a row. Is there any practical limitation on doing something like that kind of pretty regularly? Or is there anything that would omit your ability to do that?
Max Broden: So Ryan, over time, we would expect that we could see at about 10% of the Aflac Japan balance sheet to Aflac Bermuda. There are no real legal limitations to it, but at the same time, we got to acknowledge any sort of risks associated with internal reinsurance to make sure that we don't overexpose ourselves or we make sure that we can handle everything associated with it. So over time, I would expect us to see something like 10%. And to date, we have done about 4%.
Ryan Krueger: Okay. Great. Thanks a lot.
Virgil Miller: And this is Virgil. Let me just go back to add, when I was talking about being on that curve, that starts this year, in 2024. I just want to make sure you got that. I said next year, but I mean 2024.
Operator: The next question comes from Josh Shanker with Bank of America. Please go ahead.
Josh Shanker: Thank you for taking my question. Just a question as to whether or not the yen at ¥140, ¥150 to the dollar versus 110, does that change your hedging costs, your desire to hedge the strategy at all in your investment portfolio?
Max Broden: So obviously, the pricing of options will move, and that impacts, to some extent, the cost of hedging. And so obviously, every input that you would have to the pricing of options would impact that. In terms of the level of the yen, the answer is no. We want to structurally protect the economic exposure we have to the yen. And we do that through the dollar allocation that we have in the general account. We do that through the debt that we issue in yen, and we do that through the forwards that we hold at the holding company, where we are long dollars, short yen. So overall, we do this in order to reduce risk, not necessarily to express an opinion on the yen. Now, how we hedge and protect ourselves, we have all these different levers that we can pull, and the cost and return on capital associated with those can vary over time because of the capital markets. So that's why we will then dial up and dial down some of those associated with that. But it's not necessarily associated with the level of the yen-dollar rate. We are not FX traders. We're looking to protect ourselves long term.
Joshua Shanker: Thank you very much and have a good day.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young: Thank you, Betsy, and thank you all for joining us this morning. If you have any additional questions, please reach out to the Investor and Rating Agency Relations team. We will be happy to talk to you then, and we look forward to speaking to you soon. Have a great day.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to the Aflac Incorporated Fourth Quarter Year End 2023 Earnings and 2024 Outlook Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations for Aflac Incorporated. Please go ahead."
},
{
"speaker": "David Young",
"text": "Good morning and welcome. This morning, we will be hearing remarks about earnings for 2023 as well as our outlook for 2024. First, Dan Amos, Chairman, CEO, and President of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then Max Broden, Executive Vice-President and CFO of Aflac Incorporated, will provide an update on our financial results and current capital and liquidity, as well as our outlook for 2024. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2024. We also posted, under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans. For Q&A, we are also joined by Virgil Miller, President of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non- U.S. GAAP measures. I'll now turn the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, David, and good morning, everyone. We're glad you are joining us. Reflecting on 2023, it was a very good year. Our management team, employees, sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for our policyholders when they need us most, just as we promised. Aflac Incorporated delivered a very strong earnings for the year. Net earnings per diluted share for 2023 were $7.78, adjusted earnings per diluted share was $6.23 were the best in the company's history despite the weakening yen and the impact of the reinsurance retrocession late in the fourth quarter. Beginning with Japan, Aflac Japan generated solid overall financial results in 2023. For the year, total adjusted revenues declined 3.6% to nearly ¥1.5 trillion, largely reflecting the impacts of reinsurance and paid-up policies. But this was largely offset by a 7.3% decrease in total benefits and adjusted expenses. Pre-tax adjusted earnings increased 6% to nearly ¥457 billion for the year. As a result, Aflac Japan produced an extremely strong profit margin of 30.5%. I am pleased with Aflac Japan's 10.9% year-over-year increase in sales, which was largely driven 26% increase in cancer insurance sales with very significant contributions from Japan Post Company and Japan Post Insurance as well as other alliances, Dai-ichi Life and Daido Life. As you may recall, Aflac Japan aims to have a product lined up to meet customers' needs during any life stage. Our latest medical insurance is designed to appeal to younger policyholders' basic needs and older and existing policyholders who want additional or updated coverage. While our medical insurance sales were off for the year, they increased 6.5% year-over-year in the fourth quarter following the introduction of our new medical insurance product in mid-September. Similarly, Aflac Japan refreshed WAYS and Child Endowment in 2022 as a way of acquiring younger customers and also introducing opportunities to sell our core third-sector products to them. Since the launch of our refreshed WAYS product, approximately 80% of our sales are to younger customers below the age of 50. The level of concurrent third-sector sales remains above 50%. Given Japan's demographics, our product strategy is to fit the needs of the customers at any stage in life. Acquiring younger customers is critical to our success along with our intense focus on being where the customer wants to buy insurance. We have a broad network of distribution channels, including agencies, alliance partners, and banks. This reach continually optimizes opportunities to help provide financial protection to the Japanese consumers. We are working hard to support each channel. While the market presents challenges, we expect to reach ¥67 billion to ¥73 billion of sales in Japan by the end of 2026. Turning to the U.S. We also generated strong overall financial results in 2023. Total adjusted revenues increased 2.1% to $6.6 billion. The decline in total net benefits and claims was slightly offset by the increase in adjusted expenses. Pretax adjusted earnings increased 10.4% to an all-time high of $1.5 billion for the year. As a result, Aflac U.S. produced an extremely strong profit margin of 22.7%. Aflac U.S. sales increased 5% in 2023, which was at the lower end of our expectations. As you know, we've been focused on increasing persistence to grow profitable earned premiums. In addition, we continually evaluate new business to ensure that it is profitable. During the fourth quarter, we made some tactical decisions to avoid sales opportunities to certain less profitable larger accounts like those of high turnover. At the same time, we focused on updating our products to ensure that our policyholders continue to realize the value of -- our products provide. As part of our efforts, we introduced our new cancer protection insurance policy in the second quarter of 2023. Since that time, our cancer insurance has increased nearly 25%. We know that when people experience the value of our products, it increases persistency, which benefits our policyholders and lowers our expenses. I believe that the need for the products and the solutions we offer are as strong or stronger than ever before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers, particularly given that our products are sold, not bought. As we communicate the value of our products, we know that the strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face, even when they have major medical insurance. Knowing our products help lift people up when they need us most is something that makes all of us at Aflac very proud, and propels us to do more and achieve more. We continue to reinforce our leading position and build on that momentum. We are confident that the successful execution of our strategy will lead to sales of at least $1.8 billion in the U.S. by the end of 2025. I'd like to end on addressing our ongoing commitment to prudent liquidity and capital management. We have taken proactive steps in recent years to defend our cash flow and deployable capital against the weakening yen. At the end of 2023, we had nearly $2.8 billion of liquidity at the holding company, which means more than $1 billion over the minimum balance. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders while being responsive to the needs of our shareholders. We remain committed to maintaining strong capital ratios on behalf of our policyholders and balance this financial strength with the tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both the dividend track record and the tactical share repurchase. 2023 marked the 41st consecutive year of dividend increases. We treasure our track record of dividend growth and remain committed to extending it. Last quarter, the Board put us on a path to continue this record when it increased in the first quarter of 2024 dividend 19% to $0.50. We also remain in the market, repurchasing our shares through 2023 at a historically high level of $700 million per quarter. We have remained tactical in our approach to share repurchase, deploying $2.8 billion in capital to repurchase nearly 39 million of our shares in 2023. Combined with a dividend, this means we delivered over $3.8 billion back to the shareholders in 2023, while also investing in the growth of our business. At the same time, we have maintained our position among companies with the highest return on capital and the lowest cost of capital in the industry. Overall, I think we can say that it's been another strong year. I'll now turn the program over to Max, who will cover more details on the financial results for this year and provide an outlook for the key drivers of earnings in 2024. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Dan. This morning, I'm going to address our 2023 results before providing an outlook for certain drivers for 2024 that were included in the slides with our earnings materials filed yesterday with our 8-K. Aflac Incorporated delivered very strong earnings for the year as adjusted earnings per diluted share rose 9.9% to $6.23, the highest amount in our company's history. This result included a $0.19 negative impact from foreign currency and variable investment income was $0.14 per share below our long-term return expectations. In addition, our annual results included remeasurement gains of $0.51 per share, a $0.20 per share non-economic loss in the fourth quarter under U.S. GAAP related to the innovation of our reinsurance treaty with a third-party ceded back to the company, and a $0.04 per share write-off of certain capitalized software development costs in the third quarter. Our liquidity remained strong with unencumbered holding company liquidity being $1 billion above our minimum balance. Likewise, our capital position remained strong and we ended the year with an SMR above 1,100% in Japan. At the end of 2023, we estimated our internally modeled ESR to be above 250% and we expect the FSA to provide final guidance on the ESR later in 2024. We also estimated our combined RBC in the U.S. to be greater than 650% at the end of 2023. These are strong capital ratios which we actively monitor, stress, and manage to withstand credit cycles as well as external shocks. In addition, impairments have remained within our expectations and with limited impact to both earnings and capital. Our Adjusted leverage remains below our leverage corridor of 20% to 25% at 19.7%. And this will fluctuate with the yen-dollar rate, since we hold approximately two-thirds of our debt denominated in yen as part of our enterprise hedging program to protect the economic value of Aflac Japan in U.S. dollar terms. In 2023, we repurchased $2.8 billion of our own stock and paid dividends of $245 million in Q4, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Adjusted book value per share increased 10.1% and the adjusted ROE was 13.8%, an acceptable spread to our cost of capital. I'm also pleased with our continued development of our Bermuda reinsurance platform, which resulted in three transactions during 2023. We will continue to utilize this platform to better manage risk and improve capital efficiency across the enterprise, and we expect these transactions to be part of a series that will improve our run-rate adjusted ROE by 100 to 200 basis points over time, all things being equal. Overall, we're very pleased with these results, especially when normalizing for one-time items. Turning to Aflac Japan. Its total benefit ratio for the year was 66%, down 140 basis points from the prior year. Throughout the year, we continue to experience favorable actual to expected on our well-priced large and mature in-force block. We estimate the impact from remeasurement gains to be 130 basis points favorable to the benefit ratio in 2023. Long-term experience trends, as it relates to the treatment of cancer and hospitalization, have continued to lead to favorable underwriting experience. Persistency remained solid with a rate of 93.4%, and was down 70 basis points year-over-year, reflecting elevated lapse as customers updated their cancer and medical coverage with our latest cancer and medical products. Our expense ratio in Japan was 19.8%, down 50 basis points year-over-year, driven primarily by good expense control and to some extent, by expense allowance from reinsurance transactions. For the full year, total adjusted revenues in yen were down 3.6% to ¥1.5 trillion. Net earned premiums declined 5.9% to ¥1.1 trillion, reflecting the impacts of reinsurance transactions, paid-up policies, and deferred profit liability. When excluding these three factors, net earned premiums declined an estimated 1.7%. On this same basis, we would expect net earned premiums in 2024 to decline 2.5% to 1.5% when taking into consideration the impact of reinsurance, paid-up policies, and the deferred profit liability reclassification. Adjusted net investment income increased by 4% to ¥365.6 billion as we experienced higher yields on our U.S. dollar-denominated investments and related favorable FX. This was partially offset by a transfer of assets due to reinsurance. Pretax earnings were ¥456.9 billion or 6% higher than a year ago. For 2024, we would expect our well-priced in-force to show greater stability in terms of the benefit ratio excluding unlockings and to be in the range of 66% to 68%. This is a function of both favorable morbidity experience and improved mix of business. With the current trend in revenues, we are actively reducing our expenses. We are taking both tactical efforts as well as more long-term transformational initiatives and we would expect our expense ratio to be in the range of 19% to 21% going forward. The pre-tax profit margin for Japan for 2023 was 30.5%, up 280 basis points year-over-year. A very good result. With approximately 30% of the Japan portfolio in U.S. dollar assets, the strength of the U.S. dollar versus the yen has increased the proportion of net investment income as a component of our pretax profit. With a greater contribution to profitability from net investment income in yen terms, our pre-tax margin is naturally pushed up. In addition, having transitioned to option-based currency hedging, we expect quarterly hedge costs to remain roughly in line with what we experienced in the fourth quarter of 2023. In combination with a lower expected benefit ratio, we expect a pretax profit margin of 29% to 31% in 2024. Turning to Aflac U.S. Our 2023 total benefit ratio came in well below expectations at 42.8%. We estimate that the remeasurement gains impacted the benefit ratio by 500 basis points in 2023. Claims utilization has stabilized, but as we incorporate more recent experience into our reserve models, we unlocked assumptions and released reserves during the year. Persistency increased 130 basis points year-over-year to 78.6%. This is a function of poor persistency quarters falling out of the metric and stabilization across numerous product categories. Our expense ratio in the U.S. was 40.6%, up 90 basis points year-over-year, primarily driven by our growth initiatives and higher DAC amortization. We would expect the U.S. expense ratio to decrease over time as these businesses grow to scale and improve their profitability. For the full year, total adjusted revenues were up 2.1% to $6.6 billion. Net earned premiums increased 1.9% to $5.7 billion in 2023. Adjusted net investment income increased 8.6% to $820 million, mainly driven by higher yields on both our fixed and floating-rate portfolios. Pretax earnings were $1.5 billion or 10.4% higher than a year ago, driven primarily by the lower benefit ratio which was largely impacted by the third quarter unlock and only partially offset by the higher expense ratio. For 2024, we would expect net earned premium growth to be in the range of 3% to 5%. Profitability for the U.S. segment was solid with a pretax margin of 22.7%, driven primarily by the remeasurement gains from unlocking. Looking forward at 2024, as we grow products with a higher benefit ratio and lower expense ratio, like group life and disability, and network dental and vision, you should start to see those changes reflected in our ratios over time. In 2024, we would expect to operate with a benefit ratio in the range of 45% to 47% and an expense ratio of 38% to 40%. This translates into an expected profit margin of 19% to 21%. In our corporate segment, we recorded a pre-tax loss of $425 million, compared to a loss of $218 million a year ago, primarily due to higher investment tax credits and the impact of the innovation of our reinsurance treaty with a third party. Adjusted net investment income was $54 million lower than last year due to an increased volume of tax credit investments. Higher rates began to earn in and amortized hedge income increased. These tax credit investments impacted the corporate net investment income line for U.S. GAAP purposes negatively by $343 million with an associated credit to the tax line. The net impact to our bottom line was a positive $39 million. To date, these investments are performing well and in line with expectations. The impact from the reinsurance innovation was a one-time negative of $151 million. Overall, we're very pleased with our 2023 results and our outlook for 2024. I'll now turn the call back to David, so we can begin Q&A. David?"
},
{
"speaker": "David Young",
"text": "Thank you, Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. Then you're welcome to rejoin the queue to ask any additional questions. Betsy, we will now take the first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] The first question today comes from Tom Gallagher with Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Good morning. One numbers question and then one on strategy. Just the numbers question. I guess for the last several years, you've had better portfolio yield in Japan being driven by the pivot into USD portfolio. If I look at the last couple of quarters, that seems to be flattening out. So your portfolio yield has been more stable. Can you talk about what's driving that and what it means for 2024 NII in Japan? And then, Dan, strategy question is, just given the growth headwinds in Japan, would you guys consider anything more meaningful on M&A strategically to help facilitate growth? I know you haven't really done this in the past, but there does seem to be an element of kind of unavoidable demographic headwind in Japan that you're fighting against here. So curious what you think on strategy there. Thanks."
},
{
"speaker": "Max Broden",
"text": "Thank you, Tom. I'll kick it off and then hand over to Brad and then to Dan for the strategy question. As it relates to our investment portfolio and net investment income, you're correct in noticing that our net investment income has increased over the last couple of years. A portion of that is driven by our increased allocation to U.S. dollar assets. And I do want to remind you that, that is primarily driven by the view that we have of hedging our economic exposure to the yen as it relates to the overall exposure that we have as a company to the yen throughout like Japan. We have now reached what we view to be more of a steady state as it relates to our total U.S. dollar allocation. So from that level, I would expect a stabilization in terms of our total allocation between yen and dollars within the investment portfolio. But as it relates to more of an outlook into 2024 for our NII, I'll turn to Brad, and he can give you some more color."
},
{
"speaker": "BradDyslin",
"text": "Yes. The only thing I would add is just to remind you that our new money yield is both a blend of lower yen rates as well as the higher U.S. dollar rates. Most of our deployment is planned for U.S. dollar assets and that is to maintain the balances, as Max just described. But we do still like yen spread products when we can locate acceptable outlets. When that happens, then we will put them in the portfolio, and that does result in pulling down the overall reported new money yield just because of the simple math of lower yen rates."
},
{
"speaker": "DanAmos",
"text": "And Tom, in regards to strategy, that's been an issue we've had for several years. We feel like that one of the things we are addressing is cancer or medical product suite is by starting them off on an inexpensive savings plan that gets them to participate with us. We also continue to look for new product. We have still not found that third product or third leg that we want to find and we're continuing to try things. But I don't know of anyone right now that I would trade places with in Japan in terms of distribution and product that we have and believe we can continue to grow our business moving forward. Saying that, we have to be realistic that it is an aging population, and it also is a position where it's not the population is declining, but all in all, I still believe it's the best market in the country or in the world because of the persistency and our ability to continue to grow it. And so, I think you're going to see growth for the next several years. We did lower that number to -- from 80 billion just to be cautious, but we're encouraged. Our Japan Post growth and what's gone there continues to do very well, and we've enjoyed our relationship there. It's our existing distribution system that was really hurt, both in the U.S. and Japan, by COVID, but more so in Japan because if you look back at COVID, it really lasted an additional year in Japan. And because our agents are commission-driven, our newer agents, when COVID hit, all of a sudden did not have an opportunity to go out and sell one-on-one. And as we've always said, our products are sold, they're not bought. And so, we go out and make those presentations, and we couldn't do it. And so people that were normally working for us on a commission basis tried to find other jobs that were salary in nature, and that's what we've been fighting, but it is coming back both in the U.S. and Japan, and I'm encouraged by what I'm seeing there."
},
{
"speaker": "Operator",
"text": "The next question comes from Suneet Kamath with Jefferies. Please go ahead."
},
{
"speaker": "Suneet Kamath",
"text": "Thanks. Just a couple on Japan. And the first one, Dan, just gets back to something you're just talking about in terms of the ¥67 billion to ¥73 billion sort of target down from the ¥80 billion. Are you viewing that as sort of just a delay? And that, that ¥80 billion is ultimately achievable, maybe a year beyond your original target? Just -- I wanted to think about it a little bit longer term."
},
{
"speaker": "DanAmos",
"text": "Well, I certainly think it's the potential out there. I don't know what year -- because the COVID, with such an anomaly, what I'd like to do is, is to let our people that are there on the -- Koide or whoever wants to take this particular question can do it. And then I'll follow up if there's any other part you want me to directly address."
},
{
"speaker": "Masatoshi Koide",
"text": "This is Koide Aflac Japan. So let me answer the question. And the reason why we've changed our target from ¥80 billion to ¥67 billion to ¥73 billion was because we knew that it would take a longer time. So we do think that we are able to achieve ¥80 billion if we look beyond 2026 or after."
},
{
"speaker": "Suneet Kamath",
"text": "Got it. Okay. All right. And then I just had another question on, I guess, persistency in Japan. If I just think back to Aflac from years ago, it strikes me that part of the reason the persistency was so strong is because you sold at the work site and there just was very little job mobility in Japan so people just kept the products for a long time. And I guess the question is, as you're shifting now to new distribution channels outside of the work site and to a younger population, which seems to be the objective, should we just expect a natural decline in that persistency over time?"
},
{
"speaker": "Max Broden",
"text": "I'll kick it off and I'll let anybody add some commentary to that as well. As we sell to younger customers, that should actually improve the persistency. Because of the age-based pricing that we have in Japan, there's a very strong incentive to hold on to the product for a long time and maybe even for life. So as you sell into a younger population, that tends to reduce your lapse rates and improve your persistency. Suneet, you are correct to -- when you look at the corporate agencies that you are referring to from the past that, that was -- had very strong persistency overall in that channel. And as that has become a smaller piece of our overall inforce, that have structurally reduced our persistency. The other thing I would mention as well is that we have seen an aging of the block. And when you have an aging of the block, that naturally leads to higher lapsation and lower persistency as well. So you hear us talk about that we are trying to reach younger customers, that is partially to sort of fight these sort of long-term trends that we have going on in our in-force block to not only provide coverage and new coverages to the younger population but also to improve the overall persistency of the block. All of this is marginal from year to year, and it's very slow-moving, but it's certainly something that we're watching closely."
},
{
"speaker": "DanAmos",
"text": "Yoshizumi, do you have any comments you'd like to add? Our head of sales in Japan."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Thank you. This is Yoshizumi. And regarding the persistency that was just asked and answered by Max, and as Max answered, by us focusing on young and middle-aged customers, our persistency is going to be higher, and that is our strategy. And that is actually represented by the medical insurance that was just launched on September 19. And this product is very popular among the young and middle-aged customers whose ages are under 49 -- or 49 and under. In terms of the number of policy count that we sold to these young and middle-aged customers, we actually saw a 46% increase year-on-year from the time that we launched in September to the end of the year last year. And these customers are for our middle and long-term growth of Aflac Japan. And these are the customers who will be our asset and our treasure going forward. And the actual premiums that are being paid by young and middle-aged customers are lower. And we truly believe that by focusing on these younger customers and increasing these young customers would contribute to stable growth of our company. And at the same time, as I mentioned, the persistency rate will be higher, and this is our strategy."
},
{
"speaker": "Suneet Kamath",
"text": "Okay. Thanks for the answers."
},
{
"speaker": "DanAmos",
"text": "I just want to remind you all that the persistency rate is really high. And we can move it up a little bit, move down a little bit, but it is more than we ever dreamed when we first started doing business over there. So we're very pleased with it. So -- but at the same time, we will improve because when you're writing younger people, of course, they'll live longer, and therefore, they'll be more persistent."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar with JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Good morning. So first, a question on Japan. And if you think really long term, is it even realistic to assume that the business can grow given that the population shrinking, the population is aging as well? And then versus 10, 20 years ago, there are a lot more companies in the product lines that you're in? So if you could just comment on that, like -- and maybe on your -- the reduction in guidance on sales, how much of that has to do with just Japan taking longer to recover from COVID versus some of these demographic headwinds?"
},
{
"speaker": "DanAmos",
"text": "Well, my first comment is, you're correct in terms of a competitive environment. But what is in Japan or any other country that isn't competitive. So being competitive is nothing new to us, and something that we are understanding that we have to constantly look for ways to address how we can identify with consumers and show the need for our products even more. Now don't forget, we've seen copays and deductibles over many years. I don't know when another one will take place or what will happen. But as inflation, even though small in Japan, you have to take that into account, too. So remember, our ability to convert and add more premium to existing policyholders always makes a difference and grows our block of business as well, and we especially think that with the younger people. Let me now turn to Japan and let them comment on it."
},
{
"speaker": "Masatoshi Koide",
"text": "Yes. This is Koide, Aflac Japan. And it is true that Japan is being projected as having declining population. But at the same time, with the advancement of longevity in the 100-year life era, the need to prepare for longevity risk is expected to increase steadily. And it's also expected that the aging population could increase the medical cost because as you live long, the probability of suffering from cancer and other diseases will increase. And in Japan, the sustainability of the overall social security system is being discussed. And this would also include medical and nursing care. And this is being questioned and the discussions are underway within the Japanese government to review how the benefits and burden should be balanced. And given these circumstances, there is a way of thinking about helping themselves or self-help and preparing for the future as people become more aware of the situation. And as a result, although the population may decline, we do think that the third sector market will steadily grow going forward as well."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. And then on the U.S. business, do you have a better clarity on the tri-agency rule and its potential impact on your sales?"
},
{
"speaker": "Virgil Miller",
"text": "Hi. This is Virgil, from the U.S. We have been working with the tri-agency sales to talk about any potential impact we could see to those selling supplemental into the consumers out there. And we're waiting on a ruling. Thus far, they set a date to be on April 2024, you know and I know that a date may move. However, we remain encouraged that our policies and coverages are relevant regardless if that rule does come through. We looked at our indemnity sales from last year. We really didn't see any decline. We remain flat there. And again, regardless, even if there is a rule of not a rule, our coverage is relevant, and we're not predicting any major impact going forward."
},
{
"speaker": "Jimmy Bhullar",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Wilma Burdis with Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"text": "Hi, good morning. Could you talk a little bit about the outlook for capital generation, and if we should expect anything on an ongoing basis from internal reinsurance opportunities? Thank you."
},
{
"speaker": "Max Broden",
"text": "Thank you, Wilma. If you think about the total capital generation that we've had recently and also going into 2024, I don't see any significant change to our overall capital generation on an organic basis. That remains in the $2.6 billion to $3 billion range. On top of that, we know that we have opportunities that we can, over time, unlock more capital through utilizing our reinsurance platform, and we intend to do so. We can't necessarily predict exactly when that will happen or what amounts that will be, but you've seen us in the recent past be quite active on that front. So I would expect us to do more. But on a pure sort of run rate organic basis, I would have pegged our underlying capital generation at $2.6 billion to $3 billion annually."
},
{
"speaker": "Wilma Burdis",
"text": "Thank you. And could you just talk more about the commercial real estate watch list? It's higher than a lot of the peers, and you guys have taken the keys back on a few properties lately. So if you could go into that and what you're seeing there? Thank you."
},
{
"speaker": "Virgil Miller",
"text": "Sure. I think there's one primary thing related to our watch list relative to our portfolio that makes us different than peers, and that's the fact that the bulk of our exposure is in transitional real estate. Remember, that's a much shorter asset class. It's a much shorter maturity, generally a three-year term with some options to extend out a fourth and fifth year. So because of that, when you have a market downturn and you've got these maturities coming due and the liquidity is as poor as we're seeing in the market today, it naturally creates an elevated watch list and creates an elevated amount of potential foreclosures. Now, we work very closely with our borrowers to address those maturities. We do our best to avoid foreclosure. But if they are not willing to work with us, if they're not willing to reset the loan to reflect current valuations and give us other protections, we are fortunate that we're in a position, we can and will foreclose if we think that's the best route to maximize our recoveries. We are blessed with a strong capital and liquidity position, which prevents us from being a forced seller here. So I think it's a combination of the nature of our portfolio, having shorter maturities relative to our total exposure. And then the fact that we are much more willing to foreclose and able to foreclose, if we think that's the best route."
},
{
"speaker": "Wilma Burdis",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Elyse Greenspan with Wells Fargo. Please go ahead."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good morning. My first question, going back to just Japan sales guidance. Dan, I know you said you guys are being cautious in lowering the outlook there. But how do we think about -- how should we think about going from the ¥60.7 billion of sales in '23 to the new ¥67 billion to ¥73 billion target? Should we think about that being even -- even over the next few years or maybe a bit more back-ended?"
},
{
"speaker": "DanAmos",
"text": "Japan? Okay. Well, we, at this particular time, are just evaluating what we think might happen for the next two years. And frankly, we've just tried to be conservative and give us some latitude on what would happen. But we have some very positive things coming out in 2024 that we think will drive sales and are encouraged about it and even some things as we're looking to 2025 that will be coming. Let me make sure that Koide or -- they don't want to make any comments in that regard. Koide?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Yes. This is Yoshizumi."
},
{
"speaker": "DanAmos",
"text": "Okay, Yoshizumi."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Yes, thank you. Okay. Let me answer the question. And as Dan mentioned earlier, it is true that COVID has impacted Japan way beyond our expectation. And as a result, the number of solicitors or sales agents have decreased significantly. And even if you were -- even if our agencies are able to hire the sales agents, we were not able to train them. It was not until May last year in Japan that COVID has been reclassified at the same level as with influenza. So we had no choice, but to face really truly difficult situation in sales for a long time. And at the same time, it is also true that it took us quite a bit of time to train those sales agents that have lower skills. But right now, what we are very much focused on is really recruit and train the solicitors or sales agents. Otherwise, we will not be able to train and grow those sales agents that are customer-centric. Aflac sales agents must be those agents that are very welcomed by our customers. What I mean by that is that those sales agents must respond to customers' needs when they solicit policies, but at the same time, when the benefits and claims are paid. And I do believe that it is Aflac's mission to send out these kind of sales agents to the market appropriately. And that is the reason why we have set our sales target relatively conservative. And we currently do have recruiting and development and training plan for our future, as Koide mentioned earlier, beyond maybe ¥80 billion or even more in the future. Thank you."
},
{
"speaker": "Max Broden",
"text": "Elyse, I would think about the sales trajectory as being relatively linear, i.e., not back-end loaded."
},
{
"speaker": "Elyse Greenspan",
"text": "That's helpful. Thanks Max. And then my second question, you guys you pointed out, you obviously have a good amount of buffer at the holdco relative to where you've talked about running. How do you think about, I guess, managing that down? And how should we think about the level of potential buybacks in '24?"
},
{
"speaker": "Max Broden",
"text": "So we're obviously operating with a very significant capital levels in all of our subsidiaries at the moment. Over time, I would expect us to operate at slightly lower capital levels in terms of the ratios and where we are today. I would reflect that in Japan, we are now going through a transition from SMR to ESR. So I wouldn't necessarily make any dramatic changes ahead of that. In the U.S., we are looking to, over time, target in an RBC of closer to 400%, and we have active plans towards drawing that down. At the same time, we have strong capital and liquidity at the holding companies. We always think about where is capital serving us the best at that very point in time, at the same time making sure that we have capital available for deployment into dividends, buybacks, et cetera. So overall, I would say that our capital plans remain solid. We've got plenty of capital around, and we try to place it where it makes the best use."
},
{
"speaker": "Elyse Greenspan",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Your next question comes from John B. Barnidge from Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thanks for the opportunity. I had a question of - going back to the Japan sales target. I know you put out a press release in December about the Trupanion pet insurance partnership for Japan. Did that pivot remove any sales contribution from the ¥80 billion assumption? And can you talk - thank you."
},
{
"speaker": "Dan Amos",
"text": "No, it did not."
},
{
"speaker": "John Barnidge",
"text": "Okay. Then can you maybe talk about the growth opportunity for that product in the U.S. that was called out in the pivot and commitment to ownership stake? Thank you."
},
{
"speaker": "Max Broden",
"text": "Pet insurance, we think, has a significant opportunity in the U.S. market because of the very low penetration of the product itself. For Aflac, we act as a distributor where these premiums, claims, et cetera, do not hit our income statement. So it's an opportunity to - for our distribution to earn additional commissions, so in that sense, it's very positive to Aflac. We do, obviously, have an alliance and a partnership with Trupanion that is strong through the equity ownership that we have in the company, and we capture significant economics over time through that equity ownership."
},
{
"speaker": "John Barnidge",
"text": "Thanks for the answers. Appreciate it."
},
{
"speaker": "Operator",
"text": "Your next question comes from Joel Hurwitz with Dowling & Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"text": "Hi. Good morning. First, a question on U.S. expenses. So the outlook looks to be largely in line with prior year. You've talked in the past on bending the expense curve and getting closer to a mid-30% expense ratio. Can you just provide an update on those expectations and when we should start to see a more significant drop in the expense ratio in the U.S.?"
},
{
"speaker": "Max Broden",
"text": "So you are starting to see a drop in 2024, and I would expect that to continue. There are two forces at play here, both expenses and our revenues. Expenses, we have active plans to improve our expense efficiency and reduce expenses both from a tactical and transformational standpoint. But also do not disregard the impact from revenues here. So as we have a number of businesses that are not at scale today, they will grow to scale. And when they do that, their expense ratios will drop significantly, and that will improve overall our expense ratio, i.e., push that down. The last piece to all of this is also where is our future growth coming from. It is generally coming from low expense ratio businesses. Predominantly, the group life and disability business that operates at a significantly lower structural expense ratio than the voluntary benefits business. So if you take all of that together, we should have a trajectory that is going lower, and we would expect to operate in the 35% to 37% over time."
},
{
"speaker": "Joel Hurwitz",
"text": "Okay. Makes sense. And then just on the recapture. Any color on the economic benefit? And then are there other blocks that you could potentially execute something similar on?"
},
{
"speaker": "Max Broden",
"text": "So overall, we're very pleased with the economics. In terms of the impact on future run rate results, they're relatively small, but they're obviously favorable. So there's a favorable run rate going forward. In terms of the other blocks out there, I do deem that this is - was the one that we really had out there. I wish we had more than we could do, but this was really the one that we had outstanding."
},
{
"speaker": "Joel Hurwitz",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Ryan Krueger with KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "Hi, thanks. Good morning. First, I just wanted to follow up on the U.S. expense ratio, given that the group products also tend to have higher benefit ratio. So just curious, as you continue - as you do grow those business lines and the expense ratio comes down, would you expect, ultimately, for the margins in the U.S. is to increase? Or to what extent would that be offset by naturally higher benefit ratios on those products?"
},
{
"speaker": "Max Broden",
"text": "So I think that we have been in a structurally low benefit ratio period, which means that over time, I would expect our benefit ratios to increase. And you're right, Ryan, to acknowledge that the mix impact will also push our benefit ratios higher. So we're always going to see that mix impact impacting both expense ratio and benefit ratios going forward. And that will have a slightly negative impact to the pretax margin going forward because of mix. But I'll kick it over to Virgil Miller to give his comments as well."
},
{
"speaker": "Virgil Miller",
"text": "Thank you, Max. So first, we're not pleased where we sit with the expense ratio. That is absolutely a focus for the U.S. And one of the things we're doing is making sure we have plans that are going to continue to be in that curve, and you'll see that happening over a period of time. And we're basically challenging all of the U.S. leadership to be accountable for that, and it is tied to our little compensation. Now I'll go step further, though, I mentioned that when we talked about the actual sales growth this year, one of the things we mentioned - you heard Dan mention earlier, is our strong underwriting discipline. We are making sure that we only put policies and business on the books that actually have better persistency and lower turnover rates with employees. So the underwriting discipline itself will continue to help drive and bend that expense curve and drive up that benefit ratio, along with, as Max mentioned, the continued growth that we're seeing in our vita bills, it would change the overall business mix in the U.S. So just to conclude, it is absolutely a focus for us and that we are confident we've got the right plans in place to start bidding that curve starting next year."
},
{
"speaker": "Ryan Krueger",
"text": "Thank you. And then on Japan internal reinsurance, you've done a transaction two years in a row. Is there any practical limitation on doing something like that kind of pretty regularly? Or is there anything that would omit your ability to do that?"
},
{
"speaker": "Max Broden",
"text": "So Ryan, over time, we would expect that we could see at about 10% of the Aflac Japan balance sheet to Aflac Bermuda. There are no real legal limitations to it, but at the same time, we got to acknowledge any sort of risks associated with internal reinsurance to make sure that we don't overexpose ourselves or we make sure that we can handle everything associated with it. So over time, I would expect us to see something like 10%. And to date, we have done about 4%."
},
{
"speaker": "Ryan Krueger",
"text": "Okay. Great. Thanks a lot."
},
{
"speaker": "Virgil Miller",
"text": "And this is Virgil. Let me just go back to add, when I was talking about being on that curve, that starts this year, in 2024. I just want to make sure you got that. I said next year, but I mean 2024."
},
{
"speaker": "Operator",
"text": "The next question comes from Josh Shanker with Bank of America. Please go ahead."
},
{
"speaker": "Josh Shanker",
"text": "Thank you for taking my question. Just a question as to whether or not the yen at ¥140, ¥150 to the dollar versus 110, does that change your hedging costs, your desire to hedge the strategy at all in your investment portfolio?"
},
{
"speaker": "Max Broden",
"text": "So obviously, the pricing of options will move, and that impacts, to some extent, the cost of hedging. And so obviously, every input that you would have to the pricing of options would impact that. In terms of the level of the yen, the answer is no. We want to structurally protect the economic exposure we have to the yen. And we do that through the dollar allocation that we have in the general account. We do that through the debt that we issue in yen, and we do that through the forwards that we hold at the holding company, where we are long dollars, short yen. So overall, we do this in order to reduce risk, not necessarily to express an opinion on the yen. Now, how we hedge and protect ourselves, we have all these different levers that we can pull, and the cost and return on capital associated with those can vary over time because of the capital markets. So that's why we will then dial up and dial down some of those associated with that. But it's not necessarily associated with the level of the yen-dollar rate. We are not FX traders. We're looking to protect ourselves long term."
},
{
"speaker": "Joshua Shanker",
"text": "Thank you very much and have a good day."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you, Betsy, and thank you all for joining us this morning. If you have any additional questions, please reach out to the Investor and Rating Agency Relations team. We will be happy to talk to you then, and we look forward to speaking to you soon. Have a great day."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 3 | 2,023 | 2023-11-02 08:00:00 | Operator: Good morning, and welcome to the Aflac Incorporated Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations. Please go ahead.
David Young: Good morning and welcome. This morning, we will be hearing remarks about the third quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated, and Fred Crawford, President and COO of Aflac Incorporated. Max Broden, Executive Vice President and CFO of Aflac Incorporated will provide an update on our financial results in current capital and liquidity, which can also be found with the materials that we posted along with our earnings release and financial supplement on investors.aflac.com. We also posted under financials on the same site updated slides of investment details related to our commercial real estate and middle market loans. In addition, Max provided his quarterly video update, which you will find there also. Other members of our executive management team who are joining us for Q&A include Virgil Miller, President of Aflac US; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan. Dan?
Dan Amos: Thank you, David. Good morning. We're glad you joined us. Reflecting on the third quarter of 2023, our management team, employees, and sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for the policyholders when they need us most, just as we promised. Aflac Incorporated delivered very strong earnings for both the quarter and for the first nine months. Beginning with Japan, I am pleased with our 12.4% year-over-year increase in sales, which was largely driven by a nearly 23% increase in cancer insurance sales, with a significant contribution from Japan Post Company and Japan Post Insurance. I am also pleased to see continued improvements in cancer insurance sales through our other alliances, Dai-ichi Life and Daido Life. These alliance partners, along with agencies and banks, combine to form our extensive distribution channels that are so important to being where the customer wants to buy insurance and providing them with financial protection. We continue to work hard to support each channel. We also introduced our new medical insurance product on September 19. The product design is simple to appeal to younger policyholders with basic needs and older or existing policyholders who desire additional or updated coverage. While it's too early to evaluate the success of this product launch, early indications show that it's being well received. We continue to gain new customers through WAYS and Child Endowment, while also increasing opportunities to sell our third sector products. Since the launch of our refreshed WAYS product, approximately 80% of our sales are to younger customers below the age of 50, and the level of concurrent third sector sales remains approximately 50%. Thus far, our product strategy in Japan has served us well, and I'm encouraged by our progress so far. Turning to the US, I'm encouraged by our sales increase of 7.5% in the quarter. This reflects continued productivity improvements and the contribution from our growth initiatives of group life and disability, consumer markets, network dental and vision. We remain focused on driving scale, stabilizing new platforms, and leveraging our ability to bundle essential product lines as we work with brokers on larger groups. Agents and brokers contributed to the growth of our individual business. Our group platform benefited significantly from the sales of group life and disability. I am very excited about our new cancer protection assurance policy, which provides enhanced benefits at no additional cost. We know that when people experience the value of our products, it increases persistency, which benefits our policyholders and lowers our expenses. I believe that the need for our products and solutions we offer is strong or stronger than ever before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers, particularly given that our products are sold, not bought. As we communicate the value of our products, we know that a strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face when they get medical treatments, even though they may have major medical insurance. Knowing our products help lift people up when they need it most is something that makes all of us at Aflac very proud and propels us to do more and achieve more. We continue to reinforce our leading position and build on that momentum. As always, we are committed to prudent liquidity and capital management. We continue to generate strong investment results while remaining in a defensive position as we monitor evolving economic conditions. In addition, we have taken proactive steps in recent years to defend our cash flow and deployable capital against a weakening yen. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders. At the same time, we are listening to our shareholders and understanding the importance of prudent liquidity and capital management. We remain committed to maintaining strong capital ratios on behalf of the policyholder and balance this financial strength with tactical capital deployment. I am very pleased with the Board's declaration of the fourth quarter dividend and declaring this dividend of 2023 marks the 41st consecutive year of dividend increases, a record that we treasure. I am even more pleased with the Board's action to increase the first quarter of 2024 dividend by 19% to $0.50 per share. We also remain in the market purchasing shares at a historically high level of $700 million, as seen in the first two quarters of this year. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows, which support both our dividend track record and tactical share repurchase. Overall, I think we can say that it has been a very strong quarter, especially when a vast number of factors are in our favor. Aflac Japan had a strong quarter for sales as we executed product and distribution strategy. Aflac US continued to build on its momentum as it nears pre-pandemic levels. Pre-tax profit margins remain strong in both Japan at 32.8% and the US at 28.8%. Plus, our capital ratios remain very strong, and our quarterly share repurchase was, like last quarter, one of the largest in the company's history. Before I hand it over to Fred, I want to address an announcement of his retirement. I have enjoyed working closely with Fred over the last eight years and certainly understand his desire to retire and spend more time with the family and personal interests. Fred, you will be missed, and I look forward to working with you and Aflac's executive team to ensure a smooth transition until your official retirement day. And I wish you many happy years. As for me and the company, we have some outstanding candidates who are capable of running Aflac. It is my responsibility to continue to train and watch the progress of these potential heir apparent while the Board oversees the process. To be prepared for any unknowns, we have always had an interim CEO ready should something abruptly happen to me, as well as a strong process within the Board's corporate governance committee. I recently had a physical at Emory University and received an excellent report. So I plan on being around to prepare our leaders for the future and drive shareholder value. With that, I'll now turn the program over to Fred. Fred?
Fred Crawford: Thank you, Dan. As announced last night, I plan to retire in September of next year to spend more time with my family and pursue other interests. It's a personal decision, but also a recognition of the very capable leadership team surrounding Dan and the company being in a very strong position. While I believe this is the best for me and my family, I also believe it is in the best interest of Aflac. I've enjoyed 25 years as an executive in the insurance industry and feel blessed to have worked with talented professionals and leaders throughout. However, the highlight has clearly been my time here working for Dan and for Aflac. Over the next year, I will be focused on transition and helping on select initiatives where I can add value. I'll now hand the call back over to Max. Max?
Max Broden: Thank you, Fred. For the third quarter, adjusted earnings per diluted share increased 27.8% year-over-year to $1.84 with a $0.06 negative impact from FX in the quarter. With this being the third quarter under the new LDTI accounting regime, we evaluate our reserve assumptions for morbidity, persistency, and mortality, at least annually, to see if an update is needed. If necessary, these assumptions will be unlocked on a prospective basis as they were in this quarter, leading to remeasurement gains of $205 million. Variable investment income ran $13 million or $0.02 per share below our long-term return expectations. We also wrote down certain software intangibles in our US segment, impacting our results by $0.04 per share. Adjusted book value per share, including foreign currency translation gains and losses, increased 10.3%, and the adjusted ROE was 15.6%, a significant spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premium for the quarter declined 2.8%, reflecting the impact of paid-up policies, our January 1 reinsurance transaction and deferred profit liability. Lapses were somewhat elevated but within our expectations. However, if adjusting for all these factors, the earned premium declined an estimated 1.7%. Japan's total benefit ratio came in at 65.1% for the quarter, down 170 basis points year-over-year, and the third sector benefit ratio was 54.8%, down approximately 460 basis points year-over-year. We continue to experience favorable actual to expected on our well-priced, large and mature in-force block. We estimate the impact from remeasurement gains to be 260 basis points favorable to the benefit ratio in Q3. Long-term experience trends as it relates to treatment of cancer and hospitalization continue to be in place, leading to favorable underwriting experience. Persistency remained solid with a rate of 93.5% but was down 80 basis points year-over-year. With product refreshments, we tend to experience some elevation in lapses as customers update and refresh their coverage, which was the case with the recently refreshed cancer and first sector products. Our expense ratio in Japan was 19%, down 100 basis points year-over-year, driven primarily by good expense control and, to some extent, by expense allowance from reinsurance transactions and DAC commission true-up. For the full year, we would expect to end up towards the low end of our expense ratio range of 20% to 22%. Adjusted net investment income in yen terms was up 7.2% as we experienced higher yields on our US dollar-denominated investments and related favorable FX and a return on our alternatives portfolio, more in line with our long-term return expectations. This was offset by transfer of assets due to reinsurance. In the quarter, we reduced our FX forwards and increased FX put options notional, leading to lower run rate hedge costs and a more efficient use of our investment risk capital. The pretax margin for Japan in the quarter was 32.8%, up 350 basis points year-over-year, a very good result for the quarter. Turning to US results, net earned premium was up 3.2%. Persistency increased 80 basis points year-over-year to 78.7%. This is a function of poor persistency quarters falling out of the metric and stabilization across numerous product categories, especially group voluntary benefits. Our total benefit ratio came in lower than expected at 35.9%, a full 890 basis points lower than Q3 2022. We estimate that the remeasurement gains impacted the benefit ratio by 12.1 percentage points in the quarter. Claims utilization remains subdued. And as we incorporate more recent experience into our reserve models, we have released some reserves. For the full year, we now estimate our benefit ratio to be materially below our outlook range of 47% to 50%. Excluding remeasurement gains, however, we are tracking well within the 47% to 50% outlook range. Our expense ratio in the US was 40.6%, up 70 basis points year-over-year. This includes a 190 basis points impact from a software intangibles write-down. Adjusting for this write-down, we are trending in the right direction. Our growth initiatives, group life and disability, network dental and vision, direct-to-consumer increased our total expense ratio by 330 basis points. We would expect this impact to decrease over time as these businesses grow to scale and improve their profitability. For the full year, we now expect our expense ratio to come in slightly above our outlook range of 37% to 40%. Adjusted net investment income in the US was up 13%, mainly driven by higher yields on both our fixed and floating rate portfolios and variable investment income in the quarter more in line with long-term return expectations. Profitability in the US segment was solid with a pretax margin of 28.8%, driven primarily by the remeasurement gains from unlocking. As you know, the commercial real estate markets are going through the worst cycle in decades, especially in the office subsector. We're seeing most property values quoted down 25% to 40%, but some distressed situations are driving market values down as much as 60%, far exceeding the 35% to 40% declines of the financial crisis. Our total commercial real estate watch list remains approximately $1 billion, with around two-thirds of these in active foreclosure proceedings. As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $34 million this quarter. We also moved two properties into real estate owned, which resulted in a $53 million write-down. We do not believe the current distressed market is indicative of the true intrinsic economic value of the underlying properties currently undergoing a foreclosure process. We continue to believe our ability to take ownership of these quality buildings and manage them through this cycle will allow us to maximize our recoveries. In our Corporate segment, we recorded a pretax loss of $49 million, which is somewhat smaller than a year ago, primarily due to our reinsurance transaction. Adjusted net investment income was $8 million lower than last year due to an increased volume of tax credit investments. Higher rates began to earn in and amortized hedge income increased. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $64 million with an associated credit to the tax line. The net impact to our bottom line was a positive $3.8 million in the quarter. To date, these investments are performing well and in line with expectations. We are continuing to build out our reinsurance platform, and I'm pleased with the outcome and performance. In Q4, we intend to execute another tranche with similar structure and economics to our first transaction from January this year. Our capital position remains strong, and we ended the quarter with an SMR above 1,000% in Japan. And our combined RBC, while not finalized, we estimate to be greater than 650%. Unencumbered holding company liquidity stood at $3.3 billion, $1.6 billion above our minimum balance. These are strong capital ratios which we actively monitor, stress and manage to withstand credit cycles as well as external shocks. US stat impairments were $4 million and Japan FSA impairments JPY2.9 billion or roughly $20 million. This is well within our expectations and with limited impact to both earnings and capital. Leverage remains at a comfortable 18.8%, just below our leverage corridor of 20% to 25%. The decline in the quarter is primarily driven by the weakening yen. As we hold approximately two-thirds of our debt denominated in yen, our leverage will fluctuate with movements in the yen-dollar rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in US dollar terms. We repurchased $700 million of our own stock and paid dividends of $248 million in Q3, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. I will now hand the call back to David to begin Q&A.
David Young: Thank you, Max. Before we begin our Q&A we ask that you please limit yourself to one initial question and a related a follow-up. Then, you are welcome to rejoin the queue to ask an additional question. We will now take the first question.
Operator: [Operator Instructions] Our first question will come from Tom Gallagher with Evercore ISI. You may now go ahead.
Tom Gallagher: Good morning. Dan, wanted to start with your comment about succession planning and having several strong candidates. Should we take that to mean you won't be looking to do an outside search to replace Fred? And are you looking to replace Fred in the COO role? A little bit of color on what you're thinking overall there. Thanks.
Dan Amos: Sure. First, I would say that you have to understand that one of the reasons that we created the Chief Operating Officer and also for Fred to go to Japan, part of it was due to the COVID period of time and that we had a situation where with COVID, we wanted more interaction with Japan. And so Fred was willing to go over there and do that. And that was very helpful to us. And we continue to rotate people over to Japan and from Japan to the United States. And it's -- for example, Steve Beaver, who you probably know has been around a long time, will be working with him. As far as how and what will evolve, these decisions ultimately come from the Board. I think there's always two ways to look at transition and what would take place would be abruptness of something happening and then well it was structured. So we work with the concept that this will be planned over a long period of time and we've had internal candidates. It's always been my preference that it'd be internal candidates because of the Japanese operation and the uniqueness that we have there. Saying that, I would say the Board would -- the Corporate Governance Committee specifically and then the full Board would be reviewing every aspect to make sure you have the best person for the job. And so we would also take that into consideration as we're moving forward. As I said in my comments, I'm enjoying life. I'm enjoying working with the company and want to continue to do so. At the same time, these adjustments of people retiring and moving on happens, and I've been around to see a lot of them. But I think there's a little element of pride that keeps me around because of the family. And frankly, I just enjoy doing it. So I look forward to working with these people. There are several that are on the horizon. We continue to add new people that have potential. So I'm encouraged about that and I think we're in a strong position. I think this quarter sent a signal of how strong we are, managerially-wise, and we'll continue to do that.
Tom Gallagher: Got you. Thanks for that, Dan. And just an operational question for my follow-up. Max, can you comment on what's behind the bigger reserve release in the US and if there's a go-forward earnings impact associated with that? I would have thought there might have been a bigger benefit coming from Japan, just given how strong and this efficiency of margins there are. So any -- maybe any color comparing and contrasting how the actuarial review stacked up US versus Japan? Thanks.
Max Broden: Thank you, Tom. So obviously, this is the first year we're running on an LDTI basis, and the third quarter is when we do the unlockings, including prospective unlockings. When you think about it, if you go back and look at the last couple of years and you see the morbidity trends and also trends in hospitalization and outpatient treatment, and you compare and contrast Japan and the United States, in the US, we shut down a lot more than what you ended up doing in Japan as it relates to how people went to the hospital and how people changed their behavior. And that is coming through in our morbidity experience. So we did see, for example, accident hospitalizations, et cetera, drop a lot more in the United States than what you saw in Japan. And that was simply a factor of the COVID virus had a much more significant spread in the US than what it did have in Japan. In Japan, you really had a big spike in the third quarter of 2022. But outside of that, it was a significantly lower spread than what we had in the US. And that is why you're now seeing that having a much more pronounced impact on the morbidity experience that is feeding into our actuarial models that is then leading to the outcome that you saw this quarter.
Tom Gallagher: Okay. Thanks.
Operator: Our next question will come from Jimmy Bhullar with JPMorgan. You may now go ahead.
Jimmy Bhullar: Hi, good morning. So Fred, I'm sure we'll be dealing with you a little bit more over the next year, but good luck in the future. I had, first, a question on just any updates you have on the potential tri-agency rules. And in sort of the worst-case scenario, what are the products that are in scope and what could be the impact on your business, assuming that the industry does not get any concessions from the rule as it's initially written?
Virgil Miller: Good morning. This is Virgil Miller from the US. I'll take that question for you. So we continue to advocate on behalf of our policyholders to provide them the protection when they need it most. The comment period is closed, but you can see and review our comments out there as well as others. I'll just say that we saw no impact in the third quarter to our sales. If you think about it, our hospital indemnity product could be one that's impacted. We had relatively flat sales in third quarter. But you've heard Dan mention in his comments about our cancer insurance protection plan. We saw our cancer sales up in the third quarter. I would say this also that remember, one of the considerations as part of the proposal is around pretax implications. Aflac has been selling, we were selling our policies without those pretax benefits long before it actually occurred years ago. So I think we'll be positioned well even if the rule were to pass.
Dan Amos: Let me make one other comment. I was in Washington for three days about three weeks ago and met with probably 18 senators and congressmen to just see their positions on it. I want to go back to the pretax situation that Virgil was talking about because it was an anomaly. What actually happened was it ended up being passed. And we, as a company, back 20-something years ago, we didn't sell pretax for the first two years because the Congress said it was a mistake and it was never really meant to happen. And so once it was in the bill, then when they tried to take it, thought about taking it out, there would -- it looked like it was a [free tax] (ph). If they took it out, it became a tax on the average American. And you take, for example, a school teacher that has come down with cancer to, all of a sudden, say you're going to tax their benefits will not sit well with the contingency of people that they deal with. And so we were able to talk to a lot of people about it, and we had no feedback that thought that it should be the opposite. Now saying that, we know that this has been submitted by the branch outside Congress through the executive branch, and we've got to handle it and we plan on talking to them. But it is -- it will absolutely be a direct tax. But we sold in that environment. I'm one of the ones -- one thing about me being around a long time is I remember a lot of things. And we saw -- I was around when we sold in a pretax environment. In fact, I was in the sales force for 10 years and saw it. And so it's a matter of adjustment no matter what happens. And what I've always said is with change comes opportunity. And so no matter what happens, we're going to find a way to do well in that environment.
Jimmy Bhullar: Okay. And if I could ask just one more. Your comments on CRE seem fairly negative and the environment is pretty challenging as well. But how do you square the watch list of over $1 billion or around $1 billion with your CECL reserve, which seems pretty modest at around $34 million?
Brad Dyslin: Yeah. Good morning, Jimmy, this is Brad Dyslin. I'll take that. There's a couple of things behind the relatively modest reserving that you've seen so far compared to that $1 billion watch list. One is the average LTV of the portfolio and the price declines we've seen. What happens when we go through the foreclosure process is we have to mark that asset to the lower of the principal balance of the loan or the value of the asset. So when you're starting at a 60% LTV, you've got a fair amount of cushion before you start to realize losses on that mark. The second dynamic at play here is we are still in process on about half of that $1 billion of watch list, which means we are in workout negotiations with the borrower. Those can be very long-lasting, very intense and they can ebb and flow a lot of different directions. Once we get certainty that we expect to foreclose, we have to order a third-party appraisal. Those take time to come in. And as they come in, that's when we end up re-marking our assets. So it's a combination of our relatively conservative LTVs and the fact that we've still got about half that portfolio subject to appraisal.
Jimmy Bhullar: Thank you.
Operator: Our next question will come from Ryan Krueger with KBW. You may now go ahead.
Ryan Krueger: Hey, thanks. Good morning. My first question was on the changes you made to the FX hedging program. And I just wanted to confirm, you had a pretty major decline in the hedge costs in the third quarter versus the last couple of quarters. Just wanted to confirm that -- that's a reasonable expectation on the hedge cost going forward for the foreseeable future?
Max Broden: Yeah. Thank you, Ryan. Yes, I think what you saw in terms of hedge cost for the third quarter, it's a blend of us rolling into our new structure, so it's a mix between the old structure and the new structure. In terms of run rate hedge costs going forward, I do think that the third quarter hedge cost that you saw, it's certainly not going to be higher. We’re probably going to, on a run rate basis going forward, be at this level or slightly lower going forward in terms of actual hedge cost. That is obviously subject to capital markets inputs and everything that impacts the cost of a put option and also, to some extent, if we decide to increase our forward exposure in the future as well. So things like the FX volatility, interest rates, et cetera, will come into play here. But in the near future, I would expect our hedge cost to be similar to the third quarter level or slightly lower.
Ryan Krueger: And there's no offset anywhere else, right, that would drop to the bottom line?
Max Broden: Sorry, Ryan, I didn't quite catch that. Can you repeat?
Ryan Krueger: I just want to -- there's no offset anywhere else that would drop to the bottom line?
Max Broden: The way to think about this in terms of the P&L, this will drop to the bottom line. When you think about the P&L here, what we have done when we move gradually from using forwards to put options, what happens is that we are now increasing the volatility for small moves in the yen-dollar as it relates to our capital ratios in Japan, i.e., the SMR and ESR. So for a strengthening yen or a weakening yen, you're going to see slightly higher volatility in that ratio for small moves. But what the put options give us is that we have dramatically reduced the tails. So any dramatic moves or shock moves in the yen-dollar, we have reduced our risk exposure to those kind of events. And we feel that this is a very good risk reward for us.
Ryan Krueger: Thanks. And then on the reinsurance transaction, the transaction you did last year, I think, freed up $900 million of capital. But then I think around half of it or so was retained and then the other half was available for redeployment to shareholders. On this next transaction, would you expect closer to all of it to be available to return to shareholders?
Max Broden: We will deploy the capital appropriately in the respective business units, and if we have good opportunities to deploy the capital there, we will do so. If we feel that we have significant surplus capital, it will be moved up to holding company. And the holding company will deploy it in the different sort of capital distributions that the holding company generally does, i.e., dividends, buybacks, et cetera.
Ryan Krueger: Thank you.
Operator: Our next question will come from Suneet Kamath with Jefferies. You may now go ahead.
Suneet Kamath: Thanks, good morning. I just wanted to follow up to Tom's question on the US reserve releases. It sounded like some of the benefit here was lower hospitalizations in the US due to COVID. And I just want to understand, are you assuming that kind of that lower level of hospitalization sort of persist going forward? Or are you assuming some sort of reversion to historical trend?
Max Broden: Let me kick off on that question, and I would ask Al Riggieri to fill in any blanks and add his color as well. But the fact of the matter is that we have seen lower levels, generally speaking, in terms of hospitalizations come through. And we've also seen changes in the way treatments are being done, i.e. more outpatient treatments as well. So we believe that we have seen a shift in both the way hospitals are operating and also the way individuals are going for their treatments. And we have factored that in to some extent.
Al Riggieri: Yeah. This is Al Riggieri. Just to add in a little bit on that. Remember, the COVID period dropped all hospital utilization, treatment patterns. Many of that during COVID would have some ups and downs during the period as hospitals had more capacity and people would return and get elective surgeries and all that. What we did this year was begin to recognize that 2022 was the first year in the United States where you would say that the pandemic was kind of in the rearview mirror. So we broadened the experience for 2022. We did still remove the experience, very low experience during COVID period. We brought in the post-COVID period, we called it, for 2022. And as Max was saying, continued to see even in that period in '22, that we did have lower experience. So we've built that into the experience base or updating the assumptions.
Suneet Kamath: And I think, Max, you said you factored some of that into your reserve. Is it -- does that mean that if things sort of persist the way they are, that there would be the potential for some more reserve releases down the road?
Max Broden: We believe that we have adequately reflected sort of the new paradigm or the new experience that we're seeing now into our models. Now, please remember, these are obviously models. So what that means is that if these trends were to improve further than what we have experienced to date, there is the potential for further unlocking, favorable or negative. It can go the other way as well. We believe that we have reflected it to our best -- the best way we can, given the data that we see. And it's important that we do reflect it to the best way we can. But I also want to make sure that you understand that these are estimates and they can go both ways.
Suneet Kamath: Yeah. No, that makes sense. My other one is on Japan and the earned premium drop of 1.7% sort of adjusted. I would have thought at some point, the impact of the paid-up policies would sort of have run its course. And I know some of those policies were very long-dated, but I believe that they were sold quite a bit ago. So are we getting closer to the point where that impact is expected to fall off?
Max Broden: So when we look forward into the paid-up schedules, you are going to see a little bit of a drop in 2014 -- sorry, 2024, and then a further drop in 2025. And that's where I would say that I would expect us to run more on a normalized basis for paid-up. Keep in mind that the big sales that we had of the WAYS product, they really occurred in the 2012 through 2014 time period, and there was five-year pay and there were 10-year pay. So when you roll that forward, that's when you see that you get a little bit of a drop-off in 2024 and then further in 2025. That being said, paid-up is something that we generally build into our products, both first sector and third sector. But when we -- I wanted to mention 2024 and 2025 because that's when we move into a more normal schedule, and you're not necessarily going to see these more significant year-over-year deviations.
Suneet Kamath: Okay. Thanks.
Operator: Our next question will come from Alex Scott with Goldman Sachs. You may now go ahead.
Marly Reese: Good morning. It's Marly on for Alex. I was hoping you could provide a little more color on the Japan Post sales and partnership. It looks like it's been progressing, so I was hoping to hear a little more on this versus the longer-term sales guidance.
Koichiro Yoshizumi: [Foreign Language] This is Yoshizumi. I oversee the entire sales in Japan. [Foreign Language] The sales of our cancer insurance, new cancer insurance wings and also lump-sum serious disease benefit rider continues to be very strong. [Foreign Language] We will continue to aim at growth in cancer insurance sales by providing sales support to the sales offices and post offices of Japan Post Company and Japan Post Insurance nationwide, including sales process management and the sharing of good practices. [Foreign Language] We are also actively working on the training and also developing of the sales agents across all the branches nationwide by sharing good practices and best practices. [Foreign Language] And we are expecting to have growth in sales even more by having all these activities done in a solid manner. [Foreign Language] And that's all for me.
Dan Amos: Yeah. I want to make one other comment. We've been waiting for Japan Post to come back for several years now. And we had assurances that they would do that and I'm happy to see it take place. They are our largest shareholder. And so what is good for us is good for them and vice versa. So I believe this is a strong alliance and will continue to be strong as we move forward.
Marly Reese: Thank you. And then just as a follow-up, if we could turn to capital a little bit, would you mind providing an update on what you view as near-term versus longer-term capital management priorities or capital deployment?
Max Broden: So obviously, the capital ratios in our subsidiaries, they are strong, and that's obviously priority number one to make sure that we have adequate and strong capital in our operating subsidiaries. And then obviously, we want to move operating cash flow up to the holding company and then deploy it from there. You did see that in the quarter, we bought back $700 million of our own stock. I view that as quite a strong capital deployment. And we also increased the dividend by 19% starting in the first quarter of next year. So overall, the company is generating significant cash flow, and we are deploying significant cash flow as well.
Marly Reese: Thank you.
Operator: Our next question will come from John Barnidge with Piper Sandler. You may now go ahead.
John Barnidge: Good morning. Thanks for the opportunity. Fred, congrats on the retirement. Question is around Japan and the expense reduction efforts. I know there was a paperless effort and other expense efficiencies. Have you already completed any required software installations or do you have any planned upcoming? Thank you.
Fred Crawford: Why don't I just make a couple of comments on that, and then Koide-san can comment. But what we are focused on in Japan from an efficiency perspective is digitizing the platform. That's the major thrust of what we're looking at, which is a long-term plan of investment followed by returns. And that is a plan to digitize or increase the usage of digital applications away from paper applications, the use of digital self-service where policyholders go online and serve themselves through technology as opposed to inundating our call center and then claims payments or digital claims. We've been making steady progress on both the digital application front and on the customer self-service, but we are engaged currently in updating those tools. Think of it as no different than your iPhone 1 to iPhone 11. We are updating those tools to modernize them and improve the customer experience. We have been in a proof of concept over the last year and, in fact, have moved those digital adoption rates up. And so with that will come natural efficiencies over time but it will take time. So it's a long-term progress of moving customer and agent experience to digital and away from paper, but that will yield benefits. The claims side of it is more stubborn. And the reason for that has nothing to do with Aflac. It's because the Japanese healthcare system is a paper-based healthcare system that requires the exchange of paper forms when one goes to the doctor. That's really requiring a modernization of the healthcare system in Japan. And interestingly, they actually do have an effort underway to attempt to modernize or digitize the healthcare system. But until that takes place, our ability to process claims digitally will be somewhat contained. But over time, we expect to improve. So what you should expect as investors is that over the long time, we will be increasing that digital adoption. It will yield a lower per-policy expense outcome from an administrative standpoint, but it will be over multiple years of slow and steady progress because this is about adoption, it's not about installing software, okay?
John Barnidge: Very helpful. Thank you very much. And then on the investment portfolio, those properties you took keys, can you maybe talk about the occupancy rates in those versus the ones that remain on the watch list? Thanks a lot.
Brad Dyslin: Sure, thank you. The two properties that we took back, the current occupancy levels are in the low to mid-50s, which has been pretty stable since we first got involved and did the loan. The occupancy across the portfolio, it does range a fair amount. We've got a few that are below 50%, given the nature of the asset class, the nature of transitional real estate. But for the most part, our averages are right around the 55% to 65%.
John Barnidge: Thank you very much.
Operator: Our next question will come from Wilma Burdis with Raymond James. You may now go ahead. Pardon me, Wilma, your line is open for question.
Wilma Burdis: Thank you. Good morning. Is it fair to think that Aflac can rewrite its hospital indemnity policies to comply with the potential DOL-HHS rule without compromising the attractiveness of the product? And has Aflac started to work on this? If so, does the burden appear manageable?
Virgil Miller: This is Virgil from the US. We absolutely are taking precautions to make sure that we prepare just in case the proposal does go through, and we are confident that we can do that. We've been continuing to enhance our benefits while current policies are out there. I think Dan stated earlier, we were clear that we've sold before in an environment without some of the pretax benefits that currently exist, and we're confident we'll be able to do that again. We have a random process here that we are always looking to innovate and reinvent our products and enhance our benefits. We demonstrated that this past year with our cancer enhancements we did that really had no additional cost to our policyholders. So you can expect more of the same related to that.
Wilma Burdis: Okay. Thank you. And then I just want to confirm, I know you guys sort of said it but I just want to make sure that I understand. In the reinsurance deal that you just recently completed, you freed up around $900 million of capital, and it sounds like that could either be used to reinvest or maybe ultimately for shareholder returns.
Max Broden: Yeah. Obviously, our priorities with all the capital that we have is always to deploy it into writing new business and use it in our operating entities. That is where we get generally the best IRR on that capital. If we cannot deploy it in our operating entities, then it will flow up to the holding company.
Wilma Burdis: But it was around $900 million is what you freed up for that?
Max Broden: Yeah, that is our estimate, yes.
Wilma Burdis: Okay. Thank you.
Operator: Our next question will come from Josh Shanker with Bank of America. You may now go ahead.
Josh Shanker: Yes. Thank you. When I think about the commercial loan portfolio, are the properties most at risk, those that have been more recently loaned to or the ones that have a longer vintage in terms of when they were established? And along those lines, when did you cool the deployment of new investment flows into commercial loans?
Brad Dyslin: Sure. Thank you, Josh. The loans that we're dealing with now that are on the watch list are those that were made a couple of years ago. The transitional real estate book is our biggest focus area, and that differs from a more traditional CML book in that the maturities are much shorter. They tend to be three-year fixed maturities with options to extend up to five, in some cases, up to seven years based on certain thresholds and the operating metrics being met. So what we're dealing with now are those maturities predominantly in 2023 and a few in 2024 as obviously, the maturity is coming up and when those loans need to be addressed, either being repaid or if that is not an option, then we get into the workout discussions. We have really substantially reduced our deployment into the asset class this year. Part of that is the market -- well, not part of it, it is frankly driven by the market. Very much a lack of activity. We're seeing a large bid ask between buyers and sellers. The increase in rates has really put valuations upside down. Buyers are trying to get -- take advantage of the current levels. Sellers are trying to get yesterday's prices, and we're just not seeing a lot of good, solid transactions, and there's a lack of liquidity in the market. So that's really limited our opportunities. And of course, we always adjust our underwriting standards to the current experience, to the current market. So we're being a little bit more difficult in our terms and conditions as well.
Josh Shanker: And then related, is there any way you can frame the capital consumption or rating agency charge for those two properties? What was it before they were converted into wholly-owned properties and what is it now?
Max Broden: Yeah. So when they move from being a CML to real estate owned, there is a significant uptick in terms of the capital charge associated with that. For us, it's still very small. So if you think about RBC points, it's very -- I would estimate it to be low single-digits. And as it relates to SMR, the same applies. When you then think about the -- you generally should think about the distribution on what balance sheet or capital base if they go into as follow it the same way the size of the investment portfolio is between the two segments, i.e., roughly 85% falls into Japan and 15% falls into the US.
Josh Shanker: Okay, thank you very much for that.
Operator: Our next question will come from Wes Carmichael with Wells Fargo. You may now go ahead.
Wes Carmichael: Hey, good morning. Just wanted to follow up on capital a bit. Max, I know you said that your first priority is to deploy that within the subs on organic. But to the extent that there's not that opportunity, I just wanted to get your thoughts around potential M&A and given that you've got pretty significant excess at the holdco and subs.
Max Broden: Yeah. We -- if you think about what our track record, you have seen what we have done historically. Aflac has not been an acquisitive company. This is a company that is built selling one policy at a time. We've done a number of, I would call it, tuck-in acquisitions in the United States to broaden our product portfolio. And we do feel that we are in a good spot in terms of the products that we have to offer in our go-to-market strategy. So at this point, I don't see that we have any holes that need to be filled using M&A.
Wes Carmichael: Got it. Thanks. And then maybe just a follow-up on the middle market loan book away from commercial real estate, it seems like that's -- the book yield now is near 11%. So just wondering if you're seeing any terms and any collateral deterioration. And if interest rates remain high for a year or so, like, do you expect defaults within that portfolio?
Brad Dyslin: Yeah. Thank you. So far, we have been extremely pleased with the performance of the middle market loan portfolio. It is, frankly, performing better than we expected, given where we are at this point in the cycle. There are several reasons for that. And then ultimately, it boils down to fundamentals, underwriting and then how we've chosen to build the portfolio. We have a very small average loan size. We have maintained a discipline around only first-lien secured structures. We've kept leverage at a very modest level. We have maintained our use of strong covenants. And then ultimately, it's about good businesses, good companies with sound business plans that are seeing good top line growth and have the margins and cash flow, avoiding cyclical companies, and that's really played out. We have built this as our primary below-investment grade portfolio. So we do expect to incur some losses. But relative to the outsized yields we've received, they are really quite modest. And as I said, it is doing better than we expected at this point in the cycle. Going forward, we're going to have to wait and see just how the macro environment does. It does look like we've got the possibility of a soft or at least a soft-ish landing. And then how quickly rates turn around is something that we're going to watch very closely.
Wes Carmichael: Thank you.
Operator: Our next question will come from Joel Hurwitz with Dowling & Partners. You may now go ahead.
Joel Hurwitz: Hey, good morning. So RBC is strong at over 650%, well above your 400% target. Can you just talk about plans in managing that down towards the target?
Max Broden: So obviously in the US, we are seeing some growth, and we're seeing some growth in lines of business that are driving a little bit more new business strain. And that's why we have, in the pandemic, we wanted to run with a little bit more capital and then coming out of the pandemic, we see a little bit higher strain associated with that growth that we are starting to see and expect to see come through. That has led us to run with a little bit higher RBC than what -- than the 400%. But we are at a point in time now where I would expect us over the next couple of years to really get down to that 400% level long term.
Joel Hurwitz: Okay. And do you expect that to be driven by the needs for growth or do you expect to actually draw that down with outsized dividends to the holdco?
Max Broden: The preferred option would be to drive it by growth because that's where we're getting the best returns on our capital by just writing more policies. At the same time, our -- even though we have some lines of business that are consuming a little bit more capital, overall, we're a relatively capital-light business. So given that we're operating at a 650% RBC right now, I don't see that growth alone will necessarily drive us all the way down to 400%. In order to do so, we probably would, over time, need to address our capital base through special dividends, et cetera.
Joel Hurwitz: Okay. Thank you.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young: Thank you, Anthony, and thank you all for joining us this morning. While we are not hosting our financial analyst briefing this year, we will be in 2024, but we will also be giving an outlook for 2024 on our fourth quarter 2023 earnings call. In the interim, please reach out to the Investor and Rating Agency Relations team if you have any questions, and we look forward to speaking to you then. Everyone, have a great day. Thank you.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the Aflac Incorporated Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations. Please go ahead."
},
{
"speaker": "David Young",
"text": "Good morning and welcome. This morning, we will be hearing remarks about the third quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated, and Fred Crawford, President and COO of Aflac Incorporated. Max Broden, Executive Vice President and CFO of Aflac Incorporated will provide an update on our financial results in current capital and liquidity, which can also be found with the materials that we posted along with our earnings release and financial supplement on investors.aflac.com. We also posted under financials on the same site updated slides of investment details related to our commercial real estate and middle market loans. In addition, Max provided his quarterly video update, which you will find there also. Other members of our executive management team who are joining us for Q&A include Virgil Miller, President of Aflac US; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, David. Good morning. We're glad you joined us. Reflecting on the third quarter of 2023, our management team, employees, and sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for the policyholders when they need us most, just as we promised. Aflac Incorporated delivered very strong earnings for both the quarter and for the first nine months. Beginning with Japan, I am pleased with our 12.4% year-over-year increase in sales, which was largely driven by a nearly 23% increase in cancer insurance sales, with a significant contribution from Japan Post Company and Japan Post Insurance. I am also pleased to see continued improvements in cancer insurance sales through our other alliances, Dai-ichi Life and Daido Life. These alliance partners, along with agencies and banks, combine to form our extensive distribution channels that are so important to being where the customer wants to buy insurance and providing them with financial protection. We continue to work hard to support each channel. We also introduced our new medical insurance product on September 19. The product design is simple to appeal to younger policyholders with basic needs and older or existing policyholders who desire additional or updated coverage. While it's too early to evaluate the success of this product launch, early indications show that it's being well received. We continue to gain new customers through WAYS and Child Endowment, while also increasing opportunities to sell our third sector products. Since the launch of our refreshed WAYS product, approximately 80% of our sales are to younger customers below the age of 50, and the level of concurrent third sector sales remains approximately 50%. Thus far, our product strategy in Japan has served us well, and I'm encouraged by our progress so far. Turning to the US, I'm encouraged by our sales increase of 7.5% in the quarter. This reflects continued productivity improvements and the contribution from our growth initiatives of group life and disability, consumer markets, network dental and vision. We remain focused on driving scale, stabilizing new platforms, and leveraging our ability to bundle essential product lines as we work with brokers on larger groups. Agents and brokers contributed to the growth of our individual business. Our group platform benefited significantly from the sales of group life and disability. I am very excited about our new cancer protection assurance policy, which provides enhanced benefits at no additional cost. We know that when people experience the value of our products, it increases persistency, which benefits our policyholders and lowers our expenses. I believe that the need for our products and solutions we offer is strong or stronger than ever before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers, particularly given that our products are sold, not bought. As we communicate the value of our products, we know that a strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face when they get medical treatments, even though they may have major medical insurance. Knowing our products help lift people up when they need it most is something that makes all of us at Aflac very proud and propels us to do more and achieve more. We continue to reinforce our leading position and build on that momentum. As always, we are committed to prudent liquidity and capital management. We continue to generate strong investment results while remaining in a defensive position as we monitor evolving economic conditions. In addition, we have taken proactive steps in recent years to defend our cash flow and deployable capital against a weakening yen. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders. At the same time, we are listening to our shareholders and understanding the importance of prudent liquidity and capital management. We remain committed to maintaining strong capital ratios on behalf of the policyholder and balance this financial strength with tactical capital deployment. I am very pleased with the Board's declaration of the fourth quarter dividend and declaring this dividend of 2023 marks the 41st consecutive year of dividend increases, a record that we treasure. I am even more pleased with the Board's action to increase the first quarter of 2024 dividend by 19% to $0.50 per share. We also remain in the market purchasing shares at a historically high level of $700 million, as seen in the first two quarters of this year. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows, which support both our dividend track record and tactical share repurchase. Overall, I think we can say that it has been a very strong quarter, especially when a vast number of factors are in our favor. Aflac Japan had a strong quarter for sales as we executed product and distribution strategy. Aflac US continued to build on its momentum as it nears pre-pandemic levels. Pre-tax profit margins remain strong in both Japan at 32.8% and the US at 28.8%. Plus, our capital ratios remain very strong, and our quarterly share repurchase was, like last quarter, one of the largest in the company's history. Before I hand it over to Fred, I want to address an announcement of his retirement. I have enjoyed working closely with Fred over the last eight years and certainly understand his desire to retire and spend more time with the family and personal interests. Fred, you will be missed, and I look forward to working with you and Aflac's executive team to ensure a smooth transition until your official retirement day. And I wish you many happy years. As for me and the company, we have some outstanding candidates who are capable of running Aflac. It is my responsibility to continue to train and watch the progress of these potential heir apparent while the Board oversees the process. To be prepared for any unknowns, we have always had an interim CEO ready should something abruptly happen to me, as well as a strong process within the Board's corporate governance committee. I recently had a physical at Emory University and received an excellent report. So I plan on being around to prepare our leaders for the future and drive shareholder value. With that, I'll now turn the program over to Fred. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Dan. As announced last night, I plan to retire in September of next year to spend more time with my family and pursue other interests. It's a personal decision, but also a recognition of the very capable leadership team surrounding Dan and the company being in a very strong position. While I believe this is the best for me and my family, I also believe it is in the best interest of Aflac. I've enjoyed 25 years as an executive in the insurance industry and feel blessed to have worked with talented professionals and leaders throughout. However, the highlight has clearly been my time here working for Dan and for Aflac. Over the next year, I will be focused on transition and helping on select initiatives where I can add value. I'll now hand the call back over to Max. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Fred. For the third quarter, adjusted earnings per diluted share increased 27.8% year-over-year to $1.84 with a $0.06 negative impact from FX in the quarter. With this being the third quarter under the new LDTI accounting regime, we evaluate our reserve assumptions for morbidity, persistency, and mortality, at least annually, to see if an update is needed. If necessary, these assumptions will be unlocked on a prospective basis as they were in this quarter, leading to remeasurement gains of $205 million. Variable investment income ran $13 million or $0.02 per share below our long-term return expectations. We also wrote down certain software intangibles in our US segment, impacting our results by $0.04 per share. Adjusted book value per share, including foreign currency translation gains and losses, increased 10.3%, and the adjusted ROE was 15.6%, a significant spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premium for the quarter declined 2.8%, reflecting the impact of paid-up policies, our January 1 reinsurance transaction and deferred profit liability. Lapses were somewhat elevated but within our expectations. However, if adjusting for all these factors, the earned premium declined an estimated 1.7%. Japan's total benefit ratio came in at 65.1% for the quarter, down 170 basis points year-over-year, and the third sector benefit ratio was 54.8%, down approximately 460 basis points year-over-year. We continue to experience favorable actual to expected on our well-priced, large and mature in-force block. We estimate the impact from remeasurement gains to be 260 basis points favorable to the benefit ratio in Q3. Long-term experience trends as it relates to treatment of cancer and hospitalization continue to be in place, leading to favorable underwriting experience. Persistency remained solid with a rate of 93.5% but was down 80 basis points year-over-year. With product refreshments, we tend to experience some elevation in lapses as customers update and refresh their coverage, which was the case with the recently refreshed cancer and first sector products. Our expense ratio in Japan was 19%, down 100 basis points year-over-year, driven primarily by good expense control and, to some extent, by expense allowance from reinsurance transactions and DAC commission true-up. For the full year, we would expect to end up towards the low end of our expense ratio range of 20% to 22%. Adjusted net investment income in yen terms was up 7.2% as we experienced higher yields on our US dollar-denominated investments and related favorable FX and a return on our alternatives portfolio, more in line with our long-term return expectations. This was offset by transfer of assets due to reinsurance. In the quarter, we reduced our FX forwards and increased FX put options notional, leading to lower run rate hedge costs and a more efficient use of our investment risk capital. The pretax margin for Japan in the quarter was 32.8%, up 350 basis points year-over-year, a very good result for the quarter. Turning to US results, net earned premium was up 3.2%. Persistency increased 80 basis points year-over-year to 78.7%. This is a function of poor persistency quarters falling out of the metric and stabilization across numerous product categories, especially group voluntary benefits. Our total benefit ratio came in lower than expected at 35.9%, a full 890 basis points lower than Q3 2022. We estimate that the remeasurement gains impacted the benefit ratio by 12.1 percentage points in the quarter. Claims utilization remains subdued. And as we incorporate more recent experience into our reserve models, we have released some reserves. For the full year, we now estimate our benefit ratio to be materially below our outlook range of 47% to 50%. Excluding remeasurement gains, however, we are tracking well within the 47% to 50% outlook range. Our expense ratio in the US was 40.6%, up 70 basis points year-over-year. This includes a 190 basis points impact from a software intangibles write-down. Adjusting for this write-down, we are trending in the right direction. Our growth initiatives, group life and disability, network dental and vision, direct-to-consumer increased our total expense ratio by 330 basis points. We would expect this impact to decrease over time as these businesses grow to scale and improve their profitability. For the full year, we now expect our expense ratio to come in slightly above our outlook range of 37% to 40%. Adjusted net investment income in the US was up 13%, mainly driven by higher yields on both our fixed and floating rate portfolios and variable investment income in the quarter more in line with long-term return expectations. Profitability in the US segment was solid with a pretax margin of 28.8%, driven primarily by the remeasurement gains from unlocking. As you know, the commercial real estate markets are going through the worst cycle in decades, especially in the office subsector. We're seeing most property values quoted down 25% to 40%, but some distressed situations are driving market values down as much as 60%, far exceeding the 35% to 40% declines of the financial crisis. Our total commercial real estate watch list remains approximately $1 billion, with around two-thirds of these in active foreclosure proceedings. As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $34 million this quarter. We also moved two properties into real estate owned, which resulted in a $53 million write-down. We do not believe the current distressed market is indicative of the true intrinsic economic value of the underlying properties currently undergoing a foreclosure process. We continue to believe our ability to take ownership of these quality buildings and manage them through this cycle will allow us to maximize our recoveries. In our Corporate segment, we recorded a pretax loss of $49 million, which is somewhat smaller than a year ago, primarily due to our reinsurance transaction. Adjusted net investment income was $8 million lower than last year due to an increased volume of tax credit investments. Higher rates began to earn in and amortized hedge income increased. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $64 million with an associated credit to the tax line. The net impact to our bottom line was a positive $3.8 million in the quarter. To date, these investments are performing well and in line with expectations. We are continuing to build out our reinsurance platform, and I'm pleased with the outcome and performance. In Q4, we intend to execute another tranche with similar structure and economics to our first transaction from January this year. Our capital position remains strong, and we ended the quarter with an SMR above 1,000% in Japan. And our combined RBC, while not finalized, we estimate to be greater than 650%. Unencumbered holding company liquidity stood at $3.3 billion, $1.6 billion above our minimum balance. These are strong capital ratios which we actively monitor, stress and manage to withstand credit cycles as well as external shocks. US stat impairments were $4 million and Japan FSA impairments JPY2.9 billion or roughly $20 million. This is well within our expectations and with limited impact to both earnings and capital. Leverage remains at a comfortable 18.8%, just below our leverage corridor of 20% to 25%. The decline in the quarter is primarily driven by the weakening yen. As we hold approximately two-thirds of our debt denominated in yen, our leverage will fluctuate with movements in the yen-dollar rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in US dollar terms. We repurchased $700 million of our own stock and paid dividends of $248 million in Q3, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. I will now hand the call back to David to begin Q&A."
},
{
"speaker": "David Young",
"text": "Thank you, Max. Before we begin our Q&A we ask that you please limit yourself to one initial question and a related a follow-up. Then, you are welcome to rejoin the queue to ask an additional question. We will now take the first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question will come from Tom Gallagher with Evercore ISI. You may now go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Good morning. Dan, wanted to start with your comment about succession planning and having several strong candidates. Should we take that to mean you won't be looking to do an outside search to replace Fred? And are you looking to replace Fred in the COO role? A little bit of color on what you're thinking overall there. Thanks."
},
{
"speaker": "Dan Amos",
"text": "Sure. First, I would say that you have to understand that one of the reasons that we created the Chief Operating Officer and also for Fred to go to Japan, part of it was due to the COVID period of time and that we had a situation where with COVID, we wanted more interaction with Japan. And so Fred was willing to go over there and do that. And that was very helpful to us. And we continue to rotate people over to Japan and from Japan to the United States. And it's -- for example, Steve Beaver, who you probably know has been around a long time, will be working with him. As far as how and what will evolve, these decisions ultimately come from the Board. I think there's always two ways to look at transition and what would take place would be abruptness of something happening and then well it was structured. So we work with the concept that this will be planned over a long period of time and we've had internal candidates. It's always been my preference that it'd be internal candidates because of the Japanese operation and the uniqueness that we have there. Saying that, I would say the Board would -- the Corporate Governance Committee specifically and then the full Board would be reviewing every aspect to make sure you have the best person for the job. And so we would also take that into consideration as we're moving forward. As I said in my comments, I'm enjoying life. I'm enjoying working with the company and want to continue to do so. At the same time, these adjustments of people retiring and moving on happens, and I've been around to see a lot of them. But I think there's a little element of pride that keeps me around because of the family. And frankly, I just enjoy doing it. So I look forward to working with these people. There are several that are on the horizon. We continue to add new people that have potential. So I'm encouraged about that and I think we're in a strong position. I think this quarter sent a signal of how strong we are, managerially-wise, and we'll continue to do that."
},
{
"speaker": "Tom Gallagher",
"text": "Got you. Thanks for that, Dan. And just an operational question for my follow-up. Max, can you comment on what's behind the bigger reserve release in the US and if there's a go-forward earnings impact associated with that? I would have thought there might have been a bigger benefit coming from Japan, just given how strong and this efficiency of margins there are. So any -- maybe any color comparing and contrasting how the actuarial review stacked up US versus Japan? Thanks."
},
{
"speaker": "Max Broden",
"text": "Thank you, Tom. So obviously, this is the first year we're running on an LDTI basis, and the third quarter is when we do the unlockings, including prospective unlockings. When you think about it, if you go back and look at the last couple of years and you see the morbidity trends and also trends in hospitalization and outpatient treatment, and you compare and contrast Japan and the United States, in the US, we shut down a lot more than what you ended up doing in Japan as it relates to how people went to the hospital and how people changed their behavior. And that is coming through in our morbidity experience. So we did see, for example, accident hospitalizations, et cetera, drop a lot more in the United States than what you saw in Japan. And that was simply a factor of the COVID virus had a much more significant spread in the US than what it did have in Japan. In Japan, you really had a big spike in the third quarter of 2022. But outside of that, it was a significantly lower spread than what we had in the US. And that is why you're now seeing that having a much more pronounced impact on the morbidity experience that is feeding into our actuarial models that is then leading to the outcome that you saw this quarter."
},
{
"speaker": "Tom Gallagher",
"text": "Okay. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question will come from Jimmy Bhullar with JPMorgan. You may now go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hi, good morning. So Fred, I'm sure we'll be dealing with you a little bit more over the next year, but good luck in the future. I had, first, a question on just any updates you have on the potential tri-agency rules. And in sort of the worst-case scenario, what are the products that are in scope and what could be the impact on your business, assuming that the industry does not get any concessions from the rule as it's initially written?"
},
{
"speaker": "Virgil Miller",
"text": "Good morning. This is Virgil Miller from the US. I'll take that question for you. So we continue to advocate on behalf of our policyholders to provide them the protection when they need it most. The comment period is closed, but you can see and review our comments out there as well as others. I'll just say that we saw no impact in the third quarter to our sales. If you think about it, our hospital indemnity product could be one that's impacted. We had relatively flat sales in third quarter. But you've heard Dan mention in his comments about our cancer insurance protection plan. We saw our cancer sales up in the third quarter. I would say this also that remember, one of the considerations as part of the proposal is around pretax implications. Aflac has been selling, we were selling our policies without those pretax benefits long before it actually occurred years ago. So I think we'll be positioned well even if the rule were to pass."
},
{
"speaker": "Dan Amos",
"text": "Let me make one other comment. I was in Washington for three days about three weeks ago and met with probably 18 senators and congressmen to just see their positions on it. I want to go back to the pretax situation that Virgil was talking about because it was an anomaly. What actually happened was it ended up being passed. And we, as a company, back 20-something years ago, we didn't sell pretax for the first two years because the Congress said it was a mistake and it was never really meant to happen. And so once it was in the bill, then when they tried to take it, thought about taking it out, there would -- it looked like it was a [free tax] (ph). If they took it out, it became a tax on the average American. And you take, for example, a school teacher that has come down with cancer to, all of a sudden, say you're going to tax their benefits will not sit well with the contingency of people that they deal with. And so we were able to talk to a lot of people about it, and we had no feedback that thought that it should be the opposite. Now saying that, we know that this has been submitted by the branch outside Congress through the executive branch, and we've got to handle it and we plan on talking to them. But it is -- it will absolutely be a direct tax. But we sold in that environment. I'm one of the ones -- one thing about me being around a long time is I remember a lot of things. And we saw -- I was around when we sold in a pretax environment. In fact, I was in the sales force for 10 years and saw it. And so it's a matter of adjustment no matter what happens. And what I've always said is with change comes opportunity. And so no matter what happens, we're going to find a way to do well in that environment."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. And if I could ask just one more. Your comments on CRE seem fairly negative and the environment is pretty challenging as well. But how do you square the watch list of over $1 billion or around $1 billion with your CECL reserve, which seems pretty modest at around $34 million?"
},
{
"speaker": "Brad Dyslin",
"text": "Yeah. Good morning, Jimmy, this is Brad Dyslin. I'll take that. There's a couple of things behind the relatively modest reserving that you've seen so far compared to that $1 billion watch list. One is the average LTV of the portfolio and the price declines we've seen. What happens when we go through the foreclosure process is we have to mark that asset to the lower of the principal balance of the loan or the value of the asset. So when you're starting at a 60% LTV, you've got a fair amount of cushion before you start to realize losses on that mark. The second dynamic at play here is we are still in process on about half of that $1 billion of watch list, which means we are in workout negotiations with the borrower. Those can be very long-lasting, very intense and they can ebb and flow a lot of different directions. Once we get certainty that we expect to foreclose, we have to order a third-party appraisal. Those take time to come in. And as they come in, that's when we end up re-marking our assets. So it's a combination of our relatively conservative LTVs and the fact that we've still got about half that portfolio subject to appraisal."
},
{
"speaker": "Jimmy Bhullar",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question will come from Ryan Krueger with KBW. You may now go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "Hey, thanks. Good morning. My first question was on the changes you made to the FX hedging program. And I just wanted to confirm, you had a pretty major decline in the hedge costs in the third quarter versus the last couple of quarters. Just wanted to confirm that -- that's a reasonable expectation on the hedge cost going forward for the foreseeable future?"
},
{
"speaker": "Max Broden",
"text": "Yeah. Thank you, Ryan. Yes, I think what you saw in terms of hedge cost for the third quarter, it's a blend of us rolling into our new structure, so it's a mix between the old structure and the new structure. In terms of run rate hedge costs going forward, I do think that the third quarter hedge cost that you saw, it's certainly not going to be higher. We’re probably going to, on a run rate basis going forward, be at this level or slightly lower going forward in terms of actual hedge cost. That is obviously subject to capital markets inputs and everything that impacts the cost of a put option and also, to some extent, if we decide to increase our forward exposure in the future as well. So things like the FX volatility, interest rates, et cetera, will come into play here. But in the near future, I would expect our hedge cost to be similar to the third quarter level or slightly lower."
},
{
"speaker": "Ryan Krueger",
"text": "And there's no offset anywhere else, right, that would drop to the bottom line?"
},
{
"speaker": "Max Broden",
"text": "Sorry, Ryan, I didn't quite catch that. Can you repeat?"
},
{
"speaker": "Ryan Krueger",
"text": "I just want to -- there's no offset anywhere else that would drop to the bottom line?"
},
{
"speaker": "Max Broden",
"text": "The way to think about this in terms of the P&L, this will drop to the bottom line. When you think about the P&L here, what we have done when we move gradually from using forwards to put options, what happens is that we are now increasing the volatility for small moves in the yen-dollar as it relates to our capital ratios in Japan, i.e., the SMR and ESR. So for a strengthening yen or a weakening yen, you're going to see slightly higher volatility in that ratio for small moves. But what the put options give us is that we have dramatically reduced the tails. So any dramatic moves or shock moves in the yen-dollar, we have reduced our risk exposure to those kind of events. And we feel that this is a very good risk reward for us."
},
{
"speaker": "Ryan Krueger",
"text": "Thanks. And then on the reinsurance transaction, the transaction you did last year, I think, freed up $900 million of capital. But then I think around half of it or so was retained and then the other half was available for redeployment to shareholders. On this next transaction, would you expect closer to all of it to be available to return to shareholders?"
},
{
"speaker": "Max Broden",
"text": "We will deploy the capital appropriately in the respective business units, and if we have good opportunities to deploy the capital there, we will do so. If we feel that we have significant surplus capital, it will be moved up to holding company. And the holding company will deploy it in the different sort of capital distributions that the holding company generally does, i.e., dividends, buybacks, et cetera."
},
{
"speaker": "Ryan Krueger",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question will come from Suneet Kamath with Jefferies. You may now go ahead."
},
{
"speaker": "Suneet Kamath",
"text": "Thanks, good morning. I just wanted to follow up to Tom's question on the US reserve releases. It sounded like some of the benefit here was lower hospitalizations in the US due to COVID. And I just want to understand, are you assuming that kind of that lower level of hospitalization sort of persist going forward? Or are you assuming some sort of reversion to historical trend?"
},
{
"speaker": "Max Broden",
"text": "Let me kick off on that question, and I would ask Al Riggieri to fill in any blanks and add his color as well. But the fact of the matter is that we have seen lower levels, generally speaking, in terms of hospitalizations come through. And we've also seen changes in the way treatments are being done, i.e. more outpatient treatments as well. So we believe that we have seen a shift in both the way hospitals are operating and also the way individuals are going for their treatments. And we have factored that in to some extent."
},
{
"speaker": "Al Riggieri",
"text": "Yeah. This is Al Riggieri. Just to add in a little bit on that. Remember, the COVID period dropped all hospital utilization, treatment patterns. Many of that during COVID would have some ups and downs during the period as hospitals had more capacity and people would return and get elective surgeries and all that. What we did this year was begin to recognize that 2022 was the first year in the United States where you would say that the pandemic was kind of in the rearview mirror. So we broadened the experience for 2022. We did still remove the experience, very low experience during COVID period. We brought in the post-COVID period, we called it, for 2022. And as Max was saying, continued to see even in that period in '22, that we did have lower experience. So we've built that into the experience base or updating the assumptions."
},
{
"speaker": "Suneet Kamath",
"text": "And I think, Max, you said you factored some of that into your reserve. Is it -- does that mean that if things sort of persist the way they are, that there would be the potential for some more reserve releases down the road?"
},
{
"speaker": "Max Broden",
"text": "We believe that we have adequately reflected sort of the new paradigm or the new experience that we're seeing now into our models. Now, please remember, these are obviously models. So what that means is that if these trends were to improve further than what we have experienced to date, there is the potential for further unlocking, favorable or negative. It can go the other way as well. We believe that we have reflected it to our best -- the best way we can, given the data that we see. And it's important that we do reflect it to the best way we can. But I also want to make sure that you understand that these are estimates and they can go both ways."
},
{
"speaker": "Suneet Kamath",
"text": "Yeah. No, that makes sense. My other one is on Japan and the earned premium drop of 1.7% sort of adjusted. I would have thought at some point, the impact of the paid-up policies would sort of have run its course. And I know some of those policies were very long-dated, but I believe that they were sold quite a bit ago. So are we getting closer to the point where that impact is expected to fall off?"
},
{
"speaker": "Max Broden",
"text": "So when we look forward into the paid-up schedules, you are going to see a little bit of a drop in 2014 -- sorry, 2024, and then a further drop in 2025. And that's where I would say that I would expect us to run more on a normalized basis for paid-up. Keep in mind that the big sales that we had of the WAYS product, they really occurred in the 2012 through 2014 time period, and there was five-year pay and there were 10-year pay. So when you roll that forward, that's when you see that you get a little bit of a drop-off in 2024 and then further in 2025. That being said, paid-up is something that we generally build into our products, both first sector and third sector. But when we -- I wanted to mention 2024 and 2025 because that's when we move into a more normal schedule, and you're not necessarily going to see these more significant year-over-year deviations."
},
{
"speaker": "Suneet Kamath",
"text": "Okay. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question will come from Alex Scott with Goldman Sachs. You may now go ahead."
},
{
"speaker": "Marly Reese",
"text": "Good morning. It's Marly on for Alex. I was hoping you could provide a little more color on the Japan Post sales and partnership. It looks like it's been progressing, so I was hoping to hear a little more on this versus the longer-term sales guidance."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] This is Yoshizumi. I oversee the entire sales in Japan. [Foreign Language] The sales of our cancer insurance, new cancer insurance wings and also lump-sum serious disease benefit rider continues to be very strong. [Foreign Language] We will continue to aim at growth in cancer insurance sales by providing sales support to the sales offices and post offices of Japan Post Company and Japan Post Insurance nationwide, including sales process management and the sharing of good practices. [Foreign Language] We are also actively working on the training and also developing of the sales agents across all the branches nationwide by sharing good practices and best practices. [Foreign Language] And we are expecting to have growth in sales even more by having all these activities done in a solid manner. [Foreign Language] And that's all for me."
},
{
"speaker": "Dan Amos",
"text": "Yeah. I want to make one other comment. We've been waiting for Japan Post to come back for several years now. And we had assurances that they would do that and I'm happy to see it take place. They are our largest shareholder. And so what is good for us is good for them and vice versa. So I believe this is a strong alliance and will continue to be strong as we move forward."
},
{
"speaker": "Marly Reese",
"text": "Thank you. And then just as a follow-up, if we could turn to capital a little bit, would you mind providing an update on what you view as near-term versus longer-term capital management priorities or capital deployment?"
},
{
"speaker": "Max Broden",
"text": "So obviously, the capital ratios in our subsidiaries, they are strong, and that's obviously priority number one to make sure that we have adequate and strong capital in our operating subsidiaries. And then obviously, we want to move operating cash flow up to the holding company and then deploy it from there. You did see that in the quarter, we bought back $700 million of our own stock. I view that as quite a strong capital deployment. And we also increased the dividend by 19% starting in the first quarter of next year. So overall, the company is generating significant cash flow, and we are deploying significant cash flow as well."
},
{
"speaker": "Marly Reese",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question will come from John Barnidge with Piper Sandler. You may now go ahead."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thanks for the opportunity. Fred, congrats on the retirement. Question is around Japan and the expense reduction efforts. I know there was a paperless effort and other expense efficiencies. Have you already completed any required software installations or do you have any planned upcoming? Thank you."
},
{
"speaker": "Fred Crawford",
"text": "Why don't I just make a couple of comments on that, and then Koide-san can comment. But what we are focused on in Japan from an efficiency perspective is digitizing the platform. That's the major thrust of what we're looking at, which is a long-term plan of investment followed by returns. And that is a plan to digitize or increase the usage of digital applications away from paper applications, the use of digital self-service where policyholders go online and serve themselves through technology as opposed to inundating our call center and then claims payments or digital claims. We've been making steady progress on both the digital application front and on the customer self-service, but we are engaged currently in updating those tools. Think of it as no different than your iPhone 1 to iPhone 11. We are updating those tools to modernize them and improve the customer experience. We have been in a proof of concept over the last year and, in fact, have moved those digital adoption rates up. And so with that will come natural efficiencies over time but it will take time. So it's a long-term progress of moving customer and agent experience to digital and away from paper, but that will yield benefits. The claims side of it is more stubborn. And the reason for that has nothing to do with Aflac. It's because the Japanese healthcare system is a paper-based healthcare system that requires the exchange of paper forms when one goes to the doctor. That's really requiring a modernization of the healthcare system in Japan. And interestingly, they actually do have an effort underway to attempt to modernize or digitize the healthcare system. But until that takes place, our ability to process claims digitally will be somewhat contained. But over time, we expect to improve. So what you should expect as investors is that over the long time, we will be increasing that digital adoption. It will yield a lower per-policy expense outcome from an administrative standpoint, but it will be over multiple years of slow and steady progress because this is about adoption, it's not about installing software, okay?"
},
{
"speaker": "John Barnidge",
"text": "Very helpful. Thank you very much. And then on the investment portfolio, those properties you took keys, can you maybe talk about the occupancy rates in those versus the ones that remain on the watch list? Thanks a lot."
},
{
"speaker": "Brad Dyslin",
"text": "Sure, thank you. The two properties that we took back, the current occupancy levels are in the low to mid-50s, which has been pretty stable since we first got involved and did the loan. The occupancy across the portfolio, it does range a fair amount. We've got a few that are below 50%, given the nature of the asset class, the nature of transitional real estate. But for the most part, our averages are right around the 55% to 65%."
},
{
"speaker": "John Barnidge",
"text": "Thank you very much."
},
{
"speaker": "Operator",
"text": "Our next question will come from Wilma Burdis with Raymond James. You may now go ahead. Pardon me, Wilma, your line is open for question."
},
{
"speaker": "Wilma Burdis",
"text": "Thank you. Good morning. Is it fair to think that Aflac can rewrite its hospital indemnity policies to comply with the potential DOL-HHS rule without compromising the attractiveness of the product? And has Aflac started to work on this? If so, does the burden appear manageable?"
},
{
"speaker": "Virgil Miller",
"text": "This is Virgil from the US. We absolutely are taking precautions to make sure that we prepare just in case the proposal does go through, and we are confident that we can do that. We've been continuing to enhance our benefits while current policies are out there. I think Dan stated earlier, we were clear that we've sold before in an environment without some of the pretax benefits that currently exist, and we're confident we'll be able to do that again. We have a random process here that we are always looking to innovate and reinvent our products and enhance our benefits. We demonstrated that this past year with our cancer enhancements we did that really had no additional cost to our policyholders. So you can expect more of the same related to that."
},
{
"speaker": "Wilma Burdis",
"text": "Okay. Thank you. And then I just want to confirm, I know you guys sort of said it but I just want to make sure that I understand. In the reinsurance deal that you just recently completed, you freed up around $900 million of capital, and it sounds like that could either be used to reinvest or maybe ultimately for shareholder returns."
},
{
"speaker": "Max Broden",
"text": "Yeah. Obviously, our priorities with all the capital that we have is always to deploy it into writing new business and use it in our operating entities. That is where we get generally the best IRR on that capital. If we cannot deploy it in our operating entities, then it will flow up to the holding company."
},
{
"speaker": "Wilma Burdis",
"text": "But it was around $900 million is what you freed up for that?"
},
{
"speaker": "Max Broden",
"text": "Yeah, that is our estimate, yes."
},
{
"speaker": "Wilma Burdis",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question will come from Josh Shanker with Bank of America. You may now go ahead."
},
{
"speaker": "Josh Shanker",
"text": "Yes. Thank you. When I think about the commercial loan portfolio, are the properties most at risk, those that have been more recently loaned to or the ones that have a longer vintage in terms of when they were established? And along those lines, when did you cool the deployment of new investment flows into commercial loans?"
},
{
"speaker": "Brad Dyslin",
"text": "Sure. Thank you, Josh. The loans that we're dealing with now that are on the watch list are those that were made a couple of years ago. The transitional real estate book is our biggest focus area, and that differs from a more traditional CML book in that the maturities are much shorter. They tend to be three-year fixed maturities with options to extend up to five, in some cases, up to seven years based on certain thresholds and the operating metrics being met. So what we're dealing with now are those maturities predominantly in 2023 and a few in 2024 as obviously, the maturity is coming up and when those loans need to be addressed, either being repaid or if that is not an option, then we get into the workout discussions. We have really substantially reduced our deployment into the asset class this year. Part of that is the market -- well, not part of it, it is frankly driven by the market. Very much a lack of activity. We're seeing a large bid ask between buyers and sellers. The increase in rates has really put valuations upside down. Buyers are trying to get -- take advantage of the current levels. Sellers are trying to get yesterday's prices, and we're just not seeing a lot of good, solid transactions, and there's a lack of liquidity in the market. So that's really limited our opportunities. And of course, we always adjust our underwriting standards to the current experience, to the current market. So we're being a little bit more difficult in our terms and conditions as well."
},
{
"speaker": "Josh Shanker",
"text": "And then related, is there any way you can frame the capital consumption or rating agency charge for those two properties? What was it before they were converted into wholly-owned properties and what is it now?"
},
{
"speaker": "Max Broden",
"text": "Yeah. So when they move from being a CML to real estate owned, there is a significant uptick in terms of the capital charge associated with that. For us, it's still very small. So if you think about RBC points, it's very -- I would estimate it to be low single-digits. And as it relates to SMR, the same applies. When you then think about the -- you generally should think about the distribution on what balance sheet or capital base if they go into as follow it the same way the size of the investment portfolio is between the two segments, i.e., roughly 85% falls into Japan and 15% falls into the US."
},
{
"speaker": "Josh Shanker",
"text": "Okay, thank you very much for that."
},
{
"speaker": "Operator",
"text": "Our next question will come from Wes Carmichael with Wells Fargo. You may now go ahead."
},
{
"speaker": "Wes Carmichael",
"text": "Hey, good morning. Just wanted to follow up on capital a bit. Max, I know you said that your first priority is to deploy that within the subs on organic. But to the extent that there's not that opportunity, I just wanted to get your thoughts around potential M&A and given that you've got pretty significant excess at the holdco and subs."
},
{
"speaker": "Max Broden",
"text": "Yeah. We -- if you think about what our track record, you have seen what we have done historically. Aflac has not been an acquisitive company. This is a company that is built selling one policy at a time. We've done a number of, I would call it, tuck-in acquisitions in the United States to broaden our product portfolio. And we do feel that we are in a good spot in terms of the products that we have to offer in our go-to-market strategy. So at this point, I don't see that we have any holes that need to be filled using M&A."
},
{
"speaker": "Wes Carmichael",
"text": "Got it. Thanks. And then maybe just a follow-up on the middle market loan book away from commercial real estate, it seems like that's -- the book yield now is near 11%. So just wondering if you're seeing any terms and any collateral deterioration. And if interest rates remain high for a year or so, like, do you expect defaults within that portfolio?"
},
{
"speaker": "Brad Dyslin",
"text": "Yeah. Thank you. So far, we have been extremely pleased with the performance of the middle market loan portfolio. It is, frankly, performing better than we expected, given where we are at this point in the cycle. There are several reasons for that. And then ultimately, it boils down to fundamentals, underwriting and then how we've chosen to build the portfolio. We have a very small average loan size. We have maintained a discipline around only first-lien secured structures. We've kept leverage at a very modest level. We have maintained our use of strong covenants. And then ultimately, it's about good businesses, good companies with sound business plans that are seeing good top line growth and have the margins and cash flow, avoiding cyclical companies, and that's really played out. We have built this as our primary below-investment grade portfolio. So we do expect to incur some losses. But relative to the outsized yields we've received, they are really quite modest. And as I said, it is doing better than we expected at this point in the cycle. Going forward, we're going to have to wait and see just how the macro environment does. It does look like we've got the possibility of a soft or at least a soft-ish landing. And then how quickly rates turn around is something that we're going to watch very closely."
},
{
"speaker": "Wes Carmichael",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question will come from Joel Hurwitz with Dowling & Partners. You may now go ahead."
},
{
"speaker": "Joel Hurwitz",
"text": "Hey, good morning. So RBC is strong at over 650%, well above your 400% target. Can you just talk about plans in managing that down towards the target?"
},
{
"speaker": "Max Broden",
"text": "So obviously in the US, we are seeing some growth, and we're seeing some growth in lines of business that are driving a little bit more new business strain. And that's why we have, in the pandemic, we wanted to run with a little bit more capital and then coming out of the pandemic, we see a little bit higher strain associated with that growth that we are starting to see and expect to see come through. That has led us to run with a little bit higher RBC than what -- than the 400%. But we are at a point in time now where I would expect us over the next couple of years to really get down to that 400% level long term."
},
{
"speaker": "Joel Hurwitz",
"text": "Okay. And do you expect that to be driven by the needs for growth or do you expect to actually draw that down with outsized dividends to the holdco?"
},
{
"speaker": "Max Broden",
"text": "The preferred option would be to drive it by growth because that's where we're getting the best returns on our capital by just writing more policies. At the same time, our -- even though we have some lines of business that are consuming a little bit more capital, overall, we're a relatively capital-light business. So given that we're operating at a 650% RBC right now, I don't see that growth alone will necessarily drive us all the way down to 400%. In order to do so, we probably would, over time, need to address our capital base through special dividends, et cetera."
},
{
"speaker": "Joel Hurwitz",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you, Anthony, and thank you all for joining us this morning. While we are not hosting our financial analyst briefing this year, we will be in 2024, but we will also be giving an outlook for 2024 on our fourth quarter 2023 earnings call. In the interim, please reach out to the Investor and Rating Agency Relations team if you have any questions, and we look forward to speaking to you then. Everyone, have a great day. Thank you."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 2 | 2,023 | 2023-08-02 08:00:00 | Operator: Good morning, and welcome to the Aflac Incorporated Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor Relations. Please go ahead.
David Young: Thank you, Jeff. Good morning and welcome. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated; Fred Crawford, President and COO of Aflac Incorporated will touch briefly on conditions in the quarter and discuss key initiatives; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments, will provide an update on the investments. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com. We also posted under Financials on the same site, updated slides of investment details related to our commercial real estate and middle market loans. In addition, Max Broden, Executive Vice President and CFO of Aflac Incorporated, provided his quarterly video update addressing our financial results and current capital and liquidity. Max will be joining us for the Q&A segment of this call along with the following members of our executive management in the US: Virgil Miller, President of Aflac U.S.; Al Roziere, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac US. We are also joined by members of our executive management team from Aflac Life Insurance Japan: Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan. Dan?
Daniel Amos: Thank you, David. And good morning. Glad you joined us. Reflecting on the second quarter of 2023, our management team, employees and sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for the policyholders when they need us most, just as we promised. Aflac Incorporated delivered very strong earnings for both the quarter and the first six months. We remain actively focused on numerous initiatives in the United States and Japan around new products, distribution strategies to set the stage for future growth. Looking at the operation in Japan, we have continued our rollout of our WINGS cancer insurance, and refreshed WAYS and Child Endowment policies. By introducing new refreshed products, we positioned our distribution channels for success, as Japan makes great strides in recovering from the pandemic. I am very pleased with our new sales premium increase of a 26.6% increase in Japan. This reflects a 60% increase in cancer insurance sales versus the second quarter of 2022 and a significant contributor from Japan Post Company and Japan Post Insurance, which began selling our new cancer product in early April. I'm also pleased to see improvements in our sales through agencies and our other strategic alliances, Daido Life and Dai-ichi Life. We also continue to gain new customers through WAYS and Child Endowment, while also increasing opportunities to sell out third sector products, which Fred will address in a moment. Thus far, our product strategy has served us well. And I'm encouraged by our progress as we prepare for the anticipated mid-September launch of our new medical product. In addition to our products, we know how important it is for us to be where the customers want to buy insurance. Our extensive network of distribution channels, including agencies, alliance partners, and banks, allow us more opportunities to help provide financial protection to Japanese consumers, as we are working hard to support each channel. Turning to the US, I remain encouraged by the continued productivity improvements of our agents and the contribution from growth initiatives. We continue to see success in our efforts to reengage our veteran associates. At the same time, we're seeing strong growth through brokers. I'm very excited at our cancer protection insurance policy, which provides enhanced benefits at no additional cost. We know that when people experience the value of our products, it increases persistency which benefits our policyholders and lowers our expenses. I believe that the need for the products and solutions we offer is strong or stronger than it's ever been before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers. As always, we are committed to prudent liquidity and capital management. We continue to generate strong investment results, while remaining in a defensive position as we monitor evolving economic conditions. In addition, we have taken proactive steps in recent years to defend cash flow and deployable capital against a weakening yen. We remain committed to extending our track record of annual dividend increases, supported by the strength of our capital and cash flows. At the same time, we remain in the market repurchasing shares with the tactical approach, focused on integrating the growth investments we have made in our platform to improve our strength and leadership position. Overall, I think we can say that it's been a very strong quarter, especially with the vast number of factors that are in our favor. Aflac Japan had a strong quarter of sales as we executed product and distribution strategy. Aflac U.S. continued to build on its momentum as it nears pre-pandemic sales level. Pre-tax profit margins remain very strong in Japan at 30.4% and in the US at 22.2%. Plus, our capital ratios remain very strong and our quarterly share repurchase was, like last quarter, one of the biggest in the company's history. So with that, I'll turn the program over to Fred. Fred?
Frederick Crawford : Thank you, Dan. Let me begin by briefly commenting on conditions in Japan. As Dan commented on our revised cancer product, which we refer to as WINGS, is doing well, now introduced in the Japan Post group. Having rolled out WINGS in Japan Post, we are now at full strength with this refreshed product in all channels. Our entire cancer platform, including in-force policyholders, is now supported by our Yorisou Cancer Consultation services. This platform provides conscientious care to cancer policyholders connecting them with non-insurance services. In dialogue with key alliances and distribution partners, we continued to receive feedback that this platform is a differentiator in the marketplace. From a data perspective, our market research has shown a positive and meaningful impact to our net promoter scores. The sales of WAYS and Child Endowment continues to deliver on our strategy of attracting younger and new policyholders, along with cross sell performance. Since the launch of our refreshed WAYS product, approximately 80% of sales are to younger customers below the age of 50. This cohort of younger buyers has driven a concurrent third sector sales rate of approximately 50%. Looking forward, we anticipate launching our new medical product mid-September. As mentioned last quarter, this product design has been simplified to appeal to both younger policyholders with basic needs, and older or existing policyholders who desire upgrading coverage. As we move through the natural product renewal cycles, we believe simplifying our products is key to driving sales productivity, attracting new and younger policyholders, and lowering our operating costs. Turning to operations, we are pleased with our expense ratio traveling below 20% in the first half of the year and in the face of continued revenue pressure. We are actively working to increase digital adoption focused on new business applications, customer self-service and claims. As we look forward, we anticipate increased levels of investment to drive digital adoption, with the goal of remaining competitive by lowering our long term operating expenses on a per policy basis. Turning to the US, our second quarter results followed a similar pattern as the first quarter with individual, dental and vision, group life and disability and consumer markets, all contributing to sales growth. Group voluntary sales has been down modestly from a strong 2022. However, we remain encouraged by the level of quoting activity that we believe positions us for a stronger second half of the year. Our growth platforms of dental and vision, group life and disability, and consumer markets are beginning to have a more material impact on performance. In aggregate. sales produced by these platforms are up over 50%, albeit off a smaller and building base. With the build largely behind us, we are focused on driving scale, stabilizing new platforms and leveraging our ability to bundle core voluntary products as we work with brokers on larger groups. We are absorbing a pace of investment in growth platforms that pressures our expense ratio, but naturally precedes revenue development. This is particularly the case in our group life and disability business, which is more capital intensive. As we settle into operating these platforms, we're also refining our approach to drive expense efficiencies and a long term path to profitability, in some cases making decisions around business we choose to exit and opportunities we aggressively pursue. Last quarter, we commented on our renewed focus on product development in the US. Our refreshed cancer product is up roughly 23% and still in the early stages of rollout. Of all the critical illnesses, cancer remains the most frequent and devastating to families and their financial security, and we have high expectations for this product. Last week, we announced a new group voluntary term life product, which is part of an important effort to increase our overall worksite and life sales. We have lagged in terms of life sales and see this product line as an area where we have market share opportunity. Like cancer insurance, this is a product that should contribute to improved persistency. We are pleased to see a return to earn premium growth in the US and modest recovery in persistency. We continue to drive utilization through wellness campaigns and benefit endorsements to in-force policies, with the objective of improved sales, persistency and driving core revenue growth. Now, let me pause and I'm going to turn the call over to Brad Dyslin to bring you current on the health of our investment portfolio with a focus on the loan book. Brad?
Bradley Dyslin : Thank you, Fred. During the last quarter's call, we provided an update on our loan portfolios with a special focus on our middle market direct lending and real estate mortgage holdings. I am pleased to report that both of these portfolios continue to perform in line with the expectations we shared last quarter. Let me start with commercial real estate. As a reminder, most of our exposure is to transitional properties, where we make short-term floating rate loans to facilitate the assets repositioning in the local market. TRE comprises $6.4 billion, or about three-fourths of our total $8.1 billion commercial mortgage loan portfolio, with the balance held in more traditional longer term fixed rate loans. Our commercial real estate loan watchlist has remained constant at approximately $900 million and consists almost entirely of TRE office properties. The workout process for these loans is complex, and negotiations with the property's owner tend to be very fluid, a dynamic we follow very closely. As a result, our foreclosure watchlist gets updated relatively frequently as negotiations with the property owner ebb and flow. However, the total value of these loans has also remained relatively stable, with only a modest increase from first quarter. As we mentioned last quarter, when a loan foreclosure is likely to occur, we must mark the carrying value of our loan to the fair market value of the underlying property assets. With our average loan-to-value of 65%, this accounting process resulted in a small $11 million of additional reserves in the quarter. This brings the total amount of additional reserves recognized in the first half of the year to $21 million, which represents about 26 basis points of our $8.1 billion total commercial real estate portfolio, and is the result of property value declines generally in the range of 25% to 40%, price drops that are in line with those of the financial crisis. If you simply apply a 40% price decline across our entire $900 million watchlist, we would expect very manageable additional reserves of $50 million. Once the property goes into foreclosure proceedings, we no longer accrue interest on the loan, but instead realize the net operating income from the property. Given the transitional nature of these properties, we will see a decline in net investment income from this change. When considering overall investment performance, we do not expect this to have a material impact to enterprise NII. While we are not immune from the industry pressure in commercial real estate, we remain confident in the quality of the property supporting our loans. Our strong capital position and ample liquidity allow us to be a patient investor as we manage through the downturn to maximize our overall economics. I am pleased to report our portfolio of loans to middle market companies continues to perform well and is exceeding our expectations for credit losses at this point in the cycle. Recall this is our primary outlet for below investment grade exposure and was purposely built with a quality bias to perform well during difficult periods for credit. Our strategy of allowing only modest levels of first lien leverage on growing companies in non-cyclical industries, owned by supportive sponsors, is delivering strong risk adjusted returns. Finally, you may have seen the announcement last month that Varagon Capital is being acquired by Man Group, a leading UK alternative asset manager. As part of this transaction, as was announced, we are exiting our equity position in Varagon, but will remain a major client. We generated strong returns on this strategic investment, realizing over 3 times our invested capital, in addition to solid performance on the $3 billion of middle market loans Varagon had managed for us the last three plus years. Varagon has proven to be a great partner and terrific investor and we are excited about their future as part of the Man Group. Our relationship with Varagon and our other current strategic equity partners is a valuable part of our strategy for accessing certain specialized private asset classes that have a strategic role in our portfolio. We continue to invest significant amounts in these high value-add forms of private credit. We look forward to continuing to execute on the strategy and creating additional value through an ownership presence in these important asset classes. Let me turn it back to Fred.
Frederick Crawford : Thank you, Brad. As Brad noted, we follow the disciplined approach that began with building out our external manager program that matured into taking a minority interest in select managers. These investments have produced strong returns and we intend to expand upon this strategy as opportunities present themselves. Market conditions remain volatile as both the US and Japan economies go through a period of transition. Last week featured moves by both the Fed and the BOJ. The US is looking to calm down inflation and avoid recession, while Japan continues to maintain its ultra loose monetary policy as economic and inflationary uncertainty remain high. As Max noted in his recorded comments, through investment strategy, hedging, and capital engineering, we have greatly reduced our enterprise economic exposure to movements in the yen. In addition, our low asset leverage places us in a naturally strong position to absorb weak or volatile economic conditions and maintain capital deployment plans. I'll now turn it back to David to take us to Q&A. David?
David Young : Thank you, Fred. Before we take questions, I want to ask that you please limit yourself to one initial question and a follow-up before getting back in the queue to allow other participants an opportunity to ask a question. And, Joe, we will now take that first question.
Operator: Our first question will come from Tom Gallagher with Evercore ISI.
Tom Gallagher: It was encouraging to see the growth in Japanese sales. I guess the question I have related to it is two parts. One is, how do you see the contribution from Japan Post building out? Is that continued gradual slow ramp or are you seeing any signs of stronger acceleration there? I guess the follow-up is, while there were good sales, the overall top line in terms of earned premium was a bit soft. So, can you talk about your expectations for earned premium and what's weighing on that and not allowing the sales improvement to necessarily translate?
Frederick Crawford: Let me let me start by making just a couple of comments. And then I'll hand off to some of the folks around the table to contribute. Tom, this is Fred. First on sales results and Japan Post in the quarter, as you may know or may remember, based on our alliance, we don't comment on some of the specific results coming out of those channels. But what we certainly can say is that the launch of the cancer product in the quarter was the majority contributor to the increase in cancer sales that you saw in our results. For example, in the first quarter without being launched in Japan Post, our sales were up in cancer around 25% or so. And as Dan mentioned in his comments, in the second quarter, we were up around 60%. And you can safely assume the majority contributor of that was from Japan Post. Your question then is what about continuation. And our view is that there is still much more runway in Japan Post over the long term, predominantly as they build efficiency in their distribution channel and more and more agents take on the cancer product and begin producing. So, we do think that there's a continuation of upside in Japan Post. However, it is also the case that, commonly, right when you launch the product, you'll have an immediate jump in sales in the early months followed by a calming down. But let me just turn to Yoshizumi-san and/or Koide-san if they'd like to comment or add any color beyond what I just said.
Koichiro Yoshizumi: [Foreign Language] This is Yoshizumi-san. Let me answer your question regarding JP. [Foreign Language] Well, let me mention about that new products launched into the Japan Post channel. The cancer product in the Japan Post channel was launched in April. And towards this April timing, we have been conducting trainings to the Japan Post company, the postal company as well as Japan Post Insurance since January throughout their entire nationwide post offices. [Foreign Language] We do believe that steady increase of sales by the Japan Post has a result of us conducting these kinds of trainings as well as offering our support to them directly after the launch of the product. [Foreign Language] And since the second quarter between Japan Post and Aflac, we have been confirming each layer, each level sales process at the management level and we'll be managing these processes at each level. [Foreign Language] And what that means is that we will try to identify where the issues are at each management level. And we are checking those items on a monthly basis. And we are also offering solutions to these issues and solving them on a monthly basis. [Foreign Language] As a result of all of these, we do believe that cancer sales will gradually increase going forward as well.
Frederick Crawford: Tom, your second question was related to revenue in Japan and how to think about it. obviously, having to take into account both our reinsurance agreement and paid up policy, so I'll ask Todd to address that.
Todd Daniels: I think that one thing to remember when we went to LDTI accounting. We had to move our deferred profit liability from the benefits line to the earned premium line. And that's going to create a little bit of noise, in that it's not going to be as stable as it was before. But as Fred said, the reinsurance transaction that we entered into at the beginning of the year caused about ¥8 billion reduction in earned premium in the quarter. The paid up impact is also still there. And that was, again, about ¥8 billion. When you normalize for those two factors and considering the DPL, we're still in the right in the middle of the range that we gave for guidance for earned premium at approximately minus 1.9%.
Max Broden: Tom, I would just add as well, if you look at it long term, for us, to sort of get to a level where we are replacing the business that is falling off, i.e. get to an earned premium growth of zero, we need to essentially get back for all distribution channels to pre-pandemic levels in terms of production and also have the Japan Post channel get back to a restored production level.
Operator: And our next question will come from Alex Scott with Goldman Sachs.
Alex Scott: First one I had for you is on some of the comments that were made in the remarks video that you all post. It was mentioned that the [indiscernible] are continuing to run favorable in what you're seeing in the claims activity and the benefit ratios. I was just interested what the updated view is on whether that's temporary, associated with utilization levels, potentially being temporarily depressed versus maybe something that you guys have just seen longer term and that you potentially need to adjust in your long term assumptions?
Daniel Amos: This is Dan. I kind of mentioned that [indiscernible] Todd or whoever. But it has continued to run at a lower rate than we have anticipated year after year after year. And we have tried to counter that with different things from increased benefits on certain policies when a new one came out, but for some reason you're seeing more and more trends to do – well, we know one, outpatient treatments and things of that nature as we're seeing changes take place where we have to adapt accordingly. But some of the policyholders don't change over policies. And that's something that we continue to monitor and encourage people to do. If you specifically want to talk about US, that's a great example. The wellness benefit hadn't been used as much. So we have really encouraged that. We're seeing that improvement. And we feel like that will be reflected in a positive manner. I think Virgil might touch on that, if he's around to say something. Virgil?
Virgil Miller: Yes, utilization continues to be our focus in the US. We have launched a series of wellness campaigns really driving our policyholders to leverage the coverage. I think Fred or Dan mentioned that we've seen over a 22% increase in wellness utilization during that time period, which started about the first quarter of the year. And we're going to continue to do that. Our main thing is to drive and demonstrate value. We know that the average American has less than $1,000 in savings out there. So there's a benefit to them that make sure they're prepared for any unexpected medical event. And also, getting regular checkups will help anyone that gets diagnosed with some catastrophic disease like cancer. It helps them, of course, be able to get the right treatment and save their lives. So we're going to continue to push on that. And I expect us to see continued improvement going forward.
Max Broden: Alex, just to sort of add in terms of utilization, if you think about it, the US is absolutely out of the pandemic. And you should expect the utilization to sort of get back to sort of as normal level at this point. I think we're still a little bit off where we should expect some rebound on utilization. But, definitely, the vast majority of the benefits that we offer should run at more normal levels at this point. And so, what we're doing, as Dan and Virgil alluded to, we are enhancing our products for that because we have not seen utilization bounce back to pre-pandemic levels. And so why is that? Well, there are some fundamental differences that have happened during the pandemic. There's definitely less usage of emergency rooms that we see in the data, greater use of local facilities, greater use of outpatient services rather than in-hospital services. All of this leads to lower claims utilization overall for us. If you go to Japan, we continue to see the long term trends of shorter hospitalization stays, especially as it relates to cancer. We have seen first diagnosis, i.e. diagnosis of cancer, bounce back to more normal levels. But the surgeries and hospitalization trends are still pretty muted. And we believe that that's more driven by greater use of outpatient services as well in Japan as well because we see that increase. Overall, the mathematic effect of this is that it leads to a lower benefit ratio overall for us if these trends continue to stay in place.
Alex Scott: A follow-up I had is just on Japanese interest rates. I was interested in just how it affects your strategy in terms of – if you all are thinking through different products that you may emphasize more in higher rate environment, as well as on the investment side, choices you're making between USD investing and yen investing?
Frederick Crawford: I'll let Brad comment on the asset allocation question. I think relative to the business model, as you may know from some of our previous comments, we continue to work on what we call internally, our asset formation product strategy in Japan. That's most notably surrounding the WAYS product and refreshment and refinement of the WAYS product, training and development around that product and working with customers and then, of course, an emphasis on cross selling. What we've also mentioned, Alex, in the past is that not only as a recent recovery – I'd put recovery in quotes, of course – but recovery in rates in Japan helped with supporting those types of products. Also, importantly, is building out our reinsurance strategy because there's no question reinsurance is going to play into the long term viability of those types of products and maintaining economic value as a company. So, yes, some rise in rates is supportive of asset formation products. And we pay attention to that. But as you can see, there's a long way to go before we characterized the rate environment as supportive of strong profitability in those products. You still need some heavy engineering. And you absolutely are in that business for the cross sell experience and bringing younger policyholders into the fold that we can cross sell into the future. Brad, comments on…?
Bradley Dyslin: In terms of investment activity, the rise in yen rates is certainly welcome news. It's been a long time since we've had these kinds of levels. But one of the biggest issues we face in Japan is finding attractive spread products. And that remains our biggest challenge. We continue to take advantage of those opportunities when we can find them. We have been relatively successful in finding yen credit where we can get an acceptable level of pickup over JGB yields for what we think is a pretty acceptable level of risk. And although the rising race is definitely welcome, it still pales in comparison to what we're able to get in some of the dollar assets. So we'll continue to always be active there, but you shouldn't expect to see a big wholesale change in strategy, at least not yet.
Operator: Our next question will come from Suneet Kamath with Jefferies.
Suneet Kamath: I want to go back to some of the comments that you're making on utilization, both in Japan and the US. It seems like things are moving in the right direction. My question is how quickly did these benefits get reflected in your financial statements under this kind of remeasurement concept in LDTI? My thought was historically these impacts would take a while to kind of feather in. But I'm wondering, if under LDTI, does this get reflected in your financials much faster?
Max Broden: Suneet, they definitely come into our financials faster than they've done historically. And it's because we run these remeasurements each quarter and reset the net premium ratio for our forward reserves. So, therefore, you get it into the results much quicker.
Suneet Kamath: I guess where are we with that now? Should we expect some of these benefits that you saw here in 2Q to persist going forward? Or is it more – you've baked in these lower utilization trends and so, going forward, we need to see them decline even more to get incremental benefits?
Max Broden: We true-up our reserves for recent experience and to our best estimate. And then going forward, what that means is that for you to get lower reserves in the future, you need to have an improved trend. If the utilization stays at this level, our reserves are adequate. If you were to have worsening trends, the opposite would then occur.
Suneet Kamath: My follow-up is just on persistency in Japan. I just noticed that it fell below 94%, which is something we haven't seen in a while. Just wondering if you can unpack that a little bit. Is this lapse/reissue related to the new cancer product? Or is there something else going on?
Frederick Crawford: I'll ask Todd to comment on it. But you pretty much answered your own question. It has a lot to do with the introduction of cancer and natural replacement activity. Todd?
Todd Daniels: I think that we saw a lower lapse and reissue rate during the quarter than we did first quarter. And that's typical. As we launch a new product, we expect that to wane over time. With the product being launched in the Japan Post channel, we did have some lapse and reissue activity during the quarter. But it's within our expectation, and it's still running somewhere around 50%.
Max Broden: When you naturally have sales running lower than lapses, by definition, the age of the block increases. And when you have an older and more mature block, you're going to get higher lapses from it as well.
Frederick Crawford: One thing that I'd really like to add when we have this conversation, particularly spending some time in Japan and with the team is, we proactively promote the notion of an existing policyholder with an older cancer policy replacing their policy if it's in their best interest, if it serves them economically and from a benefit and overall quality of coverage perspective. And we do that because it's good for the customer. But we also do it because it brings that customer into our shops and allows for face to face interaction between our distribution partners and their clients. And that often leads to cross sell – cross sell activity with the individual, but also cross sell activity with their family members, as the agents have a chance to engage. And so, please realize that we don't actually look to avoid or curtail lapse and reissue activity. It's actually part of the strategy. And it's particularly important on the cancer side, as you can imagine.
Daniel Amos: Because we have Koide here from Japan, being President of Aflac Japan, I just think it's important for him to say a couple of words because we had such a stellar performance with sales and things. So, Koide, would you just – I'll ask the question, tell us how things are going in Japan.
Masatoshi Koide: [Foreign Language] As our sales results show, the cancer insurance product that we launched newly in August last year called WINGS, it's going extremely well. [Foreign Language] We now sell in cancer, WINGS, through all channels because we had somewhat a progressive launch of this product starting August last year with our associates and then in January this year, Dai-ichi Life and [indiscernible] has introduced it, and then in April of this year did the Japan Post has launched its product. [Foreign Language] Well, all distribution channel sales has been active of surrounding this new cancer product. Because of the new product launch, it is obviously the case that things will become very active. But at the same time, the Japanese society's economic activities have recovered during the same time. So with these two factors, I think the product has been extremely well. [Foreign Language] And our cancer new product competitiveness has increased as well. As Fred mentioned earlier, we now have this support service called Yorisou Cancer Consultation service, which is somewhat of a concierge service for our customers. And by having this integrated with our cancer product, it is also pushing the sales as well. [Foreign Language] And we're also preparing to launch a new medical product with very good competitiveness in September. [Foreign Language] So as a result of all these things that are going well, all our employees in Aflac Japan as well as our sales people in our distribution channel, all channels are extremely motivated to do more sales.
Operator: Our next question will come from Wes Carmichael with Wells Fargo.
Wes Carmichael: I'm hoping you could just talk a little bit about the lapse in persistency trends in Aflac U.S. It looks like it's improving a bit, but maybe you can help us with your expectation for how that should trend from here and maybe any impact on the expense ratios. I think that's been a little bit elevated by lapses.
Virgil Miller: This is Virgil. Let me first say that I'm pleased with the stabilization that you see that's occurring with our persistency rate. So this quarter, we came in at 78.2%. It's about 10 basis points higher than last year. I mentioned in Q1, we have done quite a few conservative efforts to go after this. We have stood up, what I call, office of the persistency, which is really a team of data scientists that's been 24 hours a day looking at different efforts that we can really do. So I think that you're going to see even more to come from that. Today, what you heard me say earlier is mainly about driving utilization. We're really pushing out campaigns for wellness. What we did in Q1 and Q2 was more of a shotgun approach, reminding everyone that has those benefits within those policies to go out and find those wellness claims. What you'll see us doing going forward now is more of a – what I would call a more strategic or surgical attack, which is around event driven notifications. For example, if someone recently got married or they have a birthday, we're going to be reaching out there to remind them to utilize those benefits that we have. Overall, you saw that the persistency plus the 6.4% increase we had in US sales drove to higher earned premiums for us. That earned premium rate was up about 2.2%. And that's really what's happening right now. The growth is what's happened to balance our expense ratios. We still see higher expenses right now with our investments, our growth initiatives. But those growth initiatives did contribute about 48% growth in the second quarter toward our revenue. Let me just ask Steve Beaver, our CFO in the US to see if he wants to come in any further.
Steven Beaver: I'll just add that, remember, the activity around driving persistency takes time to emerge in a 12-month rolling metric. But we do expect, like Max said in his video, it will help us bend that curve and lower the expense ratio going forward.
Max Broden: Wes, the impact on the second quarter expense ratio from higher-than-normal back amortization was about 50 basis points.
Wes Carmichael: I just wanted to kind of clarify, maybe a follow-up to Tom's question, but on net earned premium growth in Japan, I think it was impacted by 260 basis points related to the reinsurance transaction and some lapses. I just want to clarify, for the rest of 2023, do you think that roughly 6-ish-percent decline is reasonable for the full year and then it kind of moves back into that 1.5% to 2.5% decline in 2024? Just wondering your thoughts on that.
Max Broden: The impact from reinsurance will continue throughout the year, and I would expect it to be running at that level. The impact from paid up and the DPL impact, it was rather high in this quarter. It's going to be a quite a volatile number overall. But I will just note that it was – we deem it to be quite high this quarter.
Operator: Our next question will come from Jimmy Bhullar with J.P. Morgan.
Jimmy Bhullar: First, just a question on the upcoming launch of the medical product in mid-September. Should we assume that going into that sales of medical policies will be depressed as agents are sort of waiting for the new product to be rolled out? Or is that already in your numbers in 2Q as well?
Frederick Crawford: Why don't we have our team here in Japan comment on that. So, Yoshizumi-san, the question is, is there a natural pullback in medical when there's anticipation of a new medical product to come later in the year?
Koichiro Yoshizumi: [Foreign Language] I'll answer the question. [Foreign Language] So since we are selling our products in multi-channel, let me start out with associates channel. In the associates channel, as we launch our medical product soon, what I need to talk about is the cancer product that we launched in August last year. And since the cancer product will have gone around a cycle of a year, that sales will go down. [Foreign Language] But then when we look at other channels that only sell cancer product such as the Japan Post channel, Dai-ichi Life and Daido Life, it will not have been a year since they launched new cancer WINGS. And there should not be any impact on medical insurance. Sorry, there should not be any impact on cancer sales for the medical launch.
Daniel Amos: [Technical Difficulty] any time that we come out with a new product, it always has some impact. So we're taking that as being a standard, no matter what. If it's a new cancer, it affects medical. If it's a new medical, it's cancer. Because everyone goes to the easiest thing to sell. And so, something new and sparkly always looks better. So that's going to always happen. But the variation can be such. But, all in all, that's part of the system. That's why we're constantly having to upgrade is because we have to show that competitors come out with new things. We have to come out with new things. But because it isn't actual expenses, but fixed cost, we have to do this.
Jimmy Bhullar: As you think of the longer term, the alliance with the Post, what's your view on the likelihood of that being expanded beyond just cancer? Or do you think it's unlikely given that they've already got other providers for some of the other products?
Daniel Amos: Well, I don't think you ever say never. And you also remember that they're our largest shareholder. Those are positive things that we'll look at going forward. Fred, you've got any comment?
Frederick Crawford: No, I agree, Dan. I think, right now, what we focus on is just expanding within the line of cancer, meaning so when looking at refreshing our cancer product, we also have lumpsum critical illness that we include. We also have, as I mentioned earlier, this Yorisou cancer consulting service. And so, quite honestly, what we're focusing on now with Japan Post is not just cancer sales, but how do we expand and enrich the overall activity within that cancer line of business. So I think what you can assume is anything that comes out or any developments or innovation around the cancer line of business, that we will certainly deploy that within the Japan Post system.
Operator: And our next question will come from Josh Shanker with Bank of America.
Joshua Shanker: Looking at the turnaround in premium growth in the US, it's very favorable. Is there any senior management type compensation to support the turnaround growth specifically at the company?
Max Broden: Essentially, all of it, both senior management and employees, have incentive compensation based on earned premium.
Joshua Shanker: And is that targeted? Can you go into how that works a little bit?
Max Broden: You mean in terms of specific levels?
Joshua Shanker: Is it above a certain target? There's a long term compensation grant. Is there a trajectory? How should we think about how invested the company is in growing premium?
Max Broden: In the short term, it's outlined in our proxy and you can see our MIP targets there.
Joshua Shanker: And that's true for both the Japan business and the US business?
Max Broden: That is correct.
Daniel Amos: We try our best to keep these tied together to our bonuses to where – when you're happy, we're happy. Or we're happy, you're happy. So if you look at those, you will see that. That's a very important part of our board function under the compensation committee that we tie that together,
Frederick Crawford: You'll see very clearly in each segment, US and Japan, there's both sales and earned premium targets. And then as you can imagine, we cascade that down and get more particular by line of business when we get down to executives or officers that are in charge more directly to a particular line of business. So the concept of earned premium is an essential piece of how we compensate.
Max Broden: Josh, just to remind you that the earned premium outlook that we gave for the year 2023 and 2024 is a CAGR of 3% to 5% earned premium growth.
Joshua Shanker: I'm aware of that.
Operator: Our next question will come from Mark Hughes of Truist Securities.
Mark Hughes: This is actually Maxwell Fritscher. I'm calling on behalf of Mark Hughes. So looking at the total recruited agent count, it looks like it reduced to 4% year-over-year. On a tough comp, though, and up 6% sequentially. I was just wondering if you could give me an outlook or what the environment looks like for recruiting and the labor market right now.
Virgil Miller: This is Virgil for the US. Actually, I will tell you, I'm sitting very pleased with our performance for the first half of the year. To your point, we did see a decline in the second quarter. But if you look underneath some of the numbers, I look at the lead indicators. We had strong recruitment in January, February, March, April and May. The climb really happened in June. If you look at for the first six months, so we're sitting about 8% up. If you look at the actual career agents themselves, we had a strong increase in Q1 at about 35%. So we're sitting about – I'll be specific on a number. We got about 600 more than I really expected this time of year. What that really means to me, though, is we've got a great opportunity, which we did in June to really push on productivity and conversions. We have first year conversions up 5.2%, and then really driving to our average weekly producers. So, average weekly producer number is up again for the quarter over 2%. That's really what we're trying to do. We're bringing them into the pipeline, we're getting quality recruits, we're getting them converted, we happen to drive productivity, and then we're looking to turn them into average weekly producers. So, I will tell you that recruiting is favorable for the remainder of the year. We really don't see any major headwinds out there. But we will take those recruits, convert them and get them average weekly producers. Som looking forward to an even stronger second half of the year.
Daniel Amos: Let me make a comment about recruiting for the past. And we have to remember we're in a post pandemic period. But our track record for the past has been that, with high unemployment, people tend to come selling for us because they can't get a job on the south. So they're working on commission. That's not limited to Aflac. Anybody that's in that business – most people prefer a salary with a bonus versus all commission. So that's the first point. But on the other hand, when you have high unemployment, recruiting becomes more difficult. But at the workplace, there are more people to enroll. So the people that are selling are seeing more people at the worksite. It will be interesting, what happens here is we see more people working from home. We're seeing that there – I was in a restaurant the other day that it was closed for lunch because they couldn't get enough people to work there. So, these things are happening, and we're having to do that. But I would say, considering that it's hard to find employees, certainly at the lower levels, it tells you that we're doing a pretty good job. And I give kudos to Virgil and their team for what they're doing because it is a little bit uncharted waters because the tradition of the way we've been doing it, I've just got to see how it falls out. So I want to make that comment.
Virgil Miller: To that point, Dan, we had that baked into our numbers. So that's what I mean when I say we're on target with our expectations. I mentioned in Q1, you won't see these humongous numbers we used to see in the past, right? And that's why you see a concerted effort on making sure we convert who we have. It's going pretty well for us this year.
Frederick Crawford: If we could for a minute before we go to the next question, Jimmy had asked a question earlier about our expansion opportunities in Japan Post. And as Dan mentioned, our president, Koide-san, is here with us today this morning in Columbus and he would like to add just a few comments about the Japan Post alliance. Koide-san.
Masatoshi Koide: [Foreign Language] This is Koide once again. Let me just add a little bit on what we are doing with the Japan Post group or the Japan Post Insurance. We are actually doing a lot of collaboration in various areas. For example, apart from the cancer insurance sales, we are also working with Japan Post Insurance Group to have concierge service on nursing care area. And on top of that, we are also doing some startup acceleration program together with the Japan Post Insurance Group. So as you can see, we are working with the Japan Post group outside of cancer insurance area as well. That's all.
Operator: This concludes our question-and-answer session. I'd like to turn the conference back over to David Young for any closing remarks.
David Young : Thank you, Joe. That concludes our call. I want to thank you all for joining us this morning. Please reach out to the investor relations team if you have any questions and we look forward to speaking with you soon and wish you all continued good health. Thank you.
Operator: The conference is now concluded Thank you very much for attending today's presentation. You may now disconnect your lines. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the Aflac Incorporated Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "David Young",
"text": "Thank you, Jeff. Good morning and welcome. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated; Fred Crawford, President and COO of Aflac Incorporated will touch briefly on conditions in the quarter and discuss key initiatives; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments, will provide an update on the investments. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com. We also posted under Financials on the same site, updated slides of investment details related to our commercial real estate and middle market loans. In addition, Max Broden, Executive Vice President and CFO of Aflac Incorporated, provided his quarterly video update addressing our financial results and current capital and liquidity. Max will be joining us for the Q&A segment of this call along with the following members of our executive management in the US: Virgil Miller, President of Aflac U.S.; Al Roziere, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac US. We are also joined by members of our executive management team from Aflac Life Insurance Japan: Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Daniel Amos",
"text": "Thank you, David. And good morning. Glad you joined us. Reflecting on the second quarter of 2023, our management team, employees and sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for the policyholders when they need us most, just as we promised. Aflac Incorporated delivered very strong earnings for both the quarter and the first six months. We remain actively focused on numerous initiatives in the United States and Japan around new products, distribution strategies to set the stage for future growth. Looking at the operation in Japan, we have continued our rollout of our WINGS cancer insurance, and refreshed WAYS and Child Endowment policies. By introducing new refreshed products, we positioned our distribution channels for success, as Japan makes great strides in recovering from the pandemic. I am very pleased with our new sales premium increase of a 26.6% increase in Japan. This reflects a 60% increase in cancer insurance sales versus the second quarter of 2022 and a significant contributor from Japan Post Company and Japan Post Insurance, which began selling our new cancer product in early April. I'm also pleased to see improvements in our sales through agencies and our other strategic alliances, Daido Life and Dai-ichi Life. We also continue to gain new customers through WAYS and Child Endowment, while also increasing opportunities to sell out third sector products, which Fred will address in a moment. Thus far, our product strategy has served us well. And I'm encouraged by our progress as we prepare for the anticipated mid-September launch of our new medical product. In addition to our products, we know how important it is for us to be where the customers want to buy insurance. Our extensive network of distribution channels, including agencies, alliance partners, and banks, allow us more opportunities to help provide financial protection to Japanese consumers, as we are working hard to support each channel. Turning to the US, I remain encouraged by the continued productivity improvements of our agents and the contribution from growth initiatives. We continue to see success in our efforts to reengage our veteran associates. At the same time, we're seeing strong growth through brokers. I'm very excited at our cancer protection insurance policy, which provides enhanced benefits at no additional cost. We know that when people experience the value of our products, it increases persistency which benefits our policyholders and lowers our expenses. I believe that the need for the products and solutions we offer is strong or stronger than it's ever been before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers. As always, we are committed to prudent liquidity and capital management. We continue to generate strong investment results, while remaining in a defensive position as we monitor evolving economic conditions. In addition, we have taken proactive steps in recent years to defend cash flow and deployable capital against a weakening yen. We remain committed to extending our track record of annual dividend increases, supported by the strength of our capital and cash flows. At the same time, we remain in the market repurchasing shares with the tactical approach, focused on integrating the growth investments we have made in our platform to improve our strength and leadership position. Overall, I think we can say that it's been a very strong quarter, especially with the vast number of factors that are in our favor. Aflac Japan had a strong quarter of sales as we executed product and distribution strategy. Aflac U.S. continued to build on its momentum as it nears pre-pandemic sales level. Pre-tax profit margins remain very strong in Japan at 30.4% and in the US at 22.2%. Plus, our capital ratios remain very strong and our quarterly share repurchase was, like last quarter, one of the biggest in the company's history. So with that, I'll turn the program over to Fred. Fred?"
},
{
"speaker": "Frederick Crawford",
"text": "Thank you, Dan. Let me begin by briefly commenting on conditions in Japan. As Dan commented on our revised cancer product, which we refer to as WINGS, is doing well, now introduced in the Japan Post group. Having rolled out WINGS in Japan Post, we are now at full strength with this refreshed product in all channels. Our entire cancer platform, including in-force policyholders, is now supported by our Yorisou Cancer Consultation services. This platform provides conscientious care to cancer policyholders connecting them with non-insurance services. In dialogue with key alliances and distribution partners, we continued to receive feedback that this platform is a differentiator in the marketplace. From a data perspective, our market research has shown a positive and meaningful impact to our net promoter scores. The sales of WAYS and Child Endowment continues to deliver on our strategy of attracting younger and new policyholders, along with cross sell performance. Since the launch of our refreshed WAYS product, approximately 80% of sales are to younger customers below the age of 50. This cohort of younger buyers has driven a concurrent third sector sales rate of approximately 50%. Looking forward, we anticipate launching our new medical product mid-September. As mentioned last quarter, this product design has been simplified to appeal to both younger policyholders with basic needs, and older or existing policyholders who desire upgrading coverage. As we move through the natural product renewal cycles, we believe simplifying our products is key to driving sales productivity, attracting new and younger policyholders, and lowering our operating costs. Turning to operations, we are pleased with our expense ratio traveling below 20% in the first half of the year and in the face of continued revenue pressure. We are actively working to increase digital adoption focused on new business applications, customer self-service and claims. As we look forward, we anticipate increased levels of investment to drive digital adoption, with the goal of remaining competitive by lowering our long term operating expenses on a per policy basis. Turning to the US, our second quarter results followed a similar pattern as the first quarter with individual, dental and vision, group life and disability and consumer markets, all contributing to sales growth. Group voluntary sales has been down modestly from a strong 2022. However, we remain encouraged by the level of quoting activity that we believe positions us for a stronger second half of the year. Our growth platforms of dental and vision, group life and disability, and consumer markets are beginning to have a more material impact on performance. In aggregate. sales produced by these platforms are up over 50%, albeit off a smaller and building base. With the build largely behind us, we are focused on driving scale, stabilizing new platforms and leveraging our ability to bundle core voluntary products as we work with brokers on larger groups. We are absorbing a pace of investment in growth platforms that pressures our expense ratio, but naturally precedes revenue development. This is particularly the case in our group life and disability business, which is more capital intensive. As we settle into operating these platforms, we're also refining our approach to drive expense efficiencies and a long term path to profitability, in some cases making decisions around business we choose to exit and opportunities we aggressively pursue. Last quarter, we commented on our renewed focus on product development in the US. Our refreshed cancer product is up roughly 23% and still in the early stages of rollout. Of all the critical illnesses, cancer remains the most frequent and devastating to families and their financial security, and we have high expectations for this product. Last week, we announced a new group voluntary term life product, which is part of an important effort to increase our overall worksite and life sales. We have lagged in terms of life sales and see this product line as an area where we have market share opportunity. Like cancer insurance, this is a product that should contribute to improved persistency. We are pleased to see a return to earn premium growth in the US and modest recovery in persistency. We continue to drive utilization through wellness campaigns and benefit endorsements to in-force policies, with the objective of improved sales, persistency and driving core revenue growth. Now, let me pause and I'm going to turn the call over to Brad Dyslin to bring you current on the health of our investment portfolio with a focus on the loan book. Brad?"
},
{
"speaker": "Bradley Dyslin",
"text": "Thank you, Fred. During the last quarter's call, we provided an update on our loan portfolios with a special focus on our middle market direct lending and real estate mortgage holdings. I am pleased to report that both of these portfolios continue to perform in line with the expectations we shared last quarter. Let me start with commercial real estate. As a reminder, most of our exposure is to transitional properties, where we make short-term floating rate loans to facilitate the assets repositioning in the local market. TRE comprises $6.4 billion, or about three-fourths of our total $8.1 billion commercial mortgage loan portfolio, with the balance held in more traditional longer term fixed rate loans. Our commercial real estate loan watchlist has remained constant at approximately $900 million and consists almost entirely of TRE office properties. The workout process for these loans is complex, and negotiations with the property's owner tend to be very fluid, a dynamic we follow very closely. As a result, our foreclosure watchlist gets updated relatively frequently as negotiations with the property owner ebb and flow. However, the total value of these loans has also remained relatively stable, with only a modest increase from first quarter. As we mentioned last quarter, when a loan foreclosure is likely to occur, we must mark the carrying value of our loan to the fair market value of the underlying property assets. With our average loan-to-value of 65%, this accounting process resulted in a small $11 million of additional reserves in the quarter. This brings the total amount of additional reserves recognized in the first half of the year to $21 million, which represents about 26 basis points of our $8.1 billion total commercial real estate portfolio, and is the result of property value declines generally in the range of 25% to 40%, price drops that are in line with those of the financial crisis. If you simply apply a 40% price decline across our entire $900 million watchlist, we would expect very manageable additional reserves of $50 million. Once the property goes into foreclosure proceedings, we no longer accrue interest on the loan, but instead realize the net operating income from the property. Given the transitional nature of these properties, we will see a decline in net investment income from this change. When considering overall investment performance, we do not expect this to have a material impact to enterprise NII. While we are not immune from the industry pressure in commercial real estate, we remain confident in the quality of the property supporting our loans. Our strong capital position and ample liquidity allow us to be a patient investor as we manage through the downturn to maximize our overall economics. I am pleased to report our portfolio of loans to middle market companies continues to perform well and is exceeding our expectations for credit losses at this point in the cycle. Recall this is our primary outlet for below investment grade exposure and was purposely built with a quality bias to perform well during difficult periods for credit. Our strategy of allowing only modest levels of first lien leverage on growing companies in non-cyclical industries, owned by supportive sponsors, is delivering strong risk adjusted returns. Finally, you may have seen the announcement last month that Varagon Capital is being acquired by Man Group, a leading UK alternative asset manager. As part of this transaction, as was announced, we are exiting our equity position in Varagon, but will remain a major client. We generated strong returns on this strategic investment, realizing over 3 times our invested capital, in addition to solid performance on the $3 billion of middle market loans Varagon had managed for us the last three plus years. Varagon has proven to be a great partner and terrific investor and we are excited about their future as part of the Man Group. Our relationship with Varagon and our other current strategic equity partners is a valuable part of our strategy for accessing certain specialized private asset classes that have a strategic role in our portfolio. We continue to invest significant amounts in these high value-add forms of private credit. We look forward to continuing to execute on the strategy and creating additional value through an ownership presence in these important asset classes. Let me turn it back to Fred."
},
{
"speaker": "Frederick Crawford",
"text": "Thank you, Brad. As Brad noted, we follow the disciplined approach that began with building out our external manager program that matured into taking a minority interest in select managers. These investments have produced strong returns and we intend to expand upon this strategy as opportunities present themselves. Market conditions remain volatile as both the US and Japan economies go through a period of transition. Last week featured moves by both the Fed and the BOJ. The US is looking to calm down inflation and avoid recession, while Japan continues to maintain its ultra loose monetary policy as economic and inflationary uncertainty remain high. As Max noted in his recorded comments, through investment strategy, hedging, and capital engineering, we have greatly reduced our enterprise economic exposure to movements in the yen. In addition, our low asset leverage places us in a naturally strong position to absorb weak or volatile economic conditions and maintain capital deployment plans. I'll now turn it back to David to take us to Q&A. David?"
},
{
"speaker": "David Young",
"text": "Thank you, Fred. Before we take questions, I want to ask that you please limit yourself to one initial question and a follow-up before getting back in the queue to allow other participants an opportunity to ask a question. And, Joe, we will now take that first question."
},
{
"speaker": "Operator",
"text": "Our first question will come from Tom Gallagher with Evercore ISI."
},
{
"speaker": "Tom Gallagher",
"text": "It was encouraging to see the growth in Japanese sales. I guess the question I have related to it is two parts. One is, how do you see the contribution from Japan Post building out? Is that continued gradual slow ramp or are you seeing any signs of stronger acceleration there? I guess the follow-up is, while there were good sales, the overall top line in terms of earned premium was a bit soft. So, can you talk about your expectations for earned premium and what's weighing on that and not allowing the sales improvement to necessarily translate?"
},
{
"speaker": "Frederick Crawford",
"text": "Let me let me start by making just a couple of comments. And then I'll hand off to some of the folks around the table to contribute. Tom, this is Fred. First on sales results and Japan Post in the quarter, as you may know or may remember, based on our alliance, we don't comment on some of the specific results coming out of those channels. But what we certainly can say is that the launch of the cancer product in the quarter was the majority contributor to the increase in cancer sales that you saw in our results. For example, in the first quarter without being launched in Japan Post, our sales were up in cancer around 25% or so. And as Dan mentioned in his comments, in the second quarter, we were up around 60%. And you can safely assume the majority contributor of that was from Japan Post. Your question then is what about continuation. And our view is that there is still much more runway in Japan Post over the long term, predominantly as they build efficiency in their distribution channel and more and more agents take on the cancer product and begin producing. So, we do think that there's a continuation of upside in Japan Post. However, it is also the case that, commonly, right when you launch the product, you'll have an immediate jump in sales in the early months followed by a calming down. But let me just turn to Yoshizumi-san and/or Koide-san if they'd like to comment or add any color beyond what I just said."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] This is Yoshizumi-san. Let me answer your question regarding JP. [Foreign Language] Well, let me mention about that new products launched into the Japan Post channel. The cancer product in the Japan Post channel was launched in April. And towards this April timing, we have been conducting trainings to the Japan Post company, the postal company as well as Japan Post Insurance since January throughout their entire nationwide post offices. [Foreign Language] We do believe that steady increase of sales by the Japan Post has a result of us conducting these kinds of trainings as well as offering our support to them directly after the launch of the product. [Foreign Language] And since the second quarter between Japan Post and Aflac, we have been confirming each layer, each level sales process at the management level and we'll be managing these processes at each level. [Foreign Language] And what that means is that we will try to identify where the issues are at each management level. And we are checking those items on a monthly basis. And we are also offering solutions to these issues and solving them on a monthly basis. [Foreign Language] As a result of all of these, we do believe that cancer sales will gradually increase going forward as well."
},
{
"speaker": "Frederick Crawford",
"text": "Tom, your second question was related to revenue in Japan and how to think about it. obviously, having to take into account both our reinsurance agreement and paid up policy, so I'll ask Todd to address that."
},
{
"speaker": "Todd Daniels",
"text": "I think that one thing to remember when we went to LDTI accounting. We had to move our deferred profit liability from the benefits line to the earned premium line. And that's going to create a little bit of noise, in that it's not going to be as stable as it was before. But as Fred said, the reinsurance transaction that we entered into at the beginning of the year caused about ¥8 billion reduction in earned premium in the quarter. The paid up impact is also still there. And that was, again, about ¥8 billion. When you normalize for those two factors and considering the DPL, we're still in the right in the middle of the range that we gave for guidance for earned premium at approximately minus 1.9%."
},
{
"speaker": "Max Broden",
"text": "Tom, I would just add as well, if you look at it long term, for us, to sort of get to a level where we are replacing the business that is falling off, i.e. get to an earned premium growth of zero, we need to essentially get back for all distribution channels to pre-pandemic levels in terms of production and also have the Japan Post channel get back to a restored production level."
},
{
"speaker": "Operator",
"text": "And our next question will come from Alex Scott with Goldman Sachs."
},
{
"speaker": "Alex Scott",
"text": "First one I had for you is on some of the comments that were made in the remarks video that you all post. It was mentioned that the [indiscernible] are continuing to run favorable in what you're seeing in the claims activity and the benefit ratios. I was just interested what the updated view is on whether that's temporary, associated with utilization levels, potentially being temporarily depressed versus maybe something that you guys have just seen longer term and that you potentially need to adjust in your long term assumptions?"
},
{
"speaker": "Daniel Amos",
"text": "This is Dan. I kind of mentioned that [indiscernible] Todd or whoever. But it has continued to run at a lower rate than we have anticipated year after year after year. And we have tried to counter that with different things from increased benefits on certain policies when a new one came out, but for some reason you're seeing more and more trends to do – well, we know one, outpatient treatments and things of that nature as we're seeing changes take place where we have to adapt accordingly. But some of the policyholders don't change over policies. And that's something that we continue to monitor and encourage people to do. If you specifically want to talk about US, that's a great example. The wellness benefit hadn't been used as much. So we have really encouraged that. We're seeing that improvement. And we feel like that will be reflected in a positive manner. I think Virgil might touch on that, if he's around to say something. Virgil?"
},
{
"speaker": "Virgil Miller",
"text": "Yes, utilization continues to be our focus in the US. We have launched a series of wellness campaigns really driving our policyholders to leverage the coverage. I think Fred or Dan mentioned that we've seen over a 22% increase in wellness utilization during that time period, which started about the first quarter of the year. And we're going to continue to do that. Our main thing is to drive and demonstrate value. We know that the average American has less than $1,000 in savings out there. So there's a benefit to them that make sure they're prepared for any unexpected medical event. And also, getting regular checkups will help anyone that gets diagnosed with some catastrophic disease like cancer. It helps them, of course, be able to get the right treatment and save their lives. So we're going to continue to push on that. And I expect us to see continued improvement going forward."
},
{
"speaker": "Max Broden",
"text": "Alex, just to sort of add in terms of utilization, if you think about it, the US is absolutely out of the pandemic. And you should expect the utilization to sort of get back to sort of as normal level at this point. I think we're still a little bit off where we should expect some rebound on utilization. But, definitely, the vast majority of the benefits that we offer should run at more normal levels at this point. And so, what we're doing, as Dan and Virgil alluded to, we are enhancing our products for that because we have not seen utilization bounce back to pre-pandemic levels. And so why is that? Well, there are some fundamental differences that have happened during the pandemic. There's definitely less usage of emergency rooms that we see in the data, greater use of local facilities, greater use of outpatient services rather than in-hospital services. All of this leads to lower claims utilization overall for us. If you go to Japan, we continue to see the long term trends of shorter hospitalization stays, especially as it relates to cancer. We have seen first diagnosis, i.e. diagnosis of cancer, bounce back to more normal levels. But the surgeries and hospitalization trends are still pretty muted. And we believe that that's more driven by greater use of outpatient services as well in Japan as well because we see that increase. Overall, the mathematic effect of this is that it leads to a lower benefit ratio overall for us if these trends continue to stay in place."
},
{
"speaker": "Alex Scott",
"text": "A follow-up I had is just on Japanese interest rates. I was interested in just how it affects your strategy in terms of – if you all are thinking through different products that you may emphasize more in higher rate environment, as well as on the investment side, choices you're making between USD investing and yen investing?"
},
{
"speaker": "Frederick Crawford",
"text": "I'll let Brad comment on the asset allocation question. I think relative to the business model, as you may know from some of our previous comments, we continue to work on what we call internally, our asset formation product strategy in Japan. That's most notably surrounding the WAYS product and refreshment and refinement of the WAYS product, training and development around that product and working with customers and then, of course, an emphasis on cross selling. What we've also mentioned, Alex, in the past is that not only as a recent recovery – I'd put recovery in quotes, of course – but recovery in rates in Japan helped with supporting those types of products. Also, importantly, is building out our reinsurance strategy because there's no question reinsurance is going to play into the long term viability of those types of products and maintaining economic value as a company. So, yes, some rise in rates is supportive of asset formation products. And we pay attention to that. But as you can see, there's a long way to go before we characterized the rate environment as supportive of strong profitability in those products. You still need some heavy engineering. And you absolutely are in that business for the cross sell experience and bringing younger policyholders into the fold that we can cross sell into the future. Brad, comments on…?"
},
{
"speaker": "Bradley Dyslin",
"text": "In terms of investment activity, the rise in yen rates is certainly welcome news. It's been a long time since we've had these kinds of levels. But one of the biggest issues we face in Japan is finding attractive spread products. And that remains our biggest challenge. We continue to take advantage of those opportunities when we can find them. We have been relatively successful in finding yen credit where we can get an acceptable level of pickup over JGB yields for what we think is a pretty acceptable level of risk. And although the rising race is definitely welcome, it still pales in comparison to what we're able to get in some of the dollar assets. So we'll continue to always be active there, but you shouldn't expect to see a big wholesale change in strategy, at least not yet."
},
{
"speaker": "Operator",
"text": "Our next question will come from Suneet Kamath with Jefferies."
},
{
"speaker": "Suneet Kamath",
"text": "I want to go back to some of the comments that you're making on utilization, both in Japan and the US. It seems like things are moving in the right direction. My question is how quickly did these benefits get reflected in your financial statements under this kind of remeasurement concept in LDTI? My thought was historically these impacts would take a while to kind of feather in. But I'm wondering, if under LDTI, does this get reflected in your financials much faster?"
},
{
"speaker": "Max Broden",
"text": "Suneet, they definitely come into our financials faster than they've done historically. And it's because we run these remeasurements each quarter and reset the net premium ratio for our forward reserves. So, therefore, you get it into the results much quicker."
},
{
"speaker": "Suneet Kamath",
"text": "I guess where are we with that now? Should we expect some of these benefits that you saw here in 2Q to persist going forward? Or is it more – you've baked in these lower utilization trends and so, going forward, we need to see them decline even more to get incremental benefits?"
},
{
"speaker": "Max Broden",
"text": "We true-up our reserves for recent experience and to our best estimate. And then going forward, what that means is that for you to get lower reserves in the future, you need to have an improved trend. If the utilization stays at this level, our reserves are adequate. If you were to have worsening trends, the opposite would then occur."
},
{
"speaker": "Suneet Kamath",
"text": "My follow-up is just on persistency in Japan. I just noticed that it fell below 94%, which is something we haven't seen in a while. Just wondering if you can unpack that a little bit. Is this lapse/reissue related to the new cancer product? Or is there something else going on?"
},
{
"speaker": "Frederick Crawford",
"text": "I'll ask Todd to comment on it. But you pretty much answered your own question. It has a lot to do with the introduction of cancer and natural replacement activity. Todd?"
},
{
"speaker": "Todd Daniels",
"text": "I think that we saw a lower lapse and reissue rate during the quarter than we did first quarter. And that's typical. As we launch a new product, we expect that to wane over time. With the product being launched in the Japan Post channel, we did have some lapse and reissue activity during the quarter. But it's within our expectation, and it's still running somewhere around 50%."
},
{
"speaker": "Max Broden",
"text": "When you naturally have sales running lower than lapses, by definition, the age of the block increases. And when you have an older and more mature block, you're going to get higher lapses from it as well."
},
{
"speaker": "Frederick Crawford",
"text": "One thing that I'd really like to add when we have this conversation, particularly spending some time in Japan and with the team is, we proactively promote the notion of an existing policyholder with an older cancer policy replacing their policy if it's in their best interest, if it serves them economically and from a benefit and overall quality of coverage perspective. And we do that because it's good for the customer. But we also do it because it brings that customer into our shops and allows for face to face interaction between our distribution partners and their clients. And that often leads to cross sell – cross sell activity with the individual, but also cross sell activity with their family members, as the agents have a chance to engage. And so, please realize that we don't actually look to avoid or curtail lapse and reissue activity. It's actually part of the strategy. And it's particularly important on the cancer side, as you can imagine."
},
{
"speaker": "Daniel Amos",
"text": "Because we have Koide here from Japan, being President of Aflac Japan, I just think it's important for him to say a couple of words because we had such a stellar performance with sales and things. So, Koide, would you just – I'll ask the question, tell us how things are going in Japan."
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language] As our sales results show, the cancer insurance product that we launched newly in August last year called WINGS, it's going extremely well. [Foreign Language] We now sell in cancer, WINGS, through all channels because we had somewhat a progressive launch of this product starting August last year with our associates and then in January this year, Dai-ichi Life and [indiscernible] has introduced it, and then in April of this year did the Japan Post has launched its product. [Foreign Language] Well, all distribution channel sales has been active of surrounding this new cancer product. Because of the new product launch, it is obviously the case that things will become very active. But at the same time, the Japanese society's economic activities have recovered during the same time. So with these two factors, I think the product has been extremely well. [Foreign Language] And our cancer new product competitiveness has increased as well. As Fred mentioned earlier, we now have this support service called Yorisou Cancer Consultation service, which is somewhat of a concierge service for our customers. And by having this integrated with our cancer product, it is also pushing the sales as well. [Foreign Language] And we're also preparing to launch a new medical product with very good competitiveness in September. [Foreign Language] So as a result of all these things that are going well, all our employees in Aflac Japan as well as our sales people in our distribution channel, all channels are extremely motivated to do more sales."
},
{
"speaker": "Operator",
"text": "Our next question will come from Wes Carmichael with Wells Fargo."
},
{
"speaker": "Wes Carmichael",
"text": "I'm hoping you could just talk a little bit about the lapse in persistency trends in Aflac U.S. It looks like it's improving a bit, but maybe you can help us with your expectation for how that should trend from here and maybe any impact on the expense ratios. I think that's been a little bit elevated by lapses."
},
{
"speaker": "Virgil Miller",
"text": "This is Virgil. Let me first say that I'm pleased with the stabilization that you see that's occurring with our persistency rate. So this quarter, we came in at 78.2%. It's about 10 basis points higher than last year. I mentioned in Q1, we have done quite a few conservative efforts to go after this. We have stood up, what I call, office of the persistency, which is really a team of data scientists that's been 24 hours a day looking at different efforts that we can really do. So I think that you're going to see even more to come from that. Today, what you heard me say earlier is mainly about driving utilization. We're really pushing out campaigns for wellness. What we did in Q1 and Q2 was more of a shotgun approach, reminding everyone that has those benefits within those policies to go out and find those wellness claims. What you'll see us doing going forward now is more of a – what I would call a more strategic or surgical attack, which is around event driven notifications. For example, if someone recently got married or they have a birthday, we're going to be reaching out there to remind them to utilize those benefits that we have. Overall, you saw that the persistency plus the 6.4% increase we had in US sales drove to higher earned premiums for us. That earned premium rate was up about 2.2%. And that's really what's happening right now. The growth is what's happened to balance our expense ratios. We still see higher expenses right now with our investments, our growth initiatives. But those growth initiatives did contribute about 48% growth in the second quarter toward our revenue. Let me just ask Steve Beaver, our CFO in the US to see if he wants to come in any further."
},
{
"speaker": "Steven Beaver",
"text": "I'll just add that, remember, the activity around driving persistency takes time to emerge in a 12-month rolling metric. But we do expect, like Max said in his video, it will help us bend that curve and lower the expense ratio going forward."
},
{
"speaker": "Max Broden",
"text": "Wes, the impact on the second quarter expense ratio from higher-than-normal back amortization was about 50 basis points."
},
{
"speaker": "Wes Carmichael",
"text": "I just wanted to kind of clarify, maybe a follow-up to Tom's question, but on net earned premium growth in Japan, I think it was impacted by 260 basis points related to the reinsurance transaction and some lapses. I just want to clarify, for the rest of 2023, do you think that roughly 6-ish-percent decline is reasonable for the full year and then it kind of moves back into that 1.5% to 2.5% decline in 2024? Just wondering your thoughts on that."
},
{
"speaker": "Max Broden",
"text": "The impact from reinsurance will continue throughout the year, and I would expect it to be running at that level. The impact from paid up and the DPL impact, it was rather high in this quarter. It's going to be a quite a volatile number overall. But I will just note that it was – we deem it to be quite high this quarter."
},
{
"speaker": "Operator",
"text": "Our next question will come from Jimmy Bhullar with J.P. Morgan."
},
{
"speaker": "Jimmy Bhullar",
"text": "First, just a question on the upcoming launch of the medical product in mid-September. Should we assume that going into that sales of medical policies will be depressed as agents are sort of waiting for the new product to be rolled out? Or is that already in your numbers in 2Q as well?"
},
{
"speaker": "Frederick Crawford",
"text": "Why don't we have our team here in Japan comment on that. So, Yoshizumi-san, the question is, is there a natural pullback in medical when there's anticipation of a new medical product to come later in the year?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] I'll answer the question. [Foreign Language] So since we are selling our products in multi-channel, let me start out with associates channel. In the associates channel, as we launch our medical product soon, what I need to talk about is the cancer product that we launched in August last year. And since the cancer product will have gone around a cycle of a year, that sales will go down. [Foreign Language] But then when we look at other channels that only sell cancer product such as the Japan Post channel, Dai-ichi Life and Daido Life, it will not have been a year since they launched new cancer WINGS. And there should not be any impact on medical insurance. Sorry, there should not be any impact on cancer sales for the medical launch."
},
{
"speaker": "Daniel Amos",
"text": "[Technical Difficulty] any time that we come out with a new product, it always has some impact. So we're taking that as being a standard, no matter what. If it's a new cancer, it affects medical. If it's a new medical, it's cancer. Because everyone goes to the easiest thing to sell. And so, something new and sparkly always looks better. So that's going to always happen. But the variation can be such. But, all in all, that's part of the system. That's why we're constantly having to upgrade is because we have to show that competitors come out with new things. We have to come out with new things. But because it isn't actual expenses, but fixed cost, we have to do this."
},
{
"speaker": "Jimmy Bhullar",
"text": "As you think of the longer term, the alliance with the Post, what's your view on the likelihood of that being expanded beyond just cancer? Or do you think it's unlikely given that they've already got other providers for some of the other products?"
},
{
"speaker": "Daniel Amos",
"text": "Well, I don't think you ever say never. And you also remember that they're our largest shareholder. Those are positive things that we'll look at going forward. Fred, you've got any comment?"
},
{
"speaker": "Frederick Crawford",
"text": "No, I agree, Dan. I think, right now, what we focus on is just expanding within the line of cancer, meaning so when looking at refreshing our cancer product, we also have lumpsum critical illness that we include. We also have, as I mentioned earlier, this Yorisou cancer consulting service. And so, quite honestly, what we're focusing on now with Japan Post is not just cancer sales, but how do we expand and enrich the overall activity within that cancer line of business. So I think what you can assume is anything that comes out or any developments or innovation around the cancer line of business, that we will certainly deploy that within the Japan Post system."
},
{
"speaker": "Operator",
"text": "And our next question will come from Josh Shanker with Bank of America."
},
{
"speaker": "Joshua Shanker",
"text": "Looking at the turnaround in premium growth in the US, it's very favorable. Is there any senior management type compensation to support the turnaround growth specifically at the company?"
},
{
"speaker": "Max Broden",
"text": "Essentially, all of it, both senior management and employees, have incentive compensation based on earned premium."
},
{
"speaker": "Joshua Shanker",
"text": "And is that targeted? Can you go into how that works a little bit?"
},
{
"speaker": "Max Broden",
"text": "You mean in terms of specific levels?"
},
{
"speaker": "Joshua Shanker",
"text": "Is it above a certain target? There's a long term compensation grant. Is there a trajectory? How should we think about how invested the company is in growing premium?"
},
{
"speaker": "Max Broden",
"text": "In the short term, it's outlined in our proxy and you can see our MIP targets there."
},
{
"speaker": "Joshua Shanker",
"text": "And that's true for both the Japan business and the US business?"
},
{
"speaker": "Max Broden",
"text": "That is correct."
},
{
"speaker": "Daniel Amos",
"text": "We try our best to keep these tied together to our bonuses to where – when you're happy, we're happy. Or we're happy, you're happy. So if you look at those, you will see that. That's a very important part of our board function under the compensation committee that we tie that together,"
},
{
"speaker": "Frederick Crawford",
"text": "You'll see very clearly in each segment, US and Japan, there's both sales and earned premium targets. And then as you can imagine, we cascade that down and get more particular by line of business when we get down to executives or officers that are in charge more directly to a particular line of business. So the concept of earned premium is an essential piece of how we compensate."
},
{
"speaker": "Max Broden",
"text": "Josh, just to remind you that the earned premium outlook that we gave for the year 2023 and 2024 is a CAGR of 3% to 5% earned premium growth."
},
{
"speaker": "Joshua Shanker",
"text": "I'm aware of that."
},
{
"speaker": "Operator",
"text": "Our next question will come from Mark Hughes of Truist Securities."
},
{
"speaker": "Mark Hughes",
"text": "This is actually Maxwell Fritscher. I'm calling on behalf of Mark Hughes. So looking at the total recruited agent count, it looks like it reduced to 4% year-over-year. On a tough comp, though, and up 6% sequentially. I was just wondering if you could give me an outlook or what the environment looks like for recruiting and the labor market right now."
},
{
"speaker": "Virgil Miller",
"text": "This is Virgil for the US. Actually, I will tell you, I'm sitting very pleased with our performance for the first half of the year. To your point, we did see a decline in the second quarter. But if you look underneath some of the numbers, I look at the lead indicators. We had strong recruitment in January, February, March, April and May. The climb really happened in June. If you look at for the first six months, so we're sitting about 8% up. If you look at the actual career agents themselves, we had a strong increase in Q1 at about 35%. So we're sitting about – I'll be specific on a number. We got about 600 more than I really expected this time of year. What that really means to me, though, is we've got a great opportunity, which we did in June to really push on productivity and conversions. We have first year conversions up 5.2%, and then really driving to our average weekly producers. So, average weekly producer number is up again for the quarter over 2%. That's really what we're trying to do. We're bringing them into the pipeline, we're getting quality recruits, we're getting them converted, we happen to drive productivity, and then we're looking to turn them into average weekly producers. So, I will tell you that recruiting is favorable for the remainder of the year. We really don't see any major headwinds out there. But we will take those recruits, convert them and get them average weekly producers. Som looking forward to an even stronger second half of the year."
},
{
"speaker": "Daniel Amos",
"text": "Let me make a comment about recruiting for the past. And we have to remember we're in a post pandemic period. But our track record for the past has been that, with high unemployment, people tend to come selling for us because they can't get a job on the south. So they're working on commission. That's not limited to Aflac. Anybody that's in that business – most people prefer a salary with a bonus versus all commission. So that's the first point. But on the other hand, when you have high unemployment, recruiting becomes more difficult. But at the workplace, there are more people to enroll. So the people that are selling are seeing more people at the worksite. It will be interesting, what happens here is we see more people working from home. We're seeing that there – I was in a restaurant the other day that it was closed for lunch because they couldn't get enough people to work there. So, these things are happening, and we're having to do that. But I would say, considering that it's hard to find employees, certainly at the lower levels, it tells you that we're doing a pretty good job. And I give kudos to Virgil and their team for what they're doing because it is a little bit uncharted waters because the tradition of the way we've been doing it, I've just got to see how it falls out. So I want to make that comment."
},
{
"speaker": "Virgil Miller",
"text": "To that point, Dan, we had that baked into our numbers. So that's what I mean when I say we're on target with our expectations. I mentioned in Q1, you won't see these humongous numbers we used to see in the past, right? And that's why you see a concerted effort on making sure we convert who we have. It's going pretty well for us this year."
},
{
"speaker": "Frederick Crawford",
"text": "If we could for a minute before we go to the next question, Jimmy had asked a question earlier about our expansion opportunities in Japan Post. And as Dan mentioned, our president, Koide-san, is here with us today this morning in Columbus and he would like to add just a few comments about the Japan Post alliance. Koide-san."
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language] This is Koide once again. Let me just add a little bit on what we are doing with the Japan Post group or the Japan Post Insurance. We are actually doing a lot of collaboration in various areas. For example, apart from the cancer insurance sales, we are also working with Japan Post Insurance Group to have concierge service on nursing care area. And on top of that, we are also doing some startup acceleration program together with the Japan Post Insurance Group. So as you can see, we are working with the Japan Post group outside of cancer insurance area as well. That's all."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I'd like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you, Joe. That concludes our call. I want to thank you all for joining us this morning. Please reach out to the investor relations team if you have any questions and we look forward to speaking with you soon and wish you all continued good health. Thank you."
},
{
"speaker": "Operator",
"text": "The conference is now concluded Thank you very much for attending today's presentation. You may now disconnect your lines."
}
] | Aflac Incorporated | 250,178 |
AFL | 1 | 2,023 | 2023-04-27 08:45:00 | Operator: Good morning, and welcome to the Aflac Incorporated First Quarter 2023 Earnings Conference Call. All participants will be in listen0only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Ratings Agency Relations and ESG. Please go ahead.
David Young: Thank you, Andrea. Good morning and welcome. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated; Fred Crawford, President and COO of Aflac Incorporated is joining us from Japan and will touch briefly on conditions in the quarter and discuss key initiatives; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments will discuss the investment portfolio and its positioning given recent market events and volatility. Yesterday after the close, we posted our earnings release and financial supplement to investors.aflac.com. Under financials and the menu of that site, we also posted several slides of investment details related to our bank, commercial real estate and middle market loan exposure. In addition, Max Broden, Executive Vice President and CFO of Aflac Incorporated, provided his quarterly video update addressing our financial results and current capital and liquidity. Max will be joining us for the Q&A segment of this call along with the following members of our Executive Management in the U.S. The following Virgil Miller, President of Aflac U.S.; Al Roziere, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac US. We are also joined by members of our Executive Management team at Aflac Life Insurance Japan: Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?
Dan Amos: Thank you, David, and good morning. And we're glad you joined us. Reflecting on the first quarter of 2023, our management team, employees and sales distribution, have continued to be devoted stewards of our business. Being there for the policyholders when they need us most just as we promised. The first quarter marked a good start to the year. Aflac delivered another quarter of solid earnings results, especially considering our material weakening of the yen. Looking at our operations in Japan and as noted last quarter, we are actively focused on numerous initiatives in Japan involving new and refreshed products and distribution that continues to cover from the -- as we recover from the pandemic. In addition, we are encouraged by the planned May reclassification of COVID-19 to the same level as influenza as Japan continues to emerge from the pandemic. I am pleased with the continued sales improvements, which reflect the ongoing rollout of our cancer insurance policy initially through associates and Daido Life followed by Dai-ichi Life and the financial institutions. First quarter sales also reflected the refreshed first sector ways in child endowment products, which we're using as a way of reaching new customers to whom we can also sell third sector products, including cancer and medical products. I'm also encouraged by the fact that Japan Post Group began selling our new cancer insurance product earlier this month. We expect this close collaboration to produce continued gradual improvement of Aflac's cancer insurance sales over the immediate term and to further position the companies for the long-term. In addition to product, another important element of our growth strategy is our intense focus on being where the customer wants to buy insurance. Our broad network of distribution channels, including agencies, alliance, partners and banks continually optimize opportunities to help provide financial protection to Japanese consumers. And we are working hard to support each channel. Turning to the U.S. while the first quarter tends to generate the lowest sales of the year, I'm encouraged by the continued improvement in the productivity of our agent and brokers, as well as the contribution from the build out of our network, dental and vision and group life and disability. We are seeing success in our efforts to reengage veteran associates and at the same time we are seeing strong growth through brokers. I'm very excited that we're in the process of refreshing our cancer protection assurance policy with increased benefits at no additional cost. We believe this will increase persistency, which will benefit our policyholders and lower our expenses. I believe that the need for the products we offer is stronger or stronger than it has ever been before in both Japan and the United States. At the same time, we know consumer habits, buying preferences have been evolving. We also know that our products are sold not bought. As we communicate the value of our products, we know that a strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face when they get medical treatment. We continue to reinforce our leading position and build on that momentum. As always, we continue to prudent liquidity and capital management. We continue to generate strong investment results, while remaining in a defensive position as we monitor evolving economic conditions. In addition, we've taken proactive steps in recent years to defend cash flows and deployable capital against the weakening yen. We treasure our track record of dividend growth, highlighted by 2022 marking the 40th consecutive year of dividend increases. We remain committed to extending this track record, supported by the strength of a capital and cash flows. At the same time, we remain in the market repurchasing shares with tactical approach focused on integrating the growth investments we've made in the platform to improve our strength and leadership position. We also believe in the underlying strength of our business, and our potential for continued growth in the United States and Japan, two of the largest life insurance markets in the world. We are well positioned as we work toward achieving long-term growth, while also ensuring we deliver on a promise to the policyholders. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Now, I'll turn the program over to Fred in Japan. Fred?
Fred Crawford: Thank you, Dan. Let me first begin with brief comments on our Japan and U.S. operations. As Dan noted, we're off to a promising start. The revised cancer product is doing well and now supported by our Yorisou Cancer Consultation Platform. This providing Concierge’s care to cancer policyholders and connecting them with non-insurance services. As we look ahead this year, we are focused on the following here in Japan. Continued recovery with our longstanding alliance partners fueled by a refreshed cancer product and joint marketing and training support. Based on our preliminary read of activity levels within Japan Post, the Wings product appears to be off to a promising start and gaining traction. We are preparing to launch a new medical product in the fourth quarter. We are operating in a highly competitive environment with medical product representing 70% of the third sector marketplace. We are focused on simplifying the product and appealing to both younger policyholders with basic needs and older or existing policyholders, who desire upgrading to a more comprehensive coverage. The sale of WAYS is delivering on our strategy of attracting younger policyholders and cross sell activity. We are primarily selling in our associates channel and are being cautious with respect to selling in the bank channel with limited volume expected. We understand that over the long-term, leveraging the bank channel will require marrying a competitive medical and cancer product with a formal asset formation strategy to drive shelf space. Finally, our short-term insurance subsidiary SUDACHI launched a line of affordable term medical and cancer products in April. We anticipate a modest level of sales as measured in annualized premium. The focus is on introducing young first time buyers to the importance of medical and cancer insurance to then upgrade to more comprehensive coverage in the future. From an operations perspective, we are pleased with our expense ratio coming in below 20% in the phase of continued revenue pressure. This is in part a cumulative result of addressing expenses over the past few years. Turning to the U.S., we have discussed our balanced attack and this remains the case with individual, dental and vision, group life and disability and consumer markets all contributing to sales growth in the quarter. The underlying signs of momentum remain encouraging in our agent driven small business franchise recruiting the number of average weekly producers and agent productivity are all up in the quarter. Dental and vision sales increased 40% in the quarter with continued strength in cross sell of core voluntary products. While this is traditionally a slower quarter in the life and disability markets, our platform is off to a strong start for the year. Finally, we are encouraged by consumer markets sales up 29% in the quarter and with new products gaining traction and alliances coming online. With expanded business lines and new distribution channels, product development is a key focus in the U.S. We have launched a refreshed approach to cancer as Dan mentioned, we've advanced coverage for mental health conditions and are adding non-insurance services to our group disability products. We are proactively driving benefit utilization through wellness campaigns and benefit endorsements to in-force policies. We know that utilization drives persistency. In terms of operations, our expense ratio remains elevated, but as Max commented on in his recorded remarks, roughly 300 basis points are due to the pace of investment in emerging growth businesses all performing in line with our expectations. So what bends the expense curve in the U.S.? Traditional managing of expenses along with investment in process automation in our mature individual and career driven small business franchise, a multi-year technology modernization path, including a new group administrative platform driving process improvement and cost reduction. Finally, delivering on revenue build in our inquired and Greenfield properties that requires investment upfront to secure and retain quality business. Now I'd like to hand over to Brad Dyslin to discuss our investment portfolio and positioning with respect to recent market events and volatility. Brad?
Brad Dyslin: Thank you, Fred. Given recent events with the global banking system and the uncertain macro outlook as the Fed continues to raise rates to fight inflation, I would like to provide a brief update on those segments of our portfolio that are most directly impacted by the current environment. Let me start with our bank exposure. As at the end of the quarter, our total global bank portfolio is $5.6 billion with an average credit rating of single A minus. Our holdings are concentrated in large, systemically important banks located in stable countries. As of today, our U.S. bank exposure is limited to the largest banks. We have virtually no exposure to smaller U.S. regional banks. We do not have holdings or other direct exposure to any of the three U.S. banks that failed in early March. While the swift and decisive action of regulators has helped the calm markets, we are watching very closely for signs of further instability in the global banking system and feel good about our holdings. Like the rest of the industry, we are seeing pressure in the commercial real estate markets. Office properties are the current area of focus given the difficult market for office leasing. Office represents approximately 30% of our total $8.1 billion commercial mortgage loan portfolio with most of our exposure in our transitional real estate book. We currently expect approximately $500 million of loans to enter into some form of foreclosure, approximately 6% of our total mortgage holdings. When going into foreclosure, we revalue the property to current market levels. In those cases where we do not yet have an independent third-party appraisal as an interim step, we establish an updated value based on our current -- based on our external manager's current assumptions of the local market and updated cap rates. This process resulted in a small $10 million of additional asset reserves this quarter. To offer perspective of our potential loss exposure, we have approximately $900 million of TRE loans currently on our watchlist. At the time of origination, these loans were 65% loan to value. If you apply a simple stress scenario, that assumes we foreclose on the entire amount and each property declines 50% in value, a drop which would exceed what we saw during the financial crisis by about 15 percentage points. We would have to establish approximately $200 million of reserves. To be clear, this is not our base case, but it highlights that our exposure under such a severe downturn in the office segment is manageable. Although accounting rules may require additional reserves, our strong capital and liquidity position will allow us to hold these properties to maximize our recovery. Turning to our middle market loan portfolio, despite the headwinds from rates and inflation, this portfolio continues to perform quite well. Our borrowers average leverage is stable. They have largely been successful passing through higher costs, and sponsors have generally been supportive whenever required. This quarter, we did take reserves of $20 million related to two names that were struggling with issues unique to them and not reflective of broader systemic issues in the asset class. As the primary outlet for our below investment grade exposure, we very deliberately built this portfolio with a strong focus on managing through the inevitable downturns in the credit cycle. Our average loan size is a very modest $16 million, we only invest in senior secured first lien positions. We utilize strict limits on position size, diversification and other characteristics. Should conditions worsen, we believe this approach will serve us well. We expect market volatility to remain elevated as the global economy absorbs the impact of higher interest rates. We will, of course, experience the impact of this volatility across our portfolio namely in our alternatives holdings. Relative to many in the industry, our exposure is rather modest, but we expect our $2.4 billion portfolio to experience volatile marks in the near-term. We remain committed to our disciplined systemic approach to building this portfolio and fully expect to enjoy the benefits of enhanced returns over time. Let me turn it back to Fred.
Fred Crawford: Thanks, Brad. Let me just give some additional perspective before we go to Q&A and that is connecting Brad's comments to capital. Our low asset leverage, which we define as the ratio of assets to statutory capital, particularly when you consider our natural concentration in JGBs, places us in a strong position to absorb weak economic conditions. We watch SMR in Japan carefully, as historically, it is more volatile during periods of economic stress. However, our SMR as you can see remains very strong. We are also comforted by a stable ESR ratio that like our U.S. statutory RBC is robust and more resilient to market volatility. The punch line is we do not see the events of the last quarter and/or mild to medium recession causing disruption to our capital deployment plans. So with that, let me hand back to David, who will take us to Q&A. David?
David Young: Thank you, Fred. Now we are ready to take your question. But first, let me ask you to please limit yourself to one initial question and a related follow-up to allow other participants an opportunity to ask their question. Andrea will now take the first question and if you want to let people know how to get back in the queue, that would be great.
Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Wes Carmichael of Wells Fargo. Please go ahead.
Wes Carmichael: Hey, good morning. In Japan Post, you talked about the revised cancer product doing well, but how are you kind of seeing the sales trajectory play out in the second quarter and through the balance of the year? Should we see it kind of accelerate in the near-term or will that take some time to play out?
Fred Crawford: Sure. Let me -- this is Fred. Let me do this, let’s go to Koide-san to comment on Japan Post and Yoshizumi-san can follow-up with any color from his perspective. Koide?
Masatoshi Koide: [Foreign Language] Hey, this is Koide of Aflac Japan. [Foreign Language] Now regarding Japan Post Group, our new cancer wings has been launched in April this year. [Foreign Language] And we believe that the start of the sales has been very successful, because we have been preparing to launch product towards April by doing a lot of preparation, as well as training. [Foreign Language] Mr. Yoshizumi, if you'd like to add anything, please do so?
Koichiro Yoshizumi: [Foreign Language] Thank you. This is Yoshizumi of Aflac Japan. [Foreign Language] To launch this product in April, we have been thoroughly preparing for the launch. [Foreign Language] We are seeing the start of the sale, this new product is very good, and it is gradually growing and it is meeting our expectation. However, having said that, because this product has just been launched, it would probably be a bit too early to say whether this is truly successful or not. But this is the product that we have launched this year as a continued new product. [Foreign Language] And I do believe that we have been able to get started with a very good new product process, because we have been training since January, and we have also introduced just so means. So we do believe that this product can be successful and at the same time this can be a trigger to even know more success. [Foreign Language] So let me just repeat this again, our start of the sale of this product has been very successful and that can be proved by the number of calls that we are receiving at the call center and also the number of illustration and estimates that we are providing to customers. [Foreign Language] And that's all for me. Thank you very much.
Fred Crawford: Thank you, Yoshizumi. And again, I would say we have been rolling this cancer product out gradually across channels, which is different than we've done in the past. And so started in our associates channel, but then it's spread on to other affiliate channels, Daido Life, Dai-ichi, and the financial institutions. And so we've seen this product rollout and rollout successfully and we know it's considered one of the ranked products in the country in terms of the attractiveness of the products. So we do come at it with a level of confidence. But as Yoshizumi-san said, it's still early in their system.
Wes Carmichael: No, that's helpful. Thank you. And on capital, the capital ratios are pretty strong with RBC north of 600 and SMR 850 plus and Holdco capital strong at $3.3 billion. But how do we think about the outlook for dividends or distributions out of the insurance companies this year? And I think you had proceeds from the reinsurance transaction, but it seems like there may be a lot of capital coming. So is there any help you can give us there?
Dan Amos: So I would start by -- go back to our Investor Day where we announced that on an underlying basis, we expect to generate $2.6 billion to $3 billion of capital each year. And that's a reasonable starting point. And on top of that, we will periodically generate additional capital through different actions that we take reinsurance being one of those actions. And we would use that capital pool to then obviously redeploy that capital generated in conjunction with any additional capital that we may be freeing up from having high capital ratios in our operating subsidiaries or at the holding company. But I do think that over time as a run rate base, you should think about the $2.6 billion to $3 billion that's a reasonable annual capital deployment for us with periodic additional capital deployments from other actions taken. And as you know, that goes through our capital management policy where we allocate capital obviously to the dividend. Currently, that is about $1 billion that we spend on our dividend each year and we cherish our dividend highly and expect to continue to increase the dividend on top of that we are then allocating capital to buybacks where we see appropriate IRRs and also for opportunistic employment where we can accelerate our growth long-term.
Operator: The next question comes from Suneet Kamath of Jefferies. Please go ahead.
Suneet Kamath: Yes, thanks. Just a bigger picture question for Japan. Obviously, you've had a lot of success there with the cancer block for years, but it sounds like you're losing market share in medical. If you look at the benefits, there definitely is some overlap in terms of hospitalization and surgical benefits. So I guess my question is, is there a risk that people will just start using medical insurance to, sort of, cover their cancer exposure and as a consequence, the cancer insurance market will just continually shrink?
Fred Crawford: We're going to go to Koide-san and Yoshizumi-san to help you out with that Suneet.
Masatoshi Koide: [Foreign Language] So let me start, this is Aflac Japan Koide. [Foreign Language] And cancer is an illness that is different from other diseases for example, it would require long-term treatment, as well as some mental support, our treatment required. Therefore, when you try to prepare for cancer, you would definitely be needing cancer protection type of policy. [Foreign Language] And the awareness regarding cancer is becoming very high in cancer, the reason is because one in two in Japan does suffer from cancer in their lifetime. [Foreign Language] And by looking at the penetration or enrollment of cancer insurance, the cancer insurance penetration is lower than that of medical insurance. Therefore, we do see that there is a bigger potential in counter insurance sales going forward. [Foreign Language] So the conclusion here is that it is not that there is no need for cancer insurance just because that you have medical insurance.
Fred Crawford: One of the things I would also add is that I have mentioned in my comments our Yorisou cancer care consulting practice, which is really wrapping non-insurance services around our cancer policies for our policyholders and that's gotten off to a good start and is building. And I mentioned that only because one of the things we do have to do, Suneet is continue to differentiate and protect our leadership position. And we differentiate the overall value proposition of a cancer product, not just from the enhanced coverage, advanced treatments, advanced types of care, but we also wrap that policy with non-insurance services and that really differentiates it from a traditional and often basic medical product sold to individuals.
Suneet Kamath: Got it. And then, I guess, one on the transitional real estate and middle market loans. If I just look at the book yields that you're disclosing, and compare them to what we saw at fab. I mean, I think they're up 175 basis points to 200 basis points in six months. So I'm just curious how have these borrowers essentially been able to pay what is a pretty sizable increase in interest payments and kind of what's the outlook there?
Brad Dyslin: Yes, thank you. This is Brad. It's a very good question. A couple of things I'd say in response to that. On the transitional real estate book, most of those loans contain rate caps. So the sponsors are protected from the large increase in rates. In fact, our average rate cap is about 200 basis points below where SOFR is today. Now that benefits the borrower, we still get the benefit of the higher rate. They just get the offset through the rate cap and the hedging that they've put in place. On the middle market loan portfolio, there's a couple of things at play here. First, these are largely service-oriented companies, which means they generate a fair amount of free cash flow. Now that's less free cash when you have a higher cost structure. But these companies have also been part of a growth strategy for the underlying sponsors who own these. So they've continued to perform well. They're continuing to grow. Margins have been relatively stable. And while cash flow may be reduced, they are taking actions to mitigate that. And the overall thesis for most of these companies remains intact.
Daniel Amos: This is Dan. I want to go back to one -- the question about the cancer insurance. Sorry took me a second to get my connection here. But we've got an aging society in Japan, cancer is a disease of age. I've been around since we got licensed in Japan, and I think there's more need and more emphasis on buying cancer insurance today than ever in Japan, and it only makes sense that, that should be the case because of it being a disease of age. And so not only do I disagree with that question, I feel very strong about that it's the opposite. People are wanting cancer insurance more. We've done a good job in buying it. But as you can imagine, it's the middle-aged people more than the younger ones. And our challenge there is how to get younger people involved, because they're not as frightened of cancer. And that's no different than it was in 1974. It's just a matter of being able to do that, and we've come up with some things to do that as well. But I think, if anything, I want to leave you with confidence that we feel like the market is more important now than it was in 1974.
Suneet Kamath: Okay. Thanks, Dan.
Operator: The next question comes from Jimmy Bhullar of JPMorgan Securities. Please go ahead.
Jimmy Bhullar: Hey, good morning. So first, just a question for Brad. On the real estate portfolio, commercial real estate, you mentioned a loan-to-value at origination of 60%. What would you guess that is now given that rates are higher since you've originated most of these loans? And then obviously, demand for office space has dropped over the past couple of years because the COVID is gone and work from home.
Brad Dyslin: Yes. Thank you, Jimmy. Actually, the average is 65% when we originated these. And when you look at the office portfolio, it really does depend on the specific asset, and it's driven in part by the overall occupancy, as well as other investment needed to boost the occupancy to get the asset relatively full. I will tell you that for those loans that are in the process of being revalued, we generally saw a decline based on input from our managers and the updated cap rates of 30% to 35%. Now those are -- I would caution those are unique to the assets that we are in the process of foreclosing. I'm not sure you can apply that across the universe of all office space, but that's what we saw in the specific loans that went through the revaluation process.
Jimmy Bhullar: Okay. And then fair to assume that the numbers are smaller, but there's a similar decline across the rest of the portfolio in terms of value as well?
Brad Dyslin: Again, it depends on the specific asset. We -- not all office in the portfolio is bad. We have some that are performing very, very strongly. They have good occupancy. The business plans are at or above plan. And we don't expect those have seen nearly the price decline is those that are -- have less occupancy and are resulting in us taking the keys.
Operator: The next question comes from Alex Scott of Goldman Sachs. Please go ahead.
Alex Scott: Hi, good morning. First one I had is just on the potential impact if the yen rates or JGB yields, I should say, were to go up in a more significant way. I know you guys have provided the financial analyst brief meeting and so forth some sensitivities to your capital ratios. But could you maybe unpack how something like that would affect your business maybe across sales, like maybe the product mix. What are the ways that would impact your business?
Fred Crawford: This is Fred. From a business perspective, and I'll let Max comment on capital sensitivity, and I would invite in either Koide or Yoshizumi-san to comment on. But as you start to see rates recover, then you start to bring in some of the first sector savings products, particularly the yen-based products as potentially being able to price to offer up a more valuable value proposition, a better value proposition to the consumer. So you can see some of that, but it takes quite a while, because the way that reserve discounting works in Japan, you have to go for quite a while of rate recovery before you are able to price more appealing and make the product more appealing broadly. So you need to have consecutive years, if you will, of recovery. But it does add some added tailwind to those products. I don't think you see much of any impact to the other aspects of our business that are far less rate sensitive and are really more of a morbidity play, as you can imagine. Max, I'll let you comment on the SMR dynamics, ESR dynamics.
Max Broden: Well, Alex, you obviously know the sensitivities to SMR, ESR, RBC, et cetera. But I would make one comment, and that is that as we get closer to ESR adoption in Japan, that is going to make our business slightly less interest rate sensitive. And the reason I say that is that our yen interest rates are now going to be much more aligned between the assets and liabilities, which means that movements in interest rates are going to follow more the economics of it, i.e., the economic impact on our business is going to flow through and have an economic impact on our capital base as well. So that means that our sensitivity is somewhat less, which obviously then means that currently I can tell you that we do hold volatility capital associated with interest rate volatility. And to some extent, if you have a lower interest rate sensitivity going forward, that means that you obviously need slightly lower in terms of a volatility buffer. All of this is going to be optimized as we get closer to ESR adoption, so I'm not going to put a number on what that is, but I am encouraged by what I see in terms of the sensitivity to interest rates.
Alex Scott: Got it. That's helpful. And then for a follow-up, I wanted to ask about the additional benefits you were talking about for the U.S., some of the things you're doing to improve persistency. I mean, could you help us think through what some of those things may be. And I mean when I hear higher benefits and no additional costs, I would think maybe that would put pressure on the benefit ratio itself. But maybe I'm not thinking about that right.
Virgil Miller: First, good morning. this is Virgil from the U.S. Let me give you a perspective first on what are we doing to help improve our persistency. The first thing I'll say though is you saw the numbers, and given that the numbers reflect a 12-month rolling period, I will first start by saying that we did see improvement in our lapses during Q1. If you compare Q1 of this year to Q1 of last year, our lapses were down about 20% when it comes to related premium. What we've done though to ensure we continue to see a term with this though is we stood up an office of persistency. The intent there is to get a team of data-driven experts to look at the analytics behind what are some of the key drivers to help improve persistency, but also put together a framework and a governance framework to ensure there are actions going forward. Some things we've already done this year would be to drive utilization of benefits. You heard Fred allude to this in his comments, but we launched a wellness campaign in Q1. What we're really trying to do, a is really push preventive maintenance when it comes to helping our consumer base. But more importantly though, it is to drive utilization of the benefit. When people utilize the benefits, we generally see a higher persistency, generating more loyalty to the product and have them keep them longer. So during a five-week period, during the campaign, for the wellness benefit alone on the individual products, we saw a 27% increase in wellness utilization on that particular product line. You will see us continue to do things like that, but the premise would be driving utilization. Another key foundational effort would be, remember, our products are portable with a lot of movement in the job market, if you see someone leave one organization to go into another or perhaps no longer working with their current employer, you can keep your coverage with Aflac. We're making sure there's ease of portability, making sure we've improved our ways to collect money through billing mechanisms and making sure we have digital needs for people to go online to keep the available coverage. So those are some of the things I'll share right now, but overall, I am pleased to say that there is progress and we have a definitive focus on that going forward for the remainder of the year.
Operator: The next question comes from John Barnidge of Piper Sandler. Please go ahead.
John Barnidge: Thank you very much. I know there's a traditional seasonal 4Q increase in the expense ratios, but there's also expense increases around product launches. So with the new cancer product being rolled out in Japan Post in the second quarter and are they any efforts really through that channel dated back before the pandemic, can you maybe talk about one-off efforts to train agents or any market partnership that we should be thinking about? Thank you.
Fred Crawford: John, I want to make sure I heard that last part of your -- you're on the track of expense ratio quarter-to-quarter related to product launches. But what's your last part of your question?
John Barnidge: Yes. Yes, so with the new cancer product being rolled out in Japan Post in the second quarter, are there any efforts to like retrain the agents or remarket the partnership and expenses associated with that, because big launch since before the pandemic [Indiscernible].
Fred Crawford: Understood. Why don't we do this? Let's go to Yoshizumi to talk about the training and rollout of training for Japan Post agents. And then Todd Daniels is with us and can comment on any implications for expense ratio. So why don't you go ahead, Yoshizumi-san?
Koichiro Yoshizumi: [Foreign Language] So regarding the Japan Post training, what we are doing is that the management layer or the management of both companies are very involved at each layer of the training. So what we are doing is going through the cycle plan, do check and action to make sure that things are going successfully. And through this planned do check and action cycle, we are trying to identify weaknesses and try to resolve those weaknesses and overcome them. And those are being monitored and also being taken action by both companies. And as one of the examples of having the checking process is this once in every three months or on a quarterly basis, we do have this strategic alliance committee where the top management of each company is involved to talk about these issues. [Foreign Language] And furthermore, in the associate channel, we are strengthening our training method.
Masatoshi Koide: [Foreign Language] Now this is Aflac Japan Koide once again. Regarding expenses, normally, when we launch a new cancer product, we will be doing training or renewing our solicitation materials, et cetera. And this is sort of like a normal course of action that we normally take when launching a new product. So that's what we did for this new cancer product as well.
Fred Crawford: And Todd, I don't know if you have any color on timing of expenses. John, the premise of your question, that was correct. And that is, for example, this quarter, we had a pretty low expense ratio in Japan, but that oftentimes can move around with the timing of product launch and training and promotion costs. Todd, if you have any comments on that?
Todd Daniels: Yes. I agree, Fred. I think the first quarter is traditionally lower with expense ratio, and you see a higher expense ratio later in the year with IP and marketing spend. But we have been paying for the training and the marketing of the product all throughout the quarter, so a lot of that is cost. And now you have the sales of the product and most of the acquisition expenses will be amortized into DAC. So you should see a slightly higher expense ratio as expected in the second quarter, but not really materially a result of Japan Post.
Dan Amos: John, for the full-year, we would expect to have an expense ratio in the 20% to 22% range.
John Barnidge: Thank you so much for the answers.
Operator: The next question comes from Erik Bass of Autonomous Research. Please go ahead.
Erik Bass: Hi, thank you. I had a couple of questions for Brad on the CRE portfolio. And I was hoping you could talk more about the common factors among the loans that are entering foreclosure. And then also maybe talk about what's driving the $900 million of CRE loans you have in your watch list currently. Maybe how that watch list has changed in the past few months and what's the risk of that growing over time.
Brad Dyslin: Sure. Thanks, Erik. On the common factors, it's really a combination of the leasing velocity not being quick enough relative to the original business plan and the sponsors being unwilling to continue to support the asset. In many cases, we have an upcoming maturity. And when that happens, we have a couple of choices. We can enter into negotiations to extend and renew the loan. But in those examples, we always require additional protections. It usually involves a pay down of the loan to reflect the current market and current progress of the plan. It can include personal guarantees, cash sweeps, a variety of other things. Then we usually get paid a little more as well. And if the sponsor is unable to meet those, that's when we enter into a more intense workout process, which will usually lead to foreclosure. And that's been the bulk of the issue with the $500 million of current [NREO] (ph). I do want to mention though that of that $500 million, we do have occupancy. These are running on average about 60%, which obviously is lower than we would like and the sponsors would like. But these are not sitting there as empty buildings, they are functional, they do have tenants, it's just a matter of continuing to grow the tenant base and that has slowed in this current environment. As to the $900 million, that's just our forward look on loans where we do have maturities coming up. We do have some issues with the underlying business plan. We are in negotiations with the sponsor and we're still unclear on exactly how those situations will resolve. But if we thought they were imminent, they would have been included in that $500 million. So we're watching that $900 million very closely, but those are largely issues that are coming down later in the year.
Erik Bass: Got it. And then just to clarify, when you talked about the $200 million of reserves that could be needed in your stress scenario, is that the full capital impact? Or could there be any additional pressure from capital charge changes when you bring a property on to your balance sheet?
Max Broden: So the additional capital that you would also have on top of that would be, let's call it, rating migration. As you take ownership of a property, you obviously move from the capital charge of that being a loan to being an owned real estate equity and operated property. If you -- just to give you a sense for it, if we were to add $500 million of real estate-owned equity versus that being a mortgage loan, that would impact our SMR negatively by 5 points, a relatively modest number. If we were to add $100 million on our U.S. balance sheet going from a loan to real estate-owned equity, that would decrease our combined RBC ratio by 8 points. Keep in mind, these numbers are not going to be exactly linear, but it's going to -- that gives you a good flavor for our sensitivity.
Operator: The next question comes from Tom Gallagher of Evercore ISI. Please go ahead.
Tom Gallagher: Good morning. Just a few follow-ups on the real estate foreclosures. The $500 million that you're, I guess, in the process of foreclosing on, did you not take any reserves or losses on those? And is that -- and if not, is that just because of the value of the land still exceeds the value of the loans? That's my first question.
Brad Dyslin: Yes. We did -- that is where the $10 million of additional reserves came from. It was on that $500 million in process of foreclosure. And the reason it wasn't larger is because looking at the decline in the asset, both the physical property, as well as land or any other peripheral value, the declines were not severe enough to dip into our 65% loan to value.
Tom Gallagher: Got you. That makes sense. The -- what about lost NII? You were getting presumably 8% or 9% yields on these loans. Now as you -- as they become owned real estate assets, would you expect there to be a meaningful change in the yield on those assets? Sorry, go ahead.
Brad Dyslin: Sorry, Tom. Yes, it's a really good question. It's one we spend a lot of time on. These properties, by and large, are generating some income. There is an NOI coming off of them. It is going to be lower than the yield we're getting on the underlying loan, and that is baked into all of our projections and planning.
Tom Gallagher: Got you. And Brad, any indication on the $500 million, are we talking about eight or nine going to four, six, two? Like some range would be helpful.
Brad Dyslin: Yes. Well, right now, it's currently nine properties. We think that is -- that reflects our current best estimate of the number. There are different levels of discussions going on in the workout process with the sponsors. We may have a couple of those break positively where they end up coming out of this bucket. But at this point, we think that's unlikely and we believe it was prudent to assume that this full $500 million are going to be foreclosed and become real estate-owned.
Operator: Next question comes from Wilma Burdis of Raymond James. Please go ahead.
Wilma Burdis: Hey, good morning. Could you give an update on any plans to refresh the Japan medical product? I think it's about 18 months old, and you tend to refresh the product every two years or so.
Fred Crawford: Yes. As I mentioned in my comments, we're coming out and ready to be prepared to have that -- our new product in the market in the fourth quarter. And as I made comments in my script, the idea there is to have a simplified product that attracts younger and new policyholders as well as a more comprehensive version of the product that's attractive for existing policyholders, as well as older policyholders that seek more comprehensive coverage, that’s the basic game plan. I'll go to Yoshizumi-san to comment on the rollout of the medical product and any thoughts he has on how we're going to market with that product.
Koichiro Yoshizumi: [Foreign Language] Okay, this is Yoshizumi once again. Thank you for the question. Well, regarding the Japanese medical market, what I can say is that it is very competitive. [Foreign Language] And especially the competition is in trying to acquire young to middle-aged customers, and that's where all the companies are aiming for. [Foreign Language] As a result, what is being asked by the market is to come up with something with reasonable premiums and simple benefit structure. [Foreign Language] And we are hoping to launch a new product that are focused on those points and will have competitive advantage. [Foreign Language] And especially by using this new product, the channel that where the competition is the most severe is a large, enormous collusive agencies channel, and that's where we would like to regain our share. [Foreign Language] Right now, we are collaborating between Japan and the U.S. to come up with a good product and we are in a full preparation mode. [Foreign Language] And that's all for me. Thank you very much.
Wilma Burdis: Thank you. And then just give a little bit of color on the WAYS and Child Endowment products. I know these products have been a little bit pressured in the past by fluctuations in interest rates. So maybe talk a little bit about why you feel like this is the right product for now and how it's different than earlier versions of the product.
Fred Crawford: Yes, I'll make just a couple of comments, and then I'll ask Koide-san and Yoshizumi-san to comment. But first, remember back when we were selling WAYS a number of years ago, 10 years ago, much of the volume of that sale -- those sales were through banks and particularly what we would call mega banks or the large banks and regional banks. And much of it is sold with discount advanced premium features. So products structured more for deposit like mining, meaning single premium-type short pay products, which can be much more attractive particularly in the banking channel. During our investor conference, we talked a bit about the approach we're taking here which is more of a level pay process product. And that level pay product is less appealing in the bank channel which is why we have rather muted expectations for volume. But it is -- it can be a useful tool and sell in our associate channel and more of a financial planning environment and attracts a younger policyholder in the process. And so that's where we came back in. From an engineering perspective, I'd also add that in the last 10-years, we've quite advanced our investment strategies and structures quite a bit under the leadership of Aflac Global Investments. And that is a nice weapon to have when looking at first sector savings products and dialing in investment strategy to back product and product pricing. And then as Max Broden has covered with you, we now have a reinsurance unit, and reinsurance is actively used to help manage capital returns over time of that product. So we have some engineering benefits that make it more attractive to come in at this time. Koide-san or Yoshizumi, maybe on the [Multiple Speakers]
Dan Amos: Yes, this is Dan. I want to make one comment about it is that one of the ways or the most important way we're judging WAYS and Child Endowment is our ability to add on our third sector product with that. So we're not just looking at sales. If you gave us nothing, but sales, although it's profitable and hit some of the targets we want, it's the ability to do that. It also is very helpful because of the premium that's involved for our agents to make commissions and getting them reengaged, which they had been off a little bit. So that's been very helpful, too. So it is a product we're watching carefully. But I think Fred's comments were good ones in that it's really the bank channel that we do not see as being the market for us, because of the single premium and the older ages. We want these younger people with lower premiums to get them engaged, and it has been working so far.
Fred Crawford: Yes, I think that -- I think we've covered it here. I would say we're -- I believe roughly half of our sales are to individuals younger than -- even more than that, younger than 50-years old, that may be even north of that. And then I think we're achieving upwards of 40% cross-sell results to new and younger policyholders to Dan's point. So those are critical metrics, we want to see it attracting young and we want to see the cross-sell activity, because that's fundamental to the strategy of coming back in the market.
Masatoshi Koide: [Foreign Language] This is Koide from Aflac Japan. Well, let me just add a little bit information here. Last year, in October, we did change rates of Child Endowment and WAYS product. And the purpose of that time was to acquire new customers, as well as young customers using these products. And for that purpose, we have focused on selling level premium type of product. [Foreign Language] And as Fred mentioned, this level premium-focused product is very important for associates to sell. However, it is not so popular among the bank channel. [Foreign Language] And as a result, associates sales were our focus. And as Dan mentioned earlier, these products also go well in terms of doing cross-sell with third sector products. So we are using a lot of leverage where -- we are using these products as leverage to sell third sector. [Foreign Language] And the proportion of WAYS product being sold through banks is still maintained very low, and it will be very limited again this year. That's all for me.
Koichiro Yoshizumi: [Foreign Language] So let me just add a word as well, this is Yoshizumi speaking. [Foreign Language] So what I would like to say is that those customers that have actually purchased WAYS and Child Endowment are basically 40s and below. So those customers in their 30s and 40s account for 83% of all customers. [Foreign Language] And on top of that, as was mentioned, we are planning to sell third sector product using WAYS and Child Endowment by using this level premium product. That was our strategy. And right now, our sell rate is 47%. [Foreign Language] And so what I'd like to do going forward is to really expand and really sell more in third sector products by using Child Endowment and WAYS as a trigger and catalyst. That's it from me. Thank you
Operator: The next question comes from Ryan Krueger of KBW. Please go ahead.
Ryan Krueger: Hey, thanks. Good morning. Get back to this transitional real estate. A couple of questions. One is, can you -- what is the total people reserve specifically against the transitional real estate that you're holding at this point? And then I also just wanted to confirm that the $900 million on the watch list, is that in addition to the $500 million potentially foreclosed or is the $500 million the subset of the $900 million?
Brad Dyslin: Yes. Thanks, Ryan. Let me start with the second question first. The $900 million does include the $500 million, so an incremental $400 million that we're watching. On the CECL reserves, essentially all of those reserves are related to the loan book. The split between middle market loan and TRE -- or real estate, generally, most of which is in TRE, it's about 35%, 40% of the total CECL reserve is related to mortgage loans.
Max Broden: And Ryan, our total CECL reserve was $250 million.
Ryan Krueger: Thanks. And then I guess for Max, you have the 400% RBC target in the U.S. When you think about Japan, how would you frame kind of your targeted capital ratios there at this point? Because it's a bit more challenging from the outside to think about the cushion you have.
Max Broden: Yes. So we obviously operate with strong levels of capital, and you know our sensitivities to different, kind of, macro factors. We're also in this now transition over time from SMR into the new ESR world. As we do that transition, we obviously are going to find our way to, over time, optimize our capital base somewhat. But also every time you go through a transition, you actually want to do that with some additional level of capital in order to make sure that you have the flexibility to then down the road optimize your capital structure. So right now, we feel comfortable where we operate, both from a standpoint of it gives us flexibility to be opportunistic where we can, but also then obviously absorb any kind of losses that may come our way. And also it gives opportunities for us to also deploy capital organically into opportunities that we might see as well.
Operator: The next question comes from Michael Ward of Citi. Please go ahead.
Michael Ward: Thank you, guys. And thank you for all the color on the loan books. Extremely helpful. So Brad, on the commercial mortgage loans, I think you mentioned the process of making office buildings more attractive for tenants and leases. I guess my understanding on office is that they, sort of, have to be super new and exciting to attract new leases. We've heard that the cost of that can be super expensive at times. So just curious if you have any thoughts on that and if the $10 million reserve math incorporates that.
Brad Dyslin: Yes. Thanks, Michael. You're right. In this environment, the leasing that is occurring is migrating towards newer properties with nicer amenities. About 80% plus of our total TRE book is in Class A properties. But keep in mind, too, the nature of transitional real estate is that transitional piece. These loans are providing that funding to reposition the asset. A lot of them are lease-up transitions. So our capital is going to refresh the asset. So through this process, we're getting, in most cases, the newest, most refreshed with the current amenities asset in the local submarkets. So that is one very good thing we have going for us. But in some cases, the business plans just need a little bit further work, and that's what's resulting in some of the foreclosures.
Michael Ward: Awesome. Thank you. And then on the rate caps. I was wondering if you can help us understand maybe the percentage of rate caps on the portfolio that have reset with the jump in rates over the last 12-months?
Brad Dyslin: The rate caps exist for the life of the loan. So only those that have reached maturity and are in some process of workout would have -- they would lose that protection. So the bulk of the portfolio prior to maturity is still protected by those rate caps. And for transitional real estate, it is essentially the entire book. And as I said for middle-market loans, it's a very small percent.
Operator: The next question is a follow-up from Wes Carmichael of Wells Fargo. Please go ahead.
Wes Carmichael: Hey, thanks for taking my follow-up. I actually had a question for Dan, and it relates to succession. And I know you've had a couple of leaders transition, but I'm really thinking about your CEO role, how -- I know you've laid out some ‘25, ‘26 sales targets. But what are you thinking for your role in the timing on that and how we should think about transition.
Dan Amos: Well, I'm not going to be that good a retiree and I'm not in that big a hurry. I just had a physical at Emory and got a good report. So I plan on staying around a few more years. But I still think my number one responsibility is to make sure I have it prepared. We never know what can happen in life, and we've got to have a company ready to go and go uninterrupted. And so that's one of the things that I'm doing. I will say, for example, with Virgil and the changeover to Teresa, that's been smooth. I will say that Eric's changeover to Brad has been smooth. You go back to Koide, we've gone on interrupted on the -- as things take place. And to me, that's one of the things I have to make sure happens. And I promise you, I'm working toward that with the Board of Directors, who ultimately make the call. But we have very structured and very intense meetings about what goes on in regard to personnel and human resources at our August meeting. And so I'll be constantly updating on what's going on there. But I would say I'll be around a few more years. So unless the Board gets tired of me, look for me to be here.
Wes Carmichael: Thanks, Dan.
Operator: The next question is a follow-up from Tom Gallagher of Evercore ISI. Please go ahead.
Tom Gallagher: Thanks. Just a few CRE follow-ups. Brad, the $900 million watch list, are those all ‘23 maturities? And can you comment on total maturities for both ‘23 and ‘24?
Brad Dyslin: Yes. Thanks, Tom. The $900 million on the watch list is predominantly near-term maturities. I will have to double check, but I don't believe we have anything out into 2024 on that watch list. But it is predominantly near-term maturities that we have to address. No, I'm sorry, what was your second question?
Tom Gallagher: Just what are the total maturities of your total...
Brad Dyslin: Sorry. Yes, these are very short-term loans. The -- at origination, they're generally three years in term with options for one-year extensions based on certain thresholds being met. So these do turn over pretty quick. We do have -- it's less than one-third of the total portfolio rolling over this year. But a big portion of those are what's on this watch list.
Tom Gallagher: Got you. And then just one on, you mentioned your alts portfolio, you expected near-term returns to be volatile. Should we -- is the interpretation that 2Q alts return should be negative? Or just any perspective on that?
Brad Dyslin: It's really way too early to try to give any insight on second quarter. I think you're familiar with the lag we have in our marks. For first quarter, we're really reflecting broad market activity from third and fourth quarter just given the lag in the reporting to our managers and then the reporting to us and it gets extended a little bit longer in fourth quarter. So second quarter should correlate more closely with the general market activity we saw in fourth quarter and a little bit of first quarter, but it's just way too early to give you any direction on that.
Operator: The next question is a follow-up from Jimmy Bhullar of JPMorgan Securities. Please go ahead.
Jimmy Bhullar: Hey, just a question for Fred on the implications of the May reclassification of COVID equivalent to influenza. What do you think the financial implications are? Because your margins in Japan have already been pretty good actually.
Fred Crawford: Well, really, the reclassification to five, the Class 5 influenza, is really more related to overall business activity, in other words. And you're starting to see it here in Japan. I would just tell you from a personal perspective, when I first got here, people inside office buildings, outside office buildings, in meetings, out of meetings, at restaurants, doing daily activities, you were talking about 3% to 5% of people not wearing a mask. That now has clearly freed up. And in fact, the Japanese government has been encouraging companies and hotel operators and office building managers to adjust their policies in accordance to guidelines from the Ministry of Health here in Japan, and companies are taking that to heart. And so you're starting to see less and less mask wearing, although still a considerable level of mask wearing. And so I wouldn't call it back to normal, but clearly has improved. And we think with that, there's improved face-to-face activity and improved economic activity overall. So we are seeing that, and that's really what we would point to. It's not anything related to, for example, benefit ratios and margins from that perspective. The whole deemed hospitalization issue is behind us. We've seen claims come back to their normal levels. Our operating platforms here in Japan are back to normal response times and volumes in the claims departments and call centers. And so we're through that episode. Maybe that answers your question.
Jimmy Bhullar: Yes. So obviously, more of an implication for potential sales activity than…
Fred Crawford: That's right. And it’s gradual, but we certainly hope that's the case. Yes.
Jimmy Bhullar: And then for Max, the stress that you're seeing in your investment portfolio, specifically in CRE, is that causing you to reevaluate your capital plans, because you did buy back a decent amount of stock, and your overall capital levels, both in Japan and the U.S. are pretty healthy.
Max Broden: So obviously, we factor that into our capital plan. And obviously, the way we, sort of, think about buybacks, dividends, et cetera, it's all a combination of our current capital levels, our cash flow generation, any stresses that we see on the asset side of the balance sheet and the overall economy and the outlook for our business. And that all then boils down into the actions that we take. And we bought back $700 million of our own stock in the first quarter. And I do believe that, that is the most that the company has ever done in the history of the company. And I hope you should see that as a reflection of our view of both our business cash flow generation capital levels and any thoughts that we have around, sort of, future stress on the asset side of the balance sheet.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young: Thank you, Andrea, and thank you all for joining us this morning for our call. Please reach out to the Investor and Rating Agency Relations team if you have any questions. And we look forward to speaking with you soon, and wish you all continued good health. Have a good one.
Operator: The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good morning, and welcome to the Aflac Incorporated First Quarter 2023 Earnings Conference Call. All participants will be in listen0only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Ratings Agency Relations and ESG. Please go ahead."
},
{
"speaker": "David Young",
"text": "Thank you, Andrea. Good morning and welcome. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated; Fred Crawford, President and COO of Aflac Incorporated is joining us from Japan and will touch briefly on conditions in the quarter and discuss key initiatives; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments will discuss the investment portfolio and its positioning given recent market events and volatility. Yesterday after the close, we posted our earnings release and financial supplement to investors.aflac.com. Under financials and the menu of that site, we also posted several slides of investment details related to our bank, commercial real estate and middle market loan exposure. In addition, Max Broden, Executive Vice President and CFO of Aflac Incorporated, provided his quarterly video update addressing our financial results and current capital and liquidity. Max will be joining us for the Q&A segment of this call along with the following members of our Executive Management in the U.S. The following Virgil Miller, President of Aflac U.S.; Al Roziere, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac US. We are also joined by members of our Executive Management team at Aflac Life Insurance Japan: Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, David, and good morning. And we're glad you joined us. Reflecting on the first quarter of 2023, our management team, employees and sales distribution, have continued to be devoted stewards of our business. Being there for the policyholders when they need us most just as we promised. The first quarter marked a good start to the year. Aflac delivered another quarter of solid earnings results, especially considering our material weakening of the yen. Looking at our operations in Japan and as noted last quarter, we are actively focused on numerous initiatives in Japan involving new and refreshed products and distribution that continues to cover from the -- as we recover from the pandemic. In addition, we are encouraged by the planned May reclassification of COVID-19 to the same level as influenza as Japan continues to emerge from the pandemic. I am pleased with the continued sales improvements, which reflect the ongoing rollout of our cancer insurance policy initially through associates and Daido Life followed by Dai-ichi Life and the financial institutions. First quarter sales also reflected the refreshed first sector ways in child endowment products, which we're using as a way of reaching new customers to whom we can also sell third sector products, including cancer and medical products. I'm also encouraged by the fact that Japan Post Group began selling our new cancer insurance product earlier this month. We expect this close collaboration to produce continued gradual improvement of Aflac's cancer insurance sales over the immediate term and to further position the companies for the long-term. In addition to product, another important element of our growth strategy is our intense focus on being where the customer wants to buy insurance. Our broad network of distribution channels, including agencies, alliance, partners and banks continually optimize opportunities to help provide financial protection to Japanese consumers. And we are working hard to support each channel. Turning to the U.S. while the first quarter tends to generate the lowest sales of the year, I'm encouraged by the continued improvement in the productivity of our agent and brokers, as well as the contribution from the build out of our network, dental and vision and group life and disability. We are seeing success in our efforts to reengage veteran associates and at the same time we are seeing strong growth through brokers. I'm very excited that we're in the process of refreshing our cancer protection assurance policy with increased benefits at no additional cost. We believe this will increase persistency, which will benefit our policyholders and lower our expenses. I believe that the need for the products we offer is stronger or stronger than it has ever been before in both Japan and the United States. At the same time, we know consumer habits, buying preferences have been evolving. We also know that our products are sold not bought. As we communicate the value of our products, we know that a strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face when they get medical treatment. We continue to reinforce our leading position and build on that momentum. As always, we continue to prudent liquidity and capital management. We continue to generate strong investment results, while remaining in a defensive position as we monitor evolving economic conditions. In addition, we've taken proactive steps in recent years to defend cash flows and deployable capital against the weakening yen. We treasure our track record of dividend growth, highlighted by 2022 marking the 40th consecutive year of dividend increases. We remain committed to extending this track record, supported by the strength of a capital and cash flows. At the same time, we remain in the market repurchasing shares with tactical approach focused on integrating the growth investments we've made in the platform to improve our strength and leadership position. We also believe in the underlying strength of our business, and our potential for continued growth in the United States and Japan, two of the largest life insurance markets in the world. We are well positioned as we work toward achieving long-term growth, while also ensuring we deliver on a promise to the policyholders. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Now, I'll turn the program over to Fred in Japan. Fred?"
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Dan. Let me first begin with brief comments on our Japan and U.S. operations. As Dan noted, we're off to a promising start. The revised cancer product is doing well and now supported by our Yorisou Cancer Consultation Platform. This providing Concierge’s care to cancer policyholders and connecting them with non-insurance services. As we look ahead this year, we are focused on the following here in Japan. Continued recovery with our longstanding alliance partners fueled by a refreshed cancer product and joint marketing and training support. Based on our preliminary read of activity levels within Japan Post, the Wings product appears to be off to a promising start and gaining traction. We are preparing to launch a new medical product in the fourth quarter. We are operating in a highly competitive environment with medical product representing 70% of the third sector marketplace. We are focused on simplifying the product and appealing to both younger policyholders with basic needs and older or existing policyholders, who desire upgrading to a more comprehensive coverage. The sale of WAYS is delivering on our strategy of attracting younger policyholders and cross sell activity. We are primarily selling in our associates channel and are being cautious with respect to selling in the bank channel with limited volume expected. We understand that over the long-term, leveraging the bank channel will require marrying a competitive medical and cancer product with a formal asset formation strategy to drive shelf space. Finally, our short-term insurance subsidiary SUDACHI launched a line of affordable term medical and cancer products in April. We anticipate a modest level of sales as measured in annualized premium. The focus is on introducing young first time buyers to the importance of medical and cancer insurance to then upgrade to more comprehensive coverage in the future. From an operations perspective, we are pleased with our expense ratio coming in below 20% in the phase of continued revenue pressure. This is in part a cumulative result of addressing expenses over the past few years. Turning to the U.S., we have discussed our balanced attack and this remains the case with individual, dental and vision, group life and disability and consumer markets all contributing to sales growth in the quarter. The underlying signs of momentum remain encouraging in our agent driven small business franchise recruiting the number of average weekly producers and agent productivity are all up in the quarter. Dental and vision sales increased 40% in the quarter with continued strength in cross sell of core voluntary products. While this is traditionally a slower quarter in the life and disability markets, our platform is off to a strong start for the year. Finally, we are encouraged by consumer markets sales up 29% in the quarter and with new products gaining traction and alliances coming online. With expanded business lines and new distribution channels, product development is a key focus in the U.S. We have launched a refreshed approach to cancer as Dan mentioned, we've advanced coverage for mental health conditions and are adding non-insurance services to our group disability products. We are proactively driving benefit utilization through wellness campaigns and benefit endorsements to in-force policies. We know that utilization drives persistency. In terms of operations, our expense ratio remains elevated, but as Max commented on in his recorded remarks, roughly 300 basis points are due to the pace of investment in emerging growth businesses all performing in line with our expectations. So what bends the expense curve in the U.S.? Traditional managing of expenses along with investment in process automation in our mature individual and career driven small business franchise, a multi-year technology modernization path, including a new group administrative platform driving process improvement and cost reduction. Finally, delivering on revenue build in our inquired and Greenfield properties that requires investment upfront to secure and retain quality business. Now I'd like to hand over to Brad Dyslin to discuss our investment portfolio and positioning with respect to recent market events and volatility. Brad?"
},
{
"speaker": "Brad Dyslin",
"text": "Thank you, Fred. Given recent events with the global banking system and the uncertain macro outlook as the Fed continues to raise rates to fight inflation, I would like to provide a brief update on those segments of our portfolio that are most directly impacted by the current environment. Let me start with our bank exposure. As at the end of the quarter, our total global bank portfolio is $5.6 billion with an average credit rating of single A minus. Our holdings are concentrated in large, systemically important banks located in stable countries. As of today, our U.S. bank exposure is limited to the largest banks. We have virtually no exposure to smaller U.S. regional banks. We do not have holdings or other direct exposure to any of the three U.S. banks that failed in early March. While the swift and decisive action of regulators has helped the calm markets, we are watching very closely for signs of further instability in the global banking system and feel good about our holdings. Like the rest of the industry, we are seeing pressure in the commercial real estate markets. Office properties are the current area of focus given the difficult market for office leasing. Office represents approximately 30% of our total $8.1 billion commercial mortgage loan portfolio with most of our exposure in our transitional real estate book. We currently expect approximately $500 million of loans to enter into some form of foreclosure, approximately 6% of our total mortgage holdings. When going into foreclosure, we revalue the property to current market levels. In those cases where we do not yet have an independent third-party appraisal as an interim step, we establish an updated value based on our current -- based on our external manager's current assumptions of the local market and updated cap rates. This process resulted in a small $10 million of additional asset reserves this quarter. To offer perspective of our potential loss exposure, we have approximately $900 million of TRE loans currently on our watchlist. At the time of origination, these loans were 65% loan to value. If you apply a simple stress scenario, that assumes we foreclose on the entire amount and each property declines 50% in value, a drop which would exceed what we saw during the financial crisis by about 15 percentage points. We would have to establish approximately $200 million of reserves. To be clear, this is not our base case, but it highlights that our exposure under such a severe downturn in the office segment is manageable. Although accounting rules may require additional reserves, our strong capital and liquidity position will allow us to hold these properties to maximize our recovery. Turning to our middle market loan portfolio, despite the headwinds from rates and inflation, this portfolio continues to perform quite well. Our borrowers average leverage is stable. They have largely been successful passing through higher costs, and sponsors have generally been supportive whenever required. This quarter, we did take reserves of $20 million related to two names that were struggling with issues unique to them and not reflective of broader systemic issues in the asset class. As the primary outlet for our below investment grade exposure, we very deliberately built this portfolio with a strong focus on managing through the inevitable downturns in the credit cycle. Our average loan size is a very modest $16 million, we only invest in senior secured first lien positions. We utilize strict limits on position size, diversification and other characteristics. Should conditions worsen, we believe this approach will serve us well. We expect market volatility to remain elevated as the global economy absorbs the impact of higher interest rates. We will, of course, experience the impact of this volatility across our portfolio namely in our alternatives holdings. Relative to many in the industry, our exposure is rather modest, but we expect our $2.4 billion portfolio to experience volatile marks in the near-term. We remain committed to our disciplined systemic approach to building this portfolio and fully expect to enjoy the benefits of enhanced returns over time. Let me turn it back to Fred."
},
{
"speaker": "Fred Crawford",
"text": "Thanks, Brad. Let me just give some additional perspective before we go to Q&A and that is connecting Brad's comments to capital. Our low asset leverage, which we define as the ratio of assets to statutory capital, particularly when you consider our natural concentration in JGBs, places us in a strong position to absorb weak economic conditions. We watch SMR in Japan carefully, as historically, it is more volatile during periods of economic stress. However, our SMR as you can see remains very strong. We are also comforted by a stable ESR ratio that like our U.S. statutory RBC is robust and more resilient to market volatility. The punch line is we do not see the events of the last quarter and/or mild to medium recession causing disruption to our capital deployment plans. So with that, let me hand back to David, who will take us to Q&A. David?"
},
{
"speaker": "David Young",
"text": "Thank you, Fred. Now we are ready to take your question. But first, let me ask you to please limit yourself to one initial question and a related follow-up to allow other participants an opportunity to ask their question. Andrea will now take the first question and if you want to let people know how to get back in the queue, that would be great."
},
{
"speaker": "Operator",
"text": "We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Wes Carmichael of Wells Fargo. Please go ahead."
},
{
"speaker": "Wes Carmichael",
"text": "Hey, good morning. In Japan Post, you talked about the revised cancer product doing well, but how are you kind of seeing the sales trajectory play out in the second quarter and through the balance of the year? Should we see it kind of accelerate in the near-term or will that take some time to play out?"
},
{
"speaker": "Fred Crawford",
"text": "Sure. Let me -- this is Fred. Let me do this, let’s go to Koide-san to comment on Japan Post and Yoshizumi-san can follow-up with any color from his perspective. Koide?"
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language] Hey, this is Koide of Aflac Japan. [Foreign Language] Now regarding Japan Post Group, our new cancer wings has been launched in April this year. [Foreign Language] And we believe that the start of the sales has been very successful, because we have been preparing to launch product towards April by doing a lot of preparation, as well as training. [Foreign Language] Mr. Yoshizumi, if you'd like to add anything, please do so?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Thank you. This is Yoshizumi of Aflac Japan. [Foreign Language] To launch this product in April, we have been thoroughly preparing for the launch. [Foreign Language] We are seeing the start of the sale, this new product is very good, and it is gradually growing and it is meeting our expectation. However, having said that, because this product has just been launched, it would probably be a bit too early to say whether this is truly successful or not. But this is the product that we have launched this year as a continued new product. [Foreign Language] And I do believe that we have been able to get started with a very good new product process, because we have been training since January, and we have also introduced just so means. So we do believe that this product can be successful and at the same time this can be a trigger to even know more success. [Foreign Language] So let me just repeat this again, our start of the sale of this product has been very successful and that can be proved by the number of calls that we are receiving at the call center and also the number of illustration and estimates that we are providing to customers. [Foreign Language] And that's all for me. Thank you very much."
},
{
"speaker": "Fred Crawford",
"text": "Thank you, Yoshizumi. And again, I would say we have been rolling this cancer product out gradually across channels, which is different than we've done in the past. And so started in our associates channel, but then it's spread on to other affiliate channels, Daido Life, Dai-ichi, and the financial institutions. And so we've seen this product rollout and rollout successfully and we know it's considered one of the ranked products in the country in terms of the attractiveness of the products. So we do come at it with a level of confidence. But as Yoshizumi-san said, it's still early in their system."
},
{
"speaker": "Wes Carmichael",
"text": "No, that's helpful. Thank you. And on capital, the capital ratios are pretty strong with RBC north of 600 and SMR 850 plus and Holdco capital strong at $3.3 billion. But how do we think about the outlook for dividends or distributions out of the insurance companies this year? And I think you had proceeds from the reinsurance transaction, but it seems like there may be a lot of capital coming. So is there any help you can give us there?"
},
{
"speaker": "Dan Amos",
"text": "So I would start by -- go back to our Investor Day where we announced that on an underlying basis, we expect to generate $2.6 billion to $3 billion of capital each year. And that's a reasonable starting point. And on top of that, we will periodically generate additional capital through different actions that we take reinsurance being one of those actions. And we would use that capital pool to then obviously redeploy that capital generated in conjunction with any additional capital that we may be freeing up from having high capital ratios in our operating subsidiaries or at the holding company. But I do think that over time as a run rate base, you should think about the $2.6 billion to $3 billion that's a reasonable annual capital deployment for us with periodic additional capital deployments from other actions taken. And as you know, that goes through our capital management policy where we allocate capital obviously to the dividend. Currently, that is about $1 billion that we spend on our dividend each year and we cherish our dividend highly and expect to continue to increase the dividend on top of that we are then allocating capital to buybacks where we see appropriate IRRs and also for opportunistic employment where we can accelerate our growth long-term."
},
{
"speaker": "Operator",
"text": "The next question comes from Suneet Kamath of Jefferies. Please go ahead."
},
{
"speaker": "Suneet Kamath",
"text": "Yes, thanks. Just a bigger picture question for Japan. Obviously, you've had a lot of success there with the cancer block for years, but it sounds like you're losing market share in medical. If you look at the benefits, there definitely is some overlap in terms of hospitalization and surgical benefits. So I guess my question is, is there a risk that people will just start using medical insurance to, sort of, cover their cancer exposure and as a consequence, the cancer insurance market will just continually shrink?"
},
{
"speaker": "Fred Crawford",
"text": "We're going to go to Koide-san and Yoshizumi-san to help you out with that Suneet."
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language] So let me start, this is Aflac Japan Koide. [Foreign Language] And cancer is an illness that is different from other diseases for example, it would require long-term treatment, as well as some mental support, our treatment required. Therefore, when you try to prepare for cancer, you would definitely be needing cancer protection type of policy. [Foreign Language] And the awareness regarding cancer is becoming very high in cancer, the reason is because one in two in Japan does suffer from cancer in their lifetime. [Foreign Language] And by looking at the penetration or enrollment of cancer insurance, the cancer insurance penetration is lower than that of medical insurance. Therefore, we do see that there is a bigger potential in counter insurance sales going forward. [Foreign Language] So the conclusion here is that it is not that there is no need for cancer insurance just because that you have medical insurance."
},
{
"speaker": "Fred Crawford",
"text": "One of the things I would also add is that I have mentioned in my comments our Yorisou cancer care consulting practice, which is really wrapping non-insurance services around our cancer policies for our policyholders and that's gotten off to a good start and is building. And I mentioned that only because one of the things we do have to do, Suneet is continue to differentiate and protect our leadership position. And we differentiate the overall value proposition of a cancer product, not just from the enhanced coverage, advanced treatments, advanced types of care, but we also wrap that policy with non-insurance services and that really differentiates it from a traditional and often basic medical product sold to individuals."
},
{
"speaker": "Suneet Kamath",
"text": "Got it. And then, I guess, one on the transitional real estate and middle market loans. If I just look at the book yields that you're disclosing, and compare them to what we saw at fab. I mean, I think they're up 175 basis points to 200 basis points in six months. So I'm just curious how have these borrowers essentially been able to pay what is a pretty sizable increase in interest payments and kind of what's the outlook there?"
},
{
"speaker": "Brad Dyslin",
"text": "Yes, thank you. This is Brad. It's a very good question. A couple of things I'd say in response to that. On the transitional real estate book, most of those loans contain rate caps. So the sponsors are protected from the large increase in rates. In fact, our average rate cap is about 200 basis points below where SOFR is today. Now that benefits the borrower, we still get the benefit of the higher rate. They just get the offset through the rate cap and the hedging that they've put in place. On the middle market loan portfolio, there's a couple of things at play here. First, these are largely service-oriented companies, which means they generate a fair amount of free cash flow. Now that's less free cash when you have a higher cost structure. But these companies have also been part of a growth strategy for the underlying sponsors who own these. So they've continued to perform well. They're continuing to grow. Margins have been relatively stable. And while cash flow may be reduced, they are taking actions to mitigate that. And the overall thesis for most of these companies remains intact."
},
{
"speaker": "Daniel Amos",
"text": "This is Dan. I want to go back to one -- the question about the cancer insurance. Sorry took me a second to get my connection here. But we've got an aging society in Japan, cancer is a disease of age. I've been around since we got licensed in Japan, and I think there's more need and more emphasis on buying cancer insurance today than ever in Japan, and it only makes sense that, that should be the case because of it being a disease of age. And so not only do I disagree with that question, I feel very strong about that it's the opposite. People are wanting cancer insurance more. We've done a good job in buying it. But as you can imagine, it's the middle-aged people more than the younger ones. And our challenge there is how to get younger people involved, because they're not as frightened of cancer. And that's no different than it was in 1974. It's just a matter of being able to do that, and we've come up with some things to do that as well. But I think, if anything, I want to leave you with confidence that we feel like the market is more important now than it was in 1974."
},
{
"speaker": "Suneet Kamath",
"text": "Okay. Thanks, Dan."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar of JPMorgan Securities. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hey, good morning. So first, just a question for Brad. On the real estate portfolio, commercial real estate, you mentioned a loan-to-value at origination of 60%. What would you guess that is now given that rates are higher since you've originated most of these loans? And then obviously, demand for office space has dropped over the past couple of years because the COVID is gone and work from home."
},
{
"speaker": "Brad Dyslin",
"text": "Yes. Thank you, Jimmy. Actually, the average is 65% when we originated these. And when you look at the office portfolio, it really does depend on the specific asset, and it's driven in part by the overall occupancy, as well as other investment needed to boost the occupancy to get the asset relatively full. I will tell you that for those loans that are in the process of being revalued, we generally saw a decline based on input from our managers and the updated cap rates of 30% to 35%. Now those are -- I would caution those are unique to the assets that we are in the process of foreclosing. I'm not sure you can apply that across the universe of all office space, but that's what we saw in the specific loans that went through the revaluation process."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. And then fair to assume that the numbers are smaller, but there's a similar decline across the rest of the portfolio in terms of value as well?"
},
{
"speaker": "Brad Dyslin",
"text": "Again, it depends on the specific asset. We -- not all office in the portfolio is bad. We have some that are performing very, very strongly. They have good occupancy. The business plans are at or above plan. And we don't expect those have seen nearly the price decline is those that are -- have less occupancy and are resulting in us taking the keys."
},
{
"speaker": "Operator",
"text": "The next question comes from Alex Scott of Goldman Sachs. Please go ahead."
},
{
"speaker": "Alex Scott",
"text": "Hi, good morning. First one I had is just on the potential impact if the yen rates or JGB yields, I should say, were to go up in a more significant way. I know you guys have provided the financial analyst brief meeting and so forth some sensitivities to your capital ratios. But could you maybe unpack how something like that would affect your business maybe across sales, like maybe the product mix. What are the ways that would impact your business?"
},
{
"speaker": "Fred Crawford",
"text": "This is Fred. From a business perspective, and I'll let Max comment on capital sensitivity, and I would invite in either Koide or Yoshizumi-san to comment on. But as you start to see rates recover, then you start to bring in some of the first sector savings products, particularly the yen-based products as potentially being able to price to offer up a more valuable value proposition, a better value proposition to the consumer. So you can see some of that, but it takes quite a while, because the way that reserve discounting works in Japan, you have to go for quite a while of rate recovery before you are able to price more appealing and make the product more appealing broadly. So you need to have consecutive years, if you will, of recovery. But it does add some added tailwind to those products. I don't think you see much of any impact to the other aspects of our business that are far less rate sensitive and are really more of a morbidity play, as you can imagine. Max, I'll let you comment on the SMR dynamics, ESR dynamics."
},
{
"speaker": "Max Broden",
"text": "Well, Alex, you obviously know the sensitivities to SMR, ESR, RBC, et cetera. But I would make one comment, and that is that as we get closer to ESR adoption in Japan, that is going to make our business slightly less interest rate sensitive. And the reason I say that is that our yen interest rates are now going to be much more aligned between the assets and liabilities, which means that movements in interest rates are going to follow more the economics of it, i.e., the economic impact on our business is going to flow through and have an economic impact on our capital base as well. So that means that our sensitivity is somewhat less, which obviously then means that currently I can tell you that we do hold volatility capital associated with interest rate volatility. And to some extent, if you have a lower interest rate sensitivity going forward, that means that you obviously need slightly lower in terms of a volatility buffer. All of this is going to be optimized as we get closer to ESR adoption, so I'm not going to put a number on what that is, but I am encouraged by what I see in terms of the sensitivity to interest rates."
},
{
"speaker": "Alex Scott",
"text": "Got it. That's helpful. And then for a follow-up, I wanted to ask about the additional benefits you were talking about for the U.S., some of the things you're doing to improve persistency. I mean, could you help us think through what some of those things may be. And I mean when I hear higher benefits and no additional costs, I would think maybe that would put pressure on the benefit ratio itself. But maybe I'm not thinking about that right."
},
{
"speaker": "Virgil Miller",
"text": "First, good morning. this is Virgil from the U.S. Let me give you a perspective first on what are we doing to help improve our persistency. The first thing I'll say though is you saw the numbers, and given that the numbers reflect a 12-month rolling period, I will first start by saying that we did see improvement in our lapses during Q1. If you compare Q1 of this year to Q1 of last year, our lapses were down about 20% when it comes to related premium. What we've done though to ensure we continue to see a term with this though is we stood up an office of persistency. The intent there is to get a team of data-driven experts to look at the analytics behind what are some of the key drivers to help improve persistency, but also put together a framework and a governance framework to ensure there are actions going forward. Some things we've already done this year would be to drive utilization of benefits. You heard Fred allude to this in his comments, but we launched a wellness campaign in Q1. What we're really trying to do, a is really push preventive maintenance when it comes to helping our consumer base. But more importantly though, it is to drive utilization of the benefit. When people utilize the benefits, we generally see a higher persistency, generating more loyalty to the product and have them keep them longer. So during a five-week period, during the campaign, for the wellness benefit alone on the individual products, we saw a 27% increase in wellness utilization on that particular product line. You will see us continue to do things like that, but the premise would be driving utilization. Another key foundational effort would be, remember, our products are portable with a lot of movement in the job market, if you see someone leave one organization to go into another or perhaps no longer working with their current employer, you can keep your coverage with Aflac. We're making sure there's ease of portability, making sure we've improved our ways to collect money through billing mechanisms and making sure we have digital needs for people to go online to keep the available coverage. So those are some of the things I'll share right now, but overall, I am pleased to say that there is progress and we have a definitive focus on that going forward for the remainder of the year."
},
{
"speaker": "Operator",
"text": "The next question comes from John Barnidge of Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Thank you very much. I know there's a traditional seasonal 4Q increase in the expense ratios, but there's also expense increases around product launches. So with the new cancer product being rolled out in Japan Post in the second quarter and are they any efforts really through that channel dated back before the pandemic, can you maybe talk about one-off efforts to train agents or any market partnership that we should be thinking about? Thank you."
},
{
"speaker": "Fred Crawford",
"text": "John, I want to make sure I heard that last part of your -- you're on the track of expense ratio quarter-to-quarter related to product launches. But what's your last part of your question?"
},
{
"speaker": "John Barnidge",
"text": "Yes. Yes, so with the new cancer product being rolled out in Japan Post in the second quarter, are there any efforts to like retrain the agents or remarket the partnership and expenses associated with that, because big launch since before the pandemic [Indiscernible]."
},
{
"speaker": "Fred Crawford",
"text": "Understood. Why don't we do this? Let's go to Yoshizumi to talk about the training and rollout of training for Japan Post agents. And then Todd Daniels is with us and can comment on any implications for expense ratio. So why don't you go ahead, Yoshizumi-san?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] So regarding the Japan Post training, what we are doing is that the management layer or the management of both companies are very involved at each layer of the training. So what we are doing is going through the cycle plan, do check and action to make sure that things are going successfully. And through this planned do check and action cycle, we are trying to identify weaknesses and try to resolve those weaknesses and overcome them. And those are being monitored and also being taken action by both companies. And as one of the examples of having the checking process is this once in every three months or on a quarterly basis, we do have this strategic alliance committee where the top management of each company is involved to talk about these issues. [Foreign Language] And furthermore, in the associate channel, we are strengthening our training method."
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language] Now this is Aflac Japan Koide once again. Regarding expenses, normally, when we launch a new cancer product, we will be doing training or renewing our solicitation materials, et cetera. And this is sort of like a normal course of action that we normally take when launching a new product. So that's what we did for this new cancer product as well."
},
{
"speaker": "Fred Crawford",
"text": "And Todd, I don't know if you have any color on timing of expenses. John, the premise of your question, that was correct. And that is, for example, this quarter, we had a pretty low expense ratio in Japan, but that oftentimes can move around with the timing of product launch and training and promotion costs. Todd, if you have any comments on that?"
},
{
"speaker": "Todd Daniels",
"text": "Yes. I agree, Fred. I think the first quarter is traditionally lower with expense ratio, and you see a higher expense ratio later in the year with IP and marketing spend. But we have been paying for the training and the marketing of the product all throughout the quarter, so a lot of that is cost. And now you have the sales of the product and most of the acquisition expenses will be amortized into DAC. So you should see a slightly higher expense ratio as expected in the second quarter, but not really materially a result of Japan Post."
},
{
"speaker": "Dan Amos",
"text": "John, for the full-year, we would expect to have an expense ratio in the 20% to 22% range."
},
{
"speaker": "John Barnidge",
"text": "Thank you so much for the answers."
},
{
"speaker": "Operator",
"text": "The next question comes from Erik Bass of Autonomous Research. Please go ahead."
},
{
"speaker": "Erik Bass",
"text": "Hi, thank you. I had a couple of questions for Brad on the CRE portfolio. And I was hoping you could talk more about the common factors among the loans that are entering foreclosure. And then also maybe talk about what's driving the $900 million of CRE loans you have in your watch list currently. Maybe how that watch list has changed in the past few months and what's the risk of that growing over time."
},
{
"speaker": "Brad Dyslin",
"text": "Sure. Thanks, Erik. On the common factors, it's really a combination of the leasing velocity not being quick enough relative to the original business plan and the sponsors being unwilling to continue to support the asset. In many cases, we have an upcoming maturity. And when that happens, we have a couple of choices. We can enter into negotiations to extend and renew the loan. But in those examples, we always require additional protections. It usually involves a pay down of the loan to reflect the current market and current progress of the plan. It can include personal guarantees, cash sweeps, a variety of other things. Then we usually get paid a little more as well. And if the sponsor is unable to meet those, that's when we enter into a more intense workout process, which will usually lead to foreclosure. And that's been the bulk of the issue with the $500 million of current [NREO] (ph). I do want to mention though that of that $500 million, we do have occupancy. These are running on average about 60%, which obviously is lower than we would like and the sponsors would like. But these are not sitting there as empty buildings, they are functional, they do have tenants, it's just a matter of continuing to grow the tenant base and that has slowed in this current environment. As to the $900 million, that's just our forward look on loans where we do have maturities coming up. We do have some issues with the underlying business plan. We are in negotiations with the sponsor and we're still unclear on exactly how those situations will resolve. But if we thought they were imminent, they would have been included in that $500 million. So we're watching that $900 million very closely, but those are largely issues that are coming down later in the year."
},
{
"speaker": "Erik Bass",
"text": "Got it. And then just to clarify, when you talked about the $200 million of reserves that could be needed in your stress scenario, is that the full capital impact? Or could there be any additional pressure from capital charge changes when you bring a property on to your balance sheet?"
},
{
"speaker": "Max Broden",
"text": "So the additional capital that you would also have on top of that would be, let's call it, rating migration. As you take ownership of a property, you obviously move from the capital charge of that being a loan to being an owned real estate equity and operated property. If you -- just to give you a sense for it, if we were to add $500 million of real estate-owned equity versus that being a mortgage loan, that would impact our SMR negatively by 5 points, a relatively modest number. If we were to add $100 million on our U.S. balance sheet going from a loan to real estate-owned equity, that would decrease our combined RBC ratio by 8 points. Keep in mind, these numbers are not going to be exactly linear, but it's going to -- that gives you a good flavor for our sensitivity."
},
{
"speaker": "Operator",
"text": "The next question comes from Tom Gallagher of Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Good morning. Just a few follow-ups on the real estate foreclosures. The $500 million that you're, I guess, in the process of foreclosing on, did you not take any reserves or losses on those? And is that -- and if not, is that just because of the value of the land still exceeds the value of the loans? That's my first question."
},
{
"speaker": "Brad Dyslin",
"text": "Yes. We did -- that is where the $10 million of additional reserves came from. It was on that $500 million in process of foreclosure. And the reason it wasn't larger is because looking at the decline in the asset, both the physical property, as well as land or any other peripheral value, the declines were not severe enough to dip into our 65% loan to value."
},
{
"speaker": "Tom Gallagher",
"text": "Got you. That makes sense. The -- what about lost NII? You were getting presumably 8% or 9% yields on these loans. Now as you -- as they become owned real estate assets, would you expect there to be a meaningful change in the yield on those assets? Sorry, go ahead."
},
{
"speaker": "Brad Dyslin",
"text": "Sorry, Tom. Yes, it's a really good question. It's one we spend a lot of time on. These properties, by and large, are generating some income. There is an NOI coming off of them. It is going to be lower than the yield we're getting on the underlying loan, and that is baked into all of our projections and planning."
},
{
"speaker": "Tom Gallagher",
"text": "Got you. And Brad, any indication on the $500 million, are we talking about eight or nine going to four, six, two? Like some range would be helpful."
},
{
"speaker": "Brad Dyslin",
"text": "Yes. Well, right now, it's currently nine properties. We think that is -- that reflects our current best estimate of the number. There are different levels of discussions going on in the workout process with the sponsors. We may have a couple of those break positively where they end up coming out of this bucket. But at this point, we think that's unlikely and we believe it was prudent to assume that this full $500 million are going to be foreclosed and become real estate-owned."
},
{
"speaker": "Operator",
"text": "Next question comes from Wilma Burdis of Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"text": "Hey, good morning. Could you give an update on any plans to refresh the Japan medical product? I think it's about 18 months old, and you tend to refresh the product every two years or so."
},
{
"speaker": "Fred Crawford",
"text": "Yes. As I mentioned in my comments, we're coming out and ready to be prepared to have that -- our new product in the market in the fourth quarter. And as I made comments in my script, the idea there is to have a simplified product that attracts younger and new policyholders as well as a more comprehensive version of the product that's attractive for existing policyholders, as well as older policyholders that seek more comprehensive coverage, that’s the basic game plan. I'll go to Yoshizumi-san to comment on the rollout of the medical product and any thoughts he has on how we're going to market with that product."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Okay, this is Yoshizumi once again. Thank you for the question. Well, regarding the Japanese medical market, what I can say is that it is very competitive. [Foreign Language] And especially the competition is in trying to acquire young to middle-aged customers, and that's where all the companies are aiming for. [Foreign Language] As a result, what is being asked by the market is to come up with something with reasonable premiums and simple benefit structure. [Foreign Language] And we are hoping to launch a new product that are focused on those points and will have competitive advantage. [Foreign Language] And especially by using this new product, the channel that where the competition is the most severe is a large, enormous collusive agencies channel, and that's where we would like to regain our share. [Foreign Language] Right now, we are collaborating between Japan and the U.S. to come up with a good product and we are in a full preparation mode. [Foreign Language] And that's all for me. Thank you very much."
},
{
"speaker": "Wilma Burdis",
"text": "Thank you. And then just give a little bit of color on the WAYS and Child Endowment products. I know these products have been a little bit pressured in the past by fluctuations in interest rates. So maybe talk a little bit about why you feel like this is the right product for now and how it's different than earlier versions of the product."
},
{
"speaker": "Fred Crawford",
"text": "Yes, I'll make just a couple of comments, and then I'll ask Koide-san and Yoshizumi-san to comment. But first, remember back when we were selling WAYS a number of years ago, 10 years ago, much of the volume of that sale -- those sales were through banks and particularly what we would call mega banks or the large banks and regional banks. And much of it is sold with discount advanced premium features. So products structured more for deposit like mining, meaning single premium-type short pay products, which can be much more attractive particularly in the banking channel. During our investor conference, we talked a bit about the approach we're taking here which is more of a level pay process product. And that level pay product is less appealing in the bank channel which is why we have rather muted expectations for volume. But it is -- it can be a useful tool and sell in our associate channel and more of a financial planning environment and attracts a younger policyholder in the process. And so that's where we came back in. From an engineering perspective, I'd also add that in the last 10-years, we've quite advanced our investment strategies and structures quite a bit under the leadership of Aflac Global Investments. And that is a nice weapon to have when looking at first sector savings products and dialing in investment strategy to back product and product pricing. And then as Max Broden has covered with you, we now have a reinsurance unit, and reinsurance is actively used to help manage capital returns over time of that product. So we have some engineering benefits that make it more attractive to come in at this time. Koide-san or Yoshizumi, maybe on the [Multiple Speakers]"
},
{
"speaker": "Dan Amos",
"text": "Yes, this is Dan. I want to make one comment about it is that one of the ways or the most important way we're judging WAYS and Child Endowment is our ability to add on our third sector product with that. So we're not just looking at sales. If you gave us nothing, but sales, although it's profitable and hit some of the targets we want, it's the ability to do that. It also is very helpful because of the premium that's involved for our agents to make commissions and getting them reengaged, which they had been off a little bit. So that's been very helpful, too. So it is a product we're watching carefully. But I think Fred's comments were good ones in that it's really the bank channel that we do not see as being the market for us, because of the single premium and the older ages. We want these younger people with lower premiums to get them engaged, and it has been working so far."
},
{
"speaker": "Fred Crawford",
"text": "Yes, I think that -- I think we've covered it here. I would say we're -- I believe roughly half of our sales are to individuals younger than -- even more than that, younger than 50-years old, that may be even north of that. And then I think we're achieving upwards of 40% cross-sell results to new and younger policyholders to Dan's point. So those are critical metrics, we want to see it attracting young and we want to see the cross-sell activity, because that's fundamental to the strategy of coming back in the market."
},
{
"speaker": "Masatoshi Koide",
"text": "[Foreign Language] This is Koide from Aflac Japan. Well, let me just add a little bit information here. Last year, in October, we did change rates of Child Endowment and WAYS product. And the purpose of that time was to acquire new customers, as well as young customers using these products. And for that purpose, we have focused on selling level premium type of product. [Foreign Language] And as Fred mentioned, this level premium-focused product is very important for associates to sell. However, it is not so popular among the bank channel. [Foreign Language] And as a result, associates sales were our focus. And as Dan mentioned earlier, these products also go well in terms of doing cross-sell with third sector products. So we are using a lot of leverage where -- we are using these products as leverage to sell third sector. [Foreign Language] And the proportion of WAYS product being sold through banks is still maintained very low, and it will be very limited again this year. That's all for me."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] So let me just add a word as well, this is Yoshizumi speaking. [Foreign Language] So what I would like to say is that those customers that have actually purchased WAYS and Child Endowment are basically 40s and below. So those customers in their 30s and 40s account for 83% of all customers. [Foreign Language] And on top of that, as was mentioned, we are planning to sell third sector product using WAYS and Child Endowment by using this level premium product. That was our strategy. And right now, our sell rate is 47%. [Foreign Language] And so what I'd like to do going forward is to really expand and really sell more in third sector products by using Child Endowment and WAYS as a trigger and catalyst. That's it from me. Thank you"
},
{
"speaker": "Operator",
"text": "The next question comes from Ryan Krueger of KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "Hey, thanks. Good morning. Get back to this transitional real estate. A couple of questions. One is, can you -- what is the total people reserve specifically against the transitional real estate that you're holding at this point? And then I also just wanted to confirm that the $900 million on the watch list, is that in addition to the $500 million potentially foreclosed or is the $500 million the subset of the $900 million?"
},
{
"speaker": "Brad Dyslin",
"text": "Yes. Thanks, Ryan. Let me start with the second question first. The $900 million does include the $500 million, so an incremental $400 million that we're watching. On the CECL reserves, essentially all of those reserves are related to the loan book. The split between middle market loan and TRE -- or real estate, generally, most of which is in TRE, it's about 35%, 40% of the total CECL reserve is related to mortgage loans."
},
{
"speaker": "Max Broden",
"text": "And Ryan, our total CECL reserve was $250 million."
},
{
"speaker": "Ryan Krueger",
"text": "Thanks. And then I guess for Max, you have the 400% RBC target in the U.S. When you think about Japan, how would you frame kind of your targeted capital ratios there at this point? Because it's a bit more challenging from the outside to think about the cushion you have."
},
{
"speaker": "Max Broden",
"text": "Yes. So we obviously operate with strong levels of capital, and you know our sensitivities to different, kind of, macro factors. We're also in this now transition over time from SMR into the new ESR world. As we do that transition, we obviously are going to find our way to, over time, optimize our capital base somewhat. But also every time you go through a transition, you actually want to do that with some additional level of capital in order to make sure that you have the flexibility to then down the road optimize your capital structure. So right now, we feel comfortable where we operate, both from a standpoint of it gives us flexibility to be opportunistic where we can, but also then obviously absorb any kind of losses that may come our way. And also it gives opportunities for us to also deploy capital organically into opportunities that we might see as well."
},
{
"speaker": "Operator",
"text": "The next question comes from Michael Ward of Citi. Please go ahead."
},
{
"speaker": "Michael Ward",
"text": "Thank you, guys. And thank you for all the color on the loan books. Extremely helpful. So Brad, on the commercial mortgage loans, I think you mentioned the process of making office buildings more attractive for tenants and leases. I guess my understanding on office is that they, sort of, have to be super new and exciting to attract new leases. We've heard that the cost of that can be super expensive at times. So just curious if you have any thoughts on that and if the $10 million reserve math incorporates that."
},
{
"speaker": "Brad Dyslin",
"text": "Yes. Thanks, Michael. You're right. In this environment, the leasing that is occurring is migrating towards newer properties with nicer amenities. About 80% plus of our total TRE book is in Class A properties. But keep in mind, too, the nature of transitional real estate is that transitional piece. These loans are providing that funding to reposition the asset. A lot of them are lease-up transitions. So our capital is going to refresh the asset. So through this process, we're getting, in most cases, the newest, most refreshed with the current amenities asset in the local submarkets. So that is one very good thing we have going for us. But in some cases, the business plans just need a little bit further work, and that's what's resulting in some of the foreclosures."
},
{
"speaker": "Michael Ward",
"text": "Awesome. Thank you. And then on the rate caps. I was wondering if you can help us understand maybe the percentage of rate caps on the portfolio that have reset with the jump in rates over the last 12-months?"
},
{
"speaker": "Brad Dyslin",
"text": "The rate caps exist for the life of the loan. So only those that have reached maturity and are in some process of workout would have -- they would lose that protection. So the bulk of the portfolio prior to maturity is still protected by those rate caps. And for transitional real estate, it is essentially the entire book. And as I said for middle-market loans, it's a very small percent."
},
{
"speaker": "Operator",
"text": "The next question is a follow-up from Wes Carmichael of Wells Fargo. Please go ahead."
},
{
"speaker": "Wes Carmichael",
"text": "Hey, thanks for taking my follow-up. I actually had a question for Dan, and it relates to succession. And I know you've had a couple of leaders transition, but I'm really thinking about your CEO role, how -- I know you've laid out some ‘25, ‘26 sales targets. But what are you thinking for your role in the timing on that and how we should think about transition."
},
{
"speaker": "Dan Amos",
"text": "Well, I'm not going to be that good a retiree and I'm not in that big a hurry. I just had a physical at Emory and got a good report. So I plan on staying around a few more years. But I still think my number one responsibility is to make sure I have it prepared. We never know what can happen in life, and we've got to have a company ready to go and go uninterrupted. And so that's one of the things that I'm doing. I will say, for example, with Virgil and the changeover to Teresa, that's been smooth. I will say that Eric's changeover to Brad has been smooth. You go back to Koide, we've gone on interrupted on the -- as things take place. And to me, that's one of the things I have to make sure happens. And I promise you, I'm working toward that with the Board of Directors, who ultimately make the call. But we have very structured and very intense meetings about what goes on in regard to personnel and human resources at our August meeting. And so I'll be constantly updating on what's going on there. But I would say I'll be around a few more years. So unless the Board gets tired of me, look for me to be here."
},
{
"speaker": "Wes Carmichael",
"text": "Thanks, Dan."
},
{
"speaker": "Operator",
"text": "The next question is a follow-up from Tom Gallagher of Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Thanks. Just a few CRE follow-ups. Brad, the $900 million watch list, are those all ‘23 maturities? And can you comment on total maturities for both ‘23 and ‘24?"
},
{
"speaker": "Brad Dyslin",
"text": "Yes. Thanks, Tom. The $900 million on the watch list is predominantly near-term maturities. I will have to double check, but I don't believe we have anything out into 2024 on that watch list. But it is predominantly near-term maturities that we have to address. No, I'm sorry, what was your second question?"
},
{
"speaker": "Tom Gallagher",
"text": "Just what are the total maturities of your total..."
},
{
"speaker": "Brad Dyslin",
"text": "Sorry. Yes, these are very short-term loans. The -- at origination, they're generally three years in term with options for one-year extensions based on certain thresholds being met. So these do turn over pretty quick. We do have -- it's less than one-third of the total portfolio rolling over this year. But a big portion of those are what's on this watch list."
},
{
"speaker": "Tom Gallagher",
"text": "Got you. And then just one on, you mentioned your alts portfolio, you expected near-term returns to be volatile. Should we -- is the interpretation that 2Q alts return should be negative? Or just any perspective on that?"
},
{
"speaker": "Brad Dyslin",
"text": "It's really way too early to try to give any insight on second quarter. I think you're familiar with the lag we have in our marks. For first quarter, we're really reflecting broad market activity from third and fourth quarter just given the lag in the reporting to our managers and then the reporting to us and it gets extended a little bit longer in fourth quarter. So second quarter should correlate more closely with the general market activity we saw in fourth quarter and a little bit of first quarter, but it's just way too early to give you any direction on that."
},
{
"speaker": "Operator",
"text": "The next question is a follow-up from Jimmy Bhullar of JPMorgan Securities. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hey, just a question for Fred on the implications of the May reclassification of COVID equivalent to influenza. What do you think the financial implications are? Because your margins in Japan have already been pretty good actually."
},
{
"speaker": "Fred Crawford",
"text": "Well, really, the reclassification to five, the Class 5 influenza, is really more related to overall business activity, in other words. And you're starting to see it here in Japan. I would just tell you from a personal perspective, when I first got here, people inside office buildings, outside office buildings, in meetings, out of meetings, at restaurants, doing daily activities, you were talking about 3% to 5% of people not wearing a mask. That now has clearly freed up. And in fact, the Japanese government has been encouraging companies and hotel operators and office building managers to adjust their policies in accordance to guidelines from the Ministry of Health here in Japan, and companies are taking that to heart. And so you're starting to see less and less mask wearing, although still a considerable level of mask wearing. And so I wouldn't call it back to normal, but clearly has improved. And we think with that, there's improved face-to-face activity and improved economic activity overall. So we are seeing that, and that's really what we would point to. It's not anything related to, for example, benefit ratios and margins from that perspective. The whole deemed hospitalization issue is behind us. We've seen claims come back to their normal levels. Our operating platforms here in Japan are back to normal response times and volumes in the claims departments and call centers. And so we're through that episode. Maybe that answers your question."
},
{
"speaker": "Jimmy Bhullar",
"text": "Yes. So obviously, more of an implication for potential sales activity than…"
},
{
"speaker": "Fred Crawford",
"text": "That's right. And it’s gradual, but we certainly hope that's the case. Yes."
},
{
"speaker": "Jimmy Bhullar",
"text": "And then for Max, the stress that you're seeing in your investment portfolio, specifically in CRE, is that causing you to reevaluate your capital plans, because you did buy back a decent amount of stock, and your overall capital levels, both in Japan and the U.S. are pretty healthy."
},
{
"speaker": "Max Broden",
"text": "So obviously, we factor that into our capital plan. And obviously, the way we, sort of, think about buybacks, dividends, et cetera, it's all a combination of our current capital levels, our cash flow generation, any stresses that we see on the asset side of the balance sheet and the overall economy and the outlook for our business. And that all then boils down into the actions that we take. And we bought back $700 million of our own stock in the first quarter. And I do believe that, that is the most that the company has ever done in the history of the company. And I hope you should see that as a reflection of our view of both our business cash flow generation capital levels and any thoughts that we have around, sort of, future stress on the asset side of the balance sheet."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you, Andrea, and thank you all for joining us this morning for our call. Please reach out to the Investor and Rating Agency Relations team if you have any questions. And we look forward to speaking with you soon, and wish you all continued good health. Have a good one."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 4 | 2,024 | 2025-02-06 08:00:00 | Operator: Good day. And welcome to the Aflac Incorporated Fourth Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. If you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Please note this event is being recorded. I would now like to hand the call over to David Young, Vice President of Capital Markets. Please go ahead.
David Young: Good morning and welcome. Thank you for joining us for Aflac Incorporated's fourth quarter earnings call. This morning, Dan Amos, Chairman and CEO of Aflac Incorporated, will provide an overview of our 2024 results and operations in Japan and the United States. Then Max Broden, Senior Executive Vice President and CFO of Aflac Incorporated, will provide an update on our fourth quarter and 2024 financial results, current capital and liquidity, as well as some color on our outlook for 2025. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2025. We also posted under financials on the same site updated slides of investment details related to our commercial real estate and middle market loans. For Q&A today, we are also joined by Virgil Miller, President of Aflac Incorporated and Aflac US, Charles Lake, Chairman and Representative Director, President of Aflac International, President and Representative Director, Aflac Life Insurance Japan, and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan.
Dan Amos: Thank you, David, and good morning, everyone. We are glad you joined us. Before Max provides a more detailed view of our financial results, I would like to reflect on what was another very good year. Aflac Incorporated delivered very strong earnings for the year with net earnings per diluted share up 23.8% to $9.63 and adjusted earnings per diluted share up 15.7% to $7.21. Aflac Japan represented more than 70% of pretax adjusted earnings and three-quarters of the company's consolidated balance sheet in 2024. Aflac Japan also generated a 15.5% increase in pretax adjusted earnings and a record 36% pretax profit margin in 2024. I am pleased with Aflac Japan's 93.4% premium persistency and 5.6% year-over-year sales increase, which included a 9% sales increase in the fourth quarter. By maintaining strong persistency and adding new premium through sales, we are partially offsetting the impact of reinsurance and policies reaching paid-up status. This will be integral to the future growth of Aflac Japan. Taking into account Japan's demographics, our product strategy is to fit the needs of customers throughout all stages of life. Acquiring younger customers is critical to our success. We believe Sumitos appeals to younger customers in Japan. Our strong sales in Japan reflect the success our agencies have had selling Sumitos. As the pioneer of cancer insurance and leading third-sector insurer, we also aim to sell the Sumitos policyholders a medical policy or cancer policy. Our last cancer insurance, Wings, was launched in stages in 2022. Therefore, we are planning a staged launch through our distribution channels of our new cancer insurance product between March and April. This new product includes our unique Uriso cancer consultation support service along with insurance coverage that offers enhanced protection before, during, and after cancer treatment. This product also features flexible coverage and introduces a new plan for children, thus providing comprehensive protection for customers. We will also maintain our focus on being where the customers want to buy insurance through our broad network of distribution channels, including agencies, alliance partners, and banks. This reach continually optimizes opportunities to help provide financial security to Japanese consumers. Turning to Aflac US, we have focused on updating our products to ensure that our policyholders understand the value our products provide. When people experience the value of our products, we believe it enhances product persistency, which both benefits our policyholders and lowers our expenses. In the US, I continue to be pleased with our 70 basis point improvement in premium persistency to 79.3%. We also generated a 2.7% increase in net earned premiums, a measure we continue to focus on improving. Additionally, our pretax profit margin for the year was strong at 21.1%. Sales were lower than expected in the fourth quarter, leading to a 1% decline for the year. We continue to focus on more profitable growth through our stronger underwriting discipline. At the same time, we are engaging agents and brokers following the stabilization of our network dental operation. As always, we continue our prudent approach to expense management and maintaining a strong pretax margin. I believe that the need for our product and the solutions we offer is as strong or stronger than they have ever been before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers. Knowing our products help lift people up when they need it most is something that makes all of us at Aflac very proud and inspires us to reach more people. We continue to reinforce our leading position and build on that momentum. We continue to generate strong capital and cash flows while maintaining our commitment to prudent liquidity and capital management. We have been very pleased with our investments, which have continued to produce strong net investment income. As an insurance company, our primary responsibility is to fulfill the promises that we make to our policyholders while being responsive to the needs of our shareholders. Our solid portfolio supports our promise to our policyholders, as does our commitment to maintain strong capital ratios. We balance this financial strength with tactical capital deployment. I am very happy with how management has handled capital deployment and liquidity and specifically how well we have adapted to this environment. Year to date, Aflac Incorporated's deployment of $2.8 billion in capital to repurchase more than 30 million shares of Aflac stock. Additionally, we treasure our track record of what is now 42 consecutive years of dividend growth. At the same time, we have maintained our position among companies with the highest return on capital and the lowest cost of capital in the industry. Combined with dividends, this means that we delivered $3.9 billion back to the shareholders in 2024. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. I'll now turn the program over to Max to cover more details of the financial results.
Max Broden: Thank you for joining me as I provide a financial update on Aflac Incorporated's results for the fourth quarter of 2024. For the quarter, adjusted earnings per diluted share increased 24.8% year over year to $1.56, with a one-cent negative impact from FX in the quarter. In this quarter, remeasurement gains on reserves totaled $43 million, reducing benefits. Variable investment income ran $17 million above our long-term return expectation. Adjusted book value per share excluding foreign currency remeasurement increased 3.2%. The adjusted ROE was 12% and 14.5% excluding FX remeasurement, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 5.4%. This decline reflects a 7.2 billion yen negative impact from an internal cancer reinsurance transaction executed in the fourth quarter of 2024 and a 4.4 billion yen negative impact from paid-up policies. In addition, there's a 300 million yen positive impact from deferred profit liability. At the same time, policies in force declined 2.3%. Japan's total benefit ratio came in at 66.5% for the quarter, up 40 basis points year over year, and 62.5% for the year. The third sector benefits ratio was 56.9% for the quarter, up approximately 70 basis points year over year. We estimate the impact from remeasurement gains to be approximately 100 basis points favorable to the benefit ratio in Q4 2024. Long-term experience trends as they relate to treatments of cancer and hospitalization continue to be in place, leading to continued favorable underwriting experience. Persistency remains solid at 93.4%, which was unchanged year over year and in line with our expectations. Our expense ratio in Japan was 20.8% for the quarter, down 30 basis points year over year, driven primarily by a decline in expenses. For the year, the expense ratio in Japan was 19.1%. For the quarter, adjusted net investment income in yen terms was up 3.7%, as the transfer of assets to Aflac Bermuda associated with reinsurance and lower floating rate income was more than offset by higher returns from structured private credit infrastructure and our alternatives portfolio. Adjusted net investment income was up 12.1% for the year. The pretax margin for Japan in the quarter was 31.6%, up 120 basis points year over year, a very good result. For the full year, the pretax margin was even stronger at 36%, which is also the highest in 30 years. Turning to US results, net income premium was up 2.7%. Persistency increased 70 basis points year over year to 79.3%. Our US total benefit ratio came in at 46.3%, 170 basis points higher than Q4 2023, driven by lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by approximately 170 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and is now more in line with our long-term expectations. For the full year, the US total benefit ratio was 46.8%. Our expense ratio in the US was 40.3%, down 310 basis points year over year, primarily driven by platforms improving scale and strong expense management. For the year, the US expense ratio was 38.5%. Our growth initiatives in group life and disability, network dental and vision, and direct-to-consumer increased our total expense ratio by 170 basis points for the quarter. This is in line with our expectations, and we would expect this impact to decrease going forward as this business grows to scale and improves its profitability. Adjusted net investment income in the US was up 0.9% for the quarter, mainly driven by high returns from alternatives, and 3.3% for the year. Profitability in the US segment was solid with a pretax margin of 19.7%, also a good result, as was the 21.1% for the full year. We continue managing through the worst commercial real estate downturn in decades. During the quarter, we increased our CECL reserve associated with our commercial real estate portfolio by $40 million net of charge-offs as property values remain at distressed valuations. We also foreclosed on two loans, adding them to our real estate-owned portfolio. We continue to believe that the current distressed market does not reflect the true intrinsic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through the cycle, and maximize our recoveries. Our portfolio of first lien senior secured middle market loans continues to perform well, with losses below our expectations for this point in the cycle. In our corporate segment, we recorded a pretax loss of $4 million. Adjusted net investment income was $153 million higher than last year, due to a combination of continued lower volume of tax credit investments, higher rates, and asset balances, which included the impact of the reinsurance transaction in Q4 2024, which was similar in structure and economics in yen terms to our October 2023 transaction. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $46 million in the quarter, with an associated credit to the tax line. The net impact to our bottom line was a positive $4 million for the quarter. To date, these investments are performing well and in line with our expectations. Our capital position remains strong, and we ended the quarter with an SMR above 1150%, an estimated ESR above 270%, and combined RBC, while not finalized, we estimate to be greater than 650%. These are strong capital ratios, which we actively monitor, stress, and manage to withstand credit cycles as well as external shocks. US statutory impairments were $3 million, and there were 700 million yen of Japan FSA impairments in Q4. This is well within our expectations and with limited impact to both earnings and capital. Our leverage was 19.7% for the quarter, which is just below our target range of 20 to 25%. As we hold approximately 60% of our debt in yen, this leverage ratio is impacted by moves in the yen-dollar exchange rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in US dollar terms. Unencumbered holding company liquidity stood at $4.1 billion, $2.3 billion above our minimum balance. We repurchased $750 million of our own stock and paid dividends of $277 million in Q4, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. On December 3rd, we shared estimated ranges for annual key metrics for both segments for 2025 through 2027 at our financial analyst briefing, and we continue to stand by these ranges. However, for 2025, we expect the benefit ratio in Japan to be toward the higher end of the 64 to 66% range, and we continue to expect the expense ratio to be at the lower end of the 20 to 23% range as we pursue various growth and strategic initiatives. As a result, we expect Aflac Japan's pretax profit margin to be at the lower end of the 30 to 33% range. In the US, we expect the benefit ratio for 2025 to be at the lower end of the 48 to 52% range, and the expense ratio to be at the upper end of the 36 to 39% range as we continue to scale new business lines. At the same time, we expect the pretax profit margin for 2025 in the US to be at the upper end of the 17 to 20% range. Thank you. I'll now hand it back to David to begin the Q&A.
David Young: Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. You may then rejoin the queue. We will now take the first question.
Operator: To ask a question, if you are using a speakerphone, please pick up your handset before entering the key. To withdraw your question, please press star then two. And our first question will come from Joel Hurwitz of Dooling and Partners. Please go ahead.
Joel Hurwitz: Hey. Good morning. One to start. On US sales, Virgil, can you just provide some more color on what you are seeing in the competitive environment that's impacting your sales? Is it specific products or specific areas of the market?
Virgil Miller: Hey. Thank you, Joel. Good morning. Yeah. Look, first, let me set the stage for going into the fourth quarter. We knew going through the fourth quarter, Joel, that we were up against one of the tougher comparisons with Q4. In Q4 of 2023, that was one of the largest sales quarters we have had in the history of Aflac. So we knew we had to have strong solid performance. The second thing I would say is that we also knew that we would stick to the underwriting discipline we have put forth in our group BB products. What that really means is that we are not going to be bringing business on board that does not fit our profit profile. Therefore, businesses that have high turnover, businesses that have low claims filing, we are not going to accept those because they are not good for the company longer term. The stronger underwriting just wants to help set us up for profitable business and profitable growth in the long-term vision that we have at Aflac. Then the third thing I would say is we knew that the market needs to respond to the improvements we have made with our dental and vision platform. I had disclosed in prior conversations that we had a failed system implementation that we were recovering from. I am very pleased with the recovery that we have seen, though. A partnership that we formed with one of the industry-leading third-party administrators out there has helped substantially move the needle on improvements. And we are open for business. We needed to get the brokers and our veteran agents to come back on board and really put that product back in the market as a very competitive product. And quite frankly, we did not get the response we needed. We saw a 33% decline in our dental sales for Q4. Along with the dental sales themselves, though, there's the impact that we call halo, which means that on a general census, we get additional voluntary benefit sales when we sell the dental product. Those are really the things that we add them up that impacted how we performed in that Q4. I would say, Joel, that I am disappointed with the softer sales, but I am very pleased with our overall performance. We did demonstrate solid financial management. If you heard from Max, you heard from Dan, they mentioned that pretax earnings were up 9.3%. Our margins were up 1.3%. Earned premiums up 2.7%. Persistency up 0.7% overall. Very pleased with that. That tells you though this management discipline of making sure that we are looking at proper business is generating the response that we need, reduced expenses by 3.1%. And then overall, we were able to give other additional value to all policyholders with an increased benefit ratio. Now we are watching that very closely. But very solid performance based on that discipline we put out there in the market.
Joel Hurwitz: Alright. Very helpful. Thank you. And then for my second one, just wanted to move to the 2025 outlook area that Max provided. So for Japan, you guided to the pretax margin to be at the low end of the range, which is below where I was, and I think most were. I think it's largely on net investment income and there's some misunderstanding on how the accounting works on the floating rate security hedges. Could you just provide more color on how the benefits from those hedges flow through earnings?
Max Broden: Yes. Thank you, Joel. So we obviously have a floating rate book in the Japan segment that is a little bit less than $9 billion of notional balance. Also at the corporate segment, we have a little bit over $4 billion of cash that is invested at the short end of the curve. That means that all these asset balances are very sensitive to SOFR. And that is both the one-month and the three-month SOFR that they reprice at. As we go into 2025, obviously, we had a rate cut in December, and there is an expectation about further rate cuts in 2025 when you look at the forward curves. When we just inject the forward curves onto our projected yields for 2025, that means that they are likely to be lower than what they were in 2024. So that is why our floating rate income is expected to be lower. As it relates to our interest rate swap, this is really a tail hedge swap that made sure that we protected our floating rate income from any significant declines in interest rates at the short end of the curve. That means that, obviously, we are at higher rates now than when this swap was entered into. That means that it is out of the money and somewhat ineffective at this point. And that's why you see the full brunt of any relatively even relatively small declines of interest rates at the short end immediately flows through and impacts our net investment income in 2025. Also, the mark-to-market component of the interest rate swap that falls below the line in the realized gains losses, i.e., outside of adjusted earnings but obviously included in our US GAAP earnings. I hope that's helpful.
Joel Hurwitz: It is. Thank you.
Operator: The next question comes from Jimmy Bhullar of JPMorgan. Please go ahead.
Jimmy Bhullar: Hey. Good morning. So first, just had a question either for Dan or for Charles on Japan sales. You obviously grew at a strong pace this quarter. But if you look at where sales are versus where they used to be pre-pandemic, they're still fairly depressed. So just wondering what's changed in the market, and what's your optimism of being able to get to, in an absolute sense, the sales levels that you had before that'll allow you to potentially grow your in-force as opposed to report declining premium growth.
Koichiro Yoshizumi: This is Yoshizumi from Aflac Japan. Pandemic public has recovered. So we do not see we see that it has recovered, and that is her. So we have been focusing on making a recovery in a solicitor's activity because during the two, three years of the COVID, the sales activities had been stagnant. So that has been a focus point, which is to make a recurring revenue. Let me answer. This is Yoshizumi. First of all, we have gone through this marketing and sales transformation starting January. This is to conduct integrated or end-to-end marketing activities based on the different brand group pipelines starting with medical, cancer, asset formation, and nursing care. And we will be continuously injecting our competitive product centered around our main products, cancer and medical insurance. And we plan to launch a new cancer insurance product in stages from March to April in order to respond to change in customer needs. And now with the launch of the new product Sumitasso, which was launched last June 2024, we have managed to expand our product lineup and now been able to approach a greater customer audience. And we will be executing measures in order to develop and enhance the potential of the solicitor or agent. With these efforts, we would like to recover our performance on the pre-COVID level. That's all.
Jimmy Bhullar: And then maybe for Virgil, in the US business, I think there have been a couple of reasons that you've cited for sales being weak in 2024. One is just the dental DPA issues, and then secondly, competition in and margins in supplemental products or in the voluntary market. I'm assuming that the competition and market issue is something that's not going to change, but and if that is the case, assuming that that'll be an ongoing headwind to your sales, but then on the dental rollout, should is that starting to get to normal, or is that more of a 2026 event?
Virgil Miller: No. I thank you for the question. We absolutely want everyone listening to know we're open for business. We've invested time, resources, and dollars to make sure we got a strong platform. We went through a very diligent process to get the right partner who is an industry-leading partner to make sure that we're prepared to deliver on the customer experience that we need. So we are confident in our dental platform the way we have it now. The concern though is making sure that the brokers and the agents are back in market with it and that they're on board to sell it. I expected to see a stronger return for them in the fourth quarter, but I'm looking forward to see how we deliver on that this year. We're out meeting with them. We'll let them know about how the process works. We're energetic to say come back and sell the product. I would also say, though, what's going well for us is you look at the investments we made in our life and assets disability platform, we term as PLAT. We exceeded our sales expectations there. We are strong in that large case market now. Very competitive against some very known brands that have been in that space for a long time. Our disability products are competitive. Have a world-class absence management discipline. Where we're doing it for, you know, one state in particular, and we're delivering well on that. And then we are also selling our what we would call our paid-up life or employee life product. We also invested in a direct-to-consumer flat as consumer markets. We draw a better than expected sales year there. So those are the things that are going well. We get our dental platform back in line this year, and I expect it to demonstrate an increase.
Dan Amos: And this is Dan. I am encouraged about what I'm seeing. Virgil talked to me early on in the first quarter and said, you know, there's some ways we can make this sales number. And do you know, I but I've got to push some areas. And I said, don't push lower profits for the sake of making the sale now. That's the wrong way. I want to look at earned premium. I want to look at what's going on. And I think our model for the future is much stronger to date than it was a year ago, especially on the dental and vision side. And we are expecting that to come through for the full year.
Jimmy Bhullar: Okay. Thank you.
Operator: The next question comes from Mike Ward of UBS. Please go ahead.
Mike Ward: Thank you. Good morning. I was just wondering just on the contribution to the Japan sales growth from Sumikasu seems like a primary driver of the growth. I guess, is it how fair is it to assume that we might be relying on first sector sales maybe more heavily than we previously thought in order to reach the Japan sales targets?
Koichiro Yoshizumi: To begin with, we do not announce or disclose the sales percentage or contribution. However, Aflac is a company centered around the third sector insurance product. And the main way to conduct our sales activity today is to also offer medical or cancer insurance whenever the product Sumitasso is being offered. Although we didn't show that Sumitasso will make a certain contribution to our first sector performance, our goal is to grow our third sector performance. And last year, right after the launch of this, we have enjoyed significant growth in sales. And we expect sales to settle compared to 2024. However, we believe the product will continue to generate solid results. And Sumitasso is unlike the traditional product features in the first sector product. It is developed to respond to the needs of the younger generation who are looking to accumulate their assets. Another nature of this product is that in addition to the asset formation nature, it also carries a nursing care feature. And another characteristic is that after the policy premiums are paid up, they can convert it to medical insurance or other types of insurance. And it also carries a strategic objective, which is to expand our customer base by capturing the younger generation and through concurrently offering this product together with a third sector product. So this is a very unique product. That's all.
Max Broden: Thank you. I just wanted to add a few comments as well, Mike. We do not have a sales cap on our Sumitomo sales. And the reason why is that number one, we do believe that we get very good profitability out of this product. This is both on a GAAP basis but also on an IRR basis post-reinsurance. And what it means is that we also now have a very good hook product that ultimately will drive higher third sector sales as well. So we definitely see ourselves as a third sector company but this is an additional product that will help grow both our first sector business and the third sector business while also giving another tool to our distribution to sell more and make more commissions. Now I do want to say that the reason why now is because interest rates are higher in yen terms. But more importantly, we have built reinsurance expertise in and around the company which means that we can now conduct these operations and get the better capital efficiency associated with these products so we can really make them work.
Dan Amos: And I will add that I have been so impressed with the job that Koichiro and his team have done in monitoring this through the guidance of Max, and what and Steve Bieber and what we've done to watch this. And every Sunday night, I get a report when we have our call on what is taking place and how interest rates are going, and where the lines are and our actuarial department is on it. And it's just I think you'd be proud if you saw the inner workings of what has taken place over the last couple of years with reinsurance. It shows that we're a company that's evolving over time. And just getting stronger in what we're doing and having better financial controls over the things that are taking place.
Operator: The next question comes from Wes Carmichael of Autonomous Research. Please go ahead.
Wes Carmichael: Hey. Good morning. My first question, just on remeasurement gains losses. It appears that the gains benefit has been flowing, which is, you know, perhaps not surprisingly given a pretty sizable unlocking in the third quarter. But when you look at trends going forward, would you expect that to continue, Max, or should that be relatively muted?
Max Broden: We obviously have experienced very significant remeasurement gains and also favorable gains from the unlock of our actuarial assumptions in the US in 2023 and in Japan in 2024. As it relates to our assumptions going forward, we do feel that we obviously have realistic and very good assumptions that by definition, otherwise, we would have to change it. This is something that we look at every quarter. But we and if something material were to change, we will unlock assumptions but our deep dive study occurs in the third quarter of every year. Each quarter, though, there are remeasurement gains, losses, that are coming through our results as we true up for the experience in that quarter. And that has continued to be favorable as we have come out of the pandemic. That being said, I do want to be a little bit cautious as we are seeing higher claims come through, especially on products, for example, in the US on our accident and our hospital product and to some extent also cancer. And that means that our remeasurement gains may not be as strong going forward as they have been in the past. But generally speaking, we are a company that takes a cautious approach to our underwriting to make sure that we get good results. And I think that the remeasurement gains that you have seen is a testament to the underwriting decisions that a company has taken in the past.
Wes Carmichael: Thank you. And my follow-up, I guess, in the press release, Dan, you mentioned efforts on reengaging agents in the US. Can you just talk about the recruiting environment in the US? Are you seeing progress there, or is that kind of slowed?
Virgil Miller: Hey. Good morning. This is Virgil. Let me give you a color on that. I mentioned last year, so we're in a new regime out here. So definitely, there's a lot of competition. There are things like, you know, the economy that would impact recruitings from time to time. But all in all, I'm sticking to the point that we're going to always be around the ten thousand mark with our recruiting. We've demonstrated that now back to back. Although it's a little bit down from the year over year, we're still right around that ten thousand mark. Here's what I would say is that the core strength of our Aflac has always been our distribution. When you think about that, we will continue to go out, recruit agents, convert them, make the field force strong and dominant in that small market. I've added some new levels of leadership where we continue that focus. Our compensation plans are built around recruitment, and conversion to average week of producer and opening new small accounts. We continue to be strong doing our partnership with brokers in the mid-market and as I mentioned earlier, very strong in the upper case market now with the relationships we formed in our life and as the disability discipline. So we've got the market covered when it comes to distribution. I expect to recruit another ten thousand, around ten thousand this year. And continue to invest in what we're doing in that field force.
Wes Carmichael: Thank you.
Operator: The next question comes from Elyse Greenspan of Wells Fargo. Please go ahead.
Elyse Greenspan: Hi. Thanks. Good morning. I guess my first one's on capital. You know, buyback picked up $750 million the quarter. You know, you guys obviously have pretty healthy capital positions in both the US and Japan. Does that $750 million, you know, feel like a good run rate level, or, you know, how should we think about share repurchase in 2025?
Max Broden: Thank you, Elyse. Your observation is correct that we obviously have a very healthy capital position around the company. And together with that, we also have a very good free cash flow generation overall as well, and that is what gives us the opportunity to reinvest into our operations and to redeploy capital back to our shareholders as well. We are very IRR driven, and as of right now, I would say that we get by far the best IRR on selling another policy. So as it relates to capital, that is the number one area. There are capital is going to. So we're looking for areas to grow our business organically. On top of that, we obviously have increased our dividends quite significantly over the last five years where we almost doubled our dividend per share. And on top of that, we want to be opportunistic and tactical in the way we redeploy capital back to shareholders through share repurchase. We stepped that up a little bit in the fourth quarter by $750 million, which I believe is the most that we've done in a single quarter. So that's a meaningful return back to shareholders. But going forward, we will continue to obviously evaluate all the opportunities that we have and make sure that we get good IRRs on all the deployments that we do.
Elyse Greenspan: Thanks. And then my second question, you know, I believe there was, you know, a data sharing issue with Japan Post. Not related to Aflac, I believe. Right? But in general, you could just comment on that. And then did that have any impact on your sales in the fourth quarter? Would you expect there to be an impact in 2025?
Koichiro Yoshizumi: This is speaking from Aflac Japan. First of all, let me be clear, there were no issues with the sales of Aflac Japan's cancer insurance upon this incident. And given its past experience, Japan Post is taking a conservative approach to addressing this matter. The Japan Post Group is committed to selling your products and for our standard practice, Aflac Japan is in close communication with Japan Post Group at all levels of the organization. We'll continue to work closely with Japan Post Group in support of its sales of Aflac Cancer Insurance.
Elyse Greenspan: Thank you.
Operator: The next question comes from John Barnidge of Piper Sandler. Please go ahead.
John Barnidge: Good morning. Thank you for the opportunity. Virgil, in your comments, you talked about a failed implementation that was corrected. And how much of the market was dental and vision not present?
Virgil Miller: Hey, John. Great to hear from you. Ask me that question one more time. I didn't catch the last part, please.
John Barnidge: So, yeah, you talked about a failed implementation that was corrected. And how much of the market was dental and vision not present as a result of the failed implementation?
Virgil Miller: Oh, no. I have it. Thanks, John. Yeah. We were available, John. So I would tell you this, though, that we had some service degradation earlier in the year. That definitely impacts the perception of trust. And making sure that the brokers and the agents will come back and sell it. So during the fourth quarter, we were open for business and ready to go. We have tested all of our processes. We work with a partner who has a strong reputation and who's doing a good job with Aflac. Our network of dentists is one of the largest out in the industry. We do a rented network, and we also have a proprietary network, both to offer. What I would say to you though is that in this business where agents and brokers have a choice of business, we have to earn trust. That's what we're focused on, getting back that trust and demonstrating that the processes work. So if you look again, just to mention, in Q4, sales from the prior year were down 33%. Now although they don't make up a large part of our overall sales right now, I would say to you though that we get additional voluntary benefits alongside. So it's not just impacting dental, it also has this halo effect where you're not bringing other business that you normally would have. Seeing progress here, as we look into January. We're regaining some confidence. We are going around to all of our broker partners, and we put all types of messages out, demonstrating confidence to our agents. And I'm looking forward to seeing them come back and sell the product. It is a competitive product. We spend a lot of time developing it, I think it's good for all consumers out there to give it a try.
John Barnidge: Thank you for that. And my follow-up question is remains on distribution. Ahead of the anticipated new cancer product launch. Should we expect more modest sales in the near term for that?
Koichiro Yoshizumi: Hi. Yoshizumi speaking. This new cancer insurance will be launched in March 2025. And we're expecting this to be a big driver. And we have been introducing innovative cancer insurance to the market this past year. But this time, in addition to the insurance coverage, we'll be integrating our Aflac Yodizel Cancer Consultation Support, which is our unique concierge service into the coverage. And I would like to mention three characteristics. It carries a very rich and simple coverage structure. And not only during the treatment, but there will be a coverage will be enhanced before and after the treatment. And we have changed the payment conditions for the benefit to be more easy to understand. The next major is the fact that it has a very flexible coverage design that allows combining the existing policies and other products. And we have also newly established a child plan with lower premiums to support pediatric cancer patient families whose economic burden tends to be high with longer treatment periods. And we expect to see a big increase in performance by introducing this product to various channels in stages.
Dan Amos: Let me add one thing that I think is part of your question is that anytime we introduce a new product or revised product, we'll call it, there's a little dip in sales waiting for the new product and then the product should take off with the excitement of it being introduced throughout the country. So I just want to be clear on that. You can see a little dip and then strong growth.
John Barnidge: Thank you.
Operator: The next question comes from Wilma Burdis of Raymond James. Please go ahead.
Wilma Burdis: Hey. Good morning. First question, could you talk a little bit about any change in your thinking regarding the 10% reinsurance of the Japan block to Bermuda? And also just maybe touch on how you would reevaluate that, if at all. Thanks.
Max Broden: Thank you, Wilma. So we currently have no change in our thinking. To date, we have seeded roughly 6% of our asset base of Aflac Japan to Bermuda. And so we have significant capacity as it relates to our internal cap of 10%. I want to stress that this is not an external cap, but it's an internal cap. And I think it's good risk management practice to have these kinds of caps in place because it means that we now have an opportunity to evaluate what we have done. And once we get closer to that 10%, then, obviously, all legal entities involved will make their own evaluation of if it makes sense to then move forward and increase that level for reasons where it may make sense for that legal entity. That applies to Aflac Bermuda, that applies to Aflac Japan, and obviously to Aflac Inc, as well. To date, we are very pleased with the outcomes of our reinsurance operations both in how they are being conducted, but also the overall outcome of it as it relates to improved balance sheet efficiency. And as you can see, improved return on equity overall for the group. And in fact, it has also reduced the risk of our Aflac Japan operations as well. So overall, we're quite pleased with where we are. And as we get closer to that 10% level, we will reassess.
Wilma Burdis: Thank you. And then, are there any dynamics of the weaker yen that could impact Aflac's operations or results aside from, I guess, the repatriation impacts? Thank you.
Max Broden: So, Wilma, the yen-dollar exchange rate does have an impact on our GAAP financials. As you know, we do not hedge our GAAP financials. So as you translate our yen-denominated earnings into US dollars, it does have an impact. And you obviously have seen that, especially over the last three years when you have experienced a significant depreciation of the yen versus the dollar. That being said, we do believe and we have the philosophy that we protect the economic value of Aflac Japan through an enterprise hedging program, and this is, as you know, three components to it. Where we hold US dollar assets on the Aflac Japan balance sheet, it is us at Aflac Inc. We are borrowing in yen and we also have an overlay of FX forwards at the holding company as well. And you add that up, and we believe that gives us very good protection on an economic basis to any moves, both small and significant, to the yen-dollar rate.
Wilma Burdis: Okay. Thank you.
Operator: The next question comes from Tom Gallagher of Evercore ISI. Please go ahead.
Tom Gallagher: Morning. Max, how much of the Japan margin coming in at the low end of the guide is floating rate impact on NII and how much of it is more limited benefit ratio improvement? If you can unpack that.
Max Broden: I would say that the vast majority of it is obviously driven by net investment income. And I'll let Brad comment a little bit on that because, obviously, we're coming off a very good base here in 2024. That being said, when you think about the components of the benefit ratio, I would expect that over the forecast period at 2025 to 2027, that as we travel through that forecast period, the benefit ratio, all things being equal, we would expect to decline. Yeah. So it will start at the high end of the range and end at the lower end of the range. And the reason for that is that as our in-force mix is changing and it's each year tilting a little bit more towards third sector and a little bit less towards first sector, that means that the third sector lower benefit ratio business makes up a bigger component. So the mix impact of that is going to push us from the higher end of the benefit ratio range towards the lower end of the benefit ratio range. But it also means that from a pretax margin standpoint, it means that we expect to travel throughout the forecast period starting at the lower end of the range and then travel higher towards the higher end of the range throughout the forecast period. But I'll let Brad give some more color on net investment income as we go into 2025.
Brad Dyslin: Yeah, Tom. You're right that we are definitely facing some headwinds with the floating rate portfolio. As discussed, this is driven by the decrease in short rates, the 100 basis points decline we saw last year in SOFR. It does hit our $9 billion floating rate portfolio, but it also impacts our cash holdings and other short-term opportunities that we can see throughout the year, which we were able to take advantage of in 2024. But we also had a couple of one-off items that had a strong contribution last year. That we're facing this year. One was a rather large make-whole. And then we were also able to accelerate deployment in certain asset classes that had very attractive spreads earlier in the year. So there's a variety of things that contributed to a very strong 2024 that puts us up against some very difficult comps for 2025 that is the source of that headwind.
Tom Gallagher: Gotcha. And then just for a follow-up around looking at your capital position in Japan, it looks like you have about $4 billion of excess under the new ESR framework anyway. Would you anticipate getting an extraordinary dividend out of that entity? And any updated thoughts on what you might do with that much level of excess? I guess it's a high-class problem, but still, you know, without robust growth opportunities, I can't imagine it makes a lot of economic sense to leave that much excess in Japan.
Max Broden: So, Tom, I would characterize it. Our capital position in Japan is very strong. We are still going through the transition of the capital regime framework from SMR to ESR. And while ESR has not formally been implemented yet, I think it would not be very smart to go and try to right-size your capital base on a future capital regime basis. So step one is we would expect to certainly wait and fully evaluate this until after the ESR has been implemented. And as you know, that is at the end of the first quarter of 2026. So that means that over time, we would expect to be in the target operating range of 170% to 230%. But for the time being, I would not expect any special dividend in the near term.
Tom Gallagher: Okay. Thanks.
Operator: The next question comes from Josh Shanker of Bank of America. Please go ahead.
Josh Shanker: Yeah. Thanks for fitting in. I guess this is for Virgil. I was wondering with the elevated expense ratio in Aflac US, how long do you expect the investments in the work you're doing to accelerate growth to weigh on the expense ratio?
Virgil Miller: Yeah. Hi. Thanks, Josh. I would say, you know, we started to bend that curve. You know, we had one time been up to around 41% with the expense ratio. This year, we came in around 38.5%, I think, to be exact. So very, very pleased with that performance that we are bending it. And that is why we're still, as you pointed out, investing in the buy the bills. The key is to get these buy the bills to scale. And we are experiencing solid better than expected growth on the PLAS platform, better than expected growth on the consumer markets platform. And like I said, it sounds like I'm a broken record, but we've got to turn the curve with the dental vision platform. We're doing all the right things to get that done. If we do that right, that will help not only contribute to the expense ratio by bringing in additional new sales revenue that we need to offset that expense ratio, but we will continue to do strong, though, disciplined expense management. I expect the curve to come down even further this year in 2025.
Josh Shanker: Are you know, if we think out more long term, you know, 2026, 2027, are we thinking it's on the margin or this is several hundred basis points?
Virgil Miller: Yeah. So I would tell you that we would at FAL, we put forth a range on the margin between 17 and 20%. We're going to stay within our range because we're going to make sure that our disciplined expense management hits those marks. If you look at 2025, 2026, and 2027, I am showing a decrease though in expense margin in expense ratio incrementally year over year over year.
Josh Shanker: Okay. Thank you very much.
Dan Amos: I think the important factor to get from this sales part of dental and vision is we got it right in the we want that distance. We just didn't execute to the level we needed to. And made a mistake, and I've got that now on target. And we've just got an outcome through with it. So we can achieve and will achieve.
Josh Shanker: Appreciate it. Appreciate it. Thank you.
Operator: The next question comes from Alex Scott of Barclays. Please go ahead.
Alex Scott: Hey. Good morning. First question I had is just on the competitive environment a bit. And going back to some of the comments you all made around sales and, you know, you remain disciplined, like, you know, you could've shown better sales, but you're remaining disciplined. And I just want to dig into that a bit. I mean, when I think about, like, the signpost that I look at, I mean, it seems like well, reinsurance to Bermuda. The new money yields were in excess of 9% in the US and 8% in Japan. So I'm just trying to understand, you know, you're pulling are you getting those targeted IRRs because of some of the leverage or, you know, do you still feel like there's the same opportunity here that you've had in the past?
Max Broden: Let me address our life insurance business in Japan in particular because I think that's what you're really driving at. Obviously, higher yields matter, especially in yen terms as we sell yen-denominated products. But it's really the new business strain associated with these products and high reserving levels still puts the IRRs under significant pressure. But if you look at it on a post-reinsurance basis, we get very, very good IRRs, and that's why we feel very confident selling both our waste and our consummator product into the marketplace.
Alex Scott: Okay. And maybe as a follow-up, I mean, one of the themes we've seen in group benefits this quarter from some of the peers is there seems to be sort of a have versus have-nots in terms of, like, capabilities on the platform and, you know, having that translate to sales growth being favorable or less favorable. And I guess I just pose the question to you. I mean, how do you feel about the capabilities in your group benefits platform, the scale? Do you have what you need? Is there more that you could go out and acquire whether inorganically or things that you may need to invest in?
Virgil Miller: I would say this is, Virgil. I would say this that when we acquired the life and disability business, we had invested to make sure we've got the right platform for that business line. I'm very technical on this, meaning that we have the right technology. We have the right resources, the talent to scale. On our group BB, we've made significant investments over the years to get the same with talent, with technology. And then we're doing that. We just did the same with our dental platform. Where I'm going with this is we have put forth what I would call a market segmentation strategy. We've got the right products for each segment. We've got the right distribution for each segment. What we're investing in right now is the ability to bring those things together so we're able to be more competitive with the ability to bundle and to present one unique experience to the market. Each platform stands strong independently. The talent stands strong independently. The product stands strong independently. Our core strategy will be bringing those things together. So there will be little additional investment to do that over the next couple of years. We're currently doing it right now. We respond to RFPs in the market as one Aflac, and we're going to really demonstrate the ability to be best in class with the technology and the discipline to have those things fit together going forward.
Alex Scott: Got it. Thank you.
Operator: The next question comes from Jack Matting of BMO Capital Markets. Please go ahead.
Jack Matting: Hi. Good morning. Most might have answered, but maybe just one on commercial real estate. Could you just talk a little bit more about trends in that market and how you expect things to develop on Aflac's portfolio in 2025?
Brad Dyslin: Sure. Thank you, Jack, for the question. As you're undoubtedly aware, the market remains pretty difficult. It does seem that we may have hit the bottom, but we're very slow to recover. We'll continue working through our portfolio. Our preference is to work with borrowers to find a solution, but if the best way to protect our interest is to foreclose, we've demonstrated we're willing to do that to maximize our recoveries. We do expect this to be a long recovery. We have seen some early signs that things are moving the right way, but it's very early and values remain still quite depressed. At this point, we expect 2025 to largely play out much like 2024. We'll continue working through our watch list. We will manage our REO portfolio to maximize our long-term returns. We expect it is going to take quite some time for this recovery to happen. But that's our general outlook at this point. We do think it's going to be one that's going to take time to work through.
Jack Matting: Thank you. And then, just a quick follow-up on the Japan sales outlook. I guess other than the major kind of cancer product launch you have coming in a couple of months, are there any kind of other launches or refreshes that you have planned this year that could impact the cadence of sales in 2025?
Koichiro Yoshizumi: Yes. As for the new product, we'll be launching the new cancer insurance in stages from March to April. And for the medical insurance, we have rebranded and improved the service last August. And we have also been strengthening our sales with a new plan targeting the middle-aged and older customers that was launched in September 2024. And we'll be able to provide one more strengthened promotion through our end-to-end structure, and that has been developed recently. And this structure is developed by each brand. In terms of the parameters, in comparison to the sales volume of 2024, this year will settle down. However, we believe that this will continue to generate solid results. With regards to the channel, we started an effort two years ago to enhance and increase other agents. And in 2023, we have hired approximately 600 agents. And they have made a great deal of contribution to our activities last year in 2024. But we have succeeded in hiring much more than 600 people in 2024. And we expect these new agents to be more active in 2025. As I said earlier, we will be utilizing the first sector product as a hook to expand the third sector business, actually. And such training is being implemented and strengthened. That's all.
Jack Matting: Thank you.
Operator: This concludes our question and answer session. I'd like to turn the call back over to David Young for any closing remarks.
David Young: Thank you, Andrea, and thank you all for joining us on today's call. We appreciate your interest in Aflac Incorporated and look forward to hearing from you and seeing you soon. Have a good day.
Operator: The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day. And welcome to the Aflac Incorporated Fourth Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. If you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Please note this event is being recorded. I would now like to hand the call over to David Young, Vice President of Capital Markets. Please go ahead."
},
{
"speaker": "David Young",
"text": "Good morning and welcome. Thank you for joining us for Aflac Incorporated's fourth quarter earnings call. This morning, Dan Amos, Chairman and CEO of Aflac Incorporated, will provide an overview of our 2024 results and operations in Japan and the United States. Then Max Broden, Senior Executive Vice President and CFO of Aflac Incorporated, will provide an update on our fourth quarter and 2024 financial results, current capital and liquidity, as well as some color on our outlook for 2025. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2025. We also posted under financials on the same site updated slides of investment details related to our commercial real estate and middle market loans. For Q&A today, we are also joined by Virgil Miller, President of Aflac Incorporated and Aflac US, Charles Lake, Chairman and Representative Director, President of Aflac International, President and Representative Director, Aflac Life Insurance Japan, and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan."
},
{
"speaker": "Dan Amos",
"text": "Thank you, David, and good morning, everyone. We are glad you joined us. Before Max provides a more detailed view of our financial results, I would like to reflect on what was another very good year. Aflac Incorporated delivered very strong earnings for the year with net earnings per diluted share up 23.8% to $9.63 and adjusted earnings per diluted share up 15.7% to $7.21. Aflac Japan represented more than 70% of pretax adjusted earnings and three-quarters of the company's consolidated balance sheet in 2024. Aflac Japan also generated a 15.5% increase in pretax adjusted earnings and a record 36% pretax profit margin in 2024. I am pleased with Aflac Japan's 93.4% premium persistency and 5.6% year-over-year sales increase, which included a 9% sales increase in the fourth quarter. By maintaining strong persistency and adding new premium through sales, we are partially offsetting the impact of reinsurance and policies reaching paid-up status. This will be integral to the future growth of Aflac Japan. Taking into account Japan's demographics, our product strategy is to fit the needs of customers throughout all stages of life. Acquiring younger customers is critical to our success. We believe Sumitos appeals to younger customers in Japan. Our strong sales in Japan reflect the success our agencies have had selling Sumitos. As the pioneer of cancer insurance and leading third-sector insurer, we also aim to sell the Sumitos policyholders a medical policy or cancer policy. Our last cancer insurance, Wings, was launched in stages in 2022. Therefore, we are planning a staged launch through our distribution channels of our new cancer insurance product between March and April. This new product includes our unique Uriso cancer consultation support service along with insurance coverage that offers enhanced protection before, during, and after cancer treatment. This product also features flexible coverage and introduces a new plan for children, thus providing comprehensive protection for customers. We will also maintain our focus on being where the customers want to buy insurance through our broad network of distribution channels, including agencies, alliance partners, and banks. This reach continually optimizes opportunities to help provide financial security to Japanese consumers. Turning to Aflac US, we have focused on updating our products to ensure that our policyholders understand the value our products provide. When people experience the value of our products, we believe it enhances product persistency, which both benefits our policyholders and lowers our expenses. In the US, I continue to be pleased with our 70 basis point improvement in premium persistency to 79.3%. We also generated a 2.7% increase in net earned premiums, a measure we continue to focus on improving. Additionally, our pretax profit margin for the year was strong at 21.1%. Sales were lower than expected in the fourth quarter, leading to a 1% decline for the year. We continue to focus on more profitable growth through our stronger underwriting discipline. At the same time, we are engaging agents and brokers following the stabilization of our network dental operation. As always, we continue our prudent approach to expense management and maintaining a strong pretax margin. I believe that the need for our product and the solutions we offer is as strong or stronger than they have ever been before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers. Knowing our products help lift people up when they need it most is something that makes all of us at Aflac very proud and inspires us to reach more people. We continue to reinforce our leading position and build on that momentum. We continue to generate strong capital and cash flows while maintaining our commitment to prudent liquidity and capital management. We have been very pleased with our investments, which have continued to produce strong net investment income. As an insurance company, our primary responsibility is to fulfill the promises that we make to our policyholders while being responsive to the needs of our shareholders. Our solid portfolio supports our promise to our policyholders, as does our commitment to maintain strong capital ratios. We balance this financial strength with tactical capital deployment. I am very happy with how management has handled capital deployment and liquidity and specifically how well we have adapted to this environment. Year to date, Aflac Incorporated's deployment of $2.8 billion in capital to repurchase more than 30 million shares of Aflac stock. Additionally, we treasure our track record of what is now 42 consecutive years of dividend growth. At the same time, we have maintained our position among companies with the highest return on capital and the lowest cost of capital in the industry. Combined with dividends, this means that we delivered $3.9 billion back to the shareholders in 2024. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. I'll now turn the program over to Max to cover more details of the financial results."
},
{
"speaker": "Max Broden",
"text": "Thank you for joining me as I provide a financial update on Aflac Incorporated's results for the fourth quarter of 2024. For the quarter, adjusted earnings per diluted share increased 24.8% year over year to $1.56, with a one-cent negative impact from FX in the quarter. In this quarter, remeasurement gains on reserves totaled $43 million, reducing benefits. Variable investment income ran $17 million above our long-term return expectation. Adjusted book value per share excluding foreign currency remeasurement increased 3.2%. The adjusted ROE was 12% and 14.5% excluding FX remeasurement, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 5.4%. This decline reflects a 7.2 billion yen negative impact from an internal cancer reinsurance transaction executed in the fourth quarter of 2024 and a 4.4 billion yen negative impact from paid-up policies. In addition, there's a 300 million yen positive impact from deferred profit liability. At the same time, policies in force declined 2.3%. Japan's total benefit ratio came in at 66.5% for the quarter, up 40 basis points year over year, and 62.5% for the year. The third sector benefits ratio was 56.9% for the quarter, up approximately 70 basis points year over year. We estimate the impact from remeasurement gains to be approximately 100 basis points favorable to the benefit ratio in Q4 2024. Long-term experience trends as they relate to treatments of cancer and hospitalization continue to be in place, leading to continued favorable underwriting experience. Persistency remains solid at 93.4%, which was unchanged year over year and in line with our expectations. Our expense ratio in Japan was 20.8% for the quarter, down 30 basis points year over year, driven primarily by a decline in expenses. For the year, the expense ratio in Japan was 19.1%. For the quarter, adjusted net investment income in yen terms was up 3.7%, as the transfer of assets to Aflac Bermuda associated with reinsurance and lower floating rate income was more than offset by higher returns from structured private credit infrastructure and our alternatives portfolio. Adjusted net investment income was up 12.1% for the year. The pretax margin for Japan in the quarter was 31.6%, up 120 basis points year over year, a very good result. For the full year, the pretax margin was even stronger at 36%, which is also the highest in 30 years. Turning to US results, net income premium was up 2.7%. Persistency increased 70 basis points year over year to 79.3%. Our US total benefit ratio came in at 46.3%, 170 basis points higher than Q4 2023, driven by lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by approximately 170 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and is now more in line with our long-term expectations. For the full year, the US total benefit ratio was 46.8%. Our expense ratio in the US was 40.3%, down 310 basis points year over year, primarily driven by platforms improving scale and strong expense management. For the year, the US expense ratio was 38.5%. Our growth initiatives in group life and disability, network dental and vision, and direct-to-consumer increased our total expense ratio by 170 basis points for the quarter. This is in line with our expectations, and we would expect this impact to decrease going forward as this business grows to scale and improves its profitability. Adjusted net investment income in the US was up 0.9% for the quarter, mainly driven by high returns from alternatives, and 3.3% for the year. Profitability in the US segment was solid with a pretax margin of 19.7%, also a good result, as was the 21.1% for the full year. We continue managing through the worst commercial real estate downturn in decades. During the quarter, we increased our CECL reserve associated with our commercial real estate portfolio by $40 million net of charge-offs as property values remain at distressed valuations. We also foreclosed on two loans, adding them to our real estate-owned portfolio. We continue to believe that the current distressed market does not reflect the true intrinsic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through the cycle, and maximize our recoveries. Our portfolio of first lien senior secured middle market loans continues to perform well, with losses below our expectations for this point in the cycle. In our corporate segment, we recorded a pretax loss of $4 million. Adjusted net investment income was $153 million higher than last year, due to a combination of continued lower volume of tax credit investments, higher rates, and asset balances, which included the impact of the reinsurance transaction in Q4 2024, which was similar in structure and economics in yen terms to our October 2023 transaction. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $46 million in the quarter, with an associated credit to the tax line. The net impact to our bottom line was a positive $4 million for the quarter. To date, these investments are performing well and in line with our expectations. Our capital position remains strong, and we ended the quarter with an SMR above 1150%, an estimated ESR above 270%, and combined RBC, while not finalized, we estimate to be greater than 650%. These are strong capital ratios, which we actively monitor, stress, and manage to withstand credit cycles as well as external shocks. US statutory impairments were $3 million, and there were 700 million yen of Japan FSA impairments in Q4. This is well within our expectations and with limited impact to both earnings and capital. Our leverage was 19.7% for the quarter, which is just below our target range of 20 to 25%. As we hold approximately 60% of our debt in yen, this leverage ratio is impacted by moves in the yen-dollar exchange rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in US dollar terms. Unencumbered holding company liquidity stood at $4.1 billion, $2.3 billion above our minimum balance. We repurchased $750 million of our own stock and paid dividends of $277 million in Q4, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. On December 3rd, we shared estimated ranges for annual key metrics for both segments for 2025 through 2027 at our financial analyst briefing, and we continue to stand by these ranges. However, for 2025, we expect the benefit ratio in Japan to be toward the higher end of the 64 to 66% range, and we continue to expect the expense ratio to be at the lower end of the 20 to 23% range as we pursue various growth and strategic initiatives. As a result, we expect Aflac Japan's pretax profit margin to be at the lower end of the 30 to 33% range. In the US, we expect the benefit ratio for 2025 to be at the lower end of the 48 to 52% range, and the expense ratio to be at the upper end of the 36 to 39% range as we continue to scale new business lines. At the same time, we expect the pretax profit margin for 2025 in the US to be at the upper end of the 17 to 20% range. Thank you. I'll now hand it back to David to begin the Q&A."
},
{
"speaker": "David Young",
"text": "Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. You may then rejoin the queue. We will now take the first question."
},
{
"speaker": "Operator",
"text": "To ask a question, if you are using a speakerphone, please pick up your handset before entering the key. To withdraw your question, please press star then two. And our first question will come from Joel Hurwitz of Dooling and Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"text": "Hey. Good morning. One to start. On US sales, Virgil, can you just provide some more color on what you are seeing in the competitive environment that's impacting your sales? Is it specific products or specific areas of the market?"
},
{
"speaker": "Virgil Miller",
"text": "Hey. Thank you, Joel. Good morning. Yeah. Look, first, let me set the stage for going into the fourth quarter. We knew going through the fourth quarter, Joel, that we were up against one of the tougher comparisons with Q4. In Q4 of 2023, that was one of the largest sales quarters we have had in the history of Aflac. So we knew we had to have strong solid performance. The second thing I would say is that we also knew that we would stick to the underwriting discipline we have put forth in our group BB products. What that really means is that we are not going to be bringing business on board that does not fit our profit profile. Therefore, businesses that have high turnover, businesses that have low claims filing, we are not going to accept those because they are not good for the company longer term. The stronger underwriting just wants to help set us up for profitable business and profitable growth in the long-term vision that we have at Aflac. Then the third thing I would say is we knew that the market needs to respond to the improvements we have made with our dental and vision platform. I had disclosed in prior conversations that we had a failed system implementation that we were recovering from. I am very pleased with the recovery that we have seen, though. A partnership that we formed with one of the industry-leading third-party administrators out there has helped substantially move the needle on improvements. And we are open for business. We needed to get the brokers and our veteran agents to come back on board and really put that product back in the market as a very competitive product. And quite frankly, we did not get the response we needed. We saw a 33% decline in our dental sales for Q4. Along with the dental sales themselves, though, there's the impact that we call halo, which means that on a general census, we get additional voluntary benefit sales when we sell the dental product. Those are really the things that we add them up that impacted how we performed in that Q4. I would say, Joel, that I am disappointed with the softer sales, but I am very pleased with our overall performance. We did demonstrate solid financial management. If you heard from Max, you heard from Dan, they mentioned that pretax earnings were up 9.3%. Our margins were up 1.3%. Earned premiums up 2.7%. Persistency up 0.7% overall. Very pleased with that. That tells you though this management discipline of making sure that we are looking at proper business is generating the response that we need, reduced expenses by 3.1%. And then overall, we were able to give other additional value to all policyholders with an increased benefit ratio. Now we are watching that very closely. But very solid performance based on that discipline we put out there in the market."
},
{
"speaker": "Joel Hurwitz",
"text": "Alright. Very helpful. Thank you. And then for my second one, just wanted to move to the 2025 outlook area that Max provided. So for Japan, you guided to the pretax margin to be at the low end of the range, which is below where I was, and I think most were. I think it's largely on net investment income and there's some misunderstanding on how the accounting works on the floating rate security hedges. Could you just provide more color on how the benefits from those hedges flow through earnings?"
},
{
"speaker": "Max Broden",
"text": "Yes. Thank you, Joel. So we obviously have a floating rate book in the Japan segment that is a little bit less than $9 billion of notional balance. Also at the corporate segment, we have a little bit over $4 billion of cash that is invested at the short end of the curve. That means that all these asset balances are very sensitive to SOFR. And that is both the one-month and the three-month SOFR that they reprice at. As we go into 2025, obviously, we had a rate cut in December, and there is an expectation about further rate cuts in 2025 when you look at the forward curves. When we just inject the forward curves onto our projected yields for 2025, that means that they are likely to be lower than what they were in 2024. So that is why our floating rate income is expected to be lower. As it relates to our interest rate swap, this is really a tail hedge swap that made sure that we protected our floating rate income from any significant declines in interest rates at the short end of the curve. That means that, obviously, we are at higher rates now than when this swap was entered into. That means that it is out of the money and somewhat ineffective at this point. And that's why you see the full brunt of any relatively even relatively small declines of interest rates at the short end immediately flows through and impacts our net investment income in 2025. Also, the mark-to-market component of the interest rate swap that falls below the line in the realized gains losses, i.e., outside of adjusted earnings but obviously included in our US GAAP earnings. I hope that's helpful."
},
{
"speaker": "Joel Hurwitz",
"text": "It is. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar of JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hey. Good morning. So first, just had a question either for Dan or for Charles on Japan sales. You obviously grew at a strong pace this quarter. But if you look at where sales are versus where they used to be pre-pandemic, they're still fairly depressed. So just wondering what's changed in the market, and what's your optimism of being able to get to, in an absolute sense, the sales levels that you had before that'll allow you to potentially grow your in-force as opposed to report declining premium growth."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "This is Yoshizumi from Aflac Japan. Pandemic public has recovered. So we do not see we see that it has recovered, and that is her. So we have been focusing on making a recovery in a solicitor's activity because during the two, three years of the COVID, the sales activities had been stagnant. So that has been a focus point, which is to make a recurring revenue. Let me answer. This is Yoshizumi. First of all, we have gone through this marketing and sales transformation starting January. This is to conduct integrated or end-to-end marketing activities based on the different brand group pipelines starting with medical, cancer, asset formation, and nursing care. And we will be continuously injecting our competitive product centered around our main products, cancer and medical insurance. And we plan to launch a new cancer insurance product in stages from March to April in order to respond to change in customer needs. And now with the launch of the new product Sumitasso, which was launched last June 2024, we have managed to expand our product lineup and now been able to approach a greater customer audience. And we will be executing measures in order to develop and enhance the potential of the solicitor or agent. With these efforts, we would like to recover our performance on the pre-COVID level. That's all."
},
{
"speaker": "Jimmy Bhullar",
"text": "And then maybe for Virgil, in the US business, I think there have been a couple of reasons that you've cited for sales being weak in 2024. One is just the dental DPA issues, and then secondly, competition in and margins in supplemental products or in the voluntary market. I'm assuming that the competition and market issue is something that's not going to change, but and if that is the case, assuming that that'll be an ongoing headwind to your sales, but then on the dental rollout, should is that starting to get to normal, or is that more of a 2026 event?"
},
{
"speaker": "Virgil Miller",
"text": "No. I thank you for the question. We absolutely want everyone listening to know we're open for business. We've invested time, resources, and dollars to make sure we got a strong platform. We went through a very diligent process to get the right partner who is an industry-leading partner to make sure that we're prepared to deliver on the customer experience that we need. So we are confident in our dental platform the way we have it now. The concern though is making sure that the brokers and the agents are back in market with it and that they're on board to sell it. I expected to see a stronger return for them in the fourth quarter, but I'm looking forward to see how we deliver on that this year. We're out meeting with them. We'll let them know about how the process works. We're energetic to say come back and sell the product. I would also say, though, what's going well for us is you look at the investments we made in our life and assets disability platform, we term as PLAT. We exceeded our sales expectations there. We are strong in that large case market now. Very competitive against some very known brands that have been in that space for a long time. Our disability products are competitive. Have a world-class absence management discipline. Where we're doing it for, you know, one state in particular, and we're delivering well on that. And then we are also selling our what we would call our paid-up life or employee life product. We also invested in a direct-to-consumer flat as consumer markets. We draw a better than expected sales year there. So those are the things that are going well. We get our dental platform back in line this year, and I expect it to demonstrate an increase."
},
{
"speaker": "Dan Amos",
"text": "And this is Dan. I am encouraged about what I'm seeing. Virgil talked to me early on in the first quarter and said, you know, there's some ways we can make this sales number. And do you know, I but I've got to push some areas. And I said, don't push lower profits for the sake of making the sale now. That's the wrong way. I want to look at earned premium. I want to look at what's going on. And I think our model for the future is much stronger to date than it was a year ago, especially on the dental and vision side. And we are expecting that to come through for the full year."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Mike Ward of UBS. Please go ahead."
},
{
"speaker": "Mike Ward",
"text": "Thank you. Good morning. I was just wondering just on the contribution to the Japan sales growth from Sumikasu seems like a primary driver of the growth. I guess, is it how fair is it to assume that we might be relying on first sector sales maybe more heavily than we previously thought in order to reach the Japan sales targets?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "To begin with, we do not announce or disclose the sales percentage or contribution. However, Aflac is a company centered around the third sector insurance product. And the main way to conduct our sales activity today is to also offer medical or cancer insurance whenever the product Sumitasso is being offered. Although we didn't show that Sumitasso will make a certain contribution to our first sector performance, our goal is to grow our third sector performance. And last year, right after the launch of this, we have enjoyed significant growth in sales. And we expect sales to settle compared to 2024. However, we believe the product will continue to generate solid results. And Sumitasso is unlike the traditional product features in the first sector product. It is developed to respond to the needs of the younger generation who are looking to accumulate their assets. Another nature of this product is that in addition to the asset formation nature, it also carries a nursing care feature. And another characteristic is that after the policy premiums are paid up, they can convert it to medical insurance or other types of insurance. And it also carries a strategic objective, which is to expand our customer base by capturing the younger generation and through concurrently offering this product together with a third sector product. So this is a very unique product. That's all."
},
{
"speaker": "Max Broden",
"text": "Thank you. I just wanted to add a few comments as well, Mike. We do not have a sales cap on our Sumitomo sales. And the reason why is that number one, we do believe that we get very good profitability out of this product. This is both on a GAAP basis but also on an IRR basis post-reinsurance. And what it means is that we also now have a very good hook product that ultimately will drive higher third sector sales as well. So we definitely see ourselves as a third sector company but this is an additional product that will help grow both our first sector business and the third sector business while also giving another tool to our distribution to sell more and make more commissions. Now I do want to say that the reason why now is because interest rates are higher in yen terms. But more importantly, we have built reinsurance expertise in and around the company which means that we can now conduct these operations and get the better capital efficiency associated with these products so we can really make them work."
},
{
"speaker": "Dan Amos",
"text": "And I will add that I have been so impressed with the job that Koichiro and his team have done in monitoring this through the guidance of Max, and what and Steve Bieber and what we've done to watch this. And every Sunday night, I get a report when we have our call on what is taking place and how interest rates are going, and where the lines are and our actuarial department is on it. And it's just I think you'd be proud if you saw the inner workings of what has taken place over the last couple of years with reinsurance. It shows that we're a company that's evolving over time. And just getting stronger in what we're doing and having better financial controls over the things that are taking place."
},
{
"speaker": "Operator",
"text": "The next question comes from Wes Carmichael of Autonomous Research. Please go ahead."
},
{
"speaker": "Wes Carmichael",
"text": "Hey. Good morning. My first question, just on remeasurement gains losses. It appears that the gains benefit has been flowing, which is, you know, perhaps not surprisingly given a pretty sizable unlocking in the third quarter. But when you look at trends going forward, would you expect that to continue, Max, or should that be relatively muted?"
},
{
"speaker": "Max Broden",
"text": "We obviously have experienced very significant remeasurement gains and also favorable gains from the unlock of our actuarial assumptions in the US in 2023 and in Japan in 2024. As it relates to our assumptions going forward, we do feel that we obviously have realistic and very good assumptions that by definition, otherwise, we would have to change it. This is something that we look at every quarter. But we and if something material were to change, we will unlock assumptions but our deep dive study occurs in the third quarter of every year. Each quarter, though, there are remeasurement gains, losses, that are coming through our results as we true up for the experience in that quarter. And that has continued to be favorable as we have come out of the pandemic. That being said, I do want to be a little bit cautious as we are seeing higher claims come through, especially on products, for example, in the US on our accident and our hospital product and to some extent also cancer. And that means that our remeasurement gains may not be as strong going forward as they have been in the past. But generally speaking, we are a company that takes a cautious approach to our underwriting to make sure that we get good results. And I think that the remeasurement gains that you have seen is a testament to the underwriting decisions that a company has taken in the past."
},
{
"speaker": "Wes Carmichael",
"text": "Thank you. And my follow-up, I guess, in the press release, Dan, you mentioned efforts on reengaging agents in the US. Can you just talk about the recruiting environment in the US? Are you seeing progress there, or is that kind of slowed?"
},
{
"speaker": "Virgil Miller",
"text": "Hey. Good morning. This is Virgil. Let me give you a color on that. I mentioned last year, so we're in a new regime out here. So definitely, there's a lot of competition. There are things like, you know, the economy that would impact recruitings from time to time. But all in all, I'm sticking to the point that we're going to always be around the ten thousand mark with our recruiting. We've demonstrated that now back to back. Although it's a little bit down from the year over year, we're still right around that ten thousand mark. Here's what I would say is that the core strength of our Aflac has always been our distribution. When you think about that, we will continue to go out, recruit agents, convert them, make the field force strong and dominant in that small market. I've added some new levels of leadership where we continue that focus. Our compensation plans are built around recruitment, and conversion to average week of producer and opening new small accounts. We continue to be strong doing our partnership with brokers in the mid-market and as I mentioned earlier, very strong in the upper case market now with the relationships we formed in our life and as the disability discipline. So we've got the market covered when it comes to distribution. I expect to recruit another ten thousand, around ten thousand this year. And continue to invest in what we're doing in that field force."
},
{
"speaker": "Wes Carmichael",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Elyse Greenspan of Wells Fargo. Please go ahead."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi. Thanks. Good morning. I guess my first one's on capital. You know, buyback picked up $750 million the quarter. You know, you guys obviously have pretty healthy capital positions in both the US and Japan. Does that $750 million, you know, feel like a good run rate level, or, you know, how should we think about share repurchase in 2025?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Elyse. Your observation is correct that we obviously have a very healthy capital position around the company. And together with that, we also have a very good free cash flow generation overall as well, and that is what gives us the opportunity to reinvest into our operations and to redeploy capital back to our shareholders as well. We are very IRR driven, and as of right now, I would say that we get by far the best IRR on selling another policy. So as it relates to capital, that is the number one area. There are capital is going to. So we're looking for areas to grow our business organically. On top of that, we obviously have increased our dividends quite significantly over the last five years where we almost doubled our dividend per share. And on top of that, we want to be opportunistic and tactical in the way we redeploy capital back to shareholders through share repurchase. We stepped that up a little bit in the fourth quarter by $750 million, which I believe is the most that we've done in a single quarter. So that's a meaningful return back to shareholders. But going forward, we will continue to obviously evaluate all the opportunities that we have and make sure that we get good IRRs on all the deployments that we do."
},
{
"speaker": "Elyse Greenspan",
"text": "Thanks. And then my second question, you know, I believe there was, you know, a data sharing issue with Japan Post. Not related to Aflac, I believe. Right? But in general, you could just comment on that. And then did that have any impact on your sales in the fourth quarter? Would you expect there to be an impact in 2025?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "This is speaking from Aflac Japan. First of all, let me be clear, there were no issues with the sales of Aflac Japan's cancer insurance upon this incident. And given its past experience, Japan Post is taking a conservative approach to addressing this matter. The Japan Post Group is committed to selling your products and for our standard practice, Aflac Japan is in close communication with Japan Post Group at all levels of the organization. We'll continue to work closely with Japan Post Group in support of its sales of Aflac Cancer Insurance."
},
{
"speaker": "Elyse Greenspan",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from John Barnidge of Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thank you for the opportunity. Virgil, in your comments, you talked about a failed implementation that was corrected. And how much of the market was dental and vision not present?"
},
{
"speaker": "Virgil Miller",
"text": "Hey, John. Great to hear from you. Ask me that question one more time. I didn't catch the last part, please."
},
{
"speaker": "John Barnidge",
"text": "So, yeah, you talked about a failed implementation that was corrected. And how much of the market was dental and vision not present as a result of the failed implementation?"
},
{
"speaker": "Virgil Miller",
"text": "Oh, no. I have it. Thanks, John. Yeah. We were available, John. So I would tell you this, though, that we had some service degradation earlier in the year. That definitely impacts the perception of trust. And making sure that the brokers and the agents will come back and sell it. So during the fourth quarter, we were open for business and ready to go. We have tested all of our processes. We work with a partner who has a strong reputation and who's doing a good job with Aflac. Our network of dentists is one of the largest out in the industry. We do a rented network, and we also have a proprietary network, both to offer. What I would say to you though is that in this business where agents and brokers have a choice of business, we have to earn trust. That's what we're focused on, getting back that trust and demonstrating that the processes work. So if you look again, just to mention, in Q4, sales from the prior year were down 33%. Now although they don't make up a large part of our overall sales right now, I would say to you though that we get additional voluntary benefits alongside. So it's not just impacting dental, it also has this halo effect where you're not bringing other business that you normally would have. Seeing progress here, as we look into January. We're regaining some confidence. We are going around to all of our broker partners, and we put all types of messages out, demonstrating confidence to our agents. And I'm looking forward to seeing them come back and sell the product. It is a competitive product. We spend a lot of time developing it, I think it's good for all consumers out there to give it a try."
},
{
"speaker": "John Barnidge",
"text": "Thank you for that. And my follow-up question is remains on distribution. Ahead of the anticipated new cancer product launch. Should we expect more modest sales in the near term for that?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Hi. Yoshizumi speaking. This new cancer insurance will be launched in March 2025. And we're expecting this to be a big driver. And we have been introducing innovative cancer insurance to the market this past year. But this time, in addition to the insurance coverage, we'll be integrating our Aflac Yodizel Cancer Consultation Support, which is our unique concierge service into the coverage. And I would like to mention three characteristics. It carries a very rich and simple coverage structure. And not only during the treatment, but there will be a coverage will be enhanced before and after the treatment. And we have changed the payment conditions for the benefit to be more easy to understand. The next major is the fact that it has a very flexible coverage design that allows combining the existing policies and other products. And we have also newly established a child plan with lower premiums to support pediatric cancer patient families whose economic burden tends to be high with longer treatment periods. And we expect to see a big increase in performance by introducing this product to various channels in stages."
},
{
"speaker": "Dan Amos",
"text": "Let me add one thing that I think is part of your question is that anytime we introduce a new product or revised product, we'll call it, there's a little dip in sales waiting for the new product and then the product should take off with the excitement of it being introduced throughout the country. So I just want to be clear on that. You can see a little dip and then strong growth."
},
{
"speaker": "John Barnidge",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Wilma Burdis of Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"text": "Hey. Good morning. First question, could you talk a little bit about any change in your thinking regarding the 10% reinsurance of the Japan block to Bermuda? And also just maybe touch on how you would reevaluate that, if at all. Thanks."
},
{
"speaker": "Max Broden",
"text": "Thank you, Wilma. So we currently have no change in our thinking. To date, we have seeded roughly 6% of our asset base of Aflac Japan to Bermuda. And so we have significant capacity as it relates to our internal cap of 10%. I want to stress that this is not an external cap, but it's an internal cap. And I think it's good risk management practice to have these kinds of caps in place because it means that we now have an opportunity to evaluate what we have done. And once we get closer to that 10%, then, obviously, all legal entities involved will make their own evaluation of if it makes sense to then move forward and increase that level for reasons where it may make sense for that legal entity. That applies to Aflac Bermuda, that applies to Aflac Japan, and obviously to Aflac Inc, as well. To date, we are very pleased with the outcomes of our reinsurance operations both in how they are being conducted, but also the overall outcome of it as it relates to improved balance sheet efficiency. And as you can see, improved return on equity overall for the group. And in fact, it has also reduced the risk of our Aflac Japan operations as well. So overall, we're quite pleased with where we are. And as we get closer to that 10% level, we will reassess."
},
{
"speaker": "Wilma Burdis",
"text": "Thank you. And then, are there any dynamics of the weaker yen that could impact Aflac's operations or results aside from, I guess, the repatriation impacts? Thank you."
},
{
"speaker": "Max Broden",
"text": "So, Wilma, the yen-dollar exchange rate does have an impact on our GAAP financials. As you know, we do not hedge our GAAP financials. So as you translate our yen-denominated earnings into US dollars, it does have an impact. And you obviously have seen that, especially over the last three years when you have experienced a significant depreciation of the yen versus the dollar. That being said, we do believe and we have the philosophy that we protect the economic value of Aflac Japan through an enterprise hedging program, and this is, as you know, three components to it. Where we hold US dollar assets on the Aflac Japan balance sheet, it is us at Aflac Inc. We are borrowing in yen and we also have an overlay of FX forwards at the holding company as well. And you add that up, and we believe that gives us very good protection on an economic basis to any moves, both small and significant, to the yen-dollar rate."
},
{
"speaker": "Wilma Burdis",
"text": "Okay. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Tom Gallagher of Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Morning. Max, how much of the Japan margin coming in at the low end of the guide is floating rate impact on NII and how much of it is more limited benefit ratio improvement? If you can unpack that."
},
{
"speaker": "Max Broden",
"text": "I would say that the vast majority of it is obviously driven by net investment income. And I'll let Brad comment a little bit on that because, obviously, we're coming off a very good base here in 2024. That being said, when you think about the components of the benefit ratio, I would expect that over the forecast period at 2025 to 2027, that as we travel through that forecast period, the benefit ratio, all things being equal, we would expect to decline. Yeah. So it will start at the high end of the range and end at the lower end of the range. And the reason for that is that as our in-force mix is changing and it's each year tilting a little bit more towards third sector and a little bit less towards first sector, that means that the third sector lower benefit ratio business makes up a bigger component. So the mix impact of that is going to push us from the higher end of the benefit ratio range towards the lower end of the benefit ratio range. But it also means that from a pretax margin standpoint, it means that we expect to travel throughout the forecast period starting at the lower end of the range and then travel higher towards the higher end of the range throughout the forecast period. But I'll let Brad give some more color on net investment income as we go into 2025."
},
{
"speaker": "Brad Dyslin",
"text": "Yeah, Tom. You're right that we are definitely facing some headwinds with the floating rate portfolio. As discussed, this is driven by the decrease in short rates, the 100 basis points decline we saw last year in SOFR. It does hit our $9 billion floating rate portfolio, but it also impacts our cash holdings and other short-term opportunities that we can see throughout the year, which we were able to take advantage of in 2024. But we also had a couple of one-off items that had a strong contribution last year. That we're facing this year. One was a rather large make-whole. And then we were also able to accelerate deployment in certain asset classes that had very attractive spreads earlier in the year. So there's a variety of things that contributed to a very strong 2024 that puts us up against some very difficult comps for 2025 that is the source of that headwind."
},
{
"speaker": "Tom Gallagher",
"text": "Gotcha. And then just for a follow-up around looking at your capital position in Japan, it looks like you have about $4 billion of excess under the new ESR framework anyway. Would you anticipate getting an extraordinary dividend out of that entity? And any updated thoughts on what you might do with that much level of excess? I guess it's a high-class problem, but still, you know, without robust growth opportunities, I can't imagine it makes a lot of economic sense to leave that much excess in Japan."
},
{
"speaker": "Max Broden",
"text": "So, Tom, I would characterize it. Our capital position in Japan is very strong. We are still going through the transition of the capital regime framework from SMR to ESR. And while ESR has not formally been implemented yet, I think it would not be very smart to go and try to right-size your capital base on a future capital regime basis. So step one is we would expect to certainly wait and fully evaluate this until after the ESR has been implemented. And as you know, that is at the end of the first quarter of 2026. So that means that over time, we would expect to be in the target operating range of 170% to 230%. But for the time being, I would not expect any special dividend in the near term."
},
{
"speaker": "Tom Gallagher",
"text": "Okay. Thanks."
},
{
"speaker": "Operator",
"text": "The next question comes from Josh Shanker of Bank of America. Please go ahead."
},
{
"speaker": "Josh Shanker",
"text": "Yeah. Thanks for fitting in. I guess this is for Virgil. I was wondering with the elevated expense ratio in Aflac US, how long do you expect the investments in the work you're doing to accelerate growth to weigh on the expense ratio?"
},
{
"speaker": "Virgil Miller",
"text": "Yeah. Hi. Thanks, Josh. I would say, you know, we started to bend that curve. You know, we had one time been up to around 41% with the expense ratio. This year, we came in around 38.5%, I think, to be exact. So very, very pleased with that performance that we are bending it. And that is why we're still, as you pointed out, investing in the buy the bills. The key is to get these buy the bills to scale. And we are experiencing solid better than expected growth on the PLAS platform, better than expected growth on the consumer markets platform. And like I said, it sounds like I'm a broken record, but we've got to turn the curve with the dental vision platform. We're doing all the right things to get that done. If we do that right, that will help not only contribute to the expense ratio by bringing in additional new sales revenue that we need to offset that expense ratio, but we will continue to do strong, though, disciplined expense management. I expect the curve to come down even further this year in 2025."
},
{
"speaker": "Josh Shanker",
"text": "Are you know, if we think out more long term, you know, 2026, 2027, are we thinking it's on the margin or this is several hundred basis points?"
},
{
"speaker": "Virgil Miller",
"text": "Yeah. So I would tell you that we would at FAL, we put forth a range on the margin between 17 and 20%. We're going to stay within our range because we're going to make sure that our disciplined expense management hits those marks. If you look at 2025, 2026, and 2027, I am showing a decrease though in expense margin in expense ratio incrementally year over year over year."
},
{
"speaker": "Josh Shanker",
"text": "Okay. Thank you very much."
},
{
"speaker": "Dan Amos",
"text": "I think the important factor to get from this sales part of dental and vision is we got it right in the we want that distance. We just didn't execute to the level we needed to. And made a mistake, and I've got that now on target. And we've just got an outcome through with it. So we can achieve and will achieve."
},
{
"speaker": "Josh Shanker",
"text": "Appreciate it. Appreciate it. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Alex Scott of Barclays. Please go ahead."
},
{
"speaker": "Alex Scott",
"text": "Hey. Good morning. First question I had is just on the competitive environment a bit. And going back to some of the comments you all made around sales and, you know, you remain disciplined, like, you know, you could've shown better sales, but you're remaining disciplined. And I just want to dig into that a bit. I mean, when I think about, like, the signpost that I look at, I mean, it seems like well, reinsurance to Bermuda. The new money yields were in excess of 9% in the US and 8% in Japan. So I'm just trying to understand, you know, you're pulling are you getting those targeted IRRs because of some of the leverage or, you know, do you still feel like there's the same opportunity here that you've had in the past?"
},
{
"speaker": "Max Broden",
"text": "Let me address our life insurance business in Japan in particular because I think that's what you're really driving at. Obviously, higher yields matter, especially in yen terms as we sell yen-denominated products. But it's really the new business strain associated with these products and high reserving levels still puts the IRRs under significant pressure. But if you look at it on a post-reinsurance basis, we get very, very good IRRs, and that's why we feel very confident selling both our waste and our consummator product into the marketplace."
},
{
"speaker": "Alex Scott",
"text": "Okay. And maybe as a follow-up, I mean, one of the themes we've seen in group benefits this quarter from some of the peers is there seems to be sort of a have versus have-nots in terms of, like, capabilities on the platform and, you know, having that translate to sales growth being favorable or less favorable. And I guess I just pose the question to you. I mean, how do you feel about the capabilities in your group benefits platform, the scale? Do you have what you need? Is there more that you could go out and acquire whether inorganically or things that you may need to invest in?"
},
{
"speaker": "Virgil Miller",
"text": "I would say this is, Virgil. I would say this that when we acquired the life and disability business, we had invested to make sure we've got the right platform for that business line. I'm very technical on this, meaning that we have the right technology. We have the right resources, the talent to scale. On our group BB, we've made significant investments over the years to get the same with talent, with technology. And then we're doing that. We just did the same with our dental platform. Where I'm going with this is we have put forth what I would call a market segmentation strategy. We've got the right products for each segment. We've got the right distribution for each segment. What we're investing in right now is the ability to bring those things together so we're able to be more competitive with the ability to bundle and to present one unique experience to the market. Each platform stands strong independently. The talent stands strong independently. The product stands strong independently. Our core strategy will be bringing those things together. So there will be little additional investment to do that over the next couple of years. We're currently doing it right now. We respond to RFPs in the market as one Aflac, and we're going to really demonstrate the ability to be best in class with the technology and the discipline to have those things fit together going forward."
},
{
"speaker": "Alex Scott",
"text": "Got it. Thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Jack Matting of BMO Capital Markets. Please go ahead."
},
{
"speaker": "Jack Matting",
"text": "Hi. Good morning. Most might have answered, but maybe just one on commercial real estate. Could you just talk a little bit more about trends in that market and how you expect things to develop on Aflac's portfolio in 2025?"
},
{
"speaker": "Brad Dyslin",
"text": "Sure. Thank you, Jack, for the question. As you're undoubtedly aware, the market remains pretty difficult. It does seem that we may have hit the bottom, but we're very slow to recover. We'll continue working through our portfolio. Our preference is to work with borrowers to find a solution, but if the best way to protect our interest is to foreclose, we've demonstrated we're willing to do that to maximize our recoveries. We do expect this to be a long recovery. We have seen some early signs that things are moving the right way, but it's very early and values remain still quite depressed. At this point, we expect 2025 to largely play out much like 2024. We'll continue working through our watch list. We will manage our REO portfolio to maximize our long-term returns. We expect it is going to take quite some time for this recovery to happen. But that's our general outlook at this point. We do think it's going to be one that's going to take time to work through."
},
{
"speaker": "Jack Matting",
"text": "Thank you. And then, just a quick follow-up on the Japan sales outlook. I guess other than the major kind of cancer product launch you have coming in a couple of months, are there any kind of other launches or refreshes that you have planned this year that could impact the cadence of sales in 2025?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Yes. As for the new product, we'll be launching the new cancer insurance in stages from March to April. And for the medical insurance, we have rebranded and improved the service last August. And we have also been strengthening our sales with a new plan targeting the middle-aged and older customers that was launched in September 2024. And we'll be able to provide one more strengthened promotion through our end-to-end structure, and that has been developed recently. And this structure is developed by each brand. In terms of the parameters, in comparison to the sales volume of 2024, this year will settle down. However, we believe that this will continue to generate solid results. With regards to the channel, we started an effort two years ago to enhance and increase other agents. And in 2023, we have hired approximately 600 agents. And they have made a great deal of contribution to our activities last year in 2024. But we have succeeded in hiring much more than 600 people in 2024. And we expect these new agents to be more active in 2025. As I said earlier, we will be utilizing the first sector product as a hook to expand the third sector business, actually. And such training is being implemented and strengthened. That's all."
},
{
"speaker": "Jack Matting",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "This concludes our question and answer session. I'd like to turn the call back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you, Andrea, and thank you all for joining us on today's call. We appreciate your interest in Aflac Incorporated and look forward to hearing from you and seeing you soon. Have a good day."
},
{
"speaker": "Operator",
"text": "The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 3 | 2,024 | 2024-10-31 08:00:00 | Operator: Good day, and welcome to the Aflac Incorporated Third Quarter 2024 Earnings Call. All participants will be in listen only mode. [Operator Instructions]. After today's remarks, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Capital Markets. Please go ahead.
David Young: Good morning and welcome. Thank you for joining us for Aflac Incorporated third quarter earnings call. I hope you will also join us for our Financial Analyst Briefing on December 3rd at the New York Stock Exchange. Registration reminders for this event will go out over the next few weeks. This morning, Dan Amos, Chairman, CEO of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then, Max Broden, Executive Vice President and CFO of Aflac Incorporated will provide an update on our financial results and current capital and liquidity. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2024. We also posted under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans. For Q&A today, we are joined by Virgil Miller, President of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our Annual Report on Form 10-K for some of the various Risk Factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?
Dan Amos: Thank you, David, and good morning. We're glad you joined us. As you saw, Aflac Incorporated reported a loss of $0.17 per diluted share on a U.S. GAAP basis for the quarter, primarily due to increased foreign exchange related losses from the yen and the strengthening of 12.9% during the quarter. However, adjusted earnings per diluted share for the quarter increased 17.4% to $2.16. Year-to-date, earnings per diluted share were $6.23 and adjusted earnings per share on a diluted basis rose 13.5% to $5.64. Beginning with Japan, we drove a 12.3% year-over-year increase in sales in the third quarter, maintaining the initial momentum from the June launch of Tsumitasu. As you'll recall, Tsumitasu combines asset formation with a nursing care option. It is part of our strategy to attract new and younger customers while also introducing them to our third sector policies. Tsumitasu also played an important role in the sales growth at the agencies. I'm also very pleased with the continued improvement in cancer insurance sales through Japan Post Channel, especially considering that WINGS has been in the market for over two years. On November 15, we'll be celebrating 50 years in Japan. Our marketing efforts will focus on creating additional touch points with customers around their needs and our products. Overall, Koide San and his team have done a great job of driving sales in Japan and even more so of delivering record profit margins for the quarter. Turning to the U.S., we achieved 5.5% sales growth for the quarter. These sales results reflects strong growth in Group Life, absent management and disability, which is encouraging as we continue to scale up that platform. In addition, it's good to see a continued increase in cancer insurance sales given our efforts to enhance the value proposition to our cancer policyholders. As we enter the fourth quarter and what tends to be our heaviest enrollment period, we will continue to focus on profitable growth, disciplined expense management, and optimizing our Dental and Vision platform. Overall, Virgil and his team are doing a good job balancing profitable growth, enhancing the value proposition of our policyholders, and curving the expense ratios. Their efforts contributed to the strong 20.8% pre-tax profit margin for the quarter. Max has done a great job leading the team to proactively defend our cash flows and deployable capital against a weakening yen, as well as establish our reinsurance platform in Bermuda. Over the course of this year, Virgil and Max as well as Audrey Tillman have taken on additional responsibilities. The Board and I are thrilled to recognize the tremendous contributions these executive leaders have made with their promotion announcements yesterday. You've probably heard me say many times that in conjunction with the Board, one of my key responsibilities is succession planning for key roles and I look forward to continuing to work with them and prepare them for the future. Turning to investments. We have been very pleased with our investment portfolio's performance as it continues to produce strong net investment income with minimal losses and impairments. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders, while being responsive to the needs of our shareholders. Our solid portfolio supports our promise to our policyholders as does our commitment to maintaining strong capital ratios. We balance this financial strength with tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both our dividend track record and tactical share repurchase. We treasure our track record of what is now 42 consecutive years of dividend growth with the Board of Directors declaration of the fourth quarter dividend of $0.50. We repurchased $500 million in shares during the quarter and intend to continue our balanced tactical approach of investing in growth and driving long-term operating efficiencies. Our management team, employees, and sales distribution continue to be dedicated stewards of our business, being there for the policyholders when they need us most just as we promised. This exemplifies our goal of providing customers with the best value in the supplemental insurance products in the United States and Japan. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. Aflac is well-positioned as we work toward achieving long-term growth while also ensuring we deliver on our promise to our policyholders. I'll now turn the program over to Max to cover more details of the financial results. Max?
Max Broden: Thank you, Dan. Thank you for joining me as I provide a financial update on Aflac Incorporated's results for the third quarter of 2024. For the quarter, adjusted earnings per diluted share increased 17.4% year-over-year to $2.16 with a $0.03 negative impact from FX in the quarter. In the quarter, remeasurement gains on reserves totaled $408 million, reducing benefits while an offsetting unlock of the deferred profit liability in Japan reduced earned premium by $75 million. Variable investment income ran $27 million below our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses increased 7.3% and the adjusted ROE was 16.7%, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 10.5%. This decline reflects a ¥7.3 billion negative impact from an internal cancer reinsurance transaction executed in the fourth quarter of 2023 and a ¥4.6 billion negative impact from paid-up policies. In addition, there is a ¥13.3 billion negative impact from deferred profit liability, the majority of which is a one-time impact from unlocking of LDTI assumptions. At the same time, policies in force declined 2.3%. Japan's total benefit ratio came in at 49.2% for the quarter down 15.9 percentage points year-over-year and the third sector benefit ratio was 41.8% down approximately 13 percentage points year-over-year. We estimate the impact from remeasurement gains to be approximately 18 percentage points favorable to the benefit ratio in Q3 2024. Long-term experience trends as it relates to treatments of cancer and hospitalization continue to be in place, leading to continued favorable underwriting experience. Given the impact from unlocking, we now expect the full year benefit ratio to end up in the range of 62% to 63%. Persistency remained solid with a rate of 93.3%, which was down 20 basis points year-over-year. This change in persistency is in line with our expectations. Our expense ratio in Japan was 20% up 100 basis points year-over-year driven primarily by decline in revenues. Adjusted net investment income in yen terms was up 0.1% as the benefits from lower hedge costs and favorable impact from foreign currency on U.S. dollar investments in yen terms were largely offset by lower floating rate income and lower volume as we have continued to shift assets from Aflac Japan to Aflac Re Bermuda. The pre-tax margin for Japan in the quarter was 44.7%, up 11.9 percentage points year-over-year, a very good result. For the full year, we now expect the pre-tax margin to be in the range of 35% to 36%. Turning to U.S. results, net earned premium was up 2.8%, persistency increased 20 basis points year-over-year to 78.9%. Considering our year-to-date results, we now expect full year net earned premium to be towards the lower end of our guidance range of 3% to 5%. Our total benefit ratio came in at 47.6%, 11.7 percentage points higher than Q3 2023 driven by lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by approximately 120 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and are now more in line with our long-term expectations. For the full year, we would expect the benefit ratio to be towards the higher end of our guidance range of 45% to 47%. Our expense ratio in the U.S. was 38% down 260 basis points year-over-year, primarily driven by platforms improving scale and strong expense management. Given business seasonality, we would expect an uptick in expense ratio for Q4, but to remain with our guidance range of 38% to 40% for the full year. Our growth initiatives Group Life and Disability, Network Dental Vision and direct-to-consumer increased our total expense ratio by 100 basis points. This is in line with our expectations and we would expect this impact to decrease going forward as these businesses grow to scale and improve their profitability. Adjusted net investment income in the U.S. was up 0.5% mainly driven by higher fixed rate income. Profitability in the U.S. segment was solid with a pre-tax margin of 20.8% also a good result. Our total commercial real estate loan watchlist remains approximately $1 billion with less than $250 million in process of foreclosure currently. As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $3 million in this quarter, net of charge-offs. We've had one foreclosure moved into real estate-owned. We continue to believe that the current distressed market does not reflect the true intrinsic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through this cycle, and maximize our recoveries. Our portfolio of first lien senior secured middle market loans continued to perform well with losses below our expectations for this point in the cycle. In our Corporate segment, we recorded a pre-tax gain of $15 million. Adjusted net investment income was $37 million higher than last year due to a combination of higher rates and asset balances, which included the impact of reinsurance transactions in Q4 of 2023, as well as continued lower volume of tax credit investments. These tax credit investments impacted the corporate net investment income line for U.S. GAAP purposes negatively by $57 million in the quarter with an associated credit to the tax line. The net impact to our bottom line was a positive $5 million in the quarter. To-date, these investments are performing well and in line with our expectations. We are continuing to build out our internal reinsurance platform, and I'm pleased with the outcome and performance. In the fourth quarter, we intend to execute another tranche with similar structure and economics in yen terms to our October 2023 transaction. Our capital position remained strong, and we ended the quarter with an SMR about 1,100% and our combined RBC, while not finalized, we estimate to be greater than 650%. These are strong capital ratios, which we actively monitor, stress and manage to withstand credit cycles as well as external shocks. U.S. statutory impairments were $58 million, and there were no additional Japan FSA impairments in Q3. This is well within our expectations and with limited impact to both earnings and capital. As we hold approximately 60% of our debt in yen, our leverage increased to 21% as a result of the move in the yen-dollar exchange rate, well within our target range of 20% to 25%. Our leverage will fluctuate with movements in the yen-dollar rate. This is intentional and part of our enterprise hedging program protecting the economic value of Aflac Japan in the U.S. dollar terms. Unencumbered holding company liquidity stood at $3.9 billion, $2.1 billion above our minimum balance. We repurchased $500 million of our own stock and paid dividends of $280 million in Q3, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. And I will now hand over to David to begin Q&A.
David Young: Thank you, Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. You may then rejoin the queue. We'll now take the first question.
Operator: We'll now begin the question-and-answer session. [Operator Instructions]. And our first question comes from Joel Hurwitz from Dowling & Partners. Please go ahead.
Joel Hurwitz: Hi, good morning. I wanted to start on Japan sales. So third sector sales continues to be a bit challenged. Can you just talk about plans for both cancer and medical? And what are you expecting from sales promotions related to the 50th anniversary?
Koichiro Yoshizumi: [Foreign Language] This is Yoshizumi, in charge of Sales and Marketing in Japan. [Foreign Language] So let me first start off with how we are successful. And the reason for that is because of this new product that we've launched, which is an asset formation product plus the nursing care coverage. And this product also has a feature that once it becomes paid up, this can be converted into medical, nursing care or death benefit. [Foreign Language] First of all, again, this Tsumitasu was developed to meet the young and middle-aged customers' needs for asset formation and contribute to the expansion of third sector sales. [Foreign Language] And considerable preparations for sales from June through third quarter led to 12.3% growth. [Foreign Language] And the purpose was to approach young and middle aged new customers and new customers. [Foreign Language] As well as proposing additional sales of third sector products. [Foreign Language] And also to cross-sell products. [Foreign Language] And this has led to revitalizing the sales activities of the associates. [Foreign Language] So as a result, what we are expecting is that our third sector sales would grow increase by selling Tsumitasu. [Foreign Language] Now let me turn to cancer insurance. [Foreign Language] And as you mentioned, by using 50th anniversary as our trader or a hook, we are trying to sell our cancer insurance and cross-sell cancer insurance. [Foreign Language] And as you may know, our cancer insurance was launched two years ago, meaning that it has gone two years already. [Foreign Language] We have a service called concierge service that no other company is able to offer. [Foreign Language] In other words, this is called the Yoriso cancer consultation support service. [Foreign Language] And what we are trying to do is by using to appeal this product and service; we are using TV commercials and web advertisement to really appeal the value of this product and service. [Foreign Language] And we are also considering to launch a new product around spring next year. [Foreign Language] So as a result, we are expecting that our cancer sales will increase. [Foreign Language] Now turning to medical insurance. [Foreign Language] We've changed the product name and rerounded. [Foreign Language] And this is also one of its kind that only Aflac has in terms of the coverage, and it's really attracting attention of the market. In other words, we have this mostly coverage feature that no other company has. [Foreign Language] And we would like to grow the sale of this product together with Tsumitasu. [Foreign Language] And we've also launched a new plan for middle and older aged customers over 50 years old. [Foreign Language] So as a result, we are seeing a gradual recovery in medical sales, and we are expecting good sales from it. [Foreign Language] And overall, we are expecting that our third sector product sales will recover and increase because of the reasons that I've mentioned. At the same time, we have been quite successful in recruiting sales agents for the third sector, and we are strengthening our sales force, too. [Foreign Language] That's all for me.
Operator: The next question comes from Tom Gallagher from Evercore ISI. Please go ahead.
Tom Gallagher: Good morning. First question just on capital allocation, and I'll just have a quick follow-up on sales. So can you talk a bit about broader capital allocation, how you're thinking about it? I know the buyback was a bit lower this quarter, but you have the strong level of excess capital accumulating. Any thoughts on a special dividend, M&A, as you think about -- let's just say if the stock does continue to trade at strong levels, what would your plans be? Would you still do good levels of buybacks heading into next year? Or would you consider these other options? Thanks.
Max Broden: Thank you, Tom. You're right in acknowledging that our capital ratios, they are strong. We are also generating significant capital both organically throughout our operations, plus what we are doing around reinsurance as well, freeing up additional levels of capital. So we are very strong on that front. And then we look at all of those opportunities that you mentioned, and I would not put anything off the table. We evaluate what -- where we can get the best returns currently, but more importantly, long-term. When we evaluate our business, we think about it over the next 1, 2, 3, 5, 10, 15, 20 years and think about what is going to generate the highest return on that capital for us over that time period. And especially when you think strategically around things like M&A, you have to take that into consideration. So these are the things that go into our capital allocation consideration, both in terms of, obviously, how much we have, how we see capital generation coming to us and then ultimately, the returns that we can get. And we really mean it when we say that we are thinking about what those returns are, and it is a dynamic world where these things are changing but I will not take anything off the table. That includes, obviously, everything that you mentioned.
Tom Gallagher: Okay. Thanks for that, Max. And just a follow-up on sales. Can you give a sense for the split between -- of the first sector product you're selling? What's the split between new customers versus existing customers that are buying that product? Thanks.
Koichiro Yoshizumi: [Foreign Language] If you're asking about the new customer ratio of the sale of first sector product. [Foreign Language] Well, right now, sales to existing customers is larger than to those of new customers. And this is always the case when we launch a new product. [Foreign Language] And when we do this kind of first sector sale, there's always a cross-sell, and we do -- we are meeting the expected level of cross-sell rate at the moment. And as we move forward on a monthly basis, more and more new customers are increasing. [Foreign Language] And what it also means is that when we explore -- try to acquire young and middle-aged customers using Tsumitasu that just purely means that we are trying to acquire new customers. [Foreign Language] So our strategy to increase new customers after we go around the cycle of approaching to our existing customers, and that's what we are doing and that's our strategy. Thank you. That's all.
Dan Amos: Yes. I'd like to make a comment about that. I would say that the numbers are falling in line with our expectations. We thought it would be over 20%. We hope it would be closer to 25%. Sure not been started at about 20%, and it's moved up to 25%. And so that's in the range of what we had anticipated or maybe even a little better. So we're very pleased with Tsumitasu and what is taking place and how it's bringing on new customers for us, young and middle age. So that should answer your question.
Operator: Next question comes from Wes Carmichael from Autonomous Research. Please go ahead.
Wes Carmichael: Hey, thanks. Good morning. From Yoshizumi-san's remarks, it sounds like the sales force is really leaning into Tsumitasu. I guess my question is, does this really kind of like contemplate a fee change where we should see a greater contribution from first sector sales going forward. And I know, Max, you said the returns after reinsurance are kind of similar to third sector products. So really just want to understand strategically if we should expect that mix to be more balanced going forward, between first sector and third.
Max Broden: Given -- given what Japan is going through and I would -- and I would expect that --
Koichiro Yoshizumi: [Foreign Language] So our strategy can be divided into two parts. One is, of course, to ensure profitability by using reinsurance. And the other is as I've mentioned earlier, by Tsumitasu, we are also bringing in new third sector. And that way, we are trying to secure profits and revenue from that perspective.
Max Broden: Let me add a comment to that answer. Tsumitasu has important aspects to many parts of our business. And it is the fact that Japan, as a society, obviously, is aging. And with that, there is a significant increase in retirement needs and retirement funding. And Japan is pushing harder to become more of an asset management country as well with policies. That means that we would expect that a retirement products are going to going to be and more important tool for both the financial industry and for us going forward. And you have seen how Yoshizumi-san outlined how we are using Tsumitasu to then also cross-sell our third sector business. So I would expect it to be a more meaningful part of our portfolio going forward than what it has been in a more recent past. I still definitely think that we will predominantly be a third sector company, but where the first sector savings business will be a meaningful component of our total sales.
Operator: The next question comes from Ryan Krueger from KBW. Please go ahead.
Ryan Krueger: Hey, thanks. Good morning. I had a question on the Japan benefit ratio. I think coming into the year, your guidance was 66% to 68%. I guess when we think about the assumptions unlocking, and year-to-date experience, would you expect that to be improved from the original expectation going forward? I guess, it looks like your guidance for the full year implied maybe something closer to 65% to 67% in the fourth quarter.
Max Broden: Yes. The impact from this unlock is that we have lowered the future net premium ratio by roughly 100 basis points. So all things being equal, that means that we would expect our benefit ratio going forward for our in-force business to be roughly 100 basis points lower than what we previously expected before the unlock. So it does have an impact for future benefit ratios as well and that would apply going into 2025 as well.
Ryan Krueger: Thanks. And then just a quick one. Can you give us your run rate earnings expectations for the Corporate segment at this point? I guess, let's say, assuming 0 tax credit impact.
Max Broden: So, in this quarter, we had a $15 million pre-tax profit and the tax credit investments lowered that number by roughly $57 million on a pre-tax basis. So that will get you closer to the run rate as of this quarter. I would acknowledge that this is an area where we are sensitive to short-term yields. So if you have a short-term yields coming down, that would put pressure a little bit on that number. But I would expect that in the near-term, our run rate profitability should be that we will continue to be profitable in that segment, all things being equal for -- that's the current run rate.
Operator: The next question comes from John Barnidge from Piper Sandler. Please go ahead.
John Barnidge: Good morning. Thanks for the opportunity. My question sticks there. On the 100 basis points of future benefit ratio benefit that are or do you take into account long-term experience? Would short-term experience that continues to be favorable, be incremental to that 100 basis points. Thank you.
Max Broden: Let me start off, and I'll ask Alycia, our Global Chief Actuary, to fill in with any comments she may have. Obviously, when we do a deep dive study as we just concluded, we try to incorporate all the experience that we've had to-date, but then also obviously unlocking future assumptions. In those future assumptions, there is a future trend incorporated in that. And if future experience tends to -- if it would were to deviate to that trend that could lead to either further releases or increases related to that. But I do want to acknowledge that there is an element of a future trend incorporated in these unlocks as well.
Alycia Slyck: Thank you, Max. Yes, we incorporated our future trend into our unlock this year. So we believe we have reflected all of our current experience and expectations. We do review our assumptions annually to investigate new trends, but all of that has currently been reflected in this unlock.
John Barnidge: Thank you for that. And my follow-up question that's related following an 18-point benefit from the unlock, do you view that, that increases the total addressable market for liabilities that over the long-term could potentially go to Bermuda? Thank you.
Max Broden: Yes. I would view them as somewhat unrelated. This unlock is a U.S. GAAP unlock only with no impact to our U.S. statutory results in the U.S. and reserves and no impact to our FSA results or FSA reserves. So I would not draw that link.
Operator: Our next question comes from Jimmy Bhullar from J.P. Morgan. Please go ahead.
Jimmy Bhullar: First, I had a question on just your expected -- your expectations for how Tsumitasu sales are going to trend? Should we assume that they're going to keep growing from here? Or was there sort of a pent-up demand phenomena to where sales will begin to fade over the next few quarters?
Koichiro Yoshizumi: [Foreign Language] Thank you for the questions. Let me answer this question. This is Yoshizumi once again. [Foreign Language] Well, Tsumitasu was launched in June as a new product. And in that month, in June, we had a very big sales. And the reason why we were able to do so is because we had fully prepared for it in advance of the launch. [Foreign Language] And from July and on, Tsumitasu sales have been successful, and it is meeting -- it is meeting the level that we have been expecting. [Foreign Language] And as I have mentioned several times that Tsumitasu is very well known and we're very well taken by customers, and it's a very popular product in the market. [Foreign Language] So as a result, what we are thinking is that until the end of the year, perhaps next quarter, we should be able to generate a very stable number from Tsumitasu. [Foreign Language] And as I have mentioned earlier that this product is very popular among young people because this product does meet the needs of these young people. And what that means is that during their payment period, they would have asset formation function as well as nursing care. And then, after that period, the customer can choose from medical, nursing care or a death benefit. And that's the reason why this product is so popular among young people. [Foreign Language] So my conclusion is that we are expecting to have a certain level of sales from Tsumitasu going forward as well. [Foreign Language] That's all for me.
Jimmy Bhullar: Okay. Thanks. And then on the U.S. business, it seems like incurred claims are running a lot higher so far this year than they have in the last several years. Is that a mix issue? Or are you just seeing usage in some of the products pick up? Or are there other factors driving that?
Virgil Miller: Hi, good morning. This is Virgil from the U.S. It is -- I would say that some of it is definitely delivered an extension on our part. We want to make sure that we put the value of the benefits in the hands of the policyholders but we don't want to over toggle. So what we've done this year is we've increased benefits on certain lines of business at no additional cost. We've gone out and pushed campaigns for consumers to file one of those benefits to make sure that we try to catch any type of problem before it turns into a long-term condition. And then the last thing I would say to you, though, is that mix does matter. We've been pushing on the cancer business while an individual line of business, and we've had good success year-to-date with sales up about 9%. And then the last thing I would say is we introduced and I mentioned this before, about our stronger underwriting discipline on our VB benefits. And we're really looking now to bring on business with high turnover and thus yielding better persistency for us over the long-term. All of these things are factoring in to help drive a move that benefit ratio. We are constantly monitoring though, to make sure that we're within our tolerance.
Max Broden: And then just to add to that, there is one more mix impact that is running through the U.S. results. And that is as we grow our Group Life and Disability business and that becomes a greater proportion of our in-force that will, over time, drive up the benefit ratio for the U.S. segment. The Group Life and Disability business, we would expect to run at sort of a low 80s benefit ratio. So all things being equal, that will continue to push that benefit ratio higher.
Operator: The next question comes from Wilma Burdis from Raymond James. Please go ahead.
Wilma Burdis: Hey, good morning. I guess, what is the Dan's recent promotions? Could you talk a little bit about what you're most focused on from a development and succession perspective over the next couple of years? Thanks.
Max Broden: Wilma, there was something that moved when you asked the question at the very start. What were you asking?
Wilma Burdis: Sorry, I said for Dan, given the recent promotions, could you talk a little bit more about what you're focused on from a development and succession perspective for the next couple of years? Thanks.
Dan Amos: Well, I think the first question is how does it relate to me specifically and what are my plans? And my plans really haven't changed. I serve at the pleasure of the Board and frankly, enjoy doing that. They ultimately make the final decisions on what they want to happen, but I'm enjoying it. But at the same time, I owe it to the shareholders and the Board to make sure there's a succession plan and there's a depth in management that is there to show our ability to continue on without disruption. And I believe that we've got the people in place with the opportunity. And first, I have suggested to the Board and that they begin to place someone internally several people that they think have potential to take over one day. And certainly, Virgil is at the top of that list. He -- I have to say I'm very pleased with the U.S. because it's become a much different company than it was five years ago. As we've gotten into the plans business that I think it was Max was talking about, and we've seen look at group business and how Virgil mentioned that we're not right in certain types of business. And then we've got our distribution channel, which is very unusual. There really aren't many people out there that have the distribution channel that we have from an independent agent's perspective. And then building on the broker business and what's going on there in the U.S. And so, yes, I think he certainly deserves the opportunity to have his name in the pot for what will take place when I do retire at some point in time. I think Max is showing his strength on the call today and what he's doing. And he's gone in as if it was uninterrupted with the job that Fred was doing before he left at this year. And so I've been very pleased with that. And then Audrey has always been an outstanding person for us from counsel, from independent review of not just that, but any issue that might be out there that concerns understanding the employees, understanding the law, understanding all of those aspects of it. So I feel very good about these promotions. And then we had several others our Head of IT, being Executive Vice President, and she is doing a great job. She's rated one of the 100 in best women in America in the IT area. So we're lucky to have her. You heard Alycia has been with us a little over a year, and she has jumped right in. So I'm very pleased with the bench. We've got Robin, who's now Chief Accounting Officer of the company and you, we've got Fred Simard. Certainly, what Brad has done has been uninterrupted in terms of taking over Eric's position. So all in all, I have to tell you that our bench is strong. There -- most of them are relatively new in the positions. They've had more responsibility added to them in certain cases, as is in the case of Brad, he's picked up more. You've seen it with Max and what's taking place. So all in all, that's where I am. And I'll just tell you that I'm happy and we'll continue on. But I want someone that if something happened tomorrow, there would be a smooth transition and the Board has plenty of options to do what they deem as necessary.
Wilma Burdis: Thank you, and congrats to Virgil, Max and Audrey as well. One maybe for Virgil, could you discuss any macro or employment environment impacts that you're seeing in the U.S. that are impacting sales and/or recruiting. Thanks.
Virgil Miller: Yes. Thank you for the question. And thank you for the congratulations. I'm excited about the opportunity and look forward to partnering with my colleagues here in pushing the Aflac forward for the future. I would say that you saw that earlier in the year, we started out of the gate slow with our sales, put it up a negative quarter that we were able to rebound in the second quarter, coming up with about a 2.2% increase. And then for this quarter, really exceeded what I expect at a 5.5% increase. And it's really accumulating from a couple of things. Max and Dan both mentioned the plans business. What that means from my perspective, till is we have an opportunity right now in a strong product base to compete in the jumbo case market. Generally, we're talking about employer groups with more than 5,000 employees. And then we're also talking about the relationships that we forged with the brokers in that space. At the same time, though, we continue to focus on building our career field force channel bank. And what you're seeing, though, is in that first quarter, slow movement on recruitment. We were able to come back with a 10% increase in recruiting. And I'm pleased, again, this quarter; we were able to come up with a positive increase in recruiting. So therefore, I will tell you that there are some economics of things happening around us, but it's all about getting and building up our field and making sure we've got talented recruits that become veterans. Our pipeline is stronger this year and will have strong. Our goal is to convert them into average week of producer. So in that environment, we're going to continue to play in the small case market, make sure we for its broker relationship and then continue to build reputation up in that larger case space. And I would think that we continue to see consistency in the U.S. like you're saying.
Operator: The next question comes from Nick Annitto from Wells Fargo. Please go ahead.
Nick Annitto: Hey, good morning. Thanks. Just on the U.S., can you touch a little bit on persistency and what's driving the strength there, assuming it's just some sort of mix?
Virgil Miller: Hi, yes. Let me start again. This is Virgil, and let me start with the dimension of Max mentioned that earlier. Mix does matched. So as we continue to scale up our life and absence and disability business that we brought on Board, it does start now to influence overall. But I would say if you kind of go back and just look at our original individual business; we are also seeing some improvement there. That is driven by some intentional efforts. So some of the things we're doing, I mentioned earlier, is making sure we focus on those products that have a higher persistency. We started in this business known with the reputation of a cancer insurance company. Cancer insurance is still extremely important to us. We continue to push on that product have success. And as Dan would say, cancer is a disease of age. Therefore, people are more likely to keep it once they have it, and we absolutely see that in our numbers. I would also tell you though that we're also doing intentional efforts, and this is why you're seeing some of the movement in the benefit ratio. We continue to drive our wellness benefits. We've actually made some increases on what we pay out on some of our policies. We've also increased the benefit though, on things like our hospital, our policy groups demonstrating though adding additional benefit and value for those consumers. As long as we can demonstrate consumer value, we have a likelihood of building that loyalty we're going to keep the products, we want to continue those things and we do think that it's having to influence our persistency along with the mix that you mentioned.
Operator: The next question comes from Alex Scott from Barclays. Please go ahead.
Unidentified Analyst: Good morning. This is Jack Ellison [ph] on for Alex. So I appreciate all the color around sales initiatives in Japan. But do you mind talking more about the competitive environment you're seeing over there and specifically in third sector products. Thank you.
Koichiro Yoshizumi: [Foreign Language] Okay. This is Yoshizumi once again. I will be answering your questions. [Foreign Language] And when you talk about third sector, it's basically about medical insurance. And as you may know, the competition continues to be very to severe. [Foreign Language] So the situation where one company launched their product and then another company will launch a product, and that situation has not changed. [Foreign Language] So in order for us to survive in this competitive environment, what we need to do is, first of all, to have some uniqueness. [Foreign Language] And also the flexibility that would serve customers' needs. [Foreign Language] An easy-to-understand feature. [Foreign Language] These would be the features that would be needed in a product. [Foreign Language] And then on top of that, we would need a distribution channel to sell this kind of product. [Foreign Language] And Aflac now currently has this new medical feature called monthly coverage, which is very reasonable and which is very well received by the market. [Foreign Language] And this product also has a very flexible features, too. [Foreign Language] So because of these products, uniqueness as well as the flexibility, this product is attracting a lot of attention in the market. [Foreign Language] And talking about our distribution channel, which is really a strength of ours is that there are agencies that only sell Aflac products and they're very loyal to our products. [Foreign Language] And at the same time, we also register our products with large non-exclusive agencies that have large volume of young and middle aged customers. [Foreign Language] And we firmly believe that we can win in the competition by increasing our sales through these channels. [Foreign Language] And now let me talk about cancer. [Foreign Language] We have 50 years of history with cancer insurance. [Foreign Language] So that intelligence that we've gathered. [Foreign Language] And the expertise that we have is something that no other company has and we also have a relationship with the government, politics, and also other areas of businesses. And this network is not something that any other company has. [Foreign Language] And as a very big channel, we also have Japan Post. [Foreign Language] Well, Japan Post sells Aflac Cancer Insurance. [Foreign Language] And Japan Post does not sell any other companies cancer insurance. [Foreign Language] And I do firmly believe that we can have a very good future and have had expectation for the future in both cancer and medical by fully leveraging this third sector power, and we truly become number one or we are the number one third sector company. [Foreign Language] We will constantly be looking at the market. [Foreign Language] And we'll be launching products to meet the needs and respond to the customers' needs. [Foreign Language] And of course, develop and grow our distribution channel. [Foreign Language] And win against our competitors. [Foreign Language] And that is my way of thinking.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young: Thank you all for joining us today. We hope you'll join us on December 3rd at our Financial Analyst Briefing. If you have any questions, please follow-up with Investor and Rating Agency Relations, and we appreciate it. Have a good day.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to the Aflac Incorporated Third Quarter 2024 Earnings Call. All participants will be in listen only mode. [Operator Instructions]. After today's remarks, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Capital Markets. Please go ahead."
},
{
"speaker": "David Young",
"text": "Good morning and welcome. Thank you for joining us for Aflac Incorporated third quarter earnings call. I hope you will also join us for our Financial Analyst Briefing on December 3rd at the New York Stock Exchange. Registration reminders for this event will go out over the next few weeks. This morning, Dan Amos, Chairman, CEO of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then, Max Broden, Executive Vice President and CFO of Aflac Incorporated will provide an update on our financial results and current capital and liquidity. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2024. We also posted under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans. For Q&A today, we are joined by Virgil Miller, President of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our Annual Report on Form 10-K for some of the various Risk Factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, David, and good morning. We're glad you joined us. As you saw, Aflac Incorporated reported a loss of $0.17 per diluted share on a U.S. GAAP basis for the quarter, primarily due to increased foreign exchange related losses from the yen and the strengthening of 12.9% during the quarter. However, adjusted earnings per diluted share for the quarter increased 17.4% to $2.16. Year-to-date, earnings per diluted share were $6.23 and adjusted earnings per share on a diluted basis rose 13.5% to $5.64. Beginning with Japan, we drove a 12.3% year-over-year increase in sales in the third quarter, maintaining the initial momentum from the June launch of Tsumitasu. As you'll recall, Tsumitasu combines asset formation with a nursing care option. It is part of our strategy to attract new and younger customers while also introducing them to our third sector policies. Tsumitasu also played an important role in the sales growth at the agencies. I'm also very pleased with the continued improvement in cancer insurance sales through Japan Post Channel, especially considering that WINGS has been in the market for over two years. On November 15, we'll be celebrating 50 years in Japan. Our marketing efforts will focus on creating additional touch points with customers around their needs and our products. Overall, Koide San and his team have done a great job of driving sales in Japan and even more so of delivering record profit margins for the quarter. Turning to the U.S., we achieved 5.5% sales growth for the quarter. These sales results reflects strong growth in Group Life, absent management and disability, which is encouraging as we continue to scale up that platform. In addition, it's good to see a continued increase in cancer insurance sales given our efforts to enhance the value proposition to our cancer policyholders. As we enter the fourth quarter and what tends to be our heaviest enrollment period, we will continue to focus on profitable growth, disciplined expense management, and optimizing our Dental and Vision platform. Overall, Virgil and his team are doing a good job balancing profitable growth, enhancing the value proposition of our policyholders, and curving the expense ratios. Their efforts contributed to the strong 20.8% pre-tax profit margin for the quarter. Max has done a great job leading the team to proactively defend our cash flows and deployable capital against a weakening yen, as well as establish our reinsurance platform in Bermuda. Over the course of this year, Virgil and Max as well as Audrey Tillman have taken on additional responsibilities. The Board and I are thrilled to recognize the tremendous contributions these executive leaders have made with their promotion announcements yesterday. You've probably heard me say many times that in conjunction with the Board, one of my key responsibilities is succession planning for key roles and I look forward to continuing to work with them and prepare them for the future. Turning to investments. We have been very pleased with our investment portfolio's performance as it continues to produce strong net investment income with minimal losses and impairments. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders, while being responsive to the needs of our shareholders. Our solid portfolio supports our promise to our policyholders as does our commitment to maintaining strong capital ratios. We balance this financial strength with tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both our dividend track record and tactical share repurchase. We treasure our track record of what is now 42 consecutive years of dividend growth with the Board of Directors declaration of the fourth quarter dividend of $0.50. We repurchased $500 million in shares during the quarter and intend to continue our balanced tactical approach of investing in growth and driving long-term operating efficiencies. Our management team, employees, and sales distribution continue to be dedicated stewards of our business, being there for the policyholders when they need us most just as we promised. This exemplifies our goal of providing customers with the best value in the supplemental insurance products in the United States and Japan. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. Aflac is well-positioned as we work toward achieving long-term growth while also ensuring we deliver on our promise to our policyholders. I'll now turn the program over to Max to cover more details of the financial results. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Dan. Thank you for joining me as I provide a financial update on Aflac Incorporated's results for the third quarter of 2024. For the quarter, adjusted earnings per diluted share increased 17.4% year-over-year to $2.16 with a $0.03 negative impact from FX in the quarter. In the quarter, remeasurement gains on reserves totaled $408 million, reducing benefits while an offsetting unlock of the deferred profit liability in Japan reduced earned premium by $75 million. Variable investment income ran $27 million below our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses increased 7.3% and the adjusted ROE was 16.7%, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 10.5%. This decline reflects a ¥7.3 billion negative impact from an internal cancer reinsurance transaction executed in the fourth quarter of 2023 and a ¥4.6 billion negative impact from paid-up policies. In addition, there is a ¥13.3 billion negative impact from deferred profit liability, the majority of which is a one-time impact from unlocking of LDTI assumptions. At the same time, policies in force declined 2.3%. Japan's total benefit ratio came in at 49.2% for the quarter down 15.9 percentage points year-over-year and the third sector benefit ratio was 41.8% down approximately 13 percentage points year-over-year. We estimate the impact from remeasurement gains to be approximately 18 percentage points favorable to the benefit ratio in Q3 2024. Long-term experience trends as it relates to treatments of cancer and hospitalization continue to be in place, leading to continued favorable underwriting experience. Given the impact from unlocking, we now expect the full year benefit ratio to end up in the range of 62% to 63%. Persistency remained solid with a rate of 93.3%, which was down 20 basis points year-over-year. This change in persistency is in line with our expectations. Our expense ratio in Japan was 20% up 100 basis points year-over-year driven primarily by decline in revenues. Adjusted net investment income in yen terms was up 0.1% as the benefits from lower hedge costs and favorable impact from foreign currency on U.S. dollar investments in yen terms were largely offset by lower floating rate income and lower volume as we have continued to shift assets from Aflac Japan to Aflac Re Bermuda. The pre-tax margin for Japan in the quarter was 44.7%, up 11.9 percentage points year-over-year, a very good result. For the full year, we now expect the pre-tax margin to be in the range of 35% to 36%. Turning to U.S. results, net earned premium was up 2.8%, persistency increased 20 basis points year-over-year to 78.9%. Considering our year-to-date results, we now expect full year net earned premium to be towards the lower end of our guidance range of 3% to 5%. Our total benefit ratio came in at 47.6%, 11.7 percentage points higher than Q3 2023 driven by lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by approximately 120 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and are now more in line with our long-term expectations. For the full year, we would expect the benefit ratio to be towards the higher end of our guidance range of 45% to 47%. Our expense ratio in the U.S. was 38% down 260 basis points year-over-year, primarily driven by platforms improving scale and strong expense management. Given business seasonality, we would expect an uptick in expense ratio for Q4, but to remain with our guidance range of 38% to 40% for the full year. Our growth initiatives Group Life and Disability, Network Dental Vision and direct-to-consumer increased our total expense ratio by 100 basis points. This is in line with our expectations and we would expect this impact to decrease going forward as these businesses grow to scale and improve their profitability. Adjusted net investment income in the U.S. was up 0.5% mainly driven by higher fixed rate income. Profitability in the U.S. segment was solid with a pre-tax margin of 20.8% also a good result. Our total commercial real estate loan watchlist remains approximately $1 billion with less than $250 million in process of foreclosure currently. As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $3 million in this quarter, net of charge-offs. We've had one foreclosure moved into real estate-owned. We continue to believe that the current distressed market does not reflect the true intrinsic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through this cycle, and maximize our recoveries. Our portfolio of first lien senior secured middle market loans continued to perform well with losses below our expectations for this point in the cycle. In our Corporate segment, we recorded a pre-tax gain of $15 million. Adjusted net investment income was $37 million higher than last year due to a combination of higher rates and asset balances, which included the impact of reinsurance transactions in Q4 of 2023, as well as continued lower volume of tax credit investments. These tax credit investments impacted the corporate net investment income line for U.S. GAAP purposes negatively by $57 million in the quarter with an associated credit to the tax line. The net impact to our bottom line was a positive $5 million in the quarter. To-date, these investments are performing well and in line with our expectations. We are continuing to build out our internal reinsurance platform, and I'm pleased with the outcome and performance. In the fourth quarter, we intend to execute another tranche with similar structure and economics in yen terms to our October 2023 transaction. Our capital position remained strong, and we ended the quarter with an SMR about 1,100% and our combined RBC, while not finalized, we estimate to be greater than 650%. These are strong capital ratios, which we actively monitor, stress and manage to withstand credit cycles as well as external shocks. U.S. statutory impairments were $58 million, and there were no additional Japan FSA impairments in Q3. This is well within our expectations and with limited impact to both earnings and capital. As we hold approximately 60% of our debt in yen, our leverage increased to 21% as a result of the move in the yen-dollar exchange rate, well within our target range of 20% to 25%. Our leverage will fluctuate with movements in the yen-dollar rate. This is intentional and part of our enterprise hedging program protecting the economic value of Aflac Japan in the U.S. dollar terms. Unencumbered holding company liquidity stood at $3.9 billion, $2.1 billion above our minimum balance. We repurchased $500 million of our own stock and paid dividends of $280 million in Q3, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. And I will now hand over to David to begin Q&A."
},
{
"speaker": "David Young",
"text": "Thank you, Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. You may then rejoin the queue. We'll now take the first question."
},
{
"speaker": "Operator",
"text": "We'll now begin the question-and-answer session. [Operator Instructions]. And our first question comes from Joel Hurwitz from Dowling & Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"text": "Hi, good morning. I wanted to start on Japan sales. So third sector sales continues to be a bit challenged. Can you just talk about plans for both cancer and medical? And what are you expecting from sales promotions related to the 50th anniversary?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] This is Yoshizumi, in charge of Sales and Marketing in Japan. [Foreign Language] So let me first start off with how we are successful. And the reason for that is because of this new product that we've launched, which is an asset formation product plus the nursing care coverage. And this product also has a feature that once it becomes paid up, this can be converted into medical, nursing care or death benefit. [Foreign Language] First of all, again, this Tsumitasu was developed to meet the young and middle-aged customers' needs for asset formation and contribute to the expansion of third sector sales. [Foreign Language] And considerable preparations for sales from June through third quarter led to 12.3% growth. [Foreign Language] And the purpose was to approach young and middle aged new customers and new customers. [Foreign Language] As well as proposing additional sales of third sector products. [Foreign Language] And also to cross-sell products. [Foreign Language] And this has led to revitalizing the sales activities of the associates. [Foreign Language] So as a result, what we are expecting is that our third sector sales would grow increase by selling Tsumitasu. [Foreign Language] Now let me turn to cancer insurance. [Foreign Language] And as you mentioned, by using 50th anniversary as our trader or a hook, we are trying to sell our cancer insurance and cross-sell cancer insurance. [Foreign Language] And as you may know, our cancer insurance was launched two years ago, meaning that it has gone two years already. [Foreign Language] We have a service called concierge service that no other company is able to offer. [Foreign Language] In other words, this is called the Yoriso cancer consultation support service. [Foreign Language] And what we are trying to do is by using to appeal this product and service; we are using TV commercials and web advertisement to really appeal the value of this product and service. [Foreign Language] And we are also considering to launch a new product around spring next year. [Foreign Language] So as a result, we are expecting that our cancer sales will increase. [Foreign Language] Now turning to medical insurance. [Foreign Language] We've changed the product name and rerounded. [Foreign Language] And this is also one of its kind that only Aflac has in terms of the coverage, and it's really attracting attention of the market. In other words, we have this mostly coverage feature that no other company has. [Foreign Language] And we would like to grow the sale of this product together with Tsumitasu. [Foreign Language] And we've also launched a new plan for middle and older aged customers over 50 years old. [Foreign Language] So as a result, we are seeing a gradual recovery in medical sales, and we are expecting good sales from it. [Foreign Language] And overall, we are expecting that our third sector product sales will recover and increase because of the reasons that I've mentioned. At the same time, we have been quite successful in recruiting sales agents for the third sector, and we are strengthening our sales force, too. [Foreign Language] That's all for me."
},
{
"speaker": "Operator",
"text": "The next question comes from Tom Gallagher from Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Good morning. First question just on capital allocation, and I'll just have a quick follow-up on sales. So can you talk a bit about broader capital allocation, how you're thinking about it? I know the buyback was a bit lower this quarter, but you have the strong level of excess capital accumulating. Any thoughts on a special dividend, M&A, as you think about -- let's just say if the stock does continue to trade at strong levels, what would your plans be? Would you still do good levels of buybacks heading into next year? Or would you consider these other options? Thanks."
},
{
"speaker": "Max Broden",
"text": "Thank you, Tom. You're right in acknowledging that our capital ratios, they are strong. We are also generating significant capital both organically throughout our operations, plus what we are doing around reinsurance as well, freeing up additional levels of capital. So we are very strong on that front. And then we look at all of those opportunities that you mentioned, and I would not put anything off the table. We evaluate what -- where we can get the best returns currently, but more importantly, long-term. When we evaluate our business, we think about it over the next 1, 2, 3, 5, 10, 15, 20 years and think about what is going to generate the highest return on that capital for us over that time period. And especially when you think strategically around things like M&A, you have to take that into consideration. So these are the things that go into our capital allocation consideration, both in terms of, obviously, how much we have, how we see capital generation coming to us and then ultimately, the returns that we can get. And we really mean it when we say that we are thinking about what those returns are, and it is a dynamic world where these things are changing but I will not take anything off the table. That includes, obviously, everything that you mentioned."
},
{
"speaker": "Tom Gallagher",
"text": "Okay. Thanks for that, Max. And just a follow-up on sales. Can you give a sense for the split between -- of the first sector product you're selling? What's the split between new customers versus existing customers that are buying that product? Thanks."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] If you're asking about the new customer ratio of the sale of first sector product. [Foreign Language] Well, right now, sales to existing customers is larger than to those of new customers. And this is always the case when we launch a new product. [Foreign Language] And when we do this kind of first sector sale, there's always a cross-sell, and we do -- we are meeting the expected level of cross-sell rate at the moment. And as we move forward on a monthly basis, more and more new customers are increasing. [Foreign Language] And what it also means is that when we explore -- try to acquire young and middle-aged customers using Tsumitasu that just purely means that we are trying to acquire new customers. [Foreign Language] So our strategy to increase new customers after we go around the cycle of approaching to our existing customers, and that's what we are doing and that's our strategy. Thank you. That's all."
},
{
"speaker": "Dan Amos",
"text": "Yes. I'd like to make a comment about that. I would say that the numbers are falling in line with our expectations. We thought it would be over 20%. We hope it would be closer to 25%. Sure not been started at about 20%, and it's moved up to 25%. And so that's in the range of what we had anticipated or maybe even a little better. So we're very pleased with Tsumitasu and what is taking place and how it's bringing on new customers for us, young and middle age. So that should answer your question."
},
{
"speaker": "Operator",
"text": "Next question comes from Wes Carmichael from Autonomous Research. Please go ahead."
},
{
"speaker": "Wes Carmichael",
"text": "Hey, thanks. Good morning. From Yoshizumi-san's remarks, it sounds like the sales force is really leaning into Tsumitasu. I guess my question is, does this really kind of like contemplate a fee change where we should see a greater contribution from first sector sales going forward. And I know, Max, you said the returns after reinsurance are kind of similar to third sector products. So really just want to understand strategically if we should expect that mix to be more balanced going forward, between first sector and third."
},
{
"speaker": "Max Broden",
"text": "Given -- given what Japan is going through and I would -- and I would expect that --"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] So our strategy can be divided into two parts. One is, of course, to ensure profitability by using reinsurance. And the other is as I've mentioned earlier, by Tsumitasu, we are also bringing in new third sector. And that way, we are trying to secure profits and revenue from that perspective."
},
{
"speaker": "Max Broden",
"text": "Let me add a comment to that answer. Tsumitasu has important aspects to many parts of our business. And it is the fact that Japan, as a society, obviously, is aging. And with that, there is a significant increase in retirement needs and retirement funding. And Japan is pushing harder to become more of an asset management country as well with policies. That means that we would expect that a retirement products are going to going to be and more important tool for both the financial industry and for us going forward. And you have seen how Yoshizumi-san outlined how we are using Tsumitasu to then also cross-sell our third sector business. So I would expect it to be a more meaningful part of our portfolio going forward than what it has been in a more recent past. I still definitely think that we will predominantly be a third sector company, but where the first sector savings business will be a meaningful component of our total sales."
},
{
"speaker": "Operator",
"text": "The next question comes from Ryan Krueger from KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "Hey, thanks. Good morning. I had a question on the Japan benefit ratio. I think coming into the year, your guidance was 66% to 68%. I guess when we think about the assumptions unlocking, and year-to-date experience, would you expect that to be improved from the original expectation going forward? I guess, it looks like your guidance for the full year implied maybe something closer to 65% to 67% in the fourth quarter."
},
{
"speaker": "Max Broden",
"text": "Yes. The impact from this unlock is that we have lowered the future net premium ratio by roughly 100 basis points. So all things being equal, that means that we would expect our benefit ratio going forward for our in-force business to be roughly 100 basis points lower than what we previously expected before the unlock. So it does have an impact for future benefit ratios as well and that would apply going into 2025 as well."
},
{
"speaker": "Ryan Krueger",
"text": "Thanks. And then just a quick one. Can you give us your run rate earnings expectations for the Corporate segment at this point? I guess, let's say, assuming 0 tax credit impact."
},
{
"speaker": "Max Broden",
"text": "So, in this quarter, we had a $15 million pre-tax profit and the tax credit investments lowered that number by roughly $57 million on a pre-tax basis. So that will get you closer to the run rate as of this quarter. I would acknowledge that this is an area where we are sensitive to short-term yields. So if you have a short-term yields coming down, that would put pressure a little bit on that number. But I would expect that in the near-term, our run rate profitability should be that we will continue to be profitable in that segment, all things being equal for -- that's the current run rate."
},
{
"speaker": "Operator",
"text": "The next question comes from John Barnidge from Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thanks for the opportunity. My question sticks there. On the 100 basis points of future benefit ratio benefit that are or do you take into account long-term experience? Would short-term experience that continues to be favorable, be incremental to that 100 basis points. Thank you."
},
{
"speaker": "Max Broden",
"text": "Let me start off, and I'll ask Alycia, our Global Chief Actuary, to fill in with any comments she may have. Obviously, when we do a deep dive study as we just concluded, we try to incorporate all the experience that we've had to-date, but then also obviously unlocking future assumptions. In those future assumptions, there is a future trend incorporated in that. And if future experience tends to -- if it would were to deviate to that trend that could lead to either further releases or increases related to that. But I do want to acknowledge that there is an element of a future trend incorporated in these unlocks as well."
},
{
"speaker": "Alycia Slyck",
"text": "Thank you, Max. Yes, we incorporated our future trend into our unlock this year. So we believe we have reflected all of our current experience and expectations. We do review our assumptions annually to investigate new trends, but all of that has currently been reflected in this unlock."
},
{
"speaker": "John Barnidge",
"text": "Thank you for that. And my follow-up question that's related following an 18-point benefit from the unlock, do you view that, that increases the total addressable market for liabilities that over the long-term could potentially go to Bermuda? Thank you."
},
{
"speaker": "Max Broden",
"text": "Yes. I would view them as somewhat unrelated. This unlock is a U.S. GAAP unlock only with no impact to our U.S. statutory results in the U.S. and reserves and no impact to our FSA results or FSA reserves. So I would not draw that link."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jimmy Bhullar from J.P. Morgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "First, I had a question on just your expected -- your expectations for how Tsumitasu sales are going to trend? Should we assume that they're going to keep growing from here? Or was there sort of a pent-up demand phenomena to where sales will begin to fade over the next few quarters?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Thank you for the questions. Let me answer this question. This is Yoshizumi once again. [Foreign Language] Well, Tsumitasu was launched in June as a new product. And in that month, in June, we had a very big sales. And the reason why we were able to do so is because we had fully prepared for it in advance of the launch. [Foreign Language] And from July and on, Tsumitasu sales have been successful, and it is meeting -- it is meeting the level that we have been expecting. [Foreign Language] And as I have mentioned several times that Tsumitasu is very well known and we're very well taken by customers, and it's a very popular product in the market. [Foreign Language] So as a result, what we are thinking is that until the end of the year, perhaps next quarter, we should be able to generate a very stable number from Tsumitasu. [Foreign Language] And as I have mentioned earlier that this product is very popular among young people because this product does meet the needs of these young people. And what that means is that during their payment period, they would have asset formation function as well as nursing care. And then, after that period, the customer can choose from medical, nursing care or a death benefit. And that's the reason why this product is so popular among young people. [Foreign Language] So my conclusion is that we are expecting to have a certain level of sales from Tsumitasu going forward as well. [Foreign Language] That's all for me."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. Thanks. And then on the U.S. business, it seems like incurred claims are running a lot higher so far this year than they have in the last several years. Is that a mix issue? Or are you just seeing usage in some of the products pick up? Or are there other factors driving that?"
},
{
"speaker": "Virgil Miller",
"text": "Hi, good morning. This is Virgil from the U.S. It is -- I would say that some of it is definitely delivered an extension on our part. We want to make sure that we put the value of the benefits in the hands of the policyholders but we don't want to over toggle. So what we've done this year is we've increased benefits on certain lines of business at no additional cost. We've gone out and pushed campaigns for consumers to file one of those benefits to make sure that we try to catch any type of problem before it turns into a long-term condition. And then the last thing I would say to you, though, is that mix does matter. We've been pushing on the cancer business while an individual line of business, and we've had good success year-to-date with sales up about 9%. And then the last thing I would say is we introduced and I mentioned this before, about our stronger underwriting discipline on our VB benefits. And we're really looking now to bring on business with high turnover and thus yielding better persistency for us over the long-term. All of these things are factoring in to help drive a move that benefit ratio. We are constantly monitoring though, to make sure that we're within our tolerance."
},
{
"speaker": "Max Broden",
"text": "And then just to add to that, there is one more mix impact that is running through the U.S. results. And that is as we grow our Group Life and Disability business and that becomes a greater proportion of our in-force that will, over time, drive up the benefit ratio for the U.S. segment. The Group Life and Disability business, we would expect to run at sort of a low 80s benefit ratio. So all things being equal, that will continue to push that benefit ratio higher."
},
{
"speaker": "Operator",
"text": "The next question comes from Wilma Burdis from Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"text": "Hey, good morning. I guess, what is the Dan's recent promotions? Could you talk a little bit about what you're most focused on from a development and succession perspective over the next couple of years? Thanks."
},
{
"speaker": "Max Broden",
"text": "Wilma, there was something that moved when you asked the question at the very start. What were you asking?"
},
{
"speaker": "Wilma Burdis",
"text": "Sorry, I said for Dan, given the recent promotions, could you talk a little bit more about what you're focused on from a development and succession perspective for the next couple of years? Thanks."
},
{
"speaker": "Dan Amos",
"text": "Well, I think the first question is how does it relate to me specifically and what are my plans? And my plans really haven't changed. I serve at the pleasure of the Board and frankly, enjoy doing that. They ultimately make the final decisions on what they want to happen, but I'm enjoying it. But at the same time, I owe it to the shareholders and the Board to make sure there's a succession plan and there's a depth in management that is there to show our ability to continue on without disruption. And I believe that we've got the people in place with the opportunity. And first, I have suggested to the Board and that they begin to place someone internally several people that they think have potential to take over one day. And certainly, Virgil is at the top of that list. He -- I have to say I'm very pleased with the U.S. because it's become a much different company than it was five years ago. As we've gotten into the plans business that I think it was Max was talking about, and we've seen look at group business and how Virgil mentioned that we're not right in certain types of business. And then we've got our distribution channel, which is very unusual. There really aren't many people out there that have the distribution channel that we have from an independent agent's perspective. And then building on the broker business and what's going on there in the U.S. And so, yes, I think he certainly deserves the opportunity to have his name in the pot for what will take place when I do retire at some point in time. I think Max is showing his strength on the call today and what he's doing. And he's gone in as if it was uninterrupted with the job that Fred was doing before he left at this year. And so I've been very pleased with that. And then Audrey has always been an outstanding person for us from counsel, from independent review of not just that, but any issue that might be out there that concerns understanding the employees, understanding the law, understanding all of those aspects of it. So I feel very good about these promotions. And then we had several others our Head of IT, being Executive Vice President, and she is doing a great job. She's rated one of the 100 in best women in America in the IT area. So we're lucky to have her. You heard Alycia has been with us a little over a year, and she has jumped right in. So I'm very pleased with the bench. We've got Robin, who's now Chief Accounting Officer of the company and you, we've got Fred Simard. Certainly, what Brad has done has been uninterrupted in terms of taking over Eric's position. So all in all, I have to tell you that our bench is strong. There -- most of them are relatively new in the positions. They've had more responsibility added to them in certain cases, as is in the case of Brad, he's picked up more. You've seen it with Max and what's taking place. So all in all, that's where I am. And I'll just tell you that I'm happy and we'll continue on. But I want someone that if something happened tomorrow, there would be a smooth transition and the Board has plenty of options to do what they deem as necessary."
},
{
"speaker": "Wilma Burdis",
"text": "Thank you, and congrats to Virgil, Max and Audrey as well. One maybe for Virgil, could you discuss any macro or employment environment impacts that you're seeing in the U.S. that are impacting sales and/or recruiting. Thanks."
},
{
"speaker": "Virgil Miller",
"text": "Yes. Thank you for the question. And thank you for the congratulations. I'm excited about the opportunity and look forward to partnering with my colleagues here in pushing the Aflac forward for the future. I would say that you saw that earlier in the year, we started out of the gate slow with our sales, put it up a negative quarter that we were able to rebound in the second quarter, coming up with about a 2.2% increase. And then for this quarter, really exceeded what I expect at a 5.5% increase. And it's really accumulating from a couple of things. Max and Dan both mentioned the plans business. What that means from my perspective, till is we have an opportunity right now in a strong product base to compete in the jumbo case market. Generally, we're talking about employer groups with more than 5,000 employees. And then we're also talking about the relationships that we forged with the brokers in that space. At the same time, though, we continue to focus on building our career field force channel bank. And what you're seeing, though, is in that first quarter, slow movement on recruitment. We were able to come back with a 10% increase in recruiting. And I'm pleased, again, this quarter; we were able to come up with a positive increase in recruiting. So therefore, I will tell you that there are some economics of things happening around us, but it's all about getting and building up our field and making sure we've got talented recruits that become veterans. Our pipeline is stronger this year and will have strong. Our goal is to convert them into average week of producer. So in that environment, we're going to continue to play in the small case market, make sure we for its broker relationship and then continue to build reputation up in that larger case space. And I would think that we continue to see consistency in the U.S. like you're saying."
},
{
"speaker": "Operator",
"text": "The next question comes from Nick Annitto from Wells Fargo. Please go ahead."
},
{
"speaker": "Nick Annitto",
"text": "Hey, good morning. Thanks. Just on the U.S., can you touch a little bit on persistency and what's driving the strength there, assuming it's just some sort of mix?"
},
{
"speaker": "Virgil Miller",
"text": "Hi, yes. Let me start again. This is Virgil, and let me start with the dimension of Max mentioned that earlier. Mix does matched. So as we continue to scale up our life and absence and disability business that we brought on Board, it does start now to influence overall. But I would say if you kind of go back and just look at our original individual business; we are also seeing some improvement there. That is driven by some intentional efforts. So some of the things we're doing, I mentioned earlier, is making sure we focus on those products that have a higher persistency. We started in this business known with the reputation of a cancer insurance company. Cancer insurance is still extremely important to us. We continue to push on that product have success. And as Dan would say, cancer is a disease of age. Therefore, people are more likely to keep it once they have it, and we absolutely see that in our numbers. I would also tell you though that we're also doing intentional efforts, and this is why you're seeing some of the movement in the benefit ratio. We continue to drive our wellness benefits. We've actually made some increases on what we pay out on some of our policies. We've also increased the benefit though, on things like our hospital, our policy groups demonstrating though adding additional benefit and value for those consumers. As long as we can demonstrate consumer value, we have a likelihood of building that loyalty we're going to keep the products, we want to continue those things and we do think that it's having to influence our persistency along with the mix that you mentioned."
},
{
"speaker": "Operator",
"text": "The next question comes from Alex Scott from Barclays. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"text": "Good morning. This is Jack Ellison [ph] on for Alex. So I appreciate all the color around sales initiatives in Japan. But do you mind talking more about the competitive environment you're seeing over there and specifically in third sector products. Thank you."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Okay. This is Yoshizumi once again. I will be answering your questions. [Foreign Language] And when you talk about third sector, it's basically about medical insurance. And as you may know, the competition continues to be very to severe. [Foreign Language] So the situation where one company launched their product and then another company will launch a product, and that situation has not changed. [Foreign Language] So in order for us to survive in this competitive environment, what we need to do is, first of all, to have some uniqueness. [Foreign Language] And also the flexibility that would serve customers' needs. [Foreign Language] An easy-to-understand feature. [Foreign Language] These would be the features that would be needed in a product. [Foreign Language] And then on top of that, we would need a distribution channel to sell this kind of product. [Foreign Language] And Aflac now currently has this new medical feature called monthly coverage, which is very reasonable and which is very well received by the market. [Foreign Language] And this product also has a very flexible features, too. [Foreign Language] So because of these products, uniqueness as well as the flexibility, this product is attracting a lot of attention in the market. [Foreign Language] And talking about our distribution channel, which is really a strength of ours is that there are agencies that only sell Aflac products and they're very loyal to our products. [Foreign Language] And at the same time, we also register our products with large non-exclusive agencies that have large volume of young and middle aged customers. [Foreign Language] And we firmly believe that we can win in the competition by increasing our sales through these channels. [Foreign Language] And now let me talk about cancer. [Foreign Language] We have 50 years of history with cancer insurance. [Foreign Language] So that intelligence that we've gathered. [Foreign Language] And the expertise that we have is something that no other company has and we also have a relationship with the government, politics, and also other areas of businesses. And this network is not something that any other company has. [Foreign Language] And as a very big channel, we also have Japan Post. [Foreign Language] Well, Japan Post sells Aflac Cancer Insurance. [Foreign Language] And Japan Post does not sell any other companies cancer insurance. [Foreign Language] And I do firmly believe that we can have a very good future and have had expectation for the future in both cancer and medical by fully leveraging this third sector power, and we truly become number one or we are the number one third sector company. [Foreign Language] We will constantly be looking at the market. [Foreign Language] And we'll be launching products to meet the needs and respond to the customers' needs. [Foreign Language] And of course, develop and grow our distribution channel. [Foreign Language] And win against our competitors. [Foreign Language] And that is my way of thinking."
},
{
"speaker": "Operator",
"text": "This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you all for joining us today. We hope you'll join us on December 3rd at our Financial Analyst Briefing. If you have any questions, please follow-up with Investor and Rating Agency Relations, and we appreciate it. Have a good day."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 2 | 2,024 | 2024-08-01 08:00:00 | Operator: Good day, and welcome to the Aflac Incorporated Second Quarter 2024 Earnings Conference Call. All participants will be in a listen only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations. Please go ahead.
David Young: Good morning, and welcome. Thank you for joining us for Aflac Incorporated Second quarter earnings call. While I have your attention I also want you to mark your calendars to join us for our Financial Analyst Briefing at the New York Stock Exchange on December 3rd. Now this morning, Dan Amos, Chairman, CEO and President of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then, Max Broden, Executive Vice-President and CFO of Aflac Incorporated will provide an update on our financial results and current capital and liquidity. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com, including Max's quarterly video updates which also includes information about the outlook for 2024. We also posted under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans. For Q&A today, we are also joined by Virgil Miller, President of Aflac US.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan.
Dan Amos: Thank you, David, and good morning, and we're glad you joined us. Aflac Incorporated delivered another quarter and six months of very solid earnings results. Net earnings per diluted share were $3.10 for the quarter and $4.64 for the first six months. On an adjusted basis, earnings per diluted share for the quarter were we're up 15.8% to $1.83 and for the first six months, we were up 11.5% to $3.49. From a broad operational perspective, we've generated profitable growth in the United States and Japan with new products and distribution strategies. We believe our strategy will continue to create long-term value for the shareholders, at the same time, we believe that the need for our products we offer is a strong or stronger than it has ever been before in both the United States and Japan. Beginning with Japan, we have continued to focus on third sector products like our cancer insurance product called the WINGS as the new fiscal year began in Japan, we saw continued improvement in cancer insurance through the Japan Post Channel. We have continued our strategy of introducing life insurance products including Tsumitasu, which we launched on June 2nd. This product offers policyholders an hazard formation component with nursing care option. It was designed to attract new and younger customers, while also introducing opportunities to sell them our core third sector products. While still very early, we are pleased with how our agencies have sold this product, which drove a 4.5% sales increase for the second quarter being where consumers want to buy insurance remains in an important element of the growth strategy in Japan. Our broad network of distribution channels including agencies, alliance partners and banks continually optimize our opportunities to help provide financial protection to the Japanese consumers. We will continue to work hard to support each channel. Overall, Koide San and his team have done a great job of turning around sales in Japan and delivering record profit margins for the quarter. I am very pleased with their efforts. Turning to the US, we achieved a 2% sales growth for the quarter benefiting from good growth in Group Life Absent Management and Disability and individual voluntary benefits This is a welcome results as we enter the second half of the year that tends to be the heaviest enrollment period. At the same time, we continue to focus on more profitable growth by exercising a stronger underwriting discipline. Additionally, we've increased benefits in certain policies to improve the value for the policyholder. We believe persistency will remain strong as customers realize the value of their policies and the related benefits. We have also continued our disciplined approach to expense management, which Max will address. As we enter the second half of the year, we are continuing to focus on optimizing our Dental and Vision platform. Overall, I'm pleased with what Virgil and his team are doing to balance profitable growth enhance the value proposition for the policyholders and curb the expense ratios. Their efforts contributed to the very strong pre-tax profit margin of 22.7% for the second quarter. Now turn to our ongoing commitment to prudent liquidity and capital management. Max has done a great job leading his team to take proactive steps in recent years to defend our cash flow and deployable capital against a weakening yen, as well as establishing a reinsurance platform in Bermuda. We have been very pleased with our investment portfolios’ performance as it continues to produce strong net investment income with minimal losses and impairments responsibility is to fulfill the promises we make to our policyholders, while being responsive to the needs of our shareholders. We remain committed to maintaining strong capital ratios on behalf of the policyholders. We balance this financial strength with tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both our dividend track record and tactical share repurchase. We treasure our track record of 41 consecutive years of dividend growth and remain committed to extending it. I am pleased that the Board set us on a path to continue this record when it increased the first quarter 2024 dividend 19% to $0.50 and declared the second and third quarter dividends of $0.50. We repurchased a record $800 million in shares during the quarter, and intend to continue our balanced, tactical approach of investing in growth and driving long-term operating efficiencies. Our management team, employees and sales distribution continue to be dedicated stewards of our business, being there for the policyholders when they need us most just as we promised. This underpins our goal of providing customers with the best value in the supplemental insurance products in the United States and Japan. In November, we celebrate our 50th year of doing business in Japan. Additionally, in June, we celebrated our 50th year as a publicly traded company on the New York Stock Exchange. We are reminded that one thing has not changed since the founding in 1955, families and individuals still seek to protect themselves from financial hardships that not even the best health insurance covers. Today’s complex healthcare environment has produced incredible medical advances that come with incredible costs. It’s more important than ever to have that partner. We believe our approach to offering relevant products makes us that partner. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. Aflac is well-positioned as we work toward achieving our long-term growth while also ensuring we deliver on our promise to our policyholders. I'll now turn the program over to Max to cover in more details the financial results. Max?
Max Broden: Thank you, Dan and thank you for joining me as I’ll provide a financial update on Aflac Incorporated’s results for the second quarter of 2024. For the quarter, adjusted earnings per diluted share increased 15.8% year-over-year to the $1.83 with a $0.07 negative impact from FX in the quarter. In this quarter, reinvestment gains on reserves totaled $51 million and variable investment income ran $1 million above our long-term return expectations. We also received a make whole payment adding approximately $20 million or $0.03 per share to our adjusted earnings. Adjusted book value per share, including foreign currency translation and the gains and losses increased 9.4% and the adjusted ROE was 14.3%, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 5.7%. This decline reflects a 7.4 billion yen negative impact from internal reinsurance transaction executed in the fourth quarter of 2023 and 4.8 billion yen negative impact from paid up policies. In addition, there is a 1.2 billion yen positive impact from deferred profit liability. Lapses were somewhat elevated but within our expectations. At the same time, policies in force declined 2.4%. Japan's total benefit ratio came in at 66.9% for the quarter up 120 basis points year-over-year and the third sector benefit ratio was 57.8%, up the approximately 160 basis points year-over-year. We estimate the impact from reinvestment gains to be 140 basis points favorable to the benefit ratio in Q2 2024. Long-term experience trends as it relates to treatment of cancer and hospitalization continue to be in place leading to the continued favorable underwriting experience. Persistency remains solid with a rate of 93.3%, which was down 50 basis points year-over-year. This change in persistency is in line with our expectations. Our expense ratio in Japan was 17.8%, down 170 basis points year-over-year, driven primarily by the expense allowance from reinsurance transactions and continued discipline expense management. Adjusted net investment income in Yen terms was up 28.4%, mainly by favorably impact from FX on US dollar investments in yen terms, lower hedge costs, higher return on our alternatives portfolio compared to second quarter of 2023 and call income. The pre-tax more than for Japan in the quarter was 35.3%, up $490 basis points year-over-year, a very good result. Turning to US results, net earned premium was up 2.1%, persistency increased 50 basis points year-over-year to 78.7%. We are encouraged by early signs from our persistency efforts and we will remain focused on driving profitable growth. Our total benefit ratio came in at 46.7%, 140 basis points higher than Q2 2023 driven by product mix and lower reinvestment gains than a year ago. We estimate that reinvestment gains impacted the benefit ratio by 170 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and are now more in line with our long-term expectations. Our expense ratio in the US was 36.9%, down to 210 basis points year-over-year, primarily driven by platforms improving scale and strong expense management. We tend to benefit from seasonality in the first half and would expect higher expenses in the second half. Our growth initiatives, Group Life and Disability, network, dental and vision and the direct-to-consumer increased our total expense ratio by 230 basis points. This is in line with our expectation and we would expect this impact to decrease going forward as these businesses grow to scale and improve their profitability. In just that net investment income, in the US was up 7.4%, mainly driven by higher yields on both our alternatives and fixed rate portfolios. Profitability in the US segment was solid with a pre-tax margin of 22.7%, also a very good result. Our total commercial real estate loan watch list stands at approximately $1 billion, with less than $300 million in process of foreclosures currently. As a result of these current low valuation marks, we increased our seasonal reserves associated with these loans by $14 million in this quarter net of charge-offs. We had six loan foreclosures and moved nine properties into real estate owned. We continue to believe that they currently distressed market does not reflect the true intrinsic economic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through this cycle and maximize our recoveries. Our portfolio of first lean senior, secured middle market loans continue to perform well with losses below our expectations for this point in the cycle. In our Corporate segment, we recorded a pre-tax gain of $23 million. Adjusted net investment income was $39 million higher than last year due to lower volume of tax credit Investments at Aflac Inc. and higher volume of investable assets at Aflac REIT. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $30 million with an associated credit to the tax line. The net impact to our bottom-line was a positive $4 million in the quarter. To-date, these Investments are performing well and in line with expectations. We're continuing to build up our reinsurance platform and I'm pleased with the outcome and performance. Our capital position remains strong and we ended the quarter with an SMR above 1100 % in Japan, now combined RBC, while not finalized we estimate to be greater than 650%. Unencumbered holding company liquidity stood at $4.1 billion, $2.3 billion above our minimum balance. These are strong capital ratios, which we actively monitor stress and managed to withstand credit cycles, as well as external shocks. US statutory impairments were released of $7 million and Japan FSA impairments were 10.4 billion yen or roughly $67 million in the quarter. This is well within our expectations and with limited impact to both earnings and capital. Adjusted leverage is 19.5% and below our leverage corridor of 20% to 25%. As we hold approximately 60% of our debt denominated in the yen, our leverage will fluctuate with movements in the yen dollar rate. This is intentional and part of our enterprise hedging program protecting the economic value of Aflac Japan in US dollar terms. We repurchased $800 million of our own stock and paid dividends of $283 million in Q2, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. I will now turn the call over to David.
David Young : Thank you Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. Then you're welcome to rejoin the queue. We will now take the first question.
Operator: [Operator Instructions] The first question today comes from Joel Hurwitz with Dowling & Partners. Please go ahead.
Joel Hurwitz : Hey, good morning. So the new product launch in Japan that happened in June had very strong sales. I guess, can you just talk about the target return on that that first sector product and how it compares to the third sector product? And then what do you see as the cross-sell opportunity there?
Dan Amos : Max might just take that for chat.
Max Broden : Yeah, let me start on the product profitability. So, when we look at this product through a GAAP lens, it has at or higher GAAP margins than our core third sector business. And on an IR basis, this is obviously lower than our third sector business because of the very significant new business strain associated with the high reserves, but we have lined up reinsurance that we then expect on a post-reinsurance basis it brings us very, very attractive returns, as well. And not too different from our core first sector business.
Joel Hurwitz : Okay and the cross-sell opportunity there with the third sector products?
Max Broden : I think we'll evolve over time where obviously this product targets a younger clientele that gives us the opportunity to build that relationship and as we travel with that customer through their lifetime, we have an opportunity to then cross-sell both medical and cancer, as well. So over time, I think, there's a good opportunity for us to both get the – Tsumitasi product to the younger clients but also over the lifetime cross-cell cancer and medical to those new clients.
Dan Amos : Yeah, I think Aflac team nicely explains that. It's important that I say it, is remember it with the Tsumitasu product we are hiding a younger group less disposable income than does an older set of potential policyholders. And so whereas, with the older, we might offer the Tsumitasu product or another product and our supplemental for third sector product. With this group, we'd start by putting in one product, which would be the Tsumitasu product and then in a year or so later follow-up and add more. So it's different as we're building that policyholder base, which of course is one of the things we promised you we would work toward doing and Aflac Japan we believe is doing the right thing here for us.
Operator: The next question comes from Jimmy Bhullar with JPMorgan. Please go ahead.
Jimmy Bhullar: Okay. First question just on the expense ratio in both the Japan and the US businesses, I think is the best it’s been in the past several years. So wondering how much of that is sustainable and driven by expense savings or other actions versus maybe just being timing - driven by the timing of discretionary and that spending in advertising?
Dan Amos : Thank you, Jimmy. Let me start with Japan. Obviously, 17.8% in a quarter is a very low number. We have a guidance range of 19% to 21% and long-term I think that is the range that we will operate within for the Japan segment. We tend to have some seasonality in Japan with the second half having a little bit higher overall spend and I would specifically call out that Aflac Japan turns 50 this year. So we will have some promotional spend associated with that including advertising and a lot of sales activities around that. So therefore I would for the full year that we would end up in the lower end of that 19% to 21% range. For the US, we also have had very good expense control especially in the first half. There are timing differences where I would expect our spend would increase in the second half and I would also caution you to please keep in mind that the fourth quarter, every year has the highest level of sales activity with that comes expenses spend, as well as our expense ratio in the fourth quarter tends to be the highest. Over time, the US still have a number of businesses that are not at scale. And therefore we have we are running those businesses with expenses overruns right now. This includes our Group Life and Disability business, it includes our dental and vision business and it includes our direct-to-consumer business and to some extent also our group our group BB platform. As those businesses really reach that scale then they come down in expense ratio and we will no longer have that expense overrun. So that means there are - there is downward pressure over time to our US expense ratio. But we're very pleased with the expense management and expense control for the first half and in particular into second quarter. But I would caution you when you think about the full year, I still would expect us to be inside of the range of 38% to 40% for the expense ratio in the US.
Jimmy Bhullar: Okay. And then, just maybe for Dan or the Japanese team, you talked a lot about competition in Japan on the last call. And it seems like as rates gone up in Japan some of the companies have cut prices to adjust for that. But what are you seeing in the competitive environment? And is it any different than what you've seen in the last few months or over the past few years?
Dan Amos : Yoshizumi, would you like to take that?
Koichiro Yoshizumi: [Foreign Language] Thank you for the question. Good morning everyone. I'm Yoshizumi. I am in charge of sales in Japan. So as you have mentioned our competitors have entered third sector market. And so the environment is totally different compared with maybe five years ago or 10 years ago. [Foreign language] And there are competitors that are launching a very reasonable or low price products. [Foreign language] However, in Aflac, our concept is to launch and sell products that have values to our customers and not just lower product buy for the sake of lowering product - lowering prices, excuse me. [Foreign language] And as we enter into our 50th anniversary this year in Aflac Japan. And this is based on the history and trust that we have from our customers in providing the appropriate insurance policies at all points by thoroughly thinking about what is needed in each environment or at times because the illnesses change and treatment methods change. [Foreign language] Now according to the data that’s been publicized between April 2022 and March 2023, [Foreign language] And Aflac is record the number one most sold policy company in Japan in third sector products. [Foreign language] What we will aim for is to continue to provide customers that most appropriate product for our customers, so that we can maintain our number one position. That’s all for me.
Operator: The next question comes from John Barnidge with Piper Sandler. Please go ahead.
John Barnidge : Good morning. Thank you for the opportunity. My first question is on distribution of the new first sector product in Japan. The closest customers and existing customer and one that doesn’t have that products, I know the product was introduced in early June. Have you identified how much of the existing customer base is the target for this new product? Thank you.
Dan Amos : They're translating give us one second. And Koide, or Yoshizumi please?
Koichiro Yoshizumi: Hey, this is Yoshizumi once again. Let me continue to answer your question. [Foreign language] We have a large number of existing customers as you know. [Foreign language] And our target customers are young and middle-aged customers. [Foreign language] And the reason why I say our target is young and middle-aged customers is as follows: [Foreign language] Well first of all, the Japanese government is really pushing and encouraging the Japanese citizens to go after asset accumulation products and the Japanese government is offering various systems so that the Japanese citizens can do that. [Foreign language] And as a result of that asset formation needs is heightening very strongly in Japan. [Foreign language] And we’ve launched our new product in order to respond to the kind of asset accumulation needs in Japan. [Foreign language] And this product is very well taken by the market and selling well and it is increasing our sales. [Foreign language] And the reason why this product is attracted attention is because there are various options that would allow our customers to choose after they paid up their premiums for example after they paying off the premiums, this policy can be converted to death benefit or nursing care benefits or the customer can receive cash value and use that cash as asset accumulation. [Foreign language] And as we go through these kind of discussions with our customers there will be more touch points with our customers and there will be more opportunities for our sales people to talk to our customers about third sector products. We’ve already have this established sales pattern and we have trained our sales agents to do so. [Foreign language] So our purpose is to increase our third sector sales by using this new product Tsumitasu as a hook. [Foreign language] Because we are the company that would increase sales by centering on third sector product sales. [Foreign language] And the way we are doing sales is to really ultimately sell third sector products by launching first sector product. And that is based on the needs of younger middle-aged customers at each times and a period of time. [Foreign language] That's all for me.
John Barnidge : Thank you for that. Very helpful my follow up on distribution is the 50th anniversary plans mainly related to this product or is it broader? Could you to about that? Thank you.
Koichiro Yoshizumi: Hey, this is again Yoshizumi. [Foreign language] And as I just mentioned, it’s not just about Tsumitasu, but since we are a company that mainly sell third sector product. [Foreign language] Then for example as for the 50th anniversary, we will be selling pushing for cancer insurance sales and in order to increase our touch points with our customers, we will be having campaigns to offer gifts to our customers. [Foreign language] We also have a conservative service that no other competitor has. [Foreign language] And so so what we were trying to do is to appeal this conservative service in line with our 50th anniversary through the website, TV commercials, and video services. [Foreign language] We have a large number of sales agents and agencies that only sell Aflac and have walked together with Aflac for the past 50 years. [Foreign language] And these agents and agencies are extremely pleased and happy about celebrating 50th anniversary. [Foreign language] And there's a very big momentum for these sales agents and agencies to sell a large proportion of third sector products. [Foreign language] We, as a sales team would like to support these sales agencies at our maximum. [Foreign language] That’s all for me.
Operator: [Operator Instructions] The next question comes from Tom Gallagher with Evercore ISI. Please go ahead.
Tom Gallagher: Good morning. A couple of follow-up questions on the Tsumitasu product in Japan. In response to John's question, I just want to be clear I'm assuming you're not selling this product. The Tsumitasu product to existing customers that already have third sector Aflac products. This would be all brand new Aflac customers. Is that is that correct?
Dan Amos : Correct. Our thrust is to write new customers, but if someone wants to buy, we certainly will sell it to them because as was mentioned by Max, the profit margin is very acceptable on this product. And so, yes, we'll take anyone that wants to buy. But it is not our push. We want the younger customers is what we're working toward.
Tom Gallagher: And Dan, do you have a - are you keeping track of that to make sure this doesn't become a situation where the sales force kind of monetizes the in-force customer base and does a lot of selling there because then obviously that would limit the cross-sell opportunity?
Dan Amos : Absolutely, we are. Now they can call more about it. I just was cutting through the translation and Max can cover that a little bit more too.
Max Broden : Tom, we track that closely. So we know what those numbers are. We will not necessarily publish those publicly, but it's an important factor that we keep track of.
Operator: The next question comes from Nick Annitto with Wells Fargo. Please go ahead.
Nick Annitto: Hey, thanks. Good morning. Just wanted to touch on the US a bit. I know, sales came in a little late in the quarter relative to the full year guidance. I just wanted to get your overall thoughts there on the confidence of hitting something in the guidance for the year?
Virgil Miller : Yeah, good morning. This is Virgil from the US. Let me say that, I think the big thing - the big takeaway is very strong quarter for the US, because of the balanced approach. You heard yourself from Herc and Max earlier, Herc or Dan earlier, what we saw was an increase in not just in sales of 2% but we had an increase of 50 basis points in our premium persistency. We drove a higher benefit ratio that was intentional some intentional actions to put more value into the hands of our customers. We lowered our expense ratio and then that led to one of the highest pre-tax margins we've had in US in some years of 50 basis points and 22.7%. My point on that is that, we knew going to the quarter we’ve came up negative and Q1. Second quarter, I mentioned a previous earlier that we have made a lot of changes to go to a more profitable business. That was really focused in our group with VB business, formerly it’s Continent American business that we bought. We wanted to make sure that we are only bringing business that has higher benefits where people actually filing claims and less churn. So we knew that would have an impact. So this the 2% is actually right on target of what I expected. But I am expecting a stronger push in the second half of the year. A lot of that is seasonality. But it is also what Max mentioned earlier some scale will see from buy to bills. We're going to see a stronger performance with the new files we bought with Life and Disability that we call PLATS. We're going to see better performance in the second half from our Dental and Vision property. I mentioned before that we're making huge Investments to stabilize that platform. We also announced a partnership with SKYGEN that’s bringing some operational excellence to the table with us to help manage that property. And so, all in the state being higher sales on the dental property. Stronger push with PLATS and then continue to what we have driven year-over-year with our veteran agents and with our broker partnerships, good performance from them and we'll see how our yield in the second half of the year.
Dan Amos : And I just want to make a comment. I think that we've seen one of the best years and certainly one of the best quarters in the U.S. in terms of we've got a lot of balls in the air. And to realize that they brought up the loss ratio. They brought down the expense ratio. They had switched business and our business is more complicated as we go into other products. They're training their people better. I just have a kudos to Virgil and the team for the hard work they're doing. And I think long term, our US operation is going to be a much stronger company because we're doing all the right things I think we need to do to prepare us for the future. So, I'm extremely - the sales yet I want more than 2%. But I promise you that the 2% that we had is much bigger than a normal 2%, because it's cleaner business is more profitable and it should compound as we move forward.
Nick Annitto: That's helpful. Thanks. I guess, sticking with the US can you just touch on recruiting trends there. I know you said you still have a bit of a way to go to get back to pre-pandemic levels. So it would be just good to get your thoughts on the recovery there.
Virgil Miller : Yeah, in the first quarter you know we came up with negative on recruiting came in with the second quarter though very strong with - I think we were over a 10% increase. I see us continue on that trend going forward to the second half. But when I mentioned if you kind of go back and look pre-pandemic and you look at where we are today we're going for quality recruiting. We're going for a better conversion rate. And then, that’s leading to the higher productivity. You continue to see better productivity from what we're seeing with our agents. And that is really the bigger factor for us. Last year, we were recruited over 10,000. I would expect the same this year. We've got some national recruiting efforts going on right now across the country. What we really do is we leverage support from headquarters to drive our message and then we leverage - when we call a nomination process is to local agents, local brokers going out telling people about the Aflac career path and bringing people and listen to that story. And then we actually turn them into and to recruit in the ultimately trying to get them to be average weaker producers. I am very pleased with what we did in the second quarter. Some of those efforts will definitely continue in third or fourth quarters also.
Operator: The question comes from Tom Gallagher with Evercore ISI. Please go ahead.
Tom Gallagher : Hey, thanks for taking my follow-up. Just a Tsumitasu product follow-up question. Can you talk a little bit about how you think this rollout is going to go? Clearly, the June rollout seems to have been a big success. Would you expect this to become a much larger percentage of sales as you think about the rollout over the next couple of quarters here? How do you think third sector sales are going to hang in there? Because I think it's being sold through the same distribution as your third sector. So I'm just wondering while this gets rolled out, are we going to see a slowdown in third sector? How do you see that all playing out I guess over the near term next couple of quarters? Thanks.
Dan Amos : Let me kick it off and then I'll hand it over to Yoshizumi for some more details. We do not have an explicit caps around this product. And the reason why it’s because it producing very good returns for us, both from a profit margins standpoint and also from a total - from an IRR standpoint i.e. with a significant spread to our cost of capital. So we actually do want to sell quite a bit of all this product. That being said, this product is very much about how it can lift our third sector franchise. We still believe that we are a third sector company. And we want to make sure that we keep our exceptionally strong position in that marketplace as the number one as third sector player in Japan. So, that is the context and of this product. And Yoshizumi can help give you some more details in terms of the timing of the full rollout of the product.
Koichiro Yoshizumi: [Foreign Language] Thank you. This is your Yoshizumi. I would like to answer your question. [Foreign Language] First of all this product was launched on June 2nd. We have able to record a very successful big sales. [Foreign Language] And the reason why we have been able to record such big sales at the beginning of its launch is because, we, we meaning our distribution channel has been fully prepared to really wear to sell this product where they should be selling. How we should be selling and that's what we'd be working on since the beginning of the second quarter. [Foreign Language] And the reason why this kind of preparation was needed was because. [Foreign Language] And our agents. [Foreign Language] Talk to about Tsumitasu new customers, our agents really need to practice how to sell this product. [Foreign Language] As a result, our agents did visit those customers that are easy for them to be talking to and as a result it made a big hit in the sales. [Foreign Language] And as a result of this through preparation for the June launch we are not expecting the same level of sales from July and on. [Foreign Language] But at the product to earn certain level of volume. [Foreign Language] And we are quite sure that this product will serve that kind of a role. [Foreign Language] And the big role that this product will play is to cross-sell third sector products. [Foreign Language] And it would be easier for our sales agents to talk about third sector products through their customers once they start talking about Tsumitasu. [Foreign Language] And that is the difference between other first sector products because Tsumitasu has its own feature that can make that sales agents easily talk about third sector products. [Foreign Language] So what we are expecting is to have Tsumitasu sell to certain volume on its own, but on top of that sell third sector products is to certain level, as well. [Foreign Language] That's all for me.
Dan Amos: This is Dan, I want to make a couple of comments. Number one is, we normally don't show the first month. We show a quarter of whatever new product is. It is not unusual to have a spike. What I've always said is we introduce new product no matter of what it is. You have a spike and then it levels off. We're in the spike period. And we've seen that with others. But it it will it will come down as he said and we expect that. So, just keep that in mind the other thing is that the numbers were small numbers in the past. And so that also as a percentage makes it look bigger than it normally is. But there's nothing here that makes me think that is any different from other new products other than it's doing very well as a few of our products have. And we're excited about that and pleased that we were able to find the way to get the profit margins to acceptable levels, so we could do this. We've been wanting to do it, but we haven't been able to do it and given Max his credit. He was been able to find a way to help do this and we appreciate that very much on his part.
Max Broden : Tom, I want to address a question that you did not ask, but I think you wanted to ask and that is, how is this different from the waste sales that we had in the years 2012 through 2014? And I would characterize is there are three main differences. The first one is that we will do much more frequent repricing of new business for this product. And that's very important because this is a more interest rate sensitive product than our core third sector business. The other one is that we will have a much more diligent management of the distribution channels and the third piece is that we are not utilizing reinsurance to make sure that we can relieve some of that new business train and get the IRRS higher. And if you take all of that to get or that is what makes this different from the waste sales that we had of that were very very significant back in that timeframe of 2012 through 2014. Thanks Max. You stole my follow-up. That was great. Appreciate it.
Dan Amos: Well, apparently it’s teamwork.
Operator: The next question comes from Joel Hurwitz with the Dowling & Partners. Please go ahead.
Joel Hurwitz : Hey, thanks for taking the follow-up. I just wanted to touch on net investment income in Japan and particularly, the US dollar portfolio unified just for the make whole and the slightly favorable VIII it seem to have a pretty sizeable step up in yield from the first quarter. Is there any color on what drove that and do you think that the - I guess the normalized NII level implied in Q2 is sustainable?
Brad Dyslin : Yeah, hi, Joel, this is Brad Dyslin. Thank you. Thank you for the question. We did have a very solid second quarter as you pointed out and there were several things that drove that that we do think are sustainable into the back half of the year. Besides the adjustments that you that you’ve highlighted short rates remain very attractive even with the Fed likely to cut sometime this fall, short rates remain very, very attractive compared to historical levels. And that benefits us in a few ways including our significant floating rate portfolio. We also took some actions early in the year, some tactical things we did with the portfolio. We moved a few bonds around in our public portfolio to capture some yield opportunities. It was a pretty sizable switch trade. We also took advantage of some attractive spreads and accelerated deployment in our structured private credit portfolio. So we think the things that have carried us in the second quarter these tailwinds are going to continue through the second half of the year. Now there are risks of course, but we think we're pretty well positioned and should have a good second half.
Joel Hurwitz : Great. Helpful. And then just, I had won on us persistency. So Max, you mentioned in your prepared remarks that you're encouraged by the early signs from some of the initiatives that you guys put in place. I guess, just what are you seeing and how much improvement do you guys think you can drive in persistency in the US?
Max Broden : I'm not going to put an exact number on that, but I would say that anything if you get even something like a hundred basis points is meaningful when the overtime translates that into the economic impact that would have from additional net earned premium. So, it's something that we will continue to drive over time. The other thing I want you to be aware of is that that persistency will jump around somewhat driven by mix of business. So our in-force in the US, it is gradually changing. So you are going to see more Group Life and Disability business as a proportion of our in-force, which clearly has a much, much higher persistence rate than our average. And then also the same thing applies to over time our Dental and Vision businesses as well should have an improved persistency. So we're driving all the underlying businesses and the way they improve persistency then the mix impact will be an important component as well. So, over time, what we are driving is both that business-by-business improved persistency and then obviously the mix impact, as well. So we will over time sort o. call that out and give you some more colors on that, as well.
Joel Hurwitz : I got it. Thank you.
Operator: This concludes our question and answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young : Thank you, Betsy, and thank you, all for joining us this morning. I hope you'll be able to join us on the morning of December 3rd at the New York Stock Exchange or on our webcast for our Financial Analysts Briefing. If you have any additional follow-ups, please reach out to the Investor and Rating Agency Relations team. We look forward to hearing from you. Thank you.
Operator: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to the Aflac Incorporated Second Quarter 2024 Earnings Conference Call. All participants will be in a listen only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations. Please go ahead."
},
{
"speaker": "David Young",
"text": "Good morning, and welcome. Thank you for joining us for Aflac Incorporated Second quarter earnings call. While I have your attention I also want you to mark your calendars to join us for our Financial Analyst Briefing at the New York Stock Exchange on December 3rd. Now this morning, Dan Amos, Chairman, CEO and President of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then, Max Broden, Executive Vice-President and CFO of Aflac Incorporated will provide an update on our financial results and current capital and liquidity. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com, including Max's quarterly video updates which also includes information about the outlook for 2024. We also posted under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans. For Q&A today, we are also joined by Virgil Miller, President of Aflac US.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan."
},
{
"speaker": "Dan Amos",
"text": "Thank you, David, and good morning, and we're glad you joined us. Aflac Incorporated delivered another quarter and six months of very solid earnings results. Net earnings per diluted share were $3.10 for the quarter and $4.64 for the first six months. On an adjusted basis, earnings per diluted share for the quarter were we're up 15.8% to $1.83 and for the first six months, we were up 11.5% to $3.49. From a broad operational perspective, we've generated profitable growth in the United States and Japan with new products and distribution strategies. We believe our strategy will continue to create long-term value for the shareholders, at the same time, we believe that the need for our products we offer is a strong or stronger than it has ever been before in both the United States and Japan. Beginning with Japan, we have continued to focus on third sector products like our cancer insurance product called the WINGS as the new fiscal year began in Japan, we saw continued improvement in cancer insurance through the Japan Post Channel. We have continued our strategy of introducing life insurance products including Tsumitasu, which we launched on June 2nd. This product offers policyholders an hazard formation component with nursing care option. It was designed to attract new and younger customers, while also introducing opportunities to sell them our core third sector products. While still very early, we are pleased with how our agencies have sold this product, which drove a 4.5% sales increase for the second quarter being where consumers want to buy insurance remains in an important element of the growth strategy in Japan. Our broad network of distribution channels including agencies, alliance partners and banks continually optimize our opportunities to help provide financial protection to the Japanese consumers. We will continue to work hard to support each channel. Overall, Koide San and his team have done a great job of turning around sales in Japan and delivering record profit margins for the quarter. I am very pleased with their efforts. Turning to the US, we achieved a 2% sales growth for the quarter benefiting from good growth in Group Life Absent Management and Disability and individual voluntary benefits This is a welcome results as we enter the second half of the year that tends to be the heaviest enrollment period. At the same time, we continue to focus on more profitable growth by exercising a stronger underwriting discipline. Additionally, we've increased benefits in certain policies to improve the value for the policyholder. We believe persistency will remain strong as customers realize the value of their policies and the related benefits. We have also continued our disciplined approach to expense management, which Max will address. As we enter the second half of the year, we are continuing to focus on optimizing our Dental and Vision platform. Overall, I'm pleased with what Virgil and his team are doing to balance profitable growth enhance the value proposition for the policyholders and curb the expense ratios. Their efforts contributed to the very strong pre-tax profit margin of 22.7% for the second quarter. Now turn to our ongoing commitment to prudent liquidity and capital management. Max has done a great job leading his team to take proactive steps in recent years to defend our cash flow and deployable capital against a weakening yen, as well as establishing a reinsurance platform in Bermuda. We have been very pleased with our investment portfolios’ performance as it continues to produce strong net investment income with minimal losses and impairments responsibility is to fulfill the promises we make to our policyholders, while being responsive to the needs of our shareholders. We remain committed to maintaining strong capital ratios on behalf of the policyholders. We balance this financial strength with tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both our dividend track record and tactical share repurchase. We treasure our track record of 41 consecutive years of dividend growth and remain committed to extending it. I am pleased that the Board set us on a path to continue this record when it increased the first quarter 2024 dividend 19% to $0.50 and declared the second and third quarter dividends of $0.50. We repurchased a record $800 million in shares during the quarter, and intend to continue our balanced, tactical approach of investing in growth and driving long-term operating efficiencies. Our management team, employees and sales distribution continue to be dedicated stewards of our business, being there for the policyholders when they need us most just as we promised. This underpins our goal of providing customers with the best value in the supplemental insurance products in the United States and Japan. In November, we celebrate our 50th year of doing business in Japan. Additionally, in June, we celebrated our 50th year as a publicly traded company on the New York Stock Exchange. We are reminded that one thing has not changed since the founding in 1955, families and individuals still seek to protect themselves from financial hardships that not even the best health insurance covers. Today’s complex healthcare environment has produced incredible medical advances that come with incredible costs. It’s more important than ever to have that partner. We believe our approach to offering relevant products makes us that partner. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. Aflac is well-positioned as we work toward achieving our long-term growth while also ensuring we deliver on our promise to our policyholders. I'll now turn the program over to Max to cover in more details the financial results. Max?"
},
{
"speaker": "Max Broden",
"text": "Thank you, Dan and thank you for joining me as I’ll provide a financial update on Aflac Incorporated’s results for the second quarter of 2024. For the quarter, adjusted earnings per diluted share increased 15.8% year-over-year to the $1.83 with a $0.07 negative impact from FX in the quarter. In this quarter, reinvestment gains on reserves totaled $51 million and variable investment income ran $1 million above our long-term return expectations. We also received a make whole payment adding approximately $20 million or $0.03 per share to our adjusted earnings. Adjusted book value per share, including foreign currency translation and the gains and losses increased 9.4% and the adjusted ROE was 14.3%, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 5.7%. This decline reflects a 7.4 billion yen negative impact from internal reinsurance transaction executed in the fourth quarter of 2023 and 4.8 billion yen negative impact from paid up policies. In addition, there is a 1.2 billion yen positive impact from deferred profit liability. Lapses were somewhat elevated but within our expectations. At the same time, policies in force declined 2.4%. Japan's total benefit ratio came in at 66.9% for the quarter up 120 basis points year-over-year and the third sector benefit ratio was 57.8%, up the approximately 160 basis points year-over-year. We estimate the impact from reinvestment gains to be 140 basis points favorable to the benefit ratio in Q2 2024. Long-term experience trends as it relates to treatment of cancer and hospitalization continue to be in place leading to the continued favorable underwriting experience. Persistency remains solid with a rate of 93.3%, which was down 50 basis points year-over-year. This change in persistency is in line with our expectations. Our expense ratio in Japan was 17.8%, down 170 basis points year-over-year, driven primarily by the expense allowance from reinsurance transactions and continued discipline expense management. Adjusted net investment income in Yen terms was up 28.4%, mainly by favorably impact from FX on US dollar investments in yen terms, lower hedge costs, higher return on our alternatives portfolio compared to second quarter of 2023 and call income. The pre-tax more than for Japan in the quarter was 35.3%, up $490 basis points year-over-year, a very good result. Turning to US results, net earned premium was up 2.1%, persistency increased 50 basis points year-over-year to 78.7%. We are encouraged by early signs from our persistency efforts and we will remain focused on driving profitable growth. Our total benefit ratio came in at 46.7%, 140 basis points higher than Q2 2023 driven by product mix and lower reinvestment gains than a year ago. We estimate that reinvestment gains impacted the benefit ratio by 170 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and are now more in line with our long-term expectations. Our expense ratio in the US was 36.9%, down to 210 basis points year-over-year, primarily driven by platforms improving scale and strong expense management. We tend to benefit from seasonality in the first half and would expect higher expenses in the second half. Our growth initiatives, Group Life and Disability, network, dental and vision and the direct-to-consumer increased our total expense ratio by 230 basis points. This is in line with our expectation and we would expect this impact to decrease going forward as these businesses grow to scale and improve their profitability. In just that net investment income, in the US was up 7.4%, mainly driven by higher yields on both our alternatives and fixed rate portfolios. Profitability in the US segment was solid with a pre-tax margin of 22.7%, also a very good result. Our total commercial real estate loan watch list stands at approximately $1 billion, with less than $300 million in process of foreclosures currently. As a result of these current low valuation marks, we increased our seasonal reserves associated with these loans by $14 million in this quarter net of charge-offs. We had six loan foreclosures and moved nine properties into real estate owned. We continue to believe that they currently distressed market does not reflect the true intrinsic economic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through this cycle and maximize our recoveries. Our portfolio of first lean senior, secured middle market loans continue to perform well with losses below our expectations for this point in the cycle. In our Corporate segment, we recorded a pre-tax gain of $23 million. Adjusted net investment income was $39 million higher than last year due to lower volume of tax credit Investments at Aflac Inc. and higher volume of investable assets at Aflac REIT. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $30 million with an associated credit to the tax line. The net impact to our bottom-line was a positive $4 million in the quarter. To-date, these Investments are performing well and in line with expectations. We're continuing to build up our reinsurance platform and I'm pleased with the outcome and performance. Our capital position remains strong and we ended the quarter with an SMR above 1100 % in Japan, now combined RBC, while not finalized we estimate to be greater than 650%. Unencumbered holding company liquidity stood at $4.1 billion, $2.3 billion above our minimum balance. These are strong capital ratios, which we actively monitor stress and managed to withstand credit cycles, as well as external shocks. US statutory impairments were released of $7 million and Japan FSA impairments were 10.4 billion yen or roughly $67 million in the quarter. This is well within our expectations and with limited impact to both earnings and capital. Adjusted leverage is 19.5% and below our leverage corridor of 20% to 25%. As we hold approximately 60% of our debt denominated in the yen, our leverage will fluctuate with movements in the yen dollar rate. This is intentional and part of our enterprise hedging program protecting the economic value of Aflac Japan in US dollar terms. We repurchased $800 million of our own stock and paid dividends of $283 million in Q2, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. I will now turn the call over to David."
},
{
"speaker": "David Young",
"text": "Thank you Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. Then you're welcome to rejoin the queue. We will now take the first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] The first question today comes from Joel Hurwitz with Dowling & Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"text": "Hey, good morning. So the new product launch in Japan that happened in June had very strong sales. I guess, can you just talk about the target return on that that first sector product and how it compares to the third sector product? And then what do you see as the cross-sell opportunity there?"
},
{
"speaker": "Dan Amos",
"text": "Max might just take that for chat."
},
{
"speaker": "Max Broden",
"text": "Yeah, let me start on the product profitability. So, when we look at this product through a GAAP lens, it has at or higher GAAP margins than our core third sector business. And on an IR basis, this is obviously lower than our third sector business because of the very significant new business strain associated with the high reserves, but we have lined up reinsurance that we then expect on a post-reinsurance basis it brings us very, very attractive returns, as well. And not too different from our core first sector business."
},
{
"speaker": "Joel Hurwitz",
"text": "Okay and the cross-sell opportunity there with the third sector products?"
},
{
"speaker": "Max Broden",
"text": "I think we'll evolve over time where obviously this product targets a younger clientele that gives us the opportunity to build that relationship and as we travel with that customer through their lifetime, we have an opportunity to then cross-sell both medical and cancer, as well. So over time, I think, there's a good opportunity for us to both get the – Tsumitasi product to the younger clients but also over the lifetime cross-cell cancer and medical to those new clients."
},
{
"speaker": "Dan Amos",
"text": "Yeah, I think Aflac team nicely explains that. It's important that I say it, is remember it with the Tsumitasu product we are hiding a younger group less disposable income than does an older set of potential policyholders. And so whereas, with the older, we might offer the Tsumitasu product or another product and our supplemental for third sector product. With this group, we'd start by putting in one product, which would be the Tsumitasu product and then in a year or so later follow-up and add more. So it's different as we're building that policyholder base, which of course is one of the things we promised you we would work toward doing and Aflac Japan we believe is doing the right thing here for us."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar with JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. First question just on the expense ratio in both the Japan and the US businesses, I think is the best it’s been in the past several years. So wondering how much of that is sustainable and driven by expense savings or other actions versus maybe just being timing - driven by the timing of discretionary and that spending in advertising?"
},
{
"speaker": "Dan Amos",
"text": "Thank you, Jimmy. Let me start with Japan. Obviously, 17.8% in a quarter is a very low number. We have a guidance range of 19% to 21% and long-term I think that is the range that we will operate within for the Japan segment. We tend to have some seasonality in Japan with the second half having a little bit higher overall spend and I would specifically call out that Aflac Japan turns 50 this year. So we will have some promotional spend associated with that including advertising and a lot of sales activities around that. So therefore I would for the full year that we would end up in the lower end of that 19% to 21% range. For the US, we also have had very good expense control especially in the first half. There are timing differences where I would expect our spend would increase in the second half and I would also caution you to please keep in mind that the fourth quarter, every year has the highest level of sales activity with that comes expenses spend, as well as our expense ratio in the fourth quarter tends to be the highest. Over time, the US still have a number of businesses that are not at scale. And therefore we have we are running those businesses with expenses overruns right now. This includes our Group Life and Disability business, it includes our dental and vision business and it includes our direct-to-consumer business and to some extent also our group our group BB platform. As those businesses really reach that scale then they come down in expense ratio and we will no longer have that expense overrun. So that means there are - there is downward pressure over time to our US expense ratio. But we're very pleased with the expense management and expense control for the first half and in particular into second quarter. But I would caution you when you think about the full year, I still would expect us to be inside of the range of 38% to 40% for the expense ratio in the US."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. And then, just maybe for Dan or the Japanese team, you talked a lot about competition in Japan on the last call. And it seems like as rates gone up in Japan some of the companies have cut prices to adjust for that. But what are you seeing in the competitive environment? And is it any different than what you've seen in the last few months or over the past few years?"
},
{
"speaker": "Dan Amos",
"text": "Yoshizumi, would you like to take that?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Thank you for the question. Good morning everyone. I'm Yoshizumi. I am in charge of sales in Japan. So as you have mentioned our competitors have entered third sector market. And so the environment is totally different compared with maybe five years ago or 10 years ago. [Foreign language] And there are competitors that are launching a very reasonable or low price products. [Foreign language] However, in Aflac, our concept is to launch and sell products that have values to our customers and not just lower product buy for the sake of lowering product - lowering prices, excuse me. [Foreign language] And as we enter into our 50th anniversary this year in Aflac Japan. And this is based on the history and trust that we have from our customers in providing the appropriate insurance policies at all points by thoroughly thinking about what is needed in each environment or at times because the illnesses change and treatment methods change. [Foreign language] Now according to the data that’s been publicized between April 2022 and March 2023, [Foreign language] And Aflac is record the number one most sold policy company in Japan in third sector products. [Foreign language] What we will aim for is to continue to provide customers that most appropriate product for our customers, so that we can maintain our number one position. That’s all for me."
},
{
"speaker": "Operator",
"text": "The next question comes from John Barnidge with Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thank you for the opportunity. My first question is on distribution of the new first sector product in Japan. The closest customers and existing customer and one that doesn’t have that products, I know the product was introduced in early June. Have you identified how much of the existing customer base is the target for this new product? Thank you."
},
{
"speaker": "Dan Amos",
"text": "They're translating give us one second. And Koide, or Yoshizumi please?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Hey, this is Yoshizumi once again. Let me continue to answer your question. [Foreign language] We have a large number of existing customers as you know. [Foreign language] And our target customers are young and middle-aged customers. [Foreign language] And the reason why I say our target is young and middle-aged customers is as follows: [Foreign language] Well first of all, the Japanese government is really pushing and encouraging the Japanese citizens to go after asset accumulation products and the Japanese government is offering various systems so that the Japanese citizens can do that. [Foreign language] And as a result of that asset formation needs is heightening very strongly in Japan. [Foreign language] And we’ve launched our new product in order to respond to the kind of asset accumulation needs in Japan. [Foreign language] And this product is very well taken by the market and selling well and it is increasing our sales. [Foreign language] And the reason why this product is attracted attention is because there are various options that would allow our customers to choose after they paid up their premiums for example after they paying off the premiums, this policy can be converted to death benefit or nursing care benefits or the customer can receive cash value and use that cash as asset accumulation. [Foreign language] And as we go through these kind of discussions with our customers there will be more touch points with our customers and there will be more opportunities for our sales people to talk to our customers about third sector products. We’ve already have this established sales pattern and we have trained our sales agents to do so. [Foreign language] So our purpose is to increase our third sector sales by using this new product Tsumitasu as a hook. [Foreign language] Because we are the company that would increase sales by centering on third sector product sales. [Foreign language] And the way we are doing sales is to really ultimately sell third sector products by launching first sector product. And that is based on the needs of younger middle-aged customers at each times and a period of time. [Foreign language] That's all for me."
},
{
"speaker": "John Barnidge",
"text": "Thank you for that. Very helpful my follow up on distribution is the 50th anniversary plans mainly related to this product or is it broader? Could you to about that? Thank you."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "Hey, this is again Yoshizumi. [Foreign language] And as I just mentioned, it’s not just about Tsumitasu, but since we are a company that mainly sell third sector product. [Foreign language] Then for example as for the 50th anniversary, we will be selling pushing for cancer insurance sales and in order to increase our touch points with our customers, we will be having campaigns to offer gifts to our customers. [Foreign language] We also have a conservative service that no other competitor has. [Foreign language] And so so what we were trying to do is to appeal this conservative service in line with our 50th anniversary through the website, TV commercials, and video services. [Foreign language] We have a large number of sales agents and agencies that only sell Aflac and have walked together with Aflac for the past 50 years. [Foreign language] And these agents and agencies are extremely pleased and happy about celebrating 50th anniversary. [Foreign language] And there's a very big momentum for these sales agents and agencies to sell a large proportion of third sector products. [Foreign language] We, as a sales team would like to support these sales agencies at our maximum. [Foreign language] That’s all for me."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] The next question comes from Tom Gallagher with Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Good morning. A couple of follow-up questions on the Tsumitasu product in Japan. In response to John's question, I just want to be clear I'm assuming you're not selling this product. The Tsumitasu product to existing customers that already have third sector Aflac products. This would be all brand new Aflac customers. Is that is that correct?"
},
{
"speaker": "Dan Amos",
"text": "Correct. Our thrust is to write new customers, but if someone wants to buy, we certainly will sell it to them because as was mentioned by Max, the profit margin is very acceptable on this product. And so, yes, we'll take anyone that wants to buy. But it is not our push. We want the younger customers is what we're working toward."
},
{
"speaker": "Tom Gallagher",
"text": "And Dan, do you have a - are you keeping track of that to make sure this doesn't become a situation where the sales force kind of monetizes the in-force customer base and does a lot of selling there because then obviously that would limit the cross-sell opportunity?"
},
{
"speaker": "Dan Amos",
"text": "Absolutely, we are. Now they can call more about it. I just was cutting through the translation and Max can cover that a little bit more too."
},
{
"speaker": "Max Broden",
"text": "Tom, we track that closely. So we know what those numbers are. We will not necessarily publish those publicly, but it's an important factor that we keep track of."
},
{
"speaker": "Operator",
"text": "The next question comes from Nick Annitto with Wells Fargo. Please go ahead."
},
{
"speaker": "Nick Annitto",
"text": "Hey, thanks. Good morning. Just wanted to touch on the US a bit. I know, sales came in a little late in the quarter relative to the full year guidance. I just wanted to get your overall thoughts there on the confidence of hitting something in the guidance for the year?"
},
{
"speaker": "Virgil Miller",
"text": "Yeah, good morning. This is Virgil from the US. Let me say that, I think the big thing - the big takeaway is very strong quarter for the US, because of the balanced approach. You heard yourself from Herc and Max earlier, Herc or Dan earlier, what we saw was an increase in not just in sales of 2% but we had an increase of 50 basis points in our premium persistency. We drove a higher benefit ratio that was intentional some intentional actions to put more value into the hands of our customers. We lowered our expense ratio and then that led to one of the highest pre-tax margins we've had in US in some years of 50 basis points and 22.7%. My point on that is that, we knew going to the quarter we’ve came up negative and Q1. Second quarter, I mentioned a previous earlier that we have made a lot of changes to go to a more profitable business. That was really focused in our group with VB business, formerly it’s Continent American business that we bought. We wanted to make sure that we are only bringing business that has higher benefits where people actually filing claims and less churn. So we knew that would have an impact. So this the 2% is actually right on target of what I expected. But I am expecting a stronger push in the second half of the year. A lot of that is seasonality. But it is also what Max mentioned earlier some scale will see from buy to bills. We're going to see a stronger performance with the new files we bought with Life and Disability that we call PLATS. We're going to see better performance in the second half from our Dental and Vision property. I mentioned before that we're making huge Investments to stabilize that platform. We also announced a partnership with SKYGEN that’s bringing some operational excellence to the table with us to help manage that property. And so, all in the state being higher sales on the dental property. Stronger push with PLATS and then continue to what we have driven year-over-year with our veteran agents and with our broker partnerships, good performance from them and we'll see how our yield in the second half of the year."
},
{
"speaker": "Dan Amos",
"text": "And I just want to make a comment. I think that we've seen one of the best years and certainly one of the best quarters in the U.S. in terms of we've got a lot of balls in the air. And to realize that they brought up the loss ratio. They brought down the expense ratio. They had switched business and our business is more complicated as we go into other products. They're training their people better. I just have a kudos to Virgil and the team for the hard work they're doing. And I think long term, our US operation is going to be a much stronger company because we're doing all the right things I think we need to do to prepare us for the future. So, I'm extremely - the sales yet I want more than 2%. But I promise you that the 2% that we had is much bigger than a normal 2%, because it's cleaner business is more profitable and it should compound as we move forward."
},
{
"speaker": "Nick Annitto",
"text": "That's helpful. Thanks. I guess, sticking with the US can you just touch on recruiting trends there. I know you said you still have a bit of a way to go to get back to pre-pandemic levels. So it would be just good to get your thoughts on the recovery there."
},
{
"speaker": "Virgil Miller",
"text": "Yeah, in the first quarter you know we came up with negative on recruiting came in with the second quarter though very strong with - I think we were over a 10% increase. I see us continue on that trend going forward to the second half. But when I mentioned if you kind of go back and look pre-pandemic and you look at where we are today we're going for quality recruiting. We're going for a better conversion rate. And then, that’s leading to the higher productivity. You continue to see better productivity from what we're seeing with our agents. And that is really the bigger factor for us. Last year, we were recruited over 10,000. I would expect the same this year. We've got some national recruiting efforts going on right now across the country. What we really do is we leverage support from headquarters to drive our message and then we leverage - when we call a nomination process is to local agents, local brokers going out telling people about the Aflac career path and bringing people and listen to that story. And then we actually turn them into and to recruit in the ultimately trying to get them to be average weaker producers. I am very pleased with what we did in the second quarter. Some of those efforts will definitely continue in third or fourth quarters also."
},
{
"speaker": "Operator",
"text": "The question comes from Tom Gallagher with Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"text": "Hey, thanks for taking my follow-up. Just a Tsumitasu product follow-up question. Can you talk a little bit about how you think this rollout is going to go? Clearly, the June rollout seems to have been a big success. Would you expect this to become a much larger percentage of sales as you think about the rollout over the next couple of quarters here? How do you think third sector sales are going to hang in there? Because I think it's being sold through the same distribution as your third sector. So I'm just wondering while this gets rolled out, are we going to see a slowdown in third sector? How do you see that all playing out I guess over the near term next couple of quarters? Thanks."
},
{
"speaker": "Dan Amos",
"text": "Let me kick it off and then I'll hand it over to Yoshizumi for some more details. We do not have an explicit caps around this product. And the reason why it’s because it producing very good returns for us, both from a profit margins standpoint and also from a total - from an IRR standpoint i.e. with a significant spread to our cost of capital. So we actually do want to sell quite a bit of all this product. That being said, this product is very much about how it can lift our third sector franchise. We still believe that we are a third sector company. And we want to make sure that we keep our exceptionally strong position in that marketplace as the number one as third sector player in Japan. So, that is the context and of this product. And Yoshizumi can help give you some more details in terms of the timing of the full rollout of the product."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Thank you. This is your Yoshizumi. I would like to answer your question. [Foreign Language] First of all this product was launched on June 2nd. We have able to record a very successful big sales. [Foreign Language] And the reason why we have been able to record such big sales at the beginning of its launch is because, we, we meaning our distribution channel has been fully prepared to really wear to sell this product where they should be selling. How we should be selling and that's what we'd be working on since the beginning of the second quarter. [Foreign Language] And the reason why this kind of preparation was needed was because. [Foreign Language] And our agents. [Foreign Language] Talk to about Tsumitasu new customers, our agents really need to practice how to sell this product. [Foreign Language] As a result, our agents did visit those customers that are easy for them to be talking to and as a result it made a big hit in the sales. [Foreign Language] And as a result of this through preparation for the June launch we are not expecting the same level of sales from July and on. [Foreign Language] But at the product to earn certain level of volume. [Foreign Language] And we are quite sure that this product will serve that kind of a role. [Foreign Language] And the big role that this product will play is to cross-sell third sector products. [Foreign Language] And it would be easier for our sales agents to talk about third sector products through their customers once they start talking about Tsumitasu. [Foreign Language] And that is the difference between other first sector products because Tsumitasu has its own feature that can make that sales agents easily talk about third sector products. [Foreign Language] So what we are expecting is to have Tsumitasu sell to certain volume on its own, but on top of that sell third sector products is to certain level, as well. [Foreign Language] That's all for me."
},
{
"speaker": "Dan Amos",
"text": "This is Dan, I want to make a couple of comments. Number one is, we normally don't show the first month. We show a quarter of whatever new product is. It is not unusual to have a spike. What I've always said is we introduce new product no matter of what it is. You have a spike and then it levels off. We're in the spike period. And we've seen that with others. But it it will it will come down as he said and we expect that. So, just keep that in mind the other thing is that the numbers were small numbers in the past. And so that also as a percentage makes it look bigger than it normally is. But there's nothing here that makes me think that is any different from other new products other than it's doing very well as a few of our products have. And we're excited about that and pleased that we were able to find the way to get the profit margins to acceptable levels, so we could do this. We've been wanting to do it, but we haven't been able to do it and given Max his credit. He was been able to find a way to help do this and we appreciate that very much on his part."
},
{
"speaker": "Max Broden",
"text": "Tom, I want to address a question that you did not ask, but I think you wanted to ask and that is, how is this different from the waste sales that we had in the years 2012 through 2014? And I would characterize is there are three main differences. The first one is that we will do much more frequent repricing of new business for this product. And that's very important because this is a more interest rate sensitive product than our core third sector business. The other one is that we will have a much more diligent management of the distribution channels and the third piece is that we are not utilizing reinsurance to make sure that we can relieve some of that new business train and get the IRRS higher. And if you take all of that to get or that is what makes this different from the waste sales that we had of that were very very significant back in that timeframe of 2012 through 2014. Thanks Max. You stole my follow-up. That was great. Appreciate it."
},
{
"speaker": "Dan Amos",
"text": "Well, apparently it’s teamwork."
},
{
"speaker": "Operator",
"text": "The next question comes from Joel Hurwitz with the Dowling & Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"text": "Hey, thanks for taking the follow-up. I just wanted to touch on net investment income in Japan and particularly, the US dollar portfolio unified just for the make whole and the slightly favorable VIII it seem to have a pretty sizeable step up in yield from the first quarter. Is there any color on what drove that and do you think that the - I guess the normalized NII level implied in Q2 is sustainable?"
},
{
"speaker": "Brad Dyslin",
"text": "Yeah, hi, Joel, this is Brad Dyslin. Thank you. Thank you for the question. We did have a very solid second quarter as you pointed out and there were several things that drove that that we do think are sustainable into the back half of the year. Besides the adjustments that you that you’ve highlighted short rates remain very attractive even with the Fed likely to cut sometime this fall, short rates remain very, very attractive compared to historical levels. And that benefits us in a few ways including our significant floating rate portfolio. We also took some actions early in the year, some tactical things we did with the portfolio. We moved a few bonds around in our public portfolio to capture some yield opportunities. It was a pretty sizable switch trade. We also took advantage of some attractive spreads and accelerated deployment in our structured private credit portfolio. So we think the things that have carried us in the second quarter these tailwinds are going to continue through the second half of the year. Now there are risks of course, but we think we're pretty well positioned and should have a good second half."
},
{
"speaker": "Joel Hurwitz",
"text": "Great. Helpful. And then just, I had won on us persistency. So Max, you mentioned in your prepared remarks that you're encouraged by the early signs from some of the initiatives that you guys put in place. I guess, just what are you seeing and how much improvement do you guys think you can drive in persistency in the US?"
},
{
"speaker": "Max Broden",
"text": "I'm not going to put an exact number on that, but I would say that anything if you get even something like a hundred basis points is meaningful when the overtime translates that into the economic impact that would have from additional net earned premium. So, it's something that we will continue to drive over time. The other thing I want you to be aware of is that that persistency will jump around somewhat driven by mix of business. So our in-force in the US, it is gradually changing. So you are going to see more Group Life and Disability business as a proportion of our in-force, which clearly has a much, much higher persistence rate than our average. And then also the same thing applies to over time our Dental and Vision businesses as well should have an improved persistency. So we're driving all the underlying businesses and the way they improve persistency then the mix impact will be an important component as well. So, over time, what we are driving is both that business-by-business improved persistency and then obviously the mix impact, as well. So we will over time sort o. call that out and give you some more colors on that, as well."
},
{
"speaker": "Joel Hurwitz",
"text": "I got it. Thank you."
},
{
"speaker": "Operator",
"text": "This concludes our question and answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you, Betsy, and thank you, all for joining us this morning. I hope you'll be able to join us on the morning of December 3rd at the New York Stock Exchange or on our webcast for our Financial Analysts Briefing. If you have any additional follow-ups, please reach out to the Investor and Rating Agency Relations team. We look forward to hearing from you. Thank you."
},
{
"speaker": "Operator",
"text": "The conference is now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 1 | 2,024 | 2024-05-02 07:00:00 | Operator: Good day, and welcome to the Aflac Incorporated First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President, Investor and Rating Agency Relations. Please go ahead.
David Young: Good morning, and welcome. Thank you for being here a bit earlier than our usual start time. This morning, Dan Amos, Chairman, CEO and President of Aflac Incorporated, will provide an overview of our results and operations in Japan and the United States. Then Max Broden, Executive Vice President and CFO of Aflac Incorporated, will provide an update on our financial results and current capital and liquidity.
These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com, including Max's quarterly video update. We also posted under Financials on the same site, updated slides of investment details related to our commercial real estate and middle market loans. For Q&A today, we are also joined by Virgil Miller, President of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments.
Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures.
I'll now hand the call over to Dan.
Daniel Amos: Thank you, David, and good morning, and we're glad you joined us at this earlier hour. The first quarter marked a good start for the year in terms of earnings, but proved to be challenging for sales. Aflac Incorporated delivered another solid earnings result. Net earnings per diluted share for the quarter were $3.25. On an adjusted basis, earnings per diluted share were up 7.1% to $1.66.
Beginning with Japan, our latest medical insurance launch in September of 2023, we are encouraged by the success that independent corporate and individual agencies have had in marketing this product, especially to the younger individuals. However, we clearly need to make better progress and plan on doing so. Cancer insurance sales, however, were modestly better year-over-year. We entered the final stage of our new cancer insurance launch in April of 2023 through the Japan Post channel, while we saw a significant and understandable year-over-year increase in cancer insurance sales through Japan Post channel.
We expect to see improvement with the start of the new fiscal year as they cross-sell Aflac cancer insurance along with the new Japan Post life insurance product. Being where customers want to buy insurance remains an important element of our growth strategy in Japan. Our broad network of distribution channels, including agencies, alliance partners and banks, continually optimize opportunities to help provide financial protection to Japanese consumers. We will continue to work hard to support each channel.
In addition, we are initiating sales campaigns around our 50th anniversary in Japan starting this quarter. Let me be clear, we have not lowered our sales outlook for 2024 and still expect to achieve it. With the launch of the new policy this quarter, Koide-san and his team are working hard achieving that objective. In addition, we have maintained disciplined underwriting and expense management to continue driving strong pretax profit margins of 32.8%.
Turning to the U.S. As you've seen in prior years, the first quarter tends to generate the lowest sales of the year. We have focused on driving more profitable growth by exercising a stronger underwriting discipline. We are deliberately avoiding sales opportunities to certain less profitable accounts. While this appears to have a temporary impact on sales in the first quarter, we are seeing positive results in net earned premium growth, which grew 3.3%.
At the same time, we have increased benefits in certain cases to improve value for the policyholders. We believe persistency will continue to improve as customers realize the value of their policies and the related benefits. We are pleased with the 80 basis points improvement in persistency this quarter. I believe that the need for the products we offer is as strong or stronger than it has ever been before in both Japan and the United States. We continue to work to restore our momentum and reinforce our leading position as we aim to exceed $1.8 billion of sales by the end of 2025.
We have also continued our disciplined approach to expense management. We are beginning to see progress on our expense ratio in group life and disability and consumer markets continue to grow in scale. We are continuing to focus on optimizing our dental and vision platform and expect to see stronger second half sales this year. At the same time, we have maintained a strong pretax margin of 21%. Overall, I'm very pleased with what Virgil and his team are doing to balance profitable growth, enhance the value of the proposition of our policyholders and curb the expense ratio.
I'd like to end on addressing our ongoing commitment to prudent liquidity and capital management. I'm very pleased with how Max has led the team to take proactive steps in recent years to defend our cash flows and deployable capital against a weakening Yen as well as the establishment of our reinsurance platform in Bermuda. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders while being responsive to the needs of the shareholders.
We remain committed to maintaining strong capital ratios on behalf of the policyholders. We balance this financial strength with tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both our dividend track record and our tactical share repurchase.
We treasure our track record of 41 consecutive years of dividend growth and remain committed to extending it. I am pleased that the Board set us on a path to continue this record, when it increased the first quarter 2024 dividend 19% to $0.50 and declared the second quarter dividend of $0.50. We repurchased a record $750 million in shares in the first quarter and intend to continue our balanced and tactical approach of investing in growth and driving long-term operating efficiencies. Our management team, employees and sales distribution continue to be dedicated stewards of our business, being there for our policyholders when they need us most, just as we promised.
This underpins our goal of providing customers with the best value in the supplemental products in the United States and in Japan. In 2024, we celebrated our 50th year of doing business in Japan and 50th year as a publicly traded company on the New York Stock Exchange. We are reminded that one thing has not changed since our founding in 1955. Families and individuals still seek to protect themselves from financial hardships that not even the best health insurance company covers.
Today's complex healthcare environment has produced incredible medical advances that come with incredible cost. It's more important than ever to have a partner. We believe our approach to offering relevant products makes us that partner. We believe that in the underlying strengths of our business and our potential for continued growth in Japan and the U.S., two of the largest life insurance markets in the world, Aflac is well positioned as we work toward achieving long-term growth while also ensuring we deliver on our promise to our policyholders.
I'd now like to turn the program over to Max to cover more details of the financial results. Max?
Max Broden: Thank you for joining me, as I provide a financial update on Aflac Incorporated's results for the first quarter of 2024.
For the quarter, adjusted earnings per diluted share increased 7.1% year-over-year to $1.66 with an $0.08 negative impact from FX in the quarter. In this quarter, remeasurement gains totaled $56 million and variable investment income ran $11 million or $0.01 per share below our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses, increased 8.7%, and the adjusted ROE was 13.7%, an acceptable spread to our cost of capital.
Overall, we view these results in the quarter as solid. Starting with our Japan segment. Net earned premiums for the quarter declined 6%. This decline reflects a JPY 6.2 billion negative impact from paid-up policies. In addition, there is a JPY 7 billion negative impact from internal reinsurance transactions and a JPY 1.4 billion positive impact from deferred profit liability. Lapses were somewhat elevated, but within our expectations. At the same time, policies in force declined 2.3%.
Japan's total benefit ratio came in at 67% for the quarter, flat year-over-year. And the third sector benefit ratio was 57.5%, down approximately 20 basis points year-over-year. We continue to experience favorable actual to expected on our well-priced, large and mature in-force block. We estimate the impact from remeasurement gains to be 144 basis points favorable to the benefit ratio in Q1 2024. Long-term experience trends, as it relates to treatment of cancer and hospitalization, continue to be in place, leading to continued favorable underwriting experience. Persistency remained solid with a rate of 93.4%, which was down 50 basis points year-over-year, but flat quarter-over-quarter.
We tend to experience some elevations in lapses as customers update and refresh their coverage. This change in persistency is not out of line with expectations. Our expense ratio in Japan was 18%, down 170 basis points year-over-year, driven primarily by good expense control and to some extent, by expense allowance from reinsurance transactions. Adjusted net investment income in yen terms was up 19.3%, mainly by lower hedge costs and favorable impact from FX on our U.S. dollar investments in yen terms as well as higher return on our alternatives portfolio compared to the first quarter of 2023.
This was offset by the transfer of assets due to reinsurance in the previous year, leading to a lower asset base and lower floating rate income. The pretax margin for Japan in the quarter was 32.8%, up 460 basis points year-over-year, a very good result.
Turning to U.S. results. Net earned premium was up 3.3%. Persistency increased 80 basis points year-over-year to 78.7%. This is a function of a poor persistency quarter falling out of the metric and stabilization across numerous product categories. Our total benefit ratio came in at 46.5%, 90 basis points higher than Q1 2023, driven by product mix and lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by 200 basis points in the quarter.
Claims utilization has stabilized, but as we incorporate more recent experience into our reserve models, we have released some reserves. Our expense ratio in the U.S. was 38.7%, down 90 basis points year-over-year, primarily driven by platforms improving scale and lower acquisition expenses. Our growth initiatives, group life and disability, network dental and vision and direct-to-consumer increased our total expense ratio by 230 basis points. We would expect this impact to decrease going forward as these businesses grow to scale and improve their profitability.
Adjusted net investment income in the U.S. was up 4.6%, mainly driven by higher yields on both our alternatives and fixed rate portfolios. Profitability in the U.S. segment was solid with a pretax margin of 21%, driven primarily by net earned premiums growth and improved net investment income year-over-year. Our total commercial real estate watchlist remains approximately $1.2 billion, with around $600 million of these in active foreclosure proceedings. As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $10 million in this quarter.
We also moved 1 property into real estate owned, which resulted in a $3.7 million gain. We continue to believe that the current distressed market does not reflect the true intrinsic economic value of our portfolio, which is why we are confident in our ability to take ownership of these quality assets, manage them through the cycle and maximize our recoveries.
Our portfolio of first lien, senior secured middle market loans continue to perform well with losses well below our expectations for this point in the cycle. In our Corporate segment, we recorded a pretax loss of $3 million. Adjusted net investment income was $43 million higher than last year due to higher volume on the investable assets at Aflac REIT and a lower volume of tax credit investments at Aflac Inc. These tax credit investments impacted a corporate net investment income line for U.S. GAAP purposes negatively by $32 million, with an associated credit to the tax line.
The net impact to our bottom line was a positive $4 million in the quarter. To date, these investments are performing well and in line with our expectations.
We are continuing to build out our reinsurance platform, and I am pleased with the outcome and performance. Our capital position remains strong and we ended the quarter with an SMR above 1,100% in Japan, and our combined RBC, while not finalized, we estimate it to be greater than 650%. Unencumbered holding company liquidity stood at $3.7 billion, $2 billion above our minimum balance. These are strong capital ratios, which we actively monitor, stress and manage to withstand credit cycles as well as external shocks.
U.S. statutory impairments were a release of $3 million. And Japan FSA impairments were JPY 3.6 billion or roughly $24 million in Q1. This is well within our expectations and with limited impact to both earnings and capital. Adjusted leverage remains at a comfortable 20.4%, at the low end of our leverage corridor of 20% to 25%.
In the quarter, we issued JPY 123.6 billion in multiple tranches with an average coupon of 1.72%. As we hold approximately 60% of our debt denominated in yen, our leverage will fluctuate with movements in the yen/dollar rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in U.S. dollar terms. We repurchased $750 million of our own stock and paid dividends of $288 million in Q1, offering good relative IRR on these capital deployments.
We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital.
I'll now turn the call over to David so that we can begin our Q&A.
David Young: Thank you, Max. Before we begin, I just want to remind everyone, please mark your calendars for our financial analyst briefing on December 3 at the New York Stock Exchange. We'll have more information coming out. [Operator Instructions].
Operator: [Operator Instructions] The first question today comes from Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question, starting with U.S. sales, which you guys said were weaker than expected in the quarter, but you did reaffirm the longer-term guidance for sales in that business. So can you just give us a sense of how you expect sales in the U.S. to trend from here?
Virgil Miller: This is Virgil from the U.S. First, let me start with a little bit more color on how sales performed in Q1. As you mentioned, they were a little bit softer for Q1. A couple of drivers for that. First, let me start with our plans, our life, absence and disability business. Normally, that is a business that takes place the latter part of the year. Well, last year, in 2023, we did have some business process in Q1, so therefore, we were down with that comparison. That is an anomaly. That normally doesn't happen. So again, I expect continued strong performance from that line of business for the remainder of the year. So that was a timing element.
The other timing element involved on the dental and vision business. As Dan mentioned in his opening, we continue to work on optimizing that platform. So we had softer sales. We have a dental product. We're expecting to continue to build out that platform, make those improvements and have a stronger year in the second half of the year.
Last, I will close with -- to emphasize, though, I will continue to focus on our strong underwriting discipline. To give more color on that, we're really looking to bring on business that has long-term profitability, which we believe has strengthened the company over a long-term range. This allows us to pay claims and return shareholder value and also helps us with building on persistency. So we do have an improvement in persistency of 80 basis points. We had higher earned premium of 3.3% and we had strong profitability of 21% -- profit margin of 21% in the quarter. So we believe this is the rightly way to manage the company going forward.
Elyse Greenspan: And then my follow-up, shifting to sales in Japan. The third sector sales went negative this quarter. You guys did highlight some initiatives you have to improve sales in Japan. But just hoping you could provide more color specifically on how you expect the third sector sales to trend over the course of 2024.
Daniel Amos: Let me let Aflac Japan answer that, but I think the most important thing is we still expect to attain our objective for the full year. So Koide, would you mind taking that or Yoshizumi.
Koichiro Yoshizumi: [interpreted] Thank you for the question. This is Yoshizumi, I will be answering your question. Starting from 2024, what we are expecting is that we expect to exceed 2023 results. Due to the following reasons, we are expecting our sales will recover. Number one, we are planning to enhance our associates' channel sales agents, I mean increase the number of sales associates. And in 2023, we approximately hired 600 new sales agents -- recruited and have enhanced their training. We are expecting that these 600 will become more productive in the second quarter and be successful.
And we are also continuing agent recruitment in 2024 and taking steps to ensure their effectiveness. And the second point is that we are going to be promoting the sales of Japan Post new product as well as our cancer product through the Japan Post channel. And we do expect that cancer insurance sales will increase in the second quarter. And then my third point is related to Yorisou Cancer Consultation Support, which has been highly rated by our customers. This is our consultation service for our customers that could further differentiate ourselves from our competitors.
And we will be using TV commercials, web video ads, et cetera, and leverage them to differentiate further against our competitors. And my fourth point is that we have plans to implement measures to attract more young and middle-aged customers as medical insurance has been well received among those segments and with significant growth at large nonexclusive agencies.
And furthermore, we are planning to launch a new asset formation type of product in June. The product will include future nursing care coverage feature that will bring value to young customers. We also expect to sell additional third sector product to these new customers through concurrent and follow-on sales. And by implementing these measures, we expect an increase in second quarter sales and exceed 2023 results, and as we aim to steadily increase sales. We are aiming for a steadily increase in sales toward our 2026 targets. That's all from me.
Operator: The next question comes from Tom Gallagher with Evercore.
Thomas Gallagher: Just wanted to circle back on Japan sales. Do you think the issue, as you try and assess it today, is more of an industry issue? Is it Aflac-specific? The reason I ask is I think you mentioned you're deliberately not underwriting certain products in Japan. When I hear that, I think that implies there's some irrational pricing or product features that you don't like. So just a little bit of color on what's going on? Is it medical, where that's happening? And overall, how do you see that playing out?
Daniel Amos: Let's let our Japanese cover that, and I don't -- I'll pick up on it a little bit more, too.
Koichiro Yoshizumi: [interpreted] This is Yoshizumi once again. Let me answer your questions. Regarding the medical insurance sales, we have been increasing our sales on year-on-year basis, especially to those customers under age 50 or 40 and below. And also, this -- our sales in large nonexclusive agency sales on a year-on-year basis, increasing significantly this year. And this large nonexclusive agency sales is a benchmark to see how well the medical insurance is doing.
We are planning to roll out promotional measures to further enhance our sales to young and middle aged customers, who we have been selling already successfully. That's all for me.
Masatoshi Koide: [interpreted] This is Aflac Japan, Koide. I would like to be adding a few comments. In Japan right now, third sector sales is becoming more and more competitive year-on-year. And our strategy is to have solid sale by meeting these customers under the very competitive situation by launching new products in both medical and cancer insurance. And we'd like to do this in a timely manner by really taking in the needs of customers.
And as Yoshizumi-san mentioned earlier, regarding the associates channel sales agents increase, particularly as we increase the number of sales agents, we are not only increasing the headcount, but we are also trying to increase the productivity per head per year through training. In that way, we should be able to increase our sales and strengthen our sales in third sector. Another strength of Aflac in Japan is that we have very strong alliance across the entire Japan, namely the Japan Post network because Japan Post has a nationwide network that can sell our products.
And as Yoshizumi-san mentioned, the Japan Post network sales recovery is taking a bit more time. However, just as Yoshizumi-san mentioned, Japan Post Insurance sales is increasing, especially in its activity volume. So not will they only be only increasing their sales activities and association activities, they will also -- they should also be increasing the actual sales on cancer, and that's what we are hoping to have done. That's all from us.
Thomas Gallagher: Dan, anything you would add? Or should I ask a follow-up?
Daniel Amos: Yes. Okay. Let me make a couple of comments, and then anything else you want to ask, we'll be glad. First of all, our cancer insurance is doing very well, both through our existing distribution channel and Japan Post. The other thing I would say is that the medical products are more competitive, and we have to continue to watch that. That's really nothing new, but it hasn't slacked up. And then we don't sell the foreign currency products that some of our competitors sell. We just don't think we want to take on that exposure and pass it on to our customers. And so we haven't done that. So I think those are the real differences that are created. Any other question you had, Tom?
Thomas Gallagher: Yes. And just for a follow-up, the weaker persistency in Japan. Can you talk a little bit about what you're seeing there from a product standpoint? Is that cancer and medical that you're seeing it on? And do -- is it just lapsing of coverage? Or is it switching to other companies, do you suspect?
Max Broden: So Tom, let me take that. One of the main reasons is that we obviously have an aging block of in-force. So our new sales is lower than our lapsation. That means you have a natural aging of the overall block, yes. When you have that, then you're going to see some higher surrenders, lapses and also mortality associated with the overall block. So it's very natural when you have an aging block that you have higher lapses. That in combination with -- we've also now -- in the last 5, 6 years, we moved into a little bit of a shorter product cycles. When you have that and you refresh products, you tend to have a little bit higher structural lapse and reissue come through your block. So I would point those are the 2 main reasons why we are probably in an environment now where you have a slightly lower persistency now structurally than what we did see 5, 6 years ago.
Operator: The next question comes from Jimmy Bhullar with JPMorgan.
Jamminder Bhullar: So the first question is just along the lines of what's been discussed already. And I think Virgil mentioned this as well. This is in your press release also, Dan. Just disciplined underwriting is not something that people generally associate with Aflac because your products have pretty high margins, just given the nature of your business. So I'm wondering what's changed? Because it seems like the environment for pricing in your business -- with higher interest rates, you could potentially even price them better than before. So wondering if it's outside factors that have gotten worse? And maybe you could talk about the U.S. as well, where you're seeing your competitors trying to be more aggressive? Or what's really different now than before? Because it's not like before you weren't trying to be disciplined, right? So just anything that you could sort of highlight on that, especially in the U.S. market, you talked a little bit about Japan.
Virgil Miller: Yes. Let me add to that. Again, this is Virgil. I just want to say that what you're seeing is the evolution of our block of business. Our group voluntary benefit business has continued to grow over the past several years. And really, when we talk about that underwriting discipline, that is where you're most are going to see that. If there's strong competition out there, fierce competition in the group business, and what we're doing is making sure though that we are able not only to compete, but we want to look at the business that yields profits.
So any time you bring in new business on the books, of course, there is acquisition expenses and everything that go into that, we want to make sure that we're getting the right business on the books that has the tendency to persist. So we're able to end up absolutely making profit on that business over a couple of years' period.
Daniel Amos: And if you think about it a minute, it will make plenty of sense is that -- you take an account that has high lapsation, then you have a low benefit ratio and you have a high expense ratio and basically no profit. So you actually improve every aspect of the business -- the overall business when you just don't write it. And that's what we've been looking at and seeing and then that allows us by doing that for our -- as we've increased benefits and other policies to move it up and give a better value. So it's a good balance that we think ultimately creates value not only for the policyholder, but ultimately for the shareholders as well.
Jamminder Bhullar: Okay. And then, Max, do you have an update on the Japan ESR and its potential impact on your Bermuda reinsurance or just overall capital management strategy?
Max Broden: So our ESR in Japan continues to track well. We are running a little bit north of 250% on our ESR based on our internal model. We would expect relatively soon in the second quarter for the FSA to come up with a final calibration. I would not anticipate that, that would have a material impact on our -- i.e., the difference between the FSA calibration and our current internal model. So I wouldn't expect to have that number move materially.
But then obviously, we will assess the ESR based on that, and we will talk about it in more detail in December. But currently, we're tracking on our internal model a bit north of 250%.
Operator: The next question comes from Joel Hurwitz with Dowling and Partners.
Joel Hurwitz: So Japan continues to see pretty strong remeasurement gains. Can you just talk about the underlying claim trends that you're seeing there? And I guess if this level of favorability of the remeasurement gains persists, should we likely see a bigger unlocking this year or would more experience be needed?
Max Broden: So Joe, the main driver continues to be the hospitalization trends that have been favorable for a long, long period of time, and they quite frankly have continued to improve. The way we do -- when we do our reserving, we are looking to true up to current experience, but we don't necessarily anticipate that it will be a continued future improvement in that experience. And that's why you see these -- if the hospitalization trends continue to improve from current levels, then you could see in the future but that will lead to future remeasurement gains as well. But if they stabilize at current levels, then you wouldn't necessarily see that.
Joel Hurwitz: Okay. Makes sense. And then just in Japan expenses, they came in very favorable this quarter. How much of that was cost controls that could be sustainable longer term versus just seasonality or timing?
Max Broden: Yes. There's a significant element of both seasonality and timing in this number. And for the full year, we are tracking towards our expense ratio outlook of 19% to 21%.
Operator: The next question comes from Josh Shanker with Bank of America.
Joshua Shanker: There's a lot of news out there right now about the Japanese government doing some major intervention to support the yen. What does that mean for the cost of your hedging program?
Max Broden: So Josh, volatility can obviously impact the pricing of options. That will be -- that together with all the other sort of normal inputs into the pricing of an option would be the main impact from that. The level itself has less impact to the ultimate cost of those put options. So at this point, we see relatively limited impact to the pricing of options. Quite frankly, I think that the volatility in the yen -- even though it's been trending, the short-term volatility has been quite low recently.
So given that, we don't see any significant impact. I would tell you, though, that obviously -- that there's been a significant move overall in the yen because it's been trending and it has been weakening. And that obviously has an impact to all of our financial statements and capital ratios. The way we approach this is that we take an economic view and we try to protect the economic value of Aflac Japan with a holding company lens. And we feel that we are very well protected with the 3 levers that we are using to do that. That being the U.S. dollar assets we hold in a Japanese general account. That being the yen-denominated debt that we issue out of the holding company and then also the FX forwards that we have at the holding company. So we have designed this program with these kind of moves in mind. And at this point, the program overall is performing very well.
Joshua Shanker: And look, I don't want to lessen the significance of a very large dividend increase as well as a lot of shares bought back in the quarter, but it seems to me that the capital ratios are even higher now at the end of the first quarter than they were at the end of this past year. I've been harassing David a little bit on better color, but can you walk through all the gating factors in your internal model that guide your willingness to return capital to shareholders?
Max Broden: So the overall return on capital to shareholders is really, quite frankly, driven by, number one, satisfy the capital ratios in the subsidiaries, and that means all of the subsidiaries. Then we look at the pool of capital that we have at the holding company, which currently sits at $3.7 billion on an unencumbered basis, which is roughly $2 billion north of our minimum liquidity level. We then think about what is the capital generation going forward. And that helps us then think about how we can deploy capital, both short term, i.e. in the next couple of quarters, but also long term, i.e., thinking about what it's going to look like over the next 2, 3, 5 years as well.
That helps us sort of guide then also what kind of returns we can expect on dividend, buybacks, et cetera, when we take these into account what other alternatives we have for that capital. And obviously, we try to deploy the capital in the areas where we think we can get the best IRR.
Operator: The next question comes from Wes Carmichael with Autonomous Research.
Wesley Carmichael: In the transitional real estate portfolio, Max, I think you mentioned foreclosing on a loan and taking it on balance sheet as real estate owned. Can you just talk about are there other loans that you're monitoring right now? And maybe just give us an update on the size of the overall watchlist there?
Bradley Dyslin: Sure. Wes, this is Brad Dyslin. In the quarter, we saw our overall commercial real estate, which is predominantly the transitional real estate, as you've called out, the watchlist has been relatively stable. Our overall foreclosure watchlist is about $1.2 billion. Of that, about half is in active workout proceedings where we are fully prepared to foreclose on the property. We did have one, as you mentioned, that we foreclosed in the quarter. We were actually able to book a small gain on that. The accounting rules are such that if the appraised value exceeds our loan value, we're able to book it at the higher value. It's a pretty small number, but it does highlight the value of disciplined underwriting and maintaining a good, solid loan-to-value on the underlying assets.
Generally, things were stable in the quarter. We are seeing some very early signs of life in the market. We're seeing headlines about a lot of capital being raised in different outlets, focused on commercial real estate. That will certainly help with liquidity. It's a little bit early, but we're optimistic that we could be turning a corner here in the next couple of quarters. Of course, all eyes are on the Fed right now to see the impact that will have. But all in all, nothing really significant to happen to our watchlist in the quarter.
Wesley Carmichael: Thanks, Brad. And just turning to the U.S., could you maybe just talk about agent recruiting. What's the environment like given the strong employment in the U.S.? And are you kind of expecting that to change any in your outlook there?
Virgil Miller: Yes. So I would say it's definitely a tough environment we're recruiting for commission roles out there. Still, I would tell you, if you look back at Q1 of 2023, it was a strong Q1 quarter for us. So this year, we knew we had a tough comparison. And so therefore, I would tell you we expect it to be slightly down. So I'm not throwing off about the performance of Q1. I'm expecting us to rebound and continue to recruit, develop, convert, train and actually build up on average we can produce as going forward. Again, knowing the environment is tough, we just have to recruit differently. We're deploying different means to make sure we hit our expected numbers this year.
Operator: The next question comes from Suneet Kamath with Jefferies.
Suneet Kamath: I wanted to start with Japan sales. It seems like one of the issues, I think, that you're having is the mix of sales between exclusive and nonexclusive channels. So my question is, what percentage of your sales come from these nonexclusive channels? And relatedly, are you behind the industry in terms of the mix from that channel?
Daniel Amos: Hold on there. Let me -- guys, can you hear. Did you all hear the question, Koide?
Masatoshi Koide: Yes. We will answer to that question.
Daniel Amos: Hold on, just 1 second, they'll translate.
Koichiro Yoshizumi: [interpreted] This is Yoshizumi. I will be answering your questions. I'm sorry, this is translator speaking. I just needed to clarify what Yoshizumi said about the numbers that he mentioned. Here I go.
In terms of the number of exclusive and nonexclusive agencies, 60% are exclusive agencies and 40% are nonexclusive agencies. That is in terms of the number of sales agencies, but then when it comes to sales, it's 70-30, exclusive agencies, 70% and nonexclusive agencies 40% (sic) [ 30% ]. It's not that which is larger, which is smaller that really matters, but it is what it is.
In addition to explaining about our nonexclusive agencies channel, there are particular agencies that are called large nonexclusive agencies among the nonexclusive agency channel. And the sales from that large nonexclusive agency channel accounts for about 5% of our sales.
Suneet Kamath: The bigger question is, are you behind the curve here, right? It seems like the industry is moving towards these nonexclusive agencies. That's my sense. And if it's only 5% in terms of these large nonexclusive agencies, is that just going to be an ongoing headwind in terms of your sales growth? Or do you have strategies to gain share in that channel?
Masatoshi Koide: [interpreted] Let me start out. This is Koide from Aflac Japan speaking. So first of all, let me just clarify our agency structure, our agency purpose. Ever since our foundation in Aflac Japan, we have always had exclusive agency channel as our main channel plus the so-called nonexclusive agencies that sells mainly our product in cancer and medical insurance area. And these are the main agencies that we have been dealing with.
And this, in fact, is the strength of Aflac Japan. And because this just means that there are many agencies that are very loyal to Aflac. And as you know, other companies are entering into agency channel in recent years. Because they are new entries, they are not able to build their own exclusive channel anymore. So as a result, what they've been doing is to go into the nonexclusive channel, especially trying to deal with the large nonexclusive agencies to increase their sales.
So in other words, as we mentioned, the sales from large nonexclusive agencies is small in Aflac's overall sales. However, this does not mean that we are any behind other insurance companies because we have our strength. This is in fact, our strength because we have our own exclusive channels. But then at the same time, it is also a fact that the market of large nonexclusive agency customers is increasing because the main customers of large nonexclusive agencies is young and middle aged customers.
So however, as a result, what we need to do to grow Aflac Japan going forward is not just focus on exclusive agencies, but we also need to start focusing more on large nonexclusive agencies. And that has been the strategy for the past few years. And as a result of that, what we have done last year is to launch a new medical insurance product, which we have been able to sell a lot through our large nonexclusive agencies. Because we have targeted mainly young and middle aged customers who are using this medical insurance. So as a result of this, we have had a very large growth in our medical insurance sales in the first quarter this year.
Daniel Amos: Suneet, let me try to summarize, because I think it's important here. Number one is, in the nonexclusive area, this isn't something new. If you go back and you look, and you've been around a long time, you'll remember that there was this major agency that was independent and other competitors were selling for them, we ended up selling for them. They had been in the cell phone business and transferred over to the insurance business.
We found a way to get into that market. We ended up selling a lot with them. They ended up going a different direction. But the point being is, wherever the business is, we'll be there as the leader in the third sector product. And yes, we do have a strategy. And yes, we do plan on winning. But the point that I think Aflac Japan is making is the bread and butter of everything we do are the agencies that we've had since the inception. That along now with Japan Post has made a big difference. Again, Japan Post being only cancer. But all in all, it's what's dominated our business, and we will be ready to handle that. And it's really nothing new. It was going on 15 years ago.
Masatoshi Koide: [interpreted] Dan, thank you. And I would like to add a little bit more color to that. We are really truly working on the large nonexclusive agency channel right now. However, as Dan mentioned, we have Japan Post, we have exclusive agencies, we have nonexclusive agencies and as I mentioned, we have Japan Post channel as well as other business partners and bank channel. So we have this variety of channels that sell our third sector products. And so that is how we are going to be increasing and growing our sales.
Koichiro Yoshizumi: [interpreted] So this is Yoshizumi once again. Let me just add a little bit more information to your question. The large nonexclusive agencies, the main product that they sell to a customer is the first sector product. And Aflac, our main products are cancer and medical insurance products and the total number of policies of cancer and medical added altogether combined, we are #1 in overall Japan. So we truly believe that we will be able to increase the number of sales through other channels as well. And I do think that our driver will be our exclusive agencies.
Daniel Amos: Right, I think we've answered that question. If you need a follow-up, we'll be glad to do that. But David?
David Young: Betsy, I think that's our last call, correct?
Operator: Correct. I'd like to hand it back over to David Young for any closing remarks.
David Young: Yes. Thank you all very much for joining us this morning. And in the coming months, you'll get more information about our financial analyst briefing at the New York Stock Exchange on December 3. And if you have any questions that you want to follow up, please reach out to Investor and Rating Agency Relations. We will talk to you again. Have a great day.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
[Portions of this transcript that are marked [interpreted] were spoken by an interpreter present on the live call.] | [
{
"speaker": "Operator",
"text": "Good day, and welcome to the Aflac Incorporated First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President, Investor and Rating Agency Relations. Please go ahead."
},
{
"speaker": "David Young",
"text": "Good morning, and welcome. Thank you for being here a bit earlier than our usual start time. This morning, Dan Amos, Chairman, CEO and President of Aflac Incorporated, will provide an overview of our results and operations in Japan and the United States. Then Max Broden, Executive Vice President and CFO of Aflac Incorporated, will provide an update on our financial results and current capital and liquidity."
},
{
"speaker": "Daniel Amos",
"text": "Thank you, David, and good morning, and we're glad you joined us at this earlier hour. The first quarter marked a good start for the year in terms of earnings, but proved to be challenging for sales. Aflac Incorporated delivered another solid earnings result. Net earnings per diluted share for the quarter were $3.25. On an adjusted basis, earnings per diluted share were up 7.1% to $1.66."
},
{
"speaker": "Max Broden",
"text": "Thank you for joining me, as I provide a financial update on Aflac Incorporated's results for the first quarter of 2024."
},
{
"speaker": "David Young",
"text": "Thank you, Max. Before we begin, I just want to remind everyone, please mark your calendars for our financial analyst briefing on December 3 at the New York Stock Exchange. We'll have more information coming out. [Operator Instructions]."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] The first question today comes from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, starting with U.S. sales, which you guys said were weaker than expected in the quarter, but you did reaffirm the longer-term guidance for sales in that business. So can you just give us a sense of how you expect sales in the U.S. to trend from here?"
},
{
"speaker": "Virgil Miller",
"text": "This is Virgil from the U.S. First, let me start with a little bit more color on how sales performed in Q1. As you mentioned, they were a little bit softer for Q1. A couple of drivers for that. First, let me start with our plans, our life, absence and disability business. Normally, that is a business that takes place the latter part of the year. Well, last year, in 2023, we did have some business process in Q1, so therefore, we were down with that comparison. That is an anomaly. That normally doesn't happen. So again, I expect continued strong performance from that line of business for the remainder of the year. So that was a timing element."
},
{
"speaker": "Elyse Greenspan",
"text": "And then my follow-up, shifting to sales in Japan. The third sector sales went negative this quarter. You guys did highlight some initiatives you have to improve sales in Japan. But just hoping you could provide more color specifically on how you expect the third sector sales to trend over the course of 2024."
},
{
"speaker": "Daniel Amos",
"text": "Let me let Aflac Japan answer that, but I think the most important thing is we still expect to attain our objective for the full year. So Koide, would you mind taking that or Yoshizumi."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[interpreted] Thank you for the question. This is Yoshizumi, I will be answering your question. Starting from 2024, what we are expecting is that we expect to exceed 2023 results. Due to the following reasons, we are expecting our sales will recover. Number one, we are planning to enhance our associates' channel sales agents, I mean increase the number of sales associates. And in 2023, we approximately hired 600 new sales agents -- recruited and have enhanced their training. We are expecting that these 600 will become more productive in the second quarter and be successful."
},
{
"speaker": "Operator",
"text": "The next question comes from Tom Gallagher with Evercore."
},
{
"speaker": "Thomas Gallagher",
"text": "Just wanted to circle back on Japan sales. Do you think the issue, as you try and assess it today, is more of an industry issue? Is it Aflac-specific? The reason I ask is I think you mentioned you're deliberately not underwriting certain products in Japan. When I hear that, I think that implies there's some irrational pricing or product features that you don't like. So just a little bit of color on what's going on? Is it medical, where that's happening? And overall, how do you see that playing out?"
},
{
"speaker": "Daniel Amos",
"text": "Let's let our Japanese cover that, and I don't -- I'll pick up on it a little bit more, too."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[interpreted] This is Yoshizumi once again. Let me answer your questions. Regarding the medical insurance sales, we have been increasing our sales on year-on-year basis, especially to those customers under age 50 or 40 and below. And also, this -- our sales in large nonexclusive agency sales on a year-on-year basis, increasing significantly this year. And this large nonexclusive agency sales is a benchmark to see how well the medical insurance is doing."
},
{
"speaker": "Masatoshi Koide",
"text": "[interpreted] This is Aflac Japan, Koide. I would like to be adding a few comments. In Japan right now, third sector sales is becoming more and more competitive year-on-year. And our strategy is to have solid sale by meeting these customers under the very competitive situation by launching new products in both medical and cancer insurance. And we'd like to do this in a timely manner by really taking in the needs of customers."
},
{
"speaker": "Thomas Gallagher",
"text": "Dan, anything you would add? Or should I ask a follow-up?"
},
{
"speaker": "Daniel Amos",
"text": "Yes. Okay. Let me make a couple of comments, and then anything else you want to ask, we'll be glad. First of all, our cancer insurance is doing very well, both through our existing distribution channel and Japan Post. The other thing I would say is that the medical products are more competitive, and we have to continue to watch that. That's really nothing new, but it hasn't slacked up. And then we don't sell the foreign currency products that some of our competitors sell. We just don't think we want to take on that exposure and pass it on to our customers. And so we haven't done that. So I think those are the real differences that are created. Any other question you had, Tom?"
},
{
"speaker": "Thomas Gallagher",
"text": "Yes. And just for a follow-up, the weaker persistency in Japan. Can you talk a little bit about what you're seeing there from a product standpoint? Is that cancer and medical that you're seeing it on? And do -- is it just lapsing of coverage? Or is it switching to other companies, do you suspect?"
},
{
"speaker": "Max Broden",
"text": "So Tom, let me take that. One of the main reasons is that we obviously have an aging block of in-force. So our new sales is lower than our lapsation. That means you have a natural aging of the overall block, yes. When you have that, then you're going to see some higher surrenders, lapses and also mortality associated with the overall block. So it's very natural when you have an aging block that you have higher lapses. That in combination with -- we've also now -- in the last 5, 6 years, we moved into a little bit of a shorter product cycles. When you have that and you refresh products, you tend to have a little bit higher structural lapse and reissue come through your block. So I would point those are the 2 main reasons why we are probably in an environment now where you have a slightly lower persistency now structurally than what we did see 5, 6 years ago."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar with JPMorgan."
},
{
"speaker": "Jamminder Bhullar",
"text": "So the first question is just along the lines of what's been discussed already. And I think Virgil mentioned this as well. This is in your press release also, Dan. Just disciplined underwriting is not something that people generally associate with Aflac because your products have pretty high margins, just given the nature of your business. So I'm wondering what's changed? Because it seems like the environment for pricing in your business -- with higher interest rates, you could potentially even price them better than before. So wondering if it's outside factors that have gotten worse? And maybe you could talk about the U.S. as well, where you're seeing your competitors trying to be more aggressive? Or what's really different now than before? Because it's not like before you weren't trying to be disciplined, right? So just anything that you could sort of highlight on that, especially in the U.S. market, you talked a little bit about Japan."
},
{
"speaker": "Virgil Miller",
"text": "Yes. Let me add to that. Again, this is Virgil. I just want to say that what you're seeing is the evolution of our block of business. Our group voluntary benefit business has continued to grow over the past several years. And really, when we talk about that underwriting discipline, that is where you're most are going to see that. If there's strong competition out there, fierce competition in the group business, and what we're doing is making sure though that we are able not only to compete, but we want to look at the business that yields profits."
},
{
"speaker": "Daniel Amos",
"text": "And if you think about it a minute, it will make plenty of sense is that -- you take an account that has high lapsation, then you have a low benefit ratio and you have a high expense ratio and basically no profit. So you actually improve every aspect of the business -- the overall business when you just don't write it. And that's what we've been looking at and seeing and then that allows us by doing that for our -- as we've increased benefits and other policies to move it up and give a better value. So it's a good balance that we think ultimately creates value not only for the policyholder, but ultimately for the shareholders as well."
},
{
"speaker": "Jamminder Bhullar",
"text": "Okay. And then, Max, do you have an update on the Japan ESR and its potential impact on your Bermuda reinsurance or just overall capital management strategy?"
},
{
"speaker": "Max Broden",
"text": "So our ESR in Japan continues to track well. We are running a little bit north of 250% on our ESR based on our internal model. We would expect relatively soon in the second quarter for the FSA to come up with a final calibration. I would not anticipate that, that would have a material impact on our -- i.e., the difference between the FSA calibration and our current internal model. So I wouldn't expect to have that number move materially."
},
{
"speaker": "Operator",
"text": "The next question comes from Joel Hurwitz with Dowling and Partners."
},
{
"speaker": "Joel Hurwitz",
"text": "So Japan continues to see pretty strong remeasurement gains. Can you just talk about the underlying claim trends that you're seeing there? And I guess if this level of favorability of the remeasurement gains persists, should we likely see a bigger unlocking this year or would more experience be needed?"
},
{
"speaker": "Max Broden",
"text": "So Joe, the main driver continues to be the hospitalization trends that have been favorable for a long, long period of time, and they quite frankly have continued to improve. The way we do -- when we do our reserving, we are looking to true up to current experience, but we don't necessarily anticipate that it will be a continued future improvement in that experience. And that's why you see these -- if the hospitalization trends continue to improve from current levels, then you could see in the future but that will lead to future remeasurement gains as well. But if they stabilize at current levels, then you wouldn't necessarily see that."
},
{
"speaker": "Joel Hurwitz",
"text": "Okay. Makes sense. And then just in Japan expenses, they came in very favorable this quarter. How much of that was cost controls that could be sustainable longer term versus just seasonality or timing?"
},
{
"speaker": "Max Broden",
"text": "Yes. There's a significant element of both seasonality and timing in this number. And for the full year, we are tracking towards our expense ratio outlook of 19% to 21%."
},
{
"speaker": "Operator",
"text": "The next question comes from Josh Shanker with Bank of America."
},
{
"speaker": "Joshua Shanker",
"text": "There's a lot of news out there right now about the Japanese government doing some major intervention to support the yen. What does that mean for the cost of your hedging program?"
},
{
"speaker": "Max Broden",
"text": "So Josh, volatility can obviously impact the pricing of options. That will be -- that together with all the other sort of normal inputs into the pricing of an option would be the main impact from that. The level itself has less impact to the ultimate cost of those put options. So at this point, we see relatively limited impact to the pricing of options. Quite frankly, I think that the volatility in the yen -- even though it's been trending, the short-term volatility has been quite low recently."
},
{
"speaker": "Joshua Shanker",
"text": "And look, I don't want to lessen the significance of a very large dividend increase as well as a lot of shares bought back in the quarter, but it seems to me that the capital ratios are even higher now at the end of the first quarter than they were at the end of this past year. I've been harassing David a little bit on better color, but can you walk through all the gating factors in your internal model that guide your willingness to return capital to shareholders?"
},
{
"speaker": "Max Broden",
"text": "So the overall return on capital to shareholders is really, quite frankly, driven by, number one, satisfy the capital ratios in the subsidiaries, and that means all of the subsidiaries. Then we look at the pool of capital that we have at the holding company, which currently sits at $3.7 billion on an unencumbered basis, which is roughly $2 billion north of our minimum liquidity level. We then think about what is the capital generation going forward. And that helps us then think about how we can deploy capital, both short term, i.e. in the next couple of quarters, but also long term, i.e., thinking about what it's going to look like over the next 2, 3, 5 years as well."
},
{
"speaker": "Operator",
"text": "The next question comes from Wes Carmichael with Autonomous Research."
},
{
"speaker": "Wesley Carmichael",
"text": "In the transitional real estate portfolio, Max, I think you mentioned foreclosing on a loan and taking it on balance sheet as real estate owned. Can you just talk about are there other loans that you're monitoring right now? And maybe just give us an update on the size of the overall watchlist there?"
},
{
"speaker": "Bradley Dyslin",
"text": "Sure. Wes, this is Brad Dyslin. In the quarter, we saw our overall commercial real estate, which is predominantly the transitional real estate, as you've called out, the watchlist has been relatively stable. Our overall foreclosure watchlist is about $1.2 billion. Of that, about half is in active workout proceedings where we are fully prepared to foreclose on the property. We did have one, as you mentioned, that we foreclosed in the quarter. We were actually able to book a small gain on that. The accounting rules are such that if the appraised value exceeds our loan value, we're able to book it at the higher value. It's a pretty small number, but it does highlight the value of disciplined underwriting and maintaining a good, solid loan-to-value on the underlying assets."
},
{
"speaker": "Wesley Carmichael",
"text": "Thanks, Brad. And just turning to the U.S., could you maybe just talk about agent recruiting. What's the environment like given the strong employment in the U.S.? And are you kind of expecting that to change any in your outlook there?"
},
{
"speaker": "Virgil Miller",
"text": "Yes. So I would say it's definitely a tough environment we're recruiting for commission roles out there. Still, I would tell you, if you look back at Q1 of 2023, it was a strong Q1 quarter for us. So this year, we knew we had a tough comparison. And so therefore, I would tell you we expect it to be slightly down. So I'm not throwing off about the performance of Q1. I'm expecting us to rebound and continue to recruit, develop, convert, train and actually build up on average we can produce as going forward. Again, knowing the environment is tough, we just have to recruit differently. We're deploying different means to make sure we hit our expected numbers this year."
},
{
"speaker": "Operator",
"text": "The next question comes from Suneet Kamath with Jefferies."
},
{
"speaker": "Suneet Kamath",
"text": "I wanted to start with Japan sales. It seems like one of the issues, I think, that you're having is the mix of sales between exclusive and nonexclusive channels. So my question is, what percentage of your sales come from these nonexclusive channels? And relatedly, are you behind the industry in terms of the mix from that channel?"
},
{
"speaker": "Daniel Amos",
"text": "Hold on there. Let me -- guys, can you hear. Did you all hear the question, Koide?"
},
{
"speaker": "Masatoshi Koide",
"text": "Yes. We will answer to that question."
},
{
"speaker": "Daniel Amos",
"text": "Hold on, just 1 second, they'll translate."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[interpreted] This is Yoshizumi. I will be answering your questions. I'm sorry, this is translator speaking. I just needed to clarify what Yoshizumi said about the numbers that he mentioned. Here I go."
},
{
"speaker": "Suneet Kamath",
"text": "The bigger question is, are you behind the curve here, right? It seems like the industry is moving towards these nonexclusive agencies. That's my sense. And if it's only 5% in terms of these large nonexclusive agencies, is that just going to be an ongoing headwind in terms of your sales growth? Or do you have strategies to gain share in that channel?"
},
{
"speaker": "Masatoshi Koide",
"text": "[interpreted] Let me start out. This is Koide from Aflac Japan speaking. So first of all, let me just clarify our agency structure, our agency purpose. Ever since our foundation in Aflac Japan, we have always had exclusive agency channel as our main channel plus the so-called nonexclusive agencies that sells mainly our product in cancer and medical insurance area. And these are the main agencies that we have been dealing with."
},
{
"speaker": "Daniel Amos",
"text": "Suneet, let me try to summarize, because I think it's important here. Number one is, in the nonexclusive area, this isn't something new. If you go back and you look, and you've been around a long time, you'll remember that there was this major agency that was independent and other competitors were selling for them, we ended up selling for them. They had been in the cell phone business and transferred over to the insurance business."
},
{
"speaker": "Masatoshi Koide",
"text": "[interpreted] Dan, thank you. And I would like to add a little bit more color to that. We are really truly working on the large nonexclusive agency channel right now. However, as Dan mentioned, we have Japan Post, we have exclusive agencies, we have nonexclusive agencies and as I mentioned, we have Japan Post channel as well as other business partners and bank channel. So we have this variety of channels that sell our third sector products. And so that is how we are going to be increasing and growing our sales."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[interpreted] So this is Yoshizumi once again. Let me just add a little bit more information to your question. The large nonexclusive agencies, the main product that they sell to a customer is the first sector product. And Aflac, our main products are cancer and medical insurance products and the total number of policies of cancer and medical added altogether combined, we are #1 in overall Japan. So we truly believe that we will be able to increase the number of sales through other channels as well. And I do think that our driver will be our exclusive agencies."
},
{
"speaker": "Daniel Amos",
"text": "Right, I think we've answered that question. If you need a follow-up, we'll be glad to do that. But David?"
},
{
"speaker": "David Young",
"text": "Betsy, I think that's our last call, correct?"
},
{
"speaker": "Operator",
"text": "Correct. I'd like to hand it back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Yes. Thank you all very much for joining us this morning. And in the coming months, you'll get more information about our financial analyst briefing at the New York Stock Exchange on December 3. And if you have any questions that you want to follow up, please reach out to Investor and Rating Agency Relations. We will talk to you again. Have a great day."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AFL | 1 | 2,025 | 2025-05-01 08:00:00 | Operator: Good day, and welcome to Aflac Incorporated First Quarter 2025 Earnings Call. All participants will be in listen-only mode. [Operator Instructions]. Please note, this event is being recorded. I would like now to turn the conference over to David Young, Vice President of Capital Markets. Please go ahead.
David Young: Good morning, and welcome. Thank you for joining us for Aflac Incorporated's First Quarter 2025 Earnings Call. This morning, Dan Amos, Chairman and CEO of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then Max Broden, Senior Executive Vice President and CFO of Aflac Incorporated, will provide more detail on our first quarter financial results, current capital and liquidity. These topics are also addressed in the materials we posted with our earnings release, financial supplement and quarterly CFO video update on investors.aflac.com. For Q&A today, we are also joined by Virgil Miller, President of Aflac Incorporated and Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release with reconciliations of certain non-U.S. GAAP measures and related earnings materials are available on investors.aflac.com. I'll now hand the call over to Dan. Dan?
Daniel Amos: Thank you, David, and good morning, everyone. We're glad you joined us. Although we just have one quarter under our belt, the first quarter marked a good start for the year. Aflac Incorporated reported net earnings per diluted share of $0.05, which was significantly impacted by net investment losses this quarter compared to net investment gains in the first quarter of 2024. At the same time, the company reported adjusted earnings per diluted share of $1.66, which is unchanged from the first quarter of 2024. Beginning with Aflac Japan, I am pleased with the 12.6% year-over-year sales increase. This quarter sales reflected a continued significant contribution consuming costs and a 6.3% increase from cancer insurance sales, taking into account Japan's demographics and product strategy is to fit the needs of customers throughout all stages of life. Acquiring younger customers is critical to our success. We believe Tsumitasu helped us appeal to and more importantly, reach younger customers in Japan. Our strong sales in Japan reflect the success our agencies have had selling Tsumitasu. As the pioneer of cancer insurance and leading third sector insurer, we also aim to sell these Tsumitasu policyholders a medical policy or cancer policy. We have also launched the initial stage of sales in Miraito, our newest cancer insurance on March 17th. While it is still very early, the results that we have seen thus far have been positive. As of April 21st, the product has been available through all of Japan's sales channels. Our ability to maintain strong premium persistency is a testament to Aflac's reputation and customer recognition of the value of our products. By maintaining this level of persistency and adding new premium through sales, we are partially offsetting the impact of reinsurance and policies reaching paid-up status. This will be vital to our future growth of Aflac Japan. Turning to Aflac U.S., I was pleased by the 3.5% year-over-year increase in sales and encouraged by the momentum we are seeing within all areas of our group business, especially our group life and disability. As well as network dental. In addition, we believe our efforts to drive more profitable growth with a stronger underwriting discipline have contributed to our strong premium persistency and net earned premiums growth. At the same time, Aflac U.S. has maintained its prudent approach to expense management and maintaining a strong pretax margin as Max will expand on in a moment. In both Japan and the United States, I believe that consumers need the products and solutions, Aflac offers more than ever for our policyholders who become claimants. Aflac is more than an insurance company. We are a partner in Health, a supporter of families during their times of need and a pioneer and leader in the industry. We are leveraging every opportunity to convey how our products can help fill the gaps during challenging times, providing not just financial assistance, but also compassion and care. At the same time, we continue to generate strong capital and cash flows, while maintaining our commitment to prudent liquidity and capital management. We have been very pleased with our investments, which have continued to produce strong net investment income. As an insurance company, our primary responsibility is to fulfill the promises we make to the policyholders, while being responsive to the needs of our shareholders. Our solid portfolio supports our promise to our policyholders as does our commitment to maintaining strong capital ratios. We balance this financial strength with tactical capital deployment. I am very happy with how management has handled capital deployment and liquidity and specifically how well we've adapted to this environment. In the first quarter, Aflac Incorporated deployed $900 million in capital to repurchase 8.5 million shares of our stock. Additionally, we treasure our track record of 42 consecutive years of dividend growth at the same time. We have maintained our position among companies with the highest return on capital and the lowest cost of capital in the industry, combined with dividends. This means we delivered $1.2 billion back to the shareholders in the first quarter of 2025. We believe in the underlying strength of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. On an ongoing basis, we are taking action to reinforce our leading position and build on our momentum. I will now turn the program over to Max to cover more details of the financial results. Max?
A - Max Broden: Thank you, Dan. Thank you for joining me, as I'll provide a financial update on Aflac Incorporated results for the first quarter of 2025. For the quarter, adjusted earnings per diluted share was flat year-over-year at $1.66, with a $0.01 negative impact from FX in the quarter. In this quarter, remeasurement gains on reserves totaled $41 million, reducing benefits. Variable investment income ran $27 million below our long-term return expectations, while one make-whole call generated income of $16 million. Adjusted book value per share, excluding foreign currency remeasurement increased 2.2%. The adjusted ROE was 12.7% and 15.6%, excluding foreign currency remeasurement, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment. Net and premiums for the quarter declined 5%. Aflac Japan's underlying earned premiums, which adjusts net earned premiums to exclude the impact of deferred profit liability, paid-up policies and reinsurance declined 1.4%. We believe this metric better provides insight into long-term premium trends. Japan's total benefit ratio came in at 65.8% for the quarter, down 120 basis points year-over-year. The third sector benefit ratio was 56.3% for the quarter, down approximately 120 basis points year-over-year. We estimate the impact from remeasurement gains to be approximately 150 basis points favorable to the benefit ratio in Q1 2025. Long-term experience trends as it related to treatment of cancer and hospitalization continue to be in place, leading to continued favorable underwriting experience. Persistency remained solid at 93.8%, which is up 40 basis points year-over-year and in line with our expectations. However, beginning in this quarter, we have revised the premium persistency definition to better reflect the economic trends for the business. As a result, we do not treat annuitization as a lapse for persistency purposes. And this revised definition raised the reported persistency by roughly 30 basis points. Our expense ratio in Japan was 19.6% for the quarter, up 160 basis points year-over-year, driven primarily by an increase in technology expenses. For the quarter, adjusted net investment income in yen terms was down 7.6%, primarily driven by lower floating rate income, the transfer of assets to as like Re Bermuda associated with reinsurance and variable investment income, somewhat offset by higher returns from the structured private credit portfolio. The pretax margin for Japan in the quarter was 31.8%, down 100 basis points year-over-year, but a very good result. Turning to U.S. results. Net earned premium was up 1.8%, persistency increased 60 basis points year-over-year to 79.3%. Our U.S. total benefit ratio came in at 47.7%, 120 basis points higher than Q1 2024, driven by business mix and lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by approximately 100 basis points in the quarter as claims have remained below our long-term expectations. In the quarter, we benefited from favorable underwriting on our small, but growing long-term disability block. Our expense ratio in the U.S. was 37.6%, down 110 basis points year-over-year, primarily driven by platforms improving scale and continuous focus on expense efficiency. Our growth initiatives, group life and disability, network down ambition and direct-to-consumer increase our total expense ratio by 50 basis points for the quarter. This is in line with our expectations, and we would expect this impact to decrease as we continue to approach scale. Adjusted net investment income in the U.S. was down 1.9% for the quarter, primarily driven by lower floating rate income. Profitability in the U.S. segment was very strong with a pretax margin of 20.8%, a 20 basis points decline compared to a year ago. During the quarter, we increased our CECL reserves associated with our commercial real estate portfolio by $2 million net of charge-offs as property values remain at distressed valuations. We also foreclosed on two loans, adding them to our real estate owned portfolio, consistent with our strategy for maximizing recovery values. Our portfolio of first lien senior secured middle market loans continue to perform well with increased CECL reserves of $7 million in the quarter, net of charge-offs. In our corporate segment, we recorded a pretax gain of $43 million. Adjusted net investment income was $47 million higher than last year due to a combination of lower volume of tax credit investments and higher asset balances, which included the impact of the reinsurance transaction in Q4 2024. Our tax credit investments impacted the corporate net investment income line for U.S. GAAP purposes negatively by $8 million in the quarter with an associated credit to the tax line. The net impact to our bottom line was a positive $0.4 million in the quarter. To-date, these investments are performing well and in line with our expectations. Unencumbered holding company liquidity stood at $4.3 billion, $2.6 billion above our minimum balance. We repurchased $900 million of our own stock and paid dividends of $317 million in Q1, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Our capital position remained strong, and we ended the quarter with an SMR above 950%, an estimated regulatory ESR above 250%. Our combined RBC, while not finalized, we estimate to be greater than 600%. These are strong capital ratios, which we actively monitor, stress and manage to withstand credit cycles as well as external shocks. For U.S. statutory, we recorded a $6 million valuation allowance on mortgage loans as an unrealized loss. We ended the quarter March 31, with net ¥5.2 billion of Japan FSA realized gains net of losses for securities impairment. This is well within our expectations and with limited impact to both earnings and capital. Our leverage was 20.7% for the quarter, which is within our target range of 20% to 25%. As we hold approximately 59% of our debt in Yen, this leverage ratio is impacted by move in the Yen-dollar exchange rate. This is intentional and part of our enterprise hedging program protecting the economic value of Aflac Japan in U.S. dollar terms. On a U.S. GAAP basis, we are impacted by moves in the Yen as our Yen-denominated earnings will translate into U.S. dollars at different exchange rates. We currently estimate that every ¥5 to the dollar move would impact our underlying EPS by roughly $0.07. As foreign currency markets have experienced a marked increase in volatility, I would like to reiterate our approach to managing foreign currency exposure. Fundamentally, we size our unhedged U.S. dollar exposure to the estimated economic surplus associated with our Japanese business. At the end of Q1, we held $25.5 billion of unhedged U.S. dollar assets in our Japan general account. Forward contracts at Inc, with a notional balance of $2.7 billion, and $4.4 billion of Yen-denominated debt. We also hold $24.2 billion of notional out-of-the-money put options, which provide tail protection against a large appreciation in the Yen. Adding this up, we feel that we are very well positioned on an economic basis. I'll now turn the call over to David to begin Q&A.
A - David Young: Thank you, Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. You may then rejoin the queue to ask additional questions. We'll now take the first question.
Operator: [Operator Instructions]. Our first question today comes from Tom Gallagher of Evercore ISI. Please go ahead.
Thomas Gallagher: Hey, good morning. Max, just had a few questions on Japan solvency and overall macro sensitivities. I guess my first question is -- why did the ESR ratio declined by so much in Q1? If I just look at the sensitivities, I think the sharp rise in Japan rates should have offset the strengthening of the Yen. Anyway, I'll start with that, and then I have a follow-up. Thanks.
Max Broden: Thank you, Tom. I appreciate the question. You're right that in the first quarter, we saw a small drop in our ESR and that is driven by the Yen strengthening that you saw. That is partially offset by higher Japan interest rates, especially the 30-year GDP rose in the first quarter, and that certainly helped us. That being said, we also had relatively high dividends flowing up from Aflac Japan to Aflac Inc. during the quarter as well. And that's the reason why you see the cash balances at Inc. increasing as much as they did despite very significant capital deployment in terms of dividends and buybacks in the quarter. So -- that's the -- I think that's the missing piece is the dividends flowing up to the holding company.
Thomas Gallagher: That makes sense, Max. And then my follow-up is just in light of everything that's changed macro wise with the Yen now strengthening and looking at where long rates are in Japan. Have you -- I guess, how should we think about that when you think about forward capital planning? Do you still feel that drawing down excess and returning it is the best path forward, you still have considerable excess, so I'm not suggesting you down. But I guess the volatility of capital seems kind of on the high side when they think about sensitivities to what's happened in macro recently. So just curious, are you looking maybe to change philosophy at all on capital return and/or how about just the way you're hedging this? Because I think right now, you have some very deep out of the money hedges, any thought of maybe locking in all of that capital strength or are you fine with the structure you have? Thank you.
Max Broden: So Tom, when we design our capital management, it's really done with a long-term view. It's done running many different scenarios, including stressed scenarios as well. So if you use that as a base, that means that fundamentally, we are not changing the way we are doing our capital management or in a way we are structuring the different instruments that we use for it. And I want to take you back and just think through the underlying business that we conduct, which we sell products that are relatively defensive in the way they behave that going through lapsation, that going through volatility in benefit ratios and underlying profitability as well. That is mirrored up with relatively low asset leverage, which means that the risks associated with our asset portfolio are somewhat limited as well. And when you bake all of that together, it means that our profitability and cash flows are relatively stable and predictable. Now you point out one item, and that is the volatility of our ESR as it relates to FX. And that is something that we have designed ourselves. So when we protect the economic value of Aflac Japan, the main component of that is the $25.7 billion held in U.S. dollars on our Japanese balance sheet. And that is there to obviously help protect the long-term economics of our Aflac Japan business in U.S. dollars, but it does introduce volatility to our ESR ratio. But what we have done is that we have protected details, i.e., we have looked at how much risk are we willing to take on FX as it relates to the e-volatility in the ESR ratio. And that's where we have executed a put option program where most of those puts are currently out of the money by 25% to 30% and that helps cut the tail and the volatility of those. These are one-sided -- that means that we have protection if the Yen strengthens, but if the Yen were to weaken, we keep all of that upside. So if I look at the moves that we have seen in rates, the movement we've seen in FX, I don't see at this point us making any significant changes to the way we are approaching this or hedging this. That being said, obviously, it's something that we closely monitor. And there may be tactical moves in the future around it. But I would -- I would assume that those are relatively minor in the scheme of things. So, so far, we feel like the FX hedging program is working very well and in line with our expectations.
Operator: The next question comes from Jack Matten of BMO Capital Markets. Please go ahead.
Jack Matten: Hi, good morning. Just a question on the new cancer product launch. Can you talk about what you're seeing so far in the uplift of sales you saw this quarter? I know the launch in stages, so maybe you'd see more of a benefit in the second quarter as well. So just curious what your expectations are for sales of that product this year?
Daniel Amos: Well, yes, let me make -- this is Dan. Let me make a couple of comments, and I'm going to turn it over to Aflac Japan. But just in general, I think that we're going to be fine. I think you're going to see these things. The new cancer policy continue to grow. But all in all, I thought Virgil has spent a lot of time in this quarter in Japan. And I'd like for him to take a high-level view and go over both U.S. and Japan and then have the Japanese operation talk about it, Yoshizumi can cover that and then follow up with Max and Brad on any comments they might have in those regards. So Virgil, why don't you just give a few comments, and then let's turn the program over to Japan.
Virgil Miller: Yes. Well, thanks, Dan. I'll just make a few comments. It was a great visit I had to Japan. And I would just say that as Max's point earlier, our business is really more a view from a long-term perspective. And we remain confident in the strategies we have with our products and all services that what we have is what customers need and want. I think too, Dan, I would just add, though, that as you look at Japan in particular, what we've done with the launch of the cancer product, also how we approach the market with similar trials and the focus that we have on selling more third site of products is what will help us during this time. Yes, we do look at economic downturn. Max just shared with you about how we go through that methodology. But specifically on the cancer though. I'm going to let Japan talk about how the launch went into what we see for the remainder of the year. So I'm going to turn it over to you guys.
Koichiro Yoshizumi: [Foreign Language] Thank you for the question. I'm in charge with the marketing sales and let me take that question. [Foreign Language] The new cancer reinsurance was just launched in May this year, but it is progressing as we expected. Sorry, correction, it was launched in March. [Foreign Language] Let me briefly talk about the characteristic of this new product. [Foreign Language] First, we have full and simple coverage. In addition to strengthening coverage, not only during but also before and after treatment, the qualification for payment of benefits have been changed to be easier to understand. [Foreign Language] And it has the flexible coverage design that enables combination and cross-selling with existing policies and other products, i.e., add-on plans for those who already have medical insurance. [Foreign Language] On March 18, our sales was made available, our main state associate channels, Daido and Daiichi. [Foreign Language] And in April, we started the sales at bank channels in Japan Post Group. [Foreign Language] And all the channels have made a great start, and we are still seeing a positive result from all of these channels. [Foreign Language] And let me talk a little bit about our forecast for 2025. [Foreign Language] And we have changed the structure in this January and established a new position with CMO, and this position will supervise the sales and marketing and all brands. [Foreign Language] And at this position we look after that asset formation cancer and medical and whole areas and will be totally design oriented to develop the sales line. [Foreign Language] And we are responding to the ever-changing customer needs with an agility in a cross-functional way by engaging our IT, actuarial and policy service department. [Foreign Language] And we are proud to see the successful marketing activity with the optimum activities conducted at each channel under the lead of the CMO and we are seeing a positive -- with this effort, we are seeing a positive result from cancer insurance that was launched in March. [Foreign Language] We believe the third sector sales will continue to grow with now having a very extensive product lineup with Tsumitasu and the new cancer insurance. [Foreign Language] And we are now also focusing on hiring activities at agents and mainstay associates. [Foreign Language] And with all these efforts, we expect that the 2025 sales will be above 2024. [Foreign Language] That's all.
Jack Matten: Thank you very much. And then just a follow-up on the medical insurance market in Japan. I mean can you talk about competitive dynamics there and how you see the outlook for sales of your medical product?
Koichiro Yoshizumi: [Foreign Language] Once again let me talk about our competitor landscape. [Foreign Language] First of all, about the third sector overall. [Foreign Language] Based on the latest data, we have the largest share of total new policies of cancer and medical insurance or core products in fiscal year 2023. [Foreign Language] In 2025, we expect to maintain our #1 share of new policies by expanding sales of cancer and medical insurance. [Foreign Language] Let me talk about cancer reinsurance. [Foreign Language] Although competition has increased, we are a pioneer in cancer insurance having faced cancer for the longest time in Japan. And the knowledge we have accumulated over 50 years of history is something no other company can have. [Foreign Language] We continue to provide services like [indiscernible] consulting services, unique coinsured service that no other company offers in addition to insurance coverage. By doing so, we will meet the needs of our customers and maintain a competitive advantage. [Foreign Language] And we aim to achieve further sales growth with the new cancer reinsurance product launch in March. [Foreign Language] And moving on to the medical insurance. [Foreign Language] The medical insurance sector is a much more competitive market in cancer reinsurance. This is largely due to the number -- large number of insurance companies entering the market and launching products. We will revise our product line every two years or so in order to gain a higher market share. [Foreign Language] And under this intensified competition in the medical market, we will conduct some optimized activities on each channel and bring about the better results. [Foreign Language] And let me talk about the specific activities that were carried out in Q1. [Foreign Language] We have strengthened the training to our sales agents so that they can provide an easy-to-understand explanation to the consumers. [Foreign Language] And with Tsumitasu, we're proceeding the concurrent sales with the third sector products. [Foreign Language] That's all.
Operator: Our next question comes from John B. Barnidge of Piper Sandler. Please go ahead.
John Barnidge: Good morning. Thank you for the opportunity to ask questions. So my question is focused on remeasurement gains. They continue to be present in both Japan and the U.S. We're further removed around the dislocation in individuals behavior. How should we be thinking about the waterfall or decay of remeasurement gains and will they primarily be concentrated in third quarter? Thank you.
Max Broden: Let me kick it off, and I'll also ask Alycia to maybe give some comments from her perspective as well. So obviously, the third quarter is when we unlock our actuarial assumptions. That means that the third quarter is when we will have the more significant remeasurement gains and losses associated with the claims patterns that we're seeing in the marketplace. In the other quarters, we are truing up the experience from those quarters. That means that they are generally going to be smaller. That being said, we have experienced favorable claims utilization, both in the U.S. and Japan, and this has been in place for a long time and it always -- it goes back to pre-LDTI as well where under legacy gap. You did see this come through as IBNR releases, and that was feeding through into our benefit ratio. And now you're seeing it as remeasurement gains losses coming through under LDTI. So it's a continuation of -- especially in Japan, the long-term trends that we've been seeing there. And in the U.S., to some extent, the shift in claims patterns that we've seen post-COVID. I'll stop there and see if Alycia, if you want to add any color from your perspective?
Alycia Slyck: Thank you, Max. The only thing I'd add is that we do unlock our assumptions annually in the third quarter to reflect all of our best estimate actuarial expenses and our experience to date. And then you'll see that flow through the third quarter earnings. Thank you so much.
John Barnidge: Thanks for the answers. That's it for me.
Operator: The next question comes from Jimmy Bhullar of JPMorgan. Please go ahead.
Jimmy Bhullar: Hey, good morning. So first, I had a question just along the lines of what you were commenting in terms of the dental or medical product in Japan, sales have been weak, and you've pointed out competitors coming out with maybe lower benefit type products and just that affecting your business. Should we assume that if the competitive environment stays the way it is, sales will muddle along at these levels? Or are you doing anything that would suggest that there could be a recovery, because that line has been sort of steadily dropping over time?
Daniel Amos: I'm going to answer that. Let me just say that everything that we do tends to be cyclical in nature with a rebound of a new product and although we can't talk about that because of FSA and the way they operate. As Yoshizumi mentioned, every two years or so, we come back to the table with changes in the marketplace, whether it be consumers and what they want or need or medical treatments and what are happening, whether it's more outpatient than inpatient. Whatever it might be from a medical standpoint or even the cancer insurance standpoint. So this year is the year where cancer insurance should be dominating along with our new product. So we should continue to see that. I can't stress enough how much we like what's going on in the life insurance area of adding new and younger policyholders that we've never had before. And that opens the opportunity to go back and add cancer and medical to them. So this year will be that. I think you can look for next year us to revisit, which campaign we'll be looking at. But all in all, I'm very excited about us making our numbers this year in sales and believe we'll ultimately do that. And the breakdown, although we continue to watch and monitor, it's the overall sales numbers that we want to see us achieve because the profit margins are there for our success long-term.
Jimmy Bhullar: Okay. And then just for Virgil on the Dental business in the U.S., it seems like sales have stabilized following the change in the tech platform, but are you expecting normal production this year and open enrollment? Or is it more likely that that will be next year?
Virgil Miller: Well, thanks, Jimmy, this is Virgil. I do expect us to have a consistent momentum. What I mentioned in the fourth quarter, our focus is on stabilization of that platform, but making sure that the brokers and our veteran agents knew about that we were open for business. And we had a slow start there in Q4, but off to a much better start here in Q1. I can tell you a few things about that. We did invest and making sure we got the right talent. We hired some additional talent from the industry. We maintain the talent that we have there. We continue to invest in the technology to make sure we've got the best portals for the dentists that are doing business with us. As well as making sure there's an easy enrollment process for our agents of our brokers. And then the final thing I mentioned, though, is the partnership we launched that we had now flattish with SKYGEN they're doing a great job of the administrative services that they're providing for us behind the scenes. They are industry-leading third-party administrator out there, and we're pleased with what we've seen. Now having said all of that, we have been going around to each market letting agents know to try it. For those agents that sold the demo product in Q1 along with our voluntary benefits products, their sales were up 20%. My point is that, that's the strategy it works because we look at selling both together. And I think that the more we get that message out, you will see that momentum carrying forward. I expect us to hit the plan that we set for this year, Jimmy.
Jimmy Bhullar: Thank you.
Operator: Our next question comes from Suneet Kamath of Jefferies. Please go ahead.
Suneet Kamath: Great. Thanks. Max, I wanted to come back to the ESR and the one-way hedge that you have. Is that program designed to keep you at your ESR target or is it possible if we see the dollar weaken significantly before those options sort of kick in, your ESR ratio could fall below your target? Thanks.
Max Broden: Thank you, Suneet. So that always depends a little bit on what your starting point is. Generally speaking, we originally designed this to size the risk associated with FX that we're willing to take on. And we generally sized that at around 40 to 45 ESR points. So that will give you a little bit of a sense for the impact and how we have overall size that program. So that means that at that level, we are no longer having any significant FX volatility associated with our ESR. And our starting point today is, and I ran these numbers this morning that we estimate that our ESR as of this morning is around 250%. So it's a good starting point for us.
Suneet Kamath: Okay. That's helpful. And then I wanted to come back to something that we talked about last night in terms of the U.S. weekly average producers. And I think one of the comments around why it was down year-over-year, I think, 11%. Is that more of your agents are selling other non-Aflac products. I just want to get a sense of how prevalent is that? How common is that? And does that create some issues for you in terms of the recovery in sales if they're focused on other companies' products? Thanks.
Virgil Miller: This is Virgil. I'll take that question. I would say that it's anecdotal. I don't have any data for that. And here's what I mean by that. We have engaged our veterans to look at their productivity. Now you can see overall, our productivity is up when you looking at the fat supplement. And that's driven mainly by the production we've got from our veterans, but with brokers also that are in that number, and we're having success in larger case of Aflac. But when you look into the smaller cases, I mean accounts generally averaging less than 50 employees. This is where we need to focus. And I think that comment was made, in particular, when we saw last year, our agents were having success with selling the dental product. If you look at the newest statistics that are out there from LIMRA and from East Birch, dental and steel in the top two products that are being requested and being sold. So having said that, they sold other carriers product. And when you sell that product, you tend to sell to other voluntary benefit products alongside it. What we have done this quarter, though, as I mentioned, is starting to see them return back had a 23% increase in dental sales for Q1. And we -- again, I mentioned the Jimmy a few moments ago that when they sell at dental, overall, they had a 20% overall sales increase for those agents they sold it. What we're going to do this year is focus on those veterans. I made some comp incentives that are tied to that. We're going to explain to them that the dental is stable, is working and really get them back to selling back on a normal basis of Aflac. I have seen the momentum in Q1. I expect that momentum to continue throughout the year.
Suneet Kamath: Hey, good morning. Sorry about that. On Tsumitasu, I know you're targeting younger customers, but I believe in the past, you've indicated that existing customers were or a larger percentage of the sales last year. Is that still the case? Are you seeing more new and younger customers buy the product?
Daniel Amos: The short version is we're seeing more younger people buy the product. So that's what I'd give you is the answer.
Suneet Kamath: Okay. And then just shifting to NII. So last quarter, you indicated there would be some pressure just given the floating rate portfolio, which we saw. I'm just curious how you see NII trending through the rest of the year? Is there a further impact from last year's rate cuts to still flow through?
Daniel Amos: Sure. Thank you, Joe. You're right. We have seen some pressure in first quarter. It's predominantly from the floating rate portfolio. It's both a reduction in balances as well as the roughly 100 basis point decline we've seen in SOFR year-on-year. We're going to be facing that headwind throughout the year. The comps do get a little better later in the year when the differential in SOFR is less because of the Fed action to cut later in the year last year. We are taking steps to try to offset that. We're doing more things to reposition the portfolio to capture higher yields, both in Japan and the U.S. We've also been able to deploy a significant amount of capital in first quarter and take advantage of the wider spreads. And we also took advantage of the wider spreads in April and deployed a significant amount. So we are facing that floating rate headwind, but we think we've got some things in the toolkit that's going to help us offset that.
Max Broden: And Joel, just as a reminder that our floating rate portfolio, it resets with one month and three-month SOFR.
Suneet Kamath: Got it, thank you.
Daniel Amos: Just to follow up, I wouldn't get the number. Over half of our sales are from younger people. So I wanted to validate that number for you. For Tsumitasu, and that was a question you had. Thanks.
Operator: Our next question comes from Ryan Krueger of KBW. Please go ahead.
Ryan Krueger: Hey, thanks. Good morning. One more question on the Yen sensitivity. We've been talking mostly about the ESR impact from a strength in Yen. Can you talk more about the offset though within the rest of the organization that would -- I believe you're more economically insensitive on a consolidated basis?
Max Broden: Yes, that's right. I mean the other components of this is that we hold $2.7 billion of forward contracts at the holding company. And obviously, as the Yen strengthens, they will move more into us being out of the money on those forwards. Now we also hold roughly $4.4 billion of Yen-denominated debt at the holding company as well. That means that when the Yen moves, our leverage will move with that as well. So you will in a strengthening Yen scenario, all things being equal, see our leverage ratio increased somewhat. All of these obviously then work in the negative category. As you think about the ESR, as you think about settlements on our forwards at Inc. and as you think about our leverage ratio. The offset to this is that we now expect higher future dividends in dollar terms from Aflac Japan. So when you then think about the long-term dividend cash flows in U.S. dollars, they are now going to be higher. And that offsets the decline that you see elsewhere on these other instruments. And that's what I mean by when we take an economic approach, we think about sizing what our expected cash flows are and they are offset by these other instruments. So that means that we are very well hedged, protected in U.S. dollar terms around the group.
Ryan Krueger: Great, thank you. And then just a quick follow-up on third sector Japan sales. You gave a lot of detail on the new cancer product and your strategy around both cancer and medical. I know you said you thought cancer sale, I mean overall Japan sales would be up in 2025. I was just -- can you give any more color, though I think you've typically seen a bit of a surge in sales when you have a new product introduction like this? And should that be our expectation that in the second quarter, you'll see a pretty meaningful positive impact from the cancer launch?
Alycia Slyck: That's how we think, this is even once again.
Operator: Thank you. Our next question comes from Wilma Burdis of Raymond James. Please go ahead.
Wilma Burdis: Good morning. Could you provide any updates on the Japan Post? I know there was a -- I think it was a data breach or something like that. But if you could just give us any updates? Thanks.
Daniel Amos: Well, you were asking about it. The Japan Post.
Masatoshi Koide: This is Koide from Aflac Japan. [Foreign Language] I believe that question is regarding the Japan Post companies inappropriate uses of non-publicized financial information. [Foreign Language] And right now, JPC or Japan Post Company has now established a preventative measures and implementing them. [Foreign Language] And Japan Post Company is now focused on addressing this issue. So there are certain impact on the cancer insurance sales. [Foreign Language] And within the Japan Post Group, there's another entity called Japan Post Insurance. [Foreign Language] And Japan Post Insurance is not directly impacted by this recent news. [Foreign Language] And also this recent matter regarding the inappropriate uses of the data has nothing to do with an Aflac Insurance product. [Foreign Language] So therefore, the cancer reinsurance sales activity are still continuing today. [Foreign Language] And as Yoshizumi described earlier, Japan Post Group have started the sales of new cancer products in April. [Foreign Language] And Japan Post Company has also started the sales of this new product.
Wilma Burdis: Okay, thank you.
Operator: The next question comes from Nick Annitto of Wells Fargo. Please go ahead.
Nicholas Annitto: Hey, thanks. Good morning. Just one more for Max on the ESR, and I appreciate all the comments before on it. But -- how should we be thinking about the future use of Bermuda in terms of reinsuring the Japan balance sheet, if the Yen continues to appreciate further, does it impact any of the ability or willingness to do more of the balance sheet reinsurance? Thanks.
Max Broden: So our ability to execute reinsurance is not really associated with our ESR levels. It's not making it more difficult or easier depending on where the ESR level is. That being said, it is absolutely clear that when we execute reinsurance between Aflac Japan and Aflac Bermuda, we tend to structure the transactions in a way to lower the overall risk for both the enterprise and for the seed and Aflac Japan in this case. That tends to have the outcome that the ESR is going up. So it's obviously a tool that we have available to us that we can use -- but it's one of the tools that we have and that we use overall to manage the capital base of Aflac Japan and the ESR ratio. We have a relatively broad toolkit that we can use -- at this point, obviously, we are trading significantly above our target operating both range and midpoint. So at this point, we feel very good about where we are as it relates to our ESR ratio.
Operator: The next question comes from Mike Ward of UBS. Please go ahead.
Michael Ward: Thank you. Good morning. I was just wondering how you guys are seeing the environment in Japan. And I'm just kind of curious, you guys are well tapped into their sort of cultural attitude. But is there any anti-U.S. sentiment growing there from a trade war that could pose incremental sales challenges?
Daniel Amos: Let me let Charles take that on. Charles?
Charles Lake: Yes, thank you. This is Charles Lake. We do not see any reaction in a way that will be anti-American, as you know, the Japan government is a strong supporter of the U.S.-Japan alliance, deep economic relationship is the basis of the confidence that Japan has in the United States. As you know, in the past five years, Japan was the largest investor into Japan. So when you look at the national security side, when you look at the economic relationship side, it's a deep relationship. In addition to that, because of the exchange rate, a large visitor from United States to Japan, that's booming in terms of inbound tourism. So at this stage, of course, the trade talks are getting a lot of attention. But it is not affecting in any way, in my view, this sentiment among the Japanese people about the United States.
Michael Ward: Super helpful. Thank you. And then maybe for Max, just high level on the buyback, a pretty solid amount this quarter. Just if it ends up that there's incremental sort of ongoing, I guess, sales headwinds -- should we think about you being comfortable continuing in excess of operating income and even at this level, right, as long as those headwinds may or may not persist?
Max Broden: Yes. The -- our buyback, it's really a function of the capital and liquidity we have on hand. The capital and the liquidity we see coming through to us in the future. And then obviously, the investment opportunities we have for that capital. And we look at the IRRs that we can get on different types of capital deployment that being organic growth, i.e., what returns are we getting by selling new products and that's generally our #1 source of where we deploy capital, that's where we wanted to go. We want to grow our franchise and grow it at strong IRRs when there's capital over, we are looking at other deployment opportunities. And obviously, buyback has been one of the greatest sources of that over the last couple of years. And that has given us very good IRRs. So this framework, we just continue to run and operate.
Operator: The next question comes from Alex Scott of Barclays. Please go ahead.
Alex Scott: Hey, thanks for fitting me in here. I had one on the corporate segment. I guess just from the outside, it's a little difficult to model given there's the derivative program in there. There's the Bermuda reinsurance in there, and then there's the typical kind of what we think about as a corporate segment in there. So -- could you help us think through the different components and how we should think about the trajectory maybe where you see it running more near term versus where it may build to just based on the Bermuda business?
Max Broden: So Alex, I understand the difficulties in modeling this segment given that -- you have so many different pieces that are sort of rolling up into it. If you think about the most -- the biggest pieces that are moving that number, it would be around any further reinsurance that we would do. The reinsurance profitability is very stable and predictable. But any further transactions that we would do would obviously increase the profitability of this segment. The other piece is interest expense. So if we were to issue any more debt and go up in leverage that obviously would impact the profitability of this segment as well. And the last piece is the strategy that we have around tax credit investments and the way this is accounted for. And that is particularly interesting in this quarter. When you compare it year-over-year, there was a significant delta where in the first quarter of last year, we had pretty significant tax credit investments. They were lower this year. And as you know, the way they work is that we have a negative component to the net investment income in the Corporate segment with and more than offsetting credit to the tax line. So in this quarter, we only had, I believe $8 million of tax credit investments hitting the net investment income line. And that is why you also saw the tax line having a higher tax rate than what we normally run at on a quarterly basis. So if you boil all of that together, it means that you can -- you will continue to see some volatility in this number, but I would certainly expect the number to be on a pretax basis positive, but generally speaking, lower than what you saw in the first quarter.
Alex Scott: Got it. Okay, that's helpful. I can leave it there. Thank you.
Operator: This concludes the question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young: Thank you, Alan and thank you all for joining us this morning. We appreciate your time. If you have any other questions, please reach out to Investor Relations. We'll help you with what we can and look forward to speaking to you soon. Thank you.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to Aflac Incorporated First Quarter 2025 Earnings Call. All participants will be in listen-only mode. [Operator Instructions]. Please note, this event is being recorded. I would like now to turn the conference over to David Young, Vice President of Capital Markets. Please go ahead."
},
{
"speaker": "David Young",
"text": "Good morning, and welcome. Thank you for joining us for Aflac Incorporated's First Quarter 2025 Earnings Call. This morning, Dan Amos, Chairman and CEO of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then Max Broden, Senior Executive Vice President and CFO of Aflac Incorporated, will provide more detail on our first quarter financial results, current capital and liquidity. These topics are also addressed in the materials we posted with our earnings release, financial supplement and quarterly CFO video update on investors.aflac.com. For Q&A today, we are also joined by Virgil Miller, President of Aflac Incorporated and Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release with reconciliations of certain non-U.S. GAAP measures and related earnings materials are available on investors.aflac.com. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Daniel Amos",
"text": "Thank you, David, and good morning, everyone. We're glad you joined us. Although we just have one quarter under our belt, the first quarter marked a good start for the year. Aflac Incorporated reported net earnings per diluted share of $0.05, which was significantly impacted by net investment losses this quarter compared to net investment gains in the first quarter of 2024. At the same time, the company reported adjusted earnings per diluted share of $1.66, which is unchanged from the first quarter of 2024. Beginning with Aflac Japan, I am pleased with the 12.6% year-over-year sales increase. This quarter sales reflected a continued significant contribution consuming costs and a 6.3% increase from cancer insurance sales, taking into account Japan's demographics and product strategy is to fit the needs of customers throughout all stages of life. Acquiring younger customers is critical to our success. We believe Tsumitasu helped us appeal to and more importantly, reach younger customers in Japan. Our strong sales in Japan reflect the success our agencies have had selling Tsumitasu. As the pioneer of cancer insurance and leading third sector insurer, we also aim to sell these Tsumitasu policyholders a medical policy or cancer policy. We have also launched the initial stage of sales in Miraito, our newest cancer insurance on March 17th. While it is still very early, the results that we have seen thus far have been positive. As of April 21st, the product has been available through all of Japan's sales channels. Our ability to maintain strong premium persistency is a testament to Aflac's reputation and customer recognition of the value of our products. By maintaining this level of persistency and adding new premium through sales, we are partially offsetting the impact of reinsurance and policies reaching paid-up status. This will be vital to our future growth of Aflac Japan. Turning to Aflac U.S., I was pleased by the 3.5% year-over-year increase in sales and encouraged by the momentum we are seeing within all areas of our group business, especially our group life and disability. As well as network dental. In addition, we believe our efforts to drive more profitable growth with a stronger underwriting discipline have contributed to our strong premium persistency and net earned premiums growth. At the same time, Aflac U.S. has maintained its prudent approach to expense management and maintaining a strong pretax margin as Max will expand on in a moment. In both Japan and the United States, I believe that consumers need the products and solutions, Aflac offers more than ever for our policyholders who become claimants. Aflac is more than an insurance company. We are a partner in Health, a supporter of families during their times of need and a pioneer and leader in the industry. We are leveraging every opportunity to convey how our products can help fill the gaps during challenging times, providing not just financial assistance, but also compassion and care. At the same time, we continue to generate strong capital and cash flows, while maintaining our commitment to prudent liquidity and capital management. We have been very pleased with our investments, which have continued to produce strong net investment income. As an insurance company, our primary responsibility is to fulfill the promises we make to the policyholders, while being responsive to the needs of our shareholders. Our solid portfolio supports our promise to our policyholders as does our commitment to maintaining strong capital ratios. We balance this financial strength with tactical capital deployment. I am very happy with how management has handled capital deployment and liquidity and specifically how well we've adapted to this environment. In the first quarter, Aflac Incorporated deployed $900 million in capital to repurchase 8.5 million shares of our stock. Additionally, we treasure our track record of 42 consecutive years of dividend growth at the same time. We have maintained our position among companies with the highest return on capital and the lowest cost of capital in the industry, combined with dividends. This means we delivered $1.2 billion back to the shareholders in the first quarter of 2025. We believe in the underlying strength of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. On an ongoing basis, we are taking action to reinforce our leading position and build on our momentum. I will now turn the program over to Max to cover more details of the financial results. Max?"
},
{
"speaker": "A - Max Broden",
"text": "Thank you, Dan. Thank you for joining me, as I'll provide a financial update on Aflac Incorporated results for the first quarter of 2025. For the quarter, adjusted earnings per diluted share was flat year-over-year at $1.66, with a $0.01 negative impact from FX in the quarter. In this quarter, remeasurement gains on reserves totaled $41 million, reducing benefits. Variable investment income ran $27 million below our long-term return expectations, while one make-whole call generated income of $16 million. Adjusted book value per share, excluding foreign currency remeasurement increased 2.2%. The adjusted ROE was 12.7% and 15.6%, excluding foreign currency remeasurement, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment. Net and premiums for the quarter declined 5%. Aflac Japan's underlying earned premiums, which adjusts net earned premiums to exclude the impact of deferred profit liability, paid-up policies and reinsurance declined 1.4%. We believe this metric better provides insight into long-term premium trends. Japan's total benefit ratio came in at 65.8% for the quarter, down 120 basis points year-over-year. The third sector benefit ratio was 56.3% for the quarter, down approximately 120 basis points year-over-year. We estimate the impact from remeasurement gains to be approximately 150 basis points favorable to the benefit ratio in Q1 2025. Long-term experience trends as it related to treatment of cancer and hospitalization continue to be in place, leading to continued favorable underwriting experience. Persistency remained solid at 93.8%, which is up 40 basis points year-over-year and in line with our expectations. However, beginning in this quarter, we have revised the premium persistency definition to better reflect the economic trends for the business. As a result, we do not treat annuitization as a lapse for persistency purposes. And this revised definition raised the reported persistency by roughly 30 basis points. Our expense ratio in Japan was 19.6% for the quarter, up 160 basis points year-over-year, driven primarily by an increase in technology expenses. For the quarter, adjusted net investment income in yen terms was down 7.6%, primarily driven by lower floating rate income, the transfer of assets to as like Re Bermuda associated with reinsurance and variable investment income, somewhat offset by higher returns from the structured private credit portfolio. The pretax margin for Japan in the quarter was 31.8%, down 100 basis points year-over-year, but a very good result. Turning to U.S. results. Net earned premium was up 1.8%, persistency increased 60 basis points year-over-year to 79.3%. Our U.S. total benefit ratio came in at 47.7%, 120 basis points higher than Q1 2024, driven by business mix and lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by approximately 100 basis points in the quarter as claims have remained below our long-term expectations. In the quarter, we benefited from favorable underwriting on our small, but growing long-term disability block. Our expense ratio in the U.S. was 37.6%, down 110 basis points year-over-year, primarily driven by platforms improving scale and continuous focus on expense efficiency. Our growth initiatives, group life and disability, network down ambition and direct-to-consumer increase our total expense ratio by 50 basis points for the quarter. This is in line with our expectations, and we would expect this impact to decrease as we continue to approach scale. Adjusted net investment income in the U.S. was down 1.9% for the quarter, primarily driven by lower floating rate income. Profitability in the U.S. segment was very strong with a pretax margin of 20.8%, a 20 basis points decline compared to a year ago. During the quarter, we increased our CECL reserves associated with our commercial real estate portfolio by $2 million net of charge-offs as property values remain at distressed valuations. We also foreclosed on two loans, adding them to our real estate owned portfolio, consistent with our strategy for maximizing recovery values. Our portfolio of first lien senior secured middle market loans continue to perform well with increased CECL reserves of $7 million in the quarter, net of charge-offs. In our corporate segment, we recorded a pretax gain of $43 million. Adjusted net investment income was $47 million higher than last year due to a combination of lower volume of tax credit investments and higher asset balances, which included the impact of the reinsurance transaction in Q4 2024. Our tax credit investments impacted the corporate net investment income line for U.S. GAAP purposes negatively by $8 million in the quarter with an associated credit to the tax line. The net impact to our bottom line was a positive $0.4 million in the quarter. To-date, these investments are performing well and in line with our expectations. Unencumbered holding company liquidity stood at $4.3 billion, $2.6 billion above our minimum balance. We repurchased $900 million of our own stock and paid dividends of $317 million in Q1, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Our capital position remained strong, and we ended the quarter with an SMR above 950%, an estimated regulatory ESR above 250%. Our combined RBC, while not finalized, we estimate to be greater than 600%. These are strong capital ratios, which we actively monitor, stress and manage to withstand credit cycles as well as external shocks. For U.S. statutory, we recorded a $6 million valuation allowance on mortgage loans as an unrealized loss. We ended the quarter March 31, with net ¥5.2 billion of Japan FSA realized gains net of losses for securities impairment. This is well within our expectations and with limited impact to both earnings and capital. Our leverage was 20.7% for the quarter, which is within our target range of 20% to 25%. As we hold approximately 59% of our debt in Yen, this leverage ratio is impacted by move in the Yen-dollar exchange rate. This is intentional and part of our enterprise hedging program protecting the economic value of Aflac Japan in U.S. dollar terms. On a U.S. GAAP basis, we are impacted by moves in the Yen as our Yen-denominated earnings will translate into U.S. dollars at different exchange rates. We currently estimate that every ¥5 to the dollar move would impact our underlying EPS by roughly $0.07. As foreign currency markets have experienced a marked increase in volatility, I would like to reiterate our approach to managing foreign currency exposure. Fundamentally, we size our unhedged U.S. dollar exposure to the estimated economic surplus associated with our Japanese business. At the end of Q1, we held $25.5 billion of unhedged U.S. dollar assets in our Japan general account. Forward contracts at Inc, with a notional balance of $2.7 billion, and $4.4 billion of Yen-denominated debt. We also hold $24.2 billion of notional out-of-the-money put options, which provide tail protection against a large appreciation in the Yen. Adding this up, we feel that we are very well positioned on an economic basis. I'll now turn the call over to David to begin Q&A."
},
{
"speaker": "A - David Young",
"text": "Thank you, Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. You may then rejoin the queue to ask additional questions. We'll now take the first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question today comes from Tom Gallagher of Evercore ISI. Please go ahead."
},
{
"speaker": "Thomas Gallagher",
"text": "Hey, good morning. Max, just had a few questions on Japan solvency and overall macro sensitivities. I guess my first question is -- why did the ESR ratio declined by so much in Q1? If I just look at the sensitivities, I think the sharp rise in Japan rates should have offset the strengthening of the Yen. Anyway, I'll start with that, and then I have a follow-up. Thanks."
},
{
"speaker": "Max Broden",
"text": "Thank you, Tom. I appreciate the question. You're right that in the first quarter, we saw a small drop in our ESR and that is driven by the Yen strengthening that you saw. That is partially offset by higher Japan interest rates, especially the 30-year GDP rose in the first quarter, and that certainly helped us. That being said, we also had relatively high dividends flowing up from Aflac Japan to Aflac Inc. during the quarter as well. And that's the reason why you see the cash balances at Inc. increasing as much as they did despite very significant capital deployment in terms of dividends and buybacks in the quarter. So -- that's the -- I think that's the missing piece is the dividends flowing up to the holding company."
},
{
"speaker": "Thomas Gallagher",
"text": "That makes sense, Max. And then my follow-up is just in light of everything that's changed macro wise with the Yen now strengthening and looking at where long rates are in Japan. Have you -- I guess, how should we think about that when you think about forward capital planning? Do you still feel that drawing down excess and returning it is the best path forward, you still have considerable excess, so I'm not suggesting you down. But I guess the volatility of capital seems kind of on the high side when they think about sensitivities to what's happened in macro recently. So just curious, are you looking maybe to change philosophy at all on capital return and/or how about just the way you're hedging this? Because I think right now, you have some very deep out of the money hedges, any thought of maybe locking in all of that capital strength or are you fine with the structure you have? Thank you."
},
{
"speaker": "Max Broden",
"text": "So Tom, when we design our capital management, it's really done with a long-term view. It's done running many different scenarios, including stressed scenarios as well. So if you use that as a base, that means that fundamentally, we are not changing the way we are doing our capital management or in a way we are structuring the different instruments that we use for it. And I want to take you back and just think through the underlying business that we conduct, which we sell products that are relatively defensive in the way they behave that going through lapsation, that going through volatility in benefit ratios and underlying profitability as well. That is mirrored up with relatively low asset leverage, which means that the risks associated with our asset portfolio are somewhat limited as well. And when you bake all of that together, it means that our profitability and cash flows are relatively stable and predictable. Now you point out one item, and that is the volatility of our ESR as it relates to FX. And that is something that we have designed ourselves. So when we protect the economic value of Aflac Japan, the main component of that is the $25.7 billion held in U.S. dollars on our Japanese balance sheet. And that is there to obviously help protect the long-term economics of our Aflac Japan business in U.S. dollars, but it does introduce volatility to our ESR ratio. But what we have done is that we have protected details, i.e., we have looked at how much risk are we willing to take on FX as it relates to the e-volatility in the ESR ratio. And that's where we have executed a put option program where most of those puts are currently out of the money by 25% to 30% and that helps cut the tail and the volatility of those. These are one-sided -- that means that we have protection if the Yen strengthens, but if the Yen were to weaken, we keep all of that upside. So if I look at the moves that we have seen in rates, the movement we've seen in FX, I don't see at this point us making any significant changes to the way we are approaching this or hedging this. That being said, obviously, it's something that we closely monitor. And there may be tactical moves in the future around it. But I would -- I would assume that those are relatively minor in the scheme of things. So, so far, we feel like the FX hedging program is working very well and in line with our expectations."
},
{
"speaker": "Operator",
"text": "The next question comes from Jack Matten of BMO Capital Markets. Please go ahead."
},
{
"speaker": "Jack Matten",
"text": "Hi, good morning. Just a question on the new cancer product launch. Can you talk about what you're seeing so far in the uplift of sales you saw this quarter? I know the launch in stages, so maybe you'd see more of a benefit in the second quarter as well. So just curious what your expectations are for sales of that product this year?"
},
{
"speaker": "Daniel Amos",
"text": "Well, yes, let me make -- this is Dan. Let me make a couple of comments, and I'm going to turn it over to Aflac Japan. But just in general, I think that we're going to be fine. I think you're going to see these things. The new cancer policy continue to grow. But all in all, I thought Virgil has spent a lot of time in this quarter in Japan. And I'd like for him to take a high-level view and go over both U.S. and Japan and then have the Japanese operation talk about it, Yoshizumi can cover that and then follow up with Max and Brad on any comments they might have in those regards. So Virgil, why don't you just give a few comments, and then let's turn the program over to Japan."
},
{
"speaker": "Virgil Miller",
"text": "Yes. Well, thanks, Dan. I'll just make a few comments. It was a great visit I had to Japan. And I would just say that as Max's point earlier, our business is really more a view from a long-term perspective. And we remain confident in the strategies we have with our products and all services that what we have is what customers need and want. I think too, Dan, I would just add, though, that as you look at Japan in particular, what we've done with the launch of the cancer product, also how we approach the market with similar trials and the focus that we have on selling more third site of products is what will help us during this time. Yes, we do look at economic downturn. Max just shared with you about how we go through that methodology. But specifically on the cancer though. I'm going to let Japan talk about how the launch went into what we see for the remainder of the year. So I'm going to turn it over to you guys."
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Thank you for the question. I'm in charge with the marketing sales and let me take that question. [Foreign Language] The new cancer reinsurance was just launched in May this year, but it is progressing as we expected. Sorry, correction, it was launched in March. [Foreign Language] Let me briefly talk about the characteristic of this new product. [Foreign Language] First, we have full and simple coverage. In addition to strengthening coverage, not only during but also before and after treatment, the qualification for payment of benefits have been changed to be easier to understand. [Foreign Language] And it has the flexible coverage design that enables combination and cross-selling with existing policies and other products, i.e., add-on plans for those who already have medical insurance. [Foreign Language] On March 18, our sales was made available, our main state associate channels, Daido and Daiichi. [Foreign Language] And in April, we started the sales at bank channels in Japan Post Group. [Foreign Language] And all the channels have made a great start, and we are still seeing a positive result from all of these channels. [Foreign Language] And let me talk a little bit about our forecast for 2025. [Foreign Language] And we have changed the structure in this January and established a new position with CMO, and this position will supervise the sales and marketing and all brands. [Foreign Language] And at this position we look after that asset formation cancer and medical and whole areas and will be totally design oriented to develop the sales line. [Foreign Language] And we are responding to the ever-changing customer needs with an agility in a cross-functional way by engaging our IT, actuarial and policy service department. [Foreign Language] And we are proud to see the successful marketing activity with the optimum activities conducted at each channel under the lead of the CMO and we are seeing a positive -- with this effort, we are seeing a positive result from cancer insurance that was launched in March. [Foreign Language] We believe the third sector sales will continue to grow with now having a very extensive product lineup with Tsumitasu and the new cancer insurance. [Foreign Language] And we are now also focusing on hiring activities at agents and mainstay associates. [Foreign Language] And with all these efforts, we expect that the 2025 sales will be above 2024. [Foreign Language] That's all."
},
{
"speaker": "Jack Matten",
"text": "Thank you very much. And then just a follow-up on the medical insurance market in Japan. I mean can you talk about competitive dynamics there and how you see the outlook for sales of your medical product?"
},
{
"speaker": "Koichiro Yoshizumi",
"text": "[Foreign Language] Once again let me talk about our competitor landscape. [Foreign Language] First of all, about the third sector overall. [Foreign Language] Based on the latest data, we have the largest share of total new policies of cancer and medical insurance or core products in fiscal year 2023. [Foreign Language] In 2025, we expect to maintain our #1 share of new policies by expanding sales of cancer and medical insurance. [Foreign Language] Let me talk about cancer reinsurance. [Foreign Language] Although competition has increased, we are a pioneer in cancer insurance having faced cancer for the longest time in Japan. And the knowledge we have accumulated over 50 years of history is something no other company can have. [Foreign Language] We continue to provide services like [indiscernible] consulting services, unique coinsured service that no other company offers in addition to insurance coverage. By doing so, we will meet the needs of our customers and maintain a competitive advantage. [Foreign Language] And we aim to achieve further sales growth with the new cancer reinsurance product launch in March. [Foreign Language] And moving on to the medical insurance. [Foreign Language] The medical insurance sector is a much more competitive market in cancer reinsurance. This is largely due to the number -- large number of insurance companies entering the market and launching products. We will revise our product line every two years or so in order to gain a higher market share. [Foreign Language] And under this intensified competition in the medical market, we will conduct some optimized activities on each channel and bring about the better results. [Foreign Language] And let me talk about the specific activities that were carried out in Q1. [Foreign Language] We have strengthened the training to our sales agents so that they can provide an easy-to-understand explanation to the consumers. [Foreign Language] And with Tsumitasu, we're proceeding the concurrent sales with the third sector products. [Foreign Language] That's all."
},
{
"speaker": "Operator",
"text": "Our next question comes from John B. Barnidge of Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thank you for the opportunity to ask questions. So my question is focused on remeasurement gains. They continue to be present in both Japan and the U.S. We're further removed around the dislocation in individuals behavior. How should we be thinking about the waterfall or decay of remeasurement gains and will they primarily be concentrated in third quarter? Thank you."
},
{
"speaker": "Max Broden",
"text": "Let me kick it off, and I'll also ask Alycia to maybe give some comments from her perspective as well. So obviously, the third quarter is when we unlock our actuarial assumptions. That means that the third quarter is when we will have the more significant remeasurement gains and losses associated with the claims patterns that we're seeing in the marketplace. In the other quarters, we are truing up the experience from those quarters. That means that they are generally going to be smaller. That being said, we have experienced favorable claims utilization, both in the U.S. and Japan, and this has been in place for a long time and it always -- it goes back to pre-LDTI as well where under legacy gap. You did see this come through as IBNR releases, and that was feeding through into our benefit ratio. And now you're seeing it as remeasurement gains losses coming through under LDTI. So it's a continuation of -- especially in Japan, the long-term trends that we've been seeing there. And in the U.S., to some extent, the shift in claims patterns that we've seen post-COVID. I'll stop there and see if Alycia, if you want to add any color from your perspective?"
},
{
"speaker": "Alycia Slyck",
"text": "Thank you, Max. The only thing I'd add is that we do unlock our assumptions annually in the third quarter to reflect all of our best estimate actuarial expenses and our experience to date. And then you'll see that flow through the third quarter earnings. Thank you so much."
},
{
"speaker": "John Barnidge",
"text": "Thanks for the answers. That's it for me."
},
{
"speaker": "Operator",
"text": "The next question comes from Jimmy Bhullar of JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hey, good morning. So first, I had a question just along the lines of what you were commenting in terms of the dental or medical product in Japan, sales have been weak, and you've pointed out competitors coming out with maybe lower benefit type products and just that affecting your business. Should we assume that if the competitive environment stays the way it is, sales will muddle along at these levels? Or are you doing anything that would suggest that there could be a recovery, because that line has been sort of steadily dropping over time?"
},
{
"speaker": "Daniel Amos",
"text": "I'm going to answer that. Let me just say that everything that we do tends to be cyclical in nature with a rebound of a new product and although we can't talk about that because of FSA and the way they operate. As Yoshizumi mentioned, every two years or so, we come back to the table with changes in the marketplace, whether it be consumers and what they want or need or medical treatments and what are happening, whether it's more outpatient than inpatient. Whatever it might be from a medical standpoint or even the cancer insurance standpoint. So this year is the year where cancer insurance should be dominating along with our new product. So we should continue to see that. I can't stress enough how much we like what's going on in the life insurance area of adding new and younger policyholders that we've never had before. And that opens the opportunity to go back and add cancer and medical to them. So this year will be that. I think you can look for next year us to revisit, which campaign we'll be looking at. But all in all, I'm very excited about us making our numbers this year in sales and believe we'll ultimately do that. And the breakdown, although we continue to watch and monitor, it's the overall sales numbers that we want to see us achieve because the profit margins are there for our success long-term."
},
{
"speaker": "Jimmy Bhullar",
"text": "Okay. And then just for Virgil on the Dental business in the U.S., it seems like sales have stabilized following the change in the tech platform, but are you expecting normal production this year and open enrollment? Or is it more likely that that will be next year?"
},
{
"speaker": "Virgil Miller",
"text": "Well, thanks, Jimmy, this is Virgil. I do expect us to have a consistent momentum. What I mentioned in the fourth quarter, our focus is on stabilization of that platform, but making sure that the brokers and our veteran agents knew about that we were open for business. And we had a slow start there in Q4, but off to a much better start here in Q1. I can tell you a few things about that. We did invest and making sure we got the right talent. We hired some additional talent from the industry. We maintain the talent that we have there. We continue to invest in the technology to make sure we've got the best portals for the dentists that are doing business with us. As well as making sure there's an easy enrollment process for our agents of our brokers. And then the final thing I mentioned, though, is the partnership we launched that we had now flattish with SKYGEN they're doing a great job of the administrative services that they're providing for us behind the scenes. They are industry-leading third-party administrator out there, and we're pleased with what we've seen. Now having said all of that, we have been going around to each market letting agents know to try it. For those agents that sold the demo product in Q1 along with our voluntary benefits products, their sales were up 20%. My point is that, that's the strategy it works because we look at selling both together. And I think that the more we get that message out, you will see that momentum carrying forward. I expect us to hit the plan that we set for this year, Jimmy."
},
{
"speaker": "Jimmy Bhullar",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Suneet Kamath of Jefferies. Please go ahead."
},
{
"speaker": "Suneet Kamath",
"text": "Great. Thanks. Max, I wanted to come back to the ESR and the one-way hedge that you have. Is that program designed to keep you at your ESR target or is it possible if we see the dollar weaken significantly before those options sort of kick in, your ESR ratio could fall below your target? Thanks."
},
{
"speaker": "Max Broden",
"text": "Thank you, Suneet. So that always depends a little bit on what your starting point is. Generally speaking, we originally designed this to size the risk associated with FX that we're willing to take on. And we generally sized that at around 40 to 45 ESR points. So that will give you a little bit of a sense for the impact and how we have overall size that program. So that means that at that level, we are no longer having any significant FX volatility associated with our ESR. And our starting point today is, and I ran these numbers this morning that we estimate that our ESR as of this morning is around 250%. So it's a good starting point for us."
},
{
"speaker": "Suneet Kamath",
"text": "Okay. That's helpful. And then I wanted to come back to something that we talked about last night in terms of the U.S. weekly average producers. And I think one of the comments around why it was down year-over-year, I think, 11%. Is that more of your agents are selling other non-Aflac products. I just want to get a sense of how prevalent is that? How common is that? And does that create some issues for you in terms of the recovery in sales if they're focused on other companies' products? Thanks."
},
{
"speaker": "Virgil Miller",
"text": "This is Virgil. I'll take that question. I would say that it's anecdotal. I don't have any data for that. And here's what I mean by that. We have engaged our veterans to look at their productivity. Now you can see overall, our productivity is up when you looking at the fat supplement. And that's driven mainly by the production we've got from our veterans, but with brokers also that are in that number, and we're having success in larger case of Aflac. But when you look into the smaller cases, I mean accounts generally averaging less than 50 employees. This is where we need to focus. And I think that comment was made, in particular, when we saw last year, our agents were having success with selling the dental product. If you look at the newest statistics that are out there from LIMRA and from East Birch, dental and steel in the top two products that are being requested and being sold. So having said that, they sold other carriers product. And when you sell that product, you tend to sell to other voluntary benefit products alongside it. What we have done this quarter, though, as I mentioned, is starting to see them return back had a 23% increase in dental sales for Q1. And we -- again, I mentioned the Jimmy a few moments ago that when they sell at dental, overall, they had a 20% overall sales increase for those agents they sold it. What we're going to do this year is focus on those veterans. I made some comp incentives that are tied to that. We're going to explain to them that the dental is stable, is working and really get them back to selling back on a normal basis of Aflac. I have seen the momentum in Q1. I expect that momentum to continue throughout the year."
},
{
"speaker": "Suneet Kamath",
"text": "Hey, good morning. Sorry about that. On Tsumitasu, I know you're targeting younger customers, but I believe in the past, you've indicated that existing customers were or a larger percentage of the sales last year. Is that still the case? Are you seeing more new and younger customers buy the product?"
},
{
"speaker": "Daniel Amos",
"text": "The short version is we're seeing more younger people buy the product. So that's what I'd give you is the answer."
},
{
"speaker": "Suneet Kamath",
"text": "Okay. And then just shifting to NII. So last quarter, you indicated there would be some pressure just given the floating rate portfolio, which we saw. I'm just curious how you see NII trending through the rest of the year? Is there a further impact from last year's rate cuts to still flow through?"
},
{
"speaker": "Daniel Amos",
"text": "Sure. Thank you, Joe. You're right. We have seen some pressure in first quarter. It's predominantly from the floating rate portfolio. It's both a reduction in balances as well as the roughly 100 basis point decline we've seen in SOFR year-on-year. We're going to be facing that headwind throughout the year. The comps do get a little better later in the year when the differential in SOFR is less because of the Fed action to cut later in the year last year. We are taking steps to try to offset that. We're doing more things to reposition the portfolio to capture higher yields, both in Japan and the U.S. We've also been able to deploy a significant amount of capital in first quarter and take advantage of the wider spreads. And we also took advantage of the wider spreads in April and deployed a significant amount. So we are facing that floating rate headwind, but we think we've got some things in the toolkit that's going to help us offset that."
},
{
"speaker": "Max Broden",
"text": "And Joel, just as a reminder that our floating rate portfolio, it resets with one month and three-month SOFR."
},
{
"speaker": "Suneet Kamath",
"text": "Got it, thank you."
},
{
"speaker": "Daniel Amos",
"text": "Just to follow up, I wouldn't get the number. Over half of our sales are from younger people. So I wanted to validate that number for you. For Tsumitasu, and that was a question you had. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ryan Krueger of KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"text": "Hey, thanks. Good morning. One more question on the Yen sensitivity. We've been talking mostly about the ESR impact from a strength in Yen. Can you talk more about the offset though within the rest of the organization that would -- I believe you're more economically insensitive on a consolidated basis?"
},
{
"speaker": "Max Broden",
"text": "Yes, that's right. I mean the other components of this is that we hold $2.7 billion of forward contracts at the holding company. And obviously, as the Yen strengthens, they will move more into us being out of the money on those forwards. Now we also hold roughly $4.4 billion of Yen-denominated debt at the holding company as well. That means that when the Yen moves, our leverage will move with that as well. So you will in a strengthening Yen scenario, all things being equal, see our leverage ratio increased somewhat. All of these obviously then work in the negative category. As you think about the ESR, as you think about settlements on our forwards at Inc. and as you think about our leverage ratio. The offset to this is that we now expect higher future dividends in dollar terms from Aflac Japan. So when you then think about the long-term dividend cash flows in U.S. dollars, they are now going to be higher. And that offsets the decline that you see elsewhere on these other instruments. And that's what I mean by when we take an economic approach, we think about sizing what our expected cash flows are and they are offset by these other instruments. So that means that we are very well hedged, protected in U.S. dollar terms around the group."
},
{
"speaker": "Ryan Krueger",
"text": "Great, thank you. And then just a quick follow-up on third sector Japan sales. You gave a lot of detail on the new cancer product and your strategy around both cancer and medical. I know you said you thought cancer sale, I mean overall Japan sales would be up in 2025. I was just -- can you give any more color, though I think you've typically seen a bit of a surge in sales when you have a new product introduction like this? And should that be our expectation that in the second quarter, you'll see a pretty meaningful positive impact from the cancer launch?"
},
{
"speaker": "Alycia Slyck",
"text": "That's how we think, this is even once again."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Wilma Burdis of Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"text": "Good morning. Could you provide any updates on the Japan Post? I know there was a -- I think it was a data breach or something like that. But if you could just give us any updates? Thanks."
},
{
"speaker": "Daniel Amos",
"text": "Well, you were asking about it. The Japan Post."
},
{
"speaker": "Masatoshi Koide",
"text": "This is Koide from Aflac Japan. [Foreign Language] I believe that question is regarding the Japan Post companies inappropriate uses of non-publicized financial information. [Foreign Language] And right now, JPC or Japan Post Company has now established a preventative measures and implementing them. [Foreign Language] And Japan Post Company is now focused on addressing this issue. So there are certain impact on the cancer insurance sales. [Foreign Language] And within the Japan Post Group, there's another entity called Japan Post Insurance. [Foreign Language] And Japan Post Insurance is not directly impacted by this recent news. [Foreign Language] And also this recent matter regarding the inappropriate uses of the data has nothing to do with an Aflac Insurance product. [Foreign Language] So therefore, the cancer reinsurance sales activity are still continuing today. [Foreign Language] And as Yoshizumi described earlier, Japan Post Group have started the sales of new cancer products in April. [Foreign Language] And Japan Post Company has also started the sales of this new product."
},
{
"speaker": "Wilma Burdis",
"text": "Okay, thank you."
},
{
"speaker": "Operator",
"text": "The next question comes from Nick Annitto of Wells Fargo. Please go ahead."
},
{
"speaker": "Nicholas Annitto",
"text": "Hey, thanks. Good morning. Just one more for Max on the ESR, and I appreciate all the comments before on it. But -- how should we be thinking about the future use of Bermuda in terms of reinsuring the Japan balance sheet, if the Yen continues to appreciate further, does it impact any of the ability or willingness to do more of the balance sheet reinsurance? Thanks."
},
{
"speaker": "Max Broden",
"text": "So our ability to execute reinsurance is not really associated with our ESR levels. It's not making it more difficult or easier depending on where the ESR level is. That being said, it is absolutely clear that when we execute reinsurance between Aflac Japan and Aflac Bermuda, we tend to structure the transactions in a way to lower the overall risk for both the enterprise and for the seed and Aflac Japan in this case. That tends to have the outcome that the ESR is going up. So it's obviously a tool that we have available to us that we can use -- but it's one of the tools that we have and that we use overall to manage the capital base of Aflac Japan and the ESR ratio. We have a relatively broad toolkit that we can use -- at this point, obviously, we are trading significantly above our target operating both range and midpoint. So at this point, we feel very good about where we are as it relates to our ESR ratio."
},
{
"speaker": "Operator",
"text": "The next question comes from Mike Ward of UBS. Please go ahead."
},
{
"speaker": "Michael Ward",
"text": "Thank you. Good morning. I was just wondering how you guys are seeing the environment in Japan. And I'm just kind of curious, you guys are well tapped into their sort of cultural attitude. But is there any anti-U.S. sentiment growing there from a trade war that could pose incremental sales challenges?"
},
{
"speaker": "Daniel Amos",
"text": "Let me let Charles take that on. Charles?"
},
{
"speaker": "Charles Lake",
"text": "Yes, thank you. This is Charles Lake. We do not see any reaction in a way that will be anti-American, as you know, the Japan government is a strong supporter of the U.S.-Japan alliance, deep economic relationship is the basis of the confidence that Japan has in the United States. As you know, in the past five years, Japan was the largest investor into Japan. So when you look at the national security side, when you look at the economic relationship side, it's a deep relationship. In addition to that, because of the exchange rate, a large visitor from United States to Japan, that's booming in terms of inbound tourism. So at this stage, of course, the trade talks are getting a lot of attention. But it is not affecting in any way, in my view, this sentiment among the Japanese people about the United States."
},
{
"speaker": "Michael Ward",
"text": "Super helpful. Thank you. And then maybe for Max, just high level on the buyback, a pretty solid amount this quarter. Just if it ends up that there's incremental sort of ongoing, I guess, sales headwinds -- should we think about you being comfortable continuing in excess of operating income and even at this level, right, as long as those headwinds may or may not persist?"
},
{
"speaker": "Max Broden",
"text": "Yes. The -- our buyback, it's really a function of the capital and liquidity we have on hand. The capital and the liquidity we see coming through to us in the future. And then obviously, the investment opportunities we have for that capital. And we look at the IRRs that we can get on different types of capital deployment that being organic growth, i.e., what returns are we getting by selling new products and that's generally our #1 source of where we deploy capital, that's where we wanted to go. We want to grow our franchise and grow it at strong IRRs when there's capital over, we are looking at other deployment opportunities. And obviously, buyback has been one of the greatest sources of that over the last couple of years. And that has given us very good IRRs. So this framework, we just continue to run and operate."
},
{
"speaker": "Operator",
"text": "The next question comes from Alex Scott of Barclays. Please go ahead."
},
{
"speaker": "Alex Scott",
"text": "Hey, thanks for fitting me in here. I had one on the corporate segment. I guess just from the outside, it's a little difficult to model given there's the derivative program in there. There's the Bermuda reinsurance in there, and then there's the typical kind of what we think about as a corporate segment in there. So -- could you help us think through the different components and how we should think about the trajectory maybe where you see it running more near term versus where it may build to just based on the Bermuda business?"
},
{
"speaker": "Max Broden",
"text": "So Alex, I understand the difficulties in modeling this segment given that -- you have so many different pieces that are sort of rolling up into it. If you think about the most -- the biggest pieces that are moving that number, it would be around any further reinsurance that we would do. The reinsurance profitability is very stable and predictable. But any further transactions that we would do would obviously increase the profitability of this segment. The other piece is interest expense. So if we were to issue any more debt and go up in leverage that obviously would impact the profitability of this segment as well. And the last piece is the strategy that we have around tax credit investments and the way this is accounted for. And that is particularly interesting in this quarter. When you compare it year-over-year, there was a significant delta where in the first quarter of last year, we had pretty significant tax credit investments. They were lower this year. And as you know, the way they work is that we have a negative component to the net investment income in the Corporate segment with and more than offsetting credit to the tax line. So in this quarter, we only had, I believe $8 million of tax credit investments hitting the net investment income line. And that is why you also saw the tax line having a higher tax rate than what we normally run at on a quarterly basis. So if you boil all of that together, it means that you can -- you will continue to see some volatility in this number, but I would certainly expect the number to be on a pretax basis positive, but generally speaking, lower than what you saw in the first quarter."
},
{
"speaker": "Alex Scott",
"text": "Got it. Okay, that's helpful. I can leave it there. Thank you."
},
{
"speaker": "Operator",
"text": "This concludes the question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"text": "Thank you, Alan and thank you all for joining us this morning. We appreciate your time. If you have any other questions, please reach out to Investor Relations. We'll help you with what we can and look forward to speaking to you soon. Thank you."
},
{
"speaker": "Operator",
"text": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] | Aflac Incorporated | 250,178 |
AIG | 4 | 2,020 | 2021-02-17 08:30:00 | Operator: Good day, and welcome to AIG's Fourth Quarter 2020 Financial Results Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Ms. Sabra Purtill, Head of Investor Relations. Please go ahead, ma'am.
Sabra Purtill: Thank you, Orlando. Good morning, and thank you all for joining us. Today's call will cover AIG's fourth quarter and year-end 2020 financial results announced yesterday afternoon. The news release, financial results presentation and financial supplement are available on our website, www.aig.com. Our 10-K for 2020 will be filed on Friday, February 19.
Our speakers today include Brian Duperreault, CEO; Peter Zaffino, President and COO of AIG; and Mark Lyons, Chief Financial Officer. Following their prepared remarks, we will have time for Q&A. David McElroy, CEO of General Insurance; Kevin Hogan, CEO of Life and Retirement; and Doug Dachille, our Chief Investment Officer, will be available for Q&A.
Today's remarks may contain forward-looking statements, including comments relating to company performance; strategic priorities, including AIG's intent to pursue a separation of its Life and Retirement business; business mix and market conditions, including the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may materially differ. Factors that could cause results to differ include the factors described in our third quarter 2020 report on Form 10-Q and our annual -- 2019 annual report on Form 10-K and our other recent filings made with the SEC. AIG is not under any obligation and expressly disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
Additionally, some remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at www.aig.com.
I'll now turn the call over to Brian.
Brian Duperreault: Good morning, and thank you for joining us today. I'd like to highlight some of the important milestones we achieved in 2020, and then I'll turn it over to Peter to provide more detail on our results for General Insurance and Life and Retirement as well as updates on strategic initiatives such as the separation of the Life and Retirement business and AIG 200. Lastly, Mark will provide a CFO update.
2020 was an extraordinary year during which our company demonstrated tremendous resiliency. We quickly and effectively transitioned more than 90% of our workforce in over 50 countries to remote working. We established a cross-functional task force to implement best practices to protect the health and safety of colleagues while continuing to deliver high-quality service to clients, distribution partners and other stakeholders.
AIG continues to effectively manage through COVID-19 and its collateral effects on the global economy because of the strong foundation we began to build beginning in late 2017. We instilled a culture of underwriting excellence, adjusted risk tolerances, implemented best-in-class reinsurance programs, strengthened our vast global footprint, derisked the balance sheet and maintained a balanced and diversified investment portfolio. And in October, we announced our intention to separate the Life and Retirement business from AIG, which was made possible by the work our team has done to strengthen General Insurance in particular and position each business as a market leader.
Before I turn it over to Peter, I want to note that this is the last earnings call I will participate in. As you know, we announced that on March 1, I will become Executive Chairman of the Board, and Peter will take over as President and Chief Executive Officer. The transition will be seamless.
Peter and I have tackled many of the systemic and pervasive fundamental problems from the past, and the company is now positioned for long-term sustainable and profitable growth. While there is still work to be done, I have every confidence that AIG's stakeholders will continue to reap the benefit of the hard work that is taking place across the organization on our journey to make AIG a top-performing company.
The turnaround of General Insurance and the enterprise-wide transformation at AIG is on a scale I've not seen in my 45-plus year career. I take great pride in what the team has accomplished. I know that the company and our colleagues will be in great hands with Peter as the CEO of AIG.
Now I'll turn the call over to Peter.
Peter Zaffino: Thanks, Brian. Good morning, everyone, and thank you for joining us today. This morning, I'd like to cover 4 topics that are key areas of focus for us in 2021 and which we will update you on each quarter: the separation of Life and Retirement from AIG, capital management, progress we've made on AIG 200 and financial and operating highlights for General Insurance and Life and Retirement.
2020 was a pivotal year for AIG, and I'm pleased to report that 2021 has gotten off to a good and fast start due to the momentum we have coming into the new year. Like 2020, this year will be another year of substantial progress for our company.
As Brian noted, we made a critical and strategic decision last October to separate the Life and Retirement business from AIG. We could not have made this decision without the significant turnaround taking place in General Insurance and solid performance in Life and Retirement. Our fourth quarter results provided further evidence that each of our businesses remain financially strong, market leaders and well positioned for profitable growth over the long term in their respective markets.
Since our last earnings call, we've been working purposefully and with a sense of urgency on several fronts related to separation. We are actively working towards an IPO of up to 19.9% of Life and Retirement with teams focused on stand-alone audited financials, actuarial work and rating agency discussions, among other things. Based on our work to date, we continue to believe that no additional equity capital will be required, given the improvement in our subsidiary capital positions over the last few years.
Additionally, in connection with our October announcement, we received inquiries from parties interested in strategically aligning with us and potentially purchasing the 19.9% stake in Life and Retirement. We are pleased with the level of interest and quality of potential partners for Life and Retirement business and believe a sale of a minority stake could be an attractive option for AIG, its shareholders and other stakeholders. We are carefully weighing the relative merits of this path compared to a minority IPO, taking into account the impact on value creation for AIG, execution certainty, regulatory and rating agency implications and delivery of Life and Retirement's growth strategy over the long term. As you know, any decisions we make will be subject to regulatory approvals. Overall, I am very pleased with the progress we are making on the separation, and we'll provide a further update in the near term.
Turning to capital management. We ended 2020 with parent liquidity of $10.5 billion, a $2.9 billion increase from 2019. We entered 2021 with significant financial flexibility as a result of our focus on derisking, capital management and liquidity, particularly in 2020 as a result of COVID-19.
We will continue to invest in our businesses to support growth and operational transformation, and we will return at least $500 million of capital to our shareholders through stock repurchases in the first half of 2021. This amount will more than offset dilution from stock-based compensation, which, at a minimum, will be a core principle of our capital management strategy going forward.
As we move forward on the path to separate Life and Retirement and generate capital, we will continue to focus on delevering and investing in growth in our businesses. We also intend to be active and prudent managers of capital and return it to shareholders when appropriate. Our current expectation is that an initial disposition of 19.9% of Life and Retirement, whether through a minority IPO or sale to a third party, will generate net proceeds such that some portion can be used towards further share repurchases. And while it is not currently a priority, over time, we may consider inorganic growth opportunities that would be accretive to our businesses and growth strategy and otherwise create value for our shareholders and other stakeholders. Once we make a decision on the initial step of the separation of Life and Retirement, we will provide more detail on our medium- and longer-term capital management priorities.
Now I'd like to provide an update on AIG 200. As a reminder, AIG 200 has core -- 4 core objectives: underwriting excellence, modernizing our operating infrastructure, enhancing user and customer experience and becoming a more unified company. Throughout 2020, we made measurable progress in spite of the ongoing remote work environment and, in some cases, accelerated certain initiatives. On December 31, we completed the sale of our shared services operations to Accenture, which streamlines our operating model. We've made significant progress in driving improvements in infrastructure and systems architecture while reducing real estate costs and other general operating expenses. We exceeded our target run rate savings for 2020, and the costs required to achieve were lower than initially expected. We exited 2020 with a $400 million run rate benefit, which was 30% ahead of the guidance we provided in 2020.
The success of AIG 200 to date demonstrates the discipline and rigor that the team leading the strategic initiative is using. The team is taking decisive action as we execute to position the company for the long term. AIG 200 success to date also reflects the resiliency and flexibility of our global colleagues who have embraced change while making significant contributions to our progress.
In 2021, a major focus of AIG 200 will be advancing our digital strategy through effective use of data and process-enabling technologies as well as driving greater operational efficiencies and improved customer experience. We also expect to make significant progress in 2021 on a global data warehouse in support of our finance and underwriting transformations. Our overall target for AIG 200 remain unchanged. We still expect to achieve run rate savings of $650 million by the end of 2021 and to deliver aggregate run rate savings of $1 billion by the end of 2022 against the total investment of $1.3 billion.
Turning to our financial results. I'll start with General Insurance. In the fourth quarter of 2020, we saw growth in net premium written in our commercial businesses, with year-over-year net premium written increasing 7% after adjusting for foreign exchange, driven by improved retention and higher rates. North America Commercial grew approximately 10% with meaningful growth from AIG Re, and International was up 5% after adjusting for foreign exchange.
As we previously outlined, North America Personal Insurance continued to experience reduced net premium volumes. This was primarily due to our decision to strategically reposition our high net worth business to Syndicate 2019, the partnership we established with Lloyd's, which resulted in higher ceded premium and the impact of COVID-19 on lines such as Travel and Accident & Health. While it's still very early in the year, based on what we are seeing, we expect a similar overall growth trend to continue particularly in commercial, and we will achieve top line growth for the full year 2021.
Turning to the combined ratio. We achieved another quarter of positive results in our core business with continued improvement in underwriting margins. In the fourth quarter, the accident year combined ratio excluding CATs improved by 290 basis points to 92.9% compared to 95.8% a year ago. This improvement was led by our commercial businesses, which improved our accident year combined ratio excluding CATs by 440 basis points with International Commercial improving by 490 basis points and North America Commercial improving by 400 basis points.
The adjusted accident year combined ratio for the full year 2020 was 94.1%, a 190 basis point improvement year-over-year. Commercial's adjusted accident year combined ratio for the full year 2020 was 93.2%, a 340 basis point improvement year-over-year. These combined ratio improvements reflect very strong performance as General Insurance continues to benefit from an improved business mix in the commercial portfolio driven by the strategic underwriting actions we have been taking.
Turning to rate. In the fourth quarter, we continue to see considerable improvement and tighter terms and conditions. In commercial, we saw a sustained strong rate momentum and improvement across all lines of business with the exception of workers' compensation.
For the fourth quarter, our commercial business achieved rate increases of approximately 15%. North America Commercial rate increases were 21% in the fourth quarter compared to 14% in the prior year quarter. This improvement was driven by Excess Casualty, which saw rate increases of 45%; Financial Lines with rate increases of over 25%, led by 35% increases in D&O; Retail Property and Lexington wholesale property both achieving approximately 30% rate increases; and Lexington casualty with 25% rate increases.
International Commercial rate increases remained strong at 14% in the fourth quarter with second half 2020 rate improvement accelerating from the first half of the year. The largest rate increases were in global energy with over 30% increases, Financial Lines with 20% increases, Talbot with over 15% increases and Commercial Property with 15% increase.
Turning to Validus Re 1/1 renewals. Overall, we saw solid risk-adjusted rate improvements in U.S. property CAT, U.S. Casualty, international CAT, marine and energy, Financial Lines and specialty lines. For U.S. proportional business, material underlying rate improvement was generally applicable for our assumed portfolio. In international, rate improvements were achieved in essentially every territory.
Validus achieved a material increase in net written premium at the January 1 renewal period, which generated better balance across our portfolio, led by international property. New business, along with final signings across our portfolio, were very favorable as well. With respect to reinsurance AIG purchased, overall, we're extremely pleased with the outcome of our January 1 renewals in a challenging market environment. This was a critical year for us to evolve our reinsurance program strategically to reflect our significantly improved underlying portfolio.
In General Insurance, we maintained our philosophy of partnership with reinsurers and reducing volatility in the portfolio. We restructured our core placements in every major treaty. Keep in mind that AIG places over 35 treaties at 1/1, so I'll provide a few key highlights.
We reduced the aggregate amount of property catastrophe limit purchase as a result of a significantly reduced gross exposure in property PMLs. We reduced the catastrophe per occurrence attachment points in North America from $500 million to $200 million for all territories except the Southeast and Gulf, which remained at $500 million. We reduced the global shared aggregate limit retention in North America from $750 million to $500 million. We purchased a CAT program for PCG, our high net worth business, that protects Syndicate 2019 at AIG without taking on additional net limit. We reduced our overall catastrophe premium cost by over $150 million.
In our casualty quota share, we improved the ceding commission by 4 points and reduced our overall cession. We also introduced a new excess layer of $10 million excess of $15 million to remain consistent with our risk appetite. Those were just some of the highlights of our 1/1 renewal season. We are particularly pleased with the ongoing support we receive from the global reinsurance market, particularly our core partners.
With respect to Life and Retirement, the business continued sequential improvement, generating quarterly adjusted pretax income of $1 billion and adjusted return on segment common equity of 16.4%. For the full year 2020, adjusted pretax income was $3.5 billion and adjusted return on segment common equity was 13.9%. Result for 2020 reflected higher private equity returns and higher call and tender income driven by lower interest rates and tighter credit spreads. This was partially offset by the impact of COVID-19 mortality, lower fair value option bond income and base spread compression. Life and Retirement's strong performance in the face of macroeconomic stress and high levels of volatility during 2020 is a testament to the quality of its balance sheet, diversified product offerings and disciplined risk management. The hedge program performed as expected throughout the year, and the balance sheet remained strong.
Life and Retirement has a large and diverse in-force portfolio and, as a result of the Fortitude sale, has relatively limited net exposure to legacy blocks of business, no long-term care exposure and limited risks associated with pre-2010 variable annuity living benefits. This broad portfolio across products and channels was particularly advantageous during 2020. Given the disruption in retail sales during the year, the team focused on attractive opportunities to deploy capital in the Institutional Markets business, resulting in strong growth for both pension risk transfer transactions, direct and through reinsurance; and GIC issuances.
Group Retirement maintained steady payroll deduction periodic deposits and improved large group plan retention results. Overall, Life and Retirement remains well positioned to meet the ever-growing needs for protection, retirement savings and lifetime income solutions.
As I mentioned, we entered 2021 with significant momentum and a continued sense of urgency on our path to becoming a top-performing company. I'd like to thank our colleagues around the world for their focus and determination in supporting one another while delivering significant value to our stakeholders. Thanks to their efforts, we made tremendous progress in 2020, a year when the world changed for everyone and every organization. The responsibility, accountability and opportunity that commercial enterprises face today surpass anything corporate America and the global business community have ever faced. In the months and years ahead, we will continue to adapt and evolve and introduce a stronger version of AIG as we strive to become a leading global insurance franchise.
I'm privileged to be taking on the role of Chief Executive Officer of AIG and appreciate the opportunity to lead this company. I want to thank Brian for his partnership over the many years we've worked together and for asking me to join him at AIG back in 2017. Professionally, the last few years have presented the greatest challenge in my career, but I know that this experience will also be the most rewarding. And I want to extend a special thanks to Brian on behalf of all of our colleagues for his leadership, commitment to solving complex problems and building a foundation of stability that has positioned us well for the future. I look forward to continuing our work together as Brian steps into his new role as Executive Chairman.
Now I'll turn it over to Mark.
Mark Lyons: Thank you, Peter, and good morning, everyone. Before I go into the fourth quarter results, I want to highlight that we resegmented our financials this quarter and now have 3 business segments: General Insurance, Life and Retirement and Other Operations. The historical recasted information and description of the changes were in the 8-K filed on February 1 and posted on our website and were principally the elimination of the legacy segment and the realignment of its book into Life and Retirement and Other Operations as well as some small shifts within General Insurance.
Turning to the quarter. AIG reported adjusted pretax income or APTI of $1.1 billion and adjusted after-tax income of $827 million or $0.94 per diluted share compared to $923 million or $1.03 per share in the fourth quarter of 2019. The key drivers of this quarter were: first, a General Insurance accident year 2020 combined ratio ex CAT of 92.9%, which is a 290 basis point improvement over the fourth quarter of 2019; second, strong Life and Retirement APTI of $1 billion, driven by Individual and Group Retirement as well as Institutional Markets activity and strong net investment income; thirdly, $3.2 billion of consolidated net investment income on an APTI basis, primarily reflecting higher private equity and hedge fund income.
Moving to General Insurance. Fourth quarter adjusted pretax income was $809 million, up $31 million year-over-year as increased net investment income from alternatives offset the impact of higher catastrophe losses, which totaled $545 million pretax or 9 loss ratio points this quarter compared to 6.5 loss ratio points in the prior year quarter. The CAT losses were comprised of $367 million of natural CATs primarily related to fourth quarter events Hurricane Zeta, the East Troublesome and Silverado fires and Hurricane Delta, along with revised estimates for Hurricane Sally, which occurred late in the quarter and Hurricane Laura, where Delta has a similar path.
Additionally, there were $178 million of COVID-related losses primarily related to Travel, Contingency and Validus Re. Prior year development or PYD was slightly unfavorable this quarter at $45 million compared to favorable development of $139 million in the prior year quarter. This quarter included $51 million of net unfavorable development in North America and $6 million of net favorable development internationally.
The North America unfavorable PYD was driven mostly by Financial Lines, EPLI, E&O and mergers and acquisition insurance primarily from accident years 2016 to 2018 and thus not covered by the ADC, with favorable indications primarily in GL, AIGRM, some workers' compensation units and short-tail lines. As an additional lens, the $45 million of unfavorable development was also split as $5 million unfavorable in global Commercial Lines and $40 million unfavorable in global Personal Lines, primarily driven by adverse development in prior year CATs as opposed to attritional losses. As usual, there is net favorable amortization from the ADC, which amounted to $52 million this quarter.
I'll point out that our 2020 net premium profile is now skewed towards our international operations, totaling 57% of global net premium. Furthermore, the international book is nearly evenly balanced between Commercial and Personal Lines, and this demonstrates the truly global platform of our General Insurance business, led by an international book that has had better results with less volatility than North America. We expect these proportions to stay approximately the same in 2021 but skewed a bit less towards international as North America Commercial growth strengthens.
A key indicator of the turnaround of our General Insurance business is the improvement in the accident year ex CAT combined ratio results for North America and International Commercial Lines. As Peter has noted, North American Commercial had an accident quarter (sic) [ year ] combined ratio ex CAT that was 400 basis points better than last year's quarter to 93.6%, and International Commercial Lines improved their accident year combined ratio ex CAT by 490 basis points to 89.2%. We continue to view the current accident year prudently, with an appropriate view towards the margin of safety as the book has undergone a massive transformation and also anticipate continued margin expansion into 2021, resulting from the favorable global market conditions.
As Peter discussed, our Personal Insurance premium and underwriting results continue to be impacted by the repositioning of our high net worth business and the global pandemic. North America Personal Lines was impacted the most with an accident year combined ratio ex CAT of 102.6% versus 92.2% in the prior year quarter and a 55% drop in net premiums written.
In 2021, our year-over-year comparisons will begin to improve, although the first quarter will still be unfavorable since COVID was just beginning to impact Travel and Syndicate 2019 was formed in the second quarter of 2020. On the other hand, our International Personal Insurance business continues to perform well with a 93.9% accident year ex CAT combined ratio, which is 130 basis point improvement from 95.2% in 2019, reflecting favorable Japanese auto trends and improving business mix, offset slightly by the Travel book. Expense management also contributed to the improvement with 160 basis point reduction in the General Insurance expense ratio driven by lower acquisition ratio compared to the prior year quarter.
Lastly, before we leave General Insurance, we'd like to reiterate our outlook for a sub-90 accident year combined ratio ex CAT by the end of 2022. The 94.1% that we achieved in 2020 is a significant accomplishment, but there is more to come with the significant reunderwriting of the book over the past few years as well as the current very firm commercial lines market. We're highly confident that we will achieve more progress in 2021 and 2022 as we reestablish AIG's leadership in General Insurance.
Now turning to Life and Retirement. Adjusted pretax income was $1 billion for the quarter, up 20% compared to the prior year quarter. Total Life and Retirement premium and deposits increased by 4% compared to the prior year quarter driven by 2 large GIC issuances. In addition, pension risk transfer activity grew sequentially.
Life and Retirement continued to see a rebound in retail annuity sales as distribution partners became more accustomed to the new environment with higher sequential sales for both Variable and Index Annuities. Fixed Annuities sales were lower sequentially as Life and Retirement maintained pricing discipline in this challenging rate environment. Although still lower than the prior year, Index Annuities sales continued to grow sequentially, contributing strong positive net flows, helping offset declines in Variable and Fixed Annuity net flows.
Group Retirement net flows improved from the prior year quarter due to strong group plan acquisition and retention results, reflecting the investments made to modernize that platform. On February 8, AIG announced the sale of its Retail Mutual Fund business. This sale has a nearly immaterial impact on APTI but will benefit our overall net flow metrics, given the platform has generally experienced significant outflows over the last few years.
Base investment spreads for Variable and Index Annuities, Fixed Annuities and Group Retirement were virtually flat sequentially. As noted in previous quarters, Life and Retirement's reported base investment spread compression was impacted by substantially lower returns on cash and short-term investments through 2020. Excluding this impact, based on the environment we see today, we continue to expect base spread compression across the portfolio in the range of 8 to 16 basis points annually.
Recognizing the limits of sensitivities, especially in times of macroeconomic uncertainty and this higher market volatility, our sensitivity estimates for U.S. equity markets and rates are as follows. We would expect a plus or minus 1% change in equity market returns to respectively increase or decrease adjusted pretax income by approximately $40 million to $50 million annually. A plus or minus 10 basis points movement on the 10-year reinvestment rates would increase or decrease earnings by approximately $10 million to $20 million annually. As always, it is important to note that these market sensitivity ranges are not exact nor linear since our earnings are also impacted by the timing and degree of movements as well as other factors.
Moving to Other Operations, which now includes portions of the legacy segment from prior General Insurance exposures, had an adjusted pretax loss of $720 million, inclusive of $292 million of losses for consolidation and eliminations, which this quarter principally reflects realized capital gains on private equities, which are recorded as NII in the subsidiaries but eliminated in Other Operations' APTI and recorded as realized capital gains in net income, not AATI.
For the quarter, corporate interest expenses were slightly higher than the prior year, reflecting the interest on the $4.1 billion of senior notes issued in May 2020 and Other Operations' GOE was down $38 million from the comparable quarter last year. For 2021, we expect both corporate interest expense and GOE to decrease due to debt repayments and lower corporate expenses. However, we expect continued volatility in asset management and in the consolidation and elimination lines due to returns, interest rates and credit spread volatility.
Shifting to investments. Net investment income on an APTI basis was $3.2 billion or $236 million lower than the fourth quarter of 2019, principally due to the June 2020 sale of Fortitude whose investment income was included in the prior year's quarter. Adjusting the fourth quarter 2019 accordingly, this quarter's net investment income on an APTI basis was $262 million or 9% higher than the prior year and reflected the strongest quarterly returns in 2020 for hedge funds and private equity as well as having strong bond tender and call premiums. It's also worth noting that on a full year basis, net investment income on an APTI basis excluding Fortitude was $11.8 billion.
Turning to the balance sheet. At December 31, 2020, book value per common share was $76.46, up 3.5% from September 20, 2020, and adjusted book value per share was $57.01, up slightly from September 30.
As Peter mentioned, at year-end, AIG parent had cash and short-term liquidity assets of $10.5 billion. And during the quarter, we repaid our December debt maturity of $708 million, bringing our debt leverage for year-end 2020 to 28.4%, which is 220 basis points lower than second quarter of 2020 when we raised $4.1 billion of senior notes to prefinance 2020 and 2021 maturing debt.
Our primary operating subsidiaries remain profitable and well capitalized. For General Insurance, we estimate the U.S. pool fleet risk-based capital ratio for year-end 2020 to be approximately 455% and Life and Retirement is estimated to be approximately 430%, both above our target ranges and both providing a good absorbency buffer. The impacts from investment downgrades and credit losses to our RBC ratios were less than anticipated, reflecting a high-quality investment portfolio that is positioned well to navigate the uncertain environment.
And with respect to the capital management in 2021, as intended, we repaid $1.5 billion of maturing senior notes on February 1, which reduces our leverage ratio by about 1.6 points on a pro forma basis, approaching towards our 25% leverage target. In addition, we repurchased approximately 92 million of shares to offset dilution associated with AIG warrants that were exercised prior to expiration on January 19, 2021. As Peter mentioned, we intend to repurchase additional common shares in the first half of 2021 to manage dilution. And in addition, we expect to execute some liability management actions in the first half of 2021 to facilitate the Life and Retirement separation.
And with that, I'll now turn it back over to Brian.
Brian Duperreault: Thank you, Mark. Operator, we're ready for the Q&A.
Operator: [Operator Instructions] And we will take our first question from Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question, going back, Peter, to some of your introductory comments on Life and Retirement. You pointed to however the 19.9% transaction takes place, that some portion of the proceeds would be able to use for further share repurchases. So I'm just trying to get a sense -- when you make that comment, what are you guys assuming for, I guess, the leverage target for L&R as a stand-alone entity? And then also, is the goal for RemainCo AIG still to get its leverage target within the vicinity of, I think you guys have pointed to, around 25%?
Brian Duperreault: Okay. So Peter, the question is on the repurchase and leverage at AIG, I believe. So do you want to start? And maybe Mark can jump in if he has to.
Peter Zaffino: Yes, sure. I think Elyse, what I said in my October comments and then just reinforced and provided a little bit more detail on the prepared remarks is that we have made assumptions in terms of the stand-alone Life and Retirement business with acceptable debt and capital structure that is going to work with the rating agencies. We've also had assumed how we would set up AIG, the remaining company, with the guidance that Mark has given on our delevering. I focused that in my prepared remarks. It's our first priority. And we think that based on the base case, getting Life and Retirement set up, getting the delevering done at AIG, we think we will have capital available for share repurchase. That was the context of the comment I made. I don't know if you want to add anything, Mark.
Mark Lyons: No, I think you covered it, Peter.
Elyse Greenspan: Okay. And then my follow-up. You guys gave some pretty healthy price increases for another quarter throughout your Commercial Lines business. We're getting asked questions or I am right in terms of just the pricing cycle and the continued upward momentum from here. So as you guys think about 2021 and beyond, I mean, do you think that we can continue to see this level of price increases throughout your Commercial Lines book in both North America and internationally for the good part of 2021 and perhaps into 2022?
Brian Duperreault: Peter?
Peter Zaffino: Thanks, Elyse. Yes, this momentum will continue. As we look into 2021, we expect to see rate increases to continue. We expect to see these rate increases to be above loss cost. We expect that these rate increases will be balanced across our global portfolio and across multiple lines of business. And so this is a very disciplined market, one that our capacity is highly valued. And as we deploy it in property and casualty, we're going to be very disciplined in making sure we get the right price for the exposure, make sure that we're there to solve problems for our broker distribution partners and clients.
Brian Duperreault: I think Mark wants to add something, Peter.
Mark Lyons: Yes, if I could. Elyse, also, as Peter's kind of noted, we -- the momentum has been strong. We have really seen no evidence of deceleration of it. It's pretty broad-based across all lines and geographies. And I would just remind you that the timing was different internationally versus in North America. So it started a little bit later. So its trajectory is going to be different by definition, and thus far, no slowdowns.
Operator: And next, we'll hear from Tom Gallagher with Evercore.
Thomas Gallagher: First, Brian, just wanted to say best of luck to you in the new role.
Brian Duperreault: Thanks.
Thomas Gallagher: And Peter, just wanted to come back on the consideration of the private sale for the 19.9% stake in L&R. Should we think about this as just the sale of the stake? Or are you considering doing something more strategic, including reinsuring a portion of your in-force block or outsourcing investment management functions? Anything you could add?
Brian Duperreault: Peter?
Peter Zaffino: Well, as I mentioned in my prepared remarks, I mean, we have received a number of inbound inquiries, high-quality companies. And those high-quality companies see the real value in our Life and Retirement franchise, a very diversified portfolio, minimal legacy. And so how they are approaching AIG is that they want to do something strategically on the 19.9% because that's what we've outlined. But we are focused on how we drive long-term value for Life and Retirement with any partner that we decide to go with, in the event we do go with that over the initial public offering. And that's -- we're working towards that as a primary focus. So I don't want to go into the specific details because we don't have them. But you should just think about it as, if we did enter into an agreement, it would be about positioning the business for more long-term success.
Thomas Gallagher: Got you. And then just my follow-up is just, I guess, how are you thinking about the adverse development you saw on the '16 to '18 accident years? Particularly, 2016 seems to be a recurring problematic year. Do you feel there's some conservatism in there? How does that inform your picks going forward? Any -- and anything we should be thinking about with regard to what you saw with the year-end review?
Brian Duperreault: Okay, Tom. Mark, I think it's for you.
Mark Lyons: Yes, happy to. So a few things I could just point out is that in North America, we had -- we recognized in Financial Lines, I'd say on the EPLI side, a little bit on the E&O side and the mergers and acquisitions insurance, some little changes in M&A insurance. Originally, it was a product that was really to sellers and now sellers and buyers. That kind of changes your forecasted utilization and things like that. So there's some recognition there which I think makes some sense.
In the past, when we've talked about this, we've always focused on like primary D&O and SCAs and so forth. And every assumption that we had on the public side is still coming to bear. No matter how we look at it, our commercial book, our national book, the SCAs continue to drop as the underwriting continues to improve, and that's been a steady pattern.
What we would say this time is really on the private not-for-profit side, mostly centered in the EPLI, we saw some trends that we recognized. But we think we're in pretty good shape. We think we pretty much nailed it at this point.
And I would say, the second part of your question, on a go-forward, this book has had such massive transformation that the predictive value, given the turnover of the past to the future, is almost nonexistent. So we use it. We try to carve all those things out, index forward. But the impact of that on such a transformed book is negligible. So the net is we're very comfortable with where '19 and '20 are.
Operator: And next, we will hear from Tracy Benguigui with Barclays.
Tracy Dolin-Benguigui: Congratulations to both Brian and Peter.
Brian Duperreault: Thanks, Tracy.
Tracy Dolin-Benguigui: Yes. I have some similar questions about the reserve development. Maybe you could just talk about how you feel about rate adequacy and liabilities since you've had some adverse development in Excess Casualty. And I noticed it is one of the only Commercial Lines where you've actually had net premiums written decline.
Peter Zaffino: Maybe I'll start. And then -- thanks, Tracy. And then I'll turn over to Mark. Just 2 things to keep in mind. One is the net premium written. What I said in my prepared remarks on how we've restructured the reinsurance fee, $10 million excess of $15 million was purchased in December. So you would have seen that as an impact on net premium written for the casualty lines in the fourth quarter. So that's one.
And two is I just want to reinforce Mark's point and give you an example in terms of what we're doing with the Excess Casualty book. We had talked about we were, years ago, over 90% lead in what we were doing in Excess Casualty and wanted to make sure that we were getting better balance. And so the team led by Dave McElroy, Barbara Luck have done an amazing job. We now have increased like our mid-excess by over 400% in terms of policy count. So the book is changing and getting better balance across the portfolio.
And you don't really see that, but I think that's to Mark's point before when he was commenting on the vast changes, the improvement of the portfolio. So that just needs to emerge a little bit over time, but I think we have done some very strong work on the underwriting side. And the balance is much better as we position ourselves for the future.
Mark, I don't know if you want to add anything in terms of just Excess Casualty specifically.
Mark Lyons: Yes, sure. Two things. One, I'll follow up on your direct question, which is on the rate changes and rate adequacy.
And secondly, I think on the fin sup, we could have done a little better job. We said Excess Casualty was really the Lexington casualty, which really has primary in it. The traditional admitted casualty book that's either written out of American home or like London or Bermuda has performed very, very well during the year. And so I'm just letting you know that this is not an issue whatsoever. So it's really a combination of Lexington primary and excess.
But my comments will now address all of that. So as you know, rate changes have not only been large, they've been compound over a period. The terms and conditions which drive this line of business are tighter and tighter. And whether you have a calm or an aggressive view of loss cost trends that could affect casualty businesses, getting further away from risk is the preferred way to go, and that's the strategy that Peter and Dave have put in place, moving that portfolio higher so you're further away from risk in case anything unforeseen happens.
So we're very comfortable with that. We're very comfortable on -- our indications are that the rate adequacy as opposed to rate change is stronger on new business than it is on renewal business, which you'd expect to be the case in a hard cycle of acceleration like we have. And we continue to see inferior rate adequacy on the business we're not renewing. So that's what I call the implicit lift as opposed to the explicit lift. So we feel good about that.
Tracy Dolin-Benguigui: Okay. Excellent. And at this point, it's been a few months since your initial announcement to separate L&R. And I know you've had a lot of discussions with various market constituents. I'm just wondering, at this stage, how firm is your 19.9% initial sale target. I get your point it would be a full separation, but just wanted to get a sense if you had maybe more flexibility by the rating agencies or you've figured out a way to accelerate your debt structure that could lead to a different path.
Brian Duperreault: Peter, I think you should address that one.
Peter Zaffino: Okay. Yes. Thanks, Tracy. The 19.9% remains the base case. We think it's the best way forward for the organization. We're working on all the different work streams that I outlined in my prepared remarks, working with all of our stakeholders and believe that, that will be the path that maximizes value for the organization.
Operator: And next, we will hear from Yaron Kinar with Goldman Sachs.
Yaron Kinar: I'll reiterate the congratulatory comments to Brian and Peter. I guess my first question is on the comment around expectation of similar growth trend in Commercial Lines. Are you saying that you expect commercial net premiums written to be in the high single-digit range in 2021? And I guess what I'm trying to get at is, why wouldn't we see further acceleration from 4Q levels considering that rates remain very robust, you have less reinsurance purchase and potentially we see an economic recovery?
Brian Duperreault: Peter?
Peter Zaffino: Thanks, Yaron. It's hard to give specific guidance in terms of whether it's going to be high single digits or even more. I mean we have a lot of momentum in the commercial portfolio. We talked about strong retention, strong rate.
New business in 2020 was impacted by -- if I look globally, particularly in international and some of the Specialty classes, our new business was very strong but it wasn't at the normal levels that we expect within 2021. And again, we're still in the global pandemic. We'll see -- with the economic recovery, we're cautious but we're optimistic that new business will continue to pick up. And we believe our retentions will get stronger. And so we're very optimistic that we'll have very good growth balance across commercial globally next year.
I don't know, Dave, if you want to add anything in particular on the new business and your optimism of growth.
David McElroy: Yes. Thank you, Peter. In a simple way, I just -- I think we've had a couple of turns with the book. We look at this as less limit reduction. Okay? And then our new business opportunities have always continued to be, on the commercial side, on a $3 billion range worldwide with the platform that we have. And then I look at our -- the renewal retention rate. Okay? We can forecast rate, but we also have certain positions that we think that we can actually consistently earn those rates going forward. Okay? We are not in a commodity position in our portfolio. And if you look at this worldwide in terms of the different franchises we have, we think that the rate we're looking at and the risk-adjusted rate and the -- and what -- how we're thinking about the portfolio, they are very defendable.
So there was a lot of work done over the last couple of years, okay, and we freely admit that, in terms of addressing the exposure that might have been an outlier exposure. We feel very comfortable with where we are going into 2021 with a portfolio that we can add to, not only on rate but new business and then our renewal retention. Okay? And key point, and it's worth saying, the limit reduction that went through in these last 2 years, we are through that portal. And therefore, if anything, we're adding risk, and we're thinking about growth with risk, not just risk on top of limits, on top of accounts, but additional risk with additional clients.
And that's actually where we think very strongly that the brand and the formidable nature of what is AIG, we will succeed in 2021. Okay? That's very much part of the plan, is that we've taken some of the outlier exposures down to the studs and now we are very comfortable with the portfolio that we have going forward.
Brian Duperreault: I think Mark wanted to add something too, David.
Mark Lyons: Yes. Yaron, if I could, I'm going to purposely give you an arithmetic view. And it's this -- Peter touched on it a bit with the XOL when he was talking about some of the reinsurance. So loss-occurring contracts, you basically have ceded written all bulleted, right, in the quarter, and then it's earned smoothly. Risk-attaching quota shares, you see the recognition quarter-by-quarter. So from a net earned basis, which is what's going to really matter, you're going to see much more uplift on a net earned basis over the course of the year. The benefit of a smaller cession on the casualty quota share will overwhelm the additional XOL cession. So you'll see that increase, right, but it won't be at 1Q. You're going to see that over the course of the year.
Yaron Kinar: Got it. Very, very helpful comments. And then switching over to L&R. A lot of moving parts this quarter, pandemic mortality, alternative income, a little bit of AIG 200. Can you help us think about kind of the core earnings power of that business, whether as an earnings power or ROE that you talked about in the past? How should we think about that going forward?
Brian Duperreault: Peter, do you want to take that?
Peter Zaffino: I'll give it to Kevin. [ That is his work ]. Kevin?
Kevin Hogan: Yes. Thanks, Yaron. So I think Mark's comments highlighted the sensitivities to equity markets and interest rate levels. This year, we did benefit from some strong market support that, frankly, is laid out in the noteworthy items in the earnings deck. And we had a strong year based on where the markets were with both alts and the call and tender income.
We continue to target low to mid-double-digit returns for the medium term, and our current pricing conditions suggest we are able to continue that. And so I think it's really the alternatives are the big anomaly. This year, we turn those to normalized levels. The call and tender income strength could continue based on where interest rates are, and that's, to a certain extent, the wildcard.
Operator: And next, we will hear from Josh Shanker with Bank of America.
Joshua Shanker: I want to just go back to that guidance, and we'll call it guidance, about a 90% accident year ex CAT combined ratio in General Insurance in 2022. Is that a year forecast or was that an exit forecast?
And the other part -- I'll give both my questions upfront. If you told me we'd have 15% to 20% rate increases in 2020 and maybe in 2021, I would think you could improve the combined ratio by more than 300, 400 basis points in harmony with AIG 200. Do you have any thoughts on those 2 areas?
Brian Duperreault: So let's have Mark talk about it, the 90%, and then we'll take it from there. Go ahead, Mark.
Mark Lyons: So I think -- Peter and I go back and forth on this. On the 90% which we are, Josh, reiterating, Peter will get into some of the expense ratio aspects of it.
With regard to loss ratio, that was the second part of it, well, we would expect improving margins as well as we go through '21 and '22. We're viewing that as exit though, Josh. So that's much closer and equivalent to 4Q. But the -- but nevertheless, you have to watch the compound growth or change because as the book continues to improve, and it's improved fabulously, the degree of improvement narrows and narrows and narrows that you can do. So the big, huge changes have already occurred, but we're comfortable on our cadence and approach to get there. Peter?
Peter Zaffino: Yes. Can I just add to that? Thanks, Josh. I mean a couple of things to keep in mind. One is AIG 200 contributes a meaningful portion of the improvement in expense ratio. Now while I said $400 million was the exit run rate of 2020, that hasn't even fully earned in yet. So we expect the full $1 billion by 2022. So you can just do the math that, that will contribute to the expense ratio and overall combined ratio.
The other is we think there's 2 components to growth. One is, Dave mentioned it, that we think that the portfolio is in a very good place for top line growth, and we would expect to see that to continue in 2021 and 2022. In addition, contributing to that growth will be we need less reinsurance. I think the terms and conditions that we were able to improve at 1/1 speak volumes in terms of the trajectory and what we would expect for reinsurance going forward. That will contribute.
I think when we do, and the team has proven it does very good work on operational excellence, that when we separate Life and Retirement AIG RemainCo, we will find ways to improve the expense ratio as we work through the actual separation, and we have a very disciplined expense behavior in the company. And then just the rate above loss cost and as we continue to reposition the portfolio, we think there will be improvement in the loss ratio as we look to the future. So when you add all of those components together, we are very confident that we will be below the 90% as we exit 2022.
Brian Duperreault: And Josh, don't forget this is a -- Josh, don't forget this is both commercial and personal. It's the entire book of business going below 90%. And the Personal Lines is not getting the kind of rate increases in Commercial. So you just got to put that weighted average in too.
Do you have -- you asked your questions didn't you, Josh?
Joshua Shanker: Those were 2. Good luck in your new roles, and congratulations to everyone.
Brian Duperreault: I appreciate that, Josh. Thank you very much.
Operator: All right. And we will hear from Erik Bass with Autonomous Research.
Erik Bass: I just wanted to follow up on Tom's question about the potential sale of the 19.9% stake in L&R. Can you just discuss how you're thinking about the benefits of that approach versus an IPO and some of the key considerations on which makes more sense for delivering long-term value?
Brian Duperreault: Peter?
Peter Zaffino: Yes. And Mark, you can weigh in. I mean certainly, the path with the IPO is very clear with the 19.9% IPO sale. When we look at -- I think the heart of your question on the private is that it has to be a better alternative for us. We have to be more strategic, more financially advantageous and making certain that when we look at the 19.9%, we don't look at that in isolation. We look at the 80.1% and how we position the Life and Retirement business for the future. So those are the things, among other factors, that we will consider in terms of do we go through the IPO or would we do a private sale as we work through the coming months.
Erik Bass: Got it. The next one...
Brian Duperreault: Yes. Do you have another follow-up there?
Erik Bass: Yes, please. Just one other on Life and Retirement. I was just hoping you could provide some additional detail on the mortality results this quarter. Any sensitivity to general population COVID deaths or maybe another metric to help us think about the potential impacts in 1Q?
Brian Duperreault: Kevin, do you want to do that?
Kevin Hogan: Yes, absolutely. Thanks, Erik. So look, the reality is it's hard to isolate COVID deaths. So the way we approach it in looking at our portfolio is to focus on the total portfolio actually to expected versus pricing. And in this context, we saw mortality for the year continue to be acceptable relative to our pricing in terms of short-run variances driven by COVID. Either way, we look at this as an earnings and not a capital event, and we haven't seen any data that suggest a change to our long-term assumptions.
That being said, based on our best understanding of what are the COVID-related deaths, we estimate that up to 40% of the reported claims -- COVID reported claims could be an acceleration of claims we would otherwise expect in the next 5 years. And again, based on our best understanding of the COVID deaths, we estimate our exposure to the population of approximately $65 million to $75 million per 100,000 population deaths, which is a slightly better estimate than what we would have assumed a couple of quarters ago.
Brian Duperreault: Okay. So thank you all for all your questions. Before I end the call, I want to thank everyone who's been part of the multiyear journey that began when I joined AIG in 2017 to fix the fundamental needed -- fundamentals needed for AIG to once again be a leading insurance franchise.
What has been accomplished over the last few years would not have been possible without the extraordinary efforts of AIG's exceptional talent at all levels of the organization. And I'm thankful for everyone's dedication and commitment to this great organization. I'm also grateful to the clients and distribution reinsurance partners, shareholders, regulators and many other stakeholders who have actively supported me since I returned to AIG. I look forward to being a part of the next chapter of AIG under Peter's leadership. Be well. Stay safe and healthy.
Operator: And ladies and gentlemen, this concludes today's call. We do thank you for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Fourth Quarter 2020 Financial Results Conference Call. Today's conference is being recorded."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Orlando. Good morning, and thank you all for joining us. Today's call will cover AIG's fourth quarter and year-end 2020 financial results announced yesterday afternoon. The news release, financial results presentation and financial supplement are available on our website, www.aig.com. Our 10-K for 2020 will be filed on Friday, February 19."
},
{
"speaker": "Brian Duperreault",
"text": "Good morning, and thank you for joining us today. I'd like to highlight some of the important milestones we achieved in 2020, and then I'll turn it over to Peter to provide more detail on our results for General Insurance and Life and Retirement as well as updates on strategic initiatives such as the separation of the Life and Retirement business and AIG 200. Lastly, Mark will provide a CFO update."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Brian. Good morning, everyone, and thank you for joining us today. This morning, I'd like to cover 4 topics that are key areas of focus for us in 2021 and which we will update you on each quarter: the separation of Life and Retirement from AIG, capital management, progress we've made on AIG 200 and financial and operating highlights for General Insurance and Life and Retirement."
},
{
"speaker": "Now I'd like to provide an update on AIG 200. As a reminder, AIG 200 has core -- 4 core objectives",
"text": "underwriting excellence, modernizing our operating infrastructure, enhancing user and customer experience and becoming a more unified company. Throughout 2020, we made measurable progress in spite of the ongoing remote work environment and, in some cases, accelerated certain initiatives. On December 31, we completed the sale of our shared services operations to Accenture, which streamlines our operating model. We've made significant progress in driving improvements in infrastructure and systems architecture while reducing real estate costs and other general operating expenses. We exceeded our target run rate savings for 2020, and the costs required to achieve were lower than initially expected. We exited 2020 with a $400 million run rate benefit, which was 30% ahead of the guidance we provided in 2020."
},
{
"speaker": "Mark Lyons",
"text": "Thank you, Peter, and good morning, everyone. Before I go into the fourth quarter results, I want to highlight that we resegmented our financials this quarter and now have 3 business segments: General Insurance, Life and Retirement and Other Operations. The historical recasted information and description of the changes were in the 8-K filed on February 1 and posted on our website and were principally the elimination of the legacy segment and the realignment of its book into Life and Retirement and Other Operations as well as some small shifts within General Insurance."
},
{
"speaker": "Turning to the quarter. AIG reported adjusted pretax income or APTI of $1.1 billion and adjusted after-tax income of $827 million or $0.94 per diluted share compared to $923 million or $1.03 per share in the fourth quarter of 2019. The key drivers of this quarter were",
"text": "first, a General Insurance accident year 2020 combined ratio ex CAT of 92.9%, which is a 290 basis point improvement over the fourth quarter of 2019; second, strong Life and Retirement APTI of $1 billion, driven by Individual and Group Retirement as well as Institutional Markets activity and strong net investment income; thirdly, $3.2 billion of consolidated net investment income on an APTI basis, primarily reflecting higher private equity and hedge fund income."
},
{
"speaker": "Brian Duperreault",
"text": "Thank you, Mark. Operator, we're ready for the Q&A."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] And we will take our first question from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, going back, Peter, to some of your introductory comments on Life and Retirement. You pointed to however the 19.9% transaction takes place, that some portion of the proceeds would be able to use for further share repurchases. So I'm just trying to get a sense -- when you make that comment, what are you guys assuming for, I guess, the leverage target for L&R as a stand-alone entity? And then also, is the goal for RemainCo AIG still to get its leverage target within the vicinity of, I think you guys have pointed to, around 25%?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay. So Peter, the question is on the repurchase and leverage at AIG, I believe. So do you want to start? And maybe Mark can jump in if he has to."
},
{
"speaker": "Peter Zaffino",
"text": "Yes, sure. I think Elyse, what I said in my October comments and then just reinforced and provided a little bit more detail on the prepared remarks is that we have made assumptions in terms of the stand-alone Life and Retirement business with acceptable debt and capital structure that is going to work with the rating agencies. We've also had assumed how we would set up AIG, the remaining company, with the guidance that Mark has given on our delevering. I focused that in my prepared remarks. It's our first priority. And we think that based on the base case, getting Life and Retirement set up, getting the delevering done at AIG, we think we will have capital available for share repurchase. That was the context of the comment I made. I don't know if you want to add anything, Mark."
},
{
"speaker": "Mark Lyons",
"text": "No, I think you covered it, Peter."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then my follow-up. You guys gave some pretty healthy price increases for another quarter throughout your Commercial Lines business. We're getting asked questions or I am right in terms of just the pricing cycle and the continued upward momentum from here. So as you guys think about 2021 and beyond, I mean, do you think that we can continue to see this level of price increases throughout your Commercial Lines book in both North America and internationally for the good part of 2021 and perhaps into 2022?"
},
{
"speaker": "Brian Duperreault",
"text": "Peter?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Elyse. Yes, this momentum will continue. As we look into 2021, we expect to see rate increases to continue. We expect to see these rate increases to be above loss cost. We expect that these rate increases will be balanced across our global portfolio and across multiple lines of business. And so this is a very disciplined market, one that our capacity is highly valued. And as we deploy it in property and casualty, we're going to be very disciplined in making sure we get the right price for the exposure, make sure that we're there to solve problems for our broker distribution partners and clients."
},
{
"speaker": "Brian Duperreault",
"text": "I think Mark wants to add something, Peter."
},
{
"speaker": "Mark Lyons",
"text": "Yes, if I could. Elyse, also, as Peter's kind of noted, we -- the momentum has been strong. We have really seen no evidence of deceleration of it. It's pretty broad-based across all lines and geographies. And I would just remind you that the timing was different internationally versus in North America. So it started a little bit later. So its trajectory is going to be different by definition, and thus far, no slowdowns."
},
{
"speaker": "Operator",
"text": "And next, we'll hear from Tom Gallagher with Evercore."
},
{
"speaker": "Thomas Gallagher",
"text": "First, Brian, just wanted to say best of luck to you in the new role."
},
{
"speaker": "Brian Duperreault",
"text": "Thanks."
},
{
"speaker": "Thomas Gallagher",
"text": "And Peter, just wanted to come back on the consideration of the private sale for the 19.9% stake in L&R. Should we think about this as just the sale of the stake? Or are you considering doing something more strategic, including reinsuring a portion of your in-force block or outsourcing investment management functions? Anything you could add?"
},
{
"speaker": "Brian Duperreault",
"text": "Peter?"
},
{
"speaker": "Peter Zaffino",
"text": "Well, as I mentioned in my prepared remarks, I mean, we have received a number of inbound inquiries, high-quality companies. And those high-quality companies see the real value in our Life and Retirement franchise, a very diversified portfolio, minimal legacy. And so how they are approaching AIG is that they want to do something strategically on the 19.9% because that's what we've outlined. But we are focused on how we drive long-term value for Life and Retirement with any partner that we decide to go with, in the event we do go with that over the initial public offering. And that's -- we're working towards that as a primary focus. So I don't want to go into the specific details because we don't have them. But you should just think about it as, if we did enter into an agreement, it would be about positioning the business for more long-term success."
},
{
"speaker": "Thomas Gallagher",
"text": "Got you. And then just my follow-up is just, I guess, how are you thinking about the adverse development you saw on the '16 to '18 accident years? Particularly, 2016 seems to be a recurring problematic year. Do you feel there's some conservatism in there? How does that inform your picks going forward? Any -- and anything we should be thinking about with regard to what you saw with the year-end review?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay, Tom. Mark, I think it's for you."
},
{
"speaker": "Mark Lyons",
"text": "Yes, happy to. So a few things I could just point out is that in North America, we had -- we recognized in Financial Lines, I'd say on the EPLI side, a little bit on the E&O side and the mergers and acquisitions insurance, some little changes in M&A insurance. Originally, it was a product that was really to sellers and now sellers and buyers. That kind of changes your forecasted utilization and things like that. So there's some recognition there which I think makes some sense."
},
{
"speaker": "Operator",
"text": "And next, we will hear from Tracy Benguigui with Barclays."
},
{
"speaker": "Tracy Dolin-Benguigui",
"text": "Congratulations to both Brian and Peter."
},
{
"speaker": "Brian Duperreault",
"text": "Thanks, Tracy."
},
{
"speaker": "Tracy Dolin-Benguigui",
"text": "Yes. I have some similar questions about the reserve development. Maybe you could just talk about how you feel about rate adequacy and liabilities since you've had some adverse development in Excess Casualty. And I noticed it is one of the only Commercial Lines where you've actually had net premiums written decline."
},
{
"speaker": "Peter Zaffino",
"text": "Maybe I'll start. And then -- thanks, Tracy. And then I'll turn over to Mark. Just 2 things to keep in mind. One is the net premium written. What I said in my prepared remarks on how we've restructured the reinsurance fee, $10 million excess of $15 million was purchased in December. So you would have seen that as an impact on net premium written for the casualty lines in the fourth quarter. So that's one."
},
{
"speaker": "Mark Lyons",
"text": "Yes, sure. Two things. One, I'll follow up on your direct question, which is on the rate changes and rate adequacy."
},
{
"speaker": "Tracy Dolin-Benguigui",
"text": "Okay. Excellent. And at this point, it's been a few months since your initial announcement to separate L&R. And I know you've had a lot of discussions with various market constituents. I'm just wondering, at this stage, how firm is your 19.9% initial sale target. I get your point it would be a full separation, but just wanted to get a sense if you had maybe more flexibility by the rating agencies or you've figured out a way to accelerate your debt structure that could lead to a different path."
},
{
"speaker": "Brian Duperreault",
"text": "Peter, I think you should address that one."
},
{
"speaker": "Peter Zaffino",
"text": "Okay. Yes. Thanks, Tracy. The 19.9% remains the base case. We think it's the best way forward for the organization. We're working on all the different work streams that I outlined in my prepared remarks, working with all of our stakeholders and believe that, that will be the path that maximizes value for the organization."
},
{
"speaker": "Operator",
"text": "And next, we will hear from Yaron Kinar with Goldman Sachs."
},
{
"speaker": "Yaron Kinar",
"text": "I'll reiterate the congratulatory comments to Brian and Peter. I guess my first question is on the comment around expectation of similar growth trend in Commercial Lines. Are you saying that you expect commercial net premiums written to be in the high single-digit range in 2021? And I guess what I'm trying to get at is, why wouldn't we see further acceleration from 4Q levels considering that rates remain very robust, you have less reinsurance purchase and potentially we see an economic recovery?"
},
{
"speaker": "Brian Duperreault",
"text": "Peter?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Yaron. It's hard to give specific guidance in terms of whether it's going to be high single digits or even more. I mean we have a lot of momentum in the commercial portfolio. We talked about strong retention, strong rate."
},
{
"speaker": "David McElroy",
"text": "Yes. Thank you, Peter. In a simple way, I just -- I think we've had a couple of turns with the book. We look at this as less limit reduction. Okay? And then our new business opportunities have always continued to be, on the commercial side, on a $3 billion range worldwide with the platform that we have. And then I look at our -- the renewal retention rate. Okay? We can forecast rate, but we also have certain positions that we think that we can actually consistently earn those rates going forward. Okay? We are not in a commodity position in our portfolio. And if you look at this worldwide in terms of the different franchises we have, we think that the rate we're looking at and the risk-adjusted rate and the -- and what -- how we're thinking about the portfolio, they are very defendable."
},
{
"speaker": "Brian Duperreault",
"text": "I think Mark wanted to add something too, David."
},
{
"speaker": "Mark Lyons",
"text": "Yes. Yaron, if I could, I'm going to purposely give you an arithmetic view. And it's this -- Peter touched on it a bit with the XOL when he was talking about some of the reinsurance. So loss-occurring contracts, you basically have ceded written all bulleted, right, in the quarter, and then it's earned smoothly. Risk-attaching quota shares, you see the recognition quarter-by-quarter. So from a net earned basis, which is what's going to really matter, you're going to see much more uplift on a net earned basis over the course of the year. The benefit of a smaller cession on the casualty quota share will overwhelm the additional XOL cession. So you'll see that increase, right, but it won't be at 1Q. You're going to see that over the course of the year."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. Very, very helpful comments. And then switching over to L&R. A lot of moving parts this quarter, pandemic mortality, alternative income, a little bit of AIG 200. Can you help us think about kind of the core earnings power of that business, whether as an earnings power or ROE that you talked about in the past? How should we think about that going forward?"
},
{
"speaker": "Brian Duperreault",
"text": "Peter, do you want to take that?"
},
{
"speaker": "Peter Zaffino",
"text": "I'll give it to Kevin. [ That is his work ]. Kevin?"
},
{
"speaker": "Kevin Hogan",
"text": "Yes. Thanks, Yaron. So I think Mark's comments highlighted the sensitivities to equity markets and interest rate levels. This year, we did benefit from some strong market support that, frankly, is laid out in the noteworthy items in the earnings deck. And we had a strong year based on where the markets were with both alts and the call and tender income."
},
{
"speaker": "Operator",
"text": "And next, we will hear from Josh Shanker with Bank of America."
},
{
"speaker": "Joshua Shanker",
"text": "I want to just go back to that guidance, and we'll call it guidance, about a 90% accident year ex CAT combined ratio in General Insurance in 2022. Is that a year forecast or was that an exit forecast?"
},
{
"speaker": "Brian Duperreault",
"text": "So let's have Mark talk about it, the 90%, and then we'll take it from there. Go ahead, Mark."
},
{
"speaker": "Mark Lyons",
"text": "So I think -- Peter and I go back and forth on this. On the 90% which we are, Josh, reiterating, Peter will get into some of the expense ratio aspects of it."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Can I just add to that? Thanks, Josh. I mean a couple of things to keep in mind. One is AIG 200 contributes a meaningful portion of the improvement in expense ratio. Now while I said $400 million was the exit run rate of 2020, that hasn't even fully earned in yet. So we expect the full $1 billion by 2022. So you can just do the math that, that will contribute to the expense ratio and overall combined ratio."
},
{
"speaker": "Brian Duperreault",
"text": "And Josh, don't forget this is a -- Josh, don't forget this is both commercial and personal. It's the entire book of business going below 90%. And the Personal Lines is not getting the kind of rate increases in Commercial. So you just got to put that weighted average in too."
},
{
"speaker": "Joshua Shanker",
"text": "Those were 2. Good luck in your new roles, and congratulations to everyone."
},
{
"speaker": "Brian Duperreault",
"text": "I appreciate that, Josh. Thank you very much."
},
{
"speaker": "Operator",
"text": "All right. And we will hear from Erik Bass with Autonomous Research."
},
{
"speaker": "Erik Bass",
"text": "I just wanted to follow up on Tom's question about the potential sale of the 19.9% stake in L&R. Can you just discuss how you're thinking about the benefits of that approach versus an IPO and some of the key considerations on which makes more sense for delivering long-term value?"
},
{
"speaker": "Brian Duperreault",
"text": "Peter?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. And Mark, you can weigh in. I mean certainly, the path with the IPO is very clear with the 19.9% IPO sale. When we look at -- I think the heart of your question on the private is that it has to be a better alternative for us. We have to be more strategic, more financially advantageous and making certain that when we look at the 19.9%, we don't look at that in isolation. We look at the 80.1% and how we position the Life and Retirement business for the future. So those are the things, among other factors, that we will consider in terms of do we go through the IPO or would we do a private sale as we work through the coming months."
},
{
"speaker": "Erik Bass",
"text": "Got it. The next one..."
},
{
"speaker": "Brian Duperreault",
"text": "Yes. Do you have another follow-up there?"
},
{
"speaker": "Erik Bass",
"text": "Yes, please. Just one other on Life and Retirement. I was just hoping you could provide some additional detail on the mortality results this quarter. Any sensitivity to general population COVID deaths or maybe another metric to help us think about the potential impacts in 1Q?"
},
{
"speaker": "Brian Duperreault",
"text": "Kevin, do you want to do that?"
},
{
"speaker": "Kevin Hogan",
"text": "Yes, absolutely. Thanks, Erik. So look, the reality is it's hard to isolate COVID deaths. So the way we approach it in looking at our portfolio is to focus on the total portfolio actually to expected versus pricing. And in this context, we saw mortality for the year continue to be acceptable relative to our pricing in terms of short-run variances driven by COVID. Either way, we look at this as an earnings and not a capital event, and we haven't seen any data that suggest a change to our long-term assumptions."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. So thank you all for all your questions. Before I end the call, I want to thank everyone who's been part of the multiyear journey that began when I joined AIG in 2017 to fix the fundamental needed -- fundamentals needed for AIG to once again be a leading insurance franchise."
},
{
"speaker": "Operator",
"text": "And ladies and gentlemen, this concludes today's call. We do thank you for your participation. You may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 3 | 2,020 | 2020-11-06 09:00:00 | Operator: Good day and welcome to AIG's Third Quarter 2020 Financial Results Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Ms. Sabra Purtill, Head of Investor Relations. Please go ahead, ma'am.
Sabra Purtill: Thank you. Good morning and thank you all for joining us. Today's call will cover AIG's third quarter 2020 financial results announced yesterday afternoon. The news release, financial results presentation and financial supplement are posted on our website at www.aig.com. And the 10-Q will be filed later today after the call.
Today's remarks may contain forward-looking statements, including comments relating to company performance, strategic priorities, including the announced planned separation of our Life and Retirement business, business mix and market conditions, including the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may materially differ. Factors that could cause results to differ include the factors described in our second quarter 2020 report on Form 10-Q and our 2019 annual report on Form 10-K and our other recent filings made with the SEC, inclusive of the effects of COVID-19 on AIG, which cannot be fully determined at this time. AIG is not under any obligation and expressly disclaims any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.
Additionally, some remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website.
I'll now turn the call over to Brian.
Brian Duperreault: Good morning and thank you for joining us today. Given the announcements we made last week, we will handle today's call differently with the objective to leave as much time as possible for your questions. I will focus most of my remarks on our leadership changes and the separation of Life and Retirement. Peter will expand on what the separation process will entail. He will provide an overview of our third quarter results for General Insurance and Life and Retirement and give an update on AIG 200. Lastly, Mark will provide additional color on our financial results for the quarter. Kevin Hogan, Dave McElroy and Doug Dachille will be available for the Q&A portion of the call.
As you saw in our earnings release, AIG continues to manage through the ongoing global economic uncertainty. We are financially strong and well positioned to capitalize on the opportunities for growth. In the third quarter, we reported adjusted after-tax income of $0.81 per common share, and we saw improvement in both the accident year combined ratio in General Insurance and Life and Retirement's adjusted return on attributed common equity.
As we announced last week, the AIG Board unanimously elected Peter to become the next Chief Executive Officer of AIG effective March 1. At that time, I will assume -- I will become Executive Chairman of the AIG Board. This leadership transition demonstrates our continuing momentum and focus on AIG's future. It's an honor to serve as a CEO of AIG, and I want to thank our directors for their ongoing support.
I also want to congratulate Peter. I've worked with Peter in several capacities for many years, and I'm extremely proud of him and the legacy he is building in our industry. Since joining me at AIG in 2017, he designed and executed on the turnaround in our General Insurance business, which, by any measure, has been historic. I greatly admire Peter's strength of character, leadership abilities and willingness to take decisive action. He has a proven track record of building great teams and successfully leading them in times of significant change and growth. Peter exemplifies the rare executive who is both a hard-working operational leader and a strategic visionary. I know that he will be an excellent CEO for AIG, and the company will be in great hands.
Turning to our second big announcement last week. As I stated before, we have continually examined the composite structure of AIG. And over the last several months with the assistance from independent financial and legal advisers, we conducted a very comprehensive review to determine if the change would be in the best interest of our shareholders and other stakeholders. This review included examining strategic, operational, capital and tax implications. And the output of this review was very clear, that is a simpler structure will benefit both GI and L&R. This is largely due to the significant foundational work our team has done across AIG to strengthen our businesses and position them as market leaders.
In addition, impediments to a separation that existed back in 2017 have greatly diminished. For example, the tax benefits of AIG's current composite structure have decreased over time. And with the stronger capitalization of our core business, the capital diversification benefit has become less significant. We believe our businesses will be more resilient as separate companies with more appropriate and sustainable valuations, and each will continue to be market leaders in their respective sectors with strong balance sheets, appropriate capital structures, attractive earnings and cash flows. We also believe both will have sufficient financial flexibility to compete effectively. We do not anticipate that either will require additional capital -- equity capital in connection with the separation, and neither will be overleveraged, especially when compared to their respective peers.
We have evaluated various structural alternatives for the separation, and Peter will provide details on our initial conclusions. While the separation process will be complex and will, of course, require regulatory approvals, we are confident that we will execute in a way that provides the best long-term value for shareholders and other stakeholders. We are committed to transparency and providing you with updates as the process moves forward.
Now I'll turn it over to Peter.
Peter Zaffino: Good morning, everyone. Thank you, Brian. I appreciate your kind words and want to thank the AIG Board for the opportunity to lead this company. As Brian noted, we are living through a sustained period of global economic challenges. At AIG, we are well prepared as our purpose is to partner with our clients, especially during challenging times, to help them solve complex risk issues, capture opportunities in all market cycles and provide a consistent approach to providing insurance solutions in this period of uncertainty. We continually ask ourselves whether the things that worked well yesterday will continue to work tomorrow and into the future.
This morning, I will expand on Brian's comments regarding key areas we're focused on. I'll start with additional insight into our plan to separate Life and Retirement from AIG. Then I'll provide an overview of the third quarter results for General Insurance and Life and Retirement. And lastly, I'll briefly outline our progress on AIG 200.
With respect to Life and Retirement, as Brian said, we undertook a comprehensive review of our composite structure over the last several months. We concluded that over time, the value of full separation can create for our shareholders will be significantly greater than maintaining our current structure. Our analysis took into account many factors, including potential impediments and benefits.
Among the more significant factors are: One, the progress we've made since late 2017 to strengthen the foundation of General Insurance materially reduce risk and volatility in our portfolio and position General Insurance as a market leader poised for sustainable, profitable growth. A separation of Life and Retirement from AIG would not be possible without a strong General Insurance business that can support itself and thrive on a stand-alone basis.
Two, we believe that we can effectively manage any loss of diversification benefits in our capital model as a result of separation. Our current expectation is that no additional equity capital will be required given the improvements in our subsidiary capital positions over the last 3 years. This is especially true in General Insurance, where the capital base is stronger than it's been in many years.
Three, the separation process will require us to implement a stand-alone capital structure for Life and Retirement. This will involve raising new debt at Life and Retirement and restructuring debt at AIG parent. In the end, both companies will have independent capital structures in line with peers and appropriate financial leverage for their respective ratings. Both companies will also have strong financial flexibility to execute on their strategic priorities.
Four, AIG's deferred tax asset is no longer an obstacle as it was in the past. The DTA is made up of net operating loss carryforwards and foreign tax credits. With respect to the net operating losses, we expect AIG to have taxable income post-separation that is sufficient to utilize the remaining $6.6 billion before they expire. The foreign tax credit carryforwards have been significantly utilized in recent years, and we expect to utilize the vast majority of the remaining $1.5 billion before we deconsolidate Life and Retirement, leaving only a small portion potentially at risk.
And five, there is a limited number of legal entity restructurings required to achieve a separation as well as limited expense dis-synergies. In fact, we will leverage the important work we're doing as part of AIG 200 to facilitate operational separation.
While the precise form of separation will be subject to AIG Board and regulatory approvals, rating agency considerations and market conditions, we currently contemplate either an IPO or private sale of up to 19.9% of Life and Retirement, followed by one or more dispositions of our remaining ownership interest over time. We're proceeding with a sense of urgency to determine the initial step of the separation and will continue to engage with regulators and rating agencies throughout the process.
Finally, we do not intend to break up Life and Retirement and sell it in pieces, as the significant strength of the business is the breadth of its platform and diversified product portfolio and distribution network. Throughout the separation process, we will remain laser-focused on continuing to position our businesses to deliver superior value to our clients, distribution partners, shareholders and other stakeholders.
Turning to our third quarter. In General Insurance, we achieved another quarter of positive results in our core business with continued improvement in our underwriting margins. The accident year combined ratio, excluding catastrophe, improved by 260 basis points to 93.3% compared to 95.9% a year ago and by 610 basis points compared to 99.4% in the third quarter of 2018. The improvement was driven by our Commercial business, which improved by approximately 560 basis points year-over-year as a result of lower accident year loss ratio, excluding CAT, and a lower expense ratio. The lower Commercial accident year loss ratio ex CAT reflects a higher-quality book of business, driven by a better mix and portfolio management actions.
In Personal Insurance, not surprisingly, our portfolio mix continues to be impacted by COVID-19, which has reduced premium volumes by more than 80% in our Travel business alone. The mix of business was further impacted in North America Personal Insurance due to the reinsurance cessions related to Syndicate 2019.
With respect to CAT, the third quarter was very active with low to moderate severity per event in both North America and Japan with an upper industry range of $45 billion globally. As we disclosed last week, our third quarter CAT loss estimates, net of reinsurance, totaled $790 million for the quarter. Included in this CAT number is $185 million of COVID-19 loss estimates. With respect to COVID-19, the loss estimates primarily related to Travel, Contingency and Validus Re. Our year-to-date COVID-related net loss estimates are slightly over $900 million.
Our reinsurance program continues to perform as expected with recoveries in our International per occurrence, Private Client Group per occurrence and other discrete reinsurance programs limiting volatility. Regardless of frequency and severity of natural CATs and additional COVID-19-related losses, we expect overall CAT losses for the remainder of the year to be limited due to various protections we have in place under our aggregate CAT covers.
Turning to rate. In the third quarter, our underwriting discipline continued as our team has pivoted to pursue premium growth while not losing our focus on account-level decisions, risk-adjusted rates and margin expansion. In Commercial, there is continued momentum in our portfolio optimization strategy, and we're seeing sustained rate-on-rate improvement across most lines of business. For the third quarter, our Commercial business had rate increases of approximately 17%. North America Commercial rate increases were 20% in the third quarter compared to 12% in the prior year. Rate increases in Admitted Property were over 30%. In Financial Lines, they were over 25% led by D&O. In Excess & Surplus Lines, they were over 20%. And in Excess Casualty, they were over 30%.
International Commercial rate increases were 14% in the third quarter compared to 8% in the prior year, driven by Financial Lines and Specialty. Rate increases in Commercial Property were 12%. In Financial Lines, they were over 20% led by D&O. And in U.K. Specialty, they were over 25% led by energy, aviation and trade credit. It's important to note that the rates we're achieving are on a policy year basis and will take time to earn into our accident year results. Additionally, we're confident that the rate increases we are achieving are outpacing loss cost increases in our portfolio.
Turning to Validus Re and upcoming 1/1 renewals, our team continues to be disciplined in deploying capacity and focus on acceptable terms and conditions as well as appropriate risk-adjusted rate changes. Double-digit rate increases are being quoted in most lines with tighter terms and conditions. Retro business is very active with meaningful double-digit rate increases being quoted with terms altering to modelled perils only with the occurrence covers being preferred over aggregate covers.
Before turning to Life and Retirement, I want to provide context for how we view the rate environment in the P&C market. Insurance carriers have faced challenging business conditions for more than a decade. Soft market conditions have gripped the industry since 2007 and have been coupled with historically low interest rates and an increase in frequency and severity of natural catastrophes. As an example, when looking at Property, the expected aggregate industry natural CAT losses for 2017 through the third quarter of 2020 are estimated to exceed $400 billion. Median annual losses over the last 15 years have been approximately $65 billion. These amounts are nearly double the amount of expected loss. For natural catastrophes, pricing has adjusted in light of these new norms. And keep in mind, none of these numbers include catastrophe losses from COVID-19.
With these challenges and the increasingly complex environment our clients are looking to us to help them manage, the work we do is becoming more complex. We believe our retention rates demonstrate the strength of our relationships with clients and distribution partners and confirm that a flight of quality has been backed from the fruition, particularly due to COVID. The momentum we have generated in General Insurance is significant and we believe that we will achieve top line growth in 2021. And by the end of 2022, we'll achieve an accident year combined ratio, excluding CATs, below 90%. This will represent a 1,000 basis point improvement since 2018.
Turning to Life and Retirement. I've spent the last couple of months working with Kevin and his team to analyze this business. It is a franchise that is extremely well positioned in the market and has a track record of delivering consistent performance.
Third quarter adjusted pretax income was $975 million, and adjusted return on attributed common equity was 14.5%. Third quarter results reflected strong performance in all lines of business, driven by recovering sales and strong equity market levels, resulting in favorable impacts to deferred acquisition costs and variable annuity reserves as well as higher private equity returns. Additionally, lower interest rates and tighter credit spreads drove higher call and tender income, which is a short-term benefit that will be offset in the long term in the form of additional base spread compression.
The sensitivities Kevin previously discussed generally held up, recognizing the limits of sensitivities, especially in times of macroeconomic stress and high levels of volatility. As we noted in the second quarter, reported base investment spread compression has been impacted by substantially lower returns on our tactical cash and short-term investment position. Excluding this impact, base investment spreads would continue to be in the 8 to 16 basis points range of annual spread compression.
Excluding estimated COVID-19-related deaths, mortality experience was favorable and consistent with pre-pandemic trends. Risk management efforts and discipline in Life and Retirement have continued to serve this business well. The hedge program has performed as expected, and our balance sheet remains strong. Additionally, we view our lack of large legacy blocks, such as long-term care, as a risk differentiator. As expected, retail annuity sales rebounded significantly from the historically low second quarter levels as our distribution partners became more accustomed to a new working environment. We also grew sales in Group Retirement and Institutional Markets where we successfully issued 3 large guaranteed investment contracts during the third quarter. Our total premiums and deposits decreased from second quarter levels, and we remain well positioned and confident to deploy capital as attractive opportunities arise across our business.
Now let me provide a brief update on AIG 200. Since we announced AIG 200 in 2019, we have been focused on investing in our core processes and infrastructure in order to be more competitive in the marketplace and make real transformational change at AIG. A few key points I'd like to highlight. We are on track to deliver and will likely exceed our original guidance of $300 million exit run rate savings this year. We also expect to come in below the $350 million cost to achieve that we initially communicated for 2020. An important milestone we recently achieved was entering into a partnership with Accenture, whereby Accenture will acquire our existing shared services footprint.
Working with the AIG global operations team, Accenture will help us to create a modern digital shared services platform with true end-to-end processes that will improve the user experience. This agreement is subject to regulatory approvals and marks the first phase of our overall relationship with Accenture, which we expect will expand over time. Our overall targets for AIG 200 remain unchanged. We still expect to deliver $1 billion of run rate savings by the end of 2022 against a $1.3 billion total investment. Lastly, we do not anticipate any delays or significant changes due to the planned separation of Life and Retirement.
Before I turn it over to Mark, I'd like to end my remarks where I started, and thank Brian for his leadership over the last 3 years. Since I joined Brian in mid-2017, we have navigated truly unprecedented conditions. Throughout, Brian has remained steadfast in his commitment to build a world-leading insurance franchise with no shortcuts or quick fixes. I'm incredibly proud of what we achieved so far in our journey. Our colleagues have demonstrated unmatched resilience and a commitment to excellence in all that they do despite the significant disruption we've all experienced both personally and professionally due to COVID-19. I know I speak on behalf of all AIG colleagues when I say that we look forward to continuing to work with Brian as we close out 2020 and look ahead to a very bright future for our company.
Now I'll turn it over to Mark.
Mark Lyons: Thank you, Peter, and good morning, everyone. As Brian and Peter have already commented on the announced separation of the Life and Retirement business from AIG, I will briefly discuss the third quarter results in order to allow sufficient time for Q&A.
AIG reported adjusted pretax income, or APTI, of $918 million and adjusted after-tax income of $709 million or $0.81 per diluted share compared to $505 million or $0.56 per share in the third quarter of 2019. The key drivers of this increased earnings were: one, a General Insurance underwriting gain, exclusive of the impact of catastrophes and prior year development, which improved $135 million compared to the third quarter of '19; second, a very strong Life and Retirement results, inclusive of the impact of the annual actuarial assumption update; third, solid net investment income results, up $271 million after adjusting the third quarter of 2019 for Fortitude, reflecting higher private equity and hedge fund income in addition to fixed maturity securities; fourth, reduced total AIG general operating expenses by approximately $200 million.
Turning to General Insurance. Third quarter adjusted pretax income was $416 million, down $91 million from the third quarter of 2019, due primarily to the previously announced catastrophe losses of $790 million pretax, partially offset by higher net investment income stemming from alternatives. As with respect to prior year development, $16.1 billion of reserves were carried -- excuse me, were reviewed this quarter, bringing the year-to-date total reviews to more than 60% of carried reserves. The net result was unfavorable development of $13 million, which reflects $53 million of favorable development from amortization of the ADC deferred gain. So the unfavorable development was $66 million gross of this amortization impact.
The areas reviewed were primary workers' compensation, environmental, program businesses, Western World, cyber, Personal Lines Property Casualty, Canada, U.K., Europe and Asia Pacific Casualty and Financial Lines as well as European short-tail lines. Next quarter's focus will be on U.S. Financial Lines and some Casualty areas. This quarter's PYD showed favorable development in North America, driven mostly by primary workers' compensation, California 2017 wildfire, subro (sic) [ subrogation ] and short-tail lines and unfavorable developments internationally driven mostly by Financial Lines, large losses and U.K. and Europe Casualty, mostly in prior accident years.
As Peter mentioned, the General Insurance business has continued to improve with an accident year combined ratio as adjusted of 93.3% in the quarter, a 260 basis point improvement from last year. North America was 96%, 250 basis points better than last year, while North American Commercial Lines was 630 basis points better than the prior year, 560 basis points of which emanated from an improved loss ratio.
International improved, the accident year combined ratio as adjusted by 240 basis points, to 91% with International Commercial Lines better by 410 basis points, with 170 basis points of this emanating from an improved loss ratio. The global expense ratio was 180 basis points lower quarter-over-quarter, driven by an improved acquisition ratio. General Insurance also reduced their GOE by $76 million. The margin momentum in Commercial Lines reflects the hard work of the past several years with the added tailwinds of achieved rate in 2020 above our initial expectations. Both will drive margin improvement through 2021.
I would also note that on a global basis, Personal Insurance results are not really comparable to last year due to the significant drop in Travel business, the formation of Syndicate 2019 for North American PCG business discussed last quarter and higher North American catastrophes, including the COVID impact on the Travel book. International Personal Insurance accident year combined ratio as adjusted improved by 80 basis points with favorable frequency in Japanese auto and a lower expense ratio. North American Personal Lines accident year combined ratio as adjusted was significantly higher to 118.6% due to the approximate 60% drop in net earned premium for the segment, led by Travel's nearly 80% reduction as well as the noise associated with the changes to PCG that was discussed on our prior call. Warranty, Personal A&H and Canadian Personal Lines all continued to perform well.
With the Commercial Lines reunderwriting largely behind us, we are now pivoting to growth, which will become evident in early 2021, as near-term top line results are still impacted by Personal Insurance. Global gross premiums written were $8.3 billion in the quarter, down approximately 4% before the impact of currency. And net premiums written and earned were both down approximately 11%, principally due to Personal Insurance as well as the impact of reinsurance and portfolio management on the North American Commercial Lines book.
In North America Commercial, net premiums written decreased by approximately 5%, reflecting the impact of reinsurance as stated, portfolio management actions and COVID, but retention and new business levels have improved the specific areas. For instance, our Lexington Property business grew by 20% year-over-year as a result of increased flow, continued rate increases and new business momentum. International Commercial's net premiums written increased by approximately 5%, reflecting significant rate momentum and growth in Financial Lines, Specialty and Talbot.
North America Personal Insurance net premiums written was impacted by business mix shifts due to the lower Travel premium and the changes to PCG. As we enter 2021, we will retain approximately 25% of the PCG business, and the Syndicate structure will reduce the volatility of the overall Personal Lines book as was the case this quarter.
International Personal Insurance net premiums written were down 10% on a constant dollar basis, principally because of the reduction in Travel premiums. Aside from Travel, most of the International Personal Insurance is in Japan, which had a slight decrease in premiums due to lower new business, also was the result of COVID.
Now turning to Life and Retirement. Adjusted pretax income was $975 million for the quarter, up over 50% compared to the prior year with strong performance in most businesses. Third quarter adjusted return on attributed common equity was 14.5%, as Peter noted, and 12% on a year-to-date basis. Also, as Peter mentioned, Life and Retirement's retail annuity sales rebounded significantly from historically low second quarter levels. Sequentially, fixed annuities were up 144% to $942 million from the second quarter low of $387 million. Variable annuities were up 24% to $670 million, and index annuities were up 38% to $942 million. Life and Retirement also grew sales modestly in Group Retirement. And in Institutional Markets, several large guaranteed investment contracts were issued during the quarter, totaling approximately $1.2 billion.
Total premiums and deposits increased from second quarter levels and net flows, although still negative, had a material rebound sequentially of over $612 million for fixed annuities and fixed index annuities alone.
The balance sheet remains strong with a solid investment portfolio with limited exposure to large legacy blocks on the liability side, such as long-term care, prefinancial crisis variable annuities or long-duration payout annuities. While low interest rates in the last year will drive additional spread compression, the diversity of our product portfolio is a strength in this environment. Our annual actuarial assumption update, which lowered our 10-year -- forward 10-year treasury assumption to approximately 2.8% from 3.5% previously, was generally benign as we also updated our lapse, mortality and policyholder behavior assumptions, resulting in an unfavorable impact of $120 million to adjusted pretax income and a net unfavorable impact of $22 million to pretax net income, mostly from revised lapse and policyholder assumptions.
Shifting to investments. Net investment income on an APTI basis was $3.2 billion or $277 million lower than the third quarter of 2019. As a reminder, due to the sale of Fortitude, the prior year included the full quarter income on the Fortitude portfolio, whereas it is excluded on an APTI basis this quarter. Adjusting the third quarter of last year's net investment income accordingly, this quarter's net investment income on an APTI basis actually grew $271 million compared to the prior year, reflecting stronger income on both hedge funds and private equity.
Turning to other operations. The adjusted pretax loss after consolidation and eliminations was $562 million, $62 million higher than the third quarter of 2019, principally due to additional interest expense from our May 2020 issuance of $4.1 billion of senior notes to prefund upcoming maturities.
Parent and service company GOE declined $50 million pretax, reflecting AIG's continued focus on expense reduction. Our Legacy segment or adjusted pretax income no longer reflects Fortitude at $89 million of APTI in the quarter, slightly down compared to the third quarter of 2019 due to lower income as a result of Fortitude sale, offset by higher gains on fair value option portfolios within the Legacy investments. Legacy's results also reflected a favorable impact of $13 million related to the annual actuarial assumption update.
Now turning to the balance sheet. At September 30, 2020, book value per common share was $73.86, down 1% from the prior year-end but up 3% from June 2020. Adjusted book value per share, which excludes AOCI and DTA and net cumulative unrealized gains on the Fortitude funds withheld assets, was $56.78 per share, up 2% sequentially from June 30.
At September 30, AIG parent had cash and short-term liquidity assets of $10.7 billion after third quarter dividends of holding company expenses as well as the August debt maturity of $638 million. Looking into next quarter, we expect to pay the balance of the IRS tax settlement on cross-border transactions that date back to the 1990s. During the second quarter, we had prepaid approximately $548 million related to principal and penalties. We recently settled the litigation associated with that case and are awaiting potentially by year-end, the final interest calculation from the IRS. We have requested interest netting, which may lower the total amount below our remaining settlement estimate, which we have accrued at $1.2 billion.
As for debt leverage, we reduced that ratio by approximately 100 basis points in the third quarter, driven by maturing debt, which had been prefunded and growth in retained earnings.
Finally, our primary operating subsidiaries remain profitable and well capitalized despite the continuing impact of low rates, credit experience and COVID. For General Insurance, we estimate the U.S. pool fleet risk-based capital ratio for the third quarter to be between 430% and 440%; in Life and Retirement, it's estimated to be between 410% and 420%, both above our target ranges and both providing a good buffer for the uncertainty of the current environment.
With that, I will now turn it back over to Brian.
Brian Duperreault: Thank you, Mark. I guess it's time for the Q&A portion of this. So operator, why don't we start?
Operator: [Operator Instructions] We can now take our first question from Elyse Greenspan of Wells Fargo.
Elyse Greenspan: My first question, Peter, is going back to your comments on Life and Retirement. You mentioned the option for the separation was either an IPO or a private sale. But then in reference to both, it sounds like you mentioned 19.9%. So I guess I'm confused on what a private sale -- could you go down the route of a private sale of 19.9% of L&R with subsequent sales after that? If I can just get some clarity on that comment, please.
Brian Duperreault: Peter, go ahead and take that, please?
Peter Zaffino: Yes. Thanks, Elyse. Yes, the 19.9% was referencing to the IPO. And we said that there could be -- we can't predict the future but that there could be an approach for a private sale, but it would be for the same percentage, the 19.9% or less, that we would not consider anything that would be above that. So I would think about whether it's the IPO or in the event of something came from a private party that it would be the 19.9% or less as an initial first step.
Elyse Greenspan: Okay. And then so if it was a 19.9% to a private party, I guess, then you'd just be looking for subsequent sales down the road. Is there a time frame if it was a private sale or, I guess, the IPO for the -- as you think of these 2, 19.9% option for the full disposition of L&R?
Peter Zaffino: Got you. Okay. Yes. So really, the time line, Elyse, I would think like whether we pursue a minority IPO or sale, we're going to make that decision in the near term, and we'd like to communicate that promptly. I mean the ultimate closing of an IPO or sale will depend on regulatory or other required approvals. And we'd like to think we can close on the first step of separation in 2021. But of course, we'll have to see how the process unfolds.
Operator: We can now take our next question from Josh Shanker of Bank of America.
Joshua Shanker: So the first question was the general guidance around growing premium volumes next year. Is that exclusive of what happens with travel and accident premiums?
Brian Duperreault: Well, I think that's a Peter question. Peter?
Peter Zaffino: Thanks, Josh. It was not exclusive. I mean we believe that we can grow the top line for General Insurance, even in those conditions where we would have a prolonged headwind in Travel, but we think that we can grow the top line without caveats.
Joshua Shanker: And for those who look at the third quarter liability, premium numbers down in the low double-digit range, given where pricing is. So it sounds like there's some concerns about your appetite for liability business at this price. You've obviously run a lot of liability business in the last couple of years. How does that reflect on your confidence on the last couple of years of books and the attractiveness of writing liability business on -- in November 2020?
Brian Duperreault: Go ahead, Peter.
Peter Zaffino: Well, we've been doing the reunderwriting of the liability lines for a couple of years now. And so we've seen the shift in the portfolio in a very positive way. I think what you'll see on the net premium written is just a lot of reinsurance cessions just because we put in excess of loss and quota share. In this particular year, we had even more cessions on the quota share. But we feel very good about the way in which we are positioning that portfolio. We do think that we can grow that portfolio on the top line. And the rate-on-rate increases that we're getting in the Casualty and liability lines are meaningful and, we believe, are above loss cost. So I wouldn't read into it. I would say that it's part of the remediation, it's part of reinsurance, and we think that we are in a position to grow it.
Joshua Shanker: Would you care to share the gross premium written growth?
Peter Zaffino: I'm sorry?
Brian Duperreault: Say that again, Josh.
Joshua Shanker: Would you care to share an idea about the gross written premium growth in liability, whether it was much less than down low double digits?
Peter Zaffino: No, I would -- it's the same comment. I think we can grow the top line on a gross basis as well.
Operator: Our next question comes from Brian Meredith of UBS.
Brian Meredith: Peter, when you -- the guidance with respect to the below 90% underlying combined ratio, and I assume that's kind of run rate as you go out end of '22. How do we kind of think about that expense ratio, kind of loss ratio? As you kind of think about it, how much is going to be AIG 200 related?
Brian Duperreault: Go ahead, Brian -- or go ahead, Peter.
Peter Zaffino: Yes, it's end of 2022 run rate, and we just thought about as we start to exit 2022. But I think all of the variables will contribute to the improved combined ratio. So I gave you some guidance on -- in my prepared remarks on AIG 200. So we remain committed to the billion dollars, and so we'll recognize $300 million of that as an exit run rate this year.
So you could think about a couple of hundred basis points contributing to expense improvement during that period of time. We feel very good about the opportunity to grow the top line. And so we will start to see top line growth, which will help the ratios. We think we will have a revised reinsurance program that will reflect the portfolio that we have today. And so the vast reunderwriting to pivot to where we are today, we will have a different reinsurance structure going forward, and we will likely not need quite as much.
And then the last piece is just the rate increases above loss cost will start to earn into the portfolio. And so I think all of those 4 variables will contribute to an improved combined ratio below the 90%.
Operator: Our next question comes from Paul Newsome of Piper Sandler.
Jon Paul Newsome: Perhaps you could just talk about the prioritization for use of proceeds, if you do, could be IPO or sale of Life business and if that would be different from what you expected in the past.
Brian Duperreault: So I think, Paul, the question was use of proceeds from the IPO. I think I got that right. And if that's the case, Mark, would you take that question?
Mark Lyons: Sure. Thanks, Paul, thanks for the question. Well, our primary focus for the proceeds from any initial disposition will be to reduce AIG's debt leverage. But we'll continuously to review the best use of our capital, which certainly includes share repurchases, and act accordingly based upon those priorities.
Brian Duperreault: Paul, was there another part to the question because you were a little unclear in my audio?
Jon Paul Newsome: No. I mean that was the focus of it, but maybe if you could just further that in terms of the debt leverage procedures. I mean my sense was you've sort of already prefunded all of those debt leverage. So I guess I'm a little bit surprised that there's more to do.
Brian Duperreault: Okay. Mark, can you take that?
Mark Lyons: Sure, sure. So since you talked about that, Paul, so AIG clearly has strong liquidity. That was bolstered by the $4.1 billion debt raise we did in May of this year. That attractively prefunded those forthcoming maturities, right, and provided liquidity from a risk management perspective. But the near-term capital management strategy remains focused, though, on reducing our debt level to leverage ratios and executing on this separation with Life and Retirement from AIG.
So -- but as previously noted, though, we have upcoming obligations associated with that liquidity of roughly $3.5 billion. So we've got the tax settlement that I'd mentioned in my prepared remarks, that could be up to $1.2 billion. And we have maturing debt that we did prefund, which pushed up the leverage ratio knowingly. But we know that's coming due at a $700 million range in fourth quarter and $1.5 billion by March of 2021. So we really have -- those priorities are right in front of us.
Operator: Our next question comes from Tom Gallagher of Evercore.
Thomas Gallagher: Peter, you mentioned that you don't intend to break up the Life Insurance business and sell it off in pieces. I guess my question is, we've seen some recent indications in the market that private values are potentially double that of current public market values of life insurers. Have you taken that into consideration and still concluded your path is the best one for shareholders?
Brian Duperreault: Tom, let me take that one, and Peter can add to it. I think you just have to understand that when we look at our Life business, we believe the ongoing strength of it is the breadth of the platforms. They've unequal product and distribution. We've got leading market positions. And there's a lot of cross-unit synergies. So the integrated platform, we believe, provides the kind of knowledge and expertise and stability and that's more valuable together than in pieces. And so we've cleaned it up. We've done a lot of derisking, but L&R really is a beautiful machine where these things all interact. So we believe that some of the products is definitely greater. I mean the whole is greater than each of the parts, I'll say, the right way. I hope that helps, Tom.
Peter, do you want to add anything to that?
Peter Zaffino: So I think between my prepared remarks and your comments, Brian, we did look at many alternatives and just believe that the consistent performance that Life and Retirement has produced as it's structured is going to create the most shareholder value, keeping it together.
Thomas Gallagher: I appreciate that, guys. Just my follow-up is the -- back in 2016, there was an estimate of capital diversification breakage of over $5 billion. It sounds like that's a lot less now. Is there still some dissynergy in capital diversification? And if so, could you quantify it?
Brian Duperreault: Well, I guess, I'm going to throw that one, Tom, to Mark. Mark, can you just take us through that?
Mark Lyons: Sure, sure. So Tom, 2015 is quite a while ago. And as you know, there's been massive changes to the portfolio pretty much across the board. So I mean when you think about it, not only from 2015, but when Brian arrived in 2017, you've got a targeted risk reduction program that really went across the board with a revamped risk appetite, no matter how you looked at it. So that's been successfully implemented on both sides of the balance sheet, and it's involved the parent and GI and Life and Retirement and investments. And the operating subsidiary RBC, and risk-based capital, is strong for both GI and for L&R and the volatility in total and within each of those operations has clearly been markedly reduced.
So -- and just as a little bit of a remembrance, so you see exactly the kind of risk reduction, which involves all the things you asked about. So the investment derisking, the Fortitude transaction, which we went into great detail, moving not only $35 billion of reserves, $31 billion of it was on Life and Retirement and $4-plus billion on GI, but it's also what constitutes those reserves. So when you look under the covers and you see a lot of structured settlement reserves and a lot of single premium immediate annuity reserves, those are clearly loaded with interest rate risk.
So now that type of volatility and that kind of issue has now been pushed off as well. We have the ADC that we put into place with General Insurance that still has $6.4 billion unused, representing an 80% cession. The underwriting change to the book that has been massive, both on the front end and a proper reinsurance structure to protect it, as Peter always talked about.
Consequence, the P&Ls have gone down enormously. The marketplace taking advantage of that with improved earnings by driving compound rate and improved terms and conditions but trimming the portfolio the right way, not just renewing books of business but getting into classes and things doing it properly.
And not only on that, we've got the -- what we kind of referenced earlier, which was the debt rates that we had that allowed us to having risk management -- liquidity risk management capability in front of the prefunding of those maturing debt securities. So I think all in, we've got a lot of strength in earnings, a lot of strength in -- of lesser volatility around those earnings, and there is certainly a reduction in all those things combined.
Operator: Our next question comes from Yaron Kinar of Goldman Sachs.
Yaron Kinar: My first question goes to the financial leverage commentary around separation. It sounds like you're comfortable and confident in the leverage that will be achieved by both entities after separation. Today, I think the leverage is still a bit higher than where the Life and P&C Groups are at. So I guess, if I try to connect the dots there, is that why you're talking about a 19.9% sale at first to potentially fund some of that decreased leverage and then you'd consider selling the rest?
Brian Duperreault: Well, look, since you brought up the 19, and I would have given this to Mark, but Peter, you might want to comment on 19.9% first, and then maybe Mark can go into the leverage question.
Peter Zaffino: Yes, I think, Yaron, it is largely in my script, which is the 19.9% does preserve the foreign tax credits and that's a meaningful number today, but we will earn out of that. But I think -- Mark, I don't know if you want to go in a little bit deeper as to the deconsolidation issues.
Mark Lyons: Yes. Well, as Peter said, the 19.9% certainly -- because you still consolidate. So you still continue to reap the benefits as he's noted, which is why it's important, number one. And number two is the shrinkage of that, the consumption of that has really been pretty evident over the older years to where we are now. And with L&R and GI -- because think about it, Yaron, L&R has really been the big consumer of -- for the DTA, especially on the FTC, that's the foreign tax credit side. But now you have 2 strong platforms with a lot of great prospects on a go-forward basis where both can use and both can consume that. So I think that's important.
Now getting back to the structure, both -- all the AIG subsidiaries really are strongly capitalized today. And we do anticipate, though, that each of the General Insurance and Life and Retirement businesses will maintain strong RBC levels and will have a leverage ratio that's consistent with the respective peers and ratings. And we'll be working closely with our regulators and rating agencies, as Peter referenced, throughout this process to validate our analysis. And our intention is to remain at or above our target ratings of these operating subsidiaries. So we believe as separate organizations, both will have sufficient financial flexibility to compete effectively and to generate returns above their individual cost of capital. So again, to reiterate, at this time, with all in, we do not anticipate the need for additional equity capital in either business as part of the separation.
Yaron Kinar: Okay. That's helpful. And then my second question, with regards to the guidance for 2022, combined ratio has been below 90%. And I think, Peter, you may have touched on this with your answer to Josh earlier. Did you need for the rate momentum to achieve that?
Brian Duperreault: Well, Peter, what do you think?
Peter Zaffino: In the current rate environment?
Yaron Kinar: Yes. Yes. Does that need to continue?
Peter Zaffino: No, we don't. I mean, again, I would have to -- when I'm looking through the future, I would have to talk myself out of it, not into it in terms of the underlying fundamentals as to will this continue or not. But we did not predicate getting below 90% combined at the end of 2022 with the rate environment that we're in today.
Operator: Our next question comes from Ryan Tunis of Autonomous Research.
Ryan Tunis: Just a follow-up on Tom's question about, I guess, why the outright separation is the right path forward rather than more of a piecemeal approach. And it sounded like Brian gave sort of the strategic rationale for it. But you guys also mentioned that you looked at capital and tax considerations when you decide on what you're going to do. So what, if any, of the capital and tax considerations that made this a better path than more of a piecemeal process of selling the Life business in parts?
Brian Duperreault: Okay. Ryan, let me start with this. So when you -- when we looked at this question, the question is does Life and Retirement and GI belong together? Or are they better apart? And the kind of conclusion was they were better apart. So let me look at the Life and Retirement, and you say, okay, is the Life and Retirement better together or apart? And it's the same kind of process. As I outlined it, we believe that the Life and Retirement business itself, as I said earlier, really is well integrated. There's a synergy around them that produces greater value than separating them. So that was -- we didn't see that value between Life and Retirement and General Insurance, but we see the value in the Life and Retirement business, where there is a creation of value because they are together. And that was the strategic decision.
The question, is it practical to separate and all that? We went through all that. And we have the capital. We believe we can get the -- we have the ability to appropriately stand up L&R, I should say. So -- but it really fell on that very simple process. I hope that helps, Ryan.
Ryan Tunis: Yes, it does. And then, I guess, just for Peter, it's early, but thinking about the dissynergies associated with stranded cost, that type of thing. I mean when you think about the cost base of the company, I just -- I'd like to hear your early thoughts on any complexities there.
Brian Duperreault: Go ahead, Peter.
Peter Zaffino: Yes. Thank you. So I would think about -- if I was -- if we're going to do an IPO with Life and Retirement, there will be additional investment in order to have that company stand up on its own. But how I would think about it is that the benefits of AIG 200 to Life and Retirement will be at or more than what the investment costs were. So there'll be no additional costs in terms of the run rate today.
And then I do think that there will be more expense synergies at AIG post separation, and we're working through that. And that would be in addition to AIG 200, and we'll just give you some more insight in one of our future quarter calls as we do a little bit more ground-up work on it.
Operator: And our final question comes from Meyer Shields of KBW.
Meyer Shields: Great. On the fourth quarter '19 call, I think we got the sense that the underlying accident year loss ratio improvement would be more pronounced in 2021 than in 2020. Is that still the expectation?
Brian Duperreault: Peter?
Peter Zaffino: Well, I mean, Meyer, I just want to make sure I understand the question. Is it really in terms of rate above loss cost? Or like, I just want to make sure I understand what you're asking.
Meyer Shields: I guess, I mean you talked about how rate above loss cost is helping 2020, but I'm wondering whether that would -- any of that improvement was originally expected more in 2021 and has been pulled forward. Or is it just the absolute better pricing environment?
Peter Zaffino: Mark, do you want to just take that on the -- like what we're getting on the policy year and rate cost increase?
Mark Lyons: Sure. Sure, happy to. Thank you, Meyer. So I think one thing that's been clear from the informations Peter has provided not only this call but at prior calls is we don't see any reduction of the rate of increase. It's -- one, it's global not just centered in the U.S.; and secondly, we don't see it falling off in virtually all the major areas that we've discussed. I think some others may, but we have not. And I think that's tantamount to the continued professionalism of the underwriting group.
So think of it this way. So if you have that kind of strength by policy quarter, effective quarter, and if that continues to build, it's going to flow off increasing rate adequacy into future calendar quarters. So '20, it's going to have a very strong year, and I see nothing in the way stopping 2021 from being marginally better than that.
Brian Duperreault: Meyer, do you have a follow-up?
Meyer Shields: Okay. Just a quick one. Is it possible that the proceeds from the sale or IPO of Life and Retirement can be used -- who can use the DTA?
Brian Duperreault: It could be used to -- I didn't hear that last -- that last piece of the question.
Meyer Shields: Yes. Is it possible that you can use some of the tax credits you come up against the proceeds from the partial sale or IPO of Life and Retirement?
Brian Duperreault: Well, Mark, I think that's you.
Mark Lyons: It's actually much more complicated, and there's legal structures involved. That's -- there's no short answer to that, but other than to say, not really.
Brian Duperreault: I think that's the best way to leave it, Meyer.
So look, I want to once again thank you all for joining us today. I'm very pleased with the progress we've made at AIG, and I think third quarter certainly is another indication of the fact that we are on the right track. And I got to tell, our colleagues really continue to impress me with their dedication and loyalty to our company and all our stakeholders. It's an exciting time at AIG. We continue to manage through unprecedented circumstances across the globe while elevating our market-leading businesses. And we look forward to 2021. I remain confident that our team will continue to execute on our strategies for growth, and we'll separate the Life and Retirement business from AIG. So we look forward to updating you on future calls. Have a great day. Thank you very much.
Operator: This concludes today's call. Thank you for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day and welcome to AIG's Third Quarter 2020 Financial Results Conference Call. Today's conference is being recorded."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you. Good morning and thank you all for joining us. Today's call will cover AIG's third quarter 2020 financial results announced yesterday afternoon. The news release, financial results presentation and financial supplement are posted on our website at www.aig.com. And the 10-Q will be filed later today after the call."
},
{
"speaker": "Brian Duperreault",
"text": "Good morning and thank you for joining us today. Given the announcements we made last week, we will handle today's call differently with the objective to leave as much time as possible for your questions. I will focus most of my remarks on our leadership changes and the separation of Life and Retirement. Peter will expand on what the separation process will entail. He will provide an overview of our third quarter results for General Insurance and Life and Retirement and give an update on AIG 200. Lastly, Mark will provide additional color on our financial results for the quarter. Kevin Hogan, Dave McElroy and Doug Dachille will be available for the Q&A portion of the call."
},
{
"speaker": "Peter Zaffino",
"text": "Good morning, everyone. Thank you, Brian. I appreciate your kind words and want to thank the AIG Board for the opportunity to lead this company. As Brian noted, we are living through a sustained period of global economic challenges. At AIG, we are well prepared as our purpose is to partner with our clients, especially during challenging times, to help them solve complex risk issues, capture opportunities in all market cycles and provide a consistent approach to providing insurance solutions in this period of uncertainty. We continually ask ourselves whether the things that worked well yesterday will continue to work tomorrow and into the future."
},
{
"speaker": "Among the more significant factors are",
"text": "One, the progress we've made since late 2017 to strengthen the foundation of General Insurance materially reduce risk and volatility in our portfolio and position General Insurance as a market leader poised for sustainable, profitable growth. A separation of Life and Retirement from AIG would not be possible without a strong General Insurance business that can support itself and thrive on a stand-alone basis."
},
{
"speaker": "Mark Lyons",
"text": "Thank you, Peter, and good morning, everyone. As Brian and Peter have already commented on the announced separation of the Life and Retirement business from AIG, I will briefly discuss the third quarter results in order to allow sufficient time for Q&A."
},
{
"speaker": "AIG reported adjusted pretax income, or APTI, of $918 million and adjusted after-tax income of $709 million or $0.81 per diluted share compared to $505 million or $0.56 per share in the third quarter of 2019. The key drivers of this increased earnings were",
"text": "one, a General Insurance underwriting gain, exclusive of the impact of catastrophes and prior year development, which improved $135 million compared to the third quarter of '19; second, a very strong Life and Retirement results, inclusive of the impact of the annual actuarial assumption update; third, solid net investment income results, up $271 million after adjusting the third quarter of 2019 for Fortitude, reflecting higher private equity and hedge fund income in addition to fixed maturity securities; fourth, reduced total AIG general operating expenses by approximately $200 million."
},
{
"speaker": "Brian Duperreault",
"text": "Thank you, Mark. I guess it's time for the Q&A portion of this. So operator, why don't we start?"
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We can now take our first question from Elyse Greenspan of Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, Peter, is going back to your comments on Life and Retirement. You mentioned the option for the separation was either an IPO or a private sale. But then in reference to both, it sounds like you mentioned 19.9%. So I guess I'm confused on what a private sale -- could you go down the route of a private sale of 19.9% of L&R with subsequent sales after that? If I can just get some clarity on that comment, please."
},
{
"speaker": "Brian Duperreault",
"text": "Peter, go ahead and take that, please?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Thanks, Elyse. Yes, the 19.9% was referencing to the IPO. And we said that there could be -- we can't predict the future but that there could be an approach for a private sale, but it would be for the same percentage, the 19.9% or less, that we would not consider anything that would be above that. So I would think about whether it's the IPO or in the event of something came from a private party that it would be the 19.9% or less as an initial first step."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then so if it was a 19.9% to a private party, I guess, then you'd just be looking for subsequent sales down the road. Is there a time frame if it was a private sale or, I guess, the IPO for the -- as you think of these 2, 19.9% option for the full disposition of L&R?"
},
{
"speaker": "Peter Zaffino",
"text": "Got you. Okay. Yes. So really, the time line, Elyse, I would think like whether we pursue a minority IPO or sale, we're going to make that decision in the near term, and we'd like to communicate that promptly. I mean the ultimate closing of an IPO or sale will depend on regulatory or other required approvals. And we'd like to think we can close on the first step of separation in 2021. But of course, we'll have to see how the process unfolds."
},
{
"speaker": "Operator",
"text": "We can now take our next question from Josh Shanker of Bank of America."
},
{
"speaker": "Joshua Shanker",
"text": "So the first question was the general guidance around growing premium volumes next year. Is that exclusive of what happens with travel and accident premiums?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, I think that's a Peter question. Peter?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Josh. It was not exclusive. I mean we believe that we can grow the top line for General Insurance, even in those conditions where we would have a prolonged headwind in Travel, but we think that we can grow the top line without caveats."
},
{
"speaker": "Joshua Shanker",
"text": "And for those who look at the third quarter liability, premium numbers down in the low double-digit range, given where pricing is. So it sounds like there's some concerns about your appetite for liability business at this price. You've obviously run a lot of liability business in the last couple of years. How does that reflect on your confidence on the last couple of years of books and the attractiveness of writing liability business on -- in November 2020?"
},
{
"speaker": "Brian Duperreault",
"text": "Go ahead, Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Well, we've been doing the reunderwriting of the liability lines for a couple of years now. And so we've seen the shift in the portfolio in a very positive way. I think what you'll see on the net premium written is just a lot of reinsurance cessions just because we put in excess of loss and quota share. In this particular year, we had even more cessions on the quota share. But we feel very good about the way in which we are positioning that portfolio. We do think that we can grow that portfolio on the top line. And the rate-on-rate increases that we're getting in the Casualty and liability lines are meaningful and, we believe, are above loss cost. So I wouldn't read into it. I would say that it's part of the remediation, it's part of reinsurance, and we think that we are in a position to grow it."
},
{
"speaker": "Joshua Shanker",
"text": "Would you care to share the gross premium written growth?"
},
{
"speaker": "Peter Zaffino",
"text": "I'm sorry?"
},
{
"speaker": "Brian Duperreault",
"text": "Say that again, Josh."
},
{
"speaker": "Joshua Shanker",
"text": "Would you care to share an idea about the gross written premium growth in liability, whether it was much less than down low double digits?"
},
{
"speaker": "Peter Zaffino",
"text": "No, I would -- it's the same comment. I think we can grow the top line on a gross basis as well."
},
{
"speaker": "Operator",
"text": "Our next question comes from Brian Meredith of UBS."
},
{
"speaker": "Brian Meredith",
"text": "Peter, when you -- the guidance with respect to the below 90% underlying combined ratio, and I assume that's kind of run rate as you go out end of '22. How do we kind of think about that expense ratio, kind of loss ratio? As you kind of think about it, how much is going to be AIG 200 related?"
},
{
"speaker": "Brian Duperreault",
"text": "Go ahead, Brian -- or go ahead, Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Yes, it's end of 2022 run rate, and we just thought about as we start to exit 2022. But I think all of the variables will contribute to the improved combined ratio. So I gave you some guidance on -- in my prepared remarks on AIG 200. So we remain committed to the billion dollars, and so we'll recognize $300 million of that as an exit run rate this year."
},
{
"speaker": "Operator",
"text": "Our next question comes from Paul Newsome of Piper Sandler."
},
{
"speaker": "Jon Paul Newsome",
"text": "Perhaps you could just talk about the prioritization for use of proceeds, if you do, could be IPO or sale of Life business and if that would be different from what you expected in the past."
},
{
"speaker": "Brian Duperreault",
"text": "So I think, Paul, the question was use of proceeds from the IPO. I think I got that right. And if that's the case, Mark, would you take that question?"
},
{
"speaker": "Mark Lyons",
"text": "Sure. Thanks, Paul, thanks for the question. Well, our primary focus for the proceeds from any initial disposition will be to reduce AIG's debt leverage. But we'll continuously to review the best use of our capital, which certainly includes share repurchases, and act accordingly based upon those priorities."
},
{
"speaker": "Brian Duperreault",
"text": "Paul, was there another part to the question because you were a little unclear in my audio?"
},
{
"speaker": "Jon Paul Newsome",
"text": "No. I mean that was the focus of it, but maybe if you could just further that in terms of the debt leverage procedures. I mean my sense was you've sort of already prefunded all of those debt leverage. So I guess I'm a little bit surprised that there's more to do."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Mark, can you take that?"
},
{
"speaker": "Mark Lyons",
"text": "Sure, sure. So since you talked about that, Paul, so AIG clearly has strong liquidity. That was bolstered by the $4.1 billion debt raise we did in May of this year. That attractively prefunded those forthcoming maturities, right, and provided liquidity from a risk management perspective. But the near-term capital management strategy remains focused, though, on reducing our debt level to leverage ratios and executing on this separation with Life and Retirement from AIG."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tom Gallagher of Evercore."
},
{
"speaker": "Thomas Gallagher",
"text": "Peter, you mentioned that you don't intend to break up the Life Insurance business and sell it off in pieces. I guess my question is, we've seen some recent indications in the market that private values are potentially double that of current public market values of life insurers. Have you taken that into consideration and still concluded your path is the best one for shareholders?"
},
{
"speaker": "Brian Duperreault",
"text": "Tom, let me take that one, and Peter can add to it. I think you just have to understand that when we look at our Life business, we believe the ongoing strength of it is the breadth of the platforms. They've unequal product and distribution. We've got leading market positions. And there's a lot of cross-unit synergies. So the integrated platform, we believe, provides the kind of knowledge and expertise and stability and that's more valuable together than in pieces. And so we've cleaned it up. We've done a lot of derisking, but L&R really is a beautiful machine where these things all interact. So we believe that some of the products is definitely greater. I mean the whole is greater than each of the parts, I'll say, the right way. I hope that helps, Tom."
},
{
"speaker": "Peter Zaffino",
"text": "So I think between my prepared remarks and your comments, Brian, we did look at many alternatives and just believe that the consistent performance that Life and Retirement has produced as it's structured is going to create the most shareholder value, keeping it together."
},
{
"speaker": "Thomas Gallagher",
"text": "I appreciate that, guys. Just my follow-up is the -- back in 2016, there was an estimate of capital diversification breakage of over $5 billion. It sounds like that's a lot less now. Is there still some dissynergy in capital diversification? And if so, could you quantify it?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, I guess, I'm going to throw that one, Tom, to Mark. Mark, can you just take us through that?"
},
{
"speaker": "Mark Lyons",
"text": "Sure, sure. So Tom, 2015 is quite a while ago. And as you know, there's been massive changes to the portfolio pretty much across the board. So I mean when you think about it, not only from 2015, but when Brian arrived in 2017, you've got a targeted risk reduction program that really went across the board with a revamped risk appetite, no matter how you looked at it. So that's been successfully implemented on both sides of the balance sheet, and it's involved the parent and GI and Life and Retirement and investments. And the operating subsidiary RBC, and risk-based capital, is strong for both GI and for L&R and the volatility in total and within each of those operations has clearly been markedly reduced."
},
{
"speaker": "Operator",
"text": "Our next question comes from Yaron Kinar of Goldman Sachs."
},
{
"speaker": "Yaron Kinar",
"text": "My first question goes to the financial leverage commentary around separation. It sounds like you're comfortable and confident in the leverage that will be achieved by both entities after separation. Today, I think the leverage is still a bit higher than where the Life and P&C Groups are at. So I guess, if I try to connect the dots there, is that why you're talking about a 19.9% sale at first to potentially fund some of that decreased leverage and then you'd consider selling the rest?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, look, since you brought up the 19, and I would have given this to Mark, but Peter, you might want to comment on 19.9% first, and then maybe Mark can go into the leverage question."
},
{
"speaker": "Peter Zaffino",
"text": "Yes, I think, Yaron, it is largely in my script, which is the 19.9% does preserve the foreign tax credits and that's a meaningful number today, but we will earn out of that. But I think -- Mark, I don't know if you want to go in a little bit deeper as to the deconsolidation issues."
},
{
"speaker": "Mark Lyons",
"text": "Yes. Well, as Peter said, the 19.9% certainly -- because you still consolidate. So you still continue to reap the benefits as he's noted, which is why it's important, number one. And number two is the shrinkage of that, the consumption of that has really been pretty evident over the older years to where we are now. And with L&R and GI -- because think about it, Yaron, L&R has really been the big consumer of -- for the DTA, especially on the FTC, that's the foreign tax credit side. But now you have 2 strong platforms with a lot of great prospects on a go-forward basis where both can use and both can consume that. So I think that's important."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. That's helpful. And then my second question, with regards to the guidance for 2022, combined ratio has been below 90%. And I think, Peter, you may have touched on this with your answer to Josh earlier. Did you need for the rate momentum to achieve that?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, Peter, what do you think?"
},
{
"speaker": "Peter Zaffino",
"text": "In the current rate environment?"
},
{
"speaker": "Yaron Kinar",
"text": "Yes. Yes. Does that need to continue?"
},
{
"speaker": "Peter Zaffino",
"text": "No, we don't. I mean, again, I would have to -- when I'm looking through the future, I would have to talk myself out of it, not into it in terms of the underlying fundamentals as to will this continue or not. But we did not predicate getting below 90% combined at the end of 2022 with the rate environment that we're in today."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ryan Tunis of Autonomous Research."
},
{
"speaker": "Ryan Tunis",
"text": "Just a follow-up on Tom's question about, I guess, why the outright separation is the right path forward rather than more of a piecemeal approach. And it sounded like Brian gave sort of the strategic rationale for it. But you guys also mentioned that you looked at capital and tax considerations when you decide on what you're going to do. So what, if any, of the capital and tax considerations that made this a better path than more of a piecemeal process of selling the Life business in parts?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Ryan, let me start with this. So when you -- when we looked at this question, the question is does Life and Retirement and GI belong together? Or are they better apart? And the kind of conclusion was they were better apart. So let me look at the Life and Retirement, and you say, okay, is the Life and Retirement better together or apart? And it's the same kind of process. As I outlined it, we believe that the Life and Retirement business itself, as I said earlier, really is well integrated. There's a synergy around them that produces greater value than separating them. So that was -- we didn't see that value between Life and Retirement and General Insurance, but we see the value in the Life and Retirement business, where there is a creation of value because they are together. And that was the strategic decision."
},
{
"speaker": "Ryan Tunis",
"text": "Yes, it does. And then, I guess, just for Peter, it's early, but thinking about the dissynergies associated with stranded cost, that type of thing. I mean when you think about the cost base of the company, I just -- I'd like to hear your early thoughts on any complexities there."
},
{
"speaker": "Brian Duperreault",
"text": "Go ahead, Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Thank you. So I would think about -- if I was -- if we're going to do an IPO with Life and Retirement, there will be additional investment in order to have that company stand up on its own. But how I would think about it is that the benefits of AIG 200 to Life and Retirement will be at or more than what the investment costs were. So there'll be no additional costs in terms of the run rate today."
},
{
"speaker": "Operator",
"text": "And our final question comes from Meyer Shields of KBW."
},
{
"speaker": "Meyer Shields",
"text": "Great. On the fourth quarter '19 call, I think we got the sense that the underlying accident year loss ratio improvement would be more pronounced in 2021 than in 2020. Is that still the expectation?"
},
{
"speaker": "Brian Duperreault",
"text": "Peter?"
},
{
"speaker": "Peter Zaffino",
"text": "Well, I mean, Meyer, I just want to make sure I understand the question. Is it really in terms of rate above loss cost? Or like, I just want to make sure I understand what you're asking."
},
{
"speaker": "Meyer Shields",
"text": "I guess, I mean you talked about how rate above loss cost is helping 2020, but I'm wondering whether that would -- any of that improvement was originally expected more in 2021 and has been pulled forward. Or is it just the absolute better pricing environment?"
},
{
"speaker": "Peter Zaffino",
"text": "Mark, do you want to just take that on the -- like what we're getting on the policy year and rate cost increase?"
},
{
"speaker": "Mark Lyons",
"text": "Sure. Sure, happy to. Thank you, Meyer. So I think one thing that's been clear from the informations Peter has provided not only this call but at prior calls is we don't see any reduction of the rate of increase. It's -- one, it's global not just centered in the U.S.; and secondly, we don't see it falling off in virtually all the major areas that we've discussed. I think some others may, but we have not. And I think that's tantamount to the continued professionalism of the underwriting group."
},
{
"speaker": "Brian Duperreault",
"text": "Meyer, do you have a follow-up?"
},
{
"speaker": "Meyer Shields",
"text": "Okay. Just a quick one. Is it possible that the proceeds from the sale or IPO of Life and Retirement can be used -- who can use the DTA?"
},
{
"speaker": "Brian Duperreault",
"text": "It could be used to -- I didn't hear that last -- that last piece of the question."
},
{
"speaker": "Meyer Shields",
"text": "Yes. Is it possible that you can use some of the tax credits you come up against the proceeds from the partial sale or IPO of Life and Retirement?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, Mark, I think that's you."
},
{
"speaker": "Mark Lyons",
"text": "It's actually much more complicated, and there's legal structures involved. That's -- there's no short answer to that, but other than to say, not really."
},
{
"speaker": "Brian Duperreault",
"text": "I think that's the best way to leave it, Meyer."
},
{
"speaker": "Operator",
"text": "This concludes today's call. Thank you for your participation. You may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 2 | 2,020 | 2020-08-04 08:00:00 | Operator: Good day, and welcome to AIG's Second Quarter 2020 Financial Results Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Sabra Purtill, Head of Investor Relations. Please go ahead.
Sabra Purtill: Good morning and thank you all for joining us. Today’s will cover AIG's second quarter 2020 financial results announced yesterday afternoon. The news release, financial results presentation and financial supplement were posted on our website at www.aig.com, and the 10-Q for the quarter will be filed later today after the call.
Brian Duperreault: Good morning, and thank you for joining us today. I hope everyone is staying healthy and safe. Like last quarter our team is participating on the call from different locations. I'm joined by Peter, Kevin and Mike and Doug Dachille, our Chief Investment Officer will also be available for Q&A. AIG continues to show remarkable strength and resiliency as COVID-19 remains a formidable and ongoing catastrophe. Our global workforce has adjusted to working remotely and I am incredibly proud of how the team has become more unified and focused on supporting each other, our clients and other stakeholders during this unprecedented time. Throughout the second quarter, we continue to build on the strong foundation created since late 2017 to instil a culture of underwriting excellence, adjusted risk tolerances and implement a best-in-class reinsurance program. These actions strengthened and protected our balance sheet and are allowing us to effectively manage through COVID-19 and its collateral effects on the global economy in addition to natural catastrophes. We also made progress on strategic initiatives across AIG, including the early June closing of the sale of a majority stake in Fortitude, which significantly de-risked our balance sheet and represented the vast majority of our legacy portfolio. Our focus on de-risking is also reflected in how the overall investment portfolio was held up during this extended period of market uncertainty.
Peter Zaffino: Thanks, Brian. And good morning, everyone. Today I plan to provide more detail on Brian's comments regarding the General Insurance second quarter results, COVID-19, the current market environment and I will finish with an update on AIG 200. This month marks my third anniversary of joining Brian at AIG and when I look back at where we started our journey, the progress our team has made is extraordinary. As we've discussed on prior calls, during our first year at AIG we determined the GI portfolio required a complete overhaul in terms of underwriting culture, establishing global standards and dramatically altering limits deployed. In addition, we knew that our businesses needed to be repositioned in the marketplace to become more competitive and relevant to clients. We also moved quickly to design a comprehensive global reinsurance program, which has been evolving as our portfolio improves. This program vastly reduced volatility and unpredictability in outcomes and was a critical component of our overall strategy, allowing us to move faster in re-underwriting the GI portfolio. We built a world-class team and a strengthened bench across the world and our completely revamped risk appetite was successfully communicated to and accepted by the marketplace. We also achieved our goal of entering 2020 with an underwriting profit and since the second quarter of 2018 our adjusted accident year combined ratio has gone from 101% to 94.9%, a 610 basis point improvement. This is a result of the outstanding work done by the team and we've built considerable momentum that will allow us to continue to improve our financial results. With respect to our global commercial portfolio, it has been significantly remediated and while there will always be opportunities for improvement this portfolio is now positioned for further strengthening, more diversification and profitable growth. In Personal Insurance, as I outlined in our last call, we significantly de-risked private client group, known as PCG with the creation of Syndicate 2019 through our partnership with Lloyd's. In addition in late June, we announced an agreement to transition the PCG upper middle market clients to Liberty Mutual and Heritage Insurance this fall. PCG is a market leader and the innovative capital structure we carefully designed with Lloyd's, coupled with the disposition of our upper middle market business allows us to now focus on the areas in the high net worth segment where we bring the most value clients, as well as our brokers and agents.
Kevin Hogan: Thank you, Peter. And good morning, everyone. Today I will discuss overall Life & Retirement results for the second quarter, our current outlook and the results for each of our businesses. Life & Retirement recorded adjusted pre-tax income of $881 million for the quarter and delivered adjusted return on attributed common equity of 13.2%. With a significant rebound in equity markets during the quarter, we saw favorable benefits to both reserves and deferred acquisition costs, which had been impacted by negative equity market returns in the first quarter. This market recovery is not reflected in our private equity returns for the quarter, since they are generally reported on a one quarter lag. Adjusted pre-tax income decreased by $168 million from the very strong second quarter of last year, driven by unfavorable mortality resulting from COVID-19, lower returns from fair value option bonds to the volatile credit spreads, and the expected spread compression. Our current quarter also benefited from significant yield enhancements related to low interest rates, whereas results for the second quarter last year reflected a large IPO gain from a single private equity holding. Recognizing the limits of sensitivities, especially in times of macroeconomic stress and historic volatility, the sensitivities we previously provided have generally continued to hold up. However, our reported base investments spread compression is higher than we would otherwise expect, as we have continued to maintain liquidity and have held higher levels of cash on our balance sheet. Excluding the impact from this larger liquidity position, our base investment spreads would continue to be in the 8 to 16 basis point range of annual spread compression. Relative to equity markets and total yields, we have also updated our sensitivity estimates as of the end of the second quarter. We would expect a plus or minus 1% change in equity market returns to respectively increase or decrease adjusted pre-tax income by approximately $40 million to $50 million annually, a modest increase based on higher market levels than the first quarter. As to rates, a plus or minus 10 basis point movement on 10-year reinvestment rates would increase or decrease earnings by approximately $5 million to $15 million annually consistent with prior quarter. As always, it is important to note that these market sensitivity ranges are not exact nor linear, since our earnings are also impacted by the timing and degree of movements, as well as other factors. Our risk management and discipline are serving us well in these challenging times, noting our hedging program has continued to perform as expected and our balance sheet remained strong. We currently estimate our fleet risk-based capital ratio for the second quarter to be between 420% and 430%, well above our target range of 375% to 400%, providing a good buffer for the uncertainty of the current environment. Further, as we have repriced and restructured many of our products, our new business margins generally remain within our targets at currently minimal returns Sales were significantly lower in the quarter, especially in the retail annuity market, as our distribution partners responded to their own challenges. Towards the end of the quarter, we began to see improvement in retail annuity activity, as our distribution partners responded to the new environment. As of today, based on early indications, we have seen a strong rebound in sales compared to June and our retail new business pipeline continues to build, suggesting improving volumes from historically low second quarter levels. Our broad position across products and channels has been especially advantageous during these times. For example, as retail annuity sales languished in the second quarter, we expanded our pension risk transfer business, concluding several significant reinsurance transactions. We remain well-positioned and confident to deploy capital as attractive opportunities arise across our businesses. Now, I will turn to our second quarter results for each of our businesses. The challenging sales environment for individual retirement that I noted resulted in negative net flows for annuities. For group retirement, premiums and deposits decreased due to lower new group acquisitions, as well as reduced individual product sales. Despite lower sales, net flows were essentially flat due to lower group and individual surrenders For our Life Insurance business, total premiums and deposits increased due to higher international life premiums. Our estimate for the impact from excess mortality of all causes, including COVID-19 is also in a level of mortality net of reinsurance and longevity offsets that is modestly higher than pricing assumptions. Based on a small and evolving dataset, we currently estimate that around 40% of our COVID-19 related death claims reflect an acceleration of claims we would have otherwise experienced in the next five years. Our recent mortality experience will be factored into our longer term experience studies in our annual review of actuarial assumptions which will occur in the third quarter. In isolation, we do not currently expect COVID-19 losses to have a large impact on our long term mortality assumptions. For institutional markets, adjusted pre-tax income was favorably impacted by the yield enhancement activity I noted earlier. We significantly grew premiums and deposits and continue to develop attractive new opportunities across the portfolio. In particular, the pipeline for pension risk transfer opportunities, both direct and through reinsurance is very strong. To close, we remain well-positioned to meet the ever growing needs for protection, retirement savings and lifetime income solutions. Now, I will turn it over to Mark.
Mark Lyons: Thank you, Kevin and good morning all. AIG produced strong underlying performance this quarter, particularly in the thematic areas of risk reduction, liquidity and capital preservation. Overall, AIG reported adjusted pre-tax income of $803 million and adjusted after tax income of $571 million or $0.66 per diluted share, compared to a $1.3 billion or a $1.43 per share in the second quarter of 2019. The key drivers of the year-over-year reduction were higher catastrophe losses from COVID and civil unrest, along with lower net investment income. Positive contributions stem from continued improvement in general insurances, adjusted accident year results, stronger likely retirement returns and our ongoing disciplined focus on costs. As Peter noted, the continued focus on general insurance underwriting profitability and expense management drove 120 basis point improvement in the accident year combined ratio ex-CAT. However, commercial lines was even stronger with a 400 basis point improvement on a global basis, made up of a 320 basis point improvement in North America and 500 basis points of improvement in international. General Insurance's second quarter APGI was a $175 million, down $805 from the second quarter of 2019, due to a $350 million reduction in net investment income, driven by the combined impact of alternative investment losses and the continued impact of lower reinvestment rates on available for sale income and a $500 million increase in catastrophe losses. Peter discussed second quarter catastrophe losses, but I'd point out that in the aggregate they represent 11.9 loss ratio points and that the non-COVID non-civil unrest CAT reserves represent just 1.6 loss ratio points versus 2.6 loss ratio points in the second quarter of 2019. Prior period development was net favorable by $74 million, $53 million of which was associated with the amortization of the ADC deferred gain. For North America personal lines, the combined impact of lower travel premiums and the Syndicate 2019 structure sessions caused a sharp change in business mix within the segment for the quarter, which impacted both the loss ratio and expense ratio compared to the prior year. These impacts, which include some catch-up premiums caused the net written premiums to be negative for the quarter. The structure however should significantly reduce the future only combined ratio volatility of the Personal lines book, while allowing us to continue to profitably grow this business. Looking forward to 2021, we anticipate retaining approximately 25% of the PCG premium. However for the balance of 2020 for the totality of the North America personal insurance segment, as reported in our financial supplement, we estimate roughly $425 million and $325 million of net written premium and net earned premium respectively for each of the next two quarters. Turning to Life & Retirement. As Kevin mentioned, Life & Retirement achieved a 13.2% annualized return on attributed equity for the quarter, that $881 million of APTI was aided by lower DAC amortization due to the recovery of the financial markets, after the large increase in amortization in the first quarter of 2020 related to that quarter's market decline. So a better measure is the year-to-date nearly 11% return on attributed equity. Kevin described the market through his various product sets, but it should also be noted that surrender/LAP rates were noticeably lower for both individual and group retirement, as well as the life unit of both the quarter over quarter and sequential basis. Shifting to Investments. Net investment income on an APTI basis was $3.2 billion or $537 million lower than the second quarter of 2019 and impacted both General Insurance and Life & Retirement APTI. The reduction was primarily driven by a $514 million year-over-year negative swing in private equity results, with $276 million of losses recorded in this second quarter compared with a particularly high amount in second quarter of 2019 reserve – returns, which it has included a one-time large IPO gain. Like others in the industry, we generally report private equity on a one quarter lag due to the timing evaluation information received from the managers. So the second quarter's loss reflects March 31 2020 valuations. On a sequential basis, however, APTI net investment income improved by almost $500 million from the first quarter, even though the second quarter only had two months of Fortitude related NII. This reflects the impact of the strong capital market recovery in the second quarter on hedge funds and fair value option income. But please note that in future quarters APTI and after tax income will not include Fortitude, although the investments themselves will continue to be included on our GAAP balance sheet. We'll get into more of that too. Turning to other operations, the adjusted pre-tax loss after consolidations and eliminations was $510 million, an improvement of $25 million sequentially and $76 million of improvement from the fourth quarter of 2019. Reflecting AIGs continuous focus on expense reductions, corporate interest expense was slightly higher due to our May bond issuance and will increase corporate interest expense for the second half of 2020 and into the first half of 2021. Our legacy segment had $257 million of APTI in the quarter, $96 million of which was from Fortitude before the impact of not-consolidating interests. The remaining $161 million is related to other one-off General Insurance, Life & Retirement and Investment portfolios. As Brian noted, on June 2nd we completed the sale of Fortitude and because it closed during the quarter the second quarter included earnings for April and May only in APTI. The net earnings on the funds withheld assets are excluded from APTI for the month of June, as the economics of those assets were shifted to Fortitude upon closing. Now shifting from adjusted after tax income to GAAP below the line impacts on net income attributable to common shareholders equity. The second quarter included two largely non-economic items I'd like to unpack. The first item which I focused on during our last call involves the GAAP recognition of our variable annuity hedging program, which requires a non-performance adjustment or NPA. In the second quarter, we recorded an approximate $1 billion GAAP pre-tax loss, which is shown and discussed on pages 158 through 160 of the 10-Q, which will be filed later today. And this represents a partial reversal of the large gains we recorded in the first quarter of 2020, as our hedge program is designed to offset interest rate and equity market changes on annuity reserves. The second item involves the sale of Fortitude. As Brian noted, the completion of this majority stake sale represents a significant milestone in de-risking our balance sheet and improving our asset liability management profile. However, it also created a lot of noise on a GAAWP basis, so I will highlight five key impacts that cut through the associated complex accounting. But I will also direct you to the robust disclosures we've included in our slides, financial supplement and 10-Q to help navigate the accounting involved. Additionally, our investor relations staff now stands ready to help with your understanding. The five core highlights I'd like to make sure we communicate are as follows. First, nearly $35 billion of GAAP reserves are now recoverable from a fully collateralized third party re-insurer in which AIG now retains a 3.5% interest. Second and perhaps most importantly is the recognition that the GAAP accounting impact is largely non-economic, as this transaction had no adverse impact on the statutory capital of our insurance company. The assets are marked to fair value, but GAAP reserving practices don't reflect analogous fair value adjustments on the liabilities. Accordingly had the policyholder benefit reserves been fair valued to reflect current low interest rates their fair value would have been higher and have more closely aligned the GAAP accounting with the true underlying economics. Third, from a GAAP accounting perspective the impact on common shareholders equity is a $4.3 billion reduction. However, the impact on adjusted common shareholders equity is a lesser $2.5 Billion reduction with the major difference being an adjustment for $4.2 billion of unrealized appreciation on the supporting funds withheld assets included in our AOCI. As you recall, AOCI is one of the items historically removed in AIGs definition of adjusted common shareholders equity. Fourth, the components of the $6.7 billion dollar GAAP net income loss are comprised of two broad items. First is a loss on de-consolidation of the previously disclosed $2.7 billion for prepaid reinsurance assets and deferred acquisition expenses. The second item is the loss on sale which totaled $4 billion, which is primarily due to the increase in Fortitude GAAP equity from mark-to-market on the investment portfolio, primarily the funds withheld assets. Fifth, AIG has updated several non-GAAP financial measures this quarter to remove asymmetrical accounting treatments. There will be ongoing below the line volatility in our GAAP result. So to help navigate this, our continuing disclosures, plus our Investor Relations team will drive understanding of this asymmetry and the need for these definitional adjustments. And lastly on this, we will be-re segmenting before year end to better align with management's view of assessing operating performance, given the legacy segments now expected de minimis contribution to APTI. Turning to the balance sheet. At June 30th 2020 book value per share was $71.64, down 2.7% from one year ago and adjusted book value per share, which excludes AOCI, the DTA and unrealized gains on the Fortitude funds withheld assets was down 1.7% from one year ago. During the quarter, tighter credit spreads compared to March 31 reversed the negative mark-to-market impact on AFS securities that we had at March 31, with a net increase in AOCI of $10.2 billion in the second quarter. We continue to place a high emphasis on maintaining ample liquidity and a strong capital position in this economic environment. At June 30, AIG had parent liquidity of $10.7 billion. This is in addition to our fully undrawn $4.5 billion revolving credit facility. During the second quarter, we issued $4.1 billion of senior debt and receive $2.2 billion of proceeds related to the sale of Fortitude, of which $1.3 billion were retained at parent. We also repaid our precautionary $1.3 billion March 2020 credit facility borrowing in full and made a $548 million pre payments to the IRS related to principal and penalties on our previously disclosed tax settlement on cross border transactions that date back to the 1990s. We will pay the balance of this settlement up to $1.2 billion pending receipt of the final interest calculation potentially by the end of this year, with the ultimate amount depending on the potential application of interest netting for the crude interest calculation which AIG has requested. We do not plan to repurchase shares in the near term and have $1.3 billion in maturity senior notes in the second half of 2020, as well as $1.5 billion of maturing notes in the first quarter of 2021. All of which will be funded with cash on hand. Turning to subsidiary capital. AIG's insurance fleet capitalization and liquidity levels remained very strong. At June 30th, RBC fleet ratios for General Insurances US pool as for Life & Retirement are above the prior year levels and above the higher end of our target operating ranges, providing solid buffers for absorbing potential COVID-19 losses, capital market volatility or credit impacts. Also, our ratings and stable outlook were affirmed by S&P following its regular annual review. We continue to prioritize liquidity, strong operating capitalization and financial flexibility as we navigate this ongoing uncertain environment. Our balance sheet and liquidity are strong and our investment portfolio is diversified and significantly derisked compared to years past. We remain focused on the continuing improvement of General Insurance profitability, managing Life & Retirement prudently in a low interest rate environment and executing AIG 200 on schedule and on budget. We are convinced that AIG will exit this unusual crisis as a stronger, more resilient company. And with that, I will now turn the call back over to Brian.
Brian Duperreault: Thank you, Mark. I think it's time for Q&A. So operator, can we start the Q&A process?
Operator: Thank you. We’ll now take our first question from Michael Phillips from Morgan Stanley. Please go ahead. Your line is now open.
Michael Phillips: Thank you. And good morning, Brian and everybody. First question, focus on North America Commercial lines where your core loss ratio improvement looks pretty decent on the surface. I guess, I'm going to dive into that a little bit. You know, we've seen some competitors talk about some frequency benefits, because of COVID. I suspect that's not much the case here. But I want to make sure, given your, you know, your book of business, high layers, high limits and larger corporate accounts, that may not see - you may not be seeing as much frequency benefit from COVID in that core loss ratio for North America Commercial. So can you maybe talk about that a little bit and go through what’s really behind that 1.7 improvement?
Brian Duperreault: Well, I think that's - Michael, that's a good question for Peter and the frequency benefits or lack thereof. Peter, can you answer that?
Peter Zaffino: Yeah, sure. Brian, thank you and good morning, Michael. You’re correct, we did not take the frequency benefits in the quarter. If there was any sign of a better frequency relative to expectations, it was in some of our international business in auto in Japan. But we've seen that over the last several quarters. You know, when you think about - I'm going to go to workers compensation, because I think that's the one that stands out the most, which is you know, we've had frequency in COVID, it's typically I would say 70% in industries related to healthcare. But it's very unique because again, we have high retentions, most of that over 90% is related to businesses where we have a deductible of $1 million or greater. So that frequency really hasn't impacted us. And then we have seen a commensurate reduction in frequency in non-COVID related claims. Again, their observation this quarter, again, a lot of is on retention business, but we haven't recognized it yet because we want to see how it emerges. You know, one thing back on COVID workers comp, which is very interesting is that, over 50% of the claims that we've seen over the last four months, about 50% of them are already closed. So it's a very different type of loss relative to workers compensation. Other the lines that we've seen in the liability and auto, again, it'll be slow to recognize that, we've seen reduced frequency and we’ll give you an update next quarter once we have a little bit more experience.
Michael Phillips: Okay, great. Thank you. Second question would be throughout all last year, you guys were one of the few companies that did actually have a margin improvement, and that's because of all your renovating opportunities done for the past couple years. I guess, can you talk about where are you in that process? And what inning are you in with the efforts You mentioned rate, now we're all getting rates or rates from all trend you said. But how much of that re-underwriting effort has been done and how much more still can be done?
Brian Duperreault: Okay, Michael, I think again, that's Peter.
Peter Zaffino: Yeah, Michael. So I think we're in a really good place. I mean, you know, we - when I said in my opening comments, what are the areas where we had headwinds in new business, which I think the industry has seen when everybody was going to work remotely, what drove the growth, it was driven by better retention, we had, you know, 400 basis points of improvement, in international 500 basis points improvement on retention of our clients within North America. So I think that reflects that we like the portfolio, and we're trying to be very helpful to our clients and distribution partners by deploying capital, of course, you know, in a different dynamic and need to make sure that we're getting the appropriate returns. And I think you saw that in the rate. So I think the combination of retention of a portfolio we like and we can grow, combined with a positive rate environment, I think contributed to the overall growth on the NPW commercial.
Brian Duperreault: Okay, Michael.
Michael Phillips: Thanks.
Brian Duperreault: Next question, please.
Operator: We’ll now take our next question from Elyse Greenspan from Wells Fargo. Please go ahead. Your line is open.
Elyse Greenspan: Hi, thanks. Good morning. My first question is also related to the Commercial business. You guys mentioned some of the prices that you're getting on into the double digits on and said that that's in excess of trend. Could you just give us a sense on you know, where loss trends fit in your commercial business and how that's, you know, changed so far this year, just as we think about kind of the spread between price and loss trend on that, you know, can start running through your margin?
Brian Duperreault: Okay. Elyse, thanks. I think in terms of trends, et cetera, certainly Mark is the better responder. Mark, can you answer the question?
Mark Lyons: Yeah. Thank you, Brian. Appreciate that. Hello, Elyse. So you know, in the areas, I think that mostly asking about, take like excess businesses, that trend, pure loss cost trend is approaching double digits. When you get into auto, it's a little bit less, probably in the 7%, 8% area. And then other primary lines are a little less than that. But you've got - when you weigh it all together with things like you know, with property and other loss sensitive-related exposure bases, it kind of drops it off. So there's - I'm not going to get into the weighted average in total, but I’ll tell you that we look at every single line and reflect that in our thinking. I wanted to give you the range where it could be a couple percentage points and some short tail lines up to almost double digits and some more volatile excess line.
Elyse Greenspan: Okay, that's helpful. And then my second question is on the earned premium, I guess on Commercial lines and you know, Personal lines is impacted by that quota share. But within Commercial we've seen some pretty good growth in both North America and internationally on the written side, but earned on, no, it's still decelerating just given, you know, a lot of your business mix actions that you took. So is it right way to think about it that, you know, just given the earn-ins, we could see some pressure on that earned within Commercial over the balance of the year and that could start to see some growth in 2021?
Brian Duperreault: Mark, why don’t you take that one too, please?
Mark Lyons: Yeah, I think you actually answered your own question, you get the increasing, you know, impact of the Casualty quota share, and that's really what you're seeing.
Brian Duperreault: Okay. Elyse, thank you. Next question please?
Operator: Next question is from Brian Meredith from UBS. Please go ahead. Your line is open.
Brian Meredith: Thank you. One quick numbered questions and another broader question. First one, Mark, I wonder if you could give us a quick guidance on what dividend and interest income is going to look like in General Insurance? Big drop off, obviously, in the second quarter, was there anything unusual there? Is that kind of a run rate given where we are right now, as far as investment yields?
Brian Duperreault: Hey, Mar. Go ahead, please.
Mark Lyons: Yeah, thank you, Brian. You've cut out a little bit on me Brian, were you asking about investment yields in GI?
Brian Meredith: Yeah. I am looking overall but also in GI, in particular, you had a big drop off in investment yield sequentially. And I am just wondering if there's anything in there or rate securities or something else that was causing the drop so much or that's kind of a true run rate?
Mark Lyons: Yes, yes, actually. You guys are getting good. You’re answering you own question. So there's two things going on, the last quarter, I think was the first quarter we allowed the disclosure to even see that. So the drop off you see is somewhat caused by what you just said, and I'll get it that more a little bit later and one of it is just a bit of a correction. So, last quarter's GI yield was over – so think of it as overstated. There was a $20 million Canadian security correction. But I think the heart of your question, so that would have come down another 12 basis points, something like that. To the extent of - on the current quarter with the structured securities, you're right, a lot of that stuff is floating, but you're really required to retrospectively look at it and look at what has happened and what your view of the future is, and what that implied yield is and if that yield is lower than what you've booked, you have to do a catch up on it. And that's what you're seeing in the quarter. So you can adjust for some of those Brian, and it looks to me it be a 9 to 10 basis point drop off sequentially, not as steep as it appears.
Brian Meredith: Great.
Brian Duperreault: Brian, do you have a follow up?
Brian Meredith: Yeah, absolutely Brian. And this is I guess, more for you and Peter. Given how low yields are right now. I'm wondering what type of underlying combined ratio or combined ratio do you need to achieve, do you believe in your General Insurance business now to earn an acceptable return on capital? And if you had to kind of alter your targets?
Brian Duperreault: Well, that's a great question, Brian. I guess I'll take that. Yeah, I mean, double digit returns with a higher interest rate makes sense with these low interest rates, it probably comes down. You know, I would say that, it's an evolving - right now, it's an evolving process and, you know, its difficult with COVID to understand what steady state looks like. But, you know, my gut would say that something in the double digit range is possible. It's becoming more difficult because of the low interest rates. So it's more like, you know, what's the return over the risk free rates. So, I - it's hard to say, you know, we're just driving this thing down. When we get into a market like this where rates are rising, terms and conditions are improving, you're not - you don't have a fixed number that you're going to try to hit. We're going to take advantage of the market and have the results that we can achieve with this elevated level of risk received in the marketplace, I guess, that’s the best way to put it Brian. Can me move on to the next question, thanks.
Operator: Thank you. Our next question comes from Erik Bass from Autonomous Research. Please go ahead. Your line is open.
Erik Bass: Hi, thank you. As we've talked about some of the benefits from Syndicate ‘19 in terms of volatility and reduction in the fee income you'll generate and those makes sense and should be clear positive over time. Stepping back from a near term perspective, do you see this as enhancing or detracting from the normalized earnings of the personal line segment?
Brian Duperreault: Eric, let me start with this and then I'll let Peter pick it up. So look when you make a change like this is certainly a disruption you know, with ceded premiums and the unearned going out, and so, there will be some dislocation. Obviously, we saw in the second quarter to bleed into the third. Overall though, you know, when things normalize, as we approach the end of the year, this will be a net benefit to the company, it is a - as Mark said, a capital-light structure and it basically allows us to grow the business and we could not grow it given the concentration of CAT exposure, with the approach we've taken now the structure of Lloyds and its capital efficiency and the ability to spread it, we can now take the benefits net and actually grow it and have the net grow. Peter, do you want to add anything to that?
Peter Zaffino: Yeah, just a couple of points. Brian, as you said, I mean I think de-risking, reposition the portfolio for growth is important. That reduced volatility increase in capital flexibility. I think the second quarter is going to be the noisiest just because of the catch up on the, you know, unearned premium, and seasonally the second quarter was the largest on the net premium written side. So again, you’ll still see some noise in the third and fourth, but not to the degree you saw in the second and we just been very focused on accelerating the transition. So we can get to 2021 with the unearned, you know, largely gone away and then reposition Syndicate 2019 to be very competitive in the market, in terms of value. So we're really excited about what this is going to mean for the business and for our clients, and distribution partners.
Brian Duperreault: Do you have a follow up Erik, do you have a follow up?
Erik Bass: Yes, thank you. And then second, just with the lower level of sales in Life & Retirement, how does this affect your outlook for capital generation? And are you planning to keep any sort of excess capital you generate in the Life subs? Or do you see opportunities to shift capital to P&C to take advantage of some of the more favorable pricing backdrop?
Brian Duperreault: Well, let me have Kevin just talk about the sales, because we are seeing a pickup of it. So it may be premature to talk about our capital, but I'll get back to that. Kevin, you want to start with the sales piece?
Kevin Hogan: Yeah, sure. Thanks, Erik. The quarter was the lowest in memory. But you know, towards the latter part of June, we saw some real signs of life. During the quarter, the channel that really was disrupted the most was the bank channel, which was down around 60%. And if we look at just the month of July, over June, the bank channel was back to almost double. So you know, that the disruption that impacted that channel the most we've seen starting to turn around. For financial advisors, broker dealers, and IMOs, you know, they were down about 40%. But I think that the virtual sales practices that they adopted, and we tended to reprice earlier than many companies. And so I think as other companies caught up with repricing that leveled the playing field a bit. Again, what we saw following the month of June, looking at July over June, we saw substantial increase in sales and the pipeline is growing and our sales of annuities per day continued to increase. So we're pretty optimistic that if conditions continue the way they are, we'll see recovery in July over June and in the third quarter over the second. Life Insurance continued to grow despite the disruption, we saw about 4% growth in the second quarter. And that trend continues, particularly our direct channel is performing very well. And in retirement services, it's important to note that periodic premiums, which are really the backbone of that business, we’re only down 4% in the second quarter. And again, you know, our advisor channel is back up and focused on their customers and its individual sales generally follow the retail individual retirement sales. So when you back that up with the fact that the pension risk transfer business and pipeline is as strong as we've ever seen it and we've opened up the reinsurance channel, we feel cautiously optimistic that second quarter will be the low watermark and our strategy will prevail in the third quarter and beyond, recognizing all the uncertainties in the market.
Peter Zaffino: Yeah. Thanks, Kevin. And I’ll just add, if you look at the – the opportunities seem to be much more in GI though, yes. It's not as extreme as maybe the sales in the second quarter might have indicated. But, you know, we will move our attention where we think the greatest growth and returns are occurring. And right now GI looks pretty good. So we move on to the next question then please?
Operator: Thank you. And next question comes from Yaron Kinar from Goldman Sachs. Please go ahead.
Yaron Kinar: Thank you very much. A couple of questions on GI. So first, can you maybe talk about how you're thinking of loss fix here with rates well in excess of loss trend? On the one hand, you also have the COVID driven favorable frequency, more short term, I guess, on the other. And I asked what's in the context of North America commercial loss ratio, which I guess, improved year-over-year, but actually weakened a bit sequentially?
Brian Duperreault: Yeah. Thanks, Yaron. I think that's a Mark question. Mark, loss fix?
Mark Lyons: I can certainly start that. Thank you, Brian. Well, you do have a lot of forces. We’re happy to be, I think one of the catalysts on this market. And level of increases, Peter talked about it continued to increase at an increasing rate, I think it’s a fair statement. But you do have other things, we don't know the longer term impacts on many third party and first party lines of COVID, for example. Social inflation is more of a general upward movement, as opposed to a lot of specifics that you can nail down. And so I think there's still the thought amongst us in the industry that there's potential for freight moving up. I think there should be some back to normality between interest rates and inflation and we're probably heading more into an inflationary environment. So a little cautious on the fact that we're seeing this great rate increase, and there's more variability, and I flipped it from a year ago, where there was more variability around, what kind of price increase can we get? Now we see that the magnitude of the price increases we can get, and there's more variability about the future look loss cost trends.
Yaron Kinar: Okay.
Brian Duperreault: Yaron, do you have a follow up?
Yaron Kinar: I do. So in the – in commercial premiums that has been growing, and it sounds like you're pretty constructive on those lines and growth there. Can you talk about the potential offset impact of exposure there? I think we've heard from some of your peers that exposure is coming in and that’s quite a headwind?
Brian Duperreault: Yeah. Peter, can you talk about exposures?
Peter Zaffino: Sure. Thank you, Yaron for the question. I think when you think about compared to our competitors, remember, we don't have as much you know, guaranteed cost business. And so therefore, it's not a direct correlation to effect on payroll sales, and that's going to result in a commensurate premium reduction. You know, as we have the in force book that we have, you know, minimum deposits on our excess business, in most cases. I think when, you know, we look to the future in terms of some of the changes on frequency and changes on payroll and sales, you know, it could have a modest headwind, which is what we had talked about in last quarters call. In terms of exposure base for renewals, and, you know, could have a slight impact on premium, but I would look to it on, you know, we're trying to solve issues on excess. We're deploying capital, I mean, those are - have led to better risk adjusted returns, because, we are still coming up with similar structures. And, you know, while there may be a little bit of light headwinds in terms of overall exposure, should not have a material impact on our premium, as we look to the third and fourth quarter based on what we know today.
Brian Duperreault: Thank you. We've run a little late. Maybe we could take one last question, operator?
Operator: Thank you. Our next question comes from Jimmy Bhullar from JPMorgan. Please go ahead. Your line is open.
Jimmy Bhullar: Hi. On the travel insurance book, I think you wrote a little bit over a $1 billion of premiums last year. Can you discuss how much that shrunk and whether you're seeing any sort of signs of recovery in that book, either in the US or in international markets? And then also on P&C, with you having restructured your portfolio and reinsurance program? Are you thinking about any major changes in reinsurance, as you're looking at next year, given the hardening market there?
Brian Duperreault: Jimmy the first book of business that you referred to was what? I didn't pick that up…
Jimmy Bhullar: The travel book...
Brian Duperreault: Yeah, got it. Yeah…
Jimmy Bhullar: $1billion book and it's shrinking, I'm just trying to get an idea on whether you're seeing…
Brian Duperreault: Thanks, Jimmy. Yeah, Peter, I think those are both yours.
Peter Zaffino: Yeah. So on the first one on the travel, again, the second quarter, you know, you had not only no new sales, you also had cancellation. And so I think that, that was one that was a headwind and contributed to the North American personal negative premium written. Now as we look at, it's hard to predict, again, we don't know what's going to happen with COVID. We don't know when travel is going to resume. It's less than a $1 billion in North America and it's fairly evenly spread in terms of quarter-to-quarter. I think we would have some modest sales in the third quarter, probably about a third as to what our run rate would be. But again, very hard to predict. We think that there is a dynamic in that business that's interesting, which is, you know, nobody really contemplated, I think, in terms of clients, and the CAT. And so I think there's going to be a rebase in terms of how we price this business, what the economics are going forward and don't want to overreact, you know, sort of Q2 a quarter in terms of travel and think that as it starts to rebound, we think the economics will be better. But again, we'll give an update as to what it looks like in the third quarter in terms of if there's a rebound or not. I'm sorry, I didn’t get the second question, Jimmy?
Jimmy Bhullar: It was just on reinsurance prices going up, are you kind of thinking about sort of maybe retaining more risk or changing your reinsurance program in anyway?
Peter Zaffino: Well, we're going to have to, you know, try out our virtual Monte Carlo in September, which is really with a kick off I think we probably would have had 100 meetings scheduled at AIG under normal conditions. I don't think that we're going to - you know, we look at the reinsurance structures than any repositioning, it will reflect the growth portfolio, not trying to say the market conditions are much stronger. Therefore, we're going to dump treaties because we always talked about the reduction of volatility, making sure we had more predictable outcomes. And we have great partnerships that we trade across every geography and multiple lines of business with our reinsurance partners. But we would expect to see changes in our reinsurance programs that reflect the excellent underwriting that we've been doing, and the gross improvement that we've seen quarter-to-quarter. So we begin to have those discussions, what we have in terms of structures? I don't think they'll be something that materially changes, but I would expect some refinements to reflect the portfolio as it is today.
Brian Duperreault: Okay. Thank you, Jimmy. Thank you.
Brian Duperreault: Well, let me just close and thank everybody for joining us this morning. And I particularly want to thank my AIG colleagues around the world. I mean, these last few months have really been challenging on many, many fronts and I'm so grateful for your hard work and dedication on this journey we're on and I hope everyone stays safe and healthy. Wear your masks. Okay. Thanks, everybody.
Operator: Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Second Quarter 2020 Financial Results Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Sabra Purtill, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Sabra Purtill",
"text": "Good morning and thank you all for joining us. Today’s will cover AIG's second quarter 2020 financial results announced yesterday afternoon. The news release, financial results presentation and financial supplement were posted on our website at www.aig.com, and the 10-Q for the quarter will be filed later today after the call."
},
{
"speaker": "Brian Duperreault",
"text": "Good morning, and thank you for joining us today. I hope everyone is staying healthy and safe. Like last quarter our team is participating on the call from different locations. I'm joined by Peter, Kevin and Mike and Doug Dachille, our Chief Investment Officer will also be available for Q&A. AIG continues to show remarkable strength and resiliency as COVID-19 remains a formidable and ongoing catastrophe. Our global workforce has adjusted to working remotely and I am incredibly proud of how the team has become more unified and focused on supporting each other, our clients and other stakeholders during this unprecedented time. Throughout the second quarter, we continue to build on the strong foundation created since late 2017 to instil a culture of underwriting excellence, adjusted risk tolerances and implement a best-in-class reinsurance program. These actions strengthened and protected our balance sheet and are allowing us to effectively manage through COVID-19 and its collateral effects on the global economy in addition to natural catastrophes. We also made progress on strategic initiatives across AIG, including the early June closing of the sale of a majority stake in Fortitude, which significantly de-risked our balance sheet and represented the vast majority of our legacy portfolio. Our focus on de-risking is also reflected in how the overall investment portfolio was held up during this extended period of market uncertainty."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Brian. And good morning, everyone. Today I plan to provide more detail on Brian's comments regarding the General Insurance second quarter results, COVID-19, the current market environment and I will finish with an update on AIG 200. This month marks my third anniversary of joining Brian at AIG and when I look back at where we started our journey, the progress our team has made is extraordinary. As we've discussed on prior calls, during our first year at AIG we determined the GI portfolio required a complete overhaul in terms of underwriting culture, establishing global standards and dramatically altering limits deployed. In addition, we knew that our businesses needed to be repositioned in the marketplace to become more competitive and relevant to clients. We also moved quickly to design a comprehensive global reinsurance program, which has been evolving as our portfolio improves. This program vastly reduced volatility and unpredictability in outcomes and was a critical component of our overall strategy, allowing us to move faster in re-underwriting the GI portfolio. We built a world-class team and a strengthened bench across the world and our completely revamped risk appetite was successfully communicated to and accepted by the marketplace. We also achieved our goal of entering 2020 with an underwriting profit and since the second quarter of 2018 our adjusted accident year combined ratio has gone from 101% to 94.9%, a 610 basis point improvement. This is a result of the outstanding work done by the team and we've built considerable momentum that will allow us to continue to improve our financial results. With respect to our global commercial portfolio, it has been significantly remediated and while there will always be opportunities for improvement this portfolio is now positioned for further strengthening, more diversification and profitable growth. In Personal Insurance, as I outlined in our last call, we significantly de-risked private client group, known as PCG with the creation of Syndicate 2019 through our partnership with Lloyd's. In addition in late June, we announced an agreement to transition the PCG upper middle market clients to Liberty Mutual and Heritage Insurance this fall. PCG is a market leader and the innovative capital structure we carefully designed with Lloyd's, coupled with the disposition of our upper middle market business allows us to now focus on the areas in the high net worth segment where we bring the most value clients, as well as our brokers and agents."
},
{
"speaker": "Kevin Hogan",
"text": "Thank you, Peter. And good morning, everyone. Today I will discuss overall Life & Retirement results for the second quarter, our current outlook and the results for each of our businesses. Life & Retirement recorded adjusted pre-tax income of $881 million for the quarter and delivered adjusted return on attributed common equity of 13.2%. With a significant rebound in equity markets during the quarter, we saw favorable benefits to both reserves and deferred acquisition costs, which had been impacted by negative equity market returns in the first quarter. This market recovery is not reflected in our private equity returns for the quarter, since they are generally reported on a one quarter lag. Adjusted pre-tax income decreased by $168 million from the very strong second quarter of last year, driven by unfavorable mortality resulting from COVID-19, lower returns from fair value option bonds to the volatile credit spreads, and the expected spread compression. Our current quarter also benefited from significant yield enhancements related to low interest rates, whereas results for the second quarter last year reflected a large IPO gain from a single private equity holding. Recognizing the limits of sensitivities, especially in times of macroeconomic stress and historic volatility, the sensitivities we previously provided have generally continued to hold up. However, our reported base investments spread compression is higher than we would otherwise expect, as we have continued to maintain liquidity and have held higher levels of cash on our balance sheet. Excluding the impact from this larger liquidity position, our base investment spreads would continue to be in the 8 to 16 basis point range of annual spread compression. Relative to equity markets and total yields, we have also updated our sensitivity estimates as of the end of the second quarter. We would expect a plus or minus 1% change in equity market returns to respectively increase or decrease adjusted pre-tax income by approximately $40 million to $50 million annually, a modest increase based on higher market levels than the first quarter. As to rates, a plus or minus 10 basis point movement on 10-year reinvestment rates would increase or decrease earnings by approximately $5 million to $15 million annually consistent with prior quarter. As always, it is important to note that these market sensitivity ranges are not exact nor linear, since our earnings are also impacted by the timing and degree of movements, as well as other factors. Our risk management and discipline are serving us well in these challenging times, noting our hedging program has continued to perform as expected and our balance sheet remained strong. We currently estimate our fleet risk-based capital ratio for the second quarter to be between 420% and 430%, well above our target range of 375% to 400%, providing a good buffer for the uncertainty of the current environment. Further, as we have repriced and restructured many of our products, our new business margins generally remain within our targets at currently minimal returns Sales were significantly lower in the quarter, especially in the retail annuity market, as our distribution partners responded to their own challenges. Towards the end of the quarter, we began to see improvement in retail annuity activity, as our distribution partners responded to the new environment. As of today, based on early indications, we have seen a strong rebound in sales compared to June and our retail new business pipeline continues to build, suggesting improving volumes from historically low second quarter levels. Our broad position across products and channels has been especially advantageous during these times. For example, as retail annuity sales languished in the second quarter, we expanded our pension risk transfer business, concluding several significant reinsurance transactions. We remain well-positioned and confident to deploy capital as attractive opportunities arise across our businesses. Now, I will turn to our second quarter results for each of our businesses. The challenging sales environment for individual retirement that I noted resulted in negative net flows for annuities. For group retirement, premiums and deposits decreased due to lower new group acquisitions, as well as reduced individual product sales. Despite lower sales, net flows were essentially flat due to lower group and individual surrenders For our Life Insurance business, total premiums and deposits increased due to higher international life premiums. Our estimate for the impact from excess mortality of all causes, including COVID-19 is also in a level of mortality net of reinsurance and longevity offsets that is modestly higher than pricing assumptions. Based on a small and evolving dataset, we currently estimate that around 40% of our COVID-19 related death claims reflect an acceleration of claims we would have otherwise experienced in the next five years. Our recent mortality experience will be factored into our longer term experience studies in our annual review of actuarial assumptions which will occur in the third quarter. In isolation, we do not currently expect COVID-19 losses to have a large impact on our long term mortality assumptions. For institutional markets, adjusted pre-tax income was favorably impacted by the yield enhancement activity I noted earlier. We significantly grew premiums and deposits and continue to develop attractive new opportunities across the portfolio. In particular, the pipeline for pension risk transfer opportunities, both direct and through reinsurance is very strong. To close, we remain well-positioned to meet the ever growing needs for protection, retirement savings and lifetime income solutions. Now, I will turn it over to Mark."
},
{
"speaker": "Mark Lyons",
"text": "Thank you, Kevin and good morning all. AIG produced strong underlying performance this quarter, particularly in the thematic areas of risk reduction, liquidity and capital preservation. Overall, AIG reported adjusted pre-tax income of $803 million and adjusted after tax income of $571 million or $0.66 per diluted share, compared to a $1.3 billion or a $1.43 per share in the second quarter of 2019. The key drivers of the year-over-year reduction were higher catastrophe losses from COVID and civil unrest, along with lower net investment income. Positive contributions stem from continued improvement in general insurances, adjusted accident year results, stronger likely retirement returns and our ongoing disciplined focus on costs. As Peter noted, the continued focus on general insurance underwriting profitability and expense management drove 120 basis point improvement in the accident year combined ratio ex-CAT. However, commercial lines was even stronger with a 400 basis point improvement on a global basis, made up of a 320 basis point improvement in North America and 500 basis points of improvement in international. General Insurance's second quarter APGI was a $175 million, down $805 from the second quarter of 2019, due to a $350 million reduction in net investment income, driven by the combined impact of alternative investment losses and the continued impact of lower reinvestment rates on available for sale income and a $500 million increase in catastrophe losses. Peter discussed second quarter catastrophe losses, but I'd point out that in the aggregate they represent 11.9 loss ratio points and that the non-COVID non-civil unrest CAT reserves represent just 1.6 loss ratio points versus 2.6 loss ratio points in the second quarter of 2019. Prior period development was net favorable by $74 million, $53 million of which was associated with the amortization of the ADC deferred gain. For North America personal lines, the combined impact of lower travel premiums and the Syndicate 2019 structure sessions caused a sharp change in business mix within the segment for the quarter, which impacted both the loss ratio and expense ratio compared to the prior year. These impacts, which include some catch-up premiums caused the net written premiums to be negative for the quarter. The structure however should significantly reduce the future only combined ratio volatility of the Personal lines book, while allowing us to continue to profitably grow this business. Looking forward to 2021, we anticipate retaining approximately 25% of the PCG premium. However for the balance of 2020 for the totality of the North America personal insurance segment, as reported in our financial supplement, we estimate roughly $425 million and $325 million of net written premium and net earned premium respectively for each of the next two quarters. Turning to Life & Retirement. As Kevin mentioned, Life & Retirement achieved a 13.2% annualized return on attributed equity for the quarter, that $881 million of APTI was aided by lower DAC amortization due to the recovery of the financial markets, after the large increase in amortization in the first quarter of 2020 related to that quarter's market decline. So a better measure is the year-to-date nearly 11% return on attributed equity. Kevin described the market through his various product sets, but it should also be noted that surrender/LAP rates were noticeably lower for both individual and group retirement, as well as the life unit of both the quarter over quarter and sequential basis. Shifting to Investments. Net investment income on an APTI basis was $3.2 billion or $537 million lower than the second quarter of 2019 and impacted both General Insurance and Life & Retirement APTI. The reduction was primarily driven by a $514 million year-over-year negative swing in private equity results, with $276 million of losses recorded in this second quarter compared with a particularly high amount in second quarter of 2019 reserve – returns, which it has included a one-time large IPO gain. Like others in the industry, we generally report private equity on a one quarter lag due to the timing evaluation information received from the managers. So the second quarter's loss reflects March 31 2020 valuations. On a sequential basis, however, APTI net investment income improved by almost $500 million from the first quarter, even though the second quarter only had two months of Fortitude related NII. This reflects the impact of the strong capital market recovery in the second quarter on hedge funds and fair value option income. But please note that in future quarters APTI and after tax income will not include Fortitude, although the investments themselves will continue to be included on our GAAP balance sheet. We'll get into more of that too. Turning to other operations, the adjusted pre-tax loss after consolidations and eliminations was $510 million, an improvement of $25 million sequentially and $76 million of improvement from the fourth quarter of 2019. Reflecting AIGs continuous focus on expense reductions, corporate interest expense was slightly higher due to our May bond issuance and will increase corporate interest expense for the second half of 2020 and into the first half of 2021. Our legacy segment had $257 million of APTI in the quarter, $96 million of which was from Fortitude before the impact of not-consolidating interests. The remaining $161 million is related to other one-off General Insurance, Life & Retirement and Investment portfolios. As Brian noted, on June 2nd we completed the sale of Fortitude and because it closed during the quarter the second quarter included earnings for April and May only in APTI. The net earnings on the funds withheld assets are excluded from APTI for the month of June, as the economics of those assets were shifted to Fortitude upon closing. Now shifting from adjusted after tax income to GAAP below the line impacts on net income attributable to common shareholders equity. The second quarter included two largely non-economic items I'd like to unpack. The first item which I focused on during our last call involves the GAAP recognition of our variable annuity hedging program, which requires a non-performance adjustment or NPA. In the second quarter, we recorded an approximate $1 billion GAAP pre-tax loss, which is shown and discussed on pages 158 through 160 of the 10-Q, which will be filed later today. And this represents a partial reversal of the large gains we recorded in the first quarter of 2020, as our hedge program is designed to offset interest rate and equity market changes on annuity reserves. The second item involves the sale of Fortitude. As Brian noted, the completion of this majority stake sale represents a significant milestone in de-risking our balance sheet and improving our asset liability management profile. However, it also created a lot of noise on a GAAWP basis, so I will highlight five key impacts that cut through the associated complex accounting. But I will also direct you to the robust disclosures we've included in our slides, financial supplement and 10-Q to help navigate the accounting involved. Additionally, our investor relations staff now stands ready to help with your understanding. The five core highlights I'd like to make sure we communicate are as follows. First, nearly $35 billion of GAAP reserves are now recoverable from a fully collateralized third party re-insurer in which AIG now retains a 3.5% interest. Second and perhaps most importantly is the recognition that the GAAP accounting impact is largely non-economic, as this transaction had no adverse impact on the statutory capital of our insurance company. The assets are marked to fair value, but GAAP reserving practices don't reflect analogous fair value adjustments on the liabilities. Accordingly had the policyholder benefit reserves been fair valued to reflect current low interest rates their fair value would have been higher and have more closely aligned the GAAP accounting with the true underlying economics. Third, from a GAAP accounting perspective the impact on common shareholders equity is a $4.3 billion reduction. However, the impact on adjusted common shareholders equity is a lesser $2.5 Billion reduction with the major difference being an adjustment for $4.2 billion of unrealized appreciation on the supporting funds withheld assets included in our AOCI. As you recall, AOCI is one of the items historically removed in AIGs definition of adjusted common shareholders equity. Fourth, the components of the $6.7 billion dollar GAAP net income loss are comprised of two broad items. First is a loss on de-consolidation of the previously disclosed $2.7 billion for prepaid reinsurance assets and deferred acquisition expenses. The second item is the loss on sale which totaled $4 billion, which is primarily due to the increase in Fortitude GAAP equity from mark-to-market on the investment portfolio, primarily the funds withheld assets. Fifth, AIG has updated several non-GAAP financial measures this quarter to remove asymmetrical accounting treatments. There will be ongoing below the line volatility in our GAAP result. So to help navigate this, our continuing disclosures, plus our Investor Relations team will drive understanding of this asymmetry and the need for these definitional adjustments. And lastly on this, we will be-re segmenting before year end to better align with management's view of assessing operating performance, given the legacy segments now expected de minimis contribution to APTI. Turning to the balance sheet. At June 30th 2020 book value per share was $71.64, down 2.7% from one year ago and adjusted book value per share, which excludes AOCI, the DTA and unrealized gains on the Fortitude funds withheld assets was down 1.7% from one year ago. During the quarter, tighter credit spreads compared to March 31 reversed the negative mark-to-market impact on AFS securities that we had at March 31, with a net increase in AOCI of $10.2 billion in the second quarter. We continue to place a high emphasis on maintaining ample liquidity and a strong capital position in this economic environment. At June 30, AIG had parent liquidity of $10.7 billion. This is in addition to our fully undrawn $4.5 billion revolving credit facility. During the second quarter, we issued $4.1 billion of senior debt and receive $2.2 billion of proceeds related to the sale of Fortitude, of which $1.3 billion were retained at parent. We also repaid our precautionary $1.3 billion March 2020 credit facility borrowing in full and made a $548 million pre payments to the IRS related to principal and penalties on our previously disclosed tax settlement on cross border transactions that date back to the 1990s. We will pay the balance of this settlement up to $1.2 billion pending receipt of the final interest calculation potentially by the end of this year, with the ultimate amount depending on the potential application of interest netting for the crude interest calculation which AIG has requested. We do not plan to repurchase shares in the near term and have $1.3 billion in maturity senior notes in the second half of 2020, as well as $1.5 billion of maturing notes in the first quarter of 2021. All of which will be funded with cash on hand. Turning to subsidiary capital. AIG's insurance fleet capitalization and liquidity levels remained very strong. At June 30th, RBC fleet ratios for General Insurances US pool as for Life & Retirement are above the prior year levels and above the higher end of our target operating ranges, providing solid buffers for absorbing potential COVID-19 losses, capital market volatility or credit impacts. Also, our ratings and stable outlook were affirmed by S&P following its regular annual review. We continue to prioritize liquidity, strong operating capitalization and financial flexibility as we navigate this ongoing uncertain environment. Our balance sheet and liquidity are strong and our investment portfolio is diversified and significantly derisked compared to years past. We remain focused on the continuing improvement of General Insurance profitability, managing Life & Retirement prudently in a low interest rate environment and executing AIG 200 on schedule and on budget. We are convinced that AIG will exit this unusual crisis as a stronger, more resilient company. And with that, I will now turn the call back over to Brian."
},
{
"speaker": "Brian Duperreault",
"text": "Thank you, Mark. I think it's time for Q&A. So operator, can we start the Q&A process?"
},
{
"speaker": "Operator",
"text": "Thank you. We’ll now take our first question from Michael Phillips from Morgan Stanley. Please go ahead. Your line is now open."
},
{
"speaker": "Michael Phillips",
"text": "Thank you. And good morning, Brian and everybody. First question, focus on North America Commercial lines where your core loss ratio improvement looks pretty decent on the surface. I guess, I'm going to dive into that a little bit. You know, we've seen some competitors talk about some frequency benefits, because of COVID. I suspect that's not much the case here. But I want to make sure, given your, you know, your book of business, high layers, high limits and larger corporate accounts, that may not see - you may not be seeing as much frequency benefit from COVID in that core loss ratio for North America Commercial. So can you maybe talk about that a little bit and go through what’s really behind that 1.7 improvement?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, I think that's - Michael, that's a good question for Peter and the frequency benefits or lack thereof. Peter, can you answer that?"
},
{
"speaker": "Peter Zaffino",
"text": "Yeah, sure. Brian, thank you and good morning, Michael. You’re correct, we did not take the frequency benefits in the quarter. If there was any sign of a better frequency relative to expectations, it was in some of our international business in auto in Japan. But we've seen that over the last several quarters. You know, when you think about - I'm going to go to workers compensation, because I think that's the one that stands out the most, which is you know, we've had frequency in COVID, it's typically I would say 70% in industries related to healthcare. But it's very unique because again, we have high retentions, most of that over 90% is related to businesses where we have a deductible of $1 million or greater. So that frequency really hasn't impacted us. And then we have seen a commensurate reduction in frequency in non-COVID related claims. Again, their observation this quarter, again, a lot of is on retention business, but we haven't recognized it yet because we want to see how it emerges. You know, one thing back on COVID workers comp, which is very interesting is that, over 50% of the claims that we've seen over the last four months, about 50% of them are already closed. So it's a very different type of loss relative to workers compensation. Other the lines that we've seen in the liability and auto, again, it'll be slow to recognize that, we've seen reduced frequency and we’ll give you an update next quarter once we have a little bit more experience."
},
{
"speaker": "Michael Phillips",
"text": "Okay, great. Thank you. Second question would be throughout all last year, you guys were one of the few companies that did actually have a margin improvement, and that's because of all your renovating opportunities done for the past couple years. I guess, can you talk about where are you in that process? And what inning are you in with the efforts You mentioned rate, now we're all getting rates or rates from all trend you said. But how much of that re-underwriting effort has been done and how much more still can be done?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay, Michael, I think again, that's Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Yeah, Michael. So I think we're in a really good place. I mean, you know, we - when I said in my opening comments, what are the areas where we had headwinds in new business, which I think the industry has seen when everybody was going to work remotely, what drove the growth, it was driven by better retention, we had, you know, 400 basis points of improvement, in international 500 basis points improvement on retention of our clients within North America. So I think that reflects that we like the portfolio, and we're trying to be very helpful to our clients and distribution partners by deploying capital, of course, you know, in a different dynamic and need to make sure that we're getting the appropriate returns. And I think you saw that in the rate. So I think the combination of retention of a portfolio we like and we can grow, combined with a positive rate environment, I think contributed to the overall growth on the NPW commercial."
},
{
"speaker": "Brian Duperreault",
"text": "Okay, Michael."
},
{
"speaker": "Michael Phillips",
"text": "Thanks."
},
{
"speaker": "Brian Duperreault",
"text": "Next question, please."
},
{
"speaker": "Operator",
"text": "We’ll now take our next question from Elyse Greenspan from Wells Fargo. Please go ahead. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good morning. My first question is also related to the Commercial business. You guys mentioned some of the prices that you're getting on into the double digits on and said that that's in excess of trend. Could you just give us a sense on you know, where loss trends fit in your commercial business and how that's, you know, changed so far this year, just as we think about kind of the spread between price and loss trend on that, you know, can start running through your margin?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Elyse, thanks. I think in terms of trends, et cetera, certainly Mark is the better responder. Mark, can you answer the question?"
},
{
"speaker": "Mark Lyons",
"text": "Yeah. Thank you, Brian. Appreciate that. Hello, Elyse. So you know, in the areas, I think that mostly asking about, take like excess businesses, that trend, pure loss cost trend is approaching double digits. When you get into auto, it's a little bit less, probably in the 7%, 8% area. And then other primary lines are a little less than that. But you've got - when you weigh it all together with things like you know, with property and other loss sensitive-related exposure bases, it kind of drops it off. So there's - I'm not going to get into the weighted average in total, but I’ll tell you that we look at every single line and reflect that in our thinking. I wanted to give you the range where it could be a couple percentage points and some short tail lines up to almost double digits and some more volatile excess line."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay, that's helpful. And then my second question is on the earned premium, I guess on Commercial lines and you know, Personal lines is impacted by that quota share. But within Commercial we've seen some pretty good growth in both North America and internationally on the written side, but earned on, no, it's still decelerating just given, you know, a lot of your business mix actions that you took. So is it right way to think about it that, you know, just given the earn-ins, we could see some pressure on that earned within Commercial over the balance of the year and that could start to see some growth in 2021?"
},
{
"speaker": "Brian Duperreault",
"text": "Mark, why don’t you take that one too, please?"
},
{
"speaker": "Mark Lyons",
"text": "Yeah, I think you actually answered your own question, you get the increasing, you know, impact of the Casualty quota share, and that's really what you're seeing."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Elyse, thank you. Next question please?"
},
{
"speaker": "Operator",
"text": "Next question is from Brian Meredith from UBS. Please go ahead. Your line is open."
},
{
"speaker": "Brian Meredith",
"text": "Thank you. One quick numbered questions and another broader question. First one, Mark, I wonder if you could give us a quick guidance on what dividend and interest income is going to look like in General Insurance? Big drop off, obviously, in the second quarter, was there anything unusual there? Is that kind of a run rate given where we are right now, as far as investment yields?"
},
{
"speaker": "Brian Duperreault",
"text": "Hey, Mar. Go ahead, please."
},
{
"speaker": "Mark Lyons",
"text": "Yeah, thank you, Brian. You've cut out a little bit on me Brian, were you asking about investment yields in GI?"
},
{
"speaker": "Brian Meredith",
"text": "Yeah. I am looking overall but also in GI, in particular, you had a big drop off in investment yield sequentially. And I am just wondering if there's anything in there or rate securities or something else that was causing the drop so much or that's kind of a true run rate?"
},
{
"speaker": "Mark Lyons",
"text": "Yes, yes, actually. You guys are getting good. You’re answering you own question. So there's two things going on, the last quarter, I think was the first quarter we allowed the disclosure to even see that. So the drop off you see is somewhat caused by what you just said, and I'll get it that more a little bit later and one of it is just a bit of a correction. So, last quarter's GI yield was over – so think of it as overstated. There was a $20 million Canadian security correction. But I think the heart of your question, so that would have come down another 12 basis points, something like that. To the extent of - on the current quarter with the structured securities, you're right, a lot of that stuff is floating, but you're really required to retrospectively look at it and look at what has happened and what your view of the future is, and what that implied yield is and if that yield is lower than what you've booked, you have to do a catch up on it. And that's what you're seeing in the quarter. So you can adjust for some of those Brian, and it looks to me it be a 9 to 10 basis point drop off sequentially, not as steep as it appears."
},
{
"speaker": "Brian Meredith",
"text": "Great."
},
{
"speaker": "Brian Duperreault",
"text": "Brian, do you have a follow up?"
},
{
"speaker": "Brian Meredith",
"text": "Yeah, absolutely Brian. And this is I guess, more for you and Peter. Given how low yields are right now. I'm wondering what type of underlying combined ratio or combined ratio do you need to achieve, do you believe in your General Insurance business now to earn an acceptable return on capital? And if you had to kind of alter your targets?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, that's a great question, Brian. I guess I'll take that. Yeah, I mean, double digit returns with a higher interest rate makes sense with these low interest rates, it probably comes down. You know, I would say that, it's an evolving - right now, it's an evolving process and, you know, its difficult with COVID to understand what steady state looks like. But, you know, my gut would say that something in the double digit range is possible. It's becoming more difficult because of the low interest rates. So it's more like, you know, what's the return over the risk free rates. So, I - it's hard to say, you know, we're just driving this thing down. When we get into a market like this where rates are rising, terms and conditions are improving, you're not - you don't have a fixed number that you're going to try to hit. We're going to take advantage of the market and have the results that we can achieve with this elevated level of risk received in the marketplace, I guess, that’s the best way to put it Brian. Can me move on to the next question, thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Erik Bass from Autonomous Research. Please go ahead. Your line is open."
},
{
"speaker": "Erik Bass",
"text": "Hi, thank you. As we've talked about some of the benefits from Syndicate ‘19 in terms of volatility and reduction in the fee income you'll generate and those makes sense and should be clear positive over time. Stepping back from a near term perspective, do you see this as enhancing or detracting from the normalized earnings of the personal line segment?"
},
{
"speaker": "Brian Duperreault",
"text": "Eric, let me start with this and then I'll let Peter pick it up. So look when you make a change like this is certainly a disruption you know, with ceded premiums and the unearned going out, and so, there will be some dislocation. Obviously, we saw in the second quarter to bleed into the third. Overall though, you know, when things normalize, as we approach the end of the year, this will be a net benefit to the company, it is a - as Mark said, a capital-light structure and it basically allows us to grow the business and we could not grow it given the concentration of CAT exposure, with the approach we've taken now the structure of Lloyds and its capital efficiency and the ability to spread it, we can now take the benefits net and actually grow it and have the net grow. Peter, do you want to add anything to that?"
},
{
"speaker": "Peter Zaffino",
"text": "Yeah, just a couple of points. Brian, as you said, I mean I think de-risking, reposition the portfolio for growth is important. That reduced volatility increase in capital flexibility. I think the second quarter is going to be the noisiest just because of the catch up on the, you know, unearned premium, and seasonally the second quarter was the largest on the net premium written side. So again, you’ll still see some noise in the third and fourth, but not to the degree you saw in the second and we just been very focused on accelerating the transition. So we can get to 2021 with the unearned, you know, largely gone away and then reposition Syndicate 2019 to be very competitive in the market, in terms of value. So we're really excited about what this is going to mean for the business and for our clients, and distribution partners."
},
{
"speaker": "Brian Duperreault",
"text": "Do you have a follow up Erik, do you have a follow up?"
},
{
"speaker": "Erik Bass",
"text": "Yes, thank you. And then second, just with the lower level of sales in Life & Retirement, how does this affect your outlook for capital generation? And are you planning to keep any sort of excess capital you generate in the Life subs? Or do you see opportunities to shift capital to P&C to take advantage of some of the more favorable pricing backdrop?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, let me have Kevin just talk about the sales, because we are seeing a pickup of it. So it may be premature to talk about our capital, but I'll get back to that. Kevin, you want to start with the sales piece?"
},
{
"speaker": "Kevin Hogan",
"text": "Yeah, sure. Thanks, Erik. The quarter was the lowest in memory. But you know, towards the latter part of June, we saw some real signs of life. During the quarter, the channel that really was disrupted the most was the bank channel, which was down around 60%. And if we look at just the month of July, over June, the bank channel was back to almost double. So you know, that the disruption that impacted that channel the most we've seen starting to turn around. For financial advisors, broker dealers, and IMOs, you know, they were down about 40%. But I think that the virtual sales practices that they adopted, and we tended to reprice earlier than many companies. And so I think as other companies caught up with repricing that leveled the playing field a bit. Again, what we saw following the month of June, looking at July over June, we saw substantial increase in sales and the pipeline is growing and our sales of annuities per day continued to increase. So we're pretty optimistic that if conditions continue the way they are, we'll see recovery in July over June and in the third quarter over the second. Life Insurance continued to grow despite the disruption, we saw about 4% growth in the second quarter. And that trend continues, particularly our direct channel is performing very well. And in retirement services, it's important to note that periodic premiums, which are really the backbone of that business, we’re only down 4% in the second quarter. And again, you know, our advisor channel is back up and focused on their customers and its individual sales generally follow the retail individual retirement sales. So when you back that up with the fact that the pension risk transfer business and pipeline is as strong as we've ever seen it and we've opened up the reinsurance channel, we feel cautiously optimistic that second quarter will be the low watermark and our strategy will prevail in the third quarter and beyond, recognizing all the uncertainties in the market."
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. Thanks, Kevin. And I’ll just add, if you look at the – the opportunities seem to be much more in GI though, yes. It's not as extreme as maybe the sales in the second quarter might have indicated. But, you know, we will move our attention where we think the greatest growth and returns are occurring. And right now GI looks pretty good. So we move on to the next question then please?"
},
{
"speaker": "Operator",
"text": "Thank you. And next question comes from Yaron Kinar from Goldman Sachs. Please go ahead."
},
{
"speaker": "Yaron Kinar",
"text": "Thank you very much. A couple of questions on GI. So first, can you maybe talk about how you're thinking of loss fix here with rates well in excess of loss trend? On the one hand, you also have the COVID driven favorable frequency, more short term, I guess, on the other. And I asked what's in the context of North America commercial loss ratio, which I guess, improved year-over-year, but actually weakened a bit sequentially?"
},
{
"speaker": "Brian Duperreault",
"text": "Yeah. Thanks, Yaron. I think that's a Mark question. Mark, loss fix?"
},
{
"speaker": "Mark Lyons",
"text": "I can certainly start that. Thank you, Brian. Well, you do have a lot of forces. We’re happy to be, I think one of the catalysts on this market. And level of increases, Peter talked about it continued to increase at an increasing rate, I think it’s a fair statement. But you do have other things, we don't know the longer term impacts on many third party and first party lines of COVID, for example. Social inflation is more of a general upward movement, as opposed to a lot of specifics that you can nail down. And so I think there's still the thought amongst us in the industry that there's potential for freight moving up. I think there should be some back to normality between interest rates and inflation and we're probably heading more into an inflationary environment. So a little cautious on the fact that we're seeing this great rate increase, and there's more variability, and I flipped it from a year ago, where there was more variability around, what kind of price increase can we get? Now we see that the magnitude of the price increases we can get, and there's more variability about the future look loss cost trends."
},
{
"speaker": "Yaron Kinar",
"text": "Okay."
},
{
"speaker": "Brian Duperreault",
"text": "Yaron, do you have a follow up?"
},
{
"speaker": "Yaron Kinar",
"text": "I do. So in the – in commercial premiums that has been growing, and it sounds like you're pretty constructive on those lines and growth there. Can you talk about the potential offset impact of exposure there? I think we've heard from some of your peers that exposure is coming in and that’s quite a headwind?"
},
{
"speaker": "Brian Duperreault",
"text": "Yeah. Peter, can you talk about exposures?"
},
{
"speaker": "Peter Zaffino",
"text": "Sure. Thank you, Yaron for the question. I think when you think about compared to our competitors, remember, we don't have as much you know, guaranteed cost business. And so therefore, it's not a direct correlation to effect on payroll sales, and that's going to result in a commensurate premium reduction. You know, as we have the in force book that we have, you know, minimum deposits on our excess business, in most cases. I think when, you know, we look to the future in terms of some of the changes on frequency and changes on payroll and sales, you know, it could have a modest headwind, which is what we had talked about in last quarters call. In terms of exposure base for renewals, and, you know, could have a slight impact on premium, but I would look to it on, you know, we're trying to solve issues on excess. We're deploying capital, I mean, those are - have led to better risk adjusted returns, because, we are still coming up with similar structures. And, you know, while there may be a little bit of light headwinds in terms of overall exposure, should not have a material impact on our premium, as we look to the third and fourth quarter based on what we know today."
},
{
"speaker": "Brian Duperreault",
"text": "Thank you. We've run a little late. Maybe we could take one last question, operator?"
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jimmy Bhullar from JPMorgan. Please go ahead. Your line is open."
},
{
"speaker": "Jimmy Bhullar",
"text": "Hi. On the travel insurance book, I think you wrote a little bit over a $1 billion of premiums last year. Can you discuss how much that shrunk and whether you're seeing any sort of signs of recovery in that book, either in the US or in international markets? And then also on P&C, with you having restructured your portfolio and reinsurance program? Are you thinking about any major changes in reinsurance, as you're looking at next year, given the hardening market there?"
},
{
"speaker": "Brian Duperreault",
"text": "Jimmy the first book of business that you referred to was what? I didn't pick that up…"
},
{
"speaker": "Jimmy Bhullar",
"text": "The travel book..."
},
{
"speaker": "Brian Duperreault",
"text": "Yeah, got it. Yeah…"
},
{
"speaker": "Jimmy Bhullar",
"text": "$1billion book and it's shrinking, I'm just trying to get an idea on whether you're seeing…"
},
{
"speaker": "Brian Duperreault",
"text": "Thanks, Jimmy. Yeah, Peter, I think those are both yours."
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. So on the first one on the travel, again, the second quarter, you know, you had not only no new sales, you also had cancellation. And so I think that, that was one that was a headwind and contributed to the North American personal negative premium written. Now as we look at, it's hard to predict, again, we don't know what's going to happen with COVID. We don't know when travel is going to resume. It's less than a $1 billion in North America and it's fairly evenly spread in terms of quarter-to-quarter. I think we would have some modest sales in the third quarter, probably about a third as to what our run rate would be. But again, very hard to predict. We think that there is a dynamic in that business that's interesting, which is, you know, nobody really contemplated, I think, in terms of clients, and the CAT. And so I think there's going to be a rebase in terms of how we price this business, what the economics are going forward and don't want to overreact, you know, sort of Q2 a quarter in terms of travel and think that as it starts to rebound, we think the economics will be better. But again, we'll give an update as to what it looks like in the third quarter in terms of if there's a rebound or not. I'm sorry, I didn’t get the second question, Jimmy?"
},
{
"speaker": "Jimmy Bhullar",
"text": "It was just on reinsurance prices going up, are you kind of thinking about sort of maybe retaining more risk or changing your reinsurance program in anyway?"
},
{
"speaker": "Peter Zaffino",
"text": "Well, we're going to have to, you know, try out our virtual Monte Carlo in September, which is really with a kick off I think we probably would have had 100 meetings scheduled at AIG under normal conditions. I don't think that we're going to - you know, we look at the reinsurance structures than any repositioning, it will reflect the growth portfolio, not trying to say the market conditions are much stronger. Therefore, we're going to dump treaties because we always talked about the reduction of volatility, making sure we had more predictable outcomes. And we have great partnerships that we trade across every geography and multiple lines of business with our reinsurance partners. But we would expect to see changes in our reinsurance programs that reflect the excellent underwriting that we've been doing, and the gross improvement that we've seen quarter-to-quarter. So we begin to have those discussions, what we have in terms of structures? I don't think they'll be something that materially changes, but I would expect some refinements to reflect the portfolio as it is today."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Thank you, Jimmy. Thank you."
},
{
"speaker": "Brian Duperreault",
"text": "Well, let me just close and thank everybody for joining us this morning. And I particularly want to thank my AIG colleagues around the world. I mean, these last few months have really been challenging on many, many fronts and I'm so grateful for your hard work and dedication on this journey we're on and I hope everyone stays safe and healthy. Wear your masks. Okay. Thanks, everybody."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 1 | 2,020 | 2020-05-05 08:00:00 | Operator: Ladies and gentlemen, good day, and welcome to AIG's First Quarter 2020 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Sabra Purtill, Head of Investor Relations. Please go ahead, ma'am.
Sabra Purtill: Thank you. Good morning and thank you all for joining us today. Our call today will cover AIG's first quarter 2020 financial results announced yesterday afternoon. The news release, financial results presentation and financial supplement were posted on our website at www.aig.com, and the 10-Q will be filed later today. Our speakers today are Brian Duperreault, CEO; Peter Zaffino; President and COO of AIG and CEO of General Insurance; Kevin Hogan, CEO, Life and Retirement; and Mark Lyons, Chief Financial Officer. We will have time for Q&A after their remarks. Today's call may contain forward-looking statements relating to company performance, strategic priorities, business mix and market conditions, including the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially. Factors that could cause results to differ include those described in our 2019 Annual Report on Form 10-K and other recent filings made with the SEC, inclusive of the effects of COVID-19 on AIG, which cannot be fully determined at this time. AIG is not under any obligation and expressly disclaims any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Additionally, some remarks will refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is provided in our news release and other financial results material, all of which are available on our website. I'll now turn the call over to Brian.
Brian Duperreault: Good morning, everyone. It's been an extraordinary few months since we last spoke. Before we start, I want to say that I hope you and your families are healthy, and that you've been able to adjust to the new normal that COVID-19 is creating for all of us. This crisis has been heartbreaking to witness as it unfolds across the globe. It's a tough time for everyone and the uncertainty about how long it will last and what life will be like afterwards makes this time even harder. I've witnessed a lot in my 40-plus year career in the insurance industry. But this health and humanitarian crisis, which quickly became a threat to the world economy, is like nothing any of us has experienced. We believe COVID-19 will be the single largest CAT loss the industry has ever seen and will continue to have significant global economic ramifications for the foreseeable future.
Peter Zaffino: Thank you, Brian. Good morning, everyone, and thank you for joining us. Today, I plan to review the following topics: a brief overview of the potential near and longer term impact of COVID-19 on the insurance and reinsurance markets generally, how we analyze the impact of COVID-19 on GI through March 31st, first quarter results for General Insurance, excluding COVID-19, including Validus Re, our recently announced launch of Syndicate 2019 and AIG 200 and the progress that we've made since our last earnings call. As Brian said, the near and long-term impact of COVID-19 on the global economy and insurance and reinsurance industries remains unclear. In contrast to other catastrophes like wildfires, hurricanes and earthquakes, this event is not confined to any specific geographic region, and it has already impacted over 200 countries and territories. In addition, this duration is not limited as is typically the case with traditional CATs. While the insurance industry manages risk of all kinds, it's fair to say that the profound impact and global nature of COVID-19 is something we have never encountered. There's no playbook. And as a result, we are called upon to make thoughtful and prudent decisions in a climate of unprecedented uncertainty. Before COVID, the largest catastrophes on record were Hurricane Katrina with $65 billion losses, then the Tohoku earthquake with $35 billion in loss, Hurricane Irma with $30 billion losses, and Superstorm Sandy also with approximately $30 billion in losses. With respect to COVID-19, we're starting to see early industry estimates, but they have significant ranges. While it's too early to gauge the ultimate size of the loss, we believe COVID-19 will result in the largest individual CAT loss, the insurance industry has ever seen. Going forward, COVID-related losses will impact all aspects of underwriting insurance from absolute limits available, limits deployed to certain lines of business, terms and conditions, co-insurance and structure of coverage just to name a few. With respect to the reinsurance main, unlike traditional name parallel catastrophes, COVID was not modeled. And, therefore, it will be a headwind for future capacity. We believe the retro market will contract. And in the ILS market, there will be trapped capital, which will lock up collateral, therefore, restricting capacity on a go-forward basis, and we're already seeing this.
Kevin Hogan: Thank you, Peter, and good morning, everyone. Today, I will discuss overall Life and Retirement results for the first quarter and our current outlook, changes in our operating environment due to COVID-19 and then briefly comments on the results for each of our businesses. Life and Retirement recorded adjusted pre-tax income of $574 million for the quarter and delivered adjusted return on attributed common equity at 8.4%. Adjusted pre-tax income decreased by $350 million year-over-year, primarily due to significant market stress in March compared with the strong market recovery we saw in the first quarter of 2019. The main driver of the decrease was lower equity market returns, which primarily resulted in higher variable annuity reserves of $161 million and higher deferred acquisition cost amortization back of $138 million. Also, widening credit spreads generated lower returns from fair value option bonds of $116 million and the low interest rate environment resulted in continued spread compression across our individual and group retirement product lines. Lastly, I am pleased to report that our hedge program performed as expected in response to the market stress experienced in March, generating gains exceeding the movements in our economic view of the liability and related cash collateral. Recognizing the limits of sensitivity, especially in the context of first quarter's market volatility, our sensitivities provided on our last earnings call generally held up. Based on the environment we see today, we continue to expect base spread compression across the whole portfolio of approximately eight to 16 basis points annually. However, wider risk-adjusted credit spreads should generate opportunities to attract new business as profitable margins and the reinvestment of assets slowing off the portfolio should benefit from higher credit spreads. We have updated our estimates of market sensitivities to reflect our balance sheet as of the end of the first quarter. We would expect a plus or minus 1% change in equity market returns to respectively increase or decrease adjusted pretax income by approximately $25 million to $35 million annually and a plus or minus 10 basis point movement in 10-year treasury rates to respectively increase or decrease earnings by approximately $5 million to $15 million annually. These sensitivities assume the immediate impact of market movements on reserves, fact and fair value option securities as well as investment income and other items. It is important to note that these market sensitivity ranges are not exact nor linear since our earnings are also impacted by the timing and degree of movements as well as other factors. Market conditions began to improve in April, but one can expect that should conditions continue to improve, there may be immediate benefits in reserves back for investments in the second quarter although these benefits are likely to be offset slightly by lower private equity returns that are reported on a one quarter lag. Despite the challenging environment COVID-19 created, our balance sheet is strong and we currently estimate our fleet risk-based capital ratio for the first quarter to be between 405% and 415%, including both the impacts of variable annuity reserve and capital reform as well as our hedging program. Our risk-based capital ratio will be sensitive to the impacts from COVID-19 as they flow through our balance sheet throughout the year. Market stress in the first quarter due to COVID-19, while severe in nature did not reach our modeled stress testing scenarios. Although we expect lower levels of overall industry sales for the foreseeable future due to impacts from COVID-19, our leadership position continues to provide us with a unique competitive advantage. We have a broad position across variable index and fixed annuities, term and permanent life insurance, not-for-profit retirement plan markets and institutional markets. We are not dependent on any one product type or distribution channel, which allows us to maintain our long standing disciplined approach with respect to product pricing and future development regardless of the economic environment. Over many years, we have proven our ability to redirect our marketing efforts from one product type to another as market needs and pricing conditions change. We also have a large and diverse in-force portfolio that does not have the significant risks associated with pre-2010 living benefits for long-term care. Our very small block of remaining long-term care business has been reinsured to quarter two. Our strong capital levels and broad market presence position us well to deploy capital as potential attractive opportunities arise in this widening spread environment. Now, I'd like to touch on our operations over the last few months. As Peter noted, we transitioned quickly to a remote working model, with the support of our regulators we're meeting, we successfully adapted our e-signature policies, procedures and controls to support the needs of our plant sponsors, distribution partner firms and individual customers. Also, investments we have made to enhance our digital capabilities have served us well as many more customers are taking advantage of our enhanced self service tools. We've also been very responsive in adopting changes to address the financial hardship faced by some of our customers, such as extending the grace period for premium payments and meeting the requirement of the Cares Act. Our sales and relationship management professionals quickly shifted from face-to-face to virtual meetings and have conducted thousands of such meetings and educational webinars with our producers and customers. Turning to our first quarter financial results. As mentioned, the primary drivers of the decline in Life and Retirement portal adjusted pre-tax income with short-term impacts to our individual and group retirement businesses from significant market movements. As to the top line results are individual retirement, premiums and deposits decreased primarily due to significantly lower fixed annuities fail, as we maintained our pricing discipline as Treasury rates dropped throughout the quarter with credit spreads only beginning to widen late in the period. Our index annuity sales remain strong, but we again grew variable annuity sales. Lower sales of fixed annuities resulted in negative net flows for total individual annuities. For group retirement, premiums and deposits decreased due to lower new group acquisitions, as well as reduced individual product sales driven by the uncertain environment. Net flows improved year-over-year, primarily due to lower group surrenders. In this period of uncertainty, we expect fewer plan sponsors to change providers, which may reduce new group acquisitions, but would support plan retention. For our Life Insurance business, total premiums and deposits increased due to higher international premiums. Our mortality trends continued to be favorable to overall pricing assumptions and the first quarter included a modest IBNR reserve strengthening to reflect the fluidity of COVID-19. Although we may experience some acceleration, we are not expecting large incremental impacts to mortality rates and expect any incremental impacts to be manageable in the context of our overall balance sheet. For institutional markets, we have continued to grow our asset base and earnings, and this business continues to be well-positioned. We remain focused on new opportunities and have the capacity to participate as activity arises in the pension risk transfer and other institutional businesses. To close, despite these challenging times, we remain available to serve our customers, plan sponsors and distribution partners. We are committed to further mobilizing our broad product expertise and distribution footprint to serve our stakeholders in new ways as their needs evolve. We will continue to deploy capital to the most attractive opportunities and focus on meeting ever-growing needs for protection, retirement savings and lifetime income solutions. Now, I will turn it over to Mark.
Mark Lyons: Thank you, Kevin. Before providing summary comments about the first quarter, I'd like to give COVID-19 perspective from where I sit. First, this health crisis, which quickly evolves into an associated financial crisis, is unprecedented in scope, uncertainty and length and depth of economic impact. Additionally, this ongoing event has simultaneously impacted both sides of the balance sheet, thereby nullifying most underlying disruptions that investment assets and insurance liabilities are marginally correlated. As a result, it's extremely difficult to forecast one quarter in advance let alone a full year longer. However, as Brian also noted, I want to reiterate that AIG was strongly financially positioned entering the crisis, both from a parent and subsidiary liquidity and capital perspective and is well positioned today, including our investment portfolio. The evolving situation causes us to view liquidity and capital strength as an imperative. When the crisis suddenly took hold on capital markets in mid-March and not knowing what could come next, we thought it was prudent to augment our already strong current liquidity with a $1.3 billion partial drawdown of our revolving credit facility. We did this solely as a precautionary measure given the significant uncertainty at the time, about the near-term impacts of COVID-19. I will provide an update on our capital management plans and liquidity position later in these remarks after I review our first quarter results. So turning to the first quarter. AIG reported adjusted after-tax operating earnings of $0.11 per diluted share compared to $1.58 per share in the first quarter of 2019. Contained within this result is the continued improvement of General Insurance with a 95.5% accident year 2020 ex-CAT combined ratio as Peter noted. First quarter results reflect direct and indirect impacts related to COVID-19, including the market impact on net investment income and book value, with a lesser impact on core operations APTI. Peter discussed, the General Insurance COVID reserve reflects our best estimate, the losses occurring through March 31. The first quarter, adjusted book value per share increased 2.8% and adjusted tangible book value per share increased 3.2%, both since year-end. It's also notable that AIG's adjusted tangible book value per share increased nearly 11% since March 31, one year ago, which we believe is a better measurement of the improvement in AIG's core operating performance over the last year. Book value and tangible book value per share, both of which include changes in AOCI and the DTA, were virtually flat year-over-year, even with the significant AOCI change we saw in the first quarter of this year. In the first quarter, on an adjusted pre-tax income basis, net investment income, or NII, was $2.7 billion, down approximately $1 billion from the down approximately first quarter of 2019. Recall that the first quarter of 2019 included significant gains following the downturn that occurred in the fourth quarter of 2018 as this year's first quarter experienced significant losses due to the COVID-19 volatility in March, resulting in a distorted quarter-over-quarter comparison. I want to spend some time on our global investment portfolio. Because in the current environment, I think it's important to understand its composition. Several reports have been published that use incorrect assumptions and information about our portfolio. In many cases, our consolidated global portfolio has been compared to U.S. Life or P&C peers or the industry generally, without taking into account our unique position as a global composite or multi-line insurer. In addition, some believe our portfolio has above-average inherent risk, which is simply not the case. Instead, we believe our portfolio is below average in terms of risk and we'll get into some of that. In addition, certain accounting elections AIG took in prior years relating to specific securities have created above the line accounting volatility, which has led to some confusion, but this volatility does not impact AIG on a total return basis. To address these complexities and the many questions and comments we have received, we've provided much more disclosure regarding our portfolio, including the General Insurance, Life and Retirement and Legacy portfolio composition. On pages 46 through 65 in our financial supplement, there you will find a significant expansion of our disclosure beyond segment and into credit quality distribution and asset or industry characteristics. As Brian mentioned, Doug Dachille, our Chief Investment Officer, can help address follow-up questions during Q&A, but I'll give some high-level comments now. At March 31st, AIG had a $332 billion investable asset portfolio. This portfolio is about 73% fixed income available for sale securities, which represents 75% of General Insurance's portfolio and 74% of Life and Retirement. In addition, roughly 14% of the portfolio is invested in mortgage and other loans, 6% in short-term investments, 2.5% in real estate investment, less than 2% in private equity, approximately 1.5% is in fair value option fixed income security or FVO securities and about 0.7% is in hedge funds. It's important to recognize though that roughly 80% of the FVO fixed income portfolio, which historically has had higher volatility than are available to sales fixed maturity securities is held in legacy. Notably, the FVO portfolio makes up only 1.4% of General Insurance's portfolio and 0.3% of Life and Retirement. Our historical FVO accounting election mostly on legacy non-agency RMBS that were previously credit impaired cannot be changed or be changed or modified and move mark-to-market volatility above the line into our income statement within net investment income. For available for sale securities, such volatility would be below the line in AOCI. As a result, this FVO accounting treatment puts more volatility into our income statement by NII with less relative volatility in AOCI, which is where one would ordinarily expect to see the volatility. Financial statement geography is important to note when examining AIG's NII, but it is irrelevant when you look at total return, which is how our investment function manages our portfolio. Over the last four-plus years, and Doug can address this in more detail, AIG has seen significant de-risking of its investment portfolio with material reductions in hedge funds, life settlement, CDOs, and FVO securities, totaling approximately $32 billion, which is a 60% drop in these asset classes since year end 2015. Additionally, AIG's portfolio has only a very small direct equity exposure, representing just 0.2% of the portfolio. The volatility in the equity markets has a minimal impact on our investment income and even that is below the line. On page 63 of the financial supplement, you will also see a significant $9 billion plus credit quality difference and below investment-grade securities between the rating agency view and the NAIC designation view. Most of this is non-agency RMBS on an FVO basis, which we have had evaluated and rated NAIC 1 by the securities valuation office of the NAIC. This is the highest rating category, which is important because these assets strengthen subsidiary RBC levels and can sustain RBC levels even if they fall one notch, because they still will be investment grade. However, rating agencies have not re-rated these securities with current information, so from their perspective, the securities still retains legacy below investment-grade status. When examining our $144 billion of corporate debt, which is summarized on page 56 of the financial supplement and expanded beginning on page 59, note that nearly $130 million is investment grade. And of this total, 15% is rated AA or AAA, 34% is A-rated and 51% is BBB-rated. Compared to the overall investment-grade market, we have a superior distribution of such asset by rating. Similarly, when viewing the entire corporate debt portfolio, 10% is below investment grade, which is much lower than the market average of 48%. I wanted to point this out because given the magnitude of AIG's investment portfolio; some may assume that our portfolio mirrors the industry average, which is not the case. With respect to CECL credit impacts in the first quarter, which are included in realized gains and losses and not NII, we recognized approximately $236 million of credit losses. This stems from about $198 million in fixed income securities and $38 million in loans. Now turning to the operating segment. As Peter and Kevin discuss their financial results in detail, I will just add a few remarks that augment their comments. General Insurance, I'd point out that the $419 million of total CAT reserves for the quarter represents 6.9 loss ratio points with $272 million or 4.5 loss ratio points being attributed to COVID-19 and $147 million or 2.4 loss ratio related to other CAT events, the largest of which was the tornado storm system that hit Nashville in early March. Excluding COVID-19, General Insurance generated $185 million of underwriting income, which includes the non-COVID catalog. Prior year development was minimal in the first quarter with $60 million of net favorable development, $53 million of which emanated from the amortization of the ADC deferred gain. On a pre-ADC basis, there was a net $1 million of favorable development, representing $30 million of unfavorable in North America, mostly from shorter deadlines, largely offset by favorable $31 million from international across many product lines. Lastly, as Peter discussed, Syndicate 2019 will favorably alter AIG's risk profile as concentration risk is distributed across an innovative structure and set of capital providers. We anticipate that in the second quarter and for the balance of the 2020 year, TDS premiums will increase over original expectations, and therefore, net premiums will correspondingly reduce. We project that second quarter net written premium in high net worth will be down approximately $650 million from original expectations and that net earned premiums for the 2020 year were reduced by approximately $675 million as a result. Beginning in 2021, however, the catastrophe cover costs will decrease for AIG since the high net worth exposure subject to the CAT program will be a fraction of what it is today. So for 2020, underwriting income for the high net worth unit, we anticipate approximately the same underwriting result pre and post 2019 and then to become accretive thereafter. Turning to Life and Retirement, I would just add that institutional markets benefited from approximately $700 million pension risk transfer premium in the quarter, albeit down a bit from -- corresponding quarter of last year. Legacy, a $368 million adjusted pretax loss in the first quarter was due to a reduction in NII driven by capital markets volatility we saw in March, which abated, as mentioned, in April. As a reminder, we signed a definitive agreement to sell Fortitude last year with the economic set as of December 31, 2018, which means that all net income subsequent to year-end 2018, up through closing will be included in the gain or sale or loss on sale to be recognized upon the closing of the transaction. We continue on course towards a midyear closing subject to regulatory approval and it is noteworthy that Fortitude also has benefited from strategic hedging transactions that performed as expected, and in fact, health capital ratios remain virtually unchanged since early 2019. Next, moving to other operations, and as I discussed on last quarter's earnings call, you will see on pages 37 to 39 of the financial supplement, a revised and simplified presentation that helps identify key drivers of APTI. Our previous disclosures on this segment could be difficult to understand and volatile, in part due to the gross-up of income and expense for internal items, mostly investment services, which increased other income and GOE. We simplified that and also provided APTI by activity, which should help. As for magnitude, this quarter's $280 million of other operations GOE included the COVID-19 employee grants totaling $30 million that Brian referenced, and remote access IT costs of $3 million. Excluding that, other operations GOE would have only been $247 million. Turning to tax, we had a core 23% tax rate on adjusted pretax income for the first quarter, higher than recent prior quarters due to additional items dominated by a $37 million impact, reflecting share-based compensation differences, plus by grant date versus delivery date of value resulting from spot price declines during the first quarter. Turning to liquidity and capital resources, we believe that liquidity and operating subsidiary capital strength are paramount priority in this uncertain economic environment. At year-end 2019, AIG had $7.5 billion of liquidity at the parent and the RBC fleet ratios for General Insurance's US pool finished 2019 at 419% and for Life and Retirement at 402%. During the first quarter, we repurchased $500 million of our stock and closed $350 million of most advanced. Share repurchases helped to offset share count dilution stemming from equity compensation and the promotion bond call aided our debt leverage ratio. As of March 31, AIG had a similar $7.5 billion of current liquidity, including the $1.3 billion draw from our revolver that I referenced earlier in my remarks as well as strong liquidity in both General Insurance and Life and Retirement. Before turning to AIG 200, there were two below the line items in the first quarter that I would like to highlight: First, the success of our hedging program; and the second would be Blackboard. Turning first to our hedging program, roughly $3.6 billion of variable annuity fair value benefits were reflected during the first quarter within the realized games line as a direct result of successful interest rate and equity risk hedging within the Life and Retirement and legacy segment that clearly preserve book value. It should be noted though that on a GAAP basis, this gain was aided by the NPA, or non-performance adjustment, impact, which is highly volatile and reversible depending upon rates for ebbs and equity markets. Secondly, at the end of March, AIG made a strategic decision to discontinue Blackboard, our internal insured tech startup in light of current market condition. Blackboard's GOE which was $16 million in the quarter, has been historically recorded in other operations, but that we'll cease starting with the second quarter of this year. Associated with this business decision, we recorded an approximate $165 million after-tax charge, not included in APTI. Pivoting to AIG 200, as Peter noted, we continue to refine our operational plans in response to COVID-19. We still expect that this strategic three-year transformation will result in $1.3 billion in costs to achieve an annualized $1 billion of run rate GOE savings by year-end 2022. Let me first just provide a quick review and then I'll give you the AIG 200 three-year walk as well as its impact on the first quarter of 2020. From a reporting perspective, all costs to achieve, aside from $400 million of pre-tax spending that will be capitalized will be recorded below the line, not in APTI, as restructuring and other costs, which will make it straightforward to track. These below the line charges mostly involve employee-related costs, dedicated internal resources and associated professional services. Capitalized costs of $400 million before tax, represent mostly investments in systems, development, interfaces, data conversions and associated integrated workflow processes, which have an impact on cash, but are not expensed immediately in the income statement. Instead, each investment will be capitalized and then amortized through GOE based on its useful life according to accounting principles. Hence, by year-end 2022, we would expect that the amortization portion of the $400 million will be included in our annual expense run rate, where our goal is a total annual run rate savings of $1 billion, including the amortization of these capitalized investments. So let's turn towards what this means for the next three years, acknowledging that in this uncertain world, timing of plans can somewhat change. Under Peter's leadership, we are governing AIG 200 via structured checkpoints and tollgate that control cost, confirm scope and reconfirm scope and drive key milestone achievements. Overall, we expect a total 'cash cost' at the holding company of $1.3 billion. As shown on page eight of the financial results slide, $350 million of this is expected in 2020, although still being reviewed due to COVID-19 impact; $500 million in 2021 and $450 million in 2022. Of these amounts, approximately $100 million in 2020 will be capitalized with later amortization into GOE. The combination of these two result in a below the line projected charge of $250 million before tax. Then in 2021, about $200 million will be capitalized, with a below the line charge of roughly $300 million. And finally, about $100 million will be capitalized to 2022, with a below the line charge of $350 million. Based on our current useful life schedule for depreciation and assumptions about when we expect the $400 million in capitalized assets to be placed into service, calendar year depreciation included in GOE should be zero in 2020, as the project will still be in development; rising in 2021 to be between $10 million to $15 million before tax; and $25 million to $30 million in 2022. Based on projected completion by year-end 2022, the unamortized balance of about $350 million will be amortized at about a seven-year average life, with $50 million per year in 2023 through 2027 and then trailing off a bit from there. Finally, in the first quarter of 2020, we had a $90 million restructuring charge below the line, of which about $23 million related to AIG 200 and the balance from other actions. Going forward, restructuring charges will primarily reflect AIG 200 costs. Relative to expense savings, this quarter had $10 million of GOE savings, which will translate to $60 million on an annualized run rate basis, which is part of the $300 million plan run rate benefit by year-end 2020. Now shifting to capital management and looking ahead, in light of the significant uncertainty on many fronts due to COVID-19, we do not plan to do additional share repurchases or debt reduction actions for the foreseeable future, but we will reassess this as COVID-19 impact stabilize. However, given improved stability in and access to the capital markets since March, we are reevaluating our debt and capital plan. While reducing debt leverage to 25% or below is a minimum term goal, in the near term, our priority is maintaining strong operating capitalization, financial flexibility and liquidity. As a result, we are considering options to generate additional near-term liquidity in light of ongoing economic volatility as well as upcoming debt maturities in 2020 and in the medium term. Although spreads have widened since year-end, all-in coupons are attractive. Given the significant uncertainty around the duration and depth of global recession created by COVID-19, as well as taking into account our global operating footprint and different regulatory capital regimes, we think it is prudent to evaluate debt capital market opportunities in the near term rather than waiting until later in the year, which was our original plan prior to COVID-19. Lastly, and reflecting back, the first quarter benefited in the first two months from strong momentum in GI pricing, investment return and operating initiatives. In March, COVID-19 spread incredibly fast and dramatically changed everyone's everyday world. AIG entered this crisis from a position of strength while it has certainly impacted us and caused us to recalibrate some of our plans. AIG is more resilient than it has ever been with strong leadership and greater portfolio and risk management across the organization. We are confident in our ability to weather this storm and look forward to being able to engage with you again in person, hopefully, in the near term. With that, I will turn it back to Brian.
Brian Duperreault: Thanks, Mark. Abby, I think we're ready for the Q&A portion. So please get us started and let us move first.
Operator: Thank you. And we will take our first question from Elyse Greenspan with Wells Fargo. Wells Fargo.
Elyse Greenspan: Thanks. Good morning. My first question, in your prepared remarks, you guys mentioned that a small fraction of your commercial property policies contain coverage for infectious diseases and that those policies do have small sub-units. I'm just trying to get a sense of those policies where you think you could see losses have you set up reserves within your COVID losses in the first quarter?
Brian Duperreault: Okay. Elyse, I think that's a question for Peter. Peter, would you take that, please?
Peter Zaffino: Yeah. Sure, Brian. Hi, Elyse, let me just give you a little bit more detail. Yes, we did go through it very thoroughly in the first quarter, as I outlined our process that we did bottom-up and top-down but when you look at the size and scope of our global portfolio, the nature of our clients in terms of the segmentation, we do have commercial property policy that have some manuscript warnings. As I said in my opening remarks, the overwhelming majority of the standard commercial property policies do contain clear exclusions for viruses, and it's fairly standard in the industry. These policies also require that there's direct physical loss or damage that impact the insurance business operations. As to these policies, COVID is not covered. So that's point one. There are limited instances where we do write affirmative coverage for communicable diseases. But even in those cases, it's only on a supplemented basis, and in pursuant, we have very strict underwriting guidelines that often result in coverage for only specified diseases. And in an event that there's a requirement that there would also be a government closure caused by physical presence of the disease itself. So again, it's fairly clear. And just to give you some context in terms of what I'm talking about is that 100% of our sub-limits aggregate to well less than 1% of our total limits in our commercial property policy. So it's a very small portion of the overall property exposure. And I would just note that I mentioned in my prepared remarks, we have really comprehensive reinsurance, whether it's on a property per risk basis, we have low attachment points on a per occurrence basis that's regional, and we also have global aggregates that attach to reduced volatility on a frequency severity basis. So sorry for the long answer, but I think it's important to get into the detail.
Brian Duperreault: Thank you, Peter. Next question
Operator: We will take our next question from Tom Gallagher with Evercore.
Tom Gallagher: Good morning. Mark, you mentioned your plan on running with higher debt for the time being, which I think that makes sense given the current environment. Have you gotten any sense from the rating agencies on their reaction to the higher leverage for now? And then just a follow-up question on the investment portfolio. Appreciate all the disclosure there. The $18 billion of other invested assets, it looks like $6.7 billion of that is in legacy. Would you expect most of that to be transferred with the Fortitude resale? And then sorry for the string here. But then just one related question, the $8.5 billion of real estate alternative investments, should we expect there to be any kind of impairment on that in 2Q, or is there some buffer with historical cost accounting there?
Brian Duperreault: Okay, Tom. Listen, why don't we have Mark, you wanted to talk about the debt. And then I'm going to ask Doug to take over on the investment portfolio question. So Mark, why don't you go first?
Mark Lyons: Thank you, Brian, and I will do that as well. With regards to debt, yes, we've spoken to the rating agencies. In fact, we were in conversation with them on the revolver drawdown, as a matter of fact, and had very good strong and supportive conversations with them. And in the future, we may contemplate, of course, we be involve in discussions with them as well. With that, I will turn it over to Doug to talk about this to investment questions.
Doug Dachille: Thank you, Mark and good morning. Well, I would refer you to page 49 of the financial supplement, which basically goes through the legacy segment and the assets that are held in that segment in pretty robust detail. And as you know, in addition, there's approximately $40 billion of assets, which we also disclosed in our financials, which are going to be part of the sale related to Fortitude. The portions that we’ll be retaining, there will be some real estate investments that we'll be retaining that are part of legacy. There will also be some fair value option bonds that will be retained in legacy that were part of the old financial products direct investment book. So those will not be part of the sale transaction. But the material amount of the assets will be, as you know – over $40 billion will be separating as part of the sale of Fortitude. With respect of the real estate, you -- as you know, we only experienced a rapid acceleration in the month of March with respect to the development and emergence of the COVID situation. So we're still in the midst of analyzing the impact. And I think it's very early to determine what the impact will be on our real estate portfolio. But it should be noted that our real estate portfolio is diverse. It includes both domestic and international exposures. So the impact we'll learn more as things go on. I think where we're learning the most about our real estate is obviously on the commercial mortgage loan side. So that's where we're getting some real insight into what's going on in the real estate market. And those teams, the commercial mortgage loan team work very, very closely with the real estate equity team at AIG. And all of those investments are managed directly. So we have great level sight – of line of sight to what's going on in that market, but it's still really early to determine what's going to happen.
Brian Duperreault: Okay, thanks Doug. So, why don’t we get the next question then.
Operator: We will take our next question from Yaron Kinar with Goldman Sachs.
Yaron Kinar: Hi, good morning everybody and thanks for the very helpful opening comments. I just want to start with one question on the removal of the 2021 exit rate return guidance. Just want to make sure I understand what it does and what it does not mean? Does it mean from your perspective that you could see the COVID impact linger or continue well into 2021?
Doug Dachille: Well, let me take that. Who knows? I mean, you don't know whether COVID will reemerge, if it does go down an impact in 2020. It's really a question of how much predictability is there to quarterly earnings. And it's difficult to predict quarters. So if you can't predict the quarter, I don't want to try to predict a year or several years. I think it's important to note, though, that the underlying power of the company remains. We're very, very strong in the GI. GI has continued to show improvement. Good work that has been done over the last 3 years, what Peter and his team have continued on. So the returns that we were talking about, I believe, if you – certainly, if you pick the COVID out for a second, are going to continue to improve. And so that trajectory we're on is, we're still on. Now you have a COVID event, and I think the COVID event certainly would impact L&R on a short-term basis. But again, we think the long-term power of the company is there. So COVID itself, it will be large. I told you that I believe it will be the largest event in the insurance industry, but it is -- it's an inflection point. And that effect that we'll see -- we've already been in a market on the GI side, General Insurance, P&C side that was turning. It was improving. And the rates in terms and conditions were improving for the risk taker. This COVID is going to prove to be an inflection point. So, companies with strong balance sheet, we have one; companies with strong management, we have one; companies that has been well risk managed, and we've done that now, they're going to be on the right side of that. And so we believe we can handle anything that comes with COVID and we feel very strong. But predicting quarter-to-quarter is just impossible. So, I hope that helps.
Yaron Kinar: Yes, it does.
Brian Duperreault: Next question.
Yaron Kinar: So, my follow-up question on that is when you talk about COVID being the largest catastrophe event in the industry's history. Can you maybe talk about what P&C lines in particular you would foresee having very large losses here? And maybe also the proportion of losses that you'd expect coming from L&R, maybe not directly COVID-related, but from capital markets activity?
Brian Duperreault: Well, I'm going to have Peter talk about what we see in the P&C side, and then I'll let Kevin talk about L&R. So, Peter, do you want to talk about that first?
Peter Zaffino: Sure. Thank you, Brian. We mentioned quite a few lines when we were referring to the first quarter, whether it's travel, M&A, A&H, some other lines to think about that could have activity, workers' compensation. We don't know about D&O liability. We have been watching it very carefully and making certain that we're looking at any line that we think could have an impact. But what I can tell you to add to Brian's comments before, is that we have a very thorough process and we'll be consistent all the way through. We know the CAT is still ongoing, which is a very rare. So, as things emerge and develop, we will adapt to that. And we're looking at this across every global geography where we think there's impact and multiple lines of business. But because the CAT is still going, we even have two months left in the quarter. It's hard to see what transpire in the future. But as I said, we have a great process, and we will keep everybody have a great process, and we will keep everybody updated on lines of business as they emerge.
Brian Duperreault: Kevin, on L&R?
Kevin Hogan: Yes. Thanks. So, I'll address it really in 3 pieces, mortalities of the markets and then maybe just a reminder around pricing. So, our reported mortality in the first quarter was below pricing, which continues the trend that we've had for the last two-plus years. But later in the period, what we did notice is that there were some delays in reporting, generally related the issuance of certain documentations. So, we put up the modest IBNR really for just running reporting. As we look ahead, we do expect that there will be additional mortality in the second and the third quarter, depending upon how circumstances and behaviors evolve. So, where does that leave us? We expect some expect some adverse mortality overall for 2020, but we don't expect to see significant impacts to the balance sheet based on what we know, and there could be some offsetting factors. In terms of the market effects, look, there's two things. I mean, when equity markets move, particularly when they go down, that ultimately reduces our future expected fee income, particularly in the annuities portfolio, which we have to reflect immediately and back. The reality is, is that the reduced reserve overall actually emerges as additional profits in the future. It also serves to increase our SOP all 3 1 reserves, and when changes in credit spreads, we see the immediate impact on fair value options. So those two short-term market effects are reversible. And that leads to the third thing, which is pricing and how do we feel about current pricing. And certainly, treasury rates are at all-time lows, but our ability to price product is to pace -- is based not only on where base rates are. But also where credit spreads, what is the shape of the yield curve and where investor expectations and appetites are. And so based on the power environment, we're still able to price the long-term expectations that we have. Certainly, there's disruptions in the sales environment, but it's difficult to anticipate what the future on that is going to be and how it resolves. So those are the three perspectives I have on the long-term earnings potential of the Life and Retirement environment.
Brian Duperreault: And one thing I'd just like to add there, Yaron, Peter's comments about certain lines of business, he mentioned workers' comp. I think it's important to remember that AIG has de-risked that workers' compensation business significantly, probably over the last 7, 8 years. And where AIG finds itself now is mostly in loss sensitive related programs, which have average deductibles north of $1 million. So when you think about debt in the work comp area, that's statutorily determined by state, that's going to be underneath a deductible, standard medical and temporary, all that falls away. It has to be a major permanent parcel to really penetrate it. So I think the book is well positioned given what we're talking about here.
Kevin Hogan: Yes. And just one other piece on the comp, and Peter mentioned this earlier, but, yes, there are COVID claims coming in, but I think you have to recognize that there's been a decline in a number of claims coming in otherwise. So it remains to be seen what the net effect of COVID has on the worker concept. So that's something to keep an eye on. With that, Abby, let’s go to the next question.
Operator: We will take our next question from Michael Phillips with Morgan Stanley.
Michael Phillips: Thank you. Good morning. I want to touch on comments on expected, continued underwriting core profitability in General Insurance and maybe how you think about the near-term impact of exposure drops given your economy and how that might affect the profitability improvement plan for the remainder of this year?
Kevin Hogan: Okay. Michael, well, that's Peter. So Peter, why don't you do that?
Peter Zaffino: Okay. Thank you for the question. We certainly are paying very close attention to lines of business that would be affected by the economic headwinds that are generated from COVID-19. I mentioned some of them in the prior question in areas where we're watching for loss, but I would think that there's going to be a meaningful falloff of travel in the second quarter. M&A could be some fall off in aerospace, marine and energy, and we mentioned workers' compensation. Having said all that is that you got to remember the segmentation and demographic of our portfolio, I mean, over 75% of our businesses on some form of either deductible SIR or funded captive. And so we don't have a direct correlation, even though it is rated off of a payroll, sales, auto is done on an excess basis. And therefore, we do not think we will have as much headwind in terms of premium reduction. There will be some, but it will be more modest because it's not a direct ratable exposure that generates the premium. We have different factors in terms of how we adjust excess premium. So we just don't think it's going to be as pronounced. Brian mentioned on workers' compensation, the decrease in frequency. It's not a trend yet, but it's an observation that, while COVID losses are increasing, we're seeing a commensurate drop in where our clients are retaining losses that those are dropping. So as we look at repositioning our portfolio, where we attach on an excess basis and the commensurate premium as I said, there's going to be some lines of business that will affect. We there's opportunities for other areas of growth. As we have repositioned the portfolio, we like where we are, and think that the leadership position that AIG can demonstrate in the marketplace will give us also some select opportunities for growth.
Peter Zaffino: Thanks. Michael, anything else?
Michael Phillips: No. That’s it. Thank you, Peter. Appreciate it.
Peter Zaffino: Okay. Thanks, Michael, Abby, next question.
Operator: We will take our next question from Paul Newsome with Piper Sandler.
Paul Newsome: Good morning. Thanks for the call everyone. I'm a little concerned that the loss with the – the big CAT loss that you have from Totalbank seems more of a liability loss than a property loss. Could you talk about how the reinsurance could protect you in liability-type catastrophe versus property. I think we all feel is excess loss properties, but I can't recall liability to cash is simple size. So I don't know with regard to in terms of coverage ?
Brian Duperreault: Okay. So Paul, you want us to talk about in a COVID versus our reinsurance program?
Paul Newsome: Yes. If COVID was a liability loss instead of a property loss?
Brian Duperreault: Yes. Okay. Well, Peter, I guess, that's you again.
Peter Zaffino: Thanks, Brian and Paul. So I outlined our property program and said that we had reduced volatility significantly. On the liability side, I think we've done actually even more. We used to retain significant limits within AIG and so we've been building a program over time that significantly reduce the net limits that we put out as well as the gross limits. And also we did that on an excess of loss basis and also on a quota share. So on a general liability policy, as an example, we would have less than probably, depending on the limit, we have a 50% plus quota share on our first limit retention that we have 100% reinsurance above $25 million. So we have – if you issue a policy, a significant sized policy, the multi have net is between $10 million and $12 million. So we actually have significant protection on the quota share as well as the excess of loss.
Brian Duperreault: So Paul, let me just jump in. Look, our reinsurance is good and solid, and Peter has done a tremendous job along with his team to put that together. Our first-line of defense is the way we manage our portfolio to start with. And so you can't rely on reinsurance to make a portfolio better than it is. o we've done a tremendous amount of work, risk selection, limits management, attachment points and pricing along all the lines of business property and casualty and that's where we feel very confident about our situation vis-à-vis the impact that COVID will – as those impacts unfold. So I just want to add that. So Paul, did you have another – anything else?
Paul Newsome: No. That’s it for me. Thanks for the answer and thank you very much.
Brian Duperreault: Okay. You’re welcome, Paul. Thank you. Next question, Abby?
Operator: Our next question is from Ryan Tunis with Autonomous Research.
Ryan Tunis: Hey, thanks. Good morning. I just wanted to confirm some of that, I guess, Peter said earlier in the Q&A. Yes. There's affirmative BI coverage for 1% of total property limit. But sounds like that could be somewhat of a big notional number that you might get, roughly?
Brian Duperreault: Well, I said one. Peter, go ahead.
Kevin Hogan: Peter, go ahead.
Peter Zaffino: Sorry, Ryan. What I said was, not that that was a permanent coverage and those sublimits would trigger coverage. What I said is that the limits that we provided on the affirmative, which have, again, a bunch of triggers that I outlined in my previous answer that we have well less than 1% of our total limits when you compare that to our property gross limits. So, again, it's well less than 1%. And I'm not suggesting that we confirm that there is coverage or that we are adjudicating claims on that amount. It's just that, that's what we have for limits, and then it goes case-by-case, insured-by-insured in terms of what the losses.
Brian Duperreault: Yes. Ryan, let me just add something here. And that is, Peter talked about that process of evaluating the losses occurring in the first quarter. I've been in this business a long time, 40-plus years. And I've seen a lot of things come and go. I've seen difficulties in trying to assess loss. I have to tell you the process that they – that we went through, that they went through, we went through, it's as good as anything I've ever seen. They have gone through every bit of the portfolio. They looked at everything where there was a potential and evaluated whether there would be reason to post the reserve, if it was, it was done. So we have posted the reserve that we believe are appropriate, albeit conservative for that, everything that happened in the first quarter. I just want to make sure that everybody understands that, everything that happened there.
Ryan Tunis: Yes, yes. So could you just talk a little bit about how you're seeing business interruption, losses might respond within the Validus book? And also, just the $272 million net loss number, what does that look like on a growth basis of reinsurance? Thanks.
Brian Duperreault: Okay. Well, Peter, that's you again.
Peter Zaffino: Okay. With Validus Re, we've gone seat-by-seat and have taken a look at our gross net exposures and put up what we thought was the best estimate based on, again, the same process that we outlined for the core of AIG in the first quarter. In terms of the net growth, I mean, look, there's some reinsurance. I'm not going to go into great detail in terms of what the net is versus the growth is, still an evolving loss as we outlined with meaningful IBNR. But again, I've outlined what I thought were the reinsurance structures that could apply in the event that the loss were to grow over time.
Brian Duperreault: Okay. Thanks, Ryan. Abby, let’s go to the next question.
Operator: We will take our next question from Meyer Shields with KBW.
Meyer Shields: Thanks. This is soft of a related question, but it seems to be top of mind for a lot of investors. How should we think about commercial property where there is no little bit of coverage, but no virus exclusion, given some apparent court decision saying that non circle damage would qualify?
Brian Duperreault: Well, it's a technical question, Peter, can you do this?
Peter Zaffino: Hey Meyer. It's a really hard question to answer because it's, hypothetical. The only thing I can really do is comment on the policies that we have and where we think, again, I outlined demographics of it and think that the exclusions that we have and where we granted affirmative coverage, it's very specific. And so, it's hard to answer that because I don't think it really applies to our portfolio.
Meyer Shields: Okay. That's fair, unrelated question. I guess, I would have expected maybe better results in international personal lines, assuming, an international shelter in place order. Am I missing something there?
Brian Duperreault: International personal lines, Peter?
Peter Zaffino: Yeah. What, what happened in international personal lines? It's not an anomaly, but we basically had a runoff program, that impacted we still had earned premium, so it was put into runoff in 2018 that earned premium in 2019 and as you've been doing the re underwriting of the portfolio, again not as much as we did on the commercial. We've just lost a little bit of premium. And so, the ratios, look like they perhaps are not going in the right direction, but the absolute performance is very strong. We like the personal book very much and think that there's some real discrete opportunities for growth, particularly in A&H and an areas across, all of international an accident held them new digital platform we're putting in. So I wouldn't read into that in terms of a trend is just, the impact of a runoff of business. Meyer.
Meyer Shields: Okay. Thanks.
Brian Duperreault: Thanks Peter. Thanks Meyer. Let's go to the next question. I think
Operator: Our next question is from Brian Meredith with UBS.
Brian Meredith: Yeah, thanks. So, Brian, I'll have this one for you. We're going to Peter on it. Given the impact you've seen of COVID-19 on the general church business as well as the life insurance businesses, I'm wondering if you're at all rethinking the strategic rationale of actually having both the lights in the TMT operation in the same company?
Peter Zaffino: Well, Brian, I guess, you know, my job is to continually always think about, the structure that we have. Does it make sense? Would we be better in a different structure? And so that's, that thinking continues, I think at this point. We're comfortable with where we are, but I -- that's my job is to continue to do that. So we'll continue to keep looking at that. There were reasons why these two belong together and those two are still there. But we, I'll always think about that, but there is nothing that I would talk about. Right now I think we're comfortable with it.
Brian Duperreault: Any other question, Brian?
Brian Meredith: Yeah, this is just one of the quick one here. I'm just thinking about it. So given us the largest cash loss coverage, each inch industry probably ever, if I kind of think back, AIG with -- had well over $2 billion of losses, are we talking about it potential last year? There's going to be well north of a $1 billion for you guys. Ultimately, at the end of the day, if this is truly the largest cash we lost ever?
Peter Zaffino: Well, I look at it, we're not the company we were Brian. We're not the company then, there's been a complete, change and we look at the risk, the de-risking that we've done, the limits management, the improved reinsurance profiles all lead us -- put us in a position where we are much stronger and able to withstand an event. And so I point out that this is the largest event because I want people to understand that it's creating an inflection point in the industry. But there are going to be some who do well in this process and some that won't. We're in -- we believe we will do well through this event and that we're going to emerge stronger and more in demand than we were before.
Q – Brian Meredith: Makes sense. Thank you.
Brian Duperreault: You are welcome. Abby, next question.
Operator: We will take our next question from Andrew Kligerman with Credit Suisse.
Andrew Kligerman: Hey, good morning. Thank you for taking my question. On the life insurance side, I'm wondering if you could give a bit more of sensitivity in terms of the COVID-19 exposure, what you might expect during the course of the year. And then with regard to variable annuity hedging that was very strong. What was your hedging expensive numbers for the variable annuity? And lastly, just in terms of the press release and what you said on the call, you talked about maintaining the return on equity profile for the life business, what might that profile be? I mean could you kind of drill in where you think a good range for all the Life and Retirement could be?
Brian Duperreault: Okay, Andrew, thanks. So I'm going to have Kevin, obviously, talk about the sensitivity around COVID-19 and the hedging program. And the hedging program, I think, Kevin, why don't you do the piece about the variable annuity, but I would like Doug to jump in on the -- what happened with Fortitude as well. So Kevin, why don't you start?
Kevin Hogan: Yes. Thanks, Brian. Thanks, Andrew. So look, I guess I'll address that from a couple of perspectives. I covered the market impacts, the short-term market impacts. So I'm not sure I need to go back to that. But I mean, clearly, when equity markets move, it impacts the SOP in the DAC and when the fair values move, that impacts the fair value options. Those will never -- I'm sorry, Andrew?
Andrew Kligerman: Yes. I apologize. I needed to be clear, I mean quickly the mortality. What would series…
Kevin Hogan: Mortality. So it’s very straightforward that in the first quarter, we saw mortality better than pricing. We believe there are delays in the reporting of those claims. As we look at second quarter and third quarter based on where the current estimates are, this is well within our first level modeled stress scenario. We don't expect any significant impact on the balance sheet. And there's also -- it's difficult to project how people are going to behave, how people are going to respond. So that's about the best that we can do. It's just based on where we believe our market presence and geographical presence are versus the current expected losses. In terms of hedging, what I would say is, first of all, you can only hedge what you have. And so the liability profile that we have is a big part of the success of our hedging program because we have primarily de-risked benefits, sold well after the VA arms race of the mid-2000s. And so that includes our feature of requiring fixed income allocation, volatility control funds, et cetera. We've hedged all hedgeable market risks. We've left an open position relative to credit spread, because we believe that that is a natural hedge against our general account portfolio. Over time, our hedge effectiveness is around 90%, and it's continued to perform almost exactly as we expected in the various market dynamics, resulting in I think the results, the good results were reported for the quarter. But I'm going to pass on to Doug because another feature of our hedging success in the first quarter was also in the Fortitude portfolio.
Doug Dachille: All right. Thank you, Kevin. So I just wanted to comment on the fact that what you don't really see in the financials is with respect to the legacy segment, you're seeing all the mark-to-market impact particularly of the fair value option securities that are in legacy and to some extent, in Fortitude. What you don't see is the fact that we had established interest rate and credit hedges, which all that P&L and effect goes through realized capital gains and losses. So you don't really see the net effect. But the best way to look at how that – how the entity performed and how those hedges are formed and how effective they were is as Mark made in his prepared remarks, he said that the regulatory capital ratios for the entity were preserved from over a year ago. So that gives you a sense of how effective our hedging strategy was for things that you're not necessarily seeing when you look at the mark-to-market volatility that is reported in our financial statement in the APTI. So, thank you.
Brian Duperreault: Okay. Thanks, Doug. And Abby, I think we're running a little long, but why don't we take one last question?
Operator: Yes. Our next question will be from Scott Frost with State Street Global Advisors.
Scott Frost: Thank you for taking my question. You said you expect COVID to be the largest single P&C event industry's ever seen. Could you give us some background on what the basis is with this assessment, specifically the length of shutdown you're assuming here? And what are your thoughts on the Willis piece released Friday, and over how many years do you expect claims to develop and be paid? I'm assuming multiyear payment profile, but if I'm wrong, please correct me.
Brian Duperreault: Okay. Well, let me start with that and then Peter can add from it. But in terms -- just in terms of the payments, these particularly business interruption claims are very long in process and payments. So I think we're just I think we just cleaned up the last business interruption from Superstorm Sandy to give you some idea. So anyway, but in terms of the estimate, I mean, we've seen a lot of different estimates, and I think they run the range, but the first thing you have to understand is this is global in nature. This pandemic is affected every corner of the world. It isn't that hard to come up with a reasonable assumption around the effects because we're seeing effects in Europe, we're seeing effects in Japan. We're seeing effects in Latin America, and of course, here in North America. So whether it's the effects of comp that we talked about or it's the business interruption, we've seen travel and event cancellations and on and on and on, it doesn't take much to figure out how this is spread across the globe. The question for us is, what's our position on all those things and we feel very, very comfortable with how we've managed this risk in general and how we're well-positioned for COVID. Peter, do you want to add anything to that?
Peter Zaffino: Not much. The only thing I would just add is what you said. We've seen a lot of very good written documents that have come out. But just because of the ongoing nature of the event and the complexity of the different lines of business, it's the wide range of scale in terms of the low end of the high end is about as wide as you'll see in terms of predicting cash. So, it's very hard to pinpoint anything or the level of accuracy until this evolves over time.
Scott Frost: Well then how can we say that it's going to be the largest event we've ever seen when there's a wide range, I mean, again, you're saying that's going to exceed Katrina? So, on the basis of that, what -- I mean, again, what are we saying? I mean, the world supports a length of shutdown is really the determining factor. They're saying a year its $80 billion. When you say it's greater than Katrina, is that the basis of your statement or can it be less than -- I mean, what I'm trying to get at is, how are you getting to that statement?
Brian Duperreault: Peter?
Peter Zaffino: Yes. I mean -- so looking at -- I mean, let's get off the Willis is that we've done a ground-up analysis based on what we think can be an industry loss with a lot of assumptions, again, let's get off the Willis is that we've done a ground-up analysis based on what we think can be an industry loss with a lot of assumptions, again, length of time, severity, geographic spread and have done it across multiple lines of business. And length of time, severity, geographic spread and have done it across multiple lines of business. And again, we're not in the business of putting out ranges as to what is going to happen to the industry because we look at our own portfolio. But when we look at market share of different lines of business, we came up with an estimate that exceeded Katrina. And I think that was the basis of Brian's statement.
Scott Frost: Okay. It would be helpful if you told us some of the assumptions behind that, so I'm driving that. Thank you. I appreciate the comments.
Brian Duperreault: Well, thank you very much. Like I said, we've gone past our time. So, I want to wrap this up. And so first of all, I want to thank everyone again for joining us today. And I also want to thank our clients and distribution partners, our shareholders, other stakeholders. We're all in this together and we will get through this challenging time together. Most importantly, finally, I want to thank our colleagues around the world. Guys you've exceeded my expectations and I could not be prouder of what we've accomplished together over the last few months. So, everyone, please be safe and be healthy and thank you again. Goodbye.
Operator: Ladies and gentlemen, this concludes today's call and we thank you for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, good day, and welcome to AIG's First Quarter 2020 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Sabra Purtill, Head of Investor Relations. Please go ahead, ma'am."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you. Good morning and thank you all for joining us today. Our call today will cover AIG's first quarter 2020 financial results announced yesterday afternoon. The news release, financial results presentation and financial supplement were posted on our website at www.aig.com, and the 10-Q will be filed later today. Our speakers today are Brian Duperreault, CEO; Peter Zaffino; President and COO of AIG and CEO of General Insurance; Kevin Hogan, CEO, Life and Retirement; and Mark Lyons, Chief Financial Officer. We will have time for Q&A after their remarks. Today's call may contain forward-looking statements relating to company performance, strategic priorities, business mix and market conditions, including the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially. Factors that could cause results to differ include those described in our 2019 Annual Report on Form 10-K and other recent filings made with the SEC, inclusive of the effects of COVID-19 on AIG, which cannot be fully determined at this time. AIG is not under any obligation and expressly disclaims any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Additionally, some remarks will refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is provided in our news release and other financial results material, all of which are available on our website. I'll now turn the call over to Brian."
},
{
"speaker": "Brian Duperreault",
"text": "Good morning, everyone. It's been an extraordinary few months since we last spoke. Before we start, I want to say that I hope you and your families are healthy, and that you've been able to adjust to the new normal that COVID-19 is creating for all of us. This crisis has been heartbreaking to witness as it unfolds across the globe. It's a tough time for everyone and the uncertainty about how long it will last and what life will be like afterwards makes this time even harder. I've witnessed a lot in my 40-plus year career in the insurance industry. But this health and humanitarian crisis, which quickly became a threat to the world economy, is like nothing any of us has experienced. We believe COVID-19 will be the single largest CAT loss the industry has ever seen and will continue to have significant global economic ramifications for the foreseeable future."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Brian. Good morning, everyone, and thank you for joining us. Today, I plan to review the following topics: a brief overview of the potential near and longer term impact of COVID-19 on the insurance and reinsurance markets generally, how we analyze the impact of COVID-19 on GI through March 31st, first quarter results for General Insurance, excluding COVID-19, including Validus Re, our recently announced launch of Syndicate 2019 and AIG 200 and the progress that we've made since our last earnings call. As Brian said, the near and long-term impact of COVID-19 on the global economy and insurance and reinsurance industries remains unclear. In contrast to other catastrophes like wildfires, hurricanes and earthquakes, this event is not confined to any specific geographic region, and it has already impacted over 200 countries and territories. In addition, this duration is not limited as is typically the case with traditional CATs. While the insurance industry manages risk of all kinds, it's fair to say that the profound impact and global nature of COVID-19 is something we have never encountered. There's no playbook. And as a result, we are called upon to make thoughtful and prudent decisions in a climate of unprecedented uncertainty. Before COVID, the largest catastrophes on record were Hurricane Katrina with $65 billion losses, then the Tohoku earthquake with $35 billion in loss, Hurricane Irma with $30 billion losses, and Superstorm Sandy also with approximately $30 billion in losses. With respect to COVID-19, we're starting to see early industry estimates, but they have significant ranges. While it's too early to gauge the ultimate size of the loss, we believe COVID-19 will result in the largest individual CAT loss, the insurance industry has ever seen. Going forward, COVID-related losses will impact all aspects of underwriting insurance from absolute limits available, limits deployed to certain lines of business, terms and conditions, co-insurance and structure of coverage just to name a few. With respect to the reinsurance main, unlike traditional name parallel catastrophes, COVID was not modeled. And, therefore, it will be a headwind for future capacity. We believe the retro market will contract. And in the ILS market, there will be trapped capital, which will lock up collateral, therefore, restricting capacity on a go-forward basis, and we're already seeing this."
},
{
"speaker": "Kevin Hogan",
"text": "Thank you, Peter, and good morning, everyone. Today, I will discuss overall Life and Retirement results for the first quarter and our current outlook, changes in our operating environment due to COVID-19 and then briefly comments on the results for each of our businesses. Life and Retirement recorded adjusted pre-tax income of $574 million for the quarter and delivered adjusted return on attributed common equity at 8.4%. Adjusted pre-tax income decreased by $350 million year-over-year, primarily due to significant market stress in March compared with the strong market recovery we saw in the first quarter of 2019. The main driver of the decrease was lower equity market returns, which primarily resulted in higher variable annuity reserves of $161 million and higher deferred acquisition cost amortization back of $138 million. Also, widening credit spreads generated lower returns from fair value option bonds of $116 million and the low interest rate environment resulted in continued spread compression across our individual and group retirement product lines. Lastly, I am pleased to report that our hedge program performed as expected in response to the market stress experienced in March, generating gains exceeding the movements in our economic view of the liability and related cash collateral. Recognizing the limits of sensitivity, especially in the context of first quarter's market volatility, our sensitivities provided on our last earnings call generally held up. Based on the environment we see today, we continue to expect base spread compression across the whole portfolio of approximately eight to 16 basis points annually. However, wider risk-adjusted credit spreads should generate opportunities to attract new business as profitable margins and the reinvestment of assets slowing off the portfolio should benefit from higher credit spreads. We have updated our estimates of market sensitivities to reflect our balance sheet as of the end of the first quarter. We would expect a plus or minus 1% change in equity market returns to respectively increase or decrease adjusted pretax income by approximately $25 million to $35 million annually and a plus or minus 10 basis point movement in 10-year treasury rates to respectively increase or decrease earnings by approximately $5 million to $15 million annually. These sensitivities assume the immediate impact of market movements on reserves, fact and fair value option securities as well as investment income and other items. It is important to note that these market sensitivity ranges are not exact nor linear since our earnings are also impacted by the timing and degree of movements as well as other factors. Market conditions began to improve in April, but one can expect that should conditions continue to improve, there may be immediate benefits in reserves back for investments in the second quarter although these benefits are likely to be offset slightly by lower private equity returns that are reported on a one quarter lag. Despite the challenging environment COVID-19 created, our balance sheet is strong and we currently estimate our fleet risk-based capital ratio for the first quarter to be between 405% and 415%, including both the impacts of variable annuity reserve and capital reform as well as our hedging program. Our risk-based capital ratio will be sensitive to the impacts from COVID-19 as they flow through our balance sheet throughout the year. Market stress in the first quarter due to COVID-19, while severe in nature did not reach our modeled stress testing scenarios. Although we expect lower levels of overall industry sales for the foreseeable future due to impacts from COVID-19, our leadership position continues to provide us with a unique competitive advantage. We have a broad position across variable index and fixed annuities, term and permanent life insurance, not-for-profit retirement plan markets and institutional markets. We are not dependent on any one product type or distribution channel, which allows us to maintain our long standing disciplined approach with respect to product pricing and future development regardless of the economic environment. Over many years, we have proven our ability to redirect our marketing efforts from one product type to another as market needs and pricing conditions change. We also have a large and diverse in-force portfolio that does not have the significant risks associated with pre-2010 living benefits for long-term care. Our very small block of remaining long-term care business has been reinsured to quarter two. Our strong capital levels and broad market presence position us well to deploy capital as potential attractive opportunities arise in this widening spread environment. Now, I'd like to touch on our operations over the last few months. As Peter noted, we transitioned quickly to a remote working model, with the support of our regulators we're meeting, we successfully adapted our e-signature policies, procedures and controls to support the needs of our plant sponsors, distribution partner firms and individual customers. Also, investments we have made to enhance our digital capabilities have served us well as many more customers are taking advantage of our enhanced self service tools. We've also been very responsive in adopting changes to address the financial hardship faced by some of our customers, such as extending the grace period for premium payments and meeting the requirement of the Cares Act. Our sales and relationship management professionals quickly shifted from face-to-face to virtual meetings and have conducted thousands of such meetings and educational webinars with our producers and customers. Turning to our first quarter financial results. As mentioned, the primary drivers of the decline in Life and Retirement portal adjusted pre-tax income with short-term impacts to our individual and group retirement businesses from significant market movements. As to the top line results are individual retirement, premiums and deposits decreased primarily due to significantly lower fixed annuities fail, as we maintained our pricing discipline as Treasury rates dropped throughout the quarter with credit spreads only beginning to widen late in the period. Our index annuity sales remain strong, but we again grew variable annuity sales. Lower sales of fixed annuities resulted in negative net flows for total individual annuities. For group retirement, premiums and deposits decreased due to lower new group acquisitions, as well as reduced individual product sales driven by the uncertain environment. Net flows improved year-over-year, primarily due to lower group surrenders. In this period of uncertainty, we expect fewer plan sponsors to change providers, which may reduce new group acquisitions, but would support plan retention. For our Life Insurance business, total premiums and deposits increased due to higher international premiums. Our mortality trends continued to be favorable to overall pricing assumptions and the first quarter included a modest IBNR reserve strengthening to reflect the fluidity of COVID-19. Although we may experience some acceleration, we are not expecting large incremental impacts to mortality rates and expect any incremental impacts to be manageable in the context of our overall balance sheet. For institutional markets, we have continued to grow our asset base and earnings, and this business continues to be well-positioned. We remain focused on new opportunities and have the capacity to participate as activity arises in the pension risk transfer and other institutional businesses. To close, despite these challenging times, we remain available to serve our customers, plan sponsors and distribution partners. We are committed to further mobilizing our broad product expertise and distribution footprint to serve our stakeholders in new ways as their needs evolve. We will continue to deploy capital to the most attractive opportunities and focus on meeting ever-growing needs for protection, retirement savings and lifetime income solutions. Now, I will turn it over to Mark."
},
{
"speaker": "Mark Lyons",
"text": "Thank you, Kevin. Before providing summary comments about the first quarter, I'd like to give COVID-19 perspective from where I sit. First, this health crisis, which quickly evolves into an associated financial crisis, is unprecedented in scope, uncertainty and length and depth of economic impact. Additionally, this ongoing event has simultaneously impacted both sides of the balance sheet, thereby nullifying most underlying disruptions that investment assets and insurance liabilities are marginally correlated. As a result, it's extremely difficult to forecast one quarter in advance let alone a full year longer. However, as Brian also noted, I want to reiterate that AIG was strongly financially positioned entering the crisis, both from a parent and subsidiary liquidity and capital perspective and is well positioned today, including our investment portfolio. The evolving situation causes us to view liquidity and capital strength as an imperative. When the crisis suddenly took hold on capital markets in mid-March and not knowing what could come next, we thought it was prudent to augment our already strong current liquidity with a $1.3 billion partial drawdown of our revolving credit facility. We did this solely as a precautionary measure given the significant uncertainty at the time, about the near-term impacts of COVID-19. I will provide an update on our capital management plans and liquidity position later in these remarks after I review our first quarter results. So turning to the first quarter. AIG reported adjusted after-tax operating earnings of $0.11 per diluted share compared to $1.58 per share in the first quarter of 2019. Contained within this result is the continued improvement of General Insurance with a 95.5% accident year 2020 ex-CAT combined ratio as Peter noted. First quarter results reflect direct and indirect impacts related to COVID-19, including the market impact on net investment income and book value, with a lesser impact on core operations APTI. Peter discussed, the General Insurance COVID reserve reflects our best estimate, the losses occurring through March 31. The first quarter, adjusted book value per share increased 2.8% and adjusted tangible book value per share increased 3.2%, both since year-end. It's also notable that AIG's adjusted tangible book value per share increased nearly 11% since March 31, one year ago, which we believe is a better measurement of the improvement in AIG's core operating performance over the last year. Book value and tangible book value per share, both of which include changes in AOCI and the DTA, were virtually flat year-over-year, even with the significant AOCI change we saw in the first quarter of this year. In the first quarter, on an adjusted pre-tax income basis, net investment income, or NII, was $2.7 billion, down approximately $1 billion from the down approximately first quarter of 2019. Recall that the first quarter of 2019 included significant gains following the downturn that occurred in the fourth quarter of 2018 as this year's first quarter experienced significant losses due to the COVID-19 volatility in March, resulting in a distorted quarter-over-quarter comparison. I want to spend some time on our global investment portfolio. Because in the current environment, I think it's important to understand its composition. Several reports have been published that use incorrect assumptions and information about our portfolio. In many cases, our consolidated global portfolio has been compared to U.S. Life or P&C peers or the industry generally, without taking into account our unique position as a global composite or multi-line insurer. In addition, some believe our portfolio has above-average inherent risk, which is simply not the case. Instead, we believe our portfolio is below average in terms of risk and we'll get into some of that. In addition, certain accounting elections AIG took in prior years relating to specific securities have created above the line accounting volatility, which has led to some confusion, but this volatility does not impact AIG on a total return basis. To address these complexities and the many questions and comments we have received, we've provided much more disclosure regarding our portfolio, including the General Insurance, Life and Retirement and Legacy portfolio composition. On pages 46 through 65 in our financial supplement, there you will find a significant expansion of our disclosure beyond segment and into credit quality distribution and asset or industry characteristics. As Brian mentioned, Doug Dachille, our Chief Investment Officer, can help address follow-up questions during Q&A, but I'll give some high-level comments now. At March 31st, AIG had a $332 billion investable asset portfolio. This portfolio is about 73% fixed income available for sale securities, which represents 75% of General Insurance's portfolio and 74% of Life and Retirement. In addition, roughly 14% of the portfolio is invested in mortgage and other loans, 6% in short-term investments, 2.5% in real estate investment, less than 2% in private equity, approximately 1.5% is in fair value option fixed income security or FVO securities and about 0.7% is in hedge funds. It's important to recognize though that roughly 80% of the FVO fixed income portfolio, which historically has had higher volatility than are available to sales fixed maturity securities is held in legacy. Notably, the FVO portfolio makes up only 1.4% of General Insurance's portfolio and 0.3% of Life and Retirement. Our historical FVO accounting election mostly on legacy non-agency RMBS that were previously credit impaired cannot be changed or be changed or modified and move mark-to-market volatility above the line into our income statement within net investment income. For available for sale securities, such volatility would be below the line in AOCI. As a result, this FVO accounting treatment puts more volatility into our income statement by NII with less relative volatility in AOCI, which is where one would ordinarily expect to see the volatility. Financial statement geography is important to note when examining AIG's NII, but it is irrelevant when you look at total return, which is how our investment function manages our portfolio. Over the last four-plus years, and Doug can address this in more detail, AIG has seen significant de-risking of its investment portfolio with material reductions in hedge funds, life settlement, CDOs, and FVO securities, totaling approximately $32 billion, which is a 60% drop in these asset classes since year end 2015. Additionally, AIG's portfolio has only a very small direct equity exposure, representing just 0.2% of the portfolio. The volatility in the equity markets has a minimal impact on our investment income and even that is below the line. On page 63 of the financial supplement, you will also see a significant $9 billion plus credit quality difference and below investment-grade securities between the rating agency view and the NAIC designation view. Most of this is non-agency RMBS on an FVO basis, which we have had evaluated and rated NAIC 1 by the securities valuation office of the NAIC. This is the highest rating category, which is important because these assets strengthen subsidiary RBC levels and can sustain RBC levels even if they fall one notch, because they still will be investment grade. However, rating agencies have not re-rated these securities with current information, so from their perspective, the securities still retains legacy below investment-grade status. When examining our $144 billion of corporate debt, which is summarized on page 56 of the financial supplement and expanded beginning on page 59, note that nearly $130 million is investment grade. And of this total, 15% is rated AA or AAA, 34% is A-rated and 51% is BBB-rated. Compared to the overall investment-grade market, we have a superior distribution of such asset by rating. Similarly, when viewing the entire corporate debt portfolio, 10% is below investment grade, which is much lower than the market average of 48%. I wanted to point this out because given the magnitude of AIG's investment portfolio; some may assume that our portfolio mirrors the industry average, which is not the case. With respect to CECL credit impacts in the first quarter, which are included in realized gains and losses and not NII, we recognized approximately $236 million of credit losses. This stems from about $198 million in fixed income securities and $38 million in loans. Now turning to the operating segment. As Peter and Kevin discuss their financial results in detail, I will just add a few remarks that augment their comments. General Insurance, I'd point out that the $419 million of total CAT reserves for the quarter represents 6.9 loss ratio points with $272 million or 4.5 loss ratio points being attributed to COVID-19 and $147 million or 2.4 loss ratio related to other CAT events, the largest of which was the tornado storm system that hit Nashville in early March. Excluding COVID-19, General Insurance generated $185 million of underwriting income, which includes the non-COVID catalog. Prior year development was minimal in the first quarter with $60 million of net favorable development, $53 million of which emanated from the amortization of the ADC deferred gain. On a pre-ADC basis, there was a net $1 million of favorable development, representing $30 million of unfavorable in North America, mostly from shorter deadlines, largely offset by favorable $31 million from international across many product lines. Lastly, as Peter discussed, Syndicate 2019 will favorably alter AIG's risk profile as concentration risk is distributed across an innovative structure and set of capital providers. We anticipate that in the second quarter and for the balance of the 2020 year, TDS premiums will increase over original expectations, and therefore, net premiums will correspondingly reduce. We project that second quarter net written premium in high net worth will be down approximately $650 million from original expectations and that net earned premiums for the 2020 year were reduced by approximately $675 million as a result. Beginning in 2021, however, the catastrophe cover costs will decrease for AIG since the high net worth exposure subject to the CAT program will be a fraction of what it is today. So for 2020, underwriting income for the high net worth unit, we anticipate approximately the same underwriting result pre and post 2019 and then to become accretive thereafter. Turning to Life and Retirement, I would just add that institutional markets benefited from approximately $700 million pension risk transfer premium in the quarter, albeit down a bit from -- corresponding quarter of last year. Legacy, a $368 million adjusted pretax loss in the first quarter was due to a reduction in NII driven by capital markets volatility we saw in March, which abated, as mentioned, in April. As a reminder, we signed a definitive agreement to sell Fortitude last year with the economic set as of December 31, 2018, which means that all net income subsequent to year-end 2018, up through closing will be included in the gain or sale or loss on sale to be recognized upon the closing of the transaction. We continue on course towards a midyear closing subject to regulatory approval and it is noteworthy that Fortitude also has benefited from strategic hedging transactions that performed as expected, and in fact, health capital ratios remain virtually unchanged since early 2019. Next, moving to other operations, and as I discussed on last quarter's earnings call, you will see on pages 37 to 39 of the financial supplement, a revised and simplified presentation that helps identify key drivers of APTI. Our previous disclosures on this segment could be difficult to understand and volatile, in part due to the gross-up of income and expense for internal items, mostly investment services, which increased other income and GOE. We simplified that and also provided APTI by activity, which should help. As for magnitude, this quarter's $280 million of other operations GOE included the COVID-19 employee grants totaling $30 million that Brian referenced, and remote access IT costs of $3 million. Excluding that, other operations GOE would have only been $247 million. Turning to tax, we had a core 23% tax rate on adjusted pretax income for the first quarter, higher than recent prior quarters due to additional items dominated by a $37 million impact, reflecting share-based compensation differences, plus by grant date versus delivery date of value resulting from spot price declines during the first quarter. Turning to liquidity and capital resources, we believe that liquidity and operating subsidiary capital strength are paramount priority in this uncertain economic environment. At year-end 2019, AIG had $7.5 billion of liquidity at the parent and the RBC fleet ratios for General Insurance's US pool finished 2019 at 419% and for Life and Retirement at 402%. During the first quarter, we repurchased $500 million of our stock and closed $350 million of most advanced. Share repurchases helped to offset share count dilution stemming from equity compensation and the promotion bond call aided our debt leverage ratio. As of March 31, AIG had a similar $7.5 billion of current liquidity, including the $1.3 billion draw from our revolver that I referenced earlier in my remarks as well as strong liquidity in both General Insurance and Life and Retirement. Before turning to AIG 200, there were two below the line items in the first quarter that I would like to highlight: First, the success of our hedging program; and the second would be Blackboard. Turning first to our hedging program, roughly $3.6 billion of variable annuity fair value benefits were reflected during the first quarter within the realized games line as a direct result of successful interest rate and equity risk hedging within the Life and Retirement and legacy segment that clearly preserve book value. It should be noted though that on a GAAP basis, this gain was aided by the NPA, or non-performance adjustment, impact, which is highly volatile and reversible depending upon rates for ebbs and equity markets. Secondly, at the end of March, AIG made a strategic decision to discontinue Blackboard, our internal insured tech startup in light of current market condition. Blackboard's GOE which was $16 million in the quarter, has been historically recorded in other operations, but that we'll cease starting with the second quarter of this year. Associated with this business decision, we recorded an approximate $165 million after-tax charge, not included in APTI. Pivoting to AIG 200, as Peter noted, we continue to refine our operational plans in response to COVID-19. We still expect that this strategic three-year transformation will result in $1.3 billion in costs to achieve an annualized $1 billion of run rate GOE savings by year-end 2022. Let me first just provide a quick review and then I'll give you the AIG 200 three-year walk as well as its impact on the first quarter of 2020. From a reporting perspective, all costs to achieve, aside from $400 million of pre-tax spending that will be capitalized will be recorded below the line, not in APTI, as restructuring and other costs, which will make it straightforward to track. These below the line charges mostly involve employee-related costs, dedicated internal resources and associated professional services. Capitalized costs of $400 million before tax, represent mostly investments in systems, development, interfaces, data conversions and associated integrated workflow processes, which have an impact on cash, but are not expensed immediately in the income statement. Instead, each investment will be capitalized and then amortized through GOE based on its useful life according to accounting principles. Hence, by year-end 2022, we would expect that the amortization portion of the $400 million will be included in our annual expense run rate, where our goal is a total annual run rate savings of $1 billion, including the amortization of these capitalized investments. So let's turn towards what this means for the next three years, acknowledging that in this uncertain world, timing of plans can somewhat change. Under Peter's leadership, we are governing AIG 200 via structured checkpoints and tollgate that control cost, confirm scope and reconfirm scope and drive key milestone achievements. Overall, we expect a total 'cash cost' at the holding company of $1.3 billion. As shown on page eight of the financial results slide, $350 million of this is expected in 2020, although still being reviewed due to COVID-19 impact; $500 million in 2021 and $450 million in 2022. Of these amounts, approximately $100 million in 2020 will be capitalized with later amortization into GOE. The combination of these two result in a below the line projected charge of $250 million before tax. Then in 2021, about $200 million will be capitalized, with a below the line charge of roughly $300 million. And finally, about $100 million will be capitalized to 2022, with a below the line charge of $350 million. Based on our current useful life schedule for depreciation and assumptions about when we expect the $400 million in capitalized assets to be placed into service, calendar year depreciation included in GOE should be zero in 2020, as the project will still be in development; rising in 2021 to be between $10 million to $15 million before tax; and $25 million to $30 million in 2022. Based on projected completion by year-end 2022, the unamortized balance of about $350 million will be amortized at about a seven-year average life, with $50 million per year in 2023 through 2027 and then trailing off a bit from there. Finally, in the first quarter of 2020, we had a $90 million restructuring charge below the line, of which about $23 million related to AIG 200 and the balance from other actions. Going forward, restructuring charges will primarily reflect AIG 200 costs. Relative to expense savings, this quarter had $10 million of GOE savings, which will translate to $60 million on an annualized run rate basis, which is part of the $300 million plan run rate benefit by year-end 2020. Now shifting to capital management and looking ahead, in light of the significant uncertainty on many fronts due to COVID-19, we do not plan to do additional share repurchases or debt reduction actions for the foreseeable future, but we will reassess this as COVID-19 impact stabilize. However, given improved stability in and access to the capital markets since March, we are reevaluating our debt and capital plan. While reducing debt leverage to 25% or below is a minimum term goal, in the near term, our priority is maintaining strong operating capitalization, financial flexibility and liquidity. As a result, we are considering options to generate additional near-term liquidity in light of ongoing economic volatility as well as upcoming debt maturities in 2020 and in the medium term. Although spreads have widened since year-end, all-in coupons are attractive. Given the significant uncertainty around the duration and depth of global recession created by COVID-19, as well as taking into account our global operating footprint and different regulatory capital regimes, we think it is prudent to evaluate debt capital market opportunities in the near term rather than waiting until later in the year, which was our original plan prior to COVID-19. Lastly, and reflecting back, the first quarter benefited in the first two months from strong momentum in GI pricing, investment return and operating initiatives. In March, COVID-19 spread incredibly fast and dramatically changed everyone's everyday world. AIG entered this crisis from a position of strength while it has certainly impacted us and caused us to recalibrate some of our plans. AIG is more resilient than it has ever been with strong leadership and greater portfolio and risk management across the organization. We are confident in our ability to weather this storm and look forward to being able to engage with you again in person, hopefully, in the near term. With that, I will turn it back to Brian."
},
{
"speaker": "Brian Duperreault",
"text": "Thanks, Mark. Abby, I think we're ready for the Q&A portion. So please get us started and let us move first."
},
{
"speaker": "Operator",
"text": "Thank you. And we will take our first question from Elyse Greenspan with Wells Fargo. Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "Thanks. Good morning. My first question, in your prepared remarks, you guys mentioned that a small fraction of your commercial property policies contain coverage for infectious diseases and that those policies do have small sub-units. I'm just trying to get a sense of those policies where you think you could see losses have you set up reserves within your COVID losses in the first quarter?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Elyse, I think that's a question for Peter. Peter, would you take that, please?"
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. Sure, Brian. Hi, Elyse, let me just give you a little bit more detail. Yes, we did go through it very thoroughly in the first quarter, as I outlined our process that we did bottom-up and top-down but when you look at the size and scope of our global portfolio, the nature of our clients in terms of the segmentation, we do have commercial property policy that have some manuscript warnings. As I said in my opening remarks, the overwhelming majority of the standard commercial property policies do contain clear exclusions for viruses, and it's fairly standard in the industry. These policies also require that there's direct physical loss or damage that impact the insurance business operations. As to these policies, COVID is not covered. So that's point one. There are limited instances where we do write affirmative coverage for communicable diseases. But even in those cases, it's only on a supplemented basis, and in pursuant, we have very strict underwriting guidelines that often result in coverage for only specified diseases. And in an event that there's a requirement that there would also be a government closure caused by physical presence of the disease itself. So again, it's fairly clear. And just to give you some context in terms of what I'm talking about is that 100% of our sub-limits aggregate to well less than 1% of our total limits in our commercial property policy. So it's a very small portion of the overall property exposure. And I would just note that I mentioned in my prepared remarks, we have really comprehensive reinsurance, whether it's on a property per risk basis, we have low attachment points on a per occurrence basis that's regional, and we also have global aggregates that attach to reduced volatility on a frequency severity basis. So sorry for the long answer, but I think it's important to get into the detail."
},
{
"speaker": "Brian Duperreault",
"text": "Thank you, Peter. Next question"
},
{
"speaker": "Operator",
"text": "We will take our next question from Tom Gallagher with Evercore."
},
{
"speaker": "Tom Gallagher",
"text": "Good morning. Mark, you mentioned your plan on running with higher debt for the time being, which I think that makes sense given the current environment. Have you gotten any sense from the rating agencies on their reaction to the higher leverage for now? And then just a follow-up question on the investment portfolio. Appreciate all the disclosure there. The $18 billion of other invested assets, it looks like $6.7 billion of that is in legacy. Would you expect most of that to be transferred with the Fortitude resale? And then sorry for the string here. But then just one related question, the $8.5 billion of real estate alternative investments, should we expect there to be any kind of impairment on that in 2Q, or is there some buffer with historical cost accounting there?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay, Tom. Listen, why don't we have Mark, you wanted to talk about the debt. And then I'm going to ask Doug to take over on the investment portfolio question. So Mark, why don't you go first?"
},
{
"speaker": "Mark Lyons",
"text": "Thank you, Brian, and I will do that as well. With regards to debt, yes, we've spoken to the rating agencies. In fact, we were in conversation with them on the revolver drawdown, as a matter of fact, and had very good strong and supportive conversations with them. And in the future, we may contemplate, of course, we be involve in discussions with them as well. With that, I will turn it over to Doug to talk about this to investment questions."
},
{
"speaker": "Doug Dachille",
"text": "Thank you, Mark and good morning. Well, I would refer you to page 49 of the financial supplement, which basically goes through the legacy segment and the assets that are held in that segment in pretty robust detail. And as you know, in addition, there's approximately $40 billion of assets, which we also disclosed in our financials, which are going to be part of the sale related to Fortitude. The portions that we’ll be retaining, there will be some real estate investments that we'll be retaining that are part of legacy. There will also be some fair value option bonds that will be retained in legacy that were part of the old financial products direct investment book. So those will not be part of the sale transaction. But the material amount of the assets will be, as you know – over $40 billion will be separating as part of the sale of Fortitude. With respect of the real estate, you -- as you know, we only experienced a rapid acceleration in the month of March with respect to the development and emergence of the COVID situation. So we're still in the midst of analyzing the impact. And I think it's very early to determine what the impact will be on our real estate portfolio. But it should be noted that our real estate portfolio is diverse. It includes both domestic and international exposures. So the impact we'll learn more as things go on. I think where we're learning the most about our real estate is obviously on the commercial mortgage loan side. So that's where we're getting some real insight into what's going on in the real estate market. And those teams, the commercial mortgage loan team work very, very closely with the real estate equity team at AIG. And all of those investments are managed directly. So we have great level sight – of line of sight to what's going on in that market, but it's still really early to determine what's going to happen."
},
{
"speaker": "Brian Duperreault",
"text": "Okay, thanks Doug. So, why don’t we get the next question then."
},
{
"speaker": "Operator",
"text": "We will take our next question from Yaron Kinar with Goldman Sachs."
},
{
"speaker": "Yaron Kinar",
"text": "Hi, good morning everybody and thanks for the very helpful opening comments. I just want to start with one question on the removal of the 2021 exit rate return guidance. Just want to make sure I understand what it does and what it does not mean? Does it mean from your perspective that you could see the COVID impact linger or continue well into 2021?"
},
{
"speaker": "Doug Dachille",
"text": "Well, let me take that. Who knows? I mean, you don't know whether COVID will reemerge, if it does go down an impact in 2020. It's really a question of how much predictability is there to quarterly earnings. And it's difficult to predict quarters. So if you can't predict the quarter, I don't want to try to predict a year or several years. I think it's important to note, though, that the underlying power of the company remains. We're very, very strong in the GI. GI has continued to show improvement. Good work that has been done over the last 3 years, what Peter and his team have continued on. So the returns that we were talking about, I believe, if you – certainly, if you pick the COVID out for a second, are going to continue to improve. And so that trajectory we're on is, we're still on. Now you have a COVID event, and I think the COVID event certainly would impact L&R on a short-term basis. But again, we think the long-term power of the company is there. So COVID itself, it will be large. I told you that I believe it will be the largest event in the insurance industry, but it is -- it's an inflection point. And that effect that we'll see -- we've already been in a market on the GI side, General Insurance, P&C side that was turning. It was improving. And the rates in terms and conditions were improving for the risk taker. This COVID is going to prove to be an inflection point. So, companies with strong balance sheet, we have one; companies with strong management, we have one; companies that has been well risk managed, and we've done that now, they're going to be on the right side of that. And so we believe we can handle anything that comes with COVID and we feel very strong. But predicting quarter-to-quarter is just impossible. So, I hope that helps."
},
{
"speaker": "Yaron Kinar",
"text": "Yes, it does."
},
{
"speaker": "Brian Duperreault",
"text": "Next question."
},
{
"speaker": "Yaron Kinar",
"text": "So, my follow-up question on that is when you talk about COVID being the largest catastrophe event in the industry's history. Can you maybe talk about what P&C lines in particular you would foresee having very large losses here? And maybe also the proportion of losses that you'd expect coming from L&R, maybe not directly COVID-related, but from capital markets activity?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, I'm going to have Peter talk about what we see in the P&C side, and then I'll let Kevin talk about L&R. So, Peter, do you want to talk about that first?"
},
{
"speaker": "Peter Zaffino",
"text": "Sure. Thank you, Brian. We mentioned quite a few lines when we were referring to the first quarter, whether it's travel, M&A, A&H, some other lines to think about that could have activity, workers' compensation. We don't know about D&O liability. We have been watching it very carefully and making certain that we're looking at any line that we think could have an impact. But what I can tell you to add to Brian's comments before, is that we have a very thorough process and we'll be consistent all the way through. We know the CAT is still ongoing, which is a very rare. So, as things emerge and develop, we will adapt to that. And we're looking at this across every global geography where we think there's impact and multiple lines of business. But because the CAT is still going, we even have two months left in the quarter. It's hard to see what transpire in the future. But as I said, we have a great process, and we will keep everybody have a great process, and we will keep everybody updated on lines of business as they emerge."
},
{
"speaker": "Brian Duperreault",
"text": "Kevin, on L&R?"
},
{
"speaker": "Kevin Hogan",
"text": "Yes. Thanks. So, I'll address it really in 3 pieces, mortalities of the markets and then maybe just a reminder around pricing. So, our reported mortality in the first quarter was below pricing, which continues the trend that we've had for the last two-plus years. But later in the period, what we did notice is that there were some delays in reporting, generally related the issuance of certain documentations. So, we put up the modest IBNR really for just running reporting. As we look ahead, we do expect that there will be additional mortality in the second and the third quarter, depending upon how circumstances and behaviors evolve. So, where does that leave us? We expect some expect some adverse mortality overall for 2020, but we don't expect to see significant impacts to the balance sheet based on what we know, and there could be some offsetting factors. In terms of the market effects, look, there's two things. I mean, when equity markets move, particularly when they go down, that ultimately reduces our future expected fee income, particularly in the annuities portfolio, which we have to reflect immediately and back. The reality is, is that the reduced reserve overall actually emerges as additional profits in the future. It also serves to increase our SOP all 3 1 reserves, and when changes in credit spreads, we see the immediate impact on fair value options. So those two short-term market effects are reversible. And that leads to the third thing, which is pricing and how do we feel about current pricing. And certainly, treasury rates are at all-time lows, but our ability to price product is to pace -- is based not only on where base rates are. But also where credit spreads, what is the shape of the yield curve and where investor expectations and appetites are. And so based on the power environment, we're still able to price the long-term expectations that we have. Certainly, there's disruptions in the sales environment, but it's difficult to anticipate what the future on that is going to be and how it resolves. So those are the three perspectives I have on the long-term earnings potential of the Life and Retirement environment."
},
{
"speaker": "Brian Duperreault",
"text": "And one thing I'd just like to add there, Yaron, Peter's comments about certain lines of business, he mentioned workers' comp. I think it's important to remember that AIG has de-risked that workers' compensation business significantly, probably over the last 7, 8 years. And where AIG finds itself now is mostly in loss sensitive related programs, which have average deductibles north of $1 million. So when you think about debt in the work comp area, that's statutorily determined by state, that's going to be underneath a deductible, standard medical and temporary, all that falls away. It has to be a major permanent parcel to really penetrate it. So I think the book is well positioned given what we're talking about here."
},
{
"speaker": "Kevin Hogan",
"text": "Yes. And just one other piece on the comp, and Peter mentioned this earlier, but, yes, there are COVID claims coming in, but I think you have to recognize that there's been a decline in a number of claims coming in otherwise. So it remains to be seen what the net effect of COVID has on the worker concept. So that's something to keep an eye on. With that, Abby, let’s go to the next question."
},
{
"speaker": "Operator",
"text": "We will take our next question from Michael Phillips with Morgan Stanley."
},
{
"speaker": "Michael Phillips",
"text": "Thank you. Good morning. I want to touch on comments on expected, continued underwriting core profitability in General Insurance and maybe how you think about the near-term impact of exposure drops given your economy and how that might affect the profitability improvement plan for the remainder of this year?"
},
{
"speaker": "Kevin Hogan",
"text": "Okay. Michael, well, that's Peter. So Peter, why don't you do that?"
},
{
"speaker": "Peter Zaffino",
"text": "Okay. Thank you for the question. We certainly are paying very close attention to lines of business that would be affected by the economic headwinds that are generated from COVID-19. I mentioned some of them in the prior question in areas where we're watching for loss, but I would think that there's going to be a meaningful falloff of travel in the second quarter. M&A could be some fall off in aerospace, marine and energy, and we mentioned workers' compensation. Having said all that is that you got to remember the segmentation and demographic of our portfolio, I mean, over 75% of our businesses on some form of either deductible SIR or funded captive. And so we don't have a direct correlation, even though it is rated off of a payroll, sales, auto is done on an excess basis. And therefore, we do not think we will have as much headwind in terms of premium reduction. There will be some, but it will be more modest because it's not a direct ratable exposure that generates the premium. We have different factors in terms of how we adjust excess premium. So we just don't think it's going to be as pronounced. Brian mentioned on workers' compensation, the decrease in frequency. It's not a trend yet, but it's an observation that, while COVID losses are increasing, we're seeing a commensurate drop in where our clients are retaining losses that those are dropping. So as we look at repositioning our portfolio, where we attach on an excess basis and the commensurate premium as I said, there's going to be some lines of business that will affect. We there's opportunities for other areas of growth. As we have repositioned the portfolio, we like where we are, and think that the leadership position that AIG can demonstrate in the marketplace will give us also some select opportunities for growth."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks. Michael, anything else?"
},
{
"speaker": "Michael Phillips",
"text": "No. That’s it. Thank you, Peter. Appreciate it."
},
{
"speaker": "Peter Zaffino",
"text": "Okay. Thanks, Michael, Abby, next question."
},
{
"speaker": "Operator",
"text": "We will take our next question from Paul Newsome with Piper Sandler."
},
{
"speaker": "Paul Newsome",
"text": "Good morning. Thanks for the call everyone. I'm a little concerned that the loss with the – the big CAT loss that you have from Totalbank seems more of a liability loss than a property loss. Could you talk about how the reinsurance could protect you in liability-type catastrophe versus property. I think we all feel is excess loss properties, but I can't recall liability to cash is simple size. So I don't know with regard to in terms of coverage ?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay. So Paul, you want us to talk about in a COVID versus our reinsurance program?"
},
{
"speaker": "Paul Newsome",
"text": "Yes. If COVID was a liability loss instead of a property loss?"
},
{
"speaker": "Brian Duperreault",
"text": "Yes. Okay. Well, Peter, I guess, that's you again."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Brian and Paul. So I outlined our property program and said that we had reduced volatility significantly. On the liability side, I think we've done actually even more. We used to retain significant limits within AIG and so we've been building a program over time that significantly reduce the net limits that we put out as well as the gross limits. And also we did that on an excess of loss basis and also on a quota share. So on a general liability policy, as an example, we would have less than probably, depending on the limit, we have a 50% plus quota share on our first limit retention that we have 100% reinsurance above $25 million. So we have – if you issue a policy, a significant sized policy, the multi have net is between $10 million and $12 million. So we actually have significant protection on the quota share as well as the excess of loss."
},
{
"speaker": "Brian Duperreault",
"text": "So Paul, let me just jump in. Look, our reinsurance is good and solid, and Peter has done a tremendous job along with his team to put that together. Our first-line of defense is the way we manage our portfolio to start with. And so you can't rely on reinsurance to make a portfolio better than it is. o we've done a tremendous amount of work, risk selection, limits management, attachment points and pricing along all the lines of business property and casualty and that's where we feel very confident about our situation vis-à-vis the impact that COVID will – as those impacts unfold. So I just want to add that. So Paul, did you have another – anything else?"
},
{
"speaker": "Paul Newsome",
"text": "No. That’s it for me. Thanks for the answer and thank you very much."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. You’re welcome, Paul. Thank you. Next question, Abby?"
},
{
"speaker": "Operator",
"text": "Our next question is from Ryan Tunis with Autonomous Research."
},
{
"speaker": "Ryan Tunis",
"text": "Hey, thanks. Good morning. I just wanted to confirm some of that, I guess, Peter said earlier in the Q&A. Yes. There's affirmative BI coverage for 1% of total property limit. But sounds like that could be somewhat of a big notional number that you might get, roughly?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, I said one. Peter, go ahead."
},
{
"speaker": "Kevin Hogan",
"text": "Peter, go ahead."
},
{
"speaker": "Peter Zaffino",
"text": "Sorry, Ryan. What I said was, not that that was a permanent coverage and those sublimits would trigger coverage. What I said is that the limits that we provided on the affirmative, which have, again, a bunch of triggers that I outlined in my previous answer that we have well less than 1% of our total limits when you compare that to our property gross limits. So, again, it's well less than 1%. And I'm not suggesting that we confirm that there is coverage or that we are adjudicating claims on that amount. It's just that, that's what we have for limits, and then it goes case-by-case, insured-by-insured in terms of what the losses."
},
{
"speaker": "Brian Duperreault",
"text": "Yes. Ryan, let me just add something here. And that is, Peter talked about that process of evaluating the losses occurring in the first quarter. I've been in this business a long time, 40-plus years. And I've seen a lot of things come and go. I've seen difficulties in trying to assess loss. I have to tell you the process that they – that we went through, that they went through, we went through, it's as good as anything I've ever seen. They have gone through every bit of the portfolio. They looked at everything where there was a potential and evaluated whether there would be reason to post the reserve, if it was, it was done. So we have posted the reserve that we believe are appropriate, albeit conservative for that, everything that happened in the first quarter. I just want to make sure that everybody understands that, everything that happened there."
},
{
"speaker": "Ryan Tunis",
"text": "Yes, yes. So could you just talk a little bit about how you're seeing business interruption, losses might respond within the Validus book? And also, just the $272 million net loss number, what does that look like on a growth basis of reinsurance? Thanks."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Well, Peter, that's you again."
},
{
"speaker": "Peter Zaffino",
"text": "Okay. With Validus Re, we've gone seat-by-seat and have taken a look at our gross net exposures and put up what we thought was the best estimate based on, again, the same process that we outlined for the core of AIG in the first quarter. In terms of the net growth, I mean, look, there's some reinsurance. I'm not going to go into great detail in terms of what the net is versus the growth is, still an evolving loss as we outlined with meaningful IBNR. But again, I've outlined what I thought were the reinsurance structures that could apply in the event that the loss were to grow over time."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Thanks, Ryan. Abby, let’s go to the next question."
},
{
"speaker": "Operator",
"text": "We will take our next question from Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "Thanks. This is soft of a related question, but it seems to be top of mind for a lot of investors. How should we think about commercial property where there is no little bit of coverage, but no virus exclusion, given some apparent court decision saying that non circle damage would qualify?"
},
{
"speaker": "Brian Duperreault",
"text": "Well, it's a technical question, Peter, can you do this?"
},
{
"speaker": "Peter Zaffino",
"text": "Hey Meyer. It's a really hard question to answer because it's, hypothetical. The only thing I can really do is comment on the policies that we have and where we think, again, I outlined demographics of it and think that the exclusions that we have and where we granted affirmative coverage, it's very specific. And so, it's hard to answer that because I don't think it really applies to our portfolio."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That's fair, unrelated question. I guess, I would have expected maybe better results in international personal lines, assuming, an international shelter in place order. Am I missing something there?"
},
{
"speaker": "Brian Duperreault",
"text": "International personal lines, Peter?"
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. What, what happened in international personal lines? It's not an anomaly, but we basically had a runoff program, that impacted we still had earned premium, so it was put into runoff in 2018 that earned premium in 2019 and as you've been doing the re underwriting of the portfolio, again not as much as we did on the commercial. We've just lost a little bit of premium. And so, the ratios, look like they perhaps are not going in the right direction, but the absolute performance is very strong. We like the personal book very much and think that there's some real discrete opportunities for growth, particularly in A&H and an areas across, all of international an accident held them new digital platform we're putting in. So I wouldn't read into that in terms of a trend is just, the impact of a runoff of business. Meyer."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Thanks."
},
{
"speaker": "Brian Duperreault",
"text": "Thanks Peter. Thanks Meyer. Let's go to the next question. I think"
},
{
"speaker": "Operator",
"text": "Our next question is from Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"text": "Yeah, thanks. So, Brian, I'll have this one for you. We're going to Peter on it. Given the impact you've seen of COVID-19 on the general church business as well as the life insurance businesses, I'm wondering if you're at all rethinking the strategic rationale of actually having both the lights in the TMT operation in the same company?"
},
{
"speaker": "Peter Zaffino",
"text": "Well, Brian, I guess, you know, my job is to continually always think about, the structure that we have. Does it make sense? Would we be better in a different structure? And so that's, that thinking continues, I think at this point. We're comfortable with where we are, but I -- that's my job is to continue to do that. So we'll continue to keep looking at that. There were reasons why these two belong together and those two are still there. But we, I'll always think about that, but there is nothing that I would talk about. Right now I think we're comfortable with it."
},
{
"speaker": "Brian Duperreault",
"text": "Any other question, Brian?"
},
{
"speaker": "Brian Meredith",
"text": "Yeah, this is just one of the quick one here. I'm just thinking about it. So given us the largest cash loss coverage, each inch industry probably ever, if I kind of think back, AIG with -- had well over $2 billion of losses, are we talking about it potential last year? There's going to be well north of a $1 billion for you guys. Ultimately, at the end of the day, if this is truly the largest cash we lost ever?"
},
{
"speaker": "Peter Zaffino",
"text": "Well, I look at it, we're not the company we were Brian. We're not the company then, there's been a complete, change and we look at the risk, the de-risking that we've done, the limits management, the improved reinsurance profiles all lead us -- put us in a position where we are much stronger and able to withstand an event. And so I point out that this is the largest event because I want people to understand that it's creating an inflection point in the industry. But there are going to be some who do well in this process and some that won't. We're in -- we believe we will do well through this event and that we're going to emerge stronger and more in demand than we were before."
},
{
"speaker": "Q – Brian Meredith",
"text": "Makes sense. Thank you."
},
{
"speaker": "Brian Duperreault",
"text": "You are welcome. Abby, next question."
},
{
"speaker": "Operator",
"text": "We will take our next question from Andrew Kligerman with Credit Suisse."
},
{
"speaker": "Andrew Kligerman",
"text": "Hey, good morning. Thank you for taking my question. On the life insurance side, I'm wondering if you could give a bit more of sensitivity in terms of the COVID-19 exposure, what you might expect during the course of the year. And then with regard to variable annuity hedging that was very strong. What was your hedging expensive numbers for the variable annuity? And lastly, just in terms of the press release and what you said on the call, you talked about maintaining the return on equity profile for the life business, what might that profile be? I mean could you kind of drill in where you think a good range for all the Life and Retirement could be?"
},
{
"speaker": "Brian Duperreault",
"text": "Okay, Andrew, thanks. So I'm going to have Kevin, obviously, talk about the sensitivity around COVID-19 and the hedging program. And the hedging program, I think, Kevin, why don't you do the piece about the variable annuity, but I would like Doug to jump in on the -- what happened with Fortitude as well. So Kevin, why don't you start?"
},
{
"speaker": "Kevin Hogan",
"text": "Yes. Thanks, Brian. Thanks, Andrew. So look, I guess I'll address that from a couple of perspectives. I covered the market impacts, the short-term market impacts. So I'm not sure I need to go back to that. But I mean, clearly, when equity markets move, it impacts the SOP in the DAC and when the fair values move, that impacts the fair value options. Those will never -- I'm sorry, Andrew?"
},
{
"speaker": "Andrew Kligerman",
"text": "Yes. I apologize. I needed to be clear, I mean quickly the mortality. What would series…"
},
{
"speaker": "Kevin Hogan",
"text": "Mortality. So it’s very straightforward that in the first quarter, we saw mortality better than pricing. We believe there are delays in the reporting of those claims. As we look at second quarter and third quarter based on where the current estimates are, this is well within our first level modeled stress scenario. We don't expect any significant impact on the balance sheet. And there's also -- it's difficult to project how people are going to behave, how people are going to respond. So that's about the best that we can do. It's just based on where we believe our market presence and geographical presence are versus the current expected losses. In terms of hedging, what I would say is, first of all, you can only hedge what you have. And so the liability profile that we have is a big part of the success of our hedging program because we have primarily de-risked benefits, sold well after the VA arms race of the mid-2000s. And so that includes our feature of requiring fixed income allocation, volatility control funds, et cetera. We've hedged all hedgeable market risks. We've left an open position relative to credit spread, because we believe that that is a natural hedge against our general account portfolio. Over time, our hedge effectiveness is around 90%, and it's continued to perform almost exactly as we expected in the various market dynamics, resulting in I think the results, the good results were reported for the quarter. But I'm going to pass on to Doug because another feature of our hedging success in the first quarter was also in the Fortitude portfolio."
},
{
"speaker": "Doug Dachille",
"text": "All right. Thank you, Kevin. So I just wanted to comment on the fact that what you don't really see in the financials is with respect to the legacy segment, you're seeing all the mark-to-market impact particularly of the fair value option securities that are in legacy and to some extent, in Fortitude. What you don't see is the fact that we had established interest rate and credit hedges, which all that P&L and effect goes through realized capital gains and losses. So you don't really see the net effect. But the best way to look at how that – how the entity performed and how those hedges are formed and how effective they were is as Mark made in his prepared remarks, he said that the regulatory capital ratios for the entity were preserved from over a year ago. So that gives you a sense of how effective our hedging strategy was for things that you're not necessarily seeing when you look at the mark-to-market volatility that is reported in our financial statement in the APTI. So, thank you."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Thanks, Doug. And Abby, I think we're running a little long, but why don't we take one last question?"
},
{
"speaker": "Operator",
"text": "Yes. Our next question will be from Scott Frost with State Street Global Advisors."
},
{
"speaker": "Scott Frost",
"text": "Thank you for taking my question. You said you expect COVID to be the largest single P&C event industry's ever seen. Could you give us some background on what the basis is with this assessment, specifically the length of shutdown you're assuming here? And what are your thoughts on the Willis piece released Friday, and over how many years do you expect claims to develop and be paid? I'm assuming multiyear payment profile, but if I'm wrong, please correct me."
},
{
"speaker": "Brian Duperreault",
"text": "Okay. Well, let me start with that and then Peter can add from it. But in terms -- just in terms of the payments, these particularly business interruption claims are very long in process and payments. So I think we're just I think we just cleaned up the last business interruption from Superstorm Sandy to give you some idea. So anyway, but in terms of the estimate, I mean, we've seen a lot of different estimates, and I think they run the range, but the first thing you have to understand is this is global in nature. This pandemic is affected every corner of the world. It isn't that hard to come up with a reasonable assumption around the effects because we're seeing effects in Europe, we're seeing effects in Japan. We're seeing effects in Latin America, and of course, here in North America. So whether it's the effects of comp that we talked about or it's the business interruption, we've seen travel and event cancellations and on and on and on, it doesn't take much to figure out how this is spread across the globe. The question for us is, what's our position on all those things and we feel very, very comfortable with how we've managed this risk in general and how we're well-positioned for COVID. Peter, do you want to add anything to that?"
},
{
"speaker": "Peter Zaffino",
"text": "Not much. The only thing I would just add is what you said. We've seen a lot of very good written documents that have come out. But just because of the ongoing nature of the event and the complexity of the different lines of business, it's the wide range of scale in terms of the low end of the high end is about as wide as you'll see in terms of predicting cash. So, it's very hard to pinpoint anything or the level of accuracy until this evolves over time."
},
{
"speaker": "Scott Frost",
"text": "Well then how can we say that it's going to be the largest event we've ever seen when there's a wide range, I mean, again, you're saying that's going to exceed Katrina? So, on the basis of that, what -- I mean, again, what are we saying? I mean, the world supports a length of shutdown is really the determining factor. They're saying a year its $80 billion. When you say it's greater than Katrina, is that the basis of your statement or can it be less than -- I mean, what I'm trying to get at is, how are you getting to that statement?"
},
{
"speaker": "Brian Duperreault",
"text": "Peter?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. I mean -- so looking at -- I mean, let's get off the Willis is that we've done a ground-up analysis based on what we think can be an industry loss with a lot of assumptions, again, let's get off the Willis is that we've done a ground-up analysis based on what we think can be an industry loss with a lot of assumptions, again, length of time, severity, geographic spread and have done it across multiple lines of business. And length of time, severity, geographic spread and have done it across multiple lines of business. And again, we're not in the business of putting out ranges as to what is going to happen to the industry because we look at our own portfolio. But when we look at market share of different lines of business, we came up with an estimate that exceeded Katrina. And I think that was the basis of Brian's statement."
},
{
"speaker": "Scott Frost",
"text": "Okay. It would be helpful if you told us some of the assumptions behind that, so I'm driving that. Thank you. I appreciate the comments."
},
{
"speaker": "Brian Duperreault",
"text": "Well, thank you very much. Like I said, we've gone past our time. So, I want to wrap this up. And so first of all, I want to thank everyone again for joining us today. And I also want to thank our clients and distribution partners, our shareholders, other stakeholders. We're all in this together and we will get through this challenging time together. Most importantly, finally, I want to thank our colleagues around the world. Guys you've exceeded my expectations and I could not be prouder of what we've accomplished together over the last few months. So, everyone, please be safe and be healthy and thank you again. Goodbye."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes today's call and we thank you for your participation. You may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 4 | 2,021 | 2022-02-17 08:30:00 | Operator: Good day, and welcome to AIG's Fourth Quarter 2021 Financial Results Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thank you very much, Katie. Today's remarks may contain forward-looking statements, including comments relating to company performance, strategic priorities, including AIG's pursuit of a separation of its Life and Retirement business, business mix and market conditions. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially. Factors that could cause results to differ include the factors described in our third quarter 2021 report on Form 10-Q and our 2020 annual report on Form 10-K and other recent filings made with the SEC. AIG is under -- is not under any obligation and expressly disclaims any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.
Additionally, some remarks may refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at www.aig.com.
With that, I would now like to turn the call over to our Chairman and CEO of AIG, Peter Zaffino.
Peter Zaffino;President, CEO, Global COO & Director: Good morning, and thank you for joining us. Following my prepared remarks, Mark will provide more detail on our financial results and other relevant updates to close out 2021. Shane Fitzsimons, who became AIG's CFO on January 1, will be available for Q&A, along with David McElroy and Kevin Hogan.
Today, I will cover 4 topics: First, an overview of General Insurance's fourth quarter and full year performance, where we continue to drive meaningful underwriting profitability improvement. I will also briefly touch on the 1/1 reinsurance renewal season. Second, I will review results from our Life and Retirement business, which continues to be a meaningful contributor to our overall results. Third, I will provide an update on our progress towards an IPO of Life and Retirement and operational separation of the business from AIG. And fourth, I will review our current plans regarding capital management.
Before turning to those topics, I want to take a few minutes to highlight some noteworthy achievements in 2021, which were significant for AIG. 2021 was a pivotal year and one in which our team executed on several strategic priorities. As you saw in our earnings release, adjusted after-tax income in 2021 was $5.12 per diluted share, representing a substantial increase of more than 100% year-over-year. We produced strong liquidity throughout 2021, which provided flexibility and allowed us to return $3.7 billion to shareholders through share repurchases and dividends. We also repurchased $4 billion of debt, which reduced our debt leverage by 380 basis points to 24.6%. Notwithstanding these actions, we ended 2021 with $10.7 billion in parent liquidity.
As I said on prior calls, the path we've taken to improve AIG and our portfolio in General Insurance, in particular, with a significant undertaking. In General Insurance, given the portfolio we started with in 2018, we needed to make fundamental changes. We quickly overhauled our underwriting standards and developed a culture of underwriting excellence, including significantly reducing gross limits.
To give you a sense for the magnitude of what we needed to do, we reduced gross limits by over $1 trillion in our Property, Specialty and Casualty businesses. In addition, we took a conservative approach to volatility by reducing net limits and exposure through strategic implementation of reinsurance. As a result of this strategy, since 2018 and through 2021, we've been able to grow net premiums written in Commercial by over $3 billion, while ceding an additional $2 billion of reinsurance premium to further reduce volatility and protect the balance sheet. At the same time, we improved the combined ratio, excluding CATs, by 1,000 basis points. Simply put, today, we have a different portfolio with a markedly different risk profile, which we believe is significantly stronger by all measures.
Turning to Life Retirement. We again had solid and consistent results throughout 2021, benefiting from product diversity within the business. Return on adjusted segment common equity was 14.2% for the full year. Throughout 2021, we also made tremendous progress on the separation of Life Retirement from AIG. We're executing on multiple work streams to operationally separate the business, and we closed on the sale of 9.9% equity stake and transferred $50 billion of assets under management to Blackstone.
Additionally, we achieved significant milestones at AIG 200 and remain on track to deliver $1 billion in run rate savings by the end of 2022 against the spend of $1.3 billion. I could not be prouder of what the team has accomplished. While we still have plenty of work ahead of us, it would be remiss of me not to recognize these accomplishments and the significant momentum we have heading into 2022.
Now let me turn to our business results in General Insurance for the fourth quarter of 2021. Mark is going to go into more detail, but we had a terrific quarter to close out the year. In the fourth quarter, General Insurance net premiums written increased 8% overall on an FX-adjusted basis with another strong quarter of 13% growth in Commercial, which was tempered somewhat by a slight contraction in Personal with a 1% reduction in net premiums written. The growth in Commercial lines was balanced with 11% in North America and 16% in International.
Personal Lines' net premium growth contracted by 1% in the quarter due to a 5% reduction in International, driven by our repositioning of the Personal Property portfolio in Japan, offset by 17% growth in North America, which largely reflects less year-over-year ceded reinsurance.
Looking at fourth quarter profitability. I'm very pleased with the accident year combined ratio ex CATs, which improved 310 basis points year-over-year to 89.8%, the first sub-90% quarterly result since the financial crisis. This improvement was driven by Commercial, which achieved an accident year combined ratio ex CATs of 87.9%, a 380 basis point improvement year-over-year and the third consecutive quarter below 90%. Personal reported 130 basis points of improvement in the accident year combined ratio ex CATs to 94.3%.
Pivoting to the full year 2021. We made enormous progress in improving the quality of the underwriting portfolio and driving growth throughout the year. Net premiums written grew 11% on an FX-adjusted basis, driven by Global Commercial growth of 16%. Growth in Commercial was particularly strong in both North America at 18% and International at 13%. We had very strong retention in our in-force portfolio with North America improving by 300 basis points and International improving by 500 basis points for the full year. Gross new business in Global Commercial grew 27% year-over-year to over $4 billion with 24% growth in International and 30% in North America.
Turning to rate. Overall, Global Commercial saw increases of 13%, and strong momentum continued in many lines. In Global Personal, we had some growth challenges in this segment, but Accident & Health performed very well, and overall, we had a solid year with net premiums written up 1% on an FX-adjusted basis. These results also reflect less reinsurance cessions in our high net worth business and some growth in Warranty.
Turning to underwriting profitability for full year 2021. General Insurance's accident year combined ratio ex CATs was 91%, an improvement of 310 basis points year-over-year. The full year saw 140 basis point improvement in the accident year loss ratio ex CATs and 170 basis point improvement in the expense ratio, split evenly between the GOE ratio and the acquisition ratio. These positive results were driven by our improved portfolio mix, net earned premium growth, achieving rate in excess of loss cost trends, continued expense discipline and the benefits we are receiving from AIG 200.
Global Commercial achieved an impressive accident year combined ratio ex CATs of 89.1%, an improvement of 410 basis points year-over-year. The accident year combined ratio ex CATs for North America Commercial and International Commercial were 91% and 86.7%, which reflected improvements of 450 basis points and 340 basis points, respectively.
In Global Personal, the accident year combined ratio ex CATs was 94.9%, an improvement of 120 basis points year-over-year, driven by improvement in the expense ratio. These notable combined ratio improvements across General Insurance reflected improved higher-quality Global portfolio, driven by the strategic underwriting actions and strong execution, which have enabled us to shift our focus towards accelerating profitable growth in areas of the market where we see attractive opportunities. We are very pleased with these materially improved results, which provide tangible evidence of our successful underwriting strategy and the significant progress we have made.
Turning to January 1 renewals with respect to our ceded reinsurance. We were very pleased with the outcome of our reinsurance placements. While the markets presented significant challenges across the industry with retrocessional limited along with other capacity issues, our reinsurance partners recognize the strength of our improved underwriting portfolio and reduced aggregation exposure, which translated to many improvements in our reinsurance structures along with better terms and conditions. It's important to keep in mind that we placed over 35 treaties at 1/1 with over 65 discrete layers and over $12 billion of limit placed and we cede over $3 billion of premium in the market.
As you can imagine, we're not an index of market pricing because of the significant improvement in the portfolio along with the size and complexity of our placements. We continue to maintain very strong relationships with our reinsurance partners, and the support we receive in the marketplace is evident in the quality of the overall reinsurance program. We continue to make meaningful improvements to our core placements in every major treaty on January 1, and as a result, continue to reduce volatility in our portfolio.
While there's too much detail to cover on this call, I want to provide a few key highlights on our placements. For our Property CAT treaty, we improved the per occurrence structure and improved our aggregate structure for our Global Commercial businesses. For the North America per occurrence Property CAT treaty, we lowered our attachment point to $250 million for all perils, which is a reduction from our core 2021 program that had staggered attachment points depending on peril, that range from $200 million to $500 million. And we maintained our per occurrence attachment points in International, which are $200 million for Japan and $100 million for the rest of the world.
For our Global shared limit aggregate cover, we were able to reduce our attachment point in every region across the world, most notably, $100 million reduction in the attachment point in North America. Our Global shared limit, each and every deductible remain the same or reduced in every global region, most notably $25 million reduction in North America-named storms.
Our attachment point return periods are the same or lower in every region across the world when compared to our 2021 core reinsurance program, and our exhaustion period returns are higher in every instance across the world on an OEP and AEP basis. And we achieved these significant improvements while modestly reducing the total aggregate reinsurance CAT spend.
On our core Casualty treaty, we reduced our net limits on our excess to loss treaty in both North America and International. On our proportional core North America placement, we maintained the same session amount while improving our ceding commission by 400 basis points, which represents an 800 basis point improvement over the last 24 months, reflecting our significantly improved underwriting and recognition from the reinsurance market. Lastly, we renewed our cyber structure at 1/1 with additional quota share cede increasing from 60% to 70% and the aggregate placement attaching at 85% versus a 90% loss ratio.
Given the tight terms and conditions and discipline in our portfolio along with significant rate increase we achieved during the year, we were able to secure more quota share authorization, which is a great example of the reinsurance market's flight to quality.
As we discussed on last earnings call, we've spent considerable time through AIG research and our Chief Underwriting Office analyzing the impact of climate change and the increased frequency and severity of natural catastrophes. A few observations about 2021.
It was the sixth warmest year on record since NOAA began tracking global temperatures in 1880. Hurricane Ida estimated at $36 billion of insured loss was the third largest hurricane on record. In North America, $17 billion of winter weather losses was the largest on record for this peril. And $13 billion of insured loss for European flooding was the costliest disaster on record for the continent.
While we've been working over the past few years to reposition our portfolio to limit exposure and dampen volatility, changing weather patterns and increased density of risk in peak zones have caused stress on aggregation and have hampered the ability of property underwriters to make appropriate risk-adjusted returns on capital deployed. These changes have caused us to look deeper into the exposures we are underwriting in several lines of business.
An example of a business that needs further attention and strategic repositioning is our high net worth property portfolio within our Personal Insurance segment. By the nature of the business, it's exposed to peak zones and is susceptible to increased frequency and severity. This reality together with secondary perils that have become primary perils in the underwriting and modeling process as well as secondary perils and modeling have all driven up loss costs, creating a significant issue that needs to be addressed.
When analyzing the portfolio over the last 5 years, we've seen catastrophe levels that are 10x the level the portfolio dealt with in the prior 10 years for losses in excess of $50 million. The inability to reflect emerging risk factors, the effects of changes to modeling, increased loss costs from CATs has put the profitability of the business under pressure. In addition, when you consider the increased exposure in most peak zones in the United States over the last few years, with significantly increased total insured values, in some cases, greater than 100%, more density, supply chain issues, reinsurance availability and increased reinsurance costs and all this with heightened complexity the pandemic has caused along with the impact of demand surge post-CATs, not being tested, the business model simply needs to change.
Recognizing these realities after careful review, we decided to take meaningful steps to address this risk issue in our high net worth business, which will allow us to continue to offer comprehensive solutions to our clients that are more consistent and sustainable. Aggregation and profitability challenges led us to the conclusion that we have to offer the property homeowners product as an example through excess and surplus lines on a nonadmitted basis in multiple states.
For example, in December, we announced that we would no longer be offering admitted personal property homeowners policies in the state of California. We cannot maintain our current level of aggregation in the state nor have we been able to achieve any profitability from this line of business. Being a prudent steward of capital, these actions will enable us to segment the portfolio, achieve an acceptable return, reduce volatility and offer clients more comprehensive policy wordings and service.
Now turning to Life Retirement. Full year results were driven by improved equity markets, strong alternative investment income, higher interest rates, higher call and tender income and higher fee income, partially offset by elevated mortality and base spread compression across products. Adjusted pretax income in the fourth quarter and full year was $969 million and $3.9 billion, respectively. The full year growth of 11% was driven by strong alternative investment and fee income. Full year sales were strong with premiums and deposits increasing 15% year-over-year to $31.3 billion.
Sales within our Individual Retirement segment grew 34% across our 3 product lines for the year. Assets under management were $323 billion, and assets under administration increased to $86 billion, benefiting both from strong sales activities and favorable economic conditions.
We also made excellent progress with Blackstone in the fourth quarter, completing the initial $50 billion asset transfer, incorporating them into our asset liability management process, finalizing the investment guidelines and developing initial product offerings based on Blackstone's origination platform.
Lastly, having analyzed our exposure to long duration target improvements or LDTI accounting, based on the current interest rate and macro environment, we expect the transition impact of LDTI is well within Life Retirement's current balance of AOCI. Mark will provide more detail on this topic in his remarks.
Turning to the separation and IPO of Life Retirement. In addition to closing Blackstone transactions, we also continue to make significant progress on operationally separating Life Retirement from AIG, both with respect to what can be done by the IPO and longer term to transition service agreements. We are applying the same rigor and discipline to our separation work streams as we have with our AIG 200 Transformation Program, but with a clear focus on speed to execution. We continue to work towards an IPO in the second quarter of this year, subject to regulatory approvals and market conditions.
As I mentioned on our last call, due to the sale of our affordable housing portfolio in the fourth quarter and the execution of certain tax strategies, we are not constrained in terms of how much of Life Retirement we can sell in an IPO. Having said that, the size of the IPO will be dependent on market conditions. We continue to expect to retain a greater than 50% interest immediately following the IPO and to continue to consolidate Life Retirement's financial statements at least until such time as we fall below the 50% ownership threshold.
Finally, turning to capital management. We've been giving significant thought to both Life Retirement as a stand-alone business and AIG as we continue the path to separation. With respect to Life and Retirement, our goal remains to achieve a successful IPO of a business with a capital structure that is consistent with its industry peers. Life and Retirement has a strong balance sheet and limited exposure to legacy liabilities, and its insurance operations have a history of strong cash flow generation. We expect that over time, this business will sustain a payout ratio to shareholders of 60% to 65% between dividends and share repurchases on a full calendar year basis.
We also expect that post IPO, Life and Retirement will pay an annual dividend in the range of $400 million to $600 million, which equates to roughly a 2% to 3% yield on book value. Additionally, as part of the separation process, in the fourth quarter of 2021, Life and Retirement declared a dividend payable to AIG in the amount of $8.3 billion, which will be funded by Life and Retirement debt issuances and paid prior to the IPO. Our expectation is that a vast majority of this dividend payment will be used to reduce debt at AIG, and therefore, the overall amount of debt across our consolidated company will remain relatively constant at the time of the Life Retirement IPO. Post deconsolidation, we expect Life Retirement to maintain a leverage ratio in the high 20s with AIG maintaining a leverage ratio in the low 20s.
Regarding our current capital management plan for AIG, ending 2021 with $10.7 billion in parent liquidity provides us with a significant amount of flexibility. Our capital management philosophy will continue to be balanced to maintain appropriate levels of debt and to return capital to shareholders through share buybacks and dividends, while also allowing for investment in growth opportunities across our Global portfolio. This will also be true post IPO and over time as we continue to sell down our stake in Life Retirement.
With respect to share buybacks, we have $3.9 billion remaining under our current authorization and expect to complete this amount in 2022, weighted more towards the first half of this year. We do not expect the Life Retirement IPO to impact AIG's dividend and expect to maintain our current annual dividend level at $1.28 per share.
With respect to growth opportunities, our priorities will be to allocate capital in General Insurance, where we see opportunities to grow and further improve our risk-adjusted returns. We believe there are excellent opportunities for continued growth in Global Commercial Lines, which Mark will cover in more detail in his remarks.
As we move through 2022 and are further along with the IPO and separation of Life Retirement, we will continue to provide updates regarding capital management. As you can see, we made significant progress in 2021 and had a terrific year. 2022 will be another busy and transformational year for AIG. We started 2022 with a significant amount of momentum, and our colleagues continue to demonstrate an ability to execute on multiple fronts as we continue our journey to be a top-performing company.
With that, I'll turn the call over to Mark.
Mark Lyons,Executive VP & CFO: Thank you, Peter, and good morning to all. Given Peter's comments, I will head directly into the fourth quarter results. Diluted adjusted earnings per share were $1.58, representing 68% growth over the prior year. This material improvement in adjusted EPS was driven by an over 1,000 basis point reduction in the General Insurance calendar quarter combined ratio; 9% growth in net earned premiums, led by Global Commercial with 13% net earned premium growth; and an improvement in the underlying accident year combined ratio ex CATs to 89.8%. As Peter mentioned, our first sub-90% quarterly results since before the financial crisis, which also represented a 310 basis point improvement from the prior year quarter.
Life and Retirement delivered another quarter of solid returns and remained well-positioned with a 13.7% return on adjusted segment common equity for the fourth quarter and 14.2% for the full year 2021. The strength of our operating earnings and capital actions in the quarter helped drive a near 10% adjusted annualized ROE and growth in adjusted tangible book value per share of nearly $7, which represents a sequential increase of 12% and a full year increase of 23%. We fulfilled our capital management commitments and finished the year with a GAAP leverage ratio of 24.6%, a reduction of 150 basis points in the quarter and 380 basis points over the course of the year, which is another milestone, as we stated our goal was to be at or under 25% on this important metric. This improvement was driven by approximately $4 billion of debt and hybrid retirement along with $2.6 billion of share repurchases, nearly $2.1 billion of which occurred in the second half of 2021, which was slightly above our guidance.
Moving to General Insurance. I will provide some color in areas which Peter did not touch upon in his opening remarks. Catastrophe losses of $189 million were significantly lower this quarter compared to $545 million in the prior year quarter. This quarter's main drivers were the Midwest tornadoes and the Colorado wildfire. Prior year development was $44 million favorable in the fourth quarter compared to unfavorable development of $45 million in the prior year quarter. As usual, there was net favorable amortization from the ADC, which was $45 million this quarter. So PYD was essentially flat without this amortization. On a full year basis, net favorable development amounted to $201 million relative to [ $43 billion ] in net loss and loss adjustment expense reserves. In 2020, we released $76 million of net favorable development.
Shifting to premium growth. Overall Global Commercial Insurance net premiums grew 13% on a reported and constant dollar basis for the quarter, and growth in North America commercial was 11%, driven by Casualty, which increased 50%; Lexington, which increased 14%; and Financial Lines, which increased over 10%. In International Commercial, growth was 16% on an FX-adjusted basis. And by line of business, Global Specialty, which is booked in International, grew over 25%. Talbot had 20% growth, and Property grew by 13%. Overall growth in the fourth quarter was driven by strong incremental rate improvement, higher renewal retentions and strong new business volumes.
Commercial retention improved by 300 basis points year-over-year in North America to 80% and by 400 basis points in International to 86% in the period. This increase in wholesale business in North America Commercial brings with it lower channel retention ratios in addition to purposefully lower retentions in cyber and private D&O. Excluding these items, the retention ratios between North America and International Commercial are comparable. Commercial new business grew by 33% in the fourth quarter with 41% growth in North America and 25% growth in International.
Turning to rate. Where overall Global Commercial Lines saw increases of 10% in the quarter, we achieved the third straight year of double-digit increases. Strong momentum continued across most lines, and we continue to achieve rate above loss cost trends. North America Commercial's overall 11% rate increases were balanced across the portfolio and led by Financial Lines, which increased by 15%; Excess Casualty, which increased by 14%; Retail Property, which was up 13%; and Lexington, which increased by 11%. International Commercial rate increases in the aggregate were 9%, driven by EMEA, which increased by 18%; the U.K., which increased by 12%; Financial Lines, which increased 18%; and Energy, which was up 11%, which is also its 11th consecutive quarter of double-digit rate increases.
Shifting now to a calendar year combined ratio comparison. General Insurance produced a 95.8% combined ratio for 2021, an improvement of 850 basis points over 2020 and nearly 1,600 basis points better from 2018's 111.4% calendar year combined ratio. Peeling back a bit more, the combined CAT and prior period development improvement has been 720 basis points since 2018, indicating both a material CAT exposure reduction, in line with the movement we have shown in our PMLs and a much stronger loss reserve position than 3 years ago.
Turning to additional pricing. Rate increases continue to be favorable and outpaced loss cost trends in most areas of the portfolio. With the level of rate that we have achieved in just the last 12 months, we expect that margin expansion will continue at least through 2022 and likely into accident year 2023. Getting more specific for illustrative purposes, we have communicated written rate changes during prior earnings calls and will continue to do so. However, since earned rate changes more directly impact reported results and given recent discussions around the inflation component of loss cost trend, I thought I'd go over a few areas on an earned rate basis for full year 2021.
In North America Commercial, for example, Excess Casualty business that focuses on our national and corporate accounts has achieved an approximate earned rate increase approaching 40% in 2021 over 2020's earned rate level, as has cyber. D&O and nonadmitted Casualty achieved earned rate increases in the mid-20s. And importantly, retail and wholesale property achieved earned rate increases during 2021 in the low 20s. This is noteworthy because Property is getting most of the inflation attention, and yet the level of earned rate that was achieved is, in my view, still materially ahead of property and loss cost trend. And the same could be said for both Excess Casualty and D&O.
Recent Property written rate increases are still in the low teens, and looking into policy year 2022 should keep them above loss trend even with an inflationary spike. Property pricing needs to remain firm to cover these increased costs of labor, materials and transportation.
Turning to International Commercial. Similar to North America, there are large areas of material earned rate increases for full year 2021. International Financial Lines achieved a 23% earned rate increase over 2020's earned rate level. The International property book achieved an 18% earned rate increase, and the Energy book achieved earned rate increases in the mid-20s.
Let's now step back and look at the last 3 years of cumulative written rate increases achieved at a high level during 2019 through 2021. North America Commercial across all lines of business had a 47% cumulative written rate increase, and International Commercial's cumulative written rate increase during that same time period was 40%. These measures, although they don't take into account improved terms and conditions and other difficult-to-track impact, indicate, on their own, a significant ingredient of margin improvement as evidenced by the material reduction in our reported accident year results.
As we think about moving forward into calendar year 2022 and 2023, we need to be cognizant about the absolute, significantly favorable impact on combined ratios over the last 3 years and realize that most lines of business are well into the green. Although there are several opposite forces at work, such as economic and social inflation, my sense is that the 2022 market will continue to produce tight terms and conditions and strong pricing to sustain additional margin expansion into calendar 2023.
As we think about 2022, major areas of growth for North America would be Accident & Health as the economy is expected to begin rebounding and Lexington on a nonadmitted basis. And on the International side, we see growth in our Global Specialty operations, A&H as well and select Casualty and Financial Lines areas around the globe, whereas AIG Re sees growth mostly in casualty business. The AIG Re portfolio strategically took the opportunity to further derisk and rebalance the portfolio away from property CAT due to our view of a less-than-adequate returns in that space and expanded further into Casualty and Specialty Lines and expects to continue that trend. Furthermore, limits deployed in U.S. property were down about 10%, and the retrocessional program provided $1 billion of protection with peak U.S. zone PML down meaningfully across most points in the return period curve.
Moving to Life and Retirement. Premiums and deposits grew 19% in the fourth quarter, excluding Retail Mutual funds, relative to the comparable quarter last year. Growth was driven by Individual Retirement and $2.1 billion of pension risk transfer activity. APTI for the quarter was $969 million, down 6%, driven primarily by lower net investment income and unfavorable COVID-19 base mortality, although non-COVID-19 mortality returned to being better than pricing expectations.
On a full year basis, APTI increased to $3.9 billion, reflecting higher net investment income and fee income, partially offset by adverse mortality. Our investment portfolio and hedging program continued to perform extremely well for both the quarter and the year. Composite base spreads across Individual and Group Retirement along with institutional markets compressed 12 basis points during 2021 within the sensitivity guidance we've previously provided.
Within Individual Retirement, Index Annuities continued to be the net flows growth engine with $880 million of positive net flows for the quarter and $4.1 billion of the full year. APTI was essentially flat for full year 2021 over full year 2020, but premiums and deposits were up 34% and AUM was up 2% year-over-year to $159 billion. Group Retirement had APTI of $314 million for the fourth quarter, virtually flat with last year's comparable quarter, but was up 27% on a full year basis, with premium and deposits up roughly 4% and assets under administration up over 7.5% on a full year basis to $140 billion.
Life Insurance APTI was a negative $8 million in the fourth quarter, but had a gain of $106 million for the full year. Premiums and deposits grew 4% from fourth quarter of 2020 and over 5% for the full year to $4.7 billion. Additionally, total insurance in-force grew to $1.2 trillion, representing over 3% growth.
Our COVID-19-related mortality exposure sensitivity of $65 million to $75 million pretax per 100,000 U.S. population deaths was in line based on the externally reported fourth quarter COVID-related population deaths in the U.S. Institutional Markets grew premiums and deposits by 74% relative to last year's comparable quarter, primarily due to the significant pension risk transfer sales.
Moving to other operations. The adjusted pretax loss before consolidation and eliminations was $178 million, a $250 million improvement versus the prior year quarter, with the primary drivers being higher net investment income of $237 million; a lower corporate interest expense on financial debt of $51 million, resulting from our debt redemption activities; partially offset by higher corporate GOE of $12 million, which include increases in performance-based compensation.
Heading to Peter's comment about AIG 200. $810 million of run rate savings are already executed or contracted towards the $1 billion run rate in savings objective with approximately $540 million recognized to date in our income statement and $645 million of the $1.3 billion cost to achieve having been spent to date.
Shifting to investments. Total cash and investments were $361 billion, and fourth quarter net investment income on an APTI basis was $3.3 billion, which was essentially the same both sequentially and year-over-year and was aided by higher alternative investment income, particularly within private equity. NII for the full year of $12.9 billion was up over $600 million from 2020. Private equity returns were nearly 32% for the full year, up from approximately 10% last year. Hedge funds returned approximately 14% each year, and mortgage loan returns were stable at 4.2%.
We ended the year with our primary operating subsidiaries being profitable and well-capitalized with General Insurance's U.S. pool fleet risk-based capital ratio for the fourth quarter estimated to be between 460% and 470%, and the Life and Retirement [ yields ] is estimated to be between 440% and 450%, both well above the upper bound of our target operating ranges. With respect to share count, our average total diluted shares outstanding in the fourth quarter were 847 million, a reduction of 2% as we repurchased approximately 17 million shares in the quarter. The end-of-period outstanding shares for book value per share purposes was approximately 819 million at year-end 2021.
Now I'd like to address the forthcoming LDTI accounting changes affecting our Life and Retirement business. First, this is a GAAP-only accounting standard, and there should not be impacts to cash flow or statutory results. As this continues to be a work in progress for us and the industry at large, I'd like to provide a range towards the transitional balance impact at January 1, 2021, as being between $1 billion and $3 billion decrease to shareholders' equity with our current point estimate being towards the lower end of this range. This decrease represents a netting between an increase to retained earnings and a decrease to AOCI. Once again, Life and Retirement's breadth of product offerings provides value as the LDTI impact of old traditional products covered by FAS 60 involving mortality are roughly offset by the elimination of historical AOCI adjustment associated with certain longevity products.
Also, current GAAP accounting for living benefits is at fair value, and changes go through the income statement, whereas under LDTI, a portion of that charge will be recorded in AOCI, pertaining to the company's own credit spreads, which, for that piece, will help to dampen some volatility. But mortality benefits will now also be at fair value and will act as an offset to take volatility in the other direction within the GAAP income statement.
Turning now to the recent S&P capital model changes. The deadline to respond has been extended to March of 2022, and S&P will presumably conclude shortly thereafter. Both the property, casualty and the life retirement insurance industries will likely see higher capital charges for innate insurance exposures as well as for asset credit and asset market risks. Additionally, reduced benefits of holding company cash liquidity and lower levels of accessible debt leverage is an indicated outcome, but all with material offsets due to increased diversification benefits. We have spent considerable time on the analysis of this proposal so far, but it is probably premature to make any predictions at this point before S&P and the industry have had more time to land upon the exact details of the final framework.
Now in conclusion, by virtually all measures, growth, profitability, returns, margin expansion, adjusted book, adjusted tangible book value, debt leverage reduction, EPS, adjusted pre- and after-tax income and net income all point to an outstanding year for AIG. When you also factor in our global platform, our marketplace actions and impact, the strength of our loss reserves, a robust reinsurance program and massive portfolio reconstruction, AIG is exceedingly well-positioned as we look to the separation of L&R, completing AIG 200, maintaining our path towards increasing profitable growth and for whatever else the future holds.
With that, I will turn the call back over to Peter.
Peter Zaffino;President, CEO, Global COO & Director: Great. Thank you, Mark. Operator, we're ready for questions.
Operator: [Operator Instructions] We'll take our first question from Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question, given that you guys have just under $11 billion of capital at the parent, your debt to capital is also below 25%, and you have the Life and Retirement IPO coming, shouldn't you be able to buy back more than $3.9 billion this year? Or is the $3.9 billion, Peter, that you mentioned remaining under the authorization, is that a floor? And could you come back later after the IPO and update that figure?
Peter Zaffino;President, CEO, Global COO & Director: Thanks, Elyse, for the question. Yes, that's really what we tried to outline in terms of the capital management, is the $10.7 billion, what's in front of us in terms of we see great growth opportunities in the business. And I think that the results and how much they're improving are evidence of that, maintaining the right leverage, committing to the dividend and then talking through the current share authorization and not speculating on the amount or timing of the IPO beyond the guidance that we've already provided. So as we do the IPO, we will continue to refresh that sort of capital management and sort of accelerate what we can do with capital above what we have for liquidity today.
Elyse Greenspan: Okay. And then my second question is on that sub-90% underlying margin target in General Insurance. You guys came in at 91% for 2021 for the full year. Given your comments that earned rate should exceed loss trend this year and you still have some AIG 200 expense saves coming in, should we think about seeing improvement in both the loss and the expense ratio in '22? And then also, would you expect to be at that sub-90% during every quarter of 2022?
Peter Zaffino;President, CEO, Global COO & Director: Thanks, Elyse. I'll have Mark add to my comments. But we gave you full year guidance. I think Mark gave tremendous detail in his prepared remarks in terms of the earned premium, the improvements that we've made. And again, when you look at the quality in terms of how we're growing with strong top line, strong retention, strong new business, strong rate, developing margin above loss cost, in addition, AIG 200, as you mentioned, earning in is going to give us an expense benefit.
The one thing I do want to note that in the expense benefit, we've been investing against that in terms of bringing more underwriters in for growth, particularly in A&H, where we see great opportunities. We're building an operational muscle within AIG in terms of adding high-qualified people that have backgrounds in data, digital, digital workflow. So while we're recognizing the benefits from AIG 200, we're also investing to be able to continue to perpetuate this very strong performance.
Mark, do you want to comment a little bit in terms of the -- I don't think we give quarterly guidance, but how you think about next year in a little bit more detail?
Mark Lyons,Executive VP & CFO: Yes, happy to, Peter. Thank you. So with respect to your quarterly question, I mean, the Insurance business, we take out a lot of different risks. We have the big portfolio, so you get some smoothing. But quarter-by-quarter, you never really know that. And as Dave McElroy and Peter have said in the past, every quarter has a different underlying mix to it. So we would certainly expect improvement, but I wouldn't be surprised if 1 quarter went off or something. But the year, we certainly expect continued improvement.
Operator: We'll take our next question from Meyer Shields with KBW.
Meyer Shields: Let me start with a question for Mark, if I can. It's going to be a little sort of detailed. But in the supplement, you disclosed $676 million of alternative investments that are above expectations. And then there's, I want to say, $476 million of consolidation offset. And I'm wondering if you could talk about the relationship between those 2? And what sort of rule of thumb we should apply to the outperformance that goes out on the consolidation side?
Mark Lyons,Executive VP & CFO: Well -- sorry.
Peter Zaffino;President, CEO, Global COO & Director: Go ahead, Mark.
Mark Lyons,Executive VP & CFO: So thank you for the question, Meyer. What you'll always see is the -- and basically, what you see in other operations, which always gets a little confusing, granted, is that the investment income in the subs would be double counted otherwise. So what you see as you go through that is that the elimination of that overlap, firstly.
Secondly, on the alternatives, I kind of highlighted for you what some of the returns have been on that over the last couple of years, which we certainly wouldn't count on really on a go-forward basis, you don't plan on that level. We're happy to have it, but we wouldn't really contemplate that on a strict go-forward basis.
Meyer Shields: Okay. And the second question, maybe a little bit less obscure. You mentioned the decrease in PMLs historically. How do things look, whether it's PML or AAL? How do you use 2022 based on both inward network reinsurance?
Peter Zaffino;President, CEO, Global COO & Director: Well, let me start, and then Dave, maybe you can just add a little bit of commentary on how we're thinking about the property book. But as I said in my prepared remarks, we were very conservative in terms of how we've been shedding gross limit. This is on the sort of AIG, non-AIG Re side. And we've been very conservative on growth and also we've reduced our nets, I mean. So when I was trying to outline in the reinsurance that we're taking less volatility going forward, just because of all the different factors of what we've been doing on the underwriting side and also to continue to advance and evolve our comprehensive reinsurance program.
Before turning it over to Dave, I will comment on AIG Re. We significantly reduced our aggregates in peak zones at 1/1, didn't think the risk-adjusted returns were there. As Mark alluded to, we lowered in the majority of our return periods in the frequency, severity and tail; significantly reduced our net PMLs and have a lot of ability depending on what happens in the market in the future to be able to be responsive. But we were not going to be an index in the market. And I think we were very conservative at the AIG Re level in terms of that deployment. Dave, do you want to add a couple of comments on property? David, you're on mute.
David McElroy: Yes, it's very important to understand the reunderwriting that was done in the Property book. And not only the limits that were taken out, of the $1 trillion, about $600 billion of that was Property around the world. So -- and it really did rearchitect completely different businesses with Lexington becoming more of an E&S carrier. 80 -- 90% of our limits now are less than $10 million, okay? And we let Retail Property play, and they started to do shared and layered. They weren't competing anymore with $2 billion limit. So the whole PML and AAL has come down dramatically, okay? And that's obviously influenced how we buy our [ reinsurances ].
We are reflecting the fact that there is a higher, let's say, expected loss in inflation in the 2022 plan. So we've actually added a little bit above our AAL as a marker for our CAT load in 2022 to reflect that. I think that's just prudent business. It also reflects the fact that the -- we think we have these books from a limit management standpoint, from an exposure standpoint controlled, but we need to be conservative. We need to think of it that way. So -- and that actually extends to the Global franchise, too. There was a massive amount of limits that we've taken out of that portfolio, and that feeds into the respective CAT programs that we have overseas.
Operator: We'll take our next question from Erik Bass with Autonomous Research.
Erik Bass: I just wanted to walk through the mechanics of the capital transfers prior to the IPO, just to make sure that I have this correct. Is the expectation that Life and Retirement will issue debt and then use the proceeds to pay the $8.3 billion dividend to the AIG Holding Company, and that will then, in turn, use that cash to retire debt? And I guess, is the takeaway that this will put you in a leverage position such that all of the net IPO proceeds will be available to shareholders or for growth investments?
Peter Zaffino;President, CEO, Global COO & Director: Yes, it's a really good question, Erik. Thanks for that. Shane, maybe you can just answer Erik's question, but also just give a high level in terms of how we're thinking about the sequencing with the IPO.
Shane Fitzsimons: Yes. So Erik, you're correct. So Life and Retirement declared a dividend of $8.3 billion, which is a note receivable at parent at the moment. So Life and Retirement will go into the market and actually raise some of that debt actually pre IPO, and we're working through that at the moment. And those proceeds will then come across as a repayment on the note. And then the proceeds from that note will be used to pay down debt at parent.
So the goal is to keep debt levels between the 2 companies more or less at the same level moving forward. And I think as Peter outlined, the goal in separation is to have [indiscernible] for the new company in the high 20s and in the -- for the -- what you would know going forward is kind of parent plus General Insurance in the low 20s, is kind of the way that this will evolve.
Peter Zaffino;President, CEO, Global COO & Director: Yes. Thanks, Shane. And Erik, you're right, like we're going to have more flexibility as the proceeds of the IPO become available, but we're trying to be very prudent in terms of the capital management leading up to that.
Erik Bass: Got it. And then I believe that you transferred the ownership of the asset management business to Life and Retirement at the end of the year?
Peter Zaffino;President, CEO, Global COO & Director: Yes.
Erik Bass: Can you just help us think about the impact of this change on go-forward results for both L&R and other ops?
Peter Zaffino;President, CEO, Global COO & Director: Well, this is a process that we've outlined as part of the separation. So there's a variety of steps in terms of sequencing that. One is that we transfer the investment management group to Life and Retirement as part of the separation. We've been operationally taken assets under management as we put in the prepared remarks and have been very open and transparent about Blackstone. So that was a transfer.
We have a sort of target operating model that we're working through with Life and Retirement and with the remaining AIG in terms of the pace in which we will make those changes. But we're going to optimize that structure to make sure that it's in the range of what the sort of AUM basis point fee was in terms of our internal management with using an outsourcing model. So we'll continue to give you more and more guidance, but you should know that like in sequential steps, we want to get the transfer for -- into Life Retirement, then Blackstone and then how we optimize the target operating model to make sure there's not headwinds for Life Retirement in the future.
Operator: We'll go next to Alex Scott with Goldman Sachs.
Taylor Scott: First thing I wanted to ask about is just the ROE at the remaining company. It seems like you provided some helpful guidance on Life and Retirement, what the cash flows could look like. It seems like maybe some of that's getting honed in a bit. And I know you probably can't give specifics so much, but could you give us a feel for what kind of ROE we'll be looking at sort of post separation as we have some stranded costs and things like that to deal with versus maybe where you would expect to run a company with these businesses at the remaining company more long term?
Peter Zaffino;President, CEO, Global COO & Director: Sure, Alex. Thanks for the question. Again, we have so much going on that there is, I keep using the word sequencing because we want to make sure that we're doing the underwriting turnaround and all the things that we outlined through the scripts in the right sequence and making sure that we are getting things put behind us.
We do have a path to a 10% ROE. I can't really give you a specific time frame because you can appreciate, we have so many moving pieces at the moment. Many of them we addressed in the scripts, but there's some that we can't address until we know further in terms of what are the IPO proceeds and looking further at the structure of the equity.
I'm going to ask Shane to comment a little bit more. I mean -- but we know that we have to get expenses and rationalized in the company. But again, those priorities are going to be, we got to focus on making sure that we're driving the underwriting. We have great opportunities as a global leader in the industry, and we want to make sure that we're solving risk issues and capitalizing on all the opportunities present themselves.
We want to finish AIG 200, which is going to give some of that expense benefit in terms of driving the ROE and get that done within the calendar year and then pivot to investment on digital. The operational separation of Life Retirement is incredibly important. We've been working with Kevin and the leadership team of getting that set up. So we want to continue to drive that forward, and then we have to execute on the IPO.
So once that is largely complete, we know that the parent and what it is today called General Insurance, we have to combine the 2, and we will rationalize that operating model, not only driving profitability improvement but expense improvement, and that will drive the path in terms of achieving that ROE.
Shane, I know I probably gobbled up a lot of the details, but is there anything else you'd like to add?
Shane Fitzsimons: Yes. I mean, Peter, I think the only other thing I would really add is that we also made significant progress here in 2021 with a combination of buyback and getting share. Our leverage down below 25% is a significant highlight. Peter talked about what we have to do in terms of finalizing the remaining equity as part of an efficient capital structure for Remain Co, including post-separation leverage in the low 20s and what capital is needed in the insurance subsidiaries to support accretive organic growth and return to share owners.
And I think Peter mentioned as well, we have improved expense ratios, but one of the key drags on our ROE is parent expenses. And we have been rightsizing this through AIG 200 in separation, but we need to do more. And I think Peter has assembled a team that has spent good parts of their career in transformation, driving expense and operational efficiency programs. And we'll turn this headwind at parent into a tailwind, at least, that's -- and that will help us get to where we need to get to. And we will provide updates over time.
Peter Zaffino;President, CEO, Global COO & Director: Thanks, Shane.
Taylor Scott: That's all really helpful. And maybe a follow-up, in General Insurance, can you just comment maybe a high level around how you're balancing, driving further margin improvement from here versus prioritizing growth? And maybe if you could just comment between North America and international, if you could?
Peter Zaffino;President, CEO, Global COO & Director: Yes. Let me just give a brief overview, and then ask Dave to comment on a little bit more specificity. One is we have a great balance across the globe in terms of International and North America. We've been driving top line growth, but the underwriting culture that we've developed is all about profitability. And so making sure that we continue to drive that profitability on a combined ratio, it's sustainable, but the areas in where we think we really drive significant value, there's multiple.
Mark mentioned some of the product lines. It's not a couple, it's many, and it's across many geographies. And our underwriting leadership capacity and ability to structure programs is going to be something that we think is sustainable, but we won't be sacrificing margin and bottom line for top line.
Dave, anything you want to add in terms of some of the specific areas where you're really looking to grow? Dave, you're on mute.
David McElroy: Thank you. You can hear me?
Peter Zaffino;President, CEO, Global COO & Director: Yes.
David McElroy: Yes. I think we don't want to front-run 2022, but a lot of the work that we've done over the last 3 years really -- and it manifests itself in 2021. You could see we are growing. You can see the numbers that we put forth on the accident year as well as combined year. And those books form our future. So I've spoken to a momentum business, but we now look at those books of business that we've rearchitected, okay, and it gave us a lot of room to do that, and you saw the pivot to growth. But those are now a well-formed books that we think we can grow off of.
If you think about renewal retention, when you think about rate on that book and when you think about new business on that book, we are optimistic around that forming a foundation for growth into 2022 and 2023. And renewal retention is a momentum business, okay? We've been adding a couple of hundred bps to each renewal retention each year. We think that there's opportunity there because we like the book. It's a better price book into 2022.
Rates. You've heard some of the rhetoric. We believe that rates will continue to trend above expected loss costs with an inflation buffer in there. We saw in the fourth quarter where there was concern and fear around Property, and Property turned back. And I call out not only to ourselves but to everybody on this call, how we thought there would be deceleration in 2021, but there was a respect in the industry and a reflection in the industry on inflation costs, and the market is reacting rationally to that. And we think that will continue into 2022.
And then new business, the machinery and what Peter is alluding to is we have so many franchises around the world that have, what I consider to be preferred positions, moat positions, okay? We are not trading against the comparative rater in auto. We are a specialty global company that judgment matters, underwriting matters, and we have primary positions and collateral and multinational service capabilities. These are assets that we can control and allow us to generate growth with that. So let me stop there for a change.
Peter Zaffino;President, CEO, Global COO & Director: Thank you, David. That's excellent. Thank you, everyone, for being here today. Before we end the call, I do want to take a minute to thank Mark for all the terrific work he did as a CFO over the last few years. In addition to leading the finance team, Mark has been a critical member of the executive team that transformed our GI portfolio, helped us achieve a great result, and we were able to talk about it today. Grateful for his support, really look forward to him in his new role and the transition. So Mark, thank you for everything.
We're really anxious to have Shane. And you saw it today. We introduced him, done a great job getting up to speed. And so that transition has been very seamless. And Shane, welcome to the CFO role. And lastly, I want to thank all of our global colleagues for their incredible dedication, great work and making AIG a market leader and a great place to work. So thank you, everyone, and have a great day.
Operator: That will conclude today's call. We appreciate your participation. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Fourth Quarter 2021 Financial Results Conference Call. Today's conference is being recorded."
},
{
"speaker": "Quentin McMillan",
"text": "Thank you very much, Katie. Today's remarks may contain forward-looking statements, including comments relating to company performance, strategic priorities, including AIG's pursuit of a separation of its Life and Retirement business, business mix and market conditions. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially. Factors that could cause results to differ include the factors described in our third quarter 2021 report on Form 10-Q and our 2020 annual report on Form 10-K and other recent filings made with the SEC. AIG is under -- is not under any obligation and expressly disclaims any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Good morning, and thank you for joining us. Following my prepared remarks, Mark will provide more detail on our financial results and other relevant updates to close out 2021. Shane Fitzsimons, who became AIG's CFO on January 1, will be available for Q&A, along with David McElroy and Kevin Hogan."
},
{
"speaker": "Today, I will cover 4 topics",
"text": "First, an overview of General Insurance's fourth quarter and full year performance, where we continue to drive meaningful underwriting profitability improvement. I will also briefly touch on the 1/1 reinsurance renewal season. Second, I will review results from our Life and Retirement business, which continues to be a meaningful contributor to our overall results. Third, I will provide an update on our progress towards an IPO of Life and Retirement and operational separation of the business from AIG. And fourth, I will review our current plans regarding capital management."
},
{
"speaker": "Mark Lyons,Executive VP & CFO",
"text": "Thank you, Peter, and good morning to all. Given Peter's comments, I will head directly into the fourth quarter results. Diluted adjusted earnings per share were $1.58, representing 68% growth over the prior year. This material improvement in adjusted EPS was driven by an over 1,000 basis point reduction in the General Insurance calendar quarter combined ratio; 9% growth in net earned premiums, led by Global Commercial with 13% net earned premium growth; and an improvement in the underlying accident year combined ratio ex CATs to 89.8%. As Peter mentioned, our first sub-90% quarterly results since before the financial crisis, which also represented a 310 basis point improvement from the prior year quarter."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Great. Thank you, Mark. Operator, we're ready for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We'll take our first question from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, given that you guys have just under $11 billion of capital at the parent, your debt to capital is also below 25%, and you have the Life and Retirement IPO coming, shouldn't you be able to buy back more than $3.9 billion this year? Or is the $3.9 billion, Peter, that you mentioned remaining under the authorization, is that a floor? And could you come back later after the IPO and update that figure?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thanks, Elyse, for the question. Yes, that's really what we tried to outline in terms of the capital management, is the $10.7 billion, what's in front of us in terms of we see great growth opportunities in the business. And I think that the results and how much they're improving are evidence of that, maintaining the right leverage, committing to the dividend and then talking through the current share authorization and not speculating on the amount or timing of the IPO beyond the guidance that we've already provided. So as we do the IPO, we will continue to refresh that sort of capital management and sort of accelerate what we can do with capital above what we have for liquidity today."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then my second question is on that sub-90% underlying margin target in General Insurance. You guys came in at 91% for 2021 for the full year. Given your comments that earned rate should exceed loss trend this year and you still have some AIG 200 expense saves coming in, should we think about seeing improvement in both the loss and the expense ratio in '22? And then also, would you expect to be at that sub-90% during every quarter of 2022?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thanks, Elyse. I'll have Mark add to my comments. But we gave you full year guidance. I think Mark gave tremendous detail in his prepared remarks in terms of the earned premium, the improvements that we've made. And again, when you look at the quality in terms of how we're growing with strong top line, strong retention, strong new business, strong rate, developing margin above loss cost, in addition, AIG 200, as you mentioned, earning in is going to give us an expense benefit."
},
{
"speaker": "Mark Lyons,Executive VP & CFO",
"text": "Yes, happy to, Peter. Thank you. So with respect to your quarterly question, I mean, the Insurance business, we take out a lot of different risks. We have the big portfolio, so you get some smoothing. But quarter-by-quarter, you never really know that. And as Dave McElroy and Peter have said in the past, every quarter has a different underlying mix to it. So we would certainly expect improvement, but I wouldn't be surprised if 1 quarter went off or something. But the year, we certainly expect continued improvement."
},
{
"speaker": "Operator",
"text": "We'll take our next question from Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "Let me start with a question for Mark, if I can. It's going to be a little sort of detailed. But in the supplement, you disclosed $676 million of alternative investments that are above expectations. And then there's, I want to say, $476 million of consolidation offset. And I'm wondering if you could talk about the relationship between those 2? And what sort of rule of thumb we should apply to the outperformance that goes out on the consolidation side?"
},
{
"speaker": "Mark Lyons,Executive VP & CFO",
"text": "Well -- sorry."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Go ahead, Mark."
},
{
"speaker": "Mark Lyons,Executive VP & CFO",
"text": "So thank you for the question, Meyer. What you'll always see is the -- and basically, what you see in other operations, which always gets a little confusing, granted, is that the investment income in the subs would be double counted otherwise. So what you see as you go through that is that the elimination of that overlap, firstly."
},
{
"speaker": "Meyer Shields",
"text": "Okay. And the second question, maybe a little bit less obscure. You mentioned the decrease in PMLs historically. How do things look, whether it's PML or AAL? How do you use 2022 based on both inward network reinsurance?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Well, let me start, and then Dave, maybe you can just add a little bit of commentary on how we're thinking about the property book. But as I said in my prepared remarks, we were very conservative in terms of how we've been shedding gross limit. This is on the sort of AIG, non-AIG Re side. And we've been very conservative on growth and also we've reduced our nets, I mean. So when I was trying to outline in the reinsurance that we're taking less volatility going forward, just because of all the different factors of what we've been doing on the underwriting side and also to continue to advance and evolve our comprehensive reinsurance program."
},
{
"speaker": "David McElroy",
"text": "Yes, it's very important to understand the reunderwriting that was done in the Property book. And not only the limits that were taken out, of the $1 trillion, about $600 billion of that was Property around the world. So -- and it really did rearchitect completely different businesses with Lexington becoming more of an E&S carrier. 80 -- 90% of our limits now are less than $10 million, okay? And we let Retail Property play, and they started to do shared and layered. They weren't competing anymore with $2 billion limit. So the whole PML and AAL has come down dramatically, okay? And that's obviously influenced how we buy our [ reinsurances ]."
},
{
"speaker": "Operator",
"text": "We'll take our next question from Erik Bass with Autonomous Research."
},
{
"speaker": "Erik Bass",
"text": "I just wanted to walk through the mechanics of the capital transfers prior to the IPO, just to make sure that I have this correct. Is the expectation that Life and Retirement will issue debt and then use the proceeds to pay the $8.3 billion dividend to the AIG Holding Company, and that will then, in turn, use that cash to retire debt? And I guess, is the takeaway that this will put you in a leverage position such that all of the net IPO proceeds will be available to shareholders or for growth investments?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Yes, it's a really good question, Erik. Thanks for that. Shane, maybe you can just answer Erik's question, but also just give a high level in terms of how we're thinking about the sequencing with the IPO."
},
{
"speaker": "Shane Fitzsimons",
"text": "Yes. So Erik, you're correct. So Life and Retirement declared a dividend of $8.3 billion, which is a note receivable at parent at the moment. So Life and Retirement will go into the market and actually raise some of that debt actually pre IPO, and we're working through that at the moment. And those proceeds will then come across as a repayment on the note. And then the proceeds from that note will be used to pay down debt at parent."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Yes. Thanks, Shane. And Erik, you're right, like we're going to have more flexibility as the proceeds of the IPO become available, but we're trying to be very prudent in terms of the capital management leading up to that."
},
{
"speaker": "Erik Bass",
"text": "Got it. And then I believe that you transferred the ownership of the asset management business to Life and Retirement at the end of the year?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Yes."
},
{
"speaker": "Erik Bass",
"text": "Can you just help us think about the impact of this change on go-forward results for both L&R and other ops?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Well, this is a process that we've outlined as part of the separation. So there's a variety of steps in terms of sequencing that. One is that we transfer the investment management group to Life and Retirement as part of the separation. We've been operationally taken assets under management as we put in the prepared remarks and have been very open and transparent about Blackstone. So that was a transfer."
},
{
"speaker": "Operator",
"text": "We'll go next to Alex Scott with Goldman Sachs."
},
{
"speaker": "Taylor Scott",
"text": "First thing I wanted to ask about is just the ROE at the remaining company. It seems like you provided some helpful guidance on Life and Retirement, what the cash flows could look like. It seems like maybe some of that's getting honed in a bit. And I know you probably can't give specifics so much, but could you give us a feel for what kind of ROE we'll be looking at sort of post separation as we have some stranded costs and things like that to deal with versus maybe where you would expect to run a company with these businesses at the remaining company more long term?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Sure, Alex. Thanks for the question. Again, we have so much going on that there is, I keep using the word sequencing because we want to make sure that we're doing the underwriting turnaround and all the things that we outlined through the scripts in the right sequence and making sure that we are getting things put behind us."
},
{
"speaker": "Shane Fitzsimons",
"text": "Yes. I mean, Peter, I think the only other thing I would really add is that we also made significant progress here in 2021 with a combination of buyback and getting share. Our leverage down below 25% is a significant highlight. Peter talked about what we have to do in terms of finalizing the remaining equity as part of an efficient capital structure for Remain Co, including post-separation leverage in the low 20s and what capital is needed in the insurance subsidiaries to support accretive organic growth and return to share owners."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thanks, Shane."
},
{
"speaker": "Taylor Scott",
"text": "That's all really helpful. And maybe a follow-up, in General Insurance, can you just comment maybe a high level around how you're balancing, driving further margin improvement from here versus prioritizing growth? And maybe if you could just comment between North America and international, if you could?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Yes. Let me just give a brief overview, and then ask Dave to comment on a little bit more specificity. One is we have a great balance across the globe in terms of International and North America. We've been driving top line growth, but the underwriting culture that we've developed is all about profitability. And so making sure that we continue to drive that profitability on a combined ratio, it's sustainable, but the areas in where we think we really drive significant value, there's multiple."
},
{
"speaker": "David McElroy",
"text": "Thank you. You can hear me?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Yes."
},
{
"speaker": "David McElroy",
"text": "Yes. I think we don't want to front-run 2022, but a lot of the work that we've done over the last 3 years really -- and it manifests itself in 2021. You could see we are growing. You can see the numbers that we put forth on the accident year as well as combined year. And those books form our future. So I've spoken to a momentum business, but we now look at those books of business that we've rearchitected, okay, and it gave us a lot of room to do that, and you saw the pivot to growth. But those are now a well-formed books that we think we can grow off of."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thank you, David. That's excellent. Thank you, everyone, for being here today. Before we end the call, I do want to take a minute to thank Mark for all the terrific work he did as a CFO over the last few years. In addition to leading the finance team, Mark has been a critical member of the executive team that transformed our GI portfolio, helped us achieve a great result, and we were able to talk about it today. Grateful for his support, really look forward to him in his new role and the transition. So Mark, thank you for everything."
},
{
"speaker": "Operator",
"text": "That will conclude today's call. We appreciate your participation."
}
] | American International Group, Inc. | 250,388 |
AIG | 3 | 2,021 | 2021-11-05 08:30:00 | Operator: Good day, and welcome to the AIG's Third Quarter 2021 Financial Results Conference Call. Today's conference is being recorded. And now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead, sir.
Quentin McMillan: Thank you, Jake. Today's remarks may contain forward-looking statements, including comments related to company performance, strategic priorities, including AIG's pursuit of separation of its Life and Retirement business, business mix and market conditions and the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially.
Factors that could cause results to differ include factors described in our third quarter 2021 report on Form 10-Q, our 2020 annual report on Form 10-K and other recent filings made with the SEC. AIG is under no obligation and expressly disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
Additionally, some remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website, www.aig.com.
With that, I would now like to turn the call over to Peter Zaffino, President and CEO of AIG.
Peter Zaffino;President, CEO, Global COO & Director: Good morning, and thank you for joining us today to review our third quarter results. I'm pleased to report that AIG had another outstanding quarter as we continue to build momentum and execute on our strategic priorities. We continue to drive underwriting excellence across our portfolio. We're executing on AIG 200 to instill operational excellence in everything we do. We are continuing to work on the separation of Life and Retirement from AIG. And we're demonstrating an ongoing commitment to thoughtful capital management.
I will start my remarks with an overview of our consolidated financial results for the third quarter. I will then review our results for General Insurance, where we continue to demonstrate market leadership in solving risk issues for clients while delivering improved underwriting profitability and more consistent results. I'll also comment on certain market dynamics, particularly in the property market, as well as recent CAT activity and related reinsurance considerations as we approach year-end.
Next, I'll review results from our Life and Retirement business, which we continue to prepare to be a stand-alone company. I will also provide an update on the considerable progress we're making on the operational separation of Life and Retirement from AIG and our strong execution of AIG 200.
I will then review capital management, where our near-term priorities remain unchanged from those I have outlined in the past: debt reduction, return of capital to shareholders, investment in our business through organic growth and operational improvements.
Finally, I will conclude with our recently announced senior executive changes that further position AIG for the long term. These appointments were possible due to the strong bench of internal talent and significantly augment the leadership team across our company. I will then turn the call over to Mark, who will provide more detail on our financial results, and then we'll take your questions.
Starting with our consolidated results. As I said, AIG had another outstanding quarter, continuing the terrific trends we've experienced throughout 2021. Against the backdrop of a very active CAT season and the persistent and ongoing global pandemic, our global team of colleagues continue to perform at an incredibly high level, delivering value to our clients, policyholders and distribution partners.
Adjusted after-tax income in the third quarter was $0.97 per diluted share compared to $0.81 in the prior year quarter. This result was driven by significant improvement in profitability in General Insurance, very good results in Life and Retirement, continued expense discipline and savings from AIG 200 and executing on our capital management strategy.
In General Insurance, Global Commercial drove strong top line growth. And we were especially pleased with our adjusted accident year combined ratio, which improved 280 basis points year-over-year to 90.5%. These excellent results in General Insurance validate the strategy we've been executing on to vastly improve the quality of our portfolio and build a top-performing culture of disciplined underwriting.
One data point that I believe demonstrates the incredible progress we have made is our accident year combined ratio for the first 9 months of 2021, which was 97.7%. That's including CATs. This represents a 770 basis point improvement year-over-year, with 600 of that improvement coming from the loss ratio and 170 from the expense ratio.
In Life and Retirement, we again had solid results primarily driven by improved investment performance and increased call and tender income. This business delivered a return on adjusted segment common equity of 12.2% for the third quarter and 14.3% for the first 9 months of the year. And we recently achieved an important milestone in the separation process by closing the sale of a 9.9% equity stake in Life and Retirement to Blackstone for $2.2 billion in cash. We continue to prepare the business for an IPO in 2022, and we'll begin moving certain assets under management to Blackstone.
We ended the third quarter with $5.3 billion in parent liquidity after redeeming $1.5 billion in debt outstanding and completing $1.1 billion in share repurchases. Year-to-date, we have reduced financial debt outstanding by $3.4 billion and have returned $2.5 billion to shareholders through share repurchases and dividends.
We expect to redeem or repurchase an additional $1 billion of debt in the fourth quarter and to repurchase a minimum of $900 million of common stock through year-end to complete the $2 billion of stock repurchase we announced on our last call. Through these actions, we've made clear our continuing commitment to remain active and thoughtful about capital management.
Now let me provide more detail on our business results in the third quarter. I will start with General Insurance, where, as I mentioned earlier, growth in net premiums written continued to be very strong, and we achieved our 13th consecutive quarter of improvement in the adjusted accident year combined ratio.
Adjusting for foreign exchange, net premiums written increased 10% year-over-year to $6.6 billion. This growth was driven by Global Commercial, which increased 15%, with Personal Insurance flat for the quarter.
Growth in Commercial was balanced between North America and International, with North America increasing 18% and International increasing 12%. Growth in North America Commercial was driven by Excess Casualty, which increased over 50%; Lexington Wholesale, which continued to show leadership in the E&S market and grew Property and Casualty by over 30%; Financial Lines, which increased over 20%; and Crop Risk Services, which grew more than 50% driven by increased commodity prices.
In International Commercial, Financial Lines grew 25%, Talbot had over 15% growth, and Liability had over 10% growth. In addition, gross new business in Global Commercial grew 40% year-over-year to over $1 billion. In North America, new business growth was more than 50%, and in International, it was more than 25%. North America new business was strongest in Lexington, Financial Lines and Retail Property. International new business came mostly from Financial Lines and our Specialty businesses.
We also had very strong retention in our in-force portfolio, with North America improving retention by 200 basis points and International improving retention by 700 basis points.
Turning to rate. Strong momentum continued with overall Global Commercial rate increases of 12%. In many cases, this is the third year where we have achieved double-digit rate increases in our portfolio.
North America Commercial's overall 11% rate increases were balanced across the portfolio and led by Excess Casualty, which increased over 15%; Financial Lines, which also increased over 15%; and Canada, where rates increased by 17%, representing the 10th consecutive quarter of double-digit rate increases.
International Commercial rate increases were 13% driven by EMEA, excluding Specialty, which increased by 22%; U.K., excluding Specialty, which increased 21%; Financial Lines, which increased 24%; and Energy, which was up 14%, its 11th consecutive quarter of double-digit rate increases.
Turning to Global Personal Insurance. We had a solid quarter that reflected a modest rebound in net premiums written in Travel and Warranty, offset by results in the Private Client Group due to reinsurance cessions related to Syndicate 2019 and nonrenewals in peak zones.
Shifting to underwriting profitability. As I noted earlier, General Insurance's accident year combined ratio ex CAT was 90.5%. The third quarter saw a 150 basis point improvement in the accident year loss ratio ex CAT and a 130 basis point improvement in the expense ratio, all of which came from the GOE ratio. These results were driven by our improved portfolio mix, achieving rate in excess of loss cost trends, continued expense discipline and benefits from AIG 200.
Global Commercial achieved an impressive accident year combined ratio ex CATs of 88.9%, an improvement of 290 basis points year-over-year and the second consecutive quarter with a sub-90% combined ratio result. The accident year combined ratio ex CAT for North America Commercial and International Commercial were 90.5% and 86.8%, respectively, an improvement of 370 basis points and 210 basis points. In Global Personal Insurance, the accident year combined ratio ex CATs was 94.2%, an improvement of 220 basis points year-over-year driven by improvement in the expense ratio.
Given the significant progress we have made to improve our combined ratios and our view that the momentum we have will continue for the foreseeable future, we now expect to achieve a sub-90% accident year combined ratio ex CAT for full year 2022. After 3 years of significant underwriting margin improvement, we believe that the sub-90% accident year combined ratio ex CAT is something that not only will be achieved for full year 2022, but that there will continue to be runway for further improvement in future years.
Turning to CATs. As I said earlier, the third quarter was very active, with current industry estimates ranging between $45 billion and $55 billion globally. We reported approximately $625 million of net global CAT losses with approximately $530 million in Commercial. The largest impacts were from Hurricane Ida and flooding in Europe, where we saw net CAT losses of approximately $400 million and $190 million, respectively.
We have put significant management focus into our reinsurance program, which continues to perform exceptionally well to reduce volatility, including strategic purchases for wind that we made in the second quarter. Reinsurance recoveries in our International per occurrence, Private Client Group per occurrence and other discrete reinsurance programs also reduced volatility in the third quarter.
We expect any fourth quarter CAT losses to be limited given that we are close to attaching on our North America aggregate cover and our aggregate cover for rest of the world, excluding Japan. We have each and every loss deductibles of $75 million for North America wind, $50 million for North America earthquake and $25 million for all other North America perils and $20 million for international. Our worldwide retention has approximately $175 million remaining before attaching in the aggregate, which would essentially be for Japan CAT.
Taking a step back for a moment, I want to acknowledge the frequency and severity of natural catastrophes in recent years. Since 2012 and excluding COVID, there have been 10 CATs with losses exceeding $10 billion. And 9 of those 10 occurred in 2017 through the third quarter of this year.
Average CAT losses over the last 5 years have been $114 billion, up 30% from the 10-year average and up 40% from the 15-year average. And through 2021, catastrophe losses exceed $100 billion, and we're already at $90 billion through the third quarter. This will be the fourth year in the last 5 years in which natural catastrophes have exceeded this threshold. We've never seen consistent CAT losses at this level and as an industry, need to acknowledge that frequency and severity has changed dramatically as a result of climate change and other factors.
I'll make 3 observations. First, while CAT models tended to trend acceptable over the last 20 years, that has not been the case over the last 5 years. Second, over the last 5 years, on average, models have been 20% to 30% below the expected value at the lower return periods. If you add in wildfire, those numbers dramatically increase. Third, industry losses compared to model losses at the low end of the curve have been deficient and need rate adjustments to reflect the significant increase in frequency in CATs.
To address these issues, at AIG, we've invested heavily in our CAT research team to develop our own view of risk in this new environment. As a result of this work, we made frequency and severity adjustments for wildfire, U.S. wind, storm surge, flood as well as numerous other perils in international. We will continue to leverage new scientific studies, improvements in vendor model work and our own claims data to calibrate our views on risk over time to ensure we're appropriately pricing CAT risks.
Across our portfolio, our strategy and primary focus has been and will continue to be to deliver risk solutions that meet our clients' needs while aligning within our risk appetite, which takes into consideration terms and conditions, strategic deployment of limits and a recognition of increased frequency and severity. The significant focus that we've been applying to the critical work we've been doing is showing through in our financial results as you've seen over the course of 2021 with improving combined ratios, both including and excluding CATs.
Now turning to Life and Retirement. Earnings continue to be strong, and in the third quarter were supported by stable equity markets, modestly improving interest rates relative to the second quarter and significant call and tender income. Adjusted pretax income in the third quarter was approximately $875 million.
Individual Retirement, excluding Retail Mutual Funds, which we sold in the third quarter, maintained its upward trajectory with 27% growth in sales year-over-year. Our largest retail product, Index Annuity, was up 50% compared to the prior year quarter.
Group Retirement collectively grew deposits 3% with new group acquisitions ahead of prior year, but below a robust second quarter. Kevin and his team continued to actively manage the impacts from a low interest rate and tighter credit spreads environment. And their earlier provided range for expected annual spread compression has not changed as base investment spreads for the third quarter were within the annual 8 to 6 points (sic) [ 8 to 16 basis points ] guidance.
With respect to the operational separation of Life and Retirement, we continue to make considerable progress on a number of fronts. Our goal is to deliver a clean separation with minimal business disruption and emphasis on speed execution, operational efficiency and thoughtful talent allocation.
We have many work streams in execution mode, including designing a target operating model that will position Life and Retirement to be a successful stand-alone public company, separating IT systems, data centers, software applications, real estate and material vendor contracts and determining where transition services will be required and minimizing their duration with clear exit plans.
We continue to expect an IPO to occur in the first quarter of 2022 or potentially in the second quarter, subject to regulatory approvals and market conditions. As I mentioned on our last call, due to the sale of our affordable housing portfolio and the execution of certain tax strategies, we are no longer constrained in terms of how much of Life and Retirement we can sell on an IPO.
Having said that, we currently expect to retain a greater than 50% interest immediately following the IPO and to continue to consolidate Life and Retirement's financial statements until such time as we fall below the 50% ownership threshold. As we plan for the full separation of Life and Retirement, the timing of further secondary offerings will be based on market conditions and other relevant factors over time.
With respect to AIG 200, we continue to advance this program and remain on track to deliver $1 billion in run rate savings across the company by the end of 2022 against a cost to achieve of $1.3 billion. $660 million of run rate savings are already executed or contracted, with approximately $400 million recognized to date in our income statement.
As with the underwriting turnaround, which created a culture of underwriting excellence, AIG 200 is creating a culture of operational excellence that is becoming the way we work across AIG.
Before turning the call over to Mark, I'd like to take a moment to discuss the senior leadership changes we announced last week. Having made significant progress during the first 9 months of 2021 across our strategic priorities and in light of the momentum we have heading towards the end of the year, this was an ideal time to make these appointments.
I'll start with Mark, who will step into a newly created role, Global Chief Actuary and Head of Portfolio Management for AIG on January 1. As you all know, over the last 3 years, Mark has played a critical role in the repositioning of AIG. He originally joined AIG in 2018 as our Chief Actuary. And this new role will get him back into the core of our business, driving portfolio improvement, growth and prudent decision-making by providing guidance on important performance metrics within our risk appetite and evolving our reinsurance program.
Shane Fitzsimons will take over for Mark as Chief Financial Officer on January 1. Shane joined AIG in 2019, and his strong leadership helped accelerate aspects of AIG 200 and instill discipline and rigor around our finance transformation, strategic planning, budgeting and forecasting processes. He has a strong financial and accounting background having worked at GE for over 20 years in many senior finance roles, including as Head of FP&A and Chief Financial Officer of GE's international operations. Shane has already begun working with Mark on a transition plan, and we've shifted his AIG 200 and shared services responsibility to other senior leaders.
We also announced that Elias Habayeb has been named Chief Financial Officer of Life and Retirement. Elias has been with AIG for over 15 years and was most recently our Deputy CFO and Principal Accounting Officer for AIG as well as the CFO for General Insurance. Elias has deep expertise about AIG. And his transition to Life and Retirement will be seamless as he is well known to that management team, the investments team that is now part of Life and Retirement, our regulators, rating agencies and many other stakeholders.
Overall, I am very pleased with our team, our third quarter results and the tremendous progress we're making on many fronts across AIG.
With that, I'll turn the call over to Mark.
Mark Lyons;Executive VP & CFO: Thank you, Peter, and good morning to all. I am extremely pleased with the strong adjusted earnings this quarter of $0.97 per share and our profitable General Insurance calendar quarter combined ratio, which includes CATs, of 99.7%. The year-over-year adjusted EPS improvement was driven by a 750 basis point reduction in the General Insurance calendar quarter combined ratio, strong growth in net premiums written and earned and a related 280 basis point decrease in the underlying accident year combined ratio ex CAT. Life and Retirement also produced strong APTI of $877 million, along with a healthy adjusted ROE of 12.2%.
The quarter's strong operating earnings and consistent investment performance helped increase adjusted book value per share by 3% sequentially and nearly 9% compared to 1 year ago. The strength of our balance sheet and strong liquidity position were highlights in the period as we made continued progress on our leverage goals with a GAAP debt leverage reduction of 90 basis points sequentially and 350 basis points from 1 year ago today to 26.1%, generated through retained earnings and liability management actions.
Shifting to General Insurance. Due to our achieved profitable growth to date, together with demonstrable volatility reduction and smart cycle management, makes us even more confident in achieving our stated goal of a sub-90% accident year combined ratio ex CAT for full year 2022 rather than just exiting 2022.
Shifting now to current conditions. The markets in which we operate persist in strength and show resiliency. AIG's global platform continues to see rate strengthening internationally, which adds to our overall uplift unlike more U.S.-centric competitors. As you recall, International Commercial rate increases lagged those in North America initially. But beginning in 2021, as noted by Peter in his remarks, International is now producing rate increases that surpass those strong rates still being achieved in North America, and in some areas, meaningfully so.
These rate increases continue to outstrip loss cost trends on a global basis across a broadband of assumptions and are additive towards additional margin expansion. In fact, for a more extensive view, within North America over the 3-year period, 2019 through 2021, product lines that achieved cumulative rate increases near or above 100% are found within Excess Casualty, both admitted and non-admitted; Property Lines, both admitted and non-admitted; and Financial Lines. We believe these levels of tailwind will continue driving earned margin expansion into the foreseeable future.
In the current inflationary environment, it's important to remember that products with inflation-sensitive exposure bases, such as sales, receipts and payroll, act as an inflation mitigant and furthermore are subject to additional audit premiums as the economy recovers.
Last quarter, we provided commentary about U.S. portfolio loss cost trends of 4% to 5% and in some aspects were viewed as being near term. We believe that this range still holds but now gravitates towards the upper end given another quarter of data. And in fact, our U.S. loss cost trends range from approximately 3.5% to 10%, depending on the line of business.
From a pricing perspective, we feel that we are integrating these near-term inflationary impact into our rating and portfolio tools. And we are not lowering any line of business loss cost trends since lighter claims reporting may be misconstrued as a false positive due to COVID-19 societal impacts.
It's also worth noting that all of our North America Commercial Lines loss cost trends, with the exception of workers' compensation, are materially lower than the corresponding rate increases we are seeing. This discussion around compound rate increases and loss cost trends collectively give rise to the related topic of current year loss ratio picks or indications and the result in bookings. The strong market that we now enjoy, in conjunction with the significant underwriting transformation at AIG, has driven other aspects of the portfolio that affect loss ratios.
In many lines and classes of business, the degree that cumulative rate changes have outpaced cumulative loss cost trend is substantial. And these lead to meaningfully reduced loss ratio indications between 2018 and the 2021 years. Unfortunately, this is where most discussions usually cease with external stakeholders. However, in reality, that is not the end of the discussion but merely the beginning.
Some other aspects that can have material favorable implications towards the profitability of underlying businesses are, one, terms and conditions, which can rival price in the impact; two, a much more balanced submission flow across the insured risk quality spectrum, thereby improving rate adequacy and mitigating adverse selection; three, strategic capacity deployment across various layers of an insurance tower, which can produce preferred positioning and ongoing retention with the customer; and fourth, reinsurance that tempers volatility and mitigates net losses.
Accordingly, even if modest loss ratio beneficial impacts are assigned to each of these nuances, they will additionally contribute to further driving down the 2021 indicated loss ratio beyond that signaled by rate versus loss trend alone. And these are real, and these are happening.
So why are product lines booked at this implied level of profitability by any insurer? Well, there is at least 4 reasons. First, insurers assume the heterogeneous risk of others, and each year is composed of different exposures, rendering so-called on-level projections to be imperfect. Second, most policies are written on an occurrence basis, which means the policy language can be challenged for years, if not decades, potentially including novel series of liability. Third, many lines are extremely volatile and even if every insured is underwritten perfectly -- even if every insured is underwritten perfectly. And fourth, booking an overly optimistic initial loss ratio merely increases the chance of future unfavorable development. Therefore, these types of issues require prudence in the establishment of initial loss ratio picks for most commercial lines of business.
Shifting now to our third quarter reserve review. Approximately $42 billion of reserves were reviewed this quarter, bringing the year-to-date total to approximately 90% of carried pre-ADC reserves. I'd like to spend a little time taking you through the results of our quarterly reserve analysis, which resulted in minimal net movement, confirming the strength of our overall reserve position.
On a pre-ADC basis, the prior year development was $153 million favorable. On a post-ADC basis, it was $3 million favorable. And when reflecting the $47 million ADC amortization on the deferred gain, it was $50 million favorable in total. This means that our overall reserves continue to be adequate, with favorable and unfavorable development balanced across lines of business, resulting in an improved yet neutral alignment of reserves.
Now before looking at the quarter on a segment basis, I'd like to strip away some noise that's in the quarter so we don't get overly lost in the details. One should think of this quarter's reserve analysis as performing all of the scheduled product reviews and then having to overlay 2 seemingly unrelated impacts caused by the receipt of a large subrogation recovery associated with the 2017 and 2018 California wildfires.
The first of these 2 impacts is the direct reduction from North America Personal Insurance reserves of $326 million, resulting from the subrogation recoveries. As a result, we also had to reverse a previously recorded 2018 accident year reinsurance recovery in North America Commercial Insurance of $206 million since the attachment point was no longer penetrated once the subrogation recoveries were received.
These 2 impacts from the subrogation recovery resulted in a net $120 million of favorable development. So excluding their impact restates the total General Insurance PYD as being $70 million unfavorable in total rather than the $50 million of favorable development discussed earlier. This is a better framework to discuss the true underlying reserve movements this quarter.
This $70 million of global unfavorable stems from $85 million unfavorable in global CAT losses together with $50 million favorable in global non-CAT or attritional losses. The $85 million unfavorable in CAT is driven by marginal adjustments involving multiple prior year events from 2019 and 2020. The $15 million non-CAT favorable stems from the net of $255 million unfavorable from Global Commercial and $270 million of favorable development, predominantly from short-tail personal lines businesses within accident year 2020, mostly in our International book. Consistent with our overall reserving philosophy, we were cautious towards reacting to this $270 million favorable indication until we allow the accident year to season.
North America Commercial had unfavorable development of $112 million, which was driven by Financial Lines' strengthening of approximately $400 million with favorable development and other lines led by workers' compensation with approximately $200 million, emanating mostly from accident years 2015 and prior and approximately $100 million across various other units. North America Financial Lines were negatively impacted by primary public D&O, largely in the more complex national accounts arena and within private not-for-profit D&O unit, in addition to some excess coverage mostly in the public D&O space, with 90% emanating from accident years 2016 to 2018.
International Commercial had unfavorable development of $143 million, which was comprised of Financial Lines' strengthening in D&O and professional indemnity of approximately $300 million led by the U.K. and Europe, but the accident year impacts are more spread out. Favorable development was led by our Specialty businesses at roughly $110 million with an additional favorable of approximately $50 million stemming from various lines and regions.
Now as Peter noted, the changes we've made to our underwriting culture and risk appetite over the last few years, coupled with strong market conditions, are now showing through in our financial results. U.S. Financial Lines, in particular, through careful underwriting and risk selection has meaningfully reduced our exposure to securities class actions or SCA lawsuits over the last few years.
Evidence of this underwriting change is best seen through the proportion of SCAs for which the U.S. operation has provided coverage. In 2017, AIG provided D&O coverage to 67 insurers involved in SCAs, which represents 42% of all U.S. federal security class actions in that year. Whereas in 2020, that shrunk to just 18%, and through 9 months of 2021 is only 15 insurers or 14%. This is significant because roughly 60% to 70% of public D&O loss dollars historically emanate from SCAs.
The North America private not-for-profit D&O book has also been significantly transformed. The policy retention rate here between 2018 and 2021, which is a key strategic target, is just 15%. And yet it should also be noted that the corresponding cumulative rate increase over the same period is nearly 130%. This purposeful change in risk selection criteria away from billion-dollar revenue large private companies and nonprofit universities and hospitals to instead a more balanced middle market book will also drive profitability substantially.
International Financial Lines has implemented similar underwriting actions with comparable 3-year cumulative rate increases, along with a singular underwriting authority around the world as respect U.S.-listed D&O exposure through close collaboration with the U.S. Chief Underwriting Office.
In summary, our reserving philosophy remains consistent in that we will continue to be prudent and conservative. This is evidenced by our slower recognition of attritional improvements in short-tail lines from accident year 2020 and from the sound decision to strengthen Financial Line reserves, even though there are some interpretive challenges stemming from a difficult claims environment, changes within our internal claims operations over the last couple of years and potential COVID-19 impacts on claim reporting patterns. All of these underwriting actions we've taken over the last few years make us even more confident in our total reserve position across both prior and current accident years.
Moving on to Life and Retirement. The year-to-date ROE has been a strong 14.3% compared to 12.8% in the first 9 months of last year. APTI during the third quarter saw higher net investment income and higher fee income, offset by the unfavorable impact from the annual actuarial assumption update, which is $166 million pretax, negatively affected the ROE by approximately 250 basis points on an annual basis and EPS by $0.15 per share. The main source of the impact was in the Individual Retirement division associated with fixed annuity spread compression.
Life Insurance reflected a slightly elevated COVID-19-related mortality provision in the quarter. But our exposure sensitivity of $65 million to $75 million per 100,000 population deaths proved accurate based on the reported third quarter COVID-related deaths in the United States. Mortality exclusive of COVID-19 was also slightly elevated in the period.
Within Individual Retirement, excluding the Retail Mutual Fund business, net flows were a positive $250 million this quarter compared to net outflows of $110 million in the prior year quarter largely due to the recovery from the broad industry-wide sales disruption resulting from COVID-19, which we view as a material rebound indicator.
Prior sensitivities in respect to yield and equity market movements affecting APTI continue to hold true. And new business margins generally remain within our targets at current new money returns due to active product management and disciplined pricing approach.
Moving to other operations. The adjusted pretax loss before consolidations and eliminations was $370 million, $2 million higher than the prior quarter of 2020, driven by higher corporate GOE primarily from increases in performance-based employee compensation, partially offset by higher investment income and lower corporate interest expense resulting from year-to-date debt redemption activity.
Shifting to investments. Overall net investment income on an APTI basis was $3.3 billion, an increase of $78 million compared to the prior year quarter, reflecting mostly higher private equity gains.
By business, Life and Retirement benefited most due to asset growth, higher call and tender income and another strong period of private equity returns. General Insurance's NII declined approximately 6% year-over-year due to continued yield compression and underperformance in the hedge fund position. Also, General Insurance has a much higher percentage allocation to private equity and hedge funds, which is likely to change moving forward.
As respect share count, our average total diluted shares outstanding in the quarter were 864 million, and we repurchased approximately 20 million shares. The end-of-period outstanding shares for book value per share purposes was approximately 836 million and anticipated to be approximately 820 million at year-end 2021 depending upon share price performance, given Peter's comments on additional share repurchases.
Lastly, our primary operating subsidiaries remain profitable and well capitalized, with General Insurance's U.S. pool fleet risk-based capital ratio for the third quarter estimated to be between 450% and 460%. And the Life and Retirement U.S. fleet is estimated to be between 440% and 450%, both above our target ranges.
With that, I'll now turn it back over to Peter.
Peter Zaffino;President, CEO, Global COO & Director: Great, Mark, thank you. Operator, we'll take our first question.
Operator: [Operator Instructions] And we will begin with Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question, when you guys -- Peter, when you make the comment that you think you'll hit sub-90% for full year 2022, and then you said that there would be runway for further improvement in future years, I'm just trying -- when you kind of think 2022 and beyond, what are you guys assuming for both pricing and loss trend as we kind of think out the next year and even beyond that time frame?
Peter Zaffino;President, CEO, Global COO & Director: Well, thanks, Elyse. Let me answer the first part why we're so confident that the momentum that we have and the sub-90% combined ratio is achievable. When you look at this quarter and last quarter, just the improvement from the core of the businesses continues to improve at an accelerated pace. And Dave McElroy and the leadership team on the underwriting side, Shane who's now going to move into the CFO role driving AIG 200, just the execution has been terrific.
And why we're confident it's just, again, the momentum when we look at the fundamentals of the business, we're growing top line. We talk, Mark and I, about that we're getting pricing above loss cost, developing margin, expense ratio. All of that goes into our confidence. We have higher retentions on a policy count, very strong new business and think that applied to quality. We have more relevance each quarter in the marketplace.
And so the assumptions are modest. It's not that it has to stay in the same pricing environment. But it is one that we are going to continue to be very disciplined of driving profitability and making sure that where we're deploying capital, that on a risk-adjusted basis, we're going to be getting margin. So I think that -- again, I don't want to give guidance beyond that but feel that next year, we have the momentum. We're executing on all of our strategic imperatives, and we're delivering the results.
Elyse Greenspan: Okay. And then my follow-up on -- you guys said that the Life IPO should take place in the Q1, perhaps in the second quarter of next year. How do we think about capital return? I know you guys have laid out a plan for this year, but how should we think about capital return next year? And is that dependent on when and the ultimate size of what you bring to market with the Life and Retirement business and the IPO?
Peter Zaffino;President, CEO, Global COO & Director: Well, we've been trying to give a lot of guidance in terms of what we intend to do in the short run because of a number of moving pieces. We have strong liquidity, which is what we had talked about in the prepared remarks. Some of the big moving pieces as we get to the back half of the year will be the affordable housing proceeds, the closing of Blackstone, the fact that we're going to continue to execute on debt reduction, share repurchases.
And I think as we get to the fourth quarter call and we have a better line of sight in terms of what we think the actual timing will be on the IPO plus liquidity at year-end, we'll give further guidance as we move forward. But for now, I think we're just going to stick with what we've outlined, and we continue to execute on that each quarter.
Operator: We'll now take the next question from Meyer Shields with KBW.
Meyer Shields: I guess first question for Peter. You laid out a pretty conservative case for the frequency and severity of catastrophes. How should we think about what Validus Re is interested in writing in that context?
Peter Zaffino;President, CEO, Global COO & Director: Thanks, Meyer. Well, I mean, Validus Re, since we've acquired them, we have not increased risk appetite. And as a matter of fact, they take a very conservative position in terms of their nets. And I think that was evidenced in the quarter in terms of our overall CAT number. That's number one.
I think Chris Schaper and the team have done a terrific job of diversification on the portfolio. So we've reduced our aggregates in peak zones, such as Florida, significantly from the original portfolio that we acquired. We're getting better balance in the portfolio across the world, and that's with multiple perils and multiple geographies.
So I think that, that continuation of that strategy of getting balanced diversification and making sure that we're not taking significant nets in the portfolio and making sure that we're driving risk-adjusted returns as we look to 1/1 is going to be very important for Validus Re. But we've been executing on that throughout the year.
Meyer Shields: Okay. Understood. And then as a follow-up for Mark, is there any way of describing the -- I mean you made a very strong case for conservatism in the current accident year loss picks. And I'm wondering how you're thinking about that level of conservatism in recent accident years as of 9/30.
Peter Zaffino;President, CEO, Global COO & Director: Go ahead, Mark.
Mark Lyons;Executive VP & CFO: Yes, thanks. Yes, thank you, Peter. Thanks, Meyer. Actually, we feel very good about accident year '20 and '21, I think the core of your question. And I think I've made a pretty strong case for the changes that have occurred, which I think have been, I think, pretty enormous on it.
And interestingly, overall, I'm confident not just in the current accident years. I'm confident where we are now on the reserve position even and for Financial Lines and in total across the book. And you could kind of say, well, why are you confident? And there's a lot of reasons for it.
I mean when Dave McElroy and his group got in here, they started making some pretty material underwriting changes step by step. And I think it's just endemic upon the analysis of it for not only the past years but the current year is to focus in on exactly what those changes were and then go back with a very tight eye to look at it. And that's exactly what we did. But the transformation of the book, as I itemized on private not-for-profit and public, has been enormous. So I feel very strongly about where we are on those recent years.
Peter Zaffino;President, CEO, Global COO & Director: Mark, since you mentioned Financial Lines, I think maybe Dave can provide some context as to some of the changes and how he's looking at the portfolio. So Dave, maybe you can add to what Mark commented on.
David McElroy: Yes. Thank you, Peter. Thank you, Mark. The -- I know it's probably top of mind, but the Financial Lines book has been one that has been stored at AIG. And most of you know I've been involved with P&L and Financial Lines for my entire 40-year career. So I've seen the bodies float by me. I've seen the strategies avowed and disavowed. And we knew exactly what we were doing when we came in here to look at this portfolio.
So today, I would say that both North America and International are completely different and fundamentally different books than what we had in the '16 to '18 cohort years. That's personal to me. That's also Michael Price, who's running North America for us. But we did the things that are -- that matter, and we've been doing it across all of our lines of business in terms of risk selection, limit management, portfolio balance, the diligence on terms and conditions. Mark talked about a little bit on private, and then we're measuring it on claims.
So the -- this is what this -- I view this as the story that we needed to complete. Mark hit our public company book. That is by and large the measure of a D&O underwriter. And if you're in the public company space, you're talking about your securities class action exposure, and the 67% of your annual loss costs are driven by those cases.
So when you think about that, it's a math equation of 200 of these are normally filed out of 5,500 total public companies. So risk selection matters. What we found here was probably chasing premium versus chasing quality accounts. So we might -- we were overweighted in technology and life science and health care and new economy and unicorns trying to go public instead of trying to build a portfolio of what I'd consider to be stable, less volatile stocks.
So from a company class industry standpoint, we gave some more definition to our underwriting teams about what they should be looking at and then trying to stay away from what I consider to be the target-rich environment of the plains thus far, which are stock volatility, market cap volatility and basically a ready-made securities class action case.
So that's a lot of the re-underwriting that's been done. It's -- we knew it was going to take a little bit of time. The evidence of that is now showing up. We've taken out $65 billion of limits. We -- you've heard our story around $650 billion of limits taken out across the portfolio. $65 billion of it is in these products alone. And more importantly, and that's sort of often how I'm looking at the business is we took it out in primary D&O, okay?
So the natural order of looking at large -- Fortune 500 companies used to be at $25 million. They're now at $10 million. 81% of our portfolio is at $10 million there versus what would have been $25 million 4 years ago. The same with a -- what I consider to be NASDAQ mid-cap, they were 15s and 10s. They're now $5 million. 66% of the book is now $5 million.
So we've compressed limits. We've addressed the retention issue. We were trying to -- we recognize that M&A bump-up claims were actually affecting primary underwriters -- and I think that's been on other calls. They were affecting primary underwriters more disparately than excess underwriters. So we increased our retentions there.
These are all the tools that were always available to us. We just actually pushed them forward. And I -- we're trying to get in front of it, but basically, we believe strongly that this portfolio today is a very different portfolio from a risk selection standpoint, from a balance perspective in terms of excess and side A versus primary versus the limits versus our controlling the aggregate.
I would also sort of finalize that by saying this is a claims-made book. So in many ways, we'll actually know within that 3- to 5-year window all the work that's been done. And our frequency and severity has dropped dramatically in these '20, '21 years, not only in securities class actions, we're running at less than half. But because of limit management, we're running at 2/3 lower in terms of limits exposed to class action suits as well. So these the are tools...
Peter Zaffino;President, CEO, Global COO & Director: Dave, your passion is coming through very much. We probably want to take another question.
David McElroy: And then, by the way, we have gotten compounded rate increases of 100%. So I apologize, that's...
Peter Zaffino;President, CEO, Global COO & Director: That's terrific. Thank you.
Operator: Next, we'll hear from Michael Phillips with Morgan Stanley.
Michael Phillips: I'll be -- 2 quick ones, I think. Mark, your comments on, again, the loss pick thing. Number two was, I think, about well the current stuff and it's long-tailed, and that can lead to risk. And so we're going to be conservative, it looks like the industry. I think that was your number two. Can you tell us, has there been any kind of shift in your book given everything else you guys have done and -- from occurrence to claims-made in the Commercial Lines book? So anything noteworthy that would shift away from occurrence to claims-made?
Mark Lyons;Executive VP & CFO: Great question, Michael. So I would say there's only a handful that are really claims-made, right? It's management liability, it's professional indemnity that really drive it, and super tough product liability case is really claims-made.
It's one thing to shift it gross, it's another thing to ship it net, right? So as we've used different reinsurances over time, that changes the proportions. So we're comfortable with the mix of occurrence and claims-made. There's growth in Financial Lines, as Peter pointed out. And there's some growth in Excess Casualty. The nets are somewhat different but we think appropriate for what we're doing.
Michael Phillips: Okay. Perfect. And then maybe just a real quick point on one, too, on the last question to Dave's answers in the professional lines. There's clearly lots of concerns in the past 18 months or so because of securities class actions and IPOs and SPACs. Would you say given all Dave's comments there that you think your exposure to that type of risk is pretty limited?
Mark Lyons;Executive VP & CFO: Well, yes, I think how Dave explained it is the way the business actually flows, the business actually works. So the key thing is upfront identifying the right classes and the right risk, which they've really done, I think, exceptionally well. And then the second is what goes through the court systems. Given that you have SCAs, even though we are massively reduced in the SCAs, you got to go through all the motions to dismiss and other procedurals that take it there.
So that's what Dave's comment about 3 plus -- 3 to 5 years has to work its way through the court system. But given our reduced exposure, back to a similar answer, that makes us feel so strongly about the recent accident years.
Operator: Next question, Josh Shanker, Bank of America.
Joshua Shanker: At the risk of being labeled a pariah, I'm going to go back to the D&O questions a little bit. Can we talk a little about the accident year picks, not necessarily for AIG, although it can be, what sort of combined ratios were '16, '17 and '18 producing in retrospect?
We've seen tremendous pricing come through. Is D&O business broadly for the industry written in those years being written at a substantial underwriting loss? And the extent to which you took the reserve charges in this quarter, a lot of the business, I assume, was syndicated. Are the syndicates feeling the same kind of pain that you are? Or are you getting ahead of what you think are losses to come?
Peter Zaffino;President, CEO, Global COO & Director: Mark, why don't you comment on Josh's question on loss ratios? And then I think Dave should talk about the pricing.
Mark Lyons;Executive VP & CFO: Josh, I know you're speaking of business. And if you go back -- because speaking to the industry is a little different. I don't want to get out ahead of the industry, but I know you're a schedule fee guy. You go back and look at that, of course, that's U.S. only. And you can look direct, not just net. And that's a combination of management liability and professional, right, in there. But we know it's dominated by the management liability side.
So you can go back and look at the annual statements through 2020 and get an idea. But with regard to syndication, and Dave will pick this up better than I will, but generally, primaries are 100% written. And as you go up the tower, there could be some co-participations, but it's not syndicated like in a huge property transaction the way you're thinking of it. But Dave, do you want to pick that up?
David McElroy: Yes. Thanks, Mark and Josh. Yes, the only thing I'd say there is that you've seen a lot of variability in the schedule piece in terms of portfolios over the years. There can be 40- to 50-point differences consistently. So that speaks to risk selection and the portfolios. But that said, there's definitely verticality that's been happening in those years. That is showing up in the 2019 and 2022 -- 2020 years because the courts did not close for this motion to dismiss and the securities class action. So in fact, if you look at Cornerstone, there were the equal number of settlements in 2020 during COVID that there were in 2019.
So verticality still exists in this business, market cap loss, disclosed damages and what that happens. So I think there's a lot of immaturity in those years that will continue to show up because the cases are still sort of fermenting. There's a 3- to 5-year window on these claims made. It all ties to the motion to dismiss, but they continue to be argued. I think what we saw was a lot of them were argued, and then when they're decided on -- in the client's behalf, then you start negotiating settlements, okay? If the company wins, they normally go away, therapeutics or defense costs, but that's still an unknown in that '16 to '18 cohort year as the verticality of loss for those cases, okay? A number of them got settled in '20. There's a number that are still getting settled in '21, and there'll still be a number that will be settled in '22.
Joshua Shanker: I'm going to hold it to one question for you guys, and just congratulations on everyone's new role.
Operator: Brian Meredith with UBS.
Peter Zaffino;President, CEO, Global COO & Director: And if it's a financial question on the Financial Lines, it will be the last one because I'm going to have to turn it over to Dave again.
Brian Meredith: I'll give you a broader-based one. Peter, if I look at the return on attributed equity for the General Insurance business right now, you had some corporate costs there. It's still below a double-digit return on equity. I guess my question is, is that your goal to achieve a double-digit ROE in that business? And what does the underlying combined ratio need to be in order to achieve that given the kind of current catastrophe outlook and interest rate environment?
Peter Zaffino;President, CEO, Global COO & Director: Thanks, Brian. As we've said in the past, and I really have the same answer, which is we're really focused on driving the profitability earnings, reducing volatility. We're making great progress on the combined ratio, looking at the investment portfolio over time to have less volatility on the Property and Casualty side. We're working through the separation.
And it's hard to give you an answer in terms of the absolute combined ratio and returns until we know all the math in terms of the numerator and denominator. Meaning we just need a little bit more time over the next couple of quarters to separate Life and Retirement, have the path of the IPO and the capital structure that we'll outline in more detail for you. But we know that, that is an important guidance in terms of when we are in future state, and we'll work towards that.
But I think now with the number of moving pieces between the 9.9% in terms of what we're doing to set up the IPO and what we're doing with General Insurance in terms of growth, we see a lot of opportunities to grow with margin and with improved combined ratios over time. And so that's really the primary focus now that giving the ROE guidance once we know the variable is a little bit more fixed, we can do that.
Brian Meredith: That's fair. And then just one other just quick one. Have you done any work or maybe just some general perspective on what LDTI could mean for your Life Insurance business?
Peter Zaffino;President, CEO, Global COO & Director: Well, we are in progress of implementing the new standards and working through it. And so we're analyzing the guidance that's been issued today, formulating approach. We know that we have the IPO coming up, so we have an enormous amount of resources on it. But it's really just too early for us to provide the estimates. But it's a key area of focus for the company and one that we'll give guidance as we get in subsequent quarters.
Thanks, Brian. I think that's going to wrap it. Look, I really appreciate it. Appreciate the time. I want to thank all of our colleagues for all the great work, and I hope everybody has a great day. Thank you.
Operator: And with that, ladies and gentlemen, this will conclude your conference for today. We do thank you for your participation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to the AIG's Third Quarter 2021 Financial Results Conference Call. Today's conference is being recorded. And now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead, sir."
},
{
"speaker": "Quentin McMillan",
"text": "Thank you, Jake. Today's remarks may contain forward-looking statements, including comments related to company performance, strategic priorities, including AIG's pursuit of separation of its Life and Retirement business, business mix and market conditions and the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Good morning, and thank you for joining us today to review our third quarter results. I'm pleased to report that AIG had another outstanding quarter as we continue to build momentum and execute on our strategic priorities. We continue to drive underwriting excellence across our portfolio. We're executing on AIG 200 to instill operational excellence in everything we do. We are continuing to work on the separation of Life and Retirement from AIG. And we're demonstrating an ongoing commitment to thoughtful capital management."
},
{
"speaker": "I will then review capital management, where our near-term priorities remain unchanged from those I have outlined in the past",
"text": "debt reduction, return of capital to shareholders, investment in our business through organic growth and operational improvements."
},
{
"speaker": "Mark Lyons;Executive VP & CFO",
"text": "Thank you, Peter, and good morning to all. I am extremely pleased with the strong adjusted earnings this quarter of $0.97 per share and our profitable General Insurance calendar quarter combined ratio, which includes CATs, of 99.7%. The year-over-year adjusted EPS improvement was driven by a 750 basis point reduction in the General Insurance calendar quarter combined ratio, strong growth in net premiums written and earned and a related 280 basis point decrease in the underlying accident year combined ratio ex CAT. Life and Retirement also produced strong APTI of $877 million, along with a healthy adjusted ROE of 12.2%."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Great, Mark, thank you. Operator, we'll take our first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] And we will begin with Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, when you guys -- Peter, when you make the comment that you think you'll hit sub-90% for full year 2022, and then you said that there would be runway for further improvement in future years, I'm just trying -- when you kind of think 2022 and beyond, what are you guys assuming for both pricing and loss trend as we kind of think out the next year and even beyond that time frame?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Well, thanks, Elyse. Let me answer the first part why we're so confident that the momentum that we have and the sub-90% combined ratio is achievable. When you look at this quarter and last quarter, just the improvement from the core of the businesses continues to improve at an accelerated pace. And Dave McElroy and the leadership team on the underwriting side, Shane who's now going to move into the CFO role driving AIG 200, just the execution has been terrific."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then my follow-up on -- you guys said that the Life IPO should take place in the Q1, perhaps in the second quarter of next year. How do we think about capital return? I know you guys have laid out a plan for this year, but how should we think about capital return next year? And is that dependent on when and the ultimate size of what you bring to market with the Life and Retirement business and the IPO?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Well, we've been trying to give a lot of guidance in terms of what we intend to do in the short run because of a number of moving pieces. We have strong liquidity, which is what we had talked about in the prepared remarks. Some of the big moving pieces as we get to the back half of the year will be the affordable housing proceeds, the closing of Blackstone, the fact that we're going to continue to execute on debt reduction, share repurchases."
},
{
"speaker": "Operator",
"text": "We'll now take the next question from Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "I guess first question for Peter. You laid out a pretty conservative case for the frequency and severity of catastrophes. How should we think about what Validus Re is interested in writing in that context?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thanks, Meyer. Well, I mean, Validus Re, since we've acquired them, we have not increased risk appetite. And as a matter of fact, they take a very conservative position in terms of their nets. And I think that was evidenced in the quarter in terms of our overall CAT number. That's number one."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Understood. And then as a follow-up for Mark, is there any way of describing the -- I mean you made a very strong case for conservatism in the current accident year loss picks. And I'm wondering how you're thinking about that level of conservatism in recent accident years as of 9/30."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Go ahead, Mark."
},
{
"speaker": "Mark Lyons;Executive VP & CFO",
"text": "Yes, thanks. Yes, thank you, Peter. Thanks, Meyer. Actually, we feel very good about accident year '20 and '21, I think the core of your question. And I think I've made a pretty strong case for the changes that have occurred, which I think have been, I think, pretty enormous on it."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Mark, since you mentioned Financial Lines, I think maybe Dave can provide some context as to some of the changes and how he's looking at the portfolio. So Dave, maybe you can add to what Mark commented on."
},
{
"speaker": "David McElroy",
"text": "Yes. Thank you, Peter. Thank you, Mark. The -- I know it's probably top of mind, but the Financial Lines book has been one that has been stored at AIG. And most of you know I've been involved with P&L and Financial Lines for my entire 40-year career. So I've seen the bodies float by me. I've seen the strategies avowed and disavowed. And we knew exactly what we were doing when we came in here to look at this portfolio."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Dave, your passion is coming through very much. We probably want to take another question."
},
{
"speaker": "David McElroy",
"text": "And then, by the way, we have gotten compounded rate increases of 100%. So I apologize, that's..."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "That's terrific. Thank you."
},
{
"speaker": "Operator",
"text": "Next, we'll hear from Michael Phillips with Morgan Stanley."
},
{
"speaker": "Michael Phillips",
"text": "I'll be -- 2 quick ones, I think. Mark, your comments on, again, the loss pick thing. Number two was, I think, about well the current stuff and it's long-tailed, and that can lead to risk. And so we're going to be conservative, it looks like the industry. I think that was your number two. Can you tell us, has there been any kind of shift in your book given everything else you guys have done and -- from occurrence to claims-made in the Commercial Lines book? So anything noteworthy that would shift away from occurrence to claims-made?"
},
{
"speaker": "Mark Lyons;Executive VP & CFO",
"text": "Great question, Michael. So I would say there's only a handful that are really claims-made, right? It's management liability, it's professional indemnity that really drive it, and super tough product liability case is really claims-made."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Perfect. And then maybe just a real quick point on one, too, on the last question to Dave's answers in the professional lines. There's clearly lots of concerns in the past 18 months or so because of securities class actions and IPOs and SPACs. Would you say given all Dave's comments there that you think your exposure to that type of risk is pretty limited?"
},
{
"speaker": "Mark Lyons;Executive VP & CFO",
"text": "Well, yes, I think how Dave explained it is the way the business actually flows, the business actually works. So the key thing is upfront identifying the right classes and the right risk, which they've really done, I think, exceptionally well. And then the second is what goes through the court systems. Given that you have SCAs, even though we are massively reduced in the SCAs, you got to go through all the motions to dismiss and other procedurals that take it there."
},
{
"speaker": "Operator",
"text": "Next question, Josh Shanker, Bank of America."
},
{
"speaker": "Joshua Shanker",
"text": "At the risk of being labeled a pariah, I'm going to go back to the D&O questions a little bit. Can we talk a little about the accident year picks, not necessarily for AIG, although it can be, what sort of combined ratios were '16, '17 and '18 producing in retrospect?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Mark, why don't you comment on Josh's question on loss ratios? And then I think Dave should talk about the pricing."
},
{
"speaker": "Mark Lyons;Executive VP & CFO",
"text": "Josh, I know you're speaking of business. And if you go back -- because speaking to the industry is a little different. I don't want to get out ahead of the industry, but I know you're a schedule fee guy. You go back and look at that, of course, that's U.S. only. And you can look direct, not just net. And that's a combination of management liability and professional, right, in there. But we know it's dominated by the management liability side."
},
{
"speaker": "David McElroy",
"text": "Yes. Thanks, Mark and Josh. Yes, the only thing I'd say there is that you've seen a lot of variability in the schedule piece in terms of portfolios over the years. There can be 40- to 50-point differences consistently. So that speaks to risk selection and the portfolios. But that said, there's definitely verticality that's been happening in those years. That is showing up in the 2019 and 2022 -- 2020 years because the courts did not close for this motion to dismiss and the securities class action. So in fact, if you look at Cornerstone, there were the equal number of settlements in 2020 during COVID that there were in 2019."
},
{
"speaker": "Joshua Shanker",
"text": "I'm going to hold it to one question for you guys, and just congratulations on everyone's new role."
},
{
"speaker": "Operator",
"text": "Brian Meredith with UBS."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "And if it's a financial question on the Financial Lines, it will be the last one because I'm going to have to turn it over to Dave again."
},
{
"speaker": "Brian Meredith",
"text": "I'll give you a broader-based one. Peter, if I look at the return on attributed equity for the General Insurance business right now, you had some corporate costs there. It's still below a double-digit return on equity. I guess my question is, is that your goal to achieve a double-digit ROE in that business? And what does the underlying combined ratio need to be in order to achieve that given the kind of current catastrophe outlook and interest rate environment?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thanks, Brian. As we've said in the past, and I really have the same answer, which is we're really focused on driving the profitability earnings, reducing volatility. We're making great progress on the combined ratio, looking at the investment portfolio over time to have less volatility on the Property and Casualty side. We're working through the separation."
},
{
"speaker": "Brian Meredith",
"text": "That's fair. And then just one other just quick one. Have you done any work or maybe just some general perspective on what LDTI could mean for your Life Insurance business?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Well, we are in progress of implementing the new standards and working through it. And so we're analyzing the guidance that's been issued today, formulating approach. We know that we have the IPO coming up, so we have an enormous amount of resources on it. But it's really just too early for us to provide the estimates. But it's a key area of focus for the company and one that we'll give guidance as we get in subsequent quarters."
},
{
"speaker": "Operator",
"text": "And with that, ladies and gentlemen, this will conclude your conference for today. We do thank you for your participation, and you may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 2 | 2,021 | 2021-08-06 08:30:00 | Operator: Ladies and gentlemen, good day, and welcome to AIG's Second Quarter 2021 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thank you, Nora. Today's remarks may contain forward-looking statements, including comments related to company performance, strategic priorities, including AIG's pursuit of a separation of its Life and Retirement business, business mix and market conditions and the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially.
Factors that could cause results to differ include the factors described in our first quarter 2021 report on Form 10-Q, our 2020 annual report on Form 10-K and other recent filings made with the SEC. AIG is not under any obligation and expressly disclaims any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.
Additionally, some remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at www.aig.com.
With that, I will now turn the call over to Peter Zaffino, President and CEO of AIG.
Peter Zaffino: Good morning, and thank you for joining us. We have a lot of topics to cover this morning as we made significant progress on many initiatives over the last 90 days.
I will start today's remarks with an overview of AIG's outstanding consolidated financial results for the second quarter. Then I will review results for General Insurance and Life and Retirement in more detail. Following that, I will provide an update on the progress we're making on AIG 200 and the operational separation of Life and Retirement from AIG.
Next, I will provide details on the strategic partnership we announced with Blackstone in July, which represents a significant milestone for AIG and a major step forward towards the IPO of Life and Retirement. And lastly, I will provide an update on our capital management strategy where our near-term priorities remain the same as what I've outlined in the past: debt reduction, return of capital to shareholders in the form of share repurchases and investment in organic growth. Mark will provide additional details on the quarter and we'll then take questions.
Starting with our consolidated results, I'm pleased to report that AIG had an outstanding second quarter. We have sustained the significant momentum we had coming into 2021 through the first half of the year and delivered exceptional performance in General Insurance with strong top line growth and significant improvement in our combined ratios. Our pivot to growth and focus on demonstrating leadership in the marketplace accelerated through the second quarter as we continued to prioritize underwriting discipline, portfolio optimization, reducing volatility and growing in segments where market conditions are favorable and fall within our risk appetite.
We also saw very good results in our Life and Retirement business, primarily driven by improved investment performance. Life and Retirement's adjusted pretax income increased 26% year-over-year, and the business delivered a return on adjusted segment common equity of 16.4%. We continue to advance AIG 200 with the transformation remaining on track to deliver $1 billion in run rate savings across the company by the end of 2022 against a cost to achieve of $1.3 billion. And as you saw in our press release, our adjusted after-tax income in the second quarter was $1.52 per diluted share compared to $0.64 in the prior year quarter.
Turning to our financial results. I'll start with General Insurance. Growth in net premiums written was very strong in the second quarter, accelerating from the first quarter and continuing the trend that began in 2020 as our heaviest remediation efforts were nearing completion. Net premiums written increased 24% year-over-year to $6.9 billion or approximately 20%, excluding foreign exchange. Growth was strong across both Global Commercial and Personal. Global Commercial net premiums written increased 13%, excluding foreign exchange, reflecting growth in areas with attractive risk-adjusted returns, improving renewal retentions and more than 25% increase in new business compared to the prior year quarter and overall rate increases of 13%.
North America Commercial net premiums written increased 15%, excluding foreign exchange, including strong growth in Excess Casualty, Financial Lines, Retail Property, AIG Re and Lexington. New business increased 25% from the prior year quarter, led by Financial Lines and Lexington wholesale. And renewal retentions improved 300 basis points over the same period. It's worth noting that Lexington had its strongest quarter of new business since we fully repositioned its operating model to focus on wholesale distribution and Excess & Surplus Lines. This business has significant momentum, which we expect will continue for the foreseeable future.
Shifting to International Commercial. Net premiums written grew 10%, excluding foreign exchange, primarily driven by Financial Lines across the U.K., EMEA and Asia Pacific; global specialty, particularly marine and energy; and Talbot, our Lloyd's syndicate. New business increased 26% from the prior year period, led by Financial Lines, marine, energy and Talbot. And renewal retentions increased by 500 basis points over the same period. It's important to emphasize that the growth we are achieving across Commercial is aligned with our risk appetite that we have been executing against over the past 3 years.
We continue to prudently deploy limits, including with respect to new business, with an intense focus on risk aggregation. In addition to strong retention, our growth is being driven by exceptional new business, which in Global Commercial was $1 billion in the second quarter. With respect to Personal Insurance, as we discussed on last quarter's call, the unusually high growth in net premiums written was largely reflective of the creation of Syndicate 2019 in the second quarter of 2020 and the reinsurance cessions associated with creating that syndicate.
Turning to rate. Momentum continued with overall Global Commercial rate increases of 13%. North America Commercial rate increases were 13% with the most notable improvements in Excess Casualty, which was up 20%; Lexington Casualty, which was up 19%; and Lexington wholesale property, which was up 15%. International Commercial rate increases were also 13%, driven by Financial Lines, which was up 21%; property, which was up 18%; and energy, which was up 16%.
Across the global portfolio, the largest rate increases were in cyber, where rates were up almost 40% with the strongest rate increases in North America. We continue to carefully reduce cyber limits and are obtaining tighter terms and conditions to address increasing cyber loss trends, the rising threat associated with ransomware and the systemic nature of cyber risk generally. Underwriting excellence, thoughtful risk selection, tighter terms and conditions and improving rate adequacy have been core areas of focus as we transformed our portfolio.
The General Insurance accident year combined ratio ex CAT improved for the 12th consecutive quarter, coming in at 91.1%, an improvement of 380 basis points from the second quarter of 2020 and an improvement of 990 basis points from the second quarter of 2018. This improvement was comprised of 160 basis point improvement in the accident year loss ratio ex CAT and a 220 basis point improvement in the expense ratio as AIG 200 and the benefits of premium growth continued to contribute to profitability.
Global Commercial achieved an accident year combined ratio ex CAT of 89.3%, an improvement of 500 basis points year-over-year. This is the best result Commercial has reported in the last 15 years. In Personal Insurance, the accident year combined ratio ex CAT was 95.1%, a 70 basis point improvement over the prior year quarter.
Now just a quick comment on reinsurance purchased across General Insurance, where we continue to evolve our reinsurance program to reflect our significantly improved underlying portfolio. In the second quarter, we were very active in the market with 25 specific layers on a variety of treaties placed. Notably, in nearly every instance, we were able to enhance our terms and conditions and our placements were at equivalent or improved pricing in a reinsurance market that is experiencing tighter terms and conditions and rate increases.
With respect to our property CAT program in particular, we took the opportunity in the second quarter to further reduce our per occurrence attachment point in North America through several buy-down CAT layers for peak zone exposures. Lastly, on General Insurance, we remain confident that we will achieve a sub-90% accident year combined ratio ex CAT by the end of 2022.
Based on the progress that I've seen in our underwriting, the ongoing efforts in optimizing our portfolio, the terrific execution of AIG 200 and the significant momentum we've developed, I'm optimistic we'll get there sooner. As we move through the second half of the year and get further into AIG 200 in separation execution, we will provide further comment on our combined ratio expectations.
Now let me turn to AIG Re, which oversees our global assumed reinsurance business. Net premiums written across all lines increased more than 30% in the second quarter compared to the prior year period. Writings were balanced across multiple lines of business with risk-adjusted returns and underwriting ratios improving across the portfolio. Highlights of AIG Re's second quarter results include the following. In U.S. property CAT, we saw rate improvements across all U.S. property business sectors. Increases range from mid-single-digits to upwards of 25%, depending on geography and loss-affected accounts.
In Florida, Validus Re net limits at June 2021 were reduced by more than 40% in coordination with AlphaCat. Since AIG's acquisition of Validus Re in 2018, we reduced the overall limit in Florida by more than 65% or approximately $400 million of annual limit, demonstrating Validus Re's continued discipline and focus on volatility reduction. Further, Florida-specific firms now represent less than 2% of Validus Re's total net premiums written. Our focus remains on regional and nationwide firms in the U.S. as well as international diversification.
In addition, in 2020 and through the second quarter of 2021, less than 25% of AIG Re's net premiums written came from property lines. Building on our retrocessional purchase on 1/1 of worldwide aggregate protection, Validus Re secured further retrocessional protections in June. Specifically, we purchased more peak zone coverage for U.S. wind, Asia wind and California earthquake for the 2021 season. Overall, we have substantially enhanced our portfolio despite heightened competition.
We're very pleased with how AIG Re has evolved. We have exceptionally strong intermediary market support as well as strong client relationships, which have resulted in significant renewal retention and signings. In addition, we've upgraded the talent across the board and have broadened the skill sets of our leaders. We believe this business is much more prepared to assess and opportunistically respond to market conditions.
Turning to Life and Retirement. This business once again delivered very strong results. Life and Retirement's broad leadership position across products and channels enabled us to take advantage of the significant rebound in retail annuity sales with total annuity sales up significantly across our entire annuity offering. Our strong sales resulted in positive Individual Retirement annuity net flows during the quarter. Group Retirement deposits were higher compared to first quarter 2021 levels. And second quarter 2021 new plan participant enrollments increased 20% year-over-year.
As demonstrated regularly in recent quarters, our high-quality investment portfolio is well positioned to navigate uncertain environments. Our variable annuity hedging program has continued to perform as expected, providing downside protection during prolonged periods of volatility. Finally, the strategic partnership with Blackstone further positions Life and Retirement to expand its distribution relationships, enhance its product offerings, and the business will benefit from Blackstone's significant capabilities.
Now let me turn to AIG 200, our global multiyear effort to position AIG for the long term. AIG 200 is continuing with a sense of urgency with all 10 operational programs deep into execution mode. We're 18 months into the transformation. And we have a clear execution path to $1 billion in run rate cost savings with $550 million already executed or contracted, $355 million of which has been recognized to date in our income statement. AIG 200 continues to build a strong foundation across the company and instill a culture of operational excellence.
Turning to the separation of Life and Retirement. We made considerable progress in the second quarter with a focus on speed execution with minimal business disruption. Our separation management office has identified day 1 requirements for Life and Retirement to become a stand-alone company and multiple work streams are under way. This work includes aligning our investments unit with Life and Retirement and preparing for the Blackstone partnership to close. The speed with which our colleagues have moved would not have been possible without the foundational work that's been done as part of AIG 200.
As I've discussed on prior calls, an IPO of up to 19.9% of Life and Retirement was our base case since we announced our intention to separate the business from AIG last October. And we continue to believe an IPO will maximize value for our stakeholders and position the business for additional value creation as a public company. I also noted on our last call that following our announcement, we received several credible inquiries from parties interested in purchasing a minority stake in Life and Retirement as well as our entire investment management group. One of those parties was Blackstone.
We ultimately decided not to pursue the original proposed transactions because we determined that selling the entire investment management group was not in the long-term interest of Life and Retirement. And some of the proposals also contemplated significant reinsurance transactions ahead of an IPO, which we didn't believe would optimize the outcome for shareholders at this stage in the process. In June, Blackstone reengaged with us to determine if we could find a mutually beneficial way to partner that would further our goals for the separation of Life and Retirement. These discussions led to the announcement of the strategic partnership we entered into in mid-July.
We continue to work with a sense of urgency towards an IPO of the Life and Retirement business. Following the 9.9% equity investment by Blackstone, the IPO will likely be the first quarter of 2022 event, subject to required regulatory approvals and market conditions. We previously viewed the fourth quarter of this year as the earliest in IPO would occur with the first quarter of 2022 as a more likely outcome. So our time line is essentially unchanged even with the announced Blackstone transaction.
Additionally, the gain on sale of Affordable Housing, coupled with other factors, provides us with the flexibility to sell down beyond 19.9% as we now expect to fully utilize our foreign tax credits in 2022. This development facilitated our partnership with Blackstone and, as a result, made it more compelling compared to structures we considered since our separation announcement last October. We believe that we are better positioned to accelerate operational separation. And as a result, Life and Retirement will be more comprehensively established as an independent company when the IPO occurs.
Now let me provide additional detail on the Blackstone partnership, which represents a significant milestone for AIG and provides meaningful momentum for the IPO of Life and Retirement. As I mentioned, this partnership represents the culmination of discussions that took place over the last year on several strategic initiatives, and we view it as very beneficial for AIG and Blackstone. Blackstone's leadership has indicated for some time that insurance is a key strategic priority for their firm. And the investment Blackstone is making in our Life and Retirement business is the single largest corporate investment the firm has made in its 35-year history. And Life and Retirement is now Blackstone's single largest client.
This substantial commitment by Blackstone highlights the strength of Life and Retirement's business, Blackstone's belief in the value of the investment and it's a validation of Life and Retirement's market-leading position. Furthermore, Jon Gray, President and COO of Blackstone, was directly involved in the negotiations. He has been a great partner throughout and will join the Board of Directors of the IPO entity at the closing of the equity investment, which we expect to occur in September.
Let me recap some of the terms of the transactions and how we're thinking about future capital structures for AIG and Life and Retirement as stand-alone businesses. Blackstone will acquire a 9.9% cornerstone equity stake in the holding company for AIG's Life and Retirement business for $2.2 billion in an all-cash transaction. The purchase price is equivalent to a multiple of 1.1x the target pro forma adjusted book value of $20.2 billion.
The adjusted book value reflects the combined book value of our Life and Retirement business and a majority of our investments unit as well as the financing arrangements to be undertaken and the amounts to be paid from that entity to AIG just prior to the IPO. As we look to the permanent structure of the IPO entity, we will be raising debt at this entity, consistent with its ratings and peer leverage ratios. The new debt will be used to pay down AIG debt such that the debt stack at AIG and at the IPO entity will both be in line with each company's peers and what we view as the optimal debt-to-total capital ratio for each company.
Life and Retirement will also enter into separately managed account agreements, or SMAs, with Blackstone, whereby Blackstone will manage $50 billion of specific asset classes with that amount growing to $92.5 billion over a 6-year period. Lastly, as I alluded to earlier, we sold certain Affordable Housing assets to Blackstone Real Estate Income Trust for $5.1 billion in an all-cash transaction, which is expected to close by the year-end 2021.
Turning to capital management. We ended the second quarter with $7.2 billion of parent liquidity. The net proceeds from the Blackstone transactions resulted in additional liquidity of $6.2 billion to AIG by year-end 2021. Through the remainder of this year, we plan to pay down $2.5 billion of AIG debt and buy back at least $2 billion of common stock. As we announced in our press release, the AIG Board has authorized additional share repurchases, which, together with the remaining approximately $1 billion left on our prior authorization, brings our total stock buyback authorization to $6 billion.
Together, these capital management actions demonstrate our commitment to delever and return capital to shareholders. In addition, the strength of our overall capital position leaves us with ample capacity to continue to invest in growth, particularly in General Insurance, where market conditions continue to be extremely favorable.
Now I'll turn it over to Mark to provide more detail on the quarter.
Mark Lyons: Thank you, Peter, and good morning, everyone. For the second quarter of 2021, AIG reported adjusted pretax income, or APTI, of $1.7 billion and adjusted after-tax income of $1.3 billion. We produced an annualized return on adjusted common equity of 10.5% for AIG, 12.3% for General Insurance and 16.4% for Life and Retirement.
The annualized return on adjusted tangible common equity was 11.6% for the quarter. On a GAAP basis, AIG reported $91 million of net income with the principal difference between GAAP and adjusted after-tax income of $1.3 billion being the accounting treatment of Fortitude, net investment income and associated realized gains and losses.
Before I move to General Insurance though, I'd like to add to Peter's remarks on the Blackstone SMA. This arrangement incorporates specific specialty asset classes comprised mostly of private credit, alternatives and structured products, where Blackstone is a world leader in sourcing and origination and has a demonstrated track record of delivering yield uplift and not public fixed income securities.
The fee structure is 30 basis points on the initial $50 billion of AUM, increasing to 45 basis points for the annual new AUM of $8.5 billion starting 4 quarters later as well as for the reinvested run-off AUM. Therefore, fee should rise from 30 basis points initially towards 43 basis points by the end of the initial 6-year contract term for Blackstone's share of the assets. For this part of our portfolio, it's fair to expect that fees will somewhat precede the benefits of the impact of enhanced origination and differentiated asset classes and recognition of related yield uplift.
We believe this SMA arrangement is unique in that L&R maintains control over its overall asset allocation, asset-liability management, liquidity and credit profile and the nature of individual investment structures. In addition, Life and Retirement has the opportunity to enhance overall investment management by focusing on improving efficiencies and asset classes that are not part of the SMA as well as optimizing performance across the whole portfolio. We believe the combination of these efficiencies, together with the Blackstone focus on maximizing the performance of SMA assets and growth opportunities on the overall AUM, should drive net yield uplift.
Before leaving the Blackstone transaction, I want to note that a GAAP loss on sale is anticipated with a 9.9% equity purchase by Blackstone as well as with subsequent IPO sell-downs due to the inclusion of OCI and GAAP book value. Given that OCI in future periods is subject to market fluctuations, the impact cannot be fully estimated at this time.
As respects Affordable Housing, note that the $5.1 billion purchase price translates to an approximate $3 billion after-tax gain on sale, which will benefit book value and provides approximately $4 billion of cash to parent with a minority portion held back in a regulated Life and Retirement entity to further strengthen an already historically strong RBC level. This transaction is expected to close by year-end 2021.
Moving to General Insurance. Second quarter adjusted pretax income was $1.2 billion, up $1 billion even year-over-year, primarily reflecting increased pretax underwriting income of over $800 million, along with $200 million and change of increased pretax net investment income, driven primarily by private equity returns. Catastrophe losses of $118 million were significantly lower this quarter compared to $674 million in the prior year quarter.
Prior year development was $51 million favorable this quarter compared to favorable development of $74 million in the prior year quarter. This included $58 million of net favorable development in North America and $7 million of net unfavorable development in International, both of which reflect marginal changes in the underlying operations. As usual, there is net favorable amortization from the adverse development cover, which amounted to $49 million this quarter.
It's important to put in context though the recent strength of the property and casualty market and how General Insurance has executed within this environment. As Peter mentioned in his remarks, the book has had nearly 3 turns at correction since 2018. Risk appetite and risk selection have been materially sharpened. Complementary and properly evolving reinsurance programs have been implemented. Certain lines and segments were exited or massively reduced. Clearer and broader distribution has been embraced. And Lexington has been stood up as a major E&S platform.
All of this was accomplished while simultaneously achieving significant rate in excess of loss cost trends with materially better terms and conditions. These actions formed the foundation as to why General Insurance has shown material improvement in the underlying accident year ex CAT combined ratios in both the historically underperforming North America Commercial segment and the International Commercial segment as well.
North America Commercial has shown a 620 basis point improvement in the accident year ex CAT combined ratio over the prior year quarter. The International Commercial segment has continued to improve profitability with 370 basis points improvement compared to the prior year quarter. This shows demonstrable margin improvement stemming from the totality of the actions enumerated earlier. And this level of Global Commercial improvement is noteworthy as Global Commercial made up 71% of worldwide net premiums written through the first half of 2021.
Additionally, the Global Commercial book is increasingly becoming a global specialty book comprised of below-frequency, high-severity coverages. As a result, General Insurance Commercial, although large and global in scope, is not a mere index of the market, but instead an underwriting company, where risk selection and business mix are important factors in achieving profitable growth while mitigating volatility.
Turning to Personal Insurance. As we noted on our first quarter earnings call, our year-over-year net premium written comparison for the second quarter would improve, given the timing of the initial COVID-19 impact and the distortions from Syndicate 2019 being reflected also during the second quarter of 2020. Global Personal Lines net premiums written grew by approximately 45% or 41% on a constant dollar basis, aided by the Syndicate 2019 comparison.
Elsewhere within the segment, the second quarter of 2021 North America Personal Insurance saw premiums in travel and warranty business increase. This was driven by a rebound in travel activity and increased consumer spending but not yet back to the pre-pandemic levels. Our outlook for net premiums written for the next 6 months in North America Personal Insurance is between $450 million and $500 million per quarter.
We continue to anticipate earned margin expansion throughout 2021 and into 2022, resulting from AIG's favorable underwriting actions taken and global market conditions involving strong rate increases well above loss trend, improved terms and conditions and a more profitable, less volatile mix. Given the specific market dynamics of where we choose to play, we don't foresee any material slowing-down in achieved rate levels throughout the balance of the year.
Now I'd like to comment a bit on inflation, which one needs to think about in terms of both economic and social inflation. Based on the Consumer Price Index and the Producer Price Index, headline inflation indicates an annualized rate of about 5.5% to 7.5%, which has accelerated since March. Some components of the indices have become worrisome, such as used cars and trucks being up about 45% and energy commodities being north of 40%. But medical care services, whose impact stretches across most casualty, auto, workers' compensation and excess placements, although higher, are much more tame than headline inflation would indicate with physician services up about 4% recently and hospital services up about 2.5%.
Costs involving labor, materials, construction and related services are up and will impact property coverages and CAT claim costs in the near term. These indications demonstrate that the inflationary impact on any given insurer is a direct function of the products and the mix they write and where they play within an insurance program. Social inflation, however, is much more of a U.S.-centric phenomenon, driven by a highly litigious culture. Social inflation also has correlations to social change initiatives, including income inequality and changing sentiments towards business, to name a few.
Being further away from risk though is a meaningful inflation counter. And AIG's General Insurance has taken strong preemptive action in that regard by minimizing lead umbrellas in favor of higher positions within insurance programs. For example, our Excess Casualty average attachment points for national and corporate U.S. accounts have increased approximately 3.5x and 5.5x, respectively, since 2018. This significantly increased distance from attaching is a key overall portfolio benefit. Taken all together, a U.S. view towards a total inflation rate of 4% to 5% is arguably reasonable for the near to medium term. Our second quarter rate increases, together with our view of pricing for the rest of the year, provide continued margin in excess of this loss cost trend.
Now turning to Life and Retirement. When compared with the prior year, favorable equity markets drove higher alternative investment returns, principally higher private equity returns, which reflect the impact of the 1 quarter lag on the period. Life Insurance continues to reflect the COVID-19-related mortality provision that has dropped relative to the prior quarters. We estimate our exposure to the population is approximately $65 million to $75 million per 100,000 population deaths. Mortality, however, exclusive of COVID-19, continues to be favorable compared to pricing assumptions.
Within Individual Retirement, excluding the Retail Mutual Fund business, net flows were positive for the quarter and favorable by over $1.2 billion when compared with the second quarter of 2020, led by Index Annuities rebounding to be higher by approximately $700 million with Variable Annuity net flow being about $365 million stronger year-over-year. Group Retirement premiums and deposits were up with net flows being relatively flat while also experiencing an improved surrender rate sequentially.
The Life business has seen consistent premiums and lower lapse surrender rates over the last 4 quarters than prior. And for Institutional Markets, premiums and deposits were up compared to the prior year and sequentially. GIC issuance was also higher both sequentially and year-over-year. And we executed several large pension risk transfer transactions during the quarter. The pipeline for pension risk transfer opportunities, both direct and through reinsurance, remain very strong in both the U.S. and in the U.K.
We continue to actively manage the impacts from the low interest rate and tighter credit spread environment. And our earlier provided range for expected annual spread compression has not changed as our base investment spreads for the second quarter were within our annual 8 to 16 point guidance. Further, new business margins generally remain within our targets at current new money returns due to active product management and a disciplined pricing approach. Lastly, post June 30, we closed on the sale of our Retail Mutual Fund operation. As you are aware, Retail Mutual Funds has contributed negative net flows over the last 2 years, and the drag from this will now cease.
Moving to Other Operations. The adjusted pretax loss was $610 million, inclusive of $94 million from consolidation and elimination entries, which principally reflect adjustments offsetting investment returns in the subsidiaries, which are then eliminated at Other Operations. Before consolidations and eliminations, the adjusted pretax loss was $516 million, $184 million worse than the second quarter of 2020. But that quarter included 2 months of Fortitude Re results of $96 million.
In addition, during the second quarter of 2021, we also increased prior year legacy loss reserves by a net $65 million, driven mostly by Blackboard exposures. And we increased our incentive program accrual to reflect the strong performance year-to-date, whereas in 2020, we began adjusting our incentive program accrual in the third quarter. After applying these adjustments, the comparison is actually favorable year-over-year.
Shifting to investments. Overall net investment income on an APTI basis was $3.2 billion, virtually flat from the second quarter of 2020. But again, adjusting the second quarter of 2020 for Fortitude net investment income over that 2-month period, this quarter's net investment income was $362 million higher than the prior year, reflecting strong private equity returns at an annualized 27% return rate for the quarter and hedge fund results at a 21% annualized return rate for the quarter, along with stable interest and dividend income.
Turning to the balance sheet. At June 30, book value per common share was $76.73, up 7% from 1 year ago. Adjusted book value per common share was $60.07 per share, up 7.5% from 1 year ago, driven primarily by strong operating performance. And adjusted tangible book value per common share was $54.24, up 8.1% from a year ago. As Peter noted, at quarter end, AIG parent liquidity was $7.2 billion. During the second quarter, we made a $354 million prepayment to the U.S. Treasury in connection with certain tax settlement agreements emanating from the pre-2007 period as well as completed debt tenders for an aggregate purchase price of $359 million.
Our debt leverage at June 30 was 27% even, down 140 basis points from the end of 2020 and down 360 basis points from June 30, 1 year ago. Our primary operating subsidiaries remain profitable and well capitalized. For General Insurance, we estimate the U.S. pool fleet risk-based capital ratio for the second quarter to be between 460% and 470% and Life and Retirement is estimated to be between 440% and 450%, both above our target ranges.
Lastly, as respects tax, I want to reiterate that the remaining net operating loss or NOL portion of AIG's DTA at the time of deconsolidating L&R for tax purposes will still be available to offset future General Insurance and/or AIG taxable income through their natural expiration. As of June 30, that portion of the DTA totaled $6.3 billion and is available to offset up to $30 billion of taxable income. Upon tax deconsolidation, what will cease is the ability to utilize up to 35% of Life Insurance company income against NOLs or any remaining FTC.
With that, I will now turn it back over to Peter.
Peter Zaffino: Thank you, Mark. Operator, we'll go to question and answer.
Operator: [Operator Instructions] We'll take our first question from Elyse Greenspan from Wells Fargo.
Elyse Greenspan: My first question, Peter, you said you guys could get to that sub-90% margin target within General Insurance perhaps sooner than expected. I was hoping you could expand on that just in terms of time frame. And when you make that comment, are you assuming stable pricing and inflation kind of remains around 4% to 5% based off of what Mark said into 2022?
Peter Zaffino: Thanks, Elyse. I've talked about it in the past that there's many components that are going to drive improved combined ratio. The first is the absolute underwriting performance, and we're seeing that come through in what Mark covered in his script in terms of severity, attritional losses and just less volatility. In addition, we have seen strong top line growth and believe that's in the Commercial side. We're in that market now and see that continuing.
We need less reinsurance that we once needed because of the makeup of the portfolio. So those are all tailwinds. And then in addition to that, you have AIG 200, which I gave some numbers on my prepared remarks that we have real tailwinds there. Not only are we going to continue to have a clear sight in the overall path to $1 billion, but it's starting to earn through in the income statement and just our overall expense discipline.
So we don't heavily rely on one component. There's 4 to 5 that drive it. And no, it does not require us to be in the same rate environment. I mean you have to be in the range on the social inflation and loss cost inflation. But we watch that all the time and believe that we have a lot of momentum. And I'll give more guidance specifically in the next couple of quarters. I mean, the momentum I've seen and the excellent job that Dave McElroy and the entire leadership team have done in General Insurance is a real differentiator. And the momentum they have is tremendous. So it just leaves me with a lot of optimism.
Elyse Greenspan: Great. And then my second question, in terms of Life and Retirement, now that you did this initial sale with Blackstone and you emphasized using most of the foreign tax credits, so it sounds like tax considerations won't impact the amount of L&R that you guys bring to the public market. Do you have a sense of how much you're going to bring on to the public market? And then in terms of the proceeds, do you guys get there? Since you're paying down $2.5 billion of debt now, will the majority of the proceeds from future transactions just be used for buyback and organic growth?
Peter Zaffino: Yes. Thanks, Elyse. In terms of the timing, as I said, we're targeting a first quarter IPO. We're working really hard on the operational separation. We'll close with Blackstone, who's going to be a tremendous partner for us, we hope, in July. And so working over the next 6 months to position Life and Retirement to have a very successful IPO is the primary focus.
Second is we have to think about, I said in my prepared remarks, of like the regulatory environment and the market itself. So that will really dictate in terms of how much we do. And it just gives us a lot of flexibility to accordion it up if there's really favorable market conditions or just to go in with a -- we wouldn't go to an IPO with a 9.9%. We'll do something larger than that. But the size, timing, we'll continue to give you guidance as we get further along in the year with the progress that we're making. I don't know, Mark, if you want to add anything to the capital management, the debt.
Mark Lyons: Just I think that -- I think the core point was to emphasize that this removes the constraint. So rather than on the specifics of the sizing, which as Peter said, which is very market-sensitive and contingent, but having that ability now to not have such a constraint is the main point we really wanted to push over.
Operator: We'll take our next question from Meyer Shields from KBW Investment Bank.
Meyer Shields: First question on the Blackstone partnership. Can you give us a sense of what the internal expenses are that are comparable to the 30 and 45 basis points that will constitute the fees?
Peter Zaffino: Yes. Meyer, thank you for the question. I'll turn it over to Mark in a second. But I think that when we looked at the partnership with Blackstone, there was a variety of factors that went into it, certainly them making a commitment on the equity investment, making certain that Life and Retirement still maintained its authority and ability to shape the investments with Blackstone. So we contained that. A lot of the assets that we have or will transfer are classes that they have exceptional track records on, and so we're working through that.
We do believe that the AUM will grow over time with Life and Retirement. And so this will become a smaller percentage, and the base case was that not only with the Blackstone partnership that our overall business model will evolve to be more efficient over time. But Mark, maybe you could fill in a couple of the details of that.
Mark Lyons: Yes. Well, Meyer, as Peter said, the level of these specialty assets are usually much more labor-intensive and are always on the higher end of the scale, if you think of it in a rate card sense. And so that part is completely within expectations of what we would say. Within -- with our own internal structures, we would have also increasing costs as you graduate up to the overall asset class categories that they are experiencing for us. So there's some gap, but some of that cost accounting view is less clear than you think. But we know what the value we're going to be getting out of that is going to be more than worth it.
Meyer Shields: Okay. Understood. Second question, I guess, this is probably for Mark. I know the expense ratios in North American Personal have been distorted up until the second quarter because of, I guess, depressed travel insurance and the syndicate. Is the second quarter expense ratio run rate, are those representative of what we should see going forward?
Mark Lyons: It's -- what I think that you're going to -- let me make a general statement first. And that is that I think Peter tried a position that's been -- and we may have said this a little bit in past calls. But you should think of the combined ratio gains on the Commercial side of being loss ratio and expense ratio driven and on the Personal Line side, more expense ratio driven. We've gotten a lot more stability in the loss ratios on there, so you'll continue to see that. But to the extent -- it's roughly a -- I would actually say you should anticipate the expense ratio to continue to improve in North America Personal.
Peter Zaffino: And one thing I would add, Meyer, in terms of what Mark just noted is that the high net worth space is changing dramatically in peak zones. We expect to see a continued change in the Excess & Surplus Lines as more alternatives -- it was basically split in the second quarter between admitted and non-admitted new business. So that's just something that we're going to watch. I mean, there's no specific trends that are going to be substantially different than the guidance we've given. But there is some change in that business that we want to make sure with the market-leading position that we take advantage of solving problems for clients but also repositioning the portfolio to have less volatility.
Operator: We'll take our next question from Erik Bass from Autonomous Research.
Erik Bass: I was hoping you could talk a little bit more about the asset management agreement with Blackstone and how you see this affecting Life and Retirement's NII over the next couple of years. It sounds like you expect some initial dilution. But when should this turn and start being accretive to NII? And also, will any of the assets they manage be used to support new business? And could this help you be even more competitive in your fixed indexed annuity offerings?
Peter Zaffino: Yes. Mark, why don't you start and then turn it over to Kevin in terms of talking about product?
Mark Lyons: Yes. Thank you, Peter. Yes. And I think Kevin will have a few things to help you with there as well. So on the asset management, think of it this way, Erik. You've got the -- the uplift will come more delayed than the fees, to your point, firstly. And secondly is as the $50 billion of AUM is worked through, we have been thinking about it mostly, it takes 7 years for that runoff to turn over. As that occurs, it also shifts from 30 to 45 basis points. The $8.5 million annually that will also come in to take it to the 92.5% will be at 45 bps. So you kind of have that curve that I was alluding to in my prepared remarks.
So as a result of that, you're going to have a net yield uplift coming through as a function of when those investments can be made. So if you think of it, you're really -- at the end of year 1, you still have 85% of the original AUM still not turned over, which is why you get the delay aspect. But it's -- we expect that to chip away and close a lot sooner than you might think. But that -- the important point to remember is that L&R completely has that control. So the takeoff between the liquidity and the rating distributions and the asset distribution and capital trade-offs and so forth is all within the management discretion of L&R. Kevin?
Kevin Hogan: Yes. Thank you. So Erik, I think what's important is to keep in mind that this is not a change in our portfolio strategy. This is an enhancement of our portfolio strategy. Blackstone has tremendous origination capability. And we believe that their ability to originate in these asset classes exceeds our current ability. And in addition to that, they have a broader range of assets within the subclasses. And the combination of their ability to originate with more capacity and also the breadth of their asset classes, we believe, will allow us to create new products to support transactions.
And our intention will be to work together to innovate strategies that will allow us to grow faster. We do not think of the balance sheet as static. We think about a growing balance sheet. And so rather than focusing just on the yield of this part of the portfolio, I think about the overall portfolio strategy. So again, this is not a change in our strategy. This is an enhancement of it, and that's how we think about it.
Erik Bass: And then can you help us think about the level of new public expenses that Life and Retirement will have? And will these be able to be offset by savings elsewhere? And then how should we think about the level of expenses that are running through other ops that will remain with the parent, kind of post-separation?
Peter Zaffino: Erik, let me handle that one. The guidance that I provided in the past and we'll stay with is that there are meaningful savings for Life and Retirement within AIG 200. That will be tailwinds to them. We had said around $125 million, Life and Retirement achieved some of that. But there's a big number left for us in terms of earning through that over the next 18 months. So think about roughly $100 million of AIG 200 benefits. Then there is allocations and parent service fees that goes over to Life and Retirement today that will either dissipate or we'll still have those services as we transition for Life and Retirement to become a public company.
So that's in the range of $75-plus million. So Kevin has a decent amount to invest towards building out the public company. And we think with other initiatives for expense savings through separation office that it should largely be neutral to Life and Retirement. And we think the synergies that exist within the remaining company, AIG, that it's neutral to beneficial. And we'll give more guidance as we get closer to the end of the year when we've done more work in the separation office.
Operator: We'll take our next question from Phil Stefano from Deutsche Bank.
Phil Stefano: Yes. Looking at the General Insurance book and mostly focused on Commercial, when we look at the gap in net written versus net earned, I mean, it's clearly there's a runway, just given where the pricing is today for the continued improvement in the underlying loss ratios there. How are you thinking about rate adequacy, the need to continue to push for rate versus just growing and dialing back the rate that you're getting now? Like how are you balancing these 2 dynamics?
Peter Zaffino: Thank you very much for the question. Mark put a lot of comments in his prepared remarks. We watch loss cost inflation and margin on everything we do in terms of portfolio optimization. That's really what I refer to when I talk about how do we position General Insurance, particularly on the Commercial side, to have an optimized portfolio. We've had several years of rate increases. We're building margin.
And some specific lines of business have been getting more rate than others and they're the ones that need it. But it's something that Dave McElroy and the entire team spend every day thinking about and believe that there is absolute runway to continue to develop margin. But Dave, do you want to talk a little bit about how you're approaching it in some of the different segments of the business that you're focused on?
David McElroy: Yes. Thank you, Peter. Thank you, Phil. Phil, the rate increase story is one you don't -- you want to make sure it's calibrated off of all the other things you're doing in the portfolio. So what we've done over the last 3 years is a lot of risk selection and terms and conditions and attachment point and account exposures and managing that. So if you fall in love with a singular rate increase number and you define your book, you ultimately probably end up adversely selected against. So you actually have to put that in context.
And I always use examples. It's like I might have gotten a 10% rate increase on a contractor in New York and I'm still chasing New York labor law, I will lose, okay? And for the industry, it's a little bit of like commercial auto. We've been getting rate increases in commercial auto for 8 years and we still haven't solved that problem. So rate increase can be a false positive. What we've done with a sort of technical understanding of it, looking at it and aggressively realizing that we have a large account book, upper middle-market book, and we need more rate to reflect the more complexity of that book.
So that's -- we think that's sustainable going into the latter part of this year, okay? We think we can accommodate what would be expected loss cost inflations. And at the same time, and this is what I've observed in the last quarter, is there's more pricing to the account, the account characteristics. Is it moderated? Yes, a little bit, okay? But it's moderated off of still over loss cost trends. And what I would say, when I look at my dispersion charts, we don't have the same outlier plus 30% up, but we have a swell of more of a plus 5% to 10%, plus 10% to 20%, plus 20% to 30% type of accounts that are basically aggregating in that in terms of rate reflecting the exposure.
The other piece, and I -- we have to be careful with it because we want to reflect our book and our clients. But we do -- we are in the multiyear phase of a re-underwriting and an influence in the market. And when you look at compounding and you look at the compounding that might exist in Excess Casualty or primary D&O, okay, or even programs, okay, these are numbers that are plus 93%, plus 86%, okay, plus 70% over a period of time of starting in late '18 to the first half of 2021. It's not a panacea, okay? If you're -- if I was trying to write investment banking E&O and I've got 90%, I probably would still lose. But I mean, it's a good baseline for the progress that we've done with the business.
The last thing I'd say is that we had a lot of new business this quarter. I think it was cited on a couple of calls. And remember, this is also being priced now with an elevated rate/price structure. So the same business 2 years ago or 3 years ago is now up that 30% to 40% when we can produce it as a piece of new business. And that's very much formed a lot of our success in this quarter was moving from remediation to an offensive point, capturing the quality of what AIG has with multinational claims reputation complexity and actually building off of that for the strongest new business we've had in a while. So that flows off of technical rate increases and our consistent view of that. But it's important to sort of lay that all out, so you understand that we're not -- we're really looking at this with the lens on all aspects of the business. So with that, I'll...
Phil Stefano: Yes. That's very thorough. Look, maybe a quicker one...
Operator: We'll take our next question from Tracy Benguigui from Barclays.
Tracy Dolin-Benguigui: I see that there is an IPO contingency in the Blackstone transaction. Is that just a timing thing? Or is the IPO contingency also considering a pricing floor for minority IPO proceeds or a minimum equity stake size?
Peter Zaffino: Thanks, Tracy. No, the 9.9% is predicated on a strategic partnership that starts to accelerate all the things that we want to do to set Life and Retirement up to be a public company. And we're really focused on getting that done within the first quarter and making sure that the organization is set up to do that. And again, there's regulatory and market considerations that we'll always look at. But those are really the bigger ones than tying really what the cornerstone investor has brought to the table versus the eventual IPO. As Mark mentioned, we have a lot more flexibility because of the consumption of the foreign tax credits. And so 2022, we'll start to outline what we think will likely happen as we get closer to the end of the year.
Tracy Dolin-Benguigui: Okay. Yes, I was just referring to some fine print in your 8-K that if the IPO didn't happen, there were some recourse. So I didn't know if there was something else that I should also be considering.
Peter Zaffino: No.
Tracy Dolin-Benguigui: Okay. Perfect. Look, anyone could trade growth for margin expansion, but you're at a spot where you're doing both. And I guess, the only place where I don't have visibility is your loss pick. So can you contextualize how your current accident year loss picks have been tracking maybe relative to last year and your 5-year average?
Peter Zaffino: Mark, do you want to cover that?
Mark Lyons: Sure. I guess, a couple of things. First off, we are viewing -- although we're showing substantial margin improvement on a quarter-over-quarter or year-over-year basis, we actually think we're being conservative in this. As I said, I think, on past calls, there has been a lot of change over the last 3 years, including some of the fundamental channels in which we get business. So we think we got every one of those correctly.
Nobody bats 1,000, so you wind up having a little bit of risk margin associated with each of the last several accident years. So we feel good overall. And we feel about the trajectory of the improvement and where it's coming from and that we're not booking and displaying things without having an appropriate risk margin associated with it. I hope that's helpful.
Peter Zaffino: Yes. Thanks, Mark. And I want to just thank everyone for joining us today. Before we end the call, I want to thank our colleagues around the world for what they've accomplished over the last 6 months, especially considering the challenges that have been presented in work remote environments. We have a talented, hardworking colleague base that's executing on multiple complex initiatives simultaneously, which I think makes us very unique, very proud of the team, remains very focused on ensuring quality in everything that we do and delivering significant value to all of our stakeholders. Have a great day.
Operator: That concludes today's conference call. Thank you, everyone, for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Ladies and gentlemen, good day, and welcome to AIG's Second Quarter 2021 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"text": "Thank you, Nora. Today's remarks may contain forward-looking statements, including comments related to company performance, strategic priorities, including AIG's pursuit of a separation of its Life and Retirement business, business mix and market conditions and the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially."
},
{
"speaker": "Peter Zaffino",
"text": "Good morning, and thank you for joining us. We have a lot of topics to cover this morning as we made significant progress on many initiatives over the last 90 days."
},
{
"speaker": "Next, I will provide details on the strategic partnership we announced with Blackstone in July, which represents a significant milestone for AIG and a major step forward towards the IPO of Life and Retirement. And lastly, I will provide an update on our capital management strategy where our near-term priorities remain the same as what I've outlined in the past",
"text": "debt reduction, return of capital to shareholders in the form of share repurchases and investment in organic growth. Mark will provide additional details on the quarter and we'll then take questions."
},
{
"speaker": "Mark Lyons",
"text": "Thank you, Peter, and good morning, everyone. For the second quarter of 2021, AIG reported adjusted pretax income, or APTI, of $1.7 billion and adjusted after-tax income of $1.3 billion. We produced an annualized return on adjusted common equity of 10.5% for AIG, 12.3% for General Insurance and 16.4% for Life and Retirement."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Mark. Operator, we'll go to question and answer."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We'll take our first question from Elyse Greenspan from Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, Peter, you said you guys could get to that sub-90% margin target within General Insurance perhaps sooner than expected. I was hoping you could expand on that just in terms of time frame. And when you make that comment, are you assuming stable pricing and inflation kind of remains around 4% to 5% based off of what Mark said into 2022?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Elyse. I've talked about it in the past that there's many components that are going to drive improved combined ratio. The first is the absolute underwriting performance, and we're seeing that come through in what Mark covered in his script in terms of severity, attritional losses and just less volatility. In addition, we have seen strong top line growth and believe that's in the Commercial side. We're in that market now and see that continuing."
},
{
"speaker": "Elyse Greenspan",
"text": "Great. And then my second question, in terms of Life and Retirement, now that you did this initial sale with Blackstone and you emphasized using most of the foreign tax credits, so it sounds like tax considerations won't impact the amount of L&R that you guys bring to the public market. Do you have a sense of how much you're going to bring on to the public market? And then in terms of the proceeds, do you guys get there? Since you're paying down $2.5 billion of debt now, will the majority of the proceeds from future transactions just be used for buyback and organic growth?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Thanks, Elyse. In terms of the timing, as I said, we're targeting a first quarter IPO. We're working really hard on the operational separation. We'll close with Blackstone, who's going to be a tremendous partner for us, we hope, in July. And so working over the next 6 months to position Life and Retirement to have a very successful IPO is the primary focus."
},
{
"speaker": "Mark Lyons",
"text": "Just I think that -- I think the core point was to emphasize that this removes the constraint. So rather than on the specifics of the sizing, which as Peter said, which is very market-sensitive and contingent, but having that ability now to not have such a constraint is the main point we really wanted to push over."
},
{
"speaker": "Operator",
"text": "We'll take our next question from Meyer Shields from KBW Investment Bank."
},
{
"speaker": "Meyer Shields",
"text": "First question on the Blackstone partnership. Can you give us a sense of what the internal expenses are that are comparable to the 30 and 45 basis points that will constitute the fees?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Meyer, thank you for the question. I'll turn it over to Mark in a second. But I think that when we looked at the partnership with Blackstone, there was a variety of factors that went into it, certainly them making a commitment on the equity investment, making certain that Life and Retirement still maintained its authority and ability to shape the investments with Blackstone. So we contained that. A lot of the assets that we have or will transfer are classes that they have exceptional track records on, and so we're working through that."
},
{
"speaker": "Mark Lyons",
"text": "Yes. Well, Meyer, as Peter said, the level of these specialty assets are usually much more labor-intensive and are always on the higher end of the scale, if you think of it in a rate card sense. And so that part is completely within expectations of what we would say. Within -- with our own internal structures, we would have also increasing costs as you graduate up to the overall asset class categories that they are experiencing for us. So there's some gap, but some of that cost accounting view is less clear than you think. But we know what the value we're going to be getting out of that is going to be more than worth it."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Understood. Second question, I guess, this is probably for Mark. I know the expense ratios in North American Personal have been distorted up until the second quarter because of, I guess, depressed travel insurance and the syndicate. Is the second quarter expense ratio run rate, are those representative of what we should see going forward?"
},
{
"speaker": "Mark Lyons",
"text": "It's -- what I think that you're going to -- let me make a general statement first. And that is that I think Peter tried a position that's been -- and we may have said this a little bit in past calls. But you should think of the combined ratio gains on the Commercial side of being loss ratio and expense ratio driven and on the Personal Line side, more expense ratio driven. We've gotten a lot more stability in the loss ratios on there, so you'll continue to see that. But to the extent -- it's roughly a -- I would actually say you should anticipate the expense ratio to continue to improve in North America Personal."
},
{
"speaker": "Peter Zaffino",
"text": "And one thing I would add, Meyer, in terms of what Mark just noted is that the high net worth space is changing dramatically in peak zones. We expect to see a continued change in the Excess & Surplus Lines as more alternatives -- it was basically split in the second quarter between admitted and non-admitted new business. So that's just something that we're going to watch. I mean, there's no specific trends that are going to be substantially different than the guidance we've given. But there is some change in that business that we want to make sure with the market-leading position that we take advantage of solving problems for clients but also repositioning the portfolio to have less volatility."
},
{
"speaker": "Operator",
"text": "We'll take our next question from Erik Bass from Autonomous Research."
},
{
"speaker": "Erik Bass",
"text": "I was hoping you could talk a little bit more about the asset management agreement with Blackstone and how you see this affecting Life and Retirement's NII over the next couple of years. It sounds like you expect some initial dilution. But when should this turn and start being accretive to NII? And also, will any of the assets they manage be used to support new business? And could this help you be even more competitive in your fixed indexed annuity offerings?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Mark, why don't you start and then turn it over to Kevin in terms of talking about product?"
},
{
"speaker": "Mark Lyons",
"text": "Yes. Thank you, Peter. Yes. And I think Kevin will have a few things to help you with there as well. So on the asset management, think of it this way, Erik. You've got the -- the uplift will come more delayed than the fees, to your point, firstly. And secondly is as the $50 billion of AUM is worked through, we have been thinking about it mostly, it takes 7 years for that runoff to turn over. As that occurs, it also shifts from 30 to 45 basis points. The $8.5 million annually that will also come in to take it to the 92.5% will be at 45 bps. So you kind of have that curve that I was alluding to in my prepared remarks."
},
{
"speaker": "Kevin Hogan",
"text": "Yes. Thank you. So Erik, I think what's important is to keep in mind that this is not a change in our portfolio strategy. This is an enhancement of our portfolio strategy. Blackstone has tremendous origination capability. And we believe that their ability to originate in these asset classes exceeds our current ability. And in addition to that, they have a broader range of assets within the subclasses. And the combination of their ability to originate with more capacity and also the breadth of their asset classes, we believe, will allow us to create new products to support transactions."
},
{
"speaker": "Erik Bass",
"text": "And then can you help us think about the level of new public expenses that Life and Retirement will have? And will these be able to be offset by savings elsewhere? And then how should we think about the level of expenses that are running through other ops that will remain with the parent, kind of post-separation?"
},
{
"speaker": "Peter Zaffino",
"text": "Erik, let me handle that one. The guidance that I provided in the past and we'll stay with is that there are meaningful savings for Life and Retirement within AIG 200. That will be tailwinds to them. We had said around $125 million, Life and Retirement achieved some of that. But there's a big number left for us in terms of earning through that over the next 18 months. So think about roughly $100 million of AIG 200 benefits. Then there is allocations and parent service fees that goes over to Life and Retirement today that will either dissipate or we'll still have those services as we transition for Life and Retirement to become a public company."
},
{
"speaker": "Operator",
"text": "We'll take our next question from Phil Stefano from Deutsche Bank."
},
{
"speaker": "Phil Stefano",
"text": "Yes. Looking at the General Insurance book and mostly focused on Commercial, when we look at the gap in net written versus net earned, I mean, it's clearly there's a runway, just given where the pricing is today for the continued improvement in the underlying loss ratios there. How are you thinking about rate adequacy, the need to continue to push for rate versus just growing and dialing back the rate that you're getting now? Like how are you balancing these 2 dynamics?"
},
{
"speaker": "Peter Zaffino",
"text": "Thank you very much for the question. Mark put a lot of comments in his prepared remarks. We watch loss cost inflation and margin on everything we do in terms of portfolio optimization. That's really what I refer to when I talk about how do we position General Insurance, particularly on the Commercial side, to have an optimized portfolio. We've had several years of rate increases. We're building margin."
},
{
"speaker": "David McElroy",
"text": "Yes. Thank you, Peter. Thank you, Phil. Phil, the rate increase story is one you don't -- you want to make sure it's calibrated off of all the other things you're doing in the portfolio. So what we've done over the last 3 years is a lot of risk selection and terms and conditions and attachment point and account exposures and managing that. So if you fall in love with a singular rate increase number and you define your book, you ultimately probably end up adversely selected against. So you actually have to put that in context."
},
{
"speaker": "Phil Stefano",
"text": "Yes. That's very thorough. Look, maybe a quicker one..."
},
{
"speaker": "Operator",
"text": "We'll take our next question from Tracy Benguigui from Barclays."
},
{
"speaker": "Tracy Dolin-Benguigui",
"text": "I see that there is an IPO contingency in the Blackstone transaction. Is that just a timing thing? Or is the IPO contingency also considering a pricing floor for minority IPO proceeds or a minimum equity stake size?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Tracy. No, the 9.9% is predicated on a strategic partnership that starts to accelerate all the things that we want to do to set Life and Retirement up to be a public company. And we're really focused on getting that done within the first quarter and making sure that the organization is set up to do that. And again, there's regulatory and market considerations that we'll always look at. But those are really the bigger ones than tying really what the cornerstone investor has brought to the table versus the eventual IPO. As Mark mentioned, we have a lot more flexibility because of the consumption of the foreign tax credits. And so 2022, we'll start to outline what we think will likely happen as we get closer to the end of the year."
},
{
"speaker": "Tracy Dolin-Benguigui",
"text": "Okay. Yes, I was just referring to some fine print in your 8-K that if the IPO didn't happen, there were some recourse. So I didn't know if there was something else that I should also be considering."
},
{
"speaker": "Peter Zaffino",
"text": "No."
},
{
"speaker": "Tracy Dolin-Benguigui",
"text": "Okay. Perfect. Look, anyone could trade growth for margin expansion, but you're at a spot where you're doing both. And I guess, the only place where I don't have visibility is your loss pick. So can you contextualize how your current accident year loss picks have been tracking maybe relative to last year and your 5-year average?"
},
{
"speaker": "Peter Zaffino",
"text": "Mark, do you want to cover that?"
},
{
"speaker": "Mark Lyons",
"text": "Sure. I guess, a couple of things. First off, we are viewing -- although we're showing substantial margin improvement on a quarter-over-quarter or year-over-year basis, we actually think we're being conservative in this. As I said, I think, on past calls, there has been a lot of change over the last 3 years, including some of the fundamental channels in which we get business. So we think we got every one of those correctly."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Thanks, Mark. And I want to just thank everyone for joining us today. Before we end the call, I want to thank our colleagues around the world for what they've accomplished over the last 6 months, especially considering the challenges that have been presented in work remote environments. We have a talented, hardworking colleague base that's executing on multiple complex initiatives simultaneously, which I think makes us very unique, very proud of the team, remains very focused on ensuring quality in everything that we do and delivering significant value to all of our stakeholders. Have a great day."
},
{
"speaker": "Operator",
"text": "That concludes today's conference call. Thank you, everyone, for your participation. You may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 1 | 2,021 | 2021-05-07 08:30:00 | Operator: Good day, and welcome to AIG's First Quarter 2021 Financial Results Conference Call. Today's conference is being recorded.
At this time, I'd like to turn the conference over to Ms. Sabra Purtill, Head of Investor Relations. Please go ahead.
Sabra Purtill: Thank you. Good morning, and thank you all for joining us. Today's call will cover AIG's first quarter 2021 financial results announced yesterday afternoon. The news release, the financial supplement and financial results presentation were posted on our website at www.aig.com, and the 10-Q for the quarter will be filed later today after the call.
Our speakers today include Peter Zaffino, President and CEO; and Mark Lyons, Chief Financial Officer. Following their prepared remarks, we will have time for Q&A. David McElroy, CEO, General Insurance; and Kevin Hogan, CEO, Life and Retirement, will be available for Q&A.
Today's remarks may contain forward-looking statements, including comments relating to company performance, strategic priorities, including AIG's intent to pursue a separation of its Life and Retirement business, business mix and market conditions and the effects of COVID-19 on AIG. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may materially differ.
Factors that could cause results to differ include the factors described in our 2020 annual report on Form 10-K and our other recent filings made with the SEC. AIG is not any -- under any obligation and expressly disclaims any obligation to update forward-looking statements, whether as a result of new information, future events or otherwise.
Additionally, some remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website.
I'll now turn the call over to Peter.
Peter Zaffino: Hello, and thank you for joining us today. This morning, I will start our call with a high-level overview of AIG's consolidated financial results for the first quarter. I will then review results from General Insurance and the significant progress we've made with our portfolio, which allowed us to pivot from remediation to growth heading into 2021. Following that, I will review first quarter results for Life and Retirement. I will then provide an update on the work we're doing on the separation of Life and Retirement from AIG. And lastly, I'll provide an AIG 200 update. Mark will give you more details on the financial results, and then we will take questions.
AIG had an excellent start to the year, and we have significant momentum across the entire organization. In the first quarter, we delivered outstanding performance in General Insurance. We saw continued solid results in Life and Retirement. We made meaningful progress on the separation of Life and Retirement from AIG, and we significantly advanced AIG 200 with the transformation remaining on track to deliver $1 billion in savings by the end of 2022 against the cost to achieve of $1.3 billion.
In addition, our balance sheet and financial flexibility remain exceptionally strong, allowing us to focus on profitable growth across our portfolio; prudent investments in modern technology and digital capabilities; separating Life and Retirement from AIG in a manner that maximizes value for our stakeholders and positions both companies for long-term success; and returning capital to our shareholders when appropriate.
As you saw in our press release, our adjusted after-tax income in the first quarter was $1.05 per diluted share compared to $0.12 in the prior year quarter. We ended the first quarter with parent liquidity of $7.9 billion, and we repurchased $92 million of common stock in connection with warrant exercises and an additional $270 million against the $500 million buyback plan we mentioned on our last call. We expect to complete the additional $230 million of that buyback plan by the end of the second quarter.
Turning to General Insurance. Net premiums written increased approximately $600 million year-over-year or approximately 6% on an FX constant basis driven by nearly $1 billion or a 22% year-over-year increase in our global commercial businesses. This 22% increase in global Commercial was driven by higher retentions; excellent new business production, particularly in international; strong performance in first quarter portfolio repositioning; and continued rate momentum.
North America Commercial net premiums written grew by approximately 29%, an outstanding result, due to a variety of factors, including increased 1/1 writings of Validus Re, continued strong submission flow in Lexington, rate improvement, strong retention and higher new business in segments we have been targeting for growth.
In addition, as a result of the improved quality of our North America Commercial portfolio and our improved reinsurance program, which now includes lower attachment points in North America, we did not need to purchase as much CAT reinsurance limit in 2021, the benefits of which will come through in future quarters.
International Commercial had an exceptionally strong first quarter with the year-over-year growth in net premiums written of approximately 13% on an FX constant basis. Increases were balanced across the portfolio with the strongest growth in International Financial Lines, followed by our Specialty business. Looking ahead, we expect overall growth in net premiums written for the remainder of 2021 to be higher than the 6% we saw in the first quarter of this year with more balancing growth across our global commercial and personal portfolios.
With respect to rate, momentum continued with overall global commercial rate increases of 15%. North America Commercial rate increases were also 15% driven by improvements in Lexington Casualty with 36% rate increases, Excess Casualty with 31% rate increases and Financial Lines with rate increases over 24%. International Commercial rate increases maintained strong momentum at 14% in the first quarter of 2021, which is typically the largest quarter of the year for our European business. These increases were driven by Energy with 26% rate increases; Commercial Property with 19% rate increases; and Financial Lines with 20% rate increases.
Turning to global Personal Insurance. Net premiums written in the first quarter declined 23% on an FX constant basis due to our Travel business continuing to be impacted by the pandemic as well as reinsurance cessions to Syndicate 2019, our partnership with Lloyd's. Adjusted for these impacts, global Personal Insurance net premiums written were down only 1.6% on an FX constant basis. We expect to see strong year-over-year growth for the remainder of the year with a rebound in global Personal Insurance as the effects of COVID subside, the repositioning and reunderwriting this portfolio nears completion and a full year of reinsurance cessions relating to Syndicate 2019 will be complete.
We are very pleased with the continued improvement in our combined ratios, including and excluding CATs. I don't need to remind everyone where we were when I outlined our turnaround strategy 3 years ago. In the first quarter this year, the adjusted accident year combined ratio was 92.4%, a 310 basis point improvement year-over-year, driven by a 440 basis point improvement in our adjusted commercial accident year combined ratio. The adjusted accident year loss ratio improved 160 basis points to 59.2%, driven by a 330 basis point improvement in global Commercial.
The expense ratio improved 150 basis points, reflecting the impact of AIG 200 savings and continued expense discipline. We expect to continue to improve the expense ratio throughout 2021, particularly as we deliver on our AIG 200 programs.
To provide further color on combined ratio improvements, in North America, the adjusted accident year combined ratio improved to 95.6%, a 210 basis point improvement year-over-year. This reflects a 370 basis point improvement in the North America Commercial Lines adjusted accident year combined ratio, which came in at 93.9%.
In International, the adjusted accident year combined ratio improved to 90.2%, a 340 basis point improvement year-over-year. This reflects a 490 basis point improvement in the International Commercial Lines adjusted accident year combined ratio, which came in at 86.8%, a 150 basis point improvement in the International Personal Lines adjusted accident year combined ratio, which was 94%.
With respect to catastrophes, first quarter 2021 was the worst first quarter for the industry in over a decade in terms of weather-related CAT losses, largely due to winter storms in Texas. Net CAT losses in General Insurance were $422 million, primarily driven by the Texas storms and do not include any new COVID-related estimated losses for the first quarter.
Now let me touch on reinsurance assumed. As I noted, Validus Re saw strong 1/1 renewals across most lines, with attractive levels of risk-adjusted rate improvement. The team focused on prudent capital deployment and portfolio construction, while improving technical ratios and reducing volatility. With respect to April 1 renewals, within International Property, rate adjustments varied from mid-single digits to upwards of 30% on loss-impacted accounts, and our Japanese renewals were very successful with 100% client retention, net limits largely similar year-over-year and risk-adjusted rate increases, which were in the high single digits.
Before moving on, I want to highlight the quality and the strength of our General Insurance portfolio. Of course, optimization work will continue, but the magnitude of what was accomplished over the last 3 years is worth reflecting on because the first quarter of 2021 was an important inflection point for our team. Our focus pivoted from remediation to driving profitable growth.
These are a couple of concrete examples of how we have repositioned the global portfolio. Gross limits in global Commercial will reduce by over $650 billion. North America Excess Casualty removed over $10 billion in lead limits and increased writings in mid-excess layers in order to achieve a more balanced portfolio. And in Lexington, we repositioned this business to focus on wholesale distribution. The team grew the top line in 2020 for the first time in over a decade. The portfolio is now more balanced, and the submission flow has increased over 100% the last couple of years.
The enormity of the turnaround and the complexity of execution that was accomplished cannot be understated. We now have a disciplined culture that is grounded in underwriting fundamentals, a well-defined and articulated risk appetite. We remain laser-focused on terms and conditions and obtaining rate above loss costs. And we have an appropriate reinsurance program in place to manage severity and volatility. Our global portfolio is poised for improving profitability and more predictable results.
While all this was taking place in General Insurance, our colleagues in Life and Retirement did an excellent job, maintaining a market-leading position in the protection and retirement savings industry and, together with our investment colleagues, consistently delivered solid performance against the backdrop of persistent low interest rates and challenging market conditions.
Turning to Life and Retirement's first quarter. This business also had strong results. Adjusted pretax income in the first quarter was $941 million, and adjusted return on common equity was 14.2%, reflecting our diversified businesses and high-quality investment portfolio. The sensitivities we provided last quarter generally held up with respect to equity markets, 10-year reinvestment rates and mortality, although first quarter results were towards the higher end of our mortality expectations net of reinsurance and other offsets.
We continue to actively manage impacts from the low interest rate and tighter credit spreads environment, and the range we previously provided for expected annual spread compression of 8 to 16 basis points has not changed. Our high-quality investment portfolio is well positioned to navigate uncertain environments, as demonstrated by our steady performance through the macroeconomic stress and high levels of volatility in 2020. And our variable annuity hedging program has continued to perform as expected, providing offsetting protection during periods of volatile capital markets.
We believe Life and Retirement is positioned to deliver strong, sustainable financial results due to the quality of its balance sheet, diversified product offerings and distribution, effective hedging programs and disciplined risk management.
With respect to the separation of Life and Retirement from AIG, we continue to work diligently and with a sense of urgency towards an IPO of up to 19.9% of the business. We made significant progress on several fronts, including preparing standalone audited financials and having an independent party conduct a thorough actuarial review. No concerns have been raised about Life and Retirement's portfolio as a result of this work.
As I noted on our last earnings call, we did receive a number of credible inquiries from parties interested in purchasing a minority stake in Life and Retirement and our Investment Management group. We conducted a robust evaluation of those opportunities to determine if they offered a better long-term outcome for our stakeholders than an IPO. At this time, we believe an IPO remains the optimal path forward to maximize value for our stakeholders and to position the business for additional value creation as a standalone company.
In addition, an IPO allows AIG to retain maximum flexibility regarding the operations of the business as well as the separation process. Overall, I'm pleased with the progress we've made.
Turning to AIG 200. All 10 operational programs are deep into execution mode. Our transformation teams continue to perform exceptionally well, despite the continued remote work environment. Recent progress on IT modernization has enabled us to reach the halfway point or $500 million of our run rate savings target. $250 million in cumulative run rate savings has been realized in APTI through the first quarter of this year, with $75 million of incremental savings achieved within the first quarter income statement.
Key highlights on our progress include the successful transition of our shared services operations in over 6,000 colleagues to Accenture at year-end 2020. This partnership is going extremely well, with KPIs at or better than pre-transition levels. We also negotiated a multiyear agreement with Amazon Web Services to execute on an accelerated cloud strategy, which is a significant step forward in modernizing our infrastructure.
And with the new highly experienced leader in Japan, we made significant progress during the first quarter on our AIG 200 strategy in Japan and are on track to finalize target outcomes as we modernize this business by developing digital capabilities with agile product innovation.
Before turning the call over to Mark, I want to thank our global colleagues for their resilience and excellent support of our clients, policyholders, distribution partners and other stakeholders. The last year, in particular, brought unimaginable stress and tragedy across the world. And for our colleagues that came during a time of significant and foundational change, yet they never lost sight of our purpose at AIG and continue to be focused and dedicated to the important work we do, each other and the communities in which we live and work, I could not be prouder of what we've achieved together.
We are in great businesses, have global scale, loyal clients, exceptional relationships with distribution of reinsurance partners, world-class experts and industry veterans, and we strive to be a responsible corporate citizen with a diverse and inclusive workforce that delivers value to our shareholders and all other stakeholders. I am confident AIG is on its way to becoming a top-performing company in everything that we do.
With that, I'll turn the call over to Mark.
Mark Lyons: Thank you, Peter, and good morning, everyone. Since Peter has already provided a good overview of the quarter, I'll just add that we posted a 7.4% annualized adjusted return on common equity at the AIG level, an 8.2% adjusted return on tangible common equity at the AIG level, an 8.5% adjusted return on segment common equity for General Insurance and a 14.2% adjusted return on segment common equity for Life and Retirement.
Now moving to General Insurance. First quarter adjusted pretax income was $845 million, up $344 million year-over-year, primarily reflecting increased underwriting income in International as well as increased global net investment income driven by alternatives. Catastrophe losses totaled $422 million pretax or 7.3 loss ratio points this quarter compared to 6.9 loss ratio points in the prior year quarter. The CAT losses were mostly comprised of $390 million related to the winter storms, primarily impacting Commercial Lines, including AIG Re. The net impact of the winter storms reflects the benefit of our Commercial reinsurance program and changes to our PCG portfolio as a result of Syndicate 2019.
Overall, prior year development was $56 million favorable this quarter, which included $58 million of net favorable development in North America, driven by $52 million of favorable development from the ADC amortization and $2 million of net unfavorable development in International. It's worthwhile to note that General Insurance still has $6.6 billion remaining of the 80% quota share ADC cover. There was also, embedded within these figures, $33 million of unfavorable development related to COVID-19 claims that relate back to 2020 loss occurrences or a movement of less than 3%. Emanating primarily from Validus Re and Talbot are Lloyd's Syndicate.
Our General Insurance business continued to materially improve driven largely by strong accident year 2021 ex-CAT showings in both North America and International Commercial lines. So rather than double up on facts that Peter has shared, the main drivers of the attritional underwriting gain improvements were for North America Commercial, Lexington, Financial Lines, and Excess Casualty. And from International Commercial, the main drivers of improvement stem from Property, Talbot and Financial Lines. As Peter noted, on a global Commercial Lines basis, the accident year combined ratio, excluding CAT, was 90.4%, which represents a 440 basis point improvement over the prior year's quarter with 75% of that improvement attributable to a lower loss ratio and 25% of the improvement attributable to a lower expense ratio.
Turning to Personal Insurance. Starting in the second quarter of this year, meaning next quarter, our year-over-year comparisons will begin to improve, given the timing of the initial COVID-19 impact and the formation of Syndicate 2019 in May of 2020. Although North American personal lines had a 74% drop in net premiums written, as Peter highlighted, it's also important to understand that the other units within the segment, which represented nearly 50% of the quarter's net earned premium, is comprised mostly of Warranty and Personal A&H business had their net premium only fall off marginally. Our International Personal Lines business, which by size, dominates our overall global Personal Insurance business, continues to perform well with 150 basis points improvement in the accident year ex CAT combined ratio, reflecting an improved loss ratio and expense discipline.
Now to expand on some of Peter's marketplace commentary, various areas continued to accelerate the adequacy of achieved rate beyond that of prior quarters. For example, the level of Excess Casualty rate increases continued and then many units exceed prior results, such as CAT excess coverage out of Bermuda, North America Corporate and National Admitted Excess and the Lexington. The increase achieved in the first quarter of 2020 and compounded in the first quarter of 2021 alone, ignoring prior to 2020 rate increases, exceeded 150% for Bermuda-based capacity business, which makes sense given recent years' price efficiency on these capacity excess layers, and approximately 115% for the other mentioned units. U.S. Financial Lines on the same compound basis has seen an excess of 80% increases for the staples of D&O and EPLI.
Internationally, the 14% first quarter overall rate increase saw continued rate expansion in key markets such as the U.K. at plus 23%; Global Specialty at plus 15%; Europe and the Middle East at 14%; Latin America at 13%; and Asia Pacific also at 13%, when excluding the tempering influence of predominantly Japan at 3%.
Lastly, Cyber achieved our highest rate increase yet at 41% for the quarter. These increases are clearly broad based by region and line of business all around the world.
I'd now like to spend a few minutes on 2 observations: one, the impact of net rate change versus gross rate change; and two, some examples of new business rate adequacy relative to a renewal rate adequacy. So first, our achieved North America Commercial rate change for the quarter on a net basis is now estimated to be at least 150 basis points stronger than the corresponding gross rate change largely due to our increased net positions across selected product lines.
Last year, much of the achieved gross rate increase was being ceded to reinsurers, where now there is much less so. The shift to higher net positions resulted directly from our prior stated strategy of improving the gross book such that we had increased confidence to retain the appropriate amount of net, and because we could not take a higher net position previously because of the legacy imbalance of very large limits written.
Now moving on to relative rate adequacy. We see continuing indications in North America of new business having stronger relative rate adequacy over renewal rate levels in most lines of business. This likely doesn't reflect different class mixes, but instead an additional margin for a lesser-known exposure. However, this should be expected and is also historically supported given where we are in the underwriting cycle as new business is less established with an insurer versus an existing client renewal relationship.
A further related item involves renewal retention. As General Insurance implemented revised underwriting standards, renewal retentions predictably would have been impacted, especially in the target line. Now even with superior risk selection, rate and term condition changes that have been achieved, renewal retentions have improved to the mid-80% in the aggregate across all Commercial Lines in both North America and across internationally.
We also see improvement in the Lexington, where E&S has lower industry retentions based on the nature of the business, and this is very positive for the book, and we see it across Specialty lines and across most admitted retail books. This is indicative of the reunderwriting actions being successful, having settled down and now with General Insurance being comfortable with the underlying insured exposures that meet our risk appetite.
Based on current market conditions and our view of the foreseeable future, we continue to anticipate earned margin expansion throughout 2021 and into 2022, resulting from AIG's favorable underwriting actions taken, favorable global market conditions, materially improved terms and conditions and a more profitable, less volatile business mix.
As a result, I would like to reconfirm our outlook for a sub-90% accident year combined ratio, excluding CAT by the end of 2022. Global Commercial Lines are very nearly at the sub-90% level now, and global Personal Lines is running at 96% for the first quarter. Given our portfolio composition, the market conditions and our strategic repositioning of North America Personal, we anticipate greater continued margin expansion within Commercial Lines than Personal Lines. We are highly confident that we will achieve our sub-90% target and have several paths to help us get there, some via mix, some via reasonable market conditions persisting and some via expense levers.
Now I'd also like to unpack some of Peter's high-level net written premium growth comments for 2021 with an emphasis here on next quarter -- second quarter. North America Commercial is expecting to see growth of approximately 10% for the second quarter of 2021 relative to the prior year quarter driven mostly from Lexington across a host of product lines and Admitted Casualty, both primary and excess. This growth will be two-pronged as growth on the front end will be coupled with lower reinsurance cessions, especially from those lines subject to the casualty quota share.
North America Personal is expected to see significant second quarter 2021 growth, but it is driven by the Syndicate 2019 reinsurance cession change that we've been signaling. You will recall, North American Personal had a negative $150 million net written premium in the second quarter of 2020 due to many Syndicate 2019 treaties becoming effective, including an unearned premium cover for the PCG high net worth book. That distortive spike in cession, which is not repeatable in the second quarter of 2021, will give the appearance of considerable growth but instead will provide a PCG net premium that is more stable on an ongoing basis. so overall, for North America, both Personal and Commercial combined, we anticipate net written premium growth between 35% to 40% for the second quarter over the second quarter of the prior year. International Commercial in the second quarter of 2021 is expected to be roughly plus 7% net written premium growth driven by Global Specialty, Financial Lines and Talbot, and International Personal is expected to be approximately flat relative to the prior year quarter.
Now turning to Life and Retirement. Adjusted pretax income increased by 57% or $340 million compared to the first quarter of 2020, with favorable equity markets driving higher private equity returns, lower deferred acquisition cost amortization, a rebound in most areas of sales and higher fee income. The increase also reflects favorable short-term impacts from tighter credit spreads, driving higher call and tender income and higher fair value option bond returns. This increase was partially offset by adverse mortality as U.S. COVID-related population death of approximately 205,000 in the first quarter were higher than earlier anticipated, which was also reflected in our own experience.
In terms of premiums and deposits, we continue to see encouraging improvement in retail sales. Individual Retirement premium and deposits grew 8% from the prior year quarter, which we consider a pre-COVID quarter, as the sales pipeline carried through March of last year, with index and variable annuities both exceeding prior year levels.
In Group Retirement, group acquisition deposits increased significantly from prior year, although both periodic and non-periodic deposits declined leading to a marginal reduction in overall gross group premiums and deposits of 2%.
In Life Insurance, premiums and deposits grew 6% overall with year-over-year growth in both the U.S. and international.
Finally, while Institutional Markets did not conclude any significant pension risk transfer transactions in the quarter, the pipeline of direct and reinsurance transactions going into the second quarter is very strong. particularly with many defined benefit plans nearing fully funded status.
Turning to net flows and related activity. Our portfolio reflects the dynamic environment quarter-by-quarter of the last year. Individual Retirement net flows improved by approximately $1 billion over the first quarter of 2020 driven by variable annuities and retail mutual fund. And yet when excluding retail mutual funds, net flows were positive, led by index annuities rebounding to be plus $1 billion for the quarter, which is vertically identical to 1 year ago, but with steady progress from a low of $439 million in the second quarter of 2020 to the plus $1 billion this quarter.
Surrender rates were up slightly over the last few quarters within Individual Retirement, for fixed and index, whereas variable annuity surrender rates have been more comparable as have for Group Retirement. Similarly, the Life business has seen consistently lower lapse and surrender rates over the last 4 quarters than prior.
Life and Retirement continues to actively manage the impacts from the low interest rate and tighter credit spread environment, and the previously provided range for expected annual spread compression has not changed. New business margins generally remain within our targets at current new money returns due to active product management, disciplined pricing approaches and our significant asset origination and structuring capabilities.
Moving to Other Operations. Adjusted pretax loss was $530 million, which was inclusive of $176 million of losses from the consolidation and eliminations line, which principally reflects adjustments offsetting investment returns in the subsidiaries by being eliminated in Other Operations, so it wouldn't be double counting.
Before consolidation and eliminations, adjusted pretax loss was $354 million, which was $481 million better than the first quarter of 2020, which included a $317 million adjusted pretax loss related to Fortitude and a $30 million onetime cash grant given to employees to help with unanticipated costs when the global pandemic began last March.
The first quarter also reflects lower corporate interest expense and lower corporate general expenses, and we expect this to continue throughout 2021. However, one might expect some continued volatility within the consolidations and eliminations line, which can fluctuate based on investment returns.
Now shifting to investment. Net investment income on an APTI basis was $3.2 billion or $492 million higher than the first quarter of 2020. Adjusting first quarter 2020 for Fortitude's investment income to make the comparison apples to apples, this quarter's net investment income on an APTI basis was actually $611 million higher than the prior year or plus 23%, reflecting strong private equity and real estate returns as well as bond tender and call premiums, which more than offset the lower income on the AFS fixed income portfolio. We continue to have a high-quality investment portfolio that is positioned well under any market condition.
Turning to the balance sheet. At March 31, book value per common share was $72.37, down 5.3% from year-end, reflecting net unrealized mark-to-market losses on the investment portfolio. Adjusted book value per share was $58.69, up nearly 3% from December 31.
At quarter end, AIG parent, as Peter noted, had cash and short-term liquidity assets of $7.9 billion, and we repaid our March debt maturity of $1.5 billion and repurchased the $362 million of shares, as Peter outlined. Our GAAP debt leverage at March 31 was 28.4%, flat to year-end given downward fixed income market movements negatively impacting AOCI, despite the repaid debt maturity mentioned earlier.
Our primary operating subsidiaries remain profitable and well capitalized. For General Insurance, we estimate the U.S. pool fleet risk-based capital ratio for the first quarter to be between 465% and 475%, and Life and Retirement fleet is estimated to be between 435% and 445%, both well above our target ranges.
And with that, I will now turn it back over to Peter.
Peter Zaffino: Thank you, Mark. And Jake, I think we're ready to start Q&A.
Operator: [Operator Instructions] And we will begin with Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question is on the -- sorry, the Life and Retirement separation. I appreciate the update in terms of working towards the IPO. Is the plan in terms of timing for that to still take place at some point later this year? Or do you have a more finer tune around that?
Peter Zaffino: Yes. Thanks, Elyse. As I said in my prepared remarks, we're working with a sense of urgency on the IPO. We've made really significant progress working on standalone financial statements, actuarial, have set up the organization to operationally separate. So we're working very hard on several fronts related to the IPO.
I mean, the ultimate timing of completing this step should depend on a number of factors. Some are out of our control, such as regulatory and market conditions, but we're still working towards the same time line, which is by the end of 2021. But again, depending on those factors, it could always slip into the first quarter 2022. But it's -- the company is focused, and we're going through all the details and moving forward.
Elyse Greenspan: Okay. And then my second question is on the market commentary you guys gave. A lot of helpful color. Mark, you said that you guys expect continued earned margin expansion throughout 2021 and into 2022. So is -- I guess, you're kind of giving us a market view, it sounds like, for the next year.
Is the expectation that rates would stabilize and get closer to trend in 2022? I'm just trying to put that together. You're just kind of giving us the outlook that rates should remain strong through 2021, and then we'll see how 2022 transpires with earned versus plus trends.
Peter Zaffino: Let me start with your question on rate, and then I'll turn it over to Mark to provide a little more context and then talk about the earned. But I think, look, this is the third year where we're seeing rate, at least at AIG, above loss cost. And again, you really have to just take a look at the overall portfolio because quarter-to-quarter, it may be a little bit different, meaning just the seasonality of our business, whether it's Validus Re having a big inception date in the first quarter, crop specialty Europe driven more towards the first quarter.
So when we look at it, we're looking at first quarter to first quarter, and there has been no slowdown in terms of the rate environment and believe that we're building margin above loss cost rate on rate, and I think that's kind of where Mark was alluding to.
The market environment, Elyse, is always hard to predict, but we think the market that we're in is the market we're going to see for the remaining part of the year, and it's very hard to predict beyond that.
Mark, do you want to add any more context?
Mark Lyons: Just a bit. Thank you, Peter. I think Peter nailed it both, Elyse. I want to reemphasize, though, what Peter said. Every quarter's mix is pretty different, and I know that's a written viewpoint that earns in. But we've already written business in -- that we can -- last year that's going to earn into 2021. And we've already written one quarter that's going to go into 2022. So we're not counting -- we believe we're going to have the margin expansion, as has been noted. That doesn't really depend on the existing level of rate levels in the market.
Operator: Next question will come from Brian Meredith with UBS.
Brian Meredith: So a couple here. Quickly, just Mark, I'm curious, you said you had some COVID development in the quarter. Where did that come from? And are we pretty close to, you think, kind of being done with the COVID-related losses, at least in the General Insurance business? I understand there could still be some more in Life.
Peter Zaffino: Go ahead, Mark.
Mark Lyons: So yes, we can localize a lot of that to contingency business out of Talbot. And on Validus, I think there was really just 2 contracts involved, so it's not like a widespread in any way. So that overwhelmingly accounts for it.
And I think for your second question, yes, we didn't put any additional provisions. We're happy where we are associated with it. So I think we're on the downflow, to say the least.
Brian Meredith: Got you. And then my second question, I guess, for Peter for both of you all. What is your kind of view with respect to loss trend or kind of tort inflation and loss trend as we kind of -- the economy reopens here, courts reopen? Kind of how are you thinking about that from a reserving perspective and maybe also from a pricing perspective?
Peter Zaffino: Yes. So I'll have Mark add to my comments. We're watching it very carefully, Brian. It's something that, again, as it emerges throughout the world, the economy starts to reopen, we look at it line of business by line of business, lead versus excess, different trends that we're seeing in the portfolio emerging over the last year and then how we forecast that to look for the future.
So I think the balance of the portfolio is being shaped in a way to mitigate that, and we're very focused on making sure that, even in the growth that we outlined in the first quarter that we're growing, where we know that we're going to get the risk-adjusted returns in terms of deploying the capital.
So I think we're very disciplined. It's circular with underwriting actuarial claims. We're learning a lot and making sure that we're positioned the portfolio accordingly.
Mark, do you want to add anything to that?
Mark Lyons: Yes. Thank you, Peter. I think I may have commented on this before, but I think it's probably worth bearing again is, long term, there's generally been a 200 basis point addition beyond economic inflation for social inflation. Clearly, that's been south of that over the last few years.
But that's one way of looking at it by having a range of loss trends and not necessarily just point estimating it, and it really varies by line of business, clearly. I think in the past, I've also commented that our loss trend in Excess Casualty, for example, is very close to double digits, number one, and so really it varies across the board.
And when you get to Peter's comment on portfolio, think of the best way to insulate yourself from unexpected spikes in economic or social inflation, irrespective of which one, is by having the portfolio change. And the mix away from leads and having more mid excess, not just in casualty, but other places, aggregated lead moves that portfolio further away from risk insulating you more from any compound views of that. So I think that's how we look at it. And I think all of that is important and it comes to bear.
Brian Meredith: Yes, yes. Mark, I was just -- part of my question, though, was also just asking this. Do you think about, when you make reserve assumptions or pick assumptions, are you making different assumptions with respect to what potential loss trend and when you're pricing the business?
Mark Lyons: Not materially because you have calendar year views, right? So claims when they're settled or when they're reported don't care what their accident year was.
Operator: We'll now hear from Paul Newsome with Piper Sandler.
Jon Paul Newsome: And congratulations on the quarter. I was hoping you could turn to maybe a big picture question about the Life Insurance business and just -- is there kind of a path to positive net flows?
Obviously, the Institutional business is volatile quarter-to-quarter, but maybe you could just give us a sense of -- especially as we get closer to thinking about the Life IPO, how those net flows might recover to a positive level.
Peter Zaffino: Okay. Thanks, Paul. Kevin?
Kevin Hogan: Yes. Thanks, Paul. Look, net flows reflect the trends of premiums and deposits as against the surrender behavior. As Mark pointed out, we haven't really seen much material change in the surrender behavior a little bit within sort of expected margins, but premiums and deposits is really another story.
And we said that the second quarter last year was going to be the low water mark. It certainly was. And in fact, the first quarter of this year is one of the largest sales quarters we've had in the Individual businesses since we created AIG Financial Distributors. And while the month of January was actually still below last year, and we consider last year's first quarter a pre-COVID quarter because, really, the pipelines were full right through March, April. We saw growth from February over January, March over February a pretty significant growth.
So the end of the quarter, we're really back at what we consider to be normal run rates for that business. And as Mark pointed out, both index and variable annuity, very strong for us there.
And so the one line of business, fixed annuities, they're a little bit lower than historical levels, but we also saw recovery in fixed annuities towards the end of the quarter. And so we're feeling optimistic about the forward curve for the individual business. And as Mark pointed out, across annuities, because we've announced relative to the retail mutual funds, right, we had positive flows. So I'm confident relative to the flows in the Individual Retirement business.
For Group Retirement, it's a little bit of a different story. The group acquisitions -- the new group acquisitions actually were one of our strongest quarters and increased by $150 million over the prior year, whereas periodics were down about $50 million, and I think that reflects furloughs and people leaving the workforce. And then the non-periodic were also down a little bit for a variety of reasons.
And in the Group Retirement business, we still see some modest negative flows, but I think that reflects the fact that we're a small, medium-sized plan provider. And in the consolidation that continues to go on in health care, we do see some of that large case consolidation. But the assets under management have continued to grow, obviously, supported by equity markets, and that's an important base of earnings for the fee side of the business.
So we feel confident. We're being careful about capital deployment. We're seeing conditions improve, and our diverse product range and channel allow us to be careful where we deploy the capital, and we're seeing that start to come through in the first quarter.
Jon Paul Newsome: Is there a market component to -- or an interest rate component to keeping the ROE at least stable in Life business, in your opinion?
Kevin Hogan: Well, certainly, we provide the sensitivities and depending upon where equity markets are, where interest rates are, where credit spreads are and which way they're going, they have kind of a short-term impact on earnings volatility. But we price our products to make sure that we're making our returns based on broadly expected market conditions, not necessarily a single deterministic scenario. So we're not relying on market returns necessarily in the pricing of our products.
Operator: Next question will come from Ryan Tunis with Autonomous Research.
Ryan Tunis: I had one for Mark, and would you even be interested in David's thought if he's on the call. But I guess, thinking about classic economic inflation, wage-driven historically been kind of bad for workers' confidence. It's been a long time since we've had it.
Are the risks from that type of scenarios on that line kind of still the same as they were 20 years ago? Are there mitigating factors? Just how are you thinking about workers' comp, if we do have just a normal inflationary economic cycle.
Peter Zaffino: Let me start. You got to remember that 2/3 of our business is on high retentions, and so the fluctuation of frequency and in wage inflation and loss cost inflation is largely retained by our clients. I mean, so we've seen some fluctuation just because of high attachment points in which we have in the workers' comp book.
And so Dave has been working really hard on our large account business and as well as workers' compensation in terms of the positioning in that. And I think the attachment points, the positioning of the book is really important.
Dave, do you want to just talk a little bit about what you're seeing in the marketplace and how we are reacting to it?
David McElroy: Yes. Thank you, Peter. The -- I think workers' comp, I think there was some concern with COVID that there would be presumption. That mostly does not affect our book, okay, because of the high retentions that our clients have. That's very different than the middle market books and the small commercial books that might exist.
I think the more illuminating issue is that workers' comp has been a profitable line, whether it was the state laws that muted it. And often, we get lost in our generalization of what is rate increase. Workers' comp has had modest to negative rate increase because it's been profitable for the industry. And I think it's very important for everybody to understand that, that's a discrete market, and a lot of the different parts of the market that we trade in, we -- that's absorbed by our clients.
So the -- if that same client has General Liability or Financial Lines or even Property, that's a different market with different pricing than might be existing in the workers' comp market. So workers' comp market has actually worked, and everybody talks about it in terms of the rate increase, but that's a discrete-type market that reflects that.
And I think our industry is fairly sophisticated to understand why that happens and then why other businesses need rate or need rate to expect -- to reflect exposure. So it's -- that's the workers' comp market. It's been a winner for this industry because of the reforms that happened at the state level.
Mark Lyons: Ryan, I'd add just one quick thing, if I could. You really started the question in the correlation on wage. And given Peter really talking about 2/3 of the book is really lost sensitive over high attachment points, it's actually more of a medical question than a wage indemnity question because medical trend is what could sneak over, especially on major permanent partial and things of that nature and permanent totals. So that's why it was actually a -- we're in a really good position on that because of the analysis that was done about 3 years ago on that book that's still holding today. So all those past assumptions are absolutely holding.
Ryan Tunis: Understood. And then my follow-up is just thinking about -- you're running at a little bit over 92, so you need about 2 points to get sub-90. Just you said rate alone, assumingly, would be able to get you there. Obviously, I think that there are some offsetting headwinds or just other things that, along the way, you got to get past. I'm not sure if that's more new business or what. Could you just remind us of some offsets to rate in terms of getting down to that 90 over the next couple of years?
Peter Zaffino: Thanks, Ryan. So there's multiple factors in terms of driving the sub-90 combined ratio. One is we had a terrific start to the year, and so you can see we're driving top line growth, driving margin, improving combined ratios. So we like the momentum that we have.
I think we're going to focus on continuing on the underwriting side. Certainly, the culture we're building out of risk selection, terms and conditions, making sure that we're getting rate above loss cost is the discipline that Dave is driving through General Insurance, and they're doing very well.
I think you'll start to see -- I talked about in my prepared remarks,the AIG 200, while we announced run rate, we got to catch up a little bit in terms of some of the implementations. So we know that we have expense tailwinds in terms of what will be coming through with AIG 200. In addition to that, just normal expense management and being very disciplined on reinvestment and making sure that we are a company that's very focused on ways in which we can improve what we're doing and create our own investment capacity.
I think you'll start to see the earned premium increasing from growth and strong new business. International had the best quarter new business that they've had since the new teams arrived. So that's -- there's a lot of momentum there. And then expect to see new business pick up as we continue throughout the year and the economy starts to recover.
And then what I also mentioned in my prepared remarks is that we are not going to need as much reinsurance going forward just based on the gross portfolio. And so like we needed to probably buy a little bit more CAT, a little bit more on the risk side. Those are all improving, and those will be tailwinds over a period of time. So there's 4 or 5 components that will drive improved combined ratio in the subsequent quarters and into next year.
Operator: We'll hear from Meyer Shields with KBW.
Meyer Shields: Can you hear me?
Peter Zaffino: Yes, Meyer.
Meyer Shields: Okay. Sorry about that. So Mark, I'm trying to tie together a couple of comments because you're expecting, if I understand correctly, margin improvement into 2020, but we still get below the 90% on the underlying by year-end. So does that mean that we should expect to be there sooner if you won't need margin improvement later in 2022 to get below 90?
Mark Lyons: Do you want me to start that, Peter.
Peter Zaffino: Yes. Go ahead, Mark.
Mark Lyons: So I think what we're trying to say in various ways is that looking sequentially is really not the way. You've got to really look at it quarter-over-quarter for the points that Peter brought up before about the mix being pretty different. The fact that although we've reduced the volatility dramatically, we still write volatile lines, right? So you still have a pop here or there that may not have really occurred in this quarter or the last quarter that still could at another time.
We really need to see a few more accident quarters, if you will, pop in before we can declare victory in that sense. So you can't look at each quarter as a totally independent stand-alone on a sequential basis.
Meyer Shields: Okay. That makes sense. The second question, I guess you talked about cyber rate increases, and I don't know whether sort of the way we typically think about trend is relevant. But is there any way you can outline how cyber loss expectations are changing?
Peter Zaffino: Dave, do you want to take that?
David McElroy: Yes. The -- thank you. The -- when we looked -- sometimes there's -- we index off of rate increases. And in fact, a big part of our story here at AIG has actually been risk selective and limit management and retentions and terms and conditions. And cyber was this year's case stuff, okay?
It had been a profitable business. Ransomware started showing up, and what we've done is we've cauterized that with sublimits and coinsurance to reflect the fact that we're a big primary player, and we need to manage ransomware, and that's what we've done.
And our renewal retention has come down. Our rate increase, which may be something cited and exciting for others, is up 40 -- it's 41%. But for us, it's actually managing the risk on the other side. So I look at that rate increase as a factor as opposed to our not only vertical but horizontal risk.
It's a tough risk. We have it worldwide. We're leaders. We've been very active in terms of our prophylactic and our involvement in terms of trying to stem the actual loss itself. And we look at that as a viable product that we have controlled horizontally with reinsurance and vertically with reinsurance and with partnerships.
And we look at that not only like every other Specialty business that we have in this company. We have a lot of them. We have to attack it, and we have to underwrite it with the facts of that business, and that's what we're doing. It should be -- it should scare the industry. It certainly gives us pause, and that's why we've been underwriting it very aggressively over the last 3 years.
Operator: That last question will come from Tom Gallagher with Evercore.
Thomas Gallagher: Peter, just first a question on the decision to pursue the IPO versus the private sale. Was it mainly because we've gotten so much improvement in peer L&R public valuations that the gap narrowed where it wouldn't give you as much of a benefit? But any color you can give us as to what drove that decision.
Peter Zaffino: Thanks, Tom. That is certainly one component. We always said the base case was going to be the IPO of 19.9%. So when we had entertained some of the inbounds from terrific companies, we evaluated the relative merits of the sale compared to the minority IPO.
We took into account value creation, execution certainty, regulatory and rating agency implications, the delivery of Life and Retirement growth strategy over the long term, where we're going to be making the right investments to make sure we're getting the value of the 80.1%. It's a great business, and so we want to make sure that we are investing in it.
And so when we weighed all those merits, ultimately, we felt that an IPO was going to fulfill the value for our stakeholders and decided that, that was the appropriate path for us.
Thomas Gallagher: Okay, okay. And then just a follow-up for Kevin on L&R. I think -- Peter, I think I heard you say you're reiterating the 8 to 16 basis point spread compression guide.
I guess, my question is interest rates have risen a pretty good amount. Would you change within the 8 to 16 basis point band where you expect to operate? I think you used to say it was toward the high end of that.
Peter Zaffino: Kevin, do you want to finish?
Kevin Hogan: Yes, absolutely. Yes, Tom. We have moved from the high end of the 8 to 16 towards the middle to the lower end based on the recent improvement in the yields. You have to monitor, obviously, the combination of where credit spreads are versus where actual base rates are. So it's not all what we saw in the base rates. You just have to look at the total reinvestment position.
Peter Zaffino: All right. Great. Thanks, everyone, for joining us today, and have a great day.
Operator: And with that, ladies and gentlemen, this will conclude your conference for today. Thank you for your participation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's First Quarter 2021 Financial Results Conference Call. Today's conference is being recorded."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you. Good morning, and thank you all for joining us. Today's call will cover AIG's first quarter 2021 financial results announced yesterday afternoon. The news release, the financial supplement and financial results presentation were posted on our website at www.aig.com, and the 10-Q for the quarter will be filed later today after the call."
},
{
"speaker": "Peter Zaffino",
"text": "Hello, and thank you for joining us today. This morning, I will start our call with a high-level overview of AIG's consolidated financial results for the first quarter. I will then review results from General Insurance and the significant progress we've made with our portfolio, which allowed us to pivot from remediation to growth heading into 2021. Following that, I will review first quarter results for Life and Retirement. I will then provide an update on the work we're doing on the separation of Life and Retirement from AIG. And lastly, I'll provide an AIG 200 update. Mark will give you more details on the financial results, and then we will take questions."
},
{
"speaker": "Mark Lyons",
"text": "Thank you, Peter, and good morning, everyone. Since Peter has already provided a good overview of the quarter, I'll just add that we posted a 7.4% annualized adjusted return on common equity at the AIG level, an 8.2% adjusted return on tangible common equity at the AIG level, an 8.5% adjusted return on segment common equity for General Insurance and a 14.2% adjusted return on segment common equity for Life and Retirement."
},
{
"speaker": "I'd now like to spend a few minutes on 2 observations",
"text": "one, the impact of net rate change versus gross rate change; and two, some examples of new business rate adequacy relative to a renewal rate adequacy. So first, our achieved North America Commercial rate change for the quarter on a net basis is now estimated to be at least 150 basis points stronger than the corresponding gross rate change largely due to our increased net positions across selected product lines."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Mark. And Jake, I think we're ready to start Q&A."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] And we will begin with Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question is on the -- sorry, the Life and Retirement separation. I appreciate the update in terms of working towards the IPO. Is the plan in terms of timing for that to still take place at some point later this year? Or do you have a more finer tune around that?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Thanks, Elyse. As I said in my prepared remarks, we're working with a sense of urgency on the IPO. We've made really significant progress working on standalone financial statements, actuarial, have set up the organization to operationally separate. So we're working very hard on several fronts related to the IPO."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then my second question is on the market commentary you guys gave. A lot of helpful color. Mark, you said that you guys expect continued earned margin expansion throughout 2021 and into 2022. So is -- I guess, you're kind of giving us a market view, it sounds like, for the next year."
},
{
"speaker": "Peter Zaffino",
"text": "Let me start with your question on rate, and then I'll turn it over to Mark to provide a little more context and then talk about the earned. But I think, look, this is the third year where we're seeing rate, at least at AIG, above loss cost. And again, you really have to just take a look at the overall portfolio because quarter-to-quarter, it may be a little bit different, meaning just the seasonality of our business, whether it's Validus Re having a big inception date in the first quarter, crop specialty Europe driven more towards the first quarter."
},
{
"speaker": "Mark Lyons",
"text": "Just a bit. Thank you, Peter. I think Peter nailed it both, Elyse. I want to reemphasize, though, what Peter said. Every quarter's mix is pretty different, and I know that's a written viewpoint that earns in. But we've already written business in -- that we can -- last year that's going to earn into 2021. And we've already written one quarter that's going to go into 2022. So we're not counting -- we believe we're going to have the margin expansion, as has been noted. That doesn't really depend on the existing level of rate levels in the market."
},
{
"speaker": "Operator",
"text": "Next question will come from Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"text": "So a couple here. Quickly, just Mark, I'm curious, you said you had some COVID development in the quarter. Where did that come from? And are we pretty close to, you think, kind of being done with the COVID-related losses, at least in the General Insurance business? I understand there could still be some more in Life."
},
{
"speaker": "Peter Zaffino",
"text": "Go ahead, Mark."
},
{
"speaker": "Mark Lyons",
"text": "So yes, we can localize a lot of that to contingency business out of Talbot. And on Validus, I think there was really just 2 contracts involved, so it's not like a widespread in any way. So that overwhelmingly accounts for it."
},
{
"speaker": "Brian Meredith",
"text": "Got you. And then my second question, I guess, for Peter for both of you all. What is your kind of view with respect to loss trend or kind of tort inflation and loss trend as we kind of -- the economy reopens here, courts reopen? Kind of how are you thinking about that from a reserving perspective and maybe also from a pricing perspective?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. So I'll have Mark add to my comments. We're watching it very carefully, Brian. It's something that, again, as it emerges throughout the world, the economy starts to reopen, we look at it line of business by line of business, lead versus excess, different trends that we're seeing in the portfolio emerging over the last year and then how we forecast that to look for the future."
},
{
"speaker": "Mark Lyons",
"text": "Yes. Thank you, Peter. I think I may have commented on this before, but I think it's probably worth bearing again is, long term, there's generally been a 200 basis point addition beyond economic inflation for social inflation. Clearly, that's been south of that over the last few years."
},
{
"speaker": "Brian Meredith",
"text": "Yes, yes. Mark, I was just -- part of my question, though, was also just asking this. Do you think about, when you make reserve assumptions or pick assumptions, are you making different assumptions with respect to what potential loss trend and when you're pricing the business?"
},
{
"speaker": "Mark Lyons",
"text": "Not materially because you have calendar year views, right? So claims when they're settled or when they're reported don't care what their accident year was."
},
{
"speaker": "Operator",
"text": "We'll now hear from Paul Newsome with Piper Sandler."
},
{
"speaker": "Jon Paul Newsome",
"text": "And congratulations on the quarter. I was hoping you could turn to maybe a big picture question about the Life Insurance business and just -- is there kind of a path to positive net flows?"
},
{
"speaker": "Peter Zaffino",
"text": "Okay. Thanks, Paul. Kevin?"
},
{
"speaker": "Kevin Hogan",
"text": "Yes. Thanks, Paul. Look, net flows reflect the trends of premiums and deposits as against the surrender behavior. As Mark pointed out, we haven't really seen much material change in the surrender behavior a little bit within sort of expected margins, but premiums and deposits is really another story."
},
{
"speaker": "Jon Paul Newsome",
"text": "Is there a market component to -- or an interest rate component to keeping the ROE at least stable in Life business, in your opinion?"
},
{
"speaker": "Kevin Hogan",
"text": "Well, certainly, we provide the sensitivities and depending upon where equity markets are, where interest rates are, where credit spreads are and which way they're going, they have kind of a short-term impact on earnings volatility. But we price our products to make sure that we're making our returns based on broadly expected market conditions, not necessarily a single deterministic scenario. So we're not relying on market returns necessarily in the pricing of our products."
},
{
"speaker": "Operator",
"text": "Next question will come from Ryan Tunis with Autonomous Research."
},
{
"speaker": "Ryan Tunis",
"text": "I had one for Mark, and would you even be interested in David's thought if he's on the call. But I guess, thinking about classic economic inflation, wage-driven historically been kind of bad for workers' confidence. It's been a long time since we've had it."
},
{
"speaker": "Peter Zaffino",
"text": "Let me start. You got to remember that 2/3 of our business is on high retentions, and so the fluctuation of frequency and in wage inflation and loss cost inflation is largely retained by our clients. I mean, so we've seen some fluctuation just because of high attachment points in which we have in the workers' comp book."
},
{
"speaker": "David McElroy",
"text": "Yes. Thank you, Peter. The -- I think workers' comp, I think there was some concern with COVID that there would be presumption. That mostly does not affect our book, okay, because of the high retentions that our clients have. That's very different than the middle market books and the small commercial books that might exist."
},
{
"speaker": "Mark Lyons",
"text": "Ryan, I'd add just one quick thing, if I could. You really started the question in the correlation on wage. And given Peter really talking about 2/3 of the book is really lost sensitive over high attachment points, it's actually more of a medical question than a wage indemnity question because medical trend is what could sneak over, especially on major permanent partial and things of that nature and permanent totals. So that's why it was actually a -- we're in a really good position on that because of the analysis that was done about 3 years ago on that book that's still holding today. So all those past assumptions are absolutely holding."
},
{
"speaker": "Ryan Tunis",
"text": "Understood. And then my follow-up is just thinking about -- you're running at a little bit over 92, so you need about 2 points to get sub-90. Just you said rate alone, assumingly, would be able to get you there. Obviously, I think that there are some offsetting headwinds or just other things that, along the way, you got to get past. I'm not sure if that's more new business or what. Could you just remind us of some offsets to rate in terms of getting down to that 90 over the next couple of years?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Ryan. So there's multiple factors in terms of driving the sub-90 combined ratio. One is we had a terrific start to the year, and so you can see we're driving top line growth, driving margin, improving combined ratios. So we like the momentum that we have."
},
{
"speaker": "Operator",
"text": "We'll hear from Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "Can you hear me?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes, Meyer."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Sorry about that. So Mark, I'm trying to tie together a couple of comments because you're expecting, if I understand correctly, margin improvement into 2020, but we still get below the 90% on the underlying by year-end. So does that mean that we should expect to be there sooner if you won't need margin improvement later in 2022 to get below 90?"
},
{
"speaker": "Mark Lyons",
"text": "Do you want me to start that, Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Go ahead, Mark."
},
{
"speaker": "Mark Lyons",
"text": "So I think what we're trying to say in various ways is that looking sequentially is really not the way. You've got to really look at it quarter-over-quarter for the points that Peter brought up before about the mix being pretty different. The fact that although we've reduced the volatility dramatically, we still write volatile lines, right? So you still have a pop here or there that may not have really occurred in this quarter or the last quarter that still could at another time."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That makes sense. The second question, I guess you talked about cyber rate increases, and I don't know whether sort of the way we typically think about trend is relevant. But is there any way you can outline how cyber loss expectations are changing?"
},
{
"speaker": "Peter Zaffino",
"text": "Dave, do you want to take that?"
},
{
"speaker": "David McElroy",
"text": "Yes. The -- thank you. The -- when we looked -- sometimes there's -- we index off of rate increases. And in fact, a big part of our story here at AIG has actually been risk selective and limit management and retentions and terms and conditions. And cyber was this year's case stuff, okay?"
},
{
"speaker": "Operator",
"text": "That last question will come from Tom Gallagher with Evercore."
},
{
"speaker": "Thomas Gallagher",
"text": "Peter, just first a question on the decision to pursue the IPO versus the private sale. Was it mainly because we've gotten so much improvement in peer L&R public valuations that the gap narrowed where it wouldn't give you as much of a benefit? But any color you can give us as to what drove that decision."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Tom. That is certainly one component. We always said the base case was going to be the IPO of 19.9%. So when we had entertained some of the inbounds from terrific companies, we evaluated the relative merits of the sale compared to the minority IPO."
},
{
"speaker": "Thomas Gallagher",
"text": "Okay, okay. And then just a follow-up for Kevin on L&R. I think -- Peter, I think I heard you say you're reiterating the 8 to 16 basis point spread compression guide."
},
{
"speaker": "Peter Zaffino",
"text": "Kevin, do you want to finish?"
},
{
"speaker": "Kevin Hogan",
"text": "Yes, absolutely. Yes, Tom. We have moved from the high end of the 8 to 16 towards the middle to the lower end based on the recent improvement in the yields. You have to monitor, obviously, the combination of where credit spreads are versus where actual base rates are. So it's not all what we saw in the base rates. You just have to look at the total reinvestment position."
},
{
"speaker": "Peter Zaffino",
"text": "All right. Great. Thanks, everyone, for joining us today, and have a great day."
},
{
"speaker": "Operator",
"text": "And with that, ladies and gentlemen, this will conclude your conference for today. Thank you for your participation, and you may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 4 | 2,022 | 2023-02-16 08:30:00 | Operator: Good day, and welcome to AIG's Fourth Quarter 2022 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please, go ahead.
Quentin McMillan: Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q, provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change.
Additionally, today's remarks may refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at www.aig.com.
Finally, today's remarks will discuss the results of AIG's Life and Retirement segment and Other Operations on the same basis as prior quarters, which is how we expect to continue to report until the deconsolidation of Corebridge Financial Inc.
AIG's segments and U.S. GAAP financial results as well as AIG's key financial metrics with respect thereto differ from those reported by Corebridge Financial. Corebridge Financial will host its own earnings call tomorrow on Friday, February 17, and will provide additional details on its results.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino;Chairman and CEO: Good morning, and thank you for joining us to review our fourth quarter and full year 2022 results. Following my remarks, Sabra will provide more detail on certain topics, including Life and Retirement results and our path to a 10%-or-greater ROCE, and then we will take questions. Kevin Hogan and David McElroy would join us for the Q&A portion of the call.
Today, I will cover 4 topics: First, I will provide an overview of our fourth quarter financial results. Second, I will review highlights from the full year, including some of our major accomplishments, which were remarkable given the very challenging conditions we faced throughout 2022 in the equity markets and the insurance industry. Third, I will unpack in some detail market conditions leading up to January 1 reinsurance renewals, where we saw significant shifts that we believe will impact the industry throughout 2023 and perhaps longer. Suffice it to say, this 1/1 renewal season was the most challenged that many, including myself, have seen in our careers. And fourth, I will outline our 2023 priorities and outlook regarding capital management.
Before turning to our results, I'd like to welcome Sabra to the call. We are fortunate to have her in the interim CFO role, while Shane is on a medical leave. Regarding Shane, I am personally, deeply appreciative of the tremendous outreach from many of you, the number of people who have sent good wishes for a speedy recovery is incredibly meaningful to me, and our management team, and particularly, to Shane and his family. We look forward to welcoming him back to AIG.
Now let me begin with a brief overview of AIG's fourth quarter results. Adjusted after-tax income in the fourth quarter was $1 billion and $1.36 per diluted common share. We repurchased approximately 780 million of AIG common stock and redeemed $1.8 billion of debt. AIG paid $243 million in dividends in the fourth quarter and Corebridge paid 2 dividends, totaling approximately $300 million following its IPO in September of 2022.
Turning to General Insurance. In the fourth quarter, the accident year combined ratio, ex CATs, improved 140 basis points year-over-year to 88.4%, representing the 18th consecutive quarter of margin improvement. Notably, underwriting income in the fourth quarter increased 27% year-over-year to $635 million.
Global Commercial drove the year-over-year increase, achieving an accident year combined ratio, ex CATs, of 84.1%, a 380 basis point improvement and a 69% increase in underwriting income.
Global Personal reported an accident year combined ratio, ex CATs, of 100.4%, a 610 basis point increase from the prior year quarter, as we continued to reposition this portfolio.
Moving to Global Commercial. On an FX-adjusted basis, North America Commercial net premiums written increased 3% and international increased 2%. Global Commercial had strong renewal retention in its in-force portfolio, and new business continued to be strong.
Turning to REIT. Momentum continued in North America Commercial, with overall rate increases in the quarter of 3%, 7% if you exclude Financial Lines and 9% if you also exclude workers' compensation. These rate increases were driven by Retail Property at 15%, Lexington at 12% and Excess Casualty at 9%, and the exposure increase in the North America portfolio was 3%.
International Commercial rate increases were 4%, driven by Asia Pacific at 9% and EMEA at 7%, and the exposure increase in the international portfolio was around 2%. Pricing, which includes rate plus exposure, was up 6% in both North America and international. While we experienced downward pressure on rate in certain lines early in the fourth quarter, we saw a reacceleration of price increases towards the end of the quarter.
For example, Retail Property was up 15% in the fourth quarter with rate improvement of 24% in December when market impacts from increased catastrophes started to be felt. We saw a similar upward movement at Lexington and particularly within the Property portfolio, with December seeing the strongest rate increases in the fourth quarter. Overall, we continue to earn rate above loss cost trends, which contributed to positive margin expansion.
In Global Personal, starting with North America, net premiums written declined 7%, reflecting our ongoing reshaping of this portfolio, particularly in the high and ultra-high net worth businesses that are part of PCG. Later in my remarks, I will discuss our announcement on Monday relating to PCG and our partnership with Stone Point Capital to create a new Managing General Agency or MGA.
In International Personal, net premiums written slightly increased by 1% on an FX-adjusted basis due to a rebound in travel and growth in A&H.
Now turning to the full year. We made tremendous progress throughout 2022 on a number of key priorities. I could not be more pleased with our team's ability to execute on multiple, complex, strategic objectives across AIG at once. Our most significant and impactful accomplishment was completing the IPO of Corebridge in September of 2022. Despite the very challenging equity market conditions we had to navigate. Notably, Corebridge was last year's largest IPO in the U.S. and the largest financial services IPO since 2020.
We also continue to grow underwriting income in General Insurance, which increased approximately $1 billion year-over-year, the second year in a row with over $1 billion of growth in underwriting income. As I noted on last quarter's call, we also reached significant milestones on AIG 200 that have modernized our technology infrastructure and operational capabilities while executing on an exit run rate savings of $1 billion, 6 months ahead of schedule.
We also changed AIG's investment management strategy and structure through successful partnerships with Blackstone and BlackRock, and we are seeing the benefits of these partnerships across AIG and Corebridge.
Turning to full year consolidated financial results for AIG. Adjusted after-tax income in 2022 reached $3.6 billion and was $4.55 per diluted common share. We returned $6.1 billion to shareholders through $5.1 billion of AIG common stock repurchases and $1 billion of dividends. We finished 2022 with 734 million shares outstanding, a 10% decrease since the end of 2021. And we executed on a number of capital management actions to establish the stand-alone Corebridge capital structure while reducing AIG debt by roughly $10 billion.
Consolidated financial debt outstanding was approximately $21 billion at year-end with $11.8 billion at AIG and $9.4 billion at Corebridge.
Now let me cover full year 2022 results for General Insurance. As you know, an important aspect of our turnaround over the last few years has been instituting a culture of underwriting excellence. And our rigor in this area is now clearly benefiting our financial results. General Insurance achieved underwriting income of $2 billion in 2022, despite the industry again experiencing over $100 billion of insured natural catastrophe losses. And we exceeded our combined ratio commitment by achieving a sub-90 accident year combined ratio, ex CATs, in all 4 quarters.
As I've noted on prior calls, and it's worth repeating, since 2018, we completely overhauled our underwriting standards and overlaid these standards with a comprehensive reinsurance program that can adapt to market conditions into our portfolio as it continues to change and improve. Overall, gross limits deployed were reduced by over $1.2 trillion during this period. We also meaningfully and deliberately shifted our global portfolio mix in order to reposition AIG for the future.
For example, Global Commercial now represents 74% of our net premiums written, up from 57% in 2018. And Lexington is now 17% of our North America Commercial business, up from 12% in 2018. If you exclude Validus Re, Lexington is now 23% of North America Commercial. As a result of this work, our current portfolio is very well positioned for 2023. I will discuss in more detail later, when I review January 1 reinsurance renewals, how market dynamics have shifted and how AIG should benefit as we look to capitalize on attractive opportunities for better risk-adjusted returns.
Now let me highlight a few of the key businesses in General Insurance that contributed to our performance in 2022. Lexington, our market-leading excess and surplus lines business, had 18% net premiums written growth in 2022, up over 50% since we transitioned this business to focus on the wholesale market. This business also increased underwriting profitability, excluding CATs, by 60%, and it achieved a sub-80% accident year combined ratio, ex CATs, for 2022.
Glatfelter continued its terrific performance, growing net premiums written by 14%, increasing underwriting income and achieving an 85% accident year combined ratio, ex CATs. The acquisition of Glatfelter allowed us to significantly elevate the quality of our programs business.
Global Specialty, which includes our Global Marine, Energy and Aviation businesses, grew net premiums written by over 15% on an FX-adjusted basis. This was driven by strong client retention of 88%, new business growth and rate increases across the portfolio. Global Specialty generated strong earnings in 2022 with an impressive accident year combined ratio, excluding CATs, of 80%.
These are just some examples of businesses that we prioritized last year based on their market position, our differentiated value proposition to clients and our ability to generate strong underwriting results. We see great opportunities for these businesses going forward, and they are strong anchors for AIG that we expect will contribute to profitable growth in 2023.
Our Global Personal business performed well considering some of the post-pandemic headwinds we saw in the first half of 2022 and our strategic repositioning of the business. Also, as I mentioned on our last call, the impact from deemed hospitalizations in Japan and, to a lesser extent, Taiwan, contributed over $160 million in losses in 2022, having a 290 basis point impact on the International Personal accident year combined ratio. This accident health product was discontinued in 2022.
Turning to full year net premiums written. General Insurance grew 4% on an FX-adjusted basis, driven by 6% growth in Global Commercial. North America grew 7% and International Commercial grew 6%. We had strong renewal retention in our in-force portfolio, with North America improving by 300 basis points to 86% and International achieving 86% for the full year. And as a reminder, we calculate renewal retention prior to the impact of rate and exposure changes.
Turning to underwriting profitability for the full year. 2022 was another year with strong progress. The General Insurance accident year combined ratio, ex CATs, was 88.7%, an improvement of 230 basis points year-over-year. The full year saw a 180 basis point improvement in the accident year loss ratio, ex CATs, and a 50 basis point improvement in the expense ratio.
Global Commercial achieved an impressive accident year combined ratio, ex CATs, of 84.5%, an improvement of 460 basis points year-over-year. The loss ratio was the biggest contributor with a 330 basis point improvement, and the combined ratio, including CATs and PYD of 89.6%, represented a 920 basis point improvement year-over-year.
The accident year combined ratio, ex CATs, in Global Personal deteriorated 430 basis points to 99.2% for the reasons I've outlined before.
Now let me turn to reinsurance renewals at January 1 of this year. As I stated on our last earnings call, we knew this renewal season will be very challenging and lead to fundamental changes in the market that would impact 1/1 renewals. The market was faced with a combination of factors that added further pressure to dynamics that were already creating considerable stress. We had top global macroeconomic trends. We had geopolitical uncertainty. We had short-term pressure on the asset side of the balance sheet as a consequence of rising interest rates, inflation and currency fluctuation. We had additional natural catastrophe losses late in the fourth quarter and increasing frequency and severity of secondary perils continued.
And 2022 ended with over $130 billion of insured natural catastrophe losses, making 2022 the fifth costliest year on record for insurers, with 5 out of the last 6 years having exceeded $100 billion. Hurricane Ian, in particular, proved to be a catalyst that changed market dynamics even more significantly than expected and ultimately led to shifts in the market that required the industry to rethink reinsurance placements and the commensurate changes that needed to take place in the primary market.
The unprecedented levels of natural catastrophes on a global scale massively impacted the reinsurance market in a couple of ways. Increased natural CAT activity has resulted in elevated property CAT ceded loss ratios, with average incurred loss ratios from 2017 through 2022 exceeding 85% compared to 2012 through 2016 when average incurred loss ratios trended below 30%, a dramatic deterioration.
And over the last 5 years, secondary perils contributed more than 50% to ultimate loss when compared to primary perils. These market dynamics also impacted the supply of reinsurance and retrocessional capacity and the cost of capital increase for the industry, which impacted almost all lines of business and territories, regardless of loss experienced. On top of all of this, very little new capital entered the market. Available capital is estimated to have decreased approximately 20% year-over-year.
Now let me outline what happened in the property CAT and retro markets in particular, due to the high level of CAT losses in 2022, which were further exacerbated by events in the fourth quarter. 50% of global Property CAT limits, which we estimate to be $425 billion, renewed at January 1. Approximately 70% of Global retro limits estimated at $60 billion incept at January 1. Reinsurers heavily reliant on peak peril retro protection face greater pressure as a result, whereas larger, more diversified reinsurers were better able to manage retro capacity constraints. As a result, a majority of programs placed on January 1 saw insurance companies forced increase retentions.
Despite these market challenges, AIG navigated this complex and intense renewal season extremely well. We knew we were in a strong position heading into January 1, given the repositioning and the improved quality of our Global portfolio, coupled with our considerable efforts to reduce our gross portfolio peak exposures. As we expected, this allowed us to capitalize on many attractive opportunities, and this proved to be a competitive advantage as we had an exceptionally successful renewal season.
It's also worth noting that AIG's reinsurance purchasing is, by design, more heavily weighted to January 1 than the wider market. The benefits of this are twofold. Concentrating the bulk of our purchasing at January 1 allows AIG to maximize the outcome across all of our reinsurance placements. And we have clear line of sight on our reinsurance cost for the full year, which is particularly valuable in a market, which we believe will continue to be incredibly challenging.
Some of the highlights of our January placements include the following: with respect to property catastrophe placements, we obtained more limit than we purchased in 2022; and we believe we have the lowest attachment points on a return period measurement for North America windstorm and earthquake amongst our peer group; and our modeled exhaust limits are at higher return periods compared to last year for each of our placements. These placements should further reduce volatility, which is something we remain very focused on, and they provide us with significant balance sheet protection in the event one or a series of significant catastrophe events occur.
Specifically, we separately made appropriate changes to our North America property CAT treaties to reflect our improving portfolio, with the retention of our commercial CAT portfolio attaching at $500 million and Lexington in our Programs business having an attachment point of $300 million. The property CAT aggregate cover that we placed has 4 retentions before attaching, and for North America, Japan, and Rest of World, it now could attach in the second event, which is an improvement from 2022.
Our property CAT [ per occurrence ] structures largely stayed the same for International, and we believe they are market-leading with Japan's retention staying flat at $200 million and the rest of world attaching at $125 million.
Many factors improved our overall property CAT reinsurance program, with highlights being: we were able to attain approximately $6 billion of limit, including increasing our per occurrence excess of loss placement; we maintained low attachment points on a model basis; we received support for a $500 million aggregate placement; and our overall spend for AIG increased less than 10% on an absolute and risk-adjusted basis versus 2022.
With respect to PCG, we accelerated portfolio remediation, which is driving further gross exposure reductions in key CAT-exposed states where loss costs, inflation and necessary modeling changes have not kept pace. This allowed us to reduce the total limit purchase for the PCG-specific CAT program, which partially offset increased pricing pressure due to Hurricane Ian.
Overall, casualty renewals, both excess of loss and our quota share placements, renewed close to expiring terms on a risk-adjusted basis with no impact on ceding commissions. Our reinsurance partners maintain their support for AIG with consistent capacity deployment and reinsurance terms in clear recognition of the quality of our portfolio. The outcomes we achieved at January 1 also reflect the value of the investments we have made in our reinsurance strategy, and, coupled with our relationships and credibility with reinsurance partners, are a testament to the confidence the reinsurance marketplace has in AIG and its management team. We appreciate the ongoing support we have received from our reinsurance partners.
As we look ahead to 2023, the world faces many uncertainties. And in uncertain times, our role as a market-leading global insurance company is even more important. With the momentum we have built and the strength of our portfolio, AIG is now extremely well positioned to strategically grow and lead the market by providing thoughtful, expert advice on risk solutions for our clients, distribution partners and other stakeholders.
By 2022, we have set out ambitious, strategic, and operational priorities for 2023. We will continue to improve and invest in lines of business and General Insurance, where we see significant growth potential, notably Lexington and Global Specialty. I highlight Lexington because it is presented and will continue to present tremendous growth and profitability opportunities for us. And early indications are that the rate momentum we saw in this business at the end of 2022 and into early 2023 will continue. We expect meaningful growth in Lexington this year, led by Property where, over the last few years, we have prudently tightened limits, improved terms and conditions and increased profitability while driving top line growth.
We also plan to increase investment in our assumed reinsurance business in 2023, particularly through Validus Re. As we have discussed on prior calls, over the past few years, we've been highly focused on driving value through a disciplined approach, involving strong risk assessments, sound portfolio construction, a steadfast commitment to underwriting excellence and prudent capital management.
Over this period of time, the derisking within Validus Re was particularly acute in the Global Property CAT market, where year-over-year, we reduced participations across the portfolio while concurrently purchasing sound retrocessional protections to prudently manage the portfolio and reduce volatility, all in line with our cycle management strategy. As a result, we were in a strong position to capitalize on attractive opportunities at January 1. The property market, in particular, repositioned and became very compelling in terms of risk-adjusted rates along with enhanced structures as well as beneficial terms and conditions.
Rate changes within property CAT range between 30% and 100% in the U.S. as well as in peak zones outside the U.S. Risk-adjusted rate increases were approximately 50% in the U.S. Property and 35% in International Property. And similarly, average margin improvement was approximately 50% year-over-year across the entire portfolio.
Property CAT ROEs for both the U.S. and International business increased by greater than 100% year-over-year. Additionally, we obtained improved terms and conditions, including favorable movement in attachment points in all Property lines.
For Casualty lines, quota shares remained sound with ceding commissions moving favorably for reinsurers by 1 to 2 points, along with terms and conditions remaining in line or improved. The result of these actions included: net premiums written at January 1 increased over $500 million or 50% year-over-year. This increase was driven roughly 30% from U.S., property 15% from International Property, 45% from casualty placements and the remaining 10% was from Specialty, including marine and energy.
The majority of new property limit was deployed to existing clients with a significant level of private terms being achieved on our U.S. property writings.
Looking ahead, we will continue our measured approach for other renewals. For example, if meaningful market changes continue, we will carefully consider our positions at the April 1 Japan renewals, and we will continue to be very cautious with capital deployed at June 1 in Florida.
Turning to Private Client Group or PCG. This business remains a strategic priority for us in 2023. As you know, over the last 2 years, we have undertaken a significant re-underwriting effort in this portfolio, reduced aggregate exposure, transitioned certain states to the non-admitted market and developed strong partnerships with Lloyd's and reinsurers to reduce volatility.
On Monday, we announced our intention to launch, in partnership with Stone Point Capital, a newly formed MGA that will underwrite on behalf of AIG and eventually other capital providers in the high- and ultra-high net worth markets. AIG will transfer core PCG solutions to the MGA, which will offer a single end-to-end broker and client portal, a comprehensive set of product offerings, a simplified data warehouse and the underwriting capabilities of AIG. The MGA will be rebranded as Private Client Select, or PCS, and will be led by Kathleen Zortman and our current team at PCG. We see this new structure as a logical next step in the evolution of PCG and believe it will create significant value for clients, brokers and other stakeholders.
Additionally, expense discipline will continue to be a priority for AIG. In addition to savings from AIG 200 that we expect to earn in during 2023, we plan to move $300 million of expenses currently sitting in AIG corporate GOE to Corebridge upon deconsolidation. Separately, we will continue to align our target operating model and further reduce absolute expenses across AIG parent and General Insurance to reflect the fact that AIG is becoming one company.
This year, we will also remain focused on completing the operational separation of Corebridge from AIG, and we are working towards a secondary offering of Corebridge common stock by the end of the first quarter, subject to market conditions and regulatory approvals. Our current expectation is that the majority of net proceeds of the secondary offering will be used for AIG common stock repurchases.
And as I stated on our last call, we are revisiting AIG's dividend, which has not changed in many years. We expect to say more about this on our first quarter call in May.
With respect to capital management priorities, in 2022, we did a significant amount of work to materially improve the capital structures of both AIG and Corebridge. With the reduction in AIG debt we achieved, our post-deconsolidation leverage will be in line with best-in-class peers. And with respect to share buybacks, we have $3.8 billion remaining on our existing share repurchase authorization.
Our balanced capital management philosophy will continue to allow for investment in growth opportunities, while returning appropriate levels of capital to shareholders through share buybacks and dividends. We also remain open to compelling inorganic growth opportunities, should they arise.
Before turning the call over to Sabra, I would like to pause and say that 2022 was another incredibly important year for AIG. Our colleagues did an exceptional job, particularly on the Corebridge IPO and the continued underwriting and operational improvements that are clearly showing through in our financial results. Our journey to be a top-performing company continues, and I fully expect 2023 to be another year with significant momentum and progress across the organization.
With that, I'll turn the call over to Sabra.
Sabra Purtill: Thank you, Peter. Today, I will review net investment income, additional color on our fourth quarter and full year 2022 results in capital management and also update you on the progress we are making on our path to a 10%-plus adjusted return on common equity or ROCE.
Turning to net investment income. On an APTI basis, fourth quarter net investment income was $3.0 billion, down $331 million or 10% compared to 4Q '21. Similar to trends throughout 2022, the decrease was due to lower alternative investment income, principally on private equity investments, and lower bond call and tender premiums and mortgage prepayment fees. For the full year, net investment income on an APTI basis was $11.0 billion, down $1.9 billion due to the same trends.
For the quarter and the full year, we achieved higher new money reinvestment rates and rate resets from floating rate securities. In 4Q '22, net investment income on fixed maturities and mortgage and other loans rose $224 million sequentially, with 29 basis points of yield improvement, which was ahead of our 10 to 15 basis point forecast. Since second quarter of '22, when we began to bend the curve on investment yields, the increase has been 55 basis points.
In 4Q '22, the average new money yield was just over 6% and about 173 basis points above sales and maturities. New money rates were roughly 157 basis points higher in General Insurance and 190 basis points higher in Life and Retirement. In addition, during the fourth quarter, we repositioned some of the General Insurance portfolio to lock in higher yields, while maintaining similar credit quality and duration. This resulted in a modest capital loss of $57 million, but we expect the portfolio to generate higher net investment income in '23 as a result. Given current market levels, we expect additional yield uplift of 10 to 15 basis points on the consolidated portfolio in 1Q '23.
Before I head into results for the quarter, I want to note that in the fourth quarter, we eliminated the 1-month reporting lag in General Insurance International, which had a $100 million positive impact on our GAAP net income for the quarter. This change did not impact 4Q APTI, which remain on the same reporting basis as the prior year. But in 2023, GI International results will be on a calendar quarter basis and 1 month different than 2022, which will create some slight timing mismatch in quarterly net premiums written comparisons, but with minimal impact for the full year. Please see Page 25 of the financial supplement for more details.
As Peter noted, AIG reported adjusted after-tax income of $1.0 billion or $1.36 per diluted share. General Insurance delivered APTI of $1.2 billion compared to $1.5 billion in the prior year quarter due to lower investment income, partially offset by a $136 million increase in underwriting income. Prior year development was $151 million favorable in the fourth quarter, up from $44 million of favorable development in 4Q '21.
Net favorable amortization for the ADC was $41 million, while North America favorable development was $148 million, and International was $38 million adverse, mostly driven by casualty.
Fourth quarter Other Operations adjusted pretax loss of $451 million improved $197 million from last year, despite $23 million of additional expenses related to the Corebridge separation. Annualized adjusted ROCE was 7.5% in 4Q '22, down from 9.9% in 4Q '21, principally due to lower alternative investment income.
Turning to Life and Retirement. Strong sales momentum continued in the fourth quarter. Life and Retirement APTI was $781 million, down from $969 million in 4Q '21, due to lower investment income on alternatives and other yield enhancements, partially offset by higher base investment income and more favorable mortality.
Individual Retirement sales were $3.8 billion, a 16% increase over the prior year quarter with Fixed Annuity sales up 78% and Fixed Index sales up 34%, near record sales for both products.
Group Retirement deposits grew 20%, driven by higher out-of-plan Fixed Annuity sales and large plan acquisitions. The Life Insurance business had solid sales with an improving mix of business in the U.S. and continued growth in the U.K.
In Institutional Markets, premiums and deposits were $1.6 billion, driven by $1.3 billion in pension risk transfer activity. New product margins in L&R were attractive and in excess of long-term targets, supported by higher new money yields, including from Blackstone. After years of spread compression, L&R spreads are expected to improve in 2023.
I wanted to make you aware of an update to our LDTI estimate. In the first quarter of 2023, we will adopt a change in accounting principle for LDTI with a transition date of January 1, 2021. Our current estimate is that as of September 30, 2022, the adoption would increase shareholders' equity between $800 million and $1.3 billion and AIG's adjusted shareholders' equity would increase between $1.2 billion and $1.7 billion. This increase in the estimate has been predominantly driven by capital market movements during 2021 and 2022.
Turning to full year 2022. AIG reported adjusted after-tax income of $3.6 billion or $4.55 per diluted share compared to $4.4 billion or $5.12 per diluted share in 2021. These results include much stronger underwriting profitability in GI, offset by lower alternative investment income, as previously described.
General Insurance APTI for the full year 2022 was $4.4 billion, up 2% from 2021 due to the $1 billion increase in underwriting profitability, offset by lower investment income. L&R APTI was $2.7 billion, down from $3.9 billion in 2021, principally because of lower investment income.
Other Operations adjusted pretax loss improved about $400 million in 2022 due to lower general operating expenses and higher income on short-term investments. Full year 2022 included additional expenses from the Corebridge separation of $51 million. And in 2023, we expect an incremental cost of $75 million to $100 million in Other Operations' GOE related to the separation.
Adjusted book value per share was $73.87 at December 31, 2022, up 7% from year-end 2021. Full year adjusted ROCE was 6.5%, down from 8.6% in 2021, primarily due to lower alternative investment income, which was down $1.8 billion from 2021 or about 340 basis points of ROCE compared to 2021. At year-end, our primary insurance subsidiaries remain above target ranges for statutory capital, with GI's U.S. pool estimated in the range of 485% to 495% and L&R estimated in the range of 410% to 420%.
In addition to the strong financial results, we also executed on multiple capital management priorities in 2022. As Peter described, we established a separate debt capitalization structure for Corebridge and subsequently reduced AIG holding company debt by $9.8 billion. This reduction in AIG debt will lower AIG's holding company interest expense from about $1 billion in 2021 to roughly $500 million in 2023, excluding interest expense on Corebridge issued debt.
In 2022, we also returned over $6.1 billion to shareholders with $1 billion of dividends and $5.1 billion of share repurchases, yielding a 10% reduction in shares outstanding. We ended the year with Parent liquidity of $3.7 billion.
Looking ahead, we remain highly committed and laser-focused on delivering a 10%-plus ROCE after the deconsolidation of Corebridge. As Peter and Shane have shared previously, achieving this goal is based on sustained and improved underwriting profitability; executing a leaner operating model across AIG; separation and deconsolidation of Corebridge; and continued balanced capital management, including reducing AIG common shares to between 600 million and 650 million shares through repurchases, while targeting debt to total capital leverage at the lower end of the 20% to 25% range post deconsolidation. Progress on each of these will increase ROCE, along with additional tailwinds from higher reinvestment yields and alternative returns more consistent with long-term averages.
As Peter mentioned, expense reduction remains an important goal. In the following years, we expect to achieve $300 million of additional savings from AIG 200, with the majority earning in through 2023; $300 million of AIG corporate general operating expense moving to Corebridge upon deconsolidation; and additional savings as we transition to a leaner operating model. As a reminder, every $500 million of expense savings equates to 1 point of ROCE improvement.
I will now turn the call back over to Peter.
Peter Zaffino;Chairman and CEO: Thank you. Michelle, we'll take our first question, please.
Operator: [Operator Instructions] Our first question comes from Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question is on the path to the double-digit ROE target. So the starting point is the 6.5% from '22, but I know that, that does include some contribution from L&R and will in the near term. So can you help us with what the starting point would be, if you stripped out the earnings contribution and equity of Life and Retirement? Just trying to get a sense of the ROE of the ongoing business and how the walk and that starting point changes, if you weren't including the Life and Retirement business.
Peter Zaffino;Chairman and CEO: Thanks, Elyse. I would think in terms of how you should think about this, and for us to get to the 10% ROE, Sabra outlined in detail, there's really 3 major ways in which we'll get there. One is through the underwriting results, the other is expense savings. The other is sort of the capital rebalance with share repurchases and other capital management. So you should think about that as a 300 to 350 basis point target in terms of us getting to the double-digit ROCE. Of course, net investment income can benefit, and that's more of a timing issue. We've never said, even in the prior calls, that contribution from increased NOI. NII will be the one that needs to contribute to get us to the 10%, but I think -- I would think of it in that range for the different components.
Elyse Greenspan: Okay. And then my second question, you guys had taken up your loss trend assumption to 6.5% last quarter. I'm assuming that didn't change, but correct me if I'm wrong. And Peter, you spoke to pricing of 6%, which would put written pricing below loss trend, but you also did say, right, that rates got better as we ended the year in December. So would you expect the 6% to go above loss trend in the first quarter?
Peter Zaffino;Chairman and CEO: Yes. Thank you. The first part, Elyse, we do not change our loss cost assumptions from what we had outlined in the third quarter, so 6.5% remains our view. When you look at the fourth quarter, like you said, overall, there was around 6%. But when you -- you have to take a couple of things into consideration. One is fourth quarter is our seasonally sort of lowest-sized quarter. But if you look at financial lines, like financial lines is even throughout the entire year, first quarter through fourth, so had a little bit more of a contribution to the overall rate index in the fourth quarter.
Our International was very well balanced. We had strong rate in areas where we felt we needed it, which is like Property, Excess Casualty. We're driving rate as we have been for the last several years in Lexington, the Excess & Surplus Lines. And then I look at the full year in terms of North America, the Excess Casualty, Retail Property, Lexington, all getting double-digit rate increases. And so like we have been very focused on the rate above loss cost to continue to develop margin. I think that's been evidenced through the culture that we've developed in terms of underwriting excellence. We are very focused on making sure that we continue that, and it's terms and conditions and adjustments to how we structure businesses going forward. December was much stronger than the first part of the quarter. And as we look to January, that momentum is continuing. Dave, maybe just spend a minute on what happened in Financial Lines and D&O specifically?
David McElroy: Yes. Thank you, Peter. And thank you, Elyse. To Peter's point, we have to be careful around generalizations because we are actually hitting rate over trend in most of our big businesses. The outlier is Financial Lines. And Financial Lines, you also have to unpack a little bit and understand that excess D&O, and excess D&O in large public companies is probably driving some of the macro numbers, but it's not driving the behavior underneath. So in our Financial Lines business, we have professional liability. We have cyber. We have private company business. We have financial institutions. And all those businesses are actually getting rate over trend. But sometimes, when you aggregate up the excess public company business, it suppresses it.
And in that case, Elyse, it's hard to rationalize. I'll be very frank. That's a place where, if you're primary, you're still getting rate. You're still getting flat maybe down a little bit, but you have risk-adjusted rate that's helping.
In the Excess business, it's been very competitive. It's a different sort of market. And it's actually a market that I would say that cycle manage and companies that are being thoughtful need to actually wrestle with, whether that's a place they're going to trade, okay? If the rates are going down 20% to 30%, it's probably influencing some of the numbers that you look at on an aggregate basis. And inside that portfolio, your decisions are going to have to be made as to how you trade there, okay?
In our case, it represents a small amount of the portfolio. But I'm conjecting that, that's actually where the commoditization of the business is going to cause a little bit of pain in the 2023, 2024 year, okay? But it's -- I do -- Peter hit it. We look at rate over trend on a very granular basis, and I think we're comfortable with what that means to our big businesses and even in Financial Lines, what it means to our subproducts there. And I think that's an important part of our story.
Peter Zaffino;Chairman and CEO: Thanks, Dave. And don't forget, like the cumulative rate increases we've achieved in D&O over the last 3 years have been north of 80%. So again, it's a line, as Dave says, we're laser focused on. We're not going to chase the market down. But the cumulative rate increases and margin development hasn't been fully recognized, and we're going to look to 2023 with a lot of discipline.
Operator: Our next question comes from Paul Newsome with Piper Sandler.
Jon Paul Newsome: There's been an enormous amount of conversation, and you obviously did a lot to add to about Excess Casualty -- or excess of loss reinsurance and -- but as a large account commercial writer, I assume you're using a lot of facultative as well. And I was curious if the comments that you're making extend into not just sort of excessive loss, but also facultative and even quota share as being as impacted as some of the other pieces of the business and how that would affect AIG.
Peter Zaffino;Chairman and CEO: Thanks, Paul. We do purchase facultative in certain segments of our business, but we were really referencing the core treaties. When we look at risk appetite, when we are thinking through our ability to protect the balance sheet and where we want to structure treaties, we don't require facultative reinsurance for other segments in order to supplement the core structure. So when I was referencing in my prepared remarks, the treaty structures, we did an exceptional job. The team really focused on modeling changes, inflationary changes and where we thought capital was going to be less expensive versus more expensive.
An example of that would be taking big excess of loss CAT across the world. It gets too expensive for allocation of capital, and that is something we moved away from. So we've built more vertical towers in North America and in international and Japan specifically. So I think the overall market has responded most to Property. Casualty has started to tighten up. I still think that there's ample capacity in quota shares. They may be with some tighter terms and conditions and ceding commissions or, by and large, it was placeable. And yes, facultative, I think, has become harder to place on property just based on the capital available. But for us, we don't heavily rely on facultative to deliver results. It's really our core treaty structures.
Jon Paul Newsome: Makes sense. Can you also talk about the change in conditions in commercial lines? Obviously, AIG led the market in changing terms and conditions in commercial lines. Is the impact pretty much fully there now today at AIG? And have you seen -- are you seeing any change in the market as well for terms and conditions that's meaningful sort of outside the pricing change?
Peter Zaffino;Chairman and CEO: I think we've done an exceptional job on the underwriting side with terms and conditions. I think the entire team has focused over the last several years as not only -- certainly pricing's an output, but how we structure our insurance deals, how we focus on client needs, but also how we customize terms and conditions to make sure that we have the appropriate policies and endorsements in the marketplace. I don't think it's over. It's something that's a nuance. But as we look to the property market in 2023, it's one of the areas where, when you report out rate, you really have to understand the risk-adjusted implications of rate increases.
For instance, in Excess & Surplus Lines property, I expect to see higher deductibles, more wind deductibles, tighter terms and conditions. We've seen what used to be all risk, which covered all perils, now to name perils, and so you can strip out a lot of coverage in terms of when you're placing it, whether you're trying to solve for wind or quake or flood, you don't provide all of the perils. And so if you said to me, what's one of the big areas that you'll see an improvement in 2023, it will be on the terms and conditions and how we price those perils. And I think we will offer, particularly in Excess & Surplus Lines, the appropriate coverage, but we will be restrictive on terms of conditions if we don't feel we're getting paid for. So I don't think it's over.
Operator: Our next question comes from Erik Bass with Autonomous.
Erik Bass: Just hoping you could help us think about the base NII trajectory for 2023. So we've seen a nice step up in the past couple of quarters, and you gave some guidance for the first quarter. But how much of the increase is coming from resets on floating rate assets? And how much is the tailwind from higher reinvestment yields and the portfolio changes that you're making that should continue to build throughout the year?
Peter Zaffino;Chairman and CEO: Thanks, Erik. As you know, this has been an active strategy for us, particularly over the back half of 2022. I think the team has done an exceptional job. And Sabra, maybe you can just provide a little bit of insight in terms of some of the NII and the reinvestment rates.
Sabra Purtill: Yes, happy to do that. And I would just note, we added a new footnote on Page 47 of the financial supplement that gives you the walk of the yield on fixed maturity securities and loans. So you can see the quarter-to-quarter improvement in the portfolio yield on that portfolio, which basically begin to bend the curve in the second quarter for a step-up in yields. And we also, there, give you the impact of the other yield enhancements, which year-over-year was about a $400 million headwind for AIG consolidated NII.
But to go back to your question about the path forward, and I'll put alternatives to the side. I mean, those are obviously volatile quarter-to-quarter. But like I said, that was 340 basis points of headwind year-over-year. 2021 was an exceptional year for alternative returns, whereas full year 2022 was about a 5.6% yield. So more in line with our average assumption.
But to go back, so in the quarter, as I said, the new portfolio yield or the new money rates were just above 6% and about 173 basis points over the assets going forward. And if you look at in the quarter, fourth quarter '22 grew about $160 million just due to the rate resets and about 14 basis points from the pickup in yield on the portfolio. Now in 2023, the impact is going to really depend on the path and timing of market rates, fed rate hikes, changes in credit spreads as well as the movement in the yield curve. As you know, the GI has got a shorter duration than L&R. And right now, we've got an inverted curve. So depending on where you're investing, and you're going to have different impacts on your yield.
So what I would just kind of point you to is, for the full year, we are projecting about $8 billion of reinvestment on the GI portfolio, $20 billion in Corebridge. And for the first quarter, we're projecting about 10 to 15 basis points of yield uplift just based on where we are for rates. Since the market is expecting additional rate increases, I would -- from the Fed, I would expect to see more pickup from the floating rate note resets during the course of the year. And then like I said, really what we pick up in the second or third quarter is going to be a function of how the shape of the yield curve changes.
But the point I would just make in total is that we are definitely having a tailwind from higher rates and higher spreads in the market. In addition, during the last several months, because of the -- basically the changes in the spreads and where some of the opportunities were, we were able to move up in quality on the bond portfolio investments while still getting a pickup in the yield because of the market environment.
So at this point in time, I think it's premature to give any sort of actual projection on a dollar basis. But from a yield pickup trend, we're very confident that we'll continue to see that during 2023.
Erik Bass: That's helpful. And then secondly, I just was hoping you could help us think about the trajectory for the other operations loss both before and after the Corebridge separation. So it sounds like GOE there should go up in 2023 because of some of the Corebridge expenses, maybe that's offset a little bit by interest savings. But then you'll get a big step down when you deconsolidate Corebridge, when the $300 million comes out. Is that the right way to think about it?
Peter Zaffino;Chairman and CEO: Yes, Erik, it is. We -- in Other Operations, think about it in a couple of components. I think you've outlined most of them, is that upon deconsolidation, we would have $300 million or there thereabouts go with Corebridge. I mean, there could be some stair step up. I mean, it's hard in 2023 to look at each quarter because we're building Corebridge, as we've talked about before, as a stand-alone public company. So those amounts will be in each quarter, depending on the progress that we're making. So think about the $300 million.
I think we'll have savings in Other Operations throughout the year separate from that in the $100 million to $200 million range. And then as we get to the future target operating model, we've given guidance from the past that we anticipate that we'll get around $500 million, not out of all -- that will not all come out of Other Operations. It come out of the combination of what is General Insurance in the parent company today. But that will take deconsolidation. It will take us to get to the target operating model. But I think in the short run, you should think about Corebridge's $300 million, and that between $100 million to $200 million of other reductions in Other Ops is how I would think about it in 2023.
Operator: Our next question comes from Alex Scott with Goldman Sachs.
Taylor Scott: First one I had is just on net premium written growth in General Insurance. I mean we saw it slow in 2022, particularly towards the back end of the year. And it sounds pretty interesting, some of the opportunities you have, both in Validus Re and Lexington. But I just wanted to get sort of a high level perspective from you on what the strategy has been to sort of slow some of that premium growth in the back half of this year. And how you see that potentially inflecting as we go into 2023?
Peter Zaffino;Chairman and CEO: Thank you for the question. You have to really look at the full year, I believe, in terms of showing the progress of what we've done as a company. First and foremost, again, I'll mention it again, which is a culture of underwriting excellence. When we look at Commercial with a 340 basis point improvement in the fourth quarter in terms of its action year combined ratio, ex CATs, 440 for the year, I mean that's substantial progress. I mean, we made enormous improvements in profitability.
And so we've shaped the portfolio the way we like it, where again, the fourth quarter, not all roads lead to Financial Lines. But again, it was just a disproportionate amount of premium relative to the overall size. Fourth quarter's small. We saw real good growth in the businesses that we want to grow in, which is in the Excess & Surplus Lines, Global Specialty. But as we've been talking about, I hope it's evidenced through what we did at 1/1, which is why we wanted to put it in the prepared remarks, which is, I kept talking about taking aggregate down where we didn't think we were getting the appropriate risk-adjusted returns.
But when we thought we felt that the risk-adjusted returns were there, like in the reinsurance business, we expanded significantly and expect to see that through 2023. Can't really predict the market, but I don't believe this is all played through. We had a very complicated 1/1, but you have Japan coming up.
And the hardest part in terms of the reinsurance market and thus then the primary market on peak zone is going to be Florida at [ 6/1 ]. And so we think there's great opportunities in Excess & Surplus Lines continue to grow. Again, Global Specialties, Retail Property across the world. We'll watch International, but I don't believe that the treaty increased pricing that happened, which was substantial at 1/1, will play its way through the International business until 2024. Because a lot of the deals, 60% of it comes up at 1/1, was priced off of prior year treaties.
And so I think this has momentum. We are incredibly well positioned. We have no aggregate restrictions. And where we see risk-adjusted returns that are attractive, which we already have, we're going to deploy capital. That was the whole idea of putting more capital in subsidiaries, and then it goes to other lines of business. I mean, you cross-sell what we do in casualty, how we play in these different markets, we have such tremendous following as lead experts in underwriting that we believe, across the world, our platform will be very helpful to our clients, and we expect to find really strong areas for growth.
Taylor Scott: That's really helpful. Second one I had is more specifically on Casualty -- Excess Casualty pricing. We've heard some peers kind of talk about pricing and expressed the need for it to reaccelerate. And I think some investors seem to be getting a little more cautious about the potential for continued deceleration there. I felt like your prepared remarks were a little more optimistic. I'd just be interested in your perspective on the portfolio at AIG, what you're seeing in the market and where you'd expect things to go there.
Peter Zaffino;Chairman and CEO: We watch it carefully. I mean Excess Casualty, we're still getting very strong rate we have for the last couple of years. And that didn't stop in the fourth quarter. My prepared remarks were really just focused on, I don't think the market that we entered in the fourth quarter is the market that we're in. There's been a lot of changes over the last 60 days. And like every other line of business, it needs to stand on its own. It needs to develop margin. We want to be conservative in our position and making certain that the underwriting terms and conditions are appropriate. But we're watching it carefully. I haven't seen a substantial downturn in terms of pricing. It's been right in the sort of same range for, as I said, the last 6 quarters. And it's something that we're going to watch very carefully in 2023.
Okay. We greatly appreciate the engagement and all the questions and appreciate the interest. And so I just wish everybody a great day, and thank you for being here.
Operator: Ladies and gentlemen, this concludes your conference for today. Thank you for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Fourth Quarter 2022 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please, go ahead."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q, provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Good morning, and thank you for joining us to review our fourth quarter and full year 2022 results. Following my remarks, Sabra will provide more detail on certain topics, including Life and Retirement results and our path to a 10%-or-greater ROCE, and then we will take questions. Kevin Hogan and David McElroy would join us for the Q&A portion of the call."
},
{
"speaker": "Today, I will cover 4 topics",
"text": "First, I will provide an overview of our fourth quarter financial results. Second, I will review highlights from the full year, including some of our major accomplishments, which were remarkable given the very challenging conditions we faced throughout 2022 in the equity markets and the insurance industry. Third, I will unpack in some detail market conditions leading up to January 1 reinsurance renewals, where we saw significant shifts that we believe will impact the industry throughout 2023 and perhaps longer. Suffice it to say, this 1/1 renewal season was the most challenged that many, including myself, have seen in our careers. And fourth, I will outline our 2023 priorities and outlook regarding capital management."
},
{
"speaker": "Some of the highlights of our January placements include the following",
"text": "with respect to property catastrophe placements, we obtained more limit than we purchased in 2022; and we believe we have the lowest attachment points on a return period measurement for North America windstorm and earthquake amongst our peer group; and our modeled exhaust limits are at higher return periods compared to last year for each of our placements. These placements should further reduce volatility, which is something we remain very focused on, and they provide us with significant balance sheet protection in the event one or a series of significant catastrophe events occur."
},
{
"speaker": "Many factors improved our overall property CAT reinsurance program, with highlights being",
"text": "we were able to attain approximately $6 billion of limit, including increasing our per occurrence excess of loss placement; we maintained low attachment points on a model basis; we received support for a $500 million aggregate placement; and our overall spend for AIG increased less than 10% on an absolute and risk-adjusted basis versus 2022."
},
{
"speaker": "For Casualty lines, quota shares remained sound with ceding commissions moving favorably for reinsurers by 1 to 2 points, along with terms and conditions remaining in line or improved. The result of these actions included",
"text": "net premiums written at January 1 increased over $500 million or 50% year-over-year. This increase was driven roughly 30% from U.S., property 15% from International Property, 45% from casualty placements and the remaining 10% was from Specialty, including marine and energy."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. Today, I will review net investment income, additional color on our fourth quarter and full year 2022 results in capital management and also update you on the progress we are making on our path to a 10%-plus adjusted return on common equity or ROCE."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you. Michelle, we'll take our first question, please."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question is on the path to the double-digit ROE target. So the starting point is the 6.5% from '22, but I know that, that does include some contribution from L&R and will in the near term. So can you help us with what the starting point would be, if you stripped out the earnings contribution and equity of Life and Retirement? Just trying to get a sense of the ROE of the ongoing business and how the walk and that starting point changes, if you weren't including the Life and Retirement business."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Elyse. I would think in terms of how you should think about this, and for us to get to the 10% ROE, Sabra outlined in detail, there's really 3 major ways in which we'll get there. One is through the underwriting results, the other is expense savings. The other is sort of the capital rebalance with share repurchases and other capital management. So you should think about that as a 300 to 350 basis point target in terms of us getting to the double-digit ROCE. Of course, net investment income can benefit, and that's more of a timing issue. We've never said, even in the prior calls, that contribution from increased NOI. NII will be the one that needs to contribute to get us to the 10%, but I think -- I would think of it in that range for the different components."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then my second question, you guys had taken up your loss trend assumption to 6.5% last quarter. I'm assuming that didn't change, but correct me if I'm wrong. And Peter, you spoke to pricing of 6%, which would put written pricing below loss trend, but you also did say, right, that rates got better as we ended the year in December. So would you expect the 6% to go above loss trend in the first quarter?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. Thank you. The first part, Elyse, we do not change our loss cost assumptions from what we had outlined in the third quarter, so 6.5% remains our view. When you look at the fourth quarter, like you said, overall, there was around 6%. But when you -- you have to take a couple of things into consideration. One is fourth quarter is our seasonally sort of lowest-sized quarter. But if you look at financial lines, like financial lines is even throughout the entire year, first quarter through fourth, so had a little bit more of a contribution to the overall rate index in the fourth quarter."
},
{
"speaker": "David McElroy",
"text": "Yes. Thank you, Peter. And thank you, Elyse. To Peter's point, we have to be careful around generalizations because we are actually hitting rate over trend in most of our big businesses. The outlier is Financial Lines. And Financial Lines, you also have to unpack a little bit and understand that excess D&O, and excess D&O in large public companies is probably driving some of the macro numbers, but it's not driving the behavior underneath. So in our Financial Lines business, we have professional liability. We have cyber. We have private company business. We have financial institutions. And all those businesses are actually getting rate over trend. But sometimes, when you aggregate up the excess public company business, it suppresses it."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Dave. And don't forget, like the cumulative rate increases we've achieved in D&O over the last 3 years have been north of 80%. So again, it's a line, as Dave says, we're laser focused on. We're not going to chase the market down. But the cumulative rate increases and margin development hasn't been fully recognized, and we're going to look to 2023 with a lot of discipline."
},
{
"speaker": "Operator",
"text": "Our next question comes from Paul Newsome with Piper Sandler."
},
{
"speaker": "Jon Paul Newsome",
"text": "There's been an enormous amount of conversation, and you obviously did a lot to add to about Excess Casualty -- or excess of loss reinsurance and -- but as a large account commercial writer, I assume you're using a lot of facultative as well. And I was curious if the comments that you're making extend into not just sort of excessive loss, but also facultative and even quota share as being as impacted as some of the other pieces of the business and how that would affect AIG."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Paul. We do purchase facultative in certain segments of our business, but we were really referencing the core treaties. When we look at risk appetite, when we are thinking through our ability to protect the balance sheet and where we want to structure treaties, we don't require facultative reinsurance for other segments in order to supplement the core structure. So when I was referencing in my prepared remarks, the treaty structures, we did an exceptional job. The team really focused on modeling changes, inflationary changes and where we thought capital was going to be less expensive versus more expensive."
},
{
"speaker": "Jon Paul Newsome",
"text": "Makes sense. Can you also talk about the change in conditions in commercial lines? Obviously, AIG led the market in changing terms and conditions in commercial lines. Is the impact pretty much fully there now today at AIG? And have you seen -- are you seeing any change in the market as well for terms and conditions that's meaningful sort of outside the pricing change?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "I think we've done an exceptional job on the underwriting side with terms and conditions. I think the entire team has focused over the last several years as not only -- certainly pricing's an output, but how we structure our insurance deals, how we focus on client needs, but also how we customize terms and conditions to make sure that we have the appropriate policies and endorsements in the marketplace. I don't think it's over. It's something that's a nuance. But as we look to the property market in 2023, it's one of the areas where, when you report out rate, you really have to understand the risk-adjusted implications of rate increases."
},
{
"speaker": "Operator",
"text": "Our next question comes from Erik Bass with Autonomous."
},
{
"speaker": "Erik Bass",
"text": "Just hoping you could help us think about the base NII trajectory for 2023. So we've seen a nice step up in the past couple of quarters, and you gave some guidance for the first quarter. But how much of the increase is coming from resets on floating rate assets? And how much is the tailwind from higher reinvestment yields and the portfolio changes that you're making that should continue to build throughout the year?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Erik. As you know, this has been an active strategy for us, particularly over the back half of 2022. I think the team has done an exceptional job. And Sabra, maybe you can just provide a little bit of insight in terms of some of the NII and the reinvestment rates."
},
{
"speaker": "Sabra Purtill",
"text": "Yes, happy to do that. And I would just note, we added a new footnote on Page 47 of the financial supplement that gives you the walk of the yield on fixed maturity securities and loans. So you can see the quarter-to-quarter improvement in the portfolio yield on that portfolio, which basically begin to bend the curve in the second quarter for a step-up in yields. And we also, there, give you the impact of the other yield enhancements, which year-over-year was about a $400 million headwind for AIG consolidated NII."
},
{
"speaker": "Erik Bass",
"text": "That's helpful. And then secondly, I just was hoping you could help us think about the trajectory for the other operations loss both before and after the Corebridge separation. So it sounds like GOE there should go up in 2023 because of some of the Corebridge expenses, maybe that's offset a little bit by interest savings. But then you'll get a big step down when you deconsolidate Corebridge, when the $300 million comes out. Is that the right way to think about it?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes, Erik, it is. We -- in Other Operations, think about it in a couple of components. I think you've outlined most of them, is that upon deconsolidation, we would have $300 million or there thereabouts go with Corebridge. I mean, there could be some stair step up. I mean, it's hard in 2023 to look at each quarter because we're building Corebridge, as we've talked about before, as a stand-alone public company. So those amounts will be in each quarter, depending on the progress that we're making. So think about the $300 million."
},
{
"speaker": "Operator",
"text": "Our next question comes from Alex Scott with Goldman Sachs."
},
{
"speaker": "Taylor Scott",
"text": "First one I had is just on net premium written growth in General Insurance. I mean we saw it slow in 2022, particularly towards the back end of the year. And it sounds pretty interesting, some of the opportunities you have, both in Validus Re and Lexington. But I just wanted to get sort of a high level perspective from you on what the strategy has been to sort of slow some of that premium growth in the back half of this year. And how you see that potentially inflecting as we go into 2023?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you for the question. You have to really look at the full year, I believe, in terms of showing the progress of what we've done as a company. First and foremost, again, I'll mention it again, which is a culture of underwriting excellence. When we look at Commercial with a 340 basis point improvement in the fourth quarter in terms of its action year combined ratio, ex CATs, 440 for the year, I mean that's substantial progress. I mean, we made enormous improvements in profitability."
},
{
"speaker": "Taylor Scott",
"text": "That's really helpful. Second one I had is more specifically on Casualty -- Excess Casualty pricing. We've heard some peers kind of talk about pricing and expressed the need for it to reaccelerate. And I think some investors seem to be getting a little more cautious about the potential for continued deceleration there. I felt like your prepared remarks were a little more optimistic. I'd just be interested in your perspective on the portfolio at AIG, what you're seeing in the market and where you'd expect things to go there."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "We watch it carefully. I mean Excess Casualty, we're still getting very strong rate we have for the last couple of years. And that didn't stop in the fourth quarter. My prepared remarks were really just focused on, I don't think the market that we entered in the fourth quarter is the market that we're in. There's been a lot of changes over the last 60 days. And like every other line of business, it needs to stand on its own. It needs to develop margin. We want to be conservative in our position and making certain that the underwriting terms and conditions are appropriate. But we're watching it carefully. I haven't seen a substantial downturn in terms of pricing. It's been right in the sort of same range for, as I said, the last 6 quarters. And it's something that we're going to watch very carefully in 2023."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, this concludes your conference for today. Thank you for your participation. You may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 3 | 2,022 | 2022-11-02 08:30:00 | Operator: Good day, and welcome to AIG's Third Quarter 2022 Financial Results Conference Call. This conference is being recorded.
Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by the applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change.
Additionally, today's remarks may refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at www.aig.com. Finally, today's remarks will include a discussion of the financial results of AIG's Life and Retirement segment and Other Operations on the same basis as prior quarters, which is how we expect to continue to report Life and Retirement and Other Operations until the deconsolidation of Corebridge Financial.
AIG's segments and U.S. GAAP financial results, as well as AIG's key financial metrics with respect thereto differ from those reported by Corebridge Financial. As such, we will be intentional when referring to AIG's Life and Retirement segment versus Corebridge Financial when commenting on financial results. Corebridge Financial will host its first earnings call post IPO next week on November 9, and its management team will provide additional details on the Corebridge Financial third quarter results.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino;Chairman and CEO: Thank you, Quentin. Good morning, and thank you for joining us today to review our third quarter financial results, which I'm pleased to report were very strong, along with the excellent progress we've made on our strategic priorities. Following my remarks, Shane will provide more detail on the third quarter financial results, and then we'll take questions. Kevin Hogan, David McElroy and Mark Lyons will join us for the Q&A portion of today's call.
The third quarter represented an inflection point for AIG, with important milestones achieved across the organization. Our team once again demonstrated its ability to execute on significant strategic initiatives that position AIG for a strong future, to apply discipline and the successful execution of these initiatives and to achieve high-quality outcomes even against a backdrop of very complicated capital and insurance markets.
Before I cover the third quarter in more detail, I'd like to comment on the successful Corebridge Financial IPO, which we completed in mid-September despite very challenging equity capital market conditions. On our second quarter earnings call, we explained that volatility in the capital markets was significantly elevated and that attempting to complete an IPO at that time would not have been in the best interest of AIG, Corebridge or our stakeholders.
As a result, we decided to defer the IPO and revisit timing in the third quarter. We knew that there would be limited open windows and remain committed to completing a transaction as soon as we believed an appropriate opportunity was available. Throughout the summer, our team did a remarkable job and worked diligently on the operational separation of Corebridge from AIG as well as to prepare the business for a successful IPO.
As we noted on our last call, we had already increased the targeted savings program at Corebridge from an initial range of $200 million to $300 million to $400 million within 2 to 3 years. With the additional time available pre-IPO, the business accelerated certain actions and is now expected to deliver run rate savings of over $100 million by the end of 2022, ahead of our original schedule.
We were also prepared to secure the capital structure of Corebridge prior to the IPO and access the debt markets in late summer during a short window when conditions became more favorable. In August, Corebridge issued $1 billion of hybrid debt securities and in early September drew down on a $1.5 billion bank facility to complete its initial capital structure. Using part of the net proceeds from these debt transactions, Corebridge closed out the remaining $1.9 billion due to AIG under a promissory note.
Throughout this time, we also engage in continuous discussions with our financial and other advisers about equity market conditions, investor sentiment and our ability to execute the IPO in a complicated market. While equity markets remain uncertain, volatility was not as extreme leading up to Labor Day. We were confident we could complete the IPO within an acceptable valuation range, and we continue to believe it was very important for the future of AIG and Corebridge to establish Corebridge as a public company in 2022.
Throughout the third quarter, we also made significant progress in the implementation of a new investment management model for AIG and Corebridge. As you know, in mid-2021, we finalized a strategic partnership with Blackstone, which includes the transfer of $50 billion of Corebridge AUM to Blackstone, with that number growing to $92.5 billion over 6 years.
In addition, earlier this year, we announced a partnership with BlackRock, under which we will transfer up to $150 billion of liquid assets from both AIG and Corebridge. To date, we have transferred $100 billion of assets, with $37 billion moving from AIG and $63 billion moving from Corebridge. The complexity of operationally separating Corebridge from AIG as well as implementing our new operating model for investment management cannot be understated.
Keep in mind, these businesses have been in a combined structure for over 2 decades, with aspects of each business shifting over time between segments until just a few years ago. And until we announced our intention to separate Corebridge from AIG in late 2020, investments was a stand-alone unit at AIG, servicing all businesses across the organization. Our partnerships with Blackstone and BlackRock enable us to accelerate the reshaping of our investment portfolios.
With respect to the financial commitments Corebridge made as part of the IPO, I'd like to reiterate them as they too will create significant value for shareholders over time. We continue to expect Corebridge to pay $600 million in annual dividends, with its first quarterly dividend of $148 million declared 15 days after the IPO close and already paid, to have the financial flexibility to repurchase shares or reduce AIG's ownership stake as early as the second quarter of 2023 and to achieve a return on equity of 12% to 14% over the next 24 months.
Completing the Corebridge IPO within a very narrow window was a testament to the careful preparation, hard work and dedication of our teams at AIG and Corebridge and to the quality of the business. This was a major accomplishment for our teams, and we are all very proud of the outcome.
Turning to other highlights in the third quarter. Adjusted after-tax net income per diluted common share was $0.66. General Insurance delivered very strong performance and continued profitability improvement despite significant natural CATs in the quarter. The accident year combined ratio, ex CATs, was 88.4%, a 210 basis point improvement year-over-year and the 17th consecutive quarter of improvement.
This result was primarily due to Global Commercial, which had an excellent quarter, with an accident year combined ratio, ex CATs, of 83%, a 590 basis point improvement year-over-year, driven by International Commercial, which had an impressive 80.4% accident year combined ratio, ex CATs. The accident year combined ratio was 98.2%, a 200 basis point improvement year-over-year. The calendar year combined ratio was 97.3%, a 240 basis point improvement year-over-year.
CAT losses in the third quarter were $600 million, or 9.8 points of the combined ratio. Shane will break this number down for you in his remarks. Our CAT total includes losses from AIG Re related to Hurricane Ian, which came in at $125 million. This result reflects the terrific work the team has done to reduce peak zone exposure in our assumed reinsurance business, particularly in Florida, where we've reduced limits deployed by approximately 60% since 2018 and have minimal exposure to Florida domestic insurers.
Considering Hurricane Ian and other CATs in the third quarter, our CAT losses validate the quality of our underwriting, our reinsurance strategy and our ability to successfully manage volatility. With respect to PYD, there was a favorable release in the third quarter of $72 million or 90 basis points of the calendar year combined ratio.
In Life and Retirement, the business had another quarter of strong sales with premiums and deposits coming in at approximately $9 billion, up from $7.2 billion in the prior year, with positive year-over-year growth in each of its 4 business segments. Effective capital management remains a priority for AIG. In the third quarter, we repurchased $1.3 billion of common stock and paid $247 million of dividends. We also announced $1.8 billion of debt repayments, which we commenced in the third quarter and closed last week, further strengthening our balance sheet. And lastly, AIG ended the third quarter with $6.5 billion of parent liquidity.
Now let me provide additional detail on General Insurance and the continued, sustained improvement and very good absolute performance in our underwriting. When referring to gross and net premiums written, note that all numbers are on an FX-adjusted basis. Gross premiums written increased 5% to $9.2 billion, with Global Commercial growing 8% and Global Personal decreasing 3%. Net premiums written increased 3% to $6.4 billion.
The growth was in our Global Commercial business, which grew 6%, with Global Personal decreasing 4%. North America Commercial net premiums written increased 7%, and International Commercial net premiums written increased 5% or approximately 8%, excluding the impact of nonrenewal and cancellations related to known Russia exposure.
In North America Commercial, we saw very strong growth in net premiums written in Lexington led by wholesale property, retail property and Glatfelter. In International Commercial, we also saw strong growth in net premiums written in Global Specialty, led by International Specialty, marine and energy as well as property.
In Global Commercial, we also had very strong renewal retention of 85% in our in-force portfolio, with North America up 400 basis points year-over-year to 86% and international at 85%. As a reminder, we calculate renewal retention prior to the impact of rate and exposure changes. And across Global Commercial, our new business continues to be strong. North America new business was $458 million led by Lexington. International new business was $474 million led by specialty.
Turning to rate. Momentum continued in North America Commercial with overall rate increases of 9% in the third quarter, excluding workers' compensation. Areas within North America Commercial achieved double-digit rate increases. These included Lexington, which increased 20%; cyber, which increased 32%; and excess casualty, which increased 12%. International Commercial rate increases were 6%, driven by Talbot, EMEA, Asia Pacific, each of which increased 10%.
Our team analyzes loss cost trends every quarter. On our last call, we indicated that our loss cost trend view in the second quarter for North America Commercial lines had migrated upwards to 6%. Due to inflationary and other related factors that have resulted in an increase in property loss costs, we are increasing our aggregate loss cost trend to 6.5%, both in North America and international. Overall, we continue to receive rate above loss cost trends, which contributes to margin expansion on a written basis.
Moving to Global Personal Insurance, we continue our work across the portfolio to prioritize growth in A&H, to reposition our capabilities in Japan Personal and to transform our North America high net worth portfolio. Starting with North America, personal net premiums written declined 11%, driven by warranty as well as our ongoing reshaping of our high net worth business that we've discussed on prior calls.
We continue to make progress in our high net worth business by reducing peak zone aggregation, improving the overall quality of the portfolio, transitioning a portion of the portfolio where appropriate to excess and surplus lines and enhancing the value we offer to clients. Third quarter results reflect this repositioning, with North America's gross and net premiums written declining as we continue to reduce exposures and increase reinsurance sessions to mitigate volatility.
North America Personal Insurance's premium declines were partially offset by continued momentum in individual travel and Personal A&H. In International Personal, net premiums written declined 2% due to a reduction in warranty that was partially offset by a rebound in individual travel as well as growth in A&H, which is our largest and most profitable International Personal portfolio.
One item to note in the International Personal Insurance third quarter accident year loss ratio is that it reflects approximately $100 million of losses related to COVID claims in Japan and, to a lesser extent, Taiwan. These losses were primarily due to the Japanese government instituting a policy relating to deemed hospitalizations resulting from COVID, which impacted our A&H book.
This government policy was revised in the third quarter, and as a result, we expect the issue to have a de minimis impact in future quarters, starting with the fourth quarter of this year. Additionally, some of these losses related to cleanup expense benefits offered to small businesses, which AIG no longer provides.
Turning to PYD, we conducted our annual review of approximately 75% of pre-ADC loss reserves in the third quarter. We applied conservative assumptions in this review as we believe it is appropriate to be prudent given current economic conditions. As a result of our review, we recorded $72 million of net favorable development for the third quarter or 90 basis points of the loss ratio. This reflects $42 million of amortization from the ADC combined with $30 million of other favorable development.
Our international operations were favorable in every region totaling $328 million, whereas North America was unfavorable by $256 million. Furthermore, in North America, virtually every line of business was favorable, except for U.S. financial lines, which was unfavorable by $660 million net of the ADC, predominantly in accident years 2018 and 2019 and, to a lesser extent, 2020.
Let me unpack the drivers of unfavorable development in U.S. financial lines a bit more because it's been an area of focus for us for several years given AIG's history in this line of business. The unfavorable development was primarily driven by excess D&O written out of both the U.S. and our Bermuda business. And while there was some movement on the primary side, the excess book was the most significant driver. D&O prior year emergence continues to be driven by large losses. Many from security class actions and earlier accident years also experienced stacking exposures where primary mid-excess and high-excess policies were all exposed on the same insured.
This issue is similar to what we saw across the portfolio when we first started our remediation strategy. The company had too much vertical limit on a per account basis. As we've discussed on prior calls, our underwriting strategy and ventilation standards were completely overhauled over the last few years, including U.S. financial lines to prevent stacking and overexposure to anyone insured. And we've dramatically reduced limits deployed on individual policies, obtained tighter terms and conditions and achieved higher attachment points on primary limits. Shane will provide more detail on PYDs in his remarks.
Now I'd like to spend a few minutes talking about Hurricane Ian, which was a very tragic event on a human level that also left devastating physical damage. AIG rapidly deployed significant resources to the affected areas, providing immediate support and infrastructure to help individuals, businesses and communities rebuild. Hurricane Ian is projected to be the second largest insured natural CAT loss in U.S. history.
There remain a considerable number of variables contributing to industry ultimate losses, but based on what we know today, total insurable losses are expected to be in the range of $50 billion to $60 billion. For context, Hurricane Katrina and Irma, the first and third largest U.S. natural CAT losses in the last 100 years, are estimated at $85 billion and $40 billion of insured losses, respectively, on an inflation-adjusted basis.
While Hurricane Ian will have an impact on the broader insurance, reinsurance and retro markets, we believe AIG is well positioned. Very importantly, we have strong and strategic relationships with our major reinsurers, and we are confident in our ability to obtain similar levels of capacity for 2023 as we did in 2022. In addition, we've improved and continued to improve our portfolio, and therefore, the reinsurance we require will reflect this during 2023. And we see significant growth opportunities across the market, especially in the near term and for property specifically, and our significant financial flexibility will allow us to be nimble as we deploy capital at attractive risk-adjusted returns to Retail Property, wholesale property, Talbot, global specialties and AIG Re.
With respect to the industry and markets more broadly, as we noted on our second quarter call, there are a few things you need to believe about the market prior to Ian in order to understand the impact Ian may have in the future. If you believe, as we do, that the retro market was already contracting from last year's available capacity, which itself was reduced from the prior year and the anticipated capital for 2023 was already going to further contract approximately 10%, the retro market and the property CAT market would have already been challenged even prior to Ian.
In addition to reduced capacity over 2022, prior to Ian, there was also an expectation of increased retentions, more specific peril coverage as well as rate increases resulting from several factors including increased frequency and severity of CATs over the last several years. Keeping this context in mind, 2022 will be another year with over $100 billion in natural CAT industry losses. Prior to 2017, on an inflation-adjusted basis, there were only 2 years, 2005 and 2011, that had greater than $100 billion of global natural CAT losses. And in both of these years, losses were led by primary perils.
Since 2017, 5 of the last 6 years have had greater than $100 billion in global natural CAT losses, with the predominant portion of losses in the aggregate coming from secondary perils. Furthermore, other issues potentially impacting 1/1 capacity prior to Ian were the strengthening of the dollar, euro-denominated capacity likely decreasing due to currency devaluation, asset valuations, inflation and demand surge from the post pandemic economy, just to name a few.
When considering the impact of Ian and the complexity it adds to already challenging market conditions, there are a few additional factors to consider. In Florida, residential total insured values have increased by more than 50% over the last 10 years. The significance of commercial losses, which will likely exceed 40% of the ultimate losses for Ian, compared to the average of prior natural catastrophes, where commercial losses were 30% of the ultimate loss. The prevalence of commercial losses exacerbates the complexity of CAT modeling generally and the resulting deficiencies regarding appropriate CAT load and pricing.
When considering the modeled estimated output for losses related to Ian, for example, commercial losses were deficient by 2.5x and personal by 1.5x after adjusting for inflation and other factors. Furthermore, when major CATs occur in Florida, a disproportionate amount of the loss finds its way to the reinsurance market because of the proportional and low attaching excess to loss placements completed by Florida domestic insurers as their capital structures require significant reinsurance. Available reinsurance capacity is forecasted to be the lowest aggregate limit available in over a decade, making conditions in the property CAT reinsurance market even more challenging.
Now turning to Life and Retirement. Adjusted pretax income was $589 million, decreasing from $877 million in the prior year period, mainly due to lower alternative investment income and lower call and tender income. There were no significant reserve adjustments arising out of the third quarter actuarial assumption review. As I mentioned earlier, Life and Retirement had excellent sales with premiums and deposits of approximately $9 billion, up 23% year-over-year. Sales of annuities over the course of 2022 have benefited from our relationship with Blackstone with $5 billion of assets originated year-to-date in private ABS, direct credit lending and structured assets.
While our strategic partnership with Blackstone is still in the early days, the quality and the performance of the portfolio relative to what the business could have done on its own are very encouraging. Sequential improvement in fixed income and loan portfolio yields accelerated, with a 24 basis point improvement in base investment yields. Year-over-year fixed income and loan portfolio yields also improved 8 basis points, confirming the business has surpassed year-over-year yield compression for the first time in recent memory. Shane will provide more information on the Life and Retirement segment and Corebridge in his remarks.
Shifting to capital management, we continue to be balanced and disciplined as we maintain appropriate levels of capital in our subsidiaries for profitable growth opportunities across our global portfolio as well as reduced levels of debt while returning capital to shareholders through share buybacks and dividends. Looking ahead, with respect to share buybacks, we have $4.3 billion remaining on our current share repurchase authorization and expect to end 2022 with over $5 billion of share repurchases for the full year. And balance sheet actions we've taken put us in a position of strength with significant financial flexibility that AIG has not had in many years.
As we look to 2023, our lockup agreement with the underwriters of the IPO with respect to Corebridge common stock expires in March. Subject to ordinary course blackout periods, this means that our likely windows for a secondary offering of Corebridge common stock in the first half of 2023 will be in mid- to late March as well as mid-May to late June. Our current expectation is that the net proceeds will largely be deployed to share repurchases.
While we remain committed to consistently returning capital through share repurchases for the foreseeable future, we believe there will be attractive organic growth opportunities in General Insurance and AIG Re given current market dislocations that may prove compelling. Lastly, as we discussed on our second quarter call, we continue to expect that post deconsolidation of Corebridge, AIG will achieve a return on common equity at or above 10%. Shane will provide more details in his remarks.
As we approach year-end and plan for 2023, our path forward is clear with General Insurance solidifying its position as a global market leader, the deconsolidation and eventual full separation of Corebridge firmly underway and a significantly strengthened balance sheet. With that, Shane, I'll turn the call over to you.
Shane Fitzsimons: Thank you, Peter. As Peter noted, I will provide more detail on the third quarter results, specifically EPS, reserve reviews, net investment income, capital management and the path to achieving an above 10% return on common equity. Adjusted after-tax income was $509 million or $0.66 per share compared to $837 million or $0.97 per share in the prior year quarter. This was driven by a $741 million decline in net investment income, offset by improved underwriting results in General Insurance and solid performance in Life and Retirement as well as improved GOE and Other Operations.
General Insurance finished the third quarter with adjusted pretax income of $750 million. Underwriting income was up $148 million despite Hurricane Ian, offset by a $209 million decline in net investment income due to alternative investment returns. Life and Retirement contributed adjusted pretax income of $589 million, which is $288 million below prior year quarter driven by lower alternative investment and call and tender income.
Other Operations adjusted pretax loss of $614 million compared to $562 million prior year quarter, mostly due to lower alternative investment income, partially offset by lower interest expense. This quarter, Other Operations included $16 million of additional expenses for setting up Corebridge as a stand-alone company. Excluding such expenses, GOE improved by $17 million versus prior year.
As Peter noted, results in General Insurance reflects strong underwriting performance with continued combined ratio improvement of 240 basis points to 97.3%, an accident year combined ratio ex CAT of 210 basis points to 88.4%. North America Commercial accident year combined ratio, ex CAT, improved 590 basis points over the prior year quarter to 84.6%. International Commercial accident year combined ratio, ex CAT, at 80.4% showed 640 basis points of improvement.
North America Personal reported an accident year combined ratio, ex CAT, of 112.8%, primarily reflecting higher reinsurance costs and lower ceding commission for high net worth business. International Personal accident year combined ratio, ex CAT, was 99.9%, wholly due to increased frequency of A&H claims in Japan and Taiwan. Net CAT losses, excluding reinstatement premiums, were $600 million or 9.8 loss ratio points in the third quarter, which included $450 million from Hurricane Ian and $84 million from Japanese typhoons. Additionally, the reinstatement premium impact across all CAT events was $55 million.
Switching to reserves, nearly $40 billion of reserves were reviewed this quarter, bringing the year-to-date total to approximately 90% of carried pre-ADC reserves. As Peter noted, prior year development, excluding related premium adjustments, was $72 million favorable this quarter compared to favorable development of $50 million in the prior year quarter.
Prior year emergence in accident year 2019 and 2020 was largely due to policies written in 2017 and 2018. And an accident year 2020 was largely due to policies in private and not-for-profit where gross premiums have been reduced by 54% since 2018, and limits provided have been reduced by 85%. In 2018 and prior, AIG wrote multiyear policies that contributed to accident year 2019 and 2020 losses. So for example, a policy written in 2017 had loss emergence in accident year 2020. We have strategically shifted away from this business, which now makes up less than 1% of policies in those lines.
As we've discussed previously, we overhauled the General Insurance underwriting strategy, including U.S. financial lines, resulting in reduced limits deployed on individual policies, tighter terms and conditions on higher attachment points on primary limits and termination of certain businesses. Since 2018, we have seen the following. Total primary limits exposed in U.S. financial lines have been reduced by $32 billion on a comparative basis or nearly 80% through the third quarter of this year.
Total primary limits in both corporate and national D&O have been reduced by nearly 50% on a comparative basis, and private and not-for-profit primary limits have been reduced by nearly 85%. And in all cases, rates have increased substantially over this time period. Since 2018, we have achieved cumulative rate increases of nearly 85% in both primary corporate and national D&O on a third quarter cumulative basis and over 115% in private and not-for-profit primary business.
Overall, we recognize bad news early but wait to recognize good news over time as we monitor developments, which we believe leads to a conservative view on our reserves. Along these lines, we've built in an expectation of higher inflation given the uncertainty over its potential impact on our reserves.
Turning to Life and Retirement. Adjusted pretax income was $589 million compared to $877 million in the prior year quarter. The decrease was due to lower alternative investment, call and tender and fee income, partially offset by higher investment income from fixed maturity and loan portfolios, less adverse mortality and an improved outcome in the annual actuarial assumption review, which, other than DAC acceleration of $57 million, showed no meaningful net movement in reserves this year.
Product margins were attractive and in excess of long-term targets in all businesses, supported by robust new business origination from Blackstone. Corebridge now expects spread compression to convert to expansion beginning in 2023. Strong sales momentum continued in Individual Retirement, with $3.8 billion in sales, a 16% increase year-over-year and led by over 100% growth in fixed annuity sales on a record $1.7 billion in index annuity sales.
Group Retirement deposits grew 11%, driven by higher large plan acquisitions in the third quarter. The Life business had solid sales with an improving mix of business in the U.S. and continued underlying growth in the U.K. In Institutional Markets, premiums and deposits of $1.9 billion were up from $1 billion in the prior year quarter, with larger GIC issuances on higher pension risk transfer transactions. Mortality, including COVID losses, was once again below original pricing expectations. COVID losses remain within original sensitivities of $65 million to $75 million for each 100,000 U.S. population deaths.
Adjusted pretax net investment income for the third quarter was $2.54 billion, a decline of $741 million or 23% compared to prior year quarter, with $431 million attributable to Life and Retirement. $665 million of the decline was due to alternative investment income and $150 million was due to reduced call and tender income, offset by increase in the fixed maturity and loan portfolios of $153 million from yield uplift.
Our fixed maturity and loan portfolio saw a lift in yield of 17 basis points in the third quarter, building on top of the 9 basis points from the second quarter, and we expect 10 to 15 basis points additional in the fourth quarter. The new money yields on our fixed maturity and loan portfolio was approximately 120 basis points above the assets rolling off during the third quarter, roughly 60 basis points higher in General Insurance and 130 basis points higher in Life and Retirement.
Now turning to the balance sheet and capital management. We began 2022 with $10.7 billion of parent liquidity. And since then, we have paid dividends totaling $768 million, repurchased approximately $4.4 billion or 77 million shares of common stock, bringing our ending count to 747 million shares, a 9% reduction year-to-date.
Including recently announced bond make-whole calls of $1.8 billion, we established a Corebridge debt structure of $9.4 billion and reduced $9.8 billion of AIG debt. We completed the Corebridge IPO with its parent liquidity at $1.7 billion. AIG received $1.6 billion of net proceeds from the IPO, and we exited the third quarter with $6.5 billion of AIG parent liquidity, including $1.8 billion to fund the make-whole calls.
At third quarter end, our GAAP leverage was 36.5%, a 540 basis points increase quarter-over-quarter. The decrease in AOCI added 320 basis points to the overall leverage ratio, with over 80% of the change relating to Life and Retirement. AIG's debt leverage ratio, excluding AOCI, was 27.5%, up 220 basis points from the second quarter as a result of the issuance of Corebridge debt as planned prior to the IPO. Including the impact of the make-whole calls post quarter end, AIG's leverage is 34.7% or 26%, excluding AOCI. Total adjusted return on common equity was 3.7%, down from 6.5% in 3Q '21. The decrease is mostly caused by a decline in net investment income.
Moving to the risk-based capital ratio, our primary operating subsidiaries remain profitable and well capitalized, with General Insurance's U.S. pool fleet and Life and Retirement's U.S. fleet RBC ratios both above our target ranges. We continue to make progress on the 4 priorities to achieve a 10% or greater return on capital employed. They are: underwriting profitability; leaner operating model; separation of the Life and Retirement business; and capital management. 2 points of improvement in combined ratio or $500 million of expense savings or $5 billion in share repurchases approximate to 1 point improvement in ROCE.
We expect to achieve expense savings from multiple areas, including: the remaining $350 million of savings yet to be realized from AIG 200; roughly $300 million of corporate GOE and approximately $400 million of interest expense that will be transferred to Corebridge; an additional expense savings as we transition AIG to a leaner operating model. Additionally, we've seen a 26 basis point yield uplift in the fixed maturity and loan portfolios in the past 2 quarters. Over time, we expect the yield uplift from net investment income could add 1 to 2 points to ROCE.
We are confident about delivering on our 10% plus ROCE commitment, and we will continue to execute on a prudent capital management strategy, which will reduce the share count to 600 million to 650 million range while maintaining leverage at the 20% to 25% level post deconsolidation.
With that, I will turn the call back over to you, Peter.
Peter Zaffino;Chairman and CEO: Thank you, Shane. And operator, we're ready for questions.
Operator: [Operator Instructions] Our first question will come from Elyse Greenspan with Wells Fargo. [Operator Instructions]
Peter Zaffino;Chairman and CEO: Operator, maybe we'll go to the next one in the queue, and then we'll come back to Elyse.
Operator: So our next question comes from John Heagney from Dowling & Partners. [Operator Instructions]
Peter Zaffino;Chairman and CEO: Do you want to try the next one in the queue, operator, please?
Operator: Let's try J. Paul Newsome from Piper Sandler.
Jon Paul Newsome: Sorry about the confusion from the folks on the questions, hopefully, you can hear me. I actually wanted to ask you about sort of a little bit different broad M&A question about the turmoil in the market. I think, obviously, we've seen environments where there's quite a bit of change. And I don't know if you think or you're seeing maybe the sellers getting a little bit more willing to sell given the volatility of the environment, and just your general thoughts on M&A would be fantastic.
Peter Zaffino;Chairman and CEO: Yes. So let me first take a step back, thank you for the question, and talk a little bit about our capital management strategy. And as we've outlined in the past, that we're focused on putting additional capital in the subsidiaries for organic growth because we see great opportunities. We worked very hard on reducing leverage. So while we've leveraged up Corebridge, we've been redeeming debt at the AIG level, focused on returning capital to shareholders through share repurchases, and we'll look very hard at the dividend for 2023.
And our view on M&A is, where there are compelling opportunities, I think you have seen weakness in this quarter in terms of some of the reporting. But our strategy is much more where it's compelling, where it's strategic. And I think if we use Glatfelter as an example, Glatfelter was a best-in-class program underwriter that had great distribution. We were not performing well in our Programs business. So we were able to reduce our position in programs and bring Glatfelter and Tony Campisi and the leadership team to AIG, and they just have thrived here together, where we've improved combined ratios, we've grown, and we've improved our overall performance.
So I think we will look for ways. We don't really have portfolios that need to be rehabilitated like we would have the Programs 3 years ago, but we could find those bolt-ons and things that are additive to AIG, where we are both better from being together. So I think that's how we would think about acquisition in the sort of medium term.
Jon Paul Newsome: Fantastic. Shift to a different question, maybe some thoughts on Validus in the context -- in the reinsurance business, in the context of the broader steps that you folks have done to reduce CAT exposure and maybe a little bit about the trade-off. I mean -- because, obviously, the big achievements that you've done under AIG is reduce the CAT exposure immensely. And how do you think about sort of, as we go forward, the trade-off that there seems to be a lot of opportunities in property CAT, kind of exposed areas but especially in the reinsurance market. But obviously, you've managed that trade-off pretty aggressively in the past.
Peter Zaffino;Chairman and CEO: Yes. So I think the market that's in front of us is going to reward those who are disciplined leading up to it. We have been very thoughtful and careful about reducing aggregate where we felt we had too much in peak zones as well as too much exposed to natural catastrophes. So we've talked over time that we've reduced enormous limits over the period that we've been reunderwriting.
Now on the AIG reassumed side, that's been just disciplined. We didn't like the risk-adjusted returns as we've cited in my prepared remarks, that we took down the aggregate by 60%. And I think the premiums, if you look on a gross basis in terms of CAT year-over-year, we're going to be down like 40%. And actually, some of that would be greater in North America.
We will look at opportunities in terms of -- we have plenty of aggregate for CAT, but it'll all be what's the best risk-adjusted opportunities. I mean the good news is we have multiple entry points. So we have Lexington on an E&S basis. We have retail property capabilities across the world. We have a terrific syndicate in Talbot that can access specialty classes that are more first party. We have a tremendous global specialties business that did phenomenal, I think, in the quarter and showed their sort of global leadership. And then we have the assumed business for AIG Re, where there are opportunities to deploy capital there, we are going to be prepared. So I think that the market will be very good for us to deploy more property. But again, we'll be disciplined, and we'll see what really transpires over the next 60 to 90 days. Next question, please.
Operator: And our next question comes from Meyer Shields from KBW.
Meyer Shields: Great. Am I coming through?
Peter Zaffino;Chairman and CEO: Yes, Meyer. Good to talk to you.
Meyer Shields: Fantastic. Okay. And Peter, just hoping you could talk a little bit about casualty loss trends because you mentioned property as one of the reasons for raising the overall trend 6.5%. And we obviously saw the financial lines issues that, at least superficially, could lead into other casualty lines. Can you sort of close the loop on that?
Peter Zaffino;Chairman and CEO: Sure. I'll ask Mark to provide more detail. I think what we do in our prepared remarks is say that we're looking at property, casualty, all of our lines and business in great detail. Really, what's been driving the upper end of the ranges up has been more the first-party business because of all the economic factors that are driving them. But Mark spends enormous time with the staff and the underwriting claims, looking at all the casualty trends as well. Mark, do you want to provide more detail, please?
Mark Lyons;Executive Vice President, Global Chief Actuary & Head of Portfolio Management: Sure. Peter, thank you. So yes, on the follow-up on that, Meyer, would be -- let's put it this way. The excess casualty loss cost trends are double digits. And the primary trends aren't too much lower than that, but they're single digits but on the upper end. So we think we've captured it in a pretty good fashion. But the incremental move from quarter-to-quarter, as Peter denoted, is marginally -- increases on the liability side, but it's mostly due to the much more apparent trends on the property loss cost side, which on a weighted average basis, drives it up.
Meyer Shields: Okay. That's very helpful. The second question, I guess, in recent quarters, we've been hearing about increasing competition in, I guess, in excess public D&O, which seems a little bizarre. Are you seeing any other individual product lines where there's incremental softness?
Peter Zaffino;Chairman and CEO: Thanks, Meyer. Dave, why don't you talk a little bit about what we're seeing in D&O. We really are not seeing it in other lines to the extent that what's going on in D&O, but we've been very disciplined, and Dave could provide a little bit more context.
David McElroy: Thank you, Peter and Meyer. Yes. The rates have rolled back after 4 years of cumulative increases north of 100% in public D&O. It's -- I'm not sure the logic path of that, okay? At the same time, we also have to discern different markets sitting inside what would be the public D&O. So primary versus first excess versus high excess versus Side A and classes and market cap differentiation, all those things have to be factored in.
I think certainly, in our book, which has a weighting to primary, there's less pricing pressure in the primary. There's respect for the company that leads the tower, claims reputation, multinational and underwrite a reputation with distribution and clients. So that's a different piece, Meyer, that I'd say.
Excess has been and will be a commodity product in many lines of business. D&O is showing up now. It often shows up in excess casualty and may show up in excess property. But right now, it's showing up in D&O. And once again, the risk matters, the account matters, the commoditization, it might be there, okay? It's -- I look at that as something maybe antithetical to the verticality in loss that's existing in the business and one that needs to be managed and managed by each individual company. And you will have that sort of a different portfolio that others may chase that down. And I would say that responsible markets will probably have a renewal retention that's lower in the excess capacity. And that will be showing up in future quarters.
It does not make sense. I'll be very frank. The verticality of loss is real right now, whether in securities class actions or derivative cases. So it's just supply-demand competition. I think for our portfolio, we're confident because of the control that we have and the weighting that we have between primary and Side A that's tied to primary and the financial strength of AIG that we will be there for the long duration claim. So with that, I'll turn it back.
Operator: Our next question comes from Elyse Greenspan from Wells Fargo.
Elyse Greenspan: Can you guys hear me?
Peter Zaffino;Chairman and CEO: Yes, Elyse. Yes. Sorry about the glitch.
Elyse Greenspan: No worries. So my first question, I know the timing of the deconsolidation depends upon secondary offerings of Corebridge. But when you do ultimately deconsolidate, do you envision at that point that General Insurance as a stand-alone entity will be running at a 10% ROE?
Peter Zaffino;Chairman and CEO: Yes, we do. I mean, again, like we've said, the timing of deconsolidation is subject to market conditions and the volatility in the market. But if you take that away and look at a normal course as to we get through 2023, when we deconsolidate, we expect we'll be, with all the variables that Shane outlined in the 10% ROE, we will be at that 10% ROE.
Elyse Greenspan: And then my second question is on the financial line adverse development. I know you guys mentioned part of it, right, is the multiyear covers that AIG used to write, but was there an impact on your current accident year picks as a pull forward of the charge? And if there wasn't, is it just because of the changes that you made in the business over the years?
Peter Zaffino;Chairman and CEO: Mark, would you take that one, please?
Mark Lyons;Executive Vice President, Global Chief Actuary & Head of Portfolio Management: Sure, Peter. Elyse, good to hear from you. So yes, that's a good question, Elyse, and it's actually the right question. So I guess think of it like this. Shane mentioned that we did $40 billion of reserves this quarter, that makes it 90% year-to-date, only 10% remaining. And the review was -- all our reviews have been comprehensive. But I would say particularly so this quarter, with improved actuarial methodologies but really augmented with a rigorous review of individual cases with the claims department, specifically focusing on downside risk that was more qualitatively, also incorporating, so I guess a couple of things.
First, it would be that because of that concentration of real detail, the financial reserve position is strong, firstly. Secondly, as you mentioned the multiyear policies, yes, that's an impact and probably a larger impact than you might think, which kind of preceded Dave and the team. And that excess D&O and private not-for-profit are the major drivers as Peter and Shane highlighted. But I really do not see that as a follow forward into more recent accident years.
And -- but let me just give you a few fact points on that. So Dave talked about it a bit indirectly, but I think more directly, from my point of view on risk selection, which is what it's really all about at the end of the day, back in 2017, 42% of our insurance -- or given that there was a class action -- security class action lawsuit, we had 42% of them on a primary insured basis, whereas now, it's 12%. So that's a clear risk selection difference.
But from the severity point of view of how much capacity gets placed on those from -- it's an 80% reduction on capacity provided to those given that they had a security class action suit. So both elements of that, I think, are incredibly strong and point to the capacity deployment post those years, so more recently as well as the risk selection, which is the core to everything.
But a couple of other quick things. I know you like stats, Elyse. So why do I think it -- especially on the levels that we say are more susceptible [ that caused it ]. So on primary not-for-profit, for example, when we look back at prior policy years, now it's close to accident years, which is the real driver of underwriting decisions and improvements, the loss ratio for policy year '21 at 18 months of development is 80% lower than the prior year. And on excess P&L, which is longer tail, you have a similar 80% reduction in the loss ratio. So all of these facts point to a much stronger book of business and increased confidence that what's the most recent accident years are -- is valid. So we're not seeing any change to those loss ratios.
Peter Zaffino;Chairman and CEO: Great. Thanks, Mark. Thanks, Elyse. Next question, operator.
Operator: Our next question will come from Brian Meredith from UBS.
Brian Meredith: Can you hear me?
Peter Zaffino;Chairman and CEO: Yes, Brian. Thank you. Nice to talk to you.
Brian Meredith: Great. Awesome. Yes. Peter, I'm just curious, there's been a lot of debate about how the kind of rehardening here of the property market kind of affected the casualty markets. Just curious, your thoughts there in specifically casualty re and then on the primary side as well.
Peter Zaffino;Chairman and CEO: Thanks, Brian. Again, we will see as we get to 1/1 in terms of what the pricing environment will be. It will be led by property. I mean I talked about it in my prepared remarks, some of the capacity issues and how reinsurers decide to deploy their capital is going to be very disciplined. I do think on the primary side of casualty, there will be some impacts. We look at just the normal economic potential headwinds, but also just deploying capital. So it's not going to be a single -- just we're going to get rate on property and not pay attention to casualty. You're going to look at it in a holistic way.
I think Dave and I have spent a lot of time on this, and we strongly believe that excess and surplus lines in casualty will grow more than admitted. On a same-store sale basis, meaning that the opportunities that exist today will find, I think, more growth in E&S and the specialty classes. And I think that the rate will reflect what the exposures are, and we would see the casualty lines being affected as well. But again, we'll see when we get into 2023.
Brian Meredith: Great. And then my second question, I'm just curious, looking at your North American Commercial written premium growth. Given the rate and exposure that you guys are experiencing right now, I would have thought that you'd see close to double-digit growth in that line of -- in that area, not just 7%. Is there anything unusual happening there?
Peter Zaffino;Chairman and CEO: No. Dave, why don't you add on in terms of what really happened in financial lines with M&A and IPO? But no, Brian, we saw very good growth. We outlined it in my prepared remarks, Lexington property, Glatfelter, Primary Casualty. So we saw real growth across North America and felt it was strong. Had a little bit of a headwind from financial lines just based on M&A and IPO. But Dave, maybe you can just cover that a little bit.
David McElroy: Yes, Brian, I think when you unpack it and you really look at each of the key businesses, whether it's property or casualty or even our programs group and Glatfelter, there was strong growth. The vagaries of financial lines show up here, okay? It's always -- it's tied to the stock market. It's historically tied to the stock market. A lot of new business growth is tied to the stock market and particularly last year where you might have had a number of SPACs and IPOs, and they are nonrecurring in 2022.
So -- and then there's a runoff business that's also tied to the stock market. So what we saw, it's really financial lines, and I would call it a financial lines disciplined underwriting. We weren't chasing anything into this quarter and therefore, the growth was down. We're confident around the book. But it's -- that's actually where you would say the underlying growth of a significant part of our portfolio wasn't showing up in 3Q for the right reasons, okay? The stock market is a dictate of what happens in the opportunities in financial lines.
Peter Zaffino;Chairman and CEO: Thank you, Brian. I think we have time for one more question.
Operator: And our final question will come from Alex Scott from Goldman Sachs.
Taylor Scott: First one I had for you is on the capital deployment commentary. Getting down to 600 million to 650 million share count, I just wanted to see if you could unpack sort of underlying assumptions that may be included in that. And maybe help us think through when we think about the excess capital you have today, potential Corebridge secondary proceeds. How would you think about debt reduction versus share repurchases and how that sort of triangulates to the 600 million to 650 million, if you could?
Peter Zaffino;Chairman and CEO: Yes. So thanks, Alex. We've talked about our capital management strategy over the past several quarters and focused on capital for growth, debt reduction, share repurchases. And as I said, going into 2023, we're going to focus on the dividend. The primary use of capital will be used for share repurchases and, again, like Corebridge, I think has done very well in a very challenging IPO market. We expect the value to continue to move in a very positive direction based on how strong the business is. And so I'm not going to get into like the P/E today versus the P/E of AIG, but think that the best use of capital over the foreseeable future is going to be to reduce share count to get us to the 600 million to 650 million range.
Now if I could spend 2 seconds on outlining what we've done since we've announced Blackstone in July of 2021, so you go back into early third quarter of last year and we set up Corebridge's financial structure. Not only did we do the IPO of 12.4% but set up their structure of $9.4 billion of debt, $1.7 billion of parent liquidity. During that period, we've reduced ongoing debt at AIG by approximately $12 billion, including the $1.8 billion make-whole in October. We paid common and preferred dividends of $1.3 billion during that period of time. We've also repurchased over 100 million of common shares, which is over $6 billion, and we put around $2 billion of capital in our subsidiaries for growth.
So that's a lot of capital deployment. All of it is set up to strengthen the balance sheet, strengthen AIG's strategic positioning as well as making sure that we can continue to put the capital in the subsidiaries to drive organic growth. So we're really pleased where we are, and we think that the path forward with the secondary offerings will put us even in a stronger position.
Taylor Scott: Got it. That's helpful. And maybe as a follow-up question, just on reinsurance costs, is there anything you can tell us about your spend on your natural CAT reinsurance program as it stands today? And I appreciate that you probably don't want to provide too much and tip your hand one way or the other in terms of the way you'll work through negotiations on that next year. But any way to help us think through the current cost? And anything we should consider when thinking about the materiality of that headed into a harder reinsurance market?
Peter Zaffino;Chairman and CEO: Yes. I mean the first thing I would say is AIG is not an index of the market rhetoric. We are very different in terms of how we purchase reinsurance just based on the size and scale, geographic diversity, different products. And so like when reinsurers deploy capital -- and that's why I say we have very strategic relationships because there's enormous continuity on our programs year-over-year even when we change structures. So I think that we've gotten commitments from all of our major reinsurers to be able to deploy the same amount of capital to the extent we need it for our property CAT. That's number one.
Number two is that the portfolio has changed. I mean when you are continuing to reduce gross exposures, you don't always need the same structures. And so I think we changed the structure in '22, which was to buy sort of global occurrence that sits above our per occurrence layers across the world and reduce the aggregate limit. And so we're looking at structures right now. I mean I think you're going to get -- no matter who you speak to, the truth will be it's going to be a very late renewal season. Retro needs to be put together. Nobody is quoting now. There's not going to be any firm order terms for quite some time. And I think that we're just going to have to work through the market.
But I just don't think that AIG is going to be in a detrimental position just based on our portfolio structure, partnership and actually our performance. And I think the reinsurers would say, you have to ask them, but what they tell me is that we've exceeded expectations on all the variables in terms of the commitments we've made in terms of the underwriting, and that's on property and casualty. So I think we'll be very well positioned and we'll provide updates as we get further along into the renewal season.
Okay. Yes. I want to thank everybody today for your time, and I hope everybody has a great day. Thank you.
Operator: And once again, ladies and gentlemen, this does conclude your conference for today. Thank you for your participation. You may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Third Quarter 2022 Financial Results Conference Call. This conference is being recorded."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by the applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you, Quentin. Good morning, and thank you for joining us today to review our third quarter financial results, which I'm pleased to report were very strong, along with the excellent progress we've made on our strategic priorities. Following my remarks, Shane will provide more detail on the third quarter financial results, and then we'll take questions. Kevin Hogan, David McElroy and Mark Lyons will join us for the Q&A portion of today's call."
},
{
"speaker": "Shane Fitzsimons",
"text": "Thank you, Peter. As Peter noted, I will provide more detail on the third quarter results, specifically EPS, reserve reviews, net investment income, capital management and the path to achieving an above 10% return on common equity. Adjusted after-tax income was $509 million or $0.66 per share compared to $837 million or $0.97 per share in the prior year quarter. This was driven by a $741 million decline in net investment income, offset by improved underwriting results in General Insurance and solid performance in Life and Retirement as well as improved GOE and Other Operations."
},
{
"speaker": "Moving to the risk-based capital ratio, our primary operating subsidiaries remain profitable and well capitalized, with General Insurance's U.S. pool fleet and Life and Retirement's U.S. fleet RBC ratios both above our target ranges. We continue to make progress on the 4 priorities to achieve a 10% or greater return on capital employed. They are",
"text": "underwriting profitability; leaner operating model; separation of the Life and Retirement business; and capital management. 2 points of improvement in combined ratio or $500 million of expense savings or $5 billion in share repurchases approximate to 1 point improvement in ROCE."
},
{
"speaker": "We expect to achieve expense savings from multiple areas, including",
"text": "the remaining $350 million of savings yet to be realized from AIG 200; roughly $300 million of corporate GOE and approximately $400 million of interest expense that will be transferred to Corebridge; an additional expense savings as we transition AIG to a leaner operating model. Additionally, we've seen a 26 basis point yield uplift in the fixed maturity and loan portfolios in the past 2 quarters. Over time, we expect the yield uplift from net investment income could add 1 to 2 points to ROCE."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you, Shane. And operator, we're ready for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question will come from Elyse Greenspan with Wells Fargo. [Operator Instructions]"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Operator, maybe we'll go to the next one in the queue, and then we'll come back to Elyse."
},
{
"speaker": "Operator",
"text": "So our next question comes from John Heagney from Dowling & Partners. [Operator Instructions]"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Do you want to try the next one in the queue, operator, please?"
},
{
"speaker": "Operator",
"text": "Let's try J. Paul Newsome from Piper Sandler."
},
{
"speaker": "Jon Paul Newsome",
"text": "Sorry about the confusion from the folks on the questions, hopefully, you can hear me. I actually wanted to ask you about sort of a little bit different broad M&A question about the turmoil in the market. I think, obviously, we've seen environments where there's quite a bit of change. And I don't know if you think or you're seeing maybe the sellers getting a little bit more willing to sell given the volatility of the environment, and just your general thoughts on M&A would be fantastic."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. So let me first take a step back, thank you for the question, and talk a little bit about our capital management strategy. And as we've outlined in the past, that we're focused on putting additional capital in the subsidiaries for organic growth because we see great opportunities. We worked very hard on reducing leverage. So while we've leveraged up Corebridge, we've been redeeming debt at the AIG level, focused on returning capital to shareholders through share repurchases, and we'll look very hard at the dividend for 2023."
},
{
"speaker": "Jon Paul Newsome",
"text": "Fantastic. Shift to a different question, maybe some thoughts on Validus in the context -- in the reinsurance business, in the context of the broader steps that you folks have done to reduce CAT exposure and maybe a little bit about the trade-off. I mean -- because, obviously, the big achievements that you've done under AIG is reduce the CAT exposure immensely. And how do you think about sort of, as we go forward, the trade-off that there seems to be a lot of opportunities in property CAT, kind of exposed areas but especially in the reinsurance market. But obviously, you've managed that trade-off pretty aggressively in the past."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. So I think the market that's in front of us is going to reward those who are disciplined leading up to it. We have been very thoughtful and careful about reducing aggregate where we felt we had too much in peak zones as well as too much exposed to natural catastrophes. So we've talked over time that we've reduced enormous limits over the period that we've been reunderwriting."
},
{
"speaker": "Operator",
"text": "And our next question comes from Meyer Shields from KBW."
},
{
"speaker": "Meyer Shields",
"text": "Great. Am I coming through?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes, Meyer. Good to talk to you."
},
{
"speaker": "Meyer Shields",
"text": "Fantastic. Okay. And Peter, just hoping you could talk a little bit about casualty loss trends because you mentioned property as one of the reasons for raising the overall trend 6.5%. And we obviously saw the financial lines issues that, at least superficially, could lead into other casualty lines. Can you sort of close the loop on that?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Sure. I'll ask Mark to provide more detail. I think what we do in our prepared remarks is say that we're looking at property, casualty, all of our lines and business in great detail. Really, what's been driving the upper end of the ranges up has been more the first-party business because of all the economic factors that are driving them. But Mark spends enormous time with the staff and the underwriting claims, looking at all the casualty trends as well. Mark, do you want to provide more detail, please?"
},
{
"speaker": "Mark Lyons;Executive Vice President, Global Chief Actuary & Head of Portfolio Management",
"text": "Sure. Peter, thank you. So yes, on the follow-up on that, Meyer, would be -- let's put it this way. The excess casualty loss cost trends are double digits. And the primary trends aren't too much lower than that, but they're single digits but on the upper end. So we think we've captured it in a pretty good fashion. But the incremental move from quarter-to-quarter, as Peter denoted, is marginally -- increases on the liability side, but it's mostly due to the much more apparent trends on the property loss cost side, which on a weighted average basis, drives it up."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That's very helpful. The second question, I guess, in recent quarters, we've been hearing about increasing competition in, I guess, in excess public D&O, which seems a little bizarre. Are you seeing any other individual product lines where there's incremental softness?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Meyer. Dave, why don't you talk a little bit about what we're seeing in D&O. We really are not seeing it in other lines to the extent that what's going on in D&O, but we've been very disciplined, and Dave could provide a little bit more context."
},
{
"speaker": "David McElroy",
"text": "Thank you, Peter and Meyer. Yes. The rates have rolled back after 4 years of cumulative increases north of 100% in public D&O. It's -- I'm not sure the logic path of that, okay? At the same time, we also have to discern different markets sitting inside what would be the public D&O. So primary versus first excess versus high excess versus Side A and classes and market cap differentiation, all those things have to be factored in."
},
{
"speaker": "Operator",
"text": "Our next question comes from Elyse Greenspan from Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "Can you guys hear me?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes, Elyse. Yes. Sorry about the glitch."
},
{
"speaker": "Elyse Greenspan",
"text": "No worries. So my first question, I know the timing of the deconsolidation depends upon secondary offerings of Corebridge. But when you do ultimately deconsolidate, do you envision at that point that General Insurance as a stand-alone entity will be running at a 10% ROE?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes, we do. I mean, again, like we've said, the timing of deconsolidation is subject to market conditions and the volatility in the market. But if you take that away and look at a normal course as to we get through 2023, when we deconsolidate, we expect we'll be, with all the variables that Shane outlined in the 10% ROE, we will be at that 10% ROE."
},
{
"speaker": "Elyse Greenspan",
"text": "And then my second question is on the financial line adverse development. I know you guys mentioned part of it, right, is the multiyear covers that AIG used to write, but was there an impact on your current accident year picks as a pull forward of the charge? And if there wasn't, is it just because of the changes that you made in the business over the years?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Mark, would you take that one, please?"
},
{
"speaker": "Mark Lyons;Executive Vice President, Global Chief Actuary & Head of Portfolio Management",
"text": "Sure, Peter. Elyse, good to hear from you. So yes, that's a good question, Elyse, and it's actually the right question. So I guess think of it like this. Shane mentioned that we did $40 billion of reserves this quarter, that makes it 90% year-to-date, only 10% remaining. And the review was -- all our reviews have been comprehensive. But I would say particularly so this quarter, with improved actuarial methodologies but really augmented with a rigorous review of individual cases with the claims department, specifically focusing on downside risk that was more qualitatively, also incorporating, so I guess a couple of things."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Great. Thanks, Mark. Thanks, Elyse. Next question, operator."
},
{
"speaker": "Operator",
"text": "Our next question will come from Brian Meredith from UBS."
},
{
"speaker": "Brian Meredith",
"text": "Can you hear me?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes, Brian. Thank you. Nice to talk to you."
},
{
"speaker": "Brian Meredith",
"text": "Great. Awesome. Yes. Peter, I'm just curious, there's been a lot of debate about how the kind of rehardening here of the property market kind of affected the casualty markets. Just curious, your thoughts there in specifically casualty re and then on the primary side as well."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Brian. Again, we will see as we get to 1/1 in terms of what the pricing environment will be. It will be led by property. I mean I talked about it in my prepared remarks, some of the capacity issues and how reinsurers decide to deploy their capital is going to be very disciplined. I do think on the primary side of casualty, there will be some impacts. We look at just the normal economic potential headwinds, but also just deploying capital. So it's not going to be a single -- just we're going to get rate on property and not pay attention to casualty. You're going to look at it in a holistic way."
},
{
"speaker": "Brian Meredith",
"text": "Great. And then my second question, I'm just curious, looking at your North American Commercial written premium growth. Given the rate and exposure that you guys are experiencing right now, I would have thought that you'd see close to double-digit growth in that line of -- in that area, not just 7%. Is there anything unusual happening there?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "No. Dave, why don't you add on in terms of what really happened in financial lines with M&A and IPO? But no, Brian, we saw very good growth. We outlined it in my prepared remarks, Lexington property, Glatfelter, Primary Casualty. So we saw real growth across North America and felt it was strong. Had a little bit of a headwind from financial lines just based on M&A and IPO. But Dave, maybe you can just cover that a little bit."
},
{
"speaker": "David McElroy",
"text": "Yes, Brian, I think when you unpack it and you really look at each of the key businesses, whether it's property or casualty or even our programs group and Glatfelter, there was strong growth. The vagaries of financial lines show up here, okay? It's always -- it's tied to the stock market. It's historically tied to the stock market. A lot of new business growth is tied to the stock market and particularly last year where you might have had a number of SPACs and IPOs, and they are nonrecurring in 2022."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you, Brian. I think we have time for one more question."
},
{
"speaker": "Operator",
"text": "And our final question will come from Alex Scott from Goldman Sachs."
},
{
"speaker": "Taylor Scott",
"text": "First one I had for you is on the capital deployment commentary. Getting down to 600 million to 650 million share count, I just wanted to see if you could unpack sort of underlying assumptions that may be included in that. And maybe help us think through when we think about the excess capital you have today, potential Corebridge secondary proceeds. How would you think about debt reduction versus share repurchases and how that sort of triangulates to the 600 million to 650 million, if you could?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. So thanks, Alex. We've talked about our capital management strategy over the past several quarters and focused on capital for growth, debt reduction, share repurchases. And as I said, going into 2023, we're going to focus on the dividend. The primary use of capital will be used for share repurchases and, again, like Corebridge, I think has done very well in a very challenging IPO market. We expect the value to continue to move in a very positive direction based on how strong the business is. And so I'm not going to get into like the P/E today versus the P/E of AIG, but think that the best use of capital over the foreseeable future is going to be to reduce share count to get us to the 600 million to 650 million range."
},
{
"speaker": "Taylor Scott",
"text": "Got it. That's helpful. And maybe as a follow-up question, just on reinsurance costs, is there anything you can tell us about your spend on your natural CAT reinsurance program as it stands today? And I appreciate that you probably don't want to provide too much and tip your hand one way or the other in terms of the way you'll work through negotiations on that next year. But any way to help us think through the current cost? And anything we should consider when thinking about the materiality of that headed into a harder reinsurance market?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. I mean the first thing I would say is AIG is not an index of the market rhetoric. We are very different in terms of how we purchase reinsurance just based on the size and scale, geographic diversity, different products. And so like when reinsurers deploy capital -- and that's why I say we have very strategic relationships because there's enormous continuity on our programs year-over-year even when we change structures. So I think that we've gotten commitments from all of our major reinsurers to be able to deploy the same amount of capital to the extent we need it for our property CAT. That's number one."
},
{
"speaker": "Operator",
"text": "And once again, ladies and gentlemen, this does conclude your conference for today. Thank you for your participation. You may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 2 | 2,022 | 2022-08-09 08:30:00 | Operator: Good day, and welcome to AIG's Second Quarter 2022 Financial Results Conference Call. This conference is being recorded.
Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q, provide details on important factors that could cause actual results or events to differ materially. Except as required by the applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change.
Additionally, today's remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at www.aig.com.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino;Chairman and CEO: Good morning, and thank you for joining us to review our second quarter results. AIG had an excellent quarter with strong momentum continuing across all of our strategic, financial and operational objectives. I could not be more pleased with the exceptional results in General Insurance. And Life and Retirement again delivered good results despite very challenging equity market conditions, significant volatility and other headwinds.
As you saw in our press release, adjusted after-tax net income per diluted common share was $1.19.
General Insurance achieved a calendar year combined ratio of 87.4%, the first sub-90 quarter and best result this business has achieved in over 15 years. The accident year combined ratio, excluding CATs, was 88.5%, a 260 basis point improvement year-over-year and the 16th consecutive quarter of improvement. And the accident year combined ratio, excluding CATs, in Global Commercial was 85.3%, an improvement of 400 basis points year-over-year.
Consistent with our strategy to manage volatility, catastrophe losses were very modest in the quarter, coming in at $121 million or 1.8% of a combined ratio. Life and Retirement has strong fixed annuity sales with over $1.3 billion in deposits for the second straight quarter, which benefited from the origination capabilities of Blackstone.
AIG returned nearly $2 billion to shareholders in the second quarter through $1.7 billion of common stock repurchases and $256 million of dividends. In addition, we are on track to buy back at least $1 billion of common stock in the third quarter. We ended the second quarter with $5.6 billion of parent liquidity, which Shane will go through in more detail in his remarks.
On today's call, I will provide more detail on 5 topics. First, I will provide an update on the IPO of our Life and Retirement business, which will be known as Corebridge Financial once the company is public, and discuss why we chose not to proceed with the IPO in the second quarter. I will also review the significant progress we've continued to make on various aspects of the separation of Corebridge as we prepare this business to be a stand-alone public company.
Second, as a follow-on to the IPO discussion, I will review Life and Retirement results where, as I mentioned, the core business showed continued resilience and solid performance despite headwinds largely driven from a reduction in net investment income.
Third, I will review the performance of General Insurance, where underwriting excellence continues to produce outstanding results with strong profitability and top line growth, particularly in our Global Commercial portfolio.
Fourth, I will provide an update on AIG 200, where we achieved critical milestones and delivered on our stated goal of $1 billion in exit run rate savings 6 months ahead of schedule.
Lastly, I'll provide an update on capital management, particularly with respect to stock buybacks and debt reduction.
Following my remarks, Shane will provide more detail on the quarter and then we will take questions. Mark Lyons, David McElroy and Kevin Hogan will join us for the Q&A portion of today's call.
As you can see, our team has accomplished a lot on many fronts. Before expanding on our financial and operating performance, I want to address the status of the Corebridge IPO. Our base case had always been to complete the IPO in the second quarter, subject to regulatory approvals and market conditions. In deciding whether to launch the initial public offering in May or June, we weighed several variables, which were all market-related, some specific to Corebridge and some more macro level. These included equity market conditions and particularly the trading values of companies in the Life and Retirement sector that we consider to be the most comparable to Corebridge.
In the second quarter, equity markets were down 16% with only 3 weeks seeing positive market returns, the VIX, which was above 30 resulting in extremely elevated market volatility and feedback we received from advisers, analysts and many potential institutional investors following the public filing of the S-1. While completing the IPO is a significant priority for us and something we are laser-focused on, we believe this is an attractive business and did not want to execute a transaction that would be detrimental to stakeholders in the long run. Absent something we don't see today, we remain ready to execute on the IPO, subject to regulatory approvals and market conditions. And the next window will be in September.
In the meantime, throughout the summer, we continue to make significant progress to position the business for long-term success. I'll highlight 3 areas of focus. One, expanding on our plan to achieve expense savings at Corebridge. Last quarter, we estimated these savings to be in the range of $200 million to $300 million, but we now expect to generate closer to $400 million of savings over the next 3 years with the majority of the run rate savings to be achieved in the next 24 months.
Two, progressing the implementation of a new operating model for our investments unit. This includes our strategic partnership with Blackstone announced in July of 2021 and our partnership with BlackRock, where we began moving assets under management in the second quarter of this year pursuant to the arrangement we announced in late March.
And three, planning our transition to BlackRock's Aladdin platform, which will replace aging and end-of-life technology infrastructure and provide enhanced risk analytics and reporting. We continue to expect that Corebridge will pay an annual dividend of $600 million post-IPO that will have a payout ratio of 60% to 65%, and that it will achieve a return on equity of 12% to 14% over the next 24 months.
Now turning to Life and Retirement's performance in the second quarter. As I mentioned earlier, adjusted pretax income was $563 million, decreasing from the prior year period due to lower NII, which was driven by lower alternative investment income, accelerated DAC amortization and an increase in SOP reserves. Given the pending IPO, we remain somewhat limited in what we can say about the business, but let me provide some details from the second quarter. The core business produced strong sales in fixed annuities, which were up 48% to $1.4 billion and strong sales in indexed annuities, which were flat at $1.5 billion.
In Group Retirement, contributions grew 1%, nonrecurring deposits grew 4% and enrollments were up 11%. Second quarter deposits of $1.8 billion were strong with base net investment spread growing 4 basis points sequentially due to the higher interest rate environment. The Life and Retirement balance sheet and capital position remains strong with an RBC ratio of 415% to 425%, still above our target ranges.
Now let me provide more detail on our second quarter results in General Insurance, where we continue to drive improved financial performance. Gross premiums written increased 5% on an FX-adjusted basis to $9.6 billion, with Global Commercial growing 8% and Global Personal decreasing 3%.
Net premiums written increased 5% on an FX-adjusted basis to $6.9 billion. This growth was led by our Global Commercial business, which grew 8% with Global Personal decreasing 4%.
Global Commercial net premiums written increased 10%, excluding AIG Re, where we have significantly reduced property CAT writings and exposure, particularly in the Southeast region of the U.S.
North America Commercial net premiums written increased 10% or 14% excluding AIG Re. And international net premiums written increased 5% or 8% excluding the impact of nonrenewal and cancellations related to Russia exposure in each case on an FX-adjusted basis.
In North America Commercial, we saw very strong growth in net premiums written: In Lexington, which grew 31% led by wholesale property, which was up 46%; retail property, which grew 17%; and our Canadian commercial business, which grew 10%.
In International Commercial, on an FX-adjusted basis, we also saw strong growth in net premiums written: In Global Specialty, which grew 16% led by energy, which was up 20%; and marine, which was up 10%; North America Specialty, which grew 17%; and International Specialty, which grew 15%.
In Global Commercial, we also had very strong renewal retention of 85% in our in-force portfolio, with North America up 200 basis points to 85% and International holding steady at a very strong 86%. As a reminder, we calculate renewal retention prior to the impact of rate and exposure changes. And across Global Commercial, our new business continues to be very strong, coming in slightly over $1 billion for the fifth consecutive quarter.
North America's new business grew to $542 million led by Lexington. International new business was $466 million, slightly down year-over-year due to intentional actions we took in Talbot and in our Specialty business related to Russia, Ukraine.
Turning to rate. Momentum continued in Global Commercial with overall rate increases of 7%. And in the aggregate, rate continued to exceed loss cost trends. This is the fourth consecutive year in which we're achieving rate above loss cost trends and where we are successfully driving margin expansion.
North America Commercial achieved 7% rate increases with some areas achieving double-digit increases led by Lexington, which increased 18% with 17% in Lexington wholesale property; Financial Lines, where professional increased 34% led by cyber, which increased 52%; and excess casualty, which increased 10%.
International commercial rate increases were 7% driven by Financial Lines, which increased 11%, including more than 47% rate increases in cyber; property, which increased 10%; and EMEA, which also increased 10%.
Last quarter, we indicated that our loss cost trend view in the aggregate for North America Commercial had migrated upwards from 4% to 5%, mostly driven by shorter tail lines. And as a result, we moved the upper end of the range to 5.5%.
In the second quarter, trends in casualty and other liability lines continue to show no obvious impact in either internal or external data to support a large move on loss cost, whereas property businesses have been more clearly affected. As a result, based on a review of more recent information, we again modified our view on loss cost trend to 6%. Loss cost trend represents the composite of frequency and severity. However, there is an additional mitigant to inflation built into rate decisions. Exposure trend, which we view as a partial offset to loss cost trend, reflects the additional premiums an insurer receives driven by growth in underlying inflation sensitive exposure basis. When taking this exposure mitigant into account, our current North America Commercial loss cost trend net of these inflationary exposure benefits is approximately 4%.
Additionally, our North America Commercial accident year loss ratio, ex CAT, is booked at 63% year-to-date, which is consistent with pure actuarial rate over loss cost and exposure trends but is a pure numerical approach and does not reflect our improved risk selection and continued improvement in terms of conditions. Those benefits will emerge over time.
As we discussed on prior calls, since 2018, we have implemented a clear ventilation strategy in our casualty, financial lines and property portfolios that directs our capacity deployment towards higher average attachment points, which is a strong defensive measure towards rising inflation. And this strategy continues today. We also implemented the strategy in our AIG risk management loss-sensitive workers' compensation business. And over the last few years, average deductibles have increased 30% to $1.3 million.
Turning to Personal Lines. In North America Personal, net premiums written declined nearly 4% driven by a reduction in warranty, which was partially offset by a rebound in travel. In International Personal, net premiums written declined 4% on FX-adjusted basis also due to a reduction in warranty and partially offset by growth in accident and health and travel.
Now I'd like to spend a few minutes on our high net worth business. This is a business we will continue to invest in where there are attractive opportunities for profitability improvement. Over the last 2 years and through the second quarter, we've already invested $140 million to improve digital workflow, data, a customer interface that will provide enhanced insight and value to distribution partners and policyholders. The actions we are taking are designed to position this business to be more balanced with less density and lower volatility in order to provide more sustainable financial results.
Let me review some of the market dynamics impacting this business that have created significant complexity and the resulting actions we are taking to reposition the portfolio. Currently, the level of reinsurance we purchased and the commensurate model ceded profit is a headwind to net premiums written growth and combined ratio improvement. This has been intentional as we are not willing to take volatility on frequency or tail risk on CAT in our high net worth business.
Adding to this, the inability to pass on increased loss and reinsurance costs through rate increases or limit management largely due to regulatory constraints further deteriorates margin in the short run. But we have made a deliberate decision to continue writing this business as we believe the trade-off is appropriate in the near term given the opportunity we see over the long term.
And while each of our CAT-exposed businesses has different attributes, I don't see reinsurance costs for the high net worth market generally becoming less expensive for the foreseeable future, but instead, seeing it putting pressure on the segment. In fact, for a business that is primarily underwritten in peak zones with high total insured values, reinsurance costs will likely increase and, in some cases, materially.
To understand the complexity of reinsurance for peak zones, you need to look no further than in what has happened in the retrocessional market over the last few years. While overall small market, retrocession provides approximately $60 billion of available limit across various structures, of which roughly $20 billion is indemnity-based for reinsurers with this capacity primarily supported by alternative capital.
The dynamics in the retrocessional market over the last few years are important to understand because they have materially changed even though overall retrocessional capacity has remained flat since 2017. First, the cost of retrocession has increased significantly more than in the reinsurance industry on a risk-adjusted basis. Second, available capacity has shifted from predominantly aggregate to predominantly occurrence. Third, first event aggregate and lower attaching occurrence retrocession have been put under significant stress. Fourth, the retrocessional market return period attachment points have increased 50%. And fifth, compounded risk-adjusted rate changes have also increased by over 50%, even though retrocessional exposure is reduced compared to prior year.
When you couple these factors with the additional adjustments going forward for inflation, model changes, trapped capital, you have a very complicated and challenging market. Additionally, if you review global insured net cat retrocessional losses over the last decade, 9 out of 10 years have had larger contributions from secondary peril aggregate losses than peak peril losses, which highlights the complexity of modeling catastrophes.
As a result of these dynamics and challenging circumstances, we concluded that to continue to provide high net worth clients with comprehensive solutions that meet their emerging risk issues, we needed to move property homeowners product to the non-admitted market, particularly in CAT-exposed states. In the second quarter, we exited the admitted personal property homeowners market in certain states as we could no longer maintain our level of aggregation especially given the inability to reflect the loss cost increases, inflation and increased reinsurance costs and rates as well as limitations on our ability to make coverage changes in this market.
As part of our go-forward high net worth strategy, we're going to move homeowners and possibly other products in more states to the non-admitted market. And we plan to set up a structure that, over time, we expect to be supported by third-party capital providers in addition to AIG. This structure will provide more flexibility to manage aggregation, price, limit, terms and conditions and to innovate to solve evolving client needs. We will continue to provide coverage to our clients in the U.S. utilizing a hybrid model of non-admitted and admitted products in some states and admitted-only products in other states.
We're already seeing the benefits of this strategy in our portfolio as the reduction in key catastrophe perils is apparent in these early stages. For example, since year-end 2021, gross wildfire PMLs are down approximately 35% to 40% across the entire PML return period curve.
Now I want to review Russia, Ukraine. Last quarter, I addressed the many complexities and uncertainties that this situation presents, particularly those related to aviation policies issued to airline operators and leasing companies, including questions surrounding the occurrence of actual losses, loss mitigation efforts, whether any losses arise from war versus non-war apparels and the potential applicability of sanctions. These complexities and uncertainties very much continue. The claims we have received continue to be largely reported under political violence or political risk policies. And we continue to reserve our best estimate of ultimate losses, heavily comprised of IBNR despite the fact that the information we have received in connection with these claims remains very limited. Moreover, in the event of losses and the lines of business we have outlined that are subject to a potential loss, we have multiple reinsurance programs available.
Turning to AIG 200. We started this 3-year journey in 2019. AIG 200 was designed to transform our core foundational capabilities across the company, and our financial objective was to deliver $1 billion of exit run rate savings with a cost to achieve of $1.3 billion. At the end of the second quarter, we achieved these goals 6 months earlier than expected. Delivering on these critical operational and financial objectives is a major accomplishment for our team.
AIG 200 was successful because we maintained a tight governance structure and saw exceptional collaboration from colleagues across all major areas of the company. While the original objectives of AIG 200 have been completed, our team will remain focused on continuous improvement in operational excellence.
AIG 200 has put the company in a significantly better place. Specifically, we modernized our IT platform, retiring over 50% of our identified applications and moving 80% of our infrastructure to the public cloud. We now have a global standard commercial underwriting platform that streamlines our processes and allows over 3,000 underwriters to make better risk management decisions in real time. This platform also includes a new global location management system that allows us to better understand and manage our PML exposure. We made significant investments in key capabilities, including building a consistent underlying data infrastructure, enhancing our digital capabilities through new distribution partner and client portals linked to a single common call center platform and fundamentally streamlined our finance reporting capabilities for faster decision-making. And we streamlined our global operations and shared services capabilities by moving over 10,000 roles to outsourcing partners.
I want to thank all of our colleagues involved in AIG 200 for their outstanding performance. They should take great pride in knowing they established a new infrastructure and foundation for AIG that we will continue to build on and that will drive benefits for our stakeholders now and in the future.
Turning to our capital management strategy. We will continue to be balanced and disciplined as we maintain appropriate levels of debt while returning capital to shareholders through stock buybacks and dividends while also allowing for investment in growth opportunities across our global portfolio.
As I said earlier, we had a very successful second quarter where we reduced net debt outstanding by $1.4 billion, repurchased $1.7 billion of common stock, paid $256 million in dividends and ended with $5.6 billion in parent liquidity. Looking ahead, with respect to debt repayment, AIG will receive the remaining $1.9 billion under the promissory note from Life and Retirement prior to the IPO. And we expect to use these proceeds to pay down additional AIG debt and for other purposes.
With respect to share buybacks, we have $5.8 billion remaining on our current share repurchase authorization and expect to repurchase at least $1 billion of common stock in the third quarter. With respect to growth opportunities, our priorities continue to be focused on allocating capital in General Insurance where we see opportunities for profitable organic growth and further improvement in our risk-adjusted returns.
As we discussed on our last call, we expect that post deconsolidation of the Life and Retirement business, AIG will achieve a return on common equity at or above 10%. Shane will provide more details on ROE and on capital management in his remarks.
Shane, I'll turn the call over to you.
Shane Fitzsimons: Thank you, Peter, and good morning to all. As Peter noted, I will provide more detail on our second quarter financial results and unpack a number of our key performance metrics, specifically EPS, liquidity, leverage, net investment income and ROCE.
I will begin by providing more detail on the financial results of General Insurance and Life and Retirement in the second quarter. I will then provide more detail on net investment income. I will then review our balance sheet, leverage, AOCI, liquidity and share count, which benefited from excellent execution on a number of capital transactions. And finally, I want to provide you more detail on the execution path to 10% ROCE for AIG and more detail on what we intend to do to get there, including income drivers, expense reduction and AIG 200 where, as Peter noted, we have contracted or executed on our stated goal of $1 billion of exit run rate savings 6 months ahead of our original time line.
Turning to EPS. Adjusted after-tax EPS was $1.19 per diluted common share. Improvements in General Insurance profit of $1.26 billion contributed $0.06 year-over-year. Within General Insurance, strong underwriting income of $799 million contributed $0.31 of improvement, offset by a $0.25 decline in net investment income primarily driven by the decline in alternatives. And reduction in shares outstanding also contributed $0.10.
Life and Retirement declined $0.52 in APTI to $563 million, which was below last year's second quarter primarily due to $0.36 or $387 million unfavorable from lower net investment income, $0.19 or $202 million from accelerated DAC amortization and an increased SOP 03-1 reserves. The net investment income decline in Life and Retirement was due to alternatives being down $0.21 and an $0.11 decline in yield enhancement income.
As I noted, General Insurance's adjusted pretax income contribution in the second quarter was $1.26 billion, which reflects strong underwriting profit growth and continued improvement in the calendar year combined ratio of 510 basis points to 87.4%, and the accident year combined ratio ex CAT of 260 basis points to 88.5%.
General Insurance adjusted pretax income improved by $63 million year-over-year. Underwriting income improved by $336 million driven by a $182 million improvement in accident year underwriting income in addition to $137 million from an improved PYD, offset by a reduction in alternative investment income in the quarter. The combined ratio improvement was due to improved underwriting income, earned premium growth, expense discipline, low catastrophe losses and favorable PYD, which all contributed to pretax underwriting income being up 73% year-over-year, increasing to $799 million from $463 million.
North America Commercial had another 300 basis points improvement in the accident year combined ratio ex CAT over the prior year quarter, coming in at 88.2%. International Commercial also continued to improve profitability with 550 basis points improvement in the accident year combined ratio ex CAT this quarter, coming in at a strong 81.4% for the second quarter.
North America Personal had a 40 basis points improvement in the accident year combined ratio ex CAT over the prior year quarter, coming in at 99.7%. International Personal experienced a 120 basis points deterioration in the accident year combined ratio ex CAT, coming in at 95.2% for the second quarter.
In the second quarter, CAT losses were $121 million or 1.8 loss ratio points compared to $138 million or 2.1 loss ratio points in the prior year quarter. Prior year development, excluding related premium adjustments, was $202 million favorable this quarter compared to the favorable development of $51 million in the prior year quarter. This quarter, the ADC amortization provided $42 million of favorable development. And the balance of $160 million favorable arose mostly from old accident years in workers' compensation along with primary casualty lines in the U.S. The review in the quarter was mainly focused on North America and represents approximately 15% of reserves.
Within both AIGRM loss-sensitive work comp and U.S. primary casualty lines, there were additional indications of higher favorable development, but we felt it prudent to wait and see how the inflationary environment evolves, particularly as it relates to the casualty bodily injury and the medical side of workers' comp. We look at this quarterly, and as is our standard practice, we will be reviewing approximately 75% of the total pre-ADC General insurance reserves in the third quarter.
Life and Retirement adjusted pretax income of $563 million compared to $1.12 billion in the second quarter of 2021. The year-over-year decline was due to $387 million of lower net investment income, of which $224 million is from lower alternative investment income as well as accelerated DAC and increased SOP reserves of $202 million driven by the market declines in the second quarter. The DAC and SOP charges had approximately 300 basis points negative impact on ROCE in the quarter, but these are largely noncash.
Within Individual Retirement, fixed annuity sales increased 48% year-over-year, aided by origination activity to the Blackstone relationship. And fixed index annuity had another solid quarter of sales. Sales of variable annuities declined in the quarter, consistent with market conditions.
Net flows were positive $628 million this quarter compared to negative net flows of $77 million in the prior year quarter. And variable and indexed annuity spreads expanded 2 basis points from the first quarter of 2022.
Group Retirement had strong deposits in the quarter of $1.8 billion, while surrenders declined and base net investment spread was up 4 basis points versus the first quarter of 2022.
Life Insurance adjusted pretax income was $117 million. The second quarter represented the lowest COVID mortality quarter since the pandemic began, while non-COVID mortality also ran favorable in the period. Premiums and deposits also continued to benefit from the solid international life sales, which comprise approximately 45% of new sales activity.
Our previously reported level of spread rate compression has been in the range of 8 to 16 basis points annually. But given current market conditions, we now expect to be better than 8 basis points for the full year.
As you are aware, for the Life and Retirement business, we conduct our entire reserve review in the third quarter. However, with the recent focus on the guaranteed universal life product, I will provide a few comments. First, this is not a large block for us. So we do not have much exposure in our in-force block, which is approximately $3 billion in net statutory reserves, which represents 2% of our net liabilities. For context, we did participate in the recent industry study on this topic. And our projected lapse rates, fund bases and dynamic premium modeling approach are consistent with the recommendations of the study. As additional background, over the last 5 years, we have been reviewing and strengthening our reserve assumptions for the guaranteed universal life product. And as a result, we don't expect significant adjustments.
Turning to other operations, which includes interest expense, corporate general operating expenses, institutional asset management expense, runoff portfolio and eliminations, it was a positive contributor to adjusted pretax income year-over-year by $149 million. Corporate general operating expenses improved $74 million year-over-year in the second quarter, benefiting from AIG 200 and continued emphasis on expense management.
Adjusted pretax net investment income for the quarter was $2.5 billion, a decline of $678 million compared to the second quarter of 2021. As a reminder, we report the results of our private equity holdings on a 1-quarter lag, and we may have an impact in the third quarter as well.
Over the last few years, we focused on improving the risk profile of the investment portfolio with continued vigilance around corporate and consumer credit and a strong capital and liquidity profile in both General Insurance and Life and Retirement, which support our ability to manage through difficult times as evidenced by our financial stability through COVID.
In Life and Retirement, our weighted average credit rating has improved since the end of 2015, while the percentage of capital-intensive assets has declined in the portfolio from 10.5% to 8.3%. In the second quarter, we continued the proactive steps in the investment portfolio to avoid potential overexposure in the event credit deteriorates.
We sold RMBS and ABS securities with a market value of $3.2 billion in the second quarter. In addition, we have alternative investments, particularly hedge funds, that have generated good returns over time but with more quarter-to-quarter fluctuations and that is more volatility than we would prefer.
Going forward, we would expect to move over time to an asset allocation with less volatility. We've also executed on sales of approximately $4 billion of low-yielding longer-duration corporate bonds to buy higher-yielding, shorter-duration structured securities, privates, ABS and CMLs with many of them being floaters. We feel it is appropriate to take advantage of the higher rate environment and turn the portfolio over a little more quickly than would naturally occur at maturity, thereby enhancing our forward APTI and ROCE.
The second quarter saw significant increases in benchmark treasury yields with a 65 basis point increase on the 10-year or 146 basis points through June 30. With General Insurance and Life and Retirement portfolio durations are just under 4 and 8 years, respectively, the overall rising interest rate environment will provide a tailwind to our investment portfolio returns.
Our base fixed income portfolio saw a lift in yield of 18 basis points in the second quarter versus first quarter with $17 million additional within General Insurance and $28 million additional in Life and Retirement.
The new money yield on our base portfolio was approximately 80 basis points above the assets rolling off the portfolio during the second quarter. At the end of the second quarter, the new money yield is roughly 130 basis points higher than the overall current portfolio in General Insurance and roughly 75 basis points higher in Life and Retirement.
Moving on to the balance sheet, leverage and liquidity. As Peter noted, we closed the quarter with $5.6 billion of parent liquidity. The second quarter includes execution of $1.7 billion in share repurchases, $256 million of common and preferred dividends and $1.4 billion net spend on debt reduction actions, including AIG debt retirement and extinguishment costs of $7.9 billion that is partially offset by the Corebridge debt issuance of $6.5 billion.
In the second quarter, we saw a large AOCI movement as a result of increasing interest rates. Adjusted AOCI, which excludes the cumulative unrealized gains and losses related to Fortitude, moved from negative $5.9 billion to negative $15.4 billion or an additional reduction of $9.5 billion. We exited the second quarter with GAAP leverage of 31.1%, up from 27.8%, a 330 basis point increase quarter-over-quarter. The decrease in AOCI in the period added 390 basis points to the leverage ratio. This was partially offset by the net debt reduction of $1.3 billion in the period in addition to net income gains. The impact of AOCI is substantially larger in Life and Retirement and General Insurance, given the duration of their respective asset portfolios. At quarter end, our debt leverage ratio, excluding AOCI, was 25.3%, down 60 basis points versus 25.9% at the end of the first quarter of 2022.
Total adjusted return on common equity was 7%, down from 10.5% in 2Q '21. And total company adjusted tangible return on common equity was 7.6%. The decrease is mostly caused by decline in net investment income. General Insurance's adjusted attributable return on common equity was 12% in the second quarter while Life and Retirement was 7.6%. Life and Retirement's ROCE was impacted by approximately 300 basis point drag from the acceleration of DAC, an increase in the SOP 03-1 reserves in the second quarter.
Adjusted book value per share of $72.23 increased 2.1% sequentially and 20.2% year-over-year. Adjusted tangible book value per share of $66.06 increased 2.2% sequentially and 21.8% year-over-year. Our primary operating subsidiaries remain profitable and well capitalized with General Insurance's U.S. pool fleet risk-based capital ratio for the second quarter estimated to be between 475% and 485%. And the Life and Retirement U.S. fleet estimated to be between 415% and 425%, both above our target ranges.
Finally, during the quarter, we repurchased approximately 30 million shares at an average cost of $58.25, bringing our GAAP ending share count to 771 million with the quarterly average of 801 million compared to 873 million in the prior year quarter, representing an 8% reduction in average share count.
As we previously disclosed, our agreement with Blackstone includes an exchange right put option, which is not exercisable until November of 2024. That gives Blackstone the right to exchange their stake in Corebridge for shares in AIG. Under the applicable accounting principles, this put option was dilutive in the second quarter and resulted in 43 million additional shares outstanding for the purposes of the adjusted EPS calculations in the period. It is worth noting that this put option goes away upon the execution of the IPO.
Looking ahead, we have 4 priorities, which all lead to ROCE improvement towards our 10% or greater goal: continued momentum on underwriting excellence, expense reduction through operational excellence and expense discipline, the successful IPO and separation of the Life and Retirement business and continued execution on our capital management priorities.
Continued momentum on underwriting excellence will include further improvements in our underwriting profitability without an increase in volatility as well as underwriting portfolio optimization, which involves both measured growth on proper leverage to optimize return allocation. While we have made significant progress to date, we are still achieving written rate above trends, both in business today and that which we have not yet earned in.
Expense reduction will come through continued cost discipline, operational excellence, earn-in of AIG 200 run rate savings and a reduction of parent GOE. As Peter mentioned, we have now contracted or executed on $1 billion of savings related to AIG 200, and we have realized $610 million of savings to date. That leaves $390 million of savings that AIG expects to earn in over the coming 12 to 18 months.
We also expect roughly $300 million of the AIG corporate expenses will move to Life and Retirement upon deconsolidation. In addition, as Peter stated, we now expect Life and Retirement to execute a cost savings program, which will generate close to $400 million in savings and expect the program to deliver the first $100 million before year-end.
With respect to the execution on our capital management priorities, we have already accelerated our share repurchases this year and expect additional repurchases as we get more clarity on the timing of the proceeds from the Corebridge IPO. Contemplated in our current plan, which includes the completion of the Corebridge IPO, we expect to reduce our share count to somewhere in the range of 600 million to 650 million shares, while maintaining leverage in the 20% to 25% level along with strong capitalization at the insurance subsidiary company level.
Each of these drivers has some elements of tailwind to them. Additionally, yield enhancement in the base investment portfolio should provide meaningful lift in earnings power over time based on the current economic backdrop. To date, we're beginning to see the benefit of higher yields driving higher base portfolio returns where we are not dependent on higher interest rates to achieve our goal. These focus areas give us a line of sight to a minimum of 300 to 400 basis points of ROCE improvement. We will continue to provide updates over time.
And with that, I will turn the call back over to you, Peter.
Peter Zaffino;Chairman and CEO: Great. Thank you, Shane. And operator, we're prepared to take questions.
Operator: [Operator Instructions] Our first question will come from Meyer Shields at KBW.
Meyer Shields: Peter, you provided a ton of information on rates and trend and exposure. But I was hoping we could dig a little deeper, specifically into the exposure benefits for liability lines where premiums are based on receipts, but maybe the relationship between receipts and losses is not as obvious as, let's say, in property, and we've got the concerns of longer tail lines.
Peter Zaffino;Chairman and CEO: Sure, Meyer. Thank you for the question. Like you said, we've provided a lot of information in our prepared remarks. But I think, Mark, why don't you go through what the effects are in exposure and also talk a little bit about sort of the loss ratio implications in the observations that we made?
Mark Lyons;Executive Vice President, Global Chief Actuary and Head of Portfolio Management: Happy to. So a couple of things come to mind. First off, as Peter mentioned, North America Commercial aggregate loss trend is now up to 6% this quarter as opposed to our upper revision we did last quarter, the 5.5%, because we look at that every quarter. Short-tailed lines are driving much of this increase, and that is seen in our own data as well as external information. And over the last few years, because I'm talking about the weighted average loss cost trend there, the North American portfolio has reduced its property writings and has shrunk as a percentage of total, which helps ameliorate the growth in severity.
So -- but we're seeing commercial property line loss cost trends of roughly 10% and in specialty-oriented property lines closer to 15%, driven by inflationary trends in construction materials, replacement costs, labor, transportation, things of that nature. Our view of casualty, bodily injury and the medical side of work comp, though, is unchanged from last quarter. And recall that even that reflected an increment of anticipatory medical cost increase. But as Peter said in his prepared remarks, we have yet to see it within our own data or with relevant external data.
Now I think getting into some of your question as well, it's hard to discuss loss cost trend without discussing the related topic of margin, which reflects the exposure trend and how that mitigates the loss cost trend that we've already just talked about. The aggregate North American Commercial book has an approximate 2% exposure trend, which, as you mentioned, represents additional collected premium due to the positive impact of the underlying inflation sensitive exposure basis to which the rates are applied. And therefore, it does function as a partial inflation mitigant.
And examples of that would be one of our growth engines, which is Lexington, which has approximately 60% of their book based on inflation-sensitive exposure basis. And another one would be retail property, where the focus on accurate and current statement of values is razor sharp in that level of focus. So the exposure trend is partially mitigating these loss cost trends, which then produces the approximate 4% all-in loss ratio trend that Peter commented on.
But -- so when you put that in conjunction with the 7% rate increases achieved in the quarter, we're in excess of loss cost trend and loss ratio trend, let alone the loss ratio benefits of tighter terms and conditions. And rate change alone really doesn't tell the whole picture.
We've spoken before about the power of the primary, especially in D&O. AIG's position there permits deploying [ ventilate ] capacity as we see fit, but just as important is the stronger pricing power resident in the primary versus high excess, which is fast becoming a good commodity driven by high price or highly by price and seeing the largest rate reductions. That's the strength of the primary.
But I think lastly, just I think a clarification, it may or may make some sense, so think of it this way, let's not get confused on the difference between a real underlying exposure to loss with the measurement of that exposure to loss. So to keep it simple, if storekeeper A buys a GL policy, which is mostly a premises policy, and the insurer uses square footage as the exposure base, then the premium paid is rate times square footage, of course. And next year, if there is no rate change, he'll have the same premium.
However, if storekeeper B has an identical store in the same geographic area and the same sales volume, but their insurer instead rates on gross receipts, and those receipts are 3% higher this year than last year, the true underlying exposure as measured by the propensity to have a claim didn't change, but the measurement of that exposure did change. So storekeeper B's premium will be 3% higher than that charged by insurer A, even though the stores are identical in every way.
Peter Zaffino;Chairman and CEO: That's great, Mark. Thank you. Meyer, is there a follow-up?
Meyer Shields: Yes. Just a very brief one really on the last comment. Is there an opportunity or an advantage to maybe shifting even more of the premium Phase 2 inflation-sensitive exposure?
Mark Lyons;Executive Vice President, Global Chief Actuary and Head of Portfolio Management: Yes. I mean, it's -- that is a potential strategy that you'd -- a little difficult to implement, right, because you have -- part of a profitable portfolio are those things, rated -- inflation exposure basis like premises. However, when you get into other lines, like the M&C side of GL, Meyer, I think what you're saying makes a lot of sense.
Peter Zaffino;Chairman and CEO: Yes. I think maybe I'd just add to that, and we'll take the next question, which is all the significant repositioning we've done in the excess and surplus lines, particularly with the Lexington. You hear a lot about in the prepared remarks because they've done such a great job between growth, rate, retention and pivoting that portfolio to be a significant contributor in terms of profitability improvement. I mean, we've gotten on property alone 16 consecutive quarters of double-digit rate increases. And as Mark alluded to, that just starts to drive margins. So we are repositioning the portfolio based on where we see the best risk-adjusted returns.
Operator: Our next question will come from Erik Bass with Autonomous.
Erik Bass: So with the Corebridge IPO, it sounds like your strategy is to remain patient and wait for markets to recover since you're not a forced seller. Is this the right take? Or if the IPO window opens in the fall, would you look to take advantage and get some stock floated even if at a modest discount to what you view as the ultimate fair value?
Peter Zaffino;Chairman and CEO: Yes. Thanks, Erik. We provided a lot of sort of guidance in our prepared remarks, but let me try to add to it. Our plan has always been to do an IPO of Corebridge, and that has not changed. So now we are targeting September. I mean, we gave you some of the variables, but obviously there's more to consider like you outlined. We just felt that the market conditions in the second quarter were not conducive. We always intend to own greater than 50% following the IPO. And therefore, we'll continue to consolidate results for the foreseeable future.
The base case is still to do secondary offerings, but those will likely take place in 2023. And so look, we're going to watch the market. We always have to be careful in terms of the conditions that exist in the regulatory approvals. But our base case has just shifted from May, June to September. And we'll watch it carefully, and we'd like to get it floating.
Erik Bass: Got it. And then one follow-up on Corebridge. I was just hoping you could talk a little bit more about the performance of your VA hedging program this quarter and the movements in the RBC ratio that we saw.
Peter Zaffino;Chairman and CEO: Yes, Shane, you and Kevin want to provide some insight on that?
Kevin Hogan: Yes, so...
Shane Fitzsimons: Go ahead, Kevin.
Kevin Hogan: So Erik, yes, our VA -- the hedging program, our economic target-based hedging program has continued to perform as we have expected throughout all of the market volatility. It is an economic target-based hedging program, and so the RBC decline was in part due to the variable annuity and index annuity portfolios. And as you know, those market impacts are reversible as markets recover. So we have hedged all hedgeable economic risks. We have an open credit spread position, which we believe is offset by our general account credit portfolio, and the hedge has performed as we have designed it.
Operator: Our next question will come from Brian Meredith with UBS.
Brian Meredith: Yes, two quick questions here for you. First one, thanks for all the detail on the expense outlook going forward. I'm just curious, is there another plan expense reduction program for the General Insurance business post the Corebridge split?
And Pete, I'm curious, is there a G&A expense ratio did you think you need to be at or a target you're looking at to be among the most competitive from an expense leverage perspective in the commercial insurance business?
Peter Zaffino;Chairman and CEO: Yes. Thanks, Brian. Yes. So as we said, we're really proud and pleased that we just finished AIG 200, and that will start to continue to earn in. The work that we did in the summer for Corebridge, we increased our expectations there over the 3-year period to be now at the upper end of the range of $400 million. So our primary focus is the underwriting excellence in terms of the improvement, the focus on continuing AIG 200 and making sure that operational excellence becomes a core part of the organization, which it already has, but we want to continue that, and then making sure that the separation of Corebridge is done flawlessly.
At the same time, we are looking at our overall cost structure. There's a ton of work underway. And as we start executing on those other pieces, there will be -- Shane put in his prepared remarks, where we're going to get out a meaningful amount up to $500 million more of expenses. That's the remaining company within AIG. So that will start to get executed.
As we start to deconsolidate, we'll have a path forward as we flow Corebridge and be able to give you more guidance. I don't have a percentage. I focus on the nominal in terms of -- when I look at even like General Insurance over the last 5 quarters where we've invested a lot in the business, the nominal GOE has not gone up. I mean, so the expense discipline is there. And we want to continue to benefit from the earned savings with AIG 200 and what we will take out in terms of the combined entity when we go forward. But we want to have an organization that is going to be world-class in terms of its overall expense ratios.
And I think we've proven that we not only can take it out in a really constructive way because we're investing for the future, but we maintain that level going forward. We have growth opportunities in the top line, which will help the ratios. I mean, the commercial business is growing, excluding AIG Re, which the reason why I've excluded is that we're not trying to grow that business based on the CAT exposures today, but growing at 10%. We see opportunities to grow in the future when we look to the back half of this year. We have very strong retention. The new business that's been coming in is going to be more retained. It's the fifth quarter in a row where we produced more than $1 billion of new business, all very positive, all helpful to our ratios. And so we feel like we have a lot of momentum.
Brian Meredith: Great. That's really helpful. And then one last question on the whole exposure loss trend. Everybody is talking about increasing exposure. What happens if we go into a recession? Can that actually hurt your ability to see -- accrete margin?
Peter Zaffino;Chairman and CEO: I don't think so based on the makeup of the portfolio. But Mark, why don't we end where we started with you just to give a little bit of perspective and then you can turn it back to me.
Mark Lyons;Executive Vice President, Global Chief Actuary and Head of Portfolio Management: Yes. Thank you, Peter. And Brian, good to hear from you. So to your question, remember, what Dave McElroy and his team are doing, Lexington is becoming an increasing proportion of the business. And on a non-admitted basis, you have a lot of interesting terms and conditions like minimum earned premiums. So even if that does fall off a bit, that doesn't necessarily translate on a downward movement.
Peter Zaffino;Chairman and CEO: Thanks, Mark. Thanks a lot, Brian. Have a great day. And thanks, everybody, for joining us. Really appreciate the time, and have a great day.
Operator: And once again, ladies and gentlemen, this does conclude your conference call for today. Thank you for your participation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Second Quarter 2022 Financial Results Conference Call. This conference is being recorded."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q, provide details on important factors that could cause actual results or events to differ materially. Except as required by the applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Good morning, and thank you for joining us to review our second quarter results. AIG had an excellent quarter with strong momentum continuing across all of our strategic, financial and operational objectives. I could not be more pleased with the exceptional results in General Insurance. And Life and Retirement again delivered good results despite very challenging equity market conditions, significant volatility and other headwinds."
},
{
"speaker": "In North America Commercial, we saw very strong growth in net premiums written",
"text": "In Lexington, which grew 31% led by wholesale property, which was up 46%; retail property, which grew 17%; and our Canadian commercial business, which grew 10%."
},
{
"speaker": "In International Commercial, on an FX-adjusted basis, we also saw strong growth in net premiums written",
"text": "In Global Specialty, which grew 16% led by energy, which was up 20%; and marine, which was up 10%; North America Specialty, which grew 17%; and International Specialty, which grew 15%."
},
{
"speaker": "Shane Fitzsimons",
"text": "Thank you, Peter, and good morning to all. As Peter noted, I will provide more detail on our second quarter financial results and unpack a number of our key performance metrics, specifically EPS, liquidity, leverage, net investment income and ROCE."
},
{
"speaker": "Looking ahead, we have 4 priorities, which all lead to ROCE improvement towards our 10% or greater goal",
"text": "continued momentum on underwriting excellence, expense reduction through operational excellence and expense discipline, the successful IPO and separation of the Life and Retirement business and continued execution on our capital management priorities."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Great. Thank you, Shane. And operator, we're prepared to take questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question will come from Meyer Shields at KBW."
},
{
"speaker": "Meyer Shields",
"text": "Peter, you provided a ton of information on rates and trend and exposure. But I was hoping we could dig a little deeper, specifically into the exposure benefits for liability lines where premiums are based on receipts, but maybe the relationship between receipts and losses is not as obvious as, let's say, in property, and we've got the concerns of longer tail lines."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Sure, Meyer. Thank you for the question. Like you said, we've provided a lot of information in our prepared remarks. But I think, Mark, why don't you go through what the effects are in exposure and also talk a little bit about sort of the loss ratio implications in the observations that we made?"
},
{
"speaker": "Mark Lyons;Executive Vice President, Global Chief Actuary and Head of Portfolio Management",
"text": "Happy to. So a couple of things come to mind. First off, as Peter mentioned, North America Commercial aggregate loss trend is now up to 6% this quarter as opposed to our upper revision we did last quarter, the 5.5%, because we look at that every quarter. Short-tailed lines are driving much of this increase, and that is seen in our own data as well as external information. And over the last few years, because I'm talking about the weighted average loss cost trend there, the North American portfolio has reduced its property writings and has shrunk as a percentage of total, which helps ameliorate the growth in severity."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "That's great, Mark. Thank you. Meyer, is there a follow-up?"
},
{
"speaker": "Meyer Shields",
"text": "Yes. Just a very brief one really on the last comment. Is there an opportunity or an advantage to maybe shifting even more of the premium Phase 2 inflation-sensitive exposure?"
},
{
"speaker": "Mark Lyons;Executive Vice President, Global Chief Actuary and Head of Portfolio Management",
"text": "Yes. I mean, it's -- that is a potential strategy that you'd -- a little difficult to implement, right, because you have -- part of a profitable portfolio are those things, rated -- inflation exposure basis like premises. However, when you get into other lines, like the M&C side of GL, Meyer, I think what you're saying makes a lot of sense."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. I think maybe I'd just add to that, and we'll take the next question, which is all the significant repositioning we've done in the excess and surplus lines, particularly with the Lexington. You hear a lot about in the prepared remarks because they've done such a great job between growth, rate, retention and pivoting that portfolio to be a significant contributor in terms of profitability improvement. I mean, we've gotten on property alone 16 consecutive quarters of double-digit rate increases. And as Mark alluded to, that just starts to drive margins. So we are repositioning the portfolio based on where we see the best risk-adjusted returns."
},
{
"speaker": "Operator",
"text": "Our next question will come from Erik Bass with Autonomous."
},
{
"speaker": "Erik Bass",
"text": "So with the Corebridge IPO, it sounds like your strategy is to remain patient and wait for markets to recover since you're not a forced seller. Is this the right take? Or if the IPO window opens in the fall, would you look to take advantage and get some stock floated even if at a modest discount to what you view as the ultimate fair value?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. Thanks, Erik. We provided a lot of sort of guidance in our prepared remarks, but let me try to add to it. Our plan has always been to do an IPO of Corebridge, and that has not changed. So now we are targeting September. I mean, we gave you some of the variables, but obviously there's more to consider like you outlined. We just felt that the market conditions in the second quarter were not conducive. We always intend to own greater than 50% following the IPO. And therefore, we'll continue to consolidate results for the foreseeable future."
},
{
"speaker": "Erik Bass",
"text": "Got it. And then one follow-up on Corebridge. I was just hoping you could talk a little bit more about the performance of your VA hedging program this quarter and the movements in the RBC ratio that we saw."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes, Shane, you and Kevin want to provide some insight on that?"
},
{
"speaker": "Kevin Hogan",
"text": "Yes, so..."
},
{
"speaker": "Shane Fitzsimons",
"text": "Go ahead, Kevin."
},
{
"speaker": "Kevin Hogan",
"text": "So Erik, yes, our VA -- the hedging program, our economic target-based hedging program has continued to perform as we have expected throughout all of the market volatility. It is an economic target-based hedging program, and so the RBC decline was in part due to the variable annuity and index annuity portfolios. And as you know, those market impacts are reversible as markets recover. So we have hedged all hedgeable economic risks. We have an open credit spread position, which we believe is offset by our general account credit portfolio, and the hedge has performed as we have designed it."
},
{
"speaker": "Operator",
"text": "Our next question will come from Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"text": "Yes, two quick questions here for you. First one, thanks for all the detail on the expense outlook going forward. I'm just curious, is there another plan expense reduction program for the General Insurance business post the Corebridge split?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. Thanks, Brian. Yes. So as we said, we're really proud and pleased that we just finished AIG 200, and that will start to continue to earn in. The work that we did in the summer for Corebridge, we increased our expectations there over the 3-year period to be now at the upper end of the range of $400 million. So our primary focus is the underwriting excellence in terms of the improvement, the focus on continuing AIG 200 and making sure that operational excellence becomes a core part of the organization, which it already has, but we want to continue that, and then making sure that the separation of Corebridge is done flawlessly."
},
{
"speaker": "Brian Meredith",
"text": "Great. That's really helpful. And then one last question on the whole exposure loss trend. Everybody is talking about increasing exposure. What happens if we go into a recession? Can that actually hurt your ability to see -- accrete margin?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "I don't think so based on the makeup of the portfolio. But Mark, why don't we end where we started with you just to give a little bit of perspective and then you can turn it back to me."
},
{
"speaker": "Mark Lyons;Executive Vice President, Global Chief Actuary and Head of Portfolio Management",
"text": "Yes. Thank you, Peter. And Brian, good to hear from you. So to your question, remember, what Dave McElroy and his team are doing, Lexington is becoming an increasing proportion of the business. And on a non-admitted basis, you have a lot of interesting terms and conditions like minimum earned premiums. So even if that does fall off a bit, that doesn't necessarily translate on a downward movement."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Mark. Thanks a lot, Brian. Have a great day. And thanks, everybody, for joining us. Really appreciate the time, and have a great day."
},
{
"speaker": "Operator",
"text": "And once again, ladies and gentlemen, this does conclude your conference call for today. Thank you for your participation, and you may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 1 | 2,022 | 2022-05-04 08:30:00 | Operator: Good day, and welcome to AIG's First Quarter 2022 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, Jake. Good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q, provide details on important factors that could cause actual results or events to differ materially. Except as required by the applicable securities laws, AIG is under no obligation to update any forward-looking statement if circumstances or management's estimates or opinion should change.
Additionally, today's remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at www.aig.com.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino;President, CEO, Global COO & Director: Good morning, and thank you for joining us to review our first quarter financial results. I'm very pleased to report that AIG had an excellent start to 2022. We are successfully executing on several strategic, operational and financial priorities, and our team has significant momentum on many fronts, which we believe will continue throughout the year.
Following my remarks, Shane will provide more detail on our financial results, and then we will take questions. Mark Lyons, David McElroy and Kevin Hogan will join us for the Q&A portion of today's call.
Today, I will cover 4 topics. First, I will outline the tremendous progress we've made towards the separation of our Life and Retirement business, which will be renamed Corebridge Financial. Second, I will review the excellent first quarter performance of General Insurance, where we continue to drive top line growth, particularly in Global Commercial, and saw meaningful improvement in underwriting profitability. Third, I will cover Life and Retirement's financial performance. This business remains a meaningful contributor to our overall results. And fourth, I'll provide an update on our capital management strategy, particularly as to stock buybacks, which we plan to accelerate over the course of 2022, given our positive view of AIG's future over the near, medium and long term.
Before I turn to these topics, I'd like to discuss the situation in Russia and Ukraine. It goes without saying that what is happening is heartbreaking. Ukrainian people are experiencing unimaginable pain and suffering. And it's our hope that a peaceful resolution will be achieved.
With respect to the insurance industry, we've not seen a situation like this in modern times. It presents a unique set of circumstances that make any exposure or coverage analysis complex. Let me start by commenting on what we saw at AIG in the first quarter and what we did with a few claims that were submitted.
The claims we received were largely reported under political violence or political risk policies. While the amount of information included in the claims was limited, we did reserve our best estimate of ultimate losses, including IBNR. While we know it will take time for the full impact of the Russia-Ukraine situation to emerge, based on the work we did in the first quarter to analyze our exposures and review known claims, we do not believe the impact will be material to AIG. And in the event of losses, we have multiple reinsurance programs available.
With respect to the industry more broadly, there's not been much discussion so far in this earnings season regarding what the Russia-Ukraine situation means. So I thought I'd spend a few minutes on the complexity that it presents.
As a starting point, it's important to bear in mind that standard property and energy policies issued to the types of insureds most likely to have suffered losses due to the conflict typically contain broad exclusions for losses arising at a war and other hostile acts. In instances where affirmative coverage has been provided for losses that would typically fall within the scope of these exclusions, the most relevant coverages relate to policies such as political violence, political risk and trade credit, aviation and marine.
Now I'd like to spend a few minutes on aviation because it's the topic that has received the most attention over the last 30 to 45 days. Aviation is similarly complex and it will take time before all the relevant facts and resulting coverage implications fully emerge.
Let me start with what we know. We know that aviation policies can be issued to both airline operators and airline leasing companies and typically provide separate coverage for, on the one hand, losses caused by war perils, such as nationalization and confiscation; and on the other hand, losses caused by nonwar perils.
We also know that the invasion of Ukraine first occurred on February 24, and there were sanctions issued by the U.K. and the EU on February 26, which have since been updated. These sanctions generally required airline lessors to cancel leases with Russian airline operators and gave them a brief period in which to do so. Additionally, we know that there was an aircraft reregistration law passed in Russia on March 14, which permitted Russian airline operators to reregister aircraft leased from Western lessors on the Russian aircraft registry.
What we don't know is much more expansive. As an initial matter, we don't know whether or to what extent actual losses have occurred or when they occurred, given the uncertainty surrounding the location and condition of aircraft and other equipment as well as the timing of their potential return to lessors, nor do we know if efforts have been undertaken by lessors to mitigate any damages.
As to the question of losses caused by war perils versus nonwar perils, this is a critical question that will need to be answered as the outcome will determine which policy might apply and the amount of coverage that may be available.
With respect to war perils such as government confiscation, this type of loss would typically be included in a whole war policy, but it must be first be determined if there's an actual confiscation. Even where it is determined that a government confiscation took place, consideration will also have to be given to the timing of notices and the geographic scope of coverage. The answers to these questions will impact whether there is a covered loss and, if so, whether a given whole war policy response.
With respect to reinsurance, structures likely implicated in a war peril scenario include war, marine and energy and political violence, but it's also possible that other types of reinsurance contracts could be available for recoveries. If a loss is alleged to be due to a nonwar peril, it could be covered in an all-risk policy. As an initial matter, however, a determination would need to be made that a loss in fact has occurred and then, if it has, that is due to a nonwar peril.
Additionally, as with war perils, you would have to consider if reinsurance is available. The reinsurance that would be typically available in an all-risk scenario may be in different structures than in government confiscation or other war peril scenario.
As to all potentially covered perils, there are many issues requiring analysis, including the potential applicability of any sanctions. Assuming claim payments are made, insurers will also have to consider their recovery rights through salvage and subrogation and contribution from other available insurance. This is just a high-level summary of some of the issues the industry will grapple with, but I thought they were important to highlight, and you get the idea that it's a complex situation.
Now turning to the separation of Life and Retirement. We made significant progress to prepare this business to be a stand-alone public company. We continue to target an IPO in the second quarter, subject to market conditions and required regulatory approvals. We also continue to expect that we will retain a greater than 50% interest in this business post IPO. As you can appreciate, given where we are in the process, there are limitations on how much I can say about Life and Retirement, but let me give you some highlights of what we've accomplished since our last call. In March, we announced several important milestones: the public filing of the S-1; the new name for Life and Retirement which, as I mentioned, is Corebridge Financial; and the Independent Directors who currently serve on the Corebridge Board of Directors and those who will join and strengthen the Board as of the IPO.
At the same time, we launched a $6 billion Corebridge senior notes offering which was upsized to $6.5 billion based on significant demand. Shane will provide more detail on the maturities and coupons. We also made substantial progress on the operational separation of the Life and Retirement business from AIG, including identifying $200 million to $300 million of cost savings for this business, inclusive of $125 million in savings already in flight as part of our AIG 200 transformation program. And we continue to execute on establishing a hybrid investment management model that will allow Corebridge to benefit from strategic partnerships with world-class firms that offer excellent origination and investment capabilities and that complement our own capabilities in asset classes such as commercial mortgage loans, global real estate and private equity.
The first step in moving to this hybrid model was our strategic partnership with Blackstone, which we announced in 2021. In March of this year, we announced an arrangement with BlackRock, whereby BlackRock will manage up to $90 billion of Corebridge's liquid assets.
In addition, we developed a plan to modernize the mid- and back-office functionalities of the business and the transition to BlackRock's Aladdin technology platform with respect to Life and Retirement's entire investment portfolio. Aladdin enables us to replace aging and end-of-life technology infrastructure, provides risk analytics, establishes a single accounting book of record and a single investments book of record as well as reporting, stress testing and other services currently performed across multiple systems at AIG.
We expect that the cost for Corebridge to operate this hybrid model, taking into account both Blackstone and BlackRock, will be approximately the same as the fully loaded costs of our prior investment management operating model, where asset management was largely handled in-house.
Shifting to our first quarter financial results. As you saw in our press release, adjusted after-tax income was $1.30 per diluted share, representing an increase of 24% year-over-year. This result was driven by significant improvement in profitability in General Insurance, good results in Life and Retirement considering the current environment, continued expense discipline, savings from AIG 200 and strong execution of our capital management strategy.
In General Insurance, we reported an accident year combined ratio, excluding CAT, of 89.5%, a 290 basis point improvement year-over-year and the 15th consecutive quarter of improvement. We were especially pleased with the accident year combined ratio, excluding CAT and commercial, which was 86%, an improvement of 440 basis points year-over-year.
In Life and Retirement, first quarter results benefited from product diversity despite headwinds in the capital markets. Return on adjusted segment common equity was 10%. AIG ended the first quarter with $9.1 billion in parent liquidity after returning $1.7 billion to shareholders through $1.4 billion of common stock repurchases and $265 million of dividends.
Now let me provide more detail on our first quarter results in General Insurance, where we continue to drive improved financial performance, with core fundamentals being key contributors. Gross premiums written increased 10% on an FX-adjusted basis to $11.5 billion, with commercial growing 11% and personal growing 8%. Net premiums written increased 5% on an FX-adjusted basis to $6.5 billion. This growth was led by our commercial business, which grew 8% with personal contracting 1%. Growth in North America Commercial net premiums written was 6% and then International net premiums written growth was 10%, both on an FX-adjusted basis.
I'd like to unpack certain components of North America Commercial net premiums written as we had a very strong growth in our core business that may not be immediately obvious. While there are always movements each quarter in various aspects of our portfolio, both positive and negative, there were 3 items that impacted the first quarter that I'd like to provide more insight on. These items relate to assumed and ceded reinsurance and the timing of purchases, which is not something we have focused on previously but which I think is worth spending a few minutes on given the impact they had on North America Commercial net premiums written.
The first item relates to AIG Re, our assumed reinsurance business. Financial results for AIG Re are included in the financial results for North America Commercial and, in the first quarter, represented 40% of the segment's total net premiums written. For AIG Re, the first quarter is the largest quarter of the year with over 50% of its annual business written at 1/1. In the first quarter of 2022, AIG Re's net premiums written were flat year-over-year. This result was deliberate as we applied a disciplined approach to underwriting, and the market environment that persisted leading up to 1/1 led us to conclude that AIG Re could not achieve appropriate levels of risk-adjusted returns in property CAT, in particular, even with a comprehensive retrocessional program in place.
As a result, we reduced gross limits deployed in property CAT primarily in the U.S. by $500 million, which was the main reason for AIG Re's net premiums written being flat.
With respect to the second item, you may recall that in 2021, AIG Re made discrete retrocessional purchases throughout the year to further reduce frequency and volatility, whereas this year, retrocessional purchases were consolidated into the 1/1/2022 renewals as the retro market rebalanced. As a result of this decision, AIG Re ceded premiums were higher in the first quarter of 2022, which also reduced North America Commercial's net premiums written when compared to the first quarter 2021.
Third, a similar dynamic occurred with respect to our core property CAT reinsurance program for AIG. In 2021, we purchased reinsurance throughout the year to lower net retentions and reduce volatility, particularly with respect to North America property CAT. In 2022, however, those purchases were also consolidated into our core property CAT placement at 1/1.
We were able to consolidate these reinsurance purchases because our portfolio is much improved from last year with significantly reduced exposures. Like the actions we took in AIG Re, however, this reduced North America Commercial net premiums written in the first quarter. To summarize, some of these headwinds in the first quarter of 2022 will largely reverse in the second quarter.
Now turning back to growth. In North America Commercial, we saw a very strong growth in net premiums written, particularly in Retail Property, which grew more than 20%; Crop Risk Services, which also grew more than 20%; Lexington wholesale, which grew more than 15% led by property, which grew more than 50%; and our Canadian commercial business, which grew more than 15%.
In International Commercial, we also saw very strong growth, including in property, which grew 50%; specialty, which grew 34% driven by energy and marine; and Financial Lines, which grew 14%. In Global Commercial, we also had very strong renewal retention of 86% in our in-force portfolio in both North America and International, with North America improving retention by 300 basis points and International retention holding constant year-over-year. We calculate renewal retention prior to the impact of rate and exposure changes.
And across commercial on a global basis, our new business was very strong, coming in north of $1 billion for the fourth consecutive quarter. New business growth in North America and in International were both up 13%. North America new business growth was led by Lexington and Retail Property. International Commercial new business growth was led by Financial Lines and global specialty.
Turning to rate. Strong momentum continued in Global Commercial, with overall rate increases of 9% or 10% if you exclude workers' compensation. And in the aggregate, rate continued to exceed loss cost trends. This continues to be a market in which we are achieving rate on rate in many cases for the fourth consecutive year and where we're successfully driving margin expansion above loss cost trends.
North America Commercial achieved 8% rate increases overall, 10% excluding workers' compensation, with some areas achieving double-digit increases led by Retail Property, which increased 14%; Lexington, which increased 13%; Financial Lines, which increased 12%, including more than 85% rate increases in cyber; and Canada, where rate increased 13%, representing the 11th consecutive quarter of double-digit rate increases in this region.
International Commercial rate increases were 10% overall driven by Financial Lines, which increased 21%, including more than 60% rate increases in cyber; property, which increased 14%; EMEA, which also increased 14%; and Asia Pac, which increased 10%.
Last quarter, we indicated that our severity trend view in the aggregate in North America Commercial range from 4% to 5% and that we were migrating towards the upper end of that range. We now believe the upper end is moving towards 5.5% mostly driven by shorter-tail lines. Our property rate changes, where we continue to achieve mid-teen increases, equal or exceed loss cost trends in our own data and in government-published inflationary indices. Our liability trend assumptions continue to be in the 7% to 9% range, with International indications continuing to be less than those in North America.
Turning to Personal Lines. In North America, personal net premiums written grew nearly 40%, albeit off a smaller base, driven by a rebound in Travel and A&H, which was offset by a reduction in Warranty and increased reinsurance cessions supporting Private Client Group. International Personal saw a 5% reduction in net premiums written on an FX-adjusted basis, due to a reduction in Warranty and personal auto in Japan offset by a rebound in A&H and Travel. Overall, Personal Lines is an area where we continue to invest where there are attractive opportunities for profitable growth.
Now let me review Life and Retirement's results. This business had a good quarter considering the headwinds created by the capital markets. These market dynamics were offset by continued strong alternative investment income and strong growth in premiums and deposits, which increased 13% year-over-year to $7.3 billion. Adjusted pretax income in the first quarter was $724 million, with return on attributed segment equity of 10%. Adjusted pretax income decreased in the period due to lower call and tender income and continued elevated COVID-19 mortality, which is still within our previously established guidance.
Blackstone's capabilities in the early days of our partnership resulted in Life and Retirement seeing one of its strongest fixed annuity sales quarters in over a decade, with premiums and deposits up nearly 150% year-over-year to $1.6 billion, while surrenders and death benefits both improved slightly. Post separation, we continue to expect that Life and Retirement, meaning Corebridge, will achieve a return on equity of 12% to 14%, and that it will pay an annual dividend of $600 million.
Overall, I'm pleased with the momentum in Life and Retirement and, in particular, the early success of our partnership with Blackstone that was evident in the first quarter results.
With respect to capital management, we had a very active first quarter, which ended with $9.1 billion in parent liquidity. As a result of the actions I outlined earlier in my remarks, AIG received $6.5 billion of the $8.3 billion promissory note issued to AIG from Corebridge, and those funds were used to repay outstanding AIG debt, resulting in AIG's interest expense being reduced by 23% year-over-year. In addition, AIG will receive the remaining $1.9 billion under the Corebridge promissory note during the second quarter.
Our capital management strategy will continue to be both balanced and disciplined as we maintain appropriate levels of debt while returning capital to shareholders through stock buybacks and dividends while also allowing for investment in growth opportunities across our global portfolio. This will also be true over time as we continue to sell down our stake in Life and Retirement.
With respect to share buybacks, as I mentioned earlier, we repurchased $1.4 billion of common stock in the first quarter and are on track to buy back at least $1 billion more in the second quarter. This will leave us with approximately $1.5 billion remaining under our prior Board authorization. And as you saw in our press release, the AIG Board of Directors recently authorized an additional $5 billion in share repurchases.
With respect to growth opportunities, our priorities continue to be focused on allocating capital in General Insurance, where we see opportunities for profitable organic growth and further improvement in our risk-adjusted returns. As we move through 2022 and are further along with the separation of Life and Retirement, we will provide updates regarding our capital management strategy.
Before I turn the call over to Shane, I want to emphasize how pleased I am with how we started the year across AIG and how we are continuing to execute on multiple complex strategic priorities with high-quality results that are positioning AIG as a top-performing company. Our teams have overperformed across the board, and our deep bench continues to provide us with opportunities to leverage skill sets and further develop talent across the organization.
With that, I'll turn the call over to Shane.
Shane Fitzsimons: Thank you, Peter, and good morning to all. I am very pleased to be AIG's CFO, and I look forward to working with everyone moving forward. I will provide more detail on our first quarter financial results and unpack a number of our key performance metrics, specifically EPS, liquidity, leverage, net investment income and ROCE.
I will begin by going through the financial results of the businesses in the quarter. I will then touch upon the balance sheet, leverage and liquidity, which benefited from excellent execution on a number of capital transactions. I will then supplement Peter's remarks on the separation of Corebridge, including the arrangement we announced with BlackRock and liability management actions we recently completed. I will then spend some time on investment income and will provide insight on the impact of rising interest rates. And finally, I will talk about the execution path towards our long-term 10% ROCE goal for AIG, including income drivers, AIG 200 and other areas of corporate GOE reduction.
As Peter mentioned, adjusted EPS attributable to AIG common shareholders grew 24% year-over-year to $1.30 per diluted common share compared to $1.05 per diluted common share in 1 quarter '21. Compared to the first quarter '21, improvements in General Insurance contributed $0.33 year-over-year, reduction in share count contributed $0.07 and lower interest expense contributed $0.04, offset by Life and Retirement being $0.19 unfavorable primarily due to $0.20 unfavorable due to lower net investment income.
General Insurance's adjusted pretax income contribution in the quarter was $1.2 billion, which reflects strong underwriting profit, growth in Global Commercial and continued improvement in both the GAAP combined ratio up 590 basis points to 92.9% and the accident year combined ratio ex CAT improving 290 basis points to 89.5%. The combined ratio improvement was due to improved underwriting, premium growth, expense discipline and lower CATs, which all contributed to pretax underwriting income being 6x higher than the first quarter of 2021, increasing to $446 million from $73 million. With net investment income down $7 million year-over-year, the $366 million improvement in adjusted pretax income was driven by underwriting income, of which $223 million was from improved accident year underwriting income, $146 million due to lower CAT and $4 million from improved net PYD.
North America Commercial has shown a 580 basis points improvement in the accident year combined ratio ex CAT over the prior year quarter, coming in at 88.1%. International Commercial also continued to improve profitability with 330 basis points improvement in the accident year combined ratio ex CAT this quarter, coming in at 83.5% for the first quarter.
Personal Insurance GAAP combined ratio of 97.2% improved by 160 basis points year-over-year. In the first quarter, CAT losses were $274 million or 4.5 loss ratio points compared to $422 million or 7.3 loss ratio points in the prior year quarter. The most significant loss events in the quarter came from flooding in Australia and a Japanese earthquake. The ongoing events with Russia and Ukraine, which Peter discussed, contributed approximately $85 million of the estimated loss.
Prior year development, excluding related premium adjustments, was $93 million favorable this quarter compared to favorable development of $56 million in the prior year quarter. This quarter, the ADC amortization provided $42 million of favorable development, and the balance of $51 million favorable arose from old accident years in U.S. workers' compensation along with short-tail lines in North America and in Japan Personal Lines.
Life and Retirement adjusted pretax income of $724 million compared to $941 million in 1Q '21, a reduction of $217 million mostly attributable to lower net investment income, which was $2.1 billion in the quarter compared to $2.4 billion in the prior year quarter, a decrease of $224 million, reflecting lower call and tender activity from rising interest rates; the absence of the affordable housing portfolio, which was sold in fourth quarter '21 as well as reduced fee income; and an increase in deferred acquisition cost and statement of position reserves due to lower separate account asset values.
Within Individual Retirement, excluding the Retail Mutual Fund business, which was sold, net flows were positive $874 million this quarter compared to positive net flows of $50 million in the prior year quarter, benefiting from higher fixed annuity sales aided by origination activity through the Blackstone partnership.
Group Retirement grew deposits by 3.9% in the quarter, driven by higher group acquisition and individual deposits driving a slight uptick in fee and advisory income due to higher assets under administration. Life Insurance adjusted pretax income was a loss of $44 million due to continued elevated COVID mortality, while premium and deposits grew 3.4% to $1.2 billion, benefiting from growth of international life sales. Institutional Markets grew premiums and deposits as well as reserves due to increased pension risk transfer activity in the period.
Turning to Other Operations, which includes interest expense, corporate general operating expenses, institutional asset management expense, runoff portfolios and eliminations and was a positive contributor to adjusted pretax income year-over-year by $109 million. These results benefited from lower interest expense of $51 million as we reduced our general borrowings through the course of 2021 by $4 billion and lower eliminations of $43 million. Corporate general operating expenses, excluding increased functional costs to set up Corebridge as a stand-alone public company of $6 million, were largely flat year-over-year.
Moving on to the balance sheet, leverage and liquidity. Our financial flexibility remains strong. We closed the quarter with $9.1 billion of parent liquidity. We saw a large AOCI movement as a result of increase in interest rates. Adjusted AOCI, which excludes the cumulative unrealized gains and losses related to Fortitude, moved from $3.9 billion positive to a $5.9 billion negative, or a reduction of $9.8 billion. Although this mark-to-market impact is a drag on capital, as long as we hold the assets to maturity, we will not realize this unrealized loss.
Operating interest rate movements impact our metrics primarily in 2 places: one, we end up with a gain on the Fortitude Re embedded derivative, which impacted GAAP EPS by $3.21 in the quarter; and second, it impacts our GAAP leverage by a little over 300 basis points. And with interest rates up another 55 basis points in April, we expect to see further movement in Q2.
We exited the quarter at a GAAP leverage of 27.8%, up from 24.6%, the increase of which is attributable to the AOCI movement. The impact is larger in Life and Retirement than General Insurance given the duration of their respective asset portfolios.
Total adjusted return on common equity was 7.6%, up from 7.4% in the first quarter '21, and total company adjusted tangible return on common equity was 8.3%. General Insurance's adjusted attributable return on common equity was 12.3% in the first quarter, while Life and Retirement was 10%. Adjusted book value per share of $70.72 increased 2.7% sequentially and 20.5% year-over-year. Adjusted tangible book value per share of $64.65 increased 2.9% sequentially and 22.3% year-over-year.
Our primary operating subsidiaries remain profitable and well capitalized, with General Insurance's U.S. pool fleet risk-based capital ratio for the first quarter estimated to be between 470% and 480%, and the Life and Retirement U.S. fleet is estimated to be between 430% and 440%, both well above our target ranges.
Finally, on EPS during the quarter. We repurchased 23 million shares at an average cost of $60.02 for $1.4 billion, bringing our ending share count to 800 million with a quarterly average of 826 million compared to 876 million in the prior year quarter, representing a 6% reduction in average share count, which contributed $0.07 of EPS growth in the quarter.
Turning to Corebridge. Since the start of the year, we continue to make progress on numerous fronts with respect to the separation. As Peter mentioned, at the end of the first quarter, Corebridge entered into a strategic partnership with BlackRock to manage up to $90 billion of liquid assets. At the same time, AIG also entered into a separate arrangement with BlackRock, whereby BlackRock will manage liquid assets for AIG representing up to $60 billion. Having now signed IMAs, we expect to begin transferring assets to BlackRock over the course of the second quarter.
In early April, Corebridge successfully raised $6.5 billion of senior notes which, along with the remaining $2.5 billion of delayed draw term loan facility and commitments for the $2.5 billion of revolving credit facility, this establishes the capital structure for Corebridge Financial. AIG proactively hedged treasury rates earlier in the year, and upon unwinding the hedge at quarter end, AIG realized a $223 million gain, which equates to approximately 50 basis points in yield on the notes issued. While the debt issuance closed early in Q2, the $223 million gain was realized as a gain in the first quarter.
The senior notes offering, excluding the hedge, was well structured and laddered with a 3.91% weighted average coupon rate. Corebridge used the proceeds from that offering to repay $6.4 billion of the $8.3 billion promissory note payable to AIG. Following the success of Corebridge's senior notes issuance, AIG initiated a debt tender offer. Taking advantage of strong demand, the tender offer was upsized, and AIG parent debt was ultimately reduced by $6.8 billion. An additional EUR 750 million will be redeemed on May 10, bringing the total expected AIG parent debt reduction to $7.6 billion. The average coupon on the debt that we retired was 3.82%, and the annualized interest expense savings is approximately $290 million.
We continue to target debt leverage in the high 20s, excluding AOCI for Corebridge; and in the low 20s, including AOCI for AIG going forward. Given the significant progress we have made and with $1.9 billion of proceeds from the $8.3 billion note yet to be received, we have the necessary cash to finalize our planned debt actions without utilizing any of the proceeds from the IPO. With these actions completed, we remain on track for an IPO in the second quarter subject to market conditions and regulatory approval.
Net investment income on an adjusted pretax income basis for the quarter was $3 billion. Total cash and investments were $305 billion, excluding Fortitude. Net investment income in the first quarter decreased $193 million compared to prior year, primarily reflecting lower call and tender income.
The first quarter saw significant increases in benchmark treasury yields, with an 80 basis point increase on the 10-year. With General Insurance and Life and Retirement's portfolio durations of 4 and 8.4 years, respectively, the overall rising interest rate environment will provide a tailwind to our investment portfolio returns.
In April, our portfolio crossed the equilibrium point, where new money yield is now 50 basis points higher on average than the yield on the assets rolling off the portfolio. The new money yield is higher by 20 basis points in General Insurance versus assets rolling off and 70 basis points in Life and Retirement versus the yield on sales and maturities currently.
Moving forward, the new money yield is roughly 60 basis points higher than the current portfolio in General Insurance and roughly 90 basis points higher in Life and Retirement. To illustrate the point, holding all other variables constant and assuming 100 basis point parallel shift in the yield curve, we would anticipate approximately $500 million of benefit to adjusted net investment income over a 1-year period with nearly $200 million in General Insurance and $300 million in Life and Retirement.
Within General Insurance, we have $11 billion of floating rate securities, which will begin to see some benefits in the near term, most of which are not tied to longer-dated liabilities. Life and Retirement is $25 billion of floating rate assets, but most of this portfolio is tied to floating rate liabilities that will offset the benefits.
Turning to investments that have Russian exposure. At December 31, AIG held $359 million of sovereign and other foreign debt of the Russian Federation, of which $79 million were within Fortitude. Through proactive sell-downs of $129 million, which generated a loss of $41 million as well as the establishment of a credit allowance of $127 million, the market value of these securities at the end of the first quarter was $86 million, of which $18 million is held by Fortitude.
Looking ahead, we have 3 priorities beyond continued progress on underwriting optimization and completing AIG 200. They are the successful separation of the Life and Retirement business, continued execution on our capital management priorities and ROCE improvement towards 10%. Post deconsolidation of Corebridge, we expect that AIG will earn a 10% ROCE, although there are many moving pieces that will get to this result, including the size and timing of the Corebridge IPO, additional capital management actions and continued progress on reducing expenses.
As we've improved expense ratios in General Insurance, one of the key drags on ROCE is corporate expenses, which we have been reducing through AIG 200 and work on the separation, but there remains more work to be done. As Peter noted, with respect to AIG 200, we continue to achieve significant milestones and, in the first quarter, reached $890 million of exit run rate savings with $590 million of that realized to date. We currently expect to have full line of sight into the $1 billion of exit run rate savings either contracted or identified by the end of the second quarter, 6 months earlier than originally planned.
Of the $1 billion of parent expenses, we expect that approximately $300 million will move to Corebridge upon deconsolidation. We will continue to provide updates over time, but the components to get to a 10% ROCE, our continued growth in underwriting profit; improved net investment income as we benefit from higher interest rates; continued execution on expense management, particularly at parent; and optimizing capital allocation in terms of leverage and returns to shareholders in the form of stock buybacks and dividends whilst making sure that we continue to grow the company.
Peter, I will now hand it back to you.
Peter Zaffino;President, CEO, Global COO & Director: Thank you, Shane. Operator, we're ready for questions.
Operator: [Operator Instructions] We will begin with Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question is on the capital return that you guys laid out. So you guys have just over $9 billion at the holdco. Peter, I think you said a minimum buyback of $1 billion for the second quarter. But just given that you have above $9 billion at the holdco with additional capital coming later this year, I would think that there's some flexibility to perhaps go above that $1 billion. So can you just kind of walk us through a little bit more how you're thinking about uses of capital for growth relative to buyback at least in the short term?
Peter Zaffino;President, CEO, Global COO & Director: Yes. Thanks, Elyse, for the question. Yes, we said we would do a minimum of $1 billion of share repurchases in the second quarter. I think Shane and I tried to do as much detail as we could in our prepared remarks in aligning what our priorities are for capital management. And certainly, the Board's authorization for an additional $5 billion says that we will continue to return capital to shareholders in the form of share repurchases.
We think the positioning of the business, I mean, I think you see in the results, we see great opportunities for top line growth. We see it across the world. We see it in the commercial businesses, but also what you would have seen in some of the international that's probably [ amasses ] that. Accident & Health has started to rebound over the last 3 quarters, and we're starting to see top line growth there. So we want to make sure that we are allocating the appropriate capital for growth in driving margin and making the company look at its opportunities on risk-adjusted returns and make sure that we're capitalizing on the market and our discipline.
I think really, when we get to the actual IPO and Corebridge as a public company, we'll be able to outline the capital management strategy in more detail. But we wanted to provide as much guidance as we could based on what we know today, and we would expect to continue to make the progress that we've demonstrated in the earnings call today.
Elyse Greenspan: Okay. And then my follow-up, you guys pointed out that you raised some of your severity assumptions within General Insurance on the short-tail side. When you guys set out that target for the accident year combined ratio of sub-90 for this year, was that contemplated? And then should -- how about the cadence, can you give us a sense? Should we think about sequential improvement from the Q1 level as we move through the year? Or is there some seasonality that we should be considering within General Insurance?
Peter Zaffino;President, CEO, Global COO & Director: Let me take the first part, and then I'll ask Mark to comment on the loss cost observations. We've seen -- when you think about the quality in the results that we produced this quarter, when we look at our business, what do we look at? We look at client retention, which continues to improve. We look at new business, so we're acquiring a lot of new clients across the world. And so that continues to progress and think that there's a lot of momentum there. We look at rate above loss cost trends. And so that was favorable, and we continue to get rate in areas where we believe it is required in terms of its risk-adjusted returns and, again, with our leadership in terms of deploying capital.
Are all the inflation factors considered in the sub-90? Well, no. We obviously are adjusting them, but the outperformance that we have been driving wasn't contemplated either. I mean like we're making more progress on the business at a faster pace and think that we will continue to show that we can grow the business top line and generate the risk-adjusted returns and improvement in combined ratios. Mark, do you want to comment on the loss cost?
Mark Lyons;Executive VP & CFO: Yes. Thank you, Peter. So I think Peter answered it very well. But what I'll do is just reemphasize that, yes, I mean the context of your question, we gave that original guidance before there was any spike of inflation. But like I think any good company, you don't forecast just a point estimate. You're forecasting a range, and those ranges vary by line of business, and they all meld together. And even with the changing inflation assumptions, we'd still be inside that range. So we're comfortable with that.
Operator: We'll go to Meyer Shields with KBW.
Meyer Shields: I think this might also be a question for Mark [ as to tax query ]. We're clearly seeing a little bit less core loss ratio improvement than the simple mathematical application of earned rate increases and loss trend. And I was hoping you could talk about how that's manifesting itself in prior year reserve reviews.
Peter Zaffino;President, CEO, Global COO & Director: Yes. Mark, please take that. I mean I think it's also important to give some context of the portfolio shift as well, Mark, when we look at loss ratios?
Mark Lyons;Executive VP & CFO: Yes, happy to. And thank you, Meyer, for the question. So I think on that side, first, on the reserve side, when you look at our view of inflation and severity trends and so forth, you really got to separate short-tailed lines from longer-tailed lines, right? And like in our view, the evidence within our own information as well as looking at external indices, whether it's from the perspective of the purchaser or the seller, it's clearer with -- in property-oriented lines.
And it's probably worth noting, back to Peter's comment on mix, is that less than 10% of our pre-ADC reserves are property. So it can't move the needle too much anyway. So I don't really view that as an issue.
And in terms of nonproperty, we've gone through looking at various basis point scenarios of lift and for various durations associated with it. And we still feel that all of that is pretty contained. And don't forget, especially on longer-tailed lines, there's still a high proportion of total reserves subject to the ADC on recoverables as well.
So in terms of the -- your first part of your question with regard to the arithmetic versus what's there, I think we've addressed this before, Meyer, but I'm happy to give some comments again. which is the book has changed so dramatically from policy year '18, '19, '20 '21 and its accident year conversions that you need a margin of safety associated with it because nobody backs a thousand on these things. But there's been a radical change in the quality of the risk, the distribution strategy that Dave McElroy and his team have instituted getting much better risk portfolio churn purposely done to improve it, all the limit changes that Peter has talked about over time. And as a result, the arithmetic just doesn't pan out, let alone the change in mix that has been purposeful, let alone the change in net mix. So all of those changes simultaneously require, in our view, a reasonable range of margin of safety, and that's what you're seeing.
Meyer Shields: Okay. That's very helpful. A quick follow-up, if I can. I know there are a lot of moving parts, but is there any way of quantifying the impact of the reinsurance purchasing timing on the expense ratio in the quarter?
Peter Zaffino;President, CEO, Global COO & Director: Thanks, Meyer. I'll take that. As I said, it's going to be a headwind in the first quarter will be a tailwind in the second quarter. Once we -- there's a couple of moving pieces. We can't really provide the exact numbers, but you can look at like in the second quarter where we purchased down on the North America Commercial CAT to lower retentions as well as in AIG Re, where we reduced volatility by buying single shop per occurrence retrocessional at the second quarter, and both recovered by the way, last year. So we felt that reducing the net retentions was appropriate and carrying that forward into how we were going to structure the 1/1 treaty for AIG as well as the retrocessional covers for AIG Re.
So we have lower nets than we would have at this time last year. It's not uncommon to purchase sometimes midterm if there's available capacity and you're still trying to evolve a program, but we felt very good about the consolidation of those programs at 1/1 and really like the reinsurance that we have in both instances.
Operator: And now we'll hear from Ryan Tunis with Autonomous Research.
Ryan Tunis: A couple of questions, just following up from the first 2 question askers. First one, we saw about 3.5 points of sequential loss ratio improvement this quarter in Commercial Lines in general. I noticed that, last year, we also saw like the biggest sequential move in the first quarter. So I'm curious if there's something about 1Q, if it's setting a loss pick assumption or something like that, that's leading to that level of sequential jump that's outsized.
Peter Zaffino;President, CEO, Global COO & Director: Yes. Let me start. Thanks very much for the question. We have -- there's -- Mark touched on a little bit, and I'll ask if he has any additional comments after I make a few observations on the mix of business. But what we have in the first quarter, obviously, is a big AIG Re, which when you look at if you're changing the composition of the portfolio from reducing CAT to doing more proportional, you're going to have lower loss ratios, higher acquisition costs. And so that will have a sometimes impact in terms of how it earns into the first quarter.
We also had, in terms of the overall General Insurance business, the mix changes because, on the one hand, we wanted to make sure that we were patient with A&H, which is a great business for us and Travel in terms of its rebound after COVID but not really reducing the overall overhead. But it does have an impact in terms of the mix and acquisition expense and loss ratio.
The other thing you have to consider where we started, I mean, the incredible improvement that we've had in the portfolio has been disciplined. We've always talked about underwriting from a risk selection standpoint, terms and conditions, attachment, reducing volatility with supplementing reinsurance and then, of course, price above loss cost. And I think when you do that sequentially and maintain the same level of discipline, we start to see the outcome produced like we had in the first quarter. Mark, anything you want to add to that?
Mark Lyons;Executive VP & CFO: Yes. Thank you, Peter. Yes, I think your point about mix is right on point. And remember, there's 2 mixes. You've got the mix on the front end and then you got the mix changes that manifest by the reinsurance purchases and how they earn in over time. So you got both of those factors.
I think, secondly, there's also the realization that, over time, the property and shorter-tailed businesses over the last couple of years are a -- you got to watch the mix of that over time. And therefore, with the mix of medium- and longer-term lines that have volatility associated with them that you got to watch kidding yourself that the quarter-by-quarter is super predictable. If you get the accident year right, I'm happy. Accident quarter by accident quarter is a little bit more of an academic exercise. So I think that may be some of what you're seeing.
Ryan Tunis: Got it. My follow-up just on the acquisition cost ratio. When you think about the reinsurance purchasing, the ceding commissions, the change in the mix, can you guys make a directional assessment at this point about should the acquisition cost in General Insurance, should that ratio be higher or lower in 2022 over 2021?
Peter Zaffino;President, CEO, Global COO & Director: It's hard to predict. I think your first part of the question is do ceding commissions as they start an earn-in benefit, the overall expense ratio. The answer is yes. It wasn't always the case when we were starting the turnaround and -- but today, we have market terms or better on ceding commissions, and that starts to earn in.
But I hate to go back to Travel and Accident & Health. I mean those really dipped during the pandemic. And the U.S. rebounded first. International is starting to rebound. And those businesses just by its nature of how they're set up have lower loss ratios and higher acquisition expenses. So it's hard to predict. I mean what's the recovery look like, what's our growth look like, what's the mix of business look like? So it's really hard, Ryan, to give a forecast in terms of what the impact is.
What we will focus on all the time is improvement in accident combined ratio. So we're not going to be shifting from one category of loss ratio in [ DAC ] or back. I mean we're going to make sure we're focused on the portfolio optimization and mix of business to improve the overall results.
Operator: And now we'll hear from Alex Scott with Goldman Sachs.
Taylor Scott: First question I had is just on the Life and Retirement side. When I look at the 10% ROE, it held up well in a tough environment. But that said, I think the skeptic would kind of point to the alternative returns and how strong they were and whether that can continue. But at the same time, there were probably some other things in there. I think probably DAC true-ups and things like that related to the markets would have hurt you.
Without maybe the details, it's a little hard from the outside to tell sort of what the ROE is running at on a run rate basis at the moment relative to that 12% to 14% that you all have highlighted. So could you talk about that a little bit and how we should think about sort of the level of ROE that you think you can earn right now?
Peter Zaffino;President, CEO, Global COO & Director: Thanks, Alex. I mean as you can appreciate, preparing for the IPO of Life and Retirement, we do have constraints in terms of how much detail we can go into. I think if you look at the S-1 in terms of how we believe we can drive a 12% to 14% ROE over the long term is something we're very confident about. And if you look at the historical performance of Life and Retirement in terms of its ROE and attributed capital, they've done very well. I mean, Kevin, keeping in mind, we've got to be very careful. Do you want to provide maybe 1 or 2 items of your observations on the quarter?
Kevin Hogan: Yes. Thank you, Peter, and thanks, Alex. It really is about the combination of the lower equity markets, which do impact the DAC and SI due to the lower present value of the fee income. That's kind of a one-off item. It's not expected to be continuing. And then, of course, we have the increased SOP reserves, and these are things that will be much less of an impact under LDTI. So it's really the onetime impact of that.
And then in terms of interest rates, right, with the increased rates, that does very much affect call tender income on a real basis, CML prepays and, with the direction of the markets, the fair value options. And I think we've provided that detail both in the deck for today on Page 11 and also in the fin sup.
Peter Zaffino;President, CEO, Global COO & Director: Alex, is there another question?
Taylor Scott: Yes. Maybe as a follow-up, just going back to the ROE improvement over time. some of those items certainly will take some time. And I don't know if you want to put a specific time frame around it. But I guess the piece of it that's related to corporate cost reductions, I mean for that piece specifically, over what time period do you think you'd be able to sort of take out, call it, stranded costs associated with the separation?
Peter Zaffino;President, CEO, Global COO & Director: We provided a lot of detail in Shane's prepared remarks. And so I don't think it's really worth going back and going through point by point. But the most important thing for us at this stage is to sequence really the strategic initiatives we have in front of us, the most important being right now, the Corebridge IPO. So like that's a big project in itself and making sure that Corebridge is set up to be a separate stand-alone public company and getting the IPO away.
Also making sure that all of the things that are done at AIG today that need to be transferred over or worked with Corebridge is the next highest priority. And we have a -- our parent expenses, you have to think of it as parent and what is General Insurance today coming together as one company. And coming together as one company, we want to be very thoughtful about the business we're in, in the future, what is a target operating model and how do we sequence that in a manner that we are not creating any risk with all the things that we have going on strategically and that we get to the right outcome in the end.
And I think our track record has demonstrated, whether it's the underwriting turnaround, AIG 200, what we're doing in terms of Corebridge. You should be highly confident we'll do it at a pace that is certainly front of mind but, at the same time, making sure that we have all the very important pieces of what we're doing in the separation done very well. And so like that's kind of the time frame. But it's really not going to be what month, what quarter, it's going to be how do we execute things and then sequence the next priority, which will be how we bring parent and General Insurance together.
If I may, let me just -- I just want to thank everybody for our clients, our distribution partners and our colleagues have been tremendous in terms of the work that they've done and the contribution that they've driven to get to these results. So everybody, have a great day. Thank you for your time.
Operator: And once again, ladies and gentlemen, this does conclude your conference for today. We do thank you for your participation, and you may now disconnect. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's First Quarter 2022 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, Jake. Good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q, provide details on important factors that could cause actual results or events to differ materially. Except as required by the applicable securities laws, AIG is under no obligation to update any forward-looking statement if circumstances or management's estimates or opinion should change."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Good morning, and thank you for joining us to review our first quarter financial results. I'm very pleased to report that AIG had an excellent start to 2022. We are successfully executing on several strategic, operational and financial priorities, and our team has significant momentum on many fronts, which we believe will continue throughout the year."
},
{
"speaker": "Now turning to the separation of Life and Retirement. We made significant progress to prepare this business to be a stand-alone public company. We continue to target an IPO in the second quarter, subject to market conditions and required regulatory approvals. We also continue to expect that we will retain a greater than 50% interest in this business post IPO. As you can appreciate, given where we are in the process, there are limitations on how much I can say about Life and Retirement, but let me give you some highlights of what we've accomplished since our last call. In March, we announced several important milestones",
"text": "the public filing of the S-1; the new name for Life and Retirement which, as I mentioned, is Corebridge Financial; and the Independent Directors who currently serve on the Corebridge Board of Directors and those who will join and strengthen the Board as of the IPO."
},
{
"speaker": "Shane Fitzsimons",
"text": "Thank you, Peter, and good morning to all. I am very pleased to be AIG's CFO, and I look forward to working with everyone moving forward. I will provide more detail on our first quarter financial results and unpack a number of our key performance metrics, specifically EPS, liquidity, leverage, net investment income and ROCE."
},
{
"speaker": "Operating interest rate movements impact our metrics primarily in 2 places",
"text": "one, we end up with a gain on the Fortitude Re embedded derivative, which impacted GAAP EPS by $3.21 in the quarter; and second, it impacts our GAAP leverage by a little over 300 basis points. And with interest rates up another 55 basis points in April, we expect to see further movement in Q2."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thank you, Shane. Operator, we're ready for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We will begin with Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question is on the capital return that you guys laid out. So you guys have just over $9 billion at the holdco. Peter, I think you said a minimum buyback of $1 billion for the second quarter. But just given that you have above $9 billion at the holdco with additional capital coming later this year, I would think that there's some flexibility to perhaps go above that $1 billion. So can you just kind of walk us through a little bit more how you're thinking about uses of capital for growth relative to buyback at least in the short term?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Yes. Thanks, Elyse, for the question. Yes, we said we would do a minimum of $1 billion of share repurchases in the second quarter. I think Shane and I tried to do as much detail as we could in our prepared remarks in aligning what our priorities are for capital management. And certainly, the Board's authorization for an additional $5 billion says that we will continue to return capital to shareholders in the form of share repurchases."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then my follow-up, you guys pointed out that you raised some of your severity assumptions within General Insurance on the short-tail side. When you guys set out that target for the accident year combined ratio of sub-90 for this year, was that contemplated? And then should -- how about the cadence, can you give us a sense? Should we think about sequential improvement from the Q1 level as we move through the year? Or is there some seasonality that we should be considering within General Insurance?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Let me take the first part, and then I'll ask Mark to comment on the loss cost observations. We've seen -- when you think about the quality in the results that we produced this quarter, when we look at our business, what do we look at? We look at client retention, which continues to improve. We look at new business, so we're acquiring a lot of new clients across the world. And so that continues to progress and think that there's a lot of momentum there. We look at rate above loss cost trends. And so that was favorable, and we continue to get rate in areas where we believe it is required in terms of its risk-adjusted returns and, again, with our leadership in terms of deploying capital."
},
{
"speaker": "Mark Lyons;Executive VP & CFO",
"text": "Yes. Thank you, Peter. So I think Peter answered it very well. But what I'll do is just reemphasize that, yes, I mean the context of your question, we gave that original guidance before there was any spike of inflation. But like I think any good company, you don't forecast just a point estimate. You're forecasting a range, and those ranges vary by line of business, and they all meld together. And even with the changing inflation assumptions, we'd still be inside that range. So we're comfortable with that."
},
{
"speaker": "Operator",
"text": "We'll go to Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "I think this might also be a question for Mark [ as to tax query ]. We're clearly seeing a little bit less core loss ratio improvement than the simple mathematical application of earned rate increases and loss trend. And I was hoping you could talk about how that's manifesting itself in prior year reserve reviews."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Yes. Mark, please take that. I mean I think it's also important to give some context of the portfolio shift as well, Mark, when we look at loss ratios?"
},
{
"speaker": "Mark Lyons;Executive VP & CFO",
"text": "Yes, happy to. And thank you, Meyer, for the question. So I think on that side, first, on the reserve side, when you look at our view of inflation and severity trends and so forth, you really got to separate short-tailed lines from longer-tailed lines, right? And like in our view, the evidence within our own information as well as looking at external indices, whether it's from the perspective of the purchaser or the seller, it's clearer with -- in property-oriented lines."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That's very helpful. A quick follow-up, if I can. I know there are a lot of moving parts, but is there any way of quantifying the impact of the reinsurance purchasing timing on the expense ratio in the quarter?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thanks, Meyer. I'll take that. As I said, it's going to be a headwind in the first quarter will be a tailwind in the second quarter. Once we -- there's a couple of moving pieces. We can't really provide the exact numbers, but you can look at like in the second quarter where we purchased down on the North America Commercial CAT to lower retentions as well as in AIG Re, where we reduced volatility by buying single shop per occurrence retrocessional at the second quarter, and both recovered by the way, last year. So we felt that reducing the net retentions was appropriate and carrying that forward into how we were going to structure the 1/1 treaty for AIG as well as the retrocessional covers for AIG Re."
},
{
"speaker": "Operator",
"text": "And now we'll hear from Ryan Tunis with Autonomous Research."
},
{
"speaker": "Ryan Tunis",
"text": "A couple of questions, just following up from the first 2 question askers. First one, we saw about 3.5 points of sequential loss ratio improvement this quarter in Commercial Lines in general. I noticed that, last year, we also saw like the biggest sequential move in the first quarter. So I'm curious if there's something about 1Q, if it's setting a loss pick assumption or something like that, that's leading to that level of sequential jump that's outsized."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Yes. Let me start. Thanks very much for the question. We have -- there's -- Mark touched on a little bit, and I'll ask if he has any additional comments after I make a few observations on the mix of business. But what we have in the first quarter, obviously, is a big AIG Re, which when you look at if you're changing the composition of the portfolio from reducing CAT to doing more proportional, you're going to have lower loss ratios, higher acquisition costs. And so that will have a sometimes impact in terms of how it earns into the first quarter."
},
{
"speaker": "Mark Lyons;Executive VP & CFO",
"text": "Yes. Thank you, Peter. Yes, I think your point about mix is right on point. And remember, there's 2 mixes. You've got the mix on the front end and then you got the mix changes that manifest by the reinsurance purchases and how they earn in over time. So you got both of those factors."
},
{
"speaker": "Ryan Tunis",
"text": "Got it. My follow-up just on the acquisition cost ratio. When you think about the reinsurance purchasing, the ceding commissions, the change in the mix, can you guys make a directional assessment at this point about should the acquisition cost in General Insurance, should that ratio be higher or lower in 2022 over 2021?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "It's hard to predict. I think your first part of the question is do ceding commissions as they start an earn-in benefit, the overall expense ratio. The answer is yes. It wasn't always the case when we were starting the turnaround and -- but today, we have market terms or better on ceding commissions, and that starts to earn in."
},
{
"speaker": "Operator",
"text": "And now we'll hear from Alex Scott with Goldman Sachs."
},
{
"speaker": "Taylor Scott",
"text": "First question I had is just on the Life and Retirement side. When I look at the 10% ROE, it held up well in a tough environment. But that said, I think the skeptic would kind of point to the alternative returns and how strong they were and whether that can continue. But at the same time, there were probably some other things in there. I think probably DAC true-ups and things like that related to the markets would have hurt you."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Thanks, Alex. I mean as you can appreciate, preparing for the IPO of Life and Retirement, we do have constraints in terms of how much detail we can go into. I think if you look at the S-1 in terms of how we believe we can drive a 12% to 14% ROE over the long term is something we're very confident about. And if you look at the historical performance of Life and Retirement in terms of its ROE and attributed capital, they've done very well. I mean, Kevin, keeping in mind, we've got to be very careful. Do you want to provide maybe 1 or 2 items of your observations on the quarter?"
},
{
"speaker": "Kevin Hogan",
"text": "Yes. Thank you, Peter, and thanks, Alex. It really is about the combination of the lower equity markets, which do impact the DAC and SI due to the lower present value of the fee income. That's kind of a one-off item. It's not expected to be continuing. And then, of course, we have the increased SOP reserves, and these are things that will be much less of an impact under LDTI. So it's really the onetime impact of that."
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "Alex, is there another question?"
},
{
"speaker": "Taylor Scott",
"text": "Yes. Maybe as a follow-up, just going back to the ROE improvement over time. some of those items certainly will take some time. And I don't know if you want to put a specific time frame around it. But I guess the piece of it that's related to corporate cost reductions, I mean for that piece specifically, over what time period do you think you'd be able to sort of take out, call it, stranded costs associated with the separation?"
},
{
"speaker": "Peter Zaffino;President, CEO, Global COO & Director",
"text": "We provided a lot of detail in Shane's prepared remarks. And so I don't think it's really worth going back and going through point by point. But the most important thing for us at this stage is to sequence really the strategic initiatives we have in front of us, the most important being right now, the Corebridge IPO. So like that's a big project in itself and making sure that Corebridge is set up to be a separate stand-alone public company and getting the IPO away."
},
{
"speaker": "Operator",
"text": "And once again, ladies and gentlemen, this does conclude your conference for today. We do thank you for your participation, and you may now disconnect."
}
] | American International Group, Inc. | 250,388 |
AIG | 4 | 2,023 | 2024-02-14 08:30:00 | Operator: Good day, and welcome to AIG's Fourth Quarter 2023 Financial Results Conference Call. This conference is being recorded.
Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change.
Today's remarks may also refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com.
Additionally, note that today's remarks will include results of AIG's Life and Retirement segment and other operations on the same basis as prior quarters, which is how we expect to continue to report until the deconsolidation of Corebridge Financial. AIG's segments and U.S. GAAP financial results as well as AIG's key financial metrics with respect thereto differ from those reported by Corebridge Financial. Corebridge Financial will host its earnings call on Thursday, February 15.
Finally, today's remarks, as they relate to net premiums written in General Insurance, are presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis adjusted for the international lag elimination, the sale of Crop Risk Services and the sale of Validus Re. Please refer to the footnote on Page 26 of the fourth quarter financial supplement for prior period results for the Crop business and Validus Re.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino;Chairman and CEO: Good morning, and thank you for joining us today to review our fourth quarter and full year 2023 financial results. Following my remarks, Sabra will provide more detail on the quarter and some perspective on the year, and then we'll take questions. Kevin Hogan and David McElroy will join us for the Q&A portion of the call.
We had a very strong fourth quarter, which highlighted a significant year of achievements at AIG. Throughout 2023, we continue to build on our underwriting excellence; repositioned the portfolio through several divestitures; made meaningful progress towards the deconsolidation of Corebridge, including 3 secondary sell-downs; delivered disciplined premium growth in businesses where we have scale and outstanding combined ratios; and continue to execute on our balanced capital management strategy. I'm very proud of the work our colleagues delivered for all of our stakeholders throughout the entire year.
In the fourth quarter, adjusted after-tax income per diluted common share was $1.79, an increase of 29% year-over-year driven by continued strong underwriting results, 17% growth in net investment income and excellent execution of our balanced capital management strategy that resulted in a 6% reduction in diluted common shares outstanding. For the full year 2023, adjusted after-tax income per diluted common share was $6.79, an increase of 33% over 2022. AIG overall produced an adjusted return on common equity of 9% for the year, up from 7% in 2022. As I will share with you today, 2023 was an extraordinary year for AIG.
During my remarks this morning, I'll discuss the following topics. First, I will provide an overview of our fourth quarter financial results. Second, I will review AIG's significant accomplishments in 2023, including our strategic repositioning and our financial highlights. Sabra will comment on the Life Retirement business in her prepared remarks. Third, I will cover insights on the January 1 reinsurance market and specifically AIG's reinsurance renewals. And finally, I'll share some thoughts on how we're building on our momentum and positioning the company as we enter 2024, including some specifics on AIG Next, our initiative focused on creating the AIG of the future. I will also discuss our capital management strategy and growth expectations.
AIG's strong fourth quarter results demonstrated our continued execution across all aspects of our strategy. Within General Insurance, underwriting income was $642 million. Gross premiums written for the fourth quarter were $7.6 billion, an increase of 4% from the prior year quarter. Net premiums written for the quarter increased by 7% from the prior year quarter to $5.7 billion. Global Commercial grew 5%, and Global Personal grew 9% from the prior year quarter. If you exclude Financial Lines, Global Commercial would have grown 11%.
In North America Commercial, fourth quarter net premiums written grew 5% over the prior year quarter led by Retail Property, which grew 32%; Lexington, which grew 20%. These were offset by North America Financial Lines, which was lower by 13%. In International Commercial, fourth quarter net premiums written grew 6% over the prior year quarter as International Property grew 28% and Talbot grew 12%. These were offset by International Financial Lines, which was lower by 7%.
In the fourth quarter, Global Commercial had very strong renewal retention of 86% in its in-force portfolio as well as very strong new business performance. North America Commercial produced new business of $503 million in the quarter, an increase of 21% year-over-year. The growth was led by Retail Casualty, Lexington and Retail Property. International Commercial produced new business of $467 million for the quarter, representing an increase of 14% year-over-year. This growth was led by Global Specialty and Talbot.
Moving to rate. In North America Commercial, overall rate increased 4% in the fourth quarter with exposure adding 3 points, and the overall pricing was up 7%. In North America Commercial, if you exclude Financial Lines and workers' compensation, overall rate would have increased 11% in the quarter. And with exposure adding 4 points, overall pricing would have been 15%, meaningfully above the loss cost trend.
North America Commercial rate increases were driven by Lexington wholesale, which was up 17%; Retail Property, which was up 19%; and Excess Casualty, which was up 13%. In International Commercial, overall rate increased 3% in the fourth quarter with exposure adding 2 points, and the overall pricing was up 5%, which is slightly below loss cost trend. The rate increase was driven by Property, which was up 12% and marine, which was up 8%.
Turning to Personal Insurance. Fourth quarter net premiums written increased 9% from the prior year quarter, primarily driven by North America. In North America Personal, net premiums written increased 37% in the quarter. As we've seen in prior quarters in 2023, the significant premium growth for North America Personal was driven by our high net worth business. And as we discussed in prior quarters, the growth in North America earned premium continued to generate a lower expense ratio, and we expect the expense ratio will continue to improve in 2024.
Now let me turn to the full year financial results. 2023 was another year of meaningful strategic repositioning and was, in many ways, our best year yet. The repositioning included the disposition of Validus Re and Crop Risk Services, which generated a combined $3.5 billion of proceeds, including a pre-close dividend.
Additionally, we settled a $1 billion intercompany loan from Validus Re to AIG and received approximately $250 million of RenaissanceRe common stock. The changes to our portfolio further reduced volatility and allowed us to focus on businesses where we believe we have better opportunities for stronger risk-adjusted returns.
We reshaped the reinsurance structure of our high net worth business and launched a newly formed MGA called Private Client Select. We made significant progress towards Corebridge's separation, another major strategic milestone on our journey to becoming a less complex company.
We completed 3 secondary offerings in 2023 that generated approximately $2.9 billion in cash, we worked with Corebridge on the divestiture of Laya Healthcare and announced the sale of the U.K. Life business. In 2023, AIG received $1.4 billion of capital from Corebridge through $385 million of regular dividends, $688 million of special dividends and $315 million of share repurchases. At the end of 2023, our ownership stake in Corebridge was approximately 52%.
In 2023, we continue to execute on a thoughtful and balanced capital management strategy. During the year, AIG returned $4 billion of capital to shareholders through $3 billion of share repurchases and $1 billion of dividends. We reduced our common shares outstanding by 6% and increased quarterly dividends by 12.5%.
On August 1, the AIG Board of Directors increased our share buyback authorization of $7.5 billion. At the year-end 2023, we had $6.2 billion remaining on that authorization. We reduced AIG net debt by $1.4 billion in 2023 after successfully conducting a senior notes tender offer in November. We finished 2023 with very strong parent liquidity of $7.6 billion, which gives us ample capacity to continue executing on our capital management priorities.
Turning to the full year results for General Insurance. Throughout 2023, we delivered terrific financial performance. General Insurance full year underwriting income was $2.3 billion, a 15% increase year-over-year. For the full year, the General Insurance accident year combined ratio, excluding catastrophes, was 87.7%, an improvement of 100 basis points year-over-year.
Global Commercial achieved an accident year combined ratio, excluding catastrophes, of 83.3% for the full year, an improvement of 120 basis points year-over-year driven by loss ratio improvement. The calendar year combined ratio was 87.1%, a 250 basis point improvement year-over-year.
Excluding Validus Re and Crop Risk Services for the full year results, the Global Commercial accident year combined ratio, excluding catastrophes, would have increased by 50 basis points to 83.8%, and the calendar year combined ratio would have increased by slightly over 20 basis points to 87.3%.
In Global Personal, the full year accident year combined ratio, excluding catastrophes, was 99.3%, in line with the prior year. For the full year, General Insurance grew net premiums written by 7% year-over-year, driven by 5% growth in Global Commercial and 10% in Personal Insurance. North America Commercial grew 5% and International Commercial grew 6% year-over-year.
A couple of highlights. Lexington and Global Specialty had outstanding years. We remain very focused on these businesses and made investments to accelerate growth and continue to deliver strong underwriting profitability.
Lexington grew its net premiums written by 17% year-over-year. Growth was driven by historically high retention, which was 80%, $1 billion of new business and rate increases of approximately 18%.
Global Specialty, which includes businesses in marine, energy, trade credit and aviation, grew its net premiums written 10% year-over-year driven by 88% retention, almost $750 million of new business and rate increases of 7% for the year.
Also, there are 2 parts of our business that impacted growth in Global Commercial, which I would like to offer some perspective. First, if you exclude Financial Lines, our net premiums written growth would have been 10%.
Second, as we've outlined on prior calls, we decided to not renew 2 programs that had significant property catastrophe exposure that no longer met our underwriting guidelines. We do not believe that the premium increases on a risk-adjusted basis for these 2 programs delivered an acceptable return. The decision to nonrenew impacted the gross and net premiums written for Lexington specifically as well as the Global Commercial business throughout 2023. If you exclude Financial Lines and these 2 programs that I just mentioned, our year-over-year net premiums written growth would have been 13%, which gives you a sense as to why we have significant confidence in our core portfolio where we saw meaningful overall growth for the year.
It's worth providing a little bit more detail on Financial Lines. In Financial Lines, particularly in our public directors and officers book of business, we continue to exercise underwriting discipline by maintaining our primary position in our portfolio to being very prudent on large account excess layers, where there is significant exposure to vertical loss, and these layers are highly commoditized where typically the best price wins.
We've spoken about the cumulative rate change in Financial Lines before, but I want to provide a little bit more detail. The compound annual growth rate for Financial Lines achieved from 2019 through 2023 was 49%. If you exclude 2023, the compound annual growth rate was 63%. It's a business we're very focused on and our underwriters are continuing to carefully monitor market conditions and underwrite conservatively.
Now I'd like to provide you with some insight into the current reinsurance market generally and an overview of our January 1 reinsurance renewals. As I mentioned on previous calls, AIG's reinsurance purchasing is deliberately weighted to January 1, which enables us to strategically optimize the outcome across our reinsurance placements and provides us with clarity on our cost of reinsurance at the beginning of the year.
Before I go into detail on this year's outcomes, I want to speak about how we evaluate our reinsurance purchased. We've seen significant changes in the global property market over the last 2 years, and analyzing and quantifying changes and the portfolio's risk profile has become increasingly complex.
Currently, one of the most overused phrases that has been used with more frequency in the last year is risk-adjusted pricing or risk-adjusted rate changes, which have multiple interpretations, particularly when it comes to property treaty reinsurance. Calculating the risk-adjusted rate change can be complicated and is often inconsistent. I want to outline how AIG determines risk-adjusted pricing changes, which we believe is an industry-best practice.
To begin, you must determine the baseline structure and all the variables required to assess and quantify the risk-adjusted pricing change. To do that, the base analysis should be set at the identical structure and coverage with the exact terms and conditions of the prior year structure. The analysis needs to compare the cost of capital year-over-year and any model changes from vendor model output such as RMS to determine if the loss costs have increased or decreased at the attachment point and the vertical limits deployed.
Also, an analysis is needed for any changes to the coverage provided in the treaty placement. For instance, over the last few years, many programs have gone from an all-risk coverage basis to a named or peak peril basis.
To correctly calculate the risk-adjusted rate change, perils no longer covered need to be analyzed and priced separately and the impact of any reduced coverage should be factored into the assessment of the price change. This can be particularly difficult when assessing perils that would not be economically viable to place on a standalone basis with significant limits, which could include wildfire, flood or terrorism. There needs to be consideration given to the volatility associated with the expected loss in calculating the risk-adjusted rate change.
Given the complexity of these calculations, the methodologies applied should be done with consistency and discipline. When applying the methodology I just described, AIG had a tremendous outcome with our reinsurance partners at the January 1 renewal season, building upon the very strong result achieved in a very challenging market in 2023.
Now let me turn to AIG's reinsurance renewals at January 1 of this year. To level set, the natural catastrophe insured loss activity remained at the forefront of the market with a record-setting 37 events in 2023 that exceed $1 billion of insured loss. These events contributed to a total annual insured loss currently estimated at over $100 billion, marking the sixth time in the past 7 years that insured loss from natural catastrophes has exceeded $100 billion. Over the last 7 years, there's been nearly $1 trillion of aggregate losses with over 60% driven by secondary perils.
The headline is that we were able to significantly improve our property cat structure and reinsurance coverage provided. When you review what we purchased last year, including for Validus Re, the overall spend has reduced by approximately $200 million and our core property treaties, excluding Validus Re, have slightly lower ceded premium year-over-year.
Let's start with our property catastrophe placements. Our core commercial North America retention of $500 million remained unchanged for the second straight year. The attachment on our dedicated Lexington occurrence tower was unchanged at $300 million. In both cases, the model [ detachment ] point is lower, and the exhaust limit is higher.
Our International Property cat per current structures renewed with a reduced retention in Japan to $150 million, a $50 million improvement from the prior year. The rest of the world attachment remains unchanged at $125 million.
We were very pleased to have achieved broader coverage across all of our core occurrence towers. With nominal attachment points unchanged, or in the case of Japan decreasing, the model probability of attaching our cat reinsurance improved with respect to key perils and across every major territory following the growth achieved in the property portfolio in 2023.
Our property cat aggregate cover was also successfully renewed with improved coverage, further reducing our volatility from frequency of loss. The aggregate now includes a standalone supplement dedicated to losses in North America arising from secondary perils. Importantly, it also now covers contributing losses from our high net worth portfolio.
Our annual aggregate deductible for North America is $825 million. The North America other perils deductible is $350 million, which is a new deductible. And Japan and the rest of the world deductibles are $200 million and $175 million, respectively. These are subject to each and every loss deductibles of $20 million other than for North America wind and earthquake, which are at $50 million.
Our return period attachment point is lower year-over-year. For all of our major proportional treaties across a range of classes, we improved or maintained our ceding commission levels, reflecting our market-leading underwriting expertise and position in the market.
Turning to casualty. The challenges we've spoken about previously regarding the impact of inflation, both social and economic and litigation funding in the U.S. were a focal point for reinsurers at 1/1.
For casualty at AIG, we remain very focused on our underwriting standards and the positioning of the portfolio. Our team has done a terrific job of reunderwriting the entire business, particularly considering the amount of work that was needed to reposition it to where it is today.
Additionally, our pricing assumptions today have loss trends ranging from the high single digits to over 10%. These were increased over the past 2 years, given inflationary dynamics.
I do want to make a few comments about the last 10 years of casualty results for the industry. The industry as a whole has reported meaningful reserve releases in 4 of the past 10 calendar years, including in calendar year 2017. At the same time, there have been 6 years of significant reported industry strengthening in the last 10 calendar years, including in all of the most recent 5 calendar years.
Focusing on AIG, for accident years 2016 through 2019, our initial loss picks in our Casualty lines, excluding workers' compensation, averaged 78%. Looking specifically at accident years 2016 and '17, the initial loss picks were approximately 81% in both years. These loss picks exclude unallocated loss adjustment expense.
We significantly strengthened the reserves by over $1 billion for accident years 2016 through 2019, which revised our year-end ultimate loss picks to 91% in 2016 and 96% in 2017 at an average of 87% over accident years 2016 through 2019. To further analyze our casualty results compared to industry results for other liability and commercial auto using the most recent Schedule P data, they are well above the average industry loss picks on both measures.
Our initial and year-end ultimates for both lines are roughly 10 to 20 points higher than the overall industry average. In addition, we have reinsurance in place for 2016 and 2017 to mitigate our gross results. As we outlined last quarter, we put a comprehensive reinsurance treaty in place starting 2018 that provides us with substantial amount of vertical protection.
Our renewal of the casualty reinsurance protections allowed us to maintain the same net retained lines with no impact on ceding commissions, which is an outstanding outcome. At January 1, our reinsurance partners maintained their significant support of AIG with consistent capacity and improved reinsurance terms that demonstrate a clear recognition of the quality of our portfolio and our underwriting teams.
I'll now turn to discuss our efforts to create a future state business structure for AIG post deconsolidation of Corebridge. As part of this effort, we've launched a new program, AIG Next, to create a company that's leaner, less complex and more effective with the appropriate infrastructure and capabilities for the size of business we will be post deconsolidation.
AIG Next will focus on the following key principles: driving global consistency and local relevancy across our end-to-end processes to improve operational efficiency and effectiveness, reducing organizational complexity to create a better and differentiated experience for our clients and colleagues, creating an agile and scalable organization to support business growth, optimizing our ecosystem to modernize our data analytics, digital and technology capabilities, clarifying roles' responsibilities while eliminating duplication and increasing our speed of execution.
As we've stated in the past, we expect the simplification and efficiencies created through this program to generate $500 million of sustained annual run rate savings and to incur approximately $500 million of onetime spend to achieve these savings. As part of AIG Next, we are creating a leaner parent company with a target cost structure of 1% to 1.5% of net premiums earned. Some of the current costs and other operations will be eliminated contributing to the $500 million savings, and others will be moved into the business where the service is utilized.
In 2023, we began this work, as we've moved approximately $140 million of expenses from other operations into General Insurance for services that are more closely aligned to our business operations. Even with this shift, the full year combined ratio of 90.6% improved 130 basis points year-over-year, and the full year GOE ratio only increased 40 basis points due to offsetting savings within General Insurance.
Throughout the year, we've built efficiencies into our business, which have allowed general insurers to absorb these costs. We've already begun to make meaningful progress against our $500 million savings target and have established a team to drive and govern the AIG Next program with focus and discipline.
Sabra and I will provide more detail on next quarter's call regarding the specific cost to achieve by category and the expected timeline for the realized benefits in 2024 and 2025. As we are approaching the final steps of the Corebridge deconsolidation, we remain agile and continue to explore all options based on market conditions with respect to our remaining ownership of Corebridge, always focusing on what's aligned with the best interest of our stakeholders.
Sabra will take you through a pro forma capital structure based on assumptions about the deconsolidation. Throughout 2024, we expect to continue to execute the capital management strategy we've outlined before. Our insurance company subsidiaries continue to have excess capital to support the type of organic growth we have seen through 2023 and would expect to see in the future. We made enormous progress on our debt structure and maturities. Since year-end 2021, we've reduced over 50% of AIG's debt outstanding, which is over $11 billion of debt reduction.
The primary focus in 2024 will be on returning capital to shareholders through share repurchases and dividends. Since the start of 2024, we have repurchased an additional $760 million of common shares. We expect to continue at this pace for the first half of 2024, subject to market conditions, which should bring us near the high end of our target share count range.
Post Corebridge deconsolidation, we should achieve the low end of our range, which is approximately 600 million of common shares. The AIG Board increased the dividend in 2023, reflecting our confidence in the future earnings power of AIG, and we will continue to evaluate our dividend policy in 2024.
And lastly, as I enter my seventh year at AIG, I've never been more optimistic about our opportunities for growth and the momentum that AIG has entering 2024. We now have a terrific business. Global Commercial, which we've been working on for years to reposition, is now one of the most respected portfolios in the industry.
While there's always pruning to do in any business, the remediation is now behind us. We're well positioned to grow based on AIG's strong retention, strong opportunities for new business, excellent combined ratios and a company that has been able to distinguish itself amongst our clients and distribution partners.
In Personal Insurance, we will continue to make investments, particularly in our Japan business, our global A&H business and our high net worth business where we anticipate continued growth and more importantly, profitability improvement.
With that, I will turn the call over to Sabra.
Sabra Purtill: Thank you, Peter. This morning, I will provide more detail on AIG's fourth quarter results. But first, as we are getting closer to Corebridge deconsolidation, I would like to start with an illustrative pro forma.
With AIG's current ownership of Corebridge at 52%, the next transaction may likely result in deconsolidation. Today, Corebridge is consolidated in both AIG's balance sheet and income statement with offsets of noncontrolling interest for the portion that AIG does not own. You can see those adjustments in the financial supplement on Pages 8 and 11.
When we deconsolidate, we will report Corebridge as an investment with dividends reported in net investment income and Corebridge shares included in parent investments. Corebridge's balance sheet and income statement will no longer be in our financials.
If we were able to deconsolidate Corebridge now, accounting rules require us to fair value their assets and liabilities and recognize the net difference between that valuation and the current GAAP carrying value in AIG's equity. That process also includes some changes primarily driven by differences in basis and deconsolidation of variable investment entities.
The example I will provide is a hypothetical pro forma view. Please remember that there are many factors, and each one impacts the output. This view builds on the remarks I provided last quarter about pro forma adjusted shareholders' equity.
For simplicity, in this example, we used Corebridge's current stock price as a proxy for fair value. But the process is more complicated than that and is more dependent on interest rates than stock price as the investment portfolio has to be valued on the day of deconsolidation, which will change based on interest rates.
As a very high-level illustration, as of year-end, the fair value of Corebridge's net assets and liabilities was about $2 billion higher than the book value on AIG's balance sheet. As a result, deconsolidation would have increased AIG's book value per share by almost $3 a share.
However, for AIG's adjusted shareholders' equity, the fair value adjustment would have resulted in a reduction of about $4 billion or around $6 per AIG share, given Corebridge's stock price relative to its adjusted book value.
Now let me link these items to the AIG year-end pro forma estimates that I provided last quarter of adjusted shareholders' equity of approximately $33 billion, adjusted for the sale of Validus Re, to be used in evaluating the ROCE target.
At December 31, 2023, AIG's adjusted shareholders' equity was approximately $53 billion. With the pro forma fair value decrease of $4 billion at deconsolidation, adjusted shareholders' equity would be roughly $49 billion, including about $8 billion of value for our Corebridge shares.
To get to the E, we subtract the value of Corebridge shares. And for the purposes of this exercise today, we also subtract year-end parent liquidity of almost $8 billion, most of which is to be used for 2024 capital management, interest and other parent expenses as Peter described. That results in pro forma adjusted shareholders' equity of about $33 billion invested in our business plus whatever liquidity is at the parent as the focus of our 10%-plus target. This example is illustrative based on year-end financials and subject to change based on markets and the actual path to deconsolidation, but I hope it is helpful.
Now I will turn to fourth quarter results. Fourth quarter consolidated net investment income on an APTI basis was $3.5 billion, up 17% over the fourth quarter of 2022. General Insurance net investment income was 38%, while Life and Retirement was up 15%. Higher new money reinvestment rates in both businesses drove the improvement.
Fourth quarter new money rates on fixed maturities and loans averaged 6.5%, about 180 basis points higher than the yield on sales and maturities in the quarter. Fourth quarter new money rates were 160 basis points higher in GI and 190 basis points higher in L&R.
With higher reinvestment rates, the yield on General Insurance fixed maturities and loans, excluding calls and prepayments, rose to an annualized yield of 3.8% in the quarter, up from 3.0% in 4Q '22 and up 9 basis points sequentially. L&R's fourth quarter portfolio yield was 5.0% compared to 4.4% in 4Q '22 and up 10 basis points sequentially. In the first half of 2024, we currently expect continued yield pickup on fixed maturities over the prior year but less improvement sequentially, given the cessation of Fed interest rate hikes and the current shape of the yield curve.
In contrast, alternative investment returns were weak this year, coming in slightly negative in the fourth quarter and at only 2.4% for the full year. GI alternative income was $41 million in the fourth quarter, down 11% from the prior year quarter for an annualized return of 3.9%. L&R's alternative portfolio generated a loss of $24 million in the quarter for an annualized yield of negative 1.8% compared to income of $16 million last year.
Turning to General Insurance. As Peter said, our underwriting results remain very strong. The 4Q '23 calendar year combined ratio was 89.1%, 80 basis points better than the fourth quarter of 2022. And the accident year combined ratio ex cats was 87.9%, 50 basis points better.
Global Commercial Lines delivered outstanding fourth quarter results with a calendar year combined ratio of 85.4%, a 90 basis point improvement over the prior year. The accident year combined ratio ex cats was 82.4%, a 170 basis point improvement reflecting exceptional underwriting profitability in both North America and International.
The fourth quarter included only 1 month of Validus Re due to the timing of the divestiture. Excluding Validus Re from fourth quarter results, the pro forma Global Commercial Lines calendar year combined ratio would have been 85.1%, 30 basis points lower than reported. The accident year combined ratio ex cats would have been 82.5%, only 10 basis points higher.
The fourth quarter calendar year combined ratio for Global Personal Insurance was 98.8%, 90 basis points better than 4Q '22. The accident year combined ratio ex cats was 101.8%, 140 basis points higher driven by the repositioning of the high net worth business, which made significant progress in 2023.
Fourth quarter underwriting income for GI was $642 million, up slightly from $635 million in 4Q '22 as improved accident year results, including catastrophe losses, were offset by lower favorable prior year development, net of reinsurance and prior year premiums. Catastrophe losses totaled $126 million in the quarter, down from $235 million last year. The largest event was Hurricane Otis in Mexico.
For the fourth quarter and the year, catastrophe losses, excluding Validus Re, would have been $111 million and $937 million, respectively. Favorable prior year development totaled $69 million in the fourth quarter compared to $151 million in 4Q '22. Including the impact of prior year premiums, the total impact of prior year loss reserve development was favorable by $37 million compared to favorable development of $150 million in 4Q '22.
Fourth quarter net favorable development this quarter includes $41 million of ADC gain amortization and $28 million of net favorable development from annual DVRs and other reserve reviews, particularly prior year catastrophes. The $28 million included $75 million in additional reserves for Russia-Ukraine related claims, offset by net favorable development on shorter tail lines and older catastrophes.
Turning to L&R. Fourth quarter results were solid, especially considering the continued headwinds from alternative investment returns. Fourth quarter APTI was $957 million, up 12% over the prior year driven by base spread expansion, strong sales and growth in assets under management and administration. Base net investment spreads in Individual and Group Retirement together widened 23 basis points in the quarter.
Fourth quarter premiums and deposits were $10.6 billion, up 20% from 4Q '22. For the fourth quarter, Corebridge's earnings included in AIG adjusted after-tax income decreased by about 25% due to the reduction in AIG ownership from 78% last year to 52% as of year-end. For the full year, Corebridge earnings in our adjusted after-tax income declined 20%.
Turning to other operations. Fourth quarter 2023 adjusted pretax loss improved by $52 million from 4Q '22 due to a $72 million reduction in AIG general operating expenses. Total other operations GOE was $242 million for the quarter, including $61 million for Corebridge.
On a consolidated basis, AIG's fourth quarter adjusted after-tax income rose 21% to $1.3 billion driven by 19% growth in General Insurance APTI. The annualized adjusted return on common equity was 9.4% for the quarter, almost 2 points higher than the fourth quarter of 2022.
Moving to the balance sheet. Book value per common share ended the year at $65.14, up 18% from year-end 2022 and up 16% from September 30, primarily due to the impact of lower interest rates. Adjusted book value per share was $76.65 at year-end, up 1% from year-end 2022 and down 2% for September 30, reflecting the net impact of income, dividends, share repurchases and Corebridge secondary sales.
At December 31, AIG's consolidated debt and preferred stock to total capital, excluding AOCI, was 24.3%, down 1.3 points from year-end 2022. With first quarter 2024 debt reduction, leverage is likely to be at the low end of our 20% to 25% range upon deconsolidation.
As Peter noted, we made substantial progress towards our 10%-plus ROCE goal this year. 2023 full year adjusted ROCE for AIG was 9.0% compared to 7.1% in 2022 and was 12.5% in General Insurance and 11.5% in L&R. The actions to reach 10% or greater will be driven by the 4 levers we have discussed before, including AIG Next. We are confident in our ability to achieve this goal, subject to market conditions and look forward to updating you on our progress.
With that, I will turn the call back over to Peter.
Peter Zaffino;Chairman and CEO: Thank you, Sabra. Michelle, we're ready for questions.
Operator: [Operator Instructions] Our first question comes from Michael Zaremski with BMO Capital Markets.
Michael Zaremski: Maybe first on the expense ratio. I appreciate the color, Peter, you gave us on the continued improvement. Anything -- looks like this quarter, specifically, though, it took -- it was a bit higher than expected. Anything we should be thinking about? Or I don't know, if it's profit share, given the excellent loss ratio or just anything, any noise in there or seasonality?
Peter Zaffino;Chairman and CEO: Thanks, Mike. We outlined in my script that the business has been taking a lot of additional costs. Think about cyber and usage on the cloud. And so that might have been held centrally in the past. That has now been put into the business. And so you see that they're absorbing most of it, but there is some timing on that.
Also in Personal Insurance, there is a lot of noise in the quarter. There's some onetime true-up adjustments. There's also some profit sharing, as you mentioned, in some of our Personal Insurance businesses. And so -- and there was also some catch-up on some of the reinsurance on earned premium.
So I'm not concerned at all about the uptick in expenses. It was very nominal. When I look at what the business has actually absorbed in terms of increased costs year-over-year, they've really built capacity to be able to invest in the future. And the fourth quarter reflected that, but there was a little bit of noise as well, particularly on the Personal Insurance side.
Michael Zaremski: Okay. Great. And then my final follow-up is on the -- specifically on the accident year loss ratio. You've -- the Validus is property-centric, and it's going to be kind of fully out of the numbers next quarter. You talked about nonrenewing some property throughout the year.
And I understand Financial Lines has got a lot of pricing, but Financial Lines pricing isn't great trailing 12-month basis. So just on the underlying loss ratio, given just all the dynamics, should we be thinking about any material changes to the underlying loss ratio as the year progresses, given the moving parts?
Peter Zaffino;Chairman and CEO: I don't think so. I think the accident year loss ratio that we finished the year is what I would expect in 2024. Like you said, there's always a mix of business changes. There's always a little bit of noise. There could be some shift in composition. As you mentioned, property, we think we have tremendous opportunities there based on having 5 or 6 entry points across the world in terms of getting the best risk-adjusted returns.
When I look at what we've done in property over the last 5 years, we've gone from combined ratios in North America that are well north of 130 combined into the 70s and 80s now. So I think we have a really good platform. We're able to scale up businesses when we see opportunities. But I would think absent big mix of business changes, I would not expect any changes in the loss ratio.
And I signaled on the call that the remediation is largely behind us. I mean, again, you're always going to be reunderwriting, but large programs or portions of the business in commercial, we really like what we have, and I think that there's real good opportunities for growth.
Operator: Our next question comes from Meyer Shields with KBW.
Meyer Shields: Great. One quick question just to make sure I understand it. So you talked about pricing assumptions for casualty, assuming loss trends of either high single digits or low teens. Did that match the loss trends embedded in the reserves?
Peter Zaffino;Chairman and CEO: Sabra, do you want to talk about the reserves commensurate to the increase in premium and then -- sorry, an increase in rate change, particularly on excess?
Sabra Purtill: Yes. So when we've -- and we've talked about it in the past, we've taken a proactive approach to try and to react quickly to bad news that we see in trends. And as you know, even back in 2017, we moved to increase the reserves on casualty lines.
Our underlying assumptions for casualty loss trend is in the 10% range. It does vary between primary and excess. Our book historically has been a little bit more balanced towards excess, and that's why you can see some of the changes in the loss ratios accident year by accident year.
I would note that we do our deeper dive on the casualty lines largely in the third quarter. There are some that are in the second quarter, and we did complete those reserves this year without any meaningful changes in the reserves.
Peter Zaffino;Chairman and CEO: So another observation, Meyer, on that is that the rates as we got to the back half of the year in Casualty, particularly in Excess Casualty, started to accelerate into double digits. And also not that this is a bellwether because there's different mix of business, but our casualty submissions in Lexington in the fourth quarter were up 100%, which just means it's getting harder to get casualty placements done in the admitted market. Pricing is going up driven by rate, terms of conditions are being tightened and there's more activity in E&S.
Meyer Shields: Okay. Fantastic. That's very helpful. Second question, I guess, maybe jumping off from that. I guess I'm a little surprised that there's still, if I understand correctly, the same level of proportional sessions on North American casualty despite the fact that overall profitability has gotten so much better and higher interest rates. And I was hoping you could take us through your thinking on that.
Peter Zaffino;Chairman and CEO: Sure. Look, our casualty placements have evolved over time to reflect the portfolio, the gross limit deployment. And if I could take you back to even 2016 and '17 where we had quota shares before we arrived where we had a 50% quota share on Primary Casualty and then we had a 37.5% placement on Excess Casualty. That's just continued to evolve as we got into 2018, where we bought a large excess of loss placements for our worldwide Casualty portfolio for 75 ex of 25.
And then at the end of 2018, we bought a 50% quota share for our casualty portfolio within the United States. And the reason why I just give you that as a baseline is we've changed, evolved. We've had reinsurance in place since 2016. But when you look at what we place on the quota share today, it's basically 20%. So we've taken that down while we've improved ceding commissions over 800 basis points from the original placement to 20% from north of 50.
So I think we have been recognizing that we don't need to do as much proportional. But there's a balance in those placements between the excess and the quota share partnerships with reinsurers. They like a balance between the excess of loss and quota share in terms of our underwriting and feel very comfortable that, that's a good amount to cede off for looking at our overall casualty portfolio.
Operator: Our next question comes from Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question was on the equity that you laid out, Sabra. So $33 billion pro forma adjusted equity. And then I believe you said parent liquidity would come on top of that. So can you just give us a sense of once you're through deconsolidation, what type of liquidity you would like to have in parent? Because I'm assuming it would be $33 billion plus the parent liquidity would be the equity that we should consider in reference to the double-digit plus ROCE target.
Peter Zaffino;Chairman and CEO: Thanks, Elyse. I'll turn it over to Sabra in 2 seconds. But I just want to caution us that we tried to outline what we expect shareholders' equity with a variety of different variables, but it was all pro forma.
So I think Sabra can answer the question sort of technically as to how we should be looking about our capital relative to how we get to the 10% ROCE. But I just don't want to go into too many more variables because that was a pro forma that had a lot of assumptions. Sabra?
Sabra Purtill: Yes, certainly. Look, we have a framework around our liquidity position. And clearly, given the timing of the Corebridge secondaries and the Validus sale in the fourth quarter, parent liquidity was at very attractive and high levels at year-end.
The way we think of it in a normal framework is we look at what our forward holding company needs are. So think about common dividend payments of roughly $1 billion a year. AIG-only interest expense, roughly $500 million a year. And then parent expenses, which as we've talked about, we're focused on getting those down to 1% to 1.5% of NPE range. So that's what we think about in terms of a normal liquidity position, which is lower, obviously, than where we ended the year.
Elyse Greenspan: And then my second question, appreciate all the color on the call on premium growth, right, I think it was around 9% in the quarter kind of ex Validus and Crop. And so as we think about the moving pieces and just your view of price, loss trend, et cetera, would you expect top line growth kind of on an adjusted basis to be within that range in '24? Are there other things that we should consider?
Peter Zaffino;Chairman and CEO: Well, when you take out -- again, there's a lot of moving pieces, but like you take out Validus, Crop Risk Services, and so we have a baseline. And then when we look at our commercial portfolio -- I look at the fundamentals, Elyse, in terms of how are we growing the business. And we gave you highlights in the fourth quarter about our new business, which was simply terrific, and that momentum continues. Our retentions have been fantastic. And so again, it's a portfolio that we have done such a great job to get to a place where we really like and find opportunities for stability and more growth.
Agree on the rate. I mean, again, the fourth quarter was just a moment, but we would expect Financial Lines in 2024 not to keep up at the same pace on excess. We'll see as we get into the market, but really like the opportunities in our core businesses to drive growth.
Lexington, I know there's been a lot of discussion in this quarter around is excess and surplus lines slowing down, things going back to the admitted. There's no evidence to suggest that's true.
Again, submission count is significantly up. And it's not just property. Property, if I looked at the fourth quarter, was the lowest submission count growth, and that was up over 30%. As I said, property's around 30%, casualty was up over 100%, and health care was around 50%. So there's a lot more opportunity to continue to grow in excess and surplus lines. And you know what, the property market, you get to the second quarter and there is your opportunity.
So like we have built a reinsurance structure. We've built a gross portfolio that we can flex depending on market conditions. I mentioned Global Specialty. We think there's growth opportunities there. We think there's growth opportunities in our Personal Insurance business.
So we're cautious but optimistic that the growth rate that you outlined in the high single digits is going to be achieved. But again, we have to be in the year, and we'll give you updates every quarter, but we're optimistic.
Operator: Our next question comes from Mike Ward with Citi.
Michael Ward: Maybe kind of a similar question, but specifically on International. I think rate is a little below loss cost. So I was just wondering if you have any commentary on how you see the top line growth there playing out.
Peter Zaffino;Chairman and CEO: Mike, thanks for the question. If I look at International on the rate side, just a reminder that we do rate on gross premium written, not net. And so like as you take that from the portfolio, there's a heavy weighting our Specialty business in the fourth quarter. And the Specialty business does have a lot of quota shares and has a terrific reinsurance partnership. But it's almost 50% of the business, roughly between 40 to 50 in the quarter.
And so Specialty while had good rate increase in marine, political risk had a weighting on rate in the quarter as well as Financial Lines. Financial Line is about 20% of the gross premium written in the quarter and having a negative that just weights the overall rate environment.
But we had very strong rate in property. We had very good rate, as I mentioned in my prepared remarks, of 8% in marine. And so yes, the overall index was at or perhaps slightly below loss cost trend, but it's not something we're concerned about.
The other thing too, in Specialty, you should realize is that December 1 is when all aviation renews. And so that was low single digits, again, weighting on it.
But it's mix of business, it's gross, and why I say gross is that when you take the gross to net for our Specialty business, it's basically 50% net premium written to gross. And so like we put that in the math in terms of our ceding commissions and profitability of the portfolio. But overall, we were pleased and think that there's opportunities to improve that in 2024.
Michael Ward: And then maybe just on the adverse PYD in Russia, Ukraine. Just is that related to aviation? And is that just accident year '22? Because I think there was some adverse in other -- '20 and '19.
Peter Zaffino;Chairman and CEO: Sabra, do you want to provide a little bit of update in terms of how we got to the adverse?
Sabra Purtill: Sure. And I'll just start by overall. As I mentioned, we did have some favorable prior year development from older catastrophe years. So those were basically in years 2018 through 2020.
If you look at the more recent accident years, as we indicated, we did put up $75 million of additional reserves related to Russia- and Ukraine-related claims. We've been evaluating our exposure for some time. And based on the analysis where we are at the end of the year, we felt it was appropriate to increase our reserves for the quarter.
But I would also note that in the 2022 accident year, we did have some adverse development on winter storm Elliott, which was at the very tail end of the fourth quarter of 2022. And then in the older accident years, as I said in General, we netted to a favorable reserve development. But we did have some adverse development in the 2018 and 2019 accident years on some mergers and acquisitions-related exposures.
Operator: Our next question comes from Brian Meredith with UBS.
Brian Meredith: First question, I'm just curious, as we look at this, you're getting close to the 600 million kind of share count. As we think about that and the use of proceeds from Corebridge, are you willing to go kind of meaningfully below that? And if not, what is the other kind of potential uses of capital here that you're thinking about to mitigate dilution from selling down your remaining interest in Corebridge?
Peter Zaffino;Chairman and CEO: Thank you, Brian. It's a good question. It's a little leading, but we had outlined the capital management strategy for the first 6 months, and that gets us below the [ 650 million ] share count at a base assumption of a stock price around where we are now. And so there's a few variables that could accelerate that or slow it down depending on market conditions and share price. But we know we have the liquidity, and we just wanted to outline what we thought we would do within the first 6 months.
The next is dependent upon when we do a secondary sell-down, which I would expect before the end of the second quarter another sell-down, which gives us more liquidity. And the primary focus is going to be on share repurchase and dividend payment and believe that we can then get by the end of the year down to the lower end of the range or the 600 million.
Once we're closer to that, we feel like we've made enormous progress on all the elements of our capital management strategy. It has been very balanced and believe we would have to give guidance after that in terms of what we intend to do. But I kind of want to get to the range first, in the 600 million to 650 million, and then get to the lower end of the range with proceeds, and then we would provide additional guidance.
Brian Meredith: Great. That's helpful. And then, Peter, I just want to chat briefly on the Financial Lines business. And it seems like everybody is cutting Financial Lines. I'm just kind of wondering like who is actually running the business? And do we think we're getting closer to a bottom here? And do you think that's still a significant headwind to 2024 premium growth?
Peter Zaffino;Chairman and CEO: Thank you, Brian, for the question. And I've been trying to find a way to bring in McElroy to close it out. So Dave, why don't you give Brian some insight, and then we'll send it back to me, and we'll finish up.
David McElroy: Thank you, Brian, and thank you, Peter. The -- yes, honestly, Brian, you see the weighting of the Financial Lines in our portfolio. It's a bit of an outside influence. But we've also gone through the year, and I think we trade the market we're in, not the market we hope for.
So the -- I think we've been prudent around letting excess underpriced business go. I think we've been good about holding on to our primary business. So I think that actually really has held up well.
I'd also think that it's always worth understanding there's a lot of other products in the portfolio. And they've held up well, whether that's private company business or professional indemnity or the fidelity businesses. Those are strong, and we actually anticipate those will continue to hold up in '24, okay?
The seminal event is 2023 showed up with different securities class action experience than the '20 to '22 cohort here. It actually looks more like '16 to '19. The question will be whether the industry reacts to that, okay? Much more severity flowing through that year. It obviously exposes the verticality of loss.
I do think it's put a little bit of a floor on the market going into 2024. We're seeing that. We're seeing that now. There's definitely going to be more control in primary, but I'm not going to be -- we won't sit on the front cover of CNBC -- or sitting in the middle of CNBC, but we like the business. We like the pricing of the business. And we also think that it's tethered to the economy. As that shows up, that will also help with new business opportunities that we see both in M&A, both in IPOs and both in structured. So it is the first time in 3 years that I might give it a little bit of optimism. Peter?
Peter Zaffino;Chairman and CEO: Thanks, Dave. Thank you very much, and thanks, Brian. Thank you, everyone, for coming to the earnings call today and greatly appreciate the engagement. And I want to thank all of our colleagues around the world for all they've done to progress the strategic progress that we've made and just have delivered tremendous results. So everybody, have a great day, and thank you.
Operator: Thank you for participating in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Fourth Quarter 2023 Financial Results Conference Call. This conference is being recorded."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Good morning, and thank you for joining us today to review our fourth quarter and full year 2023 financial results. Following my remarks, Sabra will provide more detail on the quarter and some perspective on the year, and then we'll take questions. Kevin Hogan and David McElroy will join us for the Q&A portion of the call."
},
{
"speaker": "AIG Next will focus on the following key principles",
"text": "driving global consistency and local relevancy across our end-to-end processes to improve operational efficiency and effectiveness, reducing organizational complexity to create a better and differentiated experience for our clients and colleagues, creating an agile and scalable organization to support business growth, optimizing our ecosystem to modernize our data analytics, digital and technology capabilities, clarifying roles' responsibilities while eliminating duplication and increasing our speed of execution."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. This morning, I will provide more detail on AIG's fourth quarter results. But first, as we are getting closer to Corebridge deconsolidation, I would like to start with an illustrative pro forma."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you, Sabra. Michelle, we're ready for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Michael Zaremski with BMO Capital Markets."
},
{
"speaker": "Michael Zaremski",
"text": "Maybe first on the expense ratio. I appreciate the color, Peter, you gave us on the continued improvement. Anything -- looks like this quarter, specifically, though, it took -- it was a bit higher than expected. Anything we should be thinking about? Or I don't know, if it's profit share, given the excellent loss ratio or just anything, any noise in there or seasonality?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Mike. We outlined in my script that the business has been taking a lot of additional costs. Think about cyber and usage on the cloud. And so that might have been held centrally in the past. That has now been put into the business. And so you see that they're absorbing most of it, but there is some timing on that."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. Great. And then my final follow-up is on the -- specifically on the accident year loss ratio. You've -- the Validus is property-centric, and it's going to be kind of fully out of the numbers next quarter. You talked about nonrenewing some property throughout the year."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "I don't think so. I think the accident year loss ratio that we finished the year is what I would expect in 2024. Like you said, there's always a mix of business changes. There's always a little bit of noise. There could be some shift in composition. As you mentioned, property, we think we have tremendous opportunities there based on having 5 or 6 entry points across the world in terms of getting the best risk-adjusted returns."
},
{
"speaker": "Operator",
"text": "Our next question comes from Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "Great. One quick question just to make sure I understand it. So you talked about pricing assumptions for casualty, assuming loss trends of either high single digits or low teens. Did that match the loss trends embedded in the reserves?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Sabra, do you want to talk about the reserves commensurate to the increase in premium and then -- sorry, an increase in rate change, particularly on excess?"
},
{
"speaker": "Sabra Purtill",
"text": "Yes. So when we've -- and we've talked about it in the past, we've taken a proactive approach to try and to react quickly to bad news that we see in trends. And as you know, even back in 2017, we moved to increase the reserves on casualty lines."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "So another observation, Meyer, on that is that the rates as we got to the back half of the year in Casualty, particularly in Excess Casualty, started to accelerate into double digits. And also not that this is a bellwether because there's different mix of business, but our casualty submissions in Lexington in the fourth quarter were up 100%, which just means it's getting harder to get casualty placements done in the admitted market. Pricing is going up driven by rate, terms of conditions are being tightened and there's more activity in E&S."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Fantastic. That's very helpful. Second question, I guess, maybe jumping off from that. I guess I'm a little surprised that there's still, if I understand correctly, the same level of proportional sessions on North American casualty despite the fact that overall profitability has gotten so much better and higher interest rates. And I was hoping you could take us through your thinking on that."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Sure. Look, our casualty placements have evolved over time to reflect the portfolio, the gross limit deployment. And if I could take you back to even 2016 and '17 where we had quota shares before we arrived where we had a 50% quota share on Primary Casualty and then we had a 37.5% placement on Excess Casualty. That's just continued to evolve as we got into 2018, where we bought a large excess of loss placements for our worldwide Casualty portfolio for 75 ex of 25."
},
{
"speaker": "Operator",
"text": "Our next question comes from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question was on the equity that you laid out, Sabra. So $33 billion pro forma adjusted equity. And then I believe you said parent liquidity would come on top of that. So can you just give us a sense of once you're through deconsolidation, what type of liquidity you would like to have in parent? Because I'm assuming it would be $33 billion plus the parent liquidity would be the equity that we should consider in reference to the double-digit plus ROCE target."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Elyse. I'll turn it over to Sabra in 2 seconds. But I just want to caution us that we tried to outline what we expect shareholders' equity with a variety of different variables, but it was all pro forma."
},
{
"speaker": "Sabra Purtill",
"text": "Yes, certainly. Look, we have a framework around our liquidity position. And clearly, given the timing of the Corebridge secondaries and the Validus sale in the fourth quarter, parent liquidity was at very attractive and high levels at year-end."
},
{
"speaker": "Elyse Greenspan",
"text": "And then my second question, appreciate all the color on the call on premium growth, right, I think it was around 9% in the quarter kind of ex Validus and Crop. And so as we think about the moving pieces and just your view of price, loss trend, et cetera, would you expect top line growth kind of on an adjusted basis to be within that range in '24? Are there other things that we should consider?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Well, when you take out -- again, there's a lot of moving pieces, but like you take out Validus, Crop Risk Services, and so we have a baseline. And then when we look at our commercial portfolio -- I look at the fundamentals, Elyse, in terms of how are we growing the business. And we gave you highlights in the fourth quarter about our new business, which was simply terrific, and that momentum continues. Our retentions have been fantastic. And so again, it's a portfolio that we have done such a great job to get to a place where we really like and find opportunities for stability and more growth."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mike Ward with Citi."
},
{
"speaker": "Michael Ward",
"text": "Maybe kind of a similar question, but specifically on International. I think rate is a little below loss cost. So I was just wondering if you have any commentary on how you see the top line growth there playing out."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Mike, thanks for the question. If I look at International on the rate side, just a reminder that we do rate on gross premium written, not net. And so like as you take that from the portfolio, there's a heavy weighting our Specialty business in the fourth quarter. And the Specialty business does have a lot of quota shares and has a terrific reinsurance partnership. But it's almost 50% of the business, roughly between 40 to 50 in the quarter."
},
{
"speaker": "Michael Ward",
"text": "And then maybe just on the adverse PYD in Russia, Ukraine. Just is that related to aviation? And is that just accident year '22? Because I think there was some adverse in other -- '20 and '19."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Sabra, do you want to provide a little bit of update in terms of how we got to the adverse?"
},
{
"speaker": "Sabra Purtill",
"text": "Sure. And I'll just start by overall. As I mentioned, we did have some favorable prior year development from older catastrophe years. So those were basically in years 2018 through 2020."
},
{
"speaker": "Operator",
"text": "Our next question comes from Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"text": "First question, I'm just curious, as we look at this, you're getting close to the 600 million kind of share count. As we think about that and the use of proceeds from Corebridge, are you willing to go kind of meaningfully below that? And if not, what is the other kind of potential uses of capital here that you're thinking about to mitigate dilution from selling down your remaining interest in Corebridge?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you, Brian. It's a good question. It's a little leading, but we had outlined the capital management strategy for the first 6 months, and that gets us below the [ 650 million ] share count at a base assumption of a stock price around where we are now. And so there's a few variables that could accelerate that or slow it down depending on market conditions and share price. But we know we have the liquidity, and we just wanted to outline what we thought we would do within the first 6 months."
},
{
"speaker": "Brian Meredith",
"text": "Great. That's helpful. And then, Peter, I just want to chat briefly on the Financial Lines business. And it seems like everybody is cutting Financial Lines. I'm just kind of wondering like who is actually running the business? And do we think we're getting closer to a bottom here? And do you think that's still a significant headwind to 2024 premium growth?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you, Brian, for the question. And I've been trying to find a way to bring in McElroy to close it out. So Dave, why don't you give Brian some insight, and then we'll send it back to me, and we'll finish up."
},
{
"speaker": "David McElroy",
"text": "Thank you, Brian, and thank you, Peter. The -- yes, honestly, Brian, you see the weighting of the Financial Lines in our portfolio. It's a bit of an outside influence. But we've also gone through the year, and I think we trade the market we're in, not the market we hope for."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Dave. Thank you very much, and thanks, Brian. Thank you, everyone, for coming to the earnings call today and greatly appreciate the engagement. And I want to thank all of our colleagues around the world for all they've done to progress the strategic progress that we've made and just have delivered tremendous results. So everybody, have a great day, and thank you."
},
{
"speaker": "Operator",
"text": "Thank you for participating in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day."
}
] | American International Group, Inc. | 250,388 |
AIG | 3 | 2,023 | 2023-11-02 08:30:00 | Operator: Good day, and welcome to AIG's Third Quarter 2023 Financial Results Conference Call. This conference is being recorded.
Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, and good morning.
Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change.
Today's remarks may also include non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com.
Additionally, note that today's remarks will include results of AIG's Life and Retirement segment and Other Operations on the same basis as prior quarters, which is how we expect to continue to report until the deconsolidation of Corebridge Financial. AIG's segments and U.S. GAAP financial results as well as AIG's key financial metrics with respect thereto differ from those reported by Corebridge Financial. Corebridge Financial will host its earnings call on Friday, November 3.
Finally, please note that today's remarks as they relate to net premiums written in General Insurance are presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis adjusted for the international lag elimination and the sale of Crop Risk Services and the sale of Validus Re. Please refer to the footnote on Page 26 of the third quarter financial supplement for prior period results for Crop Risk Services and Validus Re.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino;Chairman and CEO: Good morning, and thank you for joining us today to review our third quarter financial results. Following my remarks, Sabra will provide more detail on the quarter and then we will take questions. Kevin Hogan and David McElroy will join us for the Q&A portion of the call.
In the third quarter, AIG continued to deliver exceptional results. We made significant progress in our strategic, operational and financial objectives, reflecting continued execution across our entire organization.
During my remarks this morning, I will discuss the following topics: first, AIG's financial results, including Life and Retirement, and provide an update on recent divestitures; second, I will provide the results of AIG's General Insurance business; third, I will provide an update on the casualty insurance market more broadly and AIG's approach to our casualty portfolio; fourth, I will provide an update on our capital management strategy and the progress we have made this quarter. Sabra will provide more detail on AIG's balance sheet and capital position in her remarks. And lastly, I will reconfirm our guidance with respect to our path to a 10%-plus ROCE post deconsolidation of Corebridge.
Financial highlights from the third quarter included: adjusted after-tax income was $1.2 billion or $1.61 per diluted common share, representing a 92% increase year-over-year. Consolidated net investment income on an adjusted pretax income basis was $3.3 billion, a 29% increase year-over-year. In General Insurance, net investment income was $756 million, a 30% increase.
Net premiums written in General Insurance grew 9%. General Insurance underwriting income in the quarter was $611 million, which improved over 250% from the prior year quarter. The adjusted accident year combined ratio, excluding catastrophes, was 86.3%, a 210 basis point improvement from the prior year quarter, which is an outstanding result.
Our CAT loss ratio was 6.9% with $462 million of total catastrophe losses, including reinstatement premiums, which included $70 million from Validus Re. We had favorable prior year reserve development of $139 million, reflecting favorable loss experience on our portfolio, resulting from our continued focus on underwriting discipline.
The Life and Retirement business also delivered strong results in the third quarter with continued sales momentum and spread expansion. Life and Retirement's adjusted pretax income was $971 million, up 24% year-over-year. Premiums and deposits grew 4% year-over-year to $9.2 billion, driven by strong Fixed Index Annuity sales, which exceeded $2 billion for the third consecutive quarter.
September marked the 1-year anniversary of Corebridge's initial public offering. And since the IPO, Corebridge has returned approximately $1.4 billion to shareholders and is well on track to its committed payout ratio.
With respect to our remaining ownership of Corebridge, we continue to evaluate options that are aligned with the best interest of shareholders and our other stakeholders. We're very proud of the achievements that Corebridge has delivered towards its operational separation as a public company, and we remain committed to reducing our ownership and eventually a full separation.
Turning to AIG's balance sheet. During the quarter, AIG returned over $1 billion to shareholders through $785 million of common stock repurchases and $261 million of dividends. In addition, we purchased $170 million of common stock in October. We deployed $289 million to retire Validus Re debt prior to the close of the transaction yesterday. And we ended the quarter with $3.6 billion of parent liquidity.
During the quarter, we continued to make significant progress on our strategic repositioning as we have further simplified our portfolio, which we've talked about over the past several quarters. Yesterday, we announced the successful closing of the sale of Validus Re to RenaissanceRe for which we received a total consideration of $3.3 billion in cash, including a pre-close dividend and approximately $275 million at RenaissanceRe common stock. This divestiture streamlines our business model, simplifies our portfolio and further reduces our volatility.
Prior to closing the Validus Re transaction, we entered into an agreement with Enstar Group to provide AIG with protection against any adverse development on the 95% portion of Validus Re's loss reserves that AIG retains exposure to. The cost will be included in the gain on sale in the fourth quarter.
Enstar will provide $400 million of limit for an adverse development cover in excess of carried loss reserves on assumed reinsurance contracts underwritten by Validus Re with respect to accident year 2022 and prior. This ADC limit provides additional protection against downside exposure to reserves in excess of the expected redundancy to a modeled confidence level above the 90th percentile. Importantly, while we believe this ADC is prudent to mitigate the risk of any future adverse reserve development, we will benefit from any future favorable reserve development.
In August, Corebridge entered into a definitive agreement to sell Laya Healthcare to AXA for EUR 650 million, which closed on October 31. Proceeds to Corebridge, net of purchase price adjustments and deal-related expenses, will be approximately $730 million. It was announced that the proceeds will be used for a special dividend to Corebridge shareholders as of November 13.
In September, Corebridge entered into a definitive agreement to sell the U.K. Life Insurance business to Aviva plc for GBP 460 million. We expect the transaction to close sometime in the second quarter of 2024, subject to regulatory approvals. We anticipate that the proceeds from this transaction will largely be used for share repurchases, subject to market conditions. Both transactions streamline the Corebridge portfolio and allow the company to focus on its Life and Retirement products and solutions in the United States.
Turning to General Insurance, gross premiums written were $8.9 billion, a decrease of 1% from prior year quarter. Net premiums written were $6.5 billion, an increase of 9% from the prior year quarter. Global Commercial grew 6%, and Global Personal grew 16% from the prior year quarter. North America Commercial net premiums written increased 5% in the third quarter.
There are many variables in this quarter, and I want to provide more detail. The key businesses that drove growth were Lexington's core business, excluding Lexington programs, grew over 25% in the quarter, led by wholesale casualty, which grew 33%; and wholesale property, which grew 27%. Glatfelter grew 12%, and Retail Property grew 11%.
In terms of headwinds, in 2022, we made the underwriting decision to not renew 2 large Lexington programs. We took this action because we believe that these programs had meaningful CAT exposure in peak zones. And we do not believe the appropriate CAT loads were reflected in the pricing. These programs were not the best deployment of capital in order to achieve our targeted risk-adjusted returns. Those nonrenewals tempered overall growth in Lexington.
Lexington program's net premiums written reduced by 57% in the quarter. We believe, over time, we will replace this business on an individual risk basis as stronger risk-adjusted returns. However, it is a headwind in the quarter. The impact of the net premiums written associated with these 2 programs was approximately $115 million in the third quarter.
Also offsetting growth in North America was Financial Lines, which declined 11%, accounting for approximately 20% of North America Commercial Lines net premiums written in the quarter. In North America Financial Lines, large account public D&O remains competitive as a result of excess capacity driven by new entrants to the market.
Our renewal retention in our primary business remains strong, but retentions in our excess business were more challenged. New business in our excess book was down year-over-year as we were very disciplined in the current environment.
Rate reductions remain most prevalent on excess layers, particularly the higher excess layer vertical towers where it's more commoditized and the most pressure exists on pricing. In primary, where we are one of the few market leaders, rates remained flat to slightly down. We remain confident in our approach to Financial Lines. We have a global business with scale, focused on underwriting profit over top line growth, which is reflected in the results this quarter.
In International Commercial, net premiums written grew 7%, primarily driven by property, which was up 13%; global specialty, which was up 12%, led by energy and marine; and Talbot, which was up 7%.
Global Commercial had very strong renewal retention of 87% in its in-force portfolio. North America was up 200 basis points to 87%, and International was up 300 basis points to 88%. As a reminder, we calculate renewal retention prior to the impact of rate and exposure changes.
And across Global Commercial, we continue to see very strong new business, which was approximately $1 billion in the third quarter. North America Commercial produced new business of $516 million, an increase of 13% year-over-year or 27% if you exclude Financial Lines. This growth was driven by Lexington Casualty, which saw excellent new business growth of over 90%, as well as Western World, which grew over 50%.
Retail Property grew new business by 26%, and retail casualty grew new business by 25%. This was offset by Financial Lines where new business contracted by about 30% as a result of our underwriting discipline.
International Commercial produced new business of $532 million or 12% growth year-over-year. This growth was led by Talbot new business, which increased almost 50% year-over-year, and Global Specialty, which grew new business by over 40%, and it was balanced across the portfolio.
Moving to rate. In North America Commercial, rate increased 5.4% in the third quarter or 6% excluding workers' compensation. Exposure in the quarter added 3 points, bringing the total pricing change, excluding workers' comp, to 9%.
Rate increases were driven by Lexington wholesale, which was up 15%, marking the 18th consecutive quarter of double-digit rate increases, led by Lexington wholesale property, which was up 28%, Retail Property was up 27% and admitted excess casualty was up 12%. Financial Lines rate was down 8%.
In International Commercial, rate increased 4%, and the exposure increase was 2%. The rate increase was driven by property, which was up 13%; energy, which was up 10%; and Talbot, which was up 9%.
Turning to Personal Insurance, net premiums written increased 16% year-over-year, primarily driven by North America. In North America, Personal net premiums written increased 59%. Similar to last quarter, the increase was driven by business underwritten on behalf of PCS, offset by decreases in Travel and Warranty.
In the third quarter, AIG's net premiums written from PCS increased by over 100%, benefiting from an increase in gross premiums written and a reduction in quota share sessions. And as expected, the lag in earned premium growth continued to dissipate, providing operating leverage and a reduced expense ratio, primarily in general operating expenses.
The high and ultra high net worth business also had significant improvement in the accident year loss ratio, benefiting from improved pricing in our admitted business and transitioning more business to the non-admitted market. We expect PCS to continue to improve its financial performance and provide more operating leverage in the fourth quarter and into 2024.
In International Personal, net premiums written increased by 3% year-over-year, driven by growth in personal auto, travel, and that reflects the rebound post-pandemic and Japan personal property. The accident year loss ratio, ex CAT, improved 560 basis points. Overall, we're pleased with the International Personal improvement year-over-year.
Shifting to combined ratios. The General Insurance third quarter combined ratio was 90.5%, a 680 basis point improvement from the prior year quarter. Accident year combined ratio, ex CAT, was 86.3%, a 210 basis point improvement from the prior year quarter.
Global Commercial had an outstanding performance with third quarter accident year combined ratio, ex CAT, of 81.7%, a 130 basis point improvement year-over-year. The accident year combined ratio, including CAT, was 89.7%, a 500 basis point improvement from the prior year quarter.
The North America Commercial accident year combined ratio, ex CAT, was 83%. And the International Commercial accident year combined ratio, ex CAT, was 79.7%, both of which were exceptional outcomes.
We would like to provide a perspective both with and without Validus Re and Crop Risk Services. As I said, the third quarter Global Commercial accident year combined ratio, ex CAT, was 81.7%, and the calendar year combined ratio was 86.6%. Excluding Validus Re from the third quarter results, the Global Commercial accident year combined ratio would essentially have been flat, and the calendar year combined ratio would have improved by slightly over 100 basis points from the third quarter to 85.4%.
And for the first 9 months, the Global Commercial accident year combined ratio, ex CAT, was 83.6%, and the calendar year combined ratio was 87.6%. Excluding Crop and Validus Re from the 9-month period results, the Global Commercial accident year combined ratio, ex CAT, would have increased by 70 basis points to 84.3%, and the calendar year combined ratio would have increased by 50 basis points to 88.1%.
Global Personal reported a third quarter accident year combined ratio, ex CAT, of 99%, a 380 basis point improvement from the prior year quarter due in part to the North America PCS business.
Related to casualty liability and the excess casualty market, in particular in the United States, the level of narrative has increased over the last several years, driven in part by multiple mass tort events as well as rising economic and social inflation. The latter has been fueled by an exponential increase in third-party litigation funding, average severity trend increases and a precipitous rise in jury awards following the lull during the pandemic.
Over the past couple of years, I've spoken extensively about our portfolio remediation strategy, including where AIG has reduced gross limits since 2018 by $1.4 trillion. We have established strong underwriting guidelines and strong partnerships with reinsurers to manage both frequency and severity.
We have filed a similar strategy with our casualty portfolio with more of a focus on severity. When we began the underwriting turnaround in AIG in 2017, we found that the prior strategy in casualty was similar to that in the property business, which was to write large limits with a gross and net risk appetite much greater than what we offer today.
As I've outlined before, it was not uncommon to put out significant limits on any individual risk in excess of $100 million net on an occurrence basis. As we developed an entirely new framework and approach to underwriting, it required a change to our underwriting strategy.
Today, our global casualty portfolio represents 12% of our total gross premiums written and 13% of our net premiums written. The North America segment represents 55%, and the International segment represents 45% of that number. And since North America has been the topic of discussion, I will focus on what we have done in that portfolio.
In North America casualty, our gross limit for our excess casualty portfolio, including lead umbrella, has decreased by over 50% since 2018. Our average limit size has also reduced by over 50%. Average lead attachment points, which protect us from frequency and lower severity losses, have more than doubled since 2018.
In terms of gross pricing, primary auto and primary general liability, rates have increased approximately 200% since 2018, and excess casualty rates have increased by over 250%, remaining well above loss cost trends.
In addition to the significant investment in underwriting excellence and talent, we built and executed on a strategic reinsurance program to further mitigate our net exposure and volatility. What once was $100 million net exposure for AIG, there's now a maximum net on any one claim of $15 million in International and $11.5 million in North America.
And in our excess of loss treaties, we have reinstatement limits that exhaust based on extensive modeling done at the [ 1,000 ] return periods. This adequately protects AIG from vertical exposure with significant limit available in the event there are multiple losses.
Notably, the period prior to 2016 is covered by an adverse development cover for U.S. long-tail commercial lines. We purchased 80% of a $25 billion -- excess of $25 billion on payments made on or after January 1, 2016, for business written prior to 2016. The $25 billion retention was exceeded during the fourth quarter of 2020. We currently have $9 billion of the total unused recoverable limit left or $7.2 billion at the 80% level.
Conflicting views have emerged in the market on the combination of gross portfolio underwriting with the strategic use of reinsurance. There have been comments particularly recently that the use of reinsurance is not required if you're comfortable with the gross portfolio. We disagree and simply don't support that as a viable strategy for AIG.
We prefer to balance our approach and have developed a strong underwriting culture, which we have dramatically improved over the last 5 years, executing on the fundamentals of disciplined and consistent underwriting, being very focused on preempting the evolving changes in the market and using reinsurance strategically to mitigate unpredictable outcomes.
Building long-term strategic relationships with our reinsurance partners for all of our reinsurance needs has been key to repositioning AIG. Insurers cannot reverse social and economic inflation. However, we are in control of how we predict and respond to the impact of these changes to the forward-looking landscape, including how we manage our underwriting through coverage provided, limits deployed, attachment points and pricing.
Our business is not immune from social inflation, but we anticipated it early, and we took action. The consequence is that we're very pleased with our existing portfolio, and we're well positioned to be able to prudently take advantage of opportunities that exist in the current marketplace.
Turning to capital management. We use a balanced framework that remains focused on having ample capital in our insurance company subsidiaries to support organic growth in our business, continuing share repurchases, debt reduction in line with the lower end of the targets we provided and dividend increases. Lastly, we will consider compelling inorganic growth opportunities to meet our strategic objectives should they emerge.
We finished the third quarter with $3.6 billion of available liquidity prior to receiving the proceeds of the sale of Validus Re or the special dividend from the sale of Laya Healthcare. Together, they should contribute approximately another $3.7 billion in the fourth quarter. Our primary use of proceeds will be on share repurchases. We plan to accelerate our repurchase activity this quarter and as we enter 2024, and we expect to reduce debt outstanding to further strengthen the balance sheet.
We remain mindful of our leverage as a key consideration with our accelerated share repurchases. We expect to execute on the current share repurchase authorization of $7.5 billion, which will reduce shares outstanding to close to 600 million shares subject to market conditions.
Related to return on common equity, as we have outlined on our prior calls, we remain very focused on delivering a 10%-plus ROCE post deconsolidation of Corebridge. During the third quarter, we continue to make significant progress at all 4 components of our path to deliver on this commitment and how we are positioning AIG for the future.
I want to provide a few observations. In the last 90 days, we've continued to improve our underwriting results on an accident year and calendar year basis. We made recent leadership changes in General Insurance, which have effectively eliminated a management layer from the business, and we will continue this process throughout the organization in 2024.
We have strengthened the capital position of insurance company subsidiaries to enable continued profitable growth. We've moved into the final stages of the operational separation for Corebridge. We have announced and closed several divestitures and have repositioned the portfolio to support our strategy for the future. We have accelerated the progress we're making on our capital management strategy and have created a strong liquidity position.
The catalyst to achieving our targets remains the deconsolidation of Corebridge. This will allow AIG to simplify its business, eliminate duplication by combining our General Insurance business and our corporate functions, and create a leaner operating model for the future.
Before I turn it over to Sabra, I'd like to add a few more details on the closing of the sale of Validus Re to RenaissanceRe. In January of 2018, AIG announced it was acquiring Validus Holdings to position it for future growth and profitability improvement. Over the last several years, we reshaped Validus Re's portfolio by reducing the catastrophe exposure in certain U.S. peak zones while diversifying the business significantly to develop a more balanced portfolio in both property and casualty reinsurance in order to improve profitability.
Validus Re posted its first accident year combined ratio below 100% in 2022. And as we look back, we are grateful for the hard work, determination and perseverance of the team to dramatically improve the quality of the portfolio, particularly year-to-date in 2023, and it's evident in its performance today.
We are very proud of Validus Re's results and are pleased that the company acquiring Validus Re is RenaissanceRe. Through Kevin O'Donnell and his leadership team's terrific work, RenaissanceRe has become one of the world's most well-respected reinsurers. We are looking forward to continuing our strong partnership with RenaissanceRe, which will be further enhanced as we become an investor in RenRe's capital partner vehicles, allowing us to benefit from their future performance.
With that, I'll turn the call over to Sabra.
Sabra Purtill: Thank you, Peter. This morning, I will provide more detail on AIG's third quarter, including General Insurance reserves, net investment income, Life and Retirement results and balance sheet and capital management.
Adjusted after-tax income attributable to common shareholders this quarter was $1.2 billion, up 80% from 3Q '22, for an annualized adjusted ROCE of 8.5%. AATI per diluted share was $1.61, up 92%, reflecting the accretive impact of share repurchases over the last year. The earnings growth resulted from the 82% increase in General Insurance adjusted pretax income to $1.4 billion, driven by top line growth, improved underwriting results and higher investment income.
It's important to note that while Life and Retirement also had strong earnings, AIG's ownership of Corebridge decreased to 65.6% this quarter compared to 90.1% before the IPO. And therefore, our results include a lower percentage of their consolidated earnings than last year. In total, Corebridge contributed about $32 million to the $514 million increase in AIG's adjusted after-tax income.
Turning to General Insurance. Peter summarized our underwriting results, but I want to cover prior year development and reserves in more detail. In the quarter, General Insurance prior year development, net of reinsurance, totaled $139 million favorable, including $41 million from the amortization of deferred gain on the adverse development cover. About $129 million, including the ADC gain, resulted from the detailed valuation reviews, or DVRs, with the balance from other items like catastrophes.
The DVRs covered $34.1 billion of loss reserves on a pre-ADC basis, about 70% of the total. The DVRs of particular note this quarter were for International Casualty and Financial Lines, North America Financial Lines and North America workers' compensation, which last year was completed in the second quarter. In total, North America had $154 million of favorable development, including $39 million from the ADC. International was $15 million unfavorable.
Consistent with our prior comments, casualty, bodily injury, securities class actions and medical workers' comp trends have been and continue to be more favorable than our reserving assumptions. We believe that our changes in underwriting standards reduced limits, higher attachment points on primary limits, tightened terms and conditions and better risk selection are driving the improved experience, particularly in financial lines and casualty.
Nevertheless, our philosophy is to react to bad news quickly and to allow time for favorable trends in recent accident years to mature, particularly given the impact of COVID on recent years. Therefore, this quarter's favorable development is generally from older accident years or from short-tail lines like property where physical damage claims come in quickly.
In Financial Lines, changes from the DVRs were immaterial. North America had modest adverse development on an older Lexington architect and engineers book, offset by favorability in Canada. U.K. Financial Lines had slight adverse development, reflecting emerged experience on older D&O and professional indemnity claims, partially offset by favorable experience in Europe and Japan.
We also reviewed International casualty lines this quarter. Peter discussed our changes in underwriting limits and reinsurance on our global casualty book. I would add that we also evaluate economic and social inflation trends as well as our potential exposure to mass torts across the total book and hold reserves to address those items.
This quarter, we had adverse development in U.K. and European casualty, principally from commercial auto in France and large loss experience on a few older claims in both the U.K. and Europe. Consistent with prior trends, the DVRs for workers' compensation were favorable both for years covered by the ADC and after.
Finally, property lines and Personal Insurance had favorable development in both North America and International, while we had about $23 million of adverse development on prior year catastrophes. We will complete the balance of annual DVRs next quarter, which cover about $6 billion of reserves on a number of smaller lines.
Net investment income also contributed to earnings growth in the quarter, driven principally by higher reinvestment rates on fixed maturities and loans. The average new money yield on fixed maturities and loans was 5.88% this quarter, about 145 basis points above the yield on sales and maturities, and it was about 130 and 150 basis points higher in General Insurance and Life and Retirement, respectively. Year-to-date, the total new money yield is about 202 basis points higher than sales and maturities.
The portfolio yield in General Insurance increased 9 basis points sequentially and 88 basis points over the last year with net investment income growth of 30%. The L&R investment income rose 23%, and the portfolio yield improved 9 basis points and 63 basis points, respectively. Based on the current treasury yield curve, we expect continued pickup in portfolio yields, particularly in L&R, given the longer duration of its portfolio.
Alternative investment income totaled $26 million for an annualized return of about 1%, better than the losses last year, but below our long-term experience and outlook and down sequentially. Private equity returns are the principal driver of sequential decline in alternative returns this year as we have reduced our exposure to hedge funds over the last year. Private equity is reported on a 1-quarter lag based on when we receive the fund's financial reports. So this quarter's financial results reflect second quarter margins.
Our investment portfolios have strong credit performance and remain well diversified and highly rated. We continue to monitor commercial real estate closely. Debt service coverage ratios are strong, including in the office sector. The primary impact has been on loan-to-value ratios and real estate equity valuations rather than delinquencies or defaults. We continue to work on near-term maturities, and almost all 2023 scheduled maturities have been addressed.
Life and Retirement once again delivered strong results in the third quarter. Adjusted pretax income was $971 million, up 24% year-over-year, driven by continued investment spread expansion and strong sales, particularly in Fixed Index Annuities. Underwriting margins overall remain attractive. And on a sequential quarter basis, fee income and investment spreads improved.
During the quarter, the annual actuarial assumptions update was completed, resulting in a modest $22 million increase in APTI, mostly in the Life Insurance segment, compared to a $29 million increase last year. Individual Retirement APTI increased $195 million or 52% over the prior year quarter from base spread expansion and general account product growth.
The fixed annuity surrender rate increased sequentially from 15.9% to 17.7% this quarter as operations caught up on a backlog of surrender requests from earlier in the year. On a monthly basis, surrenders peaked early in the quarter and declined sequentially each month with continued improvement in October.
Group Retirement APTI was flat year-over-year as higher fee income and alternative investment income were offset by lower other yield enhancement income and higher general operating expenses or GOE. Net outflows included one large $1 billion plan, which was mostly in mutual funds and, therefore, was not material to earnings.
Life Insurance APT was also flat year-over-year, primarily due to lower policy fees and a lower favorable impact from the annual assumptions update, partially offset by higher net investment income.
Institutional Markets APTI decreased $8 million or 10% due to less favorable mortality experience. Sales increased 19%, supported by record production of $1.9 billion, partially offset by lower PRT sales, which are highly variable quarter-to-quarter.
Turning to Other Operations. Third quarter adjusted pretax loss improved by $149 million, driven by lower corporate and other GOE and higher short-term investment income. In addition, third quarter 2022 had investment losses on a legacy portfolio that was sold in 4Q '22.
Corporate GOE was $243 million and included $68 million for Corebridge. Excluding Corebridge, AIG corporate GOE decreased $56 million from the prior year. We remain on track to reduce 2023 corporate GOE by at least $100 million, including a higher allocation to General Insurance that has not had a material impact on the expense ratio due to expense discipline across the company.
Moving to the balance sheet. Third quarter 2023 estimated risk-based capital ratios remain above our target ranges. The General Insurance U.S. pool RBC is in the high 400s, while Life and Retirement is above its 400% target. At September 30, consolidated debt and preferred stock to total capital, excluding AOCI, was 25.9%, including $9.4 billion of Corebridge debt.
Our approach to capital management is unchanged. We will continue to balance share repurchases and debt reduction while also focusing on increasing common stock dividends. As Peter indicated, from the Validus and Laya sales, we expect about $3.7 billion of additional parent liquidity in the fourth quarter. We have significant financial flexibility, which we intend to use for both additional share repurchases and debt reduction.
Based on current average daily trading volumes, we expect to be able to repurchase about $1.5 billion of common stock a quarter or $500 million a month, which we will begin when the market window opens after earnings. We expect to continue at this rate into 2024, depending on excess parent liquidity levels, including future Corebridge sales proceeds and General Insurance dividends. In the fourth quarter, we also plan to accelerate debt repayment to rightsize our debt stock for our target deconsolidated leverage ratio.
Turning to our ROCE target. We remain laser-focused and are making progress on achieving a 10%-plus ROCE post deconsolidation. Year-to-date, annualized adjusted ROCE for AIG was 8.8% and 12.0% in General Insurance and 11.4% in Life and Retirement.
Last quarter, I provided a pro forma AIG shareholders' equity ex AOCI, excluding Corebridge, of about $40 billion, including deferred tax assets from the financial crisis era net operating losses. That's the capital supporting our General Insurance business and parent operations today, excluding our stake in Corebridge.
With the sale of Validus Re and the redeployment of proceeds into share repurchases and debt reduction, the current pro forma estimate of AIG equity, excluding Corebridge, is about $37 billion, including $4 billion of deferred tax assets, or $33 billion of adjusted shareholders' equity, which is the number we use for calculating adjusted ROCE.
Considering this equity level and our plans to simplify AIG's business and operational structure and to drive more predictable and sustainable profitability, we are confident that we will achieve our 10%-plus adjusted ROCE goal. We look forward to continuing to update you on our progress.
With that, I will turn the call back over to Peter.
Peter Zaffino;Chairman and CEO: Thanks, Sabra. And Michelle, we're ready for questions.
Operator: [Operator Instructions] Our first question comes from Meyer Shields with KBW.
Meyer Shields: One question to start on reserves. I guess, what's the process for ensuring that the adverse development in International Commercial doesn't actually reflect social inflation problem and that it's individual cases?
Peter Zaffino;Chairman and CEO: Meyer, thanks for the question. Sabra, do you want to cover? That's just a quick overview of -- Meyer mentioned the International and some of the inflation impact from reserves.
Sabra Purtill: Yes, certainly. And let me first start by explaining what the DVR process is. So DVR is a once-a-year deep-dive into our reserves. But each quarter, we do an actual versus expected analysis. So we do make adjustments to reserves on lines of business during the ordinary part of the year, but the deep-dive is where we really drill down into the lines in great detail.
This quarter, as I noted, we had International casualty. The development that you see is related to very specific books or -- and I'm sorry, I'm getting a little feedback on the line here. So I don't know, Meyer, maybe you need to mute. Anyway, the International Commercial Lines is very much related to specific cases and judgments around settlements.
And as I said and would also note in Peter's comment, these are generally from older accident years where we are exposed to much larger limits. So therefore, when you have a particular claim that goes against you, they do -- they are lumpy and they tend to be large. So what I would just say again is that we look at our book consistently during the course of the year, do a deep-dive once a year and then make some assessments based on specific facts and circumstances.
Peter Zaffino;Chairman and CEO: Thanks, Sabra. Meyer, do you have another question?
Meyer Shields: Yes, just a quick one. I know there's a lot of moving parts in North America Personal. I was hoping you could give us some sense of maybe true underlying underwriting results and the path to profitability in that segment.
Peter Zaffino;Chairman and CEO: Great. Thank you. As we've talked about before, it's a business in transition. We're not pleased with the overall printed results. But we had outlined in the past that it's complicated. 2023 would be a transition year, particularly with PCS, which we see a lot of net premium written coming in each quarter. The earned will follow, and so we should have some significant benefit on the ratios as we fully earn in the premium over the coming quarters.
When we look at fourth quarter 2023 and into 2024, we will see the mix of business change. And so therefore, the overall GOE and acquisition expenses should come down. We would see the accident year loss ratio, ex CAT, slightly go up just because of the mix of what PCS is underwriting.
We did have some onetime items that I won't go into in the quarter that were headwinds in the Travel and Warranty business. But those businesses are going to have to contribute more as we get into 2024, and we're looking at the entire business model in order to improve their financial results.
So we recognize the overall segment needs to improve. We believe we have the sort of business strategic alternatives in place, and we're going to be executing them. And again, it's just a choppy year as we make that transition.
Operator: Our next question comes from Gary Ransom with Dowling & Partners.
Gary Ransom: I wanted to ask about Financial Lines. On the one hand, you noted that rates are going down in that segment. And on the other hand, you were talking about social inflation. And I mean, just generally, it seems to be as worrisome as ever. I know your reserves held up this quarter, but it's like we're in a soft market for those financial lines. And I wondered if you could add some more color on how you're managing through that portion of the cycle in that business.
Peter Zaffino;Chairman and CEO: Sure. Yes, thanks, Gary, for the question. And I'll have Dave make some specific comments. When we talk about the headwinds in Financial Lines, and again, Dave will go into it, but it's primarily North America and it's primarily excess. We've done a tremendous job over the past couple of years to reposition the business and not only with the underwriting, but also with cumulative rate. And so we still think there's margins, still think our scale and balance across the world is a competitive advantage. And when we talk about some of the challenges in Financial Lines, it's really specific to North America.
Dave, do you want to provide some context in a little bit more detail, please?
David McElroy: Yes. Yes, thank you, Peter. And thank you, Gary. The -- this is obviously a business that I've got a lot of scar tissue in over a lot of 40 years of this. And I sometimes think of my career credibility tied into fixing this book, but I am very confident with where we have positioned the book, okay?
The -- we've taken a cautious approach to the large account public company D&O business and particularly excess, Gary, that you've referred to. So we're aware of the consequences of chasing volume, okay? We've seen companies go close to the sun, they burn out, where that's our sophistication.
So the -- what we're doing here, private -- public company, D&O, the market, the private, their primary market is, frankly, a stable market, okay? It's holding up well. Cumulative rate increases, even though they went up 120% from the '18 to '21 year, they're trending around 85% today, and they're holding, okay? This is going to be about a story about excess.
And I do want to frame this that in that primary market, there are a couple of key points that are also holding and that's retentions are holding up very nicely, okay? There hasn't been an erosion in the self-insured retentions that clients are keeping. And we look at that as sort of an acting hedge against legal cost inflation.
And then the other fact that I've always been worried about is the arms race back to limits. And this industry did a great job, and I believe there was respect for this volatility by taking 25 million limits down to 10s and 15s down to 5s. So even today, our portfolio is in the 80% to 90% range of those limits on a primary basis. And therefore, the arms race to increasing limits, which is often led by those who may not understand the volatility, that has not happened, okay? So that's a win for the primary.
I'm going to be -- I'll call out the excess because the battles and the competition in this market are classic, okay? These are tranches above $50 million. It's a commodity. We're seeing more competition there. And we're -- what we're going to do is we're going to do what we've been doing, reducing our limits, reducing our policy count. Our renewal retention right now is actually running 11 points lower than what would be normal in a standard market. And we're going to continue that way, not only on a policy count basis, but an aggregate -- in an aggregate basis.
The 2 things I just called out, everybody knows that I've lived in this business for a bit, I'd call out the claim environment in the market, okay? The market may be mistiming the pricing of excess layers, okay? The plaintiffs' bar has circled back to large account. Securities class actions, they're actually up this year and looking more like the '16 to '19 cohort years, which are problematic for the industry versus the 2022 years. So it's one to be concerned about because that verticality of loss will actually affect the excess towers that are not going to be making money at [ $8,000 a mill ].
So this environment is not conducive to be putting out limits excess at those layers. And maybe the more important thing is about our AIG global book, okay? It is a formidable asset. And we had the heightened scrutiny on the North American book. We're confident around what that looks like. But the International book is a franchise that you could not duplicate in generations.
It's performed better than the U.S. It's got -- it's actually larger than the U.S. book. It actually represents 60% of our total volume in the world. It has more geographic spread, particularly in Europe and Asia Pac. And it actually catches more private company business, SME business and middle-market cyber business than you might think in North America. So -- and other than some of the London subscription pricing, the pricing pressure there has been de minimis. And in fact, our rates are holding up better than 2023.
So I always feel like when I got here, I didn't understand the impact and the power, but the AIG global franchise is an incredible asset, and it also is one that we have coordinated better to make sure that any sort of U.S. exposures are controlled collectively by both of us. So in some special asset, it's been built over 2 generations. We like what it is. We like the portfolio today. And it's -- there's been 5 years of work to frame this book to where we all trust it. And we trust the recent years for their performance, okay?
Kicking back to you, Peter. I know I went long.
Peter Zaffino;Chairman and CEO: Thank you, David. Very thorough. Appreciate it. Gary...
Gary Ransom: Yes, that's a very thorough answer. I'm good. I mean I'm good with that.
Operator: Our next question comes from Alex Scott with Goldman Sachs.
Taylor Scott: First one I had for you is on sort of capital management related to Corebridge separation. I appreciate there's volume constraints, and it's good to have some guidance around how much capacity you can do in terms of buybacks a quarter. I did want to probe you a bit on to what degree, if at all, that, that considers further kind sell-down at Corebridge and sort of further special dividends coming out of Corebridge and so forth.
I mean I think the math would tell us that you could potentially do more than $1.5 billion a quarter, particularly for like next year over 4 quarters. And I'm just a little sensitive to it because it affects sort of accretion dilution and just the lag and what to expect. So I want to make sure we have appropriate expectations around the timing of that share count reduction and so forth. So any help is very appreciated.
Peter Zaffino;Chairman and CEO: Yes, thanks very much for the question. I mean we tried to provide between Sabra's script and in my prepared remarks a lot of detail on capital management and also the additional liquidity where we're going to have from the special dividend from the Validus Re disposition and overall how we intend to use those proceeds. And it remains the same is we want to make sure that we provide ample capital in our subsidiaries to continue to drive growth. We still think there's great opportunities for us in the businesses that we're in to drive top line growth and continue to drive profit growth and more margin, and that is our primary focus.
We've also given guidance in terms of the share count. And clearly, with the 7.5 billion of share authorization and now with the liquidity that we've outlined, we have a path towards that lower end of the 600 million. And so when we think about the next several quarters, certainly that's going to be the priority.
Sabra and I alluded to the fact that we still want to clean up a little bit of debt and make sure that we're at the lower end of the ratios, but also reflecting that buying back shares is going to have an impact on your leverage and making certain that we are being thoughtful, prudent in getting ahead of that.
In terms of the Corebridge sell-down, I mean we've been very methodical. Certainly, we would like to do something in the fourth quarter. We continue to look at all the different alternatives in terms of size and how we can do it. And it will be a priority for us to focus on when we conclude this call and start to focus into next week.
I mean Corebridge has done a terrific job of setting itself up as a public company. And they're ready for deconsolidation in terms of their operations, but we want to make certain that we are very thoughtful in the current environment. And again, we'll use those proceeds to continue to accelerate what we've outlined on the capital management.
I would expect, as we do a secondary and we get on future calls, we'll update and refresh some of the capital structure and also our guidance to see if we need to revise it. But I think that's probably all I can give you at this point.
Taylor Scott: Yes, that's helpful. Second question I had is on the, I guess, the operating company level on the RemainCo General Insurance side of things. Where do you see those metrics over time? I mean one of the things that I've looked at is just decomposing the ROE, and the underwriting leverage itself seems lower at AIG, which made all the sense in the world as you guys had more volatility.
But as you sort of expressed in your opening comments and as you guys have sort of proven out, the volatility is significantly reduced. So where can that go to over time? What are the right metrics for us to look at? Is it RBC premium to surplus? Any help on thinking through how much more business you could write on the equity you have?
Peter Zaffino;Chairman and CEO: Yes. Well, we could write significantly more business based on the capital we have in the subsidiaries today. We have a lot of moving pieces. I mean, certainly, selling Validus Re gives us a lot more flexibility in terms of how we position the portfolio for next year.
And so I'll give you a couple of examples of that is that we underwrite property business where we pick up CAT across the world, whether it's Japan, our International business through Lexington, through Talbot, through our retail in North America. But we always had to be very cautious in terms of the overall volatility in terms of how we're correlated with Validus Re, including our reinsurance purchasing where we had certain retentions that might be lower than what our risk tolerance would assume within North America and International. We bought ILWs that benefited the group.
And so like as we think about how we reposition the portfolio, I believe we have a significant amount of aggregate. We have a significant amount of capital. We have businesses that are positioned to propel growth and want to focus on that.
Now maybe the first part of your question is, what type of leverage or how can you improve it? We recognize we have an expense issue. I mean when we look at the overall combination of our corporate expenses plus the expenses that sit in the business, yes, there's a little bit of a mix issue that when you look at some of the Personal Insurance, which are great businesses, and International may have a little bit more acquisition and GOE, but by and large, we need to get expenses out.
And that's the focus. That will be the leverage in terms of contributing to ROE and also getting a future-state business that is leaner and does not have duplication across the world. I mean so that's the work we've been doing this year. We will be positioned pre-deconsolidation to start implementing that operating model.
But I think the leverage is we have enough capital to grow, and we'll continue to grow the top line where we like the risk-adjusted returns, less volatility because we don't have a reinsurance business anymore. So we can do things a little bit differently on the primary side. And we know we have expenses that need to get out, and we're going to get them out, and that's going to drive us north of the 10% ROCE.
Operator: Our next question comes from Michael Zaremski with BMO.
Michael Zaremski: My question is kind of on some points that were touched on already on the portfolio transformation strategy, which has obviously been successful over the past 5 years. So Peter, you used the T word, trillion, you said $1.4 trillion limit reduction. So just curious, I think David gave us a flavor of this answer, but does that -- is there a way to frame what percentage limit reduction your average -- this average policy is? It sounded like David said it's over 50% in some of those Financial Lines?
And just related, like how is that -- was AIG an outlier previously and you moved towards the market? Or just how has this changed your competitive position in the marketplace?
Peter Zaffino;Chairman and CEO: Yes. I think you recognize how we were able to reduce volatility. When you have -- I have to even pause when I have to write out trillion because it's a big number. And $1.4 trillion of limit, I don't think that's been done in our business before, and then reposition the portfolio to drive significant profitability improvement.
It absolutely was an outlier. Its gross limit deployment and net limit deployment was significant relative to any of its competitors. And in order to have the type of predictable results we've been able to produce over the past couple of years, when you see the relative improvement as well as absolute improvement, we are really proud of that. You had to take out the volatility, which was the outsized limits, not only from a gross perspective, and we recognize that.
While we talk about it is that, yes, we're a buyer of reinsurance, it's strategic, it matters, but it's not what's driving the results. The driver of the results is the gross underwriting and the overall reduction. Everywhere you look, property, casualty, financial lines, everything is 50% plus of reduction of gross limits. And then you add on reinsurance to temper volatility, that's how we've been able to position the portfolio to have not only significantly improved results, less volatility, it's also very sustainable. And we believe that there's opportunities for further improvement.
Michael Zaremski: Okay. Great. And my last, if I may, is on -- there's a lot of leadership changes over the past, right, years and quarters. I think Sabra used the term simplify structure. I guess any color you can offer on are we -- is the structure simplified, we're on baseball inning 4 or 9? Or any comments would be helpful.
Peter Zaffino;Chairman and CEO: Sure. Look, we've had a lot of change over the last 5 years. When I look at our overall attrition, it's at all-time low. We've had a couple of senior executives that we brought in to position the organization for the future and believe that the underwriting structure that we put forward is going to be with us for a couple of years. It's going to drive the performance that we've become accustomed to. And we'll continue to bring in skill sets in the organization that supplement what we already have in order to position us for the future.
So I'm like really very pleased. As I said, we have very low attrition, continue to upgrade talent across the organization. And people want to come work here, which is a really positive attribute of the organization and how we position it for the future.
So thank you. I do have one closing remark. First of all, I'm very proud, and I'd like to thank all of our colleagues for their efforts and all that they've done to progress our strategic plans and deliver consistently strong financial results. Very proud of them.
I would like to say a few words about our former Chief Financial Officer, Shane Fitzsimons, who passed away on Friday, October 27. Shane had a brilliant career. He was highly thought of in the global business community and quickly earned the trust and respect of the insurance industry, which is not easy to do.
He was a cherished colleague here at AIG. Shane brought energy, integrity and a very positive attitude that was both contagious and inspiring. He's a big reason why AIG is where it is today. Shane was a great friend to many of us, and we're so grateful for all that he did for AIG, our stakeholders and our colleagues.
Thank you, and have a great day.
Operator: Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Third Quarter 2023 Financial Results Conference Call. This conference is being recorded."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, and good morning."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Good morning, and thank you for joining us today to review our third quarter financial results. Following my remarks, Sabra will provide more detail on the quarter and then we will take questions. Kevin Hogan and David McElroy will join us for the Q&A portion of the call."
},
{
"speaker": "During my remarks this morning, I will discuss the following topics",
"text": "first, AIG's financial results, including Life and Retirement, and provide an update on recent divestitures; second, I will provide the results of AIG's General Insurance business; third, I will provide an update on the casualty insurance market more broadly and AIG's approach to our casualty portfolio; fourth, I will provide an update on our capital management strategy and the progress we have made this quarter. Sabra will provide more detail on AIG's balance sheet and capital position in her remarks. And lastly, I will reconfirm our guidance with respect to our path to a 10%-plus ROCE post deconsolidation of Corebridge."
},
{
"speaker": "Financial highlights from the third quarter included",
"text": "adjusted after-tax income was $1.2 billion or $1.61 per diluted common share, representing a 92% increase year-over-year. Consolidated net investment income on an adjusted pretax income basis was $3.3 billion, a 29% increase year-over-year. In General Insurance, net investment income was $756 million, a 30% increase."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. This morning, I will provide more detail on AIG's third quarter, including General Insurance reserves, net investment income, Life and Retirement results and balance sheet and capital management."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Sabra. And Michelle, we're ready for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "One question to start on reserves. I guess, what's the process for ensuring that the adverse development in International Commercial doesn't actually reflect social inflation problem and that it's individual cases?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Meyer, thanks for the question. Sabra, do you want to cover? That's just a quick overview of -- Meyer mentioned the International and some of the inflation impact from reserves."
},
{
"speaker": "Sabra Purtill",
"text": "Yes, certainly. And let me first start by explaining what the DVR process is. So DVR is a once-a-year deep-dive into our reserves. But each quarter, we do an actual versus expected analysis. So we do make adjustments to reserves on lines of business during the ordinary part of the year, but the deep-dive is where we really drill down into the lines in great detail."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Sabra. Meyer, do you have another question?"
},
{
"speaker": "Meyer Shields",
"text": "Yes, just a quick one. I know there's a lot of moving parts in North America Personal. I was hoping you could give us some sense of maybe true underlying underwriting results and the path to profitability in that segment."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Great. Thank you. As we've talked about before, it's a business in transition. We're not pleased with the overall printed results. But we had outlined in the past that it's complicated. 2023 would be a transition year, particularly with PCS, which we see a lot of net premium written coming in each quarter. The earned will follow, and so we should have some significant benefit on the ratios as we fully earn in the premium over the coming quarters."
},
{
"speaker": "Operator",
"text": "Our next question comes from Gary Ransom with Dowling & Partners."
},
{
"speaker": "Gary Ransom",
"text": "I wanted to ask about Financial Lines. On the one hand, you noted that rates are going down in that segment. And on the other hand, you were talking about social inflation. And I mean, just generally, it seems to be as worrisome as ever. I know your reserves held up this quarter, but it's like we're in a soft market for those financial lines. And I wondered if you could add some more color on how you're managing through that portion of the cycle in that business."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Sure. Yes, thanks, Gary, for the question. And I'll have Dave make some specific comments. When we talk about the headwinds in Financial Lines, and again, Dave will go into it, but it's primarily North America and it's primarily excess. We've done a tremendous job over the past couple of years to reposition the business and not only with the underwriting, but also with cumulative rate. And so we still think there's margins, still think our scale and balance across the world is a competitive advantage. And when we talk about some of the challenges in Financial Lines, it's really specific to North America."
},
{
"speaker": "David McElroy",
"text": "Yes. Yes, thank you, Peter. And thank you, Gary. The -- this is obviously a business that I've got a lot of scar tissue in over a lot of 40 years of this. And I sometimes think of my career credibility tied into fixing this book, but I am very confident with where we have positioned the book, okay?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you, David. Very thorough. Appreciate it. Gary..."
},
{
"speaker": "Gary Ransom",
"text": "Yes, that's a very thorough answer. I'm good. I mean I'm good with that."
},
{
"speaker": "Operator",
"text": "Our next question comes from Alex Scott with Goldman Sachs."
},
{
"speaker": "Taylor Scott",
"text": "First one I had for you is on sort of capital management related to Corebridge separation. I appreciate there's volume constraints, and it's good to have some guidance around how much capacity you can do in terms of buybacks a quarter. I did want to probe you a bit on to what degree, if at all, that, that considers further kind sell-down at Corebridge and sort of further special dividends coming out of Corebridge and so forth."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes, thanks very much for the question. I mean we tried to provide between Sabra's script and in my prepared remarks a lot of detail on capital management and also the additional liquidity where we're going to have from the special dividend from the Validus Re disposition and overall how we intend to use those proceeds. And it remains the same is we want to make sure that we provide ample capital in our subsidiaries to continue to drive growth. We still think there's great opportunities for us in the businesses that we're in to drive top line growth and continue to drive profit growth and more margin, and that is our primary focus."
},
{
"speaker": "Taylor Scott",
"text": "Yes, that's helpful. Second question I had is on the, I guess, the operating company level on the RemainCo General Insurance side of things. Where do you see those metrics over time? I mean one of the things that I've looked at is just decomposing the ROE, and the underwriting leverage itself seems lower at AIG, which made all the sense in the world as you guys had more volatility."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. Well, we could write significantly more business based on the capital we have in the subsidiaries today. We have a lot of moving pieces. I mean, certainly, selling Validus Re gives us a lot more flexibility in terms of how we position the portfolio for next year."
},
{
"speaker": "Operator",
"text": "Our next question comes from Michael Zaremski with BMO."
},
{
"speaker": "Michael Zaremski",
"text": "My question is kind of on some points that were touched on already on the portfolio transformation strategy, which has obviously been successful over the past 5 years. So Peter, you used the T word, trillion, you said $1.4 trillion limit reduction. So just curious, I think David gave us a flavor of this answer, but does that -- is there a way to frame what percentage limit reduction your average -- this average policy is? It sounded like David said it's over 50% in some of those Financial Lines?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. I think you recognize how we were able to reduce volatility. When you have -- I have to even pause when I have to write out trillion because it's a big number. And $1.4 trillion of limit, I don't think that's been done in our business before, and then reposition the portfolio to drive significant profitability improvement."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. Great. And my last, if I may, is on -- there's a lot of leadership changes over the past, right, years and quarters. I think Sabra used the term simplify structure. I guess any color you can offer on are we -- is the structure simplified, we're on baseball inning 4 or 9? Or any comments would be helpful."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Sure. Look, we've had a lot of change over the last 5 years. When I look at our overall attrition, it's at all-time low. We've had a couple of senior executives that we brought in to position the organization for the future and believe that the underwriting structure that we put forward is going to be with us for a couple of years. It's going to drive the performance that we've become accustomed to. And we'll continue to bring in skill sets in the organization that supplement what we already have in order to position us for the future."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone, have a great day."
}
] | American International Group, Inc. | 250,388 |
AIG | 2 | 2,023 | 2023-08-02 08:30:00 | Operator: Good day, and welcome to AIG's Second Quarter 2023 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause these actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change.
Today's remarks may also refer to non-GAAP financial measures. Reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com.
Finally, note today's remarks as they related to net premiums written in General Insurance are presented on a constant dollar basis and where applicable, are also adjusted for the lag elimination in International that is described in our earnings release and related documents. Additionally, today's remarks will include results of AIG's Life and Retirement segment and Other Operations on the same basis as prior quarters, which is how we expect to continue to report until the deconsolidation of Corebridge Financial.
AIG segments and U.S. GAAP financial results as well as AIG's key financial metrics with respect thereto differ from those reported by Corebridge Financial. Corebridge Financial will host its earnings call on Friday, August 4.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino: Good morning, and thank you for joining us to review our second quarter financial results. Following my remarks, Sabra will provide more detail on the quarter, and then we will take questions. Kevin Hogan and David McElroy will join us for the Q&A portion of the call.
I am very pleased to report that AIG delivered another exceptional quarter with strong financial performance. In addition, we made significant progress on our strategic priorities that are strengthening AIG for the future. We again demonstrated our ability to deliver high-quality outcomes while executing on multiple complex initiatives during very difficult market conditions.
I would like to start with financial highlights from the second quarter. Adjusted after-tax income was $1.3 billion or $1.75 per diluted common share, representing a 26% increase year-over-year and the best quarterly adjusted EPS result for AIG since 2007.
Net premiums written in General Insurance grew 11%, led by our Commercial business, which grew 13%. Underwriting income in the quarter was approximately $600 million. The adjusted accident year combined ratio ex cats was 88%, a 50 basis point improvement year-over-year and the best result for AIG since 2007. Our cat loss ratio was 3.9% or $250 million of catastrophe losses, a terrific result against the backdrop of a very challenging cat quarter for the industry.
The Life and Retirement business reported very good results in the second quarter. Adjusted pretax income was $991 million, up 33% year-over-year. And premiums and deposits were over $10 billion, a 42% increase year-over-year, supported by record sales of Fixed Index Annuity products.
Consolidated net investment income on an APTI basis was $3.3 billion in the second quarter, a 31% increase year-over-year. In General Insurance, net investment income was $725 million, a 58% increase.
AIG returned $822 million to shareholders in the second quarter through $554 million of common stock repurchases and a $268 million of dividends, which reflects a 12.5% increase in our quarterly common stock dividend that we announced on our last call. As you saw in our press release, the AIG Board of Directors approved an increase to our share buyback authorization to $7.5 billion, which reflects our commitment to returning capital to shareholders, consistent with the capital management strategy we have previously outlined.
Lastly, our balance sheet remains very strong. And we ended the quarter with $4.3 billion in parent liquidity. During the remainder of my remarks this morning, I will provide more information on the following 5 topics. First, the significant strategic actions we took in the second quarter to reposition AIG. During that review, I will provide additional details on the divestitures of Validus Re and Crop Risk Services, the launch of Private Client Select as an MGA serving the high and ultra-high net worth markets and the actions we took with respect to Corebridge.
Second, I will discuss financial results for General Insurance. Third, I will give an overview of the results for Life and Retirement. Fourth, I will provide an update on capital management. And lastly, I will reconfirm our guidance with respect to our path to a 10%-plus ROCE post deconsolidation of Corebridge.
Turning to the strategic actions we executed on. I will start with Validus Re. In May, we announced the divestiture of Validus Re and AlphaCat to RenaissanceRe for approximately $2.75 billion in cash and $250 million in RenRe common stock. We expect to close this transaction in the fourth quarter, subject to regulatory approval.
We're very pleased to have RenRe as the acquirer. RenRe is a very important partner to us, a company with a terrific reputation. And we value the strong relationship we have with Kevin and his management team. We believe RenRe will be an excellent owner of Validus Re.
Now let me provide some highlights on our rationale for the divestiture. We acquired Validus in 2018, which at the time provided AIG with business diversification not limited just to reinsurance but also attractive specialty businesses, including Talbot and Western World, which were not part of the sale to RenRe and will remain with AIG.
Since 2018, we transformed Validus Re by reunderwriting the portfolio, leading to significant premium growth and improved profitability. In addition, we dramatically changed the business mix of the portfolio to achieve a more attractive balance among property, casualty and specialty businesses, improved geographic diversity and decreased peak zone exposures.
For AIG, this divestiture represents a key milestone on our journey as it further streamlines our business model, simplifies the structure of our global portfolio, substantially reduces volatility, which I will explain in a moment, generate additional liquidity and capital efficiencies and accelerates our capital management strategy. Due to the nature of assumed reinsurance and the portfolio mix of Validus Re, this business is capital-intensive and disproportionately contributes to AIG's overall volatility and PMLs.
As we have discussed over the past few years, the core objectives of the property and casualty turnaround were: to substantially improve the overall quality of AIG's global portfolio and underwriting results; reduce volatility through a massive reduction in growth limits written; better manage peak zone exposures and geographic balance; and strategically use reinsurance across our overall business. A turnaround of this magnitude is made harder when you have a treaty reinsurance business, which, by its very nature, has volatility.
We have completed a rigorous enterprise-wide modeling exercise using RMS version 21 to approximate the PMLs for AIG post closing, and all categories will significantly reduce. This analysis took into account AIG's exposure, Validus Re's exposure as of February 1, 2023, and combined output for both companies on an occurrence and aggregate basis.
Let me provide a few examples of the model output for AIG post closing of the Validus Re sale on an occurrence basis. For worldwide, all perils, net PMLs were reduced by 45% at the 1-in-250 return period. Worldwide hurricane PMLs will reduce by 60% at the 1-in-250 return period and by 70% at the 1-in-100 return period.
North America hurricane PMLs will reduce by 70% at the 1-100 return period. North America earthquake PMLs will reduce by 55% at the 1-250 return period. Japan typhoon PMLs will reduce by 50% at the 1-100 return period. Japan earthquake PMLs will reduce by 50% at the 1-250 return period. And for EMEA, all PMLs will decrease by 85% at the 1-250 return period and 75% at the 1-100 return period.
In addition to the strategic repositioning of our portfolio, there were several additional components that made the sale of Validus Re appealing for AIG. The required tangible equity that AIG will deliver to RenRe upon closing, which is $2.1 billion, is substantially below what Validus Re would have required if the business remained at AIG.
We will receive $900 million above the book value of Validus Re, which reflects the improved quality of the portfolio since AIG's purchase of the business in 2018. We also expect to receive, through a pre-closing dividend, excess capital in the legal entities being transferred to RenRe, which we estimate will be approximately $200 million.
In addition, a $1 billion intercompany loan from Validus Re to AIG will be settled through internal dividends, and we expect AIG to benefit from a $400 million reduction in risk-based capital requirements following the closing. As part of the transaction, AIG will retain 95% of future reserve changes in the portfolio delivered at closing. We will receive the benefit of future reserve releases as the portfolio matures, and we will likely purchase an adverse development cover prior to the closing to minimize potential future reserve exposure.
In the second quarter, we also announced and closed the sale of Crop Risk Services to American Financial Group for $240 million in cash. Crop Risk Services was part of the Validus acquisition in 2018. Over the remainder of the 2023 crop season, AIG will continue to benefit from earned premium for crop business booked since the start of the year. But as we enter 2024, this business will no longer have an impact on AIG's financial results.
Next, I want to provide more detail on the formation of Private Client Select as an MGA, which is now referred to as PCS. The MGA has officially launched, and we expect to add new capital providers in the coming quarters. We believe the MGA structure is ideal for PCS as it creates flexibility and alternatives for clients, agents and brokers in an environment that's becoming more complex.
The high and ultra-high net worth markets PCS is focused on have significant foundational challenges include loss cost pressure, inflation, increased cat exposure through increased total insured values and more concentration in peak zones, and primary and secondary peril modeling has been [indiscernible]. AIG will continue to support the MGA. And because we will be assuming risk on our balance sheet, we've established the MGA's risk framework, which is designed to improve its financial performance in 2023 and as we enter 2024.
Overall, we are pleased with the progress we've made with Stone Point Capital on this MGA structure. And we're well positioned to accelerate the business plan through the remainder of the year.
Moving to Corebridge. In June, we completed a secondary offering of Corebridge common stock with gross proceeds to AIG of $1.2 billion. The offering was well received by the market. And the new owners included a strong mix of long-term holders, which we believe results in a more stable and well-diversified shareholder base for Corebridge.
Also in June, Corebridge announced and paid a $400 million special dividend in addition to its $150 million ordinary quarterly dividend and completed the repurchase of $200 million of common stock from AIG and Blackstone. AIG's net proceeds from these actions were approximately $540 million.
At the end of the second quarter, our ownership stake in Corebridge was approximately 65%. These actions demonstrate our commitment to deconsolidation and eventually full separation. As we noted on our last call, we continue to explore all options with respect to our remaining ownership of Corebridge that are aligned with the best interest of shareholders.
Turning to other strategic actions we are taking in Corebridge. The previously announced sale process for Laya Healthcare, the private medical insurance business in Ireland that is part of Corebridge, is proceeding very well. We expect to announce a positive outcome from this process in the near term and expect that the proceeds from this divestiture will largely be used for a special dividend to Corebridge shareholders.
Additionally, we recently retained advisers to analyze strategic alternatives for the disposition of the U.K. Life business that is part of Corebridge. The dispositions of Laya and U.K. Life will streamline the Corebridge portfolio and allow its management team to focus on core Life and Retirement products and solutions in the United States.
Turning to General Insurance. We had another quarter of strong growth in both gross and net premiums written. Gross premiums written were $10.4 billion, an increase of 11%. Global Commercial, which represents 80% of gross premiums written, grew 15%. And Global Personal decreased 1%.
Net premiums written were $7.5 billion, an increase of 11%. This growth was driven by Global Commercial, which grew 13% while Global Personal grew 5%. In North America Commercial, we saw a very strong growth of 18% in net premiums written. Excluding Validus Re, net premiums written growth in North America Commercial was 13%. The major drivers were as follows: Retail Property, which grew over 50%; Validus Re, which grew 32%; and Lexington, which grew 18%, led by wholesale property and casualty.
I would like to provide a few additional details about Lexington's growth, given it continues to be an important part of AIG's strategy. Property grew 38% year-over-year driven by very strong retention in new business as well as strong rate increases. Submission activity was up over 30% year-over-year. Casualty grew 41%, supported by strong retention in new business, and its submission count was up over 90%.
In International Commercial, net premiums written grew 6% primarily driven by property, which was up 34%; Talbot, which was up 17%; and Global Specialty, which was up mid-single digits, which reflected the impact of additional reinsurance purchasing in the second quarter.
Global Commercial had very strong renewal retention of 88% in its in-force portfolio. International was up 200 basis points to 88%, and North America was up 200 basis points to 87%. As a reminder, we calculate renewal retention prior to the impact of rate and exposure changes.
And across Global Commercial, we continue to see strong new business, which was approximately $1.1 billion in the second quarter. North America Commercial, excluding Validus Re, produced new business of approximately $600 million, an increase of 10% year-over-year.
This growth was driven by Lexington property, which saw excellent new business growth of over 40%. Retail Property had over 50% new business growth, offset by Financial Lines, where new business contracted by over 35%.
International Commercial new business was $485 million, which grew 5%. This growth was led by Talbot new business, which increased over 100% year-over-year and property, which grew new business by 40%, offset by Financial Lines where new business contracted by over 20%.
As I noted on our last call, we continue to see headwinds in certain aspects of Financial Lines due to increased competition putting pressure on pricing. Despite these continuing dynamics, we remain disciplined on risk selection, terms and conditions and price while taking a long-term view on this line of business by not following the market down.
Moving to rate. In North America Commercial, excluding Validus Re, rate increased 8% in the second quarter or 9% if you exclude workers' compensation, and the exposure increase was 2%. Rate increases were driven by Lexington wholesale, which was up 23% with wholesale property up over 35% and Retail Property, which was up 30%.
In International Commercial, rate increased 9%, and the exposure increase was 1%. The rate increase was driven by property, which was up 21%; Talbot, which was up 14%; and Global Specialty, which was up 11% driven by global energy, which was up 21%. Rate plus exposure was 10% in North America, 11% if you exclude workers' compensation and 10% in International, which in each case remains above loss cost trend.
Turning to Personal Insurance. Note that second quarter results in North America Personal reflected the fact that PCG was transitioning to become Private Client Select. North America Personal net premiums written increased 17% primarily driven by lower quota share sessions in PCG, offset by decreases in travel and warranty. Overall, we had strong growth in net premiums written of 17% with PCG net premiums written growing over 60%.
With PCS now officially launched as an MGA, there are several components of AIG's business in the high and ultra-high net worth markets that will result in improved financial performance for AIG over the balance of 2023. First, as we outlined in prior calls, over the last few years, we evolved the model for our high and ultra-high net worth business such that we expect net premiums written to grow significantly over the remainder of the year with our current expectations showing net premiums written increasing over 75% in the third and fourth quarters.
Second, the lag and earned premium growth that we saw in the first quarter of 2023 dissipated. And we saw a 36% growth in earned premium in the second quarter. And we expect that earned premium growth will continue to accelerate in the third and fourth quarter. The additional earned premium will provide operating leverage, which will reduce our GOE ratio in the third and fourth quarter.
Third, AIG has [indiscernible] costs from the transition of PCG to an MGA. And we expect to eliminate these costs over the next 18 months.
Fourth, we expect the accident year loss ratio for our high and ultra-high net worth business will improve with the combination of improved pricing in our admitted business and more business migrating to the non-admitted market, which already had a very positive impact on PCG's accident and policy year loss ratios in prior quarters. This should earn in for our high and ultra-high net worth business through the second half of 2023 and into 2024.
In International Personal, net premiums written increased 1% year-over-year. The modest growth was driven by travel and personal property in Japan. Overall, our key focus continues to be growing Accident & Health and our business in Japan.
Shifting to combined ratios. As I noted earlier, the second quarter accident year combined ratio ex-CATs was 88%, a 50 basis point improvement year-over-year. In Global Commercial, the second quarter accident year combined ratio ex-CATs was 84.4%, a 90 basis point improvement year-over-year.
The North America Commercial accident year combined ratio ex-CATs was 85.1%, a 310 basis point improvement year-over-year. And the International Commercial accident year combined ratio ex-CATs was 83.1%, which continues to be an outstanding level of profitability. Global Personal reported a second quarter accident year combined ratio ex-CATs of 98.1%, a 170 basis point increase from the prior year quarter, largely due to a decrease in earned premium.
Now I'd like to provide some context around midyear reinsurance renewals and recent conditions in the reinsurance market before moving to Life and Retirement. We purchased our major reinsurance treaties at January 1. However, approximately 20% of our overall core reinsurance purchasing occurs in the second quarter as we have a number of core midyear renewals, predominantly in specialty classes, and they were all successfully placed.
In addition, we decided to purchase additional retrocessional protection for Validus Re and a low excess of loss reinsurance placement for Private Client Group ahead of the wind season. Overall, the market exhibited more orderly behavior during midyear renewals amidst more stable trading conditions compared to January 1. Reinsure appetite for more discrete purchases increased somewhat, enabling a number of buyers to make up for shortfalls in coverage experienced at January 1.
Overall, midyear property cat pricing increased 25% to 35% year-over-year in the U.S. driven by Florida. This was the second year in a row of substantial rate increases. International renewals, driven by Australia and New Zealand, saw price increase 20% to 50% with higher increases resulting from loss activity in the region.
In previous calls, I touched on the increase in catastrophe losses from secondary perils. Through the first half of 2023, the industry has already experienced over $50 billion of insured losses, the majority of which were due to secondary perils, making 2023 already the fourth highest year on an inflation-adjusted basis.
A majority of insured losses continue to occur in the United States, highlighting the difficulty of managing volatility in the largest insurance market in the world. Against this challenging backdrop and a strengthened reinsurance rating environment, we maintained our conservative risk appetite and continue to have one of the lowest peak peril net positions in the market while managing our overall reinsurance spend.
Additionally, through each of our renewals, we maintain all of our principal relationships with our key reinsurance partners. While we are exiting the assumed reinsurance business through the sale of Validus Re, our ownership of RenRe common stock that we will receive as part of the purchase price consideration, coupled with our ability to invest up to $500 million in RenRe's capital partner vehicles, will allow us to continue to participate and benefit from partnering with a world-class reinsurer with less risk and capital requirements.
Turning to Life Retirement. As I noted earlier, the business produced very good results in the second quarter. Adjusted pretax income was $991 million. And adjusted return on segment equity was 12.2%, representing a 250 basis point improvement year-over-year.
Premiums and deposits grew 42% year-over-year to $10 billion driven by record Fixed Index Annuity sales. Corebridge ended the quarter with a strong balance sheet with parent liquidity of $1.6 billion and a financial leverage ratio of 28%. Over the second quarter, we continue to make good progress against the Corebridge operational separation so that it can eventually be a fully standalone company.
A key focus has been executing against IT separation, which we believe will be substantially complete by the end of this year. To date, approximately 55% of the transition service agreements put in place at the time of the IPO have already been exited.
Now turning to capital management. As I noted earlier, in the second quarter, we returned approximately $822 million to shareholders through common stock repurchases and dividends. And the additional $400 million of common stock we repurchased in July brings a total amount of capital we've returned to shareholders since the beginning of the second quarter to over $1.2 billion.
In addition, we continue to focus on maintaining well-capitalized subsidiaries to enable profitable growth across our global portfolio. And we remain committed to having a leverage ratio in the low 20s and a share count between 600 million to 650 million post deconsolidation of Corebridge.
The additional liquidity we will have following the closing of the sale of Validus Re will largely be used for share repurchases, which we expect to accelerate beginning in the fourth quarter and as we enter 2024. We also plan to use some of the proceeds from the sale of Validus Re to reduce outstanding debt.
Lastly with respect to ROCE. We remain highly committed to delivering a 10%-plus ROCE post deconsolidation of Corebridge. During the second quarter, we continued to make meaningful progress on all 4 components of our path to deliver on this commitment. As a reminder, these are sustain and improve underwriting profitability; executing on a simpler, leaner business model across AIG with lower expenses across the organization; operational separation and deconsolidation of Corebridge; and continued balanced capital management. The sequencing of each component has been very important.
We are now able to accelerate this work with the GI underwriting turnaround, AIG 200 and the investment group restructuring largely behind us and the operational separation of Corebridge further along, in addition to divestitures, which I've already outlined. As I stated on our last call, we're moving away from AIG's historical conglomerate structure to being a leading global insurance company with a leaner and better defined parent company.
We continue to expect approximately $500 million in cost reductions across AIG with a cost to achieve of approximately $400 million with substantially faster earn-in of savings than we saw with AIG 200. Sabra will provide more details on our path to a 10%-plus ROCE in her remarks.
Overall, I could not be more pleased with our progress and what we've accomplished in the first half of the year. Our strong momentum continues, and we have a very solid foundation to build on for the future.
Now I'll turn the call over to Sabra.
Sabra Purtill: Thank you, Peter. This morning, I will provide more detail on second quarter results, including net investment income and underwriting performance, provide a balance sheet update and review the drivers of our path to a 10%-plus adjusted ROCE.
Starting with second quarter results. As Peter noted, adjusted after-tax income was $1.3 billion, up 15% from last year or an annualized adjusted ROCE of 9.4%. Adjusted after-tax income per diluted share was $1.75, up 26% from last year, reflecting the impact of share repurchases on EPS.
Second quarter results were consistent with recent trends: strong underwriting margins and higher net investment income in General Insurance; increased base investment yields; and spreads and strong sales in Life and Retirement and continued expense reduction in balanced capital management and Corporate and Other.
Turning to net investment income. On an APTI basis, investment income improved significantly, up 31% from last year and up 7% sequentially on a consolidated basis and also rose in each segment. Reinvestment rates are driving higher yields. The average new money yield was 5.46%, about 210 basis points above the yield on sales and maturities.
In General Insurance, this increased the yield on the fixed maturities and loan portfolios 93 basis points over last year and 23 basis points sequentially. In Life and Retirement, the yield improved 75 basis points and 15 basis points, respectively.
Alternative investment returns also improved this quarter, although they remain below our long-term outlook totaling $147 million for an annualized return of 6.0%. Credit performance has been strong with more upgrades than downgrades in the fixed maturity portfolios and continued derisking of lower-rated assets.
Commercial property valuations continue to face downward pressure from higher cap rates, which impacts loan to values on commercial mortgage loans and investment returns on real estate equity funds. However, debt service coverage ratios are holding up well and are generally strong across the portfolio, including office.
Turning to General Insurance. APTI was $1.3 billion, up $62 million from the prior year. Net investment income rose by $267 million. And underwriting income for the current accident year, excluding catastrophe losses, were $73 million.
Total catastrophe losses were $250 million, up $129 million and included $56 million of first quarter CAT mostly from U.S. events, including a tornado that occurred at quarter end. This was a very solid result, as Peter noted, given the high level of industry catastrophe losses, particularly in North America.
North America cat losses were $159 million, while International totaled $91 million, largely from Typhoon Mawar. During the second quarter, we conducted North America casualty DVRs, or detailed valuation reviews, which reviewed about 20% of reserves compared to 15% last year.
In our DVRs, we focus on changes in frequency and severity trends, including social and other types of inflation as well as changes in claims trends and settlements such as occurred during COVID. As we noted previously, casualty bodily injury and medical workers' comp trends in our book have been and continue to be more favorable than our reserving assumptions.
Our approach in these situations is to react quickly to adverse development, but to be conservative and wait to recognize favorable trends until accident years are more mature. We maintain the same approach for the COVID accident years where claims development patterns in many casualty lines slowed.
For those years, we have lagged our development factors to allow more time for claims patterns to mature as we are taking the conservative position that industry claims experience will revert to pre-COVID patterns. In addition to the results of the DVRs, prior year development also includes amortization of the ADC gain, changes in prior year catastrophe losses and impacts from loss-sensitive lines that are not related to DVRs.
In this quarter, prior year development net of reinsurance and prior year premiums was $25 million favorable. This was made up of $115 million of favorable loss reserve development, partially offset by $90 million of prior year return premium. The lower favorable development compared to last year is mainly attributable to the excess workers' compensation DVR, which was favorable by about $75 million in second quarter last year but is being completed in the third quarter of this year.
Our favorable loss reserve development included $167 million from North American Commercial Lines, including $41 million of ADC amortization, $50 million of favorable development from our Agrium loss-sensitive portfolio and $74 million of favorable development resulting from North America DVRs. This was partially offset by $62 million of unfavorable development in International Commercial Lines, principally from a multiyear legacy casualty policy that was written with much higher limits than we do today.
In the third quarter, DVRs will cover nearly 70% of reserves, including Financial Lines. Financial Lines claims have not returned to the levels we experienced pre-COVID, which we believe reflects improved underwriting, better loss selection, continued ventilation of risk, our reinsurance strategy and achieving appropriate levels of rate.
With respect to underwriting. AIG's share of U.S. public company D&O securities class actions where we are the primary insurer is down from 42% in 2017 to about 20% at the end of the second quarter of this year.
With respect to rate. Since 2018, the compounded increases in the Financial Lines portfolio for corporate and national accounts are greater than 60% and 50%, respectively. However, consistent with our conservative approach, in addition to the lag development factors, we are placing more weight on longer-term experience and balancing out more favorable recent trends.
Turning to Life and Retirement. As Peter noted, second quarter results were strong with APTI up 30% over 2Q '22, driven by higher spread in underwriting margins and strong sales in Fixed Index Annuities. Both spreads and underwriting margins remain attractive, and fee margins improved with more favorable capital market levels compared to last year.
Base net investment spreads in Individual and Group Retirement continued to widen with 64 basis points improvement year-over-year and 9 basis points sequentially driven by reinvestment rates. Individual Retirement APTI increased $215 million or 58% from 2Q '22 driven by base spread expansion and growth in general account products. Positive net flows to the general account were about $400 million.
Group Retirement APTI grew by $21 million or 12% driven by continued base spread expansion despite negative flows in the general account. Life Insurance APTI decreased $42 million, or 35%, primarily due to lower other yield enhancement income, partially offset by improved base portfolio returns and marginally favorable mortality experience. Institutional markets delivered very strong results with APTI up $50 million or 65% driven by investment income and reserve growth. Second quarter premiums and deposits reached $2.9 billion with $1.9 billion of pension risk transfer activity and $970 million of GIC transactions.
Turning to AIG's Other Operations. Second quarter adjusted pretax loss improved by $41 million over last year driven by an $80 million improvement in corporate and other due to the 4Q '22 sale of legacy investment portfolios that had losses of $119 million in 2Q '22. Corporate general operating expenses of $242 million included $67 million of Corebridge expenses, including separation expenses. Excluding Corebridge and separation-related expenses, corporate GOE decreased $19 million from the prior year.
Moving to the balance sheet. We continue to execute on our balanced capital management strategy with share repurchases, an increase in our common stock dividend and repayment of maturing debt. We ended the quarter with AIG parent liquidity of $4.3 billion.
We remain committed to maintaining strong capitalization in our insurance subsidiaries to support risk and growth. The General Insurance U.S. pool risk-based capital ratio is estimated in the 470% to the 480% range, and Life and Retirement is projected to be above its 400% target.
We repaid a $388 million debt maturity in the second quarter and continue to target debt leverage in the low 20s post deconsolidation of Corebridge. At June 30, consolidated debt and preferred stock to total capital, excluding AOCI, was 26.0%, including about $9.4 billion of Corebridge debt. Book value per common share was $58.49 on June 30, 2023, up 6% from year-end. Adjusted book value per common share was $75.76 per share, flat from year-end.
Turning to ROCE. We remain intently focused and are making progress on achieving a 10%-plus adjusted ROCE post deconsolidation. Year-to-date, annualized adjusted ROCE for AIG was 9.1% on a consolidated basis and 11.8% in General Insurance and 11.4% in Life and Retirement.
Capital management and rightsizing our equity base for AIG post deconsolidation are material levers for achieving our adjusted ROCE goal. In the near term, we will accelerate share repurchases in the fourth quarter and into 2024 with the additional liquidity from Validus proceeds, in addition to ordinary course liquidity generated by our business operations through subsidiary dividends and ongoing profitability.
We will balance these share repurchases with additional debt reduction consistent with our leverage target. We are committed to achieving a share count between 600 million and 650 million shares post deconsolidation, which we will be able to achieve with the increase in our share repurchase program to $7.5 billion.
Based on the size, risk profile and profitability of our General Insurance business and holding company needs today, we estimate a pro forma GAAP equity base, excluding AOCI, of approximately $40 billion for AIG ex-Corebridge. This is inclusive of about $4 billion in deferred tax asset NOLs that we exclude for adjusted common shareholders' equity calculation.
Considering this equity level and our plans to simplify AIG's business and operational structure, reduce volatility and drive more predictable and sustainable profitability, we are confident that we will achieve our adjusted ROCE goal. We look forward to continuing to update you on our progress.
With that, I will turn the call back over to Peter.
Peter Zaffino: Thank you, Sabra. And operator, we're ready for questions.
Operator: [Operator Instructions] Our first question comes from Paul Newsome with Piper Sandler.
Jon Paul Newsome: Congrats on the quarter. I was hoping we could focus in on the general -- the North American Commercial business a little bit. I'm getting some questions about the growth. If you sort of assume a certain amount of growth is related to the price increases sort of ex-Validus and whether or not we saw a fair amount of growth -- just sort of if you normalize [indiscernible] Validus. Sorry, I know you gave a lot of detail there, but maybe if you could kind of simplify it for -- that'd be fantastic.
Peter Zaffino: Sure. Thanks, Paul. As we talked about in our prepared remarks, we are very pleased with our overall growth across the world. And retention is up, new business was terrific and balanced. And rate, well above loss cost, was evident in so many parts of our business.
If I unpack it as you asked, I mean, look at North America, we discussed Validus Re, was up 32%, but it's not cyclically its largest quarter. It was basically 25% of North America. But other businesses had tremendous quarters.
Lexington had 18% growth. But that was also part of us discontinuing a big program that we didn't like the risk-adjusted returns that had an impact on top line premium growth. And so I would look at Lexington in terms of casualty, which was 40% growth. Lexington property, which was 35% growth. Retail property was up over 50% in the quarter, and I outlined the rate increases were north of 30% for 2 quarters in a row.
Our actual retail casualty business was up in the high single digits. So it was a very good outcome for net premium written in North America. The headwind was Financial Lines, which was down a little bit over 10%, but that is something that is specific to North America. But we have a really good balance in growth.
If I look at -- I'll just expand a little bit in terms of International. We had really strong growth in property. Our syndicate Talbot was up 17%. International Specialty, I drew it out as a mid-single-digit growth net premium written in the quarter. We had some discretionary spends on treaty reinsurance. On a gross basis, it grew over 40%. And I want to call out, Financial Lines is not experiencing the same headwinds as North America, and International was flat. And that's our largest business in the second quarter in International. So had a little bit more of the weight in terms of the overall growth. But I thought it was really balanced, really well done and all the fundamentals we're executing on.
Jon Paul Newsome: And my second question, I wanted to ask about the cat load in particular in North America as we think of it going forward. I mean, clearly, from the data you showed us, you talked about on the call the volatility piece or the tail is going to be reduced a lot on Validus Re. On an ongoing basis, do you also see kind of a reduction in the cat load from the efforts that you're making with Validus Re and other pieces and changes that you [indiscernible]?
Peter Zaffino: Yes, thanks, Paul. I gave probably a little bit more PML information than people may have liked, but it's really the story is 3 components. One is what we did in the reunderwriting to reduce gross exposure across AIG. By the way, including Validus Re over the last several years. And we shed over $1 trillion of limit most of it property. And so that had an effect on exposure and PMLs at all return periods.
I think the reinsurance programs that we bought are world-class. We keep calling that out, but in a very challenging and difficult environment at 1/1, we did not compromise by taking a lot more net because of reinsurance pricing. It reflected our book. We got great partners. And as a result, we didn't really have more net in terms of overall low-return peered PMLs.
And so what I drew out in the Validus Re example, again, is on occurrence. It was the RMS model. We'll work through it. We got plenty of aggregate as to drive businesses that exists within AIG. But yes, I mean, like it's a different company. I mean, we're not going to have the tail exposure. But also at all return periods, we're going to have less cat. We've managed aggregates across the world and look at Validus Re as a very good business. But as I said, when we want to continue to reduce volatility, we do that through reinsurance. But when you have a treaty reinsurance business that is -- got a portfolio that has a lot of cat, that's harder to do. So I think the volatility, the cat loads will go down. By the very nature, we're going to lose a big part of our cat exposure. But we've been conservative on that and increased them this year and are very comfortable with our estimates and our actual results.
Operator: Our next question comes from Meyer Shields from KBW.
Meyer Shields: Peter, you gave us a lot of detail about rate and exposure changes. And we saw a little bit of sequential improvement. But I was wondering if you could talk about changes in the gap between rate increases and loss trends from the first quarter to the second quarter of this year.
Peter Zaffino: Sure, Meyer. We have given guidance. So let me start with the loss cost inflation, which is still at 6.5. And you can imagine in a company like ours, I mean, it's an index. And so we look at each line of business each quarter, make minor modifications or as we did in the back half of last year just based on inflation, more meaningful adjustments.
I'm really pleased with the discipline the company is showing on driving rate above loss cost, and we've done that across the world. So the rate environment in the second quarter was very strong. I gave you the guidance on the prepared remarks of North America excluding work comp, 9%; International at 9%. The drivers for this Retail Property, excess and surplus lines and our specialty businesses, the headwind for rate in North America was Financial Lines. And it's worth noting again that we have a very big footprint.
And I mentioned in the prior question that International is not experiencing the same rate issues. And again, when I look back over the last 14 quarters, each quarter has been a positive rate increase in Financial Lines. So it's different for our International portfolio versus our domestic. And we continue to look at businesses like properties getting a lot of attention, but you can't look at that as a single quarter.
I mentioned before, cost increases on the loss cost side, inflation, cost of capital, but also the cost of reinsurance for the industry, ours was a high single-digit risk-adjusted increase at 1/1. But those reinsurance costs in the industry are going to need to play in over the course of a year or maybe even like in Europe's case, into the first quarter, absent anything happening through cat season. So I think this is the market that we're in. It's a disciplined market. The cost of capital is more expensive, and we're going to be very prudent in where we deploy capital. But I'm very comfortable that we are driving margin on a written basis, and that will continue as we get to the back half of the year.
Meyer Shields: Okay. That's very helpful. One thing that you said in your prepared remarks also that surprised me was that you're seeing a huge uptick in casualty submissions in Lexington. I think we expected the property side. I was hoping if you can dig a little bit deeper into what's going on in specialty casualty.
Peter Zaffino: Yes. Well, Lexington is just a great story. When we look at -- we had record submission count across Lexington. We drove very strong growth at the top line, but it's one of our most profitable businesses. And Dave McElroy, Lou Levinson, who leads Lexington, this has all been about driving value for our distribution partners and wholesale brokers. And we've been asking for submission activity on all lines of business.
And so when we're going to deploy property, yes, we have aggregate. Yes, the performance has been very good. Yes, the growth opportunity is there on its own. But we have been very focused on driving opportunities across the portfolio, and we're asking for the business.
And so like the submission activity is substantial. And then I think being one of the largest wholesale underwriters and respected as one of the top in terms of underwriting excellence, we're getting looks at multiple lines of business. And we have staffed up in order to take on that additional volume on the property and casualty side. So I was very pleased that the team executed as well as it did, and I expect that to continue.
Operator: Our next question comes from Yaron Kinar with Jefferies.
Yaron Kinar: First question, I guess, going back to Paul's question on Validus. Could you offer us like a pro forma margin profile for North America Commercial ex the Validus sale, maybe even ex the crop business?
Peter Zaffino: It's a very good question, but I have to follow up with a question back to you. Do you want it over a longer period of time? Because I mean, looking at a cat business in the second quarter and again, I'm happy to provide some detail. It was accretive by a little over 100 basis points in the quarter to a combined ratio.
But don't forget, its acquisition ratio is higher than our normal business. The loss ratio was slightly below based on dynamics going on in the market today. When I look at our overall business and ones that I continue to highlight, Lexington specialty, our property, a little more accretive than Validus Re.
So I wouldn't have the impression that it's going to be highly dilutive. Obviously, it's done really well in the first half of the year. But if I go back the last 3 to 4 years, last year is the first year we were able to publish a combined ratio below 100. And so looking at the combined ratios of the business overall, it's been a positive contributor in the first half of this year. But in terms of the business, we have a lot of business to perform better. And we have -- in terms of the index, I don't think it will materially impact us.
Yaron Kinar: Got it. And maybe just as a clarification. Your commentary, is that on a reported basis or underlying?
Peter Zaffino: Both. But we don't break it out. But I mean, in terms of looking at it from 2018 through 2022, 2022 was the first year on a fully low to combined ratio is below 100.
Yaron Kinar: Got it. And then my second question, given the secondary and Corebridge and we're starting to see a line of sight to below 50%, can you maybe offer us a precise threshold for deconsolidation?
Peter Zaffino: No. I can't offer you precise, but I can give you some guidance in terms of what we're thinking if that's okay.
Yaron Kinar: Sure.
Peter Zaffino: Yes. So the secondary is our base case. And we would expect to do something hopefully before year-end, subject to market conditions. I think what we have proven over time is that we want to be prepared. And so we prepared for the IPO, ended up delaying it just based on market conditions, prepared on the secondary. And so we will be prepared to go before year-end.
I think Corebridge is doing very well in its business performance, its operation as a public company. And then we have made enormous progress of getting it ready to be a standalone public company once we deconsolidate. They're executing very well on the management plan.
Again, Kevin will outline it in detail on Friday, but they're able to execute on capital management now with share repurchases as well as ordinary dividend. And so we certainly want to continue to sell down at a reasonable pace, but it's just going to be subject to market conditions and where the business is.
Yaron Kinar: Peter, I apologize. I was not really focused on the timing. I was more interested on what the precise percentage would be to see deconsolidation. Is it the second we drop below 50%?
Peter Zaffino: Depending on Board structure. But if we modify the Board structure, it would be below 50%. But on the current Board structure, we'd have to go below 45%.
Operator: Our next question comes from Alex Scott with Goldman Sachs.
Taylor Scott: First one I had is on the capital deployment. I mean, I think one of the most challenging things to sort of model and forecast from the outside right now is just how you'll go about deploying the proceeds from a lot of the actions you're taking, including the separation of Corebridge. So I was just interested if there's any updated thoughts. I know in the past, you guys have kind of given the share count range. Any thoughts you'd provide or guidance as it relates to where the share count could go from here?
Peter Zaffino: I think what we've outlined is still the base case. We ended up in the low 700s in terms of our share count. Sabra did a very good job of outlining the liquidity that we have and liquidity that will be coming in.
We have focused on the 4 components in a very rigorous way of making sure that we have capital and subsidiaries to drive the growth in a market that we think is very favorable. We increased our dividend this year, and so we want to continue to focus on that.
Our leverage in the low 20s, and Sabra and I both indicated, we'll do some cleanup on debt because the impact of share repurchases, you need to continue to still retire debt. And the main focus from liquidity is going to be on share repurchase, and that will be highly correlated to when we close on RenRe.
We'll be active in the market in the third quarter. And I really couldn't give you much more guidance on that other than we're really focused on the share repurchase and getting to that 600 million to 650 million shares.
Taylor Scott: Got it. That makes sense. I guess a follow-up sort of in the same vein. In terms of organic deployment, I listen to the PML comments you're making and think about the volatility and how much better it is and then the fact that you guys, I think, still have below-average underwriting leverage, at least when we sort of look at like premiums to surplus, those kind of metrics. Do you have the capacity to be able to fund this greater growth, whether it's in Lexington and some other businesses in General Insurance, without using so much of the proceeds from the strategic actions?
Peter Zaffino: We do, and it's been a big focus for us. Sabra, do you want to expand on that a little bit?
Sabra Purtill: Yes. Thanks. I would just note, as I mentioned in my prepared comments, that the risk-based capital ratios in our U.S. pool are in the range of 470% to 480%, which is well above our target range of 400% to 420%. So we have ample capacity within the General Insurance businesses today to support growth.
Operator: Our next question comes from Michael Zaremski with BMO.
Michael Zaremski: My question is about the exist -- remaining portfolio post the sale of Validus pending in the crop business. Are there other and what you did on the -- what you're doing on the personal line side. Are there other pieces of the portfolio that still need additional optimization? Or are we kind of mostly through the major actions?
Peter Zaffino: I think we're through most of the major actions. We have to focus more on Personal Insurance, and then we have been certainly, the -- we spent a lot of time on the ultra and high net worth business and the actions that we're taking there in terms of improving it. And we'll see that as we go to the back half of '23 and into '24.
Japan is a big focus for us, and it's a terrific business, one that has terrific scale, performs very well, needs more digital investment. And we have such a wide distribution of agents that we can scale more products. So we'll see some investment in Japan on digital workflow and digital interfacing with customers. And we've been working through that over the past 12 to 18 months. So I would expect to see improved performance there.
And then also our Global Accident & Health business, which performs very well mostly overseas in International, but that's going to have investment. And we would expect to see more growth and more profitability improvement there.
But I don't -- it's not major. It's more of just making strategic investments in order to position the portfolio to be more advantageous. So those will be the areas of focus. But after Validus Re, we had a very active quarter and certainly would not expect another one of those, but we are going to continue to try to drive improvement throughout the portfolio.
Michael Zaremski: Okay. Great. And my follow-up is switching gears, thinking about AIG's long-term kind of combined ratio inclusive of other expenses. If we're thinking longer term, you've done a great job improving the loss ratio. We're clear that there's still -- you have guidance on expenses coming down.
But when you say longer term, most of the wood's been chopped in the loss ratio, and we should be thinking about overall expenses is kind of getting you to the double-digit ROE land sustainably? Or is there still loss ratio components such as maybe reserves and whatnot that could continue to improve over time?
Peter Zaffino: No, I think you're thinking of it the right way. I mean, we've done an incredible job in terms of getting the portfolio that was in existence in '17 and '18 to where it is today. We know that we're an outlier on the expense ratio. That's a big part of what we're doing in the future operating model. And we'll start to show more and more evidence of that in the coming quarters and as we go into 2024.
I did mention not to repeat the first part of the answer, but I do think that there's loss ratio and combined ratio opportunity for improvement in Personal Insurance. And we're heavily focused on that in terms of its balance across all of AIG. But when we look at the improvement in ROCE, expenses is going to be a big part of it. And as we focus on getting to our future operating model, that scale and discipline around having an expense ratio that's more favorable will be a huge focus of this management team.
Okay. Thanks. I want to thank everybody for joining us today. I hope you have a great day.
Operator: Thank you for participating at today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Second Quarter 2023 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause these actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change."
},
{
"speaker": "Peter Zaffino",
"text": "Good morning, and thank you for joining us to review our second quarter financial results. Following my remarks, Sabra will provide more detail on the quarter, and then we will take questions. Kevin Hogan and David McElroy will join us for the Q&A portion of the call."
},
{
"speaker": "As we have discussed over the past few years, the core objectives of the property and casualty turnaround were",
"text": "to substantially improve the overall quality of AIG's global portfolio and underwriting results; reduce volatility through a massive reduction in growth limits written; better manage peak zone exposures and geographic balance; and strategically use reinsurance across our overall business. A turnaround of this magnitude is made harder when you have a treaty reinsurance business, which, by its very nature, has volatility."
},
{
"speaker": "Net premiums written were $7.5 billion, an increase of 11%. This growth was driven by Global Commercial, which grew 13% while Global Personal grew 5%. In North America Commercial, we saw a very strong growth of 18% in net premiums written. Excluding Validus Re, net premiums written growth in North America Commercial was 13%. The major drivers were as follows",
"text": "Retail Property, which grew over 50%; Validus Re, which grew 32%; and Lexington, which grew 18%, led by wholesale property and casualty."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. This morning, I will provide more detail on second quarter results, including net investment income and underwriting performance, provide a balance sheet update and review the drivers of our path to a 10%-plus adjusted ROCE."
},
{
"speaker": "Second quarter results were consistent with recent trends",
"text": "strong underwriting margins and higher net investment income in General Insurance; increased base investment yields; and spreads and strong sales in Life and Retirement and continued expense reduction in balanced capital management and Corporate and Other."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Sabra. And operator, we're ready for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Paul Newsome with Piper Sandler."
},
{
"speaker": "Jon Paul Newsome",
"text": "Congrats on the quarter. I was hoping we could focus in on the general -- the North American Commercial business a little bit. I'm getting some questions about the growth. If you sort of assume a certain amount of growth is related to the price increases sort of ex-Validus and whether or not we saw a fair amount of growth -- just sort of if you normalize [indiscernible] Validus. Sorry, I know you gave a lot of detail there, but maybe if you could kind of simplify it for -- that'd be fantastic."
},
{
"speaker": "Peter Zaffino",
"text": "Sure. Thanks, Paul. As we talked about in our prepared remarks, we are very pleased with our overall growth across the world. And retention is up, new business was terrific and balanced. And rate, well above loss cost, was evident in so many parts of our business."
},
{
"speaker": "Jon Paul Newsome",
"text": "And my second question, I wanted to ask about the cat load in particular in North America as we think of it going forward. I mean, clearly, from the data you showed us, you talked about on the call the volatility piece or the tail is going to be reduced a lot on Validus Re. On an ongoing basis, do you also see kind of a reduction in the cat load from the efforts that you're making with Validus Re and other pieces and changes that you [indiscernible]?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes, thanks, Paul. I gave probably a little bit more PML information than people may have liked, but it's really the story is 3 components. One is what we did in the reunderwriting to reduce gross exposure across AIG. By the way, including Validus Re over the last several years. And we shed over $1 trillion of limit most of it property. And so that had an effect on exposure and PMLs at all return periods."
},
{
"speaker": "Operator",
"text": "Our next question comes from Meyer Shields from KBW."
},
{
"speaker": "Meyer Shields",
"text": "Peter, you gave us a lot of detail about rate and exposure changes. And we saw a little bit of sequential improvement. But I was wondering if you could talk about changes in the gap between rate increases and loss trends from the first quarter to the second quarter of this year."
},
{
"speaker": "Peter Zaffino",
"text": "Sure, Meyer. We have given guidance. So let me start with the loss cost inflation, which is still at 6.5. And you can imagine in a company like ours, I mean, it's an index. And so we look at each line of business each quarter, make minor modifications or as we did in the back half of last year just based on inflation, more meaningful adjustments."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That's very helpful. One thing that you said in your prepared remarks also that surprised me was that you're seeing a huge uptick in casualty submissions in Lexington. I think we expected the property side. I was hoping if you can dig a little bit deeper into what's going on in specialty casualty."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Well, Lexington is just a great story. When we look at -- we had record submission count across Lexington. We drove very strong growth at the top line, but it's one of our most profitable businesses. And Dave McElroy, Lou Levinson, who leads Lexington, this has all been about driving value for our distribution partners and wholesale brokers. And we've been asking for submission activity on all lines of business."
},
{
"speaker": "Operator",
"text": "Our next question comes from Yaron Kinar with Jefferies."
},
{
"speaker": "Yaron Kinar",
"text": "First question, I guess, going back to Paul's question on Validus. Could you offer us like a pro forma margin profile for North America Commercial ex the Validus sale, maybe even ex the crop business?"
},
{
"speaker": "Peter Zaffino",
"text": "It's a very good question, but I have to follow up with a question back to you. Do you want it over a longer period of time? Because I mean, looking at a cat business in the second quarter and again, I'm happy to provide some detail. It was accretive by a little over 100 basis points in the quarter to a combined ratio."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. And maybe just as a clarification. Your commentary, is that on a reported basis or underlying?"
},
{
"speaker": "Peter Zaffino",
"text": "Both. But we don't break it out. But I mean, in terms of looking at it from 2018 through 2022, 2022 was the first year on a fully low to combined ratio is below 100."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. And then my second question, given the secondary and Corebridge and we're starting to see a line of sight to below 50%, can you maybe offer us a precise threshold for deconsolidation?"
},
{
"speaker": "Peter Zaffino",
"text": "No. I can't offer you precise, but I can give you some guidance in terms of what we're thinking if that's okay."
},
{
"speaker": "Yaron Kinar",
"text": "Sure."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. So the secondary is our base case. And we would expect to do something hopefully before year-end, subject to market conditions. I think what we have proven over time is that we want to be prepared. And so we prepared for the IPO, ended up delaying it just based on market conditions, prepared on the secondary. And so we will be prepared to go before year-end."
},
{
"speaker": "Yaron Kinar",
"text": "Peter, I apologize. I was not really focused on the timing. I was more interested on what the precise percentage would be to see deconsolidation. Is it the second we drop below 50%?"
},
{
"speaker": "Peter Zaffino",
"text": "Depending on Board structure. But if we modify the Board structure, it would be below 50%. But on the current Board structure, we'd have to go below 45%."
},
{
"speaker": "Operator",
"text": "Our next question comes from Alex Scott with Goldman Sachs."
},
{
"speaker": "Taylor Scott",
"text": "First one I had is on the capital deployment. I mean, I think one of the most challenging things to sort of model and forecast from the outside right now is just how you'll go about deploying the proceeds from a lot of the actions you're taking, including the separation of Corebridge. So I was just interested if there's any updated thoughts. I know in the past, you guys have kind of given the share count range. Any thoughts you'd provide or guidance as it relates to where the share count could go from here?"
},
{
"speaker": "Peter Zaffino",
"text": "I think what we've outlined is still the base case. We ended up in the low 700s in terms of our share count. Sabra did a very good job of outlining the liquidity that we have and liquidity that will be coming in."
},
{
"speaker": "Taylor Scott",
"text": "Got it. That makes sense. I guess a follow-up sort of in the same vein. In terms of organic deployment, I listen to the PML comments you're making and think about the volatility and how much better it is and then the fact that you guys, I think, still have below-average underwriting leverage, at least when we sort of look at like premiums to surplus, those kind of metrics. Do you have the capacity to be able to fund this greater growth, whether it's in Lexington and some other businesses in General Insurance, without using so much of the proceeds from the strategic actions?"
},
{
"speaker": "Peter Zaffino",
"text": "We do, and it's been a big focus for us. Sabra, do you want to expand on that a little bit?"
},
{
"speaker": "Sabra Purtill",
"text": "Yes. Thanks. I would just note, as I mentioned in my prepared comments, that the risk-based capital ratios in our U.S. pool are in the range of 470% to 480%, which is well above our target range of 400% to 420%. So we have ample capacity within the General Insurance businesses today to support growth."
},
{
"speaker": "Operator",
"text": "Our next question comes from Michael Zaremski with BMO."
},
{
"speaker": "Michael Zaremski",
"text": "My question is about the exist -- remaining portfolio post the sale of Validus pending in the crop business. Are there other and what you did on the -- what you're doing on the personal line side. Are there other pieces of the portfolio that still need additional optimization? Or are we kind of mostly through the major actions?"
},
{
"speaker": "Peter Zaffino",
"text": "I think we're through most of the major actions. We have to focus more on Personal Insurance, and then we have been certainly, the -- we spent a lot of time on the ultra and high net worth business and the actions that we're taking there in terms of improving it. And we'll see that as we go to the back half of '23 and into '24."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. Great. And my follow-up is switching gears, thinking about AIG's long-term kind of combined ratio inclusive of other expenses. If we're thinking longer term, you've done a great job improving the loss ratio. We're clear that there's still -- you have guidance on expenses coming down."
},
{
"speaker": "Peter Zaffino",
"text": "No, I think you're thinking of it the right way. I mean, we've done an incredible job in terms of getting the portfolio that was in existence in '17 and '18 to where it is today. We know that we're an outlier on the expense ratio. That's a big part of what we're doing in the future operating model. And we'll start to show more and more evidence of that in the coming quarters and as we go into 2024."
},
{
"speaker": "Operator",
"text": "Thank you for participating at today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day."
}
] | American International Group, Inc. | 250,388 |
AIG | 1 | 2,023 | 2023-05-05 08:30:00 | Operator: Good day, and welcome to AIG's First Quarter 2023 Financial Results Conference Call. This conference is being recorded.
Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, Michelle, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provided details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change.
Additionally, today's remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com.
Finally, today's remarks will include results of AIG's Life and Retirement segment and Other Operations on the same basis as prior quarters, which is how we expect to continue to report until the deconsolidation of Corebridge Financial. AIG's segments and U.S. GAAP financial results as well as AIG's key financial metrics, with respect thereto, differ from those reported by Corebridge Financial. Corebridge Financial will host its earnings call on Tuesday, May 9.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino;Chairman and CEO: Good morning, and thank you for joining us to review our first quarter financial results. Following my remarks, Sabra will provide more financial detail in the quarter, and then we will take questions. Kevin Hogan and David McElroy will be available for the Q&A portion of the call.
As you saw in our press release, we reported an excellent start to the year. We continue to make meaningful progress across AIG and achieve important milestones, even in the face of ongoing complexity in the insurance industry, volatile market conditions and general economic uncertainty. We continue to diligently execute on our strategic and operational priorities, which drove very strong financial results in the first quarter and are positioning AIG for long-term value creation. Here are some highlights from the first quarter.
Adjusted after-tax income was $1.2 billion or $1.63 per diluted common share, representing a 9% increase year-over-year. Net investment income on a consolidated basis was $3.1 billion. In 2022, we began to take proactive steps to improve the credit quality, construction and return characteristics of our investment portfolio as well as to reduce volatility. We saw the benefits of these actions in the first quarter and expect that to continue throughout the year. Sabra will provide additional detail on net investment income in her remarks.
Net premiums written in General Insurance grew 10% on a constant dollar basis and adjusted for the International lag elimination that we discussed on our last call. This growth was driven by our Commercial business. Underwriting income was approximately $500 million, a 13% increase year-over-year, which is AIG's strongest first quarter underwriting result.
The accident year combined ratio, excluding catastrophes, was 88.7%, an 80 basis point improvement from prior year.
Life and Retirement reported very good results, with premiums and deposits of $10.4 billion in the first quarter, a 44% increase year-over-year, supported by record sales in fixed annuity and fixed index annuity products.
Net flows into the General Account from Individual Retirement were approximately $1.3 billion.
Corebridge and Blackstone have made substantial progress advancing their strategic partnership, which began in late 2021. Since that time, Blackstone has invested approximately $11 billion on behalf of Corebridge, with an average gross yield of 6.5% and an average credit rating of A. This partnership has allowed Corebridge to expand in certain asset classes where we had limited to no access in the past, which has been very beneficial for the business and is helping to support growth, particularly in fixed annuity products.
We returned approximately $840 million to shareholders in the first quarter through $600 million of common stock repurchases and $240 million of dividends. And we ended the first quarter with strong parent liquidity of $3.9 billion. Overall, I'm very pleased with what we accomplished in the first quarter. The strong momentum we had coming into 2023 continues.
As we announced last night, the AIG Board approved the first meaningful increase to AIG's common stock quarterly dividend in many years. Starting in the second quarter, this dividend will be $0.36 per share, an increase of 12.5%. This is another significant milestone for AIG and reflects our commitment to a disciplined, balanced capital management strategy and our confidence in the future earnings power of AIG.
Corebridge is also achieving important milestones. Since its IPO in September of last year, Corebridge has paid 3 dividends to public shareholders, totaling approximately $450 million. And yesterday, the Corebridge Board authorized a $1 billion share repurchase program. During the first quarter, we were prepared to launch a secondary offering of Corebridge common stock, but chose not to proceed when equity markets became volatile due to issues in the financial sector.
We continue to be prepared and disciplined in terms of executing a secondary offering, which remains our base case for selling down our ownership in Corebridge, subject to market conditions and regulatory approvals. We remain committed to reducing our ownership interest in Corebridge and will explore other options that are aligned with the best interest of shareholders.
During the remainder of my remarks this morning, I'll provide more information on the following 5 topics: first, I will review the first quarter results for General Insurance; second, I will give a high-level overview of the results for Life and Retirement, and Sabra will provide more detail in her remarks; third, I will provide an update on a few strategic initiatives, including the announcement last week relating to Private Client Services, our MGA partnership with Stone Point Capital, our announcement on Tuesday of the sale of Crop Risk Services and our intent to sell Laya Healthcare, which is a part of Corebridge and Ireland's second largest health insurance provider; fourth, I will provide more information on capital management actions; lastly, I will review progress on our path to a 10%-plus ROCE, including an update on the work we are doing on the future state business model of AIG.
Turning to General Insurance. Let me provide more detail on first quarter results, starting with our strong growth in gross and net premiums written. When we refer to gross and net premiums written, all numbers have been adjusted for both foreign exchange and the impact of the lag elimination.
Gross premiums written were $12 billion, an increase of 9%, with Global Commercial growing 13% and Global Personal decreasing 4%. Net premiums written were $7 billion, an increase of 10%. This growth was primarily driven by Global Commercial, which grew 11%, while Global Personal grew 6%.
In North America Commercial, we saw a very strong growth of 15% in net premiums written due to Validus Re, which had over 40% growth year-over-year due to the exceptional results we achieved with our January 1 treaty placements, which I discussed in detail on our last call. Lexington, which grew over 25%, led by Wholesale Property and Casualty, double-digit growth in Captive Solutions and Glatfelter.
Focusing on Lexington for a moment, I would like to highlight a few achievements from the first quarter. The business continues to drive excellent performance, impressive growth and has consistently improved its portfolio quarter after quarter over the last couple of years. Lexington's tremendous growth has been achieved through its relevance in the marketplace and increasing its market share, not from increasing limits deployed. Strong retention, new business and rate have been the key drivers of Lexington's financial performance. Lexington has now seen double-digit rate increases for 16 consecutive quarters, and cumulative compounded rate increases totaled over 100% since the first quarter of 2018.
Additionally, over the last few years, the average size of a Lexington Property primary policy went from $100 million in limits deployed to $5 million. This has substantially reduced volatility in Lexington's portfolio. Our thoughtful and prudent growth strategy, together with our shift in focus to wholesale distribution, continues to serve us well, particularly in the E&S market.
I also want to provide more color on Validus Re. We've provided significant detail on the 1/1 renewal season on our last call, and I think it's worth expanding on a few items from the first quarter. Net premiums written were very strong and balanced in Validus Re, and we continue to meaningfully improve the quality of the portfolio. Rate improvements were particularly strong in U.S. Property, International Property, Marine and Energy, Casualty and Specialty Lines.
With respect to April 1 renewals across the portfolio, gross and net premiums written increased. And within International Property, limits deployed were reduced slightly, and Japan property cat risk-adjusted rates were up approximately 20%.
As we consider our deployment strategy at the June 1 renewal cycle, which focuses on U.S. wind exposure, we will continue to maintain a prudent approach on limits deployed. We do not expect to deploy additional limits beyond our current aggregate allocated to Florida, although we do anticipate significant rate increases and improved terms and conditions. Like General Insurance, the Validus Re portfolio has been completely re-underwritten with a focus on risk-adjusted returns. The business had a terrific first quarter and is well positioned for profitable growth through the rest of the year.
Shifting back to our 15% net premiums written growth in the first quarter, this result was impressive despite the headwinds we continue to see in Financial Lines, where overall net premiums written contracted 9% due to increased competition putting pressure on pricing as well as continued slowdown in M&A and other transactional business.
We are one of the very few lead markets in large account public D&O where primary rates have remained relatively flat year-over-year. In contrast, high excess public company D&O saw rate declines greater than 20%. To put this in perspective, this represents a little over 5% of our overall North America Financial Lines business, and we will continue to manage this book very prudently. We have deep domain knowledge and experience, data, best-in-class underwriting capabilities and leading claims expertise that allow us to differentiate ourselves in the D&O marketplace.
During the past year, we continued to see new competitors with limited experience into the high excess public D&O market. This is driving down pricing in what is traditionally the most commoditized portion of a placement. Despite these dynamics, we remain disciplined on price and are taking a long-term view of this line of business. We have significant scale and geographic balance on our portfolio, and we will not follow the market down.
Turning to International Commercial. Net premiums written grew 6%, primarily due to Property, which was up over 40%; Global Specialty, which was up over 15%; and Casualty, which was up over 15%. Global Commercial had very strong renewal retention of 88% in its in-force portfolio, International was up 200 basis points to 88%, and North America was up 100 basis points to 87%. As a reminder, we calculate renewal retention prior to the impact of rate and exposure changes. And across Global Commercial, we continue to see strong new business, which was over $1 billion in the first quarter.
International Commercial new business was over $590 million, led by Specialty, which increased its new business by over 50%, driven by Energy and Marine. North America Commercial, excluding Validus Re, achieved new business of over $480 million, driven by Lexington, which saw excellent new business growth of over 50%. With respect to rate in North America Commercial, excluding Validus Re, rates increased 7% in the first quarter or 8% if you exclude workers' compensation, and the exposure increase was 2%.
In North America Commercial, rate was driven by Lexington wholesale, which was up 26% with Wholesale Property up 35%. For Lexington Property Wholesale, this was its strongest quarterly rate increase. Rate in Retail Property was also up significantly at 32%; International Commercial rate increases were 8%, driven by Talbot at 16%, International Property at 11% and Specialty at 9%. The exposure increase in the International portfolio was 2%. Rate plus exposure remains above loss cost trend at 9% in North America, 10% if you exclude workers' compensation and 10% in International.
Turning to Personal Insurance. First quarter results reflect our continued repositioning of this business, especially PCG, given our announcement of the creation of a managing general agency in partnership with Stone Point Capital. I will provide more information on the MGA later in my remarks.
North America Personal net premiums written increased 57%, driven by lower quota share cessions in PCG at January 1, as we transition to writing the business as an MGA, along with the recognition of an improved portfolio. The combination of improved pricing in our admitted business and more business migrating to the non-admitting market has a very positive impact on PCG's accident and policy or loss ratios. This will earn in through the second half of 2023 and into 2024.
Entering 2023, we required less excess of loss reinsurance on the upper end of our reinsurance program due to realized reduction in PCG's PMLs at all return periods as a result of ongoing improvements in risk selection and reductions in aggregate in peak zones. More specifically, all peril and all return periods from 1 in 20 to 1 in 1,000 reduced on average by 40%, while those same return periods with respect to wildfire reduced on average by 60%. These dynamics further impacted net premiums written in the first quarter.
Syndicate 2019 continues to act as a mechanism to enable third-party capital providers to support PCG's high and ultra-high net worth business for the 2023 accident year.
In terms of expectations for PCG for the full year, we expect net premiums written growth to be at or higher than we saw in the first quarter, the loss ratio to meaningfully improve and the acquisition ratio and general operating expense to also improve.
Turning to International Personal. Net premiums written were largely flat in the first quarter, Travel and Warranty grew while Personal Property declined, all driven by a further refinement of our cat reinsurance cost allocation methodology, making year-over-year comparisons difficult. Accident & Health had some timing issues that impacted net premiums written in the first quarter. We expect to see growth in International Personal for the remainder of 2023 and believe results will continue to strengthen as we move through the year.
Shifting to combined ratios. As I noted earlier, the first quarter accident year combined ratio, excluding catastrophes, was 88.7%, an 80 basis point improvement year-over-year. In Global Commercial, the first quarter accident year combined ratio, excluding catastrophes, was 84.9%, a 110 basis point improvement year-over-year and we reported a 24% increase in underwriting income.
The North America Commercial accident year combined ratio, excluding catastrophes, was 85.7%, a 240 basis point improvement year-over-year. The International Commercial accident year combined ratio, excluding catastrophes, was essentially flat at 83.7%, which is an outstanding result. Global Personal reported a first quarter accident year combined ratio, excluding catastrophes, of 98.6%, a 120 basis point increase from the prior year quarter, largely due to a decrease in earned premium from our deliberate reduction in gross exposure in PCG in North America.
Now let me comment on catastrophes. The cat loss ratio in the quarter was 4.2% or $264 million of catastrophe losses. Our largest loss in the period was from 2 storms in New Zealand, which accounted for $126 million of catastrophe losses.
Looking at North America, total losses from catastrophe-related activities in the first quarter were $116 million, which includes Validus Re. In International, excluding Japan, we have eroded approximately $75 million of our aggregate retention and have approximately $75 million net remaining, plus the annual aggregate deductible for each cat loss for the rest of the year. As we described in our last call, the reinsurance program we structured at this year's January 1 renewal provides us with the ability to manage volatility and severity. Looking ahead to the rest of 2023, we expect to see very strong top line growth in General Insurance.
Turning to Life and Retirement. The business delivered strong performance in the first quarter. Adjusted pretax income was $886 million for the first quarter, and adjusted return on segment equity was 10.7%. First quarter results benefited from continued growth in spread-based products and related spread income. As I mentioned earlier, premiums and deposits grew significantly in the first quarter, driven by strong new individual retirement business, which, despite increasing surrenders related to interest rates, contributed to growth in the General Account. The balance sheet and capital position of Corebridge remains strong with $1.8 billion of parent liquidity.
Turning to our strategic initiatives. Last week, we executed a definitive documentation with Stone Point Capital for the launch of Private Client Services, an MGA that will serve the high and ultra-high net worth market. We are excited about the prospects for PCS and are confident of the value this new operating structure will deliver for clients, brokers and other stakeholders. We look forward to continuing this journey with the PCS management team and the ongoing support of Stone Point Capital.
Subject to regulatory approvals, the MGA is expected to formally launch in the third quarter of this year, and we expect to bring on additional capital providers through the second half of 2023. As part of our ongoing review process, we regularly assess the composition of our portfolio of businesses to ensure it is aligned with our long-term strategy and best positioned to create value for our shareholders and other stakeholders.
As part of this review, as you saw in our announcement on Tuesday, we executed a definitive documentation to sell Crop Risk Services, or CRS, to American Financial Group for $240 million. We acquired CRS as part of our broader acquisition of Validus Holdings in 2018. AIG will continue to write business for the 2023 spring crop season, which ends June 30. We expect approximately $700 million to $800 million of net premiums written for 2023, 75% of which booked in the first quarter. Starting in the third quarter, AIG will act as a fronting partner for American Financial Group during a transitional period.
For full year 2023, we expect to retain about $800 million to $900 million of earned premiums, $750 million of which we'll earn in over the remainder of the year. CRS is a well-run and attractive business, led by a high-quality management team. In American Financial Group, we have found a high-quality partner for CRS and its employees and believe the business will benefit from being part of a larger combined platform. We also continually review the product portfolio and geographic footprint of Corebridge as we position this business for the future as a fully stand-alone company.
After a comprehensive review of the health product offering, we decided to evaluate strategic alternatives and a potential sale of Laya Healthcare, the private medical insurance business in Ireland. We believe this will help to streamline the Corebridge portfolio and allow it to focus on Life and Retirement products and solutions.
Turning to capital management. The first quarter marked another quarter of continued progress and execution of our balanced strategy. In addition to the first quarter share repurchases and dividends that I mentioned earlier, against the backdrop of an unstable macroeconomic environment, we thought it was prudent to raise $750 million of debt at the end of March. This provided us with financial flexibility to pay down a near-term debt maturity and complete additional share repurchases at what we viewed as attractive share prices.
Turning to return on common equity. We remain highly committed and laser-focused on delivering a 10%-plus ROCE. Through the first quarter, we continued to make meaningful progress on the 4 components of our path to deliver on this commitment. As a reminder, these components include sustained and improved underwriting profitability; executing on a simpler, leaner business model across AIG; operational separation and deconsolidation of Corebridge; and continued balanced capital management. Given the number of strategic initiatives we are executing at once, we are taking a long-term view while measuring progress in 90-day increments. We advanced each component during the first quarter and expect this to continue throughout 2023.
As I discussed earlier, our first quarter financial results were excellent, with continued top line growth and improvement in underwriting profitability in General Insurance. Over the last few months, we accelerated our work to establish AIG's future state business model. Sequencing has been very important on our journey and the work that's been accomplished over the last few years on the General Insurance turnaround, AIG 200, the separation and IPO of Corebridge and restructuring of our investment management group. This has positioned us to move forward as a more focused and simplified AIG.
Evolving our future state business model will result in us moving away from the conglomerate structure AIG operated in for decades. We will eliminate overlap and significantly reduce decentralized infrastructure across the company, which will lead to a leaner business model, particularly in our operations. In future state, we expect a redefined AIG parent expense structure to be approximately 1% to 1.5% of premiums, which today is roughly $250 million to $350 million.
AIG parent will have 5 primary roles and objectives: public company matters, including finance, legal, compliance and regulatory oversight as well as corporate governance; communications with key stakeholders, including the investment community, rating agencies, regulators, policymakers and AIG colleagues; risk management, culture, performance and human capital management; and strategy, including business development, M&A and design and execution of key initiatives. As we progress our future state business model, we anticipate achieving approximately $500 million in cost reductions at AIG parent and a cost to achieve of around $400 million with substantially quicker earn-in of savings that we achieved with AIG 200.
As expense savings begin to earn through, the reductions will largely be seen in other operations, which is where general operating expenses are currently accounted for.
With respect to Corebridge, I took you through our current thinking on separation and timing of the secondary offerings.
Lastly, on capital management. We continue to maintain appropriate levels of capital in our subsidiaries to support profitable growth. We remain on track to reduce AIG common stock outstanding to be between 600 million and 650 million shares and achieve a debt-to-capital leverage at the lower end of our 20% to 25% range post deconsolidation of Corebridge.
As I noted earlier, we increased our common stock dividend by 12.5%, starting in the second quarter of this year. And in addition to our stock repurchases in the first quarter, to date, we have repurchased $240 million of AIG common stock in the second quarter. Apart from the progress we're making on these components of our path to a 10%-plus ROCE, we also expect tailwinds from higher reinvestment yields. We are confident that our continued progress on strategic initiatives and our capital management strategy will allow us to achieve our ROCE targets and deliver long-term profitable growth that benefits all of our stakeholders.
I will now turn the call over to Sabra.
Sabra Purtill: Thank you, Peter. This morning, I will cover 2 accounting changes, provide more details on first quarter results and give an overview of Commercial Mortgage Loans. First, the 1-month lag in financial reporting for the General Insurance International segment was eliminated last quarter. The lag elimination did not impact earnings significantly, but it did affect premiums written comparisons to 2022. Details on the premium impacts are in the financial supplement on Page 26.
Second, we adopted the change in accounting standard for certain long-duration products, commonly called LDTI. Yesterday, 8-Ks were filed that provide restated prior year financial results for AIG and Corebridge. The cumulative effect at year-end 2022 was an increase of $1.5 billion to adjusted equity and an increase of $1.0 billion to total shareholders' equity. This impact is consistent with our previous guidance. As a reminder, this is a GAAP accounting change only and does not impact statutory results, insurance company cash flows or economic returns. Going forward, we expect a modest run rate increase in L&R APTI and less market and mortality-driven volatility from the change in accounting standards.
Turning to the quarter, as Peter mentioned, AIG's first quarter adjusted after-tax income was $1.2 billion or $1.63 per diluted share, up 9% from last year on a restated basis and up 25% from originally reported. Key trends in the quarter and similar to the last 3 quarters were higher GI underwriting results and higher income from fixed maturities and loans and lower alternative investment income. Compared to the prior year quarter, there was a higher impact from noncontrolling interest from the Corebridge IPO in 3Q '22.
Consolidated net investment income on an APTI basis was $3.1 billion. Similar to the fourth quarter, income from fixed maturities and loans in both GI and L&R rose sequentially and over the prior year, while returns on alternative investments were down $593 million compared to very strong annualized returns of 28% last year.
Income on fixed maturities and loans rose by $573 million over the prior year, with average new money reinvestment rates of 5.35%, about 220 basis points above sales and maturities. The yield rose to 4.29%, up 78 basis points from 1Q '22 and 23 basis points over 4Q '22. Part of the increase in fixed maturity yields resulted from our proactive repositioning over the last 2 quarters in the U.S. GI portfolio. We sold and reinvested about $6 billion in fixed maturities, resulting in a realized loss of $224 million, but added 9 basis points of GI yield improvement for the quarter. We expect incremental yield pickup from this repositioning in 2Q '23 and also from higher reinvestment rates throughout 2023 based on the current rate and spread environment.
Turning to the segments. GI adjusted pretax income, or APTI, was $1.2 billion, $37 million higher than 1Q '22, principally due to a $56 million increase in underwriting income from both higher-earned premiums and a 1 point improvement in the calendar year combined ratio, which was 91.9%. Peter covered underwriting results in detail, but I want to add that GI reserves had favorable prior year development, net of reinsurance at prior year premiums of $54 million.
Turning to L&R results for the first quarter. APTI was $886 million, down $48 million compared to $934 million in 1Q '22 as restated. Consistent with GI, L&R had a strong increase in base portfolio investment income, but lower alternative investment income. Mortality experience improved, but fee income was down due to lower capital market levels compared to a year ago. As Peter noted, L&R premiums and deposits were very strong at $10.4 billion. Notably, Individual Retirement sales were $4.9 billion, a 26% increase over the prior year quarter with record levels of fixed and fixed index annuity sales because of higher crediting rates.
Group Retirement deposits grew 19%, with higher out-of-plan fixed annuity sales and new plan acquisitions. Strong fixed and fixed index annuity sales, net of surrenders, resulted in $1.3 billion of positive flows to the General Account in Individual Retirement, up from $0.7 billion last year. While surrenders are up, they remain below projections. Variable annuity net flows, which impact the separate account, were negative.
To conclude on earnings for the quarter, other operations adjusted pretax loss, or APTL, was $491 million, a $70 million increase due to lower APTI from consolidated investment entities in Asset Management, which had strong private equity results in 1Q '22. Corporate GOE decreased $27 million from the prior year and $77 million from 4Q '22 despite $29 million of additional expense related to the corporate separation.
Turning to AIG's balance sheet. Book value per common share was $58.87 at quarter end, up 7% from year-end, principally due to higher valuations on available-for-sale securities due to lower long-term interest rates. Adjusted book value was $75.87 per share, roughly flat with year-end. At the end of March, we issued $750 million of senior notes, a portion of which was used to pay down an April bond maturity.
Our leverage ratio declined to 32.8%, down about 1 point from year-end even with the new issuance due to the change in AOCI in the quarter. Excluding AOCI and the Fortitude-embedded derivative, debt leverage was 26.3%.
For the first quarter of 2023, AIG's consolidated adjusted ROCE was 8.7%, comprised of 11.6% in GI and 10.7% in L&R. As Peter discussed, we are laser-focused on achieving a 10%-plus ROCE post deconsolidation.
Peter provided a lot of detail on the quarter. So I'll use my remaining time to cover investments, particularly Commercial Mortgage Loans, given the recent focus on this asset class. First, I want to emphasize that our investment portfolio is grounded in the liability profile of our 2 insurance businesses. We strive to achieve strong risk-adjusted returns while matching the duration, cash flow and liquidity needs of the liabilities.
Over the last several years, we have improved the risk profile of the investment portfolio by reducing capital-intensive, less liquid or more volatile assets such as hedge funds. With the onset of COVID and, again, with rising interest rates last year, we further tightened investment guidelines and moved up in quality, including the GI repositioning mentioned earlier and also sales of L&R non-investment-grade assets.
Turning to our Commercial Mortgage Loan exposures. I'll start by noting that our mortgages are senior secured loans on high-quality properties that are well diversified by type and geography with strong loan to values, or LTVs, averaging 59% and debt service coverage ratios averaging 1.9x. We are the lead lender on more than 80% of our loans, which gives us important control rights.
Excluding Fortitude funds withheld assets, we had $33.8 billion of Commercial Mortgage Loans at the end of March, of which $30.3 billion were at Corebridge and $3.5 billion at General Insurance. The largest property type is multifamily housing or apartments, about 40% of our Commercial Mortgage Loans. Industrial Property loans are about 16% of the portfolio. Both multifamily and industrial are performing well. We are, however, focused on traditional U.S. office, which is $5.4 billion or 2% of AIG's invested assets. Our U.S. office allocation has been shrinking for several years, particularly when we tightened underwriting standards further for office, retail and hotels with the onset of COVID. Currently, 94% of the office loans are high-quality rated CM1 or CM2 with debt service coverage averaging about 2.1x and weighted average LTVs of 64%. Valuations are updated annually by a third party, and we continue to monitor valuations given rising cap rates.
We also have a credit or CECL allowance against the portfolio of about $330 million or 3.7% against the office loan portfolio and $584 million for the total commercial mortgage portfolio or 1.7%, which is higher than many peers as we use CMBS default data in our methodology.
Roughly 3/4 of the building securing the loans are Class A or newer buildings with better amenities. The majority are in the top 5 U.S. metropolitan areas and concentrated in central business districts, including in New York City, which historically has been one of the strongest office markets in the country.
Today, we are intensely focused on office loan maturities in the next 2 years, about $2 billion or 28 loans. We are already in discussions with many borrowers about their plans and our requirements for refinancing or extension, including additional equity revised terms or other commitments. While valuations are under pressure, cash flows are the primary source of debt service for our loans, and we will continue to monitor the loans carefully. We look forward to updating you on our investment performance in the quarters ahead.
To wrap up, our first quarter 2023 results demonstrate continued sustained and strong financial results, rising investment portfolio yields, significant progress against strategic initiatives, robust capital and liquidity and continued progress on our path to a 10%-plus ROCE.
With that, I will turn the call back over to Peter.
Operator: [Operator Instructions] Our first question comes from Meyer Shields with KBW.
Meyer Shields: Peter, I wanted to address one aspect of growth. And you covered, I think, a ton of detail, which is helpful. But the net-to-gross ratio didn't change. And I would have thought that based on the current dynamics in the property cat market and much improved performance on a lot of casualty lines that have been heavily reinsured, that we would see AIG retaining more of its gross premium. I was hoping you could talk through that.
Quentin McMillan: Meyer, this is Quentin. I think we're having a little audio technical difficulties. So if you can bear with us for just one moment, we'll be back in just 1 second.
[Technical Difficulty]
Peter Zaffino;Chairman and CEO: Can you hear me now?
Quentin McMillan: Yes. You're coming through loud and clear, Peter. Meyer, do you want to just repeat your question?
Peter Zaffino;Chairman and CEO: I heard the questions, Quentin. Sorry, I actually had a good answer too. I just was on -- not a microphone that worked. So Meyer, back to your question is that we had -- you have to look at the portfolio composition to be able to answer the question. And Validus Re obviously had meaningful growth on gross and net during the quarter. And so, therefore, it's hard to look at the cessions year-over-year when you're having a retro program that fits the portfolio that you're underwriting.
We've never had a strategy that we're going to time the market with our reinsurance partners. They've always been strategic. They've always been supportive. They've always deployed the capital in support of AIG. And so we were not going to do anything, other than to try to get the appropriate terms and conditions with them and have not really changed much of our risk appetite in terms of taking that. And I think that has generated a terrific result for us on net premium written, but also on the combined ratios.
So I think I wouldn't look into just one quarter in terms of discussions. And as I said, we have a lot in terms of the guidance I've given on PCG, which we will still assume a lot of risk. And I guess -- let's just play it out for the full year. We're not looking to do anything materially different.
Meyer Shields: Okay. Perfect. That's helpful. And I don't know if this is even a good question. But does the changing approach to North American Personal Lines have any implications for the International Personal segment?
Peter Zaffino;Chairman and CEO: It really doesn't, Meyer. I mean they're really distinct businesses. I mean, certainly, our Travel and Warranty have platforms that are global and that give us capabilities across the world. But as you know, Private Client Group, in particular in the U.S., is a unique asset. Again, the guidance I gave in the prepared remarks, it's one that we believe we will grow the net premium written because we don't believe we need the quota shares anymore after the excellent job the team has done in repositioning and re-underwriting that portfolio. We have substantially less cat in aggregates that we once did. So I think that's something that will be a little different in terms of -- if you look at International.
While International, we have a terrific Personal Insurance business. Some of it was affected by COVID. It's growing back, between Japan's Personal Insurance, our Global Accident & Health, which is predominantly International as well as our Travel and Warranty, which are rebounding in terms of growth. So I don't think that there's a lot of correlation between International and North America. But both we believe in and we're investing in, and you'll continue to see improvement. It will just be at a different pace because of the anomaly of the high net worth business.
Operator: Our next question comes from Paul Newsome with Piper Sandler.
Jon Paul Newsome: I also had a couple of questions on the Personal Lines business, sort of micro and macro. My understanding, and tell me if I'm wrong, is that much of the change to the MGA is scale related. And does that mean that we should expect the expense ratio to fall over time as the MGA gain speed? And maybe just correct me if I'm wrong, does that shift around how we think about sort of the relationship between expenses and losses in that business over time, not necessarily next quarter, but over time?
Peter Zaffino;Chairman and CEO: Paul, let me make sure I understand the question. I mean are you asking in terms of what's going to happen to the expense ratios over time as we start to reposition and grow the business?
Jon Paul Newsome: Yes, I am.
Peter Zaffino;Chairman and CEO: Okay, thank you. This year, as I said in my prepared remarks, we are going to see a lot more net premium written. The reason for that is as we were repositioning the business over the last 2 years, we bought very low excess of loss catastrophe reinsurance. We bought a substantial quota share. We ceded a significant amount of Syndicate 2019, which also had retrocession behind that in a variety of forms. And so the net premium written was not that large as you've seen. And so part of the repositioning with Stone Point and having an MGA, one is that we think there's tremendous growth opportunities that exist in the business with other capital providers and believe that how we have repositioned the business through rate increases and disciplined underwriting on the admitted side, and then also the non-admitted became an option for us to have flexibility in form and rate. And so that was very positive for us in terms of repositioning the business.
As we look to 2023 and beyond, we believe that the business is going to perform much better, much more profitable. And we don't need to cede off as much on the quota share. So as a result, in this particular calendar year, what you'll see is a lot of net premium written growth, improved loss ratios and both the expense ratio on an acquisition basis as well as the general operating expenses will improve. And so the overall combined ratio will improve dramatically. We're not going to be where we want to be in 2023, but believe by the time we hit 2024, those results will continue to improve.
Jon Paul Newsome: That's great. And maybe a big picture talking about a little bit more of the big picture cat exposures. I mean it looks like -- I'm just looking at the General Insurance overall, the cat load has pretty much stabilized, but that's been a huge part of the improvement over time. Do you think we're pretty much done? And again, I'm not talking about next quarter. I'm talking about years to come, from making this portfolio of businesses have the cat load that you want. I mean is this sort of the run rate we should be thinking about in the long term?
Peter Zaffino;Chairman and CEO: The team has done an incredible job of underwriting the Property line of business across all of AIG over multiple years. Our ability to reposition that portfolio, we talk a lot about aggregates, we talk a lot about reductions and we talked a lot about where we want to grow. I think we were in a terrific place as we enter 2023 from that hard work. And when I look at where we decided to grow, we constantly talk about where the best risk-adjusted returns available in the marketplace, where is our capacity most valued and where we value for clients.
So when I look at where we've grown, Validus Re certainly was a big part of that. Lexington has been hitting it out of the park on just about every aspect, whether it's top line growth, retention, new business, rate, like how they actually are more relevant in the marketplace. Working with Dave McElroy and the team, we've taken back some of the Retail Property. But then in other parts of the world, we've taken it back up. So like we've repositioned the portfolio and then have coupled that with the reinsurance to reflect the portfolio it is today.
So if I summarize what happened at 1/1 is that we saw terrific opportunities for Validus Re to grow. So we took the PMLs up there a little bit. We dramatically took the PMLs down in the Private Client Group substantially. Again, I gave the return period, that every return period from 1 in 20 to 1 in 1,000 was substantially reduced on all peril and, in particular, on wildfire. And we actually took the commercial book. Despite our growth in Lexington and Global Specialty, we took those PMLs down as well. So overall, when you look at the increased PMLs in the first quarter of Validus Re and the reductions that we had in the Commercial business and the Personal business, our overall PMLs are down year-over-year.
I think that's a tremendous outcome when you look at where we're growing, how we're driving risk-adjusted returns, how we couple that with reinsurance and our overall net PMLs are down at all the critical return periods. So I think all of that's been purposeful. The team has done an unbelievable job executing.
Operator: Our next question comes from Michael Ward with Citi.
Michael Ward: I was hoping you could discuss how you think about your excess capital just given the macro volatility. You raised some debt, it sounds like, for some prudent liquidity and for buybacks. I guess given the share price, I guess, the buyback could have been a little bit higher. So just wondering from here, should we expect that you'll sort of hold a bit more capital against uncertainty?
Peter Zaffino;Chairman and CEO: Thank you. We were very disciplined in terms of the $750 million debt raise. Again, I'm going to let Sabra comment a little bit more on liquidity and capital. But when I look at all the different components of our capital strategy, I think we executed incredibly well in the first quarter. I mean our primary focus is to make sure that we have the appropriate capital levels in the insurance company subsidiaries for growth, and so it gave us tremendous opportunities at 1/1 as it will give us for the entire year.
Very focused on our leverage ratios and being at the lower end just to give us financial flexibility. And of course, I've been leading everybody every quarter saying, we're looking at the dividend and to have a 12.5% dividend increase not only helps complete some of the capital management strategy we've been talking about, but also shows the confidence that we have on our earnings and how we're managing liquidity. But I'll have Sabra comment a little bit on the parent liquidity and our approach to capital. And it is proven to be conservative at this time. Sabra?
Sabra Purtill: Thank you, Peter. Yes. And I would just comment that, first of all, we look at our capitalization, both in base and stress scenarios. I mean this is just what I would call basic risk management procedures that we do. And we're very comfortable with our balance sheet even in the current environment where, obviously, there's a lot of stress on the system with the debt ceiling and the rest.
From where we sit today, we have very strong robust capital and liquidity. And as Peter noted, the Board was comfortable raising the dividend for the first time in many, many years because of the significant turnaround of GI underwriting results over the past 5 years. So as we sit here today, yes, we'll continue to evaluate our financial flexibility for additional share repurchases, keeping in mind that our first goal is to maintain a strong balance sheet that can withstand turbulent times.
Michael Ward: Very helpful. I guess maybe on the Crop deal, I guess, I was just wondering are there -- if you could maybe point to any other sort of targeted units where you could do sort of similar value unlocking deals there as you sort of work towards margin improvement and simplification.
Peter Zaffino;Chairman and CEO: Great. Thank you. We're always looking at the portfolio and looking at areas where we can add, where we can improve the overall structure of AIG and looking at the different parts of the world that we compete in. I think Crop is a little bit anomalous just because we really do believe it's a very good business, but you know how it works, which is driven by commodity prices and yields. And I think that having scale is really important. While the top line that we publish on a gross and net basis is significant, that's gone up 40%, 50%, if not more, over the past several years based on those components.
And we believe that Crop Risk Services, in order for it to achieve its ultimate potential that being part of a bigger enterprise and one that valued it like Great American, was the prudent approach for us at this time. And so that was something that was specific to that business. It was specific to how we look to strategically position AIG for the future and also making certain that with Crop Risk Services, it had a great opportunity to scale and realize this potential. So I feel like we really found a very good partner and that's really what drove the outcome for CRS.
Operator: Our next question comes from Alex Scott with Goldman Sachs.
Taylor Scott: First one I had for you is on the separation at Corebridge. I know you mentioned the base case is still secondaries, but I think you also mentioned that you were considering some alternatives. So I just wanted to see if you could extrapolate on that a bit at all. What kind of alternatives could you look towards? And how could some of those things potentially improve things for shareholders?
Peter Zaffino;Chairman and CEO: Yes. Thanks, Alex. I'll try to expand a bit on it. Because as you can imagine, there's not a lot of more detail that I can really share beyond my prepared remarks. We do believe the secondary is the preferred path. But obviously, it's subject to market conditions as we saw in the first quarter, but we're prepared to go in the second quarter.
Our objective has not changed, which is for AIG to reduce its ownership stake in Corebridge over time. And so I think it's prudent, looking at a variety of different options to make sure that we're driving value for shareholders and provide a path that will recognize the value of Corebridge. Corebridge has done a terrific job since we've announced that we were going to commence upon doing an IPO, getting themselves positioned to be an independent public company and the stock was trading at a deep discount in the first quarter.
I mean one of the alternatives, I don't think we're going to go much beyond this, was what we announced on Laya Healthcare. And so making sure we're sticking to the core business of Corebridge. And we'll just give you updates as the weeks and over the next month progresses. But we're prepared and are very excited about hopefully getting the secondary done in the second quarter.
Taylor Scott: Got it. Follow-up I had is on corporate expenses. I think it was the first time you guys gave a bit more explicit guidance around where corporate expenses for RemainCo could shake out at that 1% to 1.5% premiums. And I just wanted to make sure I understood some of the mechanics. I mean when I think about that level, I mean, is that what I should expect in sort of Corporate GOE, overall Corporate costs? I mean how do I think about that? And then just a technical kind of question. The investment that I think you mentioned leading up to that, will that go through operating and also be reflected in Corporate?
Peter Zaffino;Chairman and CEO: Yes. So we try to provide as much detail as we could on the expense savings. Certainly, let me start with AIG 200 because we still have more to earn through on AIG 200 savings in 2023 and 2024. So over 50% of that will be earned in mostly through the second and through fourth quarter of 2023. We have begun to separate Corebridge. And -- but upon deconsolidation, approximately $300 million of the AIG Corporate expenses will move to Life and Retirement. So that's another variable that you need to consider.
We also gave guidance as we're working through our future state business model, $250 million to $350 million of parent expenses. And then the remaining will be worked through to fit the business model in terms of what we're designing for the future of AIG. We want to make sure that we have a lean model that's not synonymous with expense cutting, but it is how we're going to be in each market, how we face off with our clients and our distribution partners to maximize growth and all the opportunities that present them themselves to AIG and making sure that we have a structure that supports that.
Sequencing is important. We've been working on a variety of different initiatives that are substantial, and we're performing out all of them, making certain that General Insurance has the capital and support it needs to grow in this market; repositioning some of our businesses, which we covered in my prepared remarks; making sure we complete AIG 200, the operational separation; preparing to do the secondary; advancing Corebridge capital structure; and then making sure that we're working to get this future state business model implemented, but it has to be in that order. And we've given you the guidance. We've done the work. We know that's the savings that we'll achieve.
Some of that's going to go into the business. And so the business has to get rationalized and leaner in order to be able to absorb more expenses. But our commitment is the $500 million in addition to the guidance that we've given in the other components. And we're highly confident we'll execute on that at the right time, meaning we've got to get these other things further along. And then when we have clear line of sight in terms of separation, we'll be able to execute on the target operating model.
Operator: Our next question comes from Brian Meredith with UBS.
Brian Meredith: Peter, you gave us a lot of detail on the growth in the Commercial Lines. There's, obviously, very strong growth. I'm trying to just dumb it down a little bit here. If we look at what the growth is X, let's call it, Validus Re crop, what would have looked like? And what was the tailwind from Validus Re crop just from the Commercial Lines growth on a year-over-year basis? And the reason I'm asking is, those are obviously very big first quarter premium numbers. So I just want to make sure I'm not extrapolating that for the remainder of the year.
Peter Zaffino;Chairman and CEO: Thanks, Brian. Certainly, Validus contributed a meaningful amount to the growth. But look, we bought a lot of retro. It's the first quarter. It's not all property. So each quarter is a bit different in terms of not being able to straight line it.
Crop Risk Services had low single-digit growth. So that was not a contributor at all in terms of net premium written. We had very strong, as I said, growth in our Specialty business, in Lexington, in our Property, offset a little bit by Financial Lines. But I put the guidance in there because I feel very confident that we're going to have strong growth throughout the year. Even though the quarters are a little bit different, businesses like Europe is heavy 1/1. And we start to have sort of different mix of business over the second, third and fourth. But I feel seeing the pipeline, looking at how you grow, I mean, the first thing I would look at is what's the client retention and how is the new business, what's happening with rate and are we growing in the businesses that we want to. And I think we are checking all the boxes here and see that those businesses have more opportunity in the future, not less. And so I think the growth that you saw in the first quarter, obviously, there's a mix of business, but I would expect to see similar growth throughout the rest of the year.
Brian Meredith: Okay. Very helpful. And then second question, just curious, some other companies are talking about how the Commercial Property markets are even further firming up in the second quarter. There's more business available. Are you seeing the same kind of dynamics or things actually continuing to improve here in the Commercial Property markets?
Peter Zaffino;Chairman and CEO: Yes. Thanks, Brian. Yes, we are seeing that. I mean, again, it's early in the second quarter, but views on April. And as we look to the rest of the second quarter, we're seeing Property continue to firm up and getting stronger than it was in the first quarter. So that's something that we're trying to be focused on clients, making sure we're driving value and we have a lot of capital to deploy. So we expect to be trading actively in the second quarter.
Okay. Well, thank you, everybody. Sorry for the 1-minute hiccup on the microphone, but greatly appreciate you dialing in, and I wish everybody a great day. Thank you.
Operator: Thank you. This does conclude the program. You may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's First Quarter 2023 Financial Results Conference Call. This conference is being recorded."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, Michelle, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provided details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Good morning, and thank you for joining us to review our first quarter financial results. Following my remarks, Sabra will provide more financial detail in the quarter, and then we will take questions. Kevin Hogan and David McElroy will be available for the Q&A portion of the call."
},
{
"speaker": "During the remainder of my remarks this morning, I'll provide more information on the following 5 topics",
"text": "first, I will review the first quarter results for General Insurance; second, I will give a high-level overview of the results for Life and Retirement, and Sabra will provide more detail in her remarks; third, I will provide an update on a few strategic initiatives, including the announcement last week relating to Private Client Services, our MGA partnership with Stone Point Capital, our announcement on Tuesday of the sale of Crop Risk Services and our intent to sell Laya Healthcare, which is a part of Corebridge and Ireland's second largest health insurance provider; fourth, I will provide more information on capital management actions; lastly, I will review progress on our path to a 10%-plus ROCE, including an update on the work we are doing on the future state business model of AIG."
},
{
"speaker": "AIG parent will have 5 primary roles and objectives",
"text": "public company matters, including finance, legal, compliance and regulatory oversight as well as corporate governance; communications with key stakeholders, including the investment community, rating agencies, regulators, policymakers and AIG colleagues; risk management, culture, performance and human capital management; and strategy, including business development, M&A and design and execution of key initiatives. As we progress our future state business model, we anticipate achieving approximately $500 million in cost reductions at AIG parent and a cost to achieve of around $400 million with substantially quicker earn-in of savings that we achieved with AIG 200."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. This morning, I will cover 2 accounting changes, provide more details on first quarter results and give an overview of Commercial Mortgage Loans. First, the 1-month lag in financial reporting for the General Insurance International segment was eliminated last quarter. The lag elimination did not impact earnings significantly, but it did affect premiums written comparisons to 2022. Details on the premium impacts are in the financial supplement on Page 26."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "Peter, I wanted to address one aspect of growth. And you covered, I think, a ton of detail, which is helpful. But the net-to-gross ratio didn't change. And I would have thought that based on the current dynamics in the property cat market and much improved performance on a lot of casualty lines that have been heavily reinsured, that we would see AIG retaining more of its gross premium. I was hoping you could talk through that."
},
{
"speaker": "Quentin McMillan",
"text": "Meyer, this is Quentin. I think we're having a little audio technical difficulties. So if you can bear with us for just one moment, we'll be back in just 1 second."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Can you hear me now?"
},
{
"speaker": "Quentin McMillan",
"text": "Yes. You're coming through loud and clear, Peter. Meyer, do you want to just repeat your question?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "I heard the questions, Quentin. Sorry, I actually had a good answer too. I just was on -- not a microphone that worked. So Meyer, back to your question is that we had -- you have to look at the portfolio composition to be able to answer the question. And Validus Re obviously had meaningful growth on gross and net during the quarter. And so, therefore, it's hard to look at the cessions year-over-year when you're having a retro program that fits the portfolio that you're underwriting."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Perfect. That's helpful. And I don't know if this is even a good question. But does the changing approach to North American Personal Lines have any implications for the International Personal segment?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "It really doesn't, Meyer. I mean they're really distinct businesses. I mean, certainly, our Travel and Warranty have platforms that are global and that give us capabilities across the world. But as you know, Private Client Group, in particular in the U.S., is a unique asset. Again, the guidance I gave in the prepared remarks, it's one that we believe we will grow the net premium written because we don't believe we need the quota shares anymore after the excellent job the team has done in repositioning and re-underwriting that portfolio. We have substantially less cat in aggregates that we once did. So I think that's something that will be a little different in terms of -- if you look at International."
},
{
"speaker": "Operator",
"text": "Our next question comes from Paul Newsome with Piper Sandler."
},
{
"speaker": "Jon Paul Newsome",
"text": "I also had a couple of questions on the Personal Lines business, sort of micro and macro. My understanding, and tell me if I'm wrong, is that much of the change to the MGA is scale related. And does that mean that we should expect the expense ratio to fall over time as the MGA gain speed? And maybe just correct me if I'm wrong, does that shift around how we think about sort of the relationship between expenses and losses in that business over time, not necessarily next quarter, but over time?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Paul, let me make sure I understand the question. I mean are you asking in terms of what's going to happen to the expense ratios over time as we start to reposition and grow the business?"
},
{
"speaker": "Jon Paul Newsome",
"text": "Yes, I am."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Okay, thank you. This year, as I said in my prepared remarks, we are going to see a lot more net premium written. The reason for that is as we were repositioning the business over the last 2 years, we bought very low excess of loss catastrophe reinsurance. We bought a substantial quota share. We ceded a significant amount of Syndicate 2019, which also had retrocession behind that in a variety of forms. And so the net premium written was not that large as you've seen. And so part of the repositioning with Stone Point and having an MGA, one is that we think there's tremendous growth opportunities that exist in the business with other capital providers and believe that how we have repositioned the business through rate increases and disciplined underwriting on the admitted side, and then also the non-admitted became an option for us to have flexibility in form and rate. And so that was very positive for us in terms of repositioning the business."
},
{
"speaker": "Jon Paul Newsome",
"text": "That's great. And maybe a big picture talking about a little bit more of the big picture cat exposures. I mean it looks like -- I'm just looking at the General Insurance overall, the cat load has pretty much stabilized, but that's been a huge part of the improvement over time. Do you think we're pretty much done? And again, I'm not talking about next quarter. I'm talking about years to come, from making this portfolio of businesses have the cat load that you want. I mean is this sort of the run rate we should be thinking about in the long term?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "The team has done an incredible job of underwriting the Property line of business across all of AIG over multiple years. Our ability to reposition that portfolio, we talk a lot about aggregates, we talk a lot about reductions and we talked a lot about where we want to grow. I think we were in a terrific place as we enter 2023 from that hard work. And when I look at where we decided to grow, we constantly talk about where the best risk-adjusted returns available in the marketplace, where is our capacity most valued and where we value for clients."
},
{
"speaker": "Operator",
"text": "Our next question comes from Michael Ward with Citi."
},
{
"speaker": "Michael Ward",
"text": "I was hoping you could discuss how you think about your excess capital just given the macro volatility. You raised some debt, it sounds like, for some prudent liquidity and for buybacks. I guess given the share price, I guess, the buyback could have been a little bit higher. So just wondering from here, should we expect that you'll sort of hold a bit more capital against uncertainty?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you. We were very disciplined in terms of the $750 million debt raise. Again, I'm going to let Sabra comment a little bit more on liquidity and capital. But when I look at all the different components of our capital strategy, I think we executed incredibly well in the first quarter. I mean our primary focus is to make sure that we have the appropriate capital levels in the insurance company subsidiaries for growth, and so it gave us tremendous opportunities at 1/1 as it will give us for the entire year."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. Yes. And I would just comment that, first of all, we look at our capitalization, both in base and stress scenarios. I mean this is just what I would call basic risk management procedures that we do. And we're very comfortable with our balance sheet even in the current environment where, obviously, there's a lot of stress on the system with the debt ceiling and the rest."
},
{
"speaker": "Michael Ward",
"text": "Very helpful. I guess maybe on the Crop deal, I guess, I was just wondering are there -- if you could maybe point to any other sort of targeted units where you could do sort of similar value unlocking deals there as you sort of work towards margin improvement and simplification."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Great. Thank you. We're always looking at the portfolio and looking at areas where we can add, where we can improve the overall structure of AIG and looking at the different parts of the world that we compete in. I think Crop is a little bit anomalous just because we really do believe it's a very good business, but you know how it works, which is driven by commodity prices and yields. And I think that having scale is really important. While the top line that we publish on a gross and net basis is significant, that's gone up 40%, 50%, if not more, over the past several years based on those components."
},
{
"speaker": "Operator",
"text": "Our next question comes from Alex Scott with Goldman Sachs."
},
{
"speaker": "Taylor Scott",
"text": "First one I had for you is on the separation at Corebridge. I know you mentioned the base case is still secondaries, but I think you also mentioned that you were considering some alternatives. So I just wanted to see if you could extrapolate on that a bit at all. What kind of alternatives could you look towards? And how could some of those things potentially improve things for shareholders?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. Thanks, Alex. I'll try to expand a bit on it. Because as you can imagine, there's not a lot of more detail that I can really share beyond my prepared remarks. We do believe the secondary is the preferred path. But obviously, it's subject to market conditions as we saw in the first quarter, but we're prepared to go in the second quarter."
},
{
"speaker": "Taylor Scott",
"text": "Got it. Follow-up I had is on corporate expenses. I think it was the first time you guys gave a bit more explicit guidance around where corporate expenses for RemainCo could shake out at that 1% to 1.5% premiums. And I just wanted to make sure I understood some of the mechanics. I mean when I think about that level, I mean, is that what I should expect in sort of Corporate GOE, overall Corporate costs? I mean how do I think about that? And then just a technical kind of question. The investment that I think you mentioned leading up to that, will that go through operating and also be reflected in Corporate?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. So we try to provide as much detail as we could on the expense savings. Certainly, let me start with AIG 200 because we still have more to earn through on AIG 200 savings in 2023 and 2024. So over 50% of that will be earned in mostly through the second and through fourth quarter of 2023. We have begun to separate Corebridge. And -- but upon deconsolidation, approximately $300 million of the AIG Corporate expenses will move to Life and Retirement. So that's another variable that you need to consider."
},
{
"speaker": "Operator",
"text": "Our next question comes from Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"text": "Peter, you gave us a lot of detail on the growth in the Commercial Lines. There's, obviously, very strong growth. I'm trying to just dumb it down a little bit here. If we look at what the growth is X, let's call it, Validus Re crop, what would have looked like? And what was the tailwind from Validus Re crop just from the Commercial Lines growth on a year-over-year basis? And the reason I'm asking is, those are obviously very big first quarter premium numbers. So I just want to make sure I'm not extrapolating that for the remainder of the year."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Brian. Certainly, Validus contributed a meaningful amount to the growth. But look, we bought a lot of retro. It's the first quarter. It's not all property. So each quarter is a bit different in terms of not being able to straight line it."
},
{
"speaker": "Brian Meredith",
"text": "Okay. Very helpful. And then second question, just curious, some other companies are talking about how the Commercial Property markets are even further firming up in the second quarter. There's more business available. Are you seeing the same kind of dynamics or things actually continuing to improve here in the Commercial Property markets?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. Thanks, Brian. Yes, we are seeing that. I mean, again, it's early in the second quarter, but views on April. And as we look to the rest of the second quarter, we're seeing Property continue to firm up and getting stronger than it was in the first quarter. So that's something that we're trying to be focused on clients, making sure we're driving value and we have a lot of capital to deploy. So we expect to be trading actively in the second quarter."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude the program. You may now disconnect. Everyone, have a great day."
}
] | American International Group, Inc. | 250,388 |
AIG | 4 | 2,024 | 2025-02-12 08:30:00 | Operator: Good day and welcome to AIG's Fourth Quarter and Full Year 2024 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, Michelle, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Following the deconsolidation of Corebridge Financial on June 9th, 2024, the historical results of Corebridge for all periods presented are reflected in AIG's consolidated financial statements as discontinued operations in accordance with US GAAP. Additionally, in the fourth quarter, AIG realigned its organizational structure and the composition of its reportable segments to reflect changes in how AIG manages its operations, which our Chief Financial Officer, Keith Walsh, will discuss in detail during his remarks. Finally, today's remarks related to AIG's adjusted after tax income per diluted share as well as General Insurance results, including key metrics such as underwriting income, margin, and net investment income are presented on a comparable basis, which reflects year-over-year comparison adjusted for the sale of Crop Risk Services and the sale of Validus Re as applicable. Net premiums written and net premiums earned are also presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis and adjusted for the sale of Crop Risk Services, Validus Re, and the global personal travel and assistance business as applicable. We believe this presentation provides the most useful view of our results and the go forward business in light of the substantial changes to the portfolio since 2023. Please refer to pages 37 through 39 of the earnings presentation for reconciliation of such metrics reportable on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino: Good morning, and thank you for joining us today to review our fourth quarter and full year 2024 financial results. Following my remarks, Keith will provide additional perspectives on our financial results, and then we'll take your questions. Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Before I begin, on behalf of all of us at AIG, I want to acknowledge the devastating impact of the recent wildfires in California on families, communities and the businesses affected. Our local teams remain on the ground in California, providing critical expertise and support to our customers and partners. This tragic event serves as a stark reminder of the escalating risks, elevated catastrophe landscape and the complicated evolving environment that we operate in. It also underscores AIG's purpose to help our customers and clients navigate these challenges with resilience in rebuilding communities and restoring businesses. Let me take a moment to cover what I will walk you through during my remarks this morning. First, I will briefly share highlights from our strong fourth quarter performance. Second, I will discuss our 2024 strategic and operational accomplishments. Third, I will provide an overview of the full year financial results for AIG and our General Insurance business. Fourth, I will comment on the reinsurance market, including the January 1 renewals and provide some observations on the impact of the recent California wildfires. And lastly, I'll provide an update on the progress we have made on our capital management strategy, our path to achieving a 10% plus core ROE and how we are positioning the company for 2025. Let's begin with the fourth quarter results. We recently announced a realignment of our General Insurance business into three segments. North America Commercial, International Commercial and Global Personal. All of our comments will be aligned to these segments. During the quarter, we continued to deliver exceptional underwriting results and we maintained rigorous expense discipline. General Insurance reported strong net premiums written of $6.1 billion, an increase of 7% year-over-year led by 8% growth in Global Commercial lines. Global Commercial generated new business of $1.1 billion a 16% increase year-over-year along with continued strong retention of 86% across the portfolio. Net premiums earned of $6 billion grew 6% year-over-year. Adjusted after tax income per share grew 5% year-over-year to $1.30 per share. The calendar year combined ratio was 92.5%. And the accident year combined ratio, excluding catastrophes, was 88.6% which was an outstanding result. 2024 was a terrific year of accomplishments for AIG, during which we not only delivered strong financial performance, but also successfully executed significant strategic and operational initiatives. We delivered disciplined growth in our businesses with a primary focus on risk adjusted returns supported by our underwriting expertise. We reshaped the portfolio, including divesting a number of non-core businesses. Following the sale of Validus Re in November of 2023, we closed on the sale of the global individual personal travel insurance business in December of 2024 to further position us for the future. While these divestitures help to further simplify AIG, the biggest accomplishment of the year was the deconsolidation of Corebridge Financial. The separation was a four year journey during which we strategically positioned Corebridge for its future while creating a new capital structure for AIG. Some of the major milestones of the Corebridge journey included establishing a very important partnership with Blackstone through an initial 9.9% sale in 2021, executing the largest US IPO in 2022, setting up a strategic asset management partnership with BlackRock, divesting non-core foreign businesses, completing five successful secondary offerings, two of which were in 2024 and culminating in the fourth quarter with AIG sale of a 22% stake in Corebridge for $3.8 billion to Nippon Life, securing another strategic partner for the company. With the accounting deconsolidation of Corebridge, AIG is now a less complex and more streamlined global business. AIG Next was another operational accomplishment in the year, which further supported our journey to make the company leaner, weave the organization together and reduce expenses. We exited 2024 achieving $450 million in run rate savings as part of the program and we expect the remaining benefits to be realized in the first half of 2025. We also continue to successfully execute on our capital management strategy in a very disciplined manner with nearly $10 billion of actions in 2024. AIG reduced shares outstanding by 12% and increased the quarterly dividend per share by 11%, resulting in the return of $8.1 billion of capital to shareholders. We received over $4 billion in dividends from our subsidiaries due to the improved profitability of our operations. We further reduced our debt to total capital ratio to 17% and we ended the year with $7.7 billion of parent liquidity. Our capital management actions to-date have provided us with tremendous financial flexibility. Another strategic accomplishment in 2024 was the delivery of AIG's first generative artificial intelligence large language model powered solution to support business growth. Specifically, we implemented AIG Underwriter Assist, which automates qualitative unstructured data extraction from underlying submissions, internal AIG data sources, and external research in minutes to support underwriter review of submissions. To support and advance our GenAI aspirations, we've cultivated an ecosystem of top tier technology partners, including Palantir, Anthropic and AWS in support of an agentic architecture operating model that allows for maximum flexibility. We also launched the Reinsurance Syndicate 2478 at Lloyd's through a multiyear strategic relationship with Blackstone as part of AIG's Outwards Reinsurance Program. The syndicate began underwriting on January 1, 2025 and now serves as a key component of AIG's reinsurance strategy, which I will go over in more detail later. Turning to the financial results for the full year 2024. Adjusted after tax income was $3.3 billion or $4.95 per diluted share, an increase of 28% year-over-year. The improvement was primarily driven by stronger underlying underwriting results, expense reduction benefits from AIG Next, an increase in net investment income and the execution of our balanced capital management strategy. General Insurance delivered terrific financial performance for 2024. For the full year, net premiums written were $23.9 billion, a 6% increase year-over-year. Net premiums earned were $23.5 billion, a 7% increase year-over-year. The accident year combined ratio as adjusted was 88.2%, which marked the sixth consecutive year of improvement, largely driven by the GOE ratio. The full year General Insurance combined ratio was 91.8%. This was the third consecutive year of a sub-92% combined ratio. Prior year reserve development, net of reinsurance and prior year premium was $289 million a benefit of 1.4 points to the loss ratio. General Insurance full year underwriting income was $1.9 billion roughly in line with the prior year despite higher catastrophe losses. In Global Commercial, net premiums written of $16.8 billion increased 7% year-over-year. North America Commercial grew net premiums written by 9% year-over-year. Lexington grew net premiums written by 14% fueled by robust new business of $1.1 billion and a 42% increase in submissions year-over-year, and that was balanced across all lines. Retail casualty grew net premiums written by 11%, excluding the closeout transaction we mentioned in the third quarter. Our portfolio continues to benefit from a strong rate environment, high retention of our existing portfolio at 93%, and we have select opportunities in new business. International Commercial grew net premiums written by 4% year-over-year, driven by energy at 13%, retail property at 11% and Talbot at 7%. Global Personal grew net premiums written by 3% year-over-year, driven by International Personal Auto at 8% and our high net worth business at 6%. I would now like to turn to reinsurance and provide some observations on the market and an update on AIG's reinsurance renewals at January 1 of this year. Overall, AIG had a very strong 01/01 renewal season. Since the reinsurance market's major reset on January 1 of 2023 our consistency in strategy, placement and execution has positioned us very favorably. Benefiting from an environment of higher retentions and commensurate pricing increases, property reinsurers sought to deploy more capital, but were predominantly focused on upper layers with more remote return periods. Depending on loss activity, limited additional demand led to risk adjusted rate reductions that were consistent with expectations, with the bottom catastrophe layers renewing flat to down 5% and upper catastrophe layers receiving reductions of 10% to 15%. I want to provide some context and observations on the changes in the market as a result of the increase in reinsurance retentions, which I've mentioned on previous calls is creating an interesting dynamic for the market in 2025. One insightful statistic from an Aon study of over 150 companies over the past ten years is that retentions have risen significantly around the world with the US attachment points on average increasing by 280%. As a reminder, in 2024, insured loss from natural catastrophes was approximately 145 billion. The sixth costliest on record and this compares to the average for the last five years of 140 billion. With the increased retentions and increased catastrophe activity, much more of the risk is now being retained by insurance companies. In 2023 and 2024, primary insurance carriers are estimated to retain approximately 90% of the insured loss from natural catastrophes with the reinsurance industry absorbing 10%. Contrast this with the period prior to 2023, reinsurers would often share a significantly higher proportion of the insured loss with the distribution of losses between insurers and reinsurers at approximately 50-50 on average. Meanwhile, AIG is focused on maintaining lower excess of loss attachment points, including meaningful aggregate coverage to manage frequency of loss tailored to our geographic exposure and to the type of perils that we are exposed. Taking a closer look at wildfires and how the market has changed, the average annual insured loss from 2000 to 2024 was approximately 4 billion globally of which the US is the majority at 3.5 billion Narrow that period to the last ten years and average annual losses from wildfires have roughly doubled to around 8 billion of which 7.4 billion has occurred in the United States. Insured loss estimates for the California wildfires are currently coalescing around 40 billion with some estimates from credible catastrophe experts reaching as high as 50 billion. The economic loss is estimated to be in excess of 250 billion producing a protection gap of as much as 80%. Contrast that to the top 10 largest insured cat events on record, where insurance has typically covered 40% to 50% of the economic loss. As a point of reference, insurance covered approximately 50% of the economic loss from Hurricane Katrina, the largest natural catastrophe event this century. The California wildfires demonstrate the increased loss from secondary perils and the magnitude of tail events that are not captured well in modeling. In a month with one of the lowest model probabilities of loss, the California wildfires alone would make the first quarter of 2025 the second most costly first quarter for natural catastrophes on record. Fifteen years ago, adjusting for inflation, 100 billion was considered the benchmark for an outsized cat year. With the last eight years averaging more than 140 billion this thinking is clearly outdated. If you assume the upper end of the range for the California wildfires taking a $50 billion loss pick, adding the average annual insured loss for the past eight years, and assuming we have an active, but not abnormal wind season, which is realistic given the 2024 hurricane season experience and ocean temperatures are the warmest on record, 2025 could be a year of more than 200 billion of insured catastrophe losses. This could recalibrate the entire industry. AIG reduced our overall California exposure beginning in 2022. This decision, coupled with our 2025 reinsurance structure has effectively reduced our exposure such that the expected loss to AIG from the recent wildfires is approximately 500 million before reinstatement premiums and barring any unforeseen additional developments. Turning specifically to AIG's reinsurance outcomes at 01/01, we successfully maintained our prior objectives, our reinsurance purchasing strategy to preserve and optimize capital and enhance the quality of earnings through active management of the volatility of our underwriting results. Starting with our property catastrophe placements, our core commercial North America retention of 500 million remains unchanged in nominal terms for the third consecutive year despite growth in the underlying portfolio. We also expanded coverage and maintained our core international occurrence attachments and renewed our dedicated occurrence tower for our high net worth business, which attaches at 200 million. We improved our 500 million of aggregate protection by reducing the annual aggregate deductible for North America, creating a specific non-peak section and expanding the coverage for the high net worth portfolio. Overall, for North America, depending on loss distribution, AIG's modeled net first loss exposure, including the impact of reinstatement premiums is comparable to 2024 and our second and third event exposure is materially lower following its renewal cycle. For all of our major proportional treaties, we were able to improve or maintain our ceding commission levels, a strong recognition of our underwriting expertise and our position as a market leader across multiple classes. We were also able to establish two new proportional treaties to support the high net worth portfolio. Our strategy to establish Private Client Select as a standalone MGU and introduce capacity to support growth in the platform beyond AIG's balance sheet has been validated with the addition of five of the leading underwriting companies in the world to the platform, taking 30% of our homeowners and auto portfolios through quota share reinsurance. Casualty remains an area of caution for many reinsurers with appetite generally diminished. They are highly selective of the insurance companies they support. And overall, the casualty renewals were more orderly for the companies that have strong underwriting portfolios. We were pleased with the successful renewal of our core casualty treaties at favorable terms. This renewal cycle again signals the strong external industry recognition that AIG continues to be a leader in the casualty market. We remain optimistic on the outlook for our casualty portfolio and see considerable opportunities ahead, while being cautious and very focused on maintaining our high underwriting standards. Also of significance for AIG at 01/01 was our launch of a new dedicated reinsurance syndicate at Lloyd's supported by funds managed by Blackstone. This pioneering structure announced in December 2024 is an example of how insurance risk can be directly connected to sophisticated investors to generate attractive returns for both parties. The syndicate provides AIG with a long-term meaningful reinsurance partner and an additional source of fee income. Blackstone has access to a high quality, well diversified underwriting portfolio with the ability to generate attractive returns by taking a sizable participation in the majority of AIG's outward reinsurance treaties at market terms. We're pleased to partner with a leading global asset manager on its innovative structure. Our reinsurance strategy has played a pivotal role in our journey to establish AIG as an industry leading global P&C underwriter. We're grateful for the long-term support and partnership of the industry's leading reinsurers, which has helped position us where we are today. Turning to capital management, we continue to execute very well on our balance and disciplined strategy. We made major progress in 2024 and in many ways exceeded expectations. As we outlined last year, our guidance was to repurchase $10 billion of shares in 2024 and in 2025. The current guidance is expected to bring us within our target share count range of 550 million to 600 million shares. We have $3.4 billion of the $10 billion guidance that I provided remaining for 2025. We will likely exceed this guidance and we have over $5.6 billion remaining on our current share repurchased authorization. We expect to return to more normalized levels of share repurchases as we enter 2026, assuming we have no further sell downs of Corebridge or other additional sources of liquidity. We ended the year with a very strong parent liquidity of $7.7 billion. Additionally, we do not anticipate taking any actions that would significantly affect leverage in 2025. We are committed to reviewing our dividend annually and anticipate that we will increase our dividend in 2025 in line with the decrease in our share count over the past year, subject to AIG board approval. Going forward, our key focus is on profitable growth and allocating capital to the best opportunities for the most attractive risk adjusted returns. Our very early forecast indicates we're off to a strong start for 2025 and barring any unforeseen developments, we expect to achieve meaningful organic growth driven by our Global Commercial business and the benefits of our restructured reinsurance program. As a result of our disciplined capital management, combined with our sustained underwriting excellence and continued focus on expense management, we're well on track to deliver a 10% plus core operating ROE for the full year 2025. We have several ways in which we can deliver on this commitment. These are maintaining our strong underwriting results with a focus on improving Global Personal, improving our investment income yields, executing on a simpler, leaner business model across AIG and continued balanced capital management. In summary, I'm very pleased with our outstanding fourth quarter and full year 2024 performance. 2025 is a new chapter for AIG and we're moving forward with strong momentum. We continue to differentiate ourselves with deep industry expertise and disciplined focus on underwriting excellence and outstanding operations and claims capabilities, which drive exceptional value for our clients, partners and stakeholders. With that, I will turn the call over to Keith.
Keith Walsh: Thank you, Peter. This morning, I will provide details on fourth quarter results for General Insurance, net investment income and other operations as well as key balance sheet items. I would like to begin by addressing a few changes in our financial reporting. As Peter mentioned, we have realigned our General Insurance business into three reporting segments. North America Commercial, International Commercial and Global Personal. Global Personal lines have been consolidated into a single reporting segment. This brings together our Global Accident and Health, Personal Home and Auto, Global Warranty and Services and High Net Worth businesses. Along with our new reporting segments, we have updated the product line net premiums written disclosure on Page 8 of our financial supplement to give more transparency into the underlying trends in our businesses. The three segments and updated product line disclosure are reflected retrospectively in AIG's 2024 fourth quarter and full year financial results. Additionally, we have streamlined other operations to include activities only related to having a global regulated parent company and now exclude the results of runoff businesses from adjusted pre-tax income. We believe these changes enhance the clarity of our financial disclosures and provide a better representation and alignment of our core business. Historical results have been recast to reflect these changes with de minimis impact to operating EPS. Other operations now largely consists of net investment income from our parent liquidity portfolio, Corebridge dividend income, corporate general operating expenses and interest expense. Turning to our fourth quarter General Insurance results. Adjusted pre-tax income or APTI was $1.2 billion. In North America commercial, net premiums written increased 9% year-over-year, driven by strong new business, which grew 17% with retention of 85%. International Commercial net premiums written increased 7% year-over-year with new business growth of 15% and excellent retention of 88%. In Global Personal, net premiums written increased 1% on a constant currency basis. The sale of the Global Personal Travel and Assistance business, which closed in early December, was about a four point headwind to the year-over-year comparison. Adjusting for that, growth was 5% in the quarter on a comparable basis, driven by 16% growth in our Global High Net Worth business. The sale of the Global Personal Travel business will have an impact on the Global Personal segment in 2025. For full year 2024, this segment had $7.1 billion of net premiums written. When modeling 2025, the sale of the Global Travel business will remove approximately $720 million of net premiums written. This is a roughly 10 percentage point growth impact for the segment. General Insurance underwriting income for the quarter was $454 million, a $156 million decrease from the prior year quarter, driven entirely by higher catastrophe losses. General Insurance calendar year combined ratio was 92.5%. The accident year combined ratio as adjusted was 88.6%, a 30 basis point increase from the prior year quarter. This was driven by a slight increase in the accident year loss ratio, while the expense ratio remained flat despite absorbing more AIG parent expenses. Catastrophe losses were $325 million or 5.5 points on the loss ratio. This includes $224 million of losses from Hurricane Milton and an adjustment for prior quarters events largely from Hurricane Helene, which occurred on the final day of the third quarter. Turning to reserves and our detailed valuation reviews or DVRs. This quarter, General Insurance had $102 million of favorable prior year development, including $34 million from the ADC amortization, $16 million from our fourth quarter DVRs and $52 million from non-DVR adjustments, predominantly recognition of AVE on US short-tail lines. The fourth quarter's DVRs covered the remaining 10% or approximately $4 billion of our total loss reserves focusing on the remaining portion of US financial lines, global personal lines Canada and Glatfelter. The favorable prior year development was primarily driven by Canada Casualty and US E&O. We conduct a comprehensive DVR annually for each product line across our $40 billion of reserves. While DVRs are spread across quarters, we have a robust year-round process on our entire book in addition to our quarterly DVRs. Going forward, our comments will focus less on reporting the DVR outcomes and more on our overall reserve analysis, which reflects AVE claims diagnostics and rate monitoring across all lines and geographies. One additional item I would like to discuss is a provisional reserve we created in 2022 in response to the potential uncertainty with inflation and other variables in the post-pandemic macro environment. This provision, which is included in IBNR, has been carried in the lines that we viewed as most susceptible to rising inflation with a large portion booked in our workers' compensation reserves. This year, we undertook a thorough review of the uncertainty provision which was set above the loss picks from our actuarial reviews and refined our analysis, including its allocation among our lines of business. The uncertainty provision did not reflect any emergence and we have maintained the overall estimate. However, we have decided to reduce the provision in excess workers' comp and reapportion approximately $150 million of the provision within excess casualty. We elected to move this portion of the reserve to excess casualty as the development factors and the length of the tail can drive a wider range of outcomes on our reserves. To be clear, our traditional reserve methods are not indicating any emergence in excess casualty, but we felt, given the nature of the provision, it was more appropriate to be situated within this line. As a reminder, our reserving philosophy is to react to bad news quickly and wait to recognize good news over time as we monitor developments. Moving on to rates and pricing. Fourth quarter Global Commercial Lines pricing, which includes rate and exposure increased 5% year-over-year, excluding workers' compensation and financial lines. In North America Commercial, renewal rate increased 3% year-over-year or 7% if you exclude workers' compensation and financial lines. Exposures increased 2% year-over-year with an all-in pricing change above loss cost trend. Property market conditions were under pressure in the fourth quarter due to increased competition across both the admitted and E&S markets, while the underwriting margin remained healthy. Supported by the cumulative rate increases over the past several years and our disciplined approach. In North America Casualty lines, rate continued to outpace loss cost trend with increases in the mid-teens in wholesale and excess casualty. In North America financial lines, we continue to experience headwinds, but see indications that rate reductions are moderating. In International Commercial, overall pricing was flat or up 2% excluding financial lines. While rate is below trend, we feel good about our book given we've had over 60% cumulative risk-adjusted rate since 2018. Our well-diversified portfolio allows us to navigate different market conditions effectively prioritizing lines of business that offer the most compelling risk adjusted returns while upholding our underwriting standards. For the full year 2024, excluding workers' compensation and financial lines, Global Commercial lines pricing, which includes rate and exposure increased 6%, with 8% in North America and 4% in International. Turning to other operations. Fourth quarter adjusted pretax loss was $150 million, which improved 34% year-over-year. This was primarily driven by lower GOE reflecting AIG Next benefits as well as incremental movement of GOE into General Insurance. We continue to realize the benefits of AIG Next and push nonpublic company-related expenses into the business. We expect corporate GOE expenses to migrate towards approximately a $90 million per quarter run rate over the course of 2025. Interest expense improved $10 million year-over-year, as a result of our liability management, which reduced total debt by $1.6 billion in 2024. One other item I want to discuss is a runoff business, Blackboard. In the fourth quarter, we increased the prior accident year reserves for Blackboard by $112 million to reflect loss activity that has been well above what was expected. Turning now to investment income. For the full year 2024, net investment income on an APTI basis was $3.5 billion, up 13% from 2023, primarily driven by Corebridge dividends, an increase in short-term investment income and higher reinvestment rates on fixed maturities. Fourth quarter net investment income on an APTI basis was $872 million largely unchanged year-over-year. General Insurance net investment income was $779 million, including income on fixed maturities, loans and short-term investments of $720 million and alternative investment income of $72 million. Other operations net investment income was $93 million, consisting of income from our parent liquidity portfolio of $64 million and Corebridge dividend income of $29 million. During the fourth quarter, we continued to benefit from higher reinvestment rates on the fixed maturity and loan portfolio. The average new money yield of 5.38% was roughly 175 basis points higher than the sales and maturities in the quarter. The annualized yield on the fixed maturity and loan portfolio, excluding calls and prepayments was 3.92%, up four basis points year-over-year or three basis points sequentially. The fourth quarter alternative investment income was $67 million, an increase of $26 million year-over-year, driven by improved private equity performance, partially offset by lower hedge fund income owing to our strategy to reduce exposure. Private equity yielded 6.42% for the quarter, below our long-term expected return of 7.5%. The makeup of our private equity portfolio is a little over 25% real estate and with the current macro environment, we expect pressure from this portion of the portfolio to continue through 2025. Turning to tax. The adjusted effective tax rate for the fourth quarter and full year was 24.6%. For 2025, we expect the adjusted tax rate to be in line with 2024, but may vary based on the geographic mix of income. We finished 2024 with a very strong balance sheet. Book value per share was $70.16 at year-end, up 8% from December 31st, 2023, mainly due to the favorable impact of lower interest rates on AOCI and reduced shares outstanding. Adjusted book value per share was $73.79 down 6% from year-end 2023, primarily due to the impact of Corebridge deconsolidation. Core operating ROE was 9.1% in the quarter and for the full year. As Peter laid out, we are committed to achieving our target of a 10% plus core operating ROE for the full year 2025. As Peter mentioned, we had a substantial $6.6 billion returned to shareholders in 2024 through share repurchases and are well on our way to completing our guidance of $10 billion of repurchases in 2024 and 2025. Through February 7, we have repurchased $952 million of shares year-to-date in 2025. We are proud of the significant progress we've made in 2024 and the ability to deliver outstanding core operating results while successfully executing significant transformation initiatives. With that, I will turn the call back over to Peter.
Peter Zaffino: Thank you, Keith and Michelle, we're ready for questions..
Operator: Thank you. [Operator Instructions] Our first question comes from Alex Scott with Barclays. Your line is open.
Alex Scott: Hey, good morning. First one I have for you, excuse me, is on the core ROE that you gave. I just wanted to confirm that that's including the wildfire impact. And it looks like it's running a bit better than I would have expected based on the combined ratios that you've talked about in the past and corporate expenses and so forth. So I was just interested if you define it all on maybe some of the things that you're running ahead on or that are improving relative to some of those comments you've made in the past? Thanks.
Peter Zaffino: Yes. Certainly, Alex. And, yes, we are confirming the 10% plus ROE including the $500 million wildfire that we had in January. If I could spend a second, I think we've done an exceptional job over the past few years of structuring our sort of global portfolio structuring the reinsurance to supplement that and having net retentions well within our expectations and what we budget. If I look at what we do budget for AAL over the last couple of years relative to our overall experience, it's been exactly where we anticipated even with elevated activity. So this is no different. I mentioned on the call that we're going to take first event losses around the same with reinsurance that we did in 2024, but second and third events will be less. And so that's how we structured it. And we are confirming guidance on the 10% including what happened in January. I think Keith noted that we have a lot of different ways in which we can sort of drive improvement in terms of earnings. I did as well in my prepared remarks. We're really pleased with the commercial portfolio and how it's performed on a combined ratio basis. We just continue to, I think, elevate our overall performance. I have singled out personal because I think that combined ratio is not where any of us want to be. We consolidated that under one leader. Jon Hancock, he's shown exceptional leadership in what he's done with the commercial portfolio in international. And I think it's going to give us a much better line of sight on the overall portfolio in terms of how we can improve it, which we fully expect to do. I think there's opportunities in NII further capital management. And I think we reconfirmed what we're doing on return of capital to shareholders. So I think we have a lot of very positive momentum and want to confirm guidance. Do you have a follow-up, Alex?
Alex Scott: Yes. So as a follow-up, I'd just be interested in some of the areas you're targeting towards organic growth. And maybe in particular, your updated view on price adequacy just given some of the declines in property pricing in E&S and then maybe also on casualty?
Peter Zaffino: Okay. I'm going to have Jon Hancock and Don Bailey talk a little bit about the growth because they've done an exceptional job in terms of outlining where our portfolio can grow, focusing on risk-adjusted returns. What I would say and this is complementing their efforts is that we've just done a tremendous job in terms of client retention focusing on an underwriting culture of maintaining and improving profitability. And so like we deploy capital where we think we have the best opportunities for improved risk adjusted returns. And they've done an exceptional job on new business in targeting parts of our business where we think we can have those outsized returns over time. And I think that's how you've seen the portfolio shape. So Jon why don't I start with you in terms of international and maybe give us a little bit of insight in terms of the growth.
Jon Hancock: Yes. Okay. Thanks, Peter, and Alex. Growth through retention and new business was strong in the quarter. Peter and Keith called out a lot of that in their opening remarks, so I won't repeat it now. But what I will say is, we're working from such a strong base in this commercial portfolio in international. And when we look at where we've been growing, if you look at the quarter, there's a lot of seasonality across international. For example, in Q4, 50%, more than 50% of our net premiums come from just two lines. We like the global specialty and financial lines, but that's not the full year mix. So I think looking at growth, looking at new business, quarter-on-quarter isn't always the most insightful way. And Q4 is obviously the end of the year as well. So I think it's a good time to reflect on what we've been doing the whole of 2024 and talk about that momentum that we have been building. If I look at the full year, Keith called it out, 4% growth in the year across International Commercial. Renewal retention in the full year, 89%. I'm really, really pleased with that on such a good book of business. And new business for the year, more than $2 billion of new business during the year in International Commercial. Again, a great outcome, really reflective of the fact that we're still seeing great new business opportunities all around the world actually. And I also do want to make clear that new business is a big driver of our growth. We manage the quality, the price advocacy of our new business just as closely as we do our renewal book. And we trade on a value we offer. Our recognition as market leader, first class claims, risk management, strong balance sheet, not just price and that matters to a lot of customers. And if I could, I know you asked about property specifically. If I can just call out two places where we've been working really hard with our distribution partners on being clear on risk appetite, building propositions that customers want, building strong opportunity pipeline. That's where we've been getting the growth momentum from, and that's what we will see all through this year. There's too many areas to call out across international, but Global Specialty. A number of new business submissions up 24% year-on-year. Marine absolutely outstanding at 46% increase. Our straight rate on the business, we quote more than 25%. And again, Marine Energy, which Peter talked about earlier, 40% strike rates. So that's more than $700 million of new business in Global Specialty. Just a final one to show that momentum. Our commercial property book another standout. We spent a lot of time fixing and repositioning that portfolio. And we've now seen over the last couple of years, really strong growth and profit. Growth of 11% in the year. We're still seeing strong mid-digit rate rises as well as growth and some real high quality new business. The rating environment today, as Peter said earlier, is different to what it was in Q4. So we see lots of great opportunity all over and we'll build on that momentum.
Peter Zaffino: That's great, Jon. Thank you. Don, maybe I just want to have a little bit of a highlight of achievements in North America in terms of growth.
Don Bailey: Great. Thank you, Peter. I'll break down the North American Commercial numbers. For 2024, and you mentioned this, we grew net premiums by 9% driven by retention and our new business. We had strong retention of 91% in retail and 76% in wholesale. We also delivered impressive new business growth like Jon in North America, 15% up on a year-over-year basis and that's on top of 14% new business growth in 2023. This growth is intentional, it's strategic, it's diversified. With the great work over the past few years in our portfolio, we came into 2024 with distribution engagement as a top priority for us in all the channels in which we operate and it's paid off. Our new business was strong through all three channels. Retail, wholesale and alternative. With Lexington, we had another strong year. They represented 48% of our new business. Lex property, casualty, western world, all delivered. And as Peter referenced, Lex another big increase in submissions, 42% increase on a year-over-year basis. And there's a clear opportunity to harness the strong submission activity there to drive growth as we go forward. The rest of the new business was balanced across the portfolio. And finally, Peter, I'll just say this at the end that our growth given our unique assets at AIG, we really are able to underwrite with great discipline within our risk appetites and target opportunities with attractive risk-adjusted returns. Thanks, Peter.
Peter Zaffino: That's great, Don. Jon, thank you. I know that answer was they were very thorough, but they're doing the work. And so I thought it would be really helpful to hear from them. Next question.
Operator: Thank you. Our next question comes from Meyer Shields with KBW. Your line is open.
Meyer Shields: Great. Thanks. Peter, I was hoping you could walk us through how we should think about the impact of the artificial intelligence deployed in underwriting? I know it's simplistic to say how many loss ratio points would have moved, but how should we think about it more broadly?
Peter Zaffino: Thanks, Meyer, and good morning. For us, I could spend a meaningful amount of time talking about GenAI and we fully intend to do that at Investor Day. Our focus has always been on driving growth certainly there's opportunities in contact centers and call centers and operational capabilities that through large language models, robotics that we will gain efficiencies. But for us, it's all about ingestion of data, getting more qualified data to the underwriters in a fraction of the time. And in order to do that, you need to be very disciplined sort of end-to-end. So how we ingest data from brokers and agents, how we define what data we want in the underwriting criteria when it gets to the underwriter, how do we load that into models and how do we get more data from credible sources that may supplement the underwriters' decision making in order to continue to improve the portfolio. If I use Lexington as an example, in 2017 and 2018, we received 40,000 submissions. This year, it's over 400,000. So it's more complex today than just building out algorithms to get to different industry groups or different classes of business. We want to get more to the underwriters real time. And so we've been doing this for the better part of 18 months. I said we built out a really strong agentic ecosystem with, again, data ingestion with Palantir, building out large language models with Anthropic and using other reliable third parties to help us accelerate the modeling. And so I think it's going to help us propel top line growth by getting more data, getting richer data sets, giving the underwriters more capabilities to underwrite and having it done in the fraction amount of time and doing it at scale.
Meyer Shields: Okay. Thank you. That's very helpful. The second question is on the timeline for getting the high net worth personal lines business to growth underwriting profitability. I don't know if there's anything you can share on that.
Peter Zaffino: Yes, absolutely, Meyer. And, look, I think we've been on that journey for a couple of years, and everybody has been patient with the story. We continue to improve the combined ratio. We continue to improve the loss ratio. And if you look at Global Personal, the biggest contributor in terms of that improvement, it was primarily all the private client service or a high net worth business. There was a significant improvement in the loss ratio and we expect that to continue. We have a balanced growth strategy with non-admitted as well as admitted and believe that as we see more submission activity, which we are, not admitted that we're able to deploy our capital with more flexibility to be responsive to client needs. So I'm thinking about structure pricing, the amount of limit that we can put out and it's not only in peak zones, it's in non-peak zones. And so we expect to see that continue to accelerate. We got to scale this year. And so we've renegotiated ceding commissions with PCS and so you'll see a meaningful improvement there, which should translate into overall expense ratio improvement and combined ratio improvement. And last I mentioned is that we have tremendous partners that have joined us based on how we've repositioned the portfolio and our encouraging growth. And so we have a 30% quota share with six participants all have very strong expertise in the high net worth space that are backing us for more growth. So I think we have it all moving in the right direction, attritional loss ratios, cat support from great partners and improvement in expense ratio and you'll see that contribute in 2025 to helping overall Global Personal improve.
Meyer Shields: Okay, fantastic. Thank you so much.
Operator: Thank you. Our next question comes from Jon Newsome with Piper Sandler. Your line is open.
Jon Newsome: Good morning. Congrats on the quarter.
Peter Zaffino: Thank you, Jon.
Jon Newsome: Two sort of big picture question. One is are we at a point where there are aspirational areas of business that AIG is not in that you would be looking for either on organic or inorganic basis? And I guess sort of relatedly on the other side of that question is where are we from a divesting of noncore businesses perspective? Are we pretty much done at this point?
Peter Zaffino: Sure. Thanks for the question. I'll start with the second one first. I think we are largely done. I mean, I don't ever say never or always. But I think we now have the portfolio in a place where we'd like it, certainly on the commercial side, and now having one segment for Global Personal. We know we have work to do, but really like the mix of the portfolio, its global balance and think that we can grow it. In terms of M&A, we're going to remain very disciplined. I always use the word when I get the question on the calls or I'm in front of you. It's around being, it has to be compelling, which just means that it's either going to be a geography that's complementary that actually adds value to AIG and our clients' products that we may not be in that we like and think that it's going to be accretive to ROE and how we grow our business. There are businesses that we have that have scale, but additional scale could be quite compelling. And so we are looking at that businesses that may do that and accelerate. And of course then there's complementary businesses that we may not be in that we think could be very additive to the platform. So we have a very disciplined approach. We always are looking around the world to see if there's things that are additive. But I do want to say I think we're at the size and scale where we don't need to add anything. We are showing, and I think Jon and Don provided tremendous insight as to why we think we can grow the business organically. We have a really strong capital base, which we can grow into, and believe that there's a path there. So I don't think it's an either or. I think we have now set the company up with enormous strategic and financial flexibility. We'll remain very disciplined as we look at inorganic, but we're very excited about the organic opportunities that are in front of us.
Jon Newsome: Great. Maybe as a second question. Do you have any thoughts on the regulatory environment? Clearly lots of, as my grandmother would say, interesting things happening in California from a regulatory perspective. But broader, do you think there's some changes here that are coming or do you think it's pretty status quo?
Peter Zaffino: Insurance is complicated because we're regulated state by state. And that makes every state a little bit different, right? And I think the ones that get the attention are going to be ones that have peak zone exposure like we're seeing within California. And California is particularly complicated because I relate it almost to Japan. It's a geography that has two major perils that drive catastrophe results. And so I was in Japan's typhoon quake, California's quake and now wildfire. And but there's regulators. We work very closely with them to try and be helpful and constructive on the changes that have happened in the catastrophe climate, which is looking at modeling, looking at loss cost, looking at cost of goods sold and looking at ways in which we can be more responsive to client needs. And I think that in California, we just saw that the modeling is flawed. It doesn't necessarily always take into account tail events. There's not a lot of model losses north of $40 billion. And so therefore, it becomes very complicated. And I don't mean this in California, but we're now seeing it, which is some of these state set up sort of vehicles that become a market of last resort be sometimes become a market of only resort and then they end up taking on a lot of aggregate. So I think we just need a reset in certain spots. And I think like insurance companies that have technical capabilities working very closely with regulators. I hope that we're going to position the businesses where we will have more flexibility in the future.
Jon Newsome: Thank you very much.
Peter Zaffino: Yes. Thank you.
Operator: Thank you. Our next question comes from Michael Zaremski with BMO. Your line is open.
Michael Zaremski: Great. Follow-up, morning, on the expense ratio. I heard the comments about ceding commissions improving, so that should be a positive going forward. The expense ratio has been running a bit higher than expected for a while now. I mean, obviously, the loss ratio has been excellent. So that's the main focus. But just curious if you're willing to give any specific more specific guidance on kind of what type of expense ratio level or acquisition expense ratio level we should be thinking about on a go-forward basis?
Peter Zaffino: Michael, are we talking about PCS and high net worth or just general insurance?
Michael Zaremski: Sorry, I was talking about the whole company, General Insurance.
Peter Zaffino: Yes. So let me unpack, I mean, again, I know with AIG, it's like with the divestitures and a lot of the moving pieces from other operations into General Insurance, it's complicated. But I'm actually really pleased with what we've done on the expenses. I think we've remained incredibly disciplined. We focused on a lean parent, which just meant that there's simplicity. There's not a lot of expenses sitting in other operations and they're going to be more in the business. So if I actually take you through what happened, and if you look at our financial supplement, you'll see $2.9 billion or thereabout $2.952 billion as sort of the expenses. But if you get underneath that, look, AIG Next, the business was very proactive in getting expenses out. And so we would have gotten around $125 million to $140 million out through AIG Next. But we've added in from other operations and other technology that would have sat in other operations, almost $200 million. And so the business has absorbed a lot of expenses as we reposition the company to have this lean parent very transparent, not with a lot of expenses and the business is absorbing it as we go. And so not only am I proud that they've been able to do that and we haven't had a blip, we also believe that there's opportunities to get more expenses out and the ratios to improve as we get through the rest of 2025. Do you have a follow-up?
Michael Zaremski: Yes. Quick follow-up. Just I know you made some comments on the casualty marketplace. I'm not fast enough to update all the pricing data you gave us, which is always helpful. But I'm curious, are you experiencing any acceleration in casualty pricing, either excess or retail? And do you still feel that I feel like a couple of quarters ago, you mentioned this might be an area you're willing to play a bit of offense in.
Peter Zaffino: Yes. So it's a great question. And again when we look at rate across North America, International, it's an index. And so you don't always get a line of sight. But we do see real opportunities in casualty. We're very cautious, but the rate environment is actually quite strong. I mean in Lexington Casualty, you'll start there. We had 14% rate in 2024. In retail excess casualty, we had 15%, that's the fifth year in a row of double-digit rate increases in retail excess casualty, it's above loss cost trend. So we feel like we're building margin, really strong retention. We've been able to reposition the portfolio as we've liked. We have an exceptional particularly in the US leadership with Barbara Luck. I mean we have the best underwriting team in the industry and that's being demonstrated because clients are asking us to be on their business, help structure it, help the terms and conditions. So others will be active participants in the market. And so we're leading. We're underwriting really well. We've repositioned the portfolio. We've got great reinsurance support for severity. And we're getting rate above loss cost. So I want to be very cautious and careful, but I also don't want to miss the opportunity to be an industry leader.
Michael Zaremski: Thank you
Peter Zaffino: Okay. I want to thank everybody for questions and your active participation today. In closing, I want to thank our AIG colleagues around the world for their continued commitment, teamwork and the significant contributions. I mean, we accomplish a lot every year, and we try to capture it for you today and we really appreciate joining us today. And we look forward to sharing a lot more detail on March 31st during AIG's Investor Day. Have a great day.
Operator: Thank you for your participation. This does conclude the program and you may now disconnect. Everyone have a great day. | [
{
"speaker": "Operator",
"text": "Good day and welcome to AIG's Fourth Quarter and Full Year 2024 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, Michelle, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Following the deconsolidation of Corebridge Financial on June 9th, 2024, the historical results of Corebridge for all periods presented are reflected in AIG's consolidated financial statements as discontinued operations in accordance with US GAAP. Additionally, in the fourth quarter, AIG realigned its organizational structure and the composition of its reportable segments to reflect changes in how AIG manages its operations, which our Chief Financial Officer, Keith Walsh, will discuss in detail during his remarks. Finally, today's remarks related to AIG's adjusted after tax income per diluted share as well as General Insurance results, including key metrics such as underwriting income, margin, and net investment income are presented on a comparable basis, which reflects year-over-year comparison adjusted for the sale of Crop Risk Services and the sale of Validus Re as applicable. Net premiums written and net premiums earned are also presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis and adjusted for the sale of Crop Risk Services, Validus Re, and the global personal travel and assistance business as applicable. We believe this presentation provides the most useful view of our results and the go forward business in light of the substantial changes to the portfolio since 2023. Please refer to pages 37 through 39 of the earnings presentation for reconciliation of such metrics reportable on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino."
},
{
"speaker": "Peter Zaffino",
"text": "Good morning, and thank you for joining us today to review our fourth quarter and full year 2024 financial results. Following my remarks, Keith will provide additional perspectives on our financial results, and then we'll take your questions. Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Before I begin, on behalf of all of us at AIG, I want to acknowledge the devastating impact of the recent wildfires in California on families, communities and the businesses affected. Our local teams remain on the ground in California, providing critical expertise and support to our customers and partners. This tragic event serves as a stark reminder of the escalating risks, elevated catastrophe landscape and the complicated evolving environment that we operate in. It also underscores AIG's purpose to help our customers and clients navigate these challenges with resilience in rebuilding communities and restoring businesses. Let me take a moment to cover what I will walk you through during my remarks this morning. First, I will briefly share highlights from our strong fourth quarter performance. Second, I will discuss our 2024 strategic and operational accomplishments. Third, I will provide an overview of the full year financial results for AIG and our General Insurance business. Fourth, I will comment on the reinsurance market, including the January 1 renewals and provide some observations on the impact of the recent California wildfires. And lastly, I'll provide an update on the progress we have made on our capital management strategy, our path to achieving a 10% plus core ROE and how we are positioning the company for 2025. Let's begin with the fourth quarter results. We recently announced a realignment of our General Insurance business into three segments. North America Commercial, International Commercial and Global Personal. All of our comments will be aligned to these segments. During the quarter, we continued to deliver exceptional underwriting results and we maintained rigorous expense discipline. General Insurance reported strong net premiums written of $6.1 billion, an increase of 7% year-over-year led by 8% growth in Global Commercial lines. Global Commercial generated new business of $1.1 billion a 16% increase year-over-year along with continued strong retention of 86% across the portfolio. Net premiums earned of $6 billion grew 6% year-over-year. Adjusted after tax income per share grew 5% year-over-year to $1.30 per share. The calendar year combined ratio was 92.5%. And the accident year combined ratio, excluding catastrophes, was 88.6% which was an outstanding result. 2024 was a terrific year of accomplishments for AIG, during which we not only delivered strong financial performance, but also successfully executed significant strategic and operational initiatives. We delivered disciplined growth in our businesses with a primary focus on risk adjusted returns supported by our underwriting expertise. We reshaped the portfolio, including divesting a number of non-core businesses. Following the sale of Validus Re in November of 2023, we closed on the sale of the global individual personal travel insurance business in December of 2024 to further position us for the future. While these divestitures help to further simplify AIG, the biggest accomplishment of the year was the deconsolidation of Corebridge Financial. The separation was a four year journey during which we strategically positioned Corebridge for its future while creating a new capital structure for AIG. Some of the major milestones of the Corebridge journey included establishing a very important partnership with Blackstone through an initial 9.9% sale in 2021, executing the largest US IPO in 2022, setting up a strategic asset management partnership with BlackRock, divesting non-core foreign businesses, completing five successful secondary offerings, two of which were in 2024 and culminating in the fourth quarter with AIG sale of a 22% stake in Corebridge for $3.8 billion to Nippon Life, securing another strategic partner for the company. With the accounting deconsolidation of Corebridge, AIG is now a less complex and more streamlined global business. AIG Next was another operational accomplishment in the year, which further supported our journey to make the company leaner, weave the organization together and reduce expenses. We exited 2024 achieving $450 million in run rate savings as part of the program and we expect the remaining benefits to be realized in the first half of 2025. We also continue to successfully execute on our capital management strategy in a very disciplined manner with nearly $10 billion of actions in 2024. AIG reduced shares outstanding by 12% and increased the quarterly dividend per share by 11%, resulting in the return of $8.1 billion of capital to shareholders. We received over $4 billion in dividends from our subsidiaries due to the improved profitability of our operations. We further reduced our debt to total capital ratio to 17% and we ended the year with $7.7 billion of parent liquidity. Our capital management actions to-date have provided us with tremendous financial flexibility. Another strategic accomplishment in 2024 was the delivery of AIG's first generative artificial intelligence large language model powered solution to support business growth. Specifically, we implemented AIG Underwriter Assist, which automates qualitative unstructured data extraction from underlying submissions, internal AIG data sources, and external research in minutes to support underwriter review of submissions. To support and advance our GenAI aspirations, we've cultivated an ecosystem of top tier technology partners, including Palantir, Anthropic and AWS in support of an agentic architecture operating model that allows for maximum flexibility. We also launched the Reinsurance Syndicate 2478 at Lloyd's through a multiyear strategic relationship with Blackstone as part of AIG's Outwards Reinsurance Program. The syndicate began underwriting on January 1, 2025 and now serves as a key component of AIG's reinsurance strategy, which I will go over in more detail later. Turning to the financial results for the full year 2024. Adjusted after tax income was $3.3 billion or $4.95 per diluted share, an increase of 28% year-over-year. The improvement was primarily driven by stronger underlying underwriting results, expense reduction benefits from AIG Next, an increase in net investment income and the execution of our balanced capital management strategy. General Insurance delivered terrific financial performance for 2024. For the full year, net premiums written were $23.9 billion, a 6% increase year-over-year. Net premiums earned were $23.5 billion, a 7% increase year-over-year. The accident year combined ratio as adjusted was 88.2%, which marked the sixth consecutive year of improvement, largely driven by the GOE ratio. The full year General Insurance combined ratio was 91.8%. This was the third consecutive year of a sub-92% combined ratio. Prior year reserve development, net of reinsurance and prior year premium was $289 million a benefit of 1.4 points to the loss ratio. General Insurance full year underwriting income was $1.9 billion roughly in line with the prior year despite higher catastrophe losses. In Global Commercial, net premiums written of $16.8 billion increased 7% year-over-year. North America Commercial grew net premiums written by 9% year-over-year. Lexington grew net premiums written by 14% fueled by robust new business of $1.1 billion and a 42% increase in submissions year-over-year, and that was balanced across all lines. Retail casualty grew net premiums written by 11%, excluding the closeout transaction we mentioned in the third quarter. Our portfolio continues to benefit from a strong rate environment, high retention of our existing portfolio at 93%, and we have select opportunities in new business. International Commercial grew net premiums written by 4% year-over-year, driven by energy at 13%, retail property at 11% and Talbot at 7%. Global Personal grew net premiums written by 3% year-over-year, driven by International Personal Auto at 8% and our high net worth business at 6%. I would now like to turn to reinsurance and provide some observations on the market and an update on AIG's reinsurance renewals at January 1 of this year. Overall, AIG had a very strong 01/01 renewal season. Since the reinsurance market's major reset on January 1 of 2023 our consistency in strategy, placement and execution has positioned us very favorably. Benefiting from an environment of higher retentions and commensurate pricing increases, property reinsurers sought to deploy more capital, but were predominantly focused on upper layers with more remote return periods. Depending on loss activity, limited additional demand led to risk adjusted rate reductions that were consistent with expectations, with the bottom catastrophe layers renewing flat to down 5% and upper catastrophe layers receiving reductions of 10% to 15%. I want to provide some context and observations on the changes in the market as a result of the increase in reinsurance retentions, which I've mentioned on previous calls is creating an interesting dynamic for the market in 2025. One insightful statistic from an Aon study of over 150 companies over the past ten years is that retentions have risen significantly around the world with the US attachment points on average increasing by 280%. As a reminder, in 2024, insured loss from natural catastrophes was approximately 145 billion. The sixth costliest on record and this compares to the average for the last five years of 140 billion. With the increased retentions and increased catastrophe activity, much more of the risk is now being retained by insurance companies. In 2023 and 2024, primary insurance carriers are estimated to retain approximately 90% of the insured loss from natural catastrophes with the reinsurance industry absorbing 10%. Contrast this with the period prior to 2023, reinsurers would often share a significantly higher proportion of the insured loss with the distribution of losses between insurers and reinsurers at approximately 50-50 on average. Meanwhile, AIG is focused on maintaining lower excess of loss attachment points, including meaningful aggregate coverage to manage frequency of loss tailored to our geographic exposure and to the type of perils that we are exposed. Taking a closer look at wildfires and how the market has changed, the average annual insured loss from 2000 to 2024 was approximately 4 billion globally of which the US is the majority at 3.5 billion Narrow that period to the last ten years and average annual losses from wildfires have roughly doubled to around 8 billion of which 7.4 billion has occurred in the United States. Insured loss estimates for the California wildfires are currently coalescing around 40 billion with some estimates from credible catastrophe experts reaching as high as 50 billion. The economic loss is estimated to be in excess of 250 billion producing a protection gap of as much as 80%. Contrast that to the top 10 largest insured cat events on record, where insurance has typically covered 40% to 50% of the economic loss. As a point of reference, insurance covered approximately 50% of the economic loss from Hurricane Katrina, the largest natural catastrophe event this century. The California wildfires demonstrate the increased loss from secondary perils and the magnitude of tail events that are not captured well in modeling. In a month with one of the lowest model probabilities of loss, the California wildfires alone would make the first quarter of 2025 the second most costly first quarter for natural catastrophes on record. Fifteen years ago, adjusting for inflation, 100 billion was considered the benchmark for an outsized cat year. With the last eight years averaging more than 140 billion this thinking is clearly outdated. If you assume the upper end of the range for the California wildfires taking a $50 billion loss pick, adding the average annual insured loss for the past eight years, and assuming we have an active, but not abnormal wind season, which is realistic given the 2024 hurricane season experience and ocean temperatures are the warmest on record, 2025 could be a year of more than 200 billion of insured catastrophe losses. This could recalibrate the entire industry. AIG reduced our overall California exposure beginning in 2022. This decision, coupled with our 2025 reinsurance structure has effectively reduced our exposure such that the expected loss to AIG from the recent wildfires is approximately 500 million before reinstatement premiums and barring any unforeseen additional developments. Turning specifically to AIG's reinsurance outcomes at 01/01, we successfully maintained our prior objectives, our reinsurance purchasing strategy to preserve and optimize capital and enhance the quality of earnings through active management of the volatility of our underwriting results. Starting with our property catastrophe placements, our core commercial North America retention of 500 million remains unchanged in nominal terms for the third consecutive year despite growth in the underlying portfolio. We also expanded coverage and maintained our core international occurrence attachments and renewed our dedicated occurrence tower for our high net worth business, which attaches at 200 million. We improved our 500 million of aggregate protection by reducing the annual aggregate deductible for North America, creating a specific non-peak section and expanding the coverage for the high net worth portfolio. Overall, for North America, depending on loss distribution, AIG's modeled net first loss exposure, including the impact of reinstatement premiums is comparable to 2024 and our second and third event exposure is materially lower following its renewal cycle. For all of our major proportional treaties, we were able to improve or maintain our ceding commission levels, a strong recognition of our underwriting expertise and our position as a market leader across multiple classes. We were also able to establish two new proportional treaties to support the high net worth portfolio. Our strategy to establish Private Client Select as a standalone MGU and introduce capacity to support growth in the platform beyond AIG's balance sheet has been validated with the addition of five of the leading underwriting companies in the world to the platform, taking 30% of our homeowners and auto portfolios through quota share reinsurance. Casualty remains an area of caution for many reinsurers with appetite generally diminished. They are highly selective of the insurance companies they support. And overall, the casualty renewals were more orderly for the companies that have strong underwriting portfolios. We were pleased with the successful renewal of our core casualty treaties at favorable terms. This renewal cycle again signals the strong external industry recognition that AIG continues to be a leader in the casualty market. We remain optimistic on the outlook for our casualty portfolio and see considerable opportunities ahead, while being cautious and very focused on maintaining our high underwriting standards. Also of significance for AIG at 01/01 was our launch of a new dedicated reinsurance syndicate at Lloyd's supported by funds managed by Blackstone. This pioneering structure announced in December 2024 is an example of how insurance risk can be directly connected to sophisticated investors to generate attractive returns for both parties. The syndicate provides AIG with a long-term meaningful reinsurance partner and an additional source of fee income. Blackstone has access to a high quality, well diversified underwriting portfolio with the ability to generate attractive returns by taking a sizable participation in the majority of AIG's outward reinsurance treaties at market terms. We're pleased to partner with a leading global asset manager on its innovative structure. Our reinsurance strategy has played a pivotal role in our journey to establish AIG as an industry leading global P&C underwriter. We're grateful for the long-term support and partnership of the industry's leading reinsurers, which has helped position us where we are today. Turning to capital management, we continue to execute very well on our balance and disciplined strategy. We made major progress in 2024 and in many ways exceeded expectations. As we outlined last year, our guidance was to repurchase $10 billion of shares in 2024 and in 2025. The current guidance is expected to bring us within our target share count range of 550 million to 600 million shares. We have $3.4 billion of the $10 billion guidance that I provided remaining for 2025. We will likely exceed this guidance and we have over $5.6 billion remaining on our current share repurchased authorization. We expect to return to more normalized levels of share repurchases as we enter 2026, assuming we have no further sell downs of Corebridge or other additional sources of liquidity. We ended the year with a very strong parent liquidity of $7.7 billion. Additionally, we do not anticipate taking any actions that would significantly affect leverage in 2025. We are committed to reviewing our dividend annually and anticipate that we will increase our dividend in 2025 in line with the decrease in our share count over the past year, subject to AIG board approval. Going forward, our key focus is on profitable growth and allocating capital to the best opportunities for the most attractive risk adjusted returns. Our very early forecast indicates we're off to a strong start for 2025 and barring any unforeseen developments, we expect to achieve meaningful organic growth driven by our Global Commercial business and the benefits of our restructured reinsurance program. As a result of our disciplined capital management, combined with our sustained underwriting excellence and continued focus on expense management, we're well on track to deliver a 10% plus core operating ROE for the full year 2025. We have several ways in which we can deliver on this commitment. These are maintaining our strong underwriting results with a focus on improving Global Personal, improving our investment income yields, executing on a simpler, leaner business model across AIG and continued balanced capital management. In summary, I'm very pleased with our outstanding fourth quarter and full year 2024 performance. 2025 is a new chapter for AIG and we're moving forward with strong momentum. We continue to differentiate ourselves with deep industry expertise and disciplined focus on underwriting excellence and outstanding operations and claims capabilities, which drive exceptional value for our clients, partners and stakeholders. With that, I will turn the call over to Keith."
},
{
"speaker": "Keith Walsh",
"text": "Thank you, Peter. This morning, I will provide details on fourth quarter results for General Insurance, net investment income and other operations as well as key balance sheet items. I would like to begin by addressing a few changes in our financial reporting. As Peter mentioned, we have realigned our General Insurance business into three reporting segments. North America Commercial, International Commercial and Global Personal. Global Personal lines have been consolidated into a single reporting segment. This brings together our Global Accident and Health, Personal Home and Auto, Global Warranty and Services and High Net Worth businesses. Along with our new reporting segments, we have updated the product line net premiums written disclosure on Page 8 of our financial supplement to give more transparency into the underlying trends in our businesses. The three segments and updated product line disclosure are reflected retrospectively in AIG's 2024 fourth quarter and full year financial results. Additionally, we have streamlined other operations to include activities only related to having a global regulated parent company and now exclude the results of runoff businesses from adjusted pre-tax income. We believe these changes enhance the clarity of our financial disclosures and provide a better representation and alignment of our core business. Historical results have been recast to reflect these changes with de minimis impact to operating EPS. Other operations now largely consists of net investment income from our parent liquidity portfolio, Corebridge dividend income, corporate general operating expenses and interest expense. Turning to our fourth quarter General Insurance results. Adjusted pre-tax income or APTI was $1.2 billion. In North America commercial, net premiums written increased 9% year-over-year, driven by strong new business, which grew 17% with retention of 85%. International Commercial net premiums written increased 7% year-over-year with new business growth of 15% and excellent retention of 88%. In Global Personal, net premiums written increased 1% on a constant currency basis. The sale of the Global Personal Travel and Assistance business, which closed in early December, was about a four point headwind to the year-over-year comparison. Adjusting for that, growth was 5% in the quarter on a comparable basis, driven by 16% growth in our Global High Net Worth business. The sale of the Global Personal Travel business will have an impact on the Global Personal segment in 2025. For full year 2024, this segment had $7.1 billion of net premiums written. When modeling 2025, the sale of the Global Travel business will remove approximately $720 million of net premiums written. This is a roughly 10 percentage point growth impact for the segment. General Insurance underwriting income for the quarter was $454 million, a $156 million decrease from the prior year quarter, driven entirely by higher catastrophe losses. General Insurance calendar year combined ratio was 92.5%. The accident year combined ratio as adjusted was 88.6%, a 30 basis point increase from the prior year quarter. This was driven by a slight increase in the accident year loss ratio, while the expense ratio remained flat despite absorbing more AIG parent expenses. Catastrophe losses were $325 million or 5.5 points on the loss ratio. This includes $224 million of losses from Hurricane Milton and an adjustment for prior quarters events largely from Hurricane Helene, which occurred on the final day of the third quarter. Turning to reserves and our detailed valuation reviews or DVRs. This quarter, General Insurance had $102 million of favorable prior year development, including $34 million from the ADC amortization, $16 million from our fourth quarter DVRs and $52 million from non-DVR adjustments, predominantly recognition of AVE on US short-tail lines. The fourth quarter's DVRs covered the remaining 10% or approximately $4 billion of our total loss reserves focusing on the remaining portion of US financial lines, global personal lines Canada and Glatfelter. The favorable prior year development was primarily driven by Canada Casualty and US E&O. We conduct a comprehensive DVR annually for each product line across our $40 billion of reserves. While DVRs are spread across quarters, we have a robust year-round process on our entire book in addition to our quarterly DVRs. Going forward, our comments will focus less on reporting the DVR outcomes and more on our overall reserve analysis, which reflects AVE claims diagnostics and rate monitoring across all lines and geographies. One additional item I would like to discuss is a provisional reserve we created in 2022 in response to the potential uncertainty with inflation and other variables in the post-pandemic macro environment. This provision, which is included in IBNR, has been carried in the lines that we viewed as most susceptible to rising inflation with a large portion booked in our workers' compensation reserves. This year, we undertook a thorough review of the uncertainty provision which was set above the loss picks from our actuarial reviews and refined our analysis, including its allocation among our lines of business. The uncertainty provision did not reflect any emergence and we have maintained the overall estimate. However, we have decided to reduce the provision in excess workers' comp and reapportion approximately $150 million of the provision within excess casualty. We elected to move this portion of the reserve to excess casualty as the development factors and the length of the tail can drive a wider range of outcomes on our reserves. To be clear, our traditional reserve methods are not indicating any emergence in excess casualty, but we felt, given the nature of the provision, it was more appropriate to be situated within this line. As a reminder, our reserving philosophy is to react to bad news quickly and wait to recognize good news over time as we monitor developments. Moving on to rates and pricing. Fourth quarter Global Commercial Lines pricing, which includes rate and exposure increased 5% year-over-year, excluding workers' compensation and financial lines. In North America Commercial, renewal rate increased 3% year-over-year or 7% if you exclude workers' compensation and financial lines. Exposures increased 2% year-over-year with an all-in pricing change above loss cost trend. Property market conditions were under pressure in the fourth quarter due to increased competition across both the admitted and E&S markets, while the underwriting margin remained healthy. Supported by the cumulative rate increases over the past several years and our disciplined approach. In North America Casualty lines, rate continued to outpace loss cost trend with increases in the mid-teens in wholesale and excess casualty. In North America financial lines, we continue to experience headwinds, but see indications that rate reductions are moderating. In International Commercial, overall pricing was flat or up 2% excluding financial lines. While rate is below trend, we feel good about our book given we've had over 60% cumulative risk-adjusted rate since 2018. Our well-diversified portfolio allows us to navigate different market conditions effectively prioritizing lines of business that offer the most compelling risk adjusted returns while upholding our underwriting standards. For the full year 2024, excluding workers' compensation and financial lines, Global Commercial lines pricing, which includes rate and exposure increased 6%, with 8% in North America and 4% in International. Turning to other operations. Fourth quarter adjusted pretax loss was $150 million, which improved 34% year-over-year. This was primarily driven by lower GOE reflecting AIG Next benefits as well as incremental movement of GOE into General Insurance. We continue to realize the benefits of AIG Next and push nonpublic company-related expenses into the business. We expect corporate GOE expenses to migrate towards approximately a $90 million per quarter run rate over the course of 2025. Interest expense improved $10 million year-over-year, as a result of our liability management, which reduced total debt by $1.6 billion in 2024. One other item I want to discuss is a runoff business, Blackboard. In the fourth quarter, we increased the prior accident year reserves for Blackboard by $112 million to reflect loss activity that has been well above what was expected. Turning now to investment income. For the full year 2024, net investment income on an APTI basis was $3.5 billion, up 13% from 2023, primarily driven by Corebridge dividends, an increase in short-term investment income and higher reinvestment rates on fixed maturities. Fourth quarter net investment income on an APTI basis was $872 million largely unchanged year-over-year. General Insurance net investment income was $779 million, including income on fixed maturities, loans and short-term investments of $720 million and alternative investment income of $72 million. Other operations net investment income was $93 million, consisting of income from our parent liquidity portfolio of $64 million and Corebridge dividend income of $29 million. During the fourth quarter, we continued to benefit from higher reinvestment rates on the fixed maturity and loan portfolio. The average new money yield of 5.38% was roughly 175 basis points higher than the sales and maturities in the quarter. The annualized yield on the fixed maturity and loan portfolio, excluding calls and prepayments was 3.92%, up four basis points year-over-year or three basis points sequentially. The fourth quarter alternative investment income was $67 million, an increase of $26 million year-over-year, driven by improved private equity performance, partially offset by lower hedge fund income owing to our strategy to reduce exposure. Private equity yielded 6.42% for the quarter, below our long-term expected return of 7.5%. The makeup of our private equity portfolio is a little over 25% real estate and with the current macro environment, we expect pressure from this portion of the portfolio to continue through 2025. Turning to tax. The adjusted effective tax rate for the fourth quarter and full year was 24.6%. For 2025, we expect the adjusted tax rate to be in line with 2024, but may vary based on the geographic mix of income. We finished 2024 with a very strong balance sheet. Book value per share was $70.16 at year-end, up 8% from December 31st, 2023, mainly due to the favorable impact of lower interest rates on AOCI and reduced shares outstanding. Adjusted book value per share was $73.79 down 6% from year-end 2023, primarily due to the impact of Corebridge deconsolidation. Core operating ROE was 9.1% in the quarter and for the full year. As Peter laid out, we are committed to achieving our target of a 10% plus core operating ROE for the full year 2025. As Peter mentioned, we had a substantial $6.6 billion returned to shareholders in 2024 through share repurchases and are well on our way to completing our guidance of $10 billion of repurchases in 2024 and 2025. Through February 7, we have repurchased $952 million of shares year-to-date in 2025. We are proud of the significant progress we've made in 2024 and the ability to deliver outstanding core operating results while successfully executing significant transformation initiatives. With that, I will turn the call back over to Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Keith and Michelle, we're ready for questions.."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Alex Scott with Barclays. Your line is open."
},
{
"speaker": "Alex Scott",
"text": "Hey, good morning. First one I have for you, excuse me, is on the core ROE that you gave. I just wanted to confirm that that's including the wildfire impact. And it looks like it's running a bit better than I would have expected based on the combined ratios that you've talked about in the past and corporate expenses and so forth. So I was just interested if you define it all on maybe some of the things that you're running ahead on or that are improving relative to some of those comments you've made in the past? Thanks."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Certainly, Alex. And, yes, we are confirming the 10% plus ROE including the $500 million wildfire that we had in January. If I could spend a second, I think we've done an exceptional job over the past few years of structuring our sort of global portfolio structuring the reinsurance to supplement that and having net retentions well within our expectations and what we budget. If I look at what we do budget for AAL over the last couple of years relative to our overall experience, it's been exactly where we anticipated even with elevated activity. So this is no different. I mentioned on the call that we're going to take first event losses around the same with reinsurance that we did in 2024, but second and third events will be less. And so that's how we structured it. And we are confirming guidance on the 10% including what happened in January. I think Keith noted that we have a lot of different ways in which we can sort of drive improvement in terms of earnings. I did as well in my prepared remarks. We're really pleased with the commercial portfolio and how it's performed on a combined ratio basis. We just continue to, I think, elevate our overall performance. I have singled out personal because I think that combined ratio is not where any of us want to be. We consolidated that under one leader. Jon Hancock, he's shown exceptional leadership in what he's done with the commercial portfolio in international. And I think it's going to give us a much better line of sight on the overall portfolio in terms of how we can improve it, which we fully expect to do. I think there's opportunities in NII further capital management. And I think we reconfirmed what we're doing on return of capital to shareholders. So I think we have a lot of very positive momentum and want to confirm guidance. Do you have a follow-up, Alex?"
},
{
"speaker": "Alex Scott",
"text": "Yes. So as a follow-up, I'd just be interested in some of the areas you're targeting towards organic growth. And maybe in particular, your updated view on price adequacy just given some of the declines in property pricing in E&S and then maybe also on casualty?"
},
{
"speaker": "Peter Zaffino",
"text": "Okay. I'm going to have Jon Hancock and Don Bailey talk a little bit about the growth because they've done an exceptional job in terms of outlining where our portfolio can grow, focusing on risk-adjusted returns. What I would say and this is complementing their efforts is that we've just done a tremendous job in terms of client retention focusing on an underwriting culture of maintaining and improving profitability. And so like we deploy capital where we think we have the best opportunities for improved risk adjusted returns. And they've done an exceptional job on new business in targeting parts of our business where we think we can have those outsized returns over time. And I think that's how you've seen the portfolio shape. So Jon why don't I start with you in terms of international and maybe give us a little bit of insight in terms of the growth."
},
{
"speaker": "Jon Hancock",
"text": "Yes. Okay. Thanks, Peter, and Alex. Growth through retention and new business was strong in the quarter. Peter and Keith called out a lot of that in their opening remarks, so I won't repeat it now. But what I will say is, we're working from such a strong base in this commercial portfolio in international. And when we look at where we've been growing, if you look at the quarter, there's a lot of seasonality across international. For example, in Q4, 50%, more than 50% of our net premiums come from just two lines. We like the global specialty and financial lines, but that's not the full year mix. So I think looking at growth, looking at new business, quarter-on-quarter isn't always the most insightful way. And Q4 is obviously the end of the year as well. So I think it's a good time to reflect on what we've been doing the whole of 2024 and talk about that momentum that we have been building. If I look at the full year, Keith called it out, 4% growth in the year across International Commercial. Renewal retention in the full year, 89%. I'm really, really pleased with that on such a good book of business. And new business for the year, more than $2 billion of new business during the year in International Commercial. Again, a great outcome, really reflective of the fact that we're still seeing great new business opportunities all around the world actually. And I also do want to make clear that new business is a big driver of our growth. We manage the quality, the price advocacy of our new business just as closely as we do our renewal book. And we trade on a value we offer. Our recognition as market leader, first class claims, risk management, strong balance sheet, not just price and that matters to a lot of customers. And if I could, I know you asked about property specifically. If I can just call out two places where we've been working really hard with our distribution partners on being clear on risk appetite, building propositions that customers want, building strong opportunity pipeline. That's where we've been getting the growth momentum from, and that's what we will see all through this year. There's too many areas to call out across international, but Global Specialty. A number of new business submissions up 24% year-on-year. Marine absolutely outstanding at 46% increase. Our straight rate on the business, we quote more than 25%. And again, Marine Energy, which Peter talked about earlier, 40% strike rates. So that's more than $700 million of new business in Global Specialty. Just a final one to show that momentum. Our commercial property book another standout. We spent a lot of time fixing and repositioning that portfolio. And we've now seen over the last couple of years, really strong growth and profit. Growth of 11% in the year. We're still seeing strong mid-digit rate rises as well as growth and some real high quality new business. The rating environment today, as Peter said earlier, is different to what it was in Q4. So we see lots of great opportunity all over and we'll build on that momentum."
},
{
"speaker": "Peter Zaffino",
"text": "That's great, Jon. Thank you. Don, maybe I just want to have a little bit of a highlight of achievements in North America in terms of growth."
},
{
"speaker": "Don Bailey",
"text": "Great. Thank you, Peter. I'll break down the North American Commercial numbers. For 2024, and you mentioned this, we grew net premiums by 9% driven by retention and our new business. We had strong retention of 91% in retail and 76% in wholesale. We also delivered impressive new business growth like Jon in North America, 15% up on a year-over-year basis and that's on top of 14% new business growth in 2023. This growth is intentional, it's strategic, it's diversified. With the great work over the past few years in our portfolio, we came into 2024 with distribution engagement as a top priority for us in all the channels in which we operate and it's paid off. Our new business was strong through all three channels. Retail, wholesale and alternative. With Lexington, we had another strong year. They represented 48% of our new business. Lex property, casualty, western world, all delivered. And as Peter referenced, Lex another big increase in submissions, 42% increase on a year-over-year basis. And there's a clear opportunity to harness the strong submission activity there to drive growth as we go forward. The rest of the new business was balanced across the portfolio. And finally, Peter, I'll just say this at the end that our growth given our unique assets at AIG, we really are able to underwrite with great discipline within our risk appetites and target opportunities with attractive risk-adjusted returns. Thanks, Peter."
},
{
"speaker": "Peter Zaffino",
"text": "That's great, Don. Jon, thank you. I know that answer was they were very thorough, but they're doing the work. And so I thought it would be really helpful to hear from them. Next question."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Meyer Shields with KBW. Your line is open."
},
{
"speaker": "Meyer Shields",
"text": "Great. Thanks. Peter, I was hoping you could walk us through how we should think about the impact of the artificial intelligence deployed in underwriting? I know it's simplistic to say how many loss ratio points would have moved, but how should we think about it more broadly?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Meyer, and good morning. For us, I could spend a meaningful amount of time talking about GenAI and we fully intend to do that at Investor Day. Our focus has always been on driving growth certainly there's opportunities in contact centers and call centers and operational capabilities that through large language models, robotics that we will gain efficiencies. But for us, it's all about ingestion of data, getting more qualified data to the underwriters in a fraction of the time. And in order to do that, you need to be very disciplined sort of end-to-end. So how we ingest data from brokers and agents, how we define what data we want in the underwriting criteria when it gets to the underwriter, how do we load that into models and how do we get more data from credible sources that may supplement the underwriters' decision making in order to continue to improve the portfolio. If I use Lexington as an example, in 2017 and 2018, we received 40,000 submissions. This year, it's over 400,000. So it's more complex today than just building out algorithms to get to different industry groups or different classes of business. We want to get more to the underwriters real time. And so we've been doing this for the better part of 18 months. I said we built out a really strong agentic ecosystem with, again, data ingestion with Palantir, building out large language models with Anthropic and using other reliable third parties to help us accelerate the modeling. And so I think it's going to help us propel top line growth by getting more data, getting richer data sets, giving the underwriters more capabilities to underwrite and having it done in the fraction amount of time and doing it at scale."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Thank you. That's very helpful. The second question is on the timeline for getting the high net worth personal lines business to growth underwriting profitability. I don't know if there's anything you can share on that."
},
{
"speaker": "Peter Zaffino",
"text": "Yes, absolutely, Meyer. And, look, I think we've been on that journey for a couple of years, and everybody has been patient with the story. We continue to improve the combined ratio. We continue to improve the loss ratio. And if you look at Global Personal, the biggest contributor in terms of that improvement, it was primarily all the private client service or a high net worth business. There was a significant improvement in the loss ratio and we expect that to continue. We have a balanced growth strategy with non-admitted as well as admitted and believe that as we see more submission activity, which we are, not admitted that we're able to deploy our capital with more flexibility to be responsive to client needs. So I'm thinking about structure pricing, the amount of limit that we can put out and it's not only in peak zones, it's in non-peak zones. And so we expect to see that continue to accelerate. We got to scale this year. And so we've renegotiated ceding commissions with PCS and so you'll see a meaningful improvement there, which should translate into overall expense ratio improvement and combined ratio improvement. And last I mentioned is that we have tremendous partners that have joined us based on how we've repositioned the portfolio and our encouraging growth. And so we have a 30% quota share with six participants all have very strong expertise in the high net worth space that are backing us for more growth. So I think we have it all moving in the right direction, attritional loss ratios, cat support from great partners and improvement in expense ratio and you'll see that contribute in 2025 to helping overall Global Personal improve."
},
{
"speaker": "Meyer Shields",
"text": "Okay, fantastic. Thank you so much."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Jon Newsome with Piper Sandler. Your line is open."
},
{
"speaker": "Jon Newsome",
"text": "Good morning. Congrats on the quarter."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Jon."
},
{
"speaker": "Jon Newsome",
"text": "Two sort of big picture question. One is are we at a point where there are aspirational areas of business that AIG is not in that you would be looking for either on organic or inorganic basis? And I guess sort of relatedly on the other side of that question is where are we from a divesting of noncore businesses perspective? Are we pretty much done at this point?"
},
{
"speaker": "Peter Zaffino",
"text": "Sure. Thanks for the question. I'll start with the second one first. I think we are largely done. I mean, I don't ever say never or always. But I think we now have the portfolio in a place where we'd like it, certainly on the commercial side, and now having one segment for Global Personal. We know we have work to do, but really like the mix of the portfolio, its global balance and think that we can grow it. In terms of M&A, we're going to remain very disciplined. I always use the word when I get the question on the calls or I'm in front of you. It's around being, it has to be compelling, which just means that it's either going to be a geography that's complementary that actually adds value to AIG and our clients' products that we may not be in that we like and think that it's going to be accretive to ROE and how we grow our business. There are businesses that we have that have scale, but additional scale could be quite compelling. And so we are looking at that businesses that may do that and accelerate. And of course then there's complementary businesses that we may not be in that we think could be very additive to the platform. So we have a very disciplined approach. We always are looking around the world to see if there's things that are additive. But I do want to say I think we're at the size and scale where we don't need to add anything. We are showing, and I think Jon and Don provided tremendous insight as to why we think we can grow the business organically. We have a really strong capital base, which we can grow into, and believe that there's a path there. So I don't think it's an either or. I think we have now set the company up with enormous strategic and financial flexibility. We'll remain very disciplined as we look at inorganic, but we're very excited about the organic opportunities that are in front of us."
},
{
"speaker": "Jon Newsome",
"text": "Great. Maybe as a second question. Do you have any thoughts on the regulatory environment? Clearly lots of, as my grandmother would say, interesting things happening in California from a regulatory perspective. But broader, do you think there's some changes here that are coming or do you think it's pretty status quo?"
},
{
"speaker": "Peter Zaffino",
"text": "Insurance is complicated because we're regulated state by state. And that makes every state a little bit different, right? And I think the ones that get the attention are going to be ones that have peak zone exposure like we're seeing within California. And California is particularly complicated because I relate it almost to Japan. It's a geography that has two major perils that drive catastrophe results. And so I was in Japan's typhoon quake, California's quake and now wildfire. And but there's regulators. We work very closely with them to try and be helpful and constructive on the changes that have happened in the catastrophe climate, which is looking at modeling, looking at loss cost, looking at cost of goods sold and looking at ways in which we can be more responsive to client needs. And I think that in California, we just saw that the modeling is flawed. It doesn't necessarily always take into account tail events. There's not a lot of model losses north of $40 billion. And so therefore, it becomes very complicated. And I don't mean this in California, but we're now seeing it, which is some of these state set up sort of vehicles that become a market of last resort be sometimes become a market of only resort and then they end up taking on a lot of aggregate. So I think we just need a reset in certain spots. And I think like insurance companies that have technical capabilities working very closely with regulators. I hope that we're going to position the businesses where we will have more flexibility in the future."
},
{
"speaker": "Jon Newsome",
"text": "Thank you very much."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Michael Zaremski with BMO. Your line is open."
},
{
"speaker": "Michael Zaremski",
"text": "Great. Follow-up, morning, on the expense ratio. I heard the comments about ceding commissions improving, so that should be a positive going forward. The expense ratio has been running a bit higher than expected for a while now. I mean, obviously, the loss ratio has been excellent. So that's the main focus. But just curious if you're willing to give any specific more specific guidance on kind of what type of expense ratio level or acquisition expense ratio level we should be thinking about on a go-forward basis?"
},
{
"speaker": "Peter Zaffino",
"text": "Michael, are we talking about PCS and high net worth or just general insurance?"
},
{
"speaker": "Michael Zaremski",
"text": "Sorry, I was talking about the whole company, General Insurance."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. So let me unpack, I mean, again, I know with AIG, it's like with the divestitures and a lot of the moving pieces from other operations into General Insurance, it's complicated. But I'm actually really pleased with what we've done on the expenses. I think we've remained incredibly disciplined. We focused on a lean parent, which just meant that there's simplicity. There's not a lot of expenses sitting in other operations and they're going to be more in the business. So if I actually take you through what happened, and if you look at our financial supplement, you'll see $2.9 billion or thereabout $2.952 billion as sort of the expenses. But if you get underneath that, look, AIG Next, the business was very proactive in getting expenses out. And so we would have gotten around $125 million to $140 million out through AIG Next. But we've added in from other operations and other technology that would have sat in other operations, almost $200 million. And so the business has absorbed a lot of expenses as we reposition the company to have this lean parent very transparent, not with a lot of expenses and the business is absorbing it as we go. And so not only am I proud that they've been able to do that and we haven't had a blip, we also believe that there's opportunities to get more expenses out and the ratios to improve as we get through the rest of 2025. Do you have a follow-up?"
},
{
"speaker": "Michael Zaremski",
"text": "Yes. Quick follow-up. Just I know you made some comments on the casualty marketplace. I'm not fast enough to update all the pricing data you gave us, which is always helpful. But I'm curious, are you experiencing any acceleration in casualty pricing, either excess or retail? And do you still feel that I feel like a couple of quarters ago, you mentioned this might be an area you're willing to play a bit of offense in."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. So it's a great question. And again when we look at rate across North America, International, it's an index. And so you don't always get a line of sight. But we do see real opportunities in casualty. We're very cautious, but the rate environment is actually quite strong. I mean in Lexington Casualty, you'll start there. We had 14% rate in 2024. In retail excess casualty, we had 15%, that's the fifth year in a row of double-digit rate increases in retail excess casualty, it's above loss cost trend. So we feel like we're building margin, really strong retention. We've been able to reposition the portfolio as we've liked. We have an exceptional particularly in the US leadership with Barbara Luck. I mean we have the best underwriting team in the industry and that's being demonstrated because clients are asking us to be on their business, help structure it, help the terms and conditions. So others will be active participants in the market. And so we're leading. We're underwriting really well. We've repositioned the portfolio. We've got great reinsurance support for severity. And we're getting rate above loss cost. So I want to be very cautious and careful, but I also don't want to miss the opportunity to be an industry leader."
},
{
"speaker": "Michael Zaremski",
"text": "Thank you"
},
{
"speaker": "Peter Zaffino",
"text": "Okay. I want to thank everybody for questions and your active participation today. In closing, I want to thank our AIG colleagues around the world for their continued commitment, teamwork and the significant contributions. I mean, we accomplish a lot every year, and we try to capture it for you today and we really appreciate joining us today. And we look forward to sharing a lot more detail on March 31st during AIG's Investor Day. Have a great day."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program and you may now disconnect. Everyone have a great day."
}
] | American International Group, Inc. | 250,388 |
AIG | 3 | 2,024 | 2024-11-05 08:30:00 | Operator: Good day, and welcome to AIG's Third Quarter 2024 Financial Results Conference Call. This conference is being recorded. Now at this time, I'd like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, Michelle, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Additionally, note that following the deconsolidation of Corebridge Financial on June 9, 2024, the historical results of Corebridge for all periods presented are reflected in AIG's condensed consolidated financial statements as discontinued operations in accordance with U.S. GAAP. Finally, today's remarks related to General Insurance results, including key metrics such as net premiums written, underwriting income, margin and net investment income are presented on a comparable basis, which reflects year-over-year comparisons on a constant dollar basis as applicable and adjusted to the sale of Crop Risk Services and the sale of Validus Re. We believe this presentation provides the most useful view of General Insurance results and the go-forward business in light of the substantial changes to the portfolio since 2023. Please refer to Pages 26 through 28 of the earnings presentation for reconciliations of such metrics reported on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino: Good morning and thank you for joining us today to review our third quarter 2024 financial results. Following my remarks, Sabra will provide more detail on the quarter. Then our North America and international leaders, Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Before we begin, I want to acknowledge the devastating impact the recent weather events had on our communities, which underscores the difficult reality of changing weather patterns and the frequency and severity of these events. At AIG, our claims teams have been working hard to ensure that we respond quickly. I'm grateful to our colleagues for their commitment to our clients and distribution partners. This is our purpose and it's when our company is needed most. Now let me move to the highlights of our outstanding third quarter performance. We continue to deliver exceptional underwriting results, maintain rigorous expense discipline, execute on our capital management plan and make excellent progress on our strategic priorities. Adjusted after-tax income was $798 million or $1.23 per diluted share, representing a 31% increase in earnings per share year-over-year, driven by strong core earnings growth and disciplined execution of our capital management strategy. Underwriting income for the quarter was $437 million, which included total catastrophe related charges of $417 million. The calendar year combined ratio was 92.6%. Consolidated net investment income on an adjusted pre-tax income basis was $897 million, a 19% increase year-over-year. Other operations, adjusted pre-tax loss was $143 million, an improvement of $135 million or nearly 50% year-over-year. Core operating ROE was 9.2% with core operating equity of $34.5 billion as of September 30, 2024. In the third quarter, we returned approximately $1.8 billion to shareholders through $1.5 billion of stock repurchases and $254 million of dividends. In addition, we repurchased $520 million of common stock in October. We ended the third quarter with a debt-to-total-capital ratio of 17.9%, including AOCI and parent liquidity of $4.2 billion. During my remarks this morning, I will provide information on the following five topics. First, I will review the financial results for our General Insurance business. Second, I will provide observations on the catastrophe market and specifically AIG year-to-date. Third, I will update you on our progress with AIG Next and its impact on other operations. Fourth, I will provide an update on our significant progress in AI and related objectives moving forward. And finally, I'll give more detail on our capital management plan and the path to achieving 10% core ROE. Turning to General Insurance. We had another excellent quarter with strong profitability and growth across our businesses. Gross premiums written for the quarter were $8.6 billion, an increase of 3% from the prior year. Net premiums written for the quarter were $6.4 billion, a 6% increase. Net premiums earned for the quarter were $5.9 billion, a 7% increase with $4.2 billion coming from Global Commercial. The accident year combined ratio as adjusted was 88.3%. We had favorable prior year reserve development of $153 million, a benefit of 2.6 points to the loss ratio. Sabra will provide more detail in her prepared remarks. In Global Commercial, we had 7% net premiums written growth over the prior year quarter, driven by over $1.1 billion of new business, which grew 9% year-over-year. Retention remained at 88%, which is an outstanding outcome. The accident year combined ratio as adjusted was 84.2% and the calendar year combined ratio was 89.9%. The GOE ratio was flat year-over-year, while absorbing over $50 million of expenses that shifted from other operations. In Global Personal, we had 3% net premiums written growth over the prior year quarter, led by 9% new business growth across our Global portfolio. The accident year combined ratio as adjusted was 97.8% and the calendar year combined ratio was 98.8%, both were improvements year-over-year, and we expect this segment to continue to improve its financial performance in 2025. North America Commercial grew net premiums written by 11% year-over-year. We had a closeout transaction in the quarter in our casualty portfolio that benefited overall growth, but negatively impacted the accident year loss ratio. Absent this transaction, our net premiums written growth would have been in the high-single-digits. The businesses that drove growth were casualty at 9%, excluding the closeout transaction, 8% in Glatfelter and 7% in Lexington. Retention in North America was 90% in admitted lines and 78% in Lexington, which is an exceptional outcome for an excess and surplus lines business. New business growth in the quarter was simply outstanding. On a year-over-year basis, we had 22% growth in new business led by Lexington with 24% growth. And the story for Lexington just keeps ongoing. We had over 95,000 new business submissions in the quarter, up 35% year-over-year. Casualty submissions were up over 70%, Western World was up over 30% and property was up over 20%. Also, our financial lines new business was up double-digits. This was due almost exclusively to a rebound in M&A following a slow new business quarter for financial lines in the same period last year. North America Commercial accident year combined ratio as adjusted was 85.1% and the calendar year combined ratio was 95.5%, an exceptional outcome given the significant CAT activity in the quarter. The accident year loss ratio was 61.8% for the quarter, which was an increase of 250 basis points year-over-year and reflected two main variables. First, the closeout transaction in AIGRM that I mentioned earlier, while profitable and incrementally beneficial to the overall combined ratio, it carried a higher loss ratio, which resulted in a 70-basis point headwind. And second, the actual versus expected in the prior year quarter comparison was very favorable as a result of our admitted and wholesale property portfolios experiencing close to 30% rate increases last year that earned in over 2023 and the early part of 2024, creating a 180-basis point headwind. The combined ratio also benefited from a lower expense ratio, reflecting improvement in the GOE ratio. In International Commercial, net premiums written grew 3% year-over-year. Commercial property grew 6% as did Global Specialty, where international specialty grew 10% driven by Energy. Our Talbot business at Lloyd's also grew 6%, driven by 18% growth in the specialty lines, specifically political risk, energy and marine. International retention remained strong at 89%, which was very balanced across the portfolio, led by energy and property, both at 92% and casualty at 91%. International also had very good new business of over $500 million, led by global specialty with 25% new business growth in marine and 40% new business growth in Talbot year-over-year. The International Commercial accident year combined ratio as adjusted was 83.4%, another excellent result. The calendar year combined ratio was 84.3%. Given that the third quarter is usually the most active quarter for natural catastrophes, I want to provide some thoughts on the activity year-to-date and how the evolution of our underwriting and reinsurance strategy has significantly enhanced AIG's performance over time, even in light of this historical increased activity. For the first nine months of the year, preliminary industry estimates of insured losses from natural catastrophes are in excess of $100 billion, which appears to be the new normal. When considering the impact of Hurricane Milton on the industry and the remainder of the fourth quarter, Aon recently published a report that estimated that the 2024 total insured losses for the industry from natural catastrophes will likely exceed $125 billion. When analyzing large single catastrophes, the complexity of determining the initial and ultimate loss is complicated. Modeling firms produce industry loss estimates post event and there are many factors that go into estimating the ultimate losses. It is important to note that no two catastrophes are the same. Property claim services or PCS is a widely used source for independent property loss estimates in the United States. The loss figures that they provide are derived from claims activity and other factors at the time of loss rather than a judgment of the ultimate size of the loss. As a result, the actual scale of total loss is often subject to misinterpretation. Historically, if you look back at major events including Katrina, Superstorm Sandy and Ian, the final report of PCS figures were substantially higher than their original estimates, illustrating the uncertainty around determining ultimates or best estimates for catastrophe losses. At AIG, we've mitigated the impact that weather events have had on our business as reflected in our improved financial performance even as the world has seen more CAT activity. Over the last five years, our losses have dropped dramatically, both in nominal terms and also in terms of the overall market share of the losses. This is a testament to the work we've undertaken to change and evolve our underwriting strategy, reduce volatility and increase the quality of our earnings. If we use 2012 as a reference point, which was a year with meaningful activity, the total insured catastrophe losses on a nominal basis were $65 billion for the industry. That is roughly equivalent to the 20-year average and serves as a useful benchmark. Since 2012, expectations for annual industry catastrophe losses have grown substantially. The average annual industry loss from natural catastrophes from 2017 through 2023 has increased approximately 90% when compared to the average from 2000 to 2016. Since 2017, seven of the last eight years, including the 2024 forecast have had over $100 billion of annual insured losses. It's important to note, against this heightened level of natural catastrophe losses, based on published reports, we estimate approximately 50% of the insured natural catastrophe losses were absorbed in the reinsurance market from 2017 to 2022. However, following the major market reset in 2023, approximately 90% of the losses were retained by the primary insurance companies. And this is a significant change. As I have discussed several times, the work we've done to change AIG's approach to underwriting and reinsurance has resulted in dramatic improvements in our financial performance and balance sheet. Let me give you some specific points to contextualize the magnitude of this impact. Based on AIG's legacy underwriting strategy and reinsurance choices in 2012, AIG posted an initial pre-tax loss of $2 billion from Superstorm Sandy, which represented almost 7% of the estimated $30 billion market loss for that single event. And for the full year 2012, AIG recognized approximately $2.7 billion of losses or approximately 4% of the market losses. Today, AIG is forecasted to be within our catastrophe loss expectations for the full-year or more importantly, less than 1% market share of the forecasted total industry loss for 2024 of over $125 billion. Additionally, it's worth noting that our property portfolio net premiums written are approximately the same amount in 2024 as they were in 2012. However, today, we have 80% lower CAT losses and volatility. And importantly, our year-to-date 2024 commercial property combined ratio is in the low 80s compared to a combined ratio of nearly 120% in 2012. We've completely transformed our business over the past five years, and this is the new AIG. AIG's strategy to manage volatility through our gross underwriting actions and our approach to reinsurance, including our decision to maintain the lowest net retention amongst our Global competitors, has delivered significant benefits for the company and positions us well for the future in an environment with significantly elevated insured loss activity and modeling uncertainty. Let me take a minute to comment on high level expectations for the upcoming January 1 renewal season for property. The significant reset in the property CAT reinsurance market in 2023 means that reinsurers generally have higher attachment points, provide name perils and have significant retro protection and therefore are likely to make an underwriting profit on their global catastrophe portfolios in 2024, given the current loss levels and the benefit of reinstatement premiums. With this expectation of underwriting profit, the overall reinsurance market should remain healthy. Despite the strong capital position of the market, generally speaking, I would expect the market to remain disciplined at January 1, not reducing attachment points and focusing on deploying capital to the insurance companies with higher quality portfolios like AIG. Given that this has become the industry norm, as I mentioned earlier, industry losses from increased frequency and severity will continue to be realized by primary insurers and will not be solved by the reinsurance market in 2025. Let me move on to provide an update on AIG Next, which we launched in early 2024 to further position AIG for the future. Over the past several years, we've been on a journey to simplify the company by weaving the organization together to operate seamlessly across underwriting, actuarial, claims and all of our functional areas with the necessary skills and capabilities to effectively differentiate AIG for the future. In 2025, we expect to fully realize the $500 million in savings from AIG Next. These savings will impact multiple areas across other operations and General Insurance. As part of the AIG Next program, we've established a new definition of parent expense to exclusively reflect costs related to being a global regulated public company and expect those costs to be around $350 million going forward. In the future, costs currently attributed to other operations will either be eliminated or included within the General Insurance results. You can see the impact of this effort already flowing through our income statement as other operations expenses are down nearly $30 million year-over-year or $40 million sequentially. This reduction reflects the expense benefits from AIG Next and the transfer of a portion of these costs to General Insurance GOE. The ability of the businesses to absorb these additional costs with minimal impact to the expense ratio is due in large part to our significant focus on managing expenses. AIG Next has also enabled us to invest in core capabilities and the implementation of strategic innovation initiatives, notably in underwriting, claims and our data, digital and AI strategy. Let me provide you with more detail. Many companies are discussing their data, digital and AI strategies, but what is actually being done varies greatly from company to company. At AIG, we're utilizing GenAI in large language models as digital accelerators and applications that support the innovation journey, but they are not the innovation alone. This is what makes our recently announced collaborative space in Atlanta so unique. It will be the first location in our global footprint where an end-to-end underwriting process will exist from distribution, sales to data insights, underwriting, claims payments and client servicing. This location will allow us to innovate and evolve the end-to-end process, further develop our Agentic GenAI ecosystem, drive role clarity and digitize and modernize our processes. GenAI can produce meaningful gains from reducing manual inputs and driving process efficiencies. However, our GenAI ecosystem is doing much more than that. It integrates proprietary data from multiple sources with data ingestion capabilities to give us better data quality in a fraction of the time. In our early pilots, we've seen data collection and accuracy rates within our underwriting processes improve from levels near 75% to upwards of 90%, while reducing processing time significantly. We're also using our GenAI ecosystem to increase our submission response rate while enabling our underwriters to prioritize the highest value business within our risk appetite. These improvements will help drive growth and operating leverage as we deliver GenAI to our businesses at scale. It will allow our underwriters to spend more time quoting and winning business and less time manually collecting data. Our culture at AIG is one that is deeply rooted in underwriting expertise and excellence. We help clients solve complex risk issues that require judgment and a nuanced understanding of clients' needs, maintaining the underwriter at the center of decision making will continue to be paramount and a key differentiator for us. Our AI initiatives are designed to do just that, deliver better outcomes and drive operating leverage while keeping highly experienced underwriters at the core of the process. I'm now going to turn to capital management, where we continue to execute our balanced disciplined strategy. Our objectives are to preserve strong insurance company capital levels to support organic and potentially inorganic growth, maintain conservative debt leverage ratios, return excess capital to shareholders in the form of share repurchases and dividends and maintain parent liquidity. We made substantial progress over the last several years to improve the financial strength of AIG. General Insurance is well positioned for sustained profitable growth. This has been a multi-year process that's centered on executing on our underwriting strategy, while increasing profitability and reducing volatility in our portfolio through a better mix of business along with the strategic use of reinsurance. An important result of our improved profitability is our ability to receive ordinary dividends from our operating subsidiaries, which provides consistent and increasing liquidity to the parent company. Year-to-date, we received ordinary dividends or their equivalents of approximately $3 billion from our businesses. Our financial strength is also evidenced by the lower levels of debt on our balance sheet, historically, AIG had one of the highest debt-to-total capital leverage ratios in the industry at over 30%. In 2024, we have reduced debt levels by $1 billion, bringing our debt-to-total capital leverage ratio to 17.9%, including AOCI, amongst the lowest in our peer group, an achievement that requires significant discipline. Through the first nine months of 2024, we returned over $5.5 billion to shareholders through $4.8 billion of common stock repurchases and $765 million of dividends. As we've stated previously, we will continue to execute on our $10 billion share repurchase authorization over the course of 2024 and 2025, subject to market conditions and timing of the closing of pending transactions. The current authorization will bring us within our target share count range of 550 million to 600 million shares. Importantly, our anticipated parent liquidity provides the flexibility to support additional share repurchases, which we will review in 2025. Earlier this year, we increased the cash dividend to shareholders on AIG common stock by 11%. We will continue to review our dividend annually, considering additional increases as appropriate, supported by our increased earnings power. This will be an important focus for us in 2025 and beyond. We ended the third quarter with parent liquidity of $4.2 billion. With the combination of our disciplined capital management, sustained continued underwriting performance and focus on expense management, we expect to deliver a 10% core operating ROE for the full-year 2025. We recognize that with core operating equity of $34.5 billion at the end of the third quarter, parent liquidity, our capital in the insurance company subsidiaries and future proceeds from corporate sell-downs, we have excess capital for the size of the business we are today. We will proactively manage our capital over time to support growth in our business and we will maintain a capital management strategy centered on balance and patience while remaining nimble to execute, should attractive opportunities arise. In summary, I'm very pleased with our outstanding third quarter performance, as we approach year end and plan for 2025, our path forward is clear. We will continue to solidify AIG's position as a global market leader and remain focused on value creation for our customers and shareholders. With that, I'll turn the call over to Sabra.
Sabra Purtill: Thank you, Peter. This morning, I will provide details on third quarter results for General Insurance, net investment income, other operations and capital. Turning to General Insurance. Adjusted pre-tax income or APTI was $1.2 billion. Underwriting income was $437 million, including $411 million of catastrophe losses. Hurricanes Beryl and Helene were the two largest losses in the quarter. Hurricane Milton made landfall on October 9 and therefore, its financial impact will be recognized in the fourth quarter. Peter commented on the complexity of determining ultimates for natural catastrophes. And at this point, we have a very wide range of estimates for modeling firms. Claims activity to date for Milton has been relatively light compared to storms of similar strength and intensity. Our current preliminary loss estimate for Milton is between $175 million and $275 million. The third quarter 2024 accident year combined ratio as adjusted was 88.3%, about 140 basis points higher than last year, principally due to changes in premium mix and reinsurance structure and favorable actual versus expected experience in the third quarter of 2023. We also had one large closeout transaction, which Peter mentioned that increased the consolidated loss ratio by about 40 basis points. Year-to-date, the accident year combined ratio is 88.1%, down 60 basis points from 2023. The accident year loss ratio was 56.4% for the quarter, including the impact of the closeout transaction and 56.4% year-to-date, flat with the first nine months of 2023. We expect the fourth quarter accident year loss ratio as adjusted, will be in line with the first nine months of this year. Turning to prior year development. This quarter, we had $153 million of favorable prior year development, including $34 million from the ADC amortization. During the quarter, we completed detailed valuation reviews or DVRs on almost $22 billion or 47% of our total loss reserves. We reviewed most of the reserves for international in addition to North America property and financial lines. Overall, we had favorable prior year development on short tail lines in global specialty and global commercial property and a modest amount in North America financial lines. This was partially offset by $181 million of adverse development in U.K. and Europe casualty and financial lines on about $8 billion of reserves. This reflects refinements in loss estimates due to recent claims emergence and settlement activity on specific exposures in accident years 2019 and prior, consistent with our reserving philosophy of addressing bad news quickly. In addition, we increased U.S. excess casualty reserves by $72 million due to a large settlement of a legacy mass tort claim also related to accident years 2019 and prior with most of the gross loss and accident years that were ceded to the ADC. We remain very comfortable with the adequacy of our loss reserves, having completed DVRs covering more than 90% of reserves year-to-date and considering the results of our monthly actual versus expected process and other claims diagnostics. While North America Financial Lines had a slight amount of favorable development from accident years 2021 and prior, we did not adjust loss reserves for more recent accident years, which have continued to show favorable indications relative to our books loss assumptions, consistent with our reserving philosophy of giving favorable experience time to mature. Turning to pricing and loss trends. Third quarter experience in Global Commercial Lines was consistent with second quarter 2024 trends. Excluding financial lines and workers' compensation, AIG's Global Commercial pricing, which includes rate and exposure increased 6%, largely in line with loss cost trends. In North America Commercial, which is about half of our global commercial book, pricing excluding financial lines and workers' compensation was up 7% with rate up more than 5%. North America casualty rate increases were strong with Lexington averaging 16% and retail casualty averaging 13%. These are well above our casualty loss cost trends, which as we've previously disclosed are at 10% or higher depending on the line, risk and attachment point. Property rates in North America Retail and Lexington were consistent with second quarter and the underwriting margin remained strong, supported by cumulative rate increases over the past several years and our disciplined underwriting approach, particularly to CAT exposed property. Pricing in International commercial, excluding financial lines was up 4%, in line with loss trend and underwriting profitability remains very strong. International property continued to achieve overall pricing in excess of loss trend. Our global footprint and diverse portfolio enable us to remain agile, focusing on lines of business with attractive risk adjusted returns while maintaining underwriting discipline. We are confident that the overall strength of our portfolio positions us to deliver sustainable underwriting profitability. Turning to investments. Our investment portfolio is of high credit quality, well diversified by asset class and match to our liability duration. The increase in interest rates since 2021 has driven higher portfolio yields even as credit spreads have tightened. Third quarter 2024 net investment income on an APTI basis was $897 million, up 19% from the third quarter of 2023, driven by increased reinvestment rates on fixed maturities, higher short-term investment income, Corebridge dividends and other operations, slightly better private equity returns and lower investment expense. Reinvestment yields on fixed maturities and loans remains above runoff yields, providing positive yield pickup in the quarter. The average new money yield on General Insurance fixed maturities and loans was 60 basis points higher than sales and maturities adjusted for one large sale in the quarter. General Insurance investment income was $773 million, including income on fixed maturities, loans and short-term investments of $718 million and alternative investment income of $43 million. Considering the current interest rate curve, we project fourth quarter General Insurance investment income on fixed maturities, loans and short-term investments to be approximately $710 million due to the impact of floating rate security resets, partially offset by higher reinvestment yields. About 11% of our fixed maturities have monthly or quarterly floating rate resets to SOFR or other short-term market indices, which began to decline in the third quarter. Alternative income is principally from traditional private equity and now includes real estate investment funds that were previously consolidated. These assets are reported on a one quarter lagged basis and based on third quarter market performance, we expect fourth quarter private equity results may be similar to the year-to-date annualized return of 3.5%. Turning to other operations. Adjusted pre-tax loss in the quarter was $143 million, a nearly 50% year-over-year improvement driven by lower GOE and interest expense and higher net investment income, which totaled $125 million in the quarter. Considering both lower short-term rates and projected parent liquidity balances before proceeds from any strategic transactions, short-term investment income could decline in the fourth quarter by about $25 million sequentially. To wrap up the quarter, the balance sheet remains very strong. Book value per share was $71.46 at quarter end, up 4% from June 30, 2024, due to the favorable impact of lower interest rates on AOCI. Book value per share increased 10% from year end 2023. Adjusted book value per share was $73.90, up 2% from June 30 due to reduced shares outstanding and was down 6% from year end 2023 due to different accounting treatment of Corebridge between the two periods. As Peter noted, our debt leverage ratios are very strong. We recently called a $400 million par zero coupon bond, which will close November 22. Core operating ROE, which measures the annualized return on AIG shareholders' equity, excluding the value of Corebridge shares and deferred tax assets, was 9.2% in the quarter and 9.3% year-to-date, reflecting strong General Insurance profitability and capital levels. To conclude, AIG delivered another excellent quarter with significant financial and operational accomplishments. We are confident in our ability to deliver sustained underwriting results and a 10% core operating ROE in 2025, and we look forward to updating you on our progress. With that, I will turn the call back over to Peter.
Peter Zaffino: Thank you, Sabra. And Michelle, we're ready for our first question.
Operator: [Operator Instructions] Our first question comes from Meyer Shields with KBW. Your line is open.
Meyer Shields: Great. Thanks, and good morning. I want to start with a question about reserves, if I can. You talked about how recent accident years financial lines are emerging better than expected, but you're not booking that yet. Can you talk a little bit about what's happening in the older accident years for, I guess financial lines or casualty, we saw the one-off issues, but I'm wondering more broadly, is there the same sort of theme in the older accident years that could be getting closer to acknowledgment.
Peter Zaffino: Thanks, Meyer. Good morning. I think Sabra provided quite a bit of detail in her prepared remarks, but Sabra, do you have anything to perhaps give a little bit of context on financial lines?
Sabra Purtill: Yes. And let me just make a few comments. I mean, obviously, we had very strong favorable development in the DVRs this quarter. Consistent with our approach, we have allowed favorable development to -- our favorable experience to mature. And this quarter, particularly on shorter tail lines, we had about $300 million of favorable development. I would just note that this quarter did not include workers' compensation that was done in the third quarter of last year and this year it was done in the second quarter and we'll do it in the second quarter for next year as well. What I would just comment on in terms of the -- I'll talk to the excess casualty first because I know that's been in some focus. The trigger for the action in North America casualty, excess casualty was for a particularly large settlement, growth of reinsurance, which was from very old accident years that were covered by the ADC. Absent this settlement, we would not have made any adjustments in that line because the DVRs for that line are done in the second quarter normally. Turning to financial lines. Let me just note that for the quarter in total, we had post-ADC, the adverse development on financial lines was about $28 million in total. That was driven by the adverse development on U.K. financial lines, which again was an older book with -- related to some specific exposures. We did actually recognize favorable development on the U.S. and international portfolios. And I would note that was for older accident years. The favorable development that we recognized is generally in older years where the experience has matured as the policy form is claims made, but we continue to hold reserves, obviously for those older accident years based on the existing claims or other activity within that book. And we will evaluate again in the third quarter of next year is when we'll do our deep dive on the Global Financial lines portfolio.
Peter Zaffino: Great. Thanks, Sabra. Meyer, is there a follow-up?
Meyer Shields: Yes, just a quick one. Peter, you talked a lot about your expectations for a property reinsurance in 2025. And I was hoping for an update on your thought of the appropriate reinsurance program, property reinsurance program for AIG, whether you're thinking of other -- of changing your net exposure?
Peter Zaffino: I covered a lot in my prepared remarks. Again, I think the industry has become experts on reinsurance pricing. And I expect that the market will be orderly, but I don't expect attachment points are going to come down for the industry. What I was trying to outline in my comments was that most of it is retained by insurance companies today. And so therefore, how we're going to price business going forward, how we're going to understand the frequency of CAT is going to be really important to do as an insurance company and not rely on reinsurance. I don't think we're going to have a material change in our structures. Of course, we have low attachment points. It's very complex and I won't spend a lot of time on it. But we certainly have the balance sheet. We certainly have the risk appetite to take a little bit more net in the event that we want to, but we like having low attachment points on severity and we like having our aggregate that protects us from frequency. And so we manage our net according to our risk appetite. It's within expectations and I would expect us to continue the same strategic philosophy.
Meyer Shields: Okay, perfect. Thank you so much.
Peter Zaffino: Thank you.
Operator: Thank you. Our next question comes from Brian Meredith with UBS. Your line is open.
Brian Meredith: Yes. Thank you. Peter, I think we're hearing a little bit from other companies about some improvement in your casualty, particularly E&S, casualty lines and maybe properties' moderating. Wonder if you could give us some color on your view of market conditions and kind of organic growth opportunities here in the fourth quarter and heading into 2025.
Peter Zaffino: Thanks, Brian. And I'm going to make a comment. I'm going to have Don talk specifically about Lexington. But you're absolutely right. We see opportunities. Our clients, we have such strong retention and they're looking for us to solve risk issues. New business opportunities are very good. The rating environment is very good. So we're cautious, but we think there's opportunities to grow. In the retail casualty space, in multiple segments that we have as well as in E&S, I mentioned in my prepared remarks that our casualty submissions in E&S have been dramatic and we see great growth opportunities there. But Don, maybe you could expand a little bit on the Lexington.
Don Bailey: Great. And if I could, Peter, just maybe a couple of high-level comments on North America overall and then dig deeper into the Lex growth because they are kind of balanced. So the double-digit growth in North America is balanced growth. We're growing the lines where we see attractive opportunities. And to the point of your question, we're growing in all three channels where we operate, retail, wholesale, alternative. Peter covered some of the North American growth drivers, positive rate of 3% across the portfolio, strong retention of 87%, 90% in the admitted lines and then overall strong new business growth of 22%. On Lexington, we do continue to invest in Lex across all lines. So you'll see Lex continue to show up with more resources, more products, enhanced capabilities going forward. On the third quarter performance, as Peter mentioned, 78% per retention, which is really strong, a 24% increase in new business. And to the point of your question, casualty showed up very well in the E&S space in terms of new business for the quarter. We also saw a 35% increase in submission. So the submission activity continues to be very robust in the E&S space for us. It's generated probably by two things. One is just increasing demand for E&S solutions in general and a flight to quality within E&S. For me personally, when I think about the nature of a wholesale broker today versus when I started in this industry, it's a completely different game. The brokers in the wholesale space operate at a different level today, incredibly well resourced, data driven, effectively deployed technology to drive efficiency, which is critical in wholesale. They're also increasingly being embraced by thousands of independent agents for market access and placement capabilities. So Lex will continue to benefit from that trend in terms of the growth of our book and new business. And Peter, just a couple of data points to close out on E&S, which might be helpful. Today, E&S represents 12% of the $115 billion U.S. P&C industry. In 2018, E&S was 7% of a $50 billion industry. So the pie has gotten considerably larger. And the last data point I'd give you just on distribution. The top five wholesale brokers control over 65% of the growing $115 billion U.S. E&S market. Lex is very well positioned in E&S and very well positioned with these top brokers.
Peter Zaffino: Great. Thanks, Don. Brian, do you have a follow-up?
Brian Meredith: Yes, absolutely. A bigger picture question here, Peter. So I think you said that you're expecting a 10% core ROE for 2025. If I look at peer companies, they're kind of trending in the mid to even higher-teens. Yes, what's your kind of longer-term view of kind of ROE aspirations you think you can get to peer ROEs and what do you think it's going to take to get there? Is it more margin improvement, you need to kind of grow acquisitions? Just curious bigger picture, your thoughts there.
Peter Zaffino: Yes, thanks, Brian. I mean, obviously, we've been talking a lot about the 10% and gave guidance in my prepared remarks about getting to that in 2025. There's a variety of ways in which we can get there. We talked about our combined ratio and the opportunities to improve that. We have such a great underwriting culture and believe that there's lots of opportunities, of course, is market dependent, but our leadership position in the market allows us to remain disciplined and focused on clients. There's -- the other variables, I mean, certainly it's our equity base. We talked about that a little bit and that we believe we can grow into it and that's of course going to generate more earnings opportunity, our net investment income, net premiums written both from a peer growth in terms of strong retention, more new business, but also reinsurance structures, how we look at proportional versus excess of loss and there's ways in which we could have some tailwinds there. Quality of our reserves, which we continue to emphasize, Sabra gave a lot of detail in her prepared remarks and on the answer just now. So we have a lot of confidence there. Capital management actions. We have lots of flexibility subject to when we close Nippon and do other capital market transactions, but there's lots of ways in which from a capital management standpoint allow us to improve. Our ability and track record to successfully manage volatility is very important. And then the last one is our expense management is very disciplined. We are executing on AIG Next. That showed itself in the third quarter. We're not looking to hit the ball out of the park every quarter leading in 2025. We pulled guidance forward that we will be able to get other operations, which was substantially higher to a $350 million lean parent, but also get the expenses either eliminated or into the business without increasing the combined ratio. We're well underway. You can see evidence of that in the third quarter. You'll see more evidence of that in the fourth quarter. So there's a bunch of ways in which I think that we can deliver it. And once we get north of the 10%, we'll provide guidance after that. But thank you.
Brian Meredith: Thanks.
Operator: Thank you. Our next question comes from Rob Cox with Goldman Sachs. Your line is open.
Rob Cox: Hi, thanks. So I think you guys had previously noted M&A potentially becoming a more meaningful consideration for capital deployment, but you also mentioned revisiting share repurchase guidance as you expect some further liquidity coming in next year. Can you give us an update on your appetite for M&A and how that might help you reach premium leverage objectives quicker than organically?
Peter Zaffino: Sure, Rob. Thanks. I'll start with the second part. The guidance we gave was that we would do $10 billion of share repurchases in '24 and '25. And so like you can see through the third quarter, we are well underway executing every quarter. We'll have more liquidity coming in. And so that's the priority with the proceeds coming in from Nippon and as I said, other marketed deals and liquidity that we currently have at the parent company. In terms of M&A, we have given ourselves lots of options. We have the financial strength, the financial flexibility to explore inorganic opportunities. We're always looking at ways in which we can add strategic relevance and something that's compelling to AIG. We already have sizable very high-quality businesses in major markets. I mean, you know about the U.S., U.K., Japan, Singapore, Europe. We believe we can grow those businesses organically, but there may be more opportunities to expand inorganically as well. We're going to remain very disciplined, but we are going to look at businesses and opportunities in inorganic that may complement our geographical footprint or product capabilities. There's opportunities maybe to go into spaces that we're not in today, maybe some of the SME or looking at ones that enhance scale of businesses that we already have market leadership that just will accelerate our ability to execute our risk-adjusted returns. So I want to remain very disciplined, very patient, but we have the financial flexibility and the strategic intent of growing.
Rob Cox: Okay, great. Thank you. And as a follow-up, on GOE and General Insurance, it didn't necessarily appear like it decreased as much as the run rate in the first half of the year. So I was just hoping you could discuss kind of the puts and takes in the General Insurance GOE ratio and if this level of improvement is sort of in line with expectations.
Peter Zaffino: Yes. I was actually quite pleased with the third quarter in GOE because we looked at other operations and the significant improvement that we made there on the GOE line year-over-year and then sequentially, but also we are absorbing a lot of the expenses as they get pushed into the business. And so while the personal insurance year-over-year, the nominal was down and then on commercial, it was slightly up. When you look at putting $50 million more of cost in, the run rate is actually quite attractive. And so we have two major initiatives that have begun to earn in the third quarter, but you'll start to see a lot more of that in the fourth quarter. And as we get to 2025, one was our voluntary early retirement plan that we had announced in the United States. And then we did a restructuring international that just really happened in September. And so you'll start to see more run rate as we get into the fourth quarter and next year. But I'm really pleased with what we did in the third quarter and believe we are showing a lot of sequential improvement in executing to this future state operating model that's going to be much leaner, much simpler and much easier to follow.
Rob Cox: Awesome. Thanks for the color.
Peter Zaffino: Thanks, Rob.
Operator: Thank you. Our next question comes from Alex Scott with Barclays. Your line is open.
Alex Scott: Hi, good morning. I got a follow-up on just sort of the leverage. And I guess thinking through both leverage down at the operating companies as well as financial leverage. But when I look at the ROE, that seems to be the place where you're under index versus some of the peers, not so much like the actual combined ratio and so forth. So I was interested in, I guess on the debt leverage side, are we at a place where leverage can actually begin to come up as you see opportunities, particularly if you do engage in M&A? And then on the core operations, I mean can you frame at all like how much dry powder you see in terms of being able to lean into some of these opportunities if they get better at casualty?
Peter Zaffino: So thanks, Alex, for the question on leverage, yes, we have a lot of -- I think it goes into what I said about potential M&A where we've given ourselves a lot of financial flexibility if we find something compelling and attractive. I think the high teens of a leverage to total capital, including AOCI, we're very comfortable with, but absolutely what you were asking is a truth, which is if we find opportunities, can we increase our leverage to be able to execute on that? The answer is yes, we can. And we're going to be very mindful. Obviously, the primary use for proceeds from the Corebridge sell-down will go to share repurchase, but we could continue to work on leverage a little bit to give us even more financial flexibility over time. In terms -- I just want to make sure I understand the second part which is having -- we have a lot of capital. I don't think it's a moment in time and to quantify what we think is excess today, I don't think is something that is overly constructive just because we intend to grow into that. We have shown real opportunities in our business to acquire new business. We had a terrific new business quarter. That momentum continues. And I think look at them, property was probably the one that was sort of slowing down in terms of pricing, but Milton and Helene have changed a lot. And I think that there'll be more flight to quality and there'll be more flexibility for AIG in terms of our ability to drive property growth and on a risk-adjusted basis throughout the world. And so like I think the balanced portfolio opportunities to grow, being able to take more net and being able to hit that 10% ROE is our near-term objective.
Alex Scott: Got it. That's helpful. And then maybe a quick follow-up on personal lines in North America. Can you just give us an update on sort of where we stand with that MGA structure that was put in place and over what period of time you'd expect that combined ratio to come down below 100%?
Peter Zaffino: Yes. Thank you for the question. I mean, North America personal is in transition as we as we've spoke about. It's hard in the primary high net worth business to affect change fast, but we're making great progress. In the quarter alone, the attritional loss ratio has improved on a meaningful basis, GOEs down. What you're seeing is the acquisition ratio increased quite a bit as we transition to the MGU. Now there's a few things happening that will reverse that in 2025. One is we're at scale, everything is fully put into the MGU and we expect the ceding commission that we paid to go down, I think in a meaningful way. And so the acquisition expense ratio will improve accordingly. I want to talk a little bit about like the strategy that we talked about, which is going into more non-admitted and how that's going to accelerate progress. And we announced it last quarter, but just a couple of statistics that will frame why it's early days, but it's working. The rate environment that we're in on an emitted basis in high net worth, we increased 10% in E&S. It went up 20% on our held book. Our partnership with Ryan Specialty, they're building infrastructure, building sales capacity. We're appointing a lot of retail agents that had no access to AIG or capital for high net worth before our signing up. We expect that to accelerate and continue to grow. In the third quarter, our new business, 50% of it was E&S. Again, we had good growth. I mean, the nominal is not going to move the needle, but we have momentum there. And I would expect in 2025, E&S alone in our strategy will grow the top line 10%. The demand is going to be significant. Our ability to be able to respond to that demand is there with plenty of capacity and an appetite that is going to allow us to improve the risk-adjusted returns and the overall combined ratio.
Alex Scott: Thank you.
Peter Zaffino: Thank you.
Operator: Thank you. Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open.
Elyse Greenspan: Hi, thanks. Good morning. My first question was just on the North America commercial. If I adjust out the one-off -- the one-off in the quarter, right, the -- it came in at 61.1% on an ex-CAT accident year loss ratio basis. You guys are at 61.9% in the first half of the year. So I was just hoping to get more colors on what drove the improvement in the quarter and if that's sustainable into the fourth quarter and 2025.
Peter Zaffino: This is not going to be like the 91.6% question, is it Elyse? Don, do you want to just give a little bit of insight in terms of what's happening with the loss ratio?
Don Bailey: So in the North American portfolio this year, we've seen some different movements, Peter. And in some of it, if you look at, we have some one-off movements that certainly moved the loss ratio on this one, which you talked about in your prepared remarks. We talked a little bit about the one-time closeout deal that we did that moved it up. So adverse implications.
Peter Zaffino: I think, look, and in the commentary, Elyse, we sort of backed out the two -- they weren't headwinds, they were just anomalies relative to what the prior year was. And then the mix of business will continue to change. We see real opportunities to grow in -- in casualty and so those may have a different loss ratio relative to the overall portfolio. We think there's going to be growth opportunities in property based on the market dynamics that are shifting in 2025 and we see that the headwinds on pricing in financial lines are slowing down. We are not going to continue to ride that way down. And on lead, first excess and leading in D&O, I think Don highlighted this is that we've seen a slowdown in the rate reductions. And as we look into 2025, that's all going to stabilize. So I think that mix, if you take out the two things we talked about, which was significant outperformance in property and short tail last year in the third quarter along with the closeout that looks like a loss ratio that's sustainable.
Elyse Greenspan: Okay. That's all. Yes, that's my follow-up, I guess, would be, Peter, just building upon that comment as you view the market conditions out over the next year, how do you expect the mix to shift between property and casualty relative to where it is today?
Peter Zaffino: It's hard to tell because I -- as I mentioned before, I think the property slowdown in terms of rate increases should start to reverse as you get to next year because there's so much net that's been retained by insurance companies that they're not getting the appropriate risk-adjusted returns for the cat loss at the low return periods and the increased frequency and severity. So I think that's going to reverse. Casualty is very strong, and Don went into length on excess and surplus lines. And then also you know we're seeing slowdown in financial lines. And so I think that the overall index, I think is going to sustain, but we'll see when we get into the market and see what happens within particular property, but I'm optimistic, that's why I put some time into it in the prepared remarks that we see a rate environment that's going to improve. I don't know, Jon, maybe like we -- just before the call ends, you can give a little bit of perspective in terms of where you see opportunities as we look to 2025 and international.
Jon Hancock: Yes. Thanks, Peter. And I'll try not to repeat everything you've said, but you're right, the dynamic between the first-party lines and the third-party lines is there across international as well. And we've seen first-party lines, we're still seeing good rate and price on property classes. But for me, bit like Don with Lex, we've got these jaws in Global Specialty and Talbot. Global specialty, we are the number one writer of business around the world. We're number one in energy, we're number one in marine. We're top three in aviation. We're number four in credit. And we're growing that business really well. You referenced in your prepared remarks, Peter, 6% growth in the quarter, but actually huge growth in energy, 25% new business growth in marine in the quarter. We're seeing a different dynamic at the moment where we've grown our international specialty book by 10% in the quarter. Yes, Talbot, again, another 6% growth, but the specialty lines at Talbot, the products at Talbot is really renowned for political risks. Marine and energy growing by 18%. If you look at -- add that to the fact that submissions are 25%, up in both Talbot and specialty, our quote rates are higher, our bind rates are higher. And we've got huge opportunity there and we're the best of the market at it. So we'll still keep seeing the opportunity.
Peter Zaffino: That's great, Jon. Thank you very much and I agree. Before I finally close, I do want to take a moment to thank Sabra for her many contributions at AIG. Over the past five years, Sabra has always been willing to take on a variety of important complex roles and in each instance, she's always done everything she can to add significant value. So thank you, Sabra, including the most recent role as CFO. We wish her nothing but the best in her future endeavors as we welcome Keith Walsh as our new CFO. I also like to thank all of our colleagues around the world for their continued dedication, commitment and teamwork and execution and I want to thank everybody for joining us today. Have a great day.
Operator: Thank you for your participation. This does conclude the program. You may now disconnect. Good day. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Third Quarter 2024 Financial Results Conference Call. This conference is being recorded. Now at this time, I'd like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, Michelle, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Additionally, note that following the deconsolidation of Corebridge Financial on June 9, 2024, the historical results of Corebridge for all periods presented are reflected in AIG's condensed consolidated financial statements as discontinued operations in accordance with U.S. GAAP. Finally, today's remarks related to General Insurance results, including key metrics such as net premiums written, underwriting income, margin and net investment income are presented on a comparable basis, which reflects year-over-year comparisons on a constant dollar basis as applicable and adjusted to the sale of Crop Risk Services and the sale of Validus Re. We believe this presentation provides the most useful view of General Insurance results and the go-forward business in light of the substantial changes to the portfolio since 2023. Please refer to Pages 26 through 28 of the earnings presentation for reconciliations of such metrics reported on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino."
},
{
"speaker": "Peter Zaffino",
"text": "Good morning and thank you for joining us today to review our third quarter 2024 financial results. Following my remarks, Sabra will provide more detail on the quarter. Then our North America and international leaders, Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Before we begin, I want to acknowledge the devastating impact the recent weather events had on our communities, which underscores the difficult reality of changing weather patterns and the frequency and severity of these events. At AIG, our claims teams have been working hard to ensure that we respond quickly. I'm grateful to our colleagues for their commitment to our clients and distribution partners. This is our purpose and it's when our company is needed most. Now let me move to the highlights of our outstanding third quarter performance. We continue to deliver exceptional underwriting results, maintain rigorous expense discipline, execute on our capital management plan and make excellent progress on our strategic priorities. Adjusted after-tax income was $798 million or $1.23 per diluted share, representing a 31% increase in earnings per share year-over-year, driven by strong core earnings growth and disciplined execution of our capital management strategy. Underwriting income for the quarter was $437 million, which included total catastrophe related charges of $417 million. The calendar year combined ratio was 92.6%. Consolidated net investment income on an adjusted pre-tax income basis was $897 million, a 19% increase year-over-year. Other operations, adjusted pre-tax loss was $143 million, an improvement of $135 million or nearly 50% year-over-year. Core operating ROE was 9.2% with core operating equity of $34.5 billion as of September 30, 2024. In the third quarter, we returned approximately $1.8 billion to shareholders through $1.5 billion of stock repurchases and $254 million of dividends. In addition, we repurchased $520 million of common stock in October. We ended the third quarter with a debt-to-total-capital ratio of 17.9%, including AOCI and parent liquidity of $4.2 billion. During my remarks this morning, I will provide information on the following five topics. First, I will review the financial results for our General Insurance business. Second, I will provide observations on the catastrophe market and specifically AIG year-to-date. Third, I will update you on our progress with AIG Next and its impact on other operations. Fourth, I will provide an update on our significant progress in AI and related objectives moving forward. And finally, I'll give more detail on our capital management plan and the path to achieving 10% core ROE. Turning to General Insurance. We had another excellent quarter with strong profitability and growth across our businesses. Gross premiums written for the quarter were $8.6 billion, an increase of 3% from the prior year. Net premiums written for the quarter were $6.4 billion, a 6% increase. Net premiums earned for the quarter were $5.9 billion, a 7% increase with $4.2 billion coming from Global Commercial. The accident year combined ratio as adjusted was 88.3%. We had favorable prior year reserve development of $153 million, a benefit of 2.6 points to the loss ratio. Sabra will provide more detail in her prepared remarks. In Global Commercial, we had 7% net premiums written growth over the prior year quarter, driven by over $1.1 billion of new business, which grew 9% year-over-year. Retention remained at 88%, which is an outstanding outcome. The accident year combined ratio as adjusted was 84.2% and the calendar year combined ratio was 89.9%. The GOE ratio was flat year-over-year, while absorbing over $50 million of expenses that shifted from other operations. In Global Personal, we had 3% net premiums written growth over the prior year quarter, led by 9% new business growth across our Global portfolio. The accident year combined ratio as adjusted was 97.8% and the calendar year combined ratio was 98.8%, both were improvements year-over-year, and we expect this segment to continue to improve its financial performance in 2025. North America Commercial grew net premiums written by 11% year-over-year. We had a closeout transaction in the quarter in our casualty portfolio that benefited overall growth, but negatively impacted the accident year loss ratio. Absent this transaction, our net premiums written growth would have been in the high-single-digits. The businesses that drove growth were casualty at 9%, excluding the closeout transaction, 8% in Glatfelter and 7% in Lexington. Retention in North America was 90% in admitted lines and 78% in Lexington, which is an exceptional outcome for an excess and surplus lines business. New business growth in the quarter was simply outstanding. On a year-over-year basis, we had 22% growth in new business led by Lexington with 24% growth. And the story for Lexington just keeps ongoing. We had over 95,000 new business submissions in the quarter, up 35% year-over-year. Casualty submissions were up over 70%, Western World was up over 30% and property was up over 20%. Also, our financial lines new business was up double-digits. This was due almost exclusively to a rebound in M&A following a slow new business quarter for financial lines in the same period last year. North America Commercial accident year combined ratio as adjusted was 85.1% and the calendar year combined ratio was 95.5%, an exceptional outcome given the significant CAT activity in the quarter. The accident year loss ratio was 61.8% for the quarter, which was an increase of 250 basis points year-over-year and reflected two main variables. First, the closeout transaction in AIGRM that I mentioned earlier, while profitable and incrementally beneficial to the overall combined ratio, it carried a higher loss ratio, which resulted in a 70-basis point headwind. And second, the actual versus expected in the prior year quarter comparison was very favorable as a result of our admitted and wholesale property portfolios experiencing close to 30% rate increases last year that earned in over 2023 and the early part of 2024, creating a 180-basis point headwind. The combined ratio also benefited from a lower expense ratio, reflecting improvement in the GOE ratio. In International Commercial, net premiums written grew 3% year-over-year. Commercial property grew 6% as did Global Specialty, where international specialty grew 10% driven by Energy. Our Talbot business at Lloyd's also grew 6%, driven by 18% growth in the specialty lines, specifically political risk, energy and marine. International retention remained strong at 89%, which was very balanced across the portfolio, led by energy and property, both at 92% and casualty at 91%. International also had very good new business of over $500 million, led by global specialty with 25% new business growth in marine and 40% new business growth in Talbot year-over-year. The International Commercial accident year combined ratio as adjusted was 83.4%, another excellent result. The calendar year combined ratio was 84.3%. Given that the third quarter is usually the most active quarter for natural catastrophes, I want to provide some thoughts on the activity year-to-date and how the evolution of our underwriting and reinsurance strategy has significantly enhanced AIG's performance over time, even in light of this historical increased activity. For the first nine months of the year, preliminary industry estimates of insured losses from natural catastrophes are in excess of $100 billion, which appears to be the new normal. When considering the impact of Hurricane Milton on the industry and the remainder of the fourth quarter, Aon recently published a report that estimated that the 2024 total insured losses for the industry from natural catastrophes will likely exceed $125 billion. When analyzing large single catastrophes, the complexity of determining the initial and ultimate loss is complicated. Modeling firms produce industry loss estimates post event and there are many factors that go into estimating the ultimate losses. It is important to note that no two catastrophes are the same. Property claim services or PCS is a widely used source for independent property loss estimates in the United States. The loss figures that they provide are derived from claims activity and other factors at the time of loss rather than a judgment of the ultimate size of the loss. As a result, the actual scale of total loss is often subject to misinterpretation. Historically, if you look back at major events including Katrina, Superstorm Sandy and Ian, the final report of PCS figures were substantially higher than their original estimates, illustrating the uncertainty around determining ultimates or best estimates for catastrophe losses. At AIG, we've mitigated the impact that weather events have had on our business as reflected in our improved financial performance even as the world has seen more CAT activity. Over the last five years, our losses have dropped dramatically, both in nominal terms and also in terms of the overall market share of the losses. This is a testament to the work we've undertaken to change and evolve our underwriting strategy, reduce volatility and increase the quality of our earnings. If we use 2012 as a reference point, which was a year with meaningful activity, the total insured catastrophe losses on a nominal basis were $65 billion for the industry. That is roughly equivalent to the 20-year average and serves as a useful benchmark. Since 2012, expectations for annual industry catastrophe losses have grown substantially. The average annual industry loss from natural catastrophes from 2017 through 2023 has increased approximately 90% when compared to the average from 2000 to 2016. Since 2017, seven of the last eight years, including the 2024 forecast have had over $100 billion of annual insured losses. It's important to note, against this heightened level of natural catastrophe losses, based on published reports, we estimate approximately 50% of the insured natural catastrophe losses were absorbed in the reinsurance market from 2017 to 2022. However, following the major market reset in 2023, approximately 90% of the losses were retained by the primary insurance companies. And this is a significant change. As I have discussed several times, the work we've done to change AIG's approach to underwriting and reinsurance has resulted in dramatic improvements in our financial performance and balance sheet. Let me give you some specific points to contextualize the magnitude of this impact. Based on AIG's legacy underwriting strategy and reinsurance choices in 2012, AIG posted an initial pre-tax loss of $2 billion from Superstorm Sandy, which represented almost 7% of the estimated $30 billion market loss for that single event. And for the full year 2012, AIG recognized approximately $2.7 billion of losses or approximately 4% of the market losses. Today, AIG is forecasted to be within our catastrophe loss expectations for the full-year or more importantly, less than 1% market share of the forecasted total industry loss for 2024 of over $125 billion. Additionally, it's worth noting that our property portfolio net premiums written are approximately the same amount in 2024 as they were in 2012. However, today, we have 80% lower CAT losses and volatility. And importantly, our year-to-date 2024 commercial property combined ratio is in the low 80s compared to a combined ratio of nearly 120% in 2012. We've completely transformed our business over the past five years, and this is the new AIG. AIG's strategy to manage volatility through our gross underwriting actions and our approach to reinsurance, including our decision to maintain the lowest net retention amongst our Global competitors, has delivered significant benefits for the company and positions us well for the future in an environment with significantly elevated insured loss activity and modeling uncertainty. Let me take a minute to comment on high level expectations for the upcoming January 1 renewal season for property. The significant reset in the property CAT reinsurance market in 2023 means that reinsurers generally have higher attachment points, provide name perils and have significant retro protection and therefore are likely to make an underwriting profit on their global catastrophe portfolios in 2024, given the current loss levels and the benefit of reinstatement premiums. With this expectation of underwriting profit, the overall reinsurance market should remain healthy. Despite the strong capital position of the market, generally speaking, I would expect the market to remain disciplined at January 1, not reducing attachment points and focusing on deploying capital to the insurance companies with higher quality portfolios like AIG. Given that this has become the industry norm, as I mentioned earlier, industry losses from increased frequency and severity will continue to be realized by primary insurers and will not be solved by the reinsurance market in 2025. Let me move on to provide an update on AIG Next, which we launched in early 2024 to further position AIG for the future. Over the past several years, we've been on a journey to simplify the company by weaving the organization together to operate seamlessly across underwriting, actuarial, claims and all of our functional areas with the necessary skills and capabilities to effectively differentiate AIG for the future. In 2025, we expect to fully realize the $500 million in savings from AIG Next. These savings will impact multiple areas across other operations and General Insurance. As part of the AIG Next program, we've established a new definition of parent expense to exclusively reflect costs related to being a global regulated public company and expect those costs to be around $350 million going forward. In the future, costs currently attributed to other operations will either be eliminated or included within the General Insurance results. You can see the impact of this effort already flowing through our income statement as other operations expenses are down nearly $30 million year-over-year or $40 million sequentially. This reduction reflects the expense benefits from AIG Next and the transfer of a portion of these costs to General Insurance GOE. The ability of the businesses to absorb these additional costs with minimal impact to the expense ratio is due in large part to our significant focus on managing expenses. AIG Next has also enabled us to invest in core capabilities and the implementation of strategic innovation initiatives, notably in underwriting, claims and our data, digital and AI strategy. Let me provide you with more detail. Many companies are discussing their data, digital and AI strategies, but what is actually being done varies greatly from company to company. At AIG, we're utilizing GenAI in large language models as digital accelerators and applications that support the innovation journey, but they are not the innovation alone. This is what makes our recently announced collaborative space in Atlanta so unique. It will be the first location in our global footprint where an end-to-end underwriting process will exist from distribution, sales to data insights, underwriting, claims payments and client servicing. This location will allow us to innovate and evolve the end-to-end process, further develop our Agentic GenAI ecosystem, drive role clarity and digitize and modernize our processes. GenAI can produce meaningful gains from reducing manual inputs and driving process efficiencies. However, our GenAI ecosystem is doing much more than that. It integrates proprietary data from multiple sources with data ingestion capabilities to give us better data quality in a fraction of the time. In our early pilots, we've seen data collection and accuracy rates within our underwriting processes improve from levels near 75% to upwards of 90%, while reducing processing time significantly. We're also using our GenAI ecosystem to increase our submission response rate while enabling our underwriters to prioritize the highest value business within our risk appetite. These improvements will help drive growth and operating leverage as we deliver GenAI to our businesses at scale. It will allow our underwriters to spend more time quoting and winning business and less time manually collecting data. Our culture at AIG is one that is deeply rooted in underwriting expertise and excellence. We help clients solve complex risk issues that require judgment and a nuanced understanding of clients' needs, maintaining the underwriter at the center of decision making will continue to be paramount and a key differentiator for us. Our AI initiatives are designed to do just that, deliver better outcomes and drive operating leverage while keeping highly experienced underwriters at the core of the process. I'm now going to turn to capital management, where we continue to execute our balanced disciplined strategy. Our objectives are to preserve strong insurance company capital levels to support organic and potentially inorganic growth, maintain conservative debt leverage ratios, return excess capital to shareholders in the form of share repurchases and dividends and maintain parent liquidity. We made substantial progress over the last several years to improve the financial strength of AIG. General Insurance is well positioned for sustained profitable growth. This has been a multi-year process that's centered on executing on our underwriting strategy, while increasing profitability and reducing volatility in our portfolio through a better mix of business along with the strategic use of reinsurance. An important result of our improved profitability is our ability to receive ordinary dividends from our operating subsidiaries, which provides consistent and increasing liquidity to the parent company. Year-to-date, we received ordinary dividends or their equivalents of approximately $3 billion from our businesses. Our financial strength is also evidenced by the lower levels of debt on our balance sheet, historically, AIG had one of the highest debt-to-total capital leverage ratios in the industry at over 30%. In 2024, we have reduced debt levels by $1 billion, bringing our debt-to-total capital leverage ratio to 17.9%, including AOCI, amongst the lowest in our peer group, an achievement that requires significant discipline. Through the first nine months of 2024, we returned over $5.5 billion to shareholders through $4.8 billion of common stock repurchases and $765 million of dividends. As we've stated previously, we will continue to execute on our $10 billion share repurchase authorization over the course of 2024 and 2025, subject to market conditions and timing of the closing of pending transactions. The current authorization will bring us within our target share count range of 550 million to 600 million shares. Importantly, our anticipated parent liquidity provides the flexibility to support additional share repurchases, which we will review in 2025. Earlier this year, we increased the cash dividend to shareholders on AIG common stock by 11%. We will continue to review our dividend annually, considering additional increases as appropriate, supported by our increased earnings power. This will be an important focus for us in 2025 and beyond. We ended the third quarter with parent liquidity of $4.2 billion. With the combination of our disciplined capital management, sustained continued underwriting performance and focus on expense management, we expect to deliver a 10% core operating ROE for the full-year 2025. We recognize that with core operating equity of $34.5 billion at the end of the third quarter, parent liquidity, our capital in the insurance company subsidiaries and future proceeds from corporate sell-downs, we have excess capital for the size of the business we are today. We will proactively manage our capital over time to support growth in our business and we will maintain a capital management strategy centered on balance and patience while remaining nimble to execute, should attractive opportunities arise. In summary, I'm very pleased with our outstanding third quarter performance, as we approach year end and plan for 2025, our path forward is clear. We will continue to solidify AIG's position as a global market leader and remain focused on value creation for our customers and shareholders. With that, I'll turn the call over to Sabra."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. This morning, I will provide details on third quarter results for General Insurance, net investment income, other operations and capital. Turning to General Insurance. Adjusted pre-tax income or APTI was $1.2 billion. Underwriting income was $437 million, including $411 million of catastrophe losses. Hurricanes Beryl and Helene were the two largest losses in the quarter. Hurricane Milton made landfall on October 9 and therefore, its financial impact will be recognized in the fourth quarter. Peter commented on the complexity of determining ultimates for natural catastrophes. And at this point, we have a very wide range of estimates for modeling firms. Claims activity to date for Milton has been relatively light compared to storms of similar strength and intensity. Our current preliminary loss estimate for Milton is between $175 million and $275 million. The third quarter 2024 accident year combined ratio as adjusted was 88.3%, about 140 basis points higher than last year, principally due to changes in premium mix and reinsurance structure and favorable actual versus expected experience in the third quarter of 2023. We also had one large closeout transaction, which Peter mentioned that increased the consolidated loss ratio by about 40 basis points. Year-to-date, the accident year combined ratio is 88.1%, down 60 basis points from 2023. The accident year loss ratio was 56.4% for the quarter, including the impact of the closeout transaction and 56.4% year-to-date, flat with the first nine months of 2023. We expect the fourth quarter accident year loss ratio as adjusted, will be in line with the first nine months of this year. Turning to prior year development. This quarter, we had $153 million of favorable prior year development, including $34 million from the ADC amortization. During the quarter, we completed detailed valuation reviews or DVRs on almost $22 billion or 47% of our total loss reserves. We reviewed most of the reserves for international in addition to North America property and financial lines. Overall, we had favorable prior year development on short tail lines in global specialty and global commercial property and a modest amount in North America financial lines. This was partially offset by $181 million of adverse development in U.K. and Europe casualty and financial lines on about $8 billion of reserves. This reflects refinements in loss estimates due to recent claims emergence and settlement activity on specific exposures in accident years 2019 and prior, consistent with our reserving philosophy of addressing bad news quickly. In addition, we increased U.S. excess casualty reserves by $72 million due to a large settlement of a legacy mass tort claim also related to accident years 2019 and prior with most of the gross loss and accident years that were ceded to the ADC. We remain very comfortable with the adequacy of our loss reserves, having completed DVRs covering more than 90% of reserves year-to-date and considering the results of our monthly actual versus expected process and other claims diagnostics. While North America Financial Lines had a slight amount of favorable development from accident years 2021 and prior, we did not adjust loss reserves for more recent accident years, which have continued to show favorable indications relative to our books loss assumptions, consistent with our reserving philosophy of giving favorable experience time to mature. Turning to pricing and loss trends. Third quarter experience in Global Commercial Lines was consistent with second quarter 2024 trends. Excluding financial lines and workers' compensation, AIG's Global Commercial pricing, which includes rate and exposure increased 6%, largely in line with loss cost trends. In North America Commercial, which is about half of our global commercial book, pricing excluding financial lines and workers' compensation was up 7% with rate up more than 5%. North America casualty rate increases were strong with Lexington averaging 16% and retail casualty averaging 13%. These are well above our casualty loss cost trends, which as we've previously disclosed are at 10% or higher depending on the line, risk and attachment point. Property rates in North America Retail and Lexington were consistent with second quarter and the underwriting margin remained strong, supported by cumulative rate increases over the past several years and our disciplined underwriting approach, particularly to CAT exposed property. Pricing in International commercial, excluding financial lines was up 4%, in line with loss trend and underwriting profitability remains very strong. International property continued to achieve overall pricing in excess of loss trend. Our global footprint and diverse portfolio enable us to remain agile, focusing on lines of business with attractive risk adjusted returns while maintaining underwriting discipline. We are confident that the overall strength of our portfolio positions us to deliver sustainable underwriting profitability. Turning to investments. Our investment portfolio is of high credit quality, well diversified by asset class and match to our liability duration. The increase in interest rates since 2021 has driven higher portfolio yields even as credit spreads have tightened. Third quarter 2024 net investment income on an APTI basis was $897 million, up 19% from the third quarter of 2023, driven by increased reinvestment rates on fixed maturities, higher short-term investment income, Corebridge dividends and other operations, slightly better private equity returns and lower investment expense. Reinvestment yields on fixed maturities and loans remains above runoff yields, providing positive yield pickup in the quarter. The average new money yield on General Insurance fixed maturities and loans was 60 basis points higher than sales and maturities adjusted for one large sale in the quarter. General Insurance investment income was $773 million, including income on fixed maturities, loans and short-term investments of $718 million and alternative investment income of $43 million. Considering the current interest rate curve, we project fourth quarter General Insurance investment income on fixed maturities, loans and short-term investments to be approximately $710 million due to the impact of floating rate security resets, partially offset by higher reinvestment yields. About 11% of our fixed maturities have monthly or quarterly floating rate resets to SOFR or other short-term market indices, which began to decline in the third quarter. Alternative income is principally from traditional private equity and now includes real estate investment funds that were previously consolidated. These assets are reported on a one quarter lagged basis and based on third quarter market performance, we expect fourth quarter private equity results may be similar to the year-to-date annualized return of 3.5%. Turning to other operations. Adjusted pre-tax loss in the quarter was $143 million, a nearly 50% year-over-year improvement driven by lower GOE and interest expense and higher net investment income, which totaled $125 million in the quarter. Considering both lower short-term rates and projected parent liquidity balances before proceeds from any strategic transactions, short-term investment income could decline in the fourth quarter by about $25 million sequentially. To wrap up the quarter, the balance sheet remains very strong. Book value per share was $71.46 at quarter end, up 4% from June 30, 2024, due to the favorable impact of lower interest rates on AOCI. Book value per share increased 10% from year end 2023. Adjusted book value per share was $73.90, up 2% from June 30 due to reduced shares outstanding and was down 6% from year end 2023 due to different accounting treatment of Corebridge between the two periods. As Peter noted, our debt leverage ratios are very strong. We recently called a $400 million par zero coupon bond, which will close November 22. Core operating ROE, which measures the annualized return on AIG shareholders' equity, excluding the value of Corebridge shares and deferred tax assets, was 9.2% in the quarter and 9.3% year-to-date, reflecting strong General Insurance profitability and capital levels. To conclude, AIG delivered another excellent quarter with significant financial and operational accomplishments. We are confident in our ability to deliver sustained underwriting results and a 10% core operating ROE in 2025, and we look forward to updating you on our progress. With that, I will turn the call back over to Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Sabra. And Michelle, we're ready for our first question."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Meyer Shields with KBW. Your line is open."
},
{
"speaker": "Meyer Shields",
"text": "Great. Thanks, and good morning. I want to start with a question about reserves, if I can. You talked about how recent accident years financial lines are emerging better than expected, but you're not booking that yet. Can you talk a little bit about what's happening in the older accident years for, I guess financial lines or casualty, we saw the one-off issues, but I'm wondering more broadly, is there the same sort of theme in the older accident years that could be getting closer to acknowledgment."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Meyer. Good morning. I think Sabra provided quite a bit of detail in her prepared remarks, but Sabra, do you have anything to perhaps give a little bit of context on financial lines?"
},
{
"speaker": "Sabra Purtill",
"text": "Yes. And let me just make a few comments. I mean, obviously, we had very strong favorable development in the DVRs this quarter. Consistent with our approach, we have allowed favorable development to -- our favorable experience to mature. And this quarter, particularly on shorter tail lines, we had about $300 million of favorable development. I would just note that this quarter did not include workers' compensation that was done in the third quarter of last year and this year it was done in the second quarter and we'll do it in the second quarter for next year as well. What I would just comment on in terms of the -- I'll talk to the excess casualty first because I know that's been in some focus. The trigger for the action in North America casualty, excess casualty was for a particularly large settlement, growth of reinsurance, which was from very old accident years that were covered by the ADC. Absent this settlement, we would not have made any adjustments in that line because the DVRs for that line are done in the second quarter normally. Turning to financial lines. Let me just note that for the quarter in total, we had post-ADC, the adverse development on financial lines was about $28 million in total. That was driven by the adverse development on U.K. financial lines, which again was an older book with -- related to some specific exposures. We did actually recognize favorable development on the U.S. and international portfolios. And I would note that was for older accident years. The favorable development that we recognized is generally in older years where the experience has matured as the policy form is claims made, but we continue to hold reserves, obviously for those older accident years based on the existing claims or other activity within that book. And we will evaluate again in the third quarter of next year is when we'll do our deep dive on the Global Financial lines portfolio."
},
{
"speaker": "Peter Zaffino",
"text": "Great. Thanks, Sabra. Meyer, is there a follow-up?"
},
{
"speaker": "Meyer Shields",
"text": "Yes, just a quick one. Peter, you talked a lot about your expectations for a property reinsurance in 2025. And I was hoping for an update on your thought of the appropriate reinsurance program, property reinsurance program for AIG, whether you're thinking of other -- of changing your net exposure?"
},
{
"speaker": "Peter Zaffino",
"text": "I covered a lot in my prepared remarks. Again, I think the industry has become experts on reinsurance pricing. And I expect that the market will be orderly, but I don't expect attachment points are going to come down for the industry. What I was trying to outline in my comments was that most of it is retained by insurance companies today. And so therefore, how we're going to price business going forward, how we're going to understand the frequency of CAT is going to be really important to do as an insurance company and not rely on reinsurance. I don't think we're going to have a material change in our structures. Of course, we have low attachment points. It's very complex and I won't spend a lot of time on it. But we certainly have the balance sheet. We certainly have the risk appetite to take a little bit more net in the event that we want to, but we like having low attachment points on severity and we like having our aggregate that protects us from frequency. And so we manage our net according to our risk appetite. It's within expectations and I would expect us to continue the same strategic philosophy."
},
{
"speaker": "Meyer Shields",
"text": "Okay, perfect. Thank you so much."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Brian Meredith with UBS. Your line is open."
},
{
"speaker": "Brian Meredith",
"text": "Yes. Thank you. Peter, I think we're hearing a little bit from other companies about some improvement in your casualty, particularly E&S, casualty lines and maybe properties' moderating. Wonder if you could give us some color on your view of market conditions and kind of organic growth opportunities here in the fourth quarter and heading into 2025."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Brian. And I'm going to make a comment. I'm going to have Don talk specifically about Lexington. But you're absolutely right. We see opportunities. Our clients, we have such strong retention and they're looking for us to solve risk issues. New business opportunities are very good. The rating environment is very good. So we're cautious, but we think there's opportunities to grow. In the retail casualty space, in multiple segments that we have as well as in E&S, I mentioned in my prepared remarks that our casualty submissions in E&S have been dramatic and we see great growth opportunities there. But Don, maybe you could expand a little bit on the Lexington."
},
{
"speaker": "Don Bailey",
"text": "Great. And if I could, Peter, just maybe a couple of high-level comments on North America overall and then dig deeper into the Lex growth because they are kind of balanced. So the double-digit growth in North America is balanced growth. We're growing the lines where we see attractive opportunities. And to the point of your question, we're growing in all three channels where we operate, retail, wholesale, alternative. Peter covered some of the North American growth drivers, positive rate of 3% across the portfolio, strong retention of 87%, 90% in the admitted lines and then overall strong new business growth of 22%. On Lexington, we do continue to invest in Lex across all lines. So you'll see Lex continue to show up with more resources, more products, enhanced capabilities going forward. On the third quarter performance, as Peter mentioned, 78% per retention, which is really strong, a 24% increase in new business. And to the point of your question, casualty showed up very well in the E&S space in terms of new business for the quarter. We also saw a 35% increase in submission. So the submission activity continues to be very robust in the E&S space for us. It's generated probably by two things. One is just increasing demand for E&S solutions in general and a flight to quality within E&S. For me personally, when I think about the nature of a wholesale broker today versus when I started in this industry, it's a completely different game. The brokers in the wholesale space operate at a different level today, incredibly well resourced, data driven, effectively deployed technology to drive efficiency, which is critical in wholesale. They're also increasingly being embraced by thousands of independent agents for market access and placement capabilities. So Lex will continue to benefit from that trend in terms of the growth of our book and new business. And Peter, just a couple of data points to close out on E&S, which might be helpful. Today, E&S represents 12% of the $115 billion U.S. P&C industry. In 2018, E&S was 7% of a $50 billion industry. So the pie has gotten considerably larger. And the last data point I'd give you just on distribution. The top five wholesale brokers control over 65% of the growing $115 billion U.S. E&S market. Lex is very well positioned in E&S and very well positioned with these top brokers."
},
{
"speaker": "Peter Zaffino",
"text": "Great. Thanks, Don. Brian, do you have a follow-up?"
},
{
"speaker": "Brian Meredith",
"text": "Yes, absolutely. A bigger picture question here, Peter. So I think you said that you're expecting a 10% core ROE for 2025. If I look at peer companies, they're kind of trending in the mid to even higher-teens. Yes, what's your kind of longer-term view of kind of ROE aspirations you think you can get to peer ROEs and what do you think it's going to take to get there? Is it more margin improvement, you need to kind of grow acquisitions? Just curious bigger picture, your thoughts there."
},
{
"speaker": "Peter Zaffino",
"text": "Yes, thanks, Brian. I mean, obviously, we've been talking a lot about the 10% and gave guidance in my prepared remarks about getting to that in 2025. There's a variety of ways in which we can get there. We talked about our combined ratio and the opportunities to improve that. We have such a great underwriting culture and believe that there's lots of opportunities, of course, is market dependent, but our leadership position in the market allows us to remain disciplined and focused on clients. There's -- the other variables, I mean, certainly it's our equity base. We talked about that a little bit and that we believe we can grow into it and that's of course going to generate more earnings opportunity, our net investment income, net premiums written both from a peer growth in terms of strong retention, more new business, but also reinsurance structures, how we look at proportional versus excess of loss and there's ways in which we could have some tailwinds there. Quality of our reserves, which we continue to emphasize, Sabra gave a lot of detail in her prepared remarks and on the answer just now. So we have a lot of confidence there. Capital management actions. We have lots of flexibility subject to when we close Nippon and do other capital market transactions, but there's lots of ways in which from a capital management standpoint allow us to improve. Our ability and track record to successfully manage volatility is very important. And then the last one is our expense management is very disciplined. We are executing on AIG Next. That showed itself in the third quarter. We're not looking to hit the ball out of the park every quarter leading in 2025. We pulled guidance forward that we will be able to get other operations, which was substantially higher to a $350 million lean parent, but also get the expenses either eliminated or into the business without increasing the combined ratio. We're well underway. You can see evidence of that in the third quarter. You'll see more evidence of that in the fourth quarter. So there's a bunch of ways in which I think that we can deliver it. And once we get north of the 10%, we'll provide guidance after that. But thank you."
},
{
"speaker": "Brian Meredith",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Rob Cox with Goldman Sachs. Your line is open."
},
{
"speaker": "Rob Cox",
"text": "Hi, thanks. So I think you guys had previously noted M&A potentially becoming a more meaningful consideration for capital deployment, but you also mentioned revisiting share repurchase guidance as you expect some further liquidity coming in next year. Can you give us an update on your appetite for M&A and how that might help you reach premium leverage objectives quicker than organically?"
},
{
"speaker": "Peter Zaffino",
"text": "Sure, Rob. Thanks. I'll start with the second part. The guidance we gave was that we would do $10 billion of share repurchases in '24 and '25. And so like you can see through the third quarter, we are well underway executing every quarter. We'll have more liquidity coming in. And so that's the priority with the proceeds coming in from Nippon and as I said, other marketed deals and liquidity that we currently have at the parent company. In terms of M&A, we have given ourselves lots of options. We have the financial strength, the financial flexibility to explore inorganic opportunities. We're always looking at ways in which we can add strategic relevance and something that's compelling to AIG. We already have sizable very high-quality businesses in major markets. I mean, you know about the U.S., U.K., Japan, Singapore, Europe. We believe we can grow those businesses organically, but there may be more opportunities to expand inorganically as well. We're going to remain very disciplined, but we are going to look at businesses and opportunities in inorganic that may complement our geographical footprint or product capabilities. There's opportunities maybe to go into spaces that we're not in today, maybe some of the SME or looking at ones that enhance scale of businesses that we already have market leadership that just will accelerate our ability to execute our risk-adjusted returns. So I want to remain very disciplined, very patient, but we have the financial flexibility and the strategic intent of growing."
},
{
"speaker": "Rob Cox",
"text": "Okay, great. Thank you. And as a follow-up, on GOE and General Insurance, it didn't necessarily appear like it decreased as much as the run rate in the first half of the year. So I was just hoping you could discuss kind of the puts and takes in the General Insurance GOE ratio and if this level of improvement is sort of in line with expectations."
},
{
"speaker": "Peter Zaffino",
"text": "Yes. I was actually quite pleased with the third quarter in GOE because we looked at other operations and the significant improvement that we made there on the GOE line year-over-year and then sequentially, but also we are absorbing a lot of the expenses as they get pushed into the business. And so while the personal insurance year-over-year, the nominal was down and then on commercial, it was slightly up. When you look at putting $50 million more of cost in, the run rate is actually quite attractive. And so we have two major initiatives that have begun to earn in the third quarter, but you'll start to see a lot more of that in the fourth quarter. And as we get to 2025, one was our voluntary early retirement plan that we had announced in the United States. And then we did a restructuring international that just really happened in September. And so you'll start to see more run rate as we get into the fourth quarter and next year. But I'm really pleased with what we did in the third quarter and believe we are showing a lot of sequential improvement in executing to this future state operating model that's going to be much leaner, much simpler and much easier to follow."
},
{
"speaker": "Rob Cox",
"text": "Awesome. Thanks for the color."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Rob."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Alex Scott with Barclays. Your line is open."
},
{
"speaker": "Alex Scott",
"text": "Hi, good morning. I got a follow-up on just sort of the leverage. And I guess thinking through both leverage down at the operating companies as well as financial leverage. But when I look at the ROE, that seems to be the place where you're under index versus some of the peers, not so much like the actual combined ratio and so forth. So I was interested in, I guess on the debt leverage side, are we at a place where leverage can actually begin to come up as you see opportunities, particularly if you do engage in M&A? And then on the core operations, I mean can you frame at all like how much dry powder you see in terms of being able to lean into some of these opportunities if they get better at casualty?"
},
{
"speaker": "Peter Zaffino",
"text": "So thanks, Alex, for the question on leverage, yes, we have a lot of -- I think it goes into what I said about potential M&A where we've given ourselves a lot of financial flexibility if we find something compelling and attractive. I think the high teens of a leverage to total capital, including AOCI, we're very comfortable with, but absolutely what you were asking is a truth, which is if we find opportunities, can we increase our leverage to be able to execute on that? The answer is yes, we can. And we're going to be very mindful. Obviously, the primary use for proceeds from the Corebridge sell-down will go to share repurchase, but we could continue to work on leverage a little bit to give us even more financial flexibility over time. In terms -- I just want to make sure I understand the second part which is having -- we have a lot of capital. I don't think it's a moment in time and to quantify what we think is excess today, I don't think is something that is overly constructive just because we intend to grow into that. We have shown real opportunities in our business to acquire new business. We had a terrific new business quarter. That momentum continues. And I think look at them, property was probably the one that was sort of slowing down in terms of pricing, but Milton and Helene have changed a lot. And I think that there'll be more flight to quality and there'll be more flexibility for AIG in terms of our ability to drive property growth and on a risk-adjusted basis throughout the world. And so like I think the balanced portfolio opportunities to grow, being able to take more net and being able to hit that 10% ROE is our near-term objective."
},
{
"speaker": "Alex Scott",
"text": "Got it. That's helpful. And then maybe a quick follow-up on personal lines in North America. Can you just give us an update on sort of where we stand with that MGA structure that was put in place and over what period of time you'd expect that combined ratio to come down below 100%?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes. Thank you for the question. I mean, North America personal is in transition as we as we've spoke about. It's hard in the primary high net worth business to affect change fast, but we're making great progress. In the quarter alone, the attritional loss ratio has improved on a meaningful basis, GOEs down. What you're seeing is the acquisition ratio increased quite a bit as we transition to the MGU. Now there's a few things happening that will reverse that in 2025. One is we're at scale, everything is fully put into the MGU and we expect the ceding commission that we paid to go down, I think in a meaningful way. And so the acquisition expense ratio will improve accordingly. I want to talk a little bit about like the strategy that we talked about, which is going into more non-admitted and how that's going to accelerate progress. And we announced it last quarter, but just a couple of statistics that will frame why it's early days, but it's working. The rate environment that we're in on an emitted basis in high net worth, we increased 10% in E&S. It went up 20% on our held book. Our partnership with Ryan Specialty, they're building infrastructure, building sales capacity. We're appointing a lot of retail agents that had no access to AIG or capital for high net worth before our signing up. We expect that to accelerate and continue to grow. In the third quarter, our new business, 50% of it was E&S. Again, we had good growth. I mean, the nominal is not going to move the needle, but we have momentum there. And I would expect in 2025, E&S alone in our strategy will grow the top line 10%. The demand is going to be significant. Our ability to be able to respond to that demand is there with plenty of capacity and an appetite that is going to allow us to improve the risk-adjusted returns and the overall combined ratio."
},
{
"speaker": "Alex Scott",
"text": "Thank you."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good morning. My first question was just on the North America commercial. If I adjust out the one-off -- the one-off in the quarter, right, the -- it came in at 61.1% on an ex-CAT accident year loss ratio basis. You guys are at 61.9% in the first half of the year. So I was just hoping to get more colors on what drove the improvement in the quarter and if that's sustainable into the fourth quarter and 2025."
},
{
"speaker": "Peter Zaffino",
"text": "This is not going to be like the 91.6% question, is it Elyse? Don, do you want to just give a little bit of insight in terms of what's happening with the loss ratio?"
},
{
"speaker": "Don Bailey",
"text": "So in the North American portfolio this year, we've seen some different movements, Peter. And in some of it, if you look at, we have some one-off movements that certainly moved the loss ratio on this one, which you talked about in your prepared remarks. We talked a little bit about the one-time closeout deal that we did that moved it up. So adverse implications."
},
{
"speaker": "Peter Zaffino",
"text": "I think, look, and in the commentary, Elyse, we sort of backed out the two -- they weren't headwinds, they were just anomalies relative to what the prior year was. And then the mix of business will continue to change. We see real opportunities to grow in -- in casualty and so those may have a different loss ratio relative to the overall portfolio. We think there's going to be growth opportunities in property based on the market dynamics that are shifting in 2025 and we see that the headwinds on pricing in financial lines are slowing down. We are not going to continue to ride that way down. And on lead, first excess and leading in D&O, I think Don highlighted this is that we've seen a slowdown in the rate reductions. And as we look into 2025, that's all going to stabilize. So I think that mix, if you take out the two things we talked about, which was significant outperformance in property and short tail last year in the third quarter along with the closeout that looks like a loss ratio that's sustainable."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. That's all. Yes, that's my follow-up, I guess, would be, Peter, just building upon that comment as you view the market conditions out over the next year, how do you expect the mix to shift between property and casualty relative to where it is today?"
},
{
"speaker": "Peter Zaffino",
"text": "It's hard to tell because I -- as I mentioned before, I think the property slowdown in terms of rate increases should start to reverse as you get to next year because there's so much net that's been retained by insurance companies that they're not getting the appropriate risk-adjusted returns for the cat loss at the low return periods and the increased frequency and severity. So I think that's going to reverse. Casualty is very strong, and Don went into length on excess and surplus lines. And then also you know we're seeing slowdown in financial lines. And so I think that the overall index, I think is going to sustain, but we'll see when we get into the market and see what happens within particular property, but I'm optimistic, that's why I put some time into it in the prepared remarks that we see a rate environment that's going to improve. I don't know, Jon, maybe like we -- just before the call ends, you can give a little bit of perspective in terms of where you see opportunities as we look to 2025 and international."
},
{
"speaker": "Jon Hancock",
"text": "Yes. Thanks, Peter. And I'll try not to repeat everything you've said, but you're right, the dynamic between the first-party lines and the third-party lines is there across international as well. And we've seen first-party lines, we're still seeing good rate and price on property classes. But for me, bit like Don with Lex, we've got these jaws in Global Specialty and Talbot. Global specialty, we are the number one writer of business around the world. We're number one in energy, we're number one in marine. We're top three in aviation. We're number four in credit. And we're growing that business really well. You referenced in your prepared remarks, Peter, 6% growth in the quarter, but actually huge growth in energy, 25% new business growth in marine in the quarter. We're seeing a different dynamic at the moment where we've grown our international specialty book by 10% in the quarter. Yes, Talbot, again, another 6% growth, but the specialty lines at Talbot, the products at Talbot is really renowned for political risks. Marine and energy growing by 18%. If you look at -- add that to the fact that submissions are 25%, up in both Talbot and specialty, our quote rates are higher, our bind rates are higher. And we've got huge opportunity there and we're the best of the market at it. So we'll still keep seeing the opportunity."
},
{
"speaker": "Peter Zaffino",
"text": "That's great, Jon. Thank you very much and I agree. Before I finally close, I do want to take a moment to thank Sabra for her many contributions at AIG. Over the past five years, Sabra has always been willing to take on a variety of important complex roles and in each instance, she's always done everything she can to add significant value. So thank you, Sabra, including the most recent role as CFO. We wish her nothing but the best in her future endeavors as we welcome Keith Walsh as our new CFO. I also like to thank all of our colleagues around the world for their continued dedication, commitment and teamwork and execution and I want to thank everybody for joining us today. Have a great day."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program. You may now disconnect. Good day."
}
] | American International Group, Inc. | 250,388 |
AIG | 2 | 2,024 | 2024-08-01 08:30:00 | Operator: Good day, and welcome to AIG's Second Quarter 2024 Financial Results Conference Call. This conference is being recorded. Now, at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events, and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Additionally, note that following the deconsolidation of Corebridge Financial on June 9, 2024, the historical results of Corebridge for all periods presented, are reflected in AIG's condensed consolidated financial statements as discontinued operations in accordance with U.S. GAAP. Finally, today's remarks related to General Insurance results, including key metrics such as net premiums written, underwriting income and underwriting margin are presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis as applicable, and adjusted for the sale of Crop Risk Services and the sale of Validus Re. We believe this presentation provides the most useful view of General Insurance results and the go forward business in light of the substantial changes to the portfolio since 2023. Please refer to Pages 29 through 31 of the earnings presentation for reconciliations of such metrics reported on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino: Good morning, and thank you for joining us today to review our second quarter 2024 financial results. We have transformed AIG and have done the foundational work for the next chapter, and I'm excited to take you through it today. Following my remarks, Sabra will provide more detail on the second quarter. Then, our North America and International leaders, Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Our prepared remarks have a lot of detail, particularly related to our deconsolidation of Corebridge. We intend to provide ample time for Q&A. I want to start with highlights of our outstanding second quarter performance. As Quentin mentioned at the beginning of the call, all figures I will reference today will be on a comparable basis, excluding the impact of Validus Re and Crop Risk Services unless otherwise noted in order to provide a clear view of our underlying performance. Adjusted after tax income was $775 million, or $1.16 per diluted share, representing a 38% increase in earnings per share year-over-year, driven by strong organic growth, a continuation of our very strong underwriting performance, ongoing expense discipline, volatility containment and a decrease in shares outstanding. General Insurance net premiums written grew 7%, led by Global Commercial, which grew over 8%. Underwriting income was $430 million. The underlying underwriting income, excluding catastrophes in prior year development improved $110 million or 17% year-over-year. The calendar year combined ratio was 92.5%, a slight increase of 10 basis points from the prior year. The accident year combined ratio, excluding catastrophes was 87.6%, a 170 basis point improvement from the prior year. The CAT loss ratio was 5.7%, or $325 million of total catastrophe related losses. Consolidated net investment income on an adjusted pre-tax income basis was $884 million, a 14% increase year-over-year. During the quarter, we returned nearly $2 billion to shareholders through $1.7 billion of stock repurchases, and $261 million of dividends. We ended the second quarter with a total debt to total capital ratio of 18%, including AOCI and we have strong parent liquidity of $5.3 billion. Overall, I'm very pleased with our ability to continue to deliver outstanding financial performance and I'm equally pleased with the progress we're making on multiple strategic initiatives. There's several things I want to cover on this call to give you a sense of where we are now, how we got here, and what the future holds. In addition to walking through our financial results, on today's call, I plan to outline the recently announced transactions for our personal travel business and private client select, provide a quick update on [Technical Difficulty] reinsurance renewals and a market update, discuss our disciplined execution of our capital management strategy and provide an update on AIG Next. I should note that our strong financial results in the quarter were complicated by the complex accounting treatment of deconsolidation. In Sabra's prepared remarks, she will explain the impact to our capital structure, including shareholders' equity, as well as details on the GAAP accounting implications to our financial statements. Before I go further, I want to take a moment to comment on the deconsolidation of Corebridge, which marked a major milestone for both AIG and Corebridge. It's important to reflect on the four year journey, the significant accomplishments along the way and the rationale behind this pivotal decision for AIG. At the height of the pandemic in 2020, we undertook a detailed analysis to explore strategic options to maximize value for AIG shareholders, including evaluating whether to separate our life and retirement business, which would eventually become Corebridge from AIG. In October of 2020, we announced our intention to separate. There were many noteworthy accomplishments along the way, and I'd like to highlight a few. In July of 2021, AIG announced that Blackstone Group would become an anchor investor in the new standalone company with its acquisition of 9.9% of Corebridge. Corebridge also entered into a long-term strategic asset management relationship with Blackstone to manage up to $92.5 billion of assets under management over the subsequent six years. At the end of March of 2022, AIG announced a strategic partnership with BlackRock, where they would manage $150 billion of certain fixed income and privately placed assets, of which $90 billion would come from the Corebridge portfolio. In mid-September of 2022, AIG floated at 12.4% of Corebridge and the largest U.S. IPO of the year, a particularly noteworthy achievement during a time of significant market volatility. During 2023, we executed three marketed deals, reducing our overall ownership to 52% by year end. In 2023, Corebridge divested with considerable strategic and transactional support from AIG, Laya Healthcare and UK Life. These sales generated over $1.2 billion of proceeds for Corebridge investors. In May of 2024, AIG announced it would sell 122 million shares at Corebridge, representing an approximately 20% stake in the company to Nippon Life Insurance Company, one of the most respected life insurance companies in the world, subject to customary regulatory approvals and closing conditions. Lastly, in mid-June of this year, AIG announced it had met the requirements for the deconsolidation of Corebridge for accounting purposes. We remain committed to fully selling down a remaining ownership stake in Corebridge over time, subject to market conditions and other considerations. It's been quite a journey and we have accomplished a tremendous amount. Now let's turn to the travel business. During the quarter, we also announced the sale of our global individual personal travel insurance and assistance business, which is another important strategic step in positioning AIG for the future to further simplify our portfolio. The transaction includes the global Travel Guard insurance business as well as its service companies and infrastructure and excludes our travel insurance businesses in Japan and our AIG joint venture arrangement in India with the Tata Group. AIG will continue to provide corporate group travel coverage through our accident and health business. The annual net premiums written for travel are approximately $750 million, most of which are reported under North America Personal Insurance. The sale is expected to close by the end of 2024, subject to customary regulatory approvals and closing conditions. And last week, we announced another significant transaction involving our high net worth business. As we've discussed in prior quarters, over the course of several years, we've been deliberately transforming our high net worth business to be better positioned for the future. We've done this through a series of strategic actions, including the most recent announcement about entering into a strategic relationship with Ryan Specialty to become our excess and surplus lines distribution partner for high and ultra-high net worth markets through our managing general underwriter, Private Client Select insurance services. We like the business and we're committed to it. We've invested over $100 million in infrastructure and digital capabilities for our high net worth business over the past several years, and we believe the business is well-positioned for the future. We're also committed to delivering solutions and growing our admitted capabilities. As we previously communicated, our plan for the portfolio has been to establish an MGU (ph) with appropriate infrastructure and core foundational capabilities, enable multiple points of distribution and eventually attract more capital resources for the MGU, all while continuing to drive exceptional value for our high net worth clients as we grow the business. AIG will provide exclusive E&S paper in all 50 states through Marbleshore Specialty Insurance Company subject to regulatory approvals. This progress reflects the momentum we've created with expanded capabilities and broader partnerships. Now turning to General Insurance results. Gross premiums written for the quarter were $9.9 billion, an increase of 7% from the prior year. Net premiums written for the quarter were $6.9 billion, a 7% increase from the prior year, with 8% growth from Global Commercial and 5% growth from Global Personal. Global Commercial had an excellent quarter with strong net premiums written growth of 8%, driven by significant new business, impressive retention and continued accident year combined ratio improvement. In North America Commercial, net premiums written grew 10%. Lexington grew 16%, led by wholesale casualty, which grew 35%; Western World, which grew 20%; and wholesale property, which grew 12%. Retail casualty grew 11%, with 21% growth in our risk management business and we had 16% growth in excess casualty, and Captive Solutions grew 30%, driven by new business. In International Commercial, net premiums written grew 6%. Global Specialty grew 8%, led by 18% growth in energy, Talbot grew 12% and retail property grew 11%. In the second quarter, Global Commercial produced record new business of nearly $1.3 billion, which is an 18% increase from the prior year quarter. North America Commercial produced new business of $753 million in the quarter, an increase of 26% year-over-year and an increase of over 60% from the prior quarter. The growth was led by Lexington, which had 31% new business growth year-over-year and 75% new business growth from the first quarter, the highest new business volume of any quarter in my tenure. Lexington also achieved a significant milestone with over $1 billion of gross premiums written this quarter, a 16% increase from the prior year quarter. This is the highest gross premiums written quarter for Lexington since we repositioned the business in 2018. In other businesses, retail casualty new business grew over 40%, led by our risk management business and excess casualty. International Commercial produced new business of $522 million for the quarter, an increase of 9% year-over-year. This growth was led by Global Specialty, which had 17% new business growth, led by energy and marine. Casualty, which had over 30% growth, and property, which had over 10% growth. In addition, Global Commercial had very strong renewal retention. International retention was 89% and North America retention was 87%. Moving on to Global Personal Insurance. Net premiums written grew 5% year-over-year. North America Personal net premiums written increased 8% from the prior year quarter, primarily driven by the high net worth business. International Personal net premiums written increased by 4% year-over-year, driven by growth in personal auto and accident health new business. Shifting to the combined ratio, as I noted earlier, the second quarter General Insurance accident year combined ratio, excluding catastrophes was 87.6%, a 170 basis point improvement year-over-year, driven by 140 basis point improvement in the expense ratio. In Global Commercial, the second quarter accident year combined ratio, excluding catastrophes was 83.5%, a 180 basis point improvement. The North America Commercial accident year combined ratio, excluding catastrophes was 84.7%, a 250 basis point improvement. And the International Commercial accident year combined ratio, excluding catastrophes was 82.1% or a 130 basis point improvement. The Global Personal accident year combined ratio, excluding catastrophes was 96.8%, a 130 basis point improvement from the prior year quarter. North America personal improved its accident year combined ratio, excluding catastrophes to 101.8%, a 530 basis point improvement. International personal improved its accident year combined ratio, excluding catastrophes by 50 basis points and 94.8%, driven by improvements in the expense ratio. Now I want to shift to provide some context around mid-year reinsurance renewals and recent conditions in the reinsurance market. As we have previously discussed, we purchased the vast majority of our treaty reinsurance at January 1. However, approximately 20% of our overall core reinsurance purchasing occurs in the second quarter. We were able to execute on all of our strategic reinsurance goals this quarter, achieving risk adjusted rate decreases and lowering or maintaining retentions across all of our major purchases. The outlook for the second half of 2024, particularly with respect to natural catastrophes is uncertain. The five leading forecasters are predicting above average hurricane activity for the 2024 season. While there was a lot of positive sentiment across the industry following modest natural CAT loss activity in the first quarter, I've learned over my career to wait until the wind and typhoon seasons are over before declaring how the year will be impacted by natural disasters. It's simply too unpredictable. When reviewing capacity in the market, it's important to analyze the available capacity from the rated market and the alternative capital market. We're all well aware of what happened with rated reinsurers in 2022. On average, they moved attachment points significantly higher to higher return periods and they restricted coverage mostly to name perils. If you were to look at the complementary alternative capital market, it has approximately $110 billion of estimated capital deployed and in many ways, more stated available capital in any individual year over the prior 10 years. However, you need to review what makes up that $110 billion to appreciate the true availability for reinsurance. The CAT bond market and ILW market make up approximately 50% of the alternative capital market, the highest nominal amount of any time in history and those products are accompanied with basis risk and in some cases, meaningful basis risk. Additionally, the collateralized market is back to 2016 levels, which is somewhere between $45 billion to $50 billion of capital. The market is deploying 90% of the collateralized limit as occurrence reinsurance or occurrence retro, leaving less than 10% of the remaining collateralized reinsurance available for aggregate covers. Why do I outline this level of detail? Because we've remain very disciplined and maintained our aggregate cover at the same attachment point and AIG utilizes approximately 50% of the globally available ILS reinsurance aggregate CAT capacity. This purchase protects us from the potential frequency of CAT and allows us to prudently manage volatility. And again, based on my experience, once insurers give up lower occurrence or aggregate attachment points, you simply do not get them back. Further, analyzing industry data from over 150 companies published by AAON between 2013 and 2024, average attachment points went up on an inflation adjusted nominal basis everywhere in the world, in some cases significantly during that period. For example, in Asia, average attachment points increased over 270%, EMEA and the UK over 250%, and in the U.S. over 280%. AIG has structured its treaties to have lower attachment points with less volatility. When examining occurrence attachment points across the world from 2022 to 2024, which is another very good measurement, AIG has maintained or reduced its attaching points, making it the lowest amongst our peer group. For the balance of 2024, we have approximately $95 million remaining on our international aggregate cover, excluding Japan and $270 million on our North America aggregate cover, excluding wind and quake. This is well within our established risk appetite and believe we remain well protected against both the frequency and severity of CAT events. Reinsurance premiums are well embedded in our original pricing and our portfolio for properties performing exceptionally well. Now I will provide a high level summary of our capital management strategy and the milestones we've accomplished. We've made enormous progress executing against our capital management goals in a disciplined manner with a focus on positioning AIG for the future and driving value for our shareholders. We have deployed over $30 billion in cash towards that capital management strategy over the last three years, which has provided AIG with maximum flexibility. To provide context on the magnitude of what we accomplished, there are some key highlights. In 2021, AIG had greater than 850 million shares outstanding and approximately $25 billion of outstanding debt and preferred stock. Using current liquidity and proceeds generated from divestitures and earnings, over the past three years, we repurchased over $13.5 billion of shares, reducing our overall share count by over 200 million shares or approximately 25%. As of June 30, 2024, we have less than 650 million shares outstanding. We expect to further reduce this in the second half of 2024 and in 2025, depending on the timing of the closing of the Nippon Life transaction, subject to regulatory approvals, as well as additional future sell downs of our remaining Corebridge shares subject to market conditions. By the end of 2025, we expect our share count to be in the 550 million to 600 million target range, consistent with the guidance that I provided last quarter, representing a total of $10 billion of share repurchases over the course of 2024 and 2025, subject to market conditions. Since 2021, we paid approximately $3 billion of shareholder dividends. We increased the dividend by more than 10% in each of the last two consecutive years. Additionally, we reduced AIG's debt outstanding from $25 billion to $9.8 billion and have achieved our target debt to capital leverage ratio range of 15% to 20% with a second quarter leverage of 18% versus 27% three years ago. Our insurance company subsidiaries are in a very strong capital position with capital ratios above target ranges, which will enable us to continue to grow profitably without having to contribute additional capital. We ended the second quarter with $5.3 billion of parent liquidity and we continue to explore compelling and strategic inorganic opportunities that are complementary to our current business. As part of positioning AIG for the future, over the past several years, we've been on a journey to simplify AIG. We're weaving the company together to operate seamlessly as one cohesive organization across underwriting, claims and all of our functional areas with the skills and capabilities to compete in the future. As a company, we've completed multiple transformation programs. These efforts, including AIG 200 have resulted in a reduction of our expense base of approximately $1.5 billion since 2018, while investing for the future. For example, over the last two years, we've invested approximately $300 million in data, digital workflow, AI and talent to accelerate our progress. If you look over the past five years, it include technology, end-to-end process workflow and foundational data investments that were part of AIG 200, our investment has been over $1 billion. Also at the beginning of 2024, we formally launched AIG Next to further accelerate the realization of additional operational efficiencies. As part of the AIG Next program, we're redefining our existing retained parent costs to reflect only expenses related to being a global regulated public company such as costs related to corporate governance, enterprise risk management and audit. Our objective is to decrease retained parent cost to $325 million to $350 million, or 1% to 1.5% of net premiums earned going forward. Expenses not defined as parent company costs will be fully embedded within the General Insurance results or they'll be redundant. All of the factors being equal, we would expect our full year 2025 calendar year combined ratio to be the same or lower than the full year 2023 metric on a comparable basis as a result of the actions were taken as part of AIG Next. We originally provided guidance that we would reach the combined ratio as the exit run rate at the end of 2025, and we now believe we can achieve it in the 2025 calendar year. Additionally, while I've not spoken in detail about AI in the past, we've been making substantial progress and I want to provide a high level overview. AIG is advancing its data and digital strategy using artificial intelligence, large language models and data ingestion applications with the objective of increasing underwriting efficiency and augmenting execution capabilities. We've spent considerable time over the past 12 months to 18 months creating a blueprint for the future that we use each of these components together, where each one is integral and connected and we redesign and refine the end-to-end underwriting workflow processes. Our primary objective is to construct an AI powered underwriting portfolio optimization capability that provides faster, more thorough, deeper analysis and improved customer service in quoting, binding and policy issuance by enabling increased underwriting productivity through the automation of manual processes. This will drive more accurate informed decisions by leveraging better data through foundational sources such as broker and agent submissions, and supplemented with validated sources of additional third-party data. We will then combine this enhanced capability with advanced modeling and amplify compute capabilities, underpinning this work is a robust governance framework designed to keep pace with the rapidly evolving global AI regulatory landscape. I will discuss two areas of focus, underwriting efficiency and underwriting management. With underwriting efficiency, we're developing a mechanism using large language models by which submissions are automatically filtered through real-time underwriting guidelines, allowing underwriters more capacity and the ability to assess many more submissions that meet our defined underwriting criteria, objectives and risk appetite. In underwriting management, we're dynamically managing the review of submission data with a disciplined application of underwriting guidelines and portfolio objectives, allowing underwriting leadership to more deeply and accurately analyze market conditions and enabling dynamic adjustments to underwriting guidelines, pricing and limit deployment. As we build our agentic ecosystem, we're using a multi-vendor technology strategy with multiple partners that is designed to evolve over-time. Our platform has been built for flexibility, configurability and adaptability to accommodate current and future technology. This includes the ability to support the expansion of generative AI capabilities for scalability globally across our platform, while keeping the underwriter at the center of decision making. This is just a glimpse into the significant work we've been doing to use generative AI and large language models as part of our overall data and digital strategy. We'll continue to advance these efforts over the remainder of this year and as we enter 2025. In summary, I'm very pleased with our performance in the second quarter and what we've accomplished not only during the quarter, but over the past several years to prepare AIG for a bright future. With that, I'll turn the call over to Sabra.
Sabra Purtill: Thank you, Peter. This morning, I will provide details on AIG's exceptional second quarter financial results with a particular focus on the accounting treatment of Corebridge deconsolidation, General Insurance quarterly financial results, written premium rate trends, other operations, book value per share and ROE. I will begin with Corebridge related activity this quarter and the accounting treatment on AIG's financials. A few key dates to outline. On May 16, we announced the agreement with Nippon Life. Because that sale could close within 12 months of the announcement and reduce our ownership to well below 50%, held for sale accounting and the classification of Corebridge as discontinued operations was triggered for accounting purposes. Next, we sold 30 million shares of Corebridge on May 30, which brought our ownership to 48%. However, it did not trigger deconsolidation accounting, because AIG still had a right to majority representation on the Corebridge Board. On June 9, we raised our right to majority representation and one of our designees resigned from the Corebridge Board triggering deconsolidation accounting as well as the required filing of pro-forma financials with the SEC four days later. Discontinued operations and deconsolidation accounting principles drove significant changes in AIG's financials this quarter. We added a few slides in the investor deck to explain these changes, which I will refer to in my remarks. Let me start with the impact of held for sale and discontinued operations on Slide 15. Held for sale accounting stipulates that when you reach an agreement to sell a business, its financials must be recast in the current period with assets and liabilities each classified in one-line for both sides of the balance sheet. However, since Corebridge was a core business that we fully intend to exit, it also met the accounting criteria for discontinued operations, which requires a recast not just for the current reporting period, but also for past periods. As a result, we reclass Corebridge's assets, liabilities and net income into assets and liabilities of discontinued operations and income or loss from discontinued operations net of income tax in the AIG financials for the second quarter and prior periods. This treatment is reflected on Slide 15. While AIG total assets of $544 billion as of March 31, 2024 is the same as originally reported and following discontinued operations presentation, there is a significant movement within the line items. For example, total investments in cash of $324 billion as originally reported, decreased $88 billion with discontinued operations presentation, with $236 billion of Corebridge investments in cash now included in assets of discontinued operations. The next change in the quarter was deconsolidation, which was triggered on June 9. On the fourth quarter 2023 earnings call, I described the accounting steps related to this principle. Today, I'll walk through those steps with the final numbers. Turning to Slide 16, the first step is the fair valuing of Corebridge's assets and liabilities as of June 9. The net fair value amount was $9.7 billion comprised principally of the $8.6 billion market value of our Corebridge shares at that date and the net fair value of intercompany assets and previously consolidated investment entities. Next, we calculate the difference between the fair value of $9.7 billion and the book value on AIG's balance sheet, which was $6.7 billion. This resulted in net gain on sale of Corebridge of $3.0 billion pre-tax or $2.5 billion after tax. After that, accounting principles require the recognition of $7.2 billion of accumulated other comprehensive loss on AIG's balance sheet, which is unrealized losses on Corebridge's investment portfolio due to higher interest rates. This recognition records a $7.2 billion loss from AOCI in AIG retained earnings by booking it through the loss and discontinued operations in the income statement and then reducing AIG's AOCI on the balance sheet. This does not change shareholders' equity shown on Slide 17. To determine the income statement accounting impact of deconsolidation, the $2.5 billion after tax gain and the $7.2 billion of accumulated other comprehensive loss are added together to calculate the net after tax loss on deconsolidation of $4.7 billion. Finally, the next step is to add Corebridge's net income for the quarter prior to June 9, which was $325 million after tax to the net loss on sale, resulting in a total net loss on discontinued operations of $4.4 billion recorded in AIG's income statement for the quarter. Now, I'll cover the impact on AIG's shareholders' equity, turning to Slide 17, which has a walk of AIG's total equity from the end of March to the end of June. AIG's shareholders' equity was $43.4 billion at March 31, including Corebridge on a consolidated basis. Excluding deconsolidation impacts, the second quarter change in AIG shareholders' equity was a decrease of $1.5 billion, reflecting income from continuing operations of $475 million, offset by $1.7 billion of share repurchases and $261 million of dividends paid. This results in a pro forma AIG shareholders' equity of $41.9 billion before deconsolidation. Then, you layer in the deconsolidation impacts by adding the $2.5 billion after tax gain on sale for total AIG shareholders' equity of $44.4 billion at June 30, 2024 or a $1.1 billion net increase in the quarter, resulting in book value per share of $68.40 at June 30, a 6% increase from March 31. Please note as well that $5.7 billion of non-controlling interest in total equity, which represents the portion of Corebridge equity owned by other shareholders is also eliminated with deconsolidation through the recognition in the net book value calculation of the gain on sale. The last deconsolidation impact is on debt and leverage on Slide 18. Total debt for AIG and Corebridge at March 31, 2024 was $19.2 billion and total equity was $49.1 billion for debt to total capital ratio of 28.1%. With deconsolidation, Corebridge's debt of $9.4 billion and non-controlling interest of $5.7 billion are eliminated on AIG's balance sheet. This results in June 30 balances of $9.8 billion for total debt and $54.3 billion for total capital for a debt to total capital ratio of 18.1%, well within our 15% to 20% target leverage range. We hope this explanation in the slides are helpful in understanding the accounting treatment of Corebridge deconsolidation this quarter. I will now cover second quarter General Insurance and other operations results. Turning to General Insurance, adjusted pre-tax income or APTI was $1.2 billion, up 7% on a comparable basis due to strong underwriting results and higher net investment income. General Insurance net investment income was $746 million, up 10% on a comparable basis due to higher reinvestment rates on fixed maturities and loans. Considering current interest rates and $1.6 billion of General Insurance dividends paid to parent at quarter-end, we expect third quarter General Insurance investment income from fixed maturities, loans and short-term investments of about $700 million. Income on alternatives and other investment assets were $33 million and $52 million respectively in the quarter, up $32 million in total from $44 million and $9 million respectively in second quarter 2023. Second quarter 2024 underwriting income on a comparable basis was $430 million versus $420 million in second quarter last year, driven by lower expenses, partially offset by higher catastrophe losses. Year-to-date, underwriting results have been strong with an accident year loss ratio ex-catastrophes of 56.3%, mainly driven by changes in business mix compared to the prior year. Based on earned premium roll-forward and barring unforeseen significant changes in loss trends, we expect the accident year loss ratio ex-catastrophes will remain strong in the second half of 2024 at approximately the same level as the first half. Turning to natural catastrophes. The industry globally had another quarter of elevated losses with approximately 100 events. For AIG, second quarter catastrophe losses totaled $325 million or 5.7 points on the loss ratio, principally from secondary apparels, including severe convective storms in the United States, floods in the Middle East and Brazil, and hail in Japan with a roughly 50-50 split between North America and International. Our largest loss in the quarter totaled $90 million from exceptionally heavy rains in the UAE. Considering the forecast for hurricane season this year and secondary peril losses year-to-date, we believe that using AIG's last year total catastrophe losses is a good proxy for full year 2024. While actual losses will depend on the size and strength of events, our underwriting standards, limits and reinsurance programs, both occurrence and aggregate will help reduce the net impact of catastrophe frequency and severity on AIG's balance sheet. Nevertheless, on a global basis, the third quarter is usually by far the highest catastrophe quarter with losses averaging 40% to 50% of the total for the year. Turning to reserves, prior year development, net of reinsurance was a favorable $79 million, reflecting the net result from DVRs completed on more than $20 billion of reserves, about 45% of the total in the quarter. Overall, the DVRs, which included U.S. casualty, resulted in net favorable development on workers' compensation and modest net unfavorable development of $30 million on excess casualty, including $66 million for accident year 2021. The 2021 excess casualty reserve charges were for a few large known losses and commercial auto loss trends, reflecting the rebound in auto frequency and severity after the pandemic lockdown in 2020 when frequency was very low. We have not seen this increase in frequency and severity trends in the more recent accident years. Within the casualty and excess casualty books overall, severity trends remain generally consistent with our assumptions. While we see some favorable trends in the 2016 to 2019 accident years, we will continue to allow time for these years to mature. Pricing, which includes rate and exposure for Global Commercial Lines this quarter increased 5%, excluding workers' compensation and financial lines, while our view on loss cost trends have remained stable. In North America Commercial, renewal rates increased 2% in the second quarter or 4% if you exclude workers' compensation and financial lines and the exposure increase was 2%. In International Commercial, overall rate was largely flat or a 1% increase excluding financial lines and the exposure increase was 3% excluding financial lines. We continue to monitor our portfolio very closely and while rate in the second quarter is below trends on certain lines of business, such as property, it is above trend in others. To give more insight on property, North America retail and wholesale property saw rate increases drop below trend in the second quarter, but that's on the back of rate increases in excess of 25% in 2023 and cumulatively in excess of 150% since 2018. International property is about 100% higher. In 2023, our property portfolio had an excellent combined ratio. In North America casualty lines, in particular excess casualty, we continue to get rate in excess of loss trend. We continue to focus on writing business that has attractive returns and while the price adequacy of our portfolio, of course, varies by line, it remains strong overall and within our expectations. Turning to other operations, deconsolidation vastly simplified the income statement. Adjusted pre-tax loss in the quarter was $158 million, a 43% improvement year-over-year, primarily attributable to $68 million in Corebridge dividends and higher short-term investment income. Finally, with deconsolidation, we expect our 2024 adjusted tax rate to be about 24% before discrete items in line with our second quarter. With the deconsolidation of Corebridge this quarter, AIG's income statement and balance sheet are simpler and we no longer have the volatility of life insurance and annuity accounting. With all the changes, we took the opportunity to evaluate our non-GAAP equity metrics, which were established more than a decade ago when AIG was a vastly more complicated conglomerate. The principal change was revising our calculation of adjusted book value to only adjust for investment related accumulated other comprehensive income, which is not within management's control and which will revert to par as bonds approach maturity. Adjusted book value per share was $72.78 per share at June 30, 2024. In addition, we added a core operating shareholders' equity metric, which reflects the equity invested in AIG's go-forward business. It is calculated by subtracting from adjusted book value, the market value of Corebridge stock and GAAP deferred tax assets related to net operating losses and tax credits. Both of these assets have significant value to our shareholders, but contribute little to AATI. We believe this metric is more useful for valuing AIG's global general insurance business and also for measuring our progress towards a 10% plus ROE target. Over time, as we reduce our ownership in Corebridge to zero and monetize the DTA through earnings, core operating book value will become the same as adjusted book value. Core operating book value per share was $53.35 per share at June 30, 2024. To wrap-up, AIG delivered another excellent quarter with significant financial and operational accomplishments in 2024. Achieving the deconsolidation of Corebridge was a major accomplishment this quarter and we had continued strong profitability and growth in our General Insurance business. With our portfolio reshaping now largely behind us, we are intently focused on achieving our 10% plus ROE target driven by strong underwriting and top line growth, expense reduction and capital management. We continue to make progress on this goal with a core operating ROE of 8.9% for the second quarter and 9.3% year-to-date. With that, I will turn the call back over to Peter.
Peter Zaffino: Great. Thank you, Sabra. Operator, we're ready for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Michael Zaremski with BMO. Your line is open.
Michael Zaremski: Hey, great. Good morning. First question on the updated kind of combined ratio trajectory guidance for '25. So loud and clear that you'll be able to kind of hit it a bit sooner. I'm curious if you can kind of, if we focus on the loss ratio, what the guidance implies on a like-for-like basis on the loss ratio? Some of the questions we get continuously around most companies seeing some slippage in their loss ratios given lower levels of reserve releases. I'm curious if that's something that's considered within your loss ratio guidance.
Peter Zaffino: Thanks, Mike, for the question. The guidance that we've given in terms of what we expect for the full year 2025 does not contemplate any improvement in loss ratio. It's all in the expense ratio. And so we're trying to guide everybody is that all the expenses that exist in other operations will transition into parent, they'll go into the business or they'll be eliminated and that we're not going to be increasing our combined ratios based on the guidance that we gave at the end of '23. So we're not anticipating any caveats on loss ratios to be able to meet that guidance.
Michael Zaremski: And I guess just I'll stick on this for my follow-up. So given pricing is below loss trend in certain lines like property and understanding that the absolute, maybe this is the answer to the absolute pricing levels are still accretive to the -- to ROE or loss ratio just does it. To the extent, the current pricing environment held, why does it kind of make sense that the loss ratio should be able to kind of stay flattish, and not trying to be negative, just trying to nitpick on the margin?
Peter Zaffino: No. It's a great question. Let's take North America, for example, because you pointed out property. This quarter in terms of the overall index and rate increases, property was the headwind in that index. In casualty, we achieved mid-single digit to high-single digit rate with like 12% and excess casualty plus 2% in exposure. In Lexington, it was 11% increase in casualty, 12% in health care. So again, above loss cost trends. Property was flat this quarter. But you have to look at what's happened with the property market over the past several years. And if you look at the -- even last year in -- like excess and surplus lines, it was a 34% increase and the retail, it was 30%, that's after four years of double-digit rate increase. So I think -- look, with the low activity in CAT maybe in the first quarter, the cumulative rate increases over time, I mean, the property combined ratio fully loaded with CAT, even with giving a little bit back in the second quarter has an outstanding combined ratio. And if I can get that combined ratio for the rest of my career, I'll take it. I mean, like I don't think there's any deterioration in terms of what our overall index will be. And again, I can't really predict, that's why I kind of went into a little bit more detail about like sort of the CAT market is that we don't know. I mean, like, so property is highly driven by what happens in CAT and underlying inflation. And so I'm not going to predict what happens sort of six quarters from now, but I think we feel really comfortable with the portfolio and its profitability.
Michael Zaremski: Thank you.
Operator: Thank you. Our next question comes from Meyer Shields with KBW. Your line is open.
Meyer Shields: Thank you. First question, just I was hoping we can get a general sense of the impact of the sale of the travel insurance on underwriting results in North America Personal
Peter Zaffino: Hey, Meyer. Good morning. In terms of -- I outlined in my prepared remarks, the premium impact, which is the $750 million on net premiums written. But on the overall combined ratio, it's going to be de minimis in terms of what we would lose within General Insurance once we pro forma it out.
Meyer Shields: Okay. Perfect. Second question, I guess, on the excess casualty, if I understood Sabra's comments correctly, you had favorable development even on that line outside of 2021, which was a weird year. And I was hoping you could sort of break that down for us. I assume that that's older years rather than recent years, but I wanted to confirm that.
Peter Zaffino: Yeah. I'll hand it over to Sabra. But as you know, and she gave a lot of detail in her prepared remarks, and we reviewed 45% of our total book in the second quarter. And in casualty, just based on what's going on in the global market, we really drilled down on every line of business and every year and went through it in tremendous detail. So Sabra, maybe you can just give a few highlights in terms of that analysis.
Sabra Purtill: Yeah. Sure. And just for everyone's benefit, I'll just start by framing a little bit what we did in the quarter for the DVRs. So this quarter, we evaluated $20.2 billion of reserves for U.S. casualty. That's comprised of 23 separate DVRs and more than 200 different lines of business, and then that aggregates to the five lines that you see on the 10-Q. So the net changes in the quarter were only about $20 million after written premiums, and that was $80 million favorable in workers' comp after the ADC, which has about $8 billion of reserves. It was $22 million unfavorable in excess casualty, which also has about $5 billion of reserves. And then in casualty, it's also about $5 billion reserve for $17 million favorable. In terms of the 2021 accident year, as we've noted on previous calls, we've increased our loss cost trends for 2020 and subsequent years. The adjustments we made in 2021 are from just a combination of known early reported claims that due to their facts and circumstances, we expect to penetrate the excess attachment level, including a rebound in the auto frequency and severity. In 2022 and 2023 accident years, we just have not had that same level of early claims experience, and therefore, we still have a high level of IBNR in the reserves. With respect to the accident year within excess casualty, I would note that while we did have the $66 million of adverse development in accident year 2021, we had $33 million of favorable development excess casualty from accident years prior to 2016, and that's where the delta comes it nets down to closer to the $22 million amount.
Meyer Shields: Yes. Got it. That's exactly what you needed. Thank you.
Peter Zaffino: Thank you, Meyer. Next question, please.
Operator: Thank you. Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open.
Elyse Greenspan: Hi, thanks. Good morning. Appreciate all the color you guys are providing on the call. My first question, Peter, you said that the full year 2025 calendar year combined ratio would be the same or lower than the full year '23. Since you said comparable basis, I'm assuming you mean ex-Crop and Validus. Can you guys just disclose what that figure is, just so we know what you're setting the '25 baseline out? What was the 2023 adjusted figure?
Peter Zaffino: 91.6%.
Elyse Greenspan: Okay. Thank you. And then my second question is, you also mentioned in your prepared remarks, you said something about exploring inorganic opportunities. Can you just expand what that means? You guys have obviously taken action of divesting of certain businesses. So what would you look at on the expansion side and what criteria would any potential inorganic deals need to meet?
Peter Zaffino: Thanks, Elyse. I included that in my prepared remarks, just based on the amount of financial flexibility, strategic flexibility that we've created for ourselves. The divestitures have been really about not having like really the businesses that we divest were terrific, and they fit very well with their new owners. But some of them needed scale, like travel and crop. And we wanted to be a little bit less in the volatility business, and therefore, Validus Re was divested. I would think as we look to the future, again, we're going to be very selective, very disciplined. But there are opportunities perhaps where we have existing businesses where we feel as though, we have competitive advantages that having more scale would be helpful. There could be complementary geographies as we look to different parts of internationally, but terrific international business. But there could be places where we want to expand further that give us not only better capabilities within that geography, but also could be very good for our multinational network. There are opportunities to invest further in businesses that we have. Think about AIG TATA in India is a fast-growing large scale business that is an industry leader. And so there's opportunities there as well. So we will use the same criteria, which is to make sure it's disciplined, it's additive, its strategic and it actually furthers and accelerates the progress we can make on an organic basis. And so we will -- again, we'll keep giving updates as there's more relevant information to share.
Elyse Greenspan: Thank you.
Peter Zaffino: Thanks, Elyse.
Operator: Thank you. Our next question comes from Rob Cox with Goldman Sachs. Your line is open.
Rob Cox: Hey, thanks. Just a question on the accident year loss ratio ex-cat guidance for approximately the same level in the back half. Can you help us think a little bit more about what goes into that and where that shakes out on a comparable basis versus the -- I think, over 100 basis points of improvement AIG has reported here in the first half?
Peter Zaffino: Sure. Thank you, Rob. It's really driven by mix of business. And if you take a look at this year compared to last year on a net premium earned basis, like the commercial and personal insurance businesses are literally identical in terms of its overall contribution to total premium. And then the commercial loss ratio largely stayed flat like a 10 basis point improvement, but largely flat. What happened was the Personal Insurance loss ratio dramatically improved, driven by North America which was well over 400 basis points. And so I think that that's really driving the first six months. And if we look at the back half, I mean, should we see the same thing? I think so. But you've seen all the tremendous new business, the momentum we have. The mix of business could be changed a little bit year-over-year when we look at the back half of the year, but that's really what's driving the improved loss ratio in the first six months. So it's really a true mix of business and also the significant improvement that North America personal is making and we expect them to continue to make.
Rob Cox: Okay. Got it. Thank you. And maybe just a follow-up. The move to kind of put some more capital to work in high net worth, is that driven by a change in sort of the view in underwriting opportunities there or have they always been good for AIG and what kind of drove that decision to double down now?
Peter Zaffino: The high net worth business had the same issues that the commercial business did, which it had too much TIV and it gets more pronounced in the high net worth business, because it's more dense. And so we needed to shed aggregate for a lot of reasons. One is that we had too much exposure in certain geographies like the world changed with COVID, the pandemic and all the macro factors that affected it. And then also the evolution of more capabilities in the non-admitted market. And so what we decided, and we've been thinking about this for a couple of years, is that build out an admitted platform that is going to be very strong, the right infrastructure and have the ability to grow, but also complement that with the non-admitted market and be able to do that where you have flexibility and form rate and limits and how you can actually respond to client needs. And there's a need. And so what we've been working on is what's the best way to do that, partnering with Ryan Specialty. It's a highly fragmented wholesale market. So nobody has a real strong expertise in high net worth unless you start to build it. And I think Ryan has been doing that. And so getting access to the 40,000 independent agents with a product that's going to be saleable, and we have done such a terrific job in terms of creating opportunity for more aggregate that we want to be able to have both options. And we believe that we'll be able to grow the non-admitted property market just based on the partnership that we just announced recently. So it's always been in the plan, but we didn't want to go out and just say, we're going to do non-admitted and have it a fragmented not strategic approach. And so we believe this is going to give us great opportunities to access the market in a different way.
Rob Cox: Thank you.
Peter Zaffino: Thank you.
Operator: Thank you. Our next question comes from Mike Ward with Citi. Your line is open.
Mike Ward: Thank you. Good morning. I just had one question and is somewhat related. But overall for the business and including commercial lines, curious how you guys are shifting the culture back to sort of a growth mindset, thinking about all the change that you've executed? And I guess, where are we in that part of the story? And should we think about AIG as potentially being able to grow faster than the market, all equal, just by turning some of the spigots back on?
Peter Zaffino: Yeah. It's a terrific question, and I happen to have Don Bailey and Jon Hancock here with me. So I'm going to ask them both to comment on North America and international. It's a great question. Don, why don't you start with, how we have actually been very focused on not only retention, but new business in North America.
Don Bailey: Yeah. Thanks, Peter. And we have definitely pivoted to that growth mindset. Its first important to mention that we were doing this off of transforming the business over the last few years. So we come into the growth with a position of strength regarding underwriting discipline, profitability. You've heard about all that. Regarding the growth, we've been very deliberate and creating more value for our distribution partners and clients than ever before, and we're applying much more rigor in pursuing like targeted risks. All of that is what you start to see showing up in the numbers now. And I can give you a little bit more color. The retention that we're delivering high levels of retention across all of our business. I would also add that we're executing on specific market opportunities, notably retail casualty and Lexington. On the retail casualty side, we are on offense. The discipline in the excess market is a positive for us right now, and we're moving on that. Regarding Lex, the growth there comes from three places. We have strong -- continued strong retention there, new products and new customers. So it's not from bigger limits. I would describe it as healthy, horizontal growth. Regarding the sustainability of it, which I think is important, I can look at some of our Lex submission data and share that with you. Year-to-date submissions at Lex are up 42%, and that's on top of 39% growth through last year through six months. We view this as a clear flight to quality in that space. I should also add that we resourced all of that in advance. So we're well positioned to take advantage of what's coming. And Peter, I'll just say this in closing on my end, we're getting all that growth while achieving outstanding loss ratios in the core business.
Peter Zaffino: Don, thank you. That was great. Jon, maybe a little bit of context on International.
Jon Hancock: Yeah. I mean, I won't repeat what you've already said, Peter or Don, but I would say, this is still a very good market for us to underwrite in. We've got a really large diverse portfolio across international, gives us access to a huge amount of opportunity, different segments, different geographies, different points in time. So we can reshape and shift the book depending on what we see in each market. Similar themes to Don, this has been very planful. This is not opportunistic growth here. We've been building to this for a long time of a very, very high quality book of business. We start with retaining 89% of what we've worked really hard to build a really strong book. New business submissions are up as well. We're retaining that our own flight to quality as well as the market. Hopefully, we've done the markets flight to quality. A couple of highlights for me. We've got a world-class global specialty business. It's grown 8% in the quarter. And that's driven by some very, very good new business in all of the global specialty segments, especially in marine and energy, where we are recognized world leaders in both. We've grown new business in marine 15% over Q1 last year, especially strong in cargo in the UK and across Europe. Peter, you already referenced the energy, 13% increase in new business year-over-year. And that's in all of our global hubs and all of our products actually. So really, really strong targeted growth with one of our best performing profitability businesses. And I'll just finish on, I'll add in Talbot as well Talbot at Lloyd's another very, very good quarter of growth of 12%. And again, that's driven by targeted growth in specialty lines of marine liability that we grew at 13%, cargo and specie at 16% and upstream energy at 19%. And both of those with the market we've got the pipeline that we've got, we expect to see continued good growth.
Peter Zaffino: That's great, Jon. Thanks to you and Don for that detail, really helpful. I want to thank everybody for joining us today. I do want to thank our colleagues around the world for their continued dedication, commitment, teamwork and all of their execution. I also want to extend my deep gratitude to Tom Bolt, who's retiring at the end of the year for his many significant contributions to AIG during a very important time and congratulate him on his story career. Tom was instrumental in establishing a global framework for AIG's underwriting standards, governance and structures and alignment with our refined risk appetite and has just been a terrific executive at AIG. So again, thank you for joining us today. Everybody, have a great day.
Operator: Thank you. This does conclude the program. You may now disconnect. Good day. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's Second Quarter 2024 Financial Results Conference Call. This conference is being recorded. Now, at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events, and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Additionally, note that following the deconsolidation of Corebridge Financial on June 9, 2024, the historical results of Corebridge for all periods presented, are reflected in AIG's condensed consolidated financial statements as discontinued operations in accordance with U.S. GAAP. Finally, today's remarks related to General Insurance results, including key metrics such as net premiums written, underwriting income and underwriting margin are presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis as applicable, and adjusted for the sale of Crop Risk Services and the sale of Validus Re. We believe this presentation provides the most useful view of General Insurance results and the go forward business in light of the substantial changes to the portfolio since 2023. Please refer to Pages 29 through 31 of the earnings presentation for reconciliations of such metrics reported on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino."
},
{
"speaker": "Peter Zaffino",
"text": "Good morning, and thank you for joining us today to review our second quarter 2024 financial results. We have transformed AIG and have done the foundational work for the next chapter, and I'm excited to take you through it today. Following my remarks, Sabra will provide more detail on the second quarter. Then, our North America and International leaders, Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Our prepared remarks have a lot of detail, particularly related to our deconsolidation of Corebridge. We intend to provide ample time for Q&A. I want to start with highlights of our outstanding second quarter performance. As Quentin mentioned at the beginning of the call, all figures I will reference today will be on a comparable basis, excluding the impact of Validus Re and Crop Risk Services unless otherwise noted in order to provide a clear view of our underlying performance. Adjusted after tax income was $775 million, or $1.16 per diluted share, representing a 38% increase in earnings per share year-over-year, driven by strong organic growth, a continuation of our very strong underwriting performance, ongoing expense discipline, volatility containment and a decrease in shares outstanding. General Insurance net premiums written grew 7%, led by Global Commercial, which grew over 8%. Underwriting income was $430 million. The underlying underwriting income, excluding catastrophes in prior year development improved $110 million or 17% year-over-year. The calendar year combined ratio was 92.5%, a slight increase of 10 basis points from the prior year. The accident year combined ratio, excluding catastrophes was 87.6%, a 170 basis point improvement from the prior year. The CAT loss ratio was 5.7%, or $325 million of total catastrophe related losses. Consolidated net investment income on an adjusted pre-tax income basis was $884 million, a 14% increase year-over-year. During the quarter, we returned nearly $2 billion to shareholders through $1.7 billion of stock repurchases, and $261 million of dividends. We ended the second quarter with a total debt to total capital ratio of 18%, including AOCI and we have strong parent liquidity of $5.3 billion. Overall, I'm very pleased with our ability to continue to deliver outstanding financial performance and I'm equally pleased with the progress we're making on multiple strategic initiatives. There's several things I want to cover on this call to give you a sense of where we are now, how we got here, and what the future holds. In addition to walking through our financial results, on today's call, I plan to outline the recently announced transactions for our personal travel business and private client select, provide a quick update on [Technical Difficulty] reinsurance renewals and a market update, discuss our disciplined execution of our capital management strategy and provide an update on AIG Next. I should note that our strong financial results in the quarter were complicated by the complex accounting treatment of deconsolidation. In Sabra's prepared remarks, she will explain the impact to our capital structure, including shareholders' equity, as well as details on the GAAP accounting implications to our financial statements. Before I go further, I want to take a moment to comment on the deconsolidation of Corebridge, which marked a major milestone for both AIG and Corebridge. It's important to reflect on the four year journey, the significant accomplishments along the way and the rationale behind this pivotal decision for AIG. At the height of the pandemic in 2020, we undertook a detailed analysis to explore strategic options to maximize value for AIG shareholders, including evaluating whether to separate our life and retirement business, which would eventually become Corebridge from AIG. In October of 2020, we announced our intention to separate. There were many noteworthy accomplishments along the way, and I'd like to highlight a few. In July of 2021, AIG announced that Blackstone Group would become an anchor investor in the new standalone company with its acquisition of 9.9% of Corebridge. Corebridge also entered into a long-term strategic asset management relationship with Blackstone to manage up to $92.5 billion of assets under management over the subsequent six years. At the end of March of 2022, AIG announced a strategic partnership with BlackRock, where they would manage $150 billion of certain fixed income and privately placed assets, of which $90 billion would come from the Corebridge portfolio. In mid-September of 2022, AIG floated at 12.4% of Corebridge and the largest U.S. IPO of the year, a particularly noteworthy achievement during a time of significant market volatility. During 2023, we executed three marketed deals, reducing our overall ownership to 52% by year end. In 2023, Corebridge divested with considerable strategic and transactional support from AIG, Laya Healthcare and UK Life. These sales generated over $1.2 billion of proceeds for Corebridge investors. In May of 2024, AIG announced it would sell 122 million shares at Corebridge, representing an approximately 20% stake in the company to Nippon Life Insurance Company, one of the most respected life insurance companies in the world, subject to customary regulatory approvals and closing conditions. Lastly, in mid-June of this year, AIG announced it had met the requirements for the deconsolidation of Corebridge for accounting purposes. We remain committed to fully selling down a remaining ownership stake in Corebridge over time, subject to market conditions and other considerations. It's been quite a journey and we have accomplished a tremendous amount. Now let's turn to the travel business. During the quarter, we also announced the sale of our global individual personal travel insurance and assistance business, which is another important strategic step in positioning AIG for the future to further simplify our portfolio. The transaction includes the global Travel Guard insurance business as well as its service companies and infrastructure and excludes our travel insurance businesses in Japan and our AIG joint venture arrangement in India with the Tata Group. AIG will continue to provide corporate group travel coverage through our accident and health business. The annual net premiums written for travel are approximately $750 million, most of which are reported under North America Personal Insurance. The sale is expected to close by the end of 2024, subject to customary regulatory approvals and closing conditions. And last week, we announced another significant transaction involving our high net worth business. As we've discussed in prior quarters, over the course of several years, we've been deliberately transforming our high net worth business to be better positioned for the future. We've done this through a series of strategic actions, including the most recent announcement about entering into a strategic relationship with Ryan Specialty to become our excess and surplus lines distribution partner for high and ultra-high net worth markets through our managing general underwriter, Private Client Select insurance services. We like the business and we're committed to it. We've invested over $100 million in infrastructure and digital capabilities for our high net worth business over the past several years, and we believe the business is well-positioned for the future. We're also committed to delivering solutions and growing our admitted capabilities. As we previously communicated, our plan for the portfolio has been to establish an MGU (ph) with appropriate infrastructure and core foundational capabilities, enable multiple points of distribution and eventually attract more capital resources for the MGU, all while continuing to drive exceptional value for our high net worth clients as we grow the business. AIG will provide exclusive E&S paper in all 50 states through Marbleshore Specialty Insurance Company subject to regulatory approvals. This progress reflects the momentum we've created with expanded capabilities and broader partnerships. Now turning to General Insurance results. Gross premiums written for the quarter were $9.9 billion, an increase of 7% from the prior year. Net premiums written for the quarter were $6.9 billion, a 7% increase from the prior year, with 8% growth from Global Commercial and 5% growth from Global Personal. Global Commercial had an excellent quarter with strong net premiums written growth of 8%, driven by significant new business, impressive retention and continued accident year combined ratio improvement. In North America Commercial, net premiums written grew 10%. Lexington grew 16%, led by wholesale casualty, which grew 35%; Western World, which grew 20%; and wholesale property, which grew 12%. Retail casualty grew 11%, with 21% growth in our risk management business and we had 16% growth in excess casualty, and Captive Solutions grew 30%, driven by new business. In International Commercial, net premiums written grew 6%. Global Specialty grew 8%, led by 18% growth in energy, Talbot grew 12% and retail property grew 11%. In the second quarter, Global Commercial produced record new business of nearly $1.3 billion, which is an 18% increase from the prior year quarter. North America Commercial produced new business of $753 million in the quarter, an increase of 26% year-over-year and an increase of over 60% from the prior quarter. The growth was led by Lexington, which had 31% new business growth year-over-year and 75% new business growth from the first quarter, the highest new business volume of any quarter in my tenure. Lexington also achieved a significant milestone with over $1 billion of gross premiums written this quarter, a 16% increase from the prior year quarter. This is the highest gross premiums written quarter for Lexington since we repositioned the business in 2018. In other businesses, retail casualty new business grew over 40%, led by our risk management business and excess casualty. International Commercial produced new business of $522 million for the quarter, an increase of 9% year-over-year. This growth was led by Global Specialty, which had 17% new business growth, led by energy and marine. Casualty, which had over 30% growth, and property, which had over 10% growth. In addition, Global Commercial had very strong renewal retention. International retention was 89% and North America retention was 87%. Moving on to Global Personal Insurance. Net premiums written grew 5% year-over-year. North America Personal net premiums written increased 8% from the prior year quarter, primarily driven by the high net worth business. International Personal net premiums written increased by 4% year-over-year, driven by growth in personal auto and accident health new business. Shifting to the combined ratio, as I noted earlier, the second quarter General Insurance accident year combined ratio, excluding catastrophes was 87.6%, a 170 basis point improvement year-over-year, driven by 140 basis point improvement in the expense ratio. In Global Commercial, the second quarter accident year combined ratio, excluding catastrophes was 83.5%, a 180 basis point improvement. The North America Commercial accident year combined ratio, excluding catastrophes was 84.7%, a 250 basis point improvement. And the International Commercial accident year combined ratio, excluding catastrophes was 82.1% or a 130 basis point improvement. The Global Personal accident year combined ratio, excluding catastrophes was 96.8%, a 130 basis point improvement from the prior year quarter. North America personal improved its accident year combined ratio, excluding catastrophes to 101.8%, a 530 basis point improvement. International personal improved its accident year combined ratio, excluding catastrophes by 50 basis points and 94.8%, driven by improvements in the expense ratio. Now I want to shift to provide some context around mid-year reinsurance renewals and recent conditions in the reinsurance market. As we have previously discussed, we purchased the vast majority of our treaty reinsurance at January 1. However, approximately 20% of our overall core reinsurance purchasing occurs in the second quarter. We were able to execute on all of our strategic reinsurance goals this quarter, achieving risk adjusted rate decreases and lowering or maintaining retentions across all of our major purchases. The outlook for the second half of 2024, particularly with respect to natural catastrophes is uncertain. The five leading forecasters are predicting above average hurricane activity for the 2024 season. While there was a lot of positive sentiment across the industry following modest natural CAT loss activity in the first quarter, I've learned over my career to wait until the wind and typhoon seasons are over before declaring how the year will be impacted by natural disasters. It's simply too unpredictable. When reviewing capacity in the market, it's important to analyze the available capacity from the rated market and the alternative capital market. We're all well aware of what happened with rated reinsurers in 2022. On average, they moved attachment points significantly higher to higher return periods and they restricted coverage mostly to name perils. If you were to look at the complementary alternative capital market, it has approximately $110 billion of estimated capital deployed and in many ways, more stated available capital in any individual year over the prior 10 years. However, you need to review what makes up that $110 billion to appreciate the true availability for reinsurance. The CAT bond market and ILW market make up approximately 50% of the alternative capital market, the highest nominal amount of any time in history and those products are accompanied with basis risk and in some cases, meaningful basis risk. Additionally, the collateralized market is back to 2016 levels, which is somewhere between $45 billion to $50 billion of capital. The market is deploying 90% of the collateralized limit as occurrence reinsurance or occurrence retro, leaving less than 10% of the remaining collateralized reinsurance available for aggregate covers. Why do I outline this level of detail? Because we've remain very disciplined and maintained our aggregate cover at the same attachment point and AIG utilizes approximately 50% of the globally available ILS reinsurance aggregate CAT capacity. This purchase protects us from the potential frequency of CAT and allows us to prudently manage volatility. And again, based on my experience, once insurers give up lower occurrence or aggregate attachment points, you simply do not get them back. Further, analyzing industry data from over 150 companies published by AAON between 2013 and 2024, average attachment points went up on an inflation adjusted nominal basis everywhere in the world, in some cases significantly during that period. For example, in Asia, average attachment points increased over 270%, EMEA and the UK over 250%, and in the U.S. over 280%. AIG has structured its treaties to have lower attachment points with less volatility. When examining occurrence attachment points across the world from 2022 to 2024, which is another very good measurement, AIG has maintained or reduced its attaching points, making it the lowest amongst our peer group. For the balance of 2024, we have approximately $95 million remaining on our international aggregate cover, excluding Japan and $270 million on our North America aggregate cover, excluding wind and quake. This is well within our established risk appetite and believe we remain well protected against both the frequency and severity of CAT events. Reinsurance premiums are well embedded in our original pricing and our portfolio for properties performing exceptionally well. Now I will provide a high level summary of our capital management strategy and the milestones we've accomplished. We've made enormous progress executing against our capital management goals in a disciplined manner with a focus on positioning AIG for the future and driving value for our shareholders. We have deployed over $30 billion in cash towards that capital management strategy over the last three years, which has provided AIG with maximum flexibility. To provide context on the magnitude of what we accomplished, there are some key highlights. In 2021, AIG had greater than 850 million shares outstanding and approximately $25 billion of outstanding debt and preferred stock. Using current liquidity and proceeds generated from divestitures and earnings, over the past three years, we repurchased over $13.5 billion of shares, reducing our overall share count by over 200 million shares or approximately 25%. As of June 30, 2024, we have less than 650 million shares outstanding. We expect to further reduce this in the second half of 2024 and in 2025, depending on the timing of the closing of the Nippon Life transaction, subject to regulatory approvals, as well as additional future sell downs of our remaining Corebridge shares subject to market conditions. By the end of 2025, we expect our share count to be in the 550 million to 600 million target range, consistent with the guidance that I provided last quarter, representing a total of $10 billion of share repurchases over the course of 2024 and 2025, subject to market conditions. Since 2021, we paid approximately $3 billion of shareholder dividends. We increased the dividend by more than 10% in each of the last two consecutive years. Additionally, we reduced AIG's debt outstanding from $25 billion to $9.8 billion and have achieved our target debt to capital leverage ratio range of 15% to 20% with a second quarter leverage of 18% versus 27% three years ago. Our insurance company subsidiaries are in a very strong capital position with capital ratios above target ranges, which will enable us to continue to grow profitably without having to contribute additional capital. We ended the second quarter with $5.3 billion of parent liquidity and we continue to explore compelling and strategic inorganic opportunities that are complementary to our current business. As part of positioning AIG for the future, over the past several years, we've been on a journey to simplify AIG. We're weaving the company together to operate seamlessly as one cohesive organization across underwriting, claims and all of our functional areas with the skills and capabilities to compete in the future. As a company, we've completed multiple transformation programs. These efforts, including AIG 200 have resulted in a reduction of our expense base of approximately $1.5 billion since 2018, while investing for the future. For example, over the last two years, we've invested approximately $300 million in data, digital workflow, AI and talent to accelerate our progress. If you look over the past five years, it include technology, end-to-end process workflow and foundational data investments that were part of AIG 200, our investment has been over $1 billion. Also at the beginning of 2024, we formally launched AIG Next to further accelerate the realization of additional operational efficiencies. As part of the AIG Next program, we're redefining our existing retained parent costs to reflect only expenses related to being a global regulated public company such as costs related to corporate governance, enterprise risk management and audit. Our objective is to decrease retained parent cost to $325 million to $350 million, or 1% to 1.5% of net premiums earned going forward. Expenses not defined as parent company costs will be fully embedded within the General Insurance results or they'll be redundant. All of the factors being equal, we would expect our full year 2025 calendar year combined ratio to be the same or lower than the full year 2023 metric on a comparable basis as a result of the actions were taken as part of AIG Next. We originally provided guidance that we would reach the combined ratio as the exit run rate at the end of 2025, and we now believe we can achieve it in the 2025 calendar year. Additionally, while I've not spoken in detail about AI in the past, we've been making substantial progress and I want to provide a high level overview. AIG is advancing its data and digital strategy using artificial intelligence, large language models and data ingestion applications with the objective of increasing underwriting efficiency and augmenting execution capabilities. We've spent considerable time over the past 12 months to 18 months creating a blueprint for the future that we use each of these components together, where each one is integral and connected and we redesign and refine the end-to-end underwriting workflow processes. Our primary objective is to construct an AI powered underwriting portfolio optimization capability that provides faster, more thorough, deeper analysis and improved customer service in quoting, binding and policy issuance by enabling increased underwriting productivity through the automation of manual processes. This will drive more accurate informed decisions by leveraging better data through foundational sources such as broker and agent submissions, and supplemented with validated sources of additional third-party data. We will then combine this enhanced capability with advanced modeling and amplify compute capabilities, underpinning this work is a robust governance framework designed to keep pace with the rapidly evolving global AI regulatory landscape. I will discuss two areas of focus, underwriting efficiency and underwriting management. With underwriting efficiency, we're developing a mechanism using large language models by which submissions are automatically filtered through real-time underwriting guidelines, allowing underwriters more capacity and the ability to assess many more submissions that meet our defined underwriting criteria, objectives and risk appetite. In underwriting management, we're dynamically managing the review of submission data with a disciplined application of underwriting guidelines and portfolio objectives, allowing underwriting leadership to more deeply and accurately analyze market conditions and enabling dynamic adjustments to underwriting guidelines, pricing and limit deployment. As we build our agentic ecosystem, we're using a multi-vendor technology strategy with multiple partners that is designed to evolve over-time. Our platform has been built for flexibility, configurability and adaptability to accommodate current and future technology. This includes the ability to support the expansion of generative AI capabilities for scalability globally across our platform, while keeping the underwriter at the center of decision making. This is just a glimpse into the significant work we've been doing to use generative AI and large language models as part of our overall data and digital strategy. We'll continue to advance these efforts over the remainder of this year and as we enter 2025. In summary, I'm very pleased with our performance in the second quarter and what we've accomplished not only during the quarter, but over the past several years to prepare AIG for a bright future. With that, I'll turn the call over to Sabra."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. This morning, I will provide details on AIG's exceptional second quarter financial results with a particular focus on the accounting treatment of Corebridge deconsolidation, General Insurance quarterly financial results, written premium rate trends, other operations, book value per share and ROE. I will begin with Corebridge related activity this quarter and the accounting treatment on AIG's financials. A few key dates to outline. On May 16, we announced the agreement with Nippon Life. Because that sale could close within 12 months of the announcement and reduce our ownership to well below 50%, held for sale accounting and the classification of Corebridge as discontinued operations was triggered for accounting purposes. Next, we sold 30 million shares of Corebridge on May 30, which brought our ownership to 48%. However, it did not trigger deconsolidation accounting, because AIG still had a right to majority representation on the Corebridge Board. On June 9, we raised our right to majority representation and one of our designees resigned from the Corebridge Board triggering deconsolidation accounting as well as the required filing of pro-forma financials with the SEC four days later. Discontinued operations and deconsolidation accounting principles drove significant changes in AIG's financials this quarter. We added a few slides in the investor deck to explain these changes, which I will refer to in my remarks. Let me start with the impact of held for sale and discontinued operations on Slide 15. Held for sale accounting stipulates that when you reach an agreement to sell a business, its financials must be recast in the current period with assets and liabilities each classified in one-line for both sides of the balance sheet. However, since Corebridge was a core business that we fully intend to exit, it also met the accounting criteria for discontinued operations, which requires a recast not just for the current reporting period, but also for past periods. As a result, we reclass Corebridge's assets, liabilities and net income into assets and liabilities of discontinued operations and income or loss from discontinued operations net of income tax in the AIG financials for the second quarter and prior periods. This treatment is reflected on Slide 15. While AIG total assets of $544 billion as of March 31, 2024 is the same as originally reported and following discontinued operations presentation, there is a significant movement within the line items. For example, total investments in cash of $324 billion as originally reported, decreased $88 billion with discontinued operations presentation, with $236 billion of Corebridge investments in cash now included in assets of discontinued operations. The next change in the quarter was deconsolidation, which was triggered on June 9. On the fourth quarter 2023 earnings call, I described the accounting steps related to this principle. Today, I'll walk through those steps with the final numbers. Turning to Slide 16, the first step is the fair valuing of Corebridge's assets and liabilities as of June 9. The net fair value amount was $9.7 billion comprised principally of the $8.6 billion market value of our Corebridge shares at that date and the net fair value of intercompany assets and previously consolidated investment entities. Next, we calculate the difference between the fair value of $9.7 billion and the book value on AIG's balance sheet, which was $6.7 billion. This resulted in net gain on sale of Corebridge of $3.0 billion pre-tax or $2.5 billion after tax. After that, accounting principles require the recognition of $7.2 billion of accumulated other comprehensive loss on AIG's balance sheet, which is unrealized losses on Corebridge's investment portfolio due to higher interest rates. This recognition records a $7.2 billion loss from AOCI in AIG retained earnings by booking it through the loss and discontinued operations in the income statement and then reducing AIG's AOCI on the balance sheet. This does not change shareholders' equity shown on Slide 17. To determine the income statement accounting impact of deconsolidation, the $2.5 billion after tax gain and the $7.2 billion of accumulated other comprehensive loss are added together to calculate the net after tax loss on deconsolidation of $4.7 billion. Finally, the next step is to add Corebridge's net income for the quarter prior to June 9, which was $325 million after tax to the net loss on sale, resulting in a total net loss on discontinued operations of $4.4 billion recorded in AIG's income statement for the quarter. Now, I'll cover the impact on AIG's shareholders' equity, turning to Slide 17, which has a walk of AIG's total equity from the end of March to the end of June. AIG's shareholders' equity was $43.4 billion at March 31, including Corebridge on a consolidated basis. Excluding deconsolidation impacts, the second quarter change in AIG shareholders' equity was a decrease of $1.5 billion, reflecting income from continuing operations of $475 million, offset by $1.7 billion of share repurchases and $261 million of dividends paid. This results in a pro forma AIG shareholders' equity of $41.9 billion before deconsolidation. Then, you layer in the deconsolidation impacts by adding the $2.5 billion after tax gain on sale for total AIG shareholders' equity of $44.4 billion at June 30, 2024 or a $1.1 billion net increase in the quarter, resulting in book value per share of $68.40 at June 30, a 6% increase from March 31. Please note as well that $5.7 billion of non-controlling interest in total equity, which represents the portion of Corebridge equity owned by other shareholders is also eliminated with deconsolidation through the recognition in the net book value calculation of the gain on sale. The last deconsolidation impact is on debt and leverage on Slide 18. Total debt for AIG and Corebridge at March 31, 2024 was $19.2 billion and total equity was $49.1 billion for debt to total capital ratio of 28.1%. With deconsolidation, Corebridge's debt of $9.4 billion and non-controlling interest of $5.7 billion are eliminated on AIG's balance sheet. This results in June 30 balances of $9.8 billion for total debt and $54.3 billion for total capital for a debt to total capital ratio of 18.1%, well within our 15% to 20% target leverage range. We hope this explanation in the slides are helpful in understanding the accounting treatment of Corebridge deconsolidation this quarter. I will now cover second quarter General Insurance and other operations results. Turning to General Insurance, adjusted pre-tax income or APTI was $1.2 billion, up 7% on a comparable basis due to strong underwriting results and higher net investment income. General Insurance net investment income was $746 million, up 10% on a comparable basis due to higher reinvestment rates on fixed maturities and loans. Considering current interest rates and $1.6 billion of General Insurance dividends paid to parent at quarter-end, we expect third quarter General Insurance investment income from fixed maturities, loans and short-term investments of about $700 million. Income on alternatives and other investment assets were $33 million and $52 million respectively in the quarter, up $32 million in total from $44 million and $9 million respectively in second quarter 2023. Second quarter 2024 underwriting income on a comparable basis was $430 million versus $420 million in second quarter last year, driven by lower expenses, partially offset by higher catastrophe losses. Year-to-date, underwriting results have been strong with an accident year loss ratio ex-catastrophes of 56.3%, mainly driven by changes in business mix compared to the prior year. Based on earned premium roll-forward and barring unforeseen significant changes in loss trends, we expect the accident year loss ratio ex-catastrophes will remain strong in the second half of 2024 at approximately the same level as the first half. Turning to natural catastrophes. The industry globally had another quarter of elevated losses with approximately 100 events. For AIG, second quarter catastrophe losses totaled $325 million or 5.7 points on the loss ratio, principally from secondary apparels, including severe convective storms in the United States, floods in the Middle East and Brazil, and hail in Japan with a roughly 50-50 split between North America and International. Our largest loss in the quarter totaled $90 million from exceptionally heavy rains in the UAE. Considering the forecast for hurricane season this year and secondary peril losses year-to-date, we believe that using AIG's last year total catastrophe losses is a good proxy for full year 2024. While actual losses will depend on the size and strength of events, our underwriting standards, limits and reinsurance programs, both occurrence and aggregate will help reduce the net impact of catastrophe frequency and severity on AIG's balance sheet. Nevertheless, on a global basis, the third quarter is usually by far the highest catastrophe quarter with losses averaging 40% to 50% of the total for the year. Turning to reserves, prior year development, net of reinsurance was a favorable $79 million, reflecting the net result from DVRs completed on more than $20 billion of reserves, about 45% of the total in the quarter. Overall, the DVRs, which included U.S. casualty, resulted in net favorable development on workers' compensation and modest net unfavorable development of $30 million on excess casualty, including $66 million for accident year 2021. The 2021 excess casualty reserve charges were for a few large known losses and commercial auto loss trends, reflecting the rebound in auto frequency and severity after the pandemic lockdown in 2020 when frequency was very low. We have not seen this increase in frequency and severity trends in the more recent accident years. Within the casualty and excess casualty books overall, severity trends remain generally consistent with our assumptions. While we see some favorable trends in the 2016 to 2019 accident years, we will continue to allow time for these years to mature. Pricing, which includes rate and exposure for Global Commercial Lines this quarter increased 5%, excluding workers' compensation and financial lines, while our view on loss cost trends have remained stable. In North America Commercial, renewal rates increased 2% in the second quarter or 4% if you exclude workers' compensation and financial lines and the exposure increase was 2%. In International Commercial, overall rate was largely flat or a 1% increase excluding financial lines and the exposure increase was 3% excluding financial lines. We continue to monitor our portfolio very closely and while rate in the second quarter is below trends on certain lines of business, such as property, it is above trend in others. To give more insight on property, North America retail and wholesale property saw rate increases drop below trend in the second quarter, but that's on the back of rate increases in excess of 25% in 2023 and cumulatively in excess of 150% since 2018. International property is about 100% higher. In 2023, our property portfolio had an excellent combined ratio. In North America casualty lines, in particular excess casualty, we continue to get rate in excess of loss trend. We continue to focus on writing business that has attractive returns and while the price adequacy of our portfolio, of course, varies by line, it remains strong overall and within our expectations. Turning to other operations, deconsolidation vastly simplified the income statement. Adjusted pre-tax loss in the quarter was $158 million, a 43% improvement year-over-year, primarily attributable to $68 million in Corebridge dividends and higher short-term investment income. Finally, with deconsolidation, we expect our 2024 adjusted tax rate to be about 24% before discrete items in line with our second quarter. With the deconsolidation of Corebridge this quarter, AIG's income statement and balance sheet are simpler and we no longer have the volatility of life insurance and annuity accounting. With all the changes, we took the opportunity to evaluate our non-GAAP equity metrics, which were established more than a decade ago when AIG was a vastly more complicated conglomerate. The principal change was revising our calculation of adjusted book value to only adjust for investment related accumulated other comprehensive income, which is not within management's control and which will revert to par as bonds approach maturity. Adjusted book value per share was $72.78 per share at June 30, 2024. In addition, we added a core operating shareholders' equity metric, which reflects the equity invested in AIG's go-forward business. It is calculated by subtracting from adjusted book value, the market value of Corebridge stock and GAAP deferred tax assets related to net operating losses and tax credits. Both of these assets have significant value to our shareholders, but contribute little to AATI. We believe this metric is more useful for valuing AIG's global general insurance business and also for measuring our progress towards a 10% plus ROE target. Over time, as we reduce our ownership in Corebridge to zero and monetize the DTA through earnings, core operating book value will become the same as adjusted book value. Core operating book value per share was $53.35 per share at June 30, 2024. To wrap-up, AIG delivered another excellent quarter with significant financial and operational accomplishments in 2024. Achieving the deconsolidation of Corebridge was a major accomplishment this quarter and we had continued strong profitability and growth in our General Insurance business. With our portfolio reshaping now largely behind us, we are intently focused on achieving our 10% plus ROE target driven by strong underwriting and top line growth, expense reduction and capital management. We continue to make progress on this goal with a core operating ROE of 8.9% for the second quarter and 9.3% year-to-date. With that, I will turn the call back over to Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Great. Thank you, Sabra. Operator, we're ready for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Michael Zaremski with BMO. Your line is open."
},
{
"speaker": "Michael Zaremski",
"text": "Hey, great. Good morning. First question on the updated kind of combined ratio trajectory guidance for '25. So loud and clear that you'll be able to kind of hit it a bit sooner. I'm curious if you can kind of, if we focus on the loss ratio, what the guidance implies on a like-for-like basis on the loss ratio? Some of the questions we get continuously around most companies seeing some slippage in their loss ratios given lower levels of reserve releases. I'm curious if that's something that's considered within your loss ratio guidance."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Mike, for the question. The guidance that we've given in terms of what we expect for the full year 2025 does not contemplate any improvement in loss ratio. It's all in the expense ratio. And so we're trying to guide everybody is that all the expenses that exist in other operations will transition into parent, they'll go into the business or they'll be eliminated and that we're not going to be increasing our combined ratios based on the guidance that we gave at the end of '23. So we're not anticipating any caveats on loss ratios to be able to meet that guidance."
},
{
"speaker": "Michael Zaremski",
"text": "And I guess just I'll stick on this for my follow-up. So given pricing is below loss trend in certain lines like property and understanding that the absolute, maybe this is the answer to the absolute pricing levels are still accretive to the -- to ROE or loss ratio just does it. To the extent, the current pricing environment held, why does it kind of make sense that the loss ratio should be able to kind of stay flattish, and not trying to be negative, just trying to nitpick on the margin?"
},
{
"speaker": "Peter Zaffino",
"text": "No. It's a great question. Let's take North America, for example, because you pointed out property. This quarter in terms of the overall index and rate increases, property was the headwind in that index. In casualty, we achieved mid-single digit to high-single digit rate with like 12% and excess casualty plus 2% in exposure. In Lexington, it was 11% increase in casualty, 12% in health care. So again, above loss cost trends. Property was flat this quarter. But you have to look at what's happened with the property market over the past several years. And if you look at the -- even last year in -- like excess and surplus lines, it was a 34% increase and the retail, it was 30%, that's after four years of double-digit rate increase. So I think -- look, with the low activity in CAT maybe in the first quarter, the cumulative rate increases over time, I mean, the property combined ratio fully loaded with CAT, even with giving a little bit back in the second quarter has an outstanding combined ratio. And if I can get that combined ratio for the rest of my career, I'll take it. I mean, like I don't think there's any deterioration in terms of what our overall index will be. And again, I can't really predict, that's why I kind of went into a little bit more detail about like sort of the CAT market is that we don't know. I mean, like, so property is highly driven by what happens in CAT and underlying inflation. And so I'm not going to predict what happens sort of six quarters from now, but I think we feel really comfortable with the portfolio and its profitability."
},
{
"speaker": "Michael Zaremski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Meyer Shields with KBW. Your line is open."
},
{
"speaker": "Meyer Shields",
"text": "Thank you. First question, just I was hoping we can get a general sense of the impact of the sale of the travel insurance on underwriting results in North America Personal"
},
{
"speaker": "Peter Zaffino",
"text": "Hey, Meyer. Good morning. In terms of -- I outlined in my prepared remarks, the premium impact, which is the $750 million on net premiums written. But on the overall combined ratio, it's going to be de minimis in terms of what we would lose within General Insurance once we pro forma it out."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Perfect. Second question, I guess, on the excess casualty, if I understood Sabra's comments correctly, you had favorable development even on that line outside of 2021, which was a weird year. And I was hoping you could sort of break that down for us. I assume that that's older years rather than recent years, but I wanted to confirm that."
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. I'll hand it over to Sabra. But as you know, and she gave a lot of detail in her prepared remarks, and we reviewed 45% of our total book in the second quarter. And in casualty, just based on what's going on in the global market, we really drilled down on every line of business and every year and went through it in tremendous detail. So Sabra, maybe you can just give a few highlights in terms of that analysis."
},
{
"speaker": "Sabra Purtill",
"text": "Yeah. Sure. And just for everyone's benefit, I'll just start by framing a little bit what we did in the quarter for the DVRs. So this quarter, we evaluated $20.2 billion of reserves for U.S. casualty. That's comprised of 23 separate DVRs and more than 200 different lines of business, and then that aggregates to the five lines that you see on the 10-Q. So the net changes in the quarter were only about $20 million after written premiums, and that was $80 million favorable in workers' comp after the ADC, which has about $8 billion of reserves. It was $22 million unfavorable in excess casualty, which also has about $5 billion of reserves. And then in casualty, it's also about $5 billion reserve for $17 million favorable. In terms of the 2021 accident year, as we've noted on previous calls, we've increased our loss cost trends for 2020 and subsequent years. The adjustments we made in 2021 are from just a combination of known early reported claims that due to their facts and circumstances, we expect to penetrate the excess attachment level, including a rebound in the auto frequency and severity. In 2022 and 2023 accident years, we just have not had that same level of early claims experience, and therefore, we still have a high level of IBNR in the reserves. With respect to the accident year within excess casualty, I would note that while we did have the $66 million of adverse development in accident year 2021, we had $33 million of favorable development excess casualty from accident years prior to 2016, and that's where the delta comes it nets down to closer to the $22 million amount."
},
{
"speaker": "Meyer Shields",
"text": "Yes. Got it. That's exactly what you needed. Thank you."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Meyer. Next question, please."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good morning. Appreciate all the color you guys are providing on the call. My first question, Peter, you said that the full year 2025 calendar year combined ratio would be the same or lower than the full year '23. Since you said comparable basis, I'm assuming you mean ex-Crop and Validus. Can you guys just disclose what that figure is, just so we know what you're setting the '25 baseline out? What was the 2023 adjusted figure?"
},
{
"speaker": "Peter Zaffino",
"text": "91.6%."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. Thank you. And then my second question is, you also mentioned in your prepared remarks, you said something about exploring inorganic opportunities. Can you just expand what that means? You guys have obviously taken action of divesting of certain businesses. So what would you look at on the expansion side and what criteria would any potential inorganic deals need to meet?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Elyse. I included that in my prepared remarks, just based on the amount of financial flexibility, strategic flexibility that we've created for ourselves. The divestitures have been really about not having like really the businesses that we divest were terrific, and they fit very well with their new owners. But some of them needed scale, like travel and crop. And we wanted to be a little bit less in the volatility business, and therefore, Validus Re was divested. I would think as we look to the future, again, we're going to be very selective, very disciplined. But there are opportunities perhaps where we have existing businesses where we feel as though, we have competitive advantages that having more scale would be helpful. There could be complementary geographies as we look to different parts of internationally, but terrific international business. But there could be places where we want to expand further that give us not only better capabilities within that geography, but also could be very good for our multinational network. There are opportunities to invest further in businesses that we have. Think about AIG TATA in India is a fast-growing large scale business that is an industry leader. And so there's opportunities there as well. So we will use the same criteria, which is to make sure it's disciplined, it's additive, its strategic and it actually furthers and accelerates the progress we can make on an organic basis. And so we will -- again, we'll keep giving updates as there's more relevant information to share."
},
{
"speaker": "Elyse Greenspan",
"text": "Thank you."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks, Elyse."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Rob Cox with Goldman Sachs. Your line is open."
},
{
"speaker": "Rob Cox",
"text": "Hey, thanks. Just a question on the accident year loss ratio ex-cat guidance for approximately the same level in the back half. Can you help us think a little bit more about what goes into that and where that shakes out on a comparable basis versus the -- I think, over 100 basis points of improvement AIG has reported here in the first half?"
},
{
"speaker": "Peter Zaffino",
"text": "Sure. Thank you, Rob. It's really driven by mix of business. And if you take a look at this year compared to last year on a net premium earned basis, like the commercial and personal insurance businesses are literally identical in terms of its overall contribution to total premium. And then the commercial loss ratio largely stayed flat like a 10 basis point improvement, but largely flat. What happened was the Personal Insurance loss ratio dramatically improved, driven by North America which was well over 400 basis points. And so I think that that's really driving the first six months. And if we look at the back half, I mean, should we see the same thing? I think so. But you've seen all the tremendous new business, the momentum we have. The mix of business could be changed a little bit year-over-year when we look at the back half of the year, but that's really what's driving the improved loss ratio in the first six months. So it's really a true mix of business and also the significant improvement that North America personal is making and we expect them to continue to make."
},
{
"speaker": "Rob Cox",
"text": "Okay. Got it. Thank you. And maybe just a follow-up. The move to kind of put some more capital to work in high net worth, is that driven by a change in sort of the view in underwriting opportunities there or have they always been good for AIG and what kind of drove that decision to double down now?"
},
{
"speaker": "Peter Zaffino",
"text": "The high net worth business had the same issues that the commercial business did, which it had too much TIV and it gets more pronounced in the high net worth business, because it's more dense. And so we needed to shed aggregate for a lot of reasons. One is that we had too much exposure in certain geographies like the world changed with COVID, the pandemic and all the macro factors that affected it. And then also the evolution of more capabilities in the non-admitted market. And so what we decided, and we've been thinking about this for a couple of years, is that build out an admitted platform that is going to be very strong, the right infrastructure and have the ability to grow, but also complement that with the non-admitted market and be able to do that where you have flexibility and form rate and limits and how you can actually respond to client needs. And there's a need. And so what we've been working on is what's the best way to do that, partnering with Ryan Specialty. It's a highly fragmented wholesale market. So nobody has a real strong expertise in high net worth unless you start to build it. And I think Ryan has been doing that. And so getting access to the 40,000 independent agents with a product that's going to be saleable, and we have done such a terrific job in terms of creating opportunity for more aggregate that we want to be able to have both options. And we believe that we'll be able to grow the non-admitted property market just based on the partnership that we just announced recently. So it's always been in the plan, but we didn't want to go out and just say, we're going to do non-admitted and have it a fragmented not strategic approach. And so we believe this is going to give us great opportunities to access the market in a different way."
},
{
"speaker": "Rob Cox",
"text": "Thank you."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Mike Ward with Citi. Your line is open."
},
{
"speaker": "Mike Ward",
"text": "Thank you. Good morning. I just had one question and is somewhat related. But overall for the business and including commercial lines, curious how you guys are shifting the culture back to sort of a growth mindset, thinking about all the change that you've executed? And I guess, where are we in that part of the story? And should we think about AIG as potentially being able to grow faster than the market, all equal, just by turning some of the spigots back on?"
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. It's a terrific question, and I happen to have Don Bailey and Jon Hancock here with me. So I'm going to ask them both to comment on North America and international. It's a great question. Don, why don't you start with, how we have actually been very focused on not only retention, but new business in North America."
},
{
"speaker": "Don Bailey",
"text": "Yeah. Thanks, Peter. And we have definitely pivoted to that growth mindset. Its first important to mention that we were doing this off of transforming the business over the last few years. So we come into the growth with a position of strength regarding underwriting discipline, profitability. You've heard about all that. Regarding the growth, we've been very deliberate and creating more value for our distribution partners and clients than ever before, and we're applying much more rigor in pursuing like targeted risks. All of that is what you start to see showing up in the numbers now. And I can give you a little bit more color. The retention that we're delivering high levels of retention across all of our business. I would also add that we're executing on specific market opportunities, notably retail casualty and Lexington. On the retail casualty side, we are on offense. The discipline in the excess market is a positive for us right now, and we're moving on that. Regarding Lex, the growth there comes from three places. We have strong -- continued strong retention there, new products and new customers. So it's not from bigger limits. I would describe it as healthy, horizontal growth. Regarding the sustainability of it, which I think is important, I can look at some of our Lex submission data and share that with you. Year-to-date submissions at Lex are up 42%, and that's on top of 39% growth through last year through six months. We view this as a clear flight to quality in that space. I should also add that we resourced all of that in advance. So we're well positioned to take advantage of what's coming. And Peter, I'll just say this in closing on my end, we're getting all that growth while achieving outstanding loss ratios in the core business."
},
{
"speaker": "Peter Zaffino",
"text": "Don, thank you. That was great. Jon, maybe a little bit of context on International."
},
{
"speaker": "Jon Hancock",
"text": "Yeah. I mean, I won't repeat what you've already said, Peter or Don, but I would say, this is still a very good market for us to underwrite in. We've got a really large diverse portfolio across international, gives us access to a huge amount of opportunity, different segments, different geographies, different points in time. So we can reshape and shift the book depending on what we see in each market. Similar themes to Don, this has been very planful. This is not opportunistic growth here. We've been building to this for a long time of a very, very high quality book of business. We start with retaining 89% of what we've worked really hard to build a really strong book. New business submissions are up as well. We're retaining that our own flight to quality as well as the market. Hopefully, we've done the markets flight to quality. A couple of highlights for me. We've got a world-class global specialty business. It's grown 8% in the quarter. And that's driven by some very, very good new business in all of the global specialty segments, especially in marine and energy, where we are recognized world leaders in both. We've grown new business in marine 15% over Q1 last year, especially strong in cargo in the UK and across Europe. Peter, you already referenced the energy, 13% increase in new business year-over-year. And that's in all of our global hubs and all of our products actually. So really, really strong targeted growth with one of our best performing profitability businesses. And I'll just finish on, I'll add in Talbot as well Talbot at Lloyd's another very, very good quarter of growth of 12%. And again, that's driven by targeted growth in specialty lines of marine liability that we grew at 13%, cargo and specie at 16% and upstream energy at 19%. And both of those with the market we've got the pipeline that we've got, we expect to see continued good growth."
},
{
"speaker": "Peter Zaffino",
"text": "That's great, Jon. Thanks to you and Don for that detail, really helpful. I want to thank everybody for joining us today. I do want to thank our colleagues around the world for their continued dedication, commitment, teamwork and all of their execution. I also want to extend my deep gratitude to Tom Bolt, who's retiring at the end of the year for his many significant contributions to AIG during a very important time and congratulate him on his story career. Tom was instrumental in establishing a global framework for AIG's underwriting standards, governance and structures and alignment with our refined risk appetite and has just been a terrific executive at AIG. So again, thank you for joining us today. Everybody, have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude the program. You may now disconnect. Good day."
}
] | American International Group, Inc. | 250,388 |
AIG | 1 | 2,024 | 2024-05-02 08:30:00 | Operator: Good day, and welcome to AIG's First Quarter 2024 Financial Results Conference Call. This conference is being recorded.
Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Good morning, and thanks very much. Today's remarks may include forward-looking statements which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change.
Today's remarks may also refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our financial supplement and earnings presentation, all of which are available on our website at aig.com.
Additionally, note that today's remarks will include results of AIG Life and Retirement segment and other operations on the same basis as prior quarters, which is how we expect to continue to report until the deconsolidation of Corebridge Financial. AIG segments and U.S. GAAP financial results, as well as AIG's key financial metrics with respect thereto, differ from those reported by Corebridge Financial. Corebridge Financial will host its earnings call on Friday, May 3.
Finally, today's remarks as they relate to net premiums written, adjusted pretax income, underwriting income and margin in General Insurance are presented both on a reported basis as well as a comparable basis, which reflects year-over-year comparison on a constant dollar basis as applicable, adjusted for the sale of Crop Risk Services and the sale of Validus Re. Please refer to the footnote on Page 26 of the first quarter financial supplement for prior period results for the Crop business and Validus Re.
With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino;Chairman and CEO: Good morning, and thank you for joining us today to review our first quarter 2024 financial results. Following my remarks, Sabra will provide more detail on the quarter and then we'll take questions. Kevin Hogan will join us for the Q&A portion of the call.
Here are some highlights from the quarter. Adjusted after-tax income was $1.2 billion or $1.77 per diluted common share, representing a 9% increase in earnings per share year-over-year. Consolidated net investment income on an adjusted pretax income basis was $3.5 billion, a 13% increase year-over-year. General Insurance underwriting income was $596 million, a 19% increase year-over-year, reflecting improved accident year results, including lower catastrophes and increased 67% year-over-year on a comparable basis, if you exclude divested businesses from the prior year quarter.
The accident year combined ratio, excluding catastrophes, was 88.4%, a 30 basis point improvement from the prior year quarter and was the tenth consecutive quarter of a sub-90 combined ratio. The quarter also reflected the significant improvement we have made in controlling volatility in our property portfolio as total catastrophe-related losses in the quarter were $107 million or 1.9%, representing a 230 basis point improvement year-over-year.
Turning to Life and Retirement. The business reported very good results with premiums and deposits of $10.7 billion in the first quarter, their highest quarterly result achieved in the last decade, and strong APTI growth of 12% over the prior year quarter.
Last September, Corebridge entered into a definitive agreement to sell the U.K. Life Insurance business to Aviva plc, which calls on April 8. Net proceeds were approximately $550 million and will be used for Corebridge share repurchases.
During the quarter, we returned over $2.4 billion to shareholders through $1.7 billion of common stock repurchases, $250 million of dividends and the redemption of all our outstanding Series A preferred stock for $500 million. We repaid $459 million of debt upon maturity, lowering our total debt to $9.8 billion. In addition, we repurchased approximately $613 million of common stock in April.
Based on our strong performance, the AIG Board of Directors approved an 11% increase in AIG's quarterly common stock dividend to $0.40 per share. The AIG Board of Directors also increased the share repurchase authorization to $10 billion, effective May 1. Lastly, we ended the first quarter with strong parent liquidity of $5.1 billion. Overall, I'm very pleased with our first quarter results and the continued strong execution of our strategy to deliver sustained underwriting excellence, profitability and disciplined capital management.
During my remarks this morning, I will discuss 4 important topics: first, I will provide some financial highlights in the quarter focused on the General Insurance business, including some insight into our net premiums written; second, I will talk briefly about the results in Life and Retirement; third, I will provide an update on our capital management strategy, specifically our plans for 2024 and 2025; and finally, I will discuss our path to a 10%-plus ROCE and provide more detail on AIG Next and our future state operating structure that will create value through a leaner and more unified company.
Let me take a moment to update you on our sell-down of Corebridge. Our Corebridge holdings currently stand at 324 million common shares outstanding, which represents a 53% ownership stake. We continue to explore all alternatives to reduce our ownership stake in Corebridge. Once Corebridge is deconsolidated from AIG, Life and Retirement's balance sheet and income statement will no longer be included in AIG's consolidated financial statements, and our remaining ownership stake will be reported in parent investments with dividends reported in net investment income.
Sabra went through this in detail on our last earnings call. We have been evaluating opportunities to maximize long-term value for Corebridge and have considered multiple strategic alternatives that we believe will best position Corebridge for future success. We remain committed to reducing AIG's ownership and to fully selling our remaining stake, and I will continue to provide updates to all of our stakeholders.
In terms of the use of Corebridge-related proceeds, AIG expects to continue to utilize excess capital and liquidity, with a focus on returning capital to shareholders through share repurchases and liability management, which I will discuss later when I outline our capital management strategy.
Now turning to General Insurance. Net premiums written were $4.5 billion and reflected the impact of the dispositions of Validus Re and Crop Risk Services as well as actions we've taken to restructure specific treaty reinsurance. Overall, Global Commercial had a very strong quarter. Excluding the impact of our divestitures, Global Commercial net premiums written growth was 1% year-over-year.
First, I want to reconfirm the guidance for the year. We expect high single-digit growth in net premiums written for the full year in our Global Commercial Insurance business. Now the results. In North America Commercial, net premiums written grew 4%. Lexington grew 24%, which was led by Casualty and Western World. Our Excess Casualty line grew 46% and our Captive Solutions grew 20%.
There's been meaningful commentary on the Excess & Surplus Lines market, and we continue to experience terrific fundamentals and results in Lexington. Let me provide a few examples. Our submission volume was up over 50% year-over-year. Lexington delivered strong new business, outperforming last year's record first quarter results, balanced across all lines. And retention remains strong for Lexington at 78%.
Shifting to North America Retail Property, net premiums written were negative $120 million in the quarter, driven by first quarter reinsurance purchased and had over a 600 basis point impact on the first quarter net premiums written growth for North America commercial compared to prior year. North America Financial Lines declined 4% year-over-year. In prior quarters, we provided meaningful commentary on the dynamics within Financial Lines, so I will not go through that again.
It's been a challenging market environment with continued headwinds on rate. Having said that, we continue to believe our portfolio is strong, and we remain disciplined. Sabra will give more detail in her prepared remarks.
In International Commercial, net premiums written were flat for the quarter. International Property grew 23%, and Talbot grew 18%. This was offset by a decline in our Global Specialty business of slightly over 10% due to some top line weakness in energy and the effects of the reinsurance restructuring. Also, we had a 5% decline in International Financial Lines.
Now turning to the combined ratio. Our Global Commercial business in the first quarter had an outstanding result with an 84.4% accident year combined ratio, excluding catastrophe, a 150 basis point improvement year-over-year. The accident year combined ratio, including catastrophe, was 86.6%, a 500 basis point improvement year-over-year.
This was led by International Commercial which, on a comparable basis, had an 82.8% accident year combined ratio, excluding catastrophe, which is a 140 basis point improvement year-over-year; and an 83.5% accident year combined ratio, including catastrophe, which is a 770 basis point improvement year-over-year.
North America Commercial also had an outstanding result with an 85.9% accident year combined ratio, excluding catastrophe, which is a 180 basis point improvement year-over-year; and an 89.5% accident year combined ratio, including catastrophe which is a 260 basis point improvement year-over-year. These results were simply outstanding and are a testament to our commitment and culture of underwriting excellence.
Shifting now to global Personal Insurance. Net premiums written were flat to prior year. We had modest growth in Personal Auto and Individual Travel and reductions in high net worth driven largely by reinsurance and Accident & Health, largely driven by 2 nonrenewals in China, as part of our focus on portfolio improvements in our Accident & Health business.
North America Personal had a 97.7% accident year combined ratio, excluding catastrophe. This is a 990 basis point improvement year-over-year and a 101.6% accident year combined ratio, including catastrophe, which is an 870 basis point improvement year-over-year.
As we discussed last year, we expect a material financial improvement in 2024 that will be driven by higher earned premium and a lower loss ratio from the high net worth business. We saw this manifest in the first quarter and expect this improvement to continue throughout 2024.
International parcel insurance had a 96.8% accident year combined ratio, excluding catastrophe, which increased 90 basis points year-over-year; and a 96.8% accident year combined ratio, including catastrophe, which is a 20 basis point improvement year-over-year. Overall, I'm very pleased with the financial performance of General Insurance, which delivered another excellent quarter.
Our reinsurance decisions in the first quarter had an impact on net premiums written. As we've discussed over the past several years, our reinsurance partnerships and global treaty structures have been purposeful. Our objective has been to deliver improved underwriting profitability and evolve our business portfolio to be appropriately diversified to deliver consistent results throughout the market cycle.
We believe this strategy has provided sustained value to our clients while also delivering improved risk-adjusted returns. It has significantly repositioned AIG, especially as we prepare to deconsolidate from Corebridge. Our goals with our reinsurance purchasing have been to preserve and optimize capital and enhance the quality of earnings through active management of the volatility of our underwriting results. This deliberate approach to reinsurance has helped position AIG with a very strong balance sheet and has given us the flexibility to add exposure where risk-adjusted returns are very attractive while also moderating volatility in our underwriting results.
As a result of our divestiture of Validus Re, combined with the reduction in gross limits in property through our underwriting strategy, we have reduced our PMLs and created meaningful capacity to increase our property writings throughout our global platform should they meet our expected returns. Without going through each return period by peril and region, our key zone PMLs on average, have decreased by over 40% compared to the first quarter of 2023, which provides considerable aggregate for future growth while appropriately managing the exposures we're assuming.
Our reinsurance purchasing is deliberately concentrated at January 1. As a result, any changes in purchasing tend to be more pronounced in the first quarter reporting of net premiums written. In January 2024, we also made some changes related to the allocation of catastrophe costs among the businesses, so that catastrophe costs are more accurately reflected in pricing. Historically, some of these costs have been shared with Validus Re. We reallocated PMLs and the catastrophe costs to where we believe the most attractive opportunities for growth existed in our portfolio.
It's worth noting, when considering our property catastrophe placement, we believe we have the lowest attachment point of our peer group. Over time, we have the balance sheet and perhaps the risk appetite to take more net on our catastrophe program post deconsolidation and subject to market conditions.
As a point of reference, if we chose to raise our catastrophe attachment point to $500 million worldwide, our attachment point would likely remain the lowest among our peer group with 1 in 11 attachment point in North America wind and 1 in 19 attachment in North America earthquake based on today's exposure. Importantly, our net premiums written in commercial would have been 15% greater in the first quarter if we had elected to have a $500 million attachment point across our global portfolio.
Our earnings potential is significant. And when combined with the strength of our balance sheet, it will provide us with the flexibility to continuously evaluate and refine our strategic reinsurance purchasing as we enter 2025.
Turning to Life and Retirement. As I noted earlier, the business continued to produce strong results in the first quarter. In April, Corebridge completed their Corebridge forward restructuring. $400 million of savings has been actioned or contracted, and they expect to realize the vast majority of the savings by the end of 2024 at a cost to achieve of $300 million.
Corebridge repurchased approximately $240 million of common shares during the first quarter, and they have repurchased $370 million of common shares year-to-date. Corebridge ended the quarter with a strong balance sheet with parent liquidity of $1.7 billion. This week, the Corebridge Board of Directors approved a share buyback authorization of $2 billion, which reflects their stated commitment to delivering a 60% to 65% payout ratio to shareholders, subject to market conditions.
Turning to other operations. We have made significant progress towards our future state operating model. Adjusted pretax loss from other operations in the quarter, including Life and Retirement, was $408 million, a 17% improvement year-over-year. The improvement was primarily attributable to lower general operating expense, higher short-term investment income and lower interest expense at AIG due to debt reduction actions. We expect our future state parent expenses to be in the range of $325 million to $350 million by year-end 2024. After deconsolidation, we intend to use 1% to 1.5% of net premiums earned as a benchmark of total parent expenses in the future.
Turning to capital management. In the first quarter, we continue to execute on our balanced capital management strategy. Over the past couple of years, we have significantly strengthened our balance sheet by making key decisions that have increased our financial flexibility while always planning for the long term, which has allowed us to accelerate the execution of our strategy and unlock meaningful value for AIG shareholders.
Along with establishing appropriate debt capital structures for AIG and Corebridge and diligently executing on AIG's capital management priorities, we have also completed over $40 billion of capital market transactions since 2022. We have been very disciplined in the execution of the components of our capital management strategy that we first outlined in 2022.
As a reminder, our objectives were: to maintain very strong insurance company capital levels to support organic growth and a steady source of operating subsidiary dividends to service parent company needs; to reduce our total debt outstanding and improve our leverage ratios, providing a well-structured and well-laddered debt portfolio with no outsized amounts due in any given year, particularly over the next 5 years; to return excess capital to shareholders in the form of share repurchases and dividends; to increase our dividend as our earnings and financial flexibility improved; and to maintain a strong parent liquidity position.
All of our Tier 1 insurance company subsidiaries are at or above their target capital ranges and have the ability to support meaningful growth without additional capital contributions. At current profitability levels, we had approximately $3 billion of run rate dividend capacity from our global General Insurance subsidiaries with approximately $2 billion attributable to the U.S. General Insurance company's dividend capacity.
We have increased the U.S. General Insurance company dividend capacity by approximately 400% over the last 3 years. This reflects a significant increase from 2021, when it was $550 million; and in 2022, when it was $1.4 billion. Looking forward, we expect to continue positioning AIG with maximum capital flexibility for growth, including reviewing our reinsurance over time and considering compelling and strategic inorganic growth opportunities should they exist.
In addition to strong insurance company capitalization, we've continued to significantly reduce our overall debt. Outstanding debt is now approximately $9.8 billion, a reduction of over $12 billion since the end of 2021, which has been a remarkable result for AIG. We had previously provided guidance that we're targeting a 20% to 25% total debt-to-capital ratio, and we expect to be in the 15% to 20% range upon deconsolidation.
While we may do additional work on maturities, we would not expect that to take priority over share repurchases. Since 2022, we've increased our focus on share repurchase activities. We completed over $5 billion of repurchases in 2022 and approximately $3 billion in 2023. Looking ahead, we expect up to $6 billion in repurchases in 2024 and up to $4 billion in 2025, depending on the timing of future Corebridge sell-downs and market conditions.
All of the expected activity in 2024 and 2025 will be covered by the $10 billion share authorization that we announced yesterday. For the balance of 2024, we expect to be able to repurchase about $1.5 billion of common stock a quarter depending on excess parent liquidity levels, including future Corebridge sale proceeds, General Insurance dividends and market conditions.
And based on the current stock price, we would expect this to get us closer to the higher end of our target share count range of 600 million to 650 million common shares by the end of the second quarter and towards the lower end of the range by the end of 2024. Furthermore, based on this outlook and depending on the stock price and market conditions, we would expect to be between 550 million and 600 million shares outstanding by year-end 2025.
Turning to our dividend. The AIG Board of Directors recently increased the cash dividend of $0.40 per share on AIG common stock up 11%, the second consecutive year with an increase of more than 10%. I could not be more pleased with our progress. We remain confident in our ability to deliver while continuing the positive momentum in our financial performance.
We remain committed to delivering an adjusted 10%-plus ROCE post deconsolidation of Corebridge. For the first quarter, we achieved a 9.3% adjusted ROCE and a 13.3% adjusted ROCE in General Insurance. Contributing to ROCE will be AIG Next, which will focus on achieving an expense base that will generate additional savings for AIG while reducing complexity throughout our organization and simplifying how we operate. AIG Next will create clarity in our operating structure, including aligning our underwriting and claims organizations with our operations and functions while defining our parent company of the future.
This is the key objective as we weave AIG together. To be a less complex, more effective and leaner company with the appropriate infrastructure and capabilities for the business we will be post deconsolidation. AIG Next has clearly defined work streams governed by a very experienced, centralized team with significant experience in transformations and company design reporting directly to me.
As I stated on previous calls, we expect AIG Next to generate approximately $500 million in annual run rate savings by the end of 2025. Of the $500 million in run rate savings, we expect $350 million to be actioned in 2024, which is an increase of the guidance we have provided in the past, and the balance will be actioned within 2025 with a cost to achieve of $500 million.
To date, we've made meaningful progress on AIG Next across multiple work streams. In April, we announced a voluntary early retirement program available to colleagues in the United States who meet the eligibility criteria. Eligible participants will have the opportunity to accelerate their retirement from AIG with enhanced retirement benefits.
The population of eligible participants represents approximately 25% of our U.S. workforce. About half of the eligible participants are located in the high-cost New York metropolitan area. We are anticipating a 50% take-up rate, which would result in approximately $225 million of onetime cost and a net run rate benefit of approximately $150 million after reinvestment for the skills and capabilities we need for the future. The numbers I have provided for our early retirement program are included in the total numbers I provided for AIG Next.
In summary, I'm very pleased with our overall performance as we start 2024. As I said in my recent letter to shareholders, our ability to execute continues to be one of the company's best attributes. We have accomplished a significant amount in the past several years in order to position AIG for the future, and we have continued to deliver in the first quarter, which will enable us to achieve our objectives in 2024 and beyond.
I am confident that we will continue to uphold our commitment to achieving underwriting excellence and high-quality earnings over the long term, benefiting all of our stakeholders as we continue to simplify and streamline our business and create the AIG of tomorrow.
With that, I'll turn the call over to Sabra.
Sabra Purtill: Thank you, Peter. This morning, I will provide details on AIG's first quarter results, including General Insurance, investment income in Life and Retirement and a balance sheet update.
First quarter 2024 adjusted after-tax income attributable to AIG common shareholders, or AATI, was $1.2 billion, flat to last year due to the reduction in our ownership of Corebridge from 77.3% to 52.7% at the end of this quarter. General Insurance adjusted pretax income, or APTI, increased $110 million year-over-year, driven by higher underwriting and net investment income. The prior year quarter included APTI of approximately $175 million from Validus Re and Crop Risk Services. On a comparable basis, excluding the divested businesses, General Insurance APTI was up about $285 million.
As Peter noted, first quarter General Insurance underwriting income was $596 million, up $94 million from the prior year quarter. On a comparable basis, underwriting income rose $239 million year-over-year.
International Commercial Lines was the primary contributor to higher underwriting profitability with $175 million increase in underwriting income. North America Commercial Lines underwriting income was down $95 million from the prior year quarter as reported but up $35 million on a comparable basis. Underwriting income includes catastrophe losses of $107 million in the quarter or 190 basis points on the loss ratio, down from $265 million or 420 basis points last year.
Prior year development this quarter was a favorable $34 million compared to a favorable $68 million in the prior year quarter. This quarter's development was solely from the amortization of the deferred gain on the adverse development cover which is recalculated each year based on prior year experience. For 2024, the amortization gain will be $34 million each quarter compared to $41 million a quarter last year.
Turning to underwriting ratios. The General Insurance calendar year combined ratio was 89.8% this quarter, a 210 basis point improvement from the prior year quarter and a 380 basis point improvement on a comparable basis. We provided additional data on Page 26 of the financial supplement on the impact of the divestitures on 2023 North American commercial combined ratios.
The accident year combined ratio ex catastrophes was 88.4%, a 30 basis point improvement over the prior year quarter and a 160 basis point improvement on a comparable basis. The accident year loss ratio adjusted for catastrophes was 56.6% this quarter, 10 basis points better than the first quarter of 2023 as reported and 70 basis points better on a comparable basis. This improvement reflects continued earn-in of rate above loss cost trend and better underwriting and risk selection, particularly in Global Commercial lines.
The expense ratio for the quarter was 31.8%, down 20 basis points from the prior year quarter as reported, with a $43 million reduction in general operating expenses. On a comparable basis, the expense ratio improved 90 basis points with 10 basis points from the acquisition ratio and 80 basis points from the general operating expense ratio, reflecting continued expense discipline as general operating expenses rose only $6 million.
As Peter covered General Insurance premium growth, I will focus on Commercial Lines new business, renewal rate, loss trends and retention as well as reserves. New business production in Global Commercial remained strong. In North America, new business was almost $450 million and balanced across all lines with excellent performance from Lexington.
International Commercial new business levels were very good, with over $500 million in the quarter, led by Talbot, Property and Casualty, offset by lower new business in energy and Financial Lines. In North America Commercial, overall rate, excluding workers' compensation, increased 5% in the quarter with exposure adding 2% for overall pricing of 7%, which is above loss cost trend. Excluding workers' comp and Financial Lines, North America commercial rate was up more than 8% in the quarter, with exposure up 2% for overall pricing over 10%, meaningfully above the loss cost trend.
North America commercial rate increase reflect strengthening pricing trends in Casualty, including Lexington Casualty, which was up 11%; Lexington Healthcare up 15%; and Excess Casualty up 16%. In International Commercial, overall rate increased 3% and exposure added 2% for an overall pricing increase of 5%, modestly ahead of the loss cost trend. Excluding Financial Lines, International rate was up 5% with overall pricing up 7%, well ahead of loss cost trend. The rate increase was driven by Property, which was up 7%; energy up 8%; and marine up 7%.
As we've discussed, Financial Lines is a notable exception to pricing trends. This was particularly the case in excess. We are taking a long-term view in Financial Lines and remain disciplined on risk selection, terms and conditions, pricing and reserving. While rate trend has been negative the past few quarters, in aggregate, the cumulative rate level in North America Financial Lines is about 50% higher than 5 years ago.
Renewal retention has improved over the past several years and remained strong. As a reminder, we calculate renewal retention using expiring premiums, excluding the impact of renewal rate and exposure changes on the ratio. Global Commercial retention increased to 89%, stable at 88% in North America and rose to 89% in International.
Turning to reserves. I wanted to provide some background on AIG's reserve review schedule for 2024 and quarterly processes. At AIG, we performed detailed valuation reviews, or DVRs, on each book once a year. In DVRs, we look at loss development and trends in prior and current accident years and consider changes in our reserving factors and approaches based on emerged experience. We do not perform DVRs in the first quarter.
In the second quarter of 2024, we will review the North America Casualty book, including excess and primary Casualty, Lexington, workers' compensation and mass tort comprising about $20 billion of reserves or 44% of our total reserves. In the third quarter, we will review International Commercial Lines, Global Financial Lines, Commercial Property and other lines, totaling about $22 billion or 47% of reserves with the balance of the DVRs completed in the fourth quarter.
Between DVRs, our actuarial team evaluates pricing, claims, loss trends and reserves across the portfolio. Each quarter, we complete an actual versus expected review, or AVE, for each book. The AVE review gives us a current look at trends and the opportunity to address issues prior to the scheduled DVR. Examples of such items include large new claims, notable changes in claims patterns or settlements, changes in attritional loss trends beyond normal ranges or significant major events.
We are aware that the industry has begun to address adverse casualty loss development trends in the 2016 to 2019 accident years. On our third quarter 2023 call, Peter provided significant detail on the reunderwriting and repricing of our casualty book that we began in 2018 with an entirely new framework and approach to underwriting. In addition, we changed our reserving assumptions on the book. And by 2021, we had increased reserves on North American Casualty, 2016 through 2019 accident years, by over $1 billion. We also continued to refine our actuarial judgments, and in 2019, we raised the loss cost trend assumption for certain Excess Casualty segments to 10%. And by 2022, all Excess Casualty segments were at or above 10%.
Our AVE reviews on North American Casualty since the second quarter 2023 DVR continue to show loss experience within the range of our expectations on the 2016 to 2019 accident years. As we have previously outlined, our reserving philosophy is to react to adverse trends quickly and to allow time for favorable trends, particularly in recent accident years, to mature. We did not make any adjustments to our casualty reserves this quarter, in total or within the 2016 to 2019 accident years. AIG's reserves and balance sheet are much stronger today, and our reinsurance is much more comprehensive, helping improve our underwriting results and reduce volatility.
Turning now to investment income. AIG continues to benefit from reinvestment rates on fixed maturities and loans that exceeded sales and maturities, helping drive higher yields and net investment income in General Insurance and Life and Retirement. This quarter, consolidated net investment income on an APTI basis was $3.5 billion, up 13% from the prior year quarter and up 2% in General Insurance and 16% in Life and Retirement.
General Insurance net investment income growth was negatively impacted by the sale of Validus Re, which had a $5 billion portfolio. Adjusted for income on that portfolio in the prior year quarter, General Insurance net investment income rose about 7%, with a 9% increase in fixed maturities and loans driven by higher reinvestment rates.
This quarter, new money rates on fixed maturities and loans averaged 5.9%, 150 basis points higher than the yield on sales and maturities in the quarter. The new money rates were about 115 basis points higher in General Insurance, and 165 basis points higher in Life and Retirement.
The annualized yield on fixed maturities and loans, excluding calls, prepayments and other onetime items, was 3.9% in General Insurance, 3 basis points higher than the fourth quarter of 2023 and 44 basis points higher than the prior year quarter. The sequential yield comparison in General Insurance was negatively impacted by the sale of Validus Re. First quarter General Insurance alternative investment income was $54 million or an annualized return of 5.2% this quarter, down $41 million from the prior year quarter.
Continuing to Life and Retirement. Sales and earnings were strong this quarter. First quarter sales remained at historically high levels with premiums and deposits of $10.7 billion driven by strong sales in fixed annuities and pension risk transfer.
Life and Retirement segment APTI was $991 million, up 12% from the prior year quarter, driven by higher base portfolio spread income due to higher reinvestment rates, higher fee income due to higher market levels and lower general operating expenses, partially offset by lower alternative investment income. Life and Retirement alternative investment income was negative $23 million this quarter for an annualized yield of negative 1.8% due to private equity losses and very low income on hedge funds and real estate compared to breakeven last year. Corebridge's total contribution to AIG's AATI, including corporate expenses, declined by approximately $100 million or 20% over the prior year quarter due to the reduction in our ownership.
Turning to the balance sheet. Book value per common share was $64.66 this quarter, down 1% from year-end 2023 and up 10% from the prior year quarter, driven mostly by the impact of interest rates. Adjusted book value per share was $77.79, up 1% from year-end 2023 and up 3% from the prior year quarter, reflecting the net impact of earnings, dividends and share repurchases.
Peter covered our capital management actions year-to-date. With respect to debt leverage, consolidated debt and preferred stock to total capital, excluding AOCI, which includes $9.4 billion of Corebridge debt, was 23.6% at March 31, down 70 basis points from year-end 2023. Excluding Corebridge debt on a pro forma deconsolidated basis, AIG debt to total capital is expected to be within the new 15% to 20% debt target range that Peter provided.
To conclude, AIG delivered another excellent quarter with significant financial and operational accomplishments. In 2024, AIG Next and the deconsolidation of Corebridge will drive significant progress towards achieving our 10%-plus adjusted ROCE goal. We are confident in our ability to achieve this goal and look forward to updating you on our progress.
With that, I will turn the call back over to Peter.
Peter Zaffino;Chairman and CEO: Thank you, Sabra. And operator, we're ready for questions.
Operator: [Operator Instructions] Our first question comes from Mike Zaremski with BMO.
Michael Zaremski: Looking over the -- your prepared remarks, Peter, and you used the term inorganic opportunities should they exist in reviewing reinsurance. So you also talked about the capital management expectations. So I guess would -- should we be thinking about the repurchase program as kind of a base case, but should there be other opportunities you might look to do something organic? Or just was there anything kind of new in there, in that wording that we should -- that you're trying to get us to think about?
Peter Zaffino;Chairman and CEO: Thanks, Mike. It's a very good question. We are going to stay very committed to the capital management structure we outlined, which is why I gave guidance on not only '24 but '25 in terms of share repurchases.
I think we've been consistent, and I added in when we're more comprehensive in our description in terms of capital management, that should inorganic opportunities exist, and they're compelling, which just means does it add product, does it add geography? Not scale and size, but just something that does help us strategically reposition ourselves. I wouldn't want to rule that out, but it's not a priority in the short term. And so that's really the context of what I provide in my prepared remarks.
Michael Zaremski: Okay. Understood. And my follow-up is just on the overall competitive environment relative to growth. So you guys have been very open. You have lots of pricing gauges. You've talked about Financial Lines being -- continue to be a soft-ish marketplace. but you've also said that you estimate pricing above loss cost trend.
But is there -- is this a conducive environment for AIG to want to kind of grow opportunistically? Or is it more just in certain pockets? I guess just for the backdrop, some of us look at the Marsh pricing index and it feels like there's, in my words, not a lot of gap or a narrow gap between kind of pricing and loss trends, potentially.
Peter Zaffino;Chairman and CEO: Yes. Thanks. It's a very good question. Let me start on growth. You can't -- one is you can't always look at broker index. Again, I don't know what Marsh index tracks, but sometimes, they don't catch fee business. They don't really catch the entire sort of market, which is the market we play in.
I do think it's conducive to grow. We don't look for top line growth to sacrifice profitability, and I think we evidenced that in this quarter and we've evidenced it over the past couple of years, that we continue to want to improve our combined ratios and look at businesses where the best risk-adjusted returns are. And so we have shaped the portfolio that way.
It's hard in any one quarter to sometimes draw conclusions like you saw in terms of the gross premium written in this quarter. It's really driven by 3 lines: Specialty; Financial Lines; and Casualty. The first quarter was impacted in International by energy within the Specialty class. But it's a great business, we're a world leader in that class, great underwriting capabilities and global distribution. And expect us to continue to grow that, and it's a very attractive combined ratio.
So I think there's a little bit of noise. We had some captives. We had reinsurance impact the quarter, because we switched from some pro rata to excess of loss. I don't think I need to go into too much more detail on Financial Lines. It's definitely an area where we watch very carefully. Sabra provided a lot of great context in her prepared remarks. But we're going to focus on making sure we have the highest-quality book.
I mean, our retention I think, spoke volumes this quarter in terms of the portfolio we like. I mean, with 89% in International, 88% in North America, across the board, that was tremendous, good new business. And so we definitely find opportunities.
I mean, the one area I just want to just note. Because Lexington, we talk about it every quarter because it just continues to just be exceptional. But the market dynamics have changed quite a bit. And when we look at Excess & Surplus lines, we think there's great opportunities to continue to grow. Even though there may have been some slowdown in Property, there's other lines of business, like casualty that we're seeing massive submission activity. And I just wouldn't look at the E&S market as a hard market play or a soft market play. It's just a market that's going to be here to stay in a different way. And so we're very much investing in that. I think the margins are great and the growth opportunities are significant.
Operator: Our next question comes from Elyse Greenspan with Wells Fargo.
Elyse Greenspan: Peter, my first question, last quarter, you had implied that a Corebridge deconsolidation would come by the end of the second quarter. Does that time frame remain intact?
Peter Zaffino;Chairman and CEO: There's not a whole lot more I can offer in terms of the prepared remarks. Every sell-down has been important, but this one is particularly important just because we would likely become a seller of shares that will deconsolidate Corebridge. So we continue to focus on making certain we're looking at every option available.
And considering all of those variables, Corebridge has done a significant amount of work working with AIG and independently to position itself to be a separate public company. It's done an exceptional job. We're completed, most of our transition service agreements, which just means they're more operationally prepared to go.
And so again, subject to market conditions, I think my guidance I gave last quarter stands. We would expect to try and do something before the end of the second quarter.
Elyse Greenspan: And then my follow-up is on the new share count target that you provided for the end of '25, that 550 million to 600 million. I'm just trying to get a case of -- what the base case is for just Corebridge within that. Does that assume additional secondaries? If you did an exchange offer, would that be accretive to that share count target? I just want to get a sense of when you guys came up with this 550 million to 600 million, what you're assuming for Corebridge within that share count target.
Peter Zaffino;Chairman and CEO: Yes. Thanks, Elyse. I think while we gave the guidance into 2025 is -- what I said in my prepared remarks is that by the end of the second quarter, if we exercise on the share repurchases that we've outlined, we would be at the higher end of the range of the 600 million to 650 million. And if we continue the $1.5 billion a quarter, which, yes, would contemplate doing a sell-down of Corebridge. But there's other forms of liquidity that come into AIG, but we would need to sell down to be able to do the $1.5 billion in the third and fourth quarter, but that gets us to the lower end of the range.
And then as we continue to do future sell-downs, we would get below the 600 million share count, which is why we decided to give a little bit more guidance as we get into 2025. It does not include a sell-down to 0, but it does contemplate several transactions that would take place in the next 4 quarters.
Operator: Our next question comes from Ryan Tunis with Autonomous.
Ryan Tunis: Just a follow-up, I guess, on that last question, Peter. Just, I guess, the messaging on the $10 billion share repurchase authorization. Are you trying to say that the intention is to do kind of no more than $10 billion until the end of '25? Or is that -- should we just take this as an update of what you think you can do based on what you're seeing today?
Peter Zaffino;Chairman and CEO: I would take it as just an update. We would have gone past our current Board authorization with the 2025 guidance and worked very closely with the AIG Board of Directors to talk about what we expected the capital management strategy to be in the next 6 quarters. And that's really how we derive the $10 billion. But I wouldn't think about it anything more than that.
Ryan Tunis: Got it. And then a follow-up, I guess, just thinking about the reinsurance. And obviously, you're continuing to add more, but you're saying potentially, like in the future, maybe scaling back on that a bit could be a way you could use some of your excess capital.
Could you just talk a little bit about, I guess, how we should think about how the gross underwriting, I guess, has improved at AIG over the past few years? And yes, like what would make you comfortable -- because we only see stuff on a net basis, but like what would give you comfort in retaining more net?
Peter Zaffino;Chairman and CEO: Well, in terms of the portfolio, I'm comfortable today taking more net. But what we've done over this multiyear period in terms of strategically positioning the reinsurance is working very closely with our reinsurance partners, looking across multiple lines of business and multiple geographies in the placement of reinsurance. And then also making certain that we control volatility in this period of transition. That's been really important.
I want to emphasize that because we not only are looking at our accident year combined ratios, excluding catastrophe, we have kept our retentions or lowered them in a period of high uncertainty and high volatility because we don't want to have any outsized losses or surprises perhaps or an active cat season.
Also, I think we're very different than other insurance companies in terms of how we purchase reinsurance. It's not done at the business level. It is not done within just the finance function or treasury, it's done -- reports directly to me. And so I work very closely with Charlie Fry, work very closely with Sabra in terms of what our risk appetite is going to be for that particular year. And we've protected capital and had more quality earnings as a result of some of the reinsurance that we place.
A couple of examples of things that are just very good, but impacted the first quarter is switching more to excess of loss in certain segments like energy, we transitioned and proportionally signed down a little bit of the quota share. But it wasn't economic because we ended up getting a better outcome on the quota share with 200 basis points of improvement. So it's just repositioning the portfolio. Did the same thing with property cat.
And the reason I just gave the example on our earnings and sort of prepared remarks is just, on property cat, we can absolutely take more net if we decide to as we enter 2025, depending on the portfolio and depending on our appetite for volatility. We'll still have one of the lowest attachment points of any of our peers across the world.
We enhanced coverage. There's a lot more coverage in our property cat. We've enhanced our high net worth business in terms of excess of loss and more comprehensive coverage. And also -- again, and I'll stop here because I could go on for hours on this discussion, but is on casualty, we renewed or improved our overall construct across the globe based on the quality of our growth portfolio.
So to start thinking about ways in which we can do reinsurance differently will not have anything really to do with the gross portfolio because they're very much like that. It's more of where do we want volatility and where do we want to take more net? And we see opportunities as we enter 2025.
Operator: Our next question comes from Rob Cox with Goldman Sachs.
Robert Cox: First question on underwriting leverage. If I take comments on capital at the insurance companies with opportunities in Property post the sale of Validus, it seems like AIG could meaningfully increase underwriting leverage here, which could obviously contribute to the 10%-plus ROCE. Could you provide any additional color on how you're thinking about underwriting leverage here, and maybe some metrics you'd point us to?
Peter Zaffino;Chairman and CEO: Sure. I'll ask Sabra to comment on some of the leverage within the insurance company subsidiaries. We see great opportunities for us to grow within -- across the world. And you've mentioned Property and specifics. We have significantly reduced PMLs, which means we have aggregate to grow. And we have the capital to grow.
And the interesting part of AIG is that when we look at Property, we have so many different points of entry depending on the risk-adjusted returns that exist. If I start in the United States, and this is not all inclusive, but just as a few examples, we have Lexington E&S property, we have Retail Property, we have the high net worth business, and that can be done on an admitted or non-admitted basis. We have Retail Property. In International, we have Japan Property that's specific to Japan. We have Talbot. And we have Global Specialty. So there's so many different points of entry. Depending on the risk-adjusted returns, we can scale up or scale down, but believe that there's going to be great opportunities for us in the future.
Yes. I mean, the first quarter tempered on Property. But look, we're not in the cat season yet, and our industry is famous of just framing out the market at a point in time. We got a long ways to go this year in terms of where the opportunities exist, but we absolutely have the leverage to grow if we like the risk-adjusted returns.
Sabra, do you want to comment on that?
Sabra Purtill: Yes. Thank you, Peter. What I would just observe is, as we've stated in the past, and I'll reiterate today, all of our General Insurance subsidiaries or Tier 1 subsidiaries on a global basis have capital at or above our target ranges. And within the United States pool, which is the largest pool of our General Insurance capital, our risk-based capital ratios at the end of last year were around 460%, which is well higher than many of our peers.
So what I would note is that within the General Insurance companies, we're strongly capitalized to be able to support growth, obviously, protected by the reinsurance programs that we have. But I would just, as a general note, comment that premiums to surplus leverage isn't the best way to look at capital within a General Insurance company, particularly given a company like AIG, which is a leading player in Casualty and Specialty lines across the globe.
Robert Cox: That's really helpful color. Yes, just a follow-up on Excess Casualty. I appreciate the comments. The premiums were up 46% in the quarter, and it seems like pricing is up meaningfully. It seems like AIG is taking advantage of market conditions where perhaps some others are pulling back. So I was hoping you could provide a little bit more commentary on the opportunities you're seeing there. And what makes AIG comfortable with the current environment?
Peter Zaffino;Chairman and CEO: Thank you. We do see great opportunities in Casualty. We highlighted some of the performance in the quarter. We had to start, because of the portfolio that existed, reunderwriting the Casualty portfolio well before, I think, it was discussed really in the industry. And with that, became a new underwriting philosophy, new underwriting strategy, new terms and conditions, new attachment points, net limit, gross limits, pricing, margin. And so that's been a journey for us for years.
We mentioned the 16% in Excess Casualty in terms of rate is as strong as we've seen in the past several years. And so that we do think there's a lot of capacity pulling back. We have very comprehensive reinsurance to mitigate volatility and enable us to put out limits depending on our risk appetite. And obviously, we're cautious. We're watching the different lines of business within Casualty and their trends, but absolutely see opportunities to grow.
And when you look at our premium, don't think about it as we've grown policy count or limit, it's actually the opposite. I mean, like our client count, policy count and limits are all dramatically reduced when you compare them to 3 or 4 years ago. It's just been the effect of where we participated and how we price the business. And believe that, again, we're going to be cautious, but there are real opportunities for growth in the current market.
Operator: Our next question comes from Michael Ward with Citigroup.
Michael Ward: I'm a little bit curious just on the potential sell-down of Corebridge. How do you weigh the options between doing several smaller chunks of sell-down from here versus maybe the potential for doing a sell-down of the remaining stake? And then another thing on the other side, right, we sort of think about this $500 million a month buyback. Is there the option to potentially do an ASR post sell-down?
Peter Zaffino;Chairman and CEO: I wish I could provide a little bit more detail on the first part of the question. We're looking at all alternatives, all size. I mean, so much is market-dependent. You have certain windows. And we want to make sure -- we have multiple stakeholders, I mean, within Corebridge shareholders, AIG shareholders, so sort of balancing that is really important for us.
But as I said in my answer and prepared remarks, we're ready to go. Everybody is anxious to move forward, but we're going to make sure we do it in a very methodical way to where we don't do anything that's not in the best interest of all that we've done so far and our stakeholders. So we will consider multiple options and keep everybody updated.
On the ASR, I mean, I think we've largely thought about this, and Sabra, if you want to comment to close out. We've done share repurchase in a methodical way. We always consider different ways in which we can do it. But maybe you can just comment, and then I'll close it out.
Sabra Purtill: Yes, thanks. The thing you should keep in mind is that with the amount of shares that we can repurchase or can be repurchased by a company in any given month, whether it's an ASR or it's a 10b5-1 plan or open market purchases, it's constrained by the same factor, which is the average daily trading volume.
We have looked at doing ASRs. And to date, what we've preferred to do is just be consistently in the market every day through a 10b5-1 plan. But it's certainly something if we were to do a larger sale of a Corebridge stake where we wanted to redeploy that quickly and get the benefit of that into our share count, then an ASR is a tool that we can use to do that. But in terms of the volume per month, it doesn't really vary that different, whether it's an ASR or a 10b5-1.
Peter Zaffino;Chairman and CEO: Thanks, Sabra. And in closing, I just want to thank all of our colleagues around the world for their continued dedication, teamwork, execution on all the progress we've made. And I want to thank everybody for joining us today and your questions. Everybody, have a great day.
Operator: Thank you for your participation. This does conclude the program. You may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's First Quarter 2024 Financial Results Conference Call. This conference is being recorded."
},
{
"speaker": "Quentin McMillan",
"text": "Good morning, and thanks very much. Today's remarks may include forward-looking statements which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Good morning, and thank you for joining us today to review our first quarter 2024 financial results. Following my remarks, Sabra will provide more detail on the quarter and then we'll take questions. Kevin Hogan will join us for the Q&A portion of the call."
},
{
"speaker": "During my remarks this morning, I will discuss 4 important topics",
"text": "first, I will provide some financial highlights in the quarter focused on the General Insurance business, including some insight into our net premiums written; second, I will talk briefly about the results in Life and Retirement; third, I will provide an update on our capital management strategy, specifically our plans for 2024 and 2025; and finally, I will discuss our path to a 10%-plus ROCE and provide more detail on AIG Next and our future state operating structure that will create value through a leaner and more unified company."
},
{
"speaker": "As a reminder, our objectives were",
"text": "to maintain very strong insurance company capital levels to support organic growth and a steady source of operating subsidiary dividends to service parent company needs; to reduce our total debt outstanding and improve our leverage ratios, providing a well-structured and well-laddered debt portfolio with no outsized amounts due in any given year, particularly over the next 5 years; to return excess capital to shareholders in the form of share repurchases and dividends; to increase our dividend as our earnings and financial flexibility improved; and to maintain a strong parent liquidity position."
},
{
"speaker": "Sabra Purtill",
"text": "Thank you, Peter. This morning, I will provide details on AIG's first quarter results, including General Insurance, investment income in Life and Retirement and a balance sheet update."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you, Sabra. And operator, we're ready for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from Mike Zaremski with BMO."
},
{
"speaker": "Michael Zaremski",
"text": "Looking over the -- your prepared remarks, Peter, and you used the term inorganic opportunities should they exist in reviewing reinsurance. So you also talked about the capital management expectations. So I guess would -- should we be thinking about the repurchase program as kind of a base case, but should there be other opportunities you might look to do something organic? Or just was there anything kind of new in there, in that wording that we should -- that you're trying to get us to think about?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Mike. It's a very good question. We are going to stay very committed to the capital management structure we outlined, which is why I gave guidance on not only '24 but '25 in terms of share repurchases."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. Understood. And my follow-up is just on the overall competitive environment relative to growth. So you guys have been very open. You have lots of pricing gauges. You've talked about Financial Lines being -- continue to be a soft-ish marketplace. but you've also said that you estimate pricing above loss cost trend."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. Thanks. It's a very good question. Let me start on growth. You can't -- one is you can't always look at broker index. Again, I don't know what Marsh index tracks, but sometimes, they don't catch fee business. They don't really catch the entire sort of market, which is the market we play in."
},
{
"speaker": "It's hard in any one quarter to sometimes draw conclusions like you saw in terms of the gross premium written in this quarter. It's really driven by 3 lines",
"text": "Specialty; Financial Lines; and Casualty. The first quarter was impacted in International by energy within the Specialty class. But it's a great business, we're a world leader in that class, great underwriting capabilities and global distribution. And expect us to continue to grow that, and it's a very attractive combined ratio."
},
{
"speaker": "Operator",
"text": "Our next question comes from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "Peter, my first question, last quarter, you had implied that a Corebridge deconsolidation would come by the end of the second quarter. Does that time frame remain intact?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "There's not a whole lot more I can offer in terms of the prepared remarks. Every sell-down has been important, but this one is particularly important just because we would likely become a seller of shares that will deconsolidate Corebridge. So we continue to focus on making certain we're looking at every option available."
},
{
"speaker": "Elyse Greenspan",
"text": "And then my follow-up is on the new share count target that you provided for the end of '25, that 550 million to 600 million. I'm just trying to get a case of -- what the base case is for just Corebridge within that. Does that assume additional secondaries? If you did an exchange offer, would that be accretive to that share count target? I just want to get a sense of when you guys came up with this 550 million to 600 million, what you're assuming for Corebridge within that share count target."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Yes. Thanks, Elyse. I think while we gave the guidance into 2025 is -- what I said in my prepared remarks is that by the end of the second quarter, if we exercise on the share repurchases that we've outlined, we would be at the higher end of the range of the 600 million to 650 million. And if we continue the $1.5 billion a quarter, which, yes, would contemplate doing a sell-down of Corebridge. But there's other forms of liquidity that come into AIG, but we would need to sell down to be able to do the $1.5 billion in the third and fourth quarter, but that gets us to the lower end of the range."
},
{
"speaker": "Operator",
"text": "Our next question comes from Ryan Tunis with Autonomous."
},
{
"speaker": "Ryan Tunis",
"text": "Just a follow-up, I guess, on that last question, Peter. Just, I guess, the messaging on the $10 billion share repurchase authorization. Are you trying to say that the intention is to do kind of no more than $10 billion until the end of '25? Or is that -- should we just take this as an update of what you think you can do based on what you're seeing today?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "I would take it as just an update. We would have gone past our current Board authorization with the 2025 guidance and worked very closely with the AIG Board of Directors to talk about what we expected the capital management strategy to be in the next 6 quarters. And that's really how we derive the $10 billion. But I wouldn't think about it anything more than that."
},
{
"speaker": "Ryan Tunis",
"text": "Got it. And then a follow-up, I guess, just thinking about the reinsurance. And obviously, you're continuing to add more, but you're saying potentially, like in the future, maybe scaling back on that a bit could be a way you could use some of your excess capital."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Well, in terms of the portfolio, I'm comfortable today taking more net. But what we've done over this multiyear period in terms of strategically positioning the reinsurance is working very closely with our reinsurance partners, looking across multiple lines of business and multiple geographies in the placement of reinsurance. And then also making certain that we control volatility in this period of transition. That's been really important."
},
{
"speaker": "Operator",
"text": "Our next question comes from Rob Cox with Goldman Sachs."
},
{
"speaker": "Robert Cox",
"text": "First question on underwriting leverage. If I take comments on capital at the insurance companies with opportunities in Property post the sale of Validus, it seems like AIG could meaningfully increase underwriting leverage here, which could obviously contribute to the 10%-plus ROCE. Could you provide any additional color on how you're thinking about underwriting leverage here, and maybe some metrics you'd point us to?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Sure. I'll ask Sabra to comment on some of the leverage within the insurance company subsidiaries. We see great opportunities for us to grow within -- across the world. And you've mentioned Property and specifics. We have significantly reduced PMLs, which means we have aggregate to grow. And we have the capital to grow."
},
{
"speaker": "Sabra Purtill",
"text": "Yes. Thank you, Peter. What I would just observe is, as we've stated in the past, and I'll reiterate today, all of our General Insurance subsidiaries or Tier 1 subsidiaries on a global basis have capital at or above our target ranges. And within the United States pool, which is the largest pool of our General Insurance capital, our risk-based capital ratios at the end of last year were around 460%, which is well higher than many of our peers."
},
{
"speaker": "Robert Cox",
"text": "That's really helpful color. Yes, just a follow-up on Excess Casualty. I appreciate the comments. The premiums were up 46% in the quarter, and it seems like pricing is up meaningfully. It seems like AIG is taking advantage of market conditions where perhaps some others are pulling back. So I was hoping you could provide a little bit more commentary on the opportunities you're seeing there. And what makes AIG comfortable with the current environment?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thank you. We do see great opportunities in Casualty. We highlighted some of the performance in the quarter. We had to start, because of the portfolio that existed, reunderwriting the Casualty portfolio well before, I think, it was discussed really in the industry. And with that, became a new underwriting philosophy, new underwriting strategy, new terms and conditions, new attachment points, net limit, gross limits, pricing, margin. And so that's been a journey for us for years."
},
{
"speaker": "Operator",
"text": "Our next question comes from Michael Ward with Citigroup."
},
{
"speaker": "Michael Ward",
"text": "I'm a little bit curious just on the potential sell-down of Corebridge. How do you weigh the options between doing several smaller chunks of sell-down from here versus maybe the potential for doing a sell-down of the remaining stake? And then another thing on the other side, right, we sort of think about this $500 million a month buyback. Is there the option to potentially do an ASR post sell-down?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "I wish I could provide a little bit more detail on the first part of the question. We're looking at all alternatives, all size. I mean, so much is market-dependent. You have certain windows. And we want to make sure -- we have multiple stakeholders, I mean, within Corebridge shareholders, AIG shareholders, so sort of balancing that is really important for us."
},
{
"speaker": "Sabra Purtill",
"text": "Yes, thanks. The thing you should keep in mind is that with the amount of shares that we can repurchase or can be repurchased by a company in any given month, whether it's an ASR or it's a 10b5-1 plan or open market purchases, it's constrained by the same factor, which is the average daily trading volume."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"text": "Thanks, Sabra. And in closing, I just want to thank all of our colleagues around the world for their continued dedication, teamwork, execution on all the progress we've made. And I want to thank everybody for joining us today and your questions. Everybody, have a great day."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program. You may now disconnect. Everyone, have a great day."
}
] | American International Group, Inc. | 250,388 |
AIG | 1 | 2,025 | 2025-05-02 08:30:00 | Operator: Good day, and welcome to AIG's First Quarter 2025 Financial Results Conference Call. This conference is being recorded. Now, at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead.
Quentin McMillan: Thanks very much, and good morning. Today's remarks may include forward-looking statements which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Following the deconsolidation of Corebridge Financial on June 9, 2024, the historical results of Corebridge for all periods presented are reflected in AIG's consolidated financial statements as discontinued operations in accordance with US GAAP. Finally, today's remarks related to net premiums written and net premiums earned are presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis and adjusted for the sale of the global personal travel and assistance business as applicable. We believe this presentation provides the most useful view of our results and the go-forward business in light of the substantial changes to the portfolio since 2023. Please refer to Pages 26 of the earnings presentation for reconciliations of such metrics on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino.
Peter Zaffino: Good morning, and thank you for joining us today to review our first quarter 2025 financial results. AIG's overall performance in the quarter was exceptional and we continued to make significant progress on our strategic, operational and financial objectives. We had a very busy start to the year. And while it's hard to believe, just 30 days ago, we hosted our Investor Day. We're incredibly grateful for the positive engagement and support from our colleagues and many stakeholders and appreciated the opportunity to share our journey with them. For my prepared remarks, I will start with an overview of our Investor Day, including what we intend to achieve, some observations from the meeting, and what we've learned since. Second, I will highlight our first quarter financial results. Third, I want to provide a spotlight on our business strategy and long-term view of India, a business that we briefly touched on at our Investor Day. Fourth, given the widespread interest, I will offer a few observations on the impact of tariffs. And last, I'll provide an update on our progress toward our financial targets that we outlined at our Investor Day. Keith will then provide more detail on our financial results, and Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Beginning with Investor Day, our objective was to demonstrate the incredible progress the company has made over the last seven years and why we believe we're so well-positioned for the future. We shared how we established an underwriting culture of excellence, substantially reduced underwriting exposure, controlled volatility, structured the company for the future, refreshed our purpose and values, developed a world-class end-to-end operating structure, digitized end-to-end processes, developed a robust data hierarchy, and retired over 1,200 applications while migrating to the cloud. We discussed how we created a lean parent company and strengthened our balance sheet while executing a disciplined capital management strategy, which will enable AIG to have maximum strategic and financial flexibility for the future. We provided detail on our strategy to deploy GenAI end-to-end, and to demonstrate how the advancement in adoption is making a difference across our business to drive future growth, and that was on full display. I'm very grateful to our world-class partners, Alex Karp of Palantir and Dario Amodei of Anthropic, for joining Sara Eisen and me on stage to showcase and validate our strategy. And while they are very entertaining guests and have better things to do with their time than show up at AIG's Investor Day, they felt compelled to speak to our stakeholders about how they fully endorse AIG's strategy. It was a very important moment for our company. We demonstrated the breadth and depth of our global portfolio with $24 billion of net premiums written, which enables us to leverage both our diverse geographic footprint and strong product offerings to solve our clients' risk needs. We highlighted what a thoughtful and carefully planned reinsurance strategy can do for company over time, showcasing key structures of our portfolio and providing an introduction to our special purpose vehicle backed by Blackstone, which is an important part of our strategic evolution. Our stakeholders came away from the event with a much clearer understanding of our strategic direction, the deep expertise within our company, our differentiated approach to GenAI and our ambitious yet achievable financial targets and global growth opportunities. Inside the company, there's a sense of confidence and pride. Our Investor Day gave our colleagues the opportunity to see their hard work recognized in an impactful way, which has generated energy and engagement across the organization and we're excited to take this momentum forward. If I had to choose just one key takeaway from our Investor Day, it is that AIG is in every way a different company. Turning to our financial results, against the challenging geopolitical and macroeconomic environment, we made excellent progress towards our long-term strategic and financial goals, while delivering exceptional underwriting results, effectively manage volatility, while reducing expenses. In the first quarter, adjusted after-tax income was $702 million or $1.17 per diluted share. Building on our momentum, we had another quarter of strong premium growth. Net premiums written were $4.5 billion, an increase of 8% year-over-year on a comparable basis, led by 10% growth in Global Commercial. North America Commercial Insurance net premiums written grew 14% year-over-year. Lexington grew 23%, led by Lexington Casualty, which grew 27%. It's worth noting that Lexington submission growth continued in the first quarter, increasing 30% year-over-year, and that is following an increase of over 50% in the first quarter of 2024 when compared to 2023. Simply an outstanding result. This increase in submission activity was primarily driven by middle market casualty and property, which together represents two-thirds of the total submissions received. Glatfelter contributed 16% growth and Retail Property grew over 40%, almost entirely driven by the significant enhancements to our reinsurance structures. International Commercial Insurance net premiums written grew 8% year-over-year on an FX-adjusted basis, driven by property at 35%, largely as a result of enhanced reinsurance structures. And Marine grew an impressive 17%. Turning to expenses, our general insurance expense ratio decreased to 30.5% in the first quarter compared to 31.8% in the prior year quarter. The divestiture of our travel business was the largest contributor to this improvement, accounting for 110 basis points. The remaining 20 basis points of improvement came from AIG Next initiatives. This is very impressive when you consider that General Insurance absorbed $78 million of additional expenses that were booked in Other Operations in 2024. Other Operations general operating expenses were $85 million in the quarter. The accident year combined ratio, as adjusted, was 87.8%, the best first quarter result for AIG since the financial crisis. The prior year quarter was 88.4%. The calendar year combined ratio was 95.8% for the quarter, which included $520 million in catastrophe losses, driven by the California wildfires, which came in at $460 million. The combined ratio represented 9.1 loss ratio points and is a testament to our strategy for managing volatility. While industry losses from natural catastrophes are the second highest for the first quarter of the year on record, we expect our net retained catastrophe losses to be within expectations for 2025, largely based on our reinsurance structures. If you apply our current loss projections for the wildfire catastrophe to our aggregate cover, we will have approximately $35 million net of annual aggregate deductible remaining for all other perils in North America, excluding wind and earthquake, and approximately $385 million net left for all perils, both subject to a $50 million each and every loss deductible for the rest of this calendar year. We also continue to have significant property catastrophe occurrence limit available. Overall, the market remained favorable in the first quarter, particularly in segments with very good underlying fundamentals. Keith is going to cover rate in more detail in his remarks, but I wanted to provide some perspective. For North America, the rate increases in the quarter were led by excess casualty at 16%. In the last five calendar years, excess casualty has had double-digit rate increases each year with cumulative rate above loss trend. Gladfelter had a 6% rate increase. These increases were offset by Financial Lines, which decreased 5%, Retail Property, which decreased 7%, and Lexington Property, which decreased 10%. In Financial Lines, we have the benefit of a highly diversified business by product and segment. This enables us to position the portfolio for the best risk-adjusted returns even in a competitive market. To further outline, we have meaningfully reduced our excess capacity, where pricing is increasingly commoditized. We're focused on our primary business where we have a differentiated offering and a leadership position. Our Financial Lines portfolio has gone from representing 30% of North America Commercial net premiums written in 2021 to representing 19% of the portfolio today. Next, let me give some context on property rate. Over the past five years, we have had cumulative rate increases of 113% in Retail Property and 96% in Wholesale Property. Pricing continues to be above our technical view, nonetheless, we continue to be very disciplined and we'll monitor market conditions throughout the year. In International, the environment was more balanced. Casualty had a 7% rate increase, Property had a 2% rate increase, offset by Global Specialty and Talbot, which decreased 1% and 4%, respectively, and Financial Lines, which decreased by 3%. And please recall that we report rate on gross premiums written. And because many of our lines are heavily impacted by reinsurance in the first quarter, there's not a direct correlation to net premiums written, which are lower in certain businesses, such as our Global Specialty business. Turning to capital management, we returned $2.5 billion of capital to shareholders in the first quarter. This included $2.2 billion of share repurchases and $234 million of dividends. We ended the quarter with a debt to total capital ratio of 17.1% and parent liquidity of $4.9 billion. As I announced on Investor Day, as of April 1, the AIG Board of Directors increased our share repurchase authorization to $7.5 billion, inclusive of the outstanding authorization amount, of which approximately $7.1 billion remains available. Additionally, the Board approved a 12.5% increase in our quarterly dividend of $0.45 per share yesterday. We expect to repurchase a total of $5 billion to $6 billion of shares in 2025, subject to share price and market conditions, which should bring us to a range of 500 million to 550 million shares outstanding over time. Now, I'd like to transition to discuss one of our strategic partnerships. While we covered a lot of content on Investor Day, one part of our business that we did not address in any detail is Tata AIG. With this in mind, I'd like to share some observations on the rapidly growing market in India and insights about our joint venture with the Tata Group. India as a country has made remarkable progress over the last decade. Over that time, the economy has grown from the 10th largest to the 5th largest economy in the world and is likely to become the third largest economy after the United States and China by 2030. Real GDP is estimated to grow approximately 7% over the next two years with nominal GDP growing nearly two times higher. The changing demographics in India are well known, but worth highlighting. In a country of nearly 1.5 billion people, half of the population is below the age of 30. The middle-class is projected to more than double by 2030 with some of the fastest growth happening in Tier-3 and Tier-4 cities. Pivoting to the insurance industry, the general insurance market in India is over $35 billion in gross premiums written as of 2023 and had a compound annual growth rate of around 11% over the last five years. We expect the market will sustain this type of growth through 2030. And there's a massive opportunity for growth, given the changing dynamics. In India, non-life insurance penetration is still relatively low at 1% of GDP. In contrast, the United States is at 9% of GDP. Our presence in India began 25 years ago when we partnered with Tata Group to establish a joint venture, Tata AIG. The India insurance market opened to private insurance companies and direct foreign investment in 2000. At the time, the maximum allowable foreign investment was 26%, which is what we currently hold today. Prior to 2000, India's insurance market was dominated by public sector insurance companies, which had 100% market share. Opening up the market to private insurance and foreign direct investment dramatically shifted India's insurance landscape. Today, private sector insurance companies represent 60% of the non-life market. While India offers tremendous opportunity, it's a complex and highly competitive market. For foreign companies, it's important to choose the right partner, a company with deep and broad knowledge of India and one with a strong reputation. For AIG, there is no better choice than Tata Group, one of the highest quality global companies. Tata Group operates 30 companies in over 100 countries across diverse industries. Its 26 publicly listed enterprises have a combined market cap of $365 billion with over 1 million employees. Over the last decade, Tata Group has been consistently ranked as one of India's most valuable brands. Tata AIG is highly respected and is ranked as the #2 private insurer in the commercial insurance and motor insurance sectors. It serves 27 million customers with 8,500 employees and leverages 85,000 captive agents operating across the country. Tata AIG had $2.1 billion of gross premiums written in 2024 and its mix of business is approximately 75% personal insurance and 25% commercial insurance. Tata AIG is a high-growth business. From 2020 to 2025, we had a compound annual growth rate of 20%, outpacing the market. Through 2030, we expect to continue to grow at the same compound annual growth rate, fueled by India's accelerating economy, rising insurance adoption and Tata AIG's market-leading brand and reputation. The business has exceptional technology and data capabilities that enabled it to scale rapidly and support the continued ambition for accelerated growth. Tata AIG's products and services are digital-first with clients and agents enabled by technology at every stage of the value chain, providing a complete digital customer experience, which is what clients in India expect. Additionally, Tata AIG benefits from access to AIG's multinational network with AIG supporting the joint venture's domestic multinational corporate clients. In close partnership with Tata Group, we're prepared to significantly invest in growth organically and possibly inorganically, should opportunities present themselves. And I expect this business to continue to scale faster than any other geography in our portfolio. There's been a lot of discussion about tariffs and I'd like to share a perspective, understanding that there is still significant uncertainty around the topic of tariffs. To start, let me provide some relevant facts. First, there are only seven countries worldwide that export more than $100 billion to the United States. And China, Canada and Mexico are the only countries that export over $250 billion. When looking at a country's level of exports to the United States as a percentage of their total exports, Mexico is 79%, Canada is 74% and China is less than 20%. Altogether, tariffs create uncertainty, which may lead to lower levels of transactional activity in the near term, impacting certain commercial businesses, but it's premature to predict any specific outcomes related to these emerging macro trends. The greatest challenge for companies is understanding the real impact of tariffs and how they are changing and their implications. There is a complexity not only with tariff policies evolving, but also with the potential impact on supply chains. It's also important to consider the implications to loss costs and inflation. To help parse through this complexity, let me share a property example. Typically, in a high net worth claim and, of course, it's subject to the particular type of loss, approximately 60% of the loss would be for rebuilding costs, 30% for content and 10% or thereabouts for allocated loss adjustment expense. When considering materials, such as lumber, floor coverings, windows, steel, marble or granite, you need to take into account increased inflation rates. Then, you should consider which of these items are imported. For example, Canada represents roughly 85% of all US softwood lumber imports. This added dimension further complicates the calculation of future loss costs. Additionally, if there's another major catastrophe in 2025 beyond the January wildfires, we could see demand surge, supply constraints and further inflation, which may also lead to extended business interruption. Lastly, insurance companies need to monitor the effects of sales, payroll and other factors to calculate the potential impact on future premiums, if any. We will continue to monitor the implications for our business as more information becomes available. Before I close, I want to touch on the financial targets that we announced on Investor Day. These are multi-year goals, so I'm not going to give updates every quarter, but I did want to provide some insight. Operating EPS is on track, and the key drivers for earnings growth remain favorable. We produced strong top-line growth and managed volatility in a very heavy catastrophe quarter. We are on our way to fully replacing Corebridge earnings by 2026 and we expect to achieve a 20%-plus earnings per share compound annual growth rate over the next three years. We continue to make progress towards our goal of achieving 10% to 13% core operating ROE. Our first quarter core operating ROE was 7.7%, which was impacted by catastrophe losses. We expect to meet our 2025 objective of a 10%-plus core operating ROE as we outlined on Investor Day. We've made terrific progress towards our goal of achieving an expense ratio below 30% for General Insurance with the first quarter coming in at 30.5%. We will continue our significant focus to maintain an expense structure that aligns with the size of the company that we are while investing in our data and digital strategies. And finally, turning to our dividend, we announced our intent at Investor Day to grow the dividend per share by 10%-plus in 2025 and 2026. Yesterday, the AIG Board of Directors approved a 12.5% increase in our quarterly dividend of $0.45 per share starting in the second quarter of 2025. In summary, we've entered an exciting new chapter for AIG and we're executing on all aspects of our strategy. With that, I'll turn the call over to Keith.
Keith Walsh: Thank you, Peter, and good morning. Starting with General Insurance, overall results were strong and reflected excellent underwriting and disciplined expense management. Adjusted pre-tax income, or APTI, was $979 million, a decrease of $379 million from the prior year quarter, due to higher catastrophe losses, primarily related to the California wildfires. Underwriting income was $243 million, down $353 million from the prior year quarter. Results reflect higher catastrophe losses, partially offset by favorable prior year development and continued improvement in accident year underwriting. First quarter General Insurance gross premiums written were $9 billion, an increase of 3% from the prior year, and net premiums written were $4.5 billion, an 8% increase. General Insurance combined ratio was 95.8% compared to 89.8% in the prior year quarter and included 9.1 points of CAT losses versus 1.9 points in the first quarter of 2024. Prior year development net of reinsurance was $64 million favorable, up from $22 million favorable in the prior year. This quarter included $31 million of ADC amortization and $33 million of favorable development, largely related to favorable actual versus expected loss experience in the US Property and Global Specialty lines. Looking ahead to the rest of 2025, the ADC amortization is expected to be approximately $31 million each quarter compared to $34 million a quarter in 2024. Our Global Commercial business had a terrific start to the year. Net premiums written grew 10%. We produced a combined ratio of 91.2% despite elevated CAT activity, and our expense ratio improved 40 basis points from the prior year quarter, an excellent result. North America commercial calendar year combined ratio was 93.9%, which included 12 points of CATs. The accident year combined ratio, as adjusted, was 84.3%, an improvement of 160 basis points from the first quarter of 2024. The expense ratio declined a full 2 points, driven by a combination of AIG Next benefits and increased operating leverage, partially offset by higher corporate expense allocations, as the company implemented its lean parent structure. The accident year loss ratio was 62.2% for the quarter, a 40 basis point increase year-over-year due to changes in business mix. Turning to International Commercial. The calendar year combined ratio was 88.2%. This is the eighth consecutive quarter of a sub-90% combined ratio, an outstanding result. The accident year combined ratio, as adjusted, was 85.4%, which increased 240 basis points year-over-year. This was primarily driven by a 130 basis point increase in the expense ratio as a result of lean parent allocations. The accident year loss ratio was 54.6%, a 110 basis point increase year-over-year, reflecting business mix and increased operating costs from lean parent implementation. Turning to Global Personal. The combined ratio was 107.9%, while the accident year combined ratio, as adjusted, improved 140 basis points year-over-year to 95.6%. Excluding the divested travel business, the accident year combined ratio improved 110 basis points, owing to a 190 basis point improvement in the accident year loss ratio. This was driven by underlying improvement in our US high-net-worth book, benefiting from a combination of rate over trend, business mix and underwriting actions. This was partially offset by a 70 basis point increase in our acquisition ratio, which we expect to unwind and improve over the course of 2025 as reinsurance and improved commission terms with PCS earn through. As we outlined at Investor Day, we expect to drive financial performance in Global Personal by improving the combined ratio by 500 basis points over the next three years towards our 94% target. Moving to rates, where Peter already provided some perspective. For the first quarter, excluding workers' compensation and Financial Lines, Global Commercial line's pricing, which includes rate and exposure, increased 4%. In North America Commercial, renewal rate increased 1% year-over-year. If you exclude workers' compensation and Financial Lines, renewal rate was up 2% with overall pricing up 4% year-over-year. In International Commercial, overall pricing was up 2% or up 4% excluding Financial Lines. This is an improvement versus the fourth quarter, where pricing was flat. While International Commercial overall pricing is slightly below loss cost trend, excluding Financial Lines, pricing and loss cost trend are roughly in line. Moving to Other Operations. First quarter adjusted pre-tax loss was $70 million, a significant improvement versus the prior year quarter of $205 million, reflecting substantially lower general operating expense, higher net investment income and lower interest expense. As Peter mentioned, we have achieved our Other Operations run-rate GOE target at $85 million in the first quarter and are on track for $350 million of annual expenses in 2025. We are now a much simpler company with a lean parent corporate structure that supports our three operating segments. Turning now to investment income. Our investment portfolio is high-quality and well-diversified with durations that are closely matched to our liability profile. It's predominantly comprised of investment grade fixed maturity securities, helping to minimize exposure to short-term market swings. First quarter net investment income on an APTI basis was $845 million, an increase of $4 million year-over-year. Net investment income is comprised of two categories: our core portfolio, which sits in General Insurance and income from parent liquidity and Corebridge dividends, which sits in Other Operations. First, on General Insurance. Net investment income was $736 million, down $26 million or 3% year-over-year, owing to lower income from other invested assets and alternative investments, partially offset by higher income from the fixed maturity portfolio, as we benefit from improved reinvestment rates. Other invested assets had a loss of $18 million compared to income of $38 million in the first quarter 2024. One variable worth noting is how we account for our joint venture with Tata Group. We include 26% of Tata AIG's net income in other invested assets, which also includes mark-to-market changes in their investment portfolio, which reflects capital market movements in India. It is reported under the equity accounting method with a one quarter lag. Based on our current view, we expect General Insurance total net investment income to be up modestly in the second quarter versus the $736 million in the first quarter. The gains in the fixed maturity and loan portfolio are likely to be offset by lower income from other invested assets and alternative investments. During the first quarter, the average new money yield on the fixed maturity and loan portfolio was 4.56%, roughly 135 basis points higher than sales and maturities in the quarter. The annualized yield excluding calls and prepayments was 4.11%, a 24 basis point increase year-over-year or 19 basis points sequentially. Turning to Other Operations. Net investment income was $108 million, consisting of income from our parent liquidity portfolio of $77 million and Corebridge dividend income of $31 million. Considering current interest rates and lower liquidity balances as we repurchase shares, we expect income from our parent liquidity portfolio to be around $50 million in the second quarter, subject to market conditions. Turning to tax. The adjusted effective tax rate for the first quarter was 22.8%, which included a net benefit from discrete items. As we stated on our fourth quarter earnings call, we expect the adjusted tax rate for the full year 2025 to be in line with the full year 2024 level with slight variations quarter to quarter. Moving on to the balance sheet. We continue to have strong financial flexibility. We believe this positions us well to execute on our strategic priorities while navigating evolving market conditions. Book value per share was $71.38 at quarter-end, up 10% from March 31, 2024, mainly due to the favorable impact of lower interest rates on investment AOCI. Adjusted tangible book value per share was $67.96, down 8% from March 31, 2024, primarily due to the impact of the Corebridge deconsolidation. At the end of the first quarter, we had a debt to total capital ratio of 17.1%. In conclusion, we had a strong first quarter. We expect to deliver on our target of 10%-plus core operating ROE in 2025, while making steady progress on the financial targets we outlined at our Investor Day. With that, I will turn the call back over to Peter.
Peter Zaffino: Thank you, Keith. Michelle, we're ready for questions. Thank you.
Operator: Thank you. [Operator Instructions] Our first question comes from Mike Zaremski with BMO. Your line is open.
Mike Zaremski: Hey, good morning. Thank you. I have a -- maybe a high-level question on kind of the transformation to using GenAI, et cetera. I've got a lot of questions post Investor Day on it that I'm hoping you can help out with. So, would -- I'm just kind of curious like the process for an insurer to transform using AI. Is there a high cost of entry? Does it take a long time to get your data on the right form to be able to adopt? And maybe you can kind of just talk to whether -- what you're doing is table stakes or you feel you're a first-mover or fast follower, just kind of any -- it's tough in our seats to really kind of at this stage understand kind of what it takes to do what you're doing, which doesn't seem easy.
Peter Zaffino: Sure, Mike. Thanks for the question. A few things. One is, we've been working on this for a couple of years and it all started with a foundation of what we did with AIG 200 of having terrific end-to-end process, starting to digitize all of our workflows, getting data quality and data integrity, which enabled us to start to adopt an end-to-end process that was going to enable GenAI to accelerate underwriting and how we were going to be able to assess risks. And so, we began this process, as I said, with pilots. They are no longer pilots. I think that's something I want to be very clear. We're actually going live on a couple of our lines of business. And we continue to evolve with some of the partners that we brought to Investor Day, whether it's Palantir in terms of data ingestion, of accelerating not only the quality of data but the quantity and the speed and being able to utilize large language models to recognize data patterns and recognize risk selection criteria, and our underwriters are enabled to get more information. And so, this has been something that has been highly strategic for us. We're highly committed to it. I don't know where other insurance companies are. My understanding is this is a little bit of a different way of doing it. We think it's the best-in-class way of doing it. I think it was validated by Alex and Dario, and it takes an entire organization to really buy into, the way in which we're going to do this end-to-end and believe that we are going to have the impact that we outlined on Investor Day over time, which is just to decrease cycle time, have higher-quality data and information and empower the underwriters to make decisions.
Mike Zaremski: That's helpful. My quick follow-up is, thanks for the market commentary. I wasn't sure if you gave us North America Commercial pricing metrics. Some of the competitors have talked about kind of seeing a decline in property, which has caused pricing to move down a bit as well. Is that accurate for AIG as well?
Peter Zaffino: Well, I'm going to have Don and Jon comment because I think it's a really important question, Mike. And what I would say on pricing, as always, is that, overall, a lot of times, the index doesn't really tell the story. We know that in North America, in property, we had some headwinds. And we outlined those in my prepared remarks, but still believe that the technical pricing is very strong for very good returns, and we produced those in the quarter on an underlying basis across the world. We've gotten cumulative rate increases that are substantial. You also have to take into account for us, we are a big buyer of reinsurance because we believe in that sort of cost of goods sold approach, which is we have the embedded pricing into our product, and therefore, we know what CAT is going to cost, what risk is going to cost. Our property reinsurance risk-adjusted reductions are greater than what we're seeing on the retail side. I think that's an important point. Our submission count, flight to quality, is really important. And I would also say, and I think that based on my background, I have some credibility and context in this is that when brokers are talking about what's happening in the market, they're talking about the market. And that means they're talking about a lot of insurance companies, a lot of different parts of segmentation, and then, that becomes an index as well. My view is that not all insurance companies are created equal. So, like, if you're leading, if you're setting terms, if you're pricing, you tend to have a little bit of a different outcome. And I think that we've seen that with AIG based on our retention, based on new business, based on what we believe is a flight to quality. So, I'm going to turn it over to Don now, but, again, you have to look at also our casualty was very strong, continues to be very strong after multiple years of very strong rate increases. We saw stronger rate increases in the large account than we did in the mid-market, but all casualty on an excess basis, we saw above loss cost. So, we're seeing some very positive trends in casualty. We see some opportunities for growth. We saw that in Lexington. International is a little bit more orderly, and I'll have Jon highlight that. We saw a little bit of a headwind in pricing in specialty, but that business is performing at an exceptional level. Don, do you want to put it -- I probably answered the question for you, but, like, if maybe you can just give a little bit more context in North America.
Don Bailey: Sure, Peter. Absolutely. So, as you highlighted, Peter, in your commentary, we had some very strong rate in some areas of the North American Commercial segment and definitely had some pressure in other areas. You covered a lot of that in your prepared comments and some of the comments you just offered there. But more line by line, Mike, which I can offer you too, casually, the rate, it continues to be very strong and is in excess of loss trends. We'd also say that it's probably picking up some momentum as well. In excess, we're seeing better rate in the large accounts than we are in the middle market and small. Peter just mentioned that. We've got some data now that tracks that absolutely validates that. Programs in Glatfelter are worth noting as well. Those continue to be rate positive. Again, both program businesses for us, affinity-driven, generally experienced less rate volatility than the rest of our portfolio. We've got highly-engaged distribution partners there, and there are significant growth opportunities in that space. Financial Lines, continues to be down mid-single-digits. So, the good news is we're making an adequate return on the book. Regarding public D&O rate trends, again, if you're looking for some good news, if you look at our quarter, January from a rate standpoint was the worst. March was improved, and we have some early signs that April indicates even more continued improvement. Finally, I'll just say on property, we have had cumulative rate increases over the years. We're seeing some pressure on both retail and wholesale. We'll currently look at this as the year plays out, but we're -- pricing remains above technical, which is great, but we need to see how the rest of the year is going to play out. But overall, we're really pleased with the long tail lines, Peter.
Peter Zaffino: That's great, Don. Thanks. Jon, do you want to make some comments on international rate?
Jon Hancock: Yeah. Well, you and Keith have covered a lot of this. Well, I'll repeat some of what I've said at Investor Day. We have a huge advantage on the diversity of our portfolio products, distribution, geography across the whole of international. So, we have a huge hunting ground and opportunity to divert time, resource and capital into the most attractive areas and away from the others. And that's what we're doing right now and always do, and especially as market dynamics are not the same everywhere at the same time. Now, I'd also say, Peter, you and Keith have both said this, we've got total confidence in the portfolio, the quality, the price, the loss picks, the reserves. We've got that cumulative rate rise you've been talking about with more than price adequate in every portfolio. And you can see that in the results every quarter. And our standards haven't changed, so this market is very orderly for us. Similar trends to Don and different nuances, property rate is still positive, and it's about loss trend. And our retentions are high, and we're growing. I don't think we're giving away margin and we watch that relentlessly. But the combined ratios that we deliver in International Properly -- property, that's some of the best I've seen in my career. So, we start from a very, very strong place. Like with Don here, Financial Lines is under pressure, less pressure than it was, but still under pricing pressure, but that's mainly on D&O in certain markets, not on everything, anywhere. So, our fin lines book has shrunk a bit, and our D&O book has shrunk more. But other parts of the portfolio under much less pressure, so we've got stronger retention there. Casualty varies by region, overall, very rate positive and high retention. And I will call out, and I know you've mentioned Global Specialty and Talbot, there is some rate pressure in some places, but we talked about this on Investor Day and we put some slides up on Investor Day. Those businesses are producing exceptional results quarter in, quarter out, year in, year out. Yes, Marine is still getting really good rate. We're seeing strong growth. The other class, say, there's some pressure, but we're leaders on a lot of that business in the subscription markets in specialty and Talbot. So, we work with clients to achieve sensible and sustainable terms. And where we do follow in that subscription market, much as we won't leave the market down, we won't follow it down there either.
Peter Zaffino: Yeah. That's great, Jon. Thank you very much. Next question?
Operator: Thank you. Our next question comes from Meyer Shields with KBW. Your line is open. Meyer, your line may be muted.
Meyer Shields: Sorry. Am I coming through?
Peter Zaffino: Yes.
Operator: Yes.
Meyer Shields: Okay, great. Sorry about that. Okay. So, Peter, you talked about monitoring the uncertainty associated with tariffs. In the interim, what, I guess, underwriting pricing policy administration efforts need to happen just to reflect that uncertainty as you sort of sign contracts that are going to expose you to this risk over the next 12 months?
Peter Zaffino: Thanks for the question, Meyer. There's a couple of things. One is looking at the inflation factors within lines of business that we think will be impacted, certainly, property, we tried to outline that in my prepared remarks, you could have catastrophe losses that have been modeled that will be significantly more depending on what happens with supply and also density and also sort of size of loss. So, there's so many different variables. I think looking at each of the loss cost inputs is going to be really important. An example, if I could just expand a little bit, which is what you saw really in the international loss ratio this quarter is that we're cautious and we saw the loss ratio published increase a little bit, but none of the underlying loss ratios deteriorated. We saw one side fact was that we, part of AIG Next, had unallocated loss adjustment expense that found its way into the International business that used to sit in Other Operations. But we also looked at our best estimates, no underlying loss ratio deterioration happened in the International portfolio, but we built a little bit of risk margin in International to deal with the uncertainty that could be in front of us with sort of different lines of business. And so, we are cautious. We've done this in the past where we feel very good about loss ratios, very good about margin, but we may put a little bit more margin for lines of business that we think could be potentially impacted. So, this is something that is evolving daily. What lines of business, what part of the world changes quite a bit, and we're going to be on our front foot in terms of being proactive and making sure that we have the appropriate loss cost and margin built into our pricing.
Meyer Shields: Okay, fantastic. That's very helpful. Second question, from a modeling perspective, should the remaining quarters in 2025 have the same impact of expenses moving from other operations to the GI segments?
Peter Zaffino: So, here's how I would look at it. One is like AIG Next was taking a company that was a conglomerate and simplifying the business by getting the overall organization and culture weave together, and we've accomplished that. So that that was excellent. Two is, we gave significant guidance in terms of the expenses we felt we needed to take out of the company to have a lean operating model. We call it lean parent, but it's got to be a lean company. And so, how we look at the overall expenses are really important. And I think we overachieved because the guidance we gave was, by the end of '25, we should be done with AIG Next. And you can see in Other Operations, GOE, we got there. I mean, like, we are in a place where we've accelerated our progress and feel very pleased with it. I would have expected -- it didn't happen, but I would have expected to see the businesses' expense ratios go up as they will absorb the cost, but they did a phenomenal job of taking out expenses and being proactive as more allocations and more cost came into the business that they had a straight line, ability to not really increase expenses. Now, North America benefited more from AIG Next than international did, and because of the number of countries we're in and you're thinking about IT expenses and legal expenses and other expenses to build a proper global company, more of those allocations were went into international than went into North America. So, international would have had two variables that were kind of moving against it, which is what's reflecting this GOE ratio. But I would expect over the full year -- I could have just answered your question with this sentence, but I thought I'd give you some context, is that, I wouldn't straight line it, but I would think that the expenses you saw in the first quarter ought to be what the year will look like in terms of overall GOE expense in the business.
Meyer Shields: Okay. That is perfectly helpful, and I really appreciate that context. Thank you.
Operator: Thank you. Our next question comes from Alex Scott with Barclays. Your line is open.
Alex Scott: Hi, good morning. First one I had is on the broader environment that you described and the uncertainty that it brings. And just does it change the way you'd approach the M&A environment and just the deployment of all this capital that you have available to you?
Peter Zaffino: I don't think it changes anything, Alex. Thanks for the question. We still remain very disciplined, still looking at the medium to long term for acquisitions. Is it additive to AIG? Is it additive to the company that we may acquire? Looking at the different geographies, different product lines. I think -- and we mentioned also like GenAI and investments and scale and being able to move businesses forward. It gives us great opportunities to look across the world and to see if there's going to be an acquisition that would be additive to AIG. Now, yes, we are in a world of uncertainty, but we've done so much hard work over the past three years on the capital structure side that we have low leverage, cash and we have ample, if not, slightly excess capital in our subsidiaries to grow into. And we still have ownership of Corebridge that we can pull for additional liquidity in the event that we see an acquisition. But we're going to be very careful, we'll be very cautious, and it's not something that needs to be done today. And quite frankly, I said this at Investor Day, if we go through a period of time, which I'm not going to define, that we don't see opportunities that we think are additive to AIG and our shareholders, we'll return the capital to shareholders. But right now, I think it's actually -- some of this uncertainty may actually create opportunities.
Alex Scott: Got it. That's helpful. The second question I had for you is just on the mix shift. From the outside, it's difficult at times to model things like mix shifts. And I think the catastrophe budget, in particular, has come down massively and I guess we'll continue to as you do this mix shift in North America Commercial in particular. So, I know you already gave us some help by quantifying some of these things. I think, based on some of the disclosures you gave earlier, we might even be able to back into a cap budget. But I was hoping maybe you could just help us understand that mix shift, how should we think about the impact on underlying versus all-in combined ratio.
Peter Zaffino: First quarter is hard because of property. And it's when we do our catastrophes, it's a net premium written. I think in the past, what's happened is you could even have negative net premium just based on your seeding out more on an NPW basis than what you'd be writing in the quarter. I think that will start to sort of level out. We don't have a lot of catastrophe purchased within the second, third or fourth quarter. I think we're talking about mix of business. Look, the current environment of property in North America, because International is doing just fine, posting tremendous combined ratios, showing some small growth. But if we saw in the first quarter, that would continue, we are going to reduce our gross writings in property and the market will come back to us. I mean, we haven't even entered CAT season yet. So, I'd like to, as I always say, declare about property at the end of the year, not before CAT season. But I think what's reflected really in the reinsurance is just that the AIG in the past would probably have to pay a little bit more because of the quality of data, the quality of the portfolio. We've been moving forward with that over multiple years and I think that's what was reflected in 2025. The mix of business when we reference it, so property remains slight growth on an underlying basis and we're moving more casualty business into the portfolio of the net premium written. Those -- the combined ratios and the loss ratios are higher. So, I think that's really what we're trying to signal is that we had a tremendous growth in Lexington mid-market casualty, but that loss ratio will be higher than what we would expect for property attritional. And so, as that mix changes, you can see the loss ratios reflect that. That's what we're really referencing.
Alex Scott: Got it. Helpful. Thank you.
Peter Zaffino: Thanks.
Operator: Thank you. Our next question comes from Andrew Anderson with Jefferies. Your line is open.
Andrew Anderson: Hey, good morning. Just looking at the underlying results in North America Commercial, they seem pretty strong. Is there an opportunity to take more business net here?
Peter Zaffino: Yes, there is. I don't think we would want to, though, because how we look at Property CAT, it is a global risk appetite volatility that we're willing to take. And I think what I referenced, and when the script comes out, like we should read it again, how low nets we have going forward in North America Property, because we buy occurrence in aggregate and the volatility is massively reduced for AIG over the course of four quarters. And so, we like that volatility reduction. We like it priced into the business. And then on Casualty, I know it was probably a massive eye chart at Investor Day with the amount of reinstatements we have and what does the vertical limits do. We don't buy a lot of proportional reinsurance in North America on Casualty. We buy excess of loss. And I think in this environment with large jury verdicts, vertical exposures, I don't think it's prudent to take any more net there. And so, I think we feel really comfortable with the reinsurance structure that we have in North America. And as you pointed out, the combined ratios have improved dramatically and really like the core fundamentals of the business the way it is today.
Andrew Anderson: Thank you. And then just on North America Commercial, ex comp, ex Financial Lines pricing, 4% RPC. I guess that's on a gross basis, perhaps a little bit better net. I guess, where I'm going with this is, I would think that's below loss trend, but perhaps with terms and conditions and maybe some mix shift, it sounds like in your commentary you're not really thinking of underlying loss ratio deterioration here.
Peter Zaffino: No, I'm not. I mean, as I said, it's really being driven more by property. Property was a big negative on the weighted average. But on the other lines of business, again, we're going to watch financial lines. Don had some really good comments on that. Casualties above loss trend. Gladfelter, as we look across the portfolio, it was really just property that was below loss trend and we'll see how that plays out, but are confident that it's above our technical and also that it's not sustainable to have these type of rate decreases over a long period of time. So, we'd end up pulling back in the event that it stayed that way. But submission count is great. I think there's a lot of opportunities. Retention is good and we still think that the property line for us is going to perform very strong. And just one other data point is that in the first quarter, our International Property is as big as our North America Property. And so, I just want to make sure that we remember that, overall, we have opportunities -- if North America becomes aggressive, we have a lot of points of entry in property and the risk-adjusted returns in International are just fantastic and we'll continue to grow there. But...
Andrew Anderson: Thank you.
Peter Zaffino: Thanks. We have one more question.
Operator: Our next question comes from Brian Meredith with UBS. Your line is open.
Brian Meredith: Yeah. Thanks for fitting me in. Peter, just curious on North American Commercial growth, just wanted to unpack it a little bit. Is it possible to get maybe what gross written premiums growth was there? Just try to understand the impact of the ceded reinsurance on the growth rate. Just kind of thinking about how sustainable is that growth in the near term that you saw in North America Commercial?
Peter Zaffino: Yeah. So, Brian, the first quarter was benefited from some reinsurance on property. And I think that the growth would be largely reflecting the net, absent property that I mentioned. So, the casualty for Lexington is very close to what it would be on the net. When we had identified -- when we talked about Glatfelter, Glatfelter benefited a little bit from some of the reinsurance, but still had a very strong growth, as did our program business. Don outlined programs at great length at Investor Day. We're doing less programs. We've taken the best practices of Glatfelter and built it out. But I would say those largely, the gross and the nets, were not too far off. It was just really property that benefited. What I just wanted to signal is that you see sort of the rate environment and why you're growing in property, well, we really aren't growing on the gross. As a matter of fact, in Lexington Property, in the gross we contracted, and retail gross slight increase, but the net was really more reflective of the reinsurance on property. Do you want to say something, Don?
Don Bailey: I would just validate that, yeah, the underlying portfolio is strong, it's double-digits on a net basis.
Brian Meredith: Great. So, nothing unusual in the first quarter? I mean, this is good solid growth you're seeing is sustainable here for at least in the near term, unless, of course, some other property competitor or something else comes up?
Peter Zaffino: Yeah. I think, look, you probably won't see the same property effect in the future because we're not going to have as much reinsurance. So, I think those nets will come down. But the rest of the portfolio should reflect, as Don said, really strong new business, strong retention. We'll watch each line of business and make sure we're growing where we want to grow, but still think there's growth opportunities.
Brian Meredith: Got you. And then, one last one, Peter. Any updated thoughts on what casualty loss trend is looking like here? A couple of positive developments, I think in Georgia and some areas as far as legislation goes. Maybe thoughts on that?
Peter Zaffino: We'll watch it, Brian. We have not adjusted any of our loss costs and inflation factors on casualty, and we'll probably look at it in the sort of mid-year, but so far, we're keeping it where it was.
Brian Meredith: Perfect. Thank you.
Peter Zaffino: Okay. Thanks everybody for joining us today. Really appreciate it. Have a great day and great weekend.
Operator: Thank you for your participation. This does conclude the program and you may now disconnect. Everyone, have a great day. | [
{
"speaker": "Operator",
"text": "Good day, and welcome to AIG's First Quarter 2025 Financial Results Conference Call. This conference is being recorded. Now, at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"text": "Thanks very much, and good morning. Today's remarks may include forward-looking statements which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Following the deconsolidation of Corebridge Financial on June 9, 2024, the historical results of Corebridge for all periods presented are reflected in AIG's consolidated financial statements as discontinued operations in accordance with US GAAP. Finally, today's remarks related to net premiums written and net premiums earned are presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis and adjusted for the sale of the global personal travel and assistance business as applicable. We believe this presentation provides the most useful view of our results and the go-forward business in light of the substantial changes to the portfolio since 2023. Please refer to Pages 26 of the earnings presentation for reconciliations of such metrics on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino."
},
{
"speaker": "Peter Zaffino",
"text": "Good morning, and thank you for joining us today to review our first quarter 2025 financial results. AIG's overall performance in the quarter was exceptional and we continued to make significant progress on our strategic, operational and financial objectives. We had a very busy start to the year. And while it's hard to believe, just 30 days ago, we hosted our Investor Day. We're incredibly grateful for the positive engagement and support from our colleagues and many stakeholders and appreciated the opportunity to share our journey with them. For my prepared remarks, I will start with an overview of our Investor Day, including what we intend to achieve, some observations from the meeting, and what we've learned since. Second, I will highlight our first quarter financial results. Third, I want to provide a spotlight on our business strategy and long-term view of India, a business that we briefly touched on at our Investor Day. Fourth, given the widespread interest, I will offer a few observations on the impact of tariffs. And last, I'll provide an update on our progress toward our financial targets that we outlined at our Investor Day. Keith will then provide more detail on our financial results, and Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Beginning with Investor Day, our objective was to demonstrate the incredible progress the company has made over the last seven years and why we believe we're so well-positioned for the future. We shared how we established an underwriting culture of excellence, substantially reduced underwriting exposure, controlled volatility, structured the company for the future, refreshed our purpose and values, developed a world-class end-to-end operating structure, digitized end-to-end processes, developed a robust data hierarchy, and retired over 1,200 applications while migrating to the cloud. We discussed how we created a lean parent company and strengthened our balance sheet while executing a disciplined capital management strategy, which will enable AIG to have maximum strategic and financial flexibility for the future. We provided detail on our strategy to deploy GenAI end-to-end, and to demonstrate how the advancement in adoption is making a difference across our business to drive future growth, and that was on full display. I'm very grateful to our world-class partners, Alex Karp of Palantir and Dario Amodei of Anthropic, for joining Sara Eisen and me on stage to showcase and validate our strategy. And while they are very entertaining guests and have better things to do with their time than show up at AIG's Investor Day, they felt compelled to speak to our stakeholders about how they fully endorse AIG's strategy. It was a very important moment for our company. We demonstrated the breadth and depth of our global portfolio with $24 billion of net premiums written, which enables us to leverage both our diverse geographic footprint and strong product offerings to solve our clients' risk needs. We highlighted what a thoughtful and carefully planned reinsurance strategy can do for company over time, showcasing key structures of our portfolio and providing an introduction to our special purpose vehicle backed by Blackstone, which is an important part of our strategic evolution. Our stakeholders came away from the event with a much clearer understanding of our strategic direction, the deep expertise within our company, our differentiated approach to GenAI and our ambitious yet achievable financial targets and global growth opportunities. Inside the company, there's a sense of confidence and pride. Our Investor Day gave our colleagues the opportunity to see their hard work recognized in an impactful way, which has generated energy and engagement across the organization and we're excited to take this momentum forward. If I had to choose just one key takeaway from our Investor Day, it is that AIG is in every way a different company. Turning to our financial results, against the challenging geopolitical and macroeconomic environment, we made excellent progress towards our long-term strategic and financial goals, while delivering exceptional underwriting results, effectively manage volatility, while reducing expenses. In the first quarter, adjusted after-tax income was $702 million or $1.17 per diluted share. Building on our momentum, we had another quarter of strong premium growth. Net premiums written were $4.5 billion, an increase of 8% year-over-year on a comparable basis, led by 10% growth in Global Commercial. North America Commercial Insurance net premiums written grew 14% year-over-year. Lexington grew 23%, led by Lexington Casualty, which grew 27%. It's worth noting that Lexington submission growth continued in the first quarter, increasing 30% year-over-year, and that is following an increase of over 50% in the first quarter of 2024 when compared to 2023. Simply an outstanding result. This increase in submission activity was primarily driven by middle market casualty and property, which together represents two-thirds of the total submissions received. Glatfelter contributed 16% growth and Retail Property grew over 40%, almost entirely driven by the significant enhancements to our reinsurance structures. International Commercial Insurance net premiums written grew 8% year-over-year on an FX-adjusted basis, driven by property at 35%, largely as a result of enhanced reinsurance structures. And Marine grew an impressive 17%. Turning to expenses, our general insurance expense ratio decreased to 30.5% in the first quarter compared to 31.8% in the prior year quarter. The divestiture of our travel business was the largest contributor to this improvement, accounting for 110 basis points. The remaining 20 basis points of improvement came from AIG Next initiatives. This is very impressive when you consider that General Insurance absorbed $78 million of additional expenses that were booked in Other Operations in 2024. Other Operations general operating expenses were $85 million in the quarter. The accident year combined ratio, as adjusted, was 87.8%, the best first quarter result for AIG since the financial crisis. The prior year quarter was 88.4%. The calendar year combined ratio was 95.8% for the quarter, which included $520 million in catastrophe losses, driven by the California wildfires, which came in at $460 million. The combined ratio represented 9.1 loss ratio points and is a testament to our strategy for managing volatility. While industry losses from natural catastrophes are the second highest for the first quarter of the year on record, we expect our net retained catastrophe losses to be within expectations for 2025, largely based on our reinsurance structures. If you apply our current loss projections for the wildfire catastrophe to our aggregate cover, we will have approximately $35 million net of annual aggregate deductible remaining for all other perils in North America, excluding wind and earthquake, and approximately $385 million net left for all perils, both subject to a $50 million each and every loss deductible for the rest of this calendar year. We also continue to have significant property catastrophe occurrence limit available. Overall, the market remained favorable in the first quarter, particularly in segments with very good underlying fundamentals. Keith is going to cover rate in more detail in his remarks, but I wanted to provide some perspective. For North America, the rate increases in the quarter were led by excess casualty at 16%. In the last five calendar years, excess casualty has had double-digit rate increases each year with cumulative rate above loss trend. Gladfelter had a 6% rate increase. These increases were offset by Financial Lines, which decreased 5%, Retail Property, which decreased 7%, and Lexington Property, which decreased 10%. In Financial Lines, we have the benefit of a highly diversified business by product and segment. This enables us to position the portfolio for the best risk-adjusted returns even in a competitive market. To further outline, we have meaningfully reduced our excess capacity, where pricing is increasingly commoditized. We're focused on our primary business where we have a differentiated offering and a leadership position. Our Financial Lines portfolio has gone from representing 30% of North America Commercial net premiums written in 2021 to representing 19% of the portfolio today. Next, let me give some context on property rate. Over the past five years, we have had cumulative rate increases of 113% in Retail Property and 96% in Wholesale Property. Pricing continues to be above our technical view, nonetheless, we continue to be very disciplined and we'll monitor market conditions throughout the year. In International, the environment was more balanced. Casualty had a 7% rate increase, Property had a 2% rate increase, offset by Global Specialty and Talbot, which decreased 1% and 4%, respectively, and Financial Lines, which decreased by 3%. And please recall that we report rate on gross premiums written. And because many of our lines are heavily impacted by reinsurance in the first quarter, there's not a direct correlation to net premiums written, which are lower in certain businesses, such as our Global Specialty business. Turning to capital management, we returned $2.5 billion of capital to shareholders in the first quarter. This included $2.2 billion of share repurchases and $234 million of dividends. We ended the quarter with a debt to total capital ratio of 17.1% and parent liquidity of $4.9 billion. As I announced on Investor Day, as of April 1, the AIG Board of Directors increased our share repurchase authorization to $7.5 billion, inclusive of the outstanding authorization amount, of which approximately $7.1 billion remains available. Additionally, the Board approved a 12.5% increase in our quarterly dividend of $0.45 per share yesterday. We expect to repurchase a total of $5 billion to $6 billion of shares in 2025, subject to share price and market conditions, which should bring us to a range of 500 million to 550 million shares outstanding over time. Now, I'd like to transition to discuss one of our strategic partnerships. While we covered a lot of content on Investor Day, one part of our business that we did not address in any detail is Tata AIG. With this in mind, I'd like to share some observations on the rapidly growing market in India and insights about our joint venture with the Tata Group. India as a country has made remarkable progress over the last decade. Over that time, the economy has grown from the 10th largest to the 5th largest economy in the world and is likely to become the third largest economy after the United States and China by 2030. Real GDP is estimated to grow approximately 7% over the next two years with nominal GDP growing nearly two times higher. The changing demographics in India are well known, but worth highlighting. In a country of nearly 1.5 billion people, half of the population is below the age of 30. The middle-class is projected to more than double by 2030 with some of the fastest growth happening in Tier-3 and Tier-4 cities. Pivoting to the insurance industry, the general insurance market in India is over $35 billion in gross premiums written as of 2023 and had a compound annual growth rate of around 11% over the last five years. We expect the market will sustain this type of growth through 2030. And there's a massive opportunity for growth, given the changing dynamics. In India, non-life insurance penetration is still relatively low at 1% of GDP. In contrast, the United States is at 9% of GDP. Our presence in India began 25 years ago when we partnered with Tata Group to establish a joint venture, Tata AIG. The India insurance market opened to private insurance companies and direct foreign investment in 2000. At the time, the maximum allowable foreign investment was 26%, which is what we currently hold today. Prior to 2000, India's insurance market was dominated by public sector insurance companies, which had 100% market share. Opening up the market to private insurance and foreign direct investment dramatically shifted India's insurance landscape. Today, private sector insurance companies represent 60% of the non-life market. While India offers tremendous opportunity, it's a complex and highly competitive market. For foreign companies, it's important to choose the right partner, a company with deep and broad knowledge of India and one with a strong reputation. For AIG, there is no better choice than Tata Group, one of the highest quality global companies. Tata Group operates 30 companies in over 100 countries across diverse industries. Its 26 publicly listed enterprises have a combined market cap of $365 billion with over 1 million employees. Over the last decade, Tata Group has been consistently ranked as one of India's most valuable brands. Tata AIG is highly respected and is ranked as the #2 private insurer in the commercial insurance and motor insurance sectors. It serves 27 million customers with 8,500 employees and leverages 85,000 captive agents operating across the country. Tata AIG had $2.1 billion of gross premiums written in 2024 and its mix of business is approximately 75% personal insurance and 25% commercial insurance. Tata AIG is a high-growth business. From 2020 to 2025, we had a compound annual growth rate of 20%, outpacing the market. Through 2030, we expect to continue to grow at the same compound annual growth rate, fueled by India's accelerating economy, rising insurance adoption and Tata AIG's market-leading brand and reputation. The business has exceptional technology and data capabilities that enabled it to scale rapidly and support the continued ambition for accelerated growth. Tata AIG's products and services are digital-first with clients and agents enabled by technology at every stage of the value chain, providing a complete digital customer experience, which is what clients in India expect. Additionally, Tata AIG benefits from access to AIG's multinational network with AIG supporting the joint venture's domestic multinational corporate clients. In close partnership with Tata Group, we're prepared to significantly invest in growth organically and possibly inorganically, should opportunities present themselves. And I expect this business to continue to scale faster than any other geography in our portfolio. There's been a lot of discussion about tariffs and I'd like to share a perspective, understanding that there is still significant uncertainty around the topic of tariffs. To start, let me provide some relevant facts. First, there are only seven countries worldwide that export more than $100 billion to the United States. And China, Canada and Mexico are the only countries that export over $250 billion. When looking at a country's level of exports to the United States as a percentage of their total exports, Mexico is 79%, Canada is 74% and China is less than 20%. Altogether, tariffs create uncertainty, which may lead to lower levels of transactional activity in the near term, impacting certain commercial businesses, but it's premature to predict any specific outcomes related to these emerging macro trends. The greatest challenge for companies is understanding the real impact of tariffs and how they are changing and their implications. There is a complexity not only with tariff policies evolving, but also with the potential impact on supply chains. It's also important to consider the implications to loss costs and inflation. To help parse through this complexity, let me share a property example. Typically, in a high net worth claim and, of course, it's subject to the particular type of loss, approximately 60% of the loss would be for rebuilding costs, 30% for content and 10% or thereabouts for allocated loss adjustment expense. When considering materials, such as lumber, floor coverings, windows, steel, marble or granite, you need to take into account increased inflation rates. Then, you should consider which of these items are imported. For example, Canada represents roughly 85% of all US softwood lumber imports. This added dimension further complicates the calculation of future loss costs. Additionally, if there's another major catastrophe in 2025 beyond the January wildfires, we could see demand surge, supply constraints and further inflation, which may also lead to extended business interruption. Lastly, insurance companies need to monitor the effects of sales, payroll and other factors to calculate the potential impact on future premiums, if any. We will continue to monitor the implications for our business as more information becomes available. Before I close, I want to touch on the financial targets that we announced on Investor Day. These are multi-year goals, so I'm not going to give updates every quarter, but I did want to provide some insight. Operating EPS is on track, and the key drivers for earnings growth remain favorable. We produced strong top-line growth and managed volatility in a very heavy catastrophe quarter. We are on our way to fully replacing Corebridge earnings by 2026 and we expect to achieve a 20%-plus earnings per share compound annual growth rate over the next three years. We continue to make progress towards our goal of achieving 10% to 13% core operating ROE. Our first quarter core operating ROE was 7.7%, which was impacted by catastrophe losses. We expect to meet our 2025 objective of a 10%-plus core operating ROE as we outlined on Investor Day. We've made terrific progress towards our goal of achieving an expense ratio below 30% for General Insurance with the first quarter coming in at 30.5%. We will continue our significant focus to maintain an expense structure that aligns with the size of the company that we are while investing in our data and digital strategies. And finally, turning to our dividend, we announced our intent at Investor Day to grow the dividend per share by 10%-plus in 2025 and 2026. Yesterday, the AIG Board of Directors approved a 12.5% increase in our quarterly dividend of $0.45 per share starting in the second quarter of 2025. In summary, we've entered an exciting new chapter for AIG and we're executing on all aspects of our strategy. With that, I'll turn the call over to Keith."
},
{
"speaker": "Keith Walsh",
"text": "Thank you, Peter, and good morning. Starting with General Insurance, overall results were strong and reflected excellent underwriting and disciplined expense management. Adjusted pre-tax income, or APTI, was $979 million, a decrease of $379 million from the prior year quarter, due to higher catastrophe losses, primarily related to the California wildfires. Underwriting income was $243 million, down $353 million from the prior year quarter. Results reflect higher catastrophe losses, partially offset by favorable prior year development and continued improvement in accident year underwriting. First quarter General Insurance gross premiums written were $9 billion, an increase of 3% from the prior year, and net premiums written were $4.5 billion, an 8% increase. General Insurance combined ratio was 95.8% compared to 89.8% in the prior year quarter and included 9.1 points of CAT losses versus 1.9 points in the first quarter of 2024. Prior year development net of reinsurance was $64 million favorable, up from $22 million favorable in the prior year. This quarter included $31 million of ADC amortization and $33 million of favorable development, largely related to favorable actual versus expected loss experience in the US Property and Global Specialty lines. Looking ahead to the rest of 2025, the ADC amortization is expected to be approximately $31 million each quarter compared to $34 million a quarter in 2024. Our Global Commercial business had a terrific start to the year. Net premiums written grew 10%. We produced a combined ratio of 91.2% despite elevated CAT activity, and our expense ratio improved 40 basis points from the prior year quarter, an excellent result. North America commercial calendar year combined ratio was 93.9%, which included 12 points of CATs. The accident year combined ratio, as adjusted, was 84.3%, an improvement of 160 basis points from the first quarter of 2024. The expense ratio declined a full 2 points, driven by a combination of AIG Next benefits and increased operating leverage, partially offset by higher corporate expense allocations, as the company implemented its lean parent structure. The accident year loss ratio was 62.2% for the quarter, a 40 basis point increase year-over-year due to changes in business mix. Turning to International Commercial. The calendar year combined ratio was 88.2%. This is the eighth consecutive quarter of a sub-90% combined ratio, an outstanding result. The accident year combined ratio, as adjusted, was 85.4%, which increased 240 basis points year-over-year. This was primarily driven by a 130 basis point increase in the expense ratio as a result of lean parent allocations. The accident year loss ratio was 54.6%, a 110 basis point increase year-over-year, reflecting business mix and increased operating costs from lean parent implementation. Turning to Global Personal. The combined ratio was 107.9%, while the accident year combined ratio, as adjusted, improved 140 basis points year-over-year to 95.6%. Excluding the divested travel business, the accident year combined ratio improved 110 basis points, owing to a 190 basis point improvement in the accident year loss ratio. This was driven by underlying improvement in our US high-net-worth book, benefiting from a combination of rate over trend, business mix and underwriting actions. This was partially offset by a 70 basis point increase in our acquisition ratio, which we expect to unwind and improve over the course of 2025 as reinsurance and improved commission terms with PCS earn through. As we outlined at Investor Day, we expect to drive financial performance in Global Personal by improving the combined ratio by 500 basis points over the next three years towards our 94% target. Moving to rates, where Peter already provided some perspective. For the first quarter, excluding workers' compensation and Financial Lines, Global Commercial line's pricing, which includes rate and exposure, increased 4%. In North America Commercial, renewal rate increased 1% year-over-year. If you exclude workers' compensation and Financial Lines, renewal rate was up 2% with overall pricing up 4% year-over-year. In International Commercial, overall pricing was up 2% or up 4% excluding Financial Lines. This is an improvement versus the fourth quarter, where pricing was flat. While International Commercial overall pricing is slightly below loss cost trend, excluding Financial Lines, pricing and loss cost trend are roughly in line. Moving to Other Operations. First quarter adjusted pre-tax loss was $70 million, a significant improvement versus the prior year quarter of $205 million, reflecting substantially lower general operating expense, higher net investment income and lower interest expense. As Peter mentioned, we have achieved our Other Operations run-rate GOE target at $85 million in the first quarter and are on track for $350 million of annual expenses in 2025. We are now a much simpler company with a lean parent corporate structure that supports our three operating segments. Turning now to investment income. Our investment portfolio is high-quality and well-diversified with durations that are closely matched to our liability profile. It's predominantly comprised of investment grade fixed maturity securities, helping to minimize exposure to short-term market swings. First quarter net investment income on an APTI basis was $845 million, an increase of $4 million year-over-year. Net investment income is comprised of two categories: our core portfolio, which sits in General Insurance and income from parent liquidity and Corebridge dividends, which sits in Other Operations. First, on General Insurance. Net investment income was $736 million, down $26 million or 3% year-over-year, owing to lower income from other invested assets and alternative investments, partially offset by higher income from the fixed maturity portfolio, as we benefit from improved reinvestment rates. Other invested assets had a loss of $18 million compared to income of $38 million in the first quarter 2024. One variable worth noting is how we account for our joint venture with Tata Group. We include 26% of Tata AIG's net income in other invested assets, which also includes mark-to-market changes in their investment portfolio, which reflects capital market movements in India. It is reported under the equity accounting method with a one quarter lag. Based on our current view, we expect General Insurance total net investment income to be up modestly in the second quarter versus the $736 million in the first quarter. The gains in the fixed maturity and loan portfolio are likely to be offset by lower income from other invested assets and alternative investments. During the first quarter, the average new money yield on the fixed maturity and loan portfolio was 4.56%, roughly 135 basis points higher than sales and maturities in the quarter. The annualized yield excluding calls and prepayments was 4.11%, a 24 basis point increase year-over-year or 19 basis points sequentially. Turning to Other Operations. Net investment income was $108 million, consisting of income from our parent liquidity portfolio of $77 million and Corebridge dividend income of $31 million. Considering current interest rates and lower liquidity balances as we repurchase shares, we expect income from our parent liquidity portfolio to be around $50 million in the second quarter, subject to market conditions. Turning to tax. The adjusted effective tax rate for the first quarter was 22.8%, which included a net benefit from discrete items. As we stated on our fourth quarter earnings call, we expect the adjusted tax rate for the full year 2025 to be in line with the full year 2024 level with slight variations quarter to quarter. Moving on to the balance sheet. We continue to have strong financial flexibility. We believe this positions us well to execute on our strategic priorities while navigating evolving market conditions. Book value per share was $71.38 at quarter-end, up 10% from March 31, 2024, mainly due to the favorable impact of lower interest rates on investment AOCI. Adjusted tangible book value per share was $67.96, down 8% from March 31, 2024, primarily due to the impact of the Corebridge deconsolidation. At the end of the first quarter, we had a debt to total capital ratio of 17.1%. In conclusion, we had a strong first quarter. We expect to deliver on our target of 10%-plus core operating ROE in 2025, while making steady progress on the financial targets we outlined at our Investor Day. With that, I will turn the call back over to Peter."
},
{
"speaker": "Peter Zaffino",
"text": "Thank you, Keith. Michelle, we're ready for questions. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question comes from Mike Zaremski with BMO. Your line is open."
},
{
"speaker": "Mike Zaremski",
"text": "Hey, good morning. Thank you. I have a -- maybe a high-level question on kind of the transformation to using GenAI, et cetera. I've got a lot of questions post Investor Day on it that I'm hoping you can help out with. So, would -- I'm just kind of curious like the process for an insurer to transform using AI. Is there a high cost of entry? Does it take a long time to get your data on the right form to be able to adopt? And maybe you can kind of just talk to whether -- what you're doing is table stakes or you feel you're a first-mover or fast follower, just kind of any -- it's tough in our seats to really kind of at this stage understand kind of what it takes to do what you're doing, which doesn't seem easy."
},
{
"speaker": "Peter Zaffino",
"text": "Sure, Mike. Thanks for the question. A few things. One is, we've been working on this for a couple of years and it all started with a foundation of what we did with AIG 200 of having terrific end-to-end process, starting to digitize all of our workflows, getting data quality and data integrity, which enabled us to start to adopt an end-to-end process that was going to enable GenAI to accelerate underwriting and how we were going to be able to assess risks. And so, we began this process, as I said, with pilots. They are no longer pilots. I think that's something I want to be very clear. We're actually going live on a couple of our lines of business. And we continue to evolve with some of the partners that we brought to Investor Day, whether it's Palantir in terms of data ingestion, of accelerating not only the quality of data but the quantity and the speed and being able to utilize large language models to recognize data patterns and recognize risk selection criteria, and our underwriters are enabled to get more information. And so, this has been something that has been highly strategic for us. We're highly committed to it. I don't know where other insurance companies are. My understanding is this is a little bit of a different way of doing it. We think it's the best-in-class way of doing it. I think it was validated by Alex and Dario, and it takes an entire organization to really buy into, the way in which we're going to do this end-to-end and believe that we are going to have the impact that we outlined on Investor Day over time, which is just to decrease cycle time, have higher-quality data and information and empower the underwriters to make decisions."
},
{
"speaker": "Mike Zaremski",
"text": "That's helpful. My quick follow-up is, thanks for the market commentary. I wasn't sure if you gave us North America Commercial pricing metrics. Some of the competitors have talked about kind of seeing a decline in property, which has caused pricing to move down a bit as well. Is that accurate for AIG as well?"
},
{
"speaker": "Peter Zaffino",
"text": "Well, I'm going to have Don and Jon comment because I think it's a really important question, Mike. And what I would say on pricing, as always, is that, overall, a lot of times, the index doesn't really tell the story. We know that in North America, in property, we had some headwinds. And we outlined those in my prepared remarks, but still believe that the technical pricing is very strong for very good returns, and we produced those in the quarter on an underlying basis across the world. We've gotten cumulative rate increases that are substantial. You also have to take into account for us, we are a big buyer of reinsurance because we believe in that sort of cost of goods sold approach, which is we have the embedded pricing into our product, and therefore, we know what CAT is going to cost, what risk is going to cost. Our property reinsurance risk-adjusted reductions are greater than what we're seeing on the retail side. I think that's an important point. Our submission count, flight to quality, is really important. And I would also say, and I think that based on my background, I have some credibility and context in this is that when brokers are talking about what's happening in the market, they're talking about the market. And that means they're talking about a lot of insurance companies, a lot of different parts of segmentation, and then, that becomes an index as well. My view is that not all insurance companies are created equal. So, like, if you're leading, if you're setting terms, if you're pricing, you tend to have a little bit of a different outcome. And I think that we've seen that with AIG based on our retention, based on new business, based on what we believe is a flight to quality. So, I'm going to turn it over to Don now, but, again, you have to look at also our casualty was very strong, continues to be very strong after multiple years of very strong rate increases. We saw stronger rate increases in the large account than we did in the mid-market, but all casualty on an excess basis, we saw above loss cost. So, we're seeing some very positive trends in casualty. We see some opportunities for growth. We saw that in Lexington. International is a little bit more orderly, and I'll have Jon highlight that. We saw a little bit of a headwind in pricing in specialty, but that business is performing at an exceptional level. Don, do you want to put it -- I probably answered the question for you, but, like, if maybe you can just give a little bit more context in North America."
},
{
"speaker": "Don Bailey",
"text": "Sure, Peter. Absolutely. So, as you highlighted, Peter, in your commentary, we had some very strong rate in some areas of the North American Commercial segment and definitely had some pressure in other areas. You covered a lot of that in your prepared comments and some of the comments you just offered there. But more line by line, Mike, which I can offer you too, casually, the rate, it continues to be very strong and is in excess of loss trends. We'd also say that it's probably picking up some momentum as well. In excess, we're seeing better rate in the large accounts than we are in the middle market and small. Peter just mentioned that. We've got some data now that tracks that absolutely validates that. Programs in Glatfelter are worth noting as well. Those continue to be rate positive. Again, both program businesses for us, affinity-driven, generally experienced less rate volatility than the rest of our portfolio. We've got highly-engaged distribution partners there, and there are significant growth opportunities in that space. Financial Lines, continues to be down mid-single-digits. So, the good news is we're making an adequate return on the book. Regarding public D&O rate trends, again, if you're looking for some good news, if you look at our quarter, January from a rate standpoint was the worst. March was improved, and we have some early signs that April indicates even more continued improvement. Finally, I'll just say on property, we have had cumulative rate increases over the years. We're seeing some pressure on both retail and wholesale. We'll currently look at this as the year plays out, but we're -- pricing remains above technical, which is great, but we need to see how the rest of the year is going to play out. But overall, we're really pleased with the long tail lines, Peter."
},
{
"speaker": "Peter Zaffino",
"text": "That's great, Don. Thanks. Jon, do you want to make some comments on international rate?"
},
{
"speaker": "Jon Hancock",
"text": "Yeah. Well, you and Keith have covered a lot of this. Well, I'll repeat some of what I've said at Investor Day. We have a huge advantage on the diversity of our portfolio products, distribution, geography across the whole of international. So, we have a huge hunting ground and opportunity to divert time, resource and capital into the most attractive areas and away from the others. And that's what we're doing right now and always do, and especially as market dynamics are not the same everywhere at the same time. Now, I'd also say, Peter, you and Keith have both said this, we've got total confidence in the portfolio, the quality, the price, the loss picks, the reserves. We've got that cumulative rate rise you've been talking about with more than price adequate in every portfolio. And you can see that in the results every quarter. And our standards haven't changed, so this market is very orderly for us. Similar trends to Don and different nuances, property rate is still positive, and it's about loss trend. And our retentions are high, and we're growing. I don't think we're giving away margin and we watch that relentlessly. But the combined ratios that we deliver in International Properly -- property, that's some of the best I've seen in my career. So, we start from a very, very strong place. Like with Don here, Financial Lines is under pressure, less pressure than it was, but still under pricing pressure, but that's mainly on D&O in certain markets, not on everything, anywhere. So, our fin lines book has shrunk a bit, and our D&O book has shrunk more. But other parts of the portfolio under much less pressure, so we've got stronger retention there. Casualty varies by region, overall, very rate positive and high retention. And I will call out, and I know you've mentioned Global Specialty and Talbot, there is some rate pressure in some places, but we talked about this on Investor Day and we put some slides up on Investor Day. Those businesses are producing exceptional results quarter in, quarter out, year in, year out. Yes, Marine is still getting really good rate. We're seeing strong growth. The other class, say, there's some pressure, but we're leaders on a lot of that business in the subscription markets in specialty and Talbot. So, we work with clients to achieve sensible and sustainable terms. And where we do follow in that subscription market, much as we won't leave the market down, we won't follow it down there either."
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. That's great, Jon. Thank you very much. Next question?"
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Meyer Shields with KBW. Your line is open. Meyer, your line may be muted."
},
{
"speaker": "Meyer Shields",
"text": "Sorry. Am I coming through?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes."
},
{
"speaker": "Operator",
"text": "Yes."
},
{
"speaker": "Meyer Shields",
"text": "Okay, great. Sorry about that. Okay. So, Peter, you talked about monitoring the uncertainty associated with tariffs. In the interim, what, I guess, underwriting pricing policy administration efforts need to happen just to reflect that uncertainty as you sort of sign contracts that are going to expose you to this risk over the next 12 months?"
},
{
"speaker": "Peter Zaffino",
"text": "Thanks for the question, Meyer. There's a couple of things. One is looking at the inflation factors within lines of business that we think will be impacted, certainly, property, we tried to outline that in my prepared remarks, you could have catastrophe losses that have been modeled that will be significantly more depending on what happens with supply and also density and also sort of size of loss. So, there's so many different variables. I think looking at each of the loss cost inputs is going to be really important. An example, if I could just expand a little bit, which is what you saw really in the international loss ratio this quarter is that we're cautious and we saw the loss ratio published increase a little bit, but none of the underlying loss ratios deteriorated. We saw one side fact was that we, part of AIG Next, had unallocated loss adjustment expense that found its way into the International business that used to sit in Other Operations. But we also looked at our best estimates, no underlying loss ratio deterioration happened in the International portfolio, but we built a little bit of risk margin in International to deal with the uncertainty that could be in front of us with sort of different lines of business. And so, we are cautious. We've done this in the past where we feel very good about loss ratios, very good about margin, but we may put a little bit more margin for lines of business that we think could be potentially impacted. So, this is something that is evolving daily. What lines of business, what part of the world changes quite a bit, and we're going to be on our front foot in terms of being proactive and making sure that we have the appropriate loss cost and margin built into our pricing."
},
{
"speaker": "Meyer Shields",
"text": "Okay, fantastic. That's very helpful. Second question, from a modeling perspective, should the remaining quarters in 2025 have the same impact of expenses moving from other operations to the GI segments?"
},
{
"speaker": "Peter Zaffino",
"text": "So, here's how I would look at it. One is like AIG Next was taking a company that was a conglomerate and simplifying the business by getting the overall organization and culture weave together, and we've accomplished that. So that that was excellent. Two is, we gave significant guidance in terms of the expenses we felt we needed to take out of the company to have a lean operating model. We call it lean parent, but it's got to be a lean company. And so, how we look at the overall expenses are really important. And I think we overachieved because the guidance we gave was, by the end of '25, we should be done with AIG Next. And you can see in Other Operations, GOE, we got there. I mean, like, we are in a place where we've accelerated our progress and feel very pleased with it. I would have expected -- it didn't happen, but I would have expected to see the businesses' expense ratios go up as they will absorb the cost, but they did a phenomenal job of taking out expenses and being proactive as more allocations and more cost came into the business that they had a straight line, ability to not really increase expenses. Now, North America benefited more from AIG Next than international did, and because of the number of countries we're in and you're thinking about IT expenses and legal expenses and other expenses to build a proper global company, more of those allocations were went into international than went into North America. So, international would have had two variables that were kind of moving against it, which is what's reflecting this GOE ratio. But I would expect over the full year -- I could have just answered your question with this sentence, but I thought I'd give you some context, is that, I wouldn't straight line it, but I would think that the expenses you saw in the first quarter ought to be what the year will look like in terms of overall GOE expense in the business."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That is perfectly helpful, and I really appreciate that context. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Alex Scott with Barclays. Your line is open."
},
{
"speaker": "Alex Scott",
"text": "Hi, good morning. First one I had is on the broader environment that you described and the uncertainty that it brings. And just does it change the way you'd approach the M&A environment and just the deployment of all this capital that you have available to you?"
},
{
"speaker": "Peter Zaffino",
"text": "I don't think it changes anything, Alex. Thanks for the question. We still remain very disciplined, still looking at the medium to long term for acquisitions. Is it additive to AIG? Is it additive to the company that we may acquire? Looking at the different geographies, different product lines. I think -- and we mentioned also like GenAI and investments and scale and being able to move businesses forward. It gives us great opportunities to look across the world and to see if there's going to be an acquisition that would be additive to AIG. Now, yes, we are in a world of uncertainty, but we've done so much hard work over the past three years on the capital structure side that we have low leverage, cash and we have ample, if not, slightly excess capital in our subsidiaries to grow into. And we still have ownership of Corebridge that we can pull for additional liquidity in the event that we see an acquisition. But we're going to be very careful, we'll be very cautious, and it's not something that needs to be done today. And quite frankly, I said this at Investor Day, if we go through a period of time, which I'm not going to define, that we don't see opportunities that we think are additive to AIG and our shareholders, we'll return the capital to shareholders. But right now, I think it's actually -- some of this uncertainty may actually create opportunities."
},
{
"speaker": "Alex Scott",
"text": "Got it. That's helpful. The second question I had for you is just on the mix shift. From the outside, it's difficult at times to model things like mix shifts. And I think the catastrophe budget, in particular, has come down massively and I guess we'll continue to as you do this mix shift in North America Commercial in particular. So, I know you already gave us some help by quantifying some of these things. I think, based on some of the disclosures you gave earlier, we might even be able to back into a cap budget. But I was hoping maybe you could just help us understand that mix shift, how should we think about the impact on underlying versus all-in combined ratio."
},
{
"speaker": "Peter Zaffino",
"text": "First quarter is hard because of property. And it's when we do our catastrophes, it's a net premium written. I think in the past, what's happened is you could even have negative net premium just based on your seeding out more on an NPW basis than what you'd be writing in the quarter. I think that will start to sort of level out. We don't have a lot of catastrophe purchased within the second, third or fourth quarter. I think we're talking about mix of business. Look, the current environment of property in North America, because International is doing just fine, posting tremendous combined ratios, showing some small growth. But if we saw in the first quarter, that would continue, we are going to reduce our gross writings in property and the market will come back to us. I mean, we haven't even entered CAT season yet. So, I'd like to, as I always say, declare about property at the end of the year, not before CAT season. But I think what's reflected really in the reinsurance is just that the AIG in the past would probably have to pay a little bit more because of the quality of data, the quality of the portfolio. We've been moving forward with that over multiple years and I think that's what was reflected in 2025. The mix of business when we reference it, so property remains slight growth on an underlying basis and we're moving more casualty business into the portfolio of the net premium written. Those -- the combined ratios and the loss ratios are higher. So, I think that's really what we're trying to signal is that we had a tremendous growth in Lexington mid-market casualty, but that loss ratio will be higher than what we would expect for property attritional. And so, as that mix changes, you can see the loss ratios reflect that. That's what we're really referencing."
},
{
"speaker": "Alex Scott",
"text": "Got it. Helpful. Thank you."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from Andrew Anderson with Jefferies. Your line is open."
},
{
"speaker": "Andrew Anderson",
"text": "Hey, good morning. Just looking at the underlying results in North America Commercial, they seem pretty strong. Is there an opportunity to take more business net here?"
},
{
"speaker": "Peter Zaffino",
"text": "Yes, there is. I don't think we would want to, though, because how we look at Property CAT, it is a global risk appetite volatility that we're willing to take. And I think what I referenced, and when the script comes out, like we should read it again, how low nets we have going forward in North America Property, because we buy occurrence in aggregate and the volatility is massively reduced for AIG over the course of four quarters. And so, we like that volatility reduction. We like it priced into the business. And then on Casualty, I know it was probably a massive eye chart at Investor Day with the amount of reinstatements we have and what does the vertical limits do. We don't buy a lot of proportional reinsurance in North America on Casualty. We buy excess of loss. And I think in this environment with large jury verdicts, vertical exposures, I don't think it's prudent to take any more net there. And so, I think we feel really comfortable with the reinsurance structure that we have in North America. And as you pointed out, the combined ratios have improved dramatically and really like the core fundamentals of the business the way it is today."
},
{
"speaker": "Andrew Anderson",
"text": "Thank you. And then just on North America Commercial, ex comp, ex Financial Lines pricing, 4% RPC. I guess that's on a gross basis, perhaps a little bit better net. I guess, where I'm going with this is, I would think that's below loss trend, but perhaps with terms and conditions and maybe some mix shift, it sounds like in your commentary you're not really thinking of underlying loss ratio deterioration here."
},
{
"speaker": "Peter Zaffino",
"text": "No, I'm not. I mean, as I said, it's really being driven more by property. Property was a big negative on the weighted average. But on the other lines of business, again, we're going to watch financial lines. Don had some really good comments on that. Casualties above loss trend. Gladfelter, as we look across the portfolio, it was really just property that was below loss trend and we'll see how that plays out, but are confident that it's above our technical and also that it's not sustainable to have these type of rate decreases over a long period of time. So, we'd end up pulling back in the event that it stayed that way. But submission count is great. I think there's a lot of opportunities. Retention is good and we still think that the property line for us is going to perform very strong. And just one other data point is that in the first quarter, our International Property is as big as our North America Property. And so, I just want to make sure that we remember that, overall, we have opportunities -- if North America becomes aggressive, we have a lot of points of entry in property and the risk-adjusted returns in International are just fantastic and we'll continue to grow there. But..."
},
{
"speaker": "Andrew Anderson",
"text": "Thank you."
},
{
"speaker": "Peter Zaffino",
"text": "Thanks. We have one more question."
},
{
"speaker": "Operator",
"text": "Our next question comes from Brian Meredith with UBS. Your line is open."
},
{
"speaker": "Brian Meredith",
"text": "Yeah. Thanks for fitting me in. Peter, just curious on North American Commercial growth, just wanted to unpack it a little bit. Is it possible to get maybe what gross written premiums growth was there? Just try to understand the impact of the ceded reinsurance on the growth rate. Just kind of thinking about how sustainable is that growth in the near term that you saw in North America Commercial?"
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. So, Brian, the first quarter was benefited from some reinsurance on property. And I think that the growth would be largely reflecting the net, absent property that I mentioned. So, the casualty for Lexington is very close to what it would be on the net. When we had identified -- when we talked about Glatfelter, Glatfelter benefited a little bit from some of the reinsurance, but still had a very strong growth, as did our program business. Don outlined programs at great length at Investor Day. We're doing less programs. We've taken the best practices of Glatfelter and built it out. But I would say those largely, the gross and the nets, were not too far off. It was just really property that benefited. What I just wanted to signal is that you see sort of the rate environment and why you're growing in property, well, we really aren't growing on the gross. As a matter of fact, in Lexington Property, in the gross we contracted, and retail gross slight increase, but the net was really more reflective of the reinsurance on property. Do you want to say something, Don?"
},
{
"speaker": "Don Bailey",
"text": "I would just validate that, yeah, the underlying portfolio is strong, it's double-digits on a net basis."
},
{
"speaker": "Brian Meredith",
"text": "Great. So, nothing unusual in the first quarter? I mean, this is good solid growth you're seeing is sustainable here for at least in the near term, unless, of course, some other property competitor or something else comes up?"
},
{
"speaker": "Peter Zaffino",
"text": "Yeah. I think, look, you probably won't see the same property effect in the future because we're not going to have as much reinsurance. So, I think those nets will come down. But the rest of the portfolio should reflect, as Don said, really strong new business, strong retention. We'll watch each line of business and make sure we're growing where we want to grow, but still think there's growth opportunities."
},
{
"speaker": "Brian Meredith",
"text": "Got you. And then, one last one, Peter. Any updated thoughts on what casualty loss trend is looking like here? A couple of positive developments, I think in Georgia and some areas as far as legislation goes. Maybe thoughts on that?"
},
{
"speaker": "Peter Zaffino",
"text": "We'll watch it, Brian. We have not adjusted any of our loss costs and inflation factors on casualty, and we'll probably look at it in the sort of mid-year, but so far, we're keeping it where it was."
},
{
"speaker": "Brian Meredith",
"text": "Perfect. Thank you."
},
{
"speaker": "Peter Zaffino",
"text": "Okay. Thanks everybody for joining us today. Really appreciate it. Have a great day and great weekend."
},
{
"speaker": "Operator",
"text": "Thank you for your participation. This does conclude the program and you may now disconnect. Everyone, have a great day."
}
] | American International Group, Inc. | 250,388 |
AIZ | 4 | 2,020 | 2021-02-10 08:00:00 | Operator: Welcome to Assurant's Fourth Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode. And the floor will be opened for your question, following management's prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our fourth quarter and full year 2020 results with you today. Joining me for Assurant's conference call are Alan Colberg, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the fourth quarter and full year 2020. The release and corresponding financial supplement are available on assurant.com. We will start today's call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release, as well as in our SEC report. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan.
Alan Colberg: Thanks, Suzanne. Good morning, everyone. We're pleased with our performance for 2020, driven by our market leading specialty P&C and Connected Living offerings, 2020 represented the fourth consecutive year of strong profitable operating earnings growth for Assurant. This was a significant achievement demonstrating both the strength and resiliency of our business model and the dedication of our employees. Guided by Assurant's core values, our over 14,000 employees demonstrated an extraordinary commitment throughout this pandemic to each other, our partners and the hundreds of millions of customers we serve around the world. During this most challenging of years, I'm equally as proud of the steps we took to further advance our long-standing commitment as a responsible employer, including additional actions to foster a more diverse, equitable and inclusive environment within our communities. Some examples included sustaining enterprise forums to openly discuss challenges still faced by many as we collectively combat racism and bigotry. Expanding our supplier diversity and inclusion program to provide additional opportunities to increase the diversity of our vendor relationships and reaffirming our commitment to fair and equitable pay as we continue to review our policies and practices. Already in 2021, we've launched several additional initiatives, including more comprehensive enterprise-wide diversity training, and the mandatory adoption of diverse candidate's slates and interview teams to ensure we hire the best candidates. We also expect to launch enterprise employee resource groups to support a more diverse workforce. We believe these diversity initiatives will help us better connect to each other and the consumers we serve. Now let's move to our full year results. Net operating income excluding reportable catastrophes grew by 16% to $664 million and earnings per share increased 17% to $10.80. These results were in line with the outlook we provided in November and far exceeded the initial expectations of 10% to 14% operating earnings per share growth we outlined at the beginning of 2020. This performance was driven by strong results in global housing and continued growth in Global Lifestyle particularly Connected Living. Throughout the year, our balance sheet remained strong, combined our three operating segments contributed a total of $821 million in dividends to the holding company. During 2020, we increased our common stock dividend for the 16th consecutive year and returned $455 million in share repurchases and common stock dividends. Our 2019 Investor Day objective of returning $1.35 billion by the end of 2021 is now 65% complete and we expect to return the balance over the course of this year. As we build a stronger Assurant for the future, we've continued to make investments and enhancing key capabilities and the roll out of new and expanded offerings to support our growing global customer base. Our superior customer experience remains a key differentiator. This was critically important during the pandemic and we'll remain vital as we emerge in this period. Specifically, our digital capabilities have contributed to new business opportunities and the longevity of our most important client partnerships across Assurant. At the end of 2020, our top clients had an average 10 year of almost 17 years. We continue to believe there are significant future growth opportunities within our mobile, auto, and renters [ph] businesses also taking into account the convergence of connected devices, cars and homes, which we refer to as the connected world. These opportunities also drove our decision to explore strategic alternatives for Global Preneed, so that we can deepen our focus on our Lifestyle and Housing businesses and the Connected Consumer. Excluding global preneed and catastrophe losses, these connected businesses represented 66% of our 2020 segment net operating income, roughly doubled out of 2015. Together, they're expected to generate strong above market growth with offerings that have embedded earnings, complementing our specialty P&C offerings. Given our compelling business model and expanded future service offerings with the key source to drive growth, we continue to believe our stock remains attractively priced. We currently traded a discount to more relevant peers including those in the home services market. However, we believe our consistent earnings growth, cash flow generation and competitive position are in many ways stronger and more sustainable. Now let me share some 2020 highlights in each of our operating segments. Within Global Lifestyle, we increased earnings 7% to $437 million. This was driven by Connected Living where earnings grew by 14% as we increased our mobile subscriber base with 54 million through new and expanded partnerships. Across Asia Pacific and North America, we added almost 2.7 million subscribers last year. A portion of this year-over-year growth can be attributed to our alignment with new market entrants like U.S. cable providers and with new wireless carrier in Asia Pacific. We also processed 7 million devices through our Assurant trading facilities in 2020 and closed on the acquisition of HYLA Mobile. As a lean provider of smartphone software and trading and upgrade, HYLA will further increase our scale, strengthen our capabilities and expand our client roster as we look to capitalize on the 5G upgrade cycle over the next several years. In our expanded service contract business, we expanded our 10 plus year relationship with Lowe's Home Improvement with the introduction of Lowe's TechConnect, a white label version of our new Pocket Geek Home product providing tech support for smart home devices. In Global Automotive, we've increased the number of vehicles we protect by nearly 13% over 49 million since acquiring The Warranty Group, adding to the significant level of embedded earnings within the business. More recently, we've added scale and value to our OEM, TPA and national deal clients to two acquisitions in key global automotive markets. With American financial and automotive services, or AFAS, we added scale in our direct to dealer channel and are already leveraging their best-in-class talent and dealer training programs. In the fourth quarter, we acquired EPG, a leading provider of service contracts and insurance sold through heavy equipment dealers and manufacturers, including Volvo and Daimler. Like AFAS, we believe this is a natural extension of our extended service contract business in a niche market we know well, which has attractive long-term growth opportunities. Given our focus on the customer experience, we also continued to improve the claims process for vehicle owners through digital enhancements of our virtual claim's inspection process, reducing inspection times and minimizing the amount of time without the vehicle. Within Global Financial Services, we're excited to announce a new partnership with a large U.S. credit card issuer, where we're providing administration services for searching embedded card benefits that leverage our enhanced omni channel customer experience capabilities. We're excited about the business's attractive growth prospects for the future. Moving to Global Housing, we delivered net operating income, excluding cats of $371 million, up $71 million from 2019, and our returns remain strong as our operating ROE including cats was 15% for the year. Within our lender-placed business, we had another strong year of client renewals and we remain proud of our critical role in the mortgage lending process. We attribute the strength and longevity of our client relationships to our focus on customer experience as well as compliance and risk management. These will only get stronger as we continue to make progress on our proprietary single source processing platform, increasing productivity and improving customer experience over the long-term. In multifamily housing, we increased policies to 8% since 2019, and now percept over 2.4 million renters nationwide. We continue to invest in future growth, particularly through digital enhancements and innovations. As the ongoing rollout of our property management solution Cover360 continues to progress. We recently introduced a newly designed resident portal that makes renters insurance compliance for residents simple and fully digital, which will ultimately increase attachment rates over the long-term. In Global Preneed, earnings were down year-over-year in light of the COVID-19 global pandemic and continued low interest rate environment. But overall, Global Preneed performed well in 2020. And it's continued to produce strong cash flows with the high quality $6 billion asset base. To summarize, 2020 was a strong year for Assurant, despite a challenging global environment. We took additional transformative steps to continue to build a stronger showing for the future and capitalize on the convergence of the connected world. As we look at 2021, we expect to provide our annual outlook once we complete our evaluation of strategic alternatives for Preneed. We have made progress exploring the potential sale of the business. To-date, interest has been strong, and we expect to provide an update on our progress before our next earnings call in May. With that said, as we look at Assurant today, including Preneed, we are on track to deliver against the financial objective shared on our 2019 Investor Day, including 12% average annual operating EPS growth, excluding catastrophes for 2020 and 2021. As expected, this implies slower EPS growth in 2021, as we continue to invest for the future and build off of a stronger base in 2020. And also assumes a more normalized level of non-cat losses in Global Housing. In 2021, we will continue to prioritize investments in product innovation, further enhancing the customer experience and strengthening our social responsibility efforts, including actions to promote sustainability. I'll now turn the call over to Richard to review fourth quarter results and our high-level view of 2021. Richard?
Richard Dziadzio: Thank you, Alan, and good morning, everyone. As Alan noted, we are pleased with our performance for 2020, particularly amidst the pandemic. I'm now going to review our fourth quarter 2020 results and underlying business trends for the year. For the fourth quarter 2020, net operating income excluding catastrophes declined by $3 million to $136 million, mainly due to a $28 million reduction in net investment income across all operating segments, partially offset by more favorable non-cat loss experience in housing. This drop in investment income reflects both the lower interest rate environment and includes a $12 million decline in income from sales of real estate joint venture partnerships. In the quarter, we also incurred $11 million of severance in real estate charges as we continue to manage expenses and evolve Assurant's workplace environment. Now let's move to segment results for Global Lifestyle. This segment reported earnings of $88 million in the fourth quarter, down $9 million. The year-over-year decrease was primarily due to a $16 million decrease in net investment income spread across the businesses, half of which came from sales of real estate joint venture partnerships. Excluding the decline in investment income, segment earnings increased modestly. Underlying earnings growth was driven primarily by organic growth in Global Auto, while Connected Living earnings were flat compared to the prior year. Results in Connected Living were driven by continued mobile subscriber growth, particularly in Asia-Pacific and North America, as well as contributions from the acquisition of HYLA in December. This was largely offset by lower mobile results in Europe, mainly from $5 million of non-run rate items. In addition, the segment had $4 million of severance and real estate charges in the quarter that we don't expect going forward. Looking at total revenues, net earned premiums and fees decreased by $37 million. This was driven mainly by a $78 million reduction in mobile trading revenue, primarily due to the contract change we disclosed in the second quarter. Excluding this change, Lifestyle revenues were up $41 million, or 2%, driven by an 8% revenue increase in Global Auto from prior period sales of vehicle service contracts. Overall, trading activity which flows through fee income was down year-over-year. However, as was the case in the last few years, we saw an uptick in December. This was driven by new phone introductions, greater device availability, and contributions from HYLA during its first month with Assurant. Given the continued strong trading activity in January, we expect to see a sequential and year-over-year increase in volumes in the first quarter. For the full year of 2021, we expect to see continued growth in Global Lifestyle's net operating income, with the growth more heavily weighted towards the second half of the year. Overall, earnings expansion will be led by mobile and will mainly come from new and expanded programs as well as contributions from recent acquisitions. We also anticipate improved profitability in financial services, which is positioned to steadily improve following the lower volumes and unfavorable loss experience seen in 2020. We are cautiously optimistic, particularly as it relates to some of our travel related programs, which were negatively impacted by the pandemic. We expect Global Auto earnings to be down modestly reflecting the pressure from the low interest rate environment. Continued investments in our capabilities, product offerings, and customer experience are also anticipated during the course of the year. Moving now to Global Housing, net operating income for the fourth quarter totaled $61 million, compared to $73 million in the fourth quarter of 2019. The decrease was largely due to $28 million of higher reportable catastrophes, over half of the losses were from Hurricane Zeta, with the balance primarily related to claims from Hurricane Delta. Excluding catastrophe losses, earnings increased $16 million, or 23%, despite lower investment income of $8 million. The increase was driven by favorable non-cat loss experience across all lines of business. We saw reduced claims frequency and drove improved profitability in our sharing economy portfolio. Lender-placed results also reflected higher premium rates, mostly offset by declining REO volumes from ongoing foreclosure moratoriums. Turning to revenue. Global Housing net earned premiums and fees decreased 3%. Similar to previous quarters, this was driven mainly by three items. The exit of small commercial, the insolvent lender-placed client and lower REO volumes. The decrease was partially offset by growth in both our specialty property and multifamily housing businesses. We expect Global Housing's net operating income, excluding cats to be lower in 2021 compared to 2020. An overall increase in our non-cat loss ratio to more normalized levels, and higher cat reinsurance costs will be the primary drivers. We expect both indexes to begin in the first quarter. Regarding our cat reinsurance costs in January, we completed approximately two-thirds of our 2021 catastrophe reinsurance program placement. As part of the placement, we secured additional multiyear coverage, resulting in approximately 52% of our U.S. program now benefiting from this feature. As expected, we saw an increase in the overall pricing of reinsurance in our purchases today, which are multiyear layers help to offset. As we finalize the remaining portion of the program in July, we will continue to evaluate the risks and rewards of purchasing additional reinsurance and alternatives that could reduce our risk. We are not however, currently assuming any increased coverage. We expect some increase in our yield volumes in the second half of the year. However, we do not anticipate volumes reverting to pre-COVID levels immediately. And volumes will be influenced by the timing of the foreclosure moratoriums. Now let's move to the Global Preneed. The segment reported net operating income of $9 million, a decrease of $7 million year-over-year. In addition to lower investment income, we had nearly $4 million of non-recurring items related to a system conversion and updated assumptions for the earnings pattern and new policies. While the GAAP impact of these items was $4 million. The statutory impact was immaterial. In addition, we experienced an increase in mortality trends as we exited the quarter. We continue to monitor trends and expect the increase in claims to continue into the first half of 2021. Revenue for Preneed was up 5% primarily due to growth in U.S. sales, and base sales have increased significantly since the second quarter of 2020, so, they remain below pre COVID levels. For 2021 Global Preneed will remain in our operating results until we conclude our evaluation of strategic alternatives. Overall, we expect 2021 Preneed earnings will be up slightly compared to 2020 reported results illustrating the strength of the business despite the ongoing challenge of the global pandemic. At corporate, the net operating loss was $23 million, compared to $22 million in the fourth quarter of 2019. This was primarily due to lower investment income and expense actions in the quarter. For the full year 2021, we expect the corporate net operating loss to improve from 2020. I also wanted to provide a quick update on our investment portfolio. The portfolio continued to perform well during the quarter. While investment income levels are low due to the lower short and longer term yields available in the market and lower joint venture real estate income in the quarter. The strength of the portfolio can be seen through three items, the absence of defaults, the low level of credit downgrades and the increase in the value of those assets mark-to-market. Turning to holding company liquidity, we ended the year with $407 million, which is $182 million above our current minimum target level. In the fourth quarter, dividends from our operating segments totaled $292 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items, $147 million of share repurchases, $44 million in common and preferred stock dividends and $368 million related to the acquisitions of HYLA and EPG. As a reminder, we partially financed HYLA through the issuance of subordinated debt in the fourth quarter. As we enter 2021, our capital and liquidity positions remain strong, supported by the robust cash flows generated by Global Lifestyle and Global Housing. For the year overall, we expect dividends to approximate segment earnings subject to the growth of the businesses and rating agency and regulatory capital requirements. We have now returned approximately $880 million in the last two years. And we expect to complete our three-year $1.35 billion capital return objectives to shareholders in 2021. Similar to prior years, the pace of buybacks is expected to be somewhat weighted towards the second half of the year. In the first quarter through February 5th, we repurchased an additional 120,000 shares for $16 million. We have $770 million remaining in our share repurchase authorization, which includes the additional authorization recently approved by our Board of Directors. Additionally, in January, we redeemed the remaining $50 million of our March 2021 notes. Before closing, I also wanted to provide reminder that our mandatory convertible shares will convert to common shares on March 15th. The number of common shares issued will depend on our share price leading up to the conversion date. At Assurant's current share price, we would expect conversion would result in the minimum issuance of shares. In summary, despite a year of uncertainty, we took action to safeguard our employees, to provide our clients with superior service, and to maintain our strong financial footing. As we turn the page to 2021, we're focused on continuing to deliver profitable growth, enhancing our products and services, and meeting our commitments to all stakeholders. We look forward to the year ahead, as we continue to drive Assurant to a strong future. And with that, operator, please open the call for questions.
Operator: [Operator Instructions] Thank you. Our first question comes from Bose George with KBW. Your line is open.
Alan Colberg: Hey, good morning, Bose.
Bose George: Hey good morning. I want to ask just about the potential sale of the Preneed business. There's been a lot of life insurance and annuity transactions recently. And, just broadly, do you consider those to be good comps and should we focus on the sales pricing based on the multiple book value as opposed to an earnings multiple?
Alan Colberg: So, first of all, it's important to reflect on our Preneed business. We have a unique and strong business. We have our important distribution partners that are in a long-term contract, we have a block of business that's continued to perform well even through COVID-19. And what I would say on the process is we're encouraged. There is strong interest and robust interest in our company and in Preneed. And we're hopeful that we'll be able to announce something in advance of our Q1 earnings call. In terms of valuation, I think it's not really appropriate to speculate on that as we're in the middle of the process. But I do think we're on track to deliver a good and strong outcome for our shareholders at the end of the day, and further reposition the balance of Assurant and focus on our growth engines around the connected world and our strong specialty P&C offerings.
Bose George: Okay. That's helpful. Thanks. And just switching over to the extended warranty business. There have been a couple of headlines about competitors that was the Home Depot Allstate partnership. Can you just talk about competition in that states and just remind us what the - your targeted growth in returns in that business are?
Alan Colberg: So, extended service contracts are part of our Connected Living business, given the kind of convergence and overlap we see between mobile and service contracts. We mentioned on the call today that we've extended and deepened our relationship with Lowe's, which is an important service contract partner. And we talked in the prepared remarks about the inclusion of what we call Pocket Geek Home, which we're excited about as kind of a next generation innovation. It's really around providing all the services to keep you connected for every connected device that you own. So that's exciting. But broadly, if you look at Connected Living, it was another year of strong growth that includes in our service contract business. And we continue to believe and you see it with our success that we've been able to expand and grow and deepen. I think we've announced now more than a dozen or so new partnerships in the last three or four years, really driven by our innovation, and our strength in key global markets around the world like Japan and Europe. So, I think we feel good about the momentum and we're going to continue to invest to differentiate. We, for example, in 2020, we substantially increased our investment in digital midyear. Just not that we aren't already strong in digital, but we see the impact of COVID and we want wanted to make sure we're doing everything possible to drive a complete digital omni channel experience for our customers.
Bose George: Okay, great. Thanks.
Operator: Our next question comes from the line of Brian Meredith with UBS. Your line is open.
Alan Colberg: Hey, good morning, Brian.
Brian Meredith: Yeah. Good morning. First question, I guess. Can we take a little bit more into the Cover devices and mobile and kind of what's happening there growth continues to slow? I know you mentioned a little bit how you expect some pickup in the beginning of the year, but just how do you think this plays out, particularly also related to Sprint, T-Mobile? How does that kind of play out through the year, when do we expect to see some kind of meaningful impact from that, at least from a growth perspective and top line?
Alan Colberg: Yeah, if I reflect on the subscriber count, certainly 2020 was still a positive year. We grew the subscriber count despite COVID and despite the numerous disruptions and store closures that happened throughout the year. We had challenges in Latin America, the region that was most disrupted probably by COVID. But as I mentioned in the prepared remarks, we had strong growth in North America and Asia Pacific. And, with the Sprint business, we are beginning to ramp that and that will grow strongly as we go through 2021 and beyond. So, certainly grew a little bit slower than prior years, really because of COVID, but the underlying momentum and strength of that business remains strong.
Brian Meredith: Great, and then I guess my second question, just back to the Preneed, can you just kind of remind us, what are your thoughts as far as use of proceeds on the Preneed sale as you kind of think about it today?
Alan Colberg: Brian, I think the most important thing on Preneed is, we're very hopeful that we'll get to a great outcome for our shareholders as the first most important thing. If you look at our history, we have a strong track record of disciplined capital management and deploying capital to support and grow our company over time. Normally, we focus first on organic growth and ensuring that we're funding the growth that's happening. We have strong underlying organic growth across our company. And then we look at M&A and return to capital. With M&A as a reminder, we have a very high hurdle, we look at cash-on-cash IRR and we're really just focused in our key growth engines of the connected world. So that's mobile, auto and renters that's where the bulk of that would be. And if we have excess capital, our track record of returning it to shareholders over time is strong.
Brian Meredith: Got you. And just one last one, I'm curious. Renter's insurance marketplace. Can you talk a little bit maybe about the competitive environment there, I mean, we hear a lot about some of these insured tax very active in that marketplace, can you give a little perspective on what's going on there?
Alan Colberg: Yeah, if you look at our business, we continue to grow and gain share, our policies were up 8% last year, so we added net something like 200,000 policies, give or take to 2.4 million. And we've really invested over the last couple of years. If you do a side-by-side of our purchase experience digitally, it's as good and easy to use for consumers as any digital experience that's out there from any company. And then importantly, in the property management channel, we're rolling out Cover360, which really will drive attachment over time. It makes the whole process of compliance and having the appropriate coverage easy. So, we feel good about our momentum. We continue to grow and gain share relative to the market. If you think about multifamily, it was disrupted by COVID more than many of the markets in the U.S. just given the challenges with renters. We had a lot less mobility last year of people moving. And despite that, we grew policies 8% so, it's a good business. We continue to gain share and we continue to invest to differentiate our offering.
Brian Meredith: Great. Thank you.
Operator: Our next question comes from the line of Mark Hughes with Truist. Your line is open.
Alan Colberg: Hey, good morning, Mark.
Mark Hughes: Good morning. In the Global Auto business, what are the prospects there for growth? I think you talked about the net income being down on interest rates. I'll ask a question, like I have asked before. If interest rates are low, could you adjust your offering, adjust your pricing perhaps to compensate for that? And that question and then kind of the, what should we think about top line in 2021 in Global Auto?
Alan Colberg: So, Mark, appreciate that. Maybe I'll start. And then, Richard, you can go deeper on the question around investment income. If you look at that business, since we closed on The Warranty Group, we mentioned this in the prepared remarks, we've added something like 13% to our service contract count. That's over the last couple of years. That bodes very well for the future. Those are embedded future earnings. They're going to come through. And if you look at the underlying growth in the business before considering the investment income impacts, this is a longer duration product and others in our portfolio other than Preneed, very strong underlying growth, really driven by expanding share in our key dealer relationships and beginning to drive some of our capabilities from mobile into the business. We've also recently announced partnerships in Europe. And we've announced previously a partnership in China around electric vehicles. That's another source of innovation growth, I think, put aside, the kind of short term what shows up in our earnings, the underlying strength is strong. But Richard, you should comment more on investment income and how we think about that.
Richard Dziadzio: Sure, and just to add on to that, I mean, only part of the earnings obviously, are coming from investment income. And the overall portfolio, I would say is more-shorter in duration relative to Preneed. You think about Preneed, having a duration maybe of 10-years, think about half that or less for Auto. So, the current drop in interest rates has had somewhat of a headwind impact on us. Who knows how long that's going to last? Right. But in terms of moving forward, I think, for a large part, we've taken into account the short-term interest rate impact this year so far. So that, I don't think short-term rates are going to go any lower, much lower. So, I think that's all settled in. And that's just cash coming in and out of the enterprise there. And then from a longer-term basis, I think your question is a good one. As things move on, if interest rates stay low, it's a competitive environment. So, we'll see with pricing, but that typically would happen in any market, where there's some sort of interest rate spreads embedded in products. So, overtime that should re-price. Obviously, Mark, there's typically a lag in things like that. In terms of 2021, we feel really good. As Alan said, I mean, the business has good momentum, we've grown the number of protected vehicles that we've had. Our recent acquisition of EPG bodes well for the synergies and integration that we have with that company into ours and future growth, AFAS this summer as well. Good, good, strong acquisition for us. So, we think we're the strongest player, one of the strongest players in the market and positioned to win as we go forward.
Alan Colberg: And Mark, maybe the other thing I'd add on investment income policies, if we look at Preneed and the process, we're in and assuming we get to a good outcome there, Preneed is something like 40% or 45% of our total investment portfolio, and even more of the volatility just given long duration. So, one of the other benefits of successful outcome of Preneed is the even further reduce our exposure to interest rates as a company which will create more stability in the future.
Mark Hughes: On the - Thank you for that. On the non-cat losses in Housing, is that an industry phenomenon? Do you think COVID related or just more broadly weather related or perhaps the underwriting phenomenon? How do you do view that?
Richard Dziadzio: Yeah, good question. We have had, lower non-cat loss ratio this year, a lower non-cat loss ratio relative to last year. And that comes from a couple of different parts. I think the first part is small commercial, we exited that business, which was weighing on our overall non-cat loss ratio. The second part would be the underwriting we've done and improvements within the specialty property, and particularly the sharing economy part of the business with the growth there that we've had, and some nice results there. So those two items, I would say, are very particular to Assurant. So, not a phenomenon across the market. And then, we've also seen claims come down and frequency of claims this year. We're not so much thinking it's due to COVID as we're thinking it's really due to kind of weather, more or less weather and the wind, the flood and things like that this year, we did have a little more increase in the cats that we've had this year. So maybe there's a play against those too as well. Looking forward, we think that as we said, in 2021, the non-cat loss ratio will move up. But we don't think it's going to move up that much. It's probably potentially a slow conversion towards where we were in the past. But given what we've done in our underwriting, the movements that I discussed a moment ago, we think, we're going to be in a better place next year than we were historically. So we'll move up a little bit, progressively, but not as much as, not to where we were in 2021, it is our prediction.
Alan Colberg: Yeah, and Mark, the other thing I would add to summarize kind of what Richard said, more than half of our improvement we believe has been driven by actions we have taken, the ones Richard mentioned. The other thing we've been investing heavily in is AI and Automation, which has the benefit of driving better CX as well as improved efficiency. So, there is some effect of what's happening in the industry, but we feel most of this is being driven by us and we do expect some step up in '21 given 2020 was particularly low, but we feel good about the actions we've taken to drive improvement here.
Mark Hughes: And then, Alan, maybe a little bit of a softball, but you said you had mentioned how you feel like Assurant trades at a discount to peers in the home services market. Any elaboration you'd like to give on that?
Alan Colberg: Yeah. One of the things that we look at is if you really step back and look at our company, we've over the last four or five years really evolved to be much more of a fee income service business type company. We have a track record of strong profitable growth. If you look at it, we've delivered now we mentioned on this call, four years in a row of strong operating earnings growth. We have a cash flow ability as we've said many times over the years, if we earn $1 at our segments, we can on average get that to the holding company. And if you look at that, if you look at the competitors that we're evolving into, now people in the home services market or others, they all trade on multiples of EBITDA, that are in the mid-teens and we are well below that. And so, we continue to look at how do we help our investors better understand just the quality of our franchise, the 17 plus year client tenure that we mentioned earlier, the investments we've made differentiate. And over time, we continue to believe our stock is attractively priced, and we're going to work on continuing to evolve our metrics and disclosures and how we deploy capital to maximize the value for our shareholders.
Mark Hughes: Thank you.
Operator: [Operator Instructions] Our next question comes from the line of Michael Phillips with Morgan Stanley. Your line is open.
Alan Colberg: Hey, good morning, Mike.
Michael Phillips: Good morning. Thanks, guys. Good morning. You mentioned - Richard, you mentioned in your comments, the headwind in Europe a [ph] non-refundable amount about $5 million. Is there anything else in Europe that besides that you would point to that would cause a headwind there?
Richard Dziadzio: No, I think the biggest part of the headwind was really in terms of them positioning themselves for 2021 and for growth. I mean, overall, they had a good year, despite the pandemic. And we do think that going forward, the profitability is going to increase over Q4 in Europe. So, we really do think it was a kind of a one-time thing where there were several small items that we do not expect to recur.
Michael Phillips: Okay, great. And this is kind of a follow on to prior question on housing. A little bit of a different angle, on the frequency benefits that you've seen again. And you mentioned in prior calls, recently, theft and vandalism has been down. I'm curious, is that COVID related certain benefits theft and vandalism are down? Or is that more of what Alan was saying, kind of things that you've done to re-underwrite that have helped that piece of the business?
Alan Colberg: The other thing I would add on that one, and then Richard, feel free to add on to it is. Our book today is very different than five, six, seven years ago. If you think about after the last housing crisis, we had a lot of vacant and foreclosed properties in the portfolio, that's where you tend to see that the most. Today, we're in a strong housing market. And we're really providing a backstop when people aren't able to get coverage. So, you normally see lower theft and vandalism over time when you're in a stronger housing market anyway. So, I think that's part of what we're seeing. I don't know if Richard, would you add anything else?
Richard Dziadzio: No, that's exactly right, Alan. I think the other thing is, we were seeing a trend coming down, even prior to the pandemic. So, we're not thinking that pandemic I mean, there could be a small part of that, but that's not something that is a driver.
Michael Phillips: Okay, great. Thanks. And then last one for me on the Global Financial Services area. You've talked a bit about the impact from COVID there from balances being down. I guess has that turned around any? And then on legacy business there, are we in a trough, so you talked about what you expect for this year to be better than last year, but how much of that is a turnaround from COVID? And, again on legacy business are we at the bottom there?
Alan Colberg: I think in that business, I'm really encouraged about - excuse me, the momentum we're starting to see when we acquired The Warranty Group, they had just signed a significant new client in that space. And then as we announced on the call earlier today, we've just signed another new client. So, we've got several potential growth drivers in the future that makes us pretty optimistic about that. In terms of the areas that have been disrupted by travel - COVID, that's really travel. And we'll see how that plays out this year. But we expect to see improvement over time. And the new clients and the new offerings over the last couple of years have us in a much better position for this business to grow and contribute in the coming years.
Michael Phillips: Okay. Thank you, Alan, appreciate it.
Operator: Our next question comes from Gary Ransom with Dowling & Partners. Your line is open.
Alan Colberg: Hey, good morning, Gary.
Gary Ransom: Good morning. I wanted to ask on the severance in real estate change, whether that represents any kind of employee business model change? And if so, is there more to come?
Alan Colberg: And maybe, Richard let me start just briefly, yeah, I'll start briefly, and you can provide more. At a high level, we're looking at kind of the future of work and what those models are. We've shown we had about 30% of our employees' virtual pre COVID. And post COVID, we'll no doubt have a higher percent. So, we are looking at that and evaluating it. But I think the main driver is really our ongoing expense management and just aligning our resources with the growth of the company. But Richard, why don't you add particularly on the real estate.
Richard Dziadzio: I think, when we think of real estate, I think of the word facilities. So, it is linked to our facilities and how we're using our facilities going forward. We had a couple leases that were coming due early in 2021, we're not going to be going back to that space. We'll be getting new space or working from home in a new work environment. So, we just had to take an acceleration of the expense on that leasehold improvements and so forth. So, it's really positioning when we get to the fourth quarter, we started to position ourselves, Okay, next year, what's our footprint? Where should we be, from a headcount point of view, but also from a facilities point of view? So, we don't think that the actions we take in fourth quarter are a harbinger of things to come, it's really just a one-time $11 million total impact which is why we called it out as such.
Gary Ransom: All right, that's helpful. Thank you. Another one on the - you mentioned competition in Lifestyle, I wonder the competition on Global Housing in the lender-placed business. Obviously, you said you renewed a lot of contracts, but can you give us a sense of what goes on in those renewals, are other competitors trying to get in on it? I assume that happens regularly. But I was wondering whether it's any more intense or has changed at all?
Alan Colberg: No, I think the important thing with that business is all of ours, it is competitive. That's just the reality of the markets that we all compete in. With that said, we have a really strong position there. We've invested and continue to invest in differentiating our capabilities around compliance, around customer experience. We're early in this rolling out our SSP, our single source platform, which really differentiates our tracking capabilities. And as we mentioned, we've renewed something like 85% of our relationships over the last two years, many of them early as we prepare to work with our clients on the conversion to our new tracking system. So, I don't see the competitive pressure changing a lot, it's always there. But we've shown our ability if you look at the last decade, we've been able to grow that business dramatically, really driven off of the value that we're creating for our partners and for our customers.
Gary Ransom: And in that business, you're going through this process of reducing risk and becoming more fee oriented. And in Preneed, we can assume that that's gone, which has some volatility on the investment side. Global Housing is the last business with some volatility embedded in it. Is this a strong enough business for you that you're content with handling that volatility? Or is there something else that you might think about in the future?
Alan Colberg: Yeah, a couple comments on that. So, if we look over the last five, six, seven years, we've significantly reduced our exposure through the purchase of reinsurance. If you go back to 2012, '13, we were at about $240 million of retained event exposure. We're down to $80 million. We've also morphed our reinsurance tower more than half of its multiyear now, which also creates a lot of stability and we've also been pruning non-strategic risk. So, a great example of that was our exit of small commercial a year or so ago. So, when we look at it, we'll always look at there are other actions that could further share some of that cat exposure away. But if we look at the overlap between our Housing business and our Lifestyle business, it's strong. If you think about the convergence around the home, the device, the car, we're starting to see opportunities to roll out what we do in Lifestyle, in the Housing. A lot of our mobile capabilities are really relevant in renters and in the connected home. Also, as we mentioned in the prepared remarks, even in a relatively high cat year, we had a 15% ROE with cats in Housing. So, it's generating strong earnings, lots of cash to reinvest and continues to be an important part of our strategy and portfolio with the caveat that we have reduced our cat volatility a lot and we'll continue to look at ways to reduce that cat volatility.
Richard Dziadzio: And if I could just add to that, I mean, as Alan says, to reduce our cat volatility, we do get the question and we do look at it every year. I mean, obviously, this year was a little bit special with the pandemic and with the amount of capital that was in the reinsurance market. We've seen that capital now come back. So, we'll keep looking at things like bringing down the retention, purchasing aggregates and doing other things, quota shares or whatever, that could reduce the volatility a little as we go forward. In my prepared remarks, I said we can't plan on anything and we're not planning on anything to 2021. But as Alan said, we are keeping our eyes wide open to opportunities there.
Gary Ransom: Very helpful. Thank you very much.
Operator: Our last question comes from the line of Mark Hughes with Truist. Your line is open.
Alan Colberg: Hey, good morning again Mark.
Mark Hughes: Yeah, thank you. Another one of my usual questions, which is when we think about the lender-placed placement rate, obviously delinquencies are quite high. You talked about the REO program. You can certainly understand that being under pressure with a foreclosure moratorium in place. But how about just these higher delinquencies presumably the escrow funds are getting used up and if people aren't paying their mortgages, the lot of them are not paying insurance, how do we think about that, it seems like you've had very limited impact so far, but these have been delinquencies have been in place since early mid last year. It seems like they'd be falling into your bucket pretty soon, but apparently not. So, I'm just curious what's going on there?
Richard Dziadzio: Yes, Mark, I think the important way to think about lender-placed is, whether the housing market weakens or not, we don't know. And we're not seeing a lot of real evidence that the housing market is weakening. But through the actions over the last four or five years, we've now got to lender-placed to where it's roughly stable on earnings ex-cat even if the housing market remains strong. And obviously if the housing market does weaken at some point, we're going to be there to provide the support to the mortgage market that we've historically provided. So, we don't know what might happen this year. There is always a lag. It depends a lot on what happens with the government foreclosure moratoriums. But we've certainly called out that our business has been impacted negatively in 2020 and continuing with just the lack of REO volume, given the foreclosure moratoriums that are going on. But the business is well positioned and if the market does weaken, we're going to be there and we will support the mortgage industry through that.
Mark Hughes: If we continue to see these delinquencies, the 90 day plus delinquencies they are up substantially and maybe they're tapering a bit, but tapering slowly.
Richard Dziadzio: Yep.
Mark Hughes: Does that have an impact on the business?
Richard Dziadzio: It really as I mentioned, it really depends on what happens with foreclosure moratoriums. If there is weakness in the housing market, eventually we should see that flow through into our business. We just - it's hard to say when given what's happening in the broader economy and with our government dealing with COVID.
Mark Hughes: So, I guess it's really the foreclosure numbers that are more relevant for your business?
Richard Dziadzio: No, our business is driven by many things, but where we've seen the biggest kind of short-term negative impact is just the foreclosure moratoriums and therefore, properties aren't moving through the process that you would normally have seen. But again, we are well positioned if the market does weaken and it's allowed to function like it historically has. We're well positioned to benefit and support that. And as I said in my prepared remarks - As I said in the prepared remarks, Mark, we're not counting on any sort of big return in our real volumes next year, given the forbearance moratoriums and an extension of them. So, we do think that over time, when the market kind of gets back to a balance, and we get past the pandemic and the moratoriums, it'll start to increase maybe second half of the year a little bit, probably more into 2022, as we kind of get back to and if we call it an equilibrium, but more normal times.
Mark Hughes: Thank you for that.
Alan Colberg: All right, excellent, and if I just take a moment and reflect more broadly. We're really proud of 2020 and what our employees did to support our customers and clients through COVID. It was a strong growth year for us, both in Connected Living and then broadly in Housing. We continue to execute against our long-term strategy. You heard us say that, we still expect to deliver on the 2019 Investor Day objectives, including the 12% average annual operating EPS growth in 2020 and '21. And we continue to gain share, which really augurs well for the future as we invest, differentiate and encourage our clients to add more of our capabilities into their products. And then finally, we mentioned that we're encouraged by the progress on the potential sale of Global Preneed and hope to have some positive outcome to share shortly. So, thank you for participating in today's call. To summarize, we're really pleased with our performance in 2020. And we're going to continue to focus on building a stronger company in 2021. Following the conclusion of our evaluation of alternatives for Global Preneed, we are planning to provide our full year outlook for 2021 at that point. In the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. Thanks, everyone.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Fourth Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode. And the floor will be opened for your question, following management's prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our fourth quarter and full year 2020 results with you today. Joining me for Assurant's conference call are Alan Colberg, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the fourth quarter and full year 2020. The release and corresponding financial supplement are available on assurant.com. We will start today's call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release, as well as in our SEC report. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan."
},
{
"speaker": "Alan Colberg",
"text": "Thanks, Suzanne. Good morning, everyone. We're pleased with our performance for 2020, driven by our market leading specialty P&C and Connected Living offerings, 2020 represented the fourth consecutive year of strong profitable operating earnings growth for Assurant. This was a significant achievement demonstrating both the strength and resiliency of our business model and the dedication of our employees. Guided by Assurant's core values, our over 14,000 employees demonstrated an extraordinary commitment throughout this pandemic to each other, our partners and the hundreds of millions of customers we serve around the world. During this most challenging of years, I'm equally as proud of the steps we took to further advance our long-standing commitment as a responsible employer, including additional actions to foster a more diverse, equitable and inclusive environment within our communities. Some examples included sustaining enterprise forums to openly discuss challenges still faced by many as we collectively combat racism and bigotry. Expanding our supplier diversity and inclusion program to provide additional opportunities to increase the diversity of our vendor relationships and reaffirming our commitment to fair and equitable pay as we continue to review our policies and practices. Already in 2021, we've launched several additional initiatives, including more comprehensive enterprise-wide diversity training, and the mandatory adoption of diverse candidate's slates and interview teams to ensure we hire the best candidates. We also expect to launch enterprise employee resource groups to support a more diverse workforce. We believe these diversity initiatives will help us better connect to each other and the consumers we serve. Now let's move to our full year results. Net operating income excluding reportable catastrophes grew by 16% to $664 million and earnings per share increased 17% to $10.80. These results were in line with the outlook we provided in November and far exceeded the initial expectations of 10% to 14% operating earnings per share growth we outlined at the beginning of 2020. This performance was driven by strong results in global housing and continued growth in Global Lifestyle particularly Connected Living. Throughout the year, our balance sheet remained strong, combined our three operating segments contributed a total of $821 million in dividends to the holding company. During 2020, we increased our common stock dividend for the 16th consecutive year and returned $455 million in share repurchases and common stock dividends. Our 2019 Investor Day objective of returning $1.35 billion by the end of 2021 is now 65% complete and we expect to return the balance over the course of this year. As we build a stronger Assurant for the future, we've continued to make investments and enhancing key capabilities and the roll out of new and expanded offerings to support our growing global customer base. Our superior customer experience remains a key differentiator. This was critically important during the pandemic and we'll remain vital as we emerge in this period. Specifically, our digital capabilities have contributed to new business opportunities and the longevity of our most important client partnerships across Assurant. At the end of 2020, our top clients had an average 10 year of almost 17 years. We continue to believe there are significant future growth opportunities within our mobile, auto, and renters [ph] businesses also taking into account the convergence of connected devices, cars and homes, which we refer to as the connected world. These opportunities also drove our decision to explore strategic alternatives for Global Preneed, so that we can deepen our focus on our Lifestyle and Housing businesses and the Connected Consumer. Excluding global preneed and catastrophe losses, these connected businesses represented 66% of our 2020 segment net operating income, roughly doubled out of 2015. Together, they're expected to generate strong above market growth with offerings that have embedded earnings, complementing our specialty P&C offerings. Given our compelling business model and expanded future service offerings with the key source to drive growth, we continue to believe our stock remains attractively priced. We currently traded a discount to more relevant peers including those in the home services market. However, we believe our consistent earnings growth, cash flow generation and competitive position are in many ways stronger and more sustainable. Now let me share some 2020 highlights in each of our operating segments. Within Global Lifestyle, we increased earnings 7% to $437 million. This was driven by Connected Living where earnings grew by 14% as we increased our mobile subscriber base with 54 million through new and expanded partnerships. Across Asia Pacific and North America, we added almost 2.7 million subscribers last year. A portion of this year-over-year growth can be attributed to our alignment with new market entrants like U.S. cable providers and with new wireless carrier in Asia Pacific. We also processed 7 million devices through our Assurant trading facilities in 2020 and closed on the acquisition of HYLA Mobile. As a lean provider of smartphone software and trading and upgrade, HYLA will further increase our scale, strengthen our capabilities and expand our client roster as we look to capitalize on the 5G upgrade cycle over the next several years. In our expanded service contract business, we expanded our 10 plus year relationship with Lowe's Home Improvement with the introduction of Lowe's TechConnect, a white label version of our new Pocket Geek Home product providing tech support for smart home devices. In Global Automotive, we've increased the number of vehicles we protect by nearly 13% over 49 million since acquiring The Warranty Group, adding to the significant level of embedded earnings within the business. More recently, we've added scale and value to our OEM, TPA and national deal clients to two acquisitions in key global automotive markets. With American financial and automotive services, or AFAS, we added scale in our direct to dealer channel and are already leveraging their best-in-class talent and dealer training programs. In the fourth quarter, we acquired EPG, a leading provider of service contracts and insurance sold through heavy equipment dealers and manufacturers, including Volvo and Daimler. Like AFAS, we believe this is a natural extension of our extended service contract business in a niche market we know well, which has attractive long-term growth opportunities. Given our focus on the customer experience, we also continued to improve the claims process for vehicle owners through digital enhancements of our virtual claim's inspection process, reducing inspection times and minimizing the amount of time without the vehicle. Within Global Financial Services, we're excited to announce a new partnership with a large U.S. credit card issuer, where we're providing administration services for searching embedded card benefits that leverage our enhanced omni channel customer experience capabilities. We're excited about the business's attractive growth prospects for the future. Moving to Global Housing, we delivered net operating income, excluding cats of $371 million, up $71 million from 2019, and our returns remain strong as our operating ROE including cats was 15% for the year. Within our lender-placed business, we had another strong year of client renewals and we remain proud of our critical role in the mortgage lending process. We attribute the strength and longevity of our client relationships to our focus on customer experience as well as compliance and risk management. These will only get stronger as we continue to make progress on our proprietary single source processing platform, increasing productivity and improving customer experience over the long-term. In multifamily housing, we increased policies to 8% since 2019, and now percept over 2.4 million renters nationwide. We continue to invest in future growth, particularly through digital enhancements and innovations. As the ongoing rollout of our property management solution Cover360 continues to progress. We recently introduced a newly designed resident portal that makes renters insurance compliance for residents simple and fully digital, which will ultimately increase attachment rates over the long-term. In Global Preneed, earnings were down year-over-year in light of the COVID-19 global pandemic and continued low interest rate environment. But overall, Global Preneed performed well in 2020. And it's continued to produce strong cash flows with the high quality $6 billion asset base. To summarize, 2020 was a strong year for Assurant, despite a challenging global environment. We took additional transformative steps to continue to build a stronger showing for the future and capitalize on the convergence of the connected world. As we look at 2021, we expect to provide our annual outlook once we complete our evaluation of strategic alternatives for Preneed. We have made progress exploring the potential sale of the business. To-date, interest has been strong, and we expect to provide an update on our progress before our next earnings call in May. With that said, as we look at Assurant today, including Preneed, we are on track to deliver against the financial objective shared on our 2019 Investor Day, including 12% average annual operating EPS growth, excluding catastrophes for 2020 and 2021. As expected, this implies slower EPS growth in 2021, as we continue to invest for the future and build off of a stronger base in 2020. And also assumes a more normalized level of non-cat losses in Global Housing. In 2021, we will continue to prioritize investments in product innovation, further enhancing the customer experience and strengthening our social responsibility efforts, including actions to promote sustainability. I'll now turn the call over to Richard to review fourth quarter results and our high-level view of 2021. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Alan, and good morning, everyone. As Alan noted, we are pleased with our performance for 2020, particularly amidst the pandemic. I'm now going to review our fourth quarter 2020 results and underlying business trends for the year. For the fourth quarter 2020, net operating income excluding catastrophes declined by $3 million to $136 million, mainly due to a $28 million reduction in net investment income across all operating segments, partially offset by more favorable non-cat loss experience in housing. This drop in investment income reflects both the lower interest rate environment and includes a $12 million decline in income from sales of real estate joint venture partnerships. In the quarter, we also incurred $11 million of severance in real estate charges as we continue to manage expenses and evolve Assurant's workplace environment. Now let's move to segment results for Global Lifestyle. This segment reported earnings of $88 million in the fourth quarter, down $9 million. The year-over-year decrease was primarily due to a $16 million decrease in net investment income spread across the businesses, half of which came from sales of real estate joint venture partnerships. Excluding the decline in investment income, segment earnings increased modestly. Underlying earnings growth was driven primarily by organic growth in Global Auto, while Connected Living earnings were flat compared to the prior year. Results in Connected Living were driven by continued mobile subscriber growth, particularly in Asia-Pacific and North America, as well as contributions from the acquisition of HYLA in December. This was largely offset by lower mobile results in Europe, mainly from $5 million of non-run rate items. In addition, the segment had $4 million of severance and real estate charges in the quarter that we don't expect going forward. Looking at total revenues, net earned premiums and fees decreased by $37 million. This was driven mainly by a $78 million reduction in mobile trading revenue, primarily due to the contract change we disclosed in the second quarter. Excluding this change, Lifestyle revenues were up $41 million, or 2%, driven by an 8% revenue increase in Global Auto from prior period sales of vehicle service contracts. Overall, trading activity which flows through fee income was down year-over-year. However, as was the case in the last few years, we saw an uptick in December. This was driven by new phone introductions, greater device availability, and contributions from HYLA during its first month with Assurant. Given the continued strong trading activity in January, we expect to see a sequential and year-over-year increase in volumes in the first quarter. For the full year of 2021, we expect to see continued growth in Global Lifestyle's net operating income, with the growth more heavily weighted towards the second half of the year. Overall, earnings expansion will be led by mobile and will mainly come from new and expanded programs as well as contributions from recent acquisitions. We also anticipate improved profitability in financial services, which is positioned to steadily improve following the lower volumes and unfavorable loss experience seen in 2020. We are cautiously optimistic, particularly as it relates to some of our travel related programs, which were negatively impacted by the pandemic. We expect Global Auto earnings to be down modestly reflecting the pressure from the low interest rate environment. Continued investments in our capabilities, product offerings, and customer experience are also anticipated during the course of the year. Moving now to Global Housing, net operating income for the fourth quarter totaled $61 million, compared to $73 million in the fourth quarter of 2019. The decrease was largely due to $28 million of higher reportable catastrophes, over half of the losses were from Hurricane Zeta, with the balance primarily related to claims from Hurricane Delta. Excluding catastrophe losses, earnings increased $16 million, or 23%, despite lower investment income of $8 million. The increase was driven by favorable non-cat loss experience across all lines of business. We saw reduced claims frequency and drove improved profitability in our sharing economy portfolio. Lender-placed results also reflected higher premium rates, mostly offset by declining REO volumes from ongoing foreclosure moratoriums. Turning to revenue. Global Housing net earned premiums and fees decreased 3%. Similar to previous quarters, this was driven mainly by three items. The exit of small commercial, the insolvent lender-placed client and lower REO volumes. The decrease was partially offset by growth in both our specialty property and multifamily housing businesses. We expect Global Housing's net operating income, excluding cats to be lower in 2021 compared to 2020. An overall increase in our non-cat loss ratio to more normalized levels, and higher cat reinsurance costs will be the primary drivers. We expect both indexes to begin in the first quarter. Regarding our cat reinsurance costs in January, we completed approximately two-thirds of our 2021 catastrophe reinsurance program placement. As part of the placement, we secured additional multiyear coverage, resulting in approximately 52% of our U.S. program now benefiting from this feature. As expected, we saw an increase in the overall pricing of reinsurance in our purchases today, which are multiyear layers help to offset. As we finalize the remaining portion of the program in July, we will continue to evaluate the risks and rewards of purchasing additional reinsurance and alternatives that could reduce our risk. We are not however, currently assuming any increased coverage. We expect some increase in our yield volumes in the second half of the year. However, we do not anticipate volumes reverting to pre-COVID levels immediately. And volumes will be influenced by the timing of the foreclosure moratoriums. Now let's move to the Global Preneed. The segment reported net operating income of $9 million, a decrease of $7 million year-over-year. In addition to lower investment income, we had nearly $4 million of non-recurring items related to a system conversion and updated assumptions for the earnings pattern and new policies. While the GAAP impact of these items was $4 million. The statutory impact was immaterial. In addition, we experienced an increase in mortality trends as we exited the quarter. We continue to monitor trends and expect the increase in claims to continue into the first half of 2021. Revenue for Preneed was up 5% primarily due to growth in U.S. sales, and base sales have increased significantly since the second quarter of 2020, so, they remain below pre COVID levels. For 2021 Global Preneed will remain in our operating results until we conclude our evaluation of strategic alternatives. Overall, we expect 2021 Preneed earnings will be up slightly compared to 2020 reported results illustrating the strength of the business despite the ongoing challenge of the global pandemic. At corporate, the net operating loss was $23 million, compared to $22 million in the fourth quarter of 2019. This was primarily due to lower investment income and expense actions in the quarter. For the full year 2021, we expect the corporate net operating loss to improve from 2020. I also wanted to provide a quick update on our investment portfolio. The portfolio continued to perform well during the quarter. While investment income levels are low due to the lower short and longer term yields available in the market and lower joint venture real estate income in the quarter. The strength of the portfolio can be seen through three items, the absence of defaults, the low level of credit downgrades and the increase in the value of those assets mark-to-market. Turning to holding company liquidity, we ended the year with $407 million, which is $182 million above our current minimum target level. In the fourth quarter, dividends from our operating segments totaled $292 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items, $147 million of share repurchases, $44 million in common and preferred stock dividends and $368 million related to the acquisitions of HYLA and EPG. As a reminder, we partially financed HYLA through the issuance of subordinated debt in the fourth quarter. As we enter 2021, our capital and liquidity positions remain strong, supported by the robust cash flows generated by Global Lifestyle and Global Housing. For the year overall, we expect dividends to approximate segment earnings subject to the growth of the businesses and rating agency and regulatory capital requirements. We have now returned approximately $880 million in the last two years. And we expect to complete our three-year $1.35 billion capital return objectives to shareholders in 2021. Similar to prior years, the pace of buybacks is expected to be somewhat weighted towards the second half of the year. In the first quarter through February 5th, we repurchased an additional 120,000 shares for $16 million. We have $770 million remaining in our share repurchase authorization, which includes the additional authorization recently approved by our Board of Directors. Additionally, in January, we redeemed the remaining $50 million of our March 2021 notes. Before closing, I also wanted to provide reminder that our mandatory convertible shares will convert to common shares on March 15th. The number of common shares issued will depend on our share price leading up to the conversion date. At Assurant's current share price, we would expect conversion would result in the minimum issuance of shares. In summary, despite a year of uncertainty, we took action to safeguard our employees, to provide our clients with superior service, and to maintain our strong financial footing. As we turn the page to 2021, we're focused on continuing to deliver profitable growth, enhancing our products and services, and meeting our commitments to all stakeholders. We look forward to the year ahead, as we continue to drive Assurant to a strong future. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Thank you. Our first question comes from Bose George with KBW. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning, Bose."
},
{
"speaker": "Bose George",
"text": "Hey good morning. I want to ask just about the potential sale of the Preneed business. There's been a lot of life insurance and annuity transactions recently. And, just broadly, do you consider those to be good comps and should we focus on the sales pricing based on the multiple book value as opposed to an earnings multiple?"
},
{
"speaker": "Alan Colberg",
"text": "So, first of all, it's important to reflect on our Preneed business. We have a unique and strong business. We have our important distribution partners that are in a long-term contract, we have a block of business that's continued to perform well even through COVID-19. And what I would say on the process is we're encouraged. There is strong interest and robust interest in our company and in Preneed. And we're hopeful that we'll be able to announce something in advance of our Q1 earnings call. In terms of valuation, I think it's not really appropriate to speculate on that as we're in the middle of the process. But I do think we're on track to deliver a good and strong outcome for our shareholders at the end of the day, and further reposition the balance of Assurant and focus on our growth engines around the connected world and our strong specialty P&C offerings."
},
{
"speaker": "Bose George",
"text": "Okay. That's helpful. Thanks. And just switching over to the extended warranty business. There have been a couple of headlines about competitors that was the Home Depot Allstate partnership. Can you just talk about competition in that states and just remind us what the - your targeted growth in returns in that business are?"
},
{
"speaker": "Alan Colberg",
"text": "So, extended service contracts are part of our Connected Living business, given the kind of convergence and overlap we see between mobile and service contracts. We mentioned on the call today that we've extended and deepened our relationship with Lowe's, which is an important service contract partner. And we talked in the prepared remarks about the inclusion of what we call Pocket Geek Home, which we're excited about as kind of a next generation innovation. It's really around providing all the services to keep you connected for every connected device that you own. So that's exciting. But broadly, if you look at Connected Living, it was another year of strong growth that includes in our service contract business. And we continue to believe and you see it with our success that we've been able to expand and grow and deepen. I think we've announced now more than a dozen or so new partnerships in the last three or four years, really driven by our innovation, and our strength in key global markets around the world like Japan and Europe. So, I think we feel good about the momentum and we're going to continue to invest to differentiate. We, for example, in 2020, we substantially increased our investment in digital midyear. Just not that we aren't already strong in digital, but we see the impact of COVID and we want wanted to make sure we're doing everything possible to drive a complete digital omni channel experience for our customers."
},
{
"speaker": "Bose George",
"text": "Okay, great. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Brian Meredith with UBS. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning, Brian."
},
{
"speaker": "Brian Meredith",
"text": "Yeah. Good morning. First question, I guess. Can we take a little bit more into the Cover devices and mobile and kind of what's happening there growth continues to slow? I know you mentioned a little bit how you expect some pickup in the beginning of the year, but just how do you think this plays out, particularly also related to Sprint, T-Mobile? How does that kind of play out through the year, when do we expect to see some kind of meaningful impact from that, at least from a growth perspective and top line?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah, if I reflect on the subscriber count, certainly 2020 was still a positive year. We grew the subscriber count despite COVID and despite the numerous disruptions and store closures that happened throughout the year. We had challenges in Latin America, the region that was most disrupted probably by COVID. But as I mentioned in the prepared remarks, we had strong growth in North America and Asia Pacific. And, with the Sprint business, we are beginning to ramp that and that will grow strongly as we go through 2021 and beyond. So, certainly grew a little bit slower than prior years, really because of COVID, but the underlying momentum and strength of that business remains strong."
},
{
"speaker": "Brian Meredith",
"text": "Great, and then I guess my second question, just back to the Preneed, can you just kind of remind us, what are your thoughts as far as use of proceeds on the Preneed sale as you kind of think about it today?"
},
{
"speaker": "Alan Colberg",
"text": "Brian, I think the most important thing on Preneed is, we're very hopeful that we'll get to a great outcome for our shareholders as the first most important thing. If you look at our history, we have a strong track record of disciplined capital management and deploying capital to support and grow our company over time. Normally, we focus first on organic growth and ensuring that we're funding the growth that's happening. We have strong underlying organic growth across our company. And then we look at M&A and return to capital. With M&A as a reminder, we have a very high hurdle, we look at cash-on-cash IRR and we're really just focused in our key growth engines of the connected world. So that's mobile, auto and renters that's where the bulk of that would be. And if we have excess capital, our track record of returning it to shareholders over time is strong."
},
{
"speaker": "Brian Meredith",
"text": "Got you. And just one last one, I'm curious. Renter's insurance marketplace. Can you talk a little bit maybe about the competitive environment there, I mean, we hear a lot about some of these insured tax very active in that marketplace, can you give a little perspective on what's going on there?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah, if you look at our business, we continue to grow and gain share, our policies were up 8% last year, so we added net something like 200,000 policies, give or take to 2.4 million. And we've really invested over the last couple of years. If you do a side-by-side of our purchase experience digitally, it's as good and easy to use for consumers as any digital experience that's out there from any company. And then importantly, in the property management channel, we're rolling out Cover360, which really will drive attachment over time. It makes the whole process of compliance and having the appropriate coverage easy. So, we feel good about our momentum. We continue to grow and gain share relative to the market. If you think about multifamily, it was disrupted by COVID more than many of the markets in the U.S. just given the challenges with renters. We had a lot less mobility last year of people moving. And despite that, we grew policies 8% so, it's a good business. We continue to gain share and we continue to invest to differentiate our offering."
},
{
"speaker": "Brian Meredith",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mark Hughes with Truist. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Good morning. In the Global Auto business, what are the prospects there for growth? I think you talked about the net income being down on interest rates. I'll ask a question, like I have asked before. If interest rates are low, could you adjust your offering, adjust your pricing perhaps to compensate for that? And that question and then kind of the, what should we think about top line in 2021 in Global Auto?"
},
{
"speaker": "Alan Colberg",
"text": "So, Mark, appreciate that. Maybe I'll start. And then, Richard, you can go deeper on the question around investment income. If you look at that business, since we closed on The Warranty Group, we mentioned this in the prepared remarks, we've added something like 13% to our service contract count. That's over the last couple of years. That bodes very well for the future. Those are embedded future earnings. They're going to come through. And if you look at the underlying growth in the business before considering the investment income impacts, this is a longer duration product and others in our portfolio other than Preneed, very strong underlying growth, really driven by expanding share in our key dealer relationships and beginning to drive some of our capabilities from mobile into the business. We've also recently announced partnerships in Europe. And we've announced previously a partnership in China around electric vehicles. That's another source of innovation growth, I think, put aside, the kind of short term what shows up in our earnings, the underlying strength is strong. But Richard, you should comment more on investment income and how we think about that."
},
{
"speaker": "Richard Dziadzio",
"text": "Sure, and just to add on to that, I mean, only part of the earnings obviously, are coming from investment income. And the overall portfolio, I would say is more-shorter in duration relative to Preneed. You think about Preneed, having a duration maybe of 10-years, think about half that or less for Auto. So, the current drop in interest rates has had somewhat of a headwind impact on us. Who knows how long that's going to last? Right. But in terms of moving forward, I think, for a large part, we've taken into account the short-term interest rate impact this year so far. So that, I don't think short-term rates are going to go any lower, much lower. So, I think that's all settled in. And that's just cash coming in and out of the enterprise there. And then from a longer-term basis, I think your question is a good one. As things move on, if interest rates stay low, it's a competitive environment. So, we'll see with pricing, but that typically would happen in any market, where there's some sort of interest rate spreads embedded in products. So, overtime that should re-price. Obviously, Mark, there's typically a lag in things like that. In terms of 2021, we feel really good. As Alan said, I mean, the business has good momentum, we've grown the number of protected vehicles that we've had. Our recent acquisition of EPG bodes well for the synergies and integration that we have with that company into ours and future growth, AFAS this summer as well. Good, good, strong acquisition for us. So, we think we're the strongest player, one of the strongest players in the market and positioned to win as we go forward."
},
{
"speaker": "Alan Colberg",
"text": "And Mark, maybe the other thing I'd add on investment income policies, if we look at Preneed and the process, we're in and assuming we get to a good outcome there, Preneed is something like 40% or 45% of our total investment portfolio, and even more of the volatility just given long duration. So, one of the other benefits of successful outcome of Preneed is the even further reduce our exposure to interest rates as a company which will create more stability in the future."
},
{
"speaker": "Mark Hughes",
"text": "On the - Thank you for that. On the non-cat losses in Housing, is that an industry phenomenon? Do you think COVID related or just more broadly weather related or perhaps the underwriting phenomenon? How do you do view that?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yeah, good question. We have had, lower non-cat loss ratio this year, a lower non-cat loss ratio relative to last year. And that comes from a couple of different parts. I think the first part is small commercial, we exited that business, which was weighing on our overall non-cat loss ratio. The second part would be the underwriting we've done and improvements within the specialty property, and particularly the sharing economy part of the business with the growth there that we've had, and some nice results there. So those two items, I would say, are very particular to Assurant. So, not a phenomenon across the market. And then, we've also seen claims come down and frequency of claims this year. We're not so much thinking it's due to COVID as we're thinking it's really due to kind of weather, more or less weather and the wind, the flood and things like that this year, we did have a little more increase in the cats that we've had this year. So maybe there's a play against those too as well. Looking forward, we think that as we said, in 2021, the non-cat loss ratio will move up. But we don't think it's going to move up that much. It's probably potentially a slow conversion towards where we were in the past. But given what we've done in our underwriting, the movements that I discussed a moment ago, we think, we're going to be in a better place next year than we were historically. So we'll move up a little bit, progressively, but not as much as, not to where we were in 2021, it is our prediction."
},
{
"speaker": "Alan Colberg",
"text": "Yeah, and Mark, the other thing I would add to summarize kind of what Richard said, more than half of our improvement we believe has been driven by actions we have taken, the ones Richard mentioned. The other thing we've been investing heavily in is AI and Automation, which has the benefit of driving better CX as well as improved efficiency. So, there is some effect of what's happening in the industry, but we feel most of this is being driven by us and we do expect some step up in '21 given 2020 was particularly low, but we feel good about the actions we've taken to drive improvement here."
},
{
"speaker": "Mark Hughes",
"text": "And then, Alan, maybe a little bit of a softball, but you said you had mentioned how you feel like Assurant trades at a discount to peers in the home services market. Any elaboration you'd like to give on that?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. One of the things that we look at is if you really step back and look at our company, we've over the last four or five years really evolved to be much more of a fee income service business type company. We have a track record of strong profitable growth. If you look at it, we've delivered now we mentioned on this call, four years in a row of strong operating earnings growth. We have a cash flow ability as we've said many times over the years, if we earn $1 at our segments, we can on average get that to the holding company. And if you look at that, if you look at the competitors that we're evolving into, now people in the home services market or others, they all trade on multiples of EBITDA, that are in the mid-teens and we are well below that. And so, we continue to look at how do we help our investors better understand just the quality of our franchise, the 17 plus year client tenure that we mentioned earlier, the investments we've made differentiate. And over time, we continue to believe our stock is attractively priced, and we're going to work on continuing to evolve our metrics and disclosures and how we deploy capital to maximize the value for our shareholders."
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from the line of Michael Phillips with Morgan Stanley. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning, Mike."
},
{
"speaker": "Michael Phillips",
"text": "Good morning. Thanks, guys. Good morning. You mentioned - Richard, you mentioned in your comments, the headwind in Europe a [ph] non-refundable amount about $5 million. Is there anything else in Europe that besides that you would point to that would cause a headwind there?"
},
{
"speaker": "Richard Dziadzio",
"text": "No, I think the biggest part of the headwind was really in terms of them positioning themselves for 2021 and for growth. I mean, overall, they had a good year, despite the pandemic. And we do think that going forward, the profitability is going to increase over Q4 in Europe. So, we really do think it was a kind of a one-time thing where there were several small items that we do not expect to recur."
},
{
"speaker": "Michael Phillips",
"text": "Okay, great. And this is kind of a follow on to prior question on housing. A little bit of a different angle, on the frequency benefits that you've seen again. And you mentioned in prior calls, recently, theft and vandalism has been down. I'm curious, is that COVID related certain benefits theft and vandalism are down? Or is that more of what Alan was saying, kind of things that you've done to re-underwrite that have helped that piece of the business?"
},
{
"speaker": "Alan Colberg",
"text": "The other thing I would add on that one, and then Richard, feel free to add on to it is. Our book today is very different than five, six, seven years ago. If you think about after the last housing crisis, we had a lot of vacant and foreclosed properties in the portfolio, that's where you tend to see that the most. Today, we're in a strong housing market. And we're really providing a backstop when people aren't able to get coverage. So, you normally see lower theft and vandalism over time when you're in a stronger housing market anyway. So, I think that's part of what we're seeing. I don't know if Richard, would you add anything else?"
},
{
"speaker": "Richard Dziadzio",
"text": "No, that's exactly right, Alan. I think the other thing is, we were seeing a trend coming down, even prior to the pandemic. So, we're not thinking that pandemic I mean, there could be a small part of that, but that's not something that is a driver."
},
{
"speaker": "Michael Phillips",
"text": "Okay, great. Thanks. And then last one for me on the Global Financial Services area. You've talked a bit about the impact from COVID there from balances being down. I guess has that turned around any? And then on legacy business there, are we in a trough, so you talked about what you expect for this year to be better than last year, but how much of that is a turnaround from COVID? And, again on legacy business are we at the bottom there?"
},
{
"speaker": "Alan Colberg",
"text": "I think in that business, I'm really encouraged about - excuse me, the momentum we're starting to see when we acquired The Warranty Group, they had just signed a significant new client in that space. And then as we announced on the call earlier today, we've just signed another new client. So, we've got several potential growth drivers in the future that makes us pretty optimistic about that. In terms of the areas that have been disrupted by travel - COVID, that's really travel. And we'll see how that plays out this year. But we expect to see improvement over time. And the new clients and the new offerings over the last couple of years have us in a much better position for this business to grow and contribute in the coming years."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Thank you, Alan, appreciate it."
},
{
"speaker": "Operator",
"text": "Our next question comes from Gary Ransom with Dowling & Partners. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning, Gary."
},
{
"speaker": "Gary Ransom",
"text": "Good morning. I wanted to ask on the severance in real estate change, whether that represents any kind of employee business model change? And if so, is there more to come?"
},
{
"speaker": "Alan Colberg",
"text": "And maybe, Richard let me start just briefly, yeah, I'll start briefly, and you can provide more. At a high level, we're looking at kind of the future of work and what those models are. We've shown we had about 30% of our employees' virtual pre COVID. And post COVID, we'll no doubt have a higher percent. So, we are looking at that and evaluating it. But I think the main driver is really our ongoing expense management and just aligning our resources with the growth of the company. But Richard, why don't you add particularly on the real estate."
},
{
"speaker": "Richard Dziadzio",
"text": "I think, when we think of real estate, I think of the word facilities. So, it is linked to our facilities and how we're using our facilities going forward. We had a couple leases that were coming due early in 2021, we're not going to be going back to that space. We'll be getting new space or working from home in a new work environment. So, we just had to take an acceleration of the expense on that leasehold improvements and so forth. So, it's really positioning when we get to the fourth quarter, we started to position ourselves, Okay, next year, what's our footprint? Where should we be, from a headcount point of view, but also from a facilities point of view? So, we don't think that the actions we take in fourth quarter are a harbinger of things to come, it's really just a one-time $11 million total impact which is why we called it out as such."
},
{
"speaker": "Gary Ransom",
"text": "All right, that's helpful. Thank you. Another one on the - you mentioned competition in Lifestyle, I wonder the competition on Global Housing in the lender-placed business. Obviously, you said you renewed a lot of contracts, but can you give us a sense of what goes on in those renewals, are other competitors trying to get in on it? I assume that happens regularly. But I was wondering whether it's any more intense or has changed at all?"
},
{
"speaker": "Alan Colberg",
"text": "No, I think the important thing with that business is all of ours, it is competitive. That's just the reality of the markets that we all compete in. With that said, we have a really strong position there. We've invested and continue to invest in differentiating our capabilities around compliance, around customer experience. We're early in this rolling out our SSP, our single source platform, which really differentiates our tracking capabilities. And as we mentioned, we've renewed something like 85% of our relationships over the last two years, many of them early as we prepare to work with our clients on the conversion to our new tracking system. So, I don't see the competitive pressure changing a lot, it's always there. But we've shown our ability if you look at the last decade, we've been able to grow that business dramatically, really driven off of the value that we're creating for our partners and for our customers."
},
{
"speaker": "Gary Ransom",
"text": "And in that business, you're going through this process of reducing risk and becoming more fee oriented. And in Preneed, we can assume that that's gone, which has some volatility on the investment side. Global Housing is the last business with some volatility embedded in it. Is this a strong enough business for you that you're content with handling that volatility? Or is there something else that you might think about in the future?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah, a couple comments on that. So, if we look over the last five, six, seven years, we've significantly reduced our exposure through the purchase of reinsurance. If you go back to 2012, '13, we were at about $240 million of retained event exposure. We're down to $80 million. We've also morphed our reinsurance tower more than half of its multiyear now, which also creates a lot of stability and we've also been pruning non-strategic risk. So, a great example of that was our exit of small commercial a year or so ago. So, when we look at it, we'll always look at there are other actions that could further share some of that cat exposure away. But if we look at the overlap between our Housing business and our Lifestyle business, it's strong. If you think about the convergence around the home, the device, the car, we're starting to see opportunities to roll out what we do in Lifestyle, in the Housing. A lot of our mobile capabilities are really relevant in renters and in the connected home. Also, as we mentioned in the prepared remarks, even in a relatively high cat year, we had a 15% ROE with cats in Housing. So, it's generating strong earnings, lots of cash to reinvest and continues to be an important part of our strategy and portfolio with the caveat that we have reduced our cat volatility a lot and we'll continue to look at ways to reduce that cat volatility."
},
{
"speaker": "Richard Dziadzio",
"text": "And if I could just add to that, I mean, as Alan says, to reduce our cat volatility, we do get the question and we do look at it every year. I mean, obviously, this year was a little bit special with the pandemic and with the amount of capital that was in the reinsurance market. We've seen that capital now come back. So, we'll keep looking at things like bringing down the retention, purchasing aggregates and doing other things, quota shares or whatever, that could reduce the volatility a little as we go forward. In my prepared remarks, I said we can't plan on anything and we're not planning on anything to 2021. But as Alan said, we are keeping our eyes wide open to opportunities there."
},
{
"speaker": "Gary Ransom",
"text": "Very helpful. Thank you very much."
},
{
"speaker": "Operator",
"text": "Our last question comes from the line of Mark Hughes with Truist. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning again Mark."
},
{
"speaker": "Mark Hughes",
"text": "Yeah, thank you. Another one of my usual questions, which is when we think about the lender-placed placement rate, obviously delinquencies are quite high. You talked about the REO program. You can certainly understand that being under pressure with a foreclosure moratorium in place. But how about just these higher delinquencies presumably the escrow funds are getting used up and if people aren't paying their mortgages, the lot of them are not paying insurance, how do we think about that, it seems like you've had very limited impact so far, but these have been delinquencies have been in place since early mid last year. It seems like they'd be falling into your bucket pretty soon, but apparently not. So, I'm just curious what's going on there?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, Mark, I think the important way to think about lender-placed is, whether the housing market weakens or not, we don't know. And we're not seeing a lot of real evidence that the housing market is weakening. But through the actions over the last four or five years, we've now got to lender-placed to where it's roughly stable on earnings ex-cat even if the housing market remains strong. And obviously if the housing market does weaken at some point, we're going to be there to provide the support to the mortgage market that we've historically provided. So, we don't know what might happen this year. There is always a lag. It depends a lot on what happens with the government foreclosure moratoriums. But we've certainly called out that our business has been impacted negatively in 2020 and continuing with just the lack of REO volume, given the foreclosure moratoriums that are going on. But the business is well positioned and if the market does weaken, we're going to be there and we will support the mortgage industry through that."
},
{
"speaker": "Mark Hughes",
"text": "If we continue to see these delinquencies, the 90 day plus delinquencies they are up substantially and maybe they're tapering a bit, but tapering slowly."
},
{
"speaker": "Richard Dziadzio",
"text": "Yep."
},
{
"speaker": "Mark Hughes",
"text": "Does that have an impact on the business?"
},
{
"speaker": "Richard Dziadzio",
"text": "It really as I mentioned, it really depends on what happens with foreclosure moratoriums. If there is weakness in the housing market, eventually we should see that flow through into our business. We just - it's hard to say when given what's happening in the broader economy and with our government dealing with COVID."
},
{
"speaker": "Mark Hughes",
"text": "So, I guess it's really the foreclosure numbers that are more relevant for your business?"
},
{
"speaker": "Richard Dziadzio",
"text": "No, our business is driven by many things, but where we've seen the biggest kind of short-term negative impact is just the foreclosure moratoriums and therefore, properties aren't moving through the process that you would normally have seen. But again, we are well positioned if the market does weaken and it's allowed to function like it historically has. We're well positioned to benefit and support that. And as I said in my prepared remarks - As I said in the prepared remarks, Mark, we're not counting on any sort of big return in our real volumes next year, given the forbearance moratoriums and an extension of them. So, we do think that over time, when the market kind of gets back to a balance, and we get past the pandemic and the moratoriums, it'll start to increase maybe second half of the year a little bit, probably more into 2022, as we kind of get back to and if we call it an equilibrium, but more normal times."
},
{
"speaker": "Mark Hughes",
"text": "Thank you for that."
},
{
"speaker": "Alan Colberg",
"text": "All right, excellent, and if I just take a moment and reflect more broadly. We're really proud of 2020 and what our employees did to support our customers and clients through COVID. It was a strong growth year for us, both in Connected Living and then broadly in Housing. We continue to execute against our long-term strategy. You heard us say that, we still expect to deliver on the 2019 Investor Day objectives, including the 12% average annual operating EPS growth in 2020 and '21. And we continue to gain share, which really augurs well for the future as we invest, differentiate and encourage our clients to add more of our capabilities into their products. And then finally, we mentioned that we're encouraged by the progress on the potential sale of Global Preneed and hope to have some positive outcome to share shortly. So, thank you for participating in today's call. To summarize, we're really pleased with our performance in 2020. And we're going to continue to focus on building a stronger company in 2021. Following the conclusion of our evaluation of alternatives for Global Preneed, we are planning to provide our full year outlook for 2021 at that point. In the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. Thanks, everyone."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 3 | 2,020 | 2020-11-03 08:00:00 | Operator: Welcome to Assurant’s Third Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode. And the floor will be open for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Francesca Luthi, Chief Administrative Officer of Assurant. You may begin.
Francesca Luthi: Thank you, operator, and good morning, everyone. We look forward to discussing our third quarter 2020 results with you today. Joining me for Assurant’s conference call are Alan Colberg, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the third quarter 2020. The release and corresponding financial supplement are available on assurant.com. We will start today’s call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday’s earnings release, as well as in our SEC report. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday’s news release and financial supplement. Now I'll turn the call over to Alan.
Alan Colberg: Thanks Francesca. Good morning, everyone. We are pleased with our third quarter operating results, which demonstrate the continued resiliency and strength of our business portfolio. Our track record of delivering strong profitable growth not just this quarter, but over the past few years reinforces our strategic direction and our confidence in the future growth prospects of Assurant. Last week we made two announcements that underscore our focus on our market leading lifestyle and housing businesses while capitalizing on the convergence of the connected mobile device, car and home. Our Connected Living, Global Automotive and multifamily housing businesses have a history of profitable growth and we believe compelling future growth potential. In addition, our specialty P&C offerings including lender-placed insurance are extremely well positioned. The countercyclical nature and strong returns of the business continue to make it a critical part of our portfolio. Together lifestyle and housing should drive ongoing above-market growth and superior cash flow generation with the ability to outperform in any economic cycle and ultimately to create greater shareholder value over time. Our acquisition of HYLA Mobile, a leading provider of smartphone software and trade-in and upgrade services will strengthen our market position with increased scale, complementary client bases and favorable tailwinds in the global mobile market. We value HYLA at the multiple of low teens forward EBITDA. The combination of its patented software technology and trade-in capabilities with Assurant's end-to-end mobile device life cycle management expertise will deliver three primary benefits. First, it will enhance the customer experience making it easier for consumers to get trade-in value for their used mobile devices without an in-person inspection. Second, it will improve program economics and performance for our partners including higher trade-in attachment rates. And finally, it will further strengthen Assurant's ability to take advantage of the 5G smartphone upgrade cycle. HYLA also has strong relationships with marquee partners complementary to Assurant's client base across our critical distribution channels and geographies and including leading U.S. and Japanese mobile carriers as well as major global OEMs. As we announced, we intend to fund our acquisition through a combination of cash on hand at the holding company and new debt issued prior to closing so that we can continue to optimize our capital structure while maintaining investment-grade ratings. To better align resources to the best market opportunities within lifestyle and housing we've also announced a review of strategic alternatives for Global Preneed including a potential sale. This decision was not an easy one given the strength of the business and the considerable value its employees brought to Assurant. Global Preneed is a strong business with over two million policyholders throughout the U.S. and Canada. It has delivered consistent growth while generating robust cash flow and above market returns. It has nearly $6 billion in investable assets and is relatively low risk compared to other life insurance-type products. However, we believe the business has been historically undervalued as part of Assurant. So a transaction should unlock significant value by allowing us to deepen our focus on consumers' connected lifestyle and our differentiated P&C businesses. We expect that any proceeds from a potential transaction will be deployed to fund business growth with excess funds returned to shareholders over time. In the months ahead, we will provide updates on our progress as appropriate. And as always during this time we will continue to honor our commitments to clients and policyholders while delivering exceptional service. Now I'll provide a few key highlights from the third quarter that affirm our continued progress within our lifestyle and businesses. Within Connected Living, we've grown earnings 22% year-to-date. As we focus on continuing to drive long-term growth, we are moving forward with the build-out of our full-service customer capabilities, to deliver superior customer service to our 54 million mobile subscribers. This quarter, we also acquired Fixt providing mobile customers increased choice through a come-to-you repair capability. This acquisition complements last year's purchase of Cell Phone Repair or CPR that delivers the same-day local repair option. Like HYLA these investments will support the acceleration of our strategy, by expanding our capabilities and offerings, as we anticipate the ever-evolving needs of connected consumers. We also recently launched Pocket Geek Home, which offers personalized tech support and bundled protection of at-home technology, including laptops, gaming systems, and other electronics from accidental damage and mechanical breakdown. While it is still early, we believe this offering is an important step in the development of future-connected lifestyle protection products. In Global Automotive, we remain focused on opportunities to leverage our leadership position to scale, in key global markets. In the U.K., we recently launched a new product for electric and hybrid vehicles called EV One. This includes a new partnership with a London electric vehicle company that will cover their iconic London black cabs and electric van models. This supports the continued growth of our auto business globally, while also gaining further insights into the evolving electric vehicle market. And it supports the U.K.'s move toward EV as a standard by 2035. Within Global Financial Services, we are pleased to announce the launch of a new partnership in Canada with the Bank of Montreal, leveraging our omnichannel customer capabilities, as we continue to reposition the business for profitable growth long-term. Moving to Global Housing, we extended our agreement with yet another client in the lender-placed business. We've now renewed 20 clients, representing more than 85% of our tracked loans since the beginning of 2019. Lender-placed is a critical part of the mortgage landscape in the U.S., and continues to be an important component of our long-term strategy. In multifamily housing, we grew revenue and policies by 8% and 9% respectively, year-over-year. Our Cover 360 property management solution continues to gain momentum, and drive higher penetration of renters insurance, with our property management company partners. The product, formerly known as Point of Lease, allows the customer to combine their payment of rent and insurance. The solution now includes insurance tracking, verification and policy placement to eliminate coverage gaps. We're now tracking more than 335,000 rental units, which grew 40%, since the second quarter. We also believe that our increased investments around, the connected home and connected apartment will drive new opportunities to increase, P&C penetration rates. Turning to our key financial metrics, we're pleased with our progress against our 2020 objectives. Through the first nine months, net operating earnings per share excluding catastrophes increased 25% year-over-year to $8.69. Net operating income, excluding catastrophes was up 21% to $527 million. COVID-19 did not have a material impact on year-to-date results. For the full year, we now expect our operating earnings per share, excluding catastrophes to grow between 17%, to 21% compared to 2019, well ahead of our initial expectations. The revised outlook largely reflects Global Housing's favorable non-catastrophe loss experience, through the first nine months of 2020, as well as continued growth in Connected Living, and our disciplined expense management. Our capital position has remained strong throughout the pandemic. In the quarter, we resumed buybacks and we've now returned over 50% of our $1.35 billion objective from 2019 through the end of September. We expect to return the balance by the end of 2021 as we originally planned, primarily supported by the strong cash flow generated by our lifestyle and housing businesses. All of this is a reflection of the continued dedication of our 14,000-plus employees globally. They continue to do an outstanding job of managing through the COVID pandemic, while providing exceptional support to our customers, including those impacted by natural disasters this year. I'll now turn the call over to Richard to review third quarter results, recent trends and our 2020 outlook in more detail. Richard?
Richard Dziadzio: Thank you, Alan, and good morning everyone. I'd like to start by saying that, we're really pleased with our third quarter. We reported operating earnings per share, excluding catastrophe losses of $2.85, up 25% from the prior year period. Net operating income for the quarter also excluding catastrophe losses was $172 million, an increase of 22% from last year, largely due to more favorable non-cat loss experienced in Global Housing, continued momentum in Global Lifestyle and improved results in Global Preneed. Sales trends across the board have been improving from lows recorded in March and April at the height of the pandemic and we are seeing more normalized levels of COVID-related claims activity in Global Lifestyle and Global Housing. Now, let's review segment results in greater detail, starting with Global Lifestyle. This segment reported earnings of $107 million in the third quarter, up 4% compared to the prior year period. This increase was primarily driven by Connected Living, where we benefited from new mobile subscribers. Improved profitability within extended service contracts also contributed to growth in the quarter. Within Global Automotive results, reflected continued pressure from lower investment income and investments to support growth. Declines in Global Financial Services reflected lower card balances and volumes, as well as less favorable loss experience some of which was attributable to COVID. We also incurred additional expenses to launch new client programs. Looking at total revenue, net earned premiums and fees grew by $56 million or 3%. The increase was driven primarily by 14% growth in Global Automotive, including prior period sales of vehicle service contracts. We're continuing to monitor sales trends, which has stabilized but still trail 2019 levels on a year-to-date basis, due to impacts from COVID. Global Lifestyle revenue growth was partially offset by lower revenue from mobile trade-in, primarily due to the contract change we disclosed last quarter. This change lowered revenues by $39 million, as we changed reporting from a gross sales basis per device to a flat fee per device. As a reminder, this change will remove some of the revenue and expense variability we have historically seen in our financial results, and mitigate supply and demand pricing risk. Overall for the full year 2020, we continue to expect Global Lifestyle to grow net operating income when compared to full year 2019. Looking ahead, we anticipate an uptick in trade-in activity in the fourth quarter, which will continue into the beginning of next year. Volumes will depend on the following: the timing and availability of devices for new phone introductions, the level of carrier promotions, and the growth from new business. Looking ahead to 2021, we expect earnings expansion within lifestyle to moderate from the strong 2020 levels, which benefited from three items. First, $16 million of one-time benefits year-to-date; second, lower claims during the first few months of the COVID pandemic; and finally, lower expenditures on categories such as travel, given the uncertainty around the pandemic. We also expect ongoing headwinds from low interest rates on investment income. Moving now to Global Housing. Net operating income for the third quarter totaled $13 million compared to $ $42 million in the third quarter of 2019. The decrease was primarily due to $51 million of higher reportable catastrophes. As we pre-announced, we incurred a total of $87 million of after-tax cat losses related to several hurricanes and wildfires in the U.S. Nearly half of the losses in the quarter were from Hurricane Laura with the remainder primarily related to Hurricane Sally and Isaias, as well as wildfires in California and Oregon. Excluding catastrophe losses earnings increased $23 million year-over-year, or 30% to $100 million. Approximately two-thirds of the increase was due to favorable non-cat loss experience across specialty products and lender-placed. This included $8 million of favorable experience that we don't expect going forward, including reserve releases related to runoff businesses. Improvements in underwriting and product changes also led to more favorable experience. We also benefited from continued growth in multifamily housing from affinity partners. Within lender-placed the results also reflected higher premium rates. Growth was partially offset by the reduction in policies in force driven by declining REO volumes from the current foreclosure moratoriums and the previously disclosed financially insolvent client. Looking at placement rates. We recorded a two basis point sequential increase in the quarter to 1.58%. This was a attributable to a shift in business mix. It's not an indication of a broader macro housing shift. Turning to Global Housing revenues. Net earned premiums and fees decreased 4%. Similar to last quarter this was driven mainly by three items: The exit of small commercial, the insolvent lender-placed client and lower REO volumes. This decrease was partially offset by growth in our multifamily housing and specialty property businesses. Multifamily housing revenues increased driven mainly by growth from our affinity partners. For the full year we expect Global Housing's net operating income, excluding cats to increase year-over-year driven by favorable non-GAAP loss experience as well as improved results in each line of business. Looking ahead, we expect to see more normalized non-cat loss experience, lower REO volumes due to foreclosure moratoriums that have now been extended through the remainder of 2020, and lower investment income due to lower yields. Specifically in the fourth quarter, we also expect Hurricane Delta to be a reportable event likely in the range of $12 million to $20 million pre-tax subject to further claims analysis, and while still too early in the claims process to speculate Hurricane Zeta will likely be a reportable event as well. We will provide an update prior to fourth quarter earnings if necessary. Now let's move to Global Preneed. Overall, the business continues to perform well. The segment reported net operating income of $13 million, an increase of $6 million year-over-year. The absence of the negative one-time accounting adjustment in the third quarter of last year was offset by lower investment income this quarter. While market mortality trends have fluctuated during the pandemic, the impact on mortality on earnings continued to be immaterial in the quarter. Revenue for pre-need was up slightly primarily due to continued growth in sales of our Final Need product and we are pleased to see a rebound in face sales since the second quarter, reflecting the reopening of funeral homes. Overall for Global Pre-need, we expect 2020 earnings will approximate 2019 reported results. Moving to corporate. The net operating loss was $23 million, compared to $21 million in the third quarter of 2019. This was primarily due to lower investment income. For the full year, we expect 2020 corporate net operating loss to approximate $90 million mainly as the result of lower investment income and investments for growth. Turning to holding company liquidity. We ended September with $460 million or $235 million above our current minimum target level. In the third quarter, dividends from our operating segments totaled $245 million. In addition to our quarterly corporate and interest expenses we also had outflows from three items; first, we bought back $70 million of stock after resuming share repurchases in the quarter; second, we paid $42 million in common and preferred stock dividends; and finally, we had approximately $10 million of net cash outflows related to the acquisitions of Alegre and Fixt and the sale of our CLO platform. In the fourth quarter through October 30th, we repurchased an additional 330,000 shares for $41 million. Regarding the new debt issuance to support the financing of HYLA, we continue to target an overall debt-to-capital ratio of less than 30% and expect to remain within that target while also maintaining investment-grade ratings. For Global Preneed, we reported a $136 million goodwill impairment charge. This was related to the decision to explore strategic alternatives for this segment combined with the impact of the low interest rate environment. This is a non-cash charge and runs through net income. Moving forward, for the year, overall, we still expect dividends to approximate segment earnings subject to the growth of the businesses, rating agency and regulatory capital requirements, and the performance of the investment portfolio. In summary, we've delivered solid results and maintained a strong financial position throughout the pandemic. As we approach year-end, we remain focused on meeting our 2020 financial objectives and on building a stronger Assurant for the future. And with that operator, please open the call for questions.
Operator: The phone is now open for questions. [Operator Instructions] Thank you. Our first question is coming from the line of Mark Hughes from Truist. Mark, your line is open.
Alan Colberg: Hey good morning Mark.
Richard Dziadzio: Good morning Mark.
Mark Hughes: Good morning. Hope you all are well. On the vehicle business, the Global Automotive had a nice acceleration in earned premiums and fees up into the 13%, 14%. I think you had said that the new sales were still kind of lagging behind last year and year-to-date. Something is going on with the earned with the pickup there?
Alan Colberg: Yes. Maybe Mark let me start and then Richard you can give a little more color. If you look at the impacts of COVID in auto, we saw a real slowdown in the sales back in March and April. Since then we've been recovering. And our -- if you look at the current run rate, it's basically at or above 2019 levels. We just haven't fully caught up the gap that happened early in the year on kind of new sales for this year. But the momentum is strong and the business is strong. Richard do you want to talk a little bit more about what's happening with NEP?
Richard Dziadzio: Yes. Exactly. And then again that's exactly right. The only other thing I would add is obviously some of the earned premium is what we've written historically not just this year in prior years too. So, from time-to-time, we've had season -- seasonality where sales can be a little bit higher. So, the earnings can be a little bit higher. I always think relative to auto as in other lines of business it's good to look at it on a kind of a year-to-date basis and look over the last six months or year for trends.
Alan Colberg: Yes, the other thing I might add Mark is as we look to the future we feel very well-positioned going back to the reasons why we purchased the Warranty Group. And you heard in the prepared remarks we highlighted another step forward in electric which I think will position us to be one of the leaders around that as it grows in the market. So, well-positioned, performing well, and we look good as we look to the future for auto.
Mark Hughes: Just talk a little bit about the HYLA acquisition in terms of potential for customer expansion where they have relationships that you could perhaps build on.
Alan Colberg: Yes, what's interesting about HYLA is it really complements our business and what we do. So, we have our set of clients. We have end-to-end capabilities. What they have are generally different clients. So, they bring a variety of clients that we currently don't have a significant business with. So, they also bring a really superior software as a service and analytic capability that we can incorporate and drive into our programs over time. They've delivered strong double-digit growth over the past three years within their base. Now, they've started to expand. And together we'll have now more than 30-plus trade-in programs that are operating in key markets around the world and positions us well for the 5G megatrend. We don't know fully whether that will be a 2021 event or a 2022 event, but we'll be the partner of choice. I think for trade-in buyback around the world, after we close on HYLA.
Mark Hughes: And then finally your current thoughts on the, lender-placed business, when you look at the non-serious delinquencies. What do you think is going to shapeup on 2021?
Alan Colberg: So, right now, we're -- as we've talked about in the prepared remarks, we're seeing some -- well let me back up even more, that business is in a good place, right? We've been able over the last few years to get the earnings ex-cat to be stable, independent of any growth in the business. And through the evolution of our product, the things we've done over the past decade, we're really well positioned, as an integral part of the mortgage process. And as you know, we've been investing in our technology to really deliver superior customer experience. Now what's happening in the short-term is, we're actually not seeing any growth in that business, in terms of placement. REO volumes for example are down, and are down significantly because of the foreclosure moratoriums, that are in place. But we're well positioned if the market does weaken, next year. As we mentioned in the prepared remarks, we've now renewed the vast majority of our tracked loans. And so, we don't know what will happen in the housing market. But certainly nothing will happen in the short-term. But if the housing market does weaken, you could see, strong growth beginning maybe the second half of 2021.
Mark Hughes: Thank you.
Alan Colberg: Great. Thanks, Mark.
Richard Dziadzio: Thanks Mark.
Operator: [Operator Instructions] Your next question comes from the line of Brian Meredith with UBS. Brian, your line is open.
Alan Colberg: Hey, Good morning.
Brian Meredith: Thanks. Good morning. Good morning, everyone.
Richard Dziadzio: Good morning, Brian.
Brian Meredith: A couple of questions here for you, first on Global Lifestyle, first I guess, did the Sprint deal have any kind of impact on global covered devices much in the quarter? And then, following on that what do you kind of -- or maybe give some more color around? What do you think the potential backlog here is, with respect to trade-ins? I know you talked about it picking up in the fourth quarter? And maybe a little more context around with respect to the iPhone upgrade and the 5G upgrade cycle.
Alan Colberg: Yeah, Brian, thank you for the questions. On Sprint and T-Mobile, first of all, again I want to recognize the importance that, we have of that relationship with T-Mobile. We've been their partner, supporting their innovation and disruption for the last decade. And that is really the driver of our then now participating in the growth of Sprint. We are starting from zero. And there really the program has just begun to get going. It took a couple of months after the closing before T-Mobile really began to convert the stores, as they wanted to make sure, they didn't disrupt things during that conversion phase. So, we're starting to see some impact, but it's going to be a gradual ramp. We're also investing, as you might expect to help all the legacy Sprint stores be in a good position to sell our products, as people come in. So, not a lot of impact so far, but will be a significant growth driver over the next two to three years, as that program really ramps. In terms of the trade-in and buyback cycle, what we've seen in the last three or four years, is that the volume really begins in the latter part of Q4. And then really into Q1. And that's again what we expect to see this year. We'll see some volume beginning in Q4, but the bulk of the volume in the last couple of years has been lagged into the first quarter of next year. And it really is driven by one that new iPhones are available. And if you noticed their announcement a couple of the new models, were out right away, but a couple of the new models are still not out. And so, we'll see that over time. And I mentioned 5G earlier. This is the first year that the iPhones really have 5G capability, which is a real positive. But, when will consumers really get excited about 5G, we don't know for sure. But as we mentioned earlier, we're now well positioned to support our carrier partners with 5G when it happens.
Brian Meredith: Great. And then, two quick questions here on Global Housing. The first one, the underwriting initiatives that you guys implemented, maybe a little more color on, what those were? And what the impact was on the underlying combined ratio, because I assume that's going to be sustainable here going forward.
Alan Colberg: Yeah. Richard, do you want to take that one?
Richard Dziadzio: Yeah. Sure, sure. Good morning, Brian. Yeah, I think there -- the changes that we made in the underwriting were across a couple of different products. So first would be, we've talked about it before, small commercial. We had gone into that. We didn't have a positive experience with it and then put it into runoff. So obviously that will persist in the future because we have no plans to get back into that. So that's one positive. And then within the sharing economy I think we mentioned it on a call earlier in the year, we had had one type of product with one client who weren't getting good experience with and that we underwrote to. So again, I think there we have -- we've gotten good results out of that and are moving forward with positive results. The part of your question which is how -- what will persist or not. We have had within the non-cat loss ratio, some positives this year that won't reoccur. For example some reserve releases of a limited amount that we mentioned in our prepared remarks of about $8 million. Those won't continue. We don't think. We've also had a really good run in terms of lower frequency severity and things like theft and vandalism. Will that continue? That's sort of a question mark in terms of how that will go in the future. So there are some things that will continue. Some things that probably won't, the reserve releases. And then some things we'll wait to see what happens in the future with our experience.
Brian Meredith: Great. And then just one, last one on the Global Housing segment. It's been a fairly active year obviously for catastrophe losses given what's going on with global warming and stuff. I mean some people expect this to be more the norm than the exception. I guess my question then is, does a year like the year -- this year make you kind of question your reinsurance program -- changes to the reinsurance program maybe using more aggregate cover to kind of mitigate some of the volatility in the business?
Alan Colberg: Yes. Maybe I can offer a few thoughts and then Richard you should offer a few more. I mean, if you look at the last few years, we've dramatically changed our exposure to cat. We've done things like taking the retention down to $80 million where it is today from $240 million five years ago. We've exited certain lines that we were participating in the Caribbean. We've reduced exposure by exiting the small commercial business. And so we do feel very good about the portfolio and it's performing well. If you look at through the third quarter even with an active cat year, our ROE in housing is something like 14% or 15%. And so it's still performing and delivering well. With that said every year we revisit how we think about the risk-reward trade-offs on the cat program. And Richard maybe you want to comment a little more on how we're thinking about that in 2021?
Richard Dziadzio: Yes. Thank you. And I think Alan, you hit on a lot of the very key points which is part of cat is managing the exposure to cat. So we're very thoughtful in terms of what risk we're taking on. Obviously lender-placed, we have the exposure, we have given that flows through from the clients too to ourselves. But every year we look at it as Alan said. We look at what can we do to manage our exposure, whether it be bringing down our retention. Brian you'd mentioned buying in aggregate. That's obviously something that we look at every year. At the end of the day, there's economics around it and there's pricing in the market. So we look at that and say "Is it thoughtful for us to buy more reinsurance, or is this a risk we're happy to hold given the pricing out there in the market?" As Alan said we can have a quarter like last quarter where we do get hit by natural catastrophes. But over a period of time and I would say just one year, our combined operating ratio ends up being well below 100 and the ROEs on this business are very positive. So we're managing around that, being thoughtful around that and where there are good economic opportunities to lower our exposure, we will definitely take that.
Alan Colberg: And Brian if I step back from housing and look at our overall portfolio at this point, we've delivered strong profitable growth. We expect to continue to deliver strong growth no matter what the market environment is. And it's really that combination of lifestyle and housing capabilities and products that does that. And as we look to the future and we mentioned briefly in the prepared remarks, Pocket Geek Home, we see a real convergence coming between lifestyle and housing and great opportunities around the connected home, the connected apartment and a whole new set of growth drivers for us as we look to the future. So we feel good about the portfolio. We'll always fine-tune our cat exposure. But we feel like we're in a pretty good place with that at the moment as well.
Brian Meredith: Great. Thanks.
Operator: Your next question comes from the line of Michael Phillips with Morgan Stanley. Michael, your line is open.
Alan Colberg: Hi. Good morning, Mike.
Michael Phillips: Good morning, guys. Thanks for the questions. One more on the housing side. Not just the last two quarters, but probably looks like the last couple of years you've had a nice downdraft in the expense ratio. I guess maybe you can talk about what you're doing to make that happen. And should we expect that to continue, or are we kind of at a level you like it to be?
Alan Colberg: Yes. Maybe, again, I'll start and then, Richard, you should add into it. I mean, the business is in a good position today, as we've worked to drive efficiencies. We've, for example, been investing in improving various processes, using artificial intelligence and automation and that has helped us. We are in the middle of converting clients to our single-source processing platform, which really delivers over the next few years a much simpler and better customer experience. But I don't think we'll have continued improvement in that ratio. What I mean by that is, we've worked with our regulators to kind of agree a normal range combined ratio. And Richard, you may want to talk about that and how we think about that with our regulators. But we feel good about where it is today.
Richard Dziadzio: Yes, we do. And I think, the team has done a great job in managing expenses. If we think about the last couple of years, we've seen the revenues come down and now they're coming down very little. I mean, we've talked about the financial insolvent client that put a little bit of headwind. But over the nine months, we're down not much at all, let's call it 5%. So in terms of the expense management I think we are at the bottom with the discipline we have and what we need to deliver to our customers which is obviously at the forefront of our thoughts. And with regard to the regulators, obviously, the regulators take into account the experience we have. So if there's years where the overall loss ratio is really high, we could go and ask for some pricing improvements. If it's too low, obviously, that gets taken into account. So, overall, I think, even if the loss -- the expense ratio though a lot lower, we would see that come through rate over time. I think where we're looking at the expense ratio, was from a competitive point of view to be able to operate and produce the most efficiency for our customers, so they get the best experience that we can offer them.
Michael Phillips: Okay. Thanks. That's helpful. You both mentioned and Richard did and I think Alan did, I know, it was in your press release. Improved profitability in the extended service contracts and maybe what's driving that and how you expect that to continue. Or where should we expect it to be as we get into next year?
Alan Colberg: Richard, do you want to take it? Yes.
Richard Dziadzio: Yes. I think, first, it has had some good operations, good results in the beginning of the year here, in the last quarter in particular. That's really coming from lower client losses experienced last year. And now what we're seeing is, a little bit more normalized experience, so better experience this year. So we think now where we are, we're kind of in a more normalized place than we were in the past, if I can put it that way.
Michael Phillips: Okay. That's helpful. And then, a bit of a goofy question, I apologize. But you talked about the U.K. and the EV cars. How does the -- just the business or the contracts of car warranty extended service contracts and auto change, as cars become more technology-driven maybe in -- I don't know what year, we have a higher percentage of cars or essentially computers on wheels as compared to the [indiscernible] of cars. How does that change over time, the extended warranty contracts of this?
Alan Colberg: Yes. No you raised a great point. So as we think about the future, a couple of things happen with the car. One is the car just becomes a big connected device. So if you think about the early days of the car phone 25, 30 years ago, now in the future everything in the car is connected all the time, particularly once 5G gets rolled out. So there'll be a whole set of value that we can deliver through our service contract around keeping you connected. It's basically what we do in mobile today. And we see that coming to auto. So that's one thing. And then, if you think about electric vehicles, for example, you'll have fewer things that can go wrong, but you'll have much higher severity when something does go wrong. And so, we're learning. One of the reasons we've been pushing hard with electric, we've done a deal in China, we've now done the deal in the U.K. is to really develop the data and the learning, so that we can be the most compelling offer to support what we think for a consumer will be even a greater interest in the service contract, both because of the nature of the risk, but because of the connectivity of the car. And that really is an area where we feel our business being in both mobile and auto gives us a unique set of advantages in the market.
Michael Phillips: Okay. Makes sense. It sounds like interesting times in that regard. So I look forward to that. Thank you guys. Appreciate it.
Alan Colberg: Thanks Mike.
Operator: [Operator Instructions] Your next question comes from the line of Bose George with KBW. Bose, your line is open.
Alan Colberg: Good morning Bose.
Bose George: Good morning. Just -- I actually wanted to go back to the Global Housing. Any update on the Bank of America the RFP on that piece?
Richard Dziadzio: No. I -- the way we think about it is, we have the best capabilities the most value that we can offer our clients. Obviously that process is ongoing and confidential. And as I've talked about before the incumbent always has the significant advantage. But with that said we are doing all we can to put our best foot forward in every process as out there in the market and we really do feel we have a compelling offer. So we'll just have to see what happens over time.
Bose George: Okay great. And then actually switching over to your commentary on year-over-year growth in NOI. I mean there are quite a few moving pieces there but do you think you can do double-digit NOI growth in 2021?
Alan Colberg: Yes. Let me -- a couple of comments on that. First of all, we'll provide an outlook in Q4 earnings call so that'd be early February about what we really expect and you shall -- should expect for 2021. A couple of comments though. 2020 has been a very strong earnings growth year. I'm really proud. I think we're all really proud of our people have delivered for our customers and our clients and for our shareholders. But the really strong 2020, it does create some year-on-year challenges if we look at 2021. We had about $16 million of onetime benefits in lifestyle earlier this year. We've never assumed a onetime benefit will recur. We had about $8 million of favorable experience. We just mentioned in Q3 in housing. We don't really expect that to recur. We did have some other benefits from -- for example our expense management actions where we deferred some hiring. We reduced travel. That will come back. So definitely 2021, we do expect to grow, but we expect it to moderate from 2020. And overall if you think back to our Investor Day, we said at Investor Day that on average in 2020 and 2021 we would grow operating earnings so NOI ex-cap by 12% on average. Back in Investor Day we thought it would be a little bit lower in 2020 relative to the 12% and a little bit higher in 2021. Now we had a stronger 2020 and we now expect to moderate a little bit in 2021. But the combination of the EPS growth that we expect the 12% on average 2021 we still believe that's appropriate.
Bose George: Okay, great. Thanks very much.
Operator: Your next question comes from the line of Gary Ransom with Dowling & Partners. Gary your line is open.
Alan Colberg: Hey good morning Gary.
Gary Ransom: Good morning. I wanted to ask a bigger picture question about customer behavior. We've been through a big experiment in the United States about what happens when economies get shut down and how -- when people work from home and how they change what they do with electronics or other things? And I'm trying to discern what might be a permanent change in there versus what might be just temporary and goes away next year. And I was -- just wanted to hear your thoughts on whether there -- whether you think there is anything that has been permanently accelerated or changed in how you engage with your customers?
Alan Colberg: Gary, thank you for the question. And as you imagine we've spent a fair amount of our time thinking about what are the long-term implications of COVID. I think for us the first thing I'd highlight is just how resilient our business is. It shows the value of kind of an embedded subscriber base a range of services that really allow consumers to stay connected. And one of the things that I think COVID has highlighted with the move to be at home more then move to some sort of hybrid working model and more likely post-COVID being connected is everything. And what we do around connecting your devices making sure everything your home is working that's really important. So I think that actually helps us even more as we look to the future. A couple of other things we see with COVID digital. Digital was obviously already a trend that we've been investing against for years. But I think the acceleration of digital is real and permanent. And we for example in the last six months or so we really upped our investment in digital everywhere. So today we feel like an example in rental multifamily, our digital capabilities are at or better than anybody's in the market. So we see digital kind of as an ongoing trend. And then, the other thing we're thinking about are, are there changes for example in global supply chain? So, we may think about that over time. But at the end of the day, I would highlight just how strong our business has performed through this uncertainty and just shows the value of what we're doing for our customers and how much they appreciate being able to stay connected and having everything in their home work the way they wanted it to.
Gary Ransom: Thank you for that. I also had a question on the HYLA comments about the higher attachment of trade-ins. And I just wanted to understand better, what it is that HYLA is doing to make the customer more interested in trading in rather than keeping their phone?
Alan Colberg: Yes there are a couple of things, that are interesting, that will be additive for us. One is their analytics are very impressive. So, they can give effectively through analytics you can offer a better price to the consumer. So that's one important item. Second, with their analytics and their capabilities often now, we can offer a quote without having to see the phone and have certainty that will be the quote for the consumer. And that also increases the attach rates. And then the other thing they've done well and we also do is, work with our clients to really help them understand how trade-in can drive persistency and retention for their customers. So, it's a combination of all those things. But they've got a strong track record of being able to drive up the attachment of trade-in, which is still an opportunity to continue to get better at. But they've shown the ability to work on and improve it year-on-year for several years in a row now.
Gary Ransom: All right. Thank you, very much. That’s it from me.
Alan Colberg: All right. Thanks, Gary.
Operator: Our last question comes from the line of Brian Meredith with UBS. Brian, your line is open.
Brian Meredith: Yes, thanks. One last just follow one last quick follow-up. On the preneed sale, any timing that you can kind of give us on kind of when you think the process may be done? And then also on that, any kind of thoughts on what the potential valuation would be?
Alan Colberg: Yes. In terms of the process and valuation we're just getting started. So, I want to clarify that we're very early, but we are looking at a range of alternatives. And a good guide is what we do with Employee Benefits which took -- it took us back then something like four or five months to get to an offer and then another similar period of time to close. Who knows that that will be the case here, but that's probably a reasonable way to think about it. In terms of the valuation, I wouldn't speculate, but we are confident it's going to be an attractive valuation for our shareholders. We know from other life insurance transactions recently, there is a wide range of interest in assets like our preneed business. And we're confident that it's not valued appropriately in our stock. And that whatever we do here will unlock and create value for our shareholders over the next four to nine months, as we work through a process and then hopefully a closing.
Brian Meredith: Great. Thanks.
Alan Colberg: All right. Thank you. And I think that was the last question. So with that, I want to thank everyone for participating in today's call. In summary, we're very pleased with our year-to-date performance and believe the recent strategic announcements we've just made to focus even further on our lifestyle and housing offerings will ultimately increase our earnings momentum and cash flow and deliver value for our shareholders over time. We'll update you on our progress in the fourth quarter earnings call in early February. In the meantime, please reach out to Suzanne Shepherd or Sean Moshier with any follow-up questions. Thanks everyone.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant’s Third Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode. And the floor will be open for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Francesca Luthi, Chief Administrative Officer of Assurant. You may begin."
},
{
"speaker": "Francesca Luthi",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our third quarter 2020 results with you today. Joining me for Assurant’s conference call are Alan Colberg, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the third quarter 2020. The release and corresponding financial supplement are available on assurant.com. We will start today’s call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday’s earnings release, as well as in our SEC report. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday’s news release and financial supplement. Now I'll turn the call over to Alan."
},
{
"speaker": "Alan Colberg",
"text": "Thanks Francesca. Good morning, everyone. We are pleased with our third quarter operating results, which demonstrate the continued resiliency and strength of our business portfolio. Our track record of delivering strong profitable growth not just this quarter, but over the past few years reinforces our strategic direction and our confidence in the future growth prospects of Assurant. Last week we made two announcements that underscore our focus on our market leading lifestyle and housing businesses while capitalizing on the convergence of the connected mobile device, car and home. Our Connected Living, Global Automotive and multifamily housing businesses have a history of profitable growth and we believe compelling future growth potential. In addition, our specialty P&C offerings including lender-placed insurance are extremely well positioned. The countercyclical nature and strong returns of the business continue to make it a critical part of our portfolio. Together lifestyle and housing should drive ongoing above-market growth and superior cash flow generation with the ability to outperform in any economic cycle and ultimately to create greater shareholder value over time. Our acquisition of HYLA Mobile, a leading provider of smartphone software and trade-in and upgrade services will strengthen our market position with increased scale, complementary client bases and favorable tailwinds in the global mobile market. We value HYLA at the multiple of low teens forward EBITDA. The combination of its patented software technology and trade-in capabilities with Assurant's end-to-end mobile device life cycle management expertise will deliver three primary benefits. First, it will enhance the customer experience making it easier for consumers to get trade-in value for their used mobile devices without an in-person inspection. Second, it will improve program economics and performance for our partners including higher trade-in attachment rates. And finally, it will further strengthen Assurant's ability to take advantage of the 5G smartphone upgrade cycle. HYLA also has strong relationships with marquee partners complementary to Assurant's client base across our critical distribution channels and geographies and including leading U.S. and Japanese mobile carriers as well as major global OEMs. As we announced, we intend to fund our acquisition through a combination of cash on hand at the holding company and new debt issued prior to closing so that we can continue to optimize our capital structure while maintaining investment-grade ratings. To better align resources to the best market opportunities within lifestyle and housing we've also announced a review of strategic alternatives for Global Preneed including a potential sale. This decision was not an easy one given the strength of the business and the considerable value its employees brought to Assurant. Global Preneed is a strong business with over two million policyholders throughout the U.S. and Canada. It has delivered consistent growth while generating robust cash flow and above market returns. It has nearly $6 billion in investable assets and is relatively low risk compared to other life insurance-type products. However, we believe the business has been historically undervalued as part of Assurant. So a transaction should unlock significant value by allowing us to deepen our focus on consumers' connected lifestyle and our differentiated P&C businesses. We expect that any proceeds from a potential transaction will be deployed to fund business growth with excess funds returned to shareholders over time. In the months ahead, we will provide updates on our progress as appropriate. And as always during this time we will continue to honor our commitments to clients and policyholders while delivering exceptional service. Now I'll provide a few key highlights from the third quarter that affirm our continued progress within our lifestyle and businesses. Within Connected Living, we've grown earnings 22% year-to-date. As we focus on continuing to drive long-term growth, we are moving forward with the build-out of our full-service customer capabilities, to deliver superior customer service to our 54 million mobile subscribers. This quarter, we also acquired Fixt providing mobile customers increased choice through a come-to-you repair capability. This acquisition complements last year's purchase of Cell Phone Repair or CPR that delivers the same-day local repair option. Like HYLA these investments will support the acceleration of our strategy, by expanding our capabilities and offerings, as we anticipate the ever-evolving needs of connected consumers. We also recently launched Pocket Geek Home, which offers personalized tech support and bundled protection of at-home technology, including laptops, gaming systems, and other electronics from accidental damage and mechanical breakdown. While it is still early, we believe this offering is an important step in the development of future-connected lifestyle protection products. In Global Automotive, we remain focused on opportunities to leverage our leadership position to scale, in key global markets. In the U.K., we recently launched a new product for electric and hybrid vehicles called EV One. This includes a new partnership with a London electric vehicle company that will cover their iconic London black cabs and electric van models. This supports the continued growth of our auto business globally, while also gaining further insights into the evolving electric vehicle market. And it supports the U.K.'s move toward EV as a standard by 2035. Within Global Financial Services, we are pleased to announce the launch of a new partnership in Canada with the Bank of Montreal, leveraging our omnichannel customer capabilities, as we continue to reposition the business for profitable growth long-term. Moving to Global Housing, we extended our agreement with yet another client in the lender-placed business. We've now renewed 20 clients, representing more than 85% of our tracked loans since the beginning of 2019. Lender-placed is a critical part of the mortgage landscape in the U.S., and continues to be an important component of our long-term strategy. In multifamily housing, we grew revenue and policies by 8% and 9% respectively, year-over-year. Our Cover 360 property management solution continues to gain momentum, and drive higher penetration of renters insurance, with our property management company partners. The product, formerly known as Point of Lease, allows the customer to combine their payment of rent and insurance. The solution now includes insurance tracking, verification and policy placement to eliminate coverage gaps. We're now tracking more than 335,000 rental units, which grew 40%, since the second quarter. We also believe that our increased investments around, the connected home and connected apartment will drive new opportunities to increase, P&C penetration rates. Turning to our key financial metrics, we're pleased with our progress against our 2020 objectives. Through the first nine months, net operating earnings per share excluding catastrophes increased 25% year-over-year to $8.69. Net operating income, excluding catastrophes was up 21% to $527 million. COVID-19 did not have a material impact on year-to-date results. For the full year, we now expect our operating earnings per share, excluding catastrophes to grow between 17%, to 21% compared to 2019, well ahead of our initial expectations. The revised outlook largely reflects Global Housing's favorable non-catastrophe loss experience, through the first nine months of 2020, as well as continued growth in Connected Living, and our disciplined expense management. Our capital position has remained strong throughout the pandemic. In the quarter, we resumed buybacks and we've now returned over 50% of our $1.35 billion objective from 2019 through the end of September. We expect to return the balance by the end of 2021 as we originally planned, primarily supported by the strong cash flow generated by our lifestyle and housing businesses. All of this is a reflection of the continued dedication of our 14,000-plus employees globally. They continue to do an outstanding job of managing through the COVID pandemic, while providing exceptional support to our customers, including those impacted by natural disasters this year. I'll now turn the call over to Richard to review third quarter results, recent trends and our 2020 outlook in more detail. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Alan, and good morning everyone. I'd like to start by saying that, we're really pleased with our third quarter. We reported operating earnings per share, excluding catastrophe losses of $2.85, up 25% from the prior year period. Net operating income for the quarter also excluding catastrophe losses was $172 million, an increase of 22% from last year, largely due to more favorable non-cat loss experienced in Global Housing, continued momentum in Global Lifestyle and improved results in Global Preneed. Sales trends across the board have been improving from lows recorded in March and April at the height of the pandemic and we are seeing more normalized levels of COVID-related claims activity in Global Lifestyle and Global Housing. Now, let's review segment results in greater detail, starting with Global Lifestyle. This segment reported earnings of $107 million in the third quarter, up 4% compared to the prior year period. This increase was primarily driven by Connected Living, where we benefited from new mobile subscribers. Improved profitability within extended service contracts also contributed to growth in the quarter. Within Global Automotive results, reflected continued pressure from lower investment income and investments to support growth. Declines in Global Financial Services reflected lower card balances and volumes, as well as less favorable loss experience some of which was attributable to COVID. We also incurred additional expenses to launch new client programs. Looking at total revenue, net earned premiums and fees grew by $56 million or 3%. The increase was driven primarily by 14% growth in Global Automotive, including prior period sales of vehicle service contracts. We're continuing to monitor sales trends, which has stabilized but still trail 2019 levels on a year-to-date basis, due to impacts from COVID. Global Lifestyle revenue growth was partially offset by lower revenue from mobile trade-in, primarily due to the contract change we disclosed last quarter. This change lowered revenues by $39 million, as we changed reporting from a gross sales basis per device to a flat fee per device. As a reminder, this change will remove some of the revenue and expense variability we have historically seen in our financial results, and mitigate supply and demand pricing risk. Overall for the full year 2020, we continue to expect Global Lifestyle to grow net operating income when compared to full year 2019. Looking ahead, we anticipate an uptick in trade-in activity in the fourth quarter, which will continue into the beginning of next year. Volumes will depend on the following: the timing and availability of devices for new phone introductions, the level of carrier promotions, and the growth from new business. Looking ahead to 2021, we expect earnings expansion within lifestyle to moderate from the strong 2020 levels, which benefited from three items. First, $16 million of one-time benefits year-to-date; second, lower claims during the first few months of the COVID pandemic; and finally, lower expenditures on categories such as travel, given the uncertainty around the pandemic. We also expect ongoing headwinds from low interest rates on investment income. Moving now to Global Housing. Net operating income for the third quarter totaled $13 million compared to $ $42 million in the third quarter of 2019. The decrease was primarily due to $51 million of higher reportable catastrophes. As we pre-announced, we incurred a total of $87 million of after-tax cat losses related to several hurricanes and wildfires in the U.S. Nearly half of the losses in the quarter were from Hurricane Laura with the remainder primarily related to Hurricane Sally and Isaias, as well as wildfires in California and Oregon. Excluding catastrophe losses earnings increased $23 million year-over-year, or 30% to $100 million. Approximately two-thirds of the increase was due to favorable non-cat loss experience across specialty products and lender-placed. This included $8 million of favorable experience that we don't expect going forward, including reserve releases related to runoff businesses. Improvements in underwriting and product changes also led to more favorable experience. We also benefited from continued growth in multifamily housing from affinity partners. Within lender-placed the results also reflected higher premium rates. Growth was partially offset by the reduction in policies in force driven by declining REO volumes from the current foreclosure moratoriums and the previously disclosed financially insolvent client. Looking at placement rates. We recorded a two basis point sequential increase in the quarter to 1.58%. This was a attributable to a shift in business mix. It's not an indication of a broader macro housing shift. Turning to Global Housing revenues. Net earned premiums and fees decreased 4%. Similar to last quarter this was driven mainly by three items: The exit of small commercial, the insolvent lender-placed client and lower REO volumes. This decrease was partially offset by growth in our multifamily housing and specialty property businesses. Multifamily housing revenues increased driven mainly by growth from our affinity partners. For the full year we expect Global Housing's net operating income, excluding cats to increase year-over-year driven by favorable non-GAAP loss experience as well as improved results in each line of business. Looking ahead, we expect to see more normalized non-cat loss experience, lower REO volumes due to foreclosure moratoriums that have now been extended through the remainder of 2020, and lower investment income due to lower yields. Specifically in the fourth quarter, we also expect Hurricane Delta to be a reportable event likely in the range of $12 million to $20 million pre-tax subject to further claims analysis, and while still too early in the claims process to speculate Hurricane Zeta will likely be a reportable event as well. We will provide an update prior to fourth quarter earnings if necessary. Now let's move to Global Preneed. Overall, the business continues to perform well. The segment reported net operating income of $13 million, an increase of $6 million year-over-year. The absence of the negative one-time accounting adjustment in the third quarter of last year was offset by lower investment income this quarter. While market mortality trends have fluctuated during the pandemic, the impact on mortality on earnings continued to be immaterial in the quarter. Revenue for pre-need was up slightly primarily due to continued growth in sales of our Final Need product and we are pleased to see a rebound in face sales since the second quarter, reflecting the reopening of funeral homes. Overall for Global Pre-need, we expect 2020 earnings will approximate 2019 reported results. Moving to corporate. The net operating loss was $23 million, compared to $21 million in the third quarter of 2019. This was primarily due to lower investment income. For the full year, we expect 2020 corporate net operating loss to approximate $90 million mainly as the result of lower investment income and investments for growth. Turning to holding company liquidity. We ended September with $460 million or $235 million above our current minimum target level. In the third quarter, dividends from our operating segments totaled $245 million. In addition to our quarterly corporate and interest expenses we also had outflows from three items; first, we bought back $70 million of stock after resuming share repurchases in the quarter; second, we paid $42 million in common and preferred stock dividends; and finally, we had approximately $10 million of net cash outflows related to the acquisitions of Alegre and Fixt and the sale of our CLO platform. In the fourth quarter through October 30th, we repurchased an additional 330,000 shares for $41 million. Regarding the new debt issuance to support the financing of HYLA, we continue to target an overall debt-to-capital ratio of less than 30% and expect to remain within that target while also maintaining investment-grade ratings. For Global Preneed, we reported a $136 million goodwill impairment charge. This was related to the decision to explore strategic alternatives for this segment combined with the impact of the low interest rate environment. This is a non-cash charge and runs through net income. Moving forward, for the year, overall, we still expect dividends to approximate segment earnings subject to the growth of the businesses, rating agency and regulatory capital requirements, and the performance of the investment portfolio. In summary, we've delivered solid results and maintained a strong financial position throughout the pandemic. As we approach year-end, we remain focused on meeting our 2020 financial objectives and on building a stronger Assurant for the future. And with that operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "The phone is now open for questions. [Operator Instructions] Thank you. Our first question is coming from the line of Mark Hughes from Truist. Mark, your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey good morning Mark."
},
{
"speaker": "Richard Dziadzio",
"text": "Good morning Mark."
},
{
"speaker": "Mark Hughes",
"text": "Good morning. Hope you all are well. On the vehicle business, the Global Automotive had a nice acceleration in earned premiums and fees up into the 13%, 14%. I think you had said that the new sales were still kind of lagging behind last year and year-to-date. Something is going on with the earned with the pickup there?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. Maybe Mark let me start and then Richard you can give a little more color. If you look at the impacts of COVID in auto, we saw a real slowdown in the sales back in March and April. Since then we've been recovering. And our -- if you look at the current run rate, it's basically at or above 2019 levels. We just haven't fully caught up the gap that happened early in the year on kind of new sales for this year. But the momentum is strong and the business is strong. Richard do you want to talk a little bit more about what's happening with NEP?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Exactly. And then again that's exactly right. The only other thing I would add is obviously some of the earned premium is what we've written historically not just this year in prior years too. So, from time-to-time, we've had season -- seasonality where sales can be a little bit higher. So, the earnings can be a little bit higher. I always think relative to auto as in other lines of business it's good to look at it on a kind of a year-to-date basis and look over the last six months or year for trends."
},
{
"speaker": "Alan Colberg",
"text": "Yes, the other thing I might add Mark is as we look to the future we feel very well-positioned going back to the reasons why we purchased the Warranty Group. And you heard in the prepared remarks we highlighted another step forward in electric which I think will position us to be one of the leaders around that as it grows in the market. So, well-positioned, performing well, and we look good as we look to the future for auto."
},
{
"speaker": "Mark Hughes",
"text": "Just talk a little bit about the HYLA acquisition in terms of potential for customer expansion where they have relationships that you could perhaps build on."
},
{
"speaker": "Alan Colberg",
"text": "Yes, what's interesting about HYLA is it really complements our business and what we do. So, we have our set of clients. We have end-to-end capabilities. What they have are generally different clients. So, they bring a variety of clients that we currently don't have a significant business with. So, they also bring a really superior software as a service and analytic capability that we can incorporate and drive into our programs over time. They've delivered strong double-digit growth over the past three years within their base. Now, they've started to expand. And together we'll have now more than 30-plus trade-in programs that are operating in key markets around the world and positions us well for the 5G megatrend. We don't know fully whether that will be a 2021 event or a 2022 event, but we'll be the partner of choice. I think for trade-in buyback around the world, after we close on HYLA."
},
{
"speaker": "Mark Hughes",
"text": "And then finally your current thoughts on the, lender-placed business, when you look at the non-serious delinquencies. What do you think is going to shapeup on 2021?"
},
{
"speaker": "Alan Colberg",
"text": "So, right now, we're -- as we've talked about in the prepared remarks, we're seeing some -- well let me back up even more, that business is in a good place, right? We've been able over the last few years to get the earnings ex-cat to be stable, independent of any growth in the business. And through the evolution of our product, the things we've done over the past decade, we're really well positioned, as an integral part of the mortgage process. And as you know, we've been investing in our technology to really deliver superior customer experience. Now what's happening in the short-term is, we're actually not seeing any growth in that business, in terms of placement. REO volumes for example are down, and are down significantly because of the foreclosure moratoriums, that are in place. But we're well positioned if the market does weaken, next year. As we mentioned in the prepared remarks, we've now renewed the vast majority of our tracked loans. And so, we don't know what will happen in the housing market. But certainly nothing will happen in the short-term. But if the housing market does weaken, you could see, strong growth beginning maybe the second half of 2021."
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "Alan Colberg",
"text": "Great. Thanks, Mark."
},
{
"speaker": "Richard Dziadzio",
"text": "Thanks Mark."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Your next question comes from the line of Brian Meredith with UBS. Brian, your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey, Good morning."
},
{
"speaker": "Brian Meredith",
"text": "Thanks. Good morning. Good morning, everyone."
},
{
"speaker": "Richard Dziadzio",
"text": "Good morning, Brian."
},
{
"speaker": "Brian Meredith",
"text": "A couple of questions here for you, first on Global Lifestyle, first I guess, did the Sprint deal have any kind of impact on global covered devices much in the quarter? And then, following on that what do you kind of -- or maybe give some more color around? What do you think the potential backlog here is, with respect to trade-ins? I know you talked about it picking up in the fourth quarter? And maybe a little more context around with respect to the iPhone upgrade and the 5G upgrade cycle."
},
{
"speaker": "Alan Colberg",
"text": "Yeah, Brian, thank you for the questions. On Sprint and T-Mobile, first of all, again I want to recognize the importance that, we have of that relationship with T-Mobile. We've been their partner, supporting their innovation and disruption for the last decade. And that is really the driver of our then now participating in the growth of Sprint. We are starting from zero. And there really the program has just begun to get going. It took a couple of months after the closing before T-Mobile really began to convert the stores, as they wanted to make sure, they didn't disrupt things during that conversion phase. So, we're starting to see some impact, but it's going to be a gradual ramp. We're also investing, as you might expect to help all the legacy Sprint stores be in a good position to sell our products, as people come in. So, not a lot of impact so far, but will be a significant growth driver over the next two to three years, as that program really ramps. In terms of the trade-in and buyback cycle, what we've seen in the last three or four years, is that the volume really begins in the latter part of Q4. And then really into Q1. And that's again what we expect to see this year. We'll see some volume beginning in Q4, but the bulk of the volume in the last couple of years has been lagged into the first quarter of next year. And it really is driven by one that new iPhones are available. And if you noticed their announcement a couple of the new models, were out right away, but a couple of the new models are still not out. And so, we'll see that over time. And I mentioned 5G earlier. This is the first year that the iPhones really have 5G capability, which is a real positive. But, when will consumers really get excited about 5G, we don't know for sure. But as we mentioned earlier, we're now well positioned to support our carrier partners with 5G when it happens."
},
{
"speaker": "Brian Meredith",
"text": "Great. And then, two quick questions here on Global Housing. The first one, the underwriting initiatives that you guys implemented, maybe a little more color on, what those were? And what the impact was on the underlying combined ratio, because I assume that's going to be sustainable here going forward."
},
{
"speaker": "Alan Colberg",
"text": "Yeah. Richard, do you want to take that one?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yeah. Sure, sure. Good morning, Brian. Yeah, I think there -- the changes that we made in the underwriting were across a couple of different products. So first would be, we've talked about it before, small commercial. We had gone into that. We didn't have a positive experience with it and then put it into runoff. So obviously that will persist in the future because we have no plans to get back into that. So that's one positive. And then within the sharing economy I think we mentioned it on a call earlier in the year, we had had one type of product with one client who weren't getting good experience with and that we underwrote to. So again, I think there we have -- we've gotten good results out of that and are moving forward with positive results. The part of your question which is how -- what will persist or not. We have had within the non-cat loss ratio, some positives this year that won't reoccur. For example some reserve releases of a limited amount that we mentioned in our prepared remarks of about $8 million. Those won't continue. We don't think. We've also had a really good run in terms of lower frequency severity and things like theft and vandalism. Will that continue? That's sort of a question mark in terms of how that will go in the future. So there are some things that will continue. Some things that probably won't, the reserve releases. And then some things we'll wait to see what happens in the future with our experience."
},
{
"speaker": "Brian Meredith",
"text": "Great. And then just one, last one on the Global Housing segment. It's been a fairly active year obviously for catastrophe losses given what's going on with global warming and stuff. I mean some people expect this to be more the norm than the exception. I guess my question then is, does a year like the year -- this year make you kind of question your reinsurance program -- changes to the reinsurance program maybe using more aggregate cover to kind of mitigate some of the volatility in the business?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. Maybe I can offer a few thoughts and then Richard you should offer a few more. I mean, if you look at the last few years, we've dramatically changed our exposure to cat. We've done things like taking the retention down to $80 million where it is today from $240 million five years ago. We've exited certain lines that we were participating in the Caribbean. We've reduced exposure by exiting the small commercial business. And so we do feel very good about the portfolio and it's performing well. If you look at through the third quarter even with an active cat year, our ROE in housing is something like 14% or 15%. And so it's still performing and delivering well. With that said every year we revisit how we think about the risk-reward trade-offs on the cat program. And Richard maybe you want to comment a little more on how we're thinking about that in 2021?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Thank you. And I think Alan, you hit on a lot of the very key points which is part of cat is managing the exposure to cat. So we're very thoughtful in terms of what risk we're taking on. Obviously lender-placed, we have the exposure, we have given that flows through from the clients too to ourselves. But every year we look at it as Alan said. We look at what can we do to manage our exposure, whether it be bringing down our retention. Brian you'd mentioned buying in aggregate. That's obviously something that we look at every year. At the end of the day, there's economics around it and there's pricing in the market. So we look at that and say \"Is it thoughtful for us to buy more reinsurance, or is this a risk we're happy to hold given the pricing out there in the market?\" As Alan said we can have a quarter like last quarter where we do get hit by natural catastrophes. But over a period of time and I would say just one year, our combined operating ratio ends up being well below 100 and the ROEs on this business are very positive. So we're managing around that, being thoughtful around that and where there are good economic opportunities to lower our exposure, we will definitely take that."
},
{
"speaker": "Alan Colberg",
"text": "And Brian if I step back from housing and look at our overall portfolio at this point, we've delivered strong profitable growth. We expect to continue to deliver strong growth no matter what the market environment is. And it's really that combination of lifestyle and housing capabilities and products that does that. And as we look to the future and we mentioned briefly in the prepared remarks, Pocket Geek Home, we see a real convergence coming between lifestyle and housing and great opportunities around the connected home, the connected apartment and a whole new set of growth drivers for us as we look to the future. So we feel good about the portfolio. We'll always fine-tune our cat exposure. But we feel like we're in a pretty good place with that at the moment as well."
},
{
"speaker": "Brian Meredith",
"text": "Great. Thanks."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Michael Phillips with Morgan Stanley. Michael, your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hi. Good morning, Mike."
},
{
"speaker": "Michael Phillips",
"text": "Good morning, guys. Thanks for the questions. One more on the housing side. Not just the last two quarters, but probably looks like the last couple of years you've had a nice downdraft in the expense ratio. I guess maybe you can talk about what you're doing to make that happen. And should we expect that to continue, or are we kind of at a level you like it to be?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. Maybe, again, I'll start and then, Richard, you should add into it. I mean, the business is in a good position today, as we've worked to drive efficiencies. We've, for example, been investing in improving various processes, using artificial intelligence and automation and that has helped us. We are in the middle of converting clients to our single-source processing platform, which really delivers over the next few years a much simpler and better customer experience. But I don't think we'll have continued improvement in that ratio. What I mean by that is, we've worked with our regulators to kind of agree a normal range combined ratio. And Richard, you may want to talk about that and how we think about that with our regulators. But we feel good about where it is today."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, we do. And I think, the team has done a great job in managing expenses. If we think about the last couple of years, we've seen the revenues come down and now they're coming down very little. I mean, we've talked about the financial insolvent client that put a little bit of headwind. But over the nine months, we're down not much at all, let's call it 5%. So in terms of the expense management I think we are at the bottom with the discipline we have and what we need to deliver to our customers which is obviously at the forefront of our thoughts. And with regard to the regulators, obviously, the regulators take into account the experience we have. So if there's years where the overall loss ratio is really high, we could go and ask for some pricing improvements. If it's too low, obviously, that gets taken into account. So, overall, I think, even if the loss -- the expense ratio though a lot lower, we would see that come through rate over time. I think where we're looking at the expense ratio, was from a competitive point of view to be able to operate and produce the most efficiency for our customers, so they get the best experience that we can offer them."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Thanks. That's helpful. You both mentioned and Richard did and I think Alan did, I know, it was in your press release. Improved profitability in the extended service contracts and maybe what's driving that and how you expect that to continue. Or where should we expect it to be as we get into next year?"
},
{
"speaker": "Alan Colberg",
"text": "Richard, do you want to take it? Yes."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. I think, first, it has had some good operations, good results in the beginning of the year here, in the last quarter in particular. That's really coming from lower client losses experienced last year. And now what we're seeing is, a little bit more normalized experience, so better experience this year. So we think now where we are, we're kind of in a more normalized place than we were in the past, if I can put it that way."
},
{
"speaker": "Michael Phillips",
"text": "Okay. That's helpful. And then, a bit of a goofy question, I apologize. But you talked about the U.K. and the EV cars. How does the -- just the business or the contracts of car warranty extended service contracts and auto change, as cars become more technology-driven maybe in -- I don't know what year, we have a higher percentage of cars or essentially computers on wheels as compared to the [indiscernible] of cars. How does that change over time, the extended warranty contracts of this?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. No you raised a great point. So as we think about the future, a couple of things happen with the car. One is the car just becomes a big connected device. So if you think about the early days of the car phone 25, 30 years ago, now in the future everything in the car is connected all the time, particularly once 5G gets rolled out. So there'll be a whole set of value that we can deliver through our service contract around keeping you connected. It's basically what we do in mobile today. And we see that coming to auto. So that's one thing. And then, if you think about electric vehicles, for example, you'll have fewer things that can go wrong, but you'll have much higher severity when something does go wrong. And so, we're learning. One of the reasons we've been pushing hard with electric, we've done a deal in China, we've now done the deal in the U.K. is to really develop the data and the learning, so that we can be the most compelling offer to support what we think for a consumer will be even a greater interest in the service contract, both because of the nature of the risk, but because of the connectivity of the car. And that really is an area where we feel our business being in both mobile and auto gives us a unique set of advantages in the market."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Makes sense. It sounds like interesting times in that regard. So I look forward to that. Thank you guys. Appreciate it."
},
{
"speaker": "Alan Colberg",
"text": "Thanks Mike."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Your next question comes from the line of Bose George with KBW. Bose, your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Good morning Bose."
},
{
"speaker": "Bose George",
"text": "Good morning. Just -- I actually wanted to go back to the Global Housing. Any update on the Bank of America the RFP on that piece?"
},
{
"speaker": "Richard Dziadzio",
"text": "No. I -- the way we think about it is, we have the best capabilities the most value that we can offer our clients. Obviously that process is ongoing and confidential. And as I've talked about before the incumbent always has the significant advantage. But with that said we are doing all we can to put our best foot forward in every process as out there in the market and we really do feel we have a compelling offer. So we'll just have to see what happens over time."
},
{
"speaker": "Bose George",
"text": "Okay great. And then actually switching over to your commentary on year-over-year growth in NOI. I mean there are quite a few moving pieces there but do you think you can do double-digit NOI growth in 2021?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. Let me -- a couple of comments on that. First of all, we'll provide an outlook in Q4 earnings call so that'd be early February about what we really expect and you shall -- should expect for 2021. A couple of comments though. 2020 has been a very strong earnings growth year. I'm really proud. I think we're all really proud of our people have delivered for our customers and our clients and for our shareholders. But the really strong 2020, it does create some year-on-year challenges if we look at 2021. We had about $16 million of onetime benefits in lifestyle earlier this year. We've never assumed a onetime benefit will recur. We had about $8 million of favorable experience. We just mentioned in Q3 in housing. We don't really expect that to recur. We did have some other benefits from -- for example our expense management actions where we deferred some hiring. We reduced travel. That will come back. So definitely 2021, we do expect to grow, but we expect it to moderate from 2020. And overall if you think back to our Investor Day, we said at Investor Day that on average in 2020 and 2021 we would grow operating earnings so NOI ex-cap by 12% on average. Back in Investor Day we thought it would be a little bit lower in 2020 relative to the 12% and a little bit higher in 2021. Now we had a stronger 2020 and we now expect to moderate a little bit in 2021. But the combination of the EPS growth that we expect the 12% on average 2021 we still believe that's appropriate."
},
{
"speaker": "Bose George",
"text": "Okay, great. Thanks very much."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Gary Ransom with Dowling & Partners. Gary your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey good morning Gary."
},
{
"speaker": "Gary Ransom",
"text": "Good morning. I wanted to ask a bigger picture question about customer behavior. We've been through a big experiment in the United States about what happens when economies get shut down and how -- when people work from home and how they change what they do with electronics or other things? And I'm trying to discern what might be a permanent change in there versus what might be just temporary and goes away next year. And I was -- just wanted to hear your thoughts on whether there -- whether you think there is anything that has been permanently accelerated or changed in how you engage with your customers?"
},
{
"speaker": "Alan Colberg",
"text": "Gary, thank you for the question. And as you imagine we've spent a fair amount of our time thinking about what are the long-term implications of COVID. I think for us the first thing I'd highlight is just how resilient our business is. It shows the value of kind of an embedded subscriber base a range of services that really allow consumers to stay connected. And one of the things that I think COVID has highlighted with the move to be at home more then move to some sort of hybrid working model and more likely post-COVID being connected is everything. And what we do around connecting your devices making sure everything your home is working that's really important. So I think that actually helps us even more as we look to the future. A couple of other things we see with COVID digital. Digital was obviously already a trend that we've been investing against for years. But I think the acceleration of digital is real and permanent. And we for example in the last six months or so we really upped our investment in digital everywhere. So today we feel like an example in rental multifamily, our digital capabilities are at or better than anybody's in the market. So we see digital kind of as an ongoing trend. And then, the other thing we're thinking about are, are there changes for example in global supply chain? So, we may think about that over time. But at the end of the day, I would highlight just how strong our business has performed through this uncertainty and just shows the value of what we're doing for our customers and how much they appreciate being able to stay connected and having everything in their home work the way they wanted it to."
},
{
"speaker": "Gary Ransom",
"text": "Thank you for that. I also had a question on the HYLA comments about the higher attachment of trade-ins. And I just wanted to understand better, what it is that HYLA is doing to make the customer more interested in trading in rather than keeping their phone?"
},
{
"speaker": "Alan Colberg",
"text": "Yes there are a couple of things, that are interesting, that will be additive for us. One is their analytics are very impressive. So, they can give effectively through analytics you can offer a better price to the consumer. So that's one important item. Second, with their analytics and their capabilities often now, we can offer a quote without having to see the phone and have certainty that will be the quote for the consumer. And that also increases the attach rates. And then the other thing they've done well and we also do is, work with our clients to really help them understand how trade-in can drive persistency and retention for their customers. So, it's a combination of all those things. But they've got a strong track record of being able to drive up the attachment of trade-in, which is still an opportunity to continue to get better at. But they've shown the ability to work on and improve it year-on-year for several years in a row now."
},
{
"speaker": "Gary Ransom",
"text": "All right. Thank you, very much. That’s it from me."
},
{
"speaker": "Alan Colberg",
"text": "All right. Thanks, Gary."
},
{
"speaker": "Operator",
"text": "Our last question comes from the line of Brian Meredith with UBS. Brian, your line is open."
},
{
"speaker": "Brian Meredith",
"text": "Yes, thanks. One last just follow one last quick follow-up. On the preneed sale, any timing that you can kind of give us on kind of when you think the process may be done? And then also on that, any kind of thoughts on what the potential valuation would be?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. In terms of the process and valuation we're just getting started. So, I want to clarify that we're very early, but we are looking at a range of alternatives. And a good guide is what we do with Employee Benefits which took -- it took us back then something like four or five months to get to an offer and then another similar period of time to close. Who knows that that will be the case here, but that's probably a reasonable way to think about it. In terms of the valuation, I wouldn't speculate, but we are confident it's going to be an attractive valuation for our shareholders. We know from other life insurance transactions recently, there is a wide range of interest in assets like our preneed business. And we're confident that it's not valued appropriately in our stock. And that whatever we do here will unlock and create value for our shareholders over the next four to nine months, as we work through a process and then hopefully a closing."
},
{
"speaker": "Brian Meredith",
"text": "Great. Thanks."
},
{
"speaker": "Alan Colberg",
"text": "All right. Thank you. And I think that was the last question. So with that, I want to thank everyone for participating in today's call. In summary, we're very pleased with our year-to-date performance and believe the recent strategic announcements we've just made to focus even further on our lifestyle and housing offerings will ultimately increase our earnings momentum and cash flow and deliver value for our shareholders over time. We'll update you on our progress in the fourth quarter earnings call in early February. In the meantime, please reach out to Suzanne Shepherd or Sean Moshier with any follow-up questions. Thanks everyone."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 2 | 2,020 | 2020-08-06 08:00:00 | Operator: Welcome to Assurant’s Second Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode. And the floor will be open for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President, Investor Relations. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2020 results with you today. Joining me for Assurant’s conference call are Alan Colberg, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the second quarter 2020. The release and corresponding financial supplement are available on assurant.com. We will start today’s call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday’s earnings release, as well as in our SEC report. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday’s news release and financial supplement. I will now turn the call over to Alan.
Alan Colberg: Thanks, Suzanne. Good morning, everyone. We’re pleased with our second quarter performance. We reported operating earnings per share, excluding catastrophe losses of $2.90, up 27% from the prior year period. Net operating income for the quarter, also excluding catastrophe losses was $179 million, an increase of 24% from last year, demonstrating the continued strength and resiliency of our business. Results were above our expectations, reflecting the stability of our large installed customer base, significant client partnerships and embedded growth in Global Lifestyle. We also benefited from improved results in Global Housing. Declines in investment income and foreign exchange were more than offset by lower claims activity and expense management efforts. The initial negative impacts from COVID-19 in April gradually improved in May and June, resulting in a modest net positive to overall net operating income in the quarter. Year-to-date, net operating earnings per share, excluding catastrophe losses grew 24% and net operating income increased 21%. Even after adjusting for $16 million of one-time items during the first half of the year, our results came in at the high-end of our model pandemic scenarios. Given our strong performance in the first half and improved visibility for remainder of the year, we have decided to reinstate and increase our outlook for full-year 2020. We now expect 12% to 16% growth in operating earnings per share, excluding catastrophe losses, an increase from our initial outlook of 10% to 14%. This reflects continued growth in Connected Living, expansion within multifamily housing and improved profitability in our specialty business. Our outlook assumes a continuation of current business trends and, therefore, does not take into account a material increase in infection rates from COVID-19, which could lead to a significant change in consumer behavior, access to distribution channels, or impact to financial markets. While we expect earnings growth in the second half on a year-over-year basis, our outlook for the full-year assumes a decline in earnings from the first 6 months of this year as we anticipate more normalized claims activity across most of our businesses and make incremental investments in our digital and customer experience capabilities. The second half of the year will also reflect lower investment income and foreign exchange headwinds, the absence of $16 million of one-time benefits, as well as typical mobile seasonality. Looking at our balance sheet, our liquidity position remains strong. In July, we repaid the $200 million credit facility drawn in late March, which was done as a precautionary measure. Given the attractiveness of our stock and strong capital position, we expect to resume share repurchases in the third quarter and we continue to expect to reach our objective of returning $1.35 billion of capital to shareholders between 2019 and 2021. As always, this is subject to a variety of factors, including no significant deterioration of economic or market conditions. Recent market transactions across our space further reinforced our view that our stock remains attractively priced. Earnings momentum in Global Lifestyle continues to be strong, driven in particular by Connected Living. This business had a compound annual earnings growth rate of 38% between 2015 and 2019 led by mobile. Our installed base of customers, which represent a significant monthly recurring revenue stream, continues to expand. We are now at over 53 million mobile subscribers, up 70% since 2015. We’ve continued to provide value to consumers in services like trade-in, upgrade and technology support as part of our fee-based offerings, resulting in a better ownership experience and multiple profit pools beyond device protection. At the same time, we’ve continued to deepen our partnerships with market leaders to drive long-term profitable growth. We are pleased to announce that as Sprint becomes part of T-Mobile, we’ll offer device protection to those new T-Mobile customers. We believe this is another example to support the long-term growth of our Connected Living business. And we are proud of our long-standing partnership with T-Mobile. In August, we also strengthened our mobile device trading capabilities in Asia Pacific through the purchase of Alegre, a leading operator in the pre-owned mobile device market. After a small initial investment in 2018, we acquired the remaining equity for $12 million. Turning to Global Automotive, our installed base now includes over 48 million vehicles. We continue to strengthen our client partnerships by working with them to enhance the digital customer experience, offering live online dealer training and sales webinars. We will continue to use our scale and diverse distribution channels to grow the business over the long term, especially as we look at future opportunities with the connected car. Moving to Global Housing, our lender-placed insurance and renters businesses both continue to contribute to our attractive above-market returns. Our lender-placed business plays a unique and vital role within the housing market, protecting both lenders and homeowners. We track over 32 million loans, including for 8 of the top-10 largest U.S. mortgage servicers. Since the beginning of 2019, we have renewed relationships with clients that represent nearly 80% of our loans tracked, solidifying our position as market leader. We’ve been investing in a new technology platform to improve the customer experience. In addition, we’ve made progress with our efforts to streamline and reduce our operational cost. In our renters business, we’ve built a leadership position over the last 15 years. We now cover over 2.3 million renters and generate over $400 million in annual revenue. Since 2015, we’ve grown earnings in an 18% compound annual growth rate, with multifamily now representing roughly one-third of Global Housing’s 2019 net operating income, excluding catastrophes, illustrating the franchise strength. We will continue to invest to enhance the customer experience as this remains an important growth business for the company, especially as we think ahead to supporting consumers within the connected world. And in Global Preneed, we have more than 2 million policies and growing. This business over time gives us strong distributable cash flows, the statutory earnings greater than GAAP earnings. Overall, the level of mortality risk remains lower relative to other life insurance-type products, ultimately contributing to above-market returns. More recently, we’ve introduced new fee-for-service offerings to support the growing fee of the lifestyle market, such as Executor Assist. We believe our overall portfolio represents a compelling mix of above-market growth and counter-cyclical businesses with leading positions and a track record of innovation. These businesses generate significant cash flow to reinvest and return capital to shareholders. These are key characteristics that we believe set us apart as a long-term outperformer and enable us to create value for our shareholders, even against the backdrop of uncertainty in the global macro environment. Before I turn it over to Richard, I want to take a moment to thank our employees for their unwavering focus in supporting each other and our customers during this time. In the past few months, we’ve taken additional steps to support our employees, through an array of actions. These have included one-time relief payments for work-from-home employees, incentive bonuses for on-site staff, providing additional floating holidays and a number of well-being and mental health support services. The cost for these programs and other incremental expenses directly related to COVID-19 are reflected in net income, similar to last quarter. I’m proud and grateful for the exceptional service our employees have and continue to provide, on behalf of our clients and our 300 million customers worldwide. While in the midst of grappling with COVID-19, we’ve also recognized the need to continue to advance diversity and inclusion of Assurant and within the communities we serve, particularly in light of the tragic murder of George Floyd and many others. For us, diversity and inclusion is not only about common BCP and common sense, it is also a strategic and business imperative. Building on past initiatives, we’ve hosted candid enterprise-wide conversations with our employees on race, to ensure that we recognize these issues in our society and within the workplace. We are evaluating additional actions to support in the more diverse, equitable and inclusive community. All of this has continued to reinforce the criticality of supporting the evolving needs of all of our key stakeholders with purpose and commitment. In July, we announced several organizational changes to enable us to deliver on those objectives more effectively. Under the leadership of Francesca Luthi in a newly created role as Chief Administrative Officer, we have realigned human resources, facilities in procurement, along with Marketing, Communications, Investor Relations and Corporate Social Responsibility. A move I believe is critical to ensure we bring a holistic view to integrated stakeholder management, while at the same time, elevating the employee experience, to attract and retain the best and most diverse talent for the future. We also promoted Jay Rosenblum to Chief Legal Officer. He had been serving in that role in an internal capacity since February, after joining us last year to lead our Government Relations and Regulatory Affairs team. Jay’s diverse experience spans 25 years in various legal and HR roles. And I’m pleased to have him lead our global legal function. Overall, I’m exceptionally proud of our leaders and our 14,000 employees and how they have and will continue to live our values. I’ll now turn the call over to Richard to review second quarter results, recent trends and our updated 2020 outlook in more detail. Richard?
Richard Dziadzio: Thank you, Alan, and good morning, everyone. Let’s start with Global Lifestyle. The segment reported earnings of a $122 million, up 11%, compared to the prior year period. This increase was primarily driven by continued mobile growth, mainly from programs added in the last several years in North America and Asia Pacific. Lower claims activity outside of the U.S. in Connected Living and Auto also drove improved results. Our mobile trade-in business benefited from higher average selling prices due to scarce supply of used devices. This was partially offset by lower overall volumes due to COVID-19. Global Automotive reflected a $4 million discrete client benefit in addition to reduce claims activity, mainly from our OEM clients outside of the U.S., as a result of COVID-19 stay at home orders. Overall earnings growth was partially offset by decline in Global Financial Services from weaker results in Canada and anticipated declines in legacy credit insurance. Unfavorable foreign exchange also pressured results in the quarter. Looking at total revenue for Lifestyle, net earned premiums and fees were down $40 million, or 2%. The decrease was driven primarily by lower mobile trade-in volumes due to store closures from COVID-19 and foreign exchange movements. This was partially offset by increased enrollment and new mobile programs, especially as carrier stores began to reopen in the latter part of the quarter. Within in Global Automotive, revenue grew 3%, primarily reflecting prior period sales of vehicle service contracts. Sales and auto have rebounded since April and are nearly back to pre-COVID levels year-over-year. We will continue to monitor trends as sales levels today will impact future earnings for the business. Looking forward to full-year 2020, we expect growth in Lifestyle’s net operating income, compared to full year 2019. However, we also expect that earnings in the second half of the year will be lower compared to the strong first half results. This is due to 5 key factors. First, we recognized $16 million of one-time benefits in the first 6 months of the year, $4 million of which was incurred in the second quarter. We do not expect these items to reoccur in the second half of the year. Second, we expect claims activity in Connected Living and auto to normalize at higher levels in the coming quarters, as the global economy continues to reopen. Third, similar to previous years, the timing and availability for new phone introductions will impact trade-in activity in the second half of the year. We are not, though, assuming any material increases in volumes before year-end. Fourth, we’re ramping up our investments in digital and customer experience capabilities to further increase our competitive differentiation. And finally, we expect both foreign exchange and lower investment income to remain headwinds into the second half of the year. I will also note that effective July 1, foreign exchange and contract terms were transitioning our revenue accounting treatment from a gross sales basis per device to a flat fee per device for one of our mobile trade-in and upgrade programs. This will reduce our fees and other income by approximately $275 million on an annualized basis. Through our cost of goods sold, embedded in Lifestyle’s SG&A will substantially offset this decrease. We are pleased with this change as it will remove some of the revenue and expense variability we have historically seen in our financial results. It will also mitigate supply and demand pricing risk in the future. Moving now to Global Housing, net operating income for the second quarter totaled $85 million, an increase of $14 million, or 19% year-over-year despite higher reportable catastrophes. Excluding catastrophe losses, earnings of $96 million represented an increase of $27 million, or 39% year-over-year. Just over half of the increase was due to favorable non-cat loss experience across all major products, reflecting lower overall claims frequency and improvements in underwriting, including the benefits from artificial intelligence and claims processing initiatives. Also, the absence of losses from small commercial, along with growth in certain other specialty products contributed to the increase. Lender-placed results increased year-over-year. Higher premium rates and favorable loss experience were partially offset by a reduction of policies in force. This reduction was mainly related to the previously disclosed financially insolvent client and lower REO volumes due to the current foreclosure moratoriums. The modest sequential increase in the placement rate to 1.56% was attributable to a shift in business mix. It is not an indication of broader macro housing market shifts. Multifamily housing earnings were up slightly due to favorable non-catastrophe loss experience and modest growth from affinity partners. Turning to Global Housing revenues, net earned premiums and fees decreased 4% mainly from 3 items. The insolvent client, lower REO volumes, and the exit of small commercial. This decrease was partially offset by growth in our specialty property and multifamily housing businesses. Moving to multifamily housing, revenue increased 4% year-over-year, driven mainly by growth in our affinity partners. The impact of COVID-19 has been minimal year-to-date, although we continue to monitor state actions related to premium deferrals. At the end of June, we completed our 2020 catastrophe reinsurance program, maintaining our $80 million per event retention and increasing our multi-year coverage to nearly 50% of our U.S. [tower] [ph]. We also reduced our overall risk exposure, primarily through the exit of small commercial. Overall, we were able to leverage strong relationships with our reinsurance partners to keep rate increases on the lower end of the overall market, but we also recognize those higher costs may persist into the future. Looking forward to the full year 2020, we expect Global Housing net operating income, excluding cats, to increase over full-year 2019 earnings, driven by improved results in our specialty businesses, and growth in multifamily housing. We also believe the results for the second half of the year will be lower than the first half of Global Housing. This was due to 4 key factors: first, we expect a more normalized level of claims frequency, as previously mentioned; second, we expect REO volumes to continue to be reduced throughout the remainder of the year; third, the absence of income from the financially insolvent client in lender-placed; and finally, the segment will also continue to be impacted by lower investment income due to the lower yields available in the current interest rate environment. While lender-placed should grow due to the counter-cyclical nature of the business if economic conditions worsen, today’s mortgage industry and economic environment differ significantly from the housing crisis over 10 years ago. For example, mortgage loan underwriting standards have tightened, with the number of subprime and adjustable rate mortgages down over 60% and homeowners today have higher rates of home equity compared to that period. Now, let’s move to Global Preneed. The segment reported $14 million of net operating income, a $3 million decrease compared to the second quarter of 2019. This was driven by a combination of lower investment yields and a modest increase in mortality due to COVID-19. We continue to monitor mortality trends, especially in California, Texas, and South Carolina, given our policy concentration in those areas. So far, we have not experienced significant increases. Revenue for Preneed was up slightly, supported by sales in the U.S. And while face sales have begun to rebound recently, given funeral home reopenings and increased online sales since April, July year-over-year face sales were still down approximately 15%. We would expect new sales to continue to fluctuate. Overall, for Global Preneed, we believe 2020 earnings will increase modestly compared to 2019 reported results. The second half of the year, we expect earnings to be up slightly versus the first half of the year, due to more favorable mortality trends. We will continue to monitor these trends as our current outlook does not assume a significant worsening in COVID-19 cases. We expect the reduction in mortality to be partially offset by investment income declines. At Corporate, the net operating loss was $27 million versus $24 million in the second quarter of 2019. This was due to a lower tax rate from the consolidating tax rate adjustment and less investment income from lower yields on cash assets. For the full-year, we expect the Corporate net operating loss to be in the range of $86 million to $90 million as the result of lower investment income and one-time transition costs associated with the outsourcing of our investment management function. Across Assurant, our ongoing expense management efforts are contributing to our results. In addition, this year, we’ve benefited from lower travel expenses due to COVID-19 restrictions, as well as a reduction in discretionary spending, including deferring hiring for some positions. We are, though, filling all critical roles, particularly those needed to meet our client-customer expectations. As we look to sustain profitable growth, we expect to continue to invest in our core capabilities in the upcoming quarters, while closely managing discretionary spend, given the continued uncertainty from COVID-19. Next, I want to provide a brief update on our investment portfolio. Overall, our $12.6 billion portfolio of fixed maturities is of high-quality, well diversified, and managed for its income yield with low turnover. And as previously mentioned, we have minimal exposure to harder hit sectors like energy, hospitality, retail stores and airlines. Investment yield on our total investment portfolio dropped by 55 basis points year-over-year to 3.62%. This was largely driven by a decline in short-term cash yields, but we continue to manage the portfolio to preserve yield, our expectation is that, our investment income will remain under pressure for some time as we do expect interest rates will remain relatively low for the foreseeable future. However, we believe our consistent investment approach will continue to serve us well as it has in the past. In conjunction with our decision to outsource the management of our core investment portfolio, we sold our CLO platform for a modest gain in July. The sale will be recorded in the third quarter. While we will still have a small amount of investments in CLOs, our exposure to the asset class has been significantly reduced. Turning to holding company liquidity, we ended June with $357 million, or $132 million above our current minimum target level. This excludes the $200 million credit facility draw, which was reimbursed in July. In the second quarter, dividends from our operating segments totaled $157 million, or 71% of segment earnings. In addition to our quarterly corporate and interest expenses, we also bought back $26 million of stock. As we have indicated, we slowed and then ultimately paused share repurchases in the second quarter. We paid $44 million in common and preferred stock in dividends. We acquired AFAS for $158 million, and we sold [EK] [ph], which resulted in a cash outflow of $51 million from the holding company. In late July, we also received the one-time tax cash benefit related to the acceleration of our net operating losses, included in the CARES Act passed in March. As a result, liquidity at the holding company will increase by $84 million in the third quarter. For the full-year, we expect segment dividends to approximate segment earnings. This is subject to the growth of the businesses, rating agency and regulatory capital requirements and the performance of the investment portfolio. As Alan mentioned, we expect to resume buybacks in the third quarter, and we’ll continue to manage our capital prudently. Our approach to buybacks will be measured as we continue to monitor business performance as well as the broader macroeconomic and credit market environments. In summary, we demonstrated strong first-half performance while navigating the challenges of COVID-19. As we focus on continuing to deliver on our financial commitments for 2020, we will continue to invest in our growth businesses for the future, while monitoring global market trends. And with that, operator, please open the call for questions.
Operator: Thank you. The floor is now open for questions. [Operator Instructions] Thank you. Our first question comes from Mark Hughes of Truist Securities. Your line is open.
Alan Colberg: Hey. Good morning, Mark.
Richard Dziadzio: Good morning, Mark.
Mark Hughes: Good morning. Thank you. Could you talk about the T-Mobile announcement? It sounds like you’re going to be providing mobile contract services to new customers. Could you give a little detail? Is this going to include the back book as well or is it just new customers? What’s the timing, potential financial impact, all of that?
Alan Colberg: Yeah. No, Mark, thank you for the question. I’d start by saying we’re very proud to be T-Mobile’s partner for the past decade and assisting them in their journey to be the Un-carrier. As they migrate the stores over, the legacy Sprint stores, which they started last weekend, we will be offering our device protection program to all of the legacy Sprint customers as they come into a store. So that’s very positive. It is only go forward though, which is typical in our markets. So we’re starting with zero former Sprint customers. It will take time to grow that book of business, although obviously, it’s a very positive long-term thing. And we’re going to be investing as the program starts ramping over the next month or two, or quarters or so. But, again, very positive and we’re really proud of the partnership we’ve built with T-Mobile.
Mark Hughes: And then I assume this is publicly available, but the pace of new Sprint customers, any sense on that you can share?
Alan Colberg: I think it would just be what we normally see, which is over a cycle, call it, somewhere around three to four years is when people come into the store to turn in their handset, get a new handset or purchase a new one. So, it’s similar to the other programs we’ve launched in the last couple of years. We would expect it to grow and build over the next 3-plus years.
Mark Hughes: It’s great. Can you talk about the mobile contracts overall? You had mentioned in Auto business that you are pretty close to where you were pre-COVID. How about on the mobile service contracts, your kind of sales trajectory, as you sit here today versus pre-COVID?
Alan Colberg: Yeah. If I step back a little farther and talk about broadly the impacts from COVID on mobile, what we’ve seen over the last quarter or so is lower trade-in volumes, really as stores were closed and there was disruption in the marketplace. We were fortunate that that was offset by higher margins as we went through the quarter. But we definitely have seen lower trade-in volumes. Although, that’s now recovered as we head into June and July, things have really returned more back to pre-COVID. If you look at our subscriber count, we feel great about where we are. Our installed base is 53 million. We continue to grow in the U.S. and Japan, which are our critical markets. We did see pressure in Latin America, which is really the most disrupted region globally in terms of new sales. But overall, it’s really a large recurring revenue base that really sets us up well for the future.
Mark Hughes: The losses in housing, the underlying losses, I think you’ve mentioned you get some benefit from favorable weather, which frankly seems you’re [un-countered] [ph] to many or most other carriers. But then you got some benefit from better underwriting and claims processing, I think you mentioned use of the AI. Could you talk about that? How much does that mean for your losses, if this persists?
Alan Colberg: Yeah. Maybe I’ll start and, Richard, feel free to add on to this. So if we look at kind of the non-cat loss ratio, it was a little bit below what we normally see, really driven by a couple of things. With people at home, there was less loss in theft, there was less water damage. We mentioned a little bit less weather just in the quarter. Equally importantly, we’ve been investing over the last few years in our AI and underwriting initiatives and we’re starting to see the real benefits of that and a dramatically better customer experience with much quicker payment of claims, much faster processing. But, Richard, what would you add?
Richard Dziadzio: Yeah. Thank you. Just a few things, Mark. Good question. I think part of it, obviously, people are staying home, and so COVID, I think in some respect helped us during this period, as they’re watching their houses a little more closely. As Alan said, really the AI initiatives, the claims initiatives that we have really help us with efficiency and just staying on top of claims much better and processing them better. I’d also say that the underwriting has improved. Last year, we talked about small commercial and some losses we had there. We got out of that business, so that’s a plus for us. That won’t come back. And also within our specialty area, we’ve looked at, we talked about a single contract with a client that we changed significantly. So, all of these things will bode well for us in the future.
Mark Hughes: And just a final one, the $275 million you mentioned in the trade-in you’re going to fee rather than growth; that will all show up in the fee line, and is that neutral to earnings?
Richard Dziadzio: Alan, do you want me to take that?
Alan Colberg: Yeah. Please, Richard.
Richard Dziadzio: Yeah. So, yeah, the $275 million, that’s the contract change that we had in Lifestyle that you’re referring to, that’s an annualized impact that we’ll have. And if you think about it before we were actually buying in the units and then selling them out, so we had kind of the gross amount going through the fee income, net amounts going through cost of goods sold. Now, we’re more administrating that business. So you will see those 2 lines go down, the income line, but also cost of goods sold, the SG&A line that we showed in the supplement, will go down as well. And then, I guess, everything that we pointed out in our prepared remarks, as we think it’s a really good move for us, it provides more stability in terms of that trade-in business, it takes some of the pricing risk out from us. So, all-in-all, we’re really pleased with it, but we did want to set up to the market that revenues will go down, but we’re not expecting a material bottom line impact on that.
Mark Hughes: Thank you very much.
Alan Colberg: All right. Thanks, Mark.
Operator: Our next question comes from Brian Meredith of UBS. Your line is open.
Alan Colberg: Hey. Good morning, Brian.
Brian Meredith: Yeah, thanks. Good morning.
Richard Dziadzio: Good morning, Brian.
Brian Meredith: A couple of questions here for you. First one, just back on the whole T-Mobile transaction, is it possible to frame kind of what the potential revenue opportunity is from picking up the additional Sprint customers?
Alan Colberg: What I look at is, you can see publicly how many subscribers Sprint has, and you can assume over the next 3 years, we’ll pick up those subscribers. So that’s how I think about it. But other than that, we generally don’t talk about client specifics, but it is a very positive development for our mobile franchise.
Brian Meredith: And just curious, as I think about it historically, when you pick up a large customer like that, it’s kind of a drag on earnings, maybe for a year or so, should we still expect that?
Alan Colberg: Yeah. That’s typically the case is, we have the upfront costs for things like integrating technology for regulatory filings, for marketing, for training. So we’re in the middle of starting to invest those costs right now. So it certainly is a bit of a drag in the short-term, but a very positive long-term.
Brian Meredith: Sure. No, absolutely. And then I’m assuming it’s in your guidance for the year, so you’re expecting that to kind of kick up in the second half.
Alan Colberg: Yes, the investments, right, because we start again, as I mentioned earlier, we start with no subscribers from legacy Sprint, but it will build over time as we go through the next few years.
Brian Meredith: Terrific. And then a quick question here on the LPI business. I understand that better quality mortgages today, foreclosures are probably delaying some of the activity there, penetration. But have you got any statistics or do you take a look at what mortgage delinquencies and how they track relative to your LPI penetration?
Alan Colberg: Yeah. So a couple of thoughts on that. So we want to be clear, we don’t expect to benefit in LPI this year. If you look at what’s going on with mortgage forbearance, we’re actually – it’s a bit of a COVID-19 headwind. We’re seeing a lower REO volumes and that’s impacting 2020’s outlook. But if you look broadly at the housing market, we are starting to see delinquencies begin to creep up, and obviously our product is an important product that protects both the consumer and the banks and we’re well positioned if the housing market does weaken for a growth there in 2021 and beyond.
Brian Meredith: Yeah. I mean, if you just – to looking more 2021, I didn’t know, if you’ve got any kind of correlation statistics as mortgage delinquency trends are bit standing free, they’re running around 7%, does that equate to a certain amount of penetration that you typically see?
Alan Colberg: Yeah. What I would say is, we’re monitoring what’s happening there. There is always a lag in our placement, but we’re well positioned and it’s just hard to predict whether those delinquencies will translate into our product in place or not just given what’s going on currently in the market. But, I mean, we do feel well positioned and we do anticipate there’ll be up [Technical Difficulty].
Brian Meredith: …last question here, I’m just curious, any thoughts on the Bank of America renewal? Obviously, NatGen is getting purchased by Allstate. Any thoughts around that when that could potentially happen?
Alan Colberg: Yeah. So as it’s been talked about previously, it’s common knowledge that that RFP is in the market, which is the first time that we’ve ever had a chance in the last decade to participate in that business. And we’ll see what happens over time, but we do believe we have the industry leading capability in the market. We’ve been investing heavily in our technology, we offer a superior client and consumer experience. So we’ll see what happens. But we feel well positioned for any piece of business that comes into the market.
Brian Meredith: Great. Thank you.
Alan Colberg: Thank you, Brian.
Operator: Your next question comes from Michael Phillips of Morgan Stanley. Your line is open.
Alan Colberg: Hey. Good morning, Mike.
Michael Phillips: Hey. Good morning, guys. Thanks. And so, guys, first off just high level on the revised outlook. I guess, how do we think about – we’ve seen some reversal on open – reopenings and some uptick in cases across the country and more concerns there. So how do we match that with your uptick in your outlook with your comment that it doesn’t contemplate any uptick in COVID infection rates?
Alan Colberg: Yeah. So I think the starting point is, our business is really driven by our installed base, and that large installed base have nearly 300 million customers, over 300 million customers is there. We have a very resilient business and what we’ve seen even in July, for example, if you go through the various sectors, auto new sales of our product in July were back at or above pre-COVID levels, even as there is disruption in the U.S. marketplace. If you look at mobile, we mentioned that trading activity in July was back what we expected earlier in the year. Multifamily, we were impacted early by COVID, clearly, but as we’ve gotten into July, we began seeing the new sales rebound and be back to what we expected to see. So pretty much across the board. The exception is probably Preneed. Our Preneed new sales are still lagging 10% to 15% below where they were same year pre-COVID. But our business is strong and really driven by that installed base. And so the other important point I’d make is, as we talked about in the prepared remarks, we still expect to grow second half of 2019 – sorry, second half of 2020 versus second half of 2019, despite some of the uncertainty and headwinds from COVID-19. So we’ll certainly continue to monitor it, but we feel good about the business trends we’re seeing in our portfolio.
Michael Phillips: Okay. Thanks, Alan. That’s helpful. And just a couple of little nuances here. One more question. You’ve talked previously about some places that are overseas, where things were shut down, I think Hong Kong, some trade imposes in Hong Kong. Any impact this quarter on things like that? And are those places up and running again? Or should we expect kind of a future impact from those going forward?
Alan Colberg: Yeah. So just to clarify on that comment, what we were referring to there is in the first quarter, we had some disruption in our ability to sell phones into Hong Kong and China. This goes back to January and February. That normalized in February. And as the virus migrated from East to West, we’ve not seen any further disruptions in Asia Pacific. If you look around the world, the market that’s been most disrupted broadly is Latin America. And we’ve seen a greater impact on new sales in that geography than anywhere else in the world. We are seeing a little bit lower claims than expected in places like Europe. Again, probably a reflection of the shutdown, but we’re starting to see that normalize as we head into Q3. So at this point, we see things trending kind of back to normal, both on new sales, as well as on claims.
Michael Phillips: Okay. Thanks. And then multifamily housing, typically, you get a bit of a bump there, because of some time. I assume there’s a little bit of an impact there. Can you talk about that and maybe any impact on, I guess, demand? Or any impacts on the rental business, because of the recession?
Alan Colberg: Yeah. We were clearly impacted back in the second half of March and April as people just didn’t move, but that has rebounded and our sales are pretty much back to what we expect this for in July. So we were off track, but pretty much back on track now. And if I really step back on our multifamily business, we’re really proud of the franchise we’ve built. We now have 2.3 million policyholders. We’re profitable. We’ve been growing that franchise rapidly. Over the last few years, we’ve outgrown the market, even as different competitors have entered. And it’s really driven by our strong diverse distribution with both property management companies, as well as our affinity partners. It’s driven by our ongoing investments in digital and CX, which helps us sustain a really competitive, attractive product for consumers. And then we’ve got a lot of potential over time with our point of lease product, which has gone slowly this year just as landlords have been disrupted with COVID-19. But over time, we expect penetration to grow as we rollout our point of lease, which really provides a seamless kind of consumer experience as they move into a property.
Michael Phillips: Okay, great. Thank you, Alan. I appreciate it.
Alan Colberg: All right. Thank you.
Operator: Our next question comes from Gary Ransom of Dowling & Partners. Your line is open.
Alan Colberg: Hey. Good morning, Gary.
Gary Ransom: Yeah. Good morning. I wanted to see if I could tie the new guidance at least a little bit into the original Investor Day guidance of the 12% going into 2021. It sounds like you’re ahead of what you originally were talking about at this point. And I just – can you add any commentary on what your new guidance might mean for that old guidance?
Alan Colberg: Gary, it’s a very fair question. We do always look at a multi-year period, because over time, short-term fluctuations might impact any given year. But if you look at net operating earnings growth, so this is ex-cat, not EPS but earnings, we grew earnings 11% last year. If you look at the midpoint of our new outlook, we’re looking at least 12% earnings growth this year. So we’re ahead, both in 2019 and 2020 versus our long-term. So as we think about 2021, I would say a few things. We have a strong track record of profitable growth. I think we’ve demonstrated that we have a resilient business model that’s been proven to be able to navigate the pandemic. We have strong cash flow generation. And we still expect to grow in 2021. It’s obviously, very early, so we haven’t completed all of our planning and modeling for next year, but we are ahead. And so we may grow a little slower next year than we might have originally thought just because we’ve grown more rapidly in 2019 and 2020. But we remain confident that we will continue to grow earnings over time in next year, really driven off of our installed base of customers, some of the new programs that we’ve just won and we just announced, for example, the Sprint, T-Mobile. And just we continue to expand our offerings. The purchase of Alegre in Australia is another example, which really allows us to strengthen our repair and logistics capability, not only in Australia, but in Asia Pacific. So, we’ll provide an update later, but we feel good about the long-term profitable growth of our company.
Gary Ransom: Thank you for that. That’s helpful. A slightly related question, is this dip in revenues that you saw and maybe this is mostly about auto, but was it a big enough dip that it will actually affect what we see in the earned premium and then – and fees as it gets earned out in the future somewhere? Will there be an echo of this or is that – am I kind of making too much out of that?
Richard Dziadzio: Alan, do you want me to take that?
Alan Colberg: Yeah, please. Yeah, please, Richard.
Richard Dziadzio: It’s a good question. I mean, what we’re really seeing is a quarter, a dip and primarily from March and April when the dealerships closed down. And as you know, the unearned premium actually earns out over a number of years, call it – think about 3 to 5 years in the future. So the way I think about it, it’s a small thing. I think you used the word echo maybe. But dealerships, as Alan said, are now opening, our volumes are back. So, I wouldn’t think that going long-term we would see much of an impact, if anything from just this blip in the last couple of months there, March, April.
Gary Ransom: Okay. That’s fair. Thanks.
Alan Colberg: Yeah, Richard. Yeah, what I’d also add is, if you look at car sales, car sales are still down a little bit, but our volumes have more than recovered, which is what we normally see in economic downturns, dealers work harder to place our products when they’re having fewer car sales and we’re definitely seeing that in June/July.
Gary Ransom: And one more over on the renters product, we had a public company or an IPO of Lemonade, with a new technology, and I wondered if – how you think about that, if that’s a threat at all or just if you have any comments about it?
Alan Colberg: We spend a lot of time looking at our markets, and potential new entrants and changes in the marketplace. And what I would say is, over the last couple of years, even as new entrants have come in, we have continued to outgrow the market and gain market share. And it’s really a function of our strengthen in distribution, as well as the investments we’ve made and continue to make in digital and CX. So, we feel good about our position and we expect continued growth in multifamily regardless of who is entering the market.
Gary Ransom: All right. Thank you very much.
Alan Colberg: All right. Thank you.
Richard Dziadzio: Thank you.
Operator: Our final question comes from Mark Hughes of Truist Securities. Your line is open.
Alan Colberg: Hey. Good morning again, Mark.
Mark Hughes: Yeah. Thank you. The typical penetration when we think about the Sprint customer base, are you able to share what their current penetration is in terms of service contracts or just broadly speaking, what might one expect if we look at their overall subscriber count, but presumably some portion of that are actually going to be service contract customers. What’s the right ratio to think?
Alan Colberg: Yeah, without commenting on a specific client, because we normally don’t do that. If you look at the U.S., the average penetration now for our product is, call it, roughly high 40%s, high 40%s. So you could assume something like that over time for new clients as well.
Mark Hughes: And then NatGen, the acquisition by Allstate, do you expect Allstate to do anything here in the lender-placed market?
Alan Colberg: I couldn’t really speculate on what Allstate might do. What I would say is we are in a very good position, right? So we mentioned on the prepared remarks that over the last year or so, we’ve renewed 80%-plus of our tracked loans. That was in part as we’re rolling out our new technology, which is a real differentiator. We wanted to work with our clients to make sure our business was solid and in place. So, I think our track record speaks for itself. And we feel like we have a strong and compelling proposition, no matter who we’re competing against.
Mark Hughes: Understood. Thank you.
Alan Colberg: All right. I think that’s it for questions. So I want to thank everyone for participating in today’s call. In summary, we had a strong second quarter and a strong first half of the year. We will continue to monitor trends with the global market related to COVID-19. But we believe we are well positioned to deliver on our strategy and financial objectives, both in 2020 and beyond. We’ll update you on our progress on our third quarter earnings call in November. In the meantime, please reach out to either Suzanne Shepherd or Sean Moshier with any follow-up questions. Thanks, everyone.
Operator: Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant’s Second Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode. And the floor will be open for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President, Investor Relations. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2020 results with you today. Joining me for Assurant’s conference call are Alan Colberg, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the second quarter 2020. The release and corresponding financial supplement are available on assurant.com. We will start today’s call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday’s earnings release, as well as in our SEC report. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday’s news release and financial supplement. I will now turn the call over to Alan."
},
{
"speaker": "Alan Colberg",
"text": "Thanks, Suzanne. Good morning, everyone. We’re pleased with our second quarter performance. We reported operating earnings per share, excluding catastrophe losses of $2.90, up 27% from the prior year period. Net operating income for the quarter, also excluding catastrophe losses was $179 million, an increase of 24% from last year, demonstrating the continued strength and resiliency of our business. Results were above our expectations, reflecting the stability of our large installed customer base, significant client partnerships and embedded growth in Global Lifestyle. We also benefited from improved results in Global Housing. Declines in investment income and foreign exchange were more than offset by lower claims activity and expense management efforts. The initial negative impacts from COVID-19 in April gradually improved in May and June, resulting in a modest net positive to overall net operating income in the quarter. Year-to-date, net operating earnings per share, excluding catastrophe losses grew 24% and net operating income increased 21%. Even after adjusting for $16 million of one-time items during the first half of the year, our results came in at the high-end of our model pandemic scenarios. Given our strong performance in the first half and improved visibility for remainder of the year, we have decided to reinstate and increase our outlook for full-year 2020. We now expect 12% to 16% growth in operating earnings per share, excluding catastrophe losses, an increase from our initial outlook of 10% to 14%. This reflects continued growth in Connected Living, expansion within multifamily housing and improved profitability in our specialty business. Our outlook assumes a continuation of current business trends and, therefore, does not take into account a material increase in infection rates from COVID-19, which could lead to a significant change in consumer behavior, access to distribution channels, or impact to financial markets. While we expect earnings growth in the second half on a year-over-year basis, our outlook for the full-year assumes a decline in earnings from the first 6 months of this year as we anticipate more normalized claims activity across most of our businesses and make incremental investments in our digital and customer experience capabilities. The second half of the year will also reflect lower investment income and foreign exchange headwinds, the absence of $16 million of one-time benefits, as well as typical mobile seasonality. Looking at our balance sheet, our liquidity position remains strong. In July, we repaid the $200 million credit facility drawn in late March, which was done as a precautionary measure. Given the attractiveness of our stock and strong capital position, we expect to resume share repurchases in the third quarter and we continue to expect to reach our objective of returning $1.35 billion of capital to shareholders between 2019 and 2021. As always, this is subject to a variety of factors, including no significant deterioration of economic or market conditions. Recent market transactions across our space further reinforced our view that our stock remains attractively priced. Earnings momentum in Global Lifestyle continues to be strong, driven in particular by Connected Living. This business had a compound annual earnings growth rate of 38% between 2015 and 2019 led by mobile. Our installed base of customers, which represent a significant monthly recurring revenue stream, continues to expand. We are now at over 53 million mobile subscribers, up 70% since 2015. We’ve continued to provide value to consumers in services like trade-in, upgrade and technology support as part of our fee-based offerings, resulting in a better ownership experience and multiple profit pools beyond device protection. At the same time, we’ve continued to deepen our partnerships with market leaders to drive long-term profitable growth. We are pleased to announce that as Sprint becomes part of T-Mobile, we’ll offer device protection to those new T-Mobile customers. We believe this is another example to support the long-term growth of our Connected Living business. And we are proud of our long-standing partnership with T-Mobile. In August, we also strengthened our mobile device trading capabilities in Asia Pacific through the purchase of Alegre, a leading operator in the pre-owned mobile device market. After a small initial investment in 2018, we acquired the remaining equity for $12 million. Turning to Global Automotive, our installed base now includes over 48 million vehicles. We continue to strengthen our client partnerships by working with them to enhance the digital customer experience, offering live online dealer training and sales webinars. We will continue to use our scale and diverse distribution channels to grow the business over the long term, especially as we look at future opportunities with the connected car. Moving to Global Housing, our lender-placed insurance and renters businesses both continue to contribute to our attractive above-market returns. Our lender-placed business plays a unique and vital role within the housing market, protecting both lenders and homeowners. We track over 32 million loans, including for 8 of the top-10 largest U.S. mortgage servicers. Since the beginning of 2019, we have renewed relationships with clients that represent nearly 80% of our loans tracked, solidifying our position as market leader. We’ve been investing in a new technology platform to improve the customer experience. In addition, we’ve made progress with our efforts to streamline and reduce our operational cost. In our renters business, we’ve built a leadership position over the last 15 years. We now cover over 2.3 million renters and generate over $400 million in annual revenue. Since 2015, we’ve grown earnings in an 18% compound annual growth rate, with multifamily now representing roughly one-third of Global Housing’s 2019 net operating income, excluding catastrophes, illustrating the franchise strength. We will continue to invest to enhance the customer experience as this remains an important growth business for the company, especially as we think ahead to supporting consumers within the connected world. And in Global Preneed, we have more than 2 million policies and growing. This business over time gives us strong distributable cash flows, the statutory earnings greater than GAAP earnings. Overall, the level of mortality risk remains lower relative to other life insurance-type products, ultimately contributing to above-market returns. More recently, we’ve introduced new fee-for-service offerings to support the growing fee of the lifestyle market, such as Executor Assist. We believe our overall portfolio represents a compelling mix of above-market growth and counter-cyclical businesses with leading positions and a track record of innovation. These businesses generate significant cash flow to reinvest and return capital to shareholders. These are key characteristics that we believe set us apart as a long-term outperformer and enable us to create value for our shareholders, even against the backdrop of uncertainty in the global macro environment. Before I turn it over to Richard, I want to take a moment to thank our employees for their unwavering focus in supporting each other and our customers during this time. In the past few months, we’ve taken additional steps to support our employees, through an array of actions. These have included one-time relief payments for work-from-home employees, incentive bonuses for on-site staff, providing additional floating holidays and a number of well-being and mental health support services. The cost for these programs and other incremental expenses directly related to COVID-19 are reflected in net income, similar to last quarter. I’m proud and grateful for the exceptional service our employees have and continue to provide, on behalf of our clients and our 300 million customers worldwide. While in the midst of grappling with COVID-19, we’ve also recognized the need to continue to advance diversity and inclusion of Assurant and within the communities we serve, particularly in light of the tragic murder of George Floyd and many others. For us, diversity and inclusion is not only about common BCP and common sense, it is also a strategic and business imperative. Building on past initiatives, we’ve hosted candid enterprise-wide conversations with our employees on race, to ensure that we recognize these issues in our society and within the workplace. We are evaluating additional actions to support in the more diverse, equitable and inclusive community. All of this has continued to reinforce the criticality of supporting the evolving needs of all of our key stakeholders with purpose and commitment. In July, we announced several organizational changes to enable us to deliver on those objectives more effectively. Under the leadership of Francesca Luthi in a newly created role as Chief Administrative Officer, we have realigned human resources, facilities in procurement, along with Marketing, Communications, Investor Relations and Corporate Social Responsibility. A move I believe is critical to ensure we bring a holistic view to integrated stakeholder management, while at the same time, elevating the employee experience, to attract and retain the best and most diverse talent for the future. We also promoted Jay Rosenblum to Chief Legal Officer. He had been serving in that role in an internal capacity since February, after joining us last year to lead our Government Relations and Regulatory Affairs team. Jay’s diverse experience spans 25 years in various legal and HR roles. And I’m pleased to have him lead our global legal function. Overall, I’m exceptionally proud of our leaders and our 14,000 employees and how they have and will continue to live our values. I’ll now turn the call over to Richard to review second quarter results, recent trends and our updated 2020 outlook in more detail. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Alan, and good morning, everyone. Let’s start with Global Lifestyle. The segment reported earnings of a $122 million, up 11%, compared to the prior year period. This increase was primarily driven by continued mobile growth, mainly from programs added in the last several years in North America and Asia Pacific. Lower claims activity outside of the U.S. in Connected Living and Auto also drove improved results. Our mobile trade-in business benefited from higher average selling prices due to scarce supply of used devices. This was partially offset by lower overall volumes due to COVID-19. Global Automotive reflected a $4 million discrete client benefit in addition to reduce claims activity, mainly from our OEM clients outside of the U.S., as a result of COVID-19 stay at home orders. Overall earnings growth was partially offset by decline in Global Financial Services from weaker results in Canada and anticipated declines in legacy credit insurance. Unfavorable foreign exchange also pressured results in the quarter. Looking at total revenue for Lifestyle, net earned premiums and fees were down $40 million, or 2%. The decrease was driven primarily by lower mobile trade-in volumes due to store closures from COVID-19 and foreign exchange movements. This was partially offset by increased enrollment and new mobile programs, especially as carrier stores began to reopen in the latter part of the quarter. Within in Global Automotive, revenue grew 3%, primarily reflecting prior period sales of vehicle service contracts. Sales and auto have rebounded since April and are nearly back to pre-COVID levels year-over-year. We will continue to monitor trends as sales levels today will impact future earnings for the business. Looking forward to full-year 2020, we expect growth in Lifestyle’s net operating income, compared to full year 2019. However, we also expect that earnings in the second half of the year will be lower compared to the strong first half results. This is due to 5 key factors. First, we recognized $16 million of one-time benefits in the first 6 months of the year, $4 million of which was incurred in the second quarter. We do not expect these items to reoccur in the second half of the year. Second, we expect claims activity in Connected Living and auto to normalize at higher levels in the coming quarters, as the global economy continues to reopen. Third, similar to previous years, the timing and availability for new phone introductions will impact trade-in activity in the second half of the year. We are not, though, assuming any material increases in volumes before year-end. Fourth, we’re ramping up our investments in digital and customer experience capabilities to further increase our competitive differentiation. And finally, we expect both foreign exchange and lower investment income to remain headwinds into the second half of the year. I will also note that effective July 1, foreign exchange and contract terms were transitioning our revenue accounting treatment from a gross sales basis per device to a flat fee per device for one of our mobile trade-in and upgrade programs. This will reduce our fees and other income by approximately $275 million on an annualized basis. Through our cost of goods sold, embedded in Lifestyle’s SG&A will substantially offset this decrease. We are pleased with this change as it will remove some of the revenue and expense variability we have historically seen in our financial results. It will also mitigate supply and demand pricing risk in the future. Moving now to Global Housing, net operating income for the second quarter totaled $85 million, an increase of $14 million, or 19% year-over-year despite higher reportable catastrophes. Excluding catastrophe losses, earnings of $96 million represented an increase of $27 million, or 39% year-over-year. Just over half of the increase was due to favorable non-cat loss experience across all major products, reflecting lower overall claims frequency and improvements in underwriting, including the benefits from artificial intelligence and claims processing initiatives. Also, the absence of losses from small commercial, along with growth in certain other specialty products contributed to the increase. Lender-placed results increased year-over-year. Higher premium rates and favorable loss experience were partially offset by a reduction of policies in force. This reduction was mainly related to the previously disclosed financially insolvent client and lower REO volumes due to the current foreclosure moratoriums. The modest sequential increase in the placement rate to 1.56% was attributable to a shift in business mix. It is not an indication of broader macro housing market shifts. Multifamily housing earnings were up slightly due to favorable non-catastrophe loss experience and modest growth from affinity partners. Turning to Global Housing revenues, net earned premiums and fees decreased 4% mainly from 3 items. The insolvent client, lower REO volumes, and the exit of small commercial. This decrease was partially offset by growth in our specialty property and multifamily housing businesses. Moving to multifamily housing, revenue increased 4% year-over-year, driven mainly by growth in our affinity partners. The impact of COVID-19 has been minimal year-to-date, although we continue to monitor state actions related to premium deferrals. At the end of June, we completed our 2020 catastrophe reinsurance program, maintaining our $80 million per event retention and increasing our multi-year coverage to nearly 50% of our U.S. [tower] [ph]. We also reduced our overall risk exposure, primarily through the exit of small commercial. Overall, we were able to leverage strong relationships with our reinsurance partners to keep rate increases on the lower end of the overall market, but we also recognize those higher costs may persist into the future. Looking forward to the full year 2020, we expect Global Housing net operating income, excluding cats, to increase over full-year 2019 earnings, driven by improved results in our specialty businesses, and growth in multifamily housing. We also believe the results for the second half of the year will be lower than the first half of Global Housing. This was due to 4 key factors: first, we expect a more normalized level of claims frequency, as previously mentioned; second, we expect REO volumes to continue to be reduced throughout the remainder of the year; third, the absence of income from the financially insolvent client in lender-placed; and finally, the segment will also continue to be impacted by lower investment income due to the lower yields available in the current interest rate environment. While lender-placed should grow due to the counter-cyclical nature of the business if economic conditions worsen, today’s mortgage industry and economic environment differ significantly from the housing crisis over 10 years ago. For example, mortgage loan underwriting standards have tightened, with the number of subprime and adjustable rate mortgages down over 60% and homeowners today have higher rates of home equity compared to that period. Now, let’s move to Global Preneed. The segment reported $14 million of net operating income, a $3 million decrease compared to the second quarter of 2019. This was driven by a combination of lower investment yields and a modest increase in mortality due to COVID-19. We continue to monitor mortality trends, especially in California, Texas, and South Carolina, given our policy concentration in those areas. So far, we have not experienced significant increases. Revenue for Preneed was up slightly, supported by sales in the U.S. And while face sales have begun to rebound recently, given funeral home reopenings and increased online sales since April, July year-over-year face sales were still down approximately 15%. We would expect new sales to continue to fluctuate. Overall, for Global Preneed, we believe 2020 earnings will increase modestly compared to 2019 reported results. The second half of the year, we expect earnings to be up slightly versus the first half of the year, due to more favorable mortality trends. We will continue to monitor these trends as our current outlook does not assume a significant worsening in COVID-19 cases. We expect the reduction in mortality to be partially offset by investment income declines. At Corporate, the net operating loss was $27 million versus $24 million in the second quarter of 2019. This was due to a lower tax rate from the consolidating tax rate adjustment and less investment income from lower yields on cash assets. For the full-year, we expect the Corporate net operating loss to be in the range of $86 million to $90 million as the result of lower investment income and one-time transition costs associated with the outsourcing of our investment management function. Across Assurant, our ongoing expense management efforts are contributing to our results. In addition, this year, we’ve benefited from lower travel expenses due to COVID-19 restrictions, as well as a reduction in discretionary spending, including deferring hiring for some positions. We are, though, filling all critical roles, particularly those needed to meet our client-customer expectations. As we look to sustain profitable growth, we expect to continue to invest in our core capabilities in the upcoming quarters, while closely managing discretionary spend, given the continued uncertainty from COVID-19. Next, I want to provide a brief update on our investment portfolio. Overall, our $12.6 billion portfolio of fixed maturities is of high-quality, well diversified, and managed for its income yield with low turnover. And as previously mentioned, we have minimal exposure to harder hit sectors like energy, hospitality, retail stores and airlines. Investment yield on our total investment portfolio dropped by 55 basis points year-over-year to 3.62%. This was largely driven by a decline in short-term cash yields, but we continue to manage the portfolio to preserve yield, our expectation is that, our investment income will remain under pressure for some time as we do expect interest rates will remain relatively low for the foreseeable future. However, we believe our consistent investment approach will continue to serve us well as it has in the past. In conjunction with our decision to outsource the management of our core investment portfolio, we sold our CLO platform for a modest gain in July. The sale will be recorded in the third quarter. While we will still have a small amount of investments in CLOs, our exposure to the asset class has been significantly reduced. Turning to holding company liquidity, we ended June with $357 million, or $132 million above our current minimum target level. This excludes the $200 million credit facility draw, which was reimbursed in July. In the second quarter, dividends from our operating segments totaled $157 million, or 71% of segment earnings. In addition to our quarterly corporate and interest expenses, we also bought back $26 million of stock. As we have indicated, we slowed and then ultimately paused share repurchases in the second quarter. We paid $44 million in common and preferred stock in dividends. We acquired AFAS for $158 million, and we sold [EK] [ph], which resulted in a cash outflow of $51 million from the holding company. In late July, we also received the one-time tax cash benefit related to the acceleration of our net operating losses, included in the CARES Act passed in March. As a result, liquidity at the holding company will increase by $84 million in the third quarter. For the full-year, we expect segment dividends to approximate segment earnings. This is subject to the growth of the businesses, rating agency and regulatory capital requirements and the performance of the investment portfolio. As Alan mentioned, we expect to resume buybacks in the third quarter, and we’ll continue to manage our capital prudently. Our approach to buybacks will be measured as we continue to monitor business performance as well as the broader macroeconomic and credit market environments. In summary, we demonstrated strong first-half performance while navigating the challenges of COVID-19. As we focus on continuing to deliver on our financial commitments for 2020, we will continue to invest in our growth businesses for the future, while monitoring global market trends. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. The floor is now open for questions. [Operator Instructions] Thank you. Our first question comes from Mark Hughes of Truist Securities. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey. Good morning, Mark."
},
{
"speaker": "Richard Dziadzio",
"text": "Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Good morning. Thank you. Could you talk about the T-Mobile announcement? It sounds like you’re going to be providing mobile contract services to new customers. Could you give a little detail? Is this going to include the back book as well or is it just new customers? What’s the timing, potential financial impact, all of that?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. No, Mark, thank you for the question. I’d start by saying we’re very proud to be T-Mobile’s partner for the past decade and assisting them in their journey to be the Un-carrier. As they migrate the stores over, the legacy Sprint stores, which they started last weekend, we will be offering our device protection program to all of the legacy Sprint customers as they come into a store. So that’s very positive. It is only go forward though, which is typical in our markets. So we’re starting with zero former Sprint customers. It will take time to grow that book of business, although obviously, it’s a very positive long-term thing. And we’re going to be investing as the program starts ramping over the next month or two, or quarters or so. But, again, very positive and we’re really proud of the partnership we’ve built with T-Mobile."
},
{
"speaker": "Mark Hughes",
"text": "And then I assume this is publicly available, but the pace of new Sprint customers, any sense on that you can share?"
},
{
"speaker": "Alan Colberg",
"text": "I think it would just be what we normally see, which is over a cycle, call it, somewhere around three to four years is when people come into the store to turn in their handset, get a new handset or purchase a new one. So, it’s similar to the other programs we’ve launched in the last couple of years. We would expect it to grow and build over the next 3-plus years."
},
{
"speaker": "Mark Hughes",
"text": "It’s great. Can you talk about the mobile contracts overall? You had mentioned in Auto business that you are pretty close to where you were pre-COVID. How about on the mobile service contracts, your kind of sales trajectory, as you sit here today versus pre-COVID?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. If I step back a little farther and talk about broadly the impacts from COVID on mobile, what we’ve seen over the last quarter or so is lower trade-in volumes, really as stores were closed and there was disruption in the marketplace. We were fortunate that that was offset by higher margins as we went through the quarter. But we definitely have seen lower trade-in volumes. Although, that’s now recovered as we head into June and July, things have really returned more back to pre-COVID. If you look at our subscriber count, we feel great about where we are. Our installed base is 53 million. We continue to grow in the U.S. and Japan, which are our critical markets. We did see pressure in Latin America, which is really the most disrupted region globally in terms of new sales. But overall, it’s really a large recurring revenue base that really sets us up well for the future."
},
{
"speaker": "Mark Hughes",
"text": "The losses in housing, the underlying losses, I think you’ve mentioned you get some benefit from favorable weather, which frankly seems you’re [un-countered] [ph] to many or most other carriers. But then you got some benefit from better underwriting and claims processing, I think you mentioned use of the AI. Could you talk about that? How much does that mean for your losses, if this persists?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. Maybe I’ll start and, Richard, feel free to add on to this. So if we look at kind of the non-cat loss ratio, it was a little bit below what we normally see, really driven by a couple of things. With people at home, there was less loss in theft, there was less water damage. We mentioned a little bit less weather just in the quarter. Equally importantly, we’ve been investing over the last few years in our AI and underwriting initiatives and we’re starting to see the real benefits of that and a dramatically better customer experience with much quicker payment of claims, much faster processing. But, Richard, what would you add?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yeah. Thank you. Just a few things, Mark. Good question. I think part of it, obviously, people are staying home, and so COVID, I think in some respect helped us during this period, as they’re watching their houses a little more closely. As Alan said, really the AI initiatives, the claims initiatives that we have really help us with efficiency and just staying on top of claims much better and processing them better. I’d also say that the underwriting has improved. Last year, we talked about small commercial and some losses we had there. We got out of that business, so that’s a plus for us. That won’t come back. And also within our specialty area, we’ve looked at, we talked about a single contract with a client that we changed significantly. So, all of these things will bode well for us in the future."
},
{
"speaker": "Mark Hughes",
"text": "And just a final one, the $275 million you mentioned in the trade-in you’re going to fee rather than growth; that will all show up in the fee line, and is that neutral to earnings?"
},
{
"speaker": "Richard Dziadzio",
"text": "Alan, do you want me to take that?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. Please, Richard."
},
{
"speaker": "Richard Dziadzio",
"text": "Yeah. So, yeah, the $275 million, that’s the contract change that we had in Lifestyle that you’re referring to, that’s an annualized impact that we’ll have. And if you think about it before we were actually buying in the units and then selling them out, so we had kind of the gross amount going through the fee income, net amounts going through cost of goods sold. Now, we’re more administrating that business. So you will see those 2 lines go down, the income line, but also cost of goods sold, the SG&A line that we showed in the supplement, will go down as well. And then, I guess, everything that we pointed out in our prepared remarks, as we think it’s a really good move for us, it provides more stability in terms of that trade-in business, it takes some of the pricing risk out from us. So, all-in-all, we’re really pleased with it, but we did want to set up to the market that revenues will go down, but we’re not expecting a material bottom line impact on that."
},
{
"speaker": "Mark Hughes",
"text": "Thank you very much."
},
{
"speaker": "Alan Colberg",
"text": "All right. Thanks, Mark."
},
{
"speaker": "Operator",
"text": "Our next question comes from Brian Meredith of UBS. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey. Good morning, Brian."
},
{
"speaker": "Brian Meredith",
"text": "Yeah, thanks. Good morning."
},
{
"speaker": "Richard Dziadzio",
"text": "Good morning, Brian."
},
{
"speaker": "Brian Meredith",
"text": "A couple of questions here for you. First one, just back on the whole T-Mobile transaction, is it possible to frame kind of what the potential revenue opportunity is from picking up the additional Sprint customers?"
},
{
"speaker": "Alan Colberg",
"text": "What I look at is, you can see publicly how many subscribers Sprint has, and you can assume over the next 3 years, we’ll pick up those subscribers. So that’s how I think about it. But other than that, we generally don’t talk about client specifics, but it is a very positive development for our mobile franchise."
},
{
"speaker": "Brian Meredith",
"text": "And just curious, as I think about it historically, when you pick up a large customer like that, it’s kind of a drag on earnings, maybe for a year or so, should we still expect that?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. That’s typically the case is, we have the upfront costs for things like integrating technology for regulatory filings, for marketing, for training. So we’re in the middle of starting to invest those costs right now. So it certainly is a bit of a drag in the short-term, but a very positive long-term."
},
{
"speaker": "Brian Meredith",
"text": "Sure. No, absolutely. And then I’m assuming it’s in your guidance for the year, so you’re expecting that to kind of kick up in the second half."
},
{
"speaker": "Alan Colberg",
"text": "Yes, the investments, right, because we start again, as I mentioned earlier, we start with no subscribers from legacy Sprint, but it will build over time as we go through the next few years."
},
{
"speaker": "Brian Meredith",
"text": "Terrific. And then a quick question here on the LPI business. I understand that better quality mortgages today, foreclosures are probably delaying some of the activity there, penetration. But have you got any statistics or do you take a look at what mortgage delinquencies and how they track relative to your LPI penetration?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. So a couple of thoughts on that. So we want to be clear, we don’t expect to benefit in LPI this year. If you look at what’s going on with mortgage forbearance, we’re actually – it’s a bit of a COVID-19 headwind. We’re seeing a lower REO volumes and that’s impacting 2020’s outlook. But if you look broadly at the housing market, we are starting to see delinquencies begin to creep up, and obviously our product is an important product that protects both the consumer and the banks and we’re well positioned if the housing market does weaken for a growth there in 2021 and beyond."
},
{
"speaker": "Brian Meredith",
"text": "Yeah. I mean, if you just – to looking more 2021, I didn’t know, if you’ve got any kind of correlation statistics as mortgage delinquency trends are bit standing free, they’re running around 7%, does that equate to a certain amount of penetration that you typically see?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. What I would say is, we’re monitoring what’s happening there. There is always a lag in our placement, but we’re well positioned and it’s just hard to predict whether those delinquencies will translate into our product in place or not just given what’s going on currently in the market. But, I mean, we do feel well positioned and we do anticipate there’ll be up [Technical Difficulty]."
},
{
"speaker": "Brian Meredith",
"text": "…last question here, I’m just curious, any thoughts on the Bank of America renewal? Obviously, NatGen is getting purchased by Allstate. Any thoughts around that when that could potentially happen?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. So as it’s been talked about previously, it’s common knowledge that that RFP is in the market, which is the first time that we’ve ever had a chance in the last decade to participate in that business. And we’ll see what happens over time, but we do believe we have the industry leading capability in the market. We’ve been investing heavily in our technology, we offer a superior client and consumer experience. So we’ll see what happens. But we feel well positioned for any piece of business that comes into the market."
},
{
"speaker": "Brian Meredith",
"text": "Great. Thank you."
},
{
"speaker": "Alan Colberg",
"text": "Thank you, Brian."
},
{
"speaker": "Operator",
"text": "Your next question comes from Michael Phillips of Morgan Stanley. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey. Good morning, Mike."
},
{
"speaker": "Michael Phillips",
"text": "Hey. Good morning, guys. Thanks. And so, guys, first off just high level on the revised outlook. I guess, how do we think about – we’ve seen some reversal on open – reopenings and some uptick in cases across the country and more concerns there. So how do we match that with your uptick in your outlook with your comment that it doesn’t contemplate any uptick in COVID infection rates?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. So I think the starting point is, our business is really driven by our installed base, and that large installed base have nearly 300 million customers, over 300 million customers is there. We have a very resilient business and what we’ve seen even in July, for example, if you go through the various sectors, auto new sales of our product in July were back at or above pre-COVID levels, even as there is disruption in the U.S. marketplace. If you look at mobile, we mentioned that trading activity in July was back what we expected earlier in the year. Multifamily, we were impacted early by COVID, clearly, but as we’ve gotten into July, we began seeing the new sales rebound and be back to what we expected to see. So pretty much across the board. The exception is probably Preneed. Our Preneed new sales are still lagging 10% to 15% below where they were same year pre-COVID. But our business is strong and really driven by that installed base. And so the other important point I’d make is, as we talked about in the prepared remarks, we still expect to grow second half of 2019 – sorry, second half of 2020 versus second half of 2019, despite some of the uncertainty and headwinds from COVID-19. So we’ll certainly continue to monitor it, but we feel good about the business trends we’re seeing in our portfolio."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Thanks, Alan. That’s helpful. And just a couple of little nuances here. One more question. You’ve talked previously about some places that are overseas, where things were shut down, I think Hong Kong, some trade imposes in Hong Kong. Any impact this quarter on things like that? And are those places up and running again? Or should we expect kind of a future impact from those going forward?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. So just to clarify on that comment, what we were referring to there is in the first quarter, we had some disruption in our ability to sell phones into Hong Kong and China. This goes back to January and February. That normalized in February. And as the virus migrated from East to West, we’ve not seen any further disruptions in Asia Pacific. If you look around the world, the market that’s been most disrupted broadly is Latin America. And we’ve seen a greater impact on new sales in that geography than anywhere else in the world. We are seeing a little bit lower claims than expected in places like Europe. Again, probably a reflection of the shutdown, but we’re starting to see that normalize as we head into Q3. So at this point, we see things trending kind of back to normal, both on new sales, as well as on claims."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Thanks. And then multifamily housing, typically, you get a bit of a bump there, because of some time. I assume there’s a little bit of an impact there. Can you talk about that and maybe any impact on, I guess, demand? Or any impacts on the rental business, because of the recession?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah. We were clearly impacted back in the second half of March and April as people just didn’t move, but that has rebounded and our sales are pretty much back to what we expect this for in July. So we were off track, but pretty much back on track now. And if I really step back on our multifamily business, we’re really proud of the franchise we’ve built. We now have 2.3 million policyholders. We’re profitable. We’ve been growing that franchise rapidly. Over the last few years, we’ve outgrown the market, even as different competitors have entered. And it’s really driven by our strong diverse distribution with both property management companies, as well as our affinity partners. It’s driven by our ongoing investments in digital and CX, which helps us sustain a really competitive, attractive product for consumers. And then we’ve got a lot of potential over time with our point of lease product, which has gone slowly this year just as landlords have been disrupted with COVID-19. But over time, we expect penetration to grow as we rollout our point of lease, which really provides a seamless kind of consumer experience as they move into a property."
},
{
"speaker": "Michael Phillips",
"text": "Okay, great. Thank you, Alan. I appreciate it."
},
{
"speaker": "Alan Colberg",
"text": "All right. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Gary Ransom of Dowling & Partners. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey. Good morning, Gary."
},
{
"speaker": "Gary Ransom",
"text": "Yeah. Good morning. I wanted to see if I could tie the new guidance at least a little bit into the original Investor Day guidance of the 12% going into 2021. It sounds like you’re ahead of what you originally were talking about at this point. And I just – can you add any commentary on what your new guidance might mean for that old guidance?"
},
{
"speaker": "Alan Colberg",
"text": "Gary, it’s a very fair question. We do always look at a multi-year period, because over time, short-term fluctuations might impact any given year. But if you look at net operating earnings growth, so this is ex-cat, not EPS but earnings, we grew earnings 11% last year. If you look at the midpoint of our new outlook, we’re looking at least 12% earnings growth this year. So we’re ahead, both in 2019 and 2020 versus our long-term. So as we think about 2021, I would say a few things. We have a strong track record of profitable growth. I think we’ve demonstrated that we have a resilient business model that’s been proven to be able to navigate the pandemic. We have strong cash flow generation. And we still expect to grow in 2021. It’s obviously, very early, so we haven’t completed all of our planning and modeling for next year, but we are ahead. And so we may grow a little slower next year than we might have originally thought just because we’ve grown more rapidly in 2019 and 2020. But we remain confident that we will continue to grow earnings over time in next year, really driven off of our installed base of customers, some of the new programs that we’ve just won and we just announced, for example, the Sprint, T-Mobile. And just we continue to expand our offerings. The purchase of Alegre in Australia is another example, which really allows us to strengthen our repair and logistics capability, not only in Australia, but in Asia Pacific. So, we’ll provide an update later, but we feel good about the long-term profitable growth of our company."
},
{
"speaker": "Gary Ransom",
"text": "Thank you for that. That’s helpful. A slightly related question, is this dip in revenues that you saw and maybe this is mostly about auto, but was it a big enough dip that it will actually affect what we see in the earned premium and then – and fees as it gets earned out in the future somewhere? Will there be an echo of this or is that – am I kind of making too much out of that?"
},
{
"speaker": "Richard Dziadzio",
"text": "Alan, do you want me to take that?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah, please. Yeah, please, Richard."
},
{
"speaker": "Richard Dziadzio",
"text": "It’s a good question. I mean, what we’re really seeing is a quarter, a dip and primarily from March and April when the dealerships closed down. And as you know, the unearned premium actually earns out over a number of years, call it – think about 3 to 5 years in the future. So the way I think about it, it’s a small thing. I think you used the word echo maybe. But dealerships, as Alan said, are now opening, our volumes are back. So, I wouldn’t think that going long-term we would see much of an impact, if anything from just this blip in the last couple of months there, March, April."
},
{
"speaker": "Gary Ransom",
"text": "Okay. That’s fair. Thanks."
},
{
"speaker": "Alan Colberg",
"text": "Yeah, Richard. Yeah, what I’d also add is, if you look at car sales, car sales are still down a little bit, but our volumes have more than recovered, which is what we normally see in economic downturns, dealers work harder to place our products when they’re having fewer car sales and we’re definitely seeing that in June/July."
},
{
"speaker": "Gary Ransom",
"text": "And one more over on the renters product, we had a public company or an IPO of Lemonade, with a new technology, and I wondered if – how you think about that, if that’s a threat at all or just if you have any comments about it?"
},
{
"speaker": "Alan Colberg",
"text": "We spend a lot of time looking at our markets, and potential new entrants and changes in the marketplace. And what I would say is, over the last couple of years, even as new entrants have come in, we have continued to outgrow the market and gain market share. And it’s really a function of our strengthen in distribution, as well as the investments we’ve made and continue to make in digital and CX. So, we feel good about our position and we expect continued growth in multifamily regardless of who is entering the market."
},
{
"speaker": "Gary Ransom",
"text": "All right. Thank you very much."
},
{
"speaker": "Alan Colberg",
"text": "All right. Thank you."
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our final question comes from Mark Hughes of Truist Securities. Your line is open."
},
{
"speaker": "Alan Colberg",
"text": "Hey. Good morning again, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Yeah. Thank you. The typical penetration when we think about the Sprint customer base, are you able to share what their current penetration is in terms of service contracts or just broadly speaking, what might one expect if we look at their overall subscriber count, but presumably some portion of that are actually going to be service contract customers. What’s the right ratio to think?"
},
{
"speaker": "Alan Colberg",
"text": "Yeah, without commenting on a specific client, because we normally don’t do that. If you look at the U.S., the average penetration now for our product is, call it, roughly high 40%s, high 40%s. So you could assume something like that over time for new clients as well."
},
{
"speaker": "Mark Hughes",
"text": "And then NatGen, the acquisition by Allstate, do you expect Allstate to do anything here in the lender-placed market?"
},
{
"speaker": "Alan Colberg",
"text": "I couldn’t really speculate on what Allstate might do. What I would say is we are in a very good position, right? So we mentioned on the prepared remarks that over the last year or so, we’ve renewed 80%-plus of our tracked loans. That was in part as we’re rolling out our new technology, which is a real differentiator. We wanted to work with our clients to make sure our business was solid and in place. So, I think our track record speaks for itself. And we feel like we have a strong and compelling proposition, no matter who we’re competing against."
},
{
"speaker": "Mark Hughes",
"text": "Understood. Thank you."
},
{
"speaker": "Alan Colberg",
"text": "All right. I think that’s it for questions. So I want to thank everyone for participating in today’s call. In summary, we had a strong second quarter and a strong first half of the year. We will continue to monitor trends with the global market related to COVID-19. But we believe we are well positioned to deliver on our strategy and financial objectives, both in 2020 and beyond. We’ll update you on our progress on our third quarter earnings call in November. In the meantime, please reach out to either Suzanne Shepherd or Sean Moshier with any follow-up questions. Thanks, everyone."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 1 | 2,020 | 2020-05-09 08:00:00 | Operator: Welcome to Assurant's First Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following management's prepared remarks [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations. You may be begin.
Suzanne Shepherd: Thank you, operator and good morning, everyone. We look forward to discussing our first quarter 2020 results with you today. Joining me for Assurant's conference call are Alan Colberg, our President and Chief Executive Officer and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the first quarter 2020. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC report. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan.
Alan Colberg: Thanks, Suzanne. Good morning, everyone. Before reviewing our results for the quarter, I wanted to share a few comments regarding the COVID-19 pandemic and our ongoing response. From the beginning, Assurant's leadership team acted swiftly and deliberately led by our guiding principles, to safeguard our employees and their families, to maintain operations and service level for our customers and to support our local communities. Early in this crisis, we implemented a global ban on business travel and transitioned the vast majority of our workforce to work-from-home to help stem the spread of the virus in our communities and to protect our employees. For those employees who need to work from our offices or repair sites due to the essential nature of their roles, we've implemented strong safety and hygiene protocols. These measures include social distancing and the use of personal protective equipment, along with regular cleaning and disinfection of our locations based on the guidelines from The Centers for Disease Control. We are committed to doing what we can to protect our employees through this period of uncertainty, always treating them with respect and providing appropriate support given the challenges we are all dealing with at this time. To allay job security concerns as well as to continue to deliver for our customers, we've made commitments to our employees to not eliminate any roles due to COVID-19 in the short term. We've also offered financial support where it's most needed. As part of our Assurant Cares Employee Support or ACES Fund, we've launched a special COVID-19 Emergency Relief program to support eligible employees who are experiencing severe financial hardship caused by the pandemic. We've already raised more than $1 million through the support of our foundation and personal donations from our management committee, the Assurant Board of Directors and the generosity of hundreds of employees. Since its inception in late March, the special ACES Fund has helped more than 800 families manage through these turbulent times. Furthermore, our Assurant Foundation is honoring all of its 2020 charitable commitments and has pledged some additional $250,000 to aid core charitable partners that are providing food and emergency support in the communities where we operate. I'm exceptionally proud of how our employees have supported not only each other and our communities, but also our customers. We've been able to maintain continuous service for our clients and provide essential support for our customers, like ensuring that their homes remain protected and helping them stay connected through their mobile devices at a time when we are all socially distancing. I want to thank our more than 14,000 employees for supporting each other, our customers and our communities throughout this extraordinary time. You have truly made us, Assurant, proud. Now let's move to our first quarter results, which were strong and largely unaffected by COVID-19. We benefited from continued growth in Global Lifestyle as well as improved results in Global Housing. For Assurant overall, we reported net operating earnings per share, excluding catastrophes of $2.84, an increase of 22% from the same period last year. Net operating income, excluding catastrophes, was up 18% to $176 million. In the quarter, we incurred about $2 million of incremental expenses directly related to COVID-19, which were reflected in net income. These expenses include, among other things, cost for the standardization of our facilities and the purchase of personal protective equipment and technology to enable work-from-home. Throughout this period, our balance sheet remained strong. At the end of March, we had $433 million of holding company liquidity after returning $95 million to shareholders through dividends and buybacks during the quarter. Provide us with an additional buffer during this crisis, we drew down $200 million from our revolving credit facility in late March, solely as a precautionary measure. We do not expect to use these funds. We are pleased with our first quarter results, which reflect strong momentum across our business, pre-crisis. However, we recognize that they may not be indicative of our performance in the coming quarters as the world continues to grapple with the impact of COVID-19. We have run multiple scenarios looking at the potential duration and severity of this crisis to better understand how our business might perform and to ensure we have the agility to react appropriately. Although we believe the long-term fundamentals and resiliency of our business remains strong, we are suspending our 2020 financial outlook until we gain additional clarity on COVID-19's duration and its impact on the broader economy and our business. We believe this is a prudent and sensible action given the current uncertainty. Relative to capital deployment, we want to retain maximum flexibility. Over the next few months, we will exercise caution in light of market volatility and as we enter hurricane season. This will include an ongoing evaluation of share buybacks with an expectation that we will slow down or pause until we have greater visibility. This applies to new M&A evaluations as well. We plan to provide an update on our 2020 view and our long-term targets once we have more clarity of the economic landscape we're facing. Over the long term, however, we still believe that we can continue to deliver shareholder value through above-market growth and disciplined capital management. This confidence is grounded in the strength of our business portfolio. Our installed customer base across Connected Living, Global Automotive, multifamily housing and preneed and our countercyclical lender place business position us well to weather a prolonged crisis. Near term, however, we expect a greater impact to our business as a result of the ongoing market volatility and containment measures and how those could further impact consumer behavior. As an example, in late March and throughout April, we saw a reduction in new sales across multifamily housing, auto and preneed. Within mobile, we experienced lower trade-in activity and slower sales growth. We are taking actions to mitigate potential impacts. For instance, we've deferred some discretionary spending and delayed staffing of certain open roles in our support areas. While we are deferring some investments as a precautionary measure, we have continued to make progress against key strategic initiatives to support our clients and their customers during this crisis and beyond. These have included, among other things, continued enhancement of our self-service capabilities and our dynamic claims fulfillment to facilitate faster claims resolution as well as our ongoing IT transformation. Before turning to Richard, let me provide additional highlights from the quarter for each of our business segments. Within Global Lifestyle, we were pleased to see earnings increase by 20% year-over-year. Our growth has been driven by continued additions of new mobile subscribers, up 15% year-over-year. We believe that our ability to offer bundled value-added services to our installed base of more than 54 million subscribers provides a recurring revenue stream, even during an extended period of financial uncertainty. While we may add fewer new subscribers during this crisis, we still expect our count to grow. This should help mitigate impacts from expected lower trade-in volumes. Another driver of our success within Global Lifestyle has been our ability to expand partnerships with market leaders and new entrants. For example, this quarter, we enhanced our existing relationship with Rakuten Mobile by launching a new trade-in program in Japan. In addition to offering device protection for their mobile networks, the program provides a completely digital trade-in experience. Turning to Global Automotive. We believe the business is relatively well insulated from near-term economic shocks given its significant level of embedded earnings. At the end of the first quarter, we had approximately $8.2 billion of unearned premium related to this business, which will earn over the next three to seven years. Furthermore, approximately 50% of our business comes from service contracts on used car sales, which tend to be less impacted as a result of economic downturns as we saw during the last recession. As such, we remain positive on auto and have continued to look for select opportunities to further scale the business. Last week, we closed on the acquisition of our long time partner, American Financial & Automotive Services, or AFAS, for $158 million. This represents an attractive valuation relative to recent transactions in the space and complements our 2018 acquisition of the Warranty Group. AFAS is a provider of finance and insurance products and services, including vehicle service contracts and other ancillary offerings with nearly a 40-year history. AFAS products and services are sold directly through a network of nearly 600 franchise dealerships with a deep footprint in Texas and the Southwest. For 2020, we don't expect the acquisition to be a significant contributor to our results. However, in 2021 and beyond, we expect it to further enhance our market position and add scale with the expectation to deliver additional profitable growth over time. Moving to Global Housing. Our lender-placed franchise continues to be an integral part of our specialty risk offerings. During the quarter, we renewed another one of our largest lender-placed clients for an additional 4 years. Since the beginning of last year, we've now renewed 17 clients, representing more than 80% of our tracked loans. Our superior customer platform has been a differentiator and will serve us well through economic cycles to support our clients and policyholders. In multifamily housing, we now support almost 2.3 million renters across all 50 states. While the business tends to be more resilient during economic downturns as consumers prefer to rent versus buy, beginning in mid-March, we saw a decline in new policies as renters are delaying their moving plans due to the pandemic. During the last few weeks, we've seen some tentative signs of stabilization, especially in our affinity channel as tenants may be regaining comfort with moving. We remain cautious, however, as we enter the summer, when we typically see greater activity and sales growth. We will continue to monitor sales, persistency and claim trends while also doing what we can to support current policyholders who are experiencing financial hardship during this challenging time. This includes deferring premium where appropriate. Moving to Global Preneed, results in the first quarter were largely in line with our expectations. This business benefits from lower mortality risk than traditional life insurance products and act as more of a spread business. In light of the current low interest rate environment, we've worked with our partners to make changes to their product as well as help our clients complete the sales process virtually. We will continue to evaluate other actions as appropriate. With regards to mortality, experience has been largely consistent with our experience last year. We attribute this to our policy footprint, including the fact that we do not write in New York. In summary, despite this uncertainty, we believe our business is resilient and that Assurant will weather this period and emerge strong. I'll now turn the call over to Richard to review first quarter results and recent trends in detail. Richard?
Richard Dziadzio: Thank you, Alan, and good morning, everyone. Let's start with Global Lifestyle. The segment reported earnings of $121 million in the first quarter. Excluding a $6.7 million client recoverable in Connected Living, earnings grew 14%, primarily from continued mobile growth in both new and existing programs. Global Automotive was also a contributor, largely due to $5 million of onetime income related to client recontracting, along with modest growth from prior period sales. Global Lifestyle results were partially offset by lower margins for mobile trade-in activity, including some impacts related to COVID-19 from the shutdown of Asian markets earlier in the quarter. Unfavorable foreign exchange also impacted results. Looking at total revenue. Net earned premiums and fees were up $265 million or 16%. The increase was driven primarily by higher fee income for mobile trade-in volumes and subscriber growth across North America and Asia Pacific. Expansion within extended service contracts also contributed to growth in the quarter. Within Global Automotive, revenue grew 9%, primarily reflecting prior period sales of vehicle service contracts across all distribution channels. Looking ahead, as Alan mentioned, we are continuing to monitor trends and the impact of COVID-19 across the segment. While we believe mobile is well positioned given our large in-force subscriber base, trade-in volumes did decline significantly in the first few weeks of April, reflecting store closures and lower consumer demand for new devices. We expect volumes to rebound when stores reopen, and carriers are able to resume in-store promotional activity, although timing of such widespread recovery remains unclear. Looking at our underwriting experience, we have seen a decline in mobile claims as a result of customers staying indoors. In most cases, this favorable experience will not benefit our bottom line due to profit sharing or reinsurance agreements. In Global Automotive, near-term earnings should be relatively well protected from a slowdown due to how the business earns. However, we still have exposure related to reductions in vehicle service contract sales, which in April were down by roughly 40% year-over-year due to a decrease in vehicle sales. In general, new car sales typically earn a majority of income three to five years after being sold following the expiration of the manufacturers' warranties, thereby delaying the revenue impact. However, in the event of a prolonged downturn, we would expect to see an uptick in used car sales, which earn more quickly. The persistently low interest rate environment also creates some headwind. While Global Automotive does have a longer duration portfolio of 3 to 7 years, we do expect investment income to be pressured from lower investment yields coming from new business. Throughout Global Lifestyle, we also expect continued pressure from foreign exchange volatility, especially in Latin America, due to the economic environment. So, while we expect Global Lifestyle to be impacted in 2020, this segment should be more resilient during an economic downturn relative to other consumer-type businesses. Moving to Global Housing. Net operating income for the quarter totaled $74 million, up slightly year-over-year despite higher reportable catastrophes from the Puerto Rico earthquakes. Excluding catastrophe losses, earnings increased $6 million. This was driven by favorable non-catastrophe loss experience and improved results in property offerings, largely related to the absence of losses within small commercial as it continues to run off. Lender-placed income increased, reflecting higher premium rates, partially offset by a reduction of policies in force, including a loss of loans from the financially insolvent client we previously disclosed. And that portfolio has now completely de-boarded. Turning to revenue. Global Housing net earned premiums and fees were flat as growth in our special property and multifamily businesses was offset by the reduction in policies referenced earlier. The insolvent client portfolio also contributed to a 7 basis point year-over-year decline in the placement rate. As we continue to operate in this environment, we are tracking a few trends in Global Housing. In multifamily housing, we see a decline in new sales starting in mid-March. We continue to monitor sales, policy cancellations as well as the impact from premium deferrals, which today are primarily related to policyholders requesting premium leniency. While we initially saw a dip in claims, we are seeing activity normalize, reflecting the fact that policyholders are at home. Within lender-placed, we will continue to monitor the state of the overall housing market, including the potential impact of the current mortgage moratorium, which would delay placement of new policies, but at the same time, reduce lapsation. This business provides critical coverage to both homeowners and their lenders and provides downside protection, should the economy deteriorate significantly. However, we would not anticipate any benefit to our placement rate this year. Lastly, our small commercial business continues to run off as expected, with only 8% of the original block of policies remaining. With regard to potential exposure on business interruption coverage associated with this business, we currently believe our risk is low given virus exclusions included in our policies. We will continue to track state actions and their implications. In summary, while we remain cautious on multifamily housing, in light of the current uncertainty created by COVID-19, we continue to believe that Global Housing is well positioned to weather a prolonged economic downturn. Now let's move to Global Preneed. This segment reported $12 million of net operating income, up slightly year-over-year, driven by continued growth within the business. Revenue for preneed was up 9%, driven by U.S. growth, including final need sales. As we look ahead, we expect some pressure from lower yields on new sales through the current interest rate environment. However, given the 10-year average duration of our investment portfolio, our existing block of business should not be significantly impacted for some years to come. As Alan mentioned, so far, we haven't seen any significant spikes in mortality due to COVID-19. As a reminder, a large portion of our policies are concentrated in California, Texas, South Carolina and Tennessee. So far, these states have experienced lower mortality from COVID-19 compared to states in the Northeast. At Corporate, the net operating loss was $20 million versus $19 million in the prior year period. This was due to lower investment income in the Corporate segment, partially offset by lower employee-related expenses, including travel. We will continue to evaluate additional expense actions as necessary. In light of market volatility, I also wanted to provide an overview of our investment portfolio and strategy. In the first quarter, we recorded a $76 million mark-to-market loss in our investment portfolio. This reflects the decline in valuations of our equity securities and our CLOs, each contributing to about half of the total loss. Despite these losses, we believe that our $13.6 billion investment portfolio is well diversified and high quality. Approximately 86% of our investments are comprised of fixed maturities and 95% of these securities are investment-grade rated. While interest rates are expected to remain relatively low for the foreseeable future, we believe we are well positioned to navigate this environment given the duration of our existing investment portfolio, along with our conservative, low asset turnover approach. Our overall exposure to these sectors that have been hit the hardest by the current market turbulence is not significant. Investments in travel and leisure represent less than 0.5% of our investment portfolio. Energy makes up only 4% of our portfolio, and our investments tend to be in larger and more diversified energy companies. Retail represents 2% of our portfolio and is comprised of mostly large diversified household names. Our auto and airline exposures are each 1% or less of our portfolio. I would finish on the investment portfolio by saying we will continue to apply consistent investment approach. While we recognize every crisis is different, this is the same strategy that served us well during the financial crisis over a decade ago. Finally, I'd like to mention that in April, we completed the outsourcing of the management of our core investment portfolio to Goldman Sachs Asset Management and Voya Investment Management. We believe that their investment expertise and scaled platforms, coupled with ongoing oversight of our in-house team, should serve us well going forward. Turning to the holding company liquidity, we ended March with $433 million or $208 million above our current minimum target level. These figures do not include the $200 million draw from our $450 million revolving credit facility, the proceeds of which are also held at the holding company. In the first quarter, dividends from our operating segments totaled $127 million. In addition to our quarterly corporate and interest expenses, key outflows in the first quarter included $57 million in share repurchases and $43 million in common and preferred stock dividends. As Alan mentioned, relative to capital deployment, we will exercise even greater caution in light of market volatility and as we enter hurricane season. We have a robust risk management program, including stress testing our capital, cash flows and liquidity under a variety of scenarios, considering this uncertain environment. Before wrapping up, I wanted to address 2 additional points. First, as you saw in our release, we booked a onetime tax benefit to net income amounting to $79 million. This was related to the enactment of the Federal CARES Act in March. The benefit is associated with the carryback of losses in 2018 to 5 years prior. This allowed us to accelerate deferred tax assets, which would have been recognized over the next 3 years at a lower tax rate. Second, we still expect to close on the sale of EK in the second quarter as planned, which will result in an expected net cash outflow of approximately $54 million plus seller financing of up to $40 million. Both the EK and AFAS transactions will be reflected in second quarter holding company capital. In conclusion, I echo Alan's gratitude to our employees and how they have responded during this unprecedented crisis. We are confident that we will emerge in a position of strength from this period. In the months ahead, we will continue to closely monitor trends and take appropriate steps to sustain our financial strength for the long term. And with that, operator, please open the call for questions.
Operator: [Operator Instructions] Your first question is coming from Mark Hughes from SunTrust.
Mark Hughes: In thinking about some of the specific impacts, I note that your fee income growth was actually quite strong in the first quarter. If we think about, I think you talked about trade-in volume down significantly in April. I think you've seen some, maybe the anticipation is that it will stabilize as things start to open up. How should we think about that fee category in lifestyle in the second quarter? Just some rough parameters would be helpful.
Alan Colberg: Mark, let me start on that. And then Richard, as always, feel free to add on some comments. If you think about mobile, one of the things we've seen over the last few years is that Q1 tends to be a pretty active quarter. And we saw that again in Q1 prior to the slowdown began the second half of March. So normally, Q2 is a slower quarter anyway in terms of buyback and trade-in activity, and that often rolls into Q3 as a slower quarter, just as people are waiting to see what the new phones might be. So I think, certainly, in the second and third quarters, we'll have less activity anyway, even if we start to see a recovery. And while we're on mobile, maybe just a couple of other thoughts about what we're seeing in that important line of business. You heard us in the prepared remarks talk about we've seen new sales slow down as stores are closed, largely across the U.S. and in other markets around the world. Even with that, we do expect subscriber growth. As we've talked about previously, we have these programs that have been launched in the last year or two that are going to continue to ramp. So even in a slower sales environment, we expect some growth in new subscribers, that will help offset the slowdown that we see in buyback and trade-in. And then longer term, once we're through this crisis, it really -- whether we have a big bounce back in buyback trade-in or whether it's just a return to normal, it's going to depend a lot on what new phones come to market, what carriers elect to do. So again, we feel well positioned in mobile even as we go through this crisis. But Richard, what would you add?
Richard Dziadzio: I think you covered it well. I guess the only thing I would add that might be helpful, Mark, is when you look at the line, fees and other income, obviously, there's mix of business, various clients, et cetera. But I would say rule of thumb, probably about 40% to 60% of that fee income is made up of the trade-in upgrade volumes that we have. So maybe that helps a little bit.
Mark Hughes: Yes, the renters insurance, I think you saw some drop off, but then it's stabilized. How much is that influenced by new sales? You've been really growing in a pretty steady range in the mid-single digits, some parameters on Q2, Q3 would be helpful.
Alan Colberg: Yes, let me start again. Similar to mobile, if you look at multifamily, it's a business that is really driven by people doing something, right? So in the March time frame, second half and into early April, we didn't see people moving. And so we don't have an ability to make a new sale. Now again, those moves may just be delayed and it could return if we get through the crisis in a reasonable time period. The other thing that's unique on multifamily is we are seeing some requests for premium deferral. And that's either being driven, a few states have mandated that, others were voluntarily providing it. It's not significant so far to our overall block, but it is something we're watching, and we are putting up an appropriate reserve in the event of people not being able to pay for their insurance that we're providing. If we look longer term in multifamily, I think we're pretty optimistic about that business. If we get into any kind of downturn, people tend to rent more. We saw this in the last downturn, which has obviously been positive for that business. But more importantly, we're still early in rolling out our point of lease capability, which helps us provide a better experience and a greater attachment rate. We also see a major opportunity around the connected apartment as people, particularly look what's happened now, connectivity matters more than ever. So in both multifamily and in mobile, we're focused on ensuring we're there, we're delivering for our customers. We've been able to sustain our service levels. We're still repairing cellphones and getting them back in a timely basis. And we're doing all we can to help out our customers, both mobile and renters and, of course, across all of our businesses.
Mark Hughes: I think I might have asked this last quarter as well, but talk about the potential pressure on investment income from lower yields and how that influences the automotive business? Are you going through the process of adjusting your pricing to take into account the lower yield, so you generate adequate returns in that business?
Alan Colberg: Richard, why don't you take that one?
Richard Dziadzio: Well, I guess the first thing I would say is the business that's on the books today has a relatively long duration, I guess, let's call it, 3 to 5 years. So that business is fairly well matched in terms of asset liability matching. So really, what we're talking about is that income will roll through. And as we have new sales, those new sales will be put up at the new level of interest rates. Obviously, short-term interest rates are very low. Who knows where they'll go over time. But you're exactly right. We would have the opportunity to work with our clients and as there are new sales, to look at what the pricing on the various products would be. I guess the other thing I would add, Mark, is that a lot of the business that we do in the auto sector is reinsured to captive clients as well. So there is a straight, a strong alignment of interest for us to really provide the customer with the best product, competitive product at the right pricing.
Alan Colberg: And Mark, maybe the last thing I'd add in both Auto and in Preneed, these are our 2 businesses that have more exposure to investment income than our other businesses. We are hard at work on adding in other sources of revenue and fee income. So for example, on Auto, we started rolling out, pre-crisis, our pocket drive, kind of our onboard technology, and we're looking at other things like prepaid maintenance, which we're now driving into our programs. And in Preneed, we've been rolling out an executor assist product, which is another fee income generator that allows us to help people at time of need, really manage it. So we're working, just as we've done in mobile and elsewhere, to create some fee income streams in addition to the traditional product.
Operator: Our next question is coming from Brian Meredith from UBS.
Brian Meredith: A couple of questions for you all. First, on the global housing business, I'm just curious, number one, when could you potentially see an increase in placement rates? And number two, do you have any sensitivities that you've done around maybe macroeconomic statistics? And when or the magnitude of placement rates kind of increasing in a situation like this or something like mortgage delinquencies, unemployment, that kind of stuff, anything that you can kind of give us so we can figure out maybe some sensitivities here?
Alan Colberg: Let me maybe start with kind of the short term, and then I'll go to the long term. First of all, lender-placed, it's an important product for the mortgage industry. We're effectively there to support the functioning of the market, to protect policyholders and lenders. But in the short term, we don't really see a lot changing. If you look at the mortgage forbearance that's underway, it's not going to have a big impact on us one way or the other. And so really, if we do get into a downturn, our product tends to be placed later in that cycle. So someone needs to move into seriously delinquent and often into foreclosure. So if you look at the last downturn, which is really the data point we have, which was an extreme housing market downturn, today, we're at about 1.5%, 1.6% placement rate. In the last downturn, we peaked at about just under 3%. So that gives you some sense of at least what happened in the last downturn. Who knows if we'll have a downturn here, and I certainly hope we don't. But if we do, our business is strong. It's well positioned, and we've made significant advancements in the last five years on our compliance, our tracking infrastructure. And so we feel very well positioned if we do have a downturn, but I wouldn't expect to see anything that is material in 2020.
Brian Meredith: I guess, I'm more thinking about mortgage delinquencies. I mean, if you talk to some of the mortgage insurance companies, they are talking about mortgage delinquencies kind of picking up here, and I'm not sure if you've had any sensitivities around that?
Alan Colberg: I think it's really early days, and we'll have to see how it plays out. But even if we are starting to see what's going on with mortgage delinquencies ticking up, for us, it won't affect our placement for six to nine months. So it won't be a driver for 2020. But if we do have that downturn, it will be a significant roll for us in 2021 and beyond. And as I mentioned earlier, we feel very well positioned. Because of our kind of industry-leading capabilities and compliance, we've been able to renew and, in many cases, early renew the vast majority of our book of tracked loans. So we're well positioned if it does develop this way.
Brian Meredith: And then just, I'm just curious, I know there's a profit-sharing component to the Auto Warranty business. But is there any impact that we could potentially see from delayed warranty work?
Alan Colberg: For both of our lifestyle businesses, kind of auto and mobile, the majority of our risk is reinsured back to our clients. So we really, although they report as premium, we tend to really operate more as an administrator, and we receive fees for doing that effectively. So we're not seeing, though, for example, in Auto, service remains open across much of the U.S. Now what's been shutdown is sales, but service is viewed in most states as an essential service. So if you look at our activity levels in terms of servicing, we don't see a big dip. So it's not something that we're focused on as a risk.
Operator: Our next question comes from the line of Michael Phillips from Morgan Stanley.
Michael Phillips: I want to follow-up on an earlier question and your comments on continued growth in the covered devices. And I guess the mix between, you talked about may be able to add new subscribers versus the kind of a fall-off in trade-ins. Maybe first off, just a little more detail on those new subscribers, where that comes from? And then secondly, what's the typical mix, I guess, of your growth there between the new subscribers versus the trade-ins, with trade-ins falling off in the near term? So what's the typical mix there? And then just maybe more color on the new subscribers that you expect to get?
Alan Colberg: So the new subscribers are the biggest driver of that business over the last couple of years, and they're really coming from the new clients and programs that we've talked about that have been launched in the last couple of years. So for example, KDDI in Japan, Comcast and Charter in the U.S., et cetera. And those programs, once we launch them, it generally takes anywhere between three to four years. You need to go through a phone handset replacement cycle. So even if there are fewer sales now in the crisis, sales are still happening to a degree. So that's why they're going to grow. Buyback trade-in was a big driver of our business back in like '15 and '16 when we really ramped it up. Over the last few years, it's been more stable. We haven't, in key markets like the U.S. and Japan, you've seen the ownership of handsets lengthening. So people have gone to owning a handset for 3 years or in Japan 4 years. That's offset the growth we've had in subscribers. So that business has been more kind of flattish over the last couple of years. Now if we look forward, we see a significant wave of buyback trading coming. It may be delayed a little bit by the current crisis. But if you think about 5G, when that really starts to roll out, and it was going to start to roll out later this year in the U.S. We'll see how widely that really happens. That will create a wave of activity for the next year or 2 in buyback trade-in, and we're well positioned. The other important thing in mobile that's really driven our growth is we've been adding more services per subscriber. So if you recall, when in the early days, we have 1 service, now often, we have up to 6 different sources of value with every agreement where we're providing things like Premium Tech support, our onboard diagnostic technology, Pocket Geek, we're doing the buyback trade-in. And increasingly, we're doing an extended warranty for year three and year four of phone ownership. So overall, again, I think we're encouraged by our position. We expect to have continued growth that just may not be at the same level this year as we've seen in past years.
Michael Phillips: I guess have you seen any signs of, on the mobile piece of customers that are dropping their coverage more than usual? Is that happening at all?
Alan Colberg: No, we haven't seen that really at all. If you look at what's happened in prior downturns, our products because they protect really essential equipment for consumers, whether that's a car or a phone, they tend to be very sticky. And in downturns, the needs tend to be even higher. So we haven't really seen anything. It's certainly something we watch, but we're not seeing any trend there.
Michael Phillips: I guess last one, if I could. On the auto side, if customers become delinquent on their auto loans, what's the implication to you guys there for the Warranty business?
Alan Colberg: I think the short answer is none. It's a single premium product. So we're collecting our funds at the beginning of the sale. So I don't think it affects us at all.
Operator: Our next question is coming from Gary Ransom from Dowling and Partners.
Gary Ransom: So I wanted to ask about consumers' behavior. And I know we, you mentioned how you're sharing some of the benefits on the mobile side. But you've got the decline in revenues, but is there any places across your businesses where you're actually seeing some sort of benefit, maybe on the LPI side, there everyone is staying home. So you don't get as many losses there. Can you comment on that at all?
Alan Colberg: Well, the first thing I'd say is it's really early in this crisis. So consumers have been adapting and adjusting for 7 or 8 weeks now. So it's early to see what really might happen. So what we're really focused on is, first and foremost, being there to service customers. If you think about it, we have this installed base of 300 million or so customers, they still need our support, whether it's for their phone or their car or their renters insurance, and we've been able to quickly pivot to work-from-home for most of our operating roles, and we've been able to meet and maintain meeting all of our service levels, which is really impressive and a huge thank you to our employees across the globe who've done that. So that's important. Where might we see trends? I think it's too early to say. What we've seen is for most things consumers are just being cautious about going out and buying anything at the moment, either because the stores are closed or they don't feel safe going out. We saw the lows so far in this crisis, the first week or two of April, with activity levels dropping 40% or 50% across a lot of the channels we serve. We're starting to see a little bit of recovery in the second half of April, although still well below pre-crisis levels. So again, if you look at our businesses, I think we're well positioned to weather this crisis quite well. We've got that installed base. I mentioned we have the diversity of portfolio. As you mentioned, we have LPI, which will be a countercyclical hedge if we get into that kind of downturn. We've got the embedded earnings on the balance sheet in Auto and Preneed. We do have things like if we do end up with an economic downturn out of this crisis, Auto, for example, generally, you have more used car sales in that environment. And if we sell on a used car, we start to earn much sooner than we do on a new car. And we've got that strong balance sheet and conservative investment philosophy that Richard talked about. So at the end of the day, we're going to continue to monitor all these trends, but we feel well positioned to be there to support our customers and to weather this crises well.
Gary Ransom: I also wanted to go back to something you said in your prepared remarks about business interruption. Can you elaborate on where that exposure was arising from?
Alan Colberg: Richard, do you want to take that out?
Richard Dziadzio: Yes, if you remember last year, we had talked about the small commercial businesses that we were underwriting. So it really comes from there. On the other hand, what I would say is, as you heard in the prepared remarks, there's only about 8% of the portfolio remaining. It's been in wind down and run off for quite some time. So it's a small amount and also the products that we've sold have specific exclusions in them. So that's where that comes from, Gary.
Gary Ransom: And then I also wanted to ask about the caution on finances. On the one hand, you're cautious. On the other hand, you did buy back a little bit of stock. You made an acquisition. There's a lot of things that are still moving forward. Maybe this is a layup question. But can you comment on the things that haven't changed? I mean, what is, what continues to go forward despite the COVID-19?
Alan Colberg: The way we're approaching this, and we are, as we mentioned, fortunate to have an installed base and well positioned to manage through this crisis. So we're trying to strike an appropriate balance between the short-term and being cautious in the long-term where we, when we come through the other side of this, if you look at where we've been, we had above market profitable growth. We have a long history of very strong capital return and not, we don't see that changing. When we come out the other side of this, we're going to be as strong with the same kind of track record in front of us as we've had in the last few years as a company. So what we're trying to do is we're being prudent. So things like deferring expenses, holding off on some hiring, being cautious on preserving capital just because you never know. But we are making strategic investments. Now for example, the investment in AFAS, that is one of the industry-leading franchises in Auto. It really fills in for us the geography, particularly in Texas and the Southwest. It also brings capabilities that we can enroll across and it's a very low relative execution risk for an M&A deal because we know the company well, and we know the business well. So we went ahead and made the decision. And that dialogue has been ongoing with them for quite a while. So we felt it was appropriate. We're also investing, one of the interesting trends that was already happening, but will be accelerated by COVID-19 is the shift to digital, both on sales and service. And we've been investing against that for years. But in this crisis, the acceleration of that has moved forward dramatically. And we've been able to be there and support our clients with that. So we're fortunate we've made that investment, but we're going to continue to invest to move more things to digital. So we're making investments like that, that are against the long-term trends and our kind of strong market positions. And then we're just being cautious because what we don't know and nobody knows is the duration of how long this might go on and whether we'll have multiple ways of this going on. So we're trying to strike that balance. But we feel really good about where our company is going to be at the other side of this crisis.
Operator: [Operator Instructions] Our next question is coming from Mark Hughes from SunTrust.
Mark Hughes: You mentioned the cut down of the Asian markets is perhaps influencing your trade-in activity. Did you measure or any specific numbers you can share about how much of an impact that was?
Alan Colberg: So what you're referring to is, in the early days of the crisis, some of the phones that we end up repairing and not using back in insurance claims are sold around the world. The Asian markets are one of the big markets for that, and that was a really shut down kind of the February, March type time frame. We haven't sized it, but you can see some of the pressure in Q1 lifestyle margins. We're really on that. It was the fact we had to find alternative channels on short notice to be able to get rid of those phones. Now the positive is those markets are back open, we just don't have the same activity level that we would have had in a pre-crisis environment.
Mark Hughes: And then how does the lender-placed insurance work with the forbearance plans? People are under forbearance and it goes 3, 6 months. How does the lender-placed insurance interact with them?
Alan Colberg: Yes. I think the important thing to remember first is that the majority of mortgage loans aren't in forbearance. So I think, I haven't seen the statistics this week, but it's under 10% that are in forbearance. So for 90%-plus of our business, it's just as normal. If someone ends up being seriously delinquent or out of the home, it's the same process we've always had. For mortgage forbearance, obviously, nothing happens, right? So as long as there are mortgages in that stage, it's not going to move into serious delinquency. So for that small sliver of the market, we will still be tracking alone. We just won't be doing anything while the mortgages are in forbearance.
Mark Hughes: And then who is actually covering the, providing insurance on the property if it's in forbearance? If the homeowners insure is -- I'm not sure how long they're going to provide a grace period to the consumer or the borrower? But at some point, one would assume they're going to drop off. So does the bank assume the insurance coverage? How does that work?
Richard Dziadzio: No. I mean...
Alan Colberg: No, it's a good question, Mark. It's early days. For now, I think the majority of voluntary carriers are still providing that insurance. And there's not a rush by the voluntary players to cancel people's insurance at the moment. If they were canceled, we would then trigger a letter cycle likely our normal process. At the end of the day, that service we provide is critical for the mortgage industry and we would step in. But for now, we're not seeing anything really happening with the forbearance mortgages that are in the market.
Mark Hughes: But if they were in forbearance, but the underlying homeowners insurance had dropped off, then your letter cycle would kick in?
Alan Colberg: And our primary focus, though, across all these businesses is continuing to be there. And what I'm most proud of, many things I'm proud of how our employees who responded here is we really have been able to sustain so far all of our service levels and continue to be there. For example, in lender-place, we do a lot of the processing, what are called loss drafts and supporting consumers who are repairing their homes, we're functioning as normal, even in this environment there. So I'm very proud of that.
Alan Colberg: All right. I think that's the end of questions. I want to thank everyone for participating in today's call. We will update you on our progress on our second quarter earnings call in early August. In the meantime, please reach out to either Suzanne Shepherd or Sean Moshier with any follow-up questions you have. Thanks, everyone.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's First Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following management's prepared remarks [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations. You may be begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator and good morning, everyone. We look forward to discussing our first quarter 2020 results with you today. Joining me for Assurant's conference call are Alan Colberg, our President and Chief Executive Officer and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the first quarter 2020. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC report. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan."
},
{
"speaker": "Alan Colberg",
"text": "Thanks, Suzanne. Good morning, everyone. Before reviewing our results for the quarter, I wanted to share a few comments regarding the COVID-19 pandemic and our ongoing response. From the beginning, Assurant's leadership team acted swiftly and deliberately led by our guiding principles, to safeguard our employees and their families, to maintain operations and service level for our customers and to support our local communities. Early in this crisis, we implemented a global ban on business travel and transitioned the vast majority of our workforce to work-from-home to help stem the spread of the virus in our communities and to protect our employees. For those employees who need to work from our offices or repair sites due to the essential nature of their roles, we've implemented strong safety and hygiene protocols. These measures include social distancing and the use of personal protective equipment, along with regular cleaning and disinfection of our locations based on the guidelines from The Centers for Disease Control. We are committed to doing what we can to protect our employees through this period of uncertainty, always treating them with respect and providing appropriate support given the challenges we are all dealing with at this time. To allay job security concerns as well as to continue to deliver for our customers, we've made commitments to our employees to not eliminate any roles due to COVID-19 in the short term. We've also offered financial support where it's most needed. As part of our Assurant Cares Employee Support or ACES Fund, we've launched a special COVID-19 Emergency Relief program to support eligible employees who are experiencing severe financial hardship caused by the pandemic. We've already raised more than $1 million through the support of our foundation and personal donations from our management committee, the Assurant Board of Directors and the generosity of hundreds of employees. Since its inception in late March, the special ACES Fund has helped more than 800 families manage through these turbulent times. Furthermore, our Assurant Foundation is honoring all of its 2020 charitable commitments and has pledged some additional $250,000 to aid core charitable partners that are providing food and emergency support in the communities where we operate. I'm exceptionally proud of how our employees have supported not only each other and our communities, but also our customers. We've been able to maintain continuous service for our clients and provide essential support for our customers, like ensuring that their homes remain protected and helping them stay connected through their mobile devices at a time when we are all socially distancing. I want to thank our more than 14,000 employees for supporting each other, our customers and our communities throughout this extraordinary time. You have truly made us, Assurant, proud. Now let's move to our first quarter results, which were strong and largely unaffected by COVID-19. We benefited from continued growth in Global Lifestyle as well as improved results in Global Housing. For Assurant overall, we reported net operating earnings per share, excluding catastrophes of $2.84, an increase of 22% from the same period last year. Net operating income, excluding catastrophes, was up 18% to $176 million. In the quarter, we incurred about $2 million of incremental expenses directly related to COVID-19, which were reflected in net income. These expenses include, among other things, cost for the standardization of our facilities and the purchase of personal protective equipment and technology to enable work-from-home. Throughout this period, our balance sheet remained strong. At the end of March, we had $433 million of holding company liquidity after returning $95 million to shareholders through dividends and buybacks during the quarter. Provide us with an additional buffer during this crisis, we drew down $200 million from our revolving credit facility in late March, solely as a precautionary measure. We do not expect to use these funds. We are pleased with our first quarter results, which reflect strong momentum across our business, pre-crisis. However, we recognize that they may not be indicative of our performance in the coming quarters as the world continues to grapple with the impact of COVID-19. We have run multiple scenarios looking at the potential duration and severity of this crisis to better understand how our business might perform and to ensure we have the agility to react appropriately. Although we believe the long-term fundamentals and resiliency of our business remains strong, we are suspending our 2020 financial outlook until we gain additional clarity on COVID-19's duration and its impact on the broader economy and our business. We believe this is a prudent and sensible action given the current uncertainty. Relative to capital deployment, we want to retain maximum flexibility. Over the next few months, we will exercise caution in light of market volatility and as we enter hurricane season. This will include an ongoing evaluation of share buybacks with an expectation that we will slow down or pause until we have greater visibility. This applies to new M&A evaluations as well. We plan to provide an update on our 2020 view and our long-term targets once we have more clarity of the economic landscape we're facing. Over the long term, however, we still believe that we can continue to deliver shareholder value through above-market growth and disciplined capital management. This confidence is grounded in the strength of our business portfolio. Our installed customer base across Connected Living, Global Automotive, multifamily housing and preneed and our countercyclical lender place business position us well to weather a prolonged crisis. Near term, however, we expect a greater impact to our business as a result of the ongoing market volatility and containment measures and how those could further impact consumer behavior. As an example, in late March and throughout April, we saw a reduction in new sales across multifamily housing, auto and preneed. Within mobile, we experienced lower trade-in activity and slower sales growth. We are taking actions to mitigate potential impacts. For instance, we've deferred some discretionary spending and delayed staffing of certain open roles in our support areas. While we are deferring some investments as a precautionary measure, we have continued to make progress against key strategic initiatives to support our clients and their customers during this crisis and beyond. These have included, among other things, continued enhancement of our self-service capabilities and our dynamic claims fulfillment to facilitate faster claims resolution as well as our ongoing IT transformation. Before turning to Richard, let me provide additional highlights from the quarter for each of our business segments. Within Global Lifestyle, we were pleased to see earnings increase by 20% year-over-year. Our growth has been driven by continued additions of new mobile subscribers, up 15% year-over-year. We believe that our ability to offer bundled value-added services to our installed base of more than 54 million subscribers provides a recurring revenue stream, even during an extended period of financial uncertainty. While we may add fewer new subscribers during this crisis, we still expect our count to grow. This should help mitigate impacts from expected lower trade-in volumes. Another driver of our success within Global Lifestyle has been our ability to expand partnerships with market leaders and new entrants. For example, this quarter, we enhanced our existing relationship with Rakuten Mobile by launching a new trade-in program in Japan. In addition to offering device protection for their mobile networks, the program provides a completely digital trade-in experience. Turning to Global Automotive. We believe the business is relatively well insulated from near-term economic shocks given its significant level of embedded earnings. At the end of the first quarter, we had approximately $8.2 billion of unearned premium related to this business, which will earn over the next three to seven years. Furthermore, approximately 50% of our business comes from service contracts on used car sales, which tend to be less impacted as a result of economic downturns as we saw during the last recession. As such, we remain positive on auto and have continued to look for select opportunities to further scale the business. Last week, we closed on the acquisition of our long time partner, American Financial & Automotive Services, or AFAS, for $158 million. This represents an attractive valuation relative to recent transactions in the space and complements our 2018 acquisition of the Warranty Group. AFAS is a provider of finance and insurance products and services, including vehicle service contracts and other ancillary offerings with nearly a 40-year history. AFAS products and services are sold directly through a network of nearly 600 franchise dealerships with a deep footprint in Texas and the Southwest. For 2020, we don't expect the acquisition to be a significant contributor to our results. However, in 2021 and beyond, we expect it to further enhance our market position and add scale with the expectation to deliver additional profitable growth over time. Moving to Global Housing. Our lender-placed franchise continues to be an integral part of our specialty risk offerings. During the quarter, we renewed another one of our largest lender-placed clients for an additional 4 years. Since the beginning of last year, we've now renewed 17 clients, representing more than 80% of our tracked loans. Our superior customer platform has been a differentiator and will serve us well through economic cycles to support our clients and policyholders. In multifamily housing, we now support almost 2.3 million renters across all 50 states. While the business tends to be more resilient during economic downturns as consumers prefer to rent versus buy, beginning in mid-March, we saw a decline in new policies as renters are delaying their moving plans due to the pandemic. During the last few weeks, we've seen some tentative signs of stabilization, especially in our affinity channel as tenants may be regaining comfort with moving. We remain cautious, however, as we enter the summer, when we typically see greater activity and sales growth. We will continue to monitor sales, persistency and claim trends while also doing what we can to support current policyholders who are experiencing financial hardship during this challenging time. This includes deferring premium where appropriate. Moving to Global Preneed, results in the first quarter were largely in line with our expectations. This business benefits from lower mortality risk than traditional life insurance products and act as more of a spread business. In light of the current low interest rate environment, we've worked with our partners to make changes to their product as well as help our clients complete the sales process virtually. We will continue to evaluate other actions as appropriate. With regards to mortality, experience has been largely consistent with our experience last year. We attribute this to our policy footprint, including the fact that we do not write in New York. In summary, despite this uncertainty, we believe our business is resilient and that Assurant will weather this period and emerge strong. I'll now turn the call over to Richard to review first quarter results and recent trends in detail. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Alan, and good morning, everyone. Let's start with Global Lifestyle. The segment reported earnings of $121 million in the first quarter. Excluding a $6.7 million client recoverable in Connected Living, earnings grew 14%, primarily from continued mobile growth in both new and existing programs. Global Automotive was also a contributor, largely due to $5 million of onetime income related to client recontracting, along with modest growth from prior period sales. Global Lifestyle results were partially offset by lower margins for mobile trade-in activity, including some impacts related to COVID-19 from the shutdown of Asian markets earlier in the quarter. Unfavorable foreign exchange also impacted results. Looking at total revenue. Net earned premiums and fees were up $265 million or 16%. The increase was driven primarily by higher fee income for mobile trade-in volumes and subscriber growth across North America and Asia Pacific. Expansion within extended service contracts also contributed to growth in the quarter. Within Global Automotive, revenue grew 9%, primarily reflecting prior period sales of vehicle service contracts across all distribution channels. Looking ahead, as Alan mentioned, we are continuing to monitor trends and the impact of COVID-19 across the segment. While we believe mobile is well positioned given our large in-force subscriber base, trade-in volumes did decline significantly in the first few weeks of April, reflecting store closures and lower consumer demand for new devices. We expect volumes to rebound when stores reopen, and carriers are able to resume in-store promotional activity, although timing of such widespread recovery remains unclear. Looking at our underwriting experience, we have seen a decline in mobile claims as a result of customers staying indoors. In most cases, this favorable experience will not benefit our bottom line due to profit sharing or reinsurance agreements. In Global Automotive, near-term earnings should be relatively well protected from a slowdown due to how the business earns. However, we still have exposure related to reductions in vehicle service contract sales, which in April were down by roughly 40% year-over-year due to a decrease in vehicle sales. In general, new car sales typically earn a majority of income three to five years after being sold following the expiration of the manufacturers' warranties, thereby delaying the revenue impact. However, in the event of a prolonged downturn, we would expect to see an uptick in used car sales, which earn more quickly. The persistently low interest rate environment also creates some headwind. While Global Automotive does have a longer duration portfolio of 3 to 7 years, we do expect investment income to be pressured from lower investment yields coming from new business. Throughout Global Lifestyle, we also expect continued pressure from foreign exchange volatility, especially in Latin America, due to the economic environment. So, while we expect Global Lifestyle to be impacted in 2020, this segment should be more resilient during an economic downturn relative to other consumer-type businesses. Moving to Global Housing. Net operating income for the quarter totaled $74 million, up slightly year-over-year despite higher reportable catastrophes from the Puerto Rico earthquakes. Excluding catastrophe losses, earnings increased $6 million. This was driven by favorable non-catastrophe loss experience and improved results in property offerings, largely related to the absence of losses within small commercial as it continues to run off. Lender-placed income increased, reflecting higher premium rates, partially offset by a reduction of policies in force, including a loss of loans from the financially insolvent client we previously disclosed. And that portfolio has now completely de-boarded. Turning to revenue. Global Housing net earned premiums and fees were flat as growth in our special property and multifamily businesses was offset by the reduction in policies referenced earlier. The insolvent client portfolio also contributed to a 7 basis point year-over-year decline in the placement rate. As we continue to operate in this environment, we are tracking a few trends in Global Housing. In multifamily housing, we see a decline in new sales starting in mid-March. We continue to monitor sales, policy cancellations as well as the impact from premium deferrals, which today are primarily related to policyholders requesting premium leniency. While we initially saw a dip in claims, we are seeing activity normalize, reflecting the fact that policyholders are at home. Within lender-placed, we will continue to monitor the state of the overall housing market, including the potential impact of the current mortgage moratorium, which would delay placement of new policies, but at the same time, reduce lapsation. This business provides critical coverage to both homeowners and their lenders and provides downside protection, should the economy deteriorate significantly. However, we would not anticipate any benefit to our placement rate this year. Lastly, our small commercial business continues to run off as expected, with only 8% of the original block of policies remaining. With regard to potential exposure on business interruption coverage associated with this business, we currently believe our risk is low given virus exclusions included in our policies. We will continue to track state actions and their implications. In summary, while we remain cautious on multifamily housing, in light of the current uncertainty created by COVID-19, we continue to believe that Global Housing is well positioned to weather a prolonged economic downturn. Now let's move to Global Preneed. This segment reported $12 million of net operating income, up slightly year-over-year, driven by continued growth within the business. Revenue for preneed was up 9%, driven by U.S. growth, including final need sales. As we look ahead, we expect some pressure from lower yields on new sales through the current interest rate environment. However, given the 10-year average duration of our investment portfolio, our existing block of business should not be significantly impacted for some years to come. As Alan mentioned, so far, we haven't seen any significant spikes in mortality due to COVID-19. As a reminder, a large portion of our policies are concentrated in California, Texas, South Carolina and Tennessee. So far, these states have experienced lower mortality from COVID-19 compared to states in the Northeast. At Corporate, the net operating loss was $20 million versus $19 million in the prior year period. This was due to lower investment income in the Corporate segment, partially offset by lower employee-related expenses, including travel. We will continue to evaluate additional expense actions as necessary. In light of market volatility, I also wanted to provide an overview of our investment portfolio and strategy. In the first quarter, we recorded a $76 million mark-to-market loss in our investment portfolio. This reflects the decline in valuations of our equity securities and our CLOs, each contributing to about half of the total loss. Despite these losses, we believe that our $13.6 billion investment portfolio is well diversified and high quality. Approximately 86% of our investments are comprised of fixed maturities and 95% of these securities are investment-grade rated. While interest rates are expected to remain relatively low for the foreseeable future, we believe we are well positioned to navigate this environment given the duration of our existing investment portfolio, along with our conservative, low asset turnover approach. Our overall exposure to these sectors that have been hit the hardest by the current market turbulence is not significant. Investments in travel and leisure represent less than 0.5% of our investment portfolio. Energy makes up only 4% of our portfolio, and our investments tend to be in larger and more diversified energy companies. Retail represents 2% of our portfolio and is comprised of mostly large diversified household names. Our auto and airline exposures are each 1% or less of our portfolio. I would finish on the investment portfolio by saying we will continue to apply consistent investment approach. While we recognize every crisis is different, this is the same strategy that served us well during the financial crisis over a decade ago. Finally, I'd like to mention that in April, we completed the outsourcing of the management of our core investment portfolio to Goldman Sachs Asset Management and Voya Investment Management. We believe that their investment expertise and scaled platforms, coupled with ongoing oversight of our in-house team, should serve us well going forward. Turning to the holding company liquidity, we ended March with $433 million or $208 million above our current minimum target level. These figures do not include the $200 million draw from our $450 million revolving credit facility, the proceeds of which are also held at the holding company. In the first quarter, dividends from our operating segments totaled $127 million. In addition to our quarterly corporate and interest expenses, key outflows in the first quarter included $57 million in share repurchases and $43 million in common and preferred stock dividends. As Alan mentioned, relative to capital deployment, we will exercise even greater caution in light of market volatility and as we enter hurricane season. We have a robust risk management program, including stress testing our capital, cash flows and liquidity under a variety of scenarios, considering this uncertain environment. Before wrapping up, I wanted to address 2 additional points. First, as you saw in our release, we booked a onetime tax benefit to net income amounting to $79 million. This was related to the enactment of the Federal CARES Act in March. The benefit is associated with the carryback of losses in 2018 to 5 years prior. This allowed us to accelerate deferred tax assets, which would have been recognized over the next 3 years at a lower tax rate. Second, we still expect to close on the sale of EK in the second quarter as planned, which will result in an expected net cash outflow of approximately $54 million plus seller financing of up to $40 million. Both the EK and AFAS transactions will be reflected in second quarter holding company capital. In conclusion, I echo Alan's gratitude to our employees and how they have responded during this unprecedented crisis. We are confident that we will emerge in a position of strength from this period. In the months ahead, we will continue to closely monitor trends and take appropriate steps to sustain our financial strength for the long term. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Your first question is coming from Mark Hughes from SunTrust."
},
{
"speaker": "Mark Hughes",
"text": "In thinking about some of the specific impacts, I note that your fee income growth was actually quite strong in the first quarter. If we think about, I think you talked about trade-in volume down significantly in April. I think you've seen some, maybe the anticipation is that it will stabilize as things start to open up. How should we think about that fee category in lifestyle in the second quarter? Just some rough parameters would be helpful."
},
{
"speaker": "Alan Colberg",
"text": "Mark, let me start on that. And then Richard, as always, feel free to add on some comments. If you think about mobile, one of the things we've seen over the last few years is that Q1 tends to be a pretty active quarter. And we saw that again in Q1 prior to the slowdown began the second half of March. So normally, Q2 is a slower quarter anyway in terms of buyback and trade-in activity, and that often rolls into Q3 as a slower quarter, just as people are waiting to see what the new phones might be. So I think, certainly, in the second and third quarters, we'll have less activity anyway, even if we start to see a recovery. And while we're on mobile, maybe just a couple of other thoughts about what we're seeing in that important line of business. You heard us in the prepared remarks talk about we've seen new sales slow down as stores are closed, largely across the U.S. and in other markets around the world. Even with that, we do expect subscriber growth. As we've talked about previously, we have these programs that have been launched in the last year or two that are going to continue to ramp. So even in a slower sales environment, we expect some growth in new subscribers, that will help offset the slowdown that we see in buyback and trade-in. And then longer term, once we're through this crisis, it really -- whether we have a big bounce back in buyback trade-in or whether it's just a return to normal, it's going to depend a lot on what new phones come to market, what carriers elect to do. So again, we feel well positioned in mobile even as we go through this crisis. But Richard, what would you add?"
},
{
"speaker": "Richard Dziadzio",
"text": "I think you covered it well. I guess the only thing I would add that might be helpful, Mark, is when you look at the line, fees and other income, obviously, there's mix of business, various clients, et cetera. But I would say rule of thumb, probably about 40% to 60% of that fee income is made up of the trade-in upgrade volumes that we have. So maybe that helps a little bit."
},
{
"speaker": "Mark Hughes",
"text": "Yes, the renters insurance, I think you saw some drop off, but then it's stabilized. How much is that influenced by new sales? You've been really growing in a pretty steady range in the mid-single digits, some parameters on Q2, Q3 would be helpful."
},
{
"speaker": "Alan Colberg",
"text": "Yes, let me start again. Similar to mobile, if you look at multifamily, it's a business that is really driven by people doing something, right? So in the March time frame, second half and into early April, we didn't see people moving. And so we don't have an ability to make a new sale. Now again, those moves may just be delayed and it could return if we get through the crisis in a reasonable time period. The other thing that's unique on multifamily is we are seeing some requests for premium deferral. And that's either being driven, a few states have mandated that, others were voluntarily providing it. It's not significant so far to our overall block, but it is something we're watching, and we are putting up an appropriate reserve in the event of people not being able to pay for their insurance that we're providing. If we look longer term in multifamily, I think we're pretty optimistic about that business. If we get into any kind of downturn, people tend to rent more. We saw this in the last downturn, which has obviously been positive for that business. But more importantly, we're still early in rolling out our point of lease capability, which helps us provide a better experience and a greater attachment rate. We also see a major opportunity around the connected apartment as people, particularly look what's happened now, connectivity matters more than ever. So in both multifamily and in mobile, we're focused on ensuring we're there, we're delivering for our customers. We've been able to sustain our service levels. We're still repairing cellphones and getting them back in a timely basis. And we're doing all we can to help out our customers, both mobile and renters and, of course, across all of our businesses."
},
{
"speaker": "Mark Hughes",
"text": "I think I might have asked this last quarter as well, but talk about the potential pressure on investment income from lower yields and how that influences the automotive business? Are you going through the process of adjusting your pricing to take into account the lower yield, so you generate adequate returns in that business?"
},
{
"speaker": "Alan Colberg",
"text": "Richard, why don't you take that one?"
},
{
"speaker": "Richard Dziadzio",
"text": "Well, I guess the first thing I would say is the business that's on the books today has a relatively long duration, I guess, let's call it, 3 to 5 years. So that business is fairly well matched in terms of asset liability matching. So really, what we're talking about is that income will roll through. And as we have new sales, those new sales will be put up at the new level of interest rates. Obviously, short-term interest rates are very low. Who knows where they'll go over time. But you're exactly right. We would have the opportunity to work with our clients and as there are new sales, to look at what the pricing on the various products would be. I guess the other thing I would add, Mark, is that a lot of the business that we do in the auto sector is reinsured to captive clients as well. So there is a straight, a strong alignment of interest for us to really provide the customer with the best product, competitive product at the right pricing."
},
{
"speaker": "Alan Colberg",
"text": "And Mark, maybe the last thing I'd add in both Auto and in Preneed, these are our 2 businesses that have more exposure to investment income than our other businesses. We are hard at work on adding in other sources of revenue and fee income. So for example, on Auto, we started rolling out, pre-crisis, our pocket drive, kind of our onboard technology, and we're looking at other things like prepaid maintenance, which we're now driving into our programs. And in Preneed, we've been rolling out an executor assist product, which is another fee income generator that allows us to help people at time of need, really manage it. So we're working, just as we've done in mobile and elsewhere, to create some fee income streams in addition to the traditional product."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Brian Meredith from UBS."
},
{
"speaker": "Brian Meredith",
"text": "A couple of questions for you all. First, on the global housing business, I'm just curious, number one, when could you potentially see an increase in placement rates? And number two, do you have any sensitivities that you've done around maybe macroeconomic statistics? And when or the magnitude of placement rates kind of increasing in a situation like this or something like mortgage delinquencies, unemployment, that kind of stuff, anything that you can kind of give us so we can figure out maybe some sensitivities here?"
},
{
"speaker": "Alan Colberg",
"text": "Let me maybe start with kind of the short term, and then I'll go to the long term. First of all, lender-placed, it's an important product for the mortgage industry. We're effectively there to support the functioning of the market, to protect policyholders and lenders. But in the short term, we don't really see a lot changing. If you look at the mortgage forbearance that's underway, it's not going to have a big impact on us one way or the other. And so really, if we do get into a downturn, our product tends to be placed later in that cycle. So someone needs to move into seriously delinquent and often into foreclosure. So if you look at the last downturn, which is really the data point we have, which was an extreme housing market downturn, today, we're at about 1.5%, 1.6% placement rate. In the last downturn, we peaked at about just under 3%. So that gives you some sense of at least what happened in the last downturn. Who knows if we'll have a downturn here, and I certainly hope we don't. But if we do, our business is strong. It's well positioned, and we've made significant advancements in the last five years on our compliance, our tracking infrastructure. And so we feel very well positioned if we do have a downturn, but I wouldn't expect to see anything that is material in 2020."
},
{
"speaker": "Brian Meredith",
"text": "I guess, I'm more thinking about mortgage delinquencies. I mean, if you talk to some of the mortgage insurance companies, they are talking about mortgage delinquencies kind of picking up here, and I'm not sure if you've had any sensitivities around that?"
},
{
"speaker": "Alan Colberg",
"text": "I think it's really early days, and we'll have to see how it plays out. But even if we are starting to see what's going on with mortgage delinquencies ticking up, for us, it won't affect our placement for six to nine months. So it won't be a driver for 2020. But if we do have that downturn, it will be a significant roll for us in 2021 and beyond. And as I mentioned earlier, we feel very well positioned. Because of our kind of industry-leading capabilities and compliance, we've been able to renew and, in many cases, early renew the vast majority of our book of tracked loans. So we're well positioned if it does develop this way."
},
{
"speaker": "Brian Meredith",
"text": "And then just, I'm just curious, I know there's a profit-sharing component to the Auto Warranty business. But is there any impact that we could potentially see from delayed warranty work?"
},
{
"speaker": "Alan Colberg",
"text": "For both of our lifestyle businesses, kind of auto and mobile, the majority of our risk is reinsured back to our clients. So we really, although they report as premium, we tend to really operate more as an administrator, and we receive fees for doing that effectively. So we're not seeing, though, for example, in Auto, service remains open across much of the U.S. Now what's been shutdown is sales, but service is viewed in most states as an essential service. So if you look at our activity levels in terms of servicing, we don't see a big dip. So it's not something that we're focused on as a risk."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Michael Phillips from Morgan Stanley."
},
{
"speaker": "Michael Phillips",
"text": "I want to follow-up on an earlier question and your comments on continued growth in the covered devices. And I guess the mix between, you talked about may be able to add new subscribers versus the kind of a fall-off in trade-ins. Maybe first off, just a little more detail on those new subscribers, where that comes from? And then secondly, what's the typical mix, I guess, of your growth there between the new subscribers versus the trade-ins, with trade-ins falling off in the near term? So what's the typical mix there? And then just maybe more color on the new subscribers that you expect to get?"
},
{
"speaker": "Alan Colberg",
"text": "So the new subscribers are the biggest driver of that business over the last couple of years, and they're really coming from the new clients and programs that we've talked about that have been launched in the last couple of years. So for example, KDDI in Japan, Comcast and Charter in the U.S., et cetera. And those programs, once we launch them, it generally takes anywhere between three to four years. You need to go through a phone handset replacement cycle. So even if there are fewer sales now in the crisis, sales are still happening to a degree. So that's why they're going to grow. Buyback trade-in was a big driver of our business back in like '15 and '16 when we really ramped it up. Over the last few years, it's been more stable. We haven't, in key markets like the U.S. and Japan, you've seen the ownership of handsets lengthening. So people have gone to owning a handset for 3 years or in Japan 4 years. That's offset the growth we've had in subscribers. So that business has been more kind of flattish over the last couple of years. Now if we look forward, we see a significant wave of buyback trading coming. It may be delayed a little bit by the current crisis. But if you think about 5G, when that really starts to roll out, and it was going to start to roll out later this year in the U.S. We'll see how widely that really happens. That will create a wave of activity for the next year or 2 in buyback trade-in, and we're well positioned. The other important thing in mobile that's really driven our growth is we've been adding more services per subscriber. So if you recall, when in the early days, we have 1 service, now often, we have up to 6 different sources of value with every agreement where we're providing things like Premium Tech support, our onboard diagnostic technology, Pocket Geek, we're doing the buyback trade-in. And increasingly, we're doing an extended warranty for year three and year four of phone ownership. So overall, again, I think we're encouraged by our position. We expect to have continued growth that just may not be at the same level this year as we've seen in past years."
},
{
"speaker": "Michael Phillips",
"text": "I guess have you seen any signs of, on the mobile piece of customers that are dropping their coverage more than usual? Is that happening at all?"
},
{
"speaker": "Alan Colberg",
"text": "No, we haven't seen that really at all. If you look at what's happened in prior downturns, our products because they protect really essential equipment for consumers, whether that's a car or a phone, they tend to be very sticky. And in downturns, the needs tend to be even higher. So we haven't really seen anything. It's certainly something we watch, but we're not seeing any trend there."
},
{
"speaker": "Michael Phillips",
"text": "I guess last one, if I could. On the auto side, if customers become delinquent on their auto loans, what's the implication to you guys there for the Warranty business?"
},
{
"speaker": "Alan Colberg",
"text": "I think the short answer is none. It's a single premium product. So we're collecting our funds at the beginning of the sale. So I don't think it affects us at all."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Gary Ransom from Dowling and Partners."
},
{
"speaker": "Gary Ransom",
"text": "So I wanted to ask about consumers' behavior. And I know we, you mentioned how you're sharing some of the benefits on the mobile side. But you've got the decline in revenues, but is there any places across your businesses where you're actually seeing some sort of benefit, maybe on the LPI side, there everyone is staying home. So you don't get as many losses there. Can you comment on that at all?"
},
{
"speaker": "Alan Colberg",
"text": "Well, the first thing I'd say is it's really early in this crisis. So consumers have been adapting and adjusting for 7 or 8 weeks now. So it's early to see what really might happen. So what we're really focused on is, first and foremost, being there to service customers. If you think about it, we have this installed base of 300 million or so customers, they still need our support, whether it's for their phone or their car or their renters insurance, and we've been able to quickly pivot to work-from-home for most of our operating roles, and we've been able to meet and maintain meeting all of our service levels, which is really impressive and a huge thank you to our employees across the globe who've done that. So that's important. Where might we see trends? I think it's too early to say. What we've seen is for most things consumers are just being cautious about going out and buying anything at the moment, either because the stores are closed or they don't feel safe going out. We saw the lows so far in this crisis, the first week or two of April, with activity levels dropping 40% or 50% across a lot of the channels we serve. We're starting to see a little bit of recovery in the second half of April, although still well below pre-crisis levels. So again, if you look at our businesses, I think we're well positioned to weather this crisis quite well. We've got that installed base. I mentioned we have the diversity of portfolio. As you mentioned, we have LPI, which will be a countercyclical hedge if we get into that kind of downturn. We've got the embedded earnings on the balance sheet in Auto and Preneed. We do have things like if we do end up with an economic downturn out of this crisis, Auto, for example, generally, you have more used car sales in that environment. And if we sell on a used car, we start to earn much sooner than we do on a new car. And we've got that strong balance sheet and conservative investment philosophy that Richard talked about. So at the end of the day, we're going to continue to monitor all these trends, but we feel well positioned to be there to support our customers and to weather this crises well."
},
{
"speaker": "Gary Ransom",
"text": "I also wanted to go back to something you said in your prepared remarks about business interruption. Can you elaborate on where that exposure was arising from?"
},
{
"speaker": "Alan Colberg",
"text": "Richard, do you want to take that out?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, if you remember last year, we had talked about the small commercial businesses that we were underwriting. So it really comes from there. On the other hand, what I would say is, as you heard in the prepared remarks, there's only about 8% of the portfolio remaining. It's been in wind down and run off for quite some time. So it's a small amount and also the products that we've sold have specific exclusions in them. So that's where that comes from, Gary."
},
{
"speaker": "Gary Ransom",
"text": "And then I also wanted to ask about the caution on finances. On the one hand, you're cautious. On the other hand, you did buy back a little bit of stock. You made an acquisition. There's a lot of things that are still moving forward. Maybe this is a layup question. But can you comment on the things that haven't changed? I mean, what is, what continues to go forward despite the COVID-19?"
},
{
"speaker": "Alan Colberg",
"text": "The way we're approaching this, and we are, as we mentioned, fortunate to have an installed base and well positioned to manage through this crisis. So we're trying to strike an appropriate balance between the short-term and being cautious in the long-term where we, when we come through the other side of this, if you look at where we've been, we had above market profitable growth. We have a long history of very strong capital return and not, we don't see that changing. When we come out the other side of this, we're going to be as strong with the same kind of track record in front of us as we've had in the last few years as a company. So what we're trying to do is we're being prudent. So things like deferring expenses, holding off on some hiring, being cautious on preserving capital just because you never know. But we are making strategic investments. Now for example, the investment in AFAS, that is one of the industry-leading franchises in Auto. It really fills in for us the geography, particularly in Texas and the Southwest. It also brings capabilities that we can enroll across and it's a very low relative execution risk for an M&A deal because we know the company well, and we know the business well. So we went ahead and made the decision. And that dialogue has been ongoing with them for quite a while. So we felt it was appropriate. We're also investing, one of the interesting trends that was already happening, but will be accelerated by COVID-19 is the shift to digital, both on sales and service. And we've been investing against that for years. But in this crisis, the acceleration of that has moved forward dramatically. And we've been able to be there and support our clients with that. So we're fortunate we've made that investment, but we're going to continue to invest to move more things to digital. So we're making investments like that, that are against the long-term trends and our kind of strong market positions. And then we're just being cautious because what we don't know and nobody knows is the duration of how long this might go on and whether we'll have multiple ways of this going on. So we're trying to strike that balance. But we feel really good about where our company is going to be at the other side of this crisis."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question is coming from Mark Hughes from SunTrust."
},
{
"speaker": "Mark Hughes",
"text": "You mentioned the cut down of the Asian markets is perhaps influencing your trade-in activity. Did you measure or any specific numbers you can share about how much of an impact that was?"
},
{
"speaker": "Alan Colberg",
"text": "So what you're referring to is, in the early days of the crisis, some of the phones that we end up repairing and not using back in insurance claims are sold around the world. The Asian markets are one of the big markets for that, and that was a really shut down kind of the February, March type time frame. We haven't sized it, but you can see some of the pressure in Q1 lifestyle margins. We're really on that. It was the fact we had to find alternative channels on short notice to be able to get rid of those phones. Now the positive is those markets are back open, we just don't have the same activity level that we would have had in a pre-crisis environment."
},
{
"speaker": "Mark Hughes",
"text": "And then how does the lender-placed insurance work with the forbearance plans? People are under forbearance and it goes 3, 6 months. How does the lender-placed insurance interact with them?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. I think the important thing to remember first is that the majority of mortgage loans aren't in forbearance. So I think, I haven't seen the statistics this week, but it's under 10% that are in forbearance. So for 90%-plus of our business, it's just as normal. If someone ends up being seriously delinquent or out of the home, it's the same process we've always had. For mortgage forbearance, obviously, nothing happens, right? So as long as there are mortgages in that stage, it's not going to move into serious delinquency. So for that small sliver of the market, we will still be tracking alone. We just won't be doing anything while the mortgages are in forbearance."
},
{
"speaker": "Mark Hughes",
"text": "And then who is actually covering the, providing insurance on the property if it's in forbearance? If the homeowners insure is -- I'm not sure how long they're going to provide a grace period to the consumer or the borrower? But at some point, one would assume they're going to drop off. So does the bank assume the insurance coverage? How does that work?"
},
{
"speaker": "Richard Dziadzio",
"text": "No. I mean..."
},
{
"speaker": "Alan Colberg",
"text": "No, it's a good question, Mark. It's early days. For now, I think the majority of voluntary carriers are still providing that insurance. And there's not a rush by the voluntary players to cancel people's insurance at the moment. If they were canceled, we would then trigger a letter cycle likely our normal process. At the end of the day, that service we provide is critical for the mortgage industry and we would step in. But for now, we're not seeing anything really happening with the forbearance mortgages that are in the market."
},
{
"speaker": "Mark Hughes",
"text": "But if they were in forbearance, but the underlying homeowners insurance had dropped off, then your letter cycle would kick in?"
},
{
"speaker": "Alan Colberg",
"text": "And our primary focus, though, across all these businesses is continuing to be there. And what I'm most proud of, many things I'm proud of how our employees who responded here is we really have been able to sustain so far all of our service levels and continue to be there. For example, in lender-place, we do a lot of the processing, what are called loss drafts and supporting consumers who are repairing their homes, we're functioning as normal, even in this environment there. So I'm very proud of that."
},
{
"speaker": "Alan Colberg",
"text": "All right. I think that's the end of questions. I want to thank everyone for participating in today's call. We will update you on our progress on our second quarter earnings call in early August. In the meantime, please reach out to either Suzanne Shepherd or Sean Moshier with any follow-up questions you have. Thanks, everyone."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 4 | 2,021 | 2022-02-09 08:00:00 | Disclaimer*: This transcript is designed to be used alongside the freely available audio recording on this page. Timestamps within the transcript are designed to help you navigate the audio should the corresponding text be unclear. The machine-assisted output provided is partly edited and is designed as a guide.:
Operator: 00:04 Welcome to Assurant’s Fourth Quarter and Full-Year 2021 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode, and the floor will be opened for your questions following management's prepared remarks. [Operator Instructions]. 00:41 It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin your conference.
Suzanne Shepherd: 00:54 Thank you, operator. And good morning, everyone. We look forward to discussing our fourth quarter and full year 2021 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. 01:12 Yesterday after the market closed, we issued a news release announcing our results for the fourth quarter and full year 2021. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Keith and Richard before moving into a Q&A session. 01:30 Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release, as well as in our SEC reports. 01:55 During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday's news release and financial supplement. 02:13 I will now turn the call over to Keith.
Keith Demmings: 02:17 Thank you, Suzanne, and good morning everyone. As I begin my tenure as CEO, I'm extremely proud of the opportunity to lead our nearly 16,000 employees across the world, as we support consumers ever connected lifestyles. As I reflect on Assurant’s transformation over the past several years, not only have we evolved our business model, but also significantly expanded the breadth of our offerings and our customer base. 02:44 Today, Assurant represents a cohesive group of higher growth service oriented businesses serving more than 300 million consumers globally. Collectively, our connected consumer and specialty P&C businesses have generated and are expected to drive continued profitable growth and strong returns. As we position Assurant for 2022 and beyond, we see compelling opportunities to sustain growth, particularly with the convergence of the connected consumer in the global markets and geographies in which we operate. 03:19 Continued success will require us to deliver on our vision for the future to empower leading brands to connect, protect and support their customers connected lifestyles. Ongoing investments in our people and capabilities will enable us to meet our customers how, where and when they want to be met, differentiating our offerings through a superior customer experience. 03:44 Continuously adapting to the changing needs of the connected consumer will be critical to achieving our long-term growth. To continue to capture new opportunities, I believe, success will require more than ever our focus on 5 priorities. First, attracting, retaining and developing the best talent to unlock future potential; Second, delivering a superior digital first customer experience; Third deepening our strong partnerships with major clients and prospects worldwide, while also developing offerings and capabilities that continue to differentiate Assurant; Fourth, accelerating the pace of innovation and prioritizing the necessary investments across our operations and technology; And finally, continuing to further embed and support sustainability and inclusivity for the benefit of all stakeholders and the communities in which we operate. 04:44 And already this year, we've made progress in our continued objective to build a more sustainable Assurant. I'm proud of our recognition by CDP on our environmental impact and commitment and our continued inclusion in the Corporate Equality and Bloomberg Gender Equality Indices. I want to take a moment to highlight our lifestyle and housing businesses and how we successfully executed our strategy throughout 2021. 05:12 Within Connected Living, our mobile device lifecycle management solution has enhanced our ability to introduce value-added services and capabilities to monthly device protection plans and trade in and upgrade programs. This has helped expand our market share and further differentiate our offerings. We now cover almost 63 million mobile devices. A figure that's doubled since 2015 and increased 18% in 2021 alone. 05:44 At year-end, we launched a partnership with Deutsche Telekom in Germany to provide an innovative mobile phone device protection program and trade-in program. Assurant has already been recognized by Deutsche Telekom for our commitment to sustainability with a hash tag Green Magenta label highlighting how our products and services make a positive climate contribution and reflect a responsible use of resources. This is another example of further integrating ESG into Assurant’s business operations and offerings worldwide to drive more value for our partners and for our consumers. 06:22 Throughout the year critical investments continued to drive growth and differentiate the customer experience. Our trade-in and upgrade business now inclusive of HYLA Mobile drove exceptional performance, processing over 25 million devices supported by the rollout of 5G as well as our repair asset disposition and technology capabilities. We recently expanded our long-standing partnership with Telefonica to provide a comprehensive device trade-in program across several key countries in Europe, in Latin America where Telefonica is a market leader. The program will enable Telefonica to access our leading trade-in technology. 07:06 We also continue to integrate mobile service delivery options into our offerings through CPRs local same day capability and they come to you repair capability through our acquisition of Fixed. Demonstrating our commitment to improving the customer experience CPR by Assurant ranked first in the 2022 Entrepreneurial Franchise 500 for electronics repair. This is a testament to the success of our CPR franchisees and our commitment to provide customers with exceptional experiences, services and support. And we successfully executed on the major rollout of the in-store repair capability to nearly 500 T-Mobile store locations nationwide, showcasing our ability to adapt to rapidly changing consumer preferences. 07:54 Over a period of 5 months we recruited, trained and deployed nearly 2,000 technicians to deliver a seamless experience to T-Mobile customers in store, while also converting approximately 10 million Sprint subscribers to Assurant. The in-store repair rollout will continue in 2022 as we further enhance the overall experience for T-Mobile customers. 08:19 Turning to our global automotive business, where we also have a strong track record of growth and innovation. We've continue to capture market share and see significant opportunities ahead. In 2021, we grew global protected vehicles by 10% to nearly $54 million, and increased in net operating income by 21%. The auto business is critical to the long-term success of Assurant and we should continue to benefit in the future from increased scale through our alignment with industry leaders and our ability to support customers through digital channels. 08:55 Turning to renters. The business grew policies and revenue by 7% in 2021, a testament to strong affinity and property management company relationships. We also secured multi-year renewals with 2 top 10 property management companies. Technology and innovation are critical components to our success in this business. And we'll continue to invest in our technology over the next several years to further enhance the customer experience for our 2.6 million policyholders. 09:27 Investments in 2021 included the continued rollout of Cover360, lunching new customer facing sales portals and expanding self service capabilities that leverage machine learning to enable automation of claim payments. Ultimately, our investments should increase policy attachment rates which have not yet hit mature level throughout the industry. 09:49 Additionally, in our attractive P&C offerings, including lender placed insurance, we have maintained our market leading position with large US services and banks tracking over 30 million loans. Last year alone, we renewed 10 clients and partnered with 2 new clients. As we look to 2022, we'll continue investments in operations, such as our customer centric single source processing platform, differentiating our tracking capabilities and improving efficiency. 10:21 Overall, I'm pleased that our businesses have delivered on our commitments for 2021 as we delivered value for our clients and customers. We also further demonstrated the resiliency of our unique business model as we navigated the pandemic and manage inflationary pressures. Excluding reportable catastrophes, we generated 14% earnings per share growth, on the high end of our expectations. 10:47 Net operating income also excluding cats grew by 11% to $672 million, making 2021 our fifth consecutive year of profitable growth. Our balance sheet remains strong. Combined, our businesses contributed a total of $729 million in dividends to the holding company, representing approximately 100% of segment earnings. This allowed us to return a total of $1 billion in share repurchases and common stock dividends and complete our 3 year $1.35 billion capital return objective. In addition, we completed 60% of the $900 million we committed to return through share repurchases as part of the sale of our Preneed business. We anticipate returning the remainder by the end of the second quarter. 11:38 Next, I'd like to review some initial thoughts for 2022. As we look ahead to sharing our long-term vision, strategy and financial objectives at Investor Day in March, we can make an even more compelling case for the future. Given our ongoing shift to more service oriented fee-based businesses we believe adjusted EBITDA rather than net operating income is a better representation of how to evaluate our operating performance for the enterprise and segments. 12:08 In 2021 adjusted EBITDA excluding cats increased 9% to $1.1 billion, driven by strong results in Global Lifestyle, particularly in Global Automotive and Connected Living, as well as a lower corporate lost. In 2022, we expect growth in adjusted EBITDA ex-cats of 8% to 10%, a reflection of the strength of our business portfolio. Within Global Lifestyle, we expect adjusted EBITDA to increase by low-double digits, but likely not exceed the 12% growth we had in 2021. 12:43 Segment growth will be driven by Connected Living, particularly mobile, even as we make strategic investments to support new business, including continued investments in our in-store mobile repair capabilities. Within Global Housing, adjusted EBITDA excluding cats is expected to grow mid to high single digits, driven primarily by lender placed from higher average insured values, operating efficiencies and improved results in specialty offerings. Our corporate segment is expected to generate a loss of approximately $105 million of adjusted EBITDA, which is in line with our historical levels. 13:22 Cash flow generation is also expected to remain strong and is a core component of Assurant’s financial profile, allowing us to continue to invest in and transform this company. As we look at our capital management priorities going forward, we will continue to be strong stewards of capital. Our goal is to continue to maximize long-term value creation through disciplined capital deployment, while also maintaining our investment grade and financial strength ratings. Given the attractive business opportunities we see ahead, we expect a more balanced capital deployment mix, targeting compelling investments to drive long-term growth, whether organic or through M&A, as well as ongoing return of capital to shareholders. We believe this combination will enable us to sustain above market profitable growth and generate significant value for our shareholders. 14:14 We recognize that for periods of time this may result in higher than average levels of holding company liquidity to ensure we have the flexibility to make investments that generate compelling returns, while also returning capital mainly through buybacks, given the attractiveness of our stock. 14:31 Lastly, I wanted to acknowledge and thank all who have supported my transition to CEO over the last several quarters. Your feedback and ongoing dialog has been incredibly valuable as we collectively look to build upon the success of Assurant for the future. And I want to thank our employees around the world for their extraordinary efforts in 2021, a year in which we again outperformed despite the challenges of the pandemic. 14:56 I will turn the call over to Richard to review the fourth quarter results, our ‘22 outlook and business trends. Richard?
Richard Dziadzio: 15:05 Thank you, Keith and good morning everyone. As Keith noted, we are pleased with our performance in 2021 which continue to reinforce the strength of earnings and cash flow generation of our businesses. For the fourth quarter, we reported net operating income per share excluding reportable catastrophes of $2.49, up 21% from the prior year period. Excluding cats, net operating income for the quarter totaled $144 million and adjusted EBITDA amounted to $245 million, a year-over-year increase of 16% and 8%, respectively. 15:46 Now let's move to segment results, starting with Global Lifestyle. The segment reported net operating income of $108 million in the fourth quarter, a year-over-year increase of 20%. Growth was driven by strong performance in Global Automotive and Connected Living. 16:04 In Global Automotive, earnings increased $12 million or 29% from fourth quarter 2020. The increase is based on 3 main items, including, first, continued organic growth across distribution channels, mainly in the US and including AFAS contributions. Second, there were loss experienced from selected ancillary products. And third, higher investment income. 16:32 Connected Living’s earnings increased by $9 million or 21% year-over-year, more than offsetting the implementation costs associated with the initial deployment of in-store device repair services with T-Mobile. These costs are primarily related to technician hiring and parts sourcing and will further impact Connected Living’s earnings in 2022 as we continue investing in our in-store capabilities. 17:01 The fourth quarter increase in Connected Living was primarily driven by 3 items. Higher trading volumes, including a full quarter of contributions from HYLA and carrier promotions; higher international earnings, including improved performance in Europe and Asia Pacific; and continued mobile subscriber growth in North America, including growth from our cable operator partners. This quarter Connected Living and Global Automotive results also included a modest tax benefit that improved earnings. 17:31 For the quarter Lifestyles adjusted EBITDA increased 16% to $159 million. Adjusted EBITDA eliminates the segments increased IT depreciation from higher investments, as well as amortization resulting from higher deal related intangibles from the more recent transactions in T-Mobile and Global Automotive. 17:56 As we look at revenues, Lifestyle revenues increased by $168 million or 9%. This was driven mainly by continued growth in global automotive and Connected Living. In Global Automotive, revenue increased 12% reflecting strong prior period sales of vehicle service contracts across all distribution channels. In the US, we saw continued expansion from our national dealer network, and third-party administrators, while we benefited internationally from higher volumes with OEMs. As expected, our net written premiums, a key sales metric, continue to normalize compared to the third quarter, but remain elevated. We expect continued normalization into 2022. 18:42 Within Connected Living revenue increased 7%, primarily due to mobile fee income that was driven by strong trading volumes, including contributions from HYLA. Trading volumes continue to be elevated in the fourth quarter, supported by new phone introductions and carrier promotions from the introduction of 5G devices. Higher revenue growth in domestic mobile subscribers was offset by declines in run-off mobile programs previously mentioned. 19:13 For the year, mobile subscribers grew 18% to nearly $63 million, driven by growth in North America, including the transition of legacy Sprint subscribers. Excluding the Sprint transition, our North American device count continued to grow at a healthy pace and was up 8% offsetting declines in other regions. 19:35 Looking ahead to 2022, we expect Global Lifestyle adjusted EBITDA to increase by low double digits. Growth will be mainly driven by Connected Living and particular mobile, from continued global expansion in existing and new clients and across device protection in trade-in and upgrade programs. Given the strategic investments we're making across Lifestyle to support new business opportunities, including in-store service and repair capabilities, we do not anticipate growth to exceed the 12% growth rate we had in 2021. 20:11 In Global Automotive we expect adjusted EBITDA to be stable in 2022 compared to 2021 as we overcome headwinds in investment income and the absence of $10 million of non-recurring gains we recorded in the first half of 2012. 20:33 Moving to Global Housing. Net operating income was $80 million for the fourth quarter compared to $61 million in the fourth quarter of 2020, driven by lower reportable catastrophes. Excluding catastrophe losses, earnings decreased $7 million, mainly due to higher non-cat losses in our Specialty P&C offerings. Non-cat losses included an $8.2 million increase, primarily related to reserve strengthening for run-off claims within our small commercial book. As a reminder, this book stopped getting policies in 2019, but we continue to manage open claims. Absent this reserve increase, earnings were relatively flat as growth in lender placed was offset modestly by higher non-cat losses. 21:20 Recall, certain factors in 2020 and the first quarter of 2021 temporarily depressed non-cat loss levels. We do not consider those periods to be representative of historical and future trends. Earnings growth in lender placed insurance was driven by the higher average insured value of in-force policies and claims processing efficiencies, which were partially offset by the impact of the continued foreclosure of moratoriums. In January, we replaced our existing reinsurance coverage, representing 2/3 of our 2022 catastrophe reinsurance program placement. We were able to continue placing reinsurance covering multiple years to mitigate changes in the pricing of cat reinsurance in any one year. 22:09 And similar to prior years, the remainder of our reinsurance will be placed around mid-year. We will continue to evaluate the risks and rewards purchasing additional reinsurance, as well as alternatives that could more meaningfully reduce our risk. 22:25 In Multifamily Housing underlying growth in our affinity and P&C channels was offset by increased expenses, primarily investments to further strengthen our customer experience, including our digital capabilities. Global Housing revenue increased 2% year-over-year, mainly from higher average insured values and premium rates in lender placed and growth in Multifamily Housing. This was partially offset by lower specialty revenues from client run-off. 22:55 For 2022 we expect Global Housing's adjusted EBITDA excluding cats to grow by mid to high single digits compared to 2021. This is expected to be driven by 3 factors. First, growth in lender placed insurance from continued higher average insured values and gradually higher REO volumes due to easing foreclosure moratoriums throughout the year. Growth is expected to be partially offset by the impact of higher labor and material costs. 23:29 Second, expense savings initiatives, including our Digital first efforts focused on automation will have a positive impact, albeit partially offset by continued investment initiatives particularly in multifamily housing. And third, improved loss experience in our specialty offerings related to small commercial. At corporate, the net operating loss was $24 million, an improvement of $3 million compared to the fourth quarter of 2020. This was mainly driven by higher investment income in the quarter from higher asset balances, including proceeds from the sale of Global Preneed. For 2022, we expect the corporate adjusted EBITDA loss to approximate $105 million, more in line with historical levels. 24:16 Turning to holding company liquidity. We ended the year with slightly over $1 billion, primarily due to the proceeds from the sale of our Preneed business. In the fourth quarter, dividends from our operating segments, totaled $176 million. In addition to our quarterly corporate and interest expenses we had outflows from 3 main items. $290 million of share repurchases, $39 million in common stock dividends, and $5 million related to Assurant Ventures Investments. For 2022, we expect our businesses to continue to generate strong cash flow and at a similar rate to prior years. 24:58 With the transition to adjusted EBITDA, we expect segment dividends to be roughly 3/4 of segment adjusted EBITDA, including catastrophes. This translates to approximately 100% of segment net operating income. As always, segment dividends are subject to the growth of the businesses, rating agency and regulatory capital requirements and investment portfolio performance. 25:22 As Keith mentioned, we expect to provide additional color for 2022, including our outlook on a per share basis that aligns with adjusted EBITDA, along with further detail regarding our long-term view of financial metrics that support Assurant’s strategic direction at Investor Day next month. As a result of the expected level of share repurchases, we wanted to note that we expect that our growth on a per share basis will significantly exceed our adjusted EBITDA growth. 25:53 In closing, we are really excited to have met our objectives for 2021 despite the difficult operating conditions brought on by the pandemic. And we're excited to be entering 2022 with the positive business momentum we highlighted today. 26:09 And with that, operator, please open the call for questions.
Operator: 26:14 The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Tommy McJoynt from KBW. Your line is open.
Tommy McJoynt: 26:47 Hey, good morning guys. Thanks for taking my question. So could you guys start off and just talk about the impact of inflation on your device repair and upgrade business. Obviously, there's different factors with replacement parts and higher labor and wages. So if you could just kind of touch on how you're managing those risks?
Keith Demmings: 27:05 Sure and good morning. Maybe I'll start -- talk a little bit about mobile and then Richard, you can talk more broadly about inflation overall. I'd say, on the mobile business it had a relatively neutral impact on our financials. As we've talked about before, the business is largely reinsured and profit shared with our clients. So you do see a little bit of impact on loss ratios when we're on risk, but it's been fairly immaterial as we look over the course of the last many months. 27:33 I would also say, from our perspective, we also think about delivering service to the end consumer and making sure we've got the right levels of inventory. So that's equally important to make sure we're delivering and we've done a really good job stocking inventory, making sure we've got good lead time for parts delivery. From time to time we do see delays in terms of claim fulfillment, sometimes that means some repair might take a little longer or might have to replace a device versus doing a repair. But overall, customer service has been excellent and NPS scores in terms of what customers are telling us have been really, really strong. 28:09 So that's more from the parts side. I'd say in the labor market, no doubt, it remains challenging, and this is true across all of the businesses around the world. I would say, I’m really proud of how the teams have navigated, not just the labor market, but really the pandemic overall with work from home. I think because we kept health and safety at the front of everything that we did from a decision making perspective, we've built an incredible culture within the organization and I think we haven't seen a lot of the great resignation that you hear about every day. We've done an incredible job of protecting our employee base. And in fact we hired 2,000 employees to staff the 500 T-Mobile stores to do repairs. And obviously, including leadership positions we did that extremely well in a very challenging market. So really proud of how we've navigated labor. And I think one of our advantages is the talent that we have. 29:04 But maybe, Richard, just a little bit more on macro inflation as we think about the housing business as well.
Richard Dziadzio: 29:12 Sure, sure. Thanks, Keith. And good morning, Tommy. Yeah. Just in terms of the housing business overall, we have seen some increase in claim costs and that's a little bit of a headwind, but on the other hand, we've -- as we talked about in our remarks, we have seen an increase in average insured value. So that to a certain extent offset the pressure there. 29:35 I guess the other thing I would say too is, while short-term we do feel some pressure from it. We have factored it into the comments we made today in terms of what we would consider to be the impact of inflation on our businesses in 2022 in the outlook that we gave. And also positive will be rising interest rates that will flow through to investment income. So the higher rates will be helpful, both on a short and longer term on the cash that we have in hand today, and also on new money coming in, premiums coming in as we invested. 30:09 So overall, we don't see a material impact in the short-term or actually as we go further off. Thank you.
Tommy McJoynt: 30:19 Thanks. Appreciate the feedback. And then just switching gears a little bit to the outlook and into the guidance on EBITDA. So if I look over the past couple of years, the EBITDA margin has kind of been in the 10% to 11% range. When you kind of think of long-term where EBITDA should go, do you think you should build in some margin expansion on EBITDA or do you think that 10% to 11% is kind of a good long-term rate.
Keith Demmings: 30:43 Yeah. I guess a couple of comments. We will be obviously coming out at Investor Day in -- on March 24 with a longer-term outlook. So we will be coming to the market with 3 year longer-term financial projections. So that'll be a great time for us to lay out our vision for the future. And certainly if you look at our outlook for ’22, strong EBITDA growth, we've signaled 8% to 10% and we saw 9% in 2021. So continued strong momentum in terms of driving EBITDA growth. And I would also say we're investing more as well organically to try and set up the future. And we'll talk a lot more about some of those investments and how we think about long-term growth trajectory emerging as we get back together in a few weeks.
Tommy McJoynt: 31:31 Thanks. I look forward to speaking on. Thanks.
Keith Demmings: 31:34 Thank you.
Operator: 31:36 Your next question comes from the line of Michael Phillips from Morgan Stanley. Your line is open.
Michael Phillips: 31:43 Thanks. Good morning. Actually, you just touched on it, but maybe a little bit deeper if you could on the guidance for EBITDA. I guess I was curious. And again, maybe nothing more than what you just said, but I'll say -- curious on how much, I guess, overall investment we should think about as being done this year relative to, say, the amount that was done last year as we look at that 8% to 10% guide for EBITDA.
Keith Demmings: 32:08 Yeah. I would say we expect to make more investments overall across the company in 2022 than in 2021. We obviously had some material investments when you look at standing up, taking a repair with T-Mobile, there was a significant lift to do that, obviously, converting the Sprint business. So there certainly were investments in ’21. I would signal a little bit more investment to drive organic growth. And I would probably highlight a couple of areas. Certainly, we're going to continue to invest in service and repair capabilities, really building out the platform, the technology and the integrations. 32:45 We talked about investments in digital first in the prepared remarks, that's a really important priority for the organization. Obviously, it drives efficiency longer term, but it radically improves the customer experience, so that's a big priority. We've got several new client launches that are planned that obviously take a significant amount of energy to get right and make sure we execute and deliver. And then investment in longer term growth, new capabilities around the connected home, around innovation to drive new product bundles, a new cross-selling opportunities, and I would say further scaling capability in Europe and Japan. 33:21 So there's a lot of areas that we're trying to focus on. There is a significant amount of long-term growth potential across all of our product line. So I would say, a pretty balanced set of opportunities.
Michael Phillips: 33:35 Okay, thanks. That's all, but I’m sure we will get a lot more details in a few weeks. You mentioned this in the opening comments as well, maybe a little more detail here. Is the expenses that you've incurred from the T-Mobile rollout that was kind of pushed into 4Q and some now, end of this year. Is that going to be more of a 1Q issue or that continue at that same level as we get past 1Q 2022?
Keith Demmings: 34:03 Yeah, I would say it will moderate from what we saw in the fourth quarter. We did a great job, that was a lot of work as you can imagine, staffing up 500 stores over the course of really 4 or 5 months and then training, onboarding all of our leadership, all of our technicians. It’s just an incredible effort. I would -- First thing I would say, it underscores our ability to not only adapt to changing consumer preferences, but then drive significant focus on execution as a company and we did the same unit repair launch while we were migrating all of the Sprint business and while we were staffing up to manage all of the Sprint business as well separate from same unit repair. So a significant lift, certainly in fourth quarter. I would say, it came in broadly in line with expectations in the quarter and it will certainly moderate as we get into 2002 as we look to -- the first and second quarter, we'll certainly see more investment going forward and it will taper as we get through the rest of the year.
Michael Phillips: 35:07 Okay. Thanks, Keith. One last one and a more high level question if I could. You continue to outpace the market and growth and renters policies pretty significantly. Maybe you can talk about that. And is that something that you think you can continue to do over the long term? It's pretty significant growth there versus the ramp in market in general. So –and you've done it for quite a while. But I guess should we expect that to continue for the foreseeable future.
Keith Demmings: 35:35 Yeah. I mean we've been really pleased with the performance this year, but as you say, over time really good strong consistent growth and also growing market share. I mean, if you look back over the years, and we'll talk more about that, I'm sure at Investor Day as well. But really strong overall share gains in the market. And we've seen a lot of good trends as well. The product is -- the attachment rates on the products have gone up over time and that's certainly helping. We've grown our relationships with property management companies. And I certainly expect us to continue to drive policy growth and revenue growth going forward. That's another business that we're investing significantly in trying to evolve how we deliver services. 36:21 Thinking about investments in technology, investments in customer experience, digital integration with our partners and then thinking about other services that we can add that are relevant for renters. So, really excited about that business long term and certainly expect momentum to continue as we move forward.
Michael Phillips: 36:40 Thank you. I appreciate it.
Keith Demmings: 36:42 Great, thank you.
Operator: 36:44 Your next question comes from the line of Tom Shimp from Piper Sandler. Your line is open.
Tom Shimp: 36:50 Hi, good morning. Congrats on the strong quarter. So, very strong growth in Global Automotive in the past, you've spoken about the increase in attachment rates from the high '30s to the high '40s, given the increase in prices and technology. Given the chip shortage, there has been a number of reports of buyers paying over sticker for new cars, and we've got used car prices up as much as 40%. So, do you believe this is having an effect on attachment rates? And maybe you could just give some general thoughts on whether the pie is getting bigger? Whether Assurant is getting a bigger piece of the pie, or both?
Keith Demmings: 37:26 Yeah. I think Assurant is definitely getting a bigger piece of the pie. I would say that, attachment rates have probably drifted up more because of the mix of business that we've seen a shift between new and used and we tend to see slightly higher attach rates on used vehicles. So if you think historically, we've had a 50:50 mix roughly between new and used cars. Today, it's probably 55% used, 45% new. So that would create a little bit higher overall blended attach rate. I wouldn't say that it's significantly change otherwise, we've seen good strong consistent performance. And as always, it's a focus for our clients. We've gained market share, no doubt, in the market that we've seen a lot of consolidation in the industry. We're partnered with a lot of large publics, a lot of large dealer groups and they're gaining share through acquisition, I think we've seen more acquisitions in 2021 in terms of the big publics. And then also our franchise dealers have been investing heavily in digital and also sourcing a lot more used car inventory directly from consumers. So a pretty significant improvement in terms of the performance of our clients. And then I'd say we've also won new clients as well in the market and it's a very fragmented market today. So there's still a lot of opportunity for share gain over time.
Tom Shimp: 38:55 Okay, great. Maybe moving to mobile. There has been a lot of moving pieces in 5G after what seems like a delayed rollout. There is an uptick in 5G promotions and activity around that potential catalyst, but then we recently had the delay in 5G implementation due to the FAA. So maybe you could frame for us how to think about the potential benefit from 5G? Whether it's total covered mobile device count or trade in volumes? How should we think about the cadence of the benefit to ‘22 earnings and the years that follow?
Keith Demmings: 39:27 Yeah, we had a significant success in 21 certainly with trade in volumes at all-time highs. And that's partly due to the acquisition of HYLA and then due to a number of other factors. You point out the promotional activity from clients, obviously, the migration to 5G, we've seen clients put more focus and energy on trade in. Obviously, it's got sustainability benefits, which is really important. It also provides digital access to consumers at more affordable rate. So there's a lot of reasons why I would say trade-in is generally growing as a category. We're seeing a lot more interest around the world with different partners. So from that perspective, I feel really good about that trend continuing. 40:16 And then in terms of 5G, specifically I'd say we're still fairly early in the cycle. You've got maybe 20% to 30% of postpaid customers in the key markets that we operate that have migrated to 5G networks. So there's still a lot more opportunity as consumers continue to upgrade devices and adopt 5G. So we will see continued promotional activity and we'll see a lot of trade-in volume as we move through 2022 that certainly underpins some of our thinking with our Connected Living growth. And then I think we'll see more globally as this continues to get focused.
Tom Shimp: 40:55 Great. Thank you for your answers.
Keith Demmings: 40:57 Thank you.
Operator: 40:59 Your next question comes from the line of Mark Hughes from Truist Securities. Your line is open.
Keith Demmings: 41:06 Good morning, Mark.
Mark Hughes: 41:07 Yeah. Thank you. Good morning. You had mentioned that you're looking to evaluate perhaps alternative risk strategies in Global Housing, maybe lay off a material portion of your catastrophe exposure. As I understood you to say, I had thought that had kind of been put to bed. But it sounds like you're still working on it, still evaluating it. Could you talk about what you're thinking is there? How serious that initiative might be?
Keith Demmings: 41:44 Sure. And maybe I'll start just reinforce a little bit about the business and then I'll address your question. I mean, I would just highlight, it's a really unique high-performing business. If you think about the cash flows that generate out of our housing business and the important role that we play in the mortgage value chain. So we're really proud of the business and the result that’s delivered. And I would say if you look at housing overall. We talk about targeting of 17% to 20% ROE after a normal cat load. If you look at 2021, we actually had $114 million of cat losses, so more than what we would consider our normal cat load and still delivered a 16.5% ROE. 42:28 So, broadly really strong business, great ROEs and it generates a ton of cash flow. So we really like the business for a lot of different reasons. In terms of the comments around the cat exposure, I would say, we're always looking for ways to optimize the cat exposure. You've seen a pretty strong track record of reducing risk over the years and that's not just as we've grown other parts of the company, we've significantly grown parts of housing and then obviously Lifestyle, which don't have much of any cat exposure at all. We've also dramatically reduced our per event exposure from $240 million to $80 million over the years and then a lot of other decisions around multi-year coverage, exiting certain non-strategic cat-prone markets, et cetera. So you've seen a lot of discipline that will no doubt continue as we move forward, but we are always looking to see if there are further ways to optimize. 43:27 Is there a risk-reward trade-off that we can work with reinsurance partners in a different way to further mitigate the risk, further mitigate the volatility and try to drive the right most efficient optimal outcome. And we're going to continue to look at that. I wouldn't say there's anything imminent that we're doing other than -- this is normal course for us and it's very important for us to be thinking about our reinsurance and our cat risk all the time.
Mark Hughes: 43:55 And then you had made, I think, a point of saying that you were looking for a balanced mix of investments in share buyback. If I did the simple person and said, if you look at free cash flow for 2022 is it half share buyback, half retained for investments or M&A.
Keith Demmings: 44:15 Yeah. We will spend more time on capital management, certainly at Investor Day. I would say a couple of things. We're not trying to signal a dramatic shift in our philosophy, that's point number one. We continue to be extremely disciplined as we think about capital management. So that's not going to change. And ultimately, we're trying to maximize returns. I think what we're more trying to signal is an interest in maintaining greater flexibility. There is lots of attractive opportunities in the market to drive growth and we want to have a little more flexibility to try and evaluate the best alternatives, but obviously being extremely disciplined with how we think about long-term value creation. So we'll talk a little bit more about our expectations for capital deployment in a few weeks, but that would probably be the bigger takeaway from me.
Mark Hughes: 45:10 Yeah. And then just one if I may. You talked about expanding the Connected Home, does that suggest an appetite or maybe a broader home warranty exposure?
Keith Demmings: 45:27 Yeah, I think we're -- where we play today around the Connected Home is more around the connected technology, the appliances, the electronics that side of the business. We don't really have home warranty within our portfolio today, and that's a big competitive market. There are many strong players in that space. So I think there is an opportunity more uniquely for us as we think about building bundled subscription services to protect more broadly consumers connected technology and other products that they have in their homes. So that's more of the angle that we think is appropriate for Assurant. And we'll talk more about that at Investor Day, but we definitely see interesting trends, a lot of appetite from consumers. We operate with a broad range of distribution partners, so there is a lot of interesting bundled services that we think we can bring to bear for sort of the connected consumer of the future.
Mark Hughes: 46:26 Great. Thank you.
Keith Demmings: 46:27 Thank you.
Operator: 46:30 [Operator Instructions] Your next question comes from the line of Brian Meredith from UBS Financial. Your line is open.
Keith Demmings: 46:43 Good morning, Brian.
Brian Meredith: 46:44 Good morning. A couple of questions here. Firstly, I’m just curious on the repair centers in T-Mobile stores. Is that an exclusive deal? Or could you roll that out to other customers? And what is kind of in the inquiries you perceived on doing that? I think that a lot of the other customers would be really interested in that type of a program.
Keith Demmings: 47:04 Yeah, I think you're right. And we've certainly -- and you've seen it with our investments dating back a few years, right? We invested in and bought a company called CPR. We also bought Fix. So we have lock in repair facilities operated by Assurant. We've got come to you repair technicians as well and now for T-Mobile operating within their store. Definitely I think we'll see more and more interest from clients around the world as they think about the appropriate repair strategy and claims fulfillment strategy for each brand. So, definitely it's client by client in terms of what's most appropriate and what vision do they want to create for servicing consumers, but I definitely expect to see more appetite over time.
Brian Meredith: 47:48 Great. And then I'm just curious, one quick one on the catastrophe reinsurance program renewal. It sounds like fairly similar structure to the program. What about the cost of it? What was the additional costs associated with it?
Keith Demmings: 48:03 Yeah. And I would say we're really pleased with the renewal that we got. And Richard I know works closely on it, maybe share a couple of thoughts, Richard.
Richard Dziadzio: 48:13 Yeah, I think as we've said before on renewals in the beginning, we have to invest. And then as we go along we make profits over time. And it's gone really well so to date, I mean, to date. Our partners can deliver better solutions for our customers with what we're doing. So it's not just in service repair. I would say today we've covered most of it through the end of the year, we're probably about 2/3 of the coverage being placed. And we'll place the rest of it in the year as you know. And we had success in the pricing of it. We have a pretty stable reinsurers and if we look out in the market we had some reinsurers that -- has some insurance who have trouble placing. We placed 100%, we placed it at the low end of the market as well. It ranges from anywhere from 5% to 30% on reinsurance. So we've done a really good job.
Brian Meredith: 49:13 Got you, got you. So towards the low end of the market. Great.
Richard Dziadzio: 49:17 Yeah. Single – I’d put it in the kind of the mid to single digits overall. So in a really good place.
Brian Meredith: 49:24 Terrific. Good outcome. And then I guess this is my last and maybe you’ll be touching this in Investor Day. When I think about your 8% to 10% EBITDA ex-cat guidance for 2022, should I think about that is more margin driven or revenue driven?
Richard Dziadzio: 49:43 I mean we're – certainly both. I mean, we are grow revenues as a company, but we're also expanding margins if you think about the makeup of our business. We typically have grown profitability at a quicker pace than we've grown revenue, just based on some of the ways that revenue flows through the P&L. So I do expect to see margin expansion in terms of the breadth of services that we deliver to clients over time. So defiantly growing revenue but growing margins quicker than revenues which is typically been the case.
Brian Meredith: 50:17 Great. Thank you.
Keith Demmings: 50:21 Thank you.
Operator: 50:21 And your final question comes from the line of Grace Carter from Bank of America. Your line is open.
Keith Demmings: 50:28 Good morning. Grace.
Grace Carter: 50:30 Hi, good morning. Looking at the guidance for amortization of intangibles next year. I was wondering if we could clarify any assumptions regarding bolt-on M&A that are included in that estimate? And just given recent market volatility, if we could talk about just the outlook for bolt-on M&A opportunities in the Lifestyle business? And if valuations are any more attractive now than they were a few months ago?
Richard Dziadzio: 50:56 Maybe Keith, you want to take the first part in terms of the next year?
Keith Demmings: 51:00 Perfect.
Richard Dziadzio: 51:01 Yeah, just to start with the numbers. I mean, it doesn't -- the numbers that we've given in the earnings outlook really doesn't include any future acquisitions we buy, it's really the current acquisitions we've done and how it kind of rolls forward. So I would just say, remember, we've done deals at the end of last year where we have HYLA and AFAS. And that's going to be running through.
Keith Demmings: 51:28 Yeah. And in terms of M&A, obviously, we're always looking in the market for attractive opportunities and valuations certainly move around. We've seen really high expectations at times and more tempered than others, but I would say, we're definitely interested in acquiring strategic capabilities. You've seen us do I think some really good strong foundational acquisitions. If I think back to The Warranty Group, which was a big scale play, gave us a great overlap with our current geographies and really a global leading position around auto. The acquisition of HYLA, that really scaled us as the global leader in trade-in. Right on the front edge of the 5G super cycle, you saw the acquisition of AFAS, which gave us real strength in the US auto market to complement the acquisition of The Warranty Group. And then some of the mobile acquisitions I talked about, CPR and Fixed really just important capabilities and set the foundation for what we're doing today with T-Mobile. 52:32 So I think we're going to continue to look for those types of acquisitions. And we always try to find multiple ways to win. How do we get access to new clients or new distribution channels, new capabilities that can wrap around the services that we already provide and then clearly looking for low risk in terms of integration, execution and financial performance. So we're always looking for those types of deals. That's why we want to maintain flexibility. But as you've seen, we will continue to be disciplined and we will try to find really strategic opportunities to drive that growth.
Grace Carter: 53:11 Thank you. And just another one. Looking at the housing adjusted EBITDA guidance for next year. It sounds like the combined ratio might drift a little below that historical guidance of 86% to 90%. I was just wondering how sustainable maybe a combined ratio below that could be? And just how we should think about that going forward, just given ongoing changes in the mix of business with Multifamily Housing Kind of outgrowing lender placed?
Keith Demmings: 53:45 And Richard, do you want to talk a minute on that?
Richard Dziadzio: 53:48 Yeah, I think the historical guidance that we gave 86% to 90% is a long-term measure. And I would kind of base things on that. Obviously it depends on the mix we have within the business. And I think you're exactly right, as multifamily grows that kind of comes into the waiting on it. But I think what's more important to is, there is one part which is the combined operating ratio, the 86% to 90%, there is a second part which is the premiums. 54:20 And as we see markets changing over time, as we see the forbearance moratorium is running off and we see the inflation in average insured values and whatever. I think we're going to see premiums move up as well. So in terms of profitability, when we're talking about lender placed, for example, we are talking about looking at higher -- better performance in next year. And that is going to be driven by higher average insured values, the non-cat loss ratio staying at about current levels and that will help profitability overall. And in addition to that, obviously, we're working our expenses as we go along and the operation of efficiencies that we cited are helping the bottom line as well.
Grace Carter: 55:08 Thank you.
A - Keith Demmings: 55:09 Great. Thanks, Grace. And thank you everyone for participating in today's call. We're very pleased with our performance in 2021 and excited for another year of profitable growth in 2022. We're also looking forward to our upcoming virtual Investor Day on March 24, where we'll have the opportunity to share the Assurant vision, our strategy and multi-year financial objectives. So stay tuned for registration details coming out soon. And in the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. And thank you very much. Have a great day.
Operator: 55:44 Thank you. This does conclude today's conference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Disclaimer*",
"text": "This transcript is designed to be used alongside the freely available audio recording on this page. Timestamps within the transcript are designed to help you navigate the audio should the corresponding text be unclear. The machine-assisted output provided is partly edited and is designed as a guide.:"
},
{
"speaker": "Operator",
"text": "00:04 Welcome to Assurant’s Fourth Quarter and Full-Year 2021 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode, and the floor will be opened for your questions following management's prepared remarks. [Operator Instructions]. 00:41 It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin your conference."
},
{
"speaker": "Suzanne Shepherd",
"text": "00:54 Thank you, operator. And good morning, everyone. We look forward to discussing our fourth quarter and full year 2021 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. 01:12 Yesterday after the market closed, we issued a news release announcing our results for the fourth quarter and full year 2021. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Keith and Richard before moving into a Q&A session. 01:30 Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release, as well as in our SEC reports. 01:55 During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday's news release and financial supplement. 02:13 I will now turn the call over to Keith."
},
{
"speaker": "Keith Demmings",
"text": "02:17 Thank you, Suzanne, and good morning everyone. As I begin my tenure as CEO, I'm extremely proud of the opportunity to lead our nearly 16,000 employees across the world, as we support consumers ever connected lifestyles. As I reflect on Assurant’s transformation over the past several years, not only have we evolved our business model, but also significantly expanded the breadth of our offerings and our customer base. 02:44 Today, Assurant represents a cohesive group of higher growth service oriented businesses serving more than 300 million consumers globally. Collectively, our connected consumer and specialty P&C businesses have generated and are expected to drive continued profitable growth and strong returns. As we position Assurant for 2022 and beyond, we see compelling opportunities to sustain growth, particularly with the convergence of the connected consumer in the global markets and geographies in which we operate. 03:19 Continued success will require us to deliver on our vision for the future to empower leading brands to connect, protect and support their customers connected lifestyles. Ongoing investments in our people and capabilities will enable us to meet our customers how, where and when they want to be met, differentiating our offerings through a superior customer experience. 03:44 Continuously adapting to the changing needs of the connected consumer will be critical to achieving our long-term growth. To continue to capture new opportunities, I believe, success will require more than ever our focus on 5 priorities. First, attracting, retaining and developing the best talent to unlock future potential; Second, delivering a superior digital first customer experience; Third deepening our strong partnerships with major clients and prospects worldwide, while also developing offerings and capabilities that continue to differentiate Assurant; Fourth, accelerating the pace of innovation and prioritizing the necessary investments across our operations and technology; And finally, continuing to further embed and support sustainability and inclusivity for the benefit of all stakeholders and the communities in which we operate. 04:44 And already this year, we've made progress in our continued objective to build a more sustainable Assurant. I'm proud of our recognition by CDP on our environmental impact and commitment and our continued inclusion in the Corporate Equality and Bloomberg Gender Equality Indices. I want to take a moment to highlight our lifestyle and housing businesses and how we successfully executed our strategy throughout 2021. 05:12 Within Connected Living, our mobile device lifecycle management solution has enhanced our ability to introduce value-added services and capabilities to monthly device protection plans and trade in and upgrade programs. This has helped expand our market share and further differentiate our offerings. We now cover almost 63 million mobile devices. A figure that's doubled since 2015 and increased 18% in 2021 alone. 05:44 At year-end, we launched a partnership with Deutsche Telekom in Germany to provide an innovative mobile phone device protection program and trade-in program. Assurant has already been recognized by Deutsche Telekom for our commitment to sustainability with a hash tag Green Magenta label highlighting how our products and services make a positive climate contribution and reflect a responsible use of resources. This is another example of further integrating ESG into Assurant’s business operations and offerings worldwide to drive more value for our partners and for our consumers. 06:22 Throughout the year critical investments continued to drive growth and differentiate the customer experience. Our trade-in and upgrade business now inclusive of HYLA Mobile drove exceptional performance, processing over 25 million devices supported by the rollout of 5G as well as our repair asset disposition and technology capabilities. We recently expanded our long-standing partnership with Telefonica to provide a comprehensive device trade-in program across several key countries in Europe, in Latin America where Telefonica is a market leader. The program will enable Telefonica to access our leading trade-in technology. 07:06 We also continue to integrate mobile service delivery options into our offerings through CPRs local same day capability and they come to you repair capability through our acquisition of Fixed. Demonstrating our commitment to improving the customer experience CPR by Assurant ranked first in the 2022 Entrepreneurial Franchise 500 for electronics repair. This is a testament to the success of our CPR franchisees and our commitment to provide customers with exceptional experiences, services and support. And we successfully executed on the major rollout of the in-store repair capability to nearly 500 T-Mobile store locations nationwide, showcasing our ability to adapt to rapidly changing consumer preferences. 07:54 Over a period of 5 months we recruited, trained and deployed nearly 2,000 technicians to deliver a seamless experience to T-Mobile customers in store, while also converting approximately 10 million Sprint subscribers to Assurant. The in-store repair rollout will continue in 2022 as we further enhance the overall experience for T-Mobile customers. 08:19 Turning to our global automotive business, where we also have a strong track record of growth and innovation. We've continue to capture market share and see significant opportunities ahead. In 2021, we grew global protected vehicles by 10% to nearly $54 million, and increased in net operating income by 21%. The auto business is critical to the long-term success of Assurant and we should continue to benefit in the future from increased scale through our alignment with industry leaders and our ability to support customers through digital channels. 08:55 Turning to renters. The business grew policies and revenue by 7% in 2021, a testament to strong affinity and property management company relationships. We also secured multi-year renewals with 2 top 10 property management companies. Technology and innovation are critical components to our success in this business. And we'll continue to invest in our technology over the next several years to further enhance the customer experience for our 2.6 million policyholders. 09:27 Investments in 2021 included the continued rollout of Cover360, lunching new customer facing sales portals and expanding self service capabilities that leverage machine learning to enable automation of claim payments. Ultimately, our investments should increase policy attachment rates which have not yet hit mature level throughout the industry. 09:49 Additionally, in our attractive P&C offerings, including lender placed insurance, we have maintained our market leading position with large US services and banks tracking over 30 million loans. Last year alone, we renewed 10 clients and partnered with 2 new clients. As we look to 2022, we'll continue investments in operations, such as our customer centric single source processing platform, differentiating our tracking capabilities and improving efficiency. 10:21 Overall, I'm pleased that our businesses have delivered on our commitments for 2021 as we delivered value for our clients and customers. We also further demonstrated the resiliency of our unique business model as we navigated the pandemic and manage inflationary pressures. Excluding reportable catastrophes, we generated 14% earnings per share growth, on the high end of our expectations. 10:47 Net operating income also excluding cats grew by 11% to $672 million, making 2021 our fifth consecutive year of profitable growth. Our balance sheet remains strong. Combined, our businesses contributed a total of $729 million in dividends to the holding company, representing approximately 100% of segment earnings. This allowed us to return a total of $1 billion in share repurchases and common stock dividends and complete our 3 year $1.35 billion capital return objective. In addition, we completed 60% of the $900 million we committed to return through share repurchases as part of the sale of our Preneed business. We anticipate returning the remainder by the end of the second quarter. 11:38 Next, I'd like to review some initial thoughts for 2022. As we look ahead to sharing our long-term vision, strategy and financial objectives at Investor Day in March, we can make an even more compelling case for the future. Given our ongoing shift to more service oriented fee-based businesses we believe adjusted EBITDA rather than net operating income is a better representation of how to evaluate our operating performance for the enterprise and segments. 12:08 In 2021 adjusted EBITDA excluding cats increased 9% to $1.1 billion, driven by strong results in Global Lifestyle, particularly in Global Automotive and Connected Living, as well as a lower corporate lost. In 2022, we expect growth in adjusted EBITDA ex-cats of 8% to 10%, a reflection of the strength of our business portfolio. Within Global Lifestyle, we expect adjusted EBITDA to increase by low-double digits, but likely not exceed the 12% growth we had in 2021. 12:43 Segment growth will be driven by Connected Living, particularly mobile, even as we make strategic investments to support new business, including continued investments in our in-store mobile repair capabilities. Within Global Housing, adjusted EBITDA excluding cats is expected to grow mid to high single digits, driven primarily by lender placed from higher average insured values, operating efficiencies and improved results in specialty offerings. Our corporate segment is expected to generate a loss of approximately $105 million of adjusted EBITDA, which is in line with our historical levels. 13:22 Cash flow generation is also expected to remain strong and is a core component of Assurant’s financial profile, allowing us to continue to invest in and transform this company. As we look at our capital management priorities going forward, we will continue to be strong stewards of capital. Our goal is to continue to maximize long-term value creation through disciplined capital deployment, while also maintaining our investment grade and financial strength ratings. Given the attractive business opportunities we see ahead, we expect a more balanced capital deployment mix, targeting compelling investments to drive long-term growth, whether organic or through M&A, as well as ongoing return of capital to shareholders. We believe this combination will enable us to sustain above market profitable growth and generate significant value for our shareholders. 14:14 We recognize that for periods of time this may result in higher than average levels of holding company liquidity to ensure we have the flexibility to make investments that generate compelling returns, while also returning capital mainly through buybacks, given the attractiveness of our stock. 14:31 Lastly, I wanted to acknowledge and thank all who have supported my transition to CEO over the last several quarters. Your feedback and ongoing dialog has been incredibly valuable as we collectively look to build upon the success of Assurant for the future. And I want to thank our employees around the world for their extraordinary efforts in 2021, a year in which we again outperformed despite the challenges of the pandemic. 14:56 I will turn the call over to Richard to review the fourth quarter results, our ‘22 outlook and business trends. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "15:05 Thank you, Keith and good morning everyone. As Keith noted, we are pleased with our performance in 2021 which continue to reinforce the strength of earnings and cash flow generation of our businesses. For the fourth quarter, we reported net operating income per share excluding reportable catastrophes of $2.49, up 21% from the prior year period. Excluding cats, net operating income for the quarter totaled $144 million and adjusted EBITDA amounted to $245 million, a year-over-year increase of 16% and 8%, respectively. 15:46 Now let's move to segment results, starting with Global Lifestyle. The segment reported net operating income of $108 million in the fourth quarter, a year-over-year increase of 20%. Growth was driven by strong performance in Global Automotive and Connected Living. 16:04 In Global Automotive, earnings increased $12 million or 29% from fourth quarter 2020. The increase is based on 3 main items, including, first, continued organic growth across distribution channels, mainly in the US and including AFAS contributions. Second, there were loss experienced from selected ancillary products. And third, higher investment income. 16:32 Connected Living’s earnings increased by $9 million or 21% year-over-year, more than offsetting the implementation costs associated with the initial deployment of in-store device repair services with T-Mobile. These costs are primarily related to technician hiring and parts sourcing and will further impact Connected Living’s earnings in 2022 as we continue investing in our in-store capabilities. 17:01 The fourth quarter increase in Connected Living was primarily driven by 3 items. Higher trading volumes, including a full quarter of contributions from HYLA and carrier promotions; higher international earnings, including improved performance in Europe and Asia Pacific; and continued mobile subscriber growth in North America, including growth from our cable operator partners. This quarter Connected Living and Global Automotive results also included a modest tax benefit that improved earnings. 17:31 For the quarter Lifestyles adjusted EBITDA increased 16% to $159 million. Adjusted EBITDA eliminates the segments increased IT depreciation from higher investments, as well as amortization resulting from higher deal related intangibles from the more recent transactions in T-Mobile and Global Automotive. 17:56 As we look at revenues, Lifestyle revenues increased by $168 million or 9%. This was driven mainly by continued growth in global automotive and Connected Living. In Global Automotive, revenue increased 12% reflecting strong prior period sales of vehicle service contracts across all distribution channels. In the US, we saw continued expansion from our national dealer network, and third-party administrators, while we benefited internationally from higher volumes with OEMs. As expected, our net written premiums, a key sales metric, continue to normalize compared to the third quarter, but remain elevated. We expect continued normalization into 2022. 18:42 Within Connected Living revenue increased 7%, primarily due to mobile fee income that was driven by strong trading volumes, including contributions from HYLA. Trading volumes continue to be elevated in the fourth quarter, supported by new phone introductions and carrier promotions from the introduction of 5G devices. Higher revenue growth in domestic mobile subscribers was offset by declines in run-off mobile programs previously mentioned. 19:13 For the year, mobile subscribers grew 18% to nearly $63 million, driven by growth in North America, including the transition of legacy Sprint subscribers. Excluding the Sprint transition, our North American device count continued to grow at a healthy pace and was up 8% offsetting declines in other regions. 19:35 Looking ahead to 2022, we expect Global Lifestyle adjusted EBITDA to increase by low double digits. Growth will be mainly driven by Connected Living and particular mobile, from continued global expansion in existing and new clients and across device protection in trade-in and upgrade programs. Given the strategic investments we're making across Lifestyle to support new business opportunities, including in-store service and repair capabilities, we do not anticipate growth to exceed the 12% growth rate we had in 2021. 20:11 In Global Automotive we expect adjusted EBITDA to be stable in 2022 compared to 2021 as we overcome headwinds in investment income and the absence of $10 million of non-recurring gains we recorded in the first half of 2012. 20:33 Moving to Global Housing. Net operating income was $80 million for the fourth quarter compared to $61 million in the fourth quarter of 2020, driven by lower reportable catastrophes. Excluding catastrophe losses, earnings decreased $7 million, mainly due to higher non-cat losses in our Specialty P&C offerings. Non-cat losses included an $8.2 million increase, primarily related to reserve strengthening for run-off claims within our small commercial book. As a reminder, this book stopped getting policies in 2019, but we continue to manage open claims. Absent this reserve increase, earnings were relatively flat as growth in lender placed was offset modestly by higher non-cat losses. 21:20 Recall, certain factors in 2020 and the first quarter of 2021 temporarily depressed non-cat loss levels. We do not consider those periods to be representative of historical and future trends. Earnings growth in lender placed insurance was driven by the higher average insured value of in-force policies and claims processing efficiencies, which were partially offset by the impact of the continued foreclosure of moratoriums. In January, we replaced our existing reinsurance coverage, representing 2/3 of our 2022 catastrophe reinsurance program placement. We were able to continue placing reinsurance covering multiple years to mitigate changes in the pricing of cat reinsurance in any one year. 22:09 And similar to prior years, the remainder of our reinsurance will be placed around mid-year. We will continue to evaluate the risks and rewards purchasing additional reinsurance, as well as alternatives that could more meaningfully reduce our risk. 22:25 In Multifamily Housing underlying growth in our affinity and P&C channels was offset by increased expenses, primarily investments to further strengthen our customer experience, including our digital capabilities. Global Housing revenue increased 2% year-over-year, mainly from higher average insured values and premium rates in lender placed and growth in Multifamily Housing. This was partially offset by lower specialty revenues from client run-off. 22:55 For 2022 we expect Global Housing's adjusted EBITDA excluding cats to grow by mid to high single digits compared to 2021. This is expected to be driven by 3 factors. First, growth in lender placed insurance from continued higher average insured values and gradually higher REO volumes due to easing foreclosure moratoriums throughout the year. Growth is expected to be partially offset by the impact of higher labor and material costs. 23:29 Second, expense savings initiatives, including our Digital first efforts focused on automation will have a positive impact, albeit partially offset by continued investment initiatives particularly in multifamily housing. And third, improved loss experience in our specialty offerings related to small commercial. At corporate, the net operating loss was $24 million, an improvement of $3 million compared to the fourth quarter of 2020. This was mainly driven by higher investment income in the quarter from higher asset balances, including proceeds from the sale of Global Preneed. For 2022, we expect the corporate adjusted EBITDA loss to approximate $105 million, more in line with historical levels. 24:16 Turning to holding company liquidity. We ended the year with slightly over $1 billion, primarily due to the proceeds from the sale of our Preneed business. In the fourth quarter, dividends from our operating segments, totaled $176 million. In addition to our quarterly corporate and interest expenses we had outflows from 3 main items. $290 million of share repurchases, $39 million in common stock dividends, and $5 million related to Assurant Ventures Investments. For 2022, we expect our businesses to continue to generate strong cash flow and at a similar rate to prior years. 24:58 With the transition to adjusted EBITDA, we expect segment dividends to be roughly 3/4 of segment adjusted EBITDA, including catastrophes. This translates to approximately 100% of segment net operating income. As always, segment dividends are subject to the growth of the businesses, rating agency and regulatory capital requirements and investment portfolio performance. 25:22 As Keith mentioned, we expect to provide additional color for 2022, including our outlook on a per share basis that aligns with adjusted EBITDA, along with further detail regarding our long-term view of financial metrics that support Assurant’s strategic direction at Investor Day next month. As a result of the expected level of share repurchases, we wanted to note that we expect that our growth on a per share basis will significantly exceed our adjusted EBITDA growth. 25:53 In closing, we are really excited to have met our objectives for 2021 despite the difficult operating conditions brought on by the pandemic. And we're excited to be entering 2022 with the positive business momentum we highlighted today. 26:09 And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "26:14 The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Tommy McJoynt from KBW. Your line is open."
},
{
"speaker": "Tommy McJoynt",
"text": "26:47 Hey, good morning guys. Thanks for taking my question. So could you guys start off and just talk about the impact of inflation on your device repair and upgrade business. Obviously, there's different factors with replacement parts and higher labor and wages. So if you could just kind of touch on how you're managing those risks?"
},
{
"speaker": "Keith Demmings",
"text": "27:05 Sure and good morning. Maybe I'll start -- talk a little bit about mobile and then Richard, you can talk more broadly about inflation overall. I'd say, on the mobile business it had a relatively neutral impact on our financials. As we've talked about before, the business is largely reinsured and profit shared with our clients. So you do see a little bit of impact on loss ratios when we're on risk, but it's been fairly immaterial as we look over the course of the last many months. 27:33 I would also say, from our perspective, we also think about delivering service to the end consumer and making sure we've got the right levels of inventory. So that's equally important to make sure we're delivering and we've done a really good job stocking inventory, making sure we've got good lead time for parts delivery. From time to time we do see delays in terms of claim fulfillment, sometimes that means some repair might take a little longer or might have to replace a device versus doing a repair. But overall, customer service has been excellent and NPS scores in terms of what customers are telling us have been really, really strong. 28:09 So that's more from the parts side. I'd say in the labor market, no doubt, it remains challenging, and this is true across all of the businesses around the world. I would say, I’m really proud of how the teams have navigated, not just the labor market, but really the pandemic overall with work from home. I think because we kept health and safety at the front of everything that we did from a decision making perspective, we've built an incredible culture within the organization and I think we haven't seen a lot of the great resignation that you hear about every day. We've done an incredible job of protecting our employee base. And in fact we hired 2,000 employees to staff the 500 T-Mobile stores to do repairs. And obviously, including leadership positions we did that extremely well in a very challenging market. So really proud of how we've navigated labor. And I think one of our advantages is the talent that we have. 29:04 But maybe, Richard, just a little bit more on macro inflation as we think about the housing business as well."
},
{
"speaker": "Richard Dziadzio",
"text": "29:12 Sure, sure. Thanks, Keith. And good morning, Tommy. Yeah. Just in terms of the housing business overall, we have seen some increase in claim costs and that's a little bit of a headwind, but on the other hand, we've -- as we talked about in our remarks, we have seen an increase in average insured value. So that to a certain extent offset the pressure there. 29:35 I guess the other thing I would say too is, while short-term we do feel some pressure from it. We have factored it into the comments we made today in terms of what we would consider to be the impact of inflation on our businesses in 2022 in the outlook that we gave. And also positive will be rising interest rates that will flow through to investment income. So the higher rates will be helpful, both on a short and longer term on the cash that we have in hand today, and also on new money coming in, premiums coming in as we invested. 30:09 So overall, we don't see a material impact in the short-term or actually as we go further off. Thank you."
},
{
"speaker": "Tommy McJoynt",
"text": "30:19 Thanks. Appreciate the feedback. And then just switching gears a little bit to the outlook and into the guidance on EBITDA. So if I look over the past couple of years, the EBITDA margin has kind of been in the 10% to 11% range. When you kind of think of long-term where EBITDA should go, do you think you should build in some margin expansion on EBITDA or do you think that 10% to 11% is kind of a good long-term rate."
},
{
"speaker": "Keith Demmings",
"text": "30:43 Yeah. I guess a couple of comments. We will be obviously coming out at Investor Day in -- on March 24 with a longer-term outlook. So we will be coming to the market with 3 year longer-term financial projections. So that'll be a great time for us to lay out our vision for the future. And certainly if you look at our outlook for ’22, strong EBITDA growth, we've signaled 8% to 10% and we saw 9% in 2021. So continued strong momentum in terms of driving EBITDA growth. And I would also say we're investing more as well organically to try and set up the future. And we'll talk a lot more about some of those investments and how we think about long-term growth trajectory emerging as we get back together in a few weeks."
},
{
"speaker": "Tommy McJoynt",
"text": "31:31 Thanks. I look forward to speaking on. Thanks."
},
{
"speaker": "Keith Demmings",
"text": "31:34 Thank you."
},
{
"speaker": "Operator",
"text": "31:36 Your next question comes from the line of Michael Phillips from Morgan Stanley. Your line is open."
},
{
"speaker": "Michael Phillips",
"text": "31:43 Thanks. Good morning. Actually, you just touched on it, but maybe a little bit deeper if you could on the guidance for EBITDA. I guess I was curious. And again, maybe nothing more than what you just said, but I'll say -- curious on how much, I guess, overall investment we should think about as being done this year relative to, say, the amount that was done last year as we look at that 8% to 10% guide for EBITDA."
},
{
"speaker": "Keith Demmings",
"text": "32:08 Yeah. I would say we expect to make more investments overall across the company in 2022 than in 2021. We obviously had some material investments when you look at standing up, taking a repair with T-Mobile, there was a significant lift to do that, obviously, converting the Sprint business. So there certainly were investments in ’21. I would signal a little bit more investment to drive organic growth. And I would probably highlight a couple of areas. Certainly, we're going to continue to invest in service and repair capabilities, really building out the platform, the technology and the integrations. 32:45 We talked about investments in digital first in the prepared remarks, that's a really important priority for the organization. Obviously, it drives efficiency longer term, but it radically improves the customer experience, so that's a big priority. We've got several new client launches that are planned that obviously take a significant amount of energy to get right and make sure we execute and deliver. And then investment in longer term growth, new capabilities around the connected home, around innovation to drive new product bundles, a new cross-selling opportunities, and I would say further scaling capability in Europe and Japan. 33:21 So there's a lot of areas that we're trying to focus on. There is a significant amount of long-term growth potential across all of our product line. So I would say, a pretty balanced set of opportunities."
},
{
"speaker": "Michael Phillips",
"text": "33:35 Okay, thanks. That's all, but I’m sure we will get a lot more details in a few weeks. You mentioned this in the opening comments as well, maybe a little more detail here. Is the expenses that you've incurred from the T-Mobile rollout that was kind of pushed into 4Q and some now, end of this year. Is that going to be more of a 1Q issue or that continue at that same level as we get past 1Q 2022?"
},
{
"speaker": "Keith Demmings",
"text": "34:03 Yeah, I would say it will moderate from what we saw in the fourth quarter. We did a great job, that was a lot of work as you can imagine, staffing up 500 stores over the course of really 4 or 5 months and then training, onboarding all of our leadership, all of our technicians. It’s just an incredible effort. I would -- First thing I would say, it underscores our ability to not only adapt to changing consumer preferences, but then drive significant focus on execution as a company and we did the same unit repair launch while we were migrating all of the Sprint business and while we were staffing up to manage all of the Sprint business as well separate from same unit repair. So a significant lift, certainly in fourth quarter. I would say, it came in broadly in line with expectations in the quarter and it will certainly moderate as we get into 2002 as we look to -- the first and second quarter, we'll certainly see more investment going forward and it will taper as we get through the rest of the year."
},
{
"speaker": "Michael Phillips",
"text": "35:07 Okay. Thanks, Keith. One last one and a more high level question if I could. You continue to outpace the market and growth and renters policies pretty significantly. Maybe you can talk about that. And is that something that you think you can continue to do over the long term? It's pretty significant growth there versus the ramp in market in general. So –and you've done it for quite a while. But I guess should we expect that to continue for the foreseeable future."
},
{
"speaker": "Keith Demmings",
"text": "35:35 Yeah. I mean we've been really pleased with the performance this year, but as you say, over time really good strong consistent growth and also growing market share. I mean, if you look back over the years, and we'll talk more about that, I'm sure at Investor Day as well. But really strong overall share gains in the market. And we've seen a lot of good trends as well. The product is -- the attachment rates on the products have gone up over time and that's certainly helping. We've grown our relationships with property management companies. And I certainly expect us to continue to drive policy growth and revenue growth going forward. That's another business that we're investing significantly in trying to evolve how we deliver services. 36:21 Thinking about investments in technology, investments in customer experience, digital integration with our partners and then thinking about other services that we can add that are relevant for renters. So, really excited about that business long term and certainly expect momentum to continue as we move forward."
},
{
"speaker": "Michael Phillips",
"text": "36:40 Thank you. I appreciate it."
},
{
"speaker": "Keith Demmings",
"text": "36:42 Great, thank you."
},
{
"speaker": "Operator",
"text": "36:44 Your next question comes from the line of Tom Shimp from Piper Sandler. Your line is open."
},
{
"speaker": "Tom Shimp",
"text": "36:50 Hi, good morning. Congrats on the strong quarter. So, very strong growth in Global Automotive in the past, you've spoken about the increase in attachment rates from the high '30s to the high '40s, given the increase in prices and technology. Given the chip shortage, there has been a number of reports of buyers paying over sticker for new cars, and we've got used car prices up as much as 40%. So, do you believe this is having an effect on attachment rates? And maybe you could just give some general thoughts on whether the pie is getting bigger? Whether Assurant is getting a bigger piece of the pie, or both?"
},
{
"speaker": "Keith Demmings",
"text": "37:26 Yeah. I think Assurant is definitely getting a bigger piece of the pie. I would say that, attachment rates have probably drifted up more because of the mix of business that we've seen a shift between new and used and we tend to see slightly higher attach rates on used vehicles. So if you think historically, we've had a 50:50 mix roughly between new and used cars. Today, it's probably 55% used, 45% new. So that would create a little bit higher overall blended attach rate. I wouldn't say that it's significantly change otherwise, we've seen good strong consistent performance. And as always, it's a focus for our clients. We've gained market share, no doubt, in the market that we've seen a lot of consolidation in the industry. We're partnered with a lot of large publics, a lot of large dealer groups and they're gaining share through acquisition, I think we've seen more acquisitions in 2021 in terms of the big publics. And then also our franchise dealers have been investing heavily in digital and also sourcing a lot more used car inventory directly from consumers. So a pretty significant improvement in terms of the performance of our clients. And then I'd say we've also won new clients as well in the market and it's a very fragmented market today. So there's still a lot of opportunity for share gain over time."
},
{
"speaker": "Tom Shimp",
"text": "38:55 Okay, great. Maybe moving to mobile. There has been a lot of moving pieces in 5G after what seems like a delayed rollout. There is an uptick in 5G promotions and activity around that potential catalyst, but then we recently had the delay in 5G implementation due to the FAA. So maybe you could frame for us how to think about the potential benefit from 5G? Whether it's total covered mobile device count or trade in volumes? How should we think about the cadence of the benefit to ‘22 earnings and the years that follow?"
},
{
"speaker": "Keith Demmings",
"text": "39:27 Yeah, we had a significant success in 21 certainly with trade in volumes at all-time highs. And that's partly due to the acquisition of HYLA and then due to a number of other factors. You point out the promotional activity from clients, obviously, the migration to 5G, we've seen clients put more focus and energy on trade in. Obviously, it's got sustainability benefits, which is really important. It also provides digital access to consumers at more affordable rate. So there's a lot of reasons why I would say trade-in is generally growing as a category. We're seeing a lot more interest around the world with different partners. So from that perspective, I feel really good about that trend continuing. 40:16 And then in terms of 5G, specifically I'd say we're still fairly early in the cycle. You've got maybe 20% to 30% of postpaid customers in the key markets that we operate that have migrated to 5G networks. So there's still a lot more opportunity as consumers continue to upgrade devices and adopt 5G. So we will see continued promotional activity and we'll see a lot of trade-in volume as we move through 2022 that certainly underpins some of our thinking with our Connected Living growth. And then I think we'll see more globally as this continues to get focused."
},
{
"speaker": "Tom Shimp",
"text": "40:55 Great. Thank you for your answers."
},
{
"speaker": "Keith Demmings",
"text": "40:57 Thank you."
},
{
"speaker": "Operator",
"text": "40:59 Your next question comes from the line of Mark Hughes from Truist Securities. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "41:06 Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"text": "41:07 Yeah. Thank you. Good morning. You had mentioned that you're looking to evaluate perhaps alternative risk strategies in Global Housing, maybe lay off a material portion of your catastrophe exposure. As I understood you to say, I had thought that had kind of been put to bed. But it sounds like you're still working on it, still evaluating it. Could you talk about what you're thinking is there? How serious that initiative might be?"
},
{
"speaker": "Keith Demmings",
"text": "41:44 Sure. And maybe I'll start just reinforce a little bit about the business and then I'll address your question. I mean, I would just highlight, it's a really unique high-performing business. If you think about the cash flows that generate out of our housing business and the important role that we play in the mortgage value chain. So we're really proud of the business and the result that’s delivered. And I would say if you look at housing overall. We talk about targeting of 17% to 20% ROE after a normal cat load. If you look at 2021, we actually had $114 million of cat losses, so more than what we would consider our normal cat load and still delivered a 16.5% ROE. 42:28 So, broadly really strong business, great ROEs and it generates a ton of cash flow. So we really like the business for a lot of different reasons. In terms of the comments around the cat exposure, I would say, we're always looking for ways to optimize the cat exposure. You've seen a pretty strong track record of reducing risk over the years and that's not just as we've grown other parts of the company, we've significantly grown parts of housing and then obviously Lifestyle, which don't have much of any cat exposure at all. We've also dramatically reduced our per event exposure from $240 million to $80 million over the years and then a lot of other decisions around multi-year coverage, exiting certain non-strategic cat-prone markets, et cetera. So you've seen a lot of discipline that will no doubt continue as we move forward, but we are always looking to see if there are further ways to optimize. 43:27 Is there a risk-reward trade-off that we can work with reinsurance partners in a different way to further mitigate the risk, further mitigate the volatility and try to drive the right most efficient optimal outcome. And we're going to continue to look at that. I wouldn't say there's anything imminent that we're doing other than -- this is normal course for us and it's very important for us to be thinking about our reinsurance and our cat risk all the time."
},
{
"speaker": "Mark Hughes",
"text": "43:55 And then you had made, I think, a point of saying that you were looking for a balanced mix of investments in share buyback. If I did the simple person and said, if you look at free cash flow for 2022 is it half share buyback, half retained for investments or M&A."
},
{
"speaker": "Keith Demmings",
"text": "44:15 Yeah. We will spend more time on capital management, certainly at Investor Day. I would say a couple of things. We're not trying to signal a dramatic shift in our philosophy, that's point number one. We continue to be extremely disciplined as we think about capital management. So that's not going to change. And ultimately, we're trying to maximize returns. I think what we're more trying to signal is an interest in maintaining greater flexibility. There is lots of attractive opportunities in the market to drive growth and we want to have a little more flexibility to try and evaluate the best alternatives, but obviously being extremely disciplined with how we think about long-term value creation. So we'll talk a little bit more about our expectations for capital deployment in a few weeks, but that would probably be the bigger takeaway from me."
},
{
"speaker": "Mark Hughes",
"text": "45:10 Yeah. And then just one if I may. You talked about expanding the Connected Home, does that suggest an appetite or maybe a broader home warranty exposure?"
},
{
"speaker": "Keith Demmings",
"text": "45:27 Yeah, I think we're -- where we play today around the Connected Home is more around the connected technology, the appliances, the electronics that side of the business. We don't really have home warranty within our portfolio today, and that's a big competitive market. There are many strong players in that space. So I think there is an opportunity more uniquely for us as we think about building bundled subscription services to protect more broadly consumers connected technology and other products that they have in their homes. So that's more of the angle that we think is appropriate for Assurant. And we'll talk more about that at Investor Day, but we definitely see interesting trends, a lot of appetite from consumers. We operate with a broad range of distribution partners, so there is a lot of interesting bundled services that we think we can bring to bear for sort of the connected consumer of the future."
},
{
"speaker": "Mark Hughes",
"text": "46:26 Great. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "46:27 Thank you."
},
{
"speaker": "Operator",
"text": "46:30 [Operator Instructions] Your next question comes from the line of Brian Meredith from UBS Financial. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "46:43 Good morning, Brian."
},
{
"speaker": "Brian Meredith",
"text": "46:44 Good morning. A couple of questions here. Firstly, I’m just curious on the repair centers in T-Mobile stores. Is that an exclusive deal? Or could you roll that out to other customers? And what is kind of in the inquiries you perceived on doing that? I think that a lot of the other customers would be really interested in that type of a program."
},
{
"speaker": "Keith Demmings",
"text": "47:04 Yeah, I think you're right. And we've certainly -- and you've seen it with our investments dating back a few years, right? We invested in and bought a company called CPR. We also bought Fix. So we have lock in repair facilities operated by Assurant. We've got come to you repair technicians as well and now for T-Mobile operating within their store. Definitely I think we'll see more and more interest from clients around the world as they think about the appropriate repair strategy and claims fulfillment strategy for each brand. So, definitely it's client by client in terms of what's most appropriate and what vision do they want to create for servicing consumers, but I definitely expect to see more appetite over time."
},
{
"speaker": "Brian Meredith",
"text": "47:48 Great. And then I'm just curious, one quick one on the catastrophe reinsurance program renewal. It sounds like fairly similar structure to the program. What about the cost of it? What was the additional costs associated with it?"
},
{
"speaker": "Keith Demmings",
"text": "48:03 Yeah. And I would say we're really pleased with the renewal that we got. And Richard I know works closely on it, maybe share a couple of thoughts, Richard."
},
{
"speaker": "Richard Dziadzio",
"text": "48:13 Yeah, I think as we've said before on renewals in the beginning, we have to invest. And then as we go along we make profits over time. And it's gone really well so to date, I mean, to date. Our partners can deliver better solutions for our customers with what we're doing. So it's not just in service repair. I would say today we've covered most of it through the end of the year, we're probably about 2/3 of the coverage being placed. And we'll place the rest of it in the year as you know. And we had success in the pricing of it. We have a pretty stable reinsurers and if we look out in the market we had some reinsurers that -- has some insurance who have trouble placing. We placed 100%, we placed it at the low end of the market as well. It ranges from anywhere from 5% to 30% on reinsurance. So we've done a really good job."
},
{
"speaker": "Brian Meredith",
"text": "49:13 Got you, got you. So towards the low end of the market. Great."
},
{
"speaker": "Richard Dziadzio",
"text": "49:17 Yeah. Single – I’d put it in the kind of the mid to single digits overall. So in a really good place."
},
{
"speaker": "Brian Meredith",
"text": "49:24 Terrific. Good outcome. And then I guess this is my last and maybe you’ll be touching this in Investor Day. When I think about your 8% to 10% EBITDA ex-cat guidance for 2022, should I think about that is more margin driven or revenue driven?"
},
{
"speaker": "Richard Dziadzio",
"text": "49:43 I mean we're – certainly both. I mean, we are grow revenues as a company, but we're also expanding margins if you think about the makeup of our business. We typically have grown profitability at a quicker pace than we've grown revenue, just based on some of the ways that revenue flows through the P&L. So I do expect to see margin expansion in terms of the breadth of services that we deliver to clients over time. So defiantly growing revenue but growing margins quicker than revenues which is typically been the case."
},
{
"speaker": "Brian Meredith",
"text": "50:17 Great. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "50:21 Thank you."
},
{
"speaker": "Operator",
"text": "50:21 And your final question comes from the line of Grace Carter from Bank of America. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "50:28 Good morning. Grace."
},
{
"speaker": "Grace Carter",
"text": "50:30 Hi, good morning. Looking at the guidance for amortization of intangibles next year. I was wondering if we could clarify any assumptions regarding bolt-on M&A that are included in that estimate? And just given recent market volatility, if we could talk about just the outlook for bolt-on M&A opportunities in the Lifestyle business? And if valuations are any more attractive now than they were a few months ago?"
},
{
"speaker": "Richard Dziadzio",
"text": "50:56 Maybe Keith, you want to take the first part in terms of the next year?"
},
{
"speaker": "Keith Demmings",
"text": "51:00 Perfect."
},
{
"speaker": "Richard Dziadzio",
"text": "51:01 Yeah, just to start with the numbers. I mean, it doesn't -- the numbers that we've given in the earnings outlook really doesn't include any future acquisitions we buy, it's really the current acquisitions we've done and how it kind of rolls forward. So I would just say, remember, we've done deals at the end of last year where we have HYLA and AFAS. And that's going to be running through."
},
{
"speaker": "Keith Demmings",
"text": "51:28 Yeah. And in terms of M&A, obviously, we're always looking in the market for attractive opportunities and valuations certainly move around. We've seen really high expectations at times and more tempered than others, but I would say, we're definitely interested in acquiring strategic capabilities. You've seen us do I think some really good strong foundational acquisitions. If I think back to The Warranty Group, which was a big scale play, gave us a great overlap with our current geographies and really a global leading position around auto. The acquisition of HYLA, that really scaled us as the global leader in trade-in. Right on the front edge of the 5G super cycle, you saw the acquisition of AFAS, which gave us real strength in the US auto market to complement the acquisition of The Warranty Group. And then some of the mobile acquisitions I talked about, CPR and Fixed really just important capabilities and set the foundation for what we're doing today with T-Mobile. 52:32 So I think we're going to continue to look for those types of acquisitions. And we always try to find multiple ways to win. How do we get access to new clients or new distribution channels, new capabilities that can wrap around the services that we already provide and then clearly looking for low risk in terms of integration, execution and financial performance. So we're always looking for those types of deals. That's why we want to maintain flexibility. But as you've seen, we will continue to be disciplined and we will try to find really strategic opportunities to drive that growth."
},
{
"speaker": "Grace Carter",
"text": "53:11 Thank you. And just another one. Looking at the housing adjusted EBITDA guidance for next year. It sounds like the combined ratio might drift a little below that historical guidance of 86% to 90%. I was just wondering how sustainable maybe a combined ratio below that could be? And just how we should think about that going forward, just given ongoing changes in the mix of business with Multifamily Housing Kind of outgrowing lender placed?"
},
{
"speaker": "Keith Demmings",
"text": "53:45 And Richard, do you want to talk a minute on that?"
},
{
"speaker": "Richard Dziadzio",
"text": "53:48 Yeah, I think the historical guidance that we gave 86% to 90% is a long-term measure. And I would kind of base things on that. Obviously it depends on the mix we have within the business. And I think you're exactly right, as multifamily grows that kind of comes into the waiting on it. But I think what's more important to is, there is one part which is the combined operating ratio, the 86% to 90%, there is a second part which is the premiums. 54:20 And as we see markets changing over time, as we see the forbearance moratorium is running off and we see the inflation in average insured values and whatever. I think we're going to see premiums move up as well. So in terms of profitability, when we're talking about lender placed, for example, we are talking about looking at higher -- better performance in next year. And that is going to be driven by higher average insured values, the non-cat loss ratio staying at about current levels and that will help profitability overall. And in addition to that, obviously, we're working our expenses as we go along and the operation of efficiencies that we cited are helping the bottom line as well."
},
{
"speaker": "Grace Carter",
"text": "55:08 Thank you."
},
{
"speaker": "A - Keith Demmings",
"text": "55:09 Great. Thanks, Grace. And thank you everyone for participating in today's call. We're very pleased with our performance in 2021 and excited for another year of profitable growth in 2022. We're also looking forward to our upcoming virtual Investor Day on March 24, where we'll have the opportunity to share the Assurant vision, our strategy and multi-year financial objectives. So stay tuned for registration details coming out soon. And in the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. And thank you very much. Have a great day."
},
{
"speaker": "Operator",
"text": "55:44 Thank you. This does conclude today's conference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 3 | 2,021 | 2021-11-03 12:52:05 | Operator: Welcome to Assurant's Third Quarter 2021 conference call and webcast. At this time, all participants have been placed in a listen-only mode. And the floor will be opened for questions. Following management prepared remarks. If you would like to ask a question at that time, please press star one on your touchtone phone. Lastly, if you should require Operator assistance, please press star 0. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, Operator, and good morning, everyone. We look forward to discussing our Third Quarter 2021 results with you today. Joining me for Assurant's conference call are Alan Colberg, our Chief Executive Officer, Keith Demmings, our President, and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the Third Quarter 2021. The released and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Alan, Keith, and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties, and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release, as well as in our SEC report. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the Company's performance. For more detail on these measures, the most comparable GAAP measures, and a reconciliation of the two, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan.
Alan Colberg: Thanks, Suzanne. Good morning, everyone. Our third quarter results were strong driven by double-digit operating earnings growth in Global Lifestyle. The strength of our Global Automotive and Connected Living offerings continue to validate our long-term strategy of focusing on our higher growth, fee-based, and capital-light businesses. We continue to make progress in building a more sustainable Company for all stakeholders. During the quarter, a few key highlights included. For the first time, Assurant was awarded a bronze accreditation by EcoVadis, one of the largest sustainability ratings companies writing Assurant among the top 50% of all 75,000 participating companies. In addition, this quarter, we provided additional transparency to track our progress on our journey to build a more diverse and inclusive assurance. With the recent disclosure of our EEO one report, which provides gender, race and ethnicity data by job category for our U.S. based employees. We believe a diverse and inclusive workforce will best foster innovation, a key ingredient to sustaining our out-performance longer-term. Looking at our financial performance year-to-date, net operating income per share, excluding reportable catastrophes, was $8.75, up 12% compared to the first 9 months of last year. Net operating income and adjusted EBITDA, also excluding cats, both increased by 10% to $528 million and $862 million respectively. These results support our full-year outlook of 10% to 14% growth in net operating income per share, excluding your portable catastrophes, marking our 5th consecutive year of strong, profitable growth. Given year-to-date results and our expectations for the fourth quarter, we would expect to end the year closer to the top half of this range. We've also now completed our 3-year $1.35 billion capital return objective from our 2019 Investor Day, a quarter ahead of schedule. Following the close on the sale of Global Preneed in August, we've also made meaningful progress in returning an additional $900 million to shareholders. Our 2021 EPS outlook is driven by at least high single-digit net operating income growth excluding catastrophe, as well as sharing purchases. Turning to our business performance in Global Lifestyle we are on track to grow adjusted EBITDA by double-digits in 2021 from $637 million in 2020, driven by Global Automotive and Connected Living. We have benefited from the stable recurring revenue stream of our installed base of mobile subscribers. And our success in launching additional offerings and capabilities for mobile carrier cable operator, OEM, and retail clients globally. Additionally, our mobile trade-in and upgrade business and expanded service delivery options are increasingly important to our profitability, and also in providing a differentiated and superior customer experience. Within Global Automotive, we've benefited from increased scale, growing the number of vehicles we protect by 20% over 52 million since The Warranty Group acquisition in 2018. We believe auto will continue to be one of our key growth businesses in the future. In Global Housing, we continue to be on track for another year of better-than-market returns with an annualized operating ROE of nearly 15% for the first 9 months of this year. This includes $113 million of catastrophe losses, which further demonstrates the superior returns at this differentiated business. Our countercyclical lender placed insurance business remains an integral part of the mortgage industry framework in the U.S. Within lender place as we renew existing clients and add new partners, we will continue to enhance the experience through the ongoing rollout of our single-source processing platform. Our multifamily housing business now supports over 2.5 million ventures across the U.S. and has more than doubled earnings since 2015 through our strong partnerships with our affinity and property management Company clients. Our investments in digital capabilities such as our coverage 360 property management solution, continues to drive more value for our partners and an enhanced customer experience. Overall, we believe our portfolio of high-growth, fee-based, capital-light offerings and high return Specialty P&C businesses sets us apart as a long-term outperformer and sustained value creator for our shareholders. With my retirement at year-end, I wanted to take this opportunity to thank all of our stakeholders that have supported Assurant 's strategic vision and path over the last 7 years. Most of all, I'm humbled by our 15,000 employees who through their dedication to serve our clients and our 300 million customers worldwide, have successfully transformed assurance. Together, we have significantly strengthened our Fortune 300 Company that should continue to deliver above-market growth and superior cash flow. With our president, Keith Demmings succeeding me as CEO in January, I'm confident Assurant will accelerate our strategy and continue to differentiate our superior customer experience will further deepening client relationships. I'll now turn the call over to Keith to review our key business highlights in greater detail for the quarter. Keith?
Keith Demmings: Thank you, Alan. And good morning, everyone. On behalf of our employees, I wanted to express our sincere thanks to Alan for his leadership as CEO. I've been fortunate to have had a front row seat and a role in supporting Alan's vision and the transformation of Assurant. Importantly, he has continued to evolve the purpose of our Company to drive value for all stakeholders, customers, employees, communities, and shareholders. The impact he has had on our people and the overall culture of our Company has been exemplary. And I appreciate Alan's personal mentorship and partnership and wish him the very best in his retirement. As we build on assurance momentum over the long term, I believe our talent and innovation will be critical factors to achieving success and growth, especially as we focus more on the convergence around the connected consumer. From a talent perspective, Assurant has developed a deep and diverse bench of internal leaders. A few weeks ago, I announced our refreshed management committee effective in January, including 2 new leadership appointments illustrating our strong bench. First, Keith Meier, our current President of International, will succeed Gene Mergelmeyer as Chief Operating Officer, as Gene will be retiring at year-end. Gene 's significant contributions to Assurant over the last 30+ years, including as COO over his last 5 years, have been instrumental in creating market-leading positions, producing profitable growth, and transforming the organization. In succeeding Gene, Keith Meier brings nearly 25 years of experience at Assurant to the COO role. Since 2016 as President of Assurant International, he's driven growth across our global markets most recently with strong success in Asia-Pacific. In this new role, Keith will be focused on advancing Assurant's business strategy and market leadership positions, as well as identifying additional opportunities to deliver a superior customer experience. Second, Martin Jens will become President of Global Automotive. With over 30 years of experience, he currently leads the transformation and growth strategy for auto and has been instrumental in our introduction of innovative new products like EV One, our electric vehicle warranty protection. In addition to emerging opportunities and innovation, Martin will be focused on driving growth and improving the customer experience, including working with our partners to deliver best-in-class dealer training. These two new appointments along with recent appointments of Biju Nair as President of Connected Living, and Manny Becerra as our Chief Innovation Officer, as well as the other management committee members, represent a strong team to help lead us into the future. In addition to talent, innovation is an important strength of the organization. Not only the development of new digital products and offerings for our clients, but also through new paths to grow and scale Assurant's businesses. Within Connected Living, innovation was a significant theme this quarter through ongoing enhancements of our mobile service delivery options. As part of the recently finalized multiyear contract extension with T-Mobile, we're expanding the services Assurant provides to continuously improve the customer experience for millions of T-Mobile customers. As of November 1st, Assurant is partnering with T-Mobile to begin the nationwide rollout of in-store device repair services to approximately 500 stores provided by Assurant 's industry-certified repair experts. In addition, we have also transitioned all of the legacy Sprint protection subscribers to the new T-Mobile device protection offering. As a result, this significantly adds to our mobile device count, now at roughly 63 million as of November 1st. Overall, the expansion of our service delivery options is critical to sustaining our competitive advantage. We also recently signed a multiyear renewal with Spectrum Mobile, continuing to provide a comprehensive device protection program, which includes trade-in, premium tech support, and Pocket geek mobile. Assurance on-device diagnostic tool. With the renewal, we will also be expanding the offering to include Pocket Geek Privacy, which enables consumers to better protect and manage their personal information online through various features. This is another example of how we're able to grow by adding services and capabilities to existing clients. In addition, the mobile business continues to see strong attachment rates given the increased reliance on mobile devices, as well as rising device prices. Our fee driven trade in an upgrade business, including the previous acquisitions of Hyla and Alegre have performed extraordinarily well already this year as we enter the early innings of the 5G upgrade cycle. In fact, almost a year after the transaction of Hyla closed, I'm happy to report the acquisition has performed better than expected ahead of the low-teens forward EBITDA, the acquisition was valued on. With the growing availability and popularity of 5G enabled smartphones, we expect to see our 30-plus trade-in and upgrade programs continue to grow. Our progress is demonstrated through our ability to manage large-scale programs with superior technology. This is further supported by increasing our attach rates for trade-in programs as our clients’ promotional efforts encourage consumers to upgrade. Overall, we have processed nearly 18 million devices so far this year, reducing e-waste, and increasing digital access with high-quality, affordable phones. Through the scale and capabilities of our trading and upgrade programs, we benefit from an additional source of profits and improved client economics and customer retention. This quarter, we are pleased to announce that we have signed a multiyear contract extension with AT&T to manage their device trade-in program. This includes providing analytics, as well as device collection and processing for all of their sales channels, including retail, B2B, dealer, and direct-to-consumer. AT&T was a key client added with the Hyla acquisition, and we look forward to continuing to do business with them, specifically as we help support the growing adoption of 5G-enabled devices. In Global Automotive, policies increased by $4 million or 8% year-over-year and production is well above pre -pandemic levels as we continue to take advantage of our scale and talent. So far this year, the business has also benefited from strong used car growth, which tends to earn faster than new car sales. This along with the fact that earnings from the business are recognized over a multiyear period, provides good visibility into future performance of the business. As we drive innovation within auto, we continue the global roll out of EV One, an electric vehicle and hybrid protection product from North America. EV One has now been rolled out in 7 countries. While the electric vehicle market is still in its infancy, our EV1 product will allow Assurant and opportunity to better evaluate customer demand and leverage our learnings to position us well for the expected increase in electric vehicle adoption in the future. Our multi-family housing business grew policies by 7% year-over-year from growth in our affinity partners, as well as our PMC relationships, where we continue the rollout of our innovative Cover360 product. In addition, we have seen other digital investments create opportunities for future growth. Our newly designed digital sales portal, which makes it faster and easier for residents to sign up for a policy, is driving significantly higher product attachment rates. Our new portal has seen an increase in conversion rates versus our legacy website that was first introduced last year. In summary, our ability to strengthen Assurant's talent and innovation supported by critical investments has and should continue to drive momentum for the future. I will now turn the call over to Richard to review the third quarter results and our 2021 outlook. Richard.
Richard Dziadzio: Thank you, Keith. And good morning, everyone. As Alan noted, we are pleased with our third quarter performance as our results reflect strong growth across Global Lifestyle and solid earnings in Global Housing. For the quarter, we reported net operating income per share, excluding reportable catastrophes of $2.73, up 5% from the prior year period. Excluding cats, net operating income, and adjusted EBITDA for the quarter, each increased 4% to $162 million and $262 million, respectively. Now, let's move to segment results starting with Global Lifestyle. The segment reported net operating income of $124 million in the third quarter, a year-over-year increase of 16%. Growth was driven by Global Automotive and continued earnings expansion within Connected Living's mobile business. In Global Automotive, earnings increased $8 million or 21% from continued global growth in our U.S. national dealer and third-party administrator channels, including contributions from our AFAS and international OEM channels. Better loss experience in select ancillary products and higher investment income also supported earnings growth in the quarter. Connected Living earnings increased by $6 million or 9% year-over-year. The increase was primarily driven by continued mobile subscriber growth in North America and better performance in Asia-Pacific, as well as higher trade-in volumes led by contributions from our Hyla acquisition and carrier promotions. This quarter, Global Automotive and Connected Living results also included a modest one-time tax benefit that improved earnings. For the quarter, Lifestyle 's adjusted EBITDA increased 17% to $177 million. This reflects the segment's increased amortization resulting from higher deal-related intangibles for more recent transactions in mobile and Global Automotive. IT depreciation expense also increased, stemming from higher investments. As we look at revenues, Lifestyle revenues increased by $158 million or 9%. This was driven mainly by continued growth in Connected Living and Global Automotive. Within Connected Living, revenue increased 10%, boosted by mobile fee income that was driven by strong trade-in volumes, including contributions from Hyla. Trade-in volumes were supported by new phone introductions and carrier promotions from the introduction of new 5G devices. Higher revenue from growth in domestic mobile subscribers was offset by declines in runoff mobile programs. Mobile subscribers were up slightly year-over-year and flat year-to-date as mid-single-digit subscriber growth in North America was offset by declines in other geographies, mostly due to three factors. First, the 750,000 subscribers related to a runoff European baking program previously mentioned, which is not expected to be a significant impact in our profitability. Second, subscriber growth for existing programs moderating in Asia-Pacific. And third, a slower-than-expected recovery from the pandemic in Latin America. In Global Automotive, revenue increased 8%, reflecting strong prior period sales of vehicle service contracts. Industry auto sales remained elevated in the third quarter and we benefited from this trend as reflected in the year-over-year growth of our net written premium by 12%. We have though seen this trend began to normalize beginning into the fourth quarter. For the full year, Lifestyle revenues are expected to increase modestly compared to last year's $7.3 billion, mainly driven by global auto and Connected Living growth. For all of 2021, we still expect Global Lifestyle as net operating income to grow in the high single-digits compared to 2020. Adjusted EBITDA for the segment is expected to grow double-digits year-over-year, which continues to grow at a faster pace in segment net operating income. As previously reported, we began our investment in the T-Mo in-store repair capability this quarter. However, due to the timing of the rollout, most of our associated start-up costs will occur in the fourth quarter. These costs primarily relate to technician hiring and parts sourcing. We do expect these costs to meaningfully impact Connected Living's profitability as we end the year. In addition, we expect our effective tax rate to return to a more normal level, approximately 23%. Looking ahead to 2022, we expect earnings expansion to continue, but more likely at more moderated levels as we continue to invest for growth, including additional implementation start-up costs for in-store service and repair. Moving to Global Housing, net operating income excluding catastrophe losses was $81 million for the third quarter. Including that $78 million of pre -announced catastrophe losses, mainly from Hurricane Ida, net operating income totaled $3 million. Excluding catastrophe losses, earnings decreased $19 million due to anticipated higher non-CAT losses, which returned to levels more in line with historical averages. As a reminder, favorable losses in 2020 were not representative of historical trends in third quarter 2020 mark the lowest point of last year. Mainly driven by last experience within lender-placed and specialty products. The year-over-year earnings decline was nearly all driven by unfavorable non-CAT loss experience from several factors. Largest Trivor, which contributed close to half of the increase, was from the expected normalization of the non-GAAP loss ratio. The balance of the decline was split relatively evenly between increased reserves related to our special PP&E offerings, primarily in our on-demand sharing economy business, as well as higher claims severity. Claims severity included moderate impacts from inflationary factors, such as higher labor and material costs. Where there is always a lag, if this trend continues, we would expect higher loss cost to be offset by increased rates over time. In multi-family housing, underlying growth was offset by increased investments to further strengthen our customer experience, including our digital-first capability. Global Housing revenue decreased slightly year-over-year from lower specialty P&C revenues, as well as account reinstatement premium resulting from Hurricane Ida and lower REO volumes in lender place. This was partially offset by higher average insured values and premium rates and lender-place and growth in multi-family housing. We continue to expect Global Housing's net operating income, excluding cats to be flat for the full year compared to 2020. For the fourth quarter and into 2022, we would expect non-CAT losses to continue to be above 2020, but in line with year-to-date 2021 experience, which is consistent with long-term trends. We also continue to monitor the REO foreclosure moratoriums and any additional extensions that may be announced. At corporate, the net operating loss was $21 million, an improvement of $4 million compared to the third quarter of 2020. This was driven by two items. First, lower employee-related expenses, and third-party fees. And second, expense savings associated with reducing our real estate footprint. In the fourth quarter, we do anticipate a higher loss due to the timing of spend. For the full-year 2021, we now expect the corporate net operating loss to be approximately $80 million driven by favorable year-to-date results, mainly from the one-time tax and real estate joint venture benefits. In the second quarter. This compares to our previous estimate of $85 million. As we look forward to 2022, we would expect our net operating loss in corporate to be closer to $90 million more in line with historical trends. Turning to the holding Company liquidity, including the net proceeds from the sale of Preneed in August we ended the third quarter with over $1.3 billion, well above our current minimum target level. In the third quarter, dividends from operating segments totaled $127 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items. $323 million of share repurchases, $39 million in common stock dividends, and $11 million mainly related to Assurant Ventures investments. In addition to completing our 2019 Investor Day objective, a returning $1.35 billion to shareholders from 2019 through 2021, we have also completed roughly one quarter of our objective to return $900 million in Global Preneed sale proceeds through share repurchases. For the year overall, we continue quick update on Assurant Ventures, our venture capital arm. In the third quarter, three investments in our portfolio in public via SPACs. We are pleased with the results as the 3 investments exceeded 7 times multiple on investment capital under their respective SPAC transaction terms. These transactions combined with strong performance in the broader Ventures portfolio, led to a $75 million after-tax gain growing through net income in the quarter. In addition to strong returns, these investments also provide key insights into emerging technologies and capabilities within our connected consumer growth businesses. Before turning to Q&A, I too would like to take a minute to thank Alan for his partnership over the last 5 years. In addition to positioning Assurant for long-term success and growth, he's created an environment of inclusion and community, truly representative of our core values, common sense, and common decency. Alan, I wish you all the very best in retirement. Well-deserved. And with that, Operator, please open the call for questions.
Operator: Thank you. The floor is now open for questions. . Again, we do ask that while you pose your question that you pick up your handset
Unidentified Analyst: new potential per device and just kind of the bottom-line profitability for those new devices relative to your $53 million in forced devices at quarter-end?
Alan Colberg: Sure. Maybe I will take that and backup for just a second. So, first thing I'd emphasize is just the strong partnership that we've had with T-Mobile for many years, which is obviously scaled significantly over time. We're extremely pleased to have reached multiyear extension. And then the migration of the Sprint customers on November 1st along with the ramping of same-unit repair inside of 500 T-Mobile stores is obviously very exciting as we look to the future. As we've discussed on previous calls, it's not uncommon for us to forgo economics when we re-contract with major clients. That's particularly true if the client scales dramatically over time, which obviously is the case
Keith Demmings: with T-Mobile. As a result of the new agreement going forward, we do expect lower per unit economics. But I would say that once we get same-unit repair fully ramped and normalize our performance, which will take some time, we do expect overall to be able to more than offset the margin pressure with the additional Sprint volume with economies of scale within the business, and obviously, with the addition of the additional in-store repair services. And we're really well-positioned as partners as we -- Company -- to see at that point in more detail. But I would emphasize, our goal, as it has been, is to deliver long-term profitable growth, to increase our market-leading positions. And really focus on long-term value creation for our investors. And we intend to maintain at this. When capital management philosophy. But also looking to invest in growth organically and certainly somewhere organic as well. But we'll come back in Investor Day and share of broader vision around the -- around the future.
Alan Colberg: Yeah, and this is Alan, though the one thing I would add to Keith's comments if you think about our Company, we've always had a great business that generates earnings. That business level that we can then upstream to the holding Company. And going back since our IPO, we've been very strong stewards have companies’ capital over the last 20 years. I think that's going to continue fully. Under Keith leadership as we go forward, I don't see any major changes in the ability to generate cash and then to manage it appropriately for shareholders.
Keith Demmings: And we do remain committed to returning the balance of the $900 million from Preneed that we've talked about previously. So, we intend for that to continue as planned and get that done within 12 months of the close of the Preneed transaction as well.
Unidentified Analyst: Great. Thanks, guys.
Operator: Thank you. Our next question is coming from Gary Ransom with Dowling & Partners.
Alan Colberg: Good morning.
Gary Ransom: Yes. Good morning. I also had a question on the cover devices. I mean, you -- we've had a period of a couple of years where it's been flattish in covered devices and you explain that on your prepared remarks. Now we've got essentially in one month, this 20% jump or so, and I'm, I'm just trying to think through how that might roll forward if we're -- are we getting an unusual share of it in this first step of the roll out or -- I don't know. Can you give us any color of how that might unfold going over the next the rest of this year and into next year?
Keith Demmings: Yeah. So, we migrated all of the Sprint customers effective November 1st, so all of that volume is now enrolled in Assurant's program going forward. Obviously, we'll continue to see growth through the overall partnership as T-Mobile continues to win new customers in the marketplace, and continues to add insurance to those customers' accounts. So, this does create a really interesting long-term opportunity for growth. And as we've demonstrated over many years, we continue to innovate, not just around the products, but services, capabilities, how can we invest more around delivering exceptional customer experience. And certainly, a partnership with T-Mobile that is now significantly more scaled, we believe it's going to yield more opportunities to partner together for the future. But as we've talked about, there's a trade in terms of economics between what's our per unit fee that we're going to get relative to a much larger base of customers.
Gary Ransom: Right. Okay. And is there any remaining drag from the other things you mentioned internationally where things were running off or not growing as much?
Keith Demmings: No. I think we've seen a little bit of a slowdown in growth if we're talking specifically about mobile, just as we've come out of COVID in a couple of regions, primarily Latin America, a little bit in Europe as things have opened back up. But overall, really, really strong performance in the U.S. market and the Japanese market and really do see good long-term growth for that business overall in international as we continue to scale over time.
Gary Ransom: Okay, thank you. And then the other count statistic you gave is the autos covered in the Global Automotive and that was growing very well. And again, trying to think through how that might continue forward. Is there anything that has Momentum there that we might expect to see additional growth in those numbers going forward?
Keith Demmings: Yeah. I would say that the overall industry sales on the auto side remained quite elevated as you saw our covered policies increased a lot, $4 million and 8% from last year. But I would also highlight sales production was well above pre -pandemic levels, so we're seeing really, really strong performance. We achieved almost $1.2 billion of net written premium when you look at the quarterly results. I would say that began to normalize a little bit from where we were in the first and second quarter. But it was only modestly down from Q2, up 12% over 2020, and actually up 27% over 2019. So that would certainly expect to taper off going forward because obviously constraints around supply chain that's affecting new car sales. But those constraints have been more than offset by the volume that our clients are doing on the used side of the business, which has been very dramatic and overall leading to elevated levels of sales.
Gary Ransom: Thank you. If I could squeeze in a couple of numbers questions, there were a couple of items that were mentioned that you didn't really quantify was the tax benefit that helped the numbers in Global Lifestyle and you also mentioned in housing the reinstatement premium. Are those -- can you help quantify those are all?
Richard Dziadzio: Hi. Good morning, Gary. It's Richard. Yeah. I mean, in terms of the tax benefit, it was about $4 million and then the reinsurance, the reinstatement premium, I think that was about $7 million.
Richard Dziadzio: Exactly.
Gary Ransom: And just to be clear, the $99 million of pretax cuts does not exclude that reinstatement preview, correct.
Keith Demmings: In terms of the reinstatement premium, no, it actually does. And if you look at the numbers we have, a retention of $80 million and the total cut impact for us in the quarter was $87 million. So that comes through on that for either.
Gary Ransom: I got it. Okay. Thanks very much.
Keith Demmings: Thanks, Gary.
Operator: Thank you. Our next question is from Tom Shimp from Piper Sandler
Alan Colberg: Hey, good morning, Tom.
Tom Shimp: Hi. Good morning, guys. So, I'm thinking about the roll out of your EV1 product corresponding transition to the electric vehicle. How do the attachment rates compare -- for this product compared to the internal combustion engine? There's a lot of -- there's good amount of tech in those EV cars, but they do have less moving parts. So, how do those dynamics affect the attachment rates that you're seeing?
Keith Demmings: It's a great question. It's -- I would say it's really early in terms of scaling around electric vehicles, in terms of the service contract programs. You're correct there. There are less moving parts. There's a lot of technology. Some of the parts tend to be very expensive to get repaired. So, we may see lower frequency, we may see higher severities. There's also a little less certainty in the minds of consumers around the reliability of all of the technology. So, we do expect to see strong performance over time. I would say it's really early and it will evolve as we start to see more and more EVs in market. And as we start to see our clients maturing around, not just selling electric vehicles, but attaching F&I products and services. So, this will evolve, I think, over the next few years quite dramatically.
Tom Shimp: Okay. So, inflation, it's top of mind for insurance investors right now, Assurant operates in businesses that have attracted more attention regard to inflation parts and labor costs and automotive chip shortages in mobile global housing. Housing as a risk-based business where you have inflation exposure that you can mitigate with rate but I think a lot of investors who look at Assurant are your typical insurance investor and sometimes misunderstand to the extent of which the risk in mobile and automotive is ceded off to clients and how it operates on a fee like basis. So, I think investors understand this dynamic exists, but not the degree of which. So maybe you could give us your thoughts there and how assurances is positioned in an increasingly inflationary environment.
Keith Demmings: Yeah. And maybe I'll offer a couple of comments and then I'll ask Richard because his team's done a lot of work on this question, but I think you're right. I mean, we think our risk is quite well insulated, and mitigated based on the deal structures that we have on the lifestyle side, most of the deals are reinsured or profit shared. Not all of the deals, but we've been pretty insulated in terms of seeing volatility there. And then obviously, as we look at housing, as you talked about, there are opportunities with rate increases. insured values, and then investment income will obviously be a big driver as we go forward. Richard, stunning full analysis to look at the net overall. So maybe talk about that, Richard.
Richard Dziadzio: Sure. Thanks, Keith. And I think you sort of bolted on the main points. When we look at it, I would say short term in this quarter, we mentioned that severities were up a little bit, probably a quarter of the whole change in a non-CAT loss ratio. Those severities are really labor and claims costs increasing there. But over the long term, I think we're -- we look at it maybe being slightly positive, at least neutral because what happens, I mean, Keith mentioned the reinsurance that we have with our clients on the fee-based side. So, there's a large sharing of profitability on that side of the business, but then on the P&C side where housing, whatever where we are taking on the claims and the risk. There's two things that would happen. Lender place, we have advert insured values would go up. So as the prices of housing goes up -- go up with inflation, we would see an increase in our premiums to the average insured value. Also, over time, we would be able to recover a large part, if not all of that, through our rate filings. So, we feel that obviously insulates us quite well. And then finally with inflation over time, we would anticipate that interest rates would increase and we would get an uptick in our investment income. So overall we're not looking at it as being any type of significant negative, anything it's neutral could be a small positive.
Tom Shimp: Okay. Thank you for your answers.
Alan Colberg: Thank you.
Operator: Thank you. Our next question. And is coming from Brian Meredith with UBS.
Alan Colberg: Hey. Good morning, Brian.
Brian Meredith: Morning, morning, morning. So, I'm just curious, in Global Housing, I know early on we were thinking maybe we'd see an increase in placement rates towards the end of this year. Obviously, forbearance kind of hurt that. Now that that's gone, what is your kind of views with respect to placement rates there? Will you -- we ever going to see a pick-up?
Keith Demmings: Yeah, I think we signaled a modest change in placement rate this quarter, mainly driven by the mix. So, I'd say it's broadly flat. I would expect -- as we look to maybe the back half of '22, we'd start to see an increase modestly in the placement rates over time, expect servicers to actively work with borrowers on loan modifications to keep the loans performing. There's so much strength generally in the housing market. Customers have positive equity in the home. So, I think a lot of that activity will delay some of the placement rate from flowing through. And certainly, same thing's true on foreclosure side as well that will affect the REO business. So probably second half of '22 would be our best estimate on when we might start to see that coming through the portfolio.
Brian Meredith: Great. And then second question, just curious, the reserve increases that happened in the quarter, what was that related to in the specialty PC?
Alan Colberg: This is Alan. Maybe let me take that one and give a little bit of history on what we're doing there. So, in specialty, we have a variety of products, things like antique auto, a little bit of the international property we right. And we also, a few years ago, started to do a couple of on-demand products related to really following the consumer as they own and rent their home in their car and trying to really build off of our experience and our own rental and the franchise that we have there. And what we're really doing today is we're ensuring. Your short-term transaction. So, think about you're renting your home, or you're using your car to make food delivery. And what we're excited about with that business, and I'll answer the question directly. Both -- it's a new distribution channel for us. If you think about, we can embed some of our capabilities around rental into a rental of a home. And then what's particularly interesting is the gig economy. And if you think about the workers who are now delivering food or using their car to provide services, it's an interesting opportunity for us to drive not that product as much as our other products, our service contracts, our mobile capabilities, our renters, insurance. So that's really been the genesis of what we're doing there. In terms of the reserve this quarter, it’s affecting really maybe, but $5 million I think was the amount and its really development on prior reported claims. So, think of it as to catch up to align with all of our future expectations. And then over the last couple of years, as we've gained experienced in this business, we've been modifying our product structures. We've increased rates and we put in place extensive reinsurance so that will never -- we don't anticipate having any significant on material losses from this business. In fact, it's been a very well-performing business for us over the last couple of years.
Brian Meredith: Got you. And I assume you would get a lot of reinsurance on it and protections on it.
Alan Colberg: We do. We've got very strong structures there and it's really for us, we are trying to do the same thing we do in Auto and Mobile generally, which is making it into administration and feed business as we manage around a consumer transaction.
Brian Meredith: Great. And then my last question, just curious, so I take a look at the Global Lifestyle, there's a lot of moving parts happening here, I guess going into fourth quarter when I think about kind of the pre -tax margin on that business and obviously the additional subs coming in at a lower revenue per sub, and then you've got the investment coming in. We think about margins in that business declining here as we look into fourth quarter in 2022,
Keith Demmings: And I think as we look at overall profits in Lifestyle and in Connected Living, we do expect to see growth in Q4 over Q4 last year and continue to see growth into 2021. We had --- as you saw, a strong third quarter for Connected Living, up significantly over last year. So, I think that continues in Q4, even with the additional investments that we need to make to really not just stand up, same-unit repair, but make sure that we're executing and delivering to a really high standard. And then as we think about 2022, yeah, we expect overall. We'll see some moderation but we still expect to see strong growth across both the Lifestyle and housing businesses.
Brian Meredith: So good solid operating income growth still, it's just maybe some pressure on margins, but its top-line growth and more than offset that. It's what I think I hear you saying, right?
Keith Demmings: Correct. Yeah. The per unit economics are going to are going to look a little lighter, but the overall economics are going to be strong.
Brian Meredith: Terrific. Thanks so much for the answers and all the best in your retirement.
Alan Colberg: Thank you.
Operator: Thank you. Our next question is coming from Michael Phillips from Morgan Stanley.
Alan Colberg: Hey, good morning, Mike (ph).
Michael Phillips: Hey. Good morning, everybody. Thanks. Good morning. Richard, when you talked about the impact in the fourth quarter from the roll out expenses from T-Mobile, I guess -- Anyway you can help us quantify that meaningful impact. And then B, is it just a 4Q or any of that extended into 1Q next year?
Richard Dziadzio: Yeah. Thanks for the question, Mike. In terms of quantifying it, I guess I would say we've given sort of aggregate -- an aggregate indication in terms of where we think Lifestyle is going to come in all year, and we talked about being a high single-digit. So, if you really look at last year where we came in and look at high single-digits, it will give you a pretty good view of where we think -- sorry, where we think, Lifestyle is going to come in for the full year, and part of that decrease is going to -- is based on the increase in the setting up the service and repair and investments that we're making in Connected Living broadly. So that will be in the fourth quarter. And then we would anticipate some coming in next year. So, I mean, in terms of rolling into next year, there will be some amount of big amount -- biggest amount I would say it would be in the fourth quarter of this year. We are thinking a few million and ramp up quite a bit into into the fourth quarter. So, we are talking in terms of millions here in terms of doing it.
Keith Demmings: Yeah. And I would just add. In addition to the startup costs really ramping, doing all the recruiting, the training, the hiring, and getting all the build-outs done, there is also just the ongoing evolution of the service that we're going to deliver which inevitably will change and evolve over time as we continue to work with T-Mobile to optimize that experience. So, I do expect some investments in 2022, partly supporting the rollout to completion, but also ramping execution and investing in our technology to make sure that we're delivering services seamlessly as possible. So, you definitely would expect to see some investments as we continue to shape this part of our business going forward.
Michael Phillips: Okay, that makes sense. Two more kind of quick ones, I guess then. On the labor and material costs and the severity there, talked about that quite a bit. I guess a follow-up. Richard, you said if things continue -- I think you said if things continue, obviously that could be offset in the future by higher rates over time. Does that mean you're currently pricing in for that or still kind of waiting to see how that plays out?
Richard Dziadzio: Some of it's currently coming through. Every year in our contracts, we get an increase what we -- what I refer to as average insured value. So that's embedded in the contracts. We look at inflation. And we do get some increase in the overall premiums from that. When I was talking about the trends over time and the rate filing, one, we can't put in a rate filing for one quarter. When we file rates, it's based on averages over a couple of years. So that's really for inflation to come in the lasting and have an impact on the non-CAT loss ratio. It would need to come -- would need to happen over time is what I was referring to there, Mike. And then we would put it in and then you get it. So, there is a lag but it would be offset over time, is what I was saying.
Michael Phillips: Okay. That makes sense. I guess last quick one. Was any impact in the quarter on your sub -- mobile sub numbers from the T-Mobile cyber -attacks like on this?
Keith Demmings: Now, I would say nothing meaningful that we're aware of or that we saw. I mean, we had -- we have a really strong base of customers and I don't think we saw anything of note that I'm aware of.
Michael Phillips: Okay. Thank you, guys.
Operator: Thank you. Our next question is coming from Mark Hughes with Truist Securities.
Keith Demmings: Good morning, Mark.
Alan Colberg: Mark.
Mark Hughes: Yes. Thank you. Good morning. Congratulations, Alan.
Alan Colberg: Thank you.
Mark Hughes: The -- can you refresh me on the revenue model for the in-store business that T-Mobile, is it kind of time and materials? Is it repair per device? Hourly reimbursement? How does that work?
Keith Demmings: It's a great question. It's -- I would think of it as fee income oriented, and getting paid for the labor that we perform. And then for -- from the management of the overall program, we don't really have risk around how the business performed from our parts and labor other than we get stated fees and we've got to manage ourselves within those levels to drive profitability. So, I think it's a really, really well-structured financial deal and our interest are very aligned. And it's very motivated around delivering an exceptional experience in the store. So, I feel really good about not just the deal that we put together but how we're working together with T-Mobile to really change the industry.
Mark Hughes: And are they going to be advertising it? How are customer is going to know that the prepare capabilities available?
Keith Demmings: Well, we obviously manage the claim process within consumers and now that's what the entire base T-Mobile subscribers. So, we'll be directing customers as appropriate to take advantage of really the best option that's available to them to get repairs done. So, I think it will be largely through our claims flow, but also through T-Mobile awareness campaigns, etc.
Mark Hughes: And then Richard, I think you all have addressed this to a degree, but any more adjectives or maybe even numbers you might throw when you're talking about 2022. Earnings expansion to continue though at more moderate levels, I think you also referred to strong growth in 2022. Anything else you want to add to that?
Richard Dziadzio: I wouldn't want to jump in Investor Day, and when we talk about our outlook next year, I guess I would say two things. I mean, we're -- Steve heard during the call, we're really -- we're really pleased with where we are across our set of businesses, whether it be the growth that we're seeing in Global Auto. the extension that contract, the T-Mobile, the growth other elsewhere domestically in the U.S and mobile in Japan and mobile. And also, in the housing business. You see that we do seem to be at a bottom with placement rates. Now, when the forbearance and Foreclosure period will end, it will be a slow take up. We continue to grow in multi-family housing, so we think we're well-positioned for 2022. Having said that, as Keith mentioned, we still need to continue to invest in ourselves and in our business and it's not like we're without headwinds in terms of some interest rates or inflation. But I really feel good about where we are as a business totally. And I think Alan's put us in a good position to succeed over the future under Keith's leadership.
Mark Hughes: Thank you.
Operator: Thank you. Our next question is coming from Jeff Schmitt, from William Blair.
Alan Colberg: Hey, good morning, Jeff.
Jeff Schmitt: Good morning. How much of the increase in fee income in Connected Living was due to highlight acquisition? Obviously, there's kind of a weak comparison to, but just curious how much of that is organic growth maybe driven by the 5G upgrade cycle versus Hyla being added to the mix
Keith Demmings: I would say Hyla's been performing exceptionally well. So, as we look at what's happened since close, trading volumes are up significantly. We've seen obviously not just demand from 5G significant client promotions where trade-ins are the main incentive being used. Increasing attach rates and just I think pent-up demand coming out of the pandemic. So, we talked about the performance of the acquisition 50% better than we modeled based on '21. So, we're thrilled with how it's going, but more than that really excited about the integration, how well that's working, our ability to protect talent, obviously a significant renewal of a major relationship with AT&T. And then as you think about the overall volumes process, we talked about 18 million devices so far this year. That compares to 14 million for full-year 2020, and that's overall, in total, combining high land assurance. So yes, high-low as a big driver of fee income, but we've also seen growth on what I would call the legacy assurance side of the trading business as well. And similar trends are happening across clients and across the market. So, it's a really strong time for trading in the global market.
Jeff Schmitt: Okay. Great. And then the same-day service capabilities you've touched on that quite a bit of rolling it out with T-Mobile here a few days ago it sounds like. Did -- how much of those capabilities being affected by labor shortages right now? I don't know if you touched on them, but just curious how you're managing that in the current environment.
Keith Demmings: Our team has done an incredible job. We've been working on this for many months, trying to acquire the right labor in various markets around the country. I would say our team, the recruiters that we're partnered with, some of the incentives that we've put in place to get the best talent. It's worked really well. Not to say there aren't challenges of course there are but our teams have, have partnered really well with third-parties as well as what T-Mobile to make it happen.
Jeff Schmitt: Okay. Great. Thank you.
Operator: Thank you. Our last question is coming from Grace Carter with Bank of America.
Alan Colberg: Hey. Good morning, Grace.
Grace Carter: Hi. We've talked a lot about structural tailwinds or attachment rates in mobile devices, one of them being rising prices. I was wondering, in kind of this more inflationary environment that we're looking at, if you've seen any sort of tangible impact from the inflation impact on pricing, driving up attachment rates at all, and to the extent that we continue to see a bit of higher inflation, if you think that that should have any impact going forward?
Keith Demmings: Yeah, that's a great question. I would say maybe a little bit on the auto side if you think about really more of a mix shift point. So used cars tend to attach at slightly higher rates than new cars. And we've also seen obviously accelerating value on the used car side, which makes protecting the vehicle a higher likelihood. So, we have seen a little bit of a mix shift there which is benefiting the overall attach rate. I would say broadly though, pretty steady, pretty strong across the board. So, nothing that I would signal as being a really dramatic, but certainly good strong results.
Grace Carter: Okay, thank you. And then just kind of a quick follow-up to that, we've seen attachment rates across mobile devices and cars going up over the past several years. Do you think that there is an eventual ceiling on how high attachment rates can go? I mean, what's kind of the long-term target there, I guess?
Keith Demmings: I think it varies by market, by geography. Some markets attach just based on consumer perception, consumer demand at higher levels. I definitely think we're -- we've got robust levels of attach rates broadly. I think they could still go up over time, certainly. I think awareness for the programs, the value proposition for our products continues to improve. The service delivery and the options for consumers and how much more convenient and important the services to them today than it was a few years ago. I think all of those elements can drive in a more attach rates in the future, so still some upside but really robust if I look at in mature markets. And then certainly growth opportunity in more of the emerging or more nascent markets.
Grace Carter: Thank you and congrats to Alan.
Alan Colberg: All right, thank you Grace.
Keith Demmings: Thank you everyone for participating in today's call. In summary, we're very pleased with our year-to-date performance, and we're excited about the opportunities we have to serve our partners, our end consumers while delivering results for our shareholders. I look forward to officially taking the CEO role in January and updating you on our progress on the fourth quarter earnings call in February. We're also hard at work and anticipating Assurant 's 2022 Virtual Investor Day, which we expect to hold on March 24th and more details will be forthcoming in the weeks in months ahead. In the meantime, please reach out to Suzanne Shepherd and Gene Mergelmeyer (ph) with any follow-up questions. Thank you all. And have a great day.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Third Quarter 2021 conference call and webcast. At this time, all participants have been placed in a listen-only mode. And the floor will be opened for questions. Following management prepared remarks. If you would like to ask a question at that time, please press star one on your touchtone phone. Lastly, if you should require Operator assistance, please press star 0. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, Operator, and good morning, everyone. We look forward to discussing our Third Quarter 2021 results with you today. Joining me for Assurant's conference call are Alan Colberg, our Chief Executive Officer, Keith Demmings, our President, and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the Third Quarter 2021. The released and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Alan, Keith, and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties, and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release, as well as in our SEC report. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the Company's performance. For more detail on these measures, the most comparable GAAP measures, and a reconciliation of the two, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan."
},
{
"speaker": "Alan Colberg",
"text": "Thanks, Suzanne. Good morning, everyone. Our third quarter results were strong driven by double-digit operating earnings growth in Global Lifestyle. The strength of our Global Automotive and Connected Living offerings continue to validate our long-term strategy of focusing on our higher growth, fee-based, and capital-light businesses. We continue to make progress in building a more sustainable Company for all stakeholders. During the quarter, a few key highlights included. For the first time, Assurant was awarded a bronze accreditation by EcoVadis, one of the largest sustainability ratings companies writing Assurant among the top 50% of all 75,000 participating companies. In addition, this quarter, we provided additional transparency to track our progress on our journey to build a more diverse and inclusive assurance. With the recent disclosure of our EEO one report, which provides gender, race and ethnicity data by job category for our U.S. based employees. We believe a diverse and inclusive workforce will best foster innovation, a key ingredient to sustaining our out-performance longer-term. Looking at our financial performance year-to-date, net operating income per share, excluding reportable catastrophes, was $8.75, up 12% compared to the first 9 months of last year. Net operating income and adjusted EBITDA, also excluding cats, both increased by 10% to $528 million and $862 million respectively. These results support our full-year outlook of 10% to 14% growth in net operating income per share, excluding your portable catastrophes, marking our 5th consecutive year of strong, profitable growth. Given year-to-date results and our expectations for the fourth quarter, we would expect to end the year closer to the top half of this range. We've also now completed our 3-year $1.35 billion capital return objective from our 2019 Investor Day, a quarter ahead of schedule. Following the close on the sale of Global Preneed in August, we've also made meaningful progress in returning an additional $900 million to shareholders. Our 2021 EPS outlook is driven by at least high single-digit net operating income growth excluding catastrophe, as well as sharing purchases. Turning to our business performance in Global Lifestyle we are on track to grow adjusted EBITDA by double-digits in 2021 from $637 million in 2020, driven by Global Automotive and Connected Living. We have benefited from the stable recurring revenue stream of our installed base of mobile subscribers. And our success in launching additional offerings and capabilities for mobile carrier cable operator, OEM, and retail clients globally. Additionally, our mobile trade-in and upgrade business and expanded service delivery options are increasingly important to our profitability, and also in providing a differentiated and superior customer experience. Within Global Automotive, we've benefited from increased scale, growing the number of vehicles we protect by 20% over 52 million since The Warranty Group acquisition in 2018. We believe auto will continue to be one of our key growth businesses in the future. In Global Housing, we continue to be on track for another year of better-than-market returns with an annualized operating ROE of nearly 15% for the first 9 months of this year. This includes $113 million of catastrophe losses, which further demonstrates the superior returns at this differentiated business. Our countercyclical lender placed insurance business remains an integral part of the mortgage industry framework in the U.S. Within lender place as we renew existing clients and add new partners, we will continue to enhance the experience through the ongoing rollout of our single-source processing platform. Our multifamily housing business now supports over 2.5 million ventures across the U.S. and has more than doubled earnings since 2015 through our strong partnerships with our affinity and property management Company clients. Our investments in digital capabilities such as our coverage 360 property management solution, continues to drive more value for our partners and an enhanced customer experience. Overall, we believe our portfolio of high-growth, fee-based, capital-light offerings and high return Specialty P&C businesses sets us apart as a long-term outperformer and sustained value creator for our shareholders. With my retirement at year-end, I wanted to take this opportunity to thank all of our stakeholders that have supported Assurant 's strategic vision and path over the last 7 years. Most of all, I'm humbled by our 15,000 employees who through their dedication to serve our clients and our 300 million customers worldwide, have successfully transformed assurance. Together, we have significantly strengthened our Fortune 300 Company that should continue to deliver above-market growth and superior cash flow. With our president, Keith Demmings succeeding me as CEO in January, I'm confident Assurant will accelerate our strategy and continue to differentiate our superior customer experience will further deepening client relationships. I'll now turn the call over to Keith to review our key business highlights in greater detail for the quarter. Keith?"
},
{
"speaker": "Keith Demmings",
"text": "Thank you, Alan. And good morning, everyone. On behalf of our employees, I wanted to express our sincere thanks to Alan for his leadership as CEO. I've been fortunate to have had a front row seat and a role in supporting Alan's vision and the transformation of Assurant. Importantly, he has continued to evolve the purpose of our Company to drive value for all stakeholders, customers, employees, communities, and shareholders. The impact he has had on our people and the overall culture of our Company has been exemplary. And I appreciate Alan's personal mentorship and partnership and wish him the very best in his retirement. As we build on assurance momentum over the long term, I believe our talent and innovation will be critical factors to achieving success and growth, especially as we focus more on the convergence around the connected consumer. From a talent perspective, Assurant has developed a deep and diverse bench of internal leaders. A few weeks ago, I announced our refreshed management committee effective in January, including 2 new leadership appointments illustrating our strong bench. First, Keith Meier, our current President of International, will succeed Gene Mergelmeyer as Chief Operating Officer, as Gene will be retiring at year-end. Gene 's significant contributions to Assurant over the last 30+ years, including as COO over his last 5 years, have been instrumental in creating market-leading positions, producing profitable growth, and transforming the organization. In succeeding Gene, Keith Meier brings nearly 25 years of experience at Assurant to the COO role. Since 2016 as President of Assurant International, he's driven growth across our global markets most recently with strong success in Asia-Pacific. In this new role, Keith will be focused on advancing Assurant's business strategy and market leadership positions, as well as identifying additional opportunities to deliver a superior customer experience. Second, Martin Jens will become President of Global Automotive. With over 30 years of experience, he currently leads the transformation and growth strategy for auto and has been instrumental in our introduction of innovative new products like EV One, our electric vehicle warranty protection. In addition to emerging opportunities and innovation, Martin will be focused on driving growth and improving the customer experience, including working with our partners to deliver best-in-class dealer training. These two new appointments along with recent appointments of Biju Nair as President of Connected Living, and Manny Becerra as our Chief Innovation Officer, as well as the other management committee members, represent a strong team to help lead us into the future. In addition to talent, innovation is an important strength of the organization. Not only the development of new digital products and offerings for our clients, but also through new paths to grow and scale Assurant's businesses. Within Connected Living, innovation was a significant theme this quarter through ongoing enhancements of our mobile service delivery options. As part of the recently finalized multiyear contract extension with T-Mobile, we're expanding the services Assurant provides to continuously improve the customer experience for millions of T-Mobile customers. As of November 1st, Assurant is partnering with T-Mobile to begin the nationwide rollout of in-store device repair services to approximately 500 stores provided by Assurant 's industry-certified repair experts. In addition, we have also transitioned all of the legacy Sprint protection subscribers to the new T-Mobile device protection offering. As a result, this significantly adds to our mobile device count, now at roughly 63 million as of November 1st. Overall, the expansion of our service delivery options is critical to sustaining our competitive advantage. We also recently signed a multiyear renewal with Spectrum Mobile, continuing to provide a comprehensive device protection program, which includes trade-in, premium tech support, and Pocket geek mobile. Assurance on-device diagnostic tool. With the renewal, we will also be expanding the offering to include Pocket Geek Privacy, which enables consumers to better protect and manage their personal information online through various features. This is another example of how we're able to grow by adding services and capabilities to existing clients. In addition, the mobile business continues to see strong attachment rates given the increased reliance on mobile devices, as well as rising device prices. Our fee driven trade in an upgrade business, including the previous acquisitions of Hyla and Alegre have performed extraordinarily well already this year as we enter the early innings of the 5G upgrade cycle. In fact, almost a year after the transaction of Hyla closed, I'm happy to report the acquisition has performed better than expected ahead of the low-teens forward EBITDA, the acquisition was valued on. With the growing availability and popularity of 5G enabled smartphones, we expect to see our 30-plus trade-in and upgrade programs continue to grow. Our progress is demonstrated through our ability to manage large-scale programs with superior technology. This is further supported by increasing our attach rates for trade-in programs as our clients’ promotional efforts encourage consumers to upgrade. Overall, we have processed nearly 18 million devices so far this year, reducing e-waste, and increasing digital access with high-quality, affordable phones. Through the scale and capabilities of our trading and upgrade programs, we benefit from an additional source of profits and improved client economics and customer retention. This quarter, we are pleased to announce that we have signed a multiyear contract extension with AT&T to manage their device trade-in program. This includes providing analytics, as well as device collection and processing for all of their sales channels, including retail, B2B, dealer, and direct-to-consumer. AT&T was a key client added with the Hyla acquisition, and we look forward to continuing to do business with them, specifically as we help support the growing adoption of 5G-enabled devices. In Global Automotive, policies increased by $4 million or 8% year-over-year and production is well above pre -pandemic levels as we continue to take advantage of our scale and talent. So far this year, the business has also benefited from strong used car growth, which tends to earn faster than new car sales. This along with the fact that earnings from the business are recognized over a multiyear period, provides good visibility into future performance of the business. As we drive innovation within auto, we continue the global roll out of EV One, an electric vehicle and hybrid protection product from North America. EV One has now been rolled out in 7 countries. While the electric vehicle market is still in its infancy, our EV1 product will allow Assurant and opportunity to better evaluate customer demand and leverage our learnings to position us well for the expected increase in electric vehicle adoption in the future. Our multi-family housing business grew policies by 7% year-over-year from growth in our affinity partners, as well as our PMC relationships, where we continue the rollout of our innovative Cover360 product. In addition, we have seen other digital investments create opportunities for future growth. Our newly designed digital sales portal, which makes it faster and easier for residents to sign up for a policy, is driving significantly higher product attachment rates. Our new portal has seen an increase in conversion rates versus our legacy website that was first introduced last year. In summary, our ability to strengthen Assurant's talent and innovation supported by critical investments has and should continue to drive momentum for the future. I will now turn the call over to Richard to review the third quarter results and our 2021 outlook. Richard."
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith. And good morning, everyone. As Alan noted, we are pleased with our third quarter performance as our results reflect strong growth across Global Lifestyle and solid earnings in Global Housing. For the quarter, we reported net operating income per share, excluding reportable catastrophes of $2.73, up 5% from the prior year period. Excluding cats, net operating income, and adjusted EBITDA for the quarter, each increased 4% to $162 million and $262 million, respectively. Now, let's move to segment results starting with Global Lifestyle. The segment reported net operating income of $124 million in the third quarter, a year-over-year increase of 16%. Growth was driven by Global Automotive and continued earnings expansion within Connected Living's mobile business. In Global Automotive, earnings increased $8 million or 21% from continued global growth in our U.S. national dealer and third-party administrator channels, including contributions from our AFAS and international OEM channels. Better loss experience in select ancillary products and higher investment income also supported earnings growth in the quarter. Connected Living earnings increased by $6 million or 9% year-over-year. The increase was primarily driven by continued mobile subscriber growth in North America and better performance in Asia-Pacific, as well as higher trade-in volumes led by contributions from our Hyla acquisition and carrier promotions. This quarter, Global Automotive and Connected Living results also included a modest one-time tax benefit that improved earnings. For the quarter, Lifestyle 's adjusted EBITDA increased 17% to $177 million. This reflects the segment's increased amortization resulting from higher deal-related intangibles for more recent transactions in mobile and Global Automotive. IT depreciation expense also increased, stemming from higher investments. As we look at revenues, Lifestyle revenues increased by $158 million or 9%. This was driven mainly by continued growth in Connected Living and Global Automotive. Within Connected Living, revenue increased 10%, boosted by mobile fee income that was driven by strong trade-in volumes, including contributions from Hyla. Trade-in volumes were supported by new phone introductions and carrier promotions from the introduction of new 5G devices. Higher revenue from growth in domestic mobile subscribers was offset by declines in runoff mobile programs. Mobile subscribers were up slightly year-over-year and flat year-to-date as mid-single-digit subscriber growth in North America was offset by declines in other geographies, mostly due to three factors. First, the 750,000 subscribers related to a runoff European baking program previously mentioned, which is not expected to be a significant impact in our profitability. Second, subscriber growth for existing programs moderating in Asia-Pacific. And third, a slower-than-expected recovery from the pandemic in Latin America. In Global Automotive, revenue increased 8%, reflecting strong prior period sales of vehicle service contracts. Industry auto sales remained elevated in the third quarter and we benefited from this trend as reflected in the year-over-year growth of our net written premium by 12%. We have though seen this trend began to normalize beginning into the fourth quarter. For the full year, Lifestyle revenues are expected to increase modestly compared to last year's $7.3 billion, mainly driven by global auto and Connected Living growth. For all of 2021, we still expect Global Lifestyle as net operating income to grow in the high single-digits compared to 2020. Adjusted EBITDA for the segment is expected to grow double-digits year-over-year, which continues to grow at a faster pace in segment net operating income. As previously reported, we began our investment in the T-Mo in-store repair capability this quarter. However, due to the timing of the rollout, most of our associated start-up costs will occur in the fourth quarter. These costs primarily relate to technician hiring and parts sourcing. We do expect these costs to meaningfully impact Connected Living's profitability as we end the year. In addition, we expect our effective tax rate to return to a more normal level, approximately 23%. Looking ahead to 2022, we expect earnings expansion to continue, but more likely at more moderated levels as we continue to invest for growth, including additional implementation start-up costs for in-store service and repair. Moving to Global Housing, net operating income excluding catastrophe losses was $81 million for the third quarter. Including that $78 million of pre -announced catastrophe losses, mainly from Hurricane Ida, net operating income totaled $3 million. Excluding catastrophe losses, earnings decreased $19 million due to anticipated higher non-CAT losses, which returned to levels more in line with historical averages. As a reminder, favorable losses in 2020 were not representative of historical trends in third quarter 2020 mark the lowest point of last year. Mainly driven by last experience within lender-placed and specialty products. The year-over-year earnings decline was nearly all driven by unfavorable non-CAT loss experience from several factors. Largest Trivor, which contributed close to half of the increase, was from the expected normalization of the non-GAAP loss ratio. The balance of the decline was split relatively evenly between increased reserves related to our special PP&E offerings, primarily in our on-demand sharing economy business, as well as higher claims severity. Claims severity included moderate impacts from inflationary factors, such as higher labor and material costs. Where there is always a lag, if this trend continues, we would expect higher loss cost to be offset by increased rates over time. In multi-family housing, underlying growth was offset by increased investments to further strengthen our customer experience, including our digital-first capability. Global Housing revenue decreased slightly year-over-year from lower specialty P&C revenues, as well as account reinstatement premium resulting from Hurricane Ida and lower REO volumes in lender place. This was partially offset by higher average insured values and premium rates and lender-place and growth in multi-family housing. We continue to expect Global Housing's net operating income, excluding cats to be flat for the full year compared to 2020. For the fourth quarter and into 2022, we would expect non-CAT losses to continue to be above 2020, but in line with year-to-date 2021 experience, which is consistent with long-term trends. We also continue to monitor the REO foreclosure moratoriums and any additional extensions that may be announced. At corporate, the net operating loss was $21 million, an improvement of $4 million compared to the third quarter of 2020. This was driven by two items. First, lower employee-related expenses, and third-party fees. And second, expense savings associated with reducing our real estate footprint. In the fourth quarter, we do anticipate a higher loss due to the timing of spend. For the full-year 2021, we now expect the corporate net operating loss to be approximately $80 million driven by favorable year-to-date results, mainly from the one-time tax and real estate joint venture benefits. In the second quarter. This compares to our previous estimate of $85 million. As we look forward to 2022, we would expect our net operating loss in corporate to be closer to $90 million more in line with historical trends. Turning to the holding Company liquidity, including the net proceeds from the sale of Preneed in August we ended the third quarter with over $1.3 billion, well above our current minimum target level. In the third quarter, dividends from operating segments totaled $127 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items. $323 million of share repurchases, $39 million in common stock dividends, and $11 million mainly related to Assurant Ventures investments. In addition to completing our 2019 Investor Day objective, a returning $1.35 billion to shareholders from 2019 through 2021, we have also completed roughly one quarter of our objective to return $900 million in Global Preneed sale proceeds through share repurchases. For the year overall, we continue quick update on Assurant Ventures, our venture capital arm. In the third quarter, three investments in our portfolio in public via SPACs. We are pleased with the results as the 3 investments exceeded 7 times multiple on investment capital under their respective SPAC transaction terms. These transactions combined with strong performance in the broader Ventures portfolio, led to a $75 million after-tax gain growing through net income in the quarter. In addition to strong returns, these investments also provide key insights into emerging technologies and capabilities within our connected consumer growth businesses. Before turning to Q&A, I too would like to take a minute to thank Alan for his partnership over the last 5 years. In addition to positioning Assurant for long-term success and growth, he's created an environment of inclusion and community, truly representative of our core values, common sense, and common decency. Alan, I wish you all the very best in retirement. Well-deserved. And with that, Operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. The floor is now open for questions. . Again, we do ask that while you pose your question that you pick up your handset"
},
{
"speaker": "Unidentified Analyst",
"text": "new potential per device and just kind of the bottom-line profitability for those new devices relative to your $53 million in forced devices at quarter-end?"
},
{
"speaker": "Alan Colberg",
"text": "Sure. Maybe I will take that and backup for just a second. So, first thing I'd emphasize is just the strong partnership that we've had with T-Mobile for many years, which is obviously scaled significantly over time. We're extremely pleased to have reached multiyear extension. And then the migration of the Sprint customers on November 1st along with the ramping of same-unit repair inside of 500 T-Mobile stores is obviously very exciting as we look to the future. As we've discussed on previous calls, it's not uncommon for us to forgo economics when we re-contract with major clients. That's particularly true if the client scales dramatically over time, which obviously is the case"
},
{
"speaker": "Keith Demmings",
"text": "with T-Mobile. As a result of the new agreement going forward, we do expect lower per unit economics. But I would say that once we get same-unit repair fully ramped and normalize our performance, which will take some time, we do expect overall to be able to more than offset the margin pressure with the additional Sprint volume with economies of scale within the business, and obviously, with the addition of the additional in-store repair services. And we're really well-positioned as partners as we -- Company -- to see at that point in more detail. But I would emphasize, our goal, as it has been, is to deliver long-term profitable growth, to increase our market-leading positions. And really focus on long-term value creation for our investors. And we intend to maintain at this. When capital management philosophy. But also looking to invest in growth organically and certainly somewhere organic as well. But we'll come back in Investor Day and share of broader vision around the -- around the future."
},
{
"speaker": "Alan Colberg",
"text": "Yeah, and this is Alan, though the one thing I would add to Keith's comments if you think about our Company, we've always had a great business that generates earnings. That business level that we can then upstream to the holding Company. And going back since our IPO, we've been very strong stewards have companies’ capital over the last 20 years. I think that's going to continue fully. Under Keith leadership as we go forward, I don't see any major changes in the ability to generate cash and then to manage it appropriately for shareholders."
},
{
"speaker": "Keith Demmings",
"text": "And we do remain committed to returning the balance of the $900 million from Preneed that we've talked about previously. So, we intend for that to continue as planned and get that done within 12 months of the close of the Preneed transaction as well."
},
{
"speaker": "Unidentified Analyst",
"text": "Great. Thanks, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is coming from Gary Ransom with Dowling & Partners."
},
{
"speaker": "Alan Colberg",
"text": "Good morning."
},
{
"speaker": "Gary Ransom",
"text": "Yes. Good morning. I also had a question on the cover devices. I mean, you -- we've had a period of a couple of years where it's been flattish in covered devices and you explain that on your prepared remarks. Now we've got essentially in one month, this 20% jump or so, and I'm, I'm just trying to think through how that might roll forward if we're -- are we getting an unusual share of it in this first step of the roll out or -- I don't know. Can you give us any color of how that might unfold going over the next the rest of this year and into next year?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. So, we migrated all of the Sprint customers effective November 1st, so all of that volume is now enrolled in Assurant's program going forward. Obviously, we'll continue to see growth through the overall partnership as T-Mobile continues to win new customers in the marketplace, and continues to add insurance to those customers' accounts. So, this does create a really interesting long-term opportunity for growth. And as we've demonstrated over many years, we continue to innovate, not just around the products, but services, capabilities, how can we invest more around delivering exceptional customer experience. And certainly, a partnership with T-Mobile that is now significantly more scaled, we believe it's going to yield more opportunities to partner together for the future. But as we've talked about, there's a trade in terms of economics between what's our per unit fee that we're going to get relative to a much larger base of customers."
},
{
"speaker": "Gary Ransom",
"text": "Right. Okay. And is there any remaining drag from the other things you mentioned internationally where things were running off or not growing as much?"
},
{
"speaker": "Keith Demmings",
"text": "No. I think we've seen a little bit of a slowdown in growth if we're talking specifically about mobile, just as we've come out of COVID in a couple of regions, primarily Latin America, a little bit in Europe as things have opened back up. But overall, really, really strong performance in the U.S. market and the Japanese market and really do see good long-term growth for that business overall in international as we continue to scale over time."
},
{
"speaker": "Gary Ransom",
"text": "Okay, thank you. And then the other count statistic you gave is the autos covered in the Global Automotive and that was growing very well. And again, trying to think through how that might continue forward. Is there anything that has Momentum there that we might expect to see additional growth in those numbers going forward?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. I would say that the overall industry sales on the auto side remained quite elevated as you saw our covered policies increased a lot, $4 million and 8% from last year. But I would also highlight sales production was well above pre -pandemic levels, so we're seeing really, really strong performance. We achieved almost $1.2 billion of net written premium when you look at the quarterly results. I would say that began to normalize a little bit from where we were in the first and second quarter. But it was only modestly down from Q2, up 12% over 2020, and actually up 27% over 2019. So that would certainly expect to taper off going forward because obviously constraints around supply chain that's affecting new car sales. But those constraints have been more than offset by the volume that our clients are doing on the used side of the business, which has been very dramatic and overall leading to elevated levels of sales."
},
{
"speaker": "Gary Ransom",
"text": "Thank you. If I could squeeze in a couple of numbers questions, there were a couple of items that were mentioned that you didn't really quantify was the tax benefit that helped the numbers in Global Lifestyle and you also mentioned in housing the reinstatement premium. Are those -- can you help quantify those are all?"
},
{
"speaker": "Richard Dziadzio",
"text": "Hi. Good morning, Gary. It's Richard. Yeah. I mean, in terms of the tax benefit, it was about $4 million and then the reinsurance, the reinstatement premium, I think that was about $7 million."
},
{
"speaker": "Richard Dziadzio",
"text": "Exactly."
},
{
"speaker": "Gary Ransom",
"text": "And just to be clear, the $99 million of pretax cuts does not exclude that reinstatement preview, correct."
},
{
"speaker": "Keith Demmings",
"text": "In terms of the reinstatement premium, no, it actually does. And if you look at the numbers we have, a retention of $80 million and the total cut impact for us in the quarter was $87 million. So that comes through on that for either."
},
{
"speaker": "Gary Ransom",
"text": "I got it. Okay. Thanks very much."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Gary."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Tom Shimp from Piper Sandler"
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning, Tom."
},
{
"speaker": "Tom Shimp",
"text": "Hi. Good morning, guys. So, I'm thinking about the roll out of your EV1 product corresponding transition to the electric vehicle. How do the attachment rates compare -- for this product compared to the internal combustion engine? There's a lot of -- there's good amount of tech in those EV cars, but they do have less moving parts. So, how do those dynamics affect the attachment rates that you're seeing?"
},
{
"speaker": "Keith Demmings",
"text": "It's a great question. It's -- I would say it's really early in terms of scaling around electric vehicles, in terms of the service contract programs. You're correct there. There are less moving parts. There's a lot of technology. Some of the parts tend to be very expensive to get repaired. So, we may see lower frequency, we may see higher severities. There's also a little less certainty in the minds of consumers around the reliability of all of the technology. So, we do expect to see strong performance over time. I would say it's really early and it will evolve as we start to see more and more EVs in market. And as we start to see our clients maturing around, not just selling electric vehicles, but attaching F&I products and services. So, this will evolve, I think, over the next few years quite dramatically."
},
{
"speaker": "Tom Shimp",
"text": "Okay. So, inflation, it's top of mind for insurance investors right now, Assurant operates in businesses that have attracted more attention regard to inflation parts and labor costs and automotive chip shortages in mobile global housing. Housing as a risk-based business where you have inflation exposure that you can mitigate with rate but I think a lot of investors who look at Assurant are your typical insurance investor and sometimes misunderstand to the extent of which the risk in mobile and automotive is ceded off to clients and how it operates on a fee like basis. So, I think investors understand this dynamic exists, but not the degree of which. So maybe you could give us your thoughts there and how assurances is positioned in an increasingly inflationary environment."
},
{
"speaker": "Keith Demmings",
"text": "Yeah. And maybe I'll offer a couple of comments and then I'll ask Richard because his team's done a lot of work on this question, but I think you're right. I mean, we think our risk is quite well insulated, and mitigated based on the deal structures that we have on the lifestyle side, most of the deals are reinsured or profit shared. Not all of the deals, but we've been pretty insulated in terms of seeing volatility there. And then obviously, as we look at housing, as you talked about, there are opportunities with rate increases. insured values, and then investment income will obviously be a big driver as we go forward. Richard, stunning full analysis to look at the net overall. So maybe talk about that, Richard."
},
{
"speaker": "Richard Dziadzio",
"text": "Sure. Thanks, Keith. And I think you sort of bolted on the main points. When we look at it, I would say short term in this quarter, we mentioned that severities were up a little bit, probably a quarter of the whole change in a non-CAT loss ratio. Those severities are really labor and claims costs increasing there. But over the long term, I think we're -- we look at it maybe being slightly positive, at least neutral because what happens, I mean, Keith mentioned the reinsurance that we have with our clients on the fee-based side. So, there's a large sharing of profitability on that side of the business, but then on the P&C side where housing, whatever where we are taking on the claims and the risk. There's two things that would happen. Lender place, we have advert insured values would go up. So as the prices of housing goes up -- go up with inflation, we would see an increase in our premiums to the average insured value. Also, over time, we would be able to recover a large part, if not all of that, through our rate filings. So, we feel that obviously insulates us quite well. And then finally with inflation over time, we would anticipate that interest rates would increase and we would get an uptick in our investment income. So overall we're not looking at it as being any type of significant negative, anything it's neutral could be a small positive."
},
{
"speaker": "Tom Shimp",
"text": "Okay. Thank you for your answers."
},
{
"speaker": "Alan Colberg",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question. And is coming from Brian Meredith with UBS."
},
{
"speaker": "Alan Colberg",
"text": "Hey. Good morning, Brian."
},
{
"speaker": "Brian Meredith",
"text": "Morning, morning, morning. So, I'm just curious, in Global Housing, I know early on we were thinking maybe we'd see an increase in placement rates towards the end of this year. Obviously, forbearance kind of hurt that. Now that that's gone, what is your kind of views with respect to placement rates there? Will you -- we ever going to see a pick-up?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah, I think we signaled a modest change in placement rate this quarter, mainly driven by the mix. So, I'd say it's broadly flat. I would expect -- as we look to maybe the back half of '22, we'd start to see an increase modestly in the placement rates over time, expect servicers to actively work with borrowers on loan modifications to keep the loans performing. There's so much strength generally in the housing market. Customers have positive equity in the home. So, I think a lot of that activity will delay some of the placement rate from flowing through. And certainly, same thing's true on foreclosure side as well that will affect the REO business. So probably second half of '22 would be our best estimate on when we might start to see that coming through the portfolio."
},
{
"speaker": "Brian Meredith",
"text": "Great. And then second question, just curious, the reserve increases that happened in the quarter, what was that related to in the specialty PC?"
},
{
"speaker": "Alan Colberg",
"text": "This is Alan. Maybe let me take that one and give a little bit of history on what we're doing there. So, in specialty, we have a variety of products, things like antique auto, a little bit of the international property we right. And we also, a few years ago, started to do a couple of on-demand products related to really following the consumer as they own and rent their home in their car and trying to really build off of our experience and our own rental and the franchise that we have there. And what we're really doing today is we're ensuring. Your short-term transaction. So, think about you're renting your home, or you're using your car to make food delivery. And what we're excited about with that business, and I'll answer the question directly. Both -- it's a new distribution channel for us. If you think about, we can embed some of our capabilities around rental into a rental of a home. And then what's particularly interesting is the gig economy. And if you think about the workers who are now delivering food or using their car to provide services, it's an interesting opportunity for us to drive not that product as much as our other products, our service contracts, our mobile capabilities, our renters, insurance. So that's really been the genesis of what we're doing there. In terms of the reserve this quarter, it’s affecting really maybe, but $5 million I think was the amount and its really development on prior reported claims. So, think of it as to catch up to align with all of our future expectations. And then over the last couple of years, as we've gained experienced in this business, we've been modifying our product structures. We've increased rates and we put in place extensive reinsurance so that will never -- we don't anticipate having any significant on material losses from this business. In fact, it's been a very well-performing business for us over the last couple of years."
},
{
"speaker": "Brian Meredith",
"text": "Got you. And I assume you would get a lot of reinsurance on it and protections on it."
},
{
"speaker": "Alan Colberg",
"text": "We do. We've got very strong structures there and it's really for us, we are trying to do the same thing we do in Auto and Mobile generally, which is making it into administration and feed business as we manage around a consumer transaction."
},
{
"speaker": "Brian Meredith",
"text": "Great. And then my last question, just curious, so I take a look at the Global Lifestyle, there's a lot of moving parts happening here, I guess going into fourth quarter when I think about kind of the pre -tax margin on that business and obviously the additional subs coming in at a lower revenue per sub, and then you've got the investment coming in. We think about margins in that business declining here as we look into fourth quarter in 2022,"
},
{
"speaker": "Keith Demmings",
"text": "And I think as we look at overall profits in Lifestyle and in Connected Living, we do expect to see growth in Q4 over Q4 last year and continue to see growth into 2021. We had --- as you saw, a strong third quarter for Connected Living, up significantly over last year. So, I think that continues in Q4, even with the additional investments that we need to make to really not just stand up, same-unit repair, but make sure that we're executing and delivering to a really high standard. And then as we think about 2022, yeah, we expect overall. We'll see some moderation but we still expect to see strong growth across both the Lifestyle and housing businesses."
},
{
"speaker": "Brian Meredith",
"text": "So good solid operating income growth still, it's just maybe some pressure on margins, but its top-line growth and more than offset that. It's what I think I hear you saying, right?"
},
{
"speaker": "Keith Demmings",
"text": "Correct. Yeah. The per unit economics are going to are going to look a little lighter, but the overall economics are going to be strong."
},
{
"speaker": "Brian Meredith",
"text": "Terrific. Thanks so much for the answers and all the best in your retirement."
},
{
"speaker": "Alan Colberg",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is coming from Michael Phillips from Morgan Stanley."
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning, Mike (ph)."
},
{
"speaker": "Michael Phillips",
"text": "Hey. Good morning, everybody. Thanks. Good morning. Richard, when you talked about the impact in the fourth quarter from the roll out expenses from T-Mobile, I guess -- Anyway you can help us quantify that meaningful impact. And then B, is it just a 4Q or any of that extended into 1Q next year?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yeah. Thanks for the question, Mike. In terms of quantifying it, I guess I would say we've given sort of aggregate -- an aggregate indication in terms of where we think Lifestyle is going to come in all year, and we talked about being a high single-digit. So, if you really look at last year where we came in and look at high single-digits, it will give you a pretty good view of where we think -- sorry, where we think, Lifestyle is going to come in for the full year, and part of that decrease is going to -- is based on the increase in the setting up the service and repair and investments that we're making in Connected Living broadly. So that will be in the fourth quarter. And then we would anticipate some coming in next year. So, I mean, in terms of rolling into next year, there will be some amount of big amount -- biggest amount I would say it would be in the fourth quarter of this year. We are thinking a few million and ramp up quite a bit into into the fourth quarter. So, we are talking in terms of millions here in terms of doing it."
},
{
"speaker": "Keith Demmings",
"text": "Yeah. And I would just add. In addition to the startup costs really ramping, doing all the recruiting, the training, the hiring, and getting all the build-outs done, there is also just the ongoing evolution of the service that we're going to deliver which inevitably will change and evolve over time as we continue to work with T-Mobile to optimize that experience. So, I do expect some investments in 2022, partly supporting the rollout to completion, but also ramping execution and investing in our technology to make sure that we're delivering services seamlessly as possible. So, you definitely would expect to see some investments as we continue to shape this part of our business going forward."
},
{
"speaker": "Michael Phillips",
"text": "Okay, that makes sense. Two more kind of quick ones, I guess then. On the labor and material costs and the severity there, talked about that quite a bit. I guess a follow-up. Richard, you said if things continue -- I think you said if things continue, obviously that could be offset in the future by higher rates over time. Does that mean you're currently pricing in for that or still kind of waiting to see how that plays out?"
},
{
"speaker": "Richard Dziadzio",
"text": "Some of it's currently coming through. Every year in our contracts, we get an increase what we -- what I refer to as average insured value. So that's embedded in the contracts. We look at inflation. And we do get some increase in the overall premiums from that. When I was talking about the trends over time and the rate filing, one, we can't put in a rate filing for one quarter. When we file rates, it's based on averages over a couple of years. So that's really for inflation to come in the lasting and have an impact on the non-CAT loss ratio. It would need to come -- would need to happen over time is what I was referring to there, Mike. And then we would put it in and then you get it. So, there is a lag but it would be offset over time, is what I was saying."
},
{
"speaker": "Michael Phillips",
"text": "Okay. That makes sense. I guess last quick one. Was any impact in the quarter on your sub -- mobile sub numbers from the T-Mobile cyber -attacks like on this?"
},
{
"speaker": "Keith Demmings",
"text": "Now, I would say nothing meaningful that we're aware of or that we saw. I mean, we had -- we have a really strong base of customers and I don't think we saw anything of note that I'm aware of."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Thank you, guys."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is coming from Mark Hughes with Truist Securities."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Mark."
},
{
"speaker": "Alan Colberg",
"text": "Mark."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Thank you. Good morning. Congratulations, Alan."
},
{
"speaker": "Alan Colberg",
"text": "Thank you."
},
{
"speaker": "Mark Hughes",
"text": "The -- can you refresh me on the revenue model for the in-store business that T-Mobile, is it kind of time and materials? Is it repair per device? Hourly reimbursement? How does that work?"
},
{
"speaker": "Keith Demmings",
"text": "It's a great question. It's -- I would think of it as fee income oriented, and getting paid for the labor that we perform. And then for -- from the management of the overall program, we don't really have risk around how the business performed from our parts and labor other than we get stated fees and we've got to manage ourselves within those levels to drive profitability. So, I think it's a really, really well-structured financial deal and our interest are very aligned. And it's very motivated around delivering an exceptional experience in the store. So, I feel really good about not just the deal that we put together but how we're working together with T-Mobile to really change the industry."
},
{
"speaker": "Mark Hughes",
"text": "And are they going to be advertising it? How are customer is going to know that the prepare capabilities available?"
},
{
"speaker": "Keith Demmings",
"text": "Well, we obviously manage the claim process within consumers and now that's what the entire base T-Mobile subscribers. So, we'll be directing customers as appropriate to take advantage of really the best option that's available to them to get repairs done. So, I think it will be largely through our claims flow, but also through T-Mobile awareness campaigns, etc."
},
{
"speaker": "Mark Hughes",
"text": "And then Richard, I think you all have addressed this to a degree, but any more adjectives or maybe even numbers you might throw when you're talking about 2022. Earnings expansion to continue though at more moderate levels, I think you also referred to strong growth in 2022. Anything else you want to add to that?"
},
{
"speaker": "Richard Dziadzio",
"text": "I wouldn't want to jump in Investor Day, and when we talk about our outlook next year, I guess I would say two things. I mean, we're -- Steve heard during the call, we're really -- we're really pleased with where we are across our set of businesses, whether it be the growth that we're seeing in Global Auto. the extension that contract, the T-Mobile, the growth other elsewhere domestically in the U.S and mobile in Japan and mobile. And also, in the housing business. You see that we do seem to be at a bottom with placement rates. Now, when the forbearance and Foreclosure period will end, it will be a slow take up. We continue to grow in multi-family housing, so we think we're well-positioned for 2022. Having said that, as Keith mentioned, we still need to continue to invest in ourselves and in our business and it's not like we're without headwinds in terms of some interest rates or inflation. But I really feel good about where we are as a business totally. And I think Alan's put us in a good position to succeed over the future under Keith's leadership."
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is coming from Jeff Schmitt, from William Blair."
},
{
"speaker": "Alan Colberg",
"text": "Hey, good morning, Jeff."
},
{
"speaker": "Jeff Schmitt",
"text": "Good morning. How much of the increase in fee income in Connected Living was due to highlight acquisition? Obviously, there's kind of a weak comparison to, but just curious how much of that is organic growth maybe driven by the 5G upgrade cycle versus Hyla being added to the mix"
},
{
"speaker": "Keith Demmings",
"text": "I would say Hyla's been performing exceptionally well. So, as we look at what's happened since close, trading volumes are up significantly. We've seen obviously not just demand from 5G significant client promotions where trade-ins are the main incentive being used. Increasing attach rates and just I think pent-up demand coming out of the pandemic. So, we talked about the performance of the acquisition 50% better than we modeled based on '21. So, we're thrilled with how it's going, but more than that really excited about the integration, how well that's working, our ability to protect talent, obviously a significant renewal of a major relationship with AT&T. And then as you think about the overall volumes process, we talked about 18 million devices so far this year. That compares to 14 million for full-year 2020, and that's overall, in total, combining high land assurance. So yes, high-low as a big driver of fee income, but we've also seen growth on what I would call the legacy assurance side of the trading business as well. And similar trends are happening across clients and across the market. So, it's a really strong time for trading in the global market."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. Great. And then the same-day service capabilities you've touched on that quite a bit of rolling it out with T-Mobile here a few days ago it sounds like. Did -- how much of those capabilities being affected by labor shortages right now? I don't know if you touched on them, but just curious how you're managing that in the current environment."
},
{
"speaker": "Keith Demmings",
"text": "Our team has done an incredible job. We've been working on this for many months, trying to acquire the right labor in various markets around the country. I would say our team, the recruiters that we're partnered with, some of the incentives that we've put in place to get the best talent. It's worked really well. Not to say there aren't challenges of course there are but our teams have, have partnered really well with third-parties as well as what T-Mobile to make it happen."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. Great. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our last question is coming from Grace Carter with Bank of America."
},
{
"speaker": "Alan Colberg",
"text": "Hey. Good morning, Grace."
},
{
"speaker": "Grace Carter",
"text": "Hi. We've talked a lot about structural tailwinds or attachment rates in mobile devices, one of them being rising prices. I was wondering, in kind of this more inflationary environment that we're looking at, if you've seen any sort of tangible impact from the inflation impact on pricing, driving up attachment rates at all, and to the extent that we continue to see a bit of higher inflation, if you think that that should have any impact going forward?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah, that's a great question. I would say maybe a little bit on the auto side if you think about really more of a mix shift point. So used cars tend to attach at slightly higher rates than new cars. And we've also seen obviously accelerating value on the used car side, which makes protecting the vehicle a higher likelihood. So, we have seen a little bit of a mix shift there which is benefiting the overall attach rate. I would say broadly though, pretty steady, pretty strong across the board. So, nothing that I would signal as being a really dramatic, but certainly good strong results."
},
{
"speaker": "Grace Carter",
"text": "Okay, thank you. And then just kind of a quick follow-up to that, we've seen attachment rates across mobile devices and cars going up over the past several years. Do you think that there is an eventual ceiling on how high attachment rates can go? I mean, what's kind of the long-term target there, I guess?"
},
{
"speaker": "Keith Demmings",
"text": "I think it varies by market, by geography. Some markets attach just based on consumer perception, consumer demand at higher levels. I definitely think we're -- we've got robust levels of attach rates broadly. I think they could still go up over time, certainly. I think awareness for the programs, the value proposition for our products continues to improve. The service delivery and the options for consumers and how much more convenient and important the services to them today than it was a few years ago. I think all of those elements can drive in a more attach rates in the future, so still some upside but really robust if I look at in mature markets. And then certainly growth opportunity in more of the emerging or more nascent markets."
},
{
"speaker": "Grace Carter",
"text": "Thank you and congrats to Alan."
},
{
"speaker": "Alan Colberg",
"text": "All right, thank you Grace."
},
{
"speaker": "Keith Demmings",
"text": "Thank you everyone for participating in today's call. In summary, we're very pleased with our year-to-date performance, and we're excited about the opportunities we have to serve our partners, our end consumers while delivering results for our shareholders. I look forward to officially taking the CEO role in January and updating you on our progress on the fourth quarter earnings call in February. We're also hard at work and anticipating Assurant 's 2022 Virtual Investor Day, which we expect to hold on March 24th and more details will be forthcoming in the weeks in months ahead. In the meantime, please reach out to Suzanne Shepherd and Gene Mergelmeyer (ph) with any follow-up questions. Thank you all. And have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 2 | 2,021 | 2021-08-04 08:00:00 | Operator: Hello, and good day. Thank you for standing by. Welcome to the Assurant Second Quarter 2021 Conference Call and Webcast. At this time, all participants have been placed in listen-only mode. And floor will be open for question following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2021 results with you today. Joining me for Assurant's conference call are Alan Colberg, our Chief Executive Officer; Keith Demmings, our President; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the second quarter of 2021. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Alan, Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more information on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan.
Alan Colberg: Thanks, Suzanne. Good morning, everyone. We are very pleased with our second quarter results. Our performance so far this year across our Global Lifestyle and Global Housing businesses demonstrates the power of our strategy to support consumers connected lifestyle and continues to give us strong confidence in the future growth prospects for Assurant. Prior to reviewing our progress against our 2021 financial objectives, I wanted to take a moment to express my deep gratitude to our employees around the world, specifically for their continued dedication and support for all of Assurant's stakeholders during my tenure as CEO and especially over the last 18 months of the pandemic. Our talent is a great enabler of our company's growth and progress, and Keith Demmings' appointment as my successor is evidence of that. With a 25-year-long career with the company, Keith has a clear track record of success and personifies the values and integrity that are emblematic of Assurant's culture and he's a natural choice as our next CEO. His deep operational experience and strong engagement with clients has been instrumental in guiding Assurant's growth across the enterprise. As CEO, Keith will drive innovation through our connected world and Specialty P&C businesses. The completion of the sale of Global Preneed to CUNA Mutual Group marks another important milestone for Assurant as it enables our organization to further deepen our focus on our market-leading lifestyle and housing businesses. I would like to thank all of our former Preneed employees who have transitioned to CUNA Mutual Group for their tremendous support to Assurant and our clients and policyholders. As we look to the convergence of the connected mobile device, car and home, we believe our Connected Living, Global Automotive and Multifamily Housing businesses will continue their compelling history of strong growth into the future. Not only do our Connected World businesses have a history of profitable growth, more than tripling earnings over the last 5 years, we're also characterized by partnerships with leading global brands, broad multichannel distribution that provides consumers with choice, value and exceptional service and a track record of innovative offerings that have become industry standards. ESG is core to our strategy and sure we'll build a more sustainable Assurant for all of our stakeholders focusing on talent, products and climate. During the quarter, we continued to advance our ESG efforts as we work to create an even more diverse, equitable and inclusive culture that promotes innovation, enhances sustainability and minimizes our carbon footprint. We recently completed our 2021 CDP climate survey, our sixth annual screen submission, expanding this year to include Scope 3 greenhouse gas emissions across several categories. The CDP survey is an important climate change assessment, which many of our key stakeholders rely on each year. Our efforts have led to recognition that we're proud of. During the quarter, Assurant was recognized as a 2021 honoree of the Civic 50 by Points of Light, distinguishing Assurant as 1 of the 50 most community-minded companies in the U.S. We are proud of our progress and believe the future of Assurant is bright. Together, lifestyle and housing should continue to drive above-market growth and superior cash flow generation, with the ability to outperform in a wide spectrum of economic scenarios and ultimately, continue to create greater shareholder value over time. Year-to-date, excluding reportable catastrophes, net operating income per share was $6.02, up 14% from the first half of last year and net operating income was $366 million, an increase of 13%. Adjusted EBITDA increased 12% to $600 million. These results support our full year outlook of 10% to 14% growth in net operating income per share, excluding affordable catastrophes. While we expect earnings growth in the second half on a year-over-year basis, our outlook for the full year assumes a decline in earnings from the first half, reflecting increased investments to support long-term growth in our Connected World businesses, lower investment income and increased corporate and other expenses due to timing of spending. Turning to capital. From 2019 through June of this year, we've returned to shareholders over 88% or almost $1.2 billion of our 3-year $1.35 billion objective. In July, we repurchased an additional 737,000 shares for $115 million and declared our quarterly common stock dividend for the third quarter, essentially completing our objective when paid. In addition to completing this objective, we expect to return $900 million in net proceeds from the sale of Global Preneed within the next 12 months, and therefore, expect buybacks to continue at a higher-than-usual level throughout the remainder of the year and into 2022. I'll now turn the call over to Keith to review our key Connected World highlights for the quarter. Keith?
Keith Demmings: Thank you, Alan, and good morning, everyone. I wanted to begin by expressing my thanks to Alan for his steadfast leadership and the successful transformation of Assurant since becoming CEO at the beginning of 2015. Through his strategic vision and intense focus on the evolving needs of our clients and end consumers, Alan and our team have solidified market-leading positions in our Connected World and Specialty P&C businesses, helped Assurant establish a strong growth, capital-light service-oriented business model where our Connected World offerings now comprise approximately two-thirds of our segment earnings and ultimately, work together to unlock the power of our Fortune 300 organization, prioritizing resources against initiatives with the highest growth potential and standing up key enterprise capabilities and functions, which we can now leverage across our growing client and customer base. As a result, Assurant is on track to deliver our fifth consecutive year of strong profitable growth. As I continue to work closely with Alan over the coming months, I'm also engaging with many of our key stakeholders, including shareholders and analysts, who have shared valuable perspectives as we define our multiyear plan. As I identify key focus areas, I will prioritize developing and recruiting top talent, investing strategically to sustain and accelerate growth through product innovation and new distribution models, differentiating us further from our competition through continuous improvement in our customer service delivery and supporting the investment community in better understanding our portfolio as we look to drive further value creation. Our long-term goal will continue to be to deliver sustained growth and value to all of our stakeholders. Our ability to deliver on these ambitions will require additional innovation and investments to ultimately provide a superior customer experience and deepen our client relationships. Innovation will continue to be a key differentiator for Assurant, especially as we evolve with the convergence of the connected consumer. As part of our ongoing commitment to delivering a superior customer experience with a range of service delivery options, we'll be further building out our same-day service and repair capabilities for which there is growing demand. This requires upfront investments, which we expect to accelerate in the second half of this year as we look to provide additional choice and convenience for the end consumer. These investments are critical to sustain our competitive advantage in markets like the U.S. As we look to continue our culture of innovation, you may have seen we recently announced two key leadership changes to support those efforts. Manny Becerra, a 31-year veteran of Assurant, who is instrumental in driving the growth of our mobile business, was appointed to the newly created role of Chief Innovation Officer. Given his many contributions to our success, including the development of our mobile protection and trade-in and upgrade business, he will bring dedicated resources to accelerate innovation across the enterprise to capitalize on the rapid convergence across our home, automotive and mobile products. Biju Nair will now lead our Connected Living business as its President. His strong track record of delivering profitable growth and client service excellence combined with his depth of experience, particularly as the former CEO of Hyla Mobile makes him the perfect choice. A prime example of how innovation has allowed us to deepen and expand client relationships as well as create new revenue streams is our long-standing partnership with T-Mobile. Over the past 8 years, we have worked together to offer their customers innovative device protection, trade-in and upgrade programs while further developing our supply chain services to support their mobile ecosystem. We are happy to announce that T-Mobile has extended our partnership as their device protection provider. While we are currently finalizing contract terms, we are excited about the multiyear extension of our relationship and our ability to continue to expand our services to deliver a superior customer experience. In addition to our innovation efforts, our investments over the past several years have supported our growth through the success of new and strengthened client relationships. After an initial investment in 2017, this quarter, we purchased the remainder of Olivar, a provider of mobile device life cycle management and asset disposition services in South Korea. While small in size, this acquisition enhances our global asset disposition capabilities and deepens our footprint in the Asia-Pacific region while complementing the recent acquisitions of Alegre in Australia and Hyla Mobile. These investments have enhanced our technology, operational capabilities and partnerships in the trade-in and upgrade market, positioning us to capitalize on the 5G upgrade cycle over the next several years. While later this year, the growing availability of 5G smartphones, combined with trade-in promotions, demonstrate increasing momentum for the upgrade cycle. For carriers, retailers, OEMs and cable operators, 5G offers an opportunity to drive additional revenue and gain market share. Strong trade-in and upgrade promotions have also led to higher trade-in volumes for Assurant as well as higher Net Promoter Scores and net subscriber growth within our client base. Our focus on our client relationships, combined with our willingness to innovate to enhance the end consumer experience, continues to create momentum for our businesses. Over the last few months, we have delivered several new partnerships and renewals throughout the enterprise, including the renewal of two key European mobile clients, representing 700,000 subscribers; renewal of 8 global automotive partnerships, representing over 10 million policies across our distribution channels; renewal of 3 Multifamily Housing property management companies, including 2 of the largest in the U.S. as we continue to grow the rollout of our Cover360 product; renewal of 3 clients and 2 new partnerships in lender-placed as we provide critical support for the U.S. mortgage market. In summary, I am very excited to lead our 14,000 employees into the future and build on the tremendous momentum created under Alan's leadership. I'll now turn the call over to Richard to review the second quarter results and our 2021 outlook.
Richard Dziadzio: Thank you, Keith, and good morning, everyone. We're pleased with our second quarter performance, especially when compared to our strong results last year. For the quarter, we reported net operating income per share, excluding reportable catastrophes of $2.99, up 12% from the prior year period. Excluding GAAP's net operating income for the quarter, totaled $184 million. And adjusted EBITDA amounted to $298 million, a year-over-year increase of 12% and 10% respectively. Our performance across Lifestyle and Housing remains strong and we also benefited from a lower corporate loss and higher investment income, primarily related to the sale of a real estate joint venture partnership. Now let's move to segment results, starting with Global Lifestyle. The segment reported net operating income of $124 million in the second quarter, a year-over-year increase of 2%. This was driven by growth in Global Automotive and more favorable experience in Global Financial Services. Earnings increased $7 million or 16% from continued strong year-over-year growth related to our U.S. clients across various distribution channels. Results within auto also included a $4 million increase from the sale of a real estate joint venture partnership. Absent this gain, investment income in auto was down. Connected Living earnings decreased by $9 million compared to a strong prior year period. The decline was primarily driven by less favorable loss experience in our extended service contract business. Mobile earnings were modestly lower. The less favorable loss experience in service contracts in mobile was primarily related to our European and Latin American businesses. These regions benefited from lower claims activity in the prior year period due to the pandemic. Our underlying mobile business continued to grow in North America and Asia Pacific from enrollment increases at mobile carriers and cable operators with an increase of over 1 million covered devices in the last year. In addition, contributions from acquisitions such as Hyla Mobile benefited results. For the quarter, Lifestyle's adjusted EBITDA increased 6% to $186 million. This reflects the segment's increased amortization related to higher deal-related intangibles for more recent transactions in mobile and Global Automotive. IT depreciation expense also increased, stemming from higher investments. As we look at revenues, Lifestyle increased by $169 million or 10%. This was driven mainly by continued growth in Global Automotive and Connected Living. Within Global Automotive, revenue increased 13%, reflecting strong prior period sales of vehicle service contracts. Industry auto sales continued to increase during the quarter, with April seeing record levels in the U.S. This was reflected in our net written premiums of roughly $1.3 billion in the quarter, the highest quarter ever recorded. Connected Living revenues were 7% for the quarter. In addition to growth in service contracts, mobile fee income was driven by strong trading volumes, including contributions from Hyla. For the full year, Lifestyle revenues are expected to increase modestly compared to last year's Auto and Connected Living growth. We continue to expect covered mobile devices to grow mid-single digits in 2021 as we increase subscribers in key geographies like the U.S. and Japan. This also reflects a reduction of 750,000 mobile subscribers related to a European banking program that moved to another provider in the second quarter. As we previously outlined, this is not expected to significantly impact our profitability. For 2021, we still expect Global Lifestyle's net operating income to grow in the high single digits compared to the $437 million reported in 2020. While we expect earnings growth year-over-year for the second half, earnings in the second half of the year are expected to be lower compared to the strong first half performance, primarily due to two items: First, investment were increased across Connected Living in the second half of the year, including our same base service and repair capabilities. While these investments will meet earnings growth in the short term, they are expected to generate growth over the long term. And second, that investment income will be lower as we are not expecting gains from real estate joint venture partnerships that benefited the second quarter in auto. Adjusted EBITDA for the segment is still expected to grow double digits year-over-year at a faster pace than segment net operating income. Moving now to Global Housing. Net operating income for the quarter totaled $94 million compared to $85 million in the second quarter of 2020 due to $10 million of lower reportable catastrophes. Excluding catastrophe losses, earnings were relatively flat as growth within lender-placed and higher investment income was offset by the expected increase in non-cat loss experience across all non-cat loss experience across all lines of business. Investment income included a $4 million increase from the sale of a real estate joint venture referenced earlier. Regarding the non-cat loss ratio, the second quarter of 2020 benefited from unusually low non-cat losses, including impacts from the pandemic. As anticipated, we saw an increase in the frequency and severity of claims in the second quarter. We also increased reserves related to the cost of settling runoff claims within our small commercial book. In Multifamily Housing, underlying growth was offset by increased investments to further strengthen our customer experience, including our digital-first capabilities. Within lender-placed, higher revenues and investment income were partially offset by unfavorable non-cat loss experience and declining REO volumes from ongoing foreclosure moratoriums. Looking at loans track, the 1.5 million sequential loan declined was mainly attributable to a client portfolio that rolled off in the second quarter. However, the decline in loans track, that should be partially offset by two new client partnerships in the quarter, which should enable us to onboard approximately 700,000 loans by year-end. We also continued to reduce risk within housing. At the end of June, we completed our 2021 catastrophe reinsurance program. To mitigate multi-event risk, we added a flexible limit that can be used to reduce our retention from $80 million to $55 million in certain second and third events or increase the top of the tower of $50 million in excess of $950 million in the rare case of a 1 in 174-year event. We also increased our multiyear coverage to over 50% of our U.S. tower. In terms of revenue, Global Housing's revenue increased 5%, primarily due to double-digit growth in Multifamily Housing as well as higher revenue in lender-placed, including higher premium rates and average insured values. As a result of the strong first half, we now expect Global Housing net operating income, excluding cat, to be flat compared to the $371 million in 2020. This is above our initial expectations that earnings would be down this year. Earnings in the second half are expected to be lower than the first half of the year, primarily related to three items: First, lower net investment income, particularly considering the real estate joint venture gain in the second quarter; second, lower results in our specialty P&C offerings after a strong first half; and third, continued investments in the business, particularly in Multifamily Housing to sustain and enhance our competitive position. We also continue to monitor through REO foreclosure moratoriums and any additional extensions that may be announced. At corporate, the net operating loss was $12 million compared to $29 million in the second quarter of 2020. This was driven by two items. First, lower employee-related expenses and third-party fees, which we expect to increase in the second half of the year; and second, we had $6 million of favorable onetime items including a tax benefit and income from the sale of real estate joint venture partnership. We also anticipate high spending second half of the year compared to the first half, due to an increase in recruiting and moderate travel and related expenses. As we expect to begin a phase two reentry of our workforce. In addition, third-party expenses are expected to increase due to acceleration and timing of investments. For the full year 2021, we now expect the corporate net operating loss to be approximately $85 million. This compares to our previous estimate of $90 million. Turning to holding company liquidity, we ended the second quarter with $353 million, which is $128 million above our current minimum target level. This excludes both the $1.2 billion in net proceeds from the sale of Preneed and the net proceeds from the second quarter debt offering, which were used for the July redemption of senior notes due in 2023. In the second quarter, dividends from our operating segments totaled $243 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items: $191 million of share repurchases, $42 million in common stock dividends and $17 million mainly related to mobile acquisitions, including Olivar and Assurant Venture investments. For the overall year, we continue to expect dividends to approximate segment earnings, subject to the growth of the businesses, rating agency and regulatory capital requirements, investment portfolio performance and any impact from a potential change in corporate U.S. tax rates. In summary, our strong performance for the first half of the year positions us nicely to meet our full year financial commitments while continuing to invest in our long-term growth. And with that, operator, please open the call for questions.
Operator: [Operator Instructions] Our first question comes from the line of Brian Meredith from UBS. Your line is open.
Brian Meredith: A couple of questions here for you. First, I'm just curious, the LPI customer that you lost, why did you lose that customer? Is it competitive reasons? I always thought that's kind of a pretty sticky business.
Alan Colberg: No, I think it is actually a very sticky business. If you look at that line of business over the last two or three years, we've renewed or early renewed almost all of the clients on occasion business does move. And as you saw in our prepared remarks, we did pick up two new clients that will begin to onboard as we move into Q3 and Q4. And the reason we've had such strong success has been our investments in both the customer experience as well as the client experience and making sure we're delivering a fully compliant product. But no, we feel good about LPI and are well positioned when the housing market does weaken.
Brian Meredith: Great. And then second question, I'm just curious, how are conversions going with respect to the T-Mobile and Sprint customers? And are you seeing a pickup in that at this point?
Keith Demmings: Yes. It's Keith, maybe I'll jump in. Thanks for the question. Obviously, we continue to be pleased with the progress of the ramp of Sprint customers. As T-Mobile continues to ramp and migrate Sprint to T-Mob products and rate plans, we continue to see additional enrollments into our programs. I would say it's happening, as we would have expected, largely on track. And we talked about the renewal and extension of our relationship. We're clearly really excited about our long-term opportunities with T-Mobile. We've had a great track record working together for the last 8 years, innovating in the market, adding new products and services. And certainly, as we think about Sprint continuing to ramp over time, we're really excited about working together to grow the overall business.
Brian Meredith: And then one last one just quickly here, probably for Richard. As we look at the capital management that's going to happen here over the next 12 to 18 months, a lot of stock to buy back. Do you all considered ASRs or celebrate share repurchase programs as a part of capital management?
Richard Dziadzio: Thanks for the question, Brian. I think a couple things first, as you heard in the remarks, we're really pleased to have put a check next to our $1.35 billion commitment, with the third quarter dividend that will be issued we'll meet that objective before time. So we're very pleased about that. We did close on Preneed and received the proceeds this week on that. And as we said earlier, we will be buying back our shares at about -- over the next 12 months, I would say. So that's going to be put in place very quickly. We consider all options, we think share repurchases is the best way to go.
Alan Colberg: And Brian, this is Alan. The one thing I would add is we're also excited that we were able to complete our expectation from the 2019 Investor Day with what we did in July and then the announcement of the quarterly dividend in Q3, we are now effectively done with that expectation and we can move on to returning the $900 million from premiums in orderly fashion as Richard just said.
Operator: And your next question is from Tommy McJoynt from KBW. Your line is open.
Tommy McJoynt: So that's great to see the T-Mobile contract renewal is underway. Are there any notable changes to the economics or contract terms or anything else with that multiyear extension that you would want to share with us? And just confirming that the contract for Sprint as well, which doesn't need to be separately negotiated.
Keith Demmings: Correct. Yes. So it's for the totality of T-Mobile's business as we move forward. We mentioned earlier, we're still negotiating the final details of the agreement. So more to come as we lock down some of the moving parts. In terms of economics, I'd probably make two points. First, I'd say that it's not uncommon for us to forgo some economics when we recontract with major clients. We recontract obviously, quite regularly, often think about the broader long-term potential of the relationships. The potential for additional volume and for offering new products and services over time. Specifically with respect to T-Mobile, given that the relationship continues to scale with significant volume from Sprint, we do expect to achieve lower per unit economics, but we expect that to be offset by significant volume growth and economies of scale within the overall programs. I would also say that we're well positioned as partners to help them introduce new products and services over time. We've had a great track record of expanding the services we provide over the last 8 years to continue to evolve to serve the consumer. And finally, I'd point out from a mobile perspective, we really are excited about our overall long-term potential to compete in this market across the value chain and from an efficiency point of view.
Tommy McJoynt: And switching gears a little bit. Would you characterize the loss in claim rates that we saw in 2Q as fully back to normal? Or should we still expect some kind of further normalization over the medium term, if you could answer that with respect to both Lifestyle and Housing, that would be helpful.
Alan Colberg: Yes, Keith, you want to take a Lifestyle, then I can comment on housing maybe.
Keith Demmings: Sure. And I think we obviously saw favorability if we look back to Q2 of 2020. We've seen that normalize quite a bit as we look at the results in this quarter. So for the most part, losses have sort of come back to a more normalized level. There's still some moving parts, I would say, within international. As we look at COVID and various lockdowns and how things are progressing in different markets. But overall, we're at a much more normalized level from a loss ratio point of view.
Alan Colberg: Yes. It's effectively the same in Housing. We had a better Q1 loss experience than we would have expected, just some of the lingering impacts of the COVID and the lockdowns in various parts of the economy. But in Q2, we're more back to what we expected, and we expect that will continue the rest of the year.
Tommy McJoynt: Then I'll just sneak one more in here. So with the strong second quarter and the first half of the year, it was a bit surprising to see the full year NOI guidance to be higher that you went through some of the puts and takes as to why the second half should be lower than the first half. If you were to see some upside, but where do you think it would be, kind of which cause would you most likely to see upside?
Alan Colberg: Yes. What I would say is, first of all, we're very pleased, obviously, with the first half and second quarter, very strong. In fact, probably a little better than we'd expected going into the year. If you think about what could cause us to exceed our outlook. First of all, we're still confident that we're in that range. But it would be things that are less within our control like what happens with the loss ratio in the market or could there be some other impact from COVID and the delta variants. But with all that said, it's a really strong first half. In the second half of the year, even as we've guided to be lower than the first half, we still expect to grow strongly versus second half of 2020. And the business is performing well, and we continue to expect that looking to the future.
Operator: And your next question is from Mark Hughes from Truist Securities. Your line is open.
Mark Hughes: You had a particularly good results in the automotive business. Could you maybe try to break out how much of that was just kind of strong rebounding economy versus new relationships, higher attachment rates? How much momentum does that give you in the second half in terms of new business?
Keith Demmings: Sure. And it's Keith, maybe I'll take that. I mean, overall, I would say we've seen healthy double-digit growth rates in car volumes from pre-pandemic levels. So yes, you're correct, a huge recovery in Q2 versus Q2 of last year. Obviously, Q2 of last year was quite depressed. This year was an incredible rebound. We saw a net written premium up 68% over the same quarter last year. But a lot of that is -- the depression last year and then a really strong quarter this year. If you look at it over 2019, which is sort of pre-pandemic normal, it was a 36% increase this year. So really, really strong. And yes, we're seeing strong attach rates in the business. We've seen a slight shift between new and used. So our new and used mix is normally around 50-50 or maybe 53% used today. Used tends to have slightly higher attach rates. Obviously, it earns a little bit quicker. We've seen our clients taking share through consolidation. We've seen clients expanding their used car operations, rolling out strong digital brands. So there's a lot of growth, I would say, within our core client base. And then certainly, we've added some new clients as well. But strong car sales, large clients that are gaining share and then winning some new deals in the market.
Mark Hughes: In the lender-placed insurance business, any issues around inflation in materials or labor?
Keith Demmings: Yes. It's interesting. We kind of have offsetting effects there. So if you think about our premiums, it's driven by average insured value. So as house prices rise and we issue new policies, those are going to naturally be at a higher premium rate. So we're getting some positive benefit there. The offset is cost of claims will rise as well. And ultimately, we'll be able to reflect our experience in future rate filings. But if you put it all together, we don't think it's particularly material to our business. It may not be perfectly aligned quarter-to-quarter those effects, but over time, not material.
Mark Hughes: The lender-placed insurance, your placement rates is the end of the foreclosure moratorium. Is that an important -- or how important an trigger is that for your placement rate? I know your REO is directly impacted, but are there other drivers that are restraining our placement rates based on government action. Could you just talk a little bit about that?
Keith Demmings: Yes. What I think you've seen over the last year or so is that our placement rate is roughly flat at this point, with really no significant trend up or down. And the good news is through the actions we've taken over the years, the business is in a really strong position. We're delivering great customer and client experiences. And if the -- it weakens, we will benefit and grow over time. So in terms of moratoriums and when they come off, if and when they do come off, we will see the impact with a lag. So even if they came off today broadly, which is -- there's still a lot to work through there and there'll be modifications and other things that will happen. We don't expect anything to happen in our placement rate this year, and where we could see an impact is when you get into 2022 and beyond. But I think the important takeaway on lender-placed is, we're still a clear market leader with a strong commitment to customer and client experience. And we will be there to partner with the world's leading U.S. as leading banks when the housing market weakens.
Operator: And we have a question from Michael Phillips with Morgan Stanley. Your line is open.
Michael Phillips: First question on the investments that you talked about and the impact of that in the second half of the year. But really, the question is when will we see the impact of that -- the benefits of those? Is that more -- you talked about growth potential, is that more top line benefits? Is it more margin benefits or both? And then when you say long term, kind of -- can you kind of put a time frame around it. Is that something we'll start to see benefits of those things in next year or even longer than that?
Keith Demmings: Maybe I'll take that one, Alan. So let me just clarify first the two buckets where we're making the investments or at least the most significant investments. So first we talked about is around same-day service and repair, this has been -- become a really important component of our value proposition. It's become more critical in the market demanded by clients, demanded by consumers and really improve the overall service experience. So we are going to be accelerating investments in the second half in terms of leadership personnel, in terms of technology and equipment. We're also working very hard to integrate our service delivery options seamlessly into the claims experience to really create a more dynamic claims process to give customers a better choice and options. That's, I think, critically important strategically for us. And I think we've got great advantages there today. So we're trying to accelerate those advantages in the market. That will drive revenue as we think about moving into 2022. We see this as a important opportunity to expand services with existing clients and also expand with new clients. In terms of the second bucket, I would say, operational investments that are focused on really the entire enterprise between both housing and lifestyle, investing more heavily in digital capabilities, self-service and automation. Think about things like digital sales and self-service portals, investing in our customer-facing applications integrating our communication channels, automating decisions around claims to make the process more efficient and more repeatable and then automating back-office tasks. We've got a fairly large project going across multiple lines of business and multiple geographies. And that will generate cost efficiency over time. But more than anything, it will create a much more seamless customer experience and I think make us that much more competitive in the market.
Michael Phillips: Two more, I guess, a quicker ones. What can you share about the cost or the impact on the cost of the reinsurance structure that Richard talked about?
Alan Colberg: Richard, do you want that take?
Richard Dziadzio: Yes, maybe I can take that. The overall cost is going to be up this year from last year, but not that much. But essentially, what we did is we bought a -- what we call a second and third cover. So if ever we have an event that goes up into our retention -- past our retention on a second and third event, we actually go and reduce the retention down to $55 million from $80 million or if we didn't use that and there was a major event, it would help us at the top of the tower, too. So that will add a little bit, but it's a modest increase in our overall placement. And we were actually pleased to see that every year when we go to the market, we have a stable list of reinsurers that follow us. Think about 40 carriers being A- or better. And we are able to place our reinsurance on a kind of a like-for-like basis without this new feature I talked about at a little bit below where the market is. So we're really proud of what we've done with cat. And I guess the last thing I would say is the cat exposure that we have today is less than we had in previous years, given how we've been working on our cat exposure overall, but also the growth in our other businesses, Multifamily Housing, Global, Auto, Connected Living. So one of the things we mentioned in our press release earlier this year that, for example, in a 1 in 50-year event, back in 2017, we would have kept 40% of our earnings. Now in a 1 in 50-year event, we retained 70% of those earnings. So it would just show you the big change that's been made in our management of our cat exposure and the growth of the company elsewhere.
Michael Phillips: Last quick one for me. On the impact of rising home prices on the LPI premiums, is that true just for new policies or also for fire issue policies as well?
Alan Colberg: So for the new policies, it's obviously immediate. And when we place them for existing policies, it's on the renewal date. And these are annual policies. So it would happen on the renewal.
Operator: Your next question is from Jeff Schmitt from William Blair. Your line is open.
Jeff Schmitt: Could you discuss just how that legacy Sprint customer transition works. I believe they get an option to sort of switch over to the T-Mobile network if they want when they sort of trade in or upgrade their phone. Switching to mobile protection plan to Assurant, is that a separate decision? And do you have a sense on what that uptake rate is? How many are coming over versus kind of staying with what they have?
Keith Demmings: Yes, I would say that as they're moving customers on to T-Mobile product, T-Mobile REIT plans and services at that point, they're offering the customer the opportunity to enroll in insurance and effectively reenroll as they're enrolled today and that's automatically moving over to Assurant. So I would say, very typically, as that happens and as T-Mobile pushes more and more customers onto T-Mobile product, we're seeing the increase sort of one-for-one come through.
Jeff Schmitt: And then you'd mentioned that covered mobile device growth should start moving up here in the second half. I think you said mid-single digits. And I know it takes a couple of years for an account to mature, you kind of start at 0 there. But what are some of the newer accounts there that would drive that ramp up? Is that KBDI, the cable operators, how far into those relationships are you?
Keith Demmings: Yes. I would say the one thing to remember with the sub count is we did have a loss of client in Europe, a banking client for 750,000 subs. So that has moved down our sub count, which is why it's flat as we sit here today year-to-date, but we do expect it to be mid-single digits by the end of the year. And I would say largely the U.S. and Japan are driving the majority of that growth. And certainly, I think all of our clients in both markets are growing.
Operator: Your next question is from Grace Carter from Bank of America. Your line is open.
Grace Carter: I was wondering, since we saw growth in Global Financial Services for the first time in a little bit, does that have to do with the disruption last year at this time? Or is this an inflection point? And if we could just talk a little bit about the outlook for that segment.
Keith Demmings: Yes. I think it's more to do with the disruption last year. Q2 was depressed. We had some additional losses related to some travel products in a couple of our markets. I some travel products in a couple of our markets. I would say as we look at the results today, there are more normalized which we think is a good jumping off point. We certainly have ambitions to grow that business over time. We're excited about the work that our teams are doing around the world, but it's mainly due to the depression in results last year.
Grace Carter: And then I was wondering with the Lifestyle business, given the recent concerns about the delta variant, if you all have seen any impact on your global supply chains in that business?
Keith Demmings: I think broadly, our teams have done an incredible job. We operate physical depots in many markets around the world. So making sure that we're able to perform essential services is critical, keeping our employees safe has been a priority. I think we've done a very good job of executing service. There's some parts disruption due to the chip shortages as we think about repairing devices. Our teams have done a really good job working with manufacturers to procure and acquire parts. Broadly speaking, we haven't seen much disruption to our business to date. Hopefully, that will continue as we move forward. But overall, this is a strength of Assurant. Supply chain is one of our key differentiators in the Connected Living business and really proud of the work the team has done.
Operator: And your last question is from Gary Ransom from Dowling & Partners. Your line is open.
Gary Ransom: A lot of my questions have been answered. But I wanted to ask the -- a little bit broader question on the opening economy and recovering economy. You did respond a little bit on the auto market. But are there other parts of your business that you -- that will show more growth or be influenced significantly by an assumption that the economy continues to strengthen and reopen this year?
Alan Colberg: Yes. Maybe I'll start and talk a little bit about housing. And then, Keith, maybe you can add any more color on lifestyle. If you look at housing, our largest growth business is Multifamily Housing or our renters business. Arguably, in a market perspective, that was one of the most disruptive markets through COVID. But with that, we've still seen strong growth. So even with the disruption, even with the impacts on COVID, we've had a very strong growth in line with our long-term expectations in Multifamily. And driven in part by the strength of our partnerships, also driven by the launch of our new product, Cover360. If you looked at LPI, that business, as I mentioned earlier, is stable. We have a very strong base of customers and clients there. And if the economy weakens, we'll grow. So from a housing perspective, we've seen growth even through the disruption of COVID. And we would expect in a weaker market economy, we'll see growth, and we'll continue to see growth if the economy just chugs along. But that's housing, but let's go to Lifestyle, Keith.
Keith Demmings: I'd probably add that on the Lifestyle side, and particularly in Connected Living, we see really strong positive impacts from 5G. We talk a lot about our trade-in business. I would say trade-in is a really important part of our value proposition, something that our carrier partners lean quite heavily on to drive promotions in the market to try to get additional dollars in the hands of consumers to allow them to be able to upgrade to the latest 5G technology. We've seen obviously very aggressive promotions in that space, and we're supporting our clients scaling our operations. And I think doing an incredible job leveraging all of our acquisitions, think about Hyla, Alegre, all of our -- we've made several investments around trade-in capabilities. I think we've got a global market-leading position and this continues to be more important. We've seen dramatic increases in trade-ins in terms of volumes and promotional activity, but also the attach rates at point of sale and consumers' willingness and education about trade-ins has increased dramatically. So expect that to continue as we move forward in the year. Obviously hard to predict what will happen with COVID, but there's some pretty strong trends on mobile.
Alan Colberg: Yes. And if I just elevate to an overall Assurant level, and I mentioned this in the prepared remarks, we are well positioned and expect to outperform no matter what the external environment is. And the COVID really again demonstrated that resiliency of our business model, driven by the great value that we're bringing to consumers around the world. And with that, I want to thank everyone for participating in today's call. With the close of the sale of Global Preneed and our strong year-to-date performance, we believe we're well positioned for the future. We'll update you on our progress on our third quarter earnings call in November. In the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. Thanks, everyone.
Operator: Thank you. This concludes today's conference. Please disconnect your lines at this time, and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Hello, and good day. Thank you for standing by. Welcome to the Assurant Second Quarter 2021 Conference Call and Webcast. At this time, all participants have been placed in listen-only mode. And floor will be open for question following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2021 results with you today. Joining me for Assurant's conference call are Alan Colberg, our Chief Executive Officer; Keith Demmings, our President; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the second quarter of 2021. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Alan, Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more information on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan."
},
{
"speaker": "Alan Colberg",
"text": "Thanks, Suzanne. Good morning, everyone. We are very pleased with our second quarter results. Our performance so far this year across our Global Lifestyle and Global Housing businesses demonstrates the power of our strategy to support consumers connected lifestyle and continues to give us strong confidence in the future growth prospects for Assurant. Prior to reviewing our progress against our 2021 financial objectives, I wanted to take a moment to express my deep gratitude to our employees around the world, specifically for their continued dedication and support for all of Assurant's stakeholders during my tenure as CEO and especially over the last 18 months of the pandemic. Our talent is a great enabler of our company's growth and progress, and Keith Demmings' appointment as my successor is evidence of that. With a 25-year-long career with the company, Keith has a clear track record of success and personifies the values and integrity that are emblematic of Assurant's culture and he's a natural choice as our next CEO. His deep operational experience and strong engagement with clients has been instrumental in guiding Assurant's growth across the enterprise. As CEO, Keith will drive innovation through our connected world and Specialty P&C businesses. The completion of the sale of Global Preneed to CUNA Mutual Group marks another important milestone for Assurant as it enables our organization to further deepen our focus on our market-leading lifestyle and housing businesses. I would like to thank all of our former Preneed employees who have transitioned to CUNA Mutual Group for their tremendous support to Assurant and our clients and policyholders. As we look to the convergence of the connected mobile device, car and home, we believe our Connected Living, Global Automotive and Multifamily Housing businesses will continue their compelling history of strong growth into the future. Not only do our Connected World businesses have a history of profitable growth, more than tripling earnings over the last 5 years, we're also characterized by partnerships with leading global brands, broad multichannel distribution that provides consumers with choice, value and exceptional service and a track record of innovative offerings that have become industry standards. ESG is core to our strategy and sure we'll build a more sustainable Assurant for all of our stakeholders focusing on talent, products and climate. During the quarter, we continued to advance our ESG efforts as we work to create an even more diverse, equitable and inclusive culture that promotes innovation, enhances sustainability and minimizes our carbon footprint. We recently completed our 2021 CDP climate survey, our sixth annual screen submission, expanding this year to include Scope 3 greenhouse gas emissions across several categories. The CDP survey is an important climate change assessment, which many of our key stakeholders rely on each year. Our efforts have led to recognition that we're proud of. During the quarter, Assurant was recognized as a 2021 honoree of the Civic 50 by Points of Light, distinguishing Assurant as 1 of the 50 most community-minded companies in the U.S. We are proud of our progress and believe the future of Assurant is bright. Together, lifestyle and housing should continue to drive above-market growth and superior cash flow generation, with the ability to outperform in a wide spectrum of economic scenarios and ultimately, continue to create greater shareholder value over time. Year-to-date, excluding reportable catastrophes, net operating income per share was $6.02, up 14% from the first half of last year and net operating income was $366 million, an increase of 13%. Adjusted EBITDA increased 12% to $600 million. These results support our full year outlook of 10% to 14% growth in net operating income per share, excluding affordable catastrophes. While we expect earnings growth in the second half on a year-over-year basis, our outlook for the full year assumes a decline in earnings from the first half, reflecting increased investments to support long-term growth in our Connected World businesses, lower investment income and increased corporate and other expenses due to timing of spending. Turning to capital. From 2019 through June of this year, we've returned to shareholders over 88% or almost $1.2 billion of our 3-year $1.35 billion objective. In July, we repurchased an additional 737,000 shares for $115 million and declared our quarterly common stock dividend for the third quarter, essentially completing our objective when paid. In addition to completing this objective, we expect to return $900 million in net proceeds from the sale of Global Preneed within the next 12 months, and therefore, expect buybacks to continue at a higher-than-usual level throughout the remainder of the year and into 2022. I'll now turn the call over to Keith to review our key Connected World highlights for the quarter. Keith?"
},
{
"speaker": "Keith Demmings",
"text": "Thank you, Alan, and good morning, everyone. I wanted to begin by expressing my thanks to Alan for his steadfast leadership and the successful transformation of Assurant since becoming CEO at the beginning of 2015. Through his strategic vision and intense focus on the evolving needs of our clients and end consumers, Alan and our team have solidified market-leading positions in our Connected World and Specialty P&C businesses, helped Assurant establish a strong growth, capital-light service-oriented business model where our Connected World offerings now comprise approximately two-thirds of our segment earnings and ultimately, work together to unlock the power of our Fortune 300 organization, prioritizing resources against initiatives with the highest growth potential and standing up key enterprise capabilities and functions, which we can now leverage across our growing client and customer base. As a result, Assurant is on track to deliver our fifth consecutive year of strong profitable growth. As I continue to work closely with Alan over the coming months, I'm also engaging with many of our key stakeholders, including shareholders and analysts, who have shared valuable perspectives as we define our multiyear plan. As I identify key focus areas, I will prioritize developing and recruiting top talent, investing strategically to sustain and accelerate growth through product innovation and new distribution models, differentiating us further from our competition through continuous improvement in our customer service delivery and supporting the investment community in better understanding our portfolio as we look to drive further value creation. Our long-term goal will continue to be to deliver sustained growth and value to all of our stakeholders. Our ability to deliver on these ambitions will require additional innovation and investments to ultimately provide a superior customer experience and deepen our client relationships. Innovation will continue to be a key differentiator for Assurant, especially as we evolve with the convergence of the connected consumer. As part of our ongoing commitment to delivering a superior customer experience with a range of service delivery options, we'll be further building out our same-day service and repair capabilities for which there is growing demand. This requires upfront investments, which we expect to accelerate in the second half of this year as we look to provide additional choice and convenience for the end consumer. These investments are critical to sustain our competitive advantage in markets like the U.S. As we look to continue our culture of innovation, you may have seen we recently announced two key leadership changes to support those efforts. Manny Becerra, a 31-year veteran of Assurant, who is instrumental in driving the growth of our mobile business, was appointed to the newly created role of Chief Innovation Officer. Given his many contributions to our success, including the development of our mobile protection and trade-in and upgrade business, he will bring dedicated resources to accelerate innovation across the enterprise to capitalize on the rapid convergence across our home, automotive and mobile products. Biju Nair will now lead our Connected Living business as its President. His strong track record of delivering profitable growth and client service excellence combined with his depth of experience, particularly as the former CEO of Hyla Mobile makes him the perfect choice. A prime example of how innovation has allowed us to deepen and expand client relationships as well as create new revenue streams is our long-standing partnership with T-Mobile. Over the past 8 years, we have worked together to offer their customers innovative device protection, trade-in and upgrade programs while further developing our supply chain services to support their mobile ecosystem. We are happy to announce that T-Mobile has extended our partnership as their device protection provider. While we are currently finalizing contract terms, we are excited about the multiyear extension of our relationship and our ability to continue to expand our services to deliver a superior customer experience. In addition to our innovation efforts, our investments over the past several years have supported our growth through the success of new and strengthened client relationships. After an initial investment in 2017, this quarter, we purchased the remainder of Olivar, a provider of mobile device life cycle management and asset disposition services in South Korea. While small in size, this acquisition enhances our global asset disposition capabilities and deepens our footprint in the Asia-Pacific region while complementing the recent acquisitions of Alegre in Australia and Hyla Mobile. These investments have enhanced our technology, operational capabilities and partnerships in the trade-in and upgrade market, positioning us to capitalize on the 5G upgrade cycle over the next several years. While later this year, the growing availability of 5G smartphones, combined with trade-in promotions, demonstrate increasing momentum for the upgrade cycle. For carriers, retailers, OEMs and cable operators, 5G offers an opportunity to drive additional revenue and gain market share. Strong trade-in and upgrade promotions have also led to higher trade-in volumes for Assurant as well as higher Net Promoter Scores and net subscriber growth within our client base. Our focus on our client relationships, combined with our willingness to innovate to enhance the end consumer experience, continues to create momentum for our businesses. Over the last few months, we have delivered several new partnerships and renewals throughout the enterprise, including the renewal of two key European mobile clients, representing 700,000 subscribers; renewal of 8 global automotive partnerships, representing over 10 million policies across our distribution channels; renewal of 3 Multifamily Housing property management companies, including 2 of the largest in the U.S. as we continue to grow the rollout of our Cover360 product; renewal of 3 clients and 2 new partnerships in lender-placed as we provide critical support for the U.S. mortgage market. In summary, I am very excited to lead our 14,000 employees into the future and build on the tremendous momentum created under Alan's leadership. I'll now turn the call over to Richard to review the second quarter results and our 2021 outlook."
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith, and good morning, everyone. We're pleased with our second quarter performance, especially when compared to our strong results last year. For the quarter, we reported net operating income per share, excluding reportable catastrophes of $2.99, up 12% from the prior year period. Excluding GAAP's net operating income for the quarter, totaled $184 million. And adjusted EBITDA amounted to $298 million, a year-over-year increase of 12% and 10% respectively. Our performance across Lifestyle and Housing remains strong and we also benefited from a lower corporate loss and higher investment income, primarily related to the sale of a real estate joint venture partnership. Now let's move to segment results, starting with Global Lifestyle. The segment reported net operating income of $124 million in the second quarter, a year-over-year increase of 2%. This was driven by growth in Global Automotive and more favorable experience in Global Financial Services. Earnings increased $7 million or 16% from continued strong year-over-year growth related to our U.S. clients across various distribution channels. Results within auto also included a $4 million increase from the sale of a real estate joint venture partnership. Absent this gain, investment income in auto was down. Connected Living earnings decreased by $9 million compared to a strong prior year period. The decline was primarily driven by less favorable loss experience in our extended service contract business. Mobile earnings were modestly lower. The less favorable loss experience in service contracts in mobile was primarily related to our European and Latin American businesses. These regions benefited from lower claims activity in the prior year period due to the pandemic. Our underlying mobile business continued to grow in North America and Asia Pacific from enrollment increases at mobile carriers and cable operators with an increase of over 1 million covered devices in the last year. In addition, contributions from acquisitions such as Hyla Mobile benefited results. For the quarter, Lifestyle's adjusted EBITDA increased 6% to $186 million. This reflects the segment's increased amortization related to higher deal-related intangibles for more recent transactions in mobile and Global Automotive. IT depreciation expense also increased, stemming from higher investments. As we look at revenues, Lifestyle increased by $169 million or 10%. This was driven mainly by continued growth in Global Automotive and Connected Living. Within Global Automotive, revenue increased 13%, reflecting strong prior period sales of vehicle service contracts. Industry auto sales continued to increase during the quarter, with April seeing record levels in the U.S. This was reflected in our net written premiums of roughly $1.3 billion in the quarter, the highest quarter ever recorded. Connected Living revenues were 7% for the quarter. In addition to growth in service contracts, mobile fee income was driven by strong trading volumes, including contributions from Hyla. For the full year, Lifestyle revenues are expected to increase modestly compared to last year's Auto and Connected Living growth. We continue to expect covered mobile devices to grow mid-single digits in 2021 as we increase subscribers in key geographies like the U.S. and Japan. This also reflects a reduction of 750,000 mobile subscribers related to a European banking program that moved to another provider in the second quarter. As we previously outlined, this is not expected to significantly impact our profitability. For 2021, we still expect Global Lifestyle's net operating income to grow in the high single digits compared to the $437 million reported in 2020. While we expect earnings growth year-over-year for the second half, earnings in the second half of the year are expected to be lower compared to the strong first half performance, primarily due to two items: First, investment were increased across Connected Living in the second half of the year, including our same base service and repair capabilities. While these investments will meet earnings growth in the short term, they are expected to generate growth over the long term. And second, that investment income will be lower as we are not expecting gains from real estate joint venture partnerships that benefited the second quarter in auto. Adjusted EBITDA for the segment is still expected to grow double digits year-over-year at a faster pace than segment net operating income. Moving now to Global Housing. Net operating income for the quarter totaled $94 million compared to $85 million in the second quarter of 2020 due to $10 million of lower reportable catastrophes. Excluding catastrophe losses, earnings were relatively flat as growth within lender-placed and higher investment income was offset by the expected increase in non-cat loss experience across all non-cat loss experience across all lines of business. Investment income included a $4 million increase from the sale of a real estate joint venture referenced earlier. Regarding the non-cat loss ratio, the second quarter of 2020 benefited from unusually low non-cat losses, including impacts from the pandemic. As anticipated, we saw an increase in the frequency and severity of claims in the second quarter. We also increased reserves related to the cost of settling runoff claims within our small commercial book. In Multifamily Housing, underlying growth was offset by increased investments to further strengthen our customer experience, including our digital-first capabilities. Within lender-placed, higher revenues and investment income were partially offset by unfavorable non-cat loss experience and declining REO volumes from ongoing foreclosure moratoriums. Looking at loans track, the 1.5 million sequential loan declined was mainly attributable to a client portfolio that rolled off in the second quarter. However, the decline in loans track, that should be partially offset by two new client partnerships in the quarter, which should enable us to onboard approximately 700,000 loans by year-end. We also continued to reduce risk within housing. At the end of June, we completed our 2021 catastrophe reinsurance program. To mitigate multi-event risk, we added a flexible limit that can be used to reduce our retention from $80 million to $55 million in certain second and third events or increase the top of the tower of $50 million in excess of $950 million in the rare case of a 1 in 174-year event. We also increased our multiyear coverage to over 50% of our U.S. tower. In terms of revenue, Global Housing's revenue increased 5%, primarily due to double-digit growth in Multifamily Housing as well as higher revenue in lender-placed, including higher premium rates and average insured values. As a result of the strong first half, we now expect Global Housing net operating income, excluding cat, to be flat compared to the $371 million in 2020. This is above our initial expectations that earnings would be down this year. Earnings in the second half are expected to be lower than the first half of the year, primarily related to three items: First, lower net investment income, particularly considering the real estate joint venture gain in the second quarter; second, lower results in our specialty P&C offerings after a strong first half; and third, continued investments in the business, particularly in Multifamily Housing to sustain and enhance our competitive position. We also continue to monitor through REO foreclosure moratoriums and any additional extensions that may be announced. At corporate, the net operating loss was $12 million compared to $29 million in the second quarter of 2020. This was driven by two items. First, lower employee-related expenses and third-party fees, which we expect to increase in the second half of the year; and second, we had $6 million of favorable onetime items including a tax benefit and income from the sale of real estate joint venture partnership. We also anticipate high spending second half of the year compared to the first half, due to an increase in recruiting and moderate travel and related expenses. As we expect to begin a phase two reentry of our workforce. In addition, third-party expenses are expected to increase due to acceleration and timing of investments. For the full year 2021, we now expect the corporate net operating loss to be approximately $85 million. This compares to our previous estimate of $90 million. Turning to holding company liquidity, we ended the second quarter with $353 million, which is $128 million above our current minimum target level. This excludes both the $1.2 billion in net proceeds from the sale of Preneed and the net proceeds from the second quarter debt offering, which were used for the July redemption of senior notes due in 2023. In the second quarter, dividends from our operating segments totaled $243 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items: $191 million of share repurchases, $42 million in common stock dividends and $17 million mainly related to mobile acquisitions, including Olivar and Assurant Venture investments. For the overall year, we continue to expect dividends to approximate segment earnings, subject to the growth of the businesses, rating agency and regulatory capital requirements, investment portfolio performance and any impact from a potential change in corporate U.S. tax rates. In summary, our strong performance for the first half of the year positions us nicely to meet our full year financial commitments while continuing to invest in our long-term growth. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Brian Meredith from UBS. Your line is open."
},
{
"speaker": "Brian Meredith",
"text": "A couple of questions here for you. First, I'm just curious, the LPI customer that you lost, why did you lose that customer? Is it competitive reasons? I always thought that's kind of a pretty sticky business."
},
{
"speaker": "Alan Colberg",
"text": "No, I think it is actually a very sticky business. If you look at that line of business over the last two or three years, we've renewed or early renewed almost all of the clients on occasion business does move. And as you saw in our prepared remarks, we did pick up two new clients that will begin to onboard as we move into Q3 and Q4. And the reason we've had such strong success has been our investments in both the customer experience as well as the client experience and making sure we're delivering a fully compliant product. But no, we feel good about LPI and are well positioned when the housing market does weaken."
},
{
"speaker": "Brian Meredith",
"text": "Great. And then second question, I'm just curious, how are conversions going with respect to the T-Mobile and Sprint customers? And are you seeing a pickup in that at this point?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. It's Keith, maybe I'll jump in. Thanks for the question. Obviously, we continue to be pleased with the progress of the ramp of Sprint customers. As T-Mobile continues to ramp and migrate Sprint to T-Mob products and rate plans, we continue to see additional enrollments into our programs. I would say it's happening, as we would have expected, largely on track. And we talked about the renewal and extension of our relationship. We're clearly really excited about our long-term opportunities with T-Mobile. We've had a great track record working together for the last 8 years, innovating in the market, adding new products and services. And certainly, as we think about Sprint continuing to ramp over time, we're really excited about working together to grow the overall business."
},
{
"speaker": "Brian Meredith",
"text": "And then one last one just quickly here, probably for Richard. As we look at the capital management that's going to happen here over the next 12 to 18 months, a lot of stock to buy back. Do you all considered ASRs or celebrate share repurchase programs as a part of capital management?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thanks for the question, Brian. I think a couple things first, as you heard in the remarks, we're really pleased to have put a check next to our $1.35 billion commitment, with the third quarter dividend that will be issued we'll meet that objective before time. So we're very pleased about that. We did close on Preneed and received the proceeds this week on that. And as we said earlier, we will be buying back our shares at about -- over the next 12 months, I would say. So that's going to be put in place very quickly. We consider all options, we think share repurchases is the best way to go."
},
{
"speaker": "Alan Colberg",
"text": "And Brian, this is Alan. The one thing I would add is we're also excited that we were able to complete our expectation from the 2019 Investor Day with what we did in July and then the announcement of the quarterly dividend in Q3, we are now effectively done with that expectation and we can move on to returning the $900 million from premiums in orderly fashion as Richard just said."
},
{
"speaker": "Operator",
"text": "And your next question is from Tommy McJoynt from KBW. Your line is open."
},
{
"speaker": "Tommy McJoynt",
"text": "So that's great to see the T-Mobile contract renewal is underway. Are there any notable changes to the economics or contract terms or anything else with that multiyear extension that you would want to share with us? And just confirming that the contract for Sprint as well, which doesn't need to be separately negotiated."
},
{
"speaker": "Keith Demmings",
"text": "Correct. Yes. So it's for the totality of T-Mobile's business as we move forward. We mentioned earlier, we're still negotiating the final details of the agreement. So more to come as we lock down some of the moving parts. In terms of economics, I'd probably make two points. First, I'd say that it's not uncommon for us to forgo some economics when we recontract with major clients. We recontract obviously, quite regularly, often think about the broader long-term potential of the relationships. The potential for additional volume and for offering new products and services over time. Specifically with respect to T-Mobile, given that the relationship continues to scale with significant volume from Sprint, we do expect to achieve lower per unit economics, but we expect that to be offset by significant volume growth and economies of scale within the overall programs. I would also say that we're well positioned as partners to help them introduce new products and services over time. We've had a great track record of expanding the services we provide over the last 8 years to continue to evolve to serve the consumer. And finally, I'd point out from a mobile perspective, we really are excited about our overall long-term potential to compete in this market across the value chain and from an efficiency point of view."
},
{
"speaker": "Tommy McJoynt",
"text": "And switching gears a little bit. Would you characterize the loss in claim rates that we saw in 2Q as fully back to normal? Or should we still expect some kind of further normalization over the medium term, if you could answer that with respect to both Lifestyle and Housing, that would be helpful."
},
{
"speaker": "Alan Colberg",
"text": "Yes, Keith, you want to take a Lifestyle, then I can comment on housing maybe."
},
{
"speaker": "Keith Demmings",
"text": "Sure. And I think we obviously saw favorability if we look back to Q2 of 2020. We've seen that normalize quite a bit as we look at the results in this quarter. So for the most part, losses have sort of come back to a more normalized level. There's still some moving parts, I would say, within international. As we look at COVID and various lockdowns and how things are progressing in different markets. But overall, we're at a much more normalized level from a loss ratio point of view."
},
{
"speaker": "Alan Colberg",
"text": "Yes. It's effectively the same in Housing. We had a better Q1 loss experience than we would have expected, just some of the lingering impacts of the COVID and the lockdowns in various parts of the economy. But in Q2, we're more back to what we expected, and we expect that will continue the rest of the year."
},
{
"speaker": "Tommy McJoynt",
"text": "Then I'll just sneak one more in here. So with the strong second quarter and the first half of the year, it was a bit surprising to see the full year NOI guidance to be higher that you went through some of the puts and takes as to why the second half should be lower than the first half. If you were to see some upside, but where do you think it would be, kind of which cause would you most likely to see upside?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. What I would say is, first of all, we're very pleased, obviously, with the first half and second quarter, very strong. In fact, probably a little better than we'd expected going into the year. If you think about what could cause us to exceed our outlook. First of all, we're still confident that we're in that range. But it would be things that are less within our control like what happens with the loss ratio in the market or could there be some other impact from COVID and the delta variants. But with all that said, it's a really strong first half. In the second half of the year, even as we've guided to be lower than the first half, we still expect to grow strongly versus second half of 2020. And the business is performing well, and we continue to expect that looking to the future."
},
{
"speaker": "Operator",
"text": "And your next question is from Mark Hughes from Truist Securities. Your line is open."
},
{
"speaker": "Mark Hughes",
"text": "You had a particularly good results in the automotive business. Could you maybe try to break out how much of that was just kind of strong rebounding economy versus new relationships, higher attachment rates? How much momentum does that give you in the second half in terms of new business?"
},
{
"speaker": "Keith Demmings",
"text": "Sure. And it's Keith, maybe I'll take that. I mean, overall, I would say we've seen healthy double-digit growth rates in car volumes from pre-pandemic levels. So yes, you're correct, a huge recovery in Q2 versus Q2 of last year. Obviously, Q2 of last year was quite depressed. This year was an incredible rebound. We saw a net written premium up 68% over the same quarter last year. But a lot of that is -- the depression last year and then a really strong quarter this year. If you look at it over 2019, which is sort of pre-pandemic normal, it was a 36% increase this year. So really, really strong. And yes, we're seeing strong attach rates in the business. We've seen a slight shift between new and used. So our new and used mix is normally around 50-50 or maybe 53% used today. Used tends to have slightly higher attach rates. Obviously, it earns a little bit quicker. We've seen our clients taking share through consolidation. We've seen clients expanding their used car operations, rolling out strong digital brands. So there's a lot of growth, I would say, within our core client base. And then certainly, we've added some new clients as well. But strong car sales, large clients that are gaining share and then winning some new deals in the market."
},
{
"speaker": "Mark Hughes",
"text": "In the lender-placed insurance business, any issues around inflation in materials or labor?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. It's interesting. We kind of have offsetting effects there. So if you think about our premiums, it's driven by average insured value. So as house prices rise and we issue new policies, those are going to naturally be at a higher premium rate. So we're getting some positive benefit there. The offset is cost of claims will rise as well. And ultimately, we'll be able to reflect our experience in future rate filings. But if you put it all together, we don't think it's particularly material to our business. It may not be perfectly aligned quarter-to-quarter those effects, but over time, not material."
},
{
"speaker": "Mark Hughes",
"text": "The lender-placed insurance, your placement rates is the end of the foreclosure moratorium. Is that an important -- or how important an trigger is that for your placement rate? I know your REO is directly impacted, but are there other drivers that are restraining our placement rates based on government action. Could you just talk a little bit about that?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. What I think you've seen over the last year or so is that our placement rate is roughly flat at this point, with really no significant trend up or down. And the good news is through the actions we've taken over the years, the business is in a really strong position. We're delivering great customer and client experiences. And if the -- it weakens, we will benefit and grow over time. So in terms of moratoriums and when they come off, if and when they do come off, we will see the impact with a lag. So even if they came off today broadly, which is -- there's still a lot to work through there and there'll be modifications and other things that will happen. We don't expect anything to happen in our placement rate this year, and where we could see an impact is when you get into 2022 and beyond. But I think the important takeaway on lender-placed is, we're still a clear market leader with a strong commitment to customer and client experience. And we will be there to partner with the world's leading U.S. as leading banks when the housing market weakens."
},
{
"speaker": "Operator",
"text": "And we have a question from Michael Phillips with Morgan Stanley. Your line is open."
},
{
"speaker": "Michael Phillips",
"text": "First question on the investments that you talked about and the impact of that in the second half of the year. But really, the question is when will we see the impact of that -- the benefits of those? Is that more -- you talked about growth potential, is that more top line benefits? Is it more margin benefits or both? And then when you say long term, kind of -- can you kind of put a time frame around it. Is that something we'll start to see benefits of those things in next year or even longer than that?"
},
{
"speaker": "Keith Demmings",
"text": "Maybe I'll take that one, Alan. So let me just clarify first the two buckets where we're making the investments or at least the most significant investments. So first we talked about is around same-day service and repair, this has been -- become a really important component of our value proposition. It's become more critical in the market demanded by clients, demanded by consumers and really improve the overall service experience. So we are going to be accelerating investments in the second half in terms of leadership personnel, in terms of technology and equipment. We're also working very hard to integrate our service delivery options seamlessly into the claims experience to really create a more dynamic claims process to give customers a better choice and options. That's, I think, critically important strategically for us. And I think we've got great advantages there today. So we're trying to accelerate those advantages in the market. That will drive revenue as we think about moving into 2022. We see this as a important opportunity to expand services with existing clients and also expand with new clients. In terms of the second bucket, I would say, operational investments that are focused on really the entire enterprise between both housing and lifestyle, investing more heavily in digital capabilities, self-service and automation. Think about things like digital sales and self-service portals, investing in our customer-facing applications integrating our communication channels, automating decisions around claims to make the process more efficient and more repeatable and then automating back-office tasks. We've got a fairly large project going across multiple lines of business and multiple geographies. And that will generate cost efficiency over time. But more than anything, it will create a much more seamless customer experience and I think make us that much more competitive in the market."
},
{
"speaker": "Michael Phillips",
"text": "Two more, I guess, a quicker ones. What can you share about the cost or the impact on the cost of the reinsurance structure that Richard talked about?"
},
{
"speaker": "Alan Colberg",
"text": "Richard, do you want that take?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, maybe I can take that. The overall cost is going to be up this year from last year, but not that much. But essentially, what we did is we bought a -- what we call a second and third cover. So if ever we have an event that goes up into our retention -- past our retention on a second and third event, we actually go and reduce the retention down to $55 million from $80 million or if we didn't use that and there was a major event, it would help us at the top of the tower, too. So that will add a little bit, but it's a modest increase in our overall placement. And we were actually pleased to see that every year when we go to the market, we have a stable list of reinsurers that follow us. Think about 40 carriers being A- or better. And we are able to place our reinsurance on a kind of a like-for-like basis without this new feature I talked about at a little bit below where the market is. So we're really proud of what we've done with cat. And I guess the last thing I would say is the cat exposure that we have today is less than we had in previous years, given how we've been working on our cat exposure overall, but also the growth in our other businesses, Multifamily Housing, Global, Auto, Connected Living. So one of the things we mentioned in our press release earlier this year that, for example, in a 1 in 50-year event, back in 2017, we would have kept 40% of our earnings. Now in a 1 in 50-year event, we retained 70% of those earnings. So it would just show you the big change that's been made in our management of our cat exposure and the growth of the company elsewhere."
},
{
"speaker": "Michael Phillips",
"text": "Last quick one for me. On the impact of rising home prices on the LPI premiums, is that true just for new policies or also for fire issue policies as well?"
},
{
"speaker": "Alan Colberg",
"text": "So for the new policies, it's obviously immediate. And when we place them for existing policies, it's on the renewal date. And these are annual policies. So it would happen on the renewal."
},
{
"speaker": "Operator",
"text": "Your next question is from Jeff Schmitt from William Blair. Your line is open."
},
{
"speaker": "Jeff Schmitt",
"text": "Could you discuss just how that legacy Sprint customer transition works. I believe they get an option to sort of switch over to the T-Mobile network if they want when they sort of trade in or upgrade their phone. Switching to mobile protection plan to Assurant, is that a separate decision? And do you have a sense on what that uptake rate is? How many are coming over versus kind of staying with what they have?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I would say that as they're moving customers on to T-Mobile product, T-Mobile REIT plans and services at that point, they're offering the customer the opportunity to enroll in insurance and effectively reenroll as they're enrolled today and that's automatically moving over to Assurant. So I would say, very typically, as that happens and as T-Mobile pushes more and more customers onto T-Mobile product, we're seeing the increase sort of one-for-one come through."
},
{
"speaker": "Jeff Schmitt",
"text": "And then you'd mentioned that covered mobile device growth should start moving up here in the second half. I think you said mid-single digits. And I know it takes a couple of years for an account to mature, you kind of start at 0 there. But what are some of the newer accounts there that would drive that ramp up? Is that KBDI, the cable operators, how far into those relationships are you?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I would say the one thing to remember with the sub count is we did have a loss of client in Europe, a banking client for 750,000 subs. So that has moved down our sub count, which is why it's flat as we sit here today year-to-date, but we do expect it to be mid-single digits by the end of the year. And I would say largely the U.S. and Japan are driving the majority of that growth. And certainly, I think all of our clients in both markets are growing."
},
{
"speaker": "Operator",
"text": "Your next question is from Grace Carter from Bank of America. Your line is open."
},
{
"speaker": "Grace Carter",
"text": "I was wondering, since we saw growth in Global Financial Services for the first time in a little bit, does that have to do with the disruption last year at this time? Or is this an inflection point? And if we could just talk a little bit about the outlook for that segment."
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think it's more to do with the disruption last year. Q2 was depressed. We had some additional losses related to some travel products in a couple of our markets. I some travel products in a couple of our markets. I would say as we look at the results today, there are more normalized which we think is a good jumping off point. We certainly have ambitions to grow that business over time. We're excited about the work that our teams are doing around the world, but it's mainly due to the depression in results last year."
},
{
"speaker": "Grace Carter",
"text": "And then I was wondering with the Lifestyle business, given the recent concerns about the delta variant, if you all have seen any impact on your global supply chains in that business?"
},
{
"speaker": "Keith Demmings",
"text": "I think broadly, our teams have done an incredible job. We operate physical depots in many markets around the world. So making sure that we're able to perform essential services is critical, keeping our employees safe has been a priority. I think we've done a very good job of executing service. There's some parts disruption due to the chip shortages as we think about repairing devices. Our teams have done a really good job working with manufacturers to procure and acquire parts. Broadly speaking, we haven't seen much disruption to our business to date. Hopefully, that will continue as we move forward. But overall, this is a strength of Assurant. Supply chain is one of our key differentiators in the Connected Living business and really proud of the work the team has done."
},
{
"speaker": "Operator",
"text": "And your last question is from Gary Ransom from Dowling & Partners. Your line is open."
},
{
"speaker": "Gary Ransom",
"text": "A lot of my questions have been answered. But I wanted to ask the -- a little bit broader question on the opening economy and recovering economy. You did respond a little bit on the auto market. But are there other parts of your business that you -- that will show more growth or be influenced significantly by an assumption that the economy continues to strengthen and reopen this year?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. Maybe I'll start and talk a little bit about housing. And then, Keith, maybe you can add any more color on lifestyle. If you look at housing, our largest growth business is Multifamily Housing or our renters business. Arguably, in a market perspective, that was one of the most disruptive markets through COVID. But with that, we've still seen strong growth. So even with the disruption, even with the impacts on COVID, we've had a very strong growth in line with our long-term expectations in Multifamily. And driven in part by the strength of our partnerships, also driven by the launch of our new product, Cover360. If you looked at LPI, that business, as I mentioned earlier, is stable. We have a very strong base of customers and clients there. And if the economy weakens, we'll grow. So from a housing perspective, we've seen growth even through the disruption of COVID. And we would expect in a weaker market economy, we'll see growth, and we'll continue to see growth if the economy just chugs along. But that's housing, but let's go to Lifestyle, Keith."
},
{
"speaker": "Keith Demmings",
"text": "I'd probably add that on the Lifestyle side, and particularly in Connected Living, we see really strong positive impacts from 5G. We talk a lot about our trade-in business. I would say trade-in is a really important part of our value proposition, something that our carrier partners lean quite heavily on to drive promotions in the market to try to get additional dollars in the hands of consumers to allow them to be able to upgrade to the latest 5G technology. We've seen obviously very aggressive promotions in that space, and we're supporting our clients scaling our operations. And I think doing an incredible job leveraging all of our acquisitions, think about Hyla, Alegre, all of our -- we've made several investments around trade-in capabilities. I think we've got a global market-leading position and this continues to be more important. We've seen dramatic increases in trade-ins in terms of volumes and promotional activity, but also the attach rates at point of sale and consumers' willingness and education about trade-ins has increased dramatically. So expect that to continue as we move forward in the year. Obviously hard to predict what will happen with COVID, but there's some pretty strong trends on mobile."
},
{
"speaker": "Alan Colberg",
"text": "Yes. And if I just elevate to an overall Assurant level, and I mentioned this in the prepared remarks, we are well positioned and expect to outperform no matter what the external environment is. And the COVID really again demonstrated that resiliency of our business model, driven by the great value that we're bringing to consumers around the world. And with that, I want to thank everyone for participating in today's call. With the close of the sale of Global Preneed and our strong year-to-date performance, we believe we're well positioned for the future. We'll update you on our progress on our third quarter earnings call in November. In the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. Thanks, everyone."
},
{
"speaker": "Operator",
"text": "Thank you. This concludes today's conference. Please disconnect your lines at this time, and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 1 | 2,021 | 2021-05-07 08:00:00 | Operator: Welcome to Assurant's First Quarter 2021 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following management's prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our first quarter 2021 results with you today. Joining me for Assurant's conference call are Alan Colberg, our President and Chief Executive Officer and Richard Dziadzio, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the first quarter of 2021. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. As we continue to shift to a more fee income capital-light business mix, we introduced adjusted EBITDA as part of our restated financial statement in April. This is another important financial metrics for the company, reflective of our go-forward Global Lifestyle and Global Housing business. In addition, as of January 1, Global Preneed and the related entities included in the sale are considered discontinued operations and no longer included in our continuing operations as reflected in the earnings press release and financial supplement. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan.
Alan Colberg: Thanks, Suzanne. Good morning, everyone. We're very pleased with our results for the first quarter. We delivered double-digit earnings growth, driven by favorable non-catastrophe loss experience, including improved underwriting in Global Housing as well as continued profitable growth in our Global Automotive, Multifamily Housing and Connected Living businesses. Once again results demonstrated the attractiveness of our market leading Specialty P&C and Lifestyle offerings distributed across multiple channels. This is in addition to the compelling growth opportunities emerging across mobile, auto and renters. Together, these businesses represent what we refer to as the connected world. In 2020, our Connected World offerings represented 2/3rds of our net operating income excluding catastrophes and in combination with our Specialty P&C businesses will enable us to continue to expand our innovative offerings and deliver a superior and seamless customer experience. Generating over $1 billion of adjusted EBITDA in 2020, our business portfolio is well positioned to sustain above market growth and strong cash flows over time. And as we look ahead, we are continuously investing to bring innovation to market to build a more sustainable future for all of our stakeholders. To that end, we recently published our 2021 Social Responsibility Report highlighting the many ways we are delivering on our commitment as a purpose-driven company. We are continuing to advance our ESG efforts, specifically within our strategic focus areas of talent, products and climate. Further integrating ESG within our business operations will be critical as we look to create an even more diverse, equitable and inclusive culture that promotes innovation enhances sustainability and minimizes our carbon footprint for the benefit of all stakeholders. Recent notable examples include, we are increasing all U.S. hourly wages to at least $15 per hour by July, which supports the financial well-being of our employees. We've launched in assessment of our carbon footprint, including our investment portfolio and supply chain as a critical step to setting a future long-term carbon emissions reduction goal. And we further integrated sustainability into our offerings such as rolling out electric vehicle products globally and extending the mobile device lifecycle through trading services. With HYLA, we recently passed a significant milestone repurposing our 100 million device. This has extended the life of devices put billions of dollars back into consumers hands and prevented additional e-waste from ending up in our landfills supporting global sustainability. We are pleased with our progress and are proud of the recognitions we have received, including our inclusion in the Bloomberg Gender Equality Index and America's Best Employers for Diversity by Forbes as well as being awarded the Best Place to Work in several of the key markets we operate. Sustainability and innovation go hand-in-hand. Recently, we surpassed $100 million invested through Assurant Ventures, our venture capital arm. This quarter several high-quality investments in our portfolio announced back transactions, including Cazoo, a fully digital U.K. car sales company and SmartRent, a smart home automation provider. Given current attractive valuations, these investments have the potential to generate strong returns while also providing strategic insight that support our connected world businesses, creating value-added partnerships and piloting new innovations. Now, let me share some first quarter highlights for each of our operating segments. We continue to see strong growth in Global Lifestyle, increasing earnings by 7% year-over-year. Over the years, we continuously invested in mobile capabilities such as same day local repair or come-to-you-to-repair for mobile devices, which provide another opportunity to drive value for our clients and the end consumer. Most recently in Connected Living, we further strengthened our product capabilities and customer experience through the acquisition of TRYGLE in Japan. TRYGLE develops and operates a mobile phone app that allows consumers to manage the lifecycle of their devices and centrally organizes digital product manuals for all connected products. Collectively, all of our investments have helped lead the 15 new client program launches since 2015. This includes partnerships with several U.S. cable providers including Xfinity and Spectrum as well as large mobile carriers in Japan like KDDI and Rakuten. Recently, we've expanded our global partnership with Samsung through the launch of Samsung Care+, a smartphone protection program in Brazil and Mexico. We expect to further extend this partnership globally. We will continue to build on the strong momentum we have with our global multi-product and multi-channel strategy bolstered by the additional investments we are making. As an example, HYLA Mobile added scale and technology capabilities to our global trade-in and upgrade business and has been performing even better than our initial expectations. We're now providing over 30 trading programs around the world. The acquisition positions us to benefit from favorable tailwinds in the global mobile market, including the upcoming 5G smartphone upgrade cycle and new client relationships. In Global Automotive, we continue to benefit from our scale and expertise as we now cover over 50 million vehicles. Already this year, we've seen a significant increase in auto production versus pre-pandemic first quarter levels. In the year since acquiring AFAS, we've combined our award winning training programs to create the Automotive Training Academy by Assurant. These expanded in-person and virtual programs will allow us to scale faster and adapt to the changing needs of dealers and automotive professionals. Within Global Financial Services, we've added a number of embedded card benefit clients recently, including the previously announced partnership with American Express. We look forward to enhancing these partnerships and building on our existing suite of products. Moving to Global Housing. Net operating income excluding reportable catastrophes grew 17% as we benefited from favorable non-cat loss experience, including improved underwriting results. Within our lender-placed business, we continue to play a vital role in supporting the mortgage industry as we track over 31 million loans. The business remains well positioned and we expect to benefit from investments in our superior customer platform over the long-term. Multifamily Housing increased policies by 9% year-over-year to almost $2.5 million as we continue to grow through our affinity partnerships and PMC channel, including seven of the top 10 largest PMCs in the US. We've also continued to grow our sharing economy offerings, which include car sharing, on-demand delivery and vacation rental. Over the last two years through our partnership with market leaders and on-demand delivery, we tripled the number of deliveries we protect over 1 billion deliveries. While it is too early to gauge whether the pandemic has fundamentally changed consumer demand for these services, we're encouraged by our momentum and the potential for future products and services in the gig economy. Now let's move to our first quarter results and our 2021 outlook. Net operating income excluding cats grew by 13% to $182 million and earnings per share increased 16% to $3.03, demonstrating improved results in Global Housing and continued momentum in Global Lifestyle. Given our strong performance in the first quarter and current business trends, we are increasing our full-year outlook for 2021. We now expect 10% to 14% growth in operating earnings per share excluding catastrophes versus our initial expectation of 9% EPS growth. EPS expansion from the $9.88 in 2020 will be driven by high single-digit earnings growth mainly from Global Lifestyle and the lower corporate loss. Results will also benefit from share repurchases, including the completion of our three-year $1.35 billion objective in the initial return of net proceeds from the Global Preneed sale. Our increased outlook largely reflects Global Housing's favorable non-catastrophe loss experienced in the first quarter. As such Housing's earnings are expected to be down only modestly year-over-year from what was a strong 2020. Looking at adjusted EBITDA, excluding catastrophes, the first quarter generated $302 million, an increase of 15% year-over-year. We expect adjusted EBITDA will grow at a modestly higher rate than net operating income in 2021. Turning to capital. We ended March with $332 million of holding company liquidity, after returning $80 million to shareholders through common stock dividends and buybacks during the quarter. And we expect to deliver on all of our commitments, sustaining our strong track record of capital return. In addition, throughout the year, we will continue to make strategic investments in our portfolio to position us well for sustained long-term growth. I'll now turn the call over to Richard to review first quarter results and our 2021 outlook. Richard?
Richard Dziadzio: Thank you, Alan, and good morning, everyone. As Alan noted, we are pleased with our first quarter performance as our results across Global Lifestyle and Global Housing remains strong. Before getting into our first quarter performance, I want to provide a quick update on the sale of our Preneed business. In March, we announced our plan to sell the business for $1.3 billion to CUNA Mutual Group. Since signing, we have completed the necessary regulatory filings and we remain on track to close the transaction by the end of the third quarter. Now let's move to segment results for Global Lifestyle. This segment reported net operating income of $129 million in the first quarter, an increase of 7% driven by Global Automotive and Connected Living. In Global Automotive, earnings increased $7 million or 18%, results included a $4 million one-time benefit as well as a gain on investment income related to a specialty asset class from our TWG acquisition which we don't expect to recur. Year-over-year, underlying performance was driven by another quarter of global organic growth from U.S. CPA and international OEMs as well as some favorable loss experience. Connected Living grew earnings by 3%. However, this was muted by a $7 million favorable client recoverable with an extended service contracts in the prior year period. Underlying performance was driven by mobile subscriber growth in Asia Pacific and North America. Higher trading results from increases in volume and contributions from our HYLA acquisition. For the quarter Lifestyle's adjusted EBITDA increased 11% to $193 million, 4 points above net operating income growth. This reflects this segment increased amortization related to higher deal-related intangibles for more recent acquisitions in Global Automotive and Connected Living. IT depreciation expense also increased, stemming from higher investments. Lifestyle revenue decreased by $85 million, this was driven mainly by a $98 million reduction in mobile trade-in revenue, primarily due to the contract change we disclosed last year. Excluding this change, revenue for this segment was flat. For the full year, we continue to expect Lifestyle revenues to be in line with last year at approximately $7.3 billion. As expected overall trade-in volumes, which flow through fee income increased year-over-year and sequentially. This was driven by four elements. New phone introductions last year, greater device availability, carrier promotions and contributions from HYLA. While the first quarter did benefit from strong mobile trade-in volumes, we do expect it to be a high watermark for the year, given historical seasonal patterns. Since year-end, we've increased covered mobile devices by 600,000 subs driven by continued growth in North America and Asia-Pacific. This year, we continue to expect covered mobile devices to grow mid single-digits compared to 2020 as we go subscribers in key geographies like the U.S. and Japan. As a reminder, we expect the growth rate of earnings to exceed the growth rate of covered mobile devices over time. As we benefit from offering additional products and services to our clients and their end consumers. For 2021, we still expect Global Lifestyle's net operating income to grow in the high single-digits compared to the $437 million reported in 2020. Growth will come from all lines of business particularly Connected Living. Adjusted EBITDA for this segment is expected to grow double digits year-over-year. Moving now to Global Housing, net operating income for the first quarter totaled $67 million compared to $74 million in the first quarter of 2020. The decrease was largely due to $22 million of higher reportable catastrophes mainly related to the extreme winter weather particularly from areas like Texas. Excluding catastrophe losses, earnings increased $50 million or 17%. More than 2/3rds of the increase was from favorable non-cat loss experience mainly in our specialty offerings, including sharing economy products. We estimate that approximately half of the favorable loss experience in the first quarter was from underwriting improvements, with the remainder of the benefit, driven by favorable loss experience, which we don't expect to recur. In addition, we saw continued growth in Multifamily Housing. Lender-placed results were up modestly, higher premium rates and favorable non-cat loss experience were mostly offset by declining REO volumes from ongoing foreclosure moratoriums. Looking at the placement rate, the modest sequential increase to 1.6% was attributable to a shift in business mix and is not an indication of a broader macro housing market shifts. Revenue decreased 2% related to a reduction in our specialty product offerings, which included the impact from the exit of small commercial as well as lower REO volume. This increase was partially offset by growth in Multifamily Housing, which grew 8% year-over-year driven mainly by our affinity partners. We now expect Global Housing's net operating income excluding cat to be down modestly compared to 2020. This reflects our stronger first quarter and the assumption of a modest increase in our expected non-cat loss ratio to more normalized level for the remainder of the year. We are also monitoring the REO foreclosure moratoriums in any additional extensions that may be announced. As we position for the future, we will continue to invest in some of the business to sustain and enhance our competitive position. At Corporate, the net operating loss was $22 million, which was flat year-over-year. For the full year, we continue to expect the Corporate net operating loss to improve to approximately $90 million as we eliminate enterprise support costs associated with Global Preneed. As we think about the remainder of the year for all of the Assurant, we are beginning to plan for a phase reentry of our workforce post-COVID and we are evaluating our real estate footprint to align with new business and employee need as we adapt to the future of work. This may result in additional expenses throughout the year. I also wanted to provide a quick comment on our investment portfolio. With Preneed moving to discontinued operations, our investment portfolio is now approximately $7.9 billion, excluding cash and cash equivalent. Given Preneed's relatively longer average duration of around 10 years compared to the rest of our business, following the sale of Preneed, our go-forward duration will drop to between 4.5 years to 5 years. As a result our interest rate sensitivity will be reduced by approximately 2/3rds. Turning to Holding Company liquidity, we ended the first quarter with $332 million, which is $107 million above our current minimum target level. In the first quarter, dividends from our operating segments totaled $183 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items; $42 million of share repurchases; $43 million in common and preferred stock dividends; and $10 million mainly related to the acquisition of TRYGLE and Assurant Venture Investments. Also in January, we redeemed the remaining $50 million of our March 2021 note. And our mandatory convertible shares converted to approximately 2.7 million common shares during the quarter. For the year overall, we continue to expect dividends to approximate segment earnings subject to the growth of the businesses and rating agency and regulatory capital considerations. We've now completed over 70% of our $1.35 billion capital return objective from 2019 to 2021 and remain confident that we will meet this objective by the end of this year. In addition, we expect to begin incremental buybacks prior to closing the Preneed transaction in the third quarter. The total buybacks associated with the net proceeds from the sale are expected to be returned within one-year of the transaction close. In the second quarter through April 30, we repurchased an additional 95,000 shares for $14 million. In summary, our first quarter results demonstrate the strength of our business and our capital and liquidity position. We remain focused on completing the sale of Global Preneed and delivering on our 2021 financial objectives. And with that, operator, please open the call for questions.
Operator: Thank you. The floor is now open for questions. [Operator Instructions] Our first question is coming from Bose George of KBW.
Tom Michaud: Hey, good morning, guys. This is actually Tom Michaud on for Bose. Thanks for taking our questions. Yes, the first question is really just kind of about sizing up the rebound in contribution of the trade-in volumes. I know there's kind of a lot of moving pieces with the contract change, the HYLA contribution and it sounds like 1Q was a high watermark. So if you guys help us kind of frame how we should think about the contribution for the trade-in volumes going forward?
Alan Colberg: Yes. Maybe I'll start and then Richard certainly add-on. If you think about our trade-in and buyback business, we're now very a strong player after the acquisition of HYLA, we mentioned in the prepared remarks, we have 30 plus programs that we operate around the world. You're right, Q1 tends to be the seasonal high for trade-in really driven by the launch of new phones late in the prior year. We expect activity to moderate through the balance of the year, but again that business is well positioned growing strongly and we have a lot of duty as the 5G wave develops, which is still very early and we expect that to develop later this year and into '22 really as the driver, but Richard anything you'd add on that.
Richard Dziadzio: Yes. I think, I mean overall we're in a really good place and as Alan said, Q1 we're looking at it as a high-watermark, but on the other hand, we have 30-plus trade-in programs. So we are encouraged by the momentum of the business and also what HYLA is adding to the mix of the Lifestyle business as well.
Tom Michaud: Okay. And so just kind of thinking about the balance of the year there is some easy comps, obviously with volumes have been depleted kind of and starting in 2Q ‘20. And so as we kind of think of the fees and other income line within Global Lifestyle. Is it reasonable to think of it being somewhat flat year-over-year, even after considering the contract change, which will hit the next two quarters?
Richard Dziadzio: And I don't think we've given a total revenue outlook for Lifestyle, but we have said that when we look at Lifestyle this year we will be looking at net operating income being in the high single-digits. So hopefully that should help you.
Tom Michaud: Okay. Yes, that will. Thanks. And then, just a second question, could you just talk about the growth in subscribers in terms of how much contribution is coming from T-Mobile and Sprint versus some of the other kind of providers including our cable providers which would seem to have been gaining share in subscriber account?
Alan Colberg: Yes. And again just to frame that for everyone. So what we've said for this year is, we expect subscriber growth in mobile to be mid single-digits and that's really being driven by growth in North America, which is coming from many different programs, including the ones you mentioned as well as growth in Asia Pacific, we are seeing a bit of a drag in Europe that's been ongoing as Europe has been more severely impacted by the COVID lockdowns. Also in Q2, we're going to lose a small program in Europe. We're having a banking program in mobile that's going to transition to another provider that's going to be a reduction of about 750,000 subs, but will have no impact on our bottom-line. So we factored that into that outlook as well as mid single-digit growth for the year.
Operator: Our next question comes from Brian Meredith of UBS.
Brian Meredith: Alan, I wonder if you could talk a little bit about, we're getting closer to the mid-year reinsurance renewal what that looks like and specifically any additional thoughts with respect to trying to convert the lender-placed insurance business more to an MGA model and maybe specifically you can kind of get into what are the challenges and impediments in actually going to that type of a model?
Alan Colberg: Yes. Happy to talk about that. I think it's important when we talk about Housing though to start with. It's a really good business that's performing well. You saw the very strong 2020, good start to this year, over the last five or six years, we've really fine-tune the lender-placed business, we're now in a good position if there is housing market weakness. So I think that's an important backdrop. Now we have been taking many actions over the last few years to reduce volatility. So one of those was bringing retention down to 80 million per event that is now made, if we do have a severe cat season. It's not a business risk to the company at all, it's just a one-time kind of earnings impact. We've also done things like moving to a multi-year tower. I think as of January, we were up to 52% of the towers now multiyear that also smooths out the volatility. And then, we've been trimming exposure in areas where we don't feel like the risk return trade-off is attractive for true risk businesses like our exit of small commercial. And with that backdrop, we've been on a journey to become more credit light, it's something we look at every year. We look at all of our businesses every year. The challenge with it, it's harder to see how the economics work with reinsurance, given where we are already buying down to, so you need to come up with other structures those require a lot of earnings give up. And so it's not straightforward how you would actually do that and make sure that it was a good outcome for our shareholders. The other way we've been addressing it is just growing the rest of our company. And so, if you look at today our non-cat exposed businesses are now something like 75% of our earnings and growing much faster. And so over time, that's a dramatic shift in our exposure to what might happen with cat. So we certainly continue to work on it, but we feel like we've made great progress on it and we're not going to do anything that isn't really positive for our shareholders.
Brian Meredith: Great, thanks. And then, the second question, just curious on the other warranty business, what are your thoughts here as we progress through in 2021 on that business, obviously some pretty solid growth given what we've seen with respect to used car sales?
Alan Colberg: Yes. We're well positioned first of all in auto. After the Warranty Group acquisition and then the addition of AFAS, we're a clear significant leader in that business, we're now up to 50 million covered autos. We've seen production for our business recover fully and then some through pre-COVID. We mentioned I think Q1 '21 better than Q1 '19 in a significant way. So we feel good about that and what we're trying to also do in addition to just consolidated gaining share through our differentiated offerings. We mention the training academy for example in the call. That's another way that we can gain share over time. So we're seeing good results already strong underlying growth. Most of the benefit of that will be in future years as we realize the new cars converting out of warranty to our product, but well positioned, good momentum. And one of the other things we're looking at it, how do we bring some of our other differentiating capabilities like in what we do with premium tech support as cars become increasingly connected. We have real opportunity to innovate and bring really differentiated solutions in the market.
Operator: Our next question comes from Mark Hughes with Truist.
Mark Hughes: On the multifamily real strong acceleration in growth this quarter, could you talk about what drove that?
Alan Colberg: There are really two things, maybe three things going on there. One, we have a series of strong affinity partnerships that we've built over the years and we're continuing to gain share with those affinity partners. So that's one driver. Second in our Property Management Company channel, we're still early in the rollout of Cover360, which is our new capability to make it much easier to attach our product. And then, third, we've been investing heavily the last few years in digital and CX and our experience now we believe it's as good or better for the consumer to anyone in the market. All those factors, the 9% growth in policies year-on-year were still gaining share and we're up to I think almost 2.5 million policies now. So we've invested there, we're going to continue to invest, we see enormous convergence coming between some of our mobile capabilities around the connected apartment and connected home, early days for that, but we see strong growth just in what we're already doing and then a significant opportunity to innovate and drive growth in the future.
Mark Hughes: In the mobile business, you talked about Europe being a drag, any signs of life there? And I think also South America or Central America has been laggard for you, any signs of movement?
Alan Colberg: Yes, I think, Europe is still struggling with the COVID and the lockdowns of COVID has been more challenging than certainly the U.S. market for sure. Latin America, we're starting to see some rebound, but it's still measured in nowhere near back to kind of what we've seen in Latin America pre-COVID. So I think again what's really been driving our mobile growth in the last year or so has been our strength and position in our very diverse set of clients in North America and Asia-Pacific, but at some point Europe you would assume will begin to recover and that will be a tailwind at some point, but we're not seeing the same kind of strengthening in Europe yet that we've seen elsewhere and that we're starting to see in Latin America.
Mark Hughes: And then, on the embedded card agreements, you talked about American Express. How do the economics on those sort of agreements versus your other relationships, you mentioned the Samsung Care and other programs. How does the economics look?
Alan Colberg: Yes. I know, let me maybe backup just a little bit provide some broader context there. So when we acquired The Warranty Group, they had recently established a new relationship in the embedded card space with one of the big U.S. card issuers. So that got us into that business. And then, we leveraged our capabilities as Assurant with that entree to begin to reposition some of our legacy debt deferment and credit capabilities into this business. So that's what allowed us to go out and win new clients like American Express. Broadly the way to think about that portion of our business, which rolls out through financial services is their fee income, more effectively administered programs for our partners. We're playing a role in adjudicating claims, but the risk, there is no risk for us, so it's fee income, not significant to our earnings yet, but certainly an opportunity over time to grow and then leverage these relationships to drive some of our other products into those companies and their customers. So we're excited about the early progress there a repositioning, but a long way to go to have that be a meaningful contributor to our company.
Mark Hughes: Suzanne said that I have to tell you the story that I went to Verizon to had my phone fixed and then with no help whatsoever and they appointed me to a little place down the street, which I went to and it turned out to be CPR, had a very good experience and actually realized I've forgotten that it was through your business, but it was a godsend when my phone didn't blink out, so anyway wanted to let you know. Thank you.
Alan Colberg: Oh, Mark, I appreciate that. Maybe just a quick comment on that. One of the opportunities we see over time is to support what's called same unit repair, which is either in the store like you just saw there we acquired CPR about a year, a little over a year ago. The other place we see an opportunity over time to really deliver a superior customer experience is to do repair at your home or office, and we acquired Fixt last year, which gives us that platform. So again these are early, but I think about creating growth opportunities for the future. That really differentiate the customer experience, the example you just gave was CPR is exactly what we're trying to do.
Operator: [Operator Instructions] Our next question comes from Michael Phillips with Morgan Stanley.
Michael Phillips: Listen, my question is wanted to get [indiscernible] every quarter or talk about every quarter, but just curious what really changes consumer's attitude towards a trade-in. Is it, I paid off my phone at the time to get the new fancy one or is it really hit its 5G out there now. I wanted to get that fastest thing. So does this conversion to 5G release or any kind of incremental speed up in trade-ins and otherwise happens in the course of a year? And I ask that, I've been called a dinosaur, 4G seems good enough for me. So I'm not resetting the door to go get 5G, but can you just confirm trying to source or ask you something else, but does it really spur what is it that really kind of makes a catalyst for people to come [indiscernible] trade-in the fronts?
Alan Colberg: Yes, I think, from a consumer perspective, we're still very early in the 5G cycle. The average consumer doesn't yet see a compelling use case or benefit. There are strong benefits of 5G like speed and latency improvement, which really will create new businesses, but what really has happened so far it's not consumers broadly saying I have to have 5G yet. The carriers have been aggressively promoting the new phones more than they've done in recent years and that's linked off into an upgrade. So what we've seen so far is more I think market driven activity. Not the consumers yet saying I have to have 5G. If I was to speculate I think we believe 5G is very disruptive, longer term, but it's going to take time for use cases to come to map where you really need that new phone as opposed to being fine on 4G.
Michael Phillips: Okay, thanks, Alan. So more higher level here, I guess, can you talk about any impacts to any of your businesses or just the up tick in inflation rates?
Alan Colberg: Couple of thoughts and then Richard you should certainly comment on the investment portfolio. Although, as you mentioned in your prepared remarks that's much smaller than it used to be with the sale of Global Preneed. Our business is going to perform well in a matter of what the macro environment is. So if we get into slowdown in the economy caused by whatever and inflation could cause a slowdown. We have businesses that are countercyclical and will grow. We also just have embedded growth if you think about our mobile programs and the 15 new programs that we've launched in the last three years or so, most of those are not mature. We also have embedded growth in our auto business and with all those policies sold on new cars that haven't started to earn yet. So I don't think from our business, we're going to see a significant impact, just given how we're set out to perform whatever happens, but Richard, what would you say on the investment portfolio or other effects.
Richard Dziadzio: Yes. I think, it obviously be a positive impact on the overall investment portfolio and as Alan referred to the earlier comments with the sale of Preneed, our overall interest sensitivities going down about two-thirds. So our overall duration is going to be for 4.5 years to 5 years. Having said that, that today our overall yield on the historic portfolio, if I can put it that way is above current interest rates. So to the extent that current interest rates rise and the books rolling over the next five years, higher interest rates will actually be beneficial to us and from that respect.
Michael Phillips: Okay, thank you. That's very helpful, guys. Last one Richard real quickly, any impact you guys on any from the chip shortages that have been impacting other parts of the economy?
Alan Colberg: You know not really is the answer. If you think about our auto business where that's been one of the areas, so you see a lot of press on the chip shortages. We are well positioned on car sales. If there are fewer new car sales, which isn't what we're seeing by the way, but if there are fewer new car sales, used car sales will pick up and we benefit from that mix shift in the short-term. In terms of repairs and maybe an increased cost of repairs, for most of our auto business we're administering the repairs for our clients and the clients realize the benefit or the challenges of part shortages. So, at the end of the day, not really material to us and as we mentioned earlier, we're seeing pretty strong momentum in the underlying growth of auto at the moment.
Operator: Our next question comes from Gary Ransom of Dowling & Partners.
Gary Ransom: I wanted to ask about the EBITDA. Thank you for giving us those numbers. How are you using that internally? Is that a way that you're managing the business? Is it a compensation metric? I wonder if you could just remind us how that's -- how -- what you use it for?
Alan Colberg: Yes, let me start and then Richard you can certainly comment more on EBITDA. Today, it's not a compensation metric. Our primary compensation metrics are things like total shareholder return, operating EPS things like that, but it is a complement and net operating income and in particular as we think about M&A and growing in fee income businesses. It allows us to help the market better understand the real growth that we're setting up for the future, which it's a bit obscured when you look at the accounting of an acquisition of a fee company. But those businesses, we've been acquiring like we mentioned CPR and Fixt earlier on an EBITDA basis, it really sets up and helps the market understand better the growth that we expect in the future. But Richard what would you add?
Richard Dziadzio: Yes. I think, as Alan mentioned first is the valuation issue of it, the market being able to compare apples and apples in terms of other company's EBITDA and ours. So that's the first part. I also look at it as from an operating point of view. It's a better operating point -- a better operating metric in my perspective been NOI, because we add back purchased intangibles. So those are purchases that are made they're running out, it's a non-cash issue. So adding things like that back or taxes back gives us internally just a better view on the operations of the business from period-to-period particularly in the Lifestyle business.
Alan Colberg: Yes. And to your question, we're going to assess over time how best to link it the things like compensation. We don't know yet if we will or won't, but we do think it provides a better view of the underlying profit and momentum of our business, particularly as we're now largely shifted away from traditional risk businesses to being driven by the Connected World businesses.
Gary Ransom: Okay, that's helpful. I also wanted to ask about the macro reopening of the economy and are there areas where they might have been depressed last year where there is perhaps pent-up demand that might come through as part of the growth or anything you're seeing? I know you've talked a little bit about automotive, but are there other areas that where there might be some pent-up demand that would come through as we reopen economies this year?
Alan Colberg: Yes, I know I think broadly you saw last year how resilient our business was even in a very disruptive environment with COVID, but there are a few areas where pent-up demand is still really true. One is travel. We do some of the card benefits for example are linked to travel. And so with travel being very depressed that obviously is an area that is a rebound, so we'll have some link for us and benefit for us. The in-store traffic has been lower but we push very hard on digital even pre-COVID which I think help mitigate that. We mentioned earlier, we are seeing still some depressed activity in Europe. So that's an opportunity. But I think, I wouldn't look at, we were that impacted by COVID in terms of what was happening and so therefore growth in the economy is obviously positive, people buy things that gives us new chances to attach and sale. But as I mentioned earlier, we feel confident whatever happens in the external environment, we're going to grow and outperform.
Gary Ransom: All right. Thank you. And one of the other things I noticed that you know as an insurance analyst I'd like to look at book value and I know you, I see the equity, the book value per share calculation was gone. Can you comment on that change?
Richard Dziadzio: Yes, I think, Alan maybe I'll jump in here. Yes, I think when we look at the company and we look at the evolution of the company going more toward a capital-light type business, fee-based, service-based business. We look at it and book value is much less important than it used to be in terms of an overall indicator of the company. I mean, you can get there from math we give the balance sheets and the equity and the shares. So it's still a calc out there for you. But things like EBITDA, NOI, ex-cat, net operating income, ex-cats, those are more meaningful to us in terms of the profitability and the ongoing profitability and the growth over time of the business. So there are better value indicators in our minds.
Operator: Our last question comes from Mark Hughes of Truist.
Mark Hughes: Just a couple of things. Richard you mentioned maybe some incremental real estate costs. Could you maybe size those and are those going to be broken out separately not included in adjusted earnings?
Richard Dziadzio: Yes, thanks for the question, Mark. In terms of the facilities, it's very early days. What we did want to signal to the market today is, we are looking at our facilities footprint geographically across the world globally. And we think as we go back to the workplace, we can be thoughtful about the future at work and how our staff can work and how we can work more productively over time. So very early days with that, we have attached no numbers to it as of yet. We just wanted to signal that we'll be looking for. And it's one of the reasons why when we look at the first quarter and we look at how strong the first quarter is and we give outlook for rest of the year, we don't want to surprise the market by coming in with a facility expense. In terms of where it will be when we do, if and when we do incur it. We'll obviously call it out to the market. We haven't decided yet depending on what it is and where we go geographically where we go if it really would be a part of operating income or would be something a little bit different than that more of a one-time non-recurring thing, so to come in the future.
Alan Colberg: And Mark what I would add is, broadly with COVID and then the changes that are going to happen. We're trying to think through what is the best way to set up our business and our employees to be as successful in the future and as we work to attract talent. We had a head start that we had about 30% of employees virtual before COVID and there have been a path that we've been working on anyway. But the world is changing and we just want to be really thoughtful about how do we create advantage through the way we structure, so that we create the best possible future workplace environment. And as you saw in Q4, we had a little bit of that last year with some leases that were about to expire. So again as Richard said, we don't know exactly what is going to be, but we know we will have some changes at some point this year likely.
Mark Hughes: And then, in the Multifamily you've mentioned that your digital capabilities you think there are very good in the market. Are you doing any direct-to-consumer? Did that create channel conflict? Is that even something you're interested in just a refresher on that?
Alan Colberg: Yes. The way to think about that is today we are almost entirely B2B2C. So we work through our partners, we embedded in our partners. What we're particularly focused on as we think about innovation in the future is how do we combine some of our capabilities to create even a better offering. So for example in multifamily working through our PMC partners or our affinity partners, can we include mobile into the bundle. Can we add capabilities from mobile? So we don't have any real plans to go to direct-to-consumer. We are always looking for alternative channels and what I mean by that is our strategy has been to support the consumer wherever the consumer wants to go to get products that we sell. And so we're always looking at alternative channels, but our primary focus is that B2B2C and how we leverage our capabilities, which are pretty differentiated across auto, mobile and rental to create kind of new opportunities for growth.
Alan Colberg: All right. Thanks, everyone. We appreciate your time today and for participating in today's call. We had a very strong first quarter and we continue to look forward to closing on the sale of Global Preneed later this year. In the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. Thanks, everyone.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's First Quarter 2021 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following management's prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our first quarter 2021 results with you today. Joining me for Assurant's conference call are Alan Colberg, our President and Chief Executive Officer and Richard Dziadzio, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the first quarter of 2021. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with brief remarks from Alan and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. As we continue to shift to a more fee income capital-light business mix, we introduced adjusted EBITDA as part of our restated financial statement in April. This is another important financial metrics for the company, reflective of our go-forward Global Lifestyle and Global Housing business. In addition, as of January 1, Global Preneed and the related entities included in the sale are considered discontinued operations and no longer included in our continuing operations as reflected in the earnings press release and financial supplement. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement. I will now turn the call over to Alan."
},
{
"speaker": "Alan Colberg",
"text": "Thanks, Suzanne. Good morning, everyone. We're very pleased with our results for the first quarter. We delivered double-digit earnings growth, driven by favorable non-catastrophe loss experience, including improved underwriting in Global Housing as well as continued profitable growth in our Global Automotive, Multifamily Housing and Connected Living businesses. Once again results demonstrated the attractiveness of our market leading Specialty P&C and Lifestyle offerings distributed across multiple channels. This is in addition to the compelling growth opportunities emerging across mobile, auto and renters. Together, these businesses represent what we refer to as the connected world. In 2020, our Connected World offerings represented 2/3rds of our net operating income excluding catastrophes and in combination with our Specialty P&C businesses will enable us to continue to expand our innovative offerings and deliver a superior and seamless customer experience. Generating over $1 billion of adjusted EBITDA in 2020, our business portfolio is well positioned to sustain above market growth and strong cash flows over time. And as we look ahead, we are continuously investing to bring innovation to market to build a more sustainable future for all of our stakeholders. To that end, we recently published our 2021 Social Responsibility Report highlighting the many ways we are delivering on our commitment as a purpose-driven company. We are continuing to advance our ESG efforts, specifically within our strategic focus areas of talent, products and climate. Further integrating ESG within our business operations will be critical as we look to create an even more diverse, equitable and inclusive culture that promotes innovation enhances sustainability and minimizes our carbon footprint for the benefit of all stakeholders. Recent notable examples include, we are increasing all U.S. hourly wages to at least $15 per hour by July, which supports the financial well-being of our employees. We've launched in assessment of our carbon footprint, including our investment portfolio and supply chain as a critical step to setting a future long-term carbon emissions reduction goal. And we further integrated sustainability into our offerings such as rolling out electric vehicle products globally and extending the mobile device lifecycle through trading services. With HYLA, we recently passed a significant milestone repurposing our 100 million device. This has extended the life of devices put billions of dollars back into consumers hands and prevented additional e-waste from ending up in our landfills supporting global sustainability. We are pleased with our progress and are proud of the recognitions we have received, including our inclusion in the Bloomberg Gender Equality Index and America's Best Employers for Diversity by Forbes as well as being awarded the Best Place to Work in several of the key markets we operate. Sustainability and innovation go hand-in-hand. Recently, we surpassed $100 million invested through Assurant Ventures, our venture capital arm. This quarter several high-quality investments in our portfolio announced back transactions, including Cazoo, a fully digital U.K. car sales company and SmartRent, a smart home automation provider. Given current attractive valuations, these investments have the potential to generate strong returns while also providing strategic insight that support our connected world businesses, creating value-added partnerships and piloting new innovations. Now, let me share some first quarter highlights for each of our operating segments. We continue to see strong growth in Global Lifestyle, increasing earnings by 7% year-over-year. Over the years, we continuously invested in mobile capabilities such as same day local repair or come-to-you-to-repair for mobile devices, which provide another opportunity to drive value for our clients and the end consumer. Most recently in Connected Living, we further strengthened our product capabilities and customer experience through the acquisition of TRYGLE in Japan. TRYGLE develops and operates a mobile phone app that allows consumers to manage the lifecycle of their devices and centrally organizes digital product manuals for all connected products. Collectively, all of our investments have helped lead the 15 new client program launches since 2015. This includes partnerships with several U.S. cable providers including Xfinity and Spectrum as well as large mobile carriers in Japan like KDDI and Rakuten. Recently, we've expanded our global partnership with Samsung through the launch of Samsung Care+, a smartphone protection program in Brazil and Mexico. We expect to further extend this partnership globally. We will continue to build on the strong momentum we have with our global multi-product and multi-channel strategy bolstered by the additional investments we are making. As an example, HYLA Mobile added scale and technology capabilities to our global trade-in and upgrade business and has been performing even better than our initial expectations. We're now providing over 30 trading programs around the world. The acquisition positions us to benefit from favorable tailwinds in the global mobile market, including the upcoming 5G smartphone upgrade cycle and new client relationships. In Global Automotive, we continue to benefit from our scale and expertise as we now cover over 50 million vehicles. Already this year, we've seen a significant increase in auto production versus pre-pandemic first quarter levels. In the year since acquiring AFAS, we've combined our award winning training programs to create the Automotive Training Academy by Assurant. These expanded in-person and virtual programs will allow us to scale faster and adapt to the changing needs of dealers and automotive professionals. Within Global Financial Services, we've added a number of embedded card benefit clients recently, including the previously announced partnership with American Express. We look forward to enhancing these partnerships and building on our existing suite of products. Moving to Global Housing. Net operating income excluding reportable catastrophes grew 17% as we benefited from favorable non-cat loss experience, including improved underwriting results. Within our lender-placed business, we continue to play a vital role in supporting the mortgage industry as we track over 31 million loans. The business remains well positioned and we expect to benefit from investments in our superior customer platform over the long-term. Multifamily Housing increased policies by 9% year-over-year to almost $2.5 million as we continue to grow through our affinity partnerships and PMC channel, including seven of the top 10 largest PMCs in the US. We've also continued to grow our sharing economy offerings, which include car sharing, on-demand delivery and vacation rental. Over the last two years through our partnership with market leaders and on-demand delivery, we tripled the number of deliveries we protect over 1 billion deliveries. While it is too early to gauge whether the pandemic has fundamentally changed consumer demand for these services, we're encouraged by our momentum and the potential for future products and services in the gig economy. Now let's move to our first quarter results and our 2021 outlook. Net operating income excluding cats grew by 13% to $182 million and earnings per share increased 16% to $3.03, demonstrating improved results in Global Housing and continued momentum in Global Lifestyle. Given our strong performance in the first quarter and current business trends, we are increasing our full-year outlook for 2021. We now expect 10% to 14% growth in operating earnings per share excluding catastrophes versus our initial expectation of 9% EPS growth. EPS expansion from the $9.88 in 2020 will be driven by high single-digit earnings growth mainly from Global Lifestyle and the lower corporate loss. Results will also benefit from share repurchases, including the completion of our three-year $1.35 billion objective in the initial return of net proceeds from the Global Preneed sale. Our increased outlook largely reflects Global Housing's favorable non-catastrophe loss experienced in the first quarter. As such Housing's earnings are expected to be down only modestly year-over-year from what was a strong 2020. Looking at adjusted EBITDA, excluding catastrophes, the first quarter generated $302 million, an increase of 15% year-over-year. We expect adjusted EBITDA will grow at a modestly higher rate than net operating income in 2021. Turning to capital. We ended March with $332 million of holding company liquidity, after returning $80 million to shareholders through common stock dividends and buybacks during the quarter. And we expect to deliver on all of our commitments, sustaining our strong track record of capital return. In addition, throughout the year, we will continue to make strategic investments in our portfolio to position us well for sustained long-term growth. I'll now turn the call over to Richard to review first quarter results and our 2021 outlook. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Alan, and good morning, everyone. As Alan noted, we are pleased with our first quarter performance as our results across Global Lifestyle and Global Housing remains strong. Before getting into our first quarter performance, I want to provide a quick update on the sale of our Preneed business. In March, we announced our plan to sell the business for $1.3 billion to CUNA Mutual Group. Since signing, we have completed the necessary regulatory filings and we remain on track to close the transaction by the end of the third quarter. Now let's move to segment results for Global Lifestyle. This segment reported net operating income of $129 million in the first quarter, an increase of 7% driven by Global Automotive and Connected Living. In Global Automotive, earnings increased $7 million or 18%, results included a $4 million one-time benefit as well as a gain on investment income related to a specialty asset class from our TWG acquisition which we don't expect to recur. Year-over-year, underlying performance was driven by another quarter of global organic growth from U.S. CPA and international OEMs as well as some favorable loss experience. Connected Living grew earnings by 3%. However, this was muted by a $7 million favorable client recoverable with an extended service contracts in the prior year period. Underlying performance was driven by mobile subscriber growth in Asia Pacific and North America. Higher trading results from increases in volume and contributions from our HYLA acquisition. For the quarter Lifestyle's adjusted EBITDA increased 11% to $193 million, 4 points above net operating income growth. This reflects this segment increased amortization related to higher deal-related intangibles for more recent acquisitions in Global Automotive and Connected Living. IT depreciation expense also increased, stemming from higher investments. Lifestyle revenue decreased by $85 million, this was driven mainly by a $98 million reduction in mobile trade-in revenue, primarily due to the contract change we disclosed last year. Excluding this change, revenue for this segment was flat. For the full year, we continue to expect Lifestyle revenues to be in line with last year at approximately $7.3 billion. As expected overall trade-in volumes, which flow through fee income increased year-over-year and sequentially. This was driven by four elements. New phone introductions last year, greater device availability, carrier promotions and contributions from HYLA. While the first quarter did benefit from strong mobile trade-in volumes, we do expect it to be a high watermark for the year, given historical seasonal patterns. Since year-end, we've increased covered mobile devices by 600,000 subs driven by continued growth in North America and Asia-Pacific. This year, we continue to expect covered mobile devices to grow mid single-digits compared to 2020 as we go subscribers in key geographies like the U.S. and Japan. As a reminder, we expect the growth rate of earnings to exceed the growth rate of covered mobile devices over time. As we benefit from offering additional products and services to our clients and their end consumers. For 2021, we still expect Global Lifestyle's net operating income to grow in the high single-digits compared to the $437 million reported in 2020. Growth will come from all lines of business particularly Connected Living. Adjusted EBITDA for this segment is expected to grow double digits year-over-year. Moving now to Global Housing, net operating income for the first quarter totaled $67 million compared to $74 million in the first quarter of 2020. The decrease was largely due to $22 million of higher reportable catastrophes mainly related to the extreme winter weather particularly from areas like Texas. Excluding catastrophe losses, earnings increased $50 million or 17%. More than 2/3rds of the increase was from favorable non-cat loss experience mainly in our specialty offerings, including sharing economy products. We estimate that approximately half of the favorable loss experience in the first quarter was from underwriting improvements, with the remainder of the benefit, driven by favorable loss experience, which we don't expect to recur. In addition, we saw continued growth in Multifamily Housing. Lender-placed results were up modestly, higher premium rates and favorable non-cat loss experience were mostly offset by declining REO volumes from ongoing foreclosure moratoriums. Looking at the placement rate, the modest sequential increase to 1.6% was attributable to a shift in business mix and is not an indication of a broader macro housing market shifts. Revenue decreased 2% related to a reduction in our specialty product offerings, which included the impact from the exit of small commercial as well as lower REO volume. This increase was partially offset by growth in Multifamily Housing, which grew 8% year-over-year driven mainly by our affinity partners. We now expect Global Housing's net operating income excluding cat to be down modestly compared to 2020. This reflects our stronger first quarter and the assumption of a modest increase in our expected non-cat loss ratio to more normalized level for the remainder of the year. We are also monitoring the REO foreclosure moratoriums in any additional extensions that may be announced. As we position for the future, we will continue to invest in some of the business to sustain and enhance our competitive position. At Corporate, the net operating loss was $22 million, which was flat year-over-year. For the full year, we continue to expect the Corporate net operating loss to improve to approximately $90 million as we eliminate enterprise support costs associated with Global Preneed. As we think about the remainder of the year for all of the Assurant, we are beginning to plan for a phase reentry of our workforce post-COVID and we are evaluating our real estate footprint to align with new business and employee need as we adapt to the future of work. This may result in additional expenses throughout the year. I also wanted to provide a quick comment on our investment portfolio. With Preneed moving to discontinued operations, our investment portfolio is now approximately $7.9 billion, excluding cash and cash equivalent. Given Preneed's relatively longer average duration of around 10 years compared to the rest of our business, following the sale of Preneed, our go-forward duration will drop to between 4.5 years to 5 years. As a result our interest rate sensitivity will be reduced by approximately 2/3rds. Turning to Holding Company liquidity, we ended the first quarter with $332 million, which is $107 million above our current minimum target level. In the first quarter, dividends from our operating segments totaled $183 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items; $42 million of share repurchases; $43 million in common and preferred stock dividends; and $10 million mainly related to the acquisition of TRYGLE and Assurant Venture Investments. Also in January, we redeemed the remaining $50 million of our March 2021 note. And our mandatory convertible shares converted to approximately 2.7 million common shares during the quarter. For the year overall, we continue to expect dividends to approximate segment earnings subject to the growth of the businesses and rating agency and regulatory capital considerations. We've now completed over 70% of our $1.35 billion capital return objective from 2019 to 2021 and remain confident that we will meet this objective by the end of this year. In addition, we expect to begin incremental buybacks prior to closing the Preneed transaction in the third quarter. The total buybacks associated with the net proceeds from the sale are expected to be returned within one-year of the transaction close. In the second quarter through April 30, we repurchased an additional 95,000 shares for $14 million. In summary, our first quarter results demonstrate the strength of our business and our capital and liquidity position. We remain focused on completing the sale of Global Preneed and delivering on our 2021 financial objectives. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. The floor is now open for questions. [Operator Instructions] Our first question is coming from Bose George of KBW."
},
{
"speaker": "Tom Michaud",
"text": "Hey, good morning, guys. This is actually Tom Michaud on for Bose. Thanks for taking our questions. Yes, the first question is really just kind of about sizing up the rebound in contribution of the trade-in volumes. I know there's kind of a lot of moving pieces with the contract change, the HYLA contribution and it sounds like 1Q was a high watermark. So if you guys help us kind of frame how we should think about the contribution for the trade-in volumes going forward?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. Maybe I'll start and then Richard certainly add-on. If you think about our trade-in and buyback business, we're now very a strong player after the acquisition of HYLA, we mentioned in the prepared remarks, we have 30 plus programs that we operate around the world. You're right, Q1 tends to be the seasonal high for trade-in really driven by the launch of new phones late in the prior year. We expect activity to moderate through the balance of the year, but again that business is well positioned growing strongly and we have a lot of duty as the 5G wave develops, which is still very early and we expect that to develop later this year and into '22 really as the driver, but Richard anything you'd add on that."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. I think, I mean overall we're in a really good place and as Alan said, Q1 we're looking at it as a high-watermark, but on the other hand, we have 30-plus trade-in programs. So we are encouraged by the momentum of the business and also what HYLA is adding to the mix of the Lifestyle business as well."
},
{
"speaker": "Tom Michaud",
"text": "Okay. And so just kind of thinking about the balance of the year there is some easy comps, obviously with volumes have been depleted kind of and starting in 2Q ‘20. And so as we kind of think of the fees and other income line within Global Lifestyle. Is it reasonable to think of it being somewhat flat year-over-year, even after considering the contract change, which will hit the next two quarters?"
},
{
"speaker": "Richard Dziadzio",
"text": "And I don't think we've given a total revenue outlook for Lifestyle, but we have said that when we look at Lifestyle this year we will be looking at net operating income being in the high single-digits. So hopefully that should help you."
},
{
"speaker": "Tom Michaud",
"text": "Okay. Yes, that will. Thanks. And then, just a second question, could you just talk about the growth in subscribers in terms of how much contribution is coming from T-Mobile and Sprint versus some of the other kind of providers including our cable providers which would seem to have been gaining share in subscriber account?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. And again just to frame that for everyone. So what we've said for this year is, we expect subscriber growth in mobile to be mid single-digits and that's really being driven by growth in North America, which is coming from many different programs, including the ones you mentioned as well as growth in Asia Pacific, we are seeing a bit of a drag in Europe that's been ongoing as Europe has been more severely impacted by the COVID lockdowns. Also in Q2, we're going to lose a small program in Europe. We're having a banking program in mobile that's going to transition to another provider that's going to be a reduction of about 750,000 subs, but will have no impact on our bottom-line. So we factored that into that outlook as well as mid single-digit growth for the year."
},
{
"speaker": "Operator",
"text": "Our next question comes from Brian Meredith of UBS."
},
{
"speaker": "Brian Meredith",
"text": "Alan, I wonder if you could talk a little bit about, we're getting closer to the mid-year reinsurance renewal what that looks like and specifically any additional thoughts with respect to trying to convert the lender-placed insurance business more to an MGA model and maybe specifically you can kind of get into what are the challenges and impediments in actually going to that type of a model?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. Happy to talk about that. I think it's important when we talk about Housing though to start with. It's a really good business that's performing well. You saw the very strong 2020, good start to this year, over the last five or six years, we've really fine-tune the lender-placed business, we're now in a good position if there is housing market weakness. So I think that's an important backdrop. Now we have been taking many actions over the last few years to reduce volatility. So one of those was bringing retention down to 80 million per event that is now made, if we do have a severe cat season. It's not a business risk to the company at all, it's just a one-time kind of earnings impact. We've also done things like moving to a multi-year tower. I think as of January, we were up to 52% of the towers now multiyear that also smooths out the volatility. And then, we've been trimming exposure in areas where we don't feel like the risk return trade-off is attractive for true risk businesses like our exit of small commercial. And with that backdrop, we've been on a journey to become more credit light, it's something we look at every year. We look at all of our businesses every year. The challenge with it, it's harder to see how the economics work with reinsurance, given where we are already buying down to, so you need to come up with other structures those require a lot of earnings give up. And so it's not straightforward how you would actually do that and make sure that it was a good outcome for our shareholders. The other way we've been addressing it is just growing the rest of our company. And so, if you look at today our non-cat exposed businesses are now something like 75% of our earnings and growing much faster. And so over time, that's a dramatic shift in our exposure to what might happen with cat. So we certainly continue to work on it, but we feel like we've made great progress on it and we're not going to do anything that isn't really positive for our shareholders."
},
{
"speaker": "Brian Meredith",
"text": "Great, thanks. And then, the second question, just curious on the other warranty business, what are your thoughts here as we progress through in 2021 on that business, obviously some pretty solid growth given what we've seen with respect to used car sales?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. We're well positioned first of all in auto. After the Warranty Group acquisition and then the addition of AFAS, we're a clear significant leader in that business, we're now up to 50 million covered autos. We've seen production for our business recover fully and then some through pre-COVID. We mentioned I think Q1 '21 better than Q1 '19 in a significant way. So we feel good about that and what we're trying to also do in addition to just consolidated gaining share through our differentiated offerings. We mention the training academy for example in the call. That's another way that we can gain share over time. So we're seeing good results already strong underlying growth. Most of the benefit of that will be in future years as we realize the new cars converting out of warranty to our product, but well positioned, good momentum. And one of the other things we're looking at it, how do we bring some of our other differentiating capabilities like in what we do with premium tech support as cars become increasingly connected. We have real opportunity to innovate and bring really differentiated solutions in the market."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Hughes with Truist."
},
{
"speaker": "Mark Hughes",
"text": "On the multifamily real strong acceleration in growth this quarter, could you talk about what drove that?"
},
{
"speaker": "Alan Colberg",
"text": "There are really two things, maybe three things going on there. One, we have a series of strong affinity partnerships that we've built over the years and we're continuing to gain share with those affinity partners. So that's one driver. Second in our Property Management Company channel, we're still early in the rollout of Cover360, which is our new capability to make it much easier to attach our product. And then, third, we've been investing heavily the last few years in digital and CX and our experience now we believe it's as good or better for the consumer to anyone in the market. All those factors, the 9% growth in policies year-on-year were still gaining share and we're up to I think almost 2.5 million policies now. So we've invested there, we're going to continue to invest, we see enormous convergence coming between some of our mobile capabilities around the connected apartment and connected home, early days for that, but we see strong growth just in what we're already doing and then a significant opportunity to innovate and drive growth in the future."
},
{
"speaker": "Mark Hughes",
"text": "In the mobile business, you talked about Europe being a drag, any signs of life there? And I think also South America or Central America has been laggard for you, any signs of movement?"
},
{
"speaker": "Alan Colberg",
"text": "Yes, I think, Europe is still struggling with the COVID and the lockdowns of COVID has been more challenging than certainly the U.S. market for sure. Latin America, we're starting to see some rebound, but it's still measured in nowhere near back to kind of what we've seen in Latin America pre-COVID. So I think again what's really been driving our mobile growth in the last year or so has been our strength and position in our very diverse set of clients in North America and Asia-Pacific, but at some point Europe you would assume will begin to recover and that will be a tailwind at some point, but we're not seeing the same kind of strengthening in Europe yet that we've seen elsewhere and that we're starting to see in Latin America."
},
{
"speaker": "Mark Hughes",
"text": "And then, on the embedded card agreements, you talked about American Express. How do the economics on those sort of agreements versus your other relationships, you mentioned the Samsung Care and other programs. How does the economics look?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. I know, let me maybe backup just a little bit provide some broader context there. So when we acquired The Warranty Group, they had recently established a new relationship in the embedded card space with one of the big U.S. card issuers. So that got us into that business. And then, we leveraged our capabilities as Assurant with that entree to begin to reposition some of our legacy debt deferment and credit capabilities into this business. So that's what allowed us to go out and win new clients like American Express. Broadly the way to think about that portion of our business, which rolls out through financial services is their fee income, more effectively administered programs for our partners. We're playing a role in adjudicating claims, but the risk, there is no risk for us, so it's fee income, not significant to our earnings yet, but certainly an opportunity over time to grow and then leverage these relationships to drive some of our other products into those companies and their customers. So we're excited about the early progress there a repositioning, but a long way to go to have that be a meaningful contributor to our company."
},
{
"speaker": "Mark Hughes",
"text": "Suzanne said that I have to tell you the story that I went to Verizon to had my phone fixed and then with no help whatsoever and they appointed me to a little place down the street, which I went to and it turned out to be CPR, had a very good experience and actually realized I've forgotten that it was through your business, but it was a godsend when my phone didn't blink out, so anyway wanted to let you know. Thank you."
},
{
"speaker": "Alan Colberg",
"text": "Oh, Mark, I appreciate that. Maybe just a quick comment on that. One of the opportunities we see over time is to support what's called same unit repair, which is either in the store like you just saw there we acquired CPR about a year, a little over a year ago. The other place we see an opportunity over time to really deliver a superior customer experience is to do repair at your home or office, and we acquired Fixt last year, which gives us that platform. So again these are early, but I think about creating growth opportunities for the future. That really differentiate the customer experience, the example you just gave was CPR is exactly what we're trying to do."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from Michael Phillips with Morgan Stanley."
},
{
"speaker": "Michael Phillips",
"text": "Listen, my question is wanted to get [indiscernible] every quarter or talk about every quarter, but just curious what really changes consumer's attitude towards a trade-in. Is it, I paid off my phone at the time to get the new fancy one or is it really hit its 5G out there now. I wanted to get that fastest thing. So does this conversion to 5G release or any kind of incremental speed up in trade-ins and otherwise happens in the course of a year? And I ask that, I've been called a dinosaur, 4G seems good enough for me. So I'm not resetting the door to go get 5G, but can you just confirm trying to source or ask you something else, but does it really spur what is it that really kind of makes a catalyst for people to come [indiscernible] trade-in the fronts?"
},
{
"speaker": "Alan Colberg",
"text": "Yes, I think, from a consumer perspective, we're still very early in the 5G cycle. The average consumer doesn't yet see a compelling use case or benefit. There are strong benefits of 5G like speed and latency improvement, which really will create new businesses, but what really has happened so far it's not consumers broadly saying I have to have 5G yet. The carriers have been aggressively promoting the new phones more than they've done in recent years and that's linked off into an upgrade. So what we've seen so far is more I think market driven activity. Not the consumers yet saying I have to have 5G. If I was to speculate I think we believe 5G is very disruptive, longer term, but it's going to take time for use cases to come to map where you really need that new phone as opposed to being fine on 4G."
},
{
"speaker": "Michael Phillips",
"text": "Okay, thanks, Alan. So more higher level here, I guess, can you talk about any impacts to any of your businesses or just the up tick in inflation rates?"
},
{
"speaker": "Alan Colberg",
"text": "Couple of thoughts and then Richard you should certainly comment on the investment portfolio. Although, as you mentioned in your prepared remarks that's much smaller than it used to be with the sale of Global Preneed. Our business is going to perform well in a matter of what the macro environment is. So if we get into slowdown in the economy caused by whatever and inflation could cause a slowdown. We have businesses that are countercyclical and will grow. We also just have embedded growth if you think about our mobile programs and the 15 new programs that we've launched in the last three years or so, most of those are not mature. We also have embedded growth in our auto business and with all those policies sold on new cars that haven't started to earn yet. So I don't think from our business, we're going to see a significant impact, just given how we're set out to perform whatever happens, but Richard, what would you say on the investment portfolio or other effects."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. I think, it obviously be a positive impact on the overall investment portfolio and as Alan referred to the earlier comments with the sale of Preneed, our overall interest sensitivities going down about two-thirds. So our overall duration is going to be for 4.5 years to 5 years. Having said that, that today our overall yield on the historic portfolio, if I can put it that way is above current interest rates. So to the extent that current interest rates rise and the books rolling over the next five years, higher interest rates will actually be beneficial to us and from that respect."
},
{
"speaker": "Michael Phillips",
"text": "Okay, thank you. That's very helpful, guys. Last one Richard real quickly, any impact you guys on any from the chip shortages that have been impacting other parts of the economy?"
},
{
"speaker": "Alan Colberg",
"text": "You know not really is the answer. If you think about our auto business where that's been one of the areas, so you see a lot of press on the chip shortages. We are well positioned on car sales. If there are fewer new car sales, which isn't what we're seeing by the way, but if there are fewer new car sales, used car sales will pick up and we benefit from that mix shift in the short-term. In terms of repairs and maybe an increased cost of repairs, for most of our auto business we're administering the repairs for our clients and the clients realize the benefit or the challenges of part shortages. So, at the end of the day, not really material to us and as we mentioned earlier, we're seeing pretty strong momentum in the underlying growth of auto at the moment."
},
{
"speaker": "Operator",
"text": "Our next question comes from Gary Ransom of Dowling & Partners."
},
{
"speaker": "Gary Ransom",
"text": "I wanted to ask about the EBITDA. Thank you for giving us those numbers. How are you using that internally? Is that a way that you're managing the business? Is it a compensation metric? I wonder if you could just remind us how that's -- how -- what you use it for?"
},
{
"speaker": "Alan Colberg",
"text": "Yes, let me start and then Richard you can certainly comment more on EBITDA. Today, it's not a compensation metric. Our primary compensation metrics are things like total shareholder return, operating EPS things like that, but it is a complement and net operating income and in particular as we think about M&A and growing in fee income businesses. It allows us to help the market better understand the real growth that we're setting up for the future, which it's a bit obscured when you look at the accounting of an acquisition of a fee company. But those businesses, we've been acquiring like we mentioned CPR and Fixt earlier on an EBITDA basis, it really sets up and helps the market understand better the growth that we expect in the future. But Richard what would you add?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. I think, as Alan mentioned first is the valuation issue of it, the market being able to compare apples and apples in terms of other company's EBITDA and ours. So that's the first part. I also look at it as from an operating point of view. It's a better operating point -- a better operating metric in my perspective been NOI, because we add back purchased intangibles. So those are purchases that are made they're running out, it's a non-cash issue. So adding things like that back or taxes back gives us internally just a better view on the operations of the business from period-to-period particularly in the Lifestyle business."
},
{
"speaker": "Alan Colberg",
"text": "Yes. And to your question, we're going to assess over time how best to link it the things like compensation. We don't know yet if we will or won't, but we do think it provides a better view of the underlying profit and momentum of our business, particularly as we're now largely shifted away from traditional risk businesses to being driven by the Connected World businesses."
},
{
"speaker": "Gary Ransom",
"text": "Okay, that's helpful. I also wanted to ask about the macro reopening of the economy and are there areas where they might have been depressed last year where there is perhaps pent-up demand that might come through as part of the growth or anything you're seeing? I know you've talked a little bit about automotive, but are there other areas that where there might be some pent-up demand that would come through as we reopen economies this year?"
},
{
"speaker": "Alan Colberg",
"text": "Yes, I know I think broadly you saw last year how resilient our business was even in a very disruptive environment with COVID, but there are a few areas where pent-up demand is still really true. One is travel. We do some of the card benefits for example are linked to travel. And so with travel being very depressed that obviously is an area that is a rebound, so we'll have some link for us and benefit for us. The in-store traffic has been lower but we push very hard on digital even pre-COVID which I think help mitigate that. We mentioned earlier, we are seeing still some depressed activity in Europe. So that's an opportunity. But I think, I wouldn't look at, we were that impacted by COVID in terms of what was happening and so therefore growth in the economy is obviously positive, people buy things that gives us new chances to attach and sale. But as I mentioned earlier, we feel confident whatever happens in the external environment, we're going to grow and outperform."
},
{
"speaker": "Gary Ransom",
"text": "All right. Thank you. And one of the other things I noticed that you know as an insurance analyst I'd like to look at book value and I know you, I see the equity, the book value per share calculation was gone. Can you comment on that change?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, I think, Alan maybe I'll jump in here. Yes, I think when we look at the company and we look at the evolution of the company going more toward a capital-light type business, fee-based, service-based business. We look at it and book value is much less important than it used to be in terms of an overall indicator of the company. I mean, you can get there from math we give the balance sheets and the equity and the shares. So it's still a calc out there for you. But things like EBITDA, NOI, ex-cat, net operating income, ex-cats, those are more meaningful to us in terms of the profitability and the ongoing profitability and the growth over time of the business. So there are better value indicators in our minds."
},
{
"speaker": "Operator",
"text": "Our last question comes from Mark Hughes of Truist."
},
{
"speaker": "Mark Hughes",
"text": "Just a couple of things. Richard you mentioned maybe some incremental real estate costs. Could you maybe size those and are those going to be broken out separately not included in adjusted earnings?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, thanks for the question, Mark. In terms of the facilities, it's very early days. What we did want to signal to the market today is, we are looking at our facilities footprint geographically across the world globally. And we think as we go back to the workplace, we can be thoughtful about the future at work and how our staff can work and how we can work more productively over time. So very early days with that, we have attached no numbers to it as of yet. We just wanted to signal that we'll be looking for. And it's one of the reasons why when we look at the first quarter and we look at how strong the first quarter is and we give outlook for rest of the year, we don't want to surprise the market by coming in with a facility expense. In terms of where it will be when we do, if and when we do incur it. We'll obviously call it out to the market. We haven't decided yet depending on what it is and where we go geographically where we go if it really would be a part of operating income or would be something a little bit different than that more of a one-time non-recurring thing, so to come in the future."
},
{
"speaker": "Alan Colberg",
"text": "And Mark what I would add is, broadly with COVID and then the changes that are going to happen. We're trying to think through what is the best way to set up our business and our employees to be as successful in the future and as we work to attract talent. We had a head start that we had about 30% of employees virtual before COVID and there have been a path that we've been working on anyway. But the world is changing and we just want to be really thoughtful about how do we create advantage through the way we structure, so that we create the best possible future workplace environment. And as you saw in Q4, we had a little bit of that last year with some leases that were about to expire. So again as Richard said, we don't know exactly what is going to be, but we know we will have some changes at some point this year likely."
},
{
"speaker": "Mark Hughes",
"text": "And then, in the Multifamily you've mentioned that your digital capabilities you think there are very good in the market. Are you doing any direct-to-consumer? Did that create channel conflict? Is that even something you're interested in just a refresher on that?"
},
{
"speaker": "Alan Colberg",
"text": "Yes. The way to think about that is today we are almost entirely B2B2C. So we work through our partners, we embedded in our partners. What we're particularly focused on as we think about innovation in the future is how do we combine some of our capabilities to create even a better offering. So for example in multifamily working through our PMC partners or our affinity partners, can we include mobile into the bundle. Can we add capabilities from mobile? So we don't have any real plans to go to direct-to-consumer. We are always looking for alternative channels and what I mean by that is our strategy has been to support the consumer wherever the consumer wants to go to get products that we sell. And so we're always looking at alternative channels, but our primary focus is that B2B2C and how we leverage our capabilities, which are pretty differentiated across auto, mobile and rental to create kind of new opportunities for growth."
},
{
"speaker": "Alan Colberg",
"text": "All right. Thanks, everyone. We appreciate your time today and for participating in today's call. We had a very strong first quarter and we continue to look forward to closing on the sale of Global Preneed later this year. In the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. Thanks, everyone."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 4 | 2,022 | 2023-02-08 08:00:00 | Operator: Welcome to Assurant's Fourth Quarter and Full Year 2022 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, operator. Good morning, everyone. We look forward to discussing our fourth quarter and full year 2022 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release, announcing our results for the fourth quarter and full year 2022. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release and financial supplement as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement. Effective January 1, 2023, we realigned the composition of our segments to better manage our risk and fee-based capital-light businesses. Global Housing is now comprised of two primary lines of business, homeowners and renters and others. Certain product lines, including our lease and finance business, previously reported in housing, have been moved to Global Lifestyle to better align with our go-to-market strategy. While this change has no impact on our consolidated results, it will modestly impact the earnings trends within the segments. Our 2023 outlook is based on this realigned view. Please refer to the financial supplement for a reconciliation of certain key data for these changes. I will now turn the call over to Keith.
Keith Demmings: Thanks, Suzanne, and good morning, everyone. Reflecting on my first year as CEO, I couldn't be prouder of the extraordinary dedication and commitment demonstrated by our employees in delivering for our clients and customers around the world. During the year, we made progress in executing our vision to be the leading global business services provider supporting the advancement of the connected world. We continue to grow and strengthen our partnerships with key clients, and delivered new innovative solutions, all while navigating more volatile market conditions. Our portfolio of Lifestyle and Housing businesses proved resilient, but not immune to macroeconomic headwinds. In 2022, we grew adjusted earnings per share by 11% and delivered over $1.1 billion of adjusted EBITDA, both excluding reportable catastrophes. Adjusting for $27 million of unfavorable foreign exchange, adjusted EBITDA growth was 3%, and 2022 represented our sixth consecutive year of profitable growth. This is a reflection of our compelling strategy and resilient culture. We've held true to our company's purpose of helping people thrive with a steadfast commitment to being a socially responsible company for all of our stakeholders. I'm proud that we've been recognized as a great place to work in 13 countries, and most recently in the U.S. for the second consecutive year. Our focus remains on engaging and developing our diverse talent pool through enhanced leadership and skill development programs. We also continue to reduce our environmental impact as a core pillar of our ESG strategy. Building on our progress to date, we announced in December our goal to reduce greenhouse gas emissions by 40% by 2030. This target aligns with the Paris Agreement, and ensures we drive meaningful reductions. We've also taken a number of actions within our businesses to strengthen Assurant for the future. In Global Housing, we initiated a business transformation, including exiting certain noncore businesses, such as our sharing economy, as well as international cat-exposed business where we did not see a path to leadership positions More broadly, across Assurant, we realigned our organizational structure, as Suzanne referenced, to drive more focus and better deploy talent. We also took decisive action by accelerating several expense initiatives to realize additional efficiencies and position us for continued long-term growth. As we announced in December, we expect to realize $55 million of annualized gross savings by the end of 2024 through the simplification of our organizational structure, and our real estate consolidation program given our increasingly hybrid workforce. These actions will help mitigate the impact of higher labor costs and headwinds from the macroeconomic environment, as well as fund additional investments, including increased automation. In addition to ensuring a more streamlined organizational and cost structure, we've gained momentum throughout the year in both Global Lifestyle and Global Housing, renewing and winning new clients in each of our major lines of business. In Global Lifestyle, adjusted EBITDA increased 7% in 2022, with growth from both Connected Living and Global Automotive. On a constant currency basis, adjusted EBITDA expanded by 11%, aligned with our original expectations for the year. In Connected Living, we grew adjusted EBITDA by 15% on a constant currency basis, driven by mobile protection program growth in North America. Our ability to continuously innovate our products and services has supported a stronger and more differentiated customer experience, resulting in increased Net Promoter Scores. In addition to key partner renewals, including T-Mobile and Xfinity, we secured new business opportunities and new client partnerships, continuing to diversify our broad client base. In our mobile protection business, we now protect nearly 62 million global devices, driven by the 25 new protection programs we've added since 2015. We serviced over 28 million devices in 2022, mainly from our mobile trade-in business as we add scale and further demonstrate our position as a market leader with this important value-added service to our clients. We added several new trading clients and now have over 40 trade-in programs globally. We continue to invest in talent and strengthen supply chain operations to maintain our competitive advantage. In Global Automotive, we grew global protected autos in 2022 by 2% to 54.1 million vehicles, helping to generate adjusted EBITDA growth of 5%. Recently, we expanded and enhanced our EV1 protection offering in the U.S., and coverage is now available for battery electric vehicles and plug-in hybrid electric vehicles, including comprehensive battery coverage. In our newly combined leased and finance business, we partnered with CNH Industrial in the U.S. and Canada to provide service contracts and physical damage insurance. CNH is the third largest agriculture and construction equipment company in the world. This partnership was made possible by the talent and expertise of our teams, including through the acquisition of EPG. In Global Housing, we took swift action to mitigate the impact of high inflation within our lender-placed business. We began to see improved performance as we exited the year, reflecting the rate increases implemented over the course of the year. We expect higher rates to roll through our book into 2023 and beyond, while we manage ongoing elevated claims costs. In 2022, we renewed eight lender-placed clients, including several of our most significant partnerships with multiyear agreements. These renewals represent 36% of our over 31 million loans tracked. In Multifamily Housing, we now have over 2.6 million renters policies. While we've seen slower growth from our affinity partnerships, our volume with property management companies continues to expand as we signed several new partnerships, including two top PMCs with over 100,000 combined units. We also successfully completed multiyear renewals with six key client relationships. As we continue to convert clients to our Cover360 platform, we expect to see ongoing policy growth in that channel. Throughout the year, we maintained a strong balance sheet as we navigated increased macroeconomic uncertainty. Our businesses contributed a total of $550 million in dividends to the holding company or roughly 52% of segment earnings, including catastrophe losses. Together with the remaining net proceeds from the Global Preneed sale, we returned a total of $718 million in share repurchases and common stock dividends. Looking ahead, we believe we have a compelling vision and strategy that will drive outperformance and shareholder value long term. As a business services leader, we will continue to pursue profitable growth in more fee-based, capital-light businesses, which continue to account for the majority of our earnings. In addition, we'll continue to optimize results and cash flow generation in our risk-based business. In 2023, we believe we can drive continued profitable growth, though at a more modest pace given strong '22 results in Lifestyle and our near-term view of the broader economy. Specifically, we expect adjusted EBITDA, excluding cats, to increase low single digits, with results improving as the year progresses, reflecting trends in the business and the broader market, as well as the restructuring actions taken in 2022. Earnings growth is expected to be driven by improved performance in Global Housing, as well as more modest growth in Global Lifestyle. Adjusted earnings per share growth is expected to trail adjusted EBITDA growth, primarily reflecting a higher annual depreciation expense related to several strategic technology investments critical to executing our strategy, a higher consolidated effective tax rate compared to a favorable 2022, and timing of capital deployment. We've had a long-standing track record of strong cash flow generation and disciplined capital deployment, and we continue to believe that a balanced capital deployment strategy drives long term value. Our capital management priorities for this year will be focused on supporting the organic growth of our business and maintaining our investment-grade ratings. We expect share repurchases will remain a core component of our capital deployment strategy given the attractiveness of our stock. But in light of the continued uncertain macro environment, we believe it is prudent to preserve flexibility over the near term. Therefore, based on current market conditions and expected business performance, we anticipate that any share repurchases would occur in the second half of the year and could be below 2022 underlying buyback activity. As the broader environment begins to stabilize, and visibility improves, we will re-evaluate levels and timing of capital deployment as part of our overall capital deployment strategy. Our M&A strategy will continue to focus on compelling deals in Global Lifestyle. However, the hurdle rate for M&A will be high given the attractiveness of our stock. As we enter 2023, we remain well positioned for long-term growth through our differentiated Lifestyle and Housing portfolio. We are focused on creating new sources of growth, scaling new client wins and deepening current client relationships to continually drive added value for our key clients and customers. I'll now turn the call over to Richard to review the fourth quarter results and our 2023 outlook in greater detail. Richard?
Richard Dziadzio: Thank you, Keith, and good morning, everyone. As Keith has outlined, our full year 2022 performance, I will focus on fourth quarter trends, particularly as we outlined our expectations for 2023. Given some of the significant changes in foreign exchange rates during the year, I will be citing some growth rates in both absolute and constant currency terms. For the fourth quarter 2022, adjusted EBITDA, excluding catastrophes, totaled $296 million or $39 million or 15% year-over-year and 19% on a constant currency basis. Our performance reflected improved results from both Global Housing and Global Lifestyle. Adjusted earnings per share, excluding reportable catastrophes, totaled $3.56 for the quarter, up 24% year-over-year. Now let's move to segment results, starting with Global Lifestyle. The segment reported adjusted EBITDA of $166 million in the fourth quarter, a 6% increase year-over-year, but double that, or 12% on a constant currency basis. The increase was driven by higher Connected Living earnings, which grew 21% or 31% on a constant currency basis. Connected Living strong growth was primarily from three factors. First, reduced mobile service and repair expenses compared to the prior year period, second, continued modest mobile subscriber growth in North American device protection programs from carrier and cable operator clients, and third, higher investment income. As expected, strong U.S. results were partially offset by continued weak performance in Europe and declines in Japan as programs mature. In device trading, we serviced 7.5 million devices in the fourth quarter, our highest quarterly volume this year. While volumes were strong, trading results declined as margins were pressured by device mix resulting from carrier promotions. Claims cost in Connected Living overall remain steady. Although we did see some pockets of higher costs from labor and materials within our extended service contract business. In Global Automotive, earnings decreased $7 million or 10%, primarily from weaker global performance and higher claims costs. In the U.S., a higher portion of higher claims costs are expected to be recovered over time from client contract structures. The earnings decrease was partially offset by domestic growth across distribution channels. Turning to net earned premium fees and other income. Lifestyle was up $20 million, or 1% and 3% on a constant currency basis. This growth was primarily driven by Global Automotive, reflecting strong prior period sales of vehicle service contracts. When adjusting for unfavorable foreign exchange, Connected Living's earned premium fees and other income increased slightly from growth in mobile subscribers in North America, partially offset by premium declines in mobile from runoff programs. Based on the new reporting structure for full year 2023, Lifestyle adjusted EBITDA is expected to grow modestly from our revised 2022 baseline of $809 million, driven by both Connected Living and Global Automotive. Over the course of the year, we expect Connected Living to benefit from modest subscriber growth in existing North American mobile programs, as well as increases in U.S. auto. The gradual ramp-up of our new mobile and connected home programs, and expense savings from the previously announced restructuring plan should benefit results as we get into the second half of the year. We do anticipate some continued headwinds to partially offset these growth drivers. These will be more pronounced in the first half of the year. Specifically, in 2022, we benefited from a number of favorable items that are not expected to recur. These included $24 million in investment income from real estate joint venture investments, and $11 million from a client contract benefit. We also anticipate continued headwinds in our international business, particularly in the first half of the year given lower volumes in Europe, and modest subscriber declines as programs mature in Japan. In addition, unfavorable foreign exchange, which will impact both the top and bottom lines. And finally, we anticipate continued higher claims costs particularly in extended service contracts as well as less favorable loss experience for select ancillary auto products. In terms of net earned premiums, fees and other income for 2023, Lifestyle is expected to grow modestly as growth in Global Automotive is offset by declines in Connected Living and ongoing foreign exchange headwinds. Connected Living will be impacted by the implementation of two new contract structures, which we estimate will lower top line in 2023 by $230 million. It is important to note, though, that these two changes will have no impact to our bottom line. Excluding these changes, we would anticipate growth in Connected Living net earned premiums fees and other income. Moving now to Global Housing. Adjusted EBITDA was $135 million, which included $22 million of reportable catastrophes from winter storms and Hurricane Nicole during the quarter. Excluding catastrophe losses, adjusted EBITDA was $157 million, up $31 million or 25%. The increase was driven primarily by lender-placed insurance, partially offset by $15 million in higher non-cat loss experience across all major products, including multifamily housing. Lender-placed earnings significantly increased, accounting for most of the increase in housing earnings from higher average insured values and premium rates as well as policy growth. In addition, expense savings and higher investment income contributed to the increase. These items were partially offset by higher cat reinsurance costs. Based on the new reporting structure, for the full year 2023, we expect Global Housing adjusted EBITDA, excluding cats, to grow from a revised 2022 baseline of $417 million. Improved earnings performance is expected from two main drivers. First, top line growth from rate recovery and lender-placed, and second, ongoing expense actions to be realized over the course of the year. We expect ongoing elevated non-catastrophe losses, including higher seasonal weather-related claims in the first half and increased cat reinsurance costs to continue in 2023. Gradual improvement in lender-placed non-catastrophe losses is assumed later in the year. We also expect lower Multifamily Housing profitability from lower contributions from our affinity partners and higher non-cat losses as they return to more normalized levels. In terms of our cat reinsurance program, in January, we secured two thirds of our 2023 program. Similar to much of the industry, we've seen significant price increases, but the cost is relatively in line with our expectations. We anticipate elevated pricing will continue in June when we place the final third of the full program and have reflected this in our outlook. Given the significant increase in reinsurance prices, and in order to optimize risk and return, we expect our per event retention level to increase to $125 million. This incorporates the growth in lender-placed exposure, primarily from inflation, partially offset by some declines in our international risk exposure. Reflecting on these expected changes, we now believe the appropriate cat load for 2023 is $140 million. And finally, I'd also note that our outlook for housing assumes no meaningful deterioration in the broader U.S. housing market that would cause an increase in placement rates or a worsening of loss experience. Moving to Corporate. The fourth quarter adjusted EBITDA loss was $27 million, up $2 million, and was driven by lower investment income. For the full year 2023, we expect the Corporate adjusted EBITDA loss to be approximately $105 million. Turning to holding company liquidity. We ended the year with $446 million. In the fourth quarter, dividends from our operating segments totaled $89 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items, $13 million of share repurchases, $38 million in common stock dividends and $81 million related to the two strategic acquisitions previously announced that will strengthen our position in the commercial equipment space. During 2022, Lifestyle and Housing contributed $550 million in dividends to the holding company. This was below our expectations given changes in investment portfolio values, reserve strengthening and accounting changes for non-core operations. In 2023, we expect our businesses to continue to generate meaningful cash flow. Cash conversion should approximate 65% of segment adjusted EBITDA, including reportable catastrophes. This accounts for the previously announced restructuring charges. This also assumes a continuation of the current economic environment and is subject to the growth of the business, investment portfolio performance and regulatory rating agency requirements. In summary, we continued our track record of profitable earnings growth and strong cash flow generation in 2022 despite some challenging conditions. And although we do expect to face continued macroeconomic uncertainty in 2023, we firmly believe we're well positioned to serve our current and future clients and customers and to continue to grow Assurant. And with that, operator, please open the call for questions.
Operator: [Operator Instructions] Our first question comes from the line of John Barnidge from Piper Sandler. Your line is open.
Keith Demmings: Morning, John.
Richard Dziadzio: Morning, John.
John Barnidge: Good morning. Thank you for – good morning. Thank you for the opportunity. There is definitely seems to be a lot of conservatism in the outlook as it relates to the first half of the year. How different does your outlook differ for the first half versus the second half? And why does the second half give you confidence? Thank you.
Keith Demmings: Great. Maybe just a couple of comments on '22, and then I'll talk about how we think about '23. So certainly happy with how we finished the year, obviously, a tremendous amount of change in the marketplace, very dynamic. And the fact that we were able to grow, not just EPS, but also grow EBITDA for the full year, really proud of the work done by the team to do that. And we do feel really well positioned as we think about our market position, how we're engaged with our clients. So expect that to continue as we roll forward. As we think about 2023, I guess there is a couple of things to remember. We certainly had some favorability, particularly in Lifestyle in '22 that doesn't repeat. Richard mentioned about $35 million between real estate gains, as well as the onetime client benefits. So we've got to grow our way through that into '23. We also expect continued foreign exchange pressure in our '23 outlook in Lifestyle. And then on top of that, we do expect to grow even though we've got some pressure certainly in the international markets, which we've talked about over the last couple of quarters. And then in terms of the housing business, obviously, a really strong fourth quarter. We're excited by the progress that our team has made, not just in terms of getting rate, adjusting average insured values, but also the work done on expenses, simplifying the organization, expect continued momentum as we head into '23. Obviously, there's a natural reset between Q4 and Q1 in the housing business. We typically see higher losses in the first quarter due to winter storms and seasonality. We also had really favorable losses in Multifamily Housing in the first half of '22. That was a carryover from '21 as well. So we've got to overcome that as we think about the progression through the year. So again, expect each quarter to improve as we get through '23 and then accelerate growth into '24.
John Barnidge: Thank you for that. And then my follow-up question. It looks like there was growth in global mobile devices protected, serviced and global protected vehicles. Can you maybe talk about that? One, maybe the upgrade cycle, market positioning and then that trade-in issue that was occurring in the third quarter, that seems to have resolved itself? Thank you.
Keith Demmings: Great. Yes. So I think if I start with auto, steady progress, as we've seen over many quarters in terms of protected vehicles, and that trend certainly has continued and we continue to be well positioned there. On the mobile side, you're correct. We saw about - pretty significant growth in the U.S. market. So if I look at devices protected up 300,000 sequentially, 500,000 of that is actually from growth domestically in the U.S. market, and that's offsetting some natural runoff that we have. So pretty strong growth in the U.S., great results in the U.S. for Connected Living overall for the year. And that's driven just by market share gains from the clients that we partner with on the insurance side. So if you think about our device protection partners in the U.S., they're gaining roughly 70% of the net adds for postpaid customers. So that is helping us significantly in the U.S. market. And then we've got a little bit of softness internationally in terms of subscribers. I'd say a little bit of growth in Europe, offset by some declines in Latin America, and then a little bit of softness in Japan, which we've talked about the last couple of quarters. And then finally, on the trade-in point, we did see the issue resolve itself that we talked about in the third quarter. That did get resolved in the fourth quarter. We saw good volume growth flowing through. We saw some different margins in the business based on the mix of devices in certain client contracts. Part of our fees are based on selling prices of devices so sometimes you can have higher volume, but a potentially lower quality devices, and that can affect the ultimate margins in the business and move around from quarter-to-quarter.
John Barnidge: Thank you very much for the answers.
Keith Demmings: Great. Thanks, John.
Operator: Your next question comes from the line of Mark Hughes from Truist Securities. Your line is open.
Keith Demmings: Morning, Mark.
Mark Hughes: Hey, good morning. Kind of along those lines, the 5G upgrade programs, I think you mentioned you're getting 70% of the net adds among your customers, that's an interesting number. Where do they stand in terms of the marketing, the push to get those 5G upgrades? Does that help or is that activity decelerating? How do you see it? A - Keith Demmings Yes, I think we saw a little bit of lower marketing activity in the fourth quarter. There were certainly some supply constraints in the market. So that affected some of the traded promotional offers that we would normally see that can bounce around and be quite seasonal and also depending on the competitive nature of the market. But there's no doubt the push by carriers to move customers to 5G, to unlimited plans, to higher-end devices continues. We'll see how that evolves in '23. We obviously had a tremendous amount of trade-in activity in 2022, a relatively high watermark. Expect to see continued strength around that as we go forward. But it ebbs and flows, I would say, depending on the dynamics and the competitive landscape.
Mark Hughes: And in the coastal property markets, I think there's some reference to maybe a lender-placed being held in states like Florida, just because the standard policies are getting so expensive. Are you seeing a dynamic like that? Is that an opportunity for you, do you think that will help push out placement rates in Florida and other coastal markets?
Keith Demmings: Yeah. If you look at the fourth quarter, and we think about lender-placed, we had about 12,000 incremental policies come into the book. So we are seeing growth in in-force policies. I'd say half of that growth is we brought on a new client, which is why you'll see loans tracked up fairly significantly. And then the other half is entirely due to what I would say is the hard market. Florida is certainly a big chunk of that as well as California and other areas. So I do think that is helping support policy growth. We saw a pretty strong policy growth for the full year in lender-placed. And none of that is really from deterioration in the economy more broadly where we might expect to see placement rates increase over time if there's a lot of pressure in the economy. It's all just the difficult insurance market. So it's definitely helping us. We're well priced with our products in those markets, and we feel we're well positioned to grow from it.
Mark Hughes: Thank you.
Keith Demmings: Great.
Operator: Your next question comes from the line of Tommy McJoynt from KBW. Your line is open.
Keith Demmings: Morning, Tommy.
Richard Dziadzio: Morning, Tommy.
Tommy McJoynt: Hey. Good morning, guys. Thanks for taking my questions. Yeah, so first one, can you just go into a bit more detail on some of the drivers for pausing the buyback? I guess, I think of this business really holistically is less exposed to the - some of the economic cyclicality. So it's a bit surprising to see that as the driver for pausing the capital distribution. So if you could just go into a little bit more detail on that, that would be great.
Keith Demmings: Sure. And maybe I'll start, and certainly, Richard can chime in. But first and foremost, I would say our capital management philosophy, as an organization, has not changed. At third quarter, we signaled a disciplined approach that we wanted to exercise prudence. There's just a lot of market uncertainty today. It's been a pretty dynamic macro backdrop. So we're trying to exercise caution and make the best decisions we can with our capital. We've talked about this in the prepared remarks and consistently over time. We're definitely supporting the organic growth of the company. We still see lots of opportunity to grow organically. We want to protect our ratings, which are important to us. And then we've signaled - we do think share buybacks will be an important part of our capital deployment strategy going forward. We've talked about being balanced long term between capital deployment through share return and also M&A. But based on where we sit today, we think our shares are very attractive. And so I think about it as being prudent for the moment, getting better visibility, understanding how results are progressing and then making those rate decisions with all of that additional information as we head into the back half of the year. But, Richard, what else might you add?
Richard Dziadzio: Yeah. Thanks, Keith. Hi, Tommy. Yeah, I think exactly what Keith said in terms of being prudent and really wanting to see how the macroeconomic environment plays out. I'd also add that, last year, in terms of returns of capital to shareholders, it was a high point for us with a return of about $720 million when we talk about share repurchases and dividends together. So we have shown and demonstrated over time that we won't sit on excess capital for a long time, but we do want to be prudent in the markets here. And if everything plays out, we would expect, at some point, to be back in maybe late in the second half, but we'll see how things go. We want to be prudent.
Tommy McJoynt: Thanks. And then just my other question, going back a little bit to the Connected Living side, you talked about being some of your partners, with T-Mobile, Sprint and some of the charter spectrum [ph] Can you talk a little bit about the opportunity around Verizon and AT&T, and just kind of remind us what services you are providing for them and kind of what any kind of incremental opportunity might be?
Keith Demmings: Sure. So we do business with both Verizon and AT&T and support their trade-in business domestically in the U.S. So great partnerships, actually came through the HYLA acquisition, and there's certainly long term opportunity. We talk about our business being built on deep client relationships with the world's leading brands. Those are certainly two examples of really, really important clients and brands that we can partner with. So no doubt there's opportunity over time to help them solve problems, innovate and create value for their customers. And we certainly work hard every day to serve them today, and then look for opportunities to grow with them in the future.
Tommy McJoynt: Thank you.
Keith Demmings: You bet.
Operator: Your next question comes from the line of Brian Meredith from UBS. Your line is open.
Brian Meredith: Hey, good morning, everybody. A couple of them here for you. First, I'm just curious, Richard, maybe NII outlook here going forward in the Global Housing business? Or is there still potential upside given where new money rates are?
Richard Dziadzio: Yes. Thanks for the question, Brian. Yes, I think in terms of new money rates fixed income, we do see overall yields continuing to move up in the future as the portfolio rolls over and the lower yields that we've had in the past convert themselves into the new higher yield. So we will see that as we go forward over the next couple of years. So a nice tailwind for us. We've obviously seen short-term rates come up to. That's a nice tailwind for us. I would say that relative, if I think about '23 versus 2022, as Keith mentioned earlier and in our prepared remarks, we did have some good real estate gains during the course of the year. So I kind of look at it for 2023, that the increase in investment income will be a bit modest just given those two factors, increase in yields being offset by the real estate gains.
Brian Meredith: That makes sense. Thanks. And then I guess my second question, Keith, you talked a little bit about the international markets and some pressure we're going to see in the first half of the year. I'm just curious what your thoughts are, and built in your expectations and guidance for kind of the domestic consumer here in the U.S. What do things look like potentially if we do go into a recession second half of the year?
Keith Demmings: Yes. So our U.S. business has performed incredibly well if we think about where we're at in 2022. And we expect to continue to see growth going forward in '23. We obviously have to offset the one-time client benefit we talked about in Q3. But we do feel like, domestically, we're well positioned. If you think about the business, and I'll talk about mobile and then maybe auto quickly. On the mobile side, bulk of our economics are driven by the in-force subscribers that we protect. And as you saw that actually increased in the fourth quarter, consumers continue to want to protect their devices, and that's an in-force monthly subscription. So we don't see a lot of movement quarter-to-quarter and month-to-month. So we do feel like we're quite well protected there. To the extent there's less trade-in activity, if consumers are less incented to buy new devices because the economy is a little more pressured, we might see a little bit of softness in terms of that side of the business. It's not the biggest driver of total profitability, but it's still obviously an important factor. And then if you think about the auto business more broadly, we do expect sales of - retail sales of cars to be relatively steady in '23 versus '22. A little more growth on new offset by softness on the used side, but probably 80% of the economics in '23 are from policies that have already been written that will earn through the book. So from that perspective, we're relatively well positioned, and we've done well through typical downturns in the economy in our product lines because it just puts more focus on the sale of these ancillary products with our partners.
Brian Meredith: Makes sense. Thank you.
Keith Demmings: Great. Thanks.
Operator: Your next question comes from the line of Grace Carter from Bank of America. Your line is open.
Keith Demmings: Morning, Grace.
Richard Dziadzio: Good morning, Grace.
Grace Carter: Hi. I've seen some forecast out there for potential lower smartphone shipments to the U.S. next year. And I was just wondering how the domestic Connected Living business might be affected if that were to happen, and just the extent to which that might be reflected in your outlook for next year?
Keith Demmings: Yeah. Certainly, and I've seen the same reports. And like I said, that would definitely have an impact on trade-in volumes if there is less devices being purchased by consumers. I still expect to see a healthy number, certainly in '23 overall, but maybe a little bit muted from '22 levels. A lot of the growth that we're getting is because our clients are actually adding subscribers. So we're seeing that through the fourth quarter as well. So from a device protection point of view, we think we're well positioned there, and we have seen meaningful growth in the last quarter as a result of that. So I do feel like we'll see strength in domestic Connected Living. And obviously, that will drive to offset some of the other factors that we talked about in 2022. So we had some help in 2022 from the items we discussed. We've got to overcome foreign exchange. And domestically, we expect our business to perform well to allow us to generate that growth in '23.
Grace Carter: Thank you. And on the housing side, kind of back to the question about the Florida market. How does the risk profile of the policies that you've been adding due just to the hard market dynamics compare versus the remainder of the book? And I was wondering if the recent reforms in Florida have any noticeable impact on the growth outlook for the housing book this year?
Keith Demmings: Yeah. I think - so certainly, the housing - the reforms in Florida should be helpful to the industry over time without question and obviously looking to try to stabilize the insurance environment and really for the benefit of the end consumer try to control pricing over time. So I think, over time, that will benefit loss ratios and reduce some of the litigation. Obviously, that's not something that we're building into our forecast at this point. There's a lot of work yet to be done to see how that will roll through. I think growth in Florida for us is a positive thing. We're well priced and well positioned. And lender place is a scale business. We're tracking the loans already. So if we pick up some additional policies, we're not adding a tremendous amount of incremental expense. We've done an incredibly good job in housing in '22, actually driving down operational expenses year-over-year, even though we've seen policy growth, which demonstrates our focus on digital investments, but also the scale advantages of the business. So I think growth in Florida is a good thing for our business, and we're well positioned to take advantage of it over time.
Grace Carter: Thank you.
Richard Dziadzio: And we have been getting rate race as well. So as Keith said, it's - we have been getting a little bit more, but it's - from our point of view, it's good business. And the reforms, as you pointed out, should help over time.
Grace Carter: Thank you.
Keith Demmings: Great. Thanks, Grace.
Operator: [Operator Instructions] And we have a follow-up question from the line of Mark Hughes from Truist Securities. Your line is open.
Keith Demmings: Hey, Mark.
Mark Hughes: Thank you. Yeah, the $15 million you talked about in higher non-cat losses on the property side, you really haven't mentioned inflation. But I wonder if there's any thoughts you've got how much of that may be weather, if you have already seen that or anticipated versus just materials, labor costs, things like that? And whether you are kind of over the hump on that? Or has there been any material inflection? Just how do you see it now?
Keith Demmings: Yeah. Maybe I'll just start at a high level, Richard, and then you could add some color. But I definitely think we're - from an inflationary perspective, we're still seeing elevated claims costs, there's no question. I think where we are seeing the favorability overall is really the rate rolling through from both rate increases and average insured values, and that is obviously offsetting some of that inflationary pressure. But we definitely see inflation still, that will persist and construction inflation is different yet again from other measures of inflation. But what would you add, Richard?
Richard Dziadzio: Yeah, similar to what Keith said, I guess I would say that - I would say most of it is in severity. I think severity these days, it's we think inflation. Actually, frequencies have been coming down just in terms of weather, whatever, we haven't been seeing an increase in smaller weather-related items, so more in severity. And as Keith said, we have been getting some price increases with that. We do the rate filings on an interim basis. So we think we're in a good position. We also think as we go forward this year, we're being prudent and I guess, appropriately prudent with regard to our expectations of inflation. Obviously, that's big headline out in the markets. We do see inflation staying a little bit resistantly high for the near term, but really coming down slowly as the year goes on. So we've kind of factored that into our analysis and should be in a good place there, not trying to go -- be too aggressive about bringing inflation down.
Keith Demmings: Yeah. And one - just one other point to make, and I referenced it earlier, we did see favorability - set aside lender-placed for a second, we did see favorability of loss ratios in some of our other lines, renters and some specialty products, particularly in the first half of '22. We've seen that normalize over the balance of '22 to what are more natural levels. I think we were really at kind of pandemic level lows with respect to some of the losses that we were seeing. So that also will normalize. That puts a little pressure on the first half of the year for housing and then obviously, lender-placed where we're getting a lot of rate tries to help overcome that over the course of the year.
Mark Hughes: Appreciate it. Thank you.
Keith Demmings: Great. Thank you.
Operator: And there are no further questions at this time. I'll turn it over to Keith Demmings for some final closing comments.
Keith Demmings: Wonderful. Well, thanks, everybody, for participating in today's call. And obviously, we'll look forward to speaking to you all again at the end of the first quarter and our call in May. In the meantime, reach out to Suzanne Shepherd or Sean Moshier, if you have any other follow-up questions. But again, thanks for the time. Have a great day.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Fourth Quarter and Full Year 2022 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator. Good morning, everyone. We look forward to discussing our fourth quarter and full year 2022 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release, announcing our results for the fourth quarter and full year 2022. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release and financial supplement as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement. Effective January 1, 2023, we realigned the composition of our segments to better manage our risk and fee-based capital-light businesses. Global Housing is now comprised of two primary lines of business, homeowners and renters and others. Certain product lines, including our lease and finance business, previously reported in housing, have been moved to Global Lifestyle to better align with our go-to-market strategy. While this change has no impact on our consolidated results, it will modestly impact the earnings trends within the segments. Our 2023 outlook is based on this realigned view. Please refer to the financial supplement for a reconciliation of certain key data for these changes. I will now turn the call over to Keith."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Suzanne, and good morning, everyone. Reflecting on my first year as CEO, I couldn't be prouder of the extraordinary dedication and commitment demonstrated by our employees in delivering for our clients and customers around the world. During the year, we made progress in executing our vision to be the leading global business services provider supporting the advancement of the connected world. We continue to grow and strengthen our partnerships with key clients, and delivered new innovative solutions, all while navigating more volatile market conditions. Our portfolio of Lifestyle and Housing businesses proved resilient, but not immune to macroeconomic headwinds. In 2022, we grew adjusted earnings per share by 11% and delivered over $1.1 billion of adjusted EBITDA, both excluding reportable catastrophes. Adjusting for $27 million of unfavorable foreign exchange, adjusted EBITDA growth was 3%, and 2022 represented our sixth consecutive year of profitable growth. This is a reflection of our compelling strategy and resilient culture. We've held true to our company's purpose of helping people thrive with a steadfast commitment to being a socially responsible company for all of our stakeholders. I'm proud that we've been recognized as a great place to work in 13 countries, and most recently in the U.S. for the second consecutive year. Our focus remains on engaging and developing our diverse talent pool through enhanced leadership and skill development programs. We also continue to reduce our environmental impact as a core pillar of our ESG strategy. Building on our progress to date, we announced in December our goal to reduce greenhouse gas emissions by 40% by 2030. This target aligns with the Paris Agreement, and ensures we drive meaningful reductions. We've also taken a number of actions within our businesses to strengthen Assurant for the future. In Global Housing, we initiated a business transformation, including exiting certain noncore businesses, such as our sharing economy, as well as international cat-exposed business where we did not see a path to leadership positions More broadly, across Assurant, we realigned our organizational structure, as Suzanne referenced, to drive more focus and better deploy talent. We also took decisive action by accelerating several expense initiatives to realize additional efficiencies and position us for continued long-term growth. As we announced in December, we expect to realize $55 million of annualized gross savings by the end of 2024 through the simplification of our organizational structure, and our real estate consolidation program given our increasingly hybrid workforce. These actions will help mitigate the impact of higher labor costs and headwinds from the macroeconomic environment, as well as fund additional investments, including increased automation. In addition to ensuring a more streamlined organizational and cost structure, we've gained momentum throughout the year in both Global Lifestyle and Global Housing, renewing and winning new clients in each of our major lines of business. In Global Lifestyle, adjusted EBITDA increased 7% in 2022, with growth from both Connected Living and Global Automotive. On a constant currency basis, adjusted EBITDA expanded by 11%, aligned with our original expectations for the year. In Connected Living, we grew adjusted EBITDA by 15% on a constant currency basis, driven by mobile protection program growth in North America. Our ability to continuously innovate our products and services has supported a stronger and more differentiated customer experience, resulting in increased Net Promoter Scores. In addition to key partner renewals, including T-Mobile and Xfinity, we secured new business opportunities and new client partnerships, continuing to diversify our broad client base. In our mobile protection business, we now protect nearly 62 million global devices, driven by the 25 new protection programs we've added since 2015. We serviced over 28 million devices in 2022, mainly from our mobile trade-in business as we add scale and further demonstrate our position as a market leader with this important value-added service to our clients. We added several new trading clients and now have over 40 trade-in programs globally. We continue to invest in talent and strengthen supply chain operations to maintain our competitive advantage. In Global Automotive, we grew global protected autos in 2022 by 2% to 54.1 million vehicles, helping to generate adjusted EBITDA growth of 5%. Recently, we expanded and enhanced our EV1 protection offering in the U.S., and coverage is now available for battery electric vehicles and plug-in hybrid electric vehicles, including comprehensive battery coverage. In our newly combined leased and finance business, we partnered with CNH Industrial in the U.S. and Canada to provide service contracts and physical damage insurance. CNH is the third largest agriculture and construction equipment company in the world. This partnership was made possible by the talent and expertise of our teams, including through the acquisition of EPG. In Global Housing, we took swift action to mitigate the impact of high inflation within our lender-placed business. We began to see improved performance as we exited the year, reflecting the rate increases implemented over the course of the year. We expect higher rates to roll through our book into 2023 and beyond, while we manage ongoing elevated claims costs. In 2022, we renewed eight lender-placed clients, including several of our most significant partnerships with multiyear agreements. These renewals represent 36% of our over 31 million loans tracked. In Multifamily Housing, we now have over 2.6 million renters policies. While we've seen slower growth from our affinity partnerships, our volume with property management companies continues to expand as we signed several new partnerships, including two top PMCs with over 100,000 combined units. We also successfully completed multiyear renewals with six key client relationships. As we continue to convert clients to our Cover360 platform, we expect to see ongoing policy growth in that channel. Throughout the year, we maintained a strong balance sheet as we navigated increased macroeconomic uncertainty. Our businesses contributed a total of $550 million in dividends to the holding company or roughly 52% of segment earnings, including catastrophe losses. Together with the remaining net proceeds from the Global Preneed sale, we returned a total of $718 million in share repurchases and common stock dividends. Looking ahead, we believe we have a compelling vision and strategy that will drive outperformance and shareholder value long term. As a business services leader, we will continue to pursue profitable growth in more fee-based, capital-light businesses, which continue to account for the majority of our earnings. In addition, we'll continue to optimize results and cash flow generation in our risk-based business. In 2023, we believe we can drive continued profitable growth, though at a more modest pace given strong '22 results in Lifestyle and our near-term view of the broader economy. Specifically, we expect adjusted EBITDA, excluding cats, to increase low single digits, with results improving as the year progresses, reflecting trends in the business and the broader market, as well as the restructuring actions taken in 2022. Earnings growth is expected to be driven by improved performance in Global Housing, as well as more modest growth in Global Lifestyle. Adjusted earnings per share growth is expected to trail adjusted EBITDA growth, primarily reflecting a higher annual depreciation expense related to several strategic technology investments critical to executing our strategy, a higher consolidated effective tax rate compared to a favorable 2022, and timing of capital deployment. We've had a long-standing track record of strong cash flow generation and disciplined capital deployment, and we continue to believe that a balanced capital deployment strategy drives long term value. Our capital management priorities for this year will be focused on supporting the organic growth of our business and maintaining our investment-grade ratings. We expect share repurchases will remain a core component of our capital deployment strategy given the attractiveness of our stock. But in light of the continued uncertain macro environment, we believe it is prudent to preserve flexibility over the near term. Therefore, based on current market conditions and expected business performance, we anticipate that any share repurchases would occur in the second half of the year and could be below 2022 underlying buyback activity. As the broader environment begins to stabilize, and visibility improves, we will re-evaluate levels and timing of capital deployment as part of our overall capital deployment strategy. Our M&A strategy will continue to focus on compelling deals in Global Lifestyle. However, the hurdle rate for M&A will be high given the attractiveness of our stock. As we enter 2023, we remain well positioned for long-term growth through our differentiated Lifestyle and Housing portfolio. We are focused on creating new sources of growth, scaling new client wins and deepening current client relationships to continually drive added value for our key clients and customers. I'll now turn the call over to Richard to review the fourth quarter results and our 2023 outlook in greater detail. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith, and good morning, everyone. As Keith has outlined, our full year 2022 performance, I will focus on fourth quarter trends, particularly as we outlined our expectations for 2023. Given some of the significant changes in foreign exchange rates during the year, I will be citing some growth rates in both absolute and constant currency terms. For the fourth quarter 2022, adjusted EBITDA, excluding catastrophes, totaled $296 million or $39 million or 15% year-over-year and 19% on a constant currency basis. Our performance reflected improved results from both Global Housing and Global Lifestyle. Adjusted earnings per share, excluding reportable catastrophes, totaled $3.56 for the quarter, up 24% year-over-year. Now let's move to segment results, starting with Global Lifestyle. The segment reported adjusted EBITDA of $166 million in the fourth quarter, a 6% increase year-over-year, but double that, or 12% on a constant currency basis. The increase was driven by higher Connected Living earnings, which grew 21% or 31% on a constant currency basis. Connected Living strong growth was primarily from three factors. First, reduced mobile service and repair expenses compared to the prior year period, second, continued modest mobile subscriber growth in North American device protection programs from carrier and cable operator clients, and third, higher investment income. As expected, strong U.S. results were partially offset by continued weak performance in Europe and declines in Japan as programs mature. In device trading, we serviced 7.5 million devices in the fourth quarter, our highest quarterly volume this year. While volumes were strong, trading results declined as margins were pressured by device mix resulting from carrier promotions. Claims cost in Connected Living overall remain steady. Although we did see some pockets of higher costs from labor and materials within our extended service contract business. In Global Automotive, earnings decreased $7 million or 10%, primarily from weaker global performance and higher claims costs. In the U.S., a higher portion of higher claims costs are expected to be recovered over time from client contract structures. The earnings decrease was partially offset by domestic growth across distribution channels. Turning to net earned premium fees and other income. Lifestyle was up $20 million, or 1% and 3% on a constant currency basis. This growth was primarily driven by Global Automotive, reflecting strong prior period sales of vehicle service contracts. When adjusting for unfavorable foreign exchange, Connected Living's earned premium fees and other income increased slightly from growth in mobile subscribers in North America, partially offset by premium declines in mobile from runoff programs. Based on the new reporting structure for full year 2023, Lifestyle adjusted EBITDA is expected to grow modestly from our revised 2022 baseline of $809 million, driven by both Connected Living and Global Automotive. Over the course of the year, we expect Connected Living to benefit from modest subscriber growth in existing North American mobile programs, as well as increases in U.S. auto. The gradual ramp-up of our new mobile and connected home programs, and expense savings from the previously announced restructuring plan should benefit results as we get into the second half of the year. We do anticipate some continued headwinds to partially offset these growth drivers. These will be more pronounced in the first half of the year. Specifically, in 2022, we benefited from a number of favorable items that are not expected to recur. These included $24 million in investment income from real estate joint venture investments, and $11 million from a client contract benefit. We also anticipate continued headwinds in our international business, particularly in the first half of the year given lower volumes in Europe, and modest subscriber declines as programs mature in Japan. In addition, unfavorable foreign exchange, which will impact both the top and bottom lines. And finally, we anticipate continued higher claims costs particularly in extended service contracts as well as less favorable loss experience for select ancillary auto products. In terms of net earned premiums, fees and other income for 2023, Lifestyle is expected to grow modestly as growth in Global Automotive is offset by declines in Connected Living and ongoing foreign exchange headwinds. Connected Living will be impacted by the implementation of two new contract structures, which we estimate will lower top line in 2023 by $230 million. It is important to note, though, that these two changes will have no impact to our bottom line. Excluding these changes, we would anticipate growth in Connected Living net earned premiums fees and other income. Moving now to Global Housing. Adjusted EBITDA was $135 million, which included $22 million of reportable catastrophes from winter storms and Hurricane Nicole during the quarter. Excluding catastrophe losses, adjusted EBITDA was $157 million, up $31 million or 25%. The increase was driven primarily by lender-placed insurance, partially offset by $15 million in higher non-cat loss experience across all major products, including multifamily housing. Lender-placed earnings significantly increased, accounting for most of the increase in housing earnings from higher average insured values and premium rates as well as policy growth. In addition, expense savings and higher investment income contributed to the increase. These items were partially offset by higher cat reinsurance costs. Based on the new reporting structure, for the full year 2023, we expect Global Housing adjusted EBITDA, excluding cats, to grow from a revised 2022 baseline of $417 million. Improved earnings performance is expected from two main drivers. First, top line growth from rate recovery and lender-placed, and second, ongoing expense actions to be realized over the course of the year. We expect ongoing elevated non-catastrophe losses, including higher seasonal weather-related claims in the first half and increased cat reinsurance costs to continue in 2023. Gradual improvement in lender-placed non-catastrophe losses is assumed later in the year. We also expect lower Multifamily Housing profitability from lower contributions from our affinity partners and higher non-cat losses as they return to more normalized levels. In terms of our cat reinsurance program, in January, we secured two thirds of our 2023 program. Similar to much of the industry, we've seen significant price increases, but the cost is relatively in line with our expectations. We anticipate elevated pricing will continue in June when we place the final third of the full program and have reflected this in our outlook. Given the significant increase in reinsurance prices, and in order to optimize risk and return, we expect our per event retention level to increase to $125 million. This incorporates the growth in lender-placed exposure, primarily from inflation, partially offset by some declines in our international risk exposure. Reflecting on these expected changes, we now believe the appropriate cat load for 2023 is $140 million. And finally, I'd also note that our outlook for housing assumes no meaningful deterioration in the broader U.S. housing market that would cause an increase in placement rates or a worsening of loss experience. Moving to Corporate. The fourth quarter adjusted EBITDA loss was $27 million, up $2 million, and was driven by lower investment income. For the full year 2023, we expect the Corporate adjusted EBITDA loss to be approximately $105 million. Turning to holding company liquidity. We ended the year with $446 million. In the fourth quarter, dividends from our operating segments totaled $89 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items, $13 million of share repurchases, $38 million in common stock dividends and $81 million related to the two strategic acquisitions previously announced that will strengthen our position in the commercial equipment space. During 2022, Lifestyle and Housing contributed $550 million in dividends to the holding company. This was below our expectations given changes in investment portfolio values, reserve strengthening and accounting changes for non-core operations. In 2023, we expect our businesses to continue to generate meaningful cash flow. Cash conversion should approximate 65% of segment adjusted EBITDA, including reportable catastrophes. This accounts for the previously announced restructuring charges. This also assumes a continuation of the current economic environment and is subject to the growth of the business, investment portfolio performance and regulatory rating agency requirements. In summary, we continued our track record of profitable earnings growth and strong cash flow generation in 2022 despite some challenging conditions. And although we do expect to face continued macroeconomic uncertainty in 2023, we firmly believe we're well positioned to serve our current and future clients and customers and to continue to grow Assurant. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of John Barnidge from Piper Sandler. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Morning, John."
},
{
"speaker": "Richard Dziadzio",
"text": "Morning, John."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thank you for – good morning. Thank you for the opportunity. There is definitely seems to be a lot of conservatism in the outlook as it relates to the first half of the year. How different does your outlook differ for the first half versus the second half? And why does the second half give you confidence? Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Great. Maybe just a couple of comments on '22, and then I'll talk about how we think about '23. So certainly happy with how we finished the year, obviously, a tremendous amount of change in the marketplace, very dynamic. And the fact that we were able to grow, not just EPS, but also grow EBITDA for the full year, really proud of the work done by the team to do that. And we do feel really well positioned as we think about our market position, how we're engaged with our clients. So expect that to continue as we roll forward. As we think about 2023, I guess there is a couple of things to remember. We certainly had some favorability, particularly in Lifestyle in '22 that doesn't repeat. Richard mentioned about $35 million between real estate gains, as well as the onetime client benefits. So we've got to grow our way through that into '23. We also expect continued foreign exchange pressure in our '23 outlook in Lifestyle. And then on top of that, we do expect to grow even though we've got some pressure certainly in the international markets, which we've talked about over the last couple of quarters. And then in terms of the housing business, obviously, a really strong fourth quarter. We're excited by the progress that our team has made, not just in terms of getting rate, adjusting average insured values, but also the work done on expenses, simplifying the organization, expect continued momentum as we head into '23. Obviously, there's a natural reset between Q4 and Q1 in the housing business. We typically see higher losses in the first quarter due to winter storms and seasonality. We also had really favorable losses in Multifamily Housing in the first half of '22. That was a carryover from '21 as well. So we've got to overcome that as we think about the progression through the year. So again, expect each quarter to improve as we get through '23 and then accelerate growth into '24."
},
{
"speaker": "John Barnidge",
"text": "Thank you for that. And then my follow-up question. It looks like there was growth in global mobile devices protected, serviced and global protected vehicles. Can you maybe talk about that? One, maybe the upgrade cycle, market positioning and then that trade-in issue that was occurring in the third quarter, that seems to have resolved itself? Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Great. Yes. So I think if I start with auto, steady progress, as we've seen over many quarters in terms of protected vehicles, and that trend certainly has continued and we continue to be well positioned there. On the mobile side, you're correct. We saw about - pretty significant growth in the U.S. market. So if I look at devices protected up 300,000 sequentially, 500,000 of that is actually from growth domestically in the U.S. market, and that's offsetting some natural runoff that we have. So pretty strong growth in the U.S., great results in the U.S. for Connected Living overall for the year. And that's driven just by market share gains from the clients that we partner with on the insurance side. So if you think about our device protection partners in the U.S., they're gaining roughly 70% of the net adds for postpaid customers. So that is helping us significantly in the U.S. market. And then we've got a little bit of softness internationally in terms of subscribers. I'd say a little bit of growth in Europe, offset by some declines in Latin America, and then a little bit of softness in Japan, which we've talked about the last couple of quarters. And then finally, on the trade-in point, we did see the issue resolve itself that we talked about in the third quarter. That did get resolved in the fourth quarter. We saw good volume growth flowing through. We saw some different margins in the business based on the mix of devices in certain client contracts. Part of our fees are based on selling prices of devices so sometimes you can have higher volume, but a potentially lower quality devices, and that can affect the ultimate margins in the business and move around from quarter-to-quarter."
},
{
"speaker": "John Barnidge",
"text": "Thank you very much for the answers."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thanks, John."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Mark Hughes from Truist Securities. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Morning, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Hey, good morning. Kind of along those lines, the 5G upgrade programs, I think you mentioned you're getting 70% of the net adds among your customers, that's an interesting number. Where do they stand in terms of the marketing, the push to get those 5G upgrades? Does that help or is that activity decelerating? How do you see it? A - Keith Demmings Yes, I think we saw a little bit of lower marketing activity in the fourth quarter. There were certainly some supply constraints in the market. So that affected some of the traded promotional offers that we would normally see that can bounce around and be quite seasonal and also depending on the competitive nature of the market. But there's no doubt the push by carriers to move customers to 5G, to unlimited plans, to higher-end devices continues. We'll see how that evolves in '23. We obviously had a tremendous amount of trade-in activity in 2022, a relatively high watermark. Expect to see continued strength around that as we go forward. But it ebbs and flows, I would say, depending on the dynamics and the competitive landscape."
},
{
"speaker": "Mark Hughes",
"text": "And in the coastal property markets, I think there's some reference to maybe a lender-placed being held in states like Florida, just because the standard policies are getting so expensive. Are you seeing a dynamic like that? Is that an opportunity for you, do you think that will help push out placement rates in Florida and other coastal markets?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. If you look at the fourth quarter, and we think about lender-placed, we had about 12,000 incremental policies come into the book. So we are seeing growth in in-force policies. I'd say half of that growth is we brought on a new client, which is why you'll see loans tracked up fairly significantly. And then the other half is entirely due to what I would say is the hard market. Florida is certainly a big chunk of that as well as California and other areas. So I do think that is helping support policy growth. We saw a pretty strong policy growth for the full year in lender-placed. And none of that is really from deterioration in the economy more broadly where we might expect to see placement rates increase over time if there's a lot of pressure in the economy. It's all just the difficult insurance market. So it's definitely helping us. We're well priced with our products in those markets, and we feel we're well positioned to grow from it."
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Great."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Tommy McJoynt from KBW. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Morning, Tommy."
},
{
"speaker": "Richard Dziadzio",
"text": "Morning, Tommy."
},
{
"speaker": "Tommy McJoynt",
"text": "Hey. Good morning, guys. Thanks for taking my questions. Yeah, so first one, can you just go into a bit more detail on some of the drivers for pausing the buyback? I guess, I think of this business really holistically is less exposed to the - some of the economic cyclicality. So it's a bit surprising to see that as the driver for pausing the capital distribution. So if you could just go into a little bit more detail on that, that would be great."
},
{
"speaker": "Keith Demmings",
"text": "Sure. And maybe I'll start, and certainly, Richard can chime in. But first and foremost, I would say our capital management philosophy, as an organization, has not changed. At third quarter, we signaled a disciplined approach that we wanted to exercise prudence. There's just a lot of market uncertainty today. It's been a pretty dynamic macro backdrop. So we're trying to exercise caution and make the best decisions we can with our capital. We've talked about this in the prepared remarks and consistently over time. We're definitely supporting the organic growth of the company. We still see lots of opportunity to grow organically. We want to protect our ratings, which are important to us. And then we've signaled - we do think share buybacks will be an important part of our capital deployment strategy going forward. We've talked about being balanced long term between capital deployment through share return and also M&A. But based on where we sit today, we think our shares are very attractive. And so I think about it as being prudent for the moment, getting better visibility, understanding how results are progressing and then making those rate decisions with all of that additional information as we head into the back half of the year. But, Richard, what else might you add?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yeah. Thanks, Keith. Hi, Tommy. Yeah, I think exactly what Keith said in terms of being prudent and really wanting to see how the macroeconomic environment plays out. I'd also add that, last year, in terms of returns of capital to shareholders, it was a high point for us with a return of about $720 million when we talk about share repurchases and dividends together. So we have shown and demonstrated over time that we won't sit on excess capital for a long time, but we do want to be prudent in the markets here. And if everything plays out, we would expect, at some point, to be back in maybe late in the second half, but we'll see how things go. We want to be prudent."
},
{
"speaker": "Tommy McJoynt",
"text": "Thanks. And then just my other question, going back a little bit to the Connected Living side, you talked about being some of your partners, with T-Mobile, Sprint and some of the charter spectrum [ph] Can you talk a little bit about the opportunity around Verizon and AT&T, and just kind of remind us what services you are providing for them and kind of what any kind of incremental opportunity might be?"
},
{
"speaker": "Keith Demmings",
"text": "Sure. So we do business with both Verizon and AT&T and support their trade-in business domestically in the U.S. So great partnerships, actually came through the HYLA acquisition, and there's certainly long term opportunity. We talk about our business being built on deep client relationships with the world's leading brands. Those are certainly two examples of really, really important clients and brands that we can partner with. So no doubt there's opportunity over time to help them solve problems, innovate and create value for their customers. And we certainly work hard every day to serve them today, and then look for opportunities to grow with them in the future."
},
{
"speaker": "Tommy McJoynt",
"text": "Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Brian Meredith from UBS. Your line is open."
},
{
"speaker": "Brian Meredith",
"text": "Hey, good morning, everybody. A couple of them here for you. First, I'm just curious, Richard, maybe NII outlook here going forward in the Global Housing business? Or is there still potential upside given where new money rates are?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Thanks for the question, Brian. Yes, I think in terms of new money rates fixed income, we do see overall yields continuing to move up in the future as the portfolio rolls over and the lower yields that we've had in the past convert themselves into the new higher yield. So we will see that as we go forward over the next couple of years. So a nice tailwind for us. We've obviously seen short-term rates come up to. That's a nice tailwind for us. I would say that relative, if I think about '23 versus 2022, as Keith mentioned earlier and in our prepared remarks, we did have some good real estate gains during the course of the year. So I kind of look at it for 2023, that the increase in investment income will be a bit modest just given those two factors, increase in yields being offset by the real estate gains."
},
{
"speaker": "Brian Meredith",
"text": "That makes sense. Thanks. And then I guess my second question, Keith, you talked a little bit about the international markets and some pressure we're going to see in the first half of the year. I'm just curious what your thoughts are, and built in your expectations and guidance for kind of the domestic consumer here in the U.S. What do things look like potentially if we do go into a recession second half of the year?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So our U.S. business has performed incredibly well if we think about where we're at in 2022. And we expect to continue to see growth going forward in '23. We obviously have to offset the one-time client benefit we talked about in Q3. But we do feel like, domestically, we're well positioned. If you think about the business, and I'll talk about mobile and then maybe auto quickly. On the mobile side, bulk of our economics are driven by the in-force subscribers that we protect. And as you saw that actually increased in the fourth quarter, consumers continue to want to protect their devices, and that's an in-force monthly subscription. So we don't see a lot of movement quarter-to-quarter and month-to-month. So we do feel like we're quite well protected there. To the extent there's less trade-in activity, if consumers are less incented to buy new devices because the economy is a little more pressured, we might see a little bit of softness in terms of that side of the business. It's not the biggest driver of total profitability, but it's still obviously an important factor. And then if you think about the auto business more broadly, we do expect sales of - retail sales of cars to be relatively steady in '23 versus '22. A little more growth on new offset by softness on the used side, but probably 80% of the economics in '23 are from policies that have already been written that will earn through the book. So from that perspective, we're relatively well positioned, and we've done well through typical downturns in the economy in our product lines because it just puts more focus on the sale of these ancillary products with our partners."
},
{
"speaker": "Brian Meredith",
"text": "Makes sense. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thanks."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Grace Carter from Bank of America. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Morning, Grace."
},
{
"speaker": "Richard Dziadzio",
"text": "Good morning, Grace."
},
{
"speaker": "Grace Carter",
"text": "Hi. I've seen some forecast out there for potential lower smartphone shipments to the U.S. next year. And I was just wondering how the domestic Connected Living business might be affected if that were to happen, and just the extent to which that might be reflected in your outlook for next year?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. Certainly, and I've seen the same reports. And like I said, that would definitely have an impact on trade-in volumes if there is less devices being purchased by consumers. I still expect to see a healthy number, certainly in '23 overall, but maybe a little bit muted from '22 levels. A lot of the growth that we're getting is because our clients are actually adding subscribers. So we're seeing that through the fourth quarter as well. So from a device protection point of view, we think we're well positioned there, and we have seen meaningful growth in the last quarter as a result of that. So I do feel like we'll see strength in domestic Connected Living. And obviously, that will drive to offset some of the other factors that we talked about in 2022. So we had some help in 2022 from the items we discussed. We've got to overcome foreign exchange. And domestically, we expect our business to perform well to allow us to generate that growth in '23."
},
{
"speaker": "Grace Carter",
"text": "Thank you. And on the housing side, kind of back to the question about the Florida market. How does the risk profile of the policies that you've been adding due just to the hard market dynamics compare versus the remainder of the book? And I was wondering if the recent reforms in Florida have any noticeable impact on the growth outlook for the housing book this year?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. I think - so certainly, the housing - the reforms in Florida should be helpful to the industry over time without question and obviously looking to try to stabilize the insurance environment and really for the benefit of the end consumer try to control pricing over time. So I think, over time, that will benefit loss ratios and reduce some of the litigation. Obviously, that's not something that we're building into our forecast at this point. There's a lot of work yet to be done to see how that will roll through. I think growth in Florida for us is a positive thing. We're well priced and well positioned. And lender place is a scale business. We're tracking the loans already. So if we pick up some additional policies, we're not adding a tremendous amount of incremental expense. We've done an incredibly good job in housing in '22, actually driving down operational expenses year-over-year, even though we've seen policy growth, which demonstrates our focus on digital investments, but also the scale advantages of the business. So I think growth in Florida is a good thing for our business, and we're well positioned to take advantage of it over time."
},
{
"speaker": "Grace Carter",
"text": "Thank you."
},
{
"speaker": "Richard Dziadzio",
"text": "And we have been getting rate race as well. So as Keith said, it's - we have been getting a little bit more, but it's - from our point of view, it's good business. And the reforms, as you pointed out, should help over time."
},
{
"speaker": "Grace Carter",
"text": "Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thanks, Grace."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] And we have a follow-up question from the line of Mark Hughes from Truist Securities. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Hey, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Thank you. Yeah, the $15 million you talked about in higher non-cat losses on the property side, you really haven't mentioned inflation. But I wonder if there's any thoughts you've got how much of that may be weather, if you have already seen that or anticipated versus just materials, labor costs, things like that? And whether you are kind of over the hump on that? Or has there been any material inflection? Just how do you see it now?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. Maybe I'll just start at a high level, Richard, and then you could add some color. But I definitely think we're - from an inflationary perspective, we're still seeing elevated claims costs, there's no question. I think where we are seeing the favorability overall is really the rate rolling through from both rate increases and average insured values, and that is obviously offsetting some of that inflationary pressure. But we definitely see inflation still, that will persist and construction inflation is different yet again from other measures of inflation. But what would you add, Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yeah, similar to what Keith said, I guess I would say that - I would say most of it is in severity. I think severity these days, it's we think inflation. Actually, frequencies have been coming down just in terms of weather, whatever, we haven't been seeing an increase in smaller weather-related items, so more in severity. And as Keith said, we have been getting some price increases with that. We do the rate filings on an interim basis. So we think we're in a good position. We also think as we go forward this year, we're being prudent and I guess, appropriately prudent with regard to our expectations of inflation. Obviously, that's big headline out in the markets. We do see inflation staying a little bit resistantly high for the near term, but really coming down slowly as the year goes on. So we've kind of factored that into our analysis and should be in a good place there, not trying to go -- be too aggressive about bringing inflation down."
},
{
"speaker": "Keith Demmings",
"text": "Yeah. And one - just one other point to make, and I referenced it earlier, we did see favorability - set aside lender-placed for a second, we did see favorability of loss ratios in some of our other lines, renters and some specialty products, particularly in the first half of '22. We've seen that normalize over the balance of '22 to what are more natural levels. I think we were really at kind of pandemic level lows with respect to some of the losses that we were seeing. So that also will normalize. That puts a little pressure on the first half of the year for housing and then obviously, lender-placed where we're getting a lot of rate tries to help overcome that over the course of the year."
},
{
"speaker": "Mark Hughes",
"text": "Appreciate it. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "And there are no further questions at this time. I'll turn it over to Keith Demmings for some final closing comments."
},
{
"speaker": "Keith Demmings",
"text": "Wonderful. Well, thanks, everybody, for participating in today's call. And obviously, we'll look forward to speaking to you all again at the end of the first quarter and our call in May. In the meantime, reach out to Suzanne Shepherd or Sean Moshier, if you have any other follow-up questions. But again, thanks for the time. Have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 3 | 2,022 | 2022-11-02 08:00:00 | Operator: Welcome to Assurant’s Third Quarter 2022 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our third quarter 2022 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the third quarter of 2022. The release and corresponding financial supplement are available on assurant.com. We will start today’s call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday’s earnings release as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the Company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday’s news release and financial supplement that can be found on our website. I will now turn the call over to Keith.
Keith Demmings: Thanks, Suzanne and good morning, everyone. As we previewed last week our third quarter 2022 results came in below our expectations. This reflected a more challenging macroeconomic environment and lower contributions from Global Lifestyle. Following a very strong first half of the year where we grew Lifestyle adjusted EBITDA by 14% year-over-year this quarter had more significant headwinds internationally, including unfavorable foreign exchange, a modest uptick in claims and lower Connected Living program volumes. While disappointing our results don’t change our view of the inherent growth momentum in the Lifestyle business, we believe the actions we are taking to drive additional expense savings will also better mitigate potential further deterioration in macro conditions. Looking at Global Housing, the segments performance was in line with our expectations for the quarter. We are pleased with the progress we have made in not only increasing revenues through higher average insured values and rates, but also the transformation actions we have taken to simplify the business and drive future growth. Looking at the year-to-date performance to the first nine-months of 2022, Assurant’s reported adjusted EPS of $10.05 is up 7% for last year and adjusted EBITDA of $832 million is down 4%, both excluding reportable catastrophes. As we evaluate our progress this year we continue to believe we have a compelling strategy, strong fundamentals and momentum with clients as we continue to align with leading global brands and maintain market leading positions across our key lines of business. For example, we announced a further multi-year extension of our longstanding partnership with T-Mobile. This important contract extension provides us with increased long-term visibility in our U.S. mobile business. At the same time, it gives us greater opportunity to increase repair volumes through our over 500 cell phone repair locations with the ability to leverage this capability with other U.S. clients. We have also made investments to support our product development around the Connected Home and we continue to engage in encouraging dialogue with key clients creating a long-term opportunity for growth. This also included supporting our largest U.S. retail client with the expanded relationship we announced earlier this year. While macroeconomic conditions in Europe are challenging, we continue to win new opportunities and recently expanded our global partnership with Samsung to launch Samsung Care plus smartphone protection in six major European markets. We now offer this solution across three continents. This momentum combined with our partnerships with well-positioned global market leaders should help us outperform through an economic downturn. Turning to Global Housing, we have already begun a comprehensive transformational effort to position the business for long-term success and we are pleased with our progress. Consistent with our practice of actively managing our portfolio of businesses and reviewing it for strategic fit in addition to exiting commercial liability, we are eliminating our international Housing catastrophe exposure. We don’t see these businesses as core to our strategy or a path to leadership positions. As we execute these changes, we are designing a new organizational structure for Global Housing to better manage our risk businesses from our capital light oriented businesses as part of our transformational agenda and also to realize greater efficiencies. We are finalizing our plans for implementation in 2023. As we reflect on Assurant’s overall results to-date and current market conditions, we now expect 2022 adjusted EPS, excluding catastrophes to grow high single-digits from $12.28 last year, driven by share repurchases and Global Lifestyle growth. For the full-year, we expect adjusted EBITDA excluding catastrophes, will be down modestly to flat with 2021. This will be driven by high single-digit adjusted EBITDA growth for Lifestyle even with additional macro headwinds. In fact, on a constant-currency basis, we expect Global Lifestyle to finish 2022 aligned with our original Lifestyle expectations of low double-digit growth. In Global Automotive, we still expect to outperform our initial expectations, driven by tailwinds from investment income and underlying growth in the business, as we expand share with clients and add to our 54 million protected vehicles. For 2022, we continue to believe Global Housing will decrease by low to mid teens, but we are pleased to see the initial improvements in our underlying results. From a capital perspective, we remain good stewards. Year-to-date, we have returned a total of $667 million dollars of capital to shareholders, including proceeds from the sale of Preneed and by year end, we expect to close two small acquisitions for a total of approximately $80 million. These deals will strengthen our position in commercial equipment with attractively priced assets and minimal integration effort. Looking ahead, given macroeconomic volatility, we will exercise prudence in the near-term relative to capital deployment so that we can maintain maximum flexibility to continue to support our organic growth. This doesn’t change our conviction of the strong cash flow generation of our businesses, nor our view of the attractiveness of our stock, but rather as a reflection of the uncertain macro environment. As the broader environment begins to stabilize and visibility improves, we will evaluate capital deployment to maximize shareholder value. Looking to 2023, we are confident in the growth of our businesses. We expect both our Global Housing and Global Lifestyle adjusted EBITDA ex-cats to increase year-over-year. To that end, we are taking decisive actions to mitigate headwinds, while we maintain our relentless focus on growth. The Global Housing business is poised to grow in 2023 and we started to see evidence of that in the third quarter, as rate increases flowed through the book. In the long-term, the business should provide downside protection, if we see a further deterioration in the U.S. economy. We believe Global Lifestyle is positioned to grow in 2023. This is based on expectations of continued strong underlying growth momentum, even while factoring in lower international business volumes and increasing claims costs. We have also started several initiatives across the enterprise to drive greater operational efficiencies and leverage our economies of scale. We are now pushing even harder to realize incremental expense savings, given the increasingly volatile market. We expect to finalize plans in the months ahead, so that we can implement in 2023 and beyond. This includes optimizing our organizational structure and best aligning our talent, leveraging our global footprint to reduce labor costs where possible, continuing to review our real estate strategy, recognizing we have an increasingly more hybrid workforce and accelerating our adoption of digital solutions. Our digital first strategies are yielding positive results in 2022, both in terms of delivering better customer experiences and meaningful savings. As part of our 2023 planning, we are taking steps to accelerate digital adoption and automate processes which will further reduce cost and improve the customer experience. We are also applying the same principles to drive greater automation and self-service throughout our functional areas. With this in mind, and considering how the overall business environment has changed, we are re-evaluating our long-term financial objectives shared at Investor Day. In February, we expect to share our 2023 outlook also factoring in the most recent business trends and macro environment. This in no way changes our view on our business advantages, leadership aspirations or long-term growth potential. We continue to be well positioned with industry leading clients as we focus on key products and capabilities where we have market leading advantages. We believe we have a compelling portfolio of businesses poised to outperform as we deliver on our vision to be the leading global business services provider supporting the advancement of the connected world. I will now turn the call over to Richard to review the third quarter of results and a revised 2022 outlook in greater detail. Richard.
Richard Dziadzio: Thank you, Keith, and good morning, everyone. Adjusted EBITDA excluding catastrophes totaled $240 million down 11% from the third quarter of 2021. Our performance reflected weaker results in both Global Housing and Global Lifestyle. For the quarter, we reported adjusted earnings per share, excluding reportable catastrophes of $2.81 down 8% from the prior year period. Now let’s move to segment results, starting with Global Lifestyle. This segment reported adjusted EBITDA of $166 million in the third quarter, a year-over-year decreased to 6%, driven primarily by Connected Living. Excluding an $11 million one-time client contract benefit in Connected Living, Lifestyle earnings decreased by $22 million. The Connected Living decline of $18 million was primarily from four factors. First, $7 million of unfavorable foreign exchange, mainly from the weakening of the Japanese Yen. Second, lower margins in our device trade-in business from lower volumes. However, this is expected to improve starting in the fourth quarter, which we have already seen in October. Third, our Extended Service Contracts business was impacted by higher claims cost from wage and materials, and we did make some additional investments in Connected Home and lastly, softer international volumes for mobile particularly in Japan and Europe. The decline was partially offset by continued mobile subscriber growth in North America device protection programs from carrier and cable operator clients. In Global Automotive, earnings decrease $4 million or 6%, primarily from lower investment income and higher losses in Europe. Turning to revenue year-over-year Lifestyle revenue was up by $29 million or 1% driven by continued growth in Global Automotive. Global Automotive revenue increased 9% reflecting strong prior period sales of vehicle service contracts. On year-to-date basis, our net written premiums in auto were down 2%, demonstrating the resilience of the business relative to the broader U.S. auto market, which contracted at a faster pace. Within Connected Living revenue is down 4% year-over-year due to lower revenue in mobile mainly from premium declines from runoff programs and unfavorable foreign exchange. This was partially offset by growth in subscribers in North America. In the third quarter, we serviced 7.1 million global mobile devices supported by new phone introductions and carrier promotions from the growing adoption of 5G devices. For the full-year 2022, we now expect Lifestyle adjusted EBITDA to grow high single-digits compared to 2021, led by double-digit mobile expansion and Global Automotive growth. Earnings in the fourth quarter should grow year-over-year, mainly from growth and Connected Living. Moving to Global Housing the adjusted EBITDA loss was $25 million which included $124 million of reportable catastrophes. As a retention level event Hurricane Ian was the primary driver of reportable catastrophes in the quarter, along with the associated reinstatement premiums. Excluding catastrophe losses, adjusted EBITDA was $99 million down $18 million or 15%. The decrease was driven primarily by approximately $38 million in higher non-cat loss experience across all major products, including approximately $24 million of prior period reserve strengthening. Lender placed earnings were flat as elevated loss experienced a $13 million of higher catastrophe reinsurance costs were largely offset by higher average insured values and premium rates. The placement rate increased nine basis points sequentially, mainly from client portfolio additions having a higher average placement rate. The increase is not a reflection of a deterioration in the U.S. mortgage landscape. In Multi-Family Housing, increased non-cat losses, including some reserve strengthening and an increase in expenses from ongoing investments to expand our capabilities and strength in our customer experience resulted in lower profitability. Global Housing revenue increased 3% from growth within several specialty offerings as well as higher average insured values in premium rates and lender place. This was partially offset by higher catastrophe reinsurance costs noted earlier from Hurricane Ian. For the full-year, we expect Global Housing adjusted EBITDA, excluding cats to decline by low to mid teens from 2021 with an increasing benefit in the fourth quarter from higher AAVs and rate. We are also evaluating our catastrophe reinsurance program as we approach the January 1st purchase to ensure we optimize risk and return. This may include increasing our retention level, reflecting the growth of the book of business stemming from inflation. In the meantime, we believe the implemented rate adjustments will result in higher premiums that can help to mitigate the increase in cat reinsurance costs. At corporate the adjusted EBITDA loss was $25 million up $2 million driven by lower investment income. For the full-year, we continued to expect corporate adjusted EBITDA loss to be approximately $105 million. Turning now to holding company liquidity, we ended the third quarter with $529 million, $304 million above our current minimum target level. In the third quarter dividends from our operating segments totaled $143 million. In addition to our quarterly corporate interest expenses, we offset outflows from three main items, $80 million of share repurchases, $37 million of common stock dividends and $6 million mainly related to Assurant Venture investments. For the full-year in addition to the $365 million of preneed proceeds, we expect incremental share repurchases to be on the lower end of our targeted range of $200 million to $300 million. As always, segment dividends are subject to the growth of the businesses, investment portfolio performance and rating agency and regulatory capital requirements. Turning to future capital deployment, our objective continues to be to maintain our strong financial position, while continuing to invest in our future organic growth. However, given the interest rate volatility and uncertain global macro environment, we plan to be prudent relative to capital deployment in the near future. In conclusion, while our third quarter results were disappointing, we are confident that our fourth quarter results will improve and with the additional actions we are taking to grow the top-line and leverage our expense base, we are positioning ourselves for growth into 2023. And with that operator, please open the call for questions.
Operator: The floor is open for questions. [Operator Instructions] And your first question comes from the line of Mike Phillips from Morgan Stanley. Your line is open.
Michael Phillips: Good morning, everybody. Thanks. I guess I wanted to touch on the comments on 2023. You mentioned you expect growth in those segments. And as I compare that to your stuff you gave in February. You are pretty specific with the financial objectives of numbers by segment of EBITDA growth. Hear I believe you said if you want to reevaluate that and it sounds like, you are also expecting a Lifestyle continue to hire claim calls. So kind of want to kind of marry those and make sure we are not reading too much into your wording of reevaluating 2023 growth, as compared to your objectives before?
Keith Demmings: Okay. Yes, maybe I can try to tackle that a couple of ways. So if you think about the outlook for 2022. If we just start with that, obviously, we are below what we expected originally from Investor Day, largely driven by the decline in the Housing business, as it relates to inflation, which we talked a lot about last quarter. We had also expected Lifestyle to even outperform our original expectations, when we think back to where we started the year and kind of what we signaled last quarter. Obviously, we saw a softer Q3 in Lifestyle. We still expect Lifestyle to generate strong growth, as we think about 2022. So we talked about high single-digit growth in Lifestyle, but that is over coming relatively significant foreign exchange rates. If you think about constant currency basis, we expect to be in the low double-digit range, which was underpinning our Lifestyle Investor Day commentary. I would say that, because Housing is behind and Lifestyle is sort of inline, but not outperforming as significantly as we had hoped last quarter and we can talk about the third quarter. We have said, it is prudent for us to close the year, evaluate how we finish, look at the trends as we think about 2023 and 2024. There is a tremendous amount of turmoil in the global economy and the macro environment. So trying to make sure we take all of that into account, to set our outlook for 2023 that will also be based on the expense actions which we are taking in the fourth quarter. We do expect international softness to continue. I think foreign exchange will be a pressure. Claims costs are rising. Not a huge part of the Lifestyle story, but still important. We are trying to take expense actions to offset that pressure, and I think prudent for us to revisit and think about those longer-term commitments to make sure that we are being as transparent as we can with the market.
Michael Phillips: Okay. Thank you. I think that makes sense. I guess when you looked at the - in this quarter, one of the segments in the Lifestyle was the mobile margins. And you talk about how that is not going to continue and can I revert, I guess you mean in fourth quarter. Can you talk about why that is?
Keith Demmings: Yes. So there is a couple things. So if I think about the third quarter for Lifestyle, we certainly expected results in the third quarter to be lower than what we saw in the first half. So that wasn’t surprising, but obviously they came in even lower than we were expecting. Maybe I will unpack why we would’ve thought they would’ve been lower to start with, and then what happened in the quarter. So I would say as we thought about Q3, we knew there would be more losses in mobile from seasonality. We tend to see higher claims in the summer months, particularly for the clients where we are on risk. So that certainly happened and we saw an elevated level of claims beyond what we were expecting in the third quarter. If you think about the first half of the year, we saw tremendous favorability around mobile losses. So frequency of claims is lower than historic levels. We have done a really good job managing severity, a lot of efficiency in our supply chain, but also leveraging walk-in repair as well to drive down severity of claims. And we thought that positive trend line would continue in third core. There is a little bit of a reversal mainly around the cost of acquiring devices when we had to do replacement devices and just the sort of the mix of inventory that we had. We expect to see that normalized more into the fourth quarter and beyond. When I think about mobile losses, year-to-date, pretty in line with what we would have expected at the beginning of the year, very much in line with what we saw in 2021. So choppiness between really strong favorability in the first half and then some softness in the third quarter. We also saw accelerated investments around the Connected Home in Q3, which we knew would continue and we had some favorability in the first half with investment income in auto, which we knew wouldn’t continue. So we certainly expected Q3 to be down, but in terms of the miss to our expectations, I would say 50% of that miss is broadly international, a combination of FX and softer volumes in a softer economy, particularly in Europe and Japan. And then about half of it was domestic trade in margins, which was probably more of a timing point in terms of devices being delayed to be received in our depots, and that will reverse itself in the fourth quarter. I talked about the mobile losses being another driver, and then we saw a little bit of loss pressure on the ESC portfolio. Not a huge number, but certainly there is inflation in the system and that is flowing through.
Michael Phillips: Okay. Thank you for all the color. I appreciate it.
Keith Demmings: You bet.
Operator: Your next question comes from the line of Tommy McJoynt from KBW. Your line is open.
Tommy McJoynt: So just maybe stepping back a little bit and thinking from a high level, just thinking about the step down, I guess, in this year’s guidance from perhaps I guess six-months ago, back in May, we have seen kind of two sequential steps down. So can you just kind of frame how much of that step down has come from it is expected lost cost, the claims inflation side versus perhaps just a lower demand for your products and services, I guess, over in Europe, and then a little bit domestically. So if you were just going to bucket into those two categories, the step down and guidance over the year, how would you do that?
Keith Demmings: Yes. I think, you know, when we sat here at the end of the second quarter, we certainly saw pressure in the Housing business. No question that was the driver of the step down last quarter, offset by really, really strong first half. When we think about Lifestyle, you know, record year in 2021 and then an incredibly robust first half, we projected that trend line would continue and that favorability would continue. I would say, you know, the adjustment that we are talking about now is entirely sort of backing out that favorability for the full-year from Lifestyle. So Lifestyle, like I said, it is going to come in very much in line with our original expectations from Investor Day, from the beginning of the year and the real impact is FX. If I think about Lifestyle overall, I would say domestic Connected Living will finish the year very much in line with what we had expected. So a really strong year, really robust growth. Global auto will be ahead of what we originally expected, mainly driven by investment income, which we have talked about being a nice tailwind for the auto business. That favorability in auto, I would say offset by softness in underlying international business results, mainly in Europe, a little bit of pressure in Japan, and then we have got FX layered on top of that. But again, ignoring FX, pretty much in line and I would say auto outperforming and offsetting softness internationally. And then Housing is very much in line with expectations. If we think about what we expected in the third quarter, you know, Housing came in very much in line. We have made tremendous progress to transform Housing. We have reacted with urgency. I’m really proud of the way the team has come together. We have simplified the focus. You saw the exit of sharing economy. We have signaled the exit of international Housing related cat business. We are implementing a new org design to delineate between our Housing risk and capital light to increase our focus, drive even more efficiency. And then just a tremendous amount of work on offsetting inflation not just with expense discipline and prudence, but the work with AIVs that, you know, has started to take hold a little bit this quarter. A lot of progress on rate 31 approved rates with states that are implemented in 2022, several more for early 2023. So just a lot of progress there and I would say Housing pretty much in line as we think about what we said last quarter.
Tommy McJoynt: Thanks. And to follow up on that, what gives you guys confidence that some of the weaker pressures over in Europe and Japan might not spill over into the North American side?
Keith Demmings: Yes, we have, you know, we certainly expect the pressure in Europe and in Japan to continue. I would say, you know, obviously they are both profitable markets for us. Japan has been an incredible success story. And I think even though there is some softness in the economy, we are very well positioned in the market and there is tremendous long-term opportunity for growth and our team is doing an incredible job. So I feel really good long-term about our position there. Europe’s even more challenged, obviously with the economy and with FX in that marketplace so that we are seeing some softness. I think that persists and continues. We are taking actions to make sure we are simplifying our focus, rationalizing our expense base, but nothing that we are going to do is going to destroy long-term value, disrupt what we do with clients or customers. And then in North America, we have actually seen really robust results. You know, our subscriber counts on mobile in North America postpaid are up sequentially. They are up year-over-year, obviously with the T-mobile acquisition of Sprint. But good momentum, our clients are growing. If you think about our device protection clients in the US on the postpaid side, they are gaining a lot of net adds. I think 70% of the net adds are coming through our client - the client partnerships that we have. So that bodes well for device protection and then trade-in continues to be strong as there is a lot of competition in the broader market, particularly domestically.
Tommy McJoynt: Got it. Thanks. And then just last one for me. In Housing, you recorded the prior period development of $24 million, but the full-year guidance for Housing didn’t change. So was that prior period development already anticipated in the guidance?
Keith Demmings: So I think, we certainly expected higher claims cost in the quarter and that came through in prior period development versus current accident quarter development and maybe Richard can share some highlights on that. But I would say that, the offset to the prior period development was the significance that we saw both in terms of rate. From AIVs a little bit, but mainly from all the rate adjustments that we have made over the course of last year and then policy growth. We have got 26,000 incremental LPI policies that came through in the quarter as well, which we can talk about. But maybe Richard talk a little bit about the prior period?
Richard Dziadzio: Yes, exactly. I think you nailed it. In terms of the prior period development, obviously, when we closed Q2, we put some prior period development in and the best number in our best estimate. On the other hand, when we were looking at our outlook. We said inflation is high, let’s just assume inflation is going to stay at a very high level. So we kind of I would say hedged our bets in terms of where the total loss ratio could go at the end of this year, call it, not really prior period development, but just all-in lost cost. So that came through and we are a decent place there and that was able to absorb some of the prior period development. Of the prior period development, I would say 14 was this year, so it is truly just a movement within the calendar year, and 10 for the prior years. And then as Keith said, our premiums were a little bit better. We are seeing AIVs. We are seeing some new business come on. And so that helped to offset any other variance with the prior year development that came in.
Tommy McJoynt: Got it. Thanks.
Operator: Your next question comes from the line of Mark Hughes from Truist. Your line is open.
Mark Hughes: Yes thank you good morning. The delay on the trading activity, I got some questions on that. What was the logistical cause of the delay?
Keith Demmings: Yes. At a high level, relatively simple, so a client - we expected a client to send additional devices to us towards the end of the third quarter and that was delayed for a variety of reasons still to be received in Q4. So it is really just a shift between three and four and it wasn’t so much the lack of volume from a margin perspective. It was the fact that we had staffed labor accordingly to be able to process and receive those devices. So there is a bit of a mismatch between the labor that we had in place in anticipation of the volume, and then the volume being delayed for some logistical reasons in terms of appliance getting us those devices. So something that we expect to ride the ship in the fourth quarter.
Mark Hughes: On the reinsurance, I think you had mentioned that, you were looking at taking up your attention. Could you refresh me the timing of your renewals, I think it renews it a couple of different times through the year. How you anticipate what your early thoughts say about the cost of that program for 2023 versus 2022? And then I guess I would ask from the timing. So just timing, cost retention, if you could address those?
Keith Demmings: Sure. And maybe Richard, you can start in terms of the timing, and then I can add some color at the end.
Richard Dziadzio: Yes. Great. Thank you, and, good morning, Mark. So when we think about our reinsurance program full-year, this year will probably be about a 190 million in total cost in it. And how do we looking at the reinsurance program? Really, we need to look at it in terms of total Housing prices. Starting with the total Housing prices and Housing prices have gone up. Inflation has been boosting them, other factors have been boosting them. So if you think about the insurance that we put on the properties, we are putting more insurance on. And then that obviously results in us needing to purchase more insurance. So really by a kind of just a function of the overall book of business growing, we will be placing more reinsurance on the premium will grow. If you think about it having a bigger book of business and more premiums means we do have more exposure at the lower levels and a higher probability that those lower levels will be touched. So as we look at it, it's more of a proportional position that we would take and say, "Okay, well, what's the right new level for our retention?" That's why we wanted to signal that, that lower layer will probably go up. It's just kind of a logical conclusion in terms of what's been happening in the market. I would say, as we said a number of times, we are getting rate increases. We are getting increases in average insured values. So we are getting premium increases, the rise in the reinsurance costs, and we are expecting some increase in reinsurance costs given the state of the reinsurance market. That would be an offset to some of the premium increases that we are getting. So I would say sort of logical in that sense. In terms of timing, we typically purchase about 2/3 of our reinsurance at the beginning of the year and then the rest of it at mid-year. We always look at that, that proportion could change as we get into the market and see the dynamics of it.
Keith Demmings: Yes. And maybe just one other comment. I think at the highest level, we certainly expect the reinsurance cost increase to be more than offset by additional rate. Both from the rate increases, but also from inflation guard the average insured value increases. So even with a harder reinsurance market, we have got really strong relationships across a wide range of reinsurers. We partner with over 40 different reinsurers, a strong performing business long term. We continue to simplify the portfolio, which I think helps us as we move forward. And then definitely rising costs, but we anticipate that our rate will be more than sufficient to offset that.
Mark Hughes: So it sounds like what you are seeing on rate in your judgment at this point will more than offset both the underlying inflation and the higher reinsurance costs. Is that right?
Richard Dziadzio: That is correct, yes. And if I think about Housing, even if we just look at the third quarter revenues are up 3% year-over-year. If you back out the reinstatement premium from the premium line, we would be up 8% year-over-year. So we had 35 million in reinstatement premium this year and eight million in Q3 last year. So that is pretty meaningful up 8%. I would say that is half from rate, very little of that is from this year’s AIV. So we put the AIV increase in July, we talked about double digit rate as a result of AIV. That is had three-months to have an effect, right. So it is really a 24-month cycle. We renew policies over 12-months and they take 12-months to earn. We are three months into that 24-month cycle. So very little of the improvement is from AIV. Most of it is from all of the rate action we have taken at the individual state level, and then from the policy growth that we saw in the third quarter. So that will just continue to build and accelerate as the full effect of AIV rate comes through the program.
Mark Hughes: Your SG&A in lifestyle was up a point sequentially, that number has been a little bit volatile, but any change in the economics of the agreements that you have got with the auto dealers or your carrier partners? I know you just renewed with T-Mobile. Is there maybe a little more sharing you are having to do with those partners these days?
Keith Demmings: No. So in terms of T-Mobile, you are correct. We did do a multi-year contract extension on top of the multi-year extension that we got a year ago. The deal structure has changed as we pivoted from the in-store repair to leveraging our 500 CPR stores. But in terms of the broad economics, I would say quite simply, we protected the financial integrity of the original deal that we had. So we have restructured the way it operates, but no impact to our EBITDA expectations for that business. And then we further extended the agreement to protect that relationship over time which is really significant in terms of giving us long-term visibility into the U.S. mobile market. So nothing there that would create any economic change to us. In terms of the balance of clients, I would say, you know, tremendous momentum still commercially with our clients. Lots of focus on driving growth, driving innovation, but no fundamental changes in deal structures and services provided. So if we think about the softness in the third quarter in Lifestyle, you know, other than pointing to the broader economy and some of the impacts that I discussed earlier, nothing related to client deal related changes. And then Richard, anything on expense?
Richard Dziadzio: Yes, thanks Keith. Yes, exactly, exactly. And no changes to client contracts, but I would say the increase in the overall SG&A is reflecting, you know, some increases in the business growth in the business, you know, particularly in the auto business, obviously there is distribution costs with regard to that. And we have been growing the business over the last year. So there is some commissions in there. Also in our prepared remarks, you heard us talk about some additional investments in our home solutions and, you know, yes, a chunk of that obviously is expensed in the quarter. So those would be the two main drivers Mark.
Mark Hughes: Thank you very much.
Operator: Your next question comes from a line of Gary Ransom from Dowling and Partners. Your line is open.
Gary Ransom: Good morning. I was wondering if you could add a little color on the exit from international Housing. I mean, what, how long will that take and what, you know, size the magnitude of what is being reduced and not, it is not clear to me whether that includes the Caribbean exposure as well, but could you talk about that a little bit?
Keith Demmings: Sure. And it does include the Caribbean exposure and really anything that we write internationally that is cat exposed homeowners related business, we have made the decision strategically to exit. I would say we will be done writing policies. Most of it will be done this year. There is a little bit that will finish at the end of the first quarter, but we won’t be writing new policies as of Q2 2023. And then depending on how some of the final discussions unwind, you know, maximum, we would have a 12-month runoff on those policies, in some cases shorter. So that is to be finalized and determined. But in terms of the scale of it, I would think about, you know, maybe $50 million in net earned premium in a year as being kind of typical probably takes 10% of our tower. So if you think about the tower that Richard talked about, our reinsurance tower, 10% of that goes to protect the international exposures. And strategically it is been a challenging market hard to get rate. There has been rising costs as we know of claims. We expect rising costs of reinsurance adds a lot of complexity to not only manage the business, but negotiate the reinsurance that backs it. And ultimately with modeled ALLs, fairly limited effect to all-in EBITDA, certainly EBITDA ex-cat, but all-in EBITDA with cat, not hitting our target levels of return risk adjusted. So we are making the decision to further simplify and focus in places, where we think we have clear competitive advantages and where we are differentiated. We are not just a risk taker, we are providing deeply integrated, more differentiated services. That wasn’t the case with this business and we weren’t able to get the returns we wanted.
Gary Ransom: Is some of this business coming through the LPI business as well?
Keith Demmings: No.
Gary Ransom: No, okay. It is all just separate homeowners business basically.
Keith Demmings: Yes, separate homeowners, some of it were a reinsurer, some of it were direct writer. But none of it connects to what we do in LPI. An LPI is really unique. It is an incredibly advantaged business in terms of how we operate, how we are integrated and we create much more value than just being a risk taker. And we are able to get rate and we are able to drive the right level of profitability over time in that business. So it is quite a different business to manage versus what we have been working within the international property side.
Gary Ransom: Great. Thank you very much. And I also wanted to ask about two acquisitions. I know you had the EPG acquisition, maybe it is a couple of years ago now. But do those all fit together? I mean, is there some consolidation potential. And just I wonder is that a market size that will be additive to the growth you are thinking about over the long run?
Keith Demmings: Yes, I think that is exactly right. If we think about the EPG acquisition and then the acquisition that we are talking about now, it is really to build on the strength that we have got in that market around commercial equipment, leased and finance equipment. We have had good results and strong growth. And we operate this business both in our Housing side and Lifestyle side. So we are going to evaluate how to drive more synergies through the organization, as we move forward. But absolutely, it is capital light fee income. We are talking about small tuck-in acquisitions of existing clients that are high performing. We are already underwriting the business and it is really just buying the administrative capability and the scale to drive that forward. So we definitely see growth in this line of business, and we think it can accelerate as we make some - what are really quite small acquisitions, but can add a lot of value to our franchise.
Gary Ransom: Yes. You said that, some of it is in Housing and some of it is in Lifestyle. I guess I sort of thought of it as, sort of similar to the auto business. But maybe I was wrong on that.
Keith Demmings: Very much. I think we write two different product lines when we think about heavy equipment and commercial equipment, some of it is service contracts, some of it is physical damage. Operates very consistently, really predictable strong profitability and that has been the legacy of how we have been set up as an organization. So one of the things that we are focused on now is, as I talked about some of the Housing realignment between risk-based homeowner’s business and fee income capital light is just thinking about how do we create maximum efficiency and effectiveness organizationally, how do we create clarity in terms of where we want to focus to drive growth? What is the mindset that we need leading various different products? And then make sure that, we have got the least amount of friction in how we are organized as possible. So more changes to come as we think about our go-to-market strategy longer-term.
Gary Ransom: Okay. Thank you very much. And actually just one more maybe a bigger picture question, when you are thinking about all these macro impacts inflation for exchange and then putting that in the context of how you were thinking about 2023 and 2024 before. I’m not even really asking whether you think about hitting the 2024 or not, but just how your thinking might have changed? And what - we have had these couple of disappointments in the second and third quarter. What did that do for your thinking about the outlook as we go into 2024 and maybe even longer?
Keith Demmings: Yes, I think it probably - we step back and reflect on just how uncertain and complicated the environment is. That is true for Assurant and it is true for most companies today. So there is a lot of market volatility, market uncertainty. Interest rates are moving quickly. The economy obviously is going to shift over the course of the coming quarters, and we will see how that lands. So there is just a recognition of the complexity. And then like I talked about earlier, we knew Housing was going to be weaker this year. We thought the outperformance in Lifestyle would make up that gap as we thought about 2024. We certainly expect to continue to see the Housing growth. It is no doubt going to grow as we think forward over the next couple of years. But the question mark is around can Lifestyle outperform at the level that we would have needed to in order to offset that Housing softness? And Housing is probably more of a delay than a pivot in terms of what our expectations are. It is really just that we are a year behind where we thought we would be. But we are seeing evidence of significant improvement. And I think right now, given the uncertainty is particularly in the international markets, just taking a step back, like I said, finish the fourth quarter, deliver on a really strong plan in terms of what we expect to accomplish in 2023 relative to expenses as well as driving the right outcomes with our clients. And then stepping back and revisiting what is possible as we think about the longer term and then providing some color on a more informed basis in February.
Gary Ransom: Terrific. Thank you very much.
Keith Demmings: You are welcome.
Operator: Your next question comes from the line of John Barnidge from Piper Sandler. Your line is open.
John Barnidge: Good morning and thank you very much. You have had expanded partnerships in the lifestyle business announced this year. I had a couple of questions on that. In light of inflationary pressures, one, can you talk about how you manage that inflationary volatility? And then can you contrast that with - could that pressure actually lead to more partners looking to outsource more of their service management and refurbishment of mobile devices?
Keith Demmings: Yes, it is interesting. If I start with the second point first, just on outsourcing and this ebbs and flows over time, but I think as we think about a more challenging economy going forward, if we think about a recessionary environment, oftentimes, we will see clients focusing on core. And the same for us, how do we focus on the things where we can generate the greatest amount of return? How do we prioritize what is critically important to the company? I think clients do the same thing. So as clients reprioritize their focus, there may be opportunities for them to say, "Hey, is there someone else in the market that is better equipped to help me with something because it is just not the burning priority at the moment. So we will see how that evolves. That sort of happens over time, but it is certainly reasonable to expect as we continue to build scale and as we have better and better capabilities that are efficiently operated, we can provide a great source of value to our partners over time. So I think hopefully, that trend continues. In terms of the volatility in Lifestyle, from a macro environment, I think if you step back and look at the totality of the year, we have signaled some puts and takes around kind of the inflationary environment. You know, in lifestyle we see, you know, it is strong investment income, certainly flowing through the auto business, which is the biggest source of our portfolio. So that is a positive. We have seen mobile losses that I talked about earlier, performing quite well, not because of inflation, but because frequency of claims is reduced a little bit. And then how we are doing with controlling severity through walk and repair, et cetera. And then we have had favorability and GAAP losses on the auto side, which we have talked about. And then two-thirds of the time we are not on the risk and we are sharing that risk back with our partners. So that leaves us with a third of the deals where we are more, let’s call it, more exposed to those pressures. And we are seeing losses on the risk side escalating. It is not a huge part of the portfolio. It is not a big part of our narrative this quarter, but certainly on the ESC side, cost of parts and labor, a little bit on the auto side as well. And then there is labor inflation and we try to offset labor inflation with, you know, with digital initiatives and investments in optimizing our operational transformation efforts. So those would be the big highlights on balance, you know, not a huge driver for the year, but certainly FX and softness internationally, which is, you know, we are feeling more of that is a pressure we expect as we go forward. And do, I do think continued elevation of claims. And then our job will be to, you know, make sure that we have got the right pricing in place with clients that we are restructuring deals and we are trying to drive more stability over time.
John Barnidge: Thank you. That is helpful. And then following up on that, wanted to go back to, you know, the pre-announcement. You talked about simplifying the business portfolio. You talked about exiting commercial liability and international Housing catastrophe. Have you completed that simplification of the business portfolio or could there be additional niche lines you look to exit in the near to intermediate term?
Keith Demmings: Yes, great question. I would say, you know, we have, I think we have had a very successful track record of managing the portfolio, and you have seen us do that consistently over many years. You know, there is certainly more things that we will evaluate in terms of smaller product lines and making sure that we are investing in places where we have clear competitive advantages. I think about, you know, we need a strong right to win and the size of the prize needs to be meaningful. And there are probably other pockets where we could, where we could continue to refine the portfolio over time. And I think that will continue permanently. That is always going to be a part of our DNA, is to look to optimize and create more focus on things that can more significantly move the needle and try to limit the distraction for the company. Focusing energy on products that are smaller, don’t contribute significantly to the profitability of the company. If that effort can be better placed elsewhere to drive more meaningful growth, those are the choices and trade-offs that our management team is making on a regular basis.
John Barnidge: Thank you very much. And my last question, you talked about $12 million in buybacks in October. Does that seem like a reasonable run rate for the fourth quarter given the M&A transactions?
Keith Demmings: Yes, maybe I will offer a couple thoughts and then certainly Richard can jump in. I think when we step back and think about capital management at the highest level, we have talked about, you know, our focus on continuing to be very disciplined in terms of how we think about our capital. We have indicated an interest in being balanced between share buybacks and M&A. If you think about where we sit year to date, we have done $567 million in share repurchases and then $80 million we have signaled in M&A. So repurchases has been a big part of the story this year nearly 90% of the capital that we have deployed in that respect. So I think we feel good about meeting our commitment on the Preneed return. We feel good about meeting our commitment to in a normal year to $200 million to $300 million of share repurchases. But we also recognize the market is really challenging. There is a lot of interest rate volatility and we want to be more prudent in terms of capital management. And it is really just about maintaining flexibility, protecting our financial strength and then looking for the market to stabilize and for visibility to improve. And then as we look toward the future, we see our stock price is extremely attractive. So as we think about future M&A, we will have to have a very high hurdle rate in terms of the M&A relative to what a share buyback looks like today. But Richard, is there anything else you would add?
Richard Dziadzio: Yes. I guess, just to add on to what you said, I mean, in terms of share repurchases this year, we are already through October at little than $550 million in addition to that, $113 million in dividends. So that brings us to about say $670 million. So we had targets at the beginning of the year. We wanted to make sure we hit them for the year. And I would say we have hit them, which is why we signaled we would be at the lower end of that $200 million to $300 we had talked about earlier in terms of repurchases outside of the Preneed proceeds that we repurchased. And as Keith said, it is uncertain market conditions, and we want to make sure we continue to invest in ourselves and we continue to do the right things and remain disciplined with capital. So no change in our philosophy, our capital philosophy, the discipline we have, keeping the balance sheet very strong. As Keith said, we have always said, we always look at deployment of capital between share repurchases and M&A and in these markets with the share price where it is, the share price obviously from our perspective is extremely attractive today. So that creates a higher bar for M&A.
John Barnidge: Thank you very much for your answers.
Keith Demmings: Great. Thank you.
Operator: And your next question comes from the line of Jeff Schmitt from William Blair. Your line is open.
Jeff Schmitt: Good morning everyone. In Global Lifestyle, I understand the inflation impact being low on the claims side just because you don’t retain a ton of the risk. But what about for SG&A? How much of that is employee comp and what level of wage inflation are you seeing there kind of relative to last year?
Keith Demmings: I think we are generally doing a pretty good job of offsetting wage inflation automation and our digital efforts. So certainly paying our employees more is important in the war on talent, to make sure that we are staying competitive, but I think we are doing a really good job offsetting that with our efforts on driving automation through our operations.
Jeff Schmitt: Okay. And then in Global Housing, I’m just trying to understand the numbers. When I adjust for add back that reinstatement premium, brings that attritional loss ratio down to I think 38%. And then if you back out the unfavorable development, it brings it down quite a bit more, 33%, 34%. So I’m trying to understand, you are talking about the pressures that you are seeing there. I think you are pushing for double-digit rate increases. I guess where is that pressure being felt or I guess why is that sort of loss pick as low as it is?
Keith Demmings: Yes. Maybe, Richard, just talk - I think we don’t we don’t see it at that level. But maybe Richard just talk about our view on kind of the normalized loss ratio in the quarter.
Richard Dziadzio: Yes. And I would start, it is a great question, Jeff. I think - I would first start by - when we go in for rate increases, we are looking at it kind of bottom line. So you have to take in - you are looking at the non-cat loss ratio. I think you have to look at all-in. If you look at our combined ratio for the quarter with Hurricane Ian, it is over 100%, obviously. So that will be taken into account when we go and go for rate increases. And essentially, what we end up doing with our non-cat loss ratio, there are a couple of different moving parts. If you think about it from a net earned premium part, we have cats that the reinstatement premium, we have to add that back, but also from the incurred claims, we have to take out the prior year development. When we add back the cats and we get to kind of like from a 68% that you see in the supplement to about 45%, and then we take out the $24 million of prior period development, we get to about 40%. You are a little bit lighter. So there is maybe a numerator/denominator thing. But I think your point is a good one. You would say 40%, that looks low. But it is really the all-in cost, including cat, including the expenses, the tracking, et cetera, that are taken into account when we go for rates. So it is a bigger number on an all-in basis.
Jeff Schmitt: Alright, got t. okay, thank you.
Keith Demmings: Thank you.
Operator: And your final question comes from the line of Grace Carter from Bank of America. Your line is open.
Grace Carter: Hello everyone. So I was wondering in the Lifestyle book, just given how much of that risk that you don’t retain, it seems like inflationary pressures have been a bit more persistent than maybe a lot of people originally hoped. I know that you had mentioned in the past that you hadn’t really been seeing too much pushback from your clients regarding your profit sharing and reinsurance arrangements. I was just wondering if given the persistency of inflationary pressures and that actually started to show a little bit in the results in the quarter, if those conversations had evolved any in the past few months?
Keith Demmings: No, I would say the clients that are currently in profit share and reinsurance structures, that is the preferred approach for those clients. Those programs are typically quite large, very sophisticated. The clients understand the program economics and there is a tremendous amount of transparency in those deals, and there is sufficient profitability in those structures that can absorb the inflationary pressure. So from a client perspective, no interest in moving away from those structures. And then clients where we are more on the risk, over time, we will certainly see discussions evolve and emerge as clients become more sophisticated and interested in taking on more of the risk. That may evolve over time. But generally speaking, it has been pretty steady. And I wouldn’t say it is a huge source of discussion with our teams.
Grace Carter: Perfect, thank you. And I guess just kind of thinking of how the Lifestyle book has evolved over time, moving from sort of more of the protection in towards more fee-based services. I mean is the recent emphasis on growing fee-based services like trade-ins, upgrades, whatnot change the level of macro sensitivity today versus maybe what we have seen in downturns in the past or do you consider it to be pretty even?
Keith Demmings: I think it is pretty stable. I would say when you think about fee-based services, even what we do for clients that are reinsured, that doesn’t show up in fee income. So if you think about administrative fees and underwriting fees where we are not sitting on the risk, it still flows through outside of the fee income line, but it behaves a lot more like fee income. We get stated fees for providing insurance and related services. So that is still a significant driver of our overall economics, and that doesn’t show up in the fee income line. And then I think the thing we are excited about is the balance that we have today. We do a lot more work with partners across the value chain. So trade in related services are important to our clients and increasingly important and it gives us another way to add value for our customers. It is more defensible competitively, and then we can create other unique ways to drive value longer term because we are playing in a broader set of services across the ecosystem. So from that perspective, I think it is really favorable and it does create more balance, but the bulk of the economics on the parts where we don’t take the risk are also quite predictable. And that is evolved over time as well.
Grace Carter: Thank you.
Keith Demmings: Wonderful. Well, thanks everybody. Just a couple of closing comments from me. We believe we have performed well in what is a really challenging macroeconomic environment and remain differentiated in terms of our business model with compelling long term earnings growth potential and cash flow generation capability. We look forward to closing the year strong, and we will talk to everybody on our fourth quarter call-in February. In the meantime, as usual, please reach out to Suzanne or Sean with any follow up questions and thanks everybody. Have a great day.
Operator: Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant’s Third Quarter 2022 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our third quarter 2022 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the third quarter of 2022. The release and corresponding financial supplement are available on assurant.com. We will start today’s call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday’s earnings release as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the Company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday’s news release and financial supplement that can be found on our website. I will now turn the call over to Keith."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Suzanne and good morning, everyone. As we previewed last week our third quarter 2022 results came in below our expectations. This reflected a more challenging macroeconomic environment and lower contributions from Global Lifestyle. Following a very strong first half of the year where we grew Lifestyle adjusted EBITDA by 14% year-over-year this quarter had more significant headwinds internationally, including unfavorable foreign exchange, a modest uptick in claims and lower Connected Living program volumes. While disappointing our results don’t change our view of the inherent growth momentum in the Lifestyle business, we believe the actions we are taking to drive additional expense savings will also better mitigate potential further deterioration in macro conditions. Looking at Global Housing, the segments performance was in line with our expectations for the quarter. We are pleased with the progress we have made in not only increasing revenues through higher average insured values and rates, but also the transformation actions we have taken to simplify the business and drive future growth. Looking at the year-to-date performance to the first nine-months of 2022, Assurant’s reported adjusted EPS of $10.05 is up 7% for last year and adjusted EBITDA of $832 million is down 4%, both excluding reportable catastrophes. As we evaluate our progress this year we continue to believe we have a compelling strategy, strong fundamentals and momentum with clients as we continue to align with leading global brands and maintain market leading positions across our key lines of business. For example, we announced a further multi-year extension of our longstanding partnership with T-Mobile. This important contract extension provides us with increased long-term visibility in our U.S. mobile business. At the same time, it gives us greater opportunity to increase repair volumes through our over 500 cell phone repair locations with the ability to leverage this capability with other U.S. clients. We have also made investments to support our product development around the Connected Home and we continue to engage in encouraging dialogue with key clients creating a long-term opportunity for growth. This also included supporting our largest U.S. retail client with the expanded relationship we announced earlier this year. While macroeconomic conditions in Europe are challenging, we continue to win new opportunities and recently expanded our global partnership with Samsung to launch Samsung Care plus smartphone protection in six major European markets. We now offer this solution across three continents. This momentum combined with our partnerships with well-positioned global market leaders should help us outperform through an economic downturn. Turning to Global Housing, we have already begun a comprehensive transformational effort to position the business for long-term success and we are pleased with our progress. Consistent with our practice of actively managing our portfolio of businesses and reviewing it for strategic fit in addition to exiting commercial liability, we are eliminating our international Housing catastrophe exposure. We don’t see these businesses as core to our strategy or a path to leadership positions. As we execute these changes, we are designing a new organizational structure for Global Housing to better manage our risk businesses from our capital light oriented businesses as part of our transformational agenda and also to realize greater efficiencies. We are finalizing our plans for implementation in 2023. As we reflect on Assurant’s overall results to-date and current market conditions, we now expect 2022 adjusted EPS, excluding catastrophes to grow high single-digits from $12.28 last year, driven by share repurchases and Global Lifestyle growth. For the full-year, we expect adjusted EBITDA excluding catastrophes, will be down modestly to flat with 2021. This will be driven by high single-digit adjusted EBITDA growth for Lifestyle even with additional macro headwinds. In fact, on a constant-currency basis, we expect Global Lifestyle to finish 2022 aligned with our original Lifestyle expectations of low double-digit growth. In Global Automotive, we still expect to outperform our initial expectations, driven by tailwinds from investment income and underlying growth in the business, as we expand share with clients and add to our 54 million protected vehicles. For 2022, we continue to believe Global Housing will decrease by low to mid teens, but we are pleased to see the initial improvements in our underlying results. From a capital perspective, we remain good stewards. Year-to-date, we have returned a total of $667 million dollars of capital to shareholders, including proceeds from the sale of Preneed and by year end, we expect to close two small acquisitions for a total of approximately $80 million. These deals will strengthen our position in commercial equipment with attractively priced assets and minimal integration effort. Looking ahead, given macroeconomic volatility, we will exercise prudence in the near-term relative to capital deployment so that we can maintain maximum flexibility to continue to support our organic growth. This doesn’t change our conviction of the strong cash flow generation of our businesses, nor our view of the attractiveness of our stock, but rather as a reflection of the uncertain macro environment. As the broader environment begins to stabilize and visibility improves, we will evaluate capital deployment to maximize shareholder value. Looking to 2023, we are confident in the growth of our businesses. We expect both our Global Housing and Global Lifestyle adjusted EBITDA ex-cats to increase year-over-year. To that end, we are taking decisive actions to mitigate headwinds, while we maintain our relentless focus on growth. The Global Housing business is poised to grow in 2023 and we started to see evidence of that in the third quarter, as rate increases flowed through the book. In the long-term, the business should provide downside protection, if we see a further deterioration in the U.S. economy. We believe Global Lifestyle is positioned to grow in 2023. This is based on expectations of continued strong underlying growth momentum, even while factoring in lower international business volumes and increasing claims costs. We have also started several initiatives across the enterprise to drive greater operational efficiencies and leverage our economies of scale. We are now pushing even harder to realize incremental expense savings, given the increasingly volatile market. We expect to finalize plans in the months ahead, so that we can implement in 2023 and beyond. This includes optimizing our organizational structure and best aligning our talent, leveraging our global footprint to reduce labor costs where possible, continuing to review our real estate strategy, recognizing we have an increasingly more hybrid workforce and accelerating our adoption of digital solutions. Our digital first strategies are yielding positive results in 2022, both in terms of delivering better customer experiences and meaningful savings. As part of our 2023 planning, we are taking steps to accelerate digital adoption and automate processes which will further reduce cost and improve the customer experience. We are also applying the same principles to drive greater automation and self-service throughout our functional areas. With this in mind, and considering how the overall business environment has changed, we are re-evaluating our long-term financial objectives shared at Investor Day. In February, we expect to share our 2023 outlook also factoring in the most recent business trends and macro environment. This in no way changes our view on our business advantages, leadership aspirations or long-term growth potential. We continue to be well positioned with industry leading clients as we focus on key products and capabilities where we have market leading advantages. We believe we have a compelling portfolio of businesses poised to outperform as we deliver on our vision to be the leading global business services provider supporting the advancement of the connected world. I will now turn the call over to Richard to review the third quarter of results and a revised 2022 outlook in greater detail. Richard."
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith, and good morning, everyone. Adjusted EBITDA excluding catastrophes totaled $240 million down 11% from the third quarter of 2021. Our performance reflected weaker results in both Global Housing and Global Lifestyle. For the quarter, we reported adjusted earnings per share, excluding reportable catastrophes of $2.81 down 8% from the prior year period. Now let’s move to segment results, starting with Global Lifestyle. This segment reported adjusted EBITDA of $166 million in the third quarter, a year-over-year decreased to 6%, driven primarily by Connected Living. Excluding an $11 million one-time client contract benefit in Connected Living, Lifestyle earnings decreased by $22 million. The Connected Living decline of $18 million was primarily from four factors. First, $7 million of unfavorable foreign exchange, mainly from the weakening of the Japanese Yen. Second, lower margins in our device trade-in business from lower volumes. However, this is expected to improve starting in the fourth quarter, which we have already seen in October. Third, our Extended Service Contracts business was impacted by higher claims cost from wage and materials, and we did make some additional investments in Connected Home and lastly, softer international volumes for mobile particularly in Japan and Europe. The decline was partially offset by continued mobile subscriber growth in North America device protection programs from carrier and cable operator clients. In Global Automotive, earnings decrease $4 million or 6%, primarily from lower investment income and higher losses in Europe. Turning to revenue year-over-year Lifestyle revenue was up by $29 million or 1% driven by continued growth in Global Automotive. Global Automotive revenue increased 9% reflecting strong prior period sales of vehicle service contracts. On year-to-date basis, our net written premiums in auto were down 2%, demonstrating the resilience of the business relative to the broader U.S. auto market, which contracted at a faster pace. Within Connected Living revenue is down 4% year-over-year due to lower revenue in mobile mainly from premium declines from runoff programs and unfavorable foreign exchange. This was partially offset by growth in subscribers in North America. In the third quarter, we serviced 7.1 million global mobile devices supported by new phone introductions and carrier promotions from the growing adoption of 5G devices. For the full-year 2022, we now expect Lifestyle adjusted EBITDA to grow high single-digits compared to 2021, led by double-digit mobile expansion and Global Automotive growth. Earnings in the fourth quarter should grow year-over-year, mainly from growth and Connected Living. Moving to Global Housing the adjusted EBITDA loss was $25 million which included $124 million of reportable catastrophes. As a retention level event Hurricane Ian was the primary driver of reportable catastrophes in the quarter, along with the associated reinstatement premiums. Excluding catastrophe losses, adjusted EBITDA was $99 million down $18 million or 15%. The decrease was driven primarily by approximately $38 million in higher non-cat loss experience across all major products, including approximately $24 million of prior period reserve strengthening. Lender placed earnings were flat as elevated loss experienced a $13 million of higher catastrophe reinsurance costs were largely offset by higher average insured values and premium rates. The placement rate increased nine basis points sequentially, mainly from client portfolio additions having a higher average placement rate. The increase is not a reflection of a deterioration in the U.S. mortgage landscape. In Multi-Family Housing, increased non-cat losses, including some reserve strengthening and an increase in expenses from ongoing investments to expand our capabilities and strength in our customer experience resulted in lower profitability. Global Housing revenue increased 3% from growth within several specialty offerings as well as higher average insured values in premium rates and lender place. This was partially offset by higher catastrophe reinsurance costs noted earlier from Hurricane Ian. For the full-year, we expect Global Housing adjusted EBITDA, excluding cats to decline by low to mid teens from 2021 with an increasing benefit in the fourth quarter from higher AAVs and rate. We are also evaluating our catastrophe reinsurance program as we approach the January 1st purchase to ensure we optimize risk and return. This may include increasing our retention level, reflecting the growth of the book of business stemming from inflation. In the meantime, we believe the implemented rate adjustments will result in higher premiums that can help to mitigate the increase in cat reinsurance costs. At corporate the adjusted EBITDA loss was $25 million up $2 million driven by lower investment income. For the full-year, we continued to expect corporate adjusted EBITDA loss to be approximately $105 million. Turning now to holding company liquidity, we ended the third quarter with $529 million, $304 million above our current minimum target level. In the third quarter dividends from our operating segments totaled $143 million. In addition to our quarterly corporate interest expenses, we offset outflows from three main items, $80 million of share repurchases, $37 million of common stock dividends and $6 million mainly related to Assurant Venture investments. For the full-year in addition to the $365 million of preneed proceeds, we expect incremental share repurchases to be on the lower end of our targeted range of $200 million to $300 million. As always, segment dividends are subject to the growth of the businesses, investment portfolio performance and rating agency and regulatory capital requirements. Turning to future capital deployment, our objective continues to be to maintain our strong financial position, while continuing to invest in our future organic growth. However, given the interest rate volatility and uncertain global macro environment, we plan to be prudent relative to capital deployment in the near future. In conclusion, while our third quarter results were disappointing, we are confident that our fourth quarter results will improve and with the additional actions we are taking to grow the top-line and leverage our expense base, we are positioning ourselves for growth into 2023. And with that operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "The floor is open for questions. [Operator Instructions] And your first question comes from the line of Mike Phillips from Morgan Stanley. Your line is open."
},
{
"speaker": "Michael Phillips",
"text": "Good morning, everybody. Thanks. I guess I wanted to touch on the comments on 2023. You mentioned you expect growth in those segments. And as I compare that to your stuff you gave in February. You are pretty specific with the financial objectives of numbers by segment of EBITDA growth. Hear I believe you said if you want to reevaluate that and it sounds like, you are also expecting a Lifestyle continue to hire claim calls. So kind of want to kind of marry those and make sure we are not reading too much into your wording of reevaluating 2023 growth, as compared to your objectives before?"
},
{
"speaker": "Keith Demmings",
"text": "Okay. Yes, maybe I can try to tackle that a couple of ways. So if you think about the outlook for 2022. If we just start with that, obviously, we are below what we expected originally from Investor Day, largely driven by the decline in the Housing business, as it relates to inflation, which we talked a lot about last quarter. We had also expected Lifestyle to even outperform our original expectations, when we think back to where we started the year and kind of what we signaled last quarter. Obviously, we saw a softer Q3 in Lifestyle. We still expect Lifestyle to generate strong growth, as we think about 2022. So we talked about high single-digit growth in Lifestyle, but that is over coming relatively significant foreign exchange rates. If you think about constant currency basis, we expect to be in the low double-digit range, which was underpinning our Lifestyle Investor Day commentary. I would say that, because Housing is behind and Lifestyle is sort of inline, but not outperforming as significantly as we had hoped last quarter and we can talk about the third quarter. We have said, it is prudent for us to close the year, evaluate how we finish, look at the trends as we think about 2023 and 2024. There is a tremendous amount of turmoil in the global economy and the macro environment. So trying to make sure we take all of that into account, to set our outlook for 2023 that will also be based on the expense actions which we are taking in the fourth quarter. We do expect international softness to continue. I think foreign exchange will be a pressure. Claims costs are rising. Not a huge part of the Lifestyle story, but still important. We are trying to take expense actions to offset that pressure, and I think prudent for us to revisit and think about those longer-term commitments to make sure that we are being as transparent as we can with the market."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Thank you. I think that makes sense. I guess when you looked at the - in this quarter, one of the segments in the Lifestyle was the mobile margins. And you talk about how that is not going to continue and can I revert, I guess you mean in fourth quarter. Can you talk about why that is?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So there is a couple things. So if I think about the third quarter for Lifestyle, we certainly expected results in the third quarter to be lower than what we saw in the first half. So that wasn’t surprising, but obviously they came in even lower than we were expecting. Maybe I will unpack why we would’ve thought they would’ve been lower to start with, and then what happened in the quarter. So I would say as we thought about Q3, we knew there would be more losses in mobile from seasonality. We tend to see higher claims in the summer months, particularly for the clients where we are on risk. So that certainly happened and we saw an elevated level of claims beyond what we were expecting in the third quarter. If you think about the first half of the year, we saw tremendous favorability around mobile losses. So frequency of claims is lower than historic levels. We have done a really good job managing severity, a lot of efficiency in our supply chain, but also leveraging walk-in repair as well to drive down severity of claims. And we thought that positive trend line would continue in third core. There is a little bit of a reversal mainly around the cost of acquiring devices when we had to do replacement devices and just the sort of the mix of inventory that we had. We expect to see that normalized more into the fourth quarter and beyond. When I think about mobile losses, year-to-date, pretty in line with what we would have expected at the beginning of the year, very much in line with what we saw in 2021. So choppiness between really strong favorability in the first half and then some softness in the third quarter. We also saw accelerated investments around the Connected Home in Q3, which we knew would continue and we had some favorability in the first half with investment income in auto, which we knew wouldn’t continue. So we certainly expected Q3 to be down, but in terms of the miss to our expectations, I would say 50% of that miss is broadly international, a combination of FX and softer volumes in a softer economy, particularly in Europe and Japan. And then about half of it was domestic trade in margins, which was probably more of a timing point in terms of devices being delayed to be received in our depots, and that will reverse itself in the fourth quarter. I talked about the mobile losses being another driver, and then we saw a little bit of loss pressure on the ESC portfolio. Not a huge number, but certainly there is inflation in the system and that is flowing through."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Thank you for all the color. I appreciate it."
},
{
"speaker": "Keith Demmings",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Tommy McJoynt from KBW. Your line is open."
},
{
"speaker": "Tommy McJoynt",
"text": "So just maybe stepping back a little bit and thinking from a high level, just thinking about the step down, I guess, in this year’s guidance from perhaps I guess six-months ago, back in May, we have seen kind of two sequential steps down. So can you just kind of frame how much of that step down has come from it is expected lost cost, the claims inflation side versus perhaps just a lower demand for your products and services, I guess, over in Europe, and then a little bit domestically. So if you were just going to bucket into those two categories, the step down and guidance over the year, how would you do that?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think, you know, when we sat here at the end of the second quarter, we certainly saw pressure in the Housing business. No question that was the driver of the step down last quarter, offset by really, really strong first half. When we think about Lifestyle, you know, record year in 2021 and then an incredibly robust first half, we projected that trend line would continue and that favorability would continue. I would say, you know, the adjustment that we are talking about now is entirely sort of backing out that favorability for the full-year from Lifestyle. So Lifestyle, like I said, it is going to come in very much in line with our original expectations from Investor Day, from the beginning of the year and the real impact is FX. If I think about Lifestyle overall, I would say domestic Connected Living will finish the year very much in line with what we had expected. So a really strong year, really robust growth. Global auto will be ahead of what we originally expected, mainly driven by investment income, which we have talked about being a nice tailwind for the auto business. That favorability in auto, I would say offset by softness in underlying international business results, mainly in Europe, a little bit of pressure in Japan, and then we have got FX layered on top of that. But again, ignoring FX, pretty much in line and I would say auto outperforming and offsetting softness internationally. And then Housing is very much in line with expectations. If we think about what we expected in the third quarter, you know, Housing came in very much in line. We have made tremendous progress to transform Housing. We have reacted with urgency. I’m really proud of the way the team has come together. We have simplified the focus. You saw the exit of sharing economy. We have signaled the exit of international Housing related cat business. We are implementing a new org design to delineate between our Housing risk and capital light to increase our focus, drive even more efficiency. And then just a tremendous amount of work on offsetting inflation not just with expense discipline and prudence, but the work with AIVs that, you know, has started to take hold a little bit this quarter. A lot of progress on rate 31 approved rates with states that are implemented in 2022, several more for early 2023. So just a lot of progress there and I would say Housing pretty much in line as we think about what we said last quarter."
},
{
"speaker": "Tommy McJoynt",
"text": "Thanks. And to follow up on that, what gives you guys confidence that some of the weaker pressures over in Europe and Japan might not spill over into the North American side?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, we have, you know, we certainly expect the pressure in Europe and in Japan to continue. I would say, you know, obviously they are both profitable markets for us. Japan has been an incredible success story. And I think even though there is some softness in the economy, we are very well positioned in the market and there is tremendous long-term opportunity for growth and our team is doing an incredible job. So I feel really good long-term about our position there. Europe’s even more challenged, obviously with the economy and with FX in that marketplace so that we are seeing some softness. I think that persists and continues. We are taking actions to make sure we are simplifying our focus, rationalizing our expense base, but nothing that we are going to do is going to destroy long-term value, disrupt what we do with clients or customers. And then in North America, we have actually seen really robust results. You know, our subscriber counts on mobile in North America postpaid are up sequentially. They are up year-over-year, obviously with the T-mobile acquisition of Sprint. But good momentum, our clients are growing. If you think about our device protection clients in the US on the postpaid side, they are gaining a lot of net adds. I think 70% of the net adds are coming through our client - the client partnerships that we have. So that bodes well for device protection and then trade-in continues to be strong as there is a lot of competition in the broader market, particularly domestically."
},
{
"speaker": "Tommy McJoynt",
"text": "Got it. Thanks. And then just last one for me. In Housing, you recorded the prior period development of $24 million, but the full-year guidance for Housing didn’t change. So was that prior period development already anticipated in the guidance?"
},
{
"speaker": "Keith Demmings",
"text": "So I think, we certainly expected higher claims cost in the quarter and that came through in prior period development versus current accident quarter development and maybe Richard can share some highlights on that. But I would say that, the offset to the prior period development was the significance that we saw both in terms of rate. From AIVs a little bit, but mainly from all the rate adjustments that we have made over the course of last year and then policy growth. We have got 26,000 incremental LPI policies that came through in the quarter as well, which we can talk about. But maybe Richard talk a little bit about the prior period?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, exactly. I think you nailed it. In terms of the prior period development, obviously, when we closed Q2, we put some prior period development in and the best number in our best estimate. On the other hand, when we were looking at our outlook. We said inflation is high, let’s just assume inflation is going to stay at a very high level. So we kind of I would say hedged our bets in terms of where the total loss ratio could go at the end of this year, call it, not really prior period development, but just all-in lost cost. So that came through and we are a decent place there and that was able to absorb some of the prior period development. Of the prior period development, I would say 14 was this year, so it is truly just a movement within the calendar year, and 10 for the prior years. And then as Keith said, our premiums were a little bit better. We are seeing AIVs. We are seeing some new business come on. And so that helped to offset any other variance with the prior year development that came in."
},
{
"speaker": "Tommy McJoynt",
"text": "Got it. Thanks."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Mark Hughes from Truist. Your line is open."
},
{
"speaker": "Mark Hughes",
"text": "Yes thank you good morning. The delay on the trading activity, I got some questions on that. What was the logistical cause of the delay?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. At a high level, relatively simple, so a client - we expected a client to send additional devices to us towards the end of the third quarter and that was delayed for a variety of reasons still to be received in Q4. So it is really just a shift between three and four and it wasn’t so much the lack of volume from a margin perspective. It was the fact that we had staffed labor accordingly to be able to process and receive those devices. So there is a bit of a mismatch between the labor that we had in place in anticipation of the volume, and then the volume being delayed for some logistical reasons in terms of appliance getting us those devices. So something that we expect to ride the ship in the fourth quarter."
},
{
"speaker": "Mark Hughes",
"text": "On the reinsurance, I think you had mentioned that, you were looking at taking up your attention. Could you refresh me the timing of your renewals, I think it renews it a couple of different times through the year. How you anticipate what your early thoughts say about the cost of that program for 2023 versus 2022? And then I guess I would ask from the timing. So just timing, cost retention, if you could address those?"
},
{
"speaker": "Keith Demmings",
"text": "Sure. And maybe Richard, you can start in terms of the timing, and then I can add some color at the end."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Great. Thank you, and, good morning, Mark. So when we think about our reinsurance program full-year, this year will probably be about a 190 million in total cost in it. And how do we looking at the reinsurance program? Really, we need to look at it in terms of total Housing prices. Starting with the total Housing prices and Housing prices have gone up. Inflation has been boosting them, other factors have been boosting them. So if you think about the insurance that we put on the properties, we are putting more insurance on. And then that obviously results in us needing to purchase more insurance. So really by a kind of just a function of the overall book of business growing, we will be placing more reinsurance on the premium will grow. If you think about it having a bigger book of business and more premiums means we do have more exposure at the lower levels and a higher probability that those lower levels will be touched. So as we look at it, it's more of a proportional position that we would take and say, \"Okay, well, what's the right new level for our retention?\" That's why we wanted to signal that, that lower layer will probably go up. It's just kind of a logical conclusion in terms of what's been happening in the market. I would say, as we said a number of times, we are getting rate increases. We are getting increases in average insured values. So we are getting premium increases, the rise in the reinsurance costs, and we are expecting some increase in reinsurance costs given the state of the reinsurance market. That would be an offset to some of the premium increases that we are getting. So I would say sort of logical in that sense. In terms of timing, we typically purchase about 2/3 of our reinsurance at the beginning of the year and then the rest of it at mid-year. We always look at that, that proportion could change as we get into the market and see the dynamics of it."
},
{
"speaker": "Keith Demmings",
"text": "Yes. And maybe just one other comment. I think at the highest level, we certainly expect the reinsurance cost increase to be more than offset by additional rate. Both from the rate increases, but also from inflation guard the average insured value increases. So even with a harder reinsurance market, we have got really strong relationships across a wide range of reinsurers. We partner with over 40 different reinsurers, a strong performing business long term. We continue to simplify the portfolio, which I think helps us as we move forward. And then definitely rising costs, but we anticipate that our rate will be more than sufficient to offset that."
},
{
"speaker": "Mark Hughes",
"text": "So it sounds like what you are seeing on rate in your judgment at this point will more than offset both the underlying inflation and the higher reinsurance costs. Is that right?"
},
{
"speaker": "Richard Dziadzio",
"text": "That is correct, yes. And if I think about Housing, even if we just look at the third quarter revenues are up 3% year-over-year. If you back out the reinstatement premium from the premium line, we would be up 8% year-over-year. So we had 35 million in reinstatement premium this year and eight million in Q3 last year. So that is pretty meaningful up 8%. I would say that is half from rate, very little of that is from this year’s AIV. So we put the AIV increase in July, we talked about double digit rate as a result of AIV. That is had three-months to have an effect, right. So it is really a 24-month cycle. We renew policies over 12-months and they take 12-months to earn. We are three months into that 24-month cycle. So very little of the improvement is from AIV. Most of it is from all of the rate action we have taken at the individual state level, and then from the policy growth that we saw in the third quarter. So that will just continue to build and accelerate as the full effect of AIV rate comes through the program."
},
{
"speaker": "Mark Hughes",
"text": "Your SG&A in lifestyle was up a point sequentially, that number has been a little bit volatile, but any change in the economics of the agreements that you have got with the auto dealers or your carrier partners? I know you just renewed with T-Mobile. Is there maybe a little more sharing you are having to do with those partners these days?"
},
{
"speaker": "Keith Demmings",
"text": "No. So in terms of T-Mobile, you are correct. We did do a multi-year contract extension on top of the multi-year extension that we got a year ago. The deal structure has changed as we pivoted from the in-store repair to leveraging our 500 CPR stores. But in terms of the broad economics, I would say quite simply, we protected the financial integrity of the original deal that we had. So we have restructured the way it operates, but no impact to our EBITDA expectations for that business. And then we further extended the agreement to protect that relationship over time which is really significant in terms of giving us long-term visibility into the U.S. mobile market. So nothing there that would create any economic change to us. In terms of the balance of clients, I would say, you know, tremendous momentum still commercially with our clients. Lots of focus on driving growth, driving innovation, but no fundamental changes in deal structures and services provided. So if we think about the softness in the third quarter in Lifestyle, you know, other than pointing to the broader economy and some of the impacts that I discussed earlier, nothing related to client deal related changes. And then Richard, anything on expense?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, thanks Keith. Yes, exactly, exactly. And no changes to client contracts, but I would say the increase in the overall SG&A is reflecting, you know, some increases in the business growth in the business, you know, particularly in the auto business, obviously there is distribution costs with regard to that. And we have been growing the business over the last year. So there is some commissions in there. Also in our prepared remarks, you heard us talk about some additional investments in our home solutions and, you know, yes, a chunk of that obviously is expensed in the quarter. So those would be the two main drivers Mark."
},
{
"speaker": "Mark Hughes",
"text": "Thank you very much."
},
{
"speaker": "Operator",
"text": "Your next question comes from a line of Gary Ransom from Dowling and Partners. Your line is open."
},
{
"speaker": "Gary Ransom",
"text": "Good morning. I was wondering if you could add a little color on the exit from international Housing. I mean, what, how long will that take and what, you know, size the magnitude of what is being reduced and not, it is not clear to me whether that includes the Caribbean exposure as well, but could you talk about that a little bit?"
},
{
"speaker": "Keith Demmings",
"text": "Sure. And it does include the Caribbean exposure and really anything that we write internationally that is cat exposed homeowners related business, we have made the decision strategically to exit. I would say we will be done writing policies. Most of it will be done this year. There is a little bit that will finish at the end of the first quarter, but we won’t be writing new policies as of Q2 2023. And then depending on how some of the final discussions unwind, you know, maximum, we would have a 12-month runoff on those policies, in some cases shorter. So that is to be finalized and determined. But in terms of the scale of it, I would think about, you know, maybe $50 million in net earned premium in a year as being kind of typical probably takes 10% of our tower. So if you think about the tower that Richard talked about, our reinsurance tower, 10% of that goes to protect the international exposures. And strategically it is been a challenging market hard to get rate. There has been rising costs as we know of claims. We expect rising costs of reinsurance adds a lot of complexity to not only manage the business, but negotiate the reinsurance that backs it. And ultimately with modeled ALLs, fairly limited effect to all-in EBITDA, certainly EBITDA ex-cat, but all-in EBITDA with cat, not hitting our target levels of return risk adjusted. So we are making the decision to further simplify and focus in places, where we think we have clear competitive advantages and where we are differentiated. We are not just a risk taker, we are providing deeply integrated, more differentiated services. That wasn’t the case with this business and we weren’t able to get the returns we wanted."
},
{
"speaker": "Gary Ransom",
"text": "Is some of this business coming through the LPI business as well?"
},
{
"speaker": "Keith Demmings",
"text": "No."
},
{
"speaker": "Gary Ransom",
"text": "No, okay. It is all just separate homeowners business basically."
},
{
"speaker": "Keith Demmings",
"text": "Yes, separate homeowners, some of it were a reinsurer, some of it were direct writer. But none of it connects to what we do in LPI. An LPI is really unique. It is an incredibly advantaged business in terms of how we operate, how we are integrated and we create much more value than just being a risk taker. And we are able to get rate and we are able to drive the right level of profitability over time in that business. So it is quite a different business to manage versus what we have been working within the international property side."
},
{
"speaker": "Gary Ransom",
"text": "Great. Thank you very much. And I also wanted to ask about two acquisitions. I know you had the EPG acquisition, maybe it is a couple of years ago now. But do those all fit together? I mean, is there some consolidation potential. And just I wonder is that a market size that will be additive to the growth you are thinking about over the long run?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I think that is exactly right. If we think about the EPG acquisition and then the acquisition that we are talking about now, it is really to build on the strength that we have got in that market around commercial equipment, leased and finance equipment. We have had good results and strong growth. And we operate this business both in our Housing side and Lifestyle side. So we are going to evaluate how to drive more synergies through the organization, as we move forward. But absolutely, it is capital light fee income. We are talking about small tuck-in acquisitions of existing clients that are high performing. We are already underwriting the business and it is really just buying the administrative capability and the scale to drive that forward. So we definitely see growth in this line of business, and we think it can accelerate as we make some - what are really quite small acquisitions, but can add a lot of value to our franchise."
},
{
"speaker": "Gary Ransom",
"text": "Yes. You said that, some of it is in Housing and some of it is in Lifestyle. I guess I sort of thought of it as, sort of similar to the auto business. But maybe I was wrong on that."
},
{
"speaker": "Keith Demmings",
"text": "Very much. I think we write two different product lines when we think about heavy equipment and commercial equipment, some of it is service contracts, some of it is physical damage. Operates very consistently, really predictable strong profitability and that has been the legacy of how we have been set up as an organization. So one of the things that we are focused on now is, as I talked about some of the Housing realignment between risk-based homeowner’s business and fee income capital light is just thinking about how do we create maximum efficiency and effectiveness organizationally, how do we create clarity in terms of where we want to focus to drive growth? What is the mindset that we need leading various different products? And then make sure that, we have got the least amount of friction in how we are organized as possible. So more changes to come as we think about our go-to-market strategy longer-term."
},
{
"speaker": "Gary Ransom",
"text": "Okay. Thank you very much. And actually just one more maybe a bigger picture question, when you are thinking about all these macro impacts inflation for exchange and then putting that in the context of how you were thinking about 2023 and 2024 before. I’m not even really asking whether you think about hitting the 2024 or not, but just how your thinking might have changed? And what - we have had these couple of disappointments in the second and third quarter. What did that do for your thinking about the outlook as we go into 2024 and maybe even longer?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I think it probably - we step back and reflect on just how uncertain and complicated the environment is. That is true for Assurant and it is true for most companies today. So there is a lot of market volatility, market uncertainty. Interest rates are moving quickly. The economy obviously is going to shift over the course of the coming quarters, and we will see how that lands. So there is just a recognition of the complexity. And then like I talked about earlier, we knew Housing was going to be weaker this year. We thought the outperformance in Lifestyle would make up that gap as we thought about 2024. We certainly expect to continue to see the Housing growth. It is no doubt going to grow as we think forward over the next couple of years. But the question mark is around can Lifestyle outperform at the level that we would have needed to in order to offset that Housing softness? And Housing is probably more of a delay than a pivot in terms of what our expectations are. It is really just that we are a year behind where we thought we would be. But we are seeing evidence of significant improvement. And I think right now, given the uncertainty is particularly in the international markets, just taking a step back, like I said, finish the fourth quarter, deliver on a really strong plan in terms of what we expect to accomplish in 2023 relative to expenses as well as driving the right outcomes with our clients. And then stepping back and revisiting what is possible as we think about the longer term and then providing some color on a more informed basis in February."
},
{
"speaker": "Gary Ransom",
"text": "Terrific. Thank you very much."
},
{
"speaker": "Keith Demmings",
"text": "You are welcome."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of John Barnidge from Piper Sandler. Your line is open."
},
{
"speaker": "John Barnidge",
"text": "Good morning and thank you very much. You have had expanded partnerships in the lifestyle business announced this year. I had a couple of questions on that. In light of inflationary pressures, one, can you talk about how you manage that inflationary volatility? And then can you contrast that with - could that pressure actually lead to more partners looking to outsource more of their service management and refurbishment of mobile devices?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, it is interesting. If I start with the second point first, just on outsourcing and this ebbs and flows over time, but I think as we think about a more challenging economy going forward, if we think about a recessionary environment, oftentimes, we will see clients focusing on core. And the same for us, how do we focus on the things where we can generate the greatest amount of return? How do we prioritize what is critically important to the company? I think clients do the same thing. So as clients reprioritize their focus, there may be opportunities for them to say, \"Hey, is there someone else in the market that is better equipped to help me with something because it is just not the burning priority at the moment. So we will see how that evolves. That sort of happens over time, but it is certainly reasonable to expect as we continue to build scale and as we have better and better capabilities that are efficiently operated, we can provide a great source of value to our partners over time. So I think hopefully, that trend continues. In terms of the volatility in Lifestyle, from a macro environment, I think if you step back and look at the totality of the year, we have signaled some puts and takes around kind of the inflationary environment. You know, in lifestyle we see, you know, it is strong investment income, certainly flowing through the auto business, which is the biggest source of our portfolio. So that is a positive. We have seen mobile losses that I talked about earlier, performing quite well, not because of inflation, but because frequency of claims is reduced a little bit. And then how we are doing with controlling severity through walk and repair, et cetera. And then we have had favorability and GAAP losses on the auto side, which we have talked about. And then two-thirds of the time we are not on the risk and we are sharing that risk back with our partners. So that leaves us with a third of the deals where we are more, let’s call it, more exposed to those pressures. And we are seeing losses on the risk side escalating. It is not a huge part of the portfolio. It is not a big part of our narrative this quarter, but certainly on the ESC side, cost of parts and labor, a little bit on the auto side as well. And then there is labor inflation and we try to offset labor inflation with, you know, with digital initiatives and investments in optimizing our operational transformation efforts. So those would be the big highlights on balance, you know, not a huge driver for the year, but certainly FX and softness internationally, which is, you know, we are feeling more of that is a pressure we expect as we go forward. And do, I do think continued elevation of claims. And then our job will be to, you know, make sure that we have got the right pricing in place with clients that we are restructuring deals and we are trying to drive more stability over time."
},
{
"speaker": "John Barnidge",
"text": "Thank you. That is helpful. And then following up on that, wanted to go back to, you know, the pre-announcement. You talked about simplifying the business portfolio. You talked about exiting commercial liability and international Housing catastrophe. Have you completed that simplification of the business portfolio or could there be additional niche lines you look to exit in the near to intermediate term?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, great question. I would say, you know, we have, I think we have had a very successful track record of managing the portfolio, and you have seen us do that consistently over many years. You know, there is certainly more things that we will evaluate in terms of smaller product lines and making sure that we are investing in places where we have clear competitive advantages. I think about, you know, we need a strong right to win and the size of the prize needs to be meaningful. And there are probably other pockets where we could, where we could continue to refine the portfolio over time. And I think that will continue permanently. That is always going to be a part of our DNA, is to look to optimize and create more focus on things that can more significantly move the needle and try to limit the distraction for the company. Focusing energy on products that are smaller, don’t contribute significantly to the profitability of the company. If that effort can be better placed elsewhere to drive more meaningful growth, those are the choices and trade-offs that our management team is making on a regular basis."
},
{
"speaker": "John Barnidge",
"text": "Thank you very much. And my last question, you talked about $12 million in buybacks in October. Does that seem like a reasonable run rate for the fourth quarter given the M&A transactions?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, maybe I will offer a couple thoughts and then certainly Richard can jump in. I think when we step back and think about capital management at the highest level, we have talked about, you know, our focus on continuing to be very disciplined in terms of how we think about our capital. We have indicated an interest in being balanced between share buybacks and M&A. If you think about where we sit year to date, we have done $567 million in share repurchases and then $80 million we have signaled in M&A. So repurchases has been a big part of the story this year nearly 90% of the capital that we have deployed in that respect. So I think we feel good about meeting our commitment on the Preneed return. We feel good about meeting our commitment to in a normal year to $200 million to $300 million of share repurchases. But we also recognize the market is really challenging. There is a lot of interest rate volatility and we want to be more prudent in terms of capital management. And it is really just about maintaining flexibility, protecting our financial strength and then looking for the market to stabilize and for visibility to improve. And then as we look toward the future, we see our stock price is extremely attractive. So as we think about future M&A, we will have to have a very high hurdle rate in terms of the M&A relative to what a share buyback looks like today. But Richard, is there anything else you would add?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. I guess, just to add on to what you said, I mean, in terms of share repurchases this year, we are already through October at little than $550 million in addition to that, $113 million in dividends. So that brings us to about say $670 million. So we had targets at the beginning of the year. We wanted to make sure we hit them for the year. And I would say we have hit them, which is why we signaled we would be at the lower end of that $200 million to $300 we had talked about earlier in terms of repurchases outside of the Preneed proceeds that we repurchased. And as Keith said, it is uncertain market conditions, and we want to make sure we continue to invest in ourselves and we continue to do the right things and remain disciplined with capital. So no change in our philosophy, our capital philosophy, the discipline we have, keeping the balance sheet very strong. As Keith said, we have always said, we always look at deployment of capital between share repurchases and M&A and in these markets with the share price where it is, the share price obviously from our perspective is extremely attractive today. So that creates a higher bar for M&A."
},
{
"speaker": "John Barnidge",
"text": "Thank you very much for your answers."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "And your next question comes from the line of Jeff Schmitt from William Blair. Your line is open."
},
{
"speaker": "Jeff Schmitt",
"text": "Good morning everyone. In Global Lifestyle, I understand the inflation impact being low on the claims side just because you don’t retain a ton of the risk. But what about for SG&A? How much of that is employee comp and what level of wage inflation are you seeing there kind of relative to last year?"
},
{
"speaker": "Keith Demmings",
"text": "I think we are generally doing a pretty good job of offsetting wage inflation automation and our digital efforts. So certainly paying our employees more is important in the war on talent, to make sure that we are staying competitive, but I think we are doing a really good job offsetting that with our efforts on driving automation through our operations."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. And then in Global Housing, I’m just trying to understand the numbers. When I adjust for add back that reinstatement premium, brings that attritional loss ratio down to I think 38%. And then if you back out the unfavorable development, it brings it down quite a bit more, 33%, 34%. So I’m trying to understand, you are talking about the pressures that you are seeing there. I think you are pushing for double-digit rate increases. I guess where is that pressure being felt or I guess why is that sort of loss pick as low as it is?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. Maybe, Richard, just talk - I think we don’t we don’t see it at that level. But maybe Richard just talk about our view on kind of the normalized loss ratio in the quarter."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. And I would start, it is a great question, Jeff. I think - I would first start by - when we go in for rate increases, we are looking at it kind of bottom line. So you have to take in - you are looking at the non-cat loss ratio. I think you have to look at all-in. If you look at our combined ratio for the quarter with Hurricane Ian, it is over 100%, obviously. So that will be taken into account when we go and go for rate increases. And essentially, what we end up doing with our non-cat loss ratio, there are a couple of different moving parts. If you think about it from a net earned premium part, we have cats that the reinstatement premium, we have to add that back, but also from the incurred claims, we have to take out the prior year development. When we add back the cats and we get to kind of like from a 68% that you see in the supplement to about 45%, and then we take out the $24 million of prior period development, we get to about 40%. You are a little bit lighter. So there is maybe a numerator/denominator thing. But I think your point is a good one. You would say 40%, that looks low. But it is really the all-in cost, including cat, including the expenses, the tracking, et cetera, that are taken into account when we go for rates. So it is a bigger number on an all-in basis."
},
{
"speaker": "Jeff Schmitt",
"text": "Alright, got t. okay, thank you."
},
{
"speaker": "Keith Demmings",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "And your final question comes from the line of Grace Carter from Bank of America. Your line is open."
},
{
"speaker": "Grace Carter",
"text": "Hello everyone. So I was wondering in the Lifestyle book, just given how much of that risk that you don’t retain, it seems like inflationary pressures have been a bit more persistent than maybe a lot of people originally hoped. I know that you had mentioned in the past that you hadn’t really been seeing too much pushback from your clients regarding your profit sharing and reinsurance arrangements. I was just wondering if given the persistency of inflationary pressures and that actually started to show a little bit in the results in the quarter, if those conversations had evolved any in the past few months?"
},
{
"speaker": "Keith Demmings",
"text": "No, I would say the clients that are currently in profit share and reinsurance structures, that is the preferred approach for those clients. Those programs are typically quite large, very sophisticated. The clients understand the program economics and there is a tremendous amount of transparency in those deals, and there is sufficient profitability in those structures that can absorb the inflationary pressure. So from a client perspective, no interest in moving away from those structures. And then clients where we are more on the risk, over time, we will certainly see discussions evolve and emerge as clients become more sophisticated and interested in taking on more of the risk. That may evolve over time. But generally speaking, it has been pretty steady. And I wouldn’t say it is a huge source of discussion with our teams."
},
{
"speaker": "Grace Carter",
"text": "Perfect, thank you. And I guess just kind of thinking of how the Lifestyle book has evolved over time, moving from sort of more of the protection in towards more fee-based services. I mean is the recent emphasis on growing fee-based services like trade-ins, upgrades, whatnot change the level of macro sensitivity today versus maybe what we have seen in downturns in the past or do you consider it to be pretty even?"
},
{
"speaker": "Keith Demmings",
"text": "I think it is pretty stable. I would say when you think about fee-based services, even what we do for clients that are reinsured, that doesn’t show up in fee income. So if you think about administrative fees and underwriting fees where we are not sitting on the risk, it still flows through outside of the fee income line, but it behaves a lot more like fee income. We get stated fees for providing insurance and related services. So that is still a significant driver of our overall economics, and that doesn’t show up in the fee income line. And then I think the thing we are excited about is the balance that we have today. We do a lot more work with partners across the value chain. So trade in related services are important to our clients and increasingly important and it gives us another way to add value for our customers. It is more defensible competitively, and then we can create other unique ways to drive value longer term because we are playing in a broader set of services across the ecosystem. So from that perspective, I think it is really favorable and it does create more balance, but the bulk of the economics on the parts where we don’t take the risk are also quite predictable. And that is evolved over time as well."
},
{
"speaker": "Grace Carter",
"text": "Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Wonderful. Well, thanks everybody. Just a couple of closing comments from me. We believe we have performed well in what is a really challenging macroeconomic environment and remain differentiated in terms of our business model with compelling long term earnings growth potential and cash flow generation capability. We look forward to closing the year strong, and we will talk to everybody on our fourth quarter call-in February. In the meantime, as usual, please reach out to Suzanne or Sean with any follow up questions and thanks everybody. Have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 2 | 2,022 | 2022-08-03 08:00:00 | Operator: Welcome to Assurant's Second Quarter 2022 Conference Call and Webcast. [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2022 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the second quarter of 2022. The release and corresponding financial supplement are available on assurant.com. We will start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement that can be found on our website. We have revised all quarterly and annual results for full year 2020 through first quarter 2022 periods to reflect the change in the adjusted EBITDA calculation to exclude certain businesses that we now expect to exit fully, including our sharing economy and small commercial businesses and Global Housing as well as certain legacy long-duration insurance policies within Global Lifestyle. Results have been revised for the correction of any errors related to reinsurance of claims and benefits payable within the Global Lifestyle segment that occurred in late 2018 through first quarter 2022 as well as other immaterial corrections. The impact of these changes individually or in the aggregate, is not material to results for any prior period. A full reconciliation of certain reported and revised key measures of performance and metrics is provided in our second quarter financial supplement posted on assurant.com. I will now turn the call over to Keith.
Keith Demmings: Thanks, Suzanne, and good morning, everyone. As we outlined during our recent Investor Day in March, we aspire to be the leading global business services company supporting the advancement of the connected world. And so far in 2022, we've made solid progress delivering on that vision for the benefit of our clients and their customers, our employees and importantly, our shareholders. We delivered adjusted EPS of $7.22, up 13% in the first half of last year, and adjusted EBITDA was $592 million, both excluding reportable catastrophe losses. We're very pleased that Global Lifestyle had such a strong first half of the year with momentum expected to continue, led by both mobile and auto. Our capital-light and fee income based businesses represented 82% of our adjusted EBITDA ex-cat so far this year and continue to add to the value of our franchise. While results in Global Housing were below expectations, largely driven by broader inflationary pressures seen across our industry, we have a clear path and several key actions underway to address near-term macro challenges. Longer term, we continue to believe that our combined housing and lifestyle portfolio of businesses is positioned to deliver attractive earnings growth and strong cash flow generation relative to the broader market, while also providing a compelling countercyclical hedge in what remains a volatile economic landscape. As we look at our Global Lifestyle segment, our business services-oriented offerings generated adjusted EBITDA growth of 12% year-over-year and 14% year-to-date. Our market-leading franchise helped us expand our partnership with several world-class brands in the lifestyle market. In the U.S., we recently signed a multiyear renewal with a large cable operator within our mobile business. This includes comprehensive device protection, trade-in and premium technical support. With the renewal, we'll be including new capabilities, demonstrating our ability to grow relationships with value-added services that ultimately lead to a better customer experience. We've now renewed two major U.S. cable operators in our mobile business within the last year, while also broadening our product offerings to support their growing mobile subscriber bases. We're pleased with the continued growth momentum in Global Lifestyle, which we expect will continue into the second half of 2022. As a result, we believe the segment will deliver mid- to high teens growth in adjusted EBITDA, mainly from strong mobile results, including device protection and trade-in as well as from the continued strength of our auto business. Turning to Global Housing. Similar to others in the industry, we were impacted by significant inflationary pressure, which resulted in higher claim severities and reinsurance costs in the quarter, most notably in lender-placed. These higher costs are expected to be mitigated through rate adjustments over time. In addition to regular rate filings in key states, our lender-placed product includes an inflation guard feature designed to address changes in material and labor costs. We recently implemented a double-digit rate increase on policy renewals. This rate increase will be applied to all renewals over the next 12 months. As a result, there is a timing lag that is magnifying the higher non-cat loss experience in the quarter and ultimately pressuring results through 2022. We believe this will normalize as incremental premiums earn over time. As we look at the housing portfolio, we're also taking other actions to improve profitability through ongoing expense efficiencies and driving even greater focus on the housing businesses where we see a path to market-leading positions that can deliver attractive financial returns. Most recently, we decided to exit the sharing economy business. The strategic and financial objectives for this business did not develop as we originally anticipated, and we want to focus on opportunities that more closely align to our long-term vision and where we have market advantages with a clear right to win. Stepping back and looking at Assurant overall, we believe we have an attractive portfolio of market-leading businesses, which are poised for long-term success. Given the current macro environment, we believe we can deliver adjusted EBITDA growth of 3% to 6%. This takes into account higher expected losses in housing, but also stronger results and momentum within Global Lifestyle. Adjusted earnings per share, excluding reportable cats, is now expected to grow 14% to 18% for the full year, reflecting this view of adjusted EBITDA. EPS growth will, of course, also be supported by share repurchases, including the return of $900 million in pre-need sale proceeds, which was completed in the second quarter. As we've shown historically through various market cycles, we believe we are well positioned to deliver our strategic objectives over the long term. We expect this period of macroeconomic challenges to be no different. Over time, we believe the strength and resiliency of our business model will endure, enabling us to execute on the 2023 and 2024 objectives we outlined at Investor Day. Looking forward, we expect adjusted EBITDA acceleration starting next year. While the earnings path may not be linear, we remain confident that in the long term, our combined lifestyle and housing business portfolio will continue to deliver attractive growth, strong cash flow generation and superior shareholder returns relative to the broader market. I'll now turn the call over to Richard to review the second quarter results and our revised 2022 outlook in greater detail.
Richard Dziadzio: Thank you, Keith, and good morning, everyone. Adjusted EBITDA, excluding catastrophes, totaled $277 million, down 8% from the second quarter of 2021. As Keith mentioned, performance reflected the strong growth across global lifestyle and weaker results in Global Housing. For the quarter, we reported adjusted earnings per share excluding reportable catastrophes, of $3.25, flat from the prior year period. The 2021 baseline for lifestyle and housing adjusted EBITDA has been updated to remove noncore operations and reflect the accounting correction, Suzanne noted to our prior period results. Now let's move to segment results, starting in Global Lifestyle. The segment reported adjusted EBITDA of $207 million in the second quarter, a year-over-year increase of 12% driven by growth across both Connected Living and Global Automotive. Connected Living earnings increased by $12 million or 11% year-over-year. The increase was primarily driven by continued mobile expansion in North America device protection programs from cable operator and carrier clients, including subscriber growth and more favorable loss experience. This was partially offset by unfavorable foreign exchange. In Global Automotive, earnings increased $10 million or 15%, primarily from higher investment income, including higher real estate gains and yields, favorable loss experience and select ancillary products also contributed to the results. As we look at revenue, Lifestyle revenue was up by $48 million or 3%, driven by continued growth in Global Automotive. Global Automotive revenue increased 7%, reflecting strong prior period sales of vehicle service contracts. Despite the overall U.S. auto market showing signs of slowing, our net written premiums remained strong even against the record second quarter of 2021, as additional dealerships and strong attachment rates are offsetting the market headwinds. Within Connected Living, revenue was down slightly due to lower revenue in mobile, mainly from premium declines from runoff programs and unfavorable foreign exchange. This was partially offset by growth in subscribers in North America and higher mobile fee income driven by global mobile devices serviced. In the second quarter, the number of global mobile devices service increased by $1.1 million or approximately 18% to $7.2 million. This was due to higher trading volumes, supported by new phone introductions and carrier promotions from the growing adoption of 5G devices. In terms of mobile subscribers, growth in North America was partially offset by declines in runoff mobile programs previously mentioned, which also impacted mobile devices protected sequentially. For full year 2022, we now expect lifestyle adjusted EBITDA growth to be mid- to high teens compared to 2021 baseline of $702 million. Mobile is expected to be the key driver of adjusted EBITDA growth for global expansion in existing and new clients across device protection and trade-in and upgrade programs. This will be partially offset by unfavorable impacts, from foreign exchange and strategic investments to support new business opportunities and client implementations. Auto adjusted EBITDA is expected to grow for the full year. But earnings in the second half are expected to be lower than the first half, mainly due to the absence of $14 million of real estate gains. Growth for the year will be partially offset by higher investment income and more favorable loss experience in select ancillary products. Moving to Global Housing. Adjusted EBITDA was $75 million, which included $20 million of reportable catastrophes for the second quarter. Excluding catastrophe losses, earnings decreased $40 million, primarily driven by $25 million in higher non-cat loss experience, largely in lender-placed and to a lesser extent, Multifamily Housing. This included $12 million in year-over-year reserve strengthening and higher fire losses in the quarter. The balance of the earnings reduction was driven mainly from $17 million in higher catastrophe reinsurance costs. The cost of our reinsurance program reflected both the higher exposures and increased pricing within the reinsurance market. And with the completion of our 2022 catastrophe reinsurance program in June, we believe we fared relatively well in the market given our strong relationships with our more than 40 reinsurance partners. We maintained an $80 million per event retention including second and third events. We also continued to benefit from the placement of multiyear coverage covering 45% of our program and a cascading feature that provides multi-event protection. In Multifamily Housing, growth in our P&C channels was offset by increased non-cat losses and expenses from ongoing investments to expand our capabilities and further strengthen our client experience. Global Housing revenue was flat year-over-year as higher catastrophe reinsurance costs were offset by higher average insured values and lender placed. For the full year, we now expect Global Housing adjusted EBITDA, excluding cats, to decline by low to mid-teens from the 2021 baseline of $512 million. In addition to the higher claims costs, REO volumes have continued to be muted and placement rate trends we are seeing are softer than originally expected. At the same time, we continue to realize expense efficiencies from new system enhancements and strength in digital capabilities. While the duration and magnitude of inflationary trends remain fluid, rate filings and inflation guards are expected to start to flow through premiums as we exit the year. At corporate, adjusted EBITDA loss was $25 million, up $8 million compared to the unusually low second quarter of 2021. This was mainly driven by higher employee-related and technology expenses. For full year 2022, we expect the corporate adjusted EBITDA loss to be approximately $105 million. Turning to holding company liquidity. We ended the second quarter with $595 million, $370 million above our current minimum target level. In the second quarter, dividends from our operating segments totaled $189 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items: $232 million of share repurchases; $75 million from the repayment of our 2023 notes; and $39 million in common stock dividends. For the full year, our outlook assumes $365 million of shares repurchased from the remaining premium sale proceeds plus an additional $200 million to $300 million. Through July, we've bought back $504 million worth of our stock. Given changes in investment portfolio values, reserve strengthening for noncore operations and accounting adjustments, we expect segment dividend to be moderately below our target of roughly 3/4 of segment adjusted EBITDA, including catastrophes. While lower, we still expect capital generation to be strong given our business model and product mix. As always, segment dividends are subject to the growth of the businesses, rating agency and regulatory capital requirements and investment portfolio performance. In conclusion, we believe Assurant is well-positioned for long-term growth and strong capital generation, underscored by the attractive portfolio of Global Lifestyle and Global Housing businesses. And with that, operator, please open the call for questions.
Operator: [Operator Instructions]. Your first question comes from the line of Michael Phillips from Morgan Stanley.
Michael Phillips: So I guess I want to talk on the inflationary pressures you're seeing on the lender-placed, but can we switch that over to the lifestyle side? And anything that you're seeing there on either Auto or Mobile, maybe you can talk about how much risk you retain on that side. It's clearly not 100%. But anything that you're seeing there that might cause pressure from inflationary pressures there? And if so, kind of your ability to combat that?
Keith Demmings: Terrific. Yes. So I think the Lifestyle business has obviously performed very well this year. We've raised the outlook for the full year. So we're confident in the momentum. I would say in terms of the resiliency, we've been dealing with a couple of things, certainly inflationary pressures, but also supply chain constraints as you think about the last couple of years of the pandemic, particularly around parts, both on the Connected Living and the Auto side. So I think the nature of our deal structures is quite favorable. 2/3 of the time we're not holding the risk relative to the services we perform and the programs that we manage. So that's been very helpful. I'd say we've got a stronger orientation to fee income, even in deals where we retain risk, we're targeting fees. We've got typically allowable loss ratios, ability to reprice. You will see timing issues occur in terms of -- sometimes losses are a little higher, we may recover that over time with client deal structures. But it hasn't been an issue that's emerged over the course of the last several quarters. We feel really good about it, certainly never fully insulated, but a very different operating model. And then if you think about inflation on the housing side, we've got rate filings, inflation guard and a number of factors that are being put in place to combat that. So lifestyle has been quite resilient from that perspective.
Michael Phillips: Okay. Okay. You mentioned, Keith, on the opening comments about -- on the lender-placed side, in inflation guard and then you also mentioned double-digit on renewals. Was that the same -- was that double digit? Was that the inflation guard? Or is that on top of the inflation gaurd?
Keith Demmings: So the -- so if you think about inflation guard, we put a double-digit rate increase in July. So that is going to flow through the book as it renews. We've also got regular course rate filings. We've been accelerating rate filings with states, obviously, as severities have been higher and losses have been higher. We've actually gotten 30 state rate filings approved this year, not all of which have been fully implemented, but they're all approved and will be implemented by the end of the next year -- or by the end of this year, sorry. And then we've got an additional set of discussions ongoing with states. So that additional rate layers on top of the double-digit increase that we talked about relative to inflation guard.
Michael Phillips: Is there any difference in here, can you maybe just talk about the difference that you have in those other rate filings by state that you're alluding to, different than a traditional, say, homeowners insurance company where the clients are individuals like me and you, your clients knowing your place are a little different. So does that give any differences in the ability, the speed at which or the ability to take higher rate and the speed that you can take them than maybe a traditional insurance company?
Keith Demmings: Yes. I think probably a couple of things. First of all, these are short-tail policies, they're annual policies. So as we do get rate, it flows through over a 12-month period, number one. I think the fact that we've got inflation guard built into the product, we don't have to get approval. That's already approved, and we just apply an inflationary factor every year. That drives AIVs up and corresponding increases to rate. So that -- I would call that normal course. Obviously, inflation is elevated. The industry data supports a higher inflation factor driving more AIV. In terms of the rate, I think as we work with states, we're really looking at the historical experience to justify the increases that we're getting. And I'd say that, that happens like very consistently with what other insurers would be doing. But we've been more aggressive as others have, just in terms of the heightened severities that we're seeing in the marketplace. So good opportunity to get rate. We're looking to make fair returns on the business. I would say it doesn't have a huge impact on volume. So we've got exceptional relationships with our clients. Obviously, this is a lender-placed policy, and we expect to see consistent policy counts as we move forward even in this higher inflationary environment with more rate flowing through.
Michael Phillips: Congrats, and best of luck in the future.
Operator: Our next question comes from the line of Jeff Schmitt from William Blair.
Jeffrey Schmitt: What is your view on where the placement rate in the lender-placed business could go next year if we move into a recession, whether we're in one now or not, let's say, sort of a deeper recession if interest rates continue to move up, could that move above 2% pretty quickly? Or where do you think that could go?
Keith Demmings: Yes. I think it depends on a range of factors. I would say that as you see the placement rates are relatively stable and have been so for several quarters, and that's just the strength of the housing market, the fact that there's so much positive equity. And I also think about placement rate really tracking closely to delinquency and you've got a prevalence of servicers working on loan modifications, a lot of loss mitigation efforts that's really limiting delinquency, it's limiting foreclosure activity. Obviously, if that starts to shift and that starts to change and delinquency rates rise at any level significantly, that would have a corresponding impact on our placement rate. Obviously, if there are more foreclosures that would drive up our REO volumes, which are really probably 1/3 of pre-pandemic level. So there's certainly upside over time in placement rate. The real question is, when does that emerge in the economy just because of the strength of the Housing market. You've also got rising interest rate pressure, certainly, a hardening voluntary insurance market, higher inflationary pressure. So I think we need to see how the economy responds and how consumers respond to get a better feel. We're not counting on a big increase in placement rates as we think about our longer-term expectations. And obviously, if that does happen, that's where we talk about it being a countercyclical hedge from a housing perspective.
Jeffrey Schmitt: Right. Okay. That makes sense. And then the expense ratio in Global Housing continues to run above 46%. I think in the past, you've guided to sort of 44% to 46%. Is there some kind of inflation driving that higher? Or when do you think it could move below that 46% level?
Keith Demmings: Yes. And maybe, Richard, do you want to talk about expenses?
Richard Dziadzio: Yes. Yes, it's a great question. It is up a little bit over the last quarter to 46%. So I think you're right. It's a little bit higher than we'd like to see it. We are -- we've talked about in previous calls. We are investing digitalization in projects like that, create more efficiencies, as Keith said in his opening remarks. So we would see that, I would say, over time as these projects and these efforts come through. Also, the first question on placement rates as the volumes of the business grow, obviously, the things that we have in place in our operations are very leverageable. So that would also bring down the expense ratio over time.
Operator: Your next question comes from the line of Tommy McJoynt from KBW.
Tommy McJoynt: So what are the expectations for the noncore operations loss contribution going forward? Is that meant to be more of a breakeven? I know it's excluded from the guidance. And what's the general time horizon for that wind down?
Keith Demmings: Sure. Maybe I can start, and then Richard can add on. So we made the decision this quarter, as we talked about, to exit all of our long-tail liability business and driven by the decision around sharing economy. So as we talked about, just wasn't strategically aligned with the direction that we're headed as a company. And it was highly specialized niche business with inherent risk and volatility. We didn't see a path to leadership. We didn't think we could generate the financial returns. But it wasn't strategically aligned with the direction of the company. So as part of that, all of the clients have already been notified. All of the contracts will be non-renewed. I would say, by first quarter of '23, the net earned premium will be immaterial. And by this time next year, it will be gone completely, really just at that point, managing the runoff. As you saw, we put up a reserve. So as we exited did a very comprehensive top-to-bottom review of the performance of the business, I did a lot of scenario analysis to try to think about how this could emerge over time, put up a full reserve to adequately cover the runoff, which we think is appropriate and look to put this behind us.
Tommy McJoynt: Okay. And I guess, as you kind of explored what to do with those businesses, there was no way to sort of monetize what you've built there. And I guess, just you have typically been kind of sellers and ways to monetize things, there just wouldn't be any kind of takers for those businesses?
Keith Demmings: Yes. I think potentially, we could have looked at that as a path. We didn't see it viable. And really, it could have become a distraction to focusing on driving growth through the rest of the organization. We will certainly consider alternatives now that we've put it in runoff to see if there's a way to structure something around sharing the risk with a third party. That's certainly possible, and we'll look to consider that. But the value for monetization, I would say, was lower than the distraction factor of trying to work through that process quite candidly.
Operator: Your next question comes from the line of Mark Hughes from Truist Securities.
Mark Hughes: The multifamily business is kind of flat in terms of top line this quarter. What's happening there?
Keith Demmings: Yes. So a couple of things. First of all, I would say we feel like we're really well-positioned in the retros business. We've got 2.6 million customers. So it's giving us a great opportunity in terms of market leadership, scale. We've been investing in the customer experience, deepening our expertise. So we do expect long-term growth. It's a very attractive part of the market. I would say in terms of the results being flat, we do have strength in growth within the property management company channel. So that continues to grow exceptionally well. We're gaining share. We're driving attach rates, and we're having a lot of success with our Cover360 product, really just more integrated into the byflow. We've talked about better digital tools, collecting the insurance as part of the rent and just leveraging our full capability. So that's going extremely well. We have an affinity portion of our business, which the growth has slowed where we partner with insurance companies. I think as insurance companies have been focusing on getting rate and dealing with inflationary pressures, a little less marketing generally with some of our partners. So I think that normalizes over time as the economy finds more stability in the future. But we are seeing growth, and we do think long-term growth will emerge as we continue to focus on this part of our business.
Mark Hughes: And, Richard, the investment portfolio, what do you anticipate in terms of the progression in the yield? What's the new money yield? What kind of turnover is there in the portfolio? A little bit on that would be helpful.
Richard Dziadzio: Yes, sure, Mark. Yes. First of all, I would say that rising interest rates overall are good for the business, and we've been seeing that in this quarter as well. We've had some real estate gains, as we mentioned in our remarks, but we also have fixed income and yields on fixed income raising. We have a 5-year duration. So think about 20% of the portfolio rolling over every year. So we won't have any quantum step in terms of long-term rates and long-term yields. But it will gradually increase over time, which is a good thing. I think you probably saw the yield for this quarter over 3.5%, which is quite good. What's interesting too about it is if we look at our book of business, if we go back a year from now, the assets that were coming to maturity or the fixed income coming to maturity, we're rolling over at lower levels than they were maturing at. Now they're rolling over for the most part at higher levels. So that bodes well for the future. And short-term rates, yes, we have some of our money and cash, obviously. And we're getting an immediate impact on that. Obviously, smaller dollars given a smaller level of cash that we have relative to the fixed income portfolio.
Mark Hughes: Then, Keith, you had -- I think you said you expect adjusted EBITDA to accelerate next year. Could I hear that properly? And any other metrics you want to throw out for next year, maybe EPS growth?
Keith Demmings: Yes. I think as we look at the year at 3% to 6% in terms of our EBITDA growth. We certainly expect that to be increasing as we move into 2023. And I'd say, largely, we do expect the lender-placed business and Housing overall to continue to improve as we get more rate. And then we do have great momentum in Lifestyle. So we haven't set the specific target for 2023 and 2024. What we have said is on average, we want to deliver north of 10% EBITDA growth. We're still committed to our long-term objectives from Investor Day, which I think is really important. And we're going to do everything we can to deliver those results and be accountable to delivering our financial commitments.
Mark Hughes: And then just one final one. The timing of the rate increase is going to get the inflation guard for the lender-placed, does that only kick in if there is a renewal cycle around that? Or why wouldn't that kick in immediately?
Keith Demmings: Yes. So the policies are annual, and they renew it each year. So if you think about, let's take July, for example, we put in place double-digit rate increases for the cohort of annual policies that renewed in July. So think about that rate going in 1\12 at a time over 12 months and then think about it earning 1/12 at a time after it's in place. So the whole cycle takes 24 months, but it builds momentum month by month by month. And then we've also got, as I said, state-related rate increases that go in at different periods in the year. That's also contributing. And I mentioned 30 approved rates really affecting about 75% of our premium overall and then a number of additional filings that are ongoing. So we do feel like we've got a great opportunity with rate, it's a terrific mechanism and designed to deal with inflationary pressures. And we expect it to work, and we expect to get the housing business where it needs to be from a total return perspective. The one thing that's interesting, if you think about Housing, and it's a tough quarter, right? We're not pleased with the results in the quarter. The first half housing combined ratio is 86%. The first half annualized ROE, it's 20.6%. That will normalize as we get through the rest of the year. But we still think it will be quite strong overall, given we're underperforming our own expectations. So I do want to highlight that as the backdrop. It is a strong business. It generates tremendous cash flow. We've got great market-leading advantages, and the financial performance is still strong. It's just not where we want it to be to deliver on our total commitments.
Operator: Your next question comes from the line of John Barnidge from Piper Sandler.
John Barnidge: You talked about a -- signing a multiyear renewal with a cable operator. Last quarter, you also talked about an expanded relationship. Can you talk about maybe what the renewal calendar looks like? And how do you think about potential hit rates for expanded relationships as you come up on renewal?
Keith Demmings: Yes. We've had a pretty good track record of maintaining our clients, and this is true across the board. We actually renewed two of our larger lender-placed clients on the housing side this quarter. I didn't mention in the prepared remarks, but our team did a fantastic job on those client renewals. And I'd say that we've got a track record of renewing clients. Average tenure of clients is extremely long. So we're proud of that, and it's all based on delivering and executing for the clients, but ultimately for end consumers. In terms of the cable space, I think we've become a market leader with cable operators who are -- who have entered the mobile space, they're growing rapidly. They're evolving their products and services meaningfully every year, and we're really proud of the work that our teams have done there. And I think that's built a lot of momentum. So we're strong with carriers. We're strong with new market entrants. And we've been a company that's been quite nimble in how we've approached the market. Hopefully, that also sets us up to grow new relationships with new clients as we move forward. And we think we're extremely well-positioned in Connected Living, And we've invested significantly over many, many years to get to this position, and we have great fantastic momentum.
John Barnidge: And then as it relates to expanded relationships similar to what you announced today and then in the first quarter, how do you think about the potential to leverage what you've done so far?
Keith Demmings: Yes. I think -- when I look at the growth opportunity in Connected Living, I still think that we have more growth opportunity there than in any business that we operate. And it's growing the fastest and it's the largest contributor to financial results. So that's a pretty strong place to be. On your biggest, most successful business still has more white space, both in terms of the core of what we do, but also in terms of expanding our scope of services and then winning new clients. We've talked about trade-in and the fact that we do trade-in services with multiple brands now around the world. That creates opportunity for us to build deeper partnerships where we can add additional value over time. As we think about the evolution, we've talked a lot about leveraging our network for in-store repair. Those are additional capabilities. We operate 500 CPR stores. That is something that we want to continue to leverage to create value for our partners. As I think about the work that we've done with T-Mobile, that's another great example in terms of service and repair. It wasn't designed to be a significant financial contributor overall. It was designed around how do we give consumers choice and better options to get their repairs done at their convenience. As I think about that part of the business, volumes have been a little lower than expected, but customer feedback and Net Promoter Scores have been exceptional, and I would say higher than we would have otherwise anticipated. We actively work to optimize that program to modify the program and expect over time, changes to be financially beneficial for both parties. So a lot of interesting momentum in this part of the business.
John Barnidge: Great. And then if I could ask one more question. On the expense initiatives that you talked about, which should help to offset inflation. Is there a way to size or dimension how we should be thinking about these scale economies?
Keith Demmings: Yes. So probably a couple of thoughts, and then Richard can certainly add in. We have seen progress in a lot of the great efforts by our team, particularly in housing on digital first, so really transforming our operations and driving more efficiency and better experience. That's building quarter over quarter over quarter. So we do see momentum in the second half and further acceleration as we get into 2023, even at the current level of placement rates in the current scale. We're also looking to continue to simplify the business. optimize support structures, how do we focus our energy where we can move the needle the most. So that work is ongoing as well. And then to Richard's earlier point, if we do get an increase in volume through placement rate over time, we have natural economies of scale that will benefit the P&L over time.
Operator: Your next question comes from the line of Brian Meredith from UBS.
Brian Meredith: A couple here. First, Keith, could you remind us what the potential impact here? Is it from a consumer-led recession on mobile subs as well as just growth as well as like average revenue per subscriber. Will you see that decline if you've got a kind of consumer-led recession?
Keith Demmings: Yes. I think from a mobile perspective, I would say that, first of all, there still seems to be very strong demand for high-end smartphones in key markets, even as we see pressure in the economy. The high-end smartphone market is up year-over-year, and it's up in our core markets. So that's a really good thing. We see clients continuing to push for growth today to take advantage of their investments in 5G and the relevance of the mobile device today, it's increasingly important for consumers. So that's helpful backdrop. I would say that the majority of our total economics in mobile are driven by our device protection subscribers. We've got 63.5 million global subs. Whether a customer buys a new device or retains their old device, it doesn't move that number a significant amount. Obviously, if our clients are growing or shrinking in terms of net adds, that can have an impact over time, but fairly moderated and based on the nature of the subscription service. Where I would see more pressure would be potentially less trade-in activity, if there were less mobile phone sales, which we certainly haven't seen. Mobile phone sales are strong, trade-ins are very strong, but that would be the leading indicator if trade-in starts to slow down. That's not a big driver of total economics. The counterpoint would be used devices will become more valuable, more attractive, and there may be other ways for us to monetize it. So I think mobile is relatively protected from any kind of short-term shocks from a recessionary environment.
Brian Meredith: But I'm just curious also if -- because I know you've all talked about selling additional services per sub, right? And that's been a big -- does that slow down? Or is somebody did not take that optional AppleCare or whatever it is product?
Keith Demmings: No, I don't think so. I think we've seen really steady attach, really steady churn. I think consumers are inclined to protect high-end devices generally. And certainly, if there are more strap for cash having protection in place is probably a good thing. But we haven't seen through economic cycles, really material changes in terms of the attach of the churn over time. So we don't expect that would be a big driver.
Brian Meredith: Got you. And then I guess my next question, just curious, we've talked about the lender-placed, but on the multifamily business, what's the impact of inflation there? I would imagine you get some pressure there as well potentially.
Keith Demmings: Yes. Definitely, there is some incremental increases in the non-cat loss ratio. Certainly, a little bit of that is inflation. But I would say, broadly, it's more getting to in-line with pre-pandemic. So we saw more favorability in loss ratios as people were home more during the pandemic. I think we've seen that normalize. And obviously, we get rate adjustments on that product line, too, as needed and as justified. But I don't see a huge inflationary impact. It's more just lining up with historicals.
Brian Meredith: So it's more from a frequency perspective, that things are picking up rather than severity, okay.
Keith Demmings: Correct.
Brian Meredith: And then just quickly, last question, Richard, just curious the, call it, underlying loss ratio for Global Housing was 47%, but when you adjust out some of the current year development and prior year development. Kind of what's the baseline kind of run rate loss ratio in that non-benefit ratio?
Richard Dziadzio: Yes. When we back out the reserving that we did, the strengthening of the reserves that we did, we're getting closer to the low 40s. I would say -- on the other hand, call it 43%. On the other hand, what I would say, as Keith articulated earlier, we do have inflation coming through. There will be a lag in terms of when the rates and inflation guards come through. So I wouldn't see that rate coming down so faster than that, faster than 43% or lower than 43% any time kind of in the next quarter. I think over time, we're going to see that improve and probably go closer to 40% as we go through the end of the year into next year, so forth. It's hard to predict because, obviously, it's hard to predict what inflation is going to do for the rest of the year. But essentially, as we're looking forward at our forecasting, that's what we're looking at.
Operator: And your final question comes from the line of Grace Carter from Bank of America.
Grace Carter: So I just had kind of a quick clarification question to start from one of the prior questions. I guess thinking about the original adjusted EBITDA growth targets for 2023 and 2024, I think average of 10%. And I mean just thinking about like the lower base, I guess, expected for 2022. I mean is -- should we just assume that the 2024 adjusted EBITDA levels will come out a little bit lower than maybe the original growth expectations implied? Or I guess, what is the likelihood that EBITDA growth over the next couple of years could accelerate sufficiently to get it kind of back in that original range?
Keith Demmings: Yes. It's a great question. And I would say that my commitment and the goal that we have in terms of financial performance is to deliver the original Investor Day outlook for 2024. So what that implies is we've got to accelerate growth beyond the original 10% in '22 -- or '23 and '24 to make up for the shortfall in 2022, which is exactly your point. So that's certainly how we're thinking about it, Grace. Obviously, there's a lot of moving parts and there's a lot of unknowns as we think about the economy and inflation. The good news is, I think the miss, as we look at 2022, is entirely driven by housing loss ratio from inflation, in particular from severity. And because of the features within the product and the ability to get rate that naturally resolves itself over time without a degradation in volume. So provided that, that rolls through as we expect and hope that it will, provided inflation calms down. So our current thinking is inflation stays elevated through the end of the year begins moderating and moderates consistently through '23 and then sort of normalizes into '24. If that happens, we do feel good about our 2024 long-term commitment. And part of it is the strength of Global Lifestyle and in particular, investment income in Auto has been strong. The business has been generating significant growth. And then Connected Living and Mobile, in particular, has been on quite a role in the last handful of years.
Grace Carter: And then, I guess, I just wanted to confirm that the -- kind of target combined ratio range that Doug mentioned before, I think 84% to 89% in the housing book still holds even with the exit of certain businesses? And I guess just kind of how should we think about the ability to stay within that range over the next few quarters as -- just given the pressure from inflation, versus still kind of waiting for the rate increases turn through?
Keith Demmings: Yes. I would say that we're going to finish the year at least if we think about our forecast today and what's implied in that forecast when you unpack Housing. It may be a little above our range on a combined ratio basis, probably at the low end in terms of ROE. So pretty strong financial performance still overall based on those metrics. But let's say, a little bit worse than the range. We definitely think that 84% to 89% range over time is the right target for this business. And the exit of sharing economy, I'd say it wasn't a huge business, not a big driver, and it doesn't significantly change the way we think about combined targets. Well, thank you very much, everybody. Appreciate all the questions and the interest in the company. We had a solid first half of the year, led by the strength of the Global Lifestyle segment. We believe our business model remains well-positioned, as we've talked about, even in a challenging macro environment. In the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. Thanks, everybody. Have a great day.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Second Quarter 2022 Conference Call and Webcast. [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2022 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the second quarter of 2022. The release and corresponding financial supplement are available on assurant.com. We will start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplement that can be found on our website. We have revised all quarterly and annual results for full year 2020 through first quarter 2022 periods to reflect the change in the adjusted EBITDA calculation to exclude certain businesses that we now expect to exit fully, including our sharing economy and small commercial businesses and Global Housing as well as certain legacy long-duration insurance policies within Global Lifestyle. Results have been revised for the correction of any errors related to reinsurance of claims and benefits payable within the Global Lifestyle segment that occurred in late 2018 through first quarter 2022 as well as other immaterial corrections. The impact of these changes individually or in the aggregate, is not material to results for any prior period. A full reconciliation of certain reported and revised key measures of performance and metrics is provided in our second quarter financial supplement posted on assurant.com. I will now turn the call over to Keith."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Suzanne, and good morning, everyone. As we outlined during our recent Investor Day in March, we aspire to be the leading global business services company supporting the advancement of the connected world. And so far in 2022, we've made solid progress delivering on that vision for the benefit of our clients and their customers, our employees and importantly, our shareholders. We delivered adjusted EPS of $7.22, up 13% in the first half of last year, and adjusted EBITDA was $592 million, both excluding reportable catastrophe losses. We're very pleased that Global Lifestyle had such a strong first half of the year with momentum expected to continue, led by both mobile and auto. Our capital-light and fee income based businesses represented 82% of our adjusted EBITDA ex-cat so far this year and continue to add to the value of our franchise. While results in Global Housing were below expectations, largely driven by broader inflationary pressures seen across our industry, we have a clear path and several key actions underway to address near-term macro challenges. Longer term, we continue to believe that our combined housing and lifestyle portfolio of businesses is positioned to deliver attractive earnings growth and strong cash flow generation relative to the broader market, while also providing a compelling countercyclical hedge in what remains a volatile economic landscape. As we look at our Global Lifestyle segment, our business services-oriented offerings generated adjusted EBITDA growth of 12% year-over-year and 14% year-to-date. Our market-leading franchise helped us expand our partnership with several world-class brands in the lifestyle market. In the U.S., we recently signed a multiyear renewal with a large cable operator within our mobile business. This includes comprehensive device protection, trade-in and premium technical support. With the renewal, we'll be including new capabilities, demonstrating our ability to grow relationships with value-added services that ultimately lead to a better customer experience. We've now renewed two major U.S. cable operators in our mobile business within the last year, while also broadening our product offerings to support their growing mobile subscriber bases. We're pleased with the continued growth momentum in Global Lifestyle, which we expect will continue into the second half of 2022. As a result, we believe the segment will deliver mid- to high teens growth in adjusted EBITDA, mainly from strong mobile results, including device protection and trade-in as well as from the continued strength of our auto business. Turning to Global Housing. Similar to others in the industry, we were impacted by significant inflationary pressure, which resulted in higher claim severities and reinsurance costs in the quarter, most notably in lender-placed. These higher costs are expected to be mitigated through rate adjustments over time. In addition to regular rate filings in key states, our lender-placed product includes an inflation guard feature designed to address changes in material and labor costs. We recently implemented a double-digit rate increase on policy renewals. This rate increase will be applied to all renewals over the next 12 months. As a result, there is a timing lag that is magnifying the higher non-cat loss experience in the quarter and ultimately pressuring results through 2022. We believe this will normalize as incremental premiums earn over time. As we look at the housing portfolio, we're also taking other actions to improve profitability through ongoing expense efficiencies and driving even greater focus on the housing businesses where we see a path to market-leading positions that can deliver attractive financial returns. Most recently, we decided to exit the sharing economy business. The strategic and financial objectives for this business did not develop as we originally anticipated, and we want to focus on opportunities that more closely align to our long-term vision and where we have market advantages with a clear right to win. Stepping back and looking at Assurant overall, we believe we have an attractive portfolio of market-leading businesses, which are poised for long-term success. Given the current macro environment, we believe we can deliver adjusted EBITDA growth of 3% to 6%. This takes into account higher expected losses in housing, but also stronger results and momentum within Global Lifestyle. Adjusted earnings per share, excluding reportable cats, is now expected to grow 14% to 18% for the full year, reflecting this view of adjusted EBITDA. EPS growth will, of course, also be supported by share repurchases, including the return of $900 million in pre-need sale proceeds, which was completed in the second quarter. As we've shown historically through various market cycles, we believe we are well positioned to deliver our strategic objectives over the long term. We expect this period of macroeconomic challenges to be no different. Over time, we believe the strength and resiliency of our business model will endure, enabling us to execute on the 2023 and 2024 objectives we outlined at Investor Day. Looking forward, we expect adjusted EBITDA acceleration starting next year. While the earnings path may not be linear, we remain confident that in the long term, our combined lifestyle and housing business portfolio will continue to deliver attractive growth, strong cash flow generation and superior shareholder returns relative to the broader market. I'll now turn the call over to Richard to review the second quarter results and our revised 2022 outlook in greater detail."
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith, and good morning, everyone. Adjusted EBITDA, excluding catastrophes, totaled $277 million, down 8% from the second quarter of 2021. As Keith mentioned, performance reflected the strong growth across global lifestyle and weaker results in Global Housing. For the quarter, we reported adjusted earnings per share excluding reportable catastrophes, of $3.25, flat from the prior year period. The 2021 baseline for lifestyle and housing adjusted EBITDA has been updated to remove noncore operations and reflect the accounting correction, Suzanne noted to our prior period results. Now let's move to segment results, starting in Global Lifestyle. The segment reported adjusted EBITDA of $207 million in the second quarter, a year-over-year increase of 12% driven by growth across both Connected Living and Global Automotive. Connected Living earnings increased by $12 million or 11% year-over-year. The increase was primarily driven by continued mobile expansion in North America device protection programs from cable operator and carrier clients, including subscriber growth and more favorable loss experience. This was partially offset by unfavorable foreign exchange. In Global Automotive, earnings increased $10 million or 15%, primarily from higher investment income, including higher real estate gains and yields, favorable loss experience and select ancillary products also contributed to the results. As we look at revenue, Lifestyle revenue was up by $48 million or 3%, driven by continued growth in Global Automotive. Global Automotive revenue increased 7%, reflecting strong prior period sales of vehicle service contracts. Despite the overall U.S. auto market showing signs of slowing, our net written premiums remained strong even against the record second quarter of 2021, as additional dealerships and strong attachment rates are offsetting the market headwinds. Within Connected Living, revenue was down slightly due to lower revenue in mobile, mainly from premium declines from runoff programs and unfavorable foreign exchange. This was partially offset by growth in subscribers in North America and higher mobile fee income driven by global mobile devices serviced. In the second quarter, the number of global mobile devices service increased by $1.1 million or approximately 18% to $7.2 million. This was due to higher trading volumes, supported by new phone introductions and carrier promotions from the growing adoption of 5G devices. In terms of mobile subscribers, growth in North America was partially offset by declines in runoff mobile programs previously mentioned, which also impacted mobile devices protected sequentially. For full year 2022, we now expect lifestyle adjusted EBITDA growth to be mid- to high teens compared to 2021 baseline of $702 million. Mobile is expected to be the key driver of adjusted EBITDA growth for global expansion in existing and new clients across device protection and trade-in and upgrade programs. This will be partially offset by unfavorable impacts, from foreign exchange and strategic investments to support new business opportunities and client implementations. Auto adjusted EBITDA is expected to grow for the full year. But earnings in the second half are expected to be lower than the first half, mainly due to the absence of $14 million of real estate gains. Growth for the year will be partially offset by higher investment income and more favorable loss experience in select ancillary products. Moving to Global Housing. Adjusted EBITDA was $75 million, which included $20 million of reportable catastrophes for the second quarter. Excluding catastrophe losses, earnings decreased $40 million, primarily driven by $25 million in higher non-cat loss experience, largely in lender-placed and to a lesser extent, Multifamily Housing. This included $12 million in year-over-year reserve strengthening and higher fire losses in the quarter. The balance of the earnings reduction was driven mainly from $17 million in higher catastrophe reinsurance costs. The cost of our reinsurance program reflected both the higher exposures and increased pricing within the reinsurance market. And with the completion of our 2022 catastrophe reinsurance program in June, we believe we fared relatively well in the market given our strong relationships with our more than 40 reinsurance partners. We maintained an $80 million per event retention including second and third events. We also continued to benefit from the placement of multiyear coverage covering 45% of our program and a cascading feature that provides multi-event protection. In Multifamily Housing, growth in our P&C channels was offset by increased non-cat losses and expenses from ongoing investments to expand our capabilities and further strengthen our client experience. Global Housing revenue was flat year-over-year as higher catastrophe reinsurance costs were offset by higher average insured values and lender placed. For the full year, we now expect Global Housing adjusted EBITDA, excluding cats, to decline by low to mid-teens from the 2021 baseline of $512 million. In addition to the higher claims costs, REO volumes have continued to be muted and placement rate trends we are seeing are softer than originally expected. At the same time, we continue to realize expense efficiencies from new system enhancements and strength in digital capabilities. While the duration and magnitude of inflationary trends remain fluid, rate filings and inflation guards are expected to start to flow through premiums as we exit the year. At corporate, adjusted EBITDA loss was $25 million, up $8 million compared to the unusually low second quarter of 2021. This was mainly driven by higher employee-related and technology expenses. For full year 2022, we expect the corporate adjusted EBITDA loss to be approximately $105 million. Turning to holding company liquidity. We ended the second quarter with $595 million, $370 million above our current minimum target level. In the second quarter, dividends from our operating segments totaled $189 million. In addition to our quarterly corporate and interest expenses, we also had outflows from three main items: $232 million of share repurchases; $75 million from the repayment of our 2023 notes; and $39 million in common stock dividends. For the full year, our outlook assumes $365 million of shares repurchased from the remaining premium sale proceeds plus an additional $200 million to $300 million. Through July, we've bought back $504 million worth of our stock. Given changes in investment portfolio values, reserve strengthening for noncore operations and accounting adjustments, we expect segment dividend to be moderately below our target of roughly 3/4 of segment adjusted EBITDA, including catastrophes. While lower, we still expect capital generation to be strong given our business model and product mix. As always, segment dividends are subject to the growth of the businesses, rating agency and regulatory capital requirements and investment portfolio performance. In conclusion, we believe Assurant is well-positioned for long-term growth and strong capital generation, underscored by the attractive portfolio of Global Lifestyle and Global Housing businesses. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Your first question comes from the line of Michael Phillips from Morgan Stanley."
},
{
"speaker": "Michael Phillips",
"text": "So I guess I want to talk on the inflationary pressures you're seeing on the lender-placed, but can we switch that over to the lifestyle side? And anything that you're seeing there on either Auto or Mobile, maybe you can talk about how much risk you retain on that side. It's clearly not 100%. But anything that you're seeing there that might cause pressure from inflationary pressures there? And if so, kind of your ability to combat that?"
},
{
"speaker": "Keith Demmings",
"text": "Terrific. Yes. So I think the Lifestyle business has obviously performed very well this year. We've raised the outlook for the full year. So we're confident in the momentum. I would say in terms of the resiliency, we've been dealing with a couple of things, certainly inflationary pressures, but also supply chain constraints as you think about the last couple of years of the pandemic, particularly around parts, both on the Connected Living and the Auto side. So I think the nature of our deal structures is quite favorable. 2/3 of the time we're not holding the risk relative to the services we perform and the programs that we manage. So that's been very helpful. I'd say we've got a stronger orientation to fee income, even in deals where we retain risk, we're targeting fees. We've got typically allowable loss ratios, ability to reprice. You will see timing issues occur in terms of -- sometimes losses are a little higher, we may recover that over time with client deal structures. But it hasn't been an issue that's emerged over the course of the last several quarters. We feel really good about it, certainly never fully insulated, but a very different operating model. And then if you think about inflation on the housing side, we've got rate filings, inflation guard and a number of factors that are being put in place to combat that. So lifestyle has been quite resilient from that perspective."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Okay. You mentioned, Keith, on the opening comments about -- on the lender-placed side, in inflation guard and then you also mentioned double-digit on renewals. Was that the same -- was that double digit? Was that the inflation guard? Or is that on top of the inflation gaurd?"
},
{
"speaker": "Keith Demmings",
"text": "So the -- so if you think about inflation guard, we put a double-digit rate increase in July. So that is going to flow through the book as it renews. We've also got regular course rate filings. We've been accelerating rate filings with states, obviously, as severities have been higher and losses have been higher. We've actually gotten 30 state rate filings approved this year, not all of which have been fully implemented, but they're all approved and will be implemented by the end of the next year -- or by the end of this year, sorry. And then we've got an additional set of discussions ongoing with states. So that additional rate layers on top of the double-digit increase that we talked about relative to inflation guard."
},
{
"speaker": "Michael Phillips",
"text": "Is there any difference in here, can you maybe just talk about the difference that you have in those other rate filings by state that you're alluding to, different than a traditional, say, homeowners insurance company where the clients are individuals like me and you, your clients knowing your place are a little different. So does that give any differences in the ability, the speed at which or the ability to take higher rate and the speed that you can take them than maybe a traditional insurance company?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think probably a couple of things. First of all, these are short-tail policies, they're annual policies. So as we do get rate, it flows through over a 12-month period, number one. I think the fact that we've got inflation guard built into the product, we don't have to get approval. That's already approved, and we just apply an inflationary factor every year. That drives AIVs up and corresponding increases to rate. So that -- I would call that normal course. Obviously, inflation is elevated. The industry data supports a higher inflation factor driving more AIV. In terms of the rate, I think as we work with states, we're really looking at the historical experience to justify the increases that we're getting. And I'd say that, that happens like very consistently with what other insurers would be doing. But we've been more aggressive as others have, just in terms of the heightened severities that we're seeing in the marketplace. So good opportunity to get rate. We're looking to make fair returns on the business. I would say it doesn't have a huge impact on volume. So we've got exceptional relationships with our clients. Obviously, this is a lender-placed policy, and we expect to see consistent policy counts as we move forward even in this higher inflationary environment with more rate flowing through."
},
{
"speaker": "Michael Phillips",
"text": "Congrats, and best of luck in the future."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Jeff Schmitt from William Blair."
},
{
"speaker": "Jeffrey Schmitt",
"text": "What is your view on where the placement rate in the lender-placed business could go next year if we move into a recession, whether we're in one now or not, let's say, sort of a deeper recession if interest rates continue to move up, could that move above 2% pretty quickly? Or where do you think that could go?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think it depends on a range of factors. I would say that as you see the placement rates are relatively stable and have been so for several quarters, and that's just the strength of the housing market, the fact that there's so much positive equity. And I also think about placement rate really tracking closely to delinquency and you've got a prevalence of servicers working on loan modifications, a lot of loss mitigation efforts that's really limiting delinquency, it's limiting foreclosure activity. Obviously, if that starts to shift and that starts to change and delinquency rates rise at any level significantly, that would have a corresponding impact on our placement rate. Obviously, if there are more foreclosures that would drive up our REO volumes, which are really probably 1/3 of pre-pandemic level. So there's certainly upside over time in placement rate. The real question is, when does that emerge in the economy just because of the strength of the Housing market. You've also got rising interest rate pressure, certainly, a hardening voluntary insurance market, higher inflationary pressure. So I think we need to see how the economy responds and how consumers respond to get a better feel. We're not counting on a big increase in placement rates as we think about our longer-term expectations. And obviously, if that does happen, that's where we talk about it being a countercyclical hedge from a housing perspective."
},
{
"speaker": "Jeffrey Schmitt",
"text": "Right. Okay. That makes sense. And then the expense ratio in Global Housing continues to run above 46%. I think in the past, you've guided to sort of 44% to 46%. Is there some kind of inflation driving that higher? Or when do you think it could move below that 46% level?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. And maybe, Richard, do you want to talk about expenses?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Yes, it's a great question. It is up a little bit over the last quarter to 46%. So I think you're right. It's a little bit higher than we'd like to see it. We are -- we've talked about in previous calls. We are investing digitalization in projects like that, create more efficiencies, as Keith said in his opening remarks. So we would see that, I would say, over time as these projects and these efforts come through. Also, the first question on placement rates as the volumes of the business grow, obviously, the things that we have in place in our operations are very leverageable. So that would also bring down the expense ratio over time."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Tommy McJoynt from KBW."
},
{
"speaker": "Tommy McJoynt",
"text": "So what are the expectations for the noncore operations loss contribution going forward? Is that meant to be more of a breakeven? I know it's excluded from the guidance. And what's the general time horizon for that wind down?"
},
{
"speaker": "Keith Demmings",
"text": "Sure. Maybe I can start, and then Richard can add on. So we made the decision this quarter, as we talked about, to exit all of our long-tail liability business and driven by the decision around sharing economy. So as we talked about, just wasn't strategically aligned with the direction that we're headed as a company. And it was highly specialized niche business with inherent risk and volatility. We didn't see a path to leadership. We didn't think we could generate the financial returns. But it wasn't strategically aligned with the direction of the company. So as part of that, all of the clients have already been notified. All of the contracts will be non-renewed. I would say, by first quarter of '23, the net earned premium will be immaterial. And by this time next year, it will be gone completely, really just at that point, managing the runoff. As you saw, we put up a reserve. So as we exited did a very comprehensive top-to-bottom review of the performance of the business, I did a lot of scenario analysis to try to think about how this could emerge over time, put up a full reserve to adequately cover the runoff, which we think is appropriate and look to put this behind us."
},
{
"speaker": "Tommy McJoynt",
"text": "Okay. And I guess, as you kind of explored what to do with those businesses, there was no way to sort of monetize what you've built there. And I guess, just you have typically been kind of sellers and ways to monetize things, there just wouldn't be any kind of takers for those businesses?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think potentially, we could have looked at that as a path. We didn't see it viable. And really, it could have become a distraction to focusing on driving growth through the rest of the organization. We will certainly consider alternatives now that we've put it in runoff to see if there's a way to structure something around sharing the risk with a third party. That's certainly possible, and we'll look to consider that. But the value for monetization, I would say, was lower than the distraction factor of trying to work through that process quite candidly."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Mark Hughes from Truist Securities."
},
{
"speaker": "Mark Hughes",
"text": "The multifamily business is kind of flat in terms of top line this quarter. What's happening there?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So a couple of things. First of all, I would say we feel like we're really well-positioned in the retros business. We've got 2.6 million customers. So it's giving us a great opportunity in terms of market leadership, scale. We've been investing in the customer experience, deepening our expertise. So we do expect long-term growth. It's a very attractive part of the market. I would say in terms of the results being flat, we do have strength in growth within the property management company channel. So that continues to grow exceptionally well. We're gaining share. We're driving attach rates, and we're having a lot of success with our Cover360 product, really just more integrated into the byflow. We've talked about better digital tools, collecting the insurance as part of the rent and just leveraging our full capability. So that's going extremely well. We have an affinity portion of our business, which the growth has slowed where we partner with insurance companies. I think as insurance companies have been focusing on getting rate and dealing with inflationary pressures, a little less marketing generally with some of our partners. So I think that normalizes over time as the economy finds more stability in the future. But we are seeing growth, and we do think long-term growth will emerge as we continue to focus on this part of our business."
},
{
"speaker": "Mark Hughes",
"text": "And, Richard, the investment portfolio, what do you anticipate in terms of the progression in the yield? What's the new money yield? What kind of turnover is there in the portfolio? A little bit on that would be helpful."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, sure, Mark. Yes. First of all, I would say that rising interest rates overall are good for the business, and we've been seeing that in this quarter as well. We've had some real estate gains, as we mentioned in our remarks, but we also have fixed income and yields on fixed income raising. We have a 5-year duration. So think about 20% of the portfolio rolling over every year. So we won't have any quantum step in terms of long-term rates and long-term yields. But it will gradually increase over time, which is a good thing. I think you probably saw the yield for this quarter over 3.5%, which is quite good. What's interesting too about it is if we look at our book of business, if we go back a year from now, the assets that were coming to maturity or the fixed income coming to maturity, we're rolling over at lower levels than they were maturing at. Now they're rolling over for the most part at higher levels. So that bodes well for the future. And short-term rates, yes, we have some of our money and cash, obviously. And we're getting an immediate impact on that. Obviously, smaller dollars given a smaller level of cash that we have relative to the fixed income portfolio."
},
{
"speaker": "Mark Hughes",
"text": "Then, Keith, you had -- I think you said you expect adjusted EBITDA to accelerate next year. Could I hear that properly? And any other metrics you want to throw out for next year, maybe EPS growth?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think as we look at the year at 3% to 6% in terms of our EBITDA growth. We certainly expect that to be increasing as we move into 2023. And I'd say, largely, we do expect the lender-placed business and Housing overall to continue to improve as we get more rate. And then we do have great momentum in Lifestyle. So we haven't set the specific target for 2023 and 2024. What we have said is on average, we want to deliver north of 10% EBITDA growth. We're still committed to our long-term objectives from Investor Day, which I think is really important. And we're going to do everything we can to deliver those results and be accountable to delivering our financial commitments."
},
{
"speaker": "Mark Hughes",
"text": "And then just one final one. The timing of the rate increase is going to get the inflation guard for the lender-placed, does that only kick in if there is a renewal cycle around that? Or why wouldn't that kick in immediately?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So the policies are annual, and they renew it each year. So if you think about, let's take July, for example, we put in place double-digit rate increases for the cohort of annual policies that renewed in July. So think about that rate going in 1\\12 at a time over 12 months and then think about it earning 1/12 at a time after it's in place. So the whole cycle takes 24 months, but it builds momentum month by month by month. And then we've also got, as I said, state-related rate increases that go in at different periods in the year. That's also contributing. And I mentioned 30 approved rates really affecting about 75% of our premium overall and then a number of additional filings that are ongoing. So we do feel like we've got a great opportunity with rate, it's a terrific mechanism and designed to deal with inflationary pressures. And we expect it to work, and we expect to get the housing business where it needs to be from a total return perspective. The one thing that's interesting, if you think about Housing, and it's a tough quarter, right? We're not pleased with the results in the quarter. The first half housing combined ratio is 86%. The first half annualized ROE, it's 20.6%. That will normalize as we get through the rest of the year. But we still think it will be quite strong overall, given we're underperforming our own expectations. So I do want to highlight that as the backdrop. It is a strong business. It generates tremendous cash flow. We've got great market-leading advantages, and the financial performance is still strong. It's just not where we want it to be to deliver on our total commitments."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of John Barnidge from Piper Sandler."
},
{
"speaker": "John Barnidge",
"text": "You talked about a -- signing a multiyear renewal with a cable operator. Last quarter, you also talked about an expanded relationship. Can you talk about maybe what the renewal calendar looks like? And how do you think about potential hit rates for expanded relationships as you come up on renewal?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. We've had a pretty good track record of maintaining our clients, and this is true across the board. We actually renewed two of our larger lender-placed clients on the housing side this quarter. I didn't mention in the prepared remarks, but our team did a fantastic job on those client renewals. And I'd say that we've got a track record of renewing clients. Average tenure of clients is extremely long. So we're proud of that, and it's all based on delivering and executing for the clients, but ultimately for end consumers. In terms of the cable space, I think we've become a market leader with cable operators who are -- who have entered the mobile space, they're growing rapidly. They're evolving their products and services meaningfully every year, and we're really proud of the work that our teams have done there. And I think that's built a lot of momentum. So we're strong with carriers. We're strong with new market entrants. And we've been a company that's been quite nimble in how we've approached the market. Hopefully, that also sets us up to grow new relationships with new clients as we move forward. And we think we're extremely well-positioned in Connected Living, And we've invested significantly over many, many years to get to this position, and we have great fantastic momentum."
},
{
"speaker": "John Barnidge",
"text": "And then as it relates to expanded relationships similar to what you announced today and then in the first quarter, how do you think about the potential to leverage what you've done so far?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think -- when I look at the growth opportunity in Connected Living, I still think that we have more growth opportunity there than in any business that we operate. And it's growing the fastest and it's the largest contributor to financial results. So that's a pretty strong place to be. On your biggest, most successful business still has more white space, both in terms of the core of what we do, but also in terms of expanding our scope of services and then winning new clients. We've talked about trade-in and the fact that we do trade-in services with multiple brands now around the world. That creates opportunity for us to build deeper partnerships where we can add additional value over time. As we think about the evolution, we've talked a lot about leveraging our network for in-store repair. Those are additional capabilities. We operate 500 CPR stores. That is something that we want to continue to leverage to create value for our partners. As I think about the work that we've done with T-Mobile, that's another great example in terms of service and repair. It wasn't designed to be a significant financial contributor overall. It was designed around how do we give consumers choice and better options to get their repairs done at their convenience. As I think about that part of the business, volumes have been a little lower than expected, but customer feedback and Net Promoter Scores have been exceptional, and I would say higher than we would have otherwise anticipated. We actively work to optimize that program to modify the program and expect over time, changes to be financially beneficial for both parties. So a lot of interesting momentum in this part of the business."
},
{
"speaker": "John Barnidge",
"text": "Great. And then if I could ask one more question. On the expense initiatives that you talked about, which should help to offset inflation. Is there a way to size or dimension how we should be thinking about these scale economies?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So probably a couple of thoughts, and then Richard can certainly add in. We have seen progress in a lot of the great efforts by our team, particularly in housing on digital first, so really transforming our operations and driving more efficiency and better experience. That's building quarter over quarter over quarter. So we do see momentum in the second half and further acceleration as we get into 2023, even at the current level of placement rates in the current scale. We're also looking to continue to simplify the business. optimize support structures, how do we focus our energy where we can move the needle the most. So that work is ongoing as well. And then to Richard's earlier point, if we do get an increase in volume through placement rate over time, we have natural economies of scale that will benefit the P&L over time."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Brian Meredith from UBS."
},
{
"speaker": "Brian Meredith",
"text": "A couple here. First, Keith, could you remind us what the potential impact here? Is it from a consumer-led recession on mobile subs as well as just growth as well as like average revenue per subscriber. Will you see that decline if you've got a kind of consumer-led recession?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think from a mobile perspective, I would say that, first of all, there still seems to be very strong demand for high-end smartphones in key markets, even as we see pressure in the economy. The high-end smartphone market is up year-over-year, and it's up in our core markets. So that's a really good thing. We see clients continuing to push for growth today to take advantage of their investments in 5G and the relevance of the mobile device today, it's increasingly important for consumers. So that's helpful backdrop. I would say that the majority of our total economics in mobile are driven by our device protection subscribers. We've got 63.5 million global subs. Whether a customer buys a new device or retains their old device, it doesn't move that number a significant amount. Obviously, if our clients are growing or shrinking in terms of net adds, that can have an impact over time, but fairly moderated and based on the nature of the subscription service. Where I would see more pressure would be potentially less trade-in activity, if there were less mobile phone sales, which we certainly haven't seen. Mobile phone sales are strong, trade-ins are very strong, but that would be the leading indicator if trade-in starts to slow down. That's not a big driver of total economics. The counterpoint would be used devices will become more valuable, more attractive, and there may be other ways for us to monetize it. So I think mobile is relatively protected from any kind of short-term shocks from a recessionary environment."
},
{
"speaker": "Brian Meredith",
"text": "But I'm just curious also if -- because I know you've all talked about selling additional services per sub, right? And that's been a big -- does that slow down? Or is somebody did not take that optional AppleCare or whatever it is product?"
},
{
"speaker": "Keith Demmings",
"text": "No, I don't think so. I think we've seen really steady attach, really steady churn. I think consumers are inclined to protect high-end devices generally. And certainly, if there are more strap for cash having protection in place is probably a good thing. But we haven't seen through economic cycles, really material changes in terms of the attach of the churn over time. So we don't expect that would be a big driver."
},
{
"speaker": "Brian Meredith",
"text": "Got you. And then I guess my next question, just curious, we've talked about the lender-placed, but on the multifamily business, what's the impact of inflation there? I would imagine you get some pressure there as well potentially."
},
{
"speaker": "Keith Demmings",
"text": "Yes. Definitely, there is some incremental increases in the non-cat loss ratio. Certainly, a little bit of that is inflation. But I would say, broadly, it's more getting to in-line with pre-pandemic. So we saw more favorability in loss ratios as people were home more during the pandemic. I think we've seen that normalize. And obviously, we get rate adjustments on that product line, too, as needed and as justified. But I don't see a huge inflationary impact. It's more just lining up with historicals."
},
{
"speaker": "Brian Meredith",
"text": "So it's more from a frequency perspective, that things are picking up rather than severity, okay."
},
{
"speaker": "Keith Demmings",
"text": "Correct."
},
{
"speaker": "Brian Meredith",
"text": "And then just quickly, last question, Richard, just curious the, call it, underlying loss ratio for Global Housing was 47%, but when you adjust out some of the current year development and prior year development. Kind of what's the baseline kind of run rate loss ratio in that non-benefit ratio?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. When we back out the reserving that we did, the strengthening of the reserves that we did, we're getting closer to the low 40s. I would say -- on the other hand, call it 43%. On the other hand, what I would say, as Keith articulated earlier, we do have inflation coming through. There will be a lag in terms of when the rates and inflation guards come through. So I wouldn't see that rate coming down so faster than that, faster than 43% or lower than 43% any time kind of in the next quarter. I think over time, we're going to see that improve and probably go closer to 40% as we go through the end of the year into next year, so forth. It's hard to predict because, obviously, it's hard to predict what inflation is going to do for the rest of the year. But essentially, as we're looking forward at our forecasting, that's what we're looking at."
},
{
"speaker": "Operator",
"text": "And your final question comes from the line of Grace Carter from Bank of America."
},
{
"speaker": "Grace Carter",
"text": "So I just had kind of a quick clarification question to start from one of the prior questions. I guess thinking about the original adjusted EBITDA growth targets for 2023 and 2024, I think average of 10%. And I mean just thinking about like the lower base, I guess, expected for 2022. I mean is -- should we just assume that the 2024 adjusted EBITDA levels will come out a little bit lower than maybe the original growth expectations implied? Or I guess, what is the likelihood that EBITDA growth over the next couple of years could accelerate sufficiently to get it kind of back in that original range?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. It's a great question. And I would say that my commitment and the goal that we have in terms of financial performance is to deliver the original Investor Day outlook for 2024. So what that implies is we've got to accelerate growth beyond the original 10% in '22 -- or '23 and '24 to make up for the shortfall in 2022, which is exactly your point. So that's certainly how we're thinking about it, Grace. Obviously, there's a lot of moving parts and there's a lot of unknowns as we think about the economy and inflation. The good news is, I think the miss, as we look at 2022, is entirely driven by housing loss ratio from inflation, in particular from severity. And because of the features within the product and the ability to get rate that naturally resolves itself over time without a degradation in volume. So provided that, that rolls through as we expect and hope that it will, provided inflation calms down. So our current thinking is inflation stays elevated through the end of the year begins moderating and moderates consistently through '23 and then sort of normalizes into '24. If that happens, we do feel good about our 2024 long-term commitment. And part of it is the strength of Global Lifestyle and in particular, investment income in Auto has been strong. The business has been generating significant growth. And then Connected Living and Mobile, in particular, has been on quite a role in the last handful of years."
},
{
"speaker": "Grace Carter",
"text": "And then, I guess, I just wanted to confirm that the -- kind of target combined ratio range that Doug mentioned before, I think 84% to 89% in the housing book still holds even with the exit of certain businesses? And I guess just kind of how should we think about the ability to stay within that range over the next few quarters as -- just given the pressure from inflation, versus still kind of waiting for the rate increases turn through?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I would say that we're going to finish the year at least if we think about our forecast today and what's implied in that forecast when you unpack Housing. It may be a little above our range on a combined ratio basis, probably at the low end in terms of ROE. So pretty strong financial performance still overall based on those metrics. But let's say, a little bit worse than the range. We definitely think that 84% to 89% range over time is the right target for this business. And the exit of sharing economy, I'd say it wasn't a huge business, not a big driver, and it doesn't significantly change the way we think about combined targets. Well, thank you very much, everybody. Appreciate all the questions and the interest in the company. We had a solid first half of the year, led by the strength of the Global Lifestyle segment. We believe our business model remains well-positioned, as we've talked about, even in a challenging macro environment. In the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. Thanks, everybody. Have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 1 | 2,022 | 2022-05-04 08:00:00 | Operator: Welcome to Assurant's First Quarter 2022 Conference Call and Webcast. [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our first quarter 2022 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the first quarter 2022. The release and corresponding financial supplement are available on assurant.com. We will start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated value statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday's news release and financial supplements as well as the Investor Day presentation materials that can be found on our website. I will now turn the call over to Keith.
Keith Demmings: Thanks, Suzanne, and good morning, everyone. We're pleased with our performance for the first quarter, which demonstrates the resiliency and strength of our business during a period of macroeconomic and geopolitical uncertainty. Within Global Lifestyle, stronger-than-expected performance in our capital-light Connected Living and Global Automotive businesses offset softer-than-expected results within Global Housing, mainly from our specialty offerings. The ongoing growth of our fee-based, capital-light offerings across Global Lifestyle and Global Housing accounted for nearly 80% of segment earnings in 2021. This differentiates Assurant as both a service-oriented partner to our clients and a compelling investment given our scaled customer base in markets with strong tailwinds. Our continued alignment with world-class partners and our ability to provide best-in-class products, services and customer experiences has positioned us well for expected profitable growth this year and over the long term. As we outlined at Investor Day in March, we have a clear vision for the future, to be the leading global business services company supporting the advancement of the connected world. We aren't settling for the status quo. While we currently have scale leadership positions in attractive and growing markets, we have our sights set on being the leader in all of the businesses in which we operate. With that said, we believe the financial objectives we outlined for Assurant over the next 3 years are attractive and will be supported by our focus on market-leading innovation, business simplification, operational optimization and the benefits of scale. We believe this will lead to continued strong cash flow generation, earnings growth and financial outperformance. In Global Lifestyle, we remain focused on supporting our more than 250 million customers through our broad set of products and services across insurance, operations, mobile trading and repair and comprehensive administrative services throughout Connected Living and Global Automotive. For this segment, we continue to expect adjusted EBITDA growth in the low double digits for 2022 with average annual growth of 10% in 2023 and 2024. We anticipate Connected Living will lead our growth for the Lifestyle segment, driven by our multidimensional strategy. Over the next 3 years, Connected Living should benefit from increased mobile and retail client expansion and increase in fee-based traded and repair as well as contributions from strategic M&A. We continue to be excited about opportunities to drive growth in our retail business as we think about longer-term opportunities to serve the connected home. As of May 1, we're pleased to announce that we have expanded our relationship with one of our largest U.S. retail partners. We moved beyond program underwriting and have expanded our services to provide for the end-to-end administration of the business, including call center support, claims management and oversight of service delivery. Not only does this allow us to deepen our relationship with a critical client, it allows us to continue to grow our retail business, while dramatically increasing our scale to support claims and customer service further improving our relevance with the third-party repair network that supports this business. We now support a meaningfully larger number of appliance repairs, which we believe is strategically important to our ambitions to provide protection services to the evolving connected home. This partnership will also support additional investments in digital tools and technology platforms that are key to our long-term vision. Global Automotive is expected to benefit from our increased scale and strong national dealer, third-party administrator and international OEM partnerships. We will continue to invest in technology, integrating our systems and processes following several years of successful acquisitions. Throughout Lifestyle, we'll also continue to invest to expand our market-leading positions. We anticipate incremental spending related to the development of new products, such as our connected home offerings and increased investments for new client implementations. In Global Housing, the business is expected to grow mid- to high single digits in 2023 and 2024. For 2022, we now expect mid-single-digit growth, given the sharing economy performance in the first quarter. Growth in housing is expected to be led by our lender-placed business, an important provider of property protection in the U.S. housing market. This will be driven by efficiencies across our operating model that will position us to benefit from the modest increase to placement rates and REO volume recovery that we expect later this year. Together, these trends will create scale benefits with our large portfolio of over 30 million loans, which will drive lower expenses across the business. Multifamily Housing remains an attractive long-term growth story, although 2022 will be pressured as we continue to make investments in our customer experience and technology. These investments should ultimately support growth of our 2.6 million renters policies and further penetrate the approximately 20 million U.S. renters market. Lastly, our specialty offerings are still expected to grow over the long term despite recent elevated losses in sharing economy from policies previously written under less favorable contract terms, including those from one-off clients. As we consider potential impacts from macro factors, like inflation or supply chain disruptions throughout Lifestyle and Housing, we've not experienced a material impact to Assurant overall. In our mobile business, where the availability of parts fluctuates, we're working proactively with large suppliers to keep higher levels of inventory on hand to ensure timely and cost-effective repairs for customers. We'll continue to monitor developments and any corresponding impact on our business as is necessary. Our ability to meet our business goals is supported by the successful execution of our ESG efforts. We recently published our 2022 sustainability report, highlighting our commitment to build a more sustainable future for all stakeholders through our ESG initiative. We are continuing to advance our efforts, specifically within our strategic focus areas of talent, products and climate. Our sustainability report showcases recent actions and recognitions, while also providing insight into the impact of Assurant's sustainability efforts utilizing key ESG reporting frameworks, such as SASB and TCFD. In addition to setting long-term targets for Lifestyle and Housing at our Investor Day, we also provided 3 key enterprise financial objectives; adjusted EBITDA, adjusted earnings per share and cash generation. For this year, we continue to expect to grow adjusted earnings per share, excluding catastrophe losses, by 16% to 20% from the $12.12 we reported in 2021. This will be driven by 8% to 10% adjusted EBITDA growth from the $1.1 billion in 2021 as well as disciplined capital deployment through share repurchases, including using the remaining net proceeds from last year's sale of Global Preneed. For 2023 and 2024, we expect to grow average adjusted earnings per share by 12% or more with double-digit average adjusted EBITDA expansion, both excluding reportable catastrophes. Through the first quarter, we returned approximately 85% of the $900 million of Preneed proceeds, and we expect to return the balance by the end of the second quarter. At the end of March, holding company liquidity totaled $738 million after returning $280 million in share repurchases and common stock dividends. Over the next 3 years, as the business continues to grow, we expect to generate approximately $2.9 billion of cash from our business segments, providing us with around $2.2 billion of deployable capital. We'll continue to be disciplined about capital deployment with the objective of maximizing long-term returns, taking a balanced approach between investments in growth and returning capital to shareholders. Our goal is to maintain greater capital flexibility as we see attractive opportunities for growth. We might hold higher levels of cash, depending on the opportunities we have in front of us, but we won't accumulate cash without line of sight to value-creating opportunities. We'll continue to return excess capital through share buybacks. Overall, we're pleased with our performance in the first quarter. We're confident in our ability to continue to expand earnings and cash flows. This will also allow us to continue to invest in our businesses and sustain our track record of returning excess capital to shareholders over the long term. I'll now turn the call over to Richard to review the first quarter results and our 2022 outlook. Richard?
Richard Dziadzio: Thank you, Keith, and good morning, everyone. Adjusted EBITDA, excluding catastrophes, totaled $302 million, equal to the first quarter of 2021. Performance was driven by strong growth across Global Lifestyle, which was offset by higher non-cat loss experience in Global Housing, primarily from our specialty offerings. For the quarter, we reported adjusted earnings per share, excluding reportable catastrophes, of $3.80 , up 17% from the prior year period, driven by buybacks and a $9 million nonrecurring tax benefit from one of our international businesses. Now let's move to segment results, starting with Global Lifestyle. This segment reported adjusted EBITDA of $217 million in the first quarter, a year-over-year increase of 13%, driven by continued earnings expansion in both Connected Living and Global Automotive. Connected Living earnings increased by $16 million, or 13% year-over-year. The increase was primarily driven by continued mobile expansion in North America device protection programs from cable operator and carrier clients, including more favorable loss experience and subscriber growth as well as an increase in global mobile devices service, including higher trade-in volumes from continued carrier promotions. In Global Automotive, earnings increased $9 million or 12% from 3 items: higher investment income, favorable loss experience in select ancillary products and continued growth in our U.S. national dealer and third-party administrator channels, including growth of 5% in global vehicles protected. As we look at revenues, Lifestyle revenues increased by $99 million or 5%, aligning with our expectation that revenue would increase mid-single digits year-over-year. This was driven by continued growth in Global Automotive and Connected Living. In Global Automotive, revenue increased 9%, reflecting strong prior period sales of vehicle service contracts. Even with the decline in U.S. auto sales year-over-year, net written premiums increased 4% as we continued to benefit from higher attachment rates on used vehicles. Within Connected Living, revenue increased 2% from higher mobile fee income driven by our global mobile devices service. Devices service encompasses the devices we touch in our trade-in, repair and dynamic fulfillment ecosystem. In the first quarter, the number of global mobile devices service increased by $800,000 or approximately 13% to $6.8 million. This was led by higher trading volumes, supported by new phone introductions and carrier promotions from the introduction of 5G devices as well as initial service and repair volumes. In terms of mobile subscribers, growth in North America subscribers was partially offset by declines in runoff mobile programs, previously mentioned, which also impacted mobile devices protected sequentially. For full year 2022, we continue to expect Lifestyle adjusted EBITDA growth to be low double digits compared to the $740 million in 2021. Connected Living is expected to be the key driver of adjusted EBITDA growth, driven by global expansion in existing and new clients across device protection and trade-in and upgrade programs. This will be partially offset by strategic investments to support new business opportunities and client implementations as well as unfavorable impacts from foreign exchange in Asia Pacific and Europe. Auto adjusted EBITDA is expected to increase due to higher investment income and business performance throughout the year, which will be partially offset by higher expenses. Moving to Global Housing. Adjusted EBITDA was $104 million for the first quarter compared to $94 million in the first quarter of 2021, driven by lower reportable catastrophes. Excluding catastrophe losses, earnings decreased $30 million, primarily due to higher non-cat losses in our specialty and lender-placed businesses. Nearly 2/3 of the earnings decrease was from an unfavorable non-cat loss experience in our specialty offerings, including a $14 million increase within sharing economy, primarily related to a reserve adjustment and adverse development from policies previously written under less favorable contract terms. Taking a closer look at sharing economy, the product where we are seeing higher claims relates to on-demand delivery. It's a short-term liability policy covering the period when a driver may be using their vehicle for commercial purposes, which is not covered by a traditional auto insurance policy. We started writing this business in 2017 and is a relatively small portion of our Global Housing business, representing roughly 12% of specialists annualized net earned premium. We have taken several actions over the years, including modifying contract terms with some of our partners and discontinuing less profitable business to improve performance. However, based on the recent higher claims frequency and severity, we are taking a closer look at the business and expect to take appropriate steps to improve performance as we look to deliver on our financial objectives. Turning to lender-placed. This business comprised the majority of the balance of the increase in our non-cat loss experience within the segment. This was mainly related to elevated frequency and claim severities from fire claims, ultimately leading to lower earnings year-over-year. I did want to note that while fire claims tend to ebb and flow throughout the year, we continue to see higher cost of claims throughout our book due to inflationary factors, including labor and materials. These impacts continue to be largely offset by higher average insured values. In Multifamily Housing, underlying growth in our PMC and affinity channels was offset by more normalized losses compared to an abnormally low first quarter of 2021 as well as increased expenses from ongoing investments to further strengthen the customer experience. Global Housing revenue was up slightly year-over-year, mainly from higher average insured values and lender-placed and growth in Multifamily Housing. This was partially offset by lower specialty revenues from client runoff. Overall, we announced that Global Housing adjusted EBITDA, excluding cats, to grow mid-single digits from the $486 million in 2021. Lender-placed is expected to be a key driver for the following 4 items: first, expense efficiencies across the business, including system enhancements and new digital capabilities, we expect these to create additional scale as the volume of our business grows; second, higher average insured values; third, a modest lift from expected placement rate increases; and last, REO recovery later in the year, noting that volumes were significantly reduced from foreclosure moratoriums during the pandemic. Additionally, we are monitoring higher claims costs as well as reinsurance costs, which are aligned with the increase in AIVs. Overall, for Housing, we would expect the combined ratio, including cats, of 84% to 89%. At Corporate, adjusted EBITDA was a loss of $22 million, an improvement of $6 million compared to the first quarter of 2021. This was mainly driven by 2 items; first, lower employee-related expenses; and second, higher investment income from higher asset balances following the sale of premium. For full year 2022, we expect the Corporate adjusted EBITDA loss to be approximately $105 million. This reflects lower investment income compared to 2021. In addition, the first half of the year historically experiences lower expenses as investments ramp throughout the year. Turning to holding company liquidity. We ended the first quarter with $738 million, $513 million above our current minimum target level. In the first quarter, dividends from our operating segments totaled $129 million. In addition to our quarterly Corporate and interest expenses, we also had outflows from 2 main items: $242 million of share repurchases and $37 million in common stock dividends. As Keith mentioned, we expect to return the remaining portion of the $900 million of Preneed proceeds or approximately $125 million in the second quarter. Our outlook assumes returning an additional $200 million to $300 million throughout the year. For the year overall, we continue to expect segment dividends to be roughly 3/4 of segment adjusted EBITDA, including catastrophes. As always, segment dividends are subject to the growth of the businesses, rating agency and regulatory capital requirements and investment portfolio performance. In summary, we're confident in our ability to achieve our financial objectives for 2022 and over the long term, as we discussed at Investor Day. Our earnings growth, strong capital generation, product and service offerings as well as our business resiliency continue to differentiate Assurant as a strong partner and as a compelling investment. And with that, operator, please open the call for questions.
Operator: [Operator Instructions]. And our first question comes from the line of Michael Phillips from Morgan Stanley.
Michael Phillips: First question is on the comments, Keith, you made about the expanded partnership with the retail. How much -- anything you can quantify there and how that might impact the outlook for 2022?
Keith Demmings: Yes. Certainly, it's considered in the full year outlook. I would say not a material driver. There'll be some investments that we're making. We've been making already to this point in the year. That will continue as we kind of ramp the full scale of services. We'll also see volume and revenue start coming in as well. So that will typically be fairly well aligned in this case. So I would say fairly neutral this year. And then obviously, as we kind of build scale and ramp, it will become more meaningful as we look to '23 and beyond and really exciting opportunity for us. If you think about the retail landscape in the United States, if you think about the opportunity to broadly serve the connected consumer in the future with bundled solutions around the connected home, this does give us a pretty material step change in terms of the scale of our services, particularly around the appliance side of the business. It's a disproportionate increase to our volume. And I think it will definitely bear fruit longer term, and we're really excited. And it's an important client. Certainly, it helps us protect the client, but really expanding our services and then making investments in our platforms that I think will support further growth longer term is what gets me most excited.
Michael Phillips: Okay. Congrats on that. Second question is just again on the outlook and maybe trying to get into some of the drivers behind that. Specifically, can you say to what extent you have -- in the Lifestyle, mobile business, what's your outlook for mobile sales for the year? And how does that influence your outlook for the year there?
Keith Demmings: Yes. I mean I think we're seeing really strong results in the mobile business. If you look back over many years, it doesn't always show up in the subscriber count number. Now we've started to give devices service where you're seeing a fairly significant ramp in our trade-in volume, which has been true over the last several quarters. I think we are seeing underlying growth in our most mature markets. That's masked a little bit. So in North America, we're definitely seeing increases in our subscriber counts. That's true with our mobile partners in terms of mobile operators, but it's also true with the cable operators that we do business with for device protection. They're growing. They're achieving net adds every quarter in terms of postpaid customers. So we're definitely seeing growth there. Those are the most mature markets. And then that's kind of masked by a little bit more softness in some of our international markets and then some client runoff that's got a fairly limited economic impact overall. We're still seeing strong demand in the market for mobile devices. We're seeing a lot of carrier competition, carrier promotions. I think we're extremely well positioned with clients, both in terms of device protection, but then the breadth of clients we serve with respect to trade in, which has only grown over the last couple of years. So I feel like we're really well positioned, and there's still a tremendous amount of consumer demand. We'll see as the year progresses if that changes. But certainly, at this point, we feel really good about how we're positioned.
Michael Phillips: Okay. Last one for now. On the specialty business and the charge there. Actually, Richard, you alluded to some steps you're taking to improve the performance there. Can you kind of talk about what are the things you're doing there to make sure that doesn't happen in future results.
Richard Dziadzio: Yes. Thanks, Mike. Go ahead, Keith.
Keith Demmings: I was going to say, why don't you talk a little bit about some of the work that we're doing, Richard, and I'll talk more strategically.
Richard Dziadzio: Okay. Okay. Great. And first to start out in the specialty area, we talked about sharing economy and the charge we took of $14 million. Really, most of that charge is linked to past business, past contracts we had in place. So call it runoff, I think about it runoff in my mind that there are old contracts, clients that we canceled over time and we're getting those charges come through right now. So we have done, I would say, as Keith said in his remarks, we have done some actions. We're going to continue to do more actions. I think we're deep diving into the types of contracts we have. We're understanding the volatility about those contracts. We're understanding the quality of the clients we have behind those contracts. So our goal is to make sure that we're hitting our financial objectives, as we said in our remarks. And so we're not happy with taking the charge, and we're going to work on that very hard. Keith?
Keith Demmings: Yes. The only thing I would add, I think the business that we're writing today, to Richard's point, the team has done a really good job modifying pricing, terminating certain partnerships that we didn't think were going to pay off long term and changing deal structures, changing the terms and conditions around the products. There's been a lot of good work done. The charges that you're seeing flow through for the most part relate to business that's since been modified through a lot of those actions that we've taken. I'd say the underlying profitability on the business we write today, new business that we're putting on the books is significantly better than the historical. So that's definitely a good thing. But the team is not happy overall with how this business is performing at the moment. So we're definitely looking at it very closely. One of the strategic I guess in terms of the thesis with this business was not just giving us access to the gig economy, really fast-growing kind of emerging marketplace that we thought was really interesting, a place where we could innovate and develop some new distribution opportunities. We also thought there would be opportunities to provide additional coverages, like mobile protection, vehicle service contracts. Those are pretty important types of coverages for a gig economy worker, that hasn't materialized to this point. That was part of the strategic rationale and the thesis behind entering this marketplace. So obviously, we're evaluating whether those opportunities can exist for us in the future. So more work to be done. To Richard's point, we're not happy with the results. We're definitely going to be making sure this business is built to deliver the economics that we would expect based on the risk reward trade in the marketplace.
Operator: Your next question comes from the line of Gary Ransom from Dowling & Partners.
Gary Ransom: I had a couple of questions on the interpretation of the new items that you're giving in the earnings. One is the EBITDA margin. I know in the past you've talked about how different contracts have different revenues versus different margin levels based on how they're structured. Is there any different way I might interpret the 11% margin that came in, in Lifestyle? Or are those -- just how are you thinking about that?
Richard Dziadzio: And maybe I can...
Keith Demmings: Go ahead, Richard.
Richard Dziadzio: Yes. No, I think the EBITDA margin, to a certain extent, it's a reflection of the mix of business that we have, Gary. I think that as we go, when we become more fee-based as we've talked about, you're going to get naturally as opposed to putting it over premiums or gross premiums. You're going to have that margin naturally improve. Keith talked earlier about kind of the mix of products and the fact that we do have clients with more fee-based services. So that definitely is a positive for us. And also, I guess, the bottom line too is Lifestyle had a very good quarter overall in terms of profitability. And that obviously then translates into the margin as well, which helps.
Gary Ransom: And the other one I wanted to ask about is the mobile devices service, which you did talk about it being up strongly year-over-year. But there also seems to be some seasonality, the decline sequentially. Can you just remind us what the -- how to think about the sequential seasonality for that measurement?
Keith Demmings: Sure. And you're right, there's definitely seasonality. We tend to see a fairly significant Q4 related to devices service. We also tend to see strength in Q1. As we look at devices, iconic devices launched in the back half of the year, that obviously leads into a lot more activity in terms of customers trading in old devices in the fourth quarter to try and get the new devices that are being actively marketed in the marketplace. We tend to see that spill over into Q1 as well. And then it really is a function of the promotional activity that the carriers are doing in the market. So if you think about all of our global partners that offer trade-in programs as they're being more aggressive with trade-in offers to try and get consumers into the latest technology and which is particularly true today with the push for 5G. That is ultimately what drives -- the seasonality is those promotions that are driven by the carriers. So we saw strong activity in Q1. I expect we'll continue to see strength as we go through the year. But you're correct. We tend to see a really strong first quarter, a really strong fourth quarter. And then we'll see what happens with respect to the promotions as we go through the year. And obviously, we'll see what also happens with consumer demand and other factors that our partners are trying to navigate as well.
Operator: Your next question comes from the line of Mark Hughes from Truist.
Mark Hughes: Question on the Global Automotive business, vehicle business, what kind of new business in the -- and I'm sorry, it's kind of a strange time in the auto market in terms of sales. Should we anticipate growth in terms of vehicles covered? Or is this more steady as she goes?
Keith Demmings: Yes. I mean, first of all, I'm really happy with the overall performance of the auto business, and it was a particularly strong first quarter, not just in terms of the ultimate profitability of the business as we look at the EBITDA growth that we were able to deliver. But also just in terms of the performance on a net written premium basis, if you look at revenue was up 9%, net written premium was up 4%, and that's dealing with Q1 auto sales this year, which were down 12% versus Q1 last year. So I would say that our team is outperforming the underlying results within the auto industry in terms of car sales. So I think that's really positive. That's a testament to the I think the breadth of our client partnerships, the fact that we've got really, really well diversified distribution channels and our partners are being successful in the market, and they're gaining share. So that's helped us significantly. And our teams are also expanding our own market share just because of the scale and breadth of our offering. So feel really good about automotive broadly. Covered vehicles is relatively flat, as you mentioned right now, but we are seeing underlying growth in net written premium, which to me is a really good sign. And we'll see what happens with the auto industry. I certainly expect, at some point, there's a lot of pent-up demand for new vehicles. And as new vehicles become more readily available, obviously, we'll start to see the benefits of that flowing through on the new vehicle side. That will probably alleviate some of the pricing pressure on the used car market. Used car markets are extremely elevated right now and that too should normalize. So -- but again, I feel like there's definitely upside in this business over time, particularly as we look at interest rates today. We had favorability in the quarter, both from interest rates as well as from the underlying performance and growth of the business. And certainly, that's an opportunity as we look forward.
Mark Hughes: Maybe a similar question on Multifamily. I think your renters, the count was up 5%, 6%. The revenue was up low single digits, which is a little bit below the recent trend. What do you think is the prospect there?
Keith Demmings: Yes. I think we -- first of all, we really like the renters business. We've got a strong market position. We cover 2.6 million renters. So we've got a really nice market share as well, and it's been growing historically over time. And the renters market has also been growing. If we look back just because of attach rates improving historically. So I really like the position that we're in. You're correct. We saw a little bit slower growth in the quarter. Slower growth from some of our affinity partners offset, I would say, by really favorable strong growth within the PMC channel. We've talked before about the success we're having with Cover360 with our property management partners, where we've got just a more much more integrated solution into the buy flow with better digital access. Premiums for renters are collected as part of the rent. So there's a lot more opportunity for us to continue to grow in that market as we scale that solution and as more clients adopt it. So I do expect this business to drive long-term growth. It's a key focus. We continue to look for ways to differentiate our solutions and then broaden distribution, and that's going to be a key focus for the team as we move through the year.
Mark Hughes: And then Richard, on investment income, anything you would -- is this a good kind of run rate at this point when we think about new money yields, is that going to lead to an increase in investment income as we get into the rest of this year and next year?
Richard Dziadzio: Yes. Thanks for the question, Mark. I mean definitely, the increase in interest rates is a positive thing for us, both long term and short term. So we are benefiting from that, and we'll continue to benefit from that as kind of the book rolls through, so to speak, and the assets come to maturity. So very, very positive news for us. I would say -- in terms of your question on run rate, I wouldn't necessarily take this as a run rate because in this quarter, let's say, we're up about $8 million over the prior year quarter. That's coming part from some real estate gains. So part from interest rates and investment income coming from the fixed income book, but also part from real estate gains. We had a few million dollars of real estate gains in there, just a little under 5, I would say. So part of that, I would consider a little bit of a one-timer. But the rest of it is good news and hopefully a harbinger of things to come as interest rates continue to stay at an elevated level and even increase as we've seen over the last couple of months.
Operator: Your next question comes from the line of Tommy McJoynt from KBW.
Tommy McJoynt: So it sounds like just kind of going back to the sharing economy and on delivery products that further reserve strengthening this quarter. So while it's a growing kind of exciting piece of the economy, to the extent that you do deem that it's unlikely to meet your return hurdles? Or if you think that cross-selling to those gig economy workers just looks too challenging. Can you talk about what a wind down of that business would look like? I know in the past, you've exited things like small commercial that didn't meet your return hurdles. So just kind of how material is that business? And is it a profitable business right now? Or is it a drag? Just kind of any more kind of numbers you can put around that?
Keith Demmings: Yes, maybe I'll offer a couple of thoughts, and then Richard, feel free to chip in. But we've talked about it being 12% of the specialty line. I'd say $50 million to $60 million a year in net earned premium in terms of the size and scale of that business today operates across multiple clients, primarily in food delivery. If I look at the P&L over the lifetime of the business, I'd say it's relatively neutral. It's not been a big drag in terms of losing money. We look at the inception to date, profitability of the business. Forget about quarter-to-quarter and year-over-year changes, is this business making money. So pretty marginal at this point overall. But as we talked about, that's absorbing the learnings, the investment to scale the business, early losses as we sort of had to learn the market as the market was being created. So not a terrible result and it's something that we built and incubated. And I think our team has done a really good job. It's a really well diversified mix of business. There's a lot more protections in how that product and how the programs are structured today. We've built a lot of expertise around managing the claims and integrating with our partners. And then obviously, there's a lot of complexity in this business. So I think from that perspective, it's worked in terms of what can this mean for us going forward? How large can it be? Can we get the strategic value out to your point, that's something that we've got to continue to work on and making sure we can define that. But it's not a big drain in terms of the actual P&L effect that we're feeling. It's just not hitting the hurdle rates that we'd expect at this point, 5 years into learning this part of the market. And Richard, feel free to add anything else.
Richard Dziadzio: No. I think your last comment is the one I would underscore for Tommy, which is it was a business that we started 5 years ago as an incubator to innovate and see if there was a part to get into the gig economy that way and see that. Over time, with 5 years, the overall profitability, I would say, has been fairly neutral for us. The new contracts that we have in place are profitable. And so that's what we're going to dive into is to say, okay, well, do we have something here that we can build upon? Or is this a business that we need to change drastically? So that's what we're deep diving, as Keith said, to do and really to understand it. So overall, for this year, given the results of the first quarter, I wouldn't think it would be a positive or a negative to the rest of the year, right, in terms of the outlook that we have out there. So some work to do there, Tommy.
Tommy McJoynt: That's great. Thanks for all those numbers that you guys gave there. And then just my other question, could you guys talk about what could be some of the drivers for the favorable loss experience in Lifestyle that you guys referenced, when there's really widespread reports of higher severity via higher cost in parts and labor in most industries out there.
Keith Demmings: Yes, maybe I'll offer a couple of thoughts. We -- and there's a few moving pieces, but I would say if we look at -- the first thing to underscore is that for the vast majority of the business we're -- either we're risk sharing or reinsuring or we're profit sharing back with partners. So we're not on the majority of the risk, and we've talked about that, historically. And then where we are on risk, there are some interesting things that are happening. If I think about the auto business, we write some gap insurance. And obviously, with used car values at all-time highs, the GAAP losses have been dramatically lower as you think about the depreciated value of the used car is much higher today than it would have been under normal circumstances. So that's creating some favorability. That normalizes over time, I would say, is the used car market moderates. And when will that happen, it's hard to know, right? Because it's all connected with more broadly the supply chain issues that are creating that situation. And then in terms of the mobile side, we had a little bit of elevated losses if you look back to Q1 of '21. When you think about some of the business where we actually are on the risk, a little bit more elevated losses last year due to just some parts availability pressure in that business. Our teams have done an incredibly good job buying inventory, maintaining inventory to make sure that we're able to deal with our claims efficiently. You've got, obviously, as product continues to roll out in the market in terms of new devices, the quality of those devices continues to improve, which is also helpful. And we've just seen some underlying strength in our ability to manage loss costs around that mobile experience. We're doing a lot more repair as well. So there are several factors at play. Again, most of that accrues to the benefit of our partners because of the deal structures. But for those where we are on the risk on balance, we've been really pleased with how the team has performed.
Operator: [Operator Instructions]. Your next question comes from the line of Jeff Schmitt from William Blair.
Jeffrey Schmitt: The cost for the T-Mobile in-store repair rollout, they looked at peak in the fourth quarter of last year, but you'd mentioned that should continue in the first half of the year. Can we get a sense on how much costs for the quarter? And would you expect to see some -- there still wasn't year-over-year margin expansion, but should we sort of expect that next quarter? Or is that more of a second half of the year? Just any detail you could provide there.
Keith Demmings: Yes. I would say, first of all, we're thrilled with everything that we've done with T-Mobile as we look back over the last several months, the migration of the Sprint customers went incredibly well, and we're really proud of the work that we've done there. And then the build-out of same unit repair in the T-Mobile stores. Again, a lot of that work happened in Q4. We had to recruit technicians. We had to train. We had to develop all of our technology interfaces, all of our inventory management solutions, all of that work to stand that up and was largely done by the end of 2021. And as we look at Q1, I would say, relatively neutral effect overall in terms of the P&L. So there's some ongoing investments, a little bit less about new store scaling and more about refining process, refining platforms, investing in the underlying technology and then just trying to make sure that we're evolving how we execute and deliver value to end consumers in partnership with T-Mobile. And that will never stop, right? We'll always be looking to invest to improve. And we're seeing incredible Net Promoter Scores. I would say we had a really, really high NPS prior to same unit repair. It's taken it to another level, and it's pretty exciting to see the favorable reactions we're getting from the customers. And obviously, that's reflecting well on T-Mobile and their brand. So -- but relatively neutral in the quarter and expect that to improve as we go through the year and as we reach a more mature and steady state with the solution. But you couldn't be prouder of the work that the team has done and the actual results that are being delivered to the end customer.
Jeffrey Schmitt: Okay. Great. The -- and then on the covered mobile devices, was down a little bit sequentially, but could you talk about the sort of underlying growth there, excluding the legacy Sprint customers coming on? What was the impact of the runoff clients? And what's your outlook for that kind of underlying growth? So I think if you go back to quarter 2 before Sprint came over, you'd mentioned that maybe going in the mid-single digits. But what is your sort of outlook for that?
Keith Demmings: Sure. Yes. And obviously, when you look year-over-year, it's a big step change because of Sprint, and we've talked about the importance of that relationship. But you're right, in terms of the underlying subscriber growth, we're seeing the U.S. market continue to drive growth. It's masked in the numbers because, obviously, we're showing a global total. But we are seeing fundamental growth there, expect that to continue as we move quarter to quarter to quarter. So that's -- and as I referenced earlier, both in terms of mobile operators, but also our cable partners as well, who are having success and doing well with respect to offering our services to end consumers. So that will continue. A little bit of softness in some of the international markets where things have been a little bit slower to open up from COVID, not a big economic concern. Obviously, it shows up in the numbers in terms of accounts, but not a massive impact from an economic point of view. And then we had a client that we talked about last year that had runoff, again, not material economically. So I have no concerns with respect when I look at where we are for mobile devices protected. I think what's important is we're building deeper and deeper relationships with some incredible global partners. And the deeper those relationships get, the more services we provide, the more we can help solve problems and innovate to deliver value, and that's what gets us really excited. There's a lot of great momentum in the market. Our teams are really, really integrated, and we're passionate about serving clients, solving problems and delivering for end consumers. And I think that's the game that we're trying to win over the long term.
Operator: Your next question comes from the line of John Barnidge from Piper Sandler.
John Barnidge: That new partnership that you talked about the end-to-end sounds very exciting. Are there opportunities to expand that for other similar relationships? Or do you need to get past the ramp-up phase to really create the leverage to expand with others?
Keith Demmings: Yes, I definitely think there are opportunities to expand. I think scale, and I've talked about this previously, scale is important, right? And I think this relationship will give us a tremendous increase to our scale. It's quite material in terms of what it means for our ability to deliver customer service to manage a third-party repair network and then to make the underlying investments I think that will happen quickly. And I think we will have opportunities to drive growth, both in new and interesting ways with this partner, who is significant and always trying to innovate around the customer, but also as we think about the capabilities and the foundation that we continue to build, how do we then leverage that foundation. And I would say that foundation will get built and scaled fairly quickly. It won't be 3 or 4 years from now, we'll finally have solution that then is really relevant in the market. That relevance will emerge fairly quickly.
John Barnidge: Okay. And then a follow-up question. What does the international growth opportunity look like given increased FX volatility?
Keith Demmings: Yes. So no doubt, as we look at Q1, we saw some effects from FX. We expect that to continue as we look towards the rest of the year. Luckily, as Richard has talked about, we're pretty resilient. There are a number of pluses and minuses as we look at more broadly, inflation macroeconomic factors, interest rates. So we feel like we're well positioned. But there's definitely we'll see some effect from FX. Think about Europe and Japan, as good examples, where we'll expect to see that. I do think we've got great momentum around the world. I mean our international footprint has continued to mature over the last many years. We haven't expanded into new countries. We've really focused on how do we gain relevance and scale within the key markets that we want to be in. And I think our teams are doing a great job. Our services, our solutions, we continue to deploy them on a global basis. So as we build services like you think about it an easy example like same unit repair or premium technical support or trade in, those services are relevant everywhere in the world. They may be more relevant in a certain market today and 2 years from now, that trend catches up in another part of the world. So I think that's one of the powers of operating as a global business. It's allowed us to build things once, build them in a standard way, build kind of global platforms that we can scale and then deploy those internationally. And we've got some incredible clients around the world. I'm so proud of what our international team has done, and I think there's lots and lots of opportunities. And today, it's mobile. Connected Living is the biggest part of international. We've got through the acquisition of TWG, much more automotive going on in various parts of the world. And as we continue to find the other relevant parts of Assurant to export to take advantage of our biggest markets, I think that will create longer-term tailwinds for us. But certainly, in the short term, FX is a challenge.
Operator: And your final question comes from the line of Grace Carter from Bank of America.
Grace Carter: I was wondering if you all could talk about, I guess, the percent of the LPI book that's historically been in REO and just how that compares today versus historical and I guess, just kind of the evolution of that over the course of the year?
Keith Demmings: Yes. I would say, in simple terms, our REO volume is down significantly. It's probably 1/3 of what it would have been pre-pandemic roughly in that order of magnitude. I'd say we've seen it stabilize in terms of volume in the first quarter. I would expect that to slowly increase over time as properties enter foreclosure later in the year. So I definitely see that growing over time. Obviously, there's a ton of strength in the housing market. Our partners are working closely with customers in terms of loss mitigation activity. There's a lot of equity still in the homes for customers. There's a lot of opportunity for mortgage servicers to work with customers. So that will take some time to normalize. But certainly, it's dramatically lower than pre-pandemic, and we'd expect things to normalize over a reasonable period of time over the next couple of years, I would say.
Grace Carter: And sticking with the housing book, if there's any more color you could offer on the cost efficiencies that you referenced, just kind of thinking if that should ramp over the year or there should be kind of a more even impact starting next quarter? And just any sort of directional guidance on maybe the magnitude of the impact?
Keith Demmings: Yes, I think we're investing heavily in terms of digital investments automation. We've got a large operation that we run within the housing business. It's fairly intensive, labor-intensive in terms of the services that we provide. We've talked about how deeply integrated we are with our partners. And really, it's just operational transformation initiatives around digital and finding simpler ways to serve customers more quickly in partnership with our clients. And I would expect it to ramp naturally over the year as we continue to deploy digital tools, digital solutions, and that will allow us to drive that efficiency going forward. But Richard, what else might you want to add?
Richard Dziadzio: Yes, I think that's exactly right. I don't think there will be a threshold moment per se. And a lot of the leverage that we're getting today is based on projects that have already been launched, that already were doing. So we're going to continuously, as Keith said, gets leverage out of it. And where I see some good leverage coming out is coming back to your previous question, Grace on REO, as we get more revenues out of that as revenues grow overall in lender-placed, we should hopefully get some leverage out of the expenses as well. Knowing, of course, that over time, it's more of a revenue and top line issue as opposed to just pure expenses because, obviously, we have rate filings to do. And over the longer term, that will balance itself out. But we do see over the short term that expenses and the leverage we're creating will really be helpful to us.
Keith Demmings: All right. Well, thank you again, everyone. And I would just like to close by saying we're really pleased with our first quarter performance. I certainly look forward to updating everyone on our second quarter results in August. And then in the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. But thank you very much, and have a great day.
Operator: Thank you. This does conclude today's conference. Please disconnect your lines at this time, and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's First Quarter 2022 Conference Call and Webcast. [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our first quarter 2022 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the first quarter 2022. The release and corresponding financial supplement are available on assurant.com. We will start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated value statements. Additional information regarding these factors can be found in yesterday's earnings release as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday's news release and financial supplements as well as the Investor Day presentation materials that can be found on our website. I will now turn the call over to Keith."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Suzanne, and good morning, everyone. We're pleased with our performance for the first quarter, which demonstrates the resiliency and strength of our business during a period of macroeconomic and geopolitical uncertainty. Within Global Lifestyle, stronger-than-expected performance in our capital-light Connected Living and Global Automotive businesses offset softer-than-expected results within Global Housing, mainly from our specialty offerings. The ongoing growth of our fee-based, capital-light offerings across Global Lifestyle and Global Housing accounted for nearly 80% of segment earnings in 2021. This differentiates Assurant as both a service-oriented partner to our clients and a compelling investment given our scaled customer base in markets with strong tailwinds. Our continued alignment with world-class partners and our ability to provide best-in-class products, services and customer experiences has positioned us well for expected profitable growth this year and over the long term. As we outlined at Investor Day in March, we have a clear vision for the future, to be the leading global business services company supporting the advancement of the connected world. We aren't settling for the status quo. While we currently have scale leadership positions in attractive and growing markets, we have our sights set on being the leader in all of the businesses in which we operate. With that said, we believe the financial objectives we outlined for Assurant over the next 3 years are attractive and will be supported by our focus on market-leading innovation, business simplification, operational optimization and the benefits of scale. We believe this will lead to continued strong cash flow generation, earnings growth and financial outperformance. In Global Lifestyle, we remain focused on supporting our more than 250 million customers through our broad set of products and services across insurance, operations, mobile trading and repair and comprehensive administrative services throughout Connected Living and Global Automotive. For this segment, we continue to expect adjusted EBITDA growth in the low double digits for 2022 with average annual growth of 10% in 2023 and 2024. We anticipate Connected Living will lead our growth for the Lifestyle segment, driven by our multidimensional strategy. Over the next 3 years, Connected Living should benefit from increased mobile and retail client expansion and increase in fee-based traded and repair as well as contributions from strategic M&A. We continue to be excited about opportunities to drive growth in our retail business as we think about longer-term opportunities to serve the connected home. As of May 1, we're pleased to announce that we have expanded our relationship with one of our largest U.S. retail partners. We moved beyond program underwriting and have expanded our services to provide for the end-to-end administration of the business, including call center support, claims management and oversight of service delivery. Not only does this allow us to deepen our relationship with a critical client, it allows us to continue to grow our retail business, while dramatically increasing our scale to support claims and customer service further improving our relevance with the third-party repair network that supports this business. We now support a meaningfully larger number of appliance repairs, which we believe is strategically important to our ambitions to provide protection services to the evolving connected home. This partnership will also support additional investments in digital tools and technology platforms that are key to our long-term vision. Global Automotive is expected to benefit from our increased scale and strong national dealer, third-party administrator and international OEM partnerships. We will continue to invest in technology, integrating our systems and processes following several years of successful acquisitions. Throughout Lifestyle, we'll also continue to invest to expand our market-leading positions. We anticipate incremental spending related to the development of new products, such as our connected home offerings and increased investments for new client implementations. In Global Housing, the business is expected to grow mid- to high single digits in 2023 and 2024. For 2022, we now expect mid-single-digit growth, given the sharing economy performance in the first quarter. Growth in housing is expected to be led by our lender-placed business, an important provider of property protection in the U.S. housing market. This will be driven by efficiencies across our operating model that will position us to benefit from the modest increase to placement rates and REO volume recovery that we expect later this year. Together, these trends will create scale benefits with our large portfolio of over 30 million loans, which will drive lower expenses across the business. Multifamily Housing remains an attractive long-term growth story, although 2022 will be pressured as we continue to make investments in our customer experience and technology. These investments should ultimately support growth of our 2.6 million renters policies and further penetrate the approximately 20 million U.S. renters market. Lastly, our specialty offerings are still expected to grow over the long term despite recent elevated losses in sharing economy from policies previously written under less favorable contract terms, including those from one-off clients. As we consider potential impacts from macro factors, like inflation or supply chain disruptions throughout Lifestyle and Housing, we've not experienced a material impact to Assurant overall. In our mobile business, where the availability of parts fluctuates, we're working proactively with large suppliers to keep higher levels of inventory on hand to ensure timely and cost-effective repairs for customers. We'll continue to monitor developments and any corresponding impact on our business as is necessary. Our ability to meet our business goals is supported by the successful execution of our ESG efforts. We recently published our 2022 sustainability report, highlighting our commitment to build a more sustainable future for all stakeholders through our ESG initiative. We are continuing to advance our efforts, specifically within our strategic focus areas of talent, products and climate. Our sustainability report showcases recent actions and recognitions, while also providing insight into the impact of Assurant's sustainability efforts utilizing key ESG reporting frameworks, such as SASB and TCFD. In addition to setting long-term targets for Lifestyle and Housing at our Investor Day, we also provided 3 key enterprise financial objectives; adjusted EBITDA, adjusted earnings per share and cash generation. For this year, we continue to expect to grow adjusted earnings per share, excluding catastrophe losses, by 16% to 20% from the $12.12 we reported in 2021. This will be driven by 8% to 10% adjusted EBITDA growth from the $1.1 billion in 2021 as well as disciplined capital deployment through share repurchases, including using the remaining net proceeds from last year's sale of Global Preneed. For 2023 and 2024, we expect to grow average adjusted earnings per share by 12% or more with double-digit average adjusted EBITDA expansion, both excluding reportable catastrophes. Through the first quarter, we returned approximately 85% of the $900 million of Preneed proceeds, and we expect to return the balance by the end of the second quarter. At the end of March, holding company liquidity totaled $738 million after returning $280 million in share repurchases and common stock dividends. Over the next 3 years, as the business continues to grow, we expect to generate approximately $2.9 billion of cash from our business segments, providing us with around $2.2 billion of deployable capital. We'll continue to be disciplined about capital deployment with the objective of maximizing long-term returns, taking a balanced approach between investments in growth and returning capital to shareholders. Our goal is to maintain greater capital flexibility as we see attractive opportunities for growth. We might hold higher levels of cash, depending on the opportunities we have in front of us, but we won't accumulate cash without line of sight to value-creating opportunities. We'll continue to return excess capital through share buybacks. Overall, we're pleased with our performance in the first quarter. We're confident in our ability to continue to expand earnings and cash flows. This will also allow us to continue to invest in our businesses and sustain our track record of returning excess capital to shareholders over the long term. I'll now turn the call over to Richard to review the first quarter results and our 2022 outlook. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith, and good morning, everyone. Adjusted EBITDA, excluding catastrophes, totaled $302 million, equal to the first quarter of 2021. Performance was driven by strong growth across Global Lifestyle, which was offset by higher non-cat loss experience in Global Housing, primarily from our specialty offerings. For the quarter, we reported adjusted earnings per share, excluding reportable catastrophes, of $3.80 , up 17% from the prior year period, driven by buybacks and a $9 million nonrecurring tax benefit from one of our international businesses. Now let's move to segment results, starting with Global Lifestyle. This segment reported adjusted EBITDA of $217 million in the first quarter, a year-over-year increase of 13%, driven by continued earnings expansion in both Connected Living and Global Automotive. Connected Living earnings increased by $16 million, or 13% year-over-year. The increase was primarily driven by continued mobile expansion in North America device protection programs from cable operator and carrier clients, including more favorable loss experience and subscriber growth as well as an increase in global mobile devices service, including higher trade-in volumes from continued carrier promotions. In Global Automotive, earnings increased $9 million or 12% from 3 items: higher investment income, favorable loss experience in select ancillary products and continued growth in our U.S. national dealer and third-party administrator channels, including growth of 5% in global vehicles protected. As we look at revenues, Lifestyle revenues increased by $99 million or 5%, aligning with our expectation that revenue would increase mid-single digits year-over-year. This was driven by continued growth in Global Automotive and Connected Living. In Global Automotive, revenue increased 9%, reflecting strong prior period sales of vehicle service contracts. Even with the decline in U.S. auto sales year-over-year, net written premiums increased 4% as we continued to benefit from higher attachment rates on used vehicles. Within Connected Living, revenue increased 2% from higher mobile fee income driven by our global mobile devices service. Devices service encompasses the devices we touch in our trade-in, repair and dynamic fulfillment ecosystem. In the first quarter, the number of global mobile devices service increased by $800,000 or approximately 13% to $6.8 million. This was led by higher trading volumes, supported by new phone introductions and carrier promotions from the introduction of 5G devices as well as initial service and repair volumes. In terms of mobile subscribers, growth in North America subscribers was partially offset by declines in runoff mobile programs, previously mentioned, which also impacted mobile devices protected sequentially. For full year 2022, we continue to expect Lifestyle adjusted EBITDA growth to be low double digits compared to the $740 million in 2021. Connected Living is expected to be the key driver of adjusted EBITDA growth, driven by global expansion in existing and new clients across device protection and trade-in and upgrade programs. This will be partially offset by strategic investments to support new business opportunities and client implementations as well as unfavorable impacts from foreign exchange in Asia Pacific and Europe. Auto adjusted EBITDA is expected to increase due to higher investment income and business performance throughout the year, which will be partially offset by higher expenses. Moving to Global Housing. Adjusted EBITDA was $104 million for the first quarter compared to $94 million in the first quarter of 2021, driven by lower reportable catastrophes. Excluding catastrophe losses, earnings decreased $30 million, primarily due to higher non-cat losses in our specialty and lender-placed businesses. Nearly 2/3 of the earnings decrease was from an unfavorable non-cat loss experience in our specialty offerings, including a $14 million increase within sharing economy, primarily related to a reserve adjustment and adverse development from policies previously written under less favorable contract terms. Taking a closer look at sharing economy, the product where we are seeing higher claims relates to on-demand delivery. It's a short-term liability policy covering the period when a driver may be using their vehicle for commercial purposes, which is not covered by a traditional auto insurance policy. We started writing this business in 2017 and is a relatively small portion of our Global Housing business, representing roughly 12% of specialists annualized net earned premium. We have taken several actions over the years, including modifying contract terms with some of our partners and discontinuing less profitable business to improve performance. However, based on the recent higher claims frequency and severity, we are taking a closer look at the business and expect to take appropriate steps to improve performance as we look to deliver on our financial objectives. Turning to lender-placed. This business comprised the majority of the balance of the increase in our non-cat loss experience within the segment. This was mainly related to elevated frequency and claim severities from fire claims, ultimately leading to lower earnings year-over-year. I did want to note that while fire claims tend to ebb and flow throughout the year, we continue to see higher cost of claims throughout our book due to inflationary factors, including labor and materials. These impacts continue to be largely offset by higher average insured values. In Multifamily Housing, underlying growth in our PMC and affinity channels was offset by more normalized losses compared to an abnormally low first quarter of 2021 as well as increased expenses from ongoing investments to further strengthen the customer experience. Global Housing revenue was up slightly year-over-year, mainly from higher average insured values and lender-placed and growth in Multifamily Housing. This was partially offset by lower specialty revenues from client runoff. Overall, we announced that Global Housing adjusted EBITDA, excluding cats, to grow mid-single digits from the $486 million in 2021. Lender-placed is expected to be a key driver for the following 4 items: first, expense efficiencies across the business, including system enhancements and new digital capabilities, we expect these to create additional scale as the volume of our business grows; second, higher average insured values; third, a modest lift from expected placement rate increases; and last, REO recovery later in the year, noting that volumes were significantly reduced from foreclosure moratoriums during the pandemic. Additionally, we are monitoring higher claims costs as well as reinsurance costs, which are aligned with the increase in AIVs. Overall, for Housing, we would expect the combined ratio, including cats, of 84% to 89%. At Corporate, adjusted EBITDA was a loss of $22 million, an improvement of $6 million compared to the first quarter of 2021. This was mainly driven by 2 items; first, lower employee-related expenses; and second, higher investment income from higher asset balances following the sale of premium. For full year 2022, we expect the Corporate adjusted EBITDA loss to be approximately $105 million. This reflects lower investment income compared to 2021. In addition, the first half of the year historically experiences lower expenses as investments ramp throughout the year. Turning to holding company liquidity. We ended the first quarter with $738 million, $513 million above our current minimum target level. In the first quarter, dividends from our operating segments totaled $129 million. In addition to our quarterly Corporate and interest expenses, we also had outflows from 2 main items: $242 million of share repurchases and $37 million in common stock dividends. As Keith mentioned, we expect to return the remaining portion of the $900 million of Preneed proceeds or approximately $125 million in the second quarter. Our outlook assumes returning an additional $200 million to $300 million throughout the year. For the year overall, we continue to expect segment dividends to be roughly 3/4 of segment adjusted EBITDA, including catastrophes. As always, segment dividends are subject to the growth of the businesses, rating agency and regulatory capital requirements and investment portfolio performance. In summary, we're confident in our ability to achieve our financial objectives for 2022 and over the long term, as we discussed at Investor Day. Our earnings growth, strong capital generation, product and service offerings as well as our business resiliency continue to differentiate Assurant as a strong partner and as a compelling investment. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. And our first question comes from the line of Michael Phillips from Morgan Stanley."
},
{
"speaker": "Michael Phillips",
"text": "First question is on the comments, Keith, you made about the expanded partnership with the retail. How much -- anything you can quantify there and how that might impact the outlook for 2022?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. Certainly, it's considered in the full year outlook. I would say not a material driver. There'll be some investments that we're making. We've been making already to this point in the year. That will continue as we kind of ramp the full scale of services. We'll also see volume and revenue start coming in as well. So that will typically be fairly well aligned in this case. So I would say fairly neutral this year. And then obviously, as we kind of build scale and ramp, it will become more meaningful as we look to '23 and beyond and really exciting opportunity for us. If you think about the retail landscape in the United States, if you think about the opportunity to broadly serve the connected consumer in the future with bundled solutions around the connected home, this does give us a pretty material step change in terms of the scale of our services, particularly around the appliance side of the business. It's a disproportionate increase to our volume. And I think it will definitely bear fruit longer term, and we're really excited. And it's an important client. Certainly, it helps us protect the client, but really expanding our services and then making investments in our platforms that I think will support further growth longer term is what gets me most excited."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Congrats on that. Second question is just again on the outlook and maybe trying to get into some of the drivers behind that. Specifically, can you say to what extent you have -- in the Lifestyle, mobile business, what's your outlook for mobile sales for the year? And how does that influence your outlook for the year there?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I mean I think we're seeing really strong results in the mobile business. If you look back over many years, it doesn't always show up in the subscriber count number. Now we've started to give devices service where you're seeing a fairly significant ramp in our trade-in volume, which has been true over the last several quarters. I think we are seeing underlying growth in our most mature markets. That's masked a little bit. So in North America, we're definitely seeing increases in our subscriber counts. That's true with our mobile partners in terms of mobile operators, but it's also true with the cable operators that we do business with for device protection. They're growing. They're achieving net adds every quarter in terms of postpaid customers. So we're definitely seeing growth there. Those are the most mature markets. And then that's kind of masked by a little bit more softness in some of our international markets and then some client runoff that's got a fairly limited economic impact overall. We're still seeing strong demand in the market for mobile devices. We're seeing a lot of carrier competition, carrier promotions. I think we're extremely well positioned with clients, both in terms of device protection, but then the breadth of clients we serve with respect to trade in, which has only grown over the last couple of years. So I feel like we're really well positioned, and there's still a tremendous amount of consumer demand. We'll see as the year progresses if that changes. But certainly, at this point, we feel really good about how we're positioned."
},
{
"speaker": "Michael Phillips",
"text": "Okay. Last one for now. On the specialty business and the charge there. Actually, Richard, you alluded to some steps you're taking to improve the performance there. Can you kind of talk about what are the things you're doing there to make sure that doesn't happen in future results."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Thanks, Mike. Go ahead, Keith."
},
{
"speaker": "Keith Demmings",
"text": "I was going to say, why don't you talk a little bit about some of the work that we're doing, Richard, and I'll talk more strategically."
},
{
"speaker": "Richard Dziadzio",
"text": "Okay. Okay. Great. And first to start out in the specialty area, we talked about sharing economy and the charge we took of $14 million. Really, most of that charge is linked to past business, past contracts we had in place. So call it runoff, I think about it runoff in my mind that there are old contracts, clients that we canceled over time and we're getting those charges come through right now. So we have done, I would say, as Keith said in his remarks, we have done some actions. We're going to continue to do more actions. I think we're deep diving into the types of contracts we have. We're understanding the volatility about those contracts. We're understanding the quality of the clients we have behind those contracts. So our goal is to make sure that we're hitting our financial objectives, as we said in our remarks. And so we're not happy with taking the charge, and we're going to work on that very hard. Keith?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. The only thing I would add, I think the business that we're writing today, to Richard's point, the team has done a really good job modifying pricing, terminating certain partnerships that we didn't think were going to pay off long term and changing deal structures, changing the terms and conditions around the products. There's been a lot of good work done. The charges that you're seeing flow through for the most part relate to business that's since been modified through a lot of those actions that we've taken. I'd say the underlying profitability on the business we write today, new business that we're putting on the books is significantly better than the historical. So that's definitely a good thing. But the team is not happy overall with how this business is performing at the moment. So we're definitely looking at it very closely. One of the strategic I guess in terms of the thesis with this business was not just giving us access to the gig economy, really fast-growing kind of emerging marketplace that we thought was really interesting, a place where we could innovate and develop some new distribution opportunities. We also thought there would be opportunities to provide additional coverages, like mobile protection, vehicle service contracts. Those are pretty important types of coverages for a gig economy worker, that hasn't materialized to this point. That was part of the strategic rationale and the thesis behind entering this marketplace. So obviously, we're evaluating whether those opportunities can exist for us in the future. So more work to be done. To Richard's point, we're not happy with the results. We're definitely going to be making sure this business is built to deliver the economics that we would expect based on the risk reward trade in the marketplace."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Gary Ransom from Dowling & Partners."
},
{
"speaker": "Gary Ransom",
"text": "I had a couple of questions on the interpretation of the new items that you're giving in the earnings. One is the EBITDA margin. I know in the past you've talked about how different contracts have different revenues versus different margin levels based on how they're structured. Is there any different way I might interpret the 11% margin that came in, in Lifestyle? Or are those -- just how are you thinking about that?"
},
{
"speaker": "Richard Dziadzio",
"text": "And maybe I can..."
},
{
"speaker": "Keith Demmings",
"text": "Go ahead, Richard."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. No, I think the EBITDA margin, to a certain extent, it's a reflection of the mix of business that we have, Gary. I think that as we go, when we become more fee-based as we've talked about, you're going to get naturally as opposed to putting it over premiums or gross premiums. You're going to have that margin naturally improve. Keith talked earlier about kind of the mix of products and the fact that we do have clients with more fee-based services. So that definitely is a positive for us. And also, I guess, the bottom line too is Lifestyle had a very good quarter overall in terms of profitability. And that obviously then translates into the margin as well, which helps."
},
{
"speaker": "Gary Ransom",
"text": "And the other one I wanted to ask about is the mobile devices service, which you did talk about it being up strongly year-over-year. But there also seems to be some seasonality, the decline sequentially. Can you just remind us what the -- how to think about the sequential seasonality for that measurement?"
},
{
"speaker": "Keith Demmings",
"text": "Sure. And you're right, there's definitely seasonality. We tend to see a fairly significant Q4 related to devices service. We also tend to see strength in Q1. As we look at devices, iconic devices launched in the back half of the year, that obviously leads into a lot more activity in terms of customers trading in old devices in the fourth quarter to try and get the new devices that are being actively marketed in the marketplace. We tend to see that spill over into Q1 as well. And then it really is a function of the promotional activity that the carriers are doing in the market. So if you think about all of our global partners that offer trade-in programs as they're being more aggressive with trade-in offers to try and get consumers into the latest technology and which is particularly true today with the push for 5G. That is ultimately what drives -- the seasonality is those promotions that are driven by the carriers. So we saw strong activity in Q1. I expect we'll continue to see strength as we go through the year. But you're correct. We tend to see a really strong first quarter, a really strong fourth quarter. And then we'll see what happens with respect to the promotions as we go through the year. And obviously, we'll see what also happens with consumer demand and other factors that our partners are trying to navigate as well."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Mark Hughes from Truist."
},
{
"speaker": "Mark Hughes",
"text": "Question on the Global Automotive business, vehicle business, what kind of new business in the -- and I'm sorry, it's kind of a strange time in the auto market in terms of sales. Should we anticipate growth in terms of vehicles covered? Or is this more steady as she goes?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I mean, first of all, I'm really happy with the overall performance of the auto business, and it was a particularly strong first quarter, not just in terms of the ultimate profitability of the business as we look at the EBITDA growth that we were able to deliver. But also just in terms of the performance on a net written premium basis, if you look at revenue was up 9%, net written premium was up 4%, and that's dealing with Q1 auto sales this year, which were down 12% versus Q1 last year. So I would say that our team is outperforming the underlying results within the auto industry in terms of car sales. So I think that's really positive. That's a testament to the I think the breadth of our client partnerships, the fact that we've got really, really well diversified distribution channels and our partners are being successful in the market, and they're gaining share. So that's helped us significantly. And our teams are also expanding our own market share just because of the scale and breadth of our offering. So feel really good about automotive broadly. Covered vehicles is relatively flat, as you mentioned right now, but we are seeing underlying growth in net written premium, which to me is a really good sign. And we'll see what happens with the auto industry. I certainly expect, at some point, there's a lot of pent-up demand for new vehicles. And as new vehicles become more readily available, obviously, we'll start to see the benefits of that flowing through on the new vehicle side. That will probably alleviate some of the pricing pressure on the used car market. Used car markets are extremely elevated right now and that too should normalize. So -- but again, I feel like there's definitely upside in this business over time, particularly as we look at interest rates today. We had favorability in the quarter, both from interest rates as well as from the underlying performance and growth of the business. And certainly, that's an opportunity as we look forward."
},
{
"speaker": "Mark Hughes",
"text": "Maybe a similar question on Multifamily. I think your renters, the count was up 5%, 6%. The revenue was up low single digits, which is a little bit below the recent trend. What do you think is the prospect there?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think we -- first of all, we really like the renters business. We've got a strong market position. We cover 2.6 million renters. So we've got a really nice market share as well, and it's been growing historically over time. And the renters market has also been growing. If we look back just because of attach rates improving historically. So I really like the position that we're in. You're correct. We saw a little bit slower growth in the quarter. Slower growth from some of our affinity partners offset, I would say, by really favorable strong growth within the PMC channel. We've talked before about the success we're having with Cover360 with our property management partners, where we've got just a more much more integrated solution into the buy flow with better digital access. Premiums for renters are collected as part of the rent. So there's a lot more opportunity for us to continue to grow in that market as we scale that solution and as more clients adopt it. So I do expect this business to drive long-term growth. It's a key focus. We continue to look for ways to differentiate our solutions and then broaden distribution, and that's going to be a key focus for the team as we move through the year."
},
{
"speaker": "Mark Hughes",
"text": "And then Richard, on investment income, anything you would -- is this a good kind of run rate at this point when we think about new money yields, is that going to lead to an increase in investment income as we get into the rest of this year and next year?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Thanks for the question, Mark. I mean definitely, the increase in interest rates is a positive thing for us, both long term and short term. So we are benefiting from that, and we'll continue to benefit from that as kind of the book rolls through, so to speak, and the assets come to maturity. So very, very positive news for us. I would say -- in terms of your question on run rate, I wouldn't necessarily take this as a run rate because in this quarter, let's say, we're up about $8 million over the prior year quarter. That's coming part from some real estate gains. So part from interest rates and investment income coming from the fixed income book, but also part from real estate gains. We had a few million dollars of real estate gains in there, just a little under 5, I would say. So part of that, I would consider a little bit of a one-timer. But the rest of it is good news and hopefully a harbinger of things to come as interest rates continue to stay at an elevated level and even increase as we've seen over the last couple of months."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Tommy McJoynt from KBW."
},
{
"speaker": "Tommy McJoynt",
"text": "So it sounds like just kind of going back to the sharing economy and on delivery products that further reserve strengthening this quarter. So while it's a growing kind of exciting piece of the economy, to the extent that you do deem that it's unlikely to meet your return hurdles? Or if you think that cross-selling to those gig economy workers just looks too challenging. Can you talk about what a wind down of that business would look like? I know in the past, you've exited things like small commercial that didn't meet your return hurdles. So just kind of how material is that business? And is it a profitable business right now? Or is it a drag? Just kind of any more kind of numbers you can put around that?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, maybe I'll offer a couple of thoughts, and then Richard, feel free to chip in. But we've talked about it being 12% of the specialty line. I'd say $50 million to $60 million a year in net earned premium in terms of the size and scale of that business today operates across multiple clients, primarily in food delivery. If I look at the P&L over the lifetime of the business, I'd say it's relatively neutral. It's not been a big drag in terms of losing money. We look at the inception to date, profitability of the business. Forget about quarter-to-quarter and year-over-year changes, is this business making money. So pretty marginal at this point overall. But as we talked about, that's absorbing the learnings, the investment to scale the business, early losses as we sort of had to learn the market as the market was being created. So not a terrible result and it's something that we built and incubated. And I think our team has done a really good job. It's a really well diversified mix of business. There's a lot more protections in how that product and how the programs are structured today. We've built a lot of expertise around managing the claims and integrating with our partners. And then obviously, there's a lot of complexity in this business. So I think from that perspective, it's worked in terms of what can this mean for us going forward? How large can it be? Can we get the strategic value out to your point, that's something that we've got to continue to work on and making sure we can define that. But it's not a big drain in terms of the actual P&L effect that we're feeling. It's just not hitting the hurdle rates that we'd expect at this point, 5 years into learning this part of the market. And Richard, feel free to add anything else."
},
{
"speaker": "Richard Dziadzio",
"text": "No. I think your last comment is the one I would underscore for Tommy, which is it was a business that we started 5 years ago as an incubator to innovate and see if there was a part to get into the gig economy that way and see that. Over time, with 5 years, the overall profitability, I would say, has been fairly neutral for us. The new contracts that we have in place are profitable. And so that's what we're going to dive into is to say, okay, well, do we have something here that we can build upon? Or is this a business that we need to change drastically? So that's what we're deep diving, as Keith said, to do and really to understand it. So overall, for this year, given the results of the first quarter, I wouldn't think it would be a positive or a negative to the rest of the year, right, in terms of the outlook that we have out there. So some work to do there, Tommy."
},
{
"speaker": "Tommy McJoynt",
"text": "That's great. Thanks for all those numbers that you guys gave there. And then just my other question, could you guys talk about what could be some of the drivers for the favorable loss experience in Lifestyle that you guys referenced, when there's really widespread reports of higher severity via higher cost in parts and labor in most industries out there."
},
{
"speaker": "Keith Demmings",
"text": "Yes, maybe I'll offer a couple of thoughts. We -- and there's a few moving pieces, but I would say if we look at -- the first thing to underscore is that for the vast majority of the business we're -- either we're risk sharing or reinsuring or we're profit sharing back with partners. So we're not on the majority of the risk, and we've talked about that, historically. And then where we are on risk, there are some interesting things that are happening. If I think about the auto business, we write some gap insurance. And obviously, with used car values at all-time highs, the GAAP losses have been dramatically lower as you think about the depreciated value of the used car is much higher today than it would have been under normal circumstances. So that's creating some favorability. That normalizes over time, I would say, is the used car market moderates. And when will that happen, it's hard to know, right? Because it's all connected with more broadly the supply chain issues that are creating that situation. And then in terms of the mobile side, we had a little bit of elevated losses if you look back to Q1 of '21. When you think about some of the business where we actually are on the risk, a little bit more elevated losses last year due to just some parts availability pressure in that business. Our teams have done an incredibly good job buying inventory, maintaining inventory to make sure that we're able to deal with our claims efficiently. You've got, obviously, as product continues to roll out in the market in terms of new devices, the quality of those devices continues to improve, which is also helpful. And we've just seen some underlying strength in our ability to manage loss costs around that mobile experience. We're doing a lot more repair as well. So there are several factors at play. Again, most of that accrues to the benefit of our partners because of the deal structures. But for those where we are on the risk on balance, we've been really pleased with how the team has performed."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Your next question comes from the line of Jeff Schmitt from William Blair."
},
{
"speaker": "Jeffrey Schmitt",
"text": "The cost for the T-Mobile in-store repair rollout, they looked at peak in the fourth quarter of last year, but you'd mentioned that should continue in the first half of the year. Can we get a sense on how much costs for the quarter? And would you expect to see some -- there still wasn't year-over-year margin expansion, but should we sort of expect that next quarter? Or is that more of a second half of the year? Just any detail you could provide there."
},
{
"speaker": "Keith Demmings",
"text": "Yes. I would say, first of all, we're thrilled with everything that we've done with T-Mobile as we look back over the last several months, the migration of the Sprint customers went incredibly well, and we're really proud of the work that we've done there. And then the build-out of same unit repair in the T-Mobile stores. Again, a lot of that work happened in Q4. We had to recruit technicians. We had to train. We had to develop all of our technology interfaces, all of our inventory management solutions, all of that work to stand that up and was largely done by the end of 2021. And as we look at Q1, I would say, relatively neutral effect overall in terms of the P&L. So there's some ongoing investments, a little bit less about new store scaling and more about refining process, refining platforms, investing in the underlying technology and then just trying to make sure that we're evolving how we execute and deliver value to end consumers in partnership with T-Mobile. And that will never stop, right? We'll always be looking to invest to improve. And we're seeing incredible Net Promoter Scores. I would say we had a really, really high NPS prior to same unit repair. It's taken it to another level, and it's pretty exciting to see the favorable reactions we're getting from the customers. And obviously, that's reflecting well on T-Mobile and their brand. So -- but relatively neutral in the quarter and expect that to improve as we go through the year and as we reach a more mature and steady state with the solution. But you couldn't be prouder of the work that the team has done and the actual results that are being delivered to the end customer."
},
{
"speaker": "Jeffrey Schmitt",
"text": "Okay. Great. The -- and then on the covered mobile devices, was down a little bit sequentially, but could you talk about the sort of underlying growth there, excluding the legacy Sprint customers coming on? What was the impact of the runoff clients? And what's your outlook for that kind of underlying growth? So I think if you go back to quarter 2 before Sprint came over, you'd mentioned that maybe going in the mid-single digits. But what is your sort of outlook for that?"
},
{
"speaker": "Keith Demmings",
"text": "Sure. Yes. And obviously, when you look year-over-year, it's a big step change because of Sprint, and we've talked about the importance of that relationship. But you're right, in terms of the underlying subscriber growth, we're seeing the U.S. market continue to drive growth. It's masked in the numbers because, obviously, we're showing a global total. But we are seeing fundamental growth there, expect that to continue as we move quarter to quarter to quarter. So that's -- and as I referenced earlier, both in terms of mobile operators, but also our cable partners as well, who are having success and doing well with respect to offering our services to end consumers. So that will continue. A little bit of softness in some of the international markets where things have been a little bit slower to open up from COVID, not a big economic concern. Obviously, it shows up in the numbers in terms of accounts, but not a massive impact from an economic point of view. And then we had a client that we talked about last year that had runoff, again, not material economically. So I have no concerns with respect when I look at where we are for mobile devices protected. I think what's important is we're building deeper and deeper relationships with some incredible global partners. And the deeper those relationships get, the more services we provide, the more we can help solve problems and innovate to deliver value, and that's what gets us really excited. There's a lot of great momentum in the market. Our teams are really, really integrated, and we're passionate about serving clients, solving problems and delivering for end consumers. And I think that's the game that we're trying to win over the long term."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of John Barnidge from Piper Sandler."
},
{
"speaker": "John Barnidge",
"text": "That new partnership that you talked about the end-to-end sounds very exciting. Are there opportunities to expand that for other similar relationships? Or do you need to get past the ramp-up phase to really create the leverage to expand with others?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I definitely think there are opportunities to expand. I think scale, and I've talked about this previously, scale is important, right? And I think this relationship will give us a tremendous increase to our scale. It's quite material in terms of what it means for our ability to deliver customer service to manage a third-party repair network and then to make the underlying investments I think that will happen quickly. And I think we will have opportunities to drive growth, both in new and interesting ways with this partner, who is significant and always trying to innovate around the customer, but also as we think about the capabilities and the foundation that we continue to build, how do we then leverage that foundation. And I would say that foundation will get built and scaled fairly quickly. It won't be 3 or 4 years from now, we'll finally have solution that then is really relevant in the market. That relevance will emerge fairly quickly."
},
{
"speaker": "John Barnidge",
"text": "Okay. And then a follow-up question. What does the international growth opportunity look like given increased FX volatility?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So no doubt, as we look at Q1, we saw some effects from FX. We expect that to continue as we look towards the rest of the year. Luckily, as Richard has talked about, we're pretty resilient. There are a number of pluses and minuses as we look at more broadly, inflation macroeconomic factors, interest rates. So we feel like we're well positioned. But there's definitely we'll see some effect from FX. Think about Europe and Japan, as good examples, where we'll expect to see that. I do think we've got great momentum around the world. I mean our international footprint has continued to mature over the last many years. We haven't expanded into new countries. We've really focused on how do we gain relevance and scale within the key markets that we want to be in. And I think our teams are doing a great job. Our services, our solutions, we continue to deploy them on a global basis. So as we build services like you think about it an easy example like same unit repair or premium technical support or trade in, those services are relevant everywhere in the world. They may be more relevant in a certain market today and 2 years from now, that trend catches up in another part of the world. So I think that's one of the powers of operating as a global business. It's allowed us to build things once, build them in a standard way, build kind of global platforms that we can scale and then deploy those internationally. And we've got some incredible clients around the world. I'm so proud of what our international team has done, and I think there's lots and lots of opportunities. And today, it's mobile. Connected Living is the biggest part of international. We've got through the acquisition of TWG, much more automotive going on in various parts of the world. And as we continue to find the other relevant parts of Assurant to export to take advantage of our biggest markets, I think that will create longer-term tailwinds for us. But certainly, in the short term, FX is a challenge."
},
{
"speaker": "Operator",
"text": "And your final question comes from the line of Grace Carter from Bank of America."
},
{
"speaker": "Grace Carter",
"text": "I was wondering if you all could talk about, I guess, the percent of the LPI book that's historically been in REO and just how that compares today versus historical and I guess, just kind of the evolution of that over the course of the year?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I would say, in simple terms, our REO volume is down significantly. It's probably 1/3 of what it would have been pre-pandemic roughly in that order of magnitude. I'd say we've seen it stabilize in terms of volume in the first quarter. I would expect that to slowly increase over time as properties enter foreclosure later in the year. So I definitely see that growing over time. Obviously, there's a ton of strength in the housing market. Our partners are working closely with customers in terms of loss mitigation activity. There's a lot of equity still in the homes for customers. There's a lot of opportunity for mortgage servicers to work with customers. So that will take some time to normalize. But certainly, it's dramatically lower than pre-pandemic, and we'd expect things to normalize over a reasonable period of time over the next couple of years, I would say."
},
{
"speaker": "Grace Carter",
"text": "And sticking with the housing book, if there's any more color you could offer on the cost efficiencies that you referenced, just kind of thinking if that should ramp over the year or there should be kind of a more even impact starting next quarter? And just any sort of directional guidance on maybe the magnitude of the impact?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I think we're investing heavily in terms of digital investments automation. We've got a large operation that we run within the housing business. It's fairly intensive, labor-intensive in terms of the services that we provide. We've talked about how deeply integrated we are with our partners. And really, it's just operational transformation initiatives around digital and finding simpler ways to serve customers more quickly in partnership with our clients. And I would expect it to ramp naturally over the year as we continue to deploy digital tools, digital solutions, and that will allow us to drive that efficiency going forward. But Richard, what else might you want to add?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, I think that's exactly right. I don't think there will be a threshold moment per se. And a lot of the leverage that we're getting today is based on projects that have already been launched, that already were doing. So we're going to continuously, as Keith said, gets leverage out of it. And where I see some good leverage coming out is coming back to your previous question, Grace on REO, as we get more revenues out of that as revenues grow overall in lender-placed, we should hopefully get some leverage out of the expenses as well. Knowing, of course, that over time, it's more of a revenue and top line issue as opposed to just pure expenses because, obviously, we have rate filings to do. And over the longer term, that will balance itself out. But we do see over the short term that expenses and the leverage we're creating will really be helpful to us."
},
{
"speaker": "Keith Demmings",
"text": "All right. Well, thank you again, everyone. And I would just like to close by saying we're really pleased with our first quarter performance. I certainly look forward to updating everyone on our second quarter results in August. And then in the meantime, please reach out to Suzanne Shepherd and Sean Moshier with any follow-up questions. But thank you very much, and have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's conference. Please disconnect your lines at this time, and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 4 | 2,023 | 2024-02-07 08:00:00 | Operator: Welcome to Assurant's Fourth Quarter and Full-Year 2023 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following management's prepared remarks. [Operator Instructions]. It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin.
Sean Moshier: Thank you, operator. And good morning, everyone. We look forward to discussing our fourth quarter and full-year 2023 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer, and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the fourth quarter and full-year 2023. The release and corresponding financial supplements are available on assurant.com. Also on our website is a slide presentation that we introduced this quarter for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving in to Q&A. I will now turn the call over to Keith Demmings. Keith?
Keith Demmings: Thanks, Sean. And good morning, everyone. 2023 was an extraordinary year for Assurant, our seventh consecutive year of profitable growth. We drove shareholder value by delivering financial outperformance, maintaining a strong capital position and generating significant momentum throughout our businesses. Adjusted EBITDA grew 21% to nearly $1.4 billion and adjusted EPS increased by 26%, both excluding reportable catastrophes. Our results were driven by the strength of our homeowners business within Global Housing, which delivered adjusted EBITDA growth of nearly 65% excluding cats. In addition, our connected living business continued to grow, supported by our strong US partnerships with mobile carriers and cable operators, and our ability to innovate and execute for our clients. Together, Lifestyle and Housing generated nearly $775 million in dividends. This allowed us to return over $350 million to shareholders, including $200 million of share repurchases. 2023 was a testament to the power and attractive financial profile of our unique and differentiated lifestyle and housing businesses. Assurant would not have been able to achieve this level of success without our talented people, including our newly refreshed management committee, further strengthening our leadership team. As we celebrate our 20th year as a public company, I am proud of the world class culture we've created, exemplified by the many recognitions Assurant has received throughout 2023. Earlier this week, JUST 100 included Assurant as part of its 2024 rankings of America's most just companies, recognizing our commitment to serving our employees, customers, communities, the environment, and our shareholders. In addition, we received recognition from Fortune as one of America's most innovative companies, and Newsweek recognized the progress we've made to incorporate sustainability into our strategy by placing us on its list of America's most responsible companies. The dedication from our employees and leadership team, who strive to achieve our vision every day, makes it possible to innovate, to better serve our clients and create value for our shareholders. We begin 2024 in a position of strength and with great momentum. Over the past two years, we've focused on further strengthening our business portfolio and driving operational excellence, while accelerating innovation. By investing in businesses where we have leadership positions, we believe we're well positioned for future success. For instance, within Global Lifestyle, we've grown our presence in specialized markets, including in the commercial equipment space, where acquisitions have contributed to new client partnerships. We've strengthened our company through active portfolio management, making decisions to exit businesses that are not core to our long term strategy. This included exiting our sharing economy offerings and international cat exposed businesses in housing, further simplifying our portfolio. We've made significant progress in driving operational excellence across Assurant with a streamline organizational structure and real estate footprint. We've implemented digital first initiatives across our operations to support our businesses and drive value for end consumers. Finally, we've accelerated innovation in a variety of ways to drive our business growth. Moving forward, technology innovation will continue to be an important driver of growth and value creation for Assurant. Our approach has driven success within our financial results, and is evident in our track record of winning new business and renewing client partnerships. This expansion of our client base is an integral part of our strategy, and creates important tailwinds as we look toward the future. Now, turning to highlights across our business segments. For 2023, Global Lifestyle earnings were relatively flat on a constant currency basis. In connected living, 2023 represented another year of growth for the business with a 3% increase in earnings. Within our US business, we drove high single-digit EBITDA growth as we continue to innovate and execute for our growing carrier and cable operator clients through our device protection programs. We strengthened critical partnerships, including Spectrum Mobile, where we provide mobile protection, trade-in and other value-added services. In addition, we expanded our trade-in programs with major OEMs by adding a large new partner, as well as renewing AT&T, where we're deploying robotics in our mobile device facilities throughout the US. We continue to make progress internationally. In Europe, we stabilized earnings by driving expense efficiencies while continuing to address ongoing macroeconomic challenges. Throughout Asia-Pacific, we're excited by our market position and our long term outlook. We're very pleased to announce a new partnership with Telstra, Australia's largest mobile operator. Our new multi-year deal will allow us to provide comprehensive products to support the end-to-end device lifecycle for Telstra's broad base of customers, including their core mobile protection program, as well as trade-in and repair capabilities. This partnership is significant as we continue to build our presence in Asia-Pacific. Turning to auto, year-over-year declines were driven by inflationary impacts on claims costs. Beginning in 2022, we took decisive action to address significant inflation that impacted the auto repair industry. For the handful of deals structures where we've been negatively impacted by underwriting results, we successfully partnered with our clients to implement meaningful rate increases, while making important changes to strengthen and enhance our claims adjudication process. Given the longer average duration of our auto service contracts, we'll earn through the full benefit of these actions over time, with improvement expected to begin in 2024. Based on the actions taken in auto and the continued growth of connected living, we feel well positioned to deliver Global Lifestyle growth in 2024. Let's move on to Global Housing. In 2023, the segment grew significantly, driving our overall enterprise performance. Growth was led by our homeowners business, which was supported by higher premiums and in-force policy growth. The business rebounded from inflation impacts on claims experienced in 2022 and also benefited from favorable prior-year reserve development. In addition to highlighting the significant earnings power of the business, our 2023 housing results demonstrated differentiated returns and strong cash flow. Excluding favorable prior-year development, our 2023 combined ratio was 83%, including $111 million of reportable cats, which was below our assumed annual cat load of $140 million. We are also very pleased to announce a new partnership in our lender-placed business. Beginning in the first quarter of 2024, we'll provide lender-placed insurance services to Bank of America's 1.8 million loan portfolio, further enhancing our market position and validating the competitive strength of our offerings. In renters and other, we increased earnings modestly in 2023 as our property management channel continued to expand. Written premiums in the property management channel grew nearly 20% in 2023. Along with adding new clients, we also achieved double-digit growth across 8 of our top 10 PMC clients, creating significant business momentum. Growth was supported by the continued expansion of Cover360 where we now track over 1 million residents, a nearly 45% increase over the prior year. Technology innovation also enhanced our digital customer experience, including a new digital agent leasing portal and expanded claims processing powered by machine learning. Let's turn to our 2024 enterprise outlook. We expect continued profitable growth in 2024, driven by our business momentum. While growth is expected to be lower than the significant outperformance we delivered in 2023, we expect our 2024 results will demonstrate the combined earnings power of our advantage portfolio. Adjusted EBITDA excluding cats is expected to grow mid-single-digits, with Global Lifestyle and Global Housing delivering similar growth rates for the year. Adjusted EPS growth is expected to modestly trail adjusted EBITDA growth, primarily reflecting higher annual depreciation expenses related to technology investments critical in executing our strategy. Before concluding, I'd like to introduce our recently appointed CFO, Keith Meier. Keith has been with Assurant for over 25 years and has served in leadership positions, managing P&Ls across many of Assurant's businesses. In his most recent role as Chief Operating Officer, Keith led the transformation of our technology and drove significant operational efforts to support the end customer experience. I have no doubt that Keith as our CFO will be an enabler of driving profitable growth, while allocating capital strategically. Now over to Keith to review our quarterly results and 2024 outlook in further detail.
Keith Meier: Thanks, Keith. And good morning, everyone. Before reviewing the quarterly results, I'd like to share my perspectives as I'm about to wrap up my first 90 days as Assurant CFO. During my time at Assurant, I've been fortunate to have led several businesses, as well as take on a variety of other roles across the organization, including most recently leading our technology and operational teams. These experiences have provided me with deep insights into our global clients, and the understanding of what is needed to deliver a high level of business performance, always backed by strong financial expertise and discipline. As CFO, driving growth and financial performance will continue to be my priorities. I'm focused on ensuring our capital position remains strong as we create additional shareholder value and drive profitable growth through further innovation and differentiation within our product portfolio. As I look toward the future, I'm also focused on continued expense efficiencies by utilizing digital and AI technology, which also enables us to deliver better customer experiences. Lastly, I've appreciated the opportunity to meet with many of our investors, employees and clients over the last several months, and their willingness to share observations about Assurant as I began my tenure as CFO. Our discussions have enabled me to better shape my views and the path going forward. Now, let's talk about our fourth quarter financial results, which reinforced the strength of our businesses and the performance that we've seen throughout the year. For the quarter, adjusted EBITDA grew 29% to $382 million and adjusted EPS increased by 38% to $4.90, both excluding reportable catastrophes. Adjusted earnings and EPS growth were driven by year-over-year growth in both Housing and Lifestyle. Our capital position remains strong, generating $280 million of segment dividends in the fourth quarter, and ending the year with $606 million of holding company liquidity. This allowed us to return $169 million to shareholders in the quarter, including $130 million of share repurchases. Let's review the businesses, beginning with Global Lifestyle. For the quarter, adjusted EBITDA grew 12% to $205 million, led by strong earnings growth of 23% within connected living, as our US mobile protection programs continued to grow. Higher yields on invested assets also contributed to the improved fourth quarter results. Globally, our trade-in programs represent a critical component of our device lifecycle value proposition, as well as a fee-based income driver supporting the growth of our mobile business. Throughout 2023, we serviced over 25 million devices, including 7.5 million in the fourth quarter, which represented a high watermark for the year. While trade-in results were down modestly year-over-year, we saw fee income growth from higher sale prices for used devices and contributions from new US trade-in programs. Internationally, we continue to be impacted by subscriber declines in Japan, but have stabilized performance in a challenging macroeconomic backdrop. In global auto, fourth quarter adjusted EBITDA was relatively flat, as higher claims costs from inflation were offset by higher investment income. Claims were also elevated from the expected normalization of auto ancillary products and from international clients. During the latter part of the year, we saw positive signs in US loss trends, as we began to benefit from prospective rate increases that were implemented. Turning to net earned premiums, fees and other income, Lifestyle grew by $268 million or 13%. Growth from global automotive, which increased 14%, was due to $85 million of non-run rate premium adjustments with no corresponding earnings impact, as well as prior periods sales of vehicle service contracts. Connected living's net earned premiums, fees and other income increased 12%, benefiting from contributions from new trade-in programs, higher prices on used mobile devices and modest growth in North American mobile subscribers. Looking ahead to 2024, we expect Global Lifestyle's adjusted EBITDA to grow, driven by both connected living and global automotive. We expect growth in connected living to be led by the continued expansion of our US business. We expect Japan and Europe to remain generally stable throughout the year. In global auto, we expect rate actions taken over the past 18 months to drive improvement over time, beginning in 2024. Investments related to new client implementations will temper growth in 2024 for Lifestyle, but are critical levers to expand our portfolio and strengthen our business over the long term. We continue to monitor foreign exchange impacts, broader macroeconomic conditions and interest rates, which may impact the pace and timing of growth. In terms of full year net earned premiums, fees and other income, lifestyle is expected to grow mainly from our connected living business. Moving to Global Housing, 2023 was truly a strong year. We drove growth from the actions taken over the past few years to ensure rate adequacy and drive expense leverage, while benefiting from the streamlining that we undertook to simplify our portfolio. Fourth quarter adjusted EBITDA was $186 million, which included $22 million of reportable cats. Excluding reportable cats, adjusted EBITDA increased by nearly 50% or $68 million to $208 million. Two-thirds of the increase was driven by favorable non-cat loss experience and homeowners, including a favorable year-over-year impact of $35 million related to prior-period reserve development. This was comprised of $40 million of reserve reductions in the current quarter compared to a $5 million reduction in the fourth quarter of 2022. The remainder of the adjusted EBITDA increase was from continued top line growth in homeowners from higher premiums and an increase in the number of in-force policies. Higher investment income also contributed to earnings growth. Growth was partially offset by incremental expenses to support new business and an increase to our catastrophe reinsurance premium. For renters and other, earnings were flat as growth in our property management channel was offset by softer affinity channel volumes. For the full-year 2024, we expect Global Housing adjusted EBITDA excluding reportable cats to grow, driven by continued top line momentum in homeowners. In 2023, we benefited from $54 million of favorable prior-year reserve development. Our expectation is to deliver growth in housing in 2024, overcoming the $54 million of favorable prior-year reserve development, demonstrating the strength of the housing business. As Keith discussed, we will begin onboarding 1.8 million loans from Bank of America in the first quarter. When fully onboarded, we expect the placement rate of the book to be below Assurant's current portfolio average of 1.8%, which may impact overall placement rate trends. Due to implementation expenses, we do not expect these loans to contribute significantly to adjusted EBITDA in 2024. In terms of our cat reinsurance program, we have transitioned to a single April 1 placement date beginning this year. This greatly simplifies our placement process while maintaining comprehensive coverage in the market. As this is a transition year, we placed virtually all of our 2024 program in January, with some smaller components remaining for the April placement. For our 2024 program, our program retention will increase to $150 million, aligning with a one in five year probable maximum loss or PML as we continue to optimize risk and return. This is consistent with our 2023 program. We've expanded our risk protection to align with exposure by increasing our top end limit to protect against a 1 in 265 PML event. Over the past two years, we've continued to increase our capital protection, increasing the top end of our program from a 1 in 174 PML in 2022 to a 1 in 225 PML in 2023 and now a 1 in 265 PML in 2024. Reflecting on these expected changes, we now estimate the appropriate cat load to be $155 million for 2024. Given the exit of our international property business and the better market pricing as we leverage our strong reinsurer relationships, we expect modest overall cost savings in 2024. We will provide further updates on the reinsurance program in May. Moving to corporate. The fourth quarter adjusted EBITDA loss was $30 million, a $3 million year-over-year increase, mainly due to higher employee-related expenses. For 2024, we expect the corporate adjusted EBITDA loss to approximate $105 million. Turning to capital management. As we look forward to 2024, we expect to continue to generate significant capital and focus on maintaining balance and flexibility to support business growth. For the full year, we expect our businesses to generate meaningful cash flows, approximating two thirds of segment adjusted EBITDA, including reportable cats. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance and rating agency and regulatory requirements. We repurchased $200 million of common stock in 2023 and currently expect share repurchases to be in the range of $200 million to $300 million for 2024, which will depend on strategic M&A opportunities, market conditions, and cat activity. As you can see, we are well positioned to deliver another year of growth in 2024 through the power of the Assurant franchise. I'll now turn the call back to Keith Demmings to share his views on performance, as supported by our differentiated business model. Keith?
Keith Demmings : I'd like to take a few minutes to discuss why we believe that Assurant is so attractively valued today. Assurant is a powerful differentiated business with unique advantages that have outperformed over time. Our B2B2C business model throughout lifestyle and housing is different from other insurers and service-oriented companies. Not only do we operate in unique, highly specialized and attractive markets, but we hold strong market positions and benefit from our scale. At our core, we provide specialty insurance solutions and fee-based services that are often deeply integrated with our large clients as we play an important role delivering services to their end customers. Our alignment with industry leaders and market disruptors has helped us generate significant scale within our businesses. Our competitive advantages are further strengthened by our broad set of capabilities that allow us to innovate and execute for our partners and customers, enabling us to be flexible and agile. We have compelling and unique aspects of our business model that we believe create advantages. Our low capital intensity businesses allow us to grow efficiently, while generating additional capital for deployment. This is evident through our capital efficiency and strong cash generation of $3.5 billion over the last five years. Our risk profile is attractive. Earnings volatility is lowered by the risk sharing structures within our business models, reducing the impacts of macroeconomic volatility. For example, throughout connected living and global auto, approximately two-thirds of total risk is reinsured or profit shared to our partners. Within housing, our portfolio simplification efforts have focused on exiting more capital intensive businesses, which has enhanced our risk profile. In addition, our robust catastrophe program substantially limits retained risk due to the low per occurrence retention level and high limit at the top end of the tower. Lastly, we're well positioned to adjust pricing to enable our targeted rates of return. Lender-placed is a prime example where a product has a built-in annual inflation guard feature to ensure policy pricing accounts for higher labor and materials cost, as we've seen over the last two years. In auto, most of our client deals structures share in the risk through reinsurance or profit shares. This creates close alignment between Assurant's underlying economics and our client's financial results. Given this dynamic, we have the ability to adjust rates together with our clients to account for inflation impacts in the broader market. Over the past 18 months, we've successfully worked with our clients to put through prospective rate increases on new vehicle service contracts. Financial performance is paramount for Assurant. While growth may not always be linear, we've delivered average annual earnings and EPS growth of double digits since 2019, which has generated significant cash flow. Our 2024 outlook adds to this historical growth that we've delivered. To demonstrate the strength of our business model, we thought it would be useful to show how we perform versus a broad group of insurers on an adjusted earnings basis given the available data. Please keep in mind this example is not to suggest a new peer group. We've selected the S&P 1500 P&C index to highlight our performance against a credible and broad index that includes members we're often compared to, including specialty and P&C insurers. Over the past five years, we've grown double digits and outperform the index. Our average annual adjusted earnings growth rate excluding cats of 12% is almost double the index growth rate of 7% over the same time period. Including reportable cats, we've also outpaced the market, driving 10% average annual growth versus the index growth rate of 6%. We believe that our consistent ability to demonstrate strong, profitable growth in returns with lower volatility and required capital makes Assurant attractively valued. I'm confident that we'll continue to drive long term profitable growth and create shareholder value. And with that, operator, please open the call for questions.
Operator: [Operator Instructions]. Our first question is coming from Mark Hughes with Truist Securities.
Mark Hughes: The BofA, you said that the placement rate is going to be lower? Is that just because of placement rate on an underlying basis is lower? Or is that – the actual premiums and the covered homes are not being transferred over to you?
Keith Demmings: No, we're going to be picking up all of the loans and then all of the policies, but the placement rate on that particular block of business is just lower than the average. If you look at our current average, it's 1.8%. It'll be south of that, just the nature of the loans and the nature of the business. But to the more fundamental point, really excited about the opportunity and many years in the making, and a huge congratulations to our lender-placed team for doing an incredible job building a relationship. And then obviously getting to this point is incredibly exciting and extremely validating.
Mark Hughes: On the homeowners business, a favorable reserve development. Was that just because Hurricane Ian turned out better than expected or are you seeing a fundamental change in underlying trends? It seems like the non-cat losses have been very favorable lately? Is it something we should view as a sustained, sustainable?
Keith Meier: This is Keith Meier. So I think the first thing I would say is the positive reserve development was more in relation to the higher inflationary environment that we had previously. Now that that's more settled, that's what's really been the change in the estimates that our team has made there. So I think that was more the driver than any other type of weather activity or any other type of experience. So I think that was the key there. In terms of your question on the quarter, the way to think about that is if you take out the prior year, the prior period development, and over the whole year, we basically are about at about a 40% non-cat loss ratio. It's about a point better than last year. And then if you think about, looking at 2024, we would see our non-cat loss ratio to be somewhat level to what we're seeing in 2023. So that's probably the way to think about our views on the non-cat loss ratio.
Keith Demmings:
Keith Demmings: And just one final thought. Modestly better in the quarter when you make the adjustment at 38%. But that's just normal seasonality, nothing we would really point to there, Mark.
Mark Hughes: If I can squeeze in one more, the fee income in Lifestyle was up substantially, much more so than the devices service. What was going on there?
Keith Meier: That's mainly the higher trade-in volumes that we have seen in the fourth quarter. So, in the fourth quarter, we also saw the addition of two new programs. So, one with one of the major OEMs and then also a program that cuts across several of our other clients. Then that's also tempered a little bit by some of the promotional activity. But, overall, we felt really good about the trade-in performance in the quarter.
Operator: Our next question is coming from John Barnidge with Piper Sandler.
John Barnidge: My first question, I know there was an expense reduction program in December 2022 with full savings emerging in 2024. Are you able to talk about geography of those savings that's supposed to emerge in 2024 and how you view the run rate Global Housing expense ratio?
Keith Meier: It's a blend of both employee actions, as well as some of our facilities that we've been able to gain some efficiencies on as well. But I think in terms of the expense efficiencies for housing, we had a really, really strong year. And it's really been the story of the last couple of years, especially a lot of our technology investments and the work that we've done through our digital programs, and really driving an even better customer experience. When you look at our expense ratio year-over-year, we're down 6 points from 46 to about 40. And so, that really has been the story of a lot of our technology investments that we've been making. And I think that's what's enabling us to – if you think, into 2024, we should be able to take a lot more expense leverage with the growth we had in housing, but not increasing our expenses in a corresponding way. So really proud of the work that our teams have done there to not just lower the cost, but also create advantages in the market. And I think when you think about the customer experience that we've been delivering, I think that's a great example of why a client like Bank of America would want to do business with Assurant. So I think those investments are paying off in multiple ways.
John Barnidge: On auto input costs, can you maybe talk about the ability to recoup the elevated auto input costs through contracted actions for 2024? I think you talked about improvement expected this year?
Keith Demmings: Maybe I'll take that. And I think what I would say is, there's a handful of clients and deal structures where we're feeling the pressure on the underwriting results, which we've talked about. We've made significant rate adjustments over the last 18 months or so, with all five of these clients and feel really good about how we're positioned. The relationships are incredibly strong. To your point, our contracts are built with transparency. We've got very much aligned interests in terms of financial performance. So we put a lot of rate in, we'll continue to look at performance, obviously monitor claims activity. I would say that we saw things level off in the fourth quarter, which is a good sign. We've stabilized severity in the business. And then, based on the nature of these service contracts, it takes a little longer for it to earn through than when you think about what happened within the housing, business. Those are annual policies. These are three, four or five, six year policies. So it's a little bit different from that perspective. But I would say we feel really well positioned and certainly see improvement in 2024, and that should continuing to flow through in 2025 and beyond.
Operator: Our next question is coming from Tommy McJoyntt with KBW.
Thomas McJoyntt: Sounds like there's a couple moving pieces related to the mobile side. So you called out some upcoming investments in that space. And you also have the onboarding of Telstra in Australia. Are you able to quantify some of the figures around that, in terms of the investment costs, the onboarding costs, and then what the run rate, either revenue or earnings contribution, from Telstra could be? We're just trying to think about after the next 12 months, sort of what the earnings power of that connected living mobile device business might look like?
Keith Demmings: I'll probably offer a couple of thoughts. Obviously, it's a pretty exciting development. We're super proud of the team in Australia. And it's a great example of leveraging our capabilities and our global reach. It's going to roll out in phases. We expect to launch in the first quarter, and then there's a number of different phases to the rollout. So it'll be, I would say, probably modestly EBITDA negative this year in terms of the investment to get that wrapped up. Obviously, I would expect it to be significantly improved certainly in 2025 – sorry, in 2025 over 2024. In terms of the size and scale of investments, so one thing I would say, Tommy, there's quite a bit of investment going on with Assurant. Certainly, we talked about BofA, but even just on the lifestyle and connected living side, Telstra is one example. Obviously, we're talking about it publicly. But there are also a lot of other investments that we're making, building out capabilities. And we're in many, many discussions with different clients, different prospects, about rolling out new product, new services. So I would say we probably have more investment going on, even beyond Telstra, within connected living this year than we would in a normal average year. When we talk about mid-single-digit growth for lifestyle, you could probably think about the investment, putting pressure on that by a few points. So it would be more in the high single-digit range, if we weren't making some of these – what for us are significant investments in the future.
Thomas McJoyntt: Appreciate you quantifying some of those numbers. You also separately reported some pretty high net investment yields across the various business lines this quarter and even for the full year. Is there any upside to the net investment income from here? And what's the sensitivity of those various portfolios to potential rate cuts?
Keith Meier: Tommy, I think, one, in terms of our expectations for next year, we see investment income being relatively flat to slightly up. You mentioned the higher results for this quarter. We had our real estate joint venture sale. So, that contributed. We don't think we'll have as high of real estate sales into next year. But we do think it should be relatively positive going into next year. Right now, our portfolio book yield is at 4.99%, so just under 5%. New money rates will be a little bit higher than that. And so, we do expect as the year goes on, of course, the Feds expected to reduce rates through the year. So depending on the timing of some of those rate changes, those will be kind of offsetting the increase that you saw this year. So, overall, we think we're in a pretty good place from an investment income standpoint, but probably slightly up for next year.
Keith Demmings: Tommy, just to add a little bit more color on how I'm thinking about that. When you look at the overall guide for the year, we're overcoming $54 million of PYD in housing. And then, we don't have material tailwinds on investment income. It might be modestly positive, but not like what we saw this year. So, obviously, being able to deliver strong growth on top of those two factors, we feel really good about, along with the investments that I mentioned earlier.
Operator: Our next question is coming from Brian Meredith with UBS.
Brian Meredith: A couple of them here. First one, I'm just curious. Keith, you mentioned that Japan was going to be relatively flat this year. I'm just curious kind of how we should think about that with respect to the contract kind of changes that are going on. Is that kind of ending in 2024? There's still pressures there and you expect some growth? And then, also on that, kind of maybe you can tell us what your kind of baseline macro assumption is in your kind of outlook for 2024?
Keith Meier: Starting with Japan, we mentioned the four-year customer contracts that were running off, and then the new contracts were evergreen, that's still going to be a bit of a pressure for us, not as much as 2023, but they'll still be a pressure for us in 2024. I think that is offset a little bit by some new structures and new programs that we have launched in Japan. So that's where that you'll see that moderating. And I think longer term, I feel even better about Japan where, a few years ago, we only had a couple of relationships with the mobile carriers. Now you fast forward to today, we've got active business that we do with all of the four top mobile operators. And so, in our business, it's not easy to win big clients, but when you can be an existing partner already, and then be able to grow that relationship from there, I think that puts us in a very good position and why we have a lot of optimism for the future of Japan. But with some of those new programs coming up, I think that's what's allowed us to feel like we've gotten past some of those headwinds from before.
Keith Demmings: We certainly stabilized Japan here, if we look at the last couple of quarters, Q3 and Q4 in terms of the overall financial performance. So we feel good about that. And I would say as we look forward to 2024, expect to see some modest improvement over time. And then, to Keith's point, longer term, still an exciting market for us.
Keith Meier: In terms of the macroeconomic conditions, Brian, I don't think we're expecting anything significant. Obviously, we talked about interest rates and things like that. But beyond that, there's nothing that's contemplated that's that significant.
Brian Meredith: One other just quick one here. On the BofA deal, I'm assuming your kind of guidance for cat load for this year includes the BofA deal?
Keith Meier: Yes, it does.
Operator: Our final question is coming from Grace Carter with Bank of America. It does appear we did lose Grace. One moment please. It does appear that Grace has dropped off the call, gentlemen.
Keith Demmings: No problem. All right. And that was the last question. Am I correct?
Operator: That is correct, sir.
Keith Demmings: Wonderful. Okay. We will call it a wrap for today and we'll look forward to speaking to everybody again in May. And then, obviously, in the meantime, please feel free to reach out to our IR team who'll be happy to answer any questions that anybody has. But thanks very much, and we'll talk soon.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Fourth Quarter and Full-Year 2023 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following management's prepared remarks. [Operator Instructions]. It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin."
},
{
"speaker": "Sean Moshier",
"text": "Thank you, operator. And good morning, everyone. We look forward to discussing our fourth quarter and full-year 2023 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer, and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the fourth quarter and full-year 2023. The release and corresponding financial supplements are available on assurant.com. Also on our website is a slide presentation that we introduced this quarter for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving in to Q&A. I will now turn the call over to Keith Demmings. Keith?"
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Sean. And good morning, everyone. 2023 was an extraordinary year for Assurant, our seventh consecutive year of profitable growth. We drove shareholder value by delivering financial outperformance, maintaining a strong capital position and generating significant momentum throughout our businesses. Adjusted EBITDA grew 21% to nearly $1.4 billion and adjusted EPS increased by 26%, both excluding reportable catastrophes. Our results were driven by the strength of our homeowners business within Global Housing, which delivered adjusted EBITDA growth of nearly 65% excluding cats. In addition, our connected living business continued to grow, supported by our strong US partnerships with mobile carriers and cable operators, and our ability to innovate and execute for our clients. Together, Lifestyle and Housing generated nearly $775 million in dividends. This allowed us to return over $350 million to shareholders, including $200 million of share repurchases. 2023 was a testament to the power and attractive financial profile of our unique and differentiated lifestyle and housing businesses. Assurant would not have been able to achieve this level of success without our talented people, including our newly refreshed management committee, further strengthening our leadership team. As we celebrate our 20th year as a public company, I am proud of the world class culture we've created, exemplified by the many recognitions Assurant has received throughout 2023. Earlier this week, JUST 100 included Assurant as part of its 2024 rankings of America's most just companies, recognizing our commitment to serving our employees, customers, communities, the environment, and our shareholders. In addition, we received recognition from Fortune as one of America's most innovative companies, and Newsweek recognized the progress we've made to incorporate sustainability into our strategy by placing us on its list of America's most responsible companies. The dedication from our employees and leadership team, who strive to achieve our vision every day, makes it possible to innovate, to better serve our clients and create value for our shareholders. We begin 2024 in a position of strength and with great momentum. Over the past two years, we've focused on further strengthening our business portfolio and driving operational excellence, while accelerating innovation. By investing in businesses where we have leadership positions, we believe we're well positioned for future success. For instance, within Global Lifestyle, we've grown our presence in specialized markets, including in the commercial equipment space, where acquisitions have contributed to new client partnerships. We've strengthened our company through active portfolio management, making decisions to exit businesses that are not core to our long term strategy. This included exiting our sharing economy offerings and international cat exposed businesses in housing, further simplifying our portfolio. We've made significant progress in driving operational excellence across Assurant with a streamline organizational structure and real estate footprint. We've implemented digital first initiatives across our operations to support our businesses and drive value for end consumers. Finally, we've accelerated innovation in a variety of ways to drive our business growth. Moving forward, technology innovation will continue to be an important driver of growth and value creation for Assurant. Our approach has driven success within our financial results, and is evident in our track record of winning new business and renewing client partnerships. This expansion of our client base is an integral part of our strategy, and creates important tailwinds as we look toward the future. Now, turning to highlights across our business segments. For 2023, Global Lifestyle earnings were relatively flat on a constant currency basis. In connected living, 2023 represented another year of growth for the business with a 3% increase in earnings. Within our US business, we drove high single-digit EBITDA growth as we continue to innovate and execute for our growing carrier and cable operator clients through our device protection programs. We strengthened critical partnerships, including Spectrum Mobile, where we provide mobile protection, trade-in and other value-added services. In addition, we expanded our trade-in programs with major OEMs by adding a large new partner, as well as renewing AT&T, where we're deploying robotics in our mobile device facilities throughout the US. We continue to make progress internationally. In Europe, we stabilized earnings by driving expense efficiencies while continuing to address ongoing macroeconomic challenges. Throughout Asia-Pacific, we're excited by our market position and our long term outlook. We're very pleased to announce a new partnership with Telstra, Australia's largest mobile operator. Our new multi-year deal will allow us to provide comprehensive products to support the end-to-end device lifecycle for Telstra's broad base of customers, including their core mobile protection program, as well as trade-in and repair capabilities. This partnership is significant as we continue to build our presence in Asia-Pacific. Turning to auto, year-over-year declines were driven by inflationary impacts on claims costs. Beginning in 2022, we took decisive action to address significant inflation that impacted the auto repair industry. For the handful of deals structures where we've been negatively impacted by underwriting results, we successfully partnered with our clients to implement meaningful rate increases, while making important changes to strengthen and enhance our claims adjudication process. Given the longer average duration of our auto service contracts, we'll earn through the full benefit of these actions over time, with improvement expected to begin in 2024. Based on the actions taken in auto and the continued growth of connected living, we feel well positioned to deliver Global Lifestyle growth in 2024. Let's move on to Global Housing. In 2023, the segment grew significantly, driving our overall enterprise performance. Growth was led by our homeowners business, which was supported by higher premiums and in-force policy growth. The business rebounded from inflation impacts on claims experienced in 2022 and also benefited from favorable prior-year reserve development. In addition to highlighting the significant earnings power of the business, our 2023 housing results demonstrated differentiated returns and strong cash flow. Excluding favorable prior-year development, our 2023 combined ratio was 83%, including $111 million of reportable cats, which was below our assumed annual cat load of $140 million. We are also very pleased to announce a new partnership in our lender-placed business. Beginning in the first quarter of 2024, we'll provide lender-placed insurance services to Bank of America's 1.8 million loan portfolio, further enhancing our market position and validating the competitive strength of our offerings. In renters and other, we increased earnings modestly in 2023 as our property management channel continued to expand. Written premiums in the property management channel grew nearly 20% in 2023. Along with adding new clients, we also achieved double-digit growth across 8 of our top 10 PMC clients, creating significant business momentum. Growth was supported by the continued expansion of Cover360 where we now track over 1 million residents, a nearly 45% increase over the prior year. Technology innovation also enhanced our digital customer experience, including a new digital agent leasing portal and expanded claims processing powered by machine learning. Let's turn to our 2024 enterprise outlook. We expect continued profitable growth in 2024, driven by our business momentum. While growth is expected to be lower than the significant outperformance we delivered in 2023, we expect our 2024 results will demonstrate the combined earnings power of our advantage portfolio. Adjusted EBITDA excluding cats is expected to grow mid-single-digits, with Global Lifestyle and Global Housing delivering similar growth rates for the year. Adjusted EPS growth is expected to modestly trail adjusted EBITDA growth, primarily reflecting higher annual depreciation expenses related to technology investments critical in executing our strategy. Before concluding, I'd like to introduce our recently appointed CFO, Keith Meier. Keith has been with Assurant for over 25 years and has served in leadership positions, managing P&Ls across many of Assurant's businesses. In his most recent role as Chief Operating Officer, Keith led the transformation of our technology and drove significant operational efforts to support the end customer experience. I have no doubt that Keith as our CFO will be an enabler of driving profitable growth, while allocating capital strategically. Now over to Keith to review our quarterly results and 2024 outlook in further detail."
},
{
"speaker": "Keith Meier",
"text": "Thanks, Keith. And good morning, everyone. Before reviewing the quarterly results, I'd like to share my perspectives as I'm about to wrap up my first 90 days as Assurant CFO. During my time at Assurant, I've been fortunate to have led several businesses, as well as take on a variety of other roles across the organization, including most recently leading our technology and operational teams. These experiences have provided me with deep insights into our global clients, and the understanding of what is needed to deliver a high level of business performance, always backed by strong financial expertise and discipline. As CFO, driving growth and financial performance will continue to be my priorities. I'm focused on ensuring our capital position remains strong as we create additional shareholder value and drive profitable growth through further innovation and differentiation within our product portfolio. As I look toward the future, I'm also focused on continued expense efficiencies by utilizing digital and AI technology, which also enables us to deliver better customer experiences. Lastly, I've appreciated the opportunity to meet with many of our investors, employees and clients over the last several months, and their willingness to share observations about Assurant as I began my tenure as CFO. Our discussions have enabled me to better shape my views and the path going forward. Now, let's talk about our fourth quarter financial results, which reinforced the strength of our businesses and the performance that we've seen throughout the year. For the quarter, adjusted EBITDA grew 29% to $382 million and adjusted EPS increased by 38% to $4.90, both excluding reportable catastrophes. Adjusted earnings and EPS growth were driven by year-over-year growth in both Housing and Lifestyle. Our capital position remains strong, generating $280 million of segment dividends in the fourth quarter, and ending the year with $606 million of holding company liquidity. This allowed us to return $169 million to shareholders in the quarter, including $130 million of share repurchases. Let's review the businesses, beginning with Global Lifestyle. For the quarter, adjusted EBITDA grew 12% to $205 million, led by strong earnings growth of 23% within connected living, as our US mobile protection programs continued to grow. Higher yields on invested assets also contributed to the improved fourth quarter results. Globally, our trade-in programs represent a critical component of our device lifecycle value proposition, as well as a fee-based income driver supporting the growth of our mobile business. Throughout 2023, we serviced over 25 million devices, including 7.5 million in the fourth quarter, which represented a high watermark for the year. While trade-in results were down modestly year-over-year, we saw fee income growth from higher sale prices for used devices and contributions from new US trade-in programs. Internationally, we continue to be impacted by subscriber declines in Japan, but have stabilized performance in a challenging macroeconomic backdrop. In global auto, fourth quarter adjusted EBITDA was relatively flat, as higher claims costs from inflation were offset by higher investment income. Claims were also elevated from the expected normalization of auto ancillary products and from international clients. During the latter part of the year, we saw positive signs in US loss trends, as we began to benefit from prospective rate increases that were implemented. Turning to net earned premiums, fees and other income, Lifestyle grew by $268 million or 13%. Growth from global automotive, which increased 14%, was due to $85 million of non-run rate premium adjustments with no corresponding earnings impact, as well as prior periods sales of vehicle service contracts. Connected living's net earned premiums, fees and other income increased 12%, benefiting from contributions from new trade-in programs, higher prices on used mobile devices and modest growth in North American mobile subscribers. Looking ahead to 2024, we expect Global Lifestyle's adjusted EBITDA to grow, driven by both connected living and global automotive. We expect growth in connected living to be led by the continued expansion of our US business. We expect Japan and Europe to remain generally stable throughout the year. In global auto, we expect rate actions taken over the past 18 months to drive improvement over time, beginning in 2024. Investments related to new client implementations will temper growth in 2024 for Lifestyle, but are critical levers to expand our portfolio and strengthen our business over the long term. We continue to monitor foreign exchange impacts, broader macroeconomic conditions and interest rates, which may impact the pace and timing of growth. In terms of full year net earned premiums, fees and other income, lifestyle is expected to grow mainly from our connected living business. Moving to Global Housing, 2023 was truly a strong year. We drove growth from the actions taken over the past few years to ensure rate adequacy and drive expense leverage, while benefiting from the streamlining that we undertook to simplify our portfolio. Fourth quarter adjusted EBITDA was $186 million, which included $22 million of reportable cats. Excluding reportable cats, adjusted EBITDA increased by nearly 50% or $68 million to $208 million. Two-thirds of the increase was driven by favorable non-cat loss experience and homeowners, including a favorable year-over-year impact of $35 million related to prior-period reserve development. This was comprised of $40 million of reserve reductions in the current quarter compared to a $5 million reduction in the fourth quarter of 2022. The remainder of the adjusted EBITDA increase was from continued top line growth in homeowners from higher premiums and an increase in the number of in-force policies. Higher investment income also contributed to earnings growth. Growth was partially offset by incremental expenses to support new business and an increase to our catastrophe reinsurance premium. For renters and other, earnings were flat as growth in our property management channel was offset by softer affinity channel volumes. For the full-year 2024, we expect Global Housing adjusted EBITDA excluding reportable cats to grow, driven by continued top line momentum in homeowners. In 2023, we benefited from $54 million of favorable prior-year reserve development. Our expectation is to deliver growth in housing in 2024, overcoming the $54 million of favorable prior-year reserve development, demonstrating the strength of the housing business. As Keith discussed, we will begin onboarding 1.8 million loans from Bank of America in the first quarter. When fully onboarded, we expect the placement rate of the book to be below Assurant's current portfolio average of 1.8%, which may impact overall placement rate trends. Due to implementation expenses, we do not expect these loans to contribute significantly to adjusted EBITDA in 2024. In terms of our cat reinsurance program, we have transitioned to a single April 1 placement date beginning this year. This greatly simplifies our placement process while maintaining comprehensive coverage in the market. As this is a transition year, we placed virtually all of our 2024 program in January, with some smaller components remaining for the April placement. For our 2024 program, our program retention will increase to $150 million, aligning with a one in five year probable maximum loss or PML as we continue to optimize risk and return. This is consistent with our 2023 program. We've expanded our risk protection to align with exposure by increasing our top end limit to protect against a 1 in 265 PML event. Over the past two years, we've continued to increase our capital protection, increasing the top end of our program from a 1 in 174 PML in 2022 to a 1 in 225 PML in 2023 and now a 1 in 265 PML in 2024. Reflecting on these expected changes, we now estimate the appropriate cat load to be $155 million for 2024. Given the exit of our international property business and the better market pricing as we leverage our strong reinsurer relationships, we expect modest overall cost savings in 2024. We will provide further updates on the reinsurance program in May. Moving to corporate. The fourth quarter adjusted EBITDA loss was $30 million, a $3 million year-over-year increase, mainly due to higher employee-related expenses. For 2024, we expect the corporate adjusted EBITDA loss to approximate $105 million. Turning to capital management. As we look forward to 2024, we expect to continue to generate significant capital and focus on maintaining balance and flexibility to support business growth. For the full year, we expect our businesses to generate meaningful cash flows, approximating two thirds of segment adjusted EBITDA, including reportable cats. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance and rating agency and regulatory requirements. We repurchased $200 million of common stock in 2023 and currently expect share repurchases to be in the range of $200 million to $300 million for 2024, which will depend on strategic M&A opportunities, market conditions, and cat activity. As you can see, we are well positioned to deliver another year of growth in 2024 through the power of the Assurant franchise. I'll now turn the call back to Keith Demmings to share his views on performance, as supported by our differentiated business model. Keith?"
},
{
"speaker": "Keith Demmings",
"text": "I'd like to take a few minutes to discuss why we believe that Assurant is so attractively valued today. Assurant is a powerful differentiated business with unique advantages that have outperformed over time. Our B2B2C business model throughout lifestyle and housing is different from other insurers and service-oriented companies. Not only do we operate in unique, highly specialized and attractive markets, but we hold strong market positions and benefit from our scale. At our core, we provide specialty insurance solutions and fee-based services that are often deeply integrated with our large clients as we play an important role delivering services to their end customers. Our alignment with industry leaders and market disruptors has helped us generate significant scale within our businesses. Our competitive advantages are further strengthened by our broad set of capabilities that allow us to innovate and execute for our partners and customers, enabling us to be flexible and agile. We have compelling and unique aspects of our business model that we believe create advantages. Our low capital intensity businesses allow us to grow efficiently, while generating additional capital for deployment. This is evident through our capital efficiency and strong cash generation of $3.5 billion over the last five years. Our risk profile is attractive. Earnings volatility is lowered by the risk sharing structures within our business models, reducing the impacts of macroeconomic volatility. For example, throughout connected living and global auto, approximately two-thirds of total risk is reinsured or profit shared to our partners. Within housing, our portfolio simplification efforts have focused on exiting more capital intensive businesses, which has enhanced our risk profile. In addition, our robust catastrophe program substantially limits retained risk due to the low per occurrence retention level and high limit at the top end of the tower. Lastly, we're well positioned to adjust pricing to enable our targeted rates of return. Lender-placed is a prime example where a product has a built-in annual inflation guard feature to ensure policy pricing accounts for higher labor and materials cost, as we've seen over the last two years. In auto, most of our client deals structures share in the risk through reinsurance or profit shares. This creates close alignment between Assurant's underlying economics and our client's financial results. Given this dynamic, we have the ability to adjust rates together with our clients to account for inflation impacts in the broader market. Over the past 18 months, we've successfully worked with our clients to put through prospective rate increases on new vehicle service contracts. Financial performance is paramount for Assurant. While growth may not always be linear, we've delivered average annual earnings and EPS growth of double digits since 2019, which has generated significant cash flow. Our 2024 outlook adds to this historical growth that we've delivered. To demonstrate the strength of our business model, we thought it would be useful to show how we perform versus a broad group of insurers on an adjusted earnings basis given the available data. Please keep in mind this example is not to suggest a new peer group. We've selected the S&P 1500 P&C index to highlight our performance against a credible and broad index that includes members we're often compared to, including specialty and P&C insurers. Over the past five years, we've grown double digits and outperform the index. Our average annual adjusted earnings growth rate excluding cats of 12% is almost double the index growth rate of 7% over the same time period. Including reportable cats, we've also outpaced the market, driving 10% average annual growth versus the index growth rate of 6%. We believe that our consistent ability to demonstrate strong, profitable growth in returns with lower volatility and required capital makes Assurant attractively valued. I'm confident that we'll continue to drive long term profitable growth and create shareholder value. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question is coming from Mark Hughes with Truist Securities."
},
{
"speaker": "Mark Hughes",
"text": "The BofA, you said that the placement rate is going to be lower? Is that just because of placement rate on an underlying basis is lower? Or is that – the actual premiums and the covered homes are not being transferred over to you?"
},
{
"speaker": "Keith Demmings",
"text": "No, we're going to be picking up all of the loans and then all of the policies, but the placement rate on that particular block of business is just lower than the average. If you look at our current average, it's 1.8%. It'll be south of that, just the nature of the loans and the nature of the business. But to the more fundamental point, really excited about the opportunity and many years in the making, and a huge congratulations to our lender-placed team for doing an incredible job building a relationship. And then obviously getting to this point is incredibly exciting and extremely validating."
},
{
"speaker": "Mark Hughes",
"text": "On the homeowners business, a favorable reserve development. Was that just because Hurricane Ian turned out better than expected or are you seeing a fundamental change in underlying trends? It seems like the non-cat losses have been very favorable lately? Is it something we should view as a sustained, sustainable?"
},
{
"speaker": "Keith Meier",
"text": "This is Keith Meier. So I think the first thing I would say is the positive reserve development was more in relation to the higher inflationary environment that we had previously. Now that that's more settled, that's what's really been the change in the estimates that our team has made there. So I think that was more the driver than any other type of weather activity or any other type of experience. So I think that was the key there. In terms of your question on the quarter, the way to think about that is if you take out the prior year, the prior period development, and over the whole year, we basically are about at about a 40% non-cat loss ratio. It's about a point better than last year. And then if you think about, looking at 2024, we would see our non-cat loss ratio to be somewhat level to what we're seeing in 2023. So that's probably the way to think about our views on the non-cat loss ratio."
},
{
"speaker": "Keith Demmings",
"text": ""
},
{
"speaker": "Keith Demmings",
"text": "And just one final thought. Modestly better in the quarter when you make the adjustment at 38%. But that's just normal seasonality, nothing we would really point to there, Mark."
},
{
"speaker": "Mark Hughes",
"text": "If I can squeeze in one more, the fee income in Lifestyle was up substantially, much more so than the devices service. What was going on there?"
},
{
"speaker": "Keith Meier",
"text": "That's mainly the higher trade-in volumes that we have seen in the fourth quarter. So, in the fourth quarter, we also saw the addition of two new programs. So, one with one of the major OEMs and then also a program that cuts across several of our other clients. Then that's also tempered a little bit by some of the promotional activity. But, overall, we felt really good about the trade-in performance in the quarter."
},
{
"speaker": "Operator",
"text": "Our next question is coming from John Barnidge with Piper Sandler."
},
{
"speaker": "John Barnidge",
"text": "My first question, I know there was an expense reduction program in December 2022 with full savings emerging in 2024. Are you able to talk about geography of those savings that's supposed to emerge in 2024 and how you view the run rate Global Housing expense ratio?"
},
{
"speaker": "Keith Meier",
"text": "It's a blend of both employee actions, as well as some of our facilities that we've been able to gain some efficiencies on as well. But I think in terms of the expense efficiencies for housing, we had a really, really strong year. And it's really been the story of the last couple of years, especially a lot of our technology investments and the work that we've done through our digital programs, and really driving an even better customer experience. When you look at our expense ratio year-over-year, we're down 6 points from 46 to about 40. And so, that really has been the story of a lot of our technology investments that we've been making. And I think that's what's enabling us to – if you think, into 2024, we should be able to take a lot more expense leverage with the growth we had in housing, but not increasing our expenses in a corresponding way. So really proud of the work that our teams have done there to not just lower the cost, but also create advantages in the market. And I think when you think about the customer experience that we've been delivering, I think that's a great example of why a client like Bank of America would want to do business with Assurant. So I think those investments are paying off in multiple ways."
},
{
"speaker": "John Barnidge",
"text": "On auto input costs, can you maybe talk about the ability to recoup the elevated auto input costs through contracted actions for 2024? I think you talked about improvement expected this year?"
},
{
"speaker": "Keith Demmings",
"text": "Maybe I'll take that. And I think what I would say is, there's a handful of clients and deal structures where we're feeling the pressure on the underwriting results, which we've talked about. We've made significant rate adjustments over the last 18 months or so, with all five of these clients and feel really good about how we're positioned. The relationships are incredibly strong. To your point, our contracts are built with transparency. We've got very much aligned interests in terms of financial performance. So we put a lot of rate in, we'll continue to look at performance, obviously monitor claims activity. I would say that we saw things level off in the fourth quarter, which is a good sign. We've stabilized severity in the business. And then, based on the nature of these service contracts, it takes a little longer for it to earn through than when you think about what happened within the housing, business. Those are annual policies. These are three, four or five, six year policies. So it's a little bit different from that perspective. But I would say we feel really well positioned and certainly see improvement in 2024, and that should continuing to flow through in 2025 and beyond."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Tommy McJoyntt with KBW."
},
{
"speaker": "Thomas McJoyntt",
"text": "Sounds like there's a couple moving pieces related to the mobile side. So you called out some upcoming investments in that space. And you also have the onboarding of Telstra in Australia. Are you able to quantify some of the figures around that, in terms of the investment costs, the onboarding costs, and then what the run rate, either revenue or earnings contribution, from Telstra could be? We're just trying to think about after the next 12 months, sort of what the earnings power of that connected living mobile device business might look like?"
},
{
"speaker": "Keith Demmings",
"text": "I'll probably offer a couple of thoughts. Obviously, it's a pretty exciting development. We're super proud of the team in Australia. And it's a great example of leveraging our capabilities and our global reach. It's going to roll out in phases. We expect to launch in the first quarter, and then there's a number of different phases to the rollout. So it'll be, I would say, probably modestly EBITDA negative this year in terms of the investment to get that wrapped up. Obviously, I would expect it to be significantly improved certainly in 2025 – sorry, in 2025 over 2024. In terms of the size and scale of investments, so one thing I would say, Tommy, there's quite a bit of investment going on with Assurant. Certainly, we talked about BofA, but even just on the lifestyle and connected living side, Telstra is one example. Obviously, we're talking about it publicly. But there are also a lot of other investments that we're making, building out capabilities. And we're in many, many discussions with different clients, different prospects, about rolling out new product, new services. So I would say we probably have more investment going on, even beyond Telstra, within connected living this year than we would in a normal average year. When we talk about mid-single-digit growth for lifestyle, you could probably think about the investment, putting pressure on that by a few points. So it would be more in the high single-digit range, if we weren't making some of these – what for us are significant investments in the future."
},
{
"speaker": "Thomas McJoyntt",
"text": "Appreciate you quantifying some of those numbers. You also separately reported some pretty high net investment yields across the various business lines this quarter and even for the full year. Is there any upside to the net investment income from here? And what's the sensitivity of those various portfolios to potential rate cuts?"
},
{
"speaker": "Keith Meier",
"text": "Tommy, I think, one, in terms of our expectations for next year, we see investment income being relatively flat to slightly up. You mentioned the higher results for this quarter. We had our real estate joint venture sale. So, that contributed. We don't think we'll have as high of real estate sales into next year. But we do think it should be relatively positive going into next year. Right now, our portfolio book yield is at 4.99%, so just under 5%. New money rates will be a little bit higher than that. And so, we do expect as the year goes on, of course, the Feds expected to reduce rates through the year. So depending on the timing of some of those rate changes, those will be kind of offsetting the increase that you saw this year. So, overall, we think we're in a pretty good place from an investment income standpoint, but probably slightly up for next year."
},
{
"speaker": "Keith Demmings",
"text": "Tommy, just to add a little bit more color on how I'm thinking about that. When you look at the overall guide for the year, we're overcoming $54 million of PYD in housing. And then, we don't have material tailwinds on investment income. It might be modestly positive, but not like what we saw this year. So, obviously, being able to deliver strong growth on top of those two factors, we feel really good about, along with the investments that I mentioned earlier."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"text": "A couple of them here. First one, I'm just curious. Keith, you mentioned that Japan was going to be relatively flat this year. I'm just curious kind of how we should think about that with respect to the contract kind of changes that are going on. Is that kind of ending in 2024? There's still pressures there and you expect some growth? And then, also on that, kind of maybe you can tell us what your kind of baseline macro assumption is in your kind of outlook for 2024?"
},
{
"speaker": "Keith Meier",
"text": "Starting with Japan, we mentioned the four-year customer contracts that were running off, and then the new contracts were evergreen, that's still going to be a bit of a pressure for us, not as much as 2023, but they'll still be a pressure for us in 2024. I think that is offset a little bit by some new structures and new programs that we have launched in Japan. So that's where that you'll see that moderating. And I think longer term, I feel even better about Japan where, a few years ago, we only had a couple of relationships with the mobile carriers. Now you fast forward to today, we've got active business that we do with all of the four top mobile operators. And so, in our business, it's not easy to win big clients, but when you can be an existing partner already, and then be able to grow that relationship from there, I think that puts us in a very good position and why we have a lot of optimism for the future of Japan. But with some of those new programs coming up, I think that's what's allowed us to feel like we've gotten past some of those headwinds from before."
},
{
"speaker": "Keith Demmings",
"text": "We certainly stabilized Japan here, if we look at the last couple of quarters, Q3 and Q4 in terms of the overall financial performance. So we feel good about that. And I would say as we look forward to 2024, expect to see some modest improvement over time. And then, to Keith's point, longer term, still an exciting market for us."
},
{
"speaker": "Keith Meier",
"text": "In terms of the macroeconomic conditions, Brian, I don't think we're expecting anything significant. Obviously, we talked about interest rates and things like that. But beyond that, there's nothing that's contemplated that's that significant."
},
{
"speaker": "Brian Meredith",
"text": "One other just quick one here. On the BofA deal, I'm assuming your kind of guidance for cat load for this year includes the BofA deal?"
},
{
"speaker": "Keith Meier",
"text": "Yes, it does."
},
{
"speaker": "Operator",
"text": "Our final question is coming from Grace Carter with Bank of America. It does appear we did lose Grace. One moment please. It does appear that Grace has dropped off the call, gentlemen."
},
{
"speaker": "Keith Demmings",
"text": "No problem. All right. And that was the last question. Am I correct?"
},
{
"speaker": "Operator",
"text": "That is correct, sir."
},
{
"speaker": "Keith Demmings",
"text": "Wonderful. Okay. We will call it a wrap for today and we'll look forward to speaking to everybody again in May. And then, obviously, in the meantime, please feel free to reach out to our IR team who'll be happy to answer any questions that anybody has. But thanks very much, and we'll talk soon."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 3 | 2,023 | 2023-11-01 08:00:00 | Operator: Welcome to Assurant's Third Quarter 2023 Conference Call and Webcast. [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our third quarter 2023 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the third quarter of 2023. The release and corresponding financial supplements are available on assurant.com. We'll start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release and financial supplement as well as in our SEC reports. During today's call, we will refer to our non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplements. It is now my pleasure to turn the call over to Keith.
Keith Demmings: Thanks, Suzanne, and good morning, everyone. We're very pleased with the exceptionally strong results we achieved in the third quarter with adjusted EBITDA, excluding catastrophes, growing nearly 50% year-over-year or 19% on a year-to-date basis, both ahead of our expectations. Our results were largely driven by continued momentum in Global Housing and our steadfast focus on executing our strategy, including driving innovation, creating efficiencies and strengthening our global partnerships. These efforts have positioned us to exceed our previous expectations of high single-digit adjusted EBITDA growth, excluding catastrophes. We now expect adjusted EBITDA growth of mid- to high-teens. Our year-to-date performance highlights Assurant's competitive differentiators, including our advantaged Global Housing and Global Lifestyle businesses that have proven leadership positions with scale and significant cash generation. Combined, these businesses are extending Assurant's track record of strong financial performance, thanks in part to the swift actions we've taken across our global operations to improve results and strengthen the business given broader macroeconomic headwinds. We continue to realize benefits from the actions we announced in 2022 to simplify our business and corporate real estate and realign our organizational structure, allowing us to reinvest throughout the enterprise. We extended our 2022 restructuring plan to include additional actions across the enterprise as we believe further enhancing Assurant's operational efficiency will support our long-term profitable growth and value creation. We now expect total restructuring costs associated with our extended plan to be between $90 million and $95 million pretax, above our previously announced expectations of $60 million to $65 million. Looking at our business segments. In Global Housing, I want to thank all of our employees who supported policyholders impacted by Hurricane Idalia and the Hawaii wildfires, as well as several other significant weather events during the quarter. Assurant plays a critical role in safeguarding our policyholders and supporting the U.S. mortgage industry. Our Global Housing adjusted EBITDA, excluding cats, more than doubled year-over-year and increased 72% year-to-date, led by significant growth in our homeowners business through top line growth and improving loss experience. Our ability to quickly execute changes, particularly in our lender-placed business, has helped us gain earnings momentum from higher in-force policies, average insured values and state-approved rate increases following inflation impacts in 2022. Our performance so far this year highlights Global Housing's compelling and uniquely positioned portfolio. Year-to-date, including $89 million of reportable catastrophes, our combined ratio is 82% and our annualized ROE is 29%, demonstrating strong returns and cash generation. In our Renters business, we saw continued strength in our property management channel, where policies in-force have grown double digits this year. We continue to win new clients, grow existing partnerships and release new capabilities, including our upgraded leasing agent portal and digital insurance tracking enhancements. We're very pleased with Global Housing's strong performance year-to-date, which reflects our focused execution around streamlined product lines where we have a clear competitive advantage and scale. Turning to Global Lifestyle. Third quarter earnings increased 7% year-over-year or 14% excluding a onetime client benefit within Connected Living last year. Year-to-date adjusted EBITDA down 6% versus the same period in '22 has continued to improve throughout the year and is tracking in line with our expectations of a modest decline for the full year. Within Connected Living, we continue to support long-term growth through the development of innovative offerings for our partners. U.S. Connected Living is poised for another year of solid growth, particularly within our mobile protection business, a testament to our breadth of innovative offerings, customer experience expertise and deep relationships with mobile carriers and cable operators. As macroeconomic headwinds have persisted, including impacts from inflation, we've taken decisive action across our global operations to mitigate these impacts. In Europe, expense actions have allowed us to stabilize earnings as we focus on critical opportunities to grow our top line. We also continue to invest to advance product innovation and anticipate our clients' needs as well as improve customer experience through expanded service delivery capabilities. For example, as part of the extension of our '22 plan to realize benefits and simplify our business in corporate real estate, we're consolidating our mobile device care centers into 2 sites in the U.S. We'll move the services currently offered in York, Pennsylvania to our existing facility in Texas. Over time, we'll be investing in a new site in Nashville, where we can leverage a strong talent market and greater logistics efficiencies as we evolve with emerging clients. Turning to our Global Auto business. We're beginning to see initial signs of claims improvement, as a result of the decisive actions taken over the last year to improve performance. These actions included implementing rate increases on new policies across impacted clients and advancing opportunities to improve loss experience for programs where we hold the risk. We continue to monitor claims costs closely and expect improvement will be gradual over time given the way the auto business earns. In auto, we launched Assurant Vehicle Care at over 500 dealers. Building on decades of proprietary data on cost of claims, Assurant Vehicle Care is a comprehensive new suite of vehicle protection products. It was developed to help our dealer partners optimize product design, pricing, training and sales to ultimately enhance attachment and economics. For the consumer, Assurant Vehicle Care provides a digital experience with more vehicle coverage, flexibility and transparency. Now let's turn to our enterprise outlook and capital. Given our year-to-date results and our business outlook for the remainder of 2023, we now expect adjusted EBITDA to grow mid- to high-teens, excluding catastrophes. Adjusted EPS growth is now expected to exceed adjusted EBITDA growth, each excluding catastrophes. This is primarily due to higher earnings growth that now more than offsets the increase in depreciation expense. From a capital perspective, we upstreamed $202 million of segment dividends during the third quarter and $493 million year-to-date. We ended the third quarter with $491 million of holding company liquidity consistent with the end of the second quarter. In terms of share repurchases, during the third quarter, repurchases totaled $50 million. This brings our total repurchases to approximately $100 million for the year, including an additional $30 million of shares purchased through the end of October. Based on our strong year-to-date results, we expect fourth quarter buybacks to accelerate from third quarter levels and to be approximately $200 million for the year, consistent with our underlying repurchase activity in 2022. We're pleased with our strong capital position, which affords us more long-term flexibility over time. Looking to 2024, we expect a more modest level of earnings growth in Global Housing, excluding catastrophes, building on strong 2023 financial results, which included $40 million of favorable prior year reserve development. In Global Lifestyle, we expect earnings growth to be led by Connected Living, particularly in the U.S. from the expansion of current programs, as we work to gradually improve the auto business, which we will continue to manage closely. From a capital perspective, we're committed to maintaining flexibility for our strong balance sheet and deploying capital for share repurchases and opportunistic acquisitions to support our growth objectives. We will share our 2024 outlook in February, factoring in our fourth quarter earnings, business trends as well as the latest forecast of the macro environment for the year. In the near term, we're focused on achieving our 2023 objectives and setting a path for continued growth and value creation in 2024 and beyond. As we look ahead, we remain committed to execution, innovation and enhancing the customer experience for our clients and their end consumers, particularly as we look to capitalize on growth opportunities while supporting continued momentum. Before I turn the call over to Richard to review the third quarter results and our 2023 outlook in greater detail. I want to once again thank our employees for their hard work and dedication to deliver for our clients. Our company was recently recognized as one of TIME's best companies in the world, highlighting Assurant's strong employee satisfaction, revenue growth and sustainability efforts. Assurant was also recognized by Newsweek as one of America's greatest companies. Demonstrating our commitment to and progress in operating more sustainably. The recognition was timely as we recently introduced Carbon IQ by Assurant. This offering enables clients to see the carbon impact of each device, including new and refurbished devices and provides them with estimated CO2 emissions throughout the supply chain and life cycle to identify opportunities for reduction. We're honored to be recognized for our outstanding culture, products and sustainability all of which help us better serve our clients. And now over to Richard.
Richard Dziadzio: Thank you, Keith, and good morning, everyone. For the third quarter of 2023, adjusted EBITDA, excluding reportable catastrophes, totaled $357 million, up $118 million or nearly 50% year-over-year. Adjusted earnings per share, excluding reportable catastrophes, totaled $4.68 for the quarter, delivering year-over-year growth of 67%. To review results in greater detail, let's start with Global Lifestyle. The segment reported adjusted EBITDA of $192 million in the third quarter, an increase of $12 million or 7% year-over-year. As a reminder, prior period results included a onetime client benefit of $11 million within Connected Living. Excluding the prior period gain, Global Lifestyle's adjusted EBITDA increased 14% or $24 million. This increase was primarily driven by higher contributions from investment income and mobile growth. Connected Living earnings increased $30 million or 32% excluding the onetime client benefit, demonstrating strong mobile growth from North American device protection programs from carrier and cable operator clients and better trade-in performance. Financial Services also contributed to the growth. Trading results benefited from improved margins related to higher sales prices for used devices, partially offset by lower volumes, impacted by the timing and structure of carrier promotions. In Europe, we stabilized performance through expense actions, mitigating the impact of headwinds that began in the second half of 2022. In Japan, results were impacted by subscriber decline which is expected to continue into 2024. Global Auto adjusted EBITDA declined $6 million or 8%. Results continue to be impacted by inflation of labor and parts leading to higher average claims costs. As expected, claims experience for auto ancillary products has also contributed to higher incurred claims costs in the quarter. The auto earnings decline was partially offset by an increase in investment income from higher yields and asset values. Turning to net earned premiums, fees and other income. Lifestyle was up by $83 million or 4%. This growth was primarily driven by Global Automotive, reflecting an increase of 6% from prior period sales of vehicle service contracts. Connected Living's net earned premiums, fees and other income increased 3%. Growth was muted by the previously disclosed mobile program contract changes of approximately $55 million with no corresponding impact to profitability. Excluding the impact of these contract changes, Connected Living's net earned premiums, fees and other income grew by 8%. The quarter benefited from higher prices on used mobile devices and modest growth in North America mobile subscribers, excluding ongoing client runoff. Turning to the full year 2023. We continue to expect Lifestyle's adjusted EBITDA to decline modestly. Global Auto will be down for the full year from unfavorable loss experience, including the impacts from continued normalization for select ancillary products previously mentioned. We've taken decisive actions this year in response to higher claims experience in our auto book, including prospective rate increases and repair cost reduction. While we've seen some improvement, the improvement is expected to take place over a longer period of time given the earnings pattern of the business. In Connected Living, we expect our U.S. business to grow for the full year. Overall, we are pleased with Lifestyle's strong third quarter performance, especially in light of ongoing challenges in auto claims. For the fourth quarter, we expect higher trade-in volumes in mobile, but we also expect ongoing top line challenges in Japan and Europe and investments to support business growth. In terms of full year net earned premiums, fees and other income, Lifestyle is expected to grow consistent with year-to-date trends. Moving to Global Housing. Adjusted EBITDA was $165 million, which included $26 million in reportable catastrophes, primarily from Hurricane Idalia and Hawaii wildfires. Excluding reportable catastrophes, adjusted EBITDA more than doubled to $191 million, with an increase of $106 million. Housing performance was mainly led by 3 main items: First, continued top line growth in homeowners from higher premium rates and average insured values in lender-placed as well as an increase in the number of in-force policies. Second, favorable non-cat loss experience across the segment, including a year-over-year positive impact of $39 million related to prior period reserve development. This was comprised of $15 million of reserve reductions in the current quarter compared to reserve strengthening of $24 million in the prior period. And lastly, additional scale within our homeowners expense base ultimately driving stronger operating leverage. Higher investment income also contributed to earnings growth for homeowners. For Renters and Others, earnings grew modestly from favorable prior period reserve development. Growth within the property management channel was offset by softer affinity channel volumes. For the full year 2023, we expect Global Housing adjusted EBITDA, excluding reportable cats, to grow significantly due to the strong homeowners performance, driven by top line expansion in lender-placed and favorable non-cat loss experience. In the fourth quarter, we expect higher expenses to support business growth. In addition, the third quarter included $15 million of favorable prior period development. Moving to corporate. The third quarter adjusted EBITDA loss was $26 million, representing a modest year-over-year increase, mainly related to higher employee expenses. For the full year 2023, we continue to expect the corporate adjusted EBITDA loss to approximate $105 million. Turning to holding company liquidity. We ended the quarter with $491 million and dividends from our operating segments totaled $202 million. In addition to cash used for corporate and interest expenses, third quarter cash outflows included 3 items, $50 million of share repurchases, $37 million for common stock dividends and $50 million to complete the repayment of our September 2023 notes. As Keith mentioned, given our year-to-date performance and outlook for the year as well as the strength of Assurant's balance sheet, we expect to achieve full year share repurchases of approximately $200 million. For the full year, we continue to expect our businesses to generate meaningful cash flows, approximating 65% of segment adjusted EBITDA, including reportable catastrophes. Cash flow expectations assume a continuation of the current economic environment and are subject to the growth of the businesses, investment portfolio performance and rating agency and regulatory requirements. In closing, through the resilience of our unique business model, the decisive management actions taken and our intense client focus, we are confident in our ability to achieve the higher full year objectives we have outlined today. And with that, operator, please open the call for questions.
Operator: [Operator Instructions]. Your first question is coming from the line of Mark Hughes of Truist.
Mark Hughes: Keith, Richard, I really like this housing business, and I'm glad you didn't listen to those people who said you should divest it. Little [indiscernible]. On the housing business, increased policy count, how much of that is coming from, say, voluntary versus some uptick perhaps in the delinquencies or foreclosures or REO?
Keith Demmings: Yes. I'd say, first of all, yes, we're pretty excited about the results in housing and it's tremendous amount of work by the team in the last year, and it's really showing through here the last few quarters, and we're building a lot of momentum. I would say very little of the policy growth relates to the underlying economy or REO at all. We're really seeing no change in placement rate based on economic conditions, maybe a little bit of increase in policy count in a state like California, I'd say very modest, but a bit of a harder market. So we're seeing a little bit of growth there. Florida, basically flat year-to-date. So most of the growth is clients and client loan-related mix and nothing yet in terms of the broader economy.
Mark Hughes: What's your sense of the opportunity for sustained momentum, say, in higher values or higher rate? Has that activity peaked perhaps? Or is there still some way to go on both those fronts?
Keith Demmings: Yes. I mean, obviously, we work on rates related to that product line consistently state by state. We also have, as you know, the average insured value adjustment that we do in the summer every year. And obviously, last summer, we put a meaningful double-digit increase into average insured values. This year, it was just over 3%, 3.1% that went into July. And then state by state, based on historical performance and expected costs, we continue to work with states. I feel like we still have momentum running through the portfolio. We haven't -- certainly haven't topped out in terms of the impact from the rate adjustments. But we do see it tapering and slowing. Certainly, as we think about Q4 as we head into 2024. But year-to-date, feel good with where our loss ratios sit. In housing, we're 42% non-cat loss ratio if you adjust for prior period development, very consistent with where we were last year. So we feel like the rates that we have are certainly appropriate. And as we see impacts on cost of claims will modify as we go forward.
Mark Hughes: Then one final one. Your fee income was up in Lifestyle, your devices service were down 20%-plus. I think you mentioned the higher value per device. Anything else contributing to that, just the divergence between the fee income and the device fee service?
Keith Demmings: Yes. So if we think about that year-over-year, certainly, volumes are down. We saw softer promotional activity in the third quarter, not out of alignment with what we expected. We did see a pickup in the back half of September, obviously, after new product introduction by Apple. So hopefully, that sets us up with what we'd expect in the fourth quarter to be an improvement there. And as I look at that business, we've done a really nice job in driving operational efficiency and automation to continue to improve the efficiency with which we operate. And then as you said, we've gotten higher sale prices when we're selling devices and obviously, we derive revenue based on how well we sell devices in the secondary market. But I'd say there's not much else to report. Profitability, a little bit stronger. But if you'll remember, third quarter last year, we had a bit of a mismatch between expenses and revenue. So Q3 trading results were a little bit depressed last year.
Operator: Your next question comes from the line of Jeff Schmitt of William Blair.
Jeffrey Schmitt: Back to growth in Global Housing. So PFO growth was 23% in the quarter. And I'm just trying to think through the components. You had mentioned inflation guard was 3%, I think, in June or July, but I guess 12% last year. So maybe kind of a mix there earning through. What's rate at? How much was the rate component? And how much was the unit growth component? I'm just trying to think of the different parts there.
Keith Demmings: Yes. So maybe I can start and then certainly, Richard can jump in. Obviously, when you look at Housing's revenue year-over-year, it's up meaningfully, $100 million, $103 million year-over-year. All of that is from growth in homeowners, which is up 31% year-over-year in terms of revenue. If we think about what's driving the performance from an underlying EBITDA perspective and Richard obviously talked about the prior period development. If you adjust the development, $15 million this year against adverse development last year of '24, we still see a $67 million increase in our underlying EBITDA. And I would say 2/3 of that is really driven by rates average insured values, which obviously play together, and then relatively stable losses related to higher levels of premium rolling through. And then the balance, maybe 1/3 is split between policy growth, which is up 3.5% year-over-year and then investment income, which is obviously helping with cash yields and more assets being held. But Richard, happy to have you add any other detail.
Richard Dziadzio: Yes, sure. Yes, that's exact. And I guess I would add, by the way, good morning Jeff, what I would add is that if you just look at the premium component that Keith just talked about, think about it generally as being 1/3 for each of the components that we've just discussed. It's the increase in rates, average insured values and inflation guard. That's sort of the way to look at it. And the other thing, too, that I would mention is you see -- you heard Keith talk about how much drops to the bottom line. I think that's also a credit to the expense discipline that we've had and the leverage we're getting, and you can see that coming out in the expense ratios that the growth in the premiums and the leverage that we have in the business is really allowing us to increase the bottom line.
Jeffrey Schmitt: Got it. Very helpful. And then in Global Lifestyle, just looking at that benefit ratio kind of continue to move up. Despite rate increases, it was 23% in the quarter, mainly driven by auto, it sounds like. Could you maybe just discuss the pricing strategy there? Like when does that begin? What level of pricing can you get in this market? Really, any detail on that would be helpful.
Keith Demmings: Yes, I can certainly start, Richard. So if I think about the auto business, I'm actually pleased with the work done by our team. So we started making adjustments to rate late last year. So we've probably been in about a 12-month cycle, making adjustments with clients. We're really on the risk in a meaningful way for 4 or 5 different programs. So it's not the bulk of our business, as we've talked about before. Most of that business is reinsured. So there's a handful of clients that we're working with very closely. And we put rate in place that we feel is appropriate to get the business to perform at the levels that are expected. So that work has been done. It's been ongoing for the last 4 quarters or so feel good about the adjustments we've made. We've had incredible discussions with our clients to try to get the programs to the right level of profitability. We've also been working incredibly hard, not just on rate, but on the claims adjudication process, how we're acquiring parts, how we're thinking about repairs and which repair shops to use when the options are available to us to drive more efficiency, and a lot of diligence end-to-end and very much in partnership with the clients. So as we look at the results in the quarter, certainly seeing a similar pattern to what we saw in Q2. But the good news is we've seen relative stability. The cost of severity on the auto side is up a little bit in Q3 over Q2, but the premium earning through is also up, and we're seeing a modest improvement in the underlying loss ratio when we look at the risk clients. So I feel like we're doing the right things. It's going to take time, certainly, to earn through. But early signs of good momentum at least in starting to stabilize as we look to bend the curve. But Richard, certainly anything else you want to add?
Richard Dziadzio: Yes, I think that's exactly right. And in our prepared remarks, we basically talked about it will take some time. The claims adjudication work we're doing and the teams are doing a fantastic job, that's helping us today bend the curve a little bit. We've been able to get rate, which is fantastic. But it's going to take time because we've sold what we've sold in the past, and that's going to run through and then the new rates and the new premiums we're getting, that will come through and help us bend the curve as we go in the future, but it will take some time.
Operator: Your next question comes from the line of Brian Meredith of UBS.
Brian Meredith: Could you talk a little bit about what's going on in Japan and maybe when we might see a flip there from a growth perspective? I know you said you'll still see some pressures in 2024, and I know you've got the new contracts that are going in. When do we see that flip? I would have thought that was going to be a nice little tailwind for growth in '24.
Keith Demmings: Yes, sure. We start at the highest level with Japan, I mean -- and I've talked about this before, and hopefully, this comes through. I mean this is a really, really critical market for Assurant. It's a tremendous mobile marketplace. It's the second largest in the world after the U.S. And I do think we are well positioned for long-term growth. That's the fundamental point. We're doing a lot of investing in the market, investing in not just capabilities but also talent. And we're in a really fortunate position today in that we have relationships with every major operator in the marketplace. We don't do all things for all operators, but we've got access, we've got deep relationships. And I think over time, that will bear fruit. I would say, as we think about exiting 2023, we're certainly stabilizing the financial performance in Japan. We've seen some subscriber runoff as we've talked about in the past. I expect that to continue to decelerate into '24. And we do think we'll grow EBITDA in Japan year-over-year, '24 over '23. So I'm really pleased with the hard work that the teams are doing and how we're positioned in the market. But that market is about what is it going to look like in 5 years? And how do we unlock the full potential of what I think we can achieve in that market.
Brian Meredith: Do you have like a percentage you can give us of how much of the Japanese business is now on a perpetual policy versus, I guess, it was a 4-year policy is what they were?
Keith Demmings: Yes. So the 4-year policies continue to run down. Certainly, the majority of the business is on an evergreen policy. A 100% of the business that is sold today is on an evergreen policy, but certainly, the vast majority.
Brian Meredith: Got you. And then second question, just going back to Global Housing. I'm just curious, what are you seeing right now from an inflationary perspective in that business, right? It sounds like it's pretty modest given what your loss ratios are pretty good. But if I look at some of the other homeowners insurance companies, they're still seeing a fair amount of inflationary pressure there. And maybe you can pivot that into maybe your business is a little bit different, and you've got better ways to control those that inflation than maybe some of the traditional homeowners companies?
Keith Demmings: Yes. So we definitely have still seen inflationary pressure. If we look at the Q3 results as an example, we did see higher severities year-over-year. We did see higher frequencies year-over-year. But because of the rate action that we've taken and the change with inflation guard on insured values, the premiums that we're getting more than offset those increases from a claims perspective. So I'd say that's largely why we're outperforming in this market. And obviously, our team is doing a really good job, to Richard's point, not just on the way we operate claims and the diligence that we work with, but the effort around expense efficiency. I mean if you think about Housing, we've scaled that business -- and it really is a scale business. We've scaled tremendously and our expenses -- operational expenses are flat to down for the bulk of the Housing business. And overall, done a really good job on containing G&A, simplifying and focusing and driving a lot of digital initiatives to drive efficiency. So it's a combination of 4 or 5 things that are coming together to lead to the outperformance. It's not as simple as rate. It's a lot of work across the board over the last 12 months-or-so.
Operator: [Operator Instructions]. Your next question comes from the line of John Barnidge of Piper Sandler.
John Barnidge: You talked about on the call consolidating mobile service centers to 2 areas. I believe you name check Texas and Tennessee, if I heard correctly. Both are low tax, previously low-cost states. Are there further opportunities into '24 to move businesses or operations in cheaper areas in the U.S. that you're considering?
Keith Demmings: Yes, I would say that we're not actively considering any other relocations. If you think back to when we acquired HYLA. So go back to December 2020, we acquired HYLA. HYLA had a large facility in Nashville, Tennessee, and then Assurant had a facility in New York and a facility in Texas. And as we've looked at our business model, and we always wanted to have multiple sites for redundancy, certainly in operational resilience, but trying to get back to 2 sites, feels like a strategically the right thing to do for the business. And then looking at geographies where we feel like we're really well positioned from a access to talent, from a logistics, access to clients, et cetera. So it's really more about the strategic decision here than it is purely on a cost basis. And it's trying to have scaled facilities that we can make proper investments in and then obviously get access to the talent. So that's what's driving that change. And we will be actually scaling our facility in Nashville. We're in the process of doing that work now. So we'll be building a newer, more modern and significantly larger facility to support the long-term growth of that business.
Richard Dziadzio: I'd also just -- that's exactly right. Now I'd just add to that, too, is one of the other areas we've been getting some real estate efficiency, if I can put it that way, is on our corporate real estate. We have been either downsizing some of our offices or eliminating some of the offices. And that helps us from an expense base to that overall corporate expense that we have. So that's another area that we've gotten some pretty good efficiency in, John.
John Barnidge: That's very helpful. I appreciate that. Earnings growth has been very strong. And my follow-up question, I'm not trying to get ahead of formal guidance coming in February, and I appreciate what you've offered today. But how do we think of reinsurance savings next year emerging on the book that's being run off within Global Housing, juxtaposed against what's fortunately, knock on wood, but somewhat favorable of a cat environment for you this year?
Keith Demmings: Yes. So maybe I'll just offer one thought and then Richard can speak to the process. But to your point, we've obviously had a favorable cat year to this point, significantly below last year, and we talked about a target cat load of $140 million. We're sitting at $89 million year-to-date. So obviously, that's fortunate from that perspective and we'll certainly look to those statistics as we talk to our partners heading into the renewal cycle and hopefully a little bit of a different environment than we were in last year. But Richard, maybe talk a little bit about how we're thinking about reinsurance.
Richard Dziadzio: Yes. Thanks, Keith. Yes, in terms of the reinsurance, it's a little bit early days to talk to specifically about it, but I think you hit it on the head in the question. The market has stabilized in terms of processing pricing, it has stabilized versus what it was in the last couple of years, so we're going into better market conditions. I would say we'll have a consistent approach that we've had in the last couple of years when we go into the market. And as Keith said, we're entering the market, I would say, as one of the good guys in terms of we have not gone up into our past our retention levels to the reinsurers this year for the cat reinsurance. So we walk into the meetings, we'll be there in presenting a very favorable position relative to the reinsurers, where they ended up in 2023.
Operator: Your next question comes from the line of Tommy McJoynt of KBW.
Tommy McJoynt-Griffith: I think you said, Keith said and this [indiscernible] for 2024 that you're expecting more modest growth in housing in 2024. Just want to clarify that, that is still expecting growth? And then is that in reference or I guess some terminology excluding catastrophes or including catastrophes?
Keith Demmings: Yes, great question. So we're looking at ex cat, first of all, obviously, hard to predict what cats are going to look like. But as I think about Housing in '24, I think when we suggest modest growth, there's a couple of things to remember. First of all, a phenomenal 2023. I mean this is a pretty significant recovery year, obviously, a little bit more challenged in '22, but roaring back in 2023. So we're extremely pleased about that. And of course, that trend line can't continue because it's been such a turnaround. But what I would say is we've also seen about $40 million of prior year development benefiting the P&L in 2023. But we still think we'll grow housing even though we've got to grow through that $40 million of PYD before we generate $1 of growth, we still think we'll grow Housing because of the momentum that we see and all the great work done by the team. So that's what we're trying to signal. Obviously, we'll get into the detailed forecast as we come back in February, but we do feel good about how we're positioned, right? Housing obviously is going to moderate, but we've got great trend lines sitting behind us and great momentum. And then as we saw in Lifestyle in the third quarter, although we've got challenges we're working through on the auto side, overall, we're exactly where we thought we would be. We're still signaling down modestly for the year. We are signaling growth in 2024 for Lifestyle, and we'll come back with more details, but certainly driven by the strength of the U.S. Connected Living business, which has been growing nicely for 7 or 8 years.
Richard Dziadzio: And just another addition on Housing. We will have something like $40 million of PYD going into next year. So obviously, can't count on that in the future years. So that's something we're going to need to overcome. And as Keith said, it's just a fantastic year we're having in Housing. And kind of the way I look at it, an we look at it inside is we look at it a multiyear journey. So really looking at -- last year was a bit of a tougher year. We turned the corner really quickly in terms of the uniqueness of our business, and we've talked about the inflation guard and the rates and the expense leverage that we're getting. So we are expecting it to be continued rate but at a slower pace. But again, it can -- it's not going to be like this year, it's going to be slower given all the elements that Keith and I have mentioned.
Tommy McJoynt-Griffith: Makes sense. And then, Richard, can you talk a little bit about the new money yields that you guys are getting, the duration of your investment portfolio and just how much of the tailwinds of sort of reinvesting over time could be? And then also how that allocates between potential upside for Connected Living versus Auto versus Housing, just kind of how that investment income fits within each of those?
Richard Dziadzio: Yes. Thanks, Tommy. And in fact, yields and interest rates have been a nice tailwind for us. It's helping us offset some of the inflationary issues that we've talked about, particularly in Auto, for example. So if you look at year-to-year, our investment income is up about 50% or $40 million. So a really nice number coming through. I would say, in answer to your question, that's probably think about it being maybe 1/3 Housing, 2/3 Lifestyle and in Lifestyle, the bigger component of it is in Auto. What you're seeing in this quarter is really the result of 2 things, and I've talked about it in past earnings calls, it's really -- it's coming from fixed income and fixed income yields. Our assets are up a little bit, but yields are up as that -- as those fixed income maturities roll over and we get more investment income on those, but also cash yields are really high, as you know. Who knows what's going to -- what the Fed is going to do next year. But for the moment, we're getting nice -- real high returns off the cash that we're holding. So nice sort of tailwinds to us, and that should continue as long as rates and so forth hold up. But if rates start coming down, I would say inflation is probably coming down. So we'll get some offset there, hopefully, as well.
Operator: [Operator Instructions]. Our last question comes from the line of Grace Carter of Bank of America.
Grace Carter: I guess back to the expectations for housing next year. I was wondering if we could maybe talk a little bit about the components of the growth that's expected? I mean even excluding the reserve development this quarter, the underlying loss ratio looks pretty good. And just the extent to which maybe the improvement in the loss ratio and the expense ratio [indiscernible] is sustainable or the extent to which maybe they could improve even further just as the recent pricing actions continue to earn through the book. And I guess, just kind of the expectations for the top line, given that presumably maybe some of the benefits from the inflation adjustment and things like that start to decelerate a bit next year?
Keith Demmings: Yes. No, it's a great question. And certainly, Richard can add in. But when I think about that business, and we've talked about over the long term an expected combined ratio range of 86% to 91%. If we look at where we sit on a reported basis this year looks a little bit lower, but adjusting for the prior year development, it's about 85% year-to-date with a relatively light cat year so far in terms of the P&L. So we're relatively close to that range today, which is good. Obviously, we think that's an appropriate long-term range for the business. We do think rate will continue to come through. But as we've said, at a more moderated pace as we have less of that double-digit AIV earning through and then it obviously comes through at just over 3% going forward, let's call it a more normalized level. I think policy count is relatively stable. But we do think we're well positioned. If you think about industry consolidation and think about the clients that we operate with, we partner with a lot of major players in the space. And hopefully, as the market dynamics move around, there could be some opportunity for us to continue to grow policies over time. So I do think it will be just a moderated trend line from what we saw this year, but certainly still expect strong results in Housing and hence, overcoming the $40 million of prior year development. But Richard, what else might you add?
Richard Dziadzio: Yes. I think that, I guess, I would also say that, Grace, when we look at the combined operating ratio, something we keep our eye on. So really a combination of everything we're getting. We've talked about the top line growth, and that would be tapering the expense ratio, we're in a good place with that. I think that could continue, maybe not as low as it is now because we'll always have -- maybe some -- have some investments and so forth. But we're in a good place there. The loss ratio think about 40%, 42% maybe full year, that kind of thing. But even then, it's going to depend on what weather we're going to get. What's the severity, what's the frequency, what are the storms, the convective storms that we had in the spring time. So obviously, that's something that's hard to call. But if we talk about the combined ratio at 86% to 91% with cat, that's probably something that we look to and say, on a normal cat year, we'd probably be in and around that range, if that's helpful.
Grace Carter: Yes, that's helpful. And I guess on the Renters book. We've heard some personal auto players this quarter say that they're starting to see severity trends maybe flatten out a bit. And I was just curious on the affinity partners aspect of that business, if you all are seeing any green shoots there or when that might inflect back to strong growth.
Keith Demmings: Yes. I think we're seeing maybe early signs of modest improvement there. I'd say it's probably too early to call it, Grace. But definitely, when we look at Renters, really strong performance, and we've signaled this over the last few years in the property management channel. So certainly diversifying our portfolio between affinity and property management, and we actually grew our PMC in the third quarter this year more than we grew it all of 2022. So the team has done an incredible job adding clients, driving attach and leveraging our Cover360 platform. And then to your point, should we start to see an acceleration in marketing relative to auto insurers, then that could certainly provide upside opportunity over time? I'd say it's too early to suggest that we're seeing firm trends, but definitely feel like there's opportunity there as we look forward and certainly in '24. Okay. I think that was the last question. So thank you, everybody, for joining the call. We'll certainly look forward to reconnecting in February. And as always, if you have questions, please reach out to Suzanne or Sean, and we'll get back in touch. Thanks so much.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Third Quarter 2023 Conference Call and Webcast. [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our third quarter 2023 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the third quarter of 2023. The release and corresponding financial supplements are available on assurant.com. We'll start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release and financial supplement as well as in our SEC reports. During today's call, we will refer to our non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday's news release and financial supplements. It is now my pleasure to turn the call over to Keith."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Suzanne, and good morning, everyone. We're very pleased with the exceptionally strong results we achieved in the third quarter with adjusted EBITDA, excluding catastrophes, growing nearly 50% year-over-year or 19% on a year-to-date basis, both ahead of our expectations. Our results were largely driven by continued momentum in Global Housing and our steadfast focus on executing our strategy, including driving innovation, creating efficiencies and strengthening our global partnerships. These efforts have positioned us to exceed our previous expectations of high single-digit adjusted EBITDA growth, excluding catastrophes. We now expect adjusted EBITDA growth of mid- to high-teens. Our year-to-date performance highlights Assurant's competitive differentiators, including our advantaged Global Housing and Global Lifestyle businesses that have proven leadership positions with scale and significant cash generation. Combined, these businesses are extending Assurant's track record of strong financial performance, thanks in part to the swift actions we've taken across our global operations to improve results and strengthen the business given broader macroeconomic headwinds. We continue to realize benefits from the actions we announced in 2022 to simplify our business and corporate real estate and realign our organizational structure, allowing us to reinvest throughout the enterprise. We extended our 2022 restructuring plan to include additional actions across the enterprise as we believe further enhancing Assurant's operational efficiency will support our long-term profitable growth and value creation. We now expect total restructuring costs associated with our extended plan to be between $90 million and $95 million pretax, above our previously announced expectations of $60 million to $65 million. Looking at our business segments. In Global Housing, I want to thank all of our employees who supported policyholders impacted by Hurricane Idalia and the Hawaii wildfires, as well as several other significant weather events during the quarter. Assurant plays a critical role in safeguarding our policyholders and supporting the U.S. mortgage industry. Our Global Housing adjusted EBITDA, excluding cats, more than doubled year-over-year and increased 72% year-to-date, led by significant growth in our homeowners business through top line growth and improving loss experience. Our ability to quickly execute changes, particularly in our lender-placed business, has helped us gain earnings momentum from higher in-force policies, average insured values and state-approved rate increases following inflation impacts in 2022. Our performance so far this year highlights Global Housing's compelling and uniquely positioned portfolio. Year-to-date, including $89 million of reportable catastrophes, our combined ratio is 82% and our annualized ROE is 29%, demonstrating strong returns and cash generation. In our Renters business, we saw continued strength in our property management channel, where policies in-force have grown double digits this year. We continue to win new clients, grow existing partnerships and release new capabilities, including our upgraded leasing agent portal and digital insurance tracking enhancements. We're very pleased with Global Housing's strong performance year-to-date, which reflects our focused execution around streamlined product lines where we have a clear competitive advantage and scale. Turning to Global Lifestyle. Third quarter earnings increased 7% year-over-year or 14% excluding a onetime client benefit within Connected Living last year. Year-to-date adjusted EBITDA down 6% versus the same period in '22 has continued to improve throughout the year and is tracking in line with our expectations of a modest decline for the full year. Within Connected Living, we continue to support long-term growth through the development of innovative offerings for our partners. U.S. Connected Living is poised for another year of solid growth, particularly within our mobile protection business, a testament to our breadth of innovative offerings, customer experience expertise and deep relationships with mobile carriers and cable operators. As macroeconomic headwinds have persisted, including impacts from inflation, we've taken decisive action across our global operations to mitigate these impacts. In Europe, expense actions have allowed us to stabilize earnings as we focus on critical opportunities to grow our top line. We also continue to invest to advance product innovation and anticipate our clients' needs as well as improve customer experience through expanded service delivery capabilities. For example, as part of the extension of our '22 plan to realize benefits and simplify our business in corporate real estate, we're consolidating our mobile device care centers into 2 sites in the U.S. We'll move the services currently offered in York, Pennsylvania to our existing facility in Texas. Over time, we'll be investing in a new site in Nashville, where we can leverage a strong talent market and greater logistics efficiencies as we evolve with emerging clients. Turning to our Global Auto business. We're beginning to see initial signs of claims improvement, as a result of the decisive actions taken over the last year to improve performance. These actions included implementing rate increases on new policies across impacted clients and advancing opportunities to improve loss experience for programs where we hold the risk. We continue to monitor claims costs closely and expect improvement will be gradual over time given the way the auto business earns. In auto, we launched Assurant Vehicle Care at over 500 dealers. Building on decades of proprietary data on cost of claims, Assurant Vehicle Care is a comprehensive new suite of vehicle protection products. It was developed to help our dealer partners optimize product design, pricing, training and sales to ultimately enhance attachment and economics. For the consumer, Assurant Vehicle Care provides a digital experience with more vehicle coverage, flexibility and transparency. Now let's turn to our enterprise outlook and capital. Given our year-to-date results and our business outlook for the remainder of 2023, we now expect adjusted EBITDA to grow mid- to high-teens, excluding catastrophes. Adjusted EPS growth is now expected to exceed adjusted EBITDA growth, each excluding catastrophes. This is primarily due to higher earnings growth that now more than offsets the increase in depreciation expense. From a capital perspective, we upstreamed $202 million of segment dividends during the third quarter and $493 million year-to-date. We ended the third quarter with $491 million of holding company liquidity consistent with the end of the second quarter. In terms of share repurchases, during the third quarter, repurchases totaled $50 million. This brings our total repurchases to approximately $100 million for the year, including an additional $30 million of shares purchased through the end of October. Based on our strong year-to-date results, we expect fourth quarter buybacks to accelerate from third quarter levels and to be approximately $200 million for the year, consistent with our underlying repurchase activity in 2022. We're pleased with our strong capital position, which affords us more long-term flexibility over time. Looking to 2024, we expect a more modest level of earnings growth in Global Housing, excluding catastrophes, building on strong 2023 financial results, which included $40 million of favorable prior year reserve development. In Global Lifestyle, we expect earnings growth to be led by Connected Living, particularly in the U.S. from the expansion of current programs, as we work to gradually improve the auto business, which we will continue to manage closely. From a capital perspective, we're committed to maintaining flexibility for our strong balance sheet and deploying capital for share repurchases and opportunistic acquisitions to support our growth objectives. We will share our 2024 outlook in February, factoring in our fourth quarter earnings, business trends as well as the latest forecast of the macro environment for the year. In the near term, we're focused on achieving our 2023 objectives and setting a path for continued growth and value creation in 2024 and beyond. As we look ahead, we remain committed to execution, innovation and enhancing the customer experience for our clients and their end consumers, particularly as we look to capitalize on growth opportunities while supporting continued momentum. Before I turn the call over to Richard to review the third quarter results and our 2023 outlook in greater detail. I want to once again thank our employees for their hard work and dedication to deliver for our clients. Our company was recently recognized as one of TIME's best companies in the world, highlighting Assurant's strong employee satisfaction, revenue growth and sustainability efforts. Assurant was also recognized by Newsweek as one of America's greatest companies. Demonstrating our commitment to and progress in operating more sustainably. The recognition was timely as we recently introduced Carbon IQ by Assurant. This offering enables clients to see the carbon impact of each device, including new and refurbished devices and provides them with estimated CO2 emissions throughout the supply chain and life cycle to identify opportunities for reduction. We're honored to be recognized for our outstanding culture, products and sustainability all of which help us better serve our clients. And now over to Richard."
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith, and good morning, everyone. For the third quarter of 2023, adjusted EBITDA, excluding reportable catastrophes, totaled $357 million, up $118 million or nearly 50% year-over-year. Adjusted earnings per share, excluding reportable catastrophes, totaled $4.68 for the quarter, delivering year-over-year growth of 67%. To review results in greater detail, let's start with Global Lifestyle. The segment reported adjusted EBITDA of $192 million in the third quarter, an increase of $12 million or 7% year-over-year. As a reminder, prior period results included a onetime client benefit of $11 million within Connected Living. Excluding the prior period gain, Global Lifestyle's adjusted EBITDA increased 14% or $24 million. This increase was primarily driven by higher contributions from investment income and mobile growth. Connected Living earnings increased $30 million or 32% excluding the onetime client benefit, demonstrating strong mobile growth from North American device protection programs from carrier and cable operator clients and better trade-in performance. Financial Services also contributed to the growth. Trading results benefited from improved margins related to higher sales prices for used devices, partially offset by lower volumes, impacted by the timing and structure of carrier promotions. In Europe, we stabilized performance through expense actions, mitigating the impact of headwinds that began in the second half of 2022. In Japan, results were impacted by subscriber decline which is expected to continue into 2024. Global Auto adjusted EBITDA declined $6 million or 8%. Results continue to be impacted by inflation of labor and parts leading to higher average claims costs. As expected, claims experience for auto ancillary products has also contributed to higher incurred claims costs in the quarter. The auto earnings decline was partially offset by an increase in investment income from higher yields and asset values. Turning to net earned premiums, fees and other income. Lifestyle was up by $83 million or 4%. This growth was primarily driven by Global Automotive, reflecting an increase of 6% from prior period sales of vehicle service contracts. Connected Living's net earned premiums, fees and other income increased 3%. Growth was muted by the previously disclosed mobile program contract changes of approximately $55 million with no corresponding impact to profitability. Excluding the impact of these contract changes, Connected Living's net earned premiums, fees and other income grew by 8%. The quarter benefited from higher prices on used mobile devices and modest growth in North America mobile subscribers, excluding ongoing client runoff. Turning to the full year 2023. We continue to expect Lifestyle's adjusted EBITDA to decline modestly. Global Auto will be down for the full year from unfavorable loss experience, including the impacts from continued normalization for select ancillary products previously mentioned. We've taken decisive actions this year in response to higher claims experience in our auto book, including prospective rate increases and repair cost reduction. While we've seen some improvement, the improvement is expected to take place over a longer period of time given the earnings pattern of the business. In Connected Living, we expect our U.S. business to grow for the full year. Overall, we are pleased with Lifestyle's strong third quarter performance, especially in light of ongoing challenges in auto claims. For the fourth quarter, we expect higher trade-in volumes in mobile, but we also expect ongoing top line challenges in Japan and Europe and investments to support business growth. In terms of full year net earned premiums, fees and other income, Lifestyle is expected to grow consistent with year-to-date trends. Moving to Global Housing. Adjusted EBITDA was $165 million, which included $26 million in reportable catastrophes, primarily from Hurricane Idalia and Hawaii wildfires. Excluding reportable catastrophes, adjusted EBITDA more than doubled to $191 million, with an increase of $106 million. Housing performance was mainly led by 3 main items: First, continued top line growth in homeowners from higher premium rates and average insured values in lender-placed as well as an increase in the number of in-force policies. Second, favorable non-cat loss experience across the segment, including a year-over-year positive impact of $39 million related to prior period reserve development. This was comprised of $15 million of reserve reductions in the current quarter compared to reserve strengthening of $24 million in the prior period. And lastly, additional scale within our homeowners expense base ultimately driving stronger operating leverage. Higher investment income also contributed to earnings growth for homeowners. For Renters and Others, earnings grew modestly from favorable prior period reserve development. Growth within the property management channel was offset by softer affinity channel volumes. For the full year 2023, we expect Global Housing adjusted EBITDA, excluding reportable cats, to grow significantly due to the strong homeowners performance, driven by top line expansion in lender-placed and favorable non-cat loss experience. In the fourth quarter, we expect higher expenses to support business growth. In addition, the third quarter included $15 million of favorable prior period development. Moving to corporate. The third quarter adjusted EBITDA loss was $26 million, representing a modest year-over-year increase, mainly related to higher employee expenses. For the full year 2023, we continue to expect the corporate adjusted EBITDA loss to approximate $105 million. Turning to holding company liquidity. We ended the quarter with $491 million and dividends from our operating segments totaled $202 million. In addition to cash used for corporate and interest expenses, third quarter cash outflows included 3 items, $50 million of share repurchases, $37 million for common stock dividends and $50 million to complete the repayment of our September 2023 notes. As Keith mentioned, given our year-to-date performance and outlook for the year as well as the strength of Assurant's balance sheet, we expect to achieve full year share repurchases of approximately $200 million. For the full year, we continue to expect our businesses to generate meaningful cash flows, approximating 65% of segment adjusted EBITDA, including reportable catastrophes. Cash flow expectations assume a continuation of the current economic environment and are subject to the growth of the businesses, investment portfolio performance and rating agency and regulatory requirements. In closing, through the resilience of our unique business model, the decisive management actions taken and our intense client focus, we are confident in our ability to achieve the higher full year objectives we have outlined today. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Your first question is coming from the line of Mark Hughes of Truist."
},
{
"speaker": "Mark Hughes",
"text": "Keith, Richard, I really like this housing business, and I'm glad you didn't listen to those people who said you should divest it. Little [indiscernible]. On the housing business, increased policy count, how much of that is coming from, say, voluntary versus some uptick perhaps in the delinquencies or foreclosures or REO?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I'd say, first of all, yes, we're pretty excited about the results in housing and it's tremendous amount of work by the team in the last year, and it's really showing through here the last few quarters, and we're building a lot of momentum. I would say very little of the policy growth relates to the underlying economy or REO at all. We're really seeing no change in placement rate based on economic conditions, maybe a little bit of increase in policy count in a state like California, I'd say very modest, but a bit of a harder market. So we're seeing a little bit of growth there. Florida, basically flat year-to-date. So most of the growth is clients and client loan-related mix and nothing yet in terms of the broader economy."
},
{
"speaker": "Mark Hughes",
"text": "What's your sense of the opportunity for sustained momentum, say, in higher values or higher rate? Has that activity peaked perhaps? Or is there still some way to go on both those fronts?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I mean, obviously, we work on rates related to that product line consistently state by state. We also have, as you know, the average insured value adjustment that we do in the summer every year. And obviously, last summer, we put a meaningful double-digit increase into average insured values. This year, it was just over 3%, 3.1% that went into July. And then state by state, based on historical performance and expected costs, we continue to work with states. I feel like we still have momentum running through the portfolio. We haven't -- certainly haven't topped out in terms of the impact from the rate adjustments. But we do see it tapering and slowing. Certainly, as we think about Q4 as we head into 2024. But year-to-date, feel good with where our loss ratios sit. In housing, we're 42% non-cat loss ratio if you adjust for prior period development, very consistent with where we were last year. So we feel like the rates that we have are certainly appropriate. And as we see impacts on cost of claims will modify as we go forward."
},
{
"speaker": "Mark Hughes",
"text": "Then one final one. Your fee income was up in Lifestyle, your devices service were down 20%-plus. I think you mentioned the higher value per device. Anything else contributing to that, just the divergence between the fee income and the device fee service?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So if we think about that year-over-year, certainly, volumes are down. We saw softer promotional activity in the third quarter, not out of alignment with what we expected. We did see a pickup in the back half of September, obviously, after new product introduction by Apple. So hopefully, that sets us up with what we'd expect in the fourth quarter to be an improvement there. And as I look at that business, we've done a really nice job in driving operational efficiency and automation to continue to improve the efficiency with which we operate. And then as you said, we've gotten higher sale prices when we're selling devices and obviously, we derive revenue based on how well we sell devices in the secondary market. But I'd say there's not much else to report. Profitability, a little bit stronger. But if you'll remember, third quarter last year, we had a bit of a mismatch between expenses and revenue. So Q3 trading results were a little bit depressed last year."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Jeff Schmitt of William Blair."
},
{
"speaker": "Jeffrey Schmitt",
"text": "Back to growth in Global Housing. So PFO growth was 23% in the quarter. And I'm just trying to think through the components. You had mentioned inflation guard was 3%, I think, in June or July, but I guess 12% last year. So maybe kind of a mix there earning through. What's rate at? How much was the rate component? And how much was the unit growth component? I'm just trying to think of the different parts there."
},
{
"speaker": "Keith Demmings",
"text": "Yes. So maybe I can start and then certainly, Richard can jump in. Obviously, when you look at Housing's revenue year-over-year, it's up meaningfully, $100 million, $103 million year-over-year. All of that is from growth in homeowners, which is up 31% year-over-year in terms of revenue. If we think about what's driving the performance from an underlying EBITDA perspective and Richard obviously talked about the prior period development. If you adjust the development, $15 million this year against adverse development last year of '24, we still see a $67 million increase in our underlying EBITDA. And I would say 2/3 of that is really driven by rates average insured values, which obviously play together, and then relatively stable losses related to higher levels of premium rolling through. And then the balance, maybe 1/3 is split between policy growth, which is up 3.5% year-over-year and then investment income, which is obviously helping with cash yields and more assets being held. But Richard, happy to have you add any other detail."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, sure. Yes, that's exact. And I guess I would add, by the way, good morning Jeff, what I would add is that if you just look at the premium component that Keith just talked about, think about it generally as being 1/3 for each of the components that we've just discussed. It's the increase in rates, average insured values and inflation guard. That's sort of the way to look at it. And the other thing, too, that I would mention is you see -- you heard Keith talk about how much drops to the bottom line. I think that's also a credit to the expense discipline that we've had and the leverage we're getting, and you can see that coming out in the expense ratios that the growth in the premiums and the leverage that we have in the business is really allowing us to increase the bottom line."
},
{
"speaker": "Jeffrey Schmitt",
"text": "Got it. Very helpful. And then in Global Lifestyle, just looking at that benefit ratio kind of continue to move up. Despite rate increases, it was 23% in the quarter, mainly driven by auto, it sounds like. Could you maybe just discuss the pricing strategy there? Like when does that begin? What level of pricing can you get in this market? Really, any detail on that would be helpful."
},
{
"speaker": "Keith Demmings",
"text": "Yes, I can certainly start, Richard. So if I think about the auto business, I'm actually pleased with the work done by our team. So we started making adjustments to rate late last year. So we've probably been in about a 12-month cycle, making adjustments with clients. We're really on the risk in a meaningful way for 4 or 5 different programs. So it's not the bulk of our business, as we've talked about before. Most of that business is reinsured. So there's a handful of clients that we're working with very closely. And we put rate in place that we feel is appropriate to get the business to perform at the levels that are expected. So that work has been done. It's been ongoing for the last 4 quarters or so feel good about the adjustments we've made. We've had incredible discussions with our clients to try to get the programs to the right level of profitability. We've also been working incredibly hard, not just on rate, but on the claims adjudication process, how we're acquiring parts, how we're thinking about repairs and which repair shops to use when the options are available to us to drive more efficiency, and a lot of diligence end-to-end and very much in partnership with the clients. So as we look at the results in the quarter, certainly seeing a similar pattern to what we saw in Q2. But the good news is we've seen relative stability. The cost of severity on the auto side is up a little bit in Q3 over Q2, but the premium earning through is also up, and we're seeing a modest improvement in the underlying loss ratio when we look at the risk clients. So I feel like we're doing the right things. It's going to take time, certainly, to earn through. But early signs of good momentum at least in starting to stabilize as we look to bend the curve. But Richard, certainly anything else you want to add?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, I think that's exactly right. And in our prepared remarks, we basically talked about it will take some time. The claims adjudication work we're doing and the teams are doing a fantastic job, that's helping us today bend the curve a little bit. We've been able to get rate, which is fantastic. But it's going to take time because we've sold what we've sold in the past, and that's going to run through and then the new rates and the new premiums we're getting, that will come through and help us bend the curve as we go in the future, but it will take some time."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Brian Meredith of UBS."
},
{
"speaker": "Brian Meredith",
"text": "Could you talk a little bit about what's going on in Japan and maybe when we might see a flip there from a growth perspective? I know you said you'll still see some pressures in 2024, and I know you've got the new contracts that are going in. When do we see that flip? I would have thought that was going to be a nice little tailwind for growth in '24."
},
{
"speaker": "Keith Demmings",
"text": "Yes, sure. We start at the highest level with Japan, I mean -- and I've talked about this before, and hopefully, this comes through. I mean this is a really, really critical market for Assurant. It's a tremendous mobile marketplace. It's the second largest in the world after the U.S. And I do think we are well positioned for long-term growth. That's the fundamental point. We're doing a lot of investing in the market, investing in not just capabilities but also talent. And we're in a really fortunate position today in that we have relationships with every major operator in the marketplace. We don't do all things for all operators, but we've got access, we've got deep relationships. And I think over time, that will bear fruit. I would say, as we think about exiting 2023, we're certainly stabilizing the financial performance in Japan. We've seen some subscriber runoff as we've talked about in the past. I expect that to continue to decelerate into '24. And we do think we'll grow EBITDA in Japan year-over-year, '24 over '23. So I'm really pleased with the hard work that the teams are doing and how we're positioned in the market. But that market is about what is it going to look like in 5 years? And how do we unlock the full potential of what I think we can achieve in that market."
},
{
"speaker": "Brian Meredith",
"text": "Do you have like a percentage you can give us of how much of the Japanese business is now on a perpetual policy versus, I guess, it was a 4-year policy is what they were?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So the 4-year policies continue to run down. Certainly, the majority of the business is on an evergreen policy. A 100% of the business that is sold today is on an evergreen policy, but certainly, the vast majority."
},
{
"speaker": "Brian Meredith",
"text": "Got you. And then second question, just going back to Global Housing. I'm just curious, what are you seeing right now from an inflationary perspective in that business, right? It sounds like it's pretty modest given what your loss ratios are pretty good. But if I look at some of the other homeowners insurance companies, they're still seeing a fair amount of inflationary pressure there. And maybe you can pivot that into maybe your business is a little bit different, and you've got better ways to control those that inflation than maybe some of the traditional homeowners companies?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So we definitely have still seen inflationary pressure. If we look at the Q3 results as an example, we did see higher severities year-over-year. We did see higher frequencies year-over-year. But because of the rate action that we've taken and the change with inflation guard on insured values, the premiums that we're getting more than offset those increases from a claims perspective. So I'd say that's largely why we're outperforming in this market. And obviously, our team is doing a really good job, to Richard's point, not just on the way we operate claims and the diligence that we work with, but the effort around expense efficiency. I mean if you think about Housing, we've scaled that business -- and it really is a scale business. We've scaled tremendously and our expenses -- operational expenses are flat to down for the bulk of the Housing business. And overall, done a really good job on containing G&A, simplifying and focusing and driving a lot of digital initiatives to drive efficiency. So it's a combination of 4 or 5 things that are coming together to lead to the outperformance. It's not as simple as rate. It's a lot of work across the board over the last 12 months-or-so."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Your next question comes from the line of John Barnidge of Piper Sandler."
},
{
"speaker": "John Barnidge",
"text": "You talked about on the call consolidating mobile service centers to 2 areas. I believe you name check Texas and Tennessee, if I heard correctly. Both are low tax, previously low-cost states. Are there further opportunities into '24 to move businesses or operations in cheaper areas in the U.S. that you're considering?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I would say that we're not actively considering any other relocations. If you think back to when we acquired HYLA. So go back to December 2020, we acquired HYLA. HYLA had a large facility in Nashville, Tennessee, and then Assurant had a facility in New York and a facility in Texas. And as we've looked at our business model, and we always wanted to have multiple sites for redundancy, certainly in operational resilience, but trying to get back to 2 sites, feels like a strategically the right thing to do for the business. And then looking at geographies where we feel like we're really well positioned from a access to talent, from a logistics, access to clients, et cetera. So it's really more about the strategic decision here than it is purely on a cost basis. And it's trying to have scaled facilities that we can make proper investments in and then obviously get access to the talent. So that's what's driving that change. And we will be actually scaling our facility in Nashville. We're in the process of doing that work now. So we'll be building a newer, more modern and significantly larger facility to support the long-term growth of that business."
},
{
"speaker": "Richard Dziadzio",
"text": "I'd also just -- that's exactly right. Now I'd just add to that, too, is one of the other areas we've been getting some real estate efficiency, if I can put it that way, is on our corporate real estate. We have been either downsizing some of our offices or eliminating some of the offices. And that helps us from an expense base to that overall corporate expense that we have. So that's another area that we've gotten some pretty good efficiency in, John."
},
{
"speaker": "John Barnidge",
"text": "That's very helpful. I appreciate that. Earnings growth has been very strong. And my follow-up question, I'm not trying to get ahead of formal guidance coming in February, and I appreciate what you've offered today. But how do we think of reinsurance savings next year emerging on the book that's being run off within Global Housing, juxtaposed against what's fortunately, knock on wood, but somewhat favorable of a cat environment for you this year?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So maybe I'll just offer one thought and then Richard can speak to the process. But to your point, we've obviously had a favorable cat year to this point, significantly below last year, and we talked about a target cat load of $140 million. We're sitting at $89 million year-to-date. So obviously, that's fortunate from that perspective and we'll certainly look to those statistics as we talk to our partners heading into the renewal cycle and hopefully a little bit of a different environment than we were in last year. But Richard, maybe talk a little bit about how we're thinking about reinsurance."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Thanks, Keith. Yes, in terms of the reinsurance, it's a little bit early days to talk to specifically about it, but I think you hit it on the head in the question. The market has stabilized in terms of processing pricing, it has stabilized versus what it was in the last couple of years, so we're going into better market conditions. I would say we'll have a consistent approach that we've had in the last couple of years when we go into the market. And as Keith said, we're entering the market, I would say, as one of the good guys in terms of we have not gone up into our past our retention levels to the reinsurers this year for the cat reinsurance. So we walk into the meetings, we'll be there in presenting a very favorable position relative to the reinsurers, where they ended up in 2023."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Tommy McJoynt of KBW."
},
{
"speaker": "Tommy McJoynt-Griffith",
"text": "I think you said, Keith said and this [indiscernible] for 2024 that you're expecting more modest growth in housing in 2024. Just want to clarify that, that is still expecting growth? And then is that in reference or I guess some terminology excluding catastrophes or including catastrophes?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, great question. So we're looking at ex cat, first of all, obviously, hard to predict what cats are going to look like. But as I think about Housing in '24, I think when we suggest modest growth, there's a couple of things to remember. First of all, a phenomenal 2023. I mean this is a pretty significant recovery year, obviously, a little bit more challenged in '22, but roaring back in 2023. So we're extremely pleased about that. And of course, that trend line can't continue because it's been such a turnaround. But what I would say is we've also seen about $40 million of prior year development benefiting the P&L in 2023. But we still think we'll grow housing even though we've got to grow through that $40 million of PYD before we generate $1 of growth, we still think we'll grow Housing because of the momentum that we see and all the great work done by the team. So that's what we're trying to signal. Obviously, we'll get into the detailed forecast as we come back in February, but we do feel good about how we're positioned, right? Housing obviously is going to moderate, but we've got great trend lines sitting behind us and great momentum. And then as we saw in Lifestyle in the third quarter, although we've got challenges we're working through on the auto side, overall, we're exactly where we thought we would be. We're still signaling down modestly for the year. We are signaling growth in 2024 for Lifestyle, and we'll come back with more details, but certainly driven by the strength of the U.S. Connected Living business, which has been growing nicely for 7 or 8 years."
},
{
"speaker": "Richard Dziadzio",
"text": "And just another addition on Housing. We will have something like $40 million of PYD going into next year. So obviously, can't count on that in the future years. So that's something we're going to need to overcome. And as Keith said, it's just a fantastic year we're having in Housing. And kind of the way I look at it, an we look at it inside is we look at it a multiyear journey. So really looking at -- last year was a bit of a tougher year. We turned the corner really quickly in terms of the uniqueness of our business, and we've talked about the inflation guard and the rates and the expense leverage that we're getting. So we are expecting it to be continued rate but at a slower pace. But again, it can -- it's not going to be like this year, it's going to be slower given all the elements that Keith and I have mentioned."
},
{
"speaker": "Tommy McJoynt-Griffith",
"text": "Makes sense. And then, Richard, can you talk a little bit about the new money yields that you guys are getting, the duration of your investment portfolio and just how much of the tailwinds of sort of reinvesting over time could be? And then also how that allocates between potential upside for Connected Living versus Auto versus Housing, just kind of how that investment income fits within each of those?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. Thanks, Tommy. And in fact, yields and interest rates have been a nice tailwind for us. It's helping us offset some of the inflationary issues that we've talked about, particularly in Auto, for example. So if you look at year-to-year, our investment income is up about 50% or $40 million. So a really nice number coming through. I would say, in answer to your question, that's probably think about it being maybe 1/3 Housing, 2/3 Lifestyle and in Lifestyle, the bigger component of it is in Auto. What you're seeing in this quarter is really the result of 2 things, and I've talked about it in past earnings calls, it's really -- it's coming from fixed income and fixed income yields. Our assets are up a little bit, but yields are up as that -- as those fixed income maturities roll over and we get more investment income on those, but also cash yields are really high, as you know. Who knows what's going to -- what the Fed is going to do next year. But for the moment, we're getting nice -- real high returns off the cash that we're holding. So nice sort of tailwinds to us, and that should continue as long as rates and so forth hold up. But if rates start coming down, I would say inflation is probably coming down. So we'll get some offset there, hopefully, as well."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our last question comes from the line of Grace Carter of Bank of America."
},
{
"speaker": "Grace Carter",
"text": "I guess back to the expectations for housing next year. I was wondering if we could maybe talk a little bit about the components of the growth that's expected? I mean even excluding the reserve development this quarter, the underlying loss ratio looks pretty good. And just the extent to which maybe the improvement in the loss ratio and the expense ratio [indiscernible] is sustainable or the extent to which maybe they could improve even further just as the recent pricing actions continue to earn through the book. And I guess, just kind of the expectations for the top line, given that presumably maybe some of the benefits from the inflation adjustment and things like that start to decelerate a bit next year?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. No, it's a great question. And certainly, Richard can add in. But when I think about that business, and we've talked about over the long term an expected combined ratio range of 86% to 91%. If we look at where we sit on a reported basis this year looks a little bit lower, but adjusting for the prior year development, it's about 85% year-to-date with a relatively light cat year so far in terms of the P&L. So we're relatively close to that range today, which is good. Obviously, we think that's an appropriate long-term range for the business. We do think rate will continue to come through. But as we've said, at a more moderated pace as we have less of that double-digit AIV earning through and then it obviously comes through at just over 3% going forward, let's call it a more normalized level. I think policy count is relatively stable. But we do think we're well positioned. If you think about industry consolidation and think about the clients that we operate with, we partner with a lot of major players in the space. And hopefully, as the market dynamics move around, there could be some opportunity for us to continue to grow policies over time. So I do think it will be just a moderated trend line from what we saw this year, but certainly still expect strong results in Housing and hence, overcoming the $40 million of prior year development. But Richard, what else might you add?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. I think that, I guess, I would also say that, Grace, when we look at the combined operating ratio, something we keep our eye on. So really a combination of everything we're getting. We've talked about the top line growth, and that would be tapering the expense ratio, we're in a good place with that. I think that could continue, maybe not as low as it is now because we'll always have -- maybe some -- have some investments and so forth. But we're in a good place there. The loss ratio think about 40%, 42% maybe full year, that kind of thing. But even then, it's going to depend on what weather we're going to get. What's the severity, what's the frequency, what are the storms, the convective storms that we had in the spring time. So obviously, that's something that's hard to call. But if we talk about the combined ratio at 86% to 91% with cat, that's probably something that we look to and say, on a normal cat year, we'd probably be in and around that range, if that's helpful."
},
{
"speaker": "Grace Carter",
"text": "Yes, that's helpful. And I guess on the Renters book. We've heard some personal auto players this quarter say that they're starting to see severity trends maybe flatten out a bit. And I was just curious on the affinity partners aspect of that business, if you all are seeing any green shoots there or when that might inflect back to strong growth."
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think we're seeing maybe early signs of modest improvement there. I'd say it's probably too early to call it, Grace. But definitely, when we look at Renters, really strong performance, and we've signaled this over the last few years in the property management channel. So certainly diversifying our portfolio between affinity and property management, and we actually grew our PMC in the third quarter this year more than we grew it all of 2022. So the team has done an incredible job adding clients, driving attach and leveraging our Cover360 platform. And then to your point, should we start to see an acceleration in marketing relative to auto insurers, then that could certainly provide upside opportunity over time? I'd say it's too early to suggest that we're seeing firm trends, but definitely feel like there's opportunity there as we look forward and certainly in '24. Okay. I think that was the last question. So thank you, everybody, for joining the call. We'll certainly look forward to reconnecting in February. And as always, if you have questions, please reach out to Suzanne or Sean, and we'll get back in touch. Thanks so much."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 2 | 2,023 | 2023-08-02 08:00:00 | Operator: Welcome to Assurant's Second Quarter 2023 Conference Call and Webcast. [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2023 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the second quarter of 2023. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release and financial supplement as well as in our SEC reports. During today's call, we will refer to our non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday's news release and financial supplement. I will now turn the call over to Keith.
Keith Demmings: Thanks, Suzanne, and good morning, everyone. Our results in the second quarter were strong and well ahead of our expectations with adjusted EBITDA, excluding cats, growing 21% year-over-year or a total of 6% on a year-to-date basis. Results were largely driven by continued momentum in Global Housing, primarily from higher top line growth and more favorable loss experience from prior period development on claims. Our performance is a testament to the resilience of our global business model, our compelling client offerings and steadfast focus on operational excellence. Looking at our business segments. Global Housing adjusted EBITDA increased 49% year-to-date, excluding catastrophes. These results reflect actions taken to transform our Housing business, including focusing on product lines where we have a strong right to win, dramatically reducing noncore areas and our international catastrophe exposure and aggressively deploying digital solutions to improve customer experience while driving greater operational efficiencies. This underscores our ability to quickly respond to ever-evolving market dynamics driving continuous improvement and better performance over time. During the first half of 2023, top line performance in our Homeowners business increased 18% year-over-year. This reflects higher average insured values and state-approved rate increases to account for higher claim severities from inflationary factors in lender-placed. Policy counts increased double digits this year from expanded loan portfolios of new and existing clients. While policy growth has been a contributor so far this year, we expect to level off from the first half of the year. In our Renters business, our property management company distribution channel has shown strong policy growth year-to-date, increasing 14%. This has been driven by the ongoing rollout of our Cover360 solution, one of the many long-term investments we've made in renters that has consistently added value to our PMC partners and customers over the last several years. Our strong growth within the PMC channel has helped to diversify profit pools to partially offset lower contributions from our affinity partners, along with higher non-cat losses, which have returned to more normalized levels. In summary, we're very pleased with Global Housing's performance year-to-date and expect strong year-over-year earnings growth to continue into the second half of 2023. Turning to Global Lifestyle. Underlying segment results were solid and demonstrated steady improvement from the second half of last year. Lifestyle earnings for the first 6 months of the year have increased $34 million or 9% over the second half of last year, from improved Connected Living results. Within Connected Living, we continue to invest in our technology platforms as we deepen our focus on product innovation and evolving our service delivery capabilities to improve customer experience. Our focus on innovation and global trade-in capabilities has continued to drive a significant level of interest from existing and prospective mobile partners. As we continue to realize ongoing efficiencies, we've implemented actions to mitigate macroeconomic headwinds throughout our global operations. In Europe, these actions have had a positive impact, ultimately helping to stabilize earnings and allowing us to remain focused on growing the top line. Within extended service contracts, we've made significant progress with our partners in executing large-scale protection and administration programs. In addition, after several quarters of elevated claim severity, we've seen an improvement in the second quarter loss ratio due to rate increases with several clients. In our Global Auto business, consistent across the industry, our repair costs have continued to increase from inflation. We've taken decisive actions to improve performance. For example, we've implemented prospective rate increases with several key clients, and we're also partnering with our clients to identify cost savings on claims to improve loss experience for programs where we hold the risk. It's difficult to predict the timing of an earnings inflection point, but we expect to see continued improvements as new business earned through although improvement may take several quarters to materialize. Overall, Global Lifestyle earnings were in line with our expectations for the first half of 2023. And while we work to create new vectors of growth for Lifestyle, we now anticipate Global Lifestyle's adjusted EBITDA will be down modestly for the full year. This is mainly due to the headwinds in Global Auto we just discussed and lower international contributions primarily from Japan. Reflecting on the first half of 2023, our results have demonstrated the attractiveness of our compelling business model with clear competitive advantages, including alignment with global market leaders across lines of business, leadership positions with scale advantages in attractive and growing lifestyle and housing markets, demonstrated ability to innovate and differentiate through specialized solutions and a strong track record of taking decisive actions to overcome market challenges and drive performance. Combined, Global Lifestyle and Global Housing should continue to generate strong returns and cash flow, highlighting the strength and resiliency of Assurant. Prior to moving to our enterprise outlook and results, I want to take a moment to discuss the progress we've made through our sustainability efforts, a key differentiator for Assurant. In June, we published our 2023 sustainability report, reaffirming our long-term priorities around talent, products and climate. The report highlights our progress in reinforcing our company culture and leveraging ongoing employee listening and feedback to help support our global diverse workforce. The report reaffirms our 2020 to 2025 ESG strategic focus areas of talent, products and climate to build a more sustainable future together with our clients, customers, employees and suppliers. We continue to view our commitment to sustainability as a competitive advantage that delivers short and long-term business value. Of note, we achieved our 2025 supplier diversity target 2 years ahead of schedule. We increased our global gender diversity overall; we expanded coverage for electric vehicle protection products and we repurposed 22 million mobile devices globally. Now let's turn to our enterprise outlook and capital. Given first half results and anticipated performance for the remainder of the year, we now expect adjusted EBITDA to grow high single digits, excluding cats. This represents an increase from our original expectation of low single-digit growth. Adjusted EPS growth is now expected to approximate adjusted EBITDA growth, each excluding reportable catastrophes, an improvement over our previous expectations for EPS growth to trail our EBITDA growth. The increase is mainly due to our higher-than-expected adjusted EBITDA growth, which is now outpacing the increases to depreciation and tax expenses. From a capital perspective, we upstreamed $180 million of segment dividends during the quarter and $292 million year-to-date, nearly half of segment adjusted EBITDA, including cats. We ended the quarter with $495 million of holding company liquidity, a significantly higher level than at the end of the first quarter. As expected, we resumed share repurchases during the second quarter, repurchasing $20 million of common stock as well as an additional $10 million throughout July. For the remainder of the year, we would expect to gradually accelerate our level of buybacks with the majority weighted toward the fourth quarter, keeping in mind third quarter is hurricane season, and we will look to preserve our capital flexibility. For 2023, we don't currently expect to exceed the 2022 underlying buyback activity of $200 million. Overall, it's been a strong first half of the year, and we're well positioned for the full year. In both Housing and Lifestyle, it will be critical for us to continue to execute through innovation and enhanced customer experience for our clients and their end consumers, which is what differentiates Assurant and supports long-term growth. I'll now turn the call over to Richard to review second quarter results and our 2023 outlook in greater detail. Richard?
Richard Dziadzio: Thank you, Keith, and good morning, everyone. For the second quarter of 2023, adjusted EBITDA, excluding reportable catastrophes, totaled $337 million, up $59 million or 21% year-over-year. And adjusted earnings per share, excluding reportable catastrophes, totaled $4.09 for the quarter, up 26% year-over-year. Let's start with Global Lifestyle for our segment results. This segment reported adjusted EBITDA of $197 million in the second quarter, an 11% decline year-over-year. However, prior period results included a real estate joint venture gain of $13 million, mainly impacting Global Automotive. If we exclude this prior period gain, adjusted EBITDA declined only 5% or $11 million, in line with our expectations. This decrease was primarily driven by lower results in Global Auto as continued inflationary impacts on labor and parts increased average claim severities. We also incurred increased claims cost on ancillary products as these costs revert to more normalized levels following their post-COVID lows. The Auto earnings decline was partially offset by higher investment income from higher yields and growth in the U.S. across distribution channels. In terms of Connected Living, excluding the prior period real estate gain and $3 million of unfavorable foreign exchange, earnings were roughly flat. In Mobile, earnings were down from soft results in Japan and Europe, as expected. As a reminder, headwinds in international earnings did not materialize until the second half of 2022. In Japan, we continue to experience subscriber declines as our 4-year protection product continues to run off. And in Europe, while we are benefiting from previous expense actions taken in the latter part of 2022 and the beginning of 2023, lower volumes have impacted year-over-year results. U.S. mobile earnings were flat year-over-year as growth in North American device protection programs from carrier and cable operator clients was offset by lower mobile trade-in results. Trading results were impacted by lower volumes due to the timing and structure of carrier promotions and lower fee income from the previously disclosed contract change. However, higher prices on used devices partially offset the decline. Extended service contract earnings increased as U.S. client performance improved, benefiting the rate increases implemented from several clients that began to offset the impact of higher claims costs. Turning to net earned premium fees and other income. Lifestyle was up by $96 million or 5%. This growth was primarily driven by Global Automotive, reflecting prior period sales of vehicle service contracts. Connected Living net earned premiums fees and other income increased 1%. However, this includes an approximate $60 million negative impact from the previously disclosed mobile program contract changes, which had no impact on profitability. Excluding these contract changes, Connected Living net earned premiums, fees and other income grew by 6%. The quarter benefited from growth in mobile subscribers in North America, excluding client runoff and higher contributions from extended service contracts. For the full year 2023, we now expect adjusted EBITDA to be down modestly for Global Lifestyle. Global Auto is expected to be down for the full year as we anticipate loss experience to remain unfavorable for several quarters and the impacts from continued normalization of loss experience for select ancillary products previously mentioned. As Keith described, we've taken specific actions such as rate increases on new business, repair cost reduction and changes to client contract structures to help mitigate these impacts, which is why we expect an increase in profitability over time. Higher investment income has and is expected to continue to partially offset these impacts. In Connected Living, we do expect our U.S. Connected Living business to grow modestly for the full year. As a reminder, third quarter results historically include both lower trade-in volumes and higher loss seasonality. These items typically improve in the fourth quarter. In addition, our third quarter results last year included an $11 million onetime client benefit in Connected Living. And while Japan and Europe have stabilized, we are focused on top line growth, which has been slower to materialize than expected. Finally, we will also continue to focus on expenses while investing in growth opportunities, we have strong momentum with clients. In terms of net earned premiums, fees and other income for the full year, Lifestyle is expected to grow as growth in Global Automotive is partially offset by ongoing foreign exchange headwinds. Moving now to Global Housing. Adjusted EBITDA was $155 million, which included $13 million in reportable catastrophes from severe windstorms in the Southeast U.S. and flooding in Florida. Excluding reportable catastrophes, adjusted EBITDA more than doubled to $168 million were up $87 million from both top line growth and favorable non-cat loss experience within homeowners. Top line growth in lender-placed came from higher average insured values and premium rates as well as more policies in force. These together accounted for approximately half of the increase in earnings. Favorable non-GAAP loss experience came from a $40 million year-over-year net reduction in reserves related to prior period development and is comprised of a $28 million reserve reduction in the current quarter plus a $12 million reserve strengthening in the second quarter of '22. Excluding prior period development, non-cat loss experience increased modestly due to the increase in frequency and severity. Higher investment income also contributed to earnings growth. Turning to our reinsurance program. We completed our 2023 catastrophe reinsurance program in June. We fared well in the market with this year's total cost increasing less than previously expected and only modestly over 2022. This increase is relatively small due to strategic actions taken, including exiting our international footprint, increasing our level of retention and adjusting our reinsurance coverage. As anticipated, our first event retention increased to $125 million from its previous level of $80 million and the retention level reduces to $100 million for second and third events. We also increased our total program coverage to a 1-in-225-year, probable maximum loss to further minimize our risk from extreme catastrophes. Moving to Renters and Other. Earnings increased largely due to a benefit within our NFIP flood business of $5 million. Excluding this item, results were in line with 2022. For the full year 2023, we expect Global Housing adjusted EBITDA, excluding reportable cats, to grow significantly due to strong performance in homeowners, driven by top line expansion from lender-placed. Regarding the second half of the year, we expect ongoing momentum from a continued gradual abatement of inflation, lower seasonal losses particularly in the fourth quarter and continued revenue strength. This momentum should offset a modest increase in catastrophe reinsurance costs in the absence of both another NFIP benefit and additional favorable reserve development, which can be difficult to predict. Together, these last 2 items contributed $33 million to our first half results. Moving to Corporate. The second quarter adjusted EBITDA loss was $29 million, up $4 million from lower investment income. For the full year 2023, we expect the corporate adjusted EBITDA loss to be approximately $105 million. I would also mention that the investment portfolio continues to perform well with higher interest rates improving both short- and longer-term returns. Turning to Holding Company Liquidity. We ended the quarter with $495 million. In the second quarter, dividends from our operating segments totaled $180 million. In addition to cash used for corporate and interest expenses, second quarter cash outflows included 3 main items: $20 million of share repurchases, $40 million of common stock dividends and $50 million related to previous acquisitions within Global Auto. For the full year, we expect our businesses to continue to generate meaningful cash flows, approximating 65% of segment adjusted EBITDA, including reportable catastrophes. This is consistent with our previous forecast. Cash flow expectations assume a continuation of the current economic environment and are subject to the growth of the businesses, investment portfolio performance and rating agency and regulatory requirements. In closing, we're quite pleased with our first half overall performance, which continues to demonstrate the strength and the diversity of our businesses and believe we are well positioned to achieve our increased full year financial objectives. And with that, operator, please open the call for questions.
Operator: [Operator Instructions]. Our first question is coming from the line of Jeff Schmitt from William Blair.
Jeffrey Schmitt: Global Housing seems to really be turning a corner here. But just looking at that, you'd mentioned the favorable development charge, I think it was $28 million. When we back that out, the underlying loss ratio was at 44%, which is still sort of high relative to historical levels and especially, I think, considering with the way that housing material and labor cost inflation to move down. So are you just sort of taking a conservative posture there? Or what are you seeing?
Keith Demmings: Yes. So maybe a couple of comments. Obviously, really pleased with the progress that the team has made. We talked a lot about it last year, a lot of actions to streamline the business to focus on the core products and obviously put appropriate rate adjustments in place, and certainly, it's showing through in the first half of the year. And to your point, that's exactly the way we look at it. We adjust the $28 million of in the quarter. We also adjust for the $5 million FEMA bonus as we look at our overall results, underlying still incredibly strong, $135 million in the quarter. And then to your point, current accident quarter loss ratios are 44%. I think a little under 42% last year. And that's just a factor of the increased inflationary pressure that we see being largely offset by the work we're doing on rate but not fully back to the levels that we saw last year. So as we think about the strong fundamental performance in Housing, it's not a result of unusually low loss ratios. In fact, kind of our year-to-date normalized combined are kind of right in the range of what we would have otherwise expected. But Richard, I don't know if you wanted to add anything else to that.
Richard Dziadzio: Yes, exactly. And I would just say, if we look year-over-year, you're exactly right, Jeff, with the 44%. That's a couple of points above last year's level, same time. And as Keith said, I think we do have some inflation that's -- it's higher last year than the costs are higher this year than last year. So that's running through a little more frequency and just also, there was more, I would call, severe convexity storms in the last quarter. And while those storms, most of those storms didn't make it to reportable cats for us, over $5 million, as you know, we had a very low level in the quarter. Some of them are in the non-cat loss ratio. So we did have our share of those, I would say, overall, and that's within the couple point increase that we see over the year as well.
Jeffrey Schmitt: Okay. That makes sense. And then what was the inflation guard adjustment, I think that goes in maybe once a year, but what is that going to be this year versus last year? Obviously, that's going to go into premium. And then are you still getting rate sort of above that as well?
Keith Demmings: Yes. So we talked about inflation guard going in double-digit levels last July. So we would have put the final adjustments through based on that in June of this year. And then to your point, we do an annual adjustment, it's 3.1% adjustment that would go in on top of that for July to AIV. And then modest rate adjustments, plus and minus as we think about managing across all of our states, but certainly still have more to earn through from last year's AIV adjustments and then on top of that, the 3% that we just put in place in July.
Operator: Our next question comes from the line of Brian Meredith from UBS.
Brian Meredith: A couple of questions here for you. First, can you talk a little bit about the inflationary pressures you're seeing in Global Auto? And I understand it's going to pressure margins here through the remainder of 2023. Is this something we're going to see continuing to pressure margin throughout 2024 just as it takes time for these contract changes to work through numbers?
Keith Demmings: Yes, I definitely think there'll be continued pressure. I do expect '24 to be improved from '23, but definitely, we'll see elevated levels of losses from the inflationary pressure on the parts and labor and auto. As I think about sizing that for you, I'd probably think maybe a little north of $10 million a quarter in EBITDA impact. So if I was going to size it for this year, that's probably the range that we would put on it. I would say that's -- we expect that to recover over time, both in terms of the rate increases that I mentioned earlier, but also the actions we're taking to try to optimize the service network to improve access to parts and to try and drive down claim costs as well. And that obviously can have a more near-term benefit and the rate takes a little longer to earn through. What I would say is we've taken the actions that we want to take. So we've had great dialogue with our clients. There's only a handful of clients where this is really an impact for us, and we've made rate adjustments already in partnership. Our interests are very well aligned with our clients, and we feel confident that we're going to get this to the right level over time. You've seen us resolve issues from inflation in Housing. We've resolved issues on ESC. Obviously, auto is the new area of focus, and our team is 100% focused on delivering and executing.
Brian Meredith: Excellent. And then second question, Japan, when are we going to lap some of these kind of contract roll things that were going on? When will that finally kind of be done? Is that the end of this year? Is there any kind of going into 2024 as the contract changes in Japan?
Keith Demmings: Yes. I think that runs through really this year, and I would expect to see a lot more stability as we head into '24. And then I do think we've got an incredible position in the Japanese market. We partnered with all 4 carriers. There's a tremendous amount of long-term growth opportunity in that market. And I definitely think we'll see growth again in '24 and over the long term.
Brian Meredith: So that's a meaningful part of the headwind you're seeing is the Japan kind of contractual more than kind of an economic situation?
Keith Demmings: Yes. I think the financial performance is still very strong in Japan. I would say the first half of this year stabilized from the second half of last year. We had a very strong first half, both in Japan and Europe in our '22 results. So from a year-over-year comparison, definitely, they look down. But in terms of sequential, as we look at exiting last year, they're both very stable. So I'm really pleased with that performance. In fact, Europe is above where it finished the year in Japan very stable to where it finished. But it is a meaningful contributor for us, and it's an important part of long-term growth. So it will no doubt be a priority.
Operator: Our next question comes from the line of Mark Hughes from Truist.
Mark Hughes: The fee income, what's your outlook in terms of kind of programs or trade-in promotions as we think about the balance of the year?
Keith Demmings: Sure. And maybe I'll start and certainly, Richard, if you have other thoughts on fee income. But we saw -- and this can be volatile quarter-to-quarter really dependent on promotional activity within the industry. We're fortunate, particularly in the U.S., we partner with all of the major carriers, which is a great position to be in from a trade-in perspective. We definitely saw lower trade-in volume in Q2, whether you look at it sequentially or year-over-year. And that's really just a function of the amount of advertising, the promotion and how hard are carriers pushing to upgrade customers to new devices and then how aggressively are they promoting trade-in offers. And that ebbs and flows. It was a little bit down in the quarter. To the extent that as new devices come out in the fall, we certainly expect to see more aggressive marketing campaigns. But it's a little bit in the control of the hands of our clients, and it's a very dynamic market, but continues to be important for our clients and something that we're very focused on.
Richard Dziadzio: And typically, Mark, we would, Q3, we're not expecting big increases typically a higher period would be kind of Q4 for us. So a little bit of what we mentioned in our remarks as well. So there is some seasonality to it, as Keith mentioned, in the second half of the year.
Mark Hughes: Yes. Understood. You mentioned the inflation guard up 3%. Any prospect for additional rate on top of that based on the date approved increases?
Keith Demmings: I would say some marginal rate increases, certainly state by state. And obviously, we look at our rates very closely. So there's -- there'll be a little bit of additional rate coming through. But obviously, the big adjustments we put through last year that are still earning through the book.
Richard Dziadzio: Sorry, Mark, as we look forward to the second half of the year, we could see slight increases, but we're not seeing large increases to revenues continuing. I think we've kind of gotten there already, plus we've gotten out of certain international areas. So overall, the revenues will be impacted a little bit by that. But overall, I think there will be a little more to come, but not -- certainly not the levels we've seen over the past year.
Mark Hughes: Yes. And how about the new money yield on investments versus the portfolio yield? What are the prospects for more improvement there?
Richard Dziadzio: Well, I'd divide into a couple of things. I mean, we've actually had some nice increase in investment income over the last year. Think Absent the real estate gains, probably $30 million in cash in short term. And then obviously, we didn't have a real estate gain this quarter. But just on your question on yields, we do have, in the long term, our fixed income portfolio is a 5-year duration. So we get a continuous role on that, and we'll get a continuous kind of increase in those longer-term yields. We've really benefited from short-term rates also, which is -- accounts for almost as much as the increase or as much as the increase in the longer-term yields, right, with the Fed increasing interest rates. At some point in the future, those will probably come down. So we'll see that cash return come down. Who knows when that will happen, but we could see that as well. But on a longer-term basis, we should continue to get some yield increase.
Operator: Our next question comes from the line of Tommy McJoynt with KBW.
Tommy Griffith: You mentioned the expectations for modest growth in Connected Living this year, and we've had a little bit of discussion on sort of U.S., Japan and Europe. Could you dissect those expectations for that modest growth just into any maybe sort of ranges for U.S. x percent, Japan down x percent. Just trying to get a gauge of exactly how much of a headwind in terms of the overall number that Japan and Europe actually are?
Keith Demmings: Yes, I'd say if I look at Lifestyle and we think about the outlook for '23, I would say, domestic Connected Living, I think we had a strong first half, and that will continue consistently for the back half of the year, and that will yield modest growth for Connected Living U.S.. So performance pretty steady, but that's going to be an increase year-over-year. And again, that's overcoming the onetime client benefit we had last year in the third quarter for $11 million. In terms of international, I'd say our expectations in the second half would be consistent with what we saw in the first half. So continued stability and obviously then putting our attention to driving longer-term growth opportunities, particularly in Europe and Asia Pacific. And then in terms of the auto side of the business, I'd say auto losses will remain kind of at elevated levels as we saw in the first half. We'll continue to see the normalization of GAAP and I would expect Auto in the back half of the year to reflect something more similar to what we saw in the second quarter. That would be the simple way for me to think about it, Tommy.
Tommy Griffith: Okay. Yes. That's helpful. And then switching over to some of the line of questioning on Housing. Obviously, there's been pretty tremendous growth this year. I think you guys have last given your sort of normalized cat load expectations for $140 million for this year. With all the growth that you've seen in Housing, been any early indications for what you might consider a normalized cat load as we head into '24?
Richard Dziadzio: Yes. We haven't really updated our cat load. I mean we put it in for the year and then to be honest, after that, it's sort of like the weather the cats will get, I would say. So we're still at that $140 million number so far. But speaking of that, we were really happy with the reinsurance, the cat reinsurance placement that we put into place where we had thought going into the season at the end of last year, we get an increase, a non-negligible increase in our cat reinsurance. And actually, at the end of the day, we're only going to be modestly up over the year. We've done that through a number of things, whether it's increasing the retention level, working with our reinsurers, exiting some of the international -- or exiting the international property footprint that we have. So we've done a lot of things to kind of protect the company. We increased the top end as well to 1-in-225-year, maximum probable loss, so we think we're in good position. So far in -- through July, we haven't had any cats hit us that are reportable so far, so we'll wait and see. Obviously, we're in cat season right now, so we'll see how it comes out.
Operator: [Operator Instructions]. Our next question comes from the line of John Barnidge from Piper Sandler.
John Barnidge: In your prepared remarks, you talked about new of Global Lifestyle growth. How do you think through that? It sounds like expanding business.
Keith Demmings: Yes. Certainly, a couple of thoughts. We've got great momentum with clients in Global Lifestyle around the world. If I think about our mobile business and the traction we've had over the course of the last 7 or 8 years has been pretty steady. We've got relationships with so many of the marquee brands globally, and that yields a lot of opportunity to do new things, introduce new services, innovate with new products, try to find new ways to help them drive success. So I would say we've got as much ongoing dialogue with clients today and prospects today as we've ever had, and there seems to be a constant interest in innovating and doing new things. And the fact that we've got a really wide-ranging capability set, I think, is a huge advantage for us, and we'd look to see that continue to drive growth long term.
John Barnidge: And then my follow-up question, you talked about expense reductions across the global franchise. Is that above what was previously contemplated into the Lifestyle input cost trends drive an increase in cost reductions?
Keith Demmings: Yes. Maybe I'll start and then Richard can add on. But certainly, we've tried to be very disciplined around expense management. Our goal this year was to hold our G&A expenses relatively flat. That means we have to overcome merit increases, additional costs for health and well-being for our employees. We've got to absorb incremental growth and incremental investment and we've tried to do that with some of the expense actions that we took in the fourth quarter last year, but also a pretty intense focus on driving digital first and automation through all of our operations, whether they were call center, claims operations or even our depots. That continues to be a huge area of focus for us. And we're really pleased with the progress we've made so far. But Richard, anything else you want to add on expenses?
Richard Dziadzio: Yes, I would just say and then turning to the Housing side, in particular, we've gotten some really good leverage off our expense base with some of the investments we've made in automation and digital capabilities. And you've seen in our supplement, the expense ratio go down a number of points over the last year where we're at 38.8%. Now part of that, we had that NFIP bonus that Keith mentioned. But really, the lion's share of it is the fact that we've had increases in revenues and not a proportionate increase in expenses. So that really demonstrates we are getting leverage out of the business, out of the operations and all of the work that we talked about last year that the Housing area is doing.
Operator: Our last question is coming from the line of Grace Carter from Bank of America.
Grace Carter: I think that we had previously talked about maybe some seasonality in the Connected Living book in 3Q, just with people more likely to be out in the belt and maybe damaged devices. I was just curious if you could quantify that on a historical basis, just how we're thinking about how the loss ratio might shape up in the second half of the year?
Keith Demmings: Yes. Maybe I'll offer a couple of thoughts and then I ask Richard to jump in. But definitely, you're correct. We do see seasonality in Q3. We also see to Richard's point earlier, lower trade-in volume in the third quarter and higher trade-in volume in the fourth quarter. So as a result, we'd expect to see an improvement in Q4 over Q3 for Connected Living. And to the extent that we've got certain mobile programs where we're on risk, obviously, we see that impact on frequency in our quarterly results in the third quarter. Now we have moved one of our clients to a reinsurance structure, which we talked about, that noneconomic contract change. That certainly will help mitigate some of that impact. But I don't think we've sized what we would expect the delta to be. But Richard, you might want to add some commentary?
Richard Dziadzio: Yes. We haven't sized it, but I would say it's modest. I mean, really what we wanted to portray is really Q3 is typically a softer quarter from us -- for us, for the trade-ins and some claims increase. It's not hugely material, but it's enough for us to talk about to really say, hey, when you're looking at Q3 and Q4, if you're modeling that, Q3 is going to be softer and Q4 is usually stronger because we don't have the claims, the increase in claims that we just talked about and then trade-ins are usually higher.
Grace Carter: And then I guess on the decrease year-over-year in Global Devices service. To what extent is that driven by the discontinuation of the in-store repair capabilities versus any other factors?
Keith Demmings: Yes. That was $400,000 on a year-over-year basis. So you could remove $400,000 from Q2 last year, and that will give you an appropriate comparison. . All right. I think we took all of the questions. So thank you, everyone, for joining today, and we'll certainly look forward to speaking to you again in November for our third quarter earnings call. And as usual, please reach out to Suzanne and Sean, if you have any follow-up questions. And again, thanks, everybody.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a...
Keith Demmings: And Sean, if you have any follow-up questions. And again, thanks, everybody. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Second Quarter 2023 Conference Call and Webcast. [Operator Instructions]. It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2023 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the second quarter of 2023. The release and corresponding financial supplement are available on assurant.com. We'll start today's call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday's earnings release and financial supplement as well as in our SEC reports. During today's call, we will refer to our non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the 2, please refer to yesterday's news release and financial supplement. I will now turn the call over to Keith."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Suzanne, and good morning, everyone. Our results in the second quarter were strong and well ahead of our expectations with adjusted EBITDA, excluding cats, growing 21% year-over-year or a total of 6% on a year-to-date basis. Results were largely driven by continued momentum in Global Housing, primarily from higher top line growth and more favorable loss experience from prior period development on claims. Our performance is a testament to the resilience of our global business model, our compelling client offerings and steadfast focus on operational excellence. Looking at our business segments. Global Housing adjusted EBITDA increased 49% year-to-date, excluding catastrophes. These results reflect actions taken to transform our Housing business, including focusing on product lines where we have a strong right to win, dramatically reducing noncore areas and our international catastrophe exposure and aggressively deploying digital solutions to improve customer experience while driving greater operational efficiencies. This underscores our ability to quickly respond to ever-evolving market dynamics driving continuous improvement and better performance over time. During the first half of 2023, top line performance in our Homeowners business increased 18% year-over-year. This reflects higher average insured values and state-approved rate increases to account for higher claim severities from inflationary factors in lender-placed. Policy counts increased double digits this year from expanded loan portfolios of new and existing clients. While policy growth has been a contributor so far this year, we expect to level off from the first half of the year. In our Renters business, our property management company distribution channel has shown strong policy growth year-to-date, increasing 14%. This has been driven by the ongoing rollout of our Cover360 solution, one of the many long-term investments we've made in renters that has consistently added value to our PMC partners and customers over the last several years. Our strong growth within the PMC channel has helped to diversify profit pools to partially offset lower contributions from our affinity partners, along with higher non-cat losses, which have returned to more normalized levels. In summary, we're very pleased with Global Housing's performance year-to-date and expect strong year-over-year earnings growth to continue into the second half of 2023. Turning to Global Lifestyle. Underlying segment results were solid and demonstrated steady improvement from the second half of last year. Lifestyle earnings for the first 6 months of the year have increased $34 million or 9% over the second half of last year, from improved Connected Living results. Within Connected Living, we continue to invest in our technology platforms as we deepen our focus on product innovation and evolving our service delivery capabilities to improve customer experience. Our focus on innovation and global trade-in capabilities has continued to drive a significant level of interest from existing and prospective mobile partners. As we continue to realize ongoing efficiencies, we've implemented actions to mitigate macroeconomic headwinds throughout our global operations. In Europe, these actions have had a positive impact, ultimately helping to stabilize earnings and allowing us to remain focused on growing the top line. Within extended service contracts, we've made significant progress with our partners in executing large-scale protection and administration programs. In addition, after several quarters of elevated claim severity, we've seen an improvement in the second quarter loss ratio due to rate increases with several clients. In our Global Auto business, consistent across the industry, our repair costs have continued to increase from inflation. We've taken decisive actions to improve performance. For example, we've implemented prospective rate increases with several key clients, and we're also partnering with our clients to identify cost savings on claims to improve loss experience for programs where we hold the risk. It's difficult to predict the timing of an earnings inflection point, but we expect to see continued improvements as new business earned through although improvement may take several quarters to materialize. Overall, Global Lifestyle earnings were in line with our expectations for the first half of 2023. And while we work to create new vectors of growth for Lifestyle, we now anticipate Global Lifestyle's adjusted EBITDA will be down modestly for the full year. This is mainly due to the headwinds in Global Auto we just discussed and lower international contributions primarily from Japan. Reflecting on the first half of 2023, our results have demonstrated the attractiveness of our compelling business model with clear competitive advantages, including alignment with global market leaders across lines of business, leadership positions with scale advantages in attractive and growing lifestyle and housing markets, demonstrated ability to innovate and differentiate through specialized solutions and a strong track record of taking decisive actions to overcome market challenges and drive performance. Combined, Global Lifestyle and Global Housing should continue to generate strong returns and cash flow, highlighting the strength and resiliency of Assurant. Prior to moving to our enterprise outlook and results, I want to take a moment to discuss the progress we've made through our sustainability efforts, a key differentiator for Assurant. In June, we published our 2023 sustainability report, reaffirming our long-term priorities around talent, products and climate. The report highlights our progress in reinforcing our company culture and leveraging ongoing employee listening and feedback to help support our global diverse workforce. The report reaffirms our 2020 to 2025 ESG strategic focus areas of talent, products and climate to build a more sustainable future together with our clients, customers, employees and suppliers. We continue to view our commitment to sustainability as a competitive advantage that delivers short and long-term business value. Of note, we achieved our 2025 supplier diversity target 2 years ahead of schedule. We increased our global gender diversity overall; we expanded coverage for electric vehicle protection products and we repurposed 22 million mobile devices globally. Now let's turn to our enterprise outlook and capital. Given first half results and anticipated performance for the remainder of the year, we now expect adjusted EBITDA to grow high single digits, excluding cats. This represents an increase from our original expectation of low single-digit growth. Adjusted EPS growth is now expected to approximate adjusted EBITDA growth, each excluding reportable catastrophes, an improvement over our previous expectations for EPS growth to trail our EBITDA growth. The increase is mainly due to our higher-than-expected adjusted EBITDA growth, which is now outpacing the increases to depreciation and tax expenses. From a capital perspective, we upstreamed $180 million of segment dividends during the quarter and $292 million year-to-date, nearly half of segment adjusted EBITDA, including cats. We ended the quarter with $495 million of holding company liquidity, a significantly higher level than at the end of the first quarter. As expected, we resumed share repurchases during the second quarter, repurchasing $20 million of common stock as well as an additional $10 million throughout July. For the remainder of the year, we would expect to gradually accelerate our level of buybacks with the majority weighted toward the fourth quarter, keeping in mind third quarter is hurricane season, and we will look to preserve our capital flexibility. For 2023, we don't currently expect to exceed the 2022 underlying buyback activity of $200 million. Overall, it's been a strong first half of the year, and we're well positioned for the full year. In both Housing and Lifestyle, it will be critical for us to continue to execute through innovation and enhanced customer experience for our clients and their end consumers, which is what differentiates Assurant and supports long-term growth. I'll now turn the call over to Richard to review second quarter results and our 2023 outlook in greater detail. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith, and good morning, everyone. For the second quarter of 2023, adjusted EBITDA, excluding reportable catastrophes, totaled $337 million, up $59 million or 21% year-over-year. And adjusted earnings per share, excluding reportable catastrophes, totaled $4.09 for the quarter, up 26% year-over-year. Let's start with Global Lifestyle for our segment results. This segment reported adjusted EBITDA of $197 million in the second quarter, an 11% decline year-over-year. However, prior period results included a real estate joint venture gain of $13 million, mainly impacting Global Automotive. If we exclude this prior period gain, adjusted EBITDA declined only 5% or $11 million, in line with our expectations. This decrease was primarily driven by lower results in Global Auto as continued inflationary impacts on labor and parts increased average claim severities. We also incurred increased claims cost on ancillary products as these costs revert to more normalized levels following their post-COVID lows. The Auto earnings decline was partially offset by higher investment income from higher yields and growth in the U.S. across distribution channels. In terms of Connected Living, excluding the prior period real estate gain and $3 million of unfavorable foreign exchange, earnings were roughly flat. In Mobile, earnings were down from soft results in Japan and Europe, as expected. As a reminder, headwinds in international earnings did not materialize until the second half of 2022. In Japan, we continue to experience subscriber declines as our 4-year protection product continues to run off. And in Europe, while we are benefiting from previous expense actions taken in the latter part of 2022 and the beginning of 2023, lower volumes have impacted year-over-year results. U.S. mobile earnings were flat year-over-year as growth in North American device protection programs from carrier and cable operator clients was offset by lower mobile trade-in results. Trading results were impacted by lower volumes due to the timing and structure of carrier promotions and lower fee income from the previously disclosed contract change. However, higher prices on used devices partially offset the decline. Extended service contract earnings increased as U.S. client performance improved, benefiting the rate increases implemented from several clients that began to offset the impact of higher claims costs. Turning to net earned premium fees and other income. Lifestyle was up by $96 million or 5%. This growth was primarily driven by Global Automotive, reflecting prior period sales of vehicle service contracts. Connected Living net earned premiums fees and other income increased 1%. However, this includes an approximate $60 million negative impact from the previously disclosed mobile program contract changes, which had no impact on profitability. Excluding these contract changes, Connected Living net earned premiums, fees and other income grew by 6%. The quarter benefited from growth in mobile subscribers in North America, excluding client runoff and higher contributions from extended service contracts. For the full year 2023, we now expect adjusted EBITDA to be down modestly for Global Lifestyle. Global Auto is expected to be down for the full year as we anticipate loss experience to remain unfavorable for several quarters and the impacts from continued normalization of loss experience for select ancillary products previously mentioned. As Keith described, we've taken specific actions such as rate increases on new business, repair cost reduction and changes to client contract structures to help mitigate these impacts, which is why we expect an increase in profitability over time. Higher investment income has and is expected to continue to partially offset these impacts. In Connected Living, we do expect our U.S. Connected Living business to grow modestly for the full year. As a reminder, third quarter results historically include both lower trade-in volumes and higher loss seasonality. These items typically improve in the fourth quarter. In addition, our third quarter results last year included an $11 million onetime client benefit in Connected Living. And while Japan and Europe have stabilized, we are focused on top line growth, which has been slower to materialize than expected. Finally, we will also continue to focus on expenses while investing in growth opportunities, we have strong momentum with clients. In terms of net earned premiums, fees and other income for the full year, Lifestyle is expected to grow as growth in Global Automotive is partially offset by ongoing foreign exchange headwinds. Moving now to Global Housing. Adjusted EBITDA was $155 million, which included $13 million in reportable catastrophes from severe windstorms in the Southeast U.S. and flooding in Florida. Excluding reportable catastrophes, adjusted EBITDA more than doubled to $168 million were up $87 million from both top line growth and favorable non-cat loss experience within homeowners. Top line growth in lender-placed came from higher average insured values and premium rates as well as more policies in force. These together accounted for approximately half of the increase in earnings. Favorable non-GAAP loss experience came from a $40 million year-over-year net reduction in reserves related to prior period development and is comprised of a $28 million reserve reduction in the current quarter plus a $12 million reserve strengthening in the second quarter of '22. Excluding prior period development, non-cat loss experience increased modestly due to the increase in frequency and severity. Higher investment income also contributed to earnings growth. Turning to our reinsurance program. We completed our 2023 catastrophe reinsurance program in June. We fared well in the market with this year's total cost increasing less than previously expected and only modestly over 2022. This increase is relatively small due to strategic actions taken, including exiting our international footprint, increasing our level of retention and adjusting our reinsurance coverage. As anticipated, our first event retention increased to $125 million from its previous level of $80 million and the retention level reduces to $100 million for second and third events. We also increased our total program coverage to a 1-in-225-year, probable maximum loss to further minimize our risk from extreme catastrophes. Moving to Renters and Other. Earnings increased largely due to a benefit within our NFIP flood business of $5 million. Excluding this item, results were in line with 2022. For the full year 2023, we expect Global Housing adjusted EBITDA, excluding reportable cats, to grow significantly due to strong performance in homeowners, driven by top line expansion from lender-placed. Regarding the second half of the year, we expect ongoing momentum from a continued gradual abatement of inflation, lower seasonal losses particularly in the fourth quarter and continued revenue strength. This momentum should offset a modest increase in catastrophe reinsurance costs in the absence of both another NFIP benefit and additional favorable reserve development, which can be difficult to predict. Together, these last 2 items contributed $33 million to our first half results. Moving to Corporate. The second quarter adjusted EBITDA loss was $29 million, up $4 million from lower investment income. For the full year 2023, we expect the corporate adjusted EBITDA loss to be approximately $105 million. I would also mention that the investment portfolio continues to perform well with higher interest rates improving both short- and longer-term returns. Turning to Holding Company Liquidity. We ended the quarter with $495 million. In the second quarter, dividends from our operating segments totaled $180 million. In addition to cash used for corporate and interest expenses, second quarter cash outflows included 3 main items: $20 million of share repurchases, $40 million of common stock dividends and $50 million related to previous acquisitions within Global Auto. For the full year, we expect our businesses to continue to generate meaningful cash flows, approximating 65% of segment adjusted EBITDA, including reportable catastrophes. This is consistent with our previous forecast. Cash flow expectations assume a continuation of the current economic environment and are subject to the growth of the businesses, investment portfolio performance and rating agency and regulatory requirements. In closing, we're quite pleased with our first half overall performance, which continues to demonstrate the strength and the diversity of our businesses and believe we are well positioned to achieve our increased full year financial objectives. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question is coming from the line of Jeff Schmitt from William Blair."
},
{
"speaker": "Jeffrey Schmitt",
"text": "Global Housing seems to really be turning a corner here. But just looking at that, you'd mentioned the favorable development charge, I think it was $28 million. When we back that out, the underlying loss ratio was at 44%, which is still sort of high relative to historical levels and especially, I think, considering with the way that housing material and labor cost inflation to move down. So are you just sort of taking a conservative posture there? Or what are you seeing?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So maybe a couple of comments. Obviously, really pleased with the progress that the team has made. We talked a lot about it last year, a lot of actions to streamline the business to focus on the core products and obviously put appropriate rate adjustments in place, and certainly, it's showing through in the first half of the year. And to your point, that's exactly the way we look at it. We adjust the $28 million of in the quarter. We also adjust for the $5 million FEMA bonus as we look at our overall results, underlying still incredibly strong, $135 million in the quarter. And then to your point, current accident quarter loss ratios are 44%. I think a little under 42% last year. And that's just a factor of the increased inflationary pressure that we see being largely offset by the work we're doing on rate but not fully back to the levels that we saw last year. So as we think about the strong fundamental performance in Housing, it's not a result of unusually low loss ratios. In fact, kind of our year-to-date normalized combined are kind of right in the range of what we would have otherwise expected. But Richard, I don't know if you wanted to add anything else to that."
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, exactly. And I would just say, if we look year-over-year, you're exactly right, Jeff, with the 44%. That's a couple of points above last year's level, same time. And as Keith said, I think we do have some inflation that's -- it's higher last year than the costs are higher this year than last year. So that's running through a little more frequency and just also, there was more, I would call, severe convexity storms in the last quarter. And while those storms, most of those storms didn't make it to reportable cats for us, over $5 million, as you know, we had a very low level in the quarter. Some of them are in the non-cat loss ratio. So we did have our share of those, I would say, overall, and that's within the couple point increase that we see over the year as well."
},
{
"speaker": "Jeffrey Schmitt",
"text": "Okay. That makes sense. And then what was the inflation guard adjustment, I think that goes in maybe once a year, but what is that going to be this year versus last year? Obviously, that's going to go into premium. And then are you still getting rate sort of above that as well?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So we talked about inflation guard going in double-digit levels last July. So we would have put the final adjustments through based on that in June of this year. And then to your point, we do an annual adjustment, it's 3.1% adjustment that would go in on top of that for July to AIV. And then modest rate adjustments, plus and minus as we think about managing across all of our states, but certainly still have more to earn through from last year's AIV adjustments and then on top of that, the 3% that we just put in place in July."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Brian Meredith from UBS."
},
{
"speaker": "Brian Meredith",
"text": "A couple of questions here for you. First, can you talk a little bit about the inflationary pressures you're seeing in Global Auto? And I understand it's going to pressure margins here through the remainder of 2023. Is this something we're going to see continuing to pressure margin throughout 2024 just as it takes time for these contract changes to work through numbers?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I definitely think there'll be continued pressure. I do expect '24 to be improved from '23, but definitely, we'll see elevated levels of losses from the inflationary pressure on the parts and labor and auto. As I think about sizing that for you, I'd probably think maybe a little north of $10 million a quarter in EBITDA impact. So if I was going to size it for this year, that's probably the range that we would put on it. I would say that's -- we expect that to recover over time, both in terms of the rate increases that I mentioned earlier, but also the actions we're taking to try to optimize the service network to improve access to parts and to try and drive down claim costs as well. And that obviously can have a more near-term benefit and the rate takes a little longer to earn through. What I would say is we've taken the actions that we want to take. So we've had great dialogue with our clients. There's only a handful of clients where this is really an impact for us, and we've made rate adjustments already in partnership. Our interests are very well aligned with our clients, and we feel confident that we're going to get this to the right level over time. You've seen us resolve issues from inflation in Housing. We've resolved issues on ESC. Obviously, auto is the new area of focus, and our team is 100% focused on delivering and executing."
},
{
"speaker": "Brian Meredith",
"text": "Excellent. And then second question, Japan, when are we going to lap some of these kind of contract roll things that were going on? When will that finally kind of be done? Is that the end of this year? Is there any kind of going into 2024 as the contract changes in Japan?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think that runs through really this year, and I would expect to see a lot more stability as we head into '24. And then I do think we've got an incredible position in the Japanese market. We partnered with all 4 carriers. There's a tremendous amount of long-term growth opportunity in that market. And I definitely think we'll see growth again in '24 and over the long term."
},
{
"speaker": "Brian Meredith",
"text": "So that's a meaningful part of the headwind you're seeing is the Japan kind of contractual more than kind of an economic situation?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think the financial performance is still very strong in Japan. I would say the first half of this year stabilized from the second half of last year. We had a very strong first half, both in Japan and Europe in our '22 results. So from a year-over-year comparison, definitely, they look down. But in terms of sequential, as we look at exiting last year, they're both very stable. So I'm really pleased with that performance. In fact, Europe is above where it finished the year in Japan very stable to where it finished. But it is a meaningful contributor for us, and it's an important part of long-term growth. So it will no doubt be a priority."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mark Hughes from Truist."
},
{
"speaker": "Mark Hughes",
"text": "The fee income, what's your outlook in terms of kind of programs or trade-in promotions as we think about the balance of the year?"
},
{
"speaker": "Keith Demmings",
"text": "Sure. And maybe I'll start and certainly, Richard, if you have other thoughts on fee income. But we saw -- and this can be volatile quarter-to-quarter really dependent on promotional activity within the industry. We're fortunate, particularly in the U.S., we partner with all of the major carriers, which is a great position to be in from a trade-in perspective. We definitely saw lower trade-in volume in Q2, whether you look at it sequentially or year-over-year. And that's really just a function of the amount of advertising, the promotion and how hard are carriers pushing to upgrade customers to new devices and then how aggressively are they promoting trade-in offers. And that ebbs and flows. It was a little bit down in the quarter. To the extent that as new devices come out in the fall, we certainly expect to see more aggressive marketing campaigns. But it's a little bit in the control of the hands of our clients, and it's a very dynamic market, but continues to be important for our clients and something that we're very focused on."
},
{
"speaker": "Richard Dziadzio",
"text": "And typically, Mark, we would, Q3, we're not expecting big increases typically a higher period would be kind of Q4 for us. So a little bit of what we mentioned in our remarks as well. So there is some seasonality to it, as Keith mentioned, in the second half of the year."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Understood. You mentioned the inflation guard up 3%. Any prospect for additional rate on top of that based on the date approved increases?"
},
{
"speaker": "Keith Demmings",
"text": "I would say some marginal rate increases, certainly state by state. And obviously, we look at our rates very closely. So there's -- there'll be a little bit of additional rate coming through. But obviously, the big adjustments we put through last year that are still earning through the book."
},
{
"speaker": "Richard Dziadzio",
"text": "Sorry, Mark, as we look forward to the second half of the year, we could see slight increases, but we're not seeing large increases to revenues continuing. I think we've kind of gotten there already, plus we've gotten out of certain international areas. So overall, the revenues will be impacted a little bit by that. But overall, I think there will be a little more to come, but not -- certainly not the levels we've seen over the past year."
},
{
"speaker": "Mark Hughes",
"text": "Yes. And how about the new money yield on investments versus the portfolio yield? What are the prospects for more improvement there?"
},
{
"speaker": "Richard Dziadzio",
"text": "Well, I'd divide into a couple of things. I mean, we've actually had some nice increase in investment income over the last year. Think Absent the real estate gains, probably $30 million in cash in short term. And then obviously, we didn't have a real estate gain this quarter. But just on your question on yields, we do have, in the long term, our fixed income portfolio is a 5-year duration. So we get a continuous role on that, and we'll get a continuous kind of increase in those longer-term yields. We've really benefited from short-term rates also, which is -- accounts for almost as much as the increase or as much as the increase in the longer-term yields, right, with the Fed increasing interest rates. At some point in the future, those will probably come down. So we'll see that cash return come down. Who knows when that will happen, but we could see that as well. But on a longer-term basis, we should continue to get some yield increase."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Tommy McJoynt with KBW."
},
{
"speaker": "Tommy Griffith",
"text": "You mentioned the expectations for modest growth in Connected Living this year, and we've had a little bit of discussion on sort of U.S., Japan and Europe. Could you dissect those expectations for that modest growth just into any maybe sort of ranges for U.S. x percent, Japan down x percent. Just trying to get a gauge of exactly how much of a headwind in terms of the overall number that Japan and Europe actually are?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I'd say if I look at Lifestyle and we think about the outlook for '23, I would say, domestic Connected Living, I think we had a strong first half, and that will continue consistently for the back half of the year, and that will yield modest growth for Connected Living U.S.. So performance pretty steady, but that's going to be an increase year-over-year. And again, that's overcoming the onetime client benefit we had last year in the third quarter for $11 million. In terms of international, I'd say our expectations in the second half would be consistent with what we saw in the first half. So continued stability and obviously then putting our attention to driving longer-term growth opportunities, particularly in Europe and Asia Pacific. And then in terms of the auto side of the business, I'd say auto losses will remain kind of at elevated levels as we saw in the first half. We'll continue to see the normalization of GAAP and I would expect Auto in the back half of the year to reflect something more similar to what we saw in the second quarter. That would be the simple way for me to think about it, Tommy."
},
{
"speaker": "Tommy Griffith",
"text": "Okay. Yes. That's helpful. And then switching over to some of the line of questioning on Housing. Obviously, there's been pretty tremendous growth this year. I think you guys have last given your sort of normalized cat load expectations for $140 million for this year. With all the growth that you've seen in Housing, been any early indications for what you might consider a normalized cat load as we head into '24?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. We haven't really updated our cat load. I mean we put it in for the year and then to be honest, after that, it's sort of like the weather the cats will get, I would say. So we're still at that $140 million number so far. But speaking of that, we were really happy with the reinsurance, the cat reinsurance placement that we put into place where we had thought going into the season at the end of last year, we get an increase, a non-negligible increase in our cat reinsurance. And actually, at the end of the day, we're only going to be modestly up over the year. We've done that through a number of things, whether it's increasing the retention level, working with our reinsurers, exiting some of the international -- or exiting the international property footprint that we have. So we've done a lot of things to kind of protect the company. We increased the top end as well to 1-in-225-year, maximum probable loss, so we think we're in good position. So far in -- through July, we haven't had any cats hit us that are reportable so far, so we'll wait and see. Obviously, we're in cat season right now, so we'll see how it comes out."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our next question comes from the line of John Barnidge from Piper Sandler."
},
{
"speaker": "John Barnidge",
"text": "In your prepared remarks, you talked about new of Global Lifestyle growth. How do you think through that? It sounds like expanding business."
},
{
"speaker": "Keith Demmings",
"text": "Yes. Certainly, a couple of thoughts. We've got great momentum with clients in Global Lifestyle around the world. If I think about our mobile business and the traction we've had over the course of the last 7 or 8 years has been pretty steady. We've got relationships with so many of the marquee brands globally, and that yields a lot of opportunity to do new things, introduce new services, innovate with new products, try to find new ways to help them drive success. So I would say we've got as much ongoing dialogue with clients today and prospects today as we've ever had, and there seems to be a constant interest in innovating and doing new things. And the fact that we've got a really wide-ranging capability set, I think, is a huge advantage for us, and we'd look to see that continue to drive growth long term."
},
{
"speaker": "John Barnidge",
"text": "And then my follow-up question, you talked about expense reductions across the global franchise. Is that above what was previously contemplated into the Lifestyle input cost trends drive an increase in cost reductions?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. Maybe I'll start and then Richard can add on. But certainly, we've tried to be very disciplined around expense management. Our goal this year was to hold our G&A expenses relatively flat. That means we have to overcome merit increases, additional costs for health and well-being for our employees. We've got to absorb incremental growth and incremental investment and we've tried to do that with some of the expense actions that we took in the fourth quarter last year, but also a pretty intense focus on driving digital first and automation through all of our operations, whether they were call center, claims operations or even our depots. That continues to be a huge area of focus for us. And we're really pleased with the progress we've made so far. But Richard, anything else you want to add on expenses?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes, I would just say and then turning to the Housing side, in particular, we've gotten some really good leverage off our expense base with some of the investments we've made in automation and digital capabilities. And you've seen in our supplement, the expense ratio go down a number of points over the last year where we're at 38.8%. Now part of that, we had that NFIP bonus that Keith mentioned. But really, the lion's share of it is the fact that we've had increases in revenues and not a proportionate increase in expenses. So that really demonstrates we are getting leverage out of the business, out of the operations and all of the work that we talked about last year that the Housing area is doing."
},
{
"speaker": "Operator",
"text": "Our last question is coming from the line of Grace Carter from Bank of America."
},
{
"speaker": "Grace Carter",
"text": "I think that we had previously talked about maybe some seasonality in the Connected Living book in 3Q, just with people more likely to be out in the belt and maybe damaged devices. I was just curious if you could quantify that on a historical basis, just how we're thinking about how the loss ratio might shape up in the second half of the year?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. Maybe I'll offer a couple of thoughts and then I ask Richard to jump in. But definitely, you're correct. We do see seasonality in Q3. We also see to Richard's point earlier, lower trade-in volume in the third quarter and higher trade-in volume in the fourth quarter. So as a result, we'd expect to see an improvement in Q4 over Q3 for Connected Living. And to the extent that we've got certain mobile programs where we're on risk, obviously, we see that impact on frequency in our quarterly results in the third quarter. Now we have moved one of our clients to a reinsurance structure, which we talked about, that noneconomic contract change. That certainly will help mitigate some of that impact. But I don't think we've sized what we would expect the delta to be. But Richard, you might want to add some commentary?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. We haven't sized it, but I would say it's modest. I mean, really what we wanted to portray is really Q3 is typically a softer quarter from us -- for us, for the trade-ins and some claims increase. It's not hugely material, but it's enough for us to talk about to really say, hey, when you're looking at Q3 and Q4, if you're modeling that, Q3 is going to be softer and Q4 is usually stronger because we don't have the claims, the increase in claims that we just talked about and then trade-ins are usually higher."
},
{
"speaker": "Grace Carter",
"text": "And then I guess on the decrease year-over-year in Global Devices service. To what extent is that driven by the discontinuation of the in-store repair capabilities versus any other factors?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. That was $400,000 on a year-over-year basis. So you could remove $400,000 from Q2 last year, and that will give you an appropriate comparison. . All right. I think we took all of the questions. So thank you, everyone, for joining today, and we'll certainly look forward to speaking to you again in November for our third quarter earnings call. And as usual, please reach out to Suzanne and Sean, if you have any follow-up questions. And again, thanks, everybody."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a..."
},
{
"speaker": "Keith Demmings",
"text": "And Sean, if you have any follow-up questions. And again, thanks, everybody."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 1 | 2,023 | 2023-05-03 09:30:00 | Operator: Welcome to Assurant’s First Quarter 2023 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin.
Suzanne Shepherd: Thank you, operator, and good morning, everyone. We look forward to discussing our first quarter 2023 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the first quarter of 2023. The release and corresponding financial supplement are available on assurant.com. We will start today’s call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday’s earnings release and financial supplement as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday’s news release and financial supplement. I will now turn the call over to Keith.
Keith Demmings: Thanks, Suzanne and good morning everyone. We are pleased by our first quarter results, which reflected better-than-expected performance within our Global Housing business and our ongoing focus on driving operating excellence across Assurant. The actions we announced in 2022 to simplify our business and real estate portfolio realign our organizational structure and accelerate the deployment of digital-first experiences are beginning to yield measurable results. While early, gross savings generated from these initiatives are helping to mitigate the impact of broader macroeconomic headwinds and fund additional critical investments in innovation and our talent. This was reflected in Global Lifestyle’s results for the quarter, which improved sequentially in line with our expectations. Our first quarter results also continued to demonstrate the leadership advantages of our well-diversified business portfolio and our global client base. We believe we are well-positioned to deliver on our financial objectives for 2023 and we will continue to prudently manage our capital to drive shareholder value. Looking ahead, we will maintain a steadfast focus on execution: first, by strengthening and expanding our global partnerships; second, by driving innovation and delivering on our digital-first vision to improve the customer experience; and third, by realizing savings from ongoing expense management efforts. Recently, we were recognized as one of America’s most innovative companies by Fortune, demonstrating the importance we place on finding new ways to serve our clients and fostering a culture of innovation and inclusion. Through consumer research and investments in emerging technologies, we develop new products and services to meaningfully enhance the consumer experience and drive competitive advantages across our key markets, including mobile, auto and housing. We continue to strengthen our large embedded base of businesses. In Global Lifestyle, we work with 15 of the top 50 most valuable global brands and provide protection and services for nearly 62 million mobile subscribers with a recurring monthly subscription service and we protect nearly 54 million automobiles across a wide range of distribution partners. Our scale supports both businesses to continue their track record of long-term growth. Our U.S. Connected Living business is expected to remain a solid growth driver, anchored by mobile device protection with marquee mobile carriers and cable operators. In addition, our trade-in business continues to be a strong contributor to overall mobile results. Our international results have begun to stabilize in line with our expectations even as many of the factors impacting growth last year continue to persist, including foreign exchange headwinds and lower business volumes. In Europe, we benefited from expense actions previously taken, leading to improved earnings when compared to the second half of 2022. Additionally, we renewed 8 key clients since the beginning of 2022, solidifying a strong foundation to support continued growth. In Japan, we are implementing actions to stabilize the impact from ongoing mobile subscriber declines and believe we are well-positioned in this critical market even as programs mature. In addition to our multiyear partnership with KDDI, we are growing our footprint through expanded relationships with other large Japanese carriers. We are leveraging our core mobile solutions and technology offerings to help optimize operations and launch new services. Moving to Global Auto, we are making steady progress integrating and leveraging recent acquisitions to support commercial success with new partnerships like CNH Industrial, which leverages the combined expertise of our legacy Assurant Lease and Finance business and the broad capabilities of our EPG acquisition. Outside of the U.S., we focused on expanding our share with OEMs. And in Latin America and Europe, we signed two new business partnerships in the quarter. Overall, in Lifestyle, while we remain cautious in the short-term, given ongoing global macroeconomic uncertainty, we continue to expect modest growth for the full year. Within Global Housing, we continue to simplify our focus on product lines where we have clear competitive advantages and scale. We operate a countercyclical market-leading lender-placed business that has generated significant cash flow and attractive returns over the long-term, while we invest to drive growth in our capital-light renters’ insurance business. Despite higher than expected cat activity this quarter, Global Housing had a strong start to the year as adjusted EBITDA, excluding cats, increased 7%. In homeowners, which is primarily driven by lender-placed, top line grew 16%, both from higher policy growth and higher average insured values and rates, partially offset by increased non-cat losses and cat reinsurance costs. Policy growth came from both new and existing clients. In lender-placed, our ability to drive higher premiums both through our inflation guard product feature and rate actions have helped to offset continued inflation impacts on claims, which remain elevated across Global Housing. Entering the second quarter, the impact of inflation on building materials and labor costs is beginning to show signs of improvement. As we consider the magnitude and pace of earnings recovery for Global Housing over the year, it will be important to see how ongoing loss experience improves over the next few quarters. Let’s turn to our enterprise outlook and capital. Reflecting on the quarter and current market conditions, we continue to expect to grow adjusted EBITDA, excluding reportable cats, by low single-digits this year. Adjusted EPS growth is still expected to trail adjusted EBITDA growth both excluding reportable cats, primarily reflecting higher annual depreciation expenses related to several strategic technology investments critical to executing our strategy, a higher consolidated effective tax rate compared to favorable rates in 2022, and the timing of capital deployment. From a capital perspective, we upstreamed $112 million of segment dividends in the first quarter and ended the quarter with $383 million of holding company liquidity. We have been carefully monitoring the broader business and macroeconomic environment as we consider capital deployment. We now expect to resume share repurchases later in the second quarter, but at modest levels given the ongoing market volatility. We expect the majority of share repurchases to be weighted toward the end of the year and maybe below 2022 underlying buyback activity. As we look ahead, we are focused on the continued execution of our vision to be the leading global business services provider supporting the advancement of the connected world. We believe our strong global client partnerships and our ability to innovate for more than 300 million customers will be critical to achieving our vision. I will now turn the call over to Richard to review the first quarter results and our 2023 outlook in greater detail. Richard?
Richard Dziadzio: Thank you, Keith and good morning everyone. For the first quarter of 2023, adjusted EBITDA, excluding reportable catastrophes, totaled $293 million, down $22 million or 7% year-over-year and 5% on a constant currency basis. While the results were lower than the prior year, they came in above our expectations, driven by stronger Global Housing performance. Adjusted earnings per share, excluding reportable catastrophes, totaled $3 million and $0.49 for the quarter, down 12% year-over-year, primarily from lower segment earnings, a higher effective tax rate compared to favorability in the prior period and a higher depreciation expense. Now, let’s move to segment results, starting with Global Lifestyle. The segment reported adjusted EBITDA of $199 million in the first quarter, a 12% decline year-over-year or a 10% decline on a constant currency basis. The decrease came from lower results in both Connected Living and Global Automotive, partially offset by higher investment income. Connected Living’s earnings were down 15% or 11% on a constant currency basis from decreases in extended service contracts and weaker international results. Extended service contract results were lower due to an increase in claims costs and in particular, relative to the prior year quarter, which included favorable claims experience. We expect a modest level of higher cost to persist during the remainder of the year, the level of which will depend on the broader inflation trends in the market. However, we have recently implemented rate increases with several clients, which should begin to flow through during the course of the year, mitigating the increase. In mobile, earnings were down as expected from softer international results, mainly in Asia-Pacific and unfavorable foreign exchange, both of which are expected to continue. U.S. mobile earnings were flat year-over-year as modest mobile subscriber growth in North America device protection programs from carrier and cable operator clients was offset by lower mobile trading results. Trade and margins were impacted by device mix from carrier promotions and slightly lower volumes, mainly due to the discontinuation of in-store service and repair. Sequentially, however, we are seeing improved mobile performance, including in the U.S. and Europe, as results benefit from expense management and more favorable loss experience compared to trends that emerged in the second half of 2022, while declines in Japan have started to stabilize. Turning to Global Automotive, earnings decreased $8 million or 9% and $5 million, excluding real estate joint venture gains from the first quarter. Similar to others in the industry, the auto business was impacted by a rise in severity from higher parts and labor costs that contributed to elevated claims. We expect to recover a portion of the higher claims cost over time through client contract structures though we expect elevated claims experience to persist throughout this year. The auto earnings decrease was partially offset by growth in the U.S. across distribution channels. And although higher claims costs across auto and extended service contracts are being driven by inflation, these businesses are also benefiting from higher investment income due to higher yields. Turning to net earned premiums, fees and other income, Lifestyle was up by $52 million or 3%. This growth was primarily driven by Global Automotive, reflecting strong prior period sales of vehicle service contracts. Connected Living net earned premiums fees and other income decreased 5%. This reflects an approximately $65 million impact from the previously disclosed new contract structures as well as premium declines related to mobile runoff programs. Excluding these contract changes in foreign currency, Connected Living’s revenues grew by 4%. The quarter benefited from growth in mobile subscribers in North America and higher contributions from extended service contracts. For full year 2023, we expect modest growth for Global Lifestyle, supported by the ongoing expansion of new and existing partnerships, particularly in Connected Living and accelerating expense savings throughout the year. We also expect increasing contributions from investment income and the positive impact from the actions mentioned to address rising claims cost. In terms of net earned premiums fees and other income for 2023, Lifestyle is still expected to grow modestly as growth in Global Automotive is partially offset by ongoing foreign exchange headwinds. Moving to Global Housing. Adjusted EBITDA was $68 million which included a $43 million increase in reportable catastrophes from severe weather and tornado events. Excluding reportable catastrophes, adjusted EBITDA was $118 million up $7 million or 7%. The stronger-than-expected results were driven by Homeowners’ top line performance, mainly from lender-placed policy growth as well as higher average insured values and premium rates. Policy growth was mainly from expanded loan portfolios of new and existing clients, although we do expect the client portfolio to run off our books as the year progresses. While non-cat loss experienced across all major products increased by $32 million, our performance in the quarter demonstrates our ability to more than offset the inflation impacts. Catastrophe reinsurance costs also increased in line with our expectations. In renters and other, earnings decreased from expected higher non-cat losses, which should continue throughout the year. For full year 2023, we continue to expect Global Housing adjusted EBITDA, excluding reportable cats, to grow due to improved performance in Homeowners, driven by top line expansion from higher rates and policy growth in lender-placed and by ongoing expense actions to be realized over the course of the year. We are monitoring potential changes in the reinsurance market as we place the remaining third of our reinsurance program in the coming months. Currently, we anticipate the cost to increase year-over-year, in line with our previous expectations. Lastly, we are not anticipating a significant improvement in lender-placed non-catastrophe losses until later in the year and continue to monitor the impact of inflation closely. Please also keep in mind that the second quarter tends to be a seasonally elevated period for non-cat losses. Moving to corporate. The first quarter adjusted EBITDA loss was $24 million, up $2 million driven by lower investment income. For the full year 2023, we continue to expect corporate adjusted EBITDA loss to be approximately $105 million. Given the market volatility over the last quarter, I also want to take a moment to discuss our investment portfolio. Investments cash and cash equivalents had a value of $9.3 billion at the end of Q1. The portfolio is high quality and diversified, reflecting our conservative investment philosophy. Fixed maturity investments in cash and cash equivalents represented 86% of our total portfolio. An estimated 94% of our fixed income securities are investment-grade rated. And overall, our U.S. regional bank exposure is modest. We also have commercial real estate investments across a number of investment vehicles with the overall portfolio performing well. Our assets are diversified across geographic regions and property type with low average security size and have attractive loan-to-value and debt coverage servicing ratios. For example, our commercial mortgage loan portfolio represents approximately 3% of our investment portfolio with approximately 130 loans with an average loan amount of about $2.3 million. The loan portfolio is highly diversified across the U.S., including a variety of property classes and with office buildings representing 11% or approximately $34 million of the loan portfolio and our real estate equity portfolio represents only 2% of our investment portfolio. It is also a diverse portfolio with only four office assets with a $26 million book value. We also have CMBS and REIT positions with 98% of those investments being investment-grade rated. While certainly not risk-free, we believe our investment portfolio is relatively low risk as it relates to current macroeconomic headwinds. Turning to holding company liquidity. We ended the quarter with $383 million. In the first quarter, dividends from our operating segments totaled $112 million. During the quarter, we issued $175 million in 2026 senior notes and redeemed a portion of the $225 million of senior notes due in 2023. We intend to redeem the balance of the notes on or prior to maturity in September. In addition to the $136 million of cash used for corporate and interest expenses, first quarter cash flows included $37 million of common stock dividends. For the year, we expect our businesses to continue to generate meaningful cash flow, approximating 65% of segment adjusted EBITDA, including reportable catastrophes. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance, and rating agency and regulatory requirements. As Keith mentioned, given our performance in the first quarter and our current expectations for cash generation, we plan to resume modest buybacks as we exit the second quarter. We will continue to monitor the macroeconomic environment and adjust accordingly. In summary, our performance in the first quarter provides us with the confidence in our full year outlook. And while macroeconomic uncertainty will likely continue throughout the year, we believe the strength and momentum of our businesses and strong cash flow generation are powerful differentiators for Assurant. And with that, operator, please open the call for questions.
Operator: Thank you. [Operator Instructions] Your first question is coming from Tommy McJoynt from KBW. Your line is open.
Keith Demmings: Good morning, Tommy.
Tommy McJoynt: Hey, good morning, guys. Thanks for taking my questions here. So the first one, with regards to your comments on the claims cost in the Lifestyle business, so in the past, you’ve distinguished between the lifestyle partners where you hold the ultimate risk and the partners where the risk ultimately goes back to the partners. Could you give into a bit more detail on the timing of how some of those unfavorable claims could weigh on earnings in the current period but ultimately get recovered in the future periods. And what is the magnitude of those swings? Just from our standpoint, should we kind of see these numbers kind of ebb and flow in the numbers.
Keith Demmings: Yes. So maybe I can try to take that and then certainly, Richard, feel free to add in. I’d probably point to a couple of things. I’ll set aside housing, which I’m sure we will talk about later in the progress there from an inflation perspective. Nothing really to report on the mobile side. So a lot of stability mobile-ly – in terms of the mobile business around severity. So that’s come in line fairly nicely in the last couple of quarters. We signaled some pressure on the ESC. So the retail service contract side of the business. We’ve actually been taking rate increases with our partners adjusting program coverages, but also putting rate in place. So we saw a little bit of pressure in the first quarter, which is continued, I’d say, over the last three or four quarters or so. We expect that to moderate over the rest of the year. So we’ve taken action that will start to benefit through in terms of the earned premium this year. And hopefully, that will slow down that impact over the rest of ‘23. Where we are seeing a little more pressure is on the auto side, we talked about this a little bit last quarter, but certainly elevated severities in the repair shops, both in terms of parts costs and labor costs. We’re definitely seeing that come through in our performance. As you rightly suggested, we do share risk with a lot of our partners. So the vast majority of our deals are either reinsured or profit shared. So we’re keeping a residual amount of that severity risk. We do recover that in a lot of cases through repricing with our clients, whether contractually required, which is often the case or just with the partners, we will work to try to achieve target loss ratios over time. So we’ve already started taking pricing actions. We started taking certain actions more than 6 months ago around the auto business, and that should benefit us as we flow through probably more helpful in ‘24 than ‘23, we will definitely still see some pressure this year in the auto results. We do expect to see progress in auto over the balance of the year in ‘23. We are seeing good growth in revenue. We’re also seeing help in terms of the investment income portfolio, and those are helping to offset some of the pressure on severities.
Tommy McJoynt: Thanks. And then just my second question, what specifically are you seeing that’s different from previously that gives you comfort to resume the buyback assumingly just maybe a month or two ahead of prior plan? And how much of that is attributed to just looking at where the stock is trading relative to your assessment of intrinsic value?
Keith Demmings: Yes, I think as we sit here today, we’ve got a lot of confidence in our cash flow generation as a company, the strength of the business model. And I would say the positive momentum that we’ve seen in the housing business, the fact that we are seeing improving housing cost inflation indicators. We obviously had a really strong fourth quarter that repeated in the first quarter. We’re seeing some improvement in terms of inflation, and that gave us more confidence as we think about the full year outlook and our ability to deliver against that. And to your point, we’re starting a little bit earlier but we do want to capitalize on the fact that we think our stock is attractively valued, and we feel like there is a good opportunity for us to get back into the market and be more consistent with our buyback activity as we move forward.
Tommy McJoynt: That makes sense. Thank you.
Keith Demmings: Great. Thanks, Tommy.
Operator: Your next question comes from the line of Mark Hughes from Truist Securities. Your line is open.
Keith Demmings: Good morning, Mark.
Mark Hughes: Yes. Thank you. Good morning. The renters insurance business here, your number of renters has held up pretty well, but your revenue has dipped a little bit. Is that a mix shift? Could you give a little detail on that?
Keith Demmings: Yes, sure. I would say a couple of things to unpack with renters. Broadly, our policy counts to your point, are pretty steady over the last year we’re seeing average premium per policy, pretty steady, and really growth in the PMC channel, we’re seeing double-digit revenue growth in our PMC channel, offset by some softness on the affinity side. When you do look at the revenue for the first quarter, a couple of things I would point out. First of all, we did have an adjustment that flowed through the premium line. If I back that out, our revenue would be roughly flat in the quarter. So I think if you take something away from renters, pretty stable, consistent performance underlying revenue pretty constant compared to Q4 compared to first quarter last year. We think there is an opportunity to drive long-term growth within this business. The second thing, we did see some favorability in the quarter from NFIP, where we’re getting paid to administer claims on behalf of the U.S. government. That does not flow through the revenue line. It flows through as a ceding fee that we receive and effectively a contra commission. So the real headline from my perspective around renters is well-positioned, steady results. The loss ratios are certainly normalizing in line with what we saw in the second half and still believe we have good long-term opportunity to grow that business.
Mark Hughes: And then on the Connected Living, what’s your assessment of the amount of marketing or advertising, advertising the norm around 5G programs kind of feeding into your mobile device count, maybe feeding into your fee income driven by the upgrade and logistical operations. Are you still seeing the same tempo? How do you see that play out over the coming years?
Keith Demmings: Yes. So we certainly had a pretty high watermark in 2022 with respect to trading activity, to your point, a lot of advertising around 5G. We saw pretty consistent volumes in the first quarter so if you strip out the impact of service and repair within that device to service line, trade-in volumes are pretty constant in Q1 versus Q1 last year. We did see a little bit of margin pressure around the mix, the mix of services we provided, the clients that have flowed through. But pretty steady from that perspective, I’d say it’s still an important part of the ecosystem, clients used as an important tool to attract customers and the marketing tends to ebb and flow and very much driven by the competitive state, particularly within the domestic mobile business. The second thing I would highlight is just the strength of our device protection business, in particular in the U.S. If you look at our top clients, and we operate with obviously one of the major mobile operators, two major cable operators picked up 84% of all net ads for postpaid customers in Q1. So our clients are growing. We’re obviously participating in that growth, and that will afford us opportunity to do more services and add more value over time.
Mark Hughes: Thank you very much.
Keith Demmings: Great. Thank you.
Operator: Your next question is coming from John Barnidge, Piper Sandler. Your line is open.
Keith Demmings: Good morning, John.
John Barnidge: Good morning. Appreciate the opportunity. If we could stick with the auto business, I know there is an ability to recoup part of the deficit, but it can take a number of quarters to do so, if I’m understanding that correctly. How large is the deficit and how much of that will recruitment will leak into ‘24? Thank you.
Keith Demmings: Yes. The deficit isn’t that large. We’re obviously taking action and have been taking action now for a couple of quarters to make sure that, we are in the right side that, as we move forward. As I said, I think, we will see a little bit of pressure over the next three or four quarters, offset by the strong growth in the investment income. I definitely expect to see some of that recovery coming through in ‘24. And to your point, if I think about where we’ve seen some pressure in a good amount of the cases, we’re actually going to recover that deficit on an inception-to-date basis. Where in another cases, we will achieve target loss ratios on new business. We may not get historical losses back. But there is an ability to actually recover historical losses, to your point and recapture deficits. So, feel really good about how we are positioned in auto. We work closely with our clients on pricing. We don’t require regulatory approvals to make pricing changes. So, it’s really just working in partnership with our clients to do that. We have been dealing with this for 20-plus years as an organization, and we are very good at trying to find creative solutions with our clients to normalize results over time.
Richard Dziadzio: And I would just add too, John. I mean the other side of that, as Keith mentioned earlier in the remarks is that we are getting investment income. So, what we are seeing on the claims costs rising in auto and extended service contracts is just part of the inflationary environment, prices going up, but also interest rates have come up, which is part of what you are seeing in the investment income increase during the quarter.
John Barnidge: Appreciate that color. And then on pricing increases, I would imagine another round for inflation guard will be coming in July. Am I correct in thinking it won’t be nearly the same degree as a year ago, but should benefit the overall premium profile?
Keith Demmings: Yes, that’s right. And if we look at the core logic industry factor for inflation around housing, materials and labor. And if you look at where it was April 1st, last year, it was 16%. If you look at that this year, it’s just a little over 3%. So, a much more modest adjustment to average insured values, which obviously, it will have less of an impact on rate, but I think it’s more positive in terms of the health of the broader market. Seeing inflation rates normalize is very important for the performance of the business and obviously trying to keep premiums manageable from a consumer perspective. So, I actually feel really good about what we are seeing from CoreLogic. It matches up closely with a lot of the data that we look at within our business. So, feel good about how we are positioned there.
Richard Dziadzio: And just the other thing to add to that, John, and I am sure you are probably aware of it, but the 16% last year that takes a number of months to roll through as the policies renew themselves and new policies come in and so forth. So, that does take some time, just as when the 3% comes in, the first policies come in July when they renew that increase will come into place. So, it’s a little bit averaging as we get through the course of the year.
Keith Demmings: Great. Yes, it’s a great point. We haven’t fully written in the 16% AIVs that will fully write in through June, and then it will take 12 months from there to fully earn through the book. So, you are still going to feel significant rate and premium growth acceleration over the course of this year, regardless of what factor goes in, in July.
John Barnidge: Thank you for the answers. Appreciate it.
Keith Demmings: Great.
Richard Dziadzio: Thank you.
Operator: Your next question is coming from Grace Carter, Bank of America. Your line is open.
Keith Demmings: Good morning Grace.
Richard Dziadzio: Good morning Grace.
Grace Carter: Hi everyone. So, I was wondering, just given that you said that the first quarter came in above expectations, but guidance remains flat. I know you all called out some seasonality in housing losses in the second quarter and obviously, inflationary pressure on claims cost across the book, but are there any sort of timing items or one-off favorable items in the first quarter that we need to consider when I am trying to square the first quarter performance versus the full year guidance?
Keith Demmings: You want to start on that, Richard?
Richard Dziadzio: Yes. No, I think your question was well-phrased. I think we do see, as the year goes on, we can see some seasonality in claims and typically, Q1 is a little bit lower. We will see what happens. Obviously, there is inflation that’s coming down. So, that can help the claims cost due. We had some good investment income that depends what happens with interest rates as the year goes on. We did not have any real estate sales or gains in the numbers. So, there is no one-offs in that area as well. We have some good PIF counts in housing policies in force. And we do – we did mention that we see a client rolling off as the year goes down – a year goes on, that might temper the overall increase in policies in force. So, I would say more business than usual, nothing big in the first quarter to call out, Grace.
Grace Carter: Okay. Thank you. And I think you had previously mentioned the hard market in certain states, including Florida, as driving some of the growth in the housing book. Is there any impact that you all expect from the recent reforms in Florida on growth levels going forward or more on margins?
Keith Demmings: Yes. Maybe I will start on that, Richard, and certainly, you can add in. I would say it’s really early in terms of the Florida reforms. I think long-term, it’s going to be really important for that market to improve the competitiveness and improve pricing for consumers without question. So – and we are starting to see lower AOBs coming through. So, that will take time to work through, and we will see how that emerges. But I do feel good about how that’s positioned for the future. In terms of the hard market, I would say we certainly saw PIF count grow in Florida last year. So, we had about 14,000 new policies over the course of the year because I would say largely the hard market, some of it from new clients, but a good amount from the hard market. We actually saw that begin to reverse a little bit, Grace in the first quarter. So, our PIF count in Florida actually went down a little bit. And I think that’s a sign of potentially more competitiveness into the marketplace. So, we won’t be monitoring that, but we are not expecting Florida to be a big driver of PIF from the hard market as we look forward in the rest of the year.
Grace Carter: Thank you.
Operator: [Operator Instructions] And your next question comes from the line of Brian Meredith from UBS. Your line is open.
Keith Demmings: Good morning Brian.
Brian Meredith: Yes. Thank you. Good morning, how you are all doing? So, a couple of questions here for you. The first one, you kind of described Japan starting to get a little bit better, Europe start to get a little bit better, when do you think we could start to see some year-over-year growth in global covered mobile devices in Connected Living?
Keith Demmings: Yes, it’s a great question. So, let me just address Europe quickly, and then I will talk about Japan. So, I am really pleased with the progress that our team has made in Europe, and we had a pretty significant turnaround in the first quarter. A tough second half of last year without question, but significantly improved results in the first quarter and a lot of that was due to the expense actions that our team took in the back half of 2022. So, I think we are well-positioned there and expect strong stable results in Europe over the course of the year. And I would say Japan, that’s been the market where we have seen some subscriber declines. Everywhere else has been relatively stable. The U.S. historically has been growing for us, so that – I expect that will continue. And I would say in Japan, a couple of things that are really important. Number one, it’s a really important market for the mobile business. I think we are incredibly well-positioned and we have made a lot of progress in that market. And that’s progress around investing in local talent, capabilities, technology. We actually now have relationships with all four carriers in the Japanese market. So, that creates interesting opportunities to innovate and drive growth. The subs are definitely down quarter-over-quarter. And I would point to two things and give you a little bit more color on that. One, we see slightly lower attach rates more recently. And that’s mainly because customers have migrated to more affordable devices. Because of foreign exchange, devices became more expensive last fall, and we have seen a little bit lower attach on less expensive devices in older models, but nothing of concern. And then the second thing, which is actually the bigger driver, when we launched in Japan in 2018 with our initial device protection product, it had a 4-year term. So, a monthly pay product for 4 years as opposed to an Evergreen structure. And that was appropriate at the time in the Japanese market. After a couple of years, we actually moved to an Evergreen product, what you are seeing in Japan is some of that transition rolling through where some of those 4-year contracts are hitting their end date and the cancellation rate plus those contracts ending is a higher number than the new ads that we are putting on the book. I would say, before the end of this year, that will be fully gone and then we will be positioned in Japan for growth going forward. And to my earlier point, we expect to continue to grow U.S. mobile as we have for many years.
Richard Dziadzio: And I would just add to – yes, I would just say, Brian, in addition to the sub count, we have always talked about adding services to clients. So, you have the sub count and then you have what’s the services inside that. So, as we go on, we continue to innovate the products and innovate the services going into the client to provide us more revenue per client, I would say as well.
Brian Meredith: Got it. That’s helpful. And then my second question, I am just curious, going to capital management. I appreciate probably starting to buy back a little more stock at the end of the second quarter. But given the cash flow you are expecting and given the excess capital already at the holding company, why modest, right? I mean I understand there is a little macro uncertainty, but you have got a pretty conservative investment portfolio, as you pointed out, cash flows look like they are pretty strong. Why wouldn’t you take advantage of the really inexpensive valuation, your stock more aggressively at this point?
Keith Demmings: Yes. And I think it’s as simple as we are just trying to be prudent. We work very disciplined as a company with the way we think about capital management and we are trying to get more information just in terms of how the macro picture is going to play out. Interest rates, whether there is going to be a recession, if so, when does that start to kick in? So, I just think we are trying to be prudent with our thinking on that and certainly expect as we get more information to be able to deploy more capital. But Richard, feel free to add anything else.
Brian Meredith: Outlook, also can you add does the outlook contemplate a recession?
Richard Dziadzio: When we look at the outlook, we do take into account, for example, more I would say, a decrease in inflation as the year goes on. We don’t take into account when we are projecting that there is any sort of hard landing of things. So, we do take into account, for example, when Keith was talking about in the conversation we had on claims service, the service charges, the claims costs going up. We do take into account that, that could continue to go up during the year when we reinforce our outlook for the quarter. In terms of capital, really what Keith was saying is right on, is that we are just trying to be prudent. When you look at the macroeconomic environment today and you look at the shaky what’s going on in some of the inflation aspects and the Fed increasing rates and the banking industry and things going on just generally, I think we are trying to be prudent and just be cautious about the steps we take. I agree with you. We have a – we are in a strong financial position. We have got a strong balance sheet. We have got a conservative investment portfolio. There is nothing today that we are sitting on looking at our investment portfolio that we are worried about, although we are keeping an eye on everything so to speak. So, it’s really from just being prudent to see how things play out over the next couple of months. But we do see us increasing the share buybacks towards the end of the year if things play out okay on the number of things we just talked about.
Keith Demmings: Yes. And maybe just a little bit more color on the recession question and how we think about that. We are certainly updating our views for the full year to take into account all of the trends that we are seeing within each of our lines of business. So, there is no doubt that we are paying close attention and modifying as appropriate there. I am not having a crystal ball, but certainly we can see some of those trends emerging. I would say a couple of things, though. Number one, we haven’t assumed any change in placement rate related to a recession. So, we haven’t banked on the idea that if the economy gets tougher, we will see placement rates evolve over time. So, that we have kept relatively static, and we will see how that emerges. And then I would just remind you on the Lifestyle business, a lot of our mobile economics were driven by the in-force subscribers that we have, which is $62 million monthly pay recurring. We don’t expect that to move around a lot certainly in 2023, regardless of recessionary impacts or consumer demand because that’s an in-force block of recurring revenue. And then on the auto side, we are sitting on over $10.5 billion of unearned premium reserves that are going to roll through. The bulk of the earnings this year are on business that’s already been written. So, from that perspective, in ‘23, we feel really good about projecting forward. And to Richard’s point, really watching closely inflationary trends, good and bad, right, inflationary maybe upside if housing continues to perform well and then obviously, some pressure on auto and ESC and keeping a close eye on those two things.
Brian Meredith: Thank you.
Keith Demmings: Great. Thank you.
Operator: And that concludes our Q&A. I would like to hand back over to Keith and Richard for closing remarks.
Keith Demmings: Well, great. Just quickly, thanks everyone. Appreciate your time. As always, we are pleased with the quarter and the strong start we have had to the year and obviously very focused on delivering on all of our commitments for ‘23. We will look forward to reconnecting again for our second quarter call in August. And in the meantime, please reach out to Sean and Suzanne, if you have any other questions. And thanks everybody. Have a great day.
Operator: Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant’s First Quarter 2023 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Suzanne Shepherd, Senior Vice President of Investor Relations and Sustainability. You may begin."
},
{
"speaker": "Suzanne Shepherd",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our first quarter 2023 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Richard Dziadzio, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the first quarter of 2023. The release and corresponding financial supplement are available on assurant.com. We will start today’s call with remarks from Keith and Richard before moving into a Q&A session. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in yesterday’s earnings release and financial supplement as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to yesterday’s news release and financial supplement. I will now turn the call over to Keith."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Suzanne and good morning everyone. We are pleased by our first quarter results, which reflected better-than-expected performance within our Global Housing business and our ongoing focus on driving operating excellence across Assurant. The actions we announced in 2022 to simplify our business and real estate portfolio realign our organizational structure and accelerate the deployment of digital-first experiences are beginning to yield measurable results. While early, gross savings generated from these initiatives are helping to mitigate the impact of broader macroeconomic headwinds and fund additional critical investments in innovation and our talent. This was reflected in Global Lifestyle’s results for the quarter, which improved sequentially in line with our expectations. Our first quarter results also continued to demonstrate the leadership advantages of our well-diversified business portfolio and our global client base. We believe we are well-positioned to deliver on our financial objectives for 2023 and we will continue to prudently manage our capital to drive shareholder value. Looking ahead, we will maintain a steadfast focus on execution: first, by strengthening and expanding our global partnerships; second, by driving innovation and delivering on our digital-first vision to improve the customer experience; and third, by realizing savings from ongoing expense management efforts. Recently, we were recognized as one of America’s most innovative companies by Fortune, demonstrating the importance we place on finding new ways to serve our clients and fostering a culture of innovation and inclusion. Through consumer research and investments in emerging technologies, we develop new products and services to meaningfully enhance the consumer experience and drive competitive advantages across our key markets, including mobile, auto and housing. We continue to strengthen our large embedded base of businesses. In Global Lifestyle, we work with 15 of the top 50 most valuable global brands and provide protection and services for nearly 62 million mobile subscribers with a recurring monthly subscription service and we protect nearly 54 million automobiles across a wide range of distribution partners. Our scale supports both businesses to continue their track record of long-term growth. Our U.S. Connected Living business is expected to remain a solid growth driver, anchored by mobile device protection with marquee mobile carriers and cable operators. In addition, our trade-in business continues to be a strong contributor to overall mobile results. Our international results have begun to stabilize in line with our expectations even as many of the factors impacting growth last year continue to persist, including foreign exchange headwinds and lower business volumes. In Europe, we benefited from expense actions previously taken, leading to improved earnings when compared to the second half of 2022. Additionally, we renewed 8 key clients since the beginning of 2022, solidifying a strong foundation to support continued growth. In Japan, we are implementing actions to stabilize the impact from ongoing mobile subscriber declines and believe we are well-positioned in this critical market even as programs mature. In addition to our multiyear partnership with KDDI, we are growing our footprint through expanded relationships with other large Japanese carriers. We are leveraging our core mobile solutions and technology offerings to help optimize operations and launch new services. Moving to Global Auto, we are making steady progress integrating and leveraging recent acquisitions to support commercial success with new partnerships like CNH Industrial, which leverages the combined expertise of our legacy Assurant Lease and Finance business and the broad capabilities of our EPG acquisition. Outside of the U.S., we focused on expanding our share with OEMs. And in Latin America and Europe, we signed two new business partnerships in the quarter. Overall, in Lifestyle, while we remain cautious in the short-term, given ongoing global macroeconomic uncertainty, we continue to expect modest growth for the full year. Within Global Housing, we continue to simplify our focus on product lines where we have clear competitive advantages and scale. We operate a countercyclical market-leading lender-placed business that has generated significant cash flow and attractive returns over the long-term, while we invest to drive growth in our capital-light renters’ insurance business. Despite higher than expected cat activity this quarter, Global Housing had a strong start to the year as adjusted EBITDA, excluding cats, increased 7%. In homeowners, which is primarily driven by lender-placed, top line grew 16%, both from higher policy growth and higher average insured values and rates, partially offset by increased non-cat losses and cat reinsurance costs. Policy growth came from both new and existing clients. In lender-placed, our ability to drive higher premiums both through our inflation guard product feature and rate actions have helped to offset continued inflation impacts on claims, which remain elevated across Global Housing. Entering the second quarter, the impact of inflation on building materials and labor costs is beginning to show signs of improvement. As we consider the magnitude and pace of earnings recovery for Global Housing over the year, it will be important to see how ongoing loss experience improves over the next few quarters. Let’s turn to our enterprise outlook and capital. Reflecting on the quarter and current market conditions, we continue to expect to grow adjusted EBITDA, excluding reportable cats, by low single-digits this year. Adjusted EPS growth is still expected to trail adjusted EBITDA growth both excluding reportable cats, primarily reflecting higher annual depreciation expenses related to several strategic technology investments critical to executing our strategy, a higher consolidated effective tax rate compared to favorable rates in 2022, and the timing of capital deployment. From a capital perspective, we upstreamed $112 million of segment dividends in the first quarter and ended the quarter with $383 million of holding company liquidity. We have been carefully monitoring the broader business and macroeconomic environment as we consider capital deployment. We now expect to resume share repurchases later in the second quarter, but at modest levels given the ongoing market volatility. We expect the majority of share repurchases to be weighted toward the end of the year and maybe below 2022 underlying buyback activity. As we look ahead, we are focused on the continued execution of our vision to be the leading global business services provider supporting the advancement of the connected world. We believe our strong global client partnerships and our ability to innovate for more than 300 million customers will be critical to achieving our vision. I will now turn the call over to Richard to review the first quarter results and our 2023 outlook in greater detail. Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you, Keith and good morning everyone. For the first quarter of 2023, adjusted EBITDA, excluding reportable catastrophes, totaled $293 million, down $22 million or 7% year-over-year and 5% on a constant currency basis. While the results were lower than the prior year, they came in above our expectations, driven by stronger Global Housing performance. Adjusted earnings per share, excluding reportable catastrophes, totaled $3 million and $0.49 for the quarter, down 12% year-over-year, primarily from lower segment earnings, a higher effective tax rate compared to favorability in the prior period and a higher depreciation expense. Now, let’s move to segment results, starting with Global Lifestyle. The segment reported adjusted EBITDA of $199 million in the first quarter, a 12% decline year-over-year or a 10% decline on a constant currency basis. The decrease came from lower results in both Connected Living and Global Automotive, partially offset by higher investment income. Connected Living’s earnings were down 15% or 11% on a constant currency basis from decreases in extended service contracts and weaker international results. Extended service contract results were lower due to an increase in claims costs and in particular, relative to the prior year quarter, which included favorable claims experience. We expect a modest level of higher cost to persist during the remainder of the year, the level of which will depend on the broader inflation trends in the market. However, we have recently implemented rate increases with several clients, which should begin to flow through during the course of the year, mitigating the increase. In mobile, earnings were down as expected from softer international results, mainly in Asia-Pacific and unfavorable foreign exchange, both of which are expected to continue. U.S. mobile earnings were flat year-over-year as modest mobile subscriber growth in North America device protection programs from carrier and cable operator clients was offset by lower mobile trading results. Trade and margins were impacted by device mix from carrier promotions and slightly lower volumes, mainly due to the discontinuation of in-store service and repair. Sequentially, however, we are seeing improved mobile performance, including in the U.S. and Europe, as results benefit from expense management and more favorable loss experience compared to trends that emerged in the second half of 2022, while declines in Japan have started to stabilize. Turning to Global Automotive, earnings decreased $8 million or 9% and $5 million, excluding real estate joint venture gains from the first quarter. Similar to others in the industry, the auto business was impacted by a rise in severity from higher parts and labor costs that contributed to elevated claims. We expect to recover a portion of the higher claims cost over time through client contract structures though we expect elevated claims experience to persist throughout this year. The auto earnings decrease was partially offset by growth in the U.S. across distribution channels. And although higher claims costs across auto and extended service contracts are being driven by inflation, these businesses are also benefiting from higher investment income due to higher yields. Turning to net earned premiums, fees and other income, Lifestyle was up by $52 million or 3%. This growth was primarily driven by Global Automotive, reflecting strong prior period sales of vehicle service contracts. Connected Living net earned premiums fees and other income decreased 5%. This reflects an approximately $65 million impact from the previously disclosed new contract structures as well as premium declines related to mobile runoff programs. Excluding these contract changes in foreign currency, Connected Living’s revenues grew by 4%. The quarter benefited from growth in mobile subscribers in North America and higher contributions from extended service contracts. For full year 2023, we expect modest growth for Global Lifestyle, supported by the ongoing expansion of new and existing partnerships, particularly in Connected Living and accelerating expense savings throughout the year. We also expect increasing contributions from investment income and the positive impact from the actions mentioned to address rising claims cost. In terms of net earned premiums fees and other income for 2023, Lifestyle is still expected to grow modestly as growth in Global Automotive is partially offset by ongoing foreign exchange headwinds. Moving to Global Housing. Adjusted EBITDA was $68 million which included a $43 million increase in reportable catastrophes from severe weather and tornado events. Excluding reportable catastrophes, adjusted EBITDA was $118 million up $7 million or 7%. The stronger-than-expected results were driven by Homeowners’ top line performance, mainly from lender-placed policy growth as well as higher average insured values and premium rates. Policy growth was mainly from expanded loan portfolios of new and existing clients, although we do expect the client portfolio to run off our books as the year progresses. While non-cat loss experienced across all major products increased by $32 million, our performance in the quarter demonstrates our ability to more than offset the inflation impacts. Catastrophe reinsurance costs also increased in line with our expectations. In renters and other, earnings decreased from expected higher non-cat losses, which should continue throughout the year. For full year 2023, we continue to expect Global Housing adjusted EBITDA, excluding reportable cats, to grow due to improved performance in Homeowners, driven by top line expansion from higher rates and policy growth in lender-placed and by ongoing expense actions to be realized over the course of the year. We are monitoring potential changes in the reinsurance market as we place the remaining third of our reinsurance program in the coming months. Currently, we anticipate the cost to increase year-over-year, in line with our previous expectations. Lastly, we are not anticipating a significant improvement in lender-placed non-catastrophe losses until later in the year and continue to monitor the impact of inflation closely. Please also keep in mind that the second quarter tends to be a seasonally elevated period for non-cat losses. Moving to corporate. The first quarter adjusted EBITDA loss was $24 million, up $2 million driven by lower investment income. For the full year 2023, we continue to expect corporate adjusted EBITDA loss to be approximately $105 million. Given the market volatility over the last quarter, I also want to take a moment to discuss our investment portfolio. Investments cash and cash equivalents had a value of $9.3 billion at the end of Q1. The portfolio is high quality and diversified, reflecting our conservative investment philosophy. Fixed maturity investments in cash and cash equivalents represented 86% of our total portfolio. An estimated 94% of our fixed income securities are investment-grade rated. And overall, our U.S. regional bank exposure is modest. We also have commercial real estate investments across a number of investment vehicles with the overall portfolio performing well. Our assets are diversified across geographic regions and property type with low average security size and have attractive loan-to-value and debt coverage servicing ratios. For example, our commercial mortgage loan portfolio represents approximately 3% of our investment portfolio with approximately 130 loans with an average loan amount of about $2.3 million. The loan portfolio is highly diversified across the U.S., including a variety of property classes and with office buildings representing 11% or approximately $34 million of the loan portfolio and our real estate equity portfolio represents only 2% of our investment portfolio. It is also a diverse portfolio with only four office assets with a $26 million book value. We also have CMBS and REIT positions with 98% of those investments being investment-grade rated. While certainly not risk-free, we believe our investment portfolio is relatively low risk as it relates to current macroeconomic headwinds. Turning to holding company liquidity. We ended the quarter with $383 million. In the first quarter, dividends from our operating segments totaled $112 million. During the quarter, we issued $175 million in 2026 senior notes and redeemed a portion of the $225 million of senior notes due in 2023. We intend to redeem the balance of the notes on or prior to maturity in September. In addition to the $136 million of cash used for corporate and interest expenses, first quarter cash flows included $37 million of common stock dividends. For the year, we expect our businesses to continue to generate meaningful cash flow, approximating 65% of segment adjusted EBITDA, including reportable catastrophes. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance, and rating agency and regulatory requirements. As Keith mentioned, given our performance in the first quarter and our current expectations for cash generation, we plan to resume modest buybacks as we exit the second quarter. We will continue to monitor the macroeconomic environment and adjust accordingly. In summary, our performance in the first quarter provides us with the confidence in our full year outlook. And while macroeconomic uncertainty will likely continue throughout the year, we believe the strength and momentum of our businesses and strong cash flow generation are powerful differentiators for Assurant. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Your first question is coming from Tommy McJoynt from KBW. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Tommy."
},
{
"speaker": "Tommy McJoynt",
"text": "Hey, good morning, guys. Thanks for taking my questions here. So the first one, with regards to your comments on the claims cost in the Lifestyle business, so in the past, you’ve distinguished between the lifestyle partners where you hold the ultimate risk and the partners where the risk ultimately goes back to the partners. Could you give into a bit more detail on the timing of how some of those unfavorable claims could weigh on earnings in the current period but ultimately get recovered in the future periods. And what is the magnitude of those swings? Just from our standpoint, should we kind of see these numbers kind of ebb and flow in the numbers."
},
{
"speaker": "Keith Demmings",
"text": "Yes. So maybe I can try to take that and then certainly, Richard, feel free to add in. I’d probably point to a couple of things. I’ll set aside housing, which I’m sure we will talk about later in the progress there from an inflation perspective. Nothing really to report on the mobile side. So a lot of stability mobile-ly – in terms of the mobile business around severity. So that’s come in line fairly nicely in the last couple of quarters. We signaled some pressure on the ESC. So the retail service contract side of the business. We’ve actually been taking rate increases with our partners adjusting program coverages, but also putting rate in place. So we saw a little bit of pressure in the first quarter, which is continued, I’d say, over the last three or four quarters or so. We expect that to moderate over the rest of the year. So we’ve taken action that will start to benefit through in terms of the earned premium this year. And hopefully, that will slow down that impact over the rest of ‘23. Where we are seeing a little more pressure is on the auto side, we talked about this a little bit last quarter, but certainly elevated severities in the repair shops, both in terms of parts costs and labor costs. We’re definitely seeing that come through in our performance. As you rightly suggested, we do share risk with a lot of our partners. So the vast majority of our deals are either reinsured or profit shared. So we’re keeping a residual amount of that severity risk. We do recover that in a lot of cases through repricing with our clients, whether contractually required, which is often the case or just with the partners, we will work to try to achieve target loss ratios over time. So we’ve already started taking pricing actions. We started taking certain actions more than 6 months ago around the auto business, and that should benefit us as we flow through probably more helpful in ‘24 than ‘23, we will definitely still see some pressure this year in the auto results. We do expect to see progress in auto over the balance of the year in ‘23. We are seeing good growth in revenue. We’re also seeing help in terms of the investment income portfolio, and those are helping to offset some of the pressure on severities."
},
{
"speaker": "Tommy McJoynt",
"text": "Thanks. And then just my second question, what specifically are you seeing that’s different from previously that gives you comfort to resume the buyback assumingly just maybe a month or two ahead of prior plan? And how much of that is attributed to just looking at where the stock is trading relative to your assessment of intrinsic value?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I think as we sit here today, we’ve got a lot of confidence in our cash flow generation as a company, the strength of the business model. And I would say the positive momentum that we’ve seen in the housing business, the fact that we are seeing improving housing cost inflation indicators. We obviously had a really strong fourth quarter that repeated in the first quarter. We’re seeing some improvement in terms of inflation, and that gave us more confidence as we think about the full year outlook and our ability to deliver against that. And to your point, we’re starting a little bit earlier but we do want to capitalize on the fact that we think our stock is attractively valued, and we feel like there is a good opportunity for us to get back into the market and be more consistent with our buyback activity as we move forward."
},
{
"speaker": "Tommy McJoynt",
"text": "That makes sense. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thanks, Tommy."
},
{
"speaker": "Operator",
"text": "Your next question comes from the line of Mark Hughes from Truist Securities. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Thank you. Good morning. The renters insurance business here, your number of renters has held up pretty well, but your revenue has dipped a little bit. Is that a mix shift? Could you give a little detail on that?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, sure. I would say a couple of things to unpack with renters. Broadly, our policy counts to your point, are pretty steady over the last year we’re seeing average premium per policy, pretty steady, and really growth in the PMC channel, we’re seeing double-digit revenue growth in our PMC channel, offset by some softness on the affinity side. When you do look at the revenue for the first quarter, a couple of things I would point out. First of all, we did have an adjustment that flowed through the premium line. If I back that out, our revenue would be roughly flat in the quarter. So I think if you take something away from renters, pretty stable, consistent performance underlying revenue pretty constant compared to Q4 compared to first quarter last year. We think there is an opportunity to drive long-term growth within this business. The second thing, we did see some favorability in the quarter from NFIP, where we’re getting paid to administer claims on behalf of the U.S. government. That does not flow through the revenue line. It flows through as a ceding fee that we receive and effectively a contra commission. So the real headline from my perspective around renters is well-positioned, steady results. The loss ratios are certainly normalizing in line with what we saw in the second half and still believe we have good long-term opportunity to grow that business."
},
{
"speaker": "Mark Hughes",
"text": "And then on the Connected Living, what’s your assessment of the amount of marketing or advertising, advertising the norm around 5G programs kind of feeding into your mobile device count, maybe feeding into your fee income driven by the upgrade and logistical operations. Are you still seeing the same tempo? How do you see that play out over the coming years?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So we certainly had a pretty high watermark in 2022 with respect to trading activity, to your point, a lot of advertising around 5G. We saw pretty consistent volumes in the first quarter so if you strip out the impact of service and repair within that device to service line, trade-in volumes are pretty constant in Q1 versus Q1 last year. We did see a little bit of margin pressure around the mix, the mix of services we provided, the clients that have flowed through. But pretty steady from that perspective, I’d say it’s still an important part of the ecosystem, clients used as an important tool to attract customers and the marketing tends to ebb and flow and very much driven by the competitive state, particularly within the domestic mobile business. The second thing I would highlight is just the strength of our device protection business, in particular in the U.S. If you look at our top clients, and we operate with obviously one of the major mobile operators, two major cable operators picked up 84% of all net ads for postpaid customers in Q1. So our clients are growing. We’re obviously participating in that growth, and that will afford us opportunity to do more services and add more value over time."
},
{
"speaker": "Mark Hughes",
"text": "Thank you very much."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "Your next question is coming from John Barnidge, Piper Sandler. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, John."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Appreciate the opportunity. If we could stick with the auto business, I know there is an ability to recoup part of the deficit, but it can take a number of quarters to do so, if I’m understanding that correctly. How large is the deficit and how much of that will recruitment will leak into ‘24? Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Yes. The deficit isn’t that large. We’re obviously taking action and have been taking action now for a couple of quarters to make sure that, we are in the right side that, as we move forward. As I said, I think, we will see a little bit of pressure over the next three or four quarters, offset by the strong growth in the investment income. I definitely expect to see some of that recovery coming through in ‘24. And to your point, if I think about where we’ve seen some pressure in a good amount of the cases, we’re actually going to recover that deficit on an inception-to-date basis. Where in another cases, we will achieve target loss ratios on new business. We may not get historical losses back. But there is an ability to actually recover historical losses, to your point and recapture deficits. So, feel really good about how we are positioned in auto. We work closely with our clients on pricing. We don’t require regulatory approvals to make pricing changes. So, it’s really just working in partnership with our clients to do that. We have been dealing with this for 20-plus years as an organization, and we are very good at trying to find creative solutions with our clients to normalize results over time."
},
{
"speaker": "Richard Dziadzio",
"text": "And I would just add too, John. I mean the other side of that, as Keith mentioned earlier in the remarks is that we are getting investment income. So, what we are seeing on the claims costs rising in auto and extended service contracts is just part of the inflationary environment, prices going up, but also interest rates have come up, which is part of what you are seeing in the investment income increase during the quarter."
},
{
"speaker": "John Barnidge",
"text": "Appreciate that color. And then on pricing increases, I would imagine another round for inflation guard will be coming in July. Am I correct in thinking it won’t be nearly the same degree as a year ago, but should benefit the overall premium profile?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, that’s right. And if we look at the core logic industry factor for inflation around housing, materials and labor. And if you look at where it was April 1st, last year, it was 16%. If you look at that this year, it’s just a little over 3%. So, a much more modest adjustment to average insured values, which obviously, it will have less of an impact on rate, but I think it’s more positive in terms of the health of the broader market. Seeing inflation rates normalize is very important for the performance of the business and obviously trying to keep premiums manageable from a consumer perspective. So, I actually feel really good about what we are seeing from CoreLogic. It matches up closely with a lot of the data that we look at within our business. So, feel good about how we are positioned there."
},
{
"speaker": "Richard Dziadzio",
"text": "And just the other thing to add to that, John, and I am sure you are probably aware of it, but the 16% last year that takes a number of months to roll through as the policies renew themselves and new policies come in and so forth. So, that does take some time, just as when the 3% comes in, the first policies come in July when they renew that increase will come into place. So, it’s a little bit averaging as we get through the course of the year."
},
{
"speaker": "Keith Demmings",
"text": "Great. Yes, it’s a great point. We haven’t fully written in the 16% AIVs that will fully write in through June, and then it will take 12 months from there to fully earn through the book. So, you are still going to feel significant rate and premium growth acceleration over the course of this year, regardless of what factor goes in, in July."
},
{
"speaker": "John Barnidge",
"text": "Thank you for the answers. Appreciate it."
},
{
"speaker": "Keith Demmings",
"text": "Great."
},
{
"speaker": "Richard Dziadzio",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Your next question is coming from Grace Carter, Bank of America. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Good morning Grace."
},
{
"speaker": "Richard Dziadzio",
"text": "Good morning Grace."
},
{
"speaker": "Grace Carter",
"text": "Hi everyone. So, I was wondering, just given that you said that the first quarter came in above expectations, but guidance remains flat. I know you all called out some seasonality in housing losses in the second quarter and obviously, inflationary pressure on claims cost across the book, but are there any sort of timing items or one-off favorable items in the first quarter that we need to consider when I am trying to square the first quarter performance versus the full year guidance?"
},
{
"speaker": "Keith Demmings",
"text": "You want to start on that, Richard?"
},
{
"speaker": "Richard Dziadzio",
"text": "Yes. No, I think your question was well-phrased. I think we do see, as the year goes on, we can see some seasonality in claims and typically, Q1 is a little bit lower. We will see what happens. Obviously, there is inflation that’s coming down. So, that can help the claims cost due. We had some good investment income that depends what happens with interest rates as the year goes on. We did not have any real estate sales or gains in the numbers. So, there is no one-offs in that area as well. We have some good PIF counts in housing policies in force. And we do – we did mention that we see a client rolling off as the year goes down – a year goes on, that might temper the overall increase in policies in force. So, I would say more business than usual, nothing big in the first quarter to call out, Grace."
},
{
"speaker": "Grace Carter",
"text": "Okay. Thank you. And I think you had previously mentioned the hard market in certain states, including Florida, as driving some of the growth in the housing book. Is there any impact that you all expect from the recent reforms in Florida on growth levels going forward or more on margins?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. Maybe I will start on that, Richard, and certainly, you can add in. I would say it’s really early in terms of the Florida reforms. I think long-term, it’s going to be really important for that market to improve the competitiveness and improve pricing for consumers without question. So – and we are starting to see lower AOBs coming through. So, that will take time to work through, and we will see how that emerges. But I do feel good about how that’s positioned for the future. In terms of the hard market, I would say we certainly saw PIF count grow in Florida last year. So, we had about 14,000 new policies over the course of the year because I would say largely the hard market, some of it from new clients, but a good amount from the hard market. We actually saw that begin to reverse a little bit, Grace in the first quarter. So, our PIF count in Florida actually went down a little bit. And I think that’s a sign of potentially more competitiveness into the marketplace. So, we won’t be monitoring that, but we are not expecting Florida to be a big driver of PIF from the hard market as we look forward in the rest of the year."
},
{
"speaker": "Grace Carter",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] And your next question comes from the line of Brian Meredith from UBS. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Good morning Brian."
},
{
"speaker": "Brian Meredith",
"text": "Yes. Thank you. Good morning, how you are all doing? So, a couple of questions here for you. The first one, you kind of described Japan starting to get a little bit better, Europe start to get a little bit better, when do you think we could start to see some year-over-year growth in global covered mobile devices in Connected Living?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, it’s a great question. So, let me just address Europe quickly, and then I will talk about Japan. So, I am really pleased with the progress that our team has made in Europe, and we had a pretty significant turnaround in the first quarter. A tough second half of last year without question, but significantly improved results in the first quarter and a lot of that was due to the expense actions that our team took in the back half of 2022. So, I think we are well-positioned there and expect strong stable results in Europe over the course of the year. And I would say Japan, that’s been the market where we have seen some subscriber declines. Everywhere else has been relatively stable. The U.S. historically has been growing for us, so that – I expect that will continue. And I would say in Japan, a couple of things that are really important. Number one, it’s a really important market for the mobile business. I think we are incredibly well-positioned and we have made a lot of progress in that market. And that’s progress around investing in local talent, capabilities, technology. We actually now have relationships with all four carriers in the Japanese market. So, that creates interesting opportunities to innovate and drive growth. The subs are definitely down quarter-over-quarter. And I would point to two things and give you a little bit more color on that. One, we see slightly lower attach rates more recently. And that’s mainly because customers have migrated to more affordable devices. Because of foreign exchange, devices became more expensive last fall, and we have seen a little bit lower attach on less expensive devices in older models, but nothing of concern. And then the second thing, which is actually the bigger driver, when we launched in Japan in 2018 with our initial device protection product, it had a 4-year term. So, a monthly pay product for 4 years as opposed to an Evergreen structure. And that was appropriate at the time in the Japanese market. After a couple of years, we actually moved to an Evergreen product, what you are seeing in Japan is some of that transition rolling through where some of those 4-year contracts are hitting their end date and the cancellation rate plus those contracts ending is a higher number than the new ads that we are putting on the book. I would say, before the end of this year, that will be fully gone and then we will be positioned in Japan for growth going forward. And to my earlier point, we expect to continue to grow U.S. mobile as we have for many years."
},
{
"speaker": "Richard Dziadzio",
"text": "And I would just add to – yes, I would just say, Brian, in addition to the sub count, we have always talked about adding services to clients. So, you have the sub count and then you have what’s the services inside that. So, as we go on, we continue to innovate the products and innovate the services going into the client to provide us more revenue per client, I would say as well."
},
{
"speaker": "Brian Meredith",
"text": "Got it. That’s helpful. And then my second question, I am just curious, going to capital management. I appreciate probably starting to buy back a little more stock at the end of the second quarter. But given the cash flow you are expecting and given the excess capital already at the holding company, why modest, right? I mean I understand there is a little macro uncertainty, but you have got a pretty conservative investment portfolio, as you pointed out, cash flows look like they are pretty strong. Why wouldn’t you take advantage of the really inexpensive valuation, your stock more aggressively at this point?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. And I think it’s as simple as we are just trying to be prudent. We work very disciplined as a company with the way we think about capital management and we are trying to get more information just in terms of how the macro picture is going to play out. Interest rates, whether there is going to be a recession, if so, when does that start to kick in? So, I just think we are trying to be prudent with our thinking on that and certainly expect as we get more information to be able to deploy more capital. But Richard, feel free to add anything else."
},
{
"speaker": "Brian Meredith",
"text": "Outlook, also can you add does the outlook contemplate a recession?"
},
{
"speaker": "Richard Dziadzio",
"text": "When we look at the outlook, we do take into account, for example, more I would say, a decrease in inflation as the year goes on. We don’t take into account when we are projecting that there is any sort of hard landing of things. So, we do take into account, for example, when Keith was talking about in the conversation we had on claims service, the service charges, the claims costs going up. We do take into account that, that could continue to go up during the year when we reinforce our outlook for the quarter. In terms of capital, really what Keith was saying is right on, is that we are just trying to be prudent. When you look at the macroeconomic environment today and you look at the shaky what’s going on in some of the inflation aspects and the Fed increasing rates and the banking industry and things going on just generally, I think we are trying to be prudent and just be cautious about the steps we take. I agree with you. We have a – we are in a strong financial position. We have got a strong balance sheet. We have got a conservative investment portfolio. There is nothing today that we are sitting on looking at our investment portfolio that we are worried about, although we are keeping an eye on everything so to speak. So, it’s really from just being prudent to see how things play out over the next couple of months. But we do see us increasing the share buybacks towards the end of the year if things play out okay on the number of things we just talked about."
},
{
"speaker": "Keith Demmings",
"text": "Yes. And maybe just a little bit more color on the recession question and how we think about that. We are certainly updating our views for the full year to take into account all of the trends that we are seeing within each of our lines of business. So, there is no doubt that we are paying close attention and modifying as appropriate there. I am not having a crystal ball, but certainly we can see some of those trends emerging. I would say a couple of things, though. Number one, we haven’t assumed any change in placement rate related to a recession. So, we haven’t banked on the idea that if the economy gets tougher, we will see placement rates evolve over time. So, that we have kept relatively static, and we will see how that emerges. And then I would just remind you on the Lifestyle business, a lot of our mobile economics were driven by the in-force subscribers that we have, which is $62 million monthly pay recurring. We don’t expect that to move around a lot certainly in 2023, regardless of recessionary impacts or consumer demand because that’s an in-force block of recurring revenue. And then on the auto side, we are sitting on over $10.5 billion of unearned premium reserves that are going to roll through. The bulk of the earnings this year are on business that’s already been written. So, from that perspective, in ‘23, we feel really good about projecting forward. And to Richard’s point, really watching closely inflationary trends, good and bad, right, inflationary maybe upside if housing continues to perform well and then obviously, some pressure on auto and ESC and keeping a close eye on those two things."
},
{
"speaker": "Brian Meredith",
"text": "Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thank you."
},
{
"speaker": "Operator",
"text": "And that concludes our Q&A. I would like to hand back over to Keith and Richard for closing remarks."
},
{
"speaker": "Keith Demmings",
"text": "Well, great. Just quickly, thanks everyone. Appreciate your time. As always, we are pleased with the quarter and the strong start we have had to the year and obviously very focused on delivering on all of our commitments for ‘23. We will look forward to reconnecting again for our second quarter call in August. And in the meantime, please reach out to Sean and Suzanne, if you have any other questions. And thanks everybody. Have a great day."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 4 | 2,024 | 2025-02-12 08:00:00 | Operator: Welcome to Assurant’s Fourth Quarter and Full Year 2024 Conference Call and Webcast. At this time all participants have been placed in a listen-only mode and the floor will be opened for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may now begin.
Sean Moshier: Thank you, operator, and good morning, everyone. We look forward to discussing our fourth quarter and full year 2024 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the fourth quarter and full year 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in the earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We’ll start today’s call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings.
Keith Demmings: Thanks, Sean, and good morning, everyone. 2024 represented another strong year for Assurant. I’m incredibly proud of the performance of our teams across the company, whose commitment to delivering for our clients and customers enabled us to achieve 15% adjusted EBITDA growth and 19% adjusted earnings per share growth, both excluding reportable cats. Strategic investments in our people, client partnerships, technology and capabilities and targeted actions to drive improved performance across key areas of the business, position us to continue to outperform and deliver exceptional value through our products and services. Our people are at the center of everything we do, and our performance is made possible by our world-class culture. Our culture is how we attract and retain incredible talent to deliver for our customers. We’re extremely proud of the recognitions we’ve received, highlighting our commitment to innovation and sustainability, while supporting and empowering our employees. Our competitive advantage comes from the ongoing dedication of our global workforce and leadership team to drive new business through innovative solutions while elevating the customer experience and deepening existing partnerships. In Global Lifestyle, we had an unprecedented year of client wins and renewals, particularly within Connected Living. We continue to invest in new innovative client programs and leading-edge technology including the incorporation of automation, robotics and AI at our device care center outside of Nashville. We recently partnered to launch T-Mobile’s Protection 360 HomeTech product. This new offering provides protection for an unlimited number of WiFi-enabled devices and electronics, while providing premium tech support to consumers. This critical new product represents another strategic growth vector and underscores the long-term opportunity presented by the convergence of broadband and mobile in the connected home. By prioritizing investments in programs and capabilities, we generated significant momentum and plan to execute on additional opportunities. In Global Automotive, we made progress in stabilizing earnings through targeted actions to address elevated claim costs in our vehicle service contract business and our guaranteed asset protection product. We continue to be optimistic about the long-term outlook for this business. Before discussing Global Housing, I want to first share that our thoughts are with everyone who is impacted by the events of the last few months, including the California wildfires. In these times, we have a critical role to play in our customers’ journey. In Southern California, we’re focused on making it quick and easy for policyholders to file claims online on the phone or in-person at mobile claims centers, accelerating customer payments. We remain proud of our role in removing the risk of uninsured loss for lenders, investors and homeowners through our housing offerings. As we look at housing’s results, we delivered sustained outperformance in 2024, benefiting from the strength of our homeowners and renters businesses, including the rollout of technology innovation to enhance our customer experience. Leveraging the segment’s differentiated advantages and efficiency initiatives, we have more than doubled our adjusted EBITDA in the past two years, growing the business from just over $400 million in 2022 and to over $900 million in 2024, excluding cats. Even including cats, housing has outperformed the P&C industry. Over the past five years, we’ve achieved an average return on equity of over 22% and our increased scale and efficiency has driven a 10-year average combined ratio of 89%, compared to the broader P&C market of 95%. With clear outperformance and expected growth ahead, the business has the opportunity to be better appreciated from a valuation perspective. 2024 was a remarkable year of commercial success across Assurant, marked by significant client momentum as we enter 2025. Strong execution enabled us to capture new opportunities while solidifying and extending key client relationships. Across our global footprint, we had several key wins, including Australia’s largest mobile carrier and two major financial institutions in the U.S. We renewed client relationships and reinforced our position as a leader and preferred partner throughout our businesses. In our mobile business within Connected Living, we completed major renewals in 2024 that represent three of the top five largest mobile carriers in the U.S. More recently, we also secured a multiyear renewal with a large mobile carrier in Japan. We’ve now renewed our four largest mobile clients in the last year, who represent over 40 million mobile devices protected, a testament to our ability to execute mobile protection programs across the globe. Within housing, we renewed 10 lender-placed clients, representing over 17 million loans tracked. And in renters, we completed renewals of 2 top 10 property management companies as we continue the rollout of key technology-enabled services like Cover360 and Assurant TechPro. These help increase policy attachment while enhancing the experience of our partners and renters. Ultimately, the continuing demand for our offerings and solutions, combined with our strong competitive edge, creates commercial momentum that will extend into 2025 and beyond. We believe in the power of our unique business-to-business to consumer or B2B2C business model. At our core, we’re a premier global protection company that partners with the world’s leading brands to safeguard and service connected devices, homes and automobiles, utilizing data-driven technology solutions to provide exceptional customer experiences. The common thread across our entire enterprise is our powerful B2B2C distribution strategy in both lifestyle and housing, where we have strong leadership positions in attractive markets. Through our differentiated distribution, strong public Fortune 500 company financials and unwavering emphasis on client transparency, we create deep partnerships with leading brands across the world. In addition, our commitment to continuously enhance customer experience through customized solutions that wrap around our protection products is built on decades of investment and ongoing innovation. This allows us to deeply integrate our technology and platforms with clients, supporting long-tenured partnerships and exceptional customer experiences. Since 2019, we’ve increased adjusted EBITDA by over $630 million or a 12% compounded annual growth rate while growing adjusted EPS by over $11 per share or an 18% compounded annual growth rate, both excluding catastrophes. As we look at our performance versus the broader P&C industry, we’ve continued to outperform the S&P 1500 P&C index median, both excluding and including cats, when comparing across adjusted earnings and EPS growth. Our compelling track record of outperformance includes eight consecutive years of profitable growth, demonstrating resiliency through various macroeconomic environments. In addition, our portfolio benefits from earnings and capital diversification across geographies and business lines, positioning us to continue to invest in and achieve future growth. We believe we’ll remain an attractive investment with a compelling path ahead, and we believe we should be valued at a premium to the S&P 1500 P&C index median. Before turning it over to Keith Meier to share additional insights on our results and review business trends, I want to highlight our strong momentum heading into 2025 and how we plan to deliver future growth. First, we’ll focus on executing, optimizing and scaling significant new partnerships and program launches throughout lifestyle and housing, where we invested last year. Overall, we believe our 2024 investments should be fully earned back through 2025 with an attractive one-year payback. Next, we’ll support incremental investments for new launches in our pipeline and accelerate emerging growth opportunities. In addition to our connected home product launch, we have new opportunities with several clients particularly in global lifestyle, and we look forward to sharing more details over the coming quarters. And finally, we’ll drive financial performance and operational excellence. We believe we’re well positioned to meet our 2025 objectives given the commercial momentum we have within Connected Living, long-term tailwinds in Global Auto and sustained outperformance in Global Housing. Overall, our ability to deliver for our clients, drive efficiencies across our operations and focus on data-driven technology solutions should enhance our position as a leader in the businesses that we operate and extend our compelling track record of financial performance. I will now turn it over to Keith.
Keith Meier: Thanks Keith. And good morning everyone. I’m proud of what we achieved in 2024, including the financial results delivered by our incredibly strong team. For the year, we increased adjusted EBITDA by 15% to over $1.5 billion, while growing adjusted earnings per share to over $20, both excluding cats. We have continued our long-term track record of growing earnings consistently demonstrating the power of Assurant. Our performance was highlighted by another exceptional year in Global Housing, where we delivered double digit earnings growth overall for the second consecutive year. Within Global Lifestyle, Connected Living grew 9% excluding $25 million of investments and $12 million of unfavorable foreign exchange. More importantly, we set a solid foundation for growth as we enter 2025. In Global Auto, targeted actions in our vehicle service contract and GAP products stabilized earnings in the second half of 2024 and we are excited about the trajectory of the business as we move into 2025. I’ll begin by highlighting key trends we saw in the fourth quarter. From there, I will walk through our 2025 outlook as we look to deliver our ninth consecutive year of profitable growth. Beginning with our fourth quarter enterprise results, adjusted EBITDA and earnings per share both increased 13% excluding cats led by Global Housing. Looking at capital, Global Lifestyle and Global Housing continue to generate significant cash flow, as we up-streamed nearly $250 million from our segments in the fourth quarter and over $800 million for the full year. We returned $161 million of that cash to our shareholders in the fourth quarter, which puts our total capital returned to shareholders for the year in excess of $450 million, including $300 million of share repurchases. Our buyback level was at the top end of our expectations for the year. At the same time, we ended the year in a strong capital position with $673 million of liquidity at the holding company. This past November, we increased our common stock dividend by 11%. The increase represented the 20th consecutive year we have raised our dividend since our IPO. In addition, we were just added to the S&P High Yield Dividend Aristocrats Index earlier this month. We are incredibly proud of this achievement and expect our strong capital returns to continue as part of our balanced capital deployment framework. Turning to our segment results, beginning with Global Lifestyle, fourth quarter adjusted EBITDA was down 6% compared to last year or 5% on a constant currency basis. In Connected Living, earnings were roughly flat on a constant currency basis. Fourth quarter results included $4 million of incremental investments related to new capabilities and client partnerships that are expected to drive future growth. Investments in 2024 are already paying off as earnings from recently launched clients, including card benefits within our Financial Services business have begun to contribute to Connected Living’s fourth quarter performance. As Keith mentioned, we are now focused on scaling these partnerships for growth. These contributions were offset by lower U.S. trade-in programs. Year-over-year, trade-in results were impacted by business mix and lower volumes, however, we did see sequential trade-in growth as expected. Turning to Global Auto, in the quarter, results were down 11% compared to last year. The year-over-year decline was largely driven by lower real estate joint venture partnership income of $13.8 million. Fourth quarter 2023 included a more significant real estate joint venture gain compared to a smaller gain this year. Excluding this, results in Global Auto were largely flat as higher investment income was partially offset by elevated loss experience in both our GAP product and our vehicle service contract business compared to last year. Importantly, we continue to see claims experience remain stable from last quarter as previously implemented program changes and rate increases continue to earn through our book, leading to a sequential improvement in earnings. In terms of revenue, our net earned premiums, fees and other income for Global Lifestyle grew 2%, or approximately 6% on a constant currency basis. And excluding $85 million of favorable non-run rate premium adjustments in Global Automotive in fourth quarter 2023. Moving to Global Housing, fourth quarter results were strong building on an exceptional performance for the year. Adjusted EBITDA was $225 million which included $50 million of cat losses largely from Hurricane Milton. Excluding cats, adjusted EBITDA increased 32%. In the quarter, we saw a continuation of robust policy growth in homeowners from higher placement rates given voluntary insurance market pressure. As these additional policies are placed, we benefit from the significant expense leverage we have driven in this business from our technology investments. Earnings growth in the quarter also included impacts from favorable non-catastrophe losses due to lower frequency as well as lower catastrophe reinsurance costs. While we had favorable prior period reserve development of $38 million in the quarter, it was relatively consistent with fourth quarter 2023 and did not impact year-over-year growth trends. Within our Renters business we continued to benefit from strong results in our PMC channel which achieved its tenth consecutive quarter of double digit gross written premium growth. Now let’s discuss our outlook for 2025. We expect full year adjusted EBITDA and earnings per share to increase modestly, both excluding cats. Overcoming $107 million of favorable prior year reserve development in Housing’s 2024 results. Excluding the significant favorable PYD in 2024, strong underlying growth trends are expected to deliver high single-digit earnings and EPS growth, both excluding cats. Our outlook includes our forward view of foreign exchange rates and interest rates, but does not factor in potential impacts from tariffs including those related to claims costs or consumer demand. While tariffs could potentially affect claims costs, we believe we are well positioned to react quickly to address potential impacts. Over time, our business model has had a proven ability to deliver in the face of various economic environments and cycles. Looking at our segments for 2025, we expect Global Lifestyle growth driven by higher contributions from Connected Living and Global Automotive. Growth is expected to be partially offset by an unfavorable impact from foreign exchange rates, as well as investments in new partnerships and programs in 2025. Combined, we expect foreign exchange and incremental investments to mute growth by a few percentage points. Turning to Global Housing, we expect EBITDA excluding cats to decline modestly, given the $107 million of favorable prior year reserve development seen in 2024. Excluding the impact of prior year development in 2024, on an underlying basis, we expect strong Global Housing EBITDA growth in 2025. As a reminder, our 2025 outlook does not contemplate additional year development. Underlying growth is expected to be driven by our Homeowners business which will continue to benefit from lender placed policy growth and expense leverage. For the recent wildfires in California, we remain focused on settling claims and helping our policyholders navigate through the event. Reportable catastrophes from the California wildfires are expected to approach or slightly exceed our per event catastrophe reinsurance program retention of $150 million. We’ll provide a further update in May as we learn more and continue to settle claims. In terms of other impacts to 2025, we are working through the placement of our catastrophe reinsurance program which will be effective on April 1. We expect a similar structure to our 2024 program, maintaining robust coverage at both the top and bottom end of our program. As the program terms are finalized, we will also get greater insights into our expected cat load for the year. We will provide an update in May on expectations which will be inclusive of our California Wildfire estimates. Our capital objectives for 2025 are consistent with prior years’ as we focus on maintaining balance and flexibility to support new business growth, while returning excess capital to shareholders. From a share repurchase perspective, our expected range for 2025 is between $200 million to $300 million subject to M&A, as well as market and other conditions. This range accounts for our estimated impact from the California Wildfires. Of course, we will continue to make sound capital allocation decisions over the course of the year as our track record has shown. Through February 7 we we’ve repurchased $24 million of shares. We expect buybacks to be more consistent throughout the year compared to back-end weighted in prior years driven by our confidence in our strong capital position and cash flow generation. And finally, speaking of cash flow generation, we believe Assurant is differentiated compared to the broader P&C industry given our unique lifestyle and housing portfolio, which creates strong capital efficiencies and the ability to reinvest for growth. In 2025, we expect to continue to generate meaningful cash flows aligned with our recent performance. Overall, we are proud of our consistent outperformance and feel well positioned to continue our growth trajectory in 2025. With that operator, please open the call for questions.
Operator: The floor is now open for questions. [Operator Instructions] Our first question comes from Mark Hughes with Truist. Please unmute your line and ask your question.
Keith Demmings : Good morning, Mark.
Mark Hughes: Good morning, Keith. I muted myself and then unmuted myself. Morning. On the Homeowners business, the placement rate has been looking quite good. Can you talk about the – what is a voluntary versus the lender placed? And do you still see the same dislocation in those markets that’s been pushing the voluntary, presumably, how much momentum does that give you for 2025?
Keith Demmings : Yes. Great question, and thanks for that. So I would say a couple of things. We’ve definitely seen really strong PIF growth on lender place throughout the year. That trend continues certainly in the fourth quarter. Year-over-year, we’re up 16% in terms of policies in force. And if I simplified that, I’d probably say a third of that is client growth and loan movement within clients. A third of that is California due to the hardening market and then the other third is the rest of the country growth from a similar dynamic. So we’ve definitely still seen hard insurance markets, creating opportunity for policy growth on our book of business. And we’ve seen a lot of diversification as well across geographies. So I think that likely continues. Certainly, the trend was pretty consistent in fourth quarter as we saw for the first three quarters. So expect some continued growth there, probably not at the same level that we’ve seen, but certainly feel good about the momentum overall in housing.
Mark Hughes: Then in Global Lifestyle, how do we think about the top line growth? Just kind of broadly, you’ve given good guidance on EBITDA. You’ve given some thoughts about customer growth, that sort of thing, but how do we think about top-line growth maybe in 2025 or just more broadly in lifestyle?
Keith Demmings: Yes. I mean if I think about lifestyle, the first thing I would highlight, and we covered it in the prepared remarks, but we are particularly excited on the Connected Living side, securing our mobile clients is really, really important and so fundamental to the business long-term. It then allows us to focus more energy with our partners to drive growth, to launch new products, to optimize customer experience. There’s a lot of energy around making sure we’re optimizing all the buy flows and touch points to serve consumers. So, I think that will be a catalyst for continued momentum certainly, on the Connected Living business, we saw Chase come on in the fourth quarter. That’s going to obviously drive financial services growth throughout the year. So I do think we’re well positioned. We’ve had pretty consistent lifestyle growth in terms of the top-line for the last few years. I think that growth continues as we move forward. And then in auto, it’s about the loss recovery and our ability to continue to see that mature and feel really good about how the second half of the year stabilized, obviously, more road to go, but feel like we’re well positioned. But Keith, anything else?
Keith Meier: No, I think it really speaks to the momentum that we have and the opportunities that we have as we look forward to 2025. We’ve talked about making some investments in 2024, and we certainly expect to do that again in 2025. It’s because of the momentum we’ve got in our markets, especially in Connected Living. So we certainly look forward to sharing more of those updates as we go through the year.
Mark Hughes: And one final quick one. The ForEx headwind for 2025, I think you said, with ForEx and investments a few percentage points. How about ForEx specifically?
Keith Demmings: Yes. I think we’d probably say, foreign exchange, a couple of points of headwind. In terms of the investments, probably one to two points. If you think about 2024, just to kind of create context, we had $25 million of incremental investments. Roughly $10 million of that was Depot automation that we’ve talked about and the other $15 million or so, roughly two-thirds was client-related launches. So as we look at 2025, probably somewhere maybe approaching a similar level of investment in clients maybe slightly below. So we’ve got given the 1% to 2% headwind relative to lifestyle overall. But we do have some good things in the hopper with clients, new clients, existing clients, new product launches. And we’re certainly excited to update as we go through the year.
Mark Hughes: Thank you.
Operator: Our next question comes from Jeff Schmitt [William Blair & Company]. Please unmute your line and ask your question.
Keith Demmings: Good morning, Jeff.
Jeff Schmitt: Can you hear me?
Keith Demmings: Perfectly.
Jeff Schmitt: Hi good morning. So the placement rate in housing, just one more question on that. Are you seeing a lot of insurers fleet, California after the fires. So could we maybe see that kind of jump in Q1?
Keith Meier: Yes. And I think overall for California, Jeff, there was a moratorium put on in California so that the insurers would not be leaving, the wildfires just taking place. So we think that will temper some of that for a while. And then I’m sure that will open back up later. But for right now, in the short term, I would say, we don’t expect a lot of exits from the state.
Jeff Schmitt: Okay. And then in Global Auto, are you still seeing elevated losses in that GAAP book? And how much did that contribute to the loss ratio in the quarter?
Keith Meier: Yes. So from a GAAP perspective, Jeff, we’ve seen it stabilize. From the third quarter to the fourth quarter, it was flat to maybe slightly better. So I think from that perspective, I think that also points to why we feel good about where we’re going for 2025, and that we’ve signaled that we see growth in auto as we go through this year.
Keith Demmings: Yes. And maybe just 1 add-on comment as we think about GAAP and we’ve talked about this, when we look at the written business we expect to put on in 2025 will largely be off of most – not quite all, but close to all of the risks that we write. So that will definitely change that dynamic longer term and create more stability in our approach.
Jeff Schmitt: Okay. Any sense on the size of that impact that we could have just in the quarter or the last two quarters really?
Keith Meier: I would say just maybe $1 million or $2 million better for this quarter, Jeff, but pretty stable.
Jeff Schmitt: Okay. All right. Thanks.
Operator: Our next question comes from Tommy McJoynt with KBW. Please ask your question.
Keith Demmings: Good morning. Tommy.
Keith Meier: Hi, Tommy.
Tommy McJoynt: Hey good morning. Yes, another question on the investment spend. You called out the $25 million last year. And I just want to understand your comments about the payback period is effectively being one year. So are you saying that those new programs are generating $25 million of positive EBITDA in 2025 to fully out that really $25 million drag in 2024. Is that – am I understanding that right?
Keith Demmings: Perfectly. That’s exactly what we’re saying.
Tommy McJoynt: Okay. And the new investment spend for 2025, what types of programs are those? And are those related to the one last year, I think, related to Chase and travel benefits? Or what can you say about the new plans?
Keith Demmings: Yes. I would say entirely separate from the clients that we signaled last year. And obviously, we had T-Mobile also roll [indiscernible] in the fourth quarter that we would have been investing in last year as well. So we’re typically telling you about the things sort of after they become public in the market. But if we look at the potential for kind of one point to two points of headwind relative to those investments in 2025, it will be net new things that we haven’t discussed yet. With marquee brands and clients that I think you would very much recognize. So we’re super excited. We don’t want to get in front of ourselves. There’s a lot of ongoing contracting with clients, launch plans, technology investment. So there’s always a lot in the works, but we have a really, really strong pipeline in 2025. And I’d say it’s similar types of things with different clients, obviously in 2025.
Keith Meier: Yes. And I think, Tom, one thing you can expect is, just like we did last year, as we make those investments through 2025 we’ll be very transparent about what they were and the benefits in the clients that came as a result. So we’ll be sharing that with you and connecting that to the investments as we go through the year.
Tommy McJoynt: Okay. Got it. And then switching over to the Housing side. With the higher placement rates and seemingly ever rising average matured value, that segment continues to generate a lot of scale. Does that increase scale? And I guess, just combined with really strong underlying performance on the underwriting side, does that change your outlook for the combined ratio in that segment?
Keith Demmings: Yes. I think what I would say, if we look at 2025, even with the California fires, and we size that at slightly less than or slightly more than $150 million of overall losses. We think we’re still going to be in that mid-80s combined for the full year of 2025 and we think that’s a really, really strong result. Obviously, the dynamics changed. So we’ll see longer term what we think the right long-term target is for that. But feel really good. And again, we’ll deliver north of 20% ROEs in that business as well. And to your point, not only have we seen a lot of growth, but we’ve created a lot of expense leverage, invested a lot in technology and that’s helped us deliver pretty strong outperformance. So we’ll kind of reassess as we go forward. But if we look at 2025, we think rates will be relatively neutral to us this year. We’re not seeing big increases certainly in rate, but that will ebb and flow, and we’ll monitor that as we go.
Tommy McJoynt: Great. Thanks, Keith.
Keith Demmings: You bet, Tommy.
Operator: [Operator Instructions] Our next question comes from James Chmiel with Piper Sandler. Please ask your question.
Keith Demmings: Morning.
James Chmiel: Good morning.
Operator: James, please unmute your line and ask your question.
James Chmiel: Hello. Good morning. Thank you for the opportunity.
Keith Demmings: Good morning.
James Chmiel: How should we be thinking of reinsurance renewal cost and the ability to get additional rate through regulators in impacted geography?
Keith Demmings: So maybe, Keith will start on reinsurance, I’ll hit on rate.
Keith Meier: Yes. So from a reinsurance perspective, we were at about $186 million for 2024 that included in the first quarter a benefit when we went to the single placement of about $15 million. So that would move you to around $200 million for the reinsurance. And then we’re going through the process right now, and we’re currently evaluating our program structure. And we expect to maintain a relatively consistent program retention, historically, a one in five probable maximum loss. So with the volumes being up a little bit, we think the pricing should be pretty favorable as well. So it will probably be up a little bit for the volumes from there, maybe slightly better on the, on level pricing. But what we’ll definitely do for you is give more details on the final program as we get into our next earnings call.
Keith Demmings: Yes. And I think we’ve got a really, really strong track record. Our program has certainly outperformed the market generally for our reinsurance partners. We’ve got a really diverse panel of reinsurers, and I think our relationships are incredibly strong. So expect that to continue as we go forward. And then as we think about rate and the ability to get rate on the housing side, I’d say we obviously file our rates at a state level. Those rates are reviewed and approved, and we’ve had a really good track record of getting appropriate rates relative to the risk that we write no reason to believe that won’t continue to be true as we go forward. And I think we’ve had a long history of doing that. So not a point of concern and certainly a normal part of our process.
James Chmiel: Perfect. Thank you for the color. My follow-up question is regarding tariffs. How does this impact your view on input costs for the businesses of lifestyle? And how should we be thinking of the FX impact in 2025? Thank you.
Keith Demmings: You bet. Thank you. So we haven’t baked anything into our guide for the year relative to tariffs just because of the uncertainty that surrounds it and it’s ever evolving. So, but we did certainly think about foreign exchange. We thought about interest rates. We try to include assumptions around those elements, which obviously tariffs have an impact on. So that’s certainly baked into our 2025 view. And then what I would say on tariffs is certainly the bigger effects for us would be longer term, is there a drop in consumer demand with elevated pricing, that’s something we’ll monitor. It will have a longer-term effect certainly in terms of financial impact. The bigger short-term impact would be rising input costs around claims, parts and materials what I would highlight is we saw a significant amount of inflation in 2022 in housing and because our product is built with an automatic inflation guard feature, we’ve always got the ability to get rate. We took a lot of action around product and efficiency. The recovery from that has been quite strong in the last two years. So I feel really good about our long-term ability to get to a good place. And then the other side would be the auto business. We’ve seen elevated CPI on auto repairs in the last couple of years. We’ve built a really strong muscle with our clients in terms of regular reviews, monthly reviews around loss ratios, claims costs, by location, by geography, that will continue to be true. And if there’s elevated input costs around tariffs, we’ll continue to run the playbook that we’ve been running. It doesn’t change our long-term view around the strength of this business fundamentally. But what would you add?
Keith Meier: Yes. And I think going through the inflation environments for auto and for housing has really helped us develop a tremendous amount of rigor around navigating any changes in inflation. A good example is in our housing business, we used to have an inflation guard adjustment that would be – that would take place once a year. And now – and across all the 50 states now, we actually can do it quarterly, and we do it by state. So, I think those are the types of things that as you go through those times, you actually can come out of it stronger and better. And I think that’s a good example of what we’ve been able to do after the last couple of years.
Operator: Our last question will come from Mark Hughes with Truist. Please ask your question.
Keith Demmings: Hey Mark, you got back in.
Mark Hughes: Yes, thank you. Yes, I love it. The prior year development in the fourth quarter was the driver of that similar to what you saw earlier in the year?
Keith Meier: Yes. So I think the short answer is probably yes. The key thing Mark, is it really relates to a couple of things. One, certainly, coming out of the inflationary environment for the last couple of years, that’s really what’s contributed to our prior our prior year development in 2024. And then I think there is also an element of – we also saw moments of frequencies being lower than expected. A good example is there was a quarter in the last couple of years, that was one of the lowest frequency quarters from a historical perspective for us. So there’s a couple of those dynamics that I would say we’re playing into the reserves for the last year or so. But overall, I think we’re appropriately reserved and in a good position for the future.
Keith Demmings: Yes. And I think if you look at the housing business and you sort of walked out the $107 million of PYD this year and then you walked out the $54 million of PYD last year, you’re still at a 28% growth rate for the full year. So at every level, the housing business has outperformed, no matter how you look at it.
Mark Hughes: Am I right in thinking the fourth quarter ex-cat prior year development, loss ratio was very good. Do you assume that will continue into the in 2025? I know you said the mid-80s combined. I assume that has – does that have cats in it or not? And should we think that 4Q? Is it something that you can run rate? Or is that an anomaly?
Keith Demmings: Yes. I think our best view as we think about 2025 would be non-cat loss ratio in the high 30s an expense ratio in the high 30s and probably 10-ish points of cat given the California wildfires in the first quarter. So probably a little bit better non-cat loss ratio trend that we’ve seen a little bit higher cat load, probably gets you right back to a similar spot in mid-80s.
Keith Meier: Yes. And maybe just to add – I’m just going to say, maybe just to add the 10 points, just the way to think about it is, give or take, $150 million on the wildfires. Last year, we did $155 million cat load in. So, we expect that to be a little higher this year with the growth. But if you add those together, we expect it to be somewhere in the low 300s, and we’ll finalize that more specifically on the next earnings call.
Mark Hughes: And then you talked about the opportunity to be better appreciated, Keith, in your opening comments, and I know you gave a lot of good statistics about your performance relative to industry metrics. Anything more specific you had in mind when you think about the opportunity to be better appreciated some action on your part or positioning of the company? Just that phrase my attention.
Keith Demmings: Yes. Yes, we probably used similar phrases in different ways at different times. I think certainly, the market appreciates the lifestyle business, it’s more capital-light, fee income, et cetera. And I think what sometimes gets missed is the strength – the fundamental strength of the housing business and the housing franchise over the long term. It’s been a really, really strong performer. It’s well risk managed. We’ve demonstrated considerable resiliency. It’s much less volatile. And we’re delivering – we talked about it on the prepared remarks, a 10-year combined ratio of 89% against any measure that is outperforming the market, the industry. If you look at pure homeowner’s companies, it’d even be a more dramatic differential versus just looking at a wider cross-section across P&C. So I think the business is incredibly powerful. I think it scales well. It’s deeply integrated and it’s not a traditional product. It’s the services that we deliver that complement the core insurance products that differentiate us. And I think it’s on Assurant to help tell that story and just further educate the secret sauce of what we do and how we create value because our story is consistent, whether it’s mobile, whether it’s auto or housing, how we add value for partners is really unique, super differentiated and hard to replicate. And it scales incredibly well because we’re partnered with the who’s who, the leaders in the market and the market consolidator. So, we’ve got to continue to tell that story and that’s what we’ll do as we go forward.
Mark Hughes: Appreciate it. Thank you.
Keith Demmings: Thank you. And I think that was the last question. So we’ll go ahead and say thank you, everybody, for joining, and we’ll look forward to providing more updates on our next earnings call in May. Thanks very much. Have a great day.
Keith Meier: Thank you.
Operator: Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time, and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant’s Fourth Quarter and Full Year 2024 Conference Call and Webcast. At this time all participants have been placed in a listen-only mode and the floor will be opened for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may now begin."
},
{
"speaker": "Sean Moshier",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our fourth quarter and full year 2024 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the fourth quarter and full year 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in the earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We’ll start today’s call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Sean, and good morning, everyone. 2024 represented another strong year for Assurant. I’m incredibly proud of the performance of our teams across the company, whose commitment to delivering for our clients and customers enabled us to achieve 15% adjusted EBITDA growth and 19% adjusted earnings per share growth, both excluding reportable cats. Strategic investments in our people, client partnerships, technology and capabilities and targeted actions to drive improved performance across key areas of the business, position us to continue to outperform and deliver exceptional value through our products and services. Our people are at the center of everything we do, and our performance is made possible by our world-class culture. Our culture is how we attract and retain incredible talent to deliver for our customers. We’re extremely proud of the recognitions we’ve received, highlighting our commitment to innovation and sustainability, while supporting and empowering our employees. Our competitive advantage comes from the ongoing dedication of our global workforce and leadership team to drive new business through innovative solutions while elevating the customer experience and deepening existing partnerships. In Global Lifestyle, we had an unprecedented year of client wins and renewals, particularly within Connected Living. We continue to invest in new innovative client programs and leading-edge technology including the incorporation of automation, robotics and AI at our device care center outside of Nashville. We recently partnered to launch T-Mobile’s Protection 360 HomeTech product. This new offering provides protection for an unlimited number of WiFi-enabled devices and electronics, while providing premium tech support to consumers. This critical new product represents another strategic growth vector and underscores the long-term opportunity presented by the convergence of broadband and mobile in the connected home. By prioritizing investments in programs and capabilities, we generated significant momentum and plan to execute on additional opportunities. In Global Automotive, we made progress in stabilizing earnings through targeted actions to address elevated claim costs in our vehicle service contract business and our guaranteed asset protection product. We continue to be optimistic about the long-term outlook for this business. Before discussing Global Housing, I want to first share that our thoughts are with everyone who is impacted by the events of the last few months, including the California wildfires. In these times, we have a critical role to play in our customers’ journey. In Southern California, we’re focused on making it quick and easy for policyholders to file claims online on the phone or in-person at mobile claims centers, accelerating customer payments. We remain proud of our role in removing the risk of uninsured loss for lenders, investors and homeowners through our housing offerings. As we look at housing’s results, we delivered sustained outperformance in 2024, benefiting from the strength of our homeowners and renters businesses, including the rollout of technology innovation to enhance our customer experience. Leveraging the segment’s differentiated advantages and efficiency initiatives, we have more than doubled our adjusted EBITDA in the past two years, growing the business from just over $400 million in 2022 and to over $900 million in 2024, excluding cats. Even including cats, housing has outperformed the P&C industry. Over the past five years, we’ve achieved an average return on equity of over 22% and our increased scale and efficiency has driven a 10-year average combined ratio of 89%, compared to the broader P&C market of 95%. With clear outperformance and expected growth ahead, the business has the opportunity to be better appreciated from a valuation perspective. 2024 was a remarkable year of commercial success across Assurant, marked by significant client momentum as we enter 2025. Strong execution enabled us to capture new opportunities while solidifying and extending key client relationships. Across our global footprint, we had several key wins, including Australia’s largest mobile carrier and two major financial institutions in the U.S. We renewed client relationships and reinforced our position as a leader and preferred partner throughout our businesses. In our mobile business within Connected Living, we completed major renewals in 2024 that represent three of the top five largest mobile carriers in the U.S. More recently, we also secured a multiyear renewal with a large mobile carrier in Japan. We’ve now renewed our four largest mobile clients in the last year, who represent over 40 million mobile devices protected, a testament to our ability to execute mobile protection programs across the globe. Within housing, we renewed 10 lender-placed clients, representing over 17 million loans tracked. And in renters, we completed renewals of 2 top 10 property management companies as we continue the rollout of key technology-enabled services like Cover360 and Assurant TechPro. These help increase policy attachment while enhancing the experience of our partners and renters. Ultimately, the continuing demand for our offerings and solutions, combined with our strong competitive edge, creates commercial momentum that will extend into 2025 and beyond. We believe in the power of our unique business-to-business to consumer or B2B2C business model. At our core, we’re a premier global protection company that partners with the world’s leading brands to safeguard and service connected devices, homes and automobiles, utilizing data-driven technology solutions to provide exceptional customer experiences. The common thread across our entire enterprise is our powerful B2B2C distribution strategy in both lifestyle and housing, where we have strong leadership positions in attractive markets. Through our differentiated distribution, strong public Fortune 500 company financials and unwavering emphasis on client transparency, we create deep partnerships with leading brands across the world. In addition, our commitment to continuously enhance customer experience through customized solutions that wrap around our protection products is built on decades of investment and ongoing innovation. This allows us to deeply integrate our technology and platforms with clients, supporting long-tenured partnerships and exceptional customer experiences. Since 2019, we’ve increased adjusted EBITDA by over $630 million or a 12% compounded annual growth rate while growing adjusted EPS by over $11 per share or an 18% compounded annual growth rate, both excluding catastrophes. As we look at our performance versus the broader P&C industry, we’ve continued to outperform the S&P 1500 P&C index median, both excluding and including cats, when comparing across adjusted earnings and EPS growth. Our compelling track record of outperformance includes eight consecutive years of profitable growth, demonstrating resiliency through various macroeconomic environments. In addition, our portfolio benefits from earnings and capital diversification across geographies and business lines, positioning us to continue to invest in and achieve future growth. We believe we’ll remain an attractive investment with a compelling path ahead, and we believe we should be valued at a premium to the S&P 1500 P&C index median. Before turning it over to Keith Meier to share additional insights on our results and review business trends, I want to highlight our strong momentum heading into 2025 and how we plan to deliver future growth. First, we’ll focus on executing, optimizing and scaling significant new partnerships and program launches throughout lifestyle and housing, where we invested last year. Overall, we believe our 2024 investments should be fully earned back through 2025 with an attractive one-year payback. Next, we’ll support incremental investments for new launches in our pipeline and accelerate emerging growth opportunities. In addition to our connected home product launch, we have new opportunities with several clients particularly in global lifestyle, and we look forward to sharing more details over the coming quarters. And finally, we’ll drive financial performance and operational excellence. We believe we’re well positioned to meet our 2025 objectives given the commercial momentum we have within Connected Living, long-term tailwinds in Global Auto and sustained outperformance in Global Housing. Overall, our ability to deliver for our clients, drive efficiencies across our operations and focus on data-driven technology solutions should enhance our position as a leader in the businesses that we operate and extend our compelling track record of financial performance. I will now turn it over to Keith."
},
{
"speaker": "Keith Meier",
"text": "Thanks Keith. And good morning everyone. I’m proud of what we achieved in 2024, including the financial results delivered by our incredibly strong team. For the year, we increased adjusted EBITDA by 15% to over $1.5 billion, while growing adjusted earnings per share to over $20, both excluding cats. We have continued our long-term track record of growing earnings consistently demonstrating the power of Assurant. Our performance was highlighted by another exceptional year in Global Housing, where we delivered double digit earnings growth overall for the second consecutive year. Within Global Lifestyle, Connected Living grew 9% excluding $25 million of investments and $12 million of unfavorable foreign exchange. More importantly, we set a solid foundation for growth as we enter 2025. In Global Auto, targeted actions in our vehicle service contract and GAP products stabilized earnings in the second half of 2024 and we are excited about the trajectory of the business as we move into 2025. I’ll begin by highlighting key trends we saw in the fourth quarter. From there, I will walk through our 2025 outlook as we look to deliver our ninth consecutive year of profitable growth. Beginning with our fourth quarter enterprise results, adjusted EBITDA and earnings per share both increased 13% excluding cats led by Global Housing. Looking at capital, Global Lifestyle and Global Housing continue to generate significant cash flow, as we up-streamed nearly $250 million from our segments in the fourth quarter and over $800 million for the full year. We returned $161 million of that cash to our shareholders in the fourth quarter, which puts our total capital returned to shareholders for the year in excess of $450 million, including $300 million of share repurchases. Our buyback level was at the top end of our expectations for the year. At the same time, we ended the year in a strong capital position with $673 million of liquidity at the holding company. This past November, we increased our common stock dividend by 11%. The increase represented the 20th consecutive year we have raised our dividend since our IPO. In addition, we were just added to the S&P High Yield Dividend Aristocrats Index earlier this month. We are incredibly proud of this achievement and expect our strong capital returns to continue as part of our balanced capital deployment framework. Turning to our segment results, beginning with Global Lifestyle, fourth quarter adjusted EBITDA was down 6% compared to last year or 5% on a constant currency basis. In Connected Living, earnings were roughly flat on a constant currency basis. Fourth quarter results included $4 million of incremental investments related to new capabilities and client partnerships that are expected to drive future growth. Investments in 2024 are already paying off as earnings from recently launched clients, including card benefits within our Financial Services business have begun to contribute to Connected Living’s fourth quarter performance. As Keith mentioned, we are now focused on scaling these partnerships for growth. These contributions were offset by lower U.S. trade-in programs. Year-over-year, trade-in results were impacted by business mix and lower volumes, however, we did see sequential trade-in growth as expected. Turning to Global Auto, in the quarter, results were down 11% compared to last year. The year-over-year decline was largely driven by lower real estate joint venture partnership income of $13.8 million. Fourth quarter 2023 included a more significant real estate joint venture gain compared to a smaller gain this year. Excluding this, results in Global Auto were largely flat as higher investment income was partially offset by elevated loss experience in both our GAP product and our vehicle service contract business compared to last year. Importantly, we continue to see claims experience remain stable from last quarter as previously implemented program changes and rate increases continue to earn through our book, leading to a sequential improvement in earnings. In terms of revenue, our net earned premiums, fees and other income for Global Lifestyle grew 2%, or approximately 6% on a constant currency basis. And excluding $85 million of favorable non-run rate premium adjustments in Global Automotive in fourth quarter 2023. Moving to Global Housing, fourth quarter results were strong building on an exceptional performance for the year. Adjusted EBITDA was $225 million which included $50 million of cat losses largely from Hurricane Milton. Excluding cats, adjusted EBITDA increased 32%. In the quarter, we saw a continuation of robust policy growth in homeowners from higher placement rates given voluntary insurance market pressure. As these additional policies are placed, we benefit from the significant expense leverage we have driven in this business from our technology investments. Earnings growth in the quarter also included impacts from favorable non-catastrophe losses due to lower frequency as well as lower catastrophe reinsurance costs. While we had favorable prior period reserve development of $38 million in the quarter, it was relatively consistent with fourth quarter 2023 and did not impact year-over-year growth trends. Within our Renters business we continued to benefit from strong results in our PMC channel which achieved its tenth consecutive quarter of double digit gross written premium growth. Now let’s discuss our outlook for 2025. We expect full year adjusted EBITDA and earnings per share to increase modestly, both excluding cats. Overcoming $107 million of favorable prior year reserve development in Housing’s 2024 results. Excluding the significant favorable PYD in 2024, strong underlying growth trends are expected to deliver high single-digit earnings and EPS growth, both excluding cats. Our outlook includes our forward view of foreign exchange rates and interest rates, but does not factor in potential impacts from tariffs including those related to claims costs or consumer demand. While tariffs could potentially affect claims costs, we believe we are well positioned to react quickly to address potential impacts. Over time, our business model has had a proven ability to deliver in the face of various economic environments and cycles. Looking at our segments for 2025, we expect Global Lifestyle growth driven by higher contributions from Connected Living and Global Automotive. Growth is expected to be partially offset by an unfavorable impact from foreign exchange rates, as well as investments in new partnerships and programs in 2025. Combined, we expect foreign exchange and incremental investments to mute growth by a few percentage points. Turning to Global Housing, we expect EBITDA excluding cats to decline modestly, given the $107 million of favorable prior year reserve development seen in 2024. Excluding the impact of prior year development in 2024, on an underlying basis, we expect strong Global Housing EBITDA growth in 2025. As a reminder, our 2025 outlook does not contemplate additional year development. Underlying growth is expected to be driven by our Homeowners business which will continue to benefit from lender placed policy growth and expense leverage. For the recent wildfires in California, we remain focused on settling claims and helping our policyholders navigate through the event. Reportable catastrophes from the California wildfires are expected to approach or slightly exceed our per event catastrophe reinsurance program retention of $150 million. We’ll provide a further update in May as we learn more and continue to settle claims. In terms of other impacts to 2025, we are working through the placement of our catastrophe reinsurance program which will be effective on April 1. We expect a similar structure to our 2024 program, maintaining robust coverage at both the top and bottom end of our program. As the program terms are finalized, we will also get greater insights into our expected cat load for the year. We will provide an update in May on expectations which will be inclusive of our California Wildfire estimates. Our capital objectives for 2025 are consistent with prior years’ as we focus on maintaining balance and flexibility to support new business growth, while returning excess capital to shareholders. From a share repurchase perspective, our expected range for 2025 is between $200 million to $300 million subject to M&A, as well as market and other conditions. This range accounts for our estimated impact from the California Wildfires. Of course, we will continue to make sound capital allocation decisions over the course of the year as our track record has shown. Through February 7 we we’ve repurchased $24 million of shares. We expect buybacks to be more consistent throughout the year compared to back-end weighted in prior years driven by our confidence in our strong capital position and cash flow generation. And finally, speaking of cash flow generation, we believe Assurant is differentiated compared to the broader P&C industry given our unique lifestyle and housing portfolio, which creates strong capital efficiencies and the ability to reinvest for growth. In 2025, we expect to continue to generate meaningful cash flows aligned with our recent performance. Overall, we are proud of our consistent outperformance and feel well positioned to continue our growth trajectory in 2025. With that operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "The floor is now open for questions. [Operator Instructions] Our first question comes from Mark Hughes with Truist. Please unmute your line and ask your question."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Good morning, Keith. I muted myself and then unmuted myself. Morning. On the Homeowners business, the placement rate has been looking quite good. Can you talk about the – what is a voluntary versus the lender placed? And do you still see the same dislocation in those markets that’s been pushing the voluntary, presumably, how much momentum does that give you for 2025?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. Great question, and thanks for that. So I would say a couple of things. We’ve definitely seen really strong PIF growth on lender place throughout the year. That trend continues certainly in the fourth quarter. Year-over-year, we’re up 16% in terms of policies in force. And if I simplified that, I’d probably say a third of that is client growth and loan movement within clients. A third of that is California due to the hardening market and then the other third is the rest of the country growth from a similar dynamic. So we’ve definitely still seen hard insurance markets, creating opportunity for policy growth on our book of business. And we’ve seen a lot of diversification as well across geographies. So I think that likely continues. Certainly, the trend was pretty consistent in fourth quarter as we saw for the first three quarters. So expect some continued growth there, probably not at the same level that we’ve seen, but certainly feel good about the momentum overall in housing."
},
{
"speaker": "Mark Hughes",
"text": "Then in Global Lifestyle, how do we think about the top line growth? Just kind of broadly, you’ve given good guidance on EBITDA. You’ve given some thoughts about customer growth, that sort of thing, but how do we think about top-line growth maybe in 2025 or just more broadly in lifestyle?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I mean if I think about lifestyle, the first thing I would highlight, and we covered it in the prepared remarks, but we are particularly excited on the Connected Living side, securing our mobile clients is really, really important and so fundamental to the business long-term. It then allows us to focus more energy with our partners to drive growth, to launch new products, to optimize customer experience. There’s a lot of energy around making sure we’re optimizing all the buy flows and touch points to serve consumers. So, I think that will be a catalyst for continued momentum certainly, on the Connected Living business, we saw Chase come on in the fourth quarter. That’s going to obviously drive financial services growth throughout the year. So I do think we’re well positioned. We’ve had pretty consistent lifestyle growth in terms of the top-line for the last few years. I think that growth continues as we move forward. And then in auto, it’s about the loss recovery and our ability to continue to see that mature and feel really good about how the second half of the year stabilized, obviously, more road to go, but feel like we’re well positioned. But Keith, anything else?"
},
{
"speaker": "Keith Meier",
"text": "No, I think it really speaks to the momentum that we have and the opportunities that we have as we look forward to 2025. We’ve talked about making some investments in 2024, and we certainly expect to do that again in 2025. It’s because of the momentum we’ve got in our markets, especially in Connected Living. So we certainly look forward to sharing more of those updates as we go through the year."
},
{
"speaker": "Mark Hughes",
"text": "And one final quick one. The ForEx headwind for 2025, I think you said, with ForEx and investments a few percentage points. How about ForEx specifically?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think we’d probably say, foreign exchange, a couple of points of headwind. In terms of the investments, probably one to two points. If you think about 2024, just to kind of create context, we had $25 million of incremental investments. Roughly $10 million of that was Depot automation that we’ve talked about and the other $15 million or so, roughly two-thirds was client-related launches. So as we look at 2025, probably somewhere maybe approaching a similar level of investment in clients maybe slightly below. So we’ve got given the 1% to 2% headwind relative to lifestyle overall. But we do have some good things in the hopper with clients, new clients, existing clients, new product launches. And we’re certainly excited to update as we go through the year."
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jeff Schmitt [William Blair & Company]. Please unmute your line and ask your question."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Jeff."
},
{
"speaker": "Jeff Schmitt",
"text": "Can you hear me?"
},
{
"speaker": "Keith Demmings",
"text": "Perfectly."
},
{
"speaker": "Jeff Schmitt",
"text": "Hi good morning. So the placement rate in housing, just one more question on that. Are you seeing a lot of insurers fleet, California after the fires. So could we maybe see that kind of jump in Q1?"
},
{
"speaker": "Keith Meier",
"text": "Yes. And I think overall for California, Jeff, there was a moratorium put on in California so that the insurers would not be leaving, the wildfires just taking place. So we think that will temper some of that for a while. And then I’m sure that will open back up later. But for right now, in the short term, I would say, we don’t expect a lot of exits from the state."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. And then in Global Auto, are you still seeing elevated losses in that GAAP book? And how much did that contribute to the loss ratio in the quarter?"
},
{
"speaker": "Keith Meier",
"text": "Yes. So from a GAAP perspective, Jeff, we’ve seen it stabilize. From the third quarter to the fourth quarter, it was flat to maybe slightly better. So I think from that perspective, I think that also points to why we feel good about where we’re going for 2025, and that we’ve signaled that we see growth in auto as we go through this year."
},
{
"speaker": "Keith Demmings",
"text": "Yes. And maybe just 1 add-on comment as we think about GAAP and we’ve talked about this, when we look at the written business we expect to put on in 2025 will largely be off of most – not quite all, but close to all of the risks that we write. So that will definitely change that dynamic longer term and create more stability in our approach."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. Any sense on the size of that impact that we could have just in the quarter or the last two quarters really?"
},
{
"speaker": "Keith Meier",
"text": "I would say just maybe $1 million or $2 million better for this quarter, Jeff, but pretty stable."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. All right. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tommy McJoynt with KBW. Please ask your question."
},
{
"speaker": "Keith Demmings",
"text": "Good morning. Tommy."
},
{
"speaker": "Keith Meier",
"text": "Hi, Tommy."
},
{
"speaker": "Tommy McJoynt",
"text": "Hey good morning. Yes, another question on the investment spend. You called out the $25 million last year. And I just want to understand your comments about the payback period is effectively being one year. So are you saying that those new programs are generating $25 million of positive EBITDA in 2025 to fully out that really $25 million drag in 2024. Is that – am I understanding that right?"
},
{
"speaker": "Keith Demmings",
"text": "Perfectly. That’s exactly what we’re saying."
},
{
"speaker": "Tommy McJoynt",
"text": "Okay. And the new investment spend for 2025, what types of programs are those? And are those related to the one last year, I think, related to Chase and travel benefits? Or what can you say about the new plans?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I would say entirely separate from the clients that we signaled last year. And obviously, we had T-Mobile also roll [indiscernible] in the fourth quarter that we would have been investing in last year as well. So we’re typically telling you about the things sort of after they become public in the market. But if we look at the potential for kind of one point to two points of headwind relative to those investments in 2025, it will be net new things that we haven’t discussed yet. With marquee brands and clients that I think you would very much recognize. So we’re super excited. We don’t want to get in front of ourselves. There’s a lot of ongoing contracting with clients, launch plans, technology investment. So there’s always a lot in the works, but we have a really, really strong pipeline in 2025. And I’d say it’s similar types of things with different clients, obviously in 2025."
},
{
"speaker": "Keith Meier",
"text": "Yes. And I think, Tom, one thing you can expect is, just like we did last year, as we make those investments through 2025 we’ll be very transparent about what they were and the benefits in the clients that came as a result. So we’ll be sharing that with you and connecting that to the investments as we go through the year."
},
{
"speaker": "Tommy McJoynt",
"text": "Okay. Got it. And then switching over to the Housing side. With the higher placement rates and seemingly ever rising average matured value, that segment continues to generate a lot of scale. Does that increase scale? And I guess, just combined with really strong underlying performance on the underwriting side, does that change your outlook for the combined ratio in that segment?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think what I would say, if we look at 2025, even with the California fires, and we size that at slightly less than or slightly more than $150 million of overall losses. We think we’re still going to be in that mid-80s combined for the full year of 2025 and we think that’s a really, really strong result. Obviously, the dynamics changed. So we’ll see longer term what we think the right long-term target is for that. But feel really good. And again, we’ll deliver north of 20% ROEs in that business as well. And to your point, not only have we seen a lot of growth, but we’ve created a lot of expense leverage, invested a lot in technology and that’s helped us deliver pretty strong outperformance. So we’ll kind of reassess as we go forward. But if we look at 2025, we think rates will be relatively neutral to us this year. We’re not seeing big increases certainly in rate, but that will ebb and flow, and we’ll monitor that as we go."
},
{
"speaker": "Tommy McJoynt",
"text": "Great. Thanks, Keith."
},
{
"speaker": "Keith Demmings",
"text": "You bet, Tommy."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question comes from James Chmiel with Piper Sandler. Please ask your question."
},
{
"speaker": "Keith Demmings",
"text": "Morning."
},
{
"speaker": "James Chmiel",
"text": "Good morning."
},
{
"speaker": "Operator",
"text": "James, please unmute your line and ask your question."
},
{
"speaker": "James Chmiel",
"text": "Hello. Good morning. Thank you for the opportunity."
},
{
"speaker": "Keith Demmings",
"text": "Good morning."
},
{
"speaker": "James Chmiel",
"text": "How should we be thinking of reinsurance renewal cost and the ability to get additional rate through regulators in impacted geography?"
},
{
"speaker": "Keith Demmings",
"text": "So maybe, Keith will start on reinsurance, I’ll hit on rate."
},
{
"speaker": "Keith Meier",
"text": "Yes. So from a reinsurance perspective, we were at about $186 million for 2024 that included in the first quarter a benefit when we went to the single placement of about $15 million. So that would move you to around $200 million for the reinsurance. And then we’re going through the process right now, and we’re currently evaluating our program structure. And we expect to maintain a relatively consistent program retention, historically, a one in five probable maximum loss. So with the volumes being up a little bit, we think the pricing should be pretty favorable as well. So it will probably be up a little bit for the volumes from there, maybe slightly better on the, on level pricing. But what we’ll definitely do for you is give more details on the final program as we get into our next earnings call."
},
{
"speaker": "Keith Demmings",
"text": "Yes. And I think we’ve got a really, really strong track record. Our program has certainly outperformed the market generally for our reinsurance partners. We’ve got a really diverse panel of reinsurers, and I think our relationships are incredibly strong. So expect that to continue as we go forward. And then as we think about rate and the ability to get rate on the housing side, I’d say we obviously file our rates at a state level. Those rates are reviewed and approved, and we’ve had a really good track record of getting appropriate rates relative to the risk that we write no reason to believe that won’t continue to be true as we go forward. And I think we’ve had a long history of doing that. So not a point of concern and certainly a normal part of our process."
},
{
"speaker": "James Chmiel",
"text": "Perfect. Thank you for the color. My follow-up question is regarding tariffs. How does this impact your view on input costs for the businesses of lifestyle? And how should we be thinking of the FX impact in 2025? Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet. Thank you. So we haven’t baked anything into our guide for the year relative to tariffs just because of the uncertainty that surrounds it and it’s ever evolving. So, but we did certainly think about foreign exchange. We thought about interest rates. We try to include assumptions around those elements, which obviously tariffs have an impact on. So that’s certainly baked into our 2025 view. And then what I would say on tariffs is certainly the bigger effects for us would be longer term, is there a drop in consumer demand with elevated pricing, that’s something we’ll monitor. It will have a longer-term effect certainly in terms of financial impact. The bigger short-term impact would be rising input costs around claims, parts and materials what I would highlight is we saw a significant amount of inflation in 2022 in housing and because our product is built with an automatic inflation guard feature, we’ve always got the ability to get rate. We took a lot of action around product and efficiency. The recovery from that has been quite strong in the last two years. So I feel really good about our long-term ability to get to a good place. And then the other side would be the auto business. We’ve seen elevated CPI on auto repairs in the last couple of years. We’ve built a really strong muscle with our clients in terms of regular reviews, monthly reviews around loss ratios, claims costs, by location, by geography, that will continue to be true. And if there’s elevated input costs around tariffs, we’ll continue to run the playbook that we’ve been running. It doesn’t change our long-term view around the strength of this business fundamentally. But what would you add?"
},
{
"speaker": "Keith Meier",
"text": "Yes. And I think going through the inflation environments for auto and for housing has really helped us develop a tremendous amount of rigor around navigating any changes in inflation. A good example is in our housing business, we used to have an inflation guard adjustment that would be – that would take place once a year. And now – and across all the 50 states now, we actually can do it quarterly, and we do it by state. So, I think those are the types of things that as you go through those times, you actually can come out of it stronger and better. And I think that’s a good example of what we’ve been able to do after the last couple of years."
},
{
"speaker": "Operator",
"text": "Our last question will come from Mark Hughes with Truist. Please ask your question."
},
{
"speaker": "Keith Demmings",
"text": "Hey Mark, you got back in."
},
{
"speaker": "Mark Hughes",
"text": "Yes, thank you. Yes, I love it. The prior year development in the fourth quarter was the driver of that similar to what you saw earlier in the year?"
},
{
"speaker": "Keith Meier",
"text": "Yes. So I think the short answer is probably yes. The key thing Mark, is it really relates to a couple of things. One, certainly, coming out of the inflationary environment for the last couple of years, that’s really what’s contributed to our prior our prior year development in 2024. And then I think there is also an element of – we also saw moments of frequencies being lower than expected. A good example is there was a quarter in the last couple of years, that was one of the lowest frequency quarters from a historical perspective for us. So there’s a couple of those dynamics that I would say we’re playing into the reserves for the last year or so. But overall, I think we’re appropriately reserved and in a good position for the future."
},
{
"speaker": "Keith Demmings",
"text": "Yes. And I think if you look at the housing business and you sort of walked out the $107 million of PYD this year and then you walked out the $54 million of PYD last year, you’re still at a 28% growth rate for the full year. So at every level, the housing business has outperformed, no matter how you look at it."
},
{
"speaker": "Mark Hughes",
"text": "Am I right in thinking the fourth quarter ex-cat prior year development, loss ratio was very good. Do you assume that will continue into the in 2025? I know you said the mid-80s combined. I assume that has – does that have cats in it or not? And should we think that 4Q? Is it something that you can run rate? Or is that an anomaly?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think our best view as we think about 2025 would be non-cat loss ratio in the high 30s an expense ratio in the high 30s and probably 10-ish points of cat given the California wildfires in the first quarter. So probably a little bit better non-cat loss ratio trend that we’ve seen a little bit higher cat load, probably gets you right back to a similar spot in mid-80s."
},
{
"speaker": "Keith Meier",
"text": "Yes. And maybe just to add – I’m just going to say, maybe just to add the 10 points, just the way to think about it is, give or take, $150 million on the wildfires. Last year, we did $155 million cat load in. So, we expect that to be a little higher this year with the growth. But if you add those together, we expect it to be somewhere in the low 300s, and we’ll finalize that more specifically on the next earnings call."
},
{
"speaker": "Mark Hughes",
"text": "And then you talked about the opportunity to be better appreciated, Keith, in your opening comments, and I know you gave a lot of good statistics about your performance relative to industry metrics. Anything more specific you had in mind when you think about the opportunity to be better appreciated some action on your part or positioning of the company? Just that phrase my attention."
},
{
"speaker": "Keith Demmings",
"text": "Yes. Yes, we probably used similar phrases in different ways at different times. I think certainly, the market appreciates the lifestyle business, it’s more capital-light, fee income, et cetera. And I think what sometimes gets missed is the strength – the fundamental strength of the housing business and the housing franchise over the long term. It’s been a really, really strong performer. It’s well risk managed. We’ve demonstrated considerable resiliency. It’s much less volatile. And we’re delivering – we talked about it on the prepared remarks, a 10-year combined ratio of 89% against any measure that is outperforming the market, the industry. If you look at pure homeowner’s companies, it’d even be a more dramatic differential versus just looking at a wider cross-section across P&C. So I think the business is incredibly powerful. I think it scales well. It’s deeply integrated and it’s not a traditional product. It’s the services that we deliver that complement the core insurance products that differentiate us. And I think it’s on Assurant to help tell that story and just further educate the secret sauce of what we do and how we create value because our story is consistent, whether it’s mobile, whether it’s auto or housing, how we add value for partners is really unique, super differentiated and hard to replicate. And it scales incredibly well because we’re partnered with the who’s who, the leaders in the market and the market consolidator. So, we’ve got to continue to tell that story and that’s what we’ll do as we go forward."
},
{
"speaker": "Mark Hughes",
"text": "Appreciate it. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Thank you. And I think that was the last question. So we’ll go ahead and say thank you, everybody, for joining, and we’ll look forward to providing more updates on our next earnings call in May. Thanks very much. Have a great day."
},
{
"speaker": "Keith Meier",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time, and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 3 | 2,024 | 2024-11-06 08:00:00 | Operator: Welcome to Assurant's Third Quarter 2024 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin.
Sean Moshier: Thank you, operator, and good morning, everyone. We look-forward to discussing our third quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release, announcing our results for the third quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also, on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties, and other factors that may cause actual results to differ materially from those contemplated by those statements. Additional information regarding these factors can be found in the earnings release, presentation, and financial supplement on our website, as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings.
Keith Demmings: Thanks, Sean, and good morning, everyone. Our third quarter results further supported our strong year-to-date performance. Through the first nine months of the year, adjusted EBITDA increased by 15% and adjusted EPS grew by 21%, both excluding catastrophes. Results were led by sustained outperformance within Global Housing, as well as underlying growth within our Connected Living business, which was muted by incremental investments in new partnerships and programs and unfavorable foreign-exchange. Our year-to-date momentum has positioned us to exceed our previous expectations. Excluding catastrophes, we now expect adjusted EBITDA to increase low-double-digits for the second consecutive year and adjusted earnings per share to increase mid to high teens, led by business growth and strong share repurchases. Once again, we've outperformed the broader P&C industry, both short and long-term, reflecting the unique and differentiated nature of our combined housing and lifestyle business model. Let's begin with our year-to-date business highlights. In Global Lifestyle, year-to-date performance was relatively flat versus the prior-period, reflecting elevated claims experience in global automotive as well as impacts from unfavorable foreign exchange of 2% or $10 million, above our expectations from earlier in the year. Within Connected Living, year-to-date adjusted EBITDA increased 3% or 5% on a constant-currency basis as we continue to invest in new partnerships and programs to support future growth. Excluding investments of approximately $21 million for the first-nine months of the year, Connected Living adjusted EBITDA growth was strong at 11% on a constant-currency basis. One prime example of those investments includes our new innovation and device care center located just outside of Nashville, supporting our mobile business. In addition to repurposing millions of devices per year, the new state of the art facility employs innovative ways to leverage automation, robotics and AI. This will create greater value within our global supply-chain while driving growth in the secondary device market. The Nashville facility demonstrates our investments in innovation, allowing us to continuously improve our customer experience as we operate through end-to-end partnerships with our mobile clients, a critical competitive advantage for Assurant. Within financial services, on October 1, we launched a new program with Chase Card Services in our growing card benefits business. Beginning at program launch, we're providing end-to-end delivery for approximately 15 travel and purchase protection benefits, including underwriting, claims processing and benefit servicing to millions of Chase Card holders. We're excited about several new clients and programs targeted for 2025, adding to our growing portfolio. Similar to '24, these new opportunities may require incremental investments. Moving to Global Automotive. Our Auto business has experienced elevated claims costs in both our vehicle service contract business and our GAAP product throughout 2024. Over the past two quarters, we've started to see some positive early signs with the stabilization of underlying claims severity trends in our vehicle service contract business. Claims inflation impacts have begun to moderate and our loss ratio is beginning to benefit from rate increases we've taken over the past two years. Within our GAAP product, elevated losses have continued as anticipated, but we continue to expect higher claims to be short-term in nature in comparison to the vehicle service contract business. In addition, our proactive partnership with several clients to enable us to transition most of the risk and reduce a large portion of our claims exposure over-time. We remain focused on driving actions to improve Auto results while benefiting from moderating inflation impacts in 2025 and beyond. We're excited about the long-term trajectory of this business. Now let's turn to Global Housing. I want to begin by thanking all of our employees who supported policyholders impacted by recent weather events over the last several months, including multiple major hurricanes. We play an important role in safeguarding our policyholders as we processed approximately 35,000 claims to date associated with these events. It's an important reminder of the critical role our lender-placed product plays in the U.S. mortgage industry, removing the risk of uninsured loss for lenders, investors and homeowners. It's crucial to provide all homeowners with access to insurance. For that reason, we continue to work closely with each state to offer coverage and protection to homeowners at appropriate rates. Looking at Global Housing's year-to-date results, we've demonstrated continued strong performance, particularly within our homeowners' business. Over the first-nine months of the year, earnings increased 34% excluding reportable catastrophes. In our lender-placed business, we continue to benefit from key competitive advantages, utilizing various growth levers over the past two years to sustain results, including meaningful expense leverage, scale from new partners and product safeguards to address macroeconomic factors like inflation. Results were driven primarily by continued policy growth as the placement rate increased to 1.92%, a 12 basis-point improvement since year end and a 6 basis-point improvement sequentially. Policy growth has been led by several new partnerships and portfolios as well as from states where it's become more difficult to secure voluntary homeowners coverage. Within renters, adjusted EBITDA has also shown year-to-date growth, supported by continued expansion in our Property Management Company or PMC channel. Growth in our PMC channel has been supported by technology innovation aimed at enhancing our digital customer experience. This has included the rollouts of Assurant TechPro and our Cover360 platform, leading to higher penetration with a simplified resident enrollment process. Overall, the housing business has benefited from our unique competitive advantages throughout lender-placed and renters, showcasing its resiliency and outperformance over various macroeconomic environments. Turning to our enterprise outlook. As I mentioned earlier, given the strength of our year-to-date results, we now expect full-year adjusted EBITDA to grow low-double-digits and adjusted earnings per share to increase mid to high teens, both excluding catastrophes. This represents an increase to both metrics above our expectations, demonstrating the continued strength of our financial performance. For the year, we continue to anticipate strong growth within Global Housing with modest growth expected in Global Lifestyle as we fund incremental investments in Connected Living. Our ability to sustain profitable growth year-after-year is a true reflection of our unique and advantaged business model. Assurant's performance is the result of a multi-year transformation, which has significantly enhanced our business mix, risk profile and market positioning. We've simplified and optimized Assurant to focus on specialized attractive markets with long-term secular tailwinds within lifestyle and housing, while selling pre-need and employee benefits and exiting health and other non-core businesses. In the markets we operate in, we have leadership positions and competitive advantages through our protection solutions across devices, automobiles and homes. We are well-positioned to win due to our highly scaled and deeply integrated B2B2C partnerships where we work with our clients to innovate and create flexible solutions for their end consumers. At the same time, we've enhanced Assurant's risk profile by focusing on capital-efficient businesses within lifestyle and housing. Through purposeful transformation, we've enhanced our ability to drive long-term performance and cash generation, attracting growth partnerships with large sophisticated clients and become increasingly more capital-efficient. I'm proud of the long-term outperformance we've achieved against the broader P&C market. Slide 10 demonstrates our historical outperformance, including a five-year history of double-digit growth. Based on our current outlook for 2024, annual growth rates since 2019 are expected to average 11% for adjusted EBITDA and 17% for adjusted EPS, both excluding catastrophes. Given our historical performance and our unique and differentiated business model, we believe we have meaningful valuation upside, in particular, as compared to the S&P 1500 P&C Index, a broad index of 32 members now including Assurant. Overall, we see a compelling path for growth ahead and believe Assurant represents an attractive investment. I'll now turn it over to Keith Meier to review our third quarter results and business trends impacting our 2024 outlook.
Keith Meier: Thanks, Keith, and good morning, everyone. This November marks the conclusion of my first year as CFO of Assurant. When I began this role, I outlined my key priorities, including driving growth and strong financial performance with a focus on innovation and product differentiation. These priorities have been supported by our continuous efforts to drive expense efficiencies through automation, digital and AI technologies, while improving overall customer experience as well as ensuring our capital position remains strong, providing us with the flexibility to create value and support long-term growth. Over the past year, we have made significant progress. First, looking at growth and financial performance, our B2B2C partnerships are the lifeblood of our business model and the primary driver behind our growth story. Over the past 12 months, we've spotlighted several notable client announcements, such as renewing all major U.S. mobile clients, including three of the top-five largest mobile carriers in the U.S., launching new programs and capabilities with existing clients like Spectrum Mobile and winning new partnerships with Chase, Telstra in Australia and another leading U.S. bank within our lender-placed business. Second, we have focused on expense discipline as we've continued to drive efficiencies across the organization by utilizing automation, digital and AI technologies. This has enabled us to deliver a better customer experience and invest in new capabilities while driving profitable growth. As an example, we believe our new device care center in Nashville, combined with the numerous investments we've made across the end-to-end mobile device lifecycle, will continue to support new growth opportunities in Global Lifestyle. In Global Housing, the scale we've achieved through growth and ongoing investing in our technology and compliance solutions have resulted in meaningful operational efficiencies and expense leverage as seen in the compelling expense ratios we've achieved. Global Housing's expense ratio is at a sustainable level in the high 30s, improving by approximately 3 percentage points year-to-date compared to full-year 2023 and nearly 9 percentage points since 2022, all while we improved the customer experience. And lastly, amidst a fast-changing macroeconomic environment as well as a year with multiple catastrophes, our capital position has remained very strong. Despite higher-than-average cat losses, we expect to return $300 million to shareholders through share repurchases in 2024. This is the top end of our anticipated range from the beginning of the year. The combination of our strong capital position, investments to support growth and robust shareholder returns is a testament to our balanced capital management focus and the strong cash flows of our advantaged businesses. As we look ahead, my focus will be to continue to execute against these priorities to drive growth. Turning to our third quarter results. Adjusted EBITDA grew 8% to $385 million and adjusted earnings per share increased by 9% to $5.08, both excluding reportable catastrophes. From a capital perspective, we generated over $160 million of segment dividends in the third quarter, ending the quarter with $636 million of holding company liquidity. Our strong capital position allowed us to return $138 million to shareholders in the quarter, including $100 million of share repurchases. In addition, we repurchased $20 million of shares during the month of October. This amounts to $200 million of share repurchases year-to-date. Looking at Global Lifestyle, adjusted EBITDA decreased 4%. In Connected Living, we saw another quarter of growth in global mobile protection programs, increasing devices protected by over 2 million subscribers from growth in U.S. cable operators and new Asia-Pacific clients. This was offset by investments in the quarter of approximately $8 million in new capabilities and client partnerships that are expected to drive future growth. International results were impacted by unfavorable foreign-exchange, but remained stable on a constant-currency basis as we focus on driving results across all regions. Trading results were largely flat as declines in carrier volumes and lower promotional activity were offset by volumes from newer programs. Turning to Global Auto. Earnings were down modestly year-over-year, mainly from elevated losses within our ancillary GAAP products, which was partially offset by higher investment income. Claims experienced from inflation in our vehicle service contract business was stable as previously implemented rate increases across our client base have begun to moderate the impacts of higher auto repair costs. Moving to net earned premiums, fees and other income. Global Lifestyle grew by $144 million or 7%. Growth was primarily driven by Connected Living, which was up 13%, benefiting from new trading programs and additional mobile subscribers, including the rollout of new clients. We continue to expect Global Lifestyles adjusted EBITDA to grow modestly for the year, driven by Connected Living. Growth will be offset by lower results within Global Auto and unfavorable foreign-exchange rates. For the fourth quarter, we expect a sequential increase in Connected Living from favorable seasonal trends, including higher mobile trade-in volumes from new device introductions and carrier promotions. In addition, we anticipate higher contributions from new Connected Living partners and programs as they begin to earn. Global Auto earnings are expected to remain stable sequentially. Now let's move to Global Housing's third quarter performance. Third quarter adjusted EBITDA, including $137 million of reportable catastrophes, was $92 million. Excluding reportable cats, adjusted EBITDA increased 20% to $229 million, growing $38 million. Global Housing performance was mainly driven by policy growth due to higher placement rates from the net impacts of ongoing client and portfolio transitions and increased voluntary insurance market pressure. In addition, average premiums increased from higher insured values year-over-year and filed rates. Lastly, results benefited from $30 million of favorable year-over-year prior-period reserve development. This was comprised of a $45 million reserve reduction in the current quarter compared to a $15 million reserve reduction in the third quarter of 2023. The increase in Global Housing was partially offset by a $28 million unfavorable non-run rate adjustment related to a change in earnings pattern assumptions. Within our renters business, we benefited from continued strong results in our PMC channel, where we drove double-digit gross written premium growth. We continue to expect strong adjusted EBITDA growth in Global Housing for full-year 2024, excluding catastrophes. We anticipate growth will be driven by continued top-line momentum in homeowners, expense leverage, favorable non-cat loss experience and lower catastrophe reinsurance costs. Lastly, as we look-ahead to our fourth quarter results, we continue to settle claims and serve policyholders associated with Hurricane Milton. Early estimates indicate that impacts will range between $75 million to $110 million. For Corporate, the adjusted EBITDA loss in the third quarter was $30 million, an increase of $4 million year-over-year, driven by higher third-party and employee-related expenses. For the full-year 2024, we now expect the corporate adjusted EBITDA loss to be approximately $115 million. We generated significant deployable capital year-to-date, upstreaming $556 million in segment dividends. Looking forward to the remainder of the year, we remain focused on maintaining balance and flexibility as we support new business growth and return excess capital to shareholders. Overall, we're very pleased with our strong year-to-date performance in 2024 and feel well-positioned as we exit the year and move into 2025. With that, operator, please open the call for questions.
Operator: [Operator Instructions] Thank you. Our first question will come from Brian Meredith with UBS.
Brian Meredith: Yes, thank you.
Keith Demmings: Good morning. Brian.
Keith Meier: Good morning.
Brian Meredith: A couple -- good morning. A couple of questions here for you. First one, perhaps on Global Housing, all the catastrophe losses that we've been seeing, how are you thinking about pricing for that business when you head into 2025. And I'm assuming your cat reinsurance program since it doesn't appear you're going to have any kind of retention get into the program should be beneficial, should be good in 2025? So maybe you can give us a little color on that?
Keith Demmings: Yes. Maybe I'll start and then Keith Meier can chip in. But obviously, we feel really good about the reinsurance program that we have in place. And you're right, as we look at the effect of Milton and the other storms we've had through the year, it's been an active season, but we've not touched the reinsurance tower to this point. So I think that sets us up well in terms of favorability with our reinsurance partners. We've talked about having a panel of 40 reinsurers that have been very stable over-time. So I think we feel good heading into next year as we think about reinsurance costs. And then as we think about the rate process, obviously, we'll look at all of our losses over the course of the year, cat and non-cat, expense levels, reinsurance costs. So we look at the pricing heading into next year being relatively stable to what we've seen this year. So don't think that there'll be a big shift in premium as we head into '25.
Keith Meier: Yes. And I think we're certainly continuing to evaluate our program structure for our reinsurance cat tower. We'll share more of the details of that in February with our 2025 outlook. But in general, we expect to continue to approach our one in five probable maximum loss point for retention, which is $150 million this year. And we -- the good news is we haven't touched that tower this year. So, we certainly think with it not hitting the tower that that should be a positive as we look-forward to rates in 2025. And just as a reminder, we've moved to an effective date of April 1 for our one-time placement for our reinsurance programs as well.
Brian Meredith: Got you. That makes sense. And then, Keith and Keith, I was wondering if you could give me -- give us maybe a little bit of a preview of what you're thinking about for 2025 and Global Lifestyles. You've got a bunch of these new programs hitting and I'm assuming they'll have a nice tailwind from a growth and margin perspective as we look at 2025. Maybe a little big picture what we may be able to expect.
Keith Demmings: Sure. Yes, I'll give you a few highlights as we think about '25. Obviously, we need to close out Q4 and see where the underlying performance comes in, look at the trends et-cetera and then what we will obviously provide detailed guidance in February. But stepping back at the high-level, certainly we expect to accelerate Global Lifestyle growth in '25. I would say growth will certainly come in Connected Living. We've made a lot of investments in '24. Those investments won't continue in '25 and obviously we'll start to generate revenue and EBITDA from those client launches and the efficiency that we're driving. And then we've got good underlying strong momentum in the business overall. And then as I think about Auto, we definitely expect growth in Auto in '25 as well. We expect the business will benefit from higher earnings from the rate increases that we've implemented over the last couple of years and then stabilizing inflation levels. One thing I would mention, we do expect some additional incremental investments in '25. There are a number of things that we're actively working on similar to '24, net-new clients, net-new program launches, things that have not yet been disclosed to the market. So we'll preview that as well in '25. So think about the '24 investments really sunsetting the revenue and EBITDA flowing through. And then hopefully, if we have continued great momentum with clients, we'll have some other big exciting things that we'll be bringing to market in '25 as well. And then maybe I'll just touch on housing since we'll close out the '25 thoughts. I mean, it's been an incredible 2024, really the last couple of years in housing. As we think about '25, probably the simplest way to say it is net of the prior year development that we've seen, we do expect solid underlying growth in-housing in '25. And I'd say driven from the growth we've seen in terms of our policy counts, continued increases in average insured values and then momentum around expense leverage in the business. So more to come in February, but those are a few of the high-level thoughts.
Brian Meredith: Okay, thank you.
Keith Demmings: You bet. Thank you.
Operator: Our next question comes from Mark Hughes with Truist.
Keith Demmings: Hi, Mark. Good morning.
Mark Hughes: Yes, thank you very much. Good morning. The voluntary business that you're picking-up, can you talk about that is the momentum still building in voluntary, the markets that you're seeing success are still dislocated, how do you see that trend?
Keith Demmings: Yes, I think when we look at - yes, and really we're highlighting the impact around the placement rate. So we look at the placement rate is up 6 basis-points sequentially, it's up 18 basis-points year-over-year. So we've seen a lot of momentum with respect to that. And I would say it's probably equal parts growth in the underlying business. We obviously onboarded a major new client earlier this year. We've seen growth within our existing client bases of acquired loans, acquired portfolios. And then the other half of that growth is a result of additional policies being placed because homeowners are being more challenged to find traditional voluntary coverage. So we've talked about that hard market factor being part of the drivers for the placement rate growth, less so challenges more broadly in the economy, challenges in terms of delinquency and those types of things, those are really not factoring in at least at this point. So that's what we've tried to highlight is it's a function of the hard market that we're seeing around the country.
Mark Hughes: In the device counts, you had a nice acceleration this quarter. I think you talked about the new Asia-Pacific clients. Did they come over kind of in math or will this growth continue?
Keith Demmings: The step-change we saw earlier in the year, at this point in Q3, this is a more natural evolution. So we've seen continued steady growth both in our domestic business. We rolled-out some new products earlier this year with one of our major cable partners, that's generated a significant momentum. And then, of course, building as well in Asia-Pacific. But that was more of a natural evolution from the finish point at Q2 and those blocks had already sort of step changed earlier in the year.
Mark Hughes: Yes. And then on the GAAP, higher-than-expected, the GAAP losses. When does that run-through? When do you either reinsure that away or get enough price to offset the claims experience?
Keith Meier: Yes. So we mentioned before that the impact from GAAP is shorter-term in nature versus the vehicle service contracts. Those claims are usually heavier in the first 24 months or so. And we've been partnering with our clients to eliminate or reduce the risk on those businesses. And just as an example, from a written premium perspective, in 2022, 40% of the business, we had some risk participation. And then in 2024, it's down to just 12%. So overall, as we look into 2025, with all the actions that we've taken across our vehicle service contracts and GAAP, we expect Auto to improve as we as we move forward. And I think overall, I think we get a sense that the pressure is declining, certainly for Auto.
Keith Demmings: Yes. And maybe I'll just amplify. I think we talked about starting this process of looking at reshaping the risk that we hold relative to GAAP going back two years ago. So we started this process early. And as Keith highlighted, a pretty big reduction in the amount of risk that we're writing today. So really it's just a question of running off the unearned part of the business. But as Keith said, it's much shorter-term in nature. So it shouldn't be a headwind as we think about '25.
Mark Hughes: Thank you.
Keith Demmings: Thank you.
Operator: Our next question comes from Tommy McJoynt with KBW.
Keith Demmings: Hi, Tommy.
Keith Meier: Hello.
Tommy McJoynt: Hi, good morning, guys. Thanks for taking my questions. When we think about the subscribers that you guys are adding, I think largely calling out the cable operators in the Asia-Pacific region, is the sort of monetization opportunity of those customers any different than the traditional sort of carrier customer that represented your in force for a long-time?
Keith Demmings: No, I think it's pretty well-aligned. I mean, obviously, every deal with clients work differently. But no, I'd say it's very much aligned with the standard operating model. Obviously, we're pleased to see the subscriber growth pretty material year-over-year and then continuing to build certainly in the quarter. But no, I wouldn't say it's dramatically different than sort of the average of the total, Tommy.
Tommy McJoynt: Okay, got it. And then to clarify your comments around the investment spend in Connected Living, I think you called out $21 million of spend year-to-date. And it sounds like that investment spend is sunsetting this year, but then it's going to be replaced by sort of additional or new investment spend next year for new programs. Can you just clarify the comments around that?
Keith Demmings: Yes, that's exactly right. So we've got, to your point, $21 million year-to-date. We had about $8 million that we called out in the third quarter. We'll see a little bit more in the fourth quarter, probably moderating a little bit from kind of where we sit today. As I think about '24, two-thirds of that investment spend I'm simplifying is related to new client launches. Think about the launches with Telstra, Spectrum, Chase, some other things that we probably haven't highlighted. And then a third of it is the work that we've done to really automate and invest in our new device care center. So all of those programs are sort of delivered this year. Those don't recur and then we get all the benefit in terms of revenue, EBITDA and efficiency. And then to your point, we will have additional new investments, which I think is a really good thing, right. If we're making -- and we're only calling out investments that are meaningful and that are designed to launch net-new things in the marketplace that have strong payback and that are going to generate EBITDA and revenue once they launch. So we'll size that again in February, Tommy, to give everyone a sense of how we think about that, but there's a lot of things in our pipeline. Our commercial momentum, particularly in Connected Living is incredibly strong. So, this would be a really good thing if we've got another bucket of investment similar to what we did this year.
Tommy McJoynt: Thanks. And then just lastly in Connected Living, the fourth quarter guide seems to imply some pretty good strength there. What's sort of contemplated around trade-in volumes and perhaps the sensitivity around this iPhone upgrade cycle? Should we think of this as an unusually strong fourth quarter or is this some -- is this something I can repeat in kind of future years?
Keith Demmings: Yes, I'd probably say that when we look at the sequential growth in Connected Living going into Q4, trade-in seasonality and Keith can speak to it in a second, we definitely would expect to see that. We've got benefit from the new clients that we've launched, a little bit moderating expenses, but revenues flowing through. We also see seasonal loss improvements in the retail service contract business as well. So there's a few drivers that will create a sequential improvement in Connected Living, but maybe Keith talk a little bit about trading.
Keith Meier: Yes. And I think as you think about trade-in, we -- I think we saw a little bit of softness in trade-in and promotional activity, offset by some newer programs in this quarter. If you think about it, the iPhone 16 launched on September 20th, but the first set of Apple Intelligence features were rolled out on October 28. So we certainly expect more promotional activity as we come into the fourth quarter. I think it was muted a little bit in the third quarter, but we expect that to pick up here in the fourth quarter.
Tommy McJoynt: Thanks.
Keith Demmings: Great, thank you.
Operator: [Operator Instructions] We have no one else in the queue.
Keith Demmings: Alright, wonderful. Well, thanks, everyone...
Operator: Apologies, we do. John Barnidge from Piper Sandler just raised his hand.
Keith Demmings: Oh, John, just in time. Good morning.
John Barnidge: Yes, good morning. Sorry. Yes, must not have captured the first star nine, but got a couple questions. Appreciate you fitting me in. Given we've got past experience of improving profitability meaningfully in Global Housing, I'm wondering if there are some lessons here that can be transferred to Global Auto? With rate increases having an impact on profitability, should we expect there to be a period of favorable reserve development in that business over-time at all?
Keith Demmings: Yes, I mean, I think -- I'd probably say a couple of things where we've been through these cycles before for a variety of different reasons where maybe losses are elevated in different periods. I think our track-record of working through this with clients is exceptionally strong. The alignment of interest, the contracting got in place. So, Auto is a little different because of the nature of the product. It's longer-term in nature. So it takes a longer effort to kind of get it back to profitability where housing is an annual policy, but there's no doubt the lessons learned through housing. If you think back to a couple of years ago, simplified the business, drove a tremendous amount of focus on the core, didn't just attack the issue from a rate perspective, but look to drive operational efficiency, expense efficiency. And I think we're doing those same things on the auto side. So we're addressing it multiple ways. We're strengthening the business at a fundamental level as a result of some of the changes we're making. And we feel confident that we'll create some longer-term tailwinds. I don't think there'll be major step changes in terms of reserving releases over-time, but I'll let Keith speak to that.
Keith Meier: Yes. And I would say just in general, these types of challenges just make us stronger in terms of the rigor and the -- and the actions that we take in that business. So I think that always does provide us some positive impacts as you look-forward. Just if you think about for Auto, we implemented 16 now total rate changes with our clients. So we've been working with our clients to do that. And then we also redesign products to make them more effective for the consumer and as well. So I think being able to pull all the levers that we have, I think our examples of there's different levers, as Keith mentioned in housing versus Auto, but I think it's a lot of that similar element. And so it's not so much the reserves for auto, it's more of the earnings of those rates that will be coming through over the next few years that provides us the little bit of tailwind there for Auto business.
John Barnidge: And then my other question, you've had quite a lot of success taking wins in one business and winning in another business. I think Chase was a good example of that this year. Is there an opportunity to offer mobile coverage or other coverage to clients where you've won that global housing business? I know I get Hulu, Netflix and Apple TV with my mobile device. Wondering if there can be a bundling in the card and housing in mobile?
Keith Demmings: Yes. I mean, it's definitely an interesting thought and we always think about how do we leverage the relationships that we've got and you think about the strength of Assurant, certainly it's the B2B to see nature of the business. But the fact that we operate across a wide number of distribution channels with major brands. So as clients are looking to reinvent how they bring services to market, I think we're well-positioned to capitalize on that. So I think the logic of your question makes perfect sense. Obviously, a dramatic amount of the scale has come through partnerships with mobile operators. If we look at the U.K. market, for example, though we work with major banks in the U.K. that offer mobile protection as part of their packaged bank account. So we definitely look for those opportunities where we think we're best positioned and we can deliver at scale.
Keith Meier: Yes. And I think it's definitely a positive opportunity for us to leverage these relationships that we have with these large institutions like Chase. A good example is, I was meeting with some of their executives when we -- when they were launching the program last month and they said they did check with their Chase counterparts and basically we're doing reference checks on Assurant. They came back very positive. And so those types of things certainly can go a long way and are very positive for us to expand relationships.
John Barnidge: Thanks for the answers.
Keith Demmings: Thank you, John.
John Barnidge: Thank you.
Operator: There is no one else in the queue. I will pass it back to Keith for closing remarks.
Keith Demmings: Okay, wonderful. Well, thanks everybody for joining and we will certainly look-forward to another discussion in February. We'll share how we closed out the year and provide some guidance for 2025. So, thanks very much and have a great holiday season. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Third Quarter 2024 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin."
},
{
"speaker": "Sean Moshier",
"text": "Thank you, operator, and good morning, everyone. We look-forward to discussing our third quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release, announcing our results for the third quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also, on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties, and other factors that may cause actual results to differ materially from those contemplated by those statements. Additional information regarding these factors can be found in the earnings release, presentation, and financial supplement on our website, as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Sean, and good morning, everyone. Our third quarter results further supported our strong year-to-date performance. Through the first nine months of the year, adjusted EBITDA increased by 15% and adjusted EPS grew by 21%, both excluding catastrophes. Results were led by sustained outperformance within Global Housing, as well as underlying growth within our Connected Living business, which was muted by incremental investments in new partnerships and programs and unfavorable foreign-exchange. Our year-to-date momentum has positioned us to exceed our previous expectations. Excluding catastrophes, we now expect adjusted EBITDA to increase low-double-digits for the second consecutive year and adjusted earnings per share to increase mid to high teens, led by business growth and strong share repurchases. Once again, we've outperformed the broader P&C industry, both short and long-term, reflecting the unique and differentiated nature of our combined housing and lifestyle business model. Let's begin with our year-to-date business highlights. In Global Lifestyle, year-to-date performance was relatively flat versus the prior-period, reflecting elevated claims experience in global automotive as well as impacts from unfavorable foreign exchange of 2% or $10 million, above our expectations from earlier in the year. Within Connected Living, year-to-date adjusted EBITDA increased 3% or 5% on a constant-currency basis as we continue to invest in new partnerships and programs to support future growth. Excluding investments of approximately $21 million for the first-nine months of the year, Connected Living adjusted EBITDA growth was strong at 11% on a constant-currency basis. One prime example of those investments includes our new innovation and device care center located just outside of Nashville, supporting our mobile business. In addition to repurposing millions of devices per year, the new state of the art facility employs innovative ways to leverage automation, robotics and AI. This will create greater value within our global supply-chain while driving growth in the secondary device market. The Nashville facility demonstrates our investments in innovation, allowing us to continuously improve our customer experience as we operate through end-to-end partnerships with our mobile clients, a critical competitive advantage for Assurant. Within financial services, on October 1, we launched a new program with Chase Card Services in our growing card benefits business. Beginning at program launch, we're providing end-to-end delivery for approximately 15 travel and purchase protection benefits, including underwriting, claims processing and benefit servicing to millions of Chase Card holders. We're excited about several new clients and programs targeted for 2025, adding to our growing portfolio. Similar to '24, these new opportunities may require incremental investments. Moving to Global Automotive. Our Auto business has experienced elevated claims costs in both our vehicle service contract business and our GAAP product throughout 2024. Over the past two quarters, we've started to see some positive early signs with the stabilization of underlying claims severity trends in our vehicle service contract business. Claims inflation impacts have begun to moderate and our loss ratio is beginning to benefit from rate increases we've taken over the past two years. Within our GAAP product, elevated losses have continued as anticipated, but we continue to expect higher claims to be short-term in nature in comparison to the vehicle service contract business. In addition, our proactive partnership with several clients to enable us to transition most of the risk and reduce a large portion of our claims exposure over-time. We remain focused on driving actions to improve Auto results while benefiting from moderating inflation impacts in 2025 and beyond. We're excited about the long-term trajectory of this business. Now let's turn to Global Housing. I want to begin by thanking all of our employees who supported policyholders impacted by recent weather events over the last several months, including multiple major hurricanes. We play an important role in safeguarding our policyholders as we processed approximately 35,000 claims to date associated with these events. It's an important reminder of the critical role our lender-placed product plays in the U.S. mortgage industry, removing the risk of uninsured loss for lenders, investors and homeowners. It's crucial to provide all homeowners with access to insurance. For that reason, we continue to work closely with each state to offer coverage and protection to homeowners at appropriate rates. Looking at Global Housing's year-to-date results, we've demonstrated continued strong performance, particularly within our homeowners' business. Over the first-nine months of the year, earnings increased 34% excluding reportable catastrophes. In our lender-placed business, we continue to benefit from key competitive advantages, utilizing various growth levers over the past two years to sustain results, including meaningful expense leverage, scale from new partners and product safeguards to address macroeconomic factors like inflation. Results were driven primarily by continued policy growth as the placement rate increased to 1.92%, a 12 basis-point improvement since year end and a 6 basis-point improvement sequentially. Policy growth has been led by several new partnerships and portfolios as well as from states where it's become more difficult to secure voluntary homeowners coverage. Within renters, adjusted EBITDA has also shown year-to-date growth, supported by continued expansion in our Property Management Company or PMC channel. Growth in our PMC channel has been supported by technology innovation aimed at enhancing our digital customer experience. This has included the rollouts of Assurant TechPro and our Cover360 platform, leading to higher penetration with a simplified resident enrollment process. Overall, the housing business has benefited from our unique competitive advantages throughout lender-placed and renters, showcasing its resiliency and outperformance over various macroeconomic environments. Turning to our enterprise outlook. As I mentioned earlier, given the strength of our year-to-date results, we now expect full-year adjusted EBITDA to grow low-double-digits and adjusted earnings per share to increase mid to high teens, both excluding catastrophes. This represents an increase to both metrics above our expectations, demonstrating the continued strength of our financial performance. For the year, we continue to anticipate strong growth within Global Housing with modest growth expected in Global Lifestyle as we fund incremental investments in Connected Living. Our ability to sustain profitable growth year-after-year is a true reflection of our unique and advantaged business model. Assurant's performance is the result of a multi-year transformation, which has significantly enhanced our business mix, risk profile and market positioning. We've simplified and optimized Assurant to focus on specialized attractive markets with long-term secular tailwinds within lifestyle and housing, while selling pre-need and employee benefits and exiting health and other non-core businesses. In the markets we operate in, we have leadership positions and competitive advantages through our protection solutions across devices, automobiles and homes. We are well-positioned to win due to our highly scaled and deeply integrated B2B2C partnerships where we work with our clients to innovate and create flexible solutions for their end consumers. At the same time, we've enhanced Assurant's risk profile by focusing on capital-efficient businesses within lifestyle and housing. Through purposeful transformation, we've enhanced our ability to drive long-term performance and cash generation, attracting growth partnerships with large sophisticated clients and become increasingly more capital-efficient. I'm proud of the long-term outperformance we've achieved against the broader P&C market. Slide 10 demonstrates our historical outperformance, including a five-year history of double-digit growth. Based on our current outlook for 2024, annual growth rates since 2019 are expected to average 11% for adjusted EBITDA and 17% for adjusted EPS, both excluding catastrophes. Given our historical performance and our unique and differentiated business model, we believe we have meaningful valuation upside, in particular, as compared to the S&P 1500 P&C Index, a broad index of 32 members now including Assurant. Overall, we see a compelling path for growth ahead and believe Assurant represents an attractive investment. I'll now turn it over to Keith Meier to review our third quarter results and business trends impacting our 2024 outlook."
},
{
"speaker": "Keith Meier",
"text": "Thanks, Keith, and good morning, everyone. This November marks the conclusion of my first year as CFO of Assurant. When I began this role, I outlined my key priorities, including driving growth and strong financial performance with a focus on innovation and product differentiation. These priorities have been supported by our continuous efforts to drive expense efficiencies through automation, digital and AI technologies, while improving overall customer experience as well as ensuring our capital position remains strong, providing us with the flexibility to create value and support long-term growth. Over the past year, we have made significant progress. First, looking at growth and financial performance, our B2B2C partnerships are the lifeblood of our business model and the primary driver behind our growth story. Over the past 12 months, we've spotlighted several notable client announcements, such as renewing all major U.S. mobile clients, including three of the top-five largest mobile carriers in the U.S., launching new programs and capabilities with existing clients like Spectrum Mobile and winning new partnerships with Chase, Telstra in Australia and another leading U.S. bank within our lender-placed business. Second, we have focused on expense discipline as we've continued to drive efficiencies across the organization by utilizing automation, digital and AI technologies. This has enabled us to deliver a better customer experience and invest in new capabilities while driving profitable growth. As an example, we believe our new device care center in Nashville, combined with the numerous investments we've made across the end-to-end mobile device lifecycle, will continue to support new growth opportunities in Global Lifestyle. In Global Housing, the scale we've achieved through growth and ongoing investing in our technology and compliance solutions have resulted in meaningful operational efficiencies and expense leverage as seen in the compelling expense ratios we've achieved. Global Housing's expense ratio is at a sustainable level in the high 30s, improving by approximately 3 percentage points year-to-date compared to full-year 2023 and nearly 9 percentage points since 2022, all while we improved the customer experience. And lastly, amidst a fast-changing macroeconomic environment as well as a year with multiple catastrophes, our capital position has remained very strong. Despite higher-than-average cat losses, we expect to return $300 million to shareholders through share repurchases in 2024. This is the top end of our anticipated range from the beginning of the year. The combination of our strong capital position, investments to support growth and robust shareholder returns is a testament to our balanced capital management focus and the strong cash flows of our advantaged businesses. As we look ahead, my focus will be to continue to execute against these priorities to drive growth. Turning to our third quarter results. Adjusted EBITDA grew 8% to $385 million and adjusted earnings per share increased by 9% to $5.08, both excluding reportable catastrophes. From a capital perspective, we generated over $160 million of segment dividends in the third quarter, ending the quarter with $636 million of holding company liquidity. Our strong capital position allowed us to return $138 million to shareholders in the quarter, including $100 million of share repurchases. In addition, we repurchased $20 million of shares during the month of October. This amounts to $200 million of share repurchases year-to-date. Looking at Global Lifestyle, adjusted EBITDA decreased 4%. In Connected Living, we saw another quarter of growth in global mobile protection programs, increasing devices protected by over 2 million subscribers from growth in U.S. cable operators and new Asia-Pacific clients. This was offset by investments in the quarter of approximately $8 million in new capabilities and client partnerships that are expected to drive future growth. International results were impacted by unfavorable foreign-exchange, but remained stable on a constant-currency basis as we focus on driving results across all regions. Trading results were largely flat as declines in carrier volumes and lower promotional activity were offset by volumes from newer programs. Turning to Global Auto. Earnings were down modestly year-over-year, mainly from elevated losses within our ancillary GAAP products, which was partially offset by higher investment income. Claims experienced from inflation in our vehicle service contract business was stable as previously implemented rate increases across our client base have begun to moderate the impacts of higher auto repair costs. Moving to net earned premiums, fees and other income. Global Lifestyle grew by $144 million or 7%. Growth was primarily driven by Connected Living, which was up 13%, benefiting from new trading programs and additional mobile subscribers, including the rollout of new clients. We continue to expect Global Lifestyles adjusted EBITDA to grow modestly for the year, driven by Connected Living. Growth will be offset by lower results within Global Auto and unfavorable foreign-exchange rates. For the fourth quarter, we expect a sequential increase in Connected Living from favorable seasonal trends, including higher mobile trade-in volumes from new device introductions and carrier promotions. In addition, we anticipate higher contributions from new Connected Living partners and programs as they begin to earn. Global Auto earnings are expected to remain stable sequentially. Now let's move to Global Housing's third quarter performance. Third quarter adjusted EBITDA, including $137 million of reportable catastrophes, was $92 million. Excluding reportable cats, adjusted EBITDA increased 20% to $229 million, growing $38 million. Global Housing performance was mainly driven by policy growth due to higher placement rates from the net impacts of ongoing client and portfolio transitions and increased voluntary insurance market pressure. In addition, average premiums increased from higher insured values year-over-year and filed rates. Lastly, results benefited from $30 million of favorable year-over-year prior-period reserve development. This was comprised of a $45 million reserve reduction in the current quarter compared to a $15 million reserve reduction in the third quarter of 2023. The increase in Global Housing was partially offset by a $28 million unfavorable non-run rate adjustment related to a change in earnings pattern assumptions. Within our renters business, we benefited from continued strong results in our PMC channel, where we drove double-digit gross written premium growth. We continue to expect strong adjusted EBITDA growth in Global Housing for full-year 2024, excluding catastrophes. We anticipate growth will be driven by continued top-line momentum in homeowners, expense leverage, favorable non-cat loss experience and lower catastrophe reinsurance costs. Lastly, as we look-ahead to our fourth quarter results, we continue to settle claims and serve policyholders associated with Hurricane Milton. Early estimates indicate that impacts will range between $75 million to $110 million. For Corporate, the adjusted EBITDA loss in the third quarter was $30 million, an increase of $4 million year-over-year, driven by higher third-party and employee-related expenses. For the full-year 2024, we now expect the corporate adjusted EBITDA loss to be approximately $115 million. We generated significant deployable capital year-to-date, upstreaming $556 million in segment dividends. Looking forward to the remainder of the year, we remain focused on maintaining balance and flexibility as we support new business growth and return excess capital to shareholders. Overall, we're very pleased with our strong year-to-date performance in 2024 and feel well-positioned as we exit the year and move into 2025. With that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Thank you. Our first question will come from Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"text": "Yes, thank you."
},
{
"speaker": "Keith Demmings",
"text": "Good morning. Brian."
},
{
"speaker": "Keith Meier",
"text": "Good morning."
},
{
"speaker": "Brian Meredith",
"text": "A couple -- good morning. A couple of questions here for you. First one, perhaps on Global Housing, all the catastrophe losses that we've been seeing, how are you thinking about pricing for that business when you head into 2025. And I'm assuming your cat reinsurance program since it doesn't appear you're going to have any kind of retention get into the program should be beneficial, should be good in 2025? So maybe you can give us a little color on that?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. Maybe I'll start and then Keith Meier can chip in. But obviously, we feel really good about the reinsurance program that we have in place. And you're right, as we look at the effect of Milton and the other storms we've had through the year, it's been an active season, but we've not touched the reinsurance tower to this point. So I think that sets us up well in terms of favorability with our reinsurance partners. We've talked about having a panel of 40 reinsurers that have been very stable over-time. So I think we feel good heading into next year as we think about reinsurance costs. And then as we think about the rate process, obviously, we'll look at all of our losses over the course of the year, cat and non-cat, expense levels, reinsurance costs. So we look at the pricing heading into next year being relatively stable to what we've seen this year. So don't think that there'll be a big shift in premium as we head into '25."
},
{
"speaker": "Keith Meier",
"text": "Yes. And I think we're certainly continuing to evaluate our program structure for our reinsurance cat tower. We'll share more of the details of that in February with our 2025 outlook. But in general, we expect to continue to approach our one in five probable maximum loss point for retention, which is $150 million this year. And we -- the good news is we haven't touched that tower this year. So, we certainly think with it not hitting the tower that that should be a positive as we look-forward to rates in 2025. And just as a reminder, we've moved to an effective date of April 1 for our one-time placement for our reinsurance programs as well."
},
{
"speaker": "Brian Meredith",
"text": "Got you. That makes sense. And then, Keith and Keith, I was wondering if you could give me -- give us maybe a little bit of a preview of what you're thinking about for 2025 and Global Lifestyles. You've got a bunch of these new programs hitting and I'm assuming they'll have a nice tailwind from a growth and margin perspective as we look at 2025. Maybe a little big picture what we may be able to expect."
},
{
"speaker": "Keith Demmings",
"text": "Sure. Yes, I'll give you a few highlights as we think about '25. Obviously, we need to close out Q4 and see where the underlying performance comes in, look at the trends et-cetera and then what we will obviously provide detailed guidance in February. But stepping back at the high-level, certainly we expect to accelerate Global Lifestyle growth in '25. I would say growth will certainly come in Connected Living. We've made a lot of investments in '24. Those investments won't continue in '25 and obviously we'll start to generate revenue and EBITDA from those client launches and the efficiency that we're driving. And then we've got good underlying strong momentum in the business overall. And then as I think about Auto, we definitely expect growth in Auto in '25 as well. We expect the business will benefit from higher earnings from the rate increases that we've implemented over the last couple of years and then stabilizing inflation levels. One thing I would mention, we do expect some additional incremental investments in '25. There are a number of things that we're actively working on similar to '24, net-new clients, net-new program launches, things that have not yet been disclosed to the market. So we'll preview that as well in '25. So think about the '24 investments really sunsetting the revenue and EBITDA flowing through. And then hopefully, if we have continued great momentum with clients, we'll have some other big exciting things that we'll be bringing to market in '25 as well. And then maybe I'll just touch on housing since we'll close out the '25 thoughts. I mean, it's been an incredible 2024, really the last couple of years in housing. As we think about '25, probably the simplest way to say it is net of the prior year development that we've seen, we do expect solid underlying growth in-housing in '25. And I'd say driven from the growth we've seen in terms of our policy counts, continued increases in average insured values and then momentum around expense leverage in the business. So more to come in February, but those are a few of the high-level thoughts."
},
{
"speaker": "Brian Meredith",
"text": "Okay, thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Mark Hughes with Truist."
},
{
"speaker": "Keith Demmings",
"text": "Hi, Mark. Good morning."
},
{
"speaker": "Mark Hughes",
"text": "Yes, thank you very much. Good morning. The voluntary business that you're picking-up, can you talk about that is the momentum still building in voluntary, the markets that you're seeing success are still dislocated, how do you see that trend?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I think when we look at - yes, and really we're highlighting the impact around the placement rate. So we look at the placement rate is up 6 basis-points sequentially, it's up 18 basis-points year-over-year. So we've seen a lot of momentum with respect to that. And I would say it's probably equal parts growth in the underlying business. We obviously onboarded a major new client earlier this year. We've seen growth within our existing client bases of acquired loans, acquired portfolios. And then the other half of that growth is a result of additional policies being placed because homeowners are being more challenged to find traditional voluntary coverage. So we've talked about that hard market factor being part of the drivers for the placement rate growth, less so challenges more broadly in the economy, challenges in terms of delinquency and those types of things, those are really not factoring in at least at this point. So that's what we've tried to highlight is it's a function of the hard market that we're seeing around the country."
},
{
"speaker": "Mark Hughes",
"text": "In the device counts, you had a nice acceleration this quarter. I think you talked about the new Asia-Pacific clients. Did they come over kind of in math or will this growth continue?"
},
{
"speaker": "Keith Demmings",
"text": "The step-change we saw earlier in the year, at this point in Q3, this is a more natural evolution. So we've seen continued steady growth both in our domestic business. We rolled-out some new products earlier this year with one of our major cable partners, that's generated a significant momentum. And then, of course, building as well in Asia-Pacific. But that was more of a natural evolution from the finish point at Q2 and those blocks had already sort of step changed earlier in the year."
},
{
"speaker": "Mark Hughes",
"text": "Yes. And then on the GAAP, higher-than-expected, the GAAP losses. When does that run-through? When do you either reinsure that away or get enough price to offset the claims experience?"
},
{
"speaker": "Keith Meier",
"text": "Yes. So we mentioned before that the impact from GAAP is shorter-term in nature versus the vehicle service contracts. Those claims are usually heavier in the first 24 months or so. And we've been partnering with our clients to eliminate or reduce the risk on those businesses. And just as an example, from a written premium perspective, in 2022, 40% of the business, we had some risk participation. And then in 2024, it's down to just 12%. So overall, as we look into 2025, with all the actions that we've taken across our vehicle service contracts and GAAP, we expect Auto to improve as we as we move forward. And I think overall, I think we get a sense that the pressure is declining, certainly for Auto."
},
{
"speaker": "Keith Demmings",
"text": "Yes. And maybe I'll just amplify. I think we talked about starting this process of looking at reshaping the risk that we hold relative to GAAP going back two years ago. So we started this process early. And as Keith highlighted, a pretty big reduction in the amount of risk that we're writing today. So really it's just a question of running off the unearned part of the business. But as Keith said, it's much shorter-term in nature. So it shouldn't be a headwind as we think about '25."
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from Tommy McJoynt with KBW."
},
{
"speaker": "Keith Demmings",
"text": "Hi, Tommy."
},
{
"speaker": "Keith Meier",
"text": "Hello."
},
{
"speaker": "Tommy McJoynt",
"text": "Hi, good morning, guys. Thanks for taking my questions. When we think about the subscribers that you guys are adding, I think largely calling out the cable operators in the Asia-Pacific region, is the sort of monetization opportunity of those customers any different than the traditional sort of carrier customer that represented your in force for a long-time?"
},
{
"speaker": "Keith Demmings",
"text": "No, I think it's pretty well-aligned. I mean, obviously, every deal with clients work differently. But no, I'd say it's very much aligned with the standard operating model. Obviously, we're pleased to see the subscriber growth pretty material year-over-year and then continuing to build certainly in the quarter. But no, I wouldn't say it's dramatically different than sort of the average of the total, Tommy."
},
{
"speaker": "Tommy McJoynt",
"text": "Okay, got it. And then to clarify your comments around the investment spend in Connected Living, I think you called out $21 million of spend year-to-date. And it sounds like that investment spend is sunsetting this year, but then it's going to be replaced by sort of additional or new investment spend next year for new programs. Can you just clarify the comments around that?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, that's exactly right. So we've got, to your point, $21 million year-to-date. We had about $8 million that we called out in the third quarter. We'll see a little bit more in the fourth quarter, probably moderating a little bit from kind of where we sit today. As I think about '24, two-thirds of that investment spend I'm simplifying is related to new client launches. Think about the launches with Telstra, Spectrum, Chase, some other things that we probably haven't highlighted. And then a third of it is the work that we've done to really automate and invest in our new device care center. So all of those programs are sort of delivered this year. Those don't recur and then we get all the benefit in terms of revenue, EBITDA and efficiency. And then to your point, we will have additional new investments, which I think is a really good thing, right. If we're making -- and we're only calling out investments that are meaningful and that are designed to launch net-new things in the marketplace that have strong payback and that are going to generate EBITDA and revenue once they launch. So we'll size that again in February, Tommy, to give everyone a sense of how we think about that, but there's a lot of things in our pipeline. Our commercial momentum, particularly in Connected Living is incredibly strong. So, this would be a really good thing if we've got another bucket of investment similar to what we did this year."
},
{
"speaker": "Tommy McJoynt",
"text": "Thanks. And then just lastly in Connected Living, the fourth quarter guide seems to imply some pretty good strength there. What's sort of contemplated around trade-in volumes and perhaps the sensitivity around this iPhone upgrade cycle? Should we think of this as an unusually strong fourth quarter or is this some -- is this something I can repeat in kind of future years?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I'd probably say that when we look at the sequential growth in Connected Living going into Q4, trade-in seasonality and Keith can speak to it in a second, we definitely would expect to see that. We've got benefit from the new clients that we've launched, a little bit moderating expenses, but revenues flowing through. We also see seasonal loss improvements in the retail service contract business as well. So there's a few drivers that will create a sequential improvement in Connected Living, but maybe Keith talk a little bit about trading."
},
{
"speaker": "Keith Meier",
"text": "Yes. And I think as you think about trade-in, we -- I think we saw a little bit of softness in trade-in and promotional activity, offset by some newer programs in this quarter. If you think about it, the iPhone 16 launched on September 20th, but the first set of Apple Intelligence features were rolled out on October 28. So we certainly expect more promotional activity as we come into the fourth quarter. I think it was muted a little bit in the third quarter, but we expect that to pick up here in the fourth quarter."
},
{
"speaker": "Tommy McJoynt",
"text": "Thanks."
},
{
"speaker": "Keith Demmings",
"text": "Great, thank you."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We have no one else in the queue."
},
{
"speaker": "Keith Demmings",
"text": "Alright, wonderful. Well, thanks, everyone..."
},
{
"speaker": "Operator",
"text": "Apologies, we do. John Barnidge from Piper Sandler just raised his hand."
},
{
"speaker": "Keith Demmings",
"text": "Oh, John, just in time. Good morning."
},
{
"speaker": "John Barnidge",
"text": "Yes, good morning. Sorry. Yes, must not have captured the first star nine, but got a couple questions. Appreciate you fitting me in. Given we've got past experience of improving profitability meaningfully in Global Housing, I'm wondering if there are some lessons here that can be transferred to Global Auto? With rate increases having an impact on profitability, should we expect there to be a period of favorable reserve development in that business over-time at all?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, I mean, I think -- I'd probably say a couple of things where we've been through these cycles before for a variety of different reasons where maybe losses are elevated in different periods. I think our track-record of working through this with clients is exceptionally strong. The alignment of interest, the contracting got in place. So, Auto is a little different because of the nature of the product. It's longer-term in nature. So it takes a longer effort to kind of get it back to profitability where housing is an annual policy, but there's no doubt the lessons learned through housing. If you think back to a couple of years ago, simplified the business, drove a tremendous amount of focus on the core, didn't just attack the issue from a rate perspective, but look to drive operational efficiency, expense efficiency. And I think we're doing those same things on the auto side. So we're addressing it multiple ways. We're strengthening the business at a fundamental level as a result of some of the changes we're making. And we feel confident that we'll create some longer-term tailwinds. I don't think there'll be major step changes in terms of reserving releases over-time, but I'll let Keith speak to that."
},
{
"speaker": "Keith Meier",
"text": "Yes. And I would say just in general, these types of challenges just make us stronger in terms of the rigor and the -- and the actions that we take in that business. So I think that always does provide us some positive impacts as you look-forward. Just if you think about for Auto, we implemented 16 now total rate changes with our clients. So we've been working with our clients to do that. And then we also redesign products to make them more effective for the consumer and as well. So I think being able to pull all the levers that we have, I think our examples of there's different levers, as Keith mentioned in housing versus Auto, but I think it's a lot of that similar element. And so it's not so much the reserves for auto, it's more of the earnings of those rates that will be coming through over the next few years that provides us the little bit of tailwind there for Auto business."
},
{
"speaker": "John Barnidge",
"text": "And then my other question, you've had quite a lot of success taking wins in one business and winning in another business. I think Chase was a good example of that this year. Is there an opportunity to offer mobile coverage or other coverage to clients where you've won that global housing business? I know I get Hulu, Netflix and Apple TV with my mobile device. Wondering if there can be a bundling in the card and housing in mobile?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I mean, it's definitely an interesting thought and we always think about how do we leverage the relationships that we've got and you think about the strength of Assurant, certainly it's the B2B to see nature of the business. But the fact that we operate across a wide number of distribution channels with major brands. So as clients are looking to reinvent how they bring services to market, I think we're well-positioned to capitalize on that. So I think the logic of your question makes perfect sense. Obviously, a dramatic amount of the scale has come through partnerships with mobile operators. If we look at the U.K. market, for example, though we work with major banks in the U.K. that offer mobile protection as part of their packaged bank account. So we definitely look for those opportunities where we think we're best positioned and we can deliver at scale."
},
{
"speaker": "Keith Meier",
"text": "Yes. And I think it's definitely a positive opportunity for us to leverage these relationships that we have with these large institutions like Chase. A good example is, I was meeting with some of their executives when we -- when they were launching the program last month and they said they did check with their Chase counterparts and basically we're doing reference checks on Assurant. They came back very positive. And so those types of things certainly can go a long way and are very positive for us to expand relationships."
},
{
"speaker": "John Barnidge",
"text": "Thanks for the answers."
},
{
"speaker": "Keith Demmings",
"text": "Thank you, John."
},
{
"speaker": "John Barnidge",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "There is no one else in the queue. I will pass it back to Keith for closing remarks."
},
{
"speaker": "Keith Demmings",
"text": "Okay, wonderful. Well, thanks everybody for joining and we will certainly look-forward to another discussion in February. We'll share how we closed out the year and provide some guidance for 2025. So, thanks very much and have a great holiday season."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 2 | 2,024 | 2024-08-07 08:00:00 | Operator: Welcome to Assurant's Second Quarter 2024 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following management prepared remarks. [Operator Instructions]. It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin.
Sean Moshier: Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the second quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by those statements. Additional information regarding these factors can be found in the earnings release, presentation, and financial supplement on our website as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings.
Keith Demmings: Thanks, Sean, and good morning, everyone. Our strong first half 2024 results demonstrate continued outperformance from Global Housing and underlying momentum in Connected Living, positioning us to increase our full year 2024 growth expectations for Assurant overall. Excluding reportable catastrophes, adjusted EBITDA increased 20% year-to-date and adjusted EPS grew 29%. These results reflect the power of our combined housing and lifestyle business model. Starting with our first half business highlights. In Global Lifestyle first half 2024 adjusted EBITDA was $397 million, consistent with the first half of 2023. Our year-to-date performance has been driven by continued growth and momentum within our Connected Living business, particularly in the U.S. In Connected Living, adjusted EBITDA increased 6% or 8% on a constant currency basis. As we previously discussed, 2024 includes incremental spending related to the implementation of new partnerships and programs that we expect will support long-term growth for Assurant. Excluding first half investments of approximately $13 million, year-to-date growth for Connected Living was 14% on a constant currency basis. One example of our innovative new offerings included the rollout of two programs with Spectrum Mobile, anytime upgrade, and the repair and replace plan. Additionally, we onboarded the pre and postpaid device protection subscribers of Telstra, our new partner in Australia. Combined, these new programs added 1.6 million mobile subscribers, driving strong sequential growth. This year, we've also completed long-term contract extensions with all of our major U.S. mobile device protection clients, including T-Mobile and two U.S. cable operators, continuing to strengthen our position in the market. In total, these renewals represent three of the top five largest U.S. carriers by subscribers. With T-Mobile, this included a multi-year contract extension to continue supporting their postpaid and prepaid consumers beyond 2030. The renewal of T-Mobile allows us to continue to invest in this critical partnership and drive innovation for the future. In financial services, we expanded our longstanding relationship with Chase by partnering with Chase card services within our growing card benefits business. We executed a multi-year contract to provide coverage to millions of Chase cardholders. This program will provide end-to-end delivery for approximately 15 travel and purchase protection benefits, including underwriting, claim processing, and benefit servicing. We expect continued investments over the second half of this year as we move toward program launch at the end of 2024. This represents a marquee win for our card benefits business, which has gained strong momentum over the last several years. Our relationship with Chase now spans across our Lifestyle and Housing businesses, reinforcing the depth of client partnerships that we drive across the Assurant enterprise. Moving to Global Automotive. Our first half earnings have continued to be pressured by ongoing inflation impacts on motor vehicle repair costs. We expect that the effects of inflation will continue to impact our auto results throughout the second half of 2024 in our vehicle service contract business. In addition, we expect continued elevated loss experience within our ancillary guaranteed asset protection or GAP product. Our longer-term outlook, however, is bright, as we've begun to see moderation of claims inflation on our vehicle service contract business given the rate actions taken over the past 24 months. Within our GAP product, we're experiencing elevated losses driven by the combination of continued declines in used car prices from pandemic highs, higher interest rates, and the increase in the number of vehicles declared total losses by the primary insurance carrier. We expect this impact to be shorter-term in nature relative to vehicle service contracts, as the majority of GAP claims are made within the first 24 months after vehicle purchase. In addition, over the past year, we've been proactively partnering with several clients to transition the risk on the GAP business, which will reduce a substantial amount of our claims exposure over time. Lastly, we believe the auto business will continue to benefit from our position as a market leader with scale and strong partnerships across multiple distribution channels. Now, let's turn to Global Housing. For the first half of the year, Global Housing's earnings increased nearly 45%, excluding reportable catastrophes. Housing's year-to-date results have demonstrated both the importance of the business to our overall portfolio and the power of our unique and differentiated business model, which has largely outperformed the broader P&C market. Our lender-placed insurance business safeguards homes that need insurance regardless of geography, while supporting the U.S. mortgage industry by removing the risk of uninsured loss for lenders, investors, and homeowners. We review rates with each state on a regular basis to ensure that they are appropriate and that homeowners are protected. This process allows us to work together to balance risk and reward with fair and adequate rates, while creating product safeguards to address macroeconomic factors such as inflation. In addition, we benefit from our strong track record, continued investments in customer experience, and our compliance expertise, our most critical competitive advantages. These efforts have allowed us to renew existing partnerships and win new clients, including Bank of America. This in turn has contributed to increased scale, which combined with technology investments has led to significant operational efficiencies. Ultimately, this creates meaningful expense leverage, which we'll continue to benefit from going forward. Our specialized product and client base provide Assurant with differentiated advantages compared to many traditional homeowners insurance carriers. Overall, these combined advantages have led to the recovery and growth of this business within a relatively short time frame. We believe we are well-positioned and we continue to believe there's an opportunity for the market to better value our specialized lender-placed business. In renters, we benefit from an attractive financial profile that is more capital efficient compared to traditional P&C businesses. We are focused on expanding our presence as a market leader within the Property Management Company or PMC channel while providing our partners with innovative new offerings. In the first half of the year, we increased gross written premiums in our PMC channel by over 20%, reflecting strong client demand for our Cover360solution. This marks eight straight quarters of double-digit growth of gross written premium in the PMC channel. Following the initial launch of our Assurant Tech Pro resident troubleshooting service, we recently signed a partnership with the largest PMC in the U.S. to be the first to provide this service to the industry. We expect to begin rollout in the second half of this year. Turning to our enterprise outlook. Given the strength of our first half results, we now expect full year adjusted EBITDA to grow high-single-digits and adjusted earnings per share to increase low-double-digits both excluding catastrophes. This represents an increase from our initial expectation for both metrics. We anticipate strong growth within Global Housing, which is expected to lead our enterprise growth for 2024. In Global Lifestyle, we expect modest growth in 2024. Connected Living is expected to deliver another year of growth as we remain focused on driving long-term momentum through new partnerships and programs. Overall, we believe our first half performance and our increased 2024 outlook demonstrate the power of our differentiated business model with unique advantages which make Assurant attractively valued. Over time, we've enhanced Assurant’s risk profile by focusing on our capital efficient businesses within Lifestyle and Housing, which are highly cash generative. We've established a track record of winning and delivering for B2B2C clients throughout both Lifestyle and Housing, many of whom are industry leaders and market disruptors across the globe. We've created leadership positions in amplified competitive advantages through our protection solutions across devices, automobiles, and homes. Together with our clients, we've seen these deliver mutual benefit from scale and deep integration, supporting innovative and flexible solutions to differentiate the customer experience. We focus on specialized, attractive markets with growth opportunities and long-term secular tailwinds. These factors contributed to long-term outperformance versus the broader P&C market, particularly the S&P Composite 1500 P&C index. We believe this comparison better reflects our current mix of businesses and offerings as we provide insurance solutions and fee-based services to our partners and their end consumers. In June, our sub industry index classification under the Global Industry Classification Standard, or GICS, transitioned from multiline insurance to P&C insurance. A product of our multi-year transformation that included exiting pre-need, health and life insurance related businesses. Before handing it over to Keith Meier, I wanted to highlight our recently published 2024 Sustainability Report, which demonstrates our progress in advancing our sustainability strategy and initiatives. We've introduced our new sustainability vision focused on advancing a connected, respected, and protected world. We've established long-term ambitions to support a thriving society, a circular economy, and a stable climate. We believe there's an important connection between our vision and ambitions and how we deliver value for our business and for our stakeholders. These priorities strengthen Assurant for the future, including how we attract, empower, and reward a diverse workforce to drive innovation, contribute to the development and adoption of sustainable products and reduce the climate impact of Assurant operations and supply chain. Overall, we're excited about the progress we've made so far this year, continuing to drive attractive financial results and outperformance for the overall enterprise. As we look ahead, we believe we are well-positioned to continue to drive business momentum in the second half and beyond. I'll now turn it over to Keith Meier to review our second quarter results and business trends impacting our 2024 outlook.
Keith Meier: Thanks, Keith, and good morning, everyone. We're proud of our second quarter performance as we continue to invest in value-added solutions for our clients and end consumers. We believe we are well-positioned to build upon our historical track record of growth, strong capital generation, and long-term shareholder value creation. Let's review the specifics of our strong second quarter results, which build upon the momentum from the first quarter. In the second quarter, adjusted EBITDA grew 10% to $369 million and adjusted earnings per share increased by 17% to $4.77, both excluding reportable catastrophes. From a capital perspective, we generated $142 million of segment dividends in the second quarter, ending the quarter with $735 million of holding company liquidity, up from $622 million at the end of the first quarter. Our strong capital position has provided flexibility to invest in future growth, while returning $80 million to shareholders in the quarter, including $40 million of share repurchases. In addition, we repurchased $20 million of shares between July 1 and August 2 and have now completed $100 million in repurchases so far this year. Turning to our business segments. Let's begin with Global Lifestyle. For the quarter adjusted EBITDA decreased 4% to $190 million, or 2% on a constant currency basis, driven by Global Automotive, which declined by 8% or $6 million. Results were impacted by higher claims costs due to inflation and elevated losses from ancillary GAP products. In Connected Living, earnings increased modestly on a constant currency basis, primarily driven by global mobile protection programs, including subscriber growth from U.S. cable operators and new Asia-Pacific clients, as well as improved U.S. financial services results. International results remain stable on a constant currency basis and have started to show signs of modest growth. Growth was partially muted by investments in new capabilities and client partnerships, which are expected to support long-term growth. Trade-in results were down from a decline in carrier volumes and business mix, including from lower promotional activity. Unfavorable foreign exchange remains a headwind and impacted Lifestyle's adjusted EBITDA growth by 2 percentage points in the quarter. Turning to net earned premiums fees and other income. Lifestyle grew by $75 million, or 4%, and Connected Living increased 6%, benefiting from contributions from new Trade-in and mobile protection programs, including the U.S. and Asia-Pacific. For full year 2024, we now expect Global Lifestyle's adjusted EBITDA to grow modestly, reflecting continued strong performance from Connected Living and ongoing elevated claims in Global Auto. We expect growth in Connected Living to be led by the continued expansion of our U.S. business. We expect investments related to new clients and programs, mainly in Connected Living to temper Lifestyle growth by approximately 3% in 2024, but will be a critical driver for business growth over the long-term. In Global Auto, we now expect adjusted EBITDA to be flat to modestly down due to continued loss pressures from inflation and elevated losses within ancillary GAP products. We continue to monitor foreign exchange impacts, inflation, and interest rates, which have and may continue to impact the pace and timing of growth. I'd like to take a moment to discuss our auto business and how we have addressed inflation headwinds. As we've discussed, we expect auto claims inflation to impact our performance over the remainder of this year. Toward the end of 2022, the industry began to see large spikes in motor vehicle repair costs, even as overall CPI trends began to stabilize. Exiting 2023, the auto industry began to see signs of inflation levels declining. However, in the beginning of 2024, motor vehicle repair costs increased once again, impacting performance in the first half of 2024. Our underwriting risk in auto is limited to just a few clients, as many of our clients choose to reinsure or share in the economics of the business, given auto's profitable returns over the long-term. There are a total of five vehicle service contract clients where we retain a portion of the claims risk that will improve over time, which is a small subset of our overall client base. Since 2022, we have implemented a total of 14 rate increases for these impacted clients, with additional increases planned over the coming quarters. In addition to rate increases, we have made changes to enhance our claims adjudication process, adjusting the product and modifying deal structures with clients to ensure mutually beneficial outcomes. Even with these vehicle service contract clients, where we do retain some risk, we are profitable as we also earn investment income and receive fees for our administrative program support. Moving to Global Housing. Second quarter adjusted EBITDA, including cats was $161 million. During a quarter that included over 25 ISO events that impacted much of the P&C industry, we fared reasonably well with $46 million of reportable catastrophes across five events and no single event incurring more than $15 million in losses. Excluding reportable cats, adjusted EBITDA increased by 23%, or $38 million to $206 million. The increase was driven by continued top-line growth in homeowners, primarily from an increase in the number of in-force policies from the onboarding of the newly added Bank of America portfolio and the net impact of ongoing client and portfolio transitions. Additionally, lender-placed policies increased due to impacts from hardening traditional insurance markets in certain states. Lender-placed continued to see average premium growth related to higher average insured values and increases in filed rates. Despite higher expenses from client portfolio onboarding and offboarding activity in the quarter, expense leverage from scale, technology investments and operational efficiencies remains a key driver of performance as reflected in the continued improvement in housings expense ratio, which was 37% in the quarter. Underlying EBITDA growth was partially offset by the unfavorable year-over-year net impact of $11 million related to prior period reserve development. Second quarter 2024 had $17 million of favorable reserve development compared to $28 million in the second quarter of 2023. We continue to expect Global Housing's full year 2024 adjusted EBITDA, excluding cats, to be the growth driver of our overall enterprise performance. We anticipate growth will be driven by continued top-line momentum in homeowners, expense leverage, and lower catastrophe reinsurance costs. Placement rate and policies in-force both key drivers of earnings are expected to be impacted by ongoing client portfolio transitions in the second half of the year. However, both are expected to have healthy growth overall for 2024. Lastly, we expect Hurricane Beryl to be a reportable catastrophe in the third quarter. While claims are still developing, our early indication is that estimated losses will be between $30 million to $50 million. We will provide an update prior to our third quarter earnings call as we finalize impacts. Moving to corporate, second quarter adjusted EBITDA loss was $27 million, which improved mainly due to higher net investment income from higher asset levels and yields. We continue to expect the 2024 corporate adjusted EBITDA loss to approximate $110 million, consistent with 2023. Turning to capital management. We generated significant deployable capital in the first half of the year, upstreaming $395 million in segment dividends. For 2024, we expect our businesses to continue to generate meaningful cash flow. Cash conversion to the holding company is expected to approximate two-thirds of segment adjusted EBITDA, including reportable catastrophes. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance, and rating agency and regulatory requirements. As we look forward to the remainder of the year, we continue to be focused on maintaining flexibility to support new business growth and to return capital to shareholders. Given our strong capital position and robust reinsurance program, we expect to be on the high end of our $200 million to $300 million share repurchases range for the year. Our ultimate level of repurchases will depend on M&A opportunities, market conditions, and cat activity. Overall, we've had a very strong first half of 2024, and we believe we are well-positioned to achieve our increased full year financial outlook while also supporting business growth and shareholder value creation over the long-term. And with that, operator, please open the call for questions.
Operator: The floor is now open for questions. [Operator Instructions]. Thank you. Our first question is coming from Mark Hughes with Truist Securities.
Keith Demmings: Good morning, Mark.
Mark Hughes: Good morning. Yes, thank you. Good morning. On the Global Auto the sustained impact of inflation, when do we kind of turn the corner on that? When does it become less negative? Understanding that it will continue to be a drag trends for the foreseeable future, when does it become less of a drag?
Keith Meier: Yes, Mark. So I think the first half this year was kind of the tale of two different stories for the first quarter and the second quarter. The first quarter was really driven by the inflation from our vehicle service contracts. And so -- but in the second quarter, what we've seen is more on the GAP side, that was really what was driven by the used car values declining, higher interest rates and more total losses declared by traditional insurers. So the vehicle service contract side was really moderated a bit in the second quarter -- in the first -- sorry, in the second quarter, the GAP was really the driver of the challenges in the second quarter. So as we look at the back half of the year, we actually expect the rates that we've been putting into place with our clients to stabilize and improve modestly as we go through the back half of the year. And I think one other key point about the second quarter as it relates to the GAP product, we've been working on this over the past year or so to reduce and transition some of that risk with our clients. So we don't see that as something that's going to sustain over a long-term. And GAP actually improves faster than the vehicle service contracts that really should improve in less than in the next couple of years, so less than two years. So overall, if we're going to have a challenge in auto, this is probably a good time to have the challenge when we're raising our outlook, and I think this is really just creating a little bit more of a tailwind for us in our auto business over the next few years.
Keith Demmings: Yes. And I would just add, as we think about getting off a lot of that GAP risk over time. That process started back when our GAP was actually performing well. We know it's a volatile product line. Our goal was to strategically try to reduce volatility and make that strategic decision. And obviously, that's something that we'll continue to work on as we go forward. And as Keith said, not something that we expect to be a long-term pain point for the business.
Mark Hughes: Yes. So fair to think the pain this year is already factored into your guidance when we think about 2025 would be less negative, i.e., positive year-over-year comparisons in this dimension.
Keith Meier: Yes. It's definitely factored into our 2024 outlook. And then as we go through the year, we'll provide an update on 2025, but we certainly see an improvement going into the back half of the year.
Mark Hughes: Yes. And then in the card benefit business, could you talk a little bit more about the opportunity there? It sounds like an interesting agreement with Chase, how important is that within the Lifestyle? And is that a new opportunity that could be a marginal contributor to growth?
Keith Demmings: Yes, definitely, and I would say a couple of things. So we've been growing successfully our card benefits business the last several years, in particular, in the U.S. And a couple of things specifically on Chase, number one, it's a phenomenal opportunity to expand our relationship. We obviously have a long-standing relationship around the lender-placed business with Chase that spans many, many years, and this is a chance to expand across product lines in between segments within Lifestyle, which is great. We definitely are investing in this launch. It's part of the investments that we've talked about relative to Q2 that will ramp as the year progresses. We're actually converting all active Chase customer cardholders in the fourth quarter of the year. So there's a lot of work to stand that up. And then it will certainly be EBITDA positive as we enter 2025 because it will be at a full natural run rate entering next year. And yes, we're very excited. And certainly, it will be one of several drivers of growth for the Connected Living business. And part of what we've been signaling to the market is specific discrete investments in long-term growth that are directly connected to new programs, new products, and what I think are clear strategic growth levers for the business.
Mark Hughes: Appreciate it. Thank you.
Keith Demmings: You bet. Thanks, Mark.
Operator: Our next question comes from Dan Lukpanov with Dowling & Partners.
Keith Demmings: Good morning, Dan.
Keith Meier: Good morning.
Dan Lukpanov: Hey guys, good morning. Going back to the auto, just curious, so we've been seeing the traditional insurers -- car insurers reporting a moderation in physical damage severity and just knowing your product, you don't have the liability side. You have little mostly physical damage in all the same drivers of materials side. Just curious, I get that the GAP was sort of the negative in the quarter. But on the vehicle service contract side, did you guys see any acceleration on the improvement. I did the loss cost trend year-to-date change your view on how fast you can recover the business.
Keith Meier: Yes. So I think through the first couple of quarters, we saw the loss cost trends moderate. The CPI index for auto repairs went down modestly, and so it's about 9 million -- or 9% year-over-year. So we're seeing it moderate a bit, Dan. And I think we're in a good position to have those rates start coming through and improve sequentially for us as we go-forward.
Keith Demmings: Yes. And I think just to amplify; I mean we talked about 14 rate increases over five clients over the last couple of years. So a meaningful amount of rate increases have been put in place. And obviously, we're starting to slowly see that earn through, combined with moderation on the inflationary side. So that momentum builds over time. It doesn't solve itself nearly as quickly as what we saw in the Housing business, but certainly excited to see progress in Q2, and we'll monitor that as we think forward through the rest of the year.
Dan Lukpanov: Okay. And do you see used to new car mix normalizing, I think during the inflation of cycle, you saw more used cars in the production, do you see that normalizing at all?
Keith Demmings: Yes. I think it's still in the range of 50:50 in terms of used and new. It's definitely moderated. There's certainly more new car volume going back into the system. But it's a pretty -- we have a pretty nice balance within the business. And to your point, it did tilt more used car during the pandemic, and I'd say it's normalized at this point.
Dan Lukpanov: If I may squeeze in one more. The -- in the financial services, I think you called out a profitability improvement in the U.S. business. What was that? Can you provide any more color on that?
Keith Meier: Yes. I think that's just a continuation of the leading programs that we have in our financial services business. So we've been growing that business over the last few years. So I think that's just a continuation of that. And I think the Chase win is just another highlight of the really good momentum that we're having in our financial services business.
Dan Lukpanov: Thanks, guys. I appreciate the answers.
Keith Demmings: Thanks, Dan.
Keith Meier: Thanks, Dan.
Operator: Our next question comes from Jeff Schmitt with William Blair.
Keith Demmings: Hey, Jeff.
Keith Meier: Hey, Jeff.
Jeff Schmitt: Good morning. So how much of the auto revenue mix is the GAP business? And how much is sort of a handful of accounts where you share writing profits? Any details you could give on the actual like what inflation is kind of currently running at for those see their plans would be helpful.
Keith Meier: Yes. So for GAP, yes, it's actually a very small part of our business, Jeff, and it's actually continuing to be even less and less as we mentioned earlier, we've been working on over the last year, transitioning some of that risk. So it's becoming a smaller and smaller part. Some of the things that you're seeing now are programs that have already been transitioned for going forward contracts. So we're just working through some of the existing contracts today. So overall, not a big driver of our auto business. And that's why there's a little bit of volatility within there, and that's why we've been reducing that part of that business.
Jeff Schmitt: And just in terms of the percentage of mix of the handful of accounts that you share profits with how much is that?
Keith Meier: Yes. It's only five clients. And it's actually with our rate increases that's becoming a better performing piece of our business over time, Jeff. We don't split that out necessarily of those clients. But overall, it's -- most of the business, the vast majority, we do reduce the risk and share risk with our clients. So this is really the smaller part of the business, not the main part.
Jeff Schmitt: Okay. And then just a question on the renters business, I mean, I think a few years ago, you'd expect the growth to be kind of in the high-single-digits, continues to run much weaker. I'm just curious what the weakness there? And are you getting rate in that business as well? What rate are you getting?
Keith Demmings: Yes. I think our rate is probably at a very good level right now generally. What I would say on the revenue side is, and we've talked about this a little bit in the past. Definitely, if you look at it year-to-date, it's relatively flat. I think we're up 2% on revenue. Policies are up 4%. What's probably a little bit more exciting is our year-to-date gross written premium, think of that as a leading indicator of future revenue. It's actually up 8%. And it's really two pieces. So our property management company part of the renters' portfolio is up 20% year-to-date, which is obviously pretty significant growth. And then the affinity business is relatively stable. We expect that affinity business to slowly improve over time. We expect the momentum in the PMC side of our business to continue. We've shown double-digit growth for the last eight quarters straight. We really like the business. I think we're incredibly positioned. We've been investing not just in our products, but in our platforms. And I think we're certainly set up as the market continues to find ways to drive growth, we'll be participating in that over time.
Jeff Schmitt: Okay. Thank you.
Keith Demmings: You bet.
Keith Meier: Thanks, Jeff.
Operator: Our next question comes from John Barnidge with Piper Sandler.
Keith Demmings: Good morning, John.
Keith Meier: Hey, John.
John Barnidge: Good morning. Thanks for the opportunity. Appreciate it. My first question is on the Global Housing combined ratio. How do you view the long-term combined ratio guide? There's been consistent profitability achieved in that business, not just from underwriting improvements, but it appears to be expense leverage has been achieved over the last five quarters. I'd love to get your take on how you view the long-term combined ratio you targeted. Thank you.
Keith Demmings: You bet. I think mid-80s combined is the right way to think about the business, we think about a non-cat loss ratio of around 40%. We had about 7 points for cat losses and then expenses in the high-30s. There's no doubt we've demonstrated a tremendous amount of discipline around expense management, driving efficiency through the use of technology and a lot of other things, and it's certainly showing up. And it's a scale business. So as we've grown the business, you're seeing the benefits of that flow through on the expense line. But I would say, mid-80s combined is the way to think about that business generally longer-term, and we feel incredibly proud of the growth of that business. I mean our policies are up 9% year-over-year. AIVs are up 11% and then expense leverage of more than 200 basis points if you look back. So it's performing incredibly well and very fortunate that we've got -- the team that we've got.
Keith Meier: Yes. And I would just add, the expense ratio story really is a great one, and it's really sustainable as well. And it's really driven by the combination of scale the digital enhancements that we're making, the AI investments we're making, and then also our integration platforms. When you take all of that we've been doing over the last few years, it's really been an amazing journey. And I think that's really delivered an incredible customer experience through technology and it's also enabling us to differentiate versus others in the industry. And I think that's why you're seeing us win some important new clients with those investments we made that are really paying off for us.
John Barnidge: Thank you for that. My follow-up question is on the Global Lifestyle business. Telstra, Spectrum really seemed to have delivered nice unit growth, $1.6 million, I think you called out there. But generally, ahead of a program launching, there's a period of investor. Are you able to quantify the level of investment for Telstra and Spectrum that impacted EBITDA in the quarter for Connected Living? Thank you.
Keith Demmings: You bet. I think what we've tried to quantify is the overall level of investment. So we talked about $13 million of incremental investment year-to-date, $5 million in the first quarter, about $8 million in the second quarter and think about that trend line kind of being maintained as we think about the second half of the year. So that's probably the easiest way to think about it, not necessarily at the client level. And there's no doubt we're excited about both of those opportunities to grow in the market. And there's certainly a step up in the second quarter with subscriber counts. We took over the in-force business at Telstra, which is terrific. So we start from a pretty robust place in terms of subs. And then, with Spectrum, as well because part of the program is embedded in the top-tier rate plan that actually gave us a step up to existing subscribers in the second quarter and now we're in a more normalized period of growth. What I think you'll notice, if you unpack the subscriber counts is we actually generated net growth even separating the $1.6 million incremental that we talked about, and that's following several quarters of declines in that metric. So we're really pleased not just with the growth from these two clients but with the underlying performance around subscribers and certainly expect that growth to continue, not at that level, but to continue as we go-forward.
John Barnidge: Thank you.
Keith Demmings: You bet.
Operator: [Operator Instructions]. Our next question comes from Tommy McJoynt from KBW.
Keith Demmings: Hey Tommy, good morning.
Tommy McJoynt: Hey, good morning, guys. Good morning. How much is higher investment income offsetting, I guess, the otherwise, what I'll call core weakness in the auto segment. I guess, just basically do you know what percentage of autos bottom line EBITDA is investment income. And I'm not sure what the duration of those investments are. But is there any risk that if short-term rates come down meaningfully over the next year and that potentially fits auto's bottom line before all the work you're doing on rate increases gets a chance to earn in. Is that a risk that we should be thinking about?
Keith Meier: Yes. I think we're in a good position in terms of investment income, Tommy. Our duration is about five years on our investment portfolio. We've got a very high-quality portfolio. Our book yield is up 12 basis points over the last quarter up to $5.16. New money yields are still a little bit higher than that. So overall, we feel good about where we stand for the remainder of the year and our outlook in terms of investment income. And then also with certain clients, we share some investment income. So to the extent that interest rates go down a little bit, then it actually -- there's a natural offset there for us with some of the clients. So overall, not as big of an impact in the short-term.
Tommy McJoynt: Okay. Got it. Thank you.
Keith Demmings: Welcome.
Operator: Our next question comes from Grace Carter with Bank of America. Please unmute your line to ask a question.
Grace Carter: Good morning. Can you all hear me?
Keith Meier: Yes, we can. Hi, Grace.
Grace Carter: Okay. Perfect. Hi. So I was wondering on the auto risk question. I think historically, you all have said that you retain about a third of the risk across the Lifestyle book. I was just curious if that continues to be kind of the best way to think about the segment overall, just given the work that you've done in the auto book over the past several quarters.
Keith Demmings: Yes. I think it's generally the right way to think about it at the Lifestyle level, maybe a little bit -- we may retain a little bit less of it on the auto side. A lot of the deals are reinsured within the dealer business and with various clients. So -- but I do think, overall, that's a good way to think about it. And the nice thing with auto, as we think about the pressure on the VSC side, it's a handful of clients, so it's somewhat manageable. We're trying to work with only five partners to make the right adjustments. And as you've seen, 14 rate increases with five clients over the last couple of years is a meaningful amount of activity and traction to try to right the ship. So I do feel like that allows it to be much more manageable because it's quite concentrated.
Grace Carter: Thank you. And I guess, you mentioned expecting higher repurchases for the remainder of the year, but also gave us some guidance for how Hurricane Beryl losses might be shaping up. Just given the forecast for an active hurricane season, can you talk about what gives you the confidence to kind of increase the outlook for repurchases for the remainder of the year? And as just kind of given the seasonality of hurricane season, if we should expect those to be more weighted towards 4Q rather than 3Q?
Keith Meier: Yes. So I think, first of all, we get the confidence from our strong capital position and we've really just continued to strengthen our reinsurance program. So we feel really good about how we are positioned going into the back half of the year. I think you also highlight, Grace, the strong cash flow generation of our portfolio of businesses. And we have a very strong track record of deploying that capital back to shareholders. And we've already completed $100 million of the buybacks. And I think we're going to be on pace to deliver that higher end of the $200 million to $300 million range. And I don't think we see any reason why that wouldn't be the case, and that's why we raised our guidance there. So overall, I think being in this type of capital position is exactly where we want to be and it allows us to operate from a position of strength.
Grace Carter: Perfect. Thank you.
Keith Meier: You're welcome.
Keith Demmings: Great. Thanks, Grace.
Operator: Our last question is coming from Mark Hughes with Truist Securities.
Keith Demmings: Hey, Mark.
Keith Meier: Hey, Mark.
Mark Hughes: Yes. Thanks for taking the follow-up. In the Global Housing, your fee income was quite strong this quarter. Anything unusual there? Is this kind of elevated fees? Is that going to continue? I think we said $53 million, if I'm looking at it properly, a big jump year-over-year. Could you talk about that?
Keith Meier: Yes. So in the fee income, there was a business change that was made. And all it really was, Mark, was a reclassification between fee income and our expense lines. So no bottom line P&L impact, just movement between expenses and the fee income line.
Mark Hughes: Yes. Okay. And then you talked about a client transition in Housing that could impact the second half. I'm not sure whether you said anything more about that, but what was the import of that statement?
Keith Demmings: Yes. So we've got -- there's a lot of ongoing activity within the lender-placed business. And at times, certain portfolios roll off, certain portfolios roll on as clients are making different acquisitions in the market, buying books of loans, et cetera. And what we've said is we'll see some movement on that over the course of the back half of the year. But overall, I would say our expectation for policy counts is relatively stable as we think about the second half of the year. So any losses relative to that transition will be offset by pickups with respect to other portfolios.
Mark Hughes: Okay. Very good. Thank you.
Keith Demmings: Excellent. Thank you.
Keith Demmings: And if we have no other questions, then maybe just one final comment for me and then we can wrap it up. And I think we try to put some emphasis in the materials, but we do have a very strong track record of driving performance across a variety of different economic cycles. We're certainly proud of what we've delivered so far this year, excited about the raised guidance. And as we highlighted in the materials, with the current guidance, we're actually poised to deliver 10% EBITDA growth on average since 2019, so over the last five years. And we're going to more than double the absolute earnings per share with a 16% CAGR over that same five-year period. So again, we're incredibly proud of the track record that sits behind us. We've got a lot of momentum in the business. We're showing that with a number of new client launches, new wins. We're working on a number of other things that we'll talk about in future quarters. But again, just excited to be driving growth and creating shareholder value. So we'll look forward to the next call. We'll get back together in November after our Q3 and really appreciate the time. Thanks very much.
Operator: Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's Second Quarter 2024 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following management prepared remarks. [Operator Instructions]. It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin."
},
{
"speaker": "Sean Moshier",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the second quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by those statements. Additional information regarding these factors can be found in the earnings release, presentation, and financial supplement on our website as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Sean, and good morning, everyone. Our strong first half 2024 results demonstrate continued outperformance from Global Housing and underlying momentum in Connected Living, positioning us to increase our full year 2024 growth expectations for Assurant overall. Excluding reportable catastrophes, adjusted EBITDA increased 20% year-to-date and adjusted EPS grew 29%. These results reflect the power of our combined housing and lifestyle business model. Starting with our first half business highlights. In Global Lifestyle first half 2024 adjusted EBITDA was $397 million, consistent with the first half of 2023. Our year-to-date performance has been driven by continued growth and momentum within our Connected Living business, particularly in the U.S. In Connected Living, adjusted EBITDA increased 6% or 8% on a constant currency basis. As we previously discussed, 2024 includes incremental spending related to the implementation of new partnerships and programs that we expect will support long-term growth for Assurant. Excluding first half investments of approximately $13 million, year-to-date growth for Connected Living was 14% on a constant currency basis. One example of our innovative new offerings included the rollout of two programs with Spectrum Mobile, anytime upgrade, and the repair and replace plan. Additionally, we onboarded the pre and postpaid device protection subscribers of Telstra, our new partner in Australia. Combined, these new programs added 1.6 million mobile subscribers, driving strong sequential growth. This year, we've also completed long-term contract extensions with all of our major U.S. mobile device protection clients, including T-Mobile and two U.S. cable operators, continuing to strengthen our position in the market. In total, these renewals represent three of the top five largest U.S. carriers by subscribers. With T-Mobile, this included a multi-year contract extension to continue supporting their postpaid and prepaid consumers beyond 2030. The renewal of T-Mobile allows us to continue to invest in this critical partnership and drive innovation for the future. In financial services, we expanded our longstanding relationship with Chase by partnering with Chase card services within our growing card benefits business. We executed a multi-year contract to provide coverage to millions of Chase cardholders. This program will provide end-to-end delivery for approximately 15 travel and purchase protection benefits, including underwriting, claim processing, and benefit servicing. We expect continued investments over the second half of this year as we move toward program launch at the end of 2024. This represents a marquee win for our card benefits business, which has gained strong momentum over the last several years. Our relationship with Chase now spans across our Lifestyle and Housing businesses, reinforcing the depth of client partnerships that we drive across the Assurant enterprise. Moving to Global Automotive. Our first half earnings have continued to be pressured by ongoing inflation impacts on motor vehicle repair costs. We expect that the effects of inflation will continue to impact our auto results throughout the second half of 2024 in our vehicle service contract business. In addition, we expect continued elevated loss experience within our ancillary guaranteed asset protection or GAP product. Our longer-term outlook, however, is bright, as we've begun to see moderation of claims inflation on our vehicle service contract business given the rate actions taken over the past 24 months. Within our GAP product, we're experiencing elevated losses driven by the combination of continued declines in used car prices from pandemic highs, higher interest rates, and the increase in the number of vehicles declared total losses by the primary insurance carrier. We expect this impact to be shorter-term in nature relative to vehicle service contracts, as the majority of GAP claims are made within the first 24 months after vehicle purchase. In addition, over the past year, we've been proactively partnering with several clients to transition the risk on the GAP business, which will reduce a substantial amount of our claims exposure over time. Lastly, we believe the auto business will continue to benefit from our position as a market leader with scale and strong partnerships across multiple distribution channels. Now, let's turn to Global Housing. For the first half of the year, Global Housing's earnings increased nearly 45%, excluding reportable catastrophes. Housing's year-to-date results have demonstrated both the importance of the business to our overall portfolio and the power of our unique and differentiated business model, which has largely outperformed the broader P&C market. Our lender-placed insurance business safeguards homes that need insurance regardless of geography, while supporting the U.S. mortgage industry by removing the risk of uninsured loss for lenders, investors, and homeowners. We review rates with each state on a regular basis to ensure that they are appropriate and that homeowners are protected. This process allows us to work together to balance risk and reward with fair and adequate rates, while creating product safeguards to address macroeconomic factors such as inflation. In addition, we benefit from our strong track record, continued investments in customer experience, and our compliance expertise, our most critical competitive advantages. These efforts have allowed us to renew existing partnerships and win new clients, including Bank of America. This in turn has contributed to increased scale, which combined with technology investments has led to significant operational efficiencies. Ultimately, this creates meaningful expense leverage, which we'll continue to benefit from going forward. Our specialized product and client base provide Assurant with differentiated advantages compared to many traditional homeowners insurance carriers. Overall, these combined advantages have led to the recovery and growth of this business within a relatively short time frame. We believe we are well-positioned and we continue to believe there's an opportunity for the market to better value our specialized lender-placed business. In renters, we benefit from an attractive financial profile that is more capital efficient compared to traditional P&C businesses. We are focused on expanding our presence as a market leader within the Property Management Company or PMC channel while providing our partners with innovative new offerings. In the first half of the year, we increased gross written premiums in our PMC channel by over 20%, reflecting strong client demand for our Cover360solution. This marks eight straight quarters of double-digit growth of gross written premium in the PMC channel. Following the initial launch of our Assurant Tech Pro resident troubleshooting service, we recently signed a partnership with the largest PMC in the U.S. to be the first to provide this service to the industry. We expect to begin rollout in the second half of this year. Turning to our enterprise outlook. Given the strength of our first half results, we now expect full year adjusted EBITDA to grow high-single-digits and adjusted earnings per share to increase low-double-digits both excluding catastrophes. This represents an increase from our initial expectation for both metrics. We anticipate strong growth within Global Housing, which is expected to lead our enterprise growth for 2024. In Global Lifestyle, we expect modest growth in 2024. Connected Living is expected to deliver another year of growth as we remain focused on driving long-term momentum through new partnerships and programs. Overall, we believe our first half performance and our increased 2024 outlook demonstrate the power of our differentiated business model with unique advantages which make Assurant attractively valued. Over time, we've enhanced Assurant’s risk profile by focusing on our capital efficient businesses within Lifestyle and Housing, which are highly cash generative. We've established a track record of winning and delivering for B2B2C clients throughout both Lifestyle and Housing, many of whom are industry leaders and market disruptors across the globe. We've created leadership positions in amplified competitive advantages through our protection solutions across devices, automobiles, and homes. Together with our clients, we've seen these deliver mutual benefit from scale and deep integration, supporting innovative and flexible solutions to differentiate the customer experience. We focus on specialized, attractive markets with growth opportunities and long-term secular tailwinds. These factors contributed to long-term outperformance versus the broader P&C market, particularly the S&P Composite 1500 P&C index. We believe this comparison better reflects our current mix of businesses and offerings as we provide insurance solutions and fee-based services to our partners and their end consumers. In June, our sub industry index classification under the Global Industry Classification Standard, or GICS, transitioned from multiline insurance to P&C insurance. A product of our multi-year transformation that included exiting pre-need, health and life insurance related businesses. Before handing it over to Keith Meier, I wanted to highlight our recently published 2024 Sustainability Report, which demonstrates our progress in advancing our sustainability strategy and initiatives. We've introduced our new sustainability vision focused on advancing a connected, respected, and protected world. We've established long-term ambitions to support a thriving society, a circular economy, and a stable climate. We believe there's an important connection between our vision and ambitions and how we deliver value for our business and for our stakeholders. These priorities strengthen Assurant for the future, including how we attract, empower, and reward a diverse workforce to drive innovation, contribute to the development and adoption of sustainable products and reduce the climate impact of Assurant operations and supply chain. Overall, we're excited about the progress we've made so far this year, continuing to drive attractive financial results and outperformance for the overall enterprise. As we look ahead, we believe we are well-positioned to continue to drive business momentum in the second half and beyond. I'll now turn it over to Keith Meier to review our second quarter results and business trends impacting our 2024 outlook."
},
{
"speaker": "Keith Meier",
"text": "Thanks, Keith, and good morning, everyone. We're proud of our second quarter performance as we continue to invest in value-added solutions for our clients and end consumers. We believe we are well-positioned to build upon our historical track record of growth, strong capital generation, and long-term shareholder value creation. Let's review the specifics of our strong second quarter results, which build upon the momentum from the first quarter. In the second quarter, adjusted EBITDA grew 10% to $369 million and adjusted earnings per share increased by 17% to $4.77, both excluding reportable catastrophes. From a capital perspective, we generated $142 million of segment dividends in the second quarter, ending the quarter with $735 million of holding company liquidity, up from $622 million at the end of the first quarter. Our strong capital position has provided flexibility to invest in future growth, while returning $80 million to shareholders in the quarter, including $40 million of share repurchases. In addition, we repurchased $20 million of shares between July 1 and August 2 and have now completed $100 million in repurchases so far this year. Turning to our business segments. Let's begin with Global Lifestyle. For the quarter adjusted EBITDA decreased 4% to $190 million, or 2% on a constant currency basis, driven by Global Automotive, which declined by 8% or $6 million. Results were impacted by higher claims costs due to inflation and elevated losses from ancillary GAP products. In Connected Living, earnings increased modestly on a constant currency basis, primarily driven by global mobile protection programs, including subscriber growth from U.S. cable operators and new Asia-Pacific clients, as well as improved U.S. financial services results. International results remain stable on a constant currency basis and have started to show signs of modest growth. Growth was partially muted by investments in new capabilities and client partnerships, which are expected to support long-term growth. Trade-in results were down from a decline in carrier volumes and business mix, including from lower promotional activity. Unfavorable foreign exchange remains a headwind and impacted Lifestyle's adjusted EBITDA growth by 2 percentage points in the quarter. Turning to net earned premiums fees and other income. Lifestyle grew by $75 million, or 4%, and Connected Living increased 6%, benefiting from contributions from new Trade-in and mobile protection programs, including the U.S. and Asia-Pacific. For full year 2024, we now expect Global Lifestyle's adjusted EBITDA to grow modestly, reflecting continued strong performance from Connected Living and ongoing elevated claims in Global Auto. We expect growth in Connected Living to be led by the continued expansion of our U.S. business. We expect investments related to new clients and programs, mainly in Connected Living to temper Lifestyle growth by approximately 3% in 2024, but will be a critical driver for business growth over the long-term. In Global Auto, we now expect adjusted EBITDA to be flat to modestly down due to continued loss pressures from inflation and elevated losses within ancillary GAP products. We continue to monitor foreign exchange impacts, inflation, and interest rates, which have and may continue to impact the pace and timing of growth. I'd like to take a moment to discuss our auto business and how we have addressed inflation headwinds. As we've discussed, we expect auto claims inflation to impact our performance over the remainder of this year. Toward the end of 2022, the industry began to see large spikes in motor vehicle repair costs, even as overall CPI trends began to stabilize. Exiting 2023, the auto industry began to see signs of inflation levels declining. However, in the beginning of 2024, motor vehicle repair costs increased once again, impacting performance in the first half of 2024. Our underwriting risk in auto is limited to just a few clients, as many of our clients choose to reinsure or share in the economics of the business, given auto's profitable returns over the long-term. There are a total of five vehicle service contract clients where we retain a portion of the claims risk that will improve over time, which is a small subset of our overall client base. Since 2022, we have implemented a total of 14 rate increases for these impacted clients, with additional increases planned over the coming quarters. In addition to rate increases, we have made changes to enhance our claims adjudication process, adjusting the product and modifying deal structures with clients to ensure mutually beneficial outcomes. Even with these vehicle service contract clients, where we do retain some risk, we are profitable as we also earn investment income and receive fees for our administrative program support. Moving to Global Housing. Second quarter adjusted EBITDA, including cats was $161 million. During a quarter that included over 25 ISO events that impacted much of the P&C industry, we fared reasonably well with $46 million of reportable catastrophes across five events and no single event incurring more than $15 million in losses. Excluding reportable cats, adjusted EBITDA increased by 23%, or $38 million to $206 million. The increase was driven by continued top-line growth in homeowners, primarily from an increase in the number of in-force policies from the onboarding of the newly added Bank of America portfolio and the net impact of ongoing client and portfolio transitions. Additionally, lender-placed policies increased due to impacts from hardening traditional insurance markets in certain states. Lender-placed continued to see average premium growth related to higher average insured values and increases in filed rates. Despite higher expenses from client portfolio onboarding and offboarding activity in the quarter, expense leverage from scale, technology investments and operational efficiencies remains a key driver of performance as reflected in the continued improvement in housings expense ratio, which was 37% in the quarter. Underlying EBITDA growth was partially offset by the unfavorable year-over-year net impact of $11 million related to prior period reserve development. Second quarter 2024 had $17 million of favorable reserve development compared to $28 million in the second quarter of 2023. We continue to expect Global Housing's full year 2024 adjusted EBITDA, excluding cats, to be the growth driver of our overall enterprise performance. We anticipate growth will be driven by continued top-line momentum in homeowners, expense leverage, and lower catastrophe reinsurance costs. Placement rate and policies in-force both key drivers of earnings are expected to be impacted by ongoing client portfolio transitions in the second half of the year. However, both are expected to have healthy growth overall for 2024. Lastly, we expect Hurricane Beryl to be a reportable catastrophe in the third quarter. While claims are still developing, our early indication is that estimated losses will be between $30 million to $50 million. We will provide an update prior to our third quarter earnings call as we finalize impacts. Moving to corporate, second quarter adjusted EBITDA loss was $27 million, which improved mainly due to higher net investment income from higher asset levels and yields. We continue to expect the 2024 corporate adjusted EBITDA loss to approximate $110 million, consistent with 2023. Turning to capital management. We generated significant deployable capital in the first half of the year, upstreaming $395 million in segment dividends. For 2024, we expect our businesses to continue to generate meaningful cash flow. Cash conversion to the holding company is expected to approximate two-thirds of segment adjusted EBITDA, including reportable catastrophes. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance, and rating agency and regulatory requirements. As we look forward to the remainder of the year, we continue to be focused on maintaining flexibility to support new business growth and to return capital to shareholders. Given our strong capital position and robust reinsurance program, we expect to be on the high end of our $200 million to $300 million share repurchases range for the year. Our ultimate level of repurchases will depend on M&A opportunities, market conditions, and cat activity. Overall, we've had a very strong first half of 2024, and we believe we are well-positioned to achieve our increased full year financial outlook while also supporting business growth and shareholder value creation over the long-term. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "The floor is now open for questions. [Operator Instructions]. Thank you. Our first question is coming from Mark Hughes with Truist Securities."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Good morning. Yes, thank you. Good morning. On the Global Auto the sustained impact of inflation, when do we kind of turn the corner on that? When does it become less negative? Understanding that it will continue to be a drag trends for the foreseeable future, when does it become less of a drag?"
},
{
"speaker": "Keith Meier",
"text": "Yes, Mark. So I think the first half this year was kind of the tale of two different stories for the first quarter and the second quarter. The first quarter was really driven by the inflation from our vehicle service contracts. And so -- but in the second quarter, what we've seen is more on the GAP side, that was really what was driven by the used car values declining, higher interest rates and more total losses declared by traditional insurers. So the vehicle service contract side was really moderated a bit in the second quarter -- in the first -- sorry, in the second quarter, the GAP was really the driver of the challenges in the second quarter. So as we look at the back half of the year, we actually expect the rates that we've been putting into place with our clients to stabilize and improve modestly as we go through the back half of the year. And I think one other key point about the second quarter as it relates to the GAP product, we've been working on this over the past year or so to reduce and transition some of that risk with our clients. So we don't see that as something that's going to sustain over a long-term. And GAP actually improves faster than the vehicle service contracts that really should improve in less than in the next couple of years, so less than two years. So overall, if we're going to have a challenge in auto, this is probably a good time to have the challenge when we're raising our outlook, and I think this is really just creating a little bit more of a tailwind for us in our auto business over the next few years."
},
{
"speaker": "Keith Demmings",
"text": "Yes. And I would just add, as we think about getting off a lot of that GAP risk over time. That process started back when our GAP was actually performing well. We know it's a volatile product line. Our goal was to strategically try to reduce volatility and make that strategic decision. And obviously, that's something that we'll continue to work on as we go forward. And as Keith said, not something that we expect to be a long-term pain point for the business."
},
{
"speaker": "Mark Hughes",
"text": "Yes. So fair to think the pain this year is already factored into your guidance when we think about 2025 would be less negative, i.e., positive year-over-year comparisons in this dimension."
},
{
"speaker": "Keith Meier",
"text": "Yes. It's definitely factored into our 2024 outlook. And then as we go through the year, we'll provide an update on 2025, but we certainly see an improvement going into the back half of the year."
},
{
"speaker": "Mark Hughes",
"text": "Yes. And then in the card benefit business, could you talk a little bit more about the opportunity there? It sounds like an interesting agreement with Chase, how important is that within the Lifestyle? And is that a new opportunity that could be a marginal contributor to growth?"
},
{
"speaker": "Keith Demmings",
"text": "Yes, definitely, and I would say a couple of things. So we've been growing successfully our card benefits business the last several years, in particular, in the U.S. And a couple of things specifically on Chase, number one, it's a phenomenal opportunity to expand our relationship. We obviously have a long-standing relationship around the lender-placed business with Chase that spans many, many years, and this is a chance to expand across product lines in between segments within Lifestyle, which is great. We definitely are investing in this launch. It's part of the investments that we've talked about relative to Q2 that will ramp as the year progresses. We're actually converting all active Chase customer cardholders in the fourth quarter of the year. So there's a lot of work to stand that up. And then it will certainly be EBITDA positive as we enter 2025 because it will be at a full natural run rate entering next year. And yes, we're very excited. And certainly, it will be one of several drivers of growth for the Connected Living business. And part of what we've been signaling to the market is specific discrete investments in long-term growth that are directly connected to new programs, new products, and what I think are clear strategic growth levers for the business."
},
{
"speaker": "Mark Hughes",
"text": "Appreciate it. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet. Thanks, Mark."
},
{
"speaker": "Operator",
"text": "Our next question comes from Dan Lukpanov with Dowling & Partners."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Dan."
},
{
"speaker": "Keith Meier",
"text": "Good morning."
},
{
"speaker": "Dan Lukpanov",
"text": "Hey guys, good morning. Going back to the auto, just curious, so we've been seeing the traditional insurers -- car insurers reporting a moderation in physical damage severity and just knowing your product, you don't have the liability side. You have little mostly physical damage in all the same drivers of materials side. Just curious, I get that the GAP was sort of the negative in the quarter. But on the vehicle service contract side, did you guys see any acceleration on the improvement. I did the loss cost trend year-to-date change your view on how fast you can recover the business."
},
{
"speaker": "Keith Meier",
"text": "Yes. So I think through the first couple of quarters, we saw the loss cost trends moderate. The CPI index for auto repairs went down modestly, and so it's about 9 million -- or 9% year-over-year. So we're seeing it moderate a bit, Dan. And I think we're in a good position to have those rates start coming through and improve sequentially for us as we go-forward."
},
{
"speaker": "Keith Demmings",
"text": "Yes. And I think just to amplify; I mean we talked about 14 rate increases over five clients over the last couple of years. So a meaningful amount of rate increases have been put in place. And obviously, we're starting to slowly see that earn through, combined with moderation on the inflationary side. So that momentum builds over time. It doesn't solve itself nearly as quickly as what we saw in the Housing business, but certainly excited to see progress in Q2, and we'll monitor that as we think forward through the rest of the year."
},
{
"speaker": "Dan Lukpanov",
"text": "Okay. And do you see used to new car mix normalizing, I think during the inflation of cycle, you saw more used cars in the production, do you see that normalizing at all?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think it's still in the range of 50:50 in terms of used and new. It's definitely moderated. There's certainly more new car volume going back into the system. But it's a pretty -- we have a pretty nice balance within the business. And to your point, it did tilt more used car during the pandemic, and I'd say it's normalized at this point."
},
{
"speaker": "Dan Lukpanov",
"text": "If I may squeeze in one more. The -- in the financial services, I think you called out a profitability improvement in the U.S. business. What was that? Can you provide any more color on that?"
},
{
"speaker": "Keith Meier",
"text": "Yes. I think that's just a continuation of the leading programs that we have in our financial services business. So we've been growing that business over the last few years. So I think that's just a continuation of that. And I think the Chase win is just another highlight of the really good momentum that we're having in our financial services business."
},
{
"speaker": "Dan Lukpanov",
"text": "Thanks, guys. I appreciate the answers."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Dan."
},
{
"speaker": "Keith Meier",
"text": "Thanks, Dan."
},
{
"speaker": "Operator",
"text": "Our next question comes from Jeff Schmitt with William Blair."
},
{
"speaker": "Keith Demmings",
"text": "Hey, Jeff."
},
{
"speaker": "Keith Meier",
"text": "Hey, Jeff."
},
{
"speaker": "Jeff Schmitt",
"text": "Good morning. So how much of the auto revenue mix is the GAP business? And how much is sort of a handful of accounts where you share writing profits? Any details you could give on the actual like what inflation is kind of currently running at for those see their plans would be helpful."
},
{
"speaker": "Keith Meier",
"text": "Yes. So for GAP, yes, it's actually a very small part of our business, Jeff, and it's actually continuing to be even less and less as we mentioned earlier, we've been working on over the last year, transitioning some of that risk. So it's becoming a smaller and smaller part. Some of the things that you're seeing now are programs that have already been transitioned for going forward contracts. So we're just working through some of the existing contracts today. So overall, not a big driver of our auto business. And that's why there's a little bit of volatility within there, and that's why we've been reducing that part of that business."
},
{
"speaker": "Jeff Schmitt",
"text": "And just in terms of the percentage of mix of the handful of accounts that you share profits with how much is that?"
},
{
"speaker": "Keith Meier",
"text": "Yes. It's only five clients. And it's actually with our rate increases that's becoming a better performing piece of our business over time, Jeff. We don't split that out necessarily of those clients. But overall, it's -- most of the business, the vast majority, we do reduce the risk and share risk with our clients. So this is really the smaller part of the business, not the main part."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. And then just a question on the renters business, I mean, I think a few years ago, you'd expect the growth to be kind of in the high-single-digits, continues to run much weaker. I'm just curious what the weakness there? And are you getting rate in that business as well? What rate are you getting?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think our rate is probably at a very good level right now generally. What I would say on the revenue side is, and we've talked about this a little bit in the past. Definitely, if you look at it year-to-date, it's relatively flat. I think we're up 2% on revenue. Policies are up 4%. What's probably a little bit more exciting is our year-to-date gross written premium, think of that as a leading indicator of future revenue. It's actually up 8%. And it's really two pieces. So our property management company part of the renters' portfolio is up 20% year-to-date, which is obviously pretty significant growth. And then the affinity business is relatively stable. We expect that affinity business to slowly improve over time. We expect the momentum in the PMC side of our business to continue. We've shown double-digit growth for the last eight quarters straight. We really like the business. I think we're incredibly positioned. We've been investing not just in our products, but in our platforms. And I think we're certainly set up as the market continues to find ways to drive growth, we'll be participating in that over time."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet."
},
{
"speaker": "Keith Meier",
"text": "Thanks, Jeff."
},
{
"speaker": "Operator",
"text": "Our next question comes from John Barnidge with Piper Sandler."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, John."
},
{
"speaker": "Keith Meier",
"text": "Hey, John."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thanks for the opportunity. Appreciate it. My first question is on the Global Housing combined ratio. How do you view the long-term combined ratio guide? There's been consistent profitability achieved in that business, not just from underwriting improvements, but it appears to be expense leverage has been achieved over the last five quarters. I'd love to get your take on how you view the long-term combined ratio you targeted. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet. I think mid-80s combined is the right way to think about the business, we think about a non-cat loss ratio of around 40%. We had about 7 points for cat losses and then expenses in the high-30s. There's no doubt we've demonstrated a tremendous amount of discipline around expense management, driving efficiency through the use of technology and a lot of other things, and it's certainly showing up. And it's a scale business. So as we've grown the business, you're seeing the benefits of that flow through on the expense line. But I would say, mid-80s combined is the way to think about that business generally longer-term, and we feel incredibly proud of the growth of that business. I mean our policies are up 9% year-over-year. AIVs are up 11% and then expense leverage of more than 200 basis points if you look back. So it's performing incredibly well and very fortunate that we've got -- the team that we've got."
},
{
"speaker": "Keith Meier",
"text": "Yes. And I would just add, the expense ratio story really is a great one, and it's really sustainable as well. And it's really driven by the combination of scale the digital enhancements that we're making, the AI investments we're making, and then also our integration platforms. When you take all of that we've been doing over the last few years, it's really been an amazing journey. And I think that's really delivered an incredible customer experience through technology and it's also enabling us to differentiate versus others in the industry. And I think that's why you're seeing us win some important new clients with those investments we made that are really paying off for us."
},
{
"speaker": "John Barnidge",
"text": "Thank you for that. My follow-up question is on the Global Lifestyle business. Telstra, Spectrum really seemed to have delivered nice unit growth, $1.6 million, I think you called out there. But generally, ahead of a program launching, there's a period of investor. Are you able to quantify the level of investment for Telstra and Spectrum that impacted EBITDA in the quarter for Connected Living? Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet. I think what we've tried to quantify is the overall level of investment. So we talked about $13 million of incremental investment year-to-date, $5 million in the first quarter, about $8 million in the second quarter and think about that trend line kind of being maintained as we think about the second half of the year. So that's probably the easiest way to think about it, not necessarily at the client level. And there's no doubt we're excited about both of those opportunities to grow in the market. And there's certainly a step up in the second quarter with subscriber counts. We took over the in-force business at Telstra, which is terrific. So we start from a pretty robust place in terms of subs. And then, with Spectrum, as well because part of the program is embedded in the top-tier rate plan that actually gave us a step up to existing subscribers in the second quarter and now we're in a more normalized period of growth. What I think you'll notice, if you unpack the subscriber counts is we actually generated net growth even separating the $1.6 million incremental that we talked about, and that's following several quarters of declines in that metric. So we're really pleased not just with the growth from these two clients but with the underlying performance around subscribers and certainly expect that growth to continue, not at that level, but to continue as we go-forward."
},
{
"speaker": "John Barnidge",
"text": "Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our next question comes from Tommy McJoynt from KBW."
},
{
"speaker": "Keith Demmings",
"text": "Hey Tommy, good morning."
},
{
"speaker": "Tommy McJoynt",
"text": "Hey, good morning, guys. Good morning. How much is higher investment income offsetting, I guess, the otherwise, what I'll call core weakness in the auto segment. I guess, just basically do you know what percentage of autos bottom line EBITDA is investment income. And I'm not sure what the duration of those investments are. But is there any risk that if short-term rates come down meaningfully over the next year and that potentially fits auto's bottom line before all the work you're doing on rate increases gets a chance to earn in. Is that a risk that we should be thinking about?"
},
{
"speaker": "Keith Meier",
"text": "Yes. I think we're in a good position in terms of investment income, Tommy. Our duration is about five years on our investment portfolio. We've got a very high-quality portfolio. Our book yield is up 12 basis points over the last quarter up to $5.16. New money yields are still a little bit higher than that. So overall, we feel good about where we stand for the remainder of the year and our outlook in terms of investment income. And then also with certain clients, we share some investment income. So to the extent that interest rates go down a little bit, then it actually -- there's a natural offset there for us with some of the clients. So overall, not as big of an impact in the short-term."
},
{
"speaker": "Tommy McJoynt",
"text": "Okay. Got it. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Welcome."
},
{
"speaker": "Operator",
"text": "Our next question comes from Grace Carter with Bank of America. Please unmute your line to ask a question."
},
{
"speaker": "Grace Carter",
"text": "Good morning. Can you all hear me?"
},
{
"speaker": "Keith Meier",
"text": "Yes, we can. Hi, Grace."
},
{
"speaker": "Grace Carter",
"text": "Okay. Perfect. Hi. So I was wondering on the auto risk question. I think historically, you all have said that you retain about a third of the risk across the Lifestyle book. I was just curious if that continues to be kind of the best way to think about the segment overall, just given the work that you've done in the auto book over the past several quarters."
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think it's generally the right way to think about it at the Lifestyle level, maybe a little bit -- we may retain a little bit less of it on the auto side. A lot of the deals are reinsured within the dealer business and with various clients. So -- but I do think, overall, that's a good way to think about it. And the nice thing with auto, as we think about the pressure on the VSC side, it's a handful of clients, so it's somewhat manageable. We're trying to work with only five partners to make the right adjustments. And as you've seen, 14 rate increases with five clients over the last couple of years is a meaningful amount of activity and traction to try to right the ship. So I do feel like that allows it to be much more manageable because it's quite concentrated."
},
{
"speaker": "Grace Carter",
"text": "Thank you. And I guess, you mentioned expecting higher repurchases for the remainder of the year, but also gave us some guidance for how Hurricane Beryl losses might be shaping up. Just given the forecast for an active hurricane season, can you talk about what gives you the confidence to kind of increase the outlook for repurchases for the remainder of the year? And as just kind of given the seasonality of hurricane season, if we should expect those to be more weighted towards 4Q rather than 3Q?"
},
{
"speaker": "Keith Meier",
"text": "Yes. So I think, first of all, we get the confidence from our strong capital position and we've really just continued to strengthen our reinsurance program. So we feel really good about how we are positioned going into the back half of the year. I think you also highlight, Grace, the strong cash flow generation of our portfolio of businesses. And we have a very strong track record of deploying that capital back to shareholders. And we've already completed $100 million of the buybacks. And I think we're going to be on pace to deliver that higher end of the $200 million to $300 million range. And I don't think we see any reason why that wouldn't be the case, and that's why we raised our guidance there. So overall, I think being in this type of capital position is exactly where we want to be and it allows us to operate from a position of strength."
},
{
"speaker": "Grace Carter",
"text": "Perfect. Thank you."
},
{
"speaker": "Keith Meier",
"text": "You're welcome."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thanks, Grace."
},
{
"speaker": "Operator",
"text": "Our last question is coming from Mark Hughes with Truist Securities."
},
{
"speaker": "Keith Demmings",
"text": "Hey, Mark."
},
{
"speaker": "Keith Meier",
"text": "Hey, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Thanks for taking the follow-up. In the Global Housing, your fee income was quite strong this quarter. Anything unusual there? Is this kind of elevated fees? Is that going to continue? I think we said $53 million, if I'm looking at it properly, a big jump year-over-year. Could you talk about that?"
},
{
"speaker": "Keith Meier",
"text": "Yes. So in the fee income, there was a business change that was made. And all it really was, Mark, was a reclassification between fee income and our expense lines. So no bottom line P&L impact, just movement between expenses and the fee income line."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Okay. And then you talked about a client transition in Housing that could impact the second half. I'm not sure whether you said anything more about that, but what was the import of that statement?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So we've got -- there's a lot of ongoing activity within the lender-placed business. And at times, certain portfolios roll off, certain portfolios roll on as clients are making different acquisitions in the market, buying books of loans, et cetera. And what we've said is we'll see some movement on that over the course of the back half of the year. But overall, I would say our expectation for policy counts is relatively stable as we think about the second half of the year. So any losses relative to that transition will be offset by pickups with respect to other portfolios."
},
{
"speaker": "Mark Hughes",
"text": "Okay. Very good. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Excellent. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "And if we have no other questions, then maybe just one final comment for me and then we can wrap it up. And I think we try to put some emphasis in the materials, but we do have a very strong track record of driving performance across a variety of different economic cycles. We're certainly proud of what we've delivered so far this year, excited about the raised guidance. And as we highlighted in the materials, with the current guidance, we're actually poised to deliver 10% EBITDA growth on average since 2019, so over the last five years. And we're going to more than double the absolute earnings per share with a 16% CAGR over that same five-year period. So again, we're incredibly proud of the track record that sits behind us. We've got a lot of momentum in the business. We're showing that with a number of new client launches, new wins. We're working on a number of other things that we'll talk about in future quarters. But again, just excited to be driving growth and creating shareholder value. So we'll look forward to the next call. We'll get back together in November after our Q3 and really appreciate the time. Thanks very much."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 1 | 2,024 | 2024-05-08 08:00:00 | Operator: Welcome to Assurant's First Quarter 2024 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin.
Sean Moshier: Thank you, operator and good morning, everyone. We look forward to discussing our first quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the first quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in the earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings.
Keith Demmings: Thanks, Sean and good morning, everyone. Our first quarter results represent a strong start to 2024 reflecting the position of strength from which Assurant continues to operate. Adjusted EBITDA grew 31% year-over-year to $384 million and adjusted EPS grew 42% year-over-year both excluding reportable catastrophes. Our first quarter results were driven by the continued strength of our Global Housing segment as well as growth in Global Lifestyle. Our ability to continue to drive financial performance and operational excellence has supported strong cash flow generation and a solid capital position. Before reviewing the highlights across our business segments, I'd like to take a moment to reiterate how our unique and differentiated business model has led us to consistently deliver financial results. Assurant holds market leadership positions across a variety of attractive specialized markets, where we benefit from both scale and deep integration with our B2B2C client base. Our competitive advantages across our businesses have allowed us to be flexible and agile in executing for our partners and for end consumers. Cost savings from targeted actions, such as our previously announced restructuring plan and ongoing technology innovation including digital-first and artificial intelligence have supported reinvestment in businesses where we have leadership positions. These high-return initiatives have enhanced our capabilities and supported new partnerships laying the groundwork for continued growth. The ultimate driver of our success is our people. In March, Assurant was recognized by Ethisphere as one of the world's most ethical companies in 2024. Operating ethically is foundational to protecting our clients' brands across the globe as well as our own. This recognition is a testament to the thousands of Assurant employees who champion our values every day. Collectively, our unique advantages have led to long-term profitable growth and shareholder value creation. We've continued to drive outperformance versus the broader P&C market as evidenced by our long-term results compared to the S&P Composite 1500 P&C index. Since 2019 Assurant has delivered double-digit adjusted earnings growth including and excluding cats outperforming the broader P&C index. Now turning to the quarter I'd like to share highlights across our business segments. Global Lifestyle delivered adjusted EBITDA of $208 million in the first quarter of 2024. This reflects a year-over-year increase of 4% or 5% on a constant currency basis, which is in line with our full year growth expectation. Growth was led by our Connected Living business which delivered double-digit adjusted EBITDA growth in the first quarter. To support growth we're continuing to make several important investments in new partnerships including for recently announced new launches such as Telstra Australia's largest mobile carrier where we completed the initial launch of several offerings. We are currently offering protection upgrade and trade-in to Telstra's postpaid subscriber base. Additionally we recently completed a multiyear extension of our partnership with Spectrum Mobile demonstrating the strength of our relationship. The expanded relationship includes the launch of two new mobile programs. The first of the two programs the new anytime upgrade benefit which is now included in the Spectrum Mobile Unlimited Plus data plan at no extra cost to consumers allows new and existing customers to upgrade their phones whenever they want. The second program is the new Spectrum mobile repair and replacement plan which offers customers device protection and is supported by our dynamic fulfillment and claims management capabilities. These innovative new offerings with Spectrum Mobile are the result of our long-standing partnership and reflect our ongoing commitment to deliver market first solutions to meet the needs of end consumers. During the quarter we also enhanced our global capabilities. For example in Europe we acquired iSmash a leading independent tech repair brand in the United Kingdom offering express drop in repair services for smartphones tablets laptops with nearly 40 retail locations. This acquisition further scales our walk-in repair offerings and is a prime example of the investments we're making globally to win new business and enhance existing relationships. Moving to global automotive, similar to others in the industry first quarter results reflected persistent inflation impacts to vehicle parts and labor repair costs. We've continued to take actions to address elevated inflation including implementing additional rate increases in the first quarter that build upon those taken over the past 18 months while also strengthening and enhancing our claims adjudication process. For 2024, we expect auto earnings to be flat. Investment income growth and disciplined expense management efforts are expected to be offset by continued claims inflation. We remain confident in the long-term growth prospects of our auto business. Over the next several years, we expect rate actions to provide a tailwind for the business with the pace and timing of earnings growth dependent on broader market trends. Now let's discuss Global Housing, which drove our first quarter outperformance. Global Housing earnings grew significantly in the first quarter up nearly 75% excluding reportable cats. Following an extraordinary 2023, housing's first quarter performance reinforces the power of our unique business model which is highly differentiated versus the broader P&C market. Housing's competitive advantages have led to a compelling shift in its financial return over the past two years delivering strong financial performance with attractive returns. We have several distinct advantages in Global Housing. First, we have strong market positions in our core housing businesses. Specifically in Lender-Placed we have strong relationships with the largest U.S. banks and mortgage servicers including our new client Bank of America which we began to onboard in the first quarter. Second, as seen over the past 18 to 24 months in our Lender-Placed business we've been able to achieve rate adequacy quickly through the built-in annual inflation guard product feature designed to adjust with building and materials costs and normal course state rate filings. Third, our scale and focus on operational efficiencies have created meaningful expense leverage, which we will continue to benefit from going forward. Lastly, our lender-placed business provides a countercyclical hedge in the event of potential broader housing market weakness. While we would not expect tailwinds to be as significant as in prior recessions, we still expect policy placement increases if the housing market goes through a cyclical downturn. Similarly, in our renters and other business, we operate as a market leader across our affinity and property management company channels. The business has an attractive capital-light financial profile with limited catastrophe exposure and remains well positioned for long-term growth, as we continue to innovate with our partners and capitalize on secular tailwinds within the rental market. During the quarter, we increased gross written premiums by over 15%, driven by strong growth in our PMC channel. We've continued to leverage enterprise-wide capabilities to improve our customer experience and create value for our clients. For example, we leveraged our premium technical support capabilities from Connected Living to help us launch Assurant Tech Pro for the multifamily housing channel, providing residents access to technical troubleshooting services, which is a first in the industry. Turning to our enterprise outlook. For 2024, we continue to expect Enterprise adjusted EBITDA to grow by mid-single digits, excluding cats. Based on our strong first quarter performance within Global Housing, which included $22 million of favorable prior period reserve development, our 2024 results are trending toward the higher end of the mid-single-digit outlook. We now anticipate global housing will lead our enterprise growth. In Global Lifestyle, our full year outlook remains unchanged, driven by growth in Connected Living which is partially offset by incremental investments to support long-term growth. We continue to monitor global macroeconomic conditions, including inflation, foreign exchange and interest rate levels as well as new business investments. Looking at earnings per share, we now expect adjusted EPS growth to approximate adjusted EBITDA growth, reflecting lower expected depreciation expense as well as higher earnings within Global Housing. I'll now turn it over to Keith Meier to review our first quarter results and 2024 outlook in further detail.
Keith Meier: Thanks, Keith, and good morning, everyone. With our strong first quarter performance, we continue to focus on driving long-term shareholder value with thoughtful and decisive actions to continue to grow and outperform. To achieve this, we are committed to a deep understanding of our global partners and their end consumers' needs, executing on the opportunities identified as well as disciplined capital management to enable long-term growth. Now let's review the details of our first quarter results. In the first quarter, adjusted EBITDA grew 31% to $384 million and adjusted EPS increased by 42% to $4.97, both excluding reportable catastrophes. From a capital perspective, we generated $254 million of segment dividends in the first quarter, ending the quarter with $622 million of holding company liquidity, up from $606 million at year-end. Our strong capital position allowed us to return $77 million to shareholders in the quarter, including $40 million of share repurchases. In addition, we repurchased $10 million of shares between April 1 and May 3. Turning to our business segments. Let's begin with Global Lifestyle. For the quarter, adjusted EBITDA grew 4% to $208 million, or 5% on a constant currency basis. Year-over-year growth was driven by strong performance in Connected Living, particularly in the U.S., which was partially offset by lower results in Global Automotive. In Connected Living, earnings increased 14%, or $16 million, primarily driven by continued momentum in our U.S. mobile protection programs and higher investment income. Results were partially offset by investments in new capabilities and client partnerships. In the U.S. Connected Living growth also benefited from modest improvements in loss experience within extended service contracts, resulting from rate actions taken over the last 18 months to offset higher claim severities from inflation. Trade-in results were flat, as higher margins and contributions from new US programs were partially offset by a decline in carrier volumes, including impacts from lower promotional activity. International Connected Living results included a $7 million favorable onetime extended service contract client benefit in Japan. Excluding this item international results were stable on a constant currency basis, consistent with the trends from the end of 2023. Foreign exchange remains a headwind impacting Lifestyle's adjusted EBITDA growth by one percentage point in the quarter. In Global Automotive, first quarter adjusted EBITDA declined 9% or $7 million, driven by higher claims costs due to persistent inflation impacts, as well as the normalization of select ancillary products. The impacts of inflation continue to be felt throughout the auto industry as indicated in the March Consumer Price Index where motor vehicle repair costs rose nearly 12% year-over-year and accelerated over the quarter. Elevated claims costs were partially offset by higher investment income. Turning to net earned premiums fees and other income. Lifestyle grew by $148 million or 7% and Connected Living increased 11% benefiting from contributions from new trade-in programs and North American mobile protection programs. Growth from Global Automotive net earned premiums fees and other income was 3%, which was primarily driven by prior period sales of vehicle service contracts. For full year 2024, we continue to expect Global Lifestyle's adjusted EBITDA to grow driven by Connected Living. We expect growth in Connected Living to be led by the continued expansion of our US business. In Global Auto, we expect adjusted EBITDA to be flat as higher investment income is offset by continued loss pressure from inflation. Prospective rate actions taken over the past 18 months are expected to drive improvement over time, depending on the timing and pace of claims inflation impacts. Investments related to new clients and programs will temper lifestyle growth in 2024, but will be a critical driver in the strengthening of our business over the long term. We continue to monitor foreign exchange impacts broader macroeconomic conditions and interest rates which may impact the pace and timing of growth. As we enter the second quarter, we expect our sequential adjusted EBITDA trend to be impacted by the absence of the onetime client benefit and seasonally lower mobile trading volumes, both in Connected Living. Moving to Global Housing. First quarter adjusted EBITDA was $193 million which included $13 million of reportable catastrophes. Excluding reportable cats adjusted EBITDA increased by 74% or $88 million to $205 million. Over half of the increase was driven by improving non-cat loss ratios from moderating claims trends and higher average premiums. A portion of the claims improvement was related to a $16 million favorable year-over-year net impact to prior period reserve development. This was comprised of a $22 million reserve reduction in the current quarter compared to a $6 million reserve reduction in the first quarter of 2023. The remainder of the adjusted EBITDA increase was mainly driven by continued top line growth in homeowners and an increase in the number of in-force policies, lower catastrophe reinsurance costs and higher investment income. For renters and other, earnings increased from growth in our property management channel. As Keith mentioned, expense leverage throughout housing continues to be a strong differentiator as our technology investments and innovations are enabling a superior customer experience. This has played a critical role in our outperformance. Given the strong first quarter performance, we expect Global Housing's full year 2024 adjusted EBITDA growth excluding cats to lead our overall enterprise growth. We anticipate growth will be driven by favorable non-cat loss experience continued top line momentum in homeowners and lower catastrophe reinsurance costs. Over the course of 2024, our lender-placed business is expected to be impacted by ongoing client portfolio movements. This includes the addition of multiple client portfolios including the onboarding of Bank of America, as well as expected offboarding impacts from the sale of a client to another party. Given the unique composition of each portfolio, these movements are expected to impact tracked loans and placement rate from quarter-to-quarter. However, policies in force a key driver of earnings is expected to grow overall for 2024. As we turn to the second quarter, please keep in mind the following; first, we had $22 million of first quarter prior year reserve development. Second, we expect normalized catastrophe reinsurance costs following lower costs in the first quarter, which were impacted by timing differences related to the program transition to a single placement as well as favorable 2023 exposure true-ups. Beginning in the second quarter, we expect quarterly reinsurance premiums to be modestly above $50 million, which is an increase from the $34 million in the first quarter. And lastly, the second quarter tends to be an elevated period for non-cat loss experience. Next, I wanted to summarize the placement of our 2024 catastrophe reinsurance program which has now transitioned to a single April 1st placement date. We are pleased with our increased coverage at attractive terms including cost savings realized in this year's placement. 2024 catastrophe reinsurance premiums for the total program are estimated to be approximately $190 million, a reduction in comparison to $207 million in 2023. As previously communicated, our per event retention increased to $150 million aligning with a one-in five-year probable maximum loss or PML. Our main U.S. program will provide nearly $1.5 billion in loss coverage in excess of our retention, protecting Assurant and its policyholders against the PML of approximately one-in-265-year storm an increase above the 2023 limit aligned to a one-in-225-year PML. Overall, this year's placement was diversified and supported by the strength of our relationships with 40-plus highly rated reinsurers. Moving to corporate, the first quarter adjusted EBITDA loss was $30 million, a $5 million year-over-year increase, mainly due to higher enterprise growth initiatives. We now expect the 2024 corporate adjusted EBITDA loss to approximate $110 million, consistent with 2023. Turning to capital management, we generated significant deployable capital in the first quarter, upstreaming $254 million in segment dividends. For 2024, we expect our businesses to continue to generate meaningful cash flow. Cash conversion to the holding company is expected to approximate two-thirds of segment adjusted EBITDA including reportable catastrophes. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance, and rating agency and regulatory requirements. As we look forward to the remainder of the year, we continue to be focused on maintaining balance and flexibility to support new business growth and return capital to shareholders. From a share repurchase perspective, we continue to expect to be in the range of $200 million to $300 million, which will depend on strategic M&A opportunities, market conditions, and cat activity. Through the strength of our differentiated business model and given our first quarter results, we are increasingly confident in achieving our 2024 financial objectives. Our strong capital position provides us with the necessary resources to support business growth and shareholder value over the long-term. And with that, operator, please open the call for questions.
Operator: The floor is now open for questions. [Operator Instructions] Thank you. Our first question comes from the line of Mark Hughes with Truist Securities. Your line is open.
Keith Demmings: Good morning, Mark.
Mark Hughes: Yes. Thank you very much. Good morning. In Connected Living, your EBITDA growth 14% super strong. When you look at your covered device count, it's relatively stable, trade-ins were stable but you're getting strong top line growth. How long can you continue to push the top line and profitability in an environment where covered devices seem to be relatively steady?
Keith Demmings: Yes. No, it's a great question. I think we're really pleased with certainly how Connected Living started the year, largely driven by the strength of the US Connected Living business overall. And we've talked about this in the past, but we've had double-digit growth in Connected Living for probably seven or so years pretty consistently. As I look at the first quarter results domestic Connected Living again was up double-digits, high-single last year. So, I think we feel incredibly well positioned. We did see a little bit of softness in the devices covered count. A little bit of that is in Japan which we've talked about although our margins have been quite stable in that market. A little bit in the prepaid side as well. But the bulk of our US postpaid business, which drives the lion's share of the economics clients are performing incredibly well and feel really well positioned longer term.
Mark Hughes: Your inflation guard in the homeowners business, when does that get updated? And what does it look like for this go around?
Keith Demmings: Yes. It will get updated July 1. It will be a very modest adjustment, roughly 1%. I think last year was a little north of 3%, and then the year before, it was in the low to mid-teens. So fairly normalized level, I think as we look forward this year.
Mark Hughes: And then the non-cat loss experience in housing was a good. How would you judge the weather of this quarter? It sounds like you're benefiting from rates better claims trends. How much of a weather impact do you think there was in Q1?
Keith Demmings: Yes. I think if you set aside the development, which we called out at $22 million in the quarter, the non-cat loss ratio was just under 39%. I'd say that was relatively in line with our expectations in line with what we would expect for the full year around that loss ratio factor. So I would say, certainly we've seen normalized severity levels as inflation has come down. And then to your point, obviously, a lot of impact in the business from rate but then a tremendous amount of leverage in terms of the operating expenses both with scale but also the efforts that we've made to continue to drive automation. And Keith, did you want to add anything?
Mark Hughes: Thank you.
Keith Meier: Yes, sure. I think a good way to think about that Mark as well is, Keith mentioned, 39% non-cat loss ratio. We have an expense ratio of about 38%, combined is 77%. If you add in some cat coverage, you're probably in that mid to high-80s that we talk about on a normal basis. So I think it was pretty well in that line maybe a little bit better than that.
Mark Hughes: Understood. Appreciate the detail.
Keith Demmings: Great. Thanks Mark.
Operator: Our next question comes from the line with Brian Meredith with UBS. Your line is open.
Keith Demmings: Good morning, Brian.
Brian Meredith: Yes. Thanks. Good morning. A couple of questions here. First, I'm just curious onboarding expenses for Bank of America and maybe Telstra. Are those largely complete at this point? Or are we going to see some more of that going forward? Your expenses were quite below where I was expecting this quarter.
Keith Meier: Yes. So on Bank of America, we've been ramping them up this -- over the last quarter. And so those loans are now being tracked. And then in the second and third quarter those policies should be coming online. And then by the end of the third quarter, we should be fully up and running on Bank of America. So, I think the outlook for Bank of America should be improving as we go through the year. And then with Telstra, we just launched the rest of the program -- the main part of the program earlier this month. And so we went through a lot of investment there. There's still more to come for Telstra, but we're in a really good place getting Telstra launched in terms of the main part of the program.
Keith Demmings: Maybe just add a little bit of color as well Brian in terms of the question about ongoing investments. So if I'm thinking about global Connected Living in the first quarter, I'd probably size $5 million of incremental investments in long-term growth in the quarter. We continue to think that will be 2% to 3% impact to the overall growth for the full year. So think about that trend line continuing as we move forward. And then it's just a question of at what pace and urgency do we deploy some of the solutions with not just the clients that we've talked about publicly but a number of clients and prospects that we're actively working on in real time which we'll disclose more on later in the year.
Brian Meredith: Great. And my second question related to Global Auto. I know historically you said it was a couple of clients maybe that were really the issues. I'm wondering if it's become more pervasive. And is there anything that you're kind of thinking about doing with contracts to maybe mitigate -- some of this inflationary aspects here going forward?
Keith Demmings: Yes. So it's that -- first part of your question it's unchanged. So the clients that we've been monitoring and working on based on the deal structures their profit share type arrangements if losses go over 100% it creates short-term pressure in our P&L and then we look to recover that contractually with rate adjustments. So it isn't more pervasive than it was. But obviously there's a little bit of elevation in terms of the severity around parts and labor costs in the auto sector which I think everyone is seeing. I do feel -- continue to feel real good about our long-term opportunity in auto. Clients are working with us incredibly well. We've taken a number of rate increases over the last 18 months, 20 months. We took more rate adjustments in the first quarter. We'll do more in the second quarter. So really it's about getting this business to the right spot over the long term. We talk about relative stability in the P&L at auto in 2024 and then progressively getting better as we enter 2025.
Brian Meredith: Great. Thank you.
Keith Demmings: You bet.
Operator: [Operator Instructions] We have another question comes from the line of Tommy McJoynt with KBW. Your line is open.
Keith Demmings: Hey, Tommy. Good morning.
Keith Meier: Hey, Tommy.
Tommy McJoynt: Hey. Good morning, guys. Thanks for taking my questions. The first one can you talk about as the Bank of America portfolio comes on board and perhaps also considering any other service or client additions or deletions. Is there anything that we should expect in the placement rate or the average insured values that would be different than what we should just see in the broader economy in terms of tracking mortgage delinquencies and home price appreciation anything different that's kind of changing about the nature of your tracked portfolio?
Keith Meier: Yes. So I think I mentioned in the opening remarks where we've got various changes that go on within our portfolio. Obviously, Bank of America we've talked about. We have another client that was added by another one of our clients. So that was a positive. We also have another client that was acquired by a third-party. So those loans will be coming off. So I think there's going to be a little bit of ups and downs. Some of those have lower placement rates than the average. Some of them have higher placement rates. But when you think about between now and the end of the year overall we should be up in our policy counts when you net those kind of movements within the quarters?
Keith Demmings: Yeah. And I think in a relatively stable placement rate as we exit the year Tommy, and it may bounce around a little bit. But to Keith's point, policy counts at the end of the year should be higher than where we sit today.
Tommy McJoynt: Okay. Got it. That's good color. And then switching over, can you talk about the current level and perhaps your expectations for trade-in programs and promotional activity from the carriers? And just whether or not you think that could be a swing factor in the bottom line of Connected Living as we proceed through the year?
Keith Demmings: Yeah. I think we've done a really good job maintaining overall margins in the trade-in side of the business. You think about the first quarter, obviously devices serviced were down. But as we signaled, margins are quite stable and we're making up some of that with additional volume with new clients as well. So I think we feel really good about how we're positioned. And to your point, the promotional activity was relatively light in the quarter. I think clients were focused on other things within their portfolios, and moving customers to higher tier premium rate plans et cetera and driving upgrades wasn't a huge priority in the market, but we still performed quite well financially. So I think we're well positioned. And the dynamic environment particularly with the big three mobile operators is hard to predict. And obviously, we're well positioned should that activity pick up here in the second quarter and beyond. So it's hard to predict right now Tommy, but I think we feel really well positioned.
Tommy McJoynt: Okay. Got it. And then last one, I think I may have missed it during the remarks. I think I heard you say that the reinsurance costs decreased. I didn't catch -- well, first off could you repeat those numbers? And then secondly, did you mention like what is happening to the per event retention if there were changes to that?
Keith Meier: Yeah, sure. So well, I guess first of all, we're really pleased with the outcome of moving to the single placement. It's really simplified the program. I think it was well received by the reinsurers. We mentioned that the cost of the program was down year-over-year. So we're expecting it to be approximately $190 million this year versus $207 million from last year. And overall, our per event retention stayed at one in five probable maximum loss. So that was up from $125 million. The top end of the program we actually increased from $1.4 million to $1.63 million. So moving it from 1-in-225-year to 1-in-265 year event. So a lot of good protection and lower cost. So I think overall, moving the program to the 04/01 placement date was I think a very favorable move for us. And then also, just in general in terms of the rates, the rates were favorable online given the reinsurance market. And I think that was a reflection of the quality of our book and our overall performance.
Tommy McJoynt: Got it. Thanks for recapping that. Thank you.
Keith Meier: Thank you.
Operator: There are no more further questions at this time.
Keith Demmings: Wonderful. Well, thanks everybody, and we'll look forward to the next quarter call. And please reach out to the IR team, if you have any questions. Have a great day.
Keith Meier: Thank you.
Operator: This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Welcome to Assurant's First Quarter 2024 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin."
},
{
"speaker": "Sean Moshier",
"text": "Thank you, operator and good morning, everyone. We look forward to discussing our first quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the first quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in the earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Sean and good morning, everyone. Our first quarter results represent a strong start to 2024 reflecting the position of strength from which Assurant continues to operate. Adjusted EBITDA grew 31% year-over-year to $384 million and adjusted EPS grew 42% year-over-year both excluding reportable catastrophes. Our first quarter results were driven by the continued strength of our Global Housing segment as well as growth in Global Lifestyle. Our ability to continue to drive financial performance and operational excellence has supported strong cash flow generation and a solid capital position. Before reviewing the highlights across our business segments, I'd like to take a moment to reiterate how our unique and differentiated business model has led us to consistently deliver financial results. Assurant holds market leadership positions across a variety of attractive specialized markets, where we benefit from both scale and deep integration with our B2B2C client base. Our competitive advantages across our businesses have allowed us to be flexible and agile in executing for our partners and for end consumers. Cost savings from targeted actions, such as our previously announced restructuring plan and ongoing technology innovation including digital-first and artificial intelligence have supported reinvestment in businesses where we have leadership positions. These high-return initiatives have enhanced our capabilities and supported new partnerships laying the groundwork for continued growth. The ultimate driver of our success is our people. In March, Assurant was recognized by Ethisphere as one of the world's most ethical companies in 2024. Operating ethically is foundational to protecting our clients' brands across the globe as well as our own. This recognition is a testament to the thousands of Assurant employees who champion our values every day. Collectively, our unique advantages have led to long-term profitable growth and shareholder value creation. We've continued to drive outperformance versus the broader P&C market as evidenced by our long-term results compared to the S&P Composite 1500 P&C index. Since 2019 Assurant has delivered double-digit adjusted earnings growth including and excluding cats outperforming the broader P&C index. Now turning to the quarter I'd like to share highlights across our business segments. Global Lifestyle delivered adjusted EBITDA of $208 million in the first quarter of 2024. This reflects a year-over-year increase of 4% or 5% on a constant currency basis, which is in line with our full year growth expectation. Growth was led by our Connected Living business which delivered double-digit adjusted EBITDA growth in the first quarter. To support growth we're continuing to make several important investments in new partnerships including for recently announced new launches such as Telstra Australia's largest mobile carrier where we completed the initial launch of several offerings. We are currently offering protection upgrade and trade-in to Telstra's postpaid subscriber base. Additionally we recently completed a multiyear extension of our partnership with Spectrum Mobile demonstrating the strength of our relationship. The expanded relationship includes the launch of two new mobile programs. The first of the two programs the new anytime upgrade benefit which is now included in the Spectrum Mobile Unlimited Plus data plan at no extra cost to consumers allows new and existing customers to upgrade their phones whenever they want. The second program is the new Spectrum mobile repair and replacement plan which offers customers device protection and is supported by our dynamic fulfillment and claims management capabilities. These innovative new offerings with Spectrum Mobile are the result of our long-standing partnership and reflect our ongoing commitment to deliver market first solutions to meet the needs of end consumers. During the quarter we also enhanced our global capabilities. For example in Europe we acquired iSmash a leading independent tech repair brand in the United Kingdom offering express drop in repair services for smartphones tablets laptops with nearly 40 retail locations. This acquisition further scales our walk-in repair offerings and is a prime example of the investments we're making globally to win new business and enhance existing relationships. Moving to global automotive, similar to others in the industry first quarter results reflected persistent inflation impacts to vehicle parts and labor repair costs. We've continued to take actions to address elevated inflation including implementing additional rate increases in the first quarter that build upon those taken over the past 18 months while also strengthening and enhancing our claims adjudication process. For 2024, we expect auto earnings to be flat. Investment income growth and disciplined expense management efforts are expected to be offset by continued claims inflation. We remain confident in the long-term growth prospects of our auto business. Over the next several years, we expect rate actions to provide a tailwind for the business with the pace and timing of earnings growth dependent on broader market trends. Now let's discuss Global Housing, which drove our first quarter outperformance. Global Housing earnings grew significantly in the first quarter up nearly 75% excluding reportable cats. Following an extraordinary 2023, housing's first quarter performance reinforces the power of our unique business model which is highly differentiated versus the broader P&C market. Housing's competitive advantages have led to a compelling shift in its financial return over the past two years delivering strong financial performance with attractive returns. We have several distinct advantages in Global Housing. First, we have strong market positions in our core housing businesses. Specifically in Lender-Placed we have strong relationships with the largest U.S. banks and mortgage servicers including our new client Bank of America which we began to onboard in the first quarter. Second, as seen over the past 18 to 24 months in our Lender-Placed business we've been able to achieve rate adequacy quickly through the built-in annual inflation guard product feature designed to adjust with building and materials costs and normal course state rate filings. Third, our scale and focus on operational efficiencies have created meaningful expense leverage, which we will continue to benefit from going forward. Lastly, our lender-placed business provides a countercyclical hedge in the event of potential broader housing market weakness. While we would not expect tailwinds to be as significant as in prior recessions, we still expect policy placement increases if the housing market goes through a cyclical downturn. Similarly, in our renters and other business, we operate as a market leader across our affinity and property management company channels. The business has an attractive capital-light financial profile with limited catastrophe exposure and remains well positioned for long-term growth, as we continue to innovate with our partners and capitalize on secular tailwinds within the rental market. During the quarter, we increased gross written premiums by over 15%, driven by strong growth in our PMC channel. We've continued to leverage enterprise-wide capabilities to improve our customer experience and create value for our clients. For example, we leveraged our premium technical support capabilities from Connected Living to help us launch Assurant Tech Pro for the multifamily housing channel, providing residents access to technical troubleshooting services, which is a first in the industry. Turning to our enterprise outlook. For 2024, we continue to expect Enterprise adjusted EBITDA to grow by mid-single digits, excluding cats. Based on our strong first quarter performance within Global Housing, which included $22 million of favorable prior period reserve development, our 2024 results are trending toward the higher end of the mid-single-digit outlook. We now anticipate global housing will lead our enterprise growth. In Global Lifestyle, our full year outlook remains unchanged, driven by growth in Connected Living which is partially offset by incremental investments to support long-term growth. We continue to monitor global macroeconomic conditions, including inflation, foreign exchange and interest rate levels as well as new business investments. Looking at earnings per share, we now expect adjusted EPS growth to approximate adjusted EBITDA growth, reflecting lower expected depreciation expense as well as higher earnings within Global Housing. I'll now turn it over to Keith Meier to review our first quarter results and 2024 outlook in further detail."
},
{
"speaker": "Keith Meier",
"text": "Thanks, Keith, and good morning, everyone. With our strong first quarter performance, we continue to focus on driving long-term shareholder value with thoughtful and decisive actions to continue to grow and outperform. To achieve this, we are committed to a deep understanding of our global partners and their end consumers' needs, executing on the opportunities identified as well as disciplined capital management to enable long-term growth. Now let's review the details of our first quarter results. In the first quarter, adjusted EBITDA grew 31% to $384 million and adjusted EPS increased by 42% to $4.97, both excluding reportable catastrophes. From a capital perspective, we generated $254 million of segment dividends in the first quarter, ending the quarter with $622 million of holding company liquidity, up from $606 million at year-end. Our strong capital position allowed us to return $77 million to shareholders in the quarter, including $40 million of share repurchases. In addition, we repurchased $10 million of shares between April 1 and May 3. Turning to our business segments. Let's begin with Global Lifestyle. For the quarter, adjusted EBITDA grew 4% to $208 million, or 5% on a constant currency basis. Year-over-year growth was driven by strong performance in Connected Living, particularly in the U.S., which was partially offset by lower results in Global Automotive. In Connected Living, earnings increased 14%, or $16 million, primarily driven by continued momentum in our U.S. mobile protection programs and higher investment income. Results were partially offset by investments in new capabilities and client partnerships. In the U.S. Connected Living growth also benefited from modest improvements in loss experience within extended service contracts, resulting from rate actions taken over the last 18 months to offset higher claim severities from inflation. Trade-in results were flat, as higher margins and contributions from new US programs were partially offset by a decline in carrier volumes, including impacts from lower promotional activity. International Connected Living results included a $7 million favorable onetime extended service contract client benefit in Japan. Excluding this item international results were stable on a constant currency basis, consistent with the trends from the end of 2023. Foreign exchange remains a headwind impacting Lifestyle's adjusted EBITDA growth by one percentage point in the quarter. In Global Automotive, first quarter adjusted EBITDA declined 9% or $7 million, driven by higher claims costs due to persistent inflation impacts, as well as the normalization of select ancillary products. The impacts of inflation continue to be felt throughout the auto industry as indicated in the March Consumer Price Index where motor vehicle repair costs rose nearly 12% year-over-year and accelerated over the quarter. Elevated claims costs were partially offset by higher investment income. Turning to net earned premiums fees and other income. Lifestyle grew by $148 million or 7% and Connected Living increased 11% benefiting from contributions from new trade-in programs and North American mobile protection programs. Growth from Global Automotive net earned premiums fees and other income was 3%, which was primarily driven by prior period sales of vehicle service contracts. For full year 2024, we continue to expect Global Lifestyle's adjusted EBITDA to grow driven by Connected Living. We expect growth in Connected Living to be led by the continued expansion of our US business. In Global Auto, we expect adjusted EBITDA to be flat as higher investment income is offset by continued loss pressure from inflation. Prospective rate actions taken over the past 18 months are expected to drive improvement over time, depending on the timing and pace of claims inflation impacts. Investments related to new clients and programs will temper lifestyle growth in 2024, but will be a critical driver in the strengthening of our business over the long term. We continue to monitor foreign exchange impacts broader macroeconomic conditions and interest rates which may impact the pace and timing of growth. As we enter the second quarter, we expect our sequential adjusted EBITDA trend to be impacted by the absence of the onetime client benefit and seasonally lower mobile trading volumes, both in Connected Living. Moving to Global Housing. First quarter adjusted EBITDA was $193 million which included $13 million of reportable catastrophes. Excluding reportable cats adjusted EBITDA increased by 74% or $88 million to $205 million. Over half of the increase was driven by improving non-cat loss ratios from moderating claims trends and higher average premiums. A portion of the claims improvement was related to a $16 million favorable year-over-year net impact to prior period reserve development. This was comprised of a $22 million reserve reduction in the current quarter compared to a $6 million reserve reduction in the first quarter of 2023. The remainder of the adjusted EBITDA increase was mainly driven by continued top line growth in homeowners and an increase in the number of in-force policies, lower catastrophe reinsurance costs and higher investment income. For renters and other, earnings increased from growth in our property management channel. As Keith mentioned, expense leverage throughout housing continues to be a strong differentiator as our technology investments and innovations are enabling a superior customer experience. This has played a critical role in our outperformance. Given the strong first quarter performance, we expect Global Housing's full year 2024 adjusted EBITDA growth excluding cats to lead our overall enterprise growth. We anticipate growth will be driven by favorable non-cat loss experience continued top line momentum in homeowners and lower catastrophe reinsurance costs. Over the course of 2024, our lender-placed business is expected to be impacted by ongoing client portfolio movements. This includes the addition of multiple client portfolios including the onboarding of Bank of America, as well as expected offboarding impacts from the sale of a client to another party. Given the unique composition of each portfolio, these movements are expected to impact tracked loans and placement rate from quarter-to-quarter. However, policies in force a key driver of earnings is expected to grow overall for 2024. As we turn to the second quarter, please keep in mind the following; first, we had $22 million of first quarter prior year reserve development. Second, we expect normalized catastrophe reinsurance costs following lower costs in the first quarter, which were impacted by timing differences related to the program transition to a single placement as well as favorable 2023 exposure true-ups. Beginning in the second quarter, we expect quarterly reinsurance premiums to be modestly above $50 million, which is an increase from the $34 million in the first quarter. And lastly, the second quarter tends to be an elevated period for non-cat loss experience. Next, I wanted to summarize the placement of our 2024 catastrophe reinsurance program which has now transitioned to a single April 1st placement date. We are pleased with our increased coverage at attractive terms including cost savings realized in this year's placement. 2024 catastrophe reinsurance premiums for the total program are estimated to be approximately $190 million, a reduction in comparison to $207 million in 2023. As previously communicated, our per event retention increased to $150 million aligning with a one-in five-year probable maximum loss or PML. Our main U.S. program will provide nearly $1.5 billion in loss coverage in excess of our retention, protecting Assurant and its policyholders against the PML of approximately one-in-265-year storm an increase above the 2023 limit aligned to a one-in-225-year PML. Overall, this year's placement was diversified and supported by the strength of our relationships with 40-plus highly rated reinsurers. Moving to corporate, the first quarter adjusted EBITDA loss was $30 million, a $5 million year-over-year increase, mainly due to higher enterprise growth initiatives. We now expect the 2024 corporate adjusted EBITDA loss to approximate $110 million, consistent with 2023. Turning to capital management, we generated significant deployable capital in the first quarter, upstreaming $254 million in segment dividends. For 2024, we expect our businesses to continue to generate meaningful cash flow. Cash conversion to the holding company is expected to approximate two-thirds of segment adjusted EBITDA including reportable catastrophes. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance, and rating agency and regulatory requirements. As we look forward to the remainder of the year, we continue to be focused on maintaining balance and flexibility to support new business growth and return capital to shareholders. From a share repurchase perspective, we continue to expect to be in the range of $200 million to $300 million, which will depend on strategic M&A opportunities, market conditions, and cat activity. Through the strength of our differentiated business model and given our first quarter results, we are increasingly confident in achieving our 2024 financial objectives. Our strong capital position provides us with the necessary resources to support business growth and shareholder value over the long-term. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "The floor is now open for questions. [Operator Instructions] Thank you. Our first question comes from the line of Mark Hughes with Truist Securities. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Thank you very much. Good morning. In Connected Living, your EBITDA growth 14% super strong. When you look at your covered device count, it's relatively stable, trade-ins were stable but you're getting strong top line growth. How long can you continue to push the top line and profitability in an environment where covered devices seem to be relatively steady?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. No, it's a great question. I think we're really pleased with certainly how Connected Living started the year, largely driven by the strength of the US Connected Living business overall. And we've talked about this in the past, but we've had double-digit growth in Connected Living for probably seven or so years pretty consistently. As I look at the first quarter results domestic Connected Living again was up double-digits, high-single last year. So, I think we feel incredibly well positioned. We did see a little bit of softness in the devices covered count. A little bit of that is in Japan which we've talked about although our margins have been quite stable in that market. A little bit in the prepaid side as well. But the bulk of our US postpaid business, which drives the lion's share of the economics clients are performing incredibly well and feel really well positioned longer term."
},
{
"speaker": "Mark Hughes",
"text": "Your inflation guard in the homeowners business, when does that get updated? And what does it look like for this go around?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. It will get updated July 1. It will be a very modest adjustment, roughly 1%. I think last year was a little north of 3%, and then the year before, it was in the low to mid-teens. So fairly normalized level, I think as we look forward this year."
},
{
"speaker": "Mark Hughes",
"text": "And then the non-cat loss experience in housing was a good. How would you judge the weather of this quarter? It sounds like you're benefiting from rates better claims trends. How much of a weather impact do you think there was in Q1?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. I think if you set aside the development, which we called out at $22 million in the quarter, the non-cat loss ratio was just under 39%. I'd say that was relatively in line with our expectations in line with what we would expect for the full year around that loss ratio factor. So I would say, certainly we've seen normalized severity levels as inflation has come down. And then to your point, obviously, a lot of impact in the business from rate but then a tremendous amount of leverage in terms of the operating expenses both with scale but also the efforts that we've made to continue to drive automation. And Keith, did you want to add anything?"
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "Keith Meier",
"text": "Yes, sure. I think a good way to think about that Mark as well is, Keith mentioned, 39% non-cat loss ratio. We have an expense ratio of about 38%, combined is 77%. If you add in some cat coverage, you're probably in that mid to high-80s that we talk about on a normal basis. So I think it was pretty well in that line maybe a little bit better than that."
},
{
"speaker": "Mark Hughes",
"text": "Understood. Appreciate the detail."
},
{
"speaker": "Keith Demmings",
"text": "Great. Thanks Mark."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line with Brian Meredith with UBS. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Good morning, Brian."
},
{
"speaker": "Brian Meredith",
"text": "Yes. Thanks. Good morning. A couple of questions here. First, I'm just curious onboarding expenses for Bank of America and maybe Telstra. Are those largely complete at this point? Or are we going to see some more of that going forward? Your expenses were quite below where I was expecting this quarter."
},
{
"speaker": "Keith Meier",
"text": "Yes. So on Bank of America, we've been ramping them up this -- over the last quarter. And so those loans are now being tracked. And then in the second and third quarter those policies should be coming online. And then by the end of the third quarter, we should be fully up and running on Bank of America. So, I think the outlook for Bank of America should be improving as we go through the year. And then with Telstra, we just launched the rest of the program -- the main part of the program earlier this month. And so we went through a lot of investment there. There's still more to come for Telstra, but we're in a really good place getting Telstra launched in terms of the main part of the program."
},
{
"speaker": "Keith Demmings",
"text": "Maybe just add a little bit of color as well Brian in terms of the question about ongoing investments. So if I'm thinking about global Connected Living in the first quarter, I'd probably size $5 million of incremental investments in long-term growth in the quarter. We continue to think that will be 2% to 3% impact to the overall growth for the full year. So think about that trend line continuing as we move forward. And then it's just a question of at what pace and urgency do we deploy some of the solutions with not just the clients that we've talked about publicly but a number of clients and prospects that we're actively working on in real time which we'll disclose more on later in the year."
},
{
"speaker": "Brian Meredith",
"text": "Great. And my second question related to Global Auto. I know historically you said it was a couple of clients maybe that were really the issues. I'm wondering if it's become more pervasive. And is there anything that you're kind of thinking about doing with contracts to maybe mitigate -- some of this inflationary aspects here going forward?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So it's that -- first part of your question it's unchanged. So the clients that we've been monitoring and working on based on the deal structures their profit share type arrangements if losses go over 100% it creates short-term pressure in our P&L and then we look to recover that contractually with rate adjustments. So it isn't more pervasive than it was. But obviously there's a little bit of elevation in terms of the severity around parts and labor costs in the auto sector which I think everyone is seeing. I do feel -- continue to feel real good about our long-term opportunity in auto. Clients are working with us incredibly well. We've taken a number of rate increases over the last 18 months, 20 months. We took more rate adjustments in the first quarter. We'll do more in the second quarter. So really it's about getting this business to the right spot over the long term. We talk about relative stability in the P&L at auto in 2024 and then progressively getting better as we enter 2025."
},
{
"speaker": "Brian Meredith",
"text": "Great. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] We have another question comes from the line of Tommy McJoynt with KBW. Your line is open."
},
{
"speaker": "Keith Demmings",
"text": "Hey, Tommy. Good morning."
},
{
"speaker": "Keith Meier",
"text": "Hey, Tommy."
},
{
"speaker": "Tommy McJoynt",
"text": "Hey. Good morning, guys. Thanks for taking my questions. The first one can you talk about as the Bank of America portfolio comes on board and perhaps also considering any other service or client additions or deletions. Is there anything that we should expect in the placement rate or the average insured values that would be different than what we should just see in the broader economy in terms of tracking mortgage delinquencies and home price appreciation anything different that's kind of changing about the nature of your tracked portfolio?"
},
{
"speaker": "Keith Meier",
"text": "Yes. So I think I mentioned in the opening remarks where we've got various changes that go on within our portfolio. Obviously, Bank of America we've talked about. We have another client that was added by another one of our clients. So that was a positive. We also have another client that was acquired by a third-party. So those loans will be coming off. So I think there's going to be a little bit of ups and downs. Some of those have lower placement rates than the average. Some of them have higher placement rates. But when you think about between now and the end of the year overall we should be up in our policy counts when you net those kind of movements within the quarters?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. And I think in a relatively stable placement rate as we exit the year Tommy, and it may bounce around a little bit. But to Keith's point, policy counts at the end of the year should be higher than where we sit today."
},
{
"speaker": "Tommy McJoynt",
"text": "Okay. Got it. That's good color. And then switching over, can you talk about the current level and perhaps your expectations for trade-in programs and promotional activity from the carriers? And just whether or not you think that could be a swing factor in the bottom line of Connected Living as we proceed through the year?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. I think we've done a really good job maintaining overall margins in the trade-in side of the business. You think about the first quarter, obviously devices serviced were down. But as we signaled, margins are quite stable and we're making up some of that with additional volume with new clients as well. So I think we feel really good about how we're positioned. And to your point, the promotional activity was relatively light in the quarter. I think clients were focused on other things within their portfolios, and moving customers to higher tier premium rate plans et cetera and driving upgrades wasn't a huge priority in the market, but we still performed quite well financially. So I think we're well positioned. And the dynamic environment particularly with the big three mobile operators is hard to predict. And obviously, we're well positioned should that activity pick up here in the second quarter and beyond. So it's hard to predict right now Tommy, but I think we feel really well positioned."
},
{
"speaker": "Tommy McJoynt",
"text": "Okay. Got it. And then last one, I think I may have missed it during the remarks. I think I heard you say that the reinsurance costs decreased. I didn't catch -- well, first off could you repeat those numbers? And then secondly, did you mention like what is happening to the per event retention if there were changes to that?"
},
{
"speaker": "Keith Meier",
"text": "Yeah, sure. So well, I guess first of all, we're really pleased with the outcome of moving to the single placement. It's really simplified the program. I think it was well received by the reinsurers. We mentioned that the cost of the program was down year-over-year. So we're expecting it to be approximately $190 million this year versus $207 million from last year. And overall, our per event retention stayed at one in five probable maximum loss. So that was up from $125 million. The top end of the program we actually increased from $1.4 million to $1.63 million. So moving it from 1-in-225-year to 1-in-265 year event. So a lot of good protection and lower cost. So I think overall, moving the program to the 04/01 placement date was I think a very favorable move for us. And then also, just in general in terms of the rates, the rates were favorable online given the reinsurance market. And I think that was a reflection of the quality of our book and our overall performance."
},
{
"speaker": "Tommy McJoynt",
"text": "Got it. Thanks for recapping that. Thank you."
},
{
"speaker": "Keith Meier",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "There are no more further questions at this time."
},
{
"speaker": "Keith Demmings",
"text": "Wonderful. Well, thanks everybody, and we'll look forward to the next quarter call. And please reach out to the IR team, if you have any questions. Have a great day."
},
{
"speaker": "Keith Meier",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] | Assurant, Inc. | 4,026,111 |
AIZ | 1 | 2,025 | 2025-05-07 08:00:00 | Operator: Welcome to Assurant’s First Quarter 2025 Conference Call and Webcast. At this time all participants have been placed in a listen-only mode and the floor will be opened for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may now begin.
Sean Moshier: Thank you, operator, and good morning, everyone. We look forward to discussing our first quarter results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the first quarter 2025. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in the earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings.
Keith Demmings: Thanks, Sean, and good morning, everyone. I'm pleased to share that 2025 is off to a strong start. For the first quarter, we continue to demonstrate momentum, delivering 14% growth in adjusted EBITDA and 16% growth in adjusted earnings per share, both excluding reportable catastrophes. This quarter's performance highlights the position of strength from which we continue to operate and is supported by our diversified global operating model where we have market leading businesses across global housing and global lifestyle that are underpinned by our robust capital position. We have a proven track record of delivering through various economic cycles over the long term and we remain well positioned to achieve our 9th consecutive year of earnings growth. Our differentiated business-to-business to consumer distribution strategy in attractive markets is reinforced by our world class workforce that enables us to win, build and scale transparent partnerships with many of the world's leading brands. And our ability to deliver exceptional customer experiences through customized data driven solutions and comprehensive wraparound services reinforces the strength of Assurant's long-term fundamentals. Last quarter, we outlined our 2025 priorities and I'm incredibly proud of our team's progress to date. We're executing, optimizing and scaling significant partnerships across lifestyle and housing through the foundational investments we made in new programs and clients in 2024. We've continued to make high value incremental investments to support new program launches in our pipeline and accelerate emerging growth opportunities. And we remain focused on achieving our 2025 outlook by driving operational excellence and financial performance. Next, I want to share a few segment highlights that support our attractive position. Starting with Global Lifestyle, we're laser focused on achieving our growth objectives across Connected Living and Global Automotive. In Connected Living, we continuously enhance the customer and client experience by investing in innovative products and services while providing differentiated value to our clients with integrity and transparency. This has allowed us to build relationships with every major U.S. mobile operator along with many global leaders in the telecom industry. As mobile and cable operators continue to innovate and compete in the wireless space, Assurant's strengthened partnerships, enhance our market position and support long term growth. Our approach continues to generate momentum and through key investments in leading edge technology including automation, robotics and AI at our device care centers, we anticipate meaningful opportunities to offer additional value-added services to our key mobile clients in the near future. During the first quarter, we continue to build on our track record of deepening relationships with key clients, reinforcing our position as a preferred partner. Recently, we partnered with Verizon to launch a new mobile device protection plan from Total Wireless, Verizon's fast growing no contract wireless provider. The program Total Wireless Protect will allow new and existing customers affordable replacement and repair against accidents and mechanical breakdowns, supported by our more than 900 Assurant authorized repair centers nationwide. This provides an opportunity to continue building deeper relationships with another U.S. mobile carrier. In Global Automotive, earnings remain stable, supported by a year-over-year improvement in loss experience. Our leadership team is quickly making progress to enable further success, including a unified consistent branding approach in our go-to-market strategy, allowing us to better leverage our scale as a market leader. This has contributed to new wins within our U.S. and international distribution channels with runway to gain additional share with large national dealers. And we're launching several new products within Global Auto this year. We recently launched Assurant Vehicle Care Technology Plus, which provides coverage for high-tech vehicle components, wear and tear items and smartphone repairs. Moving to housing, shifts in the voluntary insurance market throughout the U.S. have increased demand for lender placed insurance products within homeowners. Our product helps lenders, investors, and homeowners remove the risk of uninsured loss. Through the exceptional efforts of our claims team, we remain committed to supporting our policyholders when they need us most. We're proud to be honored by the American Red Cross as a 2025 disaster relief hero, recognizing our support for those impacted by 2024 storms including hurricanes Helene and Milton and the wildfires in California. As we look at results, our strong performance continued in the first quarter, driven by 17% top-line growth within homeowners, primarily due to the addition of 70,000 lender placed policies. We've achieved significant expense leverage resulting in a compelling combined ratio. Even with elevated cats in the first quarter, we delivered a combined ratio of 90%. For 2025, we're on track to deliver a combined ratio around the mid-80s including our full year cat assumption of $300 million. We continue to extend the tenure of our client base, renewing two lender placed clients in the first quarter and we see meaningful opportunity to expand with new clients by leveraging our existing infrastructure. In renters, we're executing our strategy to scale our technology enabled services and recently added a new renters book with over 250,000 policies. Our Cover360 platform continues to support double-digit written premium growth in our Property Management Company or PMC channel, demonstrating our competitive edge in a distribution channel with further growth potential. The strength of our combined lifestyle and housing businesses has enabled us to grow significantly. Over the last five years, we've delivered a compound annual adjusted EPS growth rate of 18% and a 12% adjusted EBITDA growth rate, both excluding cats. Since we successfully placed our 2025 cat reinsurance program in April, which Keith Meier will cover, I want to take a moment to highlight how Assurant compares to certain large cat exposed P&C peers. When we look over the past six years, Assurant ranks among the lowest in terms of cat exposure as a percentage of net earned premiums and as a percentage of shareholders' equity. Since 2019, we had the lowest average cat losses as a percentage of net earned premiums as well as the third lowest as a percentage of shareholders' equity. Equally compelling, our volatility across both metrics is among the lowest in the group. Over the last 10 years, our increased scale and efficiency within housing has driven a 10-year average combined ratio of 89% compared to the broader P&C market of 95%. This data illustrates the power of Assurant's unique and advantaged business portfolio as global lifestyle and global housing have delivered strong growth and returns with lower volatility. Given our demonstrated resilience over time through various economic environments, balanced risk management, and compelling growth path ahead, it's our belief that we should be valued at a premium to the S&P composite 1,500 P&C index median. Our strategy is centered around our powerful B2B2C distribution model across lifestyle and housing, which bolsters our competitive advantage and financial performance. In the attractive markets where we operate, we see expanding opportunities to continue profitable growth through the scale and efficiency of our service delivery networks. We expect to continue extending our track record of winning new clients and solidifying relationships across the enterprise. Our business model has created diversified sources of earnings and capital while generating strong returns, cash flow and growth. Looking toward the future, we believe there are expanding growth opportunities including increasing investments in our core markets, continue to expand offerings with existing clients and winning new global partnerships, and entering attractive adjacent sectors through new product launches. Before handing it over to Keith, I want to spend a moment on the evolving economic landscape and Assurant's position. 2024 marked an exceptional year of outperformance representing our 8th consecutive year of earnings growth. Given the strong start to the year and the strength of our businesses, we remain on track to deliver our 9th consecutive year of profitable growth in 2025, reaffirming our enterprise outlook. We are closely monitoring the impact of macroeconomic conditions and tariff policies on our claims cost and consumer demand. We are also taking action to remain well positioned and stay ahead of future developments. While there remains significant uncertainty, our outlook considers the impact of tariffs. The differentiated features of our business model positions’ us to navigate the dynamic macroeconomic environment. In lifestyle, our alignment of financial interests with our partners enables us to work side by side to help mitigate risk. This includes client risk sharing contracts that allow us to manage financial exposure through Connected Living and Global Auto. Our partnerships with leading brands provides us access to diverse supply chains across the world as our clients partner with us to optimize claims costs. Within housing, our inflation guard product feature includes quarterly state-by-state rate adjustments and will allow us to react quickly to higher materials cost in our lender place business. In addition, lender place may also serve as a countercyclical hedge in the event of a broader market downturn, differentiating us from other P&C companies. Overall, the attributes that unify our Lifestyle and Housing segments also position Assurant to deliver shareholder value over time through growth and disciplined capital management. I'll now turn it over to Keith Meyer.
Keith Meier: Thanks, Keith, and good morning, everyone. Let me begin by sharing some key highlights we saw in the first quarter. 2025 is off to a strong start with double-digit growth across our primary performance metrics, achieving mid-teens growth for adjusted EBITDA and adjusted earnings per share, both excluding catastrophes. Our first quarter performance was driven by double-digit earnings growth in Global Housing led by our lender placed business. Within Global Lifestyle, we were pleased to see improved loss experience within global automotive, as well as solid contributions from our card benefits business in connected living. Looking at capital, our holding company liquidity position remained solid at over $500 million at quarter end. Our cash generation allowed us to return over $100 million of cash to our shareholders, including $62 million of share repurchases. Through May 2nd, we've repurchased an additional $25 million of shares. As we look ahead to the remainder of 2025, we continue to expect our buybacks will remain more balanced throughout the year due to the ability of our businesses to generate significant cash flow. Our ultimate level of repurchases will depend on M&A opportunities and other market conditions. Turning to our segment results, let's begin with Global Lifestyle. First quarter adjusted EBITDA was down 5% compared to last year and included a $6 million impact from unfavorable foreign exchange. As a reminder, first quarter of 2024 included a $7 million one-time client contract benefit that was previously disclosed. Excluding this benefit, Global Lifestyle's underlying adjusted EBITDA was up modestly on a constant currency basis. In Connected Living, earnings declined 6%. Excluding the one-time benefit from the prior year, Connected Living EBITDA also increased modestly on a constant currency basis. Results benefited from a newly launched card benefits program within the financial services business where we continue to be encouraged by the growth of a new client. The increase was partially offset by lower results in domestic mobile from device protection and trade in programs. First quarter results also included approximately $3 million of incremental investments related to new capabilities and client partnerships, including Verizon's Total Wireless prepaid protection program. Turning to Global Auto, adjusted EBITDA was stable as lower investment income mainly from lower real estate joint venture income and unfavorable foreign exchange was offset by improved loss experience. We were pleased to see improved loss experience both year-over-year and sequentially as program changes and rate increases continue to earn through our book. In terms of revenue, our net earned premiums, fees and other income for Global Lifestyle grew 5% or 7% on a constant currency basis led by Connected Living. Moving to Global Housing, first quarter adjusted EBITDA was $112 million which included $157 million of cat losses. Impacts from the California wildfires were $125 million which includes estimated recoveries from subrogation. We saw another quarter of strong double-digit growth as adjusted EBITDA increased 31% to $269 million excluding cats. Our homeowners business continued to benefit from significant policy growth from higher placement rates, including impacts from voluntary insurance market pressure. Non-catastrophe loss experience was also favorable year over year due to lower claims frequency. Looking at housing reserves, in the first quarter, favorable prior year reserve development was $26 million which is modestly higher than the $22 million in the first quarter of 2024. Within our renters business, we continue to benefit from results in our PMC channel, which achieved its 11th consecutive quarter of double digit written premium growth. Moving to catastrophe reinsurance, we are very pleased with the outcome of our 2025 program placement, which was finalized on April 1. We increased coverage at more attractive terms while maintaining a one in five-year probable maximum loss or PML for our per event retention level, which is now $160 million. This is slightly above the $150 million program retention in 2024 due to growth in the business, but maintains the same PML. Our main U.S. program provides nearly $1.8 billion in loss coverage in excess of our retention, protecting Assurant and its policyholders against severe events for up to a 1-265-year PML. We continue to partner with a diversified group of over 40 highly rated reinsurers. In terms of cost, our 2025 catastrophe reinsurance premiums are estimated to be approximately $225 million compared to a normalized view of $203 million in 2024, which adjusts for the timing impact of our program placement change in the first quarter of last year. The increase in costs reflects the growth of the business, partially offset by lower rates where we believe we priced on the lower end compared to the broader market. With the placement of our 2025 program, our expected annual catastrophe load is now $175 million excluding the California wildfires. Including the wildfire impacts in the first quarter, our expected full year 2025 catastrophe load is $300 million. Moving to our outlook for 2025, I want to reinforce that we continue to operate from a position of strength across the company. As we've demonstrated in previous macro cycles, strong cash flow is one of the hallmarks of our company. The ongoing cash generation from our businesses is supported by our large base of customers across our diverse lifestyle and housing segments. Our balance sheet is in a strong position. Our over $10 billion investment portfolio is well diversified across industries and 93% of our fixed income assets are investment grade. And from a growth perspective, despite macro uncertainty, we continue to prioritize targeted investing across our businesses as we look to scale and win across the globe. Turning to our enterprise outlook, we remain on track to deliver on the objectives we outlined at the start of the year to grow adjusted EBITDA and adjusted EPS modestly in 2025, both excluding cats. Keep in mind that the outlook includes growing off of a very strong 2024, including favorable prior year reserve development of $107 million last year. Given our first quarter results and the resiliency of our business model over the long term, we are well positioned to navigate the dynamic environment. We have considered the impacts of tariffs within our outlook and continue to monitor macroeconomic conditions, including inflation, foreign exchange and interest rate levels, which may impact the pace and timing of growth. In Lifestyle, growth in connected living and global automotive is expected to be partially offset by unfavorable foreign exchange as well as investments in new partnerships and programs in 2025. Combined, we continue to expect foreign exchange and incremental investments to mute Lifestyle growth by a few percentage points. Turning to Housing, we are increasing our outlook and now expect growth, reflecting our first quarter results as well as the expected continuation of lender placed policy growth in our homeowners business. Our capital objectives for 2025 remain consistent as we focus on maintaining balance and flexibility to support new business growth while returning excess capital to shareholders. From a share repurchase perspective, our expected range for 2025 continues to be between $200 million to $300 million subject to M&A as well as market and other conditions. Overall, we are off to a great start in 2025 as we continue to drive long term shareholder value. And with that, operator, please open the call for questions.
Operator: Thank you. [Operator Instructions] Our first question is coming from Jeff Schmitt with William Blair & Company.
Keith Demmings: Morning, Jeff. Are you there?
Operator: Please press *6 on your handset to unmute your line.
Jeff Schmitt: Hi. Sorry about that. Can you hear me?
Keith Demmings: Yeah. Yeah. We got you, Jeff. Good morning.
Jeff Schmitt: Alright. Good. So in Global Lifestyle, the loss ratio is still kind of relatively high versus historical levels. I know you've taken a lot of actions there, in Global Auto just in terms of rate increases, process changes, things like that. But could you maybe give us an update on when you expect to see improvement there?
Keith Demmings: Yeah. And are you speaking specifically to Auto, or are you talking more broadly to Lifestyle overall?
Jeff Schmitt: Well, yeah, I guess Lifestyle overall, but I guess Global Auto may may drive that down.
Keith Demmings: Yeah. Maybe let me let me provide a few thoughts overall, and then and then Keith can talk a little bit about the progress in Auto. We're obviously pleased with how that business continues to perform. But, when I look at Lifestyle in the quarter, came in very much in line with our expectations overall. If you look at Connected Living, there's a couple of adjustments that I would suggest you make relative to the results. We had, actually grown on a constant currency sort of normalized basis in the quarter. We had a $7 million one-time client adjustment last year in the first quarter, and then we had about $4 million of foreign exchange. So if I look at Connected Living, normalized, we're up about $3 million in the quarter. We actually had some benefit and this will be a question we'll get today at some point. We had about $5 million of EBITDA benefit in the quarter relative to the new programs that we talked about launching last year. So I'd say we're on track with our one-year payback timeline that we expected, a little bit softer results around trade in in the quarter, but nothing unexpected. So, we're generally pleased with the long-term opportunity around Connected Living and certainly we've got a lot of client momentum, which we'll talk about. And then Auto, we've certainly seen continued stability in the performance, and maybe Keith can provide a couple highlights just on lost performance and development relative to those rate increases?
Keith Meier: Yeah. So, Jeff, in terms of Auto, I think we've continued to see the results stabilizing. This is two quarters in a row of increased EBITDA for that business. We've seen our loss experience in the VFC, side of the business improving quarter over quarter. And we've also seen our GAAP experience level off now as well. So I think overall that provides some encouraging trends in terms of how we see the year playing out. And then I think that also is what enables us to reinforce our outlook for growth for our Auto business, as we think about the full year ahead. So, overall, pleased with the progress that's taking place so far.
Jeff Schmitt: Okay. Great. And then in Connected Living, could you give us an update on the size and cadence of higher investments for, I guess, new partnerships, program launches, things like that? And when do you expect that to kind of roll off this year?
Keith Demmings: Yeah. So, we talked about the $25 million that we invested in 2024. And if you'll remember, we said about $15 million was relative to new client launches and then $10 million was related to investments in our device care centers. And that would yield a full one-year payback this year embedded in our results and our outlook. As I think about the 2025 investments, we had about $3 million of incremental invest in the first quarter. And I would say we're still in that zone of a similar amount relative to the client launches. So last year was $15 million. It's probably in that order of magnitude for the full year. We'll see how things progress. And again, very excited about being able to announce what that all relates to as we get further through the year. You saw in our prepared remarks launching a relationship with Total Wireless by Verizon. We're obviously incredibly proud and excited about the opportunity to become a device protection partner with such an important client. And there'll be more things we'll talk about as the year goes on, and I think we're still on track for that type of investment level this year.
Jeff Schmitt: Okay. Great. Thank you.
Keith Demmings: You bet. Thanks, Jeff.
Operator: Our next question is coming from John Barnidge with Piper Sandler.
Keith Demmings: Hey, John. Good morning.
Keith Meier: Good morning, John.
John Barnidge: Good morning. Thanks for the opportunity. Hope you're both well. My first question is about tariffs. I believe '25 guidance now assumes impact from tariffs. What range of impacts are you assuming? And how do you view the new versus used car dynamic playing out within that?
Keith Demmings: Yes. So maybe I'll provide a few high-level thoughts around context. Keith can talk about where we see -- we mentioned we'll see some impact certainly in Auto and Housing around parts and material. He can walk through our thoughts on how to think about the impact. We're not going to size a specific dollar amount, but we will give you a sense of how we think about it. The first thing I would just say is, obviously, there's still a lot of uncertainty when it comes to the scope and the timing of tariffs and it will no doubt evolve and change over time throughout the year. We try to take a really pragmatic approach and worked with really the most current information we had available. We went ahead and assumed tariffs would remain in place throughout the entirety of 2025. And at the end of the day, when we looked at the underlying performance in the business, a really, really strong first quarter, we believe tariffs will be manageable this year and will deliver the original guidance that we had laid out. But maybe Keith, just a little bit of color, we talked about Auto and Housing having greater impact. How do we think about that flowing through the claims cost?
Keith Meier: Yes. And I think as we think about any potential impact, I think it probably is more in line with higher claims cost potentially in our Auto and in our Housing business. And the way we have approached that is in our Housing business, we have a history of navigating potential inflationary aspects. And I think one of the key drivers of our the rigor that we've developed through that process is having our ability to utilize our inflation guard features. And so I think us being able to now adjust our rates based on inflation every quarter and by state, whereas a couple years ago, it used to be, once a year across the board. So overall, I think we're in a good position to navigate those types of impacts in Housing. And then when it comes to Auto, I think you have to kind of frame it up in terms of the actual impact to our claims. So, probably about 2/3rd of our business is more risk shared with our clients and reinsurance arrangements and so forth. So you're already at a 1/3rd of our business at that point. And then of that 1/3rd, basically, you could think about claims as being half parts and half labor. So now you're down into the mid to high teens percentage of our business that could be affected. And then even of those parts, probably half or so is imported. And so now you're talking single digit kind of impacts on our claims. And so with all the work we're doing with our clients on an ongoing basis just because of the inflationary aspects of the business from the last few years and we've been putting in 18 rate increases and also working on program designs, I think we're in a good position to navigate impacts in Auto as well. So, overall, I think we're in a good position to manage through that, and I think that's what also gave us confidence to reinforce our guidance for growth across all of our businesses.
Keith Demmings: Yeah. And maybe just to pick up the question on new and used, I think, as we've talked about before, we're pretty well positioned across our Auto business. We've got very much balanced between new and used. It's in the range of 50-50. So should we see dynamic shift there where there maybe there's more used sales, less new sales, I think we're well positioned overall from that perspective. We'll obviously monitor that closely. We're working with our partners, but we do feel like we've got muscles built the last couple of years with clients to make the right adjustments, whether it's rate, product design, claims management. That will continue as we go forward and we're going to continue to focus on growth and executing and delivering financial results.
John Barnidge: Thank you for that. My follow-up question, is on Global Housing. It's about the expense ratio in the quarter. Are you able to identify by how much that expense ratio was impacted by dealing with the catastrophe loss events that occurred in the quarter related to the wildfires that brought it to 39.1% versus 37.9% a year ago? Thank you.
Keith Demmings: Yes, it's a great question. I would say that if we sort of made adjustments to normalize, we'd be relatively flat year-over-year. If you look at the first quarter '25 we had reinsurance costs up $11 million over last year. That's 110 basis points. The balance of the difference is related to the higher, expenses related to managing through the claim -- the claims cost from the cat. So broadly speaking, I would say underlying expenses, as a ratio are flat year-over-year.
Keith Meier: I think you can think about our expense ratio as being that high 30s kind of percentage. And so, I think in general, we're on track with that. And like Keith said, I think you should expect it to be a similar kind of normalized rate year-over-year.
John Barnidge: Thanks for the answers.
Keith Demmings: You got it? Have a good day. Thank you.
Operator: Our next question is coming from Mark Hughes with Truist.
Keith Demmings: Morning, Mark.
Operator: Please press *6.
Mark Hughes: I should be here now. Yeah. Good morning. The Total Wireless by Verizon seems pretty interesting. How many subscribers under that program? I think it the fact that you're extending your relationship or deepening your relationship with Verizon is great. How much financial impact from that program would you anticipate?
Keith Demmings: Yeah. I think the first thing I would say is it's starting it's not an existing base of business that's porting across to us. So this is a brand-new launch. So we're starting from customer one as we build that book. So it will naturally ramp, you know, probably three or four years to get to its full run rate potential depending on consumer behavior, etc. So I think that's the first thing to recognize. The second thing, yeah, we're really excited. I mean, we're deepening relationships with clients. We've done an amazing job in the mobile business, and I think we continue to demonstrate that we can add value to major partners. And this is just another example of that. And obviously, they're a massive potential client for other things, and we'll look to continue to execute and deliver and prove our value to them so we earn the right to do more over time. But it's a big opportunity for us, and we're very, very happy with it.
Mark Hughes: Yeah. You'd mentioned on the homeowners that the shifts in voluntary were increasing demand. How is that trending now? Is there still as much pressure on homeowners that's benefiting you or is that starting to taper a little bit?
Keith Meier: Yes, I think we're still seeing and expecting growth in our policies for our lender placed business. I think in California we're still seeing a little bit of growth. And also in the Midwest and some of the in-land Northeast as well. So, overall, I think the business is continuing to see that type of progress and progressive growth. So, I think our product is only becoming more and more valuable over time.
Keith Demmings: Yeah. And I think to your point, the year-over-year placement rate improved pretty significantly. It's definitely slowed down as we look at the sequential view. But to Keith's point, we expect to see kind of modest growth over the balance of year and I think we're really well positioned with how that business is performing and how it's performed through various cycles as well.
Mark Hughes: And then on the, trade in, anything structural around trade ins, people keeping their phones longer, anything like that, or was it just timing of customer promotional activity that impacted the quarter? Yeah.
Keith Demmings: I think it's both. Definitely, customers are keeping devices longer, but I think the what stimulates a lot of that demand is the promotional activity, the competitive intensity. Saw a little bit more muted in the first quarter. I don't think it was different than we expected it to be. We'll see how that plays out. It's a pretty competitive environment today. I think our clients are going to be looking to drive growth and that could ultimately stimulate more competition than yet to be seen as we look at Q2 and the rest of the year, but nothing that is unusual in terms of those dynamics.
Mark Hughes: And if I could squeeze in one more on the renters book, you talked about picking up 250,000 policies. You talked about that and then maybe the, underlying growth in, in renters aside from that new customer pickup.
Keith Demmings: Sure. I'll talk about the book, and then Keith can cover sort of the growth and how we think about it across the areas within renters. So, again, we worked with an insurer who was looking to exit the renters business, really more of a book roll. We talk about 250,000 policies, about $50 million of gross written premium annually. This insurance company served a wide range of Affinity clients, so it fits in incredibly well with our Affinity business. It was acquired through reinsurance, we'll convert it to our paper over time. And I would say as we think about the contribution, I don't expect a massive step change in overall financial performance, but it is a very strategic opportunity. It generates a lot of scale and it continues to reinforce our market leadership position and I think we feel good about how we've structured and derisked the deal overall. But Keith, how would you reflect on the growth for the quarter?
Keith Meier: Yes, and I would just say on that book role that we had, I think that really just speaks to our executing on our strategy to really scale our technology enabled services that we've been developing over time. And we've talked about our Cover360 product where we track renters policies for the landlords. And so I think those are the types of things where we're able to invest in this business, and I think that's enabling us to be able to leverage those capabilities to drive scale where others may not see the benefit of investing the way that we have. So, these are great opportunities for us to grow. I think you'll see contributions from the acquisition as well as through our property management channel, which again has grown for the 11th consecutive quarter at double digit. So, we'll see contribution there. And we also see, as Keith said, this helps our affinity business as well. So overall, I think we've got some nice balanced growth as we look ahead for renters.
Mark Hughes: Thank you very much.
Keith Demmings: Thank you.
Operator: Our next question is coming from Tommy McJoynt with KBW.
Keith Demmings: Morning, Tommy.
Tommy McJoynt: Hey. Good morning. A question about the mobile side and the potential impact of tariffs. It doesn't sound like you guys are expecting a significant impact there. Can you talk about why maybe the potential importing of parts or and cell phones might not be impacted? And I think a lot of it has to do with your role as more of a program administrator than being on risk. Perhaps you can lay out the details on that.
Keith Meier: Yeah. I think you actually hit on it, Tommy. I think it's the way that we work with our clients and these are large players with, highly developed supply chains, and we complement their supply chains as well. So we work very closely with them. Obviously, a lot of the programs are, reinsured or risk shared like you just spoke about. So I think that's what mitigates a lot of that impact. And then, obviously, we work very closely with them to optimize the programs for the consumer as well as for our clients. So, overall, I think those are the things that do put us in a good position overall on the mobile side.
Keith Demmings: Yeah. And I think the other thing I would add, Tommy, is think about the mobile business, particularly around device protection. We've got 64 million or so monthly subscribers, but it's monthly pay, monthly earn. So the profile of that business is different than selling a single premium contract that earns out over time. So that also helps us be a little bit more nimble with the changes we can make, whether it's product or pricing. It can have an impact more quickly than in other lines of business.
Tommy McJoynt: Okay. Got it. And then looking at the full year guidance, when I unpack the various subcomponents there, so it doesn't sound like the enterprise-wide guidance has changed, but Housing segment got a little bit better. Does that imply that that mar that on the margin, the Lifestyle segment came in a little bit worse than we were expecting a few months ago. And just want to make sure if that's the case, what is the driver of that?
Keith Demmings: Yeah. I'd say I guess a fair way to interpret it. Overall, feel really good about the full year guide. We obviously increased housing from modest decline to generating growth, so we feel really good about that adjustment. And then to your point, lifestyle, I would say we're certainly factoring in the impact of the macro environment in tariffs as we think about the year that wouldn't have been true in the same way a few months ago. So I'd say that's the only difference. But if I think about the underlying financial performance of the Lifestyle business, we feel really good where we came out in Q1, setting aside the dynamic world we're living in, we feel really good about the year in front of us. And even considering those factors, we're still planning to grow connected living, we're planning to grow Auto, and we're going to grow Housing.
Tommy McJoynt: Great. Thanks, Keith.
Keith Demmings: You bet.
Operator: Our next question is coming from Bob Huang with Morgan Stanley.
Keith Demmings: Morning, Bob.
Bob Huang: Hi. Can you guys hear me now?
Keith Demmings: Yeah. We can.
Bob Huang: Okay. Perfect. Yeah. So, maybe another follow-up on tariffs. I know we talked about this quite a bit. Just can you maybe help us think about, if there are any particular components within the tariff that is more sensitive. For example, are there like, within Housing, is there more aluminum, steel, lumber, or within the Auto? Like, is there particular parts? Just trying to see if there's anything that we should monitor from, like, a commodity futures perspective.
Keith Meier: Yeah. So, Bob, I think when we do our scenario planning, we take into account the various, tariffs that have been talked about in the marketplace. And so then we apply them into scenarios for each of those businesses. So, I kind of went through that earlier in terms of the way we think about Housing. It could impact a little bit in some building costs, but we think we're well positioned to navigate potential inflationary aspects from whether it's lumber, steel, those types of things. And then on Auto, we're consistently monitoring parts and Auto related tariff discussions. And so, I think also there by working with our clients and the way, our business is structured, we feel very good about being able to manage through the different scenarios that are being discussed today.
Keith Demmings: Did we lose Bob? Maybe.
Bob Huang: Sorry. Can you hear me now?
Keith Meier: Yeah.
Bob Huang: Perfect. Yes. So my second question is regarding, used car versus new car sales. Right? Like, if you think about, just the recent, auto sales and things of that nature, obviously, something that we've been talking you guys have mentioned. Is there a way to think about, whether or not, like, there was a new car sales pulled forward due to tariffs? Would that have any significant impact on, how we should think about the business going forward?
Keith Demmings: Yeah. I don't think it has a significant impact on how we think about business going forward. I definitely think there was a pull forward, both for new and for used. If I even look at the car sales in the month of March, they were higher than sort of the average for the quarter. So that suggests that there is a pull forward. I would expect that to probably be true in April as well. I don't think it has a significant effect on how we think about the business or the year. I suspect it's just a timing point where there'll be a little bit of additional sales front loaded and then maybe a little bit of softer sales following. We'll sort of see how the environment evolves. But obviously, it's always good to get a little more business in the door earlier in the year, but because of the nature of this business, we're earning off of a $11 billion UPR that's in force. It doesn't have a huge effect on how we think about the short-term picture for auto.
Keith Meier: I would just add there, Bob, that we look at the macroeconomic environment in terms of there could be inflation aspects and consumer impact. And so, on the consumer impact, we don't see that as really affecting Assurant as much, in 2025, because of the existing business and it takes time to earn through and so forth. So I think that part doesn't have as much. And then we talked a lot about the flip side, which is the inflationary aspects, which can, you know, happen earlier. And that's the part that we talked a lot about, and we feel well positioned on that on that side of it.
Bob Huang: Okay. Thank you. I really appreciate it.
Keith Demmings: I think that was the last question. So I will go ahead and say thanks everybody for joining us today, and we'll look forward to the next update in August. Appreciate the time. Thanks so much. Thank you.
Operator: [Operator Closing Remarks] | [
{
"speaker": "Operator",
"text": "Welcome to Assurant’s First Quarter 2025 Conference Call and Webcast. At this time all participants have been placed in a listen-only mode and the floor will be opened for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may now begin."
},
{
"speaker": "Sean Moshier",
"text": "Thank you, operator, and good morning, everyone. We look forward to discussing our first quarter results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the first quarter 2025. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in the earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"text": "Thanks, Sean, and good morning, everyone. I'm pleased to share that 2025 is off to a strong start. For the first quarter, we continue to demonstrate momentum, delivering 14% growth in adjusted EBITDA and 16% growth in adjusted earnings per share, both excluding reportable catastrophes. This quarter's performance highlights the position of strength from which we continue to operate and is supported by our diversified global operating model where we have market leading businesses across global housing and global lifestyle that are underpinned by our robust capital position. We have a proven track record of delivering through various economic cycles over the long term and we remain well positioned to achieve our 9th consecutive year of earnings growth. Our differentiated business-to-business to consumer distribution strategy in attractive markets is reinforced by our world class workforce that enables us to win, build and scale transparent partnerships with many of the world's leading brands. And our ability to deliver exceptional customer experiences through customized data driven solutions and comprehensive wraparound services reinforces the strength of Assurant's long-term fundamentals. Last quarter, we outlined our 2025 priorities and I'm incredibly proud of our team's progress to date. We're executing, optimizing and scaling significant partnerships across lifestyle and housing through the foundational investments we made in new programs and clients in 2024. We've continued to make high value incremental investments to support new program launches in our pipeline and accelerate emerging growth opportunities. And we remain focused on achieving our 2025 outlook by driving operational excellence and financial performance. Next, I want to share a few segment highlights that support our attractive position. Starting with Global Lifestyle, we're laser focused on achieving our growth objectives across Connected Living and Global Automotive. In Connected Living, we continuously enhance the customer and client experience by investing in innovative products and services while providing differentiated value to our clients with integrity and transparency. This has allowed us to build relationships with every major U.S. mobile operator along with many global leaders in the telecom industry. As mobile and cable operators continue to innovate and compete in the wireless space, Assurant's strengthened partnerships, enhance our market position and support long term growth. Our approach continues to generate momentum and through key investments in leading edge technology including automation, robotics and AI at our device care centers, we anticipate meaningful opportunities to offer additional value-added services to our key mobile clients in the near future. During the first quarter, we continue to build on our track record of deepening relationships with key clients, reinforcing our position as a preferred partner. Recently, we partnered with Verizon to launch a new mobile device protection plan from Total Wireless, Verizon's fast growing no contract wireless provider. The program Total Wireless Protect will allow new and existing customers affordable replacement and repair against accidents and mechanical breakdowns, supported by our more than 900 Assurant authorized repair centers nationwide. This provides an opportunity to continue building deeper relationships with another U.S. mobile carrier. In Global Automotive, earnings remain stable, supported by a year-over-year improvement in loss experience. Our leadership team is quickly making progress to enable further success, including a unified consistent branding approach in our go-to-market strategy, allowing us to better leverage our scale as a market leader. This has contributed to new wins within our U.S. and international distribution channels with runway to gain additional share with large national dealers. And we're launching several new products within Global Auto this year. We recently launched Assurant Vehicle Care Technology Plus, which provides coverage for high-tech vehicle components, wear and tear items and smartphone repairs. Moving to housing, shifts in the voluntary insurance market throughout the U.S. have increased demand for lender placed insurance products within homeowners. Our product helps lenders, investors, and homeowners remove the risk of uninsured loss. Through the exceptional efforts of our claims team, we remain committed to supporting our policyholders when they need us most. We're proud to be honored by the American Red Cross as a 2025 disaster relief hero, recognizing our support for those impacted by 2024 storms including hurricanes Helene and Milton and the wildfires in California. As we look at results, our strong performance continued in the first quarter, driven by 17% top-line growth within homeowners, primarily due to the addition of 70,000 lender placed policies. We've achieved significant expense leverage resulting in a compelling combined ratio. Even with elevated cats in the first quarter, we delivered a combined ratio of 90%. For 2025, we're on track to deliver a combined ratio around the mid-80s including our full year cat assumption of $300 million. We continue to extend the tenure of our client base, renewing two lender placed clients in the first quarter and we see meaningful opportunity to expand with new clients by leveraging our existing infrastructure. In renters, we're executing our strategy to scale our technology enabled services and recently added a new renters book with over 250,000 policies. Our Cover360 platform continues to support double-digit written premium growth in our Property Management Company or PMC channel, demonstrating our competitive edge in a distribution channel with further growth potential. The strength of our combined lifestyle and housing businesses has enabled us to grow significantly. Over the last five years, we've delivered a compound annual adjusted EPS growth rate of 18% and a 12% adjusted EBITDA growth rate, both excluding cats. Since we successfully placed our 2025 cat reinsurance program in April, which Keith Meier will cover, I want to take a moment to highlight how Assurant compares to certain large cat exposed P&C peers. When we look over the past six years, Assurant ranks among the lowest in terms of cat exposure as a percentage of net earned premiums and as a percentage of shareholders' equity. Since 2019, we had the lowest average cat losses as a percentage of net earned premiums as well as the third lowest as a percentage of shareholders' equity. Equally compelling, our volatility across both metrics is among the lowest in the group. Over the last 10 years, our increased scale and efficiency within housing has driven a 10-year average combined ratio of 89% compared to the broader P&C market of 95%. This data illustrates the power of Assurant's unique and advantaged business portfolio as global lifestyle and global housing have delivered strong growth and returns with lower volatility. Given our demonstrated resilience over time through various economic environments, balanced risk management, and compelling growth path ahead, it's our belief that we should be valued at a premium to the S&P composite 1,500 P&C index median. Our strategy is centered around our powerful B2B2C distribution model across lifestyle and housing, which bolsters our competitive advantage and financial performance. In the attractive markets where we operate, we see expanding opportunities to continue profitable growth through the scale and efficiency of our service delivery networks. We expect to continue extending our track record of winning new clients and solidifying relationships across the enterprise. Our business model has created diversified sources of earnings and capital while generating strong returns, cash flow and growth. Looking toward the future, we believe there are expanding growth opportunities including increasing investments in our core markets, continue to expand offerings with existing clients and winning new global partnerships, and entering attractive adjacent sectors through new product launches. Before handing it over to Keith, I want to spend a moment on the evolving economic landscape and Assurant's position. 2024 marked an exceptional year of outperformance representing our 8th consecutive year of earnings growth. Given the strong start to the year and the strength of our businesses, we remain on track to deliver our 9th consecutive year of profitable growth in 2025, reaffirming our enterprise outlook. We are closely monitoring the impact of macroeconomic conditions and tariff policies on our claims cost and consumer demand. We are also taking action to remain well positioned and stay ahead of future developments. While there remains significant uncertainty, our outlook considers the impact of tariffs. The differentiated features of our business model positions’ us to navigate the dynamic macroeconomic environment. In lifestyle, our alignment of financial interests with our partners enables us to work side by side to help mitigate risk. This includes client risk sharing contracts that allow us to manage financial exposure through Connected Living and Global Auto. Our partnerships with leading brands provides us access to diverse supply chains across the world as our clients partner with us to optimize claims costs. Within housing, our inflation guard product feature includes quarterly state-by-state rate adjustments and will allow us to react quickly to higher materials cost in our lender place business. In addition, lender place may also serve as a countercyclical hedge in the event of a broader market downturn, differentiating us from other P&C companies. Overall, the attributes that unify our Lifestyle and Housing segments also position Assurant to deliver shareholder value over time through growth and disciplined capital management. I'll now turn it over to Keith Meyer."
},
{
"speaker": "Keith Meier",
"text": "Thanks, Keith, and good morning, everyone. Let me begin by sharing some key highlights we saw in the first quarter. 2025 is off to a strong start with double-digit growth across our primary performance metrics, achieving mid-teens growth for adjusted EBITDA and adjusted earnings per share, both excluding catastrophes. Our first quarter performance was driven by double-digit earnings growth in Global Housing led by our lender placed business. Within Global Lifestyle, we were pleased to see improved loss experience within global automotive, as well as solid contributions from our card benefits business in connected living. Looking at capital, our holding company liquidity position remained solid at over $500 million at quarter end. Our cash generation allowed us to return over $100 million of cash to our shareholders, including $62 million of share repurchases. Through May 2nd, we've repurchased an additional $25 million of shares. As we look ahead to the remainder of 2025, we continue to expect our buybacks will remain more balanced throughout the year due to the ability of our businesses to generate significant cash flow. Our ultimate level of repurchases will depend on M&A opportunities and other market conditions. Turning to our segment results, let's begin with Global Lifestyle. First quarter adjusted EBITDA was down 5% compared to last year and included a $6 million impact from unfavorable foreign exchange. As a reminder, first quarter of 2024 included a $7 million one-time client contract benefit that was previously disclosed. Excluding this benefit, Global Lifestyle's underlying adjusted EBITDA was up modestly on a constant currency basis. In Connected Living, earnings declined 6%. Excluding the one-time benefit from the prior year, Connected Living EBITDA also increased modestly on a constant currency basis. Results benefited from a newly launched card benefits program within the financial services business where we continue to be encouraged by the growth of a new client. The increase was partially offset by lower results in domestic mobile from device protection and trade in programs. First quarter results also included approximately $3 million of incremental investments related to new capabilities and client partnerships, including Verizon's Total Wireless prepaid protection program. Turning to Global Auto, adjusted EBITDA was stable as lower investment income mainly from lower real estate joint venture income and unfavorable foreign exchange was offset by improved loss experience. We were pleased to see improved loss experience both year-over-year and sequentially as program changes and rate increases continue to earn through our book. In terms of revenue, our net earned premiums, fees and other income for Global Lifestyle grew 5% or 7% on a constant currency basis led by Connected Living. Moving to Global Housing, first quarter adjusted EBITDA was $112 million which included $157 million of cat losses. Impacts from the California wildfires were $125 million which includes estimated recoveries from subrogation. We saw another quarter of strong double-digit growth as adjusted EBITDA increased 31% to $269 million excluding cats. Our homeowners business continued to benefit from significant policy growth from higher placement rates, including impacts from voluntary insurance market pressure. Non-catastrophe loss experience was also favorable year over year due to lower claims frequency. Looking at housing reserves, in the first quarter, favorable prior year reserve development was $26 million which is modestly higher than the $22 million in the first quarter of 2024. Within our renters business, we continue to benefit from results in our PMC channel, which achieved its 11th consecutive quarter of double digit written premium growth. Moving to catastrophe reinsurance, we are very pleased with the outcome of our 2025 program placement, which was finalized on April 1. We increased coverage at more attractive terms while maintaining a one in five-year probable maximum loss or PML for our per event retention level, which is now $160 million. This is slightly above the $150 million program retention in 2024 due to growth in the business, but maintains the same PML. Our main U.S. program provides nearly $1.8 billion in loss coverage in excess of our retention, protecting Assurant and its policyholders against severe events for up to a 1-265-year PML. We continue to partner with a diversified group of over 40 highly rated reinsurers. In terms of cost, our 2025 catastrophe reinsurance premiums are estimated to be approximately $225 million compared to a normalized view of $203 million in 2024, which adjusts for the timing impact of our program placement change in the first quarter of last year. The increase in costs reflects the growth of the business, partially offset by lower rates where we believe we priced on the lower end compared to the broader market. With the placement of our 2025 program, our expected annual catastrophe load is now $175 million excluding the California wildfires. Including the wildfire impacts in the first quarter, our expected full year 2025 catastrophe load is $300 million. Moving to our outlook for 2025, I want to reinforce that we continue to operate from a position of strength across the company. As we've demonstrated in previous macro cycles, strong cash flow is one of the hallmarks of our company. The ongoing cash generation from our businesses is supported by our large base of customers across our diverse lifestyle and housing segments. Our balance sheet is in a strong position. Our over $10 billion investment portfolio is well diversified across industries and 93% of our fixed income assets are investment grade. And from a growth perspective, despite macro uncertainty, we continue to prioritize targeted investing across our businesses as we look to scale and win across the globe. Turning to our enterprise outlook, we remain on track to deliver on the objectives we outlined at the start of the year to grow adjusted EBITDA and adjusted EPS modestly in 2025, both excluding cats. Keep in mind that the outlook includes growing off of a very strong 2024, including favorable prior year reserve development of $107 million last year. Given our first quarter results and the resiliency of our business model over the long term, we are well positioned to navigate the dynamic environment. We have considered the impacts of tariffs within our outlook and continue to monitor macroeconomic conditions, including inflation, foreign exchange and interest rate levels, which may impact the pace and timing of growth. In Lifestyle, growth in connected living and global automotive is expected to be partially offset by unfavorable foreign exchange as well as investments in new partnerships and programs in 2025. Combined, we continue to expect foreign exchange and incremental investments to mute Lifestyle growth by a few percentage points. Turning to Housing, we are increasing our outlook and now expect growth, reflecting our first quarter results as well as the expected continuation of lender placed policy growth in our homeowners business. Our capital objectives for 2025 remain consistent as we focus on maintaining balance and flexibility to support new business growth while returning excess capital to shareholders. From a share repurchase perspective, our expected range for 2025 continues to be between $200 million to $300 million subject to M&A as well as market and other conditions. Overall, we are off to a great start in 2025 as we continue to drive long term shareholder value. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question is coming from Jeff Schmitt with William Blair & Company."
},
{
"speaker": "Keith Demmings",
"text": "Morning, Jeff. Are you there?"
},
{
"speaker": "Operator",
"text": "Please press *6 on your handset to unmute your line."
},
{
"speaker": "Jeff Schmitt",
"text": "Hi. Sorry about that. Can you hear me?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. Yeah. We got you, Jeff. Good morning."
},
{
"speaker": "Jeff Schmitt",
"text": "Alright. Good. So in Global Lifestyle, the loss ratio is still kind of relatively high versus historical levels. I know you've taken a lot of actions there, in Global Auto just in terms of rate increases, process changes, things like that. But could you maybe give us an update on when you expect to see improvement there?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. And are you speaking specifically to Auto, or are you talking more broadly to Lifestyle overall?"
},
{
"speaker": "Jeff Schmitt",
"text": "Well, yeah, I guess Lifestyle overall, but I guess Global Auto may may drive that down."
},
{
"speaker": "Keith Demmings",
"text": "Yeah. Maybe let me let me provide a few thoughts overall, and then and then Keith can talk a little bit about the progress in Auto. We're obviously pleased with how that business continues to perform. But, when I look at Lifestyle in the quarter, came in very much in line with our expectations overall. If you look at Connected Living, there's a couple of adjustments that I would suggest you make relative to the results. We had, actually grown on a constant currency sort of normalized basis in the quarter. We had a $7 million one-time client adjustment last year in the first quarter, and then we had about $4 million of foreign exchange. So if I look at Connected Living, normalized, we're up about $3 million in the quarter. We actually had some benefit and this will be a question we'll get today at some point. We had about $5 million of EBITDA benefit in the quarter relative to the new programs that we talked about launching last year. So I'd say we're on track with our one-year payback timeline that we expected, a little bit softer results around trade in in the quarter, but nothing unexpected. So, we're generally pleased with the long-term opportunity around Connected Living and certainly we've got a lot of client momentum, which we'll talk about. And then Auto, we've certainly seen continued stability in the performance, and maybe Keith can provide a couple highlights just on lost performance and development relative to those rate increases?"
},
{
"speaker": "Keith Meier",
"text": "Yeah. So, Jeff, in terms of Auto, I think we've continued to see the results stabilizing. This is two quarters in a row of increased EBITDA for that business. We've seen our loss experience in the VFC, side of the business improving quarter over quarter. And we've also seen our GAAP experience level off now as well. So I think overall that provides some encouraging trends in terms of how we see the year playing out. And then I think that also is what enables us to reinforce our outlook for growth for our Auto business, as we think about the full year ahead. So, overall, pleased with the progress that's taking place so far."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. Great. And then in Connected Living, could you give us an update on the size and cadence of higher investments for, I guess, new partnerships, program launches, things like that? And when do you expect that to kind of roll off this year?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. So, we talked about the $25 million that we invested in 2024. And if you'll remember, we said about $15 million was relative to new client launches and then $10 million was related to investments in our device care centers. And that would yield a full one-year payback this year embedded in our results and our outlook. As I think about the 2025 investments, we had about $3 million of incremental invest in the first quarter. And I would say we're still in that zone of a similar amount relative to the client launches. So last year was $15 million. It's probably in that order of magnitude for the full year. We'll see how things progress. And again, very excited about being able to announce what that all relates to as we get further through the year. You saw in our prepared remarks launching a relationship with Total Wireless by Verizon. We're obviously incredibly proud and excited about the opportunity to become a device protection partner with such an important client. And there'll be more things we'll talk about as the year goes on, and I think we're still on track for that type of investment level this year."
},
{
"speaker": "Jeff Schmitt",
"text": "Okay. Great. Thank you."
},
{
"speaker": "Keith Demmings",
"text": "You bet. Thanks, Jeff."
},
{
"speaker": "Operator",
"text": "Our next question is coming from John Barnidge with Piper Sandler."
},
{
"speaker": "Keith Demmings",
"text": "Hey, John. Good morning."
},
{
"speaker": "Keith Meier",
"text": "Good morning, John."
},
{
"speaker": "John Barnidge",
"text": "Good morning. Thanks for the opportunity. Hope you're both well. My first question is about tariffs. I believe '25 guidance now assumes impact from tariffs. What range of impacts are you assuming? And how do you view the new versus used car dynamic playing out within that?"
},
{
"speaker": "Keith Demmings",
"text": "Yes. So maybe I'll provide a few high-level thoughts around context. Keith can talk about where we see -- we mentioned we'll see some impact certainly in Auto and Housing around parts and material. He can walk through our thoughts on how to think about the impact. We're not going to size a specific dollar amount, but we will give you a sense of how we think about it. The first thing I would just say is, obviously, there's still a lot of uncertainty when it comes to the scope and the timing of tariffs and it will no doubt evolve and change over time throughout the year. We try to take a really pragmatic approach and worked with really the most current information we had available. We went ahead and assumed tariffs would remain in place throughout the entirety of 2025. And at the end of the day, when we looked at the underlying performance in the business, a really, really strong first quarter, we believe tariffs will be manageable this year and will deliver the original guidance that we had laid out. But maybe Keith, just a little bit of color, we talked about Auto and Housing having greater impact. How do we think about that flowing through the claims cost?"
},
{
"speaker": "Keith Meier",
"text": "Yes. And I think as we think about any potential impact, I think it probably is more in line with higher claims cost potentially in our Auto and in our Housing business. And the way we have approached that is in our Housing business, we have a history of navigating potential inflationary aspects. And I think one of the key drivers of our the rigor that we've developed through that process is having our ability to utilize our inflation guard features. And so I think us being able to now adjust our rates based on inflation every quarter and by state, whereas a couple years ago, it used to be, once a year across the board. So overall, I think we're in a good position to navigate those types of impacts in Housing. And then when it comes to Auto, I think you have to kind of frame it up in terms of the actual impact to our claims. So, probably about 2/3rd of our business is more risk shared with our clients and reinsurance arrangements and so forth. So you're already at a 1/3rd of our business at that point. And then of that 1/3rd, basically, you could think about claims as being half parts and half labor. So now you're down into the mid to high teens percentage of our business that could be affected. And then even of those parts, probably half or so is imported. And so now you're talking single digit kind of impacts on our claims. And so with all the work we're doing with our clients on an ongoing basis just because of the inflationary aspects of the business from the last few years and we've been putting in 18 rate increases and also working on program designs, I think we're in a good position to navigate impacts in Auto as well. So, overall, I think we're in a good position to manage through that, and I think that's what also gave us confidence to reinforce our guidance for growth across all of our businesses."
},
{
"speaker": "Keith Demmings",
"text": "Yeah. And maybe just to pick up the question on new and used, I think, as we've talked about before, we're pretty well positioned across our Auto business. We've got very much balanced between new and used. It's in the range of 50-50. So should we see dynamic shift there where there maybe there's more used sales, less new sales, I think we're well positioned overall from that perspective. We'll obviously monitor that closely. We're working with our partners, but we do feel like we've got muscles built the last couple of years with clients to make the right adjustments, whether it's rate, product design, claims management. That will continue as we go forward and we're going to continue to focus on growth and executing and delivering financial results."
},
{
"speaker": "John Barnidge",
"text": "Thank you for that. My follow-up question, is on Global Housing. It's about the expense ratio in the quarter. Are you able to identify by how much that expense ratio was impacted by dealing with the catastrophe loss events that occurred in the quarter related to the wildfires that brought it to 39.1% versus 37.9% a year ago? Thank you."
},
{
"speaker": "Keith Demmings",
"text": "Yes, it's a great question. I would say that if we sort of made adjustments to normalize, we'd be relatively flat year-over-year. If you look at the first quarter '25 we had reinsurance costs up $11 million over last year. That's 110 basis points. The balance of the difference is related to the higher, expenses related to managing through the claim -- the claims cost from the cat. So broadly speaking, I would say underlying expenses, as a ratio are flat year-over-year."
},
{
"speaker": "Keith Meier",
"text": "I think you can think about our expense ratio as being that high 30s kind of percentage. And so, I think in general, we're on track with that. And like Keith said, I think you should expect it to be a similar kind of normalized rate year-over-year."
},
{
"speaker": "John Barnidge",
"text": "Thanks for the answers."
},
{
"speaker": "Keith Demmings",
"text": "You got it? Have a good day. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Mark Hughes with Truist."
},
{
"speaker": "Keith Demmings",
"text": "Morning, Mark."
},
{
"speaker": "Operator",
"text": "Please press *6."
},
{
"speaker": "Mark Hughes",
"text": "I should be here now. Yeah. Good morning. The Total Wireless by Verizon seems pretty interesting. How many subscribers under that program? I think it the fact that you're extending your relationship or deepening your relationship with Verizon is great. How much financial impact from that program would you anticipate?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. I think the first thing I would say is it's starting it's not an existing base of business that's porting across to us. So this is a brand-new launch. So we're starting from customer one as we build that book. So it will naturally ramp, you know, probably three or four years to get to its full run rate potential depending on consumer behavior, etc. So I think that's the first thing to recognize. The second thing, yeah, we're really excited. I mean, we're deepening relationships with clients. We've done an amazing job in the mobile business, and I think we continue to demonstrate that we can add value to major partners. And this is just another example of that. And obviously, they're a massive potential client for other things, and we'll look to continue to execute and deliver and prove our value to them so we earn the right to do more over time. But it's a big opportunity for us, and we're very, very happy with it."
},
{
"speaker": "Mark Hughes",
"text": "Yeah. You'd mentioned on the homeowners that the shifts in voluntary were increasing demand. How is that trending now? Is there still as much pressure on homeowners that's benefiting you or is that starting to taper a little bit?"
},
{
"speaker": "Keith Meier",
"text": "Yes, I think we're still seeing and expecting growth in our policies for our lender placed business. I think in California we're still seeing a little bit of growth. And also in the Midwest and some of the in-land Northeast as well. So, overall, I think the business is continuing to see that type of progress and progressive growth. So, I think our product is only becoming more and more valuable over time."
},
{
"speaker": "Keith Demmings",
"text": "Yeah. And I think to your point, the year-over-year placement rate improved pretty significantly. It's definitely slowed down as we look at the sequential view. But to Keith's point, we expect to see kind of modest growth over the balance of year and I think we're really well positioned with how that business is performing and how it's performed through various cycles as well."
},
{
"speaker": "Mark Hughes",
"text": "And then on the, trade in, anything structural around trade ins, people keeping their phones longer, anything like that, or was it just timing of customer promotional activity that impacted the quarter? Yeah."
},
{
"speaker": "Keith Demmings",
"text": "I think it's both. Definitely, customers are keeping devices longer, but I think the what stimulates a lot of that demand is the promotional activity, the competitive intensity. Saw a little bit more muted in the first quarter. I don't think it was different than we expected it to be. We'll see how that plays out. It's a pretty competitive environment today. I think our clients are going to be looking to drive growth and that could ultimately stimulate more competition than yet to be seen as we look at Q2 and the rest of the year, but nothing that is unusual in terms of those dynamics."
},
{
"speaker": "Mark Hughes",
"text": "And if I could squeeze in one more on the renters book, you talked about picking up 250,000 policies. You talked about that and then maybe the, underlying growth in, in renters aside from that new customer pickup."
},
{
"speaker": "Keith Demmings",
"text": "Sure. I'll talk about the book, and then Keith can cover sort of the growth and how we think about it across the areas within renters. So, again, we worked with an insurer who was looking to exit the renters business, really more of a book roll. We talk about 250,000 policies, about $50 million of gross written premium annually. This insurance company served a wide range of Affinity clients, so it fits in incredibly well with our Affinity business. It was acquired through reinsurance, we'll convert it to our paper over time. And I would say as we think about the contribution, I don't expect a massive step change in overall financial performance, but it is a very strategic opportunity. It generates a lot of scale and it continues to reinforce our market leadership position and I think we feel good about how we've structured and derisked the deal overall. But Keith, how would you reflect on the growth for the quarter?"
},
{
"speaker": "Keith Meier",
"text": "Yes, and I would just say on that book role that we had, I think that really just speaks to our executing on our strategy to really scale our technology enabled services that we've been developing over time. And we've talked about our Cover360 product where we track renters policies for the landlords. And so I think those are the types of things where we're able to invest in this business, and I think that's enabling us to be able to leverage those capabilities to drive scale where others may not see the benefit of investing the way that we have. So, these are great opportunities for us to grow. I think you'll see contributions from the acquisition as well as through our property management channel, which again has grown for the 11th consecutive quarter at double digit. So, we'll see contribution there. And we also see, as Keith said, this helps our affinity business as well. So overall, I think we've got some nice balanced growth as we look ahead for renters."
},
{
"speaker": "Mark Hughes",
"text": "Thank you very much."
},
{
"speaker": "Keith Demmings",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Tommy McJoynt with KBW."
},
{
"speaker": "Keith Demmings",
"text": "Morning, Tommy."
},
{
"speaker": "Tommy McJoynt",
"text": "Hey. Good morning. A question about the mobile side and the potential impact of tariffs. It doesn't sound like you guys are expecting a significant impact there. Can you talk about why maybe the potential importing of parts or and cell phones might not be impacted? And I think a lot of it has to do with your role as more of a program administrator than being on risk. Perhaps you can lay out the details on that."
},
{
"speaker": "Keith Meier",
"text": "Yeah. I think you actually hit on it, Tommy. I think it's the way that we work with our clients and these are large players with, highly developed supply chains, and we complement their supply chains as well. So we work very closely with them. Obviously, a lot of the programs are, reinsured or risk shared like you just spoke about. So I think that's what mitigates a lot of that impact. And then, obviously, we work very closely with them to optimize the programs for the consumer as well as for our clients. So, overall, I think those are the things that do put us in a good position overall on the mobile side."
},
{
"speaker": "Keith Demmings",
"text": "Yeah. And I think the other thing I would add, Tommy, is think about the mobile business, particularly around device protection. We've got 64 million or so monthly subscribers, but it's monthly pay, monthly earn. So the profile of that business is different than selling a single premium contract that earns out over time. So that also helps us be a little bit more nimble with the changes we can make, whether it's product or pricing. It can have an impact more quickly than in other lines of business."
},
{
"speaker": "Tommy McJoynt",
"text": "Okay. Got it. And then looking at the full year guidance, when I unpack the various subcomponents there, so it doesn't sound like the enterprise-wide guidance has changed, but Housing segment got a little bit better. Does that imply that that mar that on the margin, the Lifestyle segment came in a little bit worse than we were expecting a few months ago. And just want to make sure if that's the case, what is the driver of that?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. I'd say I guess a fair way to interpret it. Overall, feel really good about the full year guide. We obviously increased housing from modest decline to generating growth, so we feel really good about that adjustment. And then to your point, lifestyle, I would say we're certainly factoring in the impact of the macro environment in tariffs as we think about the year that wouldn't have been true in the same way a few months ago. So I'd say that's the only difference. But if I think about the underlying financial performance of the Lifestyle business, we feel really good where we came out in Q1, setting aside the dynamic world we're living in, we feel really good about the year in front of us. And even considering those factors, we're still planning to grow connected living, we're planning to grow Auto, and we're going to grow Housing."
},
{
"speaker": "Tommy McJoynt",
"text": "Great. Thanks, Keith."
},
{
"speaker": "Keith Demmings",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Bob Huang with Morgan Stanley."
},
{
"speaker": "Keith Demmings",
"text": "Morning, Bob."
},
{
"speaker": "Bob Huang",
"text": "Hi. Can you guys hear me now?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. We can."
},
{
"speaker": "Bob Huang",
"text": "Okay. Perfect. Yeah. So, maybe another follow-up on tariffs. I know we talked about this quite a bit. Just can you maybe help us think about, if there are any particular components within the tariff that is more sensitive. For example, are there like, within Housing, is there more aluminum, steel, lumber, or within the Auto? Like, is there particular parts? Just trying to see if there's anything that we should monitor from, like, a commodity futures perspective."
},
{
"speaker": "Keith Meier",
"text": "Yeah. So, Bob, I think when we do our scenario planning, we take into account the various, tariffs that have been talked about in the marketplace. And so then we apply them into scenarios for each of those businesses. So, I kind of went through that earlier in terms of the way we think about Housing. It could impact a little bit in some building costs, but we think we're well positioned to navigate potential inflationary aspects from whether it's lumber, steel, those types of things. And then on Auto, we're consistently monitoring parts and Auto related tariff discussions. And so, I think also there by working with our clients and the way, our business is structured, we feel very good about being able to manage through the different scenarios that are being discussed today."
},
{
"speaker": "Keith Demmings",
"text": "Did we lose Bob? Maybe."
},
{
"speaker": "Bob Huang",
"text": "Sorry. Can you hear me now?"
},
{
"speaker": "Keith Meier",
"text": "Yeah."
},
{
"speaker": "Bob Huang",
"text": "Perfect. Yes. So my second question is regarding, used car versus new car sales. Right? Like, if you think about, just the recent, auto sales and things of that nature, obviously, something that we've been talking you guys have mentioned. Is there a way to think about, whether or not, like, there was a new car sales pulled forward due to tariffs? Would that have any significant impact on, how we should think about the business going forward?"
},
{
"speaker": "Keith Demmings",
"text": "Yeah. I don't think it has a significant impact on how we think about business going forward. I definitely think there was a pull forward, both for new and for used. If I even look at the car sales in the month of March, they were higher than sort of the average for the quarter. So that suggests that there is a pull forward. I would expect that to probably be true in April as well. I don't think it has a significant effect on how we think about the business or the year. I suspect it's just a timing point where there'll be a little bit of additional sales front loaded and then maybe a little bit of softer sales following. We'll sort of see how the environment evolves. But obviously, it's always good to get a little more business in the door earlier in the year, but because of the nature of this business, we're earning off of a $11 billion UPR that's in force. It doesn't have a huge effect on how we think about the short-term picture for auto."
},
{
"speaker": "Keith Meier",
"text": "I would just add there, Bob, that we look at the macroeconomic environment in terms of there could be inflation aspects and consumer impact. And so, on the consumer impact, we don't see that as really affecting Assurant as much, in 2025, because of the existing business and it takes time to earn through and so forth. So I think that part doesn't have as much. And then we talked a lot about the flip side, which is the inflationary aspects, which can, you know, happen earlier. And that's the part that we talked a lot about, and we feel well positioned on that on that side of it."
},
{
"speaker": "Bob Huang",
"text": "Okay. Thank you. I really appreciate it."
},
{
"speaker": "Keith Demmings",
"text": "I think that was the last question. So I will go ahead and say thanks everybody for joining us today, and we'll look forward to the next update in August. Appreciate the time. Thanks so much. Thank you."
},
{
"speaker": "Operator",
"text": "[Operator Closing Remarks]"
}
] | Assurant, Inc. | 4,026,111 |
AJG | 4 | 2,020 | 2021-01-28 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher and Co's Fourth Quarter 2020 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be opened for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in your response to questions may constitute forward-looking statements within the meanings of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risks factors contained in the company's 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce Mr. J. Gallagher, Chairman, President and CEO of Arthur J. Gallagher and Co. Mr. Gallagher, you may begin.
J. Gallagher: Thank you. Good afternoon everyone. Thank you for joining us for our fourth quarter 2020 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer; as well as the Heads of our Operating Divisions. Before we get started, I'd like to make a few comments regarding the tumultuous year that was 2020. It was a year that tested everything from our physical health to our mental state of mind to how we see one another is impacted our colleagues, our families, our communities around the world. They brought personal hardship and loss, stresses and challenges that none of us would have predicted a year ago. I believe we've learned a lot about ourselves and our society over the past year and while 2020 is behind us many issues and difficulties remain, but let's not forget 2020 also showed us that the world can work together towards a common goal to develop vaccines in order to solve a global problem. And for that, I'm both thankful and I remain optimistic about our future. Now onto the discussion of the quarter and year. We delivered an excellent fourth quarter in the midst of the pandemic. We grew organically. We picked up momentum and grew through acquisitions. We improved our productivity and raised our quality. We continued to invest in our bedrock culture. I'm extremely proud of how the team performed during the quarter and the full year. In our Brokerage segment, fourth quarter reported revenue growth was a positive 3.6%. Most of that or 3.1% was organic revenue growth. We executed on our cost containment playbook and further utilized our centers of excellence saving about $60 million in the quarter, helping drive our net earnings margin higher by 281 basis points and expanding our adjusted EBITDAC margin by 579 basis points and net earnings were up 33% and adjusted EBITDAC was up 30%, another fantastic quarter for the Brokerage team. Let me walk you around the world and give you some sound bites about each of our brokerage units, starting with our PC operations. In U.S. retail, organic growth was strong at about 4.5%. New business and client retention was similar to last year's fourth quarter and mid-term policy modifications, including full policy cancellations, were slightly better than prior year levels. In our U.S. wholesale operations, risk placement services organic was about 5%, open brokerage organic was more than 20% due to strong renewals fueled by double digit rate increases. Our MGA programs binding businesses were up about 2%, retention was better sequentially, but as expected new business wins are still lagging given the economy. Moving to the UK, around 4.5% organic for the quarter in both our retail and specialty operations, new and lost business was consistent with prior year and special mention to our aviation team. They performed well in their largest quarter of the year helping clients navigate exposures that were down significantly, call it 30% to 40%, and rate increases that pushed premiums close to pre-COVID levels. Australia and New Zealand combined posted organic of about 1%. The spread between new and lost business was similar to last year, but we're not getting as much lift from rate and exposure as we had in previous years. And finally, our Canadian retail operations posted organic of 13%, another terrific new business quarter combined with a nice tick-up in client retention and strong rate environment. So, overall, our global PC operations posted 4.5% organic, which is a bit better than the 4% we discussed at our December Investor Day. Moving to our employee benefit brokerage and consulting business, fourth quarter organic was around minus 2%, which is at the favorable end of what we thought during our December IR Day. Similar to the previous couple of quarters fees from consulting arrangements and special project work were down. However, revenue from our traditional health and welfare business continues to hold up, with slightly positive fourth quarter organic, which is an encouraging sign. So, when I bring PC and benefits together, total brokerage segment, organic of 3.1%, a really strong quarter in this environment. And even better when you consider the tough compare against the fourth quarter of 2019 of over 6%. Next, I'd like to make a few comments on the PC market, starting the rate environment. Global PC rates continued to march higher during the fourth quarter and overall. Rate was up around 8% across our footprint. Rates in Canada led the way up more than 12%. The U.S. was up more than 8% with wholesale stronger than retail, including rate increases of 15% within our wholesale open brokerage operations, followed by the UK, including London Specialty at about 5% and Australia and New Zealand combined in the low single digits. By line of business property and professional liability are up 12%, other casually lines are up mid-to-high single digits and worker's comp was flat to modestly positive. Not only are PC rates, continuing to rise terms and conditions are tightening and capacity is becoming increasingly constrained for some coverages. Nearly every area and line of business is firm or firming. And there are even a few lines that are very hard, like umbrella, cyber and public company D&O. So needless to say, it is a difficult PC environment. This is where our teams excel, helping businesses, many of which are still struggling, navigate the market through creative program design, shopping coverages, and altering programs with increasing deductibles or reduced limits to help their risk management programs fit their budgets. Looking forward, I see similar PC market conditions continuing in 2021. And while economic growth is coming, the pace of the recovery remains uncertain. So we remain laser-focused on what we can control, delivering the very best insurance and risk management advice. Now successfully doing this virtually more than ever before, constantly improving our high-quality customer service, engaging with new prospects and growing our new business pipeline. Thus far in January, full policy cancellations and other midterm policy adjustments are trending similar to January 2020. Although it's still early, we're seeing year-over-year, renewal premium increases at levels comparable to fourth quarter 2020. On the benefit side, the annual enrollment season is behind us. And for many of our clients we saw covered lives stabilize from last year's declines, while retention in new business were similar to pre-COVID levels. In addition, a few of our benefits consulting practices are seeing increased activity and engagements early on in the year. So, while there's a lot of year left, these early January indications give me further conviction that full year 2021 Brokerage segment organic will be even better than 3.2% we delivered in 2020. Moving on to mergers and acquisitions, following an active December, we finished the fourth quarter with 10 completed brokerage mergers representing about a $100 million of estimated annualized revenues. And we've announced a handful more so far in January, representing an additional $85 million of estimated annualized revenues. This includes The Bollington merger in the UK, which we think will close in early February after receiving regulatory approval this week. I'd like to thank all of our new partners for joining us. And I extend a very warm welcome to our growing Gallagher family of professionals. As I look at our M&A pipeline, we have 30 term sheets signed or being prepared, representing around $300 million of annualized revenues. We believe we are the platform of choice for successful entrepreneurs looking to take their business to the next level, by leveraging our niche expertise, our tools and data, in addition to being a great place for their employees to advance their careers. We expect to have a very active 2021, particularly in the U.S. due to concerns related to possible tax changes. So, to wrap up the Brokerage segment for the full year, we delivered 5.4% growth in revenue, 3.2%, all-in organic growth. Adjusted EBITDAC margin expansion of 418 basis points, fueled by cost savings of about $180 million. And we completed 27 mergers representing about $250 million of estimated annualized revenue, a fantastic year for the brokerage team. Next, I would like to move to our Risk Management segment, Gallagher Bassett. Fourth quarter, organic edged back into positive territory, nicely surpassing our December expectations of being down as much as 2%, with some positive lift due to increasing COVID-related workers' compensation claims and saw strong retention in new business. So we ended 2020 with full year organic of minus 2.7%. And this environment to close a year in which core claim counts were down double-digits for more than 10 months of the year. And after posting 10% organic decline in the second quarter alone is a just terrific recovery story. Going back to April in the beginning of the pandemic, we set our sites on delivering full year 2020 adjusted EBITDAC, similar to 2019, even with full year revenues forecasted to be down $38 million or more. And boy, that the team deliver, the team proactively manage this workforce carefully rebalanced claim loads across adjusters and implemented expense controls, ultimately driving 2020 adjusted EBITDAC of nearly $150 million, $4 million better than 2019. Being able to grow full year EBITDAC despite organic revenues that were backwards. It's just fantastic work by the risk management team. As we look forward, January claim counts are trending very similar to the fourth quarter with many clients operating still at partial capacity with new business sold in 2020, incepting over the next few quarters and still room for substantial job recovery. We believe full year 2021 organic will be closer to pre-COVID levels in the mid single-digit range. Let me wrap up with some comments regarding our unique and resilient Gallagher culture. Culture guides our organization, our people in both good times and even more so in demanding times. And I believe culture is the source of our perseverance, our determination, and our constant push for excellence. I'm extremely proud of our collective successes during 2020, but more importantly, how we came together to work as a team, even while physically apart, our culture has never been better and I believe we're ending 2021 even stronger. Okay, I'll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks Pat, and good afternoon, everyone. I'll echo Pat's comments on great quarter and an excellent year. I too would like to extend my appreciation to the team. Today, I'll begin with some comments on our cost savings, provide some, a few observations from our CFO commentary document that we posted on our website. Then I'll do a vignette on our clean energy investments and finish with some thoughts on M&A, cash and liquidity. All right, let's turn to the earnings release, Page 6 to the brokerage EBITDAC table. You'll see that we grew adjusted EBITDAC by about $85 million over last year's fourth quarter, resulting in about 580 basis points of adjusted margin expansion. Within that, we realized about $60 million of cost savings relative to fourth quarter 2019 adjusted for merger. So underlying margin expansion was about 115 basis points on 3.1% all-in organic, which on its own is impressive. When you move to Page 8, in Risk Management segment, we grew EBITDAC a bit more than $4 million on slightly positive organic, resulting in about 190 basis points of adjusted margin expansion. Within that, we realized about $5 million of cost savings relative to Q4 2019, which was moderated just a little by new client ramp-up costs. So underlying margins were up just a bit, that too is actually giving the flattish organic this quarter. Categories of fourth quarter savings for the combined brokerage and risk management segment were consistent with second and third quarter. Reduced travel, entertainment and advertising about $25 million, reduced consulting and professional fees $14 million, reduced outside labor and other workforce savings $16 million, office supplies, consumables, and occupancy costs about $10 million. So that total is around $65 million, which is consistent with what we said at our December IR Day. Now looking forward the pace of recovery isn't clear, we came into the year with another virus surge. Now maybe some positive cases coming down. Some areas are imposing more lockdowns yet others are loosening up. There's been some successes but mostly delays in a vaccine rollout. And now it's looking like more and more that's the stimulus might be caught in gridlock here in the U.S. Regardless of whether you're looking at half full or half empty glass, very few outlooks are expecting the business environment to be much different by the end of the first quarter. So for us, when it comes to first quarter 2021, we're inorganic in the 3% to 4% range, and we're seeing expense saving similar to fourth quarter 2020, call it another $600 million – excuse me, $60 million. If that happens, and we could again show margin expansion over about 500 basis points. Then looking towards second, third and fourth quarters of 2021, it gets a little more tricky when you do your models, because the slope of the recovery is still uncertain and we're getting through – we're already realizing substantial COVID induced expense savings beginning early in April of 2020. But if the recovery steps up in those quarters and we get back to organic of, say, high 4% or 5%, it does give us a path towards holding full year margins, especially if travel and entertainment remains limited. Now, all of this needs to be taken into context. In 2017, 2018 and 2019, we were expanding margins 50 to 75 basis points a year on organic in that 4% to 5% range. Then the COVID hits, we execute on our cost containment playbook, and still managed to grow organic 3% that pops margins over 400 basis points in the face of this global pandemic. So now what I'm saying is that we have a fighting chance to hold or even improve full year margins here in 2021 on the prospect of getting closer to pre-pandemic organic growth later in the year. To me, that's still about a bullish story as you could write. Now, if we move to the CFO commentary document that we posted on our website, on Page 2, the blue fourth quarter column, you'll see most of the items are consistent with what we provided during our December IR Day, and that's in the gray column. FX came in a $0.01 better and severance and integration costs also a $0.01 better when you compare that to the prior quarters. Also on Page 2 in the reddish column, we're now providing our quarterly look at 2021, a few comments. First, foreign exchange. With the U.S. dollar weakening and if it stays that way throughout the year, 2021 revenue could see $100 million tailwind in brokerage and $14 million in risk management. Wouldn't be much EPS impact within risk management, but could translate late into a $0.05 or so for our brokerage segment, and that would even be better on reported EBITDA. Second, amortization expense. We're currently forecasting a little over $100 million a quarter in brokerage, which includes all announced mergers to-date. You can see the role in revenues associated with all announced mergers to-date on Page 5. And then also don't forget to adjust your amortization expense in the second and later quarters to reflect any future M&A you might be including in your model. Third, when you look at M&A multiples shown on Page 2 on the last line of the table, like that said, we had an active December closing ten. Three of which were on the larger end of our typical tuck-in size. That pushed the multiple up a tuner so this year, but still creating a nice arbitrage to our trading multiple. More importantly, it brings some really terrific merger partners to the team letting us grow better together over the long-haul. When you move to Page 3 of the CFO commentary in the corporate table, when you compare our December IR Day estimates in the gray column with our fourth quarter results in the blue column, you posted favorable interest expense due to strong cash flows, we had better clean energy earnings, in line M&A expense and a slightly more favorable corporate line. Also on Page 3, we're now providing a first look at 2021 ranges for the corporate segment, and that's in the reddish column. Nothing surprising and there's no change on our outlook for clean energy, still in that $60 million to $75 million of annual after tax earnings we've provided during our IR Day. So this brings me to my vignette on clean energy. You read on Page 4, Note 5 of the CFO commentary document that these investments are winding down at the end of 2021, unless there's an extension. That means in 2022, we will have zero GAAP earnings. But remember, that would be more than replaced with substantial cash flow benefits. In other words, 2021 and prior years were the credit generation years when we report the GAAP benefit or P&L. But 2022 starts the cash harvest years, where we will get considerably larger cash benefits in our operating cash flows. Here's the shortcut way to think about how to compete those cash benefits. First, if you go to Page 14 of the earnings release about the seventh line down in our balance sheet, you’ll read that we have a deferred tax asset of over $1 billion, mostly consisting of clean energy credit carry forwards. With one more year of credit generation, that asset should grow by another $100 million. So call it $1.1 billion of credit carry over is by the end of 2021. Then assuming 2022, we will begin using more credits than we’ve been using thus far. How – third, then how fast we’ll be using those credits will depend on how fast we grow our U.S. taxable income. But for this illustration, and if you assume a seven-year period, it might mean we’d be harvesting about $125 million to $150 million in 2022 with that ramping up to say about $175 million to $200 million in 2028. It’s a little odd that GAAP earnings go to zero and then the cash benefits become dramatically better, but that’s just how it works. This is and has been a really important part of our story over the last decade. So I think it was worth some extra time today. All right, let me go on to some comments on cash in M&A. At December 31, available cash on hand was nearly $700 million. We have a significant untapped capacity in our – on our revolving credit facility. And we have another year ahead of us have really strong cash flows. That might mean that we would have perhaps two point – up to $2.5 billion of M&A capacity here in 2021. That’s a terrific position as we come into our year that we see as perhaps the most active year ever in the brokerage M&A space. Okay. That’s wraps up 2020 and we’re positioned really well for 2021. Organic looks better, bolt-on M&A, it looks better. We have a decent chance of keeping a large chunk of our cost savings, assuming – harvesting cash flows from our clean energy initiatives. And most important, I can feel our team’s excitement about coming out of the pandemic stronger than ever before. My thanks to them for another fantastic year. Back to you, Pat.
J. Gallagher: Thanks, Doug. Operator, let’s go to questions and answers if we can.
Operator: Thank you. The call is now open for questions. [Operator Instructions] Our first question comes from the line of Elyse Greenspan with Wells Fargo. You may proceed with your question.
Elyse Greenspan: Hi, thanks. Good evening. My first question Doug, I appreciate the color by speaking provide on the expense savings. So as we continue to think about I guess coming out of COVID, I know last quarter, I believe you guys had said, right, kind of when things settled that half of the state could persist and maybe think about some level between half and the $60 million, I guess I’m just talking about brokerage in kind of the middle two quarters of 2021. Do those figures, I guess I would assume that they still seem about right given where we sit today.
Doug Howell: Yes, I think your recollection is right. It was I did say as, it’s that there was a silver lining coming out of something so terrible, and that’s we’ve learned a lot about ourselves. I think that ultimately we think there’s $125 million to $150 million of annual cost savings that we might, that we’re pulling forward earlier into our continued march on margin improvement. As it emerges for the quarters this year, it really is a kind of a sensitive interplay between organic and then just really what happens with the economy. We’ll follow our customer’s expectations. We are learning that they are much more receptive now to virtual interactions allows to get our niche expertise at the point of sale, easier than jumping on an airplane or in spending days traveling. So we are learning a lot in that, but we will follow our customers’ expectations. How that exactly plays out in the second and third and fourth quarters really depends on how fast organic moves from that 3% to 4% range up into maybe the 5% or 6% range.
Elyse Greenspan: Okay. That’s helpful. And then on the M&A environment, so you guys mentioned, right, you posed a couple of larger deals to end December, right. The two of us, the multiples on the $300 million of revenue within those 30 term sheets that you guys mentioned. Can you just give us a sense like kind of the skew are there any larger ones in there? Or is it more just kind of the typical smaller bolt-on deals that you guys focused on of late as well?
Doug Howell: Yes, I would say that just clarifying that we had some larger tuck-in ones at the end of the December call in revenues that $20 million, $25 million range. The deal sheets that we’re looking at right now, $300 million of revenue spread across 30, 35 term sheets, they’re in the smaller range, nice local family owned entrepreneurial businesses. The range is lower than where we are right now for year. So I would see us back kind of more where we were in the second, third – first, second and third quarters.
Elyse Greenspan: Okay. And then can you give us an update on Capsicum, your reinsurance business, I guess, where that sits at the end of the year. How that’s been trending from both a growth and margin perspective?
Doug Howell: Yes, it’s doing really well. We couldn’t be more pleased with the team. Pat can talk about some of the cultural excitement that we have on that. But financially, they’re growing in double-digit still; their margins are north of 30%. We see terrific opportunities for that business.
J. Gallagher: As you know, this is my second go around. This was a lot better.
Elyse Greenspan: And then one last question, Doug. Is there a chance that there isn’t any kind of extender bill that would extend your ability? I know you gave us a lot of helpful color assuming that you can’t generate any credits beyond the end of this year. Is there a chance that there could be any extended bill or I guess, most likely not at this point?
Doug Howell: Sure. I always think there’s a chance. And I think that when Congress said about this, about helping us get better in burning some fossil fuel. They wanted help in making it better. So as long as we’re going to be using it, let’s make it better. So I think they see that, and I think they see the opportunity for this to continue to help innovate. So we hope that there’s some – there are some proposed legislative changes that would – that possibly could make the extension happen. So we’re hopeful for that. And we certainly are trying to get that message on everybody’s desk that we can.
Elyse Greenspan: Hey, thanks, Doug and Pat for the color.
J. Gallagher: Thanks, Elyse.
Doug Howell: Thanks, Elyse.
Operator: Our next question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question.
Phil Stefano: Yes. Thanks and good afternoon. Thinking about the sales pipeline, I’ve been trying to contemplate, I guess, in my mind, clients would have hunkered down early on in COVID and been less likely to change brokers or to really contemplate a move like that. Does it feel like people are just getting more comfortable with the world we live in today and that’s opening up or when we think about the past from 3% to 4% organic growth to 5% to 6% organic growth? Are we just waiting for the economy to improve and the shops to get in the arms so everyone can get back out there and living.
J. Gallagher: Well, Phil, this is Pat. There’s a lot of answers to your question. So let me back up a little bit. First of all, did the clients hunker down? You start with March of last year and the answer, that’s, yes. Having said that they have a lot of needs and a lot of requests, so we were running webinars around COVID return to work all kinds of different as cyber would have you blew my mind, thousands of people signed up. And it was not unusual for us to run a webinar with 5,000 attendees. I mean, I’d never heard of such a thing. So there’s a huge thirst for information, which helped our people, of course, know exactly some of the hot buttons that they should be talking to potential clients and to get out. And I was amazed. I really would have told you that I thought maybe new business would have hunkered down. I didn’t think our lost business would increase because of that. In fact, it’s amazing to me, that kind of new business that we did generate. So I think that it gives us a lot of confidence to sell the kind of business we sold last year. And you’d get some fall over from 2019 into the first quarter, maybe a little in the second quarter, but everything from May on was really generated after the first of the year, so really a incredible new business year. Secondly, are we seeing the advent potentially of people beginning to come back into the businesses? I think, yes. I think we’re seeing that there is going to end whether stimulus happens or not. I think businesses have learned how to do this tick just to look at your local restaurants. And I had a better a year ago, they weren’t March, they might, they’re not going to survive. Take out. It’s not making them robust, but they’re surviving and they’re ready. I mean, in the Chicago land area, now we can go to restaurants again, they have very limited occupancy, but they are ready. They’re welcoming. They want people back and people are excited about it. So I think the pent up demand for people to be able to go do things is also going to be helpful. Then lastly, let’s not forget something. I’ve told you guys this a thousand times, I don’t like hard markets and I get it. They all look good on paper what have you, but they tick every customer off. And they’re suffering through this right now, because they don’t really have a choice. But they are going to shop. And we are there for them to understand that both our data capabilities, as well as our professional niche capabilities and our ability to work them through the process of taking more risk, becoming more self-insured, that's our bread and butter. We're better at that than anybody. So I think that, that is it's all of those combined that leads me to believe that we see a very robust new business year ahead in 2021 and 2022.
Phil Stefano: Okay. Thanks. And switching gears a bit, I feel like the dividend is something that we don't really talk about, but I was a bit surprised by the extent of the raise in the past week or so. Is there a long-term growth rate that you target a payout ratio, or maybe you can just refresh our understanding on how you think about the dividend?
J. Gallagher: Yes, I mean, we just pop it up a little bit more yesterday. We did raise, I think it's an indication that our cash flows are very strong. We typically raise it a few cents and then maybe a little bit more and sit there for a year or so. But I think there was a vote of confidence by the board that said that let's take that dividend up just a little bit more this week. So we did that. And so we'll look at that every year, but we agreed with the observations that cash is strong. So let's increase the dividend.
Phil Stefano: Okay. Thanks.
Operator: Our next question comes from the line of Mike Zaremski with Credit Suisse. You may proceed with your question.
Mike Zaremski: Good early evening. I guess first question on expenses, I know we've talked about this a lot but it's just – it's been phenomenal. And so I try to understand do you feel that a lot of these expenses that will persist are kind of more Gallagher’s specific and it'll give you a leg up on your competitors, or like do you feel like a lot of these things are things that just your competitors are going to catch up to you eventually, you're just a kind of first mover. I know that's maybe a complicated question, but just trying to get a sense of whether this kind of gives you a advantage that'll persist versus peers or others just are going to kind of follow you guys, but just will take some time?
Doug Howell: All right. So let's break this into a couple of things. Let me talk about who our competitor, 90% of the time we're competing with somebody that's smaller than us, right? So when you look at the – where are we really getting leverage? I think there we're getting leverage because of our scale, especially relative to that, but that level of competitive, the smaller ones that we compete with day in and day out. I think we have opportunities to continue to use our lower cost labor locations and our centers of excellence. I think our ability in order to rationalize our real estate footprint I think that we can buy goods and services cheaper. I think our ability to automate many of the interactions with the clients and with our own employees all of those things, I would say that Gallagher is positioned. We have a common agency management system in most of our countries, in most of our businesses. Those are things that we believe that we will continue to bring scale advantages versus our smaller competitors. How do I feel about it comparing to, let's say the other top 10 brokers, first of all, you got to pick the ones that have the culture that want to work together and make it happen. And then you've got to pick the ones that haven't already gone down this journey to see whether or not there yet or not. But we think that we're in really terrific place to continue to leverage our technologies and our scale compared to most of our competitions. So I don't know if they're catching up or if they're already there or they just don't have the culture to pull it off.
Mike Zaremski: Okay. That’s helpful, Doug. Did you more straight forward question, free cash flow for 2021, did you site kind of an estimate for what we should expect?
Doug Howell: I didn't, but I said that we probably could do about up to $2.5 billion in M&A for this year. So if you break that apart, we've got $700 million on hand. And if you look at our operating cash flows being somewhere in the $1.3 billion to $1.5 billion range something like that, I think. And then you borrow a little bit more so that's how you get to the $2.5 billion.
Mike Zaremski: Okay. And just lastly curious a broker that reported earnings earlier today, kind of actually talked about stepping on the gas on hiring and taking advantage of some of the M&A that's just taking place in the industry. Just curious, are you seeing any increased opportunities on the hiring side?
J. Gallagher: Definitely seeing opportunities from two areas, Doug mentioned that 90% of the time we compete, we compete with smaller brokers and the smaller brokers have the problem of just simply not having the capabilities that clients are starting to ask for. And these can be simple questions, like, how do I know? How do I know you just gave me the best deal? When I was out selling 30 years ago on a daily basis that would be answered by saying, I went to three carriers. This is the best price that does not float today. They want to know what you're doing with clients, what carriers are doing at, where the ranges are, what their loss ratio looks like to bear to others. They want detail, they want data. Smaller people can't do that. So what you've got is folks that are losing accounts to the likes of ourselves, and we're out telling them, why wouldn't you come to a place that's happy to pay you, for what you hunt and kill. And at the same time, you have all the support and the capabilities in the world. We can write any account of any size, no matter where it's located in the world and that's very attractive. And then of course, there's always opportunities as larger competitors, we clearly believe we offer a cultural difference.
Mike Zaremski: Thank you.
Operator: Our next question comes from the line of Greg Peters with Raymond James. You may proceed with your question.
Greg Peters: Good afternoon. Just a follow-up on Mike's question, I don't know, if I missed it in the prepared remarks. The free cash flow for 2020 was what?
Doug Howell: For 2020, our free cash flow in operating – free operating cash flow be about $1.4 billion this year in the cash flow statement, when we file our 10-K in a week, you'll see it's around $1.4 billion.
Greg Peters: And so you said the guidance for 2021 is $1.3 billion to $1.5 billion. Was there some one-time benefits that floats through in 2020 that you're not going to realize in 2021, otherwise I would normally expect the free cash flow to grow, if you're growing your top line and bottom line, I expect free cash flow to grow. And what am I missing?
Doug Howell: I don't think it will appreciably change significantly in 2020 versus 2021, we will grow at – if we hold margins in there, we're going to grow based on not including acquisitions in that number. So if the cash flows off the acquisitions, we will also – that too…
Greg Peters: So then just to close the loop on your previous comments, when you said in 2022 that you'll drive, was it $125 million cash benefit from the pull down of the tax credit?
Doug Howell: In 2022, yes?
Greg Peters: I can assume whatever free cash flow growth I have off of 2021 on an operating basis. And then just add on an additional $125 million. Is that a fair way to think about it?
Doug Howell: Yes, if you factor in mergers. Yes, that's a fair way.
Greg Peters: Okay. The second question I had listen, I know you've comment on this before, and you were sort of dancing around it in the prepared remarks and the Q&A. But you just talked about an 8% rate increase across your entire footprint. And you talked about, terms and conditions being changed – changing. I'm just curious about your customers and how they're dialing up retentions reducing limits to offset the price. And I guess what I'm really trying to gauge is how does it look here at year end 2020 verse how it was looking at year end 2019?
J. Gallagher: Well, I think it's continuing to get stronger, Greg. This is Pat. I think that, look, if we're telling you that, basically we're seeing rate increases of around 8% and organic is about 3.5%. You see a 5% difference where to go. Well it went to modification of what the purchase – with the purchasers buying. And that's our job. I mean we sit down with these guys and say, men and women, and say, look here are your options, you had $250 million of limits last year. We could show you the stats that would be a very unusual claim to break the $150 million barrier. Do you need that extra $100 million? And we help them work through that. Retentions are a very big part of it. And a big part of it is, and this is where our history comes from, clients that enter self-insurance for the first time. I don't understand this, what's the deal. Well, why don't you take a $150,000 retention and you'll basically save ex on the transaction that you'll only have to pay, if you do have the claims. Now, let’s really focus on loss control. So, I don’t need to get too detailed with you, but that’s really – that’s what we do for a living.
Greg Peters: Right. Well, I guess, what I was – I had assumed that the difference between the eight and the three was a combination of retentions, reduced limits and reduced economic activity, but maybe, I was overthinking there.
J. Gallagher: Okay. That’s fair. That’s fair. Yes, I look out the economic activity. That’s fair.
Greg Peters: Okay. The final – I guess the final thing and I know you’ve been talking about M&A, but listen, the dirty little, not so big of a secret is the two – number two and number three are out there and the merger dance. And it feels like that is an opportunity for dislocation for customers being unhappy for you to bank new hires, et cetera. And so I guess from the time that they announced this thing back in March of last year to now, have you seen anything in the marketplace that’s disruptive that you see as an opportunity or is the disruption, if there is any going come later in this process?
J. Gallagher: So Greg, let me, obviously, I’m not going to talk about our competitors and I – but I’ve said to you many times, change is good for us. And when we move to further consolidation of three players at the top end of the spectrum and our name happens to be one of them, there’s lots and lots, and lots of opportunities along the lines of everything you’re talking about. There’s clients that have never really talked to Gallagher that we’re going to have a shot at. I mean, if you go back in time and I went to the RIMS Conference 100 years ago, nobody came by our booth. We’ve got 5,000 people that show up to our RIMS Conference virtually. I mean, there’s interest. And so really, it’s – we’re in a very, very good position.
Greg Peters: Got it. I probably got a little too cute on the question, sorry about that, but thanks for your answers.
J. Gallagher: Sure. Thanks, Greg.
Operator: Our next question comes from the line of Yaron Kinar with Goldman Sachs. You may proceed with your question.
Yaron Kinar: Hi, good evening. I guess my first question, just trying to tie the organic growth to margins next year. So, I would think there are different ways to get the 4% to 5% organic growth, and each of those potentially, has a very different impact on margins, namely, if you’re getting more of that organic growth through rate versus exposure unit growth. So maybe, you can talk about that a little bit. And then on the flip side, I think in the past you used to talk about, of needing to get at least 3% organic in order to keep margins stable. How should we think about, let’s say a 3% organic growth for – if you achieve that in 2021, what does that mean for margins?
Doug Howell: All right. The workload, the difference in workload on a customer that is adding exposure units, i.e. adding vehicles or changing miles, isn’t significant whether they’re adding a couple of failures. So, the workload associated with a rate increase that comes from exposure units. Not that much more. If it comes from additional rate, that means we want to go out and shop more, we’ll take a little bit more effort, but because of our efficiencies, we can do that at a pretty low cost month. So, just the number of policies or the exposure units or a modest rate increase or decrease doesn’t change our workload that much. So, I wouldn’t say that that would have a significant impact on margin if you’re kind of in that 2% to 4% range on rates and exposures. When you’re asking the next part of the question about when – where do we see the kind of the old tried and true line, if you grow organically 3%, is there margin lift in it? Yes, I think there is, is it – in this year in 2021, since we were up 400 basis points in margin this year alone, I think that’d be pretty tough to get a 3%.
Yaron Kinar: Okay. So, beyond 2021 though, if you do achieve 3% organic growth, even though the bar is so much higher today, you can still achieve margin improvement even with that.
Doug Howell: Yes. we’ve moved that to 3% to 4% over the number of years. As our margins are getting over 30%, there’s just not as much there to harvest as our technologies get rolled up. As our scale grows, we’ll be able to have margin improvement on those tuck-in acquisitions that can come onto our chassis can use our technologies. It’s really more about selling more than it is necessarily about making more margin. but there would be upward tick. Do I see that in at 3% organic growth in 2022? I don’t know if we’d have that much more margin expansion.
Yaron Kinar: Okay.
Doug Howell: Do it for five years in a row. Sure, there could be some.
Yaron Kinar: Got it. And then was this step-up in Gallagher’s margins was a good portion of that being retained. How do you think about the – about acquisitions and potential targets? I would think that the bar to clear there could be significantly higher that your margins are higher today.
Doug Howell: If they’re running good margins for the business that they’re in and they show a prospect for growth, we’ll buy them regardless of whether it’s dilutive to all our margin if they come in. they are what they are and if we can improve their margins, terrific; if they’re already at the upper end of the scale, then terrific. But they just happened to be in a space that requires a significant amount of service that maybe, it will say that their margins are 22%, but they have a good growth. We’ll still buy them. And we’ll let you know, we’ve done that in the past, where we’ve said a role in impact of acquisitions had X, Y, or Z impact on our margins.
Yaron Kinar: Got it. Thank you.
Doug Howell: Sure. Thanks, Yaron.
Operator: Our next question comes from the line of David Montemaden with Evercore ISI. You may proceed with your question.
David Montemaden: Thanks. Good evening. Just a question on P&C exposure units; in the press release, it sounded like, we’re continuing to see an increase in exposure versus April and May 2020, which not a big surprise. but I guess I’m wondering how exposure units were trending thus far this year relative to 4Q, obviously a tough comp year-over-year. but are we continuing to see an improvement in exposure units in 4Q or is it sort of flattened out thus far in January?
J. Gallagher: They’re flat in January.
Doug Howell: Yes. I think that we’ve kind of bounced off the bottom. We’re not seeing significant daily step-up. We are seeing – we look at our global positive endorsements that go through on our policies on every day. And we can see that that’s still showing a nice upward trend similar to pre-pandemic, but you weren’t seeing massive exposure unit growth a year ago in the – fourth quarter of 2019 or early into 2020. You weren’t seeing it there. but there is a steady increase. There’s been a bounce off the bottom and we would expect throughout 2021 and 2022 as the economy recovers that those exposure and this would go back up also, but not much different today than let’s say, in December.
David Montemaden: Got it. Okay. That makes sense. And then I’m just – I guess I’m wondering, after we’ve gotten through some of the renewals here in January, I guess, are you seeing any movement on the commission rates? And I guess just conversations around contingents and supplementals, maybe, an update on how those are looking.
J. Gallagher: Yes. I think that commission rates and the like are solid. We’re not having pressure from our carrier partners to try to diminish their payment to their distributors and as far as contingents and supplemental. So, we think we’ll have a solid year, some growth this year.
David Montemaden: Great, thank you.
J. Gallagher: Thanks, David.
Operator: Our next question comes from the line of Mark Hughes of Truist. You may proceed with your question.
Mark Hughes: Thank you. Good afternoon.
J. Gallagher: Hi, Mark.
Mark Hughes: Why the rebound in risk management, I wonder if you could break that into pieces, more claims, more employees, new business. How does that shake out?
J. Gallagher: Yes. well, I think Doug, if you want to granular to the percent, I can’t do that. but it’s – you hit right on it, Mark. I mean, we’ve got claims are recovering. We mentioned in our prepared remarks that COVID claims in particular have helped out. The economic activity people are adding more folks and those are the factors that produce claims. So, as we get people driving, as we get people going back to work, they will come back to more normal levels. And we don’t hope to get more COVID claims, but they are filling a hole in the bucket right now.
Doug Howell: And they had a terrific new business here, too. It’s starting to incept. you saw that we had some. It’s been a couple of million or a million or so on some new client ramp up costs as we transitioned to them. We’ve got a solid outlook for this year of being back and been single digits maybe, this year. So that team has done a terrific job of new business wins too. Didn't hit a ton this year, but it will next year.
Mark Hughes: How are you thinking about the open-broker, it sounds like that was particularly strong in the fourth quarter. Is that continued into Q1?
J. Gallagher: Yes, it's continued. It's very strong, Mark. I mean, you understand wholesaling is a business that has an awful lot of market leverage up and down. So we were in a very firm property market, in particular our team. And this is – what's exciting about this is, these brokers do not want to go to wholesalers. It's not a friendly business in the sense that we're looking to give you one-third of our commission. So they're providing an unbelievable service to the brokerage community, with whom we trade about 15,000 in the United States alone. And those people need help and we're giving them help and that's why along with rate. So we're getting at both in item count and rate just by being ready to be very, very helpful.
Mark Hughes: Thank you.
J. Gallagher: Thanks Mark.
Operator: Our next question comes from the line of Paul Newsome, [Managing Director]. You may proceed with your question.
Paul Newsome: Good afternoon. I wanted to ask, tell me a little bit more about your comment, about the lack of shopping by the customers. I mean, I think of a hard market is one with increased shopping, but one of your comments seem to square with every company I cover where the retention levels seem to be really unchanged through the last couple of years. Why do you think we haven't seen the increase in shopping? Why do you think the customers seem to be just kind of taking rate and moving on?
J. Gallagher: Well, Paul, again my comment was predicated on two things. To start within the pandemic, I didn't think customers would be having people knocking on their door as much as they do right now. And as much as they did in 2019. And I think that as they started to ferret their way through, what's going to go on in this pandemic themselves, they were willing to very much hunker down and say, I've got a good insurance program, this is where it is. I don't have – I've got to be considering my own survival tactics. And I surmised there'd be less shopping of our existing business. Now I was right a little bit. It certainly didn't stop shopping. It wasn't like everything came to a grounding halt. But if you're a good broker and we've got really good competition in this market. In our hard market, you early on explained to your client that if you are unhappy with hard market and you want to be really unhappier, shop the hell out of it, because you're going to get slaughtered. And in fact hard market shopping does decreased, pardon me. Unfortunately, as things ease up a bit, people are unhappy and it tends to increased shopping. So right now we're in a very firm and firming market, and people understand that they need our expertise. And it also does scare some of those little competitors that we compete with 90% of the time out of being so bold as to say they can do better than we do, pretty tough to prove it.
Doug Howell: Yes, I think there's a flight to quality. I think that when you sit down and look at what you get from Gallagher, get more and how do you get more from us? You get price, you get service, you get access, you get creativity, you get innovation. It's pretty hard to leave that if you don't have competition knocking on the door that can offer that. So I think it's a different era from when you and I were cutting our teeth Paul, that it basically as small, small brokers competing with small brokers offering kind of the same thing, you get so much more from Gallagher today, than you ever got before.
J. Gallagher: And another thing piling in on that. Once you show someone how to get through these days and primarily by doing what we do so well, which is help people deal with assuming risk, bringing Gallagher Bassett into help pay the claims, mitigating those claims and showing them that in the long term, they've really garnered a lot more control of their destiny. You never lose those clients. A client that moves from the traditional first dollar purchase into any form of self-insurance pooling with other public entities, moving into a group, captive doing their own single parent captive, taking a large retention on their worker's comp in a very heavy employee state. Once you do that for them, it shifts the game completely.
Paul Newsome: Makes sense. Switching to a different topic. Obviously with the change in the quick tax rates potentially going away, we're probably looking at a change in how we value your company, plus on earnings, more of something else like free cash flow. I guess my question is, is free cash flow the right number, is operating cash flow the right number. I'm just curious is I know their customer usually get intertwined with yours in the measurements and what's your theory on how we should measure cash flow if we have the proper way to do it?
Doug Howell: Yes. Great. I think that's a terrific question. And all right, first, I still believe that EBITDA gives a good proxy for how to value a broker. Then you just have to back off the cash taxes paid. And interest expense, of course, and the cash tax was paid, an interest shield on that. But if you basically start with EBITDA, you're going to get pretty close to the way, and that's been a traditional way. So what does that mean for Gallagher is that we've said this for years, we're still pay taxes. People sometimes think that we're not paying our fair share. That's not the case at all. We've still pay taxes. It runs about, I said this, if you go back to when tax changed that we are – we think that we're going to pay in that 5% to 6% to 7% of EBITDA range just as a proxy. We're probably at that same range, even if tax rates go up to 28% from 21%, it would be a book rate differential. It wouldn't really be a cash difference. If the Biden tax measures were put in place, it might cost us 10 million bucks a year in taxes, more Paul, but it wouldn't be a huge number. The value of tax credits become more valuable if tax rates go up. So really for Gallagher to take our EBITDA, back off our CapEx, back off our interest expense and put in 7% or 8% for cash taxes paid and you get pretty close to the cash flow amount for Gallagher. I might've missed something in there, but I think I got most of the pieces in that, but I would start with EBITDA still.
Paul Newsome: Fantastic. Thanks guys. Appreciate it.
Doug Howell: Thanks, Paul.
J. Gallagher: Thanks, Paul.
Operator: Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question.
Meyer Shields: Great. Thanks. Good evening. One small question, one big one. Are the claims that you're seeing recover in Gallagher basket, sorry, Gallagher Bassett. Are any of those, like just late reported claims that occurred earlier, or that just now you're seeing more claims because of COVID or because of rising economic activity?
J. Gallagher: More claims rising out of better economic activity. And the addition of COVID claims, which was a category that didn't exist a year ago.
Meyer Shields: Okay, perfect. And then bigger picture, Pat, you talked about Gallagher's ability to write any clients to actually win those clients. Didn't need to a more extensive set of consulting services comparable to the brokers that are bigger than you?
J. Gallagher: Yes, we do. [indiscernible] I’m sorry when it was?
Meyer Shields: No. When you said we do, is that we – the Gallagher has those services or needs them in the same proportion?
J. Gallagher: No. No. We do. We've got them. I mean, Doug was going to go down the line. If you take a look at our verticals, our niche capabilities, I mean, we don't stand second to anybody and I can go through the list of those. We provided every time we get a chance, but, you take a public sector client anywhere in the world, you take a college or university we had some great college and university wins in the last month. Names that if I throw them out, which I won't today, you'd go, wow. And I'm talking on a global basis. We'll be probably the largest provider of college and university risk management advice in Australia. So you're not going to be winning those types of accounts. We're very – we've gotten much stronger in terms of our benefits capabilities. When you take a look at what we do on the consulting work for health and welfare alone, but also all the other human resource needs. I mean, we're clearly a top three consultant in that regard. So, no, I mean, look, we know that over 90% of our business falls include, defined niches, which we have expertise that we think is frankly, better than our large competitors.
Meyer Shields: Okay. Excellent. Thanks so much.
J. Gallagher: Thanks, Meyer.
Operator: Our final question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question.
Phil Stefano: Yes. Thanks for taking the follow-up. I was just hoping, is there any way you can help frame for us what the ceiling on the brokerage organic growth – brokerage organic margin – brokerage margin might be?
J. Gallagher: Phil, that's a tough question. I'd rather not, but I think that the answer is, it's just such an interplay between organic service expectation by our clients, and then in underlying inflation too that we face every day and certain of that. Right now, we're in a low wage inflation environment. We've kind of been in a low wage inflation environment since really 2007, 2008. We're getting more efficient with scale. Technology costs are coming down; on the other hand there are costs that more specific technical expertise costs more. Getting smarter people on your payroll that can handle some of the really, really technical aspects of what's going on, systems there's cost inflation and systems right now, so it's a tough, tough answer, but you're seeing the brokerage business somehow is running around 30 points plus or minus two points right now. That's the way it's running. You look across Austin and the other large Publix, and you look at the PE owned firms. There's a number around 30% plus or minus a couple of p0oints there.
Phil Stefano: Yes. Fair enough. I figured I'd give it a try. Thank you.
J. Gallagher: Thanks Phil.
Operator: Ladies and gentlemen, you have reached your...
J. Gallagher: I think that's all our questions, yes.
Operator: Yes. I would like to turn it back over to you, Mr. Gallagher for closing remarks.
J. Gallagher: Thanks. And thank you again, everyone for joining us this afternoon. We mentioned this in our prepared remarks, but we delivered an excellent quarter and full year, and we all know how difficult the economic environment was. So I would like to thank all of our Gallagher professionals around the globe for being flexible, working hard and never losing focus on our job at hand. I'm competent that we can deliver another great year of financial performance in 2021, and truly believe that as an enterprise, we are just getting started. So thanks for being with us folks. We appreciate it.
Operator: This does conclude today's conference. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher and Co's Fourth Quarter 2020 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be opened for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in your response to questions may constitute forward-looking statements within the meanings of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risks factors contained in the company's 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce Mr. J. Gallagher, Chairman, President and CEO of Arthur J. Gallagher and Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Gallagher",
"text": "Thank you. Good afternoon everyone. Thank you for joining us for our fourth quarter 2020 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer; as well as the Heads of our Operating Divisions. Before we get started, I'd like to make a few comments regarding the tumultuous year that was 2020. It was a year that tested everything from our physical health to our mental state of mind to how we see one another is impacted our colleagues, our families, our communities around the world. They brought personal hardship and loss, stresses and challenges that none of us would have predicted a year ago. I believe we've learned a lot about ourselves and our society over the past year and while 2020 is behind us many issues and difficulties remain, but let's not forget 2020 also showed us that the world can work together towards a common goal to develop vaccines in order to solve a global problem. And for that, I'm both thankful and I remain optimistic about our future. Now onto the discussion of the quarter and year. We delivered an excellent fourth quarter in the midst of the pandemic. We grew organically. We picked up momentum and grew through acquisitions. We improved our productivity and raised our quality. We continued to invest in our bedrock culture. I'm extremely proud of how the team performed during the quarter and the full year. In our Brokerage segment, fourth quarter reported revenue growth was a positive 3.6%. Most of that or 3.1% was organic revenue growth. We executed on our cost containment playbook and further utilized our centers of excellence saving about $60 million in the quarter, helping drive our net earnings margin higher by 281 basis points and expanding our adjusted EBITDAC margin by 579 basis points and net earnings were up 33% and adjusted EBITDAC was up 30%, another fantastic quarter for the Brokerage team. Let me walk you around the world and give you some sound bites about each of our brokerage units, starting with our PC operations. In U.S. retail, organic growth was strong at about 4.5%. New business and client retention was similar to last year's fourth quarter and mid-term policy modifications, including full policy cancellations, were slightly better than prior year levels. In our U.S. wholesale operations, risk placement services organic was about 5%, open brokerage organic was more than 20% due to strong renewals fueled by double digit rate increases. Our MGA programs binding businesses were up about 2%, retention was better sequentially, but as expected new business wins are still lagging given the economy. Moving to the UK, around 4.5% organic for the quarter in both our retail and specialty operations, new and lost business was consistent with prior year and special mention to our aviation team. They performed well in their largest quarter of the year helping clients navigate exposures that were down significantly, call it 30% to 40%, and rate increases that pushed premiums close to pre-COVID levels. Australia and New Zealand combined posted organic of about 1%. The spread between new and lost business was similar to last year, but we're not getting as much lift from rate and exposure as we had in previous years. And finally, our Canadian retail operations posted organic of 13%, another terrific new business quarter combined with a nice tick-up in client retention and strong rate environment. So, overall, our global PC operations posted 4.5% organic, which is a bit better than the 4% we discussed at our December Investor Day. Moving to our employee benefit brokerage and consulting business, fourth quarter organic was around minus 2%, which is at the favorable end of what we thought during our December IR Day. Similar to the previous couple of quarters fees from consulting arrangements and special project work were down. However, revenue from our traditional health and welfare business continues to hold up, with slightly positive fourth quarter organic, which is an encouraging sign. So, when I bring PC and benefits together, total brokerage segment, organic of 3.1%, a really strong quarter in this environment. And even better when you consider the tough compare against the fourth quarter of 2019 of over 6%. Next, I'd like to make a few comments on the PC market, starting the rate environment. Global PC rates continued to march higher during the fourth quarter and overall. Rate was up around 8% across our footprint. Rates in Canada led the way up more than 12%. The U.S. was up more than 8% with wholesale stronger than retail, including rate increases of 15% within our wholesale open brokerage operations, followed by the UK, including London Specialty at about 5% and Australia and New Zealand combined in the low single digits. By line of business property and professional liability are up 12%, other casually lines are up mid-to-high single digits and worker's comp was flat to modestly positive. Not only are PC rates, continuing to rise terms and conditions are tightening and capacity is becoming increasingly constrained for some coverages. Nearly every area and line of business is firm or firming. And there are even a few lines that are very hard, like umbrella, cyber and public company D&O. So needless to say, it is a difficult PC environment. This is where our teams excel, helping businesses, many of which are still struggling, navigate the market through creative program design, shopping coverages, and altering programs with increasing deductibles or reduced limits to help their risk management programs fit their budgets. Looking forward, I see similar PC market conditions continuing in 2021. And while economic growth is coming, the pace of the recovery remains uncertain. So we remain laser-focused on what we can control, delivering the very best insurance and risk management advice. Now successfully doing this virtually more than ever before, constantly improving our high-quality customer service, engaging with new prospects and growing our new business pipeline. Thus far in January, full policy cancellations and other midterm policy adjustments are trending similar to January 2020. Although it's still early, we're seeing year-over-year, renewal premium increases at levels comparable to fourth quarter 2020. On the benefit side, the annual enrollment season is behind us. And for many of our clients we saw covered lives stabilize from last year's declines, while retention in new business were similar to pre-COVID levels. In addition, a few of our benefits consulting practices are seeing increased activity and engagements early on in the year. So, while there's a lot of year left, these early January indications give me further conviction that full year 2021 Brokerage segment organic will be even better than 3.2% we delivered in 2020. Moving on to mergers and acquisitions, following an active December, we finished the fourth quarter with 10 completed brokerage mergers representing about a $100 million of estimated annualized revenues. And we've announced a handful more so far in January, representing an additional $85 million of estimated annualized revenues. This includes The Bollington merger in the UK, which we think will close in early February after receiving regulatory approval this week. I'd like to thank all of our new partners for joining us. And I extend a very warm welcome to our growing Gallagher family of professionals. As I look at our M&A pipeline, we have 30 term sheets signed or being prepared, representing around $300 million of annualized revenues. We believe we are the platform of choice for successful entrepreneurs looking to take their business to the next level, by leveraging our niche expertise, our tools and data, in addition to being a great place for their employees to advance their careers. We expect to have a very active 2021, particularly in the U.S. due to concerns related to possible tax changes. So, to wrap up the Brokerage segment for the full year, we delivered 5.4% growth in revenue, 3.2%, all-in organic growth. Adjusted EBITDAC margin expansion of 418 basis points, fueled by cost savings of about $180 million. And we completed 27 mergers representing about $250 million of estimated annualized revenue, a fantastic year for the brokerage team. Next, I would like to move to our Risk Management segment, Gallagher Bassett. Fourth quarter, organic edged back into positive territory, nicely surpassing our December expectations of being down as much as 2%, with some positive lift due to increasing COVID-related workers' compensation claims and saw strong retention in new business. So we ended 2020 with full year organic of minus 2.7%. And this environment to close a year in which core claim counts were down double-digits for more than 10 months of the year. And after posting 10% organic decline in the second quarter alone is a just terrific recovery story. Going back to April in the beginning of the pandemic, we set our sites on delivering full year 2020 adjusted EBITDAC, similar to 2019, even with full year revenues forecasted to be down $38 million or more. And boy, that the team deliver, the team proactively manage this workforce carefully rebalanced claim loads across adjusters and implemented expense controls, ultimately driving 2020 adjusted EBITDAC of nearly $150 million, $4 million better than 2019. Being able to grow full year EBITDAC despite organic revenues that were backwards. It's just fantastic work by the risk management team. As we look forward, January claim counts are trending very similar to the fourth quarter with many clients operating still at partial capacity with new business sold in 2020, incepting over the next few quarters and still room for substantial job recovery. We believe full year 2021 organic will be closer to pre-COVID levels in the mid single-digit range. Let me wrap up with some comments regarding our unique and resilient Gallagher culture. Culture guides our organization, our people in both good times and even more so in demanding times. And I believe culture is the source of our perseverance, our determination, and our constant push for excellence. I'm extremely proud of our collective successes during 2020, but more importantly, how we came together to work as a team, even while physically apart, our culture has never been better and I believe we're ending 2021 even stronger. Okay, I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks Pat, and good afternoon, everyone. I'll echo Pat's comments on great quarter and an excellent year. I too would like to extend my appreciation to the team. Today, I'll begin with some comments on our cost savings, provide some, a few observations from our CFO commentary document that we posted on our website. Then I'll do a vignette on our clean energy investments and finish with some thoughts on M&A, cash and liquidity. All right, let's turn to the earnings release, Page 6 to the brokerage EBITDAC table. You'll see that we grew adjusted EBITDAC by about $85 million over last year's fourth quarter, resulting in about 580 basis points of adjusted margin expansion. Within that, we realized about $60 million of cost savings relative to fourth quarter 2019 adjusted for merger. So underlying margin expansion was about 115 basis points on 3.1% all-in organic, which on its own is impressive. When you move to Page 8, in Risk Management segment, we grew EBITDAC a bit more than $4 million on slightly positive organic, resulting in about 190 basis points of adjusted margin expansion. Within that, we realized about $5 million of cost savings relative to Q4 2019, which was moderated just a little by new client ramp-up costs. So underlying margins were up just a bit, that too is actually giving the flattish organic this quarter. Categories of fourth quarter savings for the combined brokerage and risk management segment were consistent with second and third quarter. Reduced travel, entertainment and advertising about $25 million, reduced consulting and professional fees $14 million, reduced outside labor and other workforce savings $16 million, office supplies, consumables, and occupancy costs about $10 million. So that total is around $65 million, which is consistent with what we said at our December IR Day. Now looking forward the pace of recovery isn't clear, we came into the year with another virus surge. Now maybe some positive cases coming down. Some areas are imposing more lockdowns yet others are loosening up. There's been some successes but mostly delays in a vaccine rollout. And now it's looking like more and more that's the stimulus might be caught in gridlock here in the U.S. Regardless of whether you're looking at half full or half empty glass, very few outlooks are expecting the business environment to be much different by the end of the first quarter. So for us, when it comes to first quarter 2021, we're inorganic in the 3% to 4% range, and we're seeing expense saving similar to fourth quarter 2020, call it another $600 million – excuse me, $60 million. If that happens, and we could again show margin expansion over about 500 basis points. Then looking towards second, third and fourth quarters of 2021, it gets a little more tricky when you do your models, because the slope of the recovery is still uncertain and we're getting through – we're already realizing substantial COVID induced expense savings beginning early in April of 2020. But if the recovery steps up in those quarters and we get back to organic of, say, high 4% or 5%, it does give us a path towards holding full year margins, especially if travel and entertainment remains limited. Now, all of this needs to be taken into context. In 2017, 2018 and 2019, we were expanding margins 50 to 75 basis points a year on organic in that 4% to 5% range. Then the COVID hits, we execute on our cost containment playbook, and still managed to grow organic 3% that pops margins over 400 basis points in the face of this global pandemic. So now what I'm saying is that we have a fighting chance to hold or even improve full year margins here in 2021 on the prospect of getting closer to pre-pandemic organic growth later in the year. To me, that's still about a bullish story as you could write. Now, if we move to the CFO commentary document that we posted on our website, on Page 2, the blue fourth quarter column, you'll see most of the items are consistent with what we provided during our December IR Day, and that's in the gray column. FX came in a $0.01 better and severance and integration costs also a $0.01 better when you compare that to the prior quarters. Also on Page 2 in the reddish column, we're now providing our quarterly look at 2021, a few comments. First, foreign exchange. With the U.S. dollar weakening and if it stays that way throughout the year, 2021 revenue could see $100 million tailwind in brokerage and $14 million in risk management. Wouldn't be much EPS impact within risk management, but could translate late into a $0.05 or so for our brokerage segment, and that would even be better on reported EBITDA. Second, amortization expense. We're currently forecasting a little over $100 million a quarter in brokerage, which includes all announced mergers to-date. You can see the role in revenues associated with all announced mergers to-date on Page 5. And then also don't forget to adjust your amortization expense in the second and later quarters to reflect any future M&A you might be including in your model. Third, when you look at M&A multiples shown on Page 2 on the last line of the table, like that said, we had an active December closing ten. Three of which were on the larger end of our typical tuck-in size. That pushed the multiple up a tuner so this year, but still creating a nice arbitrage to our trading multiple. More importantly, it brings some really terrific merger partners to the team letting us grow better together over the long-haul. When you move to Page 3 of the CFO commentary in the corporate table, when you compare our December IR Day estimates in the gray column with our fourth quarter results in the blue column, you posted favorable interest expense due to strong cash flows, we had better clean energy earnings, in line M&A expense and a slightly more favorable corporate line. Also on Page 3, we're now providing a first look at 2021 ranges for the corporate segment, and that's in the reddish column. Nothing surprising and there's no change on our outlook for clean energy, still in that $60 million to $75 million of annual after tax earnings we've provided during our IR Day. So this brings me to my vignette on clean energy. You read on Page 4, Note 5 of the CFO commentary document that these investments are winding down at the end of 2021, unless there's an extension. That means in 2022, we will have zero GAAP earnings. But remember, that would be more than replaced with substantial cash flow benefits. In other words, 2021 and prior years were the credit generation years when we report the GAAP benefit or P&L. But 2022 starts the cash harvest years, where we will get considerably larger cash benefits in our operating cash flows. Here's the shortcut way to think about how to compete those cash benefits. First, if you go to Page 14 of the earnings release about the seventh line down in our balance sheet, you’ll read that we have a deferred tax asset of over $1 billion, mostly consisting of clean energy credit carry forwards. With one more year of credit generation, that asset should grow by another $100 million. So call it $1.1 billion of credit carry over is by the end of 2021. Then assuming 2022, we will begin using more credits than we’ve been using thus far. How – third, then how fast we’ll be using those credits will depend on how fast we grow our U.S. taxable income. But for this illustration, and if you assume a seven-year period, it might mean we’d be harvesting about $125 million to $150 million in 2022 with that ramping up to say about $175 million to $200 million in 2028. It’s a little odd that GAAP earnings go to zero and then the cash benefits become dramatically better, but that’s just how it works. This is and has been a really important part of our story over the last decade. So I think it was worth some extra time today. All right, let me go on to some comments on cash in M&A. At December 31, available cash on hand was nearly $700 million. We have a significant untapped capacity in our – on our revolving credit facility. And we have another year ahead of us have really strong cash flows. That might mean that we would have perhaps two point – up to $2.5 billion of M&A capacity here in 2021. That’s a terrific position as we come into our year that we see as perhaps the most active year ever in the brokerage M&A space. Okay. That’s wraps up 2020 and we’re positioned really well for 2021. Organic looks better, bolt-on M&A, it looks better. We have a decent chance of keeping a large chunk of our cost savings, assuming – harvesting cash flows from our clean energy initiatives. And most important, I can feel our team’s excitement about coming out of the pandemic stronger than ever before. My thanks to them for another fantastic year. Back to you, Pat."
},
{
"speaker": "J. Gallagher",
"text": "Thanks, Doug. Operator, let’s go to questions and answers if we can."
},
{
"speaker": "Operator",
"text": "Thank you. The call is now open for questions. [Operator Instructions] Our first question comes from the line of Elyse Greenspan with Wells Fargo. You may proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good evening. My first question Doug, I appreciate the color by speaking provide on the expense savings. So as we continue to think about I guess coming out of COVID, I know last quarter, I believe you guys had said, right, kind of when things settled that half of the state could persist and maybe think about some level between half and the $60 million, I guess I’m just talking about brokerage in kind of the middle two quarters of 2021. Do those figures, I guess I would assume that they still seem about right given where we sit today."
},
{
"speaker": "Doug Howell",
"text": "Yes, I think your recollection is right. It was I did say as, it’s that there was a silver lining coming out of something so terrible, and that’s we’ve learned a lot about ourselves. I think that ultimately we think there’s $125 million to $150 million of annual cost savings that we might, that we’re pulling forward earlier into our continued march on margin improvement. As it emerges for the quarters this year, it really is a kind of a sensitive interplay between organic and then just really what happens with the economy. We’ll follow our customer’s expectations. We are learning that they are much more receptive now to virtual interactions allows to get our niche expertise at the point of sale, easier than jumping on an airplane or in spending days traveling. So we are learning a lot in that, but we will follow our customers’ expectations. How that exactly plays out in the second and third and fourth quarters really depends on how fast organic moves from that 3% to 4% range up into maybe the 5% or 6% range."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. That’s helpful. And then on the M&A environment, so you guys mentioned, right, you posed a couple of larger deals to end December, right. The two of us, the multiples on the $300 million of revenue within those 30 term sheets that you guys mentioned. Can you just give us a sense like kind of the skew are there any larger ones in there? Or is it more just kind of the typical smaller bolt-on deals that you guys focused on of late as well?"
},
{
"speaker": "Doug Howell",
"text": "Yes, I would say that just clarifying that we had some larger tuck-in ones at the end of the December call in revenues that $20 million, $25 million range. The deal sheets that we’re looking at right now, $300 million of revenue spread across 30, 35 term sheets, they’re in the smaller range, nice local family owned entrepreneurial businesses. The range is lower than where we are right now for year. So I would see us back kind of more where we were in the second, third – first, second and third quarters."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then can you give us an update on Capsicum, your reinsurance business, I guess, where that sits at the end of the year. How that’s been trending from both a growth and margin perspective?"
},
{
"speaker": "Doug Howell",
"text": "Yes, it’s doing really well. We couldn’t be more pleased with the team. Pat can talk about some of the cultural excitement that we have on that. But financially, they’re growing in double-digit still; their margins are north of 30%. We see terrific opportunities for that business."
},
{
"speaker": "J. Gallagher",
"text": "As you know, this is my second go around. This was a lot better."
},
{
"speaker": "Elyse Greenspan",
"text": "And then one last question, Doug. Is there a chance that there isn’t any kind of extender bill that would extend your ability? I know you gave us a lot of helpful color assuming that you can’t generate any credits beyond the end of this year. Is there a chance that there could be any extended bill or I guess, most likely not at this point?"
},
{
"speaker": "Doug Howell",
"text": "Sure. I always think there’s a chance. And I think that when Congress said about this, about helping us get better in burning some fossil fuel. They wanted help in making it better. So as long as we’re going to be using it, let’s make it better. So I think they see that, and I think they see the opportunity for this to continue to help innovate. So we hope that there’s some – there are some proposed legislative changes that would – that possibly could make the extension happen. So we’re hopeful for that. And we certainly are trying to get that message on everybody’s desk that we can."
},
{
"speaker": "Elyse Greenspan",
"text": "Hey, thanks, Doug and Pat for the color."
},
{
"speaker": "J. Gallagher",
"text": "Thanks, Elyse."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Elyse."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question."
},
{
"speaker": "Phil Stefano",
"text": "Yes. Thanks and good afternoon. Thinking about the sales pipeline, I’ve been trying to contemplate, I guess, in my mind, clients would have hunkered down early on in COVID and been less likely to change brokers or to really contemplate a move like that. Does it feel like people are just getting more comfortable with the world we live in today and that’s opening up or when we think about the past from 3% to 4% organic growth to 5% to 6% organic growth? Are we just waiting for the economy to improve and the shops to get in the arms so everyone can get back out there and living."
},
{
"speaker": "J. Gallagher",
"text": "Well, Phil, this is Pat. There’s a lot of answers to your question. So let me back up a little bit. First of all, did the clients hunker down? You start with March of last year and the answer, that’s, yes. Having said that they have a lot of needs and a lot of requests, so we were running webinars around COVID return to work all kinds of different as cyber would have you blew my mind, thousands of people signed up. And it was not unusual for us to run a webinar with 5,000 attendees. I mean, I’d never heard of such a thing. So there’s a huge thirst for information, which helped our people, of course, know exactly some of the hot buttons that they should be talking to potential clients and to get out. And I was amazed. I really would have told you that I thought maybe new business would have hunkered down. I didn’t think our lost business would increase because of that. In fact, it’s amazing to me, that kind of new business that we did generate. So I think that it gives us a lot of confidence to sell the kind of business we sold last year. And you’d get some fall over from 2019 into the first quarter, maybe a little in the second quarter, but everything from May on was really generated after the first of the year, so really a incredible new business year. Secondly, are we seeing the advent potentially of people beginning to come back into the businesses? I think, yes. I think we’re seeing that there is going to end whether stimulus happens or not. I think businesses have learned how to do this tick just to look at your local restaurants. And I had a better a year ago, they weren’t March, they might, they’re not going to survive. Take out. It’s not making them robust, but they’re surviving and they’re ready. I mean, in the Chicago land area, now we can go to restaurants again, they have very limited occupancy, but they are ready. They’re welcoming. They want people back and people are excited about it. So I think the pent up demand for people to be able to go do things is also going to be helpful. Then lastly, let’s not forget something. I’ve told you guys this a thousand times, I don’t like hard markets and I get it. They all look good on paper what have you, but they tick every customer off. And they’re suffering through this right now, because they don’t really have a choice. But they are going to shop. And we are there for them to understand that both our data capabilities, as well as our professional niche capabilities and our ability to work them through the process of taking more risk, becoming more self-insured, that's our bread and butter. We're better at that than anybody. So I think that, that is it's all of those combined that leads me to believe that we see a very robust new business year ahead in 2021 and 2022."
},
{
"speaker": "Phil Stefano",
"text": "Okay. Thanks. And switching gears a bit, I feel like the dividend is something that we don't really talk about, but I was a bit surprised by the extent of the raise in the past week or so. Is there a long-term growth rate that you target a payout ratio, or maybe you can just refresh our understanding on how you think about the dividend?"
},
{
"speaker": "J. Gallagher",
"text": "Yes, I mean, we just pop it up a little bit more yesterday. We did raise, I think it's an indication that our cash flows are very strong. We typically raise it a few cents and then maybe a little bit more and sit there for a year or so. But I think there was a vote of confidence by the board that said that let's take that dividend up just a little bit more this week. So we did that. And so we'll look at that every year, but we agreed with the observations that cash is strong. So let's increase the dividend."
},
{
"speaker": "Phil Stefano",
"text": "Okay. Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mike Zaremski with Credit Suisse. You may proceed with your question."
},
{
"speaker": "Mike Zaremski",
"text": "Good early evening. I guess first question on expenses, I know we've talked about this a lot but it's just – it's been phenomenal. And so I try to understand do you feel that a lot of these expenses that will persist are kind of more Gallagher’s specific and it'll give you a leg up on your competitors, or like do you feel like a lot of these things are things that just your competitors are going to catch up to you eventually, you're just a kind of first mover. I know that's maybe a complicated question, but just trying to get a sense of whether this kind of gives you a advantage that'll persist versus peers or others just are going to kind of follow you guys, but just will take some time?"
},
{
"speaker": "Doug Howell",
"text": "All right. So let's break this into a couple of things. Let me talk about who our competitor, 90% of the time we're competing with somebody that's smaller than us, right? So when you look at the – where are we really getting leverage? I think there we're getting leverage because of our scale, especially relative to that, but that level of competitive, the smaller ones that we compete with day in and day out. I think we have opportunities to continue to use our lower cost labor locations and our centers of excellence. I think our ability in order to rationalize our real estate footprint I think that we can buy goods and services cheaper. I think our ability to automate many of the interactions with the clients and with our own employees all of those things, I would say that Gallagher is positioned. We have a common agency management system in most of our countries, in most of our businesses. Those are things that we believe that we will continue to bring scale advantages versus our smaller competitors. How do I feel about it comparing to, let's say the other top 10 brokers, first of all, you got to pick the ones that have the culture that want to work together and make it happen. And then you've got to pick the ones that haven't already gone down this journey to see whether or not there yet or not. But we think that we're in really terrific place to continue to leverage our technologies and our scale compared to most of our competitions. So I don't know if they're catching up or if they're already there or they just don't have the culture to pull it off."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. That’s helpful, Doug. Did you more straight forward question, free cash flow for 2021, did you site kind of an estimate for what we should expect?"
},
{
"speaker": "Doug Howell",
"text": "I didn't, but I said that we probably could do about up to $2.5 billion in M&A for this year. So if you break that apart, we've got $700 million on hand. And if you look at our operating cash flows being somewhere in the $1.3 billion to $1.5 billion range something like that, I think. And then you borrow a little bit more so that's how you get to the $2.5 billion."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. And just lastly curious a broker that reported earnings earlier today, kind of actually talked about stepping on the gas on hiring and taking advantage of some of the M&A that's just taking place in the industry. Just curious, are you seeing any increased opportunities on the hiring side?"
},
{
"speaker": "J. Gallagher",
"text": "Definitely seeing opportunities from two areas, Doug mentioned that 90% of the time we compete, we compete with smaller brokers and the smaller brokers have the problem of just simply not having the capabilities that clients are starting to ask for. And these can be simple questions, like, how do I know? How do I know you just gave me the best deal? When I was out selling 30 years ago on a daily basis that would be answered by saying, I went to three carriers. This is the best price that does not float today. They want to know what you're doing with clients, what carriers are doing at, where the ranges are, what their loss ratio looks like to bear to others. They want detail, they want data. Smaller people can't do that. So what you've got is folks that are losing accounts to the likes of ourselves, and we're out telling them, why wouldn't you come to a place that's happy to pay you, for what you hunt and kill. And at the same time, you have all the support and the capabilities in the world. We can write any account of any size, no matter where it's located in the world and that's very attractive. And then of course, there's always opportunities as larger competitors, we clearly believe we offer a cultural difference."
},
{
"speaker": "Mike Zaremski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Greg Peters with Raymond James. You may proceed with your question."
},
{
"speaker": "Greg Peters",
"text": "Good afternoon. Just a follow-up on Mike's question, I don't know, if I missed it in the prepared remarks. The free cash flow for 2020 was what?"
},
{
"speaker": "Doug Howell",
"text": "For 2020, our free cash flow in operating – free operating cash flow be about $1.4 billion this year in the cash flow statement, when we file our 10-K in a week, you'll see it's around $1.4 billion."
},
{
"speaker": "Greg Peters",
"text": "And so you said the guidance for 2021 is $1.3 billion to $1.5 billion. Was there some one-time benefits that floats through in 2020 that you're not going to realize in 2021, otherwise I would normally expect the free cash flow to grow, if you're growing your top line and bottom line, I expect free cash flow to grow. And what am I missing?"
},
{
"speaker": "Doug Howell",
"text": "I don't think it will appreciably change significantly in 2020 versus 2021, we will grow at – if we hold margins in there, we're going to grow based on not including acquisitions in that number. So if the cash flows off the acquisitions, we will also – that too…"
},
{
"speaker": "Greg Peters",
"text": "So then just to close the loop on your previous comments, when you said in 2022 that you'll drive, was it $125 million cash benefit from the pull down of the tax credit?"
},
{
"speaker": "Doug Howell",
"text": "In 2022, yes?"
},
{
"speaker": "Greg Peters",
"text": "I can assume whatever free cash flow growth I have off of 2021 on an operating basis. And then just add on an additional $125 million. Is that a fair way to think about it?"
},
{
"speaker": "Doug Howell",
"text": "Yes, if you factor in mergers. Yes, that's a fair way."
},
{
"speaker": "Greg Peters",
"text": "Okay. The second question I had listen, I know you've comment on this before, and you were sort of dancing around it in the prepared remarks and the Q&A. But you just talked about an 8% rate increase across your entire footprint. And you talked about, terms and conditions being changed – changing. I'm just curious about your customers and how they're dialing up retentions reducing limits to offset the price. And I guess what I'm really trying to gauge is how does it look here at year end 2020 verse how it was looking at year end 2019?"
},
{
"speaker": "J. Gallagher",
"text": "Well, I think it's continuing to get stronger, Greg. This is Pat. I think that, look, if we're telling you that, basically we're seeing rate increases of around 8% and organic is about 3.5%. You see a 5% difference where to go. Well it went to modification of what the purchase – with the purchasers buying. And that's our job. I mean we sit down with these guys and say, men and women, and say, look here are your options, you had $250 million of limits last year. We could show you the stats that would be a very unusual claim to break the $150 million barrier. Do you need that extra $100 million? And we help them work through that. Retentions are a very big part of it. And a big part of it is, and this is where our history comes from, clients that enter self-insurance for the first time. I don't understand this, what's the deal. Well, why don't you take a $150,000 retention and you'll basically save ex on the transaction that you'll only have to pay, if you do have the claims. Now, let’s really focus on loss control. So, I don’t need to get too detailed with you, but that’s really – that’s what we do for a living."
},
{
"speaker": "Greg Peters",
"text": "Right. Well, I guess, what I was – I had assumed that the difference between the eight and the three was a combination of retentions, reduced limits and reduced economic activity, but maybe, I was overthinking there."
},
{
"speaker": "J. Gallagher",
"text": "Okay. That’s fair. That’s fair. Yes, I look out the economic activity. That’s fair."
},
{
"speaker": "Greg Peters",
"text": "Okay. The final – I guess the final thing and I know you’ve been talking about M&A, but listen, the dirty little, not so big of a secret is the two – number two and number three are out there and the merger dance. And it feels like that is an opportunity for dislocation for customers being unhappy for you to bank new hires, et cetera. And so I guess from the time that they announced this thing back in March of last year to now, have you seen anything in the marketplace that’s disruptive that you see as an opportunity or is the disruption, if there is any going come later in this process?"
},
{
"speaker": "J. Gallagher",
"text": "So Greg, let me, obviously, I’m not going to talk about our competitors and I – but I’ve said to you many times, change is good for us. And when we move to further consolidation of three players at the top end of the spectrum and our name happens to be one of them, there’s lots and lots, and lots of opportunities along the lines of everything you’re talking about. There’s clients that have never really talked to Gallagher that we’re going to have a shot at. I mean, if you go back in time and I went to the RIMS Conference 100 years ago, nobody came by our booth. We’ve got 5,000 people that show up to our RIMS Conference virtually. I mean, there’s interest. And so really, it’s – we’re in a very, very good position."
},
{
"speaker": "Greg Peters",
"text": "Got it. I probably got a little too cute on the question, sorry about that, but thanks for your answers."
},
{
"speaker": "J. Gallagher",
"text": "Sure. Thanks, Greg."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Yaron Kinar with Goldman Sachs. You may proceed with your question."
},
{
"speaker": "Yaron Kinar",
"text": "Hi, good evening. I guess my first question, just trying to tie the organic growth to margins next year. So, I would think there are different ways to get the 4% to 5% organic growth, and each of those potentially, has a very different impact on margins, namely, if you’re getting more of that organic growth through rate versus exposure unit growth. So maybe, you can talk about that a little bit. And then on the flip side, I think in the past you used to talk about, of needing to get at least 3% organic in order to keep margins stable. How should we think about, let’s say a 3% organic growth for – if you achieve that in 2021, what does that mean for margins?"
},
{
"speaker": "Doug Howell",
"text": "All right. The workload, the difference in workload on a customer that is adding exposure units, i.e. adding vehicles or changing miles, isn’t significant whether they’re adding a couple of failures. So, the workload associated with a rate increase that comes from exposure units. Not that much more. If it comes from additional rate, that means we want to go out and shop more, we’ll take a little bit more effort, but because of our efficiencies, we can do that at a pretty low cost month. So, just the number of policies or the exposure units or a modest rate increase or decrease doesn’t change our workload that much. So, I wouldn’t say that that would have a significant impact on margin if you’re kind of in that 2% to 4% range on rates and exposures. When you’re asking the next part of the question about when – where do we see the kind of the old tried and true line, if you grow organically 3%, is there margin lift in it? Yes, I think there is, is it – in this year in 2021, since we were up 400 basis points in margin this year alone, I think that’d be pretty tough to get a 3%."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. So, beyond 2021 though, if you do achieve 3% organic growth, even though the bar is so much higher today, you can still achieve margin improvement even with that."
},
{
"speaker": "Doug Howell",
"text": "Yes. we’ve moved that to 3% to 4% over the number of years. As our margins are getting over 30%, there’s just not as much there to harvest as our technologies get rolled up. As our scale grows, we’ll be able to have margin improvement on those tuck-in acquisitions that can come onto our chassis can use our technologies. It’s really more about selling more than it is necessarily about making more margin. but there would be upward tick. Do I see that in at 3% organic growth in 2022? I don’t know if we’d have that much more margin expansion."
},
{
"speaker": "Yaron Kinar",
"text": "Okay."
},
{
"speaker": "Doug Howell",
"text": "Do it for five years in a row. Sure, there could be some."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. And then was this step-up in Gallagher’s margins was a good portion of that being retained. How do you think about the – about acquisitions and potential targets? I would think that the bar to clear there could be significantly higher that your margins are higher today."
},
{
"speaker": "Doug Howell",
"text": "If they’re running good margins for the business that they’re in and they show a prospect for growth, we’ll buy them regardless of whether it’s dilutive to all our margin if they come in. they are what they are and if we can improve their margins, terrific; if they’re already at the upper end of the scale, then terrific. But they just happened to be in a space that requires a significant amount of service that maybe, it will say that their margins are 22%, but they have a good growth. We’ll still buy them. And we’ll let you know, we’ve done that in the past, where we’ve said a role in impact of acquisitions had X, Y, or Z impact on our margins."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. Thank you."
},
{
"speaker": "Doug Howell",
"text": "Sure. Thanks, Yaron."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of David Montemaden with Evercore ISI. You may proceed with your question."
},
{
"speaker": "David Montemaden",
"text": "Thanks. Good evening. Just a question on P&C exposure units; in the press release, it sounded like, we’re continuing to see an increase in exposure versus April and May 2020, which not a big surprise. but I guess I’m wondering how exposure units were trending thus far this year relative to 4Q, obviously a tough comp year-over-year. but are we continuing to see an improvement in exposure units in 4Q or is it sort of flattened out thus far in January?"
},
{
"speaker": "J. Gallagher",
"text": "They’re flat in January."
},
{
"speaker": "Doug Howell",
"text": "Yes. I think that we’ve kind of bounced off the bottom. We’re not seeing significant daily step-up. We are seeing – we look at our global positive endorsements that go through on our policies on every day. And we can see that that’s still showing a nice upward trend similar to pre-pandemic, but you weren’t seeing massive exposure unit growth a year ago in the – fourth quarter of 2019 or early into 2020. You weren’t seeing it there. but there is a steady increase. There’s been a bounce off the bottom and we would expect throughout 2021 and 2022 as the economy recovers that those exposure and this would go back up also, but not much different today than let’s say, in December."
},
{
"speaker": "David Montemaden",
"text": "Got it. Okay. That makes sense. And then I’m just – I guess I’m wondering, after we’ve gotten through some of the renewals here in January, I guess, are you seeing any movement on the commission rates? And I guess just conversations around contingents and supplementals, maybe, an update on how those are looking."
},
{
"speaker": "J. Gallagher",
"text": "Yes. I think that commission rates and the like are solid. We’re not having pressure from our carrier partners to try to diminish their payment to their distributors and as far as contingents and supplemental. So, we think we’ll have a solid year, some growth this year."
},
{
"speaker": "David Montemaden",
"text": "Great, thank you."
},
{
"speaker": "J. Gallagher",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mark Hughes of Truist. You may proceed with your question."
},
{
"speaker": "Mark Hughes",
"text": "Thank you. Good afternoon."
},
{
"speaker": "J. Gallagher",
"text": "Hi, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Why the rebound in risk management, I wonder if you could break that into pieces, more claims, more employees, new business. How does that shake out?"
},
{
"speaker": "J. Gallagher",
"text": "Yes. well, I think Doug, if you want to granular to the percent, I can’t do that. but it’s – you hit right on it, Mark. I mean, we’ve got claims are recovering. We mentioned in our prepared remarks that COVID claims in particular have helped out. The economic activity people are adding more folks and those are the factors that produce claims. So, as we get people driving, as we get people going back to work, they will come back to more normal levels. And we don’t hope to get more COVID claims, but they are filling a hole in the bucket right now."
},
{
"speaker": "Doug Howell",
"text": "And they had a terrific new business here, too. It’s starting to incept. you saw that we had some. It’s been a couple of million or a million or so on some new client ramp up costs as we transitioned to them. We’ve got a solid outlook for this year of being back and been single digits maybe, this year. So that team has done a terrific job of new business wins too. Didn't hit a ton this year, but it will next year."
},
{
"speaker": "Mark Hughes",
"text": "How are you thinking about the open-broker, it sounds like that was particularly strong in the fourth quarter. Is that continued into Q1?"
},
{
"speaker": "J. Gallagher",
"text": "Yes, it's continued. It's very strong, Mark. I mean, you understand wholesaling is a business that has an awful lot of market leverage up and down. So we were in a very firm property market, in particular our team. And this is – what's exciting about this is, these brokers do not want to go to wholesalers. It's not a friendly business in the sense that we're looking to give you one-third of our commission. So they're providing an unbelievable service to the brokerage community, with whom we trade about 15,000 in the United States alone. And those people need help and we're giving them help and that's why along with rate. So we're getting at both in item count and rate just by being ready to be very, very helpful."
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "J. Gallagher",
"text": "Thanks Mark."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Paul Newsome, [Managing Director]. You may proceed with your question."
},
{
"speaker": "Paul Newsome",
"text": "Good afternoon. I wanted to ask, tell me a little bit more about your comment, about the lack of shopping by the customers. I mean, I think of a hard market is one with increased shopping, but one of your comments seem to square with every company I cover where the retention levels seem to be really unchanged through the last couple of years. Why do you think we haven't seen the increase in shopping? Why do you think the customers seem to be just kind of taking rate and moving on?"
},
{
"speaker": "J. Gallagher",
"text": "Well, Paul, again my comment was predicated on two things. To start within the pandemic, I didn't think customers would be having people knocking on their door as much as they do right now. And as much as they did in 2019. And I think that as they started to ferret their way through, what's going to go on in this pandemic themselves, they were willing to very much hunker down and say, I've got a good insurance program, this is where it is. I don't have – I've got to be considering my own survival tactics. And I surmised there'd be less shopping of our existing business. Now I was right a little bit. It certainly didn't stop shopping. It wasn't like everything came to a grounding halt. But if you're a good broker and we've got really good competition in this market. In our hard market, you early on explained to your client that if you are unhappy with hard market and you want to be really unhappier, shop the hell out of it, because you're going to get slaughtered. And in fact hard market shopping does decreased, pardon me. Unfortunately, as things ease up a bit, people are unhappy and it tends to increased shopping. So right now we're in a very firm and firming market, and people understand that they need our expertise. And it also does scare some of those little competitors that we compete with 90% of the time out of being so bold as to say they can do better than we do, pretty tough to prove it."
},
{
"speaker": "Doug Howell",
"text": "Yes, I think there's a flight to quality. I think that when you sit down and look at what you get from Gallagher, get more and how do you get more from us? You get price, you get service, you get access, you get creativity, you get innovation. It's pretty hard to leave that if you don't have competition knocking on the door that can offer that. So I think it's a different era from when you and I were cutting our teeth Paul, that it basically as small, small brokers competing with small brokers offering kind of the same thing, you get so much more from Gallagher today, than you ever got before."
},
{
"speaker": "J. Gallagher",
"text": "And another thing piling in on that. Once you show someone how to get through these days and primarily by doing what we do so well, which is help people deal with assuming risk, bringing Gallagher Bassett into help pay the claims, mitigating those claims and showing them that in the long term, they've really garnered a lot more control of their destiny. You never lose those clients. A client that moves from the traditional first dollar purchase into any form of self-insurance pooling with other public entities, moving into a group, captive doing their own single parent captive, taking a large retention on their worker's comp in a very heavy employee state. Once you do that for them, it shifts the game completely."
},
{
"speaker": "Paul Newsome",
"text": "Makes sense. Switching to a different topic. Obviously with the change in the quick tax rates potentially going away, we're probably looking at a change in how we value your company, plus on earnings, more of something else like free cash flow. I guess my question is, is free cash flow the right number, is operating cash flow the right number. I'm just curious is I know their customer usually get intertwined with yours in the measurements and what's your theory on how we should measure cash flow if we have the proper way to do it?"
},
{
"speaker": "Doug Howell",
"text": "Yes. Great. I think that's a terrific question. And all right, first, I still believe that EBITDA gives a good proxy for how to value a broker. Then you just have to back off the cash taxes paid. And interest expense, of course, and the cash tax was paid, an interest shield on that. But if you basically start with EBITDA, you're going to get pretty close to the way, and that's been a traditional way. So what does that mean for Gallagher is that we've said this for years, we're still pay taxes. People sometimes think that we're not paying our fair share. That's not the case at all. We've still pay taxes. It runs about, I said this, if you go back to when tax changed that we are – we think that we're going to pay in that 5% to 6% to 7% of EBITDA range just as a proxy. We're probably at that same range, even if tax rates go up to 28% from 21%, it would be a book rate differential. It wouldn't really be a cash difference. If the Biden tax measures were put in place, it might cost us 10 million bucks a year in taxes, more Paul, but it wouldn't be a huge number. The value of tax credits become more valuable if tax rates go up. So really for Gallagher to take our EBITDA, back off our CapEx, back off our interest expense and put in 7% or 8% for cash taxes paid and you get pretty close to the cash flow amount for Gallagher. I might've missed something in there, but I think I got most of the pieces in that, but I would start with EBITDA still."
},
{
"speaker": "Paul Newsome",
"text": "Fantastic. Thanks guys. Appreciate it."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Paul."
},
{
"speaker": "J. Gallagher",
"text": "Thanks, Paul."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question."
},
{
"speaker": "Meyer Shields",
"text": "Great. Thanks. Good evening. One small question, one big one. Are the claims that you're seeing recover in Gallagher basket, sorry, Gallagher Bassett. Are any of those, like just late reported claims that occurred earlier, or that just now you're seeing more claims because of COVID or because of rising economic activity?"
},
{
"speaker": "J. Gallagher",
"text": "More claims rising out of better economic activity. And the addition of COVID claims, which was a category that didn't exist a year ago."
},
{
"speaker": "Meyer Shields",
"text": "Okay, perfect. And then bigger picture, Pat, you talked about Gallagher's ability to write any clients to actually win those clients. Didn't need to a more extensive set of consulting services comparable to the brokers that are bigger than you?"
},
{
"speaker": "J. Gallagher",
"text": "Yes, we do. [indiscernible] I’m sorry when it was?"
},
{
"speaker": "Meyer Shields",
"text": "No. When you said we do, is that we – the Gallagher has those services or needs them in the same proportion?"
},
{
"speaker": "J. Gallagher",
"text": "No. No. We do. We've got them. I mean, Doug was going to go down the line. If you take a look at our verticals, our niche capabilities, I mean, we don't stand second to anybody and I can go through the list of those. We provided every time we get a chance, but, you take a public sector client anywhere in the world, you take a college or university we had some great college and university wins in the last month. Names that if I throw them out, which I won't today, you'd go, wow. And I'm talking on a global basis. We'll be probably the largest provider of college and university risk management advice in Australia. So you're not going to be winning those types of accounts. We're very – we've gotten much stronger in terms of our benefits capabilities. When you take a look at what we do on the consulting work for health and welfare alone, but also all the other human resource needs. I mean, we're clearly a top three consultant in that regard. So, no, I mean, look, we know that over 90% of our business falls include, defined niches, which we have expertise that we think is frankly, better than our large competitors."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Excellent. Thanks so much."
},
{
"speaker": "J. Gallagher",
"text": "Thanks, Meyer."
},
{
"speaker": "Operator",
"text": "Our final question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question."
},
{
"speaker": "Phil Stefano",
"text": "Yes. Thanks for taking the follow-up. I was just hoping, is there any way you can help frame for us what the ceiling on the brokerage organic growth – brokerage organic margin – brokerage margin might be?"
},
{
"speaker": "J. Gallagher",
"text": "Phil, that's a tough question. I'd rather not, but I think that the answer is, it's just such an interplay between organic service expectation by our clients, and then in underlying inflation too that we face every day and certain of that. Right now, we're in a low wage inflation environment. We've kind of been in a low wage inflation environment since really 2007, 2008. We're getting more efficient with scale. Technology costs are coming down; on the other hand there are costs that more specific technical expertise costs more. Getting smarter people on your payroll that can handle some of the really, really technical aspects of what's going on, systems there's cost inflation and systems right now, so it's a tough, tough answer, but you're seeing the brokerage business somehow is running around 30 points plus or minus two points right now. That's the way it's running. You look across Austin and the other large Publix, and you look at the PE owned firms. There's a number around 30% plus or minus a couple of p0oints there."
},
{
"speaker": "Phil Stefano",
"text": "Yes. Fair enough. I figured I'd give it a try. Thank you."
},
{
"speaker": "J. Gallagher",
"text": "Thanks Phil."
},
{
"speaker": "Operator",
"text": "Ladies and gentlemen, you have reached your..."
},
{
"speaker": "J. Gallagher",
"text": "I think that's all our questions, yes."
},
{
"speaker": "Operator",
"text": "Yes. I would like to turn it back over to you, Mr. Gallagher for closing remarks."
},
{
"speaker": "J. Gallagher",
"text": "Thanks. And thank you again, everyone for joining us this afternoon. We mentioned this in our prepared remarks, but we delivered an excellent quarter and full year, and we all know how difficult the economic environment was. So I would like to thank all of our Gallagher professionals around the globe for being flexible, working hard and never losing focus on our job at hand. I'm competent that we can deliver another great year of financial performance in 2021, and truly believe that as an enterprise, we are just getting started. So thanks for being with us folks. We appreciate it."
},
{
"speaker": "Operator",
"text": "This does conclude today's conference. You may disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 3 | 2,020 | 2020-10-31 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Co.’s Third Quarter 2020 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today’s call is being recorded. If you have any objections, you may disconnect at any time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company’s 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you. Good afternoon. Thank you for joining us for our third quarter 2020 earnings call. Also on the call today is Doug Howell, our Chief Financial Officer; as well as the heads of our operating divisions. We delivered a very strong third quarter. Despite the current global health crisis and the related economic slowdown resulting from COVID-19, our teams continue to execute at the highest levels. While we continue to place health and safety first, we are selling new business, we are servicing and retaining our clients, we continue to look at merger and acquisition opportunities and our bedrock culture keeps us working together even while physically apart. These are times when our global capabilities, niche expertise and product specialists support our local professionals as they help our customers navigate these challenging times. I’d like to thank our 30,000-plus Gallagher professionals for their efforts and relentless focus on delivering the very best Insurance Brokerage, Consulting and Risk Management services our customers. That is the Gallagher way. Moving to our third quarter financial performance. We grew our combined Brokerage and Risk Management revenues in the third quarter organically and through mergers and acquisitions, and together with our expense control efforts, delivered excellent growth in EBITDAC and net earnings. These results demonstrate our operating flexibility, which has enabled us to quickly adjust our expense base, optimize our workforce, improve our productivity while also raising our quality. Let me break down our results further, starting with our brokerage segment. Reported revenue growth was a positive 8.3%. Of that, more than half or 4.2% was organic revenue growth. We did have some favorable timing, I’ll discuss that more in a minute. Net earnings margin was up 334 basis points, and adjusted EBITDAC margin expanded 632 basis points to 33.4%. Net earnings up 37% and adjusted EBITDAC up 32%, so another excellent quarter during a global pandemic, a fantastic job by the team. Let me walk you around the world and give you some sound bites about each of our brokerage units, and I’ll start with our P/C operations. In U.S. retail, another strong quarter with organic growth of about 4%. We saw solid new business and slightly better retention versus last year’s third quarter. Rate increases are more than offsetting exposure unit declines, midterm policy modifications, including full policy cancellations, are similar to prior year levels. And our U.S. wholesale operations, risk placement services, organic was 8% and our open brokerage business even better than that, while our MGA program binding businesses returned to positive organic in the quarter. Hereto, rate increases are more than offsetting exposure unit declines. Moving to the UK. Around 2% base organic with stronger growth in our London specialty business due to firmer pricing. In Australia and New Zealand combined, also around 2% organic, with New Zealand slightly stronger than Australia. New business is down a touch in Australia and up in New Zealand. Rate increases there remain positive, but not enough to offset exposure decline. And finally, our Canadian retail operations posted organic of 8%, another terrific new business quarter and stable client retention. So overall, our global P/C operations reported about 4% organic in the quarter, again, an excellent result in a difficult environment and on the higher end of our mid-September expectations. Moving to our employee benefit brokerage and consulting business, third quarter organic was positive 6%. This includes a large life insurance pension funding product sale that we expected to close in the fourth quarter. Otherwise, new consulting and special project work remains soft, while covered lives under employer-sponsored health plans continue to be more resilient than headline unemployment numbers. So when I bring P/C and benefits together, organic of 4.2% and even allowing for the big benefits win, a great quarter. Looking forward to our fourth quarter. First, recall we had a terrific fourth quarter last year, 6% plus organic, so we’re starting off with a tough compare. Second, I just discussed some favorable timing here in the third quarter, so I don’t see us hitting 4% again. But thus far in October, P/C retentions, new business, full policy cancellations and other midterm policy adjustments are in line to slightly better than the third quarter, so perhaps we can read nicely in the 2% to 3% range. That would deliver a full year 2020 around 3% organic, which will be a great year in this environment. While there is still a lot of economic and governmental uncertainty which makes forecasting organic a challenge, we can control what we spend. We’ve demonstrated over the last seven months that we can execute on our cost containment playbook that makes us highly confident we can deliver another quarter and full year of really strong EBITDAC growth. Now let me give you an update on the P/C rate environment. Rate again continued to move higher around the globe during the third quarter. Globally, caught up nearly 7% with tighter terms and conditions and increasingly restrained capacity. By geography, Canada has seen the greatest rate increases, up more than 9%; the U.S. is up about 8%; followed by the UK, including London specialty at about 6%; and Australia and New Zealand, around 3%. By line of business, property remains the strongest, up 12%; next is professional liability, up over 10%; other casualty lines are up 5% to 10%, with umbrella rate increases at least twice that level; and workers’ compensation is flat. So while P/C rates are moving higher, the total amount of premium increases our clients are paying are more modest. This is a result of reduced exposure units, higher deductibles, lower limits and clients opting out of coverages. Looking forward, October results are already indicating continued increases during the fourth quarter, and the carriers in the face of catastrophe, the pandemic, rising casualty loss cost, low investment returns, are making a case for firm rates to persist. But remember, that’s where we excel. Our job is to make sure our clients get a well-structured insurance program at a fair price. Regardless, it is certainly a more difficult market today than last quarter, and we are seeing some pockets of a hard market in certain lines and geographies. I see that continuing into 2021, next year, organic should be better than we are seeing this year play out. Moving on to mergers and acquisitions. We completed five brokerage mergers during the third quarter at fair multiples. I’d like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing Gallagher family of professionals. As I look at our M&A pipeline, we have more than 40 term sheets signed or being prepared, representing around $350 million of annualized revenues, and our pipeline continues to grow. Difficult market conditions in the pandemic are further highlighting the need for expertise and data-driven tools. Our platform is an excellent fit for entrepreneurs looking to support their current clients, use our tools and data to grow their businesses and advance their employees’ careers. Right now, it feels like it will be a more active finish to the year as merger prospects have concerns over possible 2021 tax change. Next, I’d like to move to our risk management segment, Gallagher Bassett. Third quarter organic revenue at minus 5.3% was a bit better than what we said at our September IR day. This is a really nice sequential improvement from second quarter organic being down nearly 10%. And our risk management team also did a fantastic job managing its workforce and controlling costs, delivering third quarter adjusted EBITDAC higher than last year by $1 million. Looking forward, we are seeing October claim counts trending similar to September. While we have experienced a steady climb out of the second quarter bottom, many clients are still operating at partial capacity in claim counts have not yet fully rebounded to last year’s levels. So we’re seeing fourth quarter organic revenues in our Risk Management segment, similar or slightly better than third quarter. And just like our Brokerage segment, we expect to grow our EBITDAC again in the fourth quarter due to expense savings. That means we should deliver on our goal of full year 2020 adjusted EBITDAC coming in better than 2019. That’s just an amazing job by the team. Before I pass it to Doug, I’ll finish with some comments on our bedrock culture. Despite the pandemic challenges, our global colleagues, together as a team, continued to deliver the very best service, expertise and advice to our clients. I believe it’s our unique Gallagher culture that is guiding our team through these challenging times. Specifically, I’m reminded of tenet number 20 of the Gallagher way, we run to our clients’ problems, not away from them. Since my grandfather started the company more than 90 years ago, our people have been solving problems and working hard for clients in both easier and more difficult times. And I can tell you this about our culture, it will guide us through the global pandemic, hurricanes, wildfires and any other obstacle in front of us. Throughout Gallagher’s history, we have emerged as a better, more cohesive company. I believe we will emerge from today’s difficult environment stronger than ever. Okay. I’ll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks, Pat, and hello, everyone. Like Pat said, another excellent quarter. I, too, would like to extend my appreciation to all of our Gallagher colleagues around the globe, what a remarkable job you are doing in these challenging times, servicing our clients, generating new business, all the while executing our cost control playbook. Today, I’ll begin with some comments on organic and the interplay with our cost saving. That seemed to get a lot of questions during our July earnings call and again during our September Investor Day call, so I’ll spend a little more time on that today. I will then provide a few observations from our CFO Commentary document and finish with some thoughts on M&A, cash and liquidity. So all right, let’s go to the earnings release, Page 4, to the brokerage organic table. Now as Pat said, a great quarter with 4.2% all in organic, which equates to about $50 million of organic growth. Then, when you turn to Page 6 to the brokerage EBITDAC table, you see that we grew adjusted EBITDAC by $105 million this quarter. So how do we deliver that $105 million on $50 million of organic? First, about $13 million of EBITDAC came from M&A, net of divestitures. Next, a bit over $30 million came from that $50 million of organic. So that means we saved about $60 million from our cost control playbook. From a margin perspective, all in, we grew adjusted EBITDAC margin about 630 basis points. And then when you do the math, you’ll see that even without the additional expense savings, we expanded margin about 150 basis points, which is impressive in and by itself. In the Risk Management segment, a little easier to compute. Revenues were backwards about $10 million, but EBITDAC grew about $1 million, so cost savings were about $11 million. Combine both segments, you get about $70 million of cost savings, which is at the top end of our estimates provided during our September IR Day and close to what we saved in the second quarter. Let me give you a breakdown of these savings: reduced travel, entertainment and advertising, down about $26 million; reduced consulting and professional fees, down $15 million; reduced outside labor and other workforce actions, $14 million; reduced office supplies, consumables and occupancy costs, about $11 million; and reduced employee benefit and medical plan costs about $4 million. Now when I look towards the fourth quarter, we’re starting to see a slight increase in our producers traveling more to see clients and prospects. We are executing on some targeted marketing and advertising programs and our medical plan utilization continues to return to pre-pandemic levels. But even with that, we’re still seeing savings in that $65 million to $70 million range relative to last year, again, given pro forma affects the roll-in mergers. Now moving to the CFO Commentary document we posted on our investor website. On Page 2, most of the items are consistent with what we provided to you during our September Investor Day. Then on Page 3, in total, the Corporate segment came in about $0.02 better than the midpoint of our September estimate. The interest and banking line, about $0.01 favorable, the acquisition cost line also slightly favorable. The corporate adjusted line, that’s in line with our September midpoint, and you’ll also see we have a small adjustment for a onetime tax expense related to Brexit. We described that a little bit more in Footnote 6 on that same page. Then in terms of clean energy, third quarter came in a bit better, and you’ll also see our fourth quarter estimate is also a bit better. Then on Page 4, you’ll see that we provided our first look at our 2021 estimates based on the preliminary forecasting from our utility partners. It looks like 2021 could be a lot like we’re seeing here this year. And then when you get back to Page 14 of the earnings release, you’ll see that we have about $1 billion of credit carryforwards on our balance sheet at September 30. Remember, those credits are fully earned. And while we are using some currently, the big return comes between 2022 and, say, 2028, when we will use those credits and thereby harvest about $150 million to $200 million of annual cash. Sure, book or GAAP earnings of $60 million to $65 million will go away in 2022, but instead, we’ll have that $150 million to $200 million of cash earnings in those years. As for M&A, you heard Pat say, we have a really strong pipeline. I think there could be a flurry of activity between now and year-end, given what could happen with taxes. So we’re really well positioned for that. We have more than $1.6 billion of liquidity, consisting of available cash on hand of nearly $550 million and more than $1 billion of borrowing power on our revolving credit facility. Okay. Those are my comments. Thanks to the team for another great quarter. I think we are well positioned to pull off a terrific 2020. Back to you, Pat.
J. Patrick Gallagher: Thanks, Doug. And operator, I think we’re ready for questions.
Operator: Thank you. The call is now open for questions. [Operator Instructions] And our first question is from Phil Stefano with Deutsche Bank. Please proceed with your question.
Phil Stefano: Yes, thanks. So I’ll start with a quick numbers question. The timing impact of the large life pension fund product. Did that have any margin bump to it in the quarter or any onetime impact there?
Doug Howell: No more or less than any of our other business. That was in that $30 million. We had $50 million of organic growth. It included the onetime or the sale that we have there. And if you assume about 60 points of margin on that business, you get about $30 million. So no more or less than what the other business has.
Phil Stefano: Okay, got it. And so, Pat, I think it was in your initial comments you made the remark that next year organic should be better than we’re seeing this year play out. And I was hoping you could talk a little bit about the extent to which stimulus plays a role in that and how government support might be a moving mechanism or at least how you felt that impacted you through 2020 to use as a – for us to contemplate in 2021?
J. Patrick Gallagher: Well, I think for sure, in 2020, in terms of a pressure release for our clients, as we got into the summer, it was huge. I mean it just – it made a huge difference in terms of giving businesses an ability to keep their employees and to keep their businesses going. And quite honestly, to pay their insurance bills. So I do hope and do believe that stimulus will be brought about in the new year. And I think that, again, will be viewed as a very strong positive for the economy and for our individual businesses. I can’t put a specific number on that, Phil. But anything that keeps the economy chugging along, as you well know, our entire business is predicated on exposure units.
Phil Stefano: Yes. Okay. And the last one I got for you, and it’s an unfair question, so I apologize. But we are getting a lot of questions from our end about the concept of brokerage margin expansion and the extent to which expectations should be up, flat or down for next year. And I mean, it’s something of a crystal ball question, depending on how the economy unfolds and such, but I know that this question is something that’s important to investors’ minds. So if you have any thoughts about how we should contemplate this, it would be appreciated.
Doug Howell: All right. I don’t know if it’s an unfair question or not, but I don’t know if it’s an easy answer. So let me see if I can help you with that. Let’s take a couple of things that we know. First, as I said in my prepared remarks, we should be able to hold most of the expense savings that we’re seeing here in the third quarter when we hit our fourth quarter – in our fourth quarter right now. Then the next question is, let’s go out one more quarter, let’s say, to first quarter 2021. Absent a miracle, I just don’t see that quarter much different than what we’re seeing here in the fourth quarter. So let’s say that we can hold $60 million to $70 million of that, the savings that we’re seeing now. Let’s invest. Now you’ve got to jump way out to 2022. So let’s just go to 2022. I think that we’re turning the pandemic adversity into a real advantage for Gallagher. We’ve learned a lot in the short period about our business and how our clients are operating, so over the next 15 months, we believe a good portion of those savings that we’re seeing now could become permanent. So let’s call that half or $30 million. So that leaves really what happens in the second, third and fourth quarters of 2021 to fill in. The answer to that, I believe, kind of lies somewhere in between. I should have a better answer when we get to our December IR Day, but we’ll stick to the $60 million to $70 million or $65 million to $70 million, we’ll figure that out here over the next six weeks and have a better answer for you in December. Regardless, if you get out to 2022, we believe there could be over $100 million of savings, annualized savings, that we might not have realized by 2022 had there not been a pandemic. So it has pulled together our efforts to relook at our business and change some of the ways that we operate. So there will be permanent savings there relative to where we would have gotten on our own, let’s say, without a pandemic, by 2022. How that actually emerges in 2021? I’ll have a better idea as we go through our budget and planning process over the next six weeks. So I hope that helps, it gets you a part way. I don’t know if it’s a complete answer, but that’s what we know right now.
Phil Stefano: That’s better than I hoped for. Thank you. It’s perfect.
J. Patrick Gallagher: Thanks, Phil.
Operator: Our next question is from Elyse Greenspan with Wells Fargo. Please proceed with your question.
Elyse Greenspan: Hi, thanks. Good evening. My first question, I guess, kind of picking up on that margin question. So that kind of helps us think through the expenses, but then the second portion, is that, Pat alluded to, organic revenue growth in 2021, he feels like should be better than 2020, right, which you guys essentially end up at around 3%? And so this quarter, right you saw about 150 basis points of margin improvement off of your organic revenue growth. So how do we think of that component of the margin, right? So you’re growing organically over 3% next year, what’s the component of underlying margin improvement that we should think about adding on to whatever expenses can be utilized?
Doug Howell: I think that you’ll see – if we hit 3% of organic growth next year, absent all these savings, there’s a 0.5 point to 3.25 point of margin expansion in that 3% number next year. If it’s 4%, maybe we get back closer to a full point, which isn’t all that dissimilar to what we are running pre-pandemic. Now if you draw a line between 2017, we are marching up in margin every year. And you draw that line out to 2022, whatever you would have gotten in 2022, add another $100 million, $120 million of savings to that, and you’ll get pretty close to where we think the margin would be in 2022. So our March forward hasn’t changed on the base organic piece.
Elyse Greenspan: Was there anything though then that was one-off that you saw 150 basis points this quarter? I mean, obviously, there could be quarterly seasonality on, I guess, 4% organic growth or 3% ex the onetime item?
Doug Howell: Well, I think when we’re at 4.2% organic this quarter, I think you did – we would see over 1 point of margin expansion. That’s probably not out of whack for other quarters in the past where it’s 4.2%, but nothing that really pops out at me. We did have some headcount savings in there. Our hiring hasn’t been as robust as it has in the past. Raises have been deferred a little bit though. That might influence a little bit, but there’s nothing onetime in there that I would point to.
Elyse Greenspan: Okay, that’s helpful. Then a couple of questions on M&A. The first one, I believe at your last IR Day was alluded to some – like modestly larger deals, I want to say in the $25 million range, that you thought could come to fruition. By looking at the activity this quarter, that hasn’t happened. So are those some of the deals, I guess, that you guys alluded to that maybe could come to fruition in the fourth quarter as deals get done in advance of potential track changes?
Doug Howell: That’s right. There are two nice $25 million revenue acquisitions that were nearly done with due diligence on. We’ve had Board approval on it, and we hope to get them wrapped up between now and the end of the year.
Elyse Greenspan: Okay. And then my last question. So as we think about larger M&A, it’s been a few years, like Gallagher expanded internationally, Australia, New Zealand, Canada and the UK. And so if you guys are going to consider another larger transaction, Doug, you alluded to the debt capacity as well as cash that you have, if there is a sizable deal in the market that perhaps you chose to use more of your equity than you have in the recent times, would there be certain metrics, be it revenue, earnings accretion or something that you guys would be looking to, if it was a more sizable transaction that potentially required the use of your own equity?
Doug Howell: Yes. We do the traditional review of that to make sure that it wasn’t dilutive that there were synergies that could take out of it. But really, to be honest, Elyse, we like our tuck-in merger strategy. This is our opportunity to pick every single one that wants to join the family. We have that. We have fair multiples on those that we’re paying for them. We integrate much better into one another. We like our small tuck-in strategy at this point, and there’s lots and lots of opportunity for that, so.
J. Patrick Gallagher: I think that’s a key point, Elyse. This is Pat. When you look at the top 100 in business insurance in the United States alone that doesn’t recognize the rest of the world, you still have another 19,000 to 25,000, maybe even 30,000 firms out there that are not in that top 100. And a good portion of those are still owned by baby boomers. So our – the opportunity to do these tuck-ins is just way, way greater than the large play.
Elyse Greenspan: Okay, thank you. I appreciate all the colors. Thanks, guys.
J. Patrick Gallagher: Thanks, Elyse.
Doug Howell: Thanks, Elyse.
Operator: Our next question is from Greg Peters with Raymond James. Please proceed with your question.
Greg Peters: Good afternoon. Just a couple of follow-on questions. If you were pointing to, I think, Page 5 or 6 of your press release – 6, where you go through the adjusted EBITDAC margin. And I think through the nine months Doug, you reported a 33.6% EBITDAC margin on an adjusted basis. And I know you’re doing a good job of chronicling how much of the savings are going to – should extend themselves beyond just the opportunity you’ve had this year. At what point do you hit that threshold where you can’t grow margins because you have to invest in the business? Or put it another way, at some point, you can’t turn this into a 50% margin business or maybe you can, you just haven’t mapped it out for us yet.
Doug Howell: No, Greg. Listen, trees don’t grow to the moon. I think that there are plateaus when you reach them. I think when you get into that 30% to 32% type range as an annual margin in a brokerage segment across the globe, that’s a pretty fair margin to have. But scale does bring advantages. And this is a – the brokerage business is showing that size can be helpful, especially with size in the same fairway that you’re playing. If you can get more acquisitions that are right down the middle of the fairway, using the technologies that we’ve developed, using our offshore centers of excellence, our centralization that we’ve worked on for 15 years, we think that there’s still terrific opportunity for us to roll in and have nice, steady margin improvement. If we’re growing over 3% or 4%, well, I think it can be – you can eke out a little margin just because of scale. And some of it depends on wage inflation, too. I mean we are a people company, and we are lucky that after the Great Recession that wage inflation remained in check. Perhaps here in the pandemic, we’ll keep wage inflation in check a little bit. But we are a people company, so raises are something that we want to give. And so – but if we can keep wage inflation in check, I think that you can eke out some margins.
Greg Peters: Just as a follow-up to that comment, when do wage or salary increases typically happen for staff? Is that a beginning of the year event to midyear event? When does that generally hit?
Doug Howell: Kind of late second quarter, early third quarter. It’s a little bit later this year. We’ll do that here in December.
Greg Peters: Got it. In the balance sheet, I noticed that the premiums and fees receivable jumped up from year-end. And I’m just curious if you – if there’s anything in that increase that is troublesome or if that’s expected, on plan, or just some color behind that. Then, the numbers I’m looking at are, on the balance sheet, the 6,702.5 versus the 5,419.2.
Doug Howell: Yes. Okay. Good question. First of all, we look at our cash receipts every day. We’re not having any slowdown at all from client premium payments coming in, so we don’t have a liquidity issue there. And again, I just looked at the report at 2:00 this afternoon, and our October is equal – since the pandemic, our cash flows have been equally, if not better, than what they were in pre-pandemic time. So that isn’t it. We do have some – as we have a reinsurance operation, now you can get some significant reinsurance premiums that flow through that can cause some of that to be a little more volatile on that, but there is nothing there that I would – that is at all indicative of any type of slowdown in payments by our customers in that.
Greg Peters: So in other words, DSOs have remained fairly stable this year relative to previous year?
Doug Howell: Yes. That’s right.
Greg Peters: Got it. I guess the final question, I know you’ve already provided a lot of commentary around M&A, but I can’t help myself but go back to that well. First of all, Pat, when you’re talking culture, I know it’s very important to you. Are you – when you’re looking at M&A opportunities, are you willing to consider M&A that has a slower organic growth profile? Or, put it another way, is the deals that you’ve done in the last couple of years, have they boosted your – have they been a net gain to organic revenue on a consolidated basis? Or has it been neutral or been a headwind? Does that make sense?
J. Patrick Gallagher: Well, it certainly hasn’t been a headwind. And the nice thing about tuck-ins, Greg, is that if you get the right folks on, sometimes they can be terrifically accretive. But by and large, I think when you add all this, it’s probably right in line with the rest of our organization. And we’re seeing lots of opportunities, but again, you followed us for years. It’s not brain surgery, culture is absolutely critical. And I’d like to sound more sophisticated, we try to find people who care about their people, love this business and run a good business. If they can’t make money for themselves, they’re not going to make money for us and our shareholders. But once they cross that hurdle, it’s really got to be about, are they going to fit culturally and are they going to really be able to take advantage of the things that we bring to the table? And I think you’ve heard me talk about this before. I tell them that when we bring them here to Rolling Meadows or they joined one of our offices out there, we open the curtain and show them the candy store. And they’re like, "Wow, I’ve got all this to work with now?" And when that happens, it opens up, in many instances, accounts that are local to them, and we’re very strong in our local communities. We want to help them build that strength and accounts that they never had a chance to touch because of their size are now open to them because really, there’s nothing that we can’t help them tackle. And frankly, that gets them excited. So for us, are they going to stay? Do they love selling insurance, which I know sounds crazy, but there are some of us that were born to do that? And the fact is those people end up being with us a long time, building great businesses having a great time doing it. And it really does come down to cultural fit.
Greg Peters: Right. Well, I know you’ve described it before. I don’t think you’ve used the word – the phrase candy store with me, but it doesn’t mean you haven’t used it before.
J. Patrick Gallagher: But you understood what I meant, right, Greg.
Greg Peters: Absolutely.
J. Patrick Gallagher: There you go.
Greg Peters: So the final piece on M&A, obviously, there’s a lot of stuff going around the election, anticipation of maybe a change in tax cuts in the – tax rates in the U.S., et cetera, that may lead to accelerating deal flow. Are you seeing any activity in Europe? Are you seeing any change in the flow of potential deals outside the U.S.?
J. Patrick Gallagher: Yes. And I’ll tell you why. It’s exactly what we told you in 14 when we did our transactions in the UK, Australia and Canada, in particular, and now in Europe and Latin America. Once we’ve got a platform that gives people confidence that we’re really there to stay, then the smaller broker has something to look at, that is not just getting a new name or changing where they send their reports, they get the benefit of the fact that we’ve got scale, we’ve got brand recognition and we have capabilities. So yes, our pipeline in the UK, our pipeline in Australia, Latin America, New Zealand and Continental Europe are stronger than they’ve ever been.
Greg Peters: Got it. Thank you for the answers.
J. Patrick Gallagher: Thanks, Greg.
Operator: And our next question is from Mike Zaremski with Credit Suisse. Please proceed with your question.
Mike Zaremski: Hey, great. Maybe we could talk about Risk Management a little bit. I think from the prepared remarks, it sounded like claims counts were – are continuing to improve, but still down. Maybe you can put some numbers around work comp and GL. Are those still down kind of double digits year-over-year? What are you guys – any update on the outlook for the Risk Management segment? I mean margins improved more than what you thought, probably. Maybe can you talk why margins improved more than expected as well?
Doug Howell: Yes. I think the question is what type of claims? I think the more difficult claims that are rising, the kind of the churn business is still down, maybe 20% to 30% on the small, but we don’t make a lot of money off of those anyway, so they’re kind of low margin. So that doesn’t hurt us so much. I think we have had a little bit of boost in settling claims that have risen because of COVID. And so our complicated claims, they’re still there. And so that has helped this business be more resilient. If you think about it, it might be more of a lost revenue story than it is a lost profit story as you can see by the margin. So the advantage we have is that we’ve held on pretty well, being only down 5% this quarter on a revenue basis. As we get a vaccine, as things start to improve, you will have that business come back in and hopefully be up nicely in the positive organic space next year.
Mike Zaremski: Okay. Maybe stepping back and thinking about brokerage again, one of your competitors today I think kind of hinted at maybe pricing had reached a point that had reached its limit. At least, there’s definitely some businesses that are experiencing some fairly high double-digit rate increases. And I think that your competitor alluded to maybe the carriers have – some are getting enough freight and maybe we’re at peak freight. Any thoughts about kind of what you’re hearing and seeing from the carriers? And it feels like there’s some new capital coming into the space as well.
J. Patrick Gallagher: Well, there’s clearly new capital coming in, and I will tell you that there is zero interest from the people that – the partners we’re talking to at modifying rate increases at all. I mean they’re not getting any rate of return on new invested dollars. Social inflation is killing them. Lines of coverage that have been under attack for years while the market stayed soft are raising their – continuing to raise their head. This is – I see nothing in the way of softening or stopping the momentum. Now remember, again, we tried to give you some detail in our prepared remarks, workers’ compensation is about flat. They make good money on workers’ comp. Workers’ comp is competitive in the United States, and our clients benefit from that. And remember, our job is to make sure we do everything we can for our clients to make sure the hard market doesn’t cripple. So it’s not like I’m sitting here and saying, "Hey, this is – it’s getting harder by the minute." But I can tell you, when you talk to the people that are the actual providers of capital, they’re not seeing light at the end of the tunnel being yahoo we’re back to soften, that’s for sure.
Mike Zaremski: Okay. Great. And just lastly, just making sure, there’s nothing supplementals and contingents that was unusual this quarter?
Doug Howell: No. No. Not this quarter. Not this year at all, as a matter of fact.
Mike Zaremski: Thank you very much.
J. Patrick Gallagher: Thanks, Mike.
Operator: [Operator Instructions] Our next question is with Josh Shanker with Deutsche Bank. Please proceed with your question.
Josh Shanker: Yes. Good evening, everyone. Thanks for taking my call.
J. Patrick Gallagher: Thanks, Josh.
Josh Shanker: So I was curious, historically, I guess, for a number of years, we’ve been in a middling market, and I think that benefits brokers who have a lot of visibility on pricing and maybe it disadvantages carriers and the negotiation with the client. As things are perhaps changing, is there any benefit being given to the carriers in that negotiation, where the client demand or you’ve encouraged some more competitive fee structure from the broker? Is there any renegotiation going on at that level?
J. Patrick Gallagher: Fees are one of the things that always happen. And this is – since 2006, in the United States, in particular, we’ve been completely transparent with our clients on what we make. And we are not feeling huge pressure on the income that we make for the extra work that we’re doing today. And that’s another reason when you look at fees and what have you, that even if rates were up 25%, you’re not going to see our revenue jump 25%. That wouldn’t be a fair transaction. But at the same time, there’s a lot more work, and it’s our expertise now that we’re selling that sells a lot better in a hard market than it does a soft market. If it’s in a soft market, the person down the street that hangs a shingle out can get you five quotes. We’re not getting five quotes today. And you better work hard with somebody who’s got some real dedicated inside clear understanding of your business that can differentiate your risk and your approach to risk to that underwriting community or you’re going to get whacked. And so our services are more valuable than ever. And you’re right, we went for about 10 years. And you’ll recall in my conversations on these conference calls, I always alluded to the fact that I don’t like hard markets. And everybody would say were – and when the rates were up 1%, down 2%, up 3%, sideways, flat, that was perfect for clients. It gave them a chance to choose. It gave us a chance to be able to say this market or that one put them together this way, build the tower this way, and it was really another way to show our expertise. Now this is a time where we’ve got to give good counsel, and they’ve got to understand that in many respects, it’s a seller’s market. And we’ll get them through it. No, it won’t last forever, but now is the time to make sure you’re partnering with someone that knows what they’re doing. And we’re getting paid.
Josh Shanker: That’s very clear. And then on Gallagher Bassett, can you talk about throughput of workers’ comp claims and what the marketplace is shaping up to be with lower employment or with a work at home and how that changes the services you provide there?
J. Patrick Gallagher: Well, the services we provide there, Josh, they’re not different in the sense that if you have a workers’ comp claim, we’re going to handle it. There’s all kinds of protocols, state by state, rules, regulations, et cetera. There are fewer claims when you’re not in the office, you’re not in the factory, you’re working from home. There are clearly fewer claims and fewer accidents. And when economic activity regains itself and people come back to the places of work, we expect that those claims will reflect that. But in terms of how you deal with someone that gets hurt, it’s – we still have to file those state rules, and we still have to adjust and adjudicate the claim, which we think, if you use Gallagher Bassett, will give you a better outcome.
Josh Shanker: And in terms of flow of claims incidences?
J. Patrick Gallagher: I’m sorry, you broke up, Josh, what was that?
Josh Shanker: Claims incidents during the pandemic, how is that shaping up?
J. Patrick Gallagher: Incidents are down, significantly down. That’s the whole reason – when we talk about claim counts, that’s incidents.
Josh Shanker: Yes. Yes. And so does that change the service or the fees? They say, well, look, we don’t – in terms of your interaction with the clients for Gallagher Bassett, does that change what you can charge or change the negotiation at all? Or is it a typically a fee for service?
J. Patrick Gallagher: No. No. No. It doesn’t at all.
Josh Shanker: Okay, great. Thanks, Josh.
J. Patrick Gallagher: Thank you.
Operator: Our next question is from Yaron Kinar with Goldman Sachs. Please proceed with your question.
Yaron Kinar: Hi, good afternoon. Thanks for taking my questions. A few timing questions, if I could. One, you’re talking about M&A maybe being a little bit – is the pipeline being robust here as we head into 2021 because of the potential tax impact there? Do you think that could mean that there’s a bit of a lull in M&A as we enter 2021?
J. Patrick Gallagher: I don’t think so. I mean, when I look at it, it really is a very interesting market, which is why you see, it was not that long ago that there were very few billion-dollar brokers. Today, there’s about 11 or 12 of us. By that, I mean revenue. That’s why private equity has been so prevalent in the business, which is good for us because private equity is smart money telling the investment community, we’re a great bet. But the fact is, there are thousands and thousands of independent agents and brokers that ultimately have a chance to capitalize their life’s work, and I think that’s not going to stop.
Yaron Kinar: Okay. And then could you remind us when in 2021 do the 2011 clean coal plant sunset – does the tax credit sunset?
Doug Howell: Okay, there’s two answers to that. Our plants that we operate will sunset mostly in late November, early December, absent an extension. For those plants that we don’t operate at our Chem Mod affiliate that we own a substantial piece of that gets a royalty of, those could stop production sometime more in the late third quarter or early fourth quarter. It just depends on – it’s 10 years from the date that they were placed in service. So if they were placed in service before December of 2011, then they would be – they would sunset a little bit earlier. So that’s why on Page 5 of the CFO Commentary, you’ll see that our royalty income is just – we’re forecasting that just to be down a little bit relative to 2020 because some of those will sunset just a little bit earlier.
Yaron Kinar: Okay. Okay. And those last couple of months of the year don’t tend to be very large months from a clean coal perspective, right?
Doug Howell: It can be. If you get a cold December, you can – the southern plants that are dependent on baseboard heat, electric heat, would be. And again, I can’t miss the opportunity to reinforce, just because $60 million to $70 million of GAAP earnings go away, that’s – right away, we’ll flip in 2022 into harvesting all the credits that we’ve been generating over the last 10 years. So that’s – you might almost double the amount of earnings on a cash basis versus then on a GAAP basis at that time.
Yaron Kinar: Right. And then final timing question. The contract that you’ve pulled forward into the third quarter in Brokerage, does that get renewed in the third quarter of next year?
Doug Howell: Well, first of all, I wouldn’t say we pulled it forward. They just got it closed sooner. So that was a great work by the guys that have been working on that product for a lot. That’s going to be an occasional sale. I don’t think that it’s something that would repeat year in and year out. It would be another customer that would happen to see the real smarts in this product and decide to close it in third quarter next year. But that would be hitting us. It’s a little bit more elephant hunting on that, so call it that – if you close one every 18 months, that would be great, but who knows. It’s a terrific product that’s getting some momentum. So we might see it a little bit more frequently, but I’d be happy with one of those every 18 months.
Yaron Kinar: Okay. Thank you.
Doug Howell: Thanks, Yaron.
Operator: And our next question is from Ryan Tunis with Autonomous. Please proceed with your question.
Ryan Tunis: Hey, thanks. Good evening. I just had one. So employee benefits, I might have missed this, Pat, but I thought you said it was plus 6%, but that included the one-off transaction.
J. Patrick Gallagher: That’s right.
Ryan Tunis: What was the organic, excluding that within the employee benefits unit?
J. Patrick Gallagher: Hold on.
Doug Howell: Flat to 2%. I mean, so let’s call it 1.3%, if I look at my notes.
Ryan Tunis: Got it. And then just looking for an update, obviously, that is a business that economically impacted at a lot of the other brokers. We’ve had three quarters – kind of three quarters in the recession. Are you learning anything new that would change your organic outlook for employee benefits? Or is it still kind of the same story you’ve been talking about in previous quarters at the mid-quarter updates?
J. Patrick Gallagher: I think the thing that’s probably most beneficial to our business that we learned. And first of all, thanks for the question, Ryan. When we look at the business in general and say, what have we learned over the last seven, eight months about what can happen, how this business can be run, where people can do it? How expertise can be exported around the world? I mean, we’ve got experts in verticals that are world-class. And you want to try to get them to a prospect or a client, you can use up a whole day or two days of travel. Today, they can drop in by video call and bam, they’re there and people accept that. So we’ve learned a lot, and there’s lots of opportunities for our business because of that. But I think probably the thing that reemphasizes why we’re so high on the benefits businesses, even in this pandemic and even with the recession that hit, the amount of employees that stay employed, the employers holding on to their people, it’s incredible. I mean we thought in March and April, get ready, the floor is going to drop out, everybody is going to let everybody go. And of course, I’m being facetious. But the fact is, this war for talent, ongoing long term, what’s your product? I don’t care if you’re making big steel drums, you’re a people business. And people are holding on to their folks and our censuses by count have not dropped through the floor. And people are saying – and as we come out of this, to me, it just makes that business even better, which demands incredible expertise to balance all the costs and all the covers and to make sure that you are, in fact, providing what the employees need, but that you also make sure through communication that they understand that they’re better off with you. So it’s – basically, it’s really put us in a spot to want to double down on that business.
Ryan Tunis: Got it. Understood, thanks.
J. Patrick Gallagher: Thanks, Ryan.
Operator: And our last question is from Meyer Shields with KBW. Please proceed with your question.
Meyer Shields: Great. Thanks. Just a small question. I just – I feel like I missed the amount of the employee benefits contract that was signed earlier than expected. Have you given quantification on the actual revenue?
Doug Howell: No, we really haven’t. I think you can probably do the math. It was about $12 million to $15 million, so…
Meyer Shields: Okay. I can do the math now.
J. Patrick Gallagher: Thanks for making it easy, teacher.
Meyer Shields: The second question, I know there’s been sort of a long-term strategy at Gallagher of moving clients along to self-insurance over time. Has the pandemic interrupted that at all?
J. Patrick Gallagher: No. I mean, in fact, if anything, it’s made it more of a crucial conversation because it’s crunching businesses. And when the economy is good and employees are being hired and there’s fight over employees over – because of a full employment, those times are heady times for many, many people. And yes, financially, we can always point out to those businesses why considering a large self-insured retention, bringing Gallagher Bassett in, getting better outcomes on your claims, makes for better control of not only your insurance purchase, but your entire risk management program, and we do a good job of selling that. You put a buyer against the wall, they’re all ears, and we’re really good at moving people first dollar cover into a form of risk management, risk retention, group captives, et cetera. That is our – that’s our heritage.
Doug Howell: Typically, when you have increasing pricing, an account that customer that had really good loss experience is more willing to look to build self as a component of their program being through self insurance. And as prices go up, that gets their attention. And we do a lot of workers’ comp in this, and workers’ comp has had rate cuts recently. It’s flat right now. I think that if workers’ comp goes hard, I think you’ll see considerably more folks with good experience or companies wanting to look at alternative risk transfer.
J. Patrick Gallagher: Well Doug hit on something, Meyer, I think this has been the dilemma that really wasn’t talked about during that eight to ten-year period where the market was relatively soft or was flat. When the market starts to firm, one of the dilemmas for the insurance carriers is they need the entire base to give then more rate. The better units of risk look to move out of that buying community. And so now you’re taking from the insuring community their better units of risk, leaving them to fight over what is maybe not the best units and even needing more rate. And that is when the competition thins because there just aren’t thousands of people that can do what we do.
Meyer Shields: Okay. No, that makes perfect sense. And that was very helpful. Final question, and I may have just been modeling this incorrectly. But the investment income in the brokerage, the investment income and net gains on divestitures ticked up something like $3 million from the second quarter to the third quarter. Should we expect that sort of seasonality? Or is that just random now?
Doug Howell: All right. So there’s two questions there. What happened with investment income, right, what you’re saying?
Meyer Shields: Yes.
Doug Howell: Well, listen, first, some of that – some of the numbers running through there has to do with our premium finance business down in Australia and New Zealand. But let me give you the punch line on it because we are down somewhat in investment income, just in true investment income that is – that we earn on the premium trust accounts, et cetera, we are down probably in the third quarter somewhere around $4 million, $3.5 million from where we were last year. So you wouldn’t be seeing that right.
Meyer Shields: Okay. That’s very helpful. Thank you.
Doug Howell: Thanks, Meyer.
Operator: And we have reached the end of the question-and-answer session. And I will now return the call back over to Pat for any closing remarks.
J. Patrick Gallagher: Thank you very much. Let me give you just a quick comment. Again, thanks, everybody, for joining us this afternoon. We delivered an excellent quarter in first nine months of the year in the face of a difficult economic environment. And again, I’d like to thank our 32,000-plus Gallagher professionals for their relentless efforts and dedication. I remain confident that we can deliver another outstanding year of financial performance and successfully navigate these challenging times. Thank you, again, for being with us. We really appreciate it.
Operator: And this does conclude today’s conference call. You may disconnect your lines at this time. Thank you, and have a good day. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Co.’s Third Quarter 2020 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today’s call is being recorded. If you have any objections, you may disconnect at any time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company’s 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you. Good afternoon. Thank you for joining us for our third quarter 2020 earnings call. Also on the call today is Doug Howell, our Chief Financial Officer; as well as the heads of our operating divisions. We delivered a very strong third quarter. Despite the current global health crisis and the related economic slowdown resulting from COVID-19, our teams continue to execute at the highest levels. While we continue to place health and safety first, we are selling new business, we are servicing and retaining our clients, we continue to look at merger and acquisition opportunities and our bedrock culture keeps us working together even while physically apart. These are times when our global capabilities, niche expertise and product specialists support our local professionals as they help our customers navigate these challenging times. I’d like to thank our 30,000-plus Gallagher professionals for their efforts and relentless focus on delivering the very best Insurance Brokerage, Consulting and Risk Management services our customers. That is the Gallagher way. Moving to our third quarter financial performance. We grew our combined Brokerage and Risk Management revenues in the third quarter organically and through mergers and acquisitions, and together with our expense control efforts, delivered excellent growth in EBITDAC and net earnings. These results demonstrate our operating flexibility, which has enabled us to quickly adjust our expense base, optimize our workforce, improve our productivity while also raising our quality. Let me break down our results further, starting with our brokerage segment. Reported revenue growth was a positive 8.3%. Of that, more than half or 4.2% was organic revenue growth. We did have some favorable timing, I’ll discuss that more in a minute. Net earnings margin was up 334 basis points, and adjusted EBITDAC margin expanded 632 basis points to 33.4%. Net earnings up 37% and adjusted EBITDAC up 32%, so another excellent quarter during a global pandemic, a fantastic job by the team. Let me walk you around the world and give you some sound bites about each of our brokerage units, and I’ll start with our P/C operations. In U.S. retail, another strong quarter with organic growth of about 4%. We saw solid new business and slightly better retention versus last year’s third quarter. Rate increases are more than offsetting exposure unit declines, midterm policy modifications, including full policy cancellations, are similar to prior year levels. And our U.S. wholesale operations, risk placement services, organic was 8% and our open brokerage business even better than that, while our MGA program binding businesses returned to positive organic in the quarter. Hereto, rate increases are more than offsetting exposure unit declines. Moving to the UK. Around 2% base organic with stronger growth in our London specialty business due to firmer pricing. In Australia and New Zealand combined, also around 2% organic, with New Zealand slightly stronger than Australia. New business is down a touch in Australia and up in New Zealand. Rate increases there remain positive, but not enough to offset exposure decline. And finally, our Canadian retail operations posted organic of 8%, another terrific new business quarter and stable client retention. So overall, our global P/C operations reported about 4% organic in the quarter, again, an excellent result in a difficult environment and on the higher end of our mid-September expectations. Moving to our employee benefit brokerage and consulting business, third quarter organic was positive 6%. This includes a large life insurance pension funding product sale that we expected to close in the fourth quarter. Otherwise, new consulting and special project work remains soft, while covered lives under employer-sponsored health plans continue to be more resilient than headline unemployment numbers. So when I bring P/C and benefits together, organic of 4.2% and even allowing for the big benefits win, a great quarter. Looking forward to our fourth quarter. First, recall we had a terrific fourth quarter last year, 6% plus organic, so we’re starting off with a tough compare. Second, I just discussed some favorable timing here in the third quarter, so I don’t see us hitting 4% again. But thus far in October, P/C retentions, new business, full policy cancellations and other midterm policy adjustments are in line to slightly better than the third quarter, so perhaps we can read nicely in the 2% to 3% range. That would deliver a full year 2020 around 3% organic, which will be a great year in this environment. While there is still a lot of economic and governmental uncertainty which makes forecasting organic a challenge, we can control what we spend. We’ve demonstrated over the last seven months that we can execute on our cost containment playbook that makes us highly confident we can deliver another quarter and full year of really strong EBITDAC growth. Now let me give you an update on the P/C rate environment. Rate again continued to move higher around the globe during the third quarter. Globally, caught up nearly 7% with tighter terms and conditions and increasingly restrained capacity. By geography, Canada has seen the greatest rate increases, up more than 9%; the U.S. is up about 8%; followed by the UK, including London specialty at about 6%; and Australia and New Zealand, around 3%. By line of business, property remains the strongest, up 12%; next is professional liability, up over 10%; other casualty lines are up 5% to 10%, with umbrella rate increases at least twice that level; and workers’ compensation is flat. So while P/C rates are moving higher, the total amount of premium increases our clients are paying are more modest. This is a result of reduced exposure units, higher deductibles, lower limits and clients opting out of coverages. Looking forward, October results are already indicating continued increases during the fourth quarter, and the carriers in the face of catastrophe, the pandemic, rising casualty loss cost, low investment returns, are making a case for firm rates to persist. But remember, that’s where we excel. Our job is to make sure our clients get a well-structured insurance program at a fair price. Regardless, it is certainly a more difficult market today than last quarter, and we are seeing some pockets of a hard market in certain lines and geographies. I see that continuing into 2021, next year, organic should be better than we are seeing this year play out. Moving on to mergers and acquisitions. We completed five brokerage mergers during the third quarter at fair multiples. I’d like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing Gallagher family of professionals. As I look at our M&A pipeline, we have more than 40 term sheets signed or being prepared, representing around $350 million of annualized revenues, and our pipeline continues to grow. Difficult market conditions in the pandemic are further highlighting the need for expertise and data-driven tools. Our platform is an excellent fit for entrepreneurs looking to support their current clients, use our tools and data to grow their businesses and advance their employees’ careers. Right now, it feels like it will be a more active finish to the year as merger prospects have concerns over possible 2021 tax change. Next, I’d like to move to our risk management segment, Gallagher Bassett. Third quarter organic revenue at minus 5.3% was a bit better than what we said at our September IR day. This is a really nice sequential improvement from second quarter organic being down nearly 10%. And our risk management team also did a fantastic job managing its workforce and controlling costs, delivering third quarter adjusted EBITDAC higher than last year by $1 million. Looking forward, we are seeing October claim counts trending similar to September. While we have experienced a steady climb out of the second quarter bottom, many clients are still operating at partial capacity in claim counts have not yet fully rebounded to last year’s levels. So we’re seeing fourth quarter organic revenues in our Risk Management segment, similar or slightly better than third quarter. And just like our Brokerage segment, we expect to grow our EBITDAC again in the fourth quarter due to expense savings. That means we should deliver on our goal of full year 2020 adjusted EBITDAC coming in better than 2019. That’s just an amazing job by the team. Before I pass it to Doug, I’ll finish with some comments on our bedrock culture. Despite the pandemic challenges, our global colleagues, together as a team, continued to deliver the very best service, expertise and advice to our clients. I believe it’s our unique Gallagher culture that is guiding our team through these challenging times. Specifically, I’m reminded of tenet number 20 of the Gallagher way, we run to our clients’ problems, not away from them. Since my grandfather started the company more than 90 years ago, our people have been solving problems and working hard for clients in both easier and more difficult times. And I can tell you this about our culture, it will guide us through the global pandemic, hurricanes, wildfires and any other obstacle in front of us. Throughout Gallagher’s history, we have emerged as a better, more cohesive company. I believe we will emerge from today’s difficult environment stronger than ever. Okay. I’ll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat, and hello, everyone. Like Pat said, another excellent quarter. I, too, would like to extend my appreciation to all of our Gallagher colleagues around the globe, what a remarkable job you are doing in these challenging times, servicing our clients, generating new business, all the while executing our cost control playbook. Today, I’ll begin with some comments on organic and the interplay with our cost saving. That seemed to get a lot of questions during our July earnings call and again during our September Investor Day call, so I’ll spend a little more time on that today. I will then provide a few observations from our CFO Commentary document and finish with some thoughts on M&A, cash and liquidity. So all right, let’s go to the earnings release, Page 4, to the brokerage organic table. Now as Pat said, a great quarter with 4.2% all in organic, which equates to about $50 million of organic growth. Then, when you turn to Page 6 to the brokerage EBITDAC table, you see that we grew adjusted EBITDAC by $105 million this quarter. So how do we deliver that $105 million on $50 million of organic? First, about $13 million of EBITDAC came from M&A, net of divestitures. Next, a bit over $30 million came from that $50 million of organic. So that means we saved about $60 million from our cost control playbook. From a margin perspective, all in, we grew adjusted EBITDAC margin about 630 basis points. And then when you do the math, you’ll see that even without the additional expense savings, we expanded margin about 150 basis points, which is impressive in and by itself. In the Risk Management segment, a little easier to compute. Revenues were backwards about $10 million, but EBITDAC grew about $1 million, so cost savings were about $11 million. Combine both segments, you get about $70 million of cost savings, which is at the top end of our estimates provided during our September IR Day and close to what we saved in the second quarter. Let me give you a breakdown of these savings: reduced travel, entertainment and advertising, down about $26 million; reduced consulting and professional fees, down $15 million; reduced outside labor and other workforce actions, $14 million; reduced office supplies, consumables and occupancy costs, about $11 million; and reduced employee benefit and medical plan costs about $4 million. Now when I look towards the fourth quarter, we’re starting to see a slight increase in our producers traveling more to see clients and prospects. We are executing on some targeted marketing and advertising programs and our medical plan utilization continues to return to pre-pandemic levels. But even with that, we’re still seeing savings in that $65 million to $70 million range relative to last year, again, given pro forma affects the roll-in mergers. Now moving to the CFO Commentary document we posted on our investor website. On Page 2, most of the items are consistent with what we provided to you during our September Investor Day. Then on Page 3, in total, the Corporate segment came in about $0.02 better than the midpoint of our September estimate. The interest and banking line, about $0.01 favorable, the acquisition cost line also slightly favorable. The corporate adjusted line, that’s in line with our September midpoint, and you’ll also see we have a small adjustment for a onetime tax expense related to Brexit. We described that a little bit more in Footnote 6 on that same page. Then in terms of clean energy, third quarter came in a bit better, and you’ll also see our fourth quarter estimate is also a bit better. Then on Page 4, you’ll see that we provided our first look at our 2021 estimates based on the preliminary forecasting from our utility partners. It looks like 2021 could be a lot like we’re seeing here this year. And then when you get back to Page 14 of the earnings release, you’ll see that we have about $1 billion of credit carryforwards on our balance sheet at September 30. Remember, those credits are fully earned. And while we are using some currently, the big return comes between 2022 and, say, 2028, when we will use those credits and thereby harvest about $150 million to $200 million of annual cash. Sure, book or GAAP earnings of $60 million to $65 million will go away in 2022, but instead, we’ll have that $150 million to $200 million of cash earnings in those years. As for M&A, you heard Pat say, we have a really strong pipeline. I think there could be a flurry of activity between now and year-end, given what could happen with taxes. So we’re really well positioned for that. We have more than $1.6 billion of liquidity, consisting of available cash on hand of nearly $550 million and more than $1 billion of borrowing power on our revolving credit facility. Okay. Those are my comments. Thanks to the team for another great quarter. I think we are well positioned to pull off a terrific 2020. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Doug. And operator, I think we’re ready for questions."
},
{
"speaker": "Operator",
"text": "Thank you. The call is now open for questions. [Operator Instructions] And our first question is from Phil Stefano with Deutsche Bank. Please proceed with your question."
},
{
"speaker": "Phil Stefano",
"text": "Yes, thanks. So I’ll start with a quick numbers question. The timing impact of the large life pension fund product. Did that have any margin bump to it in the quarter or any onetime impact there?"
},
{
"speaker": "Doug Howell",
"text": "No more or less than any of our other business. That was in that $30 million. We had $50 million of organic growth. It included the onetime or the sale that we have there. And if you assume about 60 points of margin on that business, you get about $30 million. So no more or less than what the other business has."
},
{
"speaker": "Phil Stefano",
"text": "Okay, got it. And so, Pat, I think it was in your initial comments you made the remark that next year organic should be better than we’re seeing this year play out. And I was hoping you could talk a little bit about the extent to which stimulus plays a role in that and how government support might be a moving mechanism or at least how you felt that impacted you through 2020 to use as a – for us to contemplate in 2021?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I think for sure, in 2020, in terms of a pressure release for our clients, as we got into the summer, it was huge. I mean it just – it made a huge difference in terms of giving businesses an ability to keep their employees and to keep their businesses going. And quite honestly, to pay their insurance bills. So I do hope and do believe that stimulus will be brought about in the new year. And I think that, again, will be viewed as a very strong positive for the economy and for our individual businesses. I can’t put a specific number on that, Phil. But anything that keeps the economy chugging along, as you well know, our entire business is predicated on exposure units."
},
{
"speaker": "Phil Stefano",
"text": "Yes. Okay. And the last one I got for you, and it’s an unfair question, so I apologize. But we are getting a lot of questions from our end about the concept of brokerage margin expansion and the extent to which expectations should be up, flat or down for next year. And I mean, it’s something of a crystal ball question, depending on how the economy unfolds and such, but I know that this question is something that’s important to investors’ minds. So if you have any thoughts about how we should contemplate this, it would be appreciated."
},
{
"speaker": "Doug Howell",
"text": "All right. I don’t know if it’s an unfair question or not, but I don’t know if it’s an easy answer. So let me see if I can help you with that. Let’s take a couple of things that we know. First, as I said in my prepared remarks, we should be able to hold most of the expense savings that we’re seeing here in the third quarter when we hit our fourth quarter – in our fourth quarter right now. Then the next question is, let’s go out one more quarter, let’s say, to first quarter 2021. Absent a miracle, I just don’t see that quarter much different than what we’re seeing here in the fourth quarter. So let’s say that we can hold $60 million to $70 million of that, the savings that we’re seeing now. Let’s invest. Now you’ve got to jump way out to 2022. So let’s just go to 2022. I think that we’re turning the pandemic adversity into a real advantage for Gallagher. We’ve learned a lot in the short period about our business and how our clients are operating, so over the next 15 months, we believe a good portion of those savings that we’re seeing now could become permanent. So let’s call that half or $30 million. So that leaves really what happens in the second, third and fourth quarters of 2021 to fill in. The answer to that, I believe, kind of lies somewhere in between. I should have a better answer when we get to our December IR Day, but we’ll stick to the $60 million to $70 million or $65 million to $70 million, we’ll figure that out here over the next six weeks and have a better answer for you in December. Regardless, if you get out to 2022, we believe there could be over $100 million of savings, annualized savings, that we might not have realized by 2022 had there not been a pandemic. So it has pulled together our efforts to relook at our business and change some of the ways that we operate. So there will be permanent savings there relative to where we would have gotten on our own, let’s say, without a pandemic, by 2022. How that actually emerges in 2021? I’ll have a better idea as we go through our budget and planning process over the next six weeks. So I hope that helps, it gets you a part way. I don’t know if it’s a complete answer, but that’s what we know right now."
},
{
"speaker": "Phil Stefano",
"text": "That’s better than I hoped for. Thank you. It’s perfect."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Phil."
},
{
"speaker": "Operator",
"text": "Our next question is from Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good evening. My first question, I guess, kind of picking up on that margin question. So that kind of helps us think through the expenses, but then the second portion, is that, Pat alluded to, organic revenue growth in 2021, he feels like should be better than 2020, right, which you guys essentially end up at around 3%? And so this quarter, right you saw about 150 basis points of margin improvement off of your organic revenue growth. So how do we think of that component of the margin, right? So you’re growing organically over 3% next year, what’s the component of underlying margin improvement that we should think about adding on to whatever expenses can be utilized?"
},
{
"speaker": "Doug Howell",
"text": "I think that you’ll see – if we hit 3% of organic growth next year, absent all these savings, there’s a 0.5 point to 3.25 point of margin expansion in that 3% number next year. If it’s 4%, maybe we get back closer to a full point, which isn’t all that dissimilar to what we are running pre-pandemic. Now if you draw a line between 2017, we are marching up in margin every year. And you draw that line out to 2022, whatever you would have gotten in 2022, add another $100 million, $120 million of savings to that, and you’ll get pretty close to where we think the margin would be in 2022. So our March forward hasn’t changed on the base organic piece."
},
{
"speaker": "Elyse Greenspan",
"text": "Was there anything though then that was one-off that you saw 150 basis points this quarter? I mean, obviously, there could be quarterly seasonality on, I guess, 4% organic growth or 3% ex the onetime item?"
},
{
"speaker": "Doug Howell",
"text": "Well, I think when we’re at 4.2% organic this quarter, I think you did – we would see over 1 point of margin expansion. That’s probably not out of whack for other quarters in the past where it’s 4.2%, but nothing that really pops out at me. We did have some headcount savings in there. Our hiring hasn’t been as robust as it has in the past. Raises have been deferred a little bit though. That might influence a little bit, but there’s nothing onetime in there that I would point to."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay, that’s helpful. Then a couple of questions on M&A. The first one, I believe at your last IR Day was alluded to some – like modestly larger deals, I want to say in the $25 million range, that you thought could come to fruition. By looking at the activity this quarter, that hasn’t happened. So are those some of the deals, I guess, that you guys alluded to that maybe could come to fruition in the fourth quarter as deals get done in advance of potential track changes?"
},
{
"speaker": "Doug Howell",
"text": "That’s right. There are two nice $25 million revenue acquisitions that were nearly done with due diligence on. We’ve had Board approval on it, and we hope to get them wrapped up between now and the end of the year."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then my last question. So as we think about larger M&A, it’s been a few years, like Gallagher expanded internationally, Australia, New Zealand, Canada and the UK. And so if you guys are going to consider another larger transaction, Doug, you alluded to the debt capacity as well as cash that you have, if there is a sizable deal in the market that perhaps you chose to use more of your equity than you have in the recent times, would there be certain metrics, be it revenue, earnings accretion or something that you guys would be looking to, if it was a more sizable transaction that potentially required the use of your own equity?"
},
{
"speaker": "Doug Howell",
"text": "Yes. We do the traditional review of that to make sure that it wasn’t dilutive that there were synergies that could take out of it. But really, to be honest, Elyse, we like our tuck-in merger strategy. This is our opportunity to pick every single one that wants to join the family. We have that. We have fair multiples on those that we’re paying for them. We integrate much better into one another. We like our small tuck-in strategy at this point, and there’s lots and lots of opportunity for that, so."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I think that’s a key point, Elyse. This is Pat. When you look at the top 100 in business insurance in the United States alone that doesn’t recognize the rest of the world, you still have another 19,000 to 25,000, maybe even 30,000 firms out there that are not in that top 100. And a good portion of those are still owned by baby boomers. So our – the opportunity to do these tuck-ins is just way, way greater than the large play."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay, thank you. I appreciate all the colors. Thanks, guys."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Elyse."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Elyse."
},
{
"speaker": "Operator",
"text": "Our next question is from Greg Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Greg Peters",
"text": "Good afternoon. Just a couple of follow-on questions. If you were pointing to, I think, Page 5 or 6 of your press release – 6, where you go through the adjusted EBITDAC margin. And I think through the nine months Doug, you reported a 33.6% EBITDAC margin on an adjusted basis. And I know you’re doing a good job of chronicling how much of the savings are going to – should extend themselves beyond just the opportunity you’ve had this year. At what point do you hit that threshold where you can’t grow margins because you have to invest in the business? Or put it another way, at some point, you can’t turn this into a 50% margin business or maybe you can, you just haven’t mapped it out for us yet."
},
{
"speaker": "Doug Howell",
"text": "No, Greg. Listen, trees don’t grow to the moon. I think that there are plateaus when you reach them. I think when you get into that 30% to 32% type range as an annual margin in a brokerage segment across the globe, that’s a pretty fair margin to have. But scale does bring advantages. And this is a – the brokerage business is showing that size can be helpful, especially with size in the same fairway that you’re playing. If you can get more acquisitions that are right down the middle of the fairway, using the technologies that we’ve developed, using our offshore centers of excellence, our centralization that we’ve worked on for 15 years, we think that there’s still terrific opportunity for us to roll in and have nice, steady margin improvement. If we’re growing over 3% or 4%, well, I think it can be – you can eke out a little margin just because of scale. And some of it depends on wage inflation, too. I mean we are a people company, and we are lucky that after the Great Recession that wage inflation remained in check. Perhaps here in the pandemic, we’ll keep wage inflation in check a little bit. But we are a people company, so raises are something that we want to give. And so – but if we can keep wage inflation in check, I think that you can eke out some margins."
},
{
"speaker": "Greg Peters",
"text": "Just as a follow-up to that comment, when do wage or salary increases typically happen for staff? Is that a beginning of the year event to midyear event? When does that generally hit?"
},
{
"speaker": "Doug Howell",
"text": "Kind of late second quarter, early third quarter. It’s a little bit later this year. We’ll do that here in December."
},
{
"speaker": "Greg Peters",
"text": "Got it. In the balance sheet, I noticed that the premiums and fees receivable jumped up from year-end. And I’m just curious if you – if there’s anything in that increase that is troublesome or if that’s expected, on plan, or just some color behind that. Then, the numbers I’m looking at are, on the balance sheet, the 6,702.5 versus the 5,419.2."
},
{
"speaker": "Doug Howell",
"text": "Yes. Okay. Good question. First of all, we look at our cash receipts every day. We’re not having any slowdown at all from client premium payments coming in, so we don’t have a liquidity issue there. And again, I just looked at the report at 2:00 this afternoon, and our October is equal – since the pandemic, our cash flows have been equally, if not better, than what they were in pre-pandemic time. So that isn’t it. We do have some – as we have a reinsurance operation, now you can get some significant reinsurance premiums that flow through that can cause some of that to be a little more volatile on that, but there is nothing there that I would – that is at all indicative of any type of slowdown in payments by our customers in that."
},
{
"speaker": "Greg Peters",
"text": "So in other words, DSOs have remained fairly stable this year relative to previous year?"
},
{
"speaker": "Doug Howell",
"text": "Yes. That’s right."
},
{
"speaker": "Greg Peters",
"text": "Got it. I guess the final question, I know you’ve already provided a lot of commentary around M&A, but I can’t help myself but go back to that well. First of all, Pat, when you’re talking culture, I know it’s very important to you. Are you – when you’re looking at M&A opportunities, are you willing to consider M&A that has a slower organic growth profile? Or, put it another way, is the deals that you’ve done in the last couple of years, have they boosted your – have they been a net gain to organic revenue on a consolidated basis? Or has it been neutral or been a headwind? Does that make sense?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, it certainly hasn’t been a headwind. And the nice thing about tuck-ins, Greg, is that if you get the right folks on, sometimes they can be terrifically accretive. But by and large, I think when you add all this, it’s probably right in line with the rest of our organization. And we’re seeing lots of opportunities, but again, you followed us for years. It’s not brain surgery, culture is absolutely critical. And I’d like to sound more sophisticated, we try to find people who care about their people, love this business and run a good business. If they can’t make money for themselves, they’re not going to make money for us and our shareholders. But once they cross that hurdle, it’s really got to be about, are they going to fit culturally and are they going to really be able to take advantage of the things that we bring to the table? And I think you’ve heard me talk about this before. I tell them that when we bring them here to Rolling Meadows or they joined one of our offices out there, we open the curtain and show them the candy store. And they’re like, \"Wow, I’ve got all this to work with now?\" And when that happens, it opens up, in many instances, accounts that are local to them, and we’re very strong in our local communities. We want to help them build that strength and accounts that they never had a chance to touch because of their size are now open to them because really, there’s nothing that we can’t help them tackle. And frankly, that gets them excited. So for us, are they going to stay? Do they love selling insurance, which I know sounds crazy, but there are some of us that were born to do that? And the fact is those people end up being with us a long time, building great businesses having a great time doing it. And it really does come down to cultural fit."
},
{
"speaker": "Greg Peters",
"text": "Right. Well, I know you’ve described it before. I don’t think you’ve used the word – the phrase candy store with me, but it doesn’t mean you haven’t used it before."
},
{
"speaker": "J. Patrick Gallagher",
"text": "But you understood what I meant, right, Greg."
},
{
"speaker": "Greg Peters",
"text": "Absolutely."
},
{
"speaker": "J. Patrick Gallagher",
"text": "There you go."
},
{
"speaker": "Greg Peters",
"text": "So the final piece on M&A, obviously, there’s a lot of stuff going around the election, anticipation of maybe a change in tax cuts in the – tax rates in the U.S., et cetera, that may lead to accelerating deal flow. Are you seeing any activity in Europe? Are you seeing any change in the flow of potential deals outside the U.S.?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes. And I’ll tell you why. It’s exactly what we told you in 14 when we did our transactions in the UK, Australia and Canada, in particular, and now in Europe and Latin America. Once we’ve got a platform that gives people confidence that we’re really there to stay, then the smaller broker has something to look at, that is not just getting a new name or changing where they send their reports, they get the benefit of the fact that we’ve got scale, we’ve got brand recognition and we have capabilities. So yes, our pipeline in the UK, our pipeline in Australia, Latin America, New Zealand and Continental Europe are stronger than they’ve ever been."
},
{
"speaker": "Greg Peters",
"text": "Got it. Thank you for the answers."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Greg."
},
{
"speaker": "Operator",
"text": "And our next question is from Mike Zaremski with Credit Suisse. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"text": "Hey, great. Maybe we could talk about Risk Management a little bit. I think from the prepared remarks, it sounded like claims counts were – are continuing to improve, but still down. Maybe you can put some numbers around work comp and GL. Are those still down kind of double digits year-over-year? What are you guys – any update on the outlook for the Risk Management segment? I mean margins improved more than what you thought, probably. Maybe can you talk why margins improved more than expected as well?"
},
{
"speaker": "Doug Howell",
"text": "Yes. I think the question is what type of claims? I think the more difficult claims that are rising, the kind of the churn business is still down, maybe 20% to 30% on the small, but we don’t make a lot of money off of those anyway, so they’re kind of low margin. So that doesn’t hurt us so much. I think we have had a little bit of boost in settling claims that have risen because of COVID. And so our complicated claims, they’re still there. And so that has helped this business be more resilient. If you think about it, it might be more of a lost revenue story than it is a lost profit story as you can see by the margin. So the advantage we have is that we’ve held on pretty well, being only down 5% this quarter on a revenue basis. As we get a vaccine, as things start to improve, you will have that business come back in and hopefully be up nicely in the positive organic space next year."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Maybe stepping back and thinking about brokerage again, one of your competitors today I think kind of hinted at maybe pricing had reached a point that had reached its limit. At least, there’s definitely some businesses that are experiencing some fairly high double-digit rate increases. And I think that your competitor alluded to maybe the carriers have – some are getting enough freight and maybe we’re at peak freight. Any thoughts about kind of what you’re hearing and seeing from the carriers? And it feels like there’s some new capital coming into the space as well."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, there’s clearly new capital coming in, and I will tell you that there is zero interest from the people that – the partners we’re talking to at modifying rate increases at all. I mean they’re not getting any rate of return on new invested dollars. Social inflation is killing them. Lines of coverage that have been under attack for years while the market stayed soft are raising their – continuing to raise their head. This is – I see nothing in the way of softening or stopping the momentum. Now remember, again, we tried to give you some detail in our prepared remarks, workers’ compensation is about flat. They make good money on workers’ comp. Workers’ comp is competitive in the United States, and our clients benefit from that. And remember, our job is to make sure we do everything we can for our clients to make sure the hard market doesn’t cripple. So it’s not like I’m sitting here and saying, \"Hey, this is – it’s getting harder by the minute.\" But I can tell you, when you talk to the people that are the actual providers of capital, they’re not seeing light at the end of the tunnel being yahoo we’re back to soften, that’s for sure."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Great. And just lastly, just making sure, there’s nothing supplementals and contingents that was unusual this quarter?"
},
{
"speaker": "Doug Howell",
"text": "No. No. Not this quarter. Not this year at all, as a matter of fact."
},
{
"speaker": "Mike Zaremski",
"text": "Thank you very much."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Mike."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our next question is with Josh Shanker with Deutsche Bank. Please proceed with your question."
},
{
"speaker": "Josh Shanker",
"text": "Yes. Good evening, everyone. Thanks for taking my call."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Josh."
},
{
"speaker": "Josh Shanker",
"text": "So I was curious, historically, I guess, for a number of years, we’ve been in a middling market, and I think that benefits brokers who have a lot of visibility on pricing and maybe it disadvantages carriers and the negotiation with the client. As things are perhaps changing, is there any benefit being given to the carriers in that negotiation, where the client demand or you’ve encouraged some more competitive fee structure from the broker? Is there any renegotiation going on at that level?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Fees are one of the things that always happen. And this is – since 2006, in the United States, in particular, we’ve been completely transparent with our clients on what we make. And we are not feeling huge pressure on the income that we make for the extra work that we’re doing today. And that’s another reason when you look at fees and what have you, that even if rates were up 25%, you’re not going to see our revenue jump 25%. That wouldn’t be a fair transaction. But at the same time, there’s a lot more work, and it’s our expertise now that we’re selling that sells a lot better in a hard market than it does a soft market. If it’s in a soft market, the person down the street that hangs a shingle out can get you five quotes. We’re not getting five quotes today. And you better work hard with somebody who’s got some real dedicated inside clear understanding of your business that can differentiate your risk and your approach to risk to that underwriting community or you’re going to get whacked. And so our services are more valuable than ever. And you’re right, we went for about 10 years. And you’ll recall in my conversations on these conference calls, I always alluded to the fact that I don’t like hard markets. And everybody would say were – and when the rates were up 1%, down 2%, up 3%, sideways, flat, that was perfect for clients. It gave them a chance to choose. It gave us a chance to be able to say this market or that one put them together this way, build the tower this way, and it was really another way to show our expertise. Now this is a time where we’ve got to give good counsel, and they’ve got to understand that in many respects, it’s a seller’s market. And we’ll get them through it. No, it won’t last forever, but now is the time to make sure you’re partnering with someone that knows what they’re doing. And we’re getting paid."
},
{
"speaker": "Josh Shanker",
"text": "That’s very clear. And then on Gallagher Bassett, can you talk about throughput of workers’ comp claims and what the marketplace is shaping up to be with lower employment or with a work at home and how that changes the services you provide there?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, the services we provide there, Josh, they’re not different in the sense that if you have a workers’ comp claim, we’re going to handle it. There’s all kinds of protocols, state by state, rules, regulations, et cetera. There are fewer claims when you’re not in the office, you’re not in the factory, you’re working from home. There are clearly fewer claims and fewer accidents. And when economic activity regains itself and people come back to the places of work, we expect that those claims will reflect that. But in terms of how you deal with someone that gets hurt, it’s – we still have to file those state rules, and we still have to adjust and adjudicate the claim, which we think, if you use Gallagher Bassett, will give you a better outcome."
},
{
"speaker": "Josh Shanker",
"text": "And in terms of flow of claims incidences?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I’m sorry, you broke up, Josh, what was that?"
},
{
"speaker": "Josh Shanker",
"text": "Claims incidents during the pandemic, how is that shaping up?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Incidents are down, significantly down. That’s the whole reason – when we talk about claim counts, that’s incidents."
},
{
"speaker": "Josh Shanker",
"text": "Yes. Yes. And so does that change the service or the fees? They say, well, look, we don’t – in terms of your interaction with the clients for Gallagher Bassett, does that change what you can charge or change the negotiation at all? Or is it a typically a fee for service?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No. No. No. It doesn’t at all."
},
{
"speaker": "Josh Shanker",
"text": "Okay, great. Thanks, Josh."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question is from Yaron Kinar with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Yaron Kinar",
"text": "Hi, good afternoon. Thanks for taking my questions. A few timing questions, if I could. One, you’re talking about M&A maybe being a little bit – is the pipeline being robust here as we head into 2021 because of the potential tax impact there? Do you think that could mean that there’s a bit of a lull in M&A as we enter 2021?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I don’t think so. I mean, when I look at it, it really is a very interesting market, which is why you see, it was not that long ago that there were very few billion-dollar brokers. Today, there’s about 11 or 12 of us. By that, I mean revenue. That’s why private equity has been so prevalent in the business, which is good for us because private equity is smart money telling the investment community, we’re a great bet. But the fact is, there are thousands and thousands of independent agents and brokers that ultimately have a chance to capitalize their life’s work, and I think that’s not going to stop."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. And then could you remind us when in 2021 do the 2011 clean coal plant sunset – does the tax credit sunset?"
},
{
"speaker": "Doug Howell",
"text": "Okay, there’s two answers to that. Our plants that we operate will sunset mostly in late November, early December, absent an extension. For those plants that we don’t operate at our Chem Mod affiliate that we own a substantial piece of that gets a royalty of, those could stop production sometime more in the late third quarter or early fourth quarter. It just depends on – it’s 10 years from the date that they were placed in service. So if they were placed in service before December of 2011, then they would be – they would sunset a little bit earlier. So that’s why on Page 5 of the CFO Commentary, you’ll see that our royalty income is just – we’re forecasting that just to be down a little bit relative to 2020 because some of those will sunset just a little bit earlier."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. Okay. And those last couple of months of the year don’t tend to be very large months from a clean coal perspective, right?"
},
{
"speaker": "Doug Howell",
"text": "It can be. If you get a cold December, you can – the southern plants that are dependent on baseboard heat, electric heat, would be. And again, I can’t miss the opportunity to reinforce, just because $60 million to $70 million of GAAP earnings go away, that’s – right away, we’ll flip in 2022 into harvesting all the credits that we’ve been generating over the last 10 years. So that’s – you might almost double the amount of earnings on a cash basis versus then on a GAAP basis at that time."
},
{
"speaker": "Yaron Kinar",
"text": "Right. And then final timing question. The contract that you’ve pulled forward into the third quarter in Brokerage, does that get renewed in the third quarter of next year?"
},
{
"speaker": "Doug Howell",
"text": "Well, first of all, I wouldn’t say we pulled it forward. They just got it closed sooner. So that was a great work by the guys that have been working on that product for a lot. That’s going to be an occasional sale. I don’t think that it’s something that would repeat year in and year out. It would be another customer that would happen to see the real smarts in this product and decide to close it in third quarter next year. But that would be hitting us. It’s a little bit more elephant hunting on that, so call it that – if you close one every 18 months, that would be great, but who knows. It’s a terrific product that’s getting some momentum. So we might see it a little bit more frequently, but I’d be happy with one of those every 18 months."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. Thank you."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Yaron."
},
{
"speaker": "Operator",
"text": "And our next question is from Ryan Tunis with Autonomous. Please proceed with your question."
},
{
"speaker": "Ryan Tunis",
"text": "Hey, thanks. Good evening. I just had one. So employee benefits, I might have missed this, Pat, but I thought you said it was plus 6%, but that included the one-off transaction."
},
{
"speaker": "J. Patrick Gallagher",
"text": "That’s right."
},
{
"speaker": "Ryan Tunis",
"text": "What was the organic, excluding that within the employee benefits unit?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hold on."
},
{
"speaker": "Doug Howell",
"text": "Flat to 2%. I mean, so let’s call it 1.3%, if I look at my notes."
},
{
"speaker": "Ryan Tunis",
"text": "Got it. And then just looking for an update, obviously, that is a business that economically impacted at a lot of the other brokers. We’ve had three quarters – kind of three quarters in the recession. Are you learning anything new that would change your organic outlook for employee benefits? Or is it still kind of the same story you’ve been talking about in previous quarters at the mid-quarter updates?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I think the thing that’s probably most beneficial to our business that we learned. And first of all, thanks for the question, Ryan. When we look at the business in general and say, what have we learned over the last seven, eight months about what can happen, how this business can be run, where people can do it? How expertise can be exported around the world? I mean, we’ve got experts in verticals that are world-class. And you want to try to get them to a prospect or a client, you can use up a whole day or two days of travel. Today, they can drop in by video call and bam, they’re there and people accept that. So we’ve learned a lot, and there’s lots of opportunities for our business because of that. But I think probably the thing that reemphasizes why we’re so high on the benefits businesses, even in this pandemic and even with the recession that hit, the amount of employees that stay employed, the employers holding on to their people, it’s incredible. I mean we thought in March and April, get ready, the floor is going to drop out, everybody is going to let everybody go. And of course, I’m being facetious. But the fact is, this war for talent, ongoing long term, what’s your product? I don’t care if you’re making big steel drums, you’re a people business. And people are holding on to their folks and our censuses by count have not dropped through the floor. And people are saying – and as we come out of this, to me, it just makes that business even better, which demands incredible expertise to balance all the costs and all the covers and to make sure that you are, in fact, providing what the employees need, but that you also make sure through communication that they understand that they’re better off with you. So it’s – basically, it’s really put us in a spot to want to double down on that business."
},
{
"speaker": "Ryan Tunis",
"text": "Got it. Understood, thanks."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Ryan."
},
{
"speaker": "Operator",
"text": "And our last question is from Meyer Shields with KBW. Please proceed with your question."
},
{
"speaker": "Meyer Shields",
"text": "Great. Thanks. Just a small question. I just – I feel like I missed the amount of the employee benefits contract that was signed earlier than expected. Have you given quantification on the actual revenue?"
},
{
"speaker": "Doug Howell",
"text": "No, we really haven’t. I think you can probably do the math. It was about $12 million to $15 million, so…"
},
{
"speaker": "Meyer Shields",
"text": "Okay. I can do the math now."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks for making it easy, teacher."
},
{
"speaker": "Meyer Shields",
"text": "The second question, I know there’s been sort of a long-term strategy at Gallagher of moving clients along to self-insurance over time. Has the pandemic interrupted that at all?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No. I mean, in fact, if anything, it’s made it more of a crucial conversation because it’s crunching businesses. And when the economy is good and employees are being hired and there’s fight over employees over – because of a full employment, those times are heady times for many, many people. And yes, financially, we can always point out to those businesses why considering a large self-insured retention, bringing Gallagher Bassett in, getting better outcomes on your claims, makes for better control of not only your insurance purchase, but your entire risk management program, and we do a good job of selling that. You put a buyer against the wall, they’re all ears, and we’re really good at moving people first dollar cover into a form of risk management, risk retention, group captives, et cetera. That is our – that’s our heritage."
},
{
"speaker": "Doug Howell",
"text": "Typically, when you have increasing pricing, an account that customer that had really good loss experience is more willing to look to build self as a component of their program being through self insurance. And as prices go up, that gets their attention. And we do a lot of workers’ comp in this, and workers’ comp has had rate cuts recently. It’s flat right now. I think that if workers’ comp goes hard, I think you’ll see considerably more folks with good experience or companies wanting to look at alternative risk transfer."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well Doug hit on something, Meyer, I think this has been the dilemma that really wasn’t talked about during that eight to ten-year period where the market was relatively soft or was flat. When the market starts to firm, one of the dilemmas for the insurance carriers is they need the entire base to give then more rate. The better units of risk look to move out of that buying community. And so now you’re taking from the insuring community their better units of risk, leaving them to fight over what is maybe not the best units and even needing more rate. And that is when the competition thins because there just aren’t thousands of people that can do what we do."
},
{
"speaker": "Meyer Shields",
"text": "Okay. No, that makes perfect sense. And that was very helpful. Final question, and I may have just been modeling this incorrectly. But the investment income in the brokerage, the investment income and net gains on divestitures ticked up something like $3 million from the second quarter to the third quarter. Should we expect that sort of seasonality? Or is that just random now?"
},
{
"speaker": "Doug Howell",
"text": "All right. So there’s two questions there. What happened with investment income, right, what you’re saying?"
},
{
"speaker": "Meyer Shields",
"text": "Yes."
},
{
"speaker": "Doug Howell",
"text": "Well, listen, first, some of that – some of the numbers running through there has to do with our premium finance business down in Australia and New Zealand. But let me give you the punch line on it because we are down somewhat in investment income, just in true investment income that is – that we earn on the premium trust accounts, et cetera, we are down probably in the third quarter somewhere around $4 million, $3.5 million from where we were last year. So you wouldn’t be seeing that right."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That’s very helpful. Thank you."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Meyer."
},
{
"speaker": "Operator",
"text": "And we have reached the end of the question-and-answer session. And I will now return the call back over to Pat for any closing remarks."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you very much. Let me give you just a quick comment. Again, thanks, everybody, for joining us this afternoon. We delivered an excellent quarter in first nine months of the year in the face of a difficult economic environment. And again, I’d like to thank our 32,000-plus Gallagher professionals for their relentless efforts and dedication. I remain confident that we can deliver another outstanding year of financial performance and successfully navigate these challenging times. Thank you, again, for being with us. We really appreciate it."
},
{
"speaker": "Operator",
"text": "And this does conclude today’s conference call. You may disconnect your lines at this time. Thank you, and have a good day."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 2 | 2,020 | 2020-07-30 17:15:00 | Operator: Good afternoon and welcome to Arthur J. Gallagher and Company's Second Quarter Earnings Conference Call. [Operator Instructions] Today's call is being recorded. If you have any objections, you may disconnect at this time.
Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meanings of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to cautionary statements and risks factors contained in the company's 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements.
In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website.
It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
J. Gallagher: Thank you. Good afternoon. Thank you for joining us for our second quarter 2020 earnings call. Also on the call today is Doug Howell, our CFO, as well as the heads of our operating divisions. We delivered an excellent second quarter. Despite the economic deterioration caused by COVID-19, our teams are executing at the highest levels while we continue to place health and safety first. We are servicing our clients. We're selling new business. We continue to look at merger and acquisition opportunities, and our bedrock culture keeps our teams working together even while physically apart. I would like to thank our 33,000 Gallagher professionals around the globe for their constant and tireless focus on delivering the very best insurance brokerage, consulting and risk management services to our customers. More than ever, these are times when our global capabilities and resources support our local professionals as they help our customers navigate these challenging times and still generate strong new business. That really truly is the Gallagher way.
Moving to our second quarter financial performance. We grew our combined Brokerage and Risk Management revenues in the second quarter organically and through mergers and acquisitions. And together with our expense control actions, delivered excellent growth in EBITDAC and net earnings. This demonstrates that our investments over the last decade have enabled us to quickly adjust our workforce and expense base, increase the utilization of our centers of excellence, efficiently work remotely, improve our productivity while always raising our quality.
Let me break down our results further, starting with our Brokerage segment. Reported revenue growth was a positive 6.2% and even a bit better at 7.6% when leveling for foreign exchange. Of that, 2.1% was organic revenue growth. Net earnings margin was up 364 basis points, and adjusted EBITDAC margin expanded by 635 basis points to 32.6%. Doug will provide some additional details on our expense control efforts, which was primarily responsible as we drove net earnings up 38% and adjusted EBITDAC up 34%. Clearly, a very strong quarter and pointed the team execute in a difficult environment.
Let me give you some sound bites about each of our brokerage units around the world. Starting in the U.S., our retail P&C business held up very well during the quarter, delivering organic growth of about 4%. Still strong new business generation, a small drop in retention and nonrecurring business, rate increases offset exposure unit declines, cancellations were not up over first quarter levels, and midterm policy modifications were still a net positive, but a bit lower than first quarter levels.
All-in, we are seeing similar trends in our domestic wholesale operations, but a bit of a tale of two cities. Our open brokerage business had mid-teens organic growth benefiting from strong new business and rate. Our MGA program binding businesses were backwards about 5%, resulting from a slowdown in programs like transportation, amateur sports and construction. However, when we look at June alone, our MGA and program businesses were showing improvement over the lower in activity -- over the lower activity seen in April and May. We had an excellent quarter in Canada at more than 5% organic driven by strong new business and higher rates. The U.K. delivered 4% organic, and Australia and New Zealand were closer to flat, where we are not seeing as much tailwind from rate. So exposure declines are weighing just a little bit more on our organic. So overall, our global PC operations reported about 4% organic in a quarter, a really strong result in a difficult environment.
Moving to our benefits business. As anticipated, we saw some second quarter weakness, down about 3% on an organic basis. New consulting and special project work declined in addition to a decrease in covered lives on renewal business, but we are not seeing covered lives decreasing as much as the headline unemployment numbers. So when I bring our PC and benefits together, the 2.1% organic here in the second quarter came in pretty close to where we thought it would be at our June Investor Day.
Looking forward, so far in July, nearly every metric we are monitoring is trending better than the second quarter.
Accordingly, based on what we're seeing today, we think third quarter brokerage organic and expense saves will be similar to the second quarter. As we move into the fourth quarter, if the economy continues to recover, feels like organic would equal or even be a bit better than the third quarter, and we should be able to continue to deliver cost containment as well. Still a lot of economic and governmental uncertainty, but that is where we are forecasting today.
Before I leave the Brokerage segment, let me go a bit deeper on the PC pricing environment. PC pricing continued to move higher around the globe, with most geographies reporting 5% or greater price increases, tighter terms and conditions and somewhat restrained capacity. By line of business, property remains the strongest, up more than 10%. Next is professional liability, up over 7%. Other casualty lines are up 5% to 10%, with umbrella rate increases at least twice that level, and workers' comp is flat to down 2%.
By geography, Canada is seeing the greatest price increases up more than 8%. The U.S. is up about 7%, followed by the U.K., including London Specialty at about 6% and Australia and New Zealand between 2% and 3%. So PC pricing is up across the board, but client premium changes are more modest due to lower exposure units, higher deductible, reduced limits and clients opting out of coverages.
Looking forward, I see rates continuing to increase within an already firm market and early indications from July point to continued increases in the third quarter. Before the pandemic began, loss costs were outpacing rate and I see just as strong a case for underwriters to push for even more rate in this environment.
It is certainly a more difficult market today, but not yet a hard market because most risks can still find a home.
Jumping to mergers and acquisitions. We completed 4 brokerage mergers during the second quarter at fair multiples. I'd like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing Gallagher family of professionals. While second quarter mergers were lower than normal, the number of conversations with potential merger partners is picking up so far in the third quarter. Difficult market conditions and the pandemic are further highlighting the need for expertise and data-driven tools. Our platform is an excellent fit for entrepreneurs looking to support their current clients, use our tools and data to grow their businesses and advance their employees' careers.
As I look at our M&A pipeline, we have about 40 term sheets signed or being prepared, representing around $300 million or so of revenue. Based on the activity we are experiencing in July, we are optimistic we will return to more normal levels of merger activity later this year.
Next, I'd like to move to our risk management segment. Second quarter revenue was in line with the guidance we provided at our June IR Day, with reported revenues down about 8.8% and organic down about 9.6%. This reflects a dramatic pullback in new claims arising due to higher unemployment and a reduction in overall business activity, offset somewhat by an increase in COVID-related claims. We think April was the worst of it, and I'm encouraged that claim counts in the latter half of the quarter and into July improved off the lows. However, new claims arising are still well below pre-COVID levels. Our risk management team also did a terrific job on cost containment. Adjusted EBITDAC was only $2.7 million lower in the quarter relative to last year and margins held which is also right in line with our expectation. It takes a little longer to turn this ship versus our Brokerage segment. So we would expect to see third quarter EBITDAC improve relative to second quarter and then as our expense actions are fully realized, even greater improvement in the fourth quarter, leading to full year adjusted EBITDAC at least equal to 2019, just a fantastic job by the team to adjust our expense base and rebalance claim loads across adjusters while maintaining our client service and quality levels. So when I combine our core Brokerage and Risk Management segments together, despite the unprecedented economic challenges, we grew our adjusted revenues 5.3% and grew our net earnings and adjusted EBITDAC about 30%. That's truly an excellent quarter.
But before I turn it over to Doug, let me finish with some comments on our bedrock culture. When times are tough, teams can either break apart or band together. Since my grandfather started the company in 1927, we have consistently expected every leader in associated Gallagher to live our culture, talk about our culture and promote our culture. Culture matters. Culture prevails. Culture is important in the best time, but even more important during challenging times. Our team is together. We respect and support one another. No one is an island. There are no second class citizens. We learn from each other. Everyone is important. For those of you that have followed Gallagher since we came public more than 35 years ago, you'll recognize those statements as just a few of the 25 tenets of the Gallagher way. This document puts our core values in new words, which shapes and then guides our culture, and we believe in it because it matters to us. We live it every day, and it's guiding us through these challenging times. I believe we will emerge on the other side even stronger than we were before.
Okay. I'll stop now and turn it over to Doug. Doug?
Douglas Howell: Thanks, Pat, and good afternoon, everyone. Like Pat said, solid top line growth and truly remarkable bottom line performance. Our combined Brokerage and Risk management adjusted EBITDAC is up nearly 30% over second quarter last year. Many thanks to all of our colleagues around the globe for continuing to [indiscernible] on our cost control efforts, all the while continuing to deliver unique insights and high-quality service that our clients need even more in these times. Today, I'll spend most of my time on our expense savings, give you some comments using the CFO commentary document and then finish with thoughts on cash, M&A and liquidity.
All right. Let's go to the earnings release, Pages 4 and 7. You'll see both the Brokerage and Risk Management segments expanded adjusted EBITDAC margins this quarter. Our Brokerage segment reduced compensation and operating costs by about $60 million versus prior year when you adjust that for roll-in impact of mergers closed after March 31, 2019. In the Risk Management segment, the savings amounted to about $14 million. So in total, we were able to adjust our expense base by about $74 million during the second quarter. That's at the top end of our estimates that we provided in April and again at our June IR Day.
Let me give you a breakdown of these savings. We reduced travel, entertainment and advertising by about $24 million. We reduced technology consulting and professional fees, $14 million, reduced outside labor and other workforce actions, saved about $13 million. We saved on office supplies, consumables and occupancy costs of about $12 million and lower medical plan utilization by our employees saved about $11 million.
When I look towards the third quarter, I think savings will be in the $65 million to $70 million range relative to last year, again adjusting for roll-in mergers. This is a bit lower than second quarter, simply because our production staff is beginning to travel to see clients and prospects. We are increasing our advertising costs again. And in June, we did see a reversion to pre-pandemic levels of our employees utilizing our medical plan. As for the fourth quarter, that all depends on what happens with organic. If we're at plus 2% or plus 3% organic, then our producers are likely traveling more and we may restart some of our postponed investments, and thus, we wouldn't see as much savings in areas like technology, consulting and professional fees. But if organic is flattish, we'd expect to see a similar level of savings as the third quarter.
Okay. Let's go to the CFO commentary document that we posted on our IR website.
On Page 2, most of the items are fairly straightforward and consistent with what we provided to you in our June IR Day. There's 2 items to highlight, which basically offset one another. First, foreign exchange in our Brokerage segment was slightly unfavorable this quarter, call it about $0.01; and second, in the Brokerage segment amortization, that came in about $0.01 favorable, again, offsetting the FX.
Flipping to Page 3 to the corporate segment table. Relative to the midpoint of the guidance we provided at our June IR Day, interest in banking came in about $0.01 or so favorable. The acquisition line came in just a little bit less than $0.01, but still favorable. The corporate line is about $0.01 unfavorable, but you'll read in footnote 3, that was simply due to foreign exchange rates bouncing around. In the quarter.
Finally, clean energy was $0.01 below the midpoint of the range due to mild temperatures, more use of natural gas and weaker electricity consumption due to COVID. Hot July has started off a strong third quarter, but we are still seeing natural gas prices on the lower end and lower economic activity could likely dampen generation later in the second half of the year. So we have lowered a bit our full year range to $60 million to $70 million net after tax earnings. But let's not forget the $1 billion of tax credit carryforwards we have on our balance sheet. That's effectively a receivable from the government that should allow us to pay lower cash taxes for many years to come.
All right. Let me wrap up with some comments on cash, M&A and liquidity. Our customer cash receipts were strong during the quarter, rebounding in May and June after a slight slowdown in early April. So far, in July, we're tracking back to prepandemic levels. So we don't see any concerns at this time. As of today, we have more than $1.3 billion of liquidity, consisting of available cash on hand of nearly $275 million and we have access to over $1 billion on our revolving credit facility. As for M&A, as Pat mentioned, we did complete 4 acquisitions during the quarter. A couple were tax-free exchanges. So we used a little of our stock but even then with an average multiple paid below 8x, there was a nice arbitrage to our own trading multiple. More importantly, our pipeline is really heating up. So we could have a strong finish to the year and a strong start early next year.
Okay. Those are my comments. A great quarter by the team for them to continue growing revenues and executing on cost containment. Let's keep the economy from another clench we should pull off an excellent full year. Back to you, Pat.
J. Gallagher: Thank you, Doug. Operator, let's go to questions and answers.
Operator: [Operator Instructions] Our first question is coming in from Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question, Pat, or maybe this is, I guess, for Doug, is on the expense saves. So I guess I have a few questions here, but the first one is, you guys expanded your brokerage margin by 6.2%. So what I think maybe gets a little bit lost in the numbers and if we adjust out the save on 2% organic revenue growth, if my math is right, you saw around 120 basis points of margin improvement. So am I thinking about that correctly? And then I guess there's just some pretty good just margin improvement in your business away from just the base. Or am I missing something there?
Douglas Howell: No, you have it about right. I think that's right. We had -- no, we didn't give raises this quarter. So that would have dampened to 1.2% a little bit, but you're looking at it the right way.
Elyse Greenspan: Okay. And then I think you guys -- you just provided some good color in terms of the save that we could see in the third and potentially the fourth quarter. If I remember from your June Investor Day, you had said that kind of post-COVID that about half of the saves, I believe, could persist on an ongoing basis? I just -- given you provided some updated figures, I wanted to make sure that guidance still exists today?
Douglas Howell: Yes. I think probably when we looked at it 6 weeks ago, that probably would have been about right. I think right now, we are learning a lot as a result of this crisis, and we are finding ways to deliver service and advice clearly more cost effectively than prepandemic. But I think what matters in the end is what we spend will be highly correlated at least to how our clients' prospects and underwriting partners expect us to do business. That will determine really how much we travel, how much we communicate virtually. Do they want to be entertained anymore? How much do we advertise? And how do we advertise in the market? And then also it drives what investments in technology and technical resources we are -- that we need in order to service and compete in the market. It also goes further when you look at what it takes to attract and retain talent. That will dictate a lot on how we leverage our work-from-home capabilities, maybe where we locate our offices, how we configure them. And then also a little impact how we train, develop and mentor our folks. So that will influence the ultimate cost savings. And then also, one thing I have to say as being experts in employee benefits, we truly hope that our employees get back to utilizing our medical health and welfare plans. We need everybody to be doing their prevented exams and getting the services they need. Nothing good comes from delays in getting your medical treatment. And that saved us several million dollars this quarter. So when I bring it all back together, over the long term, could we be saving $30 million to $40 million a quarter after we adjust the real estate footprint as we adjust postage express, office occupancy cost, maybe hire some of the external resources that we were using externally. Yes, maybe we could get to that number. So it wasn't far off as a guess, but it will really depend a little bit on how our clients' prospects and underwriting partners want us to do business.
Elyse Greenspan: Okay. That's helpful. And then on the organic side, Pat, I think you said that the third quarter brokerage organic seems to be trending in line with the Q2, which is a little bit better than your June Investor Day. And then we've been hearing from some peers that there are some lags in some of the businesses, right, so the third quarter could be worse than the second quarter? And [indiscernible] is that business mix that's helping the Q3? Is it incremental pricing? Just a little bit more color on how you see the third quarter transpiring.
J. Gallagher: Well, first of all, Elyse, as you know, July is a very big month for us. So it's a good bellwether. And we had a very, very strong July. And so I think as we sit here today, if things don't completely fall off the table in August and September, we feel just exactly the way we phrase it today.
Operator: And now our next question is from Mike Zaremski with Crédit Suisse.
Michael Zaremski: First question. What -- in terms of leverage levels, where could you go to temporarily with the rating agencies if there was kind of something chunkier or larger? Could you go to a -- kind of a materially higher level for a year or 2 and then kind of work its way down if something became available?
Douglas Howell: Yes. I think they'd be receptive to that. I think we've seen that with other brokers. So that would seem reasonable that they would be willing to accommodate that. Do we have the appetite to do that? We probably won't push our debt ratios very much at all, but I think they could be willing to listen to that.
Michael Zaremski: Okay. And along the same lines then, like -- so in terms of kind of making inroads into maybe the mid- to large account space as a result of the merger that's taking place. Is it more of kind of winning RFPs as the clients look for a new potentially to find another broker because they've consolidated to one? Or is it more hiring or both? And if it's the RFP process, is that taking place more kind of next year when the account comes up for renewal after the merger?
J. Gallagher: Well, Mike, this is Pat. I think you touched on a very good subject. But let me go back to our genesis. I mean Gallagher Bassett was started in 1962, basically, to take care of the claims for Petrus Foods with a Fortune 100 company at that time. So we've been in the large account risk management business since the 60s. Now over the past number of years, we've gotten much, much stronger in that business as well, both on the claims service side as well as on the brokerage side. And yes, I think that the fact that the 4 top players are going to consolidate to 3 is clearly giving us more opportunities. And as I said, our capabilities have gotten stronger and stronger, and we feel really good about our chances to expand that business.
Michael Zaremski: Okay. Great. And just lastly, back to Elyse's question, given just a phenomenal quarter in terms of margins. So again it sounds like, Doug, to your answer about kind of -- there was margin improvement beyond just the expense savings. And Doug, it sounded like you were saying that there was over 100 basis points of margin improvement beyond it. And it sounded like that could recur unless business kind of gets back to usual in terms of entertainment and more people feeling comfortable, employees feeling comfortable going back to the doctor's offices. And so it sounds like that kind of underlying net of expense save positive trend could continue?
I guess it's just -- it's, I think, sell-side estimates, as we know, haven't come up enough because it's just -- it's such a great margin improvement during what is fairly muted organic growth times. So I want to make sure we're understanding.
Douglas Howell: All right. So first of all, let's go back. What do we think in the future? In the third quarter, we think they're going to be $65 million to $70 million of savings. We won't give some of that back up because there are some costs coming back into the structure. In the fourth quarter, might be closer to a $60 million to $70 million. We might have to give back another $5 million there somewhere. But that's the way we sit today. The margin expansion that Elyse talked about is 2 things is we did have some strength in our supplementals and contingents this quarter, which probably drove a little bit of that margin expansion. Longer term, we think we're learning a lot about our business. And so I think there could be opportunities here for us to do things differently because our clients' expectations have changed in this 4 month period. And the question is, will they stay that way? Or will they expect to see 5 people showing up for a meeting for an hour? Or are they okay with our industry experts not getting on a plane, traveling a day for a half hour presentation. We're finding some really good success in that, that we can put our niche experts at the point of sale, and our customers are much more willing to accept a virtual face-to-face versus a real face-to-face. So there is going to be some savings on that, that survives. So margin expansion, we've always said it's hard to expand margins if it's below 3%. And we are okay at 2% with a little strength in supplementals and contingents. We got a point of margin expansion out of it in the near term. I think it would be pretty hard to post 2% organic growth for the next 3% and expand margins a percentage point a year. I think that would be difficult. Get us over 3%, we can hold in there, get us over 5% -- 4% or 5%, we'll expand them. So I don't see that changing much from what we provided in the past. But there's opportunity there, but -- yes, I think that this in the near term, 1% organic -- or excuse me, margin expansion on 2% organic is a pretty darn good quarter.
Operator: Our next question is from Phil Stefano with Deutsche Bank.
Phil Stefano: Yes. I was hoping you could give a little thoughts on contingents and supplementals to the extent that you have any forward view into them. I guess were there any catch-ups in first quarter or second quarter that we should kind of try to normalize out? In my mind, in this 606 world, the contingents and supplementals will be a bit more flat than maybe what we've seen or at least actual versus what I've expected.
Douglas Howell: Yes. I think there's probably a little bit -- a small, little bit of catch-up in the second quarter. A lot of these things get paid in the first quarter. We have like hundreds and hundreds of contingent commission contracts and even several hundred supplemental contracts. So we probably will have some positive development in our second quarter a little bit, but might be targeting a couple million bucks on announcement. So the team does a really good job of making estimates. I think what happens in the future because of the pandemic, loss ratios are hanging in there pretty well. So -- and it's -- our cost and value that we deliver right now. I think that we're earning our contingents and earning our supplementals, and I think we've got a pretty fair series of contracts. I think the carriers -- yes, that will hold up well with the carriers. So I don't see anything out of the ordinary in this.
Phil Stefano: Okay. Look, just to go back to the expense saves, and I don't want to beat this too much. But I guess, in my mind, thinking about the $60 million to $70 million we can expect third quarter, fourth quarter and then the idea that bringing this all together, maybe we could be $30 million or $40 million a quarter, who knows what the normal looks like moving forward. Can you give us a sense for how quickly that gap closes? And is 2020 a pivotal year where things back come back relatively quickly? Or does it really depend on the economy and shelter-in-place and the fallout of COVID in all those ways?
Douglas Howell: Probably more of the second. It is highly dependent on that. I wish I had a crystal ball, and I think all of us would kind of hope that they come back a little bit faster because that means the economy gets back to zooming, people are back to work. I don't mean zooming face-to-face. I mean, the economy is moving fast and forward. Guys, I think you want to have some expenses coming back in to our number.
J. Gallagher: Phil, let me hit that too, this is Pat. We haven't gone to see a client in 3 months. That isn't going to hold up. So there will be bump in your models full of no travel, no face-to-face, no entertainment, no new people. We're writing a lot of new business, and we're going to service that business. And there is pressure in the field to take a trip to see a client. We do have clients that are back at work now saying to come see us. And we've got very stringent restrictions for health and safety reasons about whether we're even letting our people do that. Believe me, we get a vaccine, and our people are going back [indiscernible], myself included. I haven't been on the ground this long since I was 11 years old.
Operator: Our next question is from Ryan Tunis with Autonomous Research.
Ryan Tunis: I guess just thinking about the third quarter organic thinking it's going to be somewhat similar to this. Behind that, what are you assuming organic revenue growth is going to be for employee benefits to get about 2% again?
Douglas Howell: I think it'd be much the same as what we've got now. I don't see a lot of difference between the third quarter and the second quarter for our P&C business or our benefits business. So it was back about 3% this quarter.
Ryan Tunis: And at this point, workers' comp revenues were down what, you said 10% through mid-June, correct?
Douglas Howell: Rates are down 2-ish, maybe 3%, something like that. But if you talk about exposure units being down, I can probably dig that out here for you in a second, but let me work on that.
Ryan Tunis: So what I'm getting at is I'm just trying to understand why ultimately you're not going to have some convergence of the employee benefits, which is only down 3%. And obviously, you're still collecting on furloughed workers, COBRA, that type of thing in the workers comp, that's just based on level of payroll. So we're down like 10 on exposures in workers' comp, I'm trying to understand why we wouldn't think that health and benefits will be down a bit more in the third quarter.
Douglas Howell: Well, I think that it might have to do with the mix of our business, too. As you know, we look at this in high, medium and low impact industries. And when we look at that, and stack it up. We have a lot of business that's in very low impact industries. So right now, you're not seeing the decreases in workers' comp and benefits in those industries at this point, even the medium categories, we're not seeing it. So there could be a convergence on it.
J. Gallagher: A big part of the drop in benefits is also related to project work and onetime stuff that we do when the economy is robust. Then people are willing to spend and come in and help me communicate with my people. Right now, they're more willing to not necessarily communicate as well. They'll take that burden on themselves. So it's projects and things like that, that also diminished in the quarter that we'll have to see a return to prior growth to get that kind of project work back. But the underlying health and welfare business does probably look more like work comp.
Ryan Tunis: Got it. And then, Pat, I guess my follow-up is, is it still safe to say that pricing increases are offsetting exposure declines?
J. Gallagher: Yes.
Ryan Tunis: So is it fair to say then that essentially, on average, accounts are renewing at basically a flat premium?
J. Gallagher: Or down because one of our key jobs is to help those clients in a difficult environment navigate what they spend. So people will take limits down. You had a $100 million umbrella this renewal or this expiration. Do you need $100 million next year, maybe it should be $50 million. Your retention was $150 million, should we take it to $250 million. There's a lot of work that we do around that, that helps our clients mitigate the cost of their insurance, while at the same time, protecting their future.
Douglas Howell: I am jumping on too. Our workers comp business was down 2% in the quarter, so -- and if our benefits business is about 3%, we're seeing it there, but it's...
Ryan Tunis: Got it. So, Pat, do you think it's sustainable that pricing can continue to offset exposure declines. Does that feel like something that can happen if we really are in a recession?
J. Gallagher: Yes, I do. I mean, for now, if you'd ask me that maybe March 30, I might not have been as bullish.
Operator: Our next question is from Yaron Kinar with Goldman Sachs.
Yaron Kinar: My first question is with regards to the cost saves. I just want to understand when you're looking at $60 million to $70 million in the third quarter, I think, Doug, you highlighted a few bad guys there. Are there other kind of positives that you haven't yet achieved in the second quarter that you think you can still dial up? Or is that $60 million to $70 million, simply a decline in the positive that you had the second quarter without any offset?
Douglas Howell: Just a couple of clarification. We can't wait for our employees to get back using their medical plan. So I wouldn't call that necessarily a bad guy. We want our folks to access our medical plans.
Yaron Kinar: Fair, fair. I apologize for the use of words.
Douglas Howell: No, that's okay. I just want to make sure we -- but we all know -- we don't want a severity problem coming out at the end of the year because people aren't getting their annual exam. So if that costs us a $5 million to $10 million a quarter, we're happy to spend it. I think that other bad guys, I wouldn't call travel bad, so I won't quibble on that. Do we have some other good guys that could come through? I think that we've done a pretty good job in the near-term of getting down to a number that's going to be harder to keep than it is harder to create more of them. So I think that we're about where we are in this environment. So I wouldn't expect too many good guys to offset the bad guys using your terminology coming through in the third and the fourth quarter.
So I think our estimates are pretty close. And if you think about it, we gave you an estimate between $50 million and $75 million when we came out of the gates here in April, 30 days into it, and we hit $74 million so I think we've got a pretty good insight about where we're spending money and what's going to stick and what's going to come back in.
Yaron Kinar: Right. Okay. And again, I apologize for using that terminology.
Douglas Howell: No, no, I know. I just wanted to make sure you...
Yaron Kinar: Yes. And then my second question just goes back to the buckets, kind of high impact, medium impact, low impact. Six months into this situation, as you look back, do you think -- how much of those buckets shifted? Like how much of the -- what you initially felt was a high-impact bucket ended up being in a low-impact bucket or vice versa?
Douglas Howell: Right. So if you look at it, let's say, there were 25 SIC codes in there what we picked in the second quarter. Of the high-impact 25, we got 20 of them right -- excuse me, 21 of them right, and then we had 3 of them in the medium category that probably moved up to high. When you get to the low kind of the same thing, and the medium, not much. So our pick on low, medium and high coming out of the gate, 3 weeks into this thing, I would say, is pretty damn good. And so I feel fairly comfortable that those are the impact businesses that we forecasted in the near term. We'll see what happens over the next longer-term and whether our picks are going to be right again. But we did a pretty good job of it. So I think that we've got a good insight into the nature of our business. So...
Operator: Our next question is from Mark Hughes with SunTrust.
Mark Hughes: Yes. Just another crack at the expense question. When we think about 2Q next year, do we -- is this the kind of right run rate on a go-forward basis, kind of a step function on 2Q. And so next year, we go back to your usual template of 3% or better. We get some margin expansion. Is that the right way to think about it?
Douglas Howell: Yes. I think you've got to go back and reset and take us basically. If you think about, we were expanding margins about 1 point a year, and we've been doing that 70 basis points a year for the last 5 or 6 years. If we get into a 5% organic growth environment, you're going to see us give back some of these savings, and then you're going to also see us just our natural continued margin improvement programs, you would be back into kind of that 50 to 70 basis point margin expansion on 5% organic growth. So you're looking at it the right way. But would there be a reset compared to second quarter next year? Probably because if we're back to -- if you put in $30 million or $40 million of expenses, and you're taking 70 basis points on $6 billion, you get in $40 million. It's about a push, maybe a little expansion.
Mark Hughes: Okay. And then on the benefits business, it sounds like most measures are improving. Pat, you talked about July being very, very strong. I'm not sure if that was completely focused on P&C. But it sounds like 3Q organic in benefits has the prospects of being better? Is that a fair read?.
J. Gallagher: I'd say that -- I think I was referring more to PC in my comments on July, Mark, it's only fair to say. I think what you're seeing in benefits now is systemic, and I think that will continue. Now I will tell you from getting into the sales force data, et cetera or what have you, we did have a good July in new business. So people are still looking at needing help around both their health and welfare and retirement and all the other aspects. So I think new business will be good. But I do think you have an underlying softness in what's going forward with employment, et cetera. So I would not be predicting a stronger third quarter.
Douglas Howell: One thing we are seeing, Mark, we're seeing a lot of people on our webinars. We're doing a lot of joint webinars with -- between the benefits in our P&C business. So there is interest in learning. We did a back to work, safety in the workplace, webinar. So we are getting customers that are interested in thinking about how their 2021 medical plans and health and welfare plans should look in this environment. So that could lead to some better growth in the fourth quarter or first quarter next year as people are trying to redesign their plans. Third quarter, I don't know if you'll see it quite yet.
J. Gallagher: Mark, you know that you've heard us say this 1,000 times. 90% of the time when we compete, we're competing with smaller local brokers. And believe me, they're wondering now what else is out there. And those relationships are strong, for sure. I mean, our new business would even be higher. We don't win all the time. But just to put this in perspective, in the second quarter, our webinars, where, as Doug said, we combined property casualty and benefits in many of them around things like return to work. Unprecedented attendance, with 60,000 people attend webinars in the second quarter on content and material that we're putting out. We haven't had 60,000 people attend in 10 years.
Mark Hughes: Yes. Interesting. One final question. This question about furloughs. Once maybe some of these stimulus packages, furloughs expire, maybe businesses just won't hire and they'll cut the -- lose the number of employees at that point, and that will impact your employee benefits business. Do you have any perspective on that?
Douglas Howell: Yes. One of the things, we don't have that many people that actually have been technically furloughed. Maybe there's 100.5, something like that, that we've furloughed. So I think that what will happen after furlough, we're hoping we're bringing them back.
J. Gallagher: No. I think, Mark, were you talking about our clients?
Mark Hughes: Correct. That's right.
J. Gallagher: I think -- yes. I think that, that is a possibility. I think that when the furlough support and the unemployment support erodes, yes, I do think you could see those people actually have their jobs disappear.
Mark Hughes: Any sense on the magnitude of the risk there?
J. Gallagher: No.
Operator: And now our next question is from Meyer Shields with KBW.
Meyer Shields: Two questions on reinsurance. One is the big picture question. And Pat, you talked to, I don't know, gazillion insurance company CEOS. And I'm wondering whether you could give us their sense on concerns over reinsurance brokerage consolidation. And then second, just hoping you could update us on how Capsicum performed over the course of the second quarter?
J. Gallagher: Well, let me take number 2 first. I think I've said this publicly a number of times. Capsicum is the single best start-up I've been involved with in my career. And we were very pleased to get the final acquisition of the remaining equity over the line. That team is an excellent team. They've had an excellent first half and continue to do just a terrific job of expanding that business. And so what we started with 5, 7 years ago, literally from dead scratch today is really -- it's remarkable. So that team is doing a great job. And they'll continue to. The opportunities, I guess I've been -- in my career, I've seen an awful lot of consolidation. I've gone through -- if you look at who is out there competing with us, 30 years ago, 20 years ago, and how many of those have consolidated down, consolidation offers this opportunity. And I think Capsicum is very well positioned to take advantage of that. And I'll be blunt with you. The big buyers of reinsurance don't like it.
Douglas Howell: And Meyer, we are well over 10% year-to-date organic growth in Capsicum.
J. Gallagher: Okay. Operator, I think that's it. And let me just make a quick comment, and we'll say good evening. Thank you again for joining us this afternoon. As we said over and over, we delivered an excellent quarter. It's a difficult economic environment, but I remain confident that we have the right platform and strategy in place to successfully navigate these challenging times for the rest of this year and hopefully, in better times next year. Thank you all for being with us this afternoon. We really appreciate it.
Operator: This does conclude today's conference call. You may disconnect your lines at this time, and thank you for your participation. | [
{
"speaker": "Operator",
"text": "Good afternoon and welcome to Arthur J. Gallagher and Company's Second Quarter Earnings Conference Call. [Operator Instructions] Today's call is being recorded. If you have any objections, you may disconnect at this time."
},
{
"speaker": "J. Gallagher",
"text": "Thank you. Good afternoon. Thank you for joining us for our second quarter 2020 earnings call. Also on the call today is Doug Howell, our CFO, as well as the heads of our operating divisions. We delivered an excellent second quarter. Despite the economic deterioration caused by COVID-19, our teams are executing at the highest levels while we continue to place health and safety first. We are servicing our clients. We're selling new business. We continue to look at merger and acquisition opportunities, and our bedrock culture keeps our teams working together even while physically apart. I would like to thank our 33,000 Gallagher professionals around the globe for their constant and tireless focus on delivering the very best insurance brokerage, consulting and risk management services to our customers. More than ever, these are times when our global capabilities and resources support our local professionals as they help our customers navigate these challenging times and still generate strong new business. That really truly is the Gallagher way."
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Pat, and good afternoon, everyone. Like Pat said, solid top line growth and truly remarkable bottom line performance. Our combined Brokerage and Risk management adjusted EBITDAC is up nearly 30% over second quarter last year. Many thanks to all of our colleagues around the globe for continuing to [indiscernible] on our cost control efforts, all the while continuing to deliver unique insights and high-quality service that our clients need even more in these times. Today, I'll spend most of my time on our expense savings, give you some comments using the CFO commentary document and then finish with thoughts on cash, M&A and liquidity."
},
{
"speaker": "J. Gallagher",
"text": "Thank you, Doug. Operator, let's go to questions and answers."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question is coming in from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, Pat, or maybe this is, I guess, for Doug, is on the expense saves. So I guess I have a few questions here, but the first one is, you guys expanded your brokerage margin by 6.2%. So what I think maybe gets a little bit lost in the numbers and if we adjust out the save on 2% organic revenue growth, if my math is right, you saw around 120 basis points of margin improvement. So am I thinking about that correctly? And then I guess there's just some pretty good just margin improvement in your business away from just the base. Or am I missing something there?"
},
{
"speaker": "Douglas Howell",
"text": "No, you have it about right. I think that's right. We had -- no, we didn't give raises this quarter. So that would have dampened to 1.2% a little bit, but you're looking at it the right way."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then I think you guys -- you just provided some good color in terms of the save that we could see in the third and potentially the fourth quarter. If I remember from your June Investor Day, you had said that kind of post-COVID that about half of the saves, I believe, could persist on an ongoing basis? I just -- given you provided some updated figures, I wanted to make sure that guidance still exists today?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. I think probably when we looked at it 6 weeks ago, that probably would have been about right. I think right now, we are learning a lot as a result of this crisis, and we are finding ways to deliver service and advice clearly more cost effectively than prepandemic. But I think what matters in the end is what we spend will be highly correlated at least to how our clients' prospects and underwriting partners expect us to do business. That will determine really how much we travel, how much we communicate virtually. Do they want to be entertained anymore? How much do we advertise? And how do we advertise in the market? And then also it drives what investments in technology and technical resources we are -- that we need in order to service and compete in the market. It also goes further when you look at what it takes to attract and retain talent. That will dictate a lot on how we leverage our work-from-home capabilities, maybe where we locate our offices, how we configure them. And then also a little impact how we train, develop and mentor our folks. So that will influence the ultimate cost savings. And then also, one thing I have to say as being experts in employee benefits, we truly hope that our employees get back to utilizing our medical health and welfare plans. We need everybody to be doing their prevented exams and getting the services they need. Nothing good comes from delays in getting your medical treatment. And that saved us several million dollars this quarter. So when I bring it all back together, over the long term, could we be saving $30 million to $40 million a quarter after we adjust the real estate footprint as we adjust postage express, office occupancy cost, maybe hire some of the external resources that we were using externally. Yes, maybe we could get to that number. So it wasn't far off as a guess, but it will really depend a little bit on how our clients' prospects and underwriting partners want us to do business."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. That's helpful. And then on the organic side, Pat, I think you said that the third quarter brokerage organic seems to be trending in line with the Q2, which is a little bit better than your June Investor Day. And then we've been hearing from some peers that there are some lags in some of the businesses, right, so the third quarter could be worse than the second quarter? And [indiscernible] is that business mix that's helping the Q3? Is it incremental pricing? Just a little bit more color on how you see the third quarter transpiring."
},
{
"speaker": "J. Gallagher",
"text": "Well, first of all, Elyse, as you know, July is a very big month for us. So it's a good bellwether. And we had a very, very strong July. And so I think as we sit here today, if things don't completely fall off the table in August and September, we feel just exactly the way we phrase it today."
},
{
"speaker": "Operator",
"text": "And now our next question is from Mike Zaremski with Crédit Suisse."
},
{
"speaker": "Michael Zaremski",
"text": "First question. What -- in terms of leverage levels, where could you go to temporarily with the rating agencies if there was kind of something chunkier or larger? Could you go to a -- kind of a materially higher level for a year or 2 and then kind of work its way down if something became available?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. I think they'd be receptive to that. I think we've seen that with other brokers. So that would seem reasonable that they would be willing to accommodate that. Do we have the appetite to do that? We probably won't push our debt ratios very much at all, but I think they could be willing to listen to that."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. And along the same lines then, like -- so in terms of kind of making inroads into maybe the mid- to large account space as a result of the merger that's taking place. Is it more of kind of winning RFPs as the clients look for a new potentially to find another broker because they've consolidated to one? Or is it more hiring or both? And if it's the RFP process, is that taking place more kind of next year when the account comes up for renewal after the merger?"
},
{
"speaker": "J. Gallagher",
"text": "Well, Mike, this is Pat. I think you touched on a very good subject. But let me go back to our genesis. I mean Gallagher Bassett was started in 1962, basically, to take care of the claims for Petrus Foods with a Fortune 100 company at that time. So we've been in the large account risk management business since the 60s. Now over the past number of years, we've gotten much, much stronger in that business as well, both on the claims service side as well as on the brokerage side. And yes, I think that the fact that the 4 top players are going to consolidate to 3 is clearly giving us more opportunities. And as I said, our capabilities have gotten stronger and stronger, and we feel really good about our chances to expand that business."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. Great. And just lastly, back to Elyse's question, given just a phenomenal quarter in terms of margins. So again it sounds like, Doug, to your answer about kind of -- there was margin improvement beyond just the expense savings. And Doug, it sounded like you were saying that there was over 100 basis points of margin improvement beyond it. And it sounded like that could recur unless business kind of gets back to usual in terms of entertainment and more people feeling comfortable, employees feeling comfortable going back to the doctor's offices. And so it sounds like that kind of underlying net of expense save positive trend could continue?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So first of all, let's go back. What do we think in the future? In the third quarter, we think they're going to be $65 million to $70 million of savings. We won't give some of that back up because there are some costs coming back into the structure. In the fourth quarter, might be closer to a $60 million to $70 million. We might have to give back another $5 million there somewhere. But that's the way we sit today. The margin expansion that Elyse talked about is 2 things is we did have some strength in our supplementals and contingents this quarter, which probably drove a little bit of that margin expansion. Longer term, we think we're learning a lot about our business. And so I think there could be opportunities here for us to do things differently because our clients' expectations have changed in this 4 month period. And the question is, will they stay that way? Or will they expect to see 5 people showing up for a meeting for an hour? Or are they okay with our industry experts not getting on a plane, traveling a day for a half hour presentation. We're finding some really good success in that, that we can put our niche experts at the point of sale, and our customers are much more willing to accept a virtual face-to-face versus a real face-to-face. So there is going to be some savings on that, that survives. So margin expansion, we've always said it's hard to expand margins if it's below 3%. And we are okay at 2% with a little strength in supplementals and contingents. We got a point of margin expansion out of it in the near term. I think it would be pretty hard to post 2% organic growth for the next 3% and expand margins a percentage point a year. I think that would be difficult. Get us over 3%, we can hold in there, get us over 5% -- 4% or 5%, we'll expand them. So I don't see that changing much from what we provided in the past. But there's opportunity there, but -- yes, I think that this in the near term, 1% organic -- or excuse me, margin expansion on 2% organic is a pretty darn good quarter."
},
{
"speaker": "Operator",
"text": "Our next question is from Phil Stefano with Deutsche Bank."
},
{
"speaker": "Phil Stefano",
"text": "Yes. I was hoping you could give a little thoughts on contingents and supplementals to the extent that you have any forward view into them. I guess were there any catch-ups in first quarter or second quarter that we should kind of try to normalize out? In my mind, in this 606 world, the contingents and supplementals will be a bit more flat than maybe what we've seen or at least actual versus what I've expected."
},
{
"speaker": "Douglas Howell",
"text": "Yes. I think there's probably a little bit -- a small, little bit of catch-up in the second quarter. A lot of these things get paid in the first quarter. We have like hundreds and hundreds of contingent commission contracts and even several hundred supplemental contracts. So we probably will have some positive development in our second quarter a little bit, but might be targeting a couple million bucks on announcement. So the team does a really good job of making estimates. I think what happens in the future because of the pandemic, loss ratios are hanging in there pretty well. So -- and it's -- our cost and value that we deliver right now. I think that we're earning our contingents and earning our supplementals, and I think we've got a pretty fair series of contracts. I think the carriers -- yes, that will hold up well with the carriers. So I don't see anything out of the ordinary in this."
},
{
"speaker": "Phil Stefano",
"text": "Okay. Look, just to go back to the expense saves, and I don't want to beat this too much. But I guess, in my mind, thinking about the $60 million to $70 million we can expect third quarter, fourth quarter and then the idea that bringing this all together, maybe we could be $30 million or $40 million a quarter, who knows what the normal looks like moving forward. Can you give us a sense for how quickly that gap closes? And is 2020 a pivotal year where things back come back relatively quickly? Or does it really depend on the economy and shelter-in-place and the fallout of COVID in all those ways?"
},
{
"speaker": "Douglas Howell",
"text": "Probably more of the second. It is highly dependent on that. I wish I had a crystal ball, and I think all of us would kind of hope that they come back a little bit faster because that means the economy gets back to zooming, people are back to work. I don't mean zooming face-to-face. I mean, the economy is moving fast and forward. Guys, I think you want to have some expenses coming back in to our number."
},
{
"speaker": "J. Gallagher",
"text": "Phil, let me hit that too, this is Pat. We haven't gone to see a client in 3 months. That isn't going to hold up. So there will be bump in your models full of no travel, no face-to-face, no entertainment, no new people. We're writing a lot of new business, and we're going to service that business. And there is pressure in the field to take a trip to see a client. We do have clients that are back at work now saying to come see us. And we've got very stringent restrictions for health and safety reasons about whether we're even letting our people do that. Believe me, we get a vaccine, and our people are going back [indiscernible], myself included. I haven't been on the ground this long since I was 11 years old."
},
{
"speaker": "Operator",
"text": "Our next question is from Ryan Tunis with Autonomous Research."
},
{
"speaker": "Ryan Tunis",
"text": "I guess just thinking about the third quarter organic thinking it's going to be somewhat similar to this. Behind that, what are you assuming organic revenue growth is going to be for employee benefits to get about 2% again?"
},
{
"speaker": "Douglas Howell",
"text": "I think it'd be much the same as what we've got now. I don't see a lot of difference between the third quarter and the second quarter for our P&C business or our benefits business. So it was back about 3% this quarter."
},
{
"speaker": "Ryan Tunis",
"text": "And at this point, workers' comp revenues were down what, you said 10% through mid-June, correct?"
},
{
"speaker": "Douglas Howell",
"text": "Rates are down 2-ish, maybe 3%, something like that. But if you talk about exposure units being down, I can probably dig that out here for you in a second, but let me work on that."
},
{
"speaker": "Ryan Tunis",
"text": "So what I'm getting at is I'm just trying to understand why ultimately you're not going to have some convergence of the employee benefits, which is only down 3%. And obviously, you're still collecting on furloughed workers, COBRA, that type of thing in the workers comp, that's just based on level of payroll. So we're down like 10 on exposures in workers' comp, I'm trying to understand why we wouldn't think that health and benefits will be down a bit more in the third quarter."
},
{
"speaker": "Douglas Howell",
"text": "Well, I think that it might have to do with the mix of our business, too. As you know, we look at this in high, medium and low impact industries. And when we look at that, and stack it up. We have a lot of business that's in very low impact industries. So right now, you're not seeing the decreases in workers' comp and benefits in those industries at this point, even the medium categories, we're not seeing it. So there could be a convergence on it."
},
{
"speaker": "J. Gallagher",
"text": "A big part of the drop in benefits is also related to project work and onetime stuff that we do when the economy is robust. Then people are willing to spend and come in and help me communicate with my people. Right now, they're more willing to not necessarily communicate as well. They'll take that burden on themselves. So it's projects and things like that, that also diminished in the quarter that we'll have to see a return to prior growth to get that kind of project work back. But the underlying health and welfare business does probably look more like work comp."
},
{
"speaker": "Ryan Tunis",
"text": "Got it. And then, Pat, I guess my follow-up is, is it still safe to say that pricing increases are offsetting exposure declines?"
},
{
"speaker": "J. Gallagher",
"text": "Yes."
},
{
"speaker": "Ryan Tunis",
"text": "So is it fair to say then that essentially, on average, accounts are renewing at basically a flat premium?"
},
{
"speaker": "J. Gallagher",
"text": "Or down because one of our key jobs is to help those clients in a difficult environment navigate what they spend. So people will take limits down. You had a $100 million umbrella this renewal or this expiration. Do you need $100 million next year, maybe it should be $50 million. Your retention was $150 million, should we take it to $250 million. There's a lot of work that we do around that, that helps our clients mitigate the cost of their insurance, while at the same time, protecting their future."
},
{
"speaker": "Douglas Howell",
"text": "I am jumping on too. Our workers comp business was down 2% in the quarter, so -- and if our benefits business is about 3%, we're seeing it there, but it's..."
},
{
"speaker": "Ryan Tunis",
"text": "Got it. So, Pat, do you think it's sustainable that pricing can continue to offset exposure declines. Does that feel like something that can happen if we really are in a recession?"
},
{
"speaker": "J. Gallagher",
"text": "Yes, I do. I mean, for now, if you'd ask me that maybe March 30, I might not have been as bullish."
},
{
"speaker": "Operator",
"text": "Our next question is from Yaron Kinar with Goldman Sachs."
},
{
"speaker": "Yaron Kinar",
"text": "My first question is with regards to the cost saves. I just want to understand when you're looking at $60 million to $70 million in the third quarter, I think, Doug, you highlighted a few bad guys there. Are there other kind of positives that you haven't yet achieved in the second quarter that you think you can still dial up? Or is that $60 million to $70 million, simply a decline in the positive that you had the second quarter without any offset?"
},
{
"speaker": "Douglas Howell",
"text": "Just a couple of clarification. We can't wait for our employees to get back using their medical plan. So I wouldn't call that necessarily a bad guy. We want our folks to access our medical plans."
},
{
"speaker": "Yaron Kinar",
"text": "Fair, fair. I apologize for the use of words."
},
{
"speaker": "Douglas Howell",
"text": "No, that's okay. I just want to make sure we -- but we all know -- we don't want a severity problem coming out at the end of the year because people aren't getting their annual exam. So if that costs us a $5 million to $10 million a quarter, we're happy to spend it. I think that other bad guys, I wouldn't call travel bad, so I won't quibble on that. Do we have some other good guys that could come through? I think that we've done a pretty good job in the near-term of getting down to a number that's going to be harder to keep than it is harder to create more of them. So I think that we're about where we are in this environment. So I wouldn't expect too many good guys to offset the bad guys using your terminology coming through in the third and the fourth quarter."
},
{
"speaker": "Yaron Kinar",
"text": "Right. Okay. And again, I apologize for using that terminology."
},
{
"speaker": "Douglas Howell",
"text": "No, no, I know. I just wanted to make sure you..."
},
{
"speaker": "Yaron Kinar",
"text": "Yes. And then my second question just goes back to the buckets, kind of high impact, medium impact, low impact. Six months into this situation, as you look back, do you think -- how much of those buckets shifted? Like how much of the -- what you initially felt was a high-impact bucket ended up being in a low-impact bucket or vice versa?"
},
{
"speaker": "Douglas Howell",
"text": "Right. So if you look at it, let's say, there were 25 SIC codes in there what we picked in the second quarter. Of the high-impact 25, we got 20 of them right -- excuse me, 21 of them right, and then we had 3 of them in the medium category that probably moved up to high. When you get to the low kind of the same thing, and the medium, not much. So our pick on low, medium and high coming out of the gate, 3 weeks into this thing, I would say, is pretty damn good. And so I feel fairly comfortable that those are the impact businesses that we forecasted in the near term. We'll see what happens over the next longer-term and whether our picks are going to be right again. But we did a pretty good job of it. So I think that we've got a good insight into the nature of our business. So..."
},
{
"speaker": "Operator",
"text": "Our next question is from Mark Hughes with SunTrust."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Just another crack at the expense question. When we think about 2Q next year, do we -- is this the kind of right run rate on a go-forward basis, kind of a step function on 2Q. And so next year, we go back to your usual template of 3% or better. We get some margin expansion. Is that the right way to think about it?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. I think you've got to go back and reset and take us basically. If you think about, we were expanding margins about 1 point a year, and we've been doing that 70 basis points a year for the last 5 or 6 years. If we get into a 5% organic growth environment, you're going to see us give back some of these savings, and then you're going to also see us just our natural continued margin improvement programs, you would be back into kind of that 50 to 70 basis point margin expansion on 5% organic growth. So you're looking at it the right way. But would there be a reset compared to second quarter next year? Probably because if we're back to -- if you put in $30 million or $40 million of expenses, and you're taking 70 basis points on $6 billion, you get in $40 million. It's about a push, maybe a little expansion."
},
{
"speaker": "Mark Hughes",
"text": "Okay. And then on the benefits business, it sounds like most measures are improving. Pat, you talked about July being very, very strong. I'm not sure if that was completely focused on P&C. But it sounds like 3Q organic in benefits has the prospects of being better? Is that a fair read?."
},
{
"speaker": "J. Gallagher",
"text": "I'd say that -- I think I was referring more to PC in my comments on July, Mark, it's only fair to say. I think what you're seeing in benefits now is systemic, and I think that will continue. Now I will tell you from getting into the sales force data, et cetera or what have you, we did have a good July in new business. So people are still looking at needing help around both their health and welfare and retirement and all the other aspects. So I think new business will be good. But I do think you have an underlying softness in what's going forward with employment, et cetera. So I would not be predicting a stronger third quarter."
},
{
"speaker": "Douglas Howell",
"text": "One thing we are seeing, Mark, we're seeing a lot of people on our webinars. We're doing a lot of joint webinars with -- between the benefits in our P&C business. So there is interest in learning. We did a back to work, safety in the workplace, webinar. So we are getting customers that are interested in thinking about how their 2021 medical plans and health and welfare plans should look in this environment. So that could lead to some better growth in the fourth quarter or first quarter next year as people are trying to redesign their plans. Third quarter, I don't know if you'll see it quite yet."
},
{
"speaker": "J. Gallagher",
"text": "Mark, you know that you've heard us say this 1,000 times. 90% of the time when we compete, we're competing with smaller local brokers. And believe me, they're wondering now what else is out there. And those relationships are strong, for sure. I mean, our new business would even be higher. We don't win all the time. But just to put this in perspective, in the second quarter, our webinars, where, as Doug said, we combined property casualty and benefits in many of them around things like return to work. Unprecedented attendance, with 60,000 people attend webinars in the second quarter on content and material that we're putting out. We haven't had 60,000 people attend in 10 years."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Interesting. One final question. This question about furloughs. Once maybe some of these stimulus packages, furloughs expire, maybe businesses just won't hire and they'll cut the -- lose the number of employees at that point, and that will impact your employee benefits business. Do you have any perspective on that?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. One of the things, we don't have that many people that actually have been technically furloughed. Maybe there's 100.5, something like that, that we've furloughed. So I think that what will happen after furlough, we're hoping we're bringing them back."
},
{
"speaker": "J. Gallagher",
"text": "No. I think, Mark, were you talking about our clients?"
},
{
"speaker": "Mark Hughes",
"text": "Correct. That's right."
},
{
"speaker": "J. Gallagher",
"text": "I think -- yes. I think that, that is a possibility. I think that when the furlough support and the unemployment support erodes, yes, I do think you could see those people actually have their jobs disappear."
},
{
"speaker": "Mark Hughes",
"text": "Any sense on the magnitude of the risk there?"
},
{
"speaker": "J. Gallagher",
"text": "No."
},
{
"speaker": "Operator",
"text": "And now our next question is from Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "Two questions on reinsurance. One is the big picture question. And Pat, you talked to, I don't know, gazillion insurance company CEOS. And I'm wondering whether you could give us their sense on concerns over reinsurance brokerage consolidation. And then second, just hoping you could update us on how Capsicum performed over the course of the second quarter?"
},
{
"speaker": "J. Gallagher",
"text": "Well, let me take number 2 first. I think I've said this publicly a number of times. Capsicum is the single best start-up I've been involved with in my career. And we were very pleased to get the final acquisition of the remaining equity over the line. That team is an excellent team. They've had an excellent first half and continue to do just a terrific job of expanding that business. And so what we started with 5, 7 years ago, literally from dead scratch today is really -- it's remarkable. So that team is doing a great job. And they'll continue to. The opportunities, I guess I've been -- in my career, I've seen an awful lot of consolidation. I've gone through -- if you look at who is out there competing with us, 30 years ago, 20 years ago, and how many of those have consolidated down, consolidation offers this opportunity. And I think Capsicum is very well positioned to take advantage of that. And I'll be blunt with you. The big buyers of reinsurance don't like it."
},
{
"speaker": "Douglas Howell",
"text": "And Meyer, we are well over 10% year-to-date organic growth in Capsicum."
},
{
"speaker": "J. Gallagher",
"text": "Okay. Operator, I think that's it. And let me just make a quick comment, and we'll say good evening. Thank you again for joining us this afternoon. As we said over and over, we delivered an excellent quarter. It's a difficult economic environment, but I remain confident that we have the right platform and strategy in place to successfully navigate these challenging times for the rest of this year and hopefully, in better times next year. Thank you all for being with us this afternoon. We really appreciate it."
},
{
"speaker": "Operator",
"text": "This does conclude today's conference call. You may disconnect your lines at this time, and thank you for your participation."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 1 | 2,020 | 2020-04-30 17:15:00 | Operator: Good afternoon, and welcome to the Arthur J. Gallagher and Company's First Quarter 2020 Earnings Conference Call. . Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements.
Patrick Gallagher: Thank you very much. Good afternoon, everyone, and thank you for joining us for our first quarter 2020 earnings call. Also on the call today is Doug Howell, our Chief Financial Officer as well as the heads of our operating divisions. Before we get into our first quarter results, let me acknowledge those directly affected by COVID-19, including those on the front lines of the global pandemic. We are in all their dedication and courage. At Gallagher, our priority is the health and safety of our colleagues. We're very fortunate that less than 50 of our 34,000 associates have contracted the virus, nearly all of whom have fully recovered. With a few that are still self-quarantined, we wish you a speedy recovery. I'm incredibly proud of how all our associates have performed over the past 6 weeks. In March, we mobilized our business continuity plans around the globe, and we're up and running, working from home in a few days. We are working remotely without missing a step. This is the payoff of our relentless efforts over the past decade to standardize work, streamline processes and operate using common systems. All of our colleagues are productive, too. At home, they have the right tools and systems in order to deliver the highest quality service to our clients. And that includes more than 5,000 associates that are based in our service centers. And every day, we see countless examples of our employees unselfishly giving back from providing first responders with protective equipment, to sending meals to senior citizens, to distributing masks to the less fortunate. I'm proud but not surprised at the level of dedication, support and professionalism from all of our colleagues around the world. I thank every single one of you from the bottom of my heart. Now moving to our first quarter financial performance for our combined Brokerage and Risk Management segments. Here are some highlights. We had a terrific revenue growth quarter. Total reported revenue growth of 4% and adjusted revenue growth of 9%, which includes 3% reduction due to COVID. Included in that is organic growth of 3.3%, but again, we had nearly 3% of an unfavorable impact due to COVID-19. This would have been another quarter like our fourth quarter last year. And even with around 2% adverse impact of COVID-19, we posted a net earnings margin of 20.1% and more impressive adjusted EBITDAC margin of 32.2%. And we completed 8 acquisitions this quarter with estimated annualized revenues of $124 million.
Douglas Howell: Thanks, Pat, and good afternoon, everyone. I, too, extend my sincere appreciation to first responders and those on the front line. And also my thanks for our 34,000 colleagues. You had to navigate your own personal challenges presented by the pandemic, yet we're up and running in a few days, delivering timely advice and service to our clients. That's just simply amazing. So thank you. Today, I'll walk you through the COVID-19 impact table on Page 2 of the earnings release and how that impacts our organic and margins on Pages 4 to 7. I'll address our expense savings initiatives. I'll provide some thoughts on our capital and liquidity, and I'll finish with a few short comments in the CFO Commentary Document. So okay. Turning to the table on Page 2 of the earnings release. This table captures all of the COVID matters in our numbers. They are -- they all fully hit our reported GAAP numbers, and we did not adjust any of them out where we show our non-GAAP adjusted numbers. You'll see in the end, COVID didn't have much impact on net earnings nor on EPS, but there are 4 moving estimates that have a noticeable impact on revenues and EBITDAC. First, let's address how it impacts revenues. And just as a reminder, about accounting standard 606 that drives our revenue accounting. We adopted that in 2008. Recall it requires us to estimate annualized ultimate revenues for contracts and policies with effective dates prior to closing the books, even if those annualized revenues are dependent on future events. We must make our best estimate. And as most of you know, there are a lot of insurance policies that have volume-like adjustments that can occur in the year after the policy effective date. Lines like workers' compensation, employee group medical plans, casualty lines that have adjustable premiums based on, say, future miles driven or flown. Those are just examples. And then you have experience-rated contracts. So there's a lot, so on and so forth. In the past, historical patterns drove those estimates, and changes in volumes would emerge slowly as our clients' businesses naturally evolve. That's not today's environment. Our customers' businesses have been dramatically altered in a few short weeks. That's the reality. So we need to make our best estimates of what will happen in the future for those pre-April 1 contract. It's not easy, but we still must do it.
Patrick Gallagher: Thanks, Doug. I think with that,, we'll go to some questions.
Operator: . Our first question is from Mike Zaremski from Crédit Suisse.
Michael Zaremski: First question. Pat, you talked about being prepared for the possibility that organic could go flat to even a bit negative for a couple of quarters, which I think makes sense to most investors given the backdrop. I just wanted to clarify that, that -- is that inclusive of the Gallagher Bassett segment, which I believe you're alluding to maybe having more of an organic growth impact versus Brokerage? And I guess should we be thinking then that earnings then and margins then given the CFO Commentary, then we'll also go -- would go a bit negative if that scenario plays out?
Patrick Gallagher: Well, again, Mike, as we try to be really clear that we don't know and we put language in the prepared remarks to make sure we understood that it could be material. But I'll be the perennial optimist, yes. We think that depending on what happens as these states begin to open up and economic activity, we'll see how deep and how long this recession goes. It could adversely impact just to the point, as we said, of a flat to down quarter or a number of quarters. I do think you're right that the Gallagher Bassett numbers, which, yes, are included in those discussions, could be a little bit more hard hit, but we'll just have to see how deep this thing goes.
Douglas Howell: Yes. Mike, on margins, just so you know, even if we end up in a flat environment for a couple of quarters with the expense saves that we are seeing, we should easily hold EBITDAC margins at historical levels and actually can probably increase them.
Michael Zaremski: Okay. So that -- I guess I'll use that as my follow-up, Doug. So $30 million of charges spread over the next 3 quarters. I typically think of -- in the -- typically think kind of a payback ratio and the payback ratio seems to be very large, $50 million to $75 million per quarter. So it sounds like a lot of these expense saves, should we be careful on our models not to kind of roll them over into future years because lots of this -- some of these things are just going to be temporary?
Douglas Howell: That's right. I think that this will get us through the trough in revenues. And then I think you have to think about us more in 2021 and '22, if we go back to organic growth, kind of where we were in '19, you would probably see margins like you saw in '19, maybe up 50 basis points for the year. Let's say that we get back to 5% organic growth in 2021 by some hook or crook, you would see probably our margins up 50 to 100 basis points over where they were in 2019. So we can fill the hole this year. And then I think we can get back to normal business, hopefully, in 2021 and '22, you would see it like the trends you saw going from 2018 to 2019. And then so just start with 2019 and pick 2021. That's probably how you should be looking at it. And then in '20, we just hope we can fill the hole.
Operator: And our next question is coming from Greg Peters of Raymond James.
Charles Peters: Pat, can we go back to your comments where you segmented out the 20% higher impact, 60% in the middle and 20% lower impact? Just curious how you came up with that. I'd characterize -- as I think about your business, for example, take the aerospace business, I don't hear of a lot of rate in aerospace. And yet, I would characterize that as a higher-impact business. And so you seem to imply that you're getting enough rate to offset exposure. But maybe you can give us some more color.
Patrick Gallagher: Yes. Sure. First of all, what we did, Greg, is say, all right, let's -- we can now segment our book of business, as you said, into quite detailed chunks. So we sat down and said, what are the industries out there that we think are going to be really hard hit. And those are the ones that we would then lump into the higher impact. So our hotel business, for instance. We can get very granular about how much of our business over the entire $5.6 billion to $6 billion revenue business is hotels. And it's less than $100 million. That's an example. So we took all those businesses that we -- and we just had to bucket them. So it was down and dirty. Hotels, restaurants, those went into the very high impact. Moderate impact, some construction, some transportation, and then low impact would be things that would go on like our public entity business, any hospital business, that type of thing. So when we looked at that, we then went in, we can also segment out. We can look at what's happening to the rates. And we can do that by account. We can do it by geography, and we can do it by type. And we looked at, we said, all right, let's take a look at the accounts that we put in each of those buckets. And again, Greg, as we said throughout this whole thing, it's very early information, but what has actually happened to those clients that we thought were in the most impacted bucket. Now again, we're cautioning. We're saying this is what's happened in the first quarter and early days of April. So we've said clearly, hotels are going to show a lot more pain in the second and third quarter off of what happened to them in the first quarter. But nonetheless, what's happening to hotel rates? Well, guess what? They're not going down at the same time. So hotels are not going away. They are renewing their accounts. And those that are renewing their accounts are paying higher property rates. Now exposure units are down on renewal. But what we're saying in our prepared remarks is that right now, this bar, you've got a pretty nice offset. And those rates are holding.
Douglas Howell: And Greg, just to amplify that, we've got 156 sick codes on a sheet that counts for our revenue all of last year. And it's -- there's kind of that 20-60-20 distribution on it, both in terms of -- in terms of our last year's revenues and, like Pat said, eating and drinking places. That's in the high-impact one. You've got stone, clay, glass and concrete product manufacturers might be in the medium, and then you've got legal services that might be in the low. So you just pick out a sick code, we can slice and dice our revenues exactly by that. And then we can tell you by the coverage across the 2. So not only do we weight it by the industry, but we also looked at the coverage lines, too, as it informed our positions.
Charles Peters: Got it. Do the supplemental and contingents get affected by volumes as well?
Douglas Howell: Yes. In some case -- supplemental is not so much. That automatically adjusts with the volumes in the quarter. So that's not an issue. Our contingent -- pure contingents, you actually might have a lift in pure contingents if loss ratios are down because of lack of activity. But we do have contracts where there is a double trigger on their volume expectation, and then there's a loss expectation. And that's the one as we look at it going forward, we could have a little softness in that. And we put up about -- I think that was about $8 million of possible estimate reserve for that.
Charles Peters: Got it. I'm going to pivot to the balance sheet. Just two questions on that. First of all, given what the carriers are doing in terms of rebates, givebacks, delayed payments. I noted that your premium and fees receivable were up quite substantially from year-end. I'm wondering if there's anything in there, and how you're looking at that from a level of concern perspective. And then secondly, I just wanted to circle back on your intangible amortization charge. I think 30 -- in excess of 30 million people filed for unemployment in the last 6 weeks, I got to believe there's more potential risk in it and write-offs of customer lists than just that, but maybe you can add some color there.
Douglas Howell: Let's talk about the balance sheet. The big difference between December and March is that our reinsurance operations have a very heavy first quarter, and that's what influences that. It should not be looked at as a collectibility issue. Our cash flows during April are still strong. And so we are not having collectibility issues on that. That's not an indication that there's collectibility on those receivables. We only put up a bad debt reserve of $6 million, something like that, $7 million, $8 million this quarter. So it's -- we're not seeing that at all. And so you can't read-through on the balance sheet for that. So that's the reason why the balance sheet is up. The second part of your question was what?
Charles Peters: Around the intangible asset, the write-off of the customer lists. And just the fact that the balance of what's going on in the economy seems like there's more risk to goodwill and intangible write-offs than ever before. But we're just sitting on the outside looking in, so you have better perspective.
Douglas Howell: Yes. I can answer that. And first of all, we're nowhere near any type of goodwill impairment on this. As for the customer lists, maybe on the surface, it appears to be that way, Greg. But when you got a -- we got businesses that are really retaining 92%, 93%, 94% of their customers on an annual basis. Just because there's a bunch of people that are out of work doesn't necessarily mean that, that business is out of work. If they don't come back immediately -- don't come back in the next 2, 3, 4 months, maybe there could be. But again, it's a non -- one thing, as you know, it's a noncash charge, but we look very hard through hundreds and hundreds and hundreds of acquisitions during this quarter. And we do it every quarter anyway, and we just didn't see where there's massive falloff. So when you come up with $40-some million across the board of all these acquisitions, that's a pretty small tweak, like I said, it's 2%. If it deteriorates further and we have prolonged business outages, sure, there'll be some noncash write-offs on this, but it's kind of a no. Never mind.
Operator: Our next question comes from Elyse Greenspan of Wells Fargo.
Elyse Greenspan: My first question is on the expense saves. So could you just give us a sense of like the geography by the segment? Or should we think about it in relation to the proportion of revenue between Brokerage and Risk Management? And then I guess tied to that question. Pat, by saying, right, this expense focus, you could probably expand your margins even as books close. Was that a comment specific to both of your segments?
Douglas Howell: All right. So let me break this down. And you were cracking just a little bit, at least. So let me see if I -- is there a disproportionate cost-cutting opportunity between Gallagher Bassett and -- or the Risk Management segment and the Brokerage segment? Yes, I think in the Risk Management segment, you're probably looking at 25% to 30% of those savings, whereas that business itself is somewhere around 20% of our total business. So there's a slight skew to that business which would make sense because they're the ones that have the more volume-sensitive -- immediate volume-sensitive type business than the Brokerage business does. So that's the first part of the question. It's slightly skewed more towards that. The margin question that you're asking is that if we're successful in achieving the expense savings to the level that we've planned for, you would actually see increasing margins in both segments on a quarterly basis.
Elyse Greenspan: And you expect to be at this $50 million to $75 million quarterly kind of run rate figure for the full Q2, right, because you started working on this in the middle of March?
Douglas Howell: Yes. We might not get -- listen, here it is May 1 tomorrow. We're going to get much of it this quarter. But if I -- if we can get 90% of this quarter, then we'll catch up in the third quarter.
Elyse Greenspan: Okay. And then one more question on the COVID-related revenue adjustments. So just so I understand, so that's on basically -- it's everything as it sits today. So even if we continue in this economic slowdown, you wouldn't expect to see any further 606-related adjustments? Or I guess unless assumption changed materially from what you're thinking today?
Douglas Howell: All right. Two answers to that is for there should be none of that going forward, if customers adjust their exposure units for renewals beginning April 1, May 1, June 1. So they adjust down, then there would be no COVID-related type adjustment, right? They're just going to buy less insurance, right? For contracts that were basically written -- in January, we put all those to bed. We did all the work for it. We booked what we thought was the revenue that we'd get over the 12 months following that contract date. We had to reestimate what we think we're going to get from those here in the last few weeks, almost a subsequent-event type of valuation of those revenues. Could there be further deterioration in that? Yes. Sure. There could be if the number of covered lives decreases further than our estimates, if we get more audits that come in afterwards if there are more midterm cancellations, you could have a further COVID adjustment. But I hope that we've got it all at this point, but we'll see. And we'll track that for you, and we'll show you how much it was.
Elyse Greenspan: And just one last clarification. Your organic outlook of flat to maybe slightly down. That's an all-in, including your contingency supplementals like you usually give guidance, correct?
Douglas Howell: Yes. That's right. And let's make sure we understand that. Here we are chugging along and having good organic this quarter. If we have a dip next quarter, and we might have a little dip in the third quarter, our assumptions are by the fourth quarter that we would be back to a decent organic level. And if that pushes into 2021, what I'm saying is I don't see us being negative for, at the most, a couple of quarters. Even then, I think I'd be a little bit surprised.
Operator: Our next question comes from Yaron Kinar of Goldman Sachs.
Yaron Kinar: I guess first question, Doug, I think in your prepared comments, you said that you'd expect EBITDAC margins to be at historical levels maybe slightly above. When you talk about historical levels, what are we talking about here? Are we looking at last three years, last decade? Could you give us maybe a sense of what it is your thinking here?
Douglas Howell: All right. So let's go back to the margin comment. I think that probably the better way for you to do it to just assume we're going to get $50 million to $75 million of revenue. And if you just hold our revenue flat to last year for the second and third quarter, you can't help but get margin expansion, right? If you take last year, so you're going to get margin expansion even a flat or in a slightly down organic environment if that happens. It will -- if it reverts in the fourth quarter or into next year, then you're going to be -- I think Mike asked the question about it earlier, by the time you get to 2021, if we're chugging out organic like we were in 2019, we're going to put some of these costs back into the structure. So take your 2019 margin and grow it kind of what we did between '18 and '19 and '21, and you'll kind of be there. So you're going to get an increase in margin in the short term, and then it's going to revert back a little bit more in the longer term. I want to make sure that I'm clear on something there. Does everybody understand? I don't know if I misspoke. We think that we're going to get $50 million to $75 million of expense savings each quarter going forward, not revenue saving. Whatever the revenue, it is what it is. But we're adjusting our expense basis down $50 million to $75 million of expense. I may have misspoke on that, but...
Yaron Kinar: I think I understand that. But if I look at the revenue base of 2019, that's like over 4% of margins, right, in Brokerage and Risk Management.
Douglas Howell: Say again. Yaron, sorry, we got some static on the line.
Yaron Kinar: Sorry about that. I think if I look at that $50 million to $75 million of quarterly expense saves and I look at the revenue base for 2019, that's over 4% margin.
Douglas Howell: Could be.
Yaron Kinar: Okay. All right. And then I guess my second question is around capital, how you're thinking about it here? I would think you have a lot of disruption in the space, maybe creating opportunity for M&A., besides the fact that you can't really meet with anybody right now in this environment. Are you interested? Has your appetite for M&A increased here? Or would you say that maybe you have a greater maybe as a precautionary measure, more interest in preserving capital and liquidity here?
Patrick Gallagher: No. This is Pat, Yaron. We are really interested in the acquisitions. This is a time for people now to sit back and take a look at what the competitive landscape was. There were an awful lot of competitors out there with great stories and lots of money in the bank. And now I think there'll be a time for people to look and really think who do they want to be with. And if we can get people to sort of think through the acquisition of their life's work, and where they want to have their people employed after the deal is done, we think we'll do very, very well. So we are wide open for business, and we are not trying to preserve capital when it comes to acquisitions.
Douglas Howell: You get a little bit of difficult rate and conditions out there in the marketplace, Yaron. And you sit there and say, would you rather do it alone? Or would you rather do it with us? I know where I'd be if I own my own agency. I'd be sitting there saying, how do I go to a strategic that can actually deliver capabilities and resources that will help me sell more business, that's where I'd want to be right now. And we're tightening our belt here on expenses, but we still have -- we're not cutting into the meat of our capabilities. We're -- we can tighten our belt and get through this trough in the revenues. If I were somebody selling, I'd be thinking pretty hard about coming to Gallagher right now.
Yaron Kinar: So I think -- in one of the more recent Investor Days, you had talked about targeting about $1.5 billion worth of acquisitions in 2020. So is that still achievable or something you could do?
Douglas Howell: Listen, we have the capacity to do that type of ball. I just don't think it will present itself. I think that there's a lot going on right now, getting people back out to do due diligence, it'd be pretty hard for us to spend that amount of money between now and the end of the year. But does that mean we couldn't catch up in 2021? If this is a V-shape recovery, there'll be plenty of opportunities to buy, and we might be a little short for a quarter or two. But by 2021, you could see us having a huge year.
Operator: And our next question is from Mark Hughes of SunTrust.
Mark Hughes: Doug, I'm not sure whether you touched on this, but your cash flow expectations for this year. If you undertake all these measures and it sort of plays out as expected, what does that do for free cash?
Douglas Howell: Okay. Let's say, I don't know if I have a number right for you on how much could generate. But the fact is, if we have a little bit of a lull in M&A, right? If we have expense cuts of, let's say, $75 million a quarter for 3 quarters, there's another 2.25, right? And we typically -- we're probably starting with $500 million to probably $700 million even after paying the dividend. So you've got a lot of -- you could have $1 billion of excess cash by the end of the year if organic doesn't -- if it's flat for a couple of quarters or down just a little bit. I don't know if I care either way. You could have a substantial amount of cash on the balance sheet at the end of the year.
Mark Hughes: Any distinctions internationally, when you look at the different markets you're in, any doing notably better or worse?
Douglas Howell: We had really a great quarter in our U.K. operations. The organic was very strong in the U.K. So that business there seems to be holding in very well. Early April, returns on that don't show a lot of stress either. So we're having really terrific results in our U.K. operations. Canada had a great quarter also. I think that's really doing well in Canada. Our operations there has really come together in the last few years, and we're running really nice, upper 30 points of margin in it. Australia and New Zealand, they were coming off some pretty hard market there's -- rate environment there for a while. We'll see what happens with the fires happening, but there seems to be good organic growth there. And then in the U.S. we had terrific results, too. In April, I was surprised by our guys, to be honest, they're selling a lot of business. I look at the new business sheet every day. And there are -- our guys are selling a lot of new business out there still here in April.
Patrick Gallagher: Yes. And I'd add to that, too, Doug, that if you take a look at places where we're smaller around the rest of the world, very, very strong start to the year. Latin America, our operations and, as you said, Canada, the global picture looks really, really good so far.
Mark Hughes: And then last question. I just wonder on the claims count. You talked about the kind of high-frequency claims are down 50%. Anything that jumps out at you about things you might not have expected? Other types of claims that frequency is down, and I'm curious, any observations about workers' comp, specifically. How you see claims there?
Patrick Gallagher: I think Mark... you go Doug, and then I'll go ahead. Go ahead, Doug.
Douglas Howell: I think I think we're surprised in the Gallagher Bassett unit about the strength of some of the industries like -- especially like in the hospital sector right now. It's -- claims are still coming in. And we are starting to get more and more workers' comp claims related to COVID also. So our customers are going to have workers' comp claims related to COVID. But the kind of the recurring just manufacturing medical-only type "back to work in a day or so" type claims, if you don't have a lot of people working, you just don't have a lot of those arising. So I think that, to be honest, the severity claims are still there. The frequency is down. But again, it was -- it's 10% of our business. And that's -- it's not all that margin fix. So we've got the ability to adjust our headcount on that, and we've used a lot of temporary labor there. We do a lot of contract or contingent labor. So we have the ability to flex that labor pool pretty easily on it.
Patrick Gallagher: I would add to that, though, Mark. One thing I was surprised at is how quickly on that side of claims side, it began to move. I mean as we saw unemployment requests go up very quickly in end of March, those claims came down very quickly as well. People getting out of work were not filing claims, which is interesting.
Operator: And our next question is from Paul Newsome of Piper Sandler.
Jon Newsome: I thought it was interesting in the CFO Commentary that the expected weighted average of EBITDAC acquisition pricing was down a tick or 2. Is that a reflection of what you perceive as the acquisition market? Or is that a reflection of just trying to be more disciplined in a difficult environment?
Douglas Howell: I think really when you look at it, when you look at it, Paul, when you're talking about doing 7 deals, mergers across $30 million of revenue, you're talking about a nice bolt-in acquisition. We didn't have any big larger ones in the quarter caps because that was already in our numbers, but we didn't have a Stackhouse Poland for last year. We didn't have a Jones brown up in Canada. So it's these nice tuck-in bolt-on acquisitions. We're still doing nicely in the 8s in there. So that's what you're seeing there.
Jon Newsome: And then I guess do you have expectations when you're doing deals that you'll also see similar drop-offs in revenues that you would experience?
Douglas Howell: I think it certainly puts -- the idea of growth in an acquisition has always been one of those things that the seller believes they're going to grow x, we believe they're going to grow at a percentage of x. And so we put part of purchase price on an earnout. And I think in this uncertain time, there will be considerably more sellers willing to take more on an earnout because I think they're going to want to grow out of this environment. We're going to want to help them grow. Nothing would make me happier for everybody to come in and hit their earnout. That means they're growing well, and we're all doing well then.
Patrick Gallagher: Let me weigh in on that. As Doug had said earlier, if you're going to be running a smaller brokerage right now, who would you like to partner with? I'd like to partner with the firm that's going to help me make my earnout. When rates are going up and everything is dandy, making my earnout the way I did it all the time in the past might not be that difficult. All of a sudden, right now, capabilities make a difference.
Operator: And our next question comes from Meyer Shields of KBW.
Meyer Shields: Two really quick questions. First, it really sounds like, other than exposure units, that things are going full bore. I was wondering if you could comment on the producer recruitment that is a company in that.
Patrick Gallagher: Yes. We are wide open for producer recruitment. I mean this is -- no matter what the day or the time is in terms of good economies, bad economies, we are always looking for solid production talent, and that's no different now. But as we've talked about the acquisition process, I think that there's going to be a little less competition. Or maybe let me put it this way. We're still one of the few places of size and capability that are happy to pay our producers on what they actually produce, what they're buying and what they bill. And if I'm looking around at where I'm going to go, am I going to go down the street to the Jones agency or am I going to come to a Gallagher, who understands production from the standpoint that we are a broker run by brokers. Every single one of us, with the exception of the professionals, have been on the street. And I think that resonates right now. And we get a lot of people that are interested in. "Yes, really, how does this work?" Well, now they've got capabilities with us to go out and pick on the smaller guys and say, "no, no, no, you don't understand. This is really something we can help you with." And that resonates in today's market. So I think that: number one, it's a great time for us to be recruiting; and number two, we're going to have lots of success with that.
Meyer Shields: Yes. No. That makes perfect sense. Maybe this is a question for Doug. Are we going to see any impact in 2021 from the expense pullbacks in 2020?
Douglas Howell: So do you think we could have savings in 2021 versus what we put in this year as they got a carryover impact? Is that your question?
Meyer Shields: No. The other way. In other words, obviously, you were spending this for a reason, which doesn't preclude -- responding to sort of the weird situation, but are these loss, I'm thinking of them in terms of investments, are those going to show up at 2021?
Douglas Howell: I think you're asking, do we think we're going to have a setback in our progress of building a better franchise as a result of these expense cuts. I think that's really what you're asking. We believe that most of these are immediately consumable type of expenses that if we're not traveling today, I don't know how that's going to impact us next year. So travel comes back, I don't think that's going to hurt us. I think that some of our other belt-tightening exercises that we're doing right now have shown that really, we can bring some of this work that we've been doing in-house that maybe we've been using external consultants for. We actually can be using some things and doing some cost-saving measures that we didn't realize that we had the opportunity to do by sharing across divisions, kind of breaking down some of those silos in terms of being better together internally. How much is it going to keep -- hurt us going back? Maybe a little bit on the technology investment, but we're cutting technology investments in nonclient-facing type areas. So are we going to refresh our website this year again? Maybe not. But if we do it next year, that's probably okay. We still want to make those investments. But that would be an example of -- is it going to really hold us back from selling more insurance? Probably not.
Patrick Gallagher: Meyer, let me give you a bit of where I think this is going to carry over to next year, which are some things I've been seeing in the last 2 months that I'm really excited about. Number one, cross-selling. I think you've heard me say 100 times that that's one of the things in the company that I'm always harping on. And this, all of a sudden has given a lot of light to that. People are saying from the property casualty side or the benefit side, wait a minute, my customers really do need help. So we're seeing those opportunities grow. We're also finding an opportunity to wipe out more of what we refer to as white space. We know that on average, we're doing, I'll make this up, 3 or 4 lines of coverage per client when they're probably buying 10 to 12. Wait a minute, we're doing 4 really well for you, and you need help on the other 8. We're picking up those accounts. And the other thing is trading with ourselves. As we've been doing acquisitions, of course, they all come with their London broker. They've been in business with for 100 years. And we explained to them why they should trade with us in London. And by and large, we've done a good job of moving some of that business. But today, when you get a crisis like this and you say, "Guys, this is really about making sure we do the right thing for the client, and we've got a better group of people in our London office than you've been trading with. No more excuses. Move it." They're doing it. So their benefits have come from these bad times that will, in fact, pull over into '21 and 22.
Operator: . Our next question is coming from Ryan Tunis of Autonomous.
Ryan Tunis: So I just wanted to talk a little bit about thinking about the mousetrap for even like in '19, when we were getting to mid-single-digit organic, clearly, to get there, there was quite a bit of new business that was being written. What was the new business volume? What's kind of been the annual pace of new business?
Douglas Howell: Go ahead, Ryan.
Ryan Tunis: Yes. No. No. I was just going to say in terms of on the revenue line. Yes, the number, sorry, Doug.
Douglas Howell: There's two different numbers in there. Some of it, if you just talk about new business relating to one-shot type opportunities like a bond or something like that. You've got that, and then you've got the other, just what's the annual -- related to annual policies that you would expect to keep a client and keep renewing. The way to really think about this is the delta between the new and lost. And we've been getting probably about 2 or 3 points of limp from rate in the past. So our new business has been always outgrowing our lost business, call it, by 3%. And maybe it's more 4% net new and 2% because of rate and exposure, we were kind of toggling to a point really at the end of last year, where almost all of that was -- of the 2 to 3 points for June rate and exposure was really coming from rate, not from exposure. We had gone through the exposure growth period from 2012 to 2017, and we're kind of -- the other -- that kind of declined a little or flattened out a little bit and we're getting rate. What could happen as we come out of this? Well, you could see another growth in exposure units. It will recover from the contraction. And I still believe that there's rate out there. That tends to -- when there's rate happening out there, you tend to get more looks at new business. And then it also -- you got to make sure that you secure and hold on to your renewal business. So what do we see in next year? I would say maybe a new business in excess of loss business because we compete 90% of the time with somebody less than us, maybe you'll see that widen out by 1 point at least in that spread.
Patrick Gallagher: Yes, Ryan. Doug can give you the numbers in terms of the spread and what have you. What we saw in the last couple of years, which has been really heartening is that we bifurcated our business or trifurcated into the small business kind of medium and the large risk management stuff. And what we're finding is we've had a lot more success the last couple of years on accounts that we would consider just slightly bigger than the norm in the past. So we have been -- and those have not been coming from taking on our larger competitors. We do find and we compete against and we do fine, they do fine against us. But as Doug just said, 90% of the time, we're competing with somebody smaller. And what we found in the last two years is we are taking their bigger accounts. They're actually -- we're having more success with accounts that are a bit bigger. So that does add up to a percentage of trailing book of business, which has grown nicely over the last couple of years.
Ryan Tunis: So then it's fair to say that in your outlook for kind of flat to maybe slightly down, you're assuming that you're still going to be able to generate more new business than you lose for 2020.
Patrick Gallagher: By far. Listen, here's the thing, right. Right now this is my calls every day. This is our time. This is difficult on our people, working at home, where half of them are sturt crazy, bunch of them have kids, it's not easy. They're still making calls. We're picking up orders right now from clients we haven't had a personal meeting with. We're going through what we have in terms of communication capabilities, what we have in terms of capabilities, to help them through, whether it's the CARES Act or what they're doing and what's going on in the market. And they're not getting that help from the smaller local broker. So I'm very pleased with the new business that's actually occurred over the last month. I mean we've actually had it -- it's held up comparative to January and February, which I've been amazed at. And of course, as Doug mentioned in his remarks, our retention is a bit stronger because when we're in a normal environment, that local broker who's got good markets, just doesn't have the capabilities. They could beat us from time to time. So we're seeing our lost business come down a smidge and our new business is up. So now what happens with exposure units and bankruptcies and unemployment and all the rest of that tends to suck the wind out of you. But I'm excited about new business right now. We're a new business machine.
Ryan Tunis: So my other one is just on, I guess, thinking about your revenues, what percent of your revenues are tied to some sort of headcount metric? Like I'm being in workers' comp and employee benefits and also. What percentage of your revenues are -- maybe -- I don't know if nonrecurring is the right question, but I'm thinking about like a construction project. So like to replace the construction project from last year, you need to write a new construction project this year.
Patrick Gallagher: That's right.
Ryan Tunis: That type of thing.
Patrick Gallagher: Our entire bond book is exactly what we're talking about. We look at it every year and budget the fact that the XYZ construction company who does infrastructure work is going to be able to continue to do that work. And of course, new projects are going to come up. Now you take those projects away, and they'll drop. Now presently, the government is not withdrawing into those projects. So those that are doing hard infrastructure work, we're going to probably continue right on with that. But you asked a question, a lot of the business, all workers' compensation is predicated, as you know, on payroll. And by and large, what you've got in our entire benefits book, which is over $1 billion in revenue, is tied to employee headcounts. So we are subject to the decrease of employees or decrease in payrolls.
Ryan Tunis: How big is the bond book? I'm sorry.
Douglas Howell: The bond book?
Ryan Tunis: Yes.
Douglas Howell: I don't know. I'd have to take a look at. I got to see if I can dig that up for you quickly.
Patrick Gallagher: Don't have that.
Ryan Tunis: My last 1 was just, obviously, on the carrier calls, there's been a lot of discussion around business interruption. And I'm just curious in how hectic is it in terms of talking to your clients? Are there a lot of claims coming in? Is there a lot of handholding? Or you feel like a lot of the coverages are pretty easy to explain. They kind of get it that type of thing?
Patrick Gallagher: Well, first of all, you've got to start with. There's a tremendous number of clients who for their own reasons have chosen -- this is why we're getting some feedback. There's a number of clients, of course, that have chosen not to buy business interruption. So we take them and move them aside. Then there's different forms of business interruption throughout the marketplace. And those forms will dictate whether or not the carriers or the coverage. And we represent our clients. We're going to sit with our clients. And yes, there's a lot of activity in this regard and take them through what they bought, what the limits are that they bought, and whether or not it looks as though they have coverage because there are some coverages in the market that clearly cover pandemic. Now there are many others that simply say, there has to be a physical damage to the premises for it to be a covered loss. And there's been strong leadership from the insurance company side, saying, look, we're going to pay the claims that we know we have that are appropriate claims. We're going to pay them quickly. But we're not going to amend our contract, and we're going to have to help our clients, which is what we do, go through that environment. And if they have a rightful claim, we're going to do everything we can to make sure it gets paid.
Douglas Howell: Ryan, just a follow-up, I did dig a couple of numbers out for you. Last year, we did nonrecurring type business, which would probably include our bonds and everything of about 1% of our total revenue. So if it all went away forever, our organic last year of 6% would have been 5%. Workers' comp and what we consider to be high-impact areas is also about 1%. So 100% of all those employees went away and stayed away and never came back for an entire year and cost us another point on our organic.
Operator: And our next question is from Elyse Greenspan of Wells Fargo.
Elyse Greenspan: And I had one last question. Do you guys have through the years, have spoken about the outsourcing operations that you have in India, it seems like the impact of COVID there has been lagging the U.S. by about 4 to 5 weeks. So I was just wondering if there was -- we should be thinking about any impact on your business within India. And then I might have one other follow-up as well.
Patrick Gallagher: Yes. I'll take that. I think I just couldn't be more pleased with our capabilities. Those folks have trained and planned and had actually done exercises of working from home. We knew that if any of those locations went down, we could move that work to their home with their laptops. We have not seen any delimitation at all in the service provided by our service centers. And remember, our service centers are now in India, small in the Philippines and also in Las Vegas in the United States. And those service centers have continued to provide absolutely impactable service for the last two months, not even a noticeable change. And while it's difficult for many of them as well to be at home, we don't see that changing at all in the future.
Douglas Howell: Yes. It's really been a remarkable, Elyse. They -- since day 1, they are trained and they rehearse to do all their work from home. We're a paperless environment there, the laptops come home with them every day. We have -- you get some brownouts there from time to time, where you have a little problem with electrical grid. So we've got experience with them being at home. Internet connectivity is required for them in order to have a job at as a home Internet connectivity. So I'm really impressed with the sturdiness of that operation that hasn't missed a beat.
Elyse Greenspan: Okay. That's great. And then last question. In terms of the expense saves, is there -- can you give us a sense of just by geography, if they might be more pronounced in the U.S., the U.K., obviously, Australia, New Zealand or even within India? How do you think about the geographic base of the expense save?
Douglas Howell: Yes. I can probably dig that out for you here if I get to the right piece of paper. I'm a little short on it. But I don't see it disproportionately in any 1 location versus the other. So obviously, I would say it's proportional to our revenues by geography. But I'll look at it here if you have another question, but I'll take a look at it as I dug this out.
Elyse Greenspan: Well, that was maybe the last.
Douglas Howell: I got it here. I don't see it as being disproportionately different by country or by division, other than the Gallagher Bassett matter that we talked about.
Patrick Gallagher: I think that's probably it for questions. Why don't I just make a quick comment here, we'll wrap it up. Again, thanks for joining us this afternoon. We really appreciate you being here. As you can see from our comments, our focus is clearly now on the difficult, evolving operating environment. I'm confident that we have the right platform, people and strategy to manage through the current environment for the benefit of all of our stakeholders, our employees, our clients, our carrier partners and our shareholders. Thanks for being with us, and thanks to all of our teammates for delivering a great quarter again. Stay healthy, everybody.
Operator: This does conclude today's conference call. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to the Arthur J. Gallagher and Company's First Quarter 2020 Earnings Conference Call. . Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements."
},
{
"speaker": "Patrick Gallagher",
"text": "Thank you very much. Good afternoon, everyone, and thank you for joining us for our first quarter 2020 earnings call. Also on the call today is Doug Howell, our Chief Financial Officer as well as the heads of our operating divisions. Before we get into our first quarter results, let me acknowledge those directly affected by COVID-19, including those on the front lines of the global pandemic. We are in all their dedication and courage. At Gallagher, our priority is the health and safety of our colleagues. We're very fortunate that less than 50 of our 34,000 associates have contracted the virus, nearly all of whom have fully recovered. With a few that are still self-quarantined, we wish you a speedy recovery. I'm incredibly proud of how all our associates have performed over the past 6 weeks. In March, we mobilized our business continuity plans around the globe, and we're up and running, working from home in a few days. We are working remotely without missing a step. This is the payoff of our relentless efforts over the past decade to standardize work, streamline processes and operate using common systems. All of our colleagues are productive, too. At home, they have the right tools and systems in order to deliver the highest quality service to our clients. And that includes more than 5,000 associates that are based in our service centers. And every day, we see countless examples of our employees unselfishly giving back from providing first responders with protective equipment, to sending meals to senior citizens, to distributing masks to the less fortunate. I'm proud but not surprised at the level of dedication, support and professionalism from all of our colleagues around the world. I thank every single one of you from the bottom of my heart. Now moving to our first quarter financial performance for our combined Brokerage and Risk Management segments. Here are some highlights. We had a terrific revenue growth quarter. Total reported revenue growth of 4% and adjusted revenue growth of 9%, which includes 3% reduction due to COVID. Included in that is organic growth of 3.3%, but again, we had nearly 3% of an unfavorable impact due to COVID-19. This would have been another quarter like our fourth quarter last year. And even with around 2% adverse impact of COVID-19, we posted a net earnings margin of 20.1% and more impressive adjusted EBITDAC margin of 32.2%. And we completed 8 acquisitions this quarter with estimated annualized revenues of $124 million."
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Pat, and good afternoon, everyone. I, too, extend my sincere appreciation to first responders and those on the front line. And also my thanks for our 34,000 colleagues. You had to navigate your own personal challenges presented by the pandemic, yet we're up and running in a few days, delivering timely advice and service to our clients. That's just simply amazing. So thank you. Today, I'll walk you through the COVID-19 impact table on Page 2 of the earnings release and how that impacts our organic and margins on Pages 4 to 7. I'll address our expense savings initiatives. I'll provide some thoughts on our capital and liquidity, and I'll finish with a few short comments in the CFO Commentary Document. So okay. Turning to the table on Page 2 of the earnings release. This table captures all of the COVID matters in our numbers. They are -- they all fully hit our reported GAAP numbers, and we did not adjust any of them out where we show our non-GAAP adjusted numbers. You'll see in the end, COVID didn't have much impact on net earnings nor on EPS, but there are 4 moving estimates that have a noticeable impact on revenues and EBITDAC. First, let's address how it impacts revenues. And just as a reminder, about accounting standard 606 that drives our revenue accounting. We adopted that in 2008. Recall it requires us to estimate annualized ultimate revenues for contracts and policies with effective dates prior to closing the books, even if those annualized revenues are dependent on future events. We must make our best estimate. And as most of you know, there are a lot of insurance policies that have volume-like adjustments that can occur in the year after the policy effective date. Lines like workers' compensation, employee group medical plans, casualty lines that have adjustable premiums based on, say, future miles driven or flown. Those are just examples. And then you have experience-rated contracts. So there's a lot, so on and so forth. In the past, historical patterns drove those estimates, and changes in volumes would emerge slowly as our clients' businesses naturally evolve. That's not today's environment. Our customers' businesses have been dramatically altered in a few short weeks. That's the reality. So we need to make our best estimates of what will happen in the future for those pre-April 1 contract. It's not easy, but we still must do it."
},
{
"speaker": "Patrick Gallagher",
"text": "Thanks, Doug. I think with that,, we'll go to some questions."
},
{
"speaker": "Operator",
"text": ". Our first question is from Mike Zaremski from Crédit Suisse."
},
{
"speaker": "Michael Zaremski",
"text": "First question. Pat, you talked about being prepared for the possibility that organic could go flat to even a bit negative for a couple of quarters, which I think makes sense to most investors given the backdrop. I just wanted to clarify that, that -- is that inclusive of the Gallagher Bassett segment, which I believe you're alluding to maybe having more of an organic growth impact versus Brokerage? And I guess should we be thinking then that earnings then and margins then given the CFO Commentary, then we'll also go -- would go a bit negative if that scenario plays out?"
},
{
"speaker": "Patrick Gallagher",
"text": "Well, again, Mike, as we try to be really clear that we don't know and we put language in the prepared remarks to make sure we understood that it could be material. But I'll be the perennial optimist, yes. We think that depending on what happens as these states begin to open up and economic activity, we'll see how deep and how long this recession goes. It could adversely impact just to the point, as we said, of a flat to down quarter or a number of quarters. I do think you're right that the Gallagher Bassett numbers, which, yes, are included in those discussions, could be a little bit more hard hit, but we'll just have to see how deep this thing goes."
},
{
"speaker": "Douglas Howell",
"text": "Yes. Mike, on margins, just so you know, even if we end up in a flat environment for a couple of quarters with the expense saves that we are seeing, we should easily hold EBITDAC margins at historical levels and actually can probably increase them."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. So that -- I guess I'll use that as my follow-up, Doug. So $30 million of charges spread over the next 3 quarters. I typically think of -- in the -- typically think kind of a payback ratio and the payback ratio seems to be very large, $50 million to $75 million per quarter. So it sounds like a lot of these expense saves, should we be careful on our models not to kind of roll them over into future years because lots of this -- some of these things are just going to be temporary?"
},
{
"speaker": "Douglas Howell",
"text": "That's right. I think that this will get us through the trough in revenues. And then I think you have to think about us more in 2021 and '22, if we go back to organic growth, kind of where we were in '19, you would probably see margins like you saw in '19, maybe up 50 basis points for the year. Let's say that we get back to 5% organic growth in 2021 by some hook or crook, you would see probably our margins up 50 to 100 basis points over where they were in 2019. So we can fill the hole this year. And then I think we can get back to normal business, hopefully, in 2021 and '22, you would see it like the trends you saw going from 2018 to 2019. And then so just start with 2019 and pick 2021. That's probably how you should be looking at it. And then in '20, we just hope we can fill the hole."
},
{
"speaker": "Operator",
"text": "And our next question is coming from Greg Peters of Raymond James."
},
{
"speaker": "Charles Peters",
"text": "Pat, can we go back to your comments where you segmented out the 20% higher impact, 60% in the middle and 20% lower impact? Just curious how you came up with that. I'd characterize -- as I think about your business, for example, take the aerospace business, I don't hear of a lot of rate in aerospace. And yet, I would characterize that as a higher-impact business. And so you seem to imply that you're getting enough rate to offset exposure. But maybe you can give us some more color."
},
{
"speaker": "Patrick Gallagher",
"text": "Yes. Sure. First of all, what we did, Greg, is say, all right, let's -- we can now segment our book of business, as you said, into quite detailed chunks. So we sat down and said, what are the industries out there that we think are going to be really hard hit. And those are the ones that we would then lump into the higher impact. So our hotel business, for instance. We can get very granular about how much of our business over the entire $5.6 billion to $6 billion revenue business is hotels. And it's less than $100 million. That's an example. So we took all those businesses that we -- and we just had to bucket them. So it was down and dirty. Hotels, restaurants, those went into the very high impact. Moderate impact, some construction, some transportation, and then low impact would be things that would go on like our public entity business, any hospital business, that type of thing. So when we looked at that, we then went in, we can also segment out. We can look at what's happening to the rates. And we can do that by account. We can do it by geography, and we can do it by type. And we looked at, we said, all right, let's take a look at the accounts that we put in each of those buckets. And again, Greg, as we said throughout this whole thing, it's very early information, but what has actually happened to those clients that we thought were in the most impacted bucket. Now again, we're cautioning. We're saying this is what's happened in the first quarter and early days of April. So we've said clearly, hotels are going to show a lot more pain in the second and third quarter off of what happened to them in the first quarter. But nonetheless, what's happening to hotel rates? Well, guess what? They're not going down at the same time. So hotels are not going away. They are renewing their accounts. And those that are renewing their accounts are paying higher property rates. Now exposure units are down on renewal. But what we're saying in our prepared remarks is that right now, this bar, you've got a pretty nice offset. And those rates are holding."
},
{
"speaker": "Douglas Howell",
"text": "And Greg, just to amplify that, we've got 156 sick codes on a sheet that counts for our revenue all of last year. And it's -- there's kind of that 20-60-20 distribution on it, both in terms of -- in terms of our last year's revenues and, like Pat said, eating and drinking places. That's in the high-impact one. You've got stone, clay, glass and concrete product manufacturers might be in the medium, and then you've got legal services that might be in the low. So you just pick out a sick code, we can slice and dice our revenues exactly by that. And then we can tell you by the coverage across the 2. So not only do we weight it by the industry, but we also looked at the coverage lines, too, as it informed our positions."
},
{
"speaker": "Charles Peters",
"text": "Got it. Do the supplemental and contingents get affected by volumes as well?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. In some case -- supplemental is not so much. That automatically adjusts with the volumes in the quarter. So that's not an issue. Our contingent -- pure contingents, you actually might have a lift in pure contingents if loss ratios are down because of lack of activity. But we do have contracts where there is a double trigger on their volume expectation, and then there's a loss expectation. And that's the one as we look at it going forward, we could have a little softness in that. And we put up about -- I think that was about $8 million of possible estimate reserve for that."
},
{
"speaker": "Charles Peters",
"text": "Got it. I'm going to pivot to the balance sheet. Just two questions on that. First of all, given what the carriers are doing in terms of rebates, givebacks, delayed payments. I noted that your premium and fees receivable were up quite substantially from year-end. I'm wondering if there's anything in there, and how you're looking at that from a level of concern perspective. And then secondly, I just wanted to circle back on your intangible amortization charge. I think 30 -- in excess of 30 million people filed for unemployment in the last 6 weeks, I got to believe there's more potential risk in it and write-offs of customer lists than just that, but maybe you can add some color there."
},
{
"speaker": "Douglas Howell",
"text": "Let's talk about the balance sheet. The big difference between December and March is that our reinsurance operations have a very heavy first quarter, and that's what influences that. It should not be looked at as a collectibility issue. Our cash flows during April are still strong. And so we are not having collectibility issues on that. That's not an indication that there's collectibility on those receivables. We only put up a bad debt reserve of $6 million, something like that, $7 million, $8 million this quarter. So it's -- we're not seeing that at all. And so you can't read-through on the balance sheet for that. So that's the reason why the balance sheet is up. The second part of your question was what?"
},
{
"speaker": "Charles Peters",
"text": "Around the intangible asset, the write-off of the customer lists. And just the fact that the balance of what's going on in the economy seems like there's more risk to goodwill and intangible write-offs than ever before. But we're just sitting on the outside looking in, so you have better perspective."
},
{
"speaker": "Douglas Howell",
"text": "Yes. I can answer that. And first of all, we're nowhere near any type of goodwill impairment on this. As for the customer lists, maybe on the surface, it appears to be that way, Greg. But when you got a -- we got businesses that are really retaining 92%, 93%, 94% of their customers on an annual basis. Just because there's a bunch of people that are out of work doesn't necessarily mean that, that business is out of work. If they don't come back immediately -- don't come back in the next 2, 3, 4 months, maybe there could be. But again, it's a non -- one thing, as you know, it's a noncash charge, but we look very hard through hundreds and hundreds and hundreds of acquisitions during this quarter. And we do it every quarter anyway, and we just didn't see where there's massive falloff. So when you come up with $40-some million across the board of all these acquisitions, that's a pretty small tweak, like I said, it's 2%. If it deteriorates further and we have prolonged business outages, sure, there'll be some noncash write-offs on this, but it's kind of a no. Never mind."
},
{
"speaker": "Operator",
"text": "Our next question comes from Elyse Greenspan of Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question is on the expense saves. So could you just give us a sense of like the geography by the segment? Or should we think about it in relation to the proportion of revenue between Brokerage and Risk Management? And then I guess tied to that question. Pat, by saying, right, this expense focus, you could probably expand your margins even as books close. Was that a comment specific to both of your segments?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So let me break this down. And you were cracking just a little bit, at least. So let me see if I -- is there a disproportionate cost-cutting opportunity between Gallagher Bassett and -- or the Risk Management segment and the Brokerage segment? Yes, I think in the Risk Management segment, you're probably looking at 25% to 30% of those savings, whereas that business itself is somewhere around 20% of our total business. So there's a slight skew to that business which would make sense because they're the ones that have the more volume-sensitive -- immediate volume-sensitive type business than the Brokerage business does. So that's the first part of the question. It's slightly skewed more towards that. The margin question that you're asking is that if we're successful in achieving the expense savings to the level that we've planned for, you would actually see increasing margins in both segments on a quarterly basis."
},
{
"speaker": "Elyse Greenspan",
"text": "And you expect to be at this $50 million to $75 million quarterly kind of run rate figure for the full Q2, right, because you started working on this in the middle of March?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. We might not get -- listen, here it is May 1 tomorrow. We're going to get much of it this quarter. But if I -- if we can get 90% of this quarter, then we'll catch up in the third quarter."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then one more question on the COVID-related revenue adjustments. So just so I understand, so that's on basically -- it's everything as it sits today. So even if we continue in this economic slowdown, you wouldn't expect to see any further 606-related adjustments? Or I guess unless assumption changed materially from what you're thinking today?"
},
{
"speaker": "Douglas Howell",
"text": "All right. Two answers to that is for there should be none of that going forward, if customers adjust their exposure units for renewals beginning April 1, May 1, June 1. So they adjust down, then there would be no COVID-related type adjustment, right? They're just going to buy less insurance, right? For contracts that were basically written -- in January, we put all those to bed. We did all the work for it. We booked what we thought was the revenue that we'd get over the 12 months following that contract date. We had to reestimate what we think we're going to get from those here in the last few weeks, almost a subsequent-event type of valuation of those revenues. Could there be further deterioration in that? Yes. Sure. There could be if the number of covered lives decreases further than our estimates, if we get more audits that come in afterwards if there are more midterm cancellations, you could have a further COVID adjustment. But I hope that we've got it all at this point, but we'll see. And we'll track that for you, and we'll show you how much it was."
},
{
"speaker": "Elyse Greenspan",
"text": "And just one last clarification. Your organic outlook of flat to maybe slightly down. That's an all-in, including your contingency supplementals like you usually give guidance, correct?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. That's right. And let's make sure we understand that. Here we are chugging along and having good organic this quarter. If we have a dip next quarter, and we might have a little dip in the third quarter, our assumptions are by the fourth quarter that we would be back to a decent organic level. And if that pushes into 2021, what I'm saying is I don't see us being negative for, at the most, a couple of quarters. Even then, I think I'd be a little bit surprised."
},
{
"speaker": "Operator",
"text": "Our next question comes from Yaron Kinar of Goldman Sachs."
},
{
"speaker": "Yaron Kinar",
"text": "I guess first question, Doug, I think in your prepared comments, you said that you'd expect EBITDAC margins to be at historical levels maybe slightly above. When you talk about historical levels, what are we talking about here? Are we looking at last three years, last decade? Could you give us maybe a sense of what it is your thinking here?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So let's go back to the margin comment. I think that probably the better way for you to do it to just assume we're going to get $50 million to $75 million of revenue. And if you just hold our revenue flat to last year for the second and third quarter, you can't help but get margin expansion, right? If you take last year, so you're going to get margin expansion even a flat or in a slightly down organic environment if that happens. It will -- if it reverts in the fourth quarter or into next year, then you're going to be -- I think Mike asked the question about it earlier, by the time you get to 2021, if we're chugging out organic like we were in 2019, we're going to put some of these costs back into the structure. So take your 2019 margin and grow it kind of what we did between '18 and '19 and '21, and you'll kind of be there. So you're going to get an increase in margin in the short term, and then it's going to revert back a little bit more in the longer term. I want to make sure that I'm clear on something there. Does everybody understand? I don't know if I misspoke. We think that we're going to get $50 million to $75 million of expense savings each quarter going forward, not revenue saving. Whatever the revenue, it is what it is. But we're adjusting our expense basis down $50 million to $75 million of expense. I may have misspoke on that, but..."
},
{
"speaker": "Yaron Kinar",
"text": "I think I understand that. But if I look at the revenue base of 2019, that's like over 4% of margins, right, in Brokerage and Risk Management."
},
{
"speaker": "Douglas Howell",
"text": "Say again. Yaron, sorry, we got some static on the line."
},
{
"speaker": "Yaron Kinar",
"text": "Sorry about that. I think if I look at that $50 million to $75 million of quarterly expense saves and I look at the revenue base for 2019, that's over 4% margin."
},
{
"speaker": "Douglas Howell",
"text": "Could be."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. All right. And then I guess my second question is around capital, how you're thinking about it here? I would think you have a lot of disruption in the space, maybe creating opportunity for M&A., besides the fact that you can't really meet with anybody right now in this environment. Are you interested? Has your appetite for M&A increased here? Or would you say that maybe you have a greater maybe as a precautionary measure, more interest in preserving capital and liquidity here?"
},
{
"speaker": "Patrick Gallagher",
"text": "No. This is Pat, Yaron. We are really interested in the acquisitions. This is a time for people now to sit back and take a look at what the competitive landscape was. There were an awful lot of competitors out there with great stories and lots of money in the bank. And now I think there'll be a time for people to look and really think who do they want to be with. And if we can get people to sort of think through the acquisition of their life's work, and where they want to have their people employed after the deal is done, we think we'll do very, very well. So we are wide open for business, and we are not trying to preserve capital when it comes to acquisitions."
},
{
"speaker": "Douglas Howell",
"text": "You get a little bit of difficult rate and conditions out there in the marketplace, Yaron. And you sit there and say, would you rather do it alone? Or would you rather do it with us? I know where I'd be if I own my own agency. I'd be sitting there saying, how do I go to a strategic that can actually deliver capabilities and resources that will help me sell more business, that's where I'd want to be right now. And we're tightening our belt here on expenses, but we still have -- we're not cutting into the meat of our capabilities. We're -- we can tighten our belt and get through this trough in the revenues. If I were somebody selling, I'd be thinking pretty hard about coming to Gallagher right now."
},
{
"speaker": "Yaron Kinar",
"text": "So I think -- in one of the more recent Investor Days, you had talked about targeting about $1.5 billion worth of acquisitions in 2020. So is that still achievable or something you could do?"
},
{
"speaker": "Douglas Howell",
"text": "Listen, we have the capacity to do that type of ball. I just don't think it will present itself. I think that there's a lot going on right now, getting people back out to do due diligence, it'd be pretty hard for us to spend that amount of money between now and the end of the year. But does that mean we couldn't catch up in 2021? If this is a V-shape recovery, there'll be plenty of opportunities to buy, and we might be a little short for a quarter or two. But by 2021, you could see us having a huge year."
},
{
"speaker": "Operator",
"text": "And our next question is from Mark Hughes of SunTrust."
},
{
"speaker": "Mark Hughes",
"text": "Doug, I'm not sure whether you touched on this, but your cash flow expectations for this year. If you undertake all these measures and it sort of plays out as expected, what does that do for free cash?"
},
{
"speaker": "Douglas Howell",
"text": "Okay. Let's say, I don't know if I have a number right for you on how much could generate. But the fact is, if we have a little bit of a lull in M&A, right? If we have expense cuts of, let's say, $75 million a quarter for 3 quarters, there's another 2.25, right? And we typically -- we're probably starting with $500 million to probably $700 million even after paying the dividend. So you've got a lot of -- you could have $1 billion of excess cash by the end of the year if organic doesn't -- if it's flat for a couple of quarters or down just a little bit. I don't know if I care either way. You could have a substantial amount of cash on the balance sheet at the end of the year."
},
{
"speaker": "Mark Hughes",
"text": "Any distinctions internationally, when you look at the different markets you're in, any doing notably better or worse?"
},
{
"speaker": "Douglas Howell",
"text": "We had really a great quarter in our U.K. operations. The organic was very strong in the U.K. So that business there seems to be holding in very well. Early April, returns on that don't show a lot of stress either. So we're having really terrific results in our U.K. operations. Canada had a great quarter also. I think that's really doing well in Canada. Our operations there has really come together in the last few years, and we're running really nice, upper 30 points of margin in it. Australia and New Zealand, they were coming off some pretty hard market there's -- rate environment there for a while. We'll see what happens with the fires happening, but there seems to be good organic growth there. And then in the U.S. we had terrific results, too. In April, I was surprised by our guys, to be honest, they're selling a lot of business. I look at the new business sheet every day. And there are -- our guys are selling a lot of new business out there still here in April."
},
{
"speaker": "Patrick Gallagher",
"text": "Yes. And I'd add to that, too, Doug, that if you take a look at places where we're smaller around the rest of the world, very, very strong start to the year. Latin America, our operations and, as you said, Canada, the global picture looks really, really good so far."
},
{
"speaker": "Mark Hughes",
"text": "And then last question. I just wonder on the claims count. You talked about the kind of high-frequency claims are down 50%. Anything that jumps out at you about things you might not have expected? Other types of claims that frequency is down, and I'm curious, any observations about workers' comp, specifically. How you see claims there?"
},
{
"speaker": "Patrick Gallagher",
"text": "I think Mark... you go Doug, and then I'll go ahead. Go ahead, Doug."
},
{
"speaker": "Douglas Howell",
"text": "I think I think we're surprised in the Gallagher Bassett unit about the strength of some of the industries like -- especially like in the hospital sector right now. It's -- claims are still coming in. And we are starting to get more and more workers' comp claims related to COVID also. So our customers are going to have workers' comp claims related to COVID. But the kind of the recurring just manufacturing medical-only type \"back to work in a day or so\" type claims, if you don't have a lot of people working, you just don't have a lot of those arising. So I think that, to be honest, the severity claims are still there. The frequency is down. But again, it was -- it's 10% of our business. And that's -- it's not all that margin fix. So we've got the ability to adjust our headcount on that, and we've used a lot of temporary labor there. We do a lot of contract or contingent labor. So we have the ability to flex that labor pool pretty easily on it."
},
{
"speaker": "Patrick Gallagher",
"text": "I would add to that, though, Mark. One thing I was surprised at is how quickly on that side of claims side, it began to move. I mean as we saw unemployment requests go up very quickly in end of March, those claims came down very quickly as well. People getting out of work were not filing claims, which is interesting."
},
{
"speaker": "Operator",
"text": "And our next question is from Paul Newsome of Piper Sandler."
},
{
"speaker": "Jon Newsome",
"text": "I thought it was interesting in the CFO Commentary that the expected weighted average of EBITDAC acquisition pricing was down a tick or 2. Is that a reflection of what you perceive as the acquisition market? Or is that a reflection of just trying to be more disciplined in a difficult environment?"
},
{
"speaker": "Douglas Howell",
"text": "I think really when you look at it, when you look at it, Paul, when you're talking about doing 7 deals, mergers across $30 million of revenue, you're talking about a nice bolt-in acquisition. We didn't have any big larger ones in the quarter caps because that was already in our numbers, but we didn't have a Stackhouse Poland for last year. We didn't have a Jones brown up in Canada. So it's these nice tuck-in bolt-on acquisitions. We're still doing nicely in the 8s in there. So that's what you're seeing there."
},
{
"speaker": "Jon Newsome",
"text": "And then I guess do you have expectations when you're doing deals that you'll also see similar drop-offs in revenues that you would experience?"
},
{
"speaker": "Douglas Howell",
"text": "I think it certainly puts -- the idea of growth in an acquisition has always been one of those things that the seller believes they're going to grow x, we believe they're going to grow at a percentage of x. And so we put part of purchase price on an earnout. And I think in this uncertain time, there will be considerably more sellers willing to take more on an earnout because I think they're going to want to grow out of this environment. We're going to want to help them grow. Nothing would make me happier for everybody to come in and hit their earnout. That means they're growing well, and we're all doing well then."
},
{
"speaker": "Patrick Gallagher",
"text": "Let me weigh in on that. As Doug had said earlier, if you're going to be running a smaller brokerage right now, who would you like to partner with? I'd like to partner with the firm that's going to help me make my earnout. When rates are going up and everything is dandy, making my earnout the way I did it all the time in the past might not be that difficult. All of a sudden, right now, capabilities make a difference."
},
{
"speaker": "Operator",
"text": "And our next question comes from Meyer Shields of KBW."
},
{
"speaker": "Meyer Shields",
"text": "Two really quick questions. First, it really sounds like, other than exposure units, that things are going full bore. I was wondering if you could comment on the producer recruitment that is a company in that."
},
{
"speaker": "Patrick Gallagher",
"text": "Yes. We are wide open for producer recruitment. I mean this is -- no matter what the day or the time is in terms of good economies, bad economies, we are always looking for solid production talent, and that's no different now. But as we've talked about the acquisition process, I think that there's going to be a little less competition. Or maybe let me put it this way. We're still one of the few places of size and capability that are happy to pay our producers on what they actually produce, what they're buying and what they bill. And if I'm looking around at where I'm going to go, am I going to go down the street to the Jones agency or am I going to come to a Gallagher, who understands production from the standpoint that we are a broker run by brokers. Every single one of us, with the exception of the professionals, have been on the street. And I think that resonates right now. And we get a lot of people that are interested in. \"Yes, really, how does this work?\" Well, now they've got capabilities with us to go out and pick on the smaller guys and say, \"no, no, no, you don't understand. This is really something we can help you with.\" And that resonates in today's market. So I think that: number one, it's a great time for us to be recruiting; and number two, we're going to have lots of success with that."
},
{
"speaker": "Meyer Shields",
"text": "Yes. No. That makes perfect sense. Maybe this is a question for Doug. Are we going to see any impact in 2021 from the expense pullbacks in 2020?"
},
{
"speaker": "Douglas Howell",
"text": "So do you think we could have savings in 2021 versus what we put in this year as they got a carryover impact? Is that your question?"
},
{
"speaker": "Meyer Shields",
"text": "No. The other way. In other words, obviously, you were spending this for a reason, which doesn't preclude -- responding to sort of the weird situation, but are these loss, I'm thinking of them in terms of investments, are those going to show up at 2021?"
},
{
"speaker": "Douglas Howell",
"text": "I think you're asking, do we think we're going to have a setback in our progress of building a better franchise as a result of these expense cuts. I think that's really what you're asking. We believe that most of these are immediately consumable type of expenses that if we're not traveling today, I don't know how that's going to impact us next year. So travel comes back, I don't think that's going to hurt us. I think that some of our other belt-tightening exercises that we're doing right now have shown that really, we can bring some of this work that we've been doing in-house that maybe we've been using external consultants for. We actually can be using some things and doing some cost-saving measures that we didn't realize that we had the opportunity to do by sharing across divisions, kind of breaking down some of those silos in terms of being better together internally. How much is it going to keep -- hurt us going back? Maybe a little bit on the technology investment, but we're cutting technology investments in nonclient-facing type areas. So are we going to refresh our website this year again? Maybe not. But if we do it next year, that's probably okay. We still want to make those investments. But that would be an example of -- is it going to really hold us back from selling more insurance? Probably not."
},
{
"speaker": "Patrick Gallagher",
"text": "Meyer, let me give you a bit of where I think this is going to carry over to next year, which are some things I've been seeing in the last 2 months that I'm really excited about. Number one, cross-selling. I think you've heard me say 100 times that that's one of the things in the company that I'm always harping on. And this, all of a sudden has given a lot of light to that. People are saying from the property casualty side or the benefit side, wait a minute, my customers really do need help. So we're seeing those opportunities grow. We're also finding an opportunity to wipe out more of what we refer to as white space. We know that on average, we're doing, I'll make this up, 3 or 4 lines of coverage per client when they're probably buying 10 to 12. Wait a minute, we're doing 4 really well for you, and you need help on the other 8. We're picking up those accounts. And the other thing is trading with ourselves. As we've been doing acquisitions, of course, they all come with their London broker. They've been in business with for 100 years. And we explained to them why they should trade with us in London. And by and large, we've done a good job of moving some of that business. But today, when you get a crisis like this and you say, \"Guys, this is really about making sure we do the right thing for the client, and we've got a better group of people in our London office than you've been trading with. No more excuses. Move it.\" They're doing it. So their benefits have come from these bad times that will, in fact, pull over into '21 and 22."
},
{
"speaker": "Operator",
"text": ". Our next question is coming from Ryan Tunis of Autonomous."
},
{
"speaker": "Ryan Tunis",
"text": "So I just wanted to talk a little bit about thinking about the mousetrap for even like in '19, when we were getting to mid-single-digit organic, clearly, to get there, there was quite a bit of new business that was being written. What was the new business volume? What's kind of been the annual pace of new business?"
},
{
"speaker": "Douglas Howell",
"text": "Go ahead, Ryan."
},
{
"speaker": "Ryan Tunis",
"text": "Yes. No. No. I was just going to say in terms of on the revenue line. Yes, the number, sorry, Doug."
},
{
"speaker": "Douglas Howell",
"text": "There's two different numbers in there. Some of it, if you just talk about new business relating to one-shot type opportunities like a bond or something like that. You've got that, and then you've got the other, just what's the annual -- related to annual policies that you would expect to keep a client and keep renewing. The way to really think about this is the delta between the new and lost. And we've been getting probably about 2 or 3 points of limp from rate in the past. So our new business has been always outgrowing our lost business, call it, by 3%. And maybe it's more 4% net new and 2% because of rate and exposure, we were kind of toggling to a point really at the end of last year, where almost all of that was -- of the 2 to 3 points for June rate and exposure was really coming from rate, not from exposure. We had gone through the exposure growth period from 2012 to 2017, and we're kind of -- the other -- that kind of declined a little or flattened out a little bit and we're getting rate. What could happen as we come out of this? Well, you could see another growth in exposure units. It will recover from the contraction. And I still believe that there's rate out there. That tends to -- when there's rate happening out there, you tend to get more looks at new business. And then it also -- you got to make sure that you secure and hold on to your renewal business. So what do we see in next year? I would say maybe a new business in excess of loss business because we compete 90% of the time with somebody less than us, maybe you'll see that widen out by 1 point at least in that spread."
},
{
"speaker": "Patrick Gallagher",
"text": "Yes, Ryan. Doug can give you the numbers in terms of the spread and what have you. What we saw in the last couple of years, which has been really heartening is that we bifurcated our business or trifurcated into the small business kind of medium and the large risk management stuff. And what we're finding is we've had a lot more success the last couple of years on accounts that we would consider just slightly bigger than the norm in the past. So we have been -- and those have not been coming from taking on our larger competitors. We do find and we compete against and we do fine, they do fine against us. But as Doug just said, 90% of the time, we're competing with somebody smaller. And what we found in the last two years is we are taking their bigger accounts. They're actually -- we're having more success with accounts that are a bit bigger. So that does add up to a percentage of trailing book of business, which has grown nicely over the last couple of years."
},
{
"speaker": "Ryan Tunis",
"text": "So then it's fair to say that in your outlook for kind of flat to maybe slightly down, you're assuming that you're still going to be able to generate more new business than you lose for 2020."
},
{
"speaker": "Patrick Gallagher",
"text": "By far. Listen, here's the thing, right. Right now this is my calls every day. This is our time. This is difficult on our people, working at home, where half of them are sturt crazy, bunch of them have kids, it's not easy. They're still making calls. We're picking up orders right now from clients we haven't had a personal meeting with. We're going through what we have in terms of communication capabilities, what we have in terms of capabilities, to help them through, whether it's the CARES Act or what they're doing and what's going on in the market. And they're not getting that help from the smaller local broker. So I'm very pleased with the new business that's actually occurred over the last month. I mean we've actually had it -- it's held up comparative to January and February, which I've been amazed at. And of course, as Doug mentioned in his remarks, our retention is a bit stronger because when we're in a normal environment, that local broker who's got good markets, just doesn't have the capabilities. They could beat us from time to time. So we're seeing our lost business come down a smidge and our new business is up. So now what happens with exposure units and bankruptcies and unemployment and all the rest of that tends to suck the wind out of you. But I'm excited about new business right now. We're a new business machine."
},
{
"speaker": "Ryan Tunis",
"text": "So my other one is just on, I guess, thinking about your revenues, what percent of your revenues are tied to some sort of headcount metric? Like I'm being in workers' comp and employee benefits and also. What percentage of your revenues are -- maybe -- I don't know if nonrecurring is the right question, but I'm thinking about like a construction project. So like to replace the construction project from last year, you need to write a new construction project this year."
},
{
"speaker": "Patrick Gallagher",
"text": "That's right."
},
{
"speaker": "Ryan Tunis",
"text": "That type of thing."
},
{
"speaker": "Patrick Gallagher",
"text": "Our entire bond book is exactly what we're talking about. We look at it every year and budget the fact that the XYZ construction company who does infrastructure work is going to be able to continue to do that work. And of course, new projects are going to come up. Now you take those projects away, and they'll drop. Now presently, the government is not withdrawing into those projects. So those that are doing hard infrastructure work, we're going to probably continue right on with that. But you asked a question, a lot of the business, all workers' compensation is predicated, as you know, on payroll. And by and large, what you've got in our entire benefits book, which is over $1 billion in revenue, is tied to employee headcounts. So we are subject to the decrease of employees or decrease in payrolls."
},
{
"speaker": "Ryan Tunis",
"text": "How big is the bond book? I'm sorry."
},
{
"speaker": "Douglas Howell",
"text": "The bond book?"
},
{
"speaker": "Ryan Tunis",
"text": "Yes."
},
{
"speaker": "Douglas Howell",
"text": "I don't know. I'd have to take a look at. I got to see if I can dig that up for you quickly."
},
{
"speaker": "Patrick Gallagher",
"text": "Don't have that."
},
{
"speaker": "Ryan Tunis",
"text": "My last 1 was just, obviously, on the carrier calls, there's been a lot of discussion around business interruption. And I'm just curious in how hectic is it in terms of talking to your clients? Are there a lot of claims coming in? Is there a lot of handholding? Or you feel like a lot of the coverages are pretty easy to explain. They kind of get it that type of thing?"
},
{
"speaker": "Patrick Gallagher",
"text": "Well, first of all, you've got to start with. There's a tremendous number of clients who for their own reasons have chosen -- this is why we're getting some feedback. There's a number of clients, of course, that have chosen not to buy business interruption. So we take them and move them aside. Then there's different forms of business interruption throughout the marketplace. And those forms will dictate whether or not the carriers or the coverage. And we represent our clients. We're going to sit with our clients. And yes, there's a lot of activity in this regard and take them through what they bought, what the limits are that they bought, and whether or not it looks as though they have coverage because there are some coverages in the market that clearly cover pandemic. Now there are many others that simply say, there has to be a physical damage to the premises for it to be a covered loss. And there's been strong leadership from the insurance company side, saying, look, we're going to pay the claims that we know we have that are appropriate claims. We're going to pay them quickly. But we're not going to amend our contract, and we're going to have to help our clients, which is what we do, go through that environment. And if they have a rightful claim, we're going to do everything we can to make sure it gets paid."
},
{
"speaker": "Douglas Howell",
"text": "Ryan, just a follow-up, I did dig a couple of numbers out for you. Last year, we did nonrecurring type business, which would probably include our bonds and everything of about 1% of our total revenue. So if it all went away forever, our organic last year of 6% would have been 5%. Workers' comp and what we consider to be high-impact areas is also about 1%. So 100% of all those employees went away and stayed away and never came back for an entire year and cost us another point on our organic."
},
{
"speaker": "Operator",
"text": "And our next question is from Elyse Greenspan of Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "And I had one last question. Do you guys have through the years, have spoken about the outsourcing operations that you have in India, it seems like the impact of COVID there has been lagging the U.S. by about 4 to 5 weeks. So I was just wondering if there was -- we should be thinking about any impact on your business within India. And then I might have one other follow-up as well."
},
{
"speaker": "Patrick Gallagher",
"text": "Yes. I'll take that. I think I just couldn't be more pleased with our capabilities. Those folks have trained and planned and had actually done exercises of working from home. We knew that if any of those locations went down, we could move that work to their home with their laptops. We have not seen any delimitation at all in the service provided by our service centers. And remember, our service centers are now in India, small in the Philippines and also in Las Vegas in the United States. And those service centers have continued to provide absolutely impactable service for the last two months, not even a noticeable change. And while it's difficult for many of them as well to be at home, we don't see that changing at all in the future."
},
{
"speaker": "Douglas Howell",
"text": "Yes. It's really been a remarkable, Elyse. They -- since day 1, they are trained and they rehearse to do all their work from home. We're a paperless environment there, the laptops come home with them every day. We have -- you get some brownouts there from time to time, where you have a little problem with electrical grid. So we've got experience with them being at home. Internet connectivity is required for them in order to have a job at as a home Internet connectivity. So I'm really impressed with the sturdiness of that operation that hasn't missed a beat."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. That's great. And then last question. In terms of the expense saves, is there -- can you give us a sense of just by geography, if they might be more pronounced in the U.S., the U.K., obviously, Australia, New Zealand or even within India? How do you think about the geographic base of the expense save?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. I can probably dig that out for you here if I get to the right piece of paper. I'm a little short on it. But I don't see it disproportionately in any 1 location versus the other. So obviously, I would say it's proportional to our revenues by geography. But I'll look at it here if you have another question, but I'll take a look at it as I dug this out."
},
{
"speaker": "Elyse Greenspan",
"text": "Well, that was maybe the last."
},
{
"speaker": "Douglas Howell",
"text": "I got it here. I don't see it as being disproportionately different by country or by division, other than the Gallagher Bassett matter that we talked about."
},
{
"speaker": "Patrick Gallagher",
"text": "I think that's probably it for questions. Why don't I just make a quick comment here, we'll wrap it up. Again, thanks for joining us this afternoon. We really appreciate you being here. As you can see from our comments, our focus is clearly now on the difficult, evolving operating environment. I'm confident that we have the right platform, people and strategy to manage through the current environment for the benefit of all of our stakeholders, our employees, our clients, our carrier partners and our shareholders. Thanks for being with us, and thanks to all of our teammates for delivering a great quarter again. Stay healthy, everybody."
},
{
"speaker": "Operator",
"text": "This does conclude today's conference call. You may disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 4 | 2,021 | 2022-01-27 17:15:00 | Operator: Good afternoon and welcome to Arthur J. Gallagher & Company's Fourth Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q, and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you. Good afternoon. Thank you for joining us for our fourth quarter 2021 earnings call. On the call with me today is Doug Howell, our CFO as well as the heads of our operating divisions. We had an outstanding fourth quarter. For our combined brokerage and risk management segments, we posted 18% growth in revenue, 11% organic growth, net earnings growth of 11% adjusted EBITDAC growth of 17% and we completed 18 new tuck-in mergers in the quarter. That's on top of closing our Willis Re merger. Our total for the year, our merger strategy added more than $1 billion of annualized revenue. That's just fantastic. Needless to say, I'm extremely proud of how the team performed during the fourth quarter and the full year. So let me give you some more detail on our outstanding fourth quarter performance starting with the brokerage segment. During the quarter reported revenue growth was an excellent 19% of that 10.6 was organic, another sequential step up from the third quarter and the fourth consecutive quarter of improvement. Net earnings growth was 8% adjusted EBITDAC growth was 17%. And we expanded our adjusted EBITDAC margin by 13 basis points in line with our December IRD expectations. Remember, that's lower because of the natural seasonality of the reinsurance acquisition, margins would have expanded nearly 90 basis points. So another great quarter for the brokerage team. Let me walk you around the world and break down the 10.6% organic, starting with our PC operations. First, a domestic retail business posted 13% of organic, driven by excellent new business, higher exposures and continued rate increases. Risk placement services, our domestic wholesale operations posted organic of 15%. This includes more than 30% organic in open brokerage, and 5% organic in our MGA programs and binding businesses. New business was better than 2020 levels and near double-digit renewal premium increases helped to. Outside the U.S., our U.K. business posted organic of 12% specialty including our existing Gallagher Re business was up in the high teens and retail is up 7% Both fueled by new business and retention in excess of 2020 levels. Australia, New Zealand combined, organic was more than 8% also benefiting from good new business and improved retention. And finally, Canada was up more than 13% organically and continues to benefit from strong new business trends, stable retention and renewal premium increases. Moving to our employee benefit brokerage and consulting business. Fourth quarter organic was up about 7% a couple of points better than our December IRD expectation. We saw some nice sequential improvement over the course of 2021 up from the 2% organic we delivered in the first quarter, thanks to a rebound in global economy, declining U.S. unemployment and increased demand for our consulting services as businesses look to grow. Next I'd like to make a few comments on the PC market. Overall, global fourth quarter renewal premium increases were above 8% broadly consistent with the increases we saw during the first three quarters of '21. Moving around the world renewal premium change which includes both rates and exposure, up about 8.5% in U.S. retail including a 13% increase in professional liability, 8% in property and casualty and 4% in workers comp. In Canada, Australia, New Zealand and the U.K., retail renewal premiums up between 7% and 9%, mostly driven by increases in professional liability and property. Within RPS, wholesale open brokerage premium increases were up 13% and binding operations were up six. Shifting to reinsurance, January 1 renewal showed price increases that vary by geography and client loss experience, loss free programs saw rates flattish to up 10%. While loss impacted accounts and cat exposed property business experienced rate increases that were in many cases double that. So rate tended to be based on client's specific attributes and loss history. And I consider that to be a healthy outcome. So whether retail, wholesale or reinsurance premiums are still increasing almost everywhere. Looking forward, I see a difficult PC market conditions continuing throughout 2022. That's because our risk bearing partners remain cautious on rising loss costs. So property coverages replacement cost inflation and the increased frequency and severity of catastrophe losses are causing underwriters to rethink rate adequacy. On the casualty side, social inflation, low investment returns and the potential for increases in claim frequency as global economies further recover are all potential negative drivers of future underwriting profitability. And on top of higher loss costs and lower investment insurance, reinsurance costs are also increasing. So I think carriers will continue to push for rate and don't see a dramatic change in the near term. We shine in this type of environment by helping our clients find appropriate coverage while mitigating price increases throughout creativity, expertise and market relationships. I'm equally as upbeat on our employee benefit consulting and brokerage business. As you know the first quarter seasonally our largest employee benefits quarter and is looking like the team had a strong annual enrollment season. Early indications are pointing to an increase in new client wins over prior year, consistent client retention and a slight increase in covered lives. With improved business activity and increased demand for goods and services businesses are trying to grow their workforce. But the labor market remains extremely tight with more than 10.5 million job openings domestically and 6.3 million people unemployed and looking for work. This lays the groundwork for robust demand for our consulting services in 2022 as employers look to attract, retain and motivate their workforce. So we finished '21 with full year organic of 8%. That's really nice improvement from the 3.2% organic we reported in '20 and above pre-pandemic 2019 organic of 5.8%. And as we sit here today, we think '22 organic will end up in a very similar range to '21 and there is a case that it ends up even better. Let me move on to mergers and acquisitions. It was great work by the team to close the reinsurance acquisition in early December. Integration is well under way and progressing at a good pace. Remember, we are a seasoned integrator. On the revenue side, much like our tuck-in acquisitions, we've mobilized our local teams from retail, wholesale and even Gallagher Bassett to partner with our new colleagues and generate new revenue opportunities. I'm also very pleased that our combined Gallagher Re team hit the ground running and had a strong finish to the year. Financially, the acquisition added about 20 million of revenue in December and as expected generated a small EBITDAC loss due to seasonality. More importantly, I'm already seeing examples of cross division cooperation and collaboration. So our new reinsurance colleagues are quickly embracing our Better Together Gallagher culture. Outside of reinsurance, we completed 18 tuck-in brokerage mergers during the quarter, representing about $65 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have around 35 term sheets signed are being prepared representing over $200 million of annualized revenues. We know all these will not close however, we believe we'll get our fair share. Next, I'd like to move to our risk management segment Gallagher Bassett. Fourth quarter organic was 13.1% a bit better than our December IRD expectation, margins approached 19% in the quarter, leading to full year adjusted EBITDAC margin of 19.1%. Another great quarter and full year for that matter from the team. We saw more new arising claims within General Liability and Property and to a lesser extent co-workers compensation during the quarter. New COVID related workers comp claims were similar to the third quarter dated slightly by the late year surge in cases from Omicron variant. Regardless of the short-term variability of new rising claim activity, we feel really good about the business. Looking forward continued strong retention, combined with new client wins in the fourth quarter should drive '22 organic into the high single digit range. So it was another fantastic year for our franchise and I'm extremely proud of our team and our collective accomplishments. Together, we produced 8.6% organic growth in our combined brokerage and risk management segments, completed 38 mergers with more than $1 billion of estimated annualized revenue, more than 110 basis points of adjusted EBITDAC margin expansion. And we were recognized as one of the world's most ethical companies for the 10th year in a row by the Ethisphere Institute and all this in the face of a pandemic. What a fantastic year, more than ever, our success is due to our bedrock culture. Our culture helps us deliver better results, better results for all of our stakeholders, including our customers, our colleagues, our underwriting partners, and of course, our shareholders. Every day, all of our teammates get up and work diligently to maintain our culture, to promote our culture and to live our culture. That truly is the Gallagher way. Okay, I'll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks, Pat. And hello, everyone. As Pat said a terrific quarter to close out in an outstanding year. Today, I'll start with our earnings release and touch on organic margins and our corporate segment shortcut table. Then I'll move to our CFO commentary document where there I'll talk a little bit about how we're now providing our their typical modeling helpers for '22, add some commentary in the Willis Re acquisition and our latest thinking on clean energy. I'll then finish up with my comments on cash liquidity and capital management. Okay, let's flip the page for the earnings release to the brokerage segment, organic table. All in brokerage organic was 10.6% a nice step up from the 9% we posted last. And the six plus percent we posted in the first half of '21 leading to full year organic of 8%. Looking forward as Pat said, we see full year '22 similar to '21 or even better. Now turn to page six for the brokerage segment adjusted EBITDAC margin table. Headline all in adjusted margin expansion for fourth quarter was 13 basis points right in line with our December IRD expectation. But recall that expansion has the adverse seasonal impact of closing Willis Re on December 1. Without that, adjusted margins would have expanded 88 basis points also right in line with the forecast we provided in December. For full year adjusted margin expansion was 123 basis points. Excluding Willis Re, it was up 142 basis points. And it's important not to forget, that's on top of 420 basis points of adjusted margin expansion in '20 and 75 basis points in '19. That's absolutely incredible execution before during and as we emerge from the pandemic. Moving on from '21. Looking forward, as the pandemic limitations continue to ease in '22, we will naturally see some costs returning in areas such as travel, entertainment and perhaps some other office consumables. Incremental full year '22 costs from these three areas could be as much as 25 million. But even then, our full year spend on these categories would be below pre-pandemic levels, showing that we're holding safe. Also, we're back to making targeted investments to drive long-term growth. In '22, we're planning for increases in marketing, advertising, consulting, professional fees and certain IT investments. These costs combined with higher insurance premiums say for E&O, D&O and work comp would total around 35 million. So like we said in our December IR Day, we should be able to absorb those costs and hold margins if we post around 7% organic. And if organic is over 7% even show some margin expansion. Then by 2023, we could be back to that pre-pandemic view that margin expansion might occur at a 4% or so organic level. And to be clear, all of these comments are before the impact of the acquisition of Willis Re. On a pro forma basis, those margins can run a bit higher. So math would say would naturally provide some lift to our consolidated brokerage segment margins in '22. A couple of things to keep in mind as you build your quarterly models for our brokerage segment in 2022. First consider seasonality, due to our benefits business, and now our larger reinsurance business, first quarter seasonality, our first quarter is our largest revenue in EBITDAC of the quarter of the year. And second perhaps slightly more nuanced, since we're not seeing price and or exposure increases in benefits and workers comp to the extent we are in other areas of PNC insurance. First quarter organic might be a point or so below your full year pick simply due to the mix. So the math would then suggest their second, third and fourth quarters could post over your full year organic pick. Again, that's just a nuance to help you with your quarterly model. Moving on to the risk management segment and the organic table at the bottom of Page Six, you'll see 13.1% organic in the fourth quarter and full year organic in excess of 12%. What a great rebound from the depths of the pandemic. And as Pat said, it's looking like revenue momentum continues into '22 with full year organic revenue growth in the high single digits, which is really terrific given '22 will naturally have more difficult compares than '21. Moving to the risk management segment EBITDAC table on page seven. Adjusted EBITDAC margin of 18.6% in the quarter and more than 19% for the full year, a fantastic result. And just like our brokerage segment, a nice step up from pre-pandemic levels of 17.5%. Again, that demonstrates our ability to maintain a portion of our pandemic period savings even as we make some further investment in technology investments. Looking forward, as you heard on our December IR Day, we will continue to make investments in analytics and tools to enhance the client experience and drive better claim outcomes. But even with those holding margins close to that 19% is achievable for full year ‘22. All right, let's turn to page eight to the corporate segment table. In total, adjusted results $0.02 better than the midpoint of our December IR Day forecast, mostly as a result of strong clean energy earnings. We did have a couple of notable adjustments this quarter. First Willis Re transaction related costs, as discussed in footnote two were 22 million after tax. And second, as discussed in footnote three and similar to third quarter, we had non-cash, deferred tax adjustments related to international M&A earnouts, which is the most of it as well as some other small tax and legal settlement items together about 19 million after tax. Now let's shift to our CFO commentary document we post on our website starting with page three. As for fourth quarter, you'll see most of the brokerage and risk management items are close to our December IR Day estimates. Also on that page, we are now providing our first look at items related to the brokerage and risk management segment. A couple lines we're highlighting, first FX, the late '21 and early '22 weakening of the U.S. dollar against our major currencies is creating about a $0.04 headwind to EPS next year. Second integration costs. You'll read in footnote one, the integration estimates provided here only reflect expense associated with Willis Re. As Pat mentioned, integration is well underway and we are still comfortable with our ultimate pack of about $250 million of total costs for integration. All right, let's turn to page five of the CFO commentary, the page addressing clean energy. The purpose of this page is to highlight we are transitioning from over a decade of showing GAAP earnings to a six-day period where we harvest cash flows. You'll see in the blue column that we reported '21 GAAP earnings of 97.4 million, a really nice step up, up 39% over '20 and we generated 40 million of net after tax cash flow. So also a nice step up from '20. But the real headline story here is in the pinkish column. Cash flows take a significant step up in '22, looks like we'll be harvesting $125 million to $150 million a year of cash flows and perhaps even more in '23 and beyond. Now there is still a possibility of an extension in the law and we're well positioned to restart production if that happens, but if not, we have over a billion dollars of credit carryovers. If we use say $150 million a year that's a seven year cash flow sweetener. Flipping to page six in the rollover revenue table. The reinsurance acquisition is off to a solid start and we are encouraged with both its December results and early indications from the 1-1 renewal season. So it's looking like our pro forma revenue and EBITDAC of 745 million and 265 million respectively, are holding up nicely. So the reinsurance acquisition is off to a terrific start. All right, as for the cash and capital management future M&A. At December 31, available cash on hand is about 300 million with strong operating cash flows expected in '22. And potentially a nice pumping cash flow from our clean energy investments, we are extremely well positioned to fund future tuck-in M&A using cash and debt. Over the next two years, we could do over $4 billion of M&A without using any stock. You also see that our Board of Directors announced a $0.03 per share increase to our quarterly dividend, that would imply an annual payout of $2.04 per share. That's a 6.3% increase over 2021. Finally, one calendar item, we are planning on our regular mid quarter IR Day from 8 am to 10 am, Central Time on March 16. Again, that will most likely be virtual. During that we will allocate some time to socialize our planned migration to reporting adjusted GAAP EPS results excluding the impact of non-cash intangible asset amortization. We'll discuss the detail of all the adjustments including representing historical results on the new basis. Okay, that's it. From my vantage point, as CFO we are extremely well positioned for another great year here in '22. Before I turn it back over to you, Pat, I'd like to thank the entire Gallagher team for a terrific quarter and fantastic year. Pat?
J. Patrick Gallagher: Thanks, Doug. Operator, let's go to questions and answers please.
Operator: Thank you. The call is now open for questions. Our first question is from Mike Zaremski of Wolfe research.
Charlie Lederer: Hey, guys, this is actually Charlie on for Mike. So organic growth in the back half of the year has been outstanding and has been accelerating. But pricing while positive seems to be decelerating and GDP is decelerating as well. Can you provide some color on what makes you comfortable with guiding us to organic growth at almost two times your historical level?
J. Patrick Gallagher: We think that the rates are going to hold. It's just that simple. market falls out. They won't, market holds the way it is, it will. I'd see all kinds of reasons for it to continue, as laid out in my prepared remarks. But beyond that, you've got a situation where underwriters are not backing off from their need for rate. We're seeing that every single day. We're into the renewals, obviously now deep into the first quarter. And we're not seeing rate relief in any way, shape or form along the lines of what I talked about in my remarks.
Doug Howell: I still think there's a lot of pent-up exposure unit growth that still to come. We think there's inflation sitting there. We think that there's a need for our benefit consulting advice, more and more. We think that wholesaling markets are becoming tough and harder to find placements. We think there are more accelerators when it comes to that then there are maybe a slight, 0.5 point pullback in what the underwriters are asking for in re that far overshadows it.
Charlie Lederer: Got it. That's great color. And then, on M&A. I guess there's -- I know you said the integration is going well. Does the reinsurance transaction have any impact on M&A decisions this year? Or is there any chance you don't spend your entire free cash flow because of it?
J. Patrick Gallagher: Of course, I said we think we have 4 billion to spend over the next couple of years. I think that's almost 2 billion next year and a little over 2 billion in the final year. So we have plenty of free cash to fund acquisition our pipeline. It does get a little slower in the first quarter. There's people that push more to have something done by year end and we have that happen every year. But we're pretty excited about what we're seeing in our pipeline right now.
Operator: Our next question is coming from Greg Peters of Raymond James.
Greg Peters: I know I can't do it Doug, but I'm wondering if you can say pre-pandemic 10 times really fast.
J. Patrick Gallagher: Pre-pandemic, Pre-pandemic.
Doug Howell: Obviously, I don’t know. I couldn’t.
Greg Peters: I'm just teasing. So let's see, I had a question about the M&A. And I was looking in the CFO commentary on page three. And of course, Pat, you always give us a view on term sheets, outstanding, et cetera. So, two-part question. When you give us term sheet numbers, the number of term -- sheets that are out there, and then ultimately, to close, can you talk about how that ratio, the close rate has changed over the last two or three years? And then, secondly, on page three of the supplement Doug, you drop in, you give us the quarterly weighted average multiple of EBITDAC tuck-in. And it's definitely trending up. So I'm just curious about your views there.
J. Patrick Gallagher: Yes, great. Let me take the first part of your question. When we get to an actual term sheet, we're usually moving down, especially in our tuck-ins, we're usually moving down a path where we're going to do a deal. And one of the things about our reputation is that we will close. Having said that, over the last two to three years, there's considerably more competition, you can take a $5 million deal today and if it's going to get spreadsheet, there'll be a dozen, really thinking of a dozen bids. So we are really trying hard to make sure that all of our new partners are excited about what the future provides being part of Gallagher, which quite honestly, we think is substantially better and more exciting than our private equity competitors. But that doesn't diminish the fact that they're good competitors and they're smart people. And they're well funded. So I don't have a number for you specifically, I can't say, oh, yeah, we closed 32% of the ones that we finally get to. We don't keep the records that way. I don't do that. But anecdotally, I'll tell you that we should close more than half of the ones that we get to we have a signed term sheet, while I will take it back, we should close 90% of the ones where we have a signed term sheet, 10% will slip out of the net. And where we're preparing term sheets, we should close about half of those.
Doug Howell: In terms of the multiple Greg. Yes, the multiples ticked up a little bit, not as much as what our multiple has. So there's still a terrific arbitrage there. But also, you have to realize the growth rates that drive those multiples have gone up quite a bit, too. So I think there's justification for higher multiples. But we're still buying in that eight to 10 range when it comes to tuck-in acquisition. It's a pretty good run rate versus our trading multiple of 15, 16, 17.
Greg Peters: Got it out. I guess, a follow up question. It's been a rough start to the year for the market. And for the insurance brokerage stocks and your stock too is traded off a little bit. And it feels like at times, some are speculating that the best for their brokerage space is in the rearview mirror. Yet, the rhetoric from you, Marsh and Brown & Brown are directly polar opposite, it seem to map out a pretty optimistic future. So I guess I'm just trying to gauge what your perspective is on the market, considering that the stock market certainly doesn't seem to appreciate what you guys are doing at this moment in time.
J. Patrick Gallagher: Well, Greg, this is Pat. Normally for 20 years, and there's never been a time in that period where I've been as bullish as I am today. I mean, everything, everything is going our way. So let me try not to spend 20 minutes answering your question here. But let's start with the fact that we've never been stronger. Vertical capabilities are absolutely critical. Data and analytics are absolutely critical. When you take a look at the volumes that we now have that we can do the data and analytics around we can tell you what's happening by day with rates and renewals or what have you. 10 years ago, we flew blind totally on that customer asked why do I have even know I've got a good deal with the rate environment going like it is. We can show them what's happening to the rates by line, by geography and why they have a good deal. And that type of question is getting asked right into the middle market. And over 90% of the time when we compete, we compete with a smaller competitor. That's why these people are selling to private equity. That's why these roll ups are working. And I'm telling you it's unbelievable the opportunity we have right now. So I see this is the greatest buying opportunity in the last five years.
Greg Peters: Yes. Just in your answer. And it was part of your comments, you talked about the difficult risk bearing market and driving further rate. And listen, I, you're looking at a global picture, so but I look at reported results, Travelers was out with an 88% combined ratio, Berkeley just came out with an 88% combined ratio tonight. It seems like the risk bearers are -- the results are beginning to improve. And so I guess it lends the question, what are we missing when you say it's difficult risk bearing market?
J. Patrick Gallagher: Well, let's start with inflation. You've done all your actuarial work at a 2% inflation rate. And now it's six. Oh, yeah, that was a blip on the radar, was going to be gone by now. I guess that's not going to happen. Secondly, let's look at last costs. What does it cost to build a house today? Well, we got it done for $200 a square foot a few years ago, certainly isn't that now. And I could go on and on and on. I mean, the level of nuclear, the number of nuclear settlements. The other thing too is, I've been saying this now for years, I think it's more true than ever. Our underwriters or our underwriting partners are very, very smart. And they've got incredible data and analytic skills. They know where they're making money in that 88% everywhere around the world every day and they know where they're not making money. And you walk in and start talking about a deal that you want to broker, it's something that's going to be substantially less than they know, they'll get or deserve. They're just not buying it.
Doug Howell: I think, Greg, there's also some things, x cat, x reserve releases, I think, and then the prospect of just inflation just have a reserve be coming in, let's say just 10% more than what the original estimate was. That's a huge difference on a combined ratio. So I think that the -- I'm not challenging the health of the insurance companies. I think they've got their rates where they think they need them right now. I don't know if there's a case that would say that they're too high. I think the case wouldn't be say more so that they're too low. And I just don't see when the courts open up, you're going to see more unfortunately losses that are just the current picks, while the best information they have right now are just too low. So I think there's not a case for cutting rates by any means. There's a case for continued increase in rates. And I just -- everything that we look at . There'll be interesting when other books get filed.
J. Patrick Gallagher: This is not a hard market is, it was in the middle 80s where everything goes up, you know that work comp was flat, through most of this adjustment work comp is now up. As work comp comes up a little bit professional liability is going through the roof. Cyber is almost unbreakable. So you sit there and you look at this. These carriers are looking line by line, geography by geography and from our perspective, daily placing accounts, we are not seeing them lose discipline.
Greg Peters: Got it. Thanks for the answers. And congratulations on the quarter and the year.
Operator: Our next question comes from Yaron Kinar of Jefferies.
Yaron Kinar: So my first question in the earnings release, there's comment that if the pace of economic recovery accelerates beyond your expectations, you could see expenses increase more than the current estimate. I just want to confirm or pick up that a little bit. Expenses may rise in that situation but wouldn't organic revenue also accelerate in that case? Essentially, what I'm trying to get at, margins don't get compressed with that, right?
Doug Howell: But that's not a margin comment. That's just comment.
Yaron Kinar: Okay. And I guess all else equal, if the economy does accelerate beyond your expectations, margins, would margins actually come in better than expected?
J. Patrick Gallagher: What we say that -- listen we think that there's a case that we can do better next year on organic than we have. We did this year if the economy accelerates exposure units grow the pent-up demand for goods and services increase, supply chains, get back to normal. Yes, your implication that question is right.
Yaron Kinar: Okay. And then in the CFO commentary, page three together, comment there on full year margins and brokerage being approximately 34%.? They were at 34% in '21, right at 33.9. So there should still be some upside to that. Is that just a rounding issue?
Doug Howell: All right, thanks. First of all, said 34 is pretty darn good. I mean, when you look across the brokerage space, we're pretty proud of that margin and I have ever been here 18 plus years, it wasn't that way that that long ago. So you got to be pretty proud of that number compared to the industry. Second of all, yes, 34%. The reason why we don't round it even more is because we don't have a crystal ball. We also have FX adjustments that will come true. Yes, we could change that number slightly as with our international business over the next year. But what we're saying right there, just like we said in the commentary at 7%, we've got a decent chance of holding those margins we really think we do. At 8%, we could see a little bit more, over 8%, maybe a little more than that. So I wouldn't read a rounded 34% with all those factors as being an indicator that we're pegging exactly 33.9 like we have this year, but 34 is greater than 33.9. And then, when you roll in the reinsurance operations, you could get a little bit more left than that. So I would say would not read too terribly much into it.
Yaron Kinar: Okay, good. I'm glad that's confirmed. Finally, any update on Willis Re, the revenues and margin? I think the initial guidance you offered for '22 was still based on the 2020 numbers kind of used as a placeholder.
J. Patrick Gallagher: Yes. We feel really good about the team. We're onboard just over a little bit over a month, almost two months now. And as we said in our prepared remarks, the team's coming together extremely well. With a good strong January 1, and we brought $745 million of revenue and 265 million of EBITDAC, and that's still looking good.
Operator: Our next question comes from David Motemaden of Evercore ISI.
David Motemaden: Just a question on the brokerage organic in 2021 that 8%, wondering if you could just walk through the different drivers behind that in terms of exposure pricing, net new business, how much those contributed to that 8%. And how you see those elements shaping up in the 2022 outlook.
Doug Howell: Okay. So first of all, let's break that down. There's the components of new lost opt-in, when customers opt-in for more coverages opt out when customers opt out because they want to control their budget for insurance spends and you got the impact of rate. So the fact is, is that we believe we're -- if you break that 8% down, let's just say that a third of it comes because we're just selling more business and we have before versus what we're losing. I think there's probably a third of that number that's coming from exposure, and a third of its coming from rate. So you've kind of got all three of them there. What's interesting on a multi-year impact is that customers can opt -- come up with -- we can help our customers come up with creative ways to mitigate the rate increases as their exposures grow, which we see is happening more and more over the next couple of years. It's harder to opt out of exposures. If you had 20 trucks and now you got to insure 22 of them. You can't just not insure two trucks. If you have a 20% increase in premiums, maybe you take a higher deductible, or you take less limits on it, and you can kind of opt out of the rate increases. But as we see exposure units fueling that organic growth going forward, top that off with rate increases that mix of -- I think would toggle probably more to exposure, more than net new wins and maybe less impact from rate as we continue to grow. As you push 10% of organic growth, it's going to be exposure unit driven.
David Motemaden: Awesome, that's great color. Thanks for that. And I guess maybe just also Doug, you mentioned the cadence, maybe the first quarter being a little light. I don't want to get too granular here. It's a long year, but it sounded like that was really driven by employee benefits and workers comp and just seasonality there. But when I think about the 7% organic in employee benefits that seems pretty strong, definitely better than it was in December. Are you expecting a deceleration off of that up seven? And that's partially why maybe the first quarter would be a little bit lower than the full year? Or is it more workers comp driven?
Doug Howell: Actually 7, if you pick, I'm just saying you have to make the pick. If you're picking 8%, next year 7, and I said it's about a point lower in the first quarter, that 7% is probably the number that you get to. If you pick 6%, I don't think that it would have that big of an impact on you. So what I said in my comments was about a point lower than the full year average. So that's what I would say it's just cautioning that business. doesn't grow as fast as our PNC right now.
David Motemaden: Okay. That makes sense. And then if I could just sneak one more in, on the 4 billion of dry powder for M&A guys have over the next two years. Without issuing stock, that's a lot. It's a lot for tuck-ins. You mentioned earlier competition is also increasing. I guess I'm wondering if at some point, you would consider allocating some to capital return through share repurchases? Is that something that's come up at all, something that you think you might institute over the next year or two?
J. Patrick Gallagher: Absolutely, that's something if we have excess capital, we'll want to make sure that we maintain our solid investment grade rating, right? Absolutely, look at share repurchases and dividends.
Operator: Our next question is from Elyse Greenspan of Wells Fargo.
Elyse Greenspan: My first question is related to clean energy. So Doug, I think you said that there's a chance that the laws could be extended, I just wanted to get a sense of the timing you thought there. And then, I thought in the past you guys had perhaps implied if you continue to be able to generate credits, you would not go the route of rolling out some kind of x amortization EPS. So are these now independent events. So meaning if you're able to generate more credits on the clean energy investments, you will still roll out some EPS estimate that is cash in nature and backs out intangibles, among other items.
Doug Howell: I don't see us backing off of going towards that metric, regardless of what happens with an extension or not. So an answer to your question, we're going that route. We've done a lot of work on it. We think it's consistent with what other brokers are doing. And so we're pretty comfortable with going that route. What happens with an extension? I think it's going to be in the spring, we think that Congress has woken up to the fact that this technology provides a terrific benefit to our environment. So we hope that they see their way cleared, finding a spot and a bill to include it.
Elyse Greenspan: So if that does happen from a cash from a credit generating perspective and you would perhaps be unchecked, generate credits at a cadence that you were generating them at in 2021, just depending upon when you can get back on track with that?
Doug Howell: You kind of broke up a little bit on that question. Can you just say it again, Elyse, sorry?
Elyse Greenspan: I was saying if you are able to regenerate credits from your clean energy investments this year, would you expect it to be at the same cadence that we saw in 2021?
Doug Howell: Yes, I think so. I listen, we posted $97 million of after tax earnings on it. The pick would be 80 million more not 40, not 50. But there will be some plants that won't start up. They were planned to be decommissioned, made a whole location as being decommissioned. So I wouldn't see it as being as high as it was in. We had a terrific year, one of our best years ever and I just don't see that happening again, if it restarts. And clearly you'd have from the restart date to but if we don't get a -- if it's retroactive, these have been idled. They're sitting there. It's not like we can go back and produce credits in January, February and March but doesn't get passed until April.
Elyse Greenspan: Okay. And then, with Willis Re in the M&A sheet, I saw that you guys put it in with the Q4 bucket. So I'm assuming based on the commentary is the embedded revenue from Willis Re just at that 745. And then if there's growth off of that, that would be additive to the M&A build. And then I'm assuming on a go forward basis, you'll just give us the revenue from Willis Re just on your quarterly calls like you did today?
Doug Howell: Yes. I think let's make sure I can restate and go to page six of the CFO commentary we provided a grid that shows the fourth quarter acquisition activity. I would I understand your question there, how much of that line adds up and then subtract up to 745. And the 745 is in that line, including what other acquisitions we did during the fourth quarter for the vast majority of it. I'd have to do that add up while we're on the phone here.
Elyse Greenspan: No, that's fine. That's helpful. And then one last one on margin.
Doug Howell: Let me restate that. We have a separate line for the reinsurance acquisition. I just didn't have my glasses on here. So we have other fourth quarter acquisitions in the line above it. So take a look at that.
Elyse Greenspan: Okay, sorry. Thank you. And then the margin guide that you could see some expansion above 7%. I guess that was unchanged from December, right? So, we should expect if you're going to get to around 8% or so organic this coming year in brokerage, we should expect a modest level of margin expansion, correct, let me take all of your expense commentary throughout the call into account?
Doug Howell: Yes, that would be what you would assume.
Operator: Our next question is from Greg Peters of Raymond James.
Greg Peters: Great, thanks for allowing me to ask a follow up. I wanted to spend a minute and ask about your supplement and contingent line in the brokerage business. If the profitability of the carriers starts to improve, when we expect supplements and contingents to also grow maybe a little bit faster than just the base organic that you're expecting, or maybe more broadly, just one of the drivers of growth in supplements are contingents outside of acquisitions?
J. Patrick Gallagher: The answer to your question is yes. And the driver is very simple, profitability on contingents, and revenue growth, premium growth on supplementals. And both of those should be impacted nicely by inflation, growing premiums and profitability.
Doug Howell: And then, also they added value that we bring through our smart market through our advantage products, where we really can help match our customers need to the carrier's appetite for risk. We're getting continued momentum on that, Greg, you've been around a lot. And so it's -- we're continuing to add value in the relationship with our carriers. And they recognize it. So your statement, there is right. It should continue to grow as business becomes more positive, should all benefit from that.
Greg Peters: I remember and this is dating me, but I remember when you started smart market. So I guess you since you brought it up, can you give us an update of how that business looks today versus where it was a year ago or two years ago? Whether it's in terms of number of clients, the amount of premium that it's accounting for or whatever metrics you're using?
J. Patrick Gallagher: Well, first of all, yeah, I can do that, Greg. The proof has been in the pudding with smart market. You were there when we started it. And to be perfectly blunt, there was some skepticism for all kinds of reasons around whether or not data and analytics being sold to insurance companies was really worth it. Okay, that question has been answered. It's very well accepted. It's now being utilized in RPS been utilized across our Gallagher global brokerage operation, including locations outside the United States, Canada, and U.K., et cetera. So it's getting very broad recepients across more than probably 15 to 20 carriers today.
Doug Howell: Yes. Think about when we think back to our IR days that we talked about. Here we speak not mostly about our -- initially about our U.S. business and the things that we've done in our U.S. business and in terms of carrier relations in terms of our core 360 platform, our use of offshore centers of excellence. And then, how we're bringing that to Canada, Australia, New Zealand, the U.K. retail, now into some of the other retail locations as we take minority positions perhaps in Europe. This is an example of how a seed planted and developed here in the U.S. can be spread around the world and vice versa. There are techniques around the world that we bring back to the U.S. So, Greg, you're right at the , yes, this is something we're proving out and rolling out around the world. And that's why when we talk about retail around the world, it all looks the same with different nuances by country.
J. Patrick Gallagher: And it's been very, very good for our people to tie closer to the insurance companies and we're generating about $25 million of income from that. So it's been a win-win for everybody.
Greg Peters: Great, thank you. Thanks for the color there. I guess the last question I would have, Doug, I've used your quote before about in reference to margins. I think you previously had said on a conference call, well, trees don't grow to the moon. So you guys have a 34% in on rounding up, EBITDAC margin in your brokerage business. When do we begin to top out? I mean, everyone's reporting margin expansion, at some point, you're going to -- you would think that there might be some downward pressure on fees or commissions or something that might cause some downward pressure on margins?
Doug Howell: Well, I think there's a difference between non-discretionary margin expansion and discretionary margin contraction. I think that scale has its advantages, there are limits to scale and all the product of organic, I think, just would be very happy if we can somehow post 9% organic growth for the rest of our lives and have just incremental margins. And that's a pretty good story.
J. Patrick Gallagher: Right. It's just it's not about talking margin strategy, acquisition strategy. You are right. They don't grow to the moon and more importantly, what does the client demands from us that require us to continue to make investments. It's not there and 100% yet, but clients are becoming more demanding. And in order for us to compete in post that stellar organic growth, we need to make investments in the business. So I don't have an answer for you. But when we do, we will announce.
Greg Peters: Well, I like the idea of putting 9% organic and margin expansion in my model for the next five years, so go get them Tiger.
Operator: Our next question is from Mark Hughes of Truist.
Mark Hughes: Yes, thank you. Good afternoon. Quick question in the risk management business, what's your latest view on kind of broader outsourcing trends among the major PNC players, the potential shifts to using third parties like your risk management operation to do that in a more comprehensive way, just a quick update would be interesting. Thank you.
J. Patrick Gallagher: Well, thanks for the question, Mark. This is Pat. I think you're going to see a continued move in that direction. It's been going on now for almost a decade. I don't think it's any secret that we've been at the forefront of that. Starting literally before the Chubb ACE combination, we were doing work on behalf of Chubb and their risk management portfolio. Prior to that, in fact, we were doing all the outsourced service for Arch as they began their program of growth in the United States. And right now, the outsourced work that we do for insurance companies is a very big part of Gallagher Bassets revenues. And I would say it's probably our largest opportunity, looking at the future over the next five to 10 years. There are some very substantial companies, I can’t name them, you understand that. That are seriously looking at this. And quite honestly, it makes a heck of a lot of sense. We've got trading partners that when I mentioned to them that Gallagher Bassett pays more claims than you do. And again, I can't mention names. They go, no, you don't. I actually we do. And I'll bet you we invest twice as much in data and analytics. And then, in our Willis systems than you do, no you don’t. Well, we will actually stand toe to toe with you and show you that. But that ends up driving is the ability we believe to prove that our outcomes are superior. And those superior outcomes come from all kinds of advantages. Both of scale but also have expertise. And once you start talking to management at these insurance companies about the fact that you've got pent-up return on investment, you've got ROE opportunities and we can do that. I honestly believe that there will come a day when people ask why did insurance companies pay their own claims?
Operator: Our final question comes from Derek Han of KBW.
Derek Han: Your comp ratio is quite good in the quarter, which kind of been a threat from some of the actions you've taken in 2020. But I was hoping that you could kind of talk about how wage inflation is impacting that number. And just curious if you know, the impact is more pronounced among producers that you're trying to hire versus the support staff?
J. Patrick Gallagher: Well, one of the things I'm very proud of Derek is, we are one of the -- we're probably the only significant broker that still is very comfortable paying our producers on a formula that pays them a percentage of their book. And that's very competitive with the local brokerage community. So think about it this way. Where do you want to sell from what platform, a platform that gives you the kind of data and analytics that we've got that has the relationships that we've got, that has the global reach that we've got? Or what would you like to do it from the Jones agency in Alsip, Illinois, hope there isn't one there. But the fact is, we're happy to have you come aboard and pay you a percentage. So really, a big part of our benefits and comp expense for producers is self-generated and self-regulated.
Doug Howell: And our middle office layer and our back office layer, as you know, we've made substantial investments in standardizing our process and using our offshore centers of excellence. As a result of that, 17 years ago, we made a decision that we could raise our quality and reduce our costs. And it's actually helping us a little bit of an inflation hedge. I'll tell you, we've been taking care of our employees. We gave a sizable raise pool this year. We gave raises even in the depths of the pandemic. Bonuses, we've been fair, these people have earned them, they've earned their raises. The raises are not as a result of -- because of we feel like we've got to hold our people, our culture holds our people. The raise is what recognize their contribution to what we've been doing. So Deming said the best is you can't have low cost without high quality. And we've worked for years on raising our quality and it's reducing our costs. It's also making our folks more effective. We have 20,000 people that do service plus another 6000 in India that get up every day and want to do a great job for our clients. So we pay them well. Our retention is as good today as it was pre-pandemic. So I think that our workforce is well-positioned for right now. So we're proud of our workforce and we've recognized our workforce and I think they deserve to be recognized on that. And despite that our volumes are helping us, and our scales helping us, our technologies are helping us, control press the numbers but those people that are here get paid very well.
J. Patrick Gallagher: Well, also you've heard now everywhere agile work, agile work, work from home. We've been agile and how we work with our workforce for the last 25 years. So pre-pandemic probably 50% of Gallagher Bassett's entire field force was at home. So, this is not new territory for us. We listen to the employees. We want people to stick around. As Doug said, our retention rates and our turnaround rates are no different than they were pre-pandemic. So the great recognition hasn’t hit Gallagher yet.
Derek Han: Okay. That’s really, really helpful. Thank you. And just going back to your expectations on the brokerage organic growth of 8% plus. Are you embedding any kind of slowdown from potential rate hikes or maybe kind of beating supply chain constraints or maybe labor constraints? I know you sounded very confident about achieving that. But kind of wanted to get a sense of what could real the percent plus organic growth.
J. Patrick Gallagher: I’m sorry, I’m too much of an optimist. But I look at the stimulus bill is coming out of Washington DC. The kind of money that’s going to flow into infrastructure. Every contractor and our book of business is going to be loaded up with work. Every single personal lines account all the way through small commercial, it’s a large commercial has got significant increases that they need in their -- in the cost of their property portfolio. Payrolls are up as you mentioned earlier Derek from just the whole employment situation and all of that. There is not an industry that I can think of that benefits more than the insurance brokerage business from a nice little touch of inflation. Hold all tickets.
J. Patrick Gallagher: Well, thanks everybody. I appreciate you being here today. Thanks for joining us. As you all know we delivered an excellent fourth quarter and full year 2021. I would like to thank our colleagues around the globe for such an outstanding year. Our results were direct reflection of their efforts. We look forward to speak with you again in our March Investor Meeting. And have a good evening. Thank you very much.
Operator: This does conclude today’s conference call. You may disconnect your lines at this time. Thank you for your participation and have a great evening. | [
{
"speaker": "Operator",
"text": "Good afternoon and welcome to Arthur J. Gallagher & Company's Fourth Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q, and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you. Good afternoon. Thank you for joining us for our fourth quarter 2021 earnings call. On the call with me today is Doug Howell, our CFO as well as the heads of our operating divisions. We had an outstanding fourth quarter. For our combined brokerage and risk management segments, we posted 18% growth in revenue, 11% organic growth, net earnings growth of 11% adjusted EBITDAC growth of 17% and we completed 18 new tuck-in mergers in the quarter. That's on top of closing our Willis Re merger. Our total for the year, our merger strategy added more than $1 billion of annualized revenue. That's just fantastic. Needless to say, I'm extremely proud of how the team performed during the fourth quarter and the full year. So let me give you some more detail on our outstanding fourth quarter performance starting with the brokerage segment. During the quarter reported revenue growth was an excellent 19% of that 10.6 was organic, another sequential step up from the third quarter and the fourth consecutive quarter of improvement. Net earnings growth was 8% adjusted EBITDAC growth was 17%. And we expanded our adjusted EBITDAC margin by 13 basis points in line with our December IRD expectations. Remember, that's lower because of the natural seasonality of the reinsurance acquisition, margins would have expanded nearly 90 basis points. So another great quarter for the brokerage team. Let me walk you around the world and break down the 10.6% organic, starting with our PC operations. First, a domestic retail business posted 13% of organic, driven by excellent new business, higher exposures and continued rate increases. Risk placement services, our domestic wholesale operations posted organic of 15%. This includes more than 30% organic in open brokerage, and 5% organic in our MGA programs and binding businesses. New business was better than 2020 levels and near double-digit renewal premium increases helped to. Outside the U.S., our U.K. business posted organic of 12% specialty including our existing Gallagher Re business was up in the high teens and retail is up 7% Both fueled by new business and retention in excess of 2020 levels. Australia, New Zealand combined, organic was more than 8% also benefiting from good new business and improved retention. And finally, Canada was up more than 13% organically and continues to benefit from strong new business trends, stable retention and renewal premium increases. Moving to our employee benefit brokerage and consulting business. Fourth quarter organic was up about 7% a couple of points better than our December IRD expectation. We saw some nice sequential improvement over the course of 2021 up from the 2% organic we delivered in the first quarter, thanks to a rebound in global economy, declining U.S. unemployment and increased demand for our consulting services as businesses look to grow. Next I'd like to make a few comments on the PC market. Overall, global fourth quarter renewal premium increases were above 8% broadly consistent with the increases we saw during the first three quarters of '21. Moving around the world renewal premium change which includes both rates and exposure, up about 8.5% in U.S. retail including a 13% increase in professional liability, 8% in property and casualty and 4% in workers comp. In Canada, Australia, New Zealand and the U.K., retail renewal premiums up between 7% and 9%, mostly driven by increases in professional liability and property. Within RPS, wholesale open brokerage premium increases were up 13% and binding operations were up six. Shifting to reinsurance, January 1 renewal showed price increases that vary by geography and client loss experience, loss free programs saw rates flattish to up 10%. While loss impacted accounts and cat exposed property business experienced rate increases that were in many cases double that. So rate tended to be based on client's specific attributes and loss history. And I consider that to be a healthy outcome. So whether retail, wholesale or reinsurance premiums are still increasing almost everywhere. Looking forward, I see a difficult PC market conditions continuing throughout 2022. That's because our risk bearing partners remain cautious on rising loss costs. So property coverages replacement cost inflation and the increased frequency and severity of catastrophe losses are causing underwriters to rethink rate adequacy. On the casualty side, social inflation, low investment returns and the potential for increases in claim frequency as global economies further recover are all potential negative drivers of future underwriting profitability. And on top of higher loss costs and lower investment insurance, reinsurance costs are also increasing. So I think carriers will continue to push for rate and don't see a dramatic change in the near term. We shine in this type of environment by helping our clients find appropriate coverage while mitigating price increases throughout creativity, expertise and market relationships. I'm equally as upbeat on our employee benefit consulting and brokerage business. As you know the first quarter seasonally our largest employee benefits quarter and is looking like the team had a strong annual enrollment season. Early indications are pointing to an increase in new client wins over prior year, consistent client retention and a slight increase in covered lives. With improved business activity and increased demand for goods and services businesses are trying to grow their workforce. But the labor market remains extremely tight with more than 10.5 million job openings domestically and 6.3 million people unemployed and looking for work. This lays the groundwork for robust demand for our consulting services in 2022 as employers look to attract, retain and motivate their workforce. So we finished '21 with full year organic of 8%. That's really nice improvement from the 3.2% organic we reported in '20 and above pre-pandemic 2019 organic of 5.8%. And as we sit here today, we think '22 organic will end up in a very similar range to '21 and there is a case that it ends up even better. Let me move on to mergers and acquisitions. It was great work by the team to close the reinsurance acquisition in early December. Integration is well under way and progressing at a good pace. Remember, we are a seasoned integrator. On the revenue side, much like our tuck-in acquisitions, we've mobilized our local teams from retail, wholesale and even Gallagher Bassett to partner with our new colleagues and generate new revenue opportunities. I'm also very pleased that our combined Gallagher Re team hit the ground running and had a strong finish to the year. Financially, the acquisition added about 20 million of revenue in December and as expected generated a small EBITDAC loss due to seasonality. More importantly, I'm already seeing examples of cross division cooperation and collaboration. So our new reinsurance colleagues are quickly embracing our Better Together Gallagher culture. Outside of reinsurance, we completed 18 tuck-in brokerage mergers during the quarter, representing about $65 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have around 35 term sheets signed are being prepared representing over $200 million of annualized revenues. We know all these will not close however, we believe we'll get our fair share. Next, I'd like to move to our risk management segment Gallagher Bassett. Fourth quarter organic was 13.1% a bit better than our December IRD expectation, margins approached 19% in the quarter, leading to full year adjusted EBITDAC margin of 19.1%. Another great quarter and full year for that matter from the team. We saw more new arising claims within General Liability and Property and to a lesser extent co-workers compensation during the quarter. New COVID related workers comp claims were similar to the third quarter dated slightly by the late year surge in cases from Omicron variant. Regardless of the short-term variability of new rising claim activity, we feel really good about the business. Looking forward continued strong retention, combined with new client wins in the fourth quarter should drive '22 organic into the high single digit range. So it was another fantastic year for our franchise and I'm extremely proud of our team and our collective accomplishments. Together, we produced 8.6% organic growth in our combined brokerage and risk management segments, completed 38 mergers with more than $1 billion of estimated annualized revenue, more than 110 basis points of adjusted EBITDAC margin expansion. And we were recognized as one of the world's most ethical companies for the 10th year in a row by the Ethisphere Institute and all this in the face of a pandemic. What a fantastic year, more than ever, our success is due to our bedrock culture. Our culture helps us deliver better results, better results for all of our stakeholders, including our customers, our colleagues, our underwriting partners, and of course, our shareholders. Every day, all of our teammates get up and work diligently to maintain our culture, to promote our culture and to live our culture. That truly is the Gallagher way. Okay, I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat. And hello, everyone. As Pat said a terrific quarter to close out in an outstanding year. Today, I'll start with our earnings release and touch on organic margins and our corporate segment shortcut table. Then I'll move to our CFO commentary document where there I'll talk a little bit about how we're now providing our their typical modeling helpers for '22, add some commentary in the Willis Re acquisition and our latest thinking on clean energy. I'll then finish up with my comments on cash liquidity and capital management. Okay, let's flip the page for the earnings release to the brokerage segment, organic table. All in brokerage organic was 10.6% a nice step up from the 9% we posted last. And the six plus percent we posted in the first half of '21 leading to full year organic of 8%. Looking forward as Pat said, we see full year '22 similar to '21 or even better. Now turn to page six for the brokerage segment adjusted EBITDAC margin table. Headline all in adjusted margin expansion for fourth quarter was 13 basis points right in line with our December IRD expectation. But recall that expansion has the adverse seasonal impact of closing Willis Re on December 1. Without that, adjusted margins would have expanded 88 basis points also right in line with the forecast we provided in December. For full year adjusted margin expansion was 123 basis points. Excluding Willis Re, it was up 142 basis points. And it's important not to forget, that's on top of 420 basis points of adjusted margin expansion in '20 and 75 basis points in '19. That's absolutely incredible execution before during and as we emerge from the pandemic. Moving on from '21. Looking forward, as the pandemic limitations continue to ease in '22, we will naturally see some costs returning in areas such as travel, entertainment and perhaps some other office consumables. Incremental full year '22 costs from these three areas could be as much as 25 million. But even then, our full year spend on these categories would be below pre-pandemic levels, showing that we're holding safe. Also, we're back to making targeted investments to drive long-term growth. In '22, we're planning for increases in marketing, advertising, consulting, professional fees and certain IT investments. These costs combined with higher insurance premiums say for E&O, D&O and work comp would total around 35 million. So like we said in our December IR Day, we should be able to absorb those costs and hold margins if we post around 7% organic. And if organic is over 7% even show some margin expansion. Then by 2023, we could be back to that pre-pandemic view that margin expansion might occur at a 4% or so organic level. And to be clear, all of these comments are before the impact of the acquisition of Willis Re. On a pro forma basis, those margins can run a bit higher. So math would say would naturally provide some lift to our consolidated brokerage segment margins in '22. A couple of things to keep in mind as you build your quarterly models for our brokerage segment in 2022. First consider seasonality, due to our benefits business, and now our larger reinsurance business, first quarter seasonality, our first quarter is our largest revenue in EBITDAC of the quarter of the year. And second perhaps slightly more nuanced, since we're not seeing price and or exposure increases in benefits and workers comp to the extent we are in other areas of PNC insurance. First quarter organic might be a point or so below your full year pick simply due to the mix. So the math would then suggest their second, third and fourth quarters could post over your full year organic pick. Again, that's just a nuance to help you with your quarterly model. Moving on to the risk management segment and the organic table at the bottom of Page Six, you'll see 13.1% organic in the fourth quarter and full year organic in excess of 12%. What a great rebound from the depths of the pandemic. And as Pat said, it's looking like revenue momentum continues into '22 with full year organic revenue growth in the high single digits, which is really terrific given '22 will naturally have more difficult compares than '21. Moving to the risk management segment EBITDAC table on page seven. Adjusted EBITDAC margin of 18.6% in the quarter and more than 19% for the full year, a fantastic result. And just like our brokerage segment, a nice step up from pre-pandemic levels of 17.5%. Again, that demonstrates our ability to maintain a portion of our pandemic period savings even as we make some further investment in technology investments. Looking forward, as you heard on our December IR Day, we will continue to make investments in analytics and tools to enhance the client experience and drive better claim outcomes. But even with those holding margins close to that 19% is achievable for full year ‘22. All right, let's turn to page eight to the corporate segment table. In total, adjusted results $0.02 better than the midpoint of our December IR Day forecast, mostly as a result of strong clean energy earnings. We did have a couple of notable adjustments this quarter. First Willis Re transaction related costs, as discussed in footnote two were 22 million after tax. And second, as discussed in footnote three and similar to third quarter, we had non-cash, deferred tax adjustments related to international M&A earnouts, which is the most of it as well as some other small tax and legal settlement items together about 19 million after tax. Now let's shift to our CFO commentary document we post on our website starting with page three. As for fourth quarter, you'll see most of the brokerage and risk management items are close to our December IR Day estimates. Also on that page, we are now providing our first look at items related to the brokerage and risk management segment. A couple lines we're highlighting, first FX, the late '21 and early '22 weakening of the U.S. dollar against our major currencies is creating about a $0.04 headwind to EPS next year. Second integration costs. You'll read in footnote one, the integration estimates provided here only reflect expense associated with Willis Re. As Pat mentioned, integration is well underway and we are still comfortable with our ultimate pack of about $250 million of total costs for integration. All right, let's turn to page five of the CFO commentary, the page addressing clean energy. The purpose of this page is to highlight we are transitioning from over a decade of showing GAAP earnings to a six-day period where we harvest cash flows. You'll see in the blue column that we reported '21 GAAP earnings of 97.4 million, a really nice step up, up 39% over '20 and we generated 40 million of net after tax cash flow. So also a nice step up from '20. But the real headline story here is in the pinkish column. Cash flows take a significant step up in '22, looks like we'll be harvesting $125 million to $150 million a year of cash flows and perhaps even more in '23 and beyond. Now there is still a possibility of an extension in the law and we're well positioned to restart production if that happens, but if not, we have over a billion dollars of credit carryovers. If we use say $150 million a year that's a seven year cash flow sweetener. Flipping to page six in the rollover revenue table. The reinsurance acquisition is off to a solid start and we are encouraged with both its December results and early indications from the 1-1 renewal season. So it's looking like our pro forma revenue and EBITDAC of 745 million and 265 million respectively, are holding up nicely. So the reinsurance acquisition is off to a terrific start. All right, as for the cash and capital management future M&A. At December 31, available cash on hand is about 300 million with strong operating cash flows expected in '22. And potentially a nice pumping cash flow from our clean energy investments, we are extremely well positioned to fund future tuck-in M&A using cash and debt. Over the next two years, we could do over $4 billion of M&A without using any stock. You also see that our Board of Directors announced a $0.03 per share increase to our quarterly dividend, that would imply an annual payout of $2.04 per share. That's a 6.3% increase over 2021. Finally, one calendar item, we are planning on our regular mid quarter IR Day from 8 am to 10 am, Central Time on March 16. Again, that will most likely be virtual. During that we will allocate some time to socialize our planned migration to reporting adjusted GAAP EPS results excluding the impact of non-cash intangible asset amortization. We'll discuss the detail of all the adjustments including representing historical results on the new basis. Okay, that's it. From my vantage point, as CFO we are extremely well positioned for another great year here in '22. Before I turn it back over to you, Pat, I'd like to thank the entire Gallagher team for a terrific quarter and fantastic year. Pat?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Doug. Operator, let's go to questions and answers please."
},
{
"speaker": "Operator",
"text": "Thank you. The call is now open for questions. Our first question is from Mike Zaremski of Wolfe research."
},
{
"speaker": "Charlie Lederer",
"text": "Hey, guys, this is actually Charlie on for Mike. So organic growth in the back half of the year has been outstanding and has been accelerating. But pricing while positive seems to be decelerating and GDP is decelerating as well. Can you provide some color on what makes you comfortable with guiding us to organic growth at almost two times your historical level?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "We think that the rates are going to hold. It's just that simple. market falls out. They won't, market holds the way it is, it will. I'd see all kinds of reasons for it to continue, as laid out in my prepared remarks. But beyond that, you've got a situation where underwriters are not backing off from their need for rate. We're seeing that every single day. We're into the renewals, obviously now deep into the first quarter. And we're not seeing rate relief in any way, shape or form along the lines of what I talked about in my remarks."
},
{
"speaker": "Doug Howell",
"text": "I still think there's a lot of pent-up exposure unit growth that still to come. We think there's inflation sitting there. We think that there's a need for our benefit consulting advice, more and more. We think that wholesaling markets are becoming tough and harder to find placements. We think there are more accelerators when it comes to that then there are maybe a slight, 0.5 point pullback in what the underwriters are asking for in re that far overshadows it."
},
{
"speaker": "Charlie Lederer",
"text": "Got it. That's great color. And then, on M&A. I guess there's -- I know you said the integration is going well. Does the reinsurance transaction have any impact on M&A decisions this year? Or is there any chance you don't spend your entire free cash flow because of it?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Of course, I said we think we have 4 billion to spend over the next couple of years. I think that's almost 2 billion next year and a little over 2 billion in the final year. So we have plenty of free cash to fund acquisition our pipeline. It does get a little slower in the first quarter. There's people that push more to have something done by year end and we have that happen every year. But we're pretty excited about what we're seeing in our pipeline right now."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Greg Peters of Raymond James."
},
{
"speaker": "Greg Peters",
"text": "I know I can't do it Doug, but I'm wondering if you can say pre-pandemic 10 times really fast."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Pre-pandemic, Pre-pandemic."
},
{
"speaker": "Doug Howell",
"text": "Obviously, I don’t know. I couldn’t."
},
{
"speaker": "Greg Peters",
"text": "I'm just teasing. So let's see, I had a question about the M&A. And I was looking in the CFO commentary on page three. And of course, Pat, you always give us a view on term sheets, outstanding, et cetera. So, two-part question. When you give us term sheet numbers, the number of term -- sheets that are out there, and then ultimately, to close, can you talk about how that ratio, the close rate has changed over the last two or three years? And then, secondly, on page three of the supplement Doug, you drop in, you give us the quarterly weighted average multiple of EBITDAC tuck-in. And it's definitely trending up. So I'm just curious about your views there."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes, great. Let me take the first part of your question. When we get to an actual term sheet, we're usually moving down, especially in our tuck-ins, we're usually moving down a path where we're going to do a deal. And one of the things about our reputation is that we will close. Having said that, over the last two to three years, there's considerably more competition, you can take a $5 million deal today and if it's going to get spreadsheet, there'll be a dozen, really thinking of a dozen bids. So we are really trying hard to make sure that all of our new partners are excited about what the future provides being part of Gallagher, which quite honestly, we think is substantially better and more exciting than our private equity competitors. But that doesn't diminish the fact that they're good competitors and they're smart people. And they're well funded. So I don't have a number for you specifically, I can't say, oh, yeah, we closed 32% of the ones that we finally get to. We don't keep the records that way. I don't do that. But anecdotally, I'll tell you that we should close more than half of the ones that we get to we have a signed term sheet, while I will take it back, we should close 90% of the ones where we have a signed term sheet, 10% will slip out of the net. And where we're preparing term sheets, we should close about half of those."
},
{
"speaker": "Doug Howell",
"text": "In terms of the multiple Greg. Yes, the multiples ticked up a little bit, not as much as what our multiple has. So there's still a terrific arbitrage there. But also, you have to realize the growth rates that drive those multiples have gone up quite a bit, too. So I think there's justification for higher multiples. But we're still buying in that eight to 10 range when it comes to tuck-in acquisition. It's a pretty good run rate versus our trading multiple of 15, 16, 17."
},
{
"speaker": "Greg Peters",
"text": "Got it out. I guess, a follow up question. It's been a rough start to the year for the market. And for the insurance brokerage stocks and your stock too is traded off a little bit. And it feels like at times, some are speculating that the best for their brokerage space is in the rearview mirror. Yet, the rhetoric from you, Marsh and Brown & Brown are directly polar opposite, it seem to map out a pretty optimistic future. So I guess I'm just trying to gauge what your perspective is on the market, considering that the stock market certainly doesn't seem to appreciate what you guys are doing at this moment in time."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, Greg, this is Pat. Normally for 20 years, and there's never been a time in that period where I've been as bullish as I am today. I mean, everything, everything is going our way. So let me try not to spend 20 minutes answering your question here. But let's start with the fact that we've never been stronger. Vertical capabilities are absolutely critical. Data and analytics are absolutely critical. When you take a look at the volumes that we now have that we can do the data and analytics around we can tell you what's happening by day with rates and renewals or what have you. 10 years ago, we flew blind totally on that customer asked why do I have even know I've got a good deal with the rate environment going like it is. We can show them what's happening to the rates by line, by geography and why they have a good deal. And that type of question is getting asked right into the middle market. And over 90% of the time when we compete, we compete with a smaller competitor. That's why these people are selling to private equity. That's why these roll ups are working. And I'm telling you it's unbelievable the opportunity we have right now. So I see this is the greatest buying opportunity in the last five years."
},
{
"speaker": "Greg Peters",
"text": "Yes. Just in your answer. And it was part of your comments, you talked about the difficult risk bearing market and driving further rate. And listen, I, you're looking at a global picture, so but I look at reported results, Travelers was out with an 88% combined ratio, Berkeley just came out with an 88% combined ratio tonight. It seems like the risk bearers are -- the results are beginning to improve. And so I guess it lends the question, what are we missing when you say it's difficult risk bearing market?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, let's start with inflation. You've done all your actuarial work at a 2% inflation rate. And now it's six. Oh, yeah, that was a blip on the radar, was going to be gone by now. I guess that's not going to happen. Secondly, let's look at last costs. What does it cost to build a house today? Well, we got it done for $200 a square foot a few years ago, certainly isn't that now. And I could go on and on and on. I mean, the level of nuclear, the number of nuclear settlements. The other thing too is, I've been saying this now for years, I think it's more true than ever. Our underwriters or our underwriting partners are very, very smart. And they've got incredible data and analytic skills. They know where they're making money in that 88% everywhere around the world every day and they know where they're not making money. And you walk in and start talking about a deal that you want to broker, it's something that's going to be substantially less than they know, they'll get or deserve. They're just not buying it."
},
{
"speaker": "Doug Howell",
"text": "I think, Greg, there's also some things, x cat, x reserve releases, I think, and then the prospect of just inflation just have a reserve be coming in, let's say just 10% more than what the original estimate was. That's a huge difference on a combined ratio. So I think that the -- I'm not challenging the health of the insurance companies. I think they've got their rates where they think they need them right now. I don't know if there's a case that would say that they're too high. I think the case wouldn't be say more so that they're too low. And I just don't see when the courts open up, you're going to see more unfortunately losses that are just the current picks, while the best information they have right now are just too low. So I think there's not a case for cutting rates by any means. There's a case for continued increase in rates. And I just -- everything that we look at . There'll be interesting when other books get filed."
},
{
"speaker": "J. Patrick Gallagher",
"text": "This is not a hard market is, it was in the middle 80s where everything goes up, you know that work comp was flat, through most of this adjustment work comp is now up. As work comp comes up a little bit professional liability is going through the roof. Cyber is almost unbreakable. So you sit there and you look at this. These carriers are looking line by line, geography by geography and from our perspective, daily placing accounts, we are not seeing them lose discipline."
},
{
"speaker": "Greg Peters",
"text": "Got it. Thanks for the answers. And congratulations on the quarter and the year."
},
{
"speaker": "Operator",
"text": "Our next question comes from Yaron Kinar of Jefferies."
},
{
"speaker": "Yaron Kinar",
"text": "So my first question in the earnings release, there's comment that if the pace of economic recovery accelerates beyond your expectations, you could see expenses increase more than the current estimate. I just want to confirm or pick up that a little bit. Expenses may rise in that situation but wouldn't organic revenue also accelerate in that case? Essentially, what I'm trying to get at, margins don't get compressed with that, right?"
},
{
"speaker": "Doug Howell",
"text": "But that's not a margin comment. That's just comment."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. And I guess all else equal, if the economy does accelerate beyond your expectations, margins, would margins actually come in better than expected?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "What we say that -- listen we think that there's a case that we can do better next year on organic than we have. We did this year if the economy accelerates exposure units grow the pent-up demand for goods and services increase, supply chains, get back to normal. Yes, your implication that question is right."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. And then in the CFO commentary, page three together, comment there on full year margins and brokerage being approximately 34%.? They were at 34% in '21, right at 33.9. So there should still be some upside to that. Is that just a rounding issue?"
},
{
"speaker": "Doug Howell",
"text": "All right, thanks. First of all, said 34 is pretty darn good. I mean, when you look across the brokerage space, we're pretty proud of that margin and I have ever been here 18 plus years, it wasn't that way that that long ago. So you got to be pretty proud of that number compared to the industry. Second of all, yes, 34%. The reason why we don't round it even more is because we don't have a crystal ball. We also have FX adjustments that will come true. Yes, we could change that number slightly as with our international business over the next year. But what we're saying right there, just like we said in the commentary at 7%, we've got a decent chance of holding those margins we really think we do. At 8%, we could see a little bit more, over 8%, maybe a little more than that. So I wouldn't read a rounded 34% with all those factors as being an indicator that we're pegging exactly 33.9 like we have this year, but 34 is greater than 33.9. And then, when you roll in the reinsurance operations, you could get a little bit more left than that. So I would say would not read too terribly much into it."
},
{
"speaker": "Yaron Kinar",
"text": "Okay, good. I'm glad that's confirmed. Finally, any update on Willis Re, the revenues and margin? I think the initial guidance you offered for '22 was still based on the 2020 numbers kind of used as a placeholder."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes. We feel really good about the team. We're onboard just over a little bit over a month, almost two months now. And as we said in our prepared remarks, the team's coming together extremely well. With a good strong January 1, and we brought $745 million of revenue and 265 million of EBITDAC, and that's still looking good."
},
{
"speaker": "Operator",
"text": "Our next question comes from David Motemaden of Evercore ISI."
},
{
"speaker": "David Motemaden",
"text": "Just a question on the brokerage organic in 2021 that 8%, wondering if you could just walk through the different drivers behind that in terms of exposure pricing, net new business, how much those contributed to that 8%. And how you see those elements shaping up in the 2022 outlook."
},
{
"speaker": "Doug Howell",
"text": "Okay. So first of all, let's break that down. There's the components of new lost opt-in, when customers opt-in for more coverages opt out when customers opt out because they want to control their budget for insurance spends and you got the impact of rate. So the fact is, is that we believe we're -- if you break that 8% down, let's just say that a third of it comes because we're just selling more business and we have before versus what we're losing. I think there's probably a third of that number that's coming from exposure, and a third of its coming from rate. So you've kind of got all three of them there. What's interesting on a multi-year impact is that customers can opt -- come up with -- we can help our customers come up with creative ways to mitigate the rate increases as their exposures grow, which we see is happening more and more over the next couple of years. It's harder to opt out of exposures. If you had 20 trucks and now you got to insure 22 of them. You can't just not insure two trucks. If you have a 20% increase in premiums, maybe you take a higher deductible, or you take less limits on it, and you can kind of opt out of the rate increases. But as we see exposure units fueling that organic growth going forward, top that off with rate increases that mix of -- I think would toggle probably more to exposure, more than net new wins and maybe less impact from rate as we continue to grow. As you push 10% of organic growth, it's going to be exposure unit driven."
},
{
"speaker": "David Motemaden",
"text": "Awesome, that's great color. Thanks for that. And I guess maybe just also Doug, you mentioned the cadence, maybe the first quarter being a little light. I don't want to get too granular here. It's a long year, but it sounded like that was really driven by employee benefits and workers comp and just seasonality there. But when I think about the 7% organic in employee benefits that seems pretty strong, definitely better than it was in December. Are you expecting a deceleration off of that up seven? And that's partially why maybe the first quarter would be a little bit lower than the full year? Or is it more workers comp driven?"
},
{
"speaker": "Doug Howell",
"text": "Actually 7, if you pick, I'm just saying you have to make the pick. If you're picking 8%, next year 7, and I said it's about a point lower in the first quarter, that 7% is probably the number that you get to. If you pick 6%, I don't think that it would have that big of an impact on you. So what I said in my comments was about a point lower than the full year average. So that's what I would say it's just cautioning that business. doesn't grow as fast as our PNC right now."
},
{
"speaker": "David Motemaden",
"text": "Okay. That makes sense. And then if I could just sneak one more in, on the 4 billion of dry powder for M&A guys have over the next two years. Without issuing stock, that's a lot. It's a lot for tuck-ins. You mentioned earlier competition is also increasing. I guess I'm wondering if at some point, you would consider allocating some to capital return through share repurchases? Is that something that's come up at all, something that you think you might institute over the next year or two?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Absolutely, that's something if we have excess capital, we'll want to make sure that we maintain our solid investment grade rating, right? Absolutely, look at share repurchases and dividends."
},
{
"speaker": "Operator",
"text": "Our next question is from Elyse Greenspan of Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question is related to clean energy. So Doug, I think you said that there's a chance that the laws could be extended, I just wanted to get a sense of the timing you thought there. And then, I thought in the past you guys had perhaps implied if you continue to be able to generate credits, you would not go the route of rolling out some kind of x amortization EPS. So are these now independent events. So meaning if you're able to generate more credits on the clean energy investments, you will still roll out some EPS estimate that is cash in nature and backs out intangibles, among other items."
},
{
"speaker": "Doug Howell",
"text": "I don't see us backing off of going towards that metric, regardless of what happens with an extension or not. So an answer to your question, we're going that route. We've done a lot of work on it. We think it's consistent with what other brokers are doing. And so we're pretty comfortable with going that route. What happens with an extension? I think it's going to be in the spring, we think that Congress has woken up to the fact that this technology provides a terrific benefit to our environment. So we hope that they see their way cleared, finding a spot and a bill to include it."
},
{
"speaker": "Elyse Greenspan",
"text": "So if that does happen from a cash from a credit generating perspective and you would perhaps be unchecked, generate credits at a cadence that you were generating them at in 2021, just depending upon when you can get back on track with that?"
},
{
"speaker": "Doug Howell",
"text": "You kind of broke up a little bit on that question. Can you just say it again, Elyse, sorry?"
},
{
"speaker": "Elyse Greenspan",
"text": "I was saying if you are able to regenerate credits from your clean energy investments this year, would you expect it to be at the same cadence that we saw in 2021?"
},
{
"speaker": "Doug Howell",
"text": "Yes, I think so. I listen, we posted $97 million of after tax earnings on it. The pick would be 80 million more not 40, not 50. But there will be some plants that won't start up. They were planned to be decommissioned, made a whole location as being decommissioned. So I wouldn't see it as being as high as it was in. We had a terrific year, one of our best years ever and I just don't see that happening again, if it restarts. And clearly you'd have from the restart date to but if we don't get a -- if it's retroactive, these have been idled. They're sitting there. It's not like we can go back and produce credits in January, February and March but doesn't get passed until April."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then, with Willis Re in the M&A sheet, I saw that you guys put it in with the Q4 bucket. So I'm assuming based on the commentary is the embedded revenue from Willis Re just at that 745. And then if there's growth off of that, that would be additive to the M&A build. And then I'm assuming on a go forward basis, you'll just give us the revenue from Willis Re just on your quarterly calls like you did today?"
},
{
"speaker": "Doug Howell",
"text": "Yes. I think let's make sure I can restate and go to page six of the CFO commentary we provided a grid that shows the fourth quarter acquisition activity. I would I understand your question there, how much of that line adds up and then subtract up to 745. And the 745 is in that line, including what other acquisitions we did during the fourth quarter for the vast majority of it. I'd have to do that add up while we're on the phone here."
},
{
"speaker": "Elyse Greenspan",
"text": "No, that's fine. That's helpful. And then one last one on margin."
},
{
"speaker": "Doug Howell",
"text": "Let me restate that. We have a separate line for the reinsurance acquisition. I just didn't have my glasses on here. So we have other fourth quarter acquisitions in the line above it. So take a look at that."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay, sorry. Thank you. And then the margin guide that you could see some expansion above 7%. I guess that was unchanged from December, right? So, we should expect if you're going to get to around 8% or so organic this coming year in brokerage, we should expect a modest level of margin expansion, correct, let me take all of your expense commentary throughout the call into account?"
},
{
"speaker": "Doug Howell",
"text": "Yes, that would be what you would assume."
},
{
"speaker": "Operator",
"text": "Our next question is from Greg Peters of Raymond James."
},
{
"speaker": "Greg Peters",
"text": "Great, thanks for allowing me to ask a follow up. I wanted to spend a minute and ask about your supplement and contingent line in the brokerage business. If the profitability of the carriers starts to improve, when we expect supplements and contingents to also grow maybe a little bit faster than just the base organic that you're expecting, or maybe more broadly, just one of the drivers of growth in supplements are contingents outside of acquisitions?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "The answer to your question is yes. And the driver is very simple, profitability on contingents, and revenue growth, premium growth on supplementals. And both of those should be impacted nicely by inflation, growing premiums and profitability."
},
{
"speaker": "Doug Howell",
"text": "And then, also they added value that we bring through our smart market through our advantage products, where we really can help match our customers need to the carrier's appetite for risk. We're getting continued momentum on that, Greg, you've been around a lot. And so it's -- we're continuing to add value in the relationship with our carriers. And they recognize it. So your statement, there is right. It should continue to grow as business becomes more positive, should all benefit from that."
},
{
"speaker": "Greg Peters",
"text": "I remember and this is dating me, but I remember when you started smart market. So I guess you since you brought it up, can you give us an update of how that business looks today versus where it was a year ago or two years ago? Whether it's in terms of number of clients, the amount of premium that it's accounting for or whatever metrics you're using?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, first of all, yeah, I can do that, Greg. The proof has been in the pudding with smart market. You were there when we started it. And to be perfectly blunt, there was some skepticism for all kinds of reasons around whether or not data and analytics being sold to insurance companies was really worth it. Okay, that question has been answered. It's very well accepted. It's now being utilized in RPS been utilized across our Gallagher global brokerage operation, including locations outside the United States, Canada, and U.K., et cetera. So it's getting very broad recepients across more than probably 15 to 20 carriers today."
},
{
"speaker": "Doug Howell",
"text": "Yes. Think about when we think back to our IR days that we talked about. Here we speak not mostly about our -- initially about our U.S. business and the things that we've done in our U.S. business and in terms of carrier relations in terms of our core 360 platform, our use of offshore centers of excellence. And then, how we're bringing that to Canada, Australia, New Zealand, the U.K. retail, now into some of the other retail locations as we take minority positions perhaps in Europe. This is an example of how a seed planted and developed here in the U.S. can be spread around the world and vice versa. There are techniques around the world that we bring back to the U.S. So, Greg, you're right at the , yes, this is something we're proving out and rolling out around the world. And that's why when we talk about retail around the world, it all looks the same with different nuances by country."
},
{
"speaker": "J. Patrick Gallagher",
"text": "And it's been very, very good for our people to tie closer to the insurance companies and we're generating about $25 million of income from that. So it's been a win-win for everybody."
},
{
"speaker": "Greg Peters",
"text": "Great, thank you. Thanks for the color there. I guess the last question I would have, Doug, I've used your quote before about in reference to margins. I think you previously had said on a conference call, well, trees don't grow to the moon. So you guys have a 34% in on rounding up, EBITDAC margin in your brokerage business. When do we begin to top out? I mean, everyone's reporting margin expansion, at some point, you're going to -- you would think that there might be some downward pressure on fees or commissions or something that might cause some downward pressure on margins?"
},
{
"speaker": "Doug Howell",
"text": "Well, I think there's a difference between non-discretionary margin expansion and discretionary margin contraction. I think that scale has its advantages, there are limits to scale and all the product of organic, I think, just would be very happy if we can somehow post 9% organic growth for the rest of our lives and have just incremental margins. And that's a pretty good story."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Right. It's just it's not about talking margin strategy, acquisition strategy. You are right. They don't grow to the moon and more importantly, what does the client demands from us that require us to continue to make investments. It's not there and 100% yet, but clients are becoming more demanding. And in order for us to compete in post that stellar organic growth, we need to make investments in the business. So I don't have an answer for you. But when we do, we will announce."
},
{
"speaker": "Greg Peters",
"text": "Well, I like the idea of putting 9% organic and margin expansion in my model for the next five years, so go get them Tiger."
},
{
"speaker": "Operator",
"text": "Our next question is from Mark Hughes of Truist."
},
{
"speaker": "Mark Hughes",
"text": "Yes, thank you. Good afternoon. Quick question in the risk management business, what's your latest view on kind of broader outsourcing trends among the major PNC players, the potential shifts to using third parties like your risk management operation to do that in a more comprehensive way, just a quick update would be interesting. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, thanks for the question, Mark. This is Pat. I think you're going to see a continued move in that direction. It's been going on now for almost a decade. I don't think it's any secret that we've been at the forefront of that. Starting literally before the Chubb ACE combination, we were doing work on behalf of Chubb and their risk management portfolio. Prior to that, in fact, we were doing all the outsourced service for Arch as they began their program of growth in the United States. And right now, the outsourced work that we do for insurance companies is a very big part of Gallagher Bassets revenues. And I would say it's probably our largest opportunity, looking at the future over the next five to 10 years. There are some very substantial companies, I can’t name them, you understand that. That are seriously looking at this. And quite honestly, it makes a heck of a lot of sense. We've got trading partners that when I mentioned to them that Gallagher Bassett pays more claims than you do. And again, I can't mention names. They go, no, you don't. I actually we do. And I'll bet you we invest twice as much in data and analytics. And then, in our Willis systems than you do, no you don’t. Well, we will actually stand toe to toe with you and show you that. But that ends up driving is the ability we believe to prove that our outcomes are superior. And those superior outcomes come from all kinds of advantages. Both of scale but also have expertise. And once you start talking to management at these insurance companies about the fact that you've got pent-up return on investment, you've got ROE opportunities and we can do that. I honestly believe that there will come a day when people ask why did insurance companies pay their own claims?"
},
{
"speaker": "Operator",
"text": "Our final question comes from Derek Han of KBW."
},
{
"speaker": "Derek Han",
"text": "Your comp ratio is quite good in the quarter, which kind of been a threat from some of the actions you've taken in 2020. But I was hoping that you could kind of talk about how wage inflation is impacting that number. And just curious if you know, the impact is more pronounced among producers that you're trying to hire versus the support staff?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, one of the things I'm very proud of Derek is, we are one of the -- we're probably the only significant broker that still is very comfortable paying our producers on a formula that pays them a percentage of their book. And that's very competitive with the local brokerage community. So think about it this way. Where do you want to sell from what platform, a platform that gives you the kind of data and analytics that we've got that has the relationships that we've got, that has the global reach that we've got? Or what would you like to do it from the Jones agency in Alsip, Illinois, hope there isn't one there. But the fact is, we're happy to have you come aboard and pay you a percentage. So really, a big part of our benefits and comp expense for producers is self-generated and self-regulated."
},
{
"speaker": "Doug Howell",
"text": "And our middle office layer and our back office layer, as you know, we've made substantial investments in standardizing our process and using our offshore centers of excellence. As a result of that, 17 years ago, we made a decision that we could raise our quality and reduce our costs. And it's actually helping us a little bit of an inflation hedge. I'll tell you, we've been taking care of our employees. We gave a sizable raise pool this year. We gave raises even in the depths of the pandemic. Bonuses, we've been fair, these people have earned them, they've earned their raises. The raises are not as a result of -- because of we feel like we've got to hold our people, our culture holds our people. The raise is what recognize their contribution to what we've been doing. So Deming said the best is you can't have low cost without high quality. And we've worked for years on raising our quality and it's reducing our costs. It's also making our folks more effective. We have 20,000 people that do service plus another 6000 in India that get up every day and want to do a great job for our clients. So we pay them well. Our retention is as good today as it was pre-pandemic. So I think that our workforce is well-positioned for right now. So we're proud of our workforce and we've recognized our workforce and I think they deserve to be recognized on that. And despite that our volumes are helping us, and our scales helping us, our technologies are helping us, control press the numbers but those people that are here get paid very well."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, also you've heard now everywhere agile work, agile work, work from home. We've been agile and how we work with our workforce for the last 25 years. So pre-pandemic probably 50% of Gallagher Bassett's entire field force was at home. So, this is not new territory for us. We listen to the employees. We want people to stick around. As Doug said, our retention rates and our turnaround rates are no different than they were pre-pandemic. So the great recognition hasn’t hit Gallagher yet."
},
{
"speaker": "Derek Han",
"text": "Okay. That’s really, really helpful. Thank you. And just going back to your expectations on the brokerage organic growth of 8% plus. Are you embedding any kind of slowdown from potential rate hikes or maybe kind of beating supply chain constraints or maybe labor constraints? I know you sounded very confident about achieving that. But kind of wanted to get a sense of what could real the percent plus organic growth."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I’m sorry, I’m too much of an optimist. But I look at the stimulus bill is coming out of Washington DC. The kind of money that’s going to flow into infrastructure. Every contractor and our book of business is going to be loaded up with work. Every single personal lines account all the way through small commercial, it’s a large commercial has got significant increases that they need in their -- in the cost of their property portfolio. Payrolls are up as you mentioned earlier Derek from just the whole employment situation and all of that. There is not an industry that I can think of that benefits more than the insurance brokerage business from a nice little touch of inflation. Hold all tickets."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, thanks everybody. I appreciate you being here today. Thanks for joining us. As you all know we delivered an excellent fourth quarter and full year 2021. I would like to thank our colleagues around the globe for such an outstanding year. Our results were direct reflection of their efforts. We look forward to speak with you again in our March Investor Meeting. And have a good evening. Thank you very much."
},
{
"speaker": "Operator",
"text": "This does conclude today’s conference call. You may disconnect your lines at this time. Thank you for your participation and have a great evening."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 3 | 2,021 | 2021-10-28 17:15:00 | Operator: Good afternoon and welcome to Arthur J. Gallagher & Co.’s Third Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you. Good afternoon. And thank you for joining us for our third quarter 2021 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had a fantastic third quarter. For our combined brokerage and risk management segments we posted 17% growth in revenue, 10% organic growth and nearly 11% organic, if you control for last year's large life sale that we've discussed frequently. Net earnings growth of 22%, adjusted EBITDA growth of 13% and we completed five new mergers in the quarter bringing our year-to-date closed merger counts in 19 representing nearly $200 million of annualized revenue. And if you add in the pending Willis Reinsurance merger, that number would be pushing $1 billion. So the team continues to execute at a very high level, growing organically, growing through acquisitions, improving our productivity, raising our quality, and most importantly, constantly building upon our unique Gallagher culture, a terrific quarter on all measures. Let me provide a brief update on our agreement to purchase Willis Re. On the regulatory approval front, we received competition clearance in five or six jurisdictions required to close, including clearance by the U.S. Department of Justice. The final jurisdiction in the UK, where the CMA is reviewing the transaction, that's the final jurisdiction. That review is ongoing, but we believe we are in good shape. Although, there's still work to be done at this point, we believe we're on track for a fourth quarter closing. On the integration front, hundreds of Gallagher and Willis Re professionals are hard at work ensuring we will be well positioned to service our clients when we close. Our 40 year acquisition history allows us to leverage our proven M&A integration path. Integration is in our DNA. We're looking forward to welcoming 2,200 new colleagues to Gallagher as a family of professionals this holiday season. It's really exciting to think about all the talent and expertise that will be joining us. It's going to be incredible for our combined organization and our clients. Okay, back to our quarterly results, starting with the brokerage segment. Reported revenue growth was excellent at 16%, of that 9% was organic revenue growth, at the upper end of our September IR Day expectation and nearly 10% controlling for last year's large life product sale. Net earnings growth was 23% and we grew our adjusted EBITDA at 13%. Doug will provide some comments on third quarter margin and our fourth quarter outlook, but needless to say another excellent quarter from the brokerage team. Let me walk you around the world and break down our organic by geography, starting with our PC operations. First, our domestic retail operations were very strong with more than 10% organic, results were driven by good new business combined with higher exposures and continued rate increases. Risk placement services, our domestic wholesale operations grew 16%. This includes more than 30% organic in open brokerage and 5% organic in our MGA programs in binding businesses. New business and retention were both up a point or so relative to 2020 levels. Outside the U.S., our UK operations posted more than 9% organic. Specialty was 12% and retail was a solid 6%, both supported by excellent new business production. Australia and New Zealand combined grew more than 6%, also benefiting from good new business. And finally, Canada was up nearly 10% on the back of double-digit new business and stable retention. Moving to our employee benefit, brokerage and consulting business. Third quarter organic was up about 5% in line with our September IR Day commentary, controlling for last year's large life insurance product sale, organic would have been up high single-digits and represents a really nice step up from the 4% organic we reported for the second quarter and the 2% organic for the first. So we were experiencing positive revenue momentum and really encouraging sign for the remainder of the year and 2022. So total brokerage segment, organic solidly in that 9% to 10% range, simply an excellent quarter. Next, I'd like to make a few comments on the PC market. Global PC rates remain firm overall, and pricing is positive at nearly all product lines. Overall, third quarter renewal premium increases were about 8% and similar to increases during the first half of this year. Moving around the world, U.S. retail premiums up about 8%, including nearly 10% increases in casualty and professional liability. Even workers' comp was up around 5%. In Canada, premiums up about 9% driven by double-digit increases in professional liability and casualty, Australia and New Zealand combined up 3% to 4%. And UK retail was up about 7% with double-digit increases in professional liability while commercial auto is closer to flat. Finally, within RPS, wholesale open brokerage premiums were up more than 10% and binding operations were up 5%. Additionally, improved economic activity, even despite the Delta variant and supply chain disruptions are leading to positive policy endorsements and other favorable midterm policy adjustments as our customers add coverages and exposures to their existing policies. So premiums are still increasing almost everywhere. As we look ahead over the coming quarters, I see the PC market remaining difficult with rate increases persisting for quite a while. In the near-term, we don't see any meaningful changes in carrier underwriting, appetite capacity, attachment points or terms and conditions. Long-term markets do not appear to be seeing a slow down in rising loss costs. Global third quarter, natural catastrophe losses likely in excess of $40 billion increased cyber incidences, social inflation, replacement cost inflation and supply chain disruptions. And all of this is before factoring in further increases in claim frequency as global economies recover and become even more robust. All of these factors combined with low investment returns suggested carriers will continue to push for rate. I just don't see a dramatic change for the foreseeable future. So it's still a very difficult and even hard in many spots, global PC environment. But remember, our job as brokers is to help our clients find the best coverage while mitigating price increases through our creativity, expertise and market relationships. As we think about the environment for our employee benefits, let’s improve business activity, lower unemployment, and increased demand for our consulting services is driving more revenue opportunities. And our customers and prospects continue to rapidly shift away from expense control strategies to plans and tactics that will help them grow their business. And with rebounding covered lives in one of the most challenging labor markets in memory, our consulting businesses are extremely well-positioned to deliver creative solutions to our clients. So as I sit here today, I think fourth quarter brokerage segment organic will be similar to the third quarter and that could take full year 2021 organic towards 8%. That would be a really nice improvement from the 3.2% organic we reported in 2020. To put that in perspective, 8% would be our best full year brokerage segment organic growth in nearly two decades. And we think 2022 organic will end up in a very similar range. Moving on to mergers and acquisitions. I mentioned earlier, we completed five brokerage mergers during the quarter representing about $16 million of estimated annualized revenues. I’d like to thank all our new partners for joining us. And I extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in M&A pipeline, we have more than 50 term sheets signed are being prepared, representing around $400 million of annualized revenues. So even without the re-insurance merger, it’s looking like we will finish 2021 strong wrapping up another successful year for our merger strategy. Next, I would like to move to our Risk Management segment, Gallagher Bassett. Third quarter organic growth was 16.6% even better than our September IR Day expectation. Margins were strong too. Adjusted EBITDAC margin once again came in above 19%. Results continue to benefit from late 2020 and early 2021 new business wins. In addition to further improvement in new arising claims within general liability and core workers’ compensation just an exceptional quarter from the team. Looking forward, while our fourth quarter comparison is somewhat more challenging, the recovering global economy, improving employment situation and excellent new business production should result in fourth quarter organic over 10%. That puts us on track for double-digit full year organic and an EBITDAC margin nicely above 19%. As I look back over the last nine months, I can’t help, but to be thoroughly impressed with our team and our accomplishments. Our commitment to our clients, and to each other’s evident in our successes and that is due to our unique Gallagher culture. In these challenging times, our clients are continuing to count on us. And I’m proud of our teams unwavering client focus. Gallagher’s unique culture is founded on the values in the Gallagher way. Those values have kept us on a steady course throughout the pandemic. And time and time again during these past months, our clients have shared their trust and appreciation for the value Gallagher brings to the table. It comes down to talented individuals tapping into the power of our expertise across the globe, working together during this ongoing pandemic to continue to deliver for our clients. That’s the Gallagher way, and it’s the backbone of who we are as an organization. Okay. I’ll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks, Pat, and hello everyone. As Pat said, a fantastic third quarter. Today, I’ll touch on a few items in the earnings release, predominantly organic and margins, then I’ll walk you through our CFO commentary document and finish up with my typical comments on cash, liquidity and capital management. Okay. Let’s move to Page 4 of the earnings release and the Brokerage segment organic table. Headline all-in organic of 9%, outstanding on its own, but as Pat said, really running closer to 10% due to last year live sales, either way, a nice step up from the 6% we posted in the first quarter and the 6.8% in the second. As we sit now, I’m seeing a fourth quarter organic again pushing that double-digit level. Turning now Page 6 to the Brokerage segment adjusted EBITDAC margin table. Okay. Underlying margin after controlling for the live sale was around 160 basis points. Let me take you through the map to get you to that. First, headline margins were down 48 basis points, right about where we forecasted at our September IR Day. So controlling for the large live sale would bring us back to flat. Second, in September, we forecasted about $25 million of expenses returning into our structure as we emerged from the pandemic and a small amount of performance comp time. We call expenses returning mostly relate to higher utilization of our self-insured medical plans, resumption of advertising costs, more use of consultants, merit increases, and a small pickup and T&E expenses We came in right on that forecast. So controlling for these expenses also brings you to that underlying margin expansion of about 160 basis points that feels about right on organic in that 9% to 10% range. Looking forward, we think about $30 million of our pre-pandemic period expense savings return in the fourth quarter. And if you assume say 9% organic math would say, we should show 90 to 100 basis points of expansion here in the fourth quarter. So in the end, the headline story is that we have a really decent chance at growing our full year 2021 margins by nearly 150 basis points. And that’s even growing over the live sale and the return of costs would come out of the pandemic. Add that to expanding margins over 400 basis points last year means we’d be growing margins more than 550 basis points over two years. That really demonstrates the embedded improvements in how we do business. No matter how you look at it, it’s simply outstanding work by the team. Moving to the Risk Management segment EBITDAC table on Page 7. Adjusted EBITDAC margin of 19.5% in the quarter is an excellent result. Year-to-date, our margins are at 19.2%, which underscores our ability to maintain a large portion of our pandemic period savings. Looking forward, we think we can hold margins above 19% in the fourth quarter and for the full year. That would result in about a 100 basis points of margin expansion relative to 2020, another fantastic margin story. Now I shift to our CFO commentary document we posted on our IR website. Starting on Page 4, you’ll see most of the third quarter items are close to our September IR Day estimates. One small exception is Brokerage segment amortization expense about $3 million below our September IR Day estimate. It’s simply because we finalized our valuation work on a recent 21 acquisition would causes a small catch-up estimate change. We adjusted that out on Page 1 of the earnings release. So it doesn’t benefit adjusted EPS. Flipping to Page 5 and the Corporate segment table. There in actual third quarter results in the blue section to our September IR estimates in gray. Interest in banking line on a reported and adjusted basis were both in line. The non-GAAP adjustment here is that $12 million charge related to the early extinguishment of debt that we issued in May related to the terminated Aon and Willis remedy package. Acquisition cost line, mostly related to the Willis retransaction came in a bit higher than our IR Day estimate on a reported basis, but in line on an adjusted non-GAAP basis. We will see some additional transaction related costs here in the fourth quarter should have a sense of what those costs might be at our December IR Day. Again, we plan on presenting these costs of the non-GAAP adjustment as well. On the corporate cost line, in line on an adjusted basis after controlling for $5 million of a one-time permanent tax item. That’s a non-cash and it’s simply a small valuation allowance related to a couple of international M&A transactions. And finally, clean energy. What a terrific quarter, came in much better than our estimate. Thanks for a warm September, less wind in certain areas of the country and higher natural gas prices. We are increasing our full year net earnings range to $87 million to $95 million on the back of the third quarter upside. Okay. As for cash and capital management and M&A. As you heard Pat say, we have a strong pipeline of tuck-in merger opportunities, and that’s on top of the Willis reacquisition that we hope to close here in the fourth quarter. At September 30, cash on hand was about $2.7 billion and we have no outstanding borrowers on our credit facility. We plan to use that cash, cash flow generated during the fourth quarter and our line of credit to fund our – the acquisition of Willis Ray. Before I turn it back over to Pat, our year-to-date performance deserves I mention. Our brokerage and risk management segments combined have produced 15% growth in revenue, nearly 8% organic growth. We completed 19 new mergers this year with nearly $200 million of estimated annualized revenue, net earnings margin expanded 81 basis points, adjusted EBITDAC margin expanded 153 basis points and our clean energy investments are on track to being up 30 this year. Setting us up nicely for substantial additional cash flows for the coming five to seven years. A terrific quarter in nine months on all measures, positions us for another great year. Okay. Those are my comments, back to you, Pat.
J. Patrick Gallagher: Thanks, Doug. And Hillary, we can go to questions.
Operator: Thank you. The call is now open for questions. [Operator Instructions] Our first question is from Mike Zaremski of Wolfe Research. Please state your question.
Mike Zaremski: Great. Good evening. Hey, how are you?
J. Patrick Gallagher: Terrific.
Mike Zaremski: Maybe – great. Yes. Imagining great results. So maybe quickly on the Willis or maybe I should call it AJ Gallagher soon. There’s a gap between kind of the estimated earnings you guys have disclosed and Willis disclosed, and there’s also this kind of shared services stranded costs issue. And just kind of curious is, is that any color you can provide on whether your guide is baking in some, I guess, sharing of expenses that will eventually change over time and I guess, improve the earnings levels of the operation for you all.
J. Patrick Gallagher: Good question. Here’s the thing. We believe we bought about $265 million worth of EBITDA, right? And I think if you kind of do some math on this morning’s report, it looks like in the nine months reporting around $321 million – excuse me, $315 million worth of EBITDA. So their numbers are a little higher than ours. I can guess on why there’s some differences. Their cost might not be fully loaded for costs that would – it would take us to run the business or they would be running the business on a standalone basis. But it was good to see the fact that their number was higher than ours.
Mike Zaremski: Okay. Yes. That’s what I’m living too. So – but in terms of the shared services, is your current guidance baking in an expense that will over time fall?
J. Patrick Gallagher: No. I think that what they can service it for and well under the TSA and what we can ultimately service it for gets us back to that $265 million.
Mike Zaremski: Okay. I guess moving gears to the pricing environment from your color and the prepared remarks. Did I hear correct saying that worker’s comp was plus five? And I guess, just generally it feels like there’s kind of been less deceleration, I think, than some expected in terms of pricing. That seems like it’s – I’m curious, if you think it’s emanating just from the property side or it’s coming back on the casualty side as well, because maybe there’s a more uncertainty about a loss inflation or maybe worker’s comp claims are coming back. I know it’s a long-winded question. But any color on kind of what’s moving the pricing environment. Thanks.
J. Patrick Gallagher: Yes. Thanks, Mike. Yes. Interestingly enough, with all the cat losses properties slightly down in rate, casually continues to spike a properties down quarter-over-quarter, just about a point and a half or so in rate and our book now. I’m speaking about our book of business. Casually, is up a little over a point and worker’s compensation is up about five. So these things moderate quarter-to-quarter that this is not a prediction of any sort for next year, but when we get ready for this call, we look at that and say, okay, what’s actually happening in the market. By the way, our statistics are airtight, by-product, by geography, by billing as of yesterday. So I’m very confident in these numbers. Overall rate is continuing to be up about 8%.
Doug Howell: Yes. Just to add to that, if you look back at third quarter 2020, we had our whole portfolio of rate up 7.1%, and this third quarter 2021, it’s up 7.9%. Now there’s a little exposure unit adjustment in there on that. When you look at casually third quarter last year was 5.7%. It’s up 8.4%. Liability was up 10.6% last year, it was up 10 points this year. Commercial auto granted I would – there’s exposure units, and this was flat it’s up 4% this quarter. Package, third quarter is 5.7% up 8.9% this quarter. Property up 11.2%, this quarter up 8%. Marine was 3% and it’s up 6%. So when you look across all in were higher this year third quarter than we were last year third quarter by almost a full point.
Mike Zaremski: Interesting. Thank you for the color.
J. Patrick Gallagher: Thanks, Mike.
Doug Howell: And those are global numbers.
Operator: Our next question is from Elyse Greenspan of Wells Fargo. Please state your question.
Elyse Greenspan: Hi, thanks. Good evening. My first question is following up on a topic that we discussed in your recent Investor Day, Doug. So we’re discussing the potential for tax changes related to clean energy, and it sounded like there was still maybe a chance, but you guys were thinking the laws would sunset at the end of this year. Has anything changed there? And is it still the plan based on the discussion from September to rollout some type of cash earnings metrics? Is it sounded like in conjunction with first quarter of 2022 earnings?
Doug Howell: Yes. We’re still on track with a project that’s going to convert it. I don’t know if I’d necessarily call it cash. Let’s be careful about that. But we’re taking a look at how other publicly held brokers and professional services report their non-GAAP EPS and what I call a modified cash approach. And there are a number of different approaches out there whether it’s adjusting for amortization depreciation, but then there’s the subtleties of pension, stock-based compensation. So we’re working through that, nothing to report today, but the projects ongoing, I hope to give you a better update at our December IR Day.
Elyse Greenspan: But if you were to roll it out, the plan would be sometime in March early April next year.
Doug Howell: Yeah, I think so. I think we’ll finish this year on this basis and then go to that basis next spring, the first quarter. We clearly have an IR Day, we’d go back and represent everything historically on that basis. Let you be well-prepared so that let’s say we did it first quarter that you wouldn’t – that you can adjust all your models before we release.
Elyse Greenspan: And then in terms of the organic outlook for next year for brokerage, it sounds like you’re expecting around 8% growth, which is what you expect this year to come in. Within I mean, I know we’re still a little ways away and it’s hard to have precision. But within that guide benefits was a little weak to start the year. So I guess that should be a tailwind or there just – would you expect that to be a tailwind and maybe brokerage slowed a little bit. But can you just help me understand kind of how you’re seeing the moving parts within your businesses for 2022 as it sits today?
Doug Howell: Well, I think we’ll have two things. I think that they’re slightly tougher compares when you get into 2022 because we did have this – we’re having some good results here in 2021. But I think we do have some businesses that are recovering our programs, our binding businesses, our new business startups are recovering better than the wholesale business. I think you’re starting to see covered lives increase, more consulting work coming back into the structure. Rate increases, we’re not seeing that slowing down at all. So I think there’s enough there on those other – in those other places that would offset the tougher compares next year.
Elyse Greenspan: Okay. Thanks for the color.
Doug Howell: Thanks, Elyse.
J. Patrick Gallagher: Thanks, Elyse.
Operator: Our next question is from Josh Shanker of Bank of America. Please state your question.
Josh Shanker: Yes. Thank you very much for taking my question. So, given a 4Q 2021 close is Willis Re and the Gallagher Re organizations going to be unfortunately competing against each other on January 1. What’s sort of the way you’re managing that given such a close proximity to one, one renewals?
J. Patrick Gallagher: Well, what’s really nice about this acquisition is there is very little, if almost no overlap. We are not competing head to head really on much at all Capsicum, which was a startup, very successful became of course, Gallagher Re. This is very complimentary business. There might be a few little areas here or there where they each touch, but there are no major renewals across the treaty book that are in conflict. And so what you’ve got is the Gallagher Re people who you could imagine if you were just reading about this numbers to numbers, could be worried about a much larger competitor being acquired, being able to come in with their name, of course, and our brand and how are we going to sort that out? And what does that mean to the clients that they’ve been calling on? Virtually none of that exists. So what you’ve got is a team of people from the Willis Re side that are very excited. The people from Gallagher Re existing are very excited. They hit the ground running in January with a new, improved, much expanded Gallagher Re, and that’s a branding exercise. It is outstanding for all parties and it brings tremendous additional capabilities because as a startup, as you can imagine, over three, four or five years, Capsicum Re has had to develop all the individual capabilities, one at a time, pay for it as they go, still driving decent margins and top line growth. Willis’ is over a hundred years old. They built this stuff they’ve just got terrific depth. And so it’s going to be a very strong combination with almost no conflict whatsoever.
Josh Shanker: Thank you. And when you talk about $400 million of annualized revenue on 50 term sheets, I sort of look at these lists of the biggest brokers and $20 million per acquisition, obviously they’re going to come in different sizes, but there’s obviously some larger ones out there numbers, $11 million through, let’s say $50 million on any list you look at. In terms of cultural fit, do the – have you for the most part found cultural fit in the smaller tuck-ins that have that same entrepreneurial spirit? And are the larger brokers they have their own culture at this point that may not be as good of a fit for Gallagher going forward.
J. Patrick Gallagher: I don’t know if I’d say Josh it’s a matter of size, but here let’s put this in perspective. There’s according to Bobby Reagan’s organization there’s 39,000 agents and brokers in America and that’s firms, not people. Now, number 100 on business insurances lists did $26 million last year. So when you look at what’s available to be purchased, you’ve got 100 that take you to $26 million. You’ve got 38,900, less than that. And our people are out every day talking to our competitors and this is done right at the Street level. Not all of them are brought to the table by brokers that are representing them. And you have large ones that come up from time to time. And when we get a chance at the SIM and we get a chance to get to know them, our number one due diligence efforts still remains culture. You don’t get to wash away culture by size and dollar amount. And no, I wouldn’t say some bigger ones don’t fit because they’re bigger. There are some larger acquisitions we’ve done in the past years that we were thrilled with the fit and they’ve been thrilled with the fit. Now by item count, as you know, most of our acquisitions fall at the $10 million or less level, and yes, they fit extremely well into our entrepreneurial culture.
Doug Howell: Yes. Josh, just to clarify, we’ve got 50 outstanding term sheets on 400, which makes the average broker size about $8 million there.
Josh Shanker: Yes. Your math is better than mine. It’s been a long couple of days.
J. Patrick Gallagher: I get that.
Doug Howell: I get it.
Josh Shanker: Thank you for correcting me.
Doug Howell: Sure. But there are some nice ones in here in that $20 million range too.
J. Patrick Gallagher: And you’re right. The top 100 have probably sold more of those in the last two years than probably five years before that combined. And that’s a matter of all kinds of things, appetite, age, multiples, tax law, et cetera. And when we look at those, and if they fit culturally, we try hard to get them to join the team.
Josh Shanker: Wonderful. Thank you.
J. Patrick Gallagher: Thanks.
Operator: Our next question is from Mark Hughes of Truist. Please state your question.
Mark Hughes: Yes. Thank you. Good afternoon.
J. Patrick Gallagher: Hi, Mark.
Mark Hughes: Worker’s comp you sounds like it doing better, any way to characterize, is this a change in appetite on the part of certain carriers? Is it just a higher payrolls what’s driving that?
J. Patrick Gallagher: I think all of the above. I think you’ve got, well, first of all, you have the economy recovering. So, we see that in our Gallagher Bassett numbers. You can see the economy in claim count growth. You do have social inflation, and you have you just got more work being done. And I think that makes a difference, but we’re talking right here, and that’s really driven by loss ratios and what they see. And the thing about worker’s comp, I have to give our carrier partners credit. They know what’s going on in that line every day, and when they see a need to move, right? And that’s why during the hard market, many, many quarters we report flat work comp, because they didn’t need the rate. So this is really interesting to me because they’re not waiting around to find out that they’re 25 points behind the eight ball, and then trying to get it back at one swoop. So, I think it’s a good sign, both of their being on top of their numbers, incredibly well, a recovering economy and need for more and more premium in the line.
Mark Hughes: Doug, I’m not sure if I’m being dense here, but I’m looking at your P&L on the press release, I guess in Page 6, the change in estimated acquisition or non payable to $34 million. And then in the CFO commentary, the recurring is I think described as $8 million pre-tax, what is the distinction between those two numbers? What’s a good number going forward, do you think?
Doug Howell: Okay. So you’ve got the natural accretion of the earn-out liability. So, if we buy somebody and they’ve got – we’ve got $50 million on an earn-out. We discount that back around at about 8% per year. So, you’ve got the accretion of what’s going to be paid out. And then you’ve got to change and what do you think the ultimate is? So again, think that total payout could be $50 million, let’s say we put up $30 million worth of liability expecting kind of that they’re going to perform at the 60% range. Yes, 8% accretion on $30 million, but if one day they really over-performing. We’ve got to pump that up to a $40 million expectation. That that’s the difference that goes to the change in an earn-out piece, as well as an accretion piece. So there were the two different pieces. What you’re seeing those quarters. We did have some acquisitions that have are looking like they’re going to better perform. And it’s that that odd accounting that says that when we think that our acquisitions are going to perform better, we have to take a charge for that as we increase that liability. So…
Mark Hughes: And is that adjust that out?
Doug Howell: Yes. We do adjust that out.
Mark Hughes: Okay. So the reported EPS is correct for that. Does it correct to like the $9 million, $8 million or $9 million? Or does it go to take it to a…
Doug Howell: Well, the EPS is only adjusted for the change and the acquisition earn-out payable. It’s not a adjusted out, for EPS, it’s not adjusted out for amortization.
Mark Hughes: Yes, exactly. Okay.
Doug Howell: The normal accretion of liability say then, it’s the change in the ultimate payment.
Mark Hughes: Yes, I think I’d probably appreciate it.
Doug Howell: All right, thanks.
Operator: Our next question is from David Montemaden of Evercore ISI. Please state your question.
David Montemaden: Hi, good afternoon.
J. Patrick Gallagher: Hi, David.
David Montemaden: Hi. I had a bigger picture question just on the growth profile of the business. I guess it would be in 2023, when Willis Re is incorporated in the organic growth. If I look back over the last 10 years it looks like brokerage organic has been around for call it 4% or 5%. I guess, how are you thinking about Willis Re or should we think about it as just, increasing the base? So, we have like more of a higher base and we’ll grow at a similar pace as we did in the previous 10 years or do you see this enhancing the company’s growth profile going forward once that’s fully reflected in organic?
J. Patrick Gallagher: Well, I’ll let Doug anchor you in reality. And let me give you fantasy. I think the fact is that this is a leg on the stool that we haven’t had. And I think everybody on this call knows that I’ve tried for years to be a big player in this business, failed miserably once got together with a great team and had a terrific start up a second time. I had a really exciting spring thinking that we were going to land this group of people into the company, through the acquisition of Willis by Aon had that rug pulled out from under me – in late May into June. And somehow was lucky enough to be in the right place at the right time to get this back on track for a close this year. So it’s been a bit of a seesaw for me. And part of the reason I’m excited about it is that it adds so much to the company. It adds, frankly, interestingly enough, to our ability to produce middle market retail property casually business on a global basis. Now, how is that possible? Well, number one data, number two, that data and analytics, but it also gives us a clear insight into what is troubling and exciting to the carrier world. What’s going on in their capital plans. What are they seeing in accumulations? Where are we helping them? And how does that translate to what’s going on the middle market take instruction. So that’s just a whole another opportunity for me to get out in front of our team and say, look, our hit ratio today is improving, but it’s still not that different than when I joined the business. Now, how can that be? We know that 90% plus of the time when we compete in the marketplace, we’re competing with somebody smaller, typically the local agent or broker that we’re buying. And frankly, we should be crushing that. So, I would hope that that would lead to even more organic growth, even into retail level. And then you go into looking at re-insurance, this is a – this isn’t true, but there’s three main players. We’re going to be one of those. And yes, there are other players. And we were proud at [indiscernible] Gallagher to become the fifth largest at a $100 million in revenue. That’s a great accomplishment, but a $1 billion player, that new capital coming into that market, that those carriers that are looking to do new things, treaties that need to be reworked and tweaked three competitors, I think we’re going to do really well.
Doug Howell: Yes. I’ll put, I don’t think there’s any fantasy in that that at all, I think that it will all perform our regular organic growth. So, I think how much more of that will be determined. But it’s at the knob of capital creation. If you look at the Genesis of Gallagher way back when to really pioneer the alternative market, which is really capital creation, we take that with our cap as we take it with our, that the wholesaling where we're creating capital with other capital markets there to come up with programs. And, I think that it's going to give us an opportunity to create more capital combine that with the knowledge that we have with respect to certain long tail liability, like workers comp and general liability, I think that we can bring some pretty exciting capital formation together with Gallagher asset to help our self-insured clients. So, and then if you just get down into our retail business globally, I think a close partnership with the Willis and Gallagher Re, reinsurers will come up with much, with considerably more creative ideas. I believe in our culture where creative ideas get pursued. I think that will help us grow better together. So I don't think there's any fantasy in what Pat was saying.
David Montemaden: Got it. Thanks so much for that answer. That's really helpful. I guess just also sticking on Willis Re, or I guess now Gallagher Re but wondering if you can just comment on the, just the third quarter performance and how that has compared to your expectations. I'm particularly interested in just attrition levels and Doug, I think you mentioned there's obviously was some volatility, earlier this year and in the summer. So just wanted to see just how retention has been holding up, employee retention since the announcement if you have a view on that?
Doug Howell: Well, I'll be honest; we're not really allowed to have some of that while we're going through regulatory approval. And so our insight into the performance of that business is limited. It's necessary where with advanced integration planning can happen, but based on what I'm seeing; being reported right now is that it seems to be holding up very well. And I don't think that the breakage that we've assumed in our assumptions, is that they've hit anywhere near that. So I think that what it's holding up well and I got to give that team a lot of credit and they're holding that team together. They know it's going to be an exciting opportunity to be at Gallagher. So I'm a not seen financially any weakness in what we think that we're getting.
J. Patrick Gallagher: Yes, I think that's was going to be my comments around the team, that management team has held their team together through what I consider to be one of the greatest leadership challenges our industry's faced. Now, it's one thing to say, we've got an acquisition, it could be good for everybody, and we're going to get together with Aon and this is going to be terrific. And you've got a lot of doubters on both sides. And to your point earlier, where's the conflict, where's the headbutting going to be? Wow, you worked that through and then that's not really, what's going to happen. You're going to join Gallagher and that's going to be great, because there's not going to be the headbutting. They're not as big as we were together. We're not going be as big, but that's going to be great for you too. Well, that's not going to happen either. So there's no surprise as to why there was some attrition. And I can tell you since the announcement anecdotally, because Doug's right, we can't get into the numbers, but there's been very little attrition since the announcement that this is really going to happen.
David Montemaden: Got it. Thanks. That's exactly what I was looking for. Thank you.
J. Patrick Gallagher: Thanks, David.
Operator: Our next question is from Meyer Shields of KBW. Please state your question.
Meyer Shields: Thanks. It's related question on Willis Re and hopefully it's something you can answer. Are there any position to hire right now sort of in between being owned by Willis Towers Watson and being owned by Gallagher?
J. Patrick Gallagher: Yes, of course.
Meyer Shields: Okay. Perfect. I just didn't know whether there's any disruption in terms of I don't know capital or whatever. Broader question, I'm just curious in terms of how this works, when you've got raising insurance rates in an inflationary period, are your clients more or less price sensitive?
J. Patrick Gallagher: Oh man, are you kidding me? I I'll tell you.
Meyer Shields: Nope.
J. Patrick Gallagher: This is so good for us. The team's laughing in the room so I’ve gone now, slow down everybody. Of course the clients are freaking out. You've got their costs going up before they've got their revenue adjusted to cover it. So take our construction risk. They've all bid everything already. They're in the middle of the job. Supply chains, cost of cement, cost of lumber, blah, blah, going up like crazy, every cost on their P&Ls under, they've got to look at everything. So here we come as a really, really good player in the construction area. Again, we compete 90% of the time and very nice accounts with smaller competitors. We can analyze and show them what's actually happening in the book by that type of cover by that type of client. And then we can show them that we can improve upon what they've been getting from their local agent. Yes, they're sensitive. Yes, it should be good new business for us.
Meyer Shields: Okay. And then the follow-up, which I guess you mostly answered already. Does that mean that your win ratios or your win rates go up relative to smaller competitors because of capability?
J. Patrick Gallagher: Yes.
Meyer Shields: Okay, perfect. I just wanted frame all this. Thank you.
J. Patrick Gallagher: Thanks Meyer.
Operator: Our final question comes from Mark Hughes of Truist. Please state your question.
Mark Hughes: Yes, thanks. Doug, did you comment on, you talked about organic for 2022 being similar. This year you did 150 basis points in the brokerage segment on that organic, is that’s a good bogie for next year as well? Are there any other costs coming or going that will influence that?
Doug Howell: Yes, I think let's break it down. I think that an organic much like this year, next year that 9% to 10% range is possible 8%, 9%, 10% range. What will margins do next year? Well, some of that depends on how much further cost return to our structure that haven't yet returned to our structure. Remember we are pretty low cost basis still in the first quarter of 2021. So that will revert to next quarter in 2021 also. So I'll put a little pressure on the year-over-year. We're in the middle of budget and planning cycle right now. Mark, I'll have a better answer for you on that in December, but if we're pumping out organic growth pushing 10% next year, there's still opportunities for us to take some of that to the bottom-line. How much is that going to improve margin next year? Give me till December to figure that out.
Mark Hughes: Very good. And then I'll ask you on the shift to cash EPS I'm just looking at your CFO commentary and looking at that recurring amortization of $95 million any comments you'd like to add throw out how much of that might be added back for a cash EPS number?
Doug Howell: Well, $400 million out a year. I think that in all cases that we've looked at a 100% of that has been added back. You got a tax effectively, but that's something that's, it's a big number.
Mark Hughes: And you wouldn't want to be outside of the mainstream on that. Would you doesn't sound like it?
Doug Howell: Say that again?
Mark Hughes: I said you wouldn't want to be outside of the mainstream, if everybody else is adding the whole net back, you would want do the same thing that I presume?
Doug Howell: I think comparability would be very helpful.
Mark Hughes: Right. Okay. Thank you for that. Appreciate it.
Doug Howell: All right. Thanks Mark.
J. Patrick Gallagher: Thanks Mark. And thanks everybody for your questions. So thank you again, all of you for joining us today. As we said over and over, we delivered a great third quarter and I'd like to thank our 35,000 plus colleagues around the globe for their hard work, dedication and unwavering client-centric attitude. We look forward to speaking to you again at our December Investor Day. Thank you for being with us and have a nice evening.
Operator: This does conclude today's conference call. You may disconnect your lines at this time and have a wonderful day. | [
{
"speaker": "Operator",
"text": "Good afternoon and welcome to Arthur J. Gallagher & Co.’s Third Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you. Good afternoon. And thank you for joining us for our third quarter 2021 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had a fantastic third quarter. For our combined brokerage and risk management segments we posted 17% growth in revenue, 10% organic growth and nearly 11% organic, if you control for last year's large life sale that we've discussed frequently. Net earnings growth of 22%, adjusted EBITDA growth of 13% and we completed five new mergers in the quarter bringing our year-to-date closed merger counts in 19 representing nearly $200 million of annualized revenue. And if you add in the pending Willis Reinsurance merger, that number would be pushing $1 billion. So the team continues to execute at a very high level, growing organically, growing through acquisitions, improving our productivity, raising our quality, and most importantly, constantly building upon our unique Gallagher culture, a terrific quarter on all measures. Let me provide a brief update on our agreement to purchase Willis Re. On the regulatory approval front, we received competition clearance in five or six jurisdictions required to close, including clearance by the U.S. Department of Justice. The final jurisdiction in the UK, where the CMA is reviewing the transaction, that's the final jurisdiction. That review is ongoing, but we believe we are in good shape. Although, there's still work to be done at this point, we believe we're on track for a fourth quarter closing. On the integration front, hundreds of Gallagher and Willis Re professionals are hard at work ensuring we will be well positioned to service our clients when we close. Our 40 year acquisition history allows us to leverage our proven M&A integration path. Integration is in our DNA. We're looking forward to welcoming 2,200 new colleagues to Gallagher as a family of professionals this holiday season. It's really exciting to think about all the talent and expertise that will be joining us. It's going to be incredible for our combined organization and our clients. Okay, back to our quarterly results, starting with the brokerage segment. Reported revenue growth was excellent at 16%, of that 9% was organic revenue growth, at the upper end of our September IR Day expectation and nearly 10% controlling for last year's large life product sale. Net earnings growth was 23% and we grew our adjusted EBITDA at 13%. Doug will provide some comments on third quarter margin and our fourth quarter outlook, but needless to say another excellent quarter from the brokerage team. Let me walk you around the world and break down our organic by geography, starting with our PC operations. First, our domestic retail operations were very strong with more than 10% organic, results were driven by good new business combined with higher exposures and continued rate increases. Risk placement services, our domestic wholesale operations grew 16%. This includes more than 30% organic in open brokerage and 5% organic in our MGA programs in binding businesses. New business and retention were both up a point or so relative to 2020 levels. Outside the U.S., our UK operations posted more than 9% organic. Specialty was 12% and retail was a solid 6%, both supported by excellent new business production. Australia and New Zealand combined grew more than 6%, also benefiting from good new business. And finally, Canada was up nearly 10% on the back of double-digit new business and stable retention. Moving to our employee benefit, brokerage and consulting business. Third quarter organic was up about 5% in line with our September IR Day commentary, controlling for last year's large life insurance product sale, organic would have been up high single-digits and represents a really nice step up from the 4% organic we reported for the second quarter and the 2% organic for the first. So we were experiencing positive revenue momentum and really encouraging sign for the remainder of the year and 2022. So total brokerage segment, organic solidly in that 9% to 10% range, simply an excellent quarter. Next, I'd like to make a few comments on the PC market. Global PC rates remain firm overall, and pricing is positive at nearly all product lines. Overall, third quarter renewal premium increases were about 8% and similar to increases during the first half of this year. Moving around the world, U.S. retail premiums up about 8%, including nearly 10% increases in casualty and professional liability. Even workers' comp was up around 5%. In Canada, premiums up about 9% driven by double-digit increases in professional liability and casualty, Australia and New Zealand combined up 3% to 4%. And UK retail was up about 7% with double-digit increases in professional liability while commercial auto is closer to flat. Finally, within RPS, wholesale open brokerage premiums were up more than 10% and binding operations were up 5%. Additionally, improved economic activity, even despite the Delta variant and supply chain disruptions are leading to positive policy endorsements and other favorable midterm policy adjustments as our customers add coverages and exposures to their existing policies. So premiums are still increasing almost everywhere. As we look ahead over the coming quarters, I see the PC market remaining difficult with rate increases persisting for quite a while. In the near-term, we don't see any meaningful changes in carrier underwriting, appetite capacity, attachment points or terms and conditions. Long-term markets do not appear to be seeing a slow down in rising loss costs. Global third quarter, natural catastrophe losses likely in excess of $40 billion increased cyber incidences, social inflation, replacement cost inflation and supply chain disruptions. And all of this is before factoring in further increases in claim frequency as global economies recover and become even more robust. All of these factors combined with low investment returns suggested carriers will continue to push for rate. I just don't see a dramatic change for the foreseeable future. So it's still a very difficult and even hard in many spots, global PC environment. But remember, our job as brokers is to help our clients find the best coverage while mitigating price increases through our creativity, expertise and market relationships. As we think about the environment for our employee benefits, let’s improve business activity, lower unemployment, and increased demand for our consulting services is driving more revenue opportunities. And our customers and prospects continue to rapidly shift away from expense control strategies to plans and tactics that will help them grow their business. And with rebounding covered lives in one of the most challenging labor markets in memory, our consulting businesses are extremely well-positioned to deliver creative solutions to our clients. So as I sit here today, I think fourth quarter brokerage segment organic will be similar to the third quarter and that could take full year 2021 organic towards 8%. That would be a really nice improvement from the 3.2% organic we reported in 2020. To put that in perspective, 8% would be our best full year brokerage segment organic growth in nearly two decades. And we think 2022 organic will end up in a very similar range. Moving on to mergers and acquisitions. I mentioned earlier, we completed five brokerage mergers during the quarter representing about $16 million of estimated annualized revenues. I’d like to thank all our new partners for joining us. And I extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in M&A pipeline, we have more than 50 term sheets signed are being prepared, representing around $400 million of annualized revenues. So even without the re-insurance merger, it’s looking like we will finish 2021 strong wrapping up another successful year for our merger strategy. Next, I would like to move to our Risk Management segment, Gallagher Bassett. Third quarter organic growth was 16.6% even better than our September IR Day expectation. Margins were strong too. Adjusted EBITDAC margin once again came in above 19%. Results continue to benefit from late 2020 and early 2021 new business wins. In addition to further improvement in new arising claims within general liability and core workers’ compensation just an exceptional quarter from the team. Looking forward, while our fourth quarter comparison is somewhat more challenging, the recovering global economy, improving employment situation and excellent new business production should result in fourth quarter organic over 10%. That puts us on track for double-digit full year organic and an EBITDAC margin nicely above 19%. As I look back over the last nine months, I can’t help, but to be thoroughly impressed with our team and our accomplishments. Our commitment to our clients, and to each other’s evident in our successes and that is due to our unique Gallagher culture. In these challenging times, our clients are continuing to count on us. And I’m proud of our teams unwavering client focus. Gallagher’s unique culture is founded on the values in the Gallagher way. Those values have kept us on a steady course throughout the pandemic. And time and time again during these past months, our clients have shared their trust and appreciation for the value Gallagher brings to the table. It comes down to talented individuals tapping into the power of our expertise across the globe, working together during this ongoing pandemic to continue to deliver for our clients. That’s the Gallagher way, and it’s the backbone of who we are as an organization. Okay. I’ll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat, and hello everyone. As Pat said, a fantastic third quarter. Today, I’ll touch on a few items in the earnings release, predominantly organic and margins, then I’ll walk you through our CFO commentary document and finish up with my typical comments on cash, liquidity and capital management. Okay. Let’s move to Page 4 of the earnings release and the Brokerage segment organic table. Headline all-in organic of 9%, outstanding on its own, but as Pat said, really running closer to 10% due to last year live sales, either way, a nice step up from the 6% we posted in the first quarter and the 6.8% in the second. As we sit now, I’m seeing a fourth quarter organic again pushing that double-digit level. Turning now Page 6 to the Brokerage segment adjusted EBITDAC margin table. Okay. Underlying margin after controlling for the live sale was around 160 basis points. Let me take you through the map to get you to that. First, headline margins were down 48 basis points, right about where we forecasted at our September IR Day. So controlling for the large live sale would bring us back to flat. Second, in September, we forecasted about $25 million of expenses returning into our structure as we emerged from the pandemic and a small amount of performance comp time. We call expenses returning mostly relate to higher utilization of our self-insured medical plans, resumption of advertising costs, more use of consultants, merit increases, and a small pickup and T&E expenses We came in right on that forecast. So controlling for these expenses also brings you to that underlying margin expansion of about 160 basis points that feels about right on organic in that 9% to 10% range. Looking forward, we think about $30 million of our pre-pandemic period expense savings return in the fourth quarter. And if you assume say 9% organic math would say, we should show 90 to 100 basis points of expansion here in the fourth quarter. So in the end, the headline story is that we have a really decent chance at growing our full year 2021 margins by nearly 150 basis points. And that’s even growing over the live sale and the return of costs would come out of the pandemic. Add that to expanding margins over 400 basis points last year means we’d be growing margins more than 550 basis points over two years. That really demonstrates the embedded improvements in how we do business. No matter how you look at it, it’s simply outstanding work by the team. Moving to the Risk Management segment EBITDAC table on Page 7. Adjusted EBITDAC margin of 19.5% in the quarter is an excellent result. Year-to-date, our margins are at 19.2%, which underscores our ability to maintain a large portion of our pandemic period savings. Looking forward, we think we can hold margins above 19% in the fourth quarter and for the full year. That would result in about a 100 basis points of margin expansion relative to 2020, another fantastic margin story. Now I shift to our CFO commentary document we posted on our IR website. Starting on Page 4, you’ll see most of the third quarter items are close to our September IR Day estimates. One small exception is Brokerage segment amortization expense about $3 million below our September IR Day estimate. It’s simply because we finalized our valuation work on a recent 21 acquisition would causes a small catch-up estimate change. We adjusted that out on Page 1 of the earnings release. So it doesn’t benefit adjusted EPS. Flipping to Page 5 and the Corporate segment table. There in actual third quarter results in the blue section to our September IR estimates in gray. Interest in banking line on a reported and adjusted basis were both in line. The non-GAAP adjustment here is that $12 million charge related to the early extinguishment of debt that we issued in May related to the terminated Aon and Willis remedy package. Acquisition cost line, mostly related to the Willis retransaction came in a bit higher than our IR Day estimate on a reported basis, but in line on an adjusted non-GAAP basis. We will see some additional transaction related costs here in the fourth quarter should have a sense of what those costs might be at our December IR Day. Again, we plan on presenting these costs of the non-GAAP adjustment as well. On the corporate cost line, in line on an adjusted basis after controlling for $5 million of a one-time permanent tax item. That’s a non-cash and it’s simply a small valuation allowance related to a couple of international M&A transactions. And finally, clean energy. What a terrific quarter, came in much better than our estimate. Thanks for a warm September, less wind in certain areas of the country and higher natural gas prices. We are increasing our full year net earnings range to $87 million to $95 million on the back of the third quarter upside. Okay. As for cash and capital management and M&A. As you heard Pat say, we have a strong pipeline of tuck-in merger opportunities, and that’s on top of the Willis reacquisition that we hope to close here in the fourth quarter. At September 30, cash on hand was about $2.7 billion and we have no outstanding borrowers on our credit facility. We plan to use that cash, cash flow generated during the fourth quarter and our line of credit to fund our – the acquisition of Willis Ray. Before I turn it back over to Pat, our year-to-date performance deserves I mention. Our brokerage and risk management segments combined have produced 15% growth in revenue, nearly 8% organic growth. We completed 19 new mergers this year with nearly $200 million of estimated annualized revenue, net earnings margin expanded 81 basis points, adjusted EBITDAC margin expanded 153 basis points and our clean energy investments are on track to being up 30 this year. Setting us up nicely for substantial additional cash flows for the coming five to seven years. A terrific quarter in nine months on all measures, positions us for another great year. Okay. Those are my comments, back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Doug. And Hillary, we can go to questions."
},
{
"speaker": "Operator",
"text": "Thank you. The call is now open for questions. [Operator Instructions] Our first question is from Mike Zaremski of Wolfe Research. Please state your question."
},
{
"speaker": "Mike Zaremski",
"text": "Great. Good evening. Hey, how are you?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Terrific."
},
{
"speaker": "Mike Zaremski",
"text": "Maybe – great. Yes. Imagining great results. So maybe quickly on the Willis or maybe I should call it AJ Gallagher soon. There’s a gap between kind of the estimated earnings you guys have disclosed and Willis disclosed, and there’s also this kind of shared services stranded costs issue. And just kind of curious is, is that any color you can provide on whether your guide is baking in some, I guess, sharing of expenses that will eventually change over time and I guess, improve the earnings levels of the operation for you all."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Good question. Here’s the thing. We believe we bought about $265 million worth of EBITDA, right? And I think if you kind of do some math on this morning’s report, it looks like in the nine months reporting around $321 million – excuse me, $315 million worth of EBITDA. So their numbers are a little higher than ours. I can guess on why there’s some differences. Their cost might not be fully loaded for costs that would – it would take us to run the business or they would be running the business on a standalone basis. But it was good to see the fact that their number was higher than ours."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Yes. That’s what I’m living too. So – but in terms of the shared services, is your current guidance baking in an expense that will over time fall?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No. I think that what they can service it for and well under the TSA and what we can ultimately service it for gets us back to that $265 million."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. I guess moving gears to the pricing environment from your color and the prepared remarks. Did I hear correct saying that worker’s comp was plus five? And I guess, just generally it feels like there’s kind of been less deceleration, I think, than some expected in terms of pricing. That seems like it’s – I’m curious, if you think it’s emanating just from the property side or it’s coming back on the casualty side as well, because maybe there’s a more uncertainty about a loss inflation or maybe worker’s comp claims are coming back. I know it’s a long-winded question. But any color on kind of what’s moving the pricing environment. Thanks."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes. Thanks, Mike. Yes. Interestingly enough, with all the cat losses properties slightly down in rate, casually continues to spike a properties down quarter-over-quarter, just about a point and a half or so in rate and our book now. I’m speaking about our book of business. Casually, is up a little over a point and worker’s compensation is up about five. So these things moderate quarter-to-quarter that this is not a prediction of any sort for next year, but when we get ready for this call, we look at that and say, okay, what’s actually happening in the market. By the way, our statistics are airtight, by-product, by geography, by billing as of yesterday. So I’m very confident in these numbers. Overall rate is continuing to be up about 8%."
},
{
"speaker": "Doug Howell",
"text": "Yes. Just to add to that, if you look back at third quarter 2020, we had our whole portfolio of rate up 7.1%, and this third quarter 2021, it’s up 7.9%. Now there’s a little exposure unit adjustment in there on that. When you look at casually third quarter last year was 5.7%. It’s up 8.4%. Liability was up 10.6% last year, it was up 10 points this year. Commercial auto granted I would – there’s exposure units, and this was flat it’s up 4% this quarter. Package, third quarter is 5.7% up 8.9% this quarter. Property up 11.2%, this quarter up 8%. Marine was 3% and it’s up 6%. So when you look across all in were higher this year third quarter than we were last year third quarter by almost a full point."
},
{
"speaker": "Mike Zaremski",
"text": "Interesting. Thank you for the color."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Mike."
},
{
"speaker": "Doug Howell",
"text": "And those are global numbers."
},
{
"speaker": "Operator",
"text": "Our next question is from Elyse Greenspan of Wells Fargo. Please state your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good evening. My first question is following up on a topic that we discussed in your recent Investor Day, Doug. So we’re discussing the potential for tax changes related to clean energy, and it sounded like there was still maybe a chance, but you guys were thinking the laws would sunset at the end of this year. Has anything changed there? And is it still the plan based on the discussion from September to rollout some type of cash earnings metrics? Is it sounded like in conjunction with first quarter of 2022 earnings?"
},
{
"speaker": "Doug Howell",
"text": "Yes. We’re still on track with a project that’s going to convert it. I don’t know if I’d necessarily call it cash. Let’s be careful about that. But we’re taking a look at how other publicly held brokers and professional services report their non-GAAP EPS and what I call a modified cash approach. And there are a number of different approaches out there whether it’s adjusting for amortization depreciation, but then there’s the subtleties of pension, stock-based compensation. So we’re working through that, nothing to report today, but the projects ongoing, I hope to give you a better update at our December IR Day."
},
{
"speaker": "Elyse Greenspan",
"text": "But if you were to roll it out, the plan would be sometime in March early April next year."
},
{
"speaker": "Doug Howell",
"text": "Yeah, I think so. I think we’ll finish this year on this basis and then go to that basis next spring, the first quarter. We clearly have an IR Day, we’d go back and represent everything historically on that basis. Let you be well-prepared so that let’s say we did it first quarter that you wouldn’t – that you can adjust all your models before we release."
},
{
"speaker": "Elyse Greenspan",
"text": "And then in terms of the organic outlook for next year for brokerage, it sounds like you’re expecting around 8% growth, which is what you expect this year to come in. Within I mean, I know we’re still a little ways away and it’s hard to have precision. But within that guide benefits was a little weak to start the year. So I guess that should be a tailwind or there just – would you expect that to be a tailwind and maybe brokerage slowed a little bit. But can you just help me understand kind of how you’re seeing the moving parts within your businesses for 2022 as it sits today?"
},
{
"speaker": "Doug Howell",
"text": "Well, I think we’ll have two things. I think that they’re slightly tougher compares when you get into 2022 because we did have this – we’re having some good results here in 2021. But I think we do have some businesses that are recovering our programs, our binding businesses, our new business startups are recovering better than the wholesale business. I think you’re starting to see covered lives increase, more consulting work coming back into the structure. Rate increases, we’re not seeing that slowing down at all. So I think there’s enough there on those other – in those other places that would offset the tougher compares next year."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. Thanks for the color."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Elyse."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Elyse."
},
{
"speaker": "Operator",
"text": "Our next question is from Josh Shanker of Bank of America. Please state your question."
},
{
"speaker": "Josh Shanker",
"text": "Yes. Thank you very much for taking my question. So, given a 4Q 2021 close is Willis Re and the Gallagher Re organizations going to be unfortunately competing against each other on January 1. What’s sort of the way you’re managing that given such a close proximity to one, one renewals?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, what’s really nice about this acquisition is there is very little, if almost no overlap. We are not competing head to head really on much at all Capsicum, which was a startup, very successful became of course, Gallagher Re. This is very complimentary business. There might be a few little areas here or there where they each touch, but there are no major renewals across the treaty book that are in conflict. And so what you’ve got is the Gallagher Re people who you could imagine if you were just reading about this numbers to numbers, could be worried about a much larger competitor being acquired, being able to come in with their name, of course, and our brand and how are we going to sort that out? And what does that mean to the clients that they’ve been calling on? Virtually none of that exists. So what you’ve got is a team of people from the Willis Re side that are very excited. The people from Gallagher Re existing are very excited. They hit the ground running in January with a new, improved, much expanded Gallagher Re, and that’s a branding exercise. It is outstanding for all parties and it brings tremendous additional capabilities because as a startup, as you can imagine, over three, four or five years, Capsicum Re has had to develop all the individual capabilities, one at a time, pay for it as they go, still driving decent margins and top line growth. Willis’ is over a hundred years old. They built this stuff they’ve just got terrific depth. And so it’s going to be a very strong combination with almost no conflict whatsoever."
},
{
"speaker": "Josh Shanker",
"text": "Thank you. And when you talk about $400 million of annualized revenue on 50 term sheets, I sort of look at these lists of the biggest brokers and $20 million per acquisition, obviously they’re going to come in different sizes, but there’s obviously some larger ones out there numbers, $11 million through, let’s say $50 million on any list you look at. In terms of cultural fit, do the – have you for the most part found cultural fit in the smaller tuck-ins that have that same entrepreneurial spirit? And are the larger brokers they have their own culture at this point that may not be as good of a fit for Gallagher going forward."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I don’t know if I’d say Josh it’s a matter of size, but here let’s put this in perspective. There’s according to Bobby Reagan’s organization there’s 39,000 agents and brokers in America and that’s firms, not people. Now, number 100 on business insurances lists did $26 million last year. So when you look at what’s available to be purchased, you’ve got 100 that take you to $26 million. You’ve got 38,900, less than that. And our people are out every day talking to our competitors and this is done right at the Street level. Not all of them are brought to the table by brokers that are representing them. And you have large ones that come up from time to time. And when we get a chance at the SIM and we get a chance to get to know them, our number one due diligence efforts still remains culture. You don’t get to wash away culture by size and dollar amount. And no, I wouldn’t say some bigger ones don’t fit because they’re bigger. There are some larger acquisitions we’ve done in the past years that we were thrilled with the fit and they’ve been thrilled with the fit. Now by item count, as you know, most of our acquisitions fall at the $10 million or less level, and yes, they fit extremely well into our entrepreneurial culture."
},
{
"speaker": "Doug Howell",
"text": "Yes. Josh, just to clarify, we’ve got 50 outstanding term sheets on 400, which makes the average broker size about $8 million there."
},
{
"speaker": "Josh Shanker",
"text": "Yes. Your math is better than mine. It’s been a long couple of days."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I get that."
},
{
"speaker": "Doug Howell",
"text": "I get it."
},
{
"speaker": "Josh Shanker",
"text": "Thank you for correcting me."
},
{
"speaker": "Doug Howell",
"text": "Sure. But there are some nice ones in here in that $20 million range too."
},
{
"speaker": "J. Patrick Gallagher",
"text": "And you’re right. The top 100 have probably sold more of those in the last two years than probably five years before that combined. And that’s a matter of all kinds of things, appetite, age, multiples, tax law, et cetera. And when we look at those, and if they fit culturally, we try hard to get them to join the team."
},
{
"speaker": "Josh Shanker",
"text": "Wonderful. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Our next question is from Mark Hughes of Truist. Please state your question."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Thank you. Good afternoon."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Worker’s comp you sounds like it doing better, any way to characterize, is this a change in appetite on the part of certain carriers? Is it just a higher payrolls what’s driving that?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I think all of the above. I think you’ve got, well, first of all, you have the economy recovering. So, we see that in our Gallagher Bassett numbers. You can see the economy in claim count growth. You do have social inflation, and you have you just got more work being done. And I think that makes a difference, but we’re talking right here, and that’s really driven by loss ratios and what they see. And the thing about worker’s comp, I have to give our carrier partners credit. They know what’s going on in that line every day, and when they see a need to move, right? And that’s why during the hard market, many, many quarters we report flat work comp, because they didn’t need the rate. So this is really interesting to me because they’re not waiting around to find out that they’re 25 points behind the eight ball, and then trying to get it back at one swoop. So, I think it’s a good sign, both of their being on top of their numbers, incredibly well, a recovering economy and need for more and more premium in the line."
},
{
"speaker": "Mark Hughes",
"text": "Doug, I’m not sure if I’m being dense here, but I’m looking at your P&L on the press release, I guess in Page 6, the change in estimated acquisition or non payable to $34 million. And then in the CFO commentary, the recurring is I think described as $8 million pre-tax, what is the distinction between those two numbers? What’s a good number going forward, do you think?"
},
{
"speaker": "Doug Howell",
"text": "Okay. So you’ve got the natural accretion of the earn-out liability. So, if we buy somebody and they’ve got – we’ve got $50 million on an earn-out. We discount that back around at about 8% per year. So, you’ve got the accretion of what’s going to be paid out. And then you’ve got to change and what do you think the ultimate is? So again, think that total payout could be $50 million, let’s say we put up $30 million worth of liability expecting kind of that they’re going to perform at the 60% range. Yes, 8% accretion on $30 million, but if one day they really over-performing. We’ve got to pump that up to a $40 million expectation. That that’s the difference that goes to the change in an earn-out piece, as well as an accretion piece. So there were the two different pieces. What you’re seeing those quarters. We did have some acquisitions that have are looking like they’re going to better perform. And it’s that that odd accounting that says that when we think that our acquisitions are going to perform better, we have to take a charge for that as we increase that liability. So…"
},
{
"speaker": "Mark Hughes",
"text": "And is that adjust that out?"
},
{
"speaker": "Doug Howell",
"text": "Yes. We do adjust that out."
},
{
"speaker": "Mark Hughes",
"text": "Okay. So the reported EPS is correct for that. Does it correct to like the $9 million, $8 million or $9 million? Or does it go to take it to a…"
},
{
"speaker": "Doug Howell",
"text": "Well, the EPS is only adjusted for the change and the acquisition earn-out payable. It’s not a adjusted out, for EPS, it’s not adjusted out for amortization."
},
{
"speaker": "Mark Hughes",
"text": "Yes, exactly. Okay."
},
{
"speaker": "Doug Howell",
"text": "The normal accretion of liability say then, it’s the change in the ultimate payment."
},
{
"speaker": "Mark Hughes",
"text": "Yes, I think I’d probably appreciate it."
},
{
"speaker": "Doug Howell",
"text": "All right, thanks."
},
{
"speaker": "Operator",
"text": "Our next question is from David Montemaden of Evercore ISI. Please state your question."
},
{
"speaker": "David Montemaden",
"text": "Hi, good afternoon."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, David."
},
{
"speaker": "David Montemaden",
"text": "Hi. I had a bigger picture question just on the growth profile of the business. I guess it would be in 2023, when Willis Re is incorporated in the organic growth. If I look back over the last 10 years it looks like brokerage organic has been around for call it 4% or 5%. I guess, how are you thinking about Willis Re or should we think about it as just, increasing the base? So, we have like more of a higher base and we’ll grow at a similar pace as we did in the previous 10 years or do you see this enhancing the company’s growth profile going forward once that’s fully reflected in organic?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I’ll let Doug anchor you in reality. And let me give you fantasy. I think the fact is that this is a leg on the stool that we haven’t had. And I think everybody on this call knows that I’ve tried for years to be a big player in this business, failed miserably once got together with a great team and had a terrific start up a second time. I had a really exciting spring thinking that we were going to land this group of people into the company, through the acquisition of Willis by Aon had that rug pulled out from under me – in late May into June. And somehow was lucky enough to be in the right place at the right time to get this back on track for a close this year. So it’s been a bit of a seesaw for me. And part of the reason I’m excited about it is that it adds so much to the company. It adds, frankly, interestingly enough, to our ability to produce middle market retail property casually business on a global basis. Now, how is that possible? Well, number one data, number two, that data and analytics, but it also gives us a clear insight into what is troubling and exciting to the carrier world. What’s going on in their capital plans. What are they seeing in accumulations? Where are we helping them? And how does that translate to what’s going on the middle market take instruction. So that’s just a whole another opportunity for me to get out in front of our team and say, look, our hit ratio today is improving, but it’s still not that different than when I joined the business. Now, how can that be? We know that 90% plus of the time when we compete in the marketplace, we’re competing with somebody smaller, typically the local agent or broker that we’re buying. And frankly, we should be crushing that. So, I would hope that that would lead to even more organic growth, even into retail level. And then you go into looking at re-insurance, this is a – this isn’t true, but there’s three main players. We’re going to be one of those. And yes, there are other players. And we were proud at [indiscernible] Gallagher to become the fifth largest at a $100 million in revenue. That’s a great accomplishment, but a $1 billion player, that new capital coming into that market, that those carriers that are looking to do new things, treaties that need to be reworked and tweaked three competitors, I think we’re going to do really well."
},
{
"speaker": "Doug Howell",
"text": "Yes. I’ll put, I don’t think there’s any fantasy in that that at all, I think that it will all perform our regular organic growth. So, I think how much more of that will be determined. But it’s at the knob of capital creation. If you look at the Genesis of Gallagher way back when to really pioneer the alternative market, which is really capital creation, we take that with our cap as we take it with our, that the wholesaling where we're creating capital with other capital markets there to come up with programs. And, I think that it's going to give us an opportunity to create more capital combine that with the knowledge that we have with respect to certain long tail liability, like workers comp and general liability, I think that we can bring some pretty exciting capital formation together with Gallagher asset to help our self-insured clients. So, and then if you just get down into our retail business globally, I think a close partnership with the Willis and Gallagher Re, reinsurers will come up with much, with considerably more creative ideas. I believe in our culture where creative ideas get pursued. I think that will help us grow better together. So I don't think there's any fantasy in what Pat was saying."
},
{
"speaker": "David Montemaden",
"text": "Got it. Thanks so much for that answer. That's really helpful. I guess just also sticking on Willis Re, or I guess now Gallagher Re but wondering if you can just comment on the, just the third quarter performance and how that has compared to your expectations. I'm particularly interested in just attrition levels and Doug, I think you mentioned there's obviously was some volatility, earlier this year and in the summer. So just wanted to see just how retention has been holding up, employee retention since the announcement if you have a view on that?"
},
{
"speaker": "Doug Howell",
"text": "Well, I'll be honest; we're not really allowed to have some of that while we're going through regulatory approval. And so our insight into the performance of that business is limited. It's necessary where with advanced integration planning can happen, but based on what I'm seeing; being reported right now is that it seems to be holding up very well. And I don't think that the breakage that we've assumed in our assumptions, is that they've hit anywhere near that. So I think that what it's holding up well and I got to give that team a lot of credit and they're holding that team together. They know it's going to be an exciting opportunity to be at Gallagher. So I'm a not seen financially any weakness in what we think that we're getting."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes, I think that's was going to be my comments around the team, that management team has held their team together through what I consider to be one of the greatest leadership challenges our industry's faced. Now, it's one thing to say, we've got an acquisition, it could be good for everybody, and we're going to get together with Aon and this is going to be terrific. And you've got a lot of doubters on both sides. And to your point earlier, where's the conflict, where's the headbutting going to be? Wow, you worked that through and then that's not really, what's going to happen. You're going to join Gallagher and that's going to be great, because there's not going to be the headbutting. They're not as big as we were together. We're not going be as big, but that's going to be great for you too. Well, that's not going to happen either. So there's no surprise as to why there was some attrition. And I can tell you since the announcement anecdotally, because Doug's right, we can't get into the numbers, but there's been very little attrition since the announcement that this is really going to happen."
},
{
"speaker": "David Montemaden",
"text": "Got it. Thanks. That's exactly what I was looking for. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Our next question is from Meyer Shields of KBW. Please state your question."
},
{
"speaker": "Meyer Shields",
"text": "Thanks. It's related question on Willis Re and hopefully it's something you can answer. Are there any position to hire right now sort of in between being owned by Willis Towers Watson and being owned by Gallagher?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes, of course."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Perfect. I just didn't know whether there's any disruption in terms of I don't know capital or whatever. Broader question, I'm just curious in terms of how this works, when you've got raising insurance rates in an inflationary period, are your clients more or less price sensitive?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Oh man, are you kidding me? I I'll tell you."
},
{
"speaker": "Meyer Shields",
"text": "Nope."
},
{
"speaker": "J. Patrick Gallagher",
"text": "This is so good for us. The team's laughing in the room so I’ve gone now, slow down everybody. Of course the clients are freaking out. You've got their costs going up before they've got their revenue adjusted to cover it. So take our construction risk. They've all bid everything already. They're in the middle of the job. Supply chains, cost of cement, cost of lumber, blah, blah, going up like crazy, every cost on their P&Ls under, they've got to look at everything. So here we come as a really, really good player in the construction area. Again, we compete 90% of the time and very nice accounts with smaller competitors. We can analyze and show them what's actually happening in the book by that type of cover by that type of client. And then we can show them that we can improve upon what they've been getting from their local agent. Yes, they're sensitive. Yes, it should be good new business for us."
},
{
"speaker": "Meyer Shields",
"text": "Okay. And then the follow-up, which I guess you mostly answered already. Does that mean that your win ratios or your win rates go up relative to smaller competitors because of capability?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes."
},
{
"speaker": "Meyer Shields",
"text": "Okay, perfect. I just wanted frame all this. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Meyer."
},
{
"speaker": "Operator",
"text": "Our final question comes from Mark Hughes of Truist. Please state your question."
},
{
"speaker": "Mark Hughes",
"text": "Yes, thanks. Doug, did you comment on, you talked about organic for 2022 being similar. This year you did 150 basis points in the brokerage segment on that organic, is that’s a good bogie for next year as well? Are there any other costs coming or going that will influence that?"
},
{
"speaker": "Doug Howell",
"text": "Yes, I think let's break it down. I think that an organic much like this year, next year that 9% to 10% range is possible 8%, 9%, 10% range. What will margins do next year? Well, some of that depends on how much further cost return to our structure that haven't yet returned to our structure. Remember we are pretty low cost basis still in the first quarter of 2021. So that will revert to next quarter in 2021 also. So I'll put a little pressure on the year-over-year. We're in the middle of budget and planning cycle right now. Mark, I'll have a better answer for you on that in December, but if we're pumping out organic growth pushing 10% next year, there's still opportunities for us to take some of that to the bottom-line. How much is that going to improve margin next year? Give me till December to figure that out."
},
{
"speaker": "Mark Hughes",
"text": "Very good. And then I'll ask you on the shift to cash EPS I'm just looking at your CFO commentary and looking at that recurring amortization of $95 million any comments you'd like to add throw out how much of that might be added back for a cash EPS number?"
},
{
"speaker": "Doug Howell",
"text": "Well, $400 million out a year. I think that in all cases that we've looked at a 100% of that has been added back. You got a tax effectively, but that's something that's, it's a big number."
},
{
"speaker": "Mark Hughes",
"text": "And you wouldn't want to be outside of the mainstream on that. Would you doesn't sound like it?"
},
{
"speaker": "Doug Howell",
"text": "Say that again?"
},
{
"speaker": "Mark Hughes",
"text": "I said you wouldn't want to be outside of the mainstream, if everybody else is adding the whole net back, you would want do the same thing that I presume?"
},
{
"speaker": "Doug Howell",
"text": "I think comparability would be very helpful."
},
{
"speaker": "Mark Hughes",
"text": "Right. Okay. Thank you for that. Appreciate it."
},
{
"speaker": "Doug Howell",
"text": "All right. Thanks Mark."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Mark. And thanks everybody for your questions. So thank you again, all of you for joining us today. As we said over and over, we delivered a great third quarter and I'd like to thank our 35,000 plus colleagues around the globe for their hard work, dedication and unwavering client-centric attitude. We look forward to speaking to you again at our December Investor Day. Thank you for being with us and have a nice evening."
},
{
"speaker": "Operator",
"text": "This does conclude today's conference call. You may disconnect your lines at this time and have a wonderful day."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 2 | 2,021 | 2021-07-29 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Co.'s Second Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. Today's call is being recorded. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements.
J. Patrick Gallagher: Thank you, Laura. Good afternoon, and thank you for joining us for our second quarter 2021 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had an excellent second quarter. The team delivered on all four of our long-term operating priorities to drive shareholder value. We grew organically. We grew through acquisitions, improved our productivity all while raising our quality and maintaining our unique Gallagher culture. For our combined Brokerage and Risk Management segments, we posted 17% growth in revenue, 8.6% organic growth, but it's over 10% when adjusted for timing, which Doug will spend some time on in a few minutes. Net earnings margin expansion of 107 basis points, adjusted EBITDAC margin expansion of 30 basis points. And we completed eight new mergers in the quarter, with more than $70 million of estimated annualized revenue. Most importantly, our Gallagher culture continues to thrive. Just a fantastic quarter on all measures. Now, before I discuss how each of our businesses performed in more detail, let me comment briefly about the termination of our agreement to purchase certain Willis Towers Watson brokerage operations. We were excited about the opportunity. We would have loved to complete the transaction. There are a lot of great people at Willis and they would have been a great addition to our team. But here's the key point. With or without this, we remained very well-positioned to support our clients, compete for new ones and ultimately drive value for all of our stakeholders. We're in the greatest business on earth. Our culture is stronger than ever, and I'm excited about our future. Okay. Back to our quarterly results. Starting with our Brokerage segment. Reported revenue growth was strong at 16%, of that 6.8% was organic revenue growth, a little better than our June IR Day expectation and closer to 9% adjusted for timing. Our net earnings margin moved higher by 53 basis points and our adjusted EBITDAC margin expanded by 23 basis points, highlighting our continued expense discipline. Another excellent quarter from the Brokerage team.
Douglas Howell: Thanks Pat and hello everyone. As Pat said, an excellent quarter and first half of the year. Today, I'll spend a little extra time on organic and then give you our current thinking on expenses and margins. Then, I'll walk you through some of the items on our CFO commentary document, and I'll finish up with some comments on cash, liquidity and capital management. Okay. Let's move to page four of the earnings release and the Brokerage segment organic table. Headline all in organic of 6.8%, excellent on its own, but as pat said, really running closer to 9%. There's two reasons for that. First, recall that we had some favorable timing in our first quarter related to contingent commissions that caused a little unfavorable timing here in the second quarter, call that 70 basis points. Second, also recall that we took our 606 revenue accounting adjustment in the first quarter of 2020, we then adjusted that in the second quarter of 2020. So that creates a more difficult compare this year second quarter, call that about 150 basis points. These two items combined for about 220 basis points of a headwind here in the second quarter. We don't expect similar headwinds in the second half. Okay. Let's go to page six to the Brokerage adjusted EBITDAC table. You'll see that we expanded our EBITDAC margin by 23 basis points here in the second quarter. Considering last year second quarter was in the depth of the pandemic and our Brokerage segment save $60 million in that quarter to post any expansion at all this quarter is terrific work by the team, shows we are indeed holding a lot of our savings. So, the natural question is, when you levelize for the $60 million of pandemic savings last year second quarter, and about $15 million of cost that came back this second quarter, what was the underlying margin expansion? Answer to that is about 125 basis points, which on 6.8% organic feels about right. That $15 million mostly relates to higher utilization of our self-insurance medical plans, a modest pickup in T&E expenses and incentive comp. So, we held $45 million of cost savings this quarter. And that's really terrific. Looking forward, we continue to think we can hold a lot of our pandemic period savings, perhaps more than half, but naturally some of those costs will come back. As of now we think about $20 million of costs returned in the third quarter and $30 million return in the fourth quarter, both of those numbers are relative to last year same quarters. So, again, the natural question might be, what organic do you need to post third and fourth quarter to overcome those expenses and still have margin expansion? Math would say about 7%, which is really the real story. Recall at the beginning of the year, after expanding margins 420 basis points in 2020, we were looking at just holding margins flat.
J. Patrick Gallagher: Thanks Doug. Laura, I think we take some questions now.
Operator: Thank you. Our first question comes from the line of Elyse Greenspan with Wells Fargo. You may proceed with your question.
Elyse Greenspan: Hi. Thanks. Good evening.
J. Patrick Gallagher: Good evening.
Elyse Greenspan: My first question is on, Pat, your organic growth comments. I think you mentioned that you guys would get the full year to 8%. So, if my math is right, if you were sitting at 6.4% for the first half of the year, that would imply that you guys are expecting the back half to come close to 10%. Is there something wrong with that thinking, or are you thinking given the timing impact in the second quarter so we get close to double-digits in the second half a year within Brokerage?
J. Patrick Gallagher: Yeah. Elyse, I think you might be a little strong on that, based on the math. So, just take a look at it again. I think why are math produced more like, towards 9%.
Elyse Greenspan: Okay. So, 9%. Okay. Close. And then my second question, you guys announced a $1.5 billion share repurchase program, right, to effectively buyback the stock issued for the Willis deal. So I just wanted to get a sense of timing on the buybacks. Is that something you expect to complete this year? And then, is the expectation that you will buyback all those shares? Or is that also a little bit dependent upon some of the tuck-in deals if some of them come together pretty quickly?
J. Patrick Gallagher: No, I think as we sit right now, our intent is to repurchase the $1.5 billion. We think we can get that done in short order also and certainly by the end of the year. Now the point here is that we're -- we won't let access capital sip idle by any means.
Elyse Greenspan: Okay. That's helpful. And then, on the margin side if you were, give us some helpful information and you were giving an example, right, that if you guys get to pull your data of 7%, that you could show a 100 basis points of margin improvement. So, is that with the states coming back or is that kind of after adjusting for the impact of days or the expectation that we'll be about a 100 points of margin within Brokerage this year?
J. Patrick Gallagher: Yeah. I think, what I was doing is using the illustration of saying if we post 7% for the full year, you'd see about a 100 basis points of margin expansion, even with those costs coming back into our structure. And clearly if we better 7%, we should be able to better that too.
Elyse Greenspan: Okay. That's helpful. Thanks for the color.
J. Patrick Gallagher: Sure.
Douglas Howell: Thanks, Elyse
Operator: Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question.
David Motemaden: Hi. Good evening. I had a question, just on the expense side. If I just look in Brokerage at the operating expenses, non-comp, non-D&A, just the OpEx line, if I take out the $15 million of incremental costs, it looks like expenses were roughly flat year-over-year. Doug, I think you spoke about this a little bit in your comments. But I guess I'm just wondering, is that sort of right that the underlying expenses in the business, or sort of flat year-over-year and would you expect that to continue for the rest of this year?
Douglas Howell: So, did you take the entire $15 million out of OpEx or did you spread some of that into comp and then also did you factor in M&A, but you're not far off of it, being pretty close to flat when you factor in M&A.
David Motemaden: Yeah. I was just looking purely at OpEx. So, it was roughly flat, but that's something that you think can continue for the rest of the year, just given some of the changes you guys made over the course of last year.
Douglas Howell: Yeah. I think there was -- I guess I think the $20 million will come back in the third quarter of expensive, and I think $30 million will come back in the fourth quarter. That will be split some between OpEx and some between compensation. But by and large, our underlying costs, other than maybe in the IT areas, we're starting to see savings in real estate. We're starting to see savings in professional fees. We are seeing increases in travel and entertainment expenses because some of our clients are expecting us to be there and we're happy to be there for it. But you are seeing some good learnings from the pandemic. We have pretty well taken care of all of our incoming, outgoing mail. It's saving some costs there, so we can centralize that so we can deploy mail anywhere around the world with the touch of a button. So, there are some good projects that have been going on to -- that we're continuing to harvest out of the operating expense line.
David Motemaden: Got it. Yeah. That continues to come in a bit better than I would've thought. I guess, any sort of update on the thinking in terms of the sustainable expense saves, that you -- that you're getting from COVID of the -- I think it was 150 to 175. Is that still a good sort of level to think about, or -- yeah, any sort of changes to that?
Douglas Howell: Yeah. Let's level set. We were saving, let's say -- let's call it $65 million a quarter during the pandemic. And we think that we can hold $30 million of that -- $35 million of that. So, again, back to -- I don't know where your 150 came from, unless it was 60 times, four or five -- four and a half, and then divided by two. But where'd you get the 150 from?
David Motemaden: I was using more of a range, that you guys have given. But that makes sense.
Douglas Howell: Okay.
David Motemaden: That makes sense. Thanks for that. I guess also -- maybe just on the growth side, I guess, could you just break down if we sort of look at the organic, the 9% in Brokerage on sort of a clean basis? Could you just talk about some of the different components of that? Whether that is, rate versus exposure versus new business and share gains and how you expect each of those to trend over the course of this year.
J. Patrick Gallagher: Okay. So, new business was stronger than where we were, same second quarter or for also say the year new business range stronger. Retention is about the same, getting lift from rate and exposure that when we combine that together, right now I think it's about 50/50. rate and 50% exposure.
David Motemaden: Got it. Thank you.
Operator: Our next question comes from the line of Mark Hughes with Truist. You may proceed with your question.
Mark Hughes: Yeah. Thank you very much. Good afternoon.
J. Patrick Gallagher: Good afternoon, Mark.
Mark Hughes: I think some of your end markets have been a little slower getting ramped up, maybe compared to other more cyclical end markets. Could you expand on that just a little bit?
Douglas Howell: What do you mean end markets?
Mark Hughes: You're talking about your customers. If I heard you properly, tell me if I didn't, but your customers.
Douglas Howell: Our employee benefits business, you see a lot of headline recovery in employment stats that generally are citing retail, hospitality, transportation -- travel related industries. Our customer base is not concentrated in those industries. It's more diverse than that. And it's just the return to work and our customer base isn't quite at those headline returning to work numbers you see there. That what you're asking about, Mark? Nothing, it's just the mix of business down in the benefits business.
Mark Hughes: Right. Yeah. Gotcha. Yeah. No, that was my question. Then, Pat, on the pricing, I might not have heard all your commentary, but it seems like -- looking at some of your specific numbers compared to last time they were as good or better in Q1, it seems like there's some broader discussion of potential deceleration. Why do you think you may be seeing it a little more optimistically than others perhaps?
J. Patrick Gallagher: No. I just -- from where I sit, Mark, when I'm talking to people in the field and when I'm talking to our underwriting partners, there just doesn't seem to be any appetite for cutting. Now rate of increase is down, but I'm not seeing people say, oh gosh, we've got this thing right. Let's open the flood gates.
Douglas Howell: We're seeing a little bit. I think that there's a little bit of -- I think the larger account market or larger size market, we saw increases in premiums there that were a little higher than, let's say, the mid-market of a smaller market throughout the end of 2020 and here in the first half of 2021. So, we're just not seeing if a large account market is not growing rates quite as fast as they were in the past. We're not really seeing that as much in the mid-market. We are seeing it more consistent with first quarter and fourth quarter. You lose there, Mark?
Mark Hughes: No. No. Here -- I'm back. I'm sorry. I'm just curious if in a public forum, any thoughts you'd care to share around potential for adding some staff in light of the Willis Towers Watson, Aon breakup, you seeing anything out in the market? Any people moving that is noteworthy?
J. Patrick Gallagher: Well, no. We don't. But as you know, Mark, you follow us a long time. Our organic hiring is a big part of our strategy and there's no doubt that we're going to continue to hire production talent across all the lines of business that we've got. And our doors of all -- even in the depths of the soft market, as you followed us, the doors open for production talent.
Mark Hughes: Very good. Thank you.
J. Patrick Gallagher: Thanks Mark.
Operator: Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question.
Meyer Shields: Thanks. I wanted a little bit on capital management, I guess it's $850 million of the raised debt that you're keeping, is it interpret, Doug, your comments about M&A potential as being able to utilize that $850 million?
Douglas Howell: Yeah. Absolutely. That's cash in the bank right now. We think that, that -- and we might have to borrow a little bit more towards the end of the year for part of next year, depending on how the M&A pipeline looks at, but the $650 million there's a special mandatory redemption feature in there. So, we'll pay that back. And then what happened with the $850 million that we raised along with that, that -- we'll get that to work here in the second half of the year.
Meyer Shields: Okay. I might be find you hard with this one. But if you're expecting an increase in potential sellers because of capital gains tax rates, is that likely to depress placing on these assets at all?
Douglas Howell: You might have a little that end, but I think it will put -- truthfully, I think that it might put -- pricing might stay the same and it actually might pull forward a little bit less on an earn-out and more up front. So you put it here in this year, you might feel bad. Is it a full turn on the multiple, maybe to accelerate it, not have as much on that earn-out, but I wouldn't say it's going to cause a big decrease in pricing.
J. Patrick Gallagher: No, there's a lot of competition for deals out there.
Meyer Shields: Yeah. Fair enough. Okay. Thank you so much.
Operator: Our next question comes from the line of Alex Bolan with Raymond James. You may proceed with your question.
Unidentified Analyst: I am calling in on behalf of Greg Peters. Maybe kind of sticking with M&A, and the tuck-in conversation, when you're talking, I guess to potential is, as tuck-in up within the conversation as of now, or is that still a thought?
J. Patrick Gallagher: It's coming up every time.
Unidentified Analyst: Okay. And then, when looking at, I guess, M&A, I guess what is the size of acquisitions you're considering? Has that changed at all?
J. Patrick Gallagher: No. We're good at tuck-ins. By the way, looks also, Greg knows this very well. If in fact there's 39,000 agents and brokers in America, let's remember that business insurance that just brought out it's a July edition this month number 100 was $25 million in revenue. So the playing field is full of really, really good tuck-in players.
Unidentified Analyst: Okay. That makes sense. And then, when thinking about margin expansion and the effect T&E has, maybe you can touch on -- your thoughts around deployment of T&E and how that might be changed compared to 2019.
Douglas Howell: All right. Let me -- see if I can understand that again. I thought you had asked a question about India in there, or did I hear your word wrong?
Unidentified Analyst: No. I guess -- no, I didn't say anything on India. It was the effect of lower T&E on margin expansion and then, how you're considering deploying T&E in the future maybe compared to 2019.
Douglas Howell: All right. Great. Well, first of all, we have no hold on. If somebody wants to travel to see their clients where they're more than welcome to go do it, we have no restrictions on that. And people are self-governing on that. We will meet our clients wherever they would like us to meet them in order to conduct business with them. So, we are there and how they want to do it. How much is that? We probably have maybe $5 million a quarter of step-up from where we were in the past. So, maybe there's an extra $5 million in our first quarter, $5 million -- maybe we're at that $10 million this quarter, $15 million next, then $20 million next quarter relative to the depths of the pandemic. So, we're doing it. The good thing about this though, is that we are actually being able to bring our experts to the point of sale virtually much more now than we were before. So, remember the advantage that we have, and that is we have experts in every single aspect of insurance around the world. We can now drop that person into our customer's office, or even if they want to do it from home virtually. International folks, there's lots of -- there's conservative less international travel, but now we can bring our experts from London right into our terrific client or prospect in Des Moines, Iowa with the click of a button. So that's really the competitive advantage of that. But 90% of the time we compete with somebody smaller than us and they just don't have the expert. So, when we can drop our expert in and bring those capabilities to bear, it's going to leave some more wins in the future. In the past to travel somebody in for a half hour meeting, that might be a two or three-day affair. So think about even though expenses might return to a certain extent, it's the ability to get our experts at the point of sale, or the point of -- to the prospect virtually that really is the terrific outcome from the pandemic.
Unidentified Analyst: Okay. That makes sense. I appreciate the answers.
Douglas Howell: Thanks, Alex.
Operator: Our next question comes from the line of Ryan Tunis with Autonomous Research. You may proceed with your question.
Ryan Tunis: Good evening, guys.
J. Patrick Gallagher: Good evening.
Ryan Tunis: First question, thinking about the second half of the year, about 9% organic, I think you mentioned, it’s probably get 4% employee benefits. You spend a lot of visibility on how that's supposed to try -- I mean, how are you guys thinking about how that would fit into the 9% of the back half?
Douglas Howell: I think there's a sequential step-up continuing in employee benefits like we've seen, as people come back we're really starting to -- just even in the last few weeks, our HR consulting units are starting to get more calls. We're starting to get as covered lives increase -- the number of participants and medical plans and dental plans is stepping up. So, it's four went to six and then went to eight over the next couple of quarters and it wouldn't surprise me in our employee benefit.
Ryan Tunis: Got it. And then, for Pat, can you just remind us why -- you guys do 40 deals a year, but very few of them seem to be a wholesale related. What do you mean by wholesale M&A? Why don't we see more of those?
J. Patrick Gallagher: We're very active there. Ryan, I think it's just opportunistic. We've built RPS over the last 20 plus years in large part with acquisitions, and we've done some nice acquisitions over the last 12 months at RPS. One of the areas we built out, of course, we're the country's largest MGA. We also have a program business that's really strong, but open market brokers, we built the typical Gallagher way. We've recruited our own and built our own young people out of hardship. And we've done some very nice acquisitions there. So, no, there's no hole back there. And actually there's no real shortage of opportunities, a lot of competition, one of which at a very successful IPO this month.
Ryan Tunis: Gotcha. Okay. Cool. Thanks, guys.
J. Patrick Gallagher: Thanks, Ryan.
Operator: Our last question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question.
Phil Stefano: Yeah. Thanks. Good evening. Congrats on the quarter. I guess, I'm not sure how to put this in. I hope it's not offensive, but I know that the complaint I'm going to get tonight and then tomorrow is, the organic growth seems to be lagging peers. I understand the timing issue and with the contingent and the 606, but even at 9%, it feels like people are going to -- I suspect people are going to -- how do you want me to respond to this, as I'm looking conversations over the next day?
J. Patrick Gallagher: Well, I think it's -- I'll let Doug give you the tactical side, Phil, because he's good at that, but let's put it this way. If you're dropping in the room, here's what I'd say. I'm really proud of our team. We had a great quarter and so did our competitors. God bless them. And if you take a look at our results over the past number of years versus anyone else you want to put up into that, our team gets up every morning and aggressively sells a lot of assurance. And so, I take no second stance to the fact that this quarter was anything, but outstanding. And one quarter comparables, doesn't get my dander up, Doug to give you more technical answer. But I think our people did a great job of selling insurance and holding on to our clients. And I'm really happy with the quarter. On a comparable basis, there's others that look stronger. I'm okay with that.
Douglas Howell: Yeah. I think, Phil, one of the things you might want to do is take last year second quarter and this year second quarter for all of us, add them up and I think you might find that delta isn't all that much different. And like Pat said, so over two years, we're up about 10% organically in aggregate in our Brokerage segment. And again, I think that if you do the math on those that have reported are worth wherever your other insights are coming from. The second quarter and the second quarter -- last year this quarter might add up to about the same number. I think that running towards 9% is the best quarter since we've posted since fourth quarter of 2003. And like Pat said, this level of organic growth isn't an aberration just to one of us or two of us or whatever. The entire industry is showing excellent organic growth. Industry is growing at a much higher clip than GDP. And I guess what I would say is our outlook for the second half of the year is pretty bullish. So, that's how I would answer it, but mathematically take the two quarters together and we won't be all that far apart when you have like for like business.
Phil Stefano: I guess, part of this comes back to -- if I think about the two year back that you're suggesting, it comes back to the idea that your clients were more persistent. And so, we don't get the ebb and the flow that we've seen in the recovery last year. I guess, is that a fair way to tie that commentary into the numbers?
J. Patrick Gallagher: The other way I might put it, Phil, is we're doing a better job than our competition to mitigating the impact of rates for our clients.
Phil Stefano: Yeah. Yeah. Yeah. Okay. Got it. When I think about the -- you said that the door is always open for talent that wants to come. As part of the agreement for the Willis potential businesses that were going to be acquired, was there any non-compete or no shop for talent provisions within that, that would keep you on the sideline from certain talent that might be wondering, looking around.
J. Patrick Gallagher: Yeah. We have some limitations. We've agreed, of course, that we intend to honor those and they're not extensive. But generally speaking, we're not limited in our ability to hire general production talent. But of course, in that discussion, that transaction, there are some limitations which we intend on.
Phil Stefano: Yeah. Okay. Perfect. Thanks. Congrats. And look, I think the margin expansion story over the past few years has been probably second to none. So, I hope -- hopefully that's the takeaway that you get from me and my comments tonight. Appreciate it.
Douglas Howell: All right. Thanks Phil.
J. Patrick Gallagher: Thanks, Laura. Let me just -- to make a few comments here. We delivered, obviously excellent second quarter. I'm extremely proud of our team. I believe that we are in the best business in the world, and we're delivering significant value for our clients around the globe day-in and day-out. Thank you all for being with us this evening, and we'll talk to you next quarter. Thanks very much. Thank you, Laura.
Operator: This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation for the rest of your evening. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Co.'s Second Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. Today's call is being recorded. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you, Laura. Good afternoon, and thank you for joining us for our second quarter 2021 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had an excellent second quarter. The team delivered on all four of our long-term operating priorities to drive shareholder value. We grew organically. We grew through acquisitions, improved our productivity all while raising our quality and maintaining our unique Gallagher culture. For our combined Brokerage and Risk Management segments, we posted 17% growth in revenue, 8.6% organic growth, but it's over 10% when adjusted for timing, which Doug will spend some time on in a few minutes. Net earnings margin expansion of 107 basis points, adjusted EBITDAC margin expansion of 30 basis points. And we completed eight new mergers in the quarter, with more than $70 million of estimated annualized revenue. Most importantly, our Gallagher culture continues to thrive. Just a fantastic quarter on all measures. Now, before I discuss how each of our businesses performed in more detail, let me comment briefly about the termination of our agreement to purchase certain Willis Towers Watson brokerage operations. We were excited about the opportunity. We would have loved to complete the transaction. There are a lot of great people at Willis and they would have been a great addition to our team. But here's the key point. With or without this, we remained very well-positioned to support our clients, compete for new ones and ultimately drive value for all of our stakeholders. We're in the greatest business on earth. Our culture is stronger than ever, and I'm excited about our future. Okay. Back to our quarterly results. Starting with our Brokerage segment. Reported revenue growth was strong at 16%, of that 6.8% was organic revenue growth, a little better than our June IR Day expectation and closer to 9% adjusted for timing. Our net earnings margin moved higher by 53 basis points and our adjusted EBITDAC margin expanded by 23 basis points, highlighting our continued expense discipline. Another excellent quarter from the Brokerage team."
},
{
"speaker": "Douglas Howell",
"text": "Thanks Pat and hello everyone. As Pat said, an excellent quarter and first half of the year. Today, I'll spend a little extra time on organic and then give you our current thinking on expenses and margins. Then, I'll walk you through some of the items on our CFO commentary document, and I'll finish up with some comments on cash, liquidity and capital management. Okay. Let's move to page four of the earnings release and the Brokerage segment organic table. Headline all in organic of 6.8%, excellent on its own, but as pat said, really running closer to 9%. There's two reasons for that. First, recall that we had some favorable timing in our first quarter related to contingent commissions that caused a little unfavorable timing here in the second quarter, call that 70 basis points. Second, also recall that we took our 606 revenue accounting adjustment in the first quarter of 2020, we then adjusted that in the second quarter of 2020. So that creates a more difficult compare this year second quarter, call that about 150 basis points. These two items combined for about 220 basis points of a headwind here in the second quarter. We don't expect similar headwinds in the second half. Okay. Let's go to page six to the Brokerage adjusted EBITDAC table. You'll see that we expanded our EBITDAC margin by 23 basis points here in the second quarter. Considering last year second quarter was in the depth of the pandemic and our Brokerage segment save $60 million in that quarter to post any expansion at all this quarter is terrific work by the team, shows we are indeed holding a lot of our savings. So, the natural question is, when you levelize for the $60 million of pandemic savings last year second quarter, and about $15 million of cost that came back this second quarter, what was the underlying margin expansion? Answer to that is about 125 basis points, which on 6.8% organic feels about right. That $15 million mostly relates to higher utilization of our self-insurance medical plans, a modest pickup in T&E expenses and incentive comp. So, we held $45 million of cost savings this quarter. And that's really terrific. Looking forward, we continue to think we can hold a lot of our pandemic period savings, perhaps more than half, but naturally some of those costs will come back. As of now we think about $20 million of costs returned in the third quarter and $30 million return in the fourth quarter, both of those numbers are relative to last year same quarters. So, again, the natural question might be, what organic do you need to post third and fourth quarter to overcome those expenses and still have margin expansion? Math would say about 7%, which is really the real story. Recall at the beginning of the year, after expanding margins 420 basis points in 2020, we were looking at just holding margins flat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Doug. Laura, I think we take some questions now."
},
{
"speaker": "Operator",
"text": "Thank you. Our first question comes from the line of Elyse Greenspan with Wells Fargo. You may proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi. Thanks. Good evening."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Good evening."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question is on, Pat, your organic growth comments. I think you mentioned that you guys would get the full year to 8%. So, if my math is right, if you were sitting at 6.4% for the first half of the year, that would imply that you guys are expecting the back half to come close to 10%. Is there something wrong with that thinking, or are you thinking given the timing impact in the second quarter so we get close to double-digits in the second half a year within Brokerage?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. Elyse, I think you might be a little strong on that, based on the math. So, just take a look at it again. I think why are math produced more like, towards 9%."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. So, 9%. Okay. Close. And then my second question, you guys announced a $1.5 billion share repurchase program, right, to effectively buyback the stock issued for the Willis deal. So I just wanted to get a sense of timing on the buybacks. Is that something you expect to complete this year? And then, is the expectation that you will buyback all those shares? Or is that also a little bit dependent upon some of the tuck-in deals if some of them come together pretty quickly?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No, I think as we sit right now, our intent is to repurchase the $1.5 billion. We think we can get that done in short order also and certainly by the end of the year. Now the point here is that we're -- we won't let access capital sip idle by any means."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. That's helpful. And then, on the margin side if you were, give us some helpful information and you were giving an example, right, that if you guys get to pull your data of 7%, that you could show a 100 basis points of margin improvement. So, is that with the states coming back or is that kind of after adjusting for the impact of days or the expectation that we'll be about a 100 points of margin within Brokerage this year?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. I think, what I was doing is using the illustration of saying if we post 7% for the full year, you'd see about a 100 basis points of margin expansion, even with those costs coming back into our structure. And clearly if we better 7%, we should be able to better that too."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. That's helpful. Thanks for the color."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Sure."
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Elyse"
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question."
},
{
"speaker": "David Motemaden",
"text": "Hi. Good evening. I had a question, just on the expense side. If I just look in Brokerage at the operating expenses, non-comp, non-D&A, just the OpEx line, if I take out the $15 million of incremental costs, it looks like expenses were roughly flat year-over-year. Doug, I think you spoke about this a little bit in your comments. But I guess I'm just wondering, is that sort of right that the underlying expenses in the business, or sort of flat year-over-year and would you expect that to continue for the rest of this year?"
},
{
"speaker": "Douglas Howell",
"text": "So, did you take the entire $15 million out of OpEx or did you spread some of that into comp and then also did you factor in M&A, but you're not far off of it, being pretty close to flat when you factor in M&A."
},
{
"speaker": "David Motemaden",
"text": "Yeah. I was just looking purely at OpEx. So, it was roughly flat, but that's something that you think can continue for the rest of the year, just given some of the changes you guys made over the course of last year."
},
{
"speaker": "Douglas Howell",
"text": "Yeah. I think there was -- I guess I think the $20 million will come back in the third quarter of expensive, and I think $30 million will come back in the fourth quarter. That will be split some between OpEx and some between compensation. But by and large, our underlying costs, other than maybe in the IT areas, we're starting to see savings in real estate. We're starting to see savings in professional fees. We are seeing increases in travel and entertainment expenses because some of our clients are expecting us to be there and we're happy to be there for it. But you are seeing some good learnings from the pandemic. We have pretty well taken care of all of our incoming, outgoing mail. It's saving some costs there, so we can centralize that so we can deploy mail anywhere around the world with the touch of a button. So, there are some good projects that have been going on to -- that we're continuing to harvest out of the operating expense line."
},
{
"speaker": "David Motemaden",
"text": "Got it. Yeah. That continues to come in a bit better than I would've thought. I guess, any sort of update on the thinking in terms of the sustainable expense saves, that you -- that you're getting from COVID of the -- I think it was 150 to 175. Is that still a good sort of level to think about, or -- yeah, any sort of changes to that?"
},
{
"speaker": "Douglas Howell",
"text": "Yeah. Let's level set. We were saving, let's say -- let's call it $65 million a quarter during the pandemic. And we think that we can hold $30 million of that -- $35 million of that. So, again, back to -- I don't know where your 150 came from, unless it was 60 times, four or five -- four and a half, and then divided by two. But where'd you get the 150 from?"
},
{
"speaker": "David Motemaden",
"text": "I was using more of a range, that you guys have given. But that makes sense."
},
{
"speaker": "Douglas Howell",
"text": "Okay."
},
{
"speaker": "David Motemaden",
"text": "That makes sense. Thanks for that. I guess also -- maybe just on the growth side, I guess, could you just break down if we sort of look at the organic, the 9% in Brokerage on sort of a clean basis? Could you just talk about some of the different components of that? Whether that is, rate versus exposure versus new business and share gains and how you expect each of those to trend over the course of this year."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Okay. So, new business was stronger than where we were, same second quarter or for also say the year new business range stronger. Retention is about the same, getting lift from rate and exposure that when we combine that together, right now I think it's about 50/50. rate and 50% exposure."
},
{
"speaker": "David Motemaden",
"text": "Got it. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mark Hughes with Truist. You may proceed with your question."
},
{
"speaker": "Mark Hughes",
"text": "Yeah. Thank you very much. Good afternoon."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Good afternoon, Mark."
},
{
"speaker": "Mark Hughes",
"text": "I think some of your end markets have been a little slower getting ramped up, maybe compared to other more cyclical end markets. Could you expand on that just a little bit?"
},
{
"speaker": "Douglas Howell",
"text": "What do you mean end markets?"
},
{
"speaker": "Mark Hughes",
"text": "You're talking about your customers. If I heard you properly, tell me if I didn't, but your customers."
},
{
"speaker": "Douglas Howell",
"text": "Our employee benefits business, you see a lot of headline recovery in employment stats that generally are citing retail, hospitality, transportation -- travel related industries. Our customer base is not concentrated in those industries. It's more diverse than that. And it's just the return to work and our customer base isn't quite at those headline returning to work numbers you see there. That what you're asking about, Mark? Nothing, it's just the mix of business down in the benefits business."
},
{
"speaker": "Mark Hughes",
"text": "Right. Yeah. Gotcha. Yeah. No, that was my question. Then, Pat, on the pricing, I might not have heard all your commentary, but it seems like -- looking at some of your specific numbers compared to last time they were as good or better in Q1, it seems like there's some broader discussion of potential deceleration. Why do you think you may be seeing it a little more optimistically than others perhaps?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No. I just -- from where I sit, Mark, when I'm talking to people in the field and when I'm talking to our underwriting partners, there just doesn't seem to be any appetite for cutting. Now rate of increase is down, but I'm not seeing people say, oh gosh, we've got this thing right. Let's open the flood gates."
},
{
"speaker": "Douglas Howell",
"text": "We're seeing a little bit. I think that there's a little bit of -- I think the larger account market or larger size market, we saw increases in premiums there that were a little higher than, let's say, the mid-market of a smaller market throughout the end of 2020 and here in the first half of 2021. So, we're just not seeing if a large account market is not growing rates quite as fast as they were in the past. We're not really seeing that as much in the mid-market. We are seeing it more consistent with first quarter and fourth quarter. You lose there, Mark?"
},
{
"speaker": "Mark Hughes",
"text": "No. No. Here -- I'm back. I'm sorry. I'm just curious if in a public forum, any thoughts you'd care to share around potential for adding some staff in light of the Willis Towers Watson, Aon breakup, you seeing anything out in the market? Any people moving that is noteworthy?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, no. We don't. But as you know, Mark, you follow us a long time. Our organic hiring is a big part of our strategy and there's no doubt that we're going to continue to hire production talent across all the lines of business that we've got. And our doors of all -- even in the depths of the soft market, as you followed us, the doors open for production talent."
},
{
"speaker": "Mark Hughes",
"text": "Very good. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Mark."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question."
},
{
"speaker": "Meyer Shields",
"text": "Thanks. I wanted a little bit on capital management, I guess it's $850 million of the raised debt that you're keeping, is it interpret, Doug, your comments about M&A potential as being able to utilize that $850 million?"
},
{
"speaker": "Douglas Howell",
"text": "Yeah. Absolutely. That's cash in the bank right now. We think that, that -- and we might have to borrow a little bit more towards the end of the year for part of next year, depending on how the M&A pipeline looks at, but the $650 million there's a special mandatory redemption feature in there. So, we'll pay that back. And then what happened with the $850 million that we raised along with that, that -- we'll get that to work here in the second half of the year."
},
{
"speaker": "Meyer Shields",
"text": "Okay. I might be find you hard with this one. But if you're expecting an increase in potential sellers because of capital gains tax rates, is that likely to depress placing on these assets at all?"
},
{
"speaker": "Douglas Howell",
"text": "You might have a little that end, but I think it will put -- truthfully, I think that it might put -- pricing might stay the same and it actually might pull forward a little bit less on an earn-out and more up front. So you put it here in this year, you might feel bad. Is it a full turn on the multiple, maybe to accelerate it, not have as much on that earn-out, but I wouldn't say it's going to cause a big decrease in pricing."
},
{
"speaker": "J. Patrick Gallagher",
"text": "No, there's a lot of competition for deals out there."
},
{
"speaker": "Meyer Shields",
"text": "Yeah. Fair enough. Okay. Thank you so much."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Alex Bolan with Raymond James. You may proceed with your question."
},
{
"speaker": "Unidentified Analyst",
"text": "I am calling in on behalf of Greg Peters. Maybe kind of sticking with M&A, and the tuck-in conversation, when you're talking, I guess to potential is, as tuck-in up within the conversation as of now, or is that still a thought?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "It's coming up every time."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. And then, when looking at, I guess, M&A, I guess what is the size of acquisitions you're considering? Has that changed at all?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No. We're good at tuck-ins. By the way, looks also, Greg knows this very well. If in fact there's 39,000 agents and brokers in America, let's remember that business insurance that just brought out it's a July edition this month number 100 was $25 million in revenue. So the playing field is full of really, really good tuck-in players."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. That makes sense. And then, when thinking about margin expansion and the effect T&E has, maybe you can touch on -- your thoughts around deployment of T&E and how that might be changed compared to 2019."
},
{
"speaker": "Douglas Howell",
"text": "All right. Let me -- see if I can understand that again. I thought you had asked a question about India in there, or did I hear your word wrong?"
},
{
"speaker": "Unidentified Analyst",
"text": "No. I guess -- no, I didn't say anything on India. It was the effect of lower T&E on margin expansion and then, how you're considering deploying T&E in the future maybe compared to 2019."
},
{
"speaker": "Douglas Howell",
"text": "All right. Great. Well, first of all, we have no hold on. If somebody wants to travel to see their clients where they're more than welcome to go do it, we have no restrictions on that. And people are self-governing on that. We will meet our clients wherever they would like us to meet them in order to conduct business with them. So, we are there and how they want to do it. How much is that? We probably have maybe $5 million a quarter of step-up from where we were in the past. So, maybe there's an extra $5 million in our first quarter, $5 million -- maybe we're at that $10 million this quarter, $15 million next, then $20 million next quarter relative to the depths of the pandemic. So, we're doing it. The good thing about this though, is that we are actually being able to bring our experts to the point of sale virtually much more now than we were before. So, remember the advantage that we have, and that is we have experts in every single aspect of insurance around the world. We can now drop that person into our customer's office, or even if they want to do it from home virtually. International folks, there's lots of -- there's conservative less international travel, but now we can bring our experts from London right into our terrific client or prospect in Des Moines, Iowa with the click of a button. So that's really the competitive advantage of that. But 90% of the time we compete with somebody smaller than us and they just don't have the expert. So, when we can drop our expert in and bring those capabilities to bear, it's going to leave some more wins in the future. In the past to travel somebody in for a half hour meeting, that might be a two or three-day affair. So think about even though expenses might return to a certain extent, it's the ability to get our experts at the point of sale, or the point of -- to the prospect virtually that really is the terrific outcome from the pandemic."
},
{
"speaker": "Unidentified Analyst",
"text": "Okay. That makes sense. I appreciate the answers."
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Alex."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Ryan Tunis with Autonomous Research. You may proceed with your question."
},
{
"speaker": "Ryan Tunis",
"text": "Good evening, guys."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Good evening."
},
{
"speaker": "Ryan Tunis",
"text": "First question, thinking about the second half of the year, about 9% organic, I think you mentioned, it’s probably get 4% employee benefits. You spend a lot of visibility on how that's supposed to try -- I mean, how are you guys thinking about how that would fit into the 9% of the back half?"
},
{
"speaker": "Douglas Howell",
"text": "I think there's a sequential step-up continuing in employee benefits like we've seen, as people come back we're really starting to -- just even in the last few weeks, our HR consulting units are starting to get more calls. We're starting to get as covered lives increase -- the number of participants and medical plans and dental plans is stepping up. So, it's four went to six and then went to eight over the next couple of quarters and it wouldn't surprise me in our employee benefit."
},
{
"speaker": "Ryan Tunis",
"text": "Got it. And then, for Pat, can you just remind us why -- you guys do 40 deals a year, but very few of them seem to be a wholesale related. What do you mean by wholesale M&A? Why don't we see more of those?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "We're very active there. Ryan, I think it's just opportunistic. We've built RPS over the last 20 plus years in large part with acquisitions, and we've done some nice acquisitions over the last 12 months at RPS. One of the areas we built out, of course, we're the country's largest MGA. We also have a program business that's really strong, but open market brokers, we built the typical Gallagher way. We've recruited our own and built our own young people out of hardship. And we've done some very nice acquisitions there. So, no, there's no hole back there. And actually there's no real shortage of opportunities, a lot of competition, one of which at a very successful IPO this month."
},
{
"speaker": "Ryan Tunis",
"text": "Gotcha. Okay. Cool. Thanks, guys."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Ryan."
},
{
"speaker": "Operator",
"text": "Our last question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question."
},
{
"speaker": "Phil Stefano",
"text": "Yeah. Thanks. Good evening. Congrats on the quarter. I guess, I'm not sure how to put this in. I hope it's not offensive, but I know that the complaint I'm going to get tonight and then tomorrow is, the organic growth seems to be lagging peers. I understand the timing issue and with the contingent and the 606, but even at 9%, it feels like people are going to -- I suspect people are going to -- how do you want me to respond to this, as I'm looking conversations over the next day?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I think it's -- I'll let Doug give you the tactical side, Phil, because he's good at that, but let's put it this way. If you're dropping in the room, here's what I'd say. I'm really proud of our team. We had a great quarter and so did our competitors. God bless them. And if you take a look at our results over the past number of years versus anyone else you want to put up into that, our team gets up every morning and aggressively sells a lot of assurance. And so, I take no second stance to the fact that this quarter was anything, but outstanding. And one quarter comparables, doesn't get my dander up, Doug to give you more technical answer. But I think our people did a great job of selling insurance and holding on to our clients. And I'm really happy with the quarter. On a comparable basis, there's others that look stronger. I'm okay with that."
},
{
"speaker": "Douglas Howell",
"text": "Yeah. I think, Phil, one of the things you might want to do is take last year second quarter and this year second quarter for all of us, add them up and I think you might find that delta isn't all that much different. And like Pat said, so over two years, we're up about 10% organically in aggregate in our Brokerage segment. And again, I think that if you do the math on those that have reported are worth wherever your other insights are coming from. The second quarter and the second quarter -- last year this quarter might add up to about the same number. I think that running towards 9% is the best quarter since we've posted since fourth quarter of 2003. And like Pat said, this level of organic growth isn't an aberration just to one of us or two of us or whatever. The entire industry is showing excellent organic growth. Industry is growing at a much higher clip than GDP. And I guess what I would say is our outlook for the second half of the year is pretty bullish. So, that's how I would answer it, but mathematically take the two quarters together and we won't be all that far apart when you have like for like business."
},
{
"speaker": "Phil Stefano",
"text": "I guess, part of this comes back to -- if I think about the two year back that you're suggesting, it comes back to the idea that your clients were more persistent. And so, we don't get the ebb and the flow that we've seen in the recovery last year. I guess, is that a fair way to tie that commentary into the numbers?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "The other way I might put it, Phil, is we're doing a better job than our competition to mitigating the impact of rates for our clients."
},
{
"speaker": "Phil Stefano",
"text": "Yeah. Yeah. Yeah. Okay. Got it. When I think about the -- you said that the door is always open for talent that wants to come. As part of the agreement for the Willis potential businesses that were going to be acquired, was there any non-compete or no shop for talent provisions within that, that would keep you on the sideline from certain talent that might be wondering, looking around."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. We have some limitations. We've agreed, of course, that we intend to honor those and they're not extensive. But generally speaking, we're not limited in our ability to hire general production talent. But of course, in that discussion, that transaction, there are some limitations which we intend on."
},
{
"speaker": "Phil Stefano",
"text": "Yeah. Okay. Perfect. Thanks. Congrats. And look, I think the margin expansion story over the past few years has been probably second to none. So, I hope -- hopefully that's the takeaway that you get from me and my comments tonight. Appreciate it."
},
{
"speaker": "Douglas Howell",
"text": "All right. Thanks Phil."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Laura. Let me just -- to make a few comments here. We delivered, obviously excellent second quarter. I'm extremely proud of our team. I believe that we are in the best business in the world, and we're delivering significant value for our clients around the globe day-in and day-out. Thank you all for being with us this evening, and we'll talk to you next quarter. Thanks very much. Thank you, Laura."
},
{
"speaker": "Operator",
"text": "This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation for the rest of your evening."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 1 | 2,021 | 2021-05-02 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Co.’s First Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. [Operator Instructions] Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company’s 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you, Laura. Good afternoon, and thank you for joining us for our first quarter 2021 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. What a fantastic quarter. We executed against our four long-term operating priorities to drive shareholder value: first, we grew organically; second, we grew through acquisitions; third, we improved our productivity while raising our quality; and fourth, we continue to reap the benefits of our unique Gallagher culture. I’m extremely proud of how our team continues to execute and deliver world-class expertise and service day-in and day-out. We’re off to a great start in 2021. So, let me give you some more detail on the quarter, starting with our Brokerage segment. Reported revenue growth of 12.2%, of that, 6% was organic revenue growth, better than our recent IR Day expectations, thanks to an excellent March. Our cost containment efforts saved about $60 million in the quarter, helping drive our net earnings margin higher by 94 basis points and expand our adjusted EBITDAC margin by 480 basis points and net earnings were up 17% and adjusted EBITDAC was up 24%, an excellent quarter from the Brokerage team. Let me walk you around the world and give you some soundbites about each of our Brokerage units, starting with our P/C operations. In the U.S., retail organic growth was strong at about 5%. New business was excellent and retention remains strong. In our U.S. wholesale operations, Risk Placement Services organic was about 6%. Open brokerage organic was 15% due to rate increases, higher levels of new business and improved retention. Our MGA program’s binding businesses were up about 4%. Retention in new business were similar to the first quarter of 2020. However, we did see a little bit more tailwind from rate and exposure during the quarter. Moving to the UK, over 7% organic for the quarter. In both our retail and specialty operations, new business was up over prior year while retention held pretty steady. Australia and New Zealand combined posted organic of 3%. New business and retention were both similar to prior year. And finally, our Canadian retail operations, excellent organic of 13%, fantastic new business and rate all added to our stellar performance again this quarter. So overall, our global P/C operations posted more than 7% organic, which is better than the 5% to 6% we discussed at our Investor Day, thanks to a really strong March. Moving to our employee benefit brokerage and consulting business. First quarter organic was up slightly, which is better than our March IR Day expectations. Revenue from our traditional health and welfare business held up well, while fees from consulting arrangements, special project work and our life business were up slightly. So when I bring P/C and Benefits together, total Brokerage segment organic was 6%, a really strong start to the year. Next, I’d like to make a few comments on the P/C market, starting with the rate environment. Global P/C rates remain firm overall and the increases we saw during the first quarter of 2021 are consistent with the past couple of quarters. Rates in Canada led the way, up double digits, driven by property and professional liability. In the U.S., rates were up about 7%, including double-digit rate increases within our wholesale open brokerage operations. Our UK retail and London specialty operations combined, rates are up about 5%. And finally, Australia and New Zealand combined, rate increases are in the low single digits. At the same time, capacity is constrained in certain lines and carriers are pushing for tighter terms and conditions. There are also quite a few pockets in the U.S., Canada and London specialty market that I would describe as hard such as cat-exposed properties, cyber, umbrella and public company D&O, just to name a few. So the global P/C environment remains difficult but is giving us some tailwinds. Looking forward, we don’t see conditions that would indicate this rate environment will change anytime soon, and we are seeing more and more economic activity across our client base. For example, customers are adding coverages and exposures to their existing policies. And through yesterday, April endorsements, premium audits and other midterm policy adjustments are a net positive overall. That, too, is an encouraging sign. On the benefits side, a recovering labor market in 2021 should favorably impact our core health and welfare business. And we remain optimistic that we will start to see some incremental HR consulting and special project work. This is a terrific time for our team to shine, firm global rates, increasing exposure units and recovering employment. Our clients need our expertise and we are there with the very best insurance, consulting and risk management advice. So while there’s a lot of year left, I have greater conviction that our full year 2021 Brokerage segment organic will be equal to or perhaps even better than pre-pandemic 2019 organic. Moving on to mergers and acquisitions. We finished the first quarter with five completed brokerage mergers, representing about $90 million of estimated annualized revenues. I’d like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in M&A pipeline, we have more than 40 term sheets signed or being prepared, representing about $250 million of annualized revenues. Our global platform is a great fit for savvy and successful entrepreneurs. We have the tools, data, products, niche expertise and carrier relationships to help these owners support their current clients and take their business to the next level. Next, I’d like to move to our Risk Management segment, Gallagher Bassett. First quarter organic growth was 0.6%, which is in line with our March IR Day expectations of about flat. It was still a tough compare to pre-pandemic first quarter 2020. However, there is no doubt we are starting to see more and more core workers’ comp claim activity when compared to what we were seeing last year at this time. Traditional workers’ comp claims are returning and we are seeing fewer and fewer COVID-related claims. Our cost containment efforts paid off again this quarter. We saved around $4 million and expanded our adjusted EBITDAC margin by 180 basis points to 18.4%, another great quarter of execution by the Gallagher Bassett team. Looking forward to the next three quarters, we would expect new claims arising to be higher than what we saw last year, perhaps not back to pre-pandemic levels quite yet but certainly higher than last year. So when I combine that with some really nice new business wins, we should be back to seeing organic in the upper single digits for the next few quarters. That would also bode well for keeping margins above 18% for the remainder of the year. Let me wrap up with some comments regarding our unique Gallagher culture. It’s a culture that emphasizes doing things the right way for the right reasons with the right people. It’s a culture of service, service to our clients, to one another and to the communities where we work and where we live and our culture continues to be recognized externally. Just last week, Forbes named Gallagher one of the best U.S. employers for diversity and that’s on top of Gallagher being recognized by the Ethisphere Institute as one of the world’s most ethical companies for the 10th year in a row, 10 straight years, and once again, the sole insurance broker recognized. These recognitions are a direct reflection of our more than 30,000 global colleagues working together as a team guided by the 25 tenets of the Gallagher Way. Culture is a key differentiator for our franchise. Every day, all of our people get up and work diligently to maintain our culture, to promote our culture, to live our culture, and I believe our culture has never been stronger. Doug, over to you.
Doug Howell: Thanks, Pat, and good afternoon, everyone. I’ll echo Pat’s comments, an excellent quarter and a terrific start to the year. Today, I’ll spend most of my time on both our cost savings initiatives and our clean energy cash flows, then highlight a few items in our CFO commentary document, and I’ll close with some comments on M&A, cash and liquidity. Before I plunge in on cost, one quick comment on Page 3 in the Brokerage segment organic table. You’ll see that we had a great quarter for contingent commissions. There is a little bit of favorable timing in there, call it about 50 basis points on total organic. That will flip the other way next quarter but regardless, a really solid quarter. Okay, let’s go to Page 5, the Brokerage segment adjusted EBITDAC table. You’ll see that we grew adjusted EBITDAC by $122 million over last year’s first quarter, resulting in about 480 basis points of adjusted margin expansion. That would have been closer to 550 basis points, but as we discussed in our March IR Day, M&A roll-in isn’t as seasonally large, and we did strengthen bonus a bit, given our outlook for 2021 as considerably more optimistic today than it was last year at this time standing at the gates of a global pandemic. Within that $122 million of EBITDAC growth is about $60 million that is directly related to our cost savings initiatives, call that about 370 basis points of margin expansion. So when controlling for these three items, we see underlying margin expansion of about 180 basis points on that 6% all-in organic, once again, absolutely terrific execution by the team. Moving on to the Risk Management segment on Page 6. We grew adjusted EBITDAC by $4.3 million, resulting in about 180 basis points of adjusted margin expansion, leading us to post margins nicely over 18%. Most of that was due to our cost savings initiatives. So when I combine our Brokerage and Risk Management segments, savings were around $64 million, pretty similar to the last three quarters and that consists of: reduced travel, entertainment and advertising, about $25 million; reduced consulting and professional fees, about $15 million; reduced outside labor and other workforce costs, about $15 million; and then reduced office supplies, consumables and occupancy costs of about another $9 million. But remember, first quarter 2021 is the last quarter we have a favorable comparison to pre-pandemic spend levels. So now it’s all about how much of the cost savings we can hold going forward. As I look at it today, I still believe we will hold a lot of it. As we have said before, we do see certain costs coming back but that won’t happen overnight. Our best guess is maybe $15 million coming back in the second quarter 2021, then step that up by about $5 million to $7 million in the third quarter and a similar step-up again in the fourth quarter. Those amounts that I’ve given are relative to 2020 same quarters adjusted for the roll-in impact of M&A. As for how that translates into margins, that’s really dependent on where we land on organic, but say you assume organic is around 5% or above for the remainder of the year, the math would say that would be enough to show some full year margin expansion and regardless of where we land, let’s keep this in perspective for the longer term. The pandemic has allowed and perhaps even forced us to accelerate a lot of the improvements we had on the drawing board and also served as an opportunity to design new and better ways to run our business. Both of these make us more productive today than we were 15 months ago and our service quality has even improved. This will provide a lasting benefit for years to come. So let’s move now to the CFO commentary document we posted on our investor website. On Page 3, most items are very similar to what we provided at our March IR Day. On Page 4, both clean energy and the corporate line came in better than we had provided in March. The corporate line is just timing between first and third quarters for certain tax items. But the clean energy investments had a much better quarter and we bumped up our full year estimate. It’s now looking like $70 million to $80 million of full year after-tax earnings, which is really good news. Next, flip to Page 5 of the CFO commentary. If you missed the clean energy vignette that I gave during our March IR Day, it might be worth to listen to the replay on our website, starts with the hour and 9-minute mark. Here are the punchlines: First, recall, 2021 is the last year of what we call the credit generation era; second, 2022 will be the first meaningful year in the cash harvesting era. This means 2021 is the last year we will report GAAP earnings, and 2022 will be the first year meaningful cash flows show up in our cash flow statement. You’ll see here on Page 5 that we think 2022 annual cash flows could increase by around $125 million to $150 million. And finally, this is not a one year benefit to cash flow. We have more than $1 billion of tax credit carryforwards on our balance sheet that should favorably impact cash flows for the next six to seven years. As for M&A capacity, at March 31, available cash on hand was more than $400 million, and we had no outstanding borrowings on our revolving credit facility. So with cash on hand, our untapped borrowing capacity and another year of strong cash flows, it means upwards of $2.5 billion of M&A capacity here in 2021. With a nice M&A pipeline, we are in good shape to continue with our tuck-in strategy. Before I pass it back to Pat, and that was a mouthful, as I sit here today, I see a lot of positives. Organic has nice tailwinds from rate and exposure growth. Add to that a lot of pent-up consumer demand and perhaps a wave of governmental spending. Both could be additional growth catalysts. We have a robust M&A pipeline that should continue to grow, especially if an increase in capital gains tax gets momentum and we’ve learned a lot from the pandemic on how to operate better, faster and cheaper, all the while improving service quality and our productivity gains we achieved over the last year appear to be sticky. This all bodes well for another year of strong cash flow generation, with a kicker starting in 2022 from our clean energy investment. So, we are very well positioned operationally and financially. I can feel the excitement out in the field about coming out of the pandemic stronger than ever before. It’s setting up to be another great year. Back to you, Pat.
J. Patrick Gallagher: Thanks, Doug. Laura, I think we can go to some questions and answers.
Operator: [Operator Instructions] Our first question comes from the line of Elyse Greenspan with Wells Fargo. You may proceed with your question.
Elyse Greenspan: Hi, thanks. Good evening.
J. Patrick Gallagher: Hi, Elyse.
Elyse Greenspan: Hi. My first question is on organic. You guys printed 6% in the quarter. As I look to your comments, you said perhaps you get back to where we were in 2019, which is also 6%. But if you think about what’s going on today, you pointed to still strong P&C pricing and the economy is getting better. So what would cause the forward three quarters of this year to not be stronger? Like do you see anything decelerating or is it just there’s some conservatism in that outlook for things to kind of stay stable over the rest of the year?
Doug Howell: I think it depends on the recovery pattern. I think there’s still a lot of unemployment in there, and we’re running somewhere in that 5.5% to 6% range right now. We’re going to hold that for the rest of the year. It looks like it could be a pretty good year. So there’s nothing inherently different today in that thinking other than it feels kind of like 2019.
J. Patrick Gallagher: Our clients are doing much better, Elyse. I think they are coming back to 2019, not surging beyond it.
Elyse Greenspan: Okay and then in terms of the margin, right, you guys had alluded to 400 basis points of margin expansion at your IR event, and that came 80 basis points above but we still had the headwind you were alluding to. So what was better, I guess, relative to the IR Day within the margin? Was it the contingence on supplemental? Or was it just kind of the core margin expansion away from the save which is better than you were thinking?
Doug Howell: It was a contingent commission that came in better, primarily fueled that.
Elyse Greenspan: Okay and then on the M&A side of things, you pointed to an active pipeline in terms of tuck-ins. There’s obviously a pretty big merger between Aon and Willis that – where they’re working toward their regulatory approvals and I’m not sure if you can comment on it. Obviously a lot of speculation in the press in terms of what may or may not be divested. But as you guys think about larger deals, could you just give us a sense of how you’re thinking about, I guess, potentially on the M&A side, if there are properties that could become available there to the divestment process and things that could potentially be attractive to Gallagher.
Doug Howell: Right. So there’s a lot to unpack in that. I’ll hit the capacity. We have up to $2.5 billion worth of M&A capacity this year and we’ve got a full pipeline of nice tuck-in acquisitions that are out there. In terms of what comes out of the Aon and Willis opportunity, we read the same things that you’re reading and we just typically don’t comment on acquisitions that we hear about in the papers, but we’ve got $2.5 billion and we like our tuck-in merger strategy.
Elyse Greenspan: Okay, that’s helpful. Thanks for the color.
Operator: Our next question comes from the line of Greg Peters with Raymond James. You may proceed with your question.
Greg Peters: Good afternoon.
J. Patrick Gallagher: Hey Greg.
Greg Peters: So I just want to turn around the discussion on M&A. Can you go back and revisit sort of the process that evolved and emerged when you guys were doing the JLT global aerospace deal in 2019? Was it a 3-month process? Was it a one-month process? And I guess, ultimately, what we’re getting at is or I’m going with is there’s some pretty strong time line issues with Aon and Willis Towers Watson. And I guess some of your investors might be concerned that you, in an effort to meet their time lines, not that you’re doing anything, but you might sacrifice your due diligence, if that makes sense.
J. Patrick Gallagher: Greg, I’ll take a shot at that. We did the Arrow deal in London in pretty short order. We’re really happy with that acquisition. It turned out to be terrific. We didn’t seem to sacrifice anything.
Greg Peters: Okay and so one of the other areas that you referenced is culture. Maybe you can go back to the acquisitions, the large acquisitions you did in New Zealand and Australia and talk to us a little bit how you were able to ensure the continuity of your culture when you’re doing large deals.
J. Patrick Gallagher: Well, I think in that situation, you had very good strong stand-alone businesses that we could, in fact, get to meet the leadership of. I think you remember the story. We did fly to Australia, met leadership and gave them the choice. They were planning on going public in their own right. We met two leaders with – the entire top leadership. And basically, that evening said, "You’ve got a choice to make. You want to go public on your own or do you want to join us?" Steve Lockwood, who’s still with us, had that decision to make. I think he made a pretty good decision. Things are going great.
Doug Howell: Yes. I think, Greg, on that one, in particular, too, is that – and this seems odd for the accountant to say this, but when you – on that deal, it was owned by an industrial conglomerate that really didn’t view brokerage as being its priority, insurance brokerage and I’ve got to say, for the way our sales leadership and our operational leadership came down to Australia, combined with Steve’s relentless focus on sales, we really – it was really the Australia business that needed a positive shot in the arm when it comes to embracing and supporting a sales culture and we think that what works at Gallagher are people that want to come in and sell insurance and we’ve worked hard over the number of years to show that we’re a broker run by brokers and so we like to sell insurance and that is the culture that we think really, really was the secret sauce to taking – it was running negative 7% organic in Australia when we bought it and we think we did a terrific job. It’s posting nice organic year in and year out since that – since we did that.
J. Patrick Gallagher: Canada, our Canadian operation was running negative organic as well.
Greg Peters: Well, the accountant didn’t do too bad with his answer. So I’ll pivot to...
J. Patrick Gallagher: Remember, he’s been around 20 years, Greg.
Greg Peters: Yes, I’m well aware. I’d like to pivot to the operations. Just the two things that stuck out. The employee benefits business clearly is still – I don’t want to say struggling but it hasn’t rebounded the way it was pre-pandemic. Can you – is there any ASC 606 issues as we think about the first quarter results relative to the year before? Or is there – is it expected that as we move through the year, there could be some benefit in that if the economies do recover?
Doug Howell: There’s nothing noteworthy on 606 in the numbers, what could happen in the future. If you had a substantial recovery in covered lives compared to our estimates – covered lives compared to our estimates today, you could see some upside development in those estimates for the rest of this year. As you know, all that employee benefits business or most of it is a 1/1 renewal. We have to make our estimate of covered lives. And if there was a substantial surge in employment, it would probably pull up those estimates a little bit over the next three quarters as that develops.
Greg Peters: Got it. You know I feel like I’ve hogged enough of your time. I’ll let others ask their questions. Thanks for the answers.
J. Patrick Gallagher: Thanks Greg.
Operator: Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question.
David Motemaden: Hi, good evening.
J. Patrick Gallagher: Hi David.
David Motemaden: I had a question, just following up on the benefits business and hoping to maybe get a bit more granular detail just in terms of how you’re thinking about organic throughout the rest of the year and specifically, I know you spoke about, in your response to the previous question, just about your estimates about covered lives and what those do for the year. So I’m wondering what your expectations are for the rest of the year just for covered lives, like what’s baked in that statement that you’re assuming we can get back to 2019 organic levels here in 2021?
Doug Howell: Yes. So our assumptions in the 606 estimates are not substantial recovery in covered lives, different than where our brokers place the business as they put that to rest here in January. So there isn’t a substantial uptick in expectation. Also on that point, remember, that business didn’t fall off the cliff last year because the employers that we do are pretty stable employers and so while we didn’t have a substantial decrease in covered lives last year, and so I wouldn’t expect a substantial recovery of that for the rest of the year. So kind of flat where they renewed is what our expectations were used when we set that reserve – that estimate.
J. Patrick Gallagher: Where we see some opportunity to grow back is the fee business. That business was just – it was slammed shut at the end of the first quarter last year and those are projects that need to be done. They need professionals to do them, and I think that there will be some more demand there.
Doug Howell: I mean the workforce talent is coming back, so, I think that’s – and that’s where we excel and that is helping employers with that.
David Motemaden: Got it. No, that’s helpful and I’m sorry if I missed it, but did you talk about how that’s trending thus far in the second quarter just on the consulting arrangements?
Doug Howell: We didn’t comment but we’re happy to. Not a substantial difference sitting here on April 29, as we saw, let’s say, on March 29. But there is – there are some green shoots. Our consultants are getting some more calls so I think that you’ll see a little bit more active summer and fall.
J. Patrick Gallagher: Let’s hope.
David Motemaden: Got it. No, that’s helpful and then maybe just stepping back, a bigger picture question. Sort of on the M&A theme but I’m just sort of – I’m wondering just how you guys are thinking about broader acquisitions as opposed to team lift-outs and sort of how you weigh both potential. Very similar ways of growth but obviously different in terms of the way the financials work. So just wondering how you think about both of those avenues.
J. Patrick Gallagher: Yes. Let me be real clear, David. I think these players in the market, they want to ignore contracts, lift teams, litigate and call that a cheaper way to get talent. Let me see if I can clean up my comments. I don’t like that. We like to see people that have built companies, entrepreneurial in nature, have a culture, respect their clients, respect their people and sell ongoing enterprises to us. Do we recruit individual people? Absolutely. And do we bring teams across? Yes, we do. But the other method isn’t for us.
David Motemaden: Got it. Yup. That makes sense. That’s all that I have. I’ll let others ask their questions in the queue. Thank you.
J. Patrick Gallagher: Thanks David
Operator: Our next question comes from the line of Mark Hughes with Truist. You may proceed with your question.
J. Patrick Gallagher: Hi Mark.
Mark Hughes: Yeah, thank you. Good afternoon.
J. Patrick Gallagher: Hi Mark.
Mark Hughes: Hello. Hey, on the Risk Management business, I’ll ask a question about claims. You say that year-over-year, clearly, frequency or claims counts are going to be up. But it sounds like Q4 and Q1 and maybe even so far in Q2 are holding relatively steady. Is that the right way to think about that?
Doug Howell: Yes. I think there’s a little bit of a crossover here, Mark. As COVID claims started to decline, we started to see regular workers’ comp claim go up. You’ll have a little bit of that in the second quarter but not much. I think the COVID claims are pretty well through our process at this point, and then the regular workers’ comp claims will far exceed that going forward. So that might be what you’re seeing in that number.
Mark Hughes: On just the pricing environment, there’s some talk of moderation. You all seem to be pretty consistent that the trends are holding steady, similar rates of increase. I think in the text, you might have pointed to higher rates of increase in the second quarter. Are you seeing any sort of moderation?
J. Patrick Gallagher: No, we’re not. I think we’re seeing consistent demand for proper pricing. We’ve been a couple of years now into some hardening numbers. So I do think that over time, that will moderate but we’re not seeing any lack of discipline in the market at this point and underwriters are continuing to ask for increases.
Doug Howell: Yes. When you look at the dollar – the year-over-year dollar-over-dollar increases, the dollars are still going up. The rate or the percentage might not be as big because you’re on a bigger base, but there’s still rate increases happening everywhere. Even workers’ comp is getting rate at this point.
Mark Hughes: Then Doug, any green shoots about extending the clean energy legislation?
Doug Howell: There’s a lot of infrastructure packages out there, and I think that there’s opportunity to realize this process does contribute some pretty good value to the environment. So there’s always hope. If we get an opportunity to – in the infrastructure package or in the tax reconciliation process that might come through, there’s always hope on that.
Mark Hughes: Thank you.
Doug Howell: Sure.
J. Patrick Gallagher: Thanks Mark.
Operator: Our next question comes from the line of Yaron Kinar with Goldman Sachs. You may proceed with your question.
Yaron Kinar: Hi, good afternoon everybody. My first question on the contingent commissions. If I’m doing my math correct, I think I get to like 120 basis points or so of margin expansion coming from contingents. Does that resonate?
Doug Howell: What did you assume as the margin on it?
Yaron Kinar: About 70%.
Doug Howell: Yes, it might be a little thick. I mean a lot of the contingent commissions go to – when it comes to the leadership variable comp, there’s a piece of that that fuels it. So 70% might be a little rich, but some of it, yes, maybe 100 basis points, maybe not 120.
Yaron Kinar: Okay, OK. So you got like 60 basis points of, call it, organic margin expansion, 100 coming from contingents and the rest coming from cost saves, if I wanted to divide it into buckets?
Doug Howell: Probably almost a point from regular trough then – and when you take out the contingents and you can’t take out the margin from that.
Yaron Kinar: Okay, OK. That’s helpful and did I hear you say that you’re switching over to cash EPS in 2022?
Doug Howell: No. I think what I was saying is that in the clean energy segment, you’re going to start seeing $120 million to – $125 million to $150 million of additional cash flows that will come through our cash flow statement. We’ll obviously make sure that we call that out every quarter on how much is that because it’s the rundown of that deferred tax asset that sits on our balance sheet that moves from being a noncash asset into a cash asset. So we’ll make sure we highlight it as we go forward.
Yaron Kinar: Got it, OK. Thank you very much and congrats on the quarter.
Doug Howell: Thanks.
J. Patrick Gallagher: Thanks.
Operator: Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question.
Meyer Shields: Thanks. I guess the big dumb question that I’m struggling with is that if we’re seeing rate increases hold flat and we assume that the economy comes back, wouldn’t that point to organic growth on a year-over-year basis well above 5%?
J. Patrick Gallagher: Hope so.
Doug Howell: Part of that, though too, is remember, our job is to help our client structure programs that actually mitigate some of the rate increase. It’s hard to mitigate exposure growth unless you want to take more deductibles or lower limits. Rate increases, there’s some – you can do the same thing, but if somebody adds two or three more trucks, you’ve got to insure those other two or three more trucks. So if exposure units overtake the recovery from rate on that, the programs that we designed, you’d see more of that hitting the bottom line. But if it’s just purely rate, you can mitigate some of that through different program structure.
Meyer Shields: Okay, that’s very helpful and then if I can dig just a little deeper on the claims – the workers’ compensation claims that you’re seeing in the trends. Is there a material difference to your revenues when you’re handling traditional work comp claims versus COVID?
Doug Howell: Well, there’s two different – there’s different pieces and there’s the liability piece and then there’s the medical-only piece in traditional workers’ comp. I think that the longer-tail liability type workers’ comp claim is more profitable to us than just the kind of the recurring medical-only claims, where we’re basically paying the bills on it. So you would see that – you would – the revenues that come off of a liability-related workers’ comp claim would probably exceed the COVID claims.
Meyer Shields: Okay. Perfect. Good. That’s very helpful. Thanks a lot.
J. Patrick Gallagher: Thanks Meyer.
Operator: Our last question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question.
Phil Stefano: Yes, thanks and good evening. Just a few quick ones. Most have been asked and answered. But – so as we think about the appropriate base for our margin for first quarter 2022, is it the 39.2% that was printed? Or should we make some kind of adjustment for the margin benefit from the contingents and supplementals?
Doug Howell: Okay. So you’re asking about a year from now in first quarter 2022?
Phil Stefano: No it would...
Doug Howell: I’ll help you think that out a second here as I think that, yes, when you look at our 39.2%, the base should probably start from – you heard the earlier question. We probably got a little lift from contingent commissions in that number, so you want to start off a little bit lower base and let’s say by then, we’re holding half of our savings, long-term savings compared to where we are today. Maybe there’s $30 million worth of costs that are back into the structure by that time and spread that across $1.8 billion or $1.9 billion. That’s probably the right way to think about next year.
Phil Stefano: Okay, but it’s fair to say any of this lumpy stuff should probably be normalized for.
Doug Howell: Say that again, I’m sorry.
Phil Stefano: It’s fair to say that – I mean the lumpy kind of impacts like a contingent over-earning, we should probably normalize for that as we think about the forward margin.
Doug Howell: Yes, I think so. Yes.
Phil Stefano: Okay, all right. Perfect and then from the Risk Management segment, I guess, there was a comment around it being in the upper single digits for the next few quarters. Is the right way to think about this year-over-year or sequentially? I guess in my mind, when I think about your comment about claim counts being kind of flattish fourth quarter to first quarter, it feels like that’s reflected in the revenues and as we think about claim counts expanding with the economy opening back up, I guess, maybe 2021 is kind of one of the businesses where I look at this sequentially as opposed to on a year-over-year basis. Is that off base?
Doug Howell: Either way, as long as you understand that last year’s second quarter there was a trough and there will be some recovery out of it this year relative to that quarter, but if you’re basing it off the last two quarters and want to do a run rate that way, it’s probably not a bad way to do it either.
Phil Stefano: Okay. All right. Perfect. That’s all I had.
J. Patrick Gallagher: Thank you, Phil. Well, thank you again, everybody, for being on today this afternoon. We really appreciate it. We delivered an excellent first quarter, and I’d like to thank all of our Gallagher professionals for their hard work, our clients for their trust and our carrier partners for their support. I’m confident that we can deliver another great year of financial performance in 2021 and truly believe we’re just getting started. Thanks for being with us.
Operator: This does conclude today’s conference call. You may disconnect your lines at this time. Thank you for your participation and enjoy the rest of your evening. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Co.’s First Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. [Operator Instructions] Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company’s 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you, Laura. Good afternoon, and thank you for joining us for our first quarter 2021 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. What a fantastic quarter. We executed against our four long-term operating priorities to drive shareholder value: first, we grew organically; second, we grew through acquisitions; third, we improved our productivity while raising our quality; and fourth, we continue to reap the benefits of our unique Gallagher culture. I’m extremely proud of how our team continues to execute and deliver world-class expertise and service day-in and day-out. We’re off to a great start in 2021. So, let me give you some more detail on the quarter, starting with our Brokerage segment. Reported revenue growth of 12.2%, of that, 6% was organic revenue growth, better than our recent IR Day expectations, thanks to an excellent March. Our cost containment efforts saved about $60 million in the quarter, helping drive our net earnings margin higher by 94 basis points and expand our adjusted EBITDAC margin by 480 basis points and net earnings were up 17% and adjusted EBITDAC was up 24%, an excellent quarter from the Brokerage team. Let me walk you around the world and give you some soundbites about each of our Brokerage units, starting with our P/C operations. In the U.S., retail organic growth was strong at about 5%. New business was excellent and retention remains strong. In our U.S. wholesale operations, Risk Placement Services organic was about 6%. Open brokerage organic was 15% due to rate increases, higher levels of new business and improved retention. Our MGA program’s binding businesses were up about 4%. Retention in new business were similar to the first quarter of 2020. However, we did see a little bit more tailwind from rate and exposure during the quarter. Moving to the UK, over 7% organic for the quarter. In both our retail and specialty operations, new business was up over prior year while retention held pretty steady. Australia and New Zealand combined posted organic of 3%. New business and retention were both similar to prior year. And finally, our Canadian retail operations, excellent organic of 13%, fantastic new business and rate all added to our stellar performance again this quarter. So overall, our global P/C operations posted more than 7% organic, which is better than the 5% to 6% we discussed at our Investor Day, thanks to a really strong March. Moving to our employee benefit brokerage and consulting business. First quarter organic was up slightly, which is better than our March IR Day expectations. Revenue from our traditional health and welfare business held up well, while fees from consulting arrangements, special project work and our life business were up slightly. So when I bring P/C and Benefits together, total Brokerage segment organic was 6%, a really strong start to the year. Next, I’d like to make a few comments on the P/C market, starting with the rate environment. Global P/C rates remain firm overall and the increases we saw during the first quarter of 2021 are consistent with the past couple of quarters. Rates in Canada led the way, up double digits, driven by property and professional liability. In the U.S., rates were up about 7%, including double-digit rate increases within our wholesale open brokerage operations. Our UK retail and London specialty operations combined, rates are up about 5%. And finally, Australia and New Zealand combined, rate increases are in the low single digits. At the same time, capacity is constrained in certain lines and carriers are pushing for tighter terms and conditions. There are also quite a few pockets in the U.S., Canada and London specialty market that I would describe as hard such as cat-exposed properties, cyber, umbrella and public company D&O, just to name a few. So the global P/C environment remains difficult but is giving us some tailwinds. Looking forward, we don’t see conditions that would indicate this rate environment will change anytime soon, and we are seeing more and more economic activity across our client base. For example, customers are adding coverages and exposures to their existing policies. And through yesterday, April endorsements, premium audits and other midterm policy adjustments are a net positive overall. That, too, is an encouraging sign. On the benefits side, a recovering labor market in 2021 should favorably impact our core health and welfare business. And we remain optimistic that we will start to see some incremental HR consulting and special project work. This is a terrific time for our team to shine, firm global rates, increasing exposure units and recovering employment. Our clients need our expertise and we are there with the very best insurance, consulting and risk management advice. So while there’s a lot of year left, I have greater conviction that our full year 2021 Brokerage segment organic will be equal to or perhaps even better than pre-pandemic 2019 organic. Moving on to mergers and acquisitions. We finished the first quarter with five completed brokerage mergers, representing about $90 million of estimated annualized revenues. I’d like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in M&A pipeline, we have more than 40 term sheets signed or being prepared, representing about $250 million of annualized revenues. Our global platform is a great fit for savvy and successful entrepreneurs. We have the tools, data, products, niche expertise and carrier relationships to help these owners support their current clients and take their business to the next level. Next, I’d like to move to our Risk Management segment, Gallagher Bassett. First quarter organic growth was 0.6%, which is in line with our March IR Day expectations of about flat. It was still a tough compare to pre-pandemic first quarter 2020. However, there is no doubt we are starting to see more and more core workers’ comp claim activity when compared to what we were seeing last year at this time. Traditional workers’ comp claims are returning and we are seeing fewer and fewer COVID-related claims. Our cost containment efforts paid off again this quarter. We saved around $4 million and expanded our adjusted EBITDAC margin by 180 basis points to 18.4%, another great quarter of execution by the Gallagher Bassett team. Looking forward to the next three quarters, we would expect new claims arising to be higher than what we saw last year, perhaps not back to pre-pandemic levels quite yet but certainly higher than last year. So when I combine that with some really nice new business wins, we should be back to seeing organic in the upper single digits for the next few quarters. That would also bode well for keeping margins above 18% for the remainder of the year. Let me wrap up with some comments regarding our unique Gallagher culture. It’s a culture that emphasizes doing things the right way for the right reasons with the right people. It’s a culture of service, service to our clients, to one another and to the communities where we work and where we live and our culture continues to be recognized externally. Just last week, Forbes named Gallagher one of the best U.S. employers for diversity and that’s on top of Gallagher being recognized by the Ethisphere Institute as one of the world’s most ethical companies for the 10th year in a row, 10 straight years, and once again, the sole insurance broker recognized. These recognitions are a direct reflection of our more than 30,000 global colleagues working together as a team guided by the 25 tenets of the Gallagher Way. Culture is a key differentiator for our franchise. Every day, all of our people get up and work diligently to maintain our culture, to promote our culture, to live our culture, and I believe our culture has never been stronger. Doug, over to you."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat, and good afternoon, everyone. I’ll echo Pat’s comments, an excellent quarter and a terrific start to the year. Today, I’ll spend most of my time on both our cost savings initiatives and our clean energy cash flows, then highlight a few items in our CFO commentary document, and I’ll close with some comments on M&A, cash and liquidity. Before I plunge in on cost, one quick comment on Page 3 in the Brokerage segment organic table. You’ll see that we had a great quarter for contingent commissions. There is a little bit of favorable timing in there, call it about 50 basis points on total organic. That will flip the other way next quarter but regardless, a really solid quarter. Okay, let’s go to Page 5, the Brokerage segment adjusted EBITDAC table. You’ll see that we grew adjusted EBITDAC by $122 million over last year’s first quarter, resulting in about 480 basis points of adjusted margin expansion. That would have been closer to 550 basis points, but as we discussed in our March IR Day, M&A roll-in isn’t as seasonally large, and we did strengthen bonus a bit, given our outlook for 2021 as considerably more optimistic today than it was last year at this time standing at the gates of a global pandemic. Within that $122 million of EBITDAC growth is about $60 million that is directly related to our cost savings initiatives, call that about 370 basis points of margin expansion. So when controlling for these three items, we see underlying margin expansion of about 180 basis points on that 6% all-in organic, once again, absolutely terrific execution by the team. Moving on to the Risk Management segment on Page 6. We grew adjusted EBITDAC by $4.3 million, resulting in about 180 basis points of adjusted margin expansion, leading us to post margins nicely over 18%. Most of that was due to our cost savings initiatives. So when I combine our Brokerage and Risk Management segments, savings were around $64 million, pretty similar to the last three quarters and that consists of: reduced travel, entertainment and advertising, about $25 million; reduced consulting and professional fees, about $15 million; reduced outside labor and other workforce costs, about $15 million; and then reduced office supplies, consumables and occupancy costs of about another $9 million. But remember, first quarter 2021 is the last quarter we have a favorable comparison to pre-pandemic spend levels. So now it’s all about how much of the cost savings we can hold going forward. As I look at it today, I still believe we will hold a lot of it. As we have said before, we do see certain costs coming back but that won’t happen overnight. Our best guess is maybe $15 million coming back in the second quarter 2021, then step that up by about $5 million to $7 million in the third quarter and a similar step-up again in the fourth quarter. Those amounts that I’ve given are relative to 2020 same quarters adjusted for the roll-in impact of M&A. As for how that translates into margins, that’s really dependent on where we land on organic, but say you assume organic is around 5% or above for the remainder of the year, the math would say that would be enough to show some full year margin expansion and regardless of where we land, let’s keep this in perspective for the longer term. The pandemic has allowed and perhaps even forced us to accelerate a lot of the improvements we had on the drawing board and also served as an opportunity to design new and better ways to run our business. Both of these make us more productive today than we were 15 months ago and our service quality has even improved. This will provide a lasting benefit for years to come. So let’s move now to the CFO commentary document we posted on our investor website. On Page 3, most items are very similar to what we provided at our March IR Day. On Page 4, both clean energy and the corporate line came in better than we had provided in March. The corporate line is just timing between first and third quarters for certain tax items. But the clean energy investments had a much better quarter and we bumped up our full year estimate. It’s now looking like $70 million to $80 million of full year after-tax earnings, which is really good news. Next, flip to Page 5 of the CFO commentary. If you missed the clean energy vignette that I gave during our March IR Day, it might be worth to listen to the replay on our website, starts with the hour and 9-minute mark. Here are the punchlines: First, recall, 2021 is the last year of what we call the credit generation era; second, 2022 will be the first meaningful year in the cash harvesting era. This means 2021 is the last year we will report GAAP earnings, and 2022 will be the first year meaningful cash flows show up in our cash flow statement. You’ll see here on Page 5 that we think 2022 annual cash flows could increase by around $125 million to $150 million. And finally, this is not a one year benefit to cash flow. We have more than $1 billion of tax credit carryforwards on our balance sheet that should favorably impact cash flows for the next six to seven years. As for M&A capacity, at March 31, available cash on hand was more than $400 million, and we had no outstanding borrowings on our revolving credit facility. So with cash on hand, our untapped borrowing capacity and another year of strong cash flows, it means upwards of $2.5 billion of M&A capacity here in 2021. With a nice M&A pipeline, we are in good shape to continue with our tuck-in strategy. Before I pass it back to Pat, and that was a mouthful, as I sit here today, I see a lot of positives. Organic has nice tailwinds from rate and exposure growth. Add to that a lot of pent-up consumer demand and perhaps a wave of governmental spending. Both could be additional growth catalysts. We have a robust M&A pipeline that should continue to grow, especially if an increase in capital gains tax gets momentum and we’ve learned a lot from the pandemic on how to operate better, faster and cheaper, all the while improving service quality and our productivity gains we achieved over the last year appear to be sticky. This all bodes well for another year of strong cash flow generation, with a kicker starting in 2022 from our clean energy investment. So, we are very well positioned operationally and financially. I can feel the excitement out in the field about coming out of the pandemic stronger than ever before. It’s setting up to be another great year. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Doug. Laura, I think we can go to some questions and answers."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Elyse Greenspan with Wells Fargo. You may proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good evening."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Elyse."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi. My first question is on organic. You guys printed 6% in the quarter. As I look to your comments, you said perhaps you get back to where we were in 2019, which is also 6%. But if you think about what’s going on today, you pointed to still strong P&C pricing and the economy is getting better. So what would cause the forward three quarters of this year to not be stronger? Like do you see anything decelerating or is it just there’s some conservatism in that outlook for things to kind of stay stable over the rest of the year?"
},
{
"speaker": "Doug Howell",
"text": "I think it depends on the recovery pattern. I think there’s still a lot of unemployment in there, and we’re running somewhere in that 5.5% to 6% range right now. We’re going to hold that for the rest of the year. It looks like it could be a pretty good year. So there’s nothing inherently different today in that thinking other than it feels kind of like 2019."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Our clients are doing much better, Elyse. I think they are coming back to 2019, not surging beyond it."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay and then in terms of the margin, right, you guys had alluded to 400 basis points of margin expansion at your IR event, and that came 80 basis points above but we still had the headwind you were alluding to. So what was better, I guess, relative to the IR Day within the margin? Was it the contingence on supplemental? Or was it just kind of the core margin expansion away from the save which is better than you were thinking?"
},
{
"speaker": "Doug Howell",
"text": "It was a contingent commission that came in better, primarily fueled that."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay and then on the M&A side of things, you pointed to an active pipeline in terms of tuck-ins. There’s obviously a pretty big merger between Aon and Willis that – where they’re working toward their regulatory approvals and I’m not sure if you can comment on it. Obviously a lot of speculation in the press in terms of what may or may not be divested. But as you guys think about larger deals, could you just give us a sense of how you’re thinking about, I guess, potentially on the M&A side, if there are properties that could become available there to the divestment process and things that could potentially be attractive to Gallagher."
},
{
"speaker": "Doug Howell",
"text": "Right. So there’s a lot to unpack in that. I’ll hit the capacity. We have up to $2.5 billion worth of M&A capacity this year and we’ve got a full pipeline of nice tuck-in acquisitions that are out there. In terms of what comes out of the Aon and Willis opportunity, we read the same things that you’re reading and we just typically don’t comment on acquisitions that we hear about in the papers, but we’ve got $2.5 billion and we like our tuck-in merger strategy."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay, that’s helpful. Thanks for the color."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Greg Peters with Raymond James. You may proceed with your question."
},
{
"speaker": "Greg Peters",
"text": "Good afternoon."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hey Greg."
},
{
"speaker": "Greg Peters",
"text": "So I just want to turn around the discussion on M&A. Can you go back and revisit sort of the process that evolved and emerged when you guys were doing the JLT global aerospace deal in 2019? Was it a 3-month process? Was it a one-month process? And I guess, ultimately, what we’re getting at is or I’m going with is there’s some pretty strong time line issues with Aon and Willis Towers Watson. And I guess some of your investors might be concerned that you, in an effort to meet their time lines, not that you’re doing anything, but you might sacrifice your due diligence, if that makes sense."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Greg, I’ll take a shot at that. We did the Arrow deal in London in pretty short order. We’re really happy with that acquisition. It turned out to be terrific. We didn’t seem to sacrifice anything."
},
{
"speaker": "Greg Peters",
"text": "Okay and so one of the other areas that you referenced is culture. Maybe you can go back to the acquisitions, the large acquisitions you did in New Zealand and Australia and talk to us a little bit how you were able to ensure the continuity of your culture when you’re doing large deals."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I think in that situation, you had very good strong stand-alone businesses that we could, in fact, get to meet the leadership of. I think you remember the story. We did fly to Australia, met leadership and gave them the choice. They were planning on going public in their own right. We met two leaders with – the entire top leadership. And basically, that evening said, \"You’ve got a choice to make. You want to go public on your own or do you want to join us?\" Steve Lockwood, who’s still with us, had that decision to make. I think he made a pretty good decision. Things are going great."
},
{
"speaker": "Doug Howell",
"text": "Yes. I think, Greg, on that one, in particular, too, is that – and this seems odd for the accountant to say this, but when you – on that deal, it was owned by an industrial conglomerate that really didn’t view brokerage as being its priority, insurance brokerage and I’ve got to say, for the way our sales leadership and our operational leadership came down to Australia, combined with Steve’s relentless focus on sales, we really – it was really the Australia business that needed a positive shot in the arm when it comes to embracing and supporting a sales culture and we think that what works at Gallagher are people that want to come in and sell insurance and we’ve worked hard over the number of years to show that we’re a broker run by brokers and so we like to sell insurance and that is the culture that we think really, really was the secret sauce to taking – it was running negative 7% organic in Australia when we bought it and we think we did a terrific job. It’s posting nice organic year in and year out since that – since we did that."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Canada, our Canadian operation was running negative organic as well."
},
{
"speaker": "Greg Peters",
"text": "Well, the accountant didn’t do too bad with his answer. So I’ll pivot to..."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Remember, he’s been around 20 years, Greg."
},
{
"speaker": "Greg Peters",
"text": "Yes, I’m well aware. I’d like to pivot to the operations. Just the two things that stuck out. The employee benefits business clearly is still – I don’t want to say struggling but it hasn’t rebounded the way it was pre-pandemic. Can you – is there any ASC 606 issues as we think about the first quarter results relative to the year before? Or is there – is it expected that as we move through the year, there could be some benefit in that if the economies do recover?"
},
{
"speaker": "Doug Howell",
"text": "There’s nothing noteworthy on 606 in the numbers, what could happen in the future. If you had a substantial recovery in covered lives compared to our estimates – covered lives compared to our estimates today, you could see some upside development in those estimates for the rest of this year. As you know, all that employee benefits business or most of it is a 1/1 renewal. We have to make our estimate of covered lives. And if there was a substantial surge in employment, it would probably pull up those estimates a little bit over the next three quarters as that develops."
},
{
"speaker": "Greg Peters",
"text": "Got it. You know I feel like I’ve hogged enough of your time. I’ll let others ask their questions. Thanks for the answers."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Greg."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question."
},
{
"speaker": "David Motemaden",
"text": "Hi, good evening."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi David."
},
{
"speaker": "David Motemaden",
"text": "I had a question, just following up on the benefits business and hoping to maybe get a bit more granular detail just in terms of how you’re thinking about organic throughout the rest of the year and specifically, I know you spoke about, in your response to the previous question, just about your estimates about covered lives and what those do for the year. So I’m wondering what your expectations are for the rest of the year just for covered lives, like what’s baked in that statement that you’re assuming we can get back to 2019 organic levels here in 2021?"
},
{
"speaker": "Doug Howell",
"text": "Yes. So our assumptions in the 606 estimates are not substantial recovery in covered lives, different than where our brokers place the business as they put that to rest here in January. So there isn’t a substantial uptick in expectation. Also on that point, remember, that business didn’t fall off the cliff last year because the employers that we do are pretty stable employers and so while we didn’t have a substantial decrease in covered lives last year, and so I wouldn’t expect a substantial recovery of that for the rest of the year. So kind of flat where they renewed is what our expectations were used when we set that reserve – that estimate."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Where we see some opportunity to grow back is the fee business. That business was just – it was slammed shut at the end of the first quarter last year and those are projects that need to be done. They need professionals to do them, and I think that there will be some more demand there."
},
{
"speaker": "Doug Howell",
"text": "I mean the workforce talent is coming back, so, I think that’s – and that’s where we excel and that is helping employers with that."
},
{
"speaker": "David Motemaden",
"text": "Got it. No, that’s helpful and I’m sorry if I missed it, but did you talk about how that’s trending thus far in the second quarter just on the consulting arrangements?"
},
{
"speaker": "Doug Howell",
"text": "We didn’t comment but we’re happy to. Not a substantial difference sitting here on April 29, as we saw, let’s say, on March 29. But there is – there are some green shoots. Our consultants are getting some more calls so I think that you’ll see a little bit more active summer and fall."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Let’s hope."
},
{
"speaker": "David Motemaden",
"text": "Got it. No, that’s helpful and then maybe just stepping back, a bigger picture question. Sort of on the M&A theme but I’m just sort of – I’m wondering just how you guys are thinking about broader acquisitions as opposed to team lift-outs and sort of how you weigh both potential. Very similar ways of growth but obviously different in terms of the way the financials work. So just wondering how you think about both of those avenues."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes. Let me be real clear, David. I think these players in the market, they want to ignore contracts, lift teams, litigate and call that a cheaper way to get talent. Let me see if I can clean up my comments. I don’t like that. We like to see people that have built companies, entrepreneurial in nature, have a culture, respect their clients, respect their people and sell ongoing enterprises to us. Do we recruit individual people? Absolutely. And do we bring teams across? Yes, we do. But the other method isn’t for us."
},
{
"speaker": "David Motemaden",
"text": "Got it. Yup. That makes sense. That’s all that I have. I’ll let others ask their questions in the queue. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks David"
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mark Hughes with Truist. You may proceed with your question."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi Mark."
},
{
"speaker": "Mark Hughes",
"text": "Yeah, thank you. Good afternoon."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi Mark."
},
{
"speaker": "Mark Hughes",
"text": "Hello. Hey, on the Risk Management business, I’ll ask a question about claims. You say that year-over-year, clearly, frequency or claims counts are going to be up. But it sounds like Q4 and Q1 and maybe even so far in Q2 are holding relatively steady. Is that the right way to think about that?"
},
{
"speaker": "Doug Howell",
"text": "Yes. I think there’s a little bit of a crossover here, Mark. As COVID claims started to decline, we started to see regular workers’ comp claim go up. You’ll have a little bit of that in the second quarter but not much. I think the COVID claims are pretty well through our process at this point, and then the regular workers’ comp claims will far exceed that going forward. So that might be what you’re seeing in that number."
},
{
"speaker": "Mark Hughes",
"text": "On just the pricing environment, there’s some talk of moderation. You all seem to be pretty consistent that the trends are holding steady, similar rates of increase. I think in the text, you might have pointed to higher rates of increase in the second quarter. Are you seeing any sort of moderation?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No, we’re not. I think we’re seeing consistent demand for proper pricing. We’ve been a couple of years now into some hardening numbers. So I do think that over time, that will moderate but we’re not seeing any lack of discipline in the market at this point and underwriters are continuing to ask for increases."
},
{
"speaker": "Doug Howell",
"text": "Yes. When you look at the dollar – the year-over-year dollar-over-dollar increases, the dollars are still going up. The rate or the percentage might not be as big because you’re on a bigger base, but there’s still rate increases happening everywhere. Even workers’ comp is getting rate at this point."
},
{
"speaker": "Mark Hughes",
"text": "Then Doug, any green shoots about extending the clean energy legislation?"
},
{
"speaker": "Doug Howell",
"text": "There’s a lot of infrastructure packages out there, and I think that there’s opportunity to realize this process does contribute some pretty good value to the environment. So there’s always hope. If we get an opportunity to – in the infrastructure package or in the tax reconciliation process that might come through, there’s always hope on that."
},
{
"speaker": "Mark Hughes",
"text": "Thank you."
},
{
"speaker": "Doug Howell",
"text": "Sure."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Mark."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Yaron Kinar with Goldman Sachs. You may proceed with your question."
},
{
"speaker": "Yaron Kinar",
"text": "Hi, good afternoon everybody. My first question on the contingent commissions. If I’m doing my math correct, I think I get to like 120 basis points or so of margin expansion coming from contingents. Does that resonate?"
},
{
"speaker": "Doug Howell",
"text": "What did you assume as the margin on it?"
},
{
"speaker": "Yaron Kinar",
"text": "About 70%."
},
{
"speaker": "Doug Howell",
"text": "Yes, it might be a little thick. I mean a lot of the contingent commissions go to – when it comes to the leadership variable comp, there’s a piece of that that fuels it. So 70% might be a little rich, but some of it, yes, maybe 100 basis points, maybe not 120."
},
{
"speaker": "Yaron Kinar",
"text": "Okay, OK. So you got like 60 basis points of, call it, organic margin expansion, 100 coming from contingents and the rest coming from cost saves, if I wanted to divide it into buckets?"
},
{
"speaker": "Doug Howell",
"text": "Probably almost a point from regular trough then – and when you take out the contingents and you can’t take out the margin from that."
},
{
"speaker": "Yaron Kinar",
"text": "Okay, OK. That’s helpful and did I hear you say that you’re switching over to cash EPS in 2022?"
},
{
"speaker": "Doug Howell",
"text": "No. I think what I was saying is that in the clean energy segment, you’re going to start seeing $120 million to – $125 million to $150 million of additional cash flows that will come through our cash flow statement. We’ll obviously make sure that we call that out every quarter on how much is that because it’s the rundown of that deferred tax asset that sits on our balance sheet that moves from being a noncash asset into a cash asset. So we’ll make sure we highlight it as we go forward."
},
{
"speaker": "Yaron Kinar",
"text": "Got it, OK. Thank you very much and congrats on the quarter."
},
{
"speaker": "Doug Howell",
"text": "Thanks."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question."
},
{
"speaker": "Meyer Shields",
"text": "Thanks. I guess the big dumb question that I’m struggling with is that if we’re seeing rate increases hold flat and we assume that the economy comes back, wouldn’t that point to organic growth on a year-over-year basis well above 5%?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hope so."
},
{
"speaker": "Doug Howell",
"text": "Part of that, though too, is remember, our job is to help our client structure programs that actually mitigate some of the rate increase. It’s hard to mitigate exposure growth unless you want to take more deductibles or lower limits. Rate increases, there’s some – you can do the same thing, but if somebody adds two or three more trucks, you’ve got to insure those other two or three more trucks. So if exposure units overtake the recovery from rate on that, the programs that we designed, you’d see more of that hitting the bottom line. But if it’s just purely rate, you can mitigate some of that through different program structure."
},
{
"speaker": "Meyer Shields",
"text": "Okay, that’s very helpful and then if I can dig just a little deeper on the claims – the workers’ compensation claims that you’re seeing in the trends. Is there a material difference to your revenues when you’re handling traditional work comp claims versus COVID?"
},
{
"speaker": "Doug Howell",
"text": "Well, there’s two different – there’s different pieces and there’s the liability piece and then there’s the medical-only piece in traditional workers’ comp. I think that the longer-tail liability type workers’ comp claim is more profitable to us than just the kind of the recurring medical-only claims, where we’re basically paying the bills on it. So you would see that – you would – the revenues that come off of a liability-related workers’ comp claim would probably exceed the COVID claims."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Perfect. Good. That’s very helpful. Thanks a lot."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Meyer."
},
{
"speaker": "Operator",
"text": "Our last question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question."
},
{
"speaker": "Phil Stefano",
"text": "Yes, thanks and good evening. Just a few quick ones. Most have been asked and answered. But – so as we think about the appropriate base for our margin for first quarter 2022, is it the 39.2% that was printed? Or should we make some kind of adjustment for the margin benefit from the contingents and supplementals?"
},
{
"speaker": "Doug Howell",
"text": "Okay. So you’re asking about a year from now in first quarter 2022?"
},
{
"speaker": "Phil Stefano",
"text": "No it would..."
},
{
"speaker": "Doug Howell",
"text": "I’ll help you think that out a second here as I think that, yes, when you look at our 39.2%, the base should probably start from – you heard the earlier question. We probably got a little lift from contingent commissions in that number, so you want to start off a little bit lower base and let’s say by then, we’re holding half of our savings, long-term savings compared to where we are today. Maybe there’s $30 million worth of costs that are back into the structure by that time and spread that across $1.8 billion or $1.9 billion. That’s probably the right way to think about next year."
},
{
"speaker": "Phil Stefano",
"text": "Okay, but it’s fair to say any of this lumpy stuff should probably be normalized for."
},
{
"speaker": "Doug Howell",
"text": "Say that again, I’m sorry."
},
{
"speaker": "Phil Stefano",
"text": "It’s fair to say that – I mean the lumpy kind of impacts like a contingent over-earning, we should probably normalize for that as we think about the forward margin."
},
{
"speaker": "Doug Howell",
"text": "Yes, I think so. Yes."
},
{
"speaker": "Phil Stefano",
"text": "Okay, all right. Perfect and then from the Risk Management segment, I guess, there was a comment around it being in the upper single digits for the next few quarters. Is the right way to think about this year-over-year or sequentially? I guess in my mind, when I think about your comment about claim counts being kind of flattish fourth quarter to first quarter, it feels like that’s reflected in the revenues and as we think about claim counts expanding with the economy opening back up, I guess, maybe 2021 is kind of one of the businesses where I look at this sequentially as opposed to on a year-over-year basis. Is that off base?"
},
{
"speaker": "Doug Howell",
"text": "Either way, as long as you understand that last year’s second quarter there was a trough and there will be some recovery out of it this year relative to that quarter, but if you’re basing it off the last two quarters and want to do a run rate that way, it’s probably not a bad way to do it either."
},
{
"speaker": "Phil Stefano",
"text": "Okay. All right. Perfect. That’s all I had."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you, Phil. Well, thank you again, everybody, for being on today this afternoon. We really appreciate it. We delivered an excellent first quarter, and I’d like to thank all of our Gallagher professionals for their hard work, our clients for their trust and our carrier partners for their support. I’m confident that we can deliver another great year of financial performance in 2021 and truly believe we’re just getting started. Thanks for being with us."
},
{
"speaker": "Operator",
"text": "This does conclude today’s conference call. You may disconnect your lines at this time. Thank you for your participation and enjoy the rest of your evening."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 4 | 2,022 | 2023-01-26 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Company's Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions].Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce Patrick Gallagher, Chairman, President and CEO, Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
Patrick Gallagher: Thank you. Good afternoon, and thank you for joining us for our fourth quarter '22 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had a terrific finish to cap off an excellent year. During the quarter, for our combined Brokerage and Risk Management segments, we posted 16% growth in revenue, 11.7% organic growth. GAAP earnings per share of $0.83, adjusted earnings per share of $1.86, up 24% year-over-year, reported net earnings margin of 9%, adjusted EBITDAC margin of 29.6%, up 120 basis points. We also completed 17 mergers totaling more than $140 million of estimated annualized revenues in addition to announcing our agreement to acquire Buck, another fantastic quarter by the team and our best fourth quarter in decades. Let me give you some more detail on our fourth quarter performance, starting with our Brokerage segment. Reported revenue growth was 16%. Organic was 11%. Doug will explain it does include a point from our Annual 606 review, Brokerage organic and double digits is outstanding. Acquisition rollover revenues were $107 million, and our adjusted EBITDAC margin was 31.3%, up 120 basis points and in line with our December IR Day expectations, another excellent quarter for the brokerage team. Focusing on the Brokerage segment organic, let me walk you around the world and provide some more detailed commentary starting with our P/C operations. Our U.S. retail business posted 8% organic, our new business was a bit better than last year offset somewhat by less nonrecurring business, client retention and the combined impact of rate and exposure were both similar to last year's fourth quarter. Risk Placement Services, our U.S. wholesale operations, posted organic above 9%. This includes more than 12% organic and open brokerage and about 7% organic in our MGA programs and binding businesses. New business was strong and retention was consistent with last year's fourth quarter. Shifting to outside the U.S. Our U.K. businesses, both retail and specialty combined posted organic of 17% benefiting from excellent new business production, strong retention and the continued impact of renewal premium increases. Australia and New Zealand combined, organic was 12%. Net new versus loss business was consistent with last year and renewal premium increases were above fourth quarter '21 levels. Canada was up nearly 9% organically, reflecting solid new business and retention. Moving to our employee benefit brokerage and consulting business. Organic was 3%, consistent with our December IR Day expectations. New business was similar to last year's fourth quarter and retention remained excellent. And finally, to reinsurance. Our legacy reinsurance operations crushed it with some hard earned new business wins and quarterly organic well into double digits. And recall that December was the first month our newly acquired reinsurance operations were included in organic. And while off a very small revenue base, they too had a spectacular organic growth for the month. So combined, Gallagher Re team continues to deliver outstanding results. So again, Brokerage segment, all in organic double digits. And with our outstanding fourth quarter finish, full year organic came in at 9.7%. That's our best full year Brokerage segment organic performance in decades and even more impressive when you consider we grew on top of the 8% organic we posted in '21. Next, let me give you some thoughts on the current P/C market environment starting in the primary insurance market. Overall, global fourth quarter renewal premiums, that's both rate and exposure combined, were up more than 9% that's consistent with the 8% to 10% renewal premium change we have been reporting throughout '22. Fourth quarter renewal premium changes by line of business were broadly consistent with the first 3 quarters of '22 with 1 exception, which is D&O. D&O continues to be the one area where rates are flat to down slightly, but in some cases, our customers are using the weaker pricing to purchase more limit. Exposures also continue to be consistent with the first 3 quarters of '22, indicating continued strength in our customers' business activity. In fact, fourth quarter midterm policy endorsements, audits and cancellations were better than fourth quarter '21 levels. Looking ahead, these trends appear to be holding. Thus far in January, midterm policy endorsements and audit adjustments are trending higher than last year's level and global renewal premium increases are consistent with the fourth quarter. But remember, our job is to help clients mitigate premium increases and provide an appropriate level of risk transfer that fits their budgets. Shifting to reinsurance and the important January 1 renewals. As we discussed in our 1st View Market report published earlier this month, it was a very late and complex reinsurance renewal season. Not surprising, U.S. peak zone property cat reinsurance saw some of the largest price increases. But it's worth noting 4 additional trends within property cat: First, attachment points were raised broadly; second, reinsurers pushed to remove prepaid reinstatements from some contracts; third, reinsurers, in some cases, were able to reduce coverage to named perils only; and fourth, top layers of many programs saw the largest percentage increases as reinsurers sought to push up minimum premium rates. On the casualty side, prices were up in the single to low double-digit range for most programs, while terms and conditions were more stable. Despite the tough market backdrop of higher prices, lower capacity and tightening terms, the reinsurance team was able to deliver favorable outcomes for our clients. Looking forward, the challenging reinsurance market conditions will, no doubt, put pricing pressure on the primary market during '23, and that's on top of our primary carrier partners dealing with catastrophe losses in secondary perils, including convective storms, floods and wildfires, high replacement cost inflation from raw materials to shortages in labor, social inflation, combined with the easing of the judicial system law , escalating medical cost trends and ongoing geopolitical tensions. So there's good reason to expect continued price increases and cautious underwriting for the foreseeable future. And as I mentioned before, we are not seeing any signs of exposure contraction. Rather, it seems our clients' business activity remains unchanged from the past few quarters. Within our employee benefit brokerage and consulting business, the backdrop for '23 is also broadly favorable. Employers continue to add jobs and wages are growing. So demand for our services and offerings should remain robust. So as I sit here today, '23 could be another fantastic year with brokerage organic growth nicely in the 7% to 9% range. Moving on to mergers and acquisitions. We had a really active fourth quarter completing 17 new tuck-in brokerage mergers representing more than $140 million of estimated annual revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. For the year, we completed 36 mergers, representing annualized revenue of about $250 million. Additionally, we announced an agreement to acquire Buck, a very complementary business providing retirement, HR and employee benefits consulting and administrative services with estimated annualized revenues of $280 million. We expect the transaction to close during the second quarter and look forward to welcoming our new colleagues. Moving to our merger and acquisition pipeline. We have nearly 45 term sheets signed or being prepared, representing more than $300 million of annualized revenue. We know not all of these will close. However, we believe we will get our fair share. And before I conclude my M&A comments, let me give you a quick recap on our reinsurance acquisition now that we have a full year in our books. We had a fantastic '22, thanks to strong client retention, the expansion of existing client relationships, some great new business wins and excellent growth in our pro rata business. The team is fully assimilated, is delivering for clients and there's a lot of momentum. I believe we're on track for an even better '23. Needless to say, reinsurance continues to be an exciting story. Moving on to our Risk Management segment, Gallagher Bassett. Fourth quarter organic growth was 15.6% as a strong finish to the quarter pushed organic above our mid-December expectation. Core new arising claims increased during the quarter, driven by recent new business wins and continued growth from existing clients. And fourth quarter adjusted EBITDAC margin was great at 19.3%. So putting it all together, Gallagher Bassett finished the year with an adjusted EBITDAC margin of 18.5% and 13.3% organic benefiting from increased claim activity coming out of the pandemic and some really nice new business wins. Looking forward, full year '23 organic should be pushing 10% and adjusted EBITDAC margins should be around 19%. That would be another fantastic year. And I'd like to conclude with some comments regarding our bedrock culture. It's a culture of teamwork, client service and excellence, captured and celebrated in the Gallagher way. It is the culture that drove full year '22 results for our combined Brokerage and Risk Management segments of 24% growth in adjusted revenues, 10% all-in organic, 25% growth in adjusted EBITDAC, adjusted EBITDAC margin in excess of 32% and 20% growth in adjusted EPS. We have a culture that our people believe in, embrace and live every day. It's a culture that will continue to drive us forward. That is the Gallagher way. Okay. I'll stop now and turn it over to Doug. Doug?
Douglas Howell: Thanks, Pat, and hello, everyone. A fantastic fourth quarter to close out another outstanding year. Today, I'll start with our earnings release, touching on organic margins and the Corporate segment shortcut table. Next, I'll walk you through our CFO commentary document, point out a few items for the next quarter and also provide a first look at our typical modeling helpers for '23 then I'll finish up with some comments on cash, M&A capacity and capital management. Okay. Let's flip to Page 3 of the earnings release to the Brokerage segment organic table. All in brokerage organic of 11%, above the 9% to 9.5% that we foreshadowed in December. Two drivers of the upside. First, as Pat just discussed, we had a really strong finish within our P&C and reinsurance brokerage operations. Second, our annual update of 606 assumptions added about 1 point to our headline organic. Recall under ASC 606, we must routinely update our assumptions related to the amount of services provided before and after the placement of an insurance policy. Based on our most recent operational analysis, metrics and time studies, more of our services being provided at the time of placement and more of the post placement service is being handled faster in our lower-cost centers of excellence. This causes less of our revenue to be deferred and thus, we recognized an additional $15 million of revenue in the quarter. That is a small amount relative to our total deferred revenue balance nearly $435 million, but it does cause an additional point of organic. So we're the call out today. From an expense perspective, our updated 606 assumptions also caused some additional compensation expense to be recognized during the quarter. The punchline of all this, our fourth quarter organic revenues, EBITDAC and net earnings got a small boost and adjusted EBITDAC margin was not significantly impacted. So 11% headline organic, 10% controlling for 606 and 120 basis points of margin expansion, that's a terrific quarter. Looking forward to '23, we're currently not seeing a slowdown in our clients' business activity. We're not seeing signs of price moderation from the carriers, and we still have loss cost inflation and labor market imbalances. Add that to our client for sales and service culture, we are still seeing '23 organic in that 7% to 9% range, as we stated during our December IR Day. Same with our margin outlook for '23. We are still comfortable with our December commentary. We think we can deliver about 50 basis margin expansion at 6% organic and fiduciary investment income could be a nice margin sweetener provided there isn't a surge in wage and cost inflation. One other [indiscernible] heads up for '23. On December 20, we announced our acquisition of Buck. The business operations operates at an adjusted EBITDAC margin around 20%, so please make sure a portion of your pick for future M&A revenues reflects that versus what you might pick for our other mergers. Moving on to the Risk Management segment and the organic table at the bottom of Page 6. You'll see 15.6% organic in the fourth quarter and full year organic in excess of 13%. Some of that growth this year comes from our clients' business activity still rebounding out of the pandemic and getting back to levels they saw before the pandemic. Accordingly, for '23, we're seeing organic revenue approaching 10%. Flipping to Page 7. The Risk Management adjusted EBITDAC margin of 19.3% in the quarter and 18.5% for the full year. We see a nice step-up in '23 with margins around 19% even as we continue to make investments to enhance the client experience and in analytics and tools to drive better claim outcomes. Another year of double-digit growth and margin expansion would be another terrific year. Turning to Page 8 to the Corporate segment shortcut table. In total, adjusted results were at the favorable end of our December IR day forecast. You also see 2 non-GAAP adjustments this quarter. First, our M&A transaction costs of $5 million after tax, mostly related to Buck and a little relates to Willis treaty. And second, as we discussed previously, you'll see a $31 million after-tax gain related to legal and tax matters. Now shifting to our CFO commentary document we posted on our IR website, starting on Page 3. As for fourth quarter, you'll see most of the brokerage and risk management items are close to our December IR day estimates. On the right-hand side of the page, we're providing our first look at '23. A couple of things worth highlighting: First, FX. With last year's midyear strengthening in the U.S. dollar, you'll see some volatility in how FX will impact our brokerage and risk management results in first half versus second half of '23. Please make sure to consider these impacts as you're planning your models. Second, our adjusted tax rate. With the U.K. corporate tax rate increasing to 25% effective April 1, we're providing our current estimate for full year '23 tax rate. More of an impact to our Brokerage segment than it is to our Risk Management segment, given the size of our U.K. retail London specialty and reinsurance brokerage operation. And one other thing. The left side of this page might be a nice reference when making your picks for quarterly margins given our quarterly seasonality. And finally, when you do make your margin picks, recall we were still in the Omicron portion of the pandemic during the first quarter of '22. So we're not expecting as much margin expansion in first quarter as we are in the second, third and fourth quarter of '23. Okay. Moving to Page 5. This page is here to highlight the incremental cash flows from our clean energy investments over the coming years. And remember, those come through the cash flow statement, not the P&L. You'll also see that we have $773 million of available tax credits as of December 31, '22. And that we forecast using about $180 million to $200 million in '23 and that should step up a bit in '24 and each later year. That's a really nice cash flow boost to help fund our M&A. The way I look at the math, it might say that an additional $773 million of free cash, combined maybe another $70 million of recurring EBITDAC at that 10 to 11x multiple, which would then have a nice arbitrage for our current trading multiple. Moving to Page 6 on the rollover revenue table. For the fourth quarter, rollover revenues came in higher than our December IR day guidance. Most of all of that came from reinsurance. Over the last 3 weeks, cedents have been closing their books for '22, and we're getting updated ceded premium figures. That translated into additional commission revenue for '22. For the sake of clarity, nearly all of that upside is excluded from our organic results because it likely relates to pre-December 1, '22, which marked the first year anniversary of the acquisition. And no -- also, please note that not all of that hits the bottom line because of production and incentive comp expense on that additional revenue. That said, it's terrific to get the bump-up. Staying on Page 6, but moving down to the bottom table. That table shows our actual reinsurance acquisition results. In a transition year, the team overperformed our pro forma expectation. That's impressive and terrific work by the team. So now let me move to some final comments on cash, capital management and future M&A. At December 31, available cash on hand was about $325 million. Our current cash position, combined with strong expected cash flows and incremental borrowing positions us well for our pipeline of M&A opportunities. In total, we estimate towards $3 billion to fund potential M&A opportunities during '23, which would include paying for Buck. And also yesterday, our Board of Directors approved an increase in our quarterly dividend by $0.04 per share. That would imply an annual payout of $2.20 per share. That's a 7.8% increase over '22. So with a strong organic outlook, margin expansion opportunities and an ever-growing M&A pipeline, from my vantage point as CFO, we are extremely well positioned for another fantastic year in '23. I'd like to thank the entire Gallagher team for another great quarter and outstanding year. Back to you, Pat.
Patrick Gallagher: Thank you, Doug. Operator, I think we're ready for questions.
Operator: [Operator Instructions]. Our first question comes from the line of Weston Bloomer with UBS.
Weston Bloomer: So my first question is on the reinsurance market and the growth you saw there. It's obviously really strong end of the quarter. And I think you've talked about high single-digit growth there for 2023. So did the end of the year kind of change how you think about that level of growth? Or how should we be thinking that going into next year?
Patrick Gallagher: I think we are definitely going with some nice momentum. I wouldn't bank on some incremental big jump. But what I like about the momentum is when you come through a time like we did in this fourth quarter, it's interesting because you actually become much more valuable to your clients. And it's not an easy time when you're tussling back and forth with the cedents and the reinsurers trying to get these things done, terms are changing. Attachment levels are changing. But in the end, as I said in my prepared remarks, we got the placements made, and I think we are in a very strong position going forward, number one, with those clients, but also with the opportunity to pick up some new business.
Weston Bloomer: Great. And then my second question within brokerage as well. I noticed the compensation ratio as a percentage of revenue dropped pretty materially. And I think you'd called out some back-office saves, lower benefit costs, offset by some hiring. Is there a way you can call out how much each of those had an impact? Or where I'm trying to go with the question is how much additional leverage do you have to kind of bring that lower in 2023?
Douglas Howell: All right. Let me see if I can break that out from memory here. I don't have it in front of me exactly, but when you're talking about being down was at 180 basis points, something like that. Yes. Is that right? I'm just going from memory, Sorry, I'll look it up here. Probably 1/3 of that is due to the continued efficiency that we bring by being able to push work into our lower-cost centers of excellence. I think that we've had some technology wins in that area, too, to help us make our workforce more effective on that and didn't have to put on additional heads as a result of that -- those technology investments. And then I think that when it came to -- the other 1/3 is kind of escaping you right here.
Weston Bloomer: Got it. Is there any change to the compensation structure that you make in this market, too? I know there's some changes just, I guess, higher organic accounts, things like that.
Patrick Gallagher: No. We're pleased to pay our people for what they do. And we haven't messed with that compensation arrangement with our production force, in particular, in well over a decade.
Operator: Our next questions come from the line of with Autonomous Research.
Unidentified Analyst: I want to follow up on the almost 10% 2022 brokerage organic results. Would you mind giving us some more color as to how pricing and exposure and net new business drove that year-over-year acceleration in organic. And then from where you sit today, how do you see those drivers changing in 2023?
Douglas Howell: So are you asking for the quarter? Are you asking for the full year? Sorry, just so I've got the baseline.
Unidentified Analyst: Yes, yes, for the full year.
Douglas Howell: For the full year, right? So when I look at rate and exposure, as I did, our new business, we had a terrific new business here. So I'll say that our net new business spread was about 4 points and the rest of that is probably rate and exposure, remember between that. So maybe, again, you think about it, 1/3, 1/3, 1/3 net new business over loss business is 1/3, rate was 1/3 and exposure unit growth was 1/3.
Unidentified Analyst: Got it. Okay. And then as a quick follow-up, do you have any comments on the degree to which fiduciary investment income will impact margins next year, kind of thinking about that 50 bps of expansion on 6% organic, how much that move from fiduciary investment income?
Douglas Howell: I think the -- when we give the guidance of 6 points, if we grow organically, 6%, we think we can show about 50 basis points of margin expansion on that. Investment income would be a sweetener to that. to a certain extent. But I don't have a clear line of sight yet on the size of our raise pool and our hiring needs going into next year. We understand our budget. So I can't give you a specific number on it, but you give me a pick on what you think wage inflation is going to be next year to take care of our folks, and I can probably give you that number, but I don't think we're ready yet. I might be able to give you some more of that in March.
Operator: Our next questions come from the line of Greg Peters with Raymond James.
Charles Peters: I'm going to stick on the margin commentary. In your press releases on Page 4, you talked about the operating expense ratio and some of the pressures on that. So when you -- in your guide the 50 basis points or so of margin expansion provided 6% organic, how do we think about those factors affecting your ability to expand margins? And then just on the margin expansion, can you break it out based on business unit like is it going to come in international that you're going to get margin expansion or is it going to come into the employee benefits business, you get margin expansion? Or can you source where you think that's going to -- where that -- where the improvement is going to come from?
Douglas Howell: Right. A couple of things. On the operating expense ratio, it was up in fourth quarter versus '21 fourth quarter, was up about 30 to 40 basis points, let's call it, 40 basis points on that. I think the footnote on that is explaining where it's coming from, mostly travel and entertainment, some consulting use and investments in technology. So I'd say it's probably half of that increase is investments and half of it is just the inflation that we're seeing in travel and consulting costs on that. When you're -- I think the next question was how am I seeing that vis-a-vis next year. Remember, we were still in the omicron portion of the pandemic in the first quarter. So we are going to see a little more travel and entertainment expense return in our first quarter, but we don't see it being up significantly in the second, third and fourth quarters. So we're looking at 50 basis points of expansion next year. Most of that will come in the later 3 quarters than the first quarter. And what was there was another piece of your question, Greg?
Charles Peters: It was just when I think about within the Brokerage business, the different business units, the employee benefits, the international the retail RPS, when you look at it that way, where do you think the opportunity is for margin expansion in the context of that 50 basis points or so guidance?
Douglas Howell: Yes, it's pretty much so across all of them, Greg -- there is no standout in there anywhere that's a laggard in there.
Charles Peters: Makes sense. Okay. And the other -- just the other sort of cleanup question on Buck consulting. Can you give us -- is there any sort of cadence in terms of how the revenue flows and how the margins are. I mean is it heavier in the first quarter, either revenue or margins? Or any sort of color you can add as we -- and just as a follow-up, I assume that's also going to get folded into the Brokerage segment, correct?
Douglas Howell: Yes. So it will be part of our Brokerage segment and our Employee Benefit operation. Greg, we don't think we're going to close that in the first quarter. We think it's more of a second quarter close at this point. I don't really have a good quarterly spread that I would feel comfortable giving on the call today for that because we have to apply our study on conforming the accounting principles to theirs, apply our 606 assumptions to it. So I need a little more time to work through that. And we just signed the deal 30 days ago, and I just need to until March to give you that quarterly spread.
Operator: Our next questions come from the line of Michael Ward with Citi.
Michael Ward: We heard, I guess, one of your peers about -- talk about programs participants pushing back on capacity or trying to restructure commissions. I was wondering if you're seeing something similar.
Patrick Gallagher: No.
Douglas Howell: Not really.
Patrick Gallagher: Not really.
Michael Ward: Okay. Second one, I guess I was wondering, your deal spend has kind of accelerated over the last few months. It seems hoping you could maybe discuss the drivers behind that. And maybe talk about how you see 2023 playing out in this regard?
Patrick Gallagher: We have definitely seen a change in the competitive environment vis-a-vis mergers and acquisitions in the last 60 days. I'm not going to sit here and say it's not still competitive, it is. But I would say that the number of bidders is reduced, and we are seeing maybe, what I would call, a more attentive seller to exactly who the buyer is, what the culture is, the strategic value of that buyer that maybe existed 12 months ago.
Douglas Howell: Yes, we usually see a little bit of an uptick in the fourth quarter as people push to get things done by the end of the year, sometimes that's driven by tax or other financial planning that the sellers want to get done. But if there is a noticeable change in the market. I would say that we feel very good about our pipeline right now. There are some names on there that are really nice to have looking at us. So a little bit of an uptick in the fourth quarter, naturally, change in market competitiveness a little bit. But I also think it's going to be pretty strong in the first couple of quarters of the year relative to what we saw this year, in particular.
Operator: Our next questions come from the line of Elyse Greenspan with Wells Fargo.
Elyse Greenspan: Maybe sticking on the M&A point. You guys seem pretty optimistic with the pipeline, and you have announced a good number of deals of late. But if I look on the CFO commentary sheet, you also write the multiples you're seeing on deals went up 1x, right, 10 to 11x from 9 to 10, what are you seeing, I guess, in the market that's driving up multiples a little bit?
Douglas Howell: I think it's mix right now is what we're seeing is -- I think that you're seeing some pretty high performing names on the list where the growth factors are a little bit bigger than maybe they were in the past. But one turn on that, it wouldn't overly react to it one way or another.
Elyse Greenspan: And then with your margin guide for kind of the 50 to 60 basis points of expansion, are you assuming any wage inflation embedded within that guide?
Douglas Howell: Yes. We're assuming that we're paying raises this year about similar to what we have for the last 2 years. So that's in the numbers. Also in that, I did a little -- I did a small vignette during the December IR Day. If you really look underneath that, there's probably 10 or 15 basis points as we toggle to Software as a Service that might be against that 50 basis points, too. So maybe it's more like 60 basis points, but in the accounting of where that expense gets charged does influence that a little bit. You and I talked about that in December, I think, too.
Elyse Greenspan: And then on the reinsurance side, strong into the year, great rate increases we saw at January 1, but also we've seen higher retentions by primary companies. And I don't think we've really been in a similar environment, right, where you have 40% price increases with perhaps less premium to the market. So when you put that all together, does '23 feel like an environment where you could show double-digit organic growth within your reinsurance business?
Patrick Gallagher: Yes, I think we could.
Operator: Our next questions come from the line of Rob Cox with Goldman Sachs.
Robert Cox: My first question is on the U.K. retail and specialty organic of 17%. Obviously, very strong. And I was just wondering if you could talk a little bit about what's driving that growth.
Patrick Gallagher: Yes. As we said, a very, very strong new business in specialty with tenant rate increases. And as we've talked earlier, there were some term changes and the like. But also our aviation specialty team just crushed it this quarter in the U.K. And our retail operation across the United Kingdom did extremely well also. But I just think the whole London-based specialty team, reinsurance aviation just is set phenomenal close to the year.
Robert Cox: That's great. And just a question on the labor market. A number of companies are instituting layoffs. I'm just curious what type of unemployment rate is embedded in your organic guide of 7% to 9%. And if we did start to see some erosion there, at what point in the year do you think we would start to see that impact potentially in your organic growth?
Patrick Gallagher: Well, let me just back up to our prepared comments again. It's very, very interesting. First of all, we don't play that much in the high-tech Employee Benefit business, and it's not that big a segment for us in terms of the layoffs you're seeing that are making the newspaper. And as I've said in previous quarters, we're already in the same papers, right? And we all see the same news reports. However, our middle market, core business is doing -- our clients are doing extremely well, and we keep reporting our -- what we're seeing in our midterm endorsements and changes to policies and as we see both our renewals and the audits going forward, our middle market, retail, property casualty benefits business, these people are doing very, very well. Truck counts are up. Our trucking business is very strong. Our work comp renewals in terms of payrolls are not being diminished. Now that doesn't mean that if there is, in fact, a global recession that it won't impact us, of course, it will. But at this point in time, we're not seeing that. So if you ask me where do we see an impact on that type of growth as we go forward this year. I'll tell you, our plans at present don't count on any recessionary pressure. And that could be wrong.
Operator: Our next questions come from the line of Yaron Kinar with Jefferies.
Unidentified Analyst: This is Andrew on for Yaron. Just looking at head count in Brokerage, it looks like there's been a pretty good pickup year-to-date and in the quarter specifically. Can we kind of talk about what's going on there? And roles you're hiring and the degree to which those hires have been reflected in organic yet?
Douglas Howell: Yes. Well, a lot of that -- remember those numbers are impacted considerably by our M&A program. So as we close the year out strong on M&A, those numbers would be in the December numbers and not in last year's December numbers, and that would impact the quarter 2.
Patrick Gallagher: And I would want to comment on that as well. We are not undergoing an organic surge in new hiring. We have a very strong internship. We bring on a very strong number of young people every year. Of course, we're always looking for good solid production hires, but you are not seeing our organic head count surge beyond the M&A activity that Doug just mentioned.
Unidentified Analyst: Great. And as we think about supplemental and contingent commissions, I suppose a part of that is based on underwriting profitability of those programs. So when you think about '23, is there kind of a loss trend that you bake into forward guidance there? Or maybe more broadly, what is your view on loss trends over the course of the next year?
Douglas Howell: Are you're talking about the carriers loss trends?
Patrick Gallagher: Yes, our contingents.
Douglas Howell: Right, that relates to the contingents.
Patrick Gallagher: Supplementals are not subject typically to profit-sharing arrangements, our contingents are. And to date, I'd say we probably factored nothing in, in terms of having significant increases in our operating loss ratios.
Operator: Our next questions come from the line of Mark Hughes with Truist.
Mark Hughes: Another P&C CEO suggested he didn't see as much increase in property rates in the fourth quarter as you might have expected in light of the reinsurance market dynamics, but maybe that's something that builds up as the time goes by is the higher reinsurance rates do directly impact the carriers. Would you share that observation? Do you think property could get firmer on the primary level?
Patrick Gallagher: I think property could get a lot firmer. I would say in the fourth quarter, it was very firm, in particular, in anything that had to do with Coastal, any area that was exposed to wind and fire. This market in terms of property is very difficult as it exists. And, yes, the changes to reinsurance at 1/1 will filter additional pressure onto the retail buyer. And we are out early telling our retail buyers about this. And it is going to get more difficult in what is already a very extremely difficult situation.
Douglas Howell: Yes. If you think about -- remember, our fourth quarter, Ian hit right at the beginning of the fourth quarter, there were replacements that were done in October and November that hadn't had the full impact of the $70 billion loss.
Mark Hughes: Yes. Yes. And then, Pat, last quarter, you mentioned a potential spillover effect on casualty. I don't know whether you updated your commentary on that this quarter, but do you think the reinsurance market, how much of an impact, I think, it's having on casualty, ?
Patrick Gallagher: Mark, I don't have a number on that yet. I just think that it's possible that in order to pay for some of these property increases, other lines are going to have to be tagged. And I think I'll be able to feel that since it maybe have a better number around that at the end of the first quarter. And I may be wrong on that. At this point, I'm not being told by our carriers that that's happening.
Operator: Our final question will come from the line of Michael Ward with Citi.
Michael Ward: I just had a quick follow-up maybe on Elyse's question and the potential for double-digit growth in reinsurance. Just wondering if that's kind of -- if we should think about that as being achievable with current capacity or if incremental capacity might need to come to the market in order to get there?
Patrick Gallagher: I think that it will be achievable with existing capacity. I was very pleased -- our reinsurance people were telling us in late November and December, early December that they were very fearful some of these placements just weren't going to get done. And that is a nightmare on all sides of the equation. And in fact, really, really pleased and proud of the team that did the work to bring the programs together for our clients as January got going here. So I think on existing capacity, of course, the largest renewal season is now winding down. It's not over, but it's winding down. And so I do think the increases going forward could come off existing capacity. However, having said that, any additional capacity would be very welcome and will be utilized quickly and would add to that. All right. Then let me just add a few comments as I wrap up. I want to thank you again for joining us this evening. Obviously, I'm very pleased with our '22 financial performance. I am still very excited about our future. I want to thank our clients for their continued trust, our 43,000-plus colleagues for their passion, hard work and dedication. And finally, I need to mention our carrier partners. They do play an integral role in meeting our clients' insurance and risk management needs. And we look forward to speaking with you all again at our March IR Day. So thank you for being with us, and we'll talk to you then.
Operator: Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and enjoy the rest of your day. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Company's Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions].Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce Patrick Gallagher, Chairman, President and CEO, Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "Patrick Gallagher",
"text": "Thank you. Good afternoon, and thank you for joining us for our fourth quarter '22 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had a terrific finish to cap off an excellent year. During the quarter, for our combined Brokerage and Risk Management segments, we posted 16% growth in revenue, 11.7% organic growth. GAAP earnings per share of $0.83, adjusted earnings per share of $1.86, up 24% year-over-year, reported net earnings margin of 9%, adjusted EBITDAC margin of 29.6%, up 120 basis points. We also completed 17 mergers totaling more than $140 million of estimated annualized revenues in addition to announcing our agreement to acquire Buck, another fantastic quarter by the team and our best fourth quarter in decades. Let me give you some more detail on our fourth quarter performance, starting with our Brokerage segment. Reported revenue growth was 16%. Organic was 11%. Doug will explain it does include a point from our Annual 606 review, Brokerage organic and double digits is outstanding. Acquisition rollover revenues were $107 million, and our adjusted EBITDAC margin was 31.3%, up 120 basis points and in line with our December IR Day expectations, another excellent quarter for the brokerage team. Focusing on the Brokerage segment organic, let me walk you around the world and provide some more detailed commentary starting with our P/C operations. Our U.S. retail business posted 8% organic, our new business was a bit better than last year offset somewhat by less nonrecurring business, client retention and the combined impact of rate and exposure were both similar to last year's fourth quarter. Risk Placement Services, our U.S. wholesale operations, posted organic above 9%. This includes more than 12% organic and open brokerage and about 7% organic in our MGA programs and binding businesses. New business was strong and retention was consistent with last year's fourth quarter. Shifting to outside the U.S. Our U.K. businesses, both retail and specialty combined posted organic of 17% benefiting from excellent new business production, strong retention and the continued impact of renewal premium increases. Australia and New Zealand combined, organic was 12%. Net new versus loss business was consistent with last year and renewal premium increases were above fourth quarter '21 levels. Canada was up nearly 9% organically, reflecting solid new business and retention. Moving to our employee benefit brokerage and consulting business. Organic was 3%, consistent with our December IR Day expectations. New business was similar to last year's fourth quarter and retention remained excellent. And finally, to reinsurance. Our legacy reinsurance operations crushed it with some hard earned new business wins and quarterly organic well into double digits. And recall that December was the first month our newly acquired reinsurance operations were included in organic. And while off a very small revenue base, they too had a spectacular organic growth for the month. So combined, Gallagher Re team continues to deliver outstanding results. So again, Brokerage segment, all in organic double digits. And with our outstanding fourth quarter finish, full year organic came in at 9.7%. That's our best full year Brokerage segment organic performance in decades and even more impressive when you consider we grew on top of the 8% organic we posted in '21. Next, let me give you some thoughts on the current P/C market environment starting in the primary insurance market. Overall, global fourth quarter renewal premiums, that's both rate and exposure combined, were up more than 9% that's consistent with the 8% to 10% renewal premium change we have been reporting throughout '22. Fourth quarter renewal premium changes by line of business were broadly consistent with the first 3 quarters of '22 with 1 exception, which is D&O. D&O continues to be the one area where rates are flat to down slightly, but in some cases, our customers are using the weaker pricing to purchase more limit. Exposures also continue to be consistent with the first 3 quarters of '22, indicating continued strength in our customers' business activity. In fact, fourth quarter midterm policy endorsements, audits and cancellations were better than fourth quarter '21 levels. Looking ahead, these trends appear to be holding. Thus far in January, midterm policy endorsements and audit adjustments are trending higher than last year's level and global renewal premium increases are consistent with the fourth quarter. But remember, our job is to help clients mitigate premium increases and provide an appropriate level of risk transfer that fits their budgets. Shifting to reinsurance and the important January 1 renewals. As we discussed in our 1st View Market report published earlier this month, it was a very late and complex reinsurance renewal season. Not surprising, U.S. peak zone property cat reinsurance saw some of the largest price increases. But it's worth noting 4 additional trends within property cat: First, attachment points were raised broadly; second, reinsurers pushed to remove prepaid reinstatements from some contracts; third, reinsurers, in some cases, were able to reduce coverage to named perils only; and fourth, top layers of many programs saw the largest percentage increases as reinsurers sought to push up minimum premium rates. On the casualty side, prices were up in the single to low double-digit range for most programs, while terms and conditions were more stable. Despite the tough market backdrop of higher prices, lower capacity and tightening terms, the reinsurance team was able to deliver favorable outcomes for our clients. Looking forward, the challenging reinsurance market conditions will, no doubt, put pricing pressure on the primary market during '23, and that's on top of our primary carrier partners dealing with catastrophe losses in secondary perils, including convective storms, floods and wildfires, high replacement cost inflation from raw materials to shortages in labor, social inflation, combined with the easing of the judicial system law , escalating medical cost trends and ongoing geopolitical tensions. So there's good reason to expect continued price increases and cautious underwriting for the foreseeable future. And as I mentioned before, we are not seeing any signs of exposure contraction. Rather, it seems our clients' business activity remains unchanged from the past few quarters. Within our employee benefit brokerage and consulting business, the backdrop for '23 is also broadly favorable. Employers continue to add jobs and wages are growing. So demand for our services and offerings should remain robust. So as I sit here today, '23 could be another fantastic year with brokerage organic growth nicely in the 7% to 9% range. Moving on to mergers and acquisitions. We had a really active fourth quarter completing 17 new tuck-in brokerage mergers representing more than $140 million of estimated annual revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. For the year, we completed 36 mergers, representing annualized revenue of about $250 million. Additionally, we announced an agreement to acquire Buck, a very complementary business providing retirement, HR and employee benefits consulting and administrative services with estimated annualized revenues of $280 million. We expect the transaction to close during the second quarter and look forward to welcoming our new colleagues. Moving to our merger and acquisition pipeline. We have nearly 45 term sheets signed or being prepared, representing more than $300 million of annualized revenue. We know not all of these will close. However, we believe we will get our fair share. And before I conclude my M&A comments, let me give you a quick recap on our reinsurance acquisition now that we have a full year in our books. We had a fantastic '22, thanks to strong client retention, the expansion of existing client relationships, some great new business wins and excellent growth in our pro rata business. The team is fully assimilated, is delivering for clients and there's a lot of momentum. I believe we're on track for an even better '23. Needless to say, reinsurance continues to be an exciting story. Moving on to our Risk Management segment, Gallagher Bassett. Fourth quarter organic growth was 15.6% as a strong finish to the quarter pushed organic above our mid-December expectation. Core new arising claims increased during the quarter, driven by recent new business wins and continued growth from existing clients. And fourth quarter adjusted EBITDAC margin was great at 19.3%. So putting it all together, Gallagher Bassett finished the year with an adjusted EBITDAC margin of 18.5% and 13.3% organic benefiting from increased claim activity coming out of the pandemic and some really nice new business wins. Looking forward, full year '23 organic should be pushing 10% and adjusted EBITDAC margins should be around 19%. That would be another fantastic year. And I'd like to conclude with some comments regarding our bedrock culture. It's a culture of teamwork, client service and excellence, captured and celebrated in the Gallagher way. It is the culture that drove full year '22 results for our combined Brokerage and Risk Management segments of 24% growth in adjusted revenues, 10% all-in organic, 25% growth in adjusted EBITDAC, adjusted EBITDAC margin in excess of 32% and 20% growth in adjusted EPS. We have a culture that our people believe in, embrace and live every day. It's a culture that will continue to drive us forward. That is the Gallagher way. Okay. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Pat, and hello, everyone. A fantastic fourth quarter to close out another outstanding year. Today, I'll start with our earnings release, touching on organic margins and the Corporate segment shortcut table. Next, I'll walk you through our CFO commentary document, point out a few items for the next quarter and also provide a first look at our typical modeling helpers for '23 then I'll finish up with some comments on cash, M&A capacity and capital management. Okay. Let's flip to Page 3 of the earnings release to the Brokerage segment organic table. All in brokerage organic of 11%, above the 9% to 9.5% that we foreshadowed in December. Two drivers of the upside. First, as Pat just discussed, we had a really strong finish within our P&C and reinsurance brokerage operations. Second, our annual update of 606 assumptions added about 1 point to our headline organic. Recall under ASC 606, we must routinely update our assumptions related to the amount of services provided before and after the placement of an insurance policy. Based on our most recent operational analysis, metrics and time studies, more of our services being provided at the time of placement and more of the post placement service is being handled faster in our lower-cost centers of excellence. This causes less of our revenue to be deferred and thus, we recognized an additional $15 million of revenue in the quarter. That is a small amount relative to our total deferred revenue balance nearly $435 million, but it does cause an additional point of organic. So we're the call out today. From an expense perspective, our updated 606 assumptions also caused some additional compensation expense to be recognized during the quarter. The punchline of all this, our fourth quarter organic revenues, EBITDAC and net earnings got a small boost and adjusted EBITDAC margin was not significantly impacted. So 11% headline organic, 10% controlling for 606 and 120 basis points of margin expansion, that's a terrific quarter. Looking forward to '23, we're currently not seeing a slowdown in our clients' business activity. We're not seeing signs of price moderation from the carriers, and we still have loss cost inflation and labor market imbalances. Add that to our client for sales and service culture, we are still seeing '23 organic in that 7% to 9% range, as we stated during our December IR Day. Same with our margin outlook for '23. We are still comfortable with our December commentary. We think we can deliver about 50 basis margin expansion at 6% organic and fiduciary investment income could be a nice margin sweetener provided there isn't a surge in wage and cost inflation. One other [indiscernible] heads up for '23. On December 20, we announced our acquisition of Buck. The business operations operates at an adjusted EBITDAC margin around 20%, so please make sure a portion of your pick for future M&A revenues reflects that versus what you might pick for our other mergers. Moving on to the Risk Management segment and the organic table at the bottom of Page 6. You'll see 15.6% organic in the fourth quarter and full year organic in excess of 13%. Some of that growth this year comes from our clients' business activity still rebounding out of the pandemic and getting back to levels they saw before the pandemic. Accordingly, for '23, we're seeing organic revenue approaching 10%. Flipping to Page 7. The Risk Management adjusted EBITDAC margin of 19.3% in the quarter and 18.5% for the full year. We see a nice step-up in '23 with margins around 19% even as we continue to make investments to enhance the client experience and in analytics and tools to drive better claim outcomes. Another year of double-digit growth and margin expansion would be another terrific year. Turning to Page 8 to the Corporate segment shortcut table. In total, adjusted results were at the favorable end of our December IR day forecast. You also see 2 non-GAAP adjustments this quarter. First, our M&A transaction costs of $5 million after tax, mostly related to Buck and a little relates to Willis treaty. And second, as we discussed previously, you'll see a $31 million after-tax gain related to legal and tax matters. Now shifting to our CFO commentary document we posted on our IR website, starting on Page 3. As for fourth quarter, you'll see most of the brokerage and risk management items are close to our December IR day estimates. On the right-hand side of the page, we're providing our first look at '23. A couple of things worth highlighting: First, FX. With last year's midyear strengthening in the U.S. dollar, you'll see some volatility in how FX will impact our brokerage and risk management results in first half versus second half of '23. Please make sure to consider these impacts as you're planning your models. Second, our adjusted tax rate. With the U.K. corporate tax rate increasing to 25% effective April 1, we're providing our current estimate for full year '23 tax rate. More of an impact to our Brokerage segment than it is to our Risk Management segment, given the size of our U.K. retail London specialty and reinsurance brokerage operation. And one other thing. The left side of this page might be a nice reference when making your picks for quarterly margins given our quarterly seasonality. And finally, when you do make your margin picks, recall we were still in the Omicron portion of the pandemic during the first quarter of '22. So we're not expecting as much margin expansion in first quarter as we are in the second, third and fourth quarter of '23. Okay. Moving to Page 5. This page is here to highlight the incremental cash flows from our clean energy investments over the coming years. And remember, those come through the cash flow statement, not the P&L. You'll also see that we have $773 million of available tax credits as of December 31, '22. And that we forecast using about $180 million to $200 million in '23 and that should step up a bit in '24 and each later year. That's a really nice cash flow boost to help fund our M&A. The way I look at the math, it might say that an additional $773 million of free cash, combined maybe another $70 million of recurring EBITDAC at that 10 to 11x multiple, which would then have a nice arbitrage for our current trading multiple. Moving to Page 6 on the rollover revenue table. For the fourth quarter, rollover revenues came in higher than our December IR day guidance. Most of all of that came from reinsurance. Over the last 3 weeks, cedents have been closing their books for '22, and we're getting updated ceded premium figures. That translated into additional commission revenue for '22. For the sake of clarity, nearly all of that upside is excluded from our organic results because it likely relates to pre-December 1, '22, which marked the first year anniversary of the acquisition. And no -- also, please note that not all of that hits the bottom line because of production and incentive comp expense on that additional revenue. That said, it's terrific to get the bump-up. Staying on Page 6, but moving down to the bottom table. That table shows our actual reinsurance acquisition results. In a transition year, the team overperformed our pro forma expectation. That's impressive and terrific work by the team. So now let me move to some final comments on cash, capital management and future M&A. At December 31, available cash on hand was about $325 million. Our current cash position, combined with strong expected cash flows and incremental borrowing positions us well for our pipeline of M&A opportunities. In total, we estimate towards $3 billion to fund potential M&A opportunities during '23, which would include paying for Buck. And also yesterday, our Board of Directors approved an increase in our quarterly dividend by $0.04 per share. That would imply an annual payout of $2.20 per share. That's a 7.8% increase over '22. So with a strong organic outlook, margin expansion opportunities and an ever-growing M&A pipeline, from my vantage point as CFO, we are extremely well positioned for another fantastic year in '23. I'd like to thank the entire Gallagher team for another great quarter and outstanding year. Back to you, Pat."
},
{
"speaker": "Patrick Gallagher",
"text": "Thank you, Doug. Operator, I think we're ready for questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question comes from the line of Weston Bloomer with UBS."
},
{
"speaker": "Weston Bloomer",
"text": "So my first question is on the reinsurance market and the growth you saw there. It's obviously really strong end of the quarter. And I think you've talked about high single-digit growth there for 2023. So did the end of the year kind of change how you think about that level of growth? Or how should we be thinking that going into next year?"
},
{
"speaker": "Patrick Gallagher",
"text": "I think we are definitely going with some nice momentum. I wouldn't bank on some incremental big jump. But what I like about the momentum is when you come through a time like we did in this fourth quarter, it's interesting because you actually become much more valuable to your clients. And it's not an easy time when you're tussling back and forth with the cedents and the reinsurers trying to get these things done, terms are changing. Attachment levels are changing. But in the end, as I said in my prepared remarks, we got the placements made, and I think we are in a very strong position going forward, number one, with those clients, but also with the opportunity to pick up some new business."
},
{
"speaker": "Weston Bloomer",
"text": "Great. And then my second question within brokerage as well. I noticed the compensation ratio as a percentage of revenue dropped pretty materially. And I think you'd called out some back-office saves, lower benefit costs, offset by some hiring. Is there a way you can call out how much each of those had an impact? Or where I'm trying to go with the question is how much additional leverage do you have to kind of bring that lower in 2023?"
},
{
"speaker": "Douglas Howell",
"text": "All right. Let me see if I can break that out from memory here. I don't have it in front of me exactly, but when you're talking about being down was at 180 basis points, something like that. Yes. Is that right? I'm just going from memory, Sorry, I'll look it up here. Probably 1/3 of that is due to the continued efficiency that we bring by being able to push work into our lower-cost centers of excellence. I think that we've had some technology wins in that area, too, to help us make our workforce more effective on that and didn't have to put on additional heads as a result of that -- those technology investments. And then I think that when it came to -- the other 1/3 is kind of escaping you right here."
},
{
"speaker": "Weston Bloomer",
"text": "Got it. Is there any change to the compensation structure that you make in this market, too? I know there's some changes just, I guess, higher organic accounts, things like that."
},
{
"speaker": "Patrick Gallagher",
"text": "No. We're pleased to pay our people for what they do. And we haven't messed with that compensation arrangement with our production force, in particular, in well over a decade."
},
{
"speaker": "Operator",
"text": "Our next questions come from the line of with Autonomous Research."
},
{
"speaker": "Unidentified Analyst",
"text": "I want to follow up on the almost 10% 2022 brokerage organic results. Would you mind giving us some more color as to how pricing and exposure and net new business drove that year-over-year acceleration in organic. And then from where you sit today, how do you see those drivers changing in 2023?"
},
{
"speaker": "Douglas Howell",
"text": "So are you asking for the quarter? Are you asking for the full year? Sorry, just so I've got the baseline."
},
{
"speaker": "Unidentified Analyst",
"text": "Yes, yes, for the full year."
},
{
"speaker": "Douglas Howell",
"text": "For the full year, right? So when I look at rate and exposure, as I did, our new business, we had a terrific new business here. So I'll say that our net new business spread was about 4 points and the rest of that is probably rate and exposure, remember between that. So maybe, again, you think about it, 1/3, 1/3, 1/3 net new business over loss business is 1/3, rate was 1/3 and exposure unit growth was 1/3."
},
{
"speaker": "Unidentified Analyst",
"text": "Got it. Okay. And then as a quick follow-up, do you have any comments on the degree to which fiduciary investment income will impact margins next year, kind of thinking about that 50 bps of expansion on 6% organic, how much that move from fiduciary investment income?"
},
{
"speaker": "Douglas Howell",
"text": "I think the -- when we give the guidance of 6 points, if we grow organically, 6%, we think we can show about 50 basis points of margin expansion on that. Investment income would be a sweetener to that. to a certain extent. But I don't have a clear line of sight yet on the size of our raise pool and our hiring needs going into next year. We understand our budget. So I can't give you a specific number on it, but you give me a pick on what you think wage inflation is going to be next year to take care of our folks, and I can probably give you that number, but I don't think we're ready yet. I might be able to give you some more of that in March."
},
{
"speaker": "Operator",
"text": "Our next questions come from the line of Greg Peters with Raymond James."
},
{
"speaker": "Charles Peters",
"text": "I'm going to stick on the margin commentary. In your press releases on Page 4, you talked about the operating expense ratio and some of the pressures on that. So when you -- in your guide the 50 basis points or so of margin expansion provided 6% organic, how do we think about those factors affecting your ability to expand margins? And then just on the margin expansion, can you break it out based on business unit like is it going to come in international that you're going to get margin expansion or is it going to come into the employee benefits business, you get margin expansion? Or can you source where you think that's going to -- where that -- where the improvement is going to come from?"
},
{
"speaker": "Douglas Howell",
"text": "Right. A couple of things. On the operating expense ratio, it was up in fourth quarter versus '21 fourth quarter, was up about 30 to 40 basis points, let's call it, 40 basis points on that. I think the footnote on that is explaining where it's coming from, mostly travel and entertainment, some consulting use and investments in technology. So I'd say it's probably half of that increase is investments and half of it is just the inflation that we're seeing in travel and consulting costs on that. When you're -- I think the next question was how am I seeing that vis-a-vis next year. Remember, we were still in the omicron portion of the pandemic in the first quarter. So we are going to see a little more travel and entertainment expense return in our first quarter, but we don't see it being up significantly in the second, third and fourth quarters. So we're looking at 50 basis points of expansion next year. Most of that will come in the later 3 quarters than the first quarter. And what was there was another piece of your question, Greg?"
},
{
"speaker": "Charles Peters",
"text": "It was just when I think about within the Brokerage business, the different business units, the employee benefits, the international the retail RPS, when you look at it that way, where do you think the opportunity is for margin expansion in the context of that 50 basis points or so guidance?"
},
{
"speaker": "Douglas Howell",
"text": "Yes, it's pretty much so across all of them, Greg -- there is no standout in there anywhere that's a laggard in there."
},
{
"speaker": "Charles Peters",
"text": "Makes sense. Okay. And the other -- just the other sort of cleanup question on Buck consulting. Can you give us -- is there any sort of cadence in terms of how the revenue flows and how the margins are. I mean is it heavier in the first quarter, either revenue or margins? Or any sort of color you can add as we -- and just as a follow-up, I assume that's also going to get folded into the Brokerage segment, correct?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. So it will be part of our Brokerage segment and our Employee Benefit operation. Greg, we don't think we're going to close that in the first quarter. We think it's more of a second quarter close at this point. I don't really have a good quarterly spread that I would feel comfortable giving on the call today for that because we have to apply our study on conforming the accounting principles to theirs, apply our 606 assumptions to it. So I need a little more time to work through that. And we just signed the deal 30 days ago, and I just need to until March to give you that quarterly spread."
},
{
"speaker": "Operator",
"text": "Our next questions come from the line of Michael Ward with Citi."
},
{
"speaker": "Michael Ward",
"text": "We heard, I guess, one of your peers about -- talk about programs participants pushing back on capacity or trying to restructure commissions. I was wondering if you're seeing something similar."
},
{
"speaker": "Patrick Gallagher",
"text": "No."
},
{
"speaker": "Douglas Howell",
"text": "Not really."
},
{
"speaker": "Patrick Gallagher",
"text": "Not really."
},
{
"speaker": "Michael Ward",
"text": "Okay. Second one, I guess I was wondering, your deal spend has kind of accelerated over the last few months. It seems hoping you could maybe discuss the drivers behind that. And maybe talk about how you see 2023 playing out in this regard?"
},
{
"speaker": "Patrick Gallagher",
"text": "We have definitely seen a change in the competitive environment vis-a-vis mergers and acquisitions in the last 60 days. I'm not going to sit here and say it's not still competitive, it is. But I would say that the number of bidders is reduced, and we are seeing maybe, what I would call, a more attentive seller to exactly who the buyer is, what the culture is, the strategic value of that buyer that maybe existed 12 months ago."
},
{
"speaker": "Douglas Howell",
"text": "Yes, we usually see a little bit of an uptick in the fourth quarter as people push to get things done by the end of the year, sometimes that's driven by tax or other financial planning that the sellers want to get done. But if there is a noticeable change in the market. I would say that we feel very good about our pipeline right now. There are some names on there that are really nice to have looking at us. So a little bit of an uptick in the fourth quarter, naturally, change in market competitiveness a little bit. But I also think it's going to be pretty strong in the first couple of quarters of the year relative to what we saw this year, in particular."
},
{
"speaker": "Operator",
"text": "Our next questions come from the line of Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "Maybe sticking on the M&A point. You guys seem pretty optimistic with the pipeline, and you have announced a good number of deals of late. But if I look on the CFO commentary sheet, you also write the multiples you're seeing on deals went up 1x, right, 10 to 11x from 9 to 10, what are you seeing, I guess, in the market that's driving up multiples a little bit?"
},
{
"speaker": "Douglas Howell",
"text": "I think it's mix right now is what we're seeing is -- I think that you're seeing some pretty high performing names on the list where the growth factors are a little bit bigger than maybe they were in the past. But one turn on that, it wouldn't overly react to it one way or another."
},
{
"speaker": "Elyse Greenspan",
"text": "And then with your margin guide for kind of the 50 to 60 basis points of expansion, are you assuming any wage inflation embedded within that guide?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. We're assuming that we're paying raises this year about similar to what we have for the last 2 years. So that's in the numbers. Also in that, I did a little -- I did a small vignette during the December IR Day. If you really look underneath that, there's probably 10 or 15 basis points as we toggle to Software as a Service that might be against that 50 basis points, too. So maybe it's more like 60 basis points, but in the accounting of where that expense gets charged does influence that a little bit. You and I talked about that in December, I think, too."
},
{
"speaker": "Elyse Greenspan",
"text": "And then on the reinsurance side, strong into the year, great rate increases we saw at January 1, but also we've seen higher retentions by primary companies. And I don't think we've really been in a similar environment, right, where you have 40% price increases with perhaps less premium to the market. So when you put that all together, does '23 feel like an environment where you could show double-digit organic growth within your reinsurance business?"
},
{
"speaker": "Patrick Gallagher",
"text": "Yes, I think we could."
},
{
"speaker": "Operator",
"text": "Our next questions come from the line of Rob Cox with Goldman Sachs."
},
{
"speaker": "Robert Cox",
"text": "My first question is on the U.K. retail and specialty organic of 17%. Obviously, very strong. And I was just wondering if you could talk a little bit about what's driving that growth."
},
{
"speaker": "Patrick Gallagher",
"text": "Yes. As we said, a very, very strong new business in specialty with tenant rate increases. And as we've talked earlier, there were some term changes and the like. But also our aviation specialty team just crushed it this quarter in the U.K. And our retail operation across the United Kingdom did extremely well also. But I just think the whole London-based specialty team, reinsurance aviation just is set phenomenal close to the year."
},
{
"speaker": "Robert Cox",
"text": "That's great. And just a question on the labor market. A number of companies are instituting layoffs. I'm just curious what type of unemployment rate is embedded in your organic guide of 7% to 9%. And if we did start to see some erosion there, at what point in the year do you think we would start to see that impact potentially in your organic growth?"
},
{
"speaker": "Patrick Gallagher",
"text": "Well, let me just back up to our prepared comments again. It's very, very interesting. First of all, we don't play that much in the high-tech Employee Benefit business, and it's not that big a segment for us in terms of the layoffs you're seeing that are making the newspaper. And as I've said in previous quarters, we're already in the same papers, right? And we all see the same news reports. However, our middle market, core business is doing -- our clients are doing extremely well, and we keep reporting our -- what we're seeing in our midterm endorsements and changes to policies and as we see both our renewals and the audits going forward, our middle market, retail, property casualty benefits business, these people are doing very, very well. Truck counts are up. Our trucking business is very strong. Our work comp renewals in terms of payrolls are not being diminished. Now that doesn't mean that if there is, in fact, a global recession that it won't impact us, of course, it will. But at this point in time, we're not seeing that. So if you ask me where do we see an impact on that type of growth as we go forward this year. I'll tell you, our plans at present don't count on any recessionary pressure. And that could be wrong."
},
{
"speaker": "Operator",
"text": "Our next questions come from the line of Yaron Kinar with Jefferies."
},
{
"speaker": "Unidentified Analyst",
"text": "This is Andrew on for Yaron. Just looking at head count in Brokerage, it looks like there's been a pretty good pickup year-to-date and in the quarter specifically. Can we kind of talk about what's going on there? And roles you're hiring and the degree to which those hires have been reflected in organic yet?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. Well, a lot of that -- remember those numbers are impacted considerably by our M&A program. So as we close the year out strong on M&A, those numbers would be in the December numbers and not in last year's December numbers, and that would impact the quarter 2."
},
{
"speaker": "Patrick Gallagher",
"text": "And I would want to comment on that as well. We are not undergoing an organic surge in new hiring. We have a very strong internship. We bring on a very strong number of young people every year. Of course, we're always looking for good solid production hires, but you are not seeing our organic head count surge beyond the M&A activity that Doug just mentioned."
},
{
"speaker": "Unidentified Analyst",
"text": "Great. And as we think about supplemental and contingent commissions, I suppose a part of that is based on underwriting profitability of those programs. So when you think about '23, is there kind of a loss trend that you bake into forward guidance there? Or maybe more broadly, what is your view on loss trends over the course of the next year?"
},
{
"speaker": "Douglas Howell",
"text": "Are you're talking about the carriers loss trends?"
},
{
"speaker": "Patrick Gallagher",
"text": "Yes, our contingents."
},
{
"speaker": "Douglas Howell",
"text": "Right, that relates to the contingents."
},
{
"speaker": "Patrick Gallagher",
"text": "Supplementals are not subject typically to profit-sharing arrangements, our contingents are. And to date, I'd say we probably factored nothing in, in terms of having significant increases in our operating loss ratios."
},
{
"speaker": "Operator",
"text": "Our next questions come from the line of Mark Hughes with Truist."
},
{
"speaker": "Mark Hughes",
"text": "Another P&C CEO suggested he didn't see as much increase in property rates in the fourth quarter as you might have expected in light of the reinsurance market dynamics, but maybe that's something that builds up as the time goes by is the higher reinsurance rates do directly impact the carriers. Would you share that observation? Do you think property could get firmer on the primary level?"
},
{
"speaker": "Patrick Gallagher",
"text": "I think property could get a lot firmer. I would say in the fourth quarter, it was very firm, in particular, in anything that had to do with Coastal, any area that was exposed to wind and fire. This market in terms of property is very difficult as it exists. And, yes, the changes to reinsurance at 1/1 will filter additional pressure onto the retail buyer. And we are out early telling our retail buyers about this. And it is going to get more difficult in what is already a very extremely difficult situation."
},
{
"speaker": "Douglas Howell",
"text": "Yes. If you think about -- remember, our fourth quarter, Ian hit right at the beginning of the fourth quarter, there were replacements that were done in October and November that hadn't had the full impact of the $70 billion loss."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Yes. And then, Pat, last quarter, you mentioned a potential spillover effect on casualty. I don't know whether you updated your commentary on that this quarter, but do you think the reinsurance market, how much of an impact, I think, it's having on casualty, ?"
},
{
"speaker": "Patrick Gallagher",
"text": "Mark, I don't have a number on that yet. I just think that it's possible that in order to pay for some of these property increases, other lines are going to have to be tagged. And I think I'll be able to feel that since it maybe have a better number around that at the end of the first quarter. And I may be wrong on that. At this point, I'm not being told by our carriers that that's happening."
},
{
"speaker": "Operator",
"text": "Our final question will come from the line of Michael Ward with Citi."
},
{
"speaker": "Michael Ward",
"text": "I just had a quick follow-up maybe on Elyse's question and the potential for double-digit growth in reinsurance. Just wondering if that's kind of -- if we should think about that as being achievable with current capacity or if incremental capacity might need to come to the market in order to get there?"
},
{
"speaker": "Patrick Gallagher",
"text": "I think that it will be achievable with existing capacity. I was very pleased -- our reinsurance people were telling us in late November and December, early December that they were very fearful some of these placements just weren't going to get done. And that is a nightmare on all sides of the equation. And in fact, really, really pleased and proud of the team that did the work to bring the programs together for our clients as January got going here. So I think on existing capacity, of course, the largest renewal season is now winding down. It's not over, but it's winding down. And so I do think the increases going forward could come off existing capacity. However, having said that, any additional capacity would be very welcome and will be utilized quickly and would add to that. All right. Then let me just add a few comments as I wrap up. I want to thank you again for joining us this evening. Obviously, I'm very pleased with our '22 financial performance. I am still very excited about our future. I want to thank our clients for their continued trust, our 43,000-plus colleagues for their passion, hard work and dedication. And finally, I need to mention our carrier partners. They do play an integral role in meeting our clients' insurance and risk management needs. And we look forward to speaking with you all again at our March IR Day. So thank you for being with us, and we'll talk to you then."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and enjoy the rest of your day."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 3 | 2,022 | 2022-10-27 17:15:00 | Operator: Good afternoon. Welcome to Arthur J. Gallagher & Company's Third Quarter 2022 Earnings Conference Call. Participants have been placed on a listen-only mode, your lines will be open for questions, following the presentation. Today’s call is being recorded, if you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you, operator, and good afternoon, everyone. Thank you for joining us for our third quarter 2022 earnings call. On the call for today is Doug Howell, our CFO; as well as the heads of our operating divisions. Before I get to my comments about our financial results, I'd like to acknowledge the damage of devastation caused by Hurricane Ian. Our professionals are working diligently to help our clients sort through their coverages, file claims and ultimately get losses paid. At the same time, many of our own colleagues are doing the same for themselves. Our hearts go out to all of those impacted by the storm. In the aftermath of events such as in the insurance industry's role and response is paramount to help families, businesses and communities restore their lives. I'm really honored to be part of an industry with such important responsibility. Okay, on to my comments regarding our third quarter financial performance. For our combined Brokerage and Risk Management segments, we posted 15% growth in revenue, 8.4% organic growth, net earnings growth of 12%, adjusted EBITDAC growth of 15%, and we completed or signed 7 mergers in the quarter totaling about $60 million of annualized revenues. Another fantastic quarter by our team. Let me give you some more detail on our third quarter performance, starting with our Brokerage segment. During the quarter, reported revenue growth was 16%. Of that, 7.8% was organic. That's right in line with our September IR Day expectation when we previewed there would be about a full point of headwind related to timing from a tough '21 comparison within our benefits business. Acquisition rollover revenues were $162 million. Net earnings growth was 11%, and we posted adjusted EBITDAC margins of 32.3%, a bit better than our IR Day guidance. Another excellent quarter for our brokerage team. Focusing on brokerage segment organic, it continues to be broad-based by both business and geography. Let me walk you around the world and provide some more detailed commentary, starting with our P/C operations. Our U.S. retail business posted 9% organic with strong new business and solid client retention, both consistent with last year's third quarter. Risk Placement Services, our U.S. wholesale operations, also posted organic of 9%. This includes more than 20% organic in open brokerage and about 5% organic in our MGA programs and binding businesses. New business was strong at more than 27% of prior year revenue, and retention was consistent with last year's third quarter. Shifting outside the U.S. Our U.K. businesses posted organic of 15% with excellent new business production and retention. Australia and New Zealand combined organic was 9%. New business production remained very strong and retention improved relative to last year's third quarter. Canada was up 13% organically and continues to benefit from renewal premium increases, robust new business and consistent retention. Moving to our Employee Benefit Brokerage and Consulting business. As I mentioned earlier, as we signaled last quarter and again at our September IR Day, our benefits business faced a tough organic comparison this quarter. Recall that due to last year's upward development in covered lives as employers resumed hiring coming out of the depths of the pandemic. Leveling for that, our benefits business organic was about 3%. And that's consistent with our IR Day expectations and includes strong growth with our HR benefits consulting units and solid growth in our international businesses. And before I conclude my organic comments, let me give you a quick update on our December 21 reinsurance acquisition. Third quarter revenues were right in line with our expectations and while not included in our Brokerage segment organic yet after controlling for breakage prior to closing, organic was around 8%. That's just outstanding. With expected revenues and EBITDAC for full year unchanged, reinsurance continues to be a fantastic story. So headline Brokerage segment all in organic of 7.8% and around 9% after controlling for the benefits comparison either way, an outstanding organic quarter. Next, let me give you some thoughts on our current PC market environment, starting in the primary insurance market. Overall, global third quarter renewal premiums, that's both rate and exposure combined, were up 10.5%. That's a bit higher than renewal premium change in the first half of '22. As for rate, most lines of business and geographies saw increases in third quarter, similar to the first half with only one exception being D&O, where rates are now closer to flat, but our customers are buying more limits. Additionally, our customers' third quarter business activity was not reflective of any economic slowdown. In fact, revenue related to third quarter midterm policy endorsements, audits and cancellations combined were above third quarter '21 levels. Looking ahead, thus far in October, midterm policy endorsements and audit adjustments remain higher than last year's level, and renewal premium increases are also consistent with the third quarter. But remember, our job is to help our clients mitigate that overall 10% increase in premiums by developing creative risk management solutions that fit their budgets. Let me move to the reinsurance market. Let me provide you with some broad observations regarding the upcoming '23 and reinsurance renewal season. First, there is no question that rates, terms and conditions will vary depending on geography, individual seed and loss history, risk characteristics and line of business. Second, pricing on peak zone property catastrophe cover is moving higher. And tightening terms and conditions are highly likely. Third, while we haven't witnessed the impact of Hurricane Ian spill over to non-property lines yet, it is possible that, that could happen if there's a broad shift in reinsurance risk appetite and capacity deployment strategies. Fourth and finally, the amount of property reinsurance capacity available is an open question. Some reinsurance providers had already planned to pull back their cat capacity priority in. And now it is likely the significant level of ILS capital to be trapped into 1/1 renewals, further pressuring potential capacity. Ultimately, supply will depend on expected returns from changes in pricing, terms and conditions and perhaps expected returns will reach a level that will attract additional reinsurance capital. While we have yet to see any significant third-party capital into the market, given ILS capital can move quickly, there is still time before the January renewal season. This will play out over the next 2 months. But at this point, it seems the stage is set for a hard or even harder renewals market as we enter the important 1/1 renewal season. Reinsurance conditions will no doubt influence primary markets in 2023 and carriers we're already facing rising loss costs in property and casualty lines. We see good reason for our carrier partners to continue to underwrite retail and wholesale risks cautiously for the foreseeable future. Moving to our Employee Benefit Brokerage and Consulting business. U.S. labor market conditions remained tight, but broadly favorable. During August, while U.S. employers reduced job openings by 1 million positions, there are still more than 10 million job openings according to the most recent data. And the level of open jobs remains well above the nearly 6 million people unemployed in looking for work as of the end of September. So we see tight U.S. labor market conditions lingering for some time and expect strong demand for our HR and benefits consulting services to continue as businesses prioritize, attracting, retaining and motivating their workforce. Let me wrap up my Brokerage segment organic comments with 3 terrific quarters in the books. Year-to-date, brokerage organic growth stands at 9.3%. And as I look to the fourth quarter, I see us posting another quarter above 9% that would deliver a fantastic year. Moving on to mergers and acquisitions. During the third quarter, we completed 6 new tuck-in brokerage mergers representing about $20 million of estimated annualized revenues. We also signed another merger late in the third quarter, representing an additional $40 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have about 50 term sheets signed or being prepared, representing nearly $400 million of annualized revenue. We know not all of these will close, however, we believe we'll get our fair share. Next, I'd like to move to our Risk Management segment, Gallagher Bassett. Third quarter organic growth was 12.2%, a strong finish to the quarter, pushed organic a bit higher than our IR day expectation. We also continue to benefit from increases in new arising claims across general liability and core workers' compensation during the quarter. That's both on an organic existing client basis and also due to some recent new client wins, including the significant insurance company client we added to our fast-growing insurance carrier practice. And profitability remains excellent. Third quarter adjusted EBITDAC margin was 18.2%, in line with our expectations. That would have been closer to 19% without the impact from the new large client ramp-up that we spoke about at our September IR meeting. Looking forward for the fourth quarter, we believe organic revenue growth will be about 10% and adjusted EBITDAC margins between 18.5% and 19% that would close out a great year for the Gallagher Bassett team. And I'll conclude my remarks with some thoughts on our bedrock culture. October 2 marked Gallagher's 95th anniversary. I took note on that day that our teams were hard at work helping our clients assess damage, file claims and ultimately start the repairing and the building process for Ian. And if not directly assisting individuals and communities impacted many Gallagher colleagues around the world donated their own money to help those impacted by Ian. What a fitting way for us to solidly celebrate this incredible milestone. My grandfather would be proud of the company founded to employees that embody the culture he started in the industry in which we toll. It's our people's actions and challenging times that bring our unique Gallagher culture to the forefront, a culture that we believe will thrive for another 95 years. Okay. I'll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks, Pat, and hello, everyone. Today, I'll touch on organic and margins using our earnings release. Then I'll move to the CFO commentary document that we post to our website and make some comments on our corporate segment. I'll conclude my prepared remarks with some thoughts on M&A, debt and cash. During my comments today, I'll also provide some thoughts on our fourth quarter and some first thinking around how we are seeing 2023 now that we have started our budget process. Okay. Starting with the earnings release in the Brokerage segment organic table on Page 3. Headline all-in brokerage organic of 7.8%. That's over 9% when controlling for the tough benefits compare, brings us to a strong 9.3% year-to-date organic growth. When I look at our organic quarter-to-quarter, it's fairly consistent in that 9% range. We boast 9.6% organic in the first quarter, about the same in the second quarter when you exclude that infrequent large live sale we discussed last quarter. Now we're at about 9% here in the third quarter when adjusting for the benefits headwind. and It's looking like over 9% in the fourth quarter. That would deliver a full year 22% organic above 9%, a little noisy on the quarters, but very consistent and actually a fantastic performance by our sales team. As for 2023, early feel is in that 7% to 9% organic range for our Brokerage segment. Next turning to Page 5, to the Brokerage segment adjusted EBITDAC margin table. Recall, this is a year of quarterly margin change volatility due to the roll-in impact of the acquired reinsurance operations, expenses returning as we come out of the pandemic and the impact of a stronger dollar. Specifically, we've been saying to expect year-over-year margins to be up 50 basis points in first quarter, down 100 in the second quarter, down 125 basis points in the third quarter and up about 125 basis points in the fourth quarter. While that was about right for our third quarter, we posted 32.3%, which was in line with our IR day guidance and we are still comfortable with our fourth quarter outlook of around 125 basis points of margin expansion relative to the FX adjusted fourth quarter '21 EBITDAC margin. That would suggest a fourth quarter margin of around 32% at today's FX rates. In the end, since early '22, we've been targeting around 10 to 20 basis points of full year '22 margin expansion. And we're on track to deliver that. More importantly, that would mean we improved margins around 570 basis points since 2019. As we look ahead to '23, we continue to expect margin expansion next year starting around 4% or better organic growth, call it, maybe 50 basis points at 6%. Moving on to the Risk Management segment on Pages 5 and 6. As Pat said, 12.2% organic and 18.2% adjusted margins, both pretty close to our September IR Day expectations. And looking forward, we see these excellent results continuing in the fourth quarter. Organic growth -- revenue growth of about 10% and margins in the mid- to upper 18% range. That would be a full year organic growth of about 12% and full year margins around 18.5%. Looking to '23, we will see the roll in of the new large carrier client, and we have already had a nice new business win in Australia that will end up midyear. Add continued strong new business production, combined with continued growth in newer rising claims, we see organic at least in the high single digits and margins around 19% in '23. All right. Let's shift now to the CFO commentary document. Starting with Page 3, which shows our typical brokerage and risk management modeling helpers. A few things to highlight. First, the continued strengthening of the U.S. dollar since our September IR Day. Please take a look at our updated FX guidance for the fourth quarter of '22. As for 2023, perhaps the best start is just to assume what we are projecting for full year '22 repeats in '23, but most of that will be seen in the first half. Second, you'll see our current estimate for fourth quarter integration costs, most of all of this relates to the reinsurance acquisition. The team is making really excellent progress on this and is executing at a faster pace than our original plan. It was terrific to see our new reinsurance colleagues located with our other brokerage operations when I was in London a couple of weeks ago. As for technology and system rebuilds, we still see being done by the end of '23 or early '24. Turning to the Corporate segment on Page 4. Relative to our September outlook, interest in banking, clean energy and M&A costs after adjusting for the large transaction-related expenses, those 3 lines totaled to about the midpoint of our outlook. Within the corporate line, most of the upside was due to some favorable tax items and a favorable FX remeasurement gain. Looking towards the fourth quarter, moving down that page, only one significant change to our outlook. As you'll see in the fourth quarter corporate line and read in Footnote 7 on that Page 4, here in October, we settled a litigation resulting in Gallagher receiving $55 million in cash. Net of litigation costs and taxes, we will record a gain of approximately $35 million, and you'll see a few lines down that we'll adjust that gain out of our GAAP results. As for the cash proceeds, which because of our tax credits is actually closer to $40 million, we'll put that to good work over the next couple of years to fund incremental production hires and make incremental investments in technology. I'll break down our thinking a little more during our December IR day. Moving now to Page 5, Clean Energy. This page should be familiar to everyone by now. It highlights that we have close to $1 billion of tax credit carryforwards. The pinkish column shows that we expect to however, a $125 million to $150 million of cash flows here in '22, and the peach column shows that we could be even greater in '23 and beyond. And as a reminder, that would come through our cash flow statement, not our P&L. Turning to Page 6. The top of the page is the rollover revenue table. Third quarter revenues of $162 million, that's right in line with our expectations 6 weeks ago. Shifting to the lower half of the page, this table is an update on our December '21 reinsurance acquisition. Third quarter revenue of $120 million is consistent with our September IR day estimate. As for EBITDAC, a tightening difference between third and fourth quarter. Punchline is full year revenue and EBITDAC should come in very close to our pro forma. That's a really terrific story and great credit to the team. Okay. As to cash and capital management and future M&A. At September 30, available cash on hand was about $500 million, and we've been saying that we might have around $4 billion of M&A capacity in '22 and '23 combined without using stock. That still seems about right to us today. Okay. Those are my comments. Another fantastic quarter and 9 months is in the books, another strong outlook for the fourth quarter, and it's looking like we're well positioned for a terrific year in 2023. Back to you, Pat.
J. Patrick Gallagher: Thanks, Doug. Operator, if you would, let's open it up for questions, please.
Operator: [Operator Instructions] Our first question is from Weston Bloomer with UBS. Please proceed.
Weston Bloomer : Hi, thanks for taking my question. The first one is on the 7% to 9% organic growth that you're expecting next year. I was hoping if you could kind of expand on what sort of environment you're expecting next year in terms of a potential recession? And then if you can hit that target in a recessionary environment? And then -- maybe just comment on the magnitude of growth you're seeing across maybe P&C operations versus wholesale or international? Just trying to get a sense of how you're getting to that 7% to 9% more granular.
J. Patrick Gallagher: Weston, let me take the recession question. Doug, can take a look at the numbers across -- I think we did a pretty good job of laying out those numbers by division a moment ago. And I think we said we thought they're pretty consistent next year. So I think you look at our prepared remarks, you got that question answered. But the recession one is an interesting one because one of the reasons in our prepared remarks, we talk about what's going on with endorsements is we can daily look at that information to see what's going on in the underlying business of our clients. We can also look at renewal exposure units as they're being put through to the market for renewal. And as you know, when you renew a client, you have to estimate sales and payrolls going forward. So clients are pretty smart. I'm not wanting to basically overpay and then wait for a return of that premium in an audit, 18 months or 15 months after the close of the year. So it's a bit of a yin and yang between the broker, the underwriter and the client as we look at what are those payrolls that we should be providing. We're not seeing a big decrease in sales and payrolls. Renewals are going out the door with perception of their business being okay. And that's verified by the midterm audits and endorsements that we're seeing. So -- I read the Wall Street Journal every day. I read the left-hand column yesterday, the world just came to end, I didn't know it.
Doug Howell: Well, listen, I think the way we look at it this way, is we're not seeing it in our underlying business today, and we're also viewing if there is a recession in '23. We see that being more like what happened in the early -- in the 1991 period, in the 2000, 2001 period, more of a normal soft landing recession. We do not see a recession next year like the subprime financial shock of '08 and -- '07 and '08 or the pandemic recession that we saw for a few months in '20. Those normal recessions typically last about 2 or 3 quarters. And when we go back to the best we can do to get data back then, we actually performed very well during those light recessions. In this case, I think that next year, if there is -- if anything happens, and we do go into a recession, I think it's going to drive excess demand more than it is to contract supply and we ensure supply. So in our contemplation for next year is a lot like this year, exposure units holding stable, rates going up like we're seeing this year. But I see -- I don't see a lot of change all of a sudden on 1/1 that the world has changed dramatically from what it's been for the last 3 to 6 months, right now. So that's our go-in case. That's how we're preparing our budgets in that range. So that's how we came up with that 7% to 9%.
J. Patrick Gallagher: But we'll give you more of a reflection on that in December.
Weston Bloomer : Got it. And just one follow-up there is kind of like a high single, low double-digit growth for reinsurance brokerage kind of the right range as well? And can you remind us how much of that business is more property versus long tail binds?
Doug Howell: Yes. All right. So yes, in answer to your question, we see reinsurance in that high single-digit range next year. Right now, the best -- remember, you got a lot of treaties that are multi-line. But right now, the best we can tell is pure property is 28%. You put in the package on that, I'd say it might be closer to 40% of the book of business. And then you look at some of our kind of high-risk casualty lines, maybe you've got a book that's -- 60% of it is facing a kind of a tough renewal season.
Weston Bloomer : Great. And then just one more. On the commentary around 50 bps of margin based on 6% organic, does that contemplate a potential pickup in discretionary spending inflation may be offset by higher fiduciary income? Or is that just core expansion net of any items?
Doug Howell: Yes. I think for 2023, and again, I'll give you some more here in December, there will be an upside from investment income. That -- not all of that will hit the bottom line because there could be some incremental inflation that we see in some of our numbers. Remember, about 80% of our business, we don't believe has significant exposure to headline inflation. And like we said last at our IR Day or on an earlier call, about 20% of our expenses, they do have some inflation pressures on it. But in our opinion, there will be clearly an upside to that thinking as a result of incremental investment income next year. But I still need to work through that math over the next couple of months.
Weston Bloomer : I am working through it too.
Doug Howell : Our next question is from Mike Zaremski with BMO Capital Markets. Please proceed.
Mike Zaremski : Just a follow-up on the investment income levels. And are you so -- is the guidance that you provided kind of inclusive of using the current level of interest rates or the curve? Does that make sense?
Doug Howell: You're talking about the '23?
Mike Zaremski: Yes, '23. Sorry, Doug.
Doug Howell: Yes. I think that when we look at 6% organic growth with possibly 50 basis points of margin expansion, that does not include a possible upside from incremental investment income, but not all that incremental investment income will likely hit the EBITDA line. It could go to some inflationary pressures on some of our cost base or it could go to some discretionary spend, but it would be upside to that 6 points, 50 basis points outlook.
Mike Zaremski: Okay. Understood. Thanks for the clarification. Kind of switching gears a little bit. Just curious, you're not calling out any kind of potential impacts to contingents or shops as a result of the hurricane. I know the new accounting rules came into place a few years ago. Is there anything we should be contemplating that could impact Gallagher in the year to come or maybe even kind of into programs business, if there's a lack of capacity? Just trying to -- one of your peers kind of surprised us a little bit. So just trying to see if there's anything there worth talking about.
Doug Howell: Our outlook on the impact of Ian to our contingent commissions is $465,000 of impact against our revenues. That has all been fully booked in the numbers that you see here today. We do not believe that would develop differently than that. We just are not that -- we're just not exposed to contingent commissions on operating placements in our book of business.
Mike Zaremski: Okay. Great. And lastly, any change in the competitive environment on the M&A side, given there's kind of now a consensus that interest rates may stay higher for longer? Or is it still just very competitive?
J. Patrick Gallagher: No, it's still very, very competitive. And there's a lot of interest out there in our industry still, we're watching that very carefully to see if some of that falls off. You'll see some write-ups recently about the number of deals done coming down a bit. I don't know if that's an early sign that maybe some of the people want to sit on the sideline a bit. But for the deals that we're after right now, the competition is very strong.
Mike Zaremski: So multiples, I was trying to -- I should have been clear. So you don't expect multiples to move south and you're not seeing that?
J. Patrick Gallagher: I hope they do, but we're not yet.
Operator: Our next question is from Greg Peters with Raymond James. Please proceed.
Greg Peters: So I wanted to go back, Pat, to your comments about the reinsurance market and the reinsurance business and sort of unpack what's going on and get your perspectives because it really feels like we're at the seminal moment in that marketplace where we could be in a hard market, especially for cat-exposed property, but it seems like it's bleeding over into other lines. And -- so the reinsurers haven't been able to get an adequate return on their business. And then now the primary companies are going to be asked to take higher retentions and absolutely pay more on rate online. So I guess my question is, if these 2 partners of yours are getting pressure or profitability pressure, do you foresee a scenario where you actually might get some pressure on commission rates as the market evolves here?
J. Patrick Gallagher: No, I don't think so, Greg. I think it's clear that we earned our money. And that's -- you see that in the market. I mean, it's -- the business has been very stable, I've had a chance to meet with a number of managements. They know exactly every dollar that we're making. There is no hidden factor here anywhere. And we have to do the work that justifies that income level every single day. Now in my experience as a retailer, I'm not a reinsurance person, but a hard market makes you incredibly more valuable. In a soft market in the retail business, some person with a shingle out to get a quote and beat you, when you're sitting with someone in a hard market, you are talking strategy, man. You are not talking about what's going to happen to my comp premium. You're talking about, am I going to get GL cover. And that's going right down to personal lines. I've got tons of friends, as you can imagine, in South Florida. Am I going to get homeowners next year? I don't know. I mean, I think you will, but you're going to pay more and they know it. Now that, I think, trusted adviser works its way all the way back to reinsurance, and this is not a time when these carriers are going to put a lot of emphasis on how much we get paid when they're looking at trying to get returns literally on hundreds of millions of dollars of ratings.
Doug Howell: Yes, Greg, I will say this. It's been 20 years since I've been CFO of insurance companies, but right now, this is a time where my reinsurance brokers would be the most important people to have in my office with their skills, their capabilities, and this is a time where they really earn their money.
Greg Peters: Fair enough. I'm sure it's -- there's a robust conversation happening around all of this stuff. So I wanted to also -- and I know you've commented on this before, but I wanted to pivot and talk about the brokerage business and the pipeline, if we're in a recession, if we go in a recession, blah, blah, blah, it's pretty strong. Can you remind us again just when -- on the risk management piece, how you think that might perform if we go into a soft landing? What kind of -- and I know you've commented on this before, Pat, but just give us some sort of guideposts that we should be thinking about on that.
J. Patrick Gallagher: Well, I mean -- first of all, Greg, as you know, when prices are going up, one of the skills that brought us to the point we are today is the capability of taking people who are -- should be self-insuring into that market. and showing them how to take higher retentions and bringing Gallagher Bassett in. Recessionary work has the same -- now I'm talking about the larger upper middle market. The recession has the same kind of impact, especially if you get a recession, while at the same time, pricing has gone up. They're looking for alternatives. And when I say your alternative is to pay tomorrow instead of today and to really manage your claims hard and work it hard at preventing them, there's a lot better listeners than when the prices are dropping, and that's going right to their bottom line and their private companies and they're happy as a clam. When you get to the larger accounts, these are very sophisticated buyers. And they don't move around based on recessions. Now if there is a recession and our larger clients have a lesser population, they close down shifts, then you'll see claim counts drop. But I don't think you're going to see an impact on that business that happens in the short term, and we'll know well in advance of any kind of a downturn as people start slowing their business down and cutting shifts, we'll be well aware of it. We can probably comment better as we go into the new quarters. We're just not seeing that right now, Greg. I think that's the interesting thing to me. As I said, I read the journal every day, and I'm sitting there and go, okay. And then we test and test and test, and our primary business partners are doing really well. Then we looked at the GB results and claim counts are up. They're not down. So it's -- I get why you're questioning it. I really do get the conundrum. But here's the thing. Doug pointed out that the other recessions we've done well. Clients do not jump in and out of self-insurance. You make that decision to move to taking a big retention and paying your claims. You may have a -- you may see your claim counts go down because hours worked are less, but you're not jumping in on the market. It's a pretty good place to be.
Greg Peters: Got it. Thanks for the answer and I read the journal too. It does seem like the end of the world is imminent, but you guys are posting good results. So congratulations.
J. Patrick Gallagher: Thanks, Greg.
Operator: Our next question is from Elyse Greenspan with Wells Fargo. Please proceed.
Elyse Greenspan: My first question, I'm going to head in the opposite direction of talking about a recession. I want to go to the flip side and talk about how good, I guess, 2023 could be. As you had said 6% to 9% organic in September. Today, you're saying 7% to 9% for next year. But we could have a really strong reinsurance market, and it sounds like you have really good exposure on the wholesale side where the market is really firming. So at 80% of your revenue is commission based. So could there be an environment next year where pricing is still firm that Gallagher could print double-digit organic revenue growth?
J. Patrick Gallagher: Well, from your lips to god's ears, Elyse. If you take a look back at our results in other hard markets, yes, that could happen. I mean, I'm not going to sit here and say no. If capacity dries up, smaller brokers in those environments can't get the job done, reinsurance clearly is -- and look at cap trapital in the ILS market, depending on whether capacity is there or whether capacity comes in, yes, I think you could see a variable -- you could write a bullish story.
Elyse Greenspan: And then assuming, right, Doug, you said at a 6% organic, we could see 50 basis points of margin improvement. So assuming that the base is 7%, right, and it sounds like it could be better than that, so is the base case that we'll see something margin improvement that's above that 50 basis point level next year?
Doug Howell: I think that it's not linear. If we posted 9%, I don't think you'd have 150 basis points of margin expansion, but you might have 75 to a point, something like that. But I think that -- let us get through this and get through our December, look at our budgets. And some of this is discretionary spending that we might want to make in investing in technologies and other organic growth strategies. But -- yes, I mean, there is a case that, that could happen.
Elyse Greenspan: And then on the M&A side, right, you guys obviously have a good amount of capital flexibility over the next couple of years. it does seem maybe it's because you guys have had such a strong track record of M&A. Deal flow has been a little light relative to historical levels this year. So I know the pipeline is still strong. At what point do you reach that level? Will you consider buying back your shares? Or is it something where deals just ebb and flow depending upon time of year and you guys will give it some time and then maybe consider buybacks?
Doug Howell: Well, listen, if we ended up with excess capital, our first metric would be is to make sure that we maintain a solid investment grade rating borrowing. With interest rates going up, that's more and more important every day. Second of all, I think that our M&A pipeline is still robust. And the third thing is, remember, the arbitrage that we get on the multiples. And -- more importantly, we're building out the team. We bring more people on our side of the field to go out and compete on every day and create more organic afterwards. So for us, buying back stock is certainly what we can do. It's certainly part of the math, and its part of the story. But I'd like to see us doing more and more M&A every day to put our cash to work at multiples that are -- that deliver arbitrage value to our shareholders. So -- we're out there, we're looking very hard. Sometimes you win, sometimes you lose. But I think we've got a ton of opportunities in our pipeline right now.
Elyse Greenspan: Given the strength of the U.S. dollar, are you guys seeing more opportunities for international deals?
Doug Howell: Well, listen, we've got some pretty good pipelines going on, especially in Canada, Australia and the U.K. right now. So we'd be happy to continue to look at those acquisitions there. And yes, the dollar does have a little bit of an impact on that, but it's not what drives our investment choices.
Operator: Our next question is from Yaron Kinar with Jefferies. Please proceed.
Yaron Kinar: My first question is on headcount. I noticed there was a nice pickup in headcount, and the one I'm referring to specifically is in Brokerage. I think it's up 7% year-to-date. Can you maybe talk a little bit about what that is going into, what type of roles you're hiring? And secondly, I'm actually -- I was very impressed to see that the comp and benefit ratio is actually coming in year-over-year despite the increase in headcount. So is there a catch-up that we should expect? Or how are you keeping that number down?
Doug Howell: All right. So a couple of things -- you got a couple of things to unpack. But first, let's talk about the increase in the headcount. We have actually substantially increased our head count in our offshore centers of excellence. As you know, we've been talking about it for 15 years now. We think that that's a terrific spot to improve the quality of the offer of our insurance offerings. And as a result, we're ramping up significantly more in offshore right now that can do that work for us. And the -- so we're up considerably in that. So that's what's driving the metric you're seeing is mostly offshore resources there. When it comes to the opportunity -- the drop in the comp ratio this quarter, some of that has to do with bonus timing. If you recall last quarter, I said we were a little ahead on our bonus accruals. So we didn't have to post quite as much this quarter, which probably offset some of the -- well, we did have a little bit of inflation in our rates pool. We gave away another $8 million this year, something like that in that -- in the raise pool this year. What's offsetting that is the timing of the bonus.
Yaron Kinar: Got it. And I'm curious what led to the increase in the organic growth estimate for '23, at least the bottom end of the range from 6% to 7%? What changed in the last 6 weeks?
Doug Howell: Well, listen, I think that Ian has brought a different tone in the marketplace. I think you're seeing some reports of reserve strengthening across line. You saw the reinsurance outlook we've talked about -- and remember, the reason why we got to 6% to 9% is we were saying that 23 felt somewhere between 2019 and 2022 and '19 happen to be 6% organic growth. So in the context of the comment in September, relative to 2 different years. And now as we're getting closer on our budget process and really looking at what we're starting to see in the renewal pipeline, we thought we could tighten that range up a little bit.
J. Patrick Gallagher: Also, Yaron, I think that before in, it was clear that loss cost and verdicts and what have you, we're putting pressure on our carriers. Today, we look across the loss on the cat level and wonder if they're not going to bleed into the casualty lines. And I've had some conversations with some of our reinsurance pros, we think that that's a very good possibility. If that happens, that will be -- that will benefit from that as well.
Yaron Kinar: Got it. Maybe 1 last one, and following up on Greg's question. I guess, in what markets, what kind of environment do you typically see some pressure on commission rates or maybe clients trying to shift over to fees?
J. Patrick Gallagher: Primarily in the retail market, as accounts go from being, say, upper middle, middle market, where typically, you'll have about 85% to 90% of your clients, probably, we're 100% transparent. This is their choice. We have an adult conversation. They know we collect contingents. Let's not go back to 2004 and get me all in trouble, again, for accepting convenience and supplemental. They're all disclosed. This is client choice. And so as they get a little bigger, if they bring in a risk manager, that type of thing, then there's usually a shift to fee and we're happy with that.
Operator: Our next question is from David Motemaden with Evercore ISI.
David Motemaden: Just had a question on the investment income side, the fiduciary income. Could you just quantify how much that generated this quarter? I think you've said in the past it's $40 million for every 100 basis points move in short-term rates. But just wanted to -- just to double check what the benefit was to revenues this quarter? And then maybe just talk about how that impacted margins? How much of it fell to the bottom line?
Doug Howell: Okay. I'll take that in a couple of different bites. This quarter, let's call it, $12.5 million that we had as additional investment income as a result of rate changes. Then you're asking how much of that fell to the bottom line. Maybe a better way for me to do this is to take a look at what does it mean for full year. If you recall at the beginning of the year, what we said is -- since when we were sitting in January, we looked back and we had said that we had posted about 550 basis points of margin expansion. And when we looked out and that was over 2 years. Then we said, if we look forward, again, I'm standing in January of 2022, we said that we might be able to get margin expansion of 10 to 20 basis points on organic from about 8% here in '22. So what's happened since that expectations. We're still looking at 10 to 20 basis points of margin expansion. But organic is running a point better and, let's say, investment income between this year that might be up, let's say, $30 million more of investment income in the year. So that's about $80 million more of revenues this year. And so the way I look at it is, where did that go? Where did the $80 million of revenue go? Well, first of all, we dropped -- we're going to drop one-third of that to the bottom line. So that leaves $50 million to $53 million of additional revenues. Well, we have to pay our producers field leadership and support that. Usually, that runs about 45% of the revenue on that organic of $50 million, call that $23 million. So now we're down to explain where did $30 million go as a result of incremental organic and incremental investment income, again, relative to our outlook at the beginning of the year. Well, I can tell you that we spent about $10 million on incremental hiring, some incremental raises and some incremental incentive comp this year. Maybe it's one-third. And we also know that we -- about $10 million went to incremental travel and entertainment expense. Now that's mostly due to inflation, and it's not due to increased trips versus our expectation. Again, this is against our expectation at the beginning of the year. And then finally, we spent an extra $10 million on IT betterment projects than probably we would have expected at the beginning of the year because we have the bandwidth in order to implement those projects. So for me, sitting here relative to our expectations at the beginning of the year, I think it's a really terrific outcome. And what I'm really proud of is the team has done a great job this year. They have been disciplined in their travel and they've been selected in their value-added efforts that they're bringing to the clients. And they've been pretty wise about other IT investments. And yet to still deliver 10 to 20 basis points of margin expansion this year in an inflationary environment on top of the 550 that we had delivered in the previous two years I think it's a pretty darn good year, in my opinion. So relative to expectation, that's a long-winded answer -- but I think it gives you a perspective on incremental investment income and incremental organic relative to where we were sitting at the beginning of the year. And remember, we still -- at the beginning of the year, we had the Omicron crisis going on, and we were still in the depths of the pandemic. So we still have done our way out of those pandemic expenses returning along the way. So a long story, long answer, but I hope it gets you to where you need to go.
David Motemaden: Yes, that definitely did. That's really helpful. I guess maybe just switching gears to the reinsurance deal and how that's been going. The organic, I think, accelerated a point to 8% this quarter from 7% in 2Q. I guess -- high single digits in '23 feels may be a little conservative. But maybe could you just talk about the range of outcomes around that high single digit? And I guess what's stopping it from being well above that just given the market that you're experiencing there?
J. Patrick Gallagher: You're dealing with the most sophisticated buyers in the market. And as Doug just said a bit ago, when he was buying reinsurance, he wasn't messing around worrying about what the guy or gal is getting paid. The point is, this is talking at the essence of their capital, the returns, how they're going to balance out the demand, you've got a supply and demand imbalance. It's looking like it's coming down the path at being very substantial. They want to be good players. They want to take advantage of it. They want to make sure that they get good returns. And so it's good returns that ultimately hopefully bring in more capacity. But these buyers are very sophisticated. They'll pay us more money. I mean, the question earlier on was are they going to keep paying us what they're used to paying us. And they'll pay us more money, but it's not -- this is not a linear progression. I get down to the bad policies and into the lower middle market, it's linear. Price is up 10%. We're going to help the client reduce that by moving deductibles around, dropping umbrella limits, et cetera. But by and large, policy by policy, we're going to get that commission. That's not the case in reinsurance.
Doug Howell: Yes. I think it's a little bit of a -- I wouldn't say it's a symmetrical bell curve, but around 8% -- I thought -- 6% to 10% on that. So maybe it's 2 points on either side of it, and that probably favors the bull case on that more than the bare case on it.
David Motemaden: Got it. That's helpful. And then maybe just 1 more. You mentioned that you don't expect a recession. I don't want to be a Debbie Downer here, but if there is one like there was in the early '90s or early 2000s, have you guys given any thoughts on what organic growth would be in that type of scenario?
J. Patrick Gallagher: I think Doug did a very good job, sure he did, of taking it back in time. I mean, go back and take -- our results are public going back to '84. I think we do extremely well in good times and bad times. Certainly, recessions are not good for brokers. Sales and payrolls are what drive our premiums. So there's no question that if sales and payrolls go down, we'll feel the impact of that. Having said that, people get more interested in listening to us talking to them about how our professionalism, our capabilities in our niches and what have you, you can help them deal with this, the local brokers who takes the hit.
Doug Howell: Yes. I would say, listen, if we get into a recession that you wanted to refer to as you being a downer on, that type of recession, we're still in an inflating rate environment, and we're not seeing a slowdown on that. When it comes to the contraction of exposure units, I'm not seeing trucks just come out of the fleet. They may not be running quite as much, and I know there's a mileage adjustment on it, but I'm not completely convinced that the stuff that we insure will just all of a sudden evaporate next year. Might have to -- they may take different covers on it. They may take some additional deductibles. When you're also looking at an environment, if you get into a recession, that will help us on our employee retention because they will stay with a good company, versus jumping for a new opportunity. So when those 3 or 4 things applied, rate increases, stable workforce a flight to quality and what people are looking for in terms of their broker, I see us performing very well in that environment. If you want me to pick a number in there, if we have a downer I'd be hard pressed to see how it would be less than 5% organic growth.
Operator: Our next question is from Rob Cox with Goldman Sachs. Please proceed.
Robert Cox: I just had one question. I noticed open brokerage accelerated to 20% versus 15% last quarter. And I was just hoping you could talk about what inflected quarter-over-quarter and how you see open brokerage and the E&S market broadly trending from here?
J. Patrick Gallagher: The E&S market is on fire. And I think you're seeing more premiums move there, freedom of rate, freedom of form, clients need, cover everything from small accounts to large accounts. That's why we're seeing so much interest in terms of people investing in that market. That -- the primary markets, quite honestly, are not as flexible as the E&S markets are able to move at the pace that they can move, and they are in a tough market sucking business out of the primaries. Did that answer your question, Rob?
Robert Cox: Yes. Very helpful.
Operator: Our next question is from Mark Hughes with Truist Securities. Please proceed.
Mark Hughes: Thank you, good afternoon. Pat, you talked about the potential spillover to non-property lines from the hardness of the reinsurance market. Have you seen that in the past, I just wonder how much influence the cat property business is going to have on some of the other casualty lines, but I hear what you're saying. Just sort of curious to hear more about it.
J. Patrick Gallagher: Let me caution because I've been a retailer in my whole life. But for the last year, I've had a chance to spend a good bit of time with our reinsurance folks and do anything I can to learn that business and I talked about this at length in the last quarter. And it has happened in the past. I can't give you dates, times and amounts or percent. But -- yes, when you have a capital situation where you need to increase the pricing and you can add cat loads on other lines of coverage, you'll do that when you have to -- now again, I can't say to you that this is exactly what travelers or hyper did in this year given this situation or what have you. I can't take you back to Andrew or something like that or even Katrina. But what the team is telling me is that it's very likely, given the dearth of our capacity and the need -- because of the supply and demand imbalance, the need for more rate, that their other lines are selling that are likely to take in advance as well. And sorry that I'm not more specific about that. I'm learning along with you.
Mark Hughes: No. No, interesting. And then any shading -- you talked about the economy is still looking good in terms of exposure units and endorsements. Any differentiation you see between larger accounts, middle market, smaller accounts?
J. Patrick Gallagher: No. And that's the thing that's -- I keep referring to the Wall Street Journal, sorry, but I mean I read it and I sit there and I go, okay, and then I come back and I talk to our data people and they're like, no, I'm not seeing it. I can't also can't break it and say, well, construction is in the tank and retail is going through the roof or trucking is really hurting now and something -- so -- and we've checked things like our marine business. What's happening with cargo, cargo seems to be holding up and if there's any decrease in cargo, then cruise ships are, I mean, going through the roof. So it's kind of a -- it's a weird time based on what we read and what we see in our -- and these are not anecdotal stores. These are higher data points that I've got, and I can get them every day. And broad geographic, solid, continued business growth is what we're seeing. You fall off a cliff? I guess. We're just not seeing it.
Operator: Our next question is from Josh Shanker with Bank of America.
Josh Shanker: Yes. Some of the people asked about competition for deals. I just want to talk about debt. And when I think about private equity being one of your competitors, is the marketplace different for them if they have to borrow at higher costs? Is it still debt generally cheap in your mind? And so we're not at the market where that's a consideration. How do you think about their role in their appetite in a higher interest rate environment?
Doug Howell: Yes, we kind of signaled that early on. Their appetite is still strong right now. But when you're adding an extra 300 basis points of debt cost into the structure does change return expectations. And I think that we're really not competing on price when we come to these deals, Josh, we're really competing on capabilities. And we win on every day. If somebody decides our prices aren't dissimilar to what they're offering. That maybe be a turn higher, but people just have chosen that they don't want to be in an organization with increased capabilities or resources. So this will cause a compression of pricing by the PEs, it will probably come down to where we're comfortable with pain. And I think we should excel in that then because now it isn't about price. It's entirely about capabilities.
J. Patrick Gallagher: Well, dream with me a little here, Josh. I mean, yes, I think what Doug meant is that our price is similar to our competitors. Yes, multiples over the last five years have expanded substantially. Prices are higher for these deals. But money was free. So now you start paying for that money, and I'm not hoping for a recession, and we don't see one, but show a little slowdown in there. And maybe that annuity isn't as strong as it was before. Our lever is about 2.3 times EBITDA. We've got competitors in the market that are happy to be at 9 times. I'm sorry, at some point, the music has got to stop and all the chairs aren't going to be full.
Josh Shanker: And if you think over a 20-, 30-year base, I mean, 4% tenure, it's not really that high. I mean, we'll see where it goes from here. But Doug seems to have more confidence that maybe they're able to go away. But if we're at the peak here and we stay here for a while, isn't going to scare them away, I suppose. I'm obviously they're going to pay more than what the 10-year is. But it's got to go higher really to cause their exit, I guess. Am I right now?
J. Patrick Gallagher: Yes, I'd agree with that. The returns have been outstanding. I agree with that.
Operator: Our final question is from Ryan Tunis with Autonomous Research. Please proceed.
Ryan Tunis: I first just wanted to say that the $55 million good guy, that's a nice line. I can't remember the last time in broker land, you had a below-the-line item that is somehow went in the right direction. I think some of your competitors might even count that as organic.
Doug Howell: Yes. Go ahead, Ryan.
Ryan Tunis: But -- yes, Doug, take your time spending it. We don't need it to lean on margins in '23. But I just had one bigger picture question, I guess, on margins. So organic has been really soft for the past couple of years. And obviously -- but I mean, it could have not been strong, too, in which case I also don't think your expense growth would have been as high as it's been. So there seems to be some element of clearly, the organic has allowed you guys to have -- I want to make sure I'm thinking about this right, like kind of an investment cycle. So I'm just curious, is that the right way to think about it? Like, has the strong organic allowed you to kind of potentially pull forward some investing you had to do. And I'm just kind of curious, maybe some of the capabilities that you guys have been able to take on I guess, to improve the organization over the past couple of years that you wouldn't have if we were any more than a 4% organic growth environment?
Doug Howell: Yes. I think you've got your notes right in it. And I think if you go back and you listen to our IR Days, these earnings calls, we get an hour to talk to you, but during our IR Days, you hear our 5 or 6 division leaders talk about all the investments you listen to the first 5 minutes or 6 minutes of their prepared remarks. They're talking about all the value-added features and client-centric enhancements that we're doing in our business. And we're spending a lot of money on that. We've talked about Gallagher Drive. We've talked about SmartMarket, we've talked about Gallagher Submit. We've talked about our niche resources. If you look at our content that's out there, all of that is investment and we're adding to it every year. So we are running a business right now that has a substantial amount of investment in it to make us better. I think it's showing up in our organic to be real honest. I think the reason why we perform well on organic as we continue to make investments into our production and our sales and niche capabilities our service. 15 years ago, we didn't know how long it took us to turn around a set right now, we turn around 99.9% of them within one hour of request because of the investments that we've made to better the service. Those type of things are just in our blood at this point. And it's in our operating side, yet, we're still posting terrific margins on it.
J. Patrick Gallagher: So to add to that, I would say take a look at our internship, we're very proud of the fact that this summer, we had 500 young people look at our business. And these are paid interns. These aren't interns that come to work for free, and that's a U.S.-based number. If we take the people outside the U.S., it's probably closer to 600. I don't know another organization investing in the future of their people like that in our business or, frankly, another business. So I'm very proud of that. Thanks, Ryan, and thank you, everybody, for joining us. We really appreciate this evening. We had an excellent third quarter. We're well on our way to delivering a fantastic year of financial performance. I need to thank more than 42,000 colleagues around the globe for their hard work and dedication to our clients. We look forward to speaking with you again in person in December at our Investment Day in New York. Thanks again, everybody. Have a great evening.
Operator: Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation. | [
{
"speaker": "Operator",
"text": "Good afternoon. Welcome to Arthur J. Gallagher & Company's Third Quarter 2022 Earnings Conference Call. Participants have been placed on a listen-only mode, your lines will be open for questions, following the presentation. Today’s call is being recorded, if you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you, operator, and good afternoon, everyone. Thank you for joining us for our third quarter 2022 earnings call. On the call for today is Doug Howell, our CFO; as well as the heads of our operating divisions. Before I get to my comments about our financial results, I'd like to acknowledge the damage of devastation caused by Hurricane Ian. Our professionals are working diligently to help our clients sort through their coverages, file claims and ultimately get losses paid. At the same time, many of our own colleagues are doing the same for themselves. Our hearts go out to all of those impacted by the storm. In the aftermath of events such as in the insurance industry's role and response is paramount to help families, businesses and communities restore their lives. I'm really honored to be part of an industry with such important responsibility. Okay, on to my comments regarding our third quarter financial performance. For our combined Brokerage and Risk Management segments, we posted 15% growth in revenue, 8.4% organic growth, net earnings growth of 12%, adjusted EBITDAC growth of 15%, and we completed or signed 7 mergers in the quarter totaling about $60 million of annualized revenues. Another fantastic quarter by our team. Let me give you some more detail on our third quarter performance, starting with our Brokerage segment. During the quarter, reported revenue growth was 16%. Of that, 7.8% was organic. That's right in line with our September IR Day expectation when we previewed there would be about a full point of headwind related to timing from a tough '21 comparison within our benefits business. Acquisition rollover revenues were $162 million. Net earnings growth was 11%, and we posted adjusted EBITDAC margins of 32.3%, a bit better than our IR Day guidance. Another excellent quarter for our brokerage team. Focusing on brokerage segment organic, it continues to be broad-based by both business and geography. Let me walk you around the world and provide some more detailed commentary, starting with our P/C operations. Our U.S. retail business posted 9% organic with strong new business and solid client retention, both consistent with last year's third quarter. Risk Placement Services, our U.S. wholesale operations, also posted organic of 9%. This includes more than 20% organic in open brokerage and about 5% organic in our MGA programs and binding businesses. New business was strong at more than 27% of prior year revenue, and retention was consistent with last year's third quarter. Shifting outside the U.S. Our U.K. businesses posted organic of 15% with excellent new business production and retention. Australia and New Zealand combined organic was 9%. New business production remained very strong and retention improved relative to last year's third quarter. Canada was up 13% organically and continues to benefit from renewal premium increases, robust new business and consistent retention. Moving to our Employee Benefit Brokerage and Consulting business. As I mentioned earlier, as we signaled last quarter and again at our September IR Day, our benefits business faced a tough organic comparison this quarter. Recall that due to last year's upward development in covered lives as employers resumed hiring coming out of the depths of the pandemic. Leveling for that, our benefits business organic was about 3%. And that's consistent with our IR Day expectations and includes strong growth with our HR benefits consulting units and solid growth in our international businesses. And before I conclude my organic comments, let me give you a quick update on our December 21 reinsurance acquisition. Third quarter revenues were right in line with our expectations and while not included in our Brokerage segment organic yet after controlling for breakage prior to closing, organic was around 8%. That's just outstanding. With expected revenues and EBITDAC for full year unchanged, reinsurance continues to be a fantastic story. So headline Brokerage segment all in organic of 7.8% and around 9% after controlling for the benefits comparison either way, an outstanding organic quarter. Next, let me give you some thoughts on our current PC market environment, starting in the primary insurance market. Overall, global third quarter renewal premiums, that's both rate and exposure combined, were up 10.5%. That's a bit higher than renewal premium change in the first half of '22. As for rate, most lines of business and geographies saw increases in third quarter, similar to the first half with only one exception being D&O, where rates are now closer to flat, but our customers are buying more limits. Additionally, our customers' third quarter business activity was not reflective of any economic slowdown. In fact, revenue related to third quarter midterm policy endorsements, audits and cancellations combined were above third quarter '21 levels. Looking ahead, thus far in October, midterm policy endorsements and audit adjustments remain higher than last year's level, and renewal premium increases are also consistent with the third quarter. But remember, our job is to help our clients mitigate that overall 10% increase in premiums by developing creative risk management solutions that fit their budgets. Let me move to the reinsurance market. Let me provide you with some broad observations regarding the upcoming '23 and reinsurance renewal season. First, there is no question that rates, terms and conditions will vary depending on geography, individual seed and loss history, risk characteristics and line of business. Second, pricing on peak zone property catastrophe cover is moving higher. And tightening terms and conditions are highly likely. Third, while we haven't witnessed the impact of Hurricane Ian spill over to non-property lines yet, it is possible that, that could happen if there's a broad shift in reinsurance risk appetite and capacity deployment strategies. Fourth and finally, the amount of property reinsurance capacity available is an open question. Some reinsurance providers had already planned to pull back their cat capacity priority in. And now it is likely the significant level of ILS capital to be trapped into 1/1 renewals, further pressuring potential capacity. Ultimately, supply will depend on expected returns from changes in pricing, terms and conditions and perhaps expected returns will reach a level that will attract additional reinsurance capital. While we have yet to see any significant third-party capital into the market, given ILS capital can move quickly, there is still time before the January renewal season. This will play out over the next 2 months. But at this point, it seems the stage is set for a hard or even harder renewals market as we enter the important 1/1 renewal season. Reinsurance conditions will no doubt influence primary markets in 2023 and carriers we're already facing rising loss costs in property and casualty lines. We see good reason for our carrier partners to continue to underwrite retail and wholesale risks cautiously for the foreseeable future. Moving to our Employee Benefit Brokerage and Consulting business. U.S. labor market conditions remained tight, but broadly favorable. During August, while U.S. employers reduced job openings by 1 million positions, there are still more than 10 million job openings according to the most recent data. And the level of open jobs remains well above the nearly 6 million people unemployed in looking for work as of the end of September. So we see tight U.S. labor market conditions lingering for some time and expect strong demand for our HR and benefits consulting services to continue as businesses prioritize, attracting, retaining and motivating their workforce. Let me wrap up my Brokerage segment organic comments with 3 terrific quarters in the books. Year-to-date, brokerage organic growth stands at 9.3%. And as I look to the fourth quarter, I see us posting another quarter above 9% that would deliver a fantastic year. Moving on to mergers and acquisitions. During the third quarter, we completed 6 new tuck-in brokerage mergers representing about $20 million of estimated annualized revenues. We also signed another merger late in the third quarter, representing an additional $40 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have about 50 term sheets signed or being prepared, representing nearly $400 million of annualized revenue. We know not all of these will close, however, we believe we'll get our fair share. Next, I'd like to move to our Risk Management segment, Gallagher Bassett. Third quarter organic growth was 12.2%, a strong finish to the quarter, pushed organic a bit higher than our IR day expectation. We also continue to benefit from increases in new arising claims across general liability and core workers' compensation during the quarter. That's both on an organic existing client basis and also due to some recent new client wins, including the significant insurance company client we added to our fast-growing insurance carrier practice. And profitability remains excellent. Third quarter adjusted EBITDAC margin was 18.2%, in line with our expectations. That would have been closer to 19% without the impact from the new large client ramp-up that we spoke about at our September IR meeting. Looking forward for the fourth quarter, we believe organic revenue growth will be about 10% and adjusted EBITDAC margins between 18.5% and 19% that would close out a great year for the Gallagher Bassett team. And I'll conclude my remarks with some thoughts on our bedrock culture. October 2 marked Gallagher's 95th anniversary. I took note on that day that our teams were hard at work helping our clients assess damage, file claims and ultimately start the repairing and the building process for Ian. And if not directly assisting individuals and communities impacted many Gallagher colleagues around the world donated their own money to help those impacted by Ian. What a fitting way for us to solidly celebrate this incredible milestone. My grandfather would be proud of the company founded to employees that embody the culture he started in the industry in which we toll. It's our people's actions and challenging times that bring our unique Gallagher culture to the forefront, a culture that we believe will thrive for another 95 years. Okay. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat, and hello, everyone. Today, I'll touch on organic and margins using our earnings release. Then I'll move to the CFO commentary document that we post to our website and make some comments on our corporate segment. I'll conclude my prepared remarks with some thoughts on M&A, debt and cash. During my comments today, I'll also provide some thoughts on our fourth quarter and some first thinking around how we are seeing 2023 now that we have started our budget process. Okay. Starting with the earnings release in the Brokerage segment organic table on Page 3. Headline all-in brokerage organic of 7.8%. That's over 9% when controlling for the tough benefits compare, brings us to a strong 9.3% year-to-date organic growth. When I look at our organic quarter-to-quarter, it's fairly consistent in that 9% range. We boast 9.6% organic in the first quarter, about the same in the second quarter when you exclude that infrequent large live sale we discussed last quarter. Now we're at about 9% here in the third quarter when adjusting for the benefits headwind. and It's looking like over 9% in the fourth quarter. That would deliver a full year 22% organic above 9%, a little noisy on the quarters, but very consistent and actually a fantastic performance by our sales team. As for 2023, early feel is in that 7% to 9% organic range for our Brokerage segment. Next turning to Page 5, to the Brokerage segment adjusted EBITDAC margin table. Recall, this is a year of quarterly margin change volatility due to the roll-in impact of the acquired reinsurance operations, expenses returning as we come out of the pandemic and the impact of a stronger dollar. Specifically, we've been saying to expect year-over-year margins to be up 50 basis points in first quarter, down 100 in the second quarter, down 125 basis points in the third quarter and up about 125 basis points in the fourth quarter. While that was about right for our third quarter, we posted 32.3%, which was in line with our IR day guidance and we are still comfortable with our fourth quarter outlook of around 125 basis points of margin expansion relative to the FX adjusted fourth quarter '21 EBITDAC margin. That would suggest a fourth quarter margin of around 32% at today's FX rates. In the end, since early '22, we've been targeting around 10 to 20 basis points of full year '22 margin expansion. And we're on track to deliver that. More importantly, that would mean we improved margins around 570 basis points since 2019. As we look ahead to '23, we continue to expect margin expansion next year starting around 4% or better organic growth, call it, maybe 50 basis points at 6%. Moving on to the Risk Management segment on Pages 5 and 6. As Pat said, 12.2% organic and 18.2% adjusted margins, both pretty close to our September IR Day expectations. And looking forward, we see these excellent results continuing in the fourth quarter. Organic growth -- revenue growth of about 10% and margins in the mid- to upper 18% range. That would be a full year organic growth of about 12% and full year margins around 18.5%. Looking to '23, we will see the roll in of the new large carrier client, and we have already had a nice new business win in Australia that will end up midyear. Add continued strong new business production, combined with continued growth in newer rising claims, we see organic at least in the high single digits and margins around 19% in '23. All right. Let's shift now to the CFO commentary document. Starting with Page 3, which shows our typical brokerage and risk management modeling helpers. A few things to highlight. First, the continued strengthening of the U.S. dollar since our September IR Day. Please take a look at our updated FX guidance for the fourth quarter of '22. As for 2023, perhaps the best start is just to assume what we are projecting for full year '22 repeats in '23, but most of that will be seen in the first half. Second, you'll see our current estimate for fourth quarter integration costs, most of all of this relates to the reinsurance acquisition. The team is making really excellent progress on this and is executing at a faster pace than our original plan. It was terrific to see our new reinsurance colleagues located with our other brokerage operations when I was in London a couple of weeks ago. As for technology and system rebuilds, we still see being done by the end of '23 or early '24. Turning to the Corporate segment on Page 4. Relative to our September outlook, interest in banking, clean energy and M&A costs after adjusting for the large transaction-related expenses, those 3 lines totaled to about the midpoint of our outlook. Within the corporate line, most of the upside was due to some favorable tax items and a favorable FX remeasurement gain. Looking towards the fourth quarter, moving down that page, only one significant change to our outlook. As you'll see in the fourth quarter corporate line and read in Footnote 7 on that Page 4, here in October, we settled a litigation resulting in Gallagher receiving $55 million in cash. Net of litigation costs and taxes, we will record a gain of approximately $35 million, and you'll see a few lines down that we'll adjust that gain out of our GAAP results. As for the cash proceeds, which because of our tax credits is actually closer to $40 million, we'll put that to good work over the next couple of years to fund incremental production hires and make incremental investments in technology. I'll break down our thinking a little more during our December IR day. Moving now to Page 5, Clean Energy. This page should be familiar to everyone by now. It highlights that we have close to $1 billion of tax credit carryforwards. The pinkish column shows that we expect to however, a $125 million to $150 million of cash flows here in '22, and the peach column shows that we could be even greater in '23 and beyond. And as a reminder, that would come through our cash flow statement, not our P&L. Turning to Page 6. The top of the page is the rollover revenue table. Third quarter revenues of $162 million, that's right in line with our expectations 6 weeks ago. Shifting to the lower half of the page, this table is an update on our December '21 reinsurance acquisition. Third quarter revenue of $120 million is consistent with our September IR day estimate. As for EBITDAC, a tightening difference between third and fourth quarter. Punchline is full year revenue and EBITDAC should come in very close to our pro forma. That's a really terrific story and great credit to the team. Okay. As to cash and capital management and future M&A. At September 30, available cash on hand was about $500 million, and we've been saying that we might have around $4 billion of M&A capacity in '22 and '23 combined without using stock. That still seems about right to us today. Okay. Those are my comments. Another fantastic quarter and 9 months is in the books, another strong outlook for the fourth quarter, and it's looking like we're well positioned for a terrific year in 2023. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Doug. Operator, if you would, let's open it up for questions, please."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question is from Weston Bloomer with UBS. Please proceed."
},
{
"speaker": "Weston Bloomer",
"text": "Hi, thanks for taking my question. The first one is on the 7% to 9% organic growth that you're expecting next year. I was hoping if you could kind of expand on what sort of environment you're expecting next year in terms of a potential recession? And then if you can hit that target in a recessionary environment? And then -- maybe just comment on the magnitude of growth you're seeing across maybe P&C operations versus wholesale or international? Just trying to get a sense of how you're getting to that 7% to 9% more granular."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Weston, let me take the recession question. Doug, can take a look at the numbers across -- I think we did a pretty good job of laying out those numbers by division a moment ago. And I think we said we thought they're pretty consistent next year. So I think you look at our prepared remarks, you got that question answered. But the recession one is an interesting one because one of the reasons in our prepared remarks, we talk about what's going on with endorsements is we can daily look at that information to see what's going on in the underlying business of our clients. We can also look at renewal exposure units as they're being put through to the market for renewal. And as you know, when you renew a client, you have to estimate sales and payrolls going forward. So clients are pretty smart. I'm not wanting to basically overpay and then wait for a return of that premium in an audit, 18 months or 15 months after the close of the year. So it's a bit of a yin and yang between the broker, the underwriter and the client as we look at what are those payrolls that we should be providing. We're not seeing a big decrease in sales and payrolls. Renewals are going out the door with perception of their business being okay. And that's verified by the midterm audits and endorsements that we're seeing. So -- I read the Wall Street Journal every day. I read the left-hand column yesterday, the world just came to end, I didn't know it."
},
{
"speaker": "Doug Howell",
"text": "Well, listen, I think the way we look at it this way, is we're not seeing it in our underlying business today, and we're also viewing if there is a recession in '23. We see that being more like what happened in the early -- in the 1991 period, in the 2000, 2001 period, more of a normal soft landing recession. We do not see a recession next year like the subprime financial shock of '08 and -- '07 and '08 or the pandemic recession that we saw for a few months in '20. Those normal recessions typically last about 2 or 3 quarters. And when we go back to the best we can do to get data back then, we actually performed very well during those light recessions. In this case, I think that next year, if there is -- if anything happens, and we do go into a recession, I think it's going to drive excess demand more than it is to contract supply and we ensure supply. So in our contemplation for next year is a lot like this year, exposure units holding stable, rates going up like we're seeing this year. But I see -- I don't see a lot of change all of a sudden on 1/1 that the world has changed dramatically from what it's been for the last 3 to 6 months, right now. So that's our go-in case. That's how we're preparing our budgets in that range. So that's how we came up with that 7% to 9%."
},
{
"speaker": "J. Patrick Gallagher",
"text": "But we'll give you more of a reflection on that in December."
},
{
"speaker": "Weston Bloomer",
"text": "Got it. And just one follow-up there is kind of like a high single, low double-digit growth for reinsurance brokerage kind of the right range as well? And can you remind us how much of that business is more property versus long tail binds?"
},
{
"speaker": "Doug Howell",
"text": "Yes. All right. So yes, in answer to your question, we see reinsurance in that high single-digit range next year. Right now, the best -- remember, you got a lot of treaties that are multi-line. But right now, the best we can tell is pure property is 28%. You put in the package on that, I'd say it might be closer to 40% of the book of business. And then you look at some of our kind of high-risk casualty lines, maybe you've got a book that's -- 60% of it is facing a kind of a tough renewal season."
},
{
"speaker": "Weston Bloomer",
"text": "Great. And then just one more. On the commentary around 50 bps of margin based on 6% organic, does that contemplate a potential pickup in discretionary spending inflation may be offset by higher fiduciary income? Or is that just core expansion net of any items?"
},
{
"speaker": "Doug Howell",
"text": "Yes. I think for 2023, and again, I'll give you some more here in December, there will be an upside from investment income. That -- not all of that will hit the bottom line because there could be some incremental inflation that we see in some of our numbers. Remember, about 80% of our business, we don't believe has significant exposure to headline inflation. And like we said last at our IR Day or on an earlier call, about 20% of our expenses, they do have some inflation pressures on it. But in our opinion, there will be clearly an upside to that thinking as a result of incremental investment income next year. But I still need to work through that math over the next couple of months."
},
{
"speaker": "Weston Bloomer",
"text": "I am working through it too."
},
{
"speaker": "Doug Howell",
"text": "Our next question is from Mike Zaremski with BMO Capital Markets. Please proceed."
},
{
"speaker": "Mike Zaremski",
"text": "Just a follow-up on the investment income levels. And are you so -- is the guidance that you provided kind of inclusive of using the current level of interest rates or the curve? Does that make sense?"
},
{
"speaker": "Doug Howell",
"text": "You're talking about the '23?"
},
{
"speaker": "Mike Zaremski",
"text": "Yes, '23. Sorry, Doug."
},
{
"speaker": "Doug Howell",
"text": "Yes. I think that when we look at 6% organic growth with possibly 50 basis points of margin expansion, that does not include a possible upside from incremental investment income, but not all that incremental investment income will likely hit the EBITDA line. It could go to some inflationary pressures on some of our cost base or it could go to some discretionary spend, but it would be upside to that 6 points, 50 basis points outlook."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Understood. Thanks for the clarification. Kind of switching gears a little bit. Just curious, you're not calling out any kind of potential impacts to contingents or shops as a result of the hurricane. I know the new accounting rules came into place a few years ago. Is there anything we should be contemplating that could impact Gallagher in the year to come or maybe even kind of into programs business, if there's a lack of capacity? Just trying to -- one of your peers kind of surprised us a little bit. So just trying to see if there's anything there worth talking about."
},
{
"speaker": "Doug Howell",
"text": "Our outlook on the impact of Ian to our contingent commissions is $465,000 of impact against our revenues. That has all been fully booked in the numbers that you see here today. We do not believe that would develop differently than that. We just are not that -- we're just not exposed to contingent commissions on operating placements in our book of business."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Great. And lastly, any change in the competitive environment on the M&A side, given there's kind of now a consensus that interest rates may stay higher for longer? Or is it still just very competitive?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No, it's still very, very competitive. And there's a lot of interest out there in our industry still, we're watching that very carefully to see if some of that falls off. You'll see some write-ups recently about the number of deals done coming down a bit. I don't know if that's an early sign that maybe some of the people want to sit on the sideline a bit. But for the deals that we're after right now, the competition is very strong."
},
{
"speaker": "Mike Zaremski",
"text": "So multiples, I was trying to -- I should have been clear. So you don't expect multiples to move south and you're not seeing that?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I hope they do, but we're not yet."
},
{
"speaker": "Operator",
"text": "Our next question is from Greg Peters with Raymond James. Please proceed."
},
{
"speaker": "Greg Peters",
"text": "So I wanted to go back, Pat, to your comments about the reinsurance market and the reinsurance business and sort of unpack what's going on and get your perspectives because it really feels like we're at the seminal moment in that marketplace where we could be in a hard market, especially for cat-exposed property, but it seems like it's bleeding over into other lines. And -- so the reinsurers haven't been able to get an adequate return on their business. And then now the primary companies are going to be asked to take higher retentions and absolutely pay more on rate online. So I guess my question is, if these 2 partners of yours are getting pressure or profitability pressure, do you foresee a scenario where you actually might get some pressure on commission rates as the market evolves here?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No, I don't think so, Greg. I think it's clear that we earned our money. And that's -- you see that in the market. I mean, it's -- the business has been very stable, I've had a chance to meet with a number of managements. They know exactly every dollar that we're making. There is no hidden factor here anywhere. And we have to do the work that justifies that income level every single day. Now in my experience as a retailer, I'm not a reinsurance person, but a hard market makes you incredibly more valuable. In a soft market in the retail business, some person with a shingle out to get a quote and beat you, when you're sitting with someone in a hard market, you are talking strategy, man. You are not talking about what's going to happen to my comp premium. You're talking about, am I going to get GL cover. And that's going right down to personal lines. I've got tons of friends, as you can imagine, in South Florida. Am I going to get homeowners next year? I don't know. I mean, I think you will, but you're going to pay more and they know it. Now that, I think, trusted adviser works its way all the way back to reinsurance, and this is not a time when these carriers are going to put a lot of emphasis on how much we get paid when they're looking at trying to get returns literally on hundreds of millions of dollars of ratings."
},
{
"speaker": "Doug Howell",
"text": "Yes, Greg, I will say this. It's been 20 years since I've been CFO of insurance companies, but right now, this is a time where my reinsurance brokers would be the most important people to have in my office with their skills, their capabilities, and this is a time where they really earn their money."
},
{
"speaker": "Greg Peters",
"text": "Fair enough. I'm sure it's -- there's a robust conversation happening around all of this stuff. So I wanted to also -- and I know you've commented on this before, but I wanted to pivot and talk about the brokerage business and the pipeline, if we're in a recession, if we go in a recession, blah, blah, blah, it's pretty strong. Can you remind us again just when -- on the risk management piece, how you think that might perform if we go into a soft landing? What kind of -- and I know you've commented on this before, Pat, but just give us some sort of guideposts that we should be thinking about on that."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I mean -- first of all, Greg, as you know, when prices are going up, one of the skills that brought us to the point we are today is the capability of taking people who are -- should be self-insuring into that market. and showing them how to take higher retentions and bringing Gallagher Bassett in. Recessionary work has the same -- now I'm talking about the larger upper middle market. The recession has the same kind of impact, especially if you get a recession, while at the same time, pricing has gone up. They're looking for alternatives. And when I say your alternative is to pay tomorrow instead of today and to really manage your claims hard and work it hard at preventing them, there's a lot better listeners than when the prices are dropping, and that's going right to their bottom line and their private companies and they're happy as a clam. When you get to the larger accounts, these are very sophisticated buyers. And they don't move around based on recessions. Now if there is a recession and our larger clients have a lesser population, they close down shifts, then you'll see claim counts drop. But I don't think you're going to see an impact on that business that happens in the short term, and we'll know well in advance of any kind of a downturn as people start slowing their business down and cutting shifts, we'll be well aware of it. We can probably comment better as we go into the new quarters. We're just not seeing that right now, Greg. I think that's the interesting thing to me. As I said, I read the journal every day, and I'm sitting there and go, okay. And then we test and test and test, and our primary business partners are doing really well. Then we looked at the GB results and claim counts are up. They're not down. So it's -- I get why you're questioning it. I really do get the conundrum. But here's the thing. Doug pointed out that the other recessions we've done well. Clients do not jump in and out of self-insurance. You make that decision to move to taking a big retention and paying your claims. You may have a -- you may see your claim counts go down because hours worked are less, but you're not jumping in on the market. It's a pretty good place to be."
},
{
"speaker": "Greg Peters",
"text": "Got it. Thanks for the answer and I read the journal too. It does seem like the end of the world is imminent, but you guys are posting good results. So congratulations."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Greg."
},
{
"speaker": "Operator",
"text": "Our next question is from Elyse Greenspan with Wells Fargo. Please proceed."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, I'm going to head in the opposite direction of talking about a recession. I want to go to the flip side and talk about how good, I guess, 2023 could be. As you had said 6% to 9% organic in September. Today, you're saying 7% to 9% for next year. But we could have a really strong reinsurance market, and it sounds like you have really good exposure on the wholesale side where the market is really firming. So at 80% of your revenue is commission based. So could there be an environment next year where pricing is still firm that Gallagher could print double-digit organic revenue growth?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, from your lips to god's ears, Elyse. If you take a look back at our results in other hard markets, yes, that could happen. I mean, I'm not going to sit here and say no. If capacity dries up, smaller brokers in those environments can't get the job done, reinsurance clearly is -- and look at cap trapital in the ILS market, depending on whether capacity is there or whether capacity comes in, yes, I think you could see a variable -- you could write a bullish story."
},
{
"speaker": "Elyse Greenspan",
"text": "And then assuming, right, Doug, you said at a 6% organic, we could see 50 basis points of margin improvement. So assuming that the base is 7%, right, and it sounds like it could be better than that, so is the base case that we'll see something margin improvement that's above that 50 basis point level next year?"
},
{
"speaker": "Doug Howell",
"text": "I think that it's not linear. If we posted 9%, I don't think you'd have 150 basis points of margin expansion, but you might have 75 to a point, something like that. But I think that -- let us get through this and get through our December, look at our budgets. And some of this is discretionary spending that we might want to make in investing in technologies and other organic growth strategies. But -- yes, I mean, there is a case that, that could happen."
},
{
"speaker": "Elyse Greenspan",
"text": "And then on the M&A side, right, you guys obviously have a good amount of capital flexibility over the next couple of years. it does seem maybe it's because you guys have had such a strong track record of M&A. Deal flow has been a little light relative to historical levels this year. So I know the pipeline is still strong. At what point do you reach that level? Will you consider buying back your shares? Or is it something where deals just ebb and flow depending upon time of year and you guys will give it some time and then maybe consider buybacks?"
},
{
"speaker": "Doug Howell",
"text": "Well, listen, if we ended up with excess capital, our first metric would be is to make sure that we maintain a solid investment grade rating borrowing. With interest rates going up, that's more and more important every day. Second of all, I think that our M&A pipeline is still robust. And the third thing is, remember, the arbitrage that we get on the multiples. And -- more importantly, we're building out the team. We bring more people on our side of the field to go out and compete on every day and create more organic afterwards. So for us, buying back stock is certainly what we can do. It's certainly part of the math, and its part of the story. But I'd like to see us doing more and more M&A every day to put our cash to work at multiples that are -- that deliver arbitrage value to our shareholders. So -- we're out there, we're looking very hard. Sometimes you win, sometimes you lose. But I think we've got a ton of opportunities in our pipeline right now."
},
{
"speaker": "Elyse Greenspan",
"text": "Given the strength of the U.S. dollar, are you guys seeing more opportunities for international deals?"
},
{
"speaker": "Doug Howell",
"text": "Well, listen, we've got some pretty good pipelines going on, especially in Canada, Australia and the U.K. right now. So we'd be happy to continue to look at those acquisitions there. And yes, the dollar does have a little bit of an impact on that, but it's not what drives our investment choices."
},
{
"speaker": "Operator",
"text": "Our next question is from Yaron Kinar with Jefferies. Please proceed."
},
{
"speaker": "Yaron Kinar",
"text": "My first question is on headcount. I noticed there was a nice pickup in headcount, and the one I'm referring to specifically is in Brokerage. I think it's up 7% year-to-date. Can you maybe talk a little bit about what that is going into, what type of roles you're hiring? And secondly, I'm actually -- I was very impressed to see that the comp and benefit ratio is actually coming in year-over-year despite the increase in headcount. So is there a catch-up that we should expect? Or how are you keeping that number down?"
},
{
"speaker": "Doug Howell",
"text": "All right. So a couple of things -- you got a couple of things to unpack. But first, let's talk about the increase in the headcount. We have actually substantially increased our head count in our offshore centers of excellence. As you know, we've been talking about it for 15 years now. We think that that's a terrific spot to improve the quality of the offer of our insurance offerings. And as a result, we're ramping up significantly more in offshore right now that can do that work for us. And the -- so we're up considerably in that. So that's what's driving the metric you're seeing is mostly offshore resources there. When it comes to the opportunity -- the drop in the comp ratio this quarter, some of that has to do with bonus timing. If you recall last quarter, I said we were a little ahead on our bonus accruals. So we didn't have to post quite as much this quarter, which probably offset some of the -- well, we did have a little bit of inflation in our rates pool. We gave away another $8 million this year, something like that in that -- in the raise pool this year. What's offsetting that is the timing of the bonus."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. And I'm curious what led to the increase in the organic growth estimate for '23, at least the bottom end of the range from 6% to 7%? What changed in the last 6 weeks?"
},
{
"speaker": "Doug Howell",
"text": "Well, listen, I think that Ian has brought a different tone in the marketplace. I think you're seeing some reports of reserve strengthening across line. You saw the reinsurance outlook we've talked about -- and remember, the reason why we got to 6% to 9% is we were saying that 23 felt somewhere between 2019 and 2022 and '19 happen to be 6% organic growth. So in the context of the comment in September, relative to 2 different years. And now as we're getting closer on our budget process and really looking at what we're starting to see in the renewal pipeline, we thought we could tighten that range up a little bit."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Also, Yaron, I think that before in, it was clear that loss cost and verdicts and what have you, we're putting pressure on our carriers. Today, we look across the loss on the cat level and wonder if they're not going to bleed into the casualty lines. And I've had some conversations with some of our reinsurance pros, we think that that's a very good possibility. If that happens, that will be -- that will benefit from that as well."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. Maybe 1 last one, and following up on Greg's question. I guess, in what markets, what kind of environment do you typically see some pressure on commission rates or maybe clients trying to shift over to fees?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Primarily in the retail market, as accounts go from being, say, upper middle, middle market, where typically, you'll have about 85% to 90% of your clients, probably, we're 100% transparent. This is their choice. We have an adult conversation. They know we collect contingents. Let's not go back to 2004 and get me all in trouble, again, for accepting convenience and supplemental. They're all disclosed. This is client choice. And so as they get a little bigger, if they bring in a risk manager, that type of thing, then there's usually a shift to fee and we're happy with that."
},
{
"speaker": "Operator",
"text": "Our next question is from David Motemaden with Evercore ISI."
},
{
"speaker": "David Motemaden",
"text": "Just had a question on the investment income side, the fiduciary income. Could you just quantify how much that generated this quarter? I think you've said in the past it's $40 million for every 100 basis points move in short-term rates. But just wanted to -- just to double check what the benefit was to revenues this quarter? And then maybe just talk about how that impacted margins? How much of it fell to the bottom line?"
},
{
"speaker": "Doug Howell",
"text": "Okay. I'll take that in a couple of different bites. This quarter, let's call it, $12.5 million that we had as additional investment income as a result of rate changes. Then you're asking how much of that fell to the bottom line. Maybe a better way for me to do this is to take a look at what does it mean for full year. If you recall at the beginning of the year, what we said is -- since when we were sitting in January, we looked back and we had said that we had posted about 550 basis points of margin expansion. And when we looked out and that was over 2 years. Then we said, if we look forward, again, I'm standing in January of 2022, we said that we might be able to get margin expansion of 10 to 20 basis points on organic from about 8% here in '22. So what's happened since that expectations. We're still looking at 10 to 20 basis points of margin expansion. But organic is running a point better and, let's say, investment income between this year that might be up, let's say, $30 million more of investment income in the year. So that's about $80 million more of revenues this year. And so the way I look at it is, where did that go? Where did the $80 million of revenue go? Well, first of all, we dropped -- we're going to drop one-third of that to the bottom line. So that leaves $50 million to $53 million of additional revenues. Well, we have to pay our producers field leadership and support that. Usually, that runs about 45% of the revenue on that organic of $50 million, call that $23 million. So now we're down to explain where did $30 million go as a result of incremental organic and incremental investment income, again, relative to our outlook at the beginning of the year. Well, I can tell you that we spent about $10 million on incremental hiring, some incremental raises and some incremental incentive comp this year. Maybe it's one-third. And we also know that we -- about $10 million went to incremental travel and entertainment expense. Now that's mostly due to inflation, and it's not due to increased trips versus our expectation. Again, this is against our expectation at the beginning of the year. And then finally, we spent an extra $10 million on IT betterment projects than probably we would have expected at the beginning of the year because we have the bandwidth in order to implement those projects. So for me, sitting here relative to our expectations at the beginning of the year, I think it's a really terrific outcome. And what I'm really proud of is the team has done a great job this year. They have been disciplined in their travel and they've been selected in their value-added efforts that they're bringing to the clients. And they've been pretty wise about other IT investments. And yet to still deliver 10 to 20 basis points of margin expansion this year in an inflationary environment on top of the 550 that we had delivered in the previous two years I think it's a pretty darn good year, in my opinion. So relative to expectation, that's a long-winded answer -- but I think it gives you a perspective on incremental investment income and incremental organic relative to where we were sitting at the beginning of the year. And remember, we still -- at the beginning of the year, we had the Omicron crisis going on, and we were still in the depths of the pandemic. So we still have done our way out of those pandemic expenses returning along the way. So a long story, long answer, but I hope it gets you to where you need to go."
},
{
"speaker": "David Motemaden",
"text": "Yes, that definitely did. That's really helpful. I guess maybe just switching gears to the reinsurance deal and how that's been going. The organic, I think, accelerated a point to 8% this quarter from 7% in 2Q. I guess -- high single digits in '23 feels may be a little conservative. But maybe could you just talk about the range of outcomes around that high single digit? And I guess what's stopping it from being well above that just given the market that you're experiencing there?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "You're dealing with the most sophisticated buyers in the market. And as Doug just said a bit ago, when he was buying reinsurance, he wasn't messing around worrying about what the guy or gal is getting paid. The point is, this is talking at the essence of their capital, the returns, how they're going to balance out the demand, you've got a supply and demand imbalance. It's looking like it's coming down the path at being very substantial. They want to be good players. They want to take advantage of it. They want to make sure that they get good returns. And so it's good returns that ultimately hopefully bring in more capacity. But these buyers are very sophisticated. They'll pay us more money. I mean, the question earlier on was are they going to keep paying us what they're used to paying us. And they'll pay us more money, but it's not -- this is not a linear progression. I get down to the bad policies and into the lower middle market, it's linear. Price is up 10%. We're going to help the client reduce that by moving deductibles around, dropping umbrella limits, et cetera. But by and large, policy by policy, we're going to get that commission. That's not the case in reinsurance."
},
{
"speaker": "Doug Howell",
"text": "Yes. I think it's a little bit of a -- I wouldn't say it's a symmetrical bell curve, but around 8% -- I thought -- 6% to 10% on that. So maybe it's 2 points on either side of it, and that probably favors the bull case on that more than the bare case on it."
},
{
"speaker": "David Motemaden",
"text": "Got it. That's helpful. And then maybe just 1 more. You mentioned that you don't expect a recession. I don't want to be a Debbie Downer here, but if there is one like there was in the early '90s or early 2000s, have you guys given any thoughts on what organic growth would be in that type of scenario?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I think Doug did a very good job, sure he did, of taking it back in time. I mean, go back and take -- our results are public going back to '84. I think we do extremely well in good times and bad times. Certainly, recessions are not good for brokers. Sales and payrolls are what drive our premiums. So there's no question that if sales and payrolls go down, we'll feel the impact of that. Having said that, people get more interested in listening to us talking to them about how our professionalism, our capabilities in our niches and what have you, you can help them deal with this, the local brokers who takes the hit."
},
{
"speaker": "Doug Howell",
"text": "Yes. I would say, listen, if we get into a recession that you wanted to refer to as you being a downer on, that type of recession, we're still in an inflating rate environment, and we're not seeing a slowdown on that. When it comes to the contraction of exposure units, I'm not seeing trucks just come out of the fleet. They may not be running quite as much, and I know there's a mileage adjustment on it, but I'm not completely convinced that the stuff that we insure will just all of a sudden evaporate next year. Might have to -- they may take different covers on it. They may take some additional deductibles. When you're also looking at an environment, if you get into a recession, that will help us on our employee retention because they will stay with a good company, versus jumping for a new opportunity. So when those 3 or 4 things applied, rate increases, stable workforce a flight to quality and what people are looking for in terms of their broker, I see us performing very well in that environment. If you want me to pick a number in there, if we have a downer I'd be hard pressed to see how it would be less than 5% organic growth."
},
{
"speaker": "Operator",
"text": "Our next question is from Rob Cox with Goldman Sachs. Please proceed."
},
{
"speaker": "Robert Cox",
"text": "I just had one question. I noticed open brokerage accelerated to 20% versus 15% last quarter. And I was just hoping you could talk about what inflected quarter-over-quarter and how you see open brokerage and the E&S market broadly trending from here?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "The E&S market is on fire. And I think you're seeing more premiums move there, freedom of rate, freedom of form, clients need, cover everything from small accounts to large accounts. That's why we're seeing so much interest in terms of people investing in that market. That -- the primary markets, quite honestly, are not as flexible as the E&S markets are able to move at the pace that they can move, and they are in a tough market sucking business out of the primaries. Did that answer your question, Rob?"
},
{
"speaker": "Robert Cox",
"text": "Yes. Very helpful."
},
{
"speaker": "Operator",
"text": "Our next question is from Mark Hughes with Truist Securities. Please proceed."
},
{
"speaker": "Mark Hughes",
"text": "Thank you, good afternoon. Pat, you talked about the potential spillover to non-property lines from the hardness of the reinsurance market. Have you seen that in the past, I just wonder how much influence the cat property business is going to have on some of the other casualty lines, but I hear what you're saying. Just sort of curious to hear more about it."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Let me caution because I've been a retailer in my whole life. But for the last year, I've had a chance to spend a good bit of time with our reinsurance folks and do anything I can to learn that business and I talked about this at length in the last quarter. And it has happened in the past. I can't give you dates, times and amounts or percent. But -- yes, when you have a capital situation where you need to increase the pricing and you can add cat loads on other lines of coverage, you'll do that when you have to -- now again, I can't say to you that this is exactly what travelers or hyper did in this year given this situation or what have you. I can't take you back to Andrew or something like that or even Katrina. But what the team is telling me is that it's very likely, given the dearth of our capacity and the need -- because of the supply and demand imbalance, the need for more rate, that their other lines are selling that are likely to take in advance as well. And sorry that I'm not more specific about that. I'm learning along with you."
},
{
"speaker": "Mark Hughes",
"text": "No. No, interesting. And then any shading -- you talked about the economy is still looking good in terms of exposure units and endorsements. Any differentiation you see between larger accounts, middle market, smaller accounts?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No. And that's the thing that's -- I keep referring to the Wall Street Journal, sorry, but I mean I read it and I sit there and I go, okay, and then I come back and I talk to our data people and they're like, no, I'm not seeing it. I can't also can't break it and say, well, construction is in the tank and retail is going through the roof or trucking is really hurting now and something -- so -- and we've checked things like our marine business. What's happening with cargo, cargo seems to be holding up and if there's any decrease in cargo, then cruise ships are, I mean, going through the roof. So it's kind of a -- it's a weird time based on what we read and what we see in our -- and these are not anecdotal stores. These are higher data points that I've got, and I can get them every day. And broad geographic, solid, continued business growth is what we're seeing. You fall off a cliff? I guess. We're just not seeing it."
},
{
"speaker": "Operator",
"text": "Our next question is from Josh Shanker with Bank of America."
},
{
"speaker": "Josh Shanker",
"text": "Yes. Some of the people asked about competition for deals. I just want to talk about debt. And when I think about private equity being one of your competitors, is the marketplace different for them if they have to borrow at higher costs? Is it still debt generally cheap in your mind? And so we're not at the market where that's a consideration. How do you think about their role in their appetite in a higher interest rate environment?"
},
{
"speaker": "Doug Howell",
"text": "Yes, we kind of signaled that early on. Their appetite is still strong right now. But when you're adding an extra 300 basis points of debt cost into the structure does change return expectations. And I think that we're really not competing on price when we come to these deals, Josh, we're really competing on capabilities. And we win on every day. If somebody decides our prices aren't dissimilar to what they're offering. That maybe be a turn higher, but people just have chosen that they don't want to be in an organization with increased capabilities or resources. So this will cause a compression of pricing by the PEs, it will probably come down to where we're comfortable with pain. And I think we should excel in that then because now it isn't about price. It's entirely about capabilities."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, dream with me a little here, Josh. I mean, yes, I think what Doug meant is that our price is similar to our competitors. Yes, multiples over the last five years have expanded substantially. Prices are higher for these deals. But money was free. So now you start paying for that money, and I'm not hoping for a recession, and we don't see one, but show a little slowdown in there. And maybe that annuity isn't as strong as it was before. Our lever is about 2.3 times EBITDA. We've got competitors in the market that are happy to be at 9 times. I'm sorry, at some point, the music has got to stop and all the chairs aren't going to be full."
},
{
"speaker": "Josh Shanker",
"text": "And if you think over a 20-, 30-year base, I mean, 4% tenure, it's not really that high. I mean, we'll see where it goes from here. But Doug seems to have more confidence that maybe they're able to go away. But if we're at the peak here and we stay here for a while, isn't going to scare them away, I suppose. I'm obviously they're going to pay more than what the 10-year is. But it's got to go higher really to cause their exit, I guess. Am I right now?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes, I'd agree with that. The returns have been outstanding. I agree with that."
},
{
"speaker": "Operator",
"text": "Our final question is from Ryan Tunis with Autonomous Research. Please proceed."
},
{
"speaker": "Ryan Tunis",
"text": "I first just wanted to say that the $55 million good guy, that's a nice line. I can't remember the last time in broker land, you had a below-the-line item that is somehow went in the right direction. I think some of your competitors might even count that as organic."
},
{
"speaker": "Doug Howell",
"text": "Yes. Go ahead, Ryan."
},
{
"speaker": "Ryan Tunis",
"text": "But -- yes, Doug, take your time spending it. We don't need it to lean on margins in '23. But I just had one bigger picture question, I guess, on margins. So organic has been really soft for the past couple of years. And obviously -- but I mean, it could have not been strong, too, in which case I also don't think your expense growth would have been as high as it's been. So there seems to be some element of clearly, the organic has allowed you guys to have -- I want to make sure I'm thinking about this right, like kind of an investment cycle. So I'm just curious, is that the right way to think about it? Like, has the strong organic allowed you to kind of potentially pull forward some investing you had to do. And I'm just kind of curious, maybe some of the capabilities that you guys have been able to take on I guess, to improve the organization over the past couple of years that you wouldn't have if we were any more than a 4% organic growth environment?"
},
{
"speaker": "Doug Howell",
"text": "Yes. I think you've got your notes right in it. And I think if you go back and you listen to our IR Days, these earnings calls, we get an hour to talk to you, but during our IR Days, you hear our 5 or 6 division leaders talk about all the investments you listen to the first 5 minutes or 6 minutes of their prepared remarks. They're talking about all the value-added features and client-centric enhancements that we're doing in our business. And we're spending a lot of money on that. We've talked about Gallagher Drive. We've talked about SmartMarket, we've talked about Gallagher Submit. We've talked about our niche resources. If you look at our content that's out there, all of that is investment and we're adding to it every year. So we are running a business right now that has a substantial amount of investment in it to make us better. I think it's showing up in our organic to be real honest. I think the reason why we perform well on organic as we continue to make investments into our production and our sales and niche capabilities our service. 15 years ago, we didn't know how long it took us to turn around a set right now, we turn around 99.9% of them within one hour of request because of the investments that we've made to better the service. Those type of things are just in our blood at this point. And it's in our operating side, yet, we're still posting terrific margins on it."
},
{
"speaker": "J. Patrick Gallagher",
"text": "So to add to that, I would say take a look at our internship, we're very proud of the fact that this summer, we had 500 young people look at our business. And these are paid interns. These aren't interns that come to work for free, and that's a U.S.-based number. If we take the people outside the U.S., it's probably closer to 600. I don't know another organization investing in the future of their people like that in our business or, frankly, another business. So I'm very proud of that. Thanks, Ryan, and thank you, everybody, for joining us. We really appreciate this evening. We had an excellent third quarter. We're well on our way to delivering a fantastic year of financial performance. I need to thank more than 42,000 colleagues around the globe for their hard work and dedication to our clients. We look forward to speaking with you again in person in December at our Investment Day in New York. Thanks again, everybody. Have a great evening."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 2 | 2,022 | 2022-08-01 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Company's Second Quarter 2022 Earnings Conference Call. Today's call is being recorded. Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you. Good afternoon, everyone. Thank you for joining us for our second quarter 2022 earnings call. On the call with me today is Doug Howell, our CFO; as well as the heads of our operating divisions. We had another excellent quarter of financial performance. For our combined Brokerage and Risk Management segments, we posted 22% growth in revenue, 10.7% organic growth, net earnings growth of 35%, adjusted EBITDAC growth of 23% and adjusted earnings per share growth of 19%. I'm extremely proud of how our nearly 41,000 colleagues around the globe performed during the quarter in the first half of the year. So let me give you some more detail on our second quarter Brokerage segment performance. During the quarter, reported revenue growth was 25%. Of that, 10.8% was organic. We did have a tailwind of about 1 point from an infrequent large life case that I'll touch on in a minute. Rollover revenues were about $240 million, consistent with our June IR Day expectations. Net earnings growth was 36%. And as expected, we posted adjusted EBITDAC margins of 32%, an outstanding quarter for the Brokerage team. Let me walk you around the world and break down our organic, starting with our PC operations. Our U.S. retail business posted 11% organic, with strong new business, retention and continued renewal premium increases. Risk Placement Services, our U.S. wholesale operations, posted organic of 8%. This includes more than 15% organic in open brokerage and 4% organic in our MGA programs and binding businesses. New business was consistent with second quarter of '21, while retention was down just a bit from last year, as we noted in our June IR Day. Shifting outside the U.S. Our U.K. businesses posted organic of 8% with excellent new business overall and another double-digit organic growth quarter within specialty. Australia and New Zealand combined organic was more than 11%, driven by strong new business, stable retention and higher renewal premium increases. Canada was up more than 14% organically and continues to benefit from renewal premium increases, great new business and great retention. Moving to our Employee Benefits Brokerage and Consulting business. As I mentioned earlier, we were helped this quarter from a large life case. Excluding this, our benefits business organic was about 9%, in line with our IR Day expectations and driven by increased HR benefits consulting work and solid growth in our International and Health and Welfare businesses. Finally, our December reinsurance acquisition is right on target. After controlling for breakage prior to closing, second quarter organic was around 7%, just fantastic, and integration continues to progress nicely on budget and ahead of its original time line. So reinsurance continues to be a really good story. So headline Brokerage segment all in organic of 10.8% and upper 9% after controlling for the large life case, either way, an excellent quarter. Next, let me give you some thoughts on the current PC market environment, starting in the primary insurance market. Overall, global second quarter renewal premiums, that's both rate and exposure combined, were up 10.5%. That's higher than what our data showed for increases in renewal premiums in both the fourth quarter '21 and first quarter '22. When I look at our renewal premiums by line for nearly all coverages, second quarter increases were equal to or higher than first quarter. One exception to this was professional liability, mostly D&O. By geography, renewal premiums were up double digits, nearly everywhere. Again, that's a combination of both rate and exposure. So next to no slowdown in premium increases during the quarter. Additionally, we are not seeing any significant signs of economic slowdown. In fact, second quarter midterm policy endorsements, audits and cancellations continue to trend more favorable than a year ago. Thus far in July, midterm policy endorsements continue to move higher year-over-year, and renewal premium increases are consistent with second quarter. But remember, our job as brokers is to help our clients mitigate premium increases and find suitable insurance programs that fit their budgets. Moving to reinsurance. As we noted in our first view report published by our reinsurance professionals earlier this month, there are very real signs of hardening in the reinsurance market. Property reinsurance pricing is up across the board. And most notably, for U.S. hurricane and Australian property risks are up anywhere from 15% to more than 40%. On the casualty side, reinsurance placements experienced more modest price increases and were a little bit less challenging. Regardless, a firm or hardening reinsurance market will naturally show up in primary market rate increases. And there are many other reasons for our carrier partners to maintain their cautious underwriting stance outside of reinsurance market conditions, inflation, geopolitical tensions and economic uncertainty to name a few. These all translate into a difficult PC market conditions continuing for our clients across retail, wholesale and reinsurance for this foreseeable future. Moving to our Employee Benefit Brokerage and Consulting business, U.S. labor market conditions remained broadly favorable. Even with a decline in U.S. job postings in each of the last 2 months, there remain more than 11 million job openings, that's more than double the number of people unemployed and looking for work. We expect strong demand for our HR and benefits consulting services to continue as businesses prioritize attracting, retaining and motivating their workforce. The timing of the large life case and covered live changes in the second half of '21 will cause the Benefits business to post lumpy quarterly organic results this year, but that doesn't change the still favorable underlying environment. So let me wrap up on the Brokerage segment organic. A great first half and looking like the second half will lead us to a full year '22 organic over 9%, which would be an absolutely terrific year. Moving on to mergers and acquisitions. During the second quarter, we completed 8 new tuck-in brokerage mergers representing about $50 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have more than 40 term sheets signed or being prepared, representing nearly $350 million of annualized revenue. We know not all of these will close, however, we believe we will get our fair share. Next, I would like to move to our Risk Management segment, Gallagher Bassett. Second quarter organic growth was 10.3%, a bit better than our IR Day expectation due to a strong June. Adjusted EBITDAC margin was 18.9%, which is in line with our expectations. For the year, we continue to see adjusted EBITDAC margins near that 19% level. We again saw increases in new arising claims across general liability, property and core workers' compensation during the quarter. Encouragingly, property and liability claim counts are back to prepandemic levels. Core workers' comp claim counts have yet to fully rebound to 2019 levels, which represents a nice opportunity for further growth. Looking towards the second half of the year, we think organic revenue growth will continue to push 10% due to growing claim counts and new business. I'll conclude my remarks with some thoughts on our bedrock culture. As I resume traveling to our Gallagher offices around the globe, I can report to you that our culture is as strong as ever, and that's a reflection of our people, our nearly 41,000 colleagues working together for a common goal to serve our clients. As I've said before, our people underpin our culture, a culture that we believe is a true competitive advantage and drives our outstanding financial results. Okay. I'll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks, Pat, and hello, everyone, an excellent second quarter and terrific count. Today, I'll touch on organic margins and the Corporate segment using our earnings release and then make some comments using our CFO commentary document posted on our website. I'll end then with my typical comments on M&A, debt and cash. Okay, starting with the earnings release to the Brokerage segment organic table on Page 3. Fantastic headline all-in brokerage organic of 10.8%. As Pat said, we did benefit by about 1 point or so because of a large group live case found in late June. With or without that, a great quarter by our sales team. As for the rest of '22, during our June IR Day, we said third and fourth quarter would be somewhere around 8% due to a tough benefits compare. As we sit today, we're still seeing third quarter around that 8%, reflecting about 1 point of that tough benefits compare, and we're becoming more bullish in fourth quarter, call it nicely over 8% in the fourth quarter. That would lead to full year Brokerage segment organic growth of over 9%. So today, we're forecasting full year organic growth better than what we were seeing at our June IR Day. Next, turning to Page 5 to the Brokerage segment adjusted EBITDAC margin table. Headline all-in adjusted EBITDAC margin of 32%, right in line with our June IR day expectation. Recall what we've been saying all year, because of the roll-in impact of the acquired reinsurance operations, which has substantial quarterly seasonality and because there are still expenses returning as we come out of the pandemic, those in combination create quarterly margin change volatility. As a recap, we posted adjusted margins up 50 basis points in the first quarter, down 97 basis points here in the second, and we're forecasting down 100 basis points in the third, then back up 100 basis points in the fourth. Because we are seasonally the largest in the first quarter, those results would roll-up to around 10 to 20 basis points of full year margin expansion. These quarterly margin changes are right on what we've been saying all year. When I think of the inflation impact, I just don't see much here in '22 on our expenses. And as we discussed in June, headline inflation doesn't significantly impact 80% of our expense base. And we have mitigation levers to pull on that other 20% if it comes to that. So even with rising CPI, we remain comfortable with our 2020 margin outlook. Looking towards '23, all that quarter margin change volatility should go away with the pandemic behind us and reinsurance fully rolled into our books. Moving to the Risk Management segment on Pages 5 and 6, Pat hit the highlights. 10.3% organic and 18.9% adjusted margins, an excellent quarter. This unit continues to show momentum with rebounding claim counts and a large new business win coming on next quarter. It's looking now like organic revenue growth of around 10% in each of third and fourth quarters '22. Now remember, that's on top of 17% growth in third quarter '21 and 13% growth in fourth quarter '21, that would be a terrific outcome to overcome such a difficult compare. Moving to Page 7 of the earnings release to the Corporate segment shortcut table. Interest in banking is within our June IR Day range. Adjusted M&A costs in clean energy, they combined -- those combined also within our range. And Corporate, after adjusting for some favorable tax item, is slightly better than our June IR Day range, call it about $0.01 due to favorable FX remeasurement gains given the strengthening in the dollar. Let's leave the earnings release and go to the CFO commentary document. On Page 3, these are our typical Brokerage and Risk Management modeling helpers. With the rally in the U.S. dollar since our June IR Day, please take a look at our updated FX guidance for the remainder of '22. This late June strengthening also caused an extra $0.01 headwind here in the second quarter versus our IR Day guidance. Next, you'll see our current estimate of integration costs. Most of this is related to Willis Re. The punchline has no change to our original estimate of $250 million for integration charges through the end of 2024. As I mentioned last quarter, the team is making excellent progress and is executing at a faster pace than our original plan. Integration efforts around people, real estate, back-office transition services are targeted to be mostly done by late '22. In fact, our new reinsurance colleagues are now moving into our combined Gallagher locations around the world, and there's an excitement that is coming together. As for technology and system rebuild, we still see having that done by the end of '23 or early '24. So continued good news on the reinsurance integration front. Next, please take a look at the amortization of intangibles line. Recall we now adjust out our -- that out of our non-GAAP results. Also take a look at footnote number 2. That will help you reconcile this number to what we're showing in the face of our GAAP financial statements. Next to the change in estimated earn-out payable. This quarter, some component of the earn-out payable adjustment has become more pronounced. The punchline is found in footnote number 5. The note admittedly is a little account needs, but it's saying that the large noncash gain in our results this quarter is mostly due to increases in interest rates and market volatility. When these increase, the value of our earn-out liability declines, thus creating GAAP income. This gain does not reflect any meaningful change to our expectations of the acquired brokerages nor does it change our view of what we'll ultimately pay an earn-out. The accounting is a bit like the change in interest rate assumptions and pension accounting, except this change in earn-out liability goes to the P&L, not through OCI as does pensions. In our view, this is a no never mind but can dramatically impact comparability, so we adjusted out. Turning now to Page 4, our Corporate segment outlook. No changes in the third and fourth quarter estimates. Flipping to Page 5, Clean Energy. This page is here to highlight that we have around $1 billion of tax credit carryovers. And with the Sunset program late last year, we're now in the cash harvesting year of these investments. You'll see in the pinkish column that the 2022 cash flow increase should be $125 million to $150 million and perhaps more in '23 and beyond. At this rate, these investments will be a really nice 7-year cash flow sweetener. The possibility of an extension of the loss still exists, so we have idled our plans rather than decommissioning them, cost us a little to carry them, but it lets us remain well positioned to restart production if an extension happens. Turning to Page 6. The top of the page is the rollover revenue table that we've spoken about in detail. We appreciate all those that have incorporated this disclosure into their models. Moving down the page. The bottom table is an update on our December reinsurance acquisition. You'll see that these numbers are almost spot on to our June IR Day estimates. Delivering $730 million of revenue and nearly $260 million of adjusted EBITDAC here in '22 would be very close to our pro formas when we inked the deal. That would be a really good outcome. Moving on to cash and capital management and future M&A. At June 30, available cash on hand was about $450 million. Our operations continue to perform very well, and we expect strong operating cash flows. Add to that, the cash flow sweetener from our Clean Energy investments and additional borrowing capacity, it adds up to more than $4 billion of tuck-in M&A capacity here in '22 and '23 combined. So those are my comments. An excellent quarter and first half, and we're extremely well positioned for another terrific year. Back to you, Pat.
J. Patrick Gallagher: Thanks, Doug. Daryl, I think we're ready to open it up to questions.
Operator: Our first questions come from the line of Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question, Pat, in June, I had asked you about recession. You said you guys were not seeing it. And if you were going to see an impact on your business, it wouldn't be in your results until 2023. So I recognize, right, that we're sitting here 6 months in advance of hitting next year. But as you think about how things can play out from an economic slowdown, we have inflation, still good property casualty pricing, how could that all shake out from an organic growth perspective next year to say if you see things today?
J. Patrick Gallagher: Well, I think it's not all that different than the discussion that we had in June. We're seeing -- literally, we look at this daily, an interesting pattern of our underlying clients' business is doing well. They're still recruiting people. Our benefits HR folks are as busy as they can possibly be. We watch for adjustments, both in terms of audits and endorsements, and those are all positive right now. To put that in perspective, we have -- we do have a baseline on that during the pandemic, and it was -- that was obviously substantially upside down. So we do have a good feel for that, and we feel good about it. Inflation, as Doug said, really has an impact on about 20% of our expenses. I think that's probably good research on the team's part in terms of what's really subject to that, that we'll be watching. As you know, we're going into budget time in the next 6 weeks or so, and there's a lot of discussion around this. So don't hold me to it, but I think that we're pretty -- in a pretty good spot. And I think our mix of business bodes well. I think that the -- the way our expenses shake out, an awful lot of those expenses are variable, I think that's good. A lot of upside for our salespeople this year, obviously. And I think that with rate increases, with interest rates up, it's a pretty good environment for a broker.
Doug Howell: So let me pile on that a little bit because we don't want whiteboarding on that. Like that, we're not seeing daily indications of our customers' growth slowing at this point. And admittedly, that's looking at current and recent past activity. And I think your question is really more about a future slowdown. So when we looked at that, what kind of cooling might we see, whether it's a recession or just a slowdown in the economy because, obviously, not every recession is the same, we do a lot of work on that. And we see -- if it happens, when I say if, more like a normal recession, maybe more like 1990, '91, and again, of what happened maybe in 2000, 2001, and before 9/11. We do not see next year being a clinch like the subprime financial shock recession of '07 or '08 or the pandemic recession for a few months of '20. So it's also important to note that these more normal recessions in the early '90s and early 2000s, both lasted about 8 months. So we see it more like that. It's also -- it's an important point to remember that brokers -- we are in a very large portion of our revenues based on the amount of premium placed. If it goes up because of rate or because of exposure, frankly, we're a little bit different on that. So for us, we think that like taking a look at nominal GDP is the bigger factor for our revenue much more than real GDP. So absolute sales, payroll, like Pat said, and property values are what premiums are placed on. So when you say, what thoughts next year what will premium rate increases do? And you heard us say that we don't see them slowing over the next year or so. And then really, our spread between new business and loss, we're proficient broker. So selling more insurance than we lose every year. So when we put all that together for next year, the brokerage business during a normal recession during an inflating premium rate environment can still post terrific organic results. So that's how we're seeing it now. And I talked to you about on the expense side during June that we think that we have some mitigating factors for that 20% that might be highly exposed to the inflation component of that. So it's a long answer to your question between Pat and I on it, but we think '23 could still be a year of terrific organic growth.
J. Patrick Gallagher: But let me load in another thought to, Elyse, we didn't talk about June. But if you go back to 2007, 2008, you go back to the pandemic clinches, we were -- we learned again, which we have through many tough times that our clients will stop paying their people before they stop paying their premiums. And that's a pretty good business to be in regardless of the economy.
Elyse Greenspan: My second question is maybe more short term. Doug, you said the fourth quarter brokerage outlook is a little bit better, right, than at the June IR Day. What's the reason for that?
Doug Howell: I just think sustained rate increases, and our teams are doing a great job of selling more than we're losing. So I think that just the environment seems to be better. We're starting to see data come out of what's happening with second quarter rates versus first. And there might have been just a little bit of rate drop in the first quarter, and that seems to be back on a positive slope now. So you see that kind of in first quarters when you go back over the last few years that maybe rate increases aren't quite as big as they are in later quarters because you get -- for the carriers, they get the full year of the premium in the books by being maybe a little bit more competitive in the first quarter. Second quarter bounced back up again. I think that we've had a chance to look at what's in our pipeline. So I would say it's on all fronts, we're just feeling more optimistic about where we're seeing the second half.
Elyse Greenspan: And then one last one. You guys gave the M&A color, so it seems like you still have a good pipeline. Have you -- do you think there could be any timing shift in when deals get closed, if people are concerned about a recession? I mean if they're just potentially waiting to get a better multiple or have you not observed that in the past or do you not expect that to happen this time around?
J. Patrick Gallagher: No. I think brokers are opportunistic, smart people. If I had a business to sell, now is when I'd sell it.
Operator: Our next question has come from the line of Yaron Kinar with Jefferies.
Yaron Kinar: And congrats on a good quarter. First question, the large life case that you mentioned, what's the margin profile on that? Is that accretive or dilutive to the overall Brokerage business?
Doug Howell: It's about the same. So it doesn't have the leverage as you would see in some of the other incremental amount.
Yaron Kinar: Okay. And then was FX -- did that have an impact on margins or only on revenues?
Doug Howell: We adjust that out of our margin profile. So it would be just on the revenue side.
Yaron Kinar: Okay. And then another one. I know you said you're still -- you haven't fully closed the books on clean coal, holding on hope that maybe you do see some extension come through in D.C. I guess, with the Democrats kind of coming to agreement in the Senate this week or actually today, I think, is it so premature to say what you've learned from that? Or if there is maybe an increasing chance of that clean coal credit continuing or extending?
Doug Howell: Well, it's a 742 page draft bill that we're doing a lot of word searches on it. I'm not seeing how it's in that, but if you get into the kind of vote-a-rama in the Senate next week to see what other senators might want to include in the package or look at it, I think that -- we're never out of it until -- we're not. And even if it doesn't come through in this package, it could be later in the year or 2. So it doesn't cost us that much to carry the plant. Our utility partners have been very understanding about this. They're not pressing us to decommission. So if you -- that we have to carry it for another 6 months, we will. But if it happens, it would be great. If not, we're in the cash harvesting era just like we thought about for the last 15 years, we're at that point now. So harvesting the cash is pretty nice.
Operator: Our next question is come from the line of David Motemaden with Evercore.
David Motemaden: I appreciate all the detail just on the midterm policy endorsements, audits. And I guess I'm wondering just on the Employee Benefits business, maybe you could talk about what you're seeing there on HR consulting and benefits consulting specifically with the pipeline? Any changes there? Any signs of weakness at all that you're seeing?
J. Patrick Gallagher: I'll tell you. It's really interesting to see. As you can imagine, I think we talked about this when the pandemic hit, that business shutdown in a quarter. And now -- and what an interesting turnaround for our clients. Now their biggest problem is attracting and retaining. So there is this demand, frankly, at a level that exceeds what we saw prepandemic. And I think in that case, things were kind of going along well. Everything was kind of fine. And then everyone tried to come down to the lowest amount of employee base they could. Now they're coming back. Their businesses are back. As we said, when we looked at our adjustments and endorsements and audits, our clients' businesses so far are robust, and that's a demand -- that creates a demand for more people. So I mean I can't get specific with you by exactly which practice group. It's the entire consulting part of our employee, human resource and human capital business is doing extremely well this year.
Doug Howell: Yes. Let me add to that. There's -- during the pandemic, people were all about cost containment. And so they cut down their cost and they were cut any discretionary costs. It's regardless of what happens with this recession. And all the Fed actions, I think -- I don't -- I just don't believe that it's going to have a dramatic impact on unemployment. So I think that employers are really thinking about attracting, retaining and motivating their talent. So I just don't see any type of 8 months or yearlong recession putting a dent in the employment numbers. So employers are still going to have to make sure they're out there competing for talent, and that's where we really provide value. So I don't see this like the pandemic or in 2008. Again, we see it a lot, if it happens, like '90 and 2000, and there is still more for talent back then too.
J. Patrick Gallagher: I'll give you an example, David. This is one that kind of floored me in the last month. I won't mention any names, but we have a sizable client that has engaged us on a multimillion dollar contract to improve and help them with their communication with their employee base. This is a significant client, obviously, but they are willing to spend multiple millions of dollars in an outreach to existing employees to make sure they understand why they've got it so great being part of their organization. And communicating what are in the benefits plans, why they take care of them, how they're educating, what the career path is, what the growth of the company means, all those things that go into a solid communication plan, how cool is that?
David Motemaden: No. I mean that is exciting. So yes, it definitely doesn't sound like, at least now you're seeing really any sign of the slowdown. So I guess, maybe just switching gears, if I think about, if we do see a slowdown in next year, I guess one thing that I've noticed the past couple of quarters in the press release sort of in the fine print, there's been mention of office consolidations. And I believe you spoke, Doug, I think last -- on the June call, about the agile workforce strategy. So I guess, could you maybe just talk a little bit more about what you're doing on the real estate front? And if maybe that could be a bigger benefit or a bigger lever to pull if we do get into a tougher revenue backdrop? And maybe if you could put some numbers around potential saves, that would also be helpful?
Doug Howell: Yes. I think when we talked about it early, when we were coming out of the pandemic, we thought there could be $30 million or $40 million or $50 million of annualized savings coming from real estate. I think we're still on target about that. I think we're harvesting maybe about $8 million a year on that effort, and there's a couple of big office footprints that are coming up here in the next year that I think that maybe will be a little bit more on that over this next year. What are we doing? We're going to an office footprint that basically is covering 50% or so of the number of employees that we have. We're bringing technologies to bear, so their ads are within the work, so they're not dedicated locations. For those employees that have to come in every day, clearly, they have a designated spot. And we're finding that the employees are responding to it very well, especially in cities where there is a substantial commute. So I see us continuing to do that. I don't know whether it would be a more rapid exercise if we had a normal recession over the next year. I think the pace that we're making change is the pace that the organization has. And you got to -- either you wait until the lease expires and then downsize or you get out of it and you end up paying the rent to the rest of the term. So I think a paced and measured approach to that is where we are, and I don't see that changing if there was this normal recession happening over the next year.
J. Patrick Gallagher: I'll tell you, again, on the anecdote side, these plans were a foot, Doug, leading the charge on this prior to the pandemic. And I don't know about your experience. But my experience in telling people that this isn't their workstation anymore or that, that office is -- it's not a good experience. And people being able to go home and get their job done and come back in the office where we do believe the social connections are important, and we're not eliminating our footprints but allowing them to plug in, in a plug-and-play way on the days that they should be there for customer contact, for employee meetings. It's kind of like the pandemic was a real helper.
David Motemaden: Yes, I know it sounds like -- sorry, go ahead.
Doug Howell: And that is really, if you don't get the -- you leave the office is too big, it can kind of look like there's no vibe going out in the office. So we do a lot of things to make sure that we can track the workforce. The footprint responds to the workforce. It's like going into a restaurant and every other table is empty, it doesn't feel like there's much of a vibe. Same number of people in a smaller restaurant, you walk out saying, wow, that was really a happening place tonight. So we're trying to make those experiences when people come into the office, more collaborative, more near one each other, and it's actually working then. We were just in London not too long ago, and there's a real bounce in everybody step when they come into a full office.
J. Patrick Gallagher: Yes. Doug is just trying to do the age thing on me because I go to a full restaurant, I can't hear...
David Motemaden: Yes. No, I agree with all of those changes. And so yes, it sounds like $20 million to $30 million of a benefit, but it sounds like that's maybe a bit more gradual unless things change.
Doug Howell: Yes. I mean over a couple of years, 3.5 years. we'll get it.
Operator: Our next questions come from the line of Greg Peters with Raymond James.
Greg Peters: You provided a pretty robust answer about the recession and -- or a potential recession and its effect on your brokerage business. But in your answer, you kind of didn't really talk about its effect on the Risk Management business. So maybe -- or if you did, I missed it, so -- because I was more focused on Brokerage. So maybe you could pivot and just tell us about your whiteboard sort of conclusions on the effect of a potential recession on the Risk Management business?
Doug Howell: I don't think there was substantial employment changes in a normal recession. So with Gallagher Bassett being so tight, to the number of people employed in places where there might be slips and falls, et cetera, I think that -- I'm not saying they're immune to it in this next normal recession, but I think that they're pretty resilient in that right now. Same thing with the Benefits business, there's still competition for talent. I think that there's -- you heard Pat say that there's 11 million open jobs right now for -- and there's 5 million people out work or something like that. So I think that I personally believe that this next -- if there's a slowdown, it's about drying up excess demand versus supply. And Scott pays claims on what the supply is not the demand. And we sell stuff on supply, not demand. So I think that -- I think as business...
J. Patrick Gallagher: Yes. And Greg, you heard us say that of all the lines of cover right now that are adjusted by Gallagher Bassett where comp is still one line that's not -- and it's our core business in the U.S. is not back to prepandemic claim counts. So it takes a while to build that back. But that's, as Doug said, directly connected to the employee head count. And so employee head count -- if employee head counts get slashed, that will have an impact on Scott's business, if they stay stable. And what we're seeing on the Benefit side is aggressive hiring, aggressive attempts of retention. And I think we're in pretty good shape.
Greg Peters: I was just -- as you were providing the answer, I was recalling an old and I never really tested it out to know whether it was true or not. But as a recession -- as there was an onset of recession that claim counts -- workers' comp claim counts actually increase as more employees sharing the worst would slip and fall in advance of actually facing the Grim Reaper, I don't know if that's something that is...
J. Patrick Gallagher: I think that's an old life tale.
Greg Peters: Yes. Yes. Exactly.
Doug Howell: That as workers' comp premium rates increase, and we're not fully into big jumps in workers' comp. But if we get a harder market in workers' comp that will push more people to self-insurance, and that leads to pretty good growth for Gallagher Bassett, too. So when they look at self-insurance and alternatives. So if we go into a recession, but workers' comp rates go up as medical costs inflate, et cetera, you might have more people looking for self-insurance with Gallagher Bassett paying the claims.
Greg Peters: Is it -- is it your view that the work from home versus work from work is one of the contributing factors to the lower claim count in workers' comp, at least from what you're seeing in Gallagher Bassett?
J. Patrick Gallagher: No, not really.
Greg Peters: Okay. Two other questions. From your property answer regarding where your real estate footprint, should I infer that about 20,000 or so of your employees are in full work from home if you said your property is target your real estate footprint is...
J. Patrick Gallagher: No, no, no. Gallagher Bassett has moved to a more virtual environment and that people are embracing that and really like that. The Brokerage business is allowing agile work. We're working to be agile and to be flexible. But these office footprints can actually handle everybody coming in at the same time, and we are encouraging people to come in.
Doug Howell: Yes. I think, Greg, the number of people that actually are designated as purely work from home employees might be in the 8,000 person range.
J. Patrick Gallagher: A big part of that is GB.
Doug Howell: Right.
Greg Peters: I'm sorry, what was that last answer, Pat?
J. Patrick Gallagher: A big part of that is Gallagher Bassett.
Greg Peters: Okay. And the final, just a detailed question, and I'm sure you've probably provided this before, but I just forget. Is there any cadence to how the cash flow comes out from the energy business as we think about the annual sort of -- is it heavier in the first quarter, are you harvesting it, or is it spread out evenly, et cetera?
Doug Howell: That probably more closely correlates to the day that we do our estimated tax payments because we can anticipate using those credits. And therefore, we would pay less than estimated tax payment.
Greg Peters: That's done on a quarterly basis, correct?
Doug Howell: That's right.
Operator: Our next question has come from the line of Mark Hughes with Truist Securities.
Mark Hughes: Pat, the renewal premium number you gave us the 10.5%, was that sort of the global P&C market?
J. Patrick Gallagher: Wait a minute, Mark. I don't think I gave you the renewal premiums. Take a look.
Doug Howell: Well, I understand you asked about the global second quarter renewal premiums, that's both rate and exposure of 10.5%, yes, that's right. And that's higher....
Mark Hughes: That was 8% in the first quarter. Do I have that right?
Doug Howell: I'd have to pull up the script on that, but ...
J. Patrick Gallagher: I do think that's right.
Mark Hughes: Okay. All right. And then I'll say this slightly tongue in cheek, but also seriously. West Virginia Senator, Joe Manchin, does he like the clean coal business?
Doug Howell: I think he does. I mean, he's got a lot of interest in it. The real question is, is he willing to sponsor a change in this as a part of a compromised plan? So we'll find that out over the next week or 10 days or 10 months, right? I don't think there'll be a focus -- it's a pretty small program to be honest. So I think that they're trying to get a deal done. Is this something that he's willing to champion? Maybe not, but we'll see what happens when we get into next week.
Mark Hughes: In the MGA business within wholesale, the 4% organic, do you think that will continue at that level? Or is there anything unusual this quarter?
Doug Howell: No, I think it's pretty -- it's just the nature of some of those programs and MGU...
J. Patrick Gallagher: Yes, It should hold.
Doug Howell: Should hold, not be better.
J. Patrick Gallagher: That's pretty -- that stuff is pretty subject, Mark, to the economy. It's bars opening, restaurants opening, contractors starting with the wheelbarrow. Houses that get hit by hail a lot.
Mark Hughes: Yes. Okay. And then did I hear you comment on workers' comp pricing. I know you talked about claims frequency and a lot of other factors. But how about pricing in the quarter flat?
Doug Howell: On rate amount, it's growing. It's actually showing some nice mid-single-digit type growth numbers right now.
J. Patrick Gallagher: But rates are flat.
Doug Howell: That's right.
J. Patrick Gallagher: It seems to be in line that our carrier partners are happy to continue to grow and are satisfied with the results.
Operator: Our next question is coming from the line of Meyer Shields with KBW.
Meyer Shields: Just a couple of quick ones. First off, when we look at supplementals and contingents, as a percentage of core commissions and fees, they're down year-over-year. Is that reinsurance?
Doug Howell: It could have an impact on -- yes, that would be. And I think a good point on that, our supplementals and contingents, there is some difference in contract year-over-year. So it's always good look at those 2 in together, not individual. So -- but together, they were up 12% this quarter together.
Meyer Shields: Okay. Perfect. And then a second question on reinsurance. How comfortable are you with the idea that the breakage that you factored in goes away once we get into 2023? Is that can be a factor anymore?
Doug Howell: I would say it's behind us. So we've done a really good job of holding the teams in. We're not having substantial attrition on that. In fact, I think we're in good shape on that. So I would not expect -- we anticipated what we give them breakage and the team is holding together -- that leadership team has done an amazingly good job.
J. Patrick Gallagher: I've talked about this quarter in and quarter out. I'm really, really happy with and proud of the fact that, that team joined us. 7% organic growth in the second quarter after the 2 to 3 years that they had prior to an acquisition getting completed in December. We're 9 months into this thing, and they're generating 7% organic. That's fantastic. And we were sitting there talking about breakage early on, is there going to be more -- and let's be honest, breakages, people left us and accounts in that business like to work with their team. And so people staying, producing -- the other thing I would comment on is the amount of interaction and the amount of help that reinsurance is to our retail brokerage operations on a global basis is exceeding our expectations. There are risk sharing pools in the United States that we've done longer and better than anybody in the marketplace and along comes a fresh look and fresh markets and a team that works together with us. The data sharing, the discussion of our partner markets and the sharing there, it's almost unbelievable to me on a multiple number of levels, how good a fit this is.
Meyer Shields: That's tremendously positive. And then one last question. I know this is nitpicky. But the large life deal that came in June, is that something that occurs next year? Is this a onetime deal?
J. Patrick Gallagher: Onetime deal.
Doug Howell: We get them from time to time, but I wouldn't say that they're annually predictable year-over-year.
J. Patrick Gallagher: Right.
Doug Howell: Then they themselves remain...
Meyer Shields: I'm sorry.
Doug Howell: They bind when they bind. It's not like it's saying you've got to have this all put to bed by January 1, by October 1. It doesn't really drive necessarily with the calendar or fiscal year of the client. It's whenever they want to put these cases in place is when they were buying. So it would not be predictable quarter over quarter over quarter.
Operator: Our next question is come from the line of Weston Bloomer with UBS.
Weston Bloomer: My first one is on -- just a follow-up on Willis Re. Obviously, good organic there of 7%. With investments ahead of schedule, I'm curious how you're thinking about growth and margin improvement in that business in 2023? Could we potentially see organic come in above the 7%? How should we think about potential margin improvement? Would it potentially grow faster than the core portfolio currently?
Doug Howell: Well, that margin for the year is somewhere around 36%. So I think that we're very happy with that margin. I think holding that margin is the right answer for that business. It takes heavy investment. They've been underinvested for the last 3 or 4 years on that. So that is not a business, if you go back to our acquisition that was expecting substantial margin change on that. So we're happy with the margins the way they are. We think they're competitive. Sure, there will be opportunities for us to become more efficient, and we do that every year. We always become more efficient. But I think there's a ripe opportunity right now to hire brokers in that space that would like to join us. It's a hot thing going right now. So it would be nice to take and hire folks in that business. I think it's 34% for the year where we are.
Weston Bloomer: Got it. And then my follow-up is just on M&A. Curious on what you're seeing on the international M&A market. Is that more attractive from a multiple perspective or a competition perspective right now? Or is maybe your term sheet disclosure more international U.S. weighted versus historical? Just kind of curious on what you're seeing.
J. Patrick Gallagher: It's not more international weighted. It's about the same and multiples around the world, you can throw a hat over.
Doug Howell: Thanks, Weston. Thanks for being on the call, Weston. Nice to hear from you.
J. Patrick Gallagher: All of you by the way, Doug, let's not single in -- all right, I think that's our questions for now. I'd like to thank everyone on the call again for joining us. Obviously, we're excited. We had a fantastic second quarter and first half of 2022. I'd like to thank all our colleagues around the globe for their hard work, our carrier partners for their ongoing support and our clients for their continued trust. We look forward to speaking to you again at our September Investor Day meeting, and thank you all, everyone, for being with us.
Operator: Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and have a great night. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Company's Second Quarter 2022 Earnings Conference Call. Today's call is being recorded. Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you. Good afternoon, everyone. Thank you for joining us for our second quarter 2022 earnings call. On the call with me today is Doug Howell, our CFO; as well as the heads of our operating divisions. We had another excellent quarter of financial performance. For our combined Brokerage and Risk Management segments, we posted 22% growth in revenue, 10.7% organic growth, net earnings growth of 35%, adjusted EBITDAC growth of 23% and adjusted earnings per share growth of 19%. I'm extremely proud of how our nearly 41,000 colleagues around the globe performed during the quarter in the first half of the year. So let me give you some more detail on our second quarter Brokerage segment performance. During the quarter, reported revenue growth was 25%. Of that, 10.8% was organic. We did have a tailwind of about 1 point from an infrequent large life case that I'll touch on in a minute. Rollover revenues were about $240 million, consistent with our June IR Day expectations. Net earnings growth was 36%. And as expected, we posted adjusted EBITDAC margins of 32%, an outstanding quarter for the Brokerage team. Let me walk you around the world and break down our organic, starting with our PC operations. Our U.S. retail business posted 11% organic, with strong new business, retention and continued renewal premium increases. Risk Placement Services, our U.S. wholesale operations, posted organic of 8%. This includes more than 15% organic in open brokerage and 4% organic in our MGA programs and binding businesses. New business was consistent with second quarter of '21, while retention was down just a bit from last year, as we noted in our June IR Day. Shifting outside the U.S. Our U.K. businesses posted organic of 8% with excellent new business overall and another double-digit organic growth quarter within specialty. Australia and New Zealand combined organic was more than 11%, driven by strong new business, stable retention and higher renewal premium increases. Canada was up more than 14% organically and continues to benefit from renewal premium increases, great new business and great retention. Moving to our Employee Benefits Brokerage and Consulting business. As I mentioned earlier, we were helped this quarter from a large life case. Excluding this, our benefits business organic was about 9%, in line with our IR Day expectations and driven by increased HR benefits consulting work and solid growth in our International and Health and Welfare businesses. Finally, our December reinsurance acquisition is right on target. After controlling for breakage prior to closing, second quarter organic was around 7%, just fantastic, and integration continues to progress nicely on budget and ahead of its original time line. So reinsurance continues to be a really good story. So headline Brokerage segment all in organic of 10.8% and upper 9% after controlling for the large life case, either way, an excellent quarter. Next, let me give you some thoughts on the current PC market environment, starting in the primary insurance market. Overall, global second quarter renewal premiums, that's both rate and exposure combined, were up 10.5%. That's higher than what our data showed for increases in renewal premiums in both the fourth quarter '21 and first quarter '22. When I look at our renewal premiums by line for nearly all coverages, second quarter increases were equal to or higher than first quarter. One exception to this was professional liability, mostly D&O. By geography, renewal premiums were up double digits, nearly everywhere. Again, that's a combination of both rate and exposure. So next to no slowdown in premium increases during the quarter. Additionally, we are not seeing any significant signs of economic slowdown. In fact, second quarter midterm policy endorsements, audits and cancellations continue to trend more favorable than a year ago. Thus far in July, midterm policy endorsements continue to move higher year-over-year, and renewal premium increases are consistent with second quarter. But remember, our job as brokers is to help our clients mitigate premium increases and find suitable insurance programs that fit their budgets. Moving to reinsurance. As we noted in our first view report published by our reinsurance professionals earlier this month, there are very real signs of hardening in the reinsurance market. Property reinsurance pricing is up across the board. And most notably, for U.S. hurricane and Australian property risks are up anywhere from 15% to more than 40%. On the casualty side, reinsurance placements experienced more modest price increases and were a little bit less challenging. Regardless, a firm or hardening reinsurance market will naturally show up in primary market rate increases. And there are many other reasons for our carrier partners to maintain their cautious underwriting stance outside of reinsurance market conditions, inflation, geopolitical tensions and economic uncertainty to name a few. These all translate into a difficult PC market conditions continuing for our clients across retail, wholesale and reinsurance for this foreseeable future. Moving to our Employee Benefit Brokerage and Consulting business, U.S. labor market conditions remained broadly favorable. Even with a decline in U.S. job postings in each of the last 2 months, there remain more than 11 million job openings, that's more than double the number of people unemployed and looking for work. We expect strong demand for our HR and benefits consulting services to continue as businesses prioritize attracting, retaining and motivating their workforce. The timing of the large life case and covered live changes in the second half of '21 will cause the Benefits business to post lumpy quarterly organic results this year, but that doesn't change the still favorable underlying environment. So let me wrap up on the Brokerage segment organic. A great first half and looking like the second half will lead us to a full year '22 organic over 9%, which would be an absolutely terrific year. Moving on to mergers and acquisitions. During the second quarter, we completed 8 new tuck-in brokerage mergers representing about $50 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have more than 40 term sheets signed or being prepared, representing nearly $350 million of annualized revenue. We know not all of these will close, however, we believe we will get our fair share. Next, I would like to move to our Risk Management segment, Gallagher Bassett. Second quarter organic growth was 10.3%, a bit better than our IR Day expectation due to a strong June. Adjusted EBITDAC margin was 18.9%, which is in line with our expectations. For the year, we continue to see adjusted EBITDAC margins near that 19% level. We again saw increases in new arising claims across general liability, property and core workers' compensation during the quarter. Encouragingly, property and liability claim counts are back to prepandemic levels. Core workers' comp claim counts have yet to fully rebound to 2019 levels, which represents a nice opportunity for further growth. Looking towards the second half of the year, we think organic revenue growth will continue to push 10% due to growing claim counts and new business. I'll conclude my remarks with some thoughts on our bedrock culture. As I resume traveling to our Gallagher offices around the globe, I can report to you that our culture is as strong as ever, and that's a reflection of our people, our nearly 41,000 colleagues working together for a common goal to serve our clients. As I've said before, our people underpin our culture, a culture that we believe is a true competitive advantage and drives our outstanding financial results. Okay. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat, and hello, everyone, an excellent second quarter and terrific count. Today, I'll touch on organic margins and the Corporate segment using our earnings release and then make some comments using our CFO commentary document posted on our website. I'll end then with my typical comments on M&A, debt and cash. Okay, starting with the earnings release to the Brokerage segment organic table on Page 3. Fantastic headline all-in brokerage organic of 10.8%. As Pat said, we did benefit by about 1 point or so because of a large group live case found in late June. With or without that, a great quarter by our sales team. As for the rest of '22, during our June IR Day, we said third and fourth quarter would be somewhere around 8% due to a tough benefits compare. As we sit today, we're still seeing third quarter around that 8%, reflecting about 1 point of that tough benefits compare, and we're becoming more bullish in fourth quarter, call it nicely over 8% in the fourth quarter. That would lead to full year Brokerage segment organic growth of over 9%. So today, we're forecasting full year organic growth better than what we were seeing at our June IR Day. Next, turning to Page 5 to the Brokerage segment adjusted EBITDAC margin table. Headline all-in adjusted EBITDAC margin of 32%, right in line with our June IR day expectation. Recall what we've been saying all year, because of the roll-in impact of the acquired reinsurance operations, which has substantial quarterly seasonality and because there are still expenses returning as we come out of the pandemic, those in combination create quarterly margin change volatility. As a recap, we posted adjusted margins up 50 basis points in the first quarter, down 97 basis points here in the second, and we're forecasting down 100 basis points in the third, then back up 100 basis points in the fourth. Because we are seasonally the largest in the first quarter, those results would roll-up to around 10 to 20 basis points of full year margin expansion. These quarterly margin changes are right on what we've been saying all year. When I think of the inflation impact, I just don't see much here in '22 on our expenses. And as we discussed in June, headline inflation doesn't significantly impact 80% of our expense base. And we have mitigation levers to pull on that other 20% if it comes to that. So even with rising CPI, we remain comfortable with our 2020 margin outlook. Looking towards '23, all that quarter margin change volatility should go away with the pandemic behind us and reinsurance fully rolled into our books. Moving to the Risk Management segment on Pages 5 and 6, Pat hit the highlights. 10.3% organic and 18.9% adjusted margins, an excellent quarter. This unit continues to show momentum with rebounding claim counts and a large new business win coming on next quarter. It's looking now like organic revenue growth of around 10% in each of third and fourth quarters '22. Now remember, that's on top of 17% growth in third quarter '21 and 13% growth in fourth quarter '21, that would be a terrific outcome to overcome such a difficult compare. Moving to Page 7 of the earnings release to the Corporate segment shortcut table. Interest in banking is within our June IR Day range. Adjusted M&A costs in clean energy, they combined -- those combined also within our range. And Corporate, after adjusting for some favorable tax item, is slightly better than our June IR Day range, call it about $0.01 due to favorable FX remeasurement gains given the strengthening in the dollar. Let's leave the earnings release and go to the CFO commentary document. On Page 3, these are our typical Brokerage and Risk Management modeling helpers. With the rally in the U.S. dollar since our June IR Day, please take a look at our updated FX guidance for the remainder of '22. This late June strengthening also caused an extra $0.01 headwind here in the second quarter versus our IR Day guidance. Next, you'll see our current estimate of integration costs. Most of this is related to Willis Re. The punchline has no change to our original estimate of $250 million for integration charges through the end of 2024. As I mentioned last quarter, the team is making excellent progress and is executing at a faster pace than our original plan. Integration efforts around people, real estate, back-office transition services are targeted to be mostly done by late '22. In fact, our new reinsurance colleagues are now moving into our combined Gallagher locations around the world, and there's an excitement that is coming together. As for technology and system rebuild, we still see having that done by the end of '23 or early '24. So continued good news on the reinsurance integration front. Next, please take a look at the amortization of intangibles line. Recall we now adjust out our -- that out of our non-GAAP results. Also take a look at footnote number 2. That will help you reconcile this number to what we're showing in the face of our GAAP financial statements. Next to the change in estimated earn-out payable. This quarter, some component of the earn-out payable adjustment has become more pronounced. The punchline is found in footnote number 5. The note admittedly is a little account needs, but it's saying that the large noncash gain in our results this quarter is mostly due to increases in interest rates and market volatility. When these increase, the value of our earn-out liability declines, thus creating GAAP income. This gain does not reflect any meaningful change to our expectations of the acquired brokerages nor does it change our view of what we'll ultimately pay an earn-out. The accounting is a bit like the change in interest rate assumptions and pension accounting, except this change in earn-out liability goes to the P&L, not through OCI as does pensions. In our view, this is a no never mind but can dramatically impact comparability, so we adjusted out. Turning now to Page 4, our Corporate segment outlook. No changes in the third and fourth quarter estimates. Flipping to Page 5, Clean Energy. This page is here to highlight that we have around $1 billion of tax credit carryovers. And with the Sunset program late last year, we're now in the cash harvesting year of these investments. You'll see in the pinkish column that the 2022 cash flow increase should be $125 million to $150 million and perhaps more in '23 and beyond. At this rate, these investments will be a really nice 7-year cash flow sweetener. The possibility of an extension of the loss still exists, so we have idled our plans rather than decommissioning them, cost us a little to carry them, but it lets us remain well positioned to restart production if an extension happens. Turning to Page 6. The top of the page is the rollover revenue table that we've spoken about in detail. We appreciate all those that have incorporated this disclosure into their models. Moving down the page. The bottom table is an update on our December reinsurance acquisition. You'll see that these numbers are almost spot on to our June IR Day estimates. Delivering $730 million of revenue and nearly $260 million of adjusted EBITDAC here in '22 would be very close to our pro formas when we inked the deal. That would be a really good outcome. Moving on to cash and capital management and future M&A. At June 30, available cash on hand was about $450 million. Our operations continue to perform very well, and we expect strong operating cash flows. Add to that, the cash flow sweetener from our Clean Energy investments and additional borrowing capacity, it adds up to more than $4 billion of tuck-in M&A capacity here in '22 and '23 combined. So those are my comments. An excellent quarter and first half, and we're extremely well positioned for another terrific year. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Doug. Daryl, I think we're ready to open it up to questions."
},
{
"speaker": "Operator",
"text": "Our first questions come from the line of Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, Pat, in June, I had asked you about recession. You said you guys were not seeing it. And if you were going to see an impact on your business, it wouldn't be in your results until 2023. So I recognize, right, that we're sitting here 6 months in advance of hitting next year. But as you think about how things can play out from an economic slowdown, we have inflation, still good property casualty pricing, how could that all shake out from an organic growth perspective next year to say if you see things today?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I think it's not all that different than the discussion that we had in June. We're seeing -- literally, we look at this daily, an interesting pattern of our underlying clients' business is doing well. They're still recruiting people. Our benefits HR folks are as busy as they can possibly be. We watch for adjustments, both in terms of audits and endorsements, and those are all positive right now. To put that in perspective, we have -- we do have a baseline on that during the pandemic, and it was -- that was obviously substantially upside down. So we do have a good feel for that, and we feel good about it. Inflation, as Doug said, really has an impact on about 20% of our expenses. I think that's probably good research on the team's part in terms of what's really subject to that, that we'll be watching. As you know, we're going into budget time in the next 6 weeks or so, and there's a lot of discussion around this. So don't hold me to it, but I think that we're pretty -- in a pretty good spot. And I think our mix of business bodes well. I think that the -- the way our expenses shake out, an awful lot of those expenses are variable, I think that's good. A lot of upside for our salespeople this year, obviously. And I think that with rate increases, with interest rates up, it's a pretty good environment for a broker."
},
{
"speaker": "Doug Howell",
"text": "So let me pile on that a little bit because we don't want whiteboarding on that. Like that, we're not seeing daily indications of our customers' growth slowing at this point. And admittedly, that's looking at current and recent past activity. And I think your question is really more about a future slowdown. So when we looked at that, what kind of cooling might we see, whether it's a recession or just a slowdown in the economy because, obviously, not every recession is the same, we do a lot of work on that. And we see -- if it happens, when I say if, more like a normal recession, maybe more like 1990, '91, and again, of what happened maybe in 2000, 2001, and before 9/11. We do not see next year being a clinch like the subprime financial shock recession of '07 or '08 or the pandemic recession for a few months of '20. So it's also important to note that these more normal recessions in the early '90s and early 2000s, both lasted about 8 months. So we see it more like that. It's also -- it's an important point to remember that brokers -- we are in a very large portion of our revenues based on the amount of premium placed. If it goes up because of rate or because of exposure, frankly, we're a little bit different on that. So for us, we think that like taking a look at nominal GDP is the bigger factor for our revenue much more than real GDP. So absolute sales, payroll, like Pat said, and property values are what premiums are placed on. So when you say, what thoughts next year what will premium rate increases do? And you heard us say that we don't see them slowing over the next year or so. And then really, our spread between new business and loss, we're proficient broker. So selling more insurance than we lose every year. So when we put all that together for next year, the brokerage business during a normal recession during an inflating premium rate environment can still post terrific organic results. So that's how we're seeing it now. And I talked to you about on the expense side during June that we think that we have some mitigating factors for that 20% that might be highly exposed to the inflation component of that. So it's a long answer to your question between Pat and I on it, but we think '23 could still be a year of terrific organic growth."
},
{
"speaker": "J. Patrick Gallagher",
"text": "But let me load in another thought to, Elyse, we didn't talk about June. But if you go back to 2007, 2008, you go back to the pandemic clinches, we were -- we learned again, which we have through many tough times that our clients will stop paying their people before they stop paying their premiums. And that's a pretty good business to be in regardless of the economy."
},
{
"speaker": "Elyse Greenspan",
"text": "My second question is maybe more short term. Doug, you said the fourth quarter brokerage outlook is a little bit better, right, than at the June IR Day. What's the reason for that?"
},
{
"speaker": "Doug Howell",
"text": "I just think sustained rate increases, and our teams are doing a great job of selling more than we're losing. So I think that just the environment seems to be better. We're starting to see data come out of what's happening with second quarter rates versus first. And there might have been just a little bit of rate drop in the first quarter, and that seems to be back on a positive slope now. So you see that kind of in first quarters when you go back over the last few years that maybe rate increases aren't quite as big as they are in later quarters because you get -- for the carriers, they get the full year of the premium in the books by being maybe a little bit more competitive in the first quarter. Second quarter bounced back up again. I think that we've had a chance to look at what's in our pipeline. So I would say it's on all fronts, we're just feeling more optimistic about where we're seeing the second half."
},
{
"speaker": "Elyse Greenspan",
"text": "And then one last one. You guys gave the M&A color, so it seems like you still have a good pipeline. Have you -- do you think there could be any timing shift in when deals get closed, if people are concerned about a recession? I mean if they're just potentially waiting to get a better multiple or have you not observed that in the past or do you not expect that to happen this time around?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No. I think brokers are opportunistic, smart people. If I had a business to sell, now is when I'd sell it."
},
{
"speaker": "Operator",
"text": "Our next question has come from the line of Yaron Kinar with Jefferies."
},
{
"speaker": "Yaron Kinar",
"text": "And congrats on a good quarter. First question, the large life case that you mentioned, what's the margin profile on that? Is that accretive or dilutive to the overall Brokerage business?"
},
{
"speaker": "Doug Howell",
"text": "It's about the same. So it doesn't have the leverage as you would see in some of the other incremental amount."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. And then was FX -- did that have an impact on margins or only on revenues?"
},
{
"speaker": "Doug Howell",
"text": "We adjust that out of our margin profile. So it would be just on the revenue side."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. And then another one. I know you said you're still -- you haven't fully closed the books on clean coal, holding on hope that maybe you do see some extension come through in D.C. I guess, with the Democrats kind of coming to agreement in the Senate this week or actually today, I think, is it so premature to say what you've learned from that? Or if there is maybe an increasing chance of that clean coal credit continuing or extending?"
},
{
"speaker": "Doug Howell",
"text": "Well, it's a 742 page draft bill that we're doing a lot of word searches on it. I'm not seeing how it's in that, but if you get into the kind of vote-a-rama in the Senate next week to see what other senators might want to include in the package or look at it, I think that -- we're never out of it until -- we're not. And even if it doesn't come through in this package, it could be later in the year or 2. So it doesn't cost us that much to carry the plant. Our utility partners have been very understanding about this. They're not pressing us to decommission. So if you -- that we have to carry it for another 6 months, we will. But if it happens, it would be great. If not, we're in the cash harvesting era just like we thought about for the last 15 years, we're at that point now. So harvesting the cash is pretty nice."
},
{
"speaker": "Operator",
"text": "Our next question is come from the line of David Motemaden with Evercore."
},
{
"speaker": "David Motemaden",
"text": "I appreciate all the detail just on the midterm policy endorsements, audits. And I guess I'm wondering just on the Employee Benefits business, maybe you could talk about what you're seeing there on HR consulting and benefits consulting specifically with the pipeline? Any changes there? Any signs of weakness at all that you're seeing?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I'll tell you. It's really interesting to see. As you can imagine, I think we talked about this when the pandemic hit, that business shutdown in a quarter. And now -- and what an interesting turnaround for our clients. Now their biggest problem is attracting and retaining. So there is this demand, frankly, at a level that exceeds what we saw prepandemic. And I think in that case, things were kind of going along well. Everything was kind of fine. And then everyone tried to come down to the lowest amount of employee base they could. Now they're coming back. Their businesses are back. As we said, when we looked at our adjustments and endorsements and audits, our clients' businesses so far are robust, and that's a demand -- that creates a demand for more people. So I mean I can't get specific with you by exactly which practice group. It's the entire consulting part of our employee, human resource and human capital business is doing extremely well this year."
},
{
"speaker": "Doug Howell",
"text": "Yes. Let me add to that. There's -- during the pandemic, people were all about cost containment. And so they cut down their cost and they were cut any discretionary costs. It's regardless of what happens with this recession. And all the Fed actions, I think -- I don't -- I just don't believe that it's going to have a dramatic impact on unemployment. So I think that employers are really thinking about attracting, retaining and motivating their talent. So I just don't see any type of 8 months or yearlong recession putting a dent in the employment numbers. So employers are still going to have to make sure they're out there competing for talent, and that's where we really provide value. So I don't see this like the pandemic or in 2008. Again, we see it a lot, if it happens, like '90 and 2000, and there is still more for talent back then too."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I'll give you an example, David. This is one that kind of floored me in the last month. I won't mention any names, but we have a sizable client that has engaged us on a multimillion dollar contract to improve and help them with their communication with their employee base. This is a significant client, obviously, but they are willing to spend multiple millions of dollars in an outreach to existing employees to make sure they understand why they've got it so great being part of their organization. And communicating what are in the benefits plans, why they take care of them, how they're educating, what the career path is, what the growth of the company means, all those things that go into a solid communication plan, how cool is that?"
},
{
"speaker": "David Motemaden",
"text": "No. I mean that is exciting. So yes, it definitely doesn't sound like, at least now you're seeing really any sign of the slowdown. So I guess, maybe just switching gears, if I think about, if we do see a slowdown in next year, I guess one thing that I've noticed the past couple of quarters in the press release sort of in the fine print, there's been mention of office consolidations. And I believe you spoke, Doug, I think last -- on the June call, about the agile workforce strategy. So I guess, could you maybe just talk a little bit more about what you're doing on the real estate front? And if maybe that could be a bigger benefit or a bigger lever to pull if we do get into a tougher revenue backdrop? And maybe if you could put some numbers around potential saves, that would also be helpful?"
},
{
"speaker": "Doug Howell",
"text": "Yes. I think when we talked about it early, when we were coming out of the pandemic, we thought there could be $30 million or $40 million or $50 million of annualized savings coming from real estate. I think we're still on target about that. I think we're harvesting maybe about $8 million a year on that effort, and there's a couple of big office footprints that are coming up here in the next year that I think that maybe will be a little bit more on that over this next year. What are we doing? We're going to an office footprint that basically is covering 50% or so of the number of employees that we have. We're bringing technologies to bear, so their ads are within the work, so they're not dedicated locations. For those employees that have to come in every day, clearly, they have a designated spot. And we're finding that the employees are responding to it very well, especially in cities where there is a substantial commute. So I see us continuing to do that. I don't know whether it would be a more rapid exercise if we had a normal recession over the next year. I think the pace that we're making change is the pace that the organization has. And you got to -- either you wait until the lease expires and then downsize or you get out of it and you end up paying the rent to the rest of the term. So I think a paced and measured approach to that is where we are, and I don't see that changing if there was this normal recession happening over the next year."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I'll tell you, again, on the anecdote side, these plans were a foot, Doug, leading the charge on this prior to the pandemic. And I don't know about your experience. But my experience in telling people that this isn't their workstation anymore or that, that office is -- it's not a good experience. And people being able to go home and get their job done and come back in the office where we do believe the social connections are important, and we're not eliminating our footprints but allowing them to plug in, in a plug-and-play way on the days that they should be there for customer contact, for employee meetings. It's kind of like the pandemic was a real helper."
},
{
"speaker": "David Motemaden",
"text": "Yes, I know it sounds like -- sorry, go ahead."
},
{
"speaker": "Doug Howell",
"text": "And that is really, if you don't get the -- you leave the office is too big, it can kind of look like there's no vibe going out in the office. So we do a lot of things to make sure that we can track the workforce. The footprint responds to the workforce. It's like going into a restaurant and every other table is empty, it doesn't feel like there's much of a vibe. Same number of people in a smaller restaurant, you walk out saying, wow, that was really a happening place tonight. So we're trying to make those experiences when people come into the office, more collaborative, more near one each other, and it's actually working then. We were just in London not too long ago, and there's a real bounce in everybody step when they come into a full office."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes. Doug is just trying to do the age thing on me because I go to a full restaurant, I can't hear..."
},
{
"speaker": "David Motemaden",
"text": "Yes. No, I agree with all of those changes. And so yes, it sounds like $20 million to $30 million of a benefit, but it sounds like that's maybe a bit more gradual unless things change."
},
{
"speaker": "Doug Howell",
"text": "Yes. I mean over a couple of years, 3.5 years. we'll get it."
},
{
"speaker": "Operator",
"text": "Our next questions come from the line of Greg Peters with Raymond James."
},
{
"speaker": "Greg Peters",
"text": "You provided a pretty robust answer about the recession and -- or a potential recession and its effect on your brokerage business. But in your answer, you kind of didn't really talk about its effect on the Risk Management business. So maybe -- or if you did, I missed it, so -- because I was more focused on Brokerage. So maybe you could pivot and just tell us about your whiteboard sort of conclusions on the effect of a potential recession on the Risk Management business?"
},
{
"speaker": "Doug Howell",
"text": "I don't think there was substantial employment changes in a normal recession. So with Gallagher Bassett being so tight, to the number of people employed in places where there might be slips and falls, et cetera, I think that -- I'm not saying they're immune to it in this next normal recession, but I think that they're pretty resilient in that right now. Same thing with the Benefits business, there's still competition for talent. I think that there's -- you heard Pat say that there's 11 million open jobs right now for -- and there's 5 million people out work or something like that. So I think that I personally believe that this next -- if there's a slowdown, it's about drying up excess demand versus supply. And Scott pays claims on what the supply is not the demand. And we sell stuff on supply, not demand. So I think that -- I think as business..."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes. And Greg, you heard us say that of all the lines of cover right now that are adjusted by Gallagher Bassett where comp is still one line that's not -- and it's our core business in the U.S. is not back to prepandemic claim counts. So it takes a while to build that back. But that's, as Doug said, directly connected to the employee head count. And so employee head count -- if employee head counts get slashed, that will have an impact on Scott's business, if they stay stable. And what we're seeing on the Benefit side is aggressive hiring, aggressive attempts of retention. And I think we're in pretty good shape."
},
{
"speaker": "Greg Peters",
"text": "I was just -- as you were providing the answer, I was recalling an old and I never really tested it out to know whether it was true or not. But as a recession -- as there was an onset of recession that claim counts -- workers' comp claim counts actually increase as more employees sharing the worst would slip and fall in advance of actually facing the Grim Reaper, I don't know if that's something that is..."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I think that's an old life tale."
},
{
"speaker": "Greg Peters",
"text": "Yes. Yes. Exactly."
},
{
"speaker": "Doug Howell",
"text": "That as workers' comp premium rates increase, and we're not fully into big jumps in workers' comp. But if we get a harder market in workers' comp that will push more people to self-insurance, and that leads to pretty good growth for Gallagher Bassett, too. So when they look at self-insurance and alternatives. So if we go into a recession, but workers' comp rates go up as medical costs inflate, et cetera, you might have more people looking for self-insurance with Gallagher Bassett paying the claims."
},
{
"speaker": "Greg Peters",
"text": "Is it -- is it your view that the work from home versus work from work is one of the contributing factors to the lower claim count in workers' comp, at least from what you're seeing in Gallagher Bassett?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No, not really."
},
{
"speaker": "Greg Peters",
"text": "Okay. Two other questions. From your property answer regarding where your real estate footprint, should I infer that about 20,000 or so of your employees are in full work from home if you said your property is target your real estate footprint is..."
},
{
"speaker": "J. Patrick Gallagher",
"text": "No, no, no. Gallagher Bassett has moved to a more virtual environment and that people are embracing that and really like that. The Brokerage business is allowing agile work. We're working to be agile and to be flexible. But these office footprints can actually handle everybody coming in at the same time, and we are encouraging people to come in."
},
{
"speaker": "Doug Howell",
"text": "Yes. I think, Greg, the number of people that actually are designated as purely work from home employees might be in the 8,000 person range."
},
{
"speaker": "J. Patrick Gallagher",
"text": "A big part of that is GB."
},
{
"speaker": "Doug Howell",
"text": "Right."
},
{
"speaker": "Greg Peters",
"text": "I'm sorry, what was that last answer, Pat?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "A big part of that is Gallagher Bassett."
},
{
"speaker": "Greg Peters",
"text": "Okay. And the final, just a detailed question, and I'm sure you've probably provided this before, but I just forget. Is there any cadence to how the cash flow comes out from the energy business as we think about the annual sort of -- is it heavier in the first quarter, are you harvesting it, or is it spread out evenly, et cetera?"
},
{
"speaker": "Doug Howell",
"text": "That probably more closely correlates to the day that we do our estimated tax payments because we can anticipate using those credits. And therefore, we would pay less than estimated tax payment."
},
{
"speaker": "Greg Peters",
"text": "That's done on a quarterly basis, correct?"
},
{
"speaker": "Doug Howell",
"text": "That's right."
},
{
"speaker": "Operator",
"text": "Our next question has come from the line of Mark Hughes with Truist Securities."
},
{
"speaker": "Mark Hughes",
"text": "Pat, the renewal premium number you gave us the 10.5%, was that sort of the global P&C market?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Wait a minute, Mark. I don't think I gave you the renewal premiums. Take a look."
},
{
"speaker": "Doug Howell",
"text": "Well, I understand you asked about the global second quarter renewal premiums, that's both rate and exposure of 10.5%, yes, that's right. And that's higher...."
},
{
"speaker": "Mark Hughes",
"text": "That was 8% in the first quarter. Do I have that right?"
},
{
"speaker": "Doug Howell",
"text": "I'd have to pull up the script on that, but ..."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I do think that's right."
},
{
"speaker": "Mark Hughes",
"text": "Okay. All right. And then I'll say this slightly tongue in cheek, but also seriously. West Virginia Senator, Joe Manchin, does he like the clean coal business?"
},
{
"speaker": "Doug Howell",
"text": "I think he does. I mean, he's got a lot of interest in it. The real question is, is he willing to sponsor a change in this as a part of a compromised plan? So we'll find that out over the next week or 10 days or 10 months, right? I don't think there'll be a focus -- it's a pretty small program to be honest. So I think that they're trying to get a deal done. Is this something that he's willing to champion? Maybe not, but we'll see what happens when we get into next week."
},
{
"speaker": "Mark Hughes",
"text": "In the MGA business within wholesale, the 4% organic, do you think that will continue at that level? Or is there anything unusual this quarter?"
},
{
"speaker": "Doug Howell",
"text": "No, I think it's pretty -- it's just the nature of some of those programs and MGU..."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes, It should hold."
},
{
"speaker": "Doug Howell",
"text": "Should hold, not be better."
},
{
"speaker": "J. Patrick Gallagher",
"text": "That's pretty -- that stuff is pretty subject, Mark, to the economy. It's bars opening, restaurants opening, contractors starting with the wheelbarrow. Houses that get hit by hail a lot."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Okay. And then did I hear you comment on workers' comp pricing. I know you talked about claims frequency and a lot of other factors. But how about pricing in the quarter flat?"
},
{
"speaker": "Doug Howell",
"text": "On rate amount, it's growing. It's actually showing some nice mid-single-digit type growth numbers right now."
},
{
"speaker": "J. Patrick Gallagher",
"text": "But rates are flat."
},
{
"speaker": "Doug Howell",
"text": "That's right."
},
{
"speaker": "J. Patrick Gallagher",
"text": "It seems to be in line that our carrier partners are happy to continue to grow and are satisfied with the results."
},
{
"speaker": "Operator",
"text": "Our next question is coming from the line of Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "Just a couple of quick ones. First off, when we look at supplementals and contingents, as a percentage of core commissions and fees, they're down year-over-year. Is that reinsurance?"
},
{
"speaker": "Doug Howell",
"text": "It could have an impact on -- yes, that would be. And I think a good point on that, our supplementals and contingents, there is some difference in contract year-over-year. So it's always good look at those 2 in together, not individual. So -- but together, they were up 12% this quarter together."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Perfect. And then a second question on reinsurance. How comfortable are you with the idea that the breakage that you factored in goes away once we get into 2023? Is that can be a factor anymore?"
},
{
"speaker": "Doug Howell",
"text": "I would say it's behind us. So we've done a really good job of holding the teams in. We're not having substantial attrition on that. In fact, I think we're in good shape on that. So I would not expect -- we anticipated what we give them breakage and the team is holding together -- that leadership team has done an amazingly good job."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I've talked about this quarter in and quarter out. I'm really, really happy with and proud of the fact that, that team joined us. 7% organic growth in the second quarter after the 2 to 3 years that they had prior to an acquisition getting completed in December. We're 9 months into this thing, and they're generating 7% organic. That's fantastic. And we were sitting there talking about breakage early on, is there going to be more -- and let's be honest, breakages, people left us and accounts in that business like to work with their team. And so people staying, producing -- the other thing I would comment on is the amount of interaction and the amount of help that reinsurance is to our retail brokerage operations on a global basis is exceeding our expectations. There are risk sharing pools in the United States that we've done longer and better than anybody in the marketplace and along comes a fresh look and fresh markets and a team that works together with us. The data sharing, the discussion of our partner markets and the sharing there, it's almost unbelievable to me on a multiple number of levels, how good a fit this is."
},
{
"speaker": "Meyer Shields",
"text": "That's tremendously positive. And then one last question. I know this is nitpicky. But the large life deal that came in June, is that something that occurs next year? Is this a onetime deal?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Onetime deal."
},
{
"speaker": "Doug Howell",
"text": "We get them from time to time, but I wouldn't say that they're annually predictable year-over-year."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Right."
},
{
"speaker": "Doug Howell",
"text": "Then they themselves remain..."
},
{
"speaker": "Meyer Shields",
"text": "I'm sorry."
},
{
"speaker": "Doug Howell",
"text": "They bind when they bind. It's not like it's saying you've got to have this all put to bed by January 1, by October 1. It doesn't really drive necessarily with the calendar or fiscal year of the client. It's whenever they want to put these cases in place is when they were buying. So it would not be predictable quarter over quarter over quarter."
},
{
"speaker": "Operator",
"text": "Our next question is come from the line of Weston Bloomer with UBS."
},
{
"speaker": "Weston Bloomer",
"text": "My first one is on -- just a follow-up on Willis Re. Obviously, good organic there of 7%. With investments ahead of schedule, I'm curious how you're thinking about growth and margin improvement in that business in 2023? Could we potentially see organic come in above the 7%? How should we think about potential margin improvement? Would it potentially grow faster than the core portfolio currently?"
},
{
"speaker": "Doug Howell",
"text": "Well, that margin for the year is somewhere around 36%. So I think that we're very happy with that margin. I think holding that margin is the right answer for that business. It takes heavy investment. They've been underinvested for the last 3 or 4 years on that. So that is not a business, if you go back to our acquisition that was expecting substantial margin change on that. So we're happy with the margins the way they are. We think they're competitive. Sure, there will be opportunities for us to become more efficient, and we do that every year. We always become more efficient. But I think there's a ripe opportunity right now to hire brokers in that space that would like to join us. It's a hot thing going right now. So it would be nice to take and hire folks in that business. I think it's 34% for the year where we are."
},
{
"speaker": "Weston Bloomer",
"text": "Got it. And then my follow-up is just on M&A. Curious on what you're seeing on the international M&A market. Is that more attractive from a multiple perspective or a competition perspective right now? Or is maybe your term sheet disclosure more international U.S. weighted versus historical? Just kind of curious on what you're seeing."
},
{
"speaker": "J. Patrick Gallagher",
"text": "It's not more international weighted. It's about the same and multiples around the world, you can throw a hat over."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Weston. Thanks for being on the call, Weston. Nice to hear from you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "All of you by the way, Doug, let's not single in -- all right, I think that's our questions for now. I'd like to thank everyone on the call again for joining us. Obviously, we're excited. We had a fantastic second quarter and first half of 2022. I'd like to thank all our colleagues around the globe for their hard work, our carrier partners for their ongoing support and our clients for their continued trust. We look forward to speaking to you again at our September Investor Day meeting, and thank you all, everyone, for being with us."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and have a great night."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 1 | 2,022 | 2022-04-28 17:15:00 | Operator: Good afternoon and welcome to the Arthur J. Gallagher & Company First Quarter 2022 Earnings Conference Call. Today’s call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company’s 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you. Good afternoon, everyone and thank you for joining us for our first quarter 2022 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer as well as the heads of our operating divisions. We had a fantastic start to the year. For the first quarter, our combined Brokerage and Risk Management segments posted 30% growth in revenue, more than 10% organic growth, net earnings growth of 28%, adjusted EBITDAC growth of 34%, and adjusted earnings per share growth of 26%. And we were named a world’s most ethical company for the 11th year in a row, an outstanding achievement on its own and a testament to our nearly 40,000 professionals around the globe. As you can tell, I am extremely proud of how the team performed during the quarter. So, let me give you some more detail on our first quarter Brokerage segment performance. During the quarter, reported revenue growth was 32%. Of that, 9.6% was organic, which is just excellent. Rollover revenues of $380 million were pretty consistent with our March IR Day expectations and mostly driven by the December Reinsurance Brokerage acquisition. Doug will have some further comments on rollover revenues in his prepared remarks. Net earnings growth was 27%. Adjusted EBITDAC growth was 35%. And we expanded our adjusted EBITDAC margin by about 50 basis points, an outstanding all-around quarter for the brokerage team. Let me walk you around the world and breakdown the 9.6% organic, starting with our PC operations. First, our domestic retail business posted 11% organic driven by terrific new business, strong retention, and continued renewal premium increases. Risk placement services, our domestic wholesale operations, posted organic of 10%. This includes more than 20% organic in open brokerage and 6% organic in our MGA programs and binding businesses. New business was better than first quarter ‘21 levels and retention was consistent with prior year. Outside the U.S., our UK business posted organic of 14%. Within retail, fantastic new business and continued renewal premium increases helped drive 10% organic. In our London specialty business, including our legacy Gallagher Re operations, saw 17% organic. Australia and New Zealand combined organic was nearly 10% driven by strong new business, stable retention and higher renewal premium increases. And finally, Canada was up more than 12% organically and continues to benefit from renewal premium increases and great new business production. Moving to our employee benefit brokerage and consulting business, first quarter organic was up over 7%, more than 1 point better than our March IRD expectation. Our core health and welfare organic was in line with our expectations of 5% and the upside in the quarter was driven by our international operations and our HR consulting, pharmacy benefits and various other life insurance product sales. So, 7% organic in benefits, 11% organic within our PC operations, an excellent quarter. Next, I’d like to make a few comments on the PC market. Overall, global first quarter renewal premium increases were 8%, consistent with the fourth quarter of ‘21 after controlling for line of coverage mix differences. Recall, the renewal premium change includes both rate and exposure. So, let me break that down around the world. About 10% in U.S. retail, including double-digit increases in property, professional liability and casualty somewhat offset by workers’ comp and commercial auto. In Canada, New Zealand, renewal premiums were up about 8.5%, with professional liability seeing the strongest increases. In Australia and UK retail, renewal premiums were up mid single-digits driven by increases in casualty and package. Within RPS, wholesale open brokerage premium increases were up 11% and binding operations were up 6%. And in our London specialty business, we saw first quarter rate increases around 7.5%. Moving to reinsurance, as we noted in January, our 1/1 renewals showed price increases that varied by geography and client loss experience. And while rate tended to be based on client-specific attributes in loss history, even loss-free programs faced modest rate increases. Our April Gallagher Re first review report is more focused on Japanese renewals, which tend to dominate the April 1 renewal season. We saw pricing increases in property-related classes, while casualty pricing was flattish despite inflation being a key topic of discussion. You can access our April reinsurance market report on our website for more information. So whether retail, wholesale or reinsurance premiums are still increasing almost everywhere. Looking forward, we expect our mix shift away from workers’ compensation renewals in Q1 to U.S. property cat renewals in Q2 will lead to premium increases in the second quarter, very similar to full year 2021. And we see these difficult PC market conditions continuing throughout the remainder of this year. Carriers will likely continue their cautious underwriting stance due to rising loss costs and increases in reinsurance pricing. And this comes at a time when the conflict in Ukraine is elevating geopolitical uncertainty, courts are reopening and global monetary policy is tightening. So from our seat, it looks like carriers will continue to push for rate and don’t see a dramatic change in the near-term. Moving to our employee benefit brokerage and consulting business, I see domestic labor market conditions in ‘22 working in our favor. There are more than 11 million job openings in the U.S. That’s 5 million more jobs available than people unemployed in looking for work. And that imbalance lays the groundwork for robust demand for our HR and benefits consulting services as employers look to attract, retain and motivate their workforce. So, we finished first quarter with organic of 9.6%. Given our first quarter results and the current insurance market conditions, as we sit here today, we think 22% organic should end up even better than ‘21. Moving on to mergers and acquisitions, starting with some comments on our recent reinsurance acquisition. Integration is progressing at a fast pace and is ahead of schedule. Alongside the speed that we are executing comes the pull-forward of some of the future integration costs, which Doug will cover in his remarks. Also, we had a strong first quarter with the legacy Gallagher Re team growing 30% and our new reinsurance operations delivering towards $340 million of revenue and over $170 million in EBITDAC. And our reinsurance colleagues are melding together extremely well. So, it continues to be a really good story. During the first quarter, we completed 5 new tuck-in brokerage mergers, representing about $32 million of estimated annualized revenues. I’d like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have around 40 term sheets signed or being prepared, representing nearly $250 million of annualized revenue. We know not all of these will close. However, we believe we will get our fair share. Next, I’d like to move to our Risk Management segment, Gallagher Bassett. First quarter organic growth was 15.2%, better than our IR Day expectation due to a strong March, some new business wins and higher-than-expected COVID claims. Adjusted EBITDAC margin was 17.3% and would have been 18.5%, but we had a litigation settlement late in the quarter. Moving forward, we think the remaining ‘22 quarterly margins will be closer to our 19% expectation. We again saw increases in new arising claims across general liability, property, and to a lesser extent, core workers’ compensation during the quarter. New arising COVID claims were well above what we saw during the fourth quarter. However, core claim counts, which tend to have a greater impact on results, still have room to rebound fully to pre-COVID levels. Looking forward, we see ample opportunity for organic revenue growth from existing clients, growing claim counts and new business and expect organic to be around 10% per quarter for the remainder of the year. And let me finish with some thoughts on our bedrock culture. I believe our outstanding financial results are made possible because we are able to act as one company, united by one set of values, the Gallagher Way. As I mentioned earlier, we were once again named a world’s most ethical company by Ethisphere, a truly global effort that reflects our colleagues’ care and integrity to each other and our clients. Every day, I hear stories of our colleagues working together as one team to give our clients exactly what they need all around the world. That collaboration is possible because we genuinely want to deliver the best possible service at all times. When one team wins, we all win. And then there is the way our people give back to their communities. In March, we announced a special matching donation to provide humanitarian relief to the people of Ukraine. Thanks to the generosity of my Gallagher colleagues. We are able to donate over $1 million for necessities like food, water, supplies and first aid. I am proud to stand together with my Gallagher colleagues impacting communities around the world, and that is the Gallagher way. Okay, I’ll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks, Pat and hello, everyone. As Pat said, a fantastic first quarter and start to the year. Today, I will get to my typical comments on organic margins, clean energy, cash, etcetera and I will also do a financial recap of the Willis Re acquisition, but first, the modeling heads-up regarding rollover revenues this quarter. We typically don’t comment on consensus estimates, but this quarter looks like there is a large variance in brokerage segment rollover revenues relative to the guidance numbers we provided within our CFO commentary document during our March 16 IR Day. When we get to Page 6 of today’s CFO commentary document, you will see we have added a table that shows consensus overstates rollover revenues by approximately $40 million versus the number we provided in March. That has an impact of overstating consensus EPS by $0.06. We hope you take this into consideration as you analyze our performance relative to consensus and to your model. Okay. With that housekeeping behind us, let’s shift to the earnings release, to the Brokerage segment organic table on Page 3. All-in brokerage organic of 9.6%, we had a really strong finish to the quarter, some nice new business wins by the P&C team and a terrific finish by our benefits consulting teams. You will also see strong growth in both contingents and supplementals. The Ukraine-Russia conflict impact was small, about $5 million of revenue, which is about a $0.01 hit this quarter. Looking forward, it’s looking like its small also, maybe another $5 million revenue impact spread over the next three quarters. Given our strong start and given our current favorable outlook of the market, as Pat discussed, we could be pushing nicely towards upper 8% to 9% full year organic growth here in ‘22. Next, let’s turn to Page 5 to the Brokerage segment adjusted EBITDAC margin table. Headline all-in adjusted margin expansion for first quarter was 49 basis points, right in line with our March IR Day expectation. Recall that expansion includes a favorable seasonal impact from reinsurance roll-in offset in part by a return of expenses that we come out of the pandemic and it also has a little more incentive compensation given our stronger first quarter organic growth and full year expectations. Repeating what we said during March, we are well positioned to deliver around 10 to 20 basis points of full year adjusted margin expansion. But remember, as we discussed here in ‘22, there will be margin change volatility quarter-to-quarter. That’s due to expenses return as we come out of the pandemic and the roll-in impact of acquired reinsurance revenues. So, let me walk through what we said in March, 50 basis points of expansion here in the first quarter, then expecting second and third quarter margins to each be down around 100 basis points, but then that flips and we expect fourth quarter margins to be up around 100 basis points. The math, given that we are seasonally larger in the first quarter, gets us back to that 10 to 20 basis points of full year margin expansion. Looking way out towards ‘23 that quarterly margin change volatility should go away with the pandemic behind us and reinsurance fully in our books. Okay. Let’s move on to the Risk Management segment and the organic table on the bottom of Page 5. You will see 15.2% organic in the first quarter. That’s just terrific by the team. And with continued strong new business and rebounding claim counts, it’s looking like organic revenue growth of about 10% each quarter for the rest of ‘22. On the next page, you will see that our Risk Management segment posted adjusted EBITDAC margin of 17.3%. That was compressed by about 120 basis points due to an unusual late quarter litigation settlement. As Pat said, moving forward, we would expect margins for the remainder of ‘22 to be closer to 19%. Moving to Page 7 of the earnings release and the corporate segment shortcut table, most adjusted first quarter items were in line with our March IR Day estimates. Within the corporate line, we did also benefit from an FX remeasurement gain and a larger tax benefit related to employee stock option exercises given the strong performance of our stock late in the quarter. You also see a couple of non-GAAP adjustments. The first relates to transaction costs and professional fees associated with buying Willis Re. And the second was a state tax benefit related to the revaluation of our deferred income tax balances. Alright. Let’s now go to the CFO commentary document. Page 3 has our typical brokerage and risk management modeling helpers. We have updated our outlook for integration. I will get to that more in a minute. We have updated FX and you will see a slight tick-up in our expected Brokerage segment tax rate, call it 0.5 percentage point. In addition, the amortization lines in both brokerage and risk management are now highlighted in yellow. This means the item is now being treated as a non-GAAP adjustment. If you missed our March IR Day, we did a vignette on how this change – on this change and how we are reporting adjusted EPS. This is the first quarter reporting under that revised method. On Page 4 of the CFO commentary, that’s our corporate segment outlook. You will see there is no change in our outlook for second, third and fourth quarters. When you turn to Page 5 to clean energy, the purpose of this page is to highlight that we have over $1 billion of credit carry-forwards and we are now in the cash harvesting era of these investments. There is no GAAP earnings anymore other than a little bit of overhead expense, but rather now substantial cash flows. You will see in the pinkish column that the ‘22 cash flow increase should be substantial. We should be able to harvest $125 million to $150 million a year of cash flows and perhaps more in ‘23 and beyond, at that rate, a really nice 7-year cash flow sweetener. And there still is a possibility of an extension in the law, so we remain well positioned to restart production if that happens. Okay, flipping to Page 6 of the CFO commentary document. Top table is the rollover revenue table. Recall that we update this each earnings release day and also each quarter during our late quarter IR meetings. The next box, highlighted in yellow, is the math behind the $0.06 impact of consensus versus our March guidance that I touched on in my opening. Then at the bottom table is an update on our December Reinsurance acquisition. Revenue this quarter was $337 million and EBITDAC was $172 million. The very small difference to the numbers we provided during our March IR Day reflects two items: first, the quarterly timing related to further refinement in our ASC 606 accounting for both revenue and expense and second, some further movement in FX rates. In the end, if you go all the way back to our original August ‘21 projections, there is very little change to our first year of ownership expectations other than a small impact from Russia, Ukraine and FX. As for integration, the good news is that our original estimate of around a total of $250 million for integration charges through the end of 2024 is holding close. The even better news is we are making progress at a faster pace than we originally thought. Integration efforts around people, real estate, back office transition services, etcetera are targeted to be mostly done by late ‘22 versus mid to late ‘23 as originally planned. When it comes to technology rebuilds, we think most of it will be done by the end of ‘23 or early ‘24. So what that means is that we will see integration costs lumped more into ‘22 and ‘23, then spreading deep into ‘24. You will see the bump up of our ‘22 quarterly integration estimates back on Page 3 of the CFO commentary, but it’s important to remember, it isn’t changing our in-total view. So, that continues to be a really good story. As for cash, capital management and future M&A, at March 31, available cash on hand was about $450 million and no outstanding borrowing on our line of credit. With strong operating cash flows expected in ‘22 and a nice bump in cash flow from our clean energy investments, we are extremely well positioned to fund future tuck-in M&A using cash and debt. We continue to see our M&A capacity at more than $4 billion through the end of ‘23 without using any stock. So those are my comments. We’re off to a great start in ‘22. From my vantage point as CFO, we’re positioned for another great year. A huge thank you to the entire Gallagher team for another terrific quarter. Back to you, Pat.
J. Patrick Gallagher: Thank you, Doug. Darryl, I think we’re ready to open up for questions, please.
Operator: Thank you. Our first questions come from the line of Paul Newsome with Piper Sandler. Please proceed with your questions.
Paul Newsome: Good morning. Good afternoon, Patrick. Congratulations on the quarter.
J. Patrick Gallagher: Thanks, Paul.
Paul Newsome: I was going to ask about the guidance for organic growth is at a decelerating pace. Maybe you could talk about sort of the factors that go into what might be decelerating prospectively from a macro basis that’s having an effect on your business.
Doug Howell: So listen, I think we posted 9.6% this quarter, and I think that we’re guiding upper 8% to 9%. I wouldn’t call that a deceleration. I think that there is a reality, looking towards where we were in third and fourth quarter, as the compares get a little more difficult to have. But I don’t know if I’d use the word deceleration, but I think it’s pretty close.
J. Patrick Gallagher: Well, in fact, Paul, we looked at the stats before this call, and over the last eight quarters, the renewal rates across our book, including, I should add, the exposure units are about flat, around 8.5% to 9%. So I mean it varies up to 9%, 9.5%, it comes down to it. But I would say any kind of a wholesale drop-off is not what we’re seeing, to Doug’s point.
Paul Newsome: Knock on wood, my second question relates to interest rates. We are finally seeing some rising interest rates. I was wondering what your thoughts are on how that affects your earnings as well as, frankly, M&A. I wonder if we’re seeing any change in the competitive environment for M&A with interest rates changing as well. So I guess that’s sneaking in essentially two questions.
Doug Howell: Let me take the investment income for our fiduciary funds that we keep on hand. We would think that a 1 point rise in interest rates would be about another $40 million a year of investment income versus what we’ve been showing so far. That might tick up a little bit more as we get reinsurance completely rolled into our books. In terms of what that means in terms of other pressures inside of our organization, we’re just not all that sensitive to interest rates internally in our operating model.
J. Patrick Gallagher: But we do know, Paul, I mean let’s face it, a lot of the competition from our private equity competitors for acquisitions has been driven by free money. And if they got to start paying for it I think that bodes well for us.
Paul Newsome: That makes sense. You haven’t seen that – I see this as too soon with interest rate can...
J. Patrick Gallagher: Cash, no, we haven’t seen anything.
Paul Newsome: Great, thanks guys. Appreciate the help.
J. Patrick Gallagher: Thanks, Paul.
Operator: Thank you. Our next question is come from the line of Mark Hughes with Truist. Please proceed with your question.
J. Patrick Gallagher: Hi, Mark.
Mark Hughes: Yes. Hello, Pat. Good afternoon. Could you give the margin in brokerage, if you back out the Willis Re, I suppose you’ve given us the inputs, but do you have that handy, Doug?
Doug Howell: I can dig it out here for you here in a second.
J. Patrick Gallagher: We’ve got it at the table somewhere, Mark, do you have another question?
Mark Hughes: Yes. Pat, you talked about the risk management being helped by an uptick in GL property, workers’ comp claims. Anything you see in either GL or comp that influences your view of what’s going to happen in terms of the cycle, if, in fact, courts are opening and you’re seeing a pickup in GL. Does that tell you anything?
J. Patrick Gallagher: There is two things I’d comment on, Mark, really. One is it’s been in very interesting hard market. And as you know, looking over the past, what is now almost 4 years, comp hasn’t moved. Comp has not been a big rate driver up and it’s not coming down. So it’s been an interesting line. And as the economy becomes more robust. And frankly, when we pick up – when we start to fill some of those 11 million jobs, I think the natural increase in claim activity is going to really benefit Gallagher Bassett. We clearly can track back that when our economy is humming, it’s just a natural outcome. You don’t like to see people get hurt, but we have more claim volume. That’s number one. Number two, what I continue to be astounded by, and I’m sure everybody on this call reads it every week as well, when I look at our social inflation around tort, it’s incredible. And so I think what you’re seeing is, number one, case settlements at levels that never any of us would have predicted but also what that does is it drives our clients to be much more cautious and concerned about claims that, frankly, in the past, they might have said, pay us $50,000, move on or let’s not settle that. It doesn’t look like that big a deal. I mean not to get anecdotal on you all, but it is late in the evening. And you probably saw the settlement last week for some guy who got $450,000 because this company threw a surprise party for him. I mean I keep asking the folks for a surprise party. But it’s just – so that I do think is beneficial to GB. And GB continues to invest and I think capable of proving that if, in fact, you use our services, with all that we bring to the table, our outcomes are better. So all of a sudden, if you’re used to getting a lot of claims, but one of them every 5 years tends to pop. And now you’re looking at it, you go, man, what’s happening? I’m starting to get 2 a year, 3 a year. Now who pays those claims makes a bigger and bigger difference. And I think that bodes well for the long-term.
Doug Howell: Mark, I can give you the answer on the – if you have a follow-up with that, then I’ll come back to that.
Mark Hughes: Okay. I was just going to ask on the June 1 reinsurance renewals, so what kind of rate increases are you seeing, how much dislocation is there in the cat property.
J. Patrick Gallagher: Really not that much dislocation on the reinsurance side. And I would say, back to my prepared remarks, depending on the carrier, depending on the carriers experience. That’s what’s driving the renewals. And Doug, go ahead.
Mark Hughes: Okay.
Doug Howell: Yes. On the margin, Mark, we’re somewhere around high 37% margins in the brokerage business without Willis Re. And there is some variability around that because of allocations between the units, right? Second of all, I just think that in the context of margin, as you’re looking at what’s changed since last year. This quarter, I know that we’re ahead on our bonus accrual relative to where we were last year because we started off with considerably better organic growth. So that has a little bit of a margin compression impact, but I would consider that timing. We are in the first quarter. And recall, we give our raises out mid-year, so raise impact rolling in versus first quarter. As organic develops throughout the year, you grow into your raises and then when it comes back to cost returning into the business. So if you break it down, let’s say that expenses year-over-year on an apples-to-apples basis are $25 million up, $10 million of that’s bonus. You probably can call it $6 million is raise impact and then you get down to about $8 million left over. That’s probably – take third of that and call it increased professional fees that we’re spending, third of that would be T&E travel and third of that would be client entertainment. So when you look at the pieces of being up, let’s say, $25 million of expenses year-over-year, the way we look at it, call it, $10 million of it’s timing and $15 million is spread between raises that we will work ourselves into for the year and then the other piece of it, T&E, entertainment and some professional fees. Does that help?
Mark Hughes: Yes. I appreciate the detail.
Doug Howell: Sure. Yes. And let me throw in too is that we’re – I went back while you were doing that. I looked at in first quarter of 2019, we posted 35%. And this is where the supplement really helps so that we post, not the CFO commentary but the 5-year supplement we put out there, we posted 35.6% EBITDAC margin in first quarter of ‘19. And this quarter in the Brokerage segment, we’re at 39.8% so we’re up 420 basis points. If we hit our target this year of being up 10 to 20 basis points for full year, we’d be up 540 basis points over 2019. So it’s 180 basis points of margin expansion a year over the last 3 years, each year, 180 basis points. And truly, our reinsurance business is rolling in. While seasonally a little better this quarter, when you put full year and it’s not all that different than our combined brokerage operation margins. So the margin story we believe is pretty darn good. And when we’re running somewhere around 34 points of margin for full year, if we hit our targets this year, that’s pretty darn good versus the 28 and change in 2019.
Mark Hughes: Appreciate it.
Doug Howell: Sure.
J. Patrick Gallagher: Thanks, Mark.
Operator: Thank you. Our next questions come from the line of Greg Peters with Raymond James. Please proceed with your questions.
J. Patrick Gallagher: Hi, Greg.
Greg Peters: Hi, good afternoon, everyone. I can say listening to your comments, Pat, that I’m sure a number of us, myself included, would take a piece of the action on your surprise party. Keep us in mind. So I guess from a macro perspective, I’m going to comment – Paul tried to ask a question, I’m going to come at it from a different way. I know you’ve mapped out a pretty robust outlook for the remainder of the year. There are a number of economists and other reports out there that are speculating about the potential oncoming over a recession. And obviously, the data is not showing it yet, at least your data isn’t. But I’m just curious from an enterprise risk management perspective. When you think about that type of risk, what are you doing at the corporate level to prepare for something like that, if you think that might be in the cards?
J. Patrick Gallagher: Well, first of all, Greg, I’m not going to sit here and predict a recession. Unfortunately, we’ve lived through them before. And I think we do know how to react to those. And when you’re in a recession, a couple of things happen that are very, very negative. Exposure units drop, companies go broke, expenses become even more important, not that they are ever not important, and shopping can go up. Now when shopping goes up for our strength, in particular, in the middle market, I think we show well. So we hold our own there. But when you’ve got a robust economy falling off, you end up with negative audits and you’ve got lesser exposure units. And depending on the depth of that recession, it’s not a pretty picture. So when you talk about what are we doing relative to our risk management approach, we talk about it every quarter. We take a look at where we are. We’ve got significant margins, and we prepare to say here’s what we have to do to make sure that – one of the things I really like about our model is we basically pay our production for us on how their book of business performs. So, we are all in this together and if the business is sinking. Now in previous recessions, if I don’t go back too far, we’ve not had the benefit of inflation. So inflation may, in fact, help cause a recession and I don’t know whether that will be 1 point, 2 points. I know the first quarter GDP was down. But if you’re talking 5% to 8% inflation, that has the exact opposite impact. As you know, payrolls go up. We are all seeing that. I mean, I can’t go a day without somebody stopping me and saying we are getting whacked. I’ve got a mid-level service person, and it’s a problem and what am I going to do about it? And every customer is coming to Bill’s or Bell’s team and saying, how am I going to hold on to my people. Everybody wants them. They go to a restaurant. They don’t have people that can serve you. I mean there is just huge demand, and that’s pushing payrolls up. And our contractors book, they bid everything out and now they got to deliver at inflation rates they never anticipated when they made the bid. Well, if there is other business to bid, those rates are going up. So sales will go up. So there is offsetting factors there. And I think our business holds up pretty darn well in a recession.
Doug Howell: Yes, so a couple of things. We look at daily endorsements, cancellations, audits, we get that as a daily feed. And this was the biggest month of positive audits that we’ve seen. And again, that’s historical. That’s a rearview mirror metric, but I’m not seeing that trail off at all. So I’m not seeing any early signs of a recession to happen because the first thing a customer will do is they’ll ring up the phone and they’ll adjust their expected payrolls down. So we’re not seeing that. We’re not seeing it in our exposure unit and our rate monitoring the deal. We look at renewals every day also. So we’re just not seeing it happen. But what we’ve proven throughout the COVID is that we’ve got a pretty resilient model that we have a lot of levers to pull should we get into a situation where growth becomes more difficult. And I think that we’ve proven we can do that. So we think the model is resilient. We think that inflation is going to help us on the top line when it comes to revenues for the business that’s there. But we do have levers that we can pull in order to help us get through a recession.
J. Patrick Gallagher: And also, let me remind you, back in 2007, ‘08, ‘09, and this is just an incredible support of this model again. You’d think oh, my gosh, it’s going to be our clients will stop paying their people before they stop paying their insurance bill. That’s how important we are to them. That’s a good spot to be.
Greg Peters: Indeed. Thanks color on that. Pivot to perhaps a little bit more detailed question and Doug, your guidance and commentary on the various parts in your CFO commentary quite helpful. And I guess what I wanted to ask about was the free cash flow, excluding clean energy because you talked about the integration expense and some other things. I’m just wondering what you think the cadence of that looks like now for ‘22. Has there been a change versus previous expectations? And how you would suggest we look at that?
Doug Howell: Let’s see if I can break it down. Let’s start with $4 billion that we have left over for M&A in ‘22 and ‘23. Cash – clean energy provides $250 million of that. Integration is already net in that number, right? So I’ve already given you a number net of integration. Also, when we talk about integration, you’ve got to look at it as half of it being noncash and half of it being cash. You recall that integration expenses are the sign-up bonuses that we delivered and mostly equity plans, so that’s amortizing as a noncash item against that. So I would say that integration won’t consume an excessive amount of cash. I would say that the clean energy – maybe you think about it this way, the clean energy basically offsets the cash portion of that. And all that is all washed out in our $4 billion expectation for M&A over the – during ‘22 and ‘23. Does that help you give a thought on it?
Greg Peters: It does. I know you’ve given me similar answers like that in the past. It feels like that should be your voice mail, but thanks for reminding me of all that little pieces there.
Doug Howell: Listen, it generates a lot of cash. It’s like I say around here, I don’t make the money, I just count it and there is a lot of it coming in.
Greg Peters: Got it. Thanks, guys for the answers.
J. Patrick Gallagher: Thanks, Greg.
Operator: Thank you. Our next question is come from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question.
J. Patrick Gallagher: Hi, Elyse.
Elyse Greenspan: Hi, thanks. Good evening. Maybe my first question is kind of going back to the earlier discussion on organic. Pat, when you gave us the initial outlook for 2022, you had said that the full year would be about 1% above the Q1. So is it just that the – and I think that was maybe based off of the benefits business perhaps being a little lighter and heavier in concentration in the Q1. But is there something that changed? Or is there just – I understand that the rest of the year outlook is close to the Q1. Is there something that perhaps caused that view to change? Or is it just that just as simple as the Q1 being better than you expected when you made that comment?
J. Patrick Gallagher: I’ll let Doug answer the actual number piece on that because a lot of that’s mathematical. But in terms of what I’m seeing for the year, I’m not seeing – I’m not anticipating significant change in the operating environment over the next three quarters.
Doug Howell: Yes. I think that our cautious guidance in January and then again in March really was talking about the fact that we’re not getting rate lift from workers’ comp, which is heavier in the first quarter. And then also, you’re not really seeing rate and benefits yet now it’s interesting since that guidance there is medical inflation that’s coming back fast and furious. And I think that give us another quarter on that, and we might become a little bit more bullish because I think that – and of course, that will eventually translate into workers’ comp too, absent of any frequency declining or holding in there. But I think our cautiousness on the benefits business might have been overly cautious. But again, we just need to see another quarter of that before we get into a position of declaring that there is true medical inflation that’s going to affect next year’s growth, too. But I don’t see it as a headwind. I see it as a tailwind to our organic.
Elyse Greenspan: Great. And then my second question, you guys have mentioned having around $4 billion of capital over the next couple of years to spend on M&A. The tuck-ins, right, were just around $30 million this quarter, so maybe a little bit light relative to some historical averages. So as we think about just kind of deal flows, it sounds like interest rates could impact private equity interest, so maybe that helps with the pipeline. Is there a certain point and maybe we have to wait until next year where if deals don’t materialize since that’s a pretty high level of capital, Gallagher might consider using some buybacks as well with the excess capital?
Doug Howell: I think an answer to that is – yes, let’s clarify. I think that first quarter is already seasonally the smallest when it comes to M&A. It’s historically been that 5 years out of the last 6 years. So, I think there is just a natural little push towards year-end and then there is a little pause in the first quarter. So, I think there could be a rebound in opportunities through the rest of the year. If those rebounds don’t materialize and we are not seeing opportunities for it, then our next place that we would go is to make sure that our debt is clearly within an a solid investment-grade rating and then use it for stock buybacks next and then maybe even consideration on the dividend. So, those are the three or four things that we are seeing how is deal flow look, next thing is what do we do with the excess cash as the deal flow isn’t there, and we will stack that up to controlling the debt, for sure, then making sure that we are positioned well to buy back stock or do dividend increases.
Elyse Greenspan: Okay. And one last one on Willis Re, I recognize the revenue was close to what you guys had laid out at the Investor Day. Can you give us a sense of just client retention and new business and how that’s been trending in your first full quarter of owning the business?
J. Patrick Gallagher: Yes. I will do that, Lisa. It’s really been an amazing and let’s remember, as we finished the quarter, we are four months in. So, as we have this call, we are close to five months. But I will tell you that the team, we are not losing people, we are not losing clients. Our renewals have been fantastic. Tom, myself, others at the table have had a chance to meet with reinsurance clients. They continue to be very open about the fact that they are glad. That they are – there is not one less competitor in the marketplace. They are also very clear with us that the reason that the business held together over the years of discussion as to where this business was going to land was because of the people handling their business. And those people are still in place. Our losses in terms of people out the door are minimal to zero. And so when I look at it, I am really, really happy about it. And new business pipeline is strong. What I am very excited about is the integration that we are seeing or the sharing of information from our retail. Everybody said at the beginning, why is this good for retail. And people also would ask, why does reinsurance care what you are doing as a retailer. Well, I will tell you what. There is so much going back and forth right now in terms of data relative to the business we are doing with all kinds of carriers, with things that our reinsurance people are seeing can help our retailers and they are melding. So, the business is strong. We are absolutely nailing it when it comes to what we hope the performer would be and I think it’s going to continue to be a great business for us.
Doug Howell: Yes, I can give you some numbers behind that flavor is that – and I will give it to you is net new. Our net new was over 5% this quarter, if you control for those people that put on a different jersey before we bought it. And our overall organic is nicely, let’s call it, 8% first quarter plus or minus a point. So organic, really I got to give it to the team for what they went through for 3 years for them to be out there battling the way to have holding their clients, writing new business, I mean it’s really a terrific story. So, when you are posting organic nicely in that upper-single digits after what they have been through, I couldn’t be more pleased with the team.
Elyse Greenspan: Great. Thanks for all the color.
J. Patrick Gallagher: Thanks Elyse.
Operator: Thank you. Our next questions come from the line of David Motemaden with Evercore. Please proceed with your questions.
J. Patrick Gallagher: Hi David.
David Motemaden: Hi. Good evening. How is it going guys?
J. Patrick Gallagher: Great.
David Motemaden: So, great to hear the outlook on organic in the Brokerage segment, but obviously still keeping the 10 basis points to 20 basis points full year margin expansion outlook. I guess I am wondering, it definitely sounds like it’s a bit more positive on the organic growth side. So, I guess I am wondering why I guess we are not expecting or why you guys aren’t expecting more margin improvement than the 10 basis points to 20 basis points. Is it additional investments that you are making? Is it the bonus accruals? Is it something in addition, I think you had called out $60 million of incremental costs coming back in this year. Is that higher now that sort of keeps it at 10 basis points to 20 basis points of margin expansion?
Doug Howell: Yes. I think that we are just a little reluctant right now to push that up when it really comes down to it. I think that there is a lot of things that we would really like to do. And I will segue into some of the exciting stuff. When you look at what’s going on with – and you listen to our March, our late quarter IR Day. We talk about all the great things we are doing in the business. When you look at what’s going on with our electronic delivery platform, when you are looking at the automation that we are doing that we are writing 6,000 policies a month with hardly anybody involved on cyber, the Gallagher Drive, the Advantage program, the smart market. And then you look at the advertising and the brand building that we are doing and spending money on that systems. We are spending money on hardening the environment and delivering more point-of-sale capabilities to the sales force. When you look at all those things, posting another 10 basis points, 20 basis points, 30 basis points of margin expansion on top of already posting 540 basis points of expansion since 2019, we would just like to spend a little money this year. When you get to 2023, as a lot of this levelizes between the pandemic and between – and the roll-in of the reinsurance M&A, you might see a little bit more expansion in that if we are still posting in that 9% range. But right now, this is a great opportunity for us to invest in the future organic growth of the company. So, that’s where we are on it. You want to call that voluntary spend, call it, voluntary spend, but it’s not must spend.
David Motemaden: No, it makes sense. No, that makes sense. And I guess just maybe it sounded like the international business did quite well in the first quarter. So, I guess I am wondering, Pat, just specifically, could you just talk about what you are seeing on the ground in Europe and in the UK, if there is any sign of any wobbles there in terms of exposure growth or demand as I think some of the leading indicators are pointing towards economic slowdown there?
J. Patrick Gallagher: Well, let me go around the world again as I did in my prepared remarks. So, if you take a look at what we are seeing in Canada. And it’s – our team in terms of new business is on fire. When we closed on Neuraxis years ago and the Canadian economy was a little flush where it was a little slow. We weren’t together. Neuraxis has seven separate businesses kind of operating separately. Now that business is totally together. The Gallagher branding is working extremely well. People are pumped up. We are using sales force. Our pipeline has grown and the 10% organic, yes, it’s helped by rate, but new business is much better than it’s ever been. When you go to the UK, that same timeframe, we have added new – recall, we bought Heath Lambert, Giles, etcetera, again, a lot of time on integration. Today, we will do an acquisition of size in the UK. And frankly, we have got that thing integrated in five months to seven months. And they are putting on a Gallagher jersey. They are excited about it. Then our team just gets stronger and stronger there. Now, I can’t tell you that economic events aren’t going to impact us. Recessions are terrible. Bad for our clients, they are bad for us, and they are bad for our business. But I would tell you that where we are from a team perspective is fantastic. So, you are right to look through the numbers and say it seems like international is doing really well because as we walked around the world and told you the organic, they are just killing it everywhere. Latin America is strong. New Zealand is strong. Australia is strong, and all of that is not just rate driven. That’s the thing I want to make sure everybody realizes is that it’s not just because rates are moving, we are getting our fair share of our new business opportunities. And in fact, we are seeing hit ratios improve and we are being helped by our clients’ business expansions and just blocking and tackling. So, it’s a very good spot to be.
Doug Howell: Yes. I can’t predict the trickle-on effect. But remember, we are primarily in the UK. We do have inflow from the rest of Europe. Not heavily based in by any means in Eastern Europe. So, we don’t have that. And I think at one point, we looked at and our inflows from Europe might have been in that $40 million range in total revenues. So, if you think about it in the context of what it means to Gallagher, if all of Europe would stop sending any business to London, it’s $50 million of lost revenue to us. And pushing $8 billion of revenue as a total organization, we would feel it, but it wouldn’t register at all.
J. Patrick Gallagher: David, I think it’s fair to say, too, what we have done in the United States in terms of the things you have seen in your SmartMarket, Gallagher Drive. Those things are impacting our new business with carriers, our retention and clearly, our new business hit ratios using SmartMarket, and we are taking those internationally now. So, that was born and bred here in the U.S. But those are our products that are going to be available in Canada and the UK to start. And they are difference makers. And really remember, when we compete and this is one of the things about again, kind of being in a lucky spot. 90% of the time when our people go out the door to compete, we are competing with somebody smaller. Say at 10%, 11%, 12% of the time, we are competing with folks that, frankly, can come to the table with the same type of resources or story. But every other time, when I talk to our sales force, I think we should win. We don’t, obviously, but I think that’s having an impact. Our people go out the door thinking they are going to win, I will tell you that.
David Motemaden: Yes, it definitely looks like you guys are getting your fair share of wins. And I know in the past, you have broken out the brokerage organic in terms of drivers by exposure, pricing and net new. I think in the past, you said it’s about a third, a third, a third, has that changed at all this quarter?
Doug Howell: Well, I think rates might be fueling that just a little bit more, but we probably need a little more time to peel that apart. We will see if I can give you something, and get back together in June on that. But right now, rates probably used to be a third, a third, a third, and I think rates might be more 40% than, 30%, 30%, something like that.
David Motemaden: Yes. Okay. Great. Thank you.
J. Patrick Gallagher: Thanks David.
Operator: Thank you. Our next questions come from the line of Meyer Shields with KBW. Please proceed with your questions.
Meyer Shields: Thanks. Hi guys. I hope all is well. One, I guess dumb question. When I look at Page 3 of the CFO commentary, it still anticipates a full year margin of 19% in risk management. Is that – does that mean that we are going to unwind some of the first quarter underperformance, or is that assuming – is that based on like the $18.5 million?
Doug Howell: I think we will be somewhere nicely in the 18% for full year. So, I think that if we post three quarters of 19%, we will claw back into that $17.3 million for this quarter. And again, we get an unusual legal settlement probably once every 4 years, 5 years. So, it’s unfortunate it happened this quarter, but that business is really doing well.
Meyer Shields: Okay. That’s helpful. A second issue, and I know these are small numbers, but does the call it withdrawal from Russia on the reinsurance business, does that have any impact on the earn-out?
Doug Howell: Yes. I would technically have an impact. If we don’t reach some of our milestones in it, that loss of $10 million over the course of the year, yes that might have a – it would have an impact on it.
J. Patrick Gallagher: They are going to overdo that. That’s not – my prediction is it will not.
Meyer Shields: Okay. Because of other businesses compensating?
J. Patrick Gallagher: Correct.
Meyer Shields: Okay. And then one final question on the reinsurance side and Pat, you talked a lot about the fact that some of the people there were under some strain over the past couple of years. Did that depress what Willis Re was able to charge? Is there an opportunity for revenue growth now that simply because it’s a more stable platform or you can invest in it more heavily?
J. Patrick Gallagher: Well, I got to understand the question. I mean our reinsurance clients pay us very, very, very well and very fairly and now a stable environment is not going to give us the ability to charge our clients. Does it give us the ability to invest more favorably, absolutely, because you now have people and our old business is people. To be perfectly blunt, there were people who were going to join them before, like join them in the middle of a sale. Nobody knows – by the way, remember, I am not making this up, it was public. I mean they couldn’t tell the people at Willis where they are going to sit, who are they going to work for. That’s not easy to recruit into, is it. Well, there is lots of opportunities to invest. There is lots of – at the same time, reinsurance buyers are kind of frozen in the headlights. We want to see competition in the market. We don’t want Willis, frankly, to disappear, but we are not going to build the problem bigger. So, yes, there is opportunities for us to go back to those clients and say, “Hey, we think we have got something to tell you now.” So, I think once it settles down and we all get – again, I am four months into the quarter, five months in total, a year from now I will have a much better feel for the individuals.
Doug Howell: I will add to it, though the thirst for information from our reinsurance partners is there. And if we can bring them the information that they are looking for that maybe they haven’t been able to get in the past. I believe that, that will help them attract more new clients and perhaps broaden out the book of business they are doing with their existing clients. I do believe that our ability to provide real-time data like we do for our retail business to them, a compelling advantage for them in the marketplace.
Meyer Shields: Okay. That is very helpful. Thank you so much.
J. Patrick Gallagher: Thanks Meyer.
Operator: Thank you. Our final questions come from the line of Weston Bloomer with UBS. Please proceed with your questions.
Weston Bloomer: Hi. Thanks for taking my questions. My first was a follow-up on the investments that you guys described around the systems and point of sales. I guess what’s the pipeline and timing for that? Does that extend into 2023? And just curious because in 2023, can we go back to a world where the pre-pandemic commentary was we expand margins if organic is over 4%? Is that baseline potentially still the same, or could it be lower given the higher investments that you are making? Recognizing that the 34% and 19% margins are still impressive, but curious how to think about that in 2023?
Doug Howell: Well, one of the things I would like to say about it is that we have been investing in these technologies all along the way. So, we are talking about investing in another $3 million or $4 million or $5 million a quarter. I mean this is a smart market advantage, better works 360, all the things that we are doing, we are continuing to invest in them, and we really didn’t slow that down much. It’s the incremental spend on them to make them even better and more competitive. That’s what we want to do. I mean if you looked at our GB go, I am just talking in the risk management right now, what they can do to adjust a claim on your phone with you, track it, monitor it, help you get back to work, it’s impressive. So, these are the type of enhancements that we have on the table how do we make that better, how do we make Gallagher Drive better. Right now, RPS has 24 different products on their quote and buying system that’s basically a no-touch system. They are doing 6,000 policies a month. What happens when we took that out to 48 policies and our investment spend on that illustratively is about $2 million a year. But what if we get 48 different lines of cover on that and then go to 72 and then go to 100? It’s – those are the type of incremental investments that we would like to make because I think they are powerful. I say this all the time, what we are doing on the RPS automation side alone is a $1 billion business. And I think we would like to do that across 20 different things inside of the company. So, where our margin is going to be in ‘23, we are going to – I think that we are going to be over the return of expenses from the pandemic. The real question is how much are we going to spend on investment on that. But it would stand to reason that if we post at least 4% organic growth, there will be opportunities to expand on that.
Weston Bloomer: Got it. That’s helpful color. And then my second question is a follow-up to Elyse’s on M&A. I just want to clarify. Was all of the term sheet disclosure – is all of that seasonal, or is there any of that strategic around Willis Re? The reason I am asking is I am trying to frame the potential for maybe a pickup in that number in the second half as you annualized the deal?
J. Patrick Gallagher: The numbers we were talking about in the pipeline in our prepared remarks are totally outside of Willis Re. Willis Re is done, those are…
Weston Bloomer: What I meant is, yes, is the pipeline potentially lighter as you focus on integrating Willis Re?
J. Patrick Gallagher: No. Our retail operations have zero distraction by the Willis Re folks.
Doug Howell: And actually, we are starting to see some small little boutique reinsurance opportunities pipe up on our deals already.
Weston Bloomer: Okay. That’s great to hear. Thank you.
Doug Howell: Thanks Weston.
J. Patrick Gallagher: Thanks Weston. Darryl, I think that’s all our questions for tonight. So, I would like to just say thank you again for joining us. Obviously, we had a fantastic start to 2022. I would like to thank our colleagues around the globe for their hard work. We are a people business and our results directly reflect your efforts. Thank you. We look forward to speaking with you again at our June Investor Day, and thanks for being with us, everybody.
Operator: Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and enjoy the rest of your day. | [
{
"speaker": "Operator",
"text": "Good afternoon and welcome to the Arthur J. Gallagher & Company First Quarter 2022 Earnings Conference Call. Today’s call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company’s 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you. Good afternoon, everyone and thank you for joining us for our first quarter 2022 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer as well as the heads of our operating divisions. We had a fantastic start to the year. For the first quarter, our combined Brokerage and Risk Management segments posted 30% growth in revenue, more than 10% organic growth, net earnings growth of 28%, adjusted EBITDAC growth of 34%, and adjusted earnings per share growth of 26%. And we were named a world’s most ethical company for the 11th year in a row, an outstanding achievement on its own and a testament to our nearly 40,000 professionals around the globe. As you can tell, I am extremely proud of how the team performed during the quarter. So, let me give you some more detail on our first quarter Brokerage segment performance. During the quarter, reported revenue growth was 32%. Of that, 9.6% was organic, which is just excellent. Rollover revenues of $380 million were pretty consistent with our March IR Day expectations and mostly driven by the December Reinsurance Brokerage acquisition. Doug will have some further comments on rollover revenues in his prepared remarks. Net earnings growth was 27%. Adjusted EBITDAC growth was 35%. And we expanded our adjusted EBITDAC margin by about 50 basis points, an outstanding all-around quarter for the brokerage team. Let me walk you around the world and breakdown the 9.6% organic, starting with our PC operations. First, our domestic retail business posted 11% organic driven by terrific new business, strong retention, and continued renewal premium increases. Risk placement services, our domestic wholesale operations, posted organic of 10%. This includes more than 20% organic in open brokerage and 6% organic in our MGA programs and binding businesses. New business was better than first quarter ‘21 levels and retention was consistent with prior year. Outside the U.S., our UK business posted organic of 14%. Within retail, fantastic new business and continued renewal premium increases helped drive 10% organic. In our London specialty business, including our legacy Gallagher Re operations, saw 17% organic. Australia and New Zealand combined organic was nearly 10% driven by strong new business, stable retention and higher renewal premium increases. And finally, Canada was up more than 12% organically and continues to benefit from renewal premium increases and great new business production. Moving to our employee benefit brokerage and consulting business, first quarter organic was up over 7%, more than 1 point better than our March IRD expectation. Our core health and welfare organic was in line with our expectations of 5% and the upside in the quarter was driven by our international operations and our HR consulting, pharmacy benefits and various other life insurance product sales. So, 7% organic in benefits, 11% organic within our PC operations, an excellent quarter. Next, I’d like to make a few comments on the PC market. Overall, global first quarter renewal premium increases were 8%, consistent with the fourth quarter of ‘21 after controlling for line of coverage mix differences. Recall, the renewal premium change includes both rate and exposure. So, let me break that down around the world. About 10% in U.S. retail, including double-digit increases in property, professional liability and casualty somewhat offset by workers’ comp and commercial auto. In Canada, New Zealand, renewal premiums were up about 8.5%, with professional liability seeing the strongest increases. In Australia and UK retail, renewal premiums were up mid single-digits driven by increases in casualty and package. Within RPS, wholesale open brokerage premium increases were up 11% and binding operations were up 6%. And in our London specialty business, we saw first quarter rate increases around 7.5%. Moving to reinsurance, as we noted in January, our 1/1 renewals showed price increases that varied by geography and client loss experience. And while rate tended to be based on client-specific attributes in loss history, even loss-free programs faced modest rate increases. Our April Gallagher Re first review report is more focused on Japanese renewals, which tend to dominate the April 1 renewal season. We saw pricing increases in property-related classes, while casualty pricing was flattish despite inflation being a key topic of discussion. You can access our April reinsurance market report on our website for more information. So whether retail, wholesale or reinsurance premiums are still increasing almost everywhere. Looking forward, we expect our mix shift away from workers’ compensation renewals in Q1 to U.S. property cat renewals in Q2 will lead to premium increases in the second quarter, very similar to full year 2021. And we see these difficult PC market conditions continuing throughout the remainder of this year. Carriers will likely continue their cautious underwriting stance due to rising loss costs and increases in reinsurance pricing. And this comes at a time when the conflict in Ukraine is elevating geopolitical uncertainty, courts are reopening and global monetary policy is tightening. So from our seat, it looks like carriers will continue to push for rate and don’t see a dramatic change in the near-term. Moving to our employee benefit brokerage and consulting business, I see domestic labor market conditions in ‘22 working in our favor. There are more than 11 million job openings in the U.S. That’s 5 million more jobs available than people unemployed in looking for work. And that imbalance lays the groundwork for robust demand for our HR and benefits consulting services as employers look to attract, retain and motivate their workforce. So, we finished first quarter with organic of 9.6%. Given our first quarter results and the current insurance market conditions, as we sit here today, we think 22% organic should end up even better than ‘21. Moving on to mergers and acquisitions, starting with some comments on our recent reinsurance acquisition. Integration is progressing at a fast pace and is ahead of schedule. Alongside the speed that we are executing comes the pull-forward of some of the future integration costs, which Doug will cover in his remarks. Also, we had a strong first quarter with the legacy Gallagher Re team growing 30% and our new reinsurance operations delivering towards $340 million of revenue and over $170 million in EBITDAC. And our reinsurance colleagues are melding together extremely well. So, it continues to be a really good story. During the first quarter, we completed 5 new tuck-in brokerage mergers, representing about $32 million of estimated annualized revenues. I’d like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have around 40 term sheets signed or being prepared, representing nearly $250 million of annualized revenue. We know not all of these will close. However, we believe we will get our fair share. Next, I’d like to move to our Risk Management segment, Gallagher Bassett. First quarter organic growth was 15.2%, better than our IR Day expectation due to a strong March, some new business wins and higher-than-expected COVID claims. Adjusted EBITDAC margin was 17.3% and would have been 18.5%, but we had a litigation settlement late in the quarter. Moving forward, we think the remaining ‘22 quarterly margins will be closer to our 19% expectation. We again saw increases in new arising claims across general liability, property, and to a lesser extent, core workers’ compensation during the quarter. New arising COVID claims were well above what we saw during the fourth quarter. However, core claim counts, which tend to have a greater impact on results, still have room to rebound fully to pre-COVID levels. Looking forward, we see ample opportunity for organic revenue growth from existing clients, growing claim counts and new business and expect organic to be around 10% per quarter for the remainder of the year. And let me finish with some thoughts on our bedrock culture. I believe our outstanding financial results are made possible because we are able to act as one company, united by one set of values, the Gallagher Way. As I mentioned earlier, we were once again named a world’s most ethical company by Ethisphere, a truly global effort that reflects our colleagues’ care and integrity to each other and our clients. Every day, I hear stories of our colleagues working together as one team to give our clients exactly what they need all around the world. That collaboration is possible because we genuinely want to deliver the best possible service at all times. When one team wins, we all win. And then there is the way our people give back to their communities. In March, we announced a special matching donation to provide humanitarian relief to the people of Ukraine. Thanks to the generosity of my Gallagher colleagues. We are able to donate over $1 million for necessities like food, water, supplies and first aid. I am proud to stand together with my Gallagher colleagues impacting communities around the world, and that is the Gallagher way. Okay, I’ll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat and hello, everyone. As Pat said, a fantastic first quarter and start to the year. Today, I will get to my typical comments on organic margins, clean energy, cash, etcetera and I will also do a financial recap of the Willis Re acquisition, but first, the modeling heads-up regarding rollover revenues this quarter. We typically don’t comment on consensus estimates, but this quarter looks like there is a large variance in brokerage segment rollover revenues relative to the guidance numbers we provided within our CFO commentary document during our March 16 IR Day. When we get to Page 6 of today’s CFO commentary document, you will see we have added a table that shows consensus overstates rollover revenues by approximately $40 million versus the number we provided in March. That has an impact of overstating consensus EPS by $0.06. We hope you take this into consideration as you analyze our performance relative to consensus and to your model. Okay. With that housekeeping behind us, let’s shift to the earnings release, to the Brokerage segment organic table on Page 3. All-in brokerage organic of 9.6%, we had a really strong finish to the quarter, some nice new business wins by the P&C team and a terrific finish by our benefits consulting teams. You will also see strong growth in both contingents and supplementals. The Ukraine-Russia conflict impact was small, about $5 million of revenue, which is about a $0.01 hit this quarter. Looking forward, it’s looking like its small also, maybe another $5 million revenue impact spread over the next three quarters. Given our strong start and given our current favorable outlook of the market, as Pat discussed, we could be pushing nicely towards upper 8% to 9% full year organic growth here in ‘22. Next, let’s turn to Page 5 to the Brokerage segment adjusted EBITDAC margin table. Headline all-in adjusted margin expansion for first quarter was 49 basis points, right in line with our March IR Day expectation. Recall that expansion includes a favorable seasonal impact from reinsurance roll-in offset in part by a return of expenses that we come out of the pandemic and it also has a little more incentive compensation given our stronger first quarter organic growth and full year expectations. Repeating what we said during March, we are well positioned to deliver around 10 to 20 basis points of full year adjusted margin expansion. But remember, as we discussed here in ‘22, there will be margin change volatility quarter-to-quarter. That’s due to expenses return as we come out of the pandemic and the roll-in impact of acquired reinsurance revenues. So, let me walk through what we said in March, 50 basis points of expansion here in the first quarter, then expecting second and third quarter margins to each be down around 100 basis points, but then that flips and we expect fourth quarter margins to be up around 100 basis points. The math, given that we are seasonally larger in the first quarter, gets us back to that 10 to 20 basis points of full year margin expansion. Looking way out towards ‘23 that quarterly margin change volatility should go away with the pandemic behind us and reinsurance fully in our books. Okay. Let’s move on to the Risk Management segment and the organic table on the bottom of Page 5. You will see 15.2% organic in the first quarter. That’s just terrific by the team. And with continued strong new business and rebounding claim counts, it’s looking like organic revenue growth of about 10% each quarter for the rest of ‘22. On the next page, you will see that our Risk Management segment posted adjusted EBITDAC margin of 17.3%. That was compressed by about 120 basis points due to an unusual late quarter litigation settlement. As Pat said, moving forward, we would expect margins for the remainder of ‘22 to be closer to 19%. Moving to Page 7 of the earnings release and the corporate segment shortcut table, most adjusted first quarter items were in line with our March IR Day estimates. Within the corporate line, we did also benefit from an FX remeasurement gain and a larger tax benefit related to employee stock option exercises given the strong performance of our stock late in the quarter. You also see a couple of non-GAAP adjustments. The first relates to transaction costs and professional fees associated with buying Willis Re. And the second was a state tax benefit related to the revaluation of our deferred income tax balances. Alright. Let’s now go to the CFO commentary document. Page 3 has our typical brokerage and risk management modeling helpers. We have updated our outlook for integration. I will get to that more in a minute. We have updated FX and you will see a slight tick-up in our expected Brokerage segment tax rate, call it 0.5 percentage point. In addition, the amortization lines in both brokerage and risk management are now highlighted in yellow. This means the item is now being treated as a non-GAAP adjustment. If you missed our March IR Day, we did a vignette on how this change – on this change and how we are reporting adjusted EPS. This is the first quarter reporting under that revised method. On Page 4 of the CFO commentary, that’s our corporate segment outlook. You will see there is no change in our outlook for second, third and fourth quarters. When you turn to Page 5 to clean energy, the purpose of this page is to highlight that we have over $1 billion of credit carry-forwards and we are now in the cash harvesting era of these investments. There is no GAAP earnings anymore other than a little bit of overhead expense, but rather now substantial cash flows. You will see in the pinkish column that the ‘22 cash flow increase should be substantial. We should be able to harvest $125 million to $150 million a year of cash flows and perhaps more in ‘23 and beyond, at that rate, a really nice 7-year cash flow sweetener. And there still is a possibility of an extension in the law, so we remain well positioned to restart production if that happens. Okay, flipping to Page 6 of the CFO commentary document. Top table is the rollover revenue table. Recall that we update this each earnings release day and also each quarter during our late quarter IR meetings. The next box, highlighted in yellow, is the math behind the $0.06 impact of consensus versus our March guidance that I touched on in my opening. Then at the bottom table is an update on our December Reinsurance acquisition. Revenue this quarter was $337 million and EBITDAC was $172 million. The very small difference to the numbers we provided during our March IR Day reflects two items: first, the quarterly timing related to further refinement in our ASC 606 accounting for both revenue and expense and second, some further movement in FX rates. In the end, if you go all the way back to our original August ‘21 projections, there is very little change to our first year of ownership expectations other than a small impact from Russia, Ukraine and FX. As for integration, the good news is that our original estimate of around a total of $250 million for integration charges through the end of 2024 is holding close. The even better news is we are making progress at a faster pace than we originally thought. Integration efforts around people, real estate, back office transition services, etcetera are targeted to be mostly done by late ‘22 versus mid to late ‘23 as originally planned. When it comes to technology rebuilds, we think most of it will be done by the end of ‘23 or early ‘24. So what that means is that we will see integration costs lumped more into ‘22 and ‘23, then spreading deep into ‘24. You will see the bump up of our ‘22 quarterly integration estimates back on Page 3 of the CFO commentary, but it’s important to remember, it isn’t changing our in-total view. So, that continues to be a really good story. As for cash, capital management and future M&A, at March 31, available cash on hand was about $450 million and no outstanding borrowing on our line of credit. With strong operating cash flows expected in ‘22 and a nice bump in cash flow from our clean energy investments, we are extremely well positioned to fund future tuck-in M&A using cash and debt. We continue to see our M&A capacity at more than $4 billion through the end of ‘23 without using any stock. So those are my comments. We’re off to a great start in ‘22. From my vantage point as CFO, we’re positioned for another great year. A huge thank you to the entire Gallagher team for another terrific quarter. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you, Doug. Darryl, I think we’re ready to open up for questions, please."
},
{
"speaker": "Operator",
"text": "Thank you. Our first questions come from the line of Paul Newsome with Piper Sandler. Please proceed with your questions."
},
{
"speaker": "Paul Newsome",
"text": "Good morning. Good afternoon, Patrick. Congratulations on the quarter."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Paul."
},
{
"speaker": "Paul Newsome",
"text": "I was going to ask about the guidance for organic growth is at a decelerating pace. Maybe you could talk about sort of the factors that go into what might be decelerating prospectively from a macro basis that’s having an effect on your business."
},
{
"speaker": "Doug Howell",
"text": "So listen, I think we posted 9.6% this quarter, and I think that we’re guiding upper 8% to 9%. I wouldn’t call that a deceleration. I think that there is a reality, looking towards where we were in third and fourth quarter, as the compares get a little more difficult to have. But I don’t know if I’d use the word deceleration, but I think it’s pretty close."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, in fact, Paul, we looked at the stats before this call, and over the last eight quarters, the renewal rates across our book, including, I should add, the exposure units are about flat, around 8.5% to 9%. So I mean it varies up to 9%, 9.5%, it comes down to it. But I would say any kind of a wholesale drop-off is not what we’re seeing, to Doug’s point."
},
{
"speaker": "Paul Newsome",
"text": "Knock on wood, my second question relates to interest rates. We are finally seeing some rising interest rates. I was wondering what your thoughts are on how that affects your earnings as well as, frankly, M&A. I wonder if we’re seeing any change in the competitive environment for M&A with interest rates changing as well. So I guess that’s sneaking in essentially two questions."
},
{
"speaker": "Doug Howell",
"text": "Let me take the investment income for our fiduciary funds that we keep on hand. We would think that a 1 point rise in interest rates would be about another $40 million a year of investment income versus what we’ve been showing so far. That might tick up a little bit more as we get reinsurance completely rolled into our books. In terms of what that means in terms of other pressures inside of our organization, we’re just not all that sensitive to interest rates internally in our operating model."
},
{
"speaker": "J. Patrick Gallagher",
"text": "But we do know, Paul, I mean let’s face it, a lot of the competition from our private equity competitors for acquisitions has been driven by free money. And if they got to start paying for it I think that bodes well for us."
},
{
"speaker": "Paul Newsome",
"text": "That makes sense. You haven’t seen that – I see this as too soon with interest rate can..."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Cash, no, we haven’t seen anything."
},
{
"speaker": "Paul Newsome",
"text": "Great, thanks guys. Appreciate the help."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Paul."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is come from the line of Mark Hughes with Truist. Please proceed with your question."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Hello, Pat. Good afternoon. Could you give the margin in brokerage, if you back out the Willis Re, I suppose you’ve given us the inputs, but do you have that handy, Doug?"
},
{
"speaker": "Doug Howell",
"text": "I can dig it out here for you here in a second."
},
{
"speaker": "J. Patrick Gallagher",
"text": "We’ve got it at the table somewhere, Mark, do you have another question?"
},
{
"speaker": "Mark Hughes",
"text": "Yes. Pat, you talked about the risk management being helped by an uptick in GL property, workers’ comp claims. Anything you see in either GL or comp that influences your view of what’s going to happen in terms of the cycle, if, in fact, courts are opening and you’re seeing a pickup in GL. Does that tell you anything?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "There is two things I’d comment on, Mark, really. One is it’s been in very interesting hard market. And as you know, looking over the past, what is now almost 4 years, comp hasn’t moved. Comp has not been a big rate driver up and it’s not coming down. So it’s been an interesting line. And as the economy becomes more robust. And frankly, when we pick up – when we start to fill some of those 11 million jobs, I think the natural increase in claim activity is going to really benefit Gallagher Bassett. We clearly can track back that when our economy is humming, it’s just a natural outcome. You don’t like to see people get hurt, but we have more claim volume. That’s number one. Number two, what I continue to be astounded by, and I’m sure everybody on this call reads it every week as well, when I look at our social inflation around tort, it’s incredible. And so I think what you’re seeing is, number one, case settlements at levels that never any of us would have predicted but also what that does is it drives our clients to be much more cautious and concerned about claims that, frankly, in the past, they might have said, pay us $50,000, move on or let’s not settle that. It doesn’t look like that big a deal. I mean not to get anecdotal on you all, but it is late in the evening. And you probably saw the settlement last week for some guy who got $450,000 because this company threw a surprise party for him. I mean I keep asking the folks for a surprise party. But it’s just – so that I do think is beneficial to GB. And GB continues to invest and I think capable of proving that if, in fact, you use our services, with all that we bring to the table, our outcomes are better. So all of a sudden, if you’re used to getting a lot of claims, but one of them every 5 years tends to pop. And now you’re looking at it, you go, man, what’s happening? I’m starting to get 2 a year, 3 a year. Now who pays those claims makes a bigger and bigger difference. And I think that bodes well for the long-term."
},
{
"speaker": "Doug Howell",
"text": "Mark, I can give you the answer on the – if you have a follow-up with that, then I’ll come back to that."
},
{
"speaker": "Mark Hughes",
"text": "Okay. I was just going to ask on the June 1 reinsurance renewals, so what kind of rate increases are you seeing, how much dislocation is there in the cat property."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Really not that much dislocation on the reinsurance side. And I would say, back to my prepared remarks, depending on the carrier, depending on the carriers experience. That’s what’s driving the renewals. And Doug, go ahead."
},
{
"speaker": "Mark Hughes",
"text": "Okay."
},
{
"speaker": "Doug Howell",
"text": "Yes. On the margin, Mark, we’re somewhere around high 37% margins in the brokerage business without Willis Re. And there is some variability around that because of allocations between the units, right? Second of all, I just think that in the context of margin, as you’re looking at what’s changed since last year. This quarter, I know that we’re ahead on our bonus accrual relative to where we were last year because we started off with considerably better organic growth. So that has a little bit of a margin compression impact, but I would consider that timing. We are in the first quarter. And recall, we give our raises out mid-year, so raise impact rolling in versus first quarter. As organic develops throughout the year, you grow into your raises and then when it comes back to cost returning into the business. So if you break it down, let’s say that expenses year-over-year on an apples-to-apples basis are $25 million up, $10 million of that’s bonus. You probably can call it $6 million is raise impact and then you get down to about $8 million left over. That’s probably – take third of that and call it increased professional fees that we’re spending, third of that would be T&E travel and third of that would be client entertainment. So when you look at the pieces of being up, let’s say, $25 million of expenses year-over-year, the way we look at it, call it, $10 million of it’s timing and $15 million is spread between raises that we will work ourselves into for the year and then the other piece of it, T&E, entertainment and some professional fees. Does that help?"
},
{
"speaker": "Mark Hughes",
"text": "Yes. I appreciate the detail."
},
{
"speaker": "Doug Howell",
"text": "Sure. Yes. And let me throw in too is that we’re – I went back while you were doing that. I looked at in first quarter of 2019, we posted 35%. And this is where the supplement really helps so that we post, not the CFO commentary but the 5-year supplement we put out there, we posted 35.6% EBITDAC margin in first quarter of ‘19. And this quarter in the Brokerage segment, we’re at 39.8% so we’re up 420 basis points. If we hit our target this year of being up 10 to 20 basis points for full year, we’d be up 540 basis points over 2019. So it’s 180 basis points of margin expansion a year over the last 3 years, each year, 180 basis points. And truly, our reinsurance business is rolling in. While seasonally a little better this quarter, when you put full year and it’s not all that different than our combined brokerage operation margins. So the margin story we believe is pretty darn good. And when we’re running somewhere around 34 points of margin for full year, if we hit our targets this year, that’s pretty darn good versus the 28 and change in 2019."
},
{
"speaker": "Mark Hughes",
"text": "Appreciate it."
},
{
"speaker": "Doug Howell",
"text": "Sure."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Mark."
},
{
"speaker": "Operator",
"text": "Thank you. Our next questions come from the line of Greg Peters with Raymond James. Please proceed with your questions."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Greg."
},
{
"speaker": "Greg Peters",
"text": "Hi, good afternoon, everyone. I can say listening to your comments, Pat, that I’m sure a number of us, myself included, would take a piece of the action on your surprise party. Keep us in mind. So I guess from a macro perspective, I’m going to comment – Paul tried to ask a question, I’m going to come at it from a different way. I know you’ve mapped out a pretty robust outlook for the remainder of the year. There are a number of economists and other reports out there that are speculating about the potential oncoming over a recession. And obviously, the data is not showing it yet, at least your data isn’t. But I’m just curious from an enterprise risk management perspective. When you think about that type of risk, what are you doing at the corporate level to prepare for something like that, if you think that might be in the cards?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, first of all, Greg, I’m not going to sit here and predict a recession. Unfortunately, we’ve lived through them before. And I think we do know how to react to those. And when you’re in a recession, a couple of things happen that are very, very negative. Exposure units drop, companies go broke, expenses become even more important, not that they are ever not important, and shopping can go up. Now when shopping goes up for our strength, in particular, in the middle market, I think we show well. So we hold our own there. But when you’ve got a robust economy falling off, you end up with negative audits and you’ve got lesser exposure units. And depending on the depth of that recession, it’s not a pretty picture. So when you talk about what are we doing relative to our risk management approach, we talk about it every quarter. We take a look at where we are. We’ve got significant margins, and we prepare to say here’s what we have to do to make sure that – one of the things I really like about our model is we basically pay our production for us on how their book of business performs. So, we are all in this together and if the business is sinking. Now in previous recessions, if I don’t go back too far, we’ve not had the benefit of inflation. So inflation may, in fact, help cause a recession and I don’t know whether that will be 1 point, 2 points. I know the first quarter GDP was down. But if you’re talking 5% to 8% inflation, that has the exact opposite impact. As you know, payrolls go up. We are all seeing that. I mean, I can’t go a day without somebody stopping me and saying we are getting whacked. I’ve got a mid-level service person, and it’s a problem and what am I going to do about it? And every customer is coming to Bill’s or Bell’s team and saying, how am I going to hold on to my people. Everybody wants them. They go to a restaurant. They don’t have people that can serve you. I mean there is just huge demand, and that’s pushing payrolls up. And our contractors book, they bid everything out and now they got to deliver at inflation rates they never anticipated when they made the bid. Well, if there is other business to bid, those rates are going up. So sales will go up. So there is offsetting factors there. And I think our business holds up pretty darn well in a recession."
},
{
"speaker": "Doug Howell",
"text": "Yes, so a couple of things. We look at daily endorsements, cancellations, audits, we get that as a daily feed. And this was the biggest month of positive audits that we’ve seen. And again, that’s historical. That’s a rearview mirror metric, but I’m not seeing that trail off at all. So I’m not seeing any early signs of a recession to happen because the first thing a customer will do is they’ll ring up the phone and they’ll adjust their expected payrolls down. So we’re not seeing that. We’re not seeing it in our exposure unit and our rate monitoring the deal. We look at renewals every day also. So we’re just not seeing it happen. But what we’ve proven throughout the COVID is that we’ve got a pretty resilient model that we have a lot of levers to pull should we get into a situation where growth becomes more difficult. And I think that we’ve proven we can do that. So we think the model is resilient. We think that inflation is going to help us on the top line when it comes to revenues for the business that’s there. But we do have levers that we can pull in order to help us get through a recession."
},
{
"speaker": "J. Patrick Gallagher",
"text": "And also, let me remind you, back in 2007, ‘08, ‘09, and this is just an incredible support of this model again. You’d think oh, my gosh, it’s going to be our clients will stop paying their people before they stop paying their insurance bill. That’s how important we are to them. That’s a good spot to be."
},
{
"speaker": "Greg Peters",
"text": "Indeed. Thanks color on that. Pivot to perhaps a little bit more detailed question and Doug, your guidance and commentary on the various parts in your CFO commentary quite helpful. And I guess what I wanted to ask about was the free cash flow, excluding clean energy because you talked about the integration expense and some other things. I’m just wondering what you think the cadence of that looks like now for ‘22. Has there been a change versus previous expectations? And how you would suggest we look at that?"
},
{
"speaker": "Doug Howell",
"text": "Let’s see if I can break it down. Let’s start with $4 billion that we have left over for M&A in ‘22 and ‘23. Cash – clean energy provides $250 million of that. Integration is already net in that number, right? So I’ve already given you a number net of integration. Also, when we talk about integration, you’ve got to look at it as half of it being noncash and half of it being cash. You recall that integration expenses are the sign-up bonuses that we delivered and mostly equity plans, so that’s amortizing as a noncash item against that. So I would say that integration won’t consume an excessive amount of cash. I would say that the clean energy – maybe you think about it this way, the clean energy basically offsets the cash portion of that. And all that is all washed out in our $4 billion expectation for M&A over the – during ‘22 and ‘23. Does that help you give a thought on it?"
},
{
"speaker": "Greg Peters",
"text": "It does. I know you’ve given me similar answers like that in the past. It feels like that should be your voice mail, but thanks for reminding me of all that little pieces there."
},
{
"speaker": "Doug Howell",
"text": "Listen, it generates a lot of cash. It’s like I say around here, I don’t make the money, I just count it and there is a lot of it coming in."
},
{
"speaker": "Greg Peters",
"text": "Got it. Thanks, guys for the answers."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Greg."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is come from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Elyse."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good evening. Maybe my first question is kind of going back to the earlier discussion on organic. Pat, when you gave us the initial outlook for 2022, you had said that the full year would be about 1% above the Q1. So is it just that the – and I think that was maybe based off of the benefits business perhaps being a little lighter and heavier in concentration in the Q1. But is there something that changed? Or is there just – I understand that the rest of the year outlook is close to the Q1. Is there something that perhaps caused that view to change? Or is it just that just as simple as the Q1 being better than you expected when you made that comment?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I’ll let Doug answer the actual number piece on that because a lot of that’s mathematical. But in terms of what I’m seeing for the year, I’m not seeing – I’m not anticipating significant change in the operating environment over the next three quarters."
},
{
"speaker": "Doug Howell",
"text": "Yes. I think that our cautious guidance in January and then again in March really was talking about the fact that we’re not getting rate lift from workers’ comp, which is heavier in the first quarter. And then also, you’re not really seeing rate and benefits yet now it’s interesting since that guidance there is medical inflation that’s coming back fast and furious. And I think that give us another quarter on that, and we might become a little bit more bullish because I think that – and of course, that will eventually translate into workers’ comp too, absent of any frequency declining or holding in there. But I think our cautiousness on the benefits business might have been overly cautious. But again, we just need to see another quarter of that before we get into a position of declaring that there is true medical inflation that’s going to affect next year’s growth, too. But I don’t see it as a headwind. I see it as a tailwind to our organic."
},
{
"speaker": "Elyse Greenspan",
"text": "Great. And then my second question, you guys have mentioned having around $4 billion of capital over the next couple of years to spend on M&A. The tuck-ins, right, were just around $30 million this quarter, so maybe a little bit light relative to some historical averages. So as we think about just kind of deal flows, it sounds like interest rates could impact private equity interest, so maybe that helps with the pipeline. Is there a certain point and maybe we have to wait until next year where if deals don’t materialize since that’s a pretty high level of capital, Gallagher might consider using some buybacks as well with the excess capital?"
},
{
"speaker": "Doug Howell",
"text": "I think an answer to that is – yes, let’s clarify. I think that first quarter is already seasonally the smallest when it comes to M&A. It’s historically been that 5 years out of the last 6 years. So, I think there is just a natural little push towards year-end and then there is a little pause in the first quarter. So, I think there could be a rebound in opportunities through the rest of the year. If those rebounds don’t materialize and we are not seeing opportunities for it, then our next place that we would go is to make sure that our debt is clearly within an a solid investment-grade rating and then use it for stock buybacks next and then maybe even consideration on the dividend. So, those are the three or four things that we are seeing how is deal flow look, next thing is what do we do with the excess cash as the deal flow isn’t there, and we will stack that up to controlling the debt, for sure, then making sure that we are positioned well to buy back stock or do dividend increases."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And one last one on Willis Re, I recognize the revenue was close to what you guys had laid out at the Investor Day. Can you give us a sense of just client retention and new business and how that’s been trending in your first full quarter of owning the business?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes. I will do that, Lisa. It’s really been an amazing and let’s remember, as we finished the quarter, we are four months in. So, as we have this call, we are close to five months. But I will tell you that the team, we are not losing people, we are not losing clients. Our renewals have been fantastic. Tom, myself, others at the table have had a chance to meet with reinsurance clients. They continue to be very open about the fact that they are glad. That they are – there is not one less competitor in the marketplace. They are also very clear with us that the reason that the business held together over the years of discussion as to where this business was going to land was because of the people handling their business. And those people are still in place. Our losses in terms of people out the door are minimal to zero. And so when I look at it, I am really, really happy about it. And new business pipeline is strong. What I am very excited about is the integration that we are seeing or the sharing of information from our retail. Everybody said at the beginning, why is this good for retail. And people also would ask, why does reinsurance care what you are doing as a retailer. Well, I will tell you what. There is so much going back and forth right now in terms of data relative to the business we are doing with all kinds of carriers, with things that our reinsurance people are seeing can help our retailers and they are melding. So, the business is strong. We are absolutely nailing it when it comes to what we hope the performer would be and I think it’s going to continue to be a great business for us."
},
{
"speaker": "Doug Howell",
"text": "Yes, I can give you some numbers behind that flavor is that – and I will give it to you is net new. Our net new was over 5% this quarter, if you control for those people that put on a different jersey before we bought it. And our overall organic is nicely, let’s call it, 8% first quarter plus or minus a point. So organic, really I got to give it to the team for what they went through for 3 years for them to be out there battling the way to have holding their clients, writing new business, I mean it’s really a terrific story. So, when you are posting organic nicely in that upper-single digits after what they have been through, I couldn’t be more pleased with the team."
},
{
"speaker": "Elyse Greenspan",
"text": "Great. Thanks for all the color."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Elyse."
},
{
"speaker": "Operator",
"text": "Thank you. Our next questions come from the line of David Motemaden with Evercore. Please proceed with your questions."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi David."
},
{
"speaker": "David Motemaden",
"text": "Hi. Good evening. How is it going guys?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Great."
},
{
"speaker": "David Motemaden",
"text": "So, great to hear the outlook on organic in the Brokerage segment, but obviously still keeping the 10 basis points to 20 basis points full year margin expansion outlook. I guess I am wondering, it definitely sounds like it’s a bit more positive on the organic growth side. So, I guess I am wondering why I guess we are not expecting or why you guys aren’t expecting more margin improvement than the 10 basis points to 20 basis points. Is it additional investments that you are making? Is it the bonus accruals? Is it something in addition, I think you had called out $60 million of incremental costs coming back in this year. Is that higher now that sort of keeps it at 10 basis points to 20 basis points of margin expansion?"
},
{
"speaker": "Doug Howell",
"text": "Yes. I think that we are just a little reluctant right now to push that up when it really comes down to it. I think that there is a lot of things that we would really like to do. And I will segue into some of the exciting stuff. When you look at what’s going on with – and you listen to our March, our late quarter IR Day. We talk about all the great things we are doing in the business. When you look at what’s going on with our electronic delivery platform, when you are looking at the automation that we are doing that we are writing 6,000 policies a month with hardly anybody involved on cyber, the Gallagher Drive, the Advantage program, the smart market. And then you look at the advertising and the brand building that we are doing and spending money on that systems. We are spending money on hardening the environment and delivering more point-of-sale capabilities to the sales force. When you look at all those things, posting another 10 basis points, 20 basis points, 30 basis points of margin expansion on top of already posting 540 basis points of expansion since 2019, we would just like to spend a little money this year. When you get to 2023, as a lot of this levelizes between the pandemic and between – and the roll-in of the reinsurance M&A, you might see a little bit more expansion in that if we are still posting in that 9% range. But right now, this is a great opportunity for us to invest in the future organic growth of the company. So, that’s where we are on it. You want to call that voluntary spend, call it, voluntary spend, but it’s not must spend."
},
{
"speaker": "David Motemaden",
"text": "No, it makes sense. No, that makes sense. And I guess just maybe it sounded like the international business did quite well in the first quarter. So, I guess I am wondering, Pat, just specifically, could you just talk about what you are seeing on the ground in Europe and in the UK, if there is any sign of any wobbles there in terms of exposure growth or demand as I think some of the leading indicators are pointing towards economic slowdown there?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, let me go around the world again as I did in my prepared remarks. So, if you take a look at what we are seeing in Canada. And it’s – our team in terms of new business is on fire. When we closed on Neuraxis years ago and the Canadian economy was a little flush where it was a little slow. We weren’t together. Neuraxis has seven separate businesses kind of operating separately. Now that business is totally together. The Gallagher branding is working extremely well. People are pumped up. We are using sales force. Our pipeline has grown and the 10% organic, yes, it’s helped by rate, but new business is much better than it’s ever been. When you go to the UK, that same timeframe, we have added new – recall, we bought Heath Lambert, Giles, etcetera, again, a lot of time on integration. Today, we will do an acquisition of size in the UK. And frankly, we have got that thing integrated in five months to seven months. And they are putting on a Gallagher jersey. They are excited about it. Then our team just gets stronger and stronger there. Now, I can’t tell you that economic events aren’t going to impact us. Recessions are terrible. Bad for our clients, they are bad for us, and they are bad for our business. But I would tell you that where we are from a team perspective is fantastic. So, you are right to look through the numbers and say it seems like international is doing really well because as we walked around the world and told you the organic, they are just killing it everywhere. Latin America is strong. New Zealand is strong. Australia is strong, and all of that is not just rate driven. That’s the thing I want to make sure everybody realizes is that it’s not just because rates are moving, we are getting our fair share of our new business opportunities. And in fact, we are seeing hit ratios improve and we are being helped by our clients’ business expansions and just blocking and tackling. So, it’s a very good spot to be."
},
{
"speaker": "Doug Howell",
"text": "Yes. I can’t predict the trickle-on effect. But remember, we are primarily in the UK. We do have inflow from the rest of Europe. Not heavily based in by any means in Eastern Europe. So, we don’t have that. And I think at one point, we looked at and our inflows from Europe might have been in that $40 million range in total revenues. So, if you think about it in the context of what it means to Gallagher, if all of Europe would stop sending any business to London, it’s $50 million of lost revenue to us. And pushing $8 billion of revenue as a total organization, we would feel it, but it wouldn’t register at all."
},
{
"speaker": "J. Patrick Gallagher",
"text": "David, I think it’s fair to say, too, what we have done in the United States in terms of the things you have seen in your SmartMarket, Gallagher Drive. Those things are impacting our new business with carriers, our retention and clearly, our new business hit ratios using SmartMarket, and we are taking those internationally now. So, that was born and bred here in the U.S. But those are our products that are going to be available in Canada and the UK to start. And they are difference makers. And really remember, when we compete and this is one of the things about again, kind of being in a lucky spot. 90% of the time when our people go out the door to compete, we are competing with somebody smaller. Say at 10%, 11%, 12% of the time, we are competing with folks that, frankly, can come to the table with the same type of resources or story. But every other time, when I talk to our sales force, I think we should win. We don’t, obviously, but I think that’s having an impact. Our people go out the door thinking they are going to win, I will tell you that."
},
{
"speaker": "David Motemaden",
"text": "Yes, it definitely looks like you guys are getting your fair share of wins. And I know in the past, you have broken out the brokerage organic in terms of drivers by exposure, pricing and net new. I think in the past, you said it’s about a third, a third, a third, has that changed at all this quarter?"
},
{
"speaker": "Doug Howell",
"text": "Well, I think rates might be fueling that just a little bit more, but we probably need a little more time to peel that apart. We will see if I can give you something, and get back together in June on that. But right now, rates probably used to be a third, a third, a third, and I think rates might be more 40% than, 30%, 30%, something like that."
},
{
"speaker": "David Motemaden",
"text": "Yes. Okay. Great. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks David."
},
{
"speaker": "Operator",
"text": "Thank you. Our next questions come from the line of Meyer Shields with KBW. Please proceed with your questions."
},
{
"speaker": "Meyer Shields",
"text": "Thanks. Hi guys. I hope all is well. One, I guess dumb question. When I look at Page 3 of the CFO commentary, it still anticipates a full year margin of 19% in risk management. Is that – does that mean that we are going to unwind some of the first quarter underperformance, or is that assuming – is that based on like the $18.5 million?"
},
{
"speaker": "Doug Howell",
"text": "I think we will be somewhere nicely in the 18% for full year. So, I think that if we post three quarters of 19%, we will claw back into that $17.3 million for this quarter. And again, we get an unusual legal settlement probably once every 4 years, 5 years. So, it’s unfortunate it happened this quarter, but that business is really doing well."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That’s helpful. A second issue, and I know these are small numbers, but does the call it withdrawal from Russia on the reinsurance business, does that have any impact on the earn-out?"
},
{
"speaker": "Doug Howell",
"text": "Yes. I would technically have an impact. If we don’t reach some of our milestones in it, that loss of $10 million over the course of the year, yes that might have a – it would have an impact on it."
},
{
"speaker": "J. Patrick Gallagher",
"text": "They are going to overdo that. That’s not – my prediction is it will not."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Because of other businesses compensating?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Correct."
},
{
"speaker": "Meyer Shields",
"text": "Okay. And then one final question on the reinsurance side and Pat, you talked a lot about the fact that some of the people there were under some strain over the past couple of years. Did that depress what Willis Re was able to charge? Is there an opportunity for revenue growth now that simply because it’s a more stable platform or you can invest in it more heavily?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I got to understand the question. I mean our reinsurance clients pay us very, very, very well and very fairly and now a stable environment is not going to give us the ability to charge our clients. Does it give us the ability to invest more favorably, absolutely, because you now have people and our old business is people. To be perfectly blunt, there were people who were going to join them before, like join them in the middle of a sale. Nobody knows – by the way, remember, I am not making this up, it was public. I mean they couldn’t tell the people at Willis where they are going to sit, who are they going to work for. That’s not easy to recruit into, is it. Well, there is lots of opportunities to invest. There is lots of – at the same time, reinsurance buyers are kind of frozen in the headlights. We want to see competition in the market. We don’t want Willis, frankly, to disappear, but we are not going to build the problem bigger. So, yes, there is opportunities for us to go back to those clients and say, “Hey, we think we have got something to tell you now.” So, I think once it settles down and we all get – again, I am four months into the quarter, five months in total, a year from now I will have a much better feel for the individuals."
},
{
"speaker": "Doug Howell",
"text": "I will add to it, though the thirst for information from our reinsurance partners is there. And if we can bring them the information that they are looking for that maybe they haven’t been able to get in the past. I believe that, that will help them attract more new clients and perhaps broaden out the book of business they are doing with their existing clients. I do believe that our ability to provide real-time data like we do for our retail business to them, a compelling advantage for them in the marketplace."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That is very helpful. Thank you so much."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Meyer."
},
{
"speaker": "Operator",
"text": "Thank you. Our final questions come from the line of Weston Bloomer with UBS. Please proceed with your questions."
},
{
"speaker": "Weston Bloomer",
"text": "Hi. Thanks for taking my questions. My first was a follow-up on the investments that you guys described around the systems and point of sales. I guess what’s the pipeline and timing for that? Does that extend into 2023? And just curious because in 2023, can we go back to a world where the pre-pandemic commentary was we expand margins if organic is over 4%? Is that baseline potentially still the same, or could it be lower given the higher investments that you are making? Recognizing that the 34% and 19% margins are still impressive, but curious how to think about that in 2023?"
},
{
"speaker": "Doug Howell",
"text": "Well, one of the things I would like to say about it is that we have been investing in these technologies all along the way. So, we are talking about investing in another $3 million or $4 million or $5 million a quarter. I mean this is a smart market advantage, better works 360, all the things that we are doing, we are continuing to invest in them, and we really didn’t slow that down much. It’s the incremental spend on them to make them even better and more competitive. That’s what we want to do. I mean if you looked at our GB go, I am just talking in the risk management right now, what they can do to adjust a claim on your phone with you, track it, monitor it, help you get back to work, it’s impressive. So, these are the type of enhancements that we have on the table how do we make that better, how do we make Gallagher Drive better. Right now, RPS has 24 different products on their quote and buying system that’s basically a no-touch system. They are doing 6,000 policies a month. What happens when we took that out to 48 policies and our investment spend on that illustratively is about $2 million a year. But what if we get 48 different lines of cover on that and then go to 72 and then go to 100? It’s – those are the type of incremental investments that we would like to make because I think they are powerful. I say this all the time, what we are doing on the RPS automation side alone is a $1 billion business. And I think we would like to do that across 20 different things inside of the company. So, where our margin is going to be in ‘23, we are going to – I think that we are going to be over the return of expenses from the pandemic. The real question is how much are we going to spend on investment on that. But it would stand to reason that if we post at least 4% organic growth, there will be opportunities to expand on that."
},
{
"speaker": "Weston Bloomer",
"text": "Got it. That’s helpful color. And then my second question is a follow-up to Elyse’s on M&A. I just want to clarify. Was all of the term sheet disclosure – is all of that seasonal, or is there any of that strategic around Willis Re? The reason I am asking is I am trying to frame the potential for maybe a pickup in that number in the second half as you annualized the deal?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "The numbers we were talking about in the pipeline in our prepared remarks are totally outside of Willis Re. Willis Re is done, those are…"
},
{
"speaker": "Weston Bloomer",
"text": "What I meant is, yes, is the pipeline potentially lighter as you focus on integrating Willis Re?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No. Our retail operations have zero distraction by the Willis Re folks."
},
{
"speaker": "Doug Howell",
"text": "And actually, we are starting to see some small little boutique reinsurance opportunities pipe up on our deals already."
},
{
"speaker": "Weston Bloomer",
"text": "Okay. That’s great to hear. Thank you."
},
{
"speaker": "Doug Howell",
"text": "Thanks Weston."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks Weston. Darryl, I think that’s all our questions for tonight. So, I would like to just say thank you again for joining us. Obviously, we had a fantastic start to 2022. I would like to thank our colleagues around the globe for their hard work. We are a people business and our results directly reflect your efforts. Thank you. We look forward to speaking with you again at our June Investor Day, and thanks for being with us, everybody."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and enjoy the rest of your day."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 4 | 2,023 | 2024-01-26 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Co.'s Fourth Quarter 2023 Earnings Conference Call. Participants have been placed on the listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and risk factors sections contained in the company's most recent 10-K, 10-Q, and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you very much, and good afternoon, everyone. Thank you for joining us for our fourth quarter '23 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had a strong fourth quarter to wrap up another fantastic year. All measures were right in line with what we said during our December IR Day. For our combined Brokerage and Risk Management segments, we posted 20% growth in revenue, headline 8.1% organic growth, but that's more like 9.4% controlling for the 606 accounting and large life case timing. We also had a terrific merger and acquisition quarter. We completed 14 mergers totaling $410 million of estimated annualized revenue. GAAP earnings per share of $0.30 and net earnings margin of 2.8% were impacted by the counterintuitive earn-out payable accounting that Doug will elaborate on in a few minutes. So, better to look at it more on a comparable basis. Adjusted earnings per share were $2.22, up 23% year-over-year, and we posted an EBITDAC margin of 30.1%, up 69 basis points over fourth quarter '22. What a terrific quarter to close out an incredibly good year by the team. When I think about our growth for the full year, we are up 18% in revenue, that's an increase of $1.5 billion. That's amazing. Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth was 20%. Organic headline was 7.2%, but I see it more like 8.7% without the accounting and timing noise, and 11% if you include interest income. Adjusted EBITDAC was $647 million, growing 21% year-over-year, and we posted adjusted EBITDAC margin expansion of 48 basis points. Let me give you some insights behind our Brokerage segment organic, and just to level set, the following does not include interest income. Our global retail P&C brokerage operations posted organic of 8%. This includes about 8% organic in the U.S., 8% in the U.K., 5% in Canada, 10% in Australia and New Zealand. Our employee benefit brokerage and consulting business posted organic of 2% or 6%, controlling for the timing of those large life cases. Shifting to reinsurance, wholesale and specialty businesses, overall organic of 14%. This includes Gallagher Re at 12%, U.S. wholesale at 12% and U.K. specialty at 16%. So, all of these are very similar to what we were seeing throughout the year. Next, let me provide some thoughts on the P/C insurance pricing environment, starting with the primary insurance market. Global fourth quarter renewal premiums, which include both rate and exposure changes, were up 8.5%. That's in-line with the 8% to 10% renewal premium change we have been reporting throughout '22 and '23. Renewal premium increases continue to be broad-based, up across all of our major geographies and most product lines. For example, property is up 15%, even in a slow cat property quarter. General liability is up 6%, workers' comp is up 2%, umbrella and package are each up about 10%. Shifting to the reinsurance market. 1/1 renewals were orderly reflected a more balanced supply-demand dynamic. Continued strong demand for property cat cover was met with sufficient reinsurance capacity from existing reinsurers and cat bonds. Importantly, reinsurers continue to exercise discipline on pricing and terms, not giving back the structural changes achieved last year. In casualty, while there was adequate supply, most casualty treaties experienced pricing pressure. Specialty lines renewed mostly flattish. However, coverage limitations continued on war-related products. So, in our view, insurance and reinsurance carriers continued to behave rationally, pushing for a rate where it's needed to generate an acceptable underwriting profit. Property is still needing rate. And more and more, we're hearing about the need for rate in casualty lines. If prior year development turns into a big concern, we think it could be a multiyear journey of rate increases. All that said, always remember, our job as brokers is to help our clients find the best coverage while mitigating price increases. So, not all these renewal premium increases ultimately show up in our organic. Moving to our customers' business activity. Overall, it continues to be strong. During the fourth quarter, our daily indication showed positive midyear policy endorsements and audits ahead of last year's levels. So, we are not seeing a slowdown. The same strength is also evident in the U.S. labor market with continued growth in non-farm payrolls and low unemployment rate, which is why I believe our HR consulting retirement and benefits business will have terrific opportunities in '24. As we sit here today, we are very well positioned. 2023 was a great new business year, and I believe we will continue to win new clients while retaining our existing customers. We have incredible niche expertise. Our client service is top notch, and our data and analytics continues to distance ourselves from the competition. We can handle any account of any size, anywhere around the globe. All this leads me to reaffirm that we will still see further '24 Brokerage organic in the 7% to 9% range that would lead to another outstanding year. Shifting to mergers and acquisitions. We had an excellent fourth quarter, completing 13 new brokerage mergers, representing about $350 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing family of Gallagher professionals. And we are off to a strong start to '24. We've already closed four brokerage mergers here in January for about $30 million of annualized revenue. We also have around 40 term sheets signed or being prepared, representing around $350 million of annualized revenue. We know not all of these will ultimately close, but we believe we'll get our fair share, clearly, a very strong pipeline. Moving on to Risk Management segment, Gallagher Bassett. Fourth quarter organic growth was terrific at 13.2%, full year at 15.8%. Adjusted fourth quarter EBITDAC margins of 21% and full year at 20%, all this right in-line with our December expectations. We also completed one merger in Australia with expected annualized revenue of about $60 million, adding new capabilities in the disability space. Looking forward, we continue to see '24 year organic in the 9% to 11% range and full year margins close to 20%, and that would be another outstanding year. And I'll conclude with some comments regarding our bedrock culture. It's a culture of client service, ethics and teamwork encapsulated in the Gallagher way. It is an unrelenting culture of excellence that helped drive full year '23 results for our combined Brokerage and Risk Management segments of 18% growth in revenue, of which 10% was organic. 51 mergers with nearly $900 million in estimated annualized revenue and 20% growth in adjusted EBITDAC. Most importantly, we have a culture that our people believe in, embrace and live every day. It's a huge competitive advantage and will continue to fuel our success and growth. That is the Gallagher way. Okay. I'll stop now and turn it over to Doug. Doug?
Douglas Howell: Thanks, Pat, and hello, everyone. Today, I'll walk you through our earnings release commenting on fourth quarter and full year organic and margins by segment. I'll also provide some comments on our full year '24 outlook. We'll then shift to the CFO Commentary document that we posted on our IR website where I'll provide some comments on our typical modeling helpers and then give two short vignettes, one on investment income and another as a quick refresher on earn-out payable accounting. I'll then conclude my prepared remarks with a few comments on cash, M&A and capital management. Okay. Let's flip to Page 3 of the earnings release. Headline, fourth quarter Brokerage organic of 7.2% is right in-line with our December IR Day expectation of 7% to 7.5%. But as Pat noted, we see that closer to 8.7% and organic of 11% if we were to also include interest income. That's a darn good quarter, no matter what percentage you want to focus on. A couple of other puts and takes to call out on that page. First, contingents did come in a little bit better than our December thinking due to more favorable carrier performance than we thought at that time. And second, base commission and fee organic of 6.5%. That's where you should levelize for the impact of 606 in those life cases. Controlling for those takes that over 8%. Looking ahead to '24, our Brokerage segment organic outlook is unchanged from our late October and mid-December expectations. We still see full year organic growth in that 7% to 9% range. All right. Let's flip to Page 5 of the earnings release, to the Brokerage segment adjusted EBITDAC table. Adjusted fourth quarter EBITDAC margin was up 48 basis points. But remember, to get to that requires recomputing last year's fourth quarter using current FX rates. We've done that in this table and is 31.3% for fourth quarter '22. So, posting a 31.6% margin this quarter gives you that 48 basis points of margin expansion, and that's right at the high end of our December IR Day expectation. Then, if you control for the role in Buck and other mergers we closed late in the quarter that have some seasonality, that would have been 150 basis points of expansion. That's simply terrific work by the team. Looking ahead to next year, we anticipate seeing some full year margin expansion starting at 4% organic. And if organic was, say, double that, maybe around 60 basis points of expansion. And note, that includes about 40 basis points of pressure against it due to the roll in of M&A, mostly Buck. On a quarterly basis, the headwind is about 80 to 90 basis points in the first quarter '24. So, please don't forget to reflect this nuance in your models. Okay. Moving to the Risk Management segment and the organic and EBITDAC tables on Pages 5 and 6. Another excellent quarter for Gallagher Bassett, 13.2% organic growth and margins at 21%. We continue to benefit from new business wins and excellent retention. Looking forward, even as we lap growth associated with some large new business wins from early '23, we see full year '24 organic in that 9% to 11% range and margins around 20%, again, that's unchanged from our December views. So, let's turn to Page 7 of the earnings release and the corporate segment shortcut table. Total segment adjusted fourth quarter numbers came in a little better than the favorable end of our December IR Day expectations due to less borrowing on our line of credit and slightly lower corporate expenses. So, now let's shift to the CFO Commentary document, to Page 3, that's where we provide many modeling helpers. Most of the fourth quarter actual numbers are very close to our December IR Day estimates. We've also now added 2024 information. So, take a look at that. In particular, as we -- take a look at FX. We are expecting a small headwind to EPS in the first half within the Brokerage segment. Now, moving to Page 4 of the CFO Commentary document, to the corporate segment outlook for full year '24. There's no change there to our full year estimate that we provided six weeks ago during our IR Day, but we are now providing quarterly estimates. So, please take some time to refine your models with us added information. When you get to Page 5, this page shows our tax credit carryforwards. You'll see what we discussed at our December IR Day. We are able to reestablish a portion of our tax credits following the change in tax method election when we filed our '22 U.S. federal tax return here in the fourth quarter. Accordingly, as of December 31, we have about $870 million of tax credits available. That's a nice future cash flow sweetener that helps us fund future M&A. So, let's turn to the new table that we put in the top of Page 6. We thought this would be helpful as we've been giving a lot of questions about our investment income line. The punchline is that this line includes items such as premium finance revenues, book gains and equity investments in third-party brokers in addition to interest income. So, this table breaks it down for you by quarter. We hope you will find this helpful. We've also renamed that line in our financial statements to clarify that it contains other items. No numbers change, we've just broadened the descriptor. So, just shifting down on that page, on Page 6, you'll see total Brokerage rollover revenue for fourth quarter was $180 million. That's consistent with our IR Day expectation. Looking forward, we've included estimated revenues for mergers closed through yesterday for the Brokerage segment in that table and for the Risk Management segment in the text below that table. Based on Brokerage and Risk Management mergers closed through yesterday, we're estimating around $540 million of rollover revenues to be recognized in '24. And also, don't forget, you'll need to make a pick for future M&A and also add interest expense as we fund a portion of those acquisitions via future borrowings. So, while I'm on the topic of M&A, as we foreshadowed in December, we did increase our estimated earn-out payable for Willis Re during the quarter because we now have good line of sight of what we might pay out in the first quarter of 2025. Remember, the accounting for earn-out payables is a bit backwards. If expectations of performance are more favorable, it creates GAAP expense. And if expectations of performance are less favorable, it creates GAAP income. That's what Pat meant when he said counterintuitive accounting. That said, we do adjust these estimate changes, but were the highlight because it does create some GAAP earnings noise. The punchline on all this and what's more important, our reinsurance business is performing extremely well. So, moving to cash, capital management and M&A funding. Available cash on hand at December 31 was about $400 million. And with another year of strong expected cash flow generation here in '24, we estimate about $3.5 billion of capacity to fund M&A in '24 using only free cash and incremental borrowings. So, those are my comments. As I reflect on '23, two metrics for our combined Brokerage and Risk Management segments really sum up how good our year was: revenue growth of 18%, up $1.5 billion; and adjusted EBITDAC growth of 20% or nearly $550 million. So, the team delivered another terrific year, and we all have tremendous momentum to do it again here in '24. Back to you, Pat.
J. Patrick Gallagher: Thank you, Doug. And operator, I think we can go to questions now, please.
Operator: Thank you. [Operator Instructions] Our first question is coming from Elyse Greenspan with Wells Fargo. Please proceed with your question.
Elyse Greenspan: Hi, thanks. Good evening. My first question, within the 7% to 9% organic Brokerage guide for 2024, can you guys give us a sense of what you're assuming for pricing and economic exposure throughout the course of the year?
Douglas Howell: Well, I think when we did that in our budget process, the range of 7% to 9%, it's pretty much so what we're seeing today throughout next year is really the assumptions. Where are we today in pricing, where are we in exposure units, what we've been running here this year, we don't see a lot of change to that next year.
Elyse Greenspan: And then when you guys go through and come up with the 7% to 9%, are you assuming that all of your businesses will be in that range? I mean, now you've been seeing really strong growth within reinsurance, wholesale and specialty. Are those expected to continue to be above and maybe some of the others like benefits might be below? How do you see the different businesses shaking out in '24?
Douglas Howell: All right. So on that point, not every business has given a flat target number, they view it based on what they're seeing in the marketplace rate, exposure, opportunities, hiring, hiring new producers. So, every business does that differently. What would I say is being different? Who's on the upper end of the range? And who's on maybe the lower end of the range? Benefits might be a little bit on the lower end of the range, and you might see reinsurance and specialty on the upper end of the range in that. But by and large, each business unit rolls it up and that's how we get to that 7% to 9% range.
Elyse Greenspan: And then, Pat, you mentioned some interesting comments on the casualty side. We're starting to hear your thoughts about pricing pressure and just you said right, multiyear journey here. Can you just tell us like what you're seeing and then how you expect this cycle could transpire assuming we do start to see more reserve holes emerge across the industry?
J. Patrick Gallagher: Well, I just think it makes some logical sense, at least. When you take a look back, we saw this in the property side. Nobody touched values for five, six, seven years because inflation was zero. And so you've got a bunch of reserves on the casualty side, set at those very same years that all of a sudden you come into a spike in inflation. And yes, it's been tamped down, but it's still there. And you look back at those reserves and then you take a look at these settlements that are, in fact, nuclear. And you start to say, well, all right, how well are those reserves going to hold up? Now look, I can't speak for the industry as a whole. But my sense in the meetings that we're having and discussions we're having with a number of the various carriers is that they have some concerns there that they are not necessarily comfortable with exactly where they are. And so, our view on that is, okay, if you take a look at if there were inflation in those numbers and if it were something where you had to get them right, you'd have to see price increases in order to do it. I don't think that, that's something with the kind of payout structure that you have in casualty that you need to get in one year. So, I think you're going to see possibly affirming that does, in fact, take a few years to catch up with reality.
Elyse Greenspan: And then one last one. Have you guys reserved to the maximum on the earn-out associated with the Willis Re deal?
Douglas Howell: Effectively yes. I mean we still have to accrete that for one more year. So it might be -- I think there's $50 million of accretion that will go through the financial statements this next year.
Elyse Greenspan: Thank you.
J. Patrick Gallagher: Thanks, Elyse. Thanks for being with us.
Operator: Thank you. Our next question is coming from Mark Hughes with Truist Securities. Please proceed with your question.
Mark Hughes: Yeah, thanks, good afternoon.
J. Patrick Gallagher: Hi, Mark.
Mark Hughes: Pat, did you give the organic for open brokerage versus the program business within wholesale?
J. Patrick Gallagher: Well, I think open brokerage has been where we've had the real nice run-up. I mean it's probably double to triple what's going on in the program business. So, if you look at open brokerage that running around 13% to 15%, you're probably looking at 5% on the programs.
Mark Hughes: And then, what's your take on the property market? Do you think little bit of deceleration there? Well, one, do you think that's the case? And two, would it have any kind of material impact on your organic?
J. Patrick Gallagher: I think -- well, I mean, any change in pricing is going to have an impact on organic. But I'm not -- no, I don't see carriers at this point saying, "Oh, the good news is I can take the price backwards." So, we are still seeing a push on property rate. And then you do, of course, have carriers incredibly focused on valuations. That kind of went by the wayside for years. There was no inflation, fine, 0% blah, blah, blah. Now claims are coming in, they didn't get their premium for it, the replacement costs are substantially higher than they may be predicted. And so, I think you do have a little bit of time left where there's going to be some valuation correction, and I do think there is a need for continued rate strengthening.
Mark Hughes: Thank you very much.
J. Patrick Gallagher: Thanks, Mark. Thanks for being with us.
Operator: Thank you. Our next question comes from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question.
Michael Zaremski: Hey, good evening. So first question on M&A. You guys have been extremely successful integrating and acquiring firms. But I'm just curious if the landscape has changed a bit in terms of kind of what's available. And, I guess, just for example, when I was -- you've announced a few bank-owned brokers. I believe, historically, there's two of your competitors that did most of those, and they would -- one of them would talk openly about those deals being tougher, meaning take a couple of years to turn them into the growth machines that those companies are and Buck was a little different, too. So just curious if the pool is changing a bit, and so we should kind of expect probably different types of deals going forward versus the historical five, 10 years.
J. Patrick Gallagher: Well, I'd tell you, first of all, let's remember. I think that when we do acquisitions, we like to talk about the fact that we're getting two things. We're not just getting revenue and earnings, which, of course, we want, we get. But we're getting terrific brains. And the bank-owned deals happen to be more sizable and they've got a lot of terrific people. And in addition to the brain power we're getting, we're getting expertise in the niches from the brain power, but we're also getting more volume in areas that now are spreading the brand. And it adds to that the virtuous circle of knowing about Gallagher, listening to the con-call, accepting the call. And I think what we're seeing is that our acquisition targets come aboard, and I guess this is the right way to phrase it, they kind of get on fire. It is our organic engine. There's no question about it. They come in. They've got a lot to say. Now, the bank deals are bigger. But if you take our day-in and down-out, roll-in acquisitions, these are people that more often than not have not been able to really tackle the large accounts in their own geography. In the minute they sign on to us, they're out telling those clients we're part of Gallagher, here's what we've got, let me tell you about the expertise we've got, let me show you some of the things that we do in data and analytics. You've all heard us talk about drive. What do people like you buy? What kind of limits should you have? So, we arm them with tools that they just -- whether they're in a bank or not a bank, they've never had before. So, the excitement level does not take a long time to resonate. The calls go out pretty immediately, "Hey, did you hear that we're part of another firm." And these are not folks that are in any way on their back foot. They are on the front foot and moving literally at the day of closing.
Douglas Howell: Yeah. Let me add one thing on that. I think that the organic in Cadence and Eastern was running very similar to what we're seeing in our similar geographies in similar areas. So I think your premise was that it take a while to restart them. I think they're already started. I think they're going after it. Buck is already showing terrific organic growth. We don't get it in our numbers for a year. So somebody goes out and sells something within the year, but we never get organic credit for that. And we get the revenues for it, but we don't get the organic growth credit in our numbers. So, I wouldn't say that the premise was, if the ones that we bought that they were -- they needed a restart.
J. Patrick Gallagher: No, in fact, Mike, I'll tell you what we're referring to in our process is the Gallagher effect. The Gallagher effect is what happens after you announced you're part of Gallagher. It's not a slowdown, explain it. It takes their list, their pipeline of prospects and energizes the team to go back and tell about we really have something new to talk about here. And it's not just about, I know you. I've called on you many times. I've got a good relationship in the marketplace. Can I talk to you about your pricing? It's a hard market, soft market, but no, no. This is -- let me bring some data and analytics. Let me show you what's going on in our niches. We have experts in your specific area that I think you're going to want to meet. It's pretty exciting, actually. When I get a chance to get involved, it turns me on.
Michael Zaremski: Okay. No, I appreciate that color. Switching gears and you could tell me if I'm splitting hairs here. But on the December Investor Day, there was a number of reasons you kind of lowered the very near-term 4Q organic growth estimates versus what you previously have been thinking. And I think a couple of those sounded like they were more of like a push into '24 like on the life insurance side and maybe entertainment business rebounding. But I didn't think you really brought up your -- you didn't bring up your '24 guide. So I guess, should we seasonally -- obviously, we know there's seasonality in the quarters, but should we be thinking 1Q or the first half of the year gets a little bit more of a bump than it does historically? Or am I just reading too much into things?
Douglas Howell: I think you're missing the magnitude of this. In the quarter, let's call it, $10 million, we get $15 million in total here that gets pushed out on a $10 billion business next year. Okay, it's 10 or 15 basis points in there, but so that wouldn't be enough to change that 7% to 9% guide in there.
Michael Zaremski: Okay, And just lastly, you're one of the leaders. You've been doing it successfully for a while in terms of moving folks -- or sorry, in your center of excellence. Any changes in kind of the trajectory there in terms of what you guys talked about last year in terms of kind of the goal of kind of doubling, maybe the percentage of employees there over the next five or so years?
Douglas Howell: I think what we said is that over the next five or seven years, we'll need twice as many people there as we have there now. I think what's really exciting about all the work that we've done for almost two decades there now has put us in a position of being so standardized in many of the processes that we do. We now have the opportunity to unleash AI on that because that's already done. We have made that investment. And now what we can do is deploy AI against it. And, look, those folks, if you're going to hire twice as many folks, they're going to end up with better jobs over there because they're going to be using AI. So, our colleagues there are going to be well rewarded by deploying that technology into it. So, we are really fired up about it.
J. Patrick Gallagher: Yeah. Let me hit a couple of other items. Why would we need to double our employee count there because we're going to double the business. And that's going to lead to plenty of opportunities there. Secondly, and I think this is a hugely important point. Standardizing a Brokerage business from an agency system through the operating processes to things like issuing certificates of insurance is a [indiscernible]. It takes four, five years to bang it through. I've done it. It's a headache. We're there. We don't need to do it. We don't need to sell it. It's standard operating procedure. When you join us, you know that in your due diligence, you come aboard, you plan the effort to change into our agency system and you get rewarded for it by virtue of the data and analytics we can provide you to go out and sell. We don't need to sell our team on that. We don't need to prove it to them. We did that 15 years ago.
Michael Zaremski: Thank you.
Operator: Thank you. Our next question is coming from David Motemaden with Evercore ISI. Please state your question.
David Motemaden: Hey, good evening.
J. Patrick Gallagher: Hi, Dave.
David Motemaden: I just had a question on -- just on -- it looks like there was a little bit of favorable timing during the quarter on incentive compensation expenses that helped the margin in Brokerage. Was that a big help? And is that something that you guys have sort of baked into the first quarter of '24, just that timing coming through?
Douglas Howell: Well, first of all, we talked about that, I think, back in our April or June call that we were probably a little further ahead at that point of the year and our incentive comp accruals. So that's been contemplated in our guidance of margin expansion since way back then. So that -- I would say there's no new news of what we were expecting in December versus what we delivered this quarter. And what's the impact of it? It's not a point. I mean, so it's not a big number.
David Motemaden: Got it. Understood. And then I just wanted to come back to the 7% to 9% Brokerage organic for 2024 and sort of level set in terms of what you guys are thinking on the exposure growth side, the range of outcomes that you guys are considering within that 7% to 9%.
Douglas Howell: All right. So I think when you break down our organic, we usually have more net new versus lost is probably 3% to 4% on that. When you get some rate in there, probably, we're at that 2 points and maybe there's 2 points of it, that's 2 or 3 points that's exposure unit growth. I don't -- we're going to have more lift next year from new versus lost probably proportionately. So, if you break down 9%, it might be a third, a third, a third. If you break down 7%, it's probably half rate -- excuse me, mostly new business and then exposure unit growth again.
David Motemaden: Got it. Understood. Thank you.
J. Patrick Gallagher: Thanks, David.
Operator: Our next question is coming from Gregory Peters with Raymond James. Please state your question.
Gregory Peters: Good evening, everyone. I guess I'm going to the new table that you added to the CFO Commentary, which we appreciate, which is the interest income, premium finance revenues and other income. And could you give us some perspective, because ever since mid-December, when the Fed changed their perspective on what's going to happen with rates, there's obviously some mechanics we're trying to calculate on what might happen with that line depending on what the Fed does with interest rates? So maybe there's some benchmarks you can provide for us that will help us sort of map out what we think might happen there.
Douglas Howell: All right. So you got the rate sensitivity and you've got the amount of cash that we have on our balance sheet, that's not only ours, but our clients, okay? So, first and foremost, it's both the rate that we're earning and then it's the -- on what we're earning that on. Second of all, you've got the dynamic. You mentioned the Fed. The U.S. portion of that interest income is only about 45% of the numbers. So it's actually more heavily weighted to internationally, and you would expect that with kind of large reinsurance balances in some of the large specialty businesses that we have in the U.K. So you got to separate your thinking on that. The other thing, too, is that you've got the growth as it grew this year, it was not only because of rate that was going up, but it was also because of the way the reinsurance receivables migrated from Willis' books onto our books during the transition services agreement. So you got that dynamic in it. I think what you're trying to plumb for is how sensitive is that number to rate changes. I would say that it's price-sensitive $5 million per rate cut that the Fed does in the U.S. per year. So if there's 4 points in, there's $20 million -- four cuts that might be $20 million. Again, that's just answering your question about the Fed. How the other central banks, what they do with their policy next year, I just don't have that number right off the top of my head. But when you asked about the Fed, think about it as $5 million per cut.
Gregory Peters: Excellent. Just a follow-up on that table for '23. And what quarter did the services agreement with WTW shift? Because I assume that would have meant the change...
Douglas Howell: July 1.
Gregory Peters: July 1. So when we're looking at the third quarter and fourth quarter, that's more normalized under going forward operating conditions, correct?
Douglas Howell: That's correct.
Gregory Peters: Thank you for that clarification.
Douglas Howell: Yes, it's important for -- yes, okay. You've got the premium finance just to make sure you know that there's expenses associated with premium finance that's down there. So that's a spread business. But you get -- gross is up. We get the revenues up above, and then we get the -- we have the operating expenses and the interest costs down below in operational.
Gregory Peters: That's excellent detail. I appreciate that. And then there's a bigger picture question I have before I get there. I can't -- I'm hung up on the clean energy tax credit carryforward balance, which caught me by surprise going up. And I know there's obviously a revised approach towards your tax credits here. But without getting into detailed commentary on the changes and the nuances and the tax, is it your expectation going forward that this -- that you're still going to be pulling down $150 million or more of tax credits from clean energy going forward? And then, is that $867 million just related to the clean energy? Or is there other things in that?
Douglas Howell: All right. So, two things. You can see on Page 5, we have reaffirmed that we think that there'd be about $150 million worth of utilization of that balance in '24. And maybe when you get to '25, '26, '27 is somewhere around $180 million of utilization in a year. So, you need to think about it coming in over the next four years. There is a very small other balance of credits in there that I would say is a rounding there, and it has to do with when we construct our home office building. But for all intents and purposes, consider these credits to be from our clean energy work.
Gregory Peters: Great. So, pivoting back to the bigger picture question is, I'm going to focus on reinsurance because last year was one of the most challenging reinsurance renewal periods in our lifetimes, and especially on the cat side, I should say. And clearly, based on your commentary and others, it seems like it's going to be more normal this year. It seems like the lift you might get from the pricing or rate component is going to be a lot less this year than it was last year. So I don't want to get too hung up on -- and I realize casualty has its own cadence, but I was just curious about your response to that observation and how you think it might work with Gallagher?
J. Patrick Gallagher: Well, first of all, let me just say that when I look back, I can't tell you how proud I am of the team. We came into a year, new to the organization, we've got some expertise for sure that got paid, but it was very difficult a year ago. And we basically, in a tough environment, took care of our clients. And I think that's really -- we learned a lot all of us from that. And then we come around to this year, yeah, the supply and demand balance was a little easier, but what you've got now is a group of our clients that, number one, the price is up, and number two, demand is up. So, you've got pricing not coming down and people looking and saying, "No, okay, it's not as sloppy as it was a year ago, I'd like to get more of that." And we saw a bunch of that at 1/1. Remember, about 45% of our business is book 1/1. So, the year when it comes to cat property is pretty much in the bank. And it's been a great year. Easier to place than last year, but as I said, demand up and pricing up. So, it still remains a very good market for us, and one in which there aren't that many people, Greg, that can do what we do for our clients. And our larger competitors are very, very good. But it falls off pretty quick after us.
Gregory Peters: That's right, all right, Thanks for the answers.
J. Patrick Gallagher: Thank you, Greg. Thanks for being with us.
Operator: Thank you. And our next question comes from the line of Andrew Kligerman with TD Cowen. Please proceed with your question.
Andrew Kligerman: Hey, thanks a lot, and good evening. I just want to clarify, Doug, when you were saying $5 million per rate cut, just define what you meant by rate cut? How much rate gets cut?
Douglas Howell: 25 basis points.
Andrew Kligerman: How many?
Douglas Howell: 25. They do at 25. I was referring to a rate cut of 25 basis points.
Andrew Kligerman: 25 bps. Perfect. Thank you. And then, with respect to Gallagher Re, could you talk a bit about how the cross-selling with Risk Management is playing in? Is that a big driver? And also, I understand you're going to be moving into facultative reinsurance and -- or maybe you've been doing that. What kind of tailwinds do those provide to 2024?
J. Patrick Gallagher: Well, I mean, first of all, I have to say that the reinsurance team has been incredibly pleased with and nicely surprised by the amount of interaction with our retail team around the world. And when we did the deal, we told the team and ourselves that we thought there was a considerable benefit from having both sides of the equation under one roof, and that is playing out over and over and over again. As you know, we're very, very strong in our niche or niche marketing, and that's a global play. And the capability to have the reinsurance perspective in those meetings, and then we're the largest player in the pooling sector for public clients in the United States. We kind of thought we had that pretty well nailed. Not a lot to learn. Our reinsurance team has added a tremendous amount of value and helped us add cover for the pools and revenue for our retailers and revenue for our reinsurance people. So, it's been an incredible two-year journey, and we're just getting started in terms of the opportunity to play together in the sandbox. What was the other question, Andrew?
Andrew Kligerman: Facultative...
J. Patrick Gallagher: Facultative, but of course, now coming along with treaty clients and having our retailers -- here is an example of what you're talking about, where retailers are trying to get things done and oftentimes it's hard to place areas like property, et cetera. We are seeing our facultative opportunities grow. No, it's not brand new. But we are organizing ourselves better in the fac world. And I think we're getting -- we're in a better position today than six months ago to go out to our insurance carrier customers and our trading partners and say, "We want to participate in this. We want to help you." So, we are seeing an uptick in opportunities.
Andrew Kligerman: Lot of tailwinds there. Shifting over to Risk Management and the organic change in fees. I mean, just it seems terrific. And I'm just wondering on the claims management side, what kind of carriers are you growing with? Are they the large ones? Or are they the small ones? Like where are you seeing the most growth in claims management?
J. Patrick Gallagher: Well, you're seeing two things. One, our historical play in the Risk Management accounts, where you've got large accounts, you name it, whatever the large hotel chains or what have you, that are procuring our business on their accounts. And there's -- we've got a great, great year in that regard, and that includes public sector clients as well. And then as you know, we have over the last decade or so really focused on outsourcing of claims from insurance companies. And I don't have liberty on this call to name some of those because some of those carriers are pretty well-known carriers and not one that I necessarily have the approval to be touting. But from inside the organization, you look at some of these carriers you go, it's fantastic. And then, of course, the regional small companies that would like to expand that don't want to add infrastructure, they think they've got an opportunity in a given stage or geography. They don't want to be putting a lot of boots on the ground. We're picking those up as well. So, the team at GB is, in my opinion, just outperformed expectations every single year.
Andrew Kligerman: It just seems like in the carriers, I mean, there's just a lot of runway there.
J. Patrick Gallagher: Well, let me put it this way, Andrew. I really believe this. I believe that it will not be unusual, and I believe that people will ask. "Did insurance companies pay their own claims? Why would they do that?" When I sit with some of our insurance company partners and explain to them that Gallagher Bassett pays substantially more claims in numeric numbers and substantially more dollars than they do in claims by line of cover, by geography, not just in the U.S., the first reaction is oftentimes shock. And again, I won't mention any names of carriers. They go no, no. Look, if you put a capital structure around GB and called it an insurance company, it'd be one of the five top insurance companies probably in the world. Think about that in terms of the amount of claim work that's coming through. And our focus, and this is, I think, really key, and what we're selling and we believe proving day in and day out is if you outsource your claim work to us, whether you are a large risk management account through self-insuring or whether you're a carrier, your outcomes will be superior. And if I look at an insurance company CEO and saying, "I think I'm worth or could help you find 2 points of ROE," it could be pretty dramatic.
Andrew Kligerman: Maybe if I could just squeak one last one in on the contingent revenues. They were up 30% in the quarter. Just given it was such a great year for underwriting, do you see that kind of being flattish as we go into '24, when you provided your 7% to 9% guidance, maybe that impact becomes flattish in the scope of it all?
Douglas Howell: No, I said it -- I would say it would be in that same 7% to 9% range. I'm not going to see it outperforming that. And yes, we were pleasantly surprised by a few extra million bucks than we thought we were going to get there.
Douglas Howell: By the way, look through that number and see what it's telling you as a potential owner. Our book of business is superior to the competition. That's interesting, isn't it?
Andrew Kligerman: Yes. Hey, thanks a lot. That was great insights.
J. Patrick Gallagher: Thanks, Andrew.
Operator: Thank you. And your next question comes from the line of Yaron Kinar with Jefferies. Please proceed with your question.
Yaron Kinar: Thank you, all. Good afternoon or good evening.
J. Patrick Gallagher: Hi, Yaron.
Yaron Kinar: First question I have, and forgive me it's a bit nitpicky here, but in Brokerage organic, I know the organic came in-line with December guide. But I think contingents were a bit better than you were expecting. You were already accounting for the life case timing and the 606 accounting. So, it seems like there may have been something there that came in a little bit lighter than expectations? Or am I thinking about it incorrectly?
Douglas Howell: Maybe there's $5 million less than we had hoped on a few of them. But it's -- I mean, when you're looking at a $2 billion quarter, $5 million, it does move the percentage a little bit, but it doesn't -- it's not a meaningful that we are a sales organization, I look back last year, we had 11% one quarter, we had 7% in another quarter. We had 9%, 7%, 8%. So, it bounces around a little bit. So the fact that we brought it in within a 0.5 point or what we're looking at here, you do get some bounce around for a few million bucks here or there.
Yaron Kinar: Okay. And then a couple of quick ones on the CFO Commentary. So, I am seeing a bit of a slowdown in Brokerage earn-out payables in 2024. Is that just the Willis Re true-up in '23?
Douglas Howell: That's right.
Yaron Kinar: Okay. And then, I'm also seeing a meaningful increase in the amortization of intangibles and Risk Management. Are you expecting any large M&A there? Or did you already conduct...
Douglas Howell: Yeah, we announced My Plan Manager acquisition here a month or so or two months ago. So that's the $60 million worth of revenue in that disability business down in Australia.
Yaron Kinar: Okay. Got it. Thanks so much.
Douglas Howell: Sure. Thanks.
J. Patrick Gallagher: Thanks, Yaron.
Operator: Thank you. Our next question comes from the line of Michael Ward with Citi. Please proceed with your question.
Michael Ward: Hi, guys. Thank you. Maybe just curious on Canada. I think one of your peers mentioned some headwinds there. And I think if we're interpreting the commentary, it sounds like maybe you saw a slowdown, too. Just wondering if you could talk about that dynamic if you think that should persist in '24?
Douglas Howell: Well, listen, I think they had some -- they were posting 13 points, 14 points of organic growth. The market has shifted up there a little bit. So, I think they've been in the mid- to upper mid-single digits for the last four or five quarters. So, I don't see much of a shift going into 2024.
J. Patrick Gallagher: Let me pile on that one, if you would, Michael. First of all, Doug, you're right on. They've been killing in Canada. High upper digit organic year in and year out, and now they're about 5%. That makes perfect sense to me, given where they've been. And I think the 5% is a great number.
Douglas Howell: Yeah. We actually had a couple of really great new business opportunity that just didn't fall our way. For some reason, they decided to stay with the incumbent. So I think that if you normalize for those a handful of items, I think they would have had -- add 3 or 4 more points to it.
Michael Ward: Okay. Thank you. And then, in the CFO Commentary, it looked like you guys outperformed your revenue pick for 2Q '23 acquisition activity and increase the pick for first quarter for your 2Q '23 acquisition activity. Just wondering is that momentum from Buck or what's driving that?
Douglas Howell: All right. Help me understand what you're looking at again. Tell me what you saw. I just didn't track to your question. Sorry about that.
Michael Ward: It was just the revenue pick from 2Q '23 -- well, and you increased the 1Q '24 pick. Just sort of wondering if that was Buck from $90 million to $95 million?
Douglas Howell: Listen, remember, every time we buy something, you're going to get maybe four quarters of this disclosure. So as Buck runs that off, we also have Cadence and Eastern that are coming on in fourth quarter '24, but that's -- you can see it there, the 2000 -- second quarter 2,000, it falls away to nothing, right? It goes -- which it would even if it were $5 million a quarter, it's $95 million. So, that is what you're seeing there. It's just the run in a Buck that's no longer M&A roll over.
Michael Ward: Okay. Awesome. And then maybe just following up on the question from earlier. Did I hear you sort of mention for benefits growth was kind of going to be at the -- or you think it's going to be towards the bottom end of the kind of spectrum across product lines this year?
Douglas Howell: No, I just said they might be running more like 7% versus 9% in some things next year. So that's what I said. They would be more towards that lower end of that 7% to 9% range, just on the nature of their business.
Michael Ward: Okay. Thank you, guys.
Douglas Howell: Pause on that a little bit. Get the medical inflation that many are starting to worry about, we might have a different answer for you on that one, that heats up.
Michael Ward: Thank you.
J. Patrick Gallagher: Thanks, Michael.
Operator: Thank you. And our last question is coming from Meyer Shields with KBW. Please proceed with your question.
Meyer Shields: Thanks. I think two really small ball questions. Doug, you talked about why contingents in the fourth quarter a little bit better than the December expectation. But it also sounds like you're not expecting reserve development to be a problem in 2024 if contingent organic matches core organic. Am I thinking about that right?
Douglas Howell: No, I didn't say that. I think that on the casualty lines, I think that would impact our base commission. I don't see it really eroding our supplemental or our contingents. If we do have a reserving, again, I don't like you to use word crisis, but if there's something like that, that happens may be something that, but I don't see that eroding the contingent commission substantially next year as they take rational and orderly rate increases.
Meyer Shields: Okay. Understood. And then just -- I may have missed this. But the increasing detail on Page 6 of the commentary where you break out the individual components, should we assume that those are all, I don't know, 90%-plus margin revenue?
Douglas Howell: No, my point was on the premium funding, there's -- the margin on that would be very similar to our Brokerage business. So that's not -- equity interest is not that big of a number. We just don't have that many 100%-owned entities on it. And then interest income, yeah, there's margin on that. But remember, interest income is to rise -- is there because there's inflation out there. We do have inflation in some of our categories like travel and entertainment, for instance, a substantial inflation in that. So if that -- if interest rates come down, then I would expect inflation on travel to come down also. So there are some offsets on it, but the premium funding business is 30 points of margin, something like that.
Meyer Shields: Okay. Perfect. Thanks for the clarification.
J. Patrick Gallagher: Thanks, Meyer. And let me just say thank you again for joining us this afternoon. And to our 52,000-plus colleagues across the globe, thank you for another fantastic year. Our achievements are due to all of your hard work and dedication. As thrilled as I am with our fourth quarter and full year '23 performance, I get even more excited when I think about our future. We operate in an essential industry for the economy within a fragmented market, having leader data and analytics and niche expertise and limited global market share. So I believe our opportunities for future growth are immense. And while I always say, we're just getting started. It's pretty cool to be Gallagher. We look forward to seeing you at our mid-March IR Day. Thanks for being with us today.
Operator: Thank you. This does conclude today's conference call. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Co.'s Fourth Quarter 2023 Earnings Conference Call. Participants have been placed on the listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and risk factors sections contained in the company's most recent 10-K, 10-Q, and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you very much, and good afternoon, everyone. Thank you for joining us for our fourth quarter '23 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had a strong fourth quarter to wrap up another fantastic year. All measures were right in line with what we said during our December IR Day. For our combined Brokerage and Risk Management segments, we posted 20% growth in revenue, headline 8.1% organic growth, but that's more like 9.4% controlling for the 606 accounting and large life case timing. We also had a terrific merger and acquisition quarter. We completed 14 mergers totaling $410 million of estimated annualized revenue. GAAP earnings per share of $0.30 and net earnings margin of 2.8% were impacted by the counterintuitive earn-out payable accounting that Doug will elaborate on in a few minutes. So, better to look at it more on a comparable basis. Adjusted earnings per share were $2.22, up 23% year-over-year, and we posted an EBITDAC margin of 30.1%, up 69 basis points over fourth quarter '22. What a terrific quarter to close out an incredibly good year by the team. When I think about our growth for the full year, we are up 18% in revenue, that's an increase of $1.5 billion. That's amazing. Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth was 20%. Organic headline was 7.2%, but I see it more like 8.7% without the accounting and timing noise, and 11% if you include interest income. Adjusted EBITDAC was $647 million, growing 21% year-over-year, and we posted adjusted EBITDAC margin expansion of 48 basis points. Let me give you some insights behind our Brokerage segment organic, and just to level set, the following does not include interest income. Our global retail P&C brokerage operations posted organic of 8%. This includes about 8% organic in the U.S., 8% in the U.K., 5% in Canada, 10% in Australia and New Zealand. Our employee benefit brokerage and consulting business posted organic of 2% or 6%, controlling for the timing of those large life cases. Shifting to reinsurance, wholesale and specialty businesses, overall organic of 14%. This includes Gallagher Re at 12%, U.S. wholesale at 12% and U.K. specialty at 16%. So, all of these are very similar to what we were seeing throughout the year. Next, let me provide some thoughts on the P/C insurance pricing environment, starting with the primary insurance market. Global fourth quarter renewal premiums, which include both rate and exposure changes, were up 8.5%. That's in-line with the 8% to 10% renewal premium change we have been reporting throughout '22 and '23. Renewal premium increases continue to be broad-based, up across all of our major geographies and most product lines. For example, property is up 15%, even in a slow cat property quarter. General liability is up 6%, workers' comp is up 2%, umbrella and package are each up about 10%. Shifting to the reinsurance market. 1/1 renewals were orderly reflected a more balanced supply-demand dynamic. Continued strong demand for property cat cover was met with sufficient reinsurance capacity from existing reinsurers and cat bonds. Importantly, reinsurers continue to exercise discipline on pricing and terms, not giving back the structural changes achieved last year. In casualty, while there was adequate supply, most casualty treaties experienced pricing pressure. Specialty lines renewed mostly flattish. However, coverage limitations continued on war-related products. So, in our view, insurance and reinsurance carriers continued to behave rationally, pushing for a rate where it's needed to generate an acceptable underwriting profit. Property is still needing rate. And more and more, we're hearing about the need for rate in casualty lines. If prior year development turns into a big concern, we think it could be a multiyear journey of rate increases. All that said, always remember, our job as brokers is to help our clients find the best coverage while mitigating price increases. So, not all these renewal premium increases ultimately show up in our organic. Moving to our customers' business activity. Overall, it continues to be strong. During the fourth quarter, our daily indication showed positive midyear policy endorsements and audits ahead of last year's levels. So, we are not seeing a slowdown. The same strength is also evident in the U.S. labor market with continued growth in non-farm payrolls and low unemployment rate, which is why I believe our HR consulting retirement and benefits business will have terrific opportunities in '24. As we sit here today, we are very well positioned. 2023 was a great new business year, and I believe we will continue to win new clients while retaining our existing customers. We have incredible niche expertise. Our client service is top notch, and our data and analytics continues to distance ourselves from the competition. We can handle any account of any size, anywhere around the globe. All this leads me to reaffirm that we will still see further '24 Brokerage organic in the 7% to 9% range that would lead to another outstanding year. Shifting to mergers and acquisitions. We had an excellent fourth quarter, completing 13 new brokerage mergers, representing about $350 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing family of Gallagher professionals. And we are off to a strong start to '24. We've already closed four brokerage mergers here in January for about $30 million of annualized revenue. We also have around 40 term sheets signed or being prepared, representing around $350 million of annualized revenue. We know not all of these will ultimately close, but we believe we'll get our fair share, clearly, a very strong pipeline. Moving on to Risk Management segment, Gallagher Bassett. Fourth quarter organic growth was terrific at 13.2%, full year at 15.8%. Adjusted fourth quarter EBITDAC margins of 21% and full year at 20%, all this right in-line with our December expectations. We also completed one merger in Australia with expected annualized revenue of about $60 million, adding new capabilities in the disability space. Looking forward, we continue to see '24 year organic in the 9% to 11% range and full year margins close to 20%, and that would be another outstanding year. And I'll conclude with some comments regarding our bedrock culture. It's a culture of client service, ethics and teamwork encapsulated in the Gallagher way. It is an unrelenting culture of excellence that helped drive full year '23 results for our combined Brokerage and Risk Management segments of 18% growth in revenue, of which 10% was organic. 51 mergers with nearly $900 million in estimated annualized revenue and 20% growth in adjusted EBITDAC. Most importantly, we have a culture that our people believe in, embrace and live every day. It's a huge competitive advantage and will continue to fuel our success and growth. That is the Gallagher way. Okay. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Pat, and hello, everyone. Today, I'll walk you through our earnings release commenting on fourth quarter and full year organic and margins by segment. I'll also provide some comments on our full year '24 outlook. We'll then shift to the CFO Commentary document that we posted on our IR website where I'll provide some comments on our typical modeling helpers and then give two short vignettes, one on investment income and another as a quick refresher on earn-out payable accounting. I'll then conclude my prepared remarks with a few comments on cash, M&A and capital management. Okay. Let's flip to Page 3 of the earnings release. Headline, fourth quarter Brokerage organic of 7.2% is right in-line with our December IR Day expectation of 7% to 7.5%. But as Pat noted, we see that closer to 8.7% and organic of 11% if we were to also include interest income. That's a darn good quarter, no matter what percentage you want to focus on. A couple of other puts and takes to call out on that page. First, contingents did come in a little bit better than our December thinking due to more favorable carrier performance than we thought at that time. And second, base commission and fee organic of 6.5%. That's where you should levelize for the impact of 606 in those life cases. Controlling for those takes that over 8%. Looking ahead to '24, our Brokerage segment organic outlook is unchanged from our late October and mid-December expectations. We still see full year organic growth in that 7% to 9% range. All right. Let's flip to Page 5 of the earnings release, to the Brokerage segment adjusted EBITDAC table. Adjusted fourth quarter EBITDAC margin was up 48 basis points. But remember, to get to that requires recomputing last year's fourth quarter using current FX rates. We've done that in this table and is 31.3% for fourth quarter '22. So, posting a 31.6% margin this quarter gives you that 48 basis points of margin expansion, and that's right at the high end of our December IR Day expectation. Then, if you control for the role in Buck and other mergers we closed late in the quarter that have some seasonality, that would have been 150 basis points of expansion. That's simply terrific work by the team. Looking ahead to next year, we anticipate seeing some full year margin expansion starting at 4% organic. And if organic was, say, double that, maybe around 60 basis points of expansion. And note, that includes about 40 basis points of pressure against it due to the roll in of M&A, mostly Buck. On a quarterly basis, the headwind is about 80 to 90 basis points in the first quarter '24. So, please don't forget to reflect this nuance in your models. Okay. Moving to the Risk Management segment and the organic and EBITDAC tables on Pages 5 and 6. Another excellent quarter for Gallagher Bassett, 13.2% organic growth and margins at 21%. We continue to benefit from new business wins and excellent retention. Looking forward, even as we lap growth associated with some large new business wins from early '23, we see full year '24 organic in that 9% to 11% range and margins around 20%, again, that's unchanged from our December views. So, let's turn to Page 7 of the earnings release and the corporate segment shortcut table. Total segment adjusted fourth quarter numbers came in a little better than the favorable end of our December IR Day expectations due to less borrowing on our line of credit and slightly lower corporate expenses. So, now let's shift to the CFO Commentary document, to Page 3, that's where we provide many modeling helpers. Most of the fourth quarter actual numbers are very close to our December IR Day estimates. We've also now added 2024 information. So, take a look at that. In particular, as we -- take a look at FX. We are expecting a small headwind to EPS in the first half within the Brokerage segment. Now, moving to Page 4 of the CFO Commentary document, to the corporate segment outlook for full year '24. There's no change there to our full year estimate that we provided six weeks ago during our IR Day, but we are now providing quarterly estimates. So, please take some time to refine your models with us added information. When you get to Page 5, this page shows our tax credit carryforwards. You'll see what we discussed at our December IR Day. We are able to reestablish a portion of our tax credits following the change in tax method election when we filed our '22 U.S. federal tax return here in the fourth quarter. Accordingly, as of December 31, we have about $870 million of tax credits available. That's a nice future cash flow sweetener that helps us fund future M&A. So, let's turn to the new table that we put in the top of Page 6. We thought this would be helpful as we've been giving a lot of questions about our investment income line. The punchline is that this line includes items such as premium finance revenues, book gains and equity investments in third-party brokers in addition to interest income. So, this table breaks it down for you by quarter. We hope you will find this helpful. We've also renamed that line in our financial statements to clarify that it contains other items. No numbers change, we've just broadened the descriptor. So, just shifting down on that page, on Page 6, you'll see total Brokerage rollover revenue for fourth quarter was $180 million. That's consistent with our IR Day expectation. Looking forward, we've included estimated revenues for mergers closed through yesterday for the Brokerage segment in that table and for the Risk Management segment in the text below that table. Based on Brokerage and Risk Management mergers closed through yesterday, we're estimating around $540 million of rollover revenues to be recognized in '24. And also, don't forget, you'll need to make a pick for future M&A and also add interest expense as we fund a portion of those acquisitions via future borrowings. So, while I'm on the topic of M&A, as we foreshadowed in December, we did increase our estimated earn-out payable for Willis Re during the quarter because we now have good line of sight of what we might pay out in the first quarter of 2025. Remember, the accounting for earn-out payables is a bit backwards. If expectations of performance are more favorable, it creates GAAP expense. And if expectations of performance are less favorable, it creates GAAP income. That's what Pat meant when he said counterintuitive accounting. That said, we do adjust these estimate changes, but were the highlight because it does create some GAAP earnings noise. The punchline on all this and what's more important, our reinsurance business is performing extremely well. So, moving to cash, capital management and M&A funding. Available cash on hand at December 31 was about $400 million. And with another year of strong expected cash flow generation here in '24, we estimate about $3.5 billion of capacity to fund M&A in '24 using only free cash and incremental borrowings. So, those are my comments. As I reflect on '23, two metrics for our combined Brokerage and Risk Management segments really sum up how good our year was: revenue growth of 18%, up $1.5 billion; and adjusted EBITDAC growth of 20% or nearly $550 million. So, the team delivered another terrific year, and we all have tremendous momentum to do it again here in '24. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you, Doug. And operator, I think we can go to questions now, please."
},
{
"speaker": "Operator",
"text": "Thank you. [Operator Instructions] Our first question is coming from Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good evening. My first question, within the 7% to 9% organic Brokerage guide for 2024, can you guys give us a sense of what you're assuming for pricing and economic exposure throughout the course of the year?"
},
{
"speaker": "Douglas Howell",
"text": "Well, I think when we did that in our budget process, the range of 7% to 9%, it's pretty much so what we're seeing today throughout next year is really the assumptions. Where are we today in pricing, where are we in exposure units, what we've been running here this year, we don't see a lot of change to that next year."
},
{
"speaker": "Elyse Greenspan",
"text": "And then when you guys go through and come up with the 7% to 9%, are you assuming that all of your businesses will be in that range? I mean, now you've been seeing really strong growth within reinsurance, wholesale and specialty. Are those expected to continue to be above and maybe some of the others like benefits might be below? How do you see the different businesses shaking out in '24?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So on that point, not every business has given a flat target number, they view it based on what they're seeing in the marketplace rate, exposure, opportunities, hiring, hiring new producers. So, every business does that differently. What would I say is being different? Who's on the upper end of the range? And who's on maybe the lower end of the range? Benefits might be a little bit on the lower end of the range, and you might see reinsurance and specialty on the upper end of the range in that. But by and large, each business unit rolls it up and that's how we get to that 7% to 9% range."
},
{
"speaker": "Elyse Greenspan",
"text": "And then, Pat, you mentioned some interesting comments on the casualty side. We're starting to hear your thoughts about pricing pressure and just you said right, multiyear journey here. Can you just tell us like what you're seeing and then how you expect this cycle could transpire assuming we do start to see more reserve holes emerge across the industry?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I just think it makes some logical sense, at least. When you take a look back, we saw this in the property side. Nobody touched values for five, six, seven years because inflation was zero. And so you've got a bunch of reserves on the casualty side, set at those very same years that all of a sudden you come into a spike in inflation. And yes, it's been tamped down, but it's still there. And you look back at those reserves and then you take a look at these settlements that are, in fact, nuclear. And you start to say, well, all right, how well are those reserves going to hold up? Now look, I can't speak for the industry as a whole. But my sense in the meetings that we're having and discussions we're having with a number of the various carriers is that they have some concerns there that they are not necessarily comfortable with exactly where they are. And so, our view on that is, okay, if you take a look at if there were inflation in those numbers and if it were something where you had to get them right, you'd have to see price increases in order to do it. I don't think that, that's something with the kind of payout structure that you have in casualty that you need to get in one year. So, I think you're going to see possibly affirming that does, in fact, take a few years to catch up with reality."
},
{
"speaker": "Elyse Greenspan",
"text": "And then one last one. Have you guys reserved to the maximum on the earn-out associated with the Willis Re deal?"
},
{
"speaker": "Douglas Howell",
"text": "Effectively yes. I mean we still have to accrete that for one more year. So it might be -- I think there's $50 million of accretion that will go through the financial statements this next year."
},
{
"speaker": "Elyse Greenspan",
"text": "Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Elyse. Thanks for being with us."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is coming from Mark Hughes with Truist Securities. Please proceed with your question."
},
{
"speaker": "Mark Hughes",
"text": "Yeah, thanks, good afternoon."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Pat, did you give the organic for open brokerage versus the program business within wholesale?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I think open brokerage has been where we've had the real nice run-up. I mean it's probably double to triple what's going on in the program business. So, if you look at open brokerage that running around 13% to 15%, you're probably looking at 5% on the programs."
},
{
"speaker": "Mark Hughes",
"text": "And then, what's your take on the property market? Do you think little bit of deceleration there? Well, one, do you think that's the case? And two, would it have any kind of material impact on your organic?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I think -- well, I mean, any change in pricing is going to have an impact on organic. But I'm not -- no, I don't see carriers at this point saying, \"Oh, the good news is I can take the price backwards.\" So, we are still seeing a push on property rate. And then you do, of course, have carriers incredibly focused on valuations. That kind of went by the wayside for years. There was no inflation, fine, 0% blah, blah, blah. Now claims are coming in, they didn't get their premium for it, the replacement costs are substantially higher than they may be predicted. And so, I think you do have a little bit of time left where there's going to be some valuation correction, and I do think there is a need for continued rate strengthening."
},
{
"speaker": "Mark Hughes",
"text": "Thank you very much."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Mark. Thanks for being with us."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Michael Zaremski",
"text": "Hey, good evening. So first question on M&A. You guys have been extremely successful integrating and acquiring firms. But I'm just curious if the landscape has changed a bit in terms of kind of what's available. And, I guess, just for example, when I was -- you've announced a few bank-owned brokers. I believe, historically, there's two of your competitors that did most of those, and they would -- one of them would talk openly about those deals being tougher, meaning take a couple of years to turn them into the growth machines that those companies are and Buck was a little different, too. So just curious if the pool is changing a bit, and so we should kind of expect probably different types of deals going forward versus the historical five, 10 years."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I'd tell you, first of all, let's remember. I think that when we do acquisitions, we like to talk about the fact that we're getting two things. We're not just getting revenue and earnings, which, of course, we want, we get. But we're getting terrific brains. And the bank-owned deals happen to be more sizable and they've got a lot of terrific people. And in addition to the brain power we're getting, we're getting expertise in the niches from the brain power, but we're also getting more volume in areas that now are spreading the brand. And it adds to that the virtuous circle of knowing about Gallagher, listening to the con-call, accepting the call. And I think what we're seeing is that our acquisition targets come aboard, and I guess this is the right way to phrase it, they kind of get on fire. It is our organic engine. There's no question about it. They come in. They've got a lot to say. Now, the bank deals are bigger. But if you take our day-in and down-out, roll-in acquisitions, these are people that more often than not have not been able to really tackle the large accounts in their own geography. In the minute they sign on to us, they're out telling those clients we're part of Gallagher, here's what we've got, let me tell you about the expertise we've got, let me show you some of the things that we do in data and analytics. You've all heard us talk about drive. What do people like you buy? What kind of limits should you have? So, we arm them with tools that they just -- whether they're in a bank or not a bank, they've never had before. So, the excitement level does not take a long time to resonate. The calls go out pretty immediately, \"Hey, did you hear that we're part of another firm.\" And these are not folks that are in any way on their back foot. They are on the front foot and moving literally at the day of closing."
},
{
"speaker": "Douglas Howell",
"text": "Yeah. Let me add one thing on that. I think that the organic in Cadence and Eastern was running very similar to what we're seeing in our similar geographies in similar areas. So I think your premise was that it take a while to restart them. I think they're already started. I think they're going after it. Buck is already showing terrific organic growth. We don't get it in our numbers for a year. So somebody goes out and sells something within the year, but we never get organic credit for that. And we get the revenues for it, but we don't get the organic growth credit in our numbers. So, I wouldn't say that the premise was, if the ones that we bought that they were -- they needed a restart."
},
{
"speaker": "J. Patrick Gallagher",
"text": "No, in fact, Mike, I'll tell you what we're referring to in our process is the Gallagher effect. The Gallagher effect is what happens after you announced you're part of Gallagher. It's not a slowdown, explain it. It takes their list, their pipeline of prospects and energizes the team to go back and tell about we really have something new to talk about here. And it's not just about, I know you. I've called on you many times. I've got a good relationship in the marketplace. Can I talk to you about your pricing? It's a hard market, soft market, but no, no. This is -- let me bring some data and analytics. Let me show you what's going on in our niches. We have experts in your specific area that I think you're going to want to meet. It's pretty exciting, actually. When I get a chance to get involved, it turns me on."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. No, I appreciate that color. Switching gears and you could tell me if I'm splitting hairs here. But on the December Investor Day, there was a number of reasons you kind of lowered the very near-term 4Q organic growth estimates versus what you previously have been thinking. And I think a couple of those sounded like they were more of like a push into '24 like on the life insurance side and maybe entertainment business rebounding. But I didn't think you really brought up your -- you didn't bring up your '24 guide. So I guess, should we seasonally -- obviously, we know there's seasonality in the quarters, but should we be thinking 1Q or the first half of the year gets a little bit more of a bump than it does historically? Or am I just reading too much into things?"
},
{
"speaker": "Douglas Howell",
"text": "I think you're missing the magnitude of this. In the quarter, let's call it, $10 million, we get $15 million in total here that gets pushed out on a $10 billion business next year. Okay, it's 10 or 15 basis points in there, but so that wouldn't be enough to change that 7% to 9% guide in there."
},
{
"speaker": "Michael Zaremski",
"text": "Okay, And just lastly, you're one of the leaders. You've been doing it successfully for a while in terms of moving folks -- or sorry, in your center of excellence. Any changes in kind of the trajectory there in terms of what you guys talked about last year in terms of kind of the goal of kind of doubling, maybe the percentage of employees there over the next five or so years?"
},
{
"speaker": "Douglas Howell",
"text": "I think what we said is that over the next five or seven years, we'll need twice as many people there as we have there now. I think what's really exciting about all the work that we've done for almost two decades there now has put us in a position of being so standardized in many of the processes that we do. We now have the opportunity to unleash AI on that because that's already done. We have made that investment. And now what we can do is deploy AI against it. And, look, those folks, if you're going to hire twice as many folks, they're going to end up with better jobs over there because they're going to be using AI. So, our colleagues there are going to be well rewarded by deploying that technology into it. So, we are really fired up about it."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. Let me hit a couple of other items. Why would we need to double our employee count there because we're going to double the business. And that's going to lead to plenty of opportunities there. Secondly, and I think this is a hugely important point. Standardizing a Brokerage business from an agency system through the operating processes to things like issuing certificates of insurance is a [indiscernible]. It takes four, five years to bang it through. I've done it. It's a headache. We're there. We don't need to do it. We don't need to sell it. It's standard operating procedure. When you join us, you know that in your due diligence, you come aboard, you plan the effort to change into our agency system and you get rewarded for it by virtue of the data and analytics we can provide you to go out and sell. We don't need to sell our team on that. We don't need to prove it to them. We did that 15 years ago."
},
{
"speaker": "Michael Zaremski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is coming from David Motemaden with Evercore ISI. Please state your question."
},
{
"speaker": "David Motemaden",
"text": "Hey, good evening."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Dave."
},
{
"speaker": "David Motemaden",
"text": "I just had a question on -- just on -- it looks like there was a little bit of favorable timing during the quarter on incentive compensation expenses that helped the margin in Brokerage. Was that a big help? And is that something that you guys have sort of baked into the first quarter of '24, just that timing coming through?"
},
{
"speaker": "Douglas Howell",
"text": "Well, first of all, we talked about that, I think, back in our April or June call that we were probably a little further ahead at that point of the year and our incentive comp accruals. So that's been contemplated in our guidance of margin expansion since way back then. So that -- I would say there's no new news of what we were expecting in December versus what we delivered this quarter. And what's the impact of it? It's not a point. I mean, so it's not a big number."
},
{
"speaker": "David Motemaden",
"text": "Got it. Understood. And then I just wanted to come back to the 7% to 9% Brokerage organic for 2024 and sort of level set in terms of what you guys are thinking on the exposure growth side, the range of outcomes that you guys are considering within that 7% to 9%."
},
{
"speaker": "Douglas Howell",
"text": "All right. So I think when you break down our organic, we usually have more net new versus lost is probably 3% to 4% on that. When you get some rate in there, probably, we're at that 2 points and maybe there's 2 points of it, that's 2 or 3 points that's exposure unit growth. I don't -- we're going to have more lift next year from new versus lost probably proportionately. So, if you break down 9%, it might be a third, a third, a third. If you break down 7%, it's probably half rate -- excuse me, mostly new business and then exposure unit growth again."
},
{
"speaker": "David Motemaden",
"text": "Got it. Understood. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Gregory Peters with Raymond James. Please state your question."
},
{
"speaker": "Gregory Peters",
"text": "Good evening, everyone. I guess I'm going to the new table that you added to the CFO Commentary, which we appreciate, which is the interest income, premium finance revenues and other income. And could you give us some perspective, because ever since mid-December, when the Fed changed their perspective on what's going to happen with rates, there's obviously some mechanics we're trying to calculate on what might happen with that line depending on what the Fed does with interest rates? So maybe there's some benchmarks you can provide for us that will help us sort of map out what we think might happen there."
},
{
"speaker": "Douglas Howell",
"text": "All right. So you got the rate sensitivity and you've got the amount of cash that we have on our balance sheet, that's not only ours, but our clients, okay? So, first and foremost, it's both the rate that we're earning and then it's the -- on what we're earning that on. Second of all, you've got the dynamic. You mentioned the Fed. The U.S. portion of that interest income is only about 45% of the numbers. So it's actually more heavily weighted to internationally, and you would expect that with kind of large reinsurance balances in some of the large specialty businesses that we have in the U.K. So you got to separate your thinking on that. The other thing, too, is that you've got the growth as it grew this year, it was not only because of rate that was going up, but it was also because of the way the reinsurance receivables migrated from Willis' books onto our books during the transition services agreement. So you got that dynamic in it. I think what you're trying to plumb for is how sensitive is that number to rate changes. I would say that it's price-sensitive $5 million per rate cut that the Fed does in the U.S. per year. So if there's 4 points in, there's $20 million -- four cuts that might be $20 million. Again, that's just answering your question about the Fed. How the other central banks, what they do with their policy next year, I just don't have that number right off the top of my head. But when you asked about the Fed, think about it as $5 million per cut."
},
{
"speaker": "Gregory Peters",
"text": "Excellent. Just a follow-up on that table for '23. And what quarter did the services agreement with WTW shift? Because I assume that would have meant the change..."
},
{
"speaker": "Douglas Howell",
"text": "July 1."
},
{
"speaker": "Gregory Peters",
"text": "July 1. So when we're looking at the third quarter and fourth quarter, that's more normalized under going forward operating conditions, correct?"
},
{
"speaker": "Douglas Howell",
"text": "That's correct."
},
{
"speaker": "Gregory Peters",
"text": "Thank you for that clarification."
},
{
"speaker": "Douglas Howell",
"text": "Yes, it's important for -- yes, okay. You've got the premium finance just to make sure you know that there's expenses associated with premium finance that's down there. So that's a spread business. But you get -- gross is up. We get the revenues up above, and then we get the -- we have the operating expenses and the interest costs down below in operational."
},
{
"speaker": "Gregory Peters",
"text": "That's excellent detail. I appreciate that. And then there's a bigger picture question I have before I get there. I can't -- I'm hung up on the clean energy tax credit carryforward balance, which caught me by surprise going up. And I know there's obviously a revised approach towards your tax credits here. But without getting into detailed commentary on the changes and the nuances and the tax, is it your expectation going forward that this -- that you're still going to be pulling down $150 million or more of tax credits from clean energy going forward? And then, is that $867 million just related to the clean energy? Or is there other things in that?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So, two things. You can see on Page 5, we have reaffirmed that we think that there'd be about $150 million worth of utilization of that balance in '24. And maybe when you get to '25, '26, '27 is somewhere around $180 million of utilization in a year. So, you need to think about it coming in over the next four years. There is a very small other balance of credits in there that I would say is a rounding there, and it has to do with when we construct our home office building. But for all intents and purposes, consider these credits to be from our clean energy work."
},
{
"speaker": "Gregory Peters",
"text": "Great. So, pivoting back to the bigger picture question is, I'm going to focus on reinsurance because last year was one of the most challenging reinsurance renewal periods in our lifetimes, and especially on the cat side, I should say. And clearly, based on your commentary and others, it seems like it's going to be more normal this year. It seems like the lift you might get from the pricing or rate component is going to be a lot less this year than it was last year. So I don't want to get too hung up on -- and I realize casualty has its own cadence, but I was just curious about your response to that observation and how you think it might work with Gallagher?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, first of all, let me just say that when I look back, I can't tell you how proud I am of the team. We came into a year, new to the organization, we've got some expertise for sure that got paid, but it was very difficult a year ago. And we basically, in a tough environment, took care of our clients. And I think that's really -- we learned a lot all of us from that. And then we come around to this year, yeah, the supply and demand balance was a little easier, but what you've got now is a group of our clients that, number one, the price is up, and number two, demand is up. So, you've got pricing not coming down and people looking and saying, \"No, okay, it's not as sloppy as it was a year ago, I'd like to get more of that.\" And we saw a bunch of that at 1/1. Remember, about 45% of our business is book 1/1. So, the year when it comes to cat property is pretty much in the bank. And it's been a great year. Easier to place than last year, but as I said, demand up and pricing up. So, it still remains a very good market for us, and one in which there aren't that many people, Greg, that can do what we do for our clients. And our larger competitors are very, very good. But it falls off pretty quick after us."
},
{
"speaker": "Gregory Peters",
"text": "That's right, all right, Thanks for the answers."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you, Greg. Thanks for being with us."
},
{
"speaker": "Operator",
"text": "Thank you. And our next question comes from the line of Andrew Kligerman with TD Cowen. Please proceed with your question."
},
{
"speaker": "Andrew Kligerman",
"text": "Hey, thanks a lot, and good evening. I just want to clarify, Doug, when you were saying $5 million per rate cut, just define what you meant by rate cut? How much rate gets cut?"
},
{
"speaker": "Douglas Howell",
"text": "25 basis points."
},
{
"speaker": "Andrew Kligerman",
"text": "How many?"
},
{
"speaker": "Douglas Howell",
"text": "25. They do at 25. I was referring to a rate cut of 25 basis points."
},
{
"speaker": "Andrew Kligerman",
"text": "25 bps. Perfect. Thank you. And then, with respect to Gallagher Re, could you talk a bit about how the cross-selling with Risk Management is playing in? Is that a big driver? And also, I understand you're going to be moving into facultative reinsurance and -- or maybe you've been doing that. What kind of tailwinds do those provide to 2024?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I mean, first of all, I have to say that the reinsurance team has been incredibly pleased with and nicely surprised by the amount of interaction with our retail team around the world. And when we did the deal, we told the team and ourselves that we thought there was a considerable benefit from having both sides of the equation under one roof, and that is playing out over and over and over again. As you know, we're very, very strong in our niche or niche marketing, and that's a global play. And the capability to have the reinsurance perspective in those meetings, and then we're the largest player in the pooling sector for public clients in the United States. We kind of thought we had that pretty well nailed. Not a lot to learn. Our reinsurance team has added a tremendous amount of value and helped us add cover for the pools and revenue for our retailers and revenue for our reinsurance people. So, it's been an incredible two-year journey, and we're just getting started in terms of the opportunity to play together in the sandbox. What was the other question, Andrew?"
},
{
"speaker": "Andrew Kligerman",
"text": "Facultative..."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Facultative, but of course, now coming along with treaty clients and having our retailers -- here is an example of what you're talking about, where retailers are trying to get things done and oftentimes it's hard to place areas like property, et cetera. We are seeing our facultative opportunities grow. No, it's not brand new. But we are organizing ourselves better in the fac world. And I think we're getting -- we're in a better position today than six months ago to go out to our insurance carrier customers and our trading partners and say, \"We want to participate in this. We want to help you.\" So, we are seeing an uptick in opportunities."
},
{
"speaker": "Andrew Kligerman",
"text": "Lot of tailwinds there. Shifting over to Risk Management and the organic change in fees. I mean, just it seems terrific. And I'm just wondering on the claims management side, what kind of carriers are you growing with? Are they the large ones? Or are they the small ones? Like where are you seeing the most growth in claims management?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, you're seeing two things. One, our historical play in the Risk Management accounts, where you've got large accounts, you name it, whatever the large hotel chains or what have you, that are procuring our business on their accounts. And there's -- we've got a great, great year in that regard, and that includes public sector clients as well. And then as you know, we have over the last decade or so really focused on outsourcing of claims from insurance companies. And I don't have liberty on this call to name some of those because some of those carriers are pretty well-known carriers and not one that I necessarily have the approval to be touting. But from inside the organization, you look at some of these carriers you go, it's fantastic. And then, of course, the regional small companies that would like to expand that don't want to add infrastructure, they think they've got an opportunity in a given stage or geography. They don't want to be putting a lot of boots on the ground. We're picking those up as well. So, the team at GB is, in my opinion, just outperformed expectations every single year."
},
{
"speaker": "Andrew Kligerman",
"text": "It just seems like in the carriers, I mean, there's just a lot of runway there."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, let me put it this way, Andrew. I really believe this. I believe that it will not be unusual, and I believe that people will ask. \"Did insurance companies pay their own claims? Why would they do that?\" When I sit with some of our insurance company partners and explain to them that Gallagher Bassett pays substantially more claims in numeric numbers and substantially more dollars than they do in claims by line of cover, by geography, not just in the U.S., the first reaction is oftentimes shock. And again, I won't mention any names of carriers. They go no, no. Look, if you put a capital structure around GB and called it an insurance company, it'd be one of the five top insurance companies probably in the world. Think about that in terms of the amount of claim work that's coming through. And our focus, and this is, I think, really key, and what we're selling and we believe proving day in and day out is if you outsource your claim work to us, whether you are a large risk management account through self-insuring or whether you're a carrier, your outcomes will be superior. And if I look at an insurance company CEO and saying, \"I think I'm worth or could help you find 2 points of ROE,\" it could be pretty dramatic."
},
{
"speaker": "Andrew Kligerman",
"text": "Maybe if I could just squeak one last one in on the contingent revenues. They were up 30% in the quarter. Just given it was such a great year for underwriting, do you see that kind of being flattish as we go into '24, when you provided your 7% to 9% guidance, maybe that impact becomes flattish in the scope of it all?"
},
{
"speaker": "Douglas Howell",
"text": "No, I said it -- I would say it would be in that same 7% to 9% range. I'm not going to see it outperforming that. And yes, we were pleasantly surprised by a few extra million bucks than we thought we were going to get there."
},
{
"speaker": "Douglas Howell",
"text": "By the way, look through that number and see what it's telling you as a potential owner. Our book of business is superior to the competition. That's interesting, isn't it?"
},
{
"speaker": "Andrew Kligerman",
"text": "Yes. Hey, thanks a lot. That was great insights."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Andrew."
},
{
"speaker": "Operator",
"text": "Thank you. And your next question comes from the line of Yaron Kinar with Jefferies. Please proceed with your question."
},
{
"speaker": "Yaron Kinar",
"text": "Thank you, all. Good afternoon or good evening."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Yaron."
},
{
"speaker": "Yaron Kinar",
"text": "First question I have, and forgive me it's a bit nitpicky here, but in Brokerage organic, I know the organic came in-line with December guide. But I think contingents were a bit better than you were expecting. You were already accounting for the life case timing and the 606 accounting. So, it seems like there may have been something there that came in a little bit lighter than expectations? Or am I thinking about it incorrectly?"
},
{
"speaker": "Douglas Howell",
"text": "Maybe there's $5 million less than we had hoped on a few of them. But it's -- I mean, when you're looking at a $2 billion quarter, $5 million, it does move the percentage a little bit, but it doesn't -- it's not a meaningful that we are a sales organization, I look back last year, we had 11% one quarter, we had 7% in another quarter. We had 9%, 7%, 8%. So, it bounces around a little bit. So the fact that we brought it in within a 0.5 point or what we're looking at here, you do get some bounce around for a few million bucks here or there."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. And then a couple of quick ones on the CFO Commentary. So, I am seeing a bit of a slowdown in Brokerage earn-out payables in 2024. Is that just the Willis Re true-up in '23?"
},
{
"speaker": "Douglas Howell",
"text": "That's right."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. And then, I'm also seeing a meaningful increase in the amortization of intangibles and Risk Management. Are you expecting any large M&A there? Or did you already conduct..."
},
{
"speaker": "Douglas Howell",
"text": "Yeah, we announced My Plan Manager acquisition here a month or so or two months ago. So that's the $60 million worth of revenue in that disability business down in Australia."
},
{
"speaker": "Yaron Kinar",
"text": "Okay. Got it. Thanks so much."
},
{
"speaker": "Douglas Howell",
"text": "Sure. Thanks."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Yaron."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question comes from the line of Michael Ward with Citi. Please proceed with your question."
},
{
"speaker": "Michael Ward",
"text": "Hi, guys. Thank you. Maybe just curious on Canada. I think one of your peers mentioned some headwinds there. And I think if we're interpreting the commentary, it sounds like maybe you saw a slowdown, too. Just wondering if you could talk about that dynamic if you think that should persist in '24?"
},
{
"speaker": "Douglas Howell",
"text": "Well, listen, I think they had some -- they were posting 13 points, 14 points of organic growth. The market has shifted up there a little bit. So, I think they've been in the mid- to upper mid-single digits for the last four or five quarters. So, I don't see much of a shift going into 2024."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Let me pile on that one, if you would, Michael. First of all, Doug, you're right on. They've been killing in Canada. High upper digit organic year in and year out, and now they're about 5%. That makes perfect sense to me, given where they've been. And I think the 5% is a great number."
},
{
"speaker": "Douglas Howell",
"text": "Yeah. We actually had a couple of really great new business opportunity that just didn't fall our way. For some reason, they decided to stay with the incumbent. So I think that if you normalize for those a handful of items, I think they would have had -- add 3 or 4 more points to it."
},
{
"speaker": "Michael Ward",
"text": "Okay. Thank you. And then, in the CFO Commentary, it looked like you guys outperformed your revenue pick for 2Q '23 acquisition activity and increase the pick for first quarter for your 2Q '23 acquisition activity. Just wondering is that momentum from Buck or what's driving that?"
},
{
"speaker": "Douglas Howell",
"text": "All right. Help me understand what you're looking at again. Tell me what you saw. I just didn't track to your question. Sorry about that."
},
{
"speaker": "Michael Ward",
"text": "It was just the revenue pick from 2Q '23 -- well, and you increased the 1Q '24 pick. Just sort of wondering if that was Buck from $90 million to $95 million?"
},
{
"speaker": "Douglas Howell",
"text": "Listen, remember, every time we buy something, you're going to get maybe four quarters of this disclosure. So as Buck runs that off, we also have Cadence and Eastern that are coming on in fourth quarter '24, but that's -- you can see it there, the 2000 -- second quarter 2,000, it falls away to nothing, right? It goes -- which it would even if it were $5 million a quarter, it's $95 million. So, that is what you're seeing there. It's just the run in a Buck that's no longer M&A roll over."
},
{
"speaker": "Michael Ward",
"text": "Okay. Awesome. And then maybe just following up on the question from earlier. Did I hear you sort of mention for benefits growth was kind of going to be at the -- or you think it's going to be towards the bottom end of the kind of spectrum across product lines this year?"
},
{
"speaker": "Douglas Howell",
"text": "No, I just said they might be running more like 7% versus 9% in some things next year. So that's what I said. They would be more towards that lower end of that 7% to 9% range, just on the nature of their business."
},
{
"speaker": "Michael Ward",
"text": "Okay. Thank you, guys."
},
{
"speaker": "Douglas Howell",
"text": "Pause on that a little bit. Get the medical inflation that many are starting to worry about, we might have a different answer for you on that one, that heats up."
},
{
"speaker": "Michael Ward",
"text": "Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Michael."
},
{
"speaker": "Operator",
"text": "Thank you. And our last question is coming from Meyer Shields with KBW. Please proceed with your question."
},
{
"speaker": "Meyer Shields",
"text": "Thanks. I think two really small ball questions. Doug, you talked about why contingents in the fourth quarter a little bit better than the December expectation. But it also sounds like you're not expecting reserve development to be a problem in 2024 if contingent organic matches core organic. Am I thinking about that right?"
},
{
"speaker": "Douglas Howell",
"text": "No, I didn't say that. I think that on the casualty lines, I think that would impact our base commission. I don't see it really eroding our supplemental or our contingents. If we do have a reserving, again, I don't like you to use word crisis, but if there's something like that, that happens may be something that, but I don't see that eroding the contingent commission substantially next year as they take rational and orderly rate increases."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Understood. And then just -- I may have missed this. But the increasing detail on Page 6 of the commentary where you break out the individual components, should we assume that those are all, I don't know, 90%-plus margin revenue?"
},
{
"speaker": "Douglas Howell",
"text": "No, my point was on the premium funding, there's -- the margin on that would be very similar to our Brokerage business. So that's not -- equity interest is not that big of a number. We just don't have that many 100%-owned entities on it. And then interest income, yeah, there's margin on that. But remember, interest income is to rise -- is there because there's inflation out there. We do have inflation in some of our categories like travel and entertainment, for instance, a substantial inflation in that. So if that -- if interest rates come down, then I would expect inflation on travel to come down also. So there are some offsets on it, but the premium funding business is 30 points of margin, something like that."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Perfect. Thanks for the clarification."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Meyer. And let me just say thank you again for joining us this afternoon. And to our 52,000-plus colleagues across the globe, thank you for another fantastic year. Our achievements are due to all of your hard work and dedication. As thrilled as I am with our fourth quarter and full year '23 performance, I get even more excited when I think about our future. We operate in an essential industry for the economy within a fragmented market, having leader data and analytics and niche expertise and limited global market share. So I believe our opportunities for future growth are immense. And while I always say, we're just getting started. It's pretty cool to be Gallagher. We look forward to seeing you at our mid-March IR Day. Thanks for being with us today."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's conference call. You may disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 3 | 2,023 | 2023-10-26 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Co.'s Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and Risk Factors sections contained in the company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce Patrick Gallagher, Jr., Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
Patrick Gallagher: Good afternoon. Thank you for joining us for our third quarter '23 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had an excellent third quarter. For our combined brokerage and risk management segments, we posted 22% growth in revenue, 10.5% organic growth; GAAP earnings per share of $1.72, adjusted earnings per share of $2.35, up 22% year-over-year, reported net earnings margin of 15.5%, adjusted EBITDAC margin of 30.8%, up 78 basis points. We also completed 12 mergers totaling $57 million of estimated annualized revenue. Another great quarter by the team on all measures. Before I dive into more detail about the quarter and our outlook, I want to make a comment regarding the leadership appointments that were also announced this afternoon. Tom Gallagher will assume the role of President, and Patrick Gallagher will become COO, both effective January 1, 2024. These appointments are being made to better position us for the next phase of our growth. And before you ask, I have no plans to retire. I will continue to be CEO and Chairman focused on Gallagher's strategy and global expansion. In their future roles, Tom and Patrick will help me lead organic and merger and acquisition growth initiatives, drive operational improvement and further promote our bedrock culture across the entire organization. This is the best business on the planet. I love my job and believe we are just getting started. Moving to results on a segment basis. Let me give you some more detail on our quarter's performance. Starting with the Brokerage segment. Reported revenue growth was 22%. Organic was 9.3%. Acquisition rollover revenues were $153 million. Adjusted EBITDAC growth was 23%, and we posted adjusted EBITDAC margin expansion of about 55 basis points. Let me walk you around the world and provide some more detailed commentary on our brokerage organic. And just to level set versus some of our peers, the following figures do not include interest income. Starting with our retail brokerage operations. In our U.S. P/C business underlying organic growth was about 8%. New business production and retention was better than last year, while less nonrecurring construction and capital markets business was a bit of a headwind. Our U.K. P/C business posted 7% organic with new business production and retention similar to last year. Our Canadian P/C operation was up 10% organically, reflecting solid new business and retention and more modest renewal premium increases. Rounding out the retail P/C business, our combined operations in Australia and New Zealand posted 13% organic. Core new business wins remain excellent, and renewal premium increases were ahead of third quarter '22 levels. Our global employee benefit brokerage and consulting business posted organic of 6% with solid health and welfare results and continued strength across many of our retirement and HR consulting practice groups. Shifting to our reinsurance, wholesale and specialty businesses. Gallagher Re posted 20% organic, thanks to a strong 7/1 renewal season, another outstanding quarter by the team following an excellent first half. Risk Placement Services, our U.S. wholesale operations posted organic of 7%, including a couple points headwind from lower contingents. Open brokerage organic was 13% and organic was about 5% in our MGA programs and binding businesses. And finally, U.K. Specialty posted organic of 18%, benefiting from outstanding new business production, strong retention and continued firm market conditions. Next, let me provide some thoughts on the P/C insurance pricing environment, starting with the primary insurance market. Global third quarter renewal premiums, which include both rate and exposure changes were up 10%. That's at the top end of the 8% to 10% renewal premium change we had been reporting throughout '22 and early '23 and very similar to second quarter renewal premiums adjusting for business mix. Renewal premium increases remained broad-based, up across all of our major geographies and most product lines. For example, property is up more than 20%. General liability is up about 6%. Workers' comp is up about 2%. Umbrella and package are each up about 10%. Overall, the primary market continues to behave rationally in our view, with carriers pushing for rate where it's needed to generate an acceptable underwriting profit. Remember, though, our job as brokers is to help our clients find the best coverage while mitigating price increases. So not all of these premium increases ultimately show up in our organic. Shifting to the reinsurance market. Following the orderly July 1 renewal season, all eyes are turning to January renewals. Assuming no major cat events before year-end, we believe the property reinsurance market will see adequate capacity, continued firm pricing, rising insured values and increased demand overall. When it comes to casualty, reinsurers appear to be taking a cautious view of risk. With that said, we believe adequate capacity will be available to support increased demand at firmer pricing. Here in the U.S., our retail and reinsurance teams met with more than 25 of our key U.S. insurance carrier partners at the annual CIAB conference earlier this month. It remains a tough environment for carriers, dealing with frequency and severity of weather events, including secondary perils, pockets of unfavorable prior year development in casualty lines, higher replacement costs, social inflation and rising reinsurance costs. So we believe carriers are likely to seek out further renewal premium increases and to maintain their cautious underwriting posture. Moving to our customers' business activity. Overall, it continues to be more resilient than headlines would suggest and we continue to characterize it as strong. During the third quarter, our daily indications showed year-over-year increases in positive midyear policy endorsements and audits. Additionally, the U.S. labor market remains strong. With continued growth in U.S. nonfarm payrolls and a wide gap between the amount of job openings and the number of people unemployed and looking for work. We also just passed the 6-month mark of the Buck acquisition, and the team is off to a fantastic start with integration on track and financial performance in line with our expectations, and I am most pleased with how the teams have come together to better serve our clients. So I believe our HR Consulting, Retirement and Benefits business is well positioned headed into the 2024 enrollment period. So bringing it all together, as we sit here today, we see full year brokerage organic in the upper 8s and pushing towards 9%, posting that would be another fantastic year. Let me move on to mergers and acquisitions. We had an active third quarter, completing 12 new tuck-in brokerage mergers representing about $57 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. We also recently signed definitive agreements to acquire the insurance brokerage operations of Eastern Bank and Cadence Bank, with total pro forma annualized revenue towards $275 million. Building on our success from the 2022 M&T Bank transaction, we are extremely excited about these mergers and believe these 2 regional banks have built brokerage businesses that operate and feel a lot like us. And if that isn't exciting enough, we also have a very strong merger pipeline. Excluding these 2 pending mergers, we have around 45 term sheets signed or being prepared, representing more than $450 million of annualized revenue, and we know all of these won't ultimately close, but we believe we'll get our fair share. Moving on to our Risk Management segment, Gallagher Bassett. Third quarter organic growth was 17.9% ahead of September expectations due to continued growth in claim counts and new business from 22 new business wins. We still expect to grow over these wins by double digits during the fourth quarter due to our superior client offerings, some smaller new business wins in '23 and continued growth in claim activity. Third quarter adjusted EBITDAC margin of 20.4% was strong and in line with our September expectation. Looking forward, we see full year '23 organic above 15% and adjusted EBITDAC margins pushing 20%, and that would be another fantastic year. And I'll conclude with some comments regarding our bedrock culture. A few weeks ago, I had the pleasure to visit our associates in our India Gallagher Center of Excellence. It was awesome to see our team in action again. The energy, the excitement and relentless pursuit of improvement is thriving among our 10,000 colleagues. It's a huge competitive advantage for us because we can take a process, streamline and standardize it and then move it to our centers of excellence. Once there, the process is refined even further, and then we make the service available to all our geographies. At the same time, we are refining, automating, deploying robotics and using AI. We are a machine that is driving out rework, improving turnaround times and raising our quality. And remember, we don't outsource these important roles. Rather, these full-time Gallagher employees represent the very best service and support professionals who are passionate about our customers and have a culture of constant improvement, which is the Gallagher way. Okay. I'll stop now and turn it over to Doug. It was a great quarter. Doug, over to you.
Douglas Howell: All right. Thanks, Pat, and hello, everyone. Today, I'll walk through third quarter organic and margins by segment, make some comments about how we see the fourth quarter shaping up and provide some early thoughts on full year '24. Then I'll provide some comments on our typical modeling helpers using the CFO commentary document that we posted on our website, and I'll conclude my prepared remarks with a few comments on cash, M&A and capital management. Okay, let's flip to Page 3 of the earnings release. All-in brokerage organic of 9.3% which, as a reminder, does not include interest income like some of our peers report. Organic, including interest income would be about 12%. A few soundbites: first, in total, we came in a little bit better than we foreshadowed at our September IR Day due to really strong results from reinsurance and London specialty; second, base commission and fee organic was strong at 9.6%; third, supplementals and contingents, together up 5%. At our IR day, we flagged some softness, mostly related to the Maui fires. Since then, we have also seen a very slight uptick in expected insurance carrier loss ratios that also had a modest unfavorable impact to organic. Regardless, 9.3% in total without interest income, 12% with, both are fantastic results for the quarter. One special mention. Pat discussed that global renewal premium increases, we were seeing around 10% this quarter. And on the surface, it might appear this increase is a bit lower, maybe about a point from what we said in September and also from second quarter. It's important to note, when we look at our data by line and customer and then adjust for mix, the renewal premium increases for the third quarter are very similar to second quarter. So please don't interpret that there has been any meaningful shift in the market. We're just not seeing that. Looking ahead to Q4 organic. Over the last year, we have reminded that we have an accounting headwind to overcome. Recall in Q4 '22, we booked a change in estimate related to our 606 deferred revenue accounting. That will now create a more difficult compare, called out about a point of organic headwind. Again, no new news here, but just a reminder as you update your models. Controlling for this, we see fourth quarter underlying organic growth approaching 9%, but the headline might look more like 8%. If we post that, that would mean full year brokerage organic in the upper 8s pushing towards 9%. Again, these percentages do not include interest income. What a great year that would be. Flip now to Page 5 of the earnings release to the Brokerage segment adjusted EBITDAC table. We posted adjusted EBITDAC margin of 32.4% for the quarter. That's up 55 basis points over third quarter '22's FX-adjusted margin. That's great work by the team to end up a bit better than our September IR Day expectations. Looking at margins like a bridge from Q3 '22, organic gave us 80 points of expansion. Incremental interest income gave us 90 basis points. All-in M&A, mostly Buck which naturally runs at lower margins, impacted it by about 65 basis points. We also made incremental technology investments, called out about $7 million, and had some continued inflation on T&E, called out about $3 million, which in total used about 50 basis points. Follow that bridge and the math gets you close to that 55 basis points of FX adjusted margin expansion in the third quarter. As for adjusted EBITDAC margin outlook for the fourth quarter, we expect about 40 to 50 basis points of expansion. And remember, that's off of fourth quarter '22 margins recomputed at current FX levels. However, unlike the past few quarters where FX created some noise, we're fortunate that now there's not much impact to consider, so much easier to model. If we deliver on that full year '23 which show margins expanding 30 to 40 basis points or 80 to 90 basis points levelizing for the roll-in impact of Buck, that would be a terrific year. Looking ahead to next year, we are just beginning our budgeting process. And -- but our early -- very early thinking is that organic -- we're seeing organic in that 7% to 9% range. As for margins, we would anticipate seeing some margin expansion starting at 4% organic growth and perhaps if we hit 7%, call it around 50 basis points of expansion. And also, one other modeling heads up, please don't forget, first quarter '24 margins will have a slightly tougher year-over-year compare since Buck will still be rolling into our results. Okay. Let's move on to the Risk Management segment and the organic and EBITDAC tables on Page 5 and 6, a really strong finish to the third quarter. 17.9% organic growth and margins at 20.4%. As Pat mentioned, we continue to benefit from higher claim counts related to the new business wins from the second half of '22. Looking forward, we see organic in the fourth quarter around 13% and margins just above 20%. Organic does reflect the lapping of last year's newer large business wins and margins remain terrific. So if we deliver on that, full year organic would be above 15% and margins pushing 20%. That would be another record year for Gallagher Bassett. Looking ahead to full year '24, our early thinking is pointing towards 9% to 11% organic and margins around 20%. Okay. Let's turn to Page 7 of the earnings release and the corporate segment shortcut table. In total, adjusted third quarter came in $0.03 better than the midpoint of the range we provided during our September IR day. Two reasons: first, lower borrowings on our line of credit and some of the M&A opportunities were pushed into October and November and second, lesser FX remeasurement headwinds. Let's move now to the CFO commentary document to Page 3. A couple of things versus our September IR Day estimates. You'll see third quarter amortization expense is better by $7 million. But remember, this is noncash and doesn't impact adjusted EBITDAC nor adjusted EPS. This was simply due to balance sheet true-ups when we get our third-party M&A valuations. Then you'll also see depreciation is a touch higher by $2 million, but that is offset by change in acquisition earn-outs, which is lower by $2 million, so no net impact there. Looking ahead, we've updated our fourth quarter numbers and footnotes, so just do a double check of your models. And we will also update this page again during our December IR Day and give you a first look at 2024 numbers. Flip over to Page 4 of the CFO commentary document to the corporate segment outlook for the fourth quarter. Only real movement is that Q4 interest and banking expense is up a bit, reflecting more anticipated borrowing. Moving to Page 5. This is the page that shows our tax credit carryforwards. As of September 30, we have about $670 million available, a nice future cash flow sweetener that helps fund future M&A. When you turn to Page 6, you'll see the rollover revenue table for third quarter -- the rollover revenues for the third quarter were $153 million, that's a little better than our IR Day expectation, mostly due notably to 1 merger that really hit it out of the park during the second half of September. It really shows you the potential upside mergers can see after joining Gallagher. Looking forward, we have included estimated revenues for M&A closed and announced through yesterday. That's important to note these numbers already include expected revenues from Eastern and Cadence. We've assumed a mid-fourth quarter closing date, so please don't double count. And also, as we always say, please don't forget, you need to make a pick for future M&A also. In terms of funding M&A, first, available cash on hand at September 30 was around $550 million. Second, our fourth quarter is historically a very strong cash flow quarter. Third, we currently have nothing outstanding on our line of credit, so we can use that or do a bond offering. And finally, if we close a lot of the tuck-in M&A pipeline that Pat discussed, before year-end, we may use a small amount of stock, but call it a couple of hundred million dollars. As we consider these alternatives, we're always being very mindful of maintaining our solid investment-grade rating also. As for 2024, we are currently estimating about $3.5 billion of capacity to fund future M&A using only free cash and incremental borrowings. Okay. Those are my comments, another fantastic quarter by the team. It's looking like another fantastic year. Congratulations to Patrick and Tom on their new roles. We have terrific momentum taking us into '24. Back to you, Pat.
Patrick Gallagher: Okay. I think we're ready for some questions and answers. Operator, will you open it up?
Operator: [Operator Instructions]. Our first question comes from the line of Rob Cox with Goldman Sachs.
Robert Cox: Thanks for the outlook on the organic growth for 2024. Just curious, you had previously mentioned that you didn't think there would be that much of a difference in sort of the different areas within the business growing at different rates. Curious if you have any updated thoughts on how different businesses may perform in 2024 versus 2023.
Douglas Howell: Rob, thanks for that. I think let us get through the budget process here, we'll have more for you at our December IR day. But right now, we're not seeing anything significantly different kind of across the portfolio of operations, but it's going to roll up somewhere into that 7% to 9% range as we're looking at it now.
Robert Cox: Okay. Got it. And then just on the 2024 margin expansion of 50 bps. If you could achieve 7%, just curious on if that includes impacts from investment income or maybe a potential slight uplift from some of these higher-margin acquisitions you've done recently?
Douglas Howell: All right. So 3 things in there on that. Right now, the way I got to that number, doesn't assume much incremental lift from investment income. It does assume a little bit of a drag from one quarter of Buck rolling into our numbers that naturally runs lower margins. But by and large, maybe those 2 offset each other a little bit. And maybe there's a little extra roll-in impact from M&A from Buck. The rest of the M&A that we're planning on in our outlook for next year comes in pretty close to the same margins that we're at.
Operator: Our next question is coming from Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question, reinsurance. Pat, you guys said 20% organic growth in the quarter. That's the strongest you guys have printed since you closed that deal. Obviously, Q3 is smaller from a revenue perspective, but I was hoping, is there more within that number? And then when you guys are guiding to 7% to 9% next year, I mean, what are you assuming just in terms of the momentum and the growth within that reinsurance business?
Patrick Gallagher: That's a good question, Elyse. I think as Doug said earlier, we're just in the throes now of budgeting, and I'd have to say that the reinsurance team has outperformed our expectations. They came aboard and have just continued to do an unbelievable job. And that 20% does include new business and great retention. So when I look forward, I'm not going to comment on rate. I'm not there yet. I got to get their professional view as we get into the budget. But I think that the business momentum will be good. I think retention will continue to be very, very strong. So would I tell you that I think we're going to see 20% organic next year? I don't know. That would be awfully hard. But I'm really -- this is a good business for us. The market there, similar to what we're seeing on retail, we are not seeing softening. As we said in our prepared remarks, there's capacity, but you're going to pay for it. And I don't think that's going to change between 1/1 and 7/1 next year. So I think that what you've got is kind of an interesting market. And again, this is -- if nothing happens in the cat world. So I'm not trying to waffle you. I don't have a really good clear answer for you at this point.
Douglas Howell: Yes. Same thing I said to Rob. I said let's give you that -- let's give more flavor by division in December. That will be -- we'll be talking to you again in 6 weeks.
Elyse Greenspan: And then a good problem to have, the results there have been really strong. I know there's an earn-out associated with that transaction. Is that something that you would account for in '25? Or is that something that's already been accounted for?
Douglas Howell: I think we'll have -- okay, the way it works is that we'll have to -- it gets triggered off a full year '24 revenues because it's heavily skewed towards 1/1 renewals, I think we'll have a pretty good estimate of where we sit here before December. So I think I'll be able to give you a number on what we think we're going to end up booking for acquisition earn-out. Now we adjust that out, but I think I should have a good number by our December IR day, and then that would be paid out in the first quarter or second quarter of '25.
Elyse Greenspan: Okay. And then the M&A pipeline sounds still pretty robust. Doug, you mentioned that some deals were pushed into October and November. Are those the Eastern and the Cadence transactions? Or are there other transactions that were pushed from a timing perspective that could be forthcoming?
Douglas Howell: I would say that it would be more so the Eastern transaction and it wasn't necessarily pushed. We had to file an HSR on that. So really, our early estimates of maybe getting it done in September might have been a little optimistic on that. But I wouldn't -- there's nothing else that you don't know about, let me put it that way.
Operator: Our next question comes from the line of Paul Newsome with Piper Sandler.
Jon Newsome: Congratulations on the quarter. I want to ask a little bit more about the M&A environment. Is there anything to be read here that there's going to be these big deals are coming out of banks. And maybe just some thoughts, if you have any about sort of how the buyers may be changing in this environment. I think we've been waiting for shifts in the market, but at least I've been sort of surprised at how they sort of happened or not happened in the last couple of quarters. But love your thoughts on that.
Patrick Gallagher: Well, I'll give you some and then Doug can make some comments as well. I do think, and we've said this before, that some of the competition relative to some of the private equity stuff is a little bit less robust. There is still plenty of competition. And if you put a nice piece of property out for bid, you're going to get a lot of bids. So there's good competition for these good properties. I can't get into the strategy of the banks as to by their deciding now is the time to exit, and we've seen that across a broad base. And I think it's probably because multiples are at very, very solid high levels. And whether thinks that those multiples may, at some point in time, begin to diminish, I'm not sure. But we've had incredible success with our friends at M&T. We're very excited about Eastern and Cadence. And frankly, if there's other banks that are looking in that direction, we're a very good place to look. In terms of other M&A opportunities, you've got 30,000 agents and brokers across America. A good number of them are still owned and run by baby boomers. They're good businesses. This has been a very robust time for them. The last 5 years have been outstanding for them. A lot of change going on in our market, an awful lot of data and analytics that they can't compete with. Now you have the advent of AI, which is coming on stronger and faster than I think any of us thought. And I think people look at it and say, maybe it's time to check who's out there. Maybe now it's not a bad time for me to look. And when you take a look at our pipeline, we gave you some numbers today. I mean, it's just incredibly robust.
Jon Newsome: And then completely shifting to a different topic, if I could. There's been some comments this quarter, I think about the shift back and forth between excess lines and especially in the standard carriers. And I was wondering if from your perspective, you're seeing any of that shift back to the standard carrier. Is there really anything that's major from a terms and conditions environment sort of excluding pricing?
Patrick Gallagher: No, we're not. I mean, the stuff that's in the E&S market has gone there for a reason, and that is growing every single month in terms of 15%, 20%. Our submissions at RPS are up substantially this year. We measure that every day, frankly. And our submissions into RPS, our wholesaling operation, are at an all-time high. Property, in particular, is a big driving line for sure, and there just is a lack of capacity, and it is getting -- it continues to be -- whoever can tell the best story might just get a quote. So no, I'm not seeing -- and we are not seeing terms and conditions soften while things still stay in the excess market. And we're not seeing business flow back to the primaries.
Operator: Our next question comes from the line of Greg Peters with Raymond James.
Charles Peters: Pat, I feel like you have been saying you feel like you're just getting started for over 20 years now. So I guess no change there. Can we go back to your comments on the bank acquisitions. And I think you said some of the banks Cadence and Eastern are getting solid high multiples for those businesses. I think those were your words. And I look at the CFO commentary, and it looks like the -- you're -- inside that you're looking for -- your multiples are paying are 10 to 11x EBITDAC. Is that inclusive of Cadence and Eastern because it feels like those numbers were -- multiples for those businesses were a little bit higher.
Douglas Howell: Yes. Typically, what we do is for a larger transaction like that, and we have a couple of -- 1 a year or something like that, we typically exclude that. The purpose of that disclosure is really showing you what we're seeing in the tuck-ins. The reality is, is we're still seeing great opportunities, a little north of 10x, maybe sometimes you get 1 at 12, some at 10. But there's a really -- there's a ton of tuck-in opportunities that are still realizing there's terrific value in that 10% to 12% range. And the reason why is they understand that they have careers inside of Gallagher afterwards. Their employees and their producers and themselves have great careers inside of Gallagher. So what a terrific thing? Sell your business at 10 to 12x, come in and work, take on increasing responsibilities, double your agency or your location. So the reason why we can still be effective buyers at 10 to 12x is the future opportunity of getting better together. We set it for 20 years since I've been here. When 1 plus 1 is equal 3, 4 and 5, that's what they're seeing. So we continue to click those off day in and day out kind of in those multiple ranges.
Charles Peters: Okay. That makes sense. And then on those -- the larger transactions, it doesn't seem like -- maybe I'm -- I don't know the answer. So is there a lot of synergies to be harvested from as you integrate the businesses? Or are the stand-alone teams sort of like what you got with the WTW reinsurance operations.
Douglas Howell: I think with Eastern and Cadence, I mean, it's not a -- there's no -- there's very few human synergies to be gained on this. As a matter of fact, they do a really great job servicing their customers and selling the insurance. But there are efficiencies that can be gained through a common general ledger, a common agency management system only needing 1 cyber protocol that runs over your platform. So there are some synergies there. But those are in the $3 million, $4 million, $5 million type numbers, not in the $25 million, $30 million or $40 million type number.
Patrick Gallagher: The real kicker there, Greg, is that look at these bigger deals run by banks, and this is why we say it very much feels like we're buying somebody similar to us. These are firms that were rolled up by the bank, typically good community people. I've heard 3 separate outreaches from Cadence people in the last 2 days that I've known in 1 instance that they came in to kick the tires with us in 1998. And I remember the guy wrote to me and he goes, "Hey, I came with Shorty and I remember Shorty and I came with Jim, I remember Jim and I can't tell you how excited we are." Now what we're bringing to them that Cadence could never do is that whole discussion of moving upstream. We can show you statistically that our closing rate on bigger deals, and I'm not talking risk management, huge accounts. I'm just saying the bigger deals that are generating over $125,000 to $150,000 of commission are significantly greater today than they were 5 or 10 years ago. This is what we're giving them the opportunity to go after. They're typical agents in these banks that look just like everybody else, and now they're going to go out. And frankly, they're going to have our tools and they're terrifically excited about it. So that's, I think, the whole synergy thing. This is not take out headcount. This is turn them on, show them what we do, give them the tools and watch them eat the market all around them.
Charles Peters: Okay. That makes sense. I guess the final question, I know -- I think it was Paul who was trying to get at this. But frankly, we're hearing of some stress in some of the PE-backed roll-ups where the combination of higher interest costs and earn-outs are pressuring their free cash flow. What's your view of some of those smaller entities that might be having problems? Could we see you be interested in some of those properties at some point in time if they should become available?
Patrick Gallagher: Well, here's the thing. First of all, Greg, we'll look at every single opportunity we can. And our first question every single time is what's the culture. What was it that went into this group. In most of these, there are situations where we didn't succeed in buying something they bought. Let's talk about that around this table, not with them in the room. XYZ didn't sell to us. Why is that? Okay, fine. What's left there? And yes, I would say that there are some of those that we would be interested in. But we'd have to get through this whole cultural piece. When you chose not to join Gallagher, I'll tell you the one main reason why you chose not to join Gallagher is because you didn't want change. And our competition has done a very good job of saying, "Hey, why join Gallagher when I'll give you the money? I'm going to give you the cash, keep some in. Our returns have been terrific. You'll get a second bite on the apple and you don't need to change anything. You don't need to change your name, you don't need to change your agency system," and while they've been doing that, we've been building power-to-power, data, analytics, capabilities and vertical strength. They've got none of that. And now it's coming to roost with higher interest rates and tougher earnouts, and you got to make do -- you got to come due on your promises. So yes, we'd look at them. But we're going to have to fall in love.
Operator: Our next question comes from the line of Mike Zaremski with BMO Capital Markets.
Michael Zaremski: Maybe I missed this, but on the Cadence deal, is it -- am I right looking at the revenue and EBITDA disclosure that Cadence has a 36% to 37% margin, which is pretty great. And then also on the deal there was -- you called out tax benefits. I don't recall you guys calling out tax benefits in the past.
Douglas Howell: Yes. All right. First, you're right. I think it might be about 34%, but I think [indiscernible] over a point or 2 on that. I think that when it comes to the tax, I think it's important on these margins, we always get a step-up in basis on smaller deals, but on many larger mergers that these sellers are not willing to allow a step up in basis. In this case, the sellers were willing to and we paid a little bit more cash upfront on it. But we're going to get $250 million worth of deductions over the next 15 years. Your present value that back at 5% or 6%, you get something . So it really doesn't impact them all that much because I don't know if they're -- they might be able to shield it with NOL carryforwards or something like that, but it benefits us a lot. So to be able to achieve that. And it's not all that important in many times for, let's say, a PE firm that buys a bigger one over at trades because they've got the large interest shield coming off of the high levels of debt they run there. But for us to be able to negotiate that benefit and to be able to have a seller that's willing to allow that benefit to pass out, that makes a big difference. So in this case, this is a true win-win for them. They get more cash, we get more cash, and it brings our multiple down considerably on it. This is not using our clean energy credit. We have $670 million of clean energy credits available. Think about that. We'll use those over the next few years. It's almost like we have another free Cadence coming our way because of those tax credits. So tax does matter. And in this case, we think that a conservative view of that benefit is $150-some million.
Michael Zaremski: Interesting. And I guess this one probably for -- this one question is for Pat, and congrats to Thomas and Patrick on our new appointments. Just curious on Pat. Will these new appointments cause any of your existing managers other than yourself to share responsibilities they didn't previously share?
Patrick Gallagher: There will be some follow-on promotions. Sure. There's good opportunities for everybody at Gallagher, yes.
Michael Zaremski: And so were these promotions well-telegraphed? Or is this kind of like -- were these promotions like about well-telegraphed, like within the firm, like over time or were these kind of...
Patrick Gallagher: I'm going to ask you the Gallagher answer. There's not a lot secret at Gallagher, right? Yes, I would say that these moves have been telegraphed over about 20 years.
Operator: Our next question comes from the line of Mark Hughes with Truist Securities.
Mark Hughes: On the -- could you give any guidance on the corporate segment profit for 2024. Any early thoughts there?
Douglas Howell: We haven't. And can you give until December? I know you're trying to figure out your '24 models. You might want to take what we did this year and just take it by line by line and make a site pick on it to see what you think it -- what would happen there. I know it's really difficult to do, Mark, because of FX remeasurement gains. I know we put some acquisition costs through there that can be lumpy. And there's a lot of tax, restructure numbers that run through there as we implement tax planning strategy. I know it's really difficult. But if you could you just give me until December and I can get that to you.
Mark Hughes: Yes. Yes.
Douglas Howell: We get this every year.
Mark Hughes: Any thoughts on medical inflation? Just curious to get, I think, the benefit is being helped by higher health care costs for employees, but the medical inflation impact on, say, workers' comp or GL.
Patrick Gallagher: It's interesting you should ask because we were talking about that with the board this week. And yes, we're seeing a lot of pressure on medical costs. Full insured renewals at our largest carriers are showing 7% to 9% increases right now as we speak. When you start to take retentions and you start to get in the stop-loss market, we're seeing averages there closer to 17% to 18%. That's on premium now. That's not on the underlying costs. But that's because more of the claims are tagging those carriers. So they're not only trying to move away in terms of the low end of the cost, but also they're having to pay that. So if you take a look at all of it, all in, Mark, I'd say that our numbers that we're seeing are about 8% to 9% and that's embedded both in work comp as well as health insurance across the United States.
Operator: Our next question comes from the line of David Motemaden with Evercore ISI.
David Motemaden: I was wondering if you could just help me think through just how much of the organic growth over the last several years and even this quarter is driven by just the macro environment versus what you guys have been doing behind the scenes to accelerate share gains? Because it feels like there's been a lot going on to help you guys gain share and that the share gains are accelerating. So I'm just wondering as kind of a big picture question. as you guys head into next year and you think about that 7% to 9% organic, I guess, how much of that do you think is coming from market share gains as you guys continue to execute versus like rate and exposure improvements?
Patrick Gallagher: Well, let me split the question with Doug in this regard. Let me talk about market gains in terms of share gain and then he can tear the numbers a bit. But we're seeing and we're measuring this literally every single day, every month. We know now where we're producing business. We know, for instance, that 90% of the time, we compete with somebody smaller than we are. We know exactly what's happening in our verticals. We have 32 verticals that we're very, very clear on management expectation, knowing what's going on, building products and what have you. That's in the property casualty arena. We have another 7 or 8 in benefits. And in those verticals, we know that our growth rate is substantially greater than what is in our just general book of business. So internally, we know that we are taking definite share in those verticals. And I would probably -- I'd throw out a number, Mike, maybe you throw a number out on the table of what...
Douglas Howell: In terms of?
Patrick Gallagher: Just in terms of the growth rate in the vertical as opposed to general.
Douglas Howell: 92% of our new business.
Patrick Gallagher: 19% of our new business falls...
Douglas Howell: Into one of our verticals.
Patrick Gallagher: In one of those -- 19?
Douglas Howell: 92%.
Patrick Gallagher: 92, that's what I thought. I heard 19, I apologize. So each of those are growing faster than the general book. So value -- again, you've got to look at rate, you've got to look at exposure and all that other stuff. But when you talk about share, there is absolutely no doubt you go back to Doug's comment. An acquisition can be 1 plus 1 equals 5 because when Gallagher shows up with the relationships and the capabilities of the local broker and brings those relationships together with what we have as capabilities and the culture works, we don't have to force sharing on people. The fact that they can pick up the phone and say, "I've got a college University. I've never worked on one before. Can somebody help me." We will swarm that opportunity. We will write that college University they'll get their fair share, everybody wins, and we're not fighting that as a local entrepreneur who doesn't want to play with the big boys. That's the excitement. So I know that's a long-winded weird way of saying it, but we are definitely taking share. To the numbers, Doug, I'd throw over to you.
Douglas Howell: [indiscernible] that 7% organic growth next year, I'd say that half comes from net new business wins or taking share. I would say, 1/4 is coming from exposure units and another quarter is coming from rate. If you got 9%, you probably got 1/3, 1/3, 1/3 in there.
David Motemaden: Got it. That's really helpful. I appreciate that. And then maybe just a follow-up. We've seen obviously the 2 -- the Cadence and Eastern deals on top of the M&T Bank broker last year or earlier this year. So I guess I'm sort of wondering -- as we think about the sustainability of that organic, I know you're the preferred provider for I think it was Cadence. But I guess, how do you manage the fact that -- or the potential that there might be more of like an open process for some of those existing customers now that it's not wholly owned. I don't know if that's something that you guys have worked through planning? Or just maybe help us think through that.
Patrick Gallagher: I'll help you think through it and probably the people from Cadence Bank and say, he's maybe talking off the top of the head, blah, blah, blah. But I don't think the bank did much to help them produce insurance, like probably hurt their production, which is why when you look at some of these deals, the Board goes well, where is the growth. Cadence and Eastern good growth, but the fact is -- those people have gone out and scrape for that business around the bank relationship, which was, of course, when they bought those firms, supposed to be the golden nugget in terms of being able to produce business that just isn't true. In fact, I think we're going to unleash an opportunity to really grow the top line.
Operator: Our next question comes from the line of Meyer Shields with KBW.
Meyer Shields: Two big picture questions. One, there's been some press about larger insurance brokers getting back into wholesale. Would that matter at all to Gallagher?
Patrick Gallagher: Not really. If you take a look at our wholesale business, RPS. We do not mandate inside Gallagher, so it's not 100% Gallagher placements there. We did consolidate down to a smaller number of players and RPS does about 50% of Gallagher's placements. So we're very cognizant of what the world is like out there. But really, RPS trades with 15,000 to 18,000 independent agents. And RPS does not trade particularly at all with our 3 larger competitors. So if they were the ones that choose to come in back into the market, we think it would have virtually no impact on us at all.
Meyer Shields: That's very helpful. Second question, and this relates to what you've been talking about, Pat, with the additional resources that being part of Gallagher brings. How rapidly can acquisitions take advantage of that? And is that something we should factor in when we're modeling acquired revenues?
Patrick Gallagher: Day 1, and I do mean day 1 and the team will swarm that opportunity. Now do they get used to operating that way? Have they got the customer teed up. It takes -- it's still a learning curve in all fairness, they'll call and we'll jump on the plane and have a shot at that university. But it will probably be a year or 2 before we land it. So I can't sit here and go, day 1, it just ratchets up. But I'll tell you what it does. It gets everybody in that firm excited. It worked. Gallagher helped, you can't believe it. We turned this risk manager on their head. This is really cool. Next time around, what's the strategy? What's the methodology. So the resources are truly available to that team on day 1. Now would I factor into the earn-out. Some of them take great advantage of it and really does help. It makes their earnout. Others, as I said, it's a longer ramp-up speed and it's just a matter of the individual leaders.
Douglas Howell: Yes. One thing, I think we actually understate true organic because we don't consider any new business, net new business wins by those mergers in the first year. That doesn't get counted as organic. Was it $20 million, $30 million more of net new maybe across the business every year? I don't know. It might be worth 20 basis points on our organic growth over the course of the year. So I think it naturally understates it. But I think the point is, like I said on this one just a minute ago. We had a merger partner that just crushed it here at the end of September, and that doesn't go into organic, but it sure impacts our acquisition revenues. Now we try to give you that when we do these projections. So look at that on Page 6 of our CFO commentary. But the point is the great mergers are the ones that come in, hit the ground running, use our resources and capabilities. And next thing you know over the next 2, 3, 4 years, they're just hitting it out of the park.
Patrick Gallagher: We've showed you in our IR Day, things like our drive, just Gallagher Drive. One, just one item that is so cool to these people. And it's basically the ability to sit with a client and say, people like you buy this. And here's what the lines of insurance are there going to these types of truckers in your area or construction companies or senior living. Here's the layers that they're buying. And by the way, you're holding a $10 million liability limit. Most of your competitors are paying 20 -- or buying $20 million of umbrella. Let me show you the losses we have in our book that appears to $10 million. You probably ought to buy the 20, there's reason for that. It blows the competition away and our merger partners can't wait to get their hands on it. That's 1 thing, and there's a dozen of those.
Operator: Our last question is coming from Yaron Kinar with Jefferies.
Yaron Kinar: I apologize, I had some technical difficulties. So I hope I'm not asking stuff that's already been asked. With regards to Eastern and Cadence, do they have any different seasonal patterns? I think you touched on growth on the margin profile. But I'm curious if that margin profile kind of holds true to what you see in brokers already throughout the year.
Patrick Gallagher: No, there's no seasonality.
Douglas Howell: Yes. Remember, we're seasonally larger primarily because of our benefits and because of our reinsured business, our P&C business is fairly steady throughout the year over the 4 quarters. And maybe it's 23% on one quarter and 27% another, but we're not getting the wild swings like you do in reinsurance and employee benefits.
Yaron Kinar: Got it. And do either of those deals fall any vertical space that you were looking to boost stop? Or is it more of a geographic play? What's the rationale there?
Patrick Gallagher: Mike, go ahead.
Michael Pesch: Yes, this is Mike Pesch. So I would say both of them are -- in their geographies are strong where we are maybe strong in other industries. So in Cadence, in their perspective, we do a lot of public entity in the mid-south region, and that's not one of their strengths. But they do a lot in construction and manufacturing. So it complements us really, really well. It's one of the reasons we like them so much. Eastern is the same way. If you look in New England, New England is heavily weighted towards life sciences, technology and D&O, and they balance that book considerably with a lot of other industry verticals, including construction. So it is very much a complementary business to each of those areas.
Yaron Kinar: Got it. And then one quick one to end up. Corporate expenses were quite high this quarter. Were there any one-offs there?
Douglas Howell: I think when you look at it, if you look at the adjustment -- if you look at it on an adjusted basis, there were some tax and litigation items when we adjusted that out. On an adjusted basis, it's kind of noisy. Comp might be up $3 million or $4 million. I think we're a little further ahead on our corporate bonus accruals than we have been in the past. And when you look at operating expense, it looks down considerably on an adjusted basis, but that's the FX remeasurement gains that you're seeing. So if you're looking at it on a pretax basis on an unadjusted basis, that's what you'll see in there. But there's nothing fundamentally underlying our expense structure in the corporate segment.
Patrick Gallagher: Well, thank you again, everyone, for joining us this evening. To our 50,000 colleagues across the globe, thank you for your hard work this quarter and every quarter. Our operational and financial success is a direct reflection of your efforts. And as pleased as I am with our third quarter performance, I'm even more excited about our future, future organic prospects, future M&A opportunities and our ability to become more productive and increase quality. We look forward to speaking with the investment community in person at our IR Day in December. Thank you again, everybody, and have a good evening.
Operator: Thank you. This does conclude today's conference call. You may now disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Co.'s Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and Risk Factors sections contained in the company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce Patrick Gallagher, Jr., Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "Patrick Gallagher",
"text": "Good afternoon. Thank you for joining us for our third quarter '23 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had an excellent third quarter. For our combined brokerage and risk management segments, we posted 22% growth in revenue, 10.5% organic growth; GAAP earnings per share of $1.72, adjusted earnings per share of $2.35, up 22% year-over-year, reported net earnings margin of 15.5%, adjusted EBITDAC margin of 30.8%, up 78 basis points. We also completed 12 mergers totaling $57 million of estimated annualized revenue. Another great quarter by the team on all measures. Before I dive into more detail about the quarter and our outlook, I want to make a comment regarding the leadership appointments that were also announced this afternoon. Tom Gallagher will assume the role of President, and Patrick Gallagher will become COO, both effective January 1, 2024. These appointments are being made to better position us for the next phase of our growth. And before you ask, I have no plans to retire. I will continue to be CEO and Chairman focused on Gallagher's strategy and global expansion. In their future roles, Tom and Patrick will help me lead organic and merger and acquisition growth initiatives, drive operational improvement and further promote our bedrock culture across the entire organization. This is the best business on the planet. I love my job and believe we are just getting started. Moving to results on a segment basis. Let me give you some more detail on our quarter's performance. Starting with the Brokerage segment. Reported revenue growth was 22%. Organic was 9.3%. Acquisition rollover revenues were $153 million. Adjusted EBITDAC growth was 23%, and we posted adjusted EBITDAC margin expansion of about 55 basis points. Let me walk you around the world and provide some more detailed commentary on our brokerage organic. And just to level set versus some of our peers, the following figures do not include interest income. Starting with our retail brokerage operations. In our U.S. P/C business underlying organic growth was about 8%. New business production and retention was better than last year, while less nonrecurring construction and capital markets business was a bit of a headwind. Our U.K. P/C business posted 7% organic with new business production and retention similar to last year. Our Canadian P/C operation was up 10% organically, reflecting solid new business and retention and more modest renewal premium increases. Rounding out the retail P/C business, our combined operations in Australia and New Zealand posted 13% organic. Core new business wins remain excellent, and renewal premium increases were ahead of third quarter '22 levels. Our global employee benefit brokerage and consulting business posted organic of 6% with solid health and welfare results and continued strength across many of our retirement and HR consulting practice groups. Shifting to our reinsurance, wholesale and specialty businesses. Gallagher Re posted 20% organic, thanks to a strong 7/1 renewal season, another outstanding quarter by the team following an excellent first half. Risk Placement Services, our U.S. wholesale operations posted organic of 7%, including a couple points headwind from lower contingents. Open brokerage organic was 13% and organic was about 5% in our MGA programs and binding businesses. And finally, U.K. Specialty posted organic of 18%, benefiting from outstanding new business production, strong retention and continued firm market conditions. Next, let me provide some thoughts on the P/C insurance pricing environment, starting with the primary insurance market. Global third quarter renewal premiums, which include both rate and exposure changes were up 10%. That's at the top end of the 8% to 10% renewal premium change we had been reporting throughout '22 and early '23 and very similar to second quarter renewal premiums adjusting for business mix. Renewal premium increases remained broad-based, up across all of our major geographies and most product lines. For example, property is up more than 20%. General liability is up about 6%. Workers' comp is up about 2%. Umbrella and package are each up about 10%. Overall, the primary market continues to behave rationally in our view, with carriers pushing for rate where it's needed to generate an acceptable underwriting profit. Remember, though, our job as brokers is to help our clients find the best coverage while mitigating price increases. So not all of these premium increases ultimately show up in our organic. Shifting to the reinsurance market. Following the orderly July 1 renewal season, all eyes are turning to January renewals. Assuming no major cat events before year-end, we believe the property reinsurance market will see adequate capacity, continued firm pricing, rising insured values and increased demand overall. When it comes to casualty, reinsurers appear to be taking a cautious view of risk. With that said, we believe adequate capacity will be available to support increased demand at firmer pricing. Here in the U.S., our retail and reinsurance teams met with more than 25 of our key U.S. insurance carrier partners at the annual CIAB conference earlier this month. It remains a tough environment for carriers, dealing with frequency and severity of weather events, including secondary perils, pockets of unfavorable prior year development in casualty lines, higher replacement costs, social inflation and rising reinsurance costs. So we believe carriers are likely to seek out further renewal premium increases and to maintain their cautious underwriting posture. Moving to our customers' business activity. Overall, it continues to be more resilient than headlines would suggest and we continue to characterize it as strong. During the third quarter, our daily indications showed year-over-year increases in positive midyear policy endorsements and audits. Additionally, the U.S. labor market remains strong. With continued growth in U.S. nonfarm payrolls and a wide gap between the amount of job openings and the number of people unemployed and looking for work. We also just passed the 6-month mark of the Buck acquisition, and the team is off to a fantastic start with integration on track and financial performance in line with our expectations, and I am most pleased with how the teams have come together to better serve our clients. So I believe our HR Consulting, Retirement and Benefits business is well positioned headed into the 2024 enrollment period. So bringing it all together, as we sit here today, we see full year brokerage organic in the upper 8s and pushing towards 9%, posting that would be another fantastic year. Let me move on to mergers and acquisitions. We had an active third quarter, completing 12 new tuck-in brokerage mergers representing about $57 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. We also recently signed definitive agreements to acquire the insurance brokerage operations of Eastern Bank and Cadence Bank, with total pro forma annualized revenue towards $275 million. Building on our success from the 2022 M&T Bank transaction, we are extremely excited about these mergers and believe these 2 regional banks have built brokerage businesses that operate and feel a lot like us. And if that isn't exciting enough, we also have a very strong merger pipeline. Excluding these 2 pending mergers, we have around 45 term sheets signed or being prepared, representing more than $450 million of annualized revenue, and we know all of these won't ultimately close, but we believe we'll get our fair share. Moving on to our Risk Management segment, Gallagher Bassett. Third quarter organic growth was 17.9% ahead of September expectations due to continued growth in claim counts and new business from 22 new business wins. We still expect to grow over these wins by double digits during the fourth quarter due to our superior client offerings, some smaller new business wins in '23 and continued growth in claim activity. Third quarter adjusted EBITDAC margin of 20.4% was strong and in line with our September expectation. Looking forward, we see full year '23 organic above 15% and adjusted EBITDAC margins pushing 20%, and that would be another fantastic year. And I'll conclude with some comments regarding our bedrock culture. A few weeks ago, I had the pleasure to visit our associates in our India Gallagher Center of Excellence. It was awesome to see our team in action again. The energy, the excitement and relentless pursuit of improvement is thriving among our 10,000 colleagues. It's a huge competitive advantage for us because we can take a process, streamline and standardize it and then move it to our centers of excellence. Once there, the process is refined even further, and then we make the service available to all our geographies. At the same time, we are refining, automating, deploying robotics and using AI. We are a machine that is driving out rework, improving turnaround times and raising our quality. And remember, we don't outsource these important roles. Rather, these full-time Gallagher employees represent the very best service and support professionals who are passionate about our customers and have a culture of constant improvement, which is the Gallagher way. Okay. I'll stop now and turn it over to Doug. It was a great quarter. Doug, over to you."
},
{
"speaker": "Douglas Howell",
"text": "All right. Thanks, Pat, and hello, everyone. Today, I'll walk through third quarter organic and margins by segment, make some comments about how we see the fourth quarter shaping up and provide some early thoughts on full year '24. Then I'll provide some comments on our typical modeling helpers using the CFO commentary document that we posted on our website, and I'll conclude my prepared remarks with a few comments on cash, M&A and capital management. Okay, let's flip to Page 3 of the earnings release. All-in brokerage organic of 9.3% which, as a reminder, does not include interest income like some of our peers report. Organic, including interest income would be about 12%. A few soundbites: first, in total, we came in a little bit better than we foreshadowed at our September IR Day due to really strong results from reinsurance and London specialty; second, base commission and fee organic was strong at 9.6%; third, supplementals and contingents, together up 5%. At our IR day, we flagged some softness, mostly related to the Maui fires. Since then, we have also seen a very slight uptick in expected insurance carrier loss ratios that also had a modest unfavorable impact to organic. Regardless, 9.3% in total without interest income, 12% with, both are fantastic results for the quarter. One special mention. Pat discussed that global renewal premium increases, we were seeing around 10% this quarter. And on the surface, it might appear this increase is a bit lower, maybe about a point from what we said in September and also from second quarter. It's important to note, when we look at our data by line and customer and then adjust for mix, the renewal premium increases for the third quarter are very similar to second quarter. So please don't interpret that there has been any meaningful shift in the market. We're just not seeing that. Looking ahead to Q4 organic. Over the last year, we have reminded that we have an accounting headwind to overcome. Recall in Q4 '22, we booked a change in estimate related to our 606 deferred revenue accounting. That will now create a more difficult compare, called out about a point of organic headwind. Again, no new news here, but just a reminder as you update your models. Controlling for this, we see fourth quarter underlying organic growth approaching 9%, but the headline might look more like 8%. If we post that, that would mean full year brokerage organic in the upper 8s pushing towards 9%. Again, these percentages do not include interest income. What a great year that would be. Flip now to Page 5 of the earnings release to the Brokerage segment adjusted EBITDAC table. We posted adjusted EBITDAC margin of 32.4% for the quarter. That's up 55 basis points over third quarter '22's FX-adjusted margin. That's great work by the team to end up a bit better than our September IR Day expectations. Looking at margins like a bridge from Q3 '22, organic gave us 80 points of expansion. Incremental interest income gave us 90 basis points. All-in M&A, mostly Buck which naturally runs at lower margins, impacted it by about 65 basis points. We also made incremental technology investments, called out about $7 million, and had some continued inflation on T&E, called out about $3 million, which in total used about 50 basis points. Follow that bridge and the math gets you close to that 55 basis points of FX adjusted margin expansion in the third quarter. As for adjusted EBITDAC margin outlook for the fourth quarter, we expect about 40 to 50 basis points of expansion. And remember, that's off of fourth quarter '22 margins recomputed at current FX levels. However, unlike the past few quarters where FX created some noise, we're fortunate that now there's not much impact to consider, so much easier to model. If we deliver on that full year '23 which show margins expanding 30 to 40 basis points or 80 to 90 basis points levelizing for the roll-in impact of Buck, that would be a terrific year. Looking ahead to next year, we are just beginning our budgeting process. And -- but our early -- very early thinking is that organic -- we're seeing organic in that 7% to 9% range. As for margins, we would anticipate seeing some margin expansion starting at 4% organic growth and perhaps if we hit 7%, call it around 50 basis points of expansion. And also, one other modeling heads up, please don't forget, first quarter '24 margins will have a slightly tougher year-over-year compare since Buck will still be rolling into our results. Okay. Let's move on to the Risk Management segment and the organic and EBITDAC tables on Page 5 and 6, a really strong finish to the third quarter. 17.9% organic growth and margins at 20.4%. As Pat mentioned, we continue to benefit from higher claim counts related to the new business wins from the second half of '22. Looking forward, we see organic in the fourth quarter around 13% and margins just above 20%. Organic does reflect the lapping of last year's newer large business wins and margins remain terrific. So if we deliver on that, full year organic would be above 15% and margins pushing 20%. That would be another record year for Gallagher Bassett. Looking ahead to full year '24, our early thinking is pointing towards 9% to 11% organic and margins around 20%. Okay. Let's turn to Page 7 of the earnings release and the corporate segment shortcut table. In total, adjusted third quarter came in $0.03 better than the midpoint of the range we provided during our September IR day. Two reasons: first, lower borrowings on our line of credit and some of the M&A opportunities were pushed into October and November and second, lesser FX remeasurement headwinds. Let's move now to the CFO commentary document to Page 3. A couple of things versus our September IR Day estimates. You'll see third quarter amortization expense is better by $7 million. But remember, this is noncash and doesn't impact adjusted EBITDAC nor adjusted EPS. This was simply due to balance sheet true-ups when we get our third-party M&A valuations. Then you'll also see depreciation is a touch higher by $2 million, but that is offset by change in acquisition earn-outs, which is lower by $2 million, so no net impact there. Looking ahead, we've updated our fourth quarter numbers and footnotes, so just do a double check of your models. And we will also update this page again during our December IR Day and give you a first look at 2024 numbers. Flip over to Page 4 of the CFO commentary document to the corporate segment outlook for the fourth quarter. Only real movement is that Q4 interest and banking expense is up a bit, reflecting more anticipated borrowing. Moving to Page 5. This is the page that shows our tax credit carryforwards. As of September 30, we have about $670 million available, a nice future cash flow sweetener that helps fund future M&A. When you turn to Page 6, you'll see the rollover revenue table for third quarter -- the rollover revenues for the third quarter were $153 million, that's a little better than our IR Day expectation, mostly due notably to 1 merger that really hit it out of the park during the second half of September. It really shows you the potential upside mergers can see after joining Gallagher. Looking forward, we have included estimated revenues for M&A closed and announced through yesterday. That's important to note these numbers already include expected revenues from Eastern and Cadence. We've assumed a mid-fourth quarter closing date, so please don't double count. And also, as we always say, please don't forget, you need to make a pick for future M&A also. In terms of funding M&A, first, available cash on hand at September 30 was around $550 million. Second, our fourth quarter is historically a very strong cash flow quarter. Third, we currently have nothing outstanding on our line of credit, so we can use that or do a bond offering. And finally, if we close a lot of the tuck-in M&A pipeline that Pat discussed, before year-end, we may use a small amount of stock, but call it a couple of hundred million dollars. As we consider these alternatives, we're always being very mindful of maintaining our solid investment-grade rating also. As for 2024, we are currently estimating about $3.5 billion of capacity to fund future M&A using only free cash and incremental borrowings. Okay. Those are my comments, another fantastic quarter by the team. It's looking like another fantastic year. Congratulations to Patrick and Tom on their new roles. We have terrific momentum taking us into '24. Back to you, Pat."
},
{
"speaker": "Patrick Gallagher",
"text": "Okay. I think we're ready for some questions and answers. Operator, will you open it up?"
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our first question comes from the line of Rob Cox with Goldman Sachs."
},
{
"speaker": "Robert Cox",
"text": "Thanks for the outlook on the organic growth for 2024. Just curious, you had previously mentioned that you didn't think there would be that much of a difference in sort of the different areas within the business growing at different rates. Curious if you have any updated thoughts on how different businesses may perform in 2024 versus 2023."
},
{
"speaker": "Douglas Howell",
"text": "Rob, thanks for that. I think let us get through the budget process here, we'll have more for you at our December IR day. But right now, we're not seeing anything significantly different kind of across the portfolio of operations, but it's going to roll up somewhere into that 7% to 9% range as we're looking at it now."
},
{
"speaker": "Robert Cox",
"text": "Okay. Got it. And then just on the 2024 margin expansion of 50 bps. If you could achieve 7%, just curious on if that includes impacts from investment income or maybe a potential slight uplift from some of these higher-margin acquisitions you've done recently?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So 3 things in there on that. Right now, the way I got to that number, doesn't assume much incremental lift from investment income. It does assume a little bit of a drag from one quarter of Buck rolling into our numbers that naturally runs lower margins. But by and large, maybe those 2 offset each other a little bit. And maybe there's a little extra roll-in impact from M&A from Buck. The rest of the M&A that we're planning on in our outlook for next year comes in pretty close to the same margins that we're at."
},
{
"speaker": "Operator",
"text": "Our next question is coming from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question, reinsurance. Pat, you guys said 20% organic growth in the quarter. That's the strongest you guys have printed since you closed that deal. Obviously, Q3 is smaller from a revenue perspective, but I was hoping, is there more within that number? And then when you guys are guiding to 7% to 9% next year, I mean, what are you assuming just in terms of the momentum and the growth within that reinsurance business?"
},
{
"speaker": "Patrick Gallagher",
"text": "That's a good question, Elyse. I think as Doug said earlier, we're just in the throes now of budgeting, and I'd have to say that the reinsurance team has outperformed our expectations. They came aboard and have just continued to do an unbelievable job. And that 20% does include new business and great retention. So when I look forward, I'm not going to comment on rate. I'm not there yet. I got to get their professional view as we get into the budget. But I think that the business momentum will be good. I think retention will continue to be very, very strong. So would I tell you that I think we're going to see 20% organic next year? I don't know. That would be awfully hard. But I'm really -- this is a good business for us. The market there, similar to what we're seeing on retail, we are not seeing softening. As we said in our prepared remarks, there's capacity, but you're going to pay for it. And I don't think that's going to change between 1/1 and 7/1 next year. So I think that what you've got is kind of an interesting market. And again, this is -- if nothing happens in the cat world. So I'm not trying to waffle you. I don't have a really good clear answer for you at this point."
},
{
"speaker": "Douglas Howell",
"text": "Yes. Same thing I said to Rob. I said let's give you that -- let's give more flavor by division in December. That will be -- we'll be talking to you again in 6 weeks."
},
{
"speaker": "Elyse Greenspan",
"text": "And then a good problem to have, the results there have been really strong. I know there's an earn-out associated with that transaction. Is that something that you would account for in '25? Or is that something that's already been accounted for?"
},
{
"speaker": "Douglas Howell",
"text": "I think we'll have -- okay, the way it works is that we'll have to -- it gets triggered off a full year '24 revenues because it's heavily skewed towards 1/1 renewals, I think we'll have a pretty good estimate of where we sit here before December. So I think I'll be able to give you a number on what we think we're going to end up booking for acquisition earn-out. Now we adjust that out, but I think I should have a good number by our December IR day, and then that would be paid out in the first quarter or second quarter of '25."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then the M&A pipeline sounds still pretty robust. Doug, you mentioned that some deals were pushed into October and November. Are those the Eastern and the Cadence transactions? Or are there other transactions that were pushed from a timing perspective that could be forthcoming?"
},
{
"speaker": "Douglas Howell",
"text": "I would say that it would be more so the Eastern transaction and it wasn't necessarily pushed. We had to file an HSR on that. So really, our early estimates of maybe getting it done in September might have been a little optimistic on that. But I wouldn't -- there's nothing else that you don't know about, let me put it that way."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Paul Newsome with Piper Sandler."
},
{
"speaker": "Jon Newsome",
"text": "Congratulations on the quarter. I want to ask a little bit more about the M&A environment. Is there anything to be read here that there's going to be these big deals are coming out of banks. And maybe just some thoughts, if you have any about sort of how the buyers may be changing in this environment. I think we've been waiting for shifts in the market, but at least I've been sort of surprised at how they sort of happened or not happened in the last couple of quarters. But love your thoughts on that."
},
{
"speaker": "Patrick Gallagher",
"text": "Well, I'll give you some and then Doug can make some comments as well. I do think, and we've said this before, that some of the competition relative to some of the private equity stuff is a little bit less robust. There is still plenty of competition. And if you put a nice piece of property out for bid, you're going to get a lot of bids. So there's good competition for these good properties. I can't get into the strategy of the banks as to by their deciding now is the time to exit, and we've seen that across a broad base. And I think it's probably because multiples are at very, very solid high levels. And whether thinks that those multiples may, at some point in time, begin to diminish, I'm not sure. But we've had incredible success with our friends at M&T. We're very excited about Eastern and Cadence. And frankly, if there's other banks that are looking in that direction, we're a very good place to look. In terms of other M&A opportunities, you've got 30,000 agents and brokers across America. A good number of them are still owned and run by baby boomers. They're good businesses. This has been a very robust time for them. The last 5 years have been outstanding for them. A lot of change going on in our market, an awful lot of data and analytics that they can't compete with. Now you have the advent of AI, which is coming on stronger and faster than I think any of us thought. And I think people look at it and say, maybe it's time to check who's out there. Maybe now it's not a bad time for me to look. And when you take a look at our pipeline, we gave you some numbers today. I mean, it's just incredibly robust."
},
{
"speaker": "Jon Newsome",
"text": "And then completely shifting to a different topic, if I could. There's been some comments this quarter, I think about the shift back and forth between excess lines and especially in the standard carriers. And I was wondering if from your perspective, you're seeing any of that shift back to the standard carrier. Is there really anything that's major from a terms and conditions environment sort of excluding pricing?"
},
{
"speaker": "Patrick Gallagher",
"text": "No, we're not. I mean, the stuff that's in the E&S market has gone there for a reason, and that is growing every single month in terms of 15%, 20%. Our submissions at RPS are up substantially this year. We measure that every day, frankly. And our submissions into RPS, our wholesaling operation, are at an all-time high. Property, in particular, is a big driving line for sure, and there just is a lack of capacity, and it is getting -- it continues to be -- whoever can tell the best story might just get a quote. So no, I'm not seeing -- and we are not seeing terms and conditions soften while things still stay in the excess market. And we're not seeing business flow back to the primaries."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Greg Peters with Raymond James."
},
{
"speaker": "Charles Peters",
"text": "Pat, I feel like you have been saying you feel like you're just getting started for over 20 years now. So I guess no change there. Can we go back to your comments on the bank acquisitions. And I think you said some of the banks Cadence and Eastern are getting solid high multiples for those businesses. I think those were your words. And I look at the CFO commentary, and it looks like the -- you're -- inside that you're looking for -- your multiples are paying are 10 to 11x EBITDAC. Is that inclusive of Cadence and Eastern because it feels like those numbers were -- multiples for those businesses were a little bit higher."
},
{
"speaker": "Douglas Howell",
"text": "Yes. Typically, what we do is for a larger transaction like that, and we have a couple of -- 1 a year or something like that, we typically exclude that. The purpose of that disclosure is really showing you what we're seeing in the tuck-ins. The reality is, is we're still seeing great opportunities, a little north of 10x, maybe sometimes you get 1 at 12, some at 10. But there's a really -- there's a ton of tuck-in opportunities that are still realizing there's terrific value in that 10% to 12% range. And the reason why is they understand that they have careers inside of Gallagher afterwards. Their employees and their producers and themselves have great careers inside of Gallagher. So what a terrific thing? Sell your business at 10 to 12x, come in and work, take on increasing responsibilities, double your agency or your location. So the reason why we can still be effective buyers at 10 to 12x is the future opportunity of getting better together. We set it for 20 years since I've been here. When 1 plus 1 is equal 3, 4 and 5, that's what they're seeing. So we continue to click those off day in and day out kind of in those multiple ranges."
},
{
"speaker": "Charles Peters",
"text": "Okay. That makes sense. And then on those -- the larger transactions, it doesn't seem like -- maybe I'm -- I don't know the answer. So is there a lot of synergies to be harvested from as you integrate the businesses? Or are the stand-alone teams sort of like what you got with the WTW reinsurance operations."
},
{
"speaker": "Douglas Howell",
"text": "I think with Eastern and Cadence, I mean, it's not a -- there's no -- there's very few human synergies to be gained on this. As a matter of fact, they do a really great job servicing their customers and selling the insurance. But there are efficiencies that can be gained through a common general ledger, a common agency management system only needing 1 cyber protocol that runs over your platform. So there are some synergies there. But those are in the $3 million, $4 million, $5 million type numbers, not in the $25 million, $30 million or $40 million type number."
},
{
"speaker": "Patrick Gallagher",
"text": "The real kicker there, Greg, is that look at these bigger deals run by banks, and this is why we say it very much feels like we're buying somebody similar to us. These are firms that were rolled up by the bank, typically good community people. I've heard 3 separate outreaches from Cadence people in the last 2 days that I've known in 1 instance that they came in to kick the tires with us in 1998. And I remember the guy wrote to me and he goes, \"Hey, I came with Shorty and I remember Shorty and I came with Jim, I remember Jim and I can't tell you how excited we are.\" Now what we're bringing to them that Cadence could never do is that whole discussion of moving upstream. We can show you statistically that our closing rate on bigger deals, and I'm not talking risk management, huge accounts. I'm just saying the bigger deals that are generating over $125,000 to $150,000 of commission are significantly greater today than they were 5 or 10 years ago. This is what we're giving them the opportunity to go after. They're typical agents in these banks that look just like everybody else, and now they're going to go out. And frankly, they're going to have our tools and they're terrifically excited about it. So that's, I think, the whole synergy thing. This is not take out headcount. This is turn them on, show them what we do, give them the tools and watch them eat the market all around them."
},
{
"speaker": "Charles Peters",
"text": "Okay. That makes sense. I guess the final question, I know -- I think it was Paul who was trying to get at this. But frankly, we're hearing of some stress in some of the PE-backed roll-ups where the combination of higher interest costs and earn-outs are pressuring their free cash flow. What's your view of some of those smaller entities that might be having problems? Could we see you be interested in some of those properties at some point in time if they should become available?"
},
{
"speaker": "Patrick Gallagher",
"text": "Well, here's the thing. First of all, Greg, we'll look at every single opportunity we can. And our first question every single time is what's the culture. What was it that went into this group. In most of these, there are situations where we didn't succeed in buying something they bought. Let's talk about that around this table, not with them in the room. XYZ didn't sell to us. Why is that? Okay, fine. What's left there? And yes, I would say that there are some of those that we would be interested in. But we'd have to get through this whole cultural piece. When you chose not to join Gallagher, I'll tell you the one main reason why you chose not to join Gallagher is because you didn't want change. And our competition has done a very good job of saying, \"Hey, why join Gallagher when I'll give you the money? I'm going to give you the cash, keep some in. Our returns have been terrific. You'll get a second bite on the apple and you don't need to change anything. You don't need to change your name, you don't need to change your agency system,\" and while they've been doing that, we've been building power-to-power, data, analytics, capabilities and vertical strength. They've got none of that. And now it's coming to roost with higher interest rates and tougher earnouts, and you got to make do -- you got to come due on your promises. So yes, we'd look at them. But we're going to have to fall in love."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mike Zaremski with BMO Capital Markets."
},
{
"speaker": "Michael Zaremski",
"text": "Maybe I missed this, but on the Cadence deal, is it -- am I right looking at the revenue and EBITDA disclosure that Cadence has a 36% to 37% margin, which is pretty great. And then also on the deal there was -- you called out tax benefits. I don't recall you guys calling out tax benefits in the past."
},
{
"speaker": "Douglas Howell",
"text": "Yes. All right. First, you're right. I think it might be about 34%, but I think [indiscernible] over a point or 2 on that. I think that when it comes to the tax, I think it's important on these margins, we always get a step-up in basis on smaller deals, but on many larger mergers that these sellers are not willing to allow a step up in basis. In this case, the sellers were willing to and we paid a little bit more cash upfront on it. But we're going to get $250 million worth of deductions over the next 15 years. Your present value that back at 5% or 6%, you get something . So it really doesn't impact them all that much because I don't know if they're -- they might be able to shield it with NOL carryforwards or something like that, but it benefits us a lot. So to be able to achieve that. And it's not all that important in many times for, let's say, a PE firm that buys a bigger one over at trades because they've got the large interest shield coming off of the high levels of debt they run there. But for us to be able to negotiate that benefit and to be able to have a seller that's willing to allow that benefit to pass out, that makes a big difference. So in this case, this is a true win-win for them. They get more cash, we get more cash, and it brings our multiple down considerably on it. This is not using our clean energy credit. We have $670 million of clean energy credits available. Think about that. We'll use those over the next few years. It's almost like we have another free Cadence coming our way because of those tax credits. So tax does matter. And in this case, we think that a conservative view of that benefit is $150-some million."
},
{
"speaker": "Michael Zaremski",
"text": "Interesting. And I guess this one probably for -- this one question is for Pat, and congrats to Thomas and Patrick on our new appointments. Just curious on Pat. Will these new appointments cause any of your existing managers other than yourself to share responsibilities they didn't previously share?"
},
{
"speaker": "Patrick Gallagher",
"text": "There will be some follow-on promotions. Sure. There's good opportunities for everybody at Gallagher, yes."
},
{
"speaker": "Michael Zaremski",
"text": "And so were these promotions well-telegraphed? Or is this kind of like -- were these promotions like about well-telegraphed, like within the firm, like over time or were these kind of..."
},
{
"speaker": "Patrick Gallagher",
"text": "I'm going to ask you the Gallagher answer. There's not a lot secret at Gallagher, right? Yes, I would say that these moves have been telegraphed over about 20 years."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mark Hughes with Truist Securities."
},
{
"speaker": "Mark Hughes",
"text": "On the -- could you give any guidance on the corporate segment profit for 2024. Any early thoughts there?"
},
{
"speaker": "Douglas Howell",
"text": "We haven't. And can you give until December? I know you're trying to figure out your '24 models. You might want to take what we did this year and just take it by line by line and make a site pick on it to see what you think it -- what would happen there. I know it's really difficult to do, Mark, because of FX remeasurement gains. I know we put some acquisition costs through there that can be lumpy. And there's a lot of tax, restructure numbers that run through there as we implement tax planning strategy. I know it's really difficult. But if you could you just give me until December and I can get that to you."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Yes."
},
{
"speaker": "Douglas Howell",
"text": "We get this every year."
},
{
"speaker": "Mark Hughes",
"text": "Any thoughts on medical inflation? Just curious to get, I think, the benefit is being helped by higher health care costs for employees, but the medical inflation impact on, say, workers' comp or GL."
},
{
"speaker": "Patrick Gallagher",
"text": "It's interesting you should ask because we were talking about that with the board this week. And yes, we're seeing a lot of pressure on medical costs. Full insured renewals at our largest carriers are showing 7% to 9% increases right now as we speak. When you start to take retentions and you start to get in the stop-loss market, we're seeing averages there closer to 17% to 18%. That's on premium now. That's not on the underlying costs. But that's because more of the claims are tagging those carriers. So they're not only trying to move away in terms of the low end of the cost, but also they're having to pay that. So if you take a look at all of it, all in, Mark, I'd say that our numbers that we're seeing are about 8% to 9% and that's embedded both in work comp as well as health insurance across the United States."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of David Motemaden with Evercore ISI."
},
{
"speaker": "David Motemaden",
"text": "I was wondering if you could just help me think through just how much of the organic growth over the last several years and even this quarter is driven by just the macro environment versus what you guys have been doing behind the scenes to accelerate share gains? Because it feels like there's been a lot going on to help you guys gain share and that the share gains are accelerating. So I'm just wondering as kind of a big picture question. as you guys head into next year and you think about that 7% to 9% organic, I guess, how much of that do you think is coming from market share gains as you guys continue to execute versus like rate and exposure improvements?"
},
{
"speaker": "Patrick Gallagher",
"text": "Well, let me split the question with Doug in this regard. Let me talk about market gains in terms of share gain and then he can tear the numbers a bit. But we're seeing and we're measuring this literally every single day, every month. We know now where we're producing business. We know, for instance, that 90% of the time, we compete with somebody smaller than we are. We know exactly what's happening in our verticals. We have 32 verticals that we're very, very clear on management expectation, knowing what's going on, building products and what have you. That's in the property casualty arena. We have another 7 or 8 in benefits. And in those verticals, we know that our growth rate is substantially greater than what is in our just general book of business. So internally, we know that we are taking definite share in those verticals. And I would probably -- I'd throw out a number, Mike, maybe you throw a number out on the table of what..."
},
{
"speaker": "Douglas Howell",
"text": "In terms of?"
},
{
"speaker": "Patrick Gallagher",
"text": "Just in terms of the growth rate in the vertical as opposed to general."
},
{
"speaker": "Douglas Howell",
"text": "92% of our new business."
},
{
"speaker": "Patrick Gallagher",
"text": "19% of our new business falls..."
},
{
"speaker": "Douglas Howell",
"text": "Into one of our verticals."
},
{
"speaker": "Patrick Gallagher",
"text": "In one of those -- 19?"
},
{
"speaker": "Douglas Howell",
"text": "92%."
},
{
"speaker": "Patrick Gallagher",
"text": "92, that's what I thought. I heard 19, I apologize. So each of those are growing faster than the general book. So value -- again, you've got to look at rate, you've got to look at exposure and all that other stuff. But when you talk about share, there is absolutely no doubt you go back to Doug's comment. An acquisition can be 1 plus 1 equals 5 because when Gallagher shows up with the relationships and the capabilities of the local broker and brings those relationships together with what we have as capabilities and the culture works, we don't have to force sharing on people. The fact that they can pick up the phone and say, \"I've got a college University. I've never worked on one before. Can somebody help me.\" We will swarm that opportunity. We will write that college University they'll get their fair share, everybody wins, and we're not fighting that as a local entrepreneur who doesn't want to play with the big boys. That's the excitement. So I know that's a long-winded weird way of saying it, but we are definitely taking share. To the numbers, Doug, I'd throw over to you."
},
{
"speaker": "Douglas Howell",
"text": "[indiscernible] that 7% organic growth next year, I'd say that half comes from net new business wins or taking share. I would say, 1/4 is coming from exposure units and another quarter is coming from rate. If you got 9%, you probably got 1/3, 1/3, 1/3 in there."
},
{
"speaker": "David Motemaden",
"text": "Got it. That's really helpful. I appreciate that. And then maybe just a follow-up. We've seen obviously the 2 -- the Cadence and Eastern deals on top of the M&T Bank broker last year or earlier this year. So I guess I'm sort of wondering -- as we think about the sustainability of that organic, I know you're the preferred provider for I think it was Cadence. But I guess, how do you manage the fact that -- or the potential that there might be more of like an open process for some of those existing customers now that it's not wholly owned. I don't know if that's something that you guys have worked through planning? Or just maybe help us think through that."
},
{
"speaker": "Patrick Gallagher",
"text": "I'll help you think through it and probably the people from Cadence Bank and say, he's maybe talking off the top of the head, blah, blah, blah. But I don't think the bank did much to help them produce insurance, like probably hurt their production, which is why when you look at some of these deals, the Board goes well, where is the growth. Cadence and Eastern good growth, but the fact is -- those people have gone out and scrape for that business around the bank relationship, which was, of course, when they bought those firms, supposed to be the golden nugget in terms of being able to produce business that just isn't true. In fact, I think we're going to unleash an opportunity to really grow the top line."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "Two big picture questions. One, there's been some press about larger insurance brokers getting back into wholesale. Would that matter at all to Gallagher?"
},
{
"speaker": "Patrick Gallagher",
"text": "Not really. If you take a look at our wholesale business, RPS. We do not mandate inside Gallagher, so it's not 100% Gallagher placements there. We did consolidate down to a smaller number of players and RPS does about 50% of Gallagher's placements. So we're very cognizant of what the world is like out there. But really, RPS trades with 15,000 to 18,000 independent agents. And RPS does not trade particularly at all with our 3 larger competitors. So if they were the ones that choose to come in back into the market, we think it would have virtually no impact on us at all."
},
{
"speaker": "Meyer Shields",
"text": "That's very helpful. Second question, and this relates to what you've been talking about, Pat, with the additional resources that being part of Gallagher brings. How rapidly can acquisitions take advantage of that? And is that something we should factor in when we're modeling acquired revenues?"
},
{
"speaker": "Patrick Gallagher",
"text": "Day 1, and I do mean day 1 and the team will swarm that opportunity. Now do they get used to operating that way? Have they got the customer teed up. It takes -- it's still a learning curve in all fairness, they'll call and we'll jump on the plane and have a shot at that university. But it will probably be a year or 2 before we land it. So I can't sit here and go, day 1, it just ratchets up. But I'll tell you what it does. It gets everybody in that firm excited. It worked. Gallagher helped, you can't believe it. We turned this risk manager on their head. This is really cool. Next time around, what's the strategy? What's the methodology. So the resources are truly available to that team on day 1. Now would I factor into the earn-out. Some of them take great advantage of it and really does help. It makes their earnout. Others, as I said, it's a longer ramp-up speed and it's just a matter of the individual leaders."
},
{
"speaker": "Douglas Howell",
"text": "Yes. One thing, I think we actually understate true organic because we don't consider any new business, net new business wins by those mergers in the first year. That doesn't get counted as organic. Was it $20 million, $30 million more of net new maybe across the business every year? I don't know. It might be worth 20 basis points on our organic growth over the course of the year. So I think it naturally understates it. But I think the point is, like I said on this one just a minute ago. We had a merger partner that just crushed it here at the end of September, and that doesn't go into organic, but it sure impacts our acquisition revenues. Now we try to give you that when we do these projections. So look at that on Page 6 of our CFO commentary. But the point is the great mergers are the ones that come in, hit the ground running, use our resources and capabilities. And next thing you know over the next 2, 3, 4 years, they're just hitting it out of the park."
},
{
"speaker": "Patrick Gallagher",
"text": "We've showed you in our IR Day, things like our drive, just Gallagher Drive. One, just one item that is so cool to these people. And it's basically the ability to sit with a client and say, people like you buy this. And here's what the lines of insurance are there going to these types of truckers in your area or construction companies or senior living. Here's the layers that they're buying. And by the way, you're holding a $10 million liability limit. Most of your competitors are paying 20 -- or buying $20 million of umbrella. Let me show you the losses we have in our book that appears to $10 million. You probably ought to buy the 20, there's reason for that. It blows the competition away and our merger partners can't wait to get their hands on it. That's 1 thing, and there's a dozen of those."
},
{
"speaker": "Operator",
"text": "Our last question is coming from Yaron Kinar with Jefferies."
},
{
"speaker": "Yaron Kinar",
"text": "I apologize, I had some technical difficulties. So I hope I'm not asking stuff that's already been asked. With regards to Eastern and Cadence, do they have any different seasonal patterns? I think you touched on growth on the margin profile. But I'm curious if that margin profile kind of holds true to what you see in brokers already throughout the year."
},
{
"speaker": "Patrick Gallagher",
"text": "No, there's no seasonality."
},
{
"speaker": "Douglas Howell",
"text": "Yes. Remember, we're seasonally larger primarily because of our benefits and because of our reinsured business, our P&C business is fairly steady throughout the year over the 4 quarters. And maybe it's 23% on one quarter and 27% another, but we're not getting the wild swings like you do in reinsurance and employee benefits."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. And do either of those deals fall any vertical space that you were looking to boost stop? Or is it more of a geographic play? What's the rationale there?"
},
{
"speaker": "Patrick Gallagher",
"text": "Mike, go ahead."
},
{
"speaker": "Michael Pesch",
"text": "Yes, this is Mike Pesch. So I would say both of them are -- in their geographies are strong where we are maybe strong in other industries. So in Cadence, in their perspective, we do a lot of public entity in the mid-south region, and that's not one of their strengths. But they do a lot in construction and manufacturing. So it complements us really, really well. It's one of the reasons we like them so much. Eastern is the same way. If you look in New England, New England is heavily weighted towards life sciences, technology and D&O, and they balance that book considerably with a lot of other industry verticals, including construction. So it is very much a complementary business to each of those areas."
},
{
"speaker": "Yaron Kinar",
"text": "Got it. And then one quick one to end up. Corporate expenses were quite high this quarter. Were there any one-offs there?"
},
{
"speaker": "Douglas Howell",
"text": "I think when you look at it, if you look at the adjustment -- if you look at it on an adjusted basis, there were some tax and litigation items when we adjusted that out. On an adjusted basis, it's kind of noisy. Comp might be up $3 million or $4 million. I think we're a little further ahead on our corporate bonus accruals than we have been in the past. And when you look at operating expense, it looks down considerably on an adjusted basis, but that's the FX remeasurement gains that you're seeing. So if you're looking at it on a pretax basis on an unadjusted basis, that's what you'll see in there. But there's nothing fundamentally underlying our expense structure in the corporate segment."
},
{
"speaker": "Patrick Gallagher",
"text": "Well, thank you again, everyone, for joining us this evening. To our 50,000 colleagues across the globe, thank you for your hard work this quarter and every quarter. Our operational and financial success is a direct reflection of your efforts. And as pleased as I am with our third quarter performance, I'm even more excited about our future, future organic prospects, future M&A opportunities and our ability to become more productive and increase quality. We look forward to speaking with the investment community in person at our IR Day in December. Thank you again, everybody, and have a good evening."
},
{
"speaker": "Operator",
"text": "Thank you. This does conclude today's conference call. You may now disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 2 | 2,023 | 2023-07-28 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Companies Second Quarter 2023 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be opened for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call including answers given in response to questions may constitute forward looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward looking statements provided on this call. These forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward looking statements and risk factors sections contained in the company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
J. Patrick Gallagher, Jr.: Thank you very much. Good afternoon, and thank you for joining us for our second quarter 2023 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had a fantastic second quarter. For our combined brokerage and risk management segments, we posted 20% revenue growth, 10.8% organic growth, and recall, we don't include interest income in our organic. If we did, our headline number would be 13.4% and over 14% if you levelized for last year's large life products sale. GAAP earnings per share of $1.48, adjusted earnings per share of $2.28, up 21% year-over-year, reported net earnings margin of 13.6%, adjusted EBITDAC margin of 30.4%, up 52 basis points. We also completed 15 mergers totaling $349 million of estimated annualized revenue. We had a terrific month to finish the quarter that fueled the upside versus our June IR Day view. I could not be more pleased with our second quarter performance and how our teams all around the globe continue to deliver incredible value for our clients. On a segment basis, let me give you some more detail on our second quarter performance starting with our brokerage segment. Reported revenue growth was 20%. Organic was 9.7% or 12.3% if we include interest income and about 13% when levelizing for the large life product sale. Acquisition rollover revenues were $151 million. Adjusted EBITDAC growth was 23% and we posted adjusted EBITDAC margin expansive expansion of about 50 basis points. Let me walk you around then Howell will provide some more detail commentary on our brokerage organic. Again, the following figures do not include interest income. Starting with our retail brokerage operations. Our US PC business posted 13% organic. New business production was up year over year while retention was similar to last year's second quarter. Our UK PC business posted 11% organic due to strong new business production. Canada was up 6% organically, reflecting solid new business, similar retention versus last year and continued that somewhat more modest renewal premium increases. Rounding out the retail PC business, our combined operations in Australia, New Zealand posted more than 10% organic. Core new business wins were excellent and renewal premium increases were ahead of second quarter 2022 levels. Our global employee benefit brokerage and consulting business posted organic of about 2%. That includes a three-point headwind from last year's life product sale. Excluding the tough compare, organic would have been about 5%, with core health and welfare up low single digits, and many of our consulting practice groups showed continued strength. Shifting to our reinsurance, wholesale, and specialty businesses, Gallagher Re posted 11% organic, another outstanding quarter by the team, building upon their excellent first quarter results. Replacement services, our U.S. wholesale operations posted organic of 10%. This includes 19% growth in open brokerage and about 6% organic in our MGA programs and binding businesses. And finally, UK specialty posted organic of 19%, benefiting from excellent new business production and fantastic retention and a firm rate environment. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Global second quarter renewal premiums, which include both rate and exposure changes, were up 12%. That's ahead of the 8% to 10% renewal premium change we were reporting throughout 2022 in the first quarter of 2023. Renewal premium increases were made broad-based and are up across all of our major geographies. We're also seeing increases across most product lines. Property is up more than 20%. General liability is up about 8%. Workers comp is up about 3%. Umbrella and package are up about 11%. And most lines are trending similar or higher relative to previous quarters with two exceptions. First is public company D&O, where renewal premiums are lower versus last year, and second, cyber, which has flattened down slightly year-over-year. But to put this all in perspective, these two lines combined represent around 5% of our year-to-date brokerage revenues and thus don't have much of an impact. So I believe the market continues to be rational, still pushing for rate where it's needed to generate an acceptable underwriting profit. Remember though, our job as brokers is to help our clients find the best coverage while mitigating price increases to ensure their risk management programs fit their budgets. So not all of these renewal premium increases show up in our organic. Shifting to the reinsurance market. Overall, the June and July reinsurance renewals resulted in similar outcomes to what we saw during January renewals with most global reinsurance lines continuing to harden. Property continues to experience the most hardening, especially cat exposed trees. Within the U.S., Florida property cat renewals were more orderly than January due to an early start and well-defined reinsurer appetites, regardless, price increases were in the 25% to 40% range, causing many seasons to increase their retentions. While property capacity isn't abundant, we ultimately were able to place risk for most all of our seasons. As for casualty reinsurance renewals, the second quarter showed more stable supply versus demand dynamics, resulting in price increases based on product or risk-specific factors. Looking forward, carriers are likely to continue their cautious underwriting posture given the frequency and severity of weather events, replacement cost increases and social inflation, all of which can impact current and prior accident year profitability. Add to that rising insurance costs, and it's easy to make the case for pricing increases on most lines to continue here in 2023 and perhaps throughout 2024. Despite these and other inflationary cost pressures, our customers' business activity remains strong. During the second quarter, our daily indications of client business showed positive endorsements and audits. These positive policy adjustments have continued thus far in July. At the same time, labor market imbalances remain. Recent data shows the U.S. unemployment rate declining, continued growth in non-farm payrolls and a very wide gap between the amount of job openings and the number of people unemployed and looking for work. And medical cost trends are on the rise. We anticipate these costs to accelerate into 2024 due to increased costs of services, more frequent high-dollar claims, and the impact of new therapies and specialty medications. So I see demand for our HR consulting and other benefits offerings remaining strong. So, when I bring this all together, as we sit here today, we are more confident with full-year brokerage organic in the 8% to 9% range. And with an excellent second quarter in the books, more towards the upper end of that range, posting that would be another fantastic year. Moving on to mergers and acquisitions. We had a very active second quarter. In addition to the Buck acquisition, which I will discuss in a moment, we completed 14 new tuck-in brokerage mergers. Combined, these 15 mergers represent about $349 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. Moving to the Buck merger, which was completed in early April. Our integration efforts have begun and the combined business is off to a great start. While it's still early, I'm extremely pleased with how the teams are working together and excited about our combined prospects. Looking ahead, we have a very strong merger pipeline, including nearly 55 term sheets signed or being prepared, representing more than $700 million of annualized revenue. We know that not all of these will ultimately close, but we believe we will get our fair share. Moving on to our risk management segment, Gallagher Bassett. Second quarter organic growth was 18.1% ahead of our expectations due to rising claim counts and continued growth from recent new business wins. These wins have been broad-based and across all of various client segments, including large corporate enterprises, public entities, insurance carriers, and captives. Growth in each of our client verticals is great affirmation in our ability to tailor our client offerings, utilize industry-leading technology, and ultimately deliver superior outcomes for clients across the globe. Second quarter adjusted EBITDAC margin of 19.4% was very strong and at the upper end of our June expectation. Looking forward, we see full year 2023 organic around 13% and adjusted EBITDAC margins pushing 20%. That would be another outstanding year. And I'll conclude with some comments regarding our Bedrock culture. This past quarter, I was on the road for a month, visiting employees around the globe, traveling to New Zealand, Ireland, the UK, and the Czech Republic. And I can say that our culture is thriving, which makes me incredibly proud. Some of those conversations included the more than 500 young people in our 58th class of the Gallagher Summer Internship. This rigorous two-month program is an essential investment in our future, ensuring our unique culture remains strong for years to come. As we continue welcoming new colleagues and merger partners into the Gallagher fold, I'm confident that each new addition will uphold the expertise, excellence, and ethical conduct that make Gallagher the name so trusted worldwide. And that is the Gallagher way. All right. I'll stop now and turn it over to Doug. Doug?
Douglas Howell: Thanks, Pat. I'll walk through organic and margins by segment, including how we see the remainder of the year playing out. Then I'll provide some comments on our typical modeling helpers using the CFO commentary document that we post on our website. And I'll conclude my prepared remarks with a few comments on cash, M&A capacity, and capital management. Okay. Let's flip to page three of the earnings release. All-in brokerage organic of 9.7%. That would be 12.3% if we include interest income, and a little over 13% when further levelizing for last year's large live product sale. That's a bit better than what we forecasted at our IR Day in June due to a fantastic finish of the quarter across all of our divisions, especially U.S. retail and London specialty. You'll also see that contingents were up more than 20% organically. Probably a better way to look at it is in combination with supplementals, because contracts can flip from time-to-time. Together, up 12% is much more in line with our base commission and fee organic growth. So no matter which way you look at it, a fantastic organic growth quarter by the team. Looking forward, we see headline brokerage organic around 9% for third quarter and about 8% for fourth quarter. It's important to recall that fourth quarter will have a tough compare because in Q4 2022, we booked a change in estimate related to our 606 deferred revenue accounting. Controlling for that, fourth quarter 2023 organic would be towards 9%. We highlighted this matter last year and again at our June IR Day, so there's nothing new here, it's just a reminder as you update your models. With all that said, we remain bullish on our organic prospects for the second half. According, we now believe, full-year brokerage organic is looking like at the higher end of that 8% to 9% range. Again, these percentages do not include interest income. Flipping to page five of their earnings release to the brokerage segment adjusted EBITDAC table. We posted adjusted EBITDAC margin of 32.1% for the quarter. That's up about 50 basis points over second quarter 2022's FX adjusted margin. And that came in better than our June IR Day expectation of the expanding 10 basis points mostly due to the incremental organic growth. Looking at it like a bridge from Q to 2022, organic gave us 100 basis points of expansion. Incremental interest income gave us 90 basis points of margin expansion. The impact role of M&A, which is mostly Buck, uses about 80 basis points. And then we also made some incremental technology investments called out around $7 million and some continued inflation on T&E called out about $5 million, which in total used about 60 basis points. Follow that bridge and the math gets you close to that 50 basis points of FX adjusted expansion in the quarter. As for a margin outlook, we expect about 40 to 50 basis points of expansion for each of the next two quarters. For the -- so for the year, we are a bit more optimistic than our April and June views, and now see four year margin expansion of 30 to 40 basis points. Or that would be 70 to 90 basis points levelizing for the role and impact of Buck. Again, both those percentages or increases relative to prior year FX adjusted margins. We talked about that during our June IR Day when we provided a vignette on how to model margins. Let me give you 2022 margins, recomputed current FX levels for your starting points. In Q3, 2022, EBITDAC margins would have been around 31.7% versus 32.3% we reported. And as for fourth quarter 2022, not nearly as much impact, call it around 31.3%. So now if you move to the risk management segment and the organic table at the bottom of page five of the earnings release. Also, I had an excellent finish to the second quarter, 18.1% organic growth. As Pat mentioned, we continue to benefit from new business wins from the second half of 2022. Looking forward, we see organic in the third quarter on 14% and fourth quarter about 10% which reflects the lapping of last year's larger new business wins. As for margins, when you flip to page six and the adjusted margin EBITDAC table, risk management posted 19.4%. That was on the upper end of our 19% to 19.5% June expectation. Looking forward, we see margins above 19.5% in each of the last two quarters of 2023. So, full-year double digital organic and margins approaching 20%. That would lead to a record year for Gallagher Basset. Now, let's turn to page seven of the earnings release in the corporate segment short-cut table. In total, adjusted second quarter came and right at the midpoint of the range we provided during our June IR Day. Even though we did experience a further $5 million of FX related re-measurement head wins. That cost us a couple pennies in the quarter. Moving -- now, let's move to the CFO commentary document. On page three, you'll see most of the second quarter results were in line with our June commentary. And looking ahead, you'll see that we've updated our outlook to reflect current FX rates and provide our usual modeling helpers for the second half of the year. Moving to page four of the CFO commentary document and our corporate segment outlook for the second half, punch line here is not much change other than a modest weak corporate expense and interest in banking costs as we've assumed a slightly higher balance on our credit line giving our robust M&A activity. Then on page five of the CFO commentary, that shows our tax credit carry forwards. As of June 30, we have about $700 million, which will be used over the next few years and that sweetens our cash flow and helps us fund a future M&A. Shifting to rollover M&A revenues on page six of the CFO commentary document, $151 million in the quarter with Buck contributing nearly half of that. Remember, numbers in this table only include estimates for M&A closed through yesterday. So you need to make a pick for future M&A and you should also increase interest expense if you assume, we borrow for a portion of the purchase price. One other call out and that's back at the bottom of page three of the earnings release, we did use a higher than normal amount of stock for tax free exchange mergers this quarter. That can be a little lumpy, but we do like doing them. It's attractive to the sellers that are looking to defer the full tax consequence of selling the firm and it's also attractive to us because it fully aligns our new partners with our long-term shareholders. As for future M&A, we remain very well-positioned. At June 30, available cash on hand was more than $400 million. Our cash flows are strongest in the second half of the year and we have room for incremental borrowing all the while maintaining our strong investment grade ratings. We continue to see our full year 2023 M&A capacity upwards of $3 billion and another $3 billion or more in 2024 without using any equity. So another outstanding quarter by the team, from my position as CFO sitting halfway through the year, our full year 2023 outlook on all measures continues to improve, better organic, better margins, and a more robust M&A pipeline. Bottom line, we're in a great spot to deliver another record year financial performance. Okay, back to you Pat.
J. Patrick Gallagher, Jr.: Thanks, Doug. Operator, let's go ahead and open up for questions.
Operator: Thank you. The call for now open for questions. [Operator Instructions] Now, our first question is coming from the line of Weston Bloomer with UBS. Please proceed with your questions.
Weston Bloomer: Hi. Good evening. My first question, really good strong organic growth within brokerage and around 200 basis points of above what you'd said, I guess about a month ago. I was curious if you could spend on maybe what lines of businesses or geographies, or maybe whether supplementals or contingent that drove that out performance? Curious of what we can extrapolate for the back half of the year or what is about the nature?
Douglas Howell: Yes, I think extrapolating for the back half of the year, we feel that our look towards nine and then eight adjusted to nine for the second two quarters probably the best way to look at what we think for the rest of the year. The upside was due to U.S. and also U.K. specialty, they just had a terrific in the June. So, but we're seeing that across the globe, there is a noticeable uptick here in June of success on our sales. And our retention are good and there is some positive light movement in those numbers too.
J. Patrick Gallagher, Jr.: Also, I would say, clients are getting pretty darn weary of a hard market and they're looking for good advice. And we're fine and great strong growth is in property casualty. The basic blocking and tackling, workers' comp areas that in the United States at least we stand and opportunity to stand really ahead and shoulders above our competition, especially with the little guys.
Weston Bloomer: Great, thanks. And second question on M&A. I believe you said 55 term sheets for $700 million in revenue. If I kind of go back do my model. I believe that's 700's the highest I've seen maybe away from Gallagher Re. So could you maybe just expand, is there any shift in your M&A strategy or any like larger deals in the pipeline? Or could you maybe just expand on what you're seeing in the market more broadly as well?
J. Patrick Gallagher, Jr.: No I think that what we're seeing is, first of all, remember, we talked about this quite often. We don't have one individual out prospecting. And we've got dozens and dozens of people that have now done deals in our company. They are constantly talking to our competitors. The more deals we do, the more friends they have in the industry that they're telling it's working well, and they're pleased to be with us. And I think it's just a matter of straight-up blocking and tackling when it comes to the typical making calls, talking to people, renewing relationships we've had for years. And people get into a point where they're possibly ready to sell.
Douglas Howell: Yes, I think they see our capabilities. And I think some of the appeal of maybe selling to a PE firm, there's some concern about that giving that increase in interest rates in the borrowing cost. There's been some stress on that side of the industry. And so, we're seeing that folks are really more interested in being with a strategic now than trying to sell into a PE roll-up.
Weston Bloomer: Got it. Thanks. Yes. It was double-digit. I think $1 million in revenue per term. So I got a little excited there.
Douglas Howell: Me too.
Weston Bloomer: And then last one, just on fiduciary, you'd highlight around 90 bps benefiting the quarters. Is that roughly what you have baked into the back half of the year when we think about your guidance?
Douglas Howell: Yes, I think that this, I think the biggest job here in Q2, I think in the second half of the year you might see something like 70 basis points in the third quarter and it gives us maybe only 50 basis points of margin expansion in the fourth quarter just because rates have been popping up.
Weston Bloomer: Great. Thank you.
J. Patrick Gallagher, Jr.: Thanks Weston.
Operator: The next question comes from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question.
Elyse Greenspan: Hi, thanks. Good evening. My first question, Pat, I know when asked on your typically willing to provide a little bit of an outlook on how you're seeing things more than just the current year. So based on how you think about things right now, how do you think from a thing of the brokerage business from an organic growth perspective, how do you think 2024 shaping up?
J. Patrick Gallagher, Jr.: Elyse, I think it's going to look a lot like 2023. I'm not seeing any hesitation of underwriters asking for rate. I do think the cycles have shifted. When you see cyber and D&O coming down, they probably are coming down and that's reasonable. Property through the roof is reasonable. What we're seeing in inflation in terms of lawsuit, social implications we're searching for. It's very, very troubling. And then you had inflation. We've been talking about inflation, and it's called now for over a year. And you look back in the reserves and inflation tips those into a very difficult spot. And you're not going to get those healthy in one year. So I feel very strong about. And I'll tell you, our insurance companies are very, our partners are very smart about their numbers. They know where they're making money, where they're not making money, and they're telling us what they need. So I don't see people backing off on that. No one's walking in saying, the gates are wide open, let's just get volume. It's a reasonable market that you can get deals done at a reasonable price. Our clients actually understand inflation. They're living with it across the board, and inflation is good for a broker, honestly. So I think next year looks very, very strong.
Elyse Greenspan: And then Doug, I know, the bar was a little bit higher for the level of margin improvement this year, as 2024 looks like 2023 from an organic revenue growth perspective. Would we see more margin improvement next year at the same level of organic that we saw this year?
Douglas Howell: Well, I guess my reaction to that is going back, I think that you'd see some margin expansion at 6%. I don't know if you'd get it necessarily at 4%. I don't -- I think by the time you got up to 9%, it'd be better than 50 basis points of margin expansion. And we do have one more quarter of roll and impact of Buck that would, the underlying business would be going up, but that business runs a lower margin. So, depending on which question you're asking me, I would think that margin expansion in 2024 could be very similar to what we thought it'd be in this year. Give us six points of organic and there might be 40, 50 basis points, give us nine points of organic, you might get 75, 80 out of it.
Elyse Greenspan: And then, when you're talking about price increases, are you making that comment on like a nominal basis or are you expecting that when you think about property casualty pricing over the balance of this year in 2024, that will continue to exceed loss trend?
J. Patrick Gallagher, Jr.: Well, I think that's the battle isn't Elyse. I mean, the carriers are very much wanting and telling us they need that. So, yes, I think that would be the objective and we're finding that we can get it. So, I do think that they're going to look at loss trends and they're going to try to definitely keep the rate structure moving ahead of that.
Elyse Greenspan: And one last one. Do you have some initial thoughts on what we could see from reinsurance pricing at January 1, 2024?
J. Patrick Gallagher, Jr.: No. It's too early for me to comment on that, Elyse. I think, we just finished July, not as bigger month, obviously, as January, but interesting that the pricing was still very, very, very firm. The market after January 1 had a time, better chance to settle down, look at their books to understand, January was a nightmare. So as we said in our prepared remarks, July was a little bit more orderly, but still difficult. So, give me another quarter on that one.
Elyse Greenspan: Thank you.
J. Patrick Gallagher, Jr.: Thanks, Elyse.
Operator: Our next question comes from the line of Mike Zaremski with BMO Capital Markets. Please just use your questions.
Mike Zaremski: Hey, good afternoon. Investment income, is this the new run rate was better than expected or should we expected to take another like I guess, well, of course, the company's growing too?
Douglas Howell: Listen, I think the impact on our numbers, I think that it's actually will be the change in margin from investment income was 90 basis points. This quarter, we think it would be about 70 basis points in the third and about 50 basis points of margin expansion in the fourth. So, to me, I would say that the actual dollar amounts that you're seeing in the second quarter are not just similar to the dollar amounts that you would see in third and fourth quarter.
Mike Zaremski: Okay. And you guys are firing on all cylinders, I'm just trying to poke some holes here. Let's see if I can. So, I mean, just that will be realistic. U.K. inflation, the stats look like, it's high and there's wage pressures and some, at least slow in GDP outlook. How does your business look there -- has look there currently? Margin has been growing as much there, and any comments on that?
J. Patrick Gallagher, Jr.: Our U.K. retail business is on fire, really on fire. And I give a lot of credit to the team on two ways. One, as you know, we've spent money there in terms of branding and we did not do that for years when we were putting together Giles, Oval, Heath. Those firms were trading under those names. We brought those together. We started talking about ourselves as Gallagher in the field. And our Rugby partnerships there and the efforts that we spent on branding had paid incredible dividends. And people know who we are now across the entire U.K. and our people are taking advantage of that. And I just visited in -- I was in our London offices for a good part of June. I was in Dublin in Belfast and I can just say this. There's a bounce in every retailer step. They're kicking ass, they're having fun and they're taking names and getting more business for next quarter.
Mike Zaremski: Okay. And just because Elyse asked for, I mean, I'm just going to sneak in a quick one. In terms of the pricing environment, taking a kind of a step up, how much do you think is due to the reinsurance cost trying to be passed through? And it sounds like you don't -- it sounds like it's not a big deal, because you're saying that next year could be similar to this year, so there wouldn't be a step down. But I'm curious if you think some of the momentum something on the reinsurance side?
J. Patrick Gallagher, Jr.: Let's be clear. I'm saying that we're being told by our carrier CEOs that they have to cover their increasing cost base, that starts with inflation and their past reserves and, if you plan to rebuild a house for a million dollars two years ago, you're not going to spend a million dollars. So they are looking at those reserves. Then secondly, they're still in a process of making sure that we get our values right. These values haven't been touched for a decade. They haven't needed to be touched. So now you got a value increase. You've got exposure units growth. Then you add to that the cost of reinsurance, which is clearly a cost. They're not separating it out and telling our retail clients, well, this part is for reinsurance. They're say, look guys, on this line of cover, we need 25 points. Go get it. And that'll hold as long as we have to, in fact, do that to get the deal done. Now, remember, we are scouring the market for some little do-for-ten, because that's our job. But right now, there's no break in that.
Mike Zaremski: Thank you.
J. Patrick Gallagher, Jr.: Thanks, Mike.
Operator: Our next question comes from the line of Greg Peters with Raymond James. Please proceed with your question.
Greg Peters: Hey, good afternoon, Pat and Doug. Hey, I wanted just to have you for a moment talk about new business. Because when you look at the organic result, 10.8%. You look at renewal pricing 12%. When you went through a bunch of lines, Pat, where pricing was clearly double digit. And so, and you also made this comment about your clients having a budget. Just curious, how much of the growth organic is rate versus exposure, existing clients versus new business, and has that balance changed at all in the last year?
J. Patrick Gallagher, Jr.: Let Doug talk about the actual numbers, because I'm more off the cuff. And then I'll come back in on how I see the market shaping. Go ahead Doug.
Douglas Howell: So, Greg, our net new business versus loss business is up this year by two percentage points compared to where it was there. Rate is, then that's the total rate in exposure is up about a point and a half. So, you can see here that it's our net -- our increased new is actually up more than the impact from rate is up.
J. Patrick Gallagher, Jr.: Now, let me add some color to that, Greg. Number one, we're doing a much better job, I think, than ever of measuring kind of this new business stuff that you're talking about. We know that our average production is actually increasing in the income. The commission income receiving on new business has moved up from, let's call it $50,000, $60,000 into closer to $175,000 to $100,000. That's per item as we start bringing it in. So we're actually finding those clients that have for a long time probably been pretty happy with either their local broker or their relationship with a larger broker giving us a chance and we're doing very, very well. We are a new business machine. And when I take a look at the percentage of trailing revenue that we try to accomplish every year in new business. Our goal has always been 15% of trailing. We're just about right there. And as our trailing revenue growth continues, that pushes us in terms of our goals for more new business. And we are right on track with that. And when you start having 15%, 16%, 13% of trailing in new business, as long as you continue those retention levels, 94, 95, et cetera, you're getting very, very nice. You're getting very nice upside.
Greg Peters: Yes, that's good. Those are good numbers. I think I've opened up a can of worms, because we're going to want to start tracking the net new business wins you guys are posting on a quarterly basis.
J. Patrick Gallagher, Jr.: I'll give you that. Go and ask.
Greg Peters: Yes. In your comments, Pat, you also talked about on the theme of poking holes, right? You talked about the employee benefits business kind of stood out. That MGA business being low single-digit, mid single-digit type of organic. Maybe I don't want to call that an underperforming, but relative to the group, I guess it kind of is. So maybe you could spend a minute and talk about those two businesses, because you called them out in your comments?
Douglas Howell: Well, let's talk about the benefits business first. It's adjusted for the large life case 5%. I think that's pretty in line with maybe what some of the other brokers have talked about in their employee benefit space. So I wouldn't say it's necessarily out of whack compared to what's going on. That business right now doesn't have the lost cost increases that it's going to have. I think there's going to be medical inflation in that coming up. We're going to see on that a lot, but by and large, medical cost inflation does have an impact. When you go back to my early days here in 2003 through 2007, you were seeing medical loss inflation, cost inflation in the double digits, and that business was growing almost double digits also. So that will have an impact because you can't keep the inflation out of that space for too much longer. So that would happen. On the program business, you just understand in our case, there's some programs that if there's a change in the state or there's a change in the carrier appetite, sometimes that can cause a little bit of stress in that business. But still, being in those single digit organic ranges are still pretty damn good in this environment.
J. Patrick Gallagher, Jr.: Yes. And let me add to that. Greg, right now, our clients are dealing with wage cost inflation as people say, look, I've got -- I'm having a hard time buying eggs. And they are not looking to be expanding benefit offerings. In fact, they're doing everything they can to mitigate increased costs and benefits, while at the same time being able to balance what they need to give their people in their regular income. While at the same time maintaining, as you know how difficult this is, their employee base. So it is a really tough time. And our consultants, our people are doing a great job. Outside of health and welfare, the effort in terms of our consulting business that the orders that are coming through are spectacular. So it's really a balance of all that. And I agree with Doug. I think that it's a matter of them trying to deal with inflation in the cost of the cover, inflation in their compensation costs for their people and doing everything. And that's where we make our living, its helping to mitigate that. Plan design change, getting that down. And then lastly, a lot of that, as you know, we do on a fee. So when you're facing compensation costs, inflation costs in the underlying purchase of health insurance, the last thing you're doing is giving GBS, a 10% rate increase. I think by -- I think getting five points is pretty damn good.
Greg Peters: Fair enough. Just I know you provided some data. It's just the final question. I know you provided some data around Buck and the integration. That's a business that has had sort of a checkered past of success and maybe some challenges. Maybe spend a second. And this is my last question. Talking about the integration and why you think the outlook for that business is strong relative to its history?
J. Patrick Gallagher, Jr.: I'll tell you what, I am really excited about that business. And I'm a quarter in, right. And we had our board meeting yesterday and the team that's involved in the integrating and the onboarding reporting out to our board as we do in our large deals every quarter. The synergies there -- first of all, the management team could not be more excited to be finding a home. They've been traded five times. Then that's part of what you're talking about, Greg. You wake up and your name is not changing, but the owners are changing and then you're changing it again. You don't know who's on first, who's on second. A big part of our effort of onboarding here has been to tell those people, look, you found your last place. Now let's go take care of clients. And there's nothing consultants like to hear more than that. So that has been a big message to them. And I spent time with those folks in the UK. I've spent time with them here. It's resonating. Our retention of people is outstanding. And the orders we're getting in one quarter are mind boggling. So I'm really -- then you add to that. We do think there's some great synergies there. And that's not cost takeouts. That's cross selling. Seeing some of that already. And I think it's going to be just fine. And I'm one quarter in.
Greg Peters: Well, thank you for your answers and the answers make sense.
J. Patrick Gallagher, Jr.: Thanks, Greg.
Operator: Our Next question is from the line of David Montemaden with Evercore ISI. Please proceed with your question.
David Montemaden: Hey, thanks. I just wanted to follow-up just on the group benefits organic and just on the deceleration, which is still a 5% is good extra life sale comp. But that was down for seven in the first quarter. But it does sound like the acceleration is expected. Is that something, is it second half expectation? Or is that something you think will start to move up higher in 2024?
J. Patrick Gallagher, Jr.: I wouldn't be modeling out, David, a huge acceleration there. I mean, I spent a lot of time with Doug on the street explaining why 3% organic was outstanding just a few years ago. Yes, there's all, I'm now looking it. I'm now looking at a business here that is accepting hard rates. Given the fact that there's big loss cost trends or reinsurance trends, these are people buying insurance and in many instances, not buying insurance, that's the biggest part of what we do is help people self fund. And that 5% growth is earned with a lot of discussion with a client. It's more akin to what Gallagher Bassett's getting in terms of their renewal increases rather than what you look at on the PC side. So I'm very happy at 5%. I don't want to give you this idea that you're going to see some acceleration to 12%. That's not happening.
Douglas Howell: That business also can be heavily first quarter weighted. So you get a little bit of that, not only you have to recognize the full year of an account that you sell on the health and welfare side, but the consulting in the first quarter tends to be a little heavier or a little --you grow a little bit more than -- because if you think about it, most people are one-one type benefit customers. So they're putting the final touches on their business in January on some of the programs. So we tend to make a little bit more money in the first quarter.
J. Patrick Gallagher, Jr.: Can I answer an underlying question I hear from you, David, and the others. Why do we do the buck deal? It looks like its growth isn't great, doesn't have the margins that a PC broker does. You realize where the pain is for our clients right now and what we are is pain mitigation people. And it's sure it's in property, casualty, its specialty property. And we're out there working every day to help them get that down. We're bringing self-insurance plans, captive plans, group plans, what we can on the PC side. And every year, year and out, our clients are dealing with how do we get people? How do we keep them? How do we pay them? And how do we motivate them and at the same time take care of their benefits needs. And to get a firm like Buck on our team, when it absolutely recognized as the best in the business. I mean, it puts us over the top and that ability to respond to our clients needs across all of what we do for them. And I think 5% is outstanding. I want to tell the team, congratulations.
David Montemaden: No, thanks. I appreciate that. That's helpful, Pat. And I guess just maybe just switching gears just on the property casualty rating increases. You gave some numbers earlier. I missed some of them. I was hoping you could talk a little bit about what you're seeing specifically on casualty rates. And it sounds like we're seeing an acceleration there. If I just strip out D&O and workers comp. But I'm wondering if that is in fact what you guys are seeing and how sustainable you guys think those -- that acceleration is?
J. Patrick Gallagher, Jr.: What I've said in my prepared remarks, David, is the general liabilities of about eight. Workers comp, which has been flat to down for a number of years is up about three. And umbrella and package you're up about 11. So now, embedded in each of those lines have different reasons. General liability is social inflation, probably aging population. Workers comp is clearly, it floats with medical costs and it floats with employment. An umbrella and package is probably also looking at social inflation and property up 20% is clearly -- that's about exposure units and the need for rate.
Douglas Howell: Yes. David, when I look at it, you want to break it on general liability umbrella of other casualty call that 8% to 9% is what we're seeing here on the sheet commercial auto is 8.5% or more. And that's a U.S. business that I'm telling you about. So I think in the second word, call it 8% to 9% on casualty.
David Montemaden: Got it. And those did tick up versus 1Q, it sounds like?
Douglas Howell: Yes.
J. Patrick Gallagher, Jr.: A little bit.
Douglas Howell: Yes. Especially commercial auto its more around six and now its 10.5.
David Montemaden: Got it. And then, could you just level set me, if I think about full year, the business that Gallagher rates in brokerage. How much of that is coming from property at this point?
J. Patrick Gallagher, Jr.: Properties is our largest line. Doug, will give that number.
Douglas Howell: What was the specific question?
J. Patrick Gallagher, Jr.: How much of our business is property?
Douglas Howell: About 30% here for the full year 2022. That's about 30% of what we write.
David Montemaden: Great, thank you.
J. Patrick Gallagher, Jr.: Thanks, David.
Operator: Our next question is from the line of Mark Hughes with Truist Securities. Please proceed with your question.
Mark Hughes: Yes, thanks. Good afternoon.
Douglas Howell: Hi, Mark.
Mark Hughes: Pat, you talked about medical inflation. You think it's going to accelerate. Given that the broader measures of medical costs are pretty calm these days. I wonder what gives you confidence that that's going to happen?
Douglas Howell: I don't know if I'd say it's confidence, Mark. I mean, I'm not so sure it's good news for this society or for our clients. But social inflation, medical practice cost cover, and any kind of losses in that regard in the cost of employees. And you take your hospitals right now are working very hard to make sure that their people stay with them. Their turnover rates with the pandemic and the like have increased. Keeping their employees is a big deal. And the cost are doing that.
Mark Hughes: Specialty drug.
J. Patrick Gallagher, Jr.: No, on specialty builds helping me out here, specialty drug costs and procedures are up significantly.
Mark Hughes: Understood. Thank you very much.
J. Patrick Gallagher, Jr.: Thanks, Mark.
Operator: The next question is from the line of Katie Saki with Autonomous Research.. Please proceed with your question.
Katie Saki: Hi, Thanks. Good evening. I want to follow-up a little bit on the line of questioning on the Buck. And clearly an acquisition that definitely expands here. Ability to serve your clients from this portfolio. Kind of thinking about what you guys have seen in the first quarter of integration so far. Is there any opportunity to tighten up the drive or the impact that Buck has on brokerage margins over the back half of the year? Any opportunity you guys are seeing to increase cross sells or maybe find some expense synergies. Or should we kind of expect that to materialize more in 2024?
J. Patrick Gallagher, Jr.: I think it's more 2024, Doug?
Douglas Howell: Yes. I would say 2024 and 2023, we're still getting our feet under it. But also I'd like to have a friendly amendment to the statement. So that roll in natural impact of a business, it just run naturally slightly lower margins. Call it in the 20s somewhere versus in the 30s, right? So the drag on us is what you see on the face of it. But they actually have a nice improvement opportunities as we join forces together to get better themselves. And that's really what we're looking at. If we can take this business that's in the upper teens and move it into the mid 20s. I think that's a good march for that business. And I think cut that at best. They've wrote to five different owners. They have spent so much of their time and in the last couple of recent roles of becoming a free standing independent organization. And there's extra conflict goes into that. By being a part of us and us being better together, I think we'll naturally see that natural improvement in their underlying margins. So they should be margin creative after you get to, as they improve their margins, they will improve our margins once we get through the first quarter of 2024.
J. Patrick Gallagher, Jr.: And then, Katie to your point about cross selling, maybe cleared. We do see cross selling opportunities, PC to benefits, benefits PC for sure. But what we see -- we're very excited about is cross selling inside Gallagher benefit services. Their strength in the United States is in areas that we're not as strong. We've always been in defined benefit pension consulting for instance, but they come with terrific strengths there. And they're not probably as strong, although they do quite well, but not probably as strong as we've been in health and welfare. So if you take a look at that, now you're not trying to talk to a new party, add a client. You're already dealing with the person who buys benefits. Let me bring in my partner who does health and welfare, and we're already seeing a lot of that. So I think there is good cross selling. I think that margin improvement will come, and I'm excited about it.
Katie Saki: Thank you so much. And then, one more question on the outlook for risk management. Oh, sorry, just one more question on risk management. Doug, your comments seem to imply a little bit of a sequential slow down in organic on the back half of the year, adjusting for lapping last year exceptional out performance. I'm just kind of curious, is there anything you'd call out on that 14% and 10% organic gross guide that might be a slight headwind to gross as a year wraps up?
Douglas Howell: The nature of this business, if you look at it over the last 20 years is that you can get some pretty large clients that roll into your business. And they don't come as steady as let's say, a smaller client might do. So if you sell the likes of large U.S. corporation acts and you sell them in the fourth quarter last year, you're going to get to benefit in fourth quarter, first second third and you got to lap yourself in the fourth. So it's more the timing of new business on larger accounts that's causing that. But if you stack it up, 18% this quarter and if you think 14% and 10%. When you get down to the end of the year, you're talking some nice one of the 13% organic growth in that business. And then we do have some nice larger clients on the drawing board right now that we're proposing on. I don't know if they'll hit in the fourth quarter or they'll hit in the second or third quarter, it takes a year or two to sell these larger accounts. So it's just a little bit more naturally lumpy on a quarter-by-quarter basis. So I would encourage you to look at it on an annual basis. And if you think about what they did last year and then you're looking at this year at 13%, there's actually a sequential step up on an annual basis.
Katie Saki: Great. Thanks for your insights.
J. Patrick Gallagher, Jr.: Thanks Katie.
Operator: Our next question comes from the line of Meyer Shields with KVW. Please proceed with your questions.
J. Patrick Gallagher, Jr.: You out there, Meyer.
Meyer Shields: Sorry, it’s unmute. Can I connect there?
J. Patrick Gallagher, Jr.: Oh, there you go. Yes, you're coming through now.
Meyer Shields: Okay, yes, well, I probably do better on unmute. Same question from two perspective. Are your clients dealing with affordability issues in a maximum that in the context of what you said about pricing legitimately needing to go up. And I'm wondering how much of that is in client? How much more of that can client take? Is that going to shift sort of the revenue that you get from commissions as opposed to cash advantage or something like that?
J. Patrick Gallagher, Jr.: Yes. And that's one of the things that gets us excited, because that's the genesis of our growth. That's what took us to a place where we could get public in 84. We are the people that help folks deal with untenable situations and turn them basically into risk management approaches. It's called larger tensions. We do that in a number of ways, whether it's by-line by state, whether it's by putting someone into a self-captive, whether it's just finding them a pool to be part of, that is a real defining aspect of Gallagher's capabilities. Do you know that?
Meyer Shields: Okay. Yes, I know that its excellent at this point. I'm trying to digest the idea of how much more insured and pay. I'm just trying to get my head around that, which maybe at all with what underwriters actually need for rate.
Douglas Howell: I think we have to look at it this way. What percentage of customers budget really is spend on insurance? And let's say some of the averages are 3%, 4%, 5% of what their total budget they're spending on insurance. So this isn't 30% of their cost structure So how much more can customers take in terms of this? Our job is to make that a small as possible. Let's never forget that. That's what we do day in and day out. But how much more can they take? Well, if their loss experience is bad, they're going to have to take some more.
J. Patrick Gallagher, Jr.: Well, also, remember, this is not anti-underwriter. Underwriters are happy to have a self-clients move away from loss to them. If there's more self-assumption and they pick up an excess placement at the right rate, they're happy. It's not like they sell, my god, you ripped all this premium away from me. They understand the partnership. So we're counseling on, look, take more rate, make it easier for that carrier to participate in this at the right place on the coverage map. And we'll be able to get the limits you want if you got to take more skin in the game. That's all. And that I think is what we do better than anybody.
Meyer Shields: Okay, that's tremendously helpful. The same question on the re-insurance side. We've got property rates going up pretty dramatically. Is Gallagher telling its property clients that they should be buying more reinsurance in 2024 than they did in 2023?
J. Patrick Gallagher, Jr.: I'd say, what I'm impressed with our reinsurance people and it's way more sophisticated than I am frankly. But they are the best in the world of capital management with their clients. And this isn't a matter of us going in and talking to the local contractors that doesn't know what I'm going to do with a big time property increase or something like that. These are sophisticated buyers. They see it coming, they know how to balance their portfolio. And really, the advice Gallagher Re gives is not just buy it. And it's all about and again, I mean, this is one of the things that's exciting to me in terms of my learnings with Gallagher is that they are right at the crux of helping these clients manage their capital.
Meyer Shields: Okay. And then one of the final question if I can. Just could you talk about medical cost inflation. Is the medical cost inflation that you're anticipating on the college consulting side. Is that manifesting itself at all in worker's competition claimed to Gallagher Bassett processing?
J. Patrick Gallagher, Jr.: Sure, absolutely. I mean, a big part of workers' cap is medical only. That's escalating every month.
Meyer Shields: Okay.
Douglas Howell: Our job to helped mitigate that just like we do on the employee benefit side. Use of managed care is very, very important. You'll put a better growth in expert adjusting in at services in Gallagher Bassett that is medical cost inflation hits that too. Clients will look to a Gallagher Bassett to help them reduce their total cost of risk. And when medical inflation goes up, they will be clamoring for Gallagher Bassett services.
J. Patrick Gallagher, Jr.: And that's part of making sure we deliver the best outcomes.
Meyer Shields: No, absolutely. I'm just wondering why the workers come take some joy right. I'm just going to end. If this has been tremendously helpful.
Operator: Thanks Meyer.
Operator: Thank you. Our final question is from the line of Michael Ward of Citi. Please proceed with your question.
Michael Ward: Hey, guys. Thank you. I was just wondering on the M&A pipeline that you're talking about from the beginning. Is that -- would you say that's skewed to P&C, or could there be employee benefits in there too?
J. Patrick Gallagher, Jr.: Oh, there'll be both. Yes, we keep a good strong pipeline on both. Now, we're not going to have another Buck on that list. I mean, Buck is one of the biggest players in that industry. Clearly moves us up in the ranking, substantially, but there are plenty of smaller practitioners. We'd love to have on board. Our tuck-in acquisition process has been benefits forever, along with P&C. So that's not a new thing. And there's lots of activity in that regard.
Douglas Howell: Yes, I think fundamentally, any smaller brokerage business that finds that they need more capabilities, whether it's P&C or benefits, it's the same decision by the owners of those businesses that they just think that they can use, join us together when we better as we serve as those clients and the capabilities they can get from us, they'll get it from whether it's wholesale, whether it's retail, whether it's benefit, even in Gallagher Bassett, they have especially acquisitions there. If it's -- as the owners, it's the same reason they're selling themselves is because they need capabilities, and they think Gallagher is the right place to get those capabilities.
Michael Ward: Great. That's helpful. Thank you. And then maybe in terms of internally, in terms of your own wage sort of inflation monitoring, just curious if that has calmed down a little bit as inflation overall has slowed down?
Douglas Howell: Yes. Here's the thing. We didn't see the great resignation that you read about in the papers. We talked about that quite a bit. We were very fair with our employees on the amount of raise pools that we've given those raised pools are larger in 2022 and 2023 than they were in 2018 and 2019 on a per employee basis. So we've recognized that there are some costs that our employees have to bear, and so we think that the raises we've given them have been very fair and have acknowledged the inflation and the environment. We haven't really sat down to plan for next year yet to see where we'd be in those raised pools, but obviously we'd be fair with our folks. But as you see, some of the inflation numbers are cooling down and what it costs to live. But by and large, I think that we've been very fair. Throughout our history, we have given raises every single year that I've been at Gallagher, and we recognize the importance of our employees to do that. So, we haven't seen a big stress on that.
Michael Ward: Awesome. Thank you guys.
J. Patrick Gallagher, Jr.: Thank you.
Operator: Thank you. Our next question is from the line of Scott Heleniak with RBC Capital Markets. Please proceed with your question.
Scott Heleniak: Yes. Just a quick question on the risk management side. Wondering if you could give a little detail on the claims count differences and changes, you've both claims count and severity and kind of what you're seeing versus either recent quarters or year-over-year, and I guess I'm more interested at. I know you touch on a little bit just on some of the casualty lines and workers comp and liability and kind of what you're seeing there in terms of the counts and the average claims size that you're handling at Gallagher Bassett?
Douglas Howell: All right. So three things on that. First, when you look at it, we were seeing more COVID claims last year and that's basically gone to very little at this point that we still grew through that. Kind of existing customers, we consider that the claims are rising for existing customers to be flat-ish, maybe out a little bit. Now that was a trend that we were seeing also when you go back pre-pandemic, because as workplaces get safer and safer, so we're really the success that you're seeing in the organic is really our new business and excellent retention. So that kind of tells you, flat-ish from existing customers growing through the loss of COVID claims and conservatively better new business and better retention. What are we seeing for severity within that severity is going up. There's no question on average. As a percentage, I don't know if it's 5% or 7%, but overall something like that.
Scott Heleniak: Okay. That's a helpful detail. And then just another question on the M&A pipeline since it was so significant compared to recent quarters. Just wanting if you can also just talk about or comment on how much of that is, how much of the trend you're seeing is international versus domestic. I'm not looking for a specific breakdown, but anything you can share there on, or you continue to look at a lot more international deals than you had over the past few years?
J. Patrick Gallagher, Jr.: Now international pipeline is pretty steady. The majority of what we're looking at as U.S. domestic.
Scott Heleniak: Okay. And then finally, any earlier read on to my renewal premium. I know it's probably a little bit early, but how that's comparing? Is it 12% or is it just too early on that?
Douglas Howell: Our July numbers are better than our June numbers. I looked at the overnight for last year and there is a noticeable difference. Now July's not over. A lot of your activity happens in the last week here, but right now our early reads month-over-month as well as another step up.
Scott Heleniak: Okay. Interesting. Great. Thanks for all the answers.
J. Patrick Gallagher, Jr.: You bet.
Operator: Thank you. The final question is follow-up from Weston Bloomer with UBS.
Weston Bloomer: Hey, thanks for taking my follow-up question. Are you guys closing with free cash flow was in the 2Q or any updates on the level maybe as a percent of revenue they're expecting for full year as you integrate Buck or given the strong 2Q?
Douglas Howell: Well 2Q is our notoriously smallest corners because that's when we pay out all of our incentive compensation. We pay that in April. So the 2Q is as our smallest. The second half of the year is the largest. As a percentage you all toil in that those numbers more than we do that's just not really how we look at it. The fact is our cash flows closely tracked to our EBITDA growth. As you know that that because of our tax credit. Our tax load is a percentage of our EBITDAC is usually somewhere in the 8% range. Our CapEx is pretty consistent with prior year, so you don't have a significant change in that. So the only thing that really kind of impacts our cash flows different than EBITDAC would be a little bit taxes, a little bit the little growth in CapEx and then obviously, we're paying integration costs some of those we'll throw out in cash too on that. But right now we track close -- our cash flows tracked very close to what our EBITDAC is. So the growth in the EBITDAC is pretty much so what you're going to see growth in our cash flows.
Weston Bloomer: Got it. Thanks. And then maybe ex integration cost is Buck, maybe cash flow neutral or maybe slightly cash flow negative just given the lower margin there?
Douglas Howell: Oh, it's cash flow positive. I mean, we're not spending that much that on integration on this acquisition. So I would say over three years I think we're going to spend $125 million something like that. And it throws off cash flows and that's what's about.
Weston Bloomer: Great. Thank you.
J. Patrick Gallagher, Jr.: Thanks for being with us this evening everybody. I really appreciate you joining us. I think you can probably tell that myself and the team are extremely pleased with our second quarter performance. We're reflecting on fully year 2023 financial outlook relative to our early thinking, it has improved on every measure. As we sit here today we remain very bullish on the second half. And most importantly to our more than 48,000 colleagues around the globe, thank you for all you do day in and a day out, I believe our continued financial success is a direct reflection of our people and our culture. Thank you very much. We look forward to speaking with you again at our IR Day in September. Thanks for being with us.
Operator: This does conclude today's conference call. You may now disconnect your line at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Companies Second Quarter 2023 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be opened for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call including answers given in response to questions may constitute forward looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward looking statements provided on this call. These forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward looking statements and risk factors sections contained in the company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thank you very much. Good afternoon, and thank you for joining us for our second quarter 2023 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had a fantastic second quarter. For our combined brokerage and risk management segments, we posted 20% revenue growth, 10.8% organic growth, and recall, we don't include interest income in our organic. If we did, our headline number would be 13.4% and over 14% if you levelized for last year's large life products sale. GAAP earnings per share of $1.48, adjusted earnings per share of $2.28, up 21% year-over-year, reported net earnings margin of 13.6%, adjusted EBITDAC margin of 30.4%, up 52 basis points. We also completed 15 mergers totaling $349 million of estimated annualized revenue. We had a terrific month to finish the quarter that fueled the upside versus our June IR Day view. I could not be more pleased with our second quarter performance and how our teams all around the globe continue to deliver incredible value for our clients. On a segment basis, let me give you some more detail on our second quarter performance starting with our brokerage segment. Reported revenue growth was 20%. Organic was 9.7% or 12.3% if we include interest income and about 13% when levelizing for the large life product sale. Acquisition rollover revenues were $151 million. Adjusted EBITDAC growth was 23% and we posted adjusted EBITDAC margin expansive expansion of about 50 basis points. Let me walk you around then Howell will provide some more detail commentary on our brokerage organic. Again, the following figures do not include interest income. Starting with our retail brokerage operations. Our US PC business posted 13% organic. New business production was up year over year while retention was similar to last year's second quarter. Our UK PC business posted 11% organic due to strong new business production. Canada was up 6% organically, reflecting solid new business, similar retention versus last year and continued that somewhat more modest renewal premium increases. Rounding out the retail PC business, our combined operations in Australia, New Zealand posted more than 10% organic. Core new business wins were excellent and renewal premium increases were ahead of second quarter 2022 levels. Our global employee benefit brokerage and consulting business posted organic of about 2%. That includes a three-point headwind from last year's life product sale. Excluding the tough compare, organic would have been about 5%, with core health and welfare up low single digits, and many of our consulting practice groups showed continued strength. Shifting to our reinsurance, wholesale, and specialty businesses, Gallagher Re posted 11% organic, another outstanding quarter by the team, building upon their excellent first quarter results. Replacement services, our U.S. wholesale operations posted organic of 10%. This includes 19% growth in open brokerage and about 6% organic in our MGA programs and binding businesses. And finally, UK specialty posted organic of 19%, benefiting from excellent new business production and fantastic retention and a firm rate environment. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Global second quarter renewal premiums, which include both rate and exposure changes, were up 12%. That's ahead of the 8% to 10% renewal premium change we were reporting throughout 2022 in the first quarter of 2023. Renewal premium increases were made broad-based and are up across all of our major geographies. We're also seeing increases across most product lines. Property is up more than 20%. General liability is up about 8%. Workers comp is up about 3%. Umbrella and package are up about 11%. And most lines are trending similar or higher relative to previous quarters with two exceptions. First is public company D&O, where renewal premiums are lower versus last year, and second, cyber, which has flattened down slightly year-over-year. But to put this all in perspective, these two lines combined represent around 5% of our year-to-date brokerage revenues and thus don't have much of an impact. So I believe the market continues to be rational, still pushing for rate where it's needed to generate an acceptable underwriting profit. Remember though, our job as brokers is to help our clients find the best coverage while mitigating price increases to ensure their risk management programs fit their budgets. So not all of these renewal premium increases show up in our organic. Shifting to the reinsurance market. Overall, the June and July reinsurance renewals resulted in similar outcomes to what we saw during January renewals with most global reinsurance lines continuing to harden. Property continues to experience the most hardening, especially cat exposed trees. Within the U.S., Florida property cat renewals were more orderly than January due to an early start and well-defined reinsurer appetites, regardless, price increases were in the 25% to 40% range, causing many seasons to increase their retentions. While property capacity isn't abundant, we ultimately were able to place risk for most all of our seasons. As for casualty reinsurance renewals, the second quarter showed more stable supply versus demand dynamics, resulting in price increases based on product or risk-specific factors. Looking forward, carriers are likely to continue their cautious underwriting posture given the frequency and severity of weather events, replacement cost increases and social inflation, all of which can impact current and prior accident year profitability. Add to that rising insurance costs, and it's easy to make the case for pricing increases on most lines to continue here in 2023 and perhaps throughout 2024. Despite these and other inflationary cost pressures, our customers' business activity remains strong. During the second quarter, our daily indications of client business showed positive endorsements and audits. These positive policy adjustments have continued thus far in July. At the same time, labor market imbalances remain. Recent data shows the U.S. unemployment rate declining, continued growth in non-farm payrolls and a very wide gap between the amount of job openings and the number of people unemployed and looking for work. And medical cost trends are on the rise. We anticipate these costs to accelerate into 2024 due to increased costs of services, more frequent high-dollar claims, and the impact of new therapies and specialty medications. So I see demand for our HR consulting and other benefits offerings remaining strong. So, when I bring this all together, as we sit here today, we are more confident with full-year brokerage organic in the 8% to 9% range. And with an excellent second quarter in the books, more towards the upper end of that range, posting that would be another fantastic year. Moving on to mergers and acquisitions. We had a very active second quarter. In addition to the Buck acquisition, which I will discuss in a moment, we completed 14 new tuck-in brokerage mergers. Combined, these 15 mergers represent about $349 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. Moving to the Buck merger, which was completed in early April. Our integration efforts have begun and the combined business is off to a great start. While it's still early, I'm extremely pleased with how the teams are working together and excited about our combined prospects. Looking ahead, we have a very strong merger pipeline, including nearly 55 term sheets signed or being prepared, representing more than $700 million of annualized revenue. We know that not all of these will ultimately close, but we believe we will get our fair share. Moving on to our risk management segment, Gallagher Bassett. Second quarter organic growth was 18.1% ahead of our expectations due to rising claim counts and continued growth from recent new business wins. These wins have been broad-based and across all of various client segments, including large corporate enterprises, public entities, insurance carriers, and captives. Growth in each of our client verticals is great affirmation in our ability to tailor our client offerings, utilize industry-leading technology, and ultimately deliver superior outcomes for clients across the globe. Second quarter adjusted EBITDAC margin of 19.4% was very strong and at the upper end of our June expectation. Looking forward, we see full year 2023 organic around 13% and adjusted EBITDAC margins pushing 20%. That would be another outstanding year. And I'll conclude with some comments regarding our Bedrock culture. This past quarter, I was on the road for a month, visiting employees around the globe, traveling to New Zealand, Ireland, the UK, and the Czech Republic. And I can say that our culture is thriving, which makes me incredibly proud. Some of those conversations included the more than 500 young people in our 58th class of the Gallagher Summer Internship. This rigorous two-month program is an essential investment in our future, ensuring our unique culture remains strong for years to come. As we continue welcoming new colleagues and merger partners into the Gallagher fold, I'm confident that each new addition will uphold the expertise, excellence, and ethical conduct that make Gallagher the name so trusted worldwide. And that is the Gallagher way. All right. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Pat. I'll walk through organic and margins by segment, including how we see the remainder of the year playing out. Then I'll provide some comments on our typical modeling helpers using the CFO commentary document that we post on our website. And I'll conclude my prepared remarks with a few comments on cash, M&A capacity, and capital management. Okay. Let's flip to page three of the earnings release. All-in brokerage organic of 9.7%. That would be 12.3% if we include interest income, and a little over 13% when further levelizing for last year's large live product sale. That's a bit better than what we forecasted at our IR Day in June due to a fantastic finish of the quarter across all of our divisions, especially U.S. retail and London specialty. You'll also see that contingents were up more than 20% organically. Probably a better way to look at it is in combination with supplementals, because contracts can flip from time-to-time. Together, up 12% is much more in line with our base commission and fee organic growth. So no matter which way you look at it, a fantastic organic growth quarter by the team. Looking forward, we see headline brokerage organic around 9% for third quarter and about 8% for fourth quarter. It's important to recall that fourth quarter will have a tough compare because in Q4 2022, we booked a change in estimate related to our 606 deferred revenue accounting. Controlling for that, fourth quarter 2023 organic would be towards 9%. We highlighted this matter last year and again at our June IR Day, so there's nothing new here, it's just a reminder as you update your models. With all that said, we remain bullish on our organic prospects for the second half. According, we now believe, full-year brokerage organic is looking like at the higher end of that 8% to 9% range. Again, these percentages do not include interest income. Flipping to page five of their earnings release to the brokerage segment adjusted EBITDAC table. We posted adjusted EBITDAC margin of 32.1% for the quarter. That's up about 50 basis points over second quarter 2022's FX adjusted margin. And that came in better than our June IR Day expectation of the expanding 10 basis points mostly due to the incremental organic growth. Looking at it like a bridge from Q to 2022, organic gave us 100 basis points of expansion. Incremental interest income gave us 90 basis points of margin expansion. The impact role of M&A, which is mostly Buck, uses about 80 basis points. And then we also made some incremental technology investments called out around $7 million and some continued inflation on T&E called out about $5 million, which in total used about 60 basis points. Follow that bridge and the math gets you close to that 50 basis points of FX adjusted expansion in the quarter. As for a margin outlook, we expect about 40 to 50 basis points of expansion for each of the next two quarters. For the -- so for the year, we are a bit more optimistic than our April and June views, and now see four year margin expansion of 30 to 40 basis points. Or that would be 70 to 90 basis points levelizing for the role and impact of Buck. Again, both those percentages or increases relative to prior year FX adjusted margins. We talked about that during our June IR Day when we provided a vignette on how to model margins. Let me give you 2022 margins, recomputed current FX levels for your starting points. In Q3, 2022, EBITDAC margins would have been around 31.7% versus 32.3% we reported. And as for fourth quarter 2022, not nearly as much impact, call it around 31.3%. So now if you move to the risk management segment and the organic table at the bottom of page five of the earnings release. Also, I had an excellent finish to the second quarter, 18.1% organic growth. As Pat mentioned, we continue to benefit from new business wins from the second half of 2022. Looking forward, we see organic in the third quarter on 14% and fourth quarter about 10% which reflects the lapping of last year's larger new business wins. As for margins, when you flip to page six and the adjusted margin EBITDAC table, risk management posted 19.4%. That was on the upper end of our 19% to 19.5% June expectation. Looking forward, we see margins above 19.5% in each of the last two quarters of 2023. So, full-year double digital organic and margins approaching 20%. That would lead to a record year for Gallagher Basset. Now, let's turn to page seven of the earnings release in the corporate segment short-cut table. In total, adjusted second quarter came and right at the midpoint of the range we provided during our June IR Day. Even though we did experience a further $5 million of FX related re-measurement head wins. That cost us a couple pennies in the quarter. Moving -- now, let's move to the CFO commentary document. On page three, you'll see most of the second quarter results were in line with our June commentary. And looking ahead, you'll see that we've updated our outlook to reflect current FX rates and provide our usual modeling helpers for the second half of the year. Moving to page four of the CFO commentary document and our corporate segment outlook for the second half, punch line here is not much change other than a modest weak corporate expense and interest in banking costs as we've assumed a slightly higher balance on our credit line giving our robust M&A activity. Then on page five of the CFO commentary, that shows our tax credit carry forwards. As of June 30, we have about $700 million, which will be used over the next few years and that sweetens our cash flow and helps us fund a future M&A. Shifting to rollover M&A revenues on page six of the CFO commentary document, $151 million in the quarter with Buck contributing nearly half of that. Remember, numbers in this table only include estimates for M&A closed through yesterday. So you need to make a pick for future M&A and you should also increase interest expense if you assume, we borrow for a portion of the purchase price. One other call out and that's back at the bottom of page three of the earnings release, we did use a higher than normal amount of stock for tax free exchange mergers this quarter. That can be a little lumpy, but we do like doing them. It's attractive to the sellers that are looking to defer the full tax consequence of selling the firm and it's also attractive to us because it fully aligns our new partners with our long-term shareholders. As for future M&A, we remain very well-positioned. At June 30, available cash on hand was more than $400 million. Our cash flows are strongest in the second half of the year and we have room for incremental borrowing all the while maintaining our strong investment grade ratings. We continue to see our full year 2023 M&A capacity upwards of $3 billion and another $3 billion or more in 2024 without using any equity. So another outstanding quarter by the team, from my position as CFO sitting halfway through the year, our full year 2023 outlook on all measures continues to improve, better organic, better margins, and a more robust M&A pipeline. Bottom line, we're in a great spot to deliver another record year financial performance. Okay, back to you Pat."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Doug. Operator, let's go ahead and open up for questions."
},
{
"speaker": "Operator",
"text": "Thank you. The call for now open for questions. [Operator Instructions] Now, our first question is coming from the line of Weston Bloomer with UBS. Please proceed with your questions."
},
{
"speaker": "Weston Bloomer",
"text": "Hi. Good evening. My first question, really good strong organic growth within brokerage and around 200 basis points of above what you'd said, I guess about a month ago. I was curious if you could spend on maybe what lines of businesses or geographies, or maybe whether supplementals or contingent that drove that out performance? Curious of what we can extrapolate for the back half of the year or what is about the nature?"
},
{
"speaker": "Douglas Howell",
"text": "Yes, I think extrapolating for the back half of the year, we feel that our look towards nine and then eight adjusted to nine for the second two quarters probably the best way to look at what we think for the rest of the year. The upside was due to U.S. and also U.K. specialty, they just had a terrific in the June. So, but we're seeing that across the globe, there is a noticeable uptick here in June of success on our sales. And our retention are good and there is some positive light movement in those numbers too."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Also, I would say, clients are getting pretty darn weary of a hard market and they're looking for good advice. And we're fine and great strong growth is in property casualty. The basic blocking and tackling, workers' comp areas that in the United States at least we stand and opportunity to stand really ahead and shoulders above our competition, especially with the little guys."
},
{
"speaker": "Weston Bloomer",
"text": "Great, thanks. And second question on M&A. I believe you said 55 term sheets for $700 million in revenue. If I kind of go back do my model. I believe that's 700's the highest I've seen maybe away from Gallagher Re. So could you maybe just expand, is there any shift in your M&A strategy or any like larger deals in the pipeline? Or could you maybe just expand on what you're seeing in the market more broadly as well?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "No I think that what we're seeing is, first of all, remember, we talked about this quite often. We don't have one individual out prospecting. And we've got dozens and dozens of people that have now done deals in our company. They are constantly talking to our competitors. The more deals we do, the more friends they have in the industry that they're telling it's working well, and they're pleased to be with us. And I think it's just a matter of straight-up blocking and tackling when it comes to the typical making calls, talking to people, renewing relationships we've had for years. And people get into a point where they're possibly ready to sell."
},
{
"speaker": "Douglas Howell",
"text": "Yes, I think they see our capabilities. And I think some of the appeal of maybe selling to a PE firm, there's some concern about that giving that increase in interest rates in the borrowing cost. There's been some stress on that side of the industry. And so, we're seeing that folks are really more interested in being with a strategic now than trying to sell into a PE roll-up."
},
{
"speaker": "Weston Bloomer",
"text": "Got it. Thanks. Yes. It was double-digit. I think $1 million in revenue per term. So I got a little excited there."
},
{
"speaker": "Douglas Howell",
"text": "Me too."
},
{
"speaker": "Weston Bloomer",
"text": "And then last one, just on fiduciary, you'd highlight around 90 bps benefiting the quarters. Is that roughly what you have baked into the back half of the year when we think about your guidance?"
},
{
"speaker": "Douglas Howell",
"text": "Yes, I think that this, I think the biggest job here in Q2, I think in the second half of the year you might see something like 70 basis points in the third quarter and it gives us maybe only 50 basis points of margin expansion in the fourth quarter just because rates have been popping up."
},
{
"speaker": "Weston Bloomer",
"text": "Great. Thank you."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks Weston."
},
{
"speaker": "Operator",
"text": "The next question comes from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good evening. My first question, Pat, I know when asked on your typically willing to provide a little bit of an outlook on how you're seeing things more than just the current year. So based on how you think about things right now, how do you think from a thing of the brokerage business from an organic growth perspective, how do you think 2024 shaping up?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Elyse, I think it's going to look a lot like 2023. I'm not seeing any hesitation of underwriters asking for rate. I do think the cycles have shifted. When you see cyber and D&O coming down, they probably are coming down and that's reasonable. Property through the roof is reasonable. What we're seeing in inflation in terms of lawsuit, social implications we're searching for. It's very, very troubling. And then you had inflation. We've been talking about inflation, and it's called now for over a year. And you look back in the reserves and inflation tips those into a very difficult spot. And you're not going to get those healthy in one year. So I feel very strong about. And I'll tell you, our insurance companies are very, our partners are very smart about their numbers. They know where they're making money, where they're not making money, and they're telling us what they need. So I don't see people backing off on that. No one's walking in saying, the gates are wide open, let's just get volume. It's a reasonable market that you can get deals done at a reasonable price. Our clients actually understand inflation. They're living with it across the board, and inflation is good for a broker, honestly. So I think next year looks very, very strong."
},
{
"speaker": "Elyse Greenspan",
"text": "And then Doug, I know, the bar was a little bit higher for the level of margin improvement this year, as 2024 looks like 2023 from an organic revenue growth perspective. Would we see more margin improvement next year at the same level of organic that we saw this year?"
},
{
"speaker": "Douglas Howell",
"text": "Well, I guess my reaction to that is going back, I think that you'd see some margin expansion at 6%. I don't know if you'd get it necessarily at 4%. I don't -- I think by the time you got up to 9%, it'd be better than 50 basis points of margin expansion. And we do have one more quarter of roll and impact of Buck that would, the underlying business would be going up, but that business runs a lower margin. So, depending on which question you're asking me, I would think that margin expansion in 2024 could be very similar to what we thought it'd be in this year. Give us six points of organic and there might be 40, 50 basis points, give us nine points of organic, you might get 75, 80 out of it."
},
{
"speaker": "Elyse Greenspan",
"text": "And then, when you're talking about price increases, are you making that comment on like a nominal basis or are you expecting that when you think about property casualty pricing over the balance of this year in 2024, that will continue to exceed loss trend?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Well, I think that's the battle isn't Elyse. I mean, the carriers are very much wanting and telling us they need that. So, yes, I think that would be the objective and we're finding that we can get it. So, I do think that they're going to look at loss trends and they're going to try to definitely keep the rate structure moving ahead of that."
},
{
"speaker": "Elyse Greenspan",
"text": "And one last one. Do you have some initial thoughts on what we could see from reinsurance pricing at January 1, 2024?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "No. It's too early for me to comment on that, Elyse. I think, we just finished July, not as bigger month, obviously, as January, but interesting that the pricing was still very, very, very firm. The market after January 1 had a time, better chance to settle down, look at their books to understand, January was a nightmare. So as we said in our prepared remarks, July was a little bit more orderly, but still difficult. So, give me another quarter on that one."
},
{
"speaker": "Elyse Greenspan",
"text": "Thank you."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Elyse."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mike Zaremski with BMO Capital Markets. Please just use your questions."
},
{
"speaker": "Mike Zaremski",
"text": "Hey, good afternoon. Investment income, is this the new run rate was better than expected or should we expected to take another like I guess, well, of course, the company's growing too?"
},
{
"speaker": "Douglas Howell",
"text": "Listen, I think the impact on our numbers, I think that it's actually will be the change in margin from investment income was 90 basis points. This quarter, we think it would be about 70 basis points in the third and about 50 basis points of margin expansion in the fourth. So, to me, I would say that the actual dollar amounts that you're seeing in the second quarter are not just similar to the dollar amounts that you would see in third and fourth quarter."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. And you guys are firing on all cylinders, I'm just trying to poke some holes here. Let's see if I can. So, I mean, just that will be realistic. U.K. inflation, the stats look like, it's high and there's wage pressures and some, at least slow in GDP outlook. How does your business look there -- has look there currently? Margin has been growing as much there, and any comments on that?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Our U.K. retail business is on fire, really on fire. And I give a lot of credit to the team on two ways. One, as you know, we've spent money there in terms of branding and we did not do that for years when we were putting together Giles, Oval, Heath. Those firms were trading under those names. We brought those together. We started talking about ourselves as Gallagher in the field. And our Rugby partnerships there and the efforts that we spent on branding had paid incredible dividends. And people know who we are now across the entire U.K. and our people are taking advantage of that. And I just visited in -- I was in our London offices for a good part of June. I was in Dublin in Belfast and I can just say this. There's a bounce in every retailer step. They're kicking ass, they're having fun and they're taking names and getting more business for next quarter."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. And just because Elyse asked for, I mean, I'm just going to sneak in a quick one. In terms of the pricing environment, taking a kind of a step up, how much do you think is due to the reinsurance cost trying to be passed through? And it sounds like you don't -- it sounds like it's not a big deal, because you're saying that next year could be similar to this year, so there wouldn't be a step down. But I'm curious if you think some of the momentum something on the reinsurance side?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Let's be clear. I'm saying that we're being told by our carrier CEOs that they have to cover their increasing cost base, that starts with inflation and their past reserves and, if you plan to rebuild a house for a million dollars two years ago, you're not going to spend a million dollars. So they are looking at those reserves. Then secondly, they're still in a process of making sure that we get our values right. These values haven't been touched for a decade. They haven't needed to be touched. So now you got a value increase. You've got exposure units growth. Then you add to that the cost of reinsurance, which is clearly a cost. They're not separating it out and telling our retail clients, well, this part is for reinsurance. They're say, look guys, on this line of cover, we need 25 points. Go get it. And that'll hold as long as we have to, in fact, do that to get the deal done. Now, remember, we are scouring the market for some little do-for-ten, because that's our job. But right now, there's no break in that."
},
{
"speaker": "Mike Zaremski",
"text": "Thank you."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Mike."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Greg Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Greg Peters",
"text": "Hey, good afternoon, Pat and Doug. Hey, I wanted just to have you for a moment talk about new business. Because when you look at the organic result, 10.8%. You look at renewal pricing 12%. When you went through a bunch of lines, Pat, where pricing was clearly double digit. And so, and you also made this comment about your clients having a budget. Just curious, how much of the growth organic is rate versus exposure, existing clients versus new business, and has that balance changed at all in the last year?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Let Doug talk about the actual numbers, because I'm more off the cuff. And then I'll come back in on how I see the market shaping. Go ahead Doug."
},
{
"speaker": "Douglas Howell",
"text": "So, Greg, our net new business versus loss business is up this year by two percentage points compared to where it was there. Rate is, then that's the total rate in exposure is up about a point and a half. So, you can see here that it's our net -- our increased new is actually up more than the impact from rate is up."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Now, let me add some color to that, Greg. Number one, we're doing a much better job, I think, than ever of measuring kind of this new business stuff that you're talking about. We know that our average production is actually increasing in the income. The commission income receiving on new business has moved up from, let's call it $50,000, $60,000 into closer to $175,000 to $100,000. That's per item as we start bringing it in. So we're actually finding those clients that have for a long time probably been pretty happy with either their local broker or their relationship with a larger broker giving us a chance and we're doing very, very well. We are a new business machine. And when I take a look at the percentage of trailing revenue that we try to accomplish every year in new business. Our goal has always been 15% of trailing. We're just about right there. And as our trailing revenue growth continues, that pushes us in terms of our goals for more new business. And we are right on track with that. And when you start having 15%, 16%, 13% of trailing in new business, as long as you continue those retention levels, 94, 95, et cetera, you're getting very, very nice. You're getting very nice upside."
},
{
"speaker": "Greg Peters",
"text": "Yes, that's good. Those are good numbers. I think I've opened up a can of worms, because we're going to want to start tracking the net new business wins you guys are posting on a quarterly basis."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I'll give you that. Go and ask."
},
{
"speaker": "Greg Peters",
"text": "Yes. In your comments, Pat, you also talked about on the theme of poking holes, right? You talked about the employee benefits business kind of stood out. That MGA business being low single-digit, mid single-digit type of organic. Maybe I don't want to call that an underperforming, but relative to the group, I guess it kind of is. So maybe you could spend a minute and talk about those two businesses, because you called them out in your comments?"
},
{
"speaker": "Douglas Howell",
"text": "Well, let's talk about the benefits business first. It's adjusted for the large life case 5%. I think that's pretty in line with maybe what some of the other brokers have talked about in their employee benefit space. So I wouldn't say it's necessarily out of whack compared to what's going on. That business right now doesn't have the lost cost increases that it's going to have. I think there's going to be medical inflation in that coming up. We're going to see on that a lot, but by and large, medical cost inflation does have an impact. When you go back to my early days here in 2003 through 2007, you were seeing medical loss inflation, cost inflation in the double digits, and that business was growing almost double digits also. So that will have an impact because you can't keep the inflation out of that space for too much longer. So that would happen. On the program business, you just understand in our case, there's some programs that if there's a change in the state or there's a change in the carrier appetite, sometimes that can cause a little bit of stress in that business. But still, being in those single digit organic ranges are still pretty damn good in this environment."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Yes. And let me add to that. Greg, right now, our clients are dealing with wage cost inflation as people say, look, I've got -- I'm having a hard time buying eggs. And they are not looking to be expanding benefit offerings. In fact, they're doing everything they can to mitigate increased costs and benefits, while at the same time being able to balance what they need to give their people in their regular income. While at the same time maintaining, as you know how difficult this is, their employee base. So it is a really tough time. And our consultants, our people are doing a great job. Outside of health and welfare, the effort in terms of our consulting business that the orders that are coming through are spectacular. So it's really a balance of all that. And I agree with Doug. I think that it's a matter of them trying to deal with inflation in the cost of the cover, inflation in their compensation costs for their people and doing everything. And that's where we make our living, its helping to mitigate that. Plan design change, getting that down. And then lastly, a lot of that, as you know, we do on a fee. So when you're facing compensation costs, inflation costs in the underlying purchase of health insurance, the last thing you're doing is giving GBS, a 10% rate increase. I think by -- I think getting five points is pretty damn good."
},
{
"speaker": "Greg Peters",
"text": "Fair enough. Just I know you provided some data. It's just the final question. I know you provided some data around Buck and the integration. That's a business that has had sort of a checkered past of success and maybe some challenges. Maybe spend a second. And this is my last question. Talking about the integration and why you think the outlook for that business is strong relative to its history?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I'll tell you what, I am really excited about that business. And I'm a quarter in, right. And we had our board meeting yesterday and the team that's involved in the integrating and the onboarding reporting out to our board as we do in our large deals every quarter. The synergies there -- first of all, the management team could not be more excited to be finding a home. They've been traded five times. Then that's part of what you're talking about, Greg. You wake up and your name is not changing, but the owners are changing and then you're changing it again. You don't know who's on first, who's on second. A big part of our effort of onboarding here has been to tell those people, look, you found your last place. Now let's go take care of clients. And there's nothing consultants like to hear more than that. So that has been a big message to them. And I spent time with those folks in the UK. I've spent time with them here. It's resonating. Our retention of people is outstanding. And the orders we're getting in one quarter are mind boggling. So I'm really -- then you add to that. We do think there's some great synergies there. And that's not cost takeouts. That's cross selling. Seeing some of that already. And I think it's going to be just fine. And I'm one quarter in."
},
{
"speaker": "Greg Peters",
"text": "Well, thank you for your answers and the answers make sense."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Greg."
},
{
"speaker": "Operator",
"text": "Our Next question is from the line of David Montemaden with Evercore ISI. Please proceed with your question."
},
{
"speaker": "David Montemaden",
"text": "Hey, thanks. I just wanted to follow-up just on the group benefits organic and just on the deceleration, which is still a 5% is good extra life sale comp. But that was down for seven in the first quarter. But it does sound like the acceleration is expected. Is that something, is it second half expectation? Or is that something you think will start to move up higher in 2024?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I wouldn't be modeling out, David, a huge acceleration there. I mean, I spent a lot of time with Doug on the street explaining why 3% organic was outstanding just a few years ago. Yes, there's all, I'm now looking it. I'm now looking at a business here that is accepting hard rates. Given the fact that there's big loss cost trends or reinsurance trends, these are people buying insurance and in many instances, not buying insurance, that's the biggest part of what we do is help people self fund. And that 5% growth is earned with a lot of discussion with a client. It's more akin to what Gallagher Bassett's getting in terms of their renewal increases rather than what you look at on the PC side. So I'm very happy at 5%. I don't want to give you this idea that you're going to see some acceleration to 12%. That's not happening."
},
{
"speaker": "Douglas Howell",
"text": "That business also can be heavily first quarter weighted. So you get a little bit of that, not only you have to recognize the full year of an account that you sell on the health and welfare side, but the consulting in the first quarter tends to be a little heavier or a little --you grow a little bit more than -- because if you think about it, most people are one-one type benefit customers. So they're putting the final touches on their business in January on some of the programs. So we tend to make a little bit more money in the first quarter."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Can I answer an underlying question I hear from you, David, and the others. Why do we do the buck deal? It looks like its growth isn't great, doesn't have the margins that a PC broker does. You realize where the pain is for our clients right now and what we are is pain mitigation people. And it's sure it's in property, casualty, its specialty property. And we're out there working every day to help them get that down. We're bringing self-insurance plans, captive plans, group plans, what we can on the PC side. And every year, year and out, our clients are dealing with how do we get people? How do we keep them? How do we pay them? And how do we motivate them and at the same time take care of their benefits needs. And to get a firm like Buck on our team, when it absolutely recognized as the best in the business. I mean, it puts us over the top and that ability to respond to our clients needs across all of what we do for them. And I think 5% is outstanding. I want to tell the team, congratulations."
},
{
"speaker": "David Montemaden",
"text": "No, thanks. I appreciate that. That's helpful, Pat. And I guess just maybe just switching gears just on the property casualty rating increases. You gave some numbers earlier. I missed some of them. I was hoping you could talk a little bit about what you're seeing specifically on casualty rates. And it sounds like we're seeing an acceleration there. If I just strip out D&O and workers comp. But I'm wondering if that is in fact what you guys are seeing and how sustainable you guys think those -- that acceleration is?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "What I've said in my prepared remarks, David, is the general liabilities of about eight. Workers comp, which has been flat to down for a number of years is up about three. And umbrella and package you're up about 11. So now, embedded in each of those lines have different reasons. General liability is social inflation, probably aging population. Workers comp is clearly, it floats with medical costs and it floats with employment. An umbrella and package is probably also looking at social inflation and property up 20% is clearly -- that's about exposure units and the need for rate."
},
{
"speaker": "Douglas Howell",
"text": "Yes. David, when I look at it, you want to break it on general liability umbrella of other casualty call that 8% to 9% is what we're seeing here on the sheet commercial auto is 8.5% or more. And that's a U.S. business that I'm telling you about. So I think in the second word, call it 8% to 9% on casualty."
},
{
"speaker": "David Montemaden",
"text": "Got it. And those did tick up versus 1Q, it sounds like?"
},
{
"speaker": "Douglas Howell",
"text": "Yes."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "A little bit."
},
{
"speaker": "Douglas Howell",
"text": "Yes. Especially commercial auto its more around six and now its 10.5."
},
{
"speaker": "David Montemaden",
"text": "Got it. And then, could you just level set me, if I think about full year, the business that Gallagher rates in brokerage. How much of that is coming from property at this point?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Properties is our largest line. Doug, will give that number."
},
{
"speaker": "Douglas Howell",
"text": "What was the specific question?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "How much of our business is property?"
},
{
"speaker": "Douglas Howell",
"text": "About 30% here for the full year 2022. That's about 30% of what we write."
},
{
"speaker": "David Montemaden",
"text": "Great, thank you."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Mark Hughes with Truist Securities. Please proceed with your question."
},
{
"speaker": "Mark Hughes",
"text": "Yes, thanks. Good afternoon."
},
{
"speaker": "Douglas Howell",
"text": "Hi, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Pat, you talked about medical inflation. You think it's going to accelerate. Given that the broader measures of medical costs are pretty calm these days. I wonder what gives you confidence that that's going to happen?"
},
{
"speaker": "Douglas Howell",
"text": "I don't know if I'd say it's confidence, Mark. I mean, I'm not so sure it's good news for this society or for our clients. But social inflation, medical practice cost cover, and any kind of losses in that regard in the cost of employees. And you take your hospitals right now are working very hard to make sure that their people stay with them. Their turnover rates with the pandemic and the like have increased. Keeping their employees is a big deal. And the cost are doing that."
},
{
"speaker": "Mark Hughes",
"text": "Specialty drug."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "No, on specialty builds helping me out here, specialty drug costs and procedures are up significantly."
},
{
"speaker": "Mark Hughes",
"text": "Understood. Thank you very much."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Mark."
},
{
"speaker": "Operator",
"text": "The next question is from the line of Katie Saki with Autonomous Research.. Please proceed with your question."
},
{
"speaker": "Katie Saki",
"text": "Hi, Thanks. Good evening. I want to follow-up a little bit on the line of questioning on the Buck. And clearly an acquisition that definitely expands here. Ability to serve your clients from this portfolio. Kind of thinking about what you guys have seen in the first quarter of integration so far. Is there any opportunity to tighten up the drive or the impact that Buck has on brokerage margins over the back half of the year? Any opportunity you guys are seeing to increase cross sells or maybe find some expense synergies. Or should we kind of expect that to materialize more in 2024?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I think it's more 2024, Doug?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. I would say 2024 and 2023, we're still getting our feet under it. But also I'd like to have a friendly amendment to the statement. So that roll in natural impact of a business, it just run naturally slightly lower margins. Call it in the 20s somewhere versus in the 30s, right? So the drag on us is what you see on the face of it. But they actually have a nice improvement opportunities as we join forces together to get better themselves. And that's really what we're looking at. If we can take this business that's in the upper teens and move it into the mid 20s. I think that's a good march for that business. And I think cut that at best. They've wrote to five different owners. They have spent so much of their time and in the last couple of recent roles of becoming a free standing independent organization. And there's extra conflict goes into that. By being a part of us and us being better together, I think we'll naturally see that natural improvement in their underlying margins. So they should be margin creative after you get to, as they improve their margins, they will improve our margins once we get through the first quarter of 2024."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "And then, Katie to your point about cross selling, maybe cleared. We do see cross selling opportunities, PC to benefits, benefits PC for sure. But what we see -- we're very excited about is cross selling inside Gallagher benefit services. Their strength in the United States is in areas that we're not as strong. We've always been in defined benefit pension consulting for instance, but they come with terrific strengths there. And they're not probably as strong, although they do quite well, but not probably as strong as we've been in health and welfare. So if you take a look at that, now you're not trying to talk to a new party, add a client. You're already dealing with the person who buys benefits. Let me bring in my partner who does health and welfare, and we're already seeing a lot of that. So I think there is good cross selling. I think that margin improvement will come, and I'm excited about it."
},
{
"speaker": "Katie Saki",
"text": "Thank you so much. And then, one more question on the outlook for risk management. Oh, sorry, just one more question on risk management. Doug, your comments seem to imply a little bit of a sequential slow down in organic on the back half of the year, adjusting for lapping last year exceptional out performance. I'm just kind of curious, is there anything you'd call out on that 14% and 10% organic gross guide that might be a slight headwind to gross as a year wraps up?"
},
{
"speaker": "Douglas Howell",
"text": "The nature of this business, if you look at it over the last 20 years is that you can get some pretty large clients that roll into your business. And they don't come as steady as let's say, a smaller client might do. So if you sell the likes of large U.S. corporation acts and you sell them in the fourth quarter last year, you're going to get to benefit in fourth quarter, first second third and you got to lap yourself in the fourth. So it's more the timing of new business on larger accounts that's causing that. But if you stack it up, 18% this quarter and if you think 14% and 10%. When you get down to the end of the year, you're talking some nice one of the 13% organic growth in that business. And then we do have some nice larger clients on the drawing board right now that we're proposing on. I don't know if they'll hit in the fourth quarter or they'll hit in the second or third quarter, it takes a year or two to sell these larger accounts. So it's just a little bit more naturally lumpy on a quarter-by-quarter basis. So I would encourage you to look at it on an annual basis. And if you think about what they did last year and then you're looking at this year at 13%, there's actually a sequential step up on an annual basis."
},
{
"speaker": "Katie Saki",
"text": "Great. Thanks for your insights."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks Katie."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Meyer Shields with KVW. Please proceed with your questions."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "You out there, Meyer."
},
{
"speaker": "Meyer Shields",
"text": "Sorry, it’s unmute. Can I connect there?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Oh, there you go. Yes, you're coming through now."
},
{
"speaker": "Meyer Shields",
"text": "Okay, yes, well, I probably do better on unmute. Same question from two perspective. Are your clients dealing with affordability issues in a maximum that in the context of what you said about pricing legitimately needing to go up. And I'm wondering how much of that is in client? How much more of that can client take? Is that going to shift sort of the revenue that you get from commissions as opposed to cash advantage or something like that?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Yes. And that's one of the things that gets us excited, because that's the genesis of our growth. That's what took us to a place where we could get public in 84. We are the people that help folks deal with untenable situations and turn them basically into risk management approaches. It's called larger tensions. We do that in a number of ways, whether it's by-line by state, whether it's by putting someone into a self-captive, whether it's just finding them a pool to be part of, that is a real defining aspect of Gallagher's capabilities. Do you know that?"
},
{
"speaker": "Meyer Shields",
"text": "Okay. Yes, I know that its excellent at this point. I'm trying to digest the idea of how much more insured and pay. I'm just trying to get my head around that, which maybe at all with what underwriters actually need for rate."
},
{
"speaker": "Douglas Howell",
"text": "I think we have to look at it this way. What percentage of customers budget really is spend on insurance? And let's say some of the averages are 3%, 4%, 5% of what their total budget they're spending on insurance. So this isn't 30% of their cost structure So how much more can customers take in terms of this? Our job is to make that a small as possible. Let's never forget that. That's what we do day in and day out. But how much more can they take? Well, if their loss experience is bad, they're going to have to take some more."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Well, also, remember, this is not anti-underwriter. Underwriters are happy to have a self-clients move away from loss to them. If there's more self-assumption and they pick up an excess placement at the right rate, they're happy. It's not like they sell, my god, you ripped all this premium away from me. They understand the partnership. So we're counseling on, look, take more rate, make it easier for that carrier to participate in this at the right place on the coverage map. And we'll be able to get the limits you want if you got to take more skin in the game. That's all. And that I think is what we do better than anybody."
},
{
"speaker": "Meyer Shields",
"text": "Okay, that's tremendously helpful. The same question on the re-insurance side. We've got property rates going up pretty dramatically. Is Gallagher telling its property clients that they should be buying more reinsurance in 2024 than they did in 2023?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I'd say, what I'm impressed with our reinsurance people and it's way more sophisticated than I am frankly. But they are the best in the world of capital management with their clients. And this isn't a matter of us going in and talking to the local contractors that doesn't know what I'm going to do with a big time property increase or something like that. These are sophisticated buyers. They see it coming, they know how to balance their portfolio. And really, the advice Gallagher Re gives is not just buy it. And it's all about and again, I mean, this is one of the things that's exciting to me in terms of my learnings with Gallagher is that they are right at the crux of helping these clients manage their capital."
},
{
"speaker": "Meyer Shields",
"text": "Okay. And then one of the final question if I can. Just could you talk about medical cost inflation. Is the medical cost inflation that you're anticipating on the college consulting side. Is that manifesting itself at all in worker's competition claimed to Gallagher Bassett processing?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Sure, absolutely. I mean, a big part of workers' cap is medical only. That's escalating every month."
},
{
"speaker": "Meyer Shields",
"text": "Okay."
},
{
"speaker": "Douglas Howell",
"text": "Our job to helped mitigate that just like we do on the employee benefit side. Use of managed care is very, very important. You'll put a better growth in expert adjusting in at services in Gallagher Bassett that is medical cost inflation hits that too. Clients will look to a Gallagher Bassett to help them reduce their total cost of risk. And when medical inflation goes up, they will be clamoring for Gallagher Bassett services."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "And that's part of making sure we deliver the best outcomes."
},
{
"speaker": "Meyer Shields",
"text": "No, absolutely. I'm just wondering why the workers come take some joy right. I'm just going to end. If this has been tremendously helpful."
},
{
"speaker": "Operator",
"text": "Thanks Meyer."
},
{
"speaker": "Operator",
"text": "Thank you. Our final question is from the line of Michael Ward of Citi. Please proceed with your question."
},
{
"speaker": "Michael Ward",
"text": "Hey, guys. Thank you. I was just wondering on the M&A pipeline that you're talking about from the beginning. Is that -- would you say that's skewed to P&C, or could there be employee benefits in there too?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Oh, there'll be both. Yes, we keep a good strong pipeline on both. Now, we're not going to have another Buck on that list. I mean, Buck is one of the biggest players in that industry. Clearly moves us up in the ranking, substantially, but there are plenty of smaller practitioners. We'd love to have on board. Our tuck-in acquisition process has been benefits forever, along with P&C. So that's not a new thing. And there's lots of activity in that regard."
},
{
"speaker": "Douglas Howell",
"text": "Yes, I think fundamentally, any smaller brokerage business that finds that they need more capabilities, whether it's P&C or benefits, it's the same decision by the owners of those businesses that they just think that they can use, join us together when we better as we serve as those clients and the capabilities they can get from us, they'll get it from whether it's wholesale, whether it's retail, whether it's benefit, even in Gallagher Bassett, they have especially acquisitions there. If it's -- as the owners, it's the same reason they're selling themselves is because they need capabilities, and they think Gallagher is the right place to get those capabilities."
},
{
"speaker": "Michael Ward",
"text": "Great. That's helpful. Thank you. And then maybe in terms of internally, in terms of your own wage sort of inflation monitoring, just curious if that has calmed down a little bit as inflation overall has slowed down?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. Here's the thing. We didn't see the great resignation that you read about in the papers. We talked about that quite a bit. We were very fair with our employees on the amount of raise pools that we've given those raised pools are larger in 2022 and 2023 than they were in 2018 and 2019 on a per employee basis. So we've recognized that there are some costs that our employees have to bear, and so we think that the raises we've given them have been very fair and have acknowledged the inflation and the environment. We haven't really sat down to plan for next year yet to see where we'd be in those raised pools, but obviously we'd be fair with our folks. But as you see, some of the inflation numbers are cooling down and what it costs to live. But by and large, I think that we've been very fair. Throughout our history, we have given raises every single year that I've been at Gallagher, and we recognize the importance of our employees to do that. So, we haven't seen a big stress on that."
},
{
"speaker": "Michael Ward",
"text": "Awesome. Thank you guys."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from the line of Scott Heleniak with RBC Capital Markets. Please proceed with your question."
},
{
"speaker": "Scott Heleniak",
"text": "Yes. Just a quick question on the risk management side. Wondering if you could give a little detail on the claims count differences and changes, you've both claims count and severity and kind of what you're seeing versus either recent quarters or year-over-year, and I guess I'm more interested at. I know you touch on a little bit just on some of the casualty lines and workers comp and liability and kind of what you're seeing there in terms of the counts and the average claims size that you're handling at Gallagher Bassett?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So three things on that. First, when you look at it, we were seeing more COVID claims last year and that's basically gone to very little at this point that we still grew through that. Kind of existing customers, we consider that the claims are rising for existing customers to be flat-ish, maybe out a little bit. Now that was a trend that we were seeing also when you go back pre-pandemic, because as workplaces get safer and safer, so we're really the success that you're seeing in the organic is really our new business and excellent retention. So that kind of tells you, flat-ish from existing customers growing through the loss of COVID claims and conservatively better new business and better retention. What are we seeing for severity within that severity is going up. There's no question on average. As a percentage, I don't know if it's 5% or 7%, but overall something like that."
},
{
"speaker": "Scott Heleniak",
"text": "Okay. That's a helpful detail. And then just another question on the M&A pipeline since it was so significant compared to recent quarters. Just wanting if you can also just talk about or comment on how much of that is, how much of the trend you're seeing is international versus domestic. I'm not looking for a specific breakdown, but anything you can share there on, or you continue to look at a lot more international deals than you had over the past few years?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Now international pipeline is pretty steady. The majority of what we're looking at as U.S. domestic."
},
{
"speaker": "Scott Heleniak",
"text": "Okay. And then finally, any earlier read on to my renewal premium. I know it's probably a little bit early, but how that's comparing? Is it 12% or is it just too early on that?"
},
{
"speaker": "Douglas Howell",
"text": "Our July numbers are better than our June numbers. I looked at the overnight for last year and there is a noticeable difference. Now July's not over. A lot of your activity happens in the last week here, but right now our early reads month-over-month as well as another step up."
},
{
"speaker": "Scott Heleniak",
"text": "Okay. Interesting. Great. Thanks for all the answers."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "You bet."
},
{
"speaker": "Operator",
"text": "Thank you. The final question is follow-up from Weston Bloomer with UBS."
},
{
"speaker": "Weston Bloomer",
"text": "Hey, thanks for taking my follow-up question. Are you guys closing with free cash flow was in the 2Q or any updates on the level maybe as a percent of revenue they're expecting for full year as you integrate Buck or given the strong 2Q?"
},
{
"speaker": "Douglas Howell",
"text": "Well 2Q is our notoriously smallest corners because that's when we pay out all of our incentive compensation. We pay that in April. So the 2Q is as our smallest. The second half of the year is the largest. As a percentage you all toil in that those numbers more than we do that's just not really how we look at it. The fact is our cash flows closely tracked to our EBITDA growth. As you know that that because of our tax credit. Our tax load is a percentage of our EBITDAC is usually somewhere in the 8% range. Our CapEx is pretty consistent with prior year, so you don't have a significant change in that. So the only thing that really kind of impacts our cash flows different than EBITDAC would be a little bit taxes, a little bit the little growth in CapEx and then obviously, we're paying integration costs some of those we'll throw out in cash too on that. But right now we track close -- our cash flows tracked very close to what our EBITDAC is. So the growth in the EBITDAC is pretty much so what you're going to see growth in our cash flows."
},
{
"speaker": "Weston Bloomer",
"text": "Got it. Thanks. And then maybe ex integration cost is Buck, maybe cash flow neutral or maybe slightly cash flow negative just given the lower margin there?"
},
{
"speaker": "Douglas Howell",
"text": "Oh, it's cash flow positive. I mean, we're not spending that much that on integration on this acquisition. So I would say over three years I think we're going to spend $125 million something like that. And it throws off cash flows and that's what's about."
},
{
"speaker": "Weston Bloomer",
"text": "Great. Thank you."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks for being with us this evening everybody. I really appreciate you joining us. I think you can probably tell that myself and the team are extremely pleased with our second quarter performance. We're reflecting on fully year 2023 financial outlook relative to our early thinking, it has improved on every measure. As we sit here today we remain very bullish on the second half. And most importantly to our more than 48,000 colleagues around the globe, thank you for all you do day in and a day out, I believe our continued financial success is a direct reflection of our people and our culture. Thank you very much. We look forward to speaking with you again at our IR Day in September. Thanks for being with us."
},
{
"speaker": "Operator",
"text": "This does conclude today's conference call. You may now disconnect your line at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 1 | 2,023 | 2023-04-27 08:00:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Companies First Quarter 2023 Earnings Conference Call. Our participants have been placed on a listen-only mode. Your lines will be opened for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call including answers given in response to questions may constitute forward looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward looking statements provided on this call. These forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward looking statements and risk factors sections contained in the company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the and relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
J. Patrick Gallagher, Jr.: Thank you very much. Good afternoon, and thank you for joining us for our first quarter 2023 earnings call. On the call for today is Doug Howell, our CFO as well as the heads of our operating divisions. We had an excellent first quarter to start the year. For our combined brokerage and risk management segments, we posted 12% growth in revenue, 9.7% organic growth. GAAP earnings per share of $2.52, adjusted earnings per share of $3.30 up 12% year-over-year. Reported net earnings margin of 21%, adjusted EBITDAC margin of 38% up 29 basis points. We also completed 10 mergers totaling $69 million of estimated annualized revenue and we are recognized as the world's most ethical company for the thirteenth time, an outstanding quarter from the team. Let me give you some more detail on our first quarter performance starting with our Brokerage segment. Reported revenue growth was 12%. Organic was 9.1%. Acquisition rollover revenues were $61 million. Adjusted EBITDAC growth was 15% and we posted adjusted EBITDAC margin of 40.4% right on our March IR Day expectations. A fantastic quarter for the brokerage team. Let me walk you around the world and provide some more detailed commentary on our brokerage organic. Starting with our retail brokerage operations. Our U.S. PC business posted over 7% organic. Core new business was up year-over-year, even growing over the tough renewal compare in D&O lines, while retention was similar to last year's first quarter. Our UK PC business also posted more than 7% organic due to strong new business production, stable retention and the continued impact of renewal premium increases. Our combined PC operations in Australia and New Zealand posted organic of 10%. Net new versus loss business was consistent with prior year and renewal premium increases were ahead of first quarter 2022 levels. Rounding out the retail PC business, Canada was up 6% organically reflecting solid new business and consistent year-over-year retention. Our global employee benefit brokerage and consulting business posted organic of nearly 7%. New business remains strong and client retention was excellent. We saw growth across many of our practice groups with particular strength in HR consulting and pharmacy benefits. Shifting to our wholesale and specialty businesses. Risk placement services, our U.S. Wholesale operations posted organic of nearly 8%. This includes 16% growth in open brokerage and about 5% organic in our MGA programs and binding businesses. New business production and retention were both consistent with last year's first quarter. UK specialty posted organic of 17% benefiting from a strong start within aviation and the addition of new teams focused on North American risks. And finally, reinsurance, Gallagher posted 12% organic reflecting new business wins, great retention and a hardening property reinsurance market. Outstanding results from the Gallagher Re team. Pulling it all together Brokerage segment all in organic of 9.1% that's a bit above the top end of our first quarter expectation and a fantastic sales quarter by the team. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Overall, global first quarter renewal premiums that's both rate and exposure combined were up more than 9% consistent with the 8% to 10% renewal premium change we had been reporting throughout 2022. Renewal premium increases remain broad based across nearly all of our major geographies and product lines around the globe. For example, workers' comp is up low single digits, general liabilities up mid to high single digits. Umbrella and package are up in the low double digits, so most lines are trending similar to previous quarters. Two exceptions. First, public D&O where renewal premiums are down a bit and second property, where renewal premium increases are accelerating. For example, fourth quarter property renewal premiums were up 15% and through the first three months of 2023, we have seen increases of 15%, 20%, and 17%, respectively. So, our clients continue to feel cost pressures here due to rising replacement values, increasing frequency and severity of weather related events and hard reinsurance conditions. We're not seeing signs that these lost costs and profitability pressures are likely to abate in the near term. So as we head to our largest primary insurance property quarter we are focused on helping our clients navigate and mitigate these premium increases. Moving to exposures. We are seeing continued strength in our customer's business activity. First quarter mid-term policy endorsements audits and cancellations combined were better than first quarter 2022 levels greater than the eighth consecutive quarter of year-over-year increases. Shifting to reinsurance. During the heavy Japan centric April renewals, reinsurance carriers continued to focus on increased pricing and tightening terms and conditions. This was across a broader range of territories and most all lines of business, so in even harder conditions compared to January 1. The casualty trading market saw orderly renewals and a sufficient supply of capital to fulfill the demand from underwriting enterprises. The property market continued to experience its recent challenges due to more limited underwriting capital. There were some green shoots in the ILS issuance, although pricing was typically less attractive to CDs than the traditional markets. Overall, there wasn't much new capacity entering the property market regardless, our teams navigated the hard market and customers again managed to secure satisfactory cover. Those interested in more detailed commentary can find our April first view market report at our website. Looking forward, there is good reason to expect a cautious underwriting stance from carriers for the foreseeable future as they contemplate recent weather events, replacement cost increases, social inflation and ongoing geopolitical tensions into their view of lost cost trend. So we expect insurance and reinsurance pricing increases to continue throughout 2023 and while it's early likely into 2024. We also remain optimistic on our customer's business activity during 2023. We have yet to see any significant shifts to daily indications of client, business activity thus far in April. We are also seeing encouraging employment levels for our benefits clients suggesting the economic backdrop for 2023 remains broadly favorable. Recent data shows the U. S. Unemployment rate declining. Continued growth in non-farm payrolls and a very wide gap between the amount of job openings and the number of people unemployed and looking for work. So I see demand for our products and services around attracting, retaining, and motivating workforces remaining strong. As we sit here today, we continue to see full-year 2023 brokerage segment organic in that 7% to 9% range and that would be another fantastic year. Moving on to mergers and acquisitions. We had an active first quarter completing 10 new tuck in brokerage mergers representing about $69 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. Also in April, we officially welcomed the former Buck colleagues, combined with our existing employee benefits brokerage and HR consulting business we will enhance our offerings and be better positioned to deliver superior human capital solutions for all of our clients. Moving to our pipeline, we have nearly 40 term sheets signed or being prepared representing more than $350 million of annualized revenue. Good firms always have a choice of who to partner with, and we'll be very excited if they choose to join Gallagher. Moving on to our Risk Management segment, Gallagher asset. First quarter organic growth was 14.3% ahead of our expectations due to continued growth from recent new business wins and some revenue from first quarter New Zealand cyclone and flooding. We also saw core new arising claims increase in the low single digits during the quarter for existing clients across both workers' comp and liability. First quarter adjusted EBITDAC margin was also strong at 19.2% ended up a bit ahead of our March expectations. Looking forward, we see full-year 2023 organic around 12% to 13% and adjusted EBITDAC margins holding up or above 19% and that would be another excellent year. And I'll conclude with some comments regarding our Bedrock culture. I'm very pleased that just a few weeks ago, we were recognized as the World's Most Ethical Companies for the thirteenth time. We're honored to be one of only 135 companies globally to receive this award from the Ethisphere Institute. Our 45,000 plus colleagues embrace and celebrate the unique values that we have instilled in our company. The 25 tenants articulated in the Gallagher way continue to drive our global team's success today and we believe that our unique culture is a key differentiator and a competitive advantage. It's a strong culture of client focus, excellence, and inclusion and it continues to drive us forward. That is the Gallagher way. Okay. I'll stop now and turn it over to Doug. Doug?
Douglas K. Howell: Thanks, Pat, and good afternoon everyone. As Pat said, an excellent start to the year. Today, I'll begin with some comments using both our earnings release and our CFO commentary document that we post on our website. I'll touch on organic margins and provide some modeling helpers for the remainder of 2023. Then I'll finish up with my typical comments in cash, M&A capacity and capital management. Okay. Let's flip to page 2 of the earnings release. All in brokerage organic of 9.1%. Call it right at the top end of the range we foreshadowed at our March 16th IR Day, a nice finish from our London specialty operations and a little upside from reinsurance benefits. One call out on that table. Contingence didn't grow organically this quarter for three reasons. First, there's a little geography between supplementals and contention call that about $2 million. Second, there was a bit of positive development in Q1 2022 from the prior year 2021 estimates. Call that $3 million and again, that's back in first quarter 2022, causing a little difficult compare. And third, we are not expecting one of our programs to pay as large of a contingent here in 2023 because of underlying loss ratio deterioration. Call that maybe towards a million. Regardless, base organic at 9.5% and all in at 9.1% that's a fantastic quarter by the team. Hoping to page 4 of the earnings release to the Brokerage segment adjusted EBITDAC table. We posted 40.4% for the quarter, before FX, that's up 56 basis points. And FX adjusted up 14 basis points over first quarter 2022. That's right in line with our March IR Day expectations when we discuss that first quarter 2022 expenses were lower than our expected run rate simply because we are still in the Omicron portion of the pandemic and that our tuck in acquisitions are just not as seasonally weighted. But they don't roll in at 40 points of margin here in the first quarter. If you levelize for those two items, our margins expanded approximately 110 basis points. Maybe looking at it like a bridge from first quarter 2022 will be helpful. Investment income gave us 90 basis points of margin expansion. The normalization of Omicron T&E expenses and inflation on all T&E costs us 80 basis points. The seasonal impact from rolling M&A uses about 40 basis points. Organic gave us 70 basis points of expansion and some additional wages and IT investments used about 25 basis points. Follow that bridge and the mass gets you close to that 14 basis points of FX adjusted expansion in the quarter. Looking forward, it's still early yet with a fantastic first quarter combined with pass up commentary makes us more bullish on hitting that full-year brokerage organic in the 7% to 9% range and posting adjusted margins up 60 basis points to 80 basis points. Two small heads up on that. First, getting to that 7% to 9% organic for the full-year might be a little lumpy over the next three quarters given the large life case we sold in Q2 2022. And then the 606 deferred revenue accounting in our fourth quarter. We discussed both of those with you last year, so there's no new news here. Just a reminder for your modeling. Second, the 60 to 80 basis points of margin expansion is before the roll in impact of Buck, which recall naturally runs lower margins. So when you include Buck, the math would show full year margin expansion in that 20 to 30 basis points range. So moving on to the Risk Management segment and the organic table at the bottom of page 4. As Pat said, an excellent quarter, 14.3% organic growth We did get a little tailwind this quarter because Omicron caused fewer claims arising in Q1 2022 and we also had some New Zealand [CAC] (ph) claims activity. But most of this excellent result comes from strong new business wins in the second half last year. As for margins, put to page 5 of the earnings release. Risk Management posted adjusted Q1 EBITDAC margins of 19.2%. That's up 177 basis points over last year. As we look forward, we're seeing the rest of the year organic in that 12% to 13% range and full-year margins now finishing a bit above 19%. That would be the best full-year adjusted margin in Gallagher asset six decade history. Another demonstration of the benefits of scale, intellectual capital, technology and operational excellence. Let's turn to page 6 of the earnings release. That's our Corporate segment and also, when you take a look at pages 3 and 4 of the CFO commentary document, most all of the items are right in line with our March IR Day forecast. Three callouts on the CFO commentary document. When you see Page 3, you'll see a slight tick up in our expected book effective tax rate. That's entirely due to the UK rate hike to 25% that went effective April 1st. But remember what you're seeing is a book effective tax rate. Our cash taxes paid rate is substantially lower. Call that around 10% of our adjusted combined brokerage and risk management EBITDAC. That's because of the tax shield from interest, the amortization of purchase intangibles and the incremental cash flows from our clean energy investments over the coming years. Page 5 of the CFO commentary shows those tax credits. We have over $700 million as of March 31st, and it shows that we're forecasting to use about a $180 million to $200 million in 2023 with a step up in 2024 in each later year. That's a really nice cash flow sweetener to help fund future M&A. Then if you flip back to page 4 of the CFO commentary document, you'll see that we had a slight beat on the Corporate segment this quarter compared to our midpoint, but some timing in that beat. So you'll see full-year still about the same as what we forecasted our March IR Day. Moving now to page 6 of the CFO commentary document, that table shows our rollover M&A revenues. It shows $61 million this quarter, which is pretty close to that $63 million we estimated during our March IR Day. And also looking forward, we've now included Buck in that table, but remember, you'll need to add your pick for other future M&A to these estimates. Let me move to some comments on cash, capital management and future M&A. At March 31, available cash on hand was around $1 billion, but note that about $600 million was used to buy Buck in early April. So call it $400 million. This means we estimate that we have about $2 billion more to fund M&A for the rest of this year and our early look is another $3 billion or more in 2024 usually to fund our M&A program, utilizing only free cash and incremental debt while maintaining our strong investment grade ratings. One final reminder, recall during our March IR Day, we mentioned that we would be reclassifying how we present fiduciary balances on our balance sheet and in our cash flow statement. These re-classes are purely GAAP geography, and we're doing so to better align our presentation with how many other brokers present their statements. You might notice some of that movement in the recast balance sheet on page 12 of their earnings release. To help you understand all of the movement there'll be a comprehensive table in our 10-Q that we will file later next week. Again, all of this is to make our presentation more consistent with most of the other public brokers and all of the changes just gap geography. So those are my comments. Another terrific quarter and looking forward, we see strong organic growth, a great pipeline of M&A and continued opportunities for productivity improvements, all fueled by an amazing culture. I believe we are very well positioned to deliver another fantastic year. Back to you, Pat.
J. Patrick Gallagher, Jr.: Thanks, Doug. Operator, I think we're ready for some questions, please.
Operator: Thank you. This call is now open for questions. [Operator Instructions]. Our first question is from Weston Bloomer with UBS. Please proceed with your question.
Weston Bloomer: Hi. Good afternoon. My first question is on the margin expansion you're expecting for full-year 2023. How should we think about the cadence of that margin expansion as we move through the year? I think you'd previously guide to 1Q being lower relative to 2Q and 4Qs. Is that still largely the case excluding Buck or can you just help us think about the moving pieces as we go through the year?
J. Patrick Gallagher, Jr.: Alright. So you're asking me about how do we fuel the margin extension quarter-to-quarter. Is that the question?
Weston Bloomer: Yeah. More or less, because you highlighted some of the lumpy nature in organic. I'm just kind of curious on how that plays out on the margin as well.
J. Patrick Gallagher, Jr.: Alright. Let me see if I can dig that out for you here. Should have it right here, and I apologize it's not quick on this. I think that -- stand by here. In the second quarter, I think that we'd probably have -- maybe the second and third quarter more flat and then a little bit more upside, maybe towards 30 basis points in the fourth quarter, I think, is what I'm looking at here.
Weston Bloomer: And is there any seasonality to Buck's margin as well?
J. Patrick Gallagher, Jr.: I'm sorry. Let me check that. I just looked at there are 9, I'm seeing probably 10 basis points of expansion in the second quarter, 20 in the third and maybe 20 in the fourth.
Weston Bloomer: Great. And does that include seasonality to Buck as well? I think you had previously said it was roughly run rate.
J. Patrick Gallagher, Jr.: That’s right. That includes Buck.
Weston Bloomer: Okay. Great. And can you can you give a sense to of how quickly Buck is growing? I see in the acquired revenue table that's, call it $77 million per quarter. I'm assuming that's including a few other deals in there, but I'm curious if that's assuming any growth for Buck or how quickly that business is currently growing?
Douglas K. Howell: Yeah. This is [Indiscernible]. Buck has been pretty stable across the country last year, across the world last year. They have very strong growth in the U.K. and then their engagement last communications business. They just finished Q1 with their best sales quarter in the last five years. We're already beginning to have a lot of revenue synergy discussions, very organic early stages, built a pretty strong pipeline. We're already going on in on deals together. It's a little early to give predictions on what this looks like, but we do expect them to have mid-single digit growth this year.
Weston Bloomer: Great. Thanks for taking my questions.
J. Patrick Gallagher, Jr.: Thanks, Weston.
Operator: Thank you. Our next question is from Elyse Greenspan with Wells Fargo. Please proceed with your question.
Elyse Greenspan: Hi. Thanks. Good evening. My first question, maybe I'm just confused. I thought you said Brokerage margin, can expand 50 basis points sorry, 60 basis points to 80 basis points for the year. But then in response to Weston's question, you were talking about 10 basis points to 30 basis points of expansion over the next few quarters.
Douglas K. Howell: All right. Question one is without the math that results from Buck because they run naturally lower margins. That was the question that we answered for, Weston. The 60 basis points to 80 basis points is how we're looking at Gallagher before Buck. Does that help?
Elyse Greenspan: Okay. Got it. Yes. That helps. Thank you. And then in terms of the organic outlook, still kind of keeping the 79% range for the year. Can you just give us a sense of what you're embedding in there for the economy as well as pricing when you think about or you're just expecting a general stable environment over the next few quarters compared to what we saw in the Q1.
J. Patrick Gallagher, Jr.: I think, Elyse, this is Pat. I think that we're just sort of predicting that it's a stable environment over the next three quarters. We're not seeing a lot of rate reduction. We are seeing continued, and by the way, I'd point out being a little proud about this. We've been the one saying we're not seeing recessionary pressure in the middle market by our clients around the United States in particular. Those businesses are continuing to grow and they are robust, even with the headwinds of higher interest rates and higher insurance costs. And those insurance costs are not backing off, and we can tell you this data day-to-day, line-by-line, geography-by-geography, country-by-country. So, I think that our commentary in our prepared remarks about it being a pretty firm market, looking like it's going to continue that way for all the reason we enumerated, we view it that same way over the next three quarters.
Elyse Greenspan: Thanks. That's helpful. And then you guys, I know right, the laws related to your clean energy investments right expired at the end of ‘21, and you guys have kind of I think, or kept some of the plants open. Is there still the potential that you guys could generate more tax credits there or have you kind of not expecting that at this point?
Douglas K. Howell: We're preserving all the machines that allow us to generate those tax credits if there's something that might come out of an energy bill or a tax reconciliation bill yet this year. Those plants could be put back into service.
Elyse Greenspan: Do you think there's a high probability that could happen?
Douglas K. Howell: Elyse, I don't know if there's a high probability of anything getting done in Washington. So I mean, that I would hope so, but I wouldn't put high probability on anything coming out of there. Yes, but if the plant sits there for another year, they sit there for another year.
Elyse Greenspan: Thanks for the color.
J. Patrick Gallagher, Jr.: Good. Thanks, Elyse.
Douglas K. Howell: Thanks, Elyse.
Operator: Thank you. Our next question is from Greg Peters with Raymond James. Please proceed with your question.
Greg Peters: Well, good afternoon, everyone.
J. Patrick Gallagher, Jr.: Hey, Greg.
Greg Peters: So, I think before I get into the results, I wanted to step back and just talk about talent recruiting and employee producer retention, and maybe if you could give us an update on how that's progressing inside Arthur J. Gallagher. And I guess in a parallel question, there was some recent announcements of promotions in the c-suite and, Pat, I don't think you, I think you have plenty of gas left in the tank, so maybe you could provide some context about some of those announcements as well.
J. Patrick Gallagher, Jr.: Well, let me address a couple things first, Greg, so first, our recruiting efforts are ongoing. We are always recruiting producers, excited about the fact that our 500 interns will begin showing up in a few weeks here, in the United States, if I look around the globe, it's probably more like 600 interns. As you well know, we recruit heavily from that group, and our consistency of retention there is very strong, and continues to be strong. So, we have a good pipeline and a good -- we do a good job of landing new producers, nothing to announce in the way of any more robust efforts in that regard than are normal. And so I think I feel really good about that. In terms of retention of producers, very, very, very strong retention, and I think that we offer a great place to acquire trade, and we pay people well to do that. We're still one of the places that believes in remunerating people for their growth in books. So, I feel good about our production recruits. I feel good about our new hires, and I feel very good about the retention level that we have with the people that are. As it relates to the article, which was not an announcement, I would just simply say that we don't make a lot of comments on news stories, Greg, and I think you know that. I'm the CEO, and I feel great. Thank you very much.
Greg Peters: I expected that kind of comment from you, so but thank you for validating it. I guess, my follow on question will deal with M&A. And I know you comment on this almost every quarter, but the interest rate environment has posed a changing landscape for M&A. We look at your multiples sits in the, Doug's CFO commentary tables, and it doesn't look like the multiples are changing much. Can you talk about how you view M&A at the current prices that are being in the marketplace? Do you think, you talk about the 40 term sheets or outstanding, it seems like you have 40 term sheets every quarter. But can you talk about, how the interest rate environment might change your perspective on what you're willing to pay?
J. Patrick Gallagher, Jr.: Yes. I will. First of all, let me put some color on that. If I read the business insurance article correctly about a week ago, I think M&A in the first quarter is down about 29%. That's after year-after-year-after-year, more PE entries, more deals being done it's, so I think we're seeing a slowdown in the number of transactions, which I do think reflects a slowdown in the number of new entrance. There are some -- there are some people who have been very active in the past that are less active now. At present, we're not seeing a big decrease in those multiples. If you had 20 people bidding on a property 18 months ago, you still have 11 today. And so, I do believe that, like anything, supply and demand, if that demand continues to decrease and interest rates are in some way impinging that capital, I think that you will see multiples come down, but they're not doing that right now.
Greg Peters: Got it. Thanks for the answers.
J. Patrick Gallagher, Jr.: Thanks, Greg.
Operator: Thank you. Our next question is from Mike Zaremski with BMO Capital Markets. Please proceed with your question.
Mike Zaremski: Hi, good afternoon. First question, in the prepared remarks, you talked about property rates accelerating. Any stats or any way we can dimension what percentage of your revenues on the Brokerage side, touch that element of acceleration and it doesn't seem like from your organic guide that you're taking in that acceleration continuing or maybe I'm incorrect?
Douglas K. Howell: Well, listen I can give you some percentage of our book, our property book we include package in there also is going to be somewhere around just doing the mental math here real quick, is around 27%, something like that of our first quarter, total revenues in the P&C units. One of the things that our guys do is there and we all do out there is pretty good at mitigating some of that rate increase. So, when you look at it, property rates are going up 17%, you might see commissions going up 10% or 11%, 12% something like that because you increase deductibles, you bring down limits, you come up some more creative programs in that. So, that is a line of business where the direct correlation between the premium increase and then the commissions that we get there's a delta there.
J. Patrick Gallagher, Jr.: I think that's a -- I'm piling in here. This is, Pat. That's a very, very good point. Every time in a firm market, we get that question. Rates are up on XYZ 12%. You're showing 6%. Why is that? Because our job is to not pass on the 12%, and we're good at that.
Mike Zaremski: Got it. Okay. That's -- and that thanks for the answer, Doug, that excludes reinsurance?
Douglas K. Howell: Yes. That's right. But most of our reinsurance are on renewal, so you've already seen that math.
Mike Zaremski: Got it. Okay. Follow-up investment income. Maybe I might have missed this, because I jumped on a minute late, but was there any help with if this is the right investment income run rate? I know that there might have been book sales in the number two. It looks like it was better than expected. I know there were some new -- there's some noise on the fiduciary balances too now. So, should you truly be thinking we need some help there?
Douglas K. Howell: All right. So, book sales would have been tiny. I think the total amount of book sales this quarter was about 200,000 bucks, something like that. So that wouldn't have influenced it in our numbers, at all. Our investment income on the face of the financial statements also includes our premium funding businesses. So, you will -- so that the amount of invest income that translates right into that number. Just take 90% of what you see as investment income and on the face and 90% of that is real, additional incremental investment income. When you look at what it means for the rest of the year, if you follow the interest rates through the big tick-up starting about last month last year, and so second half of the year, the increase in investment income is not as dramatic as it is here in the first quarter. So, if I were to look at full year impact of investment income on our organic lift, that would be about maybe 60 basis points for full year, 60 basis points of margin expansion from invest income for the full year. So, you can see here this quarter was up fueled about 90 basis points and for the full year it would be about 60 basis points to 70 basis points, something like that.
Mike Zaremski: Okay. Great. And maybe just, well, last quick one. Given how much improvement Gallagher has shown in its margins over the last few years. Is there a way to dimension what percentage of the deals you guys look at have a better margin profile than Gallagher, or should we expect there to, there to be up maybe similar like a Buck headwind sometimes going forward as you guys continue to do deals.
Douglas K. Howell: No. I think if you look at our pipeline and you project it, we would think that if I were standing in January of next year looking back, what's to be the impact of rolling M&A excluding Buck. So, all it might use about 10 basis points to 20 basis points of margin expansion. So, it has a significantly smaller impact on the full year because we're so seasonally large in the first quarter.
Mike Zaremski: Thank you.
Operator: [Operator Instructions]. Our next question is from David Montemaden with Evercore. Please proceed with your question.
David Montemaden: Hi. Thanks. I just had a question just on the margin. So, I've understand, Doug, so we got, the 90 basis point tailwind from fiduciary income here in the first quarter, maybe that ticks down for the full year, like 60 basis points sounds like Buck is about a 50 point headwind to offset that. And then, I guess, we have organic that should contribute 60 basis points to 80 basis points I guess. Could you talk about some of the other headwinds that are going to offset some of the margin expansion going forward? Because, yes, I'm struggling to get to the 20 basis points to 30 basis points this year.
Douglas K. Howell: All right. So, maybe let me back-up and just say, and think about it this way. We built a bridge this quarter from last year first quarter, right? So, if we were look -- if we were standing in January of ‘24, looking at a year that we're kind of seeing in that organic in the 7% to 9% range, here are some of the components we've talked about already and I'll toss in a couple more. So, where we said that maybe investment income would give us 60 basis points, 70 basis points, 80 basis points of margin expansion for full year, but not the 90 basis points. We got to think about as the normalization of the Omicron T&E expenses and then maybe some inflation on other T&E throughout the year, but we were back to doing full business in the second half of last year. That may cost margin expansion, let's say a 30 basis points to 40 basis point. I told you about the rolling impact of regular tuck-in acquisitions excluding Buck that would maybe use 10 basis points to 20 basis points of margin expansion. That gives you organic maybe in that 70 basis points to a 100 basis points just pure organic without those things, 70 basis points to a 100 basis points of margin expansion. And then we are making some additional -- we provided some additional raises that we talked about last quarter. We are making some additional IT investments all those maybe $5 million to $8 million a quarter that would use maybe 20 basis points to 50 basis points of margin expansion. Again, these are ranges, follow that bridge for the full year and that gets you back to the 60 basis points to 80 basis points of FX adjusted margin expansion for the year. So, then you'd layer in Buck, and that would get you down to that margin expansion that you mentioned there. So, I hope that bridge, and I don't have a crystal ball, it's not January of next year, but you -- if that was type of range you get some from investment income, you get a lot from organic, some goes back because of T&E and the rolling impact has a little impact, and we're making some investments. So, if we ended up the year and ignored Buck being up 60 basis points to 80 basis points, knowing me in January next year, I'd probably point out that we would have expanded margins 600 basis points in five years, and knowing my personality, I probably would say that I still would feel confident that we would have more and more productivity opportunities as we look forward. So, a lot can change in nine months, but wouldn't that be a great year for us to post. So, that's those are kind of my thoughts on that, and I hope that helps all the listeners on this to understand that where the pieces are coming from and hopefully that will help you build your models.
David Montemaden: Yes. That helps a lot. Thanks for that. I appreciate that, Doug. Maybe just a follow-up, Doug, I think you said you sounded, or you did say you were bullish on hitting that full-year organic in the 7 to 9 range after being a little bit above that this quarter. It sounds like renewal premiums are chugging along. The economy is also chugging along. Is it really just the tougher comps that is holding you back from increasing that outlook? Or is there anything else that I that we should think about that that's on your guys' mind as you were thinking about the organic growth outlook over the rest of the year?
Douglas K. Howell: I think the accounting on the deferred revenue from 606 in the fourth quarter plus maybe a life cases. Now maybe we sell some more life cases that come in pretty lumpy. Those probably cost us 50 basis points. The combination of the two and full-year organic something like that. But one thing I will say is that when we look at our dailies, you know, these are the overnights where we get a scrape of all the renewals that are going on, I got to tell you, April looks a lot more -- looks stronger in terms of premium increases than we were seeing before even on a mix adjusted basis. There is a tone that we're seeing in our data, not from anecdotal polling, that there is some further strengthening in all lines and all geographies, maybe other than one or two smaller ones. So, who knows? Maybe we'll be close to the 9%, but we're still comfortable in that that 7% to 9% range.
David Montemaden: Okay. Great. I appreciate that. And then maybe if I could just sneak one more in for Scott. Just on the Gallagher asset non comp liability claims. Just it sounded like core underlying claims were up low single digits during the quarter. That was both in workers' comp on liability lines. I'm wondering on liability lines, is that up low single digits a significant change to how that core underlying claims level was running in the previous quarters?
J. Patrick Gallagher, Jr.: I mean there's a couple of things going on. One is we happen to be, if you look at kind of the new business we've been selling, it's been connected to more liability activity. So it's not necessarily that individual accounts are saying more. But the new business tends to be tilting a little bit in that direction.
David Montemaden: Got it. Thank you.
Operator: Thank you. Our next question is from Mark Hughes with Truist. Please proceed with your question.
Mark Hughes: Yeah. Thank you. Good afternoon.
J. Patrick Gallagher, Jr.: Hey, Mark.
Douglas K. Howell: Hey, Mark.
Mark Hughes: Pat, you've been pretty enthusiastic about what you're seeing around exposures. In the construction space, if banks are really tightening up, would you have started to see that? Would there be some early project work that would flow through your system. Do you have any kind of view on what you think will help or what will happen there given the banking crisis.
J. Patrick Gallagher, Jr.: So, Mark, I'm not sure I'm understanding the question. If I look in my data, is the question around what we're seeing in the construction risks that we ensure?
Mark Hughes: Correct. Any early signs of pressure because of the banking situation?
J. Patrick Gallagher, Jr.: In fact, if anything right now, construction continues to be pretty unrobust. First off, you've got, you do have a lot of infrastructure stuff that now is flowing through, and our infrastructure contractors are doing very well. And when you get down to the more -- to the smaller contractors, their backlog is strong.
Mark Hughes: Any observation about the carrier's willingness to pay claims with perhaps inflation in the system, are they tightening up there? And is that -- are you seeing that in your relationships with the carriers?
J. Patrick Gallagher, Jr.: No, I will say this. I'm proud of the industry market. One of the things that I think stays consistent is that our carriers and I'd say this on a broad based basis are paying the legitimate claims that they have filed with them. And I think they're paying them in a in a timely fashion, and I think they're paying them fairly. Now you can get to certain jurisdictions. I don't mind mentioning it. Florida was assignment of benefits and litigation on behalf of the claims, and there's a battle going on there. But by and large, when you put a legitimate claim into the system, the insurance industry is a very efficient model of paying that claim. We are not sitting there with a lot of complaints from our claimants.
Mark Hughes: Very good. Thank you.
J. Patrick Gallagher, Jr.: Thanks Mark.
Operator: Thank you. Our next question is from Josh Shanker with Bank of America. Please proceed with your question.
Joshua Shanker: Yeah. Thanks for fitting me in. I just want to ask one follow-up to Greg's question earlier. You gave a hypothetical path about and I did it. Let's say there were 18 bidders on the property. Maybe now there's only 11. I guess it was only hypothetical, but 11 still seems a lot to me. I'm wondering in the market today are there still a lot of bidders who are flush with cash? Are they raising debt in this environment to make the acquisitions? What's their funding that keeps them around?
J. Patrick Gallagher, Jr.: Well, a, I don't understand it, and I'm not smart enough too. So let's start with that. And b, yes, they're raising funds like crazy. One of our competitors that I won't name actually eliminated their integration team and their acquisition team. Announced publicly that they were no longer going to be actively pursuing acquisitions, they've got additional funding and they're back in the game. Go figure out who would sell to that. Not me. So then you go to other players that have been more consistent long term. And, yes, they're they received significant funding in the last 60 days. So they are flush. That capital's got to work. They didn't get it to put it interest. So there's competition out there.
Joshua Shanker: And in terms of the price they are paying, I mean, I've always felt that there's not really a big patching going on. People want to come in partners with Gallagher and it's a choice acquirer compared to some others. Is there evidence that certain sellers are willing to not consider certain bidders who might be less of an attractive acquirer?
J. Patrick Gallagher, Jr.: Well, I think so. So, I mean, I think that's a big part of our sales, that we are always talking about the fact that the differentiator here is twofold. One, we believe we have a great franchise that offers them the opportunity to expand their business. And if they love the business or they tend to stay in it, this is the best platform in our mind to trade from. So that starts it. And then, of course, you've got the cultural aspect. And we're competitive. We're not we're not trying to sell the fact that that should give them a deep discount. But there are, you know, there are people that sell for various reasons, and we don't win them all.
Joshua Shanker: Thank you for the answers. Appreciate it.
J. Patrick Gallagher, Jr.: Sure, Josh.
Operator: Thank you. Our next question is from Meyer Shields with KBW. Please proceed with your question.
Meyer Shields: Thanks. Two sort of big picture questions if I can. First, Pat, you talked about within wholesale and specialty. Open brokerage is growing a lot faster than MGA and binding business. Is there something you could talk us through why there's that gap in growth rate?
J. Patrick Gallagher, Jr.: Sure. I'll toss that to Joel. Go ahead, Joel.
Joel D. Cavaness: Sure. So, on the wholesale side, obviously, you work with larger accounts and larger accounts that end up in the wholesale space typically are larger accounts with larger exposures and a little tougher to play. So that would be really the first. And then really the second thing is the inflow of tougher accounts today that are coming out of the admitted market and coming into the several lines market or E&S depending on what your terminology is, is more robust. They're coming in very quickly because of especially the difficulty in the property market. So you would see a higher organic in that line versus our MGA binding business, which is more consistent, growing nicely, but it's more consistent in the nature of smaller accounts. So it doesn't move the needle as much.
J. Patrick Gallagher, Jr.: Look at it this way. Another way to put in Meyers, one is troubled business, frankly. When we're doing open market broker, brokers are coming to us because they need our help on tough to place accounts that are going up in price. Our MGAs and programs are consistently writing smaller accounts that are not distressed, that are looking for specialty coverage or specialty expertise.
Meyer Shields: Okay. No. That's very helpful. Thank you. That's definitely what I needed. Second question, I'm just wondering how should we think about reinsurance growth over the next year or so. Is there sort of a special maybe temporary boost because it's now under sort of doubters purview, and you can explain the benefits of that to the insurance company that you deal with worldwide and then once that happens, you're on a stable basis? Or is that a more enduring first of upside?
J. Patrick Gallagher, Jr.: No, I think that's an enduring thing. When this team was part of our competitor, Willis, they had a very good block of business underneath them. A very good firm they were part of. And I would say in fact similar economic. So we're not we're not changing that. But I think we do offer a different environment. We offer a different way of trading. We're bringing our retailers together with the reinsurance people at a much higher level or I shouldn't say higher level at a much greater frequency with much greater interaction than they were used to, which I do believe will fuel their growth. And I think it will accelerate beyond what they would have achieved, but that's what it could have should and we'll never know.
Meyer Shields: Okay. Perfect. Thanks so much.
J. Patrick Gallagher, Jr.: Thanks, Meyer.
Operator: Thank you. Our next question is from Rob Cox with Goldman Sachs. Please proceed with your question.
Robert Cox: Hey, thanks. I just had one question on pricing. I think you all had commented previously that Australia, New Zealand are potentially seeing a reacceleration in rate and the UK is also seeming quite strong. So I'm just curious if you're seeing or expect to see more of a divergence in the pricing trajectory between, the U.S. and the international business.
J. Patrick Gallagher, Jr.: I think they're pretty close to the same. Yes we're seeing some of those, but we're seeing, take D&O out of it right now. We are starting to see some uptick in workers' comp now. So, I mean, I don't see a lot of difference between what's going on in the U.S. and what's going on Canada, New Zealand, Australia, and the UK. So it's pretty close.
Robert Cox: Got it. Thank you.
J. Patrick Gallagher, Jr.: Sure.
Operator: Thank you. Our next question is from Elyse Greenspan with Wells Fargo. Please proceed with your question.
Elyse Greenspan: Hi. Thanks. Just a follow-up on the margin side and thanks for all the color on the moving pieces. But within that 20 to 30 basis points, are you assuming that the fiduciary investment income is in line with the Q1 level over the remaining three quarters?
Douglas K. Howell: Yeah. That's pretty close. Yeah. That's right.
Elyse Greenspan: And then, you know, I know I had asked earlier kind of just a question just in terms of just it seems like you're assuming a stable economy. Right? We see some forecasts out there for decelerating GDP or perhaps GDP to go negative. What are you guys assuming for GDP over the balance of the year?
J. Patrick Gallagher, Jr.: Well, here's the thing. Translating it directly into GDP is a different exercise But one thing, you got to separate real versus nominal first and foremost. So I can only get a look at what's the growth in the insured values and insured, what's being assured there. Remember, we're not seeing that in our data right now. I'm looking down through our industry list right now, and we talked about construction earlier, heavy construction other than building construction contractors up 12.4%, construction special trade 8%, building construction up 8%. So you look through our industry list here, we're not seeing it. We're not seeing it in our dailies overnight. The cancellations are lower than before. Negative endorsements are lower than before. Audits are audits. They have a lag factor in there, so I wouldn't look at those two terribly carefully. But we're just not seeing this in our customer’s business at this point. And believe me, our customers, if they believe they're seeing a down turn one of the things they want to do is modify their insurance program because that's cash flow to them. So, we will know in two years how accurate our dailies are. But right now, they are pretty right over the last two years.
Elyse Greenspan: And so even, I guess, if we still like, if you were thinking about what's going to have the greater impact, do we think about it being the economy and GDP or PNC pricing when we think about the next few quarters?
Douglas K. Howell: Both.
J. Patrick Gallagher, Jr.: But I think the pricing will far offset any modest contraction and exposure in it. I don't know what's going to contract in the next six months or what volumes are going to contract. We're just not seeing at least.
Douglas K. Howell: But remember, Elyse, we are the beneficiary of inflation. There are very few industries out there that really get a benefit from inflation, and we do. So as building values go up and for and right now for the first time in the decade, carriers are very, very interested in what you're insure to make sure you're ensuring the value. This inflation is hitting building costs very hard.
Elyse Greenspan: Thanks for all the color.
Douglas K. Howell: Thanks, Elyse.
J. Patrick Gallagher, Jr.: Thanks, Elyse.
Operator: Thank you. Our next question is from David Montemaden with Evercore. Please proceed with your question.
David Montemaden: Hi. Thanks for taking my follow-up. So I've noticed the last few quarters just in the adjusted compensation ratio commentary in brokerage. Just the impacts from savings related to back office headcount controls. Could you maybe just touch on that? I'm assuming some of this has to do with leveraging centres of excellence. But I don't think you had mentioned that as a tailwind when we think about the margin roll forward. So, I guess maybe just help me think through that, maybe not only for this year, but, like, broader picture. How big of an opportunity that is leveraging the centres of excellence.
J. Patrick Gallagher, Jr.: Well, maybe we back up and take a look. Do you remember some of our discussion about the sensitivity of our business to inflation? We said about 40% of it is neutral because it just moves more in tandem with premium -- with our commission rates because we pay people on incentive compensation basis there. Then we've got about 40% of our whole cost structure that is moderately impacted by inflation. And then we have 20% of it that might run a little bit more close to what headline is inflation knocking off some tops of certain things that maybe transportation, gas, etcetera on that. So when you add all that up, when you look at what could be facing an -- somebody like us that's pushing $6 billion worth of cost. If something if you say that, let's say, let's call it 30% of your – 25% of your cost structure is subject to – 75% of the headline inflation number. Just think about that. Let's say there's $4 billion, I'm just doing this off the top of my head that might have 6% or 7% inflation factor in it. That's a big number. Right? And I'm saying that the only thing that's really affecting us is $5 million to $8 million bucks a quarter on it. What that's saying is as we get more productive, not just from our offshore centres of excellence, but because of technology and other process improvements that are both domestic and offshore centres of excellence. That is absolutely controlling against inflation out there. So there is substantial uplift that's happening every day because of our productivity work, our quality work and our offshore centres of excellence. And I just kind of did that off the top of my head, but you get the point. You'd see a heck of a lot more cost or expense dropping into the bottom line if we didn't have our offshore centres of excellence.
David Montemaden: Got it. Nope. That makes sense. Thank you for that.
J. Patrick Gallagher, Jr.: Sure. We're pretty proud of the quality that comes out of that operation too. Well, thank you very much everyone. Appreciate that and thank you for joining us today. As you could tell, we're extremely pleased with our start to the year. We posted a great quarter. I'd like to thank all our colleagues for their outstanding efforts this quarter. We are people business and I believe we have the best people at Gallagher. We look forward to speaking with you again at our IR Day in June. Have a nice evening, and thanks for being with us.
Operator: This concludes today's conference call. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Companies First Quarter 2023 Earnings Conference Call. Our participants have been placed on a listen-only mode. Your lines will be opened for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call including answers given in response to questions may constitute forward looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward looking statements provided on this call. These forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward looking statements and risk factors sections contained in the company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the and relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thank you very much. Good afternoon, and thank you for joining us for our first quarter 2023 earnings call. On the call for today is Doug Howell, our CFO as well as the heads of our operating divisions. We had an excellent first quarter to start the year. For our combined brokerage and risk management segments, we posted 12% growth in revenue, 9.7% organic growth. GAAP earnings per share of $2.52, adjusted earnings per share of $3.30 up 12% year-over-year. Reported net earnings margin of 21%, adjusted EBITDAC margin of 38% up 29 basis points. We also completed 10 mergers totaling $69 million of estimated annualized revenue and we are recognized as the world's most ethical company for the thirteenth time, an outstanding quarter from the team. Let me give you some more detail on our first quarter performance starting with our Brokerage segment. Reported revenue growth was 12%. Organic was 9.1%. Acquisition rollover revenues were $61 million. Adjusted EBITDAC growth was 15% and we posted adjusted EBITDAC margin of 40.4% right on our March IR Day expectations. A fantastic quarter for the brokerage team. Let me walk you around the world and provide some more detailed commentary on our brokerage organic. Starting with our retail brokerage operations. Our U.S. PC business posted over 7% organic. Core new business was up year-over-year, even growing over the tough renewal compare in D&O lines, while retention was similar to last year's first quarter. Our UK PC business also posted more than 7% organic due to strong new business production, stable retention and the continued impact of renewal premium increases. Our combined PC operations in Australia and New Zealand posted organic of 10%. Net new versus loss business was consistent with prior year and renewal premium increases were ahead of first quarter 2022 levels. Rounding out the retail PC business, Canada was up 6% organically reflecting solid new business and consistent year-over-year retention. Our global employee benefit brokerage and consulting business posted organic of nearly 7%. New business remains strong and client retention was excellent. We saw growth across many of our practice groups with particular strength in HR consulting and pharmacy benefits. Shifting to our wholesale and specialty businesses. Risk placement services, our U.S. Wholesale operations posted organic of nearly 8%. This includes 16% growth in open brokerage and about 5% organic in our MGA programs and binding businesses. New business production and retention were both consistent with last year's first quarter. UK specialty posted organic of 17% benefiting from a strong start within aviation and the addition of new teams focused on North American risks. And finally, reinsurance, Gallagher posted 12% organic reflecting new business wins, great retention and a hardening property reinsurance market. Outstanding results from the Gallagher Re team. Pulling it all together Brokerage segment all in organic of 9.1% that's a bit above the top end of our first quarter expectation and a fantastic sales quarter by the team. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Overall, global first quarter renewal premiums that's both rate and exposure combined were up more than 9% consistent with the 8% to 10% renewal premium change we had been reporting throughout 2022. Renewal premium increases remain broad based across nearly all of our major geographies and product lines around the globe. For example, workers' comp is up low single digits, general liabilities up mid to high single digits. Umbrella and package are up in the low double digits, so most lines are trending similar to previous quarters. Two exceptions. First, public D&O where renewal premiums are down a bit and second property, where renewal premium increases are accelerating. For example, fourth quarter property renewal premiums were up 15% and through the first three months of 2023, we have seen increases of 15%, 20%, and 17%, respectively. So, our clients continue to feel cost pressures here due to rising replacement values, increasing frequency and severity of weather related events and hard reinsurance conditions. We're not seeing signs that these lost costs and profitability pressures are likely to abate in the near term. So as we head to our largest primary insurance property quarter we are focused on helping our clients navigate and mitigate these premium increases. Moving to exposures. We are seeing continued strength in our customer's business activity. First quarter mid-term policy endorsements audits and cancellations combined were better than first quarter 2022 levels greater than the eighth consecutive quarter of year-over-year increases. Shifting to reinsurance. During the heavy Japan centric April renewals, reinsurance carriers continued to focus on increased pricing and tightening terms and conditions. This was across a broader range of territories and most all lines of business, so in even harder conditions compared to January 1. The casualty trading market saw orderly renewals and a sufficient supply of capital to fulfill the demand from underwriting enterprises. The property market continued to experience its recent challenges due to more limited underwriting capital. There were some green shoots in the ILS issuance, although pricing was typically less attractive to CDs than the traditional markets. Overall, there wasn't much new capacity entering the property market regardless, our teams navigated the hard market and customers again managed to secure satisfactory cover. Those interested in more detailed commentary can find our April first view market report at our website. Looking forward, there is good reason to expect a cautious underwriting stance from carriers for the foreseeable future as they contemplate recent weather events, replacement cost increases, social inflation and ongoing geopolitical tensions into their view of lost cost trend. So we expect insurance and reinsurance pricing increases to continue throughout 2023 and while it's early likely into 2024. We also remain optimistic on our customer's business activity during 2023. We have yet to see any significant shifts to daily indications of client, business activity thus far in April. We are also seeing encouraging employment levels for our benefits clients suggesting the economic backdrop for 2023 remains broadly favorable. Recent data shows the U. S. Unemployment rate declining. Continued growth in non-farm payrolls and a very wide gap between the amount of job openings and the number of people unemployed and looking for work. So I see demand for our products and services around attracting, retaining, and motivating workforces remaining strong. As we sit here today, we continue to see full-year 2023 brokerage segment organic in that 7% to 9% range and that would be another fantastic year. Moving on to mergers and acquisitions. We had an active first quarter completing 10 new tuck in brokerage mergers representing about $69 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. Also in April, we officially welcomed the former Buck colleagues, combined with our existing employee benefits brokerage and HR consulting business we will enhance our offerings and be better positioned to deliver superior human capital solutions for all of our clients. Moving to our pipeline, we have nearly 40 term sheets signed or being prepared representing more than $350 million of annualized revenue. Good firms always have a choice of who to partner with, and we'll be very excited if they choose to join Gallagher. Moving on to our Risk Management segment, Gallagher asset. First quarter organic growth was 14.3% ahead of our expectations due to continued growth from recent new business wins and some revenue from first quarter New Zealand cyclone and flooding. We also saw core new arising claims increase in the low single digits during the quarter for existing clients across both workers' comp and liability. First quarter adjusted EBITDAC margin was also strong at 19.2% ended up a bit ahead of our March expectations. Looking forward, we see full-year 2023 organic around 12% to 13% and adjusted EBITDAC margins holding up or above 19% and that would be another excellent year. And I'll conclude with some comments regarding our Bedrock culture. I'm very pleased that just a few weeks ago, we were recognized as the World's Most Ethical Companies for the thirteenth time. We're honored to be one of only 135 companies globally to receive this award from the Ethisphere Institute. Our 45,000 plus colleagues embrace and celebrate the unique values that we have instilled in our company. The 25 tenants articulated in the Gallagher way continue to drive our global team's success today and we believe that our unique culture is a key differentiator and a competitive advantage. It's a strong culture of client focus, excellence, and inclusion and it continues to drive us forward. That is the Gallagher way. Okay. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Douglas K. Howell",
"text": "Thanks, Pat, and good afternoon everyone. As Pat said, an excellent start to the year. Today, I'll begin with some comments using both our earnings release and our CFO commentary document that we post on our website. I'll touch on organic margins and provide some modeling helpers for the remainder of 2023. Then I'll finish up with my typical comments in cash, M&A capacity and capital management. Okay. Let's flip to page 2 of the earnings release. All in brokerage organic of 9.1%. Call it right at the top end of the range we foreshadowed at our March 16th IR Day, a nice finish from our London specialty operations and a little upside from reinsurance benefits. One call out on that table. Contingence didn't grow organically this quarter for three reasons. First, there's a little geography between supplementals and contention call that about $2 million. Second, there was a bit of positive development in Q1 2022 from the prior year 2021 estimates. Call that $3 million and again, that's back in first quarter 2022, causing a little difficult compare. And third, we are not expecting one of our programs to pay as large of a contingent here in 2023 because of underlying loss ratio deterioration. Call that maybe towards a million. Regardless, base organic at 9.5% and all in at 9.1% that's a fantastic quarter by the team. Hoping to page 4 of the earnings release to the Brokerage segment adjusted EBITDAC table. We posted 40.4% for the quarter, before FX, that's up 56 basis points. And FX adjusted up 14 basis points over first quarter 2022. That's right in line with our March IR Day expectations when we discuss that first quarter 2022 expenses were lower than our expected run rate simply because we are still in the Omicron portion of the pandemic and that our tuck in acquisitions are just not as seasonally weighted. But they don't roll in at 40 points of margin here in the first quarter. If you levelize for those two items, our margins expanded approximately 110 basis points. Maybe looking at it like a bridge from first quarter 2022 will be helpful. Investment income gave us 90 basis points of margin expansion. The normalization of Omicron T&E expenses and inflation on all T&E costs us 80 basis points. The seasonal impact from rolling M&A uses about 40 basis points. Organic gave us 70 basis points of expansion and some additional wages and IT investments used about 25 basis points. Follow that bridge and the mass gets you close to that 14 basis points of FX adjusted expansion in the quarter. Looking forward, it's still early yet with a fantastic first quarter combined with pass up commentary makes us more bullish on hitting that full-year brokerage organic in the 7% to 9% range and posting adjusted margins up 60 basis points to 80 basis points. Two small heads up on that. First, getting to that 7% to 9% organic for the full-year might be a little lumpy over the next three quarters given the large life case we sold in Q2 2022. And then the 606 deferred revenue accounting in our fourth quarter. We discussed both of those with you last year, so there's no new news here. Just a reminder for your modeling. Second, the 60 to 80 basis points of margin expansion is before the roll in impact of Buck, which recall naturally runs lower margins. So when you include Buck, the math would show full year margin expansion in that 20 to 30 basis points range. So moving on to the Risk Management segment and the organic table at the bottom of page 4. As Pat said, an excellent quarter, 14.3% organic growth We did get a little tailwind this quarter because Omicron caused fewer claims arising in Q1 2022 and we also had some New Zealand [CAC] (ph) claims activity. But most of this excellent result comes from strong new business wins in the second half last year. As for margins, put to page 5 of the earnings release. Risk Management posted adjusted Q1 EBITDAC margins of 19.2%. That's up 177 basis points over last year. As we look forward, we're seeing the rest of the year organic in that 12% to 13% range and full-year margins now finishing a bit above 19%. That would be the best full-year adjusted margin in Gallagher asset six decade history. Another demonstration of the benefits of scale, intellectual capital, technology and operational excellence. Let's turn to page 6 of the earnings release. That's our Corporate segment and also, when you take a look at pages 3 and 4 of the CFO commentary document, most all of the items are right in line with our March IR Day forecast. Three callouts on the CFO commentary document. When you see Page 3, you'll see a slight tick up in our expected book effective tax rate. That's entirely due to the UK rate hike to 25% that went effective April 1st. But remember what you're seeing is a book effective tax rate. Our cash taxes paid rate is substantially lower. Call that around 10% of our adjusted combined brokerage and risk management EBITDAC. That's because of the tax shield from interest, the amortization of purchase intangibles and the incremental cash flows from our clean energy investments over the coming years. Page 5 of the CFO commentary shows those tax credits. We have over $700 million as of March 31st, and it shows that we're forecasting to use about a $180 million to $200 million in 2023 with a step up in 2024 in each later year. That's a really nice cash flow sweetener to help fund future M&A. Then if you flip back to page 4 of the CFO commentary document, you'll see that we had a slight beat on the Corporate segment this quarter compared to our midpoint, but some timing in that beat. So you'll see full-year still about the same as what we forecasted our March IR Day. Moving now to page 6 of the CFO commentary document, that table shows our rollover M&A revenues. It shows $61 million this quarter, which is pretty close to that $63 million we estimated during our March IR Day. And also looking forward, we've now included Buck in that table, but remember, you'll need to add your pick for other future M&A to these estimates. Let me move to some comments on cash, capital management and future M&A. At March 31, available cash on hand was around $1 billion, but note that about $600 million was used to buy Buck in early April. So call it $400 million. This means we estimate that we have about $2 billion more to fund M&A for the rest of this year and our early look is another $3 billion or more in 2024 usually to fund our M&A program, utilizing only free cash and incremental debt while maintaining our strong investment grade ratings. One final reminder, recall during our March IR Day, we mentioned that we would be reclassifying how we present fiduciary balances on our balance sheet and in our cash flow statement. These re-classes are purely GAAP geography, and we're doing so to better align our presentation with how many other brokers present their statements. You might notice some of that movement in the recast balance sheet on page 12 of their earnings release. To help you understand all of the movement there'll be a comprehensive table in our 10-Q that we will file later next week. Again, all of this is to make our presentation more consistent with most of the other public brokers and all of the changes just gap geography. So those are my comments. Another terrific quarter and looking forward, we see strong organic growth, a great pipeline of M&A and continued opportunities for productivity improvements, all fueled by an amazing culture. I believe we are very well positioned to deliver another fantastic year. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Doug. Operator, I think we're ready for some questions, please."
},
{
"speaker": "Operator",
"text": "Thank you. This call is now open for questions. [Operator Instructions]. Our first question is from Weston Bloomer with UBS. Please proceed with your question."
},
{
"speaker": "Weston Bloomer",
"text": "Hi. Good afternoon. My first question is on the margin expansion you're expecting for full-year 2023. How should we think about the cadence of that margin expansion as we move through the year? I think you'd previously guide to 1Q being lower relative to 2Q and 4Qs. Is that still largely the case excluding Buck or can you just help us think about the moving pieces as we go through the year?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Alright. So you're asking me about how do we fuel the margin extension quarter-to-quarter. Is that the question?"
},
{
"speaker": "Weston Bloomer",
"text": "Yeah. More or less, because you highlighted some of the lumpy nature in organic. I'm just kind of curious on how that plays out on the margin as well."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Alright. Let me see if I can dig that out for you here. Should have it right here, and I apologize it's not quick on this. I think that -- stand by here. In the second quarter, I think that we'd probably have -- maybe the second and third quarter more flat and then a little bit more upside, maybe towards 30 basis points in the fourth quarter, I think, is what I'm looking at here."
},
{
"speaker": "Weston Bloomer",
"text": "And is there any seasonality to Buck's margin as well?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I'm sorry. Let me check that. I just looked at there are 9, I'm seeing probably 10 basis points of expansion in the second quarter, 20 in the third and maybe 20 in the fourth."
},
{
"speaker": "Weston Bloomer",
"text": "Great. And does that include seasonality to Buck as well? I think you had previously said it was roughly run rate."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "That’s right. That includes Buck."
},
{
"speaker": "Weston Bloomer",
"text": "Okay. Great. And can you can you give a sense to of how quickly Buck is growing? I see in the acquired revenue table that's, call it $77 million per quarter. I'm assuming that's including a few other deals in there, but I'm curious if that's assuming any growth for Buck or how quickly that business is currently growing?"
},
{
"speaker": "Douglas K. Howell",
"text": "Yeah. This is [Indiscernible]. Buck has been pretty stable across the country last year, across the world last year. They have very strong growth in the U.K. and then their engagement last communications business. They just finished Q1 with their best sales quarter in the last five years. We're already beginning to have a lot of revenue synergy discussions, very organic early stages, built a pretty strong pipeline. We're already going on in on deals together. It's a little early to give predictions on what this looks like, but we do expect them to have mid-single digit growth this year."
},
{
"speaker": "Weston Bloomer",
"text": "Great. Thanks for taking my questions."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Weston."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi. Thanks. Good evening. My first question, maybe I'm just confused. I thought you said Brokerage margin, can expand 50 basis points sorry, 60 basis points to 80 basis points for the year. But then in response to Weston's question, you were talking about 10 basis points to 30 basis points of expansion over the next few quarters."
},
{
"speaker": "Douglas K. Howell",
"text": "All right. Question one is without the math that results from Buck because they run naturally lower margins. That was the question that we answered for, Weston. The 60 basis points to 80 basis points is how we're looking at Gallagher before Buck. Does that help?"
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. Got it. Yes. That helps. Thank you. And then in terms of the organic outlook, still kind of keeping the 79% range for the year. Can you just give us a sense of what you're embedding in there for the economy as well as pricing when you think about or you're just expecting a general stable environment over the next few quarters compared to what we saw in the Q1."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I think, Elyse, this is Pat. I think that we're just sort of predicting that it's a stable environment over the next three quarters. We're not seeing a lot of rate reduction. We are seeing continued, and by the way, I'd point out being a little proud about this. We've been the one saying we're not seeing recessionary pressure in the middle market by our clients around the United States in particular. Those businesses are continuing to grow and they are robust, even with the headwinds of higher interest rates and higher insurance costs. And those insurance costs are not backing off, and we can tell you this data day-to-day, line-by-line, geography-by-geography, country-by-country. So, I think that our commentary in our prepared remarks about it being a pretty firm market, looking like it's going to continue that way for all the reason we enumerated, we view it that same way over the next three quarters."
},
{
"speaker": "Elyse Greenspan",
"text": "Thanks. That's helpful. And then you guys, I know right, the laws related to your clean energy investments right expired at the end of ‘21, and you guys have kind of I think, or kept some of the plants open. Is there still the potential that you guys could generate more tax credits there or have you kind of not expecting that at this point?"
},
{
"speaker": "Douglas K. Howell",
"text": "We're preserving all the machines that allow us to generate those tax credits if there's something that might come out of an energy bill or a tax reconciliation bill yet this year. Those plants could be put back into service."
},
{
"speaker": "Elyse Greenspan",
"text": "Do you think there's a high probability that could happen?"
},
{
"speaker": "Douglas K. Howell",
"text": "Elyse, I don't know if there's a high probability of anything getting done in Washington. So I mean, that I would hope so, but I wouldn't put high probability on anything coming out of there. Yes, but if the plant sits there for another year, they sit there for another year."
},
{
"speaker": "Elyse Greenspan",
"text": "Thanks for the color."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Good. Thanks, Elyse."
},
{
"speaker": "Douglas K. Howell",
"text": "Thanks, Elyse."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Greg Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Greg Peters",
"text": "Well, good afternoon, everyone."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Hey, Greg."
},
{
"speaker": "Greg Peters",
"text": "So, I think before I get into the results, I wanted to step back and just talk about talent recruiting and employee producer retention, and maybe if you could give us an update on how that's progressing inside Arthur J. Gallagher. And I guess in a parallel question, there was some recent announcements of promotions in the c-suite and, Pat, I don't think you, I think you have plenty of gas left in the tank, so maybe you could provide some context about some of those announcements as well."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Well, let me address a couple things first, Greg, so first, our recruiting efforts are ongoing. We are always recruiting producers, excited about the fact that our 500 interns will begin showing up in a few weeks here, in the United States, if I look around the globe, it's probably more like 600 interns. As you well know, we recruit heavily from that group, and our consistency of retention there is very strong, and continues to be strong. So, we have a good pipeline and a good -- we do a good job of landing new producers, nothing to announce in the way of any more robust efforts in that regard than are normal. And so I think I feel really good about that. In terms of retention of producers, very, very, very strong retention, and I think that we offer a great place to acquire trade, and we pay people well to do that. We're still one of the places that believes in remunerating people for their growth in books. So, I feel good about our production recruits. I feel good about our new hires, and I feel very good about the retention level that we have with the people that are. As it relates to the article, which was not an announcement, I would just simply say that we don't make a lot of comments on news stories, Greg, and I think you know that. I'm the CEO, and I feel great. Thank you very much."
},
{
"speaker": "Greg Peters",
"text": "I expected that kind of comment from you, so but thank you for validating it. I guess, my follow on question will deal with M&A. And I know you comment on this almost every quarter, but the interest rate environment has posed a changing landscape for M&A. We look at your multiples sits in the, Doug's CFO commentary tables, and it doesn't look like the multiples are changing much. Can you talk about how you view M&A at the current prices that are being in the marketplace? Do you think, you talk about the 40 term sheets or outstanding, it seems like you have 40 term sheets every quarter. But can you talk about, how the interest rate environment might change your perspective on what you're willing to pay?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Yes. I will. First of all, let me put some color on that. If I read the business insurance article correctly about a week ago, I think M&A in the first quarter is down about 29%. That's after year-after-year-after-year, more PE entries, more deals being done it's, so I think we're seeing a slowdown in the number of transactions, which I do think reflects a slowdown in the number of new entrance. There are some -- there are some people who have been very active in the past that are less active now. At present, we're not seeing a big decrease in those multiples. If you had 20 people bidding on a property 18 months ago, you still have 11 today. And so, I do believe that, like anything, supply and demand, if that demand continues to decrease and interest rates are in some way impinging that capital, I think that you will see multiples come down, but they're not doing that right now."
},
{
"speaker": "Greg Peters",
"text": "Got it. Thanks for the answers."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Greg."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"text": "Hi, good afternoon. First question, in the prepared remarks, you talked about property rates accelerating. Any stats or any way we can dimension what percentage of your revenues on the Brokerage side, touch that element of acceleration and it doesn't seem like from your organic guide that you're taking in that acceleration continuing or maybe I'm incorrect?"
},
{
"speaker": "Douglas K. Howell",
"text": "Well, listen I can give you some percentage of our book, our property book we include package in there also is going to be somewhere around just doing the mental math here real quick, is around 27%, something like that of our first quarter, total revenues in the P&C units. One of the things that our guys do is there and we all do out there is pretty good at mitigating some of that rate increase. So, when you look at it, property rates are going up 17%, you might see commissions going up 10% or 11%, 12% something like that because you increase deductibles, you bring down limits, you come up some more creative programs in that. So, that is a line of business where the direct correlation between the premium increase and then the commissions that we get there's a delta there."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I think that's a -- I'm piling in here. This is, Pat. That's a very, very good point. Every time in a firm market, we get that question. Rates are up on XYZ 12%. You're showing 6%. Why is that? Because our job is to not pass on the 12%, and we're good at that."
},
{
"speaker": "Mike Zaremski",
"text": "Got it. Okay. That's -- and that thanks for the answer, Doug, that excludes reinsurance?"
},
{
"speaker": "Douglas K. Howell",
"text": "Yes. That's right. But most of our reinsurance are on renewal, so you've already seen that math."
},
{
"speaker": "Mike Zaremski",
"text": "Got it. Okay. Follow-up investment income. Maybe I might have missed this, because I jumped on a minute late, but was there any help with if this is the right investment income run rate? I know that there might have been book sales in the number two. It looks like it was better than expected. I know there were some new -- there's some noise on the fiduciary balances too now. So, should you truly be thinking we need some help there?"
},
{
"speaker": "Douglas K. Howell",
"text": "All right. So, book sales would have been tiny. I think the total amount of book sales this quarter was about 200,000 bucks, something like that. So that wouldn't have influenced it in our numbers, at all. Our investment income on the face of the financial statements also includes our premium funding businesses. So, you will -- so that the amount of invest income that translates right into that number. Just take 90% of what you see as investment income and on the face and 90% of that is real, additional incremental investment income. When you look at what it means for the rest of the year, if you follow the interest rates through the big tick-up starting about last month last year, and so second half of the year, the increase in investment income is not as dramatic as it is here in the first quarter. So, if I were to look at full year impact of investment income on our organic lift, that would be about maybe 60 basis points for full year, 60 basis points of margin expansion from invest income for the full year. So, you can see here this quarter was up fueled about 90 basis points and for the full year it would be about 60 basis points to 70 basis points, something like that."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Great. And maybe just, well, last quick one. Given how much improvement Gallagher has shown in its margins over the last few years. Is there a way to dimension what percentage of the deals you guys look at have a better margin profile than Gallagher, or should we expect there to, there to be up maybe similar like a Buck headwind sometimes going forward as you guys continue to do deals."
},
{
"speaker": "Douglas K. Howell",
"text": "No. I think if you look at our pipeline and you project it, we would think that if I were standing in January of next year looking back, what's to be the impact of rolling M&A excluding Buck. So, all it might use about 10 basis points to 20 basis points of margin expansion. So, it has a significantly smaller impact on the full year because we're so seasonally large in the first quarter."
},
{
"speaker": "Mike Zaremski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "[Operator Instructions]. Our next question is from David Montemaden with Evercore. Please proceed with your question."
},
{
"speaker": "David Montemaden",
"text": "Hi. Thanks. I just had a question just on the margin. So, I've understand, Doug, so we got, the 90 basis point tailwind from fiduciary income here in the first quarter, maybe that ticks down for the full year, like 60 basis points sounds like Buck is about a 50 point headwind to offset that. And then, I guess, we have organic that should contribute 60 basis points to 80 basis points I guess. Could you talk about some of the other headwinds that are going to offset some of the margin expansion going forward? Because, yes, I'm struggling to get to the 20 basis points to 30 basis points this year."
},
{
"speaker": "Douglas K. Howell",
"text": "All right. So, maybe let me back-up and just say, and think about it this way. We built a bridge this quarter from last year first quarter, right? So, if we were look -- if we were standing in January of ‘24, looking at a year that we're kind of seeing in that organic in the 7% to 9% range, here are some of the components we've talked about already and I'll toss in a couple more. So, where we said that maybe investment income would give us 60 basis points, 70 basis points, 80 basis points of margin expansion for full year, but not the 90 basis points. We got to think about as the normalization of the Omicron T&E expenses and then maybe some inflation on other T&E throughout the year, but we were back to doing full business in the second half of last year. That may cost margin expansion, let's say a 30 basis points to 40 basis point. I told you about the rolling impact of regular tuck-in acquisitions excluding Buck that would maybe use 10 basis points to 20 basis points of margin expansion. That gives you organic maybe in that 70 basis points to a 100 basis points just pure organic without those things, 70 basis points to a 100 basis points of margin expansion. And then we are making some additional -- we provided some additional raises that we talked about last quarter. We are making some additional IT investments all those maybe $5 million to $8 million a quarter that would use maybe 20 basis points to 50 basis points of margin expansion. Again, these are ranges, follow that bridge for the full year and that gets you back to the 60 basis points to 80 basis points of FX adjusted margin expansion for the year. So, then you'd layer in Buck, and that would get you down to that margin expansion that you mentioned there. So, I hope that bridge, and I don't have a crystal ball, it's not January of next year, but you -- if that was type of range you get some from investment income, you get a lot from organic, some goes back because of T&E and the rolling impact has a little impact, and we're making some investments. So, if we ended up the year and ignored Buck being up 60 basis points to 80 basis points, knowing me in January next year, I'd probably point out that we would have expanded margins 600 basis points in five years, and knowing my personality, I probably would say that I still would feel confident that we would have more and more productivity opportunities as we look forward. So, a lot can change in nine months, but wouldn't that be a great year for us to post. So, that's those are kind of my thoughts on that, and I hope that helps all the listeners on this to understand that where the pieces are coming from and hopefully that will help you build your models."
},
{
"speaker": "David Montemaden",
"text": "Yes. That helps a lot. Thanks for that. I appreciate that, Doug. Maybe just a follow-up, Doug, I think you said you sounded, or you did say you were bullish on hitting that full-year organic in the 7 to 9 range after being a little bit above that this quarter. It sounds like renewal premiums are chugging along. The economy is also chugging along. Is it really just the tougher comps that is holding you back from increasing that outlook? Or is there anything else that I that we should think about that that's on your guys' mind as you were thinking about the organic growth outlook over the rest of the year?"
},
{
"speaker": "Douglas K. Howell",
"text": "I think the accounting on the deferred revenue from 606 in the fourth quarter plus maybe a life cases. Now maybe we sell some more life cases that come in pretty lumpy. Those probably cost us 50 basis points. The combination of the two and full-year organic something like that. But one thing I will say is that when we look at our dailies, you know, these are the overnights where we get a scrape of all the renewals that are going on, I got to tell you, April looks a lot more -- looks stronger in terms of premium increases than we were seeing before even on a mix adjusted basis. There is a tone that we're seeing in our data, not from anecdotal polling, that there is some further strengthening in all lines and all geographies, maybe other than one or two smaller ones. So, who knows? Maybe we'll be close to the 9%, but we're still comfortable in that that 7% to 9% range."
},
{
"speaker": "David Montemaden",
"text": "Okay. Great. I appreciate that. And then maybe if I could just sneak one more in for Scott. Just on the Gallagher asset non comp liability claims. Just it sounded like core underlying claims were up low single digits during the quarter. That was both in workers' comp on liability lines. I'm wondering on liability lines, is that up low single digits a significant change to how that core underlying claims level was running in the previous quarters?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I mean there's a couple of things going on. One is we happen to be, if you look at kind of the new business we've been selling, it's been connected to more liability activity. So it's not necessarily that individual accounts are saying more. But the new business tends to be tilting a little bit in that direction."
},
{
"speaker": "David Montemaden",
"text": "Got it. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Mark Hughes with Truist. Please proceed with your question."
},
{
"speaker": "Mark Hughes",
"text": "Yeah. Thank you. Good afternoon."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Hey, Mark."
},
{
"speaker": "Douglas K. Howell",
"text": "Hey, Mark."
},
{
"speaker": "Mark Hughes",
"text": "Pat, you've been pretty enthusiastic about what you're seeing around exposures. In the construction space, if banks are really tightening up, would you have started to see that? Would there be some early project work that would flow through your system. Do you have any kind of view on what you think will help or what will happen there given the banking crisis."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "So, Mark, I'm not sure I'm understanding the question. If I look in my data, is the question around what we're seeing in the construction risks that we ensure?"
},
{
"speaker": "Mark Hughes",
"text": "Correct. Any early signs of pressure because of the banking situation?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "In fact, if anything right now, construction continues to be pretty unrobust. First off, you've got, you do have a lot of infrastructure stuff that now is flowing through, and our infrastructure contractors are doing very well. And when you get down to the more -- to the smaller contractors, their backlog is strong."
},
{
"speaker": "Mark Hughes",
"text": "Any observation about the carrier's willingness to pay claims with perhaps inflation in the system, are they tightening up there? And is that -- are you seeing that in your relationships with the carriers?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "No, I will say this. I'm proud of the industry market. One of the things that I think stays consistent is that our carriers and I'd say this on a broad based basis are paying the legitimate claims that they have filed with them. And I think they're paying them in a in a timely fashion, and I think they're paying them fairly. Now you can get to certain jurisdictions. I don't mind mentioning it. Florida was assignment of benefits and litigation on behalf of the claims, and there's a battle going on there. But by and large, when you put a legitimate claim into the system, the insurance industry is a very efficient model of paying that claim. We are not sitting there with a lot of complaints from our claimants."
},
{
"speaker": "Mark Hughes",
"text": "Very good. Thank you."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks Mark."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Josh Shanker with Bank of America. Please proceed with your question."
},
{
"speaker": "Joshua Shanker",
"text": "Yeah. Thanks for fitting me in. I just want to ask one follow-up to Greg's question earlier. You gave a hypothetical path about and I did it. Let's say there were 18 bidders on the property. Maybe now there's only 11. I guess it was only hypothetical, but 11 still seems a lot to me. I'm wondering in the market today are there still a lot of bidders who are flush with cash? Are they raising debt in this environment to make the acquisitions? What's their funding that keeps them around?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Well, a, I don't understand it, and I'm not smart enough too. So let's start with that. And b, yes, they're raising funds like crazy. One of our competitors that I won't name actually eliminated their integration team and their acquisition team. Announced publicly that they were no longer going to be actively pursuing acquisitions, they've got additional funding and they're back in the game. Go figure out who would sell to that. Not me. So then you go to other players that have been more consistent long term. And, yes, they're they received significant funding in the last 60 days. So they are flush. That capital's got to work. They didn't get it to put it interest. So there's competition out there."
},
{
"speaker": "Joshua Shanker",
"text": "And in terms of the price they are paying, I mean, I've always felt that there's not really a big patching going on. People want to come in partners with Gallagher and it's a choice acquirer compared to some others. Is there evidence that certain sellers are willing to not consider certain bidders who might be less of an attractive acquirer?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Well, I think so. So, I mean, I think that's a big part of our sales, that we are always talking about the fact that the differentiator here is twofold. One, we believe we have a great franchise that offers them the opportunity to expand their business. And if they love the business or they tend to stay in it, this is the best platform in our mind to trade from. So that starts it. And then, of course, you've got the cultural aspect. And we're competitive. We're not we're not trying to sell the fact that that should give them a deep discount. But there are, you know, there are people that sell for various reasons, and we don't win them all."
},
{
"speaker": "Joshua Shanker",
"text": "Thank you for the answers. Appreciate it."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Sure, Josh."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Meyer Shields with KBW. Please proceed with your question."
},
{
"speaker": "Meyer Shields",
"text": "Thanks. Two sort of big picture questions if I can. First, Pat, you talked about within wholesale and specialty. Open brokerage is growing a lot faster than MGA and binding business. Is there something you could talk us through why there's that gap in growth rate?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Sure. I'll toss that to Joel. Go ahead, Joel."
},
{
"speaker": "Joel D. Cavaness",
"text": "Sure. So, on the wholesale side, obviously, you work with larger accounts and larger accounts that end up in the wholesale space typically are larger accounts with larger exposures and a little tougher to play. So that would be really the first. And then really the second thing is the inflow of tougher accounts today that are coming out of the admitted market and coming into the several lines market or E&S depending on what your terminology is, is more robust. They're coming in very quickly because of especially the difficulty in the property market. So you would see a higher organic in that line versus our MGA binding business, which is more consistent, growing nicely, but it's more consistent in the nature of smaller accounts. So it doesn't move the needle as much."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Look at it this way. Another way to put in Meyers, one is troubled business, frankly. When we're doing open market broker, brokers are coming to us because they need our help on tough to place accounts that are going up in price. Our MGAs and programs are consistently writing smaller accounts that are not distressed, that are looking for specialty coverage or specialty expertise."
},
{
"speaker": "Meyer Shields",
"text": "Okay. No. That's very helpful. Thank you. That's definitely what I needed. Second question, I'm just wondering how should we think about reinsurance growth over the next year or so. Is there sort of a special maybe temporary boost because it's now under sort of doubters purview, and you can explain the benefits of that to the insurance company that you deal with worldwide and then once that happens, you're on a stable basis? Or is that a more enduring first of upside?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "No, I think that's an enduring thing. When this team was part of our competitor, Willis, they had a very good block of business underneath them. A very good firm they were part of. And I would say in fact similar economic. So we're not we're not changing that. But I think we do offer a different environment. We offer a different way of trading. We're bringing our retailers together with the reinsurance people at a much higher level or I shouldn't say higher level at a much greater frequency with much greater interaction than they were used to, which I do believe will fuel their growth. And I think it will accelerate beyond what they would have achieved, but that's what it could have should and we'll never know."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Perfect. Thanks so much."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Meyer."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Rob Cox with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Robert Cox",
"text": "Hey, thanks. I just had one question on pricing. I think you all had commented previously that Australia, New Zealand are potentially seeing a reacceleration in rate and the UK is also seeming quite strong. So I'm just curious if you're seeing or expect to see more of a divergence in the pricing trajectory between, the U.S. and the international business."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "I think they're pretty close to the same. Yes we're seeing some of those, but we're seeing, take D&O out of it right now. We are starting to see some uptick in workers' comp now. So, I mean, I don't see a lot of difference between what's going on in the U.S. and what's going on Canada, New Zealand, Australia, and the UK. So it's pretty close."
},
{
"speaker": "Robert Cox",
"text": "Got it. Thank you."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Sure."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi. Thanks. Just a follow-up on the margin side and thanks for all the color on the moving pieces. But within that 20 to 30 basis points, are you assuming that the fiduciary investment income is in line with the Q1 level over the remaining three quarters?"
},
{
"speaker": "Douglas K. Howell",
"text": "Yeah. That's pretty close. Yeah. That's right."
},
{
"speaker": "Elyse Greenspan",
"text": "And then, you know, I know I had asked earlier kind of just a question just in terms of just it seems like you're assuming a stable economy. Right? We see some forecasts out there for decelerating GDP or perhaps GDP to go negative. What are you guys assuming for GDP over the balance of the year?"
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Well, here's the thing. Translating it directly into GDP is a different exercise But one thing, you got to separate real versus nominal first and foremost. So I can only get a look at what's the growth in the insured values and insured, what's being assured there. Remember, we're not seeing that in our data right now. I'm looking down through our industry list right now, and we talked about construction earlier, heavy construction other than building construction contractors up 12.4%, construction special trade 8%, building construction up 8%. So you look through our industry list here, we're not seeing it. We're not seeing it in our dailies overnight. The cancellations are lower than before. Negative endorsements are lower than before. Audits are audits. They have a lag factor in there, so I wouldn't look at those two terribly carefully. But we're just not seeing this in our customer’s business at this point. And believe me, our customers, if they believe they're seeing a down turn one of the things they want to do is modify their insurance program because that's cash flow to them. So, we will know in two years how accurate our dailies are. But right now, they are pretty right over the last two years."
},
{
"speaker": "Elyse Greenspan",
"text": "And so even, I guess, if we still like, if you were thinking about what's going to have the greater impact, do we think about it being the economy and GDP or PNC pricing when we think about the next few quarters?"
},
{
"speaker": "Douglas K. Howell",
"text": "Both."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "But I think the pricing will far offset any modest contraction and exposure in it. I don't know what's going to contract in the next six months or what volumes are going to contract. We're just not seeing at least."
},
{
"speaker": "Douglas K. Howell",
"text": "But remember, Elyse, we are the beneficiary of inflation. There are very few industries out there that really get a benefit from inflation, and we do. So as building values go up and for and right now for the first time in the decade, carriers are very, very interested in what you're insure to make sure you're ensuring the value. This inflation is hitting building costs very hard."
},
{
"speaker": "Elyse Greenspan",
"text": "Thanks for all the color."
},
{
"speaker": "Douglas K. Howell",
"text": "Thanks, Elyse."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Thanks, Elyse."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from David Montemaden with Evercore. Please proceed with your question."
},
{
"speaker": "David Montemaden",
"text": "Hi. Thanks for taking my follow-up. So I've noticed the last few quarters just in the adjusted compensation ratio commentary in brokerage. Just the impacts from savings related to back office headcount controls. Could you maybe just touch on that? I'm assuming some of this has to do with leveraging centres of excellence. But I don't think you had mentioned that as a tailwind when we think about the margin roll forward. So, I guess maybe just help me think through that, maybe not only for this year, but, like, broader picture. How big of an opportunity that is leveraging the centres of excellence."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Well, maybe we back up and take a look. Do you remember some of our discussion about the sensitivity of our business to inflation? We said about 40% of it is neutral because it just moves more in tandem with premium -- with our commission rates because we pay people on incentive compensation basis there. Then we've got about 40% of our whole cost structure that is moderately impacted by inflation. And then we have 20% of it that might run a little bit more close to what headline is inflation knocking off some tops of certain things that maybe transportation, gas, etcetera on that. So when you add all that up, when you look at what could be facing an -- somebody like us that's pushing $6 billion worth of cost. If something if you say that, let's say, let's call it 30% of your – 25% of your cost structure is subject to – 75% of the headline inflation number. Just think about that. Let's say there's $4 billion, I'm just doing this off the top of my head that might have 6% or 7% inflation factor in it. That's a big number. Right? And I'm saying that the only thing that's really affecting us is $5 million to $8 million bucks a quarter on it. What that's saying is as we get more productive, not just from our offshore centres of excellence, but because of technology and other process improvements that are both domestic and offshore centres of excellence. That is absolutely controlling against inflation out there. So there is substantial uplift that's happening every day because of our productivity work, our quality work and our offshore centres of excellence. And I just kind of did that off the top of my head, but you get the point. You'd see a heck of a lot more cost or expense dropping into the bottom line if we didn't have our offshore centres of excellence."
},
{
"speaker": "David Montemaden",
"text": "Got it. Nope. That makes sense. Thank you for that."
},
{
"speaker": "J. Patrick Gallagher, Jr.",
"text": "Sure. We're pretty proud of the quality that comes out of that operation too. Well, thank you very much everyone. Appreciate that and thank you for joining us today. As you could tell, we're extremely pleased with our start to the year. We posted a great quarter. I'd like to thank all our colleagues for their outstanding efforts this quarter. We are people business and I believe we have the best people at Gallagher. We look forward to speaking with you again at our IR Day in June. Have a nice evening, and thanks for being with us."
},
{
"speaker": "Operator",
"text": "This concludes today's conference call. You may disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 4 | 2,024 | 2025-01-30 17:15:00 | Operator: Good afternoon and welcome to Arthur J. Gallagher and Company's Fourth Quarter 2024 Earnings Conference Call. Participants have been placed on listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute follow-looking statements within the meaning of the security laws. The Company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and Risk Factors sections contained in the Company's most recent 10-K, 10-Q, and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations to the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the Company's website. It is now my pleasure to introduce J. Patrick Gallagher Jr., Chairman and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
J. Patrick Gallagher Jr.: Thank you very much. Good afternoon and thank you for joining us for our fourth quarter 2024 earnings call. On the call with me today is Doug Howell, our CFO, other members of the management team, and the heads of our operating divisions. Before I get to my comments about our financial results, I'd like to acknowledge the tragic wildfires in California. Our heartfelt thoughts are with all those impacted, including our own Gallagher colleagues. Our Company and industry have such an important role and responsibility, helping families, businesses, and communities rebuild and restore their lives. And like many times before, Gallagher and the industry will rise to the occasion. Okay, on to my comments regarding our financial performance. We had an excellent fourth quarter. For our combined brokerage and risk management segments, we posted 12% growth in revenue, our 16th consecutive quarter of double-digit revenue growth, 7% organic growth, reported net earnings margin of 13.5%, adjusted EBITDA growth of 17%, and adjusted EBITDAC margin of 31.4%, up 145 basis points year-over-year. GAAP earnings per share of $1.56, and adjusted earnings per share of $2.51, up 15% year-over-year. The December capital raise for the acquisition of AssuredPartners creates some noise in these headline numbers, so I will peel back the impact in his comments. Regardless, another fantastic quarter to close out another terrific year by our team. Moving to results on a segment basis, starting with the brokerage segment. Reported revenue growth was 12%. Organic growth was 7.1%. Base commission and fees were 7.8% in line with our expectations, which got offset a bit by slightly lower contingents. Adjusted EBITDAC margin expanded 168 basis points to 33.1%, which includes interest income related to funds raised for the acquisition of AssuredPartners. Excluding that interest income, margin expansion was 109 basis points. Let me give some insights behind our brokerage segment organic. With our P/C retail operations, we delivered 6% organic overall. The U.K., Australia, and New Zealand were all in the high single digits. U.S. retail organic was around 5%, and Canada was down a couple percent, impacted by lower contingents. Our global employee benefit brokerage and consulting business posted organic of about 10%, a really strong finish that includes the catch-up of the large life case sales that shifted from earlier in 24. Shifting to our reinsurance wholesale and specialty businesses, in total organic of 9%, which overcame some expected market headwinds in our global aerospace business. So very strong growth, whether retail, wholesale, or reinsurance. Next, let me provide some thoughts on the P/C insurance pricing environment, starting with the primary insurance market. Overall, the global P/C insurance market continues to grow. With fourth quarter renewal premium increases, that's both rate and exposure combined, consistent with the past two quarters. Thus far in January, renewal premium increases are ticking slightly higher than fourth quarter and are above 5%, driven by increases in casualty lines like umbrella and commercial auto. Breaking down fourth quarter global renewal premium changes by product line, we saw the following. Property and professional lines were about flat. Workers' comp up 1%, general liability up 4%, commercial auto up 9%, umbrella up 10%, and personal lines up 9%. So we continue to see increases across most lines and geographies. Carriers are behaving rationally and pushing for increases where it's needed to generate an acceptable underwriting profit. It's a great market for us to operate in because we can further differentiate ourselves with our leading tools, data, and expertise. Remember, our job as brokers is to help clients find the best coverage that fits their budget while mitigating price increases. We're becoming more successful securing lower pricing for our property customers, especially cat exposed property, which enables them to buy more limit or reduce their deductibles, resulting in more coverage for the same spend. Shifting to the reinsurance market. Overall, 1-1 renewals were orderly and reflected an environment that generally favored reinsurance buyers. Growing demand for property cat cover was met with sufficient reinsurance capacity, despite 2024 being an elevated year with more than $150 billion of estimated insured natural catastrophe losses. This resulted in property price declines that were greater at the top end of reinsurance towers, and similar to January 24 renewals, reinsurers continued to exercise discipline on terms and did not revert to attachment points that exposed them to greater frequency. Reinsurance buyers of specialty coverages saw modest price declines across many lines of coverage, but again, no softening in terms and conditions. Shifting to casualty, while there was adequate reinsurance capacity, reinsurers remained cautious on U.S. casualty risks due to elevated loss cost trends and potential reserve deficiencies. Looking forward, wildfire losses and casualty reserve increases seem to be the stories here in January, and time will tell how each of these ultimately impacts the market. Regardless, Gallagher Re had a fantastic 1-1 with some nice new business wins and should continue to excel in this environment. Moving to some comments on our customers' business activity. During the fourth quarter, our daily revenue indications from audits, endorsements, and cancellations remained in net positive territory. The same is true for full year 2024. While the activity is not quite as high as 2023, the upward revenue adjustments this past year are very close to full year 2022. So we continue to see solid client business activity and no signs of a meaningful global economic slowdown. Within the U.S., the labor market remains strong. Since April 24, the number of open jobs has remained relatively steady and at a level that is still well above the number of unemployed people looking for work. Employers are looking for ways to grow their workforce and control their benefit costs. And at the same time, faced wage increases and continued medical cost inflation, both are headwinds that our professionals are helping to navigate. Regardless of market conditions, I believe we are well positioned to take share across our brokerage business. Remember, 90% of the time we are competing against the smaller local broker that cannot match our niche expertise, outstanding service, or extensive data and analytics offerings. So with some nice momentum in net new business production across our brokerage business, a P/C market still seeing mid-single-digit premium growth, and a strong U.S. labor market, we continue to see full year 2025 brokerage segment organic in the 6% to 8% range. Moving on to our risk management segment, Gallagher Bassett. Revenue growth was 9%, including organic of 6%. Heading into 2025, we should continue to benefit from excellent client retention, increases in our customers' business activity, and rising claim counts. Adjusted EBITDAC margin was 20.6% in line with our October expectations. Looking ahead, we still see full year 2025 organic in that 6% to 8% range, and margins around 20.5%. Shifting to mergers and acquisitions. During the fourth quarter, we completed 20 new tuck-in mergers at fair prices, representing around $200 million of estimated annualized revenue, bringing the full year to $387 million. For those new partners joining us, I'd like to extend a very warm welcome to the Gallagher family of professionals. And of course, the big news in December was signing an agreement to acquire AssuredPartners with $2.9 billion of annual pro forma revenue. It's a compelling opportunity to build upon our commercial middle market focus, deepen our niche practice groups, and further leverage our data and analytics, allowing us to provide even more value to clients. It should also expand our tuck-in M&A reach and create more retail and specialty revenue opportunities across Gallagher. What is especially exciting is that the combination involves two highly innovative, entrepreneurial, and sales-based cultures. Although we will continue to operate as two independent companies until close, we have started discussions and are very impressed with the talent, professionalism, and excitement of the Assured colleagues. We anticipate we will receive necessary approvals and complete the acquisition sometime here in the first quarter. In addition to the pending Assured Partners acquisition, we have about 45 term sheets signed or being prepared, representing around $650 million of annualized revenue. Good firms always have a choice, and it would be terrific if they chose to partner with Gallagher. With a strong close of the year, let me reflect on our full-year financial performance for brokerage and risk management combined. 15% growth in revenue, 7.6% organic growth, 18% growth in adjusted EBITDAC, 48 mergers completed with nearly $400 million in estimated annualized revenue, and we signed a definitive agreement to acquire AssuredPartners. These are terrific metrics. And as proud as I am of the excellent financial performance this year, I'm more proud of the way our culture has stayed true as we continue to expand. Our culture is about our colleagues, guided by the Gallagher way and a rock-solid foundation they form based on every interaction we have, whether it's clients, carriers, future merger partners, or with our Gallagher colleagues around the globe. Frankly, our culture is unstoppable, and that is the Gallagher way. Okay, I'll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks, Pat, and hello, everyone. Today I'll quickly recap some sound bites from our quarter and replay our early thoughts on 2025, most of which Pat just touched on, then use the rest of my time to unpack the impact of the AssuredPartners financing activities on our results during the quarter. Then I'll wrap up my prepared remarks with my usual comments on cash, M&A, and capital management. Okay, highlights from our fourth quarter that you'll see in our earnings release. Terrific base commission and fee organic growth of 7.8%, solid supplemental growth of 4.7%, and while contingents went backwards a bit this quarter, we don't see that as a trend by any means. As I look to 2025 brokerage organic, Pat relayed that we're in a favorable environment with rates still needing to increase to cover higher loss costs, trillions of global premiums growing and inflating, and our sales and service offerings outpacing our competitors, which should increase both new business and our retentions. So as we sit here today, we still believe our full year 25 brokerage segment organic growth should be in that 6% to 8% range. That's unchanged from what we said in October. As for brokerage margins, a little noise on page 5 of the earnings release. Please see the footnote. You'll read that the margin was aided by about $20 million of interest income earned on cash we're holding to close AssuredPartners. Adjusting for that, our margins would have been 32.5%, up 109 basis points over last year. That's nicely above our October expectation of margin expansion in the 90 to 100 basis point range. Looking ahead to 25, we are still viewing margin expansion like we have, like we've said many times before. We see margin expansion starting around full year organic growth of 4%. At 6%, maybe we could see 50 basis points, and at 8%, perhaps 100 basis points of expansion. Of course, those ranges can then be impacted by changes to interest income on our fiduciary assets, and then the rolling impact of M&A. By our March IR date, maybe we'll have a better read on where interest rates might go, and also the impact of Assured rolling into our numbers. But at this time, we don't see either having a significant impact on those ranges. So, really no change to how we're thinking about margins in 2025. As for risk management, another solid quarter posting 6% organic. Admittedly, a couple million dollars below our October expectations, all stemming from a smaller quarter of construction consulting revenues in the Northeast that can be just a little bit lumpy. So, adjusted margin expansion of 20.6% in the quarter was also in line with our October expectations. And then looking forward, we're seeing full year 25 organic also in that 6% to 8% range, with margins again around 20.5% for the year. So, a great quarter and full year by both our brokerage and risk management teams, and both have a strong outlook for 25. Turning to page 6 of the earnings release and the corporate segment shortcut table. For the interest and banking line, we are a bit better than our October forecast because we just were not into our line as much as we thought at that time. For the adjusted acquisition lines for M&A and clean energy, both were close to our October expectations. Then, when you look at the corporate line of the corporate segment, that was better than our expectation due to unrealized non-cash foreign exchange remeasurement income, which was partially offset by a return to actual tax catch-up of about $4 million. So, let's move from our earnings release to the CFO commentary document that we post on our IR website. First, an overarching statement. Please take some time to read any headers or footnotes throughout this document to understand what information has or hasn't been updated for the AssuredPartners deal. So, let's move to page 3 for our modeling helpers. Across the board, fourth quarter 24 actual numbers were fairly close to what we provided back in October. As for 25, we provided a first look of what we forecast. Again, none of these numbers include any impact from AssuredPartners. Turning to Page 4, a first look at our corporate segment outlook for full year 25. The only impact of Assured is found in the interest and banking line. It includes additional interest expense from the $5 billion debt raise. Flipping to Page 5 of the CFO commentary document to our tax credit carry forwards. As of year end, about $770 million that will be used over the next few years. So, still a nice sweetener to fund future M&A. We would not expect those numbers to move much because of the assured financing or the roll-in of assured's taxable income. That's because of the interest shield and also the amortization of the $5 billion deferred tax asset that we'll get with AssuredPartners. That should save us about $1.4 billion of taxes over the coming years. Flipping over to Page 6, the investment income table. This table includes an assumption of two 25 basis point rate cuts in 25. It includes interest income from cash we're holding to pay for Assured, assuming a late March close. But it does not include interest income from Assured's fiduciary assets after closing. When you shift down on page 6 to the rollover revenue table, the pinkish columns to the right include estimated revenues for brokerage M&A that we closed through yesterday. And below that table, we've added a separate section for AssuredPartners' revenues. Again, assuming a late March close, which of course is highly dependent on regulatory approvals. Then, just a reminder, you also need to make a pick for other future M&A. And then further down on that page, you'll see the risk management segment rollover revenues for 25 are expected to be approximately $5 million for each of the first two quarters. All right, moving to Page 7. This is a new page to help you see the impact of the assured partners' financing on our fourth quarter 24 revenues, EBITDAC, net earnings, and EPS by segment. The three items just to keep in mind. There was additional incremental interest income on the cash that we were holding to fund the acquisition. There was additional interest expense we incurred on the newly issued $5 billion worth of debt. And then the additional shares outstanding from the December equity offering. You'll see that for fourth quarter, it all nets out to nearly nothing, but it does cause a little noise in our numbers. Also, the callout box on the right of that page provides some information on shares outstanding because of the assured partners' equity rates for our first quarter. This includes the full impact of the shares we issued in December and the exercise of the green shoe in early January. Finally, if you flip to Page 8, you'll see that this page is just a repeat of what we provided in the December Assured presentation for ease of reference. There's no new news on this page. Finally, let's move to cash, capital management, and M&A funding. Available cash on hand at December 31st was more than $14 billion, of which approximately $13.5 billion will be used to fund AssuredPartners. Since year end, we received another $1.3 billion as the underwriters exercised the green shoe. So, considering this and our strong expected free cash flow, we are in an excellent position to fund our M&A pipeline of opportunities. Here in 25, it's looking like we could have $3.5 billion to fund future M&A. Then it jumps up to nearly $5 billion in 26, all while maintaining a solid investment grade rating. So, an excellent quarter and an excellent year to have in the books. As I reflect on 24, I have to say that we had a pretty terrific year. For the combined brokerage and risk management segments, we posted adjusted revenue growth of 14%, organic of 7.6%, overall margin expansion of 94 basis points, and most importantly, we grew our EBITDAC 18%. Those are terrific numbers and reflect what Pat said. That's our unstoppable culture. So, those are my comments. Back to you, Pat.
J. Patrick Gallagher Jr.: Thanks, Doug. Rob, you want to open it up for questions?
Operator: Sure, Mr. Gallagher. We'll now open the call for questions. [Operator Instructions]. Now, our first question comes from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question.
Mike Zaremski: First question is surrounding the cadence of organic growth next year. Loud and clear, 6-8, no change. I guess, yes, for both segments. I guess I'm more specifically focused on the brokerage segment. But in terms of the cadence or seasonality, anything you'd like to call out? Two of your peers called out kind of weaker seasonality in 1Q. We do know that reinsurance is overweight in the beginning of the year, too, and maybe downwards pricing there could cause some year-over-year tougher comps.
Doug Howell: Let me go back to that. Let me start with the end of that. There have been some price changes on the reinsurance, but our customers are buying more reinsurance. So when you look at the total spend for us that our customers are spending, we're really not seeing a decrease, and like Pat said in his comments, we had a terrific new business quarter also. Going back to the first part of your question, yes, reinsurance is typically stronger in the first quarter, and so you could see some seasonality of better organic growth in the first quarter than what develops out for the rest of the year. I'll study in a little bit about that, as we do have a substantial amount of our health and medical benefits that renew in the first quarter that mitigate maybe a higher reinsurance on it. And then throughout the year, our retail is performing well. Our wholesale seems to be getting stronger and stronger. Our programs are doing well. But, yes, you would see a little seasonality because of reinsurance in the first quarter and our organic growth.
Mike Zaremski: Okay, got it. So you're saying actually it could be higher, not lower, even if reinsurance pricing is down? Okay.
Doug Howell: I'll have a chance to talk to you again on our March IR day, and we should have a better feel of the seasonality for that, too.
Mike Zaremski: Okay, awesome. The last question is on, do we share investment income? I'm thinking through post the deal close, if you're able to comment. So my understanding is that the company you're purchasing kind of didn't fully leverage its fiduciary income in that it was direct pay relationships between the businesses paying directly to the insurance carriers, and you guys might be able to optimize that working capital to gain more fiduciary assets. If that's what I'm describing is correct, can you offer kind of a timeline on how that works in terms of kind of getting those asset balances onto your balance sheet?
Doug Howell: Yes, your recollection is correct, and I think that if you go back, I don't know, 10 years ago when we went through our exercise in consolidating bank accounts from around the world, this would be obviously mostly in the U.S. We did have some good success of picking up more fiduciary cash into our accounts, and I think that would be invested. So we do see that as an opportunity that we'll be better together on that metric. So, yes, there should be versus their run rate, I'm guessing together we'll be better on that going forward.
Mike Zaremski: Doug, is there just any, is that kind of a one-year process, or that kind of takes many years?
Doug Howell: Listen, in 18 months we shouldn't be talking about it anymore, so I think we'd get it done. Hopefully faster.
Operator: The next question is from the line of Gregory Peters with Raymond James. Please proceed with your question.
Gregory Peters: I guess I'd like to start with California. Given the substantial potential loss to the insured market, I'm curious if you could give us some perspective of how it might touch your operations. I'm interested in, you know, the business going inside RPS, if there's any impact on the wholesale market that you're seeing. If you can just talk about your perspectives of that as we watch this disaster unfold, that'd be great.
J. Patrick Gallagher Jr.: Well, first of all, Greg its Pat, we reached out to thousands of clients already to make sure that they had the knowledge of how to file claims and what have you, how to get a hold of us if they're having difficulty in filing those claims. We are presently tracking, I forget the exact number today, but we have hundreds of claims that we're helping our clients with already. I think that you've got a situation that is going to continue to unfold for us. We're a big player in California. We're a big player in Los Angeles. Not huge in personal lines there, but it's going to keep us incredibly busy for a number of months. And then in terms of the impact of that, luckily, again, we've been able to stay in touch with our people. We have had our folks in some instances were evacuated. We did not lose anybody and don't have many of our folks that have lost any of their homes. So I think we'll be well in a strong place to help our clients, but I can't give you much more than that right now in terms of how it's going to impact our day-to-day activities out there.
Gregory Peters: Okay. And then I guess my follow-up question is switch gears. You mentioned in your comments about the lower contingents. Just curious, given the profitability we're seeing in the industry, I would have imagined that supplementals and contingents would be up. And I think your guidance for 25 suggests that they should go back up again. But maybe you could spend a minute and give us some color on what happened with contingents in Europe, and then color on your outlook.
Doug Howell: Yes, great question, Greg. Thanks for asking. Like I said, I ended in my comments. This isn't a trend, and what you said there is right. We would expect it to bounce back up again. Frankly, it's simply because as we get the final year and loss ratio estimates in from the carriers, they're coming in just a little bit higher than what maybe we had been anticipating throughout the year. And to put this in context, we see this as about maybe a $7 million shortfall to what we were thinking back in October. Two-thirds of it is spread across hundreds of contracts. And so if the loss ratios are ticking up just a little bit, that probably costs us $4 million of it. And then another third is we had about three contracts and programs in Canada that just really kind of came in here in January with really not very great results. But if you look at it on an annual basis, when you combine supplements and contingents, I think if I do the math here, mentally I think it's about 8%, even with the small blip in the fourth quarter. So it's still a terrific year. But I wouldn't over-read that there's some systemic shift in what contingents and supplementals are going to be going forward. So I would expect those numbers to grow over the blip this year considerably.
Gregory Peters: Just a clarification on that answer, Doug, is there a specific line of business? Is there across a broader business set?
Doug Howell: It's across the line, Greg. I wouldn't say there's anything there. We have hundreds of these contracts, and we get a lot of this information coming in here right around the first week or two of January.
Gregory Peters: Thank you for your answers.
Doug Howell: I guess another way of saying it, on a $600 million number, only to have maybe $3 or $4 million of what I would say loss ratio, I think our picks have been pretty good throughout the year.
Gregory Peters: I would say so.
Operator: Our next question comes from the line of Andrew Kligerman with TD Securities. Please proceed with your question.
Andrew Kligerman: First question is around the risk management segment. Thinking back to last year, you had guided to 9% to 11% organic growth for this year, and now for next year, for 24, that is, and now for 25, you're guiding to 6 to 8, which I still think is fabulous. But what's kind of changing that your guidance isn't quite as robust as it was to start last year?
Doug Howell: Here's the thing. I think that this business, if you recall, we can get some pretty large contracts that come in. It is a little bit more elephant hunting, so to speak. So this year, I think that we've got some nice new business in the pipeline coming into 25, and so I'd leave you to go back in the history of Gallagher Bassett and the risk management segment. We have periods like this where it will grow mid-single digit, something like that, and then they'll have a couple of nice large contracts. We still see that happening. Some of our government programs that we do down in Australia have some nice opportunity, and then more and more we're proving to the carriers left and right that we can actually deliver better claim outcomes on that business. And as a carrier decides to use us for their claims payment process on work comp and general liability, we're not storm chasers, remember, but it is a little bit more of a lumpy business as we get some pretty nice size.
Andrew Kligerman: I see. So like you never know, you could probably find another elephant this year, right?
J. Patrick Gallagher Jr.: Yes, that's right. Our process list is always filled with elephants. They're just hard to find every once in a while.
Andrew Kligerman: And then I'm just kind of curious about your operations in India, the Center for Excellence, where I think you have about 12,000 employees right now, and, as you look out through this year, do you need to add people, given the AssuredPartners transaction? Can you keep it steady? And, you know, is technology making it such that you really don't need to hire that much?
J. Patrick Gallagher Jr.: Well, I think you got both ends of that correct. We're going to be using technology quite a bit, and as we use technology that does make that group there much more efficient, and yet at the very same time our organic growth and our acquisition growth puts a lot more demand in the structure. And so at about 12,000 employees, I think that at this time next year you'll see us up additional thousands.
Doug Howell: Yes, the other thing, too, to think about this, the value that it brings is when work goes into our service centers, remember those are our folks. They're not working for anybody else. They work for us. It causes standardization. It causes process improvement. I got to tell you, that gives us a head start by years and years when it comes to implementing technologies and AI into the work that's already been standardized. And truthfully, as we develop AI technologies that replace some of that work there, all of those folks have opportunities to, because our growth, they don't lose their jobs. It's just they move up higher in the value chain on it. And so it's really a juggernaut, in my opinion, in terms of our ability to offer some of the very best service in the world.
J. Patrick Gallagher Jr.: And unless you standardize that service, A, you can't automate it. But, B, when you do standardize it, it makes you better and better at the service for our clients. Just take certificates of insurance. We're going to issue three, four million of them pretty much error-free. There aren't any real brokers that can claim that.
Andrew Kligerman: I see. So maybe with the bottom-line takeaway is, you may add a thousand or two employees, but it's still scalable. You're still getting better margins from that. Is that the right final takeaway?
J. Patrick Gallagher Jr.: Yes, you're right on the money.
Andrew Kligerman: Thank you.
Doug Howell: It won't surprise me that, like-for-like, in five years we've doubled that number.
Operator: Our next question is from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question.
Elyse Greenspan: My first question is on the brokerage outlook for 25. So you reaffirmed the six to eight. I think when we last spoke in October, you said, maybe benefits is a five. Reinsurance is a nine. I want to confirm that's where you still see it. And then you also had said you would provide, I think, by line in a little bit more detail at the December day, right, which did not happen. Could you give us a sense even away from benefits and reinsurance, just how you see all your businesses trending organically in the 6% to 8% 25 brokerage guide?
Doug Howell: I think, yes, confirming everything you've said. So I think Pat did a pretty good job in his script of telling you how those businesses are growing right now. I think those are good guesses for next year at this point.
Elyse Greenspan: Okay. That's helpful. And then my follow up question. How do you see how's their pipeline of transactions? Right. You guys also did, a good number of bolt on deals to end the quarter. And, in terms of the AP pipeline, I know when you guys announced the deal, you highlighted the fact that there was very little overlap on pipelines. So would you expect, I guess, once that deal closes, at some point at the end of the Q1, I guess that kind of just the quarterly level of M&A activity, could pick up from bringing the two firms together.
J. Patrick Gallagher Jr.: So Elyse, this is Pat, I think that, first of all, we have to continue to operate these enterprises separately till we're closed. But we do know that there's very little overlap at all. And AssuredPartners has been very, very good at tuck-in acquisitions. And as you saw in our -- when we were making the announcement, there has not been that much overlap between things that we wanted to put on and things that they actually bought. So we view their pipeline is very, very accretive to what we're doing and not a lot of overlap. And I think that's going to be fantastic. They've got a great team doing this stuff. We're impressed with what we've seen and due diligence and the like as to what they've done, what they've bought and the pricing they're getting for that. And I think you will see us increase substantially the number of deals. Now, there's small deals. They're very good at tuck-in, bolt-ons and small, privately held firms in and about many of the parts of the country that we're not in.
Elyse Greenspan: And then the 1.3. Oh, sorry.
J. Patrick Gallagher Jr.: I'm sorry. Go ahead.
Elyse Greenspan: I was just going to say the 1.3 billion from the green shoe, right, that wasn't contemplated because the financing was there without it. So is that just extra cash that you have for the pipeline, the capital that Doug was talking about in his comments.
Doug Howell: Yes, that's right.
Operator: Our next question is from the line of Mark Hughes with Truist Security. Please proceed with your questions.
Mark Hughes: Doug, the guidance you gave for the first quarter contribution from AssuredPartners. Is there any seasonality there or is that just the timing of the deal?
Doug Howell: Right now, we've assumed that's just the timing of the deal. They will have some seasonality, especially in their benefit business. And then anything that might be a public entity type business might be skewed to July. So you'd see a little bit of seasonality. But what you see in there is a pure straight line assumption of it.
Mark Hughes: And then, Pat, in the wholesale business, you gave the wholesale and reinsurance together. I think up 9%. Any detail you can provide on wholesale observations on the E&S market?
J. Patrick Gallagher Jr.: Let me take a look, Mark.
Doug Howell: Yes, I think I've got that. I think that you've got to look at our U.K. specialty at maybe around 7%. You look at U.S. specialty, maybe on the 10%, re is pretty small in the quarter. It's just not a big quarter for us. So if you look at those two numbers, when we would get that maybe that gets us back to that that 9% number there.
Operator: The next question is from the line of David Motemaden with Evercore ISI. Please proceed with your question.
David Motemaden: I had a question for Doug, just trying to unpack the brokerage organic this quarter. And I don't want to nitpick too much, but you guys were looking for 8%. And I'm just wondering, so what was the entire differential? Just the contingent and the life sales came back as expected, and it was just totally offset by the contingent. I'm hoping you can unpack that a little bit.
Doug Howell: Yes, you're right. The base commission and fees at 7.8% percent. That business contingents and supplementals have been running kind of consistent with that together. So the difference of the $7 million, I'd put it up in the upper 7% range, somewhere pretty close to the base contingency. So you're right. You're spot on in your observation there.
David Motemaden: Okay, great. Thanks for confirming. And then I wanted to follow up just on I guess I was surprised the RPC stayed at 5%. Just given the property price was flat versus up for last quarter. So I'm wondering if maybe it's mixed, but I'm wondering if there's anything else from sort of like an increased purchasing or buy up dynamic that you guys are observing as the property rates moderate here.
Doug Howell: Well, we see that across that. Yes, I mean, we've always said it's been a long time. We've talked about this as rates are going up. Customers opt out of certain coverages. And that might be by raising deductibles or reducing limits on it. Sometimes they'll drop some coverages. So remember rates are still increasing. I think it's important for everybody to realize that kind of across the board, we're still in a rate increasing environment. They're buying more insurance. And reinsurance you're seeing that from the carriers that they're buying more. And then the customers, they are buying more coverage on it. So they'll opt in.
J. Patrick Gallagher Jr.: Insurance to value is a big deal. Much more pressure on insuring to value.
David Motemaden: Got it. Thanks. And then maybe just to sneak one else in, one other one in. Doug, I think you had said last call that the underlying brokerage business is running at like a 7% to 8% organic growth. Just on an underlying basis, but then the 25 range is in the 6% to 8% range. So I guess I'm wondering, is that 6% percent just sort of conservatism? Like what sort of scenario would sort of get that, get you guys out of that, 7% to 8% range?
Doug Howell: Well, listen, I think right now that, we said way back in October that, next year felt a lot like this year. And we're kind of in that mid-7% range somewhere this year. The range around it sitting and looking out over the next 11.5 months, I guess, that it's 6% to 8% is consistent, what we've said before. So we think we'd like to stick with that. I think our team's working pretty hard to always be better than the midpoint of the range, obviously. But the market's changing. We'll see what wildfires do. We'll see what casualty reserves will do. We're still digesting that. I will say on the wildfires, maybe you know this. I still don't know how the extra living expenses have been factored into the wildfire estimates for the cat loss on that. And then, you can't open up the news any day without somebody taking a casualty reserve strengthening. So those things, will cause carriers to take a really hard look at what they're doing with the rates. So within 2% is a pretty good guess as we look for the year. Isn't it nice being in that range versus years ago when we were pretty excited about 1% or 2% organic growth?
David Motemaden: No, completely agree. Thank you.
Operator: Our next question is in the line of Katie Sakys with Autonomous Research. Please proceed with your question.
Katie Sakys: I guess my first question is, thinking about the last call, I think, Doug, you'd mentioned that you expect brokerage organic growth in 2025, split between the components to come from about half new business and then perhaps a quarter each to rate and exposure. Has your perspective on the components of that brokerage organic growth guide changed in the context of the AssuredPartners acquisition?
Doug Howell: No. Pat summarized it pretty quickly. That's what we're still seeing happening right now.
Katie Sakys: Okay. Sounds good. And then, it looks like international retail brokerage growth kind of continues to cool off a little bit. How are you guys thinking about the environment for organic growth abroad this year versus what looks like perhaps a little bit more stable growth in the U.S.?
J. Patrick Gallagher Jr.: Katie, I think you got to really look at that by geography. I mean, there's parts of the world that are just really, really growing incredibly well. We set our board meeting and did a deep dive into some of our Latin American businesses, not huge in part of the whole overall enterprise, but incredibly nice growth there. And so there's -- it depends. Canada, a little bit of a slowdown this past quarter. We talked about that. But as you look across the whole patch, it's hard to put a finger on it, which is why we try to give you a guidance in terms of the overall how it should shake out. But we definitely have some geographies that are doing extremely well and just have continued future growth that is going to be fantastic.
Doug Howell: Yes. Katie, one of the things I'm kind of looking at what we said this quarter versus what we said back in October. We didn't have an opportunity to update you in December. But U.K. retail especially is still in high single digits. We said that it was 6% percent before. U.K. retail, I think we said 8%, and this quarter we're saying closer to 9%. Canada, maybe the one that's poking its head out to you a little bit, we said is more flattish, and now we're down a point or so. And then Australia, New Zealand, we said is about 10% maybe in October, and we're still in the very high single digits on that. So I don't know if it's necessarily – it might be just that Canadian piece that pops out at you that's causing you to have that perspective.
Katie Sakys: Appreciate the additional color there. Thanks, guys.
Operator: The next question is from Meyer Shields with KBW. Please proceed with your question.
Meyer Shields: I like how everyone's claiming they're Canadian. Doug, you mentioned –
Doug Howell: I'll tell you personally, Meyer.
Meyer Shields: Yes, I'll try not to. You mentioned, obviously accurately, that there's a ton of adverse development that we're seeing in general liability. And I was wondering whether there's any direct impact when you've got, I don't know, more frequent claims or more attorney involvement in terms of how Gallagher Bassett grows revenues.
J. Patrick Gallagher Jr.: Well, I mean, clearly claim activity helps this far. I mean, there's no question about it. But when it comes to severity, we don't participate in our clients up or down in terms of severity. We do everything we can to manage the final outcome, and we contend, and we believe we have the data and analytics to prove this, that if you hire Gallagher Bassett, your outcomes, meaning your final settlements, will be superior. And that does not mean that we're taking advantage of the claimant. That means that we're handling the claimants actually better than you see in the general market. So if you've got some severity out there, and that creates frequency, frequency definitely helps Gallagher Bassett. We get paid essentially on a per-claim basis, as does economic growth, because with economic growth comes more employment. And remember, most of Gallagher Bassett's revenues, a good portion of them, are workers' compensation driven.
Doug Howell: Yes, I think one of the things, all of those forces actually should cause clients to look at Gallagher Bassett even more. The way we can do nurse case management, the way we have our managed care offering, the way that we can understand where there are opportunities to use different physicians. We also understand the attorneys, because we deal with them so often. When claims get more complicated, Gallagher Bassett actually can show more value to the customer. And I think that's the environment we're in. They're paying $12 billion, $13 billion, $14 billion of claims, and they get pretty good at that.
J. Patrick Gallagher Jr.: And remember, by and large, about $0.60 to $0.65 on every premium dollar turns into a claim. That's the function of the industry. We're seeing that, of course, in the West Coast. And so if you're going to have an impact on your costs, you better pay attention to that portion of the dollar that goes out the door in claims. Again, we think we do that at a level that's better than the competitors, both TPAs and carriers.
Meyer Shields: Okay. No, that's very helpful, very thorough. Switching gears, I'm just looking for an update on the multiples for M&A, because we've seen not only your acquisition of AssuredPartners, but a lot of the other big brokers out there have made big acquisitions. I don't know if that speeds up or decelerates competition for tuck-ins.
J. Patrick Gallagher Jr.: Well, this, of course, is all speculation on my part. But remember, and we try to share it pretty much every quarter, what we are buying at. And you're not seeing our tuck-in acquisitions and the activity that we do on our smaller deals anywhere near the treetop levels of multiples that have been running up over the years. I do think that the AssuredPartners acquisition, we have a very smart seller. I think we were an opportunistic buyer, and I definitely think there's a signal there.
Operator: Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question.
Rob Cox: Hey, thanks. And I apologize for asking another question on brokerage organic. But when you consider the 6% to 8% organic growth range, could you give us some insight into what level of renewal premium change you're thinking about within that? Because I'm wondering if you're assuming sort of some of the acceleration that you think may be happening in the casualty market, or if you don't need that to achieve the 6 to 8.
Doug Howell: Yes, I think that estimate is not assuming that there's tailwinds produced by the fires or the casualty strengthening. We kind of see that in the current environment we had. Like we said earlier, we think that net new business over loss will contribute about half of that number. We think that exposure will be about a quarter of it, and rate will be about a quarter of it. So there's not a big assumption for rates in here, nor is there a really big assumption for exposure unit growth. I mean, this is just what we're seeing in our net new business wins right now. We're showing pretty well out there in the field. And here, go back to what we said before. When there's not as much chaos in the market, we get to show our tools and capabilities shine brighter in those environments. Because when it's chaotic in the environment and customers are listening to big rate increases, they're just trying to get their insurance placed. They're already a bit stung by the fact that rates are up. We work very hard to keep those rates down for them. Now we'll be able to go in and show prospects, just in a level playing field here. When things aren't chaotic, you should be using our tools and capabilities to buy your insurance through us, or let us buy your insurance for you using our capabilities. So this is an environment where we believe our new business will shine. We think our service offering is getting better and better every day. We have insights into what clients might be a little shaky. Let's get out and talk to them and make sure that we get the renewal put to bed soon. So I think that this is an environment where I think that our folks can shine with the tools and capabilities that they have.
J. Patrick Gallagher Jr.: I would have killed in the past, as Doug alluded to, when we were talking about up one, up two, for a 5% premium rate growth as an environment. That would be nirvana 10 years ago. So I think it's a very strong place to be. Remember, our job is to mitigate that for our clients. But it's a great place for us to show exactly what Doug was saying, which is our capabilities. In particular in the areas of data and analytics, which I want to remind the listeners, you don't get a chance to listen to the smaller brokers that we're competing with on a quarterly basis. We're pulling away from them more and more with our capabilities. And clients, I'm talking middle market clients, very much appreciate the ability to sit and talk with them about people like you buy this, or you should have this type of limit, because in our data we see losses at this size. That capability is just getting more and more attention by the buying community, and it's differentiating us every single day to a greater level.
Rob Cox: That makes sense. Thank you for all the color. Pivoting to reinsurance brokerage, I just wanted to ask, because I know your growth has been a good bit stronger than your two largest competitors in the reinsurance brokerage space for a number of years now. And Gallagher has a lower revenue base, but it doesn't seem like that would be the only driver of the outperformance. So I was hoping you could remind us what's driving Gallagher's ability to deliver what's been more like double-digit organic growth in reinsurance.
J. Patrick Gallagher Jr.: Well, I think that it's just blocking and tackling. I think one of the things that we've found there is it's a great sales team. They're backed up by terrific analytics, incredible capabilities in consulting on capital management, and there's no doubt being part of Gallagher has offered them some additional opportunities.
Doug Howell: Yes. I think that as they team up with our wholesalers, our program folks, and our retailers, they get to see firsthand what's going on on the street. I think that helps them provide better insights to their primary carriers. And I think that we're doing a terrific job of making them an integrated part of us, not just a unit within the holding company structure.
Operator: Our next question is a follow-up from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question.
Mike Zaremski: Oh, great. My thoughts on reinsurance as well, just the strong results. Just curious, maybe a mix on reinsurance? Do you potentially have a greater mix towards casualty or specialty Europe-focused that could be helping the outlook, given casualty pricing is fixed already?
Doug Howell: Yes. We have a terrific casualty bulk of business. North American casualty is a big part of our U.S. business. But we're probably a little underweighted on property, maybe, versus the others. So I think that's probably more casually weighted. I don't exactly understand their book of business, but I think that what our perception is that we're underweight on property.
J. Patrick Gallagher Jr.: And also, where's the pain right now if it was a reinsurance buyer? It's casually. We've talked about it in these calls, and there's no question about it. That's the area that's got some pain, and our team is really, really good at that.
Mike Zaremski: Got it. Maybe since it's not 6.15, I'll sneak one last one in. Just curious, health inflation for employers, at least some of the stats we've seen, it's expected to rise 25 versus 24. Maybe you disagree with that. Does that provide any uplift to the organic for employee benefits? I know there's a lot of building blocks for employee benefits.
J. Patrick Gallagher Jr.: Every time we get -- we are clearly a leader in our capabilities to consult, manage, and place health and welfare. And it's a huge problem for employers. And it's going up, as it seems to never stop doing. And so, there's all kinds of tools that you need to have in your toolbox to handle that. And we're very, very good at that. And, by the way, we're extremely good at it in the commercial middle market, where I think there's maybe not as much competition, frankly.
Operator: Thank you. Our final question is from Alex Scott with Barclays. Please proceed with your question.
Unidentified Analyst: Thank you all. This is Justin on for Alex. Just kind of going back into the brokerage segment in the commercial middle market, just wanted to ask. I understand, it seems like 90% of the time you guys are competing against independent brokers. I was just curious, in light of sort of the large-scale acquisitions that's been taking place, whether or not you see sort of this, 90% number to dwindle over time. And just let me think about 25 and ahead.
J. Patrick Gallagher Jr.: Oh, the AssuredPartners people are competing with those same independents in communities that we're not in today, which is only going to increase. When you take a look at our at-bats, our number of at-bats are going to go up substantially because of AssuredPartners. And 100% of those at-bats, that's not true. Ninety-five percent of those at-bats are going to be against smaller players.
Doug Howell: Yes, I think the fragmented market, there's 30,000 agents and brokers, and those are companies, not necessarily those with a brokerage license. So we're competing against the other 29,950 brokers that are out there. So, I mean, AssuredPartners will be absolutely there. It does help us go after those accounts that are in cities that we're not in. So we think it's a great one plus one can equal more than two for sure.
Unidentified Analyst: Sure thing. Thanks for the color.
J. Patrick Gallagher Jr.: Thanks, Justin. Thanks, Rob. I think we're ready to wrap up here, and I just have a quick comment, and that is thank you again for joining us this afternoon. As you all know now, we had a great fourth quarter to finish, an excellent year of financial performance. A huge thank you goes out from this table to our 56,000 colleagues around the globe. It's your creativity, expertise, and unwavering client focus that continue to set us apart. We look forward to speaking with the investment community at our mid-March IR Day and thank you all for being with us this evening.
Operator: This does conclude today's conference call. You may now disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon and welcome to Arthur J. Gallagher and Company's Fourth Quarter 2024 Earnings Conference Call. Participants have been placed on listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute follow-looking statements within the meaning of the security laws. The Company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and Risk Factors sections contained in the Company's most recent 10-K, 10-Q, and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations to the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the Company's website. It is now my pleasure to introduce J. Patrick Gallagher Jr., Chairman and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Thank you very much. Good afternoon and thank you for joining us for our fourth quarter 2024 earnings call. On the call with me today is Doug Howell, our CFO, other members of the management team, and the heads of our operating divisions. Before I get to my comments about our financial results, I'd like to acknowledge the tragic wildfires in California. Our heartfelt thoughts are with all those impacted, including our own Gallagher colleagues. Our Company and industry have such an important role and responsibility, helping families, businesses, and communities rebuild and restore their lives. And like many times before, Gallagher and the industry will rise to the occasion. Okay, on to my comments regarding our financial performance. We had an excellent fourth quarter. For our combined brokerage and risk management segments, we posted 12% growth in revenue, our 16th consecutive quarter of double-digit revenue growth, 7% organic growth, reported net earnings margin of 13.5%, adjusted EBITDA growth of 17%, and adjusted EBITDAC margin of 31.4%, up 145 basis points year-over-year. GAAP earnings per share of $1.56, and adjusted earnings per share of $2.51, up 15% year-over-year. The December capital raise for the acquisition of AssuredPartners creates some noise in these headline numbers, so I will peel back the impact in his comments. Regardless, another fantastic quarter to close out another terrific year by our team. Moving to results on a segment basis, starting with the brokerage segment. Reported revenue growth was 12%. Organic growth was 7.1%. Base commission and fees were 7.8% in line with our expectations, which got offset a bit by slightly lower contingents. Adjusted EBITDAC margin expanded 168 basis points to 33.1%, which includes interest income related to funds raised for the acquisition of AssuredPartners. Excluding that interest income, margin expansion was 109 basis points. Let me give some insights behind our brokerage segment organic. With our P/C retail operations, we delivered 6% organic overall. The U.K., Australia, and New Zealand were all in the high single digits. U.S. retail organic was around 5%, and Canada was down a couple percent, impacted by lower contingents. Our global employee benefit brokerage and consulting business posted organic of about 10%, a really strong finish that includes the catch-up of the large life case sales that shifted from earlier in 24. Shifting to our reinsurance wholesale and specialty businesses, in total organic of 9%, which overcame some expected market headwinds in our global aerospace business. So very strong growth, whether retail, wholesale, or reinsurance. Next, let me provide some thoughts on the P/C insurance pricing environment, starting with the primary insurance market. Overall, the global P/C insurance market continues to grow. With fourth quarter renewal premium increases, that's both rate and exposure combined, consistent with the past two quarters. Thus far in January, renewal premium increases are ticking slightly higher than fourth quarter and are above 5%, driven by increases in casualty lines like umbrella and commercial auto. Breaking down fourth quarter global renewal premium changes by product line, we saw the following. Property and professional lines were about flat. Workers' comp up 1%, general liability up 4%, commercial auto up 9%, umbrella up 10%, and personal lines up 9%. So we continue to see increases across most lines and geographies. Carriers are behaving rationally and pushing for increases where it's needed to generate an acceptable underwriting profit. It's a great market for us to operate in because we can further differentiate ourselves with our leading tools, data, and expertise. Remember, our job as brokers is to help clients find the best coverage that fits their budget while mitigating price increases. We're becoming more successful securing lower pricing for our property customers, especially cat exposed property, which enables them to buy more limit or reduce their deductibles, resulting in more coverage for the same spend. Shifting to the reinsurance market. Overall, 1-1 renewals were orderly and reflected an environment that generally favored reinsurance buyers. Growing demand for property cat cover was met with sufficient reinsurance capacity, despite 2024 being an elevated year with more than $150 billion of estimated insured natural catastrophe losses. This resulted in property price declines that were greater at the top end of reinsurance towers, and similar to January 24 renewals, reinsurers continued to exercise discipline on terms and did not revert to attachment points that exposed them to greater frequency. Reinsurance buyers of specialty coverages saw modest price declines across many lines of coverage, but again, no softening in terms and conditions. Shifting to casualty, while there was adequate reinsurance capacity, reinsurers remained cautious on U.S. casualty risks due to elevated loss cost trends and potential reserve deficiencies. Looking forward, wildfire losses and casualty reserve increases seem to be the stories here in January, and time will tell how each of these ultimately impacts the market. Regardless, Gallagher Re had a fantastic 1-1 with some nice new business wins and should continue to excel in this environment. Moving to some comments on our customers' business activity. During the fourth quarter, our daily revenue indications from audits, endorsements, and cancellations remained in net positive territory. The same is true for full year 2024. While the activity is not quite as high as 2023, the upward revenue adjustments this past year are very close to full year 2022. So we continue to see solid client business activity and no signs of a meaningful global economic slowdown. Within the U.S., the labor market remains strong. Since April 24, the number of open jobs has remained relatively steady and at a level that is still well above the number of unemployed people looking for work. Employers are looking for ways to grow their workforce and control their benefit costs. And at the same time, faced wage increases and continued medical cost inflation, both are headwinds that our professionals are helping to navigate. Regardless of market conditions, I believe we are well positioned to take share across our brokerage business. Remember, 90% of the time we are competing against the smaller local broker that cannot match our niche expertise, outstanding service, or extensive data and analytics offerings. So with some nice momentum in net new business production across our brokerage business, a P/C market still seeing mid-single-digit premium growth, and a strong U.S. labor market, we continue to see full year 2025 brokerage segment organic in the 6% to 8% range. Moving on to our risk management segment, Gallagher Bassett. Revenue growth was 9%, including organic of 6%. Heading into 2025, we should continue to benefit from excellent client retention, increases in our customers' business activity, and rising claim counts. Adjusted EBITDAC margin was 20.6% in line with our October expectations. Looking ahead, we still see full year 2025 organic in that 6% to 8% range, and margins around 20.5%. Shifting to mergers and acquisitions. During the fourth quarter, we completed 20 new tuck-in mergers at fair prices, representing around $200 million of estimated annualized revenue, bringing the full year to $387 million. For those new partners joining us, I'd like to extend a very warm welcome to the Gallagher family of professionals. And of course, the big news in December was signing an agreement to acquire AssuredPartners with $2.9 billion of annual pro forma revenue. It's a compelling opportunity to build upon our commercial middle market focus, deepen our niche practice groups, and further leverage our data and analytics, allowing us to provide even more value to clients. It should also expand our tuck-in M&A reach and create more retail and specialty revenue opportunities across Gallagher. What is especially exciting is that the combination involves two highly innovative, entrepreneurial, and sales-based cultures. Although we will continue to operate as two independent companies until close, we have started discussions and are very impressed with the talent, professionalism, and excitement of the Assured colleagues. We anticipate we will receive necessary approvals and complete the acquisition sometime here in the first quarter. In addition to the pending Assured Partners acquisition, we have about 45 term sheets signed or being prepared, representing around $650 million of annualized revenue. Good firms always have a choice, and it would be terrific if they chose to partner with Gallagher. With a strong close of the year, let me reflect on our full-year financial performance for brokerage and risk management combined. 15% growth in revenue, 7.6% organic growth, 18% growth in adjusted EBITDAC, 48 mergers completed with nearly $400 million in estimated annualized revenue, and we signed a definitive agreement to acquire AssuredPartners. These are terrific metrics. And as proud as I am of the excellent financial performance this year, I'm more proud of the way our culture has stayed true as we continue to expand. Our culture is about our colleagues, guided by the Gallagher way and a rock-solid foundation they form based on every interaction we have, whether it's clients, carriers, future merger partners, or with our Gallagher colleagues around the globe. Frankly, our culture is unstoppable, and that is the Gallagher way. Okay, I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat, and hello, everyone. Today I'll quickly recap some sound bites from our quarter and replay our early thoughts on 2025, most of which Pat just touched on, then use the rest of my time to unpack the impact of the AssuredPartners financing activities on our results during the quarter. Then I'll wrap up my prepared remarks with my usual comments on cash, M&A, and capital management. Okay, highlights from our fourth quarter that you'll see in our earnings release. Terrific base commission and fee organic growth of 7.8%, solid supplemental growth of 4.7%, and while contingents went backwards a bit this quarter, we don't see that as a trend by any means. As I look to 2025 brokerage organic, Pat relayed that we're in a favorable environment with rates still needing to increase to cover higher loss costs, trillions of global premiums growing and inflating, and our sales and service offerings outpacing our competitors, which should increase both new business and our retentions. So as we sit here today, we still believe our full year 25 brokerage segment organic growth should be in that 6% to 8% range. That's unchanged from what we said in October. As for brokerage margins, a little noise on page 5 of the earnings release. Please see the footnote. You'll read that the margin was aided by about $20 million of interest income earned on cash we're holding to close AssuredPartners. Adjusting for that, our margins would have been 32.5%, up 109 basis points over last year. That's nicely above our October expectation of margin expansion in the 90 to 100 basis point range. Looking ahead to 25, we are still viewing margin expansion like we have, like we've said many times before. We see margin expansion starting around full year organic growth of 4%. At 6%, maybe we could see 50 basis points, and at 8%, perhaps 100 basis points of expansion. Of course, those ranges can then be impacted by changes to interest income on our fiduciary assets, and then the rolling impact of M&A. By our March IR date, maybe we'll have a better read on where interest rates might go, and also the impact of Assured rolling into our numbers. But at this time, we don't see either having a significant impact on those ranges. So, really no change to how we're thinking about margins in 2025. As for risk management, another solid quarter posting 6% organic. Admittedly, a couple million dollars below our October expectations, all stemming from a smaller quarter of construction consulting revenues in the Northeast that can be just a little bit lumpy. So, adjusted margin expansion of 20.6% in the quarter was also in line with our October expectations. And then looking forward, we're seeing full year 25 organic also in that 6% to 8% range, with margins again around 20.5% for the year. So, a great quarter and full year by both our brokerage and risk management teams, and both have a strong outlook for 25. Turning to page 6 of the earnings release and the corporate segment shortcut table. For the interest and banking line, we are a bit better than our October forecast because we just were not into our line as much as we thought at that time. For the adjusted acquisition lines for M&A and clean energy, both were close to our October expectations. Then, when you look at the corporate line of the corporate segment, that was better than our expectation due to unrealized non-cash foreign exchange remeasurement income, which was partially offset by a return to actual tax catch-up of about $4 million. So, let's move from our earnings release to the CFO commentary document that we post on our IR website. First, an overarching statement. Please take some time to read any headers or footnotes throughout this document to understand what information has or hasn't been updated for the AssuredPartners deal. So, let's move to page 3 for our modeling helpers. Across the board, fourth quarter 24 actual numbers were fairly close to what we provided back in October. As for 25, we provided a first look of what we forecast. Again, none of these numbers include any impact from AssuredPartners. Turning to Page 4, a first look at our corporate segment outlook for full year 25. The only impact of Assured is found in the interest and banking line. It includes additional interest expense from the $5 billion debt raise. Flipping to Page 5 of the CFO commentary document to our tax credit carry forwards. As of year end, about $770 million that will be used over the next few years. So, still a nice sweetener to fund future M&A. We would not expect those numbers to move much because of the assured financing or the roll-in of assured's taxable income. That's because of the interest shield and also the amortization of the $5 billion deferred tax asset that we'll get with AssuredPartners. That should save us about $1.4 billion of taxes over the coming years. Flipping over to Page 6, the investment income table. This table includes an assumption of two 25 basis point rate cuts in 25. It includes interest income from cash we're holding to pay for Assured, assuming a late March close. But it does not include interest income from Assured's fiduciary assets after closing. When you shift down on page 6 to the rollover revenue table, the pinkish columns to the right include estimated revenues for brokerage M&A that we closed through yesterday. And below that table, we've added a separate section for AssuredPartners' revenues. Again, assuming a late March close, which of course is highly dependent on regulatory approvals. Then, just a reminder, you also need to make a pick for other future M&A. And then further down on that page, you'll see the risk management segment rollover revenues for 25 are expected to be approximately $5 million for each of the first two quarters. All right, moving to Page 7. This is a new page to help you see the impact of the assured partners' financing on our fourth quarter 24 revenues, EBITDAC, net earnings, and EPS by segment. The three items just to keep in mind. There was additional incremental interest income on the cash that we were holding to fund the acquisition. There was additional interest expense we incurred on the newly issued $5 billion worth of debt. And then the additional shares outstanding from the December equity offering. You'll see that for fourth quarter, it all nets out to nearly nothing, but it does cause a little noise in our numbers. Also, the callout box on the right of that page provides some information on shares outstanding because of the assured partners' equity rates for our first quarter. This includes the full impact of the shares we issued in December and the exercise of the green shoe in early January. Finally, if you flip to Page 8, you'll see that this page is just a repeat of what we provided in the December Assured presentation for ease of reference. There's no new news on this page. Finally, let's move to cash, capital management, and M&A funding. Available cash on hand at December 31st was more than $14 billion, of which approximately $13.5 billion will be used to fund AssuredPartners. Since year end, we received another $1.3 billion as the underwriters exercised the green shoe. So, considering this and our strong expected free cash flow, we are in an excellent position to fund our M&A pipeline of opportunities. Here in 25, it's looking like we could have $3.5 billion to fund future M&A. Then it jumps up to nearly $5 billion in 26, all while maintaining a solid investment grade rating. So, an excellent quarter and an excellent year to have in the books. As I reflect on 24, I have to say that we had a pretty terrific year. For the combined brokerage and risk management segments, we posted adjusted revenue growth of 14%, organic of 7.6%, overall margin expansion of 94 basis points, and most importantly, we grew our EBITDAC 18%. Those are terrific numbers and reflect what Pat said. That's our unstoppable culture. So, those are my comments. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Thanks, Doug. Rob, you want to open it up for questions?"
},
{
"speaker": "Operator",
"text": "Sure, Mr. Gallagher. We'll now open the call for questions. [Operator Instructions]. Now, our first question comes from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"text": "First question is surrounding the cadence of organic growth next year. Loud and clear, 6-8, no change. I guess, yes, for both segments. I guess I'm more specifically focused on the brokerage segment. But in terms of the cadence or seasonality, anything you'd like to call out? Two of your peers called out kind of weaker seasonality in 1Q. We do know that reinsurance is overweight in the beginning of the year, too, and maybe downwards pricing there could cause some year-over-year tougher comps."
},
{
"speaker": "Doug Howell",
"text": "Let me go back to that. Let me start with the end of that. There have been some price changes on the reinsurance, but our customers are buying more reinsurance. So when you look at the total spend for us that our customers are spending, we're really not seeing a decrease, and like Pat said in his comments, we had a terrific new business quarter also. Going back to the first part of your question, yes, reinsurance is typically stronger in the first quarter, and so you could see some seasonality of better organic growth in the first quarter than what develops out for the rest of the year. I'll study in a little bit about that, as we do have a substantial amount of our health and medical benefits that renew in the first quarter that mitigate maybe a higher reinsurance on it. And then throughout the year, our retail is performing well. Our wholesale seems to be getting stronger and stronger. Our programs are doing well. But, yes, you would see a little seasonality because of reinsurance in the first quarter and our organic growth."
},
{
"speaker": "Mike Zaremski",
"text": "Okay, got it. So you're saying actually it could be higher, not lower, even if reinsurance pricing is down? Okay."
},
{
"speaker": "Doug Howell",
"text": "I'll have a chance to talk to you again on our March IR day, and we should have a better feel of the seasonality for that, too."
},
{
"speaker": "Mike Zaremski",
"text": "Okay, awesome. The last question is on, do we share investment income? I'm thinking through post the deal close, if you're able to comment. So my understanding is that the company you're purchasing kind of didn't fully leverage its fiduciary income in that it was direct pay relationships between the businesses paying directly to the insurance carriers, and you guys might be able to optimize that working capital to gain more fiduciary assets. If that's what I'm describing is correct, can you offer kind of a timeline on how that works in terms of kind of getting those asset balances onto your balance sheet?"
},
{
"speaker": "Doug Howell",
"text": "Yes, your recollection is correct, and I think that if you go back, I don't know, 10 years ago when we went through our exercise in consolidating bank accounts from around the world, this would be obviously mostly in the U.S. We did have some good success of picking up more fiduciary cash into our accounts, and I think that would be invested. So we do see that as an opportunity that we'll be better together on that metric. So, yes, there should be versus their run rate, I'm guessing together we'll be better on that going forward."
},
{
"speaker": "Mike Zaremski",
"text": "Doug, is there just any, is that kind of a one-year process, or that kind of takes many years?"
},
{
"speaker": "Doug Howell",
"text": "Listen, in 18 months we shouldn't be talking about it anymore, so I think we'd get it done. Hopefully faster."
},
{
"speaker": "Operator",
"text": "The next question is from the line of Gregory Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Gregory Peters",
"text": "I guess I'd like to start with California. Given the substantial potential loss to the insured market, I'm curious if you could give us some perspective of how it might touch your operations. I'm interested in, you know, the business going inside RPS, if there's any impact on the wholesale market that you're seeing. If you can just talk about your perspectives of that as we watch this disaster unfold, that'd be great."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Well, first of all, Greg its Pat, we reached out to thousands of clients already to make sure that they had the knowledge of how to file claims and what have you, how to get a hold of us if they're having difficulty in filing those claims. We are presently tracking, I forget the exact number today, but we have hundreds of claims that we're helping our clients with already. I think that you've got a situation that is going to continue to unfold for us. We're a big player in California. We're a big player in Los Angeles. Not huge in personal lines there, but it's going to keep us incredibly busy for a number of months. And then in terms of the impact of that, luckily, again, we've been able to stay in touch with our people. We have had our folks in some instances were evacuated. We did not lose anybody and don't have many of our folks that have lost any of their homes. So I think we'll be well in a strong place to help our clients, but I can't give you much more than that right now in terms of how it's going to impact our day-to-day activities out there."
},
{
"speaker": "Gregory Peters",
"text": "Okay. And then I guess my follow-up question is switch gears. You mentioned in your comments about the lower contingents. Just curious, given the profitability we're seeing in the industry, I would have imagined that supplementals and contingents would be up. And I think your guidance for 25 suggests that they should go back up again. But maybe you could spend a minute and give us some color on what happened with contingents in Europe, and then color on your outlook."
},
{
"speaker": "Doug Howell",
"text": "Yes, great question, Greg. Thanks for asking. Like I said, I ended in my comments. This isn't a trend, and what you said there is right. We would expect it to bounce back up again. Frankly, it's simply because as we get the final year and loss ratio estimates in from the carriers, they're coming in just a little bit higher than what maybe we had been anticipating throughout the year. And to put this in context, we see this as about maybe a $7 million shortfall to what we were thinking back in October. Two-thirds of it is spread across hundreds of contracts. And so if the loss ratios are ticking up just a little bit, that probably costs us $4 million of it. And then another third is we had about three contracts and programs in Canada that just really kind of came in here in January with really not very great results. But if you look at it on an annual basis, when you combine supplements and contingents, I think if I do the math here, mentally I think it's about 8%, even with the small blip in the fourth quarter. So it's still a terrific year. But I wouldn't over-read that there's some systemic shift in what contingents and supplementals are going to be going forward. So I would expect those numbers to grow over the blip this year considerably."
},
{
"speaker": "Gregory Peters",
"text": "Just a clarification on that answer, Doug, is there a specific line of business? Is there across a broader business set?"
},
{
"speaker": "Doug Howell",
"text": "It's across the line, Greg. I wouldn't say there's anything there. We have hundreds of these contracts, and we get a lot of this information coming in here right around the first week or two of January."
},
{
"speaker": "Gregory Peters",
"text": "Thank you for your answers."
},
{
"speaker": "Doug Howell",
"text": "I guess another way of saying it, on a $600 million number, only to have maybe $3 or $4 million of what I would say loss ratio, I think our picks have been pretty good throughout the year."
},
{
"speaker": "Gregory Peters",
"text": "I would say so."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Andrew Kligerman with TD Securities. Please proceed with your question."
},
{
"speaker": "Andrew Kligerman",
"text": "First question is around the risk management segment. Thinking back to last year, you had guided to 9% to 11% organic growth for this year, and now for next year, for 24, that is, and now for 25, you're guiding to 6 to 8, which I still think is fabulous. But what's kind of changing that your guidance isn't quite as robust as it was to start last year?"
},
{
"speaker": "Doug Howell",
"text": "Here's the thing. I think that this business, if you recall, we can get some pretty large contracts that come in. It is a little bit more elephant hunting, so to speak. So this year, I think that we've got some nice new business in the pipeline coming into 25, and so I'd leave you to go back in the history of Gallagher Bassett and the risk management segment. We have periods like this where it will grow mid-single digit, something like that, and then they'll have a couple of nice large contracts. We still see that happening. Some of our government programs that we do down in Australia have some nice opportunity, and then more and more we're proving to the carriers left and right that we can actually deliver better claim outcomes on that business. And as a carrier decides to use us for their claims payment process on work comp and general liability, we're not storm chasers, remember, but it is a little bit more of a lumpy business as we get some pretty nice size."
},
{
"speaker": "Andrew Kligerman",
"text": "I see. So like you never know, you could probably find another elephant this year, right?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Yes, that's right. Our process list is always filled with elephants. They're just hard to find every once in a while."
},
{
"speaker": "Andrew Kligerman",
"text": "And then I'm just kind of curious about your operations in India, the Center for Excellence, where I think you have about 12,000 employees right now, and, as you look out through this year, do you need to add people, given the AssuredPartners transaction? Can you keep it steady? And, you know, is technology making it such that you really don't need to hire that much?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Well, I think you got both ends of that correct. We're going to be using technology quite a bit, and as we use technology that does make that group there much more efficient, and yet at the very same time our organic growth and our acquisition growth puts a lot more demand in the structure. And so at about 12,000 employees, I think that at this time next year you'll see us up additional thousands."
},
{
"speaker": "Doug Howell",
"text": "Yes, the other thing, too, to think about this, the value that it brings is when work goes into our service centers, remember those are our folks. They're not working for anybody else. They work for us. It causes standardization. It causes process improvement. I got to tell you, that gives us a head start by years and years when it comes to implementing technologies and AI into the work that's already been standardized. And truthfully, as we develop AI technologies that replace some of that work there, all of those folks have opportunities to, because our growth, they don't lose their jobs. It's just they move up higher in the value chain on it. And so it's really a juggernaut, in my opinion, in terms of our ability to offer some of the very best service in the world."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "And unless you standardize that service, A, you can't automate it. But, B, when you do standardize it, it makes you better and better at the service for our clients. Just take certificates of insurance. We're going to issue three, four million of them pretty much error-free. There aren't any real brokers that can claim that."
},
{
"speaker": "Andrew Kligerman",
"text": "I see. So maybe with the bottom-line takeaway is, you may add a thousand or two employees, but it's still scalable. You're still getting better margins from that. Is that the right final takeaway?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Yes, you're right on the money."
},
{
"speaker": "Andrew Kligerman",
"text": "Thank you."
},
{
"speaker": "Doug Howell",
"text": "It won't surprise me that, like-for-like, in five years we've doubled that number."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question is on the brokerage outlook for 25. So you reaffirmed the six to eight. I think when we last spoke in October, you said, maybe benefits is a five. Reinsurance is a nine. I want to confirm that's where you still see it. And then you also had said you would provide, I think, by line in a little bit more detail at the December day, right, which did not happen. Could you give us a sense even away from benefits and reinsurance, just how you see all your businesses trending organically in the 6% to 8% 25 brokerage guide?"
},
{
"speaker": "Doug Howell",
"text": "I think, yes, confirming everything you've said. So I think Pat did a pretty good job in his script of telling you how those businesses are growing right now. I think those are good guesses for next year at this point."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. That's helpful. And then my follow up question. How do you see how's their pipeline of transactions? Right. You guys also did, a good number of bolt on deals to end the quarter. And, in terms of the AP pipeline, I know when you guys announced the deal, you highlighted the fact that there was very little overlap on pipelines. So would you expect, I guess, once that deal closes, at some point at the end of the Q1, I guess that kind of just the quarterly level of M&A activity, could pick up from bringing the two firms together."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "So Elyse, this is Pat, I think that, first of all, we have to continue to operate these enterprises separately till we're closed. But we do know that there's very little overlap at all. And AssuredPartners has been very, very good at tuck-in acquisitions. And as you saw in our -- when we were making the announcement, there has not been that much overlap between things that we wanted to put on and things that they actually bought. So we view their pipeline is very, very accretive to what we're doing and not a lot of overlap. And I think that's going to be fantastic. They've got a great team doing this stuff. We're impressed with what we've seen and due diligence and the like as to what they've done, what they've bought and the pricing they're getting for that. And I think you will see us increase substantially the number of deals. Now, there's small deals. They're very good at tuck-in, bolt-ons and small, privately held firms in and about many of the parts of the country that we're not in."
},
{
"speaker": "Elyse Greenspan",
"text": "And then the 1.3. Oh, sorry."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "I'm sorry. Go ahead."
},
{
"speaker": "Elyse Greenspan",
"text": "I was just going to say the 1.3 billion from the green shoe, right, that wasn't contemplated because the financing was there without it. So is that just extra cash that you have for the pipeline, the capital that Doug was talking about in his comments."
},
{
"speaker": "Doug Howell",
"text": "Yes, that's right."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Mark Hughes with Truist Security. Please proceed with your questions."
},
{
"speaker": "Mark Hughes",
"text": "Doug, the guidance you gave for the first quarter contribution from AssuredPartners. Is there any seasonality there or is that just the timing of the deal?"
},
{
"speaker": "Doug Howell",
"text": "Right now, we've assumed that's just the timing of the deal. They will have some seasonality, especially in their benefit business. And then anything that might be a public entity type business might be skewed to July. So you'd see a little bit of seasonality. But what you see in there is a pure straight line assumption of it."
},
{
"speaker": "Mark Hughes",
"text": "And then, Pat, in the wholesale business, you gave the wholesale and reinsurance together. I think up 9%. Any detail you can provide on wholesale observations on the E&S market?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Let me take a look, Mark."
},
{
"speaker": "Doug Howell",
"text": "Yes, I think I've got that. I think that you've got to look at our U.K. specialty at maybe around 7%. You look at U.S. specialty, maybe on the 10%, re is pretty small in the quarter. It's just not a big quarter for us. So if you look at those two numbers, when we would get that maybe that gets us back to that that 9% number there."
},
{
"speaker": "Operator",
"text": "The next question is from the line of David Motemaden with Evercore ISI. Please proceed with your question."
},
{
"speaker": "David Motemaden",
"text": "I had a question for Doug, just trying to unpack the brokerage organic this quarter. And I don't want to nitpick too much, but you guys were looking for 8%. And I'm just wondering, so what was the entire differential? Just the contingent and the life sales came back as expected, and it was just totally offset by the contingent. I'm hoping you can unpack that a little bit."
},
{
"speaker": "Doug Howell",
"text": "Yes, you're right. The base commission and fees at 7.8% percent. That business contingents and supplementals have been running kind of consistent with that together. So the difference of the $7 million, I'd put it up in the upper 7% range, somewhere pretty close to the base contingency. So you're right. You're spot on in your observation there."
},
{
"speaker": "David Motemaden",
"text": "Okay, great. Thanks for confirming. And then I wanted to follow up just on I guess I was surprised the RPC stayed at 5%. Just given the property price was flat versus up for last quarter. So I'm wondering if maybe it's mixed, but I'm wondering if there's anything else from sort of like an increased purchasing or buy up dynamic that you guys are observing as the property rates moderate here."
},
{
"speaker": "Doug Howell",
"text": "Well, we see that across that. Yes, I mean, we've always said it's been a long time. We've talked about this as rates are going up. Customers opt out of certain coverages. And that might be by raising deductibles or reducing limits on it. Sometimes they'll drop some coverages. So remember rates are still increasing. I think it's important for everybody to realize that kind of across the board, we're still in a rate increasing environment. They're buying more insurance. And reinsurance you're seeing that from the carriers that they're buying more. And then the customers, they are buying more coverage on it. So they'll opt in."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Insurance to value is a big deal. Much more pressure on insuring to value."
},
{
"speaker": "David Motemaden",
"text": "Got it. Thanks. And then maybe just to sneak one else in, one other one in. Doug, I think you had said last call that the underlying brokerage business is running at like a 7% to 8% organic growth. Just on an underlying basis, but then the 25 range is in the 6% to 8% range. So I guess I'm wondering, is that 6% percent just sort of conservatism? Like what sort of scenario would sort of get that, get you guys out of that, 7% to 8% range?"
},
{
"speaker": "Doug Howell",
"text": "Well, listen, I think right now that, we said way back in October that, next year felt a lot like this year. And we're kind of in that mid-7% range somewhere this year. The range around it sitting and looking out over the next 11.5 months, I guess, that it's 6% to 8% is consistent, what we've said before. So we think we'd like to stick with that. I think our team's working pretty hard to always be better than the midpoint of the range, obviously. But the market's changing. We'll see what wildfires do. We'll see what casualty reserves will do. We're still digesting that. I will say on the wildfires, maybe you know this. I still don't know how the extra living expenses have been factored into the wildfire estimates for the cat loss on that. And then, you can't open up the news any day without somebody taking a casualty reserve strengthening. So those things, will cause carriers to take a really hard look at what they're doing with the rates. So within 2% is a pretty good guess as we look for the year. Isn't it nice being in that range versus years ago when we were pretty excited about 1% or 2% organic growth?"
},
{
"speaker": "David Motemaden",
"text": "No, completely agree. Thank you."
},
{
"speaker": "Operator",
"text": "Our next question is in the line of Katie Sakys with Autonomous Research. Please proceed with your question."
},
{
"speaker": "Katie Sakys",
"text": "I guess my first question is, thinking about the last call, I think, Doug, you'd mentioned that you expect brokerage organic growth in 2025, split between the components to come from about half new business and then perhaps a quarter each to rate and exposure. Has your perspective on the components of that brokerage organic growth guide changed in the context of the AssuredPartners acquisition?"
},
{
"speaker": "Doug Howell",
"text": "No. Pat summarized it pretty quickly. That's what we're still seeing happening right now."
},
{
"speaker": "Katie Sakys",
"text": "Okay. Sounds good. And then, it looks like international retail brokerage growth kind of continues to cool off a little bit. How are you guys thinking about the environment for organic growth abroad this year versus what looks like perhaps a little bit more stable growth in the U.S.?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Katie, I think you got to really look at that by geography. I mean, there's parts of the world that are just really, really growing incredibly well. We set our board meeting and did a deep dive into some of our Latin American businesses, not huge in part of the whole overall enterprise, but incredibly nice growth there. And so there's -- it depends. Canada, a little bit of a slowdown this past quarter. We talked about that. But as you look across the whole patch, it's hard to put a finger on it, which is why we try to give you a guidance in terms of the overall how it should shake out. But we definitely have some geographies that are doing extremely well and just have continued future growth that is going to be fantastic."
},
{
"speaker": "Doug Howell",
"text": "Yes. Katie, one of the things I'm kind of looking at what we said this quarter versus what we said back in October. We didn't have an opportunity to update you in December. But U.K. retail especially is still in high single digits. We said that it was 6% percent before. U.K. retail, I think we said 8%, and this quarter we're saying closer to 9%. Canada, maybe the one that's poking its head out to you a little bit, we said is more flattish, and now we're down a point or so. And then Australia, New Zealand, we said is about 10% maybe in October, and we're still in the very high single digits on that. So I don't know if it's necessarily – it might be just that Canadian piece that pops out at you that's causing you to have that perspective."
},
{
"speaker": "Katie Sakys",
"text": "Appreciate the additional color there. Thanks, guys."
},
{
"speaker": "Operator",
"text": "The next question is from Meyer Shields with KBW. Please proceed with your question."
},
{
"speaker": "Meyer Shields",
"text": "I like how everyone's claiming they're Canadian. Doug, you mentioned –"
},
{
"speaker": "Doug Howell",
"text": "I'll tell you personally, Meyer."
},
{
"speaker": "Meyer Shields",
"text": "Yes, I'll try not to. You mentioned, obviously accurately, that there's a ton of adverse development that we're seeing in general liability. And I was wondering whether there's any direct impact when you've got, I don't know, more frequent claims or more attorney involvement in terms of how Gallagher Bassett grows revenues."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Well, I mean, clearly claim activity helps this far. I mean, there's no question about it. But when it comes to severity, we don't participate in our clients up or down in terms of severity. We do everything we can to manage the final outcome, and we contend, and we believe we have the data and analytics to prove this, that if you hire Gallagher Bassett, your outcomes, meaning your final settlements, will be superior. And that does not mean that we're taking advantage of the claimant. That means that we're handling the claimants actually better than you see in the general market. So if you've got some severity out there, and that creates frequency, frequency definitely helps Gallagher Bassett. We get paid essentially on a per-claim basis, as does economic growth, because with economic growth comes more employment. And remember, most of Gallagher Bassett's revenues, a good portion of them, are workers' compensation driven."
},
{
"speaker": "Doug Howell",
"text": "Yes, I think one of the things, all of those forces actually should cause clients to look at Gallagher Bassett even more. The way we can do nurse case management, the way we have our managed care offering, the way that we can understand where there are opportunities to use different physicians. We also understand the attorneys, because we deal with them so often. When claims get more complicated, Gallagher Bassett actually can show more value to the customer. And I think that's the environment we're in. They're paying $12 billion, $13 billion, $14 billion of claims, and they get pretty good at that."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "And remember, by and large, about $0.60 to $0.65 on every premium dollar turns into a claim. That's the function of the industry. We're seeing that, of course, in the West Coast. And so if you're going to have an impact on your costs, you better pay attention to that portion of the dollar that goes out the door in claims. Again, we think we do that at a level that's better than the competitors, both TPAs and carriers."
},
{
"speaker": "Meyer Shields",
"text": "Okay. No, that's very helpful, very thorough. Switching gears, I'm just looking for an update on the multiples for M&A, because we've seen not only your acquisition of AssuredPartners, but a lot of the other big brokers out there have made big acquisitions. I don't know if that speeds up or decelerates competition for tuck-ins."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Well, this, of course, is all speculation on my part. But remember, and we try to share it pretty much every quarter, what we are buying at. And you're not seeing our tuck-in acquisitions and the activity that we do on our smaller deals anywhere near the treetop levels of multiples that have been running up over the years. I do think that the AssuredPartners acquisition, we have a very smart seller. I think we were an opportunistic buyer, and I definitely think there's a signal there."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Rob Cox",
"text": "Hey, thanks. And I apologize for asking another question on brokerage organic. But when you consider the 6% to 8% organic growth range, could you give us some insight into what level of renewal premium change you're thinking about within that? Because I'm wondering if you're assuming sort of some of the acceleration that you think may be happening in the casualty market, or if you don't need that to achieve the 6 to 8."
},
{
"speaker": "Doug Howell",
"text": "Yes, I think that estimate is not assuming that there's tailwinds produced by the fires or the casualty strengthening. We kind of see that in the current environment we had. Like we said earlier, we think that net new business over loss will contribute about half of that number. We think that exposure will be about a quarter of it, and rate will be about a quarter of it. So there's not a big assumption for rates in here, nor is there a really big assumption for exposure unit growth. I mean, this is just what we're seeing in our net new business wins right now. We're showing pretty well out there in the field. And here, go back to what we said before. When there's not as much chaos in the market, we get to show our tools and capabilities shine brighter in those environments. Because when it's chaotic in the environment and customers are listening to big rate increases, they're just trying to get their insurance placed. They're already a bit stung by the fact that rates are up. We work very hard to keep those rates down for them. Now we'll be able to go in and show prospects, just in a level playing field here. When things aren't chaotic, you should be using our tools and capabilities to buy your insurance through us, or let us buy your insurance for you using our capabilities. So this is an environment where we believe our new business will shine. We think our service offering is getting better and better every day. We have insights into what clients might be a little shaky. Let's get out and talk to them and make sure that we get the renewal put to bed soon. So I think that this is an environment where I think that our folks can shine with the tools and capabilities that they have."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "I would have killed in the past, as Doug alluded to, when we were talking about up one, up two, for a 5% premium rate growth as an environment. That would be nirvana 10 years ago. So I think it's a very strong place to be. Remember, our job is to mitigate that for our clients. But it's a great place for us to show exactly what Doug was saying, which is our capabilities. In particular in the areas of data and analytics, which I want to remind the listeners, you don't get a chance to listen to the smaller brokers that we're competing with on a quarterly basis. We're pulling away from them more and more with our capabilities. And clients, I'm talking middle market clients, very much appreciate the ability to sit and talk with them about people like you buy this, or you should have this type of limit, because in our data we see losses at this size. That capability is just getting more and more attention by the buying community, and it's differentiating us every single day to a greater level."
},
{
"speaker": "Rob Cox",
"text": "That makes sense. Thank you for all the color. Pivoting to reinsurance brokerage, I just wanted to ask, because I know your growth has been a good bit stronger than your two largest competitors in the reinsurance brokerage space for a number of years now. And Gallagher has a lower revenue base, but it doesn't seem like that would be the only driver of the outperformance. So I was hoping you could remind us what's driving Gallagher's ability to deliver what's been more like double-digit organic growth in reinsurance."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Well, I think that it's just blocking and tackling. I think one of the things that we've found there is it's a great sales team. They're backed up by terrific analytics, incredible capabilities in consulting on capital management, and there's no doubt being part of Gallagher has offered them some additional opportunities."
},
{
"speaker": "Doug Howell",
"text": "Yes. I think that as they team up with our wholesalers, our program folks, and our retailers, they get to see firsthand what's going on on the street. I think that helps them provide better insights to their primary carriers. And I think that we're doing a terrific job of making them an integrated part of us, not just a unit within the holding company structure."
},
{
"speaker": "Operator",
"text": "Our next question is a follow-up from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"text": "Oh, great. My thoughts on reinsurance as well, just the strong results. Just curious, maybe a mix on reinsurance? Do you potentially have a greater mix towards casualty or specialty Europe-focused that could be helping the outlook, given casualty pricing is fixed already?"
},
{
"speaker": "Doug Howell",
"text": "Yes. We have a terrific casualty bulk of business. North American casualty is a big part of our U.S. business. But we're probably a little underweighted on property, maybe, versus the others. So I think that's probably more casually weighted. I don't exactly understand their book of business, but I think that what our perception is that we're underweight on property."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "And also, where's the pain right now if it was a reinsurance buyer? It's casually. We've talked about it in these calls, and there's no question about it. That's the area that's got some pain, and our team is really, really good at that."
},
{
"speaker": "Mike Zaremski",
"text": "Got it. Maybe since it's not 6.15, I'll sneak one last one in. Just curious, health inflation for employers, at least some of the stats we've seen, it's expected to rise 25 versus 24. Maybe you disagree with that. Does that provide any uplift to the organic for employee benefits? I know there's a lot of building blocks for employee benefits."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Every time we get -- we are clearly a leader in our capabilities to consult, manage, and place health and welfare. And it's a huge problem for employers. And it's going up, as it seems to never stop doing. And so, there's all kinds of tools that you need to have in your toolbox to handle that. And we're very, very good at that. And, by the way, we're extremely good at it in the commercial middle market, where I think there's maybe not as much competition, frankly."
},
{
"speaker": "Operator",
"text": "Thank you. Our final question is from Alex Scott with Barclays. Please proceed with your question."
},
{
"speaker": "Unidentified Analyst",
"text": "Thank you all. This is Justin on for Alex. Just kind of going back into the brokerage segment in the commercial middle market, just wanted to ask. I understand, it seems like 90% of the time you guys are competing against independent brokers. I was just curious, in light of sort of the large-scale acquisitions that's been taking place, whether or not you see sort of this, 90% number to dwindle over time. And just let me think about 25 and ahead."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Oh, the AssuredPartners people are competing with those same independents in communities that we're not in today, which is only going to increase. When you take a look at our at-bats, our number of at-bats are going to go up substantially because of AssuredPartners. And 100% of those at-bats, that's not true. Ninety-five percent of those at-bats are going to be against smaller players."
},
{
"speaker": "Doug Howell",
"text": "Yes, I think the fragmented market, there's 30,000 agents and brokers, and those are companies, not necessarily those with a brokerage license. So we're competing against the other 29,950 brokers that are out there. So, I mean, AssuredPartners will be absolutely there. It does help us go after those accounts that are in cities that we're not in. So we think it's a great one plus one can equal more than two for sure."
},
{
"speaker": "Unidentified Analyst",
"text": "Sure thing. Thanks for the color."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"text": "Thanks, Justin. Thanks, Rob. I think we're ready to wrap up here, and I just have a quick comment, and that is thank you again for joining us this afternoon. As you all know now, we had a great fourth quarter to finish, an excellent year of financial performance. A huge thank you goes out from this table to our 56,000 colleagues around the globe. It's your creativity, expertise, and unwavering client focus that continue to set us apart. We look forward to speaking with the investment community at our mid-March IR Day and thank you all for being with us this evening."
},
{
"speaker": "Operator",
"text": "This does conclude today's conference call. You may now disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 3 | 2,024 | 2024-10-24 17:15:00 | Operator: Good afternoon. Welcome to Arthur J. Gallagher & Company’s Third Quarter 2024 Earnings Conference Call. Participants have been placed on listen-only mode. Your lines will be open for questions following the presentation. Today’s call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and risk factors sections contained in the company’s most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you very much. Good afternoon, everyone, and thank you for joining us for our third quarter 2024 earnings call. On the call for you today is Doug Howell, our CFO, other members of the management team and heads of our operating divisions. Before I get to my comments about our financial results, I’d like to acknowledge the damage and devastation caused by the recent storms and floods. Our thoughts are with those impacted by these events, including our own Gallagher colleagues. Our professionals are hard at work helping clients sort through their coverages, file claims and ultimately get losses paid. I’m really honored to be part of a company in an industry with such an important responsibility, helping families, businesses, and communities rebuild and restore their lives and that’s a noble cause. Okay, on to my comments regarding our financial performance. We had a great third quarter. For our combined Brokerage and Risk Management segments, we posted 13% growth in revenue, 6% organic growth, which does not include interest income. Reported net earnings margin of 15.5%, adjusted EBITDA margin of 31.9%, up 123 basis points year-over-year. GAAP earnings per share of $1.90 and adjusted earnings per share of $2.72, up 16% year-over-year. Another fantastic operating quarter by the team. Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth was 13%. Organic growth was right in line with our expectations at 6%, which, as we forecasted, reflects about a point of timing headwind from those large life cases we have highlighted over the past couple of quarters. Doug will provide you with some good news from October related to these sales in his remarks. Adjusted EBITDA margin expanded 137 basis points to 33.6%, which was better than our IR Day expectations. Let me give some insights behind our Brokerage segment organic. Within our PC retail operations, we delivered 5% in the U.S. and 7% outside the U.S. Internationally, Australia and New Zealand led the way with organic of more than 10%. The U.K. was up 6% and Canada was flattish. Our global employee benefit brokerage and consulting business posted organic of about 4%, and a few points higher, excluding the timing differences from the large life case sales. Shifting to our reinsurance wholesale and specialty businesses, overall organic of 8%. So very strong growth, whether retail, wholesale or reinsurance. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Global third quarter renewal premiums, which include both rate and exposure were up 5% and little change from the 6% we discussed at our September IR Day update a few weeks ago. Most lines and geographies had very similar renewal premium changes through all three months of the quarter, with a couple of exceptions. September casualty renewal increases outside the U.S. were lower relative to July and August, driven by changes in business mix. Additionally, large account and E&S property renewal premium increases were a bit less in September than the first two months of the quarter. But neither of these appear to be a trend. Thus far in October, we’re seeing large account property and international casualty renewal premium increases higher than September. Breaking down third quarter renewal premium changes by product line, we saw the following. Property up 4%, general liability up 6%, commercial auto up 7%, umbrella up 10%, workers comp up 2%, D&O down about 5%, cyber was flat and personal lines up 11%. So overall, increases continue to be broad-based and rational in our view, with carriers still cautious and pushing for rate where it’s needed to generate an acceptable underwriting profit. We shine in this environment. Our job as brokers is to help clients find the best coverage while mitigating premium increases. So while not all the increases ultimately show up in our organic, a rational market allows us to further differentiate ourselves with our leading tools, data and expertise. Let me shift to the reinsurance market. The July 1st renewal season saw modest property price declines concentrated at the top end of reinsurance towers, while casualty renewals saw terms and conditions tighten, and some modest price increases concentrated in the U.S. Clearly, a lot has happened in the property market over the past month, which is now adding some complexity to January 1st property renewals. It’s still early, but we now believe a flattish renewal is more likely than the downward pressure previously being discussed. And don’t forget, U.S. hurricane season is not over for another month. For casualty risks, we believe reinsurance will remain cautious heading into next year, especially if there is more noise related to U.S. reserve adequacy. We think differentiating underwriting practices will likely be the key to a successful renewal for clients. Overall, the reinsurance industry remains adequately capitalized and is likely to meet capacity demands at the upcoming January 1 renewals. We continue to believe Gallagher Re will perform very well in 2025, regardless of how the market environment unfolds in the near-term. Moving to some comments on our customers’ business activity. Our daily revenue indications from audits, endorsements and cancellations were again in positive territory for the third quarter. While the amount of upward revenue adjustments isn’t as much as 2023, they’re running in line with 2022. So client business activity remains solid and we are not seeing any signs of meaningful global economic slowdown. Within the U.S., the labor market is on solid footing. In fact, the number of open jobs increased in August and remained well above the number of unemployed people looking for work. Overall job growth, upward wage pressure and rising medical cost inflation continue to challenge employers looking for ways to grow their workforce and control their benefits costs. Regardless of market or economic conditions, I believe we are well positioned to take market share across our Brokerage business. Remember, about 90% of the time we are competing against the smaller local broker that cannot match our client value proposition, niche expertise, outstanding service and our extensive data and analytics offerings. Putting this all together, we continue to see full year 2024 Brokerage organic around 7.5% and that would be another outstanding year. Moving on to our Risk Management segment, Gallagher Bassett. Revenue growth was 12%, including organic of 6%. We continue to benefit from excellent client retention, increases in customer business activity, rising claim counts, and new business wins. Adjusted EBITDAC margin was 20.8%, 35 basis points higher than last year, and a bit above our September IR Day expectation. Looking ahead, we see organic in the fourth quarter around 7% and full year organic pushing 9%. Margins for fourth quarter and full year should be in the 20.5% range, and that, too, would be another outstanding year. Shifting to mergers and acquisitions. During the third quarter, we remain disciplined, completing four new mergers at fair prices representing $47 million of estimated annualized revenue. For those new partners joining us, I’d like to extend a very warm welcome to the Gallagher family of professionals. Looking ahead, we have more than 100 mergers in our pipeline, representing approximately $1.5 billion of annualized revenue. Of these 100 potential partners, we have about 60 turn sheets signed or being prepared, representing around $700 million of annualized revenue. Good firms always have a choice and it would be terrific if they chose to partner with Gallagher. Let me conclude with some comments regarding our culture. As we passed our 40th anniversary as a public company, I believe our greatest differentiator continues to be our bedrock culture. It’s a culture that runs towards problems, not away from them. A culture that supports one another and embraces teamwork. A culture that is grounded in the highest standards of moral and ethical behavior. It’s a culture that will continue to guide our success for many years to come. Frankly, we love this business. We enjoy taking care of our customers and that is the Gallagher way. Okay, I’ll stop now and turn it over to Doug. Doug?
Doug Howell: Thanks, Pat, and hello, everyone. Today, I’ll walk you through our earnings release. First, I’ll comment on third quarter organic growth and margins by segment. Then I’ll provide an update on how we are seeing organic growth and margins shape up for fourth quarter and provide an early look on 2025. Next, I’ll move to the CFO commentary document that we post on our IR website and walk you through our typical modeling helpers. And I’ll conclude my prepared remarks with my usual comments on cash, M&A and capital management. Okay, let’s flip to Page 3 of the earnings release. Headline Brokerage segment third quarter organic growth of 6% without interest income. That’s right in line with our September IR Day forecast during which we signaled about a point of headwind due to the timing of large life sales. Recall that these life products are interest rate sensitive. So, as we’ve been discussing, clients were waiting for lower interest rates. Well, the good news Pat mentioned happened over the last month or so. We are now seeing clients fund their policies. In fact, here in October, we have already caught up more than half of what had slipped from earlier quarters. So, the quarterly lumpiness that we have been highlighting throughout the year is starting to swing the other way here in October. And thus, we are currently seeing fourth quarter organic towards 8% and full year pushing 7.5%. As we start to budget for 2025, our early thinking is Brokerage segment full year organic growth might be in the 6% to 8% range. If so, that could mean a 2025 similar to how 2024 might ultimately play out. We’ll provide some more on our 2025 thinking at our December IR Day. But an early read through is we remain upbeat on our ability to grow given the investments we have been making in the business from adding niche experts to rolling out new sales and support tools to expanding our data and analytics offerings. We believe these actions are leading to higher new business production and strong client retention across the globe. And as Pat described, the market environment is still a tailwind for us. Flipping now to Page 5 of the earnings release to the Brokerage segment adjusted EBITDA table. Third quarter adjusted EBITDA margin was 33.6%, up 137 basis points over last year and above the upper end of our September IR Day expectations. Let me walk you through a bridge from last year. First, if you pull out last year’s 2023 earnings -- third quarter earnings release, you would see we reported back then adjusted EBITDA margin of 32.4%. But now using current period FX rates, that would have been 32.2%. Then organic and interest gave us nearly 150 basis points of expansion this quarter. Finally, the impact of M&A and divestitures used about 10 basis points of margin this quarter. You follow that and that will get you to third quarter 2024 margin of 33.6% and that’s the 137 basis points of Brokerage margin expansion. That is really, really great work by the team. As we look ahead to fourth quarter 2024, we are still expecting margin expansion in the 90-basis-point to 100-basis-point range. And again, that would be off of fourth quarter 2023 adjusted margin for FX, which currently is estimated to be about 20 basis points lower than last year’s headline margin of 31.6%. If we do that, that would mean full year 2024 could show about 70 basis points of margin expansion and 90 basis points excluding the first quarter impact from the roll in of the Buck merger. Okay. Let’s move on to the Risk Management segment and the organic and EBITDA tables on Pages 5 and 6. It was another solid quarter. We posted organic of 6%. That’s a point lower than our IR Day guidance because we just missed qualifying for a full revenue bonus related to one large account. That said, Gallagher Bassett continues to see excellent client retention and strong new business production and still delivers an adjusted EBITDA margin of 20.8%, which is up 35 basis points over prior year and ahead of our IR Day expectation. Looking forward, we see organic of 7% and margins around 20.5% in the fourth quarter. If we were to post that, we would finish the year with organic pushing 9% and margins of approximately 20.5%. That too would be great work by the team. As for 2025, our early thinking is for organic growth similar to the Brokerage segment, call it in that 6% to 8% range. Turning now to Page 6 of the earnings release in the Corporate segment shortcut table. In total adjusted third quarter numbers for interest and banking, clean energy and acquisition costs came in within our September IR Day expectations. The corporate line of the Corporate segment was below our expectations due to approximately $9 million of additional unrealized non-cash foreign exchange re-measurement expense that developed during September and wasn’t included in our IR Day forecast. After tax, call it about $0.03. That has already reversed here in October. So it really is a non-cash nothing in our opinion. But the accounting does cause some noise. Let’s now move to the CFO commentary document. Starting on Page 3, modeling helpers. There’s no new news here other than FX. So just consider these updated revenue and EPS impacts as you update your models. Turning to the Corporate segment on Page 4 of the CFO commentary document. No change to our outlook for fourth quarter. Flipping now to Page 5 to our tax credit carryforwards shows $796 million at September 30th. While this benefit won’t show up in the P&L, it does benefit our cash flow for the next few years which helps us fund future M&A. Turning to Page 6, the investment income table. We are now embedding two 25-basis-point rate cuts in the fourth quarter of 2024 and have updated our estimates in this table for current FX rates. Punchline here is our fourth quarter estimate does not change much from what we provided at our September IR Day. Shifting down that page to the rollover revenue table, the third quarter 2024 column subtotal is $111 million and 141 million before divestitures. These are consistent with our September IR Day expectations. Looking forward, the pinkish columns to the right include estimated revenues for Brokerage M&A closed through yesterday. So just a reminder, you’ll need to make a pick for future M&A. And when you move down on that page, you’ll see the Risk Management segment rollover revenues for fourth quarter 2024 are expected to be approximately $15 million. So moving to cash capital management and M&A funding. Available cash on hand at September 30 was about $1.2 billion. Considering this balance and our strong expected free cash flow, we are in an excellent position to fund our robust pipeline of M&A opportunities here in 2024. We currently estimate capacity of around $3 billion for M&A here in 2024 and is looking like we could have another $4 billion to fund M&A in 2025, all while making solid -- maintaining a solid investment grade rating. So it’s another excellent quarter in the books. Through the first nine months of the year for our combined Brokerage and Risk Management segments, we have delivered revenues up 16%, organic growth of 8%, net earnings of up 20%, adjusted EBITDA up 18% and adjusted EPS up 17%. Those are terrific numbers and reflect an unstoppable culture. We are well on our way to another great year of financial results. Hats off to the team for all of their hard work. So back to you, Pat.
J. Patrick Gallagher: Thanks, Doug. And operator, if we could go to questions-and-answers, please.
Operator: Sure. Thank you. [Operator Instructions] Our first question comes from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question.
Mike Zaremski: Hey. Thanks for the questions. First one is on the bridge from, in the Brokerage segment from 3Q organic to 4Q organic to kind of at the 2-point uplift sequentially. Is -- are you saying most of that is life insurance and if not, it sounded like RPC was still kind of more muted, but are you saying RPC is kind of, is lifting off into, is trending higher into 4Q? Just trying to understand some of the pieces there?
J. Patrick Gallagher: All right. So I think when you, renewal premium changes is what you’re referring to as RPC, I’m assuming.
Mike Zaremski: Yeah.
J. Patrick Gallagher: We’re not seeing underlying that our rates, that what we’re seeing for rates are not different all that much in the third quarter at all compared to what we saw in the first two quarters. And I think you’re seeing that in a lot of the carrier releases right now too. So rates for the fourth quarter, we’re assuming about the same as what we’re seeing here, yeah, in the third quarter, which is the same as in the first and the second. As for the increase next quarter, yes, we are getting about a point of additional organic growth from the life insurance sales. But when you bake all this in, we think that we’re running around 7.5% in our business right now. That’s the underlying growth. When you take out the puts and takes quarter-to-quarter, yeah, we’re nicely in that 7% to 8% range.
Mike Zaremski: Okay. Got it. So no other seasonality or anything there, okay.
J. Patrick Gallagher: We are a little slower in the fourth quarter. It’s not as big a quarter for reinsurance for us. And that has been an organic leader over the last couple of years. So, yes, we do have a little bit of that impact because we’re not so heavily weighted in the fourth quarter to reinsurance.
Mike Zaremski: Okay. All right. That makes sense. Okay. Switching gears a bit to, I guess, the margins or just if I look at the fiduciary investment income, looks like it was much better than expected. But I think you’re guiding down. What caused the spike and why is it expected to go back down?
J. Patrick Gallagher: Well, I think, you have to look at our premium funding business there. So when you take a look at the table on Page 6 of the earnings release, I don’t think we’ve changed our estimates all that much for the, excuse me, of the CFO commentary. I don’t think we’ve changed our comments all that much for the fourth quarter.
Mike Zaremski: Okay. Okay. Got it.
J. Patrick Gallagher: You also realize there can be some times where we have, obviously, fluctuations in our fiduciary cash balances, too, that can impact that number.
Mike Zaremski: Okay. Got it. And I guess just, Doug, as a follow-up to some of the comments you made earlier on renewal price change. So actually, from a number of the carriers we’ve seen so far, we have seen an uptick on the casualty side in terms of pricing. And I know in the past, too, you guys have had a view that what you’re hearing from carriers is that they’re under earning on some of the major casualty lines. So is that still kind of in your thought process, as you think that you gave us some tidbits on how 2025 could play out, that there could be some price hardening on the casualty side?
Doug Howell: There’s definitely some price concern on casualty across the board. And I don’t know if that’ll filter into discipline on their part to continue to take it up more than we’re presently seeing. But as you heard us earlier, umbrella is presently rising at about 10%. The only line in casualty that seems to have a difficult time finding bottom is D&O. The rest, however, are showing strength.
Mike Zaremski: Yeah. Thank you.
J. Patrick Gallagher: Yeah. I just got one number here. Our U.S. business, our casualty lines are up a 4-point third quarter versus second quarter.
Mike Zaremski: Thank you.
Operator: Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question.
Rob Cox: Hey. Thanks. So appreciate all the guidance on the Brokerage organic. I was just curious about the components. I think in the beginning of this year, you guys had talked about maybe it was a third, a third, a third exposure, new business and pricing. I was just curious how you guys expect that might unfold in 2025.
Doug Howell: I think it’s going to be half new business in excess of lost business and I think that it’s going to split the rest of it between exposure and rate.
Rob Cox: Okay. Got it. That’s helpful. Yeah. Just curious, maybe it’s a little bit tough to go through all the comments, but it seemed like maybe international retail decelerated a little bit more than the U.S. this quarter. I guess I was just curious also on your views between international and U.S. Retail going into next year.
J. Patrick Gallagher: Well, I think you’re going to see strong international growth. That’s where our strongest component is right now and that does not seem to be backing off. So, if you look at our prepared remarks, we talked about the fact that we’re a good part of our growth this quarter was international considering finance.
Doug Howell: Yeah. I mean, our Australia and New Zealand operations killed it this quarter. So, they’re up nicely. Canada’s a little flattish. I mean, if you…
J. Patrick Gallagher: Yeah.
Doug Howell: … want to do that, if you look at the U.K., there was a mixed issue there in the third quarter also that you could see through. But by and large, I wouldn’t say that there’s tatters anywhere that are causing us concern.
J. Patrick Gallagher: International is up 10% this quarter. And Doug’s comment’s right. The lead by New Zealand and Australia.
Rob Cox: Thanks, guys. Appreciate it.
Doug Howell: Thanks.
Operator: The next question is from the line of Elyse Greenspan with Wells Fargo. Please proceed with your questions.
Elyse Greenspan: Hi. Thanks. Good evening. My first question, embedded within your fourth quarter guidance, the 8% Brokerage organic, is there any assumption for an impact on continued commissions from the recent storms?
Doug Howell: Yeah. We don’t think we’re going to be heavily impacted, maybe a couple million bucks from the storms. But that wouldn’t move that. Maybe it moves at 10 basis points.
Elyse Greenspan: Okay. And then within the guidance, right, I think, you guys said 6% to 8% Brokerage for next year. Are you assuming -- what are you assuming for the benefits business, right? I understand there was some seasonality this year. Are you just assuming it’s kind of in line with the rest of the segment? I know you typically wait a little longer to give the bi-segment guidance, but just because that’s brought on some volatility this year, I wanted to get a sense of where you think that will head next year?
Doug Howell: Listen, if you want to pick the midpoint of that range, maybe benefits is around 5% and reinsurance is around 9%, something like that, when you’re looking for a couple points on either side of the midpoint.
Elyse Greenspan: For next year.
Doug Howell: Yeah. For next year.
Elyse Greenspan: Okay. And then, with the M&A, I know like yield flow rate has probably been a bit lighter through the first three quarters, right, then what we’ve seen in prior years. Do you guys think, just given it’s a presidential election year, has that caused, I guess, a slowdown in just the closing of transactions and are you expecting more activity in the fourth quarter early next year? How do you guys see things on that front?
J. Patrick Gallagher: Well, I think if you take a look at -- this is Pat. If you take -- if you look at the general marketplace in terms of acquisitions, there’s been a bit of a slowdown in general across the Board for the last year. We’ve got a great pipeline. In my experience, we’ve got one of the best pipelines we’ve ever had. So I think that possibly when the discomfort, if you want to call it that or concentration on this election finally ends, clearly if the Democrats get in, I think there could be a rush for the door. I don’t know what happens in the case the Republicans win, but at any rate, I think when things settle out, we do think there’ll be continued great opportunity and I do think that there’ll be a return to a little bit more robust market.
Doug Howell: Yeah. I think we are going to be -- I think if you looked at a year-to-date in 2021, we were closing around 17 and 2022, we closed 19. Year-to-date 2024, we’re at 27. Yeah, last year we closed 37 year-to-date with these tucked in deals acquisitions. So it was a little slower this quarter, but I think as you heard from Pat’s pretty detailed comments, our pipeline is terrific right now.
Elyse Greenspan: And then one last one on like that corporate line within the Corporate segment, Doug. I thought you said that it was worse, right, than September IR Day because of the FX re-measurement, but that reversed in the fourth quarter, but then the Q4 guide…
Doug Howell: That’s right.
Elyse Greenspan: … for Corporate did change. Are you just not modeling that in yet?
Doug Howell: Yeah. That’s a good point. We might be a little bipolar on that. We might have been able to schedule a couple extra pennies on that line for the reversal of what we saw at the end of the third quarter, but that bounces around quite a bit. So I think that we’ll see what happens again. So we just didn’t feel like for a couple pennies it was worth changing that number.
Elyse Greenspan: Okay. Thank you.
J. Patrick Gallagher: Thanks, Elyse.
Doug Howell: Thanks.
Operator: The next question is from the line of Gregory Peters with Raymond James. Please proceed with your question.
Gregory Peters: Yeah. Good afternoon, everyone. Just building on your…
J. Patrick Gallagher: Hi, Greg.
Gregory Peters: Yeah. Building on your last answer on acquisitions, one of the things that struck out or stuck out to me, I should say, is when I was going through the supplement was the weighted average multiple for tuck-in pricing of acquisitions came down a lot in the third quarter. Is there any -- maybe you can just help me understand what happened, why the multiple came down, because I don’t feel like multiples are coming down in the marketplace. And Pat, in your prepared remarks, you seem to emphasize your price discipline a little bit more than usually referenced in talking about tuck-in acquisitions?
J. Patrick Gallagher: Yeah. When we prepared the remarks, Greg, we did discuss whether in the past we’d been undisciplined. What I said…
Gregory Peters: Understood.
Doug Howell: Yeah. No, I think it’s just a good reminder. We have a lot of people listening to these calls, our own people included, and a lot of acquisitions, we try to maintain a good discipline around the pricing and we seem to strike a fair balance between that and the great people that join us.
Gregory Peters: And the multiple for the third quarter acquisitions came down materially. It’s like I felt like…
Doug Howell: Yeah. I think…
Gregory Peters: … I took a step back in time.
Doug Howell: One of those acquisitions was not priced, what I would say, it was priced a little under market because we have some opportunity to help get better.
Gregory Peters: Okay. Another sort of nitpicking item, you were going through your earnings press release and I was going through the adjustments to earnings to get your adjusted EBITDA. I’m Page 5 of Brokerage. And one of the things that stuck out to me is just the huge jump up in workforce and lease termination related charges in the year, this year versus last year, and the third quarter versus the third quarter last year. Is there something going on, on a bigger scale? Is this more offshoring that’s going on or maybe you could just help, I know it’s a small item inside your income statement, but maybe you could just give us a sense of what’s going on in that place?
Doug Howell: Greg, I’m sorry. Go ahead.
J. Patrick Gallagher: I was just going to say, Greg, you hit on the offshoring thing is really continues to be a very strong play for us and you’ll recall years ago, we started with a very small group. We’re 12,500 people strong there now and as we do acquisitions and go across the Board, illustrating the type of quality and the speed with which we can do things like issue certificates, there’s pretty quick adoption. It’s pretty good.
Doug Howell: Yeah. I think you’re seeing -- Greg, you’re starting to see the flywheel just getting stronger and stronger as we benefit from scale, we benefit from technologies that we’re deploying and we’re benefiting from our offshore standards of excellence. It just gives us an opportunity to continue to optimize our workforce. And so, I think you’re seeing that this quarter, yeah, popped up a little bit, because we have some opportunities to optimize our workforce. So, you’ll see that from time-to-time.
Gregory Peters: Great. And then just step back, macro question, and this will be the last one. I know your commercial customers set their budgets for the year. In the past, given the robust rate increases that you’ve had to sell, it seems like the market’s beginning to stabilize a little bit more than, say, for it was two years ago. How are the budgets -- when you hear from your customers, how are the budgets changing for their insurance spend? Is it -- you’re seeing more flat budgets? Are you still seeing them assume…?
J. Patrick Gallagher: No.
Gregory Peters: … increases? Give us a sense of what’s going on there.
J. Patrick Gallagher: Really not flat, Greg, for two reasons. Exposure units, thankfully, are continuing to grow. This is why we go through our daily review of the things that are coming through audits, et cetera. We’re seeing a robust economy and that’s clearly in a big part of the middle market. And so, from SME all the way through large accounts, we’ve got the data on that. People are expanding their exposure units, so budgets are going up. Secondly, we’re very, very cautious. We are not leading customers to believe that there’s any kind of nirvana relative to rates. That is not what’s happening. We show them our detail that we go over with you quarterly. Property is up 4%. General liability is up 6%. You may not deserve that. That may not hit your P&L. But on the other hand, you may deserve 25%. And this is a rational market and we’ve got to talk through that, which leads us right into discussing how much you retain, what you bring back into the coverage stack that you might not have had before. And that’s where the real strength and art of being a broker is, is understanding that appetite for risk that each individual account has, working with those primary buyers to decide how they’re going to get their best spend and it’s not a discussion all around rate by any means.
Doug Howell: Yeah. I think you take the chaos out of the pricing cycle and have this rational pricing cycle that we’re seeing right now. Our guys will show the tools and capabilities that we have, and that will shine through and differentiate ourselves. That’s why when I said before that I see a better new business versus lost business year next year than we’ve even seen in the last couple of years.
J. Patrick Gallagher: And by the way, to that point, Greg, we can take clients into our data now and I think you know this. We can say clients like you buy this and their quotes and cover looks like this. And by the way, their costs are this. Well, why is that? Think about selling or buying a house on the street. One’s been taken care of, looks pretty darn good, has street appeal. The other looks like junk. Guess who gets the better price? Why don’t we try to get you looking more like the house on the street people want to buy? And that, back to my point of art, is what it’s all about to be a good broker and that’s why when we get a rate environment like this, I feel very confident talking to our salespeople about we better see some increased sales, folks. Let’s go.
Gregory Peters: Fair enough. Thanks for the answers.
J. Patrick Gallagher: Thanks, Greg.
Operator: The next question is from the line of Dean Criscitiello with KBW. Please proceed with your question.
Dean Criscitiello: Hi. I was hoping if you guys could provide maybe some additional color on the sequential decrease in the organic growth in Brokerage, especially in the context of that renewal premium change holding up pretty strong sequentially.
Doug Howell: Well, listen, I think, I said earlier that, our first quarter is strong, because it’s a heavy reinsurance quarter, right? We’ve talked about some of the life insurance being a little lumpy. But if you bounce those two things out of there a little bit, again, we’re running around 7.5% organic growth each quarter. So while it looks like that on the face, yes, we’re at 6% now, but we warned that there was a 4-point of headwind against that. Also, we’re not seeing substantial rate differentials, rates between the quarters. So really underline it when you carve out the seasonality of a couple of our businesses, some of the mixed differences between when property renews versus when casually renews, the life lumpiness. You got to take our word for it. It’s pretty steady underlying other than that those things that I’ve said. So it’s pretty steady right now underlying.
J. Patrick Gallagher: Yeah. And if you want to go back three years or four years, D&O is up 300%. So by line, by geography, these rates do make a difference. They move. So we’re not seeing a D&O renewal anywhere near 300%. In fact, it’s off 5% or 6%. So the percentages do move. This is not an environment where you say for the next 10 years, good news is it’s 4% a quarter, bing, bang, boom.
Dean Criscitiello: Got it. That makes sense. And then my second one, a few of your competitors have made some large acquisitions to help, improve their middle market capabilities. And I was wondering what implications do you think that have on the competitive environment going forward, sort of being that you guys are a dominant player in that space?
J. Patrick Gallagher: I don’t think it has any impact, to be perfectly blunt, on our business at all.
Dean Criscitiello: Okay. Thank you.
J. Patrick Gallagher: Thanks, Dean.
Operator: The next question is from the line of Mark Hughes with Truist Securities. Please proceed with your questions.
Mark Hughes: Yeah. Thank you. Good afternoon. Doug, did you give early margin thoughts for 2025 for Brokerage and Risk Management?
Doug Howell: I have not. I will in December as we go through the budget. But I will say this, we post 6% to 8% organic growth next year. It’s there, Mark. There’s an opportunity for us to continue to get better. Our scale advantages are coming through our technologies, using the offshore centers of excellence. It still gives us an opportunity in an environment that we’re seeing with current wage inflation, with current inflation and in other categories of our spend, that we continue to have opportunities to get better and better. And when you’re punching out 6% to 8% organic growth, the underlying margins will absolutely have opportunity for expansion.
Mark Hughes: Very good. And then, did you give organic, broken out by the wholesale components and then reinsurance? I think you might have given those collectively at up 8%. But do you happen to have the components of that?
Doug Howell: Yeah. Listen, some of like our affinity businesses might be at 12%. Some of our program businesses might be around that 6%. I think our open brokerage is somewhere around 9% -- 8% or 9%. The reinsurance is somewhere around 8% or 9% this quarter. So I would say other than a couple, maybe the affinity business just a little better this quarter and maybe the program business just a little below that 8%. But the reason why we lumped them together and it was just to shorten the script, but there’s not a lot of difference when you’re looking at around 8%.
Mark Hughes: Understood. And then any comment, Pat, on the mixed shift out of admitted into the E&S line?
J. Patrick Gallagher: Yeah. I think it’s very -- it’s a really interesting one, Mark. I think we’re seeing continued tremendous submission supply into our wholesaling operation RPS that has not slowed down, which is really interesting and we are not seeing accounts flowing back to the primary market in any great extent. So the excess and surplus market, which we know has gobbled up a big chunk of the P&C market over the last five years, 10 years, seems to be continuing its growth and it’s maintaining its accounts. And I think that’s, we’ve got people in RPS that bring more than just pricing to the deal. There’s a lot of expertise there. There’s a lot of layering and structuring that goes into some of these deals that your local retailer, ourselves included, quite honestly, 50% of our wholesale business goes to RPS. That’s for a reason. So I think it’s both professional capabilities, as well as market access, and that market is still growing nicely.
Mark Hughes: Thank you very much.
J. Patrick Gallagher: Thanks, Mark.
Operator: Our next question is from the line of Alex Scott with Barclays. Please proceed with your question.
Alex Scott: Hi. Thanks for taking my question. So, I mean, when I hear what you’re saying about reinsurance and the strength and growth there, the wholesale business seems like it’s growing very nicely as well. When I look at the 6% and I guess run rating closer to 7% and change, but does that mean, I guess, it obviously means that the businesses other than reinsurance and wholesale, like the more core retail is doing something lower. Is there anything that’s causing some of the price there to not flow through? Is that just maybe some of the property deceleration we saw? I’m just trying to understand, that piece of it specifically. What are some of the trends you’re seeing and puts and takes headed into next year for the core retail piece of it?
Doug Howell: Yeah. Always keep in the back of your mind our benefits business. That business is running around 5%. Take out the large life cases and stuff that bounce around a little bit. So as that -- as you think about those that are above that, 7% range. Yeah, you’ve listed them, but you also have to remember that the benefit businesses naturally runs down below that, that level. Some of our actuarial services businesses run a little bit lower than that. But as I look across the organic, across all the operating, we mentioned that Canada was about flat. But by and large, there’s a few that offset each other. But it’s not like there’s any one particular area that is systemically running below that level right now.
Alex Scott: Got it. And maybe if we can go back to reinsurance. I mean, the growth rate you’re anticipating sounds pretty robust there despite the flight pricing. And I just want to see if you could add some color around that. I mean, does that have to do with demand? Can you talk a bit about what you’re seeing in terms of your clients’ demand for reinsurance?
J. Patrick Gallagher: Yeah. I think demand seems very, very strong, which is good news for us. Also, I think our level of expertise in helping clients in a market environment where there is capacity and they can move around how they play in that capacity. It’s a very strong demand for our consulting capabilities around reinsurance. What’s the next move for the carriers that are our customers? So you have both. You’ve got demand. I think you have more utilization. There’s strong growth at the primary level and all that flows up into the funnel for reinsurance. And as one of the top three players in that business, we have a lot of good prospects on the list.
Alex Scott: Great. Thanks for the responses.
J. Patrick Gallagher: Sure. Thanks, Alex.
Operator: Our next question is from Katie Sakys with Autonomous Research. Please proceed with your question.
Katie Sakys: Hi. I apologize. Thank you for the question. There might be some background noise. There’s a fire going on right now. I want to circle back to the subject of valuations. You’re thinking about acquisitions in the middle market that are really concentrated in excess of $15 million of revenue. We’ve seen a couple of those lately and the multiples on those deals have been a lot higher than we’ve seen in the past. I was curious how that compares to what you guys are seeing for those larger middle market deals and whether your appetite to participate in larger acquisitions has shifted at all?
Doug Howell: Listen, I think that there’s no question the larger you are, probably the higher the multiple might be for somebody that’s out there looking for an opportunity. But when we look at our tuck-in acquisitions, I think that people understand that we’ll pay a fair price. And the advantage is they get to stick with us. They come in and they get to work inside of a broker. It’s a broker selling to a broker. They understand that if they decide to take our stock, that they get to participate in equal form as you do, as I do, as Pat does, everybody else in this room. It’s one stock for every person. They get our resources. They get to put their employees and their clients into an environment where actually joining us is going to deliver considerably more career value and more insurance value to their customers. So many times they look at it and they say that they get the opportunity to continue on doing what they’re going to do and so they get excited about a 10, 11 or 12 multiple. That’s the reality about it, is they’re making a great return for their family. And they know they get to continue doing it with us for as long as they would like to do in their career and that’s valuable to them, too. Don’t forget that.
J. Patrick Gallagher: Let’s also take a look at the landscape. We don’t talk about this, I think, enough because the big deals get big headlines and they are big platforms. We estimate there’s 29,000 agents and brokers in America. Last year, business insurance -- last July, business insurance ranked the top 100 in the United States. Number 100 did $30 million in revenue. So there’s 28,900 brokers in America. That’s firms, not people, that are out there trading. And that’s why we say 90% of the time, which continues to be consistent over the last decade, when we compete in the marketplace, we’re competing with somebody smaller. And it’s probably less than 10% of the time, really, that we’re competing with Marsh and Aon, who are the only larger brokers in the world today. It’s not that we don’t compete. There’s a robust market at the top end. When you think about that, we can use our funds, as Doug says, at lower multiples. We can have 100 of these opportunities in our pipeline. We can be pricing out 70 of them and possibly put on a $1 billion of revenue with people that want to join us, haven’t joined somebody else, want to bring their culture and their people aboard a culture that fits and matches theirs. As Doug said, a Brokerage run by brokers. It doesn’t get the press, but it seems like a pretty good strategy and a good use of our cash does.
Katie Sakys: Got it. Thank you so much for the comment.
J. Patrick Gallagher: Yeah. You better evacuate, Katie.
Operator: Our next question is from the line of David Motemaden with Evercore ISI. Please proceed with your question.
David Motemaden: Hey. Good evening. I just had a question in Brokerage and the contingents were up 24% on an organic basis. I was wondering if you could just talk about what was driving that in the quarter.
Doug Howell: Yeah. Listen, I think that when you’re talking about that, it’s another $7 million or $8 million of where it developed from. We just had, between our benefits business and our U.S. Retail business, that’s where we picked up a few extra contingents in the quarter or our estimation for those contingents in the quarter. So there was nothing special in there. Again, we might give a couple million of that back next quarter because of the storms and floods, but by and large, it -- I would say around the possibility of what could have happened, it was a few million dollars in both of those businesses.
David Motemaden: Got it. Okay. That’s helpful. And then I guess just a bigger picture question. I heard the commentary on the term sheets being prepared or in the process of getting signed with $700 million of revenues. Do you have any stats historically on just how many of those are closed, like what percentage of those closed in the next year? Just to help us level set how much the contribution could be going forward?
J. Patrick Gallagher: I really don’t. Here’s the thing. Every one of these is a very interesting story unto itself. You’ve heard me say, I think the longest time we spent talking to a client, talking to a prospect and getting to know each other was 20 years. Sometimes they happen in a quarter. Sometimes they take a couple of years. And but when we get to pricing and we get to putting together a letter of intent, we’re getting serious. And that’s a deal that’s going to get decided in the next six months. I don’t really have a stat on how many of those do close, how many don’t. It’s a full-on sales process. It’s just like selling insurance, frankly. If you don’t have a lot in the hopper, you’re not going to close a lot.
David Motemaden: Yes.
J. Patrick Gallagher: We feel very good about these 60. You can ask me this every quarter and I will try to give some color. Right now, we feel very good about the deals that we’re proposing right now. I would think we’d have a good shot at an awful lot of those.
David Motemaden: Okay. That’s good to hear. And then just finally, so it sounded like the U.S. Retail, P&C organic, it sounded like that slowed a little bit. I think it was 5%, if I heard that right, and I think it was 6% last quarter. Was that just the large account property business that you were talking about that has reaccelerated here in the fourth quarter?
Doug Howell: Yeah. Listen, I’m just looking at my sheet here. If it moved, it moved a 0.5 point one way or another. We did have more. First quarter was just a little bit better than that, but second quarter is about the same number as what we’ve got right now.
David Motemaden: Great. Thank you.
J. Patrick Gallagher: Thanks, David.
Operator: Our next question is from the line of Grace Carter with Bank of America. Please proceed with your question.
Grace Carter: Hi, everyone. I was hoping we could talk about the contingents a little bit more. Just given the ongoing conversation around the casualty market, I was wondering how you all are thinking about any potential risk of maybe some of the pressures from the casualty line that we saw in contingents last quarter resurfacing over the next few months?
Doug Howell: If it did, we’re talking a few million bucks. I mean, I wouldn’t call that as being a systemic issue that we’re going to have to face. Just like with the storms, it’s a few million. There are some corridors, that -- we do have caps in our contingents. And so sometimes, if there is -- if the carriers have, let’s say, maybe loss -- more losses than they had hoped, it may still let us get to our full contingent level because there’s caps on that. So, right now, we’re not seeing a lot of pressure from that, not only in our past book, but as we look forward in the book. If carriers continue to strengthen their casualty rates the way they have been and what we’re hearing from them, what we’re reading about what they’re saying, it should maintain our contingent level also.
Grace Carter: Thank you. And just a quick follow-up on the lumpy life sales. If I’m understanding correctly, you all are expecting pretty much all of the timing issue to work itself out in 4Q or should we expect any sort of lagging impact from that in early 2025 as well?
Doug Howell: What I said is already here in October, we have recouped half of what had been the timing that had come out of this first quarter and second quarter, excuse me, second quarter and third quarter. So we’re going to pick up. So far, it’s half. We think that we’ve got a pipeline maybe to recover it all between now and the end of the year and then we’ll start over again. Just like every other sales organization, we got to start over next year and go out there and see if we can gin up some opportunities. But this product is becoming more and more necessary for many not-for-profits in order for them to be competitive in their executive benefit package. So this is a product that we think has long legs over the next many years -- several or many years.
Grace Carter: Thank you.
Doug Howell: Thanks, Grace.
Operator: Thank you. Our last question is from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question.
Mike Zaremski: Oh! Great. Just a quick follow-up on life insurance. So just ballpark, what percentage of your Brokerage revenues are life insurance and I don’t know if you want to break it out into this new product that might be more lumpy or just growing faster over time than traditional life?
Doug Howell: The lumpy business that we’re talking about is about $125 million business.
Mike Zaremski: Okay. Okay. And -- okay, that helps explain why it could move organic that much. Okay. Thank you. That’s all. Thanks.
J. Patrick Gallagher: Thanks, Mike. I think that’s it, Operator. Thank you again, everyone, for joining us this afternoon. We had an excellent third quarter and we’re well on our way to delivering another excellent year of financial performance. I’d like to thank our 55,000 colleagues around the globe for their hard work and dedication to our clients. We look forward to speaking with you again in person at our December Investor Meeting in New York City. Thank you very much for being with us this evening. We’ll talk to you then.
Operator: This does conclude today’s conference call. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon. Welcome to Arthur J. Gallagher & Company’s Third Quarter 2024 Earnings Conference Call. Participants have been placed on listen-only mode. Your lines will be open for questions following the presentation. Today’s call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and risk factors sections contained in the company’s most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you very much. Good afternoon, everyone, and thank you for joining us for our third quarter 2024 earnings call. On the call for you today is Doug Howell, our CFO, other members of the management team and heads of our operating divisions. Before I get to my comments about our financial results, I’d like to acknowledge the damage and devastation caused by the recent storms and floods. Our thoughts are with those impacted by these events, including our own Gallagher colleagues. Our professionals are hard at work helping clients sort through their coverages, file claims and ultimately get losses paid. I’m really honored to be part of a company in an industry with such an important responsibility, helping families, businesses, and communities rebuild and restore their lives and that’s a noble cause. Okay, on to my comments regarding our financial performance. We had a great third quarter. For our combined Brokerage and Risk Management segments, we posted 13% growth in revenue, 6% organic growth, which does not include interest income. Reported net earnings margin of 15.5%, adjusted EBITDA margin of 31.9%, up 123 basis points year-over-year. GAAP earnings per share of $1.90 and adjusted earnings per share of $2.72, up 16% year-over-year. Another fantastic operating quarter by the team. Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth was 13%. Organic growth was right in line with our expectations at 6%, which, as we forecasted, reflects about a point of timing headwind from those large life cases we have highlighted over the past couple of quarters. Doug will provide you with some good news from October related to these sales in his remarks. Adjusted EBITDA margin expanded 137 basis points to 33.6%, which was better than our IR Day expectations. Let me give some insights behind our Brokerage segment organic. Within our PC retail operations, we delivered 5% in the U.S. and 7% outside the U.S. Internationally, Australia and New Zealand led the way with organic of more than 10%. The U.K. was up 6% and Canada was flattish. Our global employee benefit brokerage and consulting business posted organic of about 4%, and a few points higher, excluding the timing differences from the large life case sales. Shifting to our reinsurance wholesale and specialty businesses, overall organic of 8%. So very strong growth, whether retail, wholesale or reinsurance. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Global third quarter renewal premiums, which include both rate and exposure were up 5% and little change from the 6% we discussed at our September IR Day update a few weeks ago. Most lines and geographies had very similar renewal premium changes through all three months of the quarter, with a couple of exceptions. September casualty renewal increases outside the U.S. were lower relative to July and August, driven by changes in business mix. Additionally, large account and E&S property renewal premium increases were a bit less in September than the first two months of the quarter. But neither of these appear to be a trend. Thus far in October, we’re seeing large account property and international casualty renewal premium increases higher than September. Breaking down third quarter renewal premium changes by product line, we saw the following. Property up 4%, general liability up 6%, commercial auto up 7%, umbrella up 10%, workers comp up 2%, D&O down about 5%, cyber was flat and personal lines up 11%. So overall, increases continue to be broad-based and rational in our view, with carriers still cautious and pushing for rate where it’s needed to generate an acceptable underwriting profit. We shine in this environment. Our job as brokers is to help clients find the best coverage while mitigating premium increases. So while not all the increases ultimately show up in our organic, a rational market allows us to further differentiate ourselves with our leading tools, data and expertise. Let me shift to the reinsurance market. The July 1st renewal season saw modest property price declines concentrated at the top end of reinsurance towers, while casualty renewals saw terms and conditions tighten, and some modest price increases concentrated in the U.S. Clearly, a lot has happened in the property market over the past month, which is now adding some complexity to January 1st property renewals. It’s still early, but we now believe a flattish renewal is more likely than the downward pressure previously being discussed. And don’t forget, U.S. hurricane season is not over for another month. For casualty risks, we believe reinsurance will remain cautious heading into next year, especially if there is more noise related to U.S. reserve adequacy. We think differentiating underwriting practices will likely be the key to a successful renewal for clients. Overall, the reinsurance industry remains adequately capitalized and is likely to meet capacity demands at the upcoming January 1 renewals. We continue to believe Gallagher Re will perform very well in 2025, regardless of how the market environment unfolds in the near-term. Moving to some comments on our customers’ business activity. Our daily revenue indications from audits, endorsements and cancellations were again in positive territory for the third quarter. While the amount of upward revenue adjustments isn’t as much as 2023, they’re running in line with 2022. So client business activity remains solid and we are not seeing any signs of meaningful global economic slowdown. Within the U.S., the labor market is on solid footing. In fact, the number of open jobs increased in August and remained well above the number of unemployed people looking for work. Overall job growth, upward wage pressure and rising medical cost inflation continue to challenge employers looking for ways to grow their workforce and control their benefits costs. Regardless of market or economic conditions, I believe we are well positioned to take market share across our Brokerage business. Remember, about 90% of the time we are competing against the smaller local broker that cannot match our client value proposition, niche expertise, outstanding service and our extensive data and analytics offerings. Putting this all together, we continue to see full year 2024 Brokerage organic around 7.5% and that would be another outstanding year. Moving on to our Risk Management segment, Gallagher Bassett. Revenue growth was 12%, including organic of 6%. We continue to benefit from excellent client retention, increases in customer business activity, rising claim counts, and new business wins. Adjusted EBITDAC margin was 20.8%, 35 basis points higher than last year, and a bit above our September IR Day expectation. Looking ahead, we see organic in the fourth quarter around 7% and full year organic pushing 9%. Margins for fourth quarter and full year should be in the 20.5% range, and that, too, would be another outstanding year. Shifting to mergers and acquisitions. During the third quarter, we remain disciplined, completing four new mergers at fair prices representing $47 million of estimated annualized revenue. For those new partners joining us, I’d like to extend a very warm welcome to the Gallagher family of professionals. Looking ahead, we have more than 100 mergers in our pipeline, representing approximately $1.5 billion of annualized revenue. Of these 100 potential partners, we have about 60 turn sheets signed or being prepared, representing around $700 million of annualized revenue. Good firms always have a choice and it would be terrific if they chose to partner with Gallagher. Let me conclude with some comments regarding our culture. As we passed our 40th anniversary as a public company, I believe our greatest differentiator continues to be our bedrock culture. It’s a culture that runs towards problems, not away from them. A culture that supports one another and embraces teamwork. A culture that is grounded in the highest standards of moral and ethical behavior. It’s a culture that will continue to guide our success for many years to come. Frankly, we love this business. We enjoy taking care of our customers and that is the Gallagher way. Okay, I’ll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"text": "Thanks, Pat, and hello, everyone. Today, I’ll walk you through our earnings release. First, I’ll comment on third quarter organic growth and margins by segment. Then I’ll provide an update on how we are seeing organic growth and margins shape up for fourth quarter and provide an early look on 2025. Next, I’ll move to the CFO commentary document that we post on our IR website and walk you through our typical modeling helpers. And I’ll conclude my prepared remarks with my usual comments on cash, M&A and capital management. Okay, let’s flip to Page 3 of the earnings release. Headline Brokerage segment third quarter organic growth of 6% without interest income. That’s right in line with our September IR Day forecast during which we signaled about a point of headwind due to the timing of large life sales. Recall that these life products are interest rate sensitive. So, as we’ve been discussing, clients were waiting for lower interest rates. Well, the good news Pat mentioned happened over the last month or so. We are now seeing clients fund their policies. In fact, here in October, we have already caught up more than half of what had slipped from earlier quarters. So, the quarterly lumpiness that we have been highlighting throughout the year is starting to swing the other way here in October. And thus, we are currently seeing fourth quarter organic towards 8% and full year pushing 7.5%. As we start to budget for 2025, our early thinking is Brokerage segment full year organic growth might be in the 6% to 8% range. If so, that could mean a 2025 similar to how 2024 might ultimately play out. We’ll provide some more on our 2025 thinking at our December IR Day. But an early read through is we remain upbeat on our ability to grow given the investments we have been making in the business from adding niche experts to rolling out new sales and support tools to expanding our data and analytics offerings. We believe these actions are leading to higher new business production and strong client retention across the globe. And as Pat described, the market environment is still a tailwind for us. Flipping now to Page 5 of the earnings release to the Brokerage segment adjusted EBITDA table. Third quarter adjusted EBITDA margin was 33.6%, up 137 basis points over last year and above the upper end of our September IR Day expectations. Let me walk you through a bridge from last year. First, if you pull out last year’s 2023 earnings -- third quarter earnings release, you would see we reported back then adjusted EBITDA margin of 32.4%. But now using current period FX rates, that would have been 32.2%. Then organic and interest gave us nearly 150 basis points of expansion this quarter. Finally, the impact of M&A and divestitures used about 10 basis points of margin this quarter. You follow that and that will get you to third quarter 2024 margin of 33.6% and that’s the 137 basis points of Brokerage margin expansion. That is really, really great work by the team. As we look ahead to fourth quarter 2024, we are still expecting margin expansion in the 90-basis-point to 100-basis-point range. And again, that would be off of fourth quarter 2023 adjusted margin for FX, which currently is estimated to be about 20 basis points lower than last year’s headline margin of 31.6%. If we do that, that would mean full year 2024 could show about 70 basis points of margin expansion and 90 basis points excluding the first quarter impact from the roll in of the Buck merger. Okay. Let’s move on to the Risk Management segment and the organic and EBITDA tables on Pages 5 and 6. It was another solid quarter. We posted organic of 6%. That’s a point lower than our IR Day guidance because we just missed qualifying for a full revenue bonus related to one large account. That said, Gallagher Bassett continues to see excellent client retention and strong new business production and still delivers an adjusted EBITDA margin of 20.8%, which is up 35 basis points over prior year and ahead of our IR Day expectation. Looking forward, we see organic of 7% and margins around 20.5% in the fourth quarter. If we were to post that, we would finish the year with organic pushing 9% and margins of approximately 20.5%. That too would be great work by the team. As for 2025, our early thinking is for organic growth similar to the Brokerage segment, call it in that 6% to 8% range. Turning now to Page 6 of the earnings release in the Corporate segment shortcut table. In total adjusted third quarter numbers for interest and banking, clean energy and acquisition costs came in within our September IR Day expectations. The corporate line of the Corporate segment was below our expectations due to approximately $9 million of additional unrealized non-cash foreign exchange re-measurement expense that developed during September and wasn’t included in our IR Day forecast. After tax, call it about $0.03. That has already reversed here in October. So it really is a non-cash nothing in our opinion. But the accounting does cause some noise. Let’s now move to the CFO commentary document. Starting on Page 3, modeling helpers. There’s no new news here other than FX. So just consider these updated revenue and EPS impacts as you update your models. Turning to the Corporate segment on Page 4 of the CFO commentary document. No change to our outlook for fourth quarter. Flipping now to Page 5 to our tax credit carryforwards shows $796 million at September 30th. While this benefit won’t show up in the P&L, it does benefit our cash flow for the next few years which helps us fund future M&A. Turning to Page 6, the investment income table. We are now embedding two 25-basis-point rate cuts in the fourth quarter of 2024 and have updated our estimates in this table for current FX rates. Punchline here is our fourth quarter estimate does not change much from what we provided at our September IR Day. Shifting down that page to the rollover revenue table, the third quarter 2024 column subtotal is $111 million and 141 million before divestitures. These are consistent with our September IR Day expectations. Looking forward, the pinkish columns to the right include estimated revenues for Brokerage M&A closed through yesterday. So just a reminder, you’ll need to make a pick for future M&A. And when you move down on that page, you’ll see the Risk Management segment rollover revenues for fourth quarter 2024 are expected to be approximately $15 million. So moving to cash capital management and M&A funding. Available cash on hand at September 30 was about $1.2 billion. Considering this balance and our strong expected free cash flow, we are in an excellent position to fund our robust pipeline of M&A opportunities here in 2024. We currently estimate capacity of around $3 billion for M&A here in 2024 and is looking like we could have another $4 billion to fund M&A in 2025, all while making solid -- maintaining a solid investment grade rating. So it’s another excellent quarter in the books. Through the first nine months of the year for our combined Brokerage and Risk Management segments, we have delivered revenues up 16%, organic growth of 8%, net earnings of up 20%, adjusted EBITDA up 18% and adjusted EPS up 17%. Those are terrific numbers and reflect an unstoppable culture. We are well on our way to another great year of financial results. Hats off to the team for all of their hard work. So back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Doug. And operator, if we could go to questions-and-answers, please."
},
{
"speaker": "Operator",
"text": "Sure. Thank you. [Operator Instructions] Our first question comes from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"text": "Hey. Thanks for the questions. First one is on the bridge from, in the Brokerage segment from 3Q organic to 4Q organic to kind of at the 2-point uplift sequentially. Is -- are you saying most of that is life insurance and if not, it sounded like RPC was still kind of more muted, but are you saying RPC is kind of, is lifting off into, is trending higher into 4Q? Just trying to understand some of the pieces there?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "All right. So I think when you, renewal premium changes is what you’re referring to as RPC, I’m assuming."
},
{
"speaker": "Mike Zaremski",
"text": "Yeah."
},
{
"speaker": "J. Patrick Gallagher",
"text": "We’re not seeing underlying that our rates, that what we’re seeing for rates are not different all that much in the third quarter at all compared to what we saw in the first two quarters. And I think you’re seeing that in a lot of the carrier releases right now too. So rates for the fourth quarter, we’re assuming about the same as what we’re seeing here, yeah, in the third quarter, which is the same as in the first and the second. As for the increase next quarter, yes, we are getting about a point of additional organic growth from the life insurance sales. But when you bake all this in, we think that we’re running around 7.5% in our business right now. That’s the underlying growth. When you take out the puts and takes quarter-to-quarter, yeah, we’re nicely in that 7% to 8% range."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Got it. So no other seasonality or anything there, okay."
},
{
"speaker": "J. Patrick Gallagher",
"text": "We are a little slower in the fourth quarter. It’s not as big a quarter for reinsurance for us. And that has been an organic leader over the last couple of years. So, yes, we do have a little bit of that impact because we’re not so heavily weighted in the fourth quarter to reinsurance."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. All right. That makes sense. Okay. Switching gears a bit to, I guess, the margins or just if I look at the fiduciary investment income, looks like it was much better than expected. But I think you’re guiding down. What caused the spike and why is it expected to go back down?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I think, you have to look at our premium funding business there. So when you take a look at the table on Page 6 of the earnings release, I don’t think we’ve changed our estimates all that much for the, excuse me, of the CFO commentary. I don’t think we’ve changed our comments all that much for the fourth quarter."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Okay. Got it."
},
{
"speaker": "J. Patrick Gallagher",
"text": "You also realize there can be some times where we have, obviously, fluctuations in our fiduciary cash balances, too, that can impact that number."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Got it. And I guess just, Doug, as a follow-up to some of the comments you made earlier on renewal price change. So actually, from a number of the carriers we’ve seen so far, we have seen an uptick on the casualty side in terms of pricing. And I know in the past, too, you guys have had a view that what you’re hearing from carriers is that they’re under earning on some of the major casualty lines. So is that still kind of in your thought process, as you think that you gave us some tidbits on how 2025 could play out, that there could be some price hardening on the casualty side?"
},
{
"speaker": "Doug Howell",
"text": "There’s definitely some price concern on casualty across the board. And I don’t know if that’ll filter into discipline on their part to continue to take it up more than we’re presently seeing. But as you heard us earlier, umbrella is presently rising at about 10%. The only line in casualty that seems to have a difficult time finding bottom is D&O. The rest, however, are showing strength."
},
{
"speaker": "Mike Zaremski",
"text": "Yeah. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. I just got one number here. Our U.S. business, our casualty lines are up a 4-point third quarter versus second quarter."
},
{
"speaker": "Mike Zaremski",
"text": "Thank you."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Rob Cox",
"text": "Hey. Thanks. So appreciate all the guidance on the Brokerage organic. I was just curious about the components. I think in the beginning of this year, you guys had talked about maybe it was a third, a third, a third exposure, new business and pricing. I was just curious how you guys expect that might unfold in 2025."
},
{
"speaker": "Doug Howell",
"text": "I think it’s going to be half new business in excess of lost business and I think that it’s going to split the rest of it between exposure and rate."
},
{
"speaker": "Rob Cox",
"text": "Okay. Got it. That’s helpful. Yeah. Just curious, maybe it’s a little bit tough to go through all the comments, but it seemed like maybe international retail decelerated a little bit more than the U.S. this quarter. I guess I was just curious also on your views between international and U.S. Retail going into next year."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I think you’re going to see strong international growth. That’s where our strongest component is right now and that does not seem to be backing off. So, if you look at our prepared remarks, we talked about the fact that we’re a good part of our growth this quarter was international considering finance."
},
{
"speaker": "Doug Howell",
"text": "Yeah. I mean, our Australia and New Zealand operations killed it this quarter. So, they’re up nicely. Canada’s a little flattish. I mean, if you…"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah."
},
{
"speaker": "Doug Howell",
"text": "… want to do that, if you look at the U.K., there was a mixed issue there in the third quarter also that you could see through. But by and large, I wouldn’t say that there’s tatters anywhere that are causing us concern."
},
{
"speaker": "J. Patrick Gallagher",
"text": "International is up 10% this quarter. And Doug’s comment’s right. The lead by New Zealand and Australia."
},
{
"speaker": "Rob Cox",
"text": "Thanks, guys. Appreciate it."
},
{
"speaker": "Doug Howell",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "The next question is from the line of Elyse Greenspan with Wells Fargo. Please proceed with your questions."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi. Thanks. Good evening. My first question, embedded within your fourth quarter guidance, the 8% Brokerage organic, is there any assumption for an impact on continued commissions from the recent storms?"
},
{
"speaker": "Doug Howell",
"text": "Yeah. We don’t think we’re going to be heavily impacted, maybe a couple million bucks from the storms. But that wouldn’t move that. Maybe it moves at 10 basis points."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then within the guidance, right, I think, you guys said 6% to 8% Brokerage for next year. Are you assuming -- what are you assuming for the benefits business, right? I understand there was some seasonality this year. Are you just assuming it’s kind of in line with the rest of the segment? I know you typically wait a little longer to give the bi-segment guidance, but just because that’s brought on some volatility this year, I wanted to get a sense of where you think that will head next year?"
},
{
"speaker": "Doug Howell",
"text": "Listen, if you want to pick the midpoint of that range, maybe benefits is around 5% and reinsurance is around 9%, something like that, when you’re looking for a couple points on either side of the midpoint."
},
{
"speaker": "Elyse Greenspan",
"text": "For next year."
},
{
"speaker": "Doug Howell",
"text": "Yeah. For next year."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then, with the M&A, I know like yield flow rate has probably been a bit lighter through the first three quarters, right, then what we’ve seen in prior years. Do you guys think, just given it’s a presidential election year, has that caused, I guess, a slowdown in just the closing of transactions and are you expecting more activity in the fourth quarter early next year? How do you guys see things on that front?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, I think if you take a look at -- this is Pat. If you take -- if you look at the general marketplace in terms of acquisitions, there’s been a bit of a slowdown in general across the Board for the last year. We’ve got a great pipeline. In my experience, we’ve got one of the best pipelines we’ve ever had. So I think that possibly when the discomfort, if you want to call it that or concentration on this election finally ends, clearly if the Democrats get in, I think there could be a rush for the door. I don’t know what happens in the case the Republicans win, but at any rate, I think when things settle out, we do think there’ll be continued great opportunity and I do think that there’ll be a return to a little bit more robust market."
},
{
"speaker": "Doug Howell",
"text": "Yeah. I think we are going to be -- I think if you looked at a year-to-date in 2021, we were closing around 17 and 2022, we closed 19. Year-to-date 2024, we’re at 27. Yeah, last year we closed 37 year-to-date with these tucked in deals acquisitions. So it was a little slower this quarter, but I think as you heard from Pat’s pretty detailed comments, our pipeline is terrific right now."
},
{
"speaker": "Elyse Greenspan",
"text": "And then one last one on like that corporate line within the Corporate segment, Doug. I thought you said that it was worse, right, than September IR Day because of the FX re-measurement, but that reversed in the fourth quarter, but then the Q4 guide…"
},
{
"speaker": "Doug Howell",
"text": "That’s right."
},
{
"speaker": "Elyse Greenspan",
"text": "… for Corporate did change. Are you just not modeling that in yet?"
},
{
"speaker": "Doug Howell",
"text": "Yeah. That’s a good point. We might be a little bipolar on that. We might have been able to schedule a couple extra pennies on that line for the reversal of what we saw at the end of the third quarter, but that bounces around quite a bit. So I think that we’ll see what happens again. So we just didn’t feel like for a couple pennies it was worth changing that number."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Elyse."
},
{
"speaker": "Doug Howell",
"text": "Thanks."
},
{
"speaker": "Operator",
"text": "The next question is from the line of Gregory Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Gregory Peters",
"text": "Yeah. Good afternoon, everyone. Just building on your…"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hi, Greg."
},
{
"speaker": "Gregory Peters",
"text": "Yeah. Building on your last answer on acquisitions, one of the things that struck out or stuck out to me, I should say, is when I was going through the supplement was the weighted average multiple for tuck-in pricing of acquisitions came down a lot in the third quarter. Is there any -- maybe you can just help me understand what happened, why the multiple came down, because I don’t feel like multiples are coming down in the marketplace. And Pat, in your prepared remarks, you seem to emphasize your price discipline a little bit more than usually referenced in talking about tuck-in acquisitions?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. When we prepared the remarks, Greg, we did discuss whether in the past we’d been undisciplined. What I said…"
},
{
"speaker": "Gregory Peters",
"text": "Understood."
},
{
"speaker": "Doug Howell",
"text": "Yeah. No, I think it’s just a good reminder. We have a lot of people listening to these calls, our own people included, and a lot of acquisitions, we try to maintain a good discipline around the pricing and we seem to strike a fair balance between that and the great people that join us."
},
{
"speaker": "Gregory Peters",
"text": "And the multiple for the third quarter acquisitions came down materially. It’s like I felt like…"
},
{
"speaker": "Doug Howell",
"text": "Yeah. I think…"
},
{
"speaker": "Gregory Peters",
"text": "… I took a step back in time."
},
{
"speaker": "Doug Howell",
"text": "One of those acquisitions was not priced, what I would say, it was priced a little under market because we have some opportunity to help get better."
},
{
"speaker": "Gregory Peters",
"text": "Okay. Another sort of nitpicking item, you were going through your earnings press release and I was going through the adjustments to earnings to get your adjusted EBITDA. I’m Page 5 of Brokerage. And one of the things that stuck out to me is just the huge jump up in workforce and lease termination related charges in the year, this year versus last year, and the third quarter versus the third quarter last year. Is there something going on, on a bigger scale? Is this more offshoring that’s going on or maybe you could just help, I know it’s a small item inside your income statement, but maybe you could just give us a sense of what’s going on in that place?"
},
{
"speaker": "Doug Howell",
"text": "Greg, I’m sorry. Go ahead."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I was just going to say, Greg, you hit on the offshoring thing is really continues to be a very strong play for us and you’ll recall years ago, we started with a very small group. We’re 12,500 people strong there now and as we do acquisitions and go across the Board, illustrating the type of quality and the speed with which we can do things like issue certificates, there’s pretty quick adoption. It’s pretty good."
},
{
"speaker": "Doug Howell",
"text": "Yeah. I think you’re seeing -- Greg, you’re starting to see the flywheel just getting stronger and stronger as we benefit from scale, we benefit from technologies that we’re deploying and we’re benefiting from our offshore standards of excellence. It just gives us an opportunity to continue to optimize our workforce. And so, I think you’re seeing that this quarter, yeah, popped up a little bit, because we have some opportunities to optimize our workforce. So, you’ll see that from time-to-time."
},
{
"speaker": "Gregory Peters",
"text": "Great. And then just step back, macro question, and this will be the last one. I know your commercial customers set their budgets for the year. In the past, given the robust rate increases that you’ve had to sell, it seems like the market’s beginning to stabilize a little bit more than, say, for it was two years ago. How are the budgets -- when you hear from your customers, how are the budgets changing for their insurance spend? Is it -- you’re seeing more flat budgets? Are you still seeing them assume…?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "No."
},
{
"speaker": "Gregory Peters",
"text": "… increases? Give us a sense of what’s going on there."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Really not flat, Greg, for two reasons. Exposure units, thankfully, are continuing to grow. This is why we go through our daily review of the things that are coming through audits, et cetera. We’re seeing a robust economy and that’s clearly in a big part of the middle market. And so, from SME all the way through large accounts, we’ve got the data on that. People are expanding their exposure units, so budgets are going up. Secondly, we’re very, very cautious. We are not leading customers to believe that there’s any kind of nirvana relative to rates. That is not what’s happening. We show them our detail that we go over with you quarterly. Property is up 4%. General liability is up 6%. You may not deserve that. That may not hit your P&L. But on the other hand, you may deserve 25%. And this is a rational market and we’ve got to talk through that, which leads us right into discussing how much you retain, what you bring back into the coverage stack that you might not have had before. And that’s where the real strength and art of being a broker is, is understanding that appetite for risk that each individual account has, working with those primary buyers to decide how they’re going to get their best spend and it’s not a discussion all around rate by any means."
},
{
"speaker": "Doug Howell",
"text": "Yeah. I think you take the chaos out of the pricing cycle and have this rational pricing cycle that we’re seeing right now. Our guys will show the tools and capabilities that we have, and that will shine through and differentiate ourselves. That’s why when I said before that I see a better new business versus lost business year next year than we’ve even seen in the last couple of years."
},
{
"speaker": "J. Patrick Gallagher",
"text": "And by the way, to that point, Greg, we can take clients into our data now and I think you know this. We can say clients like you buy this and their quotes and cover looks like this. And by the way, their costs are this. Well, why is that? Think about selling or buying a house on the street. One’s been taken care of, looks pretty darn good, has street appeal. The other looks like junk. Guess who gets the better price? Why don’t we try to get you looking more like the house on the street people want to buy? And that, back to my point of art, is what it’s all about to be a good broker and that’s why when we get a rate environment like this, I feel very confident talking to our salespeople about we better see some increased sales, folks. Let’s go."
},
{
"speaker": "Gregory Peters",
"text": "Fair enough. Thanks for the answers."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Greg."
},
{
"speaker": "Operator",
"text": "The next question is from the line of Dean Criscitiello with KBW. Please proceed with your question."
},
{
"speaker": "Dean Criscitiello",
"text": "Hi. I was hoping if you guys could provide maybe some additional color on the sequential decrease in the organic growth in Brokerage, especially in the context of that renewal premium change holding up pretty strong sequentially."
},
{
"speaker": "Doug Howell",
"text": "Well, listen, I think, I said earlier that, our first quarter is strong, because it’s a heavy reinsurance quarter, right? We’ve talked about some of the life insurance being a little lumpy. But if you bounce those two things out of there a little bit, again, we’re running around 7.5% organic growth each quarter. So while it looks like that on the face, yes, we’re at 6% now, but we warned that there was a 4-point of headwind against that. Also, we’re not seeing substantial rate differentials, rates between the quarters. So really underline it when you carve out the seasonality of a couple of our businesses, some of the mixed differences between when property renews versus when casually renews, the life lumpiness. You got to take our word for it. It’s pretty steady underlying other than that those things that I’ve said. So it’s pretty steady right now underlying."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. And if you want to go back three years or four years, D&O is up 300%. So by line, by geography, these rates do make a difference. They move. So we’re not seeing a D&O renewal anywhere near 300%. In fact, it’s off 5% or 6%. So the percentages do move. This is not an environment where you say for the next 10 years, good news is it’s 4% a quarter, bing, bang, boom."
},
{
"speaker": "Dean Criscitiello",
"text": "Got it. That makes sense. And then my second one, a few of your competitors have made some large acquisitions to help, improve their middle market capabilities. And I was wondering what implications do you think that have on the competitive environment going forward, sort of being that you guys are a dominant player in that space?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I don’t think it has any impact, to be perfectly blunt, on our business at all."
},
{
"speaker": "Dean Criscitiello",
"text": "Okay. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Dean."
},
{
"speaker": "Operator",
"text": "The next question is from the line of Mark Hughes with Truist Securities. Please proceed with your questions."
},
{
"speaker": "Mark Hughes",
"text": "Yeah. Thank you. Good afternoon. Doug, did you give early margin thoughts for 2025 for Brokerage and Risk Management?"
},
{
"speaker": "Doug Howell",
"text": "I have not. I will in December as we go through the budget. But I will say this, we post 6% to 8% organic growth next year. It’s there, Mark. There’s an opportunity for us to continue to get better. Our scale advantages are coming through our technologies, using the offshore centers of excellence. It still gives us an opportunity in an environment that we’re seeing with current wage inflation, with current inflation and in other categories of our spend, that we continue to have opportunities to get better and better. And when you’re punching out 6% to 8% organic growth, the underlying margins will absolutely have opportunity for expansion."
},
{
"speaker": "Mark Hughes",
"text": "Very good. And then, did you give organic, broken out by the wholesale components and then reinsurance? I think you might have given those collectively at up 8%. But do you happen to have the components of that?"
},
{
"speaker": "Doug Howell",
"text": "Yeah. Listen, some of like our affinity businesses might be at 12%. Some of our program businesses might be around that 6%. I think our open brokerage is somewhere around 9% -- 8% or 9%. The reinsurance is somewhere around 8% or 9% this quarter. So I would say other than a couple, maybe the affinity business just a little better this quarter and maybe the program business just a little below that 8%. But the reason why we lumped them together and it was just to shorten the script, but there’s not a lot of difference when you’re looking at around 8%."
},
{
"speaker": "Mark Hughes",
"text": "Understood. And then any comment, Pat, on the mixed shift out of admitted into the E&S line?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. I think it’s very -- it’s a really interesting one, Mark. I think we’re seeing continued tremendous submission supply into our wholesaling operation RPS that has not slowed down, which is really interesting and we are not seeing accounts flowing back to the primary market in any great extent. So the excess and surplus market, which we know has gobbled up a big chunk of the P&C market over the last five years, 10 years, seems to be continuing its growth and it’s maintaining its accounts. And I think that’s, we’ve got people in RPS that bring more than just pricing to the deal. There’s a lot of expertise there. There’s a lot of layering and structuring that goes into some of these deals that your local retailer, ourselves included, quite honestly, 50% of our wholesale business goes to RPS. That’s for a reason. So I think it’s both professional capabilities, as well as market access, and that market is still growing nicely."
},
{
"speaker": "Mark Hughes",
"text": "Thank you very much."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Mark."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Alex Scott with Barclays. Please proceed with your question."
},
{
"speaker": "Alex Scott",
"text": "Hi. Thanks for taking my question. So, I mean, when I hear what you’re saying about reinsurance and the strength and growth there, the wholesale business seems like it’s growing very nicely as well. When I look at the 6% and I guess run rating closer to 7% and change, but does that mean, I guess, it obviously means that the businesses other than reinsurance and wholesale, like the more core retail is doing something lower. Is there anything that’s causing some of the price there to not flow through? Is that just maybe some of the property deceleration we saw? I’m just trying to understand, that piece of it specifically. What are some of the trends you’re seeing and puts and takes headed into next year for the core retail piece of it?"
},
{
"speaker": "Doug Howell",
"text": "Yeah. Always keep in the back of your mind our benefits business. That business is running around 5%. Take out the large life cases and stuff that bounce around a little bit. So as that -- as you think about those that are above that, 7% range. Yeah, you’ve listed them, but you also have to remember that the benefit businesses naturally runs down below that, that level. Some of our actuarial services businesses run a little bit lower than that. But as I look across the organic, across all the operating, we mentioned that Canada was about flat. But by and large, there’s a few that offset each other. But it’s not like there’s any one particular area that is systemically running below that level right now."
},
{
"speaker": "Alex Scott",
"text": "Got it. And maybe if we can go back to reinsurance. I mean, the growth rate you’re anticipating sounds pretty robust there despite the flight pricing. And I just want to see if you could add some color around that. I mean, does that have to do with demand? Can you talk a bit about what you’re seeing in terms of your clients’ demand for reinsurance?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. I think demand seems very, very strong, which is good news for us. Also, I think our level of expertise in helping clients in a market environment where there is capacity and they can move around how they play in that capacity. It’s a very strong demand for our consulting capabilities around reinsurance. What’s the next move for the carriers that are our customers? So you have both. You’ve got demand. I think you have more utilization. There’s strong growth at the primary level and all that flows up into the funnel for reinsurance. And as one of the top three players in that business, we have a lot of good prospects on the list."
},
{
"speaker": "Alex Scott",
"text": "Great. Thanks for the responses."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Sure. Thanks, Alex."
},
{
"speaker": "Operator",
"text": "Our next question is from Katie Sakys with Autonomous Research. Please proceed with your question."
},
{
"speaker": "Katie Sakys",
"text": "Hi. I apologize. Thank you for the question. There might be some background noise. There’s a fire going on right now. I want to circle back to the subject of valuations. You’re thinking about acquisitions in the middle market that are really concentrated in excess of $15 million of revenue. We’ve seen a couple of those lately and the multiples on those deals have been a lot higher than we’ve seen in the past. I was curious how that compares to what you guys are seeing for those larger middle market deals and whether your appetite to participate in larger acquisitions has shifted at all?"
},
{
"speaker": "Doug Howell",
"text": "Listen, I think that there’s no question the larger you are, probably the higher the multiple might be for somebody that’s out there looking for an opportunity. But when we look at our tuck-in acquisitions, I think that people understand that we’ll pay a fair price. And the advantage is they get to stick with us. They come in and they get to work inside of a broker. It’s a broker selling to a broker. They understand that if they decide to take our stock, that they get to participate in equal form as you do, as I do, as Pat does, everybody else in this room. It’s one stock for every person. They get our resources. They get to put their employees and their clients into an environment where actually joining us is going to deliver considerably more career value and more insurance value to their customers. So many times they look at it and they say that they get the opportunity to continue on doing what they’re going to do and so they get excited about a 10, 11 or 12 multiple. That’s the reality about it, is they’re making a great return for their family. And they know they get to continue doing it with us for as long as they would like to do in their career and that’s valuable to them, too. Don’t forget that."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Let’s also take a look at the landscape. We don’t talk about this, I think, enough because the big deals get big headlines and they are big platforms. We estimate there’s 29,000 agents and brokers in America. Last year, business insurance -- last July, business insurance ranked the top 100 in the United States. Number 100 did $30 million in revenue. So there’s 28,900 brokers in America. That’s firms, not people, that are out there trading. And that’s why we say 90% of the time, which continues to be consistent over the last decade, when we compete in the marketplace, we’re competing with somebody smaller. And it’s probably less than 10% of the time, really, that we’re competing with Marsh and Aon, who are the only larger brokers in the world today. It’s not that we don’t compete. There’s a robust market at the top end. When you think about that, we can use our funds, as Doug says, at lower multiples. We can have 100 of these opportunities in our pipeline. We can be pricing out 70 of them and possibly put on a $1 billion of revenue with people that want to join us, haven’t joined somebody else, want to bring their culture and their people aboard a culture that fits and matches theirs. As Doug said, a Brokerage run by brokers. It doesn’t get the press, but it seems like a pretty good strategy and a good use of our cash does."
},
{
"speaker": "Katie Sakys",
"text": "Got it. Thank you so much for the comment."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yeah. You better evacuate, Katie."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of David Motemaden with Evercore ISI. Please proceed with your question."
},
{
"speaker": "David Motemaden",
"text": "Hey. Good evening. I just had a question in Brokerage and the contingents were up 24% on an organic basis. I was wondering if you could just talk about what was driving that in the quarter."
},
{
"speaker": "Doug Howell",
"text": "Yeah. Listen, I think that when you’re talking about that, it’s another $7 million or $8 million of where it developed from. We just had, between our benefits business and our U.S. Retail business, that’s where we picked up a few extra contingents in the quarter or our estimation for those contingents in the quarter. So there was nothing special in there. Again, we might give a couple million of that back next quarter because of the storms and floods, but by and large, it -- I would say around the possibility of what could have happened, it was a few million dollars in both of those businesses."
},
{
"speaker": "David Motemaden",
"text": "Got it. Okay. That’s helpful. And then I guess just a bigger picture question. I heard the commentary on the term sheets being prepared or in the process of getting signed with $700 million of revenues. Do you have any stats historically on just how many of those are closed, like what percentage of those closed in the next year? Just to help us level set how much the contribution could be going forward?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "I really don’t. Here’s the thing. Every one of these is a very interesting story unto itself. You’ve heard me say, I think the longest time we spent talking to a client, talking to a prospect and getting to know each other was 20 years. Sometimes they happen in a quarter. Sometimes they take a couple of years. And but when we get to pricing and we get to putting together a letter of intent, we’re getting serious. And that’s a deal that’s going to get decided in the next six months. I don’t really have a stat on how many of those do close, how many don’t. It’s a full-on sales process. It’s just like selling insurance, frankly. If you don’t have a lot in the hopper, you’re not going to close a lot."
},
{
"speaker": "David Motemaden",
"text": "Yes."
},
{
"speaker": "J. Patrick Gallagher",
"text": "We feel very good about these 60. You can ask me this every quarter and I will try to give some color. Right now, we feel very good about the deals that we’re proposing right now. I would think we’d have a good shot at an awful lot of those."
},
{
"speaker": "David Motemaden",
"text": "Okay. That’s good to hear. And then just finally, so it sounded like the U.S. Retail, P&C organic, it sounded like that slowed a little bit. I think it was 5%, if I heard that right, and I think it was 6% last quarter. Was that just the large account property business that you were talking about that has reaccelerated here in the fourth quarter?"
},
{
"speaker": "Doug Howell",
"text": "Yeah. Listen, I’m just looking at my sheet here. If it moved, it moved a 0.5 point one way or another. We did have more. First quarter was just a little bit better than that, but second quarter is about the same number as what we’ve got right now."
},
{
"speaker": "David Motemaden",
"text": "Great. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Grace Carter with Bank of America. Please proceed with your question."
},
{
"speaker": "Grace Carter",
"text": "Hi, everyone. I was hoping we could talk about the contingents a little bit more. Just given the ongoing conversation around the casualty market, I was wondering how you all are thinking about any potential risk of maybe some of the pressures from the casualty line that we saw in contingents last quarter resurfacing over the next few months?"
},
{
"speaker": "Doug Howell",
"text": "If it did, we’re talking a few million bucks. I mean, I wouldn’t call that as being a systemic issue that we’re going to have to face. Just like with the storms, it’s a few million. There are some corridors, that -- we do have caps in our contingents. And so sometimes, if there is -- if the carriers have, let’s say, maybe loss -- more losses than they had hoped, it may still let us get to our full contingent level because there’s caps on that. So, right now, we’re not seeing a lot of pressure from that, not only in our past book, but as we look forward in the book. If carriers continue to strengthen their casualty rates the way they have been and what we’re hearing from them, what we’re reading about what they’re saying, it should maintain our contingent level also."
},
{
"speaker": "Grace Carter",
"text": "Thank you. And just a quick follow-up on the lumpy life sales. If I’m understanding correctly, you all are expecting pretty much all of the timing issue to work itself out in 4Q or should we expect any sort of lagging impact from that in early 2025 as well?"
},
{
"speaker": "Doug Howell",
"text": "What I said is already here in October, we have recouped half of what had been the timing that had come out of this first quarter and second quarter, excuse me, second quarter and third quarter. So we’re going to pick up. So far, it’s half. We think that we’ve got a pipeline maybe to recover it all between now and the end of the year and then we’ll start over again. Just like every other sales organization, we got to start over next year and go out there and see if we can gin up some opportunities. But this product is becoming more and more necessary for many not-for-profits in order for them to be competitive in their executive benefit package. So this is a product that we think has long legs over the next many years -- several or many years."
},
{
"speaker": "Grace Carter",
"text": "Thank you."
},
{
"speaker": "Doug Howell",
"text": "Thanks, Grace."
},
{
"speaker": "Operator",
"text": "Thank you. Our last question is from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"text": "Oh! Great. Just a quick follow-up on life insurance. So just ballpark, what percentage of your Brokerage revenues are life insurance and I don’t know if you want to break it out into this new product that might be more lumpy or just growing faster over time than traditional life?"
},
{
"speaker": "Doug Howell",
"text": "The lumpy business that we’re talking about is about $125 million business."
},
{
"speaker": "Mike Zaremski",
"text": "Okay. Okay. And -- okay, that helps explain why it could move organic that much. Okay. Thank you. That’s all. Thanks."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Mike. I think that’s it, Operator. Thank you again, everyone, for joining us this afternoon. We had an excellent third quarter and we’re well on our way to delivering another excellent year of financial performance. I’d like to thank our 55,000 colleagues around the globe for their hard work and dedication to our clients. We look forward to speaking with you again in person at our December Investor Meeting in New York City. Thank you very much for being with us this evening. We’ll talk to you then."
},
{
"speaker": "Operator",
"text": "This does conclude today’s conference call. You may disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 2 | 2,024 | 2024-07-25 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Co's Second Quarter 2024 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The Company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer the information concerning forward-looking statements and risk factors sections contained in the Company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the Company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
J. Patrick Gallagher: Thank you very much. Good afternoon. Thank you for joining us for our second quarter 2024 earnings call. On the call with me today is Doug Howell, our CFO, other members of the management team and the heads of our operating business divisions. We had an excellent second quarter. For our combined Brokerage and Risk Management segments we posted 14% growth in revenue, 7.7% organic growth and 8.1% if you include interest income. We also completed 12 new mergers totaling $72 million of estimated annualized revenue. Reported net earnings margin expansion of 35 basis points, adjusted EBITDAC margin expansion of 102 basis points to 31.4%. GAAP earnings per share of $1.70, up 15% year-over-year, and adjusted earnings per share of $2.68, up 19% year-over-year, another great quarter by the team and right in line with the expectations we provided at our June IR Day. Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth was 14%. Organic growth was 7.7% at the midpoint of guidance, and above 8% if you include interest income. Adjusted EBITDAC margin expansion was 98 basis points at the upper end of our June IR Day expectations. Let me give you some insights behind our Brokerage segment organic. And just to level set, the following figures do not include interest income. Within our PC retail operations, we delivered 6% in the U.S. and Canada, 7% in the UK, Australia and New Zealand. Our global employee benefit brokerage and consulting business posted organic of about 3%, that would have been 5% without the timing impact from some lumpy life case sales. Shifting to our reinsurance, wholesale and specialty businesses, overall organic of 12%. This includes Gallagher Re at 13%, UK specialty at 10% and U.S. wholesale at 11%, excellent growth, whether retail, wholesale or reinsurance. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance marketplace. Global second quarter renewal premiums, which include both rate and exposure changes, were up about 5%. So no change from what we discussed four weeks ago at our June Investor meeting. Renewal premium increases continue to be broad-based, up across all of our major geographies and most product lines. For example, property was up 2% to 4%, general liability up 5% to 7%, umbrella and commercial auto up 8% to 10%, workers' comp up 1% to 3%, D&O down about 5%, cyber was flat and personal lines up over 10%. So many lines are still seeing strong increases. Moving to the reinsurance market and mid-year renewals. Property reinsurance renewals saw modest price declines concentrated at the top-end of reinsurance towers due to the increased capacity from both traditional reinsurers and the ILS market. Offsetting this was underlying exposure growth, combined with increased demand, resulting in flat year-over-year premium for reinsurers overall. U.S. Casualty renewals saw terms and conditions tightened and some modest price increases. Reinsurers continue to heavily scrutinize submissions given the industry's unfavorable prior year reserve development and reinsurers view of the current loss cost trends. In our view, insurance and reinsurance carriers continue to behave rationally. Raising rates the most where it is needed to generate an adequate underwriting profit by line, by industry and by geography. We continue to see this differentiation in our data between property and casualty lines. Carriers believe property maybe close to approaching price and exposure adequacy. And thus, we are seeing property renewal premium increases moderating, but mostly within large accounts. Underlying that accounts with premiums around $1 million or greater are seeing renewal premiums flattish year-over-year. Yet on the other hand, in the small and mid-sized client space, where we are an industry leader, we are seeing increases of 7% for the second quarter. Shifting to casualty classes, we are seeing the greatest renewal premium increases and signs of these increases advancing. In fact, global second quarter umbrella and commercial auto renewal premium increases are in the high-single digits, and there is little differentiation by client size. We have been highlighting worsening social inflation, medical expenses and growing historical reserve concerns for quite some time. And thus, we continue to believe further rate increases are to come in casualty. While renewal premium increases are rational carrier response in the current environment, our clients have experienced multiple years of increased costs. Having a trusted adviser like Gallagher can help businesses navigate a complex insurance market by finding the best coverage for our clients while mitigating price increases, and that's our job as brokers. Moving to comments on our customers' business activity. During the second quarter, our daily indications continue to show positive mid-year policy endorsements, audits and cancellations, similar with last year's levels across most geographies. So activity remains solid, and we are not seeing signs of global economic slowdown. Within the U.S., the labor market in balance remains intact with more open jobs than unemployed people looking for work. And with continued wage growth and further medical cost inflation, employers remain focused on attracting and retaining talent while controlling costs. So I see solid demand for our services and advice in 2024 and in 2025. Across the brokerage operations, I believe we continue to win market share due to our superior client value proposition, niche expertise, outstanding service and our extensive data and analytics offerings. Frankly, the smaller local brokers that we are competing against, about 90% of the time, just can't match the value we provide, and that is leading to more net brokerage wins for Gallagher. So when we pull all this together, we continue to see full-year 2024 brokerage organic in the 7% to 9% range, and that would be another outstanding year. Moving on to our Risk Management segment, Gallagher Bassett. Revenue growth was 13%, including organic of 7.7%. Adjusted EBITDAC margins were 20.6%, up 120 basis points versus last year, and in line with our June IR Day expectations. We continue to benefit from new business wins, outstanding retention, increases in customer business activity and higher new rising claims. Looking forward, we see organic in the next two quarters around 7% and margins around 20.5% that would bring full-year 2024 organic to 9% and margins to approximately 20.5%, and that, too, would be an outstanding year. Let me shift to mergers and acquisitions. We completed 12 new mergers during the second quarter, representing about $72 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us, and extend a very warm welcome to our growing Gallagher family of professionals. Looking ahead, our pipeline remains very strong. We have around 60 term sheets being signed and prepared, representing around $550 million of annualized revenue. Good firms always have a choice, and we will be very excited if they choose to join Gallagher. Let me conclude with some comments regarding our bedrock culture. Last month, we reflected on the 40th anniversary of becoming a public company. Michael Bob Gallagher, Chairman and CEO at the time, knew above all, we must maintain our unique culture of teamwork, integrity and client service. Those values are captured in the 25 tenets with the Gallagher Way. Thanks to all of our global colleagues that live and breathe the Gallagher Way day in and day out. Our culture is stronger and more vibrant than ever, and it's our culture that continues to differentiate us as a firm and help to drive an average annual total shareholder return of more than 16% over the past 40 years. That is the Gallagher Way. Okay. I'll stop now and turn it over to Doug. Doug?
Douglas Howell: Thanks, Pat, and hello, everyone. Today, I'll start with our earnings release. I'll comment on second quarter organic growth and margins by segment. Punchline is we came in right in line with our June IR Day commentary. I'll also update you on how we are seeing organic growth and margin shape up for the second half of the year. Then I'll shift to the CFO commentary document that we posted on our IR website, and I'll walk through the typical modeling helpers that we provide. And I'll conclude my prepared remarks with a few comments on cash, M&A and capital management. Okay. Let's flip to Page 3 of the earnings release. Headline Brokerage segment second quarter organic growth of 7.7%. Again, that's right in line with our June IR day, where we forecasted a range of 7.5% to 8%. Notably, we would have been above 8% if a few large live sales had not shifted from second quarter to later in the year. We signaled this possible timing to our June IR Day. So again, no new news here. Recall that we also foreshadowed in late June a small headwind from contingents that adversely impacted all inorganic by about 25 basis points. And finally, just a reminder, that we don't include interest income and organic. If we did, that would have pushed organic higher by about 40 basis points. We believe the investments that we have made in people, sales tools, niche experts and data and analytics are leading to strong new business production and favorable client retention across the globe. Additionally, the insurance market backdrop remains supportive of growth. Pat said renewal premium changes 5% in the quarter. However, our July's renewal premium change thus far is above second quarter. And with an active hurricane season predicted and noise around U.S. casualty reserves growing louder again this quarter, it's not unreasonable to expect mid single-digit or greater renewal premium changes in the second half of 2024. So our organic investments, combined with the insurance market conditions, continues to support our 2024 full-year Brokerage segment organic outlook. We are still seeing it in that 7% to 9% range. So now flip to Page 5 of the earnings release to the Brokerage segment adjusted EBITDAC table. Second quarter adjusted EBITDAC margin was 33.1%, up 98 basis points over last year and at the upper end of our June IR Day expectations. Let me walk you through a bridge from last year. First, if you pull out last year 2023 second quarter, you'd see we reported back then adjusted EBITDAC margin of 32.1%. Second, you need to adjust for current period FX rates, which had a very limited impact on margin this quarter. So 2023 adjusted FX margin was also 32.1%. Third, organic and interest gave us nearly 110 basis points of margin expansion this quarter and then the impact of M&A and divestitures used about 10 basis points of margin. That gets you to second quarter 2024 margins of 33.1%, and therefore, that's nearly 100 basis points of brokerage margin expansion. That's really, really great work by the team. As we look ahead to the second half of 2024, we are still expecting margin expansion in the 90 basis points to 100 basis points range. So third and fourth quarter will look a lot like second quarter. Recall, first quarter 2024 still had the roll-in impact of the Buck acquisition. So the math for full-year 2024 will show about 60 basis points of full-year expansion, but that would be about 80 basis points full-year without Buck, which feels about right, assuming we posted organic in the 7% to 9% range. Let's move now to the Risk Management segment and the organic and EBITDAC tables on Pages 5 and 6 of the earnings release. Another excellent quarter. We saw solid new business, fantastic retention and growing claim count. We posted organic of 7.7% and margins at 20.6%, both were right in line with our June IR Day outlook. Looking forward, as Pat said, we see organic in each of the next two quarters around 7% and margins around 20.5%. If we were to post that, we would finish the year with organic of 9% and margins of approximately 20.5%. That also would be great work by the team. Turning to Page 6 of the earnings release and the corporate segment shortcut table. Adjusted second quarter numbers came in just better than the favorable end of our June IR Day expectations. All of that was due to some favorable tax items within the corporate expense line. All right. Now let's move to the CFO commentary document, starting on Page 3, a few comments. First, foreign exchange. The dollar has weakened over the past month, so please make sure you incorporate these updated revenue and EPS impacts from FX in your models for the Brokerage and Risk Management segment. Second, Brokerage segment amortization expense. Recall, while this impacts reported GAAP results, we adjusted out so it doesn't impact adjusted non-GAAP earnings. This line can also be a bit noisy from time to time. Late this quarter, we received updated third-party M&A valuation estimates on a third – or excuse me, on a few recent acquisitions and also made some balance sheet adjustments at the end of the quarter. You'll see that in Footnote two at the bottom of the page. Looking forward, we expect amortization expense of about $155 million per quarter. Again, all of that is adjusted out, but it does cause some noise in the reported GAAP results. Now it's the risk management amortization and depreciation line. Here too, we received updated M&A valuation estimates for our recent acquisition, which is also described in Footnote five. The net impact to non-GAAP results is about $0.01 to EPS this quarter. Going forward, we are now expecting a lower level of depreciation and amortization as a result of that M&A valuation report. Turning to the Corporate segment on Page 4, no change to our outlook for the third and fourth quarter. Flipping to Page 5 to our tax credit carryforwards. It shows about $800 million at June 30. While this benefit won't show up in the P&L, it does benefit our cash flow by about $150 million to $180 million a year, which helps us fund future M&A. Turning now to Page 6, the investment income table. We call this modeling help breaks down the components of investment income, premium finance revenues, book gains and equity investments in third-party brokers. And as a reminder, none of these items are included in our organic growth computations that we present on Pages 3 and 5 of our earnings release. The punchline here is not much has changed from what we provided at our June IR Day. We are still embedding two 25 basis point rate cuts in the second half of 2024, and we have updated our estimates in this table for current FX rates. When you ship down on that page to the rollover revenue table, second quarter 2024 column, the subtotal shows $128 million and $142 million before divestitures. The $142 million was better than our IR Day outlook due to a few acquisitions performing very well during June. Looking forward, the pinkish columns to the right include estimated revenues for M&A closed through yesterday. So just a reminder, you'll need to make a pick for future M&A. Moving down on that page, you'll see Risk Management segment rollover revenues have been updated for our early third quarter acquisition. For the next two quarters, we expect approximately $20 million and $15 million, respectively. Please make sure to reflect these additional revenues in your models. Moving now to cash, capital management and M&A funding. Available cash on hand at June 30 was approaching $700 million. When combined with our expected free cash flow in the second half of 2024, which is typically stronger than the first half, we are well positioned for our pipeline of M&A opportunities. In total, we continue to estimate we could have $3.5 billion to fund M&A opportunities during 2024 and another $4 billion in 2025, all while maintaining a solid investment-grade debt rating. And remember, if we don't spend it all, it opens the door for share repurchases as well. Okay. Another excellent quarter and fantastic first half of the year. Looking ahead, we see continued strong organic growth due to net new business wins, a large and growing M&A pipeline, and many opportunities for productivity improvements. Add that to a winning culture, and I too believe we are very well positioned to deliver another terrific year here in 2024. Thanks to all the hard work by the team, and back to you, Pat.
J. Patrick Gallagher: Thanks, Doug. Operator, do you want to open it up for questions, please?
Operator: Yes, sir. Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Elyse Greenspan with Wells Fargo. Please proceed with your question.
Elyse Greenspan: Hi, thanks. Good evening. My first question is on the wholesale organic growth. You guys said it came in at 11% in the quarter. I believe the IR Day guide was 7% to 9%, and I think that reflected the slowdown you expected in open brokerage, I think, on the property side. So what changed relative to that guidance, and how the results came in, in the quarter?
Douglas Howell: Listen, we had a terrific finish to the end of June. Submissions were up 31% during June. There is a – clearly a continued use of wholesalers. We're not seeing really any significant shift back to the primary market and the submissions were up and so our guidance is up.
Elyse Greenspan: Okay. And then you – at your IR Day, you also had said when we think about next year, that it feels a lot like 2024. I think the assumption right is perhaps something still within the range of 7% to 9% organic in brokerage. I'm assuming that still remains the case, if you could confirm that. It's obviously been a few weeks. And then if that's the case next year, if this year's margin expansion was 80 basis points without the Buck and M&A noise, would that be the rule of thumb in terms of margin expansion for next year if you're in the 7% to 9% organic growth range?
Douglas Howell: Well, yes, let's reaffirm that we see next year, it could be very similar to this year. Let's see what happens with hurricane season, casualty rates, interest rates, the election. So there's some unknowns that are happening, but we still think that next year feels a lot like where this year will come in. When it comes to margin expansion, let us work on that a little bit during our budget season. We'll start that before our September IR Day. We should have a good idea in October. But there's nothing systemic out there that would cause us to believe that in a 7% to 9% organic environment, you could see margins up in that 75 basis point to 100 basis point range.
Elyse Greenspan: Okay. Thanks. And then my last one. You guys said – you said you have $3.5 billion to fund M&A this year. How much did you spend in the first half of the year? And given the pipeline that you guys see, does it feel like there might be some buyback this year? Or is it still kind of TBD?
Douglas Howell: So I think we've spent around $700 million thus far this year. We have some commitments out there. Do I see us having some buybacks? Maybe. We do have the large earn-out payable that's due right after the first of the year also. That's generally – we don't include that in that number. We kind of anticipate that, but that – we'll see. I just got off the phone an hour ago with one of our M&A bird dogs here in the U.S., and he's really starting to feel upward pressure on opportunities for M&A. There are some that are sitting there thinking that we'll see what happens with the November election. If it goes Republican, there's a lot of proposals to drop the capital gains rate maybe down to 15%. So you might have people that try to push that into January. If the Democrats win, then there might be a push to get things sold before the end of the year. So we're sitting very similar to where we were before an election three and a half years ago and where we were seven and a half years ago. There is a lot of uncertainty on M&A flow that revolves around the presidential election. So I think we've got a great shot of using it all. And if not, we'll take a look at what happens on share repurchases.
Elyse Greenspan: Thank you.
Douglas Howell: Thanks, Elyse.
Operator: Our next question is from Mike Zaremski with BMO Capital Markets. Please proceed with your question.
Michael Zaremski: Hey. Thanks. Good afternoon. I hope this question makes sense. But on the pricing environment, you always give good commentary on the renewal premium changes and you kind of give it overall and by product line. And so the RPC, right, has decelerated more recently to around 5%, how is that interchanging with your organic growth? Why is there a bigger delta now between your organic and RPC versus what we saw early this year and last year?
Douglas Howell: All right. So a great thing and maybe we haven't talked about it directly for quite a few quarters, but you always have to think about the opt-in, opt-out of the buyers' behavior. When prices are going up, buyers opt out of coverages, which might mean they increase the deductible, lower a limit or just don't buy certain coverages. As prices start to moderate or slower amounts of increases, they tend to opt back in. They reduce their deductibles, they raised their limits and maybe they buy coverages and they said, we just couldn't afford before. So if you go all the way back into our investor materials, there is always a delta between rate and exposure and what our organic growth is. And so that's why in periods when you see property is up 12%, we're not growing our property lines by 12%. They're growing 7%, 8%, 9% that's actually our revenue. So you always have to remember the opt-in, opt-out impact. Then the other thing to do is you got the dynamic of large accounts versus mid-market and small accounts that can influence that. So we're giving you a feel of what's going on in the market, but the behavior of our actual customers can vary depending on – by rational buying behavior. Prices go down, I buy more. Prices go up, I buy less.
J. Patrick Gallagher: As Doug said – let me hit on that as well, Mike. Let's not forget what our job is. So Doug hit right on it. When rate and exposure looks like it's up 12% and you say, well, how come you're not seeing that write in your renewal book? Our job is to mitigate that. And we start right with that promise like wait a minute, here's where we see the market coming. A good broker gets out in front of this with their clients' months. Here's what we see in the market, here is what's coming, what are we going to do about it? Let's take retentions up. Remember, you dropped to cover before now it's time to add it. So there's a lot of moving parts between those two numbers.
Michael Zaremski: Got it. And obviously, it's great you guys disclosed it. And so I guess I just want to put a final point on it. So is it fair to say that you're doing a good job for your clients and on a year-over-year basis, it's putting out a little bit of, I guess, pressure on your organic year-over-year? And separately related rate [indiscernible] do clients have the same amount of flexibility as they do in other lines that would cause the RPC disconnect to continue?
J. Patrick Gallagher: Yes, definitely. Absolutely. Number one, yes, if you throw me the softball, we're doing a good job for our clients, the answer is going to be best in the business. And we think these numbers show that. And we think the growth numbers show it. Absolutely. And yes, you'll continue to see always some change between what's being reported as growth in units of exposure and premium rates based on what we do. And the tools in our toolbox are unbelievable. So do you want to look at a captive? Would you like to take your attention up? It's not just, do you buy insurance or don't. Let's start with the things that maybe are the last things you should insure and the first things you'll self-insure. There's a lot of that work going on with our people every single day. By the way, that appetite for risk is very individual. It's not prescriptive. You can't take a book, there's no AI that says, Oh, an auto dealer has this much appetite for risk based on the number of cars in a lot. It's not how it works. So that's where our profession comes in and dealing with those people, and then our advice is critical. It's not just, well, I'm pretty bold here. I think $1 million retention makes a lot of sense. Wait, wait, wait, we think it looks better this way. And that's what we get paid to do.
Michael Zaremski: Okay. That's helpful. And just lastly, pivoting to reinsurance. To the extent you have a view, one of the largest reinsurers today put out some data kind of showing that reinsurance demand. I mean you guys have done a great job not only taking market share, but kind of being able to keep your organic high because of that demand, increased like mid teens-ish this year. And if we kind of think about what's going on in personal lines, there's a lot of inflation. So just curious, would you expect kind of demand for reinsurance. I don't know if you think all the way into 2025 yet, but to remain at kind of pretty high levels relative to historical and relative to this year?
J. Patrick Gallagher: It'll go up. Yes, I do for a lot of reasons. I think that you're going to see the opportunity to buy more at prices that look more reasonable. And there have been cutbacks in the purchase of certain. The other thing is that these nuclear verdicts are real, and people are seeing that and they're going, it doesn't cost us much to buy on the high-end, the top of the tower, it does downward there's a lot more activity. And I still want to be sitting here with some goofball jury comes up with a $1 billion award.
Michael Zaremski: Got it. So coming as seaside too, maybe more demand. Okay. Thank you very much.
J. Patrick Gallagher: Thanks, Mike.
Operator: Our next question is from the line of Gregory Peters with Raymond James. Please proceed with your question.
Gregory Peters: Hey, good afternoon everyone.
J. Patrick Gallagher: Hey, Greg.
Gregory Peters: I guess for my first question, during your Investor Day, you spoke about net new business wins and clearly, your results reflect that. I was wondering if you could give us some more color on how the quarter shaped up and how we should think about your net new business in the second quarter versus, say, the net new business wins in the second quarter last year or some additional metrics around that?
Douglas Howell: Well, it'll take me a minute to dig it out, but I can tell you that June year-to-date, we've actually expanded the spread between new and lost by a full point. And I think that's probably the best way to look at it. The absolute numbers are kind of irrelevant. Our non-recurring is also coming back. Before some of the non-recurring revenues might have been putting just a slight drag on organic, but now they're actually being in line with just our recurring business. So you're seeing an expansion of our spread between new and lost. How do we see that going forward? Greg, it gets more and more complicated. I actually think our team will do a better job showing our wares and our capabilities in a more of a stable rate environment versus kind of some of the chaotic rate environment that we've been seeing over the last few years. We've developed – we spent so much money on resources in the last five years. Three of those were consumed with COVID. Two of those have been consumed with some chaotic market behavior. Put our guys on a field with kind of calm rate environment, a client that's not trying to just save their business and rebuilding it after COVID, I think you'd be amazed at the digital and data and analytics and expertise. And now bring our reinsurance folks into bear, stack them up with our wholesalers, I got to tell you, it is a compelling offer at the point of sale that I would think that would absolutely deliver better net new business, more new, less loss as our clients really see the capabilities that we have built over the last five years. Arguably, maybe we've spent $1 billion in capabilities over the last seven years, something like that. So that's going to come out at the point of sale and give us a little calm in the market, and I think you're going to see our new business continue to go up.
Gregory Peters: Excellent color. Thank you. One of the things you've also talked expansively about in the past is the offshore centers of excellence. And this kind of dovetails with the opportunities for margin expansion. Is it your sense for Arthur J. Gallagher that you sort of maximize those opportunities? Or do you see further potential to – for more opportunities in offshoring to help drive some margin improvement?
J. Patrick Gallagher: Well, this is Pat, Greg. Let me take the operational side of that, and I'll throw the ball to Doug for the numbers and any kind of discussion there. But everywhere I look, I see opportunity and unbelievable benefits from using our centers of excellence. We started off checking policies 20 years ago with 12 people. We now have 12,000 people supporting over 400 services in 100 countries. It is unbelievable the level of professionalism that they help us attain. And that is a differentiator at the point of sale. It's a differentiator when we're recruiting. It's a differentiator in everything we do, and I don't see any sense of that slowing down or not being something that continues to expand. It's not just about replacing heads by any means. It's about having the people that should be doing things, doing them and freeing up those that should be doing other things, giving them the time to do that, which I do think feeds into retention and new business. So I think the – our centers of excellence are a unique product offering back to Doug's point about all the things we've invested in I think they are a very beneficial add to our sales list of things we provide at Gallagher. And as we grow through acquisitions alone, everyone of those people join us and we immediately start plugging them into this resource, which is another one of the reasons they join us. So to me, it's a very differentiating thing that we do. I think our team there is absolutely spectacular, and I'll let Doug address the numbers.
Douglas Howell: Yes. I think if you talk about the growth path of our offshore centers of excellence, I think remember they work only for us. They're an integral part of our team. There isn't that they or we they are us. If you look at some of our outlook, if we're going to be $20 billion of revenue, there'll be almost 30,000 folks there. So the growth path of our India and other area service centers will grow faster than the headcount in our other areas. But more importantly on this is we've been on this nearly 20-year journey now to standardize, make our operations consistent. It really is going to allow us to deploy AI into that environment. AI is terrific when you have consistency of information and repeatable behaviors and processes. And we have that, and we've spent nearly 20 years doing this. We have a jump, I believe, compared to most by almost a decade. And I think that some of the tests that we're using with AI now will make our folks there better, will make the different type of job for our folks in the centers better, it will make our sales folks better, our service folks better. And I can speak, and I've got 57% of my entire global finance, worldwide finance team operating out of there, and I can see it going to 80%. So it is going to be a service and sales differentiator for us because of the hard work we've put in for the last 15 years.
Gregory Peters: Thanks for the color. Just a point of clarification. And I probably should know this number, Doug, but I don't remember. On the capital management side, you said, well, listen, if we can't do the deals, you get through your earn-out, you might consider share repurchase. When was the last time you guys were active in share repurchase?
Douglas Howell: Well, let's see, it probably was maybe in 2000, when was Brexit? 2007 or 2008 years ago, whatever Brexit was.
Gregory Peters: Okay. All right. No, no. Thanks for the answers.
Douglas Howell: Thanks, Greg.
J. Patrick Gallagher: Thanks, Greg.
Operator: Our next questions are from the line of David Motemaden with Evercore. Please proceed with your question.
David Motemaden: Hey. Thanks. Good evening. I just had a question. I was hoping to get a little bit more color on the July RPC acceleration that you mentioned, Doug, maybe just a little bit around the lines. Is it property moderation kind of pausing, or is a casualty acceleration? What's going on there?
Douglas Howell: Well, actually, a little bit of both. We actually saw it in property. And actually, property is a pretty heavy quarter for us here in the second quarter. If you think it's about a third of our business, I think here in the second quarter, it might comprise 50% of our mix. So property in July. We did see a slight tick up. I'm talking a point or so. I'm not talking about is five or eight points. It's one point to two. Casualty rates are showing some, I wouldn't say acceleration. We used the word advancement in terms of where they are because – but they're steady. We'll see what happens with the – with pricing here in the second half of the year coming out of the carriers. So I would expect that to advance more. So not a jump up, but certainly, again, our dailies, they come out overnight. I looked at it last night, and we're seeing a tick up on both property and on casualty.
David Motemaden: Got it. Thanks. And there was a line in the press release on the adjusted comp ratio that caught my eye, just where you noted savings related to headcount controls. That's the first time I've seen that in, I can't remember how long. I'm just wondering, is that a – I guess, is that to do with – something to do with the offshore centers or is this more of a concerted effort to show some margin expansion as we think about this year and into next year?
Douglas Howell: I think that the answer is this. First of all, if you look at what we did during COVID, we actually took out quite a few folks, and we've been hiring back since then. Our business has grown into that. We haven't stopped hiring by any means, so it's not an indication of everything. I think the teams just are seeing of their workload models that we're probably okay staffed in the environment that we are right now. So I would read that into it, but nothing systemic, but just maybe that we've hired back into the capacity that we need in 2023.
David Motemaden: Got it. Okay. That's helpful. And then maybe just sneaking one more in. Just on the contingent commission accruals that you guys had made the true-up to this quarter. I guess, we have seen a lot of noise this quarter on casualty reserves, particularly on the more recent years. I'm wondering how you feel about the potential for more of those reserve adjustments to come through and how that might impact the contingents?
Douglas Howell: All right. First of all, on the supplementals, we've done pretty well year-to-date. Contingents, we did have some development that happened. We're probably not accruing as, I don't want to use the word bullish, but I will for the second. And as we were – as maybe we could. Casualty, we're cautious on it. Some of our programs and some of our binding operations, you got to be a little bit careful on performance-related compensation there. But I don't see a systemic shift in how we believe that our total compensation is going to happen. Maybe some bumps a little bit per quarter, but we're talking a couple of $3 million on a $130 million number year-to-date. So it's pretty small.
David Motemaden: Yes. Understood. Fair. Thank you.
J. Patrick Gallagher: Thanks, David.
Operator: Our next question is from the line of Mark Hughes with Truist Securities. Please proceed with your question.
Mark Hughes: Yes. Thank you. Good afternoon. On the risk management business, maybe we've gotten used to the elevated growth for quite an extended period of time, the 7% in the next couple of quarters. Could you maybe just talk about the growth environment there relative to what it might have been in prior years? And what's your expectation? Is this a little bit of a lull? Or is this a good number?
Douglas Howell: Right. So first of all, let's make sure you asked about the history is that I think in 2022, we posted about 12% annual organic growth, 2023, it was – excuse me, 2021 was – it was 12%, 2022 was about 13% and last year is pushing 16%. This year, if we get 9%, we did talk about a couple of very large wins that we had that incepted in mid-2023. What we're seeing in our book of business right now is actually reassuring, not that we need reassurance. This is a great near double-digit grower and has been for a very long time is we're starting to see more and more opportunities in that $2 million to $10 million type customer a year. If you look at the amount of new business sales that are happening relative to, let's say, five years ago, it's nearly doubled now. We're double the size, too, but the carriers are beginning to understand that we offer a highly customizable solution. Self-insureds are seeing that our outcomes are better. So I think that there's a market awakening that we – when we pay nearly $12 billion or $13 billion primarily workers' comp and general liability claims that would be one of the top five, six, seven tiers in the U.S. as measured by total claims paid. So the expertise customizable services is becoming more and more known in the industry. So we're getting many more trips to the plate. Maybe a couple of fewer home runs, but I think we're going to see a lot of doubles and triples out there. So I wouldn't call it a lull because we're in now 9% this year, but we did have two years of some pretty big wins in there.
J. Patrick Gallagher: But we wrote all the big ones. That's not, but [indiscernible] is a lot more difficult, more lumpy than the stuff we're seeing now.
Douglas Howell: Yes.
Mark Hughes: Yes. Understood. And then the any way to break out the – within the wholesale to open brokerage versus the MGA and binding?
Douglas Howell: Yes. Listen, I think that right now, open brokerage is maybe in that 11% to 13% range. And I think that binding and programs might be in the low-mid-single digits, something like that.
J. Patrick Gallagher: Mark, what I'm – what I'm most impressed with and pleased with is the fact that you're seeing that open brokerage number keep moving in nice double digits. My experience with these types of markets, especially with property is that the first line you kind of see submission slow down, people sort of stay where they are. There is a – our submission count is up substantially for the quarter, for the month, for the year. We are not seeing business flow back to the primaries. So the I think change that we've seen that were excess and surplus is becoming much more of the norm and where people want to check out what a wholesaler can do, and then we earn that business, we're not losing it. So submission counts are up, retention rates are up, new business is up, and that's pretty exciting.
Mark Hughes: Great. Appreciate it. Thank you.
J. Patrick Gallagher: Thanks, Mark.
Operator: Thank you. Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question.
Robert Cox: Hey, thanks. Yes. Just a question going back on the opt-in, opt-out dynamics. Just curious, does that flow through net new business and that's what's kind of driving the one point higher, you said June year-to-date of net new business? Or is that something else entirely?
J. Patrick Gallagher: Yes, I think some of that flows back – well, so for instance, a good example of that is a lot of our public entity clients, and as you know, we're very, very sizable in the public entity sector. They just work off a budget. And if the primary premiums are rising, they're taking bigger retentions, they're dropping limits, and they don't – they're not necessarily comfortable with that. So when the opportunity to buy those back up comes up, and they had an extra layer, they expand their coverage, oftentimes, we will call that new business. And at the same time, we're facing the renewal reductions on the stuff that stays with us. But it is a factor of what's available and what their budget restraints are.
Douglas Howell: Yes, I think it's a little tough for us. If they write a new cover and it goes through a different – if an existing client writes a new cover that goes through our wholesale business, that would be new business. If it's a change in premium level or like a slightly lower deductible or slightly low – higher retention, that would go as renewal change. It's a little tough sometimes to split that apart. But – so part of it goes to new business. Probably if I were going to guess, maybe 20%, 25% goes through new business and 75% would go through the renewal premium change.
Robert Cox: Okay. Thanks for walking us through the nuances there. And then just on the revenue indications from the audit endorsements and cancellations, those are remaining positive. Just curious if the rate of change on those is either accelerating or is that decelerating at this point?
Douglas Howell: All right. Great question. So on the surface, we're about the same as they were last year second quarter. But what happened last year's second quarter, we actually had quite a bit of endorsements that came out of the mini banking crisis. You were seeing a lot of banks increasing their D&Os in April of – March, April of 2023. We didn't have that repeat this year, probably a good thing we're not having that crisis. But interestingly, flat year-over-year, carve that out, that's still up pretty nice.
Robert Cox: Got it. Thank you.
J. Patrick Gallagher: Thanks, Rob.
Operator: The next question is from the line of Mike Ward with Citi. Please proceed with your question.
Michael Ward: Thanks guys. I was wondering if you could update us on the progress with your integrated approach where you're going to market with multiple businesses at a time? I think you talked about leveraging programs, reinsurance and Gallagher Bassett together?
Douglas Howell: All right. So yes, there's some good program development going on that combines those three together. Then also, you're having the introductions that happen across the units. I think our introductions to our reinsurance folks coming out of our carrier relations folks to the carriers is working very well. We're seeing some nice wins on that. Getting our program folks integrally involved with the reinsurers to create the capital, find the fronting market, it's going very well, at least from the CFO's chair.
J. Patrick Gallagher: Yes. Mike, I think when we talked about that, we weren't talking about taking just individual accounts and saying the way we want to do this is all together now on the XYZ manufacturing company. What we're talking about is what Doug was hitting on. We're now meeting with insurance companies quite regularly, and we're saying, let's talk about the broad base of our relationship. And at that table are our reinsurance people, our benefits people, our service people on the claims side as well as the property casualty production and marketing folks. That is working extremely well for us, and that's really what Doug was talking about. Now at the same time, in RPS, looking across a broad base of programs. We are looking at those saying, okay, we've got about 250 programs in the company. Where are we not, a, doing the reinsurance, b, doing the claims and what should we be doing to make sure that our retailers are using those programs as well. So it's kind of a mixed bag, and it's not like we just take XYZ account to the market and say now it's all or nothing, or to the client and say it's all or nothing. I hope that color gives you a little bit of reference to what we were talking about the last time around as well.
Michael Ward: Yes. No, that's helpful. Thank you. And then second question was just on the political election scenario type theme. Curious if you have any other kind of tax credit generation prospects in the pipeline, and any, I guess, political risk to those in the near term that we see?
Douglas Howell: Well, most of our tax credits are already in the bank. So I think we feel pretty comfortable about that. What are we working on? I think that with 45Q that really was passed under the previous above – all above-the-line inflation reduction at, it's made the tax credit market much more common, much more defined, broader, but we're pretty well suited for tax credits for the next four to five years. I'm not – I don't think we need to plunge in to new tax credit projects right now because we just generate the credits and they sit on the shelf for four or five years. The team is working on it, and there are some exciting things that are happening out there across all forms of clean energy that are exciting. But I don't see us doing something big in the next 1.5 years. Let's burn through these credits first, and then we'll see about what we can do. And by that time, there'll be a robust market out there for tax credits. You can get insurance on it now that much more to ensure the credit. So that's a good change in the law. Right now, I think the law is pretty well suited for us to do something in a few years and probably not have to do it with a lot of capital investment into it either.
Michael Ward: Okay. So maybe if I'm thinking about it right, that – this dynamic should help bolster you in terms of, I don't know, having extra leverage in the M&A scenario if rates are cut. That should help sort of bolster your competitive edge, I would think. And do you have like a sort of update on the PE interest in the market?
Douglas Howell: Well, listen not to belabor the PE update. Like I said I just got off the phone with our bird dog. And I got to tell you, my soap box is that I had during the IR Day about the new, what I call less than transparent equity structures that PEs are now doing in order to buy nice family-owned brokers. I think there's starting to be more and more of – the curtain has been pulled back on that, and I think that sellers are really looking at. They don't have the same equity. At Gallagher, you got one equity, owners, employees, people that sell into the business and you on this call own the same equity across the board. That's not how it works now with the PE structures, and it all looks okay, do the models on it, looks okay, what happens if everything goes up in a linear line. Get a little bit of a down draft on that, and the people that give their family's lifetime of work to the PE firms get very little. And I'm telling you that is something that needs to be aware out there. And I think that when I talked at one of the bird dog today, he said, it's becoming more and more apparent to sellers they're getting the last spot of the trough.
J. Patrick Gallagher: Let me take another side of that too, Mike. Second quarter, I believe it was Marsh Perry put out a reporter Optus partners. There were 62 buyers of properties in the second quarter alone. There's a lot of private equity interest in our space. That's not stupid money. I do believe that the multiples have risen, that we've been paying for these properties because of that interest over the years. Having said that, I think the quarter was 20% down in actual transactions. So you've got maybe smarter money, maybe smaller amounts of money, but the transaction count is coming down. I think sellers, as Doug said, are getting a little bit more discerning. And I do think when you take a look at what's happened with some of the roll-ups who are now at a point where it's time to go public, and I won't mention any names, you know who they are, well, let's see how that goes. It isn't an easy slog, and I think sellers are seeing that as well. And by the way, it's pretty easy to join somebody that's going to change, nothing in your shop until they want to go public. Better, I think, as Doug said, and joined me that everybody from the family to you all as investors, you have the same stack. Now one other comment on this. When we do an acquisition, we give the opportunity for everybody in that acquisition from that point on to participate in this equity. We've got an employee stock purchase plan. We have an LTIP program for management and senior producers. We've got all kinds of ways for people to participate in our success and our growth. You sell to the PE people, the owners do great, PE investors hopefully do great, and that’s it baby. Well, I like our model.
Michael Ward: Awesome. Thank you, guys.
Operator: Our next question is from the line of Grace Carter with Bank of America. Please proceed with your question.
Grace Carter: Hi everyone. I wanted to start on the risk management guidance. I think you all mentioned maybe around 9% for the year. I think that the prior guide was maybe 9% to 11%. Could you go over maybe anything that's changed since we last spoke in June? Thanks.
Douglas Howell: I think the degree of difference on a full-year on – listen, we're talking about a couple of million dollars on the difference between the 9% and 10%. So I wouldn't say that it's made $5 million. So there's nothing that's just – we think that we've got better insight for the rest of the year and so that range is coming maybe to the lower end of it than the upper end of it.
Grace Carter: Thank you. And also on the brokerage organic growth guide, I think that you all had mentioned you are considering narrowing it maybe to 7.5% to 8.5% at the Investor Day. Just keeping it at a wider range of 7% to 9%, does that just reflect uncertainty in the environment? Or has anything changed since then? Or am I just reading too much into it entirely?
Douglas Howell: Maybe the latter. I think it's been four weeks since we talked to you. We just finally got one more data point, and that's the close of June. So we'll talk to you again in September. And either way, listen, anywhere in that range. Look at that, that's 7% to 9% growth on top of 9% last year, 9% before. When you go back in 2019, we grew 6% all in. anywhere in that range is a terrific year. And if we can repeat it again next year, it's another terrific year.
Grace Carter: Cool. Thank you.
Operator: Thank you. Our last question will be from the line of Meyer Shields with KBW. Please proceed with your questions.
Meyer Shields: Thanks. Two quick ones, I think. First, I was hoping – hopefully, we won't need to know this, but give us a sense as to the contingent commissions exposure to hurricane season?
Douglas Howell: No, it's very small.
J. Patrick Gallagher: Very small. Most of that hurricane exposed business, especially in Florida, is in the excess and surplus, Meyer, we're the largest excess and surplus broker, I think, in the state. A lot of that is – all that’s in the E&S markets and none of those are subject to contingents.
Meyer Shields: Okay. Perfect. That is good news. Second question, just looking for a brief overview of your appetite for additional acquisitions in personal lines, I guess, both within high net worth and beyond that?
Douglas Howell: Well, you're talking about personal line just being a pure auto writer, that's probably not what we're going to do. We're not great at it. We're an adviser. So if somebody is going to use us to use our advice to help them buy their insurance, that's the business of what we'd like to be in. High net worth on, we do a terrific job of it. I'm telling you our folks are some of the very best in the business, and that's an important spot right now. There's planes, there's boats, there's houses on sand bars, there's – how is on views that have landslide risk, high net worth needs an adviser probably as much as any complex mid-market commercial client. Just going on and trying to buy an auto writer, auto is probably not what we're looking to do. If it's going to be one of those things that it takes advice will be there in that space.
J. Patrick Gallagher: We're actually very excited about the stuff there. I think that's – it's, a Doug said, a real opportunity for us.
Douglas Howell: Well take your call, Meyer. Just go ahead, we'll help you out with it.
Meyer Shields: I've got a ping pong table. That's about it.
Douglas Howell: Well, there's a slip and fall on that one coming.
J. Patrick Gallagher: I think that's our last comment. So just our last question, let me make just a few comments on the way out here. Thank you, again, very much all of you for joining us. I know it's a little late, and thanks to all of our Gallagher colleagues around the world for their hard work and their dedication. These quarters don't just happen. Thanks to your efforts, that means our people we're in a really enviable position our net new business is up. Our M&A pipeline is growing. I'm proud of the year-to-date financial performance. And as you can tell, I'm bullish on 2024 and beyond. So 40 years, 16% TSR, compound average annual growth rate, pretty good 40 years. I'm looking forward to the next 40. Thanks for being with us.
Operator: That does conclude today's conference call. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Co's Second Quarter 2024 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The Company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer the information concerning forward-looking statements and risk factors sections contained in the Company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the Company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thank you very much. Good afternoon. Thank you for joining us for our second quarter 2024 earnings call. On the call with me today is Doug Howell, our CFO, other members of the management team and the heads of our operating business divisions. We had an excellent second quarter. For our combined Brokerage and Risk Management segments we posted 14% growth in revenue, 7.7% organic growth and 8.1% if you include interest income. We also completed 12 new mergers totaling $72 million of estimated annualized revenue. Reported net earnings margin expansion of 35 basis points, adjusted EBITDAC margin expansion of 102 basis points to 31.4%. GAAP earnings per share of $1.70, up 15% year-over-year, and adjusted earnings per share of $2.68, up 19% year-over-year, another great quarter by the team and right in line with the expectations we provided at our June IR Day. Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth was 14%. Organic growth was 7.7% at the midpoint of guidance, and above 8% if you include interest income. Adjusted EBITDAC margin expansion was 98 basis points at the upper end of our June IR Day expectations. Let me give you some insights behind our Brokerage segment organic. And just to level set, the following figures do not include interest income. Within our PC retail operations, we delivered 6% in the U.S. and Canada, 7% in the UK, Australia and New Zealand. Our global employee benefit brokerage and consulting business posted organic of about 3%, that would have been 5% without the timing impact from some lumpy life case sales. Shifting to our reinsurance, wholesale and specialty businesses, overall organic of 12%. This includes Gallagher Re at 13%, UK specialty at 10% and U.S. wholesale at 11%, excellent growth, whether retail, wholesale or reinsurance. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance marketplace. Global second quarter renewal premiums, which include both rate and exposure changes, were up about 5%. So no change from what we discussed four weeks ago at our June Investor meeting. Renewal premium increases continue to be broad-based, up across all of our major geographies and most product lines. For example, property was up 2% to 4%, general liability up 5% to 7%, umbrella and commercial auto up 8% to 10%, workers' comp up 1% to 3%, D&O down about 5%, cyber was flat and personal lines up over 10%. So many lines are still seeing strong increases. Moving to the reinsurance market and mid-year renewals. Property reinsurance renewals saw modest price declines concentrated at the top-end of reinsurance towers due to the increased capacity from both traditional reinsurers and the ILS market. Offsetting this was underlying exposure growth, combined with increased demand, resulting in flat year-over-year premium for reinsurers overall. U.S. Casualty renewals saw terms and conditions tightened and some modest price increases. Reinsurers continue to heavily scrutinize submissions given the industry's unfavorable prior year reserve development and reinsurers view of the current loss cost trends. In our view, insurance and reinsurance carriers continue to behave rationally. Raising rates the most where it is needed to generate an adequate underwriting profit by line, by industry and by geography. We continue to see this differentiation in our data between property and casualty lines. Carriers believe property maybe close to approaching price and exposure adequacy. And thus, we are seeing property renewal premium increases moderating, but mostly within large accounts. Underlying that accounts with premiums around $1 million or greater are seeing renewal premiums flattish year-over-year. Yet on the other hand, in the small and mid-sized client space, where we are an industry leader, we are seeing increases of 7% for the second quarter. Shifting to casualty classes, we are seeing the greatest renewal premium increases and signs of these increases advancing. In fact, global second quarter umbrella and commercial auto renewal premium increases are in the high-single digits, and there is little differentiation by client size. We have been highlighting worsening social inflation, medical expenses and growing historical reserve concerns for quite some time. And thus, we continue to believe further rate increases are to come in casualty. While renewal premium increases are rational carrier response in the current environment, our clients have experienced multiple years of increased costs. Having a trusted adviser like Gallagher can help businesses navigate a complex insurance market by finding the best coverage for our clients while mitigating price increases, and that's our job as brokers. Moving to comments on our customers' business activity. During the second quarter, our daily indications continue to show positive mid-year policy endorsements, audits and cancellations, similar with last year's levels across most geographies. So activity remains solid, and we are not seeing signs of global economic slowdown. Within the U.S., the labor market in balance remains intact with more open jobs than unemployed people looking for work. And with continued wage growth and further medical cost inflation, employers remain focused on attracting and retaining talent while controlling costs. So I see solid demand for our services and advice in 2024 and in 2025. Across the brokerage operations, I believe we continue to win market share due to our superior client value proposition, niche expertise, outstanding service and our extensive data and analytics offerings. Frankly, the smaller local brokers that we are competing against, about 90% of the time, just can't match the value we provide, and that is leading to more net brokerage wins for Gallagher. So when we pull all this together, we continue to see full-year 2024 brokerage organic in the 7% to 9% range, and that would be another outstanding year. Moving on to our Risk Management segment, Gallagher Bassett. Revenue growth was 13%, including organic of 7.7%. Adjusted EBITDAC margins were 20.6%, up 120 basis points versus last year, and in line with our June IR Day expectations. We continue to benefit from new business wins, outstanding retention, increases in customer business activity and higher new rising claims. Looking forward, we see organic in the next two quarters around 7% and margins around 20.5% that would bring full-year 2024 organic to 9% and margins to approximately 20.5%, and that, too, would be an outstanding year. Let me shift to mergers and acquisitions. We completed 12 new mergers during the second quarter, representing about $72 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us, and extend a very warm welcome to our growing Gallagher family of professionals. Looking ahead, our pipeline remains very strong. We have around 60 term sheets being signed and prepared, representing around $550 million of annualized revenue. Good firms always have a choice, and we will be very excited if they choose to join Gallagher. Let me conclude with some comments regarding our bedrock culture. Last month, we reflected on the 40th anniversary of becoming a public company. Michael Bob Gallagher, Chairman and CEO at the time, knew above all, we must maintain our unique culture of teamwork, integrity and client service. Those values are captured in the 25 tenets with the Gallagher Way. Thanks to all of our global colleagues that live and breathe the Gallagher Way day in and day out. Our culture is stronger and more vibrant than ever, and it's our culture that continues to differentiate us as a firm and help to drive an average annual total shareholder return of more than 16% over the past 40 years. That is the Gallagher Way. Okay. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Pat, and hello, everyone. Today, I'll start with our earnings release. I'll comment on second quarter organic growth and margins by segment. Punchline is we came in right in line with our June IR Day commentary. I'll also update you on how we are seeing organic growth and margin shape up for the second half of the year. Then I'll shift to the CFO commentary document that we posted on our IR website, and I'll walk through the typical modeling helpers that we provide. And I'll conclude my prepared remarks with a few comments on cash, M&A and capital management. Okay. Let's flip to Page 3 of the earnings release. Headline Brokerage segment second quarter organic growth of 7.7%. Again, that's right in line with our June IR day, where we forecasted a range of 7.5% to 8%. Notably, we would have been above 8% if a few large live sales had not shifted from second quarter to later in the year. We signaled this possible timing to our June IR Day. So again, no new news here. Recall that we also foreshadowed in late June a small headwind from contingents that adversely impacted all inorganic by about 25 basis points. And finally, just a reminder, that we don't include interest income and organic. If we did, that would have pushed organic higher by about 40 basis points. We believe the investments that we have made in people, sales tools, niche experts and data and analytics are leading to strong new business production and favorable client retention across the globe. Additionally, the insurance market backdrop remains supportive of growth. Pat said renewal premium changes 5% in the quarter. However, our July's renewal premium change thus far is above second quarter. And with an active hurricane season predicted and noise around U.S. casualty reserves growing louder again this quarter, it's not unreasonable to expect mid single-digit or greater renewal premium changes in the second half of 2024. So our organic investments, combined with the insurance market conditions, continues to support our 2024 full-year Brokerage segment organic outlook. We are still seeing it in that 7% to 9% range. So now flip to Page 5 of the earnings release to the Brokerage segment adjusted EBITDAC table. Second quarter adjusted EBITDAC margin was 33.1%, up 98 basis points over last year and at the upper end of our June IR Day expectations. Let me walk you through a bridge from last year. First, if you pull out last year 2023 second quarter, you'd see we reported back then adjusted EBITDAC margin of 32.1%. Second, you need to adjust for current period FX rates, which had a very limited impact on margin this quarter. So 2023 adjusted FX margin was also 32.1%. Third, organic and interest gave us nearly 110 basis points of margin expansion this quarter and then the impact of M&A and divestitures used about 10 basis points of margin. That gets you to second quarter 2024 margins of 33.1%, and therefore, that's nearly 100 basis points of brokerage margin expansion. That's really, really great work by the team. As we look ahead to the second half of 2024, we are still expecting margin expansion in the 90 basis points to 100 basis points range. So third and fourth quarter will look a lot like second quarter. Recall, first quarter 2024 still had the roll-in impact of the Buck acquisition. So the math for full-year 2024 will show about 60 basis points of full-year expansion, but that would be about 80 basis points full-year without Buck, which feels about right, assuming we posted organic in the 7% to 9% range. Let's move now to the Risk Management segment and the organic and EBITDAC tables on Pages 5 and 6 of the earnings release. Another excellent quarter. We saw solid new business, fantastic retention and growing claim count. We posted organic of 7.7% and margins at 20.6%, both were right in line with our June IR Day outlook. Looking forward, as Pat said, we see organic in each of the next two quarters around 7% and margins around 20.5%. If we were to post that, we would finish the year with organic of 9% and margins of approximately 20.5%. That also would be great work by the team. Turning to Page 6 of the earnings release and the corporate segment shortcut table. Adjusted second quarter numbers came in just better than the favorable end of our June IR Day expectations. All of that was due to some favorable tax items within the corporate expense line. All right. Now let's move to the CFO commentary document, starting on Page 3, a few comments. First, foreign exchange. The dollar has weakened over the past month, so please make sure you incorporate these updated revenue and EPS impacts from FX in your models for the Brokerage and Risk Management segment. Second, Brokerage segment amortization expense. Recall, while this impacts reported GAAP results, we adjusted out so it doesn't impact adjusted non-GAAP earnings. This line can also be a bit noisy from time to time. Late this quarter, we received updated third-party M&A valuation estimates on a third – or excuse me, on a few recent acquisitions and also made some balance sheet adjustments at the end of the quarter. You'll see that in Footnote two at the bottom of the page. Looking forward, we expect amortization expense of about $155 million per quarter. Again, all of that is adjusted out, but it does cause some noise in the reported GAAP results. Now it's the risk management amortization and depreciation line. Here too, we received updated M&A valuation estimates for our recent acquisition, which is also described in Footnote five. The net impact to non-GAAP results is about $0.01 to EPS this quarter. Going forward, we are now expecting a lower level of depreciation and amortization as a result of that M&A valuation report. Turning to the Corporate segment on Page 4, no change to our outlook for the third and fourth quarter. Flipping to Page 5 to our tax credit carryforwards. It shows about $800 million at June 30. While this benefit won't show up in the P&L, it does benefit our cash flow by about $150 million to $180 million a year, which helps us fund future M&A. Turning now to Page 6, the investment income table. We call this modeling help breaks down the components of investment income, premium finance revenues, book gains and equity investments in third-party brokers. And as a reminder, none of these items are included in our organic growth computations that we present on Pages 3 and 5 of our earnings release. The punchline here is not much has changed from what we provided at our June IR Day. We are still embedding two 25 basis point rate cuts in the second half of 2024, and we have updated our estimates in this table for current FX rates. When you ship down on that page to the rollover revenue table, second quarter 2024 column, the subtotal shows $128 million and $142 million before divestitures. The $142 million was better than our IR Day outlook due to a few acquisitions performing very well during June. Looking forward, the pinkish columns to the right include estimated revenues for M&A closed through yesterday. So just a reminder, you'll need to make a pick for future M&A. Moving down on that page, you'll see Risk Management segment rollover revenues have been updated for our early third quarter acquisition. For the next two quarters, we expect approximately $20 million and $15 million, respectively. Please make sure to reflect these additional revenues in your models. Moving now to cash, capital management and M&A funding. Available cash on hand at June 30 was approaching $700 million. When combined with our expected free cash flow in the second half of 2024, which is typically stronger than the first half, we are well positioned for our pipeline of M&A opportunities. In total, we continue to estimate we could have $3.5 billion to fund M&A opportunities during 2024 and another $4 billion in 2025, all while maintaining a solid investment-grade debt rating. And remember, if we don't spend it all, it opens the door for share repurchases as well. Okay. Another excellent quarter and fantastic first half of the year. Looking ahead, we see continued strong organic growth due to net new business wins, a large and growing M&A pipeline, and many opportunities for productivity improvements. Add that to a winning culture, and I too believe we are very well positioned to deliver another terrific year here in 2024. Thanks to all the hard work by the team, and back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Doug. Operator, do you want to open it up for questions, please?"
},
{
"speaker": "Operator",
"text": "Yes, sir. Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"text": "Hi, thanks. Good evening. My first question is on the wholesale organic growth. You guys said it came in at 11% in the quarter. I believe the IR Day guide was 7% to 9%, and I think that reflected the slowdown you expected in open brokerage, I think, on the property side. So what changed relative to that guidance, and how the results came in, in the quarter?"
},
{
"speaker": "Douglas Howell",
"text": "Listen, we had a terrific finish to the end of June. Submissions were up 31% during June. There is a – clearly a continued use of wholesalers. We're not seeing really any significant shift back to the primary market and the submissions were up and so our guidance is up."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then you – at your IR Day, you also had said when we think about next year, that it feels a lot like 2024. I think the assumption right is perhaps something still within the range of 7% to 9% organic in brokerage. I'm assuming that still remains the case, if you could confirm that. It's obviously been a few weeks. And then if that's the case next year, if this year's margin expansion was 80 basis points without the Buck and M&A noise, would that be the rule of thumb in terms of margin expansion for next year if you're in the 7% to 9% organic growth range?"
},
{
"speaker": "Douglas Howell",
"text": "Well, yes, let's reaffirm that we see next year, it could be very similar to this year. Let's see what happens with hurricane season, casualty rates, interest rates, the election. So there's some unknowns that are happening, but we still think that next year feels a lot like where this year will come in. When it comes to margin expansion, let us work on that a little bit during our budget season. We'll start that before our September IR Day. We should have a good idea in October. But there's nothing systemic out there that would cause us to believe that in a 7% to 9% organic environment, you could see margins up in that 75 basis point to 100 basis point range."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. Thanks. And then my last one. You guys said – you said you have $3.5 billion to fund M&A this year. How much did you spend in the first half of the year? And given the pipeline that you guys see, does it feel like there might be some buyback this year? Or is it still kind of TBD?"
},
{
"speaker": "Douglas Howell",
"text": "So I think we've spent around $700 million thus far this year. We have some commitments out there. Do I see us having some buybacks? Maybe. We do have the large earn-out payable that's due right after the first of the year also. That's generally – we don't include that in that number. We kind of anticipate that, but that – we'll see. I just got off the phone an hour ago with one of our M&A bird dogs here in the U.S., and he's really starting to feel upward pressure on opportunities for M&A. There are some that are sitting there thinking that we'll see what happens with the November election. If it goes Republican, there's a lot of proposals to drop the capital gains rate maybe down to 15%. So you might have people that try to push that into January. If the Democrats win, then there might be a push to get things sold before the end of the year. So we're sitting very similar to where we were before an election three and a half years ago and where we were seven and a half years ago. There is a lot of uncertainty on M&A flow that revolves around the presidential election. So I think we've got a great shot of using it all. And if not, we'll take a look at what happens on share repurchases."
},
{
"speaker": "Elyse Greenspan",
"text": "Thank you."
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Elyse."
},
{
"speaker": "Operator",
"text": "Our next question is from Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Michael Zaremski",
"text": "Hey. Thanks. Good afternoon. I hope this question makes sense. But on the pricing environment, you always give good commentary on the renewal premium changes and you kind of give it overall and by product line. And so the RPC, right, has decelerated more recently to around 5%, how is that interchanging with your organic growth? Why is there a bigger delta now between your organic and RPC versus what we saw early this year and last year?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So a great thing and maybe we haven't talked about it directly for quite a few quarters, but you always have to think about the opt-in, opt-out of the buyers' behavior. When prices are going up, buyers opt out of coverages, which might mean they increase the deductible, lower a limit or just don't buy certain coverages. As prices start to moderate or slower amounts of increases, they tend to opt back in. They reduce their deductibles, they raised their limits and maybe they buy coverages and they said, we just couldn't afford before. So if you go all the way back into our investor materials, there is always a delta between rate and exposure and what our organic growth is. And so that's why in periods when you see property is up 12%, we're not growing our property lines by 12%. They're growing 7%, 8%, 9% that's actually our revenue. So you always have to remember the opt-in, opt-out impact. Then the other thing to do is you got the dynamic of large accounts versus mid-market and small accounts that can influence that. So we're giving you a feel of what's going on in the market, but the behavior of our actual customers can vary depending on – by rational buying behavior. Prices go down, I buy more. Prices go up, I buy less."
},
{
"speaker": "J. Patrick Gallagher",
"text": "As Doug said – let me hit on that as well, Mike. Let's not forget what our job is. So Doug hit right on it. When rate and exposure looks like it's up 12% and you say, well, how come you're not seeing that write in your renewal book? Our job is to mitigate that. And we start right with that promise like wait a minute, here's where we see the market coming. A good broker gets out in front of this with their clients' months. Here's what we see in the market, here is what's coming, what are we going to do about it? Let's take retentions up. Remember, you dropped to cover before now it's time to add it. So there's a lot of moving parts between those two numbers."
},
{
"speaker": "Michael Zaremski",
"text": "Got it. And obviously, it's great you guys disclosed it. And so I guess I just want to put a final point on it. So is it fair to say that you're doing a good job for your clients and on a year-over-year basis, it's putting out a little bit of, I guess, pressure on your organic year-over-year? And separately related rate [indiscernible] do clients have the same amount of flexibility as they do in other lines that would cause the RPC disconnect to continue?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes, definitely. Absolutely. Number one, yes, if you throw me the softball, we're doing a good job for our clients, the answer is going to be best in the business. And we think these numbers show that. And we think the growth numbers show it. Absolutely. And yes, you'll continue to see always some change between what's being reported as growth in units of exposure and premium rates based on what we do. And the tools in our toolbox are unbelievable. So do you want to look at a captive? Would you like to take your attention up? It's not just, do you buy insurance or don't. Let's start with the things that maybe are the last things you should insure and the first things you'll self-insure. There's a lot of that work going on with our people every single day. By the way, that appetite for risk is very individual. It's not prescriptive. You can't take a book, there's no AI that says, Oh, an auto dealer has this much appetite for risk based on the number of cars in a lot. It's not how it works. So that's where our profession comes in and dealing with those people, and then our advice is critical. It's not just, well, I'm pretty bold here. I think $1 million retention makes a lot of sense. Wait, wait, wait, we think it looks better this way. And that's what we get paid to do."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. That's helpful. And just lastly, pivoting to reinsurance. To the extent you have a view, one of the largest reinsurers today put out some data kind of showing that reinsurance demand. I mean you guys have done a great job not only taking market share, but kind of being able to keep your organic high because of that demand, increased like mid teens-ish this year. And if we kind of think about what's going on in personal lines, there's a lot of inflation. So just curious, would you expect kind of demand for reinsurance. I don't know if you think all the way into 2025 yet, but to remain at kind of pretty high levels relative to historical and relative to this year?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "It'll go up. Yes, I do for a lot of reasons. I think that you're going to see the opportunity to buy more at prices that look more reasonable. And there have been cutbacks in the purchase of certain. The other thing is that these nuclear verdicts are real, and people are seeing that and they're going, it doesn't cost us much to buy on the high-end, the top of the tower, it does downward there's a lot more activity. And I still want to be sitting here with some goofball jury comes up with a $1 billion award."
},
{
"speaker": "Michael Zaremski",
"text": "Got it. So coming as seaside too, maybe more demand. Okay. Thank you very much."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Mike."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Gregory Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Gregory Peters",
"text": "Hey, good afternoon everyone."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Hey, Greg."
},
{
"speaker": "Gregory Peters",
"text": "I guess for my first question, during your Investor Day, you spoke about net new business wins and clearly, your results reflect that. I was wondering if you could give us some more color on how the quarter shaped up and how we should think about your net new business in the second quarter versus, say, the net new business wins in the second quarter last year or some additional metrics around that?"
},
{
"speaker": "Douglas Howell",
"text": "Well, it'll take me a minute to dig it out, but I can tell you that June year-to-date, we've actually expanded the spread between new and lost by a full point. And I think that's probably the best way to look at it. The absolute numbers are kind of irrelevant. Our non-recurring is also coming back. Before some of the non-recurring revenues might have been putting just a slight drag on organic, but now they're actually being in line with just our recurring business. So you're seeing an expansion of our spread between new and lost. How do we see that going forward? Greg, it gets more and more complicated. I actually think our team will do a better job showing our wares and our capabilities in a more of a stable rate environment versus kind of some of the chaotic rate environment that we've been seeing over the last few years. We've developed – we spent so much money on resources in the last five years. Three of those were consumed with COVID. Two of those have been consumed with some chaotic market behavior. Put our guys on a field with kind of calm rate environment, a client that's not trying to just save their business and rebuilding it after COVID, I think you'd be amazed at the digital and data and analytics and expertise. And now bring our reinsurance folks into bear, stack them up with our wholesalers, I got to tell you, it is a compelling offer at the point of sale that I would think that would absolutely deliver better net new business, more new, less loss as our clients really see the capabilities that we have built over the last five years. Arguably, maybe we've spent $1 billion in capabilities over the last seven years, something like that. So that's going to come out at the point of sale and give us a little calm in the market, and I think you're going to see our new business continue to go up."
},
{
"speaker": "Gregory Peters",
"text": "Excellent color. Thank you. One of the things you've also talked expansively about in the past is the offshore centers of excellence. And this kind of dovetails with the opportunities for margin expansion. Is it your sense for Arthur J. Gallagher that you sort of maximize those opportunities? Or do you see further potential to – for more opportunities in offshoring to help drive some margin improvement?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Well, this is Pat, Greg. Let me take the operational side of that, and I'll throw the ball to Doug for the numbers and any kind of discussion there. But everywhere I look, I see opportunity and unbelievable benefits from using our centers of excellence. We started off checking policies 20 years ago with 12 people. We now have 12,000 people supporting over 400 services in 100 countries. It is unbelievable the level of professionalism that they help us attain. And that is a differentiator at the point of sale. It's a differentiator when we're recruiting. It's a differentiator in everything we do, and I don't see any sense of that slowing down or not being something that continues to expand. It's not just about replacing heads by any means. It's about having the people that should be doing things, doing them and freeing up those that should be doing other things, giving them the time to do that, which I do think feeds into retention and new business. So I think the – our centers of excellence are a unique product offering back to Doug's point about all the things we've invested in I think they are a very beneficial add to our sales list of things we provide at Gallagher. And as we grow through acquisitions alone, everyone of those people join us and we immediately start plugging them into this resource, which is another one of the reasons they join us. So to me, it's a very differentiating thing that we do. I think our team there is absolutely spectacular, and I'll let Doug address the numbers."
},
{
"speaker": "Douglas Howell",
"text": "Yes. I think if you talk about the growth path of our offshore centers of excellence, I think remember they work only for us. They're an integral part of our team. There isn't that they or we they are us. If you look at some of our outlook, if we're going to be $20 billion of revenue, there'll be almost 30,000 folks there. So the growth path of our India and other area service centers will grow faster than the headcount in our other areas. But more importantly on this is we've been on this nearly 20-year journey now to standardize, make our operations consistent. It really is going to allow us to deploy AI into that environment. AI is terrific when you have consistency of information and repeatable behaviors and processes. And we have that, and we've spent nearly 20 years doing this. We have a jump, I believe, compared to most by almost a decade. And I think that some of the tests that we're using with AI now will make our folks there better, will make the different type of job for our folks in the centers better, it will make our sales folks better, our service folks better. And I can speak, and I've got 57% of my entire global finance, worldwide finance team operating out of there, and I can see it going to 80%. So it is going to be a service and sales differentiator for us because of the hard work we've put in for the last 15 years."
},
{
"speaker": "Gregory Peters",
"text": "Thanks for the color. Just a point of clarification. And I probably should know this number, Doug, but I don't remember. On the capital management side, you said, well, listen, if we can't do the deals, you get through your earn-out, you might consider share repurchase. When was the last time you guys were active in share repurchase?"
},
{
"speaker": "Douglas Howell",
"text": "Well, let's see, it probably was maybe in 2000, when was Brexit? 2007 or 2008 years ago, whatever Brexit was."
},
{
"speaker": "Gregory Peters",
"text": "Okay. All right. No, no. Thanks for the answers."
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Greg."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Greg."
},
{
"speaker": "Operator",
"text": "Our next questions are from the line of David Motemaden with Evercore. Please proceed with your question."
},
{
"speaker": "David Motemaden",
"text": "Hey. Thanks. Good evening. I just had a question. I was hoping to get a little bit more color on the July RPC acceleration that you mentioned, Doug, maybe just a little bit around the lines. Is it property moderation kind of pausing, or is a casualty acceleration? What's going on there?"
},
{
"speaker": "Douglas Howell",
"text": "Well, actually, a little bit of both. We actually saw it in property. And actually, property is a pretty heavy quarter for us here in the second quarter. If you think it's about a third of our business, I think here in the second quarter, it might comprise 50% of our mix. So property in July. We did see a slight tick up. I'm talking a point or so. I'm not talking about is five or eight points. It's one point to two. Casualty rates are showing some, I wouldn't say acceleration. We used the word advancement in terms of where they are because – but they're steady. We'll see what happens with the – with pricing here in the second half of the year coming out of the carriers. So I would expect that to advance more. So not a jump up, but certainly, again, our dailies, they come out overnight. I looked at it last night, and we're seeing a tick up on both property and on casualty."
},
{
"speaker": "David Motemaden",
"text": "Got it. Thanks. And there was a line in the press release on the adjusted comp ratio that caught my eye, just where you noted savings related to headcount controls. That's the first time I've seen that in, I can't remember how long. I'm just wondering, is that a – I guess, is that to do with – something to do with the offshore centers or is this more of a concerted effort to show some margin expansion as we think about this year and into next year?"
},
{
"speaker": "Douglas Howell",
"text": "I think that the answer is this. First of all, if you look at what we did during COVID, we actually took out quite a few folks, and we've been hiring back since then. Our business has grown into that. We haven't stopped hiring by any means, so it's not an indication of everything. I think the teams just are seeing of their workload models that we're probably okay staffed in the environment that we are right now. So I would read that into it, but nothing systemic, but just maybe that we've hired back into the capacity that we need in 2023."
},
{
"speaker": "David Motemaden",
"text": "Got it. Okay. That's helpful. And then maybe just sneaking one more in. Just on the contingent commission accruals that you guys had made the true-up to this quarter. I guess, we have seen a lot of noise this quarter on casualty reserves, particularly on the more recent years. I'm wondering how you feel about the potential for more of those reserve adjustments to come through and how that might impact the contingents?"
},
{
"speaker": "Douglas Howell",
"text": "All right. First of all, on the supplementals, we've done pretty well year-to-date. Contingents, we did have some development that happened. We're probably not accruing as, I don't want to use the word bullish, but I will for the second. And as we were – as maybe we could. Casualty, we're cautious on it. Some of our programs and some of our binding operations, you got to be a little bit careful on performance-related compensation there. But I don't see a systemic shift in how we believe that our total compensation is going to happen. Maybe some bumps a little bit per quarter, but we're talking a couple of $3 million on a $130 million number year-to-date. So it's pretty small."
},
{
"speaker": "David Motemaden",
"text": "Yes. Understood. Fair. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, David."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Mark Hughes with Truist Securities. Please proceed with your question."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Thank you. Good afternoon. On the risk management business, maybe we've gotten used to the elevated growth for quite an extended period of time, the 7% in the next couple of quarters. Could you maybe just talk about the growth environment there relative to what it might have been in prior years? And what's your expectation? Is this a little bit of a lull? Or is this a good number?"
},
{
"speaker": "Douglas Howell",
"text": "Right. So first of all, let's make sure you asked about the history is that I think in 2022, we posted about 12% annual organic growth, 2023, it was – excuse me, 2021 was – it was 12%, 2022 was about 13% and last year is pushing 16%. This year, if we get 9%, we did talk about a couple of very large wins that we had that incepted in mid-2023. What we're seeing in our book of business right now is actually reassuring, not that we need reassurance. This is a great near double-digit grower and has been for a very long time is we're starting to see more and more opportunities in that $2 million to $10 million type customer a year. If you look at the amount of new business sales that are happening relative to, let's say, five years ago, it's nearly doubled now. We're double the size, too, but the carriers are beginning to understand that we offer a highly customizable solution. Self-insureds are seeing that our outcomes are better. So I think that there's a market awakening that we – when we pay nearly $12 billion or $13 billion primarily workers' comp and general liability claims that would be one of the top five, six, seven tiers in the U.S. as measured by total claims paid. So the expertise customizable services is becoming more and more known in the industry. So we're getting many more trips to the plate. Maybe a couple of fewer home runs, but I think we're going to see a lot of doubles and triples out there. So I wouldn't call it a lull because we're in now 9% this year, but we did have two years of some pretty big wins in there."
},
{
"speaker": "J. Patrick Gallagher",
"text": "But we wrote all the big ones. That's not, but [indiscernible] is a lot more difficult, more lumpy than the stuff we're seeing now."
},
{
"speaker": "Douglas Howell",
"text": "Yes."
},
{
"speaker": "Mark Hughes",
"text": "Yes. Understood. And then the any way to break out the – within the wholesale to open brokerage versus the MGA and binding?"
},
{
"speaker": "Douglas Howell",
"text": "Yes. Listen, I think that right now, open brokerage is maybe in that 11% to 13% range. And I think that binding and programs might be in the low-mid-single digits, something like that."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Mark, what I'm – what I'm most impressed with and pleased with is the fact that you're seeing that open brokerage number keep moving in nice double digits. My experience with these types of markets, especially with property is that the first line you kind of see submission slow down, people sort of stay where they are. There is a – our submission count is up substantially for the quarter, for the month, for the year. We are not seeing business flow back to the primaries. So the I think change that we've seen that were excess and surplus is becoming much more of the norm and where people want to check out what a wholesaler can do, and then we earn that business, we're not losing it. So submission counts are up, retention rates are up, new business is up, and that's pretty exciting."
},
{
"speaker": "Mark Hughes",
"text": "Great. Appreciate it. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Mark."
},
{
"speaker": "Operator",
"text": "Thank you. Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Robert Cox",
"text": "Hey, thanks. Yes. Just a question going back on the opt-in, opt-out dynamics. Just curious, does that flow through net new business and that's what's kind of driving the one point higher, you said June year-to-date of net new business? Or is that something else entirely?"
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes, I think some of that flows back – well, so for instance, a good example of that is a lot of our public entity clients, and as you know, we're very, very sizable in the public entity sector. They just work off a budget. And if the primary premiums are rising, they're taking bigger retentions, they're dropping limits, and they don't – they're not necessarily comfortable with that. So when the opportunity to buy those back up comes up, and they had an extra layer, they expand their coverage, oftentimes, we will call that new business. And at the same time, we're facing the renewal reductions on the stuff that stays with us. But it is a factor of what's available and what their budget restraints are."
},
{
"speaker": "Douglas Howell",
"text": "Yes, I think it's a little tough for us. If they write a new cover and it goes through a different – if an existing client writes a new cover that goes through our wholesale business, that would be new business. If it's a change in premium level or like a slightly lower deductible or slightly low – higher retention, that would go as renewal change. It's a little tough sometimes to split that apart. But – so part of it goes to new business. Probably if I were going to guess, maybe 20%, 25% goes through new business and 75% would go through the renewal premium change."
},
{
"speaker": "Robert Cox",
"text": "Okay. Thanks for walking us through the nuances there. And then just on the revenue indications from the audit endorsements and cancellations, those are remaining positive. Just curious if the rate of change on those is either accelerating or is that decelerating at this point?"
},
{
"speaker": "Douglas Howell",
"text": "All right. Great question. So on the surface, we're about the same as they were last year second quarter. But what happened last year's second quarter, we actually had quite a bit of endorsements that came out of the mini banking crisis. You were seeing a lot of banks increasing their D&Os in April of – March, April of 2023. We didn't have that repeat this year, probably a good thing we're not having that crisis. But interestingly, flat year-over-year, carve that out, that's still up pretty nice."
},
{
"speaker": "Robert Cox",
"text": "Got it. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Thanks, Rob."
},
{
"speaker": "Operator",
"text": "The next question is from the line of Mike Ward with Citi. Please proceed with your question."
},
{
"speaker": "Michael Ward",
"text": "Thanks guys. I was wondering if you could update us on the progress with your integrated approach where you're going to market with multiple businesses at a time? I think you talked about leveraging programs, reinsurance and Gallagher Bassett together?"
},
{
"speaker": "Douglas Howell",
"text": "All right. So yes, there's some good program development going on that combines those three together. Then also, you're having the introductions that happen across the units. I think our introductions to our reinsurance folks coming out of our carrier relations folks to the carriers is working very well. We're seeing some nice wins on that. Getting our program folks integrally involved with the reinsurers to create the capital, find the fronting market, it's going very well, at least from the CFO's chair."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Yes. Mike, I think when we talked about that, we weren't talking about taking just individual accounts and saying the way we want to do this is all together now on the XYZ manufacturing company. What we're talking about is what Doug was hitting on. We're now meeting with insurance companies quite regularly, and we're saying, let's talk about the broad base of our relationship. And at that table are our reinsurance people, our benefits people, our service people on the claims side as well as the property casualty production and marketing folks. That is working extremely well for us, and that's really what Doug was talking about. Now at the same time, in RPS, looking across a broad base of programs. We are looking at those saying, okay, we've got about 250 programs in the company. Where are we not, a, doing the reinsurance, b, doing the claims and what should we be doing to make sure that our retailers are using those programs as well. So it's kind of a mixed bag, and it's not like we just take XYZ account to the market and say now it's all or nothing, or to the client and say it's all or nothing. I hope that color gives you a little bit of reference to what we were talking about the last time around as well."
},
{
"speaker": "Michael Ward",
"text": "Yes. No, that's helpful. Thank you. And then second question was just on the political election scenario type theme. Curious if you have any other kind of tax credit generation prospects in the pipeline, and any, I guess, political risk to those in the near term that we see?"
},
{
"speaker": "Douglas Howell",
"text": "Well, most of our tax credits are already in the bank. So I think we feel pretty comfortable about that. What are we working on? I think that with 45Q that really was passed under the previous above – all above-the-line inflation reduction at, it's made the tax credit market much more common, much more defined, broader, but we're pretty well suited for tax credits for the next four to five years. I'm not – I don't think we need to plunge in to new tax credit projects right now because we just generate the credits and they sit on the shelf for four or five years. The team is working on it, and there are some exciting things that are happening out there across all forms of clean energy that are exciting. But I don't see us doing something big in the next 1.5 years. Let's burn through these credits first, and then we'll see about what we can do. And by that time, there'll be a robust market out there for tax credits. You can get insurance on it now that much more to ensure the credit. So that's a good change in the law. Right now, I think the law is pretty well suited for us to do something in a few years and probably not have to do it with a lot of capital investment into it either."
},
{
"speaker": "Michael Ward",
"text": "Okay. So maybe if I'm thinking about it right, that – this dynamic should help bolster you in terms of, I don't know, having extra leverage in the M&A scenario if rates are cut. That should help sort of bolster your competitive edge, I would think. And do you have like a sort of update on the PE interest in the market?"
},
{
"speaker": "Douglas Howell",
"text": "Well, listen not to belabor the PE update. Like I said I just got off the phone with our bird dog. And I got to tell you, my soap box is that I had during the IR Day about the new, what I call less than transparent equity structures that PEs are now doing in order to buy nice family-owned brokers. I think there's starting to be more and more of – the curtain has been pulled back on that, and I think that sellers are really looking at. They don't have the same equity. At Gallagher, you got one equity, owners, employees, people that sell into the business and you on this call own the same equity across the board. That's not how it works now with the PE structures, and it all looks okay, do the models on it, looks okay, what happens if everything goes up in a linear line. Get a little bit of a down draft on that, and the people that give their family's lifetime of work to the PE firms get very little. And I'm telling you that is something that needs to be aware out there. And I think that when I talked at one of the bird dog today, he said, it's becoming more and more apparent to sellers they're getting the last spot of the trough."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Let me take another side of that too, Mike. Second quarter, I believe it was Marsh Perry put out a reporter Optus partners. There were 62 buyers of properties in the second quarter alone. There's a lot of private equity interest in our space. That's not stupid money. I do believe that the multiples have risen, that we've been paying for these properties because of that interest over the years. Having said that, I think the quarter was 20% down in actual transactions. So you've got maybe smarter money, maybe smaller amounts of money, but the transaction count is coming down. I think sellers, as Doug said, are getting a little bit more discerning. And I do think when you take a look at what's happened with some of the roll-ups who are now at a point where it's time to go public, and I won't mention any names, you know who they are, well, let's see how that goes. It isn't an easy slog, and I think sellers are seeing that as well. And by the way, it's pretty easy to join somebody that's going to change, nothing in your shop until they want to go public. Better, I think, as Doug said, and joined me that everybody from the family to you all as investors, you have the same stack. Now one other comment on this. When we do an acquisition, we give the opportunity for everybody in that acquisition from that point on to participate in this equity. We've got an employee stock purchase plan. We have an LTIP program for management and senior producers. We've got all kinds of ways for people to participate in our success and our growth. You sell to the PE people, the owners do great, PE investors hopefully do great, and that’s it baby. Well, I like our model."
},
{
"speaker": "Michael Ward",
"text": "Awesome. Thank you, guys."
},
{
"speaker": "Operator",
"text": "Our next question is from the line of Grace Carter with Bank of America. Please proceed with your question."
},
{
"speaker": "Grace Carter",
"text": "Hi everyone. I wanted to start on the risk management guidance. I think you all mentioned maybe around 9% for the year. I think that the prior guide was maybe 9% to 11%. Could you go over maybe anything that's changed since we last spoke in June? Thanks."
},
{
"speaker": "Douglas Howell",
"text": "I think the degree of difference on a full-year on – listen, we're talking about a couple of million dollars on the difference between the 9% and 10%. So I wouldn't say that it's made $5 million. So there's nothing that's just – we think that we've got better insight for the rest of the year and so that range is coming maybe to the lower end of it than the upper end of it."
},
{
"speaker": "Grace Carter",
"text": "Thank you. And also on the brokerage organic growth guide, I think that you all had mentioned you are considering narrowing it maybe to 7.5% to 8.5% at the Investor Day. Just keeping it at a wider range of 7% to 9%, does that just reflect uncertainty in the environment? Or has anything changed since then? Or am I just reading too much into it entirely?"
},
{
"speaker": "Douglas Howell",
"text": "Maybe the latter. I think it's been four weeks since we talked to you. We just finally got one more data point, and that's the close of June. So we'll talk to you again in September. And either way, listen, anywhere in that range. Look at that, that's 7% to 9% growth on top of 9% last year, 9% before. When you go back in 2019, we grew 6% all in. anywhere in that range is a terrific year. And if we can repeat it again next year, it's another terrific year."
},
{
"speaker": "Grace Carter",
"text": "Cool. Thank you."
},
{
"speaker": "Operator",
"text": "Thank you. Our last question will be from the line of Meyer Shields with KBW. Please proceed with your questions."
},
{
"speaker": "Meyer Shields",
"text": "Thanks. Two quick ones, I think. First, I was hoping – hopefully, we won't need to know this, but give us a sense as to the contingent commissions exposure to hurricane season?"
},
{
"speaker": "Douglas Howell",
"text": "No, it's very small."
},
{
"speaker": "J. Patrick Gallagher",
"text": "Very small. Most of that hurricane exposed business, especially in Florida, is in the excess and surplus, Meyer, we're the largest excess and surplus broker, I think, in the state. A lot of that is – all that’s in the E&S markets and none of those are subject to contingents."
},
{
"speaker": "Meyer Shields",
"text": "Okay. Perfect. That is good news. Second question, just looking for a brief overview of your appetite for additional acquisitions in personal lines, I guess, both within high net worth and beyond that?"
},
{
"speaker": "Douglas Howell",
"text": "Well, you're talking about personal line just being a pure auto writer, that's probably not what we're going to do. We're not great at it. We're an adviser. So if somebody is going to use us to use our advice to help them buy their insurance, that's the business of what we'd like to be in. High net worth on, we do a terrific job of it. I'm telling you our folks are some of the very best in the business, and that's an important spot right now. There's planes, there's boats, there's houses on sand bars, there's – how is on views that have landslide risk, high net worth needs an adviser probably as much as any complex mid-market commercial client. Just going on and trying to buy an auto writer, auto is probably not what we're looking to do. If it's going to be one of those things that it takes advice will be there in that space."
},
{
"speaker": "J. Patrick Gallagher",
"text": "We're actually very excited about the stuff there. I think that's – it's, a Doug said, a real opportunity for us."
},
{
"speaker": "Douglas Howell",
"text": "Well take your call, Meyer. Just go ahead, we'll help you out with it."
},
{
"speaker": "Meyer Shields",
"text": "I've got a ping pong table. That's about it."
},
{
"speaker": "Douglas Howell",
"text": "Well, there's a slip and fall on that one coming."
},
{
"speaker": "J. Patrick Gallagher",
"text": "I think that's our last comment. So just our last question, let me make just a few comments on the way out here. Thank you, again, very much all of you for joining us. I know it's a little late, and thanks to all of our Gallagher colleagues around the world for their hard work and their dedication. These quarters don't just happen. Thanks to your efforts, that means our people we're in a really enviable position our net new business is up. Our M&A pipeline is growing. I'm proud of the year-to-date financial performance. And as you can tell, I'm bullish on 2024 and beyond. So 40 years, 16% TSR, compound average annual growth rate, pretty good 40 years. I'm looking forward to the next 40. Thanks for being with us."
},
{
"speaker": "Operator",
"text": "That does conclude today's conference call. You may disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
AJG | 1 | 2,024 | 2024-04-25 17:15:00 | Operator: Good afternoon, and welcome to Arthur J. Gallagher & Co's First Quarter 2024 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws.
The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and risk factors sections contained in the company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties.
In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
J. Gallagher: Thank you. Good afternoon. Thank you for joining us for our first quarter '24 earnings call. On the call with me today is Doug Howell, our CFO; and other members of the management team and the heads of our operating divisions. We had a great first quarter to begin 2024.
For our combined Brokerage and Risk Management segments, we posted 20% growth in revenue, our 13th straight quarter of double-digit growth, 9.4% organic; Virgin acquisition rollover revenues of approximately $250 million. We also completed 12 mergers totaling nearly $70 million of estimated annualized revenue. Reported net earnings margin of 21.5%, adjusted EBITDAC margin of 37.8%, GAAP earnings per share of $3.10 and adjusted earnings per share of $3.83, up 17% year-over-year. So another terrific quarter by the team.
Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth of 21%. Organic growth was 8.9% and about 10% if you include interest income. Adjusted EBITDAC was up 18% year-over-year. And we posted adjusted EBITDAC margin of 39.9% a bit better than our March IR Day expectations.
Let me give some insights behind our Brokerage segment organic, and just to level set, the following figures do not include interest income. Our global retail brokerage operations posted 7% organic. Within our P/C operations, we delivered 7% in the United States, 6% in the U.K., 2% in Canada and 8% in Australia and New Zealand. And our global employee benefit brokerage and consulting business posted organic of about 8%, including some large live case sales that were completed in late March.
Shifting to our reinsurance wholesale and specialty businesses, overall organic of 13%. This includes Gallagher Re at 13%, U.K. specialty at 10% and U.S. wholesale at 13%. Fantastic growth, whether retail, wholesale or reinsurance.
Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Global first quarter renewal premiums, which include both rate and exposure changes, were up about 7%. Renewal premium increases continue to be broad-based, up across all of our major geographies and most product lines.
For example, property was up nearly 10%; umbrella, up 9%; general liability, up 7%; workers' comp, up 2%; package, up 8%; and personal lines, up 13%. So many lines are seeing sizable increases. There are 2 exceptions within professional lines. First, D&O, where renewal premiums are down about 5%; and second, cyber, where renewal premiums are flattish.
These 2 lines appear close to reaching a pricing bottom, but combined, represent around 5% of our P/C business globally. So overall, our clients continue to see insurance costs increase, but our job as brokers is to mitigate these increases and deliver comprehensive insurance programs that align with their risk appetite and fit their budget.
Moving to the reinsurance market. First quarter dynamics were dominated by the January 1 renewal season where we saw stable pricing and increased demand for property cat cover. Reinsurers continue to exercise discipline and met the increased client demand with sufficient capacity. Importantly, the team was able to secure many new business wins while retaining most of our existing clients.
During April renewals, reinsurance carriers maintain their discipline, and with increased demand and stable pricing, we saw more coverage being purchased. Within property, more capacity was available at the top end of programs and the quoting of renewal process was disciplined and predictable.
The casualty treaty market saw stable pricing overall. However, carriers able to differentiate themselves through good management of prior year reserves were able to secure better reinsurance placements. Specialty class renewals were a bit more complex with some changes in terms and conditions. However, many clients were able to secure modestly lower pricing.
With that said, the tragedy in Baltimore may cause reinsurance carriers more pricing [ resolve ] throughout the rest of the year. Those interested in more detailed commentary on January or April renewals can find our first new market reports on our website.
In our view, insurance and reinsurance carriers continue to behave rationally. Carriers know where they need rate by line, by industry and by geography. We are seeing this differentiation in our data. Premiums are increasing the most, where it's needed to generate an acceptable underwriting profit. Great example of this is primary casualty, where we are seeing renewal premiums moving higher.
Global first quarter umbrella and general liability renewal premium increases are in the high single digits, including 9% increases in U.S. retail. A. M. Best recently maintained its negative outlook on the U.S. general liability insurance market due to worsening social inflation, medical expenses and litigation financing. We've been highlighting these dynamics for a while, along with hearing concerns around historical reserves, which leads us to believe further rate increases are to come in casualty.
At the other end of the spectrum, we have property. As insurance and reinsurance carriers believe they are getting closer to price and exposure adequacy, we are seeing property renewal premium increases moderating. With that said, first quarter insurance renewal premiums were still pushing double digits. As we look out for the remainder of the year, increased frequency or severity of catastrophes could again move the market in '24.
And while capacity was very challenging to come by during '22 and '23, we are now finding, when clients are looking to add coverage or limits, carriers are more than willing to provide additional cover. Notably, we are not seeing a change in the underwriting standards from our carrier partners.
While continued premium increases seem rational to our carrier partners, our clients have experienced multiple years of increased costs, having a trusted adviser like Gallagher to help businesses navigating a complex insurance market by finding the best coverage for our clients while mitigating price increases. That's what we do.
Moving to our customers' business activity. Overall, it continues to be solid. During the first quarter, our daily indication showed positive midyear policy endorsements and audits ahead of last year's levels across most geographies. So we are not seeing signs of a broad global economic slowdown.
Within the U.S., the labor market remains tight. Nonfarm payrolls continue to increase and more people are reentering the workforce. Yet there continues to be nearly 9 million job openings. Wage increases have persisted at the same time, medical cost trends are rising. With these dynamics, employers are focused on total rewards strategy to help them achieve their human capital goals while reining in costs. That's why I believe our benefits businesses will have a terrific opportunities in '24.
Overall, we continue to win new brokerage clients while retaining our existing customers. In fact, our new business production has been on an upward trend in recent quarters, and our retention is holding. We believe this is a direct reflection of our client value proposition, CORE360 and Gallagher Better Works, our niche expert service and our data and analytics.
Don't forget, we're competing with someone smaller than us, 90% of the time. These local brokers just can't match the value we provide. So putting it all together, we continue to see full year '24 brokerage organic in the 7% to 9% range, and that would be another outstanding year.
Moving on to our Risk Management segment, Gallagher Bassett. Revenue growth was 19%, including organic of 13.3% and rollover revenues of $14 million. Adjusted EBITDAC margins were 20.6%, up 140 basis points versus last year and a bit better than our March IR Day expectations. Our results continue to reflect solid new business, outstanding retention, continued increases in new arising claims across both workers' comp and liability and resilient customer business activity.
Looking forward, we continue to see '24 full year organic in the 9% to 11% range as our larger '23 new business wins have been fully onboarded. We now expect full year margin of approximately 20.5%. That would also be another outstanding year.
Shifting to mergers and acquisitions. We had an active first quarter completing 12 new mergers, representing about $70 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals.
Looking ahead, our pipeline remains strong. We have around 50 term sheets signed or being prepared, representing around $350 million of annualized revenue. Good firms always have a choice, and we'll be very excited if they choose to join Gallagher.
Let me conclude with some comments regarding our bedrock culture. It's a culture that has remained constant through the decades of incredible growth. This is largely due to the 25 tenants of The Gallagher Way, which is entering its fifth decade next month. It is deeply rooted in the values of integrity, ethics and trust, which have been guiding us since 1927.
Our culture is not just a differentiator, it's a competitive advantage. It attracts the right talent to our organization and the best merger partners and enables us to build enduring relationships. What makes me particularly proud is that I witness our culture in action every day as our employees demonstrate their commitment to our clients, and that is The Gallagher Way. Okay. I'll stop now and turn it over to Doug. Doug?
Douglas Howell: Thanks, Pat, and hello, everyone. Today, I'll walk you through our earnings release. I'll comment on first quarter organic growth and margins by segment, including how we are seeing full year organic growth and margins in each of the next 3 quarters. Then I'll provide some typical comments on the modeling helpers we provide in the CFO commentary document that we posted on our website, and I'll conclude my prepared remarks with a few comments on cash, M&A and capital management.
Okay. Let's look to Page 2 of the earnings release. Headline, first quarter brokerage organic growth of 8.9%. That's a bit better than our March IR Day expectation of 8% to 8.5%. And remember, we exclude interest income. Including such, we would have shown about 10% organic growth. Looking ahead, we continue to see strong new business production and favorable client retention.
Combine that with further rate increases, a resilient economic backdrop and sticky inflation, our 2024 brokerage organic outlook is unchanged. We are still seeing full year organic growth in that 7% to 9% range.
Moving to Page 4 of the earnings release, to the Brokerage segment adjusted EBITDAC table. First quarter adjusted EBITDAC margin was 39.9%, a bit better than our March IR Day expectations. The footnote on that page explains what we discussed in our January earnings call and again at our March IR Day. There is 90 basis points of roll-in impact from M&A, principally Buck, that naturally runs lower margins.
So on the surface, it is showing 30 basis points lower, but underlying margins actually expanded 60 basis points. Again, that improvement is a little better than what we forecasted in March. Let me walk you through a bridge from last year. First, if you were to pull out last year's 2023 first quarter, you would see we reported, back then, adjusted EBITDAC margin of 40.4%.
Second, when we update that margin using current period FX rate, gets you to an FX adjusted margin of about 40.2%. And we've done that here. So you can see that in the 2023 column in this table. Third, deduct that the 90 basis point roll-in impact. Again, that's all due to the roll-in math. And let's -- just to be clear, these are not businesses with margins that are going backwards.
So that gets you to 39.3%, Compare that to the 39.9% we show today, and that gives you the underlying 60 basis points of margin expansion. That is really great work by the team. As we look ahead to the following 3 quarters of '24, it is looking like we could expand margins in the 90 to 100 basis point range in each of the next 3 quarters. Let me give you some flavor on that.
First, as Pat said, Buck passed its 1-year anniversary, so that roll-in noise is behind us. Second, as discussed at our March IR Day, the carryover impact of raises given in 2023 is comparatively lesser over the next 3 quarters. And third, the reality is we are typically posting margins higher than most of our M&A targets.
While that slightly impacts what we report as margin expansion, we will do these mergers all day, any day. These are great businesses with terrific talent. And when we combine, we are better together. So to repeat, expansion in 90 to 100 basis points range in each of the next 3 quarters would get you to about 60 basis points of full year margin expansion. That assumes we would post organic in that 7% to 9% range and it still is allowing us to continue to make substantial investments in data analytics, sales tools, digital service and arming our sales and service folks with the best resources in the business.
Okay. Let's move to the Risk Management segment and organic and EBITDAC tables on Pages 4 and 5. Another fantastic quarter benefiting from new business wins and excellent client retention, 13.3% organic growth and margins at 20.6%. Looking forward, we are now lapping growth associated with our large new business wins from '23, and so we see quarterly organic for the rest of '24 in the 8% to 9% range. As for margins, the team has done a great job posting margins above 20% this quarter, and we believe we can hold that for the remainder of the year. That also is a bit better than our March IR Day outlook.
Turning to Page 6 of the earnings release, in the corporate segment shortcut table. Adjusted first quarter numbers came in better than the favorable end of our March IR Day expectations due to lower acquisition costs and some favorable tax items, primarily associated with stock-based compensation, and that's shown in the corporate line.
So now let's move to the CFO commentary document that we posted on our website. Not much changes at all on Page 3 or 4 other than a few tweaks to a few numbers such as FX, noncash items, et cetera. Just do a double check with your models using these numbers.
Page 5 updates our tax credit carryforwards. It shows about $820 million available at March 31, and that we would be -- that we are benefiting our cash flows about $150 million to $180 million a year. Doesn't flow through our P&L, but still a nice annual cash flow benefit to help us fund future M&A.
Turning to Page 6, the top table. Recall, we introduced this modeling helper in January. It breaks down the components of investment income, premium finance revenues, book gains and equity investments in third-party brokers. Not much has changed from what we provided in March but we are still embedding 225 basis point rate cuts in the second half of '24. And we've also updated for current FX rates.
The lower table on Page 6 is rollover revenues. Blue column subtotal of about $228 million is very close to the $224 million we provided at our March IR day. And remember, the pinkish columns only include estimated revenues for M&A through -- that we've closed through yesterday. So just a reminder, you'll need to make a pick for future M&A.
Also a little housekeeping. When you read Note 3 on that page, you'll see we had an estimate change related to some historical acquisitions that causes the gross up of revenues and expenses. It nets close to nothing, but it does flow through the P&L. We've adjusted these out, so there's no impact to organic adjusted net earnings or adjusted EBITDAC or adjusted EPS.
Moving to cash, capital management and M&A funding. Available cash on hand at March 31 was around $1 billion, which includes a portion of the proceeds from our February debt offering. So with $1 billion in the bank and expected strong future cash flows, we are still estimating we have total capacity in '24 of about $3.5 billion to fund M&A without issuing stock nor having to borrow much of any more.
As for 2025, it looks like we could fund over $4 billion of M&A with free cash and debt, all of this while maintaining a solid investment-grade rating. Okay. Another terrific quarter and start to the year. Looking ahead, we see continued strong organic growth, a growing pipeline of M&A, further opportunities for productivity improvements and a culture that makes us hard to beat. I believe we are very well positioned to deliver another fantastic year here in '24. Back to you, Pat.
J. Gallagher: Thank you, Doug. Operator, I think we're ready for some questions.
Operator: [Operator Instructions] Our first question comes from the line of Elyse Greenspan with Wells Fargo.
Elyse Greenspan: My first question is on the brokerage segment. So organic, as you guys said, right, a bit better than what you expected in March. So close to the top end of the full year guided range, right, that you guys are maintaining that outlook, could you just give us a sense, do you expect growth to slow over the balance of the year? Is there some level of conservatism?
I mean, Pat, you seemed positive on the pricing environment. We saw a little bit like GDP numbers today come out. I'm just trying to think about how you put that all together and how you would think growth would trend within brokerage over the next 3 quarters.
J. Gallagher: Well, I'm going to let Doug do the numbers. But yes, I mean, I think you're reading me right, Elyse. I'm bullish on the environment. We are not seeing a downturn in terms of our clients. They're employing more people. We're seeing robust client activity at Gallagher Bassett. That's a very good bellwether of what's going on in the economy.
Interest rates are up. The market hates inflation, but it's good for brokers and high interest rates help us as well in terms of the growth in revenues and head count and all the rest of it. So the fundamental business environment is really, really good for us. As far as the numbers, Doug, go ahead.
Douglas Howell: Yes. Listen, we don't see much difference in each quarter going forward. We think we'll be in that 7% to 9% range, Elyse. We do have a large first quarter and it is heavily weighted to reinsurance. So you would naturally expect us to -- if we're going to be in that range, that maybe the first quarter is a touch above the next 3 quarters, but I wouldn't say it's anything meaningful.
And so we're in that 7% to 9% range each of the next 3 quarters, which would bring us in, in that range for the full year. So really nothing different than what we've talked about the last couple of times we've been with you.
Elyse Greenspan: And then the second one is on margin, right? So a little bit, like you said, the Q1 was a little bit better than the March guide, but you previously had said, right, 100 basis points in the -- all three quarters. Now it's 90 to 100 and the full year guide seems unchanged. Is it just maybe Q1 was a little bit better so now you're taking some of that to invest internally? I know it's a little nitpicky because it's still 90 to 100, but just trying to kind of square the updated out-quarter margin view with what you told us in March.
Douglas Howell: Well, listen, I think that the CFO commentary document has kind of said 90 to 100, I think, consistently. If I said 100% of the last IR Day, I may have said towards 100 basis points. So I think our guidance feels, to us, about the same.
Elyse Greenspan: Okay. And then one last one. The FTC, right, is looking to potentially remove noncompetes from -- I guess my question is two-pronged from both the ability, I guess, to bring folks into Gallagher and also considering the potential to lose talent to other players, how do you think this could impact the company if it does actually go through?
J. Gallagher: Well, let me comment on that one. First of all, I think everybody saw that the U.S. Chamber has filed a lawsuit in Texas that's challenging this, and we're supportive of the Chamber's efforts. We think it's an overreach by the executive branch.
But having said that, if the new rules actually hold up, there's a count in noncompete agreements as part of the sale of the business. And so we see that rule is having a little impact, really, on our M&A strategy. And that's -- when it first came out, that was kind of my concern. Our agreements with our production staff do not contain noncompete provisions, rather we use non-solicitation clauses.
And there is a fine line difference there, but those cover clients and employees. And from our first look, we think those are going to remain enforceable. Having said all that, we want people to want to work here. The reason, this is why culture is so important. This is a great place to work, and we attract highly motivated salespeople and entrepreneurs that are passionate about doing what they do, and they want to leverage their expertise and capabilities.
And we give them the data and analytics and the centers of excellence to work with. We arm them with way better armament that they get from being part of a local competitor. We're a great place to work. So while I don't agree with the FTC, and I do agree with the Chamber's position, we're supportive of that, for our business, I think it's a nonissue.
Operator: Our next question comes from the line of Mike Zaremski with BMO Capital Markets.
Michael Zaremski: Just as a quick follow-up on the FTC question. One of the top 10 brokers is on record saying that their California margins are a bit lower than the rest of the rest of the regions due to a little bit higher turnover, which might be due to [ Cali ] not having non-solicited noncompetes. Just curious, have you ever sliced and diced your California margins? And are they a little bit lower than the rest of the company?
J. Gallagher: Sliced and diced every margin by every possible measure you can think of. And no, they're not a bit lower. We've been trading in California for 50 years. We love the state, we're big, big there, and our people love working there.
Michael Zaremski: Okay. That's clear. Switching gears to M&A. You guys -- and I've asked this in the past, but I'll just keep asking, because these are big numbers. So Doug, you said $4 billion of capacity for next year. That's clear. But these are just big numbers, $3.5 billion this year, $4 billion next year. Does this imply, if you look at, like, the top 100 list of brokers, I know that's just U.S., there's lots of overseas stuff. But just -- should we be thinking that you guys do some chunkier size deals as time progresses to be able to kind of fully deploy cash and debt?
J. Gallagher: Mike, this is Pat. I think it's fair to say that when opportunity presents itself, we're not afraid. I mean, 10 years ago, we stepped up and bought Wesfarmers out of Australia for $1 billion. That was the biggest play we'd ever made, and had, in fact, some financing for it that's worked out incredibly well.
I think our purchase of Willis was somewhere on the order of -- Willis Re was somewhere on the order of $4 billion. And last year, we spent a good bit as well. So we're not afraid to look at chunkier deals, but you hit on it. There's 100 top 100. There happens to be 29,900 in the United States alone that are smaller than that. That's where our activity is based most of the time.
Douglas Howell: Yes. I think -- Mike, this is Doug. I think that we have a chassis now that we can bring on a lot of smaller acquisitions, nice family-owned businesses that realize that they can be better together with us. I think that our M&A integration process is pretty smooth, very refined, 700 deals over the last 20 years. So we've got that down.
And I think more and more, smaller or local brokers are realizing they can get the resources from us overnight that they've been wanting to have for maybe 20 years. So I think we have an advantage right now that family-owned broker now sees that they get to join us. This is their forever home.
They don't have to sell into a different model that maybe will flip them or sell them to a different owner or break them apart in order to get value. They see that what's being talked about of capabilities is real inside of us. And sometimes when they go to another quarter for them, they're saying what they're going to do versus what they have done.
So I think that we have the opportunity to increase the volume of that nice tuck-in deals that we see out there. And I think that our story is getting stronger and stronger every day. Higher interest rate, it does not help others reinvest into their business. We reinvest so much into our business day in and day out.
There are new ideas for tools and capabilities and the others just can't say that. They haven't done it. I don't think they're going to do it in a higher interest rate. So I think the volume of our tuck-in deals will increase. Will we spend $3.5 billion this year and $4 billion next year. Yes, maybe we'll see. I think we've got a good shot at it.
Operator: Our next question comes from the line of David Motemaden with Evercore ISI.
David Motemaden: But Pat, I wanted to just talk about your comments you made on the property insurance side and on clients looking to add incremental coverage or limits and just how I can think about that as a potential offset to some of the moderation in property insurance pricing that you were talking about as well. Just help me think about the -- both of those factors and sort of how to think about that moderation and the impact that could have on your organic growth in the future.
J. Gallagher: Well, first of all, I think that when you look at that, those were in the section of the prepared remarks that had to do with reinsurance. There's been a lot of demand the last number of years for cat covers and what have you that frankly were hard to meet. And that's why we talk about the fact that it was more orderly this 1/1. We were able to complete what people wanted more or less.
But there has been an appetite for more cover there that buyers and sellers have walked away from. But I think as we start to see pricing stabilize, become more predictable, that allows it to flow into their rating structure, et cetera. There's demand for more cover on their part, and we're meeting that demand. And I think that is offsetting some of the potential.
Now remember, we didn't see property rates come down this quarter. What we're saying is that the increase moderated. So I think that there's kind of -- on the retail side, if you're a retail buyer -- and remember, most of our book of business is the commercial middle market. Don't get me wrong, we do a lot of risk management business, but these tuck-in acquisitions and the like that we're doing are clearly middle market players. Those people don't have a lot of choice. They're buying full cover at higher prices. And if that moderates a bit, it's good for the client.
Douglas Howell: Interestingly, David, we have -- we're seeing rate increases and the exposure unit increases in the middle and smaller market greater than we did in the larger account size whereas, say, you go back a year or so ago, it might have been just the opposite. So we're starting to see -- if you're talking about some rate moderation and the increase, it's starting to pick up a little bit in the middle and small market space.
The second thing is, remember, if the rate moderates, our customers are very good about opting out of coverage or as much coverage as rates go up and then opting back in for coverage to buy more when rates are coming down. So we've never captured the full increase of the rate and we won't suffer the entire give back if rates moderate a little bit. So there's that opt in, opt out. We haven't really talked about that much in the last 5 years or so. But we're seeing customers opt back in to buy more coverage if there are some moderation in the increase of the rates.
J. Gallagher: Also on the property side, back to that, David, you've got -- many years were 0 interest rates, not the last couple, but 0 interest rates left the schedules pretty much untouched. So you do have underwriters now being much more disciplined around the values, and that's pushing values up. So we've got the benefit of more values being insured in the property business.
And my prepared remarks basically pointed out that property was up nearly 10% this quarter. So we're not seeing rates dropping. We're seeing rates go up in property a little less viciously. Now having said that, if the wind blows this fall, we're 1 month away from the start of the hurricane season, I'm just telling you all bets are off. I don't know what's going to happen. So for our clients sake, I hope that we have a benign season.
David Motemaden: No, thanks for that. And yes, I do -- I was referring also, and you guys answered it, just the primary market, the moderation there. It is interesting to hear more about sort of that opt-in which I have not thought about. So that is helpful to hear about that. And then if I could just add 1 more, just 1 more question.
So it sounds like there were some large life sales that came through towards the end of March. Was that a pull forward from future quarters? Or I guess, sort of outlook on the pipeline of the life sales and just how that -- how you're thinking about that throughout the rest of the year.
Douglas Howell: As probably more of the -- if you remember, in December, we had some push out of the fourth quarter. So I would say it might be more catch-up than it is pulling from the future. And we're talking about $5 million on a $3 billion revenue quarter. So it was -- it's not meaningful in any of our numbers. The difference. We love the business, but it's not -- it doesn't make a big difference in any of our numbers.
David Motemaden: Got it. So that was in your sort of outlook range that you gave in March. So the upside this quarter was not just solely from the life sale?
Douglas Howell: That's right.
Operator: Our next question comes from the line of Mark Hughes with Truist Securities.
Mark Hughes: Pat, did you give the breakout for open brokerage versus the MGA or binding business within the wholesale?
J. Gallagher: I did not.
Douglas Howell: You got about 16% open brokerage this quarter.
Mark Hughes: And then with the binding, I think it's been running mid-single digits. Is that…
J. Gallagher: Higher than that. So more like 10%, 11%.
Mark Hughes: Okay. And then anything on the workers' comp side? Or just waiting for signs of life there in terms of frequencies, severity, pricing? Is it more of the same? Or do we have some reason to think it could be in selecting?
J. Gallagher: No, I think that's really interesting, Mark. In my career, that line has been, at times, pretty darn cyclical, and it is just as flat as a pancake. It's just going along. You might see 2 here, 3 there. And it's really just kind of flat.
Operator: Our next question comes from the line of Katie Sakys with Autonomous Research.
Katie Sakys: First, just kind of wanted to touch on the margin expansion guidance for the full year. If organic revenue growth were to come in higher than the current guide, whether that comes from the wind blowing and property rates reaccelerating or for something else, how much of that would you guys kind of envision letting fall to the bottom line? Like, should we expect to see greater margin expansion? Or are there other areas of investment opportunities that you guys would kind of like to see some progress made on.
Douglas Howell: Well, listen, I don't think that our investment opportunities would be rolled out fast enough in order to spend more going into if we had to pop up in organic growth and starting in August, if something -- the wind blows or something like that. So I don't think we would have the ability even to ramp up on some of the -- some big investment opportunities to offset that additional organic growth.
But I'm trying to do some mental math here. If we're up another 0.25 point in organic, it might produce another, in a quarter, to $10 million or $15 million if we had it for half a year, something like that, if I'm doing my math right. So I don't think -- it would probably naturally improve the margins a little bit.
I want to make sure we go back and clarify the question within wholesale, right? When you combine [ binding ] and programs, 11%. The programs are really more running around 2% to 3%. And open brokerage is in that 16% range. So just to make sure that we -- I answered 1 question, Pat has answered a combined question and just to break those 3 out, 16%, over 10% and low single digits on the program side.
Katie Sakys: It's a helpful clarification. Just maybe as a quick follow-up. In terms of benefits from head count controls and client-related expense saves, are those things that you expect to persist as the year goes on? Or are those more specific to 1Q in particular?
Douglas Howell: Listen, I think the team does a really nice job of looking at our head count controls. We have work model that show how many people we need to have, how many do we have. Do we need to hire in July, August and September, we can kind of forecast that.
Our retention's been very good. I got to say that when you look at it, our retention is better today than it was, let's say, in '18 and '19. So I think we've done a really nice job of taking care of our employees throughout this inflation period. So we're not seeing significant terminations here.
So overall, I think our work planning models and our ability to kind of forecast retention has helped us not have to push and pull on the joystick there to see how many more we need to bring on, how many do we need to take off. So it's pretty steady right now.
Operator: Our next question comes from the line of Yaron Kinar with Jefferies.
Yaron Kinar: I just want to touch on a couple of market questions, if I could. I think in the prepared remarks, you were talking about general liability and retail being up, like, 9%. If I go back to the investor meeting from, like, a month or so ago, I think you were talking about maybe seeing liability lines moving up to the 9%, 10% range over the course of 1 year or 2. So are you -- are we talking apples-to-apples here? Or are you surprised by the magnitude of improvement that you're seeing in liability lines right now?
J. Gallagher: I think -- let me go back to my prepared remarks. We've seen umbrella in the quarter, up 9%, which is kind of in line with what we're talking about in March. GL 7%, and that's where I think probably we've got to look at our carriers and say, are there going to be some reserve challenges going forward. So the 7% seems pretty -- it seems pretty stable. Maybe there'll be a push up a bit. And package, which is, of course, property and liability together at 8%; where comp, really not much, 2%. I think that feels like it's going to be there for the year. I think you could take our March discussions and kind of update them 6 weeks later for those numbers.
Douglas Howell: There's a tone of concerns that seems to be louder today in our interactions with carriers and clients around casualty rate adequacy. So I would say that what we were chatting about in January and February seems to be louder today -- that confirms to be a little bit louder today. And so I think that -- and we're just -- I don't know if I have enough data yet to say absolutely that there was a tone shift in March in our data compared to what we were seeing in January and February.
But when you look at some isolated situations, you boil that down with what we all read. When you combine that with what we hear in meetings with the carriers, we feel that casualty rates probably are more likely going up again in the next 3 quarters -- each of the next 3 quarters than we would see going down by any means. So there is a tone shift there. I just can't quite see it 100% in our data yet, but it seems like it's coming.
Yaron Kinar: That makes sense. I appreciate the color. And then -- and I apologize if you've already addressed this, and I missed it. But we saw the stamping office data come out in March around E&S flows and in the [ REITS ]. And it seems like it was a little bit of a surprise and disappointment.
How much of that do you think is noise? Are you seeing that slowdown in your wholesale business? Or is that real? And sorry, or is that just noise and you're kind of looking past that and still see a very strong E&S market?
J. Gallagher: That is noise. Our E&S business is on fire. We are seeing submissions come in. We're renewing our business. I don't have any caution on that.
Operator: Our next question comes from the line of Meyer Shields with KBW.
Meyer Shields: I was hoping to start on the reinsurance side. I think you talked about 13% organic growth. And is there any way of breaking that down between maybe the increasing limits that are being purchased versus market share wins versus pricing?
J. Gallagher: I don't have the actual stats on that.
Douglas Howell: Well, listen. I will tell you this that we had a terrific new business quarter. Our teams are working together. I think we're starting to see some nice wins of working with our retailers on that. When you go down -- we were hearing a lot of great stories about teams settled in. When we look back and see it and try to measure our success on doing that merger. Our teams are working together. We're selling more new business.
Our retention seems to be pretty darn good on that. And I think the fact is customers are buying some more cover while you're seeing a little price stability maybe. So we're checking the box on everything that we've considered to be this to be a successful merger.
Meyer Shields: Okay. That's helpful. And second question, and clearly, I guess, the premise is we're not seeing any successful pressure on the part of carriers to reduce commission percentages. I was hoping you'd update us on efforts that are being made, even if they're not successful.
J. Gallagher: No. I think that our partners are being very reasonable. We're not we're not having a lot of headbutting on that subject at all.
Operator: Our next question comes from the line of Rob Cox with Goldman Sachs.
Robert Cox: So I think in March, at the Investor Day, you guys were pretty optimistic on the potential for reacceleration in RPC in the remainder of 2024 due to higher exposure to property business and less workers' comp and the potential for casualty pricing increases. Is that still the case? Or is the property rate environment, with a little deceleration in the rate of increase, made you change your view a little bit?
J. Gallagher: No, I think our view is unchanged. We're very bullish.
Robert Cox: Okay. Okay. Got it. And then maybe sort of a similar question in some ways. But if we strip out reinsurance, is the touch lower organic guide for the remainder of the year the same? Or do you think ex reinsurance, what would you say, for the trend of organic growth ex reinsurance?
Douglas Howell: Well, yes, I think just because reinsurance is a little more skewed seasonally to the first quarter, it did help us, let's say, get from 8% to 8.9% this quarter, right? We do have some pretty good April 1 renewals coming in, so we'll see that in the second quarter. So I think we'll get the benefit of reinsurance a little bit in the second quarter, even though it's not as big percentage-wise as the total amount of our revenues.
And then in the third and fourth quarter, we'll see what happens. We'll see what happens with the wind. Hopefully, there's not a shake anywhere else in the world. But right now, that's why I say, I feel pretty comfortable each quarter in that 7% to 9% range because reinsurance did help, but it wasn't like it moved us from 6% to 9%. It moved us up 75 basis points, something like that this quarter.
Robert Cox: Got it. And if I could sneak 1 more in. In the Brokerage segment, could you remind us how much you're reinvesting in the business annually and what you're spending it on?
Douglas Howell: Well, it's a laundry list. I mean, first, you start with our people. I think that our training, our development, our internship program, I think bringing on more producers, we are seeing lots of interest in joining Gallagher by experienced producers out there. I think they see that the organization has a lot to offer for them.
Then the next thing you'd look at is technology. We're spending a ton on technology that both enables us to sell more, right, enables us to service better. Those numbers are probably -- the projects on the sheet could be $75 million, something like that. When I look at this year's budget, some of that's capital, some of that is operating expense.
Like, [ looking ] back, we're spending about $75 million a year on cyber today. If you go back 5 years ago, we were spending about $15 million on that. So the fact that we're investing in infrastructure improvement, cyber and other infrastructure improvements. Then you get down into the data and analytics. We are hiring more and more people every day that help us slice and dice our data, look at industry statistics and bring a better delivery of that data through a digital platform to our customers.
My guess is we're spending $30 million a year on those efforts. And then you look at AI now. There's starting to be a lot of AI projects inside of the company that are starting to deliver some yield. And so we're spending $5 million a year kind of on AI-related activities out there. So you add all that up, it can get to $200 million to $300 million pretty quickly in what we think we're doing to make a better franchise going forward.
J. Gallagher: I'd like to emphasize what Doug -- I've got a lot of listeners on this call. I'd like to emphasize where Doug started this. Most of that spend is, in one way or another, directly related either to making our service offering to our clients better, and we happen to know, for instance, that our digital offerings from small accounts through the risk management accounts, connectivity, things like Gallagher Go or even a middle market client can see what their policies are, what's going on with their buildings, et cetera, et cetera, are being incredibly well received.
And we're rolling things out like that literally every quarter, so that's spend. And then you get into the data and analytics. And if you'd asked me 5 years ago, clients would really care that much about being able to tell them what people like you buy? Oh my God, they care. And then they want to know the rate structure and they want to know why.
And when I started -- when I was selling insurance day to day, I tell them they had a good deal because Hartford quoted and so did CNA. Buy the cheaper one, let's move on. Or I'd have a reason why they should stay where they were, but I don't [ have ] capability of saying, here's what's happening in the world market. It's incredible.
And remember what we said in our prepared remarks, 90% of the time our people go out and they're fighting against somebody who's substantially smaller and doesn't have any of this, let alone $200 million to $300 million to reinvest in more of it. I mean, it's just -- it's an incredible advantage. I appreciate the question.
Operator: Our next question comes from the line of Mike Ward with Citi.
Michael Ward: Kind of a similar question, but specifically on reinsurance. Just curious where you guys are in terms of the innings of getting that business where you want it to be.
J. Gallagher: It's really where we had dreamed it would be. The team is incredibly solid. We're not having defections. We've got -- what's been fun about that is that there's a remarkable interest in having continued relationships and building relationships with the retail side of the house, which is what we predicted.
We predicted it, we did it that we would be, not only getting data and analytics, but we'd be working together, and we've seen that impact on existing, for instance, pooled accounts that were the biggest and probably the longest running pooling broker in the country, especially in the public sector business, been incredibly helpful, the dialogue back-and-forth. That's just 1 example.
But -- and the business now I think they really feel like they're part of the enterprise. They're not the new kids anymore. There's always a period when you come to school and you're the new kid. You're the new kid, right? Well, that's not it anymore. I mean, you see them in the hall, they recognize the retailers, they recognize me, Doug, whatever. And the opportunities to invest in data and analytics there and the thirst for that from their clients, tremendous opportunities, and it's working out incredibly well.
Michael Ward: And then maybe just one last one on group benefits. Kind of curious if you can sort of discuss how the renewals have gone and how top line is trending from your perspective. And I guess the -- what's the tone like among the customer base in terms of health of the economy and then hiring and labor?
J. Gallagher: Well, interestingly, like, the tone from our clients is there's a large amount of concern. And we're sitting with clients that, a, in some instances, don't know why they have turnover. And we're able to get in and do some data analytics around what's going on with them and where -- what's going on there. So a very deep concern about wanting to hold on to their top people.
We also have an awful lot of people just trying to attract people to fill jobs. Pick stuff off of racks, serve tables, whatever, and that's difficult. So they're trying to differentiate themselves in that regard. And there's a lot of concern on their part around cost. Medical inflation is real. Those costs get passed directly back to the employer. Then you've got the whole problem of inflation. Inflation is difficult.
So I think what it's doing is it's making our professionals far more valuable than the local person that comes out and says there are 4 of us in the office and we're really good at this, and let me show you a PPO and maybe I can get another quote for your insurance. That's just not cutting it anymore. And that's not -- I'm not talking about 5,000 live cases here. The people that are employing 100, 150, 200 people, they need this kind of help. So it's a very robust period for us, and it is a difficult time for employers. Where are they going to get the right people to fill the jobs and then how do they hold on to them.
Operator: And our last question is coming from Mike Zaremski with BMO Capital Markets.
Michael Zaremski: Just a quick follow-up. You guys always give color on umbrella, lots of people do. Just curious, is there any way you can dimension what percentage of your business is umbrella?
Douglas Howell: I can dig it out. Did you have a second piece of that?
J. Gallagher: Do you have another question, Mike? We'll dig on that for a second.
Michael Zaremski: No, I -- that was my only question.
J. Gallagher: We're looking here.
Douglas Howell: So let's see, in '23, I would say, it makes up 6% of our business.
J. Gallagher: Well, I think that's it for questions. If I can just make a comment here. Thank you again for joining us this afternoon. And I would like to thank our 53,000 colleagues around the world for their efforts. Their hard work and dedication is evident when we report another fantastic quarter of growth and profitability.
As I look ahead, I remain very bullish on our prospects and believe we are well positioned to deliver another excellent year of financial performance. We look forward to speaking with the investment community at our IR Day. Thank you again for being with us this evening. Have a nice evening.
Operator: This does conclude today's conference call. You may disconnect your lines at this time. | [
{
"speaker": "Operator",
"text": "Good afternoon, and welcome to Arthur J. Gallagher & Co's First Quarter 2024 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws."
},
{
"speaker": "J. Gallagher",
"text": "Thank you. Good afternoon. Thank you for joining us for our first quarter '24 earnings call. On the call with me today is Doug Howell, our CFO; and other members of the management team and the heads of our operating divisions. We had a great first quarter to begin 2024."
},
{
"speaker": "Douglas Howell",
"text": "Thanks, Pat, and hello, everyone. Today, I'll walk you through our earnings release. I'll comment on first quarter organic growth and margins by segment, including how we are seeing full year organic growth and margins in each of the next 3 quarters. Then I'll provide some typical comments on the modeling helpers we provide in the CFO commentary document that we posted on our website, and I'll conclude my prepared remarks with a few comments on cash, M&A and capital management."
},
{
"speaker": "J. Gallagher",
"text": "Thank you, Doug. Operator, I think we're ready for some questions."
},
{
"speaker": "Operator",
"text": "[Operator Instructions] Our first question comes from the line of Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"text": "My first question is on the brokerage segment. So organic, as you guys said, right, a bit better than what you expected in March. So close to the top end of the full year guided range, right, that you guys are maintaining that outlook, could you just give us a sense, do you expect growth to slow over the balance of the year? Is there some level of conservatism?"
},
{
"speaker": "J. Gallagher",
"text": "Well, I'm going to let Doug do the numbers. But yes, I mean, I think you're reading me right, Elyse. I'm bullish on the environment. We are not seeing a downturn in terms of our clients. They're employing more people. We're seeing robust client activity at Gallagher Bassett. That's a very good bellwether of what's going on in the economy."
},
{
"speaker": "Douglas Howell",
"text": "Yes. Listen, we don't see much difference in each quarter going forward. We think we'll be in that 7% to 9% range, Elyse. We do have a large first quarter and it is heavily weighted to reinsurance. So you would naturally expect us to -- if we're going to be in that range, that maybe the first quarter is a touch above the next 3 quarters, but I wouldn't say it's anything meaningful."
},
{
"speaker": "Elyse Greenspan",
"text": "And then the second one is on margin, right? So a little bit, like you said, the Q1 was a little bit better than the March guide, but you previously had said, right, 100 basis points in the -- all three quarters. Now it's 90 to 100 and the full year guide seems unchanged. Is it just maybe Q1 was a little bit better so now you're taking some of that to invest internally? I know it's a little nitpicky because it's still 90 to 100, but just trying to kind of square the updated out-quarter margin view with what you told us in March."
},
{
"speaker": "Douglas Howell",
"text": "Well, listen, I think that the CFO commentary document has kind of said 90 to 100, I think, consistently. If I said 100% of the last IR Day, I may have said towards 100 basis points. So I think our guidance feels, to us, about the same."
},
{
"speaker": "Elyse Greenspan",
"text": "Okay. And then one last one. The FTC, right, is looking to potentially remove noncompetes from -- I guess my question is two-pronged from both the ability, I guess, to bring folks into Gallagher and also considering the potential to lose talent to other players, how do you think this could impact the company if it does actually go through?"
},
{
"speaker": "J. Gallagher",
"text": "Well, let me comment on that one. First of all, I think everybody saw that the U.S. Chamber has filed a lawsuit in Texas that's challenging this, and we're supportive of the Chamber's efforts. We think it's an overreach by the executive branch."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mike Zaremski with BMO Capital Markets."
},
{
"speaker": "Michael Zaremski",
"text": "Just as a quick follow-up on the FTC question. One of the top 10 brokers is on record saying that their California margins are a bit lower than the rest of the rest of the regions due to a little bit higher turnover, which might be due to [ Cali ] not having non-solicited noncompetes. Just curious, have you ever sliced and diced your California margins? And are they a little bit lower than the rest of the company?"
},
{
"speaker": "J. Gallagher",
"text": "Sliced and diced every margin by every possible measure you can think of. And no, they're not a bit lower. We've been trading in California for 50 years. We love the state, we're big, big there, and our people love working there."
},
{
"speaker": "Michael Zaremski",
"text": "Okay. That's clear. Switching gears to M&A. You guys -- and I've asked this in the past, but I'll just keep asking, because these are big numbers. So Doug, you said $4 billion of capacity for next year. That's clear. But these are just big numbers, $3.5 billion this year, $4 billion next year. Does this imply, if you look at, like, the top 100 list of brokers, I know that's just U.S., there's lots of overseas stuff. But just -- should we be thinking that you guys do some chunkier size deals as time progresses to be able to kind of fully deploy cash and debt?"
},
{
"speaker": "J. Gallagher",
"text": "Mike, this is Pat. I think it's fair to say that when opportunity presents itself, we're not afraid. I mean, 10 years ago, we stepped up and bought Wesfarmers out of Australia for $1 billion. That was the biggest play we'd ever made, and had, in fact, some financing for it that's worked out incredibly well."
},
{
"speaker": "Douglas Howell",
"text": "Yes. I think -- Mike, this is Doug. I think that we have a chassis now that we can bring on a lot of smaller acquisitions, nice family-owned businesses that realize that they can be better together with us. I think that our M&A integration process is pretty smooth, very refined, 700 deals over the last 20 years. So we've got that down."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of David Motemaden with Evercore ISI."
},
{
"speaker": "David Motemaden",
"text": "But Pat, I wanted to just talk about your comments you made on the property insurance side and on clients looking to add incremental coverage or limits and just how I can think about that as a potential offset to some of the moderation in property insurance pricing that you were talking about as well. Just help me think about the -- both of those factors and sort of how to think about that moderation and the impact that could have on your organic growth in the future."
},
{
"speaker": "J. Gallagher",
"text": "Well, first of all, I think that when you look at that, those were in the section of the prepared remarks that had to do with reinsurance. There's been a lot of demand the last number of years for cat covers and what have you that frankly were hard to meet. And that's why we talk about the fact that it was more orderly this 1/1. We were able to complete what people wanted more or less."
},
{
"speaker": "Douglas Howell",
"text": "Interestingly, David, we have -- we're seeing rate increases and the exposure unit increases in the middle and smaller market greater than we did in the larger account size whereas, say, you go back a year or so ago, it might have been just the opposite. So we're starting to see -- if you're talking about some rate moderation and the increase, it's starting to pick up a little bit in the middle and small market space."
},
{
"speaker": "J. Gallagher",
"text": "Also on the property side, back to that, David, you've got -- many years were 0 interest rates, not the last couple, but 0 interest rates left the schedules pretty much untouched. So you do have underwriters now being much more disciplined around the values, and that's pushing values up. So we've got the benefit of more values being insured in the property business."
},
{
"speaker": "David Motemaden",
"text": "No, thanks for that. And yes, I do -- I was referring also, and you guys answered it, just the primary market, the moderation there. It is interesting to hear more about sort of that opt-in which I have not thought about. So that is helpful to hear about that. And then if I could just add 1 more, just 1 more question."
},
{
"speaker": "Douglas Howell",
"text": "As probably more of the -- if you remember, in December, we had some push out of the fourth quarter. So I would say it might be more catch-up than it is pulling from the future. And we're talking about $5 million on a $3 billion revenue quarter. So it was -- it's not meaningful in any of our numbers. The difference. We love the business, but it's not -- it doesn't make a big difference in any of our numbers."
},
{
"speaker": "David Motemaden",
"text": "Got it. So that was in your sort of outlook range that you gave in March. So the upside this quarter was not just solely from the life sale?"
},
{
"speaker": "Douglas Howell",
"text": "That's right."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mark Hughes with Truist Securities."
},
{
"speaker": "Mark Hughes",
"text": "Pat, did you give the breakout for open brokerage versus the MGA or binding business within the wholesale?"
},
{
"speaker": "J. Gallagher",
"text": "I did not."
},
{
"speaker": "Douglas Howell",
"text": "You got about 16% open brokerage this quarter."
},
{
"speaker": "Mark Hughes",
"text": "And then with the binding, I think it's been running mid-single digits. Is that…"
},
{
"speaker": "J. Gallagher",
"text": "Higher than that. So more like 10%, 11%."
},
{
"speaker": "Mark Hughes",
"text": "Okay. And then anything on the workers' comp side? Or just waiting for signs of life there in terms of frequencies, severity, pricing? Is it more of the same? Or do we have some reason to think it could be in selecting?"
},
{
"speaker": "J. Gallagher",
"text": "No, I think that's really interesting, Mark. In my career, that line has been, at times, pretty darn cyclical, and it is just as flat as a pancake. It's just going along. You might see 2 here, 3 there. And it's really just kind of flat."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Katie Sakys with Autonomous Research."
},
{
"speaker": "Katie Sakys",
"text": "First, just kind of wanted to touch on the margin expansion guidance for the full year. If organic revenue growth were to come in higher than the current guide, whether that comes from the wind blowing and property rates reaccelerating or for something else, how much of that would you guys kind of envision letting fall to the bottom line? Like, should we expect to see greater margin expansion? Or are there other areas of investment opportunities that you guys would kind of like to see some progress made on."
},
{
"speaker": "Douglas Howell",
"text": "Well, listen, I don't think that our investment opportunities would be rolled out fast enough in order to spend more going into if we had to pop up in organic growth and starting in August, if something -- the wind blows or something like that. So I don't think we would have the ability even to ramp up on some of the -- some big investment opportunities to offset that additional organic growth."
},
{
"speaker": "Katie Sakys",
"text": "It's a helpful clarification. Just maybe as a quick follow-up. In terms of benefits from head count controls and client-related expense saves, are those things that you expect to persist as the year goes on? Or are those more specific to 1Q in particular?"
},
{
"speaker": "Douglas Howell",
"text": "Listen, I think the team does a really nice job of looking at our head count controls. We have work model that show how many people we need to have, how many do we have. Do we need to hire in July, August and September, we can kind of forecast that."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Yaron Kinar with Jefferies."
},
{
"speaker": "Yaron Kinar",
"text": "I just want to touch on a couple of market questions, if I could. I think in the prepared remarks, you were talking about general liability and retail being up, like, 9%. If I go back to the investor meeting from, like, a month or so ago, I think you were talking about maybe seeing liability lines moving up to the 9%, 10% range over the course of 1 year or 2. So are you -- are we talking apples-to-apples here? Or are you surprised by the magnitude of improvement that you're seeing in liability lines right now?"
},
{
"speaker": "J. Gallagher",
"text": "I think -- let me go back to my prepared remarks. We've seen umbrella in the quarter, up 9%, which is kind of in line with what we're talking about in March. GL 7%, and that's where I think probably we've got to look at our carriers and say, are there going to be some reserve challenges going forward. So the 7% seems pretty -- it seems pretty stable. Maybe there'll be a push up a bit. And package, which is, of course, property and liability together at 8%; where comp, really not much, 2%. I think that feels like it's going to be there for the year. I think you could take our March discussions and kind of update them 6 weeks later for those numbers."
},
{
"speaker": "Douglas Howell",
"text": "There's a tone of concerns that seems to be louder today in our interactions with carriers and clients around casualty rate adequacy. So I would say that what we were chatting about in January and February seems to be louder today -- that confirms to be a little bit louder today. And so I think that -- and we're just -- I don't know if I have enough data yet to say absolutely that there was a tone shift in March in our data compared to what we were seeing in January and February."
},
{
"speaker": "Yaron Kinar",
"text": "That makes sense. I appreciate the color. And then -- and I apologize if you've already addressed this, and I missed it. But we saw the stamping office data come out in March around E&S flows and in the [ REITS ]. And it seems like it was a little bit of a surprise and disappointment."
},
{
"speaker": "J. Gallagher",
"text": "That is noise. Our E&S business is on fire. We are seeing submissions come in. We're renewing our business. I don't have any caution on that."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"text": "I was hoping to start on the reinsurance side. I think you talked about 13% organic growth. And is there any way of breaking that down between maybe the increasing limits that are being purchased versus market share wins versus pricing?"
},
{
"speaker": "J. Gallagher",
"text": "I don't have the actual stats on that."
},
{
"speaker": "Douglas Howell",
"text": "Well, listen. I will tell you this that we had a terrific new business quarter. Our teams are working together. I think we're starting to see some nice wins of working with our retailers on that. When you go down -- we were hearing a lot of great stories about teams settled in. When we look back and see it and try to measure our success on doing that merger. Our teams are working together. We're selling more new business."
},
{
"speaker": "Meyer Shields",
"text": "Okay. That's helpful. And second question, and clearly, I guess, the premise is we're not seeing any successful pressure on the part of carriers to reduce commission percentages. I was hoping you'd update us on efforts that are being made, even if they're not successful."
},
{
"speaker": "J. Gallagher",
"text": "No. I think that our partners are being very reasonable. We're not we're not having a lot of headbutting on that subject at all."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Rob Cox with Goldman Sachs."
},
{
"speaker": "Robert Cox",
"text": "So I think in March, at the Investor Day, you guys were pretty optimistic on the potential for reacceleration in RPC in the remainder of 2024 due to higher exposure to property business and less workers' comp and the potential for casualty pricing increases. Is that still the case? Or is the property rate environment, with a little deceleration in the rate of increase, made you change your view a little bit?"
},
{
"speaker": "J. Gallagher",
"text": "No, I think our view is unchanged. We're very bullish."
},
{
"speaker": "Robert Cox",
"text": "Okay. Okay. Got it. And then maybe sort of a similar question in some ways. But if we strip out reinsurance, is the touch lower organic guide for the remainder of the year the same? Or do you think ex reinsurance, what would you say, for the trend of organic growth ex reinsurance?"
},
{
"speaker": "Douglas Howell",
"text": "Well, yes, I think just because reinsurance is a little more skewed seasonally to the first quarter, it did help us, let's say, get from 8% to 8.9% this quarter, right? We do have some pretty good April 1 renewals coming in, so we'll see that in the second quarter. So I think we'll get the benefit of reinsurance a little bit in the second quarter, even though it's not as big percentage-wise as the total amount of our revenues."
},
{
"speaker": "Robert Cox",
"text": "Got it. And if I could sneak 1 more in. In the Brokerage segment, could you remind us how much you're reinvesting in the business annually and what you're spending it on?"
},
{
"speaker": "Douglas Howell",
"text": "Well, it's a laundry list. I mean, first, you start with our people. I think that our training, our development, our internship program, I think bringing on more producers, we are seeing lots of interest in joining Gallagher by experienced producers out there. I think they see that the organization has a lot to offer for them."
},
{
"speaker": "J. Gallagher",
"text": "I'd like to emphasize what Doug -- I've got a lot of listeners on this call. I'd like to emphasize where Doug started this. Most of that spend is, in one way or another, directly related either to making our service offering to our clients better, and we happen to know, for instance, that our digital offerings from small accounts through the risk management accounts, connectivity, things like Gallagher Go or even a middle market client can see what their policies are, what's going on with their buildings, et cetera, et cetera, are being incredibly well received."
},
{
"speaker": "Operator",
"text": "Our next question comes from the line of Mike Ward with Citi."
},
{
"speaker": "Michael Ward",
"text": "Kind of a similar question, but specifically on reinsurance. Just curious where you guys are in terms of the innings of getting that business where you want it to be."
},
{
"speaker": "J. Gallagher",
"text": "It's really where we had dreamed it would be. The team is incredibly solid. We're not having defections. We've got -- what's been fun about that is that there's a remarkable interest in having continued relationships and building relationships with the retail side of the house, which is what we predicted."
},
{
"speaker": "Michael Ward",
"text": "And then maybe just one last one on group benefits. Kind of curious if you can sort of discuss how the renewals have gone and how top line is trending from your perspective. And I guess the -- what's the tone like among the customer base in terms of health of the economy and then hiring and labor?"
},
{
"speaker": "J. Gallagher",
"text": "Well, interestingly, like, the tone from our clients is there's a large amount of concern. And we're sitting with clients that, a, in some instances, don't know why they have turnover. And we're able to get in and do some data analytics around what's going on with them and where -- what's going on there. So a very deep concern about wanting to hold on to their top people."
},
{
"speaker": "Operator",
"text": "And our last question is coming from Mike Zaremski with BMO Capital Markets."
},
{
"speaker": "Michael Zaremski",
"text": "Just a quick follow-up. You guys always give color on umbrella, lots of people do. Just curious, is there any way you can dimension what percentage of your business is umbrella?"
},
{
"speaker": "Douglas Howell",
"text": "I can dig it out. Did you have a second piece of that?"
},
{
"speaker": "J. Gallagher",
"text": "Do you have another question, Mike? We'll dig on that for a second."
},
{
"speaker": "Michael Zaremski",
"text": "No, I -- that was my only question."
},
{
"speaker": "J. Gallagher",
"text": "We're looking here."
},
{
"speaker": "Douglas Howell",
"text": "So let's see, in '23, I would say, it makes up 6% of our business."
},
{
"speaker": "J. Gallagher",
"text": "Well, I think that's it for questions. If I can just make a comment here. Thank you again for joining us this afternoon. And I would like to thank our 53,000 colleagues around the world for their efforts. Their hard work and dedication is evident when we report another fantastic quarter of growth and profitability."
},
{
"speaker": "Operator",
"text": "This does conclude today's conference call. You may disconnect your lines at this time."
}
] | Arthur J. Gallagher & Co. | 252,186 |
Subsets and Splits
No community queries yet
The top public SQL queries from the community will appear here once available.